October 2024 – Page 2

Fabrinet: Datacom, Nvidia Driving Optical Revenue Growth

Posted on October 29, 2024June 30, 2026 by io-fund

Last month, we covered the importance of optical interconnects in linking GPUs together in clusters in our thematic deep dive “Optical Interconnects Overview: Strong Growth Expected Ahead.” Optical transceivers address bandwidth, or the speed of data transfer in the data center. As hyperscalers work to expand capacity, it’s expected there will be a surge in optic connections.

Fabrinet provides advanced optical communications components for datacom and telecom end markets, customized optics and glass fabrication, and advanced laser and other electro-mechanical parts. Fabrinet has reported consecutive quarters of strong datacom growth, stemming from one of its flagship customers, Nvidia. Fundamentally, Fabrinet possesses stable margins and strong cash flow generation, as top and bottom line growth is expected to accelerate from the low-teens to the 20% range over the next few years.

Fabrinet is clearly a beneficiary of Nvidia’s surging growth in the AI GPU market, with Nvidia’s contribution nearly tripling from 12.5% to 35.1% over the past twelve months. We’ve covered how Blackwell brings an enormous revenue opportunity for Nvidia and its suppliers, and Fabrinet is expected to be a beneficiary of Nvidia’s upcoming superchip, with long-term growth opportunities for optics in the AI data center and in 800G+ data rates.

Fabrinet reports earnings on Nov 4th.

Revenue Growth Reaccelerated in 2024; 149% Q3 Datacom Growth

After a weak start to fiscal 2024 with low single digit revenue growth, Fabrinet finished its fiscal year with revenue growth reaccelerating in each quarter. Over the long-term, analysts currently estimate revenue growth to accelerate each year through fiscal 2027, as Fabrinet captures tailwinds from growth in optics.

Fabrinet reported 9% YoY growth to $2.88 billion in revenue in fiscal 2024, decelerating from 16.9% YoY growth in fiscal 2023. Much of this decline was weighted in the first half of fiscal 2024, as the broader optics industry suffered from a sharp inventory correction in the telecom industry.

Moving forward, analysts expect Fabrinet’s revenue growth to accelerate again on the back of strong datacom revenue growth, with estimates pointing to an acceleration through fiscal 2027. Fabrinet is currently estimated to report 13.4% growth in FY25 to $3.27 billion in revenue, a 5.4 percentage point acceleration, before rising to 14.1% growth in FY26 and 20.8% growth in FY27.

Here's what CEO Seamus Grady said about the long-term opportunity: “If your time horizon is much longer, I think we're in the very early stages of this. So, you can add or subtract as many various as you like, but I still think we're in the very, very early stages of this. And we're just beginning to see what this explosive growth in AI and the infrastructure that's required to power this network will do and what it will need in terms of optical interconnect.

I think it's because optical is the only way that you can get the speed and the bandwidth that you need to get the signals to move around. You just can't do it with traditional interconnect. So, I think there's a kind of a paradigm shift to optical interconnect becoming kind of almost mainstream. And you have to have optical for this. There's no other way to do it.”

On a quarterly basis, fiscal Q1 2024 was Fabrinet’s weakest quarter, with revenue growth of 4.6% YoY, decelerating 7 percentage points sequentially and 16 percentage points from the year ago quarter. This was both in part due to a quarter that was a week shorter (growth was 8% YoY when normalizing for weeks), as well as telecom revenue declining more than (28%) YoY, offsetting 161% YoY datacom growth.

Telecom headwinds continued to persist through Q2 and Q3, with declines of nearly (29%) YoY and (25%) YoY respectively. Datacom growth of 154% and 149% YoY in both quarters offset the lingering weakness in telecom, aiding revenue growth and pushing growth rates up to 10% YoY by Q3. Revenue growth accelerated nearly 5 percentage points QoQ to 14.9% in Q4, as telecom declines moderated as data center interconnect growth ticked up. Datacom remained strong in Q4, with 800G products leading growth, offset by the wind down of 100G products.

For Q1, Fabrinet expects revenue between $760 million and $780 million, for YoY growth of 12.3% at midpoint, with sequential growth in all product categories. This would represent a 2.6 percentage point deceleration at the midpoint, and a 1.1 percentage point decel at the high range to 13.8% growth. With 800G demand remaining strong, datacom is set to remain a primary driver for quarterly performance moving through 2025.

Surging Datacom Revenue Drives Optical Revenue Growth

Similar to what we discussed last month in our optics overview, Fabrinet’s management sees 800G data center transceivers as its largest growth tailwind, followed by 400 ZR and 400G transceivers as the next largest tailwinds. In just eight quarters, Fabrinet’s quarterly datacom revenue has grown nearly 3.5x, from $92.7 million in Q1 of fiscal 2023 to nearly $315 million in Q4 of fiscal 2024.

Taking a step back, growth visibly accelerated sharply in Q4 of fiscal 2023, or the June 2023 quarter, where datacom revenue surged to a record high at $192.5 million, more than doubling YoY and rising more than 50% QoQ. Management said that the “datacom growth was primarily driven by an 800-gig AI data center transceiver program for one of our customers.”

While not named, it’s likely that the customer being referenced is Nvidia, as this growth coincided with Nvidia’s breakout quarter (the July 2023 quarter) with Hopper driving more than 100% YoY and 88% QoQ revenue growth. Management explained that that AI data transceiver program “is ramping very fast, and has obviously become a meaningful contributor to our revenue and our growth rates and has really helped us to absorb the decline in the telecom business.”

They further clarified that they believe it is “very much in the early days of this [particular] program and this [broader] opportunity, very, very much in the early days. We're really just a couple of quarters into this of what we believe, as we understand, it will be a very long cycle and a very long trend.”

Four quarters later, in fiscal 2024 (June 2024 quarter, most recent reported), Fabrinet reported $314.7 million in datacom revenue, an increase of more than 63% YoY. Datacom now accounts for nearly 42% of total revenue, up from 29% a year ago.

However, Q4 saw the start of revenue deceleration in the segment as Fabrinet laps stronger comps with its ramp cycle. Datacom revenue accelerated extremely rapidly, rising from 4.4% YoY to 161.1% YoY in the span of four quarters, before hovering at ~150% YoY for three quarters in a row. While Fabrinet did not provide an exact guide for datacom revenue in Q1, it’s likely that there will be a slight deceleration sequentially as the company laps its peak growth quarter in Q1 2024.

Nvidia Jumps to 35% of Revenue

Despite passing peak growth, management remains optimistic about datacom’s opportunities, especially with core 800G customer Nvidia, which significantly boosted its purchases and relationship with Fabrinet to meet red-hot GPU demand.

Analysts pressed about the potential impacts of Nvidia’s once-rumored Blackwell delay, and if that would affect Q1’s guide, with Fabrinet CEO Seamus Grady saying that Nvidia “continue[s] to see strong demand for their products. And our understanding is that they will extend and expand production based on current GPUs to meet the demand that's there, and we're happy to continue to support them.”

Nvidia has rapidly become a core customer for Fabrinet through fiscal 2024, with its contribution to revenue nearly tripling from 2023. Nvidia was a non-significant customer through fiscal 2022, contributing anywhere from 0% to 9.99% of revenue, before contributing 12.5% of revenue in fiscal 2023 and now 35.1% in fiscal 2024 (June 2023 to June 2024).

Source: Fabrinet 10-K

In dollar terms, Nvidia’s revenue surged 206% YoY, from approximately $331 million in fiscal 2023 to $1.01 billion in fiscal 2024. Cisco remained Fabrinet’s second-largest customer, contributing 13.4% of revenue (~$386 million) in fiscal 2024, down from 15.6% in fiscal 2023 (~$413 million). Lumentum and Infinera had previously been major customers, accounting for more than 10% of revenue each in fiscal 2022 and 2023, but both fell below the 10% reporting threshold in fiscal 2024.

While Nvidia presents a strong growth opportunity, it’s also a risk, as the significant concentration in Nvidia opens up the door to a large chunk of lost revenue if Fabrinet lost Nvidia as a customer. However, management is working on additional opportunities outside of Nvidia in merchant transceivers and with hyperscalers, noting that they “really don't mind whether it's Ethernet or InfiniBand or anything else” supporting AI infrastructure buildouts, having the flexibility to work across different networking infrastructure.

Additionally, Fabrinet is one of a handful of suppliers to Nvidia, who is now expected to be expanding its supplier base in order to expand its GPU supply. Analysts from B. Riley stated earlier in October that its “latest checks indicate that Nvidia may have added another supplier for 1.6T, which it believes is Eoptolink. As such, Nvidia’s 1.6T allocations will be in question between incumbers Coherent, Innolight, Fabrinet and a newcomer in Eoptolink.”

Margins

Compared to other companies in the optics space that we covered in our prior update, Fabrinet has a much thinner gross margin profile in the 12% range, but stable and strong operating margins and a strong bottom-line.

Fabrinet has maintained its GAAP gross margin above 12% since Q1 of fiscal 2022, with some minor FX-impacted fluctuations. GAAP operating margin has steadily risen since 2020, rising from ~7% to the high 9% range in fiscal 2023 and 2024. Given the thin gross margins, this is a great example of Fabrinet’s operational leverage, to drive a 200 bp+ increase in operating margin on a <100 bp expansion in gross margin.

GAAP net margins reflect the strength of Fabrinet’s operating margin profile, with the company reporting a 10.3% GAAP net margin for fiscal 2024, expanding 70 bp from 9.6% in fiscal 2023. This is what gives Fabrinet a very strong bottom line: GAAP EPS was $8.10 in fiscal 2024, a 20.4% increase from $6.73 in fiscal 2023.

Looking ahead, GAAP earnings are expected to continue growing, with analyst estimates calling for 15.1% YoY growth to $9.32 in EPS in fiscal 2025 and 19.0% growth to $11.09 in fiscal 2026.

Balance Sheet and Cash Flows

Fabrinet also has a robust balance sheet alongside rapidly increasing cash flows.

Cash, equivalents and investments totaled $858.6 million at the end of fiscal 2024, up from $550.5 million at the end of fiscal 2023 due to strong operating cash flow growth.
Fabrinet reported zero debt at the end of fiscal 2024.
Operating cash flow was $83.1 million, or 11% of revenue, in Q4. For fiscal 2024, operating cash flow was $413.1 million, or 14.3% of revenue; this was an increase of nearly 94% YoY from $213.3 million, or 8.1% of revenue, in fiscal 2023.
Free cash flow was $70.4 million, or 9.3% of revenue, in Q4. For fiscal 2024, free cash flow was $365.6 million, or 12.7% of revenue, increasing more than 140% YoY from $152.0 million, or 5.7% of revenue, in fiscal 2023.

Valuation

Despite its strong bottom line, Fabrinet is trading at elevated multiples relative to historic trends. This is important to track as well given the longer duration of both its top line and bottom line acceleration, with growth expected to accelerate to above 20% by FY27.

Fabrinet is trading slightly above 3x sales and 2.7x forward sales, both elevated relative to its prior highs in 2021 at ~2.2x sales and 2x forward sales. Fabrinet has also struggled to maintain multiples above 3x sales – in each of the last four times Fabrinet traded above 3x sales in 2024, it pulled back to below 2.75x to 2.25x within the next six weeks.

On the bottom line, Fabrinet is trading at a ~30x PE ratio and a 24x forward PE, both elevated compared to historical highs. Through much of 2021, Fabrinet failed to sustain a 27x PE ratio, with shares currently more than 10% above that level on a TTM basis. Fabrinet’s 5-year average PE is ~22.7x, with shares briefly trading below that level just once since AI tailwinds from Nvidia became visible in August 2023.

Conclusion

Fabrinet has caught our attention due to Nvidia’s rising revenue contribution, and ahead of Blackwell’s imminent launch this quarter. Fabrinet’s datacom revenue has been strong, and a primary driver of this recent quarterly revenue growth acceleration.

Despite management guiding for a slight sequential deceleration in fiscal Q1, Fabrinet’s revenue growth is expected to accelerate in fiscal 2025 and beyond, as the company captures tailwinds from high-data rate optics and tailwinds from Nvidia. Unlike Coherent, Lumentum, and Marvell that we previously covered in our prior optics overview, Fabrinet has a solid margin profile, a strong bottom line, and exceptional cash flow growth.

Damien Robbins, Equity Analyst at I/O Fund, contributed to this analysis.

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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This Stock Is Crushing Salesforce, MongoDB And Snowflake In AI Revenue

Posted on October 22, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Updated Oct 17, 2024, 09:02pm EDTForbesForbes on Updated Oct 17, 2024, 09:02pm EDT

Palantir has been one of the top-performing AI software stocks this year with a 156% YTD return, thanks to accelerating revenue growth and strong business momentum from its Artificial Intelligence Platform (AIP) released last year.

AIP sets Palantir apart from the rest of the SaaS universe, driving visible AI-related growth and acceleration in multiple different metrics – at this time, other leading AI favorites such as Snowflake or MongoDB can’t say the same. Outside of the cloud hyperscalers, Palantir is one of the rare few that sees AI drive both real returns for its business and real value for its customers due to AIP.

Below, I break down how Palantir’s AIP is putting it a step above peer Salesforce, MongoDB and Snowflake with visible AI growth, and its undeniable ‘secret sauce’.

Palantir’s AI Growth is Visible

AIP has driven tremendous growth for Palantir’s business since its release, with primary impacts arising in the commercial segment. A clear inflection point in Palantir’s growth is visible following AIP’s release, while other ‘AI’ cloud peers can’t say the same about AI-driven growth.

Palantir said that “US commercial continues to accelerate in Q2 2024 alongside [the] AIP revolution” with “unprecedented demand”, and the numbers to back this up:

55% YoY revenue growth in US commercial to $159 million, accelerating from 40% YoY in Q1.

US Commercial revenue growth accelerated to 55% YoY in Q2 as revenue rose to $159 million.

Source: I/O Fund

83% YoY growth in US commercial customers to 295 and 98% YoY growth in US commercial deals closed to 123.
103% YoY growth in US commercial remaining deal value and 152% YoY growth in US commercial total contract value to $262 million. Chief Revenue Officer Ryan Taylor explained that “one of the most notable indicators of our delivery is the volume of existing customers who are signing expansion deals, many of which are a direct result of AIP.”

Here’s what the growth in US commercial customers looks like:

Palantir's US Commercial customer growth has reaccelerated over the past few quarters thanks to AIP.

Source: I/O Fund

US commercial customer growth began to stagnate through late 2022 and early 2023, but following AIP’s release in Q2 2023, customer count re-accelerated. There is a clear inflection point from where QoQ customer additions were decelerating – from 12 net adds in Q1 2023 to six net adds in Q2 2023. Following the AIP-driven acceleration, net adds rose to 20 QoQ in Q3 2023, then 40 QoQ in Q4 2023.

This matches a similar acceleration in commercial customer growth as Palantir quickly became a market darling following its IPO, which was seen as a way to drive growth in the commercial sector. From Q4 2020 to Q4 2021, commercial customers grew nearly 5X. Now, as a stock market darling once more with a unique and unbeatable AI offering, Palantir is seeing commercial growth resume.

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Palantir is King of AI Among Cloud SaaS Stocks

Other leading cloud ‘AI’ stocks are struggling to put up AI-driven growth numbers like Palantir.

Salesforce reported 8% YoY revenue growth in Q2, decelerating from 11% YoY in Q1, as subscription revenue growth decelerated to 9% YoY, down from 12% YoY in Q1. Salesforce sees Q3 revenue growth of 7%, another deceleration. The full-year revenue growth of just 8% to 9% translates to the SaaS giant struggling to realize AI gains. Furthermore, Salesforce’s more AI-aligned offerings, MuleSoft and Tableau, decelerated sharply in Q2, from 27% YoY to 13% YoY for MuleSoft and 21% YoY to 11% YoY for Tableau.

MongoDB witnessed a much steeper deceleration in Q2, as Atlas and new workload wins struggled at the start of the year. In Q1, MongoDB reported 22% YoY growth with Atlas growth of 32% YoY, and this decelerated to 13% YoY revenue growth in Q2 as Atlas declined 5 percentage points QoQ to 27% YoY. For the full year, MongoDB guided to about 14.6% YoY growth in Q2 as it slightly boosted its outlook, a steep deceleration from 31% YoY growth in fiscal 2024.

Snowflake’s product revenue growth decelerated from 34% YoY in Q1 to 30% YoY in Q2, and while this was ahead of its guidance by 3 percentage points, growth is set to decelerate further in Q3. Management guided for 22% YoY growth in product revenue for the third quarter, a steeper QoQ deceleration rate, with the full year product revenue guide of 26% YoY. Despite management saying that they see “great traction” in early stages of AI products, there’s no visible inflection or acceleration in growth.

In sharp contrast, AIP has helped Palantir drive a significant topline acceleration over the past four quarters.

AIP's strong momentum has helped drive quarterly revenue growth to 27.2% YoY in Q2 2024, up from 12.7% in Q2 2023.

Source: I/O Fund

Palantir reported 27.2% YoY revenue growth in Q2, aided by strength in US commercial stemming from AIP as well as government revenue accelerating significantly. Palantir’s YoY revenue growth bottomed in Q2 2023 at 12.7%, the same quarter as AIP’s release, with revenue growth now 15 points higher. Despite guiding for a slight 2 percentage point deceleration in Q3 to 25.2% YoY growth, Palantir would only need to beat its guide by 1.5% to keep this revenue acceleration intact.

Fundamentally, what’s most critical for shares is maintaining a revenue growth rate above 20% for the foreseeable future – analysts currently estimate fiscal Q2 2025 to be the one quarter of the next eight with revenue growth just below that threshold. Given AIP’s strength just one year following its launch, with clear inflections in customer and revenue growth, it will be the telling sign of Palantir’s AI status if it can maintain these revenue growth rates as it scales.

Palantir’s AIP Separates it From the SaaS Universe

Palantir’s standout performance so far in 2024 against SaaS peers can be attributed to the success of AIP, which, at its core, is a comprehensive AI platform that lets enterprises lever Palantir’s AI and machine learning tools and harness the power of the latest large language models (LLMs) within Foundry and Gotham.

Gotham was the company’s first product and is built for government operatives in defense and intelligence sectors. The platform enables users to identify patterns hidden deep within datasets using semantic, temporal, geospatial and full-text analysis, with mixed reality capabilities to allow operations to be run in virtual environment as well. Graph allows data objects to be seen as nodes and edges, while Map track geo-located objects, run searches and display key data.

Foundry was built for the commercial sector, and is centered around the three-layer Ontology Core, integrating semantic, kinetic, and dynamic layers for real-time data analytics and AI-powered decision making capabilities:

The Semantic layer brings volumes of data into one place, and lets users generate detailed object properties
The Kinetic layer brings operations and business behaviors into a real-time graph linked back to the Semantic layer, creating the basis for AI-driven analytics, real-time monitoring, identification of inefficiencies, and ability to optimize workflows
The Dynamic layer connects models to objects and actions, reasoning across both the Semantic and Kinetic layers for AI-powered automation and AI-driven decision making, alongside multi-step simulations with AI predictive analytics to explore possibilities of changing actions or events

AIP combines with Foundry’s data operations suite and Apollo’s autonomous software deployment capabilities as part of Palantir’s ‘AI Mesh’, providing enterprise and government customers with a full suite of AI products from the web to mobile to the edge. With the Ontology, linking data and logic into an AI-accessible environment, Palantir brings generative AI directly to an enterprise’s operations, delivering real-time AI-driven operational decision-making abilities.

Palantir describes Gotham and Foundry as the “ability to construct a model of the real world from countless data points.” AIP links this all together, and this is what separates Palantir as a standout in the SaaS space — outside of the cloud hyperscalers, Palantir is one of the rare few that sees AI drive both real returns for its business and real value for its customers due to AIP.

What further sets AIP apart is its scalability, interoperability and versatility. With AI Mesh, organizations can integrate AI across different operations and applications, while its design facilitates interoperability with existing enterprise software and systems. AIP is also extremely versatile, having been successfully and seamlessly integrated into enterprises spanning a wide range of industries from tech to healthcare to aerospace, while still driving value to customers.

The uniqueness of Palantir’s AIP and value that it can quickly provide has driven growth for the company. CEO Alex Karp said in Q2 that “growth across the commercial and government markets has been driven by an unrelenting wave of demand from customers for artificial intelligence systems that go beyond the merely performative and academic.”

Essentially, there is constant strong demand for an applicable, scalable, versatile AI platform that can drive real-time results with an instant value-add for an organization. Chief Revenue Officer Ryan Taylor added that Q2’s “exceptional results are a reflection of a market that is quickly awakening to a reality that our customers have already known, we stand alone in our ability to deliver enterprise AI production impact at scale.”

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Government is Palantir’s Secret Sauce

While Palantir is undoubtedly seeing strong business momentum in the commercial sector, the government sector remains Palantir’s bread and butter, being that the government sector has funded the company and allowed it to aggressively invest in AIP while expanding margins, with a recent growth acceleration

In Q2, US government revenue accelerated to 24% YoY growth, up 12 percentage points from 12% YoY growth in Q1. Overall, government revenue growth was 23% YoY, up 7 percentage points from 16% YoY in Q1. Management noted that Palantir was “selected for several notable awards in Q2, which led to the strongest US government bookings quarter since 2022, reflecting the growing demand for our government software offerings.”

This included a production contract from the DoD, Chief Digital and Artificial Intelligence Office (CDAO) for an AI-enabled operating system for the DoD, with an initial $153 million order and additional awards for up to $480 million over a 5-year period.

The acceleration in the government segment aided overall revenue growth in the quarter, as the government continues to remain Palantir’s primary revenue source, accounting for nearly 55% of total revenue. This is why the government segment is vital for Palantir, and is its ‘secret sauce’ – these long-term, high-value government contracts provide consistent and recurring revenue and financial stability, allowing the company to venture and invest to scale AIP while expanding margins and increasing its profitability.

Conclusion

Palantir has been on a tear this year, and is outperforming major cloud competitors, thanks to the strength and uniqueness of its AIP offering. Palantir has the best of both worlds in government contracts and AI exposure, as well as accelerating enterprise AI adoption and strong customer and revenue growth.

The one caveat is Palantir’s valuation, at 34x FY24 revenue and 29x FY25 revenue, is increasingly challenging to sustain. In the past, the low 20x revenue multiple range has tended to be the level that even the industry’s leading SaaS names have struggled to break past over the last few years.

Given the outsized valuation, the I/O Fund is looking for a lower entry in Palantir before adding the stock to our portfolio. Join the I/O Fund’s next webinar on Thursday, October 24th where Knox Ridley, Technical Analyst, will discuss the firm’s buy zones and targets for AI leaders. Learn more here.

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Essentials Positions Update: Nvidia, TSMC, and Bitcoin

Posted on October 17, 2024June 30, 2026 by io-fund

Nvidia (NVDA)

The demand for the newest generation of Nvidia’s Blackwell chip is strong. According to Morgan Stanley, after meeting with management said that the Blackwell GPU is fully booked for the next one year and is progressing on schedule. Nvidia CEO, Jensen Huang, had also earlier stated that the demand for Blackwell is “insane.” The supply chain data also points favorably as Foxconn is building a new facility in Mexico for Blackwell orders. Foxconn Chairman said that the capacity would be “very, very enormous”.

The fundamental story is intact and strong for NVDA, which is why the technical setup is somewhat contrarian. As growth investors, sentiment can drive a stock in the opposite direction suggested by the fundamentals over the short to intermediate time frame. This may be what is playing out for Nvidia today.

The technical pattern since the June high best resembles a large degree correction that is still playing out. Note the 3 waves down from the June high. This, so far, has been followed by a 3 wave bounce that has made lower highs. If we are in a large degree correction, then we should see the final drop into the $90 – $70 range in the coming weeks. This scenario is marked in red in the chart below.

The alternative interpretation of the price action is presented in green. If this is playing out, we are in the middle of a 5th wave push to new highs. The pattern would have to be an ending diagonal, which is typically a 5 wave pattern that consists of large swings in both directions. If this is playing out then any further weakness should hold over $120 – $114, and then breakout to new all-time highs over $141. A break below $114 will confirm the red count, as we set up targets to buy around the August low.

Taiwan Semiconductor (TSM)

TSM has a similar setup as NVDA. Strong revenue growth is expected in the coming quarters due to the robust demand for AI and smartphone chips. We have recently discussed the stock here. However, the technical setup suggests that we could see one more leg lower before the larger uptrend resumes.

We have a 3 wave bounce off the August low that is stalling at the highs. The most common interpretation of this 3 wave bounce is a corrective bounce within a larger correction. If this is instead a bullish pattern, it will also be in the form of an ending diagonal pattern. As long as any further weakness holds $179 – $176 and then definitely push towards the $225 region next, then the bullish scenario remains a viable path. If we break below $176, then we are heading back to the August lows.

Bitcoin (BTCUSD)

Bitcoin appears to be setting up for a breakout to all time highs. Note price breaking above the downtrend line. This pattern is also in the form of an ending diagonal that is targeting $78,000 – $86,000. If we fail to definitely break above the downtrend line, any additional weakness must hold over $58,500. Below this level and the correction that started in March will have one more drop before completing.

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TSMC Q3 2024 Earnings: Strong results led by AI demand

Posted on October 17, 2024June 30, 2026 by io-fund

TSMC Q3 results beat across the board, helped by strong demand for AI chips. Revenue grew 36% YoY to $23.5 billion and beat the management guide of $22.4 billion to $23.2 billion. The bottom line was even stronger, as EPS grew by 50.4% YoY to $1.94, beating analysts’ estimates by 8.6%. Management also raised the full-year revenue guidance from above mid-20% to close to 30%, primarily due to the robust demand for AI chips.

Revenue

Q3 revenue grew by 36% YoY and 12.9% QoQ to $23.5 billion, beating the management guide of $22.4 billion to $23.2 billion. The strong revenue growth was primarily helped by demand for AI and smartphone chips.

Management guide for the next quarter is $26.1 billion to $26.9 billion, representing a YoY growth of 35.1% and 12.8% sequential growth at the mid-point.
Management raised the full-year revenue guidance from above mid-20% to close to 30%. By calculating the Q4 guide, the FY 2024 revenue is expected to grow 29.4% YoY to $89.69 billion in US dollar terms.

C.C. Wei, Vice Chairman and CEO, said in the earnings call, “Moving into fourth quarter, we expect our business to continue to be supported by strong demand for our leading-edge process technologies. We continue to observe extremely robust AI-related demand from our customers throughout the second half of 2024, leading to increasing overall capacity utilization rate for our leading-edge 3-nanometer and 5-nanometer process technologies.”

Due to the technological leadership, the company is able to capture robust demand for the most advanced AI chips. The revenue contribution from server AI processors is expected to triple this year and will account for a mid-teens percentage of 2024 revenue. “At TSMC, we define server AI processor as GPUs, AI accelerators, and CPUs performing training and inference functions, and do not include networking, edge, or on-device AI. We now forecast the revenue contribution from server AI processors to more than triple this year and account for mid-teens percentage of our total revenue in 2024. Supported by our technology leadership and broader customer base, we are well-positioned to capture the industry's growth opportunities. We now forecast our full-year revenue to increase by close to 30% in U.S. dollar terms.”

Margins

Margins continue to expand due to cost controls, economies of scale, and better price negotiation with customers.

Q3 gross margin was 57.8%, up from 54.3% in the same period last year and 53.2% in Q2. It beat the management guide of 53.5% to 55.5%. The strong gross margin was due to better capacity utilization and cost improvements.
Management has guided Q4 gross margin to increase 20 basis points sequentially to 58% at the midpoint helped by higher capacity utilization, partially offset by dilution from N3 ramp, higher electricity prices in Taiwan, and N5 to N3 tool conversion cost.
Operating margin improved to 47.5% from 41.7% in the same period last year and 42.5% in Q2 due to operating leverage. Management guide for Q4 is 47.5% at the midpoint.
Net income grew by 52.4% YoY to $10.06 billion or 42.8% of revenue compared to 38.6% in the same period last year and 36.8% in Q2.

EPS

EPS grew by 50.4% YoY to $1.94, beating analysts’ estimates by 8.6% due to better capacity utilization, cost improvement and operating leverage.

Analysts expect Q4 EPS to grow 35.4% YoY to $1.95 and 26.1% YoY to $1.74 in Q1 2025.
EPS is expected to grow significantly. Analysts expect EPS to grow 26.8% YoY to $6.57 in 2024 and 29.2% YoY to $8.49 in 2025.

Cash Flows and Balance Sheet

The company’s financial stability is evident in its stable cash flow generation.

Q3 operating cash flow was $12.13 billion or 51.6% of revenue compared to $9.31 billion or 54% of revenue in the same period last year and 56.1% in Q2.
Free cash flow grew by 166% YoY to $5.72 billion or 24.4% of revenue compared to 12% of revenue in the same period last year and 25.5% of revenue in Q2. Capex was down (-9.9%) YoY to $6.4 billion.
Management expects capex to be slightly higher than $30 billion for 2024, revised down slightly from the previous guide of $30 billion to $32 billion. As the company continues to invest due to the expected strong AI growth, capex is likely to increase next year, and management mentioned that they will provide more details during the January earnings call.
Inventories were $9.26 billion compared to $8.39 billion in Q2. Inventory turnover days increased to 87 days from 83 days in Q2 due to the pre-build of N3 and N5 wafers.
Cash and marketable securities were $68.5 billion, and debt of $30.6 billion, compared to $63.05 billion and $30.4 billion in Q2.

Revenue by Platform

As the leading foundry for AI accelerators, TSMC is riding the enormous wave of demand from Big Tech. The chipmaker’s high-performance computing (HPC) revenues rose 11% QoQ to $11.99 billion and accounted for 51% of revenue, surpassing the 50% mark for the second time.

The chart below also shows that HPC revenue reached a record $11.99 billion in Q3.

Smartphone grew by 16% sequentially and accounted for 34% of revenue from 33% of revenue in Q2.

Internet of Things revenue grew by 35% sequentially and accounted for 7% of revenue.

Automotive revenue grew by 6% sequentially and accounted for 5% of revenue. Digital Consumer Electronics decreased by 19% and accounted for 1% of revenue; others grew by 8% to account for 2% of revenue.

Revenue by Technology

The Advanced nodes are defined as 7-nanometer and below. It accounted for 69% of wafer revenue in Q3 compared to 67% in Q2.

In Q3 2024, 3-nanometer process technology contributed 20% of wafer revenue, while 5-nanometer and 7-nanometer accounted for 32% and 17%, respectively.
In Q2 2024, 3-nanometer process technology contributed 15% of wafer revenue, while 5-nanometer and 7-nanometer accounted for 35% and 17%, respectively.

Earnings Call

“AI Demand is Real”

The management clarified in the earnings call to allay fears about the AI opportunity, stating that the demand is real and the return on investment from AI is high.

Question

Gokul Hariharan (Analyst)

“My first question is on the AI investments and the growth that you see. Recently, obviously, there's been a lot of questions about ROI of Gen AI investments, whether this could end up being a bubble. How does TSMC view this trend as you're making your capacity plans given you are enabling pretty much the processing capacity for pretty much everybody?”

Answer

C. C. Wei (Executive)

“Okay Gokul, let me answer your question. Simply, whether this AI demand is real or not, okay? And my judgement is real. We have talked to our customer all the time, including our hyperscaler customers who are building their own chips. And almost every AI innovator is working with TSMC. And so we probably get the deepest and widest look of anyone in this industry.

And why I say it's real, because we have our real experience. We have using the AI and machine learning in our fab and R&D operations. By using AI, we are able to create more value by driving greater productivity, efficiency, speed, qualities.

And think about it, let me use you know 1% productivity gain, that was almost equal to about 1 billion to TSMC. And this is a tangible ROI benefit. And I believe we cannot be the only one company that has benefited from this AI application. So I believe a lot of companies right now are using AI for their own improving productivity, efficiency, everything. So I think it's real.”

PC and Smartphone demand

The management expects healthy growth in the PC and Smartphone demand due to the increasing content due to AI.

Krish Sankar (Analyst)

“Yes, hi. Thanks for taking my question. The first one I had was, I'm kind of curious on the non-AI demand. How do you look at your wafer demand for PC and mobile into calendar ‘25, and have you seen any meaningful revision upwards or downwards on that?

C. C. Wei (Executive)

Okay, Krish. The unique growth of PC and smartphone is still in a low single digit, but the more important is the content. The content now we put more AI into their chip, and so the silicon area increase faster than the unique growth. So again, I would like to say that for this PC and smartphone business, not only — is gradually increased, and we expect it to be healthy in the next few years because of AI-related applications.”

Advanced Packaging

Advanced Packaging demand is strong and will account for high single-digit of revenue this year.

Krish Sankar (Analyst)

“How do you think about that advanced packaging revenue growth over the next few years, and do you think at some point in the next couple of years, advanced packaging can reach corporate-level growth margins, or would it always be below that?

Wendell Huang (Executive)

Yes, Krish, advanced packaging in the next several years, let's say five years, will be growing faster than the corporate average. This year, it accounts for about high single-digit of our revenue. In terms of margins, yes, it is also improving. However, it's still approaching corporate, but not there yet.

Rick Hsu (Analyst)

All right. Thank you so much. A little question as a follow up, the second one. Can you share with us your CoWoS capacity buildup for this year and next year? I know you guys seem to have revised it up several times, so can you share the latest one?

C. C. Wei (Executive)

Okay, Rick. In fact, we are putting a lot of effort to increase the capacity of the CoWoS. Roughly, let me share with you, today's situation is our customers' demand far exceeds our ability to supply. So even we work very hard and increase the capacity by about more than twice, more than two times as this year compared with last year, and probably double again, but still not enough. But anyway, we are working very hard to meet the customers' requirement.”

Conclusion

The company beat across the board and showed its resilience in capturing the demand for advanced chips due to its technological leadership. The top-line growth, along with the bottom-line strength, distinguishes TSMC from other companies that are struggling in the current tough macro environment. The company is the denominator to the biggest AI winners as it supplies to Nvidia, Apple, AMD, Marvell, Intel, and Qualcomm. We look forward to adding this stock to our portfolio.

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

Nova and Onto Innovation: Growth in Metrology and Semiconductor Process Control

Posted on October 16, 2024June 30, 2026 by io-fund

While Nvidia’s dominance in AI GPUs is more clearly visible downstream in the HBM market, it’s also driving growth in a lesser-known but equally as important market, in metrology/process control equipment.

Metrology, by definition, is the study of measurement. In the semiconductor industry, metrology plays a critical role, as the ability to measure circuit dimensions, microstructures inside chips, film thickness, accuracy of layers and overlays are all necessary to ensure chipmakers can consistently produce high-quality, flaw-free chips at high yields.

While KLA dominates the metrology market, reportedly holding a more than 50% market share for over 20 years, Onto Innovation and Nova are two smaller players in the market putting up accelerating revenue growth with strong margins, with exposure to AI megatrends and long-term growth drivers.

Metrology Has Multiple Drivers

The metrology market has multiple drivers of future growth, and while it’s not limited to the AI data center mega-trends spearheaded by Big Tech, there are many levers within this AI buildout to drive demand for Onto Innovation and Nova.

This is how Nova’s management team recently described the opportunity: “Artificial intelligence is reshaping our digital world and expediting the implementation of scaling agents in integrated circuits to boost performance and power efficiency which are at the core of enabling large language models through training and infra stages. Scaling is manifested in more complex designs through three avenues, dimensions, materials and advanced packaging.

It is also manifested in the size of manufactured dies and in the number of dies required in solutions such as high bandwidth memory. These developments profoundly impact our industry in the number of the wafers needed to supply demand and in the yield ratio, you must obtain to secure profitability with a lower number of dies per wafer. Couple that with the growing complexity of architecture and materials and you have the growth drivers of process control in the coming years.”

Here’s a brief look at how AI and the data center are generating demand for metrology equipment across these different drivers:

Shift to Advanced Nodes

Advanced nodes require more process steps as node sizes shrink, so for a chipmaker or foundry like TSMC or Intel to move from primarily producing on 5nm nodes to 2nm or below over the next couple of years, there will be a greater need for metrology equipment. Currently, the 5nm and 4nm nodes are primarily being used for AI chip production, such as that for Nvidia’s Hopper and Blackwell chips, while 3nm production is ramping at TSMC with volume production at the 2nm node expected in 2025, primarily for smartphone applications.

This is because the manufacturing tolerances shrinks as nodes shrink in size – the chipmaking process now becomes increasingly more sensitive to minute deviations in the process. Moving to more advanced nodes warrants much greater precision throughout the entire manufacturing process, as the smallest of deviations could greatly affect the process’ yield.

For example, Samsung has reportedly been struggling with severe yield issues for its most advanced nodes, with unstable yields reportedly around 50% or below for its gate all-around GAA 3nm second-gen process, and yields as low as 20% for its 2nm process.

TSMC sees higher yields for the 3nm process, reportedly between 60% and 70%, allowing it to command a majority of production on advanced nodes and thus a majority of market share.

Source: Nova

Rising Chip Complexity

Metrology needs also rise as chip designs get increasingly complex, from the entire GPU to memory cubes.

AI accelerators are getting larger and more complex with each generation packing more transistors than the last. Nvidia’s upcoming B200 GPU packs 208 billion transistors and 192GB of HBM3e memory, versus 80 billion transistors and 80GB HBM3 memory for the H100. Though Blackwell is in a dual-die configuration, it’s still a more complicated chip to produce using TSMC’s customized N4P process (the same as for the H100).

Having a more complex chip design increases the chances of errors, as there are more steps in the manufacturing process to produce said chips. This also goes for DRAM and NAND cubes – as HBM cubes stack higher, from 8-high cubes to 12-high cubes for the current HBM3e generations from SK Hynix, Samsung and Micron, it also increases process steps. Other advanced memory chips have seen a 6x increase in layers from 64 to 400 over the past few years. 3D stacking and building more layers necessitates more sophisticated metrology equipment to ensure critical measurements are met within each stack and layer.

Gate All Around Advanced Packaging

TSMC is phasing out FinFet after the 3nm node, and its upcoming 2nm node will be the first to use gate-all-around field-effect transistors (GAA FETs). GAA will increase chip density, and increase performance-per-watt to enable higher levels of output and efficiency.

These GAA nanosheet transistors have channels surrounded by gates on all sides to reduce leakage yet it will also uniquely widen the channels to provide a performance boost (with another option to narrow the channels to optimize power cost). The 2nm node will also allow chipmakers to customize the width and height of cells. Because of the increased complexity of GAA FETs compared to FinFETs, Nova estimates that GAA requires 20% to 30% more metrology steps than FinFET.

We’ve covered gate-all-around in a TSMC analysis that stated the following in terms of timing for N2 starting production in the last quarter of 2025 and reaching “meaningful revenue” by the Q1 to Q2 of 2026.

Accelerated Chip Development Timelines

Nvidia and AMD are both shifting to annual release cadences, aiming to bring next-generation GPUs to market once per year, compared to prior cadences of every two years. This is a major technological feat – as we had said previously for Nvidia, it’s a ‘move-fast-break-things’ problem, where Nvidia is pushing the boundaries of what had previously been seen as impossible in the chip industry.

By moving to these quicker release cycles, there’s a much greater emphasis on metrology and process control to ensure that the manufacturing process remains sharp, while also ensuring a faster ramp, and high yields to meet mass production thresholds and demand.

Fab Buildouts

Another driver for metrology equipment is chip fab buildouts, such as HBM fab construction and investments from SK Hynix, Micron and Samsung, as well as other expansion plans, such as TSMC’s planned expansion in Arizona.

Onto’s management put this in perspective from the HBM side, saying that “even if AI just stayed flat, which nobody is projecting, AI is supposed to go up, the HBM side is already doubling. … customers [are] talking about supply constraints and that they're looking at expanding factories into next year, early half of next year in order to alleviate these supply constraints.”

Currently, there are 19 global high-volume chip fabs under construction this year, with another 10 expected to be added next year to meet rising demand for semiconductors, driven by AI/HPC. Total equipment spending for these 29 fabs is expected to be approx. $140 billion. Through 2030, there are more than 100 fab projects planned, with more than $200 billion in global funding and incentives for these projects.

Building out new fabs from the ground-up will require metrology and process control equipment, providing a long-term growth runway for the industry.

Product Snapshot: Addressing Critical Challenges in Advanced Packaging, Memory, More

Onto and Nova’s management teams highlighted a few core products that are driving growth or seeing strong orders and adoption from major customers. These products address some of the more pressing challenges in advanced packaging, HBM and memory, and leading-edge nodes.

Israeli-based Nova has a diverse metrology equipment and software portfolio, from dimensional to materials to chemical metrology. One of Nova’s leading products is PRISM 2, the next-generation PRISM which offers improved sensitivity and accuracy in critical dimensions metrology.

Nova noted that its PRISM 2 product saw strong adoption last quarter, especially in GAA, with around half of its record bookings stemming from “advanced packaging processes, such as Through-Silicon Via, where PRISM has a unique advantage in filtering information from specific underlayers.”

PRISM 2 provides improved accuracy and reliability for critical component measurements in processes such as advanced logic chip fabrication and stacking nanosheets for GAA fabrication, as well as 3D NAND and DRAM.

Nova also added that “demand is also consistently high for our advanced integrated metrology and XPS material metrology platforms,” as it saw “record booking of VeraFlex XPS platforms this quarter, of which over 40% resulted from capacity growth” in FinFET advanced nodes.

Nova’s VeraFlex XPS (X-ray photoelectron spectroscopy/materials metrology) helps analyze surface structures, identifying bonding, contaminants or defects in advanced nodes for process control in high-volume manufacturing.

US-based Onto’s core products span defect inspection equipment, dimensional (optical CD) and material metrology, and lithography tools. Onto’s Dragonfly systems, which drove Q2’s performance, witnessed “better-than-expected demand” for advanced packaging for AI chips as it reached another revenue record.

Dragonfly G3 provides combo 2D and 3D inspection and process control for advanced packaging, HBM and chip-on-wafer GPUs. For example, Onto noted last August that it finalized more than $100 million in Dragonfly G3 orders for chip packages “that combine a graphics processor (GPU) and numerous high bandwidth memory (HBM) devices to create an AI GPU in a single package.”

Onto also said that Atlas and Iris demand for GAA investments were a driver of Q2’s performance, while new product launches in panel lithography, 3D bump metrology sensors for smaller interconnects in HBM, and subsurface defect inspection sensors are expected to see strong adoption through the end of the year.

By comparison, leader KLA offers a comprehensive portfolio of metrology equipment for measuring “pattern dimensions, film thicknesses, layer-to-layer alignment, pattern placement, surface topography and electro-optical properties” for chip and substrate manufacturing, from new process development, product verification, and high volume manufacturing. KLA provides advanced wafer packaging equipment, overlay metrology equipment, reticle metrology and inspection tools, OCD, shape and film metrology equipment, sheet resistance metrology equipment, and more.

Customer Concentration Extremely High

It’s common for small cap semiconductors to have high customer concentration, especially at the equipment level, as there are a limited number of fabs globally. Nova and Onto are no exception.

For Nova, its top five customers accounted for 52% of revenue in 2023, down from 57% of revenue in 2022 and 70% in 2021. Nova’s largest customer accounted for 19% of revenue, while its fifth largest customer contributed 5% of revenue. The customers are not named.

Revenue from Nova’s largest customer(s) declined from ~$130 million in 2021 and 2022 to $108 million in 2023.

Source: Nova

Onto Innovation has provided a breakout for its top three customers, along with another figure that highlight its customer concentration.

For Onto, its three largest customers accounted for 56% of revenue in the first half of fiscal 2024. TSMC accounted for 23% of revenue, up from 13% in the same period last year. Samsung accounted for 20% of revenue, down slightly from 21% last year.

SK Hynix has risen to be Onto’s third largest customer at 13% of revenue, up from <10% last year. Onto also has shared that TSMC accounted for 21% of its net accounts receivable in the first half of 2024, with Samsung accounting for 8%.

Source: Onto Innovation

Revenue Accelerating

Both Nova and Onto are reporting accelerating revenue growth in Q2 after returning to growth in Q1 this year after four consecutive quarter of declines. However, Onto guided for revenue growth to decelerate in Q3, while Nova forecast this acceleration to continue but be short-lived.

Onto reported 27.1% YoY growth to $242.3 million in revenue in Q2, accelerating from 14.9% growth in Q1. Management said that Q2’s growth and revenue above its guided $230-240 million range was “driven by additional pilot line expansions for high-performance computing using gate-all-around transistor architecture and high bandwidth memory (HBM) supporting AI market growth.” This was likely driven primarily by increased spend by TSMC and SK Hynix, seen within the customer concentration figures.

Advanced packaging and specialty device revenue reached a fourth-consecutive record at $164 million, up 49% YoY, while Onto added that it “closed over $300 million of volume purchase agreements issued by two customers for their AI advanced packaging and gate-all-around investments through 2025,” again likely to be coming from TSMC. Management expects that GAA and advanced packaging at multiple customers will be primary growth drivers through 2025.

Nova reported revenue growth of 27.8% YoY to $156.9 million in revenue in Q2, accelerating from 7.3% in Q1. Metrology product revenue was $124.6 million, accelerating to 30% YoY growth from just 6% YoY in Q1 and (16%) in Q4.

Management said that it saw “record revenue from chemical metrology, driven by demand in high-bandwidth-memory and front-end logic processes,” while demand for GAA and advanced packaging was increasing with “faster-than-expected adoption” for its PRISM 2 platform. Management added that they also saw record bookings for advanced packaging and materials metrology.

Q2 also marked both companies’ fastest YoY growth rates in two years — here’s a look at how Onto and Nova have recovered from 2023’s slowdown:

Looking ahead for Q3, Onto guided for revenue growth of 20.7% YoY to $250 million in revenue at midpoint, a more than 6 percentage point deceleration. Nova forecast a nearly 6 percentage point acceleration to 33.5% growth to $172 million in revenue at midpoint.

Through 2025, analysts expect Onto to maintain growth in the high-teens each quarter, while Nova’s higher growth rate of 30%+ is expected to decelerate into the low-teens and high-single digit range five quarters out.

Onto is expected to see quarterly revenues rise to above $300 million, while Nova is currently forecast to see revenues begin to flatline in the mid-$190 million range. Nova may be more exposed to cyclicality in the metrology industry with its focus on film metrology equipment, which may see faster growth in the ramp phase that stabilizes later on.

Onto provided a quick look into what’s driving 2025 growth: “We expect to benefit from continued investments in gate-all-around capacity, and the announced capacity expansions from several high-bandwidth memory and logic packaging manufacturers, specifically for HBM. We expect new capacity coming online in the first half of the year to support the increase of HBM content for NVIDIA's AI processors from 80 to 192 gigabytes and for AMD's AI processors from 192 gigabytes to 288 gigabytes.”

However, it’s not all AI revenue for the two. Onto clarified that AI packaging drove over half of specialty and advanced packaging revenue in Q2, implying AI packaging revenue of at least $82 million, or just over one-third of quarterly revenue. Nova is seeing demand stem from AI-driven end markets such as HBM, GAA and TSVs, though they have not broken out AI’s specific impact on revenue.

Long-Term Financial Targets:

Revenue

Both companies have set out long-term financial targets, including revenue, margins and EPS. The revenue targets will likely be achieved in 2027 to 2028 based on current expectations and historical trends. Both companies expect to have enough capacity by year end to reach these long-term revenue targets.

Nova set its long-term target of $1 billion, more than 50% higher than FY24’s projected $648 million. There are currently six analysts covering Nova with only two analysts providing estimates through Dec of 2027 with consensus at $995.7 million.

Here's Nova’s target model:

Source: Nova

Onto has its long-term revenue target at $1.8 billion, nearly double FY24’s projected $980 million. There are eight analysts covering Onto with only three analysts covering the stock through Dec of 2027 with estimates at $1.56 billion. The Dec 2028 estimate is more in line with Onto’s projections with only one analyst providing an estimate of $1.84 billion.

Here’s Onto’s target model, which provides a more detailed view down the line as revenue increases incrementally by $200 million:

Source: Onto

Margins

Nova is currently ahead of its long-term margin targets, currently benefiting from higher ASPs due to product mix, while Onto is behind on gross margin targets for its $1 billion model.

Here’s how Nova’s margins look relative to its long-term target (referencing non-GAAP margins):

Nova reported GAAP gross margin of 59% in Q2, flat QoQ and up 200 bp YoY. Non-GAAP gross margin was 61% in Q2, again flat QoQ and up 200 bp YoY.
For Q3, Nova guided gross margins to dip 300 bp QoQ sequentially, to a GAAP gross margin of 56% and non-GAAP gross margin of 58%. Nova said that faster adoption of higher ASP/margin products has previously boosted margins, but they remain at the high-end of targets despite this fluctuation.
GAAP operating margin was 29% in Q2, expanding 300 bp QoQ and 600 bp YoY. Non-GAAP operating margin was 34%, up 200 bp QoQ and 600 bp YoY. Management pointed out that non-GAAP operating margin was ahead of targets of 27% to 31%, and while Q3’s non-GAAP margin was guided to decline sequentially to 32%, this is in line with previous quarters with Q2 being a strong outlier.

Onto sits behind gross margin targets, though it sees margins expanding in the coming quarter.

Onto reported GAAP and non-GAAP gross margin of 53% in Q2, up 100 bp QoQ and flat YoY. Though current FY revenue estimates are just 2% below the $1 billion target model, gross margins are shy of its range, with Onto targeting non-GAAP gross margins of 56% to 57%.
For Q3, management guided to gross margins between 53% to 55%, flat to up 200 bp QoQ, driven by growth in advanced nodes and optimization in manufacturing. Though it’s a step in the right direction, it’s still short of targets by ~200 bp at midpoint.
GAAP operating margin was 20% in Q2, up 100 bp QoQ and 700 bp YoY. Non-GAAP operating margin was 27%, up 200 bp QoQ and 600 by YoY.
Excluding amortization (to align with long-term targets), non-GAAP operating margin was 32%, in line with the high end of the $1 billion model despite the gross margin shortfall.
For Q3, management’s guidance implies non-GAAP gross margin of 28%, up 100 bp QoQ.

EPS

Both Nova and Onto are reporting strong EPS growth, with Nova reporting 48% YoY growth to $1.41 in GAAP EPS of $1.41 and Onto reporting 102% YoY growth to $1.07 in GAAP EPS. It’s rare to see such high EPS numbers from small cap stocks, and long-term targets are both strong and rather achievable.

For Nova, management is targeting non-GAAP EPS of at least $7 per share by the time it reaches $1 billion in revenue. For the first half of 2024, Nova’s non-GAAP EPS is currently $3 per share, suggesting that if margins can be maintained at the high end of its model, $7 in EPS is easily achievable. Analyst estimates currently project $9.58 in EPS on $996 million in revenue in 2027, foreseeing Nova surpassing the $7 EPS target next year on $757 million in revenue.

Onto is targeting non-GAAP EPS of $5.50 to $6.00 at $1 billion in revenue, and long-term up to $8.50 in EPS at $1.4 billion in revenue. Non-GAAP EPS for the first half of 2024 was $2.50, and with Q3 guided to $1.30 at midpoint, Onto would need to report $1.70 in non-GAAP EPS in Q4 to reach the low end of its target at $5.50.

Onto’s longer-term view emphasizes increased operating leverage to drive earnings growth as gross margin expansion is minimal. Management is eyeing just a 2% expansion in gross margin but a 4% expansion in operating margin. This is expected to drive EPS more than 40% higher, from $6 to $8.5 per share at the high end of the range. Analysts are much more optimistic on the degree of operating leverage that Onto can drive at $1.4 billion in revenue, with estimates calling for about $9.35 in EPS on $1.44 billion in revenue in 2026. Again, it’s rare to see EPS numbers this high with small cap semiconductor stocks.

Balance Sheets, Cash Flows Healthy

With operating and net margins in the high-20% to low-30% range, Onto and Nova enjoy healthy balance sheets and cash flows.

Onto has $786 million in cash, equivalents and marketable securities on hand, zero debt, and total liabilities of $174 million. Operating cash flow for 1H 2024 increased 50% YoY to $122 million, or 26% of revenue (versus 21% of revenue in same period last year). Free cash flow rose 49% YoY to $103 million, or 22% of revenue (versus 18% of revenue in the same period last year).

Nova has $759 million in cash, equivalents, and marketable securities, and $198 million in convertible senior notes, which, if converted, would equal about 3.4% dilution to existing shareholders. Nova has no outstanding debt outside of the convertible notes. Operating cash flow for 1H increased nearly 154% YoY to $120 million, or 40% of revenue (versus 19% of revenue in the year ago period). Free cash flow rose more than 178% YoY to $115 million, or 38% of revenue (versus 17% of revenue in the year ago period).

Inventories are where the two differ, with Nova increasing inventory as Onto is working to reduce inventory. Nova reported inventory of $156.6 million at the end of Q2, up more than 13% from the end of 2023. Onto is working on inventory management, reporting $319.7 million in inventory in Q2, down from $327.8 million at the end of 2023. Management expects to further reduce inventory by $10 million to $15 million in Q3 and exit 2024 with inventory below $300 million, or a $50 million YoY reduction.

Valuations Have Enjoyed a Premium

With clear exposure to AI and HPC trends in HBM and advanced packaging, as well as strong operating, net and cash flow margins — and triple digit cash flow growth for Nova – the two have recently enjoyed premium valuations to other chip equipment stocks and metrology leader KLA.

Onto currently trades at nearly 62x TTM earnings and Nova at almost 42x TTM earnings, compared to 38x TTM earnings for KLA and 22x TTM earnings for Applied Materials, which also has exposure to metrology and advanced packaging. Multiples have compressed slightly, with Onto trading above 80x earnings and Nova above 55x earnings earlier this year; however, it’s quite a large premium to their three-year average TTM earnings multiples of 37x for Onto and 31x for Nova.

On a forward basis, strong EPS growth of 40% YoY for Onto and 31% YoY for Nova has brought forward multiples lower, though still elevated relative to peers. Onto trades at nearly 40x forward earnings of $5.22 for FY24, while Nova trades at 31x forward earnings of $6.37 for FY24. KLA trades at 26x forward earnings with 25% YoY growth expected, and Applied Materials at 23x forward earnings with just 6% YoY growth expected.

On a top-line basis, Onto, Nova and KLAC are currently trading in the high 10x, to mid 11x PS range. Multiples for the trio have been in lockstep for more than a year, following each other quite closely since the 5-6x range around Nvidia’s blowout earnings report in May 2023, the first signs of the present AI and HBM boom.

Looking longer-term, it’s quite clear that these are some of the highest top-line multiples Onto and Nova have traded at in the past decade. Both companies’ 10-year average PS multiple hovers around 4.5x to 5x, so the two are currently trading at more than double their 10-year average. If earnings or revenue growth falters, multiple compression is a possibility given the premium valuations of the two.

Technical Analysis

By Knox Ridley

What caught our eye about the technical patterns in both NVMI and ONTO was how similar their long-term trends appear to be unfolding. Like many AI names that we track, they appear to be setting up for a correction within a larger uptrend that should go on for several years.

Most stocks and markets appear to have either topped in 2021 or are in their final swing higher in 2024/2025. So, while the broad market makes a series of lower highs into the coming years, these names would trend higher.

Onto Innovation (ONTO)

The below chart is a weekly chart. In other words, every candle is one week’s worth of price data. This better helps us decipher the long-term trend. Note the vertical move off the 2009 low, which was followed by a multi-year, messy and overlapping correction into 2015. This best resembles waves 1 and 2 in a very large 5 wave uptrend.

This is further supported by the price action into today’s developing top. The below Elliott Wave count has us in the final swing of wave 3 within the larger 3rd wave. We ccould see a final push into the $257 – $339 region. However, this is not a move that we would chase, considering the warning signs.

For one, we have a completed 5 wave pattern off thew COVID low. What follows 5 waves higher is usually a 3 wave retrace. Secondly, since mid-2023, we have seen price make higher highs while momentum is making lower highs. This is characteristic of 5 wave pattern, where peak momentum typically is seen in wave 3, as we wave 5 is met with less volume and less momentum.

Nova (NVMI)

NVMI has a similar long-term chart as ONTO. We can see a near vertical 5 wave move off of the 2009 low, followed by a pullback into 2011. This lines up well as waves 1 and 2 of a very large 5 wave pattern.

Like ONTO, Nova is in the final swing of wave 3 of the larger 3rd wave. If this count is accurate, the 4th wave pullback should take us back to around projected the halfway point of this larger 5 wave pattern, which is where we would look to potentially enter both stocks.

If we zoom in on the current correction, it appears that NOVA is setting up for the final drop in this correction. A move below $186 will confirm this as we target $152 – $138 for our first entry. If NOVA can instead hold $186 and then breakout above $230, we will be in the final swing of this 3rd wave. This stock has a lot to prove before we’d consider it a longer-term buy rather than a momentum stock.

Conclusion

Nvidia, TSMC, and Micron are bellwethers for AI accelerator, advanced packaging and HBM demand, with the three showing no signs of slowing any time soon. This will continue to create opportunities for growth in the metrology equipment market, as AI accelerator-related HBM and advanced packaging demand continues to grow and outstrip supply.

Metrology equipment is positioned well to capture the increase in complexity from advanced nodes, memory stacking and other chipmaking processes where demand is outstripping supply into the foreseeable future.

Onto and Nova share in these tailwinds, evidenced by accelerating quarterly revenue in Q2 and strong margins, cash flows and healthy balance sheets. We will be watching for further evidence that these companies are participating in the Ai boom in the upcoming quarters.

Damien Robbins, Equity Analyst at I/O Fund, contributed to this analysis.

Recommended Reading:

Nova and Onto Innovation: Growth in Metrology and Semiconductor Process Control

Posted on October 16, 2024June 30, 2026 by io-fund

Metrology Has Multiple Drivers

Here’s a brief look at how AI and the data center are generating demand for metrology equipment across these different drivers:

Shift to Advanced Nodes

TSMC sees higher yields for the 3nm process, reportedly between 60% and 70%, allowing it to command a majority of production on advanced nodes and thus a majority of market share.

Source: Nova

Rising Chip Complexity

Metrology needs also rise as chip designs get increasingly complex, from the entire GPU to memory cubes.

Gate All Around Advanced Packaging

Accelerated Chip Development Timelines

Fab Buildouts

Building out new fabs from the ground-up will require metrology and process control equipment, providing a long-term growth runway for the industry.

Product Snapshot: Addressing Critical Challenges in Advanced Packaging, Memory, More

Customer Concentration Extremely High

It’s common for small cap semiconductors to have high customer concentration, especially at the equipment level, as there are a limited number of fabs globally. Nova and Onto are no exception.

Revenue from Nova’s largest customer(s) declined from ~$130 million in 2021 and 2022 to $108 million in 2023.

Source: Nova

Onto Innovation has provided a breakout for its top three customers, along with another figure that highlight its customer concentration.

Source: Onto Innovation

Revenue Accelerating

Q2 also marked both companies’ fastest YoY growth rates in two years — here’s a look at how Onto and Nova have recovered from 2023’s slowdown:

Long-Term Financial Targets:

Revenue

Here's Nova’s target model:

Source: Nova

Here’s Onto’s target model, which provides a more detailed view down the line as revenue increases incrementally by $200 million:

Source: Onto

Margins

Nova is currently ahead of its long-term margin targets, currently benefiting from higher ASPs due to product mix, while Onto is behind on gross margin targets for its $1 billion model.

Here’s how Nova’s margins look relative to its long-term target (referencing non-GAAP margins):

Nova reported GAAP gross margin of 59% in Q2, flat QoQ and up 200 bp YoY. Non-GAAP gross margin was 61% in Q2, again flat QoQ and up 200 bp YoY.
For Q3, Nova guided gross margins to dip 300 bp QoQ sequentially, to a GAAP gross margin of 56% and non-GAAP gross margin of 58%. Nova said that faster adoption of higher ASP/margin products has previously boosted margins, but they remain at the high-end of targets despite this fluctuation.
GAAP operating margin was 29% in Q2, expanding 300 bp QoQ and 600 bp YoY. Non-GAAP operating margin was 34%, up 200 bp QoQ and 600 bp YoY. Management pointed out that non-GAAP operating margin was ahead of targets of 27% to 31%, and while Q3’s non-GAAP margin was guided to decline sequentially to 32%, this is in line with previous quarters with Q2 being a strong outlier.

Onto sits behind gross margin targets, though it sees margins expanding in the coming quarter.

Onto reported GAAP and non-GAAP gross margin of 53% in Q2, up 100 bp QoQ and flat YoY. Though current FY revenue estimates are just 2% below the $1 billion target model, gross margins are shy of its range, with Onto targeting non-GAAP gross margins of 56% to 57%.
For Q3, management guided to gross margins between 53% to 55%, flat to up 200 bp QoQ, driven by growth in advanced nodes and optimization in manufacturing. Though it’s a step in the right direction, it’s still short of targets by ~200 bp at midpoint.
GAAP operating margin was 20% in Q2, up 100 bp QoQ and 700 bp YoY. Non-GAAP operating margin was 27%, up 200 bp QoQ and 600 by YoY.
Excluding amortization (to align with long-term targets), non-GAAP operating margin was 32%, in line with the high end of the $1 billion model despite the gross margin shortfall.
For Q3, management’s guidance implies non-GAAP gross margin of 28%, up 100 bp QoQ.

EPS

Balance Sheets, Cash Flows Healthy

With operating and net margins in the high-20% to low-30% range, Onto and Nova enjoy healthy balance sheets and cash flows.

Valuations Have Enjoyed a Premium

Technical Analysis

By Knox Ridley

Onto Innovation (ONTO)

Nova (NVMI)

Conclusion

Damien Robbins, Equity Analyst at I/O Fund, contributed to this analysis.

Recommended Reading:

Nvidia, Mag 7 Flash Warning Signs For Stocks

Posted on October 15, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Oct 10, 2024,10:58pm EDTForbesForbes on Oct 10, 2024,10:58pm EDT

The Fed surprised the market with an aggressive 50 bps cut recently, which has pushed the S&P 500 back to new all-time highs. However, not all markets are celebrating this move. Bond yields and mortgage rates, for example, have been in an uptrend since this decision, which is not normal to see at the onset of a rate cutting cycle.

Also, the bull market leaders – the Mag 7 and AI focused semiconductors – are making a series of lower highs, not confirming this move in the S&P 500. This divergence between the market leaders and the broad market has been the consistent theme of the I/O Fund’s broad market reports in 2024. More times than not, the bull market leaders will lead on the way up, as well on the way down. So, when my firm sees the primary beneficiaries of a bull market start to make lower highs while the broad market makes higher highs, it tends to be a warning.

In this report, my team will address the risks brewing in the market. The strange behavior in the bond market could be signaling that the FOMC has made a policy error. This coupled with key tech stocks trending lower against the S&P 500’s advance, has my firm cautious for the time being.

What Big Tech and AI Stocks Are Telling Us

In 2023 we saw these market leaders trending higher with the broad market. This was a powerful trend that lasted into late 2023. As a result, the collective Mag 7 returned around 90% in 2023 vs. the S&P 500 returning 24%. However, this trend is not continuing into 2024, as we are beginning to see cracks in market leadership.

This year, the Mag 7 are up ~30% compared to the S&P 500’s ~20%. Though this year has been excellent for investors, it’s concerning the relative strength between the bull market leaders and the broad market is narrowing, which has been a constant theme in our broad market analysis throughout all of 2024.

“When the cycle leaders start to underperform, it tends to mark the start of a trend change. The FAANGs have been the undoubted leaders of this bull run, and we are now seeing them start to trend lower against the indexes. More times than not, the leaders on the way up, tend to be the leaders on the way down.”

More importantly, the Mag 7 is making a lower high, while the S&P 500 makes a higher high. In other words, the bull market leaders are not confirming this push higher in the broad market. This is a rare pattern that has only shown up one other time in this bull market – July of 2023, just before we saw an almost 11% correction in the broad market.

A rare pattern observed in the bull market, similar to July 2023, preceding an 11% correction in the broad market. – I/O Fund

This divergence is not only happening with the Mag 7, but it’s also happening with the most important sub-sector within tech due to AI – semiconductors.

Since the current bull market began on October 13th of 2022, the Mag 7 has returned over 102% vs. the S&P 500’s 61%. During the same period, semiconductors have returned over 174%. The leading stock, Nvidia, is up over 967% over the same period. So, while the Mag 7 are the popular market leaders, the true market leaders of the current bull cycle are semiconductors, and specifically, Nvidia. This is a trend that the I/O Fund positioned for in 2022, making NVDA our largest position, as we rotated out of cloud stocks and into AI.

Performance of the Mag 7, S&P 500, and semiconductors since October 13, 2022: The Mag 7 returned over 102%, the S&P 500 returned 61%, and semiconductors returned over 174%, with Nvidia up over 967%. – I/O Fund

Semiconductor Index (SMH)Semiconductor Index (SMH)

SMH has a history of leading market swings in the broad market. Since 2021, every time the S&P 500 made a new high without SMH, it preceded a period of volatility. Today’s divergence is one of the largest on record. The Semiconductor Index topped in July at $283, and is still well below this high, compared to the S&P 500 that just pushed to new a new high this week at 5796.

Chart illustrating the semiconductor sub-sector’s corrective pattern, featuring a 3-wave drop since June followed by a bounce from the August 5th low, suggesting a potential final drop targeting $190 to $165. – 123

When digging deeper into this key sub-sector, we can see that a clear corrective pattern is playing out. Since the June top, there is a clear 3 waves down. This has been followed, so far, by a symmetrical 3 wave bounce off the August 5th low. This pattern best fits a standard corrective patten. This implies that a final drop is still needed, which is targeting between $190 – $165.

The advance seen today is poking above the downtrend line from the July top. However, this is happening on less volume and less momentum. Note the momentum indicator below the chart. It has given three lower highs while price provided three higher highs. This is a rare pattern that tends to precede a trend reversal.

Chart depicting the current market advance above the July downtrend line, showing decreasing volume and momentum. The momentum indicator reveals three lower highs, while the price shows three higher highs, suggesting a potential trend reversal. – I/O Fund

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Nvidia (NVDA)Nvidia (NVDA)

Nvidia topped in June at $140, and failed to make a new high in July with the rest of the Semiconductor Index. This was a warning that semis, and the broad market, were heading lower.

This same relative weakness is still present today. While most semiconductors have broken out above their August high, NVDA remained below it. This week, it has moved above the August high, which appears to be the final move in this bounce which is happening on less momentum and less volume. This lines up with the I/O Fund’s game plan, which was to sell a quarter of our NVDA position in June around $129, and attempt to buy it lower in the coming months, which was discussed in detail on my recent interview.

Chart illustrating NVDA’s incomplete corrective pattern, indicating potential drops below $114 and $108, which could lead to a decline toward the $90 – $70 region, completing a multi-month correction. – I/O Fund

Like SMH, NVDA appears to be tracing an incomplete corrective pattern. A move below $114 and then $108 will signal that the stock is heading toward the $90 – $70 region, which would complete this multi-month correction.

NVDA remains weaker than the broad market, as well as SMH. Considering the importance of this stock, as long as it remains below its June high, it is a warning to the current broad market advance.

Are New Leaders Developing?

Some have argued that the market is taking gains in the AI leaders and spreading that money out into beaten down sectors. In other words, there is a healthy broadening out of the market, which typically exhibits strength.

The narrative that supports this idea is that the FOMC just offered a surprise 50 bps rate cut into a seemingly healthy economy. The cheaper cost of borrowing should propel more economically sensitive sectors to play catch-up as the economic expansion continues.

As plausible as this sounds, it’s just not showing up in data, yet. Since the Fed cut rates on September 18th, we are not seeing money flowing into your beaten down sectors that should do well if this narrative is playing out.

Sectors like, transportation, small caps, retail sales, consumer discretionary and high beta are still under their 2021 highs. These are the sectors that would benefit from a soft-landing. As you can see below, aside from consumer discretionary, they are all underperforming the S&P 500.

Chart illustrating the market dynamics where AI leaders are gaining, but beaten down sectors like transportation, small caps, retail sales, consumer discretionary, and high beta are still lagging behind the S&P 500, showing no significant investment flow after the FOMC’s 50 bps rate cut. – I/O Fund

While Nvidia and Semiconductors are making a lower high, there is more money flowing into defensive and inflationary markets, like, Energy, Apple, Utilities and even the US dollar is doing better than the markets that would support the broadening out narrative.

What the Bond Market is Telling Us

Another unusual development since the Fed cut rates is that bonds are not acting as they should at the onset of a rate cutting cycle. Historically, the relationship between long-dated bonds and the Fed cutting rates has been an inverse relationship. As the Fed cuts rates, it is usually in the face of a weakening economy. If prices are going down due to demand collapsing, then a fixed yield is desirable in that environment, meaning that we should see bonds going higher.

This is not what is happening today. The day the Fed cut rates, the 10-year government bond began a sharp decline and is currently down nearly 4% from its high. This is a big move for the 10-year bond.

Chart showing the 10-year government bond’s sharp decline after the Fed’s rate cut, highlighting an unusual trend where bond prices typically rise in a weakening economy. The bond is down nearly 4% from its high. – I/O Fund

This is unusual behavior, as the above chart shows. Bonds should be going higher, not lower, based on historical comparisons. The popular narrative for this behavior in the bond market is that this is evidence that the FED accomplished a soft landing.

If we were going into a slowing economy, which could lead to a deflationary event, then bonds would be catching a bid. So, the fact that we are not must mean that the economy is strong, and the economic expansion will only continue. This will then propel asset prices higher, as well as inflation, making the need for fixed yields a poor investment.

As we just saw, the market is not buying this narrative, as money is not flowing into the sectors that would support this thesis. So, what could be going on?

It’s important to understand that the Fed does not control the 10-year yield; this is controlled by the bond market’s expectations for future growth and inflation. The Fed’s reasoning for aggressively dropping rates on September 18th was that inflation is heading to 2% and the employment market is starting to show weakness.

Since then, the ISM non-manufacturing PMI posted its hottest reading since February of 2023. Twelve out of the 18 segments of this report stated that prices are rising, not falling.

Chart highlighting the ISM non-manufacturing PMI’s highest reading since February 2023, with 12 of 18 segments reporting rising prices. Additionally, the labor market added 107,000 more jobs than expected, revising September figures up by 17,000, causing the unemployment rate to drop from 4.22% to 4.05%. – YCharts

This was accompanied with a labor market that is much stronger than expected. The most recent jobs report showed that the US added 107,000 more jobs than expected, while September’s report was revised higher by 17,000 jobs. This caused the unemployment rate to drop back to 4.05% from 4.22%.

This is further confirmed with current mortgage rates. Everyone was expecting mortgage rates to drop with the Fed Funds Rate. However, since the cut, there has been a sharp increase in average mortgage rate from 6% to 6.32%.

Current mortgage rates defy expectations, rising sharply from 6% to 6.32% following the Fed’s rate cut, contrary to the anticipated decrease. – YCharts

The reason for this is because mortgage rates are not determined by the Fed. Instead, they are the result of an equation that includes the 10-year yield and the borrower’s credit score. So, the 10-year getting sold, means yields are going up.

This happening on the day of the FED’s rate cut policy means the bond market is not convinced inflation is heading to 2%, which is pushing mortgage rates higher. This means that we could be getting signals that the FED made a policy error, and dropped rates too soon, as yields continue to climb in the weeks after this decision.

Interesting enough, at the Grant’s Annual Fall Conference, Druckenmiller stated that his largest bet is shorting the US bond market.

His reasoning is not because the Fed achieved a successful soft landing, which the consensus believes, but it is because “bipartisan fiscal recklessness is on the horizon.” In other words, the larger our deficits become, the more money will need to be borrowed to cover interest payments. As more and more debt gets created, yields will have to go up to attract more buyers, which will put pressure on fiscal budgets, and therefore creates a vicious cycle.

To put this into perspective, the budget deficit for the fiscal year 2024 is going to come in around $1.9 Trillion, or 6.7% of GDP. There is no other year in US history where the budget deficient was this large outside of a major war, like WW I & WW II, or dealing with a major recession, like 2008. It is unheard of to have fiscal spending this high, in an expanding economy, with historically low unemployment. This makes you wonder what the deficit will look like in the face of a contraction.

This was an issue that the market has been aware of for decades but was able to ignore due to historically low interest rates. With rates low and trending lower, this fiscal recklessness was allowed to go on. However, we are seeing for the first time in 30 years, bond yields are starting a new uptrend.

Since 1981, the 10-year yield has been in a classic downtrend, making a series of lower highs. This trend made borrowing easier, as low rates made the cost of borrowing affordable. However, in 2021, yields broke this downtrend and made their first higher highs in 30 years. Today, yields are higher than they were in 2008, making the cost of borrowing higher than most investors are used to in over 20 years.

Diagram illustrating the market’s awareness of excessive debt and low interest rates enabling fiscal recklessness. Since 1981, the 10-year yield has followed a downtrend until breaking the trend in 2021, resulting in the highest borrowing costs seen in over 20 years. – I/O Fund

If this uptrend in yields continues, which looks likely, it would become problematic for inflation expectations, as well as the Fed’s ability to lower rates. It will also become problematic for the cost to service government debts, as more debt will be issued at higher rates to cover current service requirements. And, it will become problematic for stocks, specifically high beta stocks that need to borrow to fund operations, as estimates on future cash flows will have to account for a higher cost to borrow. In short, the last +20 years have built on the idea that inflation will not happen, and the FED can keep rates close to zero.

Broad Market Analysis

The bull market pattern off the 2022 low has taken the shape of a messy diagonal pattern. This is a 5 wave pattern where the internal waves are 3 waves in all directions. It is also marked with large, overlapping swings. Note how wave 4 went into wave 1 territory – this is typical of diagonals. The 5th wave in this pattern is a blow off, and from what I can tell, we are in the final swing of this pattern.

If SPX can breakout above 5825, then it can likely push into the 6000 – 6185 region. If instead, it breaks down below 5675 this will be your first indication of a potential trend change. Below 5500 and then 5115 will be the final confirmations.

Chart illustrating a messy diagonal pattern in the bull market since the 2022 low, consisting of 5 waves with overlapping swings. Key breakout points are at 5825, while downtrend confirmations are at 5675 and 5500, indicating potential trend changes. I/O Fund

In conclusion, as the economic expansion continues, the odds of a recession remain low. However, money is not flowing into the beaten down sectors that would benefit from this reality. Instead, defensive and inflationary names are getting more flows than transportation, small caps, high beta and retail sales. The market leaders continue to make lower highs while the broad market pushes higher, and bonds are getting sold as if the FED stopped cutting rates, not started. The warning signs are high, and my firm remains defensive until these signals reverse, or the market corrects.

If you want to track the potential top in equities, join I/O Fund next Thursday, October 17th at 4:30 pm EST, for our premium webinar. We will go over the levels that need to hold and the specific AI stocks we are targeting for the next leg higher.

Knox Ridley, Portfolio Manager of the I/O Fund, contributed to this analysis.

Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own shares in NVDA at the time of writing and may own stocks pictured in the charts.

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TSMC Q3 2024 Earnings Preview: Strong HPC Growth Likely

Posted on October 12, 2024June 30, 2026 by io-fund

TSMC released its September monthly revenue, which grew 39.6% YoY and 0.4% MoM to NT$251.87 billion. The third quarter revenue grew 39% YoY to NT$759.69 billion, beating the LSEG estimates of NT$750.36 billion.

In US dollar terms, Q3 revenue grew by 36.2% YoY to $23.53 billion using the average exchange rate of $1=NT$32.28. We will get the official USD figures when the company releases its full results on October 17th. The company handsomely beat the upper end of the guidance of $22.4 billion to $23.2 billion.

The strong September results suggest surging demand for AI chips and with more details on full quarter performance coming this week. Due to its technological leadership, the company has over 90% market share in the manufacturing of advanced AI chips. TSMC's customer base includes leading companies like Apple, Nvidia, AMD, Qualcomm, Marvell, and Intel.

TSMC is the leading global foundry in terms of revenue. It has a market share of 62.3% in Q2 2024. Samsung ranks a distant second with a market share of 11.5% in Q2 2024. WSJ reported TSMC’s global foundry revenue share to hit about 64% in 2024, up from 51% in 2019 and Samsung’s share to drop to 10% from 16% in 2019.

Revenue

Strong revenue growth is expected in the coming quarters due to the robust demand for AI and smartphone chips. Revenue estimates have gone up over the past few quarters, 4.7 points for the current quarter and estimates have risen 7.6 points for Q1 of next year indicating analysts’ confidence in the company’s ability to maintain growth.

Management’s guide for the third quarter is between $22.4 billion and $23.2 billion. This represents year-over-year growth of 31.9% at the midpoint. Based on the monthly TWD figures, Q3 revenue grew by 36.2% YoY to $23.53 billion using the average exchange rate of $1= NT$32.28. We will get the official USD figures when the company releases its full results on October 17th.
Q2 revenue grew by 32.8% YoY and 10.3% QoQ to $20.82 billion, primarily driven by strong AI demand and partially offset by smartphone seasonality. Q2 reported a remarkable 19.9% acceleration from 12.9% growth in Q1.

During the Q2 earnings call, management increased full-year 2024 revenue guidance from low to mid-20% to slightly above mid-20% in US dollar terms as strong AI and high-end smartphone demand will lead to an increased capacity utilization for the 3-nanometer and 5-nanometer process technologies in the second half of the year.

Margins

While many companies struggle with rising costs, TSMC has successfully navigated these challenges by controlling costs and negotiating better prices with its customers. Due to reducing costs during a growth phase, referred to as “economies of scale,” and its leadership position in the foundry industry, the company has been able to report strong profitability.

According to DigiTimes, TSMC has notified its clients that prices for its 3-nanometer and 5-nanometer process products will increase by 3 to 8% in 2025. In the last earnings call, management hinted that prices will increase due to cost escalation.

Management has guided Q3 gross margin to increase 1.3 percentage points sequentially to 54.5% at the mid-point due to better capacity utilization, cost improvements, and productivity gains compared to 54.3% in Q3 last year. The margin is expected to be partially offset by the N3 ramp, N5 to N3 tool conversion costs, and higher electricity prices in Taiwan. Electricity prices in Taiwan increased by 17% last year and another 25% in April this year. Management is confident of achieving a long-term gross margin of 53% and higher.
Operating margins are expanding, helped by operating leverage. Management guide for Q3 is 43.5% at the midpoint compared to 41.7% in Q3 2023.

Net income was $7.66 billion or 36.8% of revenue which is lower than usual. This margin trends in the high 30% range and into the 40% range. Return on equity was 26.7% compared to 23.2% in the same period last year.

EPS

EPS is projected to rise significantly. Analysts expect Q3 GAAP EPS to grow 36.4% YoY to $1.76. For next quarter, EPS is expected to grow 34.7% YoY to $1.94 in Q4.

Compare this to Q2 GAAP EPS of $1.48, up 29.8% YoY, which beat estimates by 4.2% due to better capacity utilization, cost improvement and operating leverage. More importantly, analysts expect Q3 EPS to grow 18.9% sequentially.

Analysts expect 2024 GAAP EPS to grow 26.4% YoY to $6.55.
For FY2025, they expect GAAP EPS to grow 29.9% YoY to $8.51.

Cash Flows and Balance Sheet

The company’s financial stability is evident due to its strong operating cash flows, which have more than doubled in Q2. The foundry industry is capital-intensive and this is why you will notice a wide difference between operating cash flows and free cash flows for the company.

Operating cash flow was $11.68 billion or 56.1% of revenue compared to 35% of revenue in the same period last year and 73.6% in Q1.
Free cash flow was $5.32 billion or 25.5% of revenue compared to (-17%) of revenue in the same period last year and 43% in Q1. The company had negative free cash flows last year due to the income tax payment of $3.85 billion.
Management expects strong AI demand to continue and raised the midpoint of the capex for 2024 to $31 billion from the previous $30 billion, up 1.8% YoY. About 70% to 80% of the capex will be allocated to the advanced process technologies.
According to a report from Economic Daily News, Institutional Investors expect the capex to remain within the updated guide for this year. They also expect management to announce an increase in capex for next year during the January results due to the expected strong demand for 2 nm process technology.
Cash and marketable securities were $63.05 billion and debt of $30.4 billion compared to $60 billion and $30.25 billion in Q1. The company paid $2.8 billion in dividends in Q2.

Revenue by Platform

As the leading foundry for AI accelerators, TSMC is riding the enormous wave of demand from Big Tech. The chipmaker’s high-performance computing (HPC) revenues rose 28% QoQ to $10.8 billion and accounted for 52% of Q2 revenue, up from 46% of revenue in Q1. The HPC segment is above the 50% mark for the first time.

We can also notice in the below chart that the HPC revenue (which are mainly AI-related) reached a record $10.8 billion in Q2.

Smartphone revenues declined (-1%) QoQ due to seasonality and accounted for 33% of revenue compared to 38% of revenue in Q1. In the Q2 earnings call, management mentioned that they are witnessing strong AI and high-end smartphone-related demand in Q3. We will get the exact mix this week.

Internet of Things revenue grew by 6% sequentially and accounted for 6% of revenue.

Automotive revenue increased 5% sequentially and accounted for 5% of revenue. Digital Consumer Electronics increased 20% sequentially accounting for 2% of revenue. Other revenue increased 5% and accounted for 2% of revenue.

Revenue by Technology

The Advanced nodes are defined as 7-nanometer and below. We discussed in our editorial on the advanced nodes and AI-related revenue reaching fresh records. Most of the AI chips produced by the company utilize 5-nanometer and 4-nanometer process technology. 3-nanometer revenue is expected to triple this year and Apple usually gets the preference for the most advanced node in production. Volume production for 2-nanometer is expected in 2025 and should have a meaningful revenue contribution in the first half of 2026.

In Q2 2024, 3-nanometer process technology contributed 15% of wafer revenue, while 5-nanometer and 7-nanometer accounted for 35% and 17%, respectively.
In Q1 2024, 3-nanometer process technology contributed 9% of wafer revenue, while 5-nanometer and 7-nanometer accounted for 37% and 19%, respectively.

Advanced Packaging

The AI wave has also boosted the company’s advanced packaging business, particularly Chip-on-wafer-on-substrate (CoWoS). Morgan Stanley expects CoWoS capacity to reach 80,000 to 90,000 wafers per month by the end of 2025, up from a prior estimate of 70,000. The 2025 production capacity would suggest an over 430% increase from 15,000 at the end of 2023.

Management said in the Q2 earnings call Q&A that supply is expected to continue to be tight next year. They also mentioned that they are working with OSAT (Outsourced Semiconductor Assembly and Test) partners to increase production capacity.

Valuation

The company trades at a P/E ratio of 34.4 and a forward P/E ratio of 29.1. The P/S ratio is 13 and a forward P/S ratio of 11.4. In the last five years, the P/E ratio peaked at 41.8 in February 2021 and hit a low of 10.3 in November 2022. The stock is now trading above its five-year average P/E ratio of 24.1.

Conclusion

Due to technological leadership, TSMC can capture a significant portion of AI business and is the common denominator to the biggest AI winners as it supplies to Nvidia, Apple, AMD, Marvell, and Qualcomm. The company is negotiating better prices with its customers, is making cost improvements, and is maintaining strong margins and cash flows. Since TSMC generates strong cash flows, it has the scale to invest for future growth, and barriers of entry are high as the foundry industry is capital-intensive. We look forward to adding this stock to our portfolio in the coming months and will provide the play-by-play for our entries and adds to Essentials Members.

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

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Lumen Technologies – AI Turnaround Fuels Its Future

Posted on October 8, 2024June 30, 2026 by io-fund

Since July, Lumen Technologies is up over 500% and most of this rise occurred following the company’s Q2 earnings report. Given the exceptional and sudden performance, we looked at Lumen more closely.

The company provides fiber connections for high-speed transmission between data centers. Generative AI demands at least ten times more fiber connections within data centers, along with a strong fiber network to enable fast information transfer between these data hubs.

With the largest intercity fiber network in North America, Lumen is positioning itself as a key fiber provider for data centers and recently secured $5 billion in new contracts from clients, including Microsoft and the US Defense Information Systems Agency.

After suffering years of declining revenue and profits, Lumen is undergoing a turnaround as its fiber network provides the backbone for the AI economy. With that said, other segments weigh on Lumen and the company will not return to growth for some time.

Company Overview

Lumen Technologies is a telecommunications company that provides communications and data services to businesses, government agencies, and residential customers. Its business can be split into two sales channels: its business segment and its mass markets (primarily residential) segment.

The business segment operates under the flagship Lumen brand while the mass markets segment operates under Quantum Fiber for fiber-based broadband services and CenturyLink for copper-based broadband services. Lumen’s business segment has grown to 79% of revenue in FY’23, up from 72% in 2021.

The CenturyLink brand has been around since 1930, and was renamed Lumen Technologies in 2020 to reflect the shift away from the shrinking copper-based CenturyLink broadband business.

Largest Intercity Fiber Network

Lumen’s primary advantage comes from its scale with over 450,000 route miles of fiber optic cable globally that make it the largest ultra-low-loss intercity fiber network in North America.

It is further investing to more than double its intercity fiber miles by 2026, signing an agreement with fiber optic manufacturer Corning to reserve 10% of its global fiber capacity for each of the next two years.

Some of its key advantages include its use of a multi-conduit system which allows it to deploy fiber quickly and more economically than competition, and having 25% less optical loss than competition which decreases equipment costs.

The scale of Lumen’s fiber optic network was one of the key reasons it was able to secure $5 billion in new deals for its Private Connectivity Fabric (PCF) service, including with hyperscaler Microsoft. PCF is a custom network that includes dedicated access to existing fiber in the Lumen network, the installation of new fiber on existing and new routes, and the use of Lumen’s new digital services. Lumen notes that it is in talks to secure an additional $7 billion in AI-related sales opportunities and sizes the market as $50 to $60 billion, growing 4% to 5% annually.

The announcement of additional AI-related sales opportunities, as well as significantly raising its FY’24 free cash flow guidance from $100 to $300 million to $1.0 to $1.2 billion has contributed to Lumen’s outsized 3-month stock returns.

Business Segment (79% of FY’23 revenue)

As stated, Lumen is going through double-digit declines in revenue and it will be some time before the company returns to growth.

The business segment is comprised of four product and service categories denoting their stage of investment: Grow (a focus on new investments), Nurture (more mature offerings), Harvest (generating cash), and Other.

The Grow segment is the largest, comprising 41% of business revenue in Q2’24. If we back out international revenue, which experienced a (-70.5%) YoY decline due to the divestiture of Lumen’s EMEA business in November 2023, then Grow grew 1.5% YoY in Q2.

Nurture experienced the largest revenue decline at (-12.1%) YoY and is the second largest segment, comprising 29% of business revenue. The Nurture segment is comprised of mature offerings that are ex-growth where the focus is on improving margins.

Finally, the Harvest segment includes legacy services that have grown out of the Nurture phase and are managed to maximize cash. This segment experienced a (-10.6%) YoY revenue decline and comprises 22% of business revenue.

The Harvest segment has experienced the largest decline as a percentage of revenues over the last year, although all segments have seen revenue decline in absolute terms.

Mass Markets Segment (21% of FY’23 revenue)

The mass market segment is comprised of Lumen’s services for residential, small business, and government customers. This segment is split into three categories dependent on the type of service provided.

The Fiber Broadband (Quantum Fiber) segment serves high-speed internet through fiber infrastructure and is the fastest growing segment in the company at 14.6% YoY growth in Q2, comprising 26% of total Mass Markets revenue, up from 21% in the previous year’s quarter.

The Other Broadband (CenturyLink) segment uses slower, copper-based infrastructure under the legacy CenturyLink brand. This segment is rapidly shrinking as customers switch to fiber, seeing a (-16.1%) YoY decline in Q2.

Finally, the Voice and Other is comprised of phone services and government programs. This segment also saw an (-11.7%) YoY decline in Q2.

Financials

Lumen has seen years of declining revenues as the company failed to diversify itself away from its declining CenturyLink segment. Although revenue is expected to continue to decline in the coming quarters and years, Lumen’s Quantum Fiber business is growing and partially offsetting the decline in CenturyLink.

The over $5 billion in AI-related Private Connectivity Fabric (PCF) deals is also expected to reignite growth in the Business segment, with management guiding for the public sector to return to sustainable growth later this year, followed by mid-market then large enterprise. However, the overall business is not expected to return to growth until 2027 according to consensus estimates.

The cash flow from the AI-related PCF deals are also expected to close any FCF deficit between now and when the company reaches sustainable positive FCF, assuaging liquidity concerns despite the high debt load and decreasing margins.

Revenue

Q2 revenue fell by (-10.7%) YoY to $3.27 billion, beating expectations by 0.58%. This compares to Q1 revenue decline of (-12%) for revenue of $3.29 billion. Next quarter is expected to decline further at (-11.5%) YoY to $3.22 billion
2023 revenue fell by (-16.7%) YoY to $14.56 billion. This compares to 2022 revenue decline of (-11.2%) for revenue of $17.48 billion. In 2024, the revenue decline is expected to narrow to (-10.9%) YoY to $12.97 billion and (-4.3%) YoY in 2025 to $12.41 billion
The majority of the $5 billion in Private Connectivity Fabric solution sales is expected to be recognized over the next 3 to 4 years

Margins

While Lumen has consistently generated positive adjusted EBITDA, its margins have consistently declined. The company has reported large one-time GAAP losses stemming from goodwill impairments in Q4’23 and Q2’23.

Management expects the trend to continue and guided for adjusted EBITDA to fall further in 2025 as they pull forward some expenses due to their improved liquidity profile. However, this is part of their goal to take out $1 billion in costs from the business by the end of 2027 by unifying four enterprise networks into one. As a result, they expect a significant rebound in adjusted EBITDA in 2026, followed by YoY growth.

Q2’24 gross profit declined (-39%) YoY to $1.62 billion. Q2 gross margin was 49.4%, decreasing from 52.5% in the same quarter last year and 49.8% in the previous quarter
Q2 operating income increased to $135 million from loss of (-$8.42) billion in the year ago quarter which was affected by goodwill impairment charges. Q2 operating margin was 4.10%, up from (-230%) in the same quarter last year when there was a loss of $8 million, but up from 1.40% in the previous quarter

Adjusted EBITDA declined (-17.7%) YoY to $1.01 billion, representing a 30.9% margin, down from 33.6% last year but up from 29.7% last quarter.

Management guide for FY’24 adjusted EBITDA is in the range of $3.9 to $4.0 billion, slightly down from their previous guide of $4.1 to $4.3 billion issued in Q1 as Lumen pulled forward some investments associated with its business transformation.

Lumen management guided for 2025 adjusted EBITDA below 2024 levels, with a significant rebound in 2026 and growing thereafter, they note that they will provide more detailed guidance in their Q4’24 call in February 2025.

Net income was (-$49) million or (-1.5%) of revenue compared to (-$8.736) billion or (-238.6%) of revenue in the same period last year due to a non-cash goodwill impairment charge of $8.793 billion
Adjusted net income was (-$124) million or (-3.8%) of revenue compared to $98 million or 2.7% of revenue in the same period last year

EPS

Lumen is expected to remain unprofitable on a GAAP and adjusted EPS basis due to its interest expense burden.

Q2 GAAP EPS improved to ($0.05) from ($8.88) last year and beat estimates of ($0.11). Adjusted EPS fell from $0.10 last year to ($0.13) and missed estimates of ($0.04)
Analysts expect adjusted EPS to grow 4.6% YoY to ($0.09) in Q3 and to ($0.06) in Q4
Analysts expect 2024 adjusted EPS to decline from $0.20 in 2023 to ($0.32)

Cash Flow and Balance Sheet

One of the primary risks to Lumen has been its high debt load, with debt of $18.6 billion, for a debt-to-equity ratio of 39.9x.

However, Lumen has seen a significant improvement in cash flow and liquidity recently. Since Q2’23, it has addressed over $15 billion of debt and extended $10 billion of maturities as well as securing access to $2.3 billion in new liquidity.

With the company guiding for free cash flow guide of $1.0 billion to $1.2 billion for FY’24, liquidity is not much of a near-term concern.

The management guide for FY’24 FCF is in the range of $1.0 to $1.2 billion, significantly improved from their previous guide of $100 to $300 million issued in Q1.

Operating cash flow was $511 million or 15.6% of revenue compared to (-$100) million or (-2.7%) of revenue in the same period last year
Adjusted free cash outflow was (-$156) million or (-4.8%) of revenue compared to (-$896) million or (-24.5%) of revenue last year
Capex was $753 million compared to $796 million in the same period last year. The management guide for FY’24 capex is in the range of $3.1 to $3.3 billion, up from their previous guide of $2.7 to $2.9 billion issued in Q1

The company had cash of $1.5 billion and debt of $18.6 billion compared to $1.58 billion and $18.68 billion in the previous quarter. The company is guiding for net cash interest of $1.15 to $1.25 billion in 2024

Valuation

Due to the stock being up over 500% in three months, Lumen is trading at its historic averages, which reflect revenue declines, unprofitability, and liquidity concerns with its high debt load. It currently trades at a P/S multiple of 0.42x and a forward P/S ratio of 0.46x which is below its 5-year average of 0.44x. Notably, telecom companies such as AT&T are trading at 1.3x and Verizon at 1.4x.

Lumen trades at a forward EV/EBITDA multiple of 6.0x. While Adjusted EBITDA is expected to decline further in 2025, management guided for a “significant rebound” in 2026, followed by growth thereafter as previously mentioned.

Risks

Lumen’s largest risk stems from its declining revenues in combination with the interest burden from its debt. The stock went through a 98% peak-to-trough drawdown as liquidity became a key concern prior to the large AI-related contracts it recently landed.

However, the details around the $5 billion of AI-related PCF contracts remain high-level and the contribution is front-loaded, meaning the majority of the revenue and cash flow associated with these contracts will be recognized in the next 3-4 years, so Lumen needs to continue to win new business to extend its growth.

Finally, Lumen operates in a very competitive industry with large competitors like AT&T and Verizon that are investing heavily in their own fiber networks. Both companies are much larger than Lumen and thus pose a significant threat to Lumen’s ability to land more contracts and continue to pay off debt.

Technical Analysis

Lumen is up over 600% since July. This is an unusually large move in such a short amount of time. To understand if this is the start of a new, multi-year uptrend, we will need to look at Lumen’s trend on a much larger timeframe.

LUMN has been trading since the 1979s (due to CenturyLink). From its IPO into the 2000 top, it traced a perfect 5 wave pattern that took decades to complete. What always follows a 5 wave pattern is a 3 wave retrace of the same degree. The problem with the retrace that followed was that it lasted 23 years and retraced 98% of the uptrend. This is a very deep and long, which warrants caution until Lumen can further prove itself.

We need to see the pattern off the 2023 low turn into another 5 wave pattern to signal a new uptrend is starting. So far, it’s only 3 waves higher. For now, we need to see any weakness hold over $2.70 and then make a new high to meet this criterion. If we can see a new 5 wave pattern develop off the 2023 low, it will imply a new and investable uptrend has started.

Conclusion

It is not often that you see a century-old company at the forefront of new secular trends, but Lumen’s large and hard-to-replicate network of fiber assets is proving important as data center customers look to ever-increasing amounts of data with fast transmission to train AI models.

After concerns of potential bankruptcy in recent years, Lumen has successfully capitalized on recent AI-related contracts to stabilize its liquidity position as the company looks to return to growth in coming years. While the idea remains speculative given the high leverage, competition, and the lack of details surrounding the new contracts, Lumen could see a continuation of its rally if management is able to execute.

The I/O Fund has no plans to enter Lumen at this time.

This analysis is a preview of what you can expect in our upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier November/December. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!upcoming Discovery tier, which will provide additional analysis on new idea generation stocks that are not currently in the I/O Fund portfolio. We look forward to launching this tier November/December. There will be no changes to our current service tiers, rather I/O Fund Discovery is a service for those who want more new stock ideas beyond what our service currently provides. Stay tuned for more information!

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Lumen Technologies – AI Turnaround Fuels Its Future

Posted on October 8, 2024June 30, 2026 by io-fund

Company Overview

The CenturyLink brand has been around since 1930, and was renamed Lumen Technologies in 2020 to reflect the shift away from the shrinking copper-based CenturyLink broadband business.

Largest Intercity Fiber Network

Lumen’s primary advantage comes from its scale with over 450,000 route miles of fiber optic cable globally that make it the largest ultra-low-loss intercity fiber network in North America.

Business Segment (79% of FY’23 revenue)

As stated, Lumen is going through double-digit declines in revenue and it will be some time before the company returns to growth.

The Harvest segment has experienced the largest decline as a percentage of revenues over the last year, although all segments have seen revenue decline in absolute terms.

Mass Markets Segment (21% of FY’23 revenue)

Finally, the Voice and Other is comprised of phone services and government programs. This segment also saw an (-11.7%) YoY decline in Q2.

Financials

Revenue

Q2 revenue fell by (-10.7%) YoY to $3.27 billion, beating expectations by 0.58%. This compares to Q1 revenue decline of (-12%) for revenue of $3.29 billion. Next quarter is expected to decline further at (-11.5%) YoY to $3.22 billion
2023 revenue fell by (-16.7%) YoY to $14.56 billion. This compares to 2022 revenue decline of (-11.2%) for revenue of $17.48 billion. In 2024, the revenue decline is expected to narrow to (-10.9%) YoY to $12.97 billion and (-4.3%) YoY in 2025 to $12.41 billion
The majority of the $5 billion in Private Connectivity Fabric solution sales is expected to be recognized over the next 3 to 4 years

Margins

Q2’24 gross profit declined (-39%) YoY to $1.62 billion. Q2 gross margin was 49.4%, decreasing from 52.5% in the same quarter last year and 49.8% in the previous quarter
Q2 operating income increased to $135 million from loss of (-$8.42) billion in the year ago quarter which was affected by goodwill impairment charges. Q2 operating margin was 4.10%, up from (-230%) in the same quarter last year when there was a loss of $8 million, but up from 1.40% in the previous quarter

Adjusted EBITDA declined (-17.7%) YoY to $1.01 billion, representing a 30.9% margin, down from 33.6% last year but up from 29.7% last quarter.

Net income was (-$49) million or (-1.5%) of revenue compared to (-$8.736) billion or (-238.6%) of revenue in the same period last year due to a non-cash goodwill impairment charge of $8.793 billion
Adjusted net income was (-$124) million or (-3.8%) of revenue compared to $98 million or 2.7% of revenue in the same period last year

EPS

Lumen is expected to remain unprofitable on a GAAP and adjusted EPS basis due to its interest expense burden.

Q2 GAAP EPS improved to ($0.05) from ($8.88) last year and beat estimates of ($0.11). Adjusted EPS fell from $0.10 last year to ($0.13) and missed estimates of ($0.04)
Analysts expect adjusted EPS to grow 4.6% YoY to ($0.09) in Q3 and to ($0.06) in Q4
Analysts expect 2024 adjusted EPS to decline from $0.20 in 2023 to ($0.32)

Cash Flow and Balance Sheet

One of the primary risks to Lumen has been its high debt load, with debt of $18.6 billion, for a debt-to-equity ratio of 39.9x.

With the company guiding for free cash flow guide of $1.0 billion to $1.2 billion for FY’24, liquidity is not much of a near-term concern.

The management guide for FY’24 FCF is in the range of $1.0 to $1.2 billion, significantly improved from their previous guide of $100 to $300 million issued in Q1.

Operating cash flow was $511 million or 15.6% of revenue compared to (-$100) million or (-2.7%) of revenue in the same period last year
Adjusted free cash outflow was (-$156) million or (-4.8%) of revenue compared to (-$896) million or (-24.5%) of revenue last year
Capex was $753 million compared to $796 million in the same period last year. The management guide for FY’24 capex is in the range of $3.1 to $3.3 billion, up from their previous guide of $2.7 to $2.9 billion issued in Q1

Valuation

Risks

Technical Analysis

Conclusion

The I/O Fund has no plans to enter Lumen at this time.

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