Month: May 2026

SiTime: Precision Timing Solutions Increasing in Importance, FY Revenue Growth Guide of >80% 

Posted on by io-fund

MEMS timing supplier SiTime is seeing solid tailwinds in AI data centers from the increasing complexity of rack-scale platforms and shift to faster data rates in networking switches and optical transceivers, as these place more emphasis on timing solutions to ensure that all components operate as one cohesive unit with maximum performance and reliability.  

SiTime delivered a strong print this week by dramatically beating Q1 estimates, guiding far above Q2 estimates and raising full-year guidance. Q1 revenue of $113.6 million beat consensus of $103.5 million for a 10% beat, yet EPS grew 5X YoY and reported a 23% beat for $1.44.  

Gross margin was especially strong at 64.5% for a 7-point expansion, but the more pronounced margin expansion was operating margin at 28% for a 25-point expansion. Operating cash flow more than doubled to $31.2 million. 

While Q1’s strength is notable, the more pronounced beat is in the Q2 guide for revenue of $145M at the midpoint for growth of 100% YoY. This compares to analyst estimates for 62% growth in Q2. Management also stated gross margin would be above 65% and operating margin above 30% next quarter.  

This led to raising the full year fiscal year guide, with management stating: “For the full year, we are increasing our revenue growth expectations to at least 80%, well above our prior expectations and our long-term target growth rate of 25%-30%. This step change in growth reflects both the depth of our order book and the confidence customers are signaling in their own demand forecast, particularly in CED. That confidence is translating into improved visibility, reinforcing our expectation for sustained momentum throughout the year.” 

Brief Overview of Key Products 

SiTime offers a range of MEMS-based (micro-electromechanical system) timing solutions that it says offer greater resilience, lower power, higher performance and a smaller size versus traditional quartz solutions.  

  • Oscillators 

MEMS oscillators are timing devices embedded on a silicon chip that generate a clock signal (frequency) used to coordinate actions of different components, essentially serving as the ‘heartbeat’ of the device; they do this by combining clocks and resonators in a single system. As it relates to AI server buildouts, increasing rack and cluster sizes means data must move across hundreds to thousands of chips at once, requiring precise synchronization across components and interconnects to minimize latency, prevent data loss and maximize system efficiency.  

SiTime’s high-performance oscillators are prevalent across the compute tray within the GPU and CPU boards, NIC cards, and networking switches, and also within the networking fabric, from top-of-rack and spine switches to optical transceivers and AECs. SiTime says its MEMS oscillators can reduce power consumption by 30–50% versus quartz with similar or better frequency in a more compact footprint. 

  • Clock ICs – Generators and Buffers  

Clock buffers take a single clock signal input and then multiply and boost the signal across multiple different output lines, ensuring that the clock signals reach all parts of the circuit. Clock generators are a type of oscillator that produce periodic timing signals for all of the components within the circuit, and can handle different frequencies needed for GPUs, CPUs, memory, PCIe and Ethernet components. Generators also help reduce jitter and improve signal integrity on the board.  

SiTime recently launched its Chorus clock-system-on-a-chip family for AI data center applications in April 2024, which combines clocks, oscillators and resonators into a single integrated chip, offering up to 10X higher performance compared to standalone oscillators and clocks. SiTime executives say the new solution also accelerates development time by up to six weeks, and reduces board area for timing by up to 50%, while addressing issues such as noise and impedance mismatch between resonators and clocks. Back in Q3, the clock funnel was stated to have quadrupled in the past year to $300 million, though revenue was stated as sub-$20 million in December. 

SiTime is also acquiring Renesas’ timing unit, which it says will boost its clock IC portfolio by 10X – more on this below.  

  • Resonators 

Resonators are key components within oscillators that vibrate at a stable frequency, essentially setting the frequency of the oscillator, determining frequency accuracy and ensuring stability over a range of temperatures. SiTime recently launched its high-performance Titan resonator family in September, which it says offers improved performance under high shock and vibration, while occupying 4.2x and 12x less PCB space than quartz competitors. The new platform is initially geared towards IoT, wearables and medical device applications.   

Precision Timing Products Accelerate from Inference Market 

SiTime’s Communications, Enterprise and Datacenter segment (CED) grew 158% YoY and 17% QoQ for the eight consecutive quarter of triple-digit growth. According to the earnings call, the primary driver for CED strength is the shift from training to inference with newer XPUs requiring 2X to 4X more content per system than previous training workloads. According to management, utilization rates in inference workloads are running 20% to 40% today yet need to reach 50% to 60% for reasonable ROI on capex. 

Notably, there is increased unit volume combined with higher ASPs on the Elite and Elite 2 product line.  

Here is what was stated on the call: 

“On inference infrastructure built on newer XPU, it needs 2 to 4 times more timing content per system than in training infrastructure. GPU utilization in inference workloads is now 20% to 40% and is targeted to get to 50% to 60%. Here, time synchronization plays a critical role in achieving higher GPU utilization and SiTime benefits from its products being used in this application. This emphasis on synchronization is driving demand for high ASP and high-margin products.  

Elite and Elite RF Super-TCXOs are widely deployed in AI infrastructure, and we have recently exceeded and extended our leadership with the new Elite 2 Super-TCXO family. This newer Elite 2 delivers up to 3 times better synchronization performance compared to Elite, which was already significantly better than quartz oscillators.” 

Additionally, as 1.6T ramps, SiTime foresees additional share gains due to higher frequencies and “tighter resilience requirements” driving demand for advanced oscillators. 

The following was stated: 

“As hyperscalers increase networking bandwidth within the data center, we expect to see meaningful adoption of 1.6T optical modules in 2026. Higher frequencies and the need for more resilient performance are driving demand of our advanced oscillators at a higher price than those used in 800G. At the same time, we expect to see continued strong shipment for oscillators for 400G and 800G for at least the next two years.” 

As stated above, management noted that 400G and 800G will remain strong for the next wo years while 1.6T ramps. However, 1.6T will see higher ASPs than 800G with the CEO stating that SiTime can charge a premium price by being the highest-performing option: “This newer Elite 2 delivers up to 3 times better synchronization performance compared to Elite, which was already significantly better than quartz oscillators.” 

Quantifying Inference System Content Opportunities  

SiTime has offered some clues into holistic dollar content per rack, general content per networking components, as well as commentary on how the above trends are shaping content growth. This provides a bit more insight into where the 2X to 4X increase in content per system with inference deployments could land. 

In terms of the holistic dollar content per rack, management has explained that for training platforms where they have a high penetration across the system and networking topology, content opportunities “can be multiple hundreds of dollars in a fully integrated rack,” with opportunities potentially scaling larger in networking fabrics.  

Translating this ‘multiple hundreds of dollars’ to the 2X to 4X increase with inference roughly estimates that SiTime could see content above $1,000 in fully integrated racks for inference deployments — this was also mentioned by analysts in Q1’s call that content “certainly sounds like it could reach into the $1,000+ range.” 

Additionally, to briefly touch upon networking opportunities moving up the stack, SiTime has previously mentioned that content for some optical modules can vary from $1 to $2 ASPs, but shifting to switches and farther up the stack can drive more meaningful content, along the lines of $7 to $10 ASPs.   

CPO Switches to Drive 3X Timing Content 

We’ve published quite a bit on the CPO opportunity, especially in our Coherent and Lumentum analyses. As data centers migrate from pluggables to NPO/CPO, SiTime can benefit from this shift as optics move inside the switch. The result will be more oscillator sockets per switch and higher performance requirements, resulting in 3X higher timing dollar content. Management stated: “On CPO or co-packaged optics, in our discussion with customers, we see even greater strength. For example, in CPO switches, where timing content can be up to 3 times higher.” 

Regarding supply to serve an influx of demand, SiTime also offers high confidence commentary that they have no bottlenecks with an analyst referencing SiTime having a strong supply chain during 2020, unlike many peers: 

“We see no issues around supply chain in particular. I know some people have said that in the past, other semiconductor companies, so we want to be very clear about that. We see strength in our supply chain, and we don’t see any fundamental issues or macro issues or external issues that can trip us up as of now.” 

Book-to-Bill Accelerating 

SiTime does not typically offer its book-to-bill ratio, but brief commentary from Q1 that book-to-bill is growing with pull-through from CED, taken with Q4’s book-to-bill of >1.5X, suggests this ratio is moving higher.  

When management had provided the book-to-bill in Q4, analysts had questioned on the duration of this backlog, and if it would be six, 12 or 18 months and beyond, to which management said it is typically within 12 months:  

“So in terms of the book-to-bill, I think Rajesh talked about the fact that we are seeing customers maybe book out a little longer, but typically, that's well within 12 months. We see a lot of ordering over the next couple of quarters. But we are seeing some customers book meaningfully in the second half already as well. But I would say definitely weighted to Q1 and Q2 in terms of that.” 

This implies near-term demand is strengthening in Q1, driven by CED, while it provides a further layer of confidence in SiTime’s upbeat annual revenue growth guide of >80%. It also suggests Q2 momentum is likely to remain robust, and could signal a similarly strong strong 2H if orders continue to flow as Nvidia’s Blackwell Ultra and Rubin ramp throughout the year alongside strong potential growth in 1.6T transceiver volumes. 

Telecom Offers Diversity for AI-Driven Demand 

Worth noting is that SiTime sells into the telecom industry, to help diversify its customer base beyond hyperscalers. While telecom has gone through a significant trough in recent years, the industry is expected to see an AI-driven resurgence as workloads run at the edge and in the access network. The key markets that SiTime can benefit from are RAN optimization, edge AI inference at base stations, and Open RAN architectures. Each of these trends require more timing sockets and more precision timing requirements, leading to a 3X uplift in content: 

“Finishing up on the telecom part of CED, we see increasing convergence between AI and advanced telecom infrastructures, especially in 5G RAN or Radio Access Network and demand from new applications such as FWA or fixed wireless access. AI-enabled telecom designs contain 3 times higher timing content, primarily from high ASP oscillators and clocks” 

Acquisition of Renesas’ Timing Unit 

SiTime is acquiring Renesas’ timing unit for ~$1.5 billion, significantly increasing its clocking portfolio by ~10X, adding a range of hyperscaler and leading AI server customers, and providing a substantial boost to SiTime’s CED revenue.  

Most importantly, the timing unit acquisition is expected to significantly increase the scale of SiTime’s CED business. Management had explained in Q4 that the acquisition will nearly double its CED business, adding that in the first 12 months post-close (likely starting Q2 ’26), the timing unit is expected to generate more than $300 million in revenue with ~75% of that from CED, or ~$225 million.  

Moving down the line, the timing unit is expected to accretive to both margins and EPS in the first full year post-close. Management explained that the unit has adjusted gross margins around 70%, or nearly 9 points higher than SiTime’s Q4 adjusted gross margin of 61.2%; it will also help push SiTime towards the upper end of its long-term 60-65% gross margin target model. The acquisition is expected to help drive adjusted operating margins above 30% from increased operating leverage at scale, compared to FY25’s 17.9% margin. 

From the product and customer side, SiTime sees the acquisition taking them to scale in clocking, adding 500 differentiated clock products to its portfolio, boosting it by 10X, and being complementary to its high-performance oscillator suite, which contributes the majority of revenue. Customer breadth and diversity will also increase substantially, as it will now integrate the unit’s 10 hyperscalers, seven AI server leaders, 10 networking and communications vendors and other customers to its roster. Because of the complementary nature of SiTime’s oscillators with the unit’s clocking portfolio, management expects there will be minimal product overlap, which will open the door for new revenue opportunities at shared customers, such as cross-selling or integrated oscillator and clocking solutions. 

In Q4, SiTime’s CEO touched on potential revenue goals post-acquisition and set some mile markers for investors further down the line. The first goal post-acquisition is to create a $1 billion company, which is now just ~12% away after combining implied revenue of $588 million with the $300 million expected in the 12 months following the close of the acquisition. From there, they provided a TAM of $10 billion to $11 billion for the timing business with a longer-term total addressable market of $17 billion to $18 billion. 

Financials 

Revenue Accelerates to 88.3% YoY  

SiTime reported Q1 2026 revenue of $113.57 million, beating consensus estimates by 9.1%. Growth accelerated to 88.3% YoY, up from 66.3% YoY in Q4 2025, marking a re-acceleration in the top line for the second consecutive quarter after deceleration through mid-FY25. On a sequential basis, revenue was essentially flat at +0.2% QoQ, an atypical break from Q1’s seasonal declines in the teens to twenties. 

Looking ahead, management guided Q2 2026 revenue to be $140 million to $150 million, implying YoY growth of 108.6% YoY and 27.7% QoQ growth at the midpoint, beating estimates by a solid 29.1%.  

Management guided full year revenue growth of at least 80%, beating estimates by 21%. Beth Howe, Chief Financial Officer, said in the earnings call, “For the full year, we are increasing our revenue growth expectations to at least 80%, well above our prior expectations and our long-term target growth rate of 25%-30%. This step change in growth reflects both the depth of our order book and the confidence customers are signaling in their own demand forecast, particularly in CED.” 

Key Segments 

CED Dominance; Consumer Faces Headwinds 

The quarter's result was driven by continued momentum in the CED (Communications, Enterprise & Datacenter) segment, which reached $75.7 million — up 158% YoY and 17% QoQ — reinforcing SiTime's positioning as a key beneficiary of AI infrastructure buildout. CED now constitutes 67% of total revenue, up from 57% in Q4 2025.

Auto, Industrial & Aerospace revenue came in at $21.2 million, up 51% YoY but declining (13%) QoQ, reflecting some normalization after a 21% sequential growth in Q4. Within this sector, aerospace and defense were the fastest-growing area with all three subsectors benefiting from the accelerating adoption of precision timing across autonomous systems, defense modernization, and industrial automation. 

Consumer, IoT & Mobile revenue of $16.7 million declined (1%) YoY and (31%) QoQ, reflecting ongoing softness in the consumer end market. 

Margins 

Margins are improving primarily due to favorable product mix, cost controls, and operating leverage.  

Q1 adjusted gross margin improved by 7.1 percentage points YoY to 64.5%. The improvement was driven by two factors. Roughly half of the increase was driven by favorable product mix of higher margin products, reflecting strong CED growth, which carries higher above average gross margin, combined with a lower mix of consumer products. The other half was driven by product cost improvements and leverage. Management guided adjusted gross margin of 65% in the next quarter. 

Q1 operating loss was ($12.3 million) or (10.9%) of revenue compared to ($28.1 million) or (46.6%) of revenue in the same period last year. Q1 adjusted operating income was $31.8 million or 28% of revenue compared to a mere $2.1 million or 3.4% of revenue in the same period last year, reflecting strong operating leverage. Management guided Q2 adjusted operating margin to further improve to 32.9%. The difference between GAAP operating margin and non-GAAP operating margin was due to high stock-based compensation, which was 27.1% of revenue in Q1. 

Q1 adjusted net income was $38.9 million or 34.3% of revenue compared to $6.3 million or 10.5% of revenue in the same period last year.  

Management also offered some more clarity on how margins will evolve through the year, with a higher mix of CED benefitting 1H, before a higher mix of consumer weighs a bit more on 2H:   

“We certainly benefited in Q1 from kind of the double benefit of a stronger mix of CED, which has those higher gross margins and a lower mix of consumer. As we move through the year, we would expect consumer to be a larger portion of the mix in the back half, which might modulate gross margins a bit just based on mix. Overall, we still expect gross margins to be above that 60% level and kind of well into this range. It may modulate a bit, but still, very toward the higher end of our target range.” 

Q1 Adjusted EPS grew by 454% 

Q1 adjusted EPS grew by 453.8% YoY to $1.44, beating estimates by 21.4% primarily due to strong operating leverage.  

Management also provided a strong Q2 adjusted EPS guide of $1.85 to $2.00, implying a YoY growth of 309.6%, beating estimates by a stellar 65.9%. Looking ahead, 2026 full year adjusted EPS is expected to grow by 81.7% YoY to 5.81 and 33.6% YoY to $7.77 in 2027.  

Cash Flows and Balance Sheet 

The company also reported strong cash flows primarily driven by higher profits. 

  • Q1 operating cash flows grew by 108% YoY to $31.2 million or 27.5% of revenue compared to 24.9% of revenue in the same period last year. 
  • Q1 free cash flow was $17.9 million or 15.7% of revenue compared to ($1.4 million) or (2.3%) of revenue in the same period last year. 
  • The company also maintains a strong balance sheet of $788.6 million of cash & short-term investments with no debt at the end of Q1 2026. 
  • Inventories increased by 11.6% QoQ to $91.1 million, suggesting demand visibility and preparation for the anticipated Q2 ramp. 

Conclusion 

SiTime is seeing a clear inflection in its CED segment with 158% YoY and 17% QoQ growth in Q1. Management sees strong tailwinds due to a mix of increased unit volume of 3X from inference and higher ASPs, especially as we approach 1.6T. The acquisition of Renesas’s timing unit is expected to boost the company’s presence across the data center with new customer additions, while providing another lever for CED to expand. 

The company also offers a 65% gross margin, 30%+ operating margin and an 80% revenue growth guide for the year – with a healthy supply chain as the cherry on top. The setup in AI networking stocks moves quickly. SiTime is not for the passive investor and will require an active stance.

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.

Recommended Reading:

Coherent FQ3: InP Capacity Doubling to Drive CY26 Inflection

Posted on by io-fund

Coherent’s earnings report reinforced a theme being echoed by many AI optical companies, which is that demand is outpacing the industry’s ability to keep up. The company delivered another quarter of accelerating growth with improved profitability, while also discussing demand visibility as “exceptional.”  

The company posted revenue of $1.81 billion, up 7% QoQ and 21% YoY, and up 27% YoY on a pro forma basis (excluding the divested businesses). GAAP gross margin reached 37.7% with adjusted gross margin was 39.6%. Adjusted EPS grew 55% YoY with guidance that implies further growth on the bottom line.  

Datacenter and Communications grew 13% QoQ and was up 41% YoY with the Communications business leading the growth at 16% QoQ and 60% YoY. Within this, scale-across is the fastest growing driver, including DCI. The 800G transceiver business is also set to grow YoY as 1.6T is ramping faster than expected. There are additional growth vectors, such as pump lasers, CPO and OCS discussed in detail.  

The guidance for June implies continued growth across the board with 10% QoQ revenue growth at the midpoint, adjusted gross margin of 40%, and EPS guided to 62% growth. 

The most important takeaway is that management positioned the June quarter as an inflection point, driven by a 2X increase in indium phosphide (InP) capacity by the end of the calendar year. The 6-inch InP ramp is tracking a quarter earlier than expected, with Coherent expected to 4X InP capacity over a two-year period. One analyst pushed back on why this isn't already showing up in revenue; the answer, along with more Q&A on CPO, OCS, and other new growth vectors is below. 

Timing for 6-inch Wafer InP Capacity Growth 

As discussed in prior write-ups, Coherent’s 6-inch wafer line produces 4x the devices as the prior 3-inch process. According to the earnings call this evening, all three device categories are yielding higher than 3-inch yields and are already contributing to higher margins. Perhaps the important commentary from the call was the 6-inch initial contribution showed up this quarter with an expected inflection in the June quarter (the end of fiscal year) 

“And yes, I would say we're still pretty early in the 6-inch ramp. The — if you think about 6-inch — so we shipped our first transceivers last quarter that included devices from our 6-inch and that was just the initial production that we started. That will ramp significantly over the coming quarters. 

So I think it's much more of the 6-inch benefit is ahead of us. The — if you think about the total doubling of capacity, in fact that all of that doubling of capacity is 6-inch. By the end of this year, next quarter, half of our capacity will be 6-inch. So I think that benefit from 6 inches more ahead of us.”  

Later the June quarter was called out: “Yes, if you look at the midpoint of the June quarter guide, certainly, we expect an acceleration in growth versus prior quarter end, if you look at the year-over-year growth rate as well. I — we really believe the current June quarter kind of represents a new inflection point in our revenue growth rate moving forward. So faster growth this quarter. And as we look forward into fiscal '27, which starts in July. We expect our fiscal '27 growth rate to be above fiscal '26.” 

Given the market is capacity constrained, it makes sense that revenue should track capacity increases. According to management, that would be 2X by the end of this calendar year and 4X over a two-year period: “We remain on track to achieve our goal of doubling internal indium phosphide output capacity by the end of this calendar year. And based on current execution, we now expect to reach that milestone 1 quarter earlier than originally planned. We also expect to more than double our internal indium phosphide capacity again by the end of calendar 2027.” 

However, an analyst rightly called out that Coherent is not seeing that inflection yet, so why isn’t the increase in capacity tracking revenue. Management pointed toward a latency between capacity increase and revenue recognition as the main reason. Here is what was stated in this important exchange – which is the crux of the issue for this stock.  

“Sean O'Loughlin   TD Cowen 

And congrats on a solid set of results, as always. One of the things, and I think this speaks a lot to maybe Blayne and Tom's questions earlier in the call One of the things that investors are trying to get a better handle on is, as you ramp 6-inch indium phosphide and the capacity there, the delta between maybe shipping initial SKUs, initial transceivers to revenue, as you mentioned, versus having that line fully qualified at some of your customers for volume production. 

And I'm going to ask the question in a way that I know is the wrong way to frame it. But if I think about we're going to double indium phosphide capacity next quarter, why hasn't that translated into doubling revenue? And that's, I think, where I'm having conversations with a lot of folks, if you could just comment on that. 

James Anderson   CEO 

Yes. Remember that there is a latency from the indium phosphide devices to when we actually ship transceivers, right? So when the indium phosphide devices, whether that's an EML or CW laser come out of the production facility, it's really probably the next quarter, 2 to 3 months later before we see the transceivers then shift based on those devices, right? 

And as an example, those transceivers that shipped in our March quarter, that was indium phosphide devices that were produced in either our September or the early part of our December quarter. So there's usually a lag of a few months from when the devices are made to when we see the — those show up in transceiver shipments.” 

As someone who listens to a ridiculous number of earnings calls, my ears perked up because the CEO did not pushback on the analyst for stating that revenue should eventually catch up (a good sign), rather only stated it’s due to a lag. 

Incoming Growth Vectors 

Similar to our write-up this week on Lumentum, there are many incoming growth vectors for Coherent beyond the core transceiver business.  

Scale-Across Components 

Within the Communications segment, scale-across (DCI) is the fastest-growing contributor, up 16% QoQ and up 60% YoY. The growth is further supported by long-term agreements on a portfolio that includes pump lasers, ZR/ZR+ transceivers, line cards, and more. The multi-rail technology that Coherent highlighted at OFC also falls under this category and is expected to begin shipping in 1H of 2027. 

Here is what was stated about the strength in scale-across: 

“And so yes, this — we expect this area, just given the demand we see in front of us and the visibility of this to be a very strong growth area for us moving forward.  

And then a new system that we think is going to continue to accelerate our growth rate here is multi-rail. And so our multi-rail technology, which we highlighted at OFC, this helps provide a huge capacity increase within the same power and physical area of the prior solution.  

So it's a tremendous benefit to the customer. And we have a number of very differentiated component technology pieces that go into that system that really position us very well. And we're selling full systems, and we expect that revenue to start in the first half of calendar '27.” 

Co-packaged optics (CPO) 

Co-packaged optics (CPO) and near-packaged optics (NPO) are expected to ship as soon as 2H 2026 for scale-out, with more growth expected in 2027-2028 for scale-up. Below is a picture to help visualize the ramp of new products Coherent has in addition to the doubling of InP capacity:

Source: Coherent investor presentationCoherent investor presentation 

When asked to distill further Coherent’s CPO content, the following was shared: 

“So if you look at what can we provide in the CPO solution, it's not just the laser, right? We're certainly providing the high-power CW laser. But beyond that, we're providing the external laser source module. We can provide the fiber attach unit, which includes micro-lens arrays. It includes polarization maintaining fiber. So we have our own fiber optics fiber that we'll provide in those solutions.  

Within that external laser source, we provide all of the ingredients, not just the laser, but the isolators, the thermoelectric coolers. So there's a tremendous amount of content that we expect to provide in CPO. And I see this as a major new growth area for the company. And I think we're very, very well positioned in CPO. And like I said, first revenue will start in sort of later this year, this calendar year.” 

OCS Solutions 

Optical circuit switching (OCS) offers an addressable market sized at $4 billion with strong sequential growth expected as internal component bottlenecks ease. As you can see in the timeline above, OCS is expected to contribute to growth this quarter and will grow sequentially, with management stating: “On OCS, we recently, just over the last couple of months at OFC, we doubled our forecast of the market opportunity there. The revenue growth rate, the sequential growth that we're guiding in the current quarter, part of that growth, that sequential growth is OCS systems growth.  

We feel great about the differentiation of our technology. It's a very differentiated technology that provides both higher reliability, but much, much better power efficiency. And so we feel really good about the long term, both the short- and the long-term growth prospects on that product line.” 

Financials 

By Royston Roche 

Organic Revenue Growth of 27% 

Coherent’s Q3 FY2026 ending March revenue grew by 20.6% YoY and 7.1% QoQ to $1.81 billion, beating estimates by 1.4%. On a pro forma basis (organic), revenue increased 9% QoQ and 27% YoY, excluding revenue from the Aerospace and Defense business and the Munich product division, which were sold in FQ1 and FQ3, respectively. Organic revenue growth accelerated from 22% YoY in the previous quarter, primarily driven by growth in AI data center and communications revenue. 

Management guided strong FQ4 revenue in the range of $1.91 billion to $2.05 billion, implying a YoY growth of 29.5% YoY and 9.6% QoQ, beating estimates by 3.7%. 

Segments 

Data Center and Communications Segment Revenue Growth of 41% 

The datacenter & Communications segment was the primary growth driver, with revenue of $1.36 billion, up 41% YoY and 13% QoQ — representing the second consecutive quarter of double-digit sequential growth. Revenue growth accelerated from 33% YoY and 11% QoQ growth in FQ2 driven by strong AI demand. 

Data center revenue grew by 37% YoY and 13% QoQ and represented a second consecutive quarter of double-digit sequential growth. Management expects data center growth to further accelerate in the next quarter, supported by exceptionally strong demand, improving supply and continued progress in the capacity ramp. Demand in the data center business remains exceptionally strong and broad-based across multiple customers and product categories.

Communications revenue growth accelerated significantly in FQ3, with revenue increasing 16% QoQ and 60% YoY from 9% QoQ and 44% YoY in the previous quarter, driven by strong demand across data center interconnect, scale-across and traditional telecom applications. Management expects strong sequential growth again in the next quarter. 

The Industrial segment remained a modest headwind in FQ3, with revenue of $444 million, down (16%) YoY and (7%) QoQ on a reported basis — though on a pro forma basis (excluding the divested Aerospace & Defense business), revenue declined modestly on both a sequential and YoY basis. Management cited continued softness in parts of the broader industrial market but expressed confidence in improving demand looking ahead. 

Margins 

FQ3 adjusted gross margin improved by 110 basis points YoY to 39.6% primarily due to the reductions in product input costs, yield improvements from 6-inch indium phosphide production as well as significant benefits from pricing optimization. Management has guided adjusted gross margin to improve to 40% in the next quarter. 

FQ3 adjusted operating margin improved by 170 basis points YoY to 20.3%. However, marginally missed the guidance of 20.9% due to higher operating expenses to support the Datacenter & Communications segment product road maps. Management has guided adjusted operating margin to improve to 21.3% in the next quarter.

Adjusted net income grew by 56% YoY to $276.2 million with an adjusted net margin of 15.3% compared to 11.8% in the same period last year.

Adjusted EPS grew by 55% 

Coherent’s FQ3 adjusted EPS grew by 54.9% YoY to $1.41, beating estimates by 1.1%. Management also provided a strong adjusted EPS guide of $1.52 to $1.72 for the next quarter, implying a YoY growth of 62% at the midpoint, beating estimates by 5.2%. 

Cash Flow and Balance Sheet 

The company’s cash flows were weak in the recent quarter due to higher working capital and capex to support future growth.  

  • FQ3 operating cash outflow was ($93.8 million) or (5.2%) of revenue compared to operating cash flow of $162.9 million or 10.9% of revenue in the same period last year.  
  • FQ3 free cash outflow was ($383.5 million) or (21.2%) of revenue compared to a free cash flow of $51.1 million or 3.4% of revenue in the same period last year. Capex increased 159% YoY to $290 million. Management said in the earnings call that due to the strong bookings and the rapidly growing demand, they expect capital expenditures will increase sequentially in FQ4. 
  • The company had cash & short-term investments of $2.41 billion compared to debt of $3.19 billion at the end of FQ3. Cash increased from $863.7 million in the previous quarter due to the $2 billion Nvidia investment. Coherent made $162 million in debt payments during the quarter. The debt leverage ratio was 0.5x, down from 1.7x in FQ2 and 2.1x in the year ago quarter.  
  • Inventories increased 15.1% QoQ to $2.13 billion to support future growth.

Conclusion: 

There comes a point where investors must determine if a management team is reliable. According to Coherent’s management team, the 6-inch InP ramp is ahead of schedule and yielding better than the 3-inch line, and the proof point will be next quarter. In addition, scale-across is the leading growth driver this quarter; a welcome surprise. There are new growth engines spanning OCS, CPO/NPO, scale-across and multi-rail, thermal solutions, plus a strategic partnership with Nvidia, which all add enviable optionality in the secular AI networking market.

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 COHR at the time of writing and may own stocks pictured in the charts.

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Arm FQ4: AGI CPU Demand Hits $2B, Revenue Outlook Stays at $1B

Posted on by io-fund

Arm’s earnings call resulted in a sharp reversal as the stock was originally up 7%+ after hours yet settled down 6.4%. Overall, management’s commentary raised doubts in two areas – the first is whether Arm can secure the supply to meet AGI CPU demand, and the second is whether Arm has immediate inroads into Big Tech/Big Silicon given these larger players already license Arm’s IP and design their own custom CPUs. If the latter is true, then Arm’s near-term merchant silicon market is enterprises rather than hyperscalers.

Regarding supply, management stated the following on the earnings call: “As Rene noted or as Rene mentioned, customer demand for the ARM AGI CP was very strong. We now have line of sight to more than $2 billion of demand across fiscal '27 and '28. However, we are maintaining our outlook of $1 billion while we pursue supply chain capacity, and we still expect the first revenues from production ship sales to land in the fourth quarter of this fiscal year.”

In other words, regardless of demand, Arm's near-term AGI CPU revenue is supply-capped. The very catalyst that drove the stock's run into the print, anticipated demand for the new CPU, was effectively walked back in the near term.

AGI CPU Demand Doubles; But Won’t See Meaningful Revenue for 1-2 Years

We covered the launch of Arm’s AGI CPU and increasing CPU requirements being driven by agentic AI in the free newsletter, Arm Stock Could Win as Agentic AI Shifts the Bottleneck to CPUs.

Here is what we stated in our previous write-up:

“In agentic workflows, the GPU still handles inference, but between each inference call, the CPU is doing the orchestration – which are best described as handling tool calls, API requests and memory tasks. AI agents are surfacing this new constraint, which is how to prevent latency and underutilized GPUs following the exponential growth of orchestration needs.

For investors, what matters is that CPUs account for 50% to 90% of total latency in workflows, which means the CPU-to-GPU ratio in AI clusters will need to increase. Earlier this year, both AMD and Intel saw analyst upgrades based on the outstripped supply of CPUs leading to higher average sales prices of roughly 10% to 15%. Reuters also reported that Intel’s unfulfilled orders are reaching longer than six months while AMD delivery times are believed to be eight to 10 weeks.outstripped supply of CPUs leading to higher average sales prices of roughly 10% to 15%. Reuters also reported that Intel’s unfulfilled orders are reaching longer than six months while AMD delivery times are believed to be eight to 10 weeks.

Regarding how Arm fits in, the company’s expertise in lowering power requirements could matter more than the market expects. After years of supplying the architecture IP behind other companies’ CPUs, Arm is preparing to directly compete with its customers and x86 CPU competitors by transitioning to a chip designer themselves. This comes during a time when CPU cores are expected to go up 4X from 30 million CPU cores per gigawatt to 120 million CPU cores per GW.”

This long-term agentic AI-driven growth underpins Arm’s shift to chip design with the AGI CPU, with management emphasizing in FQ4 that demand for the AGI CPU is accelerating, with visibility into $2 billion through FY27 and FY28, double what was stated just six weeks ago at the CPU reveal in late March.

Despite this sharp increase in demand visibility, Arm is not yet ready to move the needle for AGI CPU revenue contribution, opting to maintain its FY27-FY28 target at $1 billion as it works to secure more supply. To secure this supply, Arm called out the following: “So the number that we talked about at the end of March was supply in place to support $1 billion of demand. And that includes memory that includes wafers, that includes packaging, that includes access to test equipment. So for the $2 billion, we are now in the process of securing supply to support that.”

To further complicate the supply-capped thesis, TSM recently exited its Arm position.

AGI CPU to Report $1B in Revenue in 2027-2028

Despite the excitement around Arm bringing to market a CPU with 2x the performance of x86 CPUs, the reality is that it will take time to secure memory wafers and ship in volume. The CFO indicated it would be FY28 (aligned to mid-CY2027 to mid-CY2028) before the $1 billion is recognized:

“The revenue split for '27, '28, something like [$90 to $100] million for Q4 '27 and then $910 million or whatever for '28. That's kind of what we laid out 5 or 6 weeks ago. And as said, we have demand above that. But for right now, let's just assume that's the number until we work through some of the wafer memory shortage issues.”

This is a rather long ramp for the AGI CPU, with Arm stating the first revenue will not come  until Q4 FY27 (next March) and contribute roughly $100 million – if you wanted to put this in perspective, Nvidia delivered nearly $700 million in data center revenue daily last quarter, and will scale much larger by this time next year.

However, for Arm, the new AGI CPU represents a rather lucrative revenue stream layering in on top of its existing IP business, despite operating far below the scale of Nvidia and AMD. Based on current consensus estimates for $7.61 billion in revenue in FY28, Arm’s projection for ~$910 million in revenue contribution from the AGI CPU would represent nearly 12% of revenue.

Assuming the full $2 billion of demand materializes and 80% converts to revenue in FY28, given Arm has >4 quarters to smooth out the supply chain and secure supply, this may present an ~$800 million uplift to consensus, or >10% on top of the $7.61 billion.

Arm IP Continues to be the Main Growth Driver

Data center royalty more than doubled YoY and is expected to double again in FY27, driven by large customers such as Amazon’s Graviton, Google’s Axion, and Nvidia’s Vera. Arm stated they have over 50% share with top hyperscalers and 100% share in DPUs/SmartNICs: “Royalty revenue grew 11% to $671 million with growth across Edge AI, physical AI and cloud AI, where our data center royalty has more than doubled year-over-year.”

Due to the Arm powering custom CPU programs, the CEO stated he foresees Arm being the largest CPU architecture by the end of the decade: “So we think it's a market that we can play in, in a very large way. And I think even indicators of AWS selling Graviton to outside partners — it's kind of an indication that there's just huge, huge demand for ARM-based capacity. So we think we're going to play alongside our partners in this space. And we also think the opportunity is very, very large for both. And I'm actually confident that by the end of the decade, I believe the largest market share by CPU type will be ARM.”

AMD Flexes Muscle for 50% Market Share with $100-120B TAM; Arm Offers a Rebuttal

AMD set the stage for strong server CPU growth earlier this week as it doubled its long-term industry growth forecast from 18% over the next three to five years to 35%, driven by increasing CPU requirements for agentic AI. This updated forecast now projects the server CPU TAM to reach over $120 billion by 2030, notably 20% higher than the $100 billion TAM Arm forecasted during its AGI CPU launch.

While discussing their new accelerated TAM, AMD’s management mentioned that they are confident in growing to >50% market share, implying a goal of capturing as much as $60 billion of the server CPU market.

In sharp contrast, Arm has stuck to its $15 billion AGI CPU revenue target by FY31, essentially implying a ~12% share based on AMD’s updated $120 billion TAM. Put differently, AMD is aiming to be 4X larger than Arm in AI-driven server CPU revenue by the turn of the decade, presenting stiff competition in server CPUs (Intel isn’t to be forgotten either).

However, when asked on the call about x86, Arm’s CEO offered a controversial take, which is that Arm CPUs will see nearly a 100% attach rate. The original statement was: “Those all connect to Arm. And increasingly, they are going to be 100% Arm. So we feel very, very good about the market share there.”

Here was the question on the call that offered a sharp rebuttal to AMD’s x86 bullish forecast:

“Timm Schulze-Melander   Rothschild & Co Redburn

So Rene, maybe just to start with you and to key off that CPU TAM commentary you just made there. I just want to check that I heard you right that you anticipate 100% attach rate of Arm CPU with those accelerators you mentioned? And then maybe just looking forward from an OpEx perspective, as you get into that merchant market, as your products attach to some of your partners' products, do you have any undertakings in terms of operating expenses in terms of in-market customer support? And then I had a quick follow-up for Jason.

Rene Haas   CEO & Director

Yes. Thank you for the question, Timm. Yes, so to clarify my comment, my expectation is that for the training platform over time, TPUs over time and NVIDIA's accelerated over time, I believe that the vast majority of the market share there will be Arm. NVIDIA is there essentially, and we are starting to see that happen with Graviton already over the last number of quarters and the announcement that Google made at Google Next with the TPU 8t and 8i, the training and inference chips. So that trend is well underway. And the reason for it, as stated, is that by getting much better performance in the same power envelope, the overall performance of the platform has greatly improved.

Google is talking about an 80% improvement in terms of the overall performance. So it's really numbers like that and the advantages that customers see in terms of embracing the platform that gives us very, very high confidence that, that trend should continue […]”

Technically, statements from both management teams offer an element of truth as there are many x86-hosted AI accelerator servers shipping today (hence Intel’s and AMD’s strong reports). While many hyperscalers deploy Arm-based servers internally, those same hyperscalers still run substantial x86 capacity for customer workloads.

Net-net, AI servers are primarily x86-hosted whereas mobile is entirely Arm-hosted. Arm is betting on a massive shift in the coming years, whereas AMD is offering the incumbent’s view.

In an important exchange with Vivek Arya, Arm CEO Rene Haas admitted the numbers don’t add up when taking management projections at face value for year-end CPU market share from AMD, Intel and Arm: “As far as the market share numbers, AMD has 50, Intel has 50 and we have 50. So you add up to some crazy number.”

Haas also had a quick comment about the AGI CPU’s initial customers that carries quite an important readthrough. Launch partners like Cloudflare, SAP or SK Telecom are adopting the chip because they do not have the capex budgets and/or engineering expertise to design and deploy custom Arm-IP based CPUs at scale – this will likely remain at the hyperscaler level with chips such as Amazon’s Graviton or Google’s Axion.

The main readthrough from Arm’s answer here is that will primarily be serving the enterprise market with the AGI CPU, having to compete with AMD and others for customers wanting internal CPU capacity, while also having to make a compelling argument for customers to adopt the chip instead of simply using Arm-based CPUs like Graviton in the cloud. It also hints that there may not be much of a runway for the AGI CPU at the hyperscalers who do indeed have the budgets and have already successfully deployed Arm-based custom CPUs at scale.  

The truth is that – nobody knows how this will play out exactly. AMD’s management team doubled their TAM very quickly in a way that suggests they were caught off guard by the demand signals. Therefore, long-term forecasts are hard to predict in this space.

Financials:

Q4 Revenue Grew by 20%

Arm’s Q4 FY26 revenue grew by 20% YoY and 20% QoQ to a record $1.49 billion, beating the midpoint of management’s guidance ($1.470 billion) by 1.36%.

Royalty revenue decelerated from 27% YoY in Q3 to 11% YoY in Q4 with revenue of $671 million; this also represented a (9%) QoQ decline off Q3’s strong $737 million. YoY growth was driven primarily Cloud AI with data center royalties more than doubling YoY. Arm also continues to benefit from an increasing mix shift to Armv9 and CSS, which carry meaningfully higher per-chip royalty rates than prior architectures.

License and other revenue grew 29% YoY and 62% QoQ to $819 million, driven by continued strong demand for Arm IP, the timing and size of multiple high-value license agreements and contributions from backlog.

Management guided Q1 FY27 revenue to $1.26 billion at the midpoint (+/- $50 million), implying YoY growth of 19.7% but down (15.4%) QoQ on the typical seasonality that follows a Q4 license catch-up. The Q1 guide is roughly in line with consensus of $1.25 billion. Both royalty revenue and license and other revenue were guided to be up around 20% YoY in Q1 FY27.

For the full year, FY26 revenue grew 23% YoY to a record $4.92 billion — the third consecutive year of more than 20% revenue growth since IPO — with royalty revenue up 21% YoY to $2.61 billion and license revenue up 25% YoY to $2.31 billion. Looking ahead, analysts expect FY27 revenue to decelerate slightly to 20.9% YoY to $5.92 billion, before reaccelerating to 28.5% YoY to $7.61 billion in FY28, the latter benefitting from initial contribution of the Arm AGI CPU silicon business.

ACV Growth Decelerates to 22% YoY

Annualized contract value (ACV), management’s preferred metric for normalized license and other revenue, grew 22% YoY and 2% QoQ to $1.66 billion; this marked a six point deceleration from 28% YoY growth maintained over the last three quarters.

Remaining performance obligations (RPO), however, declined (7%) YoY and (4%) QoQ to $2.07 billion, marking the third consecutive quarter of YoY RPO declines, which management attributed to improvements in the timing of revenue conversion (i.e. faster recognition rather than weakening demand).

Arm also signed two more CSS licenses in the quarter, one for smartphones and the other for data center networking chips. Arm Total Access licenses increased by 6 in the quarter to 56 (up 27% YoY), now including more than half of Arm’s top 30 customers, while Arm Flexible Access customers increased by 11 to 329 (up 5% YoY).

Margins

Gross margin remained near best-in-class IP-business levels, but operating margin compressed YoY (despite opex coming in below guidance) as Arm continued to invest in R&D for the AGI CPU and CSS roadmaps. Management has indicated that FY26 should mark the peak of opex growth, with non-GAAP opex CAGR decelerating from a 26% pace in FY24-FY26 to a mid-teens CAGR through FY31, which should drive operating leverage.

  • Q4 GAAP gross margin was 97.9%, up slightly from 97.7% a year ago. Non-GAAP gross margin was 98.3%, essentially flat with 98.4% a year ago.
  • Q4 GAAP operating margin was 29.4%, down from 33.0% in the prior year period. Q4 adjusted operating margin was 49.1%, down from 52.8% a year ago, as adjusted operating expenses grew ten points faster than revenue, up 30% YoY to $734 million
  • Q4 GAAP net margin was 21.0%, up from 16.9% a year ago, while adjusted net margin of 43.0% declined from 47.1% a year ago.

Full-year FY26 GAAP and non-GAAP gross margins were 97.5% and 98.2%, respectively, both increasing roughly half a point YoY. However, operating margins felt some pressure, with FY26 GAAP operating margin contracting 2.4 points to 18.3%, and adjusted operating margin contracting 3.7 points to 43%. This was driven by strong opex growth, up 33% YoY to $2.72 billion, 13 points faster than revenue.

This operating margin contraction flowed through to the bottom line, with FY26 GAAP net margin of 18.4%, down 1.4 points, and adjusted net margin of 38.4%, down nearly 5 points.

Adjusted EPS Grew 9%

Q4 adjusted EPS was $0.60, up 9.1% YoY and beating estimates for $0.58. GAAP EPS in the quarter was $0.29, up 45% YoY but missing consensus of $0.37 by (20.7%) on the higher GAAP opex line. Management guided Q1 FY27 non-GAAP fully diluted EPS to $0.40 at the midpoint (+/- $0.04), implying 12.5% YoY growth.

For the full year, FY26 adjusted EPS was a record $1.77, up 8.6% YoY, while GAAP EPS increased 13.3% to $0.85. Analysts expect FY27 adjusted EPS to accelerate to 21.4% YoY to $2.14 (up 21.4% YoY), with this accelerating extending further into FY28, up 37.4% YoY to $2.94.

Cash Flow and Balance Sheet

Cash flow generation was strong on a full-year basis, although Q4 cash conversion was light.

  • Q4 operating cash flow was $260 million, essentially flat with $258 million a year ago, for an operating cash flow margin of 17.4%, down from 20.8% a year ago as receivables grew. FY26 operating cash flow was $1.52 billion for a 31% margin, up sharply from FY25’s $397 million for a 9.9% margin.
  • Q4 adjusted free cash flow was $152 million, down from $163 million a year ago, for an FCF margin of 10.2%, down from 13.1%. FY26 adjusted free cash flow was $882 million for a 17.9% margin, up from just $99 million in FY25 (a 2.5% margin).
  • Cash and short-term investments totaled $3.60 billion at quarter-end, up from $3.54 billion in Q3, and the company continues to carry no debt.

Conclusion:

My view is that Arm remains a critical long-term player in the AI data center buildout, but this earnings report introduced more uncertainty around the near-term growth story. The issue is less about AMD or Intel’s current dominance in x86 and more about Arm’s ability to secure supply at a time when even the largest AI semiconductor companies are capacity constrained.

After years of appearing relatively uneventful compared to other AI semiconductor peers, Arm is now better positioned to compete as AI workloads expand from mobile and edge devices into the data center. The key unknown is valuation, especially because merchant CPU revenue will take time to scale, and investors may need to rely on Arm’s traditional IP engine as the primary growth lever for the next one to two years.

My takeaway is that the near-term AGI CPU narrative should be priced lower due to a capped growth trajectory, but Arm’s long-term strategic relevance remains intact.

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.

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Lumentum FQ3: Firing on All Cylinders Despite Stiff Supply Constraints Across EMLs, Pump Lasers

Posted on by io-fund

Our main takeaway from Lumentum’s Q2 was “capacity constrained and loving it”, and that theme was just as evident, if not more so, this quarter. Supply-demand imbalances for EMLs widened, transceivers face a similarly large imbalance, but the largest supply constraint arose in an unexpected area – pump lasers for DCI.  

For OCS and CPO, revenue remains modest for both, though Lumentum expects to satisfy its $400 million OCS target in calendar 2H 2026 and realize the first significant scale-out CPO revenue in calendar Q4 (FQ2 27). More importantly, the scale-up CPO opportunity was discussed as multiple times larger than scale-out, with output significantly larger than the company’s new fab capacity, with expectations it will add >$5 billion in incremental revenue capacity as it ramps in 2028. Management stated CPO will be a significant driver for meeting their $2B per quarter revenue goal that was announced at the OFC event. 

Fundamentally, Lumentum is firing on all cylinders, with YoY growth forecast to accelerate to 105% YoY and sequential growth guided to maintain >20% QoQ for a third straight quarter in FQ4. Margins showed strong expansion, with GAAP gross margin up more than 15 points YoY to 44.2% and GAAP operating margin up more than 30 points YoY to 21.6%.   

200G EML Revenue Doubled QoQ, Supply-Demand Imbalance Widening 

As we had noted in last quarter’s write-up, Lumentum is benefiting from outsized demand for its EML lasers, reaching a quarterly company record in EML laser shipments with 200G ramping faster than expected. Lumentum reached another quarterly record for EML shipments in FQ3, driven by 100G but with 200G EML revenue more than doubling QoQ.  

While Lumentum remains capacity constrained in EML, the company is working quickly to expand in Japan, noting that it expects to achieve >50% YoY growth in EML units by the December 2026 quarter versus the December 2025 baseline. Layering in higher-ASP 200G EML units in the back half of 2026 is likely to drive revenue at a higher rate than the >50% YoY growth in capacity. However, the primary challenge with this capacity expansion is that it may not be coming soon enough to alleviate widening supply shortages:  

“The supply-demand imbalance is probably even higher than we reported in our last call, somewhere greater than 30%. I think last time we gave a metric of 25% to 30%. We still seem to be behind significantly. We had conversations today with customers, significant customers looking to really up their demand and get output from us, and we simply can't service that.” 

There are a couple puts and takes here – on a positive note, the fact that the supply-demand gap is widening suggests pricing power can drive sequential margin expansion as new capacity comes online in 2H. Additionally, management believes that increasing supply in the near-term is largely within its own control and not reliant on external factors, based on the amount of InP substrates it has secured within the supply chain.  

However, the main challenge is that 2027 EML output represents “a massive step-up just given the scale-out and scale-up demands,” meaning that future capex for capacity expansion, and some InP substrate procurement, will likely be required to help close this supply-demand imbalance. This may pressure free cash flows as Lumentum is already investing heavily to ease pump laser supply tightness.  

Lumentum’s acquisition of the Greensboro fab from Qorvo earlier this year will serve as its fifth InP fab, capable of supporting >$5 billion in annual run rate capacity, though first material contributions from this fab are not expected until 2028. 

Scale-Across Components Grow 120% and 80% YoY 

While the EML constraints are rather widely known at this point in time, it’s important to touch upon pump and narrow linewidth lasers serving scale-across applications. Not only is Lumentum effectively sold out of both for the foreseeable future, but pump lasers were highlighted as an “unanticipated” constraint this quarter.  

Both products serve scale-across applications and witnessed robust growth in Q3, with narrow linewidth lasers recording a ninth consecutive quarter of growth, up 120% YoY, and pump lasers up 80% YoY. However, Lumentum detailed in Q3 that pump lasers are even more constrained than EMLs, with this hitting suddenly: 

“These components remain effectively sold out for the foreseeable future, and we are actively working to secure long-term agreements that will help offset anticipated capital expenditures.” 

For more color on the output front, Lumentum explained that near-term output should rise rather substantially as there are less constraints on the fab front for pumps versus EMLs. This near-term uplift in capacity is crucial in minimizing the supply imbalance, as well as helping meet elevated demand in the near term.  

Because capex is high, Lumentum explained that they are “talking to the major customers around trying to help, right, and put some skin in the game around the CapEx that we're going to try to lay out. One, that can entail prepayment, that can entail take-or-pay, that can entail price increases,” minimizing capital and risk associated with expansion, or in the case of price increases, aiding growth and margins. 

This connects over to what we have discussed regarding a long-haul networking stock for our Discovery members. Narrow linewidth lasers support high-bandwidth, low-power 800G/1.6T coherent pluggables for scale-across and data center interconnect (DCI) applications. Pump lasers are key components in amplifying signal strength over four, eight or 16 fiber pairs simultaneously, essential for DCI, long-haul or subsea links and more so for multi-rail optical systems. For example, by scaling from one rail per module to four, multi-rail systems could deliver up to 32X the density of current single-rail solutions. 

To learn more about this networking stock, the robust demand it is seeing for scale-across applications and upcoming catalysts for 2027, sign up for Discovery here or click to email us at premium@io-fund.com.To learn more about this networking stock, the robust demand it is seeing for scale-across applications and upcoming catalysts for 2027, sign up for Discovery here or click to email us at premium@io-fund.com.sign up for Discovery here or click to email us at premium@io-fund.com.

For Lumentum, solving or at least easing this unanticipated constraint in pump lasers by late 2026 is essential as multi-rail platform content is higher, due to needing more lasers per system. Being able to meet higher levels of multi-rail demand would likely act as a stronger revenue growth and margin lever next year, as management was explicit in pointing out both as significant gross margin drivers.   

1.6T Transceivers Ramping in Q4, Insourcing CW Lasers 

Another bright spot for Lumentum was its transceiver business, accounting for the majority of growth in its Systems segment, which was up 121% YoY and 24% QoQ to $275.1 million, or 34% of revenue. Cloud transceivers grew more than 40% QoQ with record shipments, with this likely largely driven by 800G as the ramp of 1.6T transceivers is slated for FQ4.  

As should be expected by now, Lumentum said that the “the supply-demand imbalance on our own transceivers was somewhere in that ZIP code” of EMLs at >30%. Management said that they could have actually shipped quite a bit more in Q3 and in Q4’s guide had supply constraints for electrical components or laser diodes not been this tight, and that its pricing power suggests the supply-demand imbalance “isn't going to be solved for a while,” shooting down concerns over laser oversupply.  

To help alleviate some of the external laser supply constraints, Lumentum began insourcing CW lasers in Q3, a quarter earlier than originally expected. Insourced supply is expected to scale further in Q4, accounting for ~20% of transceiver modules in the quarter. This pivot is expected to augment transceiver margins as 1.6T ramps, alongside better yields and lower scrap rates.  

Pricing power can act as an important lever in Q4 — having stronger pricing power on 800G while leaning into the 1.6T ramp in Q4 should help further improve margins, as 1.6T already carries higher margins versus 800G.  

OCS Supply Considerably Tighter, Scale-Up CPO Opportunity Multiples Larger 

As we discussed in Q1, OCS and CPO are expected to emerge as strong growth contributors in fiscal 2027, with revenue contribution at the moment remaining modest. OCS is expected to begin contributing more heavily in calendar 2H, with scale-out CPO arising in calendar Q4 (FQ2 27).  

There were a handful of key insights this quarter for both. OCS is now seeing considerable supply tightness. For CPO, Lumentum projects scale-up opportunity to be substantially larger than $5 billion, and believes it could see a faster path-to-market from vertical integration.  

For OCS, the ramp remains largely on track, with management confident in meeting its $400 million target in calendar 2H 2026 and ramping to >$1 billion in calendar 2027. The pace of this ramp will be determined by the supply chain, with Lumentum “experiencing considerable tightness” in OCS due to a substantial step-up in requested output, tied to both new OCS opportunities and likely Google’s upcoming TPU v8 chips (as its key OCS customer).  

This could create some volatility or lumpiness in the ramp phase if the supply chain tightness fails to resolve easily. However, the ramp of TPU v8 later this year could provide additional upside as there is incremental OCS content growth versus TPU v7.  

Moving to CPO, Lumentum noted that its ultra-high-power (UHP) laser ramp is progressing to plan, driving sequential growth in Q3. Meaningful revenue is slated for calendar Q4 (FQ2 27), with Lumentum on track to satisfy its multi-hundred million dollar purchase order in the first half of calendar 2027.  

These near-term opportunities for CPO are primarily for scale-out applications, yet Lumentum foresees the opportunities in scale-up CPO to be multiples larger. And if you weren’t tired of hearing this by now, Lumentum expects a massive supply-demand imbalance with CPO due to scale-up:  

“We will have a massive supply-demand imbalance on CPO. It's going to be very, very significant. We've seen multibillion-dollar orders that we've characterized on previous calls come in mostly on scale-out. 

We expect to scale-up to be significantly more than that in terms of revenue opportunity. I think it's going to be somewhere greater than $5 billion of incremental revenue that we can add [with the new Greensboro facility] if we execute properly.” 

First scale-up CPO shipments are not expected until late 2027, per Lumentum’s OFC briefing, though commentary here suggests that scale-up CPO demand could materialize as Lumentum’s largest revenue driver come 2028 and beyond.  

Financials 

Revenue Accelerates to 90.1% YoY in FQ3 

Lumentum's Q3 FY2026 ending March revenue came in at $808.4 million, missed estimates marginally by (0.2%), but represents a strong reacceleration on a YoY basis from the previous quarter. Revenue grew 90.1% YoY and 21.5% QoQ and accelerated 24.6 percentage points from 65.5% on a YoY basis although decel’d slightly from 24.7% QoQ growth in the previous quarter. 

Sequential dollar growth of $142.9 million reflects the scale of Lumentum's ramp, with the company now approaching the $1 billion quarterly revenue threshold. Management issued a strong guide for Q4 FY2026 of $960 million to $1.01 billion, implying a YoY growth of 104.9% YoY and 21.8% QoQ at the midpoint.  

While this beat estimates by 7.4% and signals that the hyperscaler-driven demand cycle remains firmly intact, the more impressive part is that sequential dollar growth was guided to be higher next quarter despite worsening supply constraints. At the midpoint, Q4’s guide implies nearly $177 million in QoQ dollar growth, driven primarily by transceivers, EMLs, scale-across components (narrow linewidth and pump lasers), and incremental OCS revenue.  

During the OFC conference held in March management also provided the $2.0 billion revenue target to be achieved in the 18 to 24 months period. Management remains confident in reaching this target, leveraging EMLs, scale-across, and upcoming OCS and CPO ramps, with consensus currently expecting Lumentum to reach its $2 billion quarter in December 2027. 

Key Segments 

Components Revenue grew by 77% 

Components revenue grew by 77.3% YoY and 20.2% QoQ to $533.3 million. However, was below the guidance of $536.7 million. Revenue growth accelerated from 68.3% YoY and 17% QoQ growth in the previous quarter.  

As noted above, shipments of the narrow linewidth laser assemblies grew for the ninth consecutive quarter, rising over 120% YoY, while pump laser shipments grew 80% YoY. EML shipments reached another quarterly record led by 100G, while 200G EML revenue more than doubled QoQ. 

Lumentum also shipped twice the number of laser chips compared to the same period last year and on track to achieve more than 50% growth in EML units by the December quarter of 2026 as compared to the same period last year. 

Systems Revenue grew by 121% 

Systems revenue grew by 121.1% YoY and 24% QoQ to $275.1 million. The strong growth was primarily due to the cloud transceivers revenue that grew by over 40% sequentially as the company successfully leverage the expanded manufacturing footprint in Thailand. The supply constraints on critical components are keeping the shipments well below customer demand. 

The company is poised to ramp poised to ramp 1.6T-speed transceiver shipments in FQ4 with a portion of this volume leveraging the company’s own CW lasers. Management highlighted that they are improving transceiver profitability through better yields and lower scrap rates. 

Looking ahead to Q4, Lumentum expects more than half of Q4’s sequential growth to be driven by Components, and the remainder from Systems. 

Margins Showing Pronounced Expansion

One of the most compelling aspects of Q3 FY2026's report is the continued margin expansion primarily driven by better manufacturing utilization, favorable product mix, and operating leverage.  

However, management admits their margins are not as strong as peers due to the transceiver business – although as noted, should improve with 1.6T: “I think we are underperforming peers. We have room to grow. We're getting better. I think we are — we've certainly gotten the lead in terms of design. And now in terms of margin, I think we're improving. We still trail.” 

  • FQ3 adjusted gross margin improved by 12.7 percentage points YoY to 47.9% primarily due to better manufacturing utilization, increased pricing on certain products, and favorable product mix. GAAP gross margin was 44.2%. 
  • FQ3 adjusted operating margin improved by 21.4 percentage points YoY to 32.2% primarily due to operating leverage along with product mix and improving factory utilization. GAAP operating margin was 21.6%. 
  • FQ3 adjusted net income grew by 184.8% YoY to $225.7 million with an adjusted net margin of 27.9% compared to 9.6% in the same period last year.   
  • Adjusted EBITDA margin also improved significantly by 19.6 percentage points YoY to 36.3% primarily due to strong operating leverage.  

For FQ4, management expects the adjusted operating margin to further improve to 35.5%, up more than 3 points QoQ and more than 20 points YoY, despite growth being driven by transceivers. Insourcing CW lasers is expected to help improve gross margins on that product line in Q4 as 1.6T layers in, alongside growth in narrow linewidth and pump lasers. 

Looking further ahead, Lumentum has other strings to pull for margin expansion, with management discussing that they will turn to contract manufacturers (like Fabrinet) to improve margins: “The margins that we pay to those contract manufacturers are more than offset by the efficiency and cost benefit that they can drive on common components. So that ends up being a lever for us.” 

EPS Showing Strong Growth Trajectory Ahead 

FQ3 adjusted EPS grew by 315.8% YoY to $2.37, beating estimates by 4.6% reflecting favorable product mix and operating leverage. Management also provided a strong adjusted EPS guide of $2.85 to $3.05 for the next quarter, implying a YoY growth of 235.2% at the midpoint and beat estimates by 9.7%. 

Looking ahead, analysts expect adjusted EPS to grow 200.1% YoY to $3.30 in FQ1 and 138.2% YoY to $3.98 in FQ2. 

Cash Flows and Balance Sheet 

The company’s cash flows improved significantly, driven by higher profits.  

  • FQ3 operating cash flow was $203.8 million or 25.2% of revenue compared to an operating cash outflow of ($1.6 million) or (0.4%) of revenue in the same period last year.  
  • FQ3 free cash flow was $79.1 million or 9.8% of revenue compared to a free cash outflow of ($64.4 million) or (15.1%) of revenue in the same period last year. 
  • The company had cash and short-term investments of $3.17 billion compared to convertible notes of $3.28 billion at the end of the quarter. Cash and short-term investments increased from $1.16 billion at the end of FQ2 primarily due to the $2.0 billion investment by Nvidia in March. 
  • Inventories grew by 10.9% QoQ to $632.8 million to support strong growth. 

Conclusion 

Lumentum is firing on all cylinders with revenue growth accelerating more than 25 points sequentially to 90% YoY alongside substantial margin expansion in Q3. The more impressive piece was Q4’s guidance for substantially higher sequential dollar growth for revenue despite supply constraints tightening in EMLs and unexpectedly arising in pump lasers.  

OCS and CPO remain bright spots for future growth, with management expecting both to begin layering in more materially in calendar 2H and calendar Q4, before ramping more significantly in 2027. The scale-up CPO opportunity, while still six to seven quarters away, will be one we’re watching with anticipation as it is expected to be perhaps the largest single upcoming opportunity ahead for Lumentum.

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 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 LITE at the time of writing and may own stocks pictured in the charts.

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AMD Q1: Doubled CPU TAM, Helios Incoming for Q4

Posted on by io-fund

AMD's offered a clear inflection this evening with $10.3B revenue (+38% Y/Y), EPS of $1.37 (+43%), and free cash flow tripling to $2.6B. Data Center saw a resurgence following the CPU boom, with $5.8B in revenue (+57%) and operating margin in the segment expanding to 28%. 

The most important update was the server CPU TAM revision: from about 18% CAGR to more than a 35% CAGR. Management doubled their forecast from $60 billion on the November analyst day to $120 billion by 2030. Management framed this as Agentic AI driving incremental CPU demand rather than GPU substitution. Q2 server CPU revenue is guided to grow over 70% Y/Y. 

Management guided to second quarter revenue of approximately $11.2 billion (±$300 million), implying year-over-year growth of approximately 46% at the midpoint and sequential growth of approximately 9%.  

Sequential growth is expected to be driven by double-digit growth in both the Data Center and Embedded segments, with modest growth in Client and Gaming. As mentioned, Server CPU revenue specifically is guided to grow more than 70% year-over-year in Q2. 

Expanded Server CPU TAM; Venice EPYCs Ship 2027  

The showstopper was that management raised their long-term server CPU TAM outlook materially. The November 2024 Financial Analyst Day target of 18% CAGR for a $60B TAM is now CAGR of 35% for $120B TAM by 2030. 

We’ve covered the CPU boom in an analysis on Arm here stating: “Multi-agent systems are also expected to drive an exponential increase in token generation, which Arm estimated at up to a 15X increase in tokens per user, due to the increase in tool calls and API requests associated with each agent. This is expected to drive CPU core demand much higher, at a time where key x86 suppliers AMD and Intel battle growing supply constraints.” 

Something similar was echoed on the call this evening with management stating: “Inferencing and Agentic AI are increasing the need for server CPU compute as these workloads require additional CPU processing for orchestration, data movement and parallel execution in addition to serving as the head nodes for GPUs and accelerators. As a result, we are seeing both stronger near-term demand and deeper engagement with customers on long-term capacity planning.” 

The 6th Gen EPYC Venice processor built on 2nm technology is expected to ship next year, and is optimized for throughput, performance per watt and performance per dollar. AMD is out to maintain its CPU lead with strong, competitive statements in the opening remarks, such as: “Across the portfolio, Venice widens our competitive advantage, delivering substantially higher performance per socket and per watt versus competitive x86 offerings and more than 2x throughput per socket versus leading ARM-based AI solutions.”  

Perhaps most notable was when the management team reiterated their plan to become “greater than 50% share" of the CPU server market.  

Helios Expected in 2H 2026 

AMD’s Data Center AI revenue was modestly lower sequentially in Q1 due to reduced China revenue, yet management expects the business to return to double-digit sequential growth in Q2.  

The more important inflection for AMD’s Instinct GPUs is the upcoming ramp of MI450 and the Helios rack-scale platform. AMD expects initial MI450/Helios volume in Q3, followed by a more significant ramp in Q4 and continued growth into 2027. Here was the update from the earnings call: 

“A key example is our expanded strategic partnership with Meta to deploy up to 6 gigawatts of AMD Instinct GPUs spanning several product generations. Our agreement includes a custom GPU accelerator based on our MI450 architecture, co-designed to support Meta's next-generation AI workloads. Shipments are on track to begin in the second half of the year, leveraging our Helios rack-scale architecture, which integrates Instinct GPUs with EPYC Venice CPUs to deliver fully optimized high-performance AI infrastructure.” 

Together with the previously announced OpenAI partnership, AMD is gaining visibility into multi-year, multi-gigawatt deployments totaling 12 GWs that move the company into production-scale infrastructure. 

Management also indicated that MI450 customer forecasts are now exceeding initial plans, with additional multi-gigawatt opportunities emerging. According to statements on the call, this gives AMD increasing confidence in its ability to deliver tens of billions of dollars in annual Data Center AI revenue in 2027 and exceed its long-term 80%+ AI revenue CAGR target.  

“As we approach production, demand for MI450 series GPUs continues to strengthen, with lead customer forecasts now exceeding our initial plans and a growing number of new customers engaging on large-scale deployments, including additional multi-gigawatt opportunities. With this expanded visibility, we have strong and increasing confidence in our ability to deliver tens of billions of dollars in annual Data Center AI revenue in 2027 and to exceed our long-term growth target of greater than 80% in the coming years.”

Financials: 

AMD reported an inflection in the company's growth trajectory and a structural shift in the business mix. Revenue of $10.3 billion exceeded the high end of guidance, growing 38% year-over-year, while diluted non-GAAP EPS of $1.37 increased 43%. Free cash flow more than tripled year-over-year to a record $2.6 billion, representing 25% of revenue. The Data Center segment was the primary driver of revenue and earnings, posting 57% year-over-year growth driven by accelerating demand from EPYC server CPUs primarily. 

Management guided to second quarter revenue of approximately $11.2 billion (±$300 million), implying year-over-year growth of approximately 46% at the midpoint and sequential growth of approximately 9%.  

Sequential growth is expected to be driven by double-digit growth in both the Data Center and Embedded segments, with modest growth in Client and Gaming. Server CPU revenue specifically is guided to grow more than 70% year-over-year in Q2. 

Segment Performance 

Data Center: 

The Data Center segment delivered record revenue of $5.8 billion, up 57% year-over-year and 7% sequentially, with operating income of $1.6 billion and operating margin expanding to 28% from 25% a year ago.  

Server CPU revenue grew more than 50% year-over-year, marking the fourth consecutive quarter of record server CPU revenue, with both Cloud and Enterprise customers each contributing more than 50% growth. Turin (5th-gen EPYC) crossed 50% of server revenue mix during the quarter. 

Data Center AI revenue grew by a significant double-digit percentage year-over-year but declined modestly sequentially due to lower China revenue versus Q4.  

Client and Gaming: 

Segment revenue of $3.6 billion was up 23% year-over-year, with operating income of $575 million representing a 16% operating margin, slightly below the 17% margin a year ago.  

The Client business generated $2.9 billion in revenue, up 26% year-over-year on strength in Ryzen processors and continued share gains in consumer and commercial markets, with commercial sell-through of Ryzen Pro PCs increasing more than 50% year-over-year.  

Gaming revenue was $720 million, up 11% year-over-year, with growth in Radeon GPUs partially offset by lower semi-custom revenue at this stage of the console cycle. Sequentially, Client was down 7% and Gaming down 15%, both consistent with normal seasonality. 

Embedded: 

Embedded segment revenue returned to growth at $873 million, up 6% year-over-year, with operating income of $338 million and operating margin of 39% (versus 40% a year ago).  

Margins and EPS: 

Non-GAAP gross margin of 55.0% expanded 170 basis points year-over-year, driven by higher product mix of EPYC 5th gen CPUs. Q2 gross margin is guided to approximately 56%, a further 100 basis-point sequential expansion. 

Non-GAAP operating margin reached 25% in Q1, with operating income of $2.5 billion growing faster than revenue and demonstrating meaningful operating leverage in the model. This came despite a 42% year-over-year increase in operating expenses to $3.1 billion, reflecting aggressive investment in AI roadmap R&D and go-to-market expansion.  

CFO Jean Hu outlined multiple structural tailwinds supporting gross margin into the second half and beyond. 

The principal headwind is the MI450 ramp beginning in Q3 and ramping significantly in Q4, which will run below the corporate gross margin average in its early phases. The long-term target range remains 55%–58% non-GAAP gross margin, as set at the November Financial Analyst Day. 

Record Q1 Free Cash Flow 

AMD generated $3.0 billion in cash from continuing operations in Q1 and a record $2.6 billion in free cash flow, representing roughly 25% of revenue. Free cash flow more than tripled year-over-year, materially outpacing the 38% revenue growth.  

Working Capital and Balance Sheet 

Inventory was roughly flat sequentially at approximately $8.0 billion.  

The company had cash & short-term investments of $12.3 billion, while the debt was $3.2 billion at the end of Q1.

Conclusion: 

The message from the call was clear, which is that AMD believes the market opportunity ahead is materially larger than previously anticipated. Combined with an expanding server CPU TAM tied to agentic AI workloads, AMD is broadening its GPU-challenger story. The dynamic around inference and agentic AI increasing demand for CPUs expands AMD’s opportunity while we await Helios arrival in Q4 and beyond.

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 AMD at the time of writing and may own stocks pictured in the charts.

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Astera Labs: Important QoQ Acceleration, Product Road Map is Loaded 

Posted on by io-fund

Astera Labs is navigating an important rite of passage that many post-IPO hypergrowth companies stumble through, which is to offer a consistent growth trajectory. Once the excitement of an IPO fades, most tech companies cannot sustain the growth the private sector primed the company for ahead of listing on the public markets.  

Astera is bucking this trend, as the company was expected to report 8% QoQ growth and instead reported 14% QoQ growth, which resulted in an official 1.6 percentage points acceleration on a YoY basis from 91.8% YoY growth last quarter to 93.4% growth this quarter. Looking ahead, Astera is offering a guide that indicates QoQ growth of 16.7% and YoY growth of 87.6% for revenue of $360 million at the midpoint. This handily beat forward expectations for revenue of $310.1 million next quarter.

As we look toward the second half of the year, management offered strong commentary that suggest growth will continue: “As we look to the second half of 2026, robust demand reflects secular AI infrastructure spending, deep customer partnerships and expansion towards higher-value solutions within our portfolio. […] As a result, we expect strong revenue growth to continue through 2026 and into 2027, driven by the proliferation of AI fabrics and the industry's transition to PCIe 6, 800 gig and 1.6T Ethernet connectivity.” 

Perhaps most notable is that Astera delivered a strong quarter even after the stock declined roughly 55% peak-to-trough from September through March, reflecting a disconnect between sentiment and fundamentals. 

Scorpio-X 320 Lane Smart Fabric Switch 

Positioning: 

In this evening’s print, Astera also announced the Scorpio X-Series 320 Lane Smart Fabric Switch, which is the largest open, memory semantic fabric switch on the market with 5.12 TB/s bidirectional bandwidth in a single ASIC. The 320 Lane variant offers 16 lanes per device and 20 accelerators per switch, which is roughly “2x the radix in a single hop,” which means twice the number of GPUs are connected on the same switch. With Scorpio-X, only one switch is needed for 320 GPUs, and fewer switch hops means lower latency.  

Astera differentiates itself from Broadcom’s Ethernet switch Tomahawk 6 and Nvidia’s NVSwitch by providing an open PCIe-based fabric for CPUs, NICs and storage with the P-Series and improving accelerator-to-accelerator performance specifically around memory sharing with the X-series. 

The X-Series is timed to the scale-up networking opportunity and the inference market. Mixture of Experts (MoE) inference is a steady stream of tasks, which requires very fast accelerator-to-accelerator communication. As discussed in the call, MoE requires frequent routing of tokens and data across expert models, which places more emphasis on the scale-up fabric. Astera Labs is uniquely positioned to enable GPUs and AI accelerators to communicate more efficiently across PCIe, especially when it comes to direct memory access. 

Here is what was stated in the opening remarks: 

“Scorpio X-Series portfolio now supports up to 320 lanes for high radix scale-up networking, and Scorpio P-Series PCIe 6 portfolio now spans 32 to 320 lanes for diverse system topologies, making it the broadest in the industry.  

Our new flagship Scorpio X-Series 320 lane has been purpose-built to maximize AI economics by leveraging hardware-accelerated hypercast and in-network compute engines to boost collective operations by up to 2x. In-network compute offloads critical accelerator to accelerator communication and computation directly onto the switch, dramatically reducing the networking overhead during large-scale training and inference.” 

This is a significant shift as it brings the math operations inside the switch instead of the GPUs, which Astera is referring to as “in-network compute.” Hypercast refers to handling operations inside the switch, which reduces the networking overhead associated with GPU-to-GPU coordination. The result for inference tasks is more tokens per dollar as Scorpio-X removes the need for GPUs to wait on other GPUs during MoE and agentic workloads.  

It's important to double-click on the memory-semantic piece. Astera's fabric lets accelerators access each other's memory directly like a single unified memory pool, eliminating the overhead of translating data into network packets. This is important for AI workloads, and especially MoE inference, which depend on constant sharing of weights, activations, KV cache, etc., across accelerators. Per the press release: “Its memory-semantic connectivity enables accelerators to access fabric resources through native load/store operations, eliminating software overhead and improving fabric efficiency at scale.” 

Astera’s X-Series offers communication across mixed architectures (both GPUs and ASICs) but also solves for memory sharing – both are key as we move into the inference market.  

Economics: 

We’ve covered the X-Series for about a year in our post-earnings analyses. For investors, some of the most important takeaways is that the Scorpio product is expected to increase from 15% of product mix at the end of CY25 to 50% of product mix by the end of CY26. Although the P-Series is driving the current growth, the X-Series will be the higher mix as we exit the year – which means this ramp is second-half weighted. 

“Given the size of the opportunity and the associated dollar content, we would expect to see that Scorpio will become our largest product line by the end of the year, which is strong performance for a product line that was only 15% of total company revenue last year. And as we go throughout the year, I would expect to see X-Series revenue exceeding P-Series.” 

Another point for investors is the average sales prices will increase from the X-Series. Here is what was stated on the call: 

“Yes. So in general, what I would say is the bigger the switch, the higher the ASP. That's the way industry works. But also, please keep in mind is that these switches are more like AI fabric class device, which are a lot more than just the number of lanes, right? […]So when it comes to ASP, obviously, it's a combination of how — what features are enabled and not just based on the port count. But we do see that our content continue to increase. And to that standpoint, we are expecting and going forward with the design wins we have, over $1,000 worth of content per accelerator.” 

Future Product Roadmap for 2027-2028 

Optical Opportunity: 

Astera’s optical roadmap is an extension of the company’s ability to offer end-to-end PCIe over optics for GPU clusters. As racks grow into larger pods, cable length and signal integrity become constraints. Astera has stated at a recent investor’s event that optical becomes necessary at higher data rates (which is also general consensus).  

Last October, Astera acquired a scale-up photonics company to offer optical scale-up interconnects. On the earnings call, it was shared that near-packaged optics will roll-out first following this acquisition in 2027, which is a bridge solution while co-packaged optics may take longer than the market cares to wait. 

Here is what was stated on the call: 

“For us, in terms of time line, what we believe is that the NPO-based opportunities, or the near package optics, would be the first one to ramp, and that will start happening in 2027. We will also be ramping our pluggable connector technologies for CPO, mostly for scale-out next year, 2027, with more of the mainstream deployments for CPO happening in the 2028 time frame.” 

NVLink Fusion Opportunity: 

Notably, Astera Labs offers connectivity solutions for hybrid AI racks. This widens Astera’s content opportunity beyond UALink as it provides an additional path to scale-up AI fabrics by offering a bridging solution for GPUs and custom silicon. In some cases, when NVLink is chosen, Astera will still be a key supplier for connectivity solutions. 

“Clearly, an area that we see tremendous opportunity for us going forward is the custom solutions under which we are developing the NVLink Fusion type of devices. And this actually is proving to be pretty interesting. We do have several opportunities. We're very deep in engagement for an initial design win in collaboration with NVIDIA and then a hyperscaler. So that project is going well. So we do expect that to start contributing revenue in 2027 as some of the GPUs that are designed for this kind of use case, which is called as a hybrid rack situation, where the GPU or the XPU still talks native protocols, which could be a protocol like PCIe or UALink and others. But then when they need to leverage and cross over and talk to an NVLink type of ecosystem, then they would need a product that's based on NVLink Fusion that we are developing.” 

CXL Opportunity: 

CXL is a longer-term opportunity for Astera Labs, and will extend Astera’s content opportunity (again) to include memory pooling and connectivity. This provides more direct exposure to the memory side of the AI buildout rather than only the accelerator interconnect. Here was the update for the call, including a newer customer win that could help with KV cache offload: “Finally, our LEO memory controller is on track for an early ramp of CXL attached memory with Microsoft Azure M-Series virtual machines. And during the quarter, we captured a new custom design win for a KV Cache offload application with shipments expected in 2027.” 

Note on UALink: 

We’ve written in the past that UALink as a scale-up fabric is expected to go head-to-head with Ethernet Scale-Up Networking (ESUN). In the past, when there are ESUN announcements, ALAB’s stock reacts negatively. However, that assumes a zero-sum outcome, whereas it’s more likely scale-up sees a mix of both UALink and ESUN. 

The quick refresher is that ESUN is attempting to make Ethernet work for scale-up whereas UALink was built from scratch for scale-up. The primary benefit ESUN offers is to move quicker than UALink (as discussed above, ALAB is saying it’ll be 2027 for UALink to be fully deployed). However, in the meantime, Astera’s PCIe solutions are in high demand and deployable now.  

Even if ESUN moves faster commercially, there is a performance gap that helps to ensure that Astera’s positioning with PCIe/CXL remains intact. That performance gap is best described as the low latency required for what are the most in-demand AI workloads today – those that require memory pooling and GPU-to-GPU communication.   

For more information, read our previous analysis here.previous analysis here. 

Financials 

By Royston Roche 

Revenue Accelerates to 93.4% YoY 

Astera Labs reported Q1 2026 revenue of $308.4 million, beating estimates by 5.5%. Growth continued at a robust pace on a YoY basis, with revenue up 93.4% YoY and accelerating 1.6 percentage points from 91.8% growth in the previous quarter. On a sequential basis, revenue grew 14.0% QoQ from $270.6 million in Q4 2025.  

Aries product revenue grew strongly in Q1 2026, with PCIe Gen 6 solutions for both scale-out and scale-up signal conditioning driving solid adoption. Management noted that PCIe Gen 6 revenue across AI fabric and signal conditioning contributed more than one-third of total revenue in the quarter — a significant milestone reflecting the accelerating industry transition to Gen 6. 

The Scorpio product family also performed well in Q1, driven by strong demand for PCIe Gen 6 switching applications and continued expansion of designs across various platforms. During the quarter, Scorpio X-Series products began shipping in initial production volumes. Management expects Scorpio X-Series shipments to increase in Q2, along with initial shipments of the new Scorpio X 320 lane product and then ramp to full volume production in the second half of 2026. 

Taurus product family continued to deliver solid results in Q1 2026, driven by broad adoption of Active Electrical Cable (AEC) to extend reach in both AI and general-purpose compute platforms. 

Leo's CXL memory expansion products continue to advance, with management highlighting an early production ramp of CXL-attached memory with Microsoft Azure M-Series virtual machines and a new custom design win for a KV Cache offload application with shipments expected in 2027. 

Management guided strong Q2 revenue guidance of $355 million to $365 million, implying a YoY growth of 87.6% and 16.7% QoQ at the midpoint, beating estimates by 16.1%. Aries revenue growth is expected to be driven by continued strong adoption of PCIe 6 across AI platforms, supporting both scale-up and scale-out connectivity. Taurus growth is expected to be driven by increased volumes for AI scale-out connectivity. And in AI fabric, management expects robust growth driven by the continued early-stage ramp of the Scorpio X-Series products for large-scale XPU clustering applications as well as continued growth in the P-Series solutions and customized GPU platforms. 

Margins Beat Guidance 

Astera Labs delivered impressive gross margin performance in Q1 2026, with GAAP gross margin coming in at 76.3%, comfortably ahead of the 74% guidance. This compares to 75.6% in Q4 2025 and 74.9% in the same period last year, a sequential expansion of 70 basis points and 140 basis points YoY, primarily due to favorable product mix. Adjusted gross margin improved 150 basis points YoY to 76.4%.  

Management has guided adjusted gross margin to be lower at 73% for the next quarter, primarily due to the estimated 200 basis point noncash impact related to a recently executed warrant agreement with one of its customers. 

GAAP operating margin improved 13 percentage points YoY to 20.1%. While adjusted operating margin improved 2.5 percentage points YoY to 36.2% primarily due to operating leverage and beat the guidance of 34.5%.  

Q1 2026 adjusted net income grew by 84.7% YoY to $110.7 million or 35.7% of revenue compared to 37.4% of revenue in the same period last year.  

Adjusted EPS grew by 84.8% 

Q1 adjusted EPS grew by 84.8% YoY to $0.61, beating estimates by 13.5% primarily due to operating leverage. GAAP EPS growth was even stronger as it grew by 144.4% YoY to $0.44 and beating estimates by 26.5%. 

Management also provided a strong EPS guide for the next quarter. GAAP EPS guide is $0.45 at the midpoint, up 55.2% YoY and beat estimates by 37.6%. Adjusted EPS guide is $0.69 at the midpoint, up 56.8% YoY and beat estimates by 25.5%. 

Cash Flow and Balance Sheet 

The company’s cash flows were strong primarily due to higher profits.  

  • Q1 operating cash flow was $74.6 million or 24.2% of revenue compared to a mere $10.5 million or 6.6% of revenue in the same period last year. 
  • Q1 free cash flow was $67 million or 21.7% of revenue compared to $5.97 million or 3.7% of revenue in the same period last year.  
  • The company maintains a robust balance sheet with cash & marketable securities of $1.18 billion and no debt.  
  • Inventories rose 2% QoQ to $60.2 million. 

Conclusion: 

Astera Labs is expanding their product road map well beyond selling PCIe retimers, and is now solving serious bottlenecks for the incoming AI inference market. Inference workloads are more memory-intensive and will see ongoing, exponential accelerator-to-accelerator communication, not to mention the critical importance of shared memory access.  

Astera’s role is becoming more strategic as the company has multiple paths to increase content through Scorpio-X scale-up switching, both UALink and NVLink Fusion content opportunities, CXL memory pooling, and they’re prepared for the optical transition – whew, that’s a lot. Near-term volatility could persist as the market debates protocol winners, but one thing is for certain – AI workloads are becoming more complex. Astera is on the front lines of solving that complexity.

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 ALAB at the time of writing and may own stocks pictured in the charts.

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Palantir Q1: Strong Headline Numbers; TCV to be Watched 

Posted on by io-fund

Palantir posted another strong quarter with revenue of $1.63 billion, representing growth of 85% YoY and 16% QoQ. The company continues to accelerate across many key metrics, including net retention rate, Rule of 40 soared to 145 and RPO also came in strong. The adjusted gross margin has expanded to 88%, the operating margin has expanded to 60% and the free cash flow margin to 57%. This remark helps to illustrate how fundamentally strong the company is “Our free cash flow this quarter is larger than our revenue a year ago in the same quarter.” 

Overall, you will find little fault with the company’s headline numbers. In fact, the company’s guidance for U.S. Commercial to be in excess of $3.2 billion for growth of more than 120% implies Palantir maintains a QoQ growth rate between 22% and 24% for the next three quarters. If it materializes, this growth rate will help maintain Palantir’s standing as one of the strongest AI software companies that we track.  

Notably, there was a timing issue which created a softer total contract value (TCV) metric. TCV Booked was down (43%) QoQ, leaving TCV of $2.41 billion – which is still flat to minimal growth over three quarters (more on this below). Last year, we did not see this flat growth over a 6-month period in TCV booked, instead there was an upward trajectory of roughly 50% growth over that 6-month period.  

Additionally, both RPO and Remaining Deal Value (RDV) are growing at a slower pace than revenue growth at 9% QoQ and 6% QoQ, respectively. Typically, it’s better when both RPO and RDV are higher than revenue growth. That may sound nitpicky, but when a company is priced to perfection, subtle shifts in forward indicators matter. My role is to highlight both the opportunity and the risk beneath the surface. Consider that done in the analysis below. 

NRR Expands 11 Points to 150%, but TCV Soft 

Palantir reported its largest sequential increase in NRR since this key metric began inflecting back in late 2023, with Q1 seeing an 11 point expansion to the coveted 150% level. AIP (and US Commercial) is likely the core driver behind Palantir’s ten-quarter NRR expansion, as customers are increasingly expanding usage of the platform. It’s also worth noting that Palantir is in a league of its own when it comes to NRR, as other best-of-breed names like Snowflake have seen NRR flatline at 125% for the last three quarters.  

This sharp sequential uptick in NRR suggests that Palantir’s customers are increasingly expanding AIP usage at a faster rate, laying the groundwork for both overall revenue and US commercial revenue growth to remain at these elevated levels for a longer period. It also signals a higher degree of stickiness for Palantir in a time where the market is growing fatigued with software and threats of AI disruption, as the company can offer something beyond just workflow automation.  

NRR does not include revenue from new customers acquired over the last twelve months, and Palantir’s deal velocity in late 2025 and in Q1 supports continued upside to NRR in 2026, as many of Palantir’s larger deals closed (those >$5M and >$10M) begin to contribute. 

Looking more closely at deal counts below, Palantir has signed 747 deals over the last twelve months, with 203 of those deals worth >$10 million; none of these have yet to appear in NRR. When considering that NRR has yet to see impacts from the prior few quarters with >180 total deals and more than 40 >$10 million, and instead is only reflecting quarters with <150 deals and ~30 >$10 million deals, there is ample evidence supporting continued strength and upside in NRR as these customers begin to expand through 2026 and 2027. Should NRR follow the acceleration in deals into Q3, there is potential for NRR to begin approaching or exceeding 160%.  

On the flip side, Palantir’s TCV was a bit soft in Q1 with TCV booked showing a sharp deceleration on a YoY growth basis as well as a sharp (43%) QoQ decline. This is not necessarily an immediate red-flag for Palantir’s growth story, as there is an element of seasonality mixed in with a $1.3 billion impact last quarter tied to long-term International contracts. However, the decline does signal that there could be trouble ahead if TCV numbers do not begin to materially rebound next quarter.  

Total TCV booked grew 61% YoY to $2.41 billion, a sharp deceleration from 138% YoY growth in Q4 and >138% growth in the prior three quarters. The bigger issue at play for Palantir is that despite the deal momentum witnessed since Q3, when the company first vaulted from the 150-range to 200, TCV booked has been essentially flat to down (when stripping out Q4’s International impact).  

The fact of the matter is, TCV should have a smooth path to sequential growth, as had been the case in Q1 2025 with TCV of $1.5 billion versus Q2/Q3 2024’s $950 million to $1.1 billion, considering deals have moved much higher with a larger number of >$10 million deals. 

US Commercial TCV was also soft at $1.176 billion, with YoY growth decelerating 22 points to 45% YoY. Sequentially, US Commercial TCV declined roughly (9.5%) QoQ, the segment’s first sequential decline since Q2 2024, despite quarterly deals signed moving to a record high this quarter. This could be due to a higher mix of $1M-$5M deals this quarter, accounting for 65% of total deals this quarter, up from 53% in Q4.  

The Death of Legacy Software 

Software stocks have sold off recently from the threat of AI disruption. What makes Palantir worth listening to on this topic is that the company’s approach is to not simply offer workflow automation (what management is referring to as “slop” on the call), but rather, to offer a way of organizing complex enterprise data into ontologies. Underneath this fundamental difference is a company that first solved the data problem for industries that other software companies ignored – such as defense agencies, manufacturers, hospitals and banks. According to management on the call tonight, it was by solving some of the hardest data problems in those industries that carved out Palantir’s leadership in AI, especially true as agentic AI requires a strong data layer.

Most companies that Palantir competes with build software on top of existing, legacy databases. We’ve discussed this in many previous analyses, stating “The differences matter as unlike traditional AI-enabled database or business intelligence competitors, Palantir can operate effectively even when data sets are incomplete or fragmented—situations where most models struggle. In that regard, traditional business intelligence companies require a complete data set, whereas Palantir can handle situations where one isn't available. You can think of the competitive advantage as actionable depth, as Palantir has described it: “the reasoning that goes into decision-making, not just data.”

Palantir took this further to discuss why cheaper inference places more emphasis on the underlying structural problem that competitors face. Essentially, as large language models improve, as models converge, and as “tokens drop precipitously” to where tokens are now 1000X cheaper, the need for AI agents grows exponentially. According to Palantir, companies have very few choices if they want to deploy AI agents at scale that can reason against data autonomously.

The point here is that investors should understand why software is struggling in the AI era; which is the gap between what Palantir provides compared to what legacy software provides, is not inherently a software issue. If it were a software issue, it could be easily resolved through a faster product cycle, a bigger budget or more software engineering, but it cannot (according to Palantir) because it's inherently a database issue.

Here is what was stated on the call:

“For over 2 years now, we've been saying that while LLMs are improving, models are converging and the cost per token continues to drop precipitously. GPT-4 equivalent performance that cost $20 per million tokens in early 2023 is now approximately 1,000x cheaper 3 years later. Because of this increased efficiency, use case demand for tokens is exploding. Our AIP workflows today utilize vastly more tokens, agents orchestrating across the ontology, training, reasoning, pool use, retrieval and execution, and it's growing […] For every agent action, our customers need to answer 3 questions: Who authorized this? What did it cost? Can I trust what it did? These questions need exact answers with precision. There's no tolerance for slop. We're building a platform-native agent engine SDK, a single set of primatives we're building, persisting, governing and operating ontology native agents, a common layer that lets you visualize every agent in your enterprise and control it, regardless of how it was built, a true agent operating system.”

Financials  

Revenue Accelerates 15 Points to Record-High 85% YoY, Up 16% QoQ 

Palantir reported $1.633 billion in revenue in Q1 2026, up 16% QoQ and beating estimates by 5.8%, driven by an extraordinary surge in both US Commercial and US Government. On a YoY basis, revenue growth accelerated 15 points to 85% YoY, the company's highest growth rate since going public and the eleventh consecutive quarter of acceleration. Over the last eleven quarters, topline growth has compounded roughly 72 points, from just 12.7% in Q2 2023, an achievement matched by virtually no other enterprise software company.  

For Q2 2026, Palantir guided for revenue of $1.797 to $1.801 billion, implying 79.1% YoY growth at the midpoint and 10.2% QoQ growth, once again well ahead of prior consensus for $1.68 billion for 67.5% growth. This represents a sequential deceleration at face value, though at this scale and against a steepening compare base, the magnitude of absolute dollar growth remains exceptional.  

For the full year, Palantir raised its revenue outlook to $7.650 to $7.662 billion, representing 71.1% YoY growth at the midpoint, a 10-point upgrade from the $7.182–7.198 billion guidance issued just last quarter for 61% growth. Going back to our Q4 analysis, Palantir Q4: Highest Growth as Public Company; US Commercial to Accelerate, we had covered what Palantir’s historical beat-and-raise patterns implied for 2026 growth, noting that 2025 had ended more than 25 points higher than initial growth guidance. A similar pattern in 2026 would see Palantir exit the year at ~86% YoY, requiring a slight acceleration into Q2 and maintaining that pace through year-end. 

US Commercial Surges to 133% YoY, Guidance Raised to >120% 

Palantir's US Commercial segment delivered its third consecutive quarter of triple-digit YoY growth, with revenue up 133% YoY and 18% QoQ to $595 million in Q1. Since the start of 2025, US Commercial growth has accelerated 62 points; since the start of 2024, it has accelerated 93 points.  

For the full year, Palantir raised its US Commercial revenue guidance to in excess of $3.224 billion, representing growth of at least 120% YoY—a further upgrade from the prior guidance of >$3.144 billion representing >115% growth set last quarter. Raising full-year growth by five points this early into the year reflects confidence in strong demand persisting, even in light of a marginal YoY deceleration, as well as elevated visibility through year-end.  

A sample model for U.S. Commercial revenue would be the following, if we assume Palantir comes in 3.6% above the guide: 

  • $595M this quarter for 18% QoQ growth (actual) 
  • $740M next quarter for 24% growth (est) 
  • $905M for Q3 for 22% growth (est) 
  • $1.1B for Q4 for 22% growth (est) 

Management did share there was a customer that moved from Commercial to Government, which had the customer not moved, would have led to 143% YoY growth and 22% QoQ growth in Commercial. 

Key metrics for the segment remained strong. US Commercial TCV closed was $1.18 billion, up 45% YoY, while remaining deal value (RDV) stood at $4.92 billion, up 112% YoY and 12% QoQ. Palantir closed 206 deals of at least $1 million, 72 of which were at least $5 million, and 47 of which were at least $10 million across the company. 

To touch on International Commercial, revenue was $179 million as growth inflected on a YoY basis, accelerating from 8% in Q4 to 27% YoY in Q1; however, sequential growth slowed seven points, from 12% QoQ in Q4 to 5% QoQ in Q1.   

Government Accelerates Sharply Alongside US Commercial 

Government still remains critical to Palantir’s success despite its robust US commercial momentum, as government accounted for more than 52% of revenue in Q1. To further hammer this point home, US government revenue also outpaced US commercial growth on a sequential basis this quarter at a larger scale, up nearly 21% QoQ to $687 million.

Similar to US Commercial, Palantir’s US Government revenue accelerated 18 points to 84% YoY, driving total government revenue up 76% YoY to $858 million, driven by Palantir's deepening entrenchment across military and intelligence workflows. 

International Government revenue was $171 million, up 50% YoY and 7% QoQ, a slight acceleration from 43% YoY and 9% QoQ in Q4.

Margins – Rule of 40 Soars to 145%, Adjusted Operating Margin Hits 60% 

Margins strengthened dramatically in Q1 2026, with Palantir setting a new benchmark for the combination of growth and profitability. Palantir’s Rule of 40 score (revenue growth rate plus adjusted operating margin) reached 145%, surpassing Q4 2025's record 127%, arguably the most elite margin-and-growth profile of any enterprise software company. 

Gross margin expanded to 86.8% in Q1, up two points QoQ from 84.6% in Q4 2025 and continuing its multi-quarter uptrend.  

GAAP operating margin was 46.2%, an expansion of roughly 13 points QoQ and over 26 points YoY, as operating leverage scaled impressively against accelerating revenue. Adjusted operating margin was 60%, beating guidance of 56.8% at the midpoint by approximately 320 basis points and expanding 3 points from Q4 2025's 57% actual result.  

For the full year, Palantir raised its adjusted income from operations guidance to $4.440–$4.452 billion, implying a full-year adjusted operating margin of approximately 58.1% at the midpoint—up from the prior $4.126–$4.142 billion guidance for a 57.5% margin. 

GAAP net margin was 53.3%, up roughly 10 points QoQ and over 29 points YoY—a remarkable achievement for a company growing revenue at 85%. Adjusted net margin was 52.5%. Stock-based compensation was $201.6 million, or 12.3% of revenue, a continued improvement from 14.0% in Q4 2025 and 17.6% in Q1 2025, reflecting growing revenue leverage over fixed equity costs. 

Earnings 

Palantir reported $0.34 in GAAP EPS in the quarter, beating estimates of $0.24 by 33.3%, while adjusted EPS was $0.33, beating estimates of $0.28 by 17.9% and representing a 154% YoY increase from $0.13 in Q1 2025. 

Palantir did not provide specific EPS guidance for Q2 2026; prior consensus had pegged adjusted EPS at approximately $0.28 for the quarter, which may see upward revisions following the Q1 beat and raised annual guidance. For FY2026, consensus had been tracking approximately $1.32 in adjusted EPS as of early May, though the Q1 beat suggests those estimates are likely to increase. 

Cash Flows and Balance Sheet

Cash flows were exceptionally strong with Palantir maintaining mid-50% margins for both operating and adjusted free cash flow.  

Operating cash flow was $899.2 million for a 55.1% margin, roughly flat with Q4 2025's 55.0% margin and materially above Q1 2025's 35.1% margin.  

Adjusted free cash flow was $924.6 million for a 56.6% margin, marginally higher from 56.0% in Q4 2025 and a notable expansion from 42.0% in Q1 2025. For the full year, Palantir raised its adjusted free cash flow guidance to $4.2–$4.4 billion, an increase from the prior $3.925–$4.125 billion range; this represents a 56.2% margin with the updated revenue guide, up from a 56% margin previously.  

Cash, cash equivalents, and short-term Treasury securities totaled $8.03 billion at quarter-end, up from $7.18 billion at the end of Q4 2025. Debt remains zero. 

Conclusion: 

By most measures, Palantir offered a strong quarter. Revenue accelerated for the sixth consecutive quarter to 85% YoY growth while most software companies today are treading water. The adjusted operating margin expanded to 60%, FCF margin increased to 57% and key metrics like the Rule of 40 reached 145% to where Palantir is now hanging with memory stocks in terms of growth combined with margins.

It’s well-known that Palantir is not priced cheap, and thus, forward-looking metrics like total contract value or slowing QoQ RDV growth can often help determine if there will be a re-rating higher or lower. Ideally, bookings would accelerate in lockstep with revenue. U.S. Commercial TCV bookings in the $1.2B to $1.3B range for three quarters does not offer the same upward trajectory we saw last year.

The likelihood Palantir joins the legacy software graveyard is very low. However, when a stock is priced for perfect execution, even temporary softening in forward-looking key metrics matter. Regardless, with the information we have today, the rare blemish in Palantir’s earnings report is not enough to prevent the company from putting up a beat/raise early in the year with an enviable bottom line.

We will use technicals on this stock only because of the valuation while the fundamentals are on a tight leash due to the very subtle decline in key metrics.

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 PLTR at the time of writing and may own stocks pictured in the charts.

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Reddit Q1: Bottom Line Expansion Will Face Off with Revenue Deceleration in Q2  

Posted on by io-fund

Reddit exhibits a quiet fundamental strength, with management highlighting its “one of one” financial model as the only publicly listed tech company with >40% revenue growth, >30% adjusted EBITDA and FCF margins, <$15 million in capex and >90% gross margins. Although it’s primarily the gross margin that sets the company apart in the “one of one” marketing language, it’s notable because Reddit’s valuation remains quite low. 

Q1 was a solid quarter for the social platform with Q1 revenue up 69% YoY, ARPU marginally accelerating to 44% YoY, operating and free cash flow margins of 47%, and a Rule of 40 score of 109%. 

On the ad front, Reddit is showing impressive strength in driving costs lower while increasing conversions and ROAS for advertisers, pointing out that they doubled the number of conversions delivered YoY in Q1. Conversion-driven lower funnel revenue was highlighted as a particular area of strength with growth of triple-digits YoY, while Reddit is focusing on driving top of funnel growth via more data in models, updating models faster and accelerating models into production – all without a high capex bill like Meta. 

We have frequently discussed the potential headwinds to Reddit’s story from algorithm changes within Google Search, its key traffic vector. This quarter, Reddit largely brushed off concerns that algorithm changes in Search would impact traffic, explaining that some changes help traffic and some hurt, but they “almost never stand out on our traffic long term.” 

There are a few puts and takes to Reddit’s growth story. Notably, the company is extremely early in its AI ads journey with Max being just 3 months old versus Meta’s Advantage+ on its fourth year, and Dynamic Product Ads only one year old, yet is already driving significant ROAS and conversion gains for advertisers with lower CPA.  

Logged-in user growth continued to decelerate, though Reddit sees an ability to monetize both logged-in and logged-out users relatively equally based on impressions. On user growth more specifically, Reddit is aiming to drive global DAU 8X higher to 1 billion, a cornerstone for future ad revenue growth via higher impressions and engagement on its platform, yet it comes with a self-inflicted headwind on relying heavier on the much lower-ARPU International region to come to fruition. To offset this, management discussed growing US DAU by roughly 2X to 100 million.  

Net-net, Reddit’s overall revenue is decelerating, which is the primary blemish. Management stated in their opening comments this is the seventh consecutive quarter of >60% growth, yet they are guiding for growth of 44%. Therefore, the main question is whether Reddit is headed permanently to sub-40% or even sub-30% growth or is there a catalyst on the horizon?  

Logged-in Users Monetize Higher, and Growth Decelerates 

Q1 is the second-to-last quarter where Reddit will offer its logged-in and logged-out user metrics.  This quarter, logged-in user growth decelerated once more while logged-out user growth remained steady with growth nearly 20 points faster.  

Logged-in daily active unique users (DAUq) grew 7% YoY to 52.0 million in Q1, though this growth was almost entirely driven by International, up 12% YoY to 28.8 million as US growth was barely 1% to 23.2 million. This also marked a three point deceleration from 10% YoY growth in logged-in users in Q4, and a seven deceleration from Q3. 

On the flip side, logged-out users grew 26% in Q1 to 74.8 million, just a one point deceleration from 27% in Q4 and a two point acceleration from Q3’s 24% growth. This again was led by International with 38% growth to 44.5 million, while US grew 12% to 30.3 million.  

This dynamic has been a major point of contention over the last couple of quarters as the Street models logged-out users monetizing at a lower rate, while they grow faster than logged-in users at a larger scale. Reddit did confirm this in Q1, but offered commentary that it does not matter as much as they can monetize both user groups rather equally based on impressions:  

“The only reason why logged-in users, you'd say have a higher ARPU than a logged out user is just because they spend more time and they see more impressions. 

But because of the time spent and the engagement, the impressions are actually pretty equal in terms of their value. So there's no differential in our ability to monetize any impression against those users. There's no difference. And we do monetize both types of users, we have great contextual signal on all our users. And then obviously, we have history on logged-out users and even more in terms of logged-in users because they subscribe to communities.” 

Outside of the higher impressions, one of the reasons why logged-in users monetize at a higher rate builds on the last point from above, and this is something we touched upon in our Meta analysis – personalization. Since logged-in users spend more time on the platform with higher engagement, Reddit knows these users better, and can better personalize their feeds and deliver the ads most relevant to them. Reddit re-emphasized this point, explaining that “seeing more users in the app, more users logging in, more users getting the personalization faster drives engagement and then, therefore, monetization.” 

This is where the market’s concerns have arisen, with logged-in users monetizing at higher rates, yet growth continues to decelerate. Reddit still has some levers to pull to drive log-ins, such as with Passkeys, which management sees as an easier and more secure way of logging in that will help drive log-in user growth.   

Overall, the takeaway is that Reddit is a unique business model as it combines heavily sought-out search function with social aspects. Management feels confident logged-out will monetize at a similar rate as logged-in – for example, Google ads do quite well due to search intent – but given the low valuation, the market is communicating it prefers to wait and see than front-load Reddit’s valuation on management commentary. 

DAU Growth a Core Focus, but Raises a Key Risk 

While increasing its monetization ability on the ads side from AI optimizations and automated campaigns is a key growth lever, the second boils down to user growth – more visits, more eyeballs, more engagement and more ad impressions.  

Q1 featured lengthy discussion on Reddit’s user growth goals over the longer-term (likely 10 years), with the company having its sights set on reaching 1 billion global DAUq, an ~8X increase from Q1, with 100 million DAUq in the US, up ~2X. This would shift Reddit’s DAUq demographics to 90% International for DAUq and 10% US, compared to its current split of ~42% US and 58% International today.   

This is one of Reddit’s core focuses for 2026: accelerating user frequency, or the number of days a Redditor visits the site. While the path to 1 billion DAUq does require Reddit to acquire half a billion more new users, it also requires the company to leverage is WAUq (weekly active user) base, which currently sits at 493.1 million, up 23% YoY.  

Reddit is already working on that piece of the puzzle: 

“So, we think about how do we increase that frequency from maybe once a week to, for example, every day. There are — there's a lot on the list here. Our focus the last couple of quarters has been onboarding. We're seeing progress there. We've moved new user retention in the quarter. Feeds will be a major driver looking forward. I think we're at the relative beginning of our journey there. Search has been a consistent driver. 

So carrying most of the weight the last couple of quarters has been machine translation. We’re translated in 30 languages today. We've been able to lower the cost there, which is nice. It allows us to scale even more there. And then performance is another big driver. And we look at gaps between iOS and Android and what the expected delta should be, which is basically 0. So I think a lot of opportunity there as well.” 

Reddit revealed more insights on user frequency in a separate question, explaining that viewing this as “how many days per week do users come to Reddit” sees the highest frequencies at 1 day and 7 days – the first being more of the WAUq (one visit per trailing seven days) and the second being its DAUq.  

This is why Reddit is focusing on performance improvements, expanding Search (with WAUq up 30%), expanding machine translation, improving the quality and personalization of its feed and improving new user retention, to bridge the gap between the 1 day and 7 day users and drive a much larger share of its weekly users to become daily. 

However, there’s one critical point to discuss here for Reddit’s long-term DAUq vision. By relying on substantial growth in International users to reach the 1 billion goal, Reddit arguably is creating its own headwind to ARPU.  

This is because US users monetize at a much higher rate, and this is not specific to Reddit as Meta also sees a similar differentiation. Reddit’s US ARPU in Q1 was $9.63, nearly 5X higher than Reddit’s International ARPU of $2.02. International ARPU is unlikely to close that gap anytime soon, as growth was three points slower than US in the quarter at 50.7% versus 53.6% YoY. As DAUq begins to shift from its current ~58% International towards the ~90% needed to hit the 1 billion target, the higher proportion of lower-monetizing users could weigh on growth, though this is not likely to be seen for quite a few years.  

Strong AI Ads Momentum with Reddit Max and DPA 

When it comes to ads automation or AI-driven campaigns for advertisers, Reddit is still early in its journey as its automated platform Max is only on its third month, while Dynamic Product Ads (DPA) are barely a year old. Despite this, Reddit is already seeing strong gains in ROAS for advertisers, meaning the two could emerge as potential catalysts to keep ARPU growth and thus revenue growth strong.  

We had said in our Q4 write-up, Reddit Q4: Unwavering Fundamentals; Change in User Reporting Metrics, that Reddit’s new Max campaigns, launched in public beta in January, represent its shift towards an AI-driven, automated ads platform that can increase the number of advertisers that Reddit onboards – the latter point was hammered home in Q1 with Reddit revealing a >75% YoY increase in active advertisers.  

Max encompasses the first and second parts of Reddit’s three-pronged ads strategy: scaling automation and delivering increased advertiser value across objectives. The reason we are watching Max closely as a potential longer-term growth catalyst is that it drives costs lower while offering strong uplifts to conversions or ROAS. Reddit says Max, on average, can drive a ~17% decrease in cost per acquisition (CPA), using tools such as auto bidding, alongside a 27% lift in conversion volumes, highlighting furniture brand Cozey in Q1, which saw a 27-28% decrease in CPM/CPA alongside a 35% increase in ROAS.  

This compares to a ~7-10% decrease in CPAs on Meta’s Advantage+ with a comparable 29% increase in ROAS with Shop ads, which could make Max a compelling option for advertisers, notably in the shopping vertical where Reddit has a rich treasure trove of data. However, the challenge here is shopping is where Advantage+ found success, reaching a $20 billion run rate, up 70% YoY, in Q4 2024. Reddit noted that 40% of conversations on Reddit see people “actively discussing products, services and purchase decisions,” with 40% YoY growth in high-intent shopping conversations last year. Additionally, Reddit said “84% of shoppers say they feel more confident in their decisions after researching on Reddit.” This suggests that shopping could be a high-velocity channel for Reddit to target, leveraging these conversations and contextually-rich data to increasingly drive higher conversions and ROAS for advertisers. 

For Max, Reddit is seeing strong adoption from advertisers, explaining that “customers have been really willing to make the conversion [and] they're very pleased with the CPA benefits that they're seeing out of the gate, which is great. And I think what this opens the door for us to do is to have faster adoption of our new performance features.” Reddit added that about 50% of Max advertisers are using AI-powered creative tools to drive stronger performance.  

The shopping strength is also visible within its Dynamic Product Ads (DPA), which launched a year ago to bring Reddit-unique content to the shopping journey. Reddit highlighted Liquid IV, which noted DPA has already generated 33% of its total platform revenue despite being a newer ad placement, while outperform other conversion campaigns by 40%.   

Similar to Max, it remains early in the journey for DPA. However, Reddit’s ability to deliver >90% higher ROAS YoY on average for brands, combined with upcoming levers such as adding more data to models, improving ad relevancy and personalization, and leveraging partnerships with Shopify and WooCommerce to onboard more advertisers could make DPA another potential growth catalyst.  

Driving Growth with Low Ad Load  

Surprisingly, Reddit is driving its current growth and Q1’s marginal acceleration in ARPU with low ad loads, implying that the company has not reached its full monetization potential. For one, Reddit could gradually begin to increase ad loads to similar levels as peers like Meta, or begin to integrate ads across more features within its site such as its new AI search tool Answers (not currently there).  

However, Reddit does not plan on increasing ad load in the near-term, instead preferring to focus on increasing ad relevancy, growing active advertisers, and increasing ad performance, all key levers in driving conversions and ROAS higher and increasing the stickiness of its platform: 

“Ad load overall is still quite low compared to peers, especially if you look at it just on a feed-to-feed basis, it's still substantially lower and overall on Reddit, we actually don't even have ads in certain high growing surfaces like Search, for example. So overall, I actually feel comfortable on an absolute basis of the ad experiences, there actually is not a high ad load. 

But that aside, we test this all the time, and I think we're very thoughtful about it. As you increase the ad relevancy, which we do through our ML work and we increased the diversity of advertisers in our marketplace, which we're doing. We said we're growing active advertisers, 75% year-over-year. That actually helps with enabling, if you were to move the ad load lever like giving you the diversity to still maintain performance. 

So just know that there are other levers that we focus on more than a lot, like our strategy is not to increase ad load. Our strategy is to grow users, all the things that Steve talked about, where we think we have a 10x opportunity there and to make the value of every impression more valuable through more competition and diversity, through stronger optimization and hard marketing outcomes, more clicks, more conversions, more installs per impression.” 

As Reddit executes on its user growth ambitions, impressions will likely grow in tandem, so if Reddit began to pull the lever on increasing ad load in the future, ad revenue growth could begin to compound.  

Financials 

Q1 Revenue Grows 69.1% YoY, beat estimates by 8.3% 

Reddit reported Q1 2026 revenue of $663.4 million, up 69.1% YoY and beating consensus estimates by 8.3%. It marked the seventh consecutive quarter of greater than 60% YoY growth. On a sequential basis, revenue declined (8.6%) QoQ, consistent with the typical seasonal pattern from Q4 peaks — Q1 2025 also saw an (8.3%) QoQ decline from Q4 2024. The strong revenue growth was primarily driven by 74% YoY growth in the advertising revenue to $625 million. While its other revenue, which includes licensing deals with Google and OpenAI, rose by 15% YoY to $39 million. 

Management guided Q2 2026 revenue in the range of $715 million to $725 million, implying YoY growth of 44.1% and QoQ growth of 8.5% at the midpoint, beating guidance by a marginal 0.6%. It represents a sequential re-acceleration on a QoQ basis. Management did note that there was some geopolitical volatility in the backdrop, with some of its advertisers shortening spending cycles and shifting month to month now, though they expect little impact from this. 

For the full year 2026, consensus currently estimates revenue of $3.14 billion, implying 42.7% YoY growth — a figure that may be revised upward in light of the Q1 beat. 

Advertising Revenue Up 74% YoY 

Advertising revenue, which constitutes the vast majority of Reddit’s top line, was $625 million in Q1 2026, up 74% YoY and down (9%) QoQ. The sequential decline was due to seasonality. This represented the sixth consecutive quarter of 60% or above advertising revenue growth, demonstrating the resilience and compounding nature of Reddit’s ad monetization engine. 

Revenue growth in Q1 was driven by a combination of both impressions and pricing growth. The company’s investments in the ad stack, including machine learning for signal optimization and ad formats, combined with the go-to-market strategy are also delivering meaningful outcomes for advertisers and driving robust growth in new advertisers. 

In Q1, conversion-driven lower-funnel revenue remained a key area of strength, delivering triple-digit YoY growth. Performance-oriented revenue represented over 60% of total ad revenue in Q1, and was well balanced across verticals with strength in retail CPG, technology, and media & entertainment, with “significant headroom for growth.”  

ARPU Grew by 44%, a Slight Acceleration 

User monetization metrics continued their strong trajectory. Global ARPU reached $5.23, up 44% YoY and down (13%) QoQ (again, seasonally expected). U.S. ARPU was $9.63, up 54% YoY, while International ARPU was $2.02, up 51% YoY, reflecting the rapid scaling of Reddit’s international ad business. Overall, this marked a slight acceleration from 42% growth in global ARPU in Q4.  

Margins: Strong Gross Margins; Operating Leverage Delivering 

Reddit’s gross margins remained elevated in Q1 2026, with gross profit of $607.1 million representing a gross margin of 91.5%, relatively stable sequentially from 91.9% in Q4 2025 and expanding 90 basis points YoY from 90.6% in Q1 2025. This marks the sixth consecutive quarter of gross margins above 90%, confirming the structural strength of Reddit’s software-based business model. 

Operating margin was 27.6% in Q1 2026, with operating income of $182.9 million — down from 31.9% in Q4 2025 (reflecting seasonally lower Q1 revenue) but improved significantly from 1.0% in Q1 2025. This demonstrates powerful year-over-year operating leverage, with operating margin expanding 26.6 percentage points YoY. 

Net margin similarly expanded to 30.7%, up from 6.7% in Q1 2025, with net income of $204 million. For context, in Q2 2024 Reddit reported a net loss of ($10.1 million); the company has fully transitioned to consistent GAAP profitability over the past seven quarters. 

Q1 adjusted EBITDA grew by 130.7% YoY to $266 million and came in well ahead of the management guidance of $215 million. Adjusted EBITDA margin improved by 10.7 percentage points YoY to 40.1% and beat the guidance of 35.8%. Management has guided adjusted EBITDA margin of 40.3% in Q2, implying a YoY improvement of 6.9 percentage points.  

Reddit’s Rule of 40 score (revenue growth plus adjusted EBITDA margin) came in at 109% for Q1 2026, up from 91% in the same period last year and down from 115% in the previous quarter. 

EPS: 677% YoY Growth, Beats by 79.1% 

GAAP EPS for Q1 2026 was $1.01, beating consensus estimates of $0.56 by 79.1% primarily driven by strong operating leverage. It grew by 677% YoY from $0.13 in Q1 2025.  

Analysts expect GAAP EPS to grow by 83.8% YoY to $0.83 in Q2 and 42.5% YoY to $1.14 in Q3. 

Cash Flows and Balance Sheet 

Cash flows were extremely robust in Q1 2026 primarily driven by higher profits.  

  • Operating cash flow was $312.3 million, representing a 47.1% margin and up significantly from $127.6 million or 32.5% margin in Q1 2025.  
  • Free cash flow was $311.2 million for a 46.9% margin, compared to $126.6 million or 32.3% margin in Q1 2025 — nearly a 2.5x increase in free cash flow YoY. 
  • Reddit’s balance sheet remains fortress-like. The company exited Q1 2026 with $2.77 billion in cash and marketable securities, up from $2.48 billion at end of FY2025, and carries zero debt.  
  • Management noted that share repurchase activity was modest in Q1, with approximately 35,000 shares repurchased or $5.0 million worth of shares, leaving $995 million remaining on the $1 billion buyback authorization announced during Q4 2025 results. This authorization provides meaningful capital return flexibility as Reddit’s cash generation accelerates. 

Conclusion 

Reddit has strong fundamentals that are mixed come Q2 as the company approaches slower growth combined with dropping user metrics that Wall Street would prefer to have visibility into. There are typically many paths to growth when you own the data layer – whether it’s through Max, data licensing, or another avenue like adding Shopping ads to leverage its rich user data in the era of AI. 

There are two key things investors should know – the first is, we are in a period of speculation as to whether Reddit can re-accelerate its growth. Secondly, the valuation is already discounting the lower revenue growth (and then some). Therefore, how we play this stock will require technicals. It’s not the strongest stock in our portfolio, but it’s one of the cheapest combined with a strong, bottom line.

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 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 RDDT at the time of writing and may own stocks pictured in the charts.

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SanDisk Fiscal Q3: Data Center Inflects 233% QoQ while New Business Models (NBMs) Weigh on the Stock 

Posted on by io-fund

The market is growing numb to the string of historic earnings reports we’ve seen from the memory industry. SanDisk delivered one of the best single-quarter earnings reports in NAND history with revenue nearly doubling sequentially, data center inflecting 233% QoQ and gross margin expanding 27.5 points – all of that in three, brief months. 

Total revenue of $5.95B beat estimates for $4.73B with data center revenue up 233% QoQ to $1.47B. Edge revenue of $3.66B also inflected 118% QoQ. The bottom line was exceptional with GAAP EPS of $23.03 and adjusted EPS of $23.41; beating estimates for $14.66 … (crazy!) Today, data center represents 25% of SanDisk’s revenue compared to 15% last quarter. 

Looking forward, revenue guidance indicates growth of 34.5% QoQ and 321% YoY for revenue of $7.75-$8.25B, beating estimates for $6.63 billion. In similar fashion, the adjusted EPS beat on next quarter’s guide is also substantial at $30-$33 versus estimates of $23.44. 

On the earnings call, the more important development is the introduction of New Business Models (NBMs) which are essentially long-term agreements. Management mentioned they have signed five NBM agreements, three in FQ3 and two more in FQ4. This is an adjustment to the market which has been fickle in how it perceives memory stocks. On one hand, the surge in pricing has allowed strong inflections like what we’ve seen today – yet, this led the market spiraling into fears around the cyclicality of pricing and the risk that memory companies build too much supply. Now, as LTAs are being introduced to smooth out some of the lumpiness that has historically defined the memory industry, and to provide commitments that can support future capacity expansion, the market is starting to swing to the opposite concern: that these agreements could cap upside if pricing remains strong. 

Extremely Dynamic Market 

Before getting into the nitty-gritty of memory jargon, the most important takeaway from arguably Wall Street's highest-growth AI winner today came from two moments in the call.  

Management stated on the FQ4 guide: "It's early in the quarter, and it's an extremely dynamic market. So it pays to be a bit conservative when you're going down that path." 

The takeaway is that management may be sandbagging due to unknowns in pricing momentum, rather than as a tactic; it’s truly due to unusual levels of uncertainty. This was in response to a question as to why the EPS guide implies a pricing deceleration, the answer is that pricing accelerated faster than we expected in FQ3, and we'd rather guide conservatively than lock in expectations we can't beat. 

There was an additional commentary about the surging demand backdrop: 

"Before what we saw this week, we would raise even our calendar year '26 data center growth number to the mid-70s from where we were in the 60s just 3 months ago, which is up from the 40s 3 months before that and the 20s 3 months before that. So we continue to see very, very strong growth in the data center." 

That's a roughly 4x increase in management's CY26 data center growth forecast over nine months, across three-month increments, with each revision higher than the last. Against a NAND bit supply base growing in the high teens through nodal transitions, the demand-supply gap is widening every quarter rather than closing. Perhaps not at the pace we saw this past quarter, but likely to continue seeing material growth. 

KV Cache will Drive more TLC and QLC Demand 

As it stands, SanDisk’s revenue is 2/3 triple-level cell (TLC) and 1/3 quad-level cell (QLC). TLC is driving the bulk of the revenue as enterprise SSDs are dominating with 8TB and 16TB PCIe Gen 5 products for speed and latency. QLC is expected to grow as it’s more of the storage-focused enterprise SSD product at 128TB and scaling to 512TB. 

Right now, KV cache requirements are driving more TLC demand with management stating: "Given the inference architectures and some of the comments earlier around KV cache and how important it is and quite frankly, how it can scale dramatically based on your assumptions of the use case you're serving. There's a very, very strong demand on TLC." 

However, QLC will increase in importance over time as it stores more bits in the same cell, it’s cheaper per bit and higher density, and has become a desirable capacity layer for the KV cache.  

As a reminder, we’ve covered the importance of KV cache for inference workloads stating “The decode phase generates the output tokens one by one in a sequential manner, relying on the KV cache and previous tokens, making it extremely reliant on memory bandwidth and capacity to rapidly access cached tokens. When discussing how AI workloads are memory constrained, it comes from the decode phase.” 

QLC is shifting from cheap bulk storage to a key component for long-context reasoning. As inference deployments scale, the capacity tier, where QLC's density advantage is strongest, should grow as a share of overall enterprise SSD demand. 

To meet this demand, SanDisk is releasing “Stargate” UltraQLC SKUs that will enter volume shipments in June at the 128TB size and with 256TB following shortly after: “Looking ahead to the fiscal fourth quarter, we expect to begin shipping our QLC Stargate solutions for revenue, adding another layer of revenue growth.” 

Here is what was stated on the call regarding why QLC will see a higher product mix: 

“Stargate is, and the progress we've seen so far in the portfolio is coming off of that compute focused TLC drive. And now we're going to bring the whole QLC product to market, which has been under qualification with some major players for well over a year." 

These are not competition with each other, rather I am pointing out stronger QLC growth may layer on top of TLC growth during the KV cache architectural shift. Here is another clue that QLC may contribute to a step-up in volume soon: “"Our BiCS shipments were flat year-over-year and down high teens sequentially as we build higher inventory levels, primarily to support strong BiCS8 QLC demand in the fourth quarter Stargate ramp and to prepare for our recently signed new business models." 

When asked how the KV cache opportunity has changed recently (given the new architecture emphasis was announced in January at CES), the response was lengthy with this as the most important excerpt: “And I think this just reinforces this business model question as our customers go through those calculations and understand the significance of NAND that, that could drive that is a good foundation for the conversation about striking deals 2 years, 3 years, 5 years in length that are very, very substantial in the amount of demand. I mean we're talking about 5 deals and more than 1/3 of our portfolio. So it's an extremely, extremely dynamic situation.” 

New Business Model Agreements (NBMs) Announced with 5 Signed and More on the Way 

SanDisk has now signed five NBM agreements with three in FQ3 and two more in early FQ4 with active negotiations underway for additional contracts. Total remaining performance obligations (RPO) have reached $42 billion, representing over a year of locked-in demand at the FQ4 guide of $8B at the midpoint. According to the CFO on the earnings call, customers have committed $11B in guarantees backing the five agreements and this as structured as a pre-payment. 

Here is what was stated on the call: “As you will see in our 10-Q, the 3 contracts signed during the quarter provide minimum contractual revenue of approximately $42 billion. We will update you as we make more progress. Each contract is secured with financial guarantees that protect us if the purchase obligations are not fully performed by our customers. In aggregate, the 5 agreements signed so far include financial guarantees that exceed $11 billion and include prepayments and other financial instruments, managed by third-party financial institutions. Out of these agreements, $0.4 billion in prepayments are included in our Q3 balance sheet. These 5 new business models account for over 1/3 of our BiCS in fiscal year 2027, which we expect to increase as we conclude additional agreements over the next few months.” 

Management stated they are targeting 50% of the supply under NBM agreements compared to current levels of 1/3rd: “So I expect the number that we said at least 1/3. So we're over 1/3, and I expect that number to go up over the next several quarters. Where can it get to? I definitely think it can get above 50%. And — but we'll see.” 

The market has been assuming that multi-year agreements cap price in the same manner that LTAs have constrained HDD pricing. Overall, the market tends to sell these announcements because the takeaway is that it limits the upside from pricing increases. However, it was stated in the call that NBM pricing is variable and not fixed.  

In this case, volume is committed while pricing flexibility remains: “These agreements are tailored to meet the needs of our customers and in aggregate, provide us with demand certainty and financials that we expect will be consistent with our fiscal fourth quarter guidance. The duration of this agreement varies, with the longest contract extending to 5 years. In aggregate, volume commitments increased during the life of the contracts with quarterly commitments and a combination of fixed and variable pricing. This agreement with variable pricing allow us to capture upside if prices rise while allowing our customers some upside if prices decline over time.” 

Durability of the Margins  

When it comes to a stock reporting very strong growth, you can pretty much pick anywhere on the income statement for where the strength is being interpreted as topping. Revenue up 97% sequentially, gross margin expanding from 51% to 78% and operating margin expanding from 35% to 69%, EPS up 4X is why every line item becomes concern for the stock peaking. Although there are no guarantees, and a lot of this depends on a mix of spot pricing and the variable pricing in the NBMs, the following statements were made to suggest the margins could be somewhat sustainable (not going to fall off a cliff) 

In the opening remarks, the CEO stated: “Our customers' commitments are backed by firm financial guarantees. These partnerships support durable structurally higher earnings and a significantly more predictable and less cyclical business for Sandisk.” 

Later, the CFO confirmed something similar: “Together, these transformations have resulted in a step change in what we believe to be sustainable gross margins, free cash flow generation and earnings power in a market that we expect to grow in the double digits for the foreseeable future.” 

When asked if the margins can sustain, the answer was vague but did hint the NBMs are not compromising on margins in exchange for certainty: “And I think that now we're getting a more even distribution of those — of that value. So we're not necessarily interested in trading away that value for certainty. We're interested in getting that value and getting certainty as well.” 

Financials 

By Royston Roche 

Revenue: Explosive Acceleration to 251% YoY 

SanDisk delivered a blockbuster Q3 FY26 ending April, with revenue surging to $5.95 billion, representing 251% YoY growth and 96.7% QoQ growth. Revenue beat consensus estimates by a remarkable 25.7%, reflecting the severity of the structural NAND supply-demand imbalance that has taken hold through 2025 and into 2026. Revenue growth accelerated sharply from 61.2% YoY and 31.1% QoQ in the previous quarter.  

Revenue has now accelerated sharply in each of the past four consecutive quarters. It is an extraordinary acceleration trajectory that underscores just how rapidly NAND pricing and data center demand have inflected. The unprecedented NAND pricing, supply tightness, and surging AI-driven enterprise SSD demand as the primary drivers of the outperformance. 

Looking ahead, management guided FQ4 revenue of $7.75 billion to $8.25 billion, implying a YoY growth of 320.8% YoY and 34.5% QoQ at the midpoint and beating estimates by a solid 20.7%. Analysts expect FQ1 revenue to grow by 241.9% YoY to $7.89 billion and 183.4% YoY to $8.57 billion in FQ2. 

Segment Performance: Data Center Leads with 645% YoY Growth 

SanDisk's segment mix continued its rapid shift toward higher-margin, AI-driven end markets. Data Center revenue exploded to $1.47 billion in FQ3, up 645% YoY and 233% QoQ, reflecting hyperscaler demand and the ramp of AI-adjacent storage solutions. The segment reported sharp acceleration from 76% YoY and 64% QoQ growth in the previous quarter. 

Edge revenue grew by 295% YoY and 118% QoQ to $3.66 billion. Consumer revenue was $820 million, while down (10%) QoQ, grew 44% YoY, with the QoQ decline attributable to seasonality. 

Margins: Rapid Expansion Across All Lines 

Margin expansion in FQ3 was exceptional at every level of the income statement, driven by pricing power, shift towards higher value mix, and operating leverage. 

  • Gross margin reached 78.4% in FQ3, a stellar expansion of 27.5 points QoQ, and 55.9 points YoY. Gross profit reached $4.66 billion in the quarter, up from $1.54 billion in FQ2 and $382 million in the same period last year. Looking ahead, management guided FQ4 gross margin of 79.9%, which would represent a further 150 basis points of sequential improvement, signaling that pricing power remains firmly intact. 
  • Adjusted operating margin improved by 33.4 percentage points sequentially to 70.9% in FQ3 and up significantly from a mere 0.1% in the same period last year, reflecting strong operating leverage. Management guided adjusted operating margin to improve 300 basis points sequentially to 73.9% in FQ4. 
  • Adjusted net income was $3.68 billion or 61.8% of revenue compared to a loss of ($43 million) or (2.5%) of revenue in the same period last year.  

Adj. EPS of $23.41, Beating Estimates by 59.7% 

SanDisk reported adjusted EPS of $23.41 in FQ3, beating estimates by 59.7%, indicating that analyst models continue to structurally underestimate NAND pricing strength. GAAP EPS came in at $23.03, beating estimates by 62.4%. 

Looking forward, management guided FQ4 adj. EPS to $30–$33, implying a midpoint of $31.50 and beating estimates by 34.4%. The company has witnessed strong EPS revisions recently and the magnitude of these revisions reflects a complete repricing of SanDisk's earnings power by the sell-side, consistent with the company's supply-constrained, pricing-dominant operating environment. 

Cash Flow & Balance Sheet 

The company’s cash flows have improved significantly primarily due to higher profits.  

  • FQ3 operating cash flow was $3.04 billion or 51.1% of revenue compared to a mere $26 million or 1.5% of revenue in the same period last year. 
  • Adjusted free cash flow was $2.96 billion or 49.7% of revenue compared to $220 million or 13% of revenue in the same period last year.  
  • Notably, SanDisk has zero debt and $3.74 billion in cash. The company repaid the outstanding $603 million debt in the recent quarter, funded by the strong cash flows. 
  • The Board authorized a $6 billion share buyback program, effective immediately with no expiration, signaling management's confidence in the durability of cash flows. 
  • Inventory increased by 13.7% QoQ to $2.24 billion. 

Conclusion:

As stated, there has been roughly a 4x increase in management's CY26 data center growth forecast over nine months, across three-month increments, with each revision higher than the last. Against a NAND bit supply base growing in the high teens, the demand-supply gap is widening every quarter rather than closing. Perhaps the pace will slow from what we saw this past quarter, but even still, it’s likely NAND will continue seeing material growth. 

We want to be sensitive to the fact that growth stocks can peak – and this happens to be our specialization. Growth stocks typically peak when the demand signals weaken rather than when companies sign more multi-year commitments. That said, we also respect pre-set price targets. Precisely because this is our arena, we may risk-manage the profits.

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 SNDK at the time of writing and may own stocks pictured in the charts.

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Is Nvidia Stock a Buy? Why Semiconductor Strength May Signal a Market Top

Posted on by io-fund

In last week's report, we announced that we are significantly trimming our Nvidia position, a stock we have often held as a top-three holding since 2021. The rationale for this pivot rests on a shifting landscape within the AI trend toward inference, and how that shift will pressure Nvidia's pristine positioning. 

The numbers back it up. Per TrendForce, GPU-based AI servers will account for 69.7% of shipments in 2026 with ASIC-based servers rising to 27.8%. This is happening while a reported one-quarter delay on Rubin, Nvidia's next-gen GPU platform, lands at exactly the wrong moment. The hardware moat that powered the first phase of Nvidia's ascent is becoming less absolute, and with it, the case for premium pricing and 70% gross margins. 

This thesis is reinforced by technical analysis, which suggests that Nvidia, as well as the broader market, is approaching a meaningful top. While that top is likely to be a correction within a much larger uptrend, it exposes investors to a level of risk we have not experienced in recent years. 

In this report, we take a deeper look at the technical scenarios, which suggests that Nvidia’s latest high is shaping up to be a potential bull trap. That view is corroborated by the broader semiconductor complex. Specifically, the failure of other key sub-sectors to confirm the move higher. 

Spotting Bull Traps: Why Market Divergences Matter at All-Time Highs 

There are several techniques investors can use to lower the odds of being caught in a bull trap. One of the most important is checking whether major markets, sectors, and bellwether stocks are confirming the move higher.  

When every major stock, sector, and index breaks out to new highs together, it is the hallmark of a powerful trend that historically extends much further and lasts for quite a while. However, not every breakout plays out that way. False breakouts, or bull traps, do exist. They occur when buyers get trapped on the final gasp of an uptrend, left holding the bag as the market rolls over and corrects. 

Today, the S&P 500, led by semiconductors, is breaking out to new highs. However, the number of divergences across major stocks, sectors and supporting markets poses a warning to larger uptrend.  

Nvidia Stock Divergence 

Since the current bull cycle began in October 2022, the defining theme has been AI, specifically the hardware buildout concentrated in the semiconductor sector. The returns tell the story as the Broad-Based Semiconductor ETF (SMH) is up over 470% from the 2022 low, while the Mag 7-heavy NASDAQ-100 has gained roughly 150% over the same period. 

Within the Semiconductor sector, the undoubted leader is Nvidia, which is up more than 1700% in the same time frame. Because of Nvidia’s outsized influence, its performance relative to the broader market has become a remarkably reliable technical tell for coming weakness. 

Case in point, since Nvidia's watershed earnings report in May 2023 — the event that effectively ignited the AI trade — every time the Broad Semiconductor Sector (SMH) has made a new high without Nvidia confirming, it has signaled the prevailing trend is running on fumes and setting up for a reversal.

Chart comparing Nvidia stock and the Semiconductor ETF (SMH), showing periods where SMH reaches new highs without confirmation from Nvidia, preceding sector pullbacks.

Chart comparing Nvidia stock with the Semiconductor ETF (SMH), highlighting repeated divergences where SMH pushes to new highs while Nvidia fails to confirm. Historically, these divergence periods have preceded notable semiconductor sector corrections, signaling elevated risk beneath the rally.

As of today, SMH sits more than 30% above its late-October 2025 top, while Nvidia is still 1% below that same level – an uncomfortable warning sign beneath the recent strength of the broader semiconductor sector. 

This divergence analysis can be applied more broadly to gauge the risk embedded in the current push higher. While the NASDAQ-100, S&P 500, and the broader Semiconductor Index sector (SMH) are all making new highs, that move is not being confirmed by other major sectors and markets. 

The Magnificent 7 Stocks 

If Nvidia is the single most important stock in the market, the Magnificent 7 are the most important group. They led the recovery out of the 2022 bear, they've driven the bulk of S&P 500 returns in every year since, and historically they've turned before the broad market does. That's why their failure to confirm new highs is one of the cleanest leading indicators we track. 

Since November 2021, when the equal-weight Mag 7 Index does not confirm a new high in the S&P 500, it has been a reliable signal of a weakening market environment. A similar divergence is occurring today and, until it resolves to the upside, it remains a warning for the durability of the broader uptrend.

Chart comparing the equal‑weight Magnificent 7 index with the S&P 500, showing periods where the broad index reaches new highs without confirmation from equal‑weight leadership.

Chart comparing the equal‑weight Magnificent 7 index with the S&P 500, highlighting recurring divergences where the S&P 500 advances while equal‑weight leadership lags. Historically, these non‑confirmation periods have preceded meaningful market pullbacks and signal weakening market breadth beneath index‑level strength. 

Financial Stocks (XLF) 

While the technology sector has undoubtedly been the most important sector in the current secular bull market, the financial sector has been a close second. Given the financialization of the US economy, which has expanded to global markets, the health of our big banks is paramount to an ongoing growth narrative.  

The financial sector has also been a leading sector off the April 2025 low, until recently. In fact, the chart suggests a top formed in January, providing early warning signs.

Daily chart of the Financial Select Sector SPDR ETF (XLF) showing a completed five‑wave advance, followed by a corrective bounce with declining volume and weakening momentum.

Chart showing XLF completing a five‑wave uptrend before rolling over into a corrective structure. The current rebound is unfolding as a three‑wave bounce on declining volume, while momentum diverges from price—a setup that typically signals a corrective rally within a broader downtrend and increased downside risk for the financial sector.

What stands out in the chart above is that XLF traced a clean five-wave uptrend off the April 2025 low, topping in early January 2026. Since then, it has carved out its first series of lower lows, retracing more than half of the gains made off the 2025 low.

mid

Note, too, that the current bounce is a three-wave move on decelerating volume, a clear sign of low conviction. At the same time, momentum is making a new high while price is putting in a lower low, the kind of behavior we typically see inside larger downtrends. Taken together, these signals strongly suggest XLF is in a corrective bounce within a broader downtrend that targets $44 (~14% lower from the current price). 

Most notably, while SMH is 14% above its February top, XLF is 8% below its January top. That is not a healthy signal, and it suggests that SMH is likely in the process of completing a bull trap. 

Industrial Stocks (XLI) 

We can see a similar pattern playing out in the industrials sector. XLI is one of the cleanest reads on real-economy capex, PMIs, and global trade. When ISM manufacturing turns, industrials lead. When the Fed pivots, industrials typically lead the rotation out of defensives. That economic sensitivity is precisely what makes the sector worth monitoring closely. 

Today, the chart of XLI looks much like XLF above.

Daily chart of the Industrial Select Sector SPDR ETF (XLI) showing a completed five‑wave advance followed by a corrective bounce with declining volume and momentum divergence.

Chart showing XLI completing a five‑wave uptrend before entering a corrective phase. The recent rebound appears to be a lower‑volume, three‑wave bounce, while momentum diverges from price—characteristics typical of corrective rallies within a broader downtrend and signals of elevated downside risk for the industrials sector. 

After a clear 5 wave uptrend off the 2025 low, XLI has provided the first lower low in the recent drop. The bounce is clearly 3-waves and on tepid volume. This is backed by momentum making a new high while price makes a lower high. The target for this sector, based on the evidence discussed, is around $150. 

These markets have not been cherry-picked. They are major bellwethers, and they are not confirming the strength we are seeing in the broad market and semiconductors. They are also joined by other key groups—the Dow Jones Industrial Average, transportation, consumer discretionary, high-beta, as well as several global markets. 

As long as these divergences persist, the risk to the bulls remains elevated.

How Elliott Wave Theory Identifies the End of a Trend 

Another technique that can help identify bull traps is Elliott Wave theory. The general idea behind this framework is that markets move in repeating patterns—five waves in the direction of the larger trend, followed by a three-wave correction against it. This is ultimately driven by the collective psychology of buyers and sellers, which is quantifiable in repetitive patterns. 

Within a five-wave structure, the third wave is typically the most powerful phase of the trend. It is the moment the market collectively "gets it" all at once, shorts rush to cover while sidelined participants panic-buy into longs. The result is often a sharp, near-vertical advance that coincides with peak expansion in both volume and momentum. 

The fifth wave, by contrast, is driven by late arrivals – those who missed the earlier move and assume the trend is only just beginning. It is often the riskiest segment of the advance and, in our view, should only be approached with a defined exit plan. In this phase, price may still push to a higher high, but it frequently does so on declining volume and weakening momentum. 

As shown below, this is precisely the behavior we are seeing in the broad semiconductor sector (SMH).

Three‑day chart of the VanEck Semiconductor ETF (SMH) showing a strong price advance within an upward channel, accompanied by weakening volume and momentum during the latest rally phase.

SMH chart showing a powerful semiconductor sector advance unfolding within a rising channel, labeled as a fifth‑wave move. While price has surged toward projected resistance levels, both volume and momentum are fading, a pattern consistent with late‑cycle rallies and increased risk of a pullback or bull trap near market highs. 

While the rally in SMH has been nearly vertical off the recent low, it is unfolding on weakening volume and fading momentum. That is classic fifth-wave behavior, and it suggests the current push higher is the final swing within the uptrend off the April 2025 low. The implication is that the Mag 7, financials, industrials, are leading the broader trend lower, while semis are simply playing catch-up to the upside.

We can see the same fifth-wave playbook in the top three holdings of SMH, which together account for roughly 38% of the entire index weighting. 

Nvidia’s Technical Setup (NVDA)

Daily chart of Nvidia stock (NVDA) showing a fifth‑wave advance toward resistance, accompanied by declining volume and weakening momentum.

Chart showing Nvidia stock progressing into a fifth‑wave rally following a completed corrective phase. While price has pushed toward key resistance levels, underlying volume and momentum are fading, a combination that often characterizes late‑cycle advances and raises the risk that the current breakout develops into a bull trap rather than a sustainable uptrend.

Nvidia barely broke above its late October 2025 high, before pushing back below it. The vertical nature of this bounce suggests that Nvidia is also in a 5th wave, like SMH. Note the decelerating volume and momentum as price attempts at a new high.  

As long as Nvidia stays over $197-$187 the odds favor one more push higher. The targets for this 5th wave are $221 – $230, if this breakout remains a lows volume and low momentum move, it will likely remain the final 5th wave swing higher and continue to be a warning.

Broadcom’s Technical Setup (AVGO) 

AVGO also appears to be in a fifth-wave swing, with the recent breakout occurring at lower volume and weakening momentum. If this read is correct, it should set up a multi-month drawdown that retraces most of the five-wave uptrend now appearing to complete.

Daily chart of Broadcom stock (AVGO) showing a fifth‑wave rally toward resistance, accompanied by declining volume and weakening momentum.

Chart showing Broadcom stock advancing into a fifth‑wave rally following a corrective phase. While price has pushed higher toward projected resistance, volume and momentum are failing to confirm the move—characteristics commonly associated with late‑cycle advances and increased risk of a corrective reversal rather than a sustained breakout. 

Taiwan Semiconductor (TSM) 

The same 5th wave characteristics can be seen in TSM’s chart below, which bolsters the evidence that SMH is likely in a final 5th wave swing higher.

Three‑day chart of Taiwan Semiconductor Manufacturing Company (TSM) showing a fifth‑wave rally near resistance, accompanied by declining volume and weakening momentum.

Chart showing Taiwan Semiconductor progressing into a fifth‑wave advance following a multi‑month uptrend. While price has reached key resistance levels, underlying volume and momentum are failing to confirm the move, a pattern that often marks late‑cycle rallies and raises the risk of a corrective pullback rather than a sustained breakout. 

While Nvidia is likely setting up for a larger period of volatility than most believe, the technical framework also supports a very large uptrend that should continue for years, with large bouts of volatility along the way. This perfectly aligns with our thesis that 2026 may not be Nvidia’s best year, yet the stock will likely still lead over the decade.  

While divergences are growing amongst key markets and stocks, the current strength in the market appears to be a 5th wave, defined as the final swing of an uptrend, met with low volume and low momentum.

Monthly chart of Nvidia stock (NVDA) showing a multi‑decade Elliott Wave advance, long‑term trend channels, and declining momentum near projected upper resistance.

Long‑term chart of Nvidia stock illustrating a multi‑decade Elliott Wave structure within a rising secular channel. While the broader trend remains upward, momentum has begun to flatten near projected upper resistance levels, a pattern that historically accompanies late‑cycle phases and signals elevated risk of significant corrective periods within a longer‑term uptrend. 

In the near-term, can the broad market handle a selloff, with Nvidia leading the way? The Nasdaq-100 is only up 9% YTD and most influencer-led tech ETFs are lagging the broad market. The I/O Fund is up 35% YTD – outperforming not just on the long side, but also through active risk management during bouts of volatility.  

The I/O Fund has built a strong track record in lesser-known AI winners, including Bloom Energy, up 1100% since our initial entry last year, an optical networking stock up more than 620% since November, and one of our largest positions at a 10% allocation already up 130% year to date. We publish more than 100 paywalled articles each year on AI stocks, supported by an actively managed portfolio and real-time trade alerts. Don’t miss out on the AI trade. Learn more hereLearn more here.

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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