Table of Contents
Other content sent this past week:
a. Demand
APP beat revenue estimates by 5.6% & beat guidance by 5.5%. Gaming revenue rose by 50% Y/Y while consumer (newer product) spending rose by 10%+ Q/Q and 100%+ Y/Y. While they are very pleased with how this segment is developing, it’s still tiny compared to gaming, and outperformance was driven by core business momentum.
b. Profits
Beat EBITDA estimates by 6.5% & beat guidance by 6.8%.
Met FCF estimates.
Beat $4.03 GAAP EPS estimates by $0.27.
FCF conversion rebounded to 77% of EBITDA from 53% last quarter. As a reminder, Q2 conversion was weighed down by the timing of cash tax payments, so this sharp sequential improvement was expected.
Year-to-date cash taxes paid jumped to $926M from $167M in the same period last year, which is why FCF growth is lagging EBITDA growth this year. They still expect full year FCF conversion of roughly 70%-75% of EBITDA. That’s a touch more conservative than the 75% they pointed to last quarter.
Margins were excellent too. EBITDA margin expanded by 40 bps Q/Q and 190 bps Y/Y, as cost of revenue (mostly data center costs) fell to 11% of revenue vs. 12.4% Y/Y. That’s despite R&D spend more than doubling Y/Y as they build bigger, more compute-hungry models.
c. Balance Sheet
$3.17B cash & equivalents.
$3.52B debt.
Share count down 2% Y/Y. Added $3.2B to its buyback, bringing current capacity to $3.6B. They accelerated buybacks to take advantage of what they see as an unfairly low stock price, and they have the balance sheet flexibility to keep doing this in the future if it happens again. They repurchased $1.4B of stock during the quarter vs. about $550M last quarter.
d. Guidance & Valuation
Q4 revenue guidance beat by 5.3%.
Q4 EBITDA guidance beat by 6.9%.
Revenue guidance implies 43.5% Y/Y and 9% Q/Q growth at the midpoint.
EBITDA guidance implies an 84.5% margin at the midpoint, roughly flat Y/Y.
Heading into the report, APP traded for under 13x forward EPS. EPS is expected to grow by 56% this year and by about 20% in each of the next two years.
They still only include contributions from model updates already launched and leave any other progress as potential upside surprise. They did not get overly aggressive in the Q4 guidance compared to previous quarters. No change in methodology.
Last quarter, I was hung up on 7% Q/Q revenue guidance, as that was well below the 10%+ Q/Q pace we had grown used to. This quarter’s guide calls for 8%-10% Q/Q growth on top of a 14% Q/Q quarter. That’s much more like it.
Leadership also reiterated its long-term expectation for the overall business to compound at ~30%/year. It looks like they have a good chance to keep growing well beyond that for at least the next few quarters. Depending on the pace of model improvement, they see a real chance for their more mature gaming business to do better than 30%, with their younger consumer business compounding well in excess of gaming. Analysts currently expect growth to slow to 28% next year and 24% the year after, so this target still implies upside to expectations.
e. Call & Release
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