Semtech is emerging as a data center networking component company that offers competitive solutions for the next leg up in AI systems. The company is going through a pivot due to a new approach for short haul networking that would rely on copper wiring and components instead of optical networking.

Over the past decade, Semtech became known for its long-range (LoRa) networking solutions, which are long range, lower power wireless platforms. Internet of Things (IoT) devices and satellites use Semtech’s low power wide area network and radio frequency transmitters for up to 10X the range and 3X less power.

Relying on this experience in providing connectivity modules, the company provides data center components for the high speed, and high bandwidth needs that AI data centers require. Nvidia is testing the upper limits of what AI servers can do, which means how these systems are built are in a constant state of flux. Semtech may have a unique opportunity to supply Nvidia with copper redrivers, DSP components, and linear pluggable optics. By the end of 2025, it’s expected that Meta and other cloud service providers will be building out Nvidia GB200 systems with Semtech’s copper networking components.

Brief Background on Data Center Networking & Components

Electro-optics help to increase data rates and has replaced NRZ data transmission due to doubling the bit rate. Hyperscalers require high bandwidth and port density. PAM4 connects networking ASICs with AI machines and servers. Digital-based PAM4 uses analog-to-digital converters to clean up the signal in the digital domain before converting it back to analog to transmit.

Data center interconnects have transitioned to 200-gig, 400-gig and 800-gig PAM-based electro-optics – which are 100GBx2, 100GBx4, and 100GBx8. Of these, the 800-gig is the primary interconnect for AI deployments. Artificial intelligence and machine learning drive demand for the 800-gig PAM to increase the speed of input-output and to process the data flows. This doubles the throughput (bandwidth) due to an 8x100Gpbs optical transceiver for inside and between AI clusters.

There is a 1.6T solution with 200-gig per lane that Marvell was first to launch for both the 5nm and 3nm. The 200-gig per lane carries outsized importance in the next leg up for PAM4-based networking. Marvell’s Ara 1.6T PAM4 DSPs on the 3nm process are designed for GenAI and the Nova 1.6T PAM4 DSPs on the 5nm process are for broader AI/ML applications. We discussed this here and most recently here.

1.6T PAM4 DSPs are retimer devices that allow for 200-gig per lane on both the frontend and backend to support the increased need for connectivity and higher bandwidth that AI infrastructure requires.

Marvell’s solutions are built for optical networking. You’ve likely heard the word “fiber,” such as Google’s Fiber internet service, which refers to fiber optic cables that transmit data as light pulses. Optic fiber networking are thin strands made of pure glass whereas the other option is copper cables. Optic has a commanding 70% market share in data centers due to significantly faster speeds than traditional copper wiring. Optic networking also allows higher bandwidth, preventing packet loss and jitter, which as you can imagine, can become a problem when training data-hungry AI models and deploying them.

Data centers have maintained a mix of optic networking and copper networking around that 70/30 split because optic networking is costly and harder to maintain. Optical components are also known for running hot and failing. Currently, the sought-after mix for AI systems is to use optical networking for long haul for large clusters of 1,000, 10,000 or 100,000 devices and to use copper for short haul.

Blackwell is Testing the Upper Limits of Power Wattage

Originally, the Blackwell B200s were designed to be 120 kilowatts of power. In order to achieve a lower power wattage of 100 kilowatts of power, Nvidia changed the interconnects from optic fiber to copper. According to the Next Platform, these systems will use up to 5,184 copper cables with up to 200GB per SerDes lane with NVLink switches. The article has a link to a picture of the copper cables, which helps to visualize what thousands of cables going into a NVL72 server looks like.

The new Blackwell systems are being designed with copper cables for the short haul of connecting up to 72 GPUs. Copper networking previously had a reach of 1.5 meters, yet this has evolved to where there is now a reach of 3 meters to assist in connecting these large systems. This leads to Semtech, which is reporting early, promising signs by offering copper networking components for the AI data center.

CopperEdge 200G Redrivers:

A notable area of difference is that optical networking requires retimers whereas copper networking relies on redrivers. The lower power requirements from the 120 kilowatts to the 100 kilowatts on Nvidia’s NVL rack scale systems partly comes from removing the retimer and the optical transceivers.

Passive copper cables can only enable reach of 1.5 meters, limiting the use of passive copper cables in data centers. The need for increased data rates has created strong demand for active copper cables (ACC) that help to extend reach for copper cables up to three meters. In Q3, Semtech initially shipped the CopperEdge 200-gig linear redrivers used in 1.6T Active Copper Cabling (ACC). The management stated there will be a “nominal ramp” next quarter and then “progressively” ramp from Q1 to Q4 of next calendar year (fiscal 2026).

According to management’s opening remarks: “At 200-gig and at a cable length up to three meters, CopperEdge will meet signal integrity requirements not readily achievable with direct attached copper, or DAC, cables. And at a lower latency, lower cost and much smaller power consumption required compared to DSP-based retime solutions.”

Semtech’s management team is essentially communicating that previous debates to where copper was not a suitable replacement for optical networking was relying on passive copper cables instead of active copper cables (ACC).

Last month, Meta presented a dual rack NVL36 system called Catalina using Semtech’s CopperEdge-enabled active copper cables (ACCs). According to management, “Semtech's low-power, low-latency CopperEdge solutions have gained positive attention in the data center ecosystem. And our technical collaboration with a number of CSPs and cable manufacturers has accelerated since last quarter.”

According to the Q&A, the qualifications with the additional CSPs are expected to contribute to revenue by mid-2025: “So, the applications on the board and in the cable and even in the connectors by the multiple CSPs are in the qualification phase, in the demonstration phase. So, the typically good thing about the copper-based solutions is the qualification cycle is relatively short compared to the optical-related products. So, I will say probably from the mid of 2025 calendar year, the other opportunities on the linear equalizer will start contributing to the revenue.”

Tri-Edge PAM4 and FiberEdge TIA, Laser Drivers:

Semtech shipped 400-gig active optic cable (AOC) PAM4 electro-optics this quarter, which includes SKUs for both long-reach and short-reach optical links. Management stated that in addition to CopperEdge, “our Tri-Edge PAM4 products continue to contribute meaningful sequential and year-over-year growth.”

FiberEdge transimpedance amplifier (TIA) and laser drivers enable high-speed, short reach interconnects with new SKUs announced a year ago. It was stated on the call that management believes they have captured incremental market share for these short reach TIA and laser components: “Data center deployment at 100-gig has been ramping up strongly and we believe we have captured incremental market shares, thanks to our closer engagement with our customers and our operations excellence.”

There is evidence that Semtech is a supplier for the TIA and laser drivers for the new Nvidia-based DSP that was announced recently. The initial reaction from analysts is that Nvidia’s DSPs could claim 10% to 20% of the market by 2026.

Semtech has a newer product within Linear Pluggable Optics (LPOs) showcased last March. According to the initial press release, these newer-gen LPOs help to deliver the high speed that AI and ML applications require while reducing power consumption by 50% versus DSP-based solutions. Note: You can read more about DSPs in our Marvell write-up here. here. According to the earnings call,

Semtech has received initial orders for test and qualification on its 800-gig and 1.6T LPO transceivers. As far as timing goes, it was stated: “Our confidence in LPO adoption has increased since last quarter with meaningful net sales contribution from TIAs and redrivers expected by the latter portion of FY '26.” LPOs can reduce the number of DSPs required, thus resulting in reduced power consumption.

$100M Opportunity for CopperEdge:

In the June earnings call, it was stated that the copper ACC opportunity was a $100 million market opportunity with Semtech seeing about 50-50 of this: “So, the number of cables that could be used is heavily dependent on both the rack configuration and NVL72 versus NVL36, and the number of horizontal connections, and obviously, the number of NVLs that we'll ship next year. So, it's heavy dependence on shipment configuration, but to just cut to the chase, we kind of size it at $100 million opportunity, not as base case, I definitely don't want to put a high side case number out there. I think on that base case, it's reasonable to expect that we're going to share production between us and one other component supplier. And if you want to just put a slug in there for the share that we would see, you could call it 50-50.”

CopperEdge had net sales this quarter that were “in the high-single-digit million dollars.” According to discussions on the call, Meta’s Catalina is going to be the main platform: “We know one major CSP is going to be used at the baseline for deployment in 2025 and beyond as long as they use GB200 GPU processors.” From there, it’s expected the capabilities will draw in more cloud service providers (CSPs) due to improved signal integrity and lower power consumption.

This quarter, for the CopperEdge 200GB redrivers, the CEO stated demand should be measured by the number of ports for the 200GB rather than the number of Nvidia NVL systems. Specifically, it was called out that Broadcom’s Tomahawk 6 will have ports for 200GB, which is likely to increase the opportunity beyond the $100 million (at 50-50 share) that was called out a few quarters back.

Here was an important exchange in the Q&A:

Craig Ellis:

Yeah. Hong, Mark, congrats on the execution, especially around growth and margins. Hong, I wanted to go back to data center a bit, maybe approach it in a more longer-term way. So, I think it was at least three quarters ago that we started talking about what seemed to be a single company, more single-product opportunity as having $100 million base opportunity to it that would be in the '25, '26 timeframe. The question is this, as the business looks like it's gotten significantly broader customer and application level exposure and design-in potential, how do we think about the size of this business two to three years down the road?

Hong Hou:

Craig, that's a great question. I think the opportunity started with as a single company, single platform and that is a great trailblazer for this new product that accelerated our time-to-market, but right now, as you mentioned, as we observed, this capability is broadly recognized and beyond that single company beyond that single platform. So, that's why we have been thinking about and to qualify the opportunity by counting the number of 200-gigabit per second ports.

The reason for that is everywhere you have 200-gigabit per second transport, you have the same challenge. You need the same solution for signal integrity. And with the Tomahawk 6 rolling out right around the corner, well, maybe six months to 12 months and all the ports is going to be 200-gig, and it's only increasing our opportunities. So, so far, the application has been for scale-up, but with the scale-out added into the opportunity pool, we got a tremendous opportunity in there.”

-End Quote

It was mentioned again that the $100 million baseline for the ACC opportunity is a floor — and not a ceiling: “We have invested time with our customer and end-users of the racks over the past few months. We reaffirmed our expectation of exceeding the floor case provided a couple of quarters ago based on the first-hand information from the ecosystem.”

Linear Pluggable Optics (LPOs) to Ramp in H2 2025:

As stated in the Product paragraph above, Linear Pluggable Optics (LPOs) will see “meaningful net sales contribution” by the “latter portion of FY26.” According to the Q&A, the NVL36 and NVL72 systems from Nvidia will drive this demand specifically for the front-end ports:

“And I have heard some others using NVL72 and — where we don't have the contribution for backplane, but at the front-end, they either need to connect 1.6T ports or 800-gigabit ports to top-of-the-rack or end-of-the row switches. I think that's where LPO can really have a good — provide a very differentiating solution because of the low power consumption. So, I think that is probably why the industry is pushing very hard on the LPO solutions.”

Semtech’s management also made it clear that they also have the best linear receive optics (LRO) and will benefit regardless of a current debate on if LPO is interchangeable with current ethernet switching chips: “To us, we have the arguably the best driver — best TIA on the receiving side. So, we'll benefit from either LPO or LRO. And whereas the industry progress in getting better understanding on the compatibility of different type of host with LPO and LRO capabilities, I do believe this type of transceivers can chip away a sizable total addressable market currently served by the DSP retimed solutions.”

According to the opening remarks, Semtech believes they have an advantage with LPOs and the issues the market has seen from other suppliers: “CSP [cloud service provider] engagement has proven insightful. It appears that LPO adoptability is meaningfully correlated with a 30 signal-to-noise ratio at the host. Fortunately, both current and future generation switches supply significantly improve the performance, and this enables easier LPO adoption in many specific use cases.”

About a year ago, there were reports that Nvidia had plans of using LPOs by the end of 2023. You can read Semtech’s LPO announcement here.

Revenue:

Semtech’s revenue returned to positive growth after two quarters of negative revenue growth. This was helped by record AI data center revenue which increased 78% YoY and 58% QoQ. The infrastructure end market is expected to provide the strongest near-term tailwinds.

• Q3 revenue grew by 17.9% YoY and up 10% sequentially to $236.8 million. Data center revenue was the main highlight of the report, increasing by 78% YoY and 58% QoQ to a record $43.1 million.
• Management has forecast a strong Q4 guide of $250 million, representing 29.6% YoY growth at the midpoint. The Q4 guide beat estimates by 3.3%. Per the call, this will be primarily driven by data center infrastructure revenue: “We expect net sales from the infrastructure end market to increase sequentially with data center applications leading to growth. Infrastructure is expected to provide the strongest near-term tailwind.”
• Analysts expect growth to sustain with Q1 revenue of 23.9% YoY to $255.27 million and 25.3% YoY to $269.9 million in FQ2.
• Looking further out, analysts expect FY2026 revenue to grow 22.3% YoY to $1.11 billion and 16.1% YoY to $1.29 billion in FY2027.

End Markets

Infrastructure:

Q3 Infrastructure End Market revenue grew by 52% YoY and 24% QoQ to $65.8 million. This segment accelerated from last quarter with 25% YoY growth and down (-5%) QoQ. The large sequential rebound was primarily led by record data center revenue of $43.1 million, up 58% QoQ and 78% YoY.

The company began shipments of the CopperEdge 200-gig linear redrivers that are used in 1.6T Active Copper Cable (ACC) applications. CopperEdge sales in FQ3 were high-single-digit million dollars, and management expects a higher contribution in Q4, followed by a ramp into FY2026. As stated, Meta is generally understood to be the lead customer with the Catalina system, yet additional CSPs (cloud service providers) are in the qualification stage with expectations there will be more customers by H2 CY2025.

While proving the outlook for Q4, CFO Mark Lin said, “We expect net sales from the infrastructure end market to increase sequentially with data center applications leading to growth. Infrastructure is expected to provide the strongest near-term tailwind.” It was later stated to an analyst: “Harsh, we said this in Q3, it was high-single-digit millions in Q3. It's a nominal ramp in Q4, and then it progressively ramps through FY '26, Q1, Q3 — Q1, Q2, Q3 and Q4. So, we've been pretty consistent with that messaging and we don't really see a change in that timing.”

Our firm will be looking to Q1 onward for Semtech to show an important acceleration in their leading segment, Infrastructure.

High-End Consumer:

High-end consumer revenue grew by 7% YoY and 8% QoQ to $40 million, helped by market share gains and seasonally strong Q3. Revenue decelerated slightly from 9% YoY and 7% QoQ growth in Q2. Due to seasonality, management expects high-end consumer revenue to decrease sequentially in Q4.

Revenue in high-end consumer TVS (Transient Voltage Suppressor) grew by 9% QoQ and 7% YoY to $28.3 million and management highlighted that Consumer TVS revenue reported sequential growth in each quarter in FY2025.

In the earnings call, the CEO said “We communicated market share growth in consumer TVS grew last quarter, augmenting our prior commentary. Our expectation is for continued market share expansion as the world's largest consumer electronics company and at other key North American and Korean companies. Based not only on our design-in activities for future generations of product, but also for Semtech's ability to deliver on time and to meet demand upside.”

Industrial:

The industrial end market grew by 9% YoY and 5% QoQ to $131 million. With the increase in LoRa and the cellular IoT portfolio, the industrial end-market revenue is expected to increase sequentially in Q4.

• LoRa-enabled solutions grew by 1% QoQ and 104% YoY to $29 million. The CEO highlighted, “Encouragingly, consumption for our recent generation LoRa product has been increasing, which signals market adoption of this enhanced capability.

  LoRa Gen 2 offers a smaller footprint and reduce the power consumption, while LoRa Gen 3 delivered improved radio performance and a further simplification of customer development through onboard LoRaWAN provisioning capability. Supporting LoRaWAN remains a key company strategy.”

• IoT systems revenue grew by 11% sequentially to $57.9 million with solid bookings and backlog.
• IoT Connected Services revenue was $24.6 million, benefiting from our AirVantage connectivity platform.
• Industrial TVS revenue was $10.2 million, up 7% QoQ. The CEO noted, “We have noticed the current market sentiment in the industrial market, but we remain confident in Semtech growth with our product offerings.”

The Sierra Wireless acquisition has negatively impacted the industrial end market revenues. The company had acquired Sierra Wireless in January 2023. However, the company experienced reduced business levels in the business acquired from Sierra Wireless due to the challenging macro environment and high-interest rate environment. This could be the portion of the business that will be divested (see below).

Margins Expanding:

The company has undertaken organizational restructuring and reduced workforce to reduce overhead spending. The company’s margins have improved, helped by operating leverage and a higher-margin product mix like CopperEdge. The incremental margin gain from the product mix was also further answered during the Q&A.

Tore Svanberg (Analyst)

“Yeah, thanks. I just had a quick follow-up for Mark. Mark, so 40 bps — basis point improve gross margin for January. How should we think about gross margin for fiscal year '26? Is it mainly mix at this point that will drive the gross margin, or is there — are there other things maybe scale or anything like that that could potentially also lift it as well?

Mark Lin (CFO)

Yeah. Scale definitely helps, but definitely, it's the primary driver in our guide is mix, right? So, it's a 40-bp improvement, but we did get a little bit of a tailwind from the CopperEdge shipments this quarter, right? So that was definitely a tailwind. But as other portions of our business inflect upward, there's a little bit lower margin in IoT, our systems hardware business, so that's a little bit lower. We'll definitely take the gross profit, right, but definitely that business doesn't contribute quite the percentages, let's say, our infrastructure business.”

• Q3 gross margin was 51.1% compared to 46.3% in the same period last year.
• Adjusted gross margin improved 110 bps YoY and 200 bps QoQ to 52.4%. Management has guided for a sequential improvement of 40 bps to 52.8% in Q4, helped by a better product mix.
• Q3 adjusted operating margin improved to 18.3% from 10.2% in the same period last year helped by operating leverage and better product mix. Management has guided for 140 bps QoQ improvement to 19.7% in Q4.
• It is also important to note that last year, the company reported non-cash goodwill and intangible impairment charges of $513.4 million in Q4 due to the lower contribution than expected from the acquired Sierra Wireless business. The company may also record the impairment charges in Q4 this year that impact the GAAP operating margins.

• Q3 net loss was (-$7.6 million) or (-3.2%) of revenue compared to (-$38.3 million) or (-19%) of revenue in the same period last year. Adjusted net income was $20.3 million or 8.6% of revenue compared to $1.5 million or 0.7% of revenue in the same period last year. Management Q4 adjusted net margin guide is 10.3%.
• Adjusted EBITDA was $51.1 million or 21.6% of revenue compared to $28.1 million or 14% of revenue in the same period last year. Management Q4 adjusted EBITDA margin guide is 22.8%.

EPS Growth in Triple Digits

The company beat Q3 adjusted EPS estimates by 11.7%, which was helped by operating leverage and a better product mix. Q3 adjusted EPS grew more than 100% sequentially to $0.26. Management Q4 adjusted EPS guide is $0.32, representing sequential growth of 23.1% and beat adjusted EPS consensus by an impressive 18.5%.

Adjusted EPS is expected to have strong growth in the coming quarters.

• Analysts expect Q1 FY2026 adjusted EPS to grow 445% YoY to $0.33 and FQ2 adjusted EPS to grow 252.7% YoY to $0.39.
• Looking further out, analysts expect FY2026 adjusted EPS to grow 120.5% YoY to $1.69 and 33.7% YoY to $2.26 in FY2027.

Cash Flow Inflected

The cash flows have been lumpy in the past. The company reported strong cash flows in the recent Q3 helped by improving bottom line and is expected to continue to generate positive cash flows in the coming quarters.

The CFO replied to an analyst question on free cash flow generation in the next few quarters, suggesting that the company will generate positive cash flows despite the inventory buildup to support the data center growth. “Yeah. Just, I’m quite pleased, Tristan, Q3 operating cash flow was $29.6 million. Free cash flow was $29.1 million. So, cash flow definitely we’ve inflected consistent with the business. And I’m pleased that cash flow is really – generation is broad-based across our businesses. We may have to build a little bit more inventory supporting demand, but we continue to generate cash.”

• Q3 operating cash flow was $29.6 million or 12.5% of revenue compared to (-$5.8 million) or (-2.9%) of revenue in the same period last year.
• Free cash flow was $29.1 million or 12.3% of revenue compared to (-$12.4 million) or (-6.2%) of revenue in the same period last year.
• The company had cash of $136.5 million and debt of $1.19 billion at the end of Q3 FY2025. The company made a principal repayment of $5 million of the credit facility in FQ3 and a further repayment of $10 million subsequent to the end of the quarter.
• The company accumulated the high debt of about 9X its cash due to the Sierra Wireless acquisition in January 2023. Management is working on reducing its high debt.
• The company also recently announced the closing of the public offering for a total gross proceeds of about $661 million and it plans to use the proceeds to repay debt. With the proceeds from the recent offering, it will help to reduce the debt to about 2X its cash. However, it will also lead to dilution of about 12% to the existing shareholders.

Potential Divesture of Non-Core Segments

Out the gate, the CEO stated the primary goal is for portfolio rationalization and balance sheet improvement. He stated: “I'm fully aware of the financial and the non-financial benefits of portfolio rationalization, and we are particularly focused on opportunities that accelerate our debt repayment and decrease our leverage ratio.”

When asked during the Q&A if Semtech is still interested in selling parts of the business, the CFO affirmed this is a top priority: “At this point, I think all of our businesses have inflected the growth. So, as Hong mentioned in his prepared remarks, we believe that should help valuation, but that in no way will delay or maybe impede our desire to potentially divest these non-core businesses.”

We view any potential divesture of non-infrastructure segments as bullish as removing those segments to allow for a more concentrated AI-stock valuation. The more that Semtech can become an AI pureplay, I think the better it’ll be for its stock performance. Psychologically, it will help investors to see more clearly the material progress in the important pivot underway.

The company’s Sierra Wireless acquisition in January 2023 did not meet the company’s expectations. The company experienced reduced growth levels in the business acquired from Sierra Wireless due to the challenging macro environment, and the high interest rates environment increased the interest expenses. So, in our view, the company might divest this business.

The company appointed Dr. Hong Q. Hou as the President and CEO in June 2024. He has been a member of the Board of Directors since July 2023. He replaced the previous CEO, Paul H. Pickle, due to his differences with the board. Dr. Hou has previously held senior leadership positions in Intel and Fabrinet.

China Exposure:

There is exposure to China in the PON product, which stands for passive optical network and is used for telecom use cases. It’s helpful this is not AI-related, per the information from the call. Per the earnings call: “So, the PON business up to this point has been primarily in China and we expect another tender offer over the next quarter or two.”

Conclusion:

As stated in the Q4 webinar, 2025 belongs to Nvidia (again), yet we plan to expand how we participate in a more unique, strategic way by looking more deeply at suppliers-of-choice in what is decidedly AI hardware’s moment to shine. Semtech’s suite of products within signal integrity are off to a great start with a noticeable rebound this past quarter, yet the opportunity is in front of this key Blackwell supplier, and the lull in Q4 should allow a reasonable entry.

The current beat was driven by the fiber products, while the ACC (copper) products are slated to meaningfully contribute come Q1. By carefully threading a needle from what’s been stated on the earnings calls and what’s been announced around the Blackwell GB200 systems, ACC could be a 5X opportunity with Meta alone — with more CSPs likely to follow suit by this time next year.

A note of caution is that Semtech has a high debt leverage ratio. The company is working on bringing the debt leverage down. Although managemet was not clear on timing, I’d like to see Semtech being more of an AI pureplay by the time we exit next year. The portfolio adjustments will help it stand out for its growth potential in the oversubscribed space of AI infrastructure.

Advanced Members should keep an eye out for trade alerts as we closely track this little-known company.

Recommended Reading:

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Vertiv offers power management and thermal management to data centers and telecom companies, such as Alibaba, AT&T, China Mobile, Tencent and Verizon. The company was formed in 2016 after spinning off from Emerson, and reported $6.8 billion in revenue last year. Vertiv is considered one of the larger players in data center technologies in terms of power management and thermal management, with 24,000 employees and 30 manufacturing facilities.

Vertiv offers many thermal management solutions. Among them is the Liebert XDU, which is a compact unit that sits in the row near the rack or on the perimeter. The liquid-to-liquid cooling distribution unit (CDU) functions as a heat exchanger between the data center and IT equipment, and is used in all forms of liquid cooling: direct-to-chip, rear door heat exchange and immersion. The Liebert XDU offers a secondary fluid cooling loop so that alternative cooling fluids can be used alongside water.

In 2023, Vertiv acquired a company called CoolTera, after partnering with the company for three years, to add advanced cooling technologies to its thermal management portfolio. One of the main areas of need for data centers and colocation sites is to convert air-cooled equipment to liquid cooled equipment. Retrofitting existing air-cooled infrastructure is an area where Vertiv specializes, as opposed to only providing thermal solutions for new servers and racks.

The benefits of retrofitting was touched on in the most recent earnings call: “A great example of enabling the industry to be future-ready is our truly unique Vertiv CoolPhase CDU, which makes it simple to deploy high density liquid cooling where needed without having to reengineer the entire data center environment, even in the absence of a chilled water loop.”

In 2024, Vertiv joined the Nvidia Partner Network with a statement that Vertiv is “collaborating to build state-of-the-art liquid cooling solutions for next-gen NVIDIA accelerated data centers powered by GB200 NVL72 systems.” Now that we are close to the roll-out for Blackwell, Vertiv has officially announced a co-developed GB200 NVL72 system with up to 40% less power management space and up to 20% lower cooling costs. Vertiv is also partnered with Intel to supply air-cooled and liquid-cooled servers for the Gaudi3 AI accelerators.

Notably, Vertiv is a vendor that supplies original design manufacturers (ODMs) such as Dell with thermal management. Here is how the mutually beneficial relationship was described (as opposed to being direct competitors):

“ODMs play certainly an important role in the go-to-market for the likes of us. ODMs in a play that for liquid cooling sometimes is a white space play. They have a role with their servers, with their racks, with their integration. So it’s natural that they integrate liquid cooling technology in what they do. […] When we think about those ODMs, we think of them as a go-to-market for us. And those ODMs very often also rely on our ability not only to deliver and provide technology, but also to provide the service and the liquid cooling know-how at rack, row and system level that they might need kind of being complemented with. So we do not look at that part of the market as competition. We look at a part of the market that we have opportunity to synergize with.”  

The data center accounts for 80% of Vertiv’s business, up from 75% when we initially covered Vertiv back in June. The communications networks and commercial/industrial facilities is at 20% of revenue.

A few quarters back, the management team stated that AI-related projects were doubling in a two-month time frame:

“The ramp-up of production of liquid cooling globally continues as planned, and I'm happy to report we have production underway already at two of the three plants we shared with you we were planning to activate in 2024. We are on track with the capacity ramp-up as shared in February. We continue to see strong momentum with AI-related orders. While we are not disclosing specific detail on our liquid cooling orders, or more broadly AI-related orders, we did see the pipeline for AI projects more than double in the last two months.”

More recently, in Q3, management highlighted its belief that liquid cooling will grow rapidly over the next three years. Per the earnings call: “We believe from a market value standpoint that air and heat rejection combined will be 70% of the market and liquid 30% over the next few years. Air and heat rejection will grow at a 10% CAGR and liquid at a 30% CAGR, all growing very nicely."

At the recent Investor’s Event, Vertiv raised its long-term projections with an updated horizon from 2028 to 2029:

Source: Vertiv’s Investor Event PresentationVertiv’s Investor Event Presentation

Q3 Financials and 2024 Investor Event Financial Forecast Updates:

Q3 revenue grew by 19% YoY to $2.1 billion, beating estimates by 4.8%. Adjusted EPS rose by 46.2% YoY to $0.76, beating consensus estimates by 10.2%. Management also revised financial metrics during the recent 2024 Investor Event, which is discussed below.

Revenue

The company is witnessing an inflection in revenue due to strong AI data center growth (data center accounts for 80% of revenue). During the 2024 Investor Event held on Nov 18, the company's financial objectives were rolled forward one year through 2029 and guided for higher organic revenue growth for the forecasted period. The long-term organic revenue growth guidance has been raised from 8% to 11% (2023-2028F CAGR) to 12% to 14% (2024-2029F CAGR).

• Q3 revenue grew by 19% YoY to $2.1 billion. Organic sales (adjusted to exclude foreign currency exchange rate impact) growth was 19.2%, which was helped by double-digit growth in all three regions.
• The company’s CEO, Giordano Albertazzi said in the Q3 earnings call, “Pipelines continue to grow. We saw pipeline increase sequentially from Q3 – from Q2 to Q3 across all regions. We also are seeing more convincing signals that AI is indeed accelerating in EMEA.”
• Organic sales in the Americas region grew by 20.5% YoY to $1.2 billion. Demand in the colocation and hyperscale markets drove organic sales growth in the Americas, with strong contributions from switchgear, busway, and liquid cooling and services.
• The APAC region showed a 470-basis sequential improvement to 10.4% YoY growth to $432.4 million, helped by strong growth in China and the Rest of Asia.
• The EMEA region witnessed the fastest growth, with 25.2% YoY to $442.5 million, driven by robust demand from colocation and hyperscale markets.
• Management has guided Q4 revenue between $2.115 billion to $2.165 billion, representing YoY growth of 14.8% at the midpoint. The organic sales growth guide for Q4 is 11% to 15%.
• Analysts expect Q4 revenue to grow 15.5%, followed by 17.5% and 16.8% in the subsequent two quarters.

• Management has guided FY2024 revenue in the range of $7.78 billion to $7.83 billion, representing YoY growth of 13.7% at the midpoint. The organic sales growth guide for FY2024 is 14% at the midpoint. Analyst consensus for FY2025 indicates an acceleration to growth of 18.4% on revenue.
• During the Q3 earnings call, the CEO said, “The orders trends and our robust backlog indicate that growth in 2025 will accelerate relative to 2024’s 14%.” During the recent Investor Event, management provided organic sales growth guidance of 16% to 18% for FY2025, representing a solid 3-point acceleration at the midpoint.

Expanding Margins Helps Vertiv Stand Apart

Vertiv’s margins are improving helped by strong operating leverage. During the 2024 Investor Event, management provided adjusted operating margin guidance of 25% for FY2029, representing an expansion of 600 bps from the 19% guide for FY2024 over a five-year period. This helps illustrate Vertiv’s ability to stand apart as a hardware company with already-strong margins that are expected to only expand further over time.

The company plans to achieve about 4% improvement through operating leverage by deepening Vertiv Operating System (VOS) adoption, functional optimization, and digitalization, including AI utilization. About 1% will come from productivity gains and another 1% from commercial execution by delivering positive price-cost through customer value creation.

During the 2023 Investor Event, management had guided the adjusted operating margin to be above 20% during the 2026-2028 timeframe. The company is expecting to reach the previous goal two years earlier, as management has provided an adjusted operating margin guide of 21% at the midpoint for FY2025.

• Q3 gross margin was 36.5% compared to 36% in the same period last year.
• This compares to 28.4% for FY2022 and 35% for FY2023.
• Q3 operating margin improved 350 bps YoY to 17.9%. Adjusted operating margin improved 310 bps YoY to 20.1%. Management’s adjusted operating margin guide for Q4 2024 is 20.4%.
• Q3 net income was $176.6 million or 8.5% of revenue compared to $94.1 million or 5.4% of revenue in the same period last year. Adjusted net income was $290.5 million or 14% of revenue compared to $201.2 million or 11.5% of revenue in the same period last year.

EPS

The company’s Q3 adjusted EPS grew by 46.2% YoY to $0.76. It beat analyst estimates by 10.2%, which was helped by strong operating leverage. Analysts expect strong EPS growth in the coming quarters.

• Management Q4 adjusted EPS guide is $0.80 to $0.84, representing YoY growth of 46.4% at the midpoint.
• Analysts expect adjusted EPS to grow 51.2% and 32.8% in Q1 and Q2, respectively.
• Analysts expect adjusted EPS to grow 32.3% YoY to $3.56 for FY2025 and 25.8% in FY2026.

Cash Flow and Balance Sheet: $1B in FCF This Year

Vertiv announced the annual dividend increase from $0.10 to $0.15, to be paid quarterly. Management expects the 2029 dividend to be about 2x the 2025 annual dividend. In addition to achieving a net leverage ratio of 1.4x, Vertiv has repurchased $600 million worth of shares in 2024 and still has $2.4 billion authorized to repurchase by 2027.

• Q3 operating cash flow was $375.1 million or 18.1% of revenue compared to 14.3% in the same period last year. It is also a significant improvement from the 13.1% for the FY2023.
• Q3 adjusted free cash flow was $335.9 million or 16.2% of revenue compared to 12.7% in the same period last year.
• Management raised the full-year adjusted free cash flow guide to $1.0 billion, up $125 million from the prior guidance. Management expects strong free cash flow generation to continue in 2025.
• Cash was $908.7 million and debt of $2.931 billion compared to $579.7 million and $2.935 billion in Q2. Net leverage ratio has come down to 1.4x from 2.4x in the same period last year.

Key Metrics

Backlog

The backlog at the end of Q3 was $7.4 billion, up 47% year over year and 5% quarter over quarter. Expansion in all three regions helped drive the strong growth in backlog. As seen below, the 47% rate for the backlog is particularly high and is more than double the rate of revenue growth.

TTM Orders Grow 37% YoY

Management introduced a trailing twelve-month metric last quarter. The CEO said in the Q2 earnings call, “This quarter, we have introduced a trailing 12-month orders metric. As we have previously highlighted, there can be a natural variation to the timing of large orders in any quarter. Trailing 12-month is a good metric to assess order activity, smoothing some of the quarter-to-quarter push and pulls.”

The trailing twelve-month orders grew by 37% YoY and were consistent with 37% TTM growth at the end of the second quarter. Q3 orders grew by 17% and were lower than 57% growth in Q2. Management has tried to temper expectations of such high order growth as previously seen this year: “We've enjoyed extremely strong orders in the first half of 2024 and we would agree that continued approximately 60% order increases are unlikely as we tried to say last quarter.” This also helps illustrate why the company is moving to TTM reporting metric.

Earnings Call:

Backlog Elongation:

Given the backlog is growing at more than double the rate of revenue, there were quite a few questions about the backlog and pipeline on the earnings call. Most of them were too forward-looking for management to answer to, however, one question in particular was insightful in terms of Vertiv continuing to have pricing power. It’s also insightful as the analyst is implying the strong backlog may be coming from deals that are elongating from 9-15 months to 12-18 months; this makes sense if we generally apply what we know about Blackwell coming in H1 2025 and these systems being more complex, perhaps requiring a longer sales cycle.

“Noah Kaye

All right. Thank you. And just to piggyback on this, Gio, for the last few quarters you talked about the elongation in order to revenue conversion cycle times for cloud and colo. And that's supporting some of the strength and visibility you have going into 2025. But just what drives your confidence in remaining price cost positive in 2025 given that longer conversion cycle?

Giordano Albertazzi

When we were talking, first of all, thanks for the question, Noah. When we think in terms of the elongation, we were talking about the elongation happening de facto and specifically for the cola and large cola and hyperscale. And that elongation was at 12, was, let's say from the 9, 15 months to the 12, 18 months. So it's not a dramatic elongation. We're talking about a three-month elongation. So we have good visibility on our pipelines. We have of course, very good visibility on our backlog. We have visibility on the price elements of that backlog and pipeline. We have good visibility on the cost side of the equation. And the cost side of the equation, of course, is very, very important. So combine the two, enhance our continued reiterated statement that we believe price cost to continue to be favorable.”

“Resounding Yes” to Higher Q4 Pipeline:

Although pipeline is not an official key metric offered, an analyst dug around for information on how Q4 is shaping up to which the CEO was quite emphatic is better than Q3. The analyst also asked more about lead elongation but the CEO is clearly referring to Blackwell’s arrival being the impetus.

“Michael Elias

Great. Thanks for taking the question. Two quick ones, if I may. First, I want to be absolutely clear. Are you saying that your demand pipeline entering 4Q is higher than the levels you saw entering 3Q? That's my first question.

And then second, I just want to revisit a prior question related to like elongating lead times. One of the things that we're seeing in the data center market is that as the preleasing window elongates and we go further out, the lower pricing that, that data center capacity is commanding. So as I think through the equipment side, does it stand to reason that as the customer lead time elongates, Vertiv actually has less pricing power in the conversation? Any color there would be helpful. Thank you.

Giordano Albertazzi

Well, thank you, Mike. The answer to the first question is if – the answer is yes. I was just trying to think about the formulation. But yes, that pipeline entering Q4 is higher than the pipeline entering Q3, no doubt. So that is a resounding, yes.

When it comes to the elongated lead times, we do not necessarily see a correlation between lead time elongation. And again, I want to remind everyone it's not a lead time elongation because of Vertiv's need to elongate lead time. So we can, most of the time deliver on shorter lead time on their request. But simply because of lead time gets elongated because that is consistent with our customers, project plans and schedules.”

Production Capacity:

It’s important to make a quick note here that capacity is something Vertiv remains confident on, which is where rival Super Micro may become weak due to cash constraints. According to the Investor Event: “But sometimes, if we go back to some of the earnings call, we talked about, yes, do you have capacity? How much capacity are you making available? Oh, I said, "Hey, we always have this 20%, 25%, 30% wiggle room. That's the way we think about capacity being made available […] And a year from now, we will have a similar probably bigger and more impressive list of all improvements of all the capacity that has been — that will be created. But it is about new factories. New factories in India, new factories in the U.S. opened this year. It's about operating and starting production. Example, for liquid cooling, virtually — actually, not virtually in every continent in which we operate.”

Conclusion:

AI power demand is forecast to rise at a rapid rate. GPU demand is showing no signs of slowing as Big Tech continues to spend billions on AI infrastructure, and each new GPU generation is seeing higher peak power consumption. The industry is quickly taking steps to address this, and power consumption, or more specifically, power efficiency per chip, looks to be emerging as the third realm of competition.

As we’ve made abundantly clear, the arrival of Nvidia’s Blackwell is the moment when things like thermal management and power distribution become mission critical. It will not only be Nvidia’s Blackwell systems, for example, we recently published on Amazon’s Trn2 systems that will have hundreds of thousands of custom chips (i.e., not GPUs). Yet, Blackwell signals the arrival of a moment when key suppliers will have their turn in the spotlight. Vertiv remains on our list as a top contender and supplier of choice in what will become a marathon for key AI beneficiaries at the hardware level.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

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Vertiv offers power management and thermal management to data centers and telecom companies, such as Alibaba, AT&T, China Mobile, Tencent and Verizon. The company was formed in 2016 after spinning off from Emerson, and reported $6.8 billion in revenue last year. Vertiv is considered one of the larger players in data center technologies in terms of power management and thermal management, with 24,000 employees and 30 manufacturing facilities.

Vertiv offers many thermal management solutions. Among them is the Liebert XDU, which is a compact unit that sits in the row near the rack or on the perimeter. The liquid-to-liquid cooling distribution unit (CDU) functions as a heat exchanger between the data center and IT equipment, and is used in all forms of liquid cooling: direct-to-chip, rear door heat exchange and immersion. The Liebert XDU offers a secondary fluid cooling loop so that alternative cooling fluids can be used alongside water.

In 2023, Vertiv acquired a company called CoolTera, after partnering with the company for three years, to add advanced cooling technologies to its thermal management portfolio. One of the main areas of need for data centers and colocation sites is to convert air-cooled equipment to liquid cooled equipment. Retrofitting existing air-cooled infrastructure is an area where Vertiv specializes, as opposed to only providing thermal solutions for new servers and racks.

The benefits of retrofitting was touched on in the most recent earnings call: “A great example of enabling the industry to be future-ready is our truly unique Vertiv CoolPhase CDU, which makes it simple to deploy high density liquid cooling where needed without having to reengineer the entire data center environment, even in the absence of a chilled water loop.”

In 2024, Vertiv joined the Nvidia Partner Network with a statement that Vertiv is “collaborating to build state-of-the-art liquid cooling solutions for next-gen NVIDIA accelerated data centers powered by GB200 NVL72 systems.” Now that we are close to the roll-out for Blackwell, Vertiv has officially announced a co-developed GB200 NVL72 system with up to 40% less power management space and up to 20% lower cooling costs. Vertiv is also partnered with Intel to supply air-cooled and liquid-cooled servers for the Gaudi3 AI accelerators.

Notably, Vertiv is a vendor that supplies original design manufacturers (ODMs) such as Dell with thermal management. Here is how the mutually beneficial relationship was described (as opposed to being direct competitors):

“ODMs play certainly an important role in the go-to-market for the likes of us. ODMs in a play that for liquid cooling sometimes is a white space play. They have a role with their servers, with their racks, with their integration. So it’s natural that they integrate liquid cooling technology in what they do. […] When we think about those ODMs, we think of them as a go-to-market for us. And those ODMs very often also rely on our ability not only to deliver and provide technology, but also to provide the service and the liquid cooling know-how at rack, row and system level that they might need kind of being complemented with. So we do not look at that part of the market as competition. We look at a part of the market that we have opportunity to synergize with.”  

The data center accounts for 80% of Vertiv’s business, up from 75% when we initially covered Vertiv back in June. The communications networks and commercial/industrial facilities is at 20% of revenue.

A few quarters back, the management team stated that AI-related projects were doubling in a two-month time frame:

“The ramp-up of production of liquid cooling globally continues as planned, and I'm happy to report we have production underway already at two of the three plants we shared with you we were planning to activate in 2024. We are on track with the capacity ramp-up as shared in February. We continue to see strong momentum with AI-related orders. While we are not disclosing specific detail on our liquid cooling orders, or more broadly AI-related orders, we did see the pipeline for AI projects more than double in the last two months.”

More recently, in Q3, management highlighted its belief that liquid cooling will grow rapidly over the next three years. Per the earnings call: “We believe from a market value standpoint that air and heat rejection combined will be 70% of the market and liquid 30% over the next few years. Air and heat rejection will grow at a 10% CAGR and liquid at a 30% CAGR, all growing very nicely."

At the recent Investor’s Event, Vertiv raised its long-term projections with an updated horizon from 2028 to 2029:

Source: Vertiv’s Investor Event PresentationVertiv’s Investor Event Presentation

Q3 Financials and 2024 Investor Event Financial Forecast Updates:

Q3 revenue grew by 19% YoY to $2.1 billion, beating estimates by 4.8%. Adjusted EPS rose by 46.2% YoY to $0.76, beating consensus estimates by 10.2%. Management also revised financial metrics during the recent 2024 Investor Event, which is discussed below.

Revenue

The company is witnessing an inflection in revenue due to strong AI data center growth (data center accounts for 80% of revenue). During the 2024 Investor Event held on Nov 18, the company's financial objectives were rolled forward one year through 2029 and guided for higher organic revenue growth for the forecasted period. The long-term organic revenue growth guidance has been raised from 8% to 11% (2023-2028F CAGR) to 12% to 14% (2024-2029F CAGR).

• Q3 revenue grew by 19% YoY to $2.1 billion. Organic sales (adjusted to exclude foreign currency exchange rate impact) growth was 19.2%, which was helped by double-digit growth in all three regions.
• The company’s CEO, Giordano Albertazzi said in the Q3 earnings call, “Pipelines continue to grow. We saw pipeline increase sequentially from Q3 – from Q2 to Q3 across all regions. We also are seeing more convincing signals that AI is indeed accelerating in EMEA.”
• Organic sales in the Americas region grew by 20.5% YoY to $1.2 billion. Demand in the colocation and hyperscale markets drove organic sales growth in the Americas, with strong contributions from switchgear, busway, and liquid cooling and services.
• The APAC region showed a 470-basis sequential improvement to 10.4% YoY growth to $432.4 million, helped by strong growth in China and the Rest of Asia.
• The EMEA region witnessed the fastest growth, with 25.2% YoY to $442.5 million, driven by robust demand from colocation and hyperscale markets.
• Management has guided Q4 revenue between $2.115 billion to $2.165 billion, representing YoY growth of 14.8% at the midpoint. The organic sales growth guide for Q4 is 11% to 15%.
• Analysts expect Q4 revenue to grow 15.5%, followed by 17.5% and 16.8% in the subsequent two quarters.

• Management has guided FY2024 revenue in the range of $7.78 billion to $7.83 billion, representing YoY growth of 13.7% at the midpoint. The organic sales growth guide for FY2024 is 14% at the midpoint. Analyst consensus for FY2025 indicates an acceleration to growth of 18.4% on revenue.
• During the Q3 earnings call, the CEO said, “The orders trends and our robust backlog indicate that growth in 2025 will accelerate relative to 2024’s 14%.” During the recent Investor Event, management provided organic sales growth guidance of 16% to 18% for FY2025, representing a solid 3-point acceleration at the midpoint.

Expanding Margins Helps Vertiv Stand Apart

Vertiv’s margins are improving helped by strong operating leverage. During the 2024 Investor Event, management provided adjusted operating margin guidance of 25% for FY2029, representing an expansion of 600 bps from the 19% guide for FY2024 over a five-year period. This helps illustrate Vertiv’s ability to stand apart as a hardware company with already-strong margins that are expected to only expand further over time.

The company plans to achieve about 4% improvement through operating leverage by deepening Vertiv Operating System (VOS) adoption, functional optimization, and digitalization, including AI utilization. About 1% will come from productivity gains and another 1% from commercial execution by delivering positive price-cost through customer value creation.

During the 2023 Investor Event, management had guided the adjusted operating margin to be above 20% during the 2026-2028 timeframe. The company is expecting to reach the previous goal two years earlier, as management has provided an adjusted operating margin guide of 21% at the midpoint for FY2025.

• Q3 gross margin was 36.5% compared to 36% in the same period last year.
• This compares to 28.4% for FY2022 and 35% for FY2023.
• Q3 operating margin improved 350 bps YoY to 17.9%. Adjusted operating margin improved 310 bps YoY to 20.1%. Management’s adjusted operating margin guide for Q4 2024 is 20.4%.
• Q3 net income was $176.6 million or 8.5% of revenue compared to $94.1 million or 5.4% of revenue in the same period last year. Adjusted net income was $290.5 million or 14% of revenue compared to $201.2 million or 11.5% of revenue in the same period last year.

EPS

The company’s Q3 adjusted EPS grew by 46.2% YoY to $0.76. It beat analyst estimates by 10.2%, which was helped by strong operating leverage. Analysts expect strong EPS growth in the coming quarters.

• Management Q4 adjusted EPS guide is $0.80 to $0.84, representing YoY growth of 46.4% at the midpoint.
• Analysts expect adjusted EPS to grow 51.2% and 32.8% in Q1 and Q2, respectively.
• Analysts expect adjusted EPS to grow 32.3% YoY to $3.56 for FY2025 and 25.8% in FY2026.

Cash Flow and Balance Sheet: $1B in FCF This Year

Vertiv announced the annual dividend increase from $0.10 to $0.15, to be paid quarterly. Management expects the 2029 dividend to be about 2x the 2025 annual dividend. In addition to achieving a net leverage ratio of 1.4x, Vertiv has repurchased $600 million worth of shares in 2024 and still has $2.4 billion authorized to repurchase by 2027.

• Q3 operating cash flow was $375.1 million or 18.1% of revenue compared to 14.3% in the same period last year. It is also a significant improvement from the 13.1% for the FY2023.
• Q3 adjusted free cash flow was $335.9 million or 16.2% of revenue compared to 12.7% in the same period last year.
• Management raised the full-year adjusted free cash flow guide to $1.0 billion, up $125 million from the prior guidance. Management expects strong free cash flow generation to continue in 2025.
• Cash was $908.7 million and debt of $2.931 billion compared to $579.7 million and $2.935 billion in Q2. Net leverage ratio has come down to 1.4x from 2.4x in the same period last year.

Key Metrics

Backlog

The backlog at the end of Q3 was $7.4 billion, up 47% year over year and 5% quarter over quarter. Expansion in all three regions helped drive the strong growth in backlog. As seen below, the 47% rate for the backlog is particularly high and is more than double the rate of revenue growth.

TTM Orders Grow 37% YoY

Management introduced a trailing twelve-month metric last quarter. The CEO said in the Q2 earnings call, “This quarter, we have introduced a trailing 12-month orders metric. As we have previously highlighted, there can be a natural variation to the timing of large orders in any quarter. Trailing 12-month is a good metric to assess order activity, smoothing some of the quarter-to-quarter push and pulls.”

The trailing twelve-month orders grew by 37% YoY and were consistent with 37% TTM growth at the end of the second quarter. Q3 orders grew by 17% and were lower than 57% growth in Q2. Management has tried to temper expectations of such high order growth as previously seen this year: “We've enjoyed extremely strong orders in the first half of 2024 and we would agree that continued approximately 60% order increases are unlikely as we tried to say last quarter.” This also helps illustrate why the company is moving to TTM reporting metric.

Earnings Call:

Backlog Elongation:

Given the backlog is growing at more than double the rate of revenue, there were quite a few questions about the backlog and pipeline on the earnings call. Most of them were too forward-looking for management to answer to, however, one question in particular was insightful in terms of Vertiv continuing to have pricing power. It’s also insightful as the analyst is implying the strong backlog may be coming from deals that are elongating from 9-15 months to 12-18 months; this makes sense if we generally apply what we know about Blackwell coming in H1 2025 and these systems being more complex, perhaps requiring a longer sales cycle.

“Noah Kaye

All right. Thank you. And just to piggyback on this, Gio, for the last few quarters you talked about the elongation in order to revenue conversion cycle times for cloud and colo. And that's supporting some of the strength and visibility you have going into 2025. But just what drives your confidence in remaining price cost positive in 2025 given that longer conversion cycle?

Giordano Albertazzi

When we were talking, first of all, thanks for the question, Noah. When we think in terms of the elongation, we were talking about the elongation happening de facto and specifically for the cola and large cola and hyperscale. And that elongation was at 12, was, let's say from the 9, 15 months to the 12, 18 months. So it's not a dramatic elongation. We're talking about a three-month elongation. So we have good visibility on our pipelines. We have of course, very good visibility on our backlog. We have visibility on the price elements of that backlog and pipeline. We have good visibility on the cost side of the equation. And the cost side of the equation, of course, is very, very important. So combine the two, enhance our continued reiterated statement that we believe price cost to continue to be favorable.”

“Resounding Yes” to Higher Q4 Pipeline:

Although pipeline is not an official key metric offered, an analyst dug around for information on how Q4 is shaping up to which the CEO was quite emphatic is better than Q3. The analyst also asked more about lead elongation but the CEO is clearly referring to Blackwell’s arrival being the impetus.

“Michael Elias

Great. Thanks for taking the question. Two quick ones, if I may. First, I want to be absolutely clear. Are you saying that your demand pipeline entering 4Q is higher than the levels you saw entering 3Q? That's my first question.

And then second, I just want to revisit a prior question related to like elongating lead times. One of the things that we're seeing in the data center market is that as the preleasing window elongates and we go further out, the lower pricing that, that data center capacity is commanding. So as I think through the equipment side, does it stand to reason that as the customer lead time elongates, Vertiv actually has less pricing power in the conversation? Any color there would be helpful. Thank you.

Giordano Albertazzi

Well, thank you, Mike. The answer to the first question is if – the answer is yes. I was just trying to think about the formulation. But yes, that pipeline entering Q4 is higher than the pipeline entering Q3, no doubt. So that is a resounding, yes.

When it comes to the elongated lead times, we do not necessarily see a correlation between lead time elongation. And again, I want to remind everyone it's not a lead time elongation because of Vertiv's need to elongate lead time. So we can, most of the time deliver on shorter lead time on their request. But simply because of lead time gets elongated because that is consistent with our customers, project plans and schedules.”

Production Capacity:

It’s important to make a quick note here that capacity is something Vertiv remains confident on, which is where rival Super Micro may become weak due to cash constraints. According to the Investor Event: “But sometimes, if we go back to some of the earnings call, we talked about, yes, do you have capacity? How much capacity are you making available? Oh, I said, "Hey, we always have this 20%, 25%, 30% wiggle room. That's the way we think about capacity being made available […] And a year from now, we will have a similar probably bigger and more impressive list of all improvements of all the capacity that has been — that will be created. But it is about new factories. New factories in India, new factories in the U.S. opened this year. It's about operating and starting production. Example, for liquid cooling, virtually — actually, not virtually in every continent in which we operate.”

Conclusion:

AI power demand is forecast to rise at a rapid rate. GPU demand is showing no signs of slowing as Big Tech continues to spend billions on AI infrastructure, and each new GPU generation is seeing higher peak power consumption. The industry is quickly taking steps to address this, and power consumption, or more specifically, power efficiency per chip, looks to be emerging as the third realm of competition.

As we’ve made abundantly clear, the arrival of Nvidia’s Blackwell is the moment when things like thermal management and power distribution become mission critical. It will not only be Nvidia’s Blackwell systems, for example, we recently published on Amazon’s Trn2 systems that will have hundreds of thousands of custom chips (i.e., not GPUs). Yet, Blackwell signals the arrival of a moment when key suppliers will have their turn in the spotlight. Vertiv remains on our list as a top contender and supplier of choice in what will become a marathon for key AI beneficiaries at the hardware level.

Recommended Reading:

• Dell Q3: AI Server Pipeline up 50% QoQ, Yet PCs Soft
• Astera Labs: Hypergrowth AI Networking Stock
• Cloudflare Q3 Earnings Preview: All eyes on the guide
• Micron Q4: Data Center Drives Beat, Profitability Soars

Marvell reported impressive Q3 results that beat revenue estimates by 4% and adjusted EPS estimates by 5.5%, led by strong AI demand. The Q4 guide was an outlier, as it beat revenue estimates by 9.1% and adjusted EPS estimates by 13.5%. Management expects to significantly exceed the full year AI revenue target of $1.5 billion and set the tone the company will easily beat the FY2026 AI revenue target of $2.5 billion.

Marvell also announced an expanded five-year partnership with AWS this week to supply the cloud infrastructure giant with custom Trainium and Inferentia chips. The deal is “multi-generational,” implying Marvell will continue to supply the Trainium2 5nm (Trn2) being released for general availability this week while also supplying the newly-announced Trainium3 (Trn3) on the 3nm process node expected to ship at the end of 2025. Amazon is an investor in Anthropic with plans to build a supercomputing system with “hundreds of thousands” of Trainium2 chips called Project Rainier.

The CEO stated the following when asked for more details on the expanded AWS partnership in the Q&A: “And the announcement we made with AWS is very significant for both companies. For us as a supplier to them, as you pointed out — first of all, it's a five-year agreement. It covers AI custom products as well as a broad range of networking products. It's significant in its — in the revenue that it's going to drive for us. And most importantly, it is multi-generational in nature. So, with this agreement and with these kinds of relationships that we're building with these customers, we have even more confidence than before to achieve our goals that we're driving.”

Financials:

Revenue: 19% Sequential Growth in Q3 and Q4

FQ3 revenue accelerated to 6.9% YoY and 19.1% QoQ growth to $1.52 billion, helped by stronger than expected ramp in the AI custom silicon business. For the next quarter, management expects revenue to grow to 26.2% YoY and 18.7% QoQ to $1.8 billion at the midpoint.

The CEO Matt Murphy said, “The exceptional performance in the third quarter, and our strong forecast for the fourth quarter, are primarily driven by our custom AI silicon programs, which are now in volume production, further augmented by robust ongoing demand from cloud customers for our market-leading interconnect products. We look forward to a strong finish to this fiscal year and expect substantial momentum to continue in fiscal 2026."

Margins:

The gross margin needs to be watched closely as a higher mix of custom silicon will result in a lower gross margin. However, there was a question about this on the call and the CFO remained confident the operating margin will expand. He also stated to expect strong optics and networking growth next year, which are accretive to margins.

There were restructuring charges that weighed on the GAAP metrics. Non-GAAP metrics are more important in this case. Reference the additional paragraph on the restructuring charges below.

• Q3 adjusted gross margin was 60.5% compared to 60.6% in the same period last year, yet  missed the guide of 61% due to higher-than-expected revenue from custom silicon. Management guide for the next quarter is 60% and expects to be about 60% through next year.
• Q3 operating margin was (-46.4%) due to the restructuring charges discussed below. Management guide for Q4 is 10.6%.
• Adjusted operating margin was 29.7% compared to 29.8% in the same period last year. It was better than the management guide of 28.9%. Management guide for Q4 is 33%.
• Net loss was ($676.3 million) or (-44.6%) of revenue compared to ($164.3 million) or (-11.6%) of revenue in the same period last year. The company reported restructuring charges of $715 million.
• Adjusted net income was $373 million or 24.6% of revenue compared to $354.1 million or 25% of revenue in the same period last year.

The CFO also pointed to improvement in the bottom line in the coming quarters. “We see a strong setup for next fiscal year as well. We remain focused on continuing to drive strong operating leverage, expanding our operating margins, bringing down stock-based compensation as a percentage of revenue and efficient cash flow generation to continue to return meaningful cash to shareholders. I'm also pleased with our guidance to return to GAAP profitability in the fourth quarter and we are looking forward to continue to drive improvement in this metric.” 

EPS: 43% Growth QoQ

The company beat on adjusted EPS by 5.5% at $0.43 compared to $0.41 expected. The Q4 GAAP EPS is expected to be $0.16 +/- $0.05 and the adjusted EPS is expected to be $0.59 +/- $0.05.

Per the opening remarks: “As a result, our non-GAAP earnings per share of $0.43 was also well above the midpoint of guidance, growing by 43% sequentially. This earnings growth rate, which was more than doubled our top-line growth rate, highlights the substantial operating leverage in our business model.”

As we look further out, the analyst estimates for fiscal year EPS is expected to grow 75% from FY2025 to FY2026 and then grow another 33% into FY2027.

Restructuring Charges:

The company reported restructuring charges of $715 million in Q3. Management mentioned that restructuring charges are essentially behind them now and that these investments are aimed at focusing on the fast-growing AI data center segment.

The CEO said in the earnings call, “In the third quarter, we made decisions to further solidify and purposefully redirect our investments towards data center relative to our other end markets. These actions resulted in a restructuring charge in the third quarter. The goal of these actions is to increase our R&D intensity towards the data center, our largest and fastest growing opportunity, while continuing to drive significant operating leverage going forward.”

The CFO further said, “As Matt mentioned in his prepared remarks, in the third quarter, we made additional decisions to further redirect investments towards the data center. This resulted in an aggregate restructuring charge of $715 million, which is reflected in our GAAP results for the third quarter. The two largest components were impairment charges for acquired intangible assets and certain purchased technology licenses and their future contractual obligations.

I would also note that approximately three quarters of these restructuring charges are non-cash in nature and that the aggregate restructuring charges are now largely behind us. These charges are a reflection of the fact that we have invested significantly in updating our enterprise and carrier product portfolios over several years and we plan on more targeted investments in these end markets going forward.”

Cash Flow and Balance Sheet

Operating cash flow margin of 35.4% is flat YoY with $536.3 million in operating cash flow this quarter. The free cash flow of $460.8 million resulted in margin of 30.4%. The company has $868 million in cash on its balance sheet and $4.1 billion in debt.

 Inventory decreased from 98 days to 67 days for total inventory of $859 million.

Key Segments 

Data Center

 Data center revenue of $1.1 billion grew 98% YoY and grew 25% sequentially. Management stated: “We are seeing strong custom AI demand continue into the fourth quarter and have secured supply chain capacity to support our customers' growth forecasts.”

Marvell’s data center revenue accounts for 73% of revenue and the CEO stated he “expects this percentage to increase again in the fourth quarter.”

Per the opening remarks: “AI continues to lead the way, enabling our data center revenue to almost double year-over-year in the third quarter, and we expect it to continue driving strong growth in the fourth quarter. With three quarter of strong AI results under our belt for this fiscal year and an even stronger fourth quarter forecast, we are clearly set to significantly exceed the full year AI revenue target of $1.5 billion, outlined earlier this year at our AI event.”

Marvell’s AI Market Opportunity: Back in April at the company’s AI Day, Marvell laid out a TAM of $42 billion for custom silicon by CY2028, of which the CEO believes Marvell will take 20% market share. This totals about $8 billion for its custom silicon AI opportunity. Assuming that materializes, the CEO is essentially forecasting 700% growth in custom silicon if we assume $1 billion is from ASICs and $500 million is from networking. Earlier, the CEO stated it was roughly half-and-half between their two AI-related segments. There is a significant customer expected to ramp in 2026, and I suspect we will see a new forecast when the company can more openly talk about an official announcement. On the networking side, the TAM is another $31 billion.

Here is an analyst note that echoes how Marvell’s current TAM forecast may be too low:

“Oppenheimer analyst Rick Schafer thinks that each of Marvell’s four custom chips could achieve $1 billion in sales next year. Production is already ramping up on the Trainium chip for Amazon, along with the Axion chip for the Google unit of Alphabet. Another Amazon chip, the Inferentia, should start production in 2025. Toward the end of next year, deliveries will begin on Microsoft’s Maia-2, which Schafer hopes will achieve the largest sales of all.”

Enterprise Networking and Carrier Infrastructure:

The carrier infrastructure segment saw revenue of $84.7 million, and was down (73%) YoY yet was up 12% QoQ. Enterprise networking was down (44%) YoY and was flat QoQ.

Per the opening remarks: “We began to see a recovery in both of these end markets, with revenue collectively growing 4% sequentially. We expect the pace of recovery to accelerate in the fourth quarter with aggregate revenue from enterprise networking and carrier infrastructure forecasted to grow sequentially in the mid-teens on a percentage basis.”

Consumer End Market:

Consumer was down (43%) yet was up 9% QoQ. Next quarter, the forecast is weak due to gaming: “Looking ahead to the fourth quarter, we expect revenue from the consumer end market to decline sequentially in the mid-teens on a percentage basis. This is due to seasonality in gaming demand, which typically weakens in our fourth quarter, bottoms out in our first fiscal quarter and then begins to rebound in the second quarter.”

Automotive/Industrial:

The automotive/industrial segment was down (22%) yet was up 9% QoQ. The segment is expected to grow sequentially in the low-to-mid single digits next quarter. 

Earnings Call:

Newly Launched 3nm 1.6T DSP (Nvidia Supplier):

The new 3nm Ara PAM4 DSP was announced this week with Marvell being first-to-market with a 3nm 1.6T interconnect. This follows Marvell being the first-to-market with a 5nm 1.6T interconnect. Overall, these interconnects help to reduce power requirements by 20% while enabling higher bandwidth and performance. This is especially important as data centers are currently power constrained. In the press release, the company stated: “We anticipate unit shipments of PAM4 DSPs will more than triple from 2024 to 2029 to nearly 127 million units a year and remain the primary optical technology for connecting assets inside data centers for the foreseeable future.”

As discussed in our July write-up (worth a read under the Quick refresher on Marvell’s Products): Nvidia is a lead partner on the 1.6T solution with the 1.6T being an upgrade from the 800GB, driven by AI workloads needing higher bandwidth: “Artificial intelligence and machine learning drive demand for the 800-gig PAM to increase the speed of input-output and to process the data flows. This doubles the throughput (bandwidth) due to an 8x100Gpbs optical transceiver for inside and between AI clusters.”

In the earnings call, there was an inspiring moment when the CEO was asked how Marvell is able to put be first-to-market with Ara, after being first to market with Nova the 5nm 1.6T electro-optic eighteen months ago. This is what he said:

“And I can tell you, when you enter an inflection in a growth market, the company with the best and leading technology that's available, you can sample it, it works, is going to win. It's that simple.

And so, our team, which is the best in the world at what they do, is heads down focused on driving best possible solutions, the best TCO, the best power and highest performance in the latest process node. And you're going to see that continue across Marvell, but particularly in this area of DSPs and broadband analog and the chipsets that we sell, we intend to maintain our market-share leadership and extend that and be the supplier of choice. So that's — it's as simple as that. We're going faster.”

There was a question from an analyst on tariffs, but the CEO shrugged off the concern and stated the 1.6T DSPs and the 800GB DSPs will continue to be a strong contributor next year.

“So, we continue to be diligent here and monitor, but as it appears right now, demand is strong, bookings continue to be strong, visibility is great. We expect that business to grow significantly for us. Next year, on the 1.6T as it relates to that, that will be part of the growth we see next year. We're shipping that product now into production. It will be a contributor next year, but I don't want to take away from the very strong 800-gig cycle that will continue to be driven through our fiscal '26 next year.”

Margins:

It’s no secret that Marvell is weaker on margins than its peers. As custom silicon ramps, this will weigh on the gross margin. However, the CFO pointed out the company has plans to increase its operating leverage next quarter to minimize the impact. It was also pointed out that the optics business is expected to help offset some of the gross margin weakness from the custom program.

Here is what was said regarding operating margins:

“In terms of the leverage, when you look at our Q3 results, we came in at around 30% OEM. And even with gross margin guide down about 0.5%, our operating margin is actually up to 33%, so up by 3%. And so, when you look at our OpEx control, you should expect us to continue to have a very significant focus on levers through next year with the top-line outgrowing OpEx right through next year. And so, really should see a very nice increase in our operating margin through next year, really starting to approach the bottom end of our long-term range towards the end of next year.”

Conclusion:

Nobody deserves a win on Marvell more than the I/O Fund. We have tracked this stock closely, counting 15 analyses in the last five years. We foresee Marvell becoming a larger position in 2025, and we foresee that position increasing in our portfolio again come 2026. Marvell is a market leader in electro-optics, which should become more evident as Blackwell ships in volume next year. In custom silicon, the company is certainly the underdog when it comes to heavyweight Broadcom, yet there will be diversification across AI suppliers with Marvell being a smaller, lesser-known stock sitting on an immense AI opportunity.

Recommended Reading:

• Marvell Q2 Earnings: Rebound in the Cards
• Marvell: Tons of AI Potential Obscured by Underperforming Segments
• Marvell and Inphi: Acquisition Analysis
• Marvell Technologies: 2019 Analysis
• Astera Labs: Hypergrowth AI Networking Stock

Dell reported a soft Q3, with revenue missing estimates and Client Solutions revenue declining YoY. AI optimized server orders were a bright spot in the quarter with orders rising nearly 13% QoQ to $3.6 billion; however, AI server shipments declined sequentially by 6.5% QoQ.

Despite the strength of AI orders and Dell’s AI pipeline, Dell guided Q4 revenue $1 billion below consensus at midpoint due to a delayed PC refresh cycle. The guide for next quarter was $24 billion to $25 billion, or $24.5 billion at the midpoint compared to analyst expectations of $25.6 billion. The soft PC market is not news to our firm, as it’s something we covered closely in our Q4 webinar.

It’s generally understood that Dell’s participation in building rack scale solutions for the Blackwell generation of GPUs is what makes the stock investable, as opposed to the Hopper generation, where Dell did not participate with hyperscaler customers quite like Super Micro did. There is evidence that Dell will become a leading AI server company next year with a 50% QoQ increase in the five-quarter pipeline, from $11B to $13B last quarter to somewhere between $16 billion and $18 billion. If we read between the lines, Dell’s current AI server backlog is $4.5B but they are guiding for a $6B increase in the pipeline from one quarter alone, which means the backlog is slated to accelerate from here.

Revenue

Dell reported $24.37 billion in revenue in the third quarter, rising 9.5% YoY. This was short of the consensus estimate of 11.1% growth for $24.72 billion. AI growth was most visible in the quarter, with COO Jeff Clarke saying: “Interest in our portfolio is at an all-time high, driving record AI server orders demand of $3.6 billion in Q3 and a pipeline that grew more than 50%, with growth across all customer types.”

This comment is a bit vague, but in the Q&A, an analyst pinpointed the 50% QoQ growth implies $16.5B at the midpoint for the five-quarter pipeline – although back of the napkin math places it potentially higher, up to $19.5 billion on the high end: “I think last quarter you said it was multiples of backlog, which would have put it at $11 billion to $13 billion. And you said it grew 50% sequentially. So are we looking at a backlog that's a pipeline, excuse me, that's like $16 billion or $17 billion.”

Revenue growth failed to return to the double digits as expected in the quarter, but the major shortfall was Q4, with management guiding for revenue between $24 billion and $25 billion. At midpoint of $24.5 billion, this was just over $1 billion below the consensus estimate for $25.54 billion, and represents growth nearly 5 points slower, at 9.8% YoY versus the 14.5% expected.

The PC refresh being pushed out to next year and the timing of AI servers is the reason for the softer guide – here was the full explanation: “I'd say we did bring Q4 revenue guidance down, as you mentioned, Toni, and it's basically those two elements. PCs, it's not a matter of if the repurchase is going to happen, it's when, and we're seeing that move more into next year and then the unpredictability of the AI shipments. And so putting those two things together, we feel strong about the overall performance in Q4, but there's some more timing differences than what we were anticipating when we gave the guide the last quarter.”

Key Operating Segments

Infrastructure Solutions Group

Dell’s ISG segment dipped slightly QoQ, as servers and networking revenue declined sequentially. AI server shipments also declined QoQ, falling from $3.1 billion in Q2 to $2.9 billion in Q3, despite orders rising nearly 13% QoQ to $3.6 billion and backlog rising more than 18% QoQ to $4.5 billion.

ISG revenue of $11.37 billion rose 34% YoY, at the upper end of management’s forecast for low-30% growth, but declined (2%) QoQ.

Growth continues to be driven by servers and networking, with revenue increasing 58% YoY to $7.36 billion. However, this represented a (4%) QoQ decline for the segment and a 2200 bp deceleration in growth rate from Q2’s 80% YoY.

As stated from the CFO, the timing of AI servers played a role in this sequential decline for the segment, as AI server shipments declined (6.5%) QoQ to $2.9 billion, down from $3.1 billion in Q2. This was nothing out of the ordinary, as Dell had said last quarter that AI servers would be down quarter-over-quarter. However, analysts were expecting some higher numbers for shipments, with Evercore expecting $3.1 billion in shipments in the quarter.

Management also noted that their “AI server pipeline grew over 50% sequentially with growth across both Tier 2 CSPs and Enterprise customers.” Outside of AI, traditional server demand also remained quite strong, with management seeing YoY growth for the fourth consecutive quarter.

Per the CFO: “In Traditional servers, demand improved double-digits in Q3, making four consecutive quarters of year-over-year growth, driven by growing units and ASPs with denser core counts, memory, and storage per server.”

ISG’s profitability also improved in Q3, with the segment’s adjusted operating income of $1.51 billion for a margin of 13.3%. This marked a 230 bp expansion from 11% in Q2. Management noted in Q3’s call that ISG’s profitability is expected to continue next quarter. Per the CFO: “OpEx is expected to decline [next quarter] mid-single-digits as we continue to drive efficiencies in the business. We expect the operating income rate to be up sequentially with continued improvement in ISG.”

Client Solutions Group

CSG was Dell’s weakness in the quarter, with revenue in the segment declining (1%) YoY, falling short of management’s guidance for flat to low single digit growth.

CSG revenue was $12.13 billion, down (1%) YoY and (2%) QoQ, falling short of the $12.42 billion estimated by analysts. Commercial revenue increased 3% YoY but declined (4%) QoQ to $10.14 billion, with Dell saying that Q3 was the third consecutive quarter with Commercial demand growth and the second consecutive quarter where they gained share in premium PCs. Consumer revenue was weaker, declining (18%) YoY but rebounded 5% QoQ to $1.99 billion.

Given the strength in AI, PCs are likely to be weak in Q4, and a primary driver of the soft revenue guide.

Margins

Margins improved across the board sequentially, with Dell beginning to show signs of improved profitability as cost-cutting impacts appear. There still is room for improvement, however, as gross margins remain lower YoY.

Analysts were pleased that ISG operating income was up QoQ to 13.3% of revenue, an improvement of 230 basis points since last quarter and up 530 basis points from the beginning of the year, driven by higher gross margin from servers and reduced opex.

• GAAP gross margin in Q3 was 21.8%, up 60 bp QoQ but down 130 bp YoY. Adjusted gross margin was 22.3%, up 50 bp QoQ but down 140 bp YoY. This is a key differentiator compared to Super Micro with a gross margin of 11% last quarter.
• GAAP operating margin was 6.8%, up 140 bp QoQ and 10 bp YoY. The YoY growth stems from cost-cutting efforts, with operating expenses declining 140 bp YoY to 15.0% of revenue. Adjusted operating margin was 9.0%, up 90 bp QoQ and 20 bp YoY.
• GAAP net margin was 4.6%, up 120 bp QoQ and 10 bp YoY. Adjusted net margin was 6.3%, up 80 bp QoQ and 10 bp YoY.

EPS

Despite the top line miss, Dell beat estimates for GAAP and adjusted EPS due to the margin strength in the quarter.

• Adjusted EPS of $2.15 beat estimates by 4.4%. Adjusted EPS growth accelerated to 14.4% YoY in the quarter, up from 8.6% last quarter. Growth is expected to accelerate further to nearly 50% YoY by fiscal Q1 before moderating to the high-teens.

• GAAP EPS of $1.58 beat estimates by 13.7%.

Cash and Balance Sheet

Operating cash flow margin expanded once again sequentially, though cash flows remain much lower on a YoY basis.

• Operating cash flow was $1.55 billion in Q3, declining nearly (28%) YoY but rebounding 16% QoQ. OCF margin was 6.4%, expanding 100 bp QoQ but contracting 330 bp YoY.
• Adjusted free cash flow was $716 million, down (17%) YoY and (44%) QoQ. Adjusted FCF margin was 2.9%, down 220 bp QoQ and 100 bp YoY.
• Inventories reached $6.65 billion in Q3, rising ~$600 million sequentially. Since the end of FY24, inventories have increased just over $3 billion, or nearly 84% growth in three quarters.
• Cash, equivalents and investments totaled $5.23 billion.
• Debt totaled $25.02 billion.

The company repurchased 3.7 million shares of stock for an average price of $107.53.

Earnings Call:

Dell’s Rack Scale Systems

In the call, the company discussed the IR7000 server, which will include up to 144 GPUs per rack, which is double the size of Nvidia’s NVL72. Dell also plans to release the PowerEdge XE9586L with u up to 96 Blackwell GPUs and AMD’s 5th Generation GPUs and up to 12 PCIe5 slots. The PowerEdge M7725 offers up to 27,000 CPU cores and is powered by AMD 5th Generation CPUs to deliver more compute in less space.

Most of these new rack scale solutions will ship in Q1 and Q2 of calendar year 2025.

Below is the full quote as this is key to understanding why Dell should have a strong year next year:

“We have accelerated the speed of innovation to respond to our customers' GenAI needs over the past year. A few highlights from the past two months. We launched our 21-inch ORv3 Integrated Rack 7000, in both a 44 and 50 OU rack design with integrated cooling, power and networking that is multi-generational and future-proofed up to 480 kilowatts per rack.

This rack falls in our Integrated Rack Scaleable Solutions, which are focused on at-scale deployment ensuring Dell's AI Factories can meet the demands of foundational training at the Data Center scale. We are shipping the industry's first enterprise ready GB200 NVL72 server racks with our new XE9712, with direct liquid cooling that holds up to 72 GPUs per rack.

We also announced at SuperCompute 24 a new AI server supporting NVL-4, also with liquid cooling, supporting up to 144 GPUs per rack, one of the industry's most dense designs. And we have the M7725, a dense compute design, which supports up to 27,000 CPU cores per rack to meet high-performance computing demands.

Our IR5000 can achieve up to 96 GPUs per rack with a more traditional 19-inch rack design. Within the IR5000, which includes the XE9680L, we introduced the XE7740 and XE7745, designed for Enterprise customers focused on inferencing.”

For storage, Dell offers a PowerScale platform for file and object storage, PowerEdge for data analytics, and most recently, has launched a data lake warehouse based on the idea that most data is on-premise and this will only intensify with AI.

Management was adamant that storage will become a growth driver for their company: “I mean, I think I've said publicly multiple times that the AI opportunity for storage is immense simply because GPUs devour data. I mean, you have to feed the beast, and they're not very effective without a lot of information” […] “And remember, 80% of the data is on-prem. So we think AI is driving new needs in the storage architecture, which really drive to a three tier architecture. So the ability to scale, the ability to drive efficient deployment of storage, the ability to be flexible and above all high performance are all things required to meet these high performance modern AI workloads and that's what our portfolio is. The Dell IP portfolio is a three tier architecture moving towards disaggregated that allows us to scale CPU and storage and networking independently to optimize for performance.”

PC Refresh Cycle Pushed Out to Next Year

Dell is contending with a weak PC market, which is weighing considerably on the report after hours. Per management: “More Enterprise customers are beginning to refresh, albeit modest and in a more price competitive environment. We are seeing an indication that customers are lining up their upgrade cycles with new AI PCs in the first half of next year.”

Later it was stated the miss for next quarter was a result of PCs and timing on AI servers:

“Yes. I'd say we did bring Q4 revenue guidance down, as you mentioned, Toni, and it's basically those two elements. PCs, it's not a matter of if the repurchase is going to happen, it's when, and we're seeing that move more into next year and then the unpredictability of the AI shipments. And so putting those two things together, we feel strong about the overall performance in Q4, but there's some more timing differences than what we were anticipating when we gave the guide the last quarter.”

Dell Surprises on Margins; An Area to Watch

This quarter, Dell surprised with better-than-expected margins. This is key, as before Super Micro became the target of short seller reports and accounting issues, we stepped aside due to margin issues and cash flow issues.

Tariffs could impact margins although the CFO stated they are not foreseeing margin issues at this time from tariffs: “So I can talk a bit about the Q4 guide and we have taken into account in that guide the mix within AI and expecting, but expecting those margins, which I know we don't talk about holistically, but expect them to stay relatively consistent. So the mix would be what's driving there. We've talked about AI revenue and our offerings being margin dollar accretive and margin rate dilutive.”

This was also a strong statement in terms of why margins may remain higher than competitors: “Per the CEO: “I think we've tried to reflect that in our previous comments, but to maybe try to be very specific here, the opportunity is beyond the node into full rack scale integration. And in full rack scale integration, it's the networking opportunity, the storage opportunity, mundane things like cooling and how you actually build very efficient cooling subsystems to take the energy density out, how do we do power distribution, power management, putting telemetry in, doing power management, all of those are opportunities for us to expand our margins and why we believe we have a differentiated solution and ultimately are at a premium to our competitors.

Conclusion:

The I/O Fund is starting to prepare our portfolio for the transformational change to how servers are built – which is breaking the upper limits of what was once thought possible at the server-level. AI-forward enterprises and Big Tech especially is moving from systems with 8 GPUs to systems with 72 GPUs with Dell offering rack scale designs of up to 144 GPUs and also dense compute options with up to 27,000 CPU cores. The way in which Dell will take business from Super Micro is not only in reputation but also in scale.

Dell made it clear they were the first to market with the NVL72 systems, providing a hint of what’s to come. The 5-quarter pipeline growth of 50% QoQ is being overshadowed, and this is the kind of data point our company looks for. Due to the complexity of Blackwell servers, it’s likely key Blackwell suppliers will exceed Nvidia’s stock returns next year. Dell is top of mind on the candidates for this list.

Recommended Reading:

• Dell Q3 Earnings Preview: Riding the AI wave
• Q4 2024 Earnings Kickoff Webinar Replay
• Cloudflare Q3 24: Soft Q4 Guide as Company Transitions on Billing Terms
• Nvidia Q3: Lackluster Quarter until Blackwell Arrives
• Real Vision Video Interview: Will Nvidia Continue to Dominate AI?

Dell will release its Q3 FY25 results on Nov 26. Analysts expect revenue to accelerate from 9.1% in Q2 to 11.1% in Q3 and adjusted EPS to grow 9% to $2.05.

The recent strong Nvidia results are a positive read-through for Dell in the coming quarters. Nvidia’s management suggested strong Blackwell and AI demand. Blackwell production shipments are scheduled for Q4 and are expected to ramp up in 2025. Nvidia’s CFO, Colette Kress, said in the earnings call, “Blackwell demand is staggering and we are racing to scale supply to meet the incredible demand customers are placing on us. Customers are gearing up to deploy Blackwell at scale.”

According to the recent UBS survey, Dell’s storage demand has been up year over year and stronger than that of its competitors. Dell’s all-flash storage demand was rated as strong by 71% of respondents compared to 53% for NetApp, 32% for HPE, and 20% for Pure Storage.

Similarly, another survey conducted by Morgan Stanley suggests that Dell is the best-positioned hardware vendor to capture traditional enterprise spending in the next three years. Analysts highlight the company's AI infrastructure momentum, driven by projected AI server shipments of about $20.6 billion in FY2026, up 56% from the previous forecast. We need an earnings report to confirm the survey results and hear management's AI demand commentary.

Dell also surprised the market with stronger-than-expected margins last quarter. The stock is a quality play compared to Super Micro even before the accounting issues cropped up.

Revenue

The company’s revenue is accelerating due to strong demand for Artificial Intelligence solutions. Management is optimistic about the significant opportunities in Enterprise AI, Tier-2 Cloud Service Providers, and sovereign AI opportunities. Dell is well-positioned to capitalize on these emerging markets by leveraging its existing solid relationships.

FQ2 revenue grew by 9.1% YoY to $25.03 billion. Jeff Clarke, Dell’s COO said in the earnings call, “Our AI momentum accelerated in Q2 and our results and outlook demonstrate that we are uniquely positioned to help customers leverage the benefits of artificial intelligence.”

• Analysts expect FQ3 revenue to accelerate to 11.1% YoY to $24.72 billion and to 14.5% growth to $25.54 billion in FQ4.

• During FQ2 results, management raised its full-year revenue guidance to $95.5 billion and $98.5 billion, representing 10% YoY growth at the midpoint. This is a $1.5 billion increase at the midpoint from the previous guidance, driven by solid momentum in AI servers and networking.
• Analysts expect FY 2026 revenue to grow 8.6% YoY to $105.88 billion and 5.9% YoY to $112.10 billion for FY2027.

Given that Blackwell is expected to ramp significantly this year, and combined with Super Micro likely losing business from its accounting issues, we are foreseeing these estimates being too low by the time we exit next year.

Key Operating Segments

Infrastructure Solutions Group

FQ2 revenue accelerated significantly in the quarter as the segment grew 38% YoY and 26% QoQ to $11.65 billion, accelerating 1600 bps sequentially from 22% YoY growth in Q1. Management guided ISG growth to be in the low 30% range for FQ3, pointing to a slight deceleration sequentially. According to Zacks consensus estimates the revenue is expected to grow 32.7% YoY to $11.28 billion in FQ3.

For the full-year, management has guided for growth to be approximately 30%. Nvidia’s CFO, Colette Kress’s commented during the recent Nvidia’s results that “Both Hopper and Blackwell systems have certain supply constraints, and the demand for Blackwell is expected to exceed supply for several quarters in fiscal 2026.” This explains the fact that the Blackwell revenue will impact Dell’s guidance in the coming quarters.

ISG’s growth in FQ2 was driven by servers and networking, with revenue accelerating to 80% YoY and 40% QoQ to $7.67 billion, a record for the segment. This was a 3700 bps sequential acceleration in the YoY growth rate from 43% in Q1. According to Zacks consensus estimates, the servers and networking revenue is expected to grow 58.7% YoY to $7.39 billion in FQ3.

Storage revenue declined by (-5%) YoY and up 6% QoQ to $4.0 billion. During the earnings call, management mentioned that for FQ3, “Servers will grow in the low-single digits and storage will be down in the low-single digits. So that's relatively normal sequentially.” According to Zacks estimates, storage revenue is expected to grow 1.1% YoY to $3.89 billion. In the opening paragraphs, we discussed that UBS survey results point to better storage demand for the company. We need an earnings report to confirm the survey results.

AI server orders were $3.2 billion in FQ2, up 23% QoQ from $2.6 billion in Q1 as Tier 2 cloud service providers and enterprise customers increased. AI server shipments rose more than 82% QoQ, from $1.7 billion in Q1 to $3.1 billion in Q2. Growth also extended beyond AI to traditional servers, as traditional server demand rose YoY for the third consecutive quarter and rose QoQ for the fifth consecutive quarter.

Management had said during the earnings call Q&A that the AI servers would be down quarter-over-quarter. Evercore analyst note sounded more optimistic and expects the company to ship over $3.1 billion AI servers in FQ3, ahead of the management expectations due to the intra-quarter Tesla pull-ins and the expansion of xAI’s Colossus cluster. They also expect the backlog to remain between $3 billion and $4 billion for FQ3.

ISG’s adjusted operating margin expanded 300 bps QoQ to 11% in Q2, easing some concerns about AI servers weighing on segment margins. Management maintained its full year view for 11% to 14% adjusted operating margins for ISG, suggesting more upside to margins in the back half of the year.

Client Solutions Group

Client Solutions Group Q2 revenue declined (-4%) YoY but rose 4% QoQ to $12.41 billion. Commercial revenue was flat YoY and up 4% QoQ at $10.55 billion, while Consumer revenue declined (22%) YoY and up 2% QoQ to $1.86 billion. According to Zacks consensus estimates, the Client Solutions Group is expected to grow 0.3% YoY to $12.32 billion, while Consumer revenue is expected to decline by (-15.1%) YoY to $2.07 billion and Commercial revenue to grow 4.2% YoY to $10.24 billion.

The company is expecting growth in CSG in the second half of the year, with growth more concentrated in Q4. Q3 is expected to see flat to low single-digit growth, with management believing the “coming PC refresh cycle and the longer-term impacts of AI will create tailwinds for the PC market.” For the full-year, CSG is expected to also be “flat to low single digits for the year.” Recent data from Canalys showed strong AI PC shipments totaled 13.3 million, up 49% QoQ and accounting for 20% of PC sales in the third quarter signals a positive read-through for the Client Solutions Group.

Margins

The company’s margins remained resilient despite gross margin contracting, as Dell faces some competitive pressure and headwinds from increased AI server mix. Margins are expected to improve with a higher proportion of storage revenue in the second half of the year, as well as cost-cutting initiatives like reducing workforce.

• FQ2 gross margin was 21.2% compared to 23.5% in the same period last year. Adjusted gross margin was 21.8% compared to 24.1% in the same period last year. For the FY25 management has guided for adjusted gross margin to decline 180 bps YoY to 22.5% due to inflationary input costs, competitive environment, and higher mix of AI optimized servers.
• Operating margin improved to 30 bps YoY to 5.4%. Adjusted operating margin declined by 50 bps YoY to 8.1%, helped by higher revenue and lower operating expenses, offset by lower gross margins. Management expects FQ3 operating expenses to be $3.6 billion, down (-9.3%) sequentially and adjusted operating expenses to be $3.3 billion, down (-3.8%) sequentially.
• For the FY25 management expects operating margin to improve 60 bps YoY to 6.5% and adjusted operating margin to decline slightly by 10 bps to 8.6%.
• Net margin was 3.4% compared to 2.0% in the same period last year and adjusted net margin was 5.5% compared to 5.6% in the same period last year.

EPS

EPS growth rate is expected to accelerate in the coming quarters.

• Management has guided FQ3 GAAP EPS in the range of $1.43 to $1.63 and adjusted EPS in the range of $1.90 to $2.10. Analysts expect adjusted EPS to grow 9.0% YoY to $2.05 in FQ3.
• Adjusted EPS is expected to accelerate to 20.8% growth and 49.8% growth in the subsequent two quarters.

• Management raised the mid-point range of FY2025 adjusted EPS by $0.15 to $7.80.
• Analysts expect FY25 adjusted EPS to grow 10.5%, followed by 19.8% and 14.6% in the subsequent years.

Cash Flow and Balance Sheet

Cash flows were lower in FQ2 due to higher working capital requirements.

• Operating cash flow was $1.34 billion or 5.4% compared to 14% in the same period last year.
• Adjusted free cash flow was $1.28 billion or 5.1% of revenue compared to 13.3% in the same period last year.
• Cash and investments were $5.85 billion and debt of $24.52 billion compared to $7.12 billion and $25.48 billion at the end of FQ1. The core leverage ratio was down to 1.4x from 1.5x in FQ1.
• The company repaid $1 billion in debt during FQ2. It also repurchased shares worth $712 million and paid $316 million in dividends.

Other Key Points

Positive Blackwell comments from Nvidia management

Nvidia’s CEO Jensen Huang said in the recent Q3 earnings call, “Blackwell production is in full steam. In fact, as Colette mentioned earlier, we will deliver this quarter more Blackwells than we had previously estimated. And so the supply chain team is doing an incredible job working with our supply partners to increase Blackwell, and we're going to continue to work hard to increase Blackwell through next year. It is the case that demand exceeds our supply and that's expected as we're in the beginnings of this generative AI revolution as we all know.

And so Blackwell demand is very strong. Our execution is on — is going well. And there's obviously a lot of engineering that we're doing across the world. You see now systems that are being stood up by Dell and CoreWeave, I think you saw systems from Oracle stood up.”

Jeff Clarke, Dell’s COO, had announced earlier this month that Dell had started shipments of servers based on Nvidia's Blackwell GPUs. The servers, which are aimed at enterprises, use liquid-cooled PowerEdge XE9712 racks.

Dell was mentioned before HPE and Super Micro is another positive read-through from Nvidia’s earnings call.

“And in terms of how much Blackwell total systems will ship this quarter, which is measured in billions, the ramp is incredible. And so almost every company in the world seems to be involved in our supply chain. And we've got great partners, everybody from, of course, TSMC and Amphenol, the connector company, incredible company, Vertiv and SK Hynix and Micron Spill, Amkor and KYEC and there's Foxconn and the many the factories that they've built and Quanta and Wiwynn and gosh, Dell and HP and Super Micro, Lenovo and the number of companies is just really quite incredible, Quanta. And I'm sure I've missed partners that are involved in the ramping up of Blackwell, which I really appreciate. And so anyways, I think we're in great shape with respect to the Blackwell ramp at this point.”

Super Micro Woes

Dell is also expected to benefit from the recent challenges faced by Super Micro. According to an article from Tomshardware Elon Musk’s xAI has reportedly shifted $6 billion of AI server orders to its rivals.

Valuation

Dell is trading at a P/E ratio of 26.26 and a forward P/E ratio of 18.31, higher than the average P/E ratio of 13.24. Similarly, it trades at a P/S ratio of 1.15 and a forward P/S ratio of 1.04, higher than the average P/S ratio of 0.47.

Conclusion

Dell is a beneficiary of the AI server opportunity. The recent Nvidia management comments allayed investor fears about Blackwell delays. The company is also expected to benefit from Super Micro issues, which is another catalyst for the stock. In FQ2 the company eased some concerns about AI servers weighing on ISG segment margins and we continue to monitor the margins in the coming quarters.

Due to timing of Blackwell, we added to our position as we may be a hair early but not by much, the risk to us is greater in missing out on Dell becoming the leader in AI servers at the very time that AI servers go through an important transition toward complex AI systems with up to 36 CPUs and 72 GPUs combined.

 Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

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Nvidia once again posted a $2 billion beat to revenue estimates, reporting YoY growth of nearly 94% to over $35 billion in revenue. Data center revenue more than doubled in the quarter to over $30 billion, speaking volumes as to the level of demand for its GPUs given that Blackwell had not begun to ship in Q3.

Blackwell matters – a lot. As stated in the webinar, the more the team looked at the details of the release, the clearer it has become that 2025 will be Nvidia’s year – again. Some of this was covered in the pre-earnings write-up published this morning.

On the positive side:

• Hopper drove the beat that analysts were expecting, with UBS tagging the beat at $2 billion. This did, indeed, materialize in the earnings report. This beat is clearly not lackluster but given the performance of the stock, up about 850% since two years ago when Hopper began to ship, the product cycle is lackluster and not able to reinvigorate the stock.
• My primary message going into tonight’s results was that the I/O Fund is tracking supply chain signals indicating the new generation of GPUs shipping in full volume by mid-2025 (and beginning to ship in the January quarter) will far exceed the GPU sales we saw in 2023 and 2024 combined. This was echoed tonight when Jensen Huang stated: “You see now that at the tail-end of the last generation of foundation models were at about 100,000 Hoppers. The next generation starts at 100,000 Blackwells.”
• The importance of big tech capex was also echoed with the CEO stating we will see $1 trillion in data infrastructure rebuild before he expects to see digestion from the hyperscalers. As Damien on the team helped to point out last week, we are at a quarter-trillion right now. Per the CEO: “I believe that there will be no digestion until we modernize a trillion dollars with the data centers.” That would imply another 3X from here for the remaining three-quarter trillion – not in stock price, but in capex. Presumably, it would mean a higher trajectory for the stock price in terms of valuing that revenue.
• Management debunked the supply chain rumors (which the inaccuracy is getting to be a tad annoying at this point). When asked about supply chain rumors, the CEO stated “Blackwell production is in full steam. In fact, as Colette mentioned earlier, we will deliver this quarter more Blackwells than we had previously estimated.” As expected, Colette Kress was tight lipped and no official number was provided. I have personally found Nvidia’s management style to be to our benefit as they were a closed book two years ago in the quarters that preceded the historic ramp.

What the Street Asked About:

• Despite the rather large top-line beat, margins were relatively in line with guidance, and forecast to contract nearly 2 points sequentially.
• Never underestimate Wall Street’s ability to miss the bigger picture. Analysts on the call cross-examined this 200 bps decline despite Nvidia having an operating margin of over 60% compared to most of the Mag 7 having operating margins at half that. The CFO was clear that following Blackwell, the gross margin will eventually return to its current percentage: “As Blackwell ramps, we expect gross margins to moderate to the low-70s. When fully ramped, we expect Blackwell margins to be in the mid-70s. GAAP and non-GAAP operating expenses are expected to be approximately $4.8 billion and $3.4 billion, respectively.”
• Supply chain constraints: There has been some FUD published by The Information back in August and again this week. Management provided a strong comment to refute these claims, primarily that: “We completed a successful mask change for Blackwell, our next Data Center architecture, that improved production yields.” Yields is what matters here and this comment along with Q4 seeing more Blackwell revenue than previously estimated helps to eliminate these concerns.
• Broadly speaking, there are supply constraints but this is nothing new as it’s been widely understood Blackwell is already sold out for next year.  
• As we close out the year and move into 2025, investors should be prepared to hear about China and tariffs. Per the pre-earnings report, Nvidia has limited exposure at 12.5% yet it’s quite clear with weak SMH and SOXX ETF price action that the market is pricing in this impact. It’s unclear to me today how TSM will be viewed in terms of tariffs given the Arizona plant is up and running. You can view our webinar clip here regarding SMH.

Fiscal Q3 2025 Results:

As stated, Hopper drove the beat that analysts were expecting, with UBS tagging the beat at $2 billion. However, due to declining from peak revenue growth of 265% earlier this year, Hopper-driven growth of 94% is not what will drive the stock up for the next leg higher. Nvidia investors, such as myself, will need Blackwell’s pricing power and Blackwell’s clear demand signals to re-invigorate the stock.

As stated, the one weak link of the report was Q4’s margin guidance, with management pointing to potential contractions down the line as Blackwell ramps.

Revenue

Nvidia reported 93.6% YoY growth to $35.08 billion in revenue, well ahead of the consensus estimate for $33.13 billion (83% YoY). Nvidia is now lapping its peak growth quarters, Q3 FY24 to Q1 FY25, where revenue more than tripled each quarter as Hopper ramped tremendously fast. Management said in Q3 that the H200 “grew significantly in the quarter.”

Growth technically is decelerating nearly 30 points in Q3 and growth will further decelerate nearly 24 points next quarter, but to be reporting above 93% YoY and almost 70% YoY versus 200-260%+ growth comps is a strong report to say the least.

For Q4, management guided for revenue of $37.5 billion, +/- 2%, just slightly ahead of consensus estimates for $37.02 billion at the midpoint. Management noted that they have “completed a successful mask change for Blackwell…that improved production yields. Blackwell production shipments are scheduled to begin in the fourth quarter of fiscal 2025 and will continue to ramp into fiscal 2026.”

Both Hopper and Blackwell will be shipping in tandem, placing more emphasis on supply constraints moving forward, as management was clear in saying that both products have “certain supply constraints” with Blackwell’s demand “expected to exceed supply for several quarters in fiscal 2026.”

China revenue was 15.4% of revenue compared to 12.7% year-to-date. This is down from the low-20% range last year.

Key Segments

It should be of no surprise that data center revenue beat estimates in the quarter, but what’s interesting is that the segment posted the largest surprise relative to estimates since Hopper’s breakout quarter in FY24.

Data center revenue of $30.77 billion increased 112.0% YoY and 17.1% QoQ, beating estimates by $1.95 billion. Assuming a similar mix as the current quarter, Q4’s data center revenue would be implied to be nearly $32.5 billion.

In the segment, data center compute revenue was $27.64 billion, rising 132% YoY and 22% QoQ. Networking revenue increased 20% YoY but declined (15%) QoQ to $3.13 billion – this slowed sharply from 114 % YoY growth in Q2.

Management said networking growth was driven by Ethernet for AI; “NVIDIA Spectrum-X Ethernet for AI revenue increased over 3 times year-on-year and our pipeline continues to build with multiple CSPs and consumer Internet companies planning large cluster deployments.” It was also indicated that networking would resume sequential growth next quarter: “So this quarter is just a slight dip down and we're going to be right back up in terms of growing. They're getting ready for Blackwell and more and more systems that will be using not only our existing networking but also the networking that is going to be incorporated in a lot of these large systems that we are providing them to.”

• Gaming revenue of $3.28 billion increased 15% YoY and 14% QoQ, driven by GeForce RTX series 40 GPUs and game console SoCs.
• Pro Viz revenue of $486 million increased 17% YoY and 7% QoQ, driven by the ramp up of RTX GPU workstations.
• Automotive revenue of $449 million increased 72% YoY and 30% QoQ, accelerating 35 bp QoQ from 37% YoY growth in Q2, driven by Nvidia’s self-driving platform.
• OEM and other revenue of $97 million increased 33% YoY and 10% QoQ.

Margins

Despite the rather large top-line beat, margins were relatively in line with guidance, and forecast to contract nearly 2 points sequentially. This forecasted weakness as Blackwell ramps may be one of the factors behind the initial post-earnings sell-off, with GAAP operating margin seen coming back towards 60%.

• GAAP gross margin was 74.6%, just ahead of guidance for 74.4%. Adjusted gross margin was 75%, in line with guidance. This reiterated our view from last quarter that Q1 was the peak for gross margins, as margins have contracted about 380 bp since then.
• For Q4, management guided for GAAP gross margin of 73%, +/- 0.5%, and adjusted gross margin of 73.5%, +/- 0.5%, for a sequential contraction of ~150-160 bp.
• GAAP operating margin was 62.3% in Q3, increasing slightly from 62.1% in the prior quarter but up from 53.1% in the year ago quarter. Adjusted operating margin of 66.3% dipped slightly from 66.4% in Q2, but increased from 64.8% in the year ago quarter.
• For Q4, similar to gross margins, management guided for sequential contraction based on operating expense forecasts. GAAP operating margin is implied to be 60.2%, while adjusted operating margin is implied to be 64.4%, or about a 200 bp sequential contraction. 

• GAAP net margin was 55.0%, down from 55.3% last quarter but up from 51.0% in the year ago quarter. Adjusted net margin was 57.0%, up from 56.4% last quarter and 55.3% in the year ago quarter.

  While it may seem like a small difference, putting it to the scale of revenue growth will show that net income has more than doubled YoY – GAAP net income was $19.31 billion in Q3, up from $9.24 billion last year despite only a 4-point margin expansion.

• GAAP EPS of $0.78 beat estimates by $0.08, and represented YoY growth of 111%. Adjusted EPS of $0.81 beat estimates by $0.06 and represented YoY growth of 103%.

Cash and Balance Sheet

Cash flows remained strong in the quarter, with operating and free cash flow margins both expanding sequentially.

• Operating cash flow was $17.63 billion, rising 141% YoY and 22% QoQ. OCF margin was  50.3%, expanding from 48.2% last quarter and 40.5% last year; to note, this remains below the 58.9% margin from Q1.
• Free cash flow was $16.79 billion, rising 138% YoY and 25% QoQ. FCF margin was 47.9%, up from 44.9% last quarter and 38.9% in the year ago quarter.
• Inventories totaled $7.65 billion, increasing nearly 60% YoY and more than 14% QoQ. Purchase commitments and obligations for inventory and capacity also rose 4% QoQ to $28.9 billion. Capacity and supply pre-payments were $5.2 billion, reaffirming that Nvidia is well prepared to launch Blackwell in full-force.
• Cash and equivalents totaled $38.49 billion, while debt totaled $8.46 billion.

Earnings Call:

To elaborate on the margin concerns, here was an exchange in the Q&A:

Timothy Arcuri:

“[…] And then Colette, you kind of talked about Blackwell bringing down gross margin to the low-70s as it ramps. So I guess if April is the crossover, is that the worst of the pressure on gross margin? So you're going to be kind of in the low-70s as soon as April. I'm just wondering if you can sort of shape that for us. Thanks.”

Colette Kress

Sure. Let me first start with your question, Tim. Thank you regarding our gross margins, and we discussed our gross margins as we are ramping Blackwell in the very beginning and the many different configurations, the many different chips that we are bringing to market, we are going to focus on making sure we have the best experience for our customers as they stand that up. We will start growing into our gross margins, but we do believe those will be in the low 70s in that first part of the ramp. So you're correct, as you look at the quarters following after that, we will start increasing our gross margins and we hope to get to the mid-70s quite quickly as part of that ramp.”

–End Quote

For More Reading:

Please reference our pre-earnings write-up which summarizes my current thoughts on the stock.

Conclusion:

I said on Fox Business News on Tuesday that I would love to get Nvidia lower, and I truly would. The nitpicking around the margins, the weaker semiconductor peers, the low volume as the stock trades near its all-time highs, the tariff concerns … one or all of these may present us that opportunity.

Nvidia’s fundamentals are a perfect 10. The pre-earnings report had stated: “Make no mistake, Nvidia is the best stock of the decade and we are only four years in. The big picture is that Nvidia's trajectory will continue due to two words: pricing power.”

We are already tracking a 30% minimum difference between GB200NVL72 orders and what Wall Street has estimated for next year. When you add that the DGX B200 systems will be priced 40% higher, and if we assume pricing power affects more SKUs the way it’s going to affect the DGX B200 systems, then we could see about 70% upside next year for Nvidia. Now, the I/O Fund likes to be aggressive, it’s why you’re here. If we can get the stock lower, that potential upside increases.

Wish us luck – and keep an eye on those trade alerts!

Recommended Reading:

• Real Vision Video Interview: Will Nvidia Continue to Dominate AI?
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