Vertiv offered a mixed report this quarter with stronger commentary about Q4 as opposed to Q3, along with a slight miss on adjusted operating margin. Considering the margins are already thin for many AI hardware stocks, any miss tends to be amplified. With that said, the stock has been on a tear off the Apri lows – up 130% since early April. Given the report was not a blowout, a cooling off may be in order regardless of the earnings numbers. 

Notably, Vertiv will not win any hypergrowth stock awards, especially as management has previously offered CAGR guidance of 15% to 17% through 2029. Rather, it’s where Vertiv is positioned as an AI infrastructure partner especially as the trend turns toward modular infrastructure that makes this a stock to watch.  

Essentially,  all roads point toward Vertiv’s power and thermal solutions becoming increasingly important for future generations of rack scale solutions. Personally, I’d like to see material evidence the current CAGR guidance through 2029 will end up 2-3X higher before we add VRT to our portfolio. This is AI, so anything is possible. I've outlined important information on how Vertiv can achieve this under the Q&A section below. 

Specifically for this earnings report, the following are a few key items: 

• Vertiv reported a large beat this quarter with 35% revenue growth in Q2 due to the America geo reporting very strong YoY growth while EMEA lagged. 
• Vertiv missed on adjusted operating margin, largely due to impact of tariffs and operational inefficiencies. The company lowered their adjusted operating margin for the year despite QoQ adjusted operating margin increases through Q4. 
• However, if management meets their margin guidance for Q4, it will represent the strongest margins since the company has been on the public markets with adjusted operating margin of 23.6%  
• EPS growth surpassed top line growth at 42% 
• Modular AI infrastructure remains Vertiv’s top catalyst and makes this stock one to watch 

We’ve covered Vertiv in the past here “AI Data Center Direct Liquid Cooling Stock” and “Vertiv Q1: Inflection Point Muted, AI Factories Catalyst for 2026” 

Revenue Rises 35% in Q2, FY25 Hiked to $10B 

Vertiv reported 35.4% YoY growth in revenue in Q2 to $2.64 billion, with organic growth of 34% on continued strength in the Americas and APAC, noting that demand remains strong with its order pipeline expanding in all regions. 

Supported by these demand signals and favorable pricing, Vertiv hiked its full year revenue guidance to $9.925 to $10.075 billion ($10 billion at midpoint), up $550 million from its prior view for $9.325 to $9.575 billion. This points to YoY growth of 24.8% YoY, more than 7 points higher than its prior guidance. Organic growth was raised to 23% to 25%, up 6 points from its prior guidance at midpoint. 

Despite the FY25 raise, Vertiv is still guiding for a rather swift topline deceleration through Q4. 

• Q3 revenue was guided between $2.51 to $2.59 billion, or 23% YoY growth at the $2.55 billion midpoint. Organic growth was guided to be 20% to 24%. This sequential decline goes against typical seasonality for VRT. 
• Q4 revenue was guided at $2.735 to $2.815 billion, or 18.3% YoY at the $2.775 billion midpoint. Organic growth was guided at 16% at midpoint. This would represent a ~17 point deceleration in growth in the second half of the year. 

If we zoom out, then Q2 represents the largest beat Vertiv has seen in recent years. As we look forward, the guide for Q4 represents a $200M increase between Q3-Q4. 

Source: Seeking AlphaSeeking Alpha 

America Region Reports Strong Growth of 43% 

As noted previously, the Americas and APAC drove Q2’s outperformance, with Americas growth accelerating more than 14 points sequentially. This is the strongest growth in the Americas region we’ve recorded since covering the stock for 2.5 years.  

• Americas revenue increased 42.9% YoY and 43.2% organic to $1.60 billion. Growth was driven by hyperscale and colocation markets with strength in switchgear, busway, liquid cooling, and infrastructure solutions. 
• APAC revenue accelerated slightly to 36.9% YoY and 36.8% organic to $560.2 million. Growth was primarily driven by hyperscale and colocation markets in China. 
• EMEA revenue accelerated back into the double digit range after a soft Q1, up 12.5% YoY and 7% organic to $475.6 million. Vertiv said its EMEA pipeline remains strong with continued sequential growth. 

For Q3: 

• Americas growth is expected to be in the mid-30% range. 
• APAC growth is expected to be in the low 20% range. 
• EMEA growth is expected to be down high single digits. 

Backlog, Orders Growth Slows 

Though Vertiv’s backlog increased to $8.5 billion, growth is decelerating, now at 21% YoY versus 25% in Q1 and 30% in Q4. This is also the slowest growth for Vertiv’s backlog since Q4 2023.  

TTM organic orders growth also decelerated more than 9 points sequentially, from 20% in Q1 to 11% in Q2.  

Margins to Expand Through Q4, Yet FY25 Operating Margin Lowered Slightly 

Margins expanded sequentially in Q2, with net margin moving into the double-digit range. Vertiv forecast Q3 and Q4 adjusted operating margin to expand sequentially, yet lowered its full-year guidance to account for tariff countermeasures and other factors. 

Vertiv expects to be back to normal on adjusted operating margin by Q4, stating they will expect to see a margin of 23%+: 

“Full year adjusted operating margin is projected to be approximately 20% at the midpoint, 60 basis points higher than last year despite tariff headwinds, and 50 basis points lower than prior guidance. We continue to drive margin improvement, including positive price/ cost and productivity. And implied in our guidance is fourth quarter adjusted operating margin in excess of 23%, once again, keeping us on track to attain our long-term target by 2029.” 

• Gross margin was 34%, down 4 points YoY but up 0.3 points QoQ. 
• GAAP operating margin was 16.8%, down 0.4 points YoY but up 2.5 points QoQ. 
• Adjusted operating margin was 18.5%, down 1.1 points YoY but up 2 points QoQ. Vertiv said the YoY decline stemmed from accelerated R&D investments, high supply chain and manufacturing transition costs stemming from tariff mitigation efforts, and operational inefficiencies from stronger than anticipated growth. Vertiv said it expects these factors to resolve by year-end. 
• GAAP net margin was 12.3%, up 3.2 points YoY and 4.2 points QoQ. Adjusted net margin was 14.1%, up 0.9 points YoY and 1.8 points QoQ. 

For Q3 to see slight margin inflection from disappointing Q2 margins: 

• GAAP operating margin was guided to be 18.2% at midpoint, up 0.3 points YoY and 1.4 points QoQ. 
• Adjusted operating margin was guided to be 19.75% to 20.25%, or approximately flat YoY and up 1.5 points QoQ at the 20% midpoint. Vertiv said the QoQ improvement will stem from moderating operational inefficiencies. 
• GAAP net margin was guided to be 13.1%, up 4.6 points YoY and 0.8 points QoQ. Adjusted net margin was guided to be 14.9% at midpoint, up less than 1 point YoY and QoQ. 

Q4 to see a return to higher margins: 

• GAAP operating margin was guided to be 22%, up 2.5 points YoY and 3.8 points QoQ.  
• Adjusted operating margin was guided to be 23.6% at midpoint, up 3 points YoY and 3.6 points QoQ. 
• GAAP net margin was guided to be 15.8% at midpoint, up 9.5 points YoY and 2.5 points QoQ. Adjusted net margin was guided to be 17.4%, up 1 point YoY and 2.5 points QoQ. 

Should Q4 margin guidance materialize … 

It’s important to note that if the Q4 margin guidance materializes, then Vertiv will be reporting the best margins since going public in 2020. This is visible in the adjusted operating margin chart listed above. 

The proverbial “seeing the forest through the trees” is that Q2 was weaker than expected yet Vertiv’s management is guiding quite strong as we exit the year. 

FY25 Margins to see impact from tariffs and operational inefficiencies: 

• GAAP operating margin was guided to be 18.1% at midpoint, up 1 point YoY.  
• Adjusted operating margin was lowered slightly to 19.7% to 20.3%, or 20% at midpoint, down half a point from its Q1 guidance for 19.75%-21.25%, or 20.5% at midpoint. This reflects the operational inefficiencies from tariff mitigation, accelerated R&D investments and capacity expansion efforts. 
• GAAP net margin was guided to be 12.6%, up 6.4 points YoY. Adjusted net margin was 14.8%, up 1 point YoY. 

EPS growth exceeded revenue growth at 42% 

While adjusted EPS growth was rather robust in Q2, growth is expected to the mid 20% level by Q4, mirroring revenue growth. 

• Q2 adjusted EPS of $0.95 beat estimates for $0.84, increasing 41.8% YoY. GAAP EPS of $0.83 beat estimates for $0.71. 
• Q3 adjusted EPS was guided at $0.94 to $1.00, or up 28% YoY at the $0.97 midpoint. This was marginally ahead of estimates for $0.96. 
• Q4 adjusted EPS was guided at $1.23 at midpoint, up 24.2% YoY and ahead of estimates for $1.14. 

For FY25, Vertiv boosted its adjusted EPS outlook from $3.55 to $3.80 at midpoint, pointing to YoY growth of 33%. Heading into Q2’s report, FY26 growth was projected at 23%, though this may be revised higher given the improvement in net margin through year-end.   

Cash Flows and Balance Sheet 

Cash flow margins dipped slightly sequentially, and remain lower than last year. However, Vertiv also boosted its FY25 adjusted free cash flow guidance by $100 million this quarter. 

The company offered the following commentary regarding cash flows being lumpy but directionally positive: 

“And finally, on this page, adjusted free cash flow was down $60 million from last year's second quarter, primarily due to favorable trade working capital timing last year. But year-to-date adjusted free cash flow is up 24%. And as you will see in a few slides, we are raising our full year guidance by $100 million to $1.4 billion. In short, you can likely check the box on free cash flow.” 

• Operating cash flow was $322.9 million in Q2 for a 12.2% margin, down more than 7 points YoY and nearly 3 points QoQ. 
• Adjusted free cash flow was $277 million in Q2 for a 10.5% margin, down more than 6.5 points YoY and 2.5 points QoQ. For FY25, Vertiv guided for $1.375 to $1.40 billion in adjusted FCF, up from its prior view for $1.25 to $1.35 billion. This implies that Vertiv is expecting ~$859 million in adjusted FCF in 2H to reach the midpoint of its guide. 
• Cash and equivalents rose to $1.74 billion, while debt remained steady at $2.9 billion. Net leverage was 0.6x in Q2, versus 0.8x in Q1. 

Earnings Q&A: 

Weak Q2 margins set to significantly rebound by Q4 

Vertiv’s margins fall into the “fair” category when compared with other AI hardware peers. Across the sector, we see a wide spectrum — Nvidia and Broadcom deliver “excellent” margins, while Dell and Supermicro are at the “weak” end. Vertiv consistently sits in the middle: not low enough to be concerning, but not high enough to command a premium valuation.  

For AI hardware investors, it’s important to recognize that earnings reactions are often driven more by margins than by top-line growth—a sharp contrast to hypergrowth and software stocks, where revenue acceleration tends to be the primary catalyst. 

Starting in 2023, Vertiv began a period of critical margin expansion, as the company had a negative GAAP operating margin in 2022 prior to the AI boom. The GAAP operating margin was 17% in the last quarter, up from 14.5% last quarter – yet the margins were flat from the year ago quarter and down from 19.5% in Q4. 

The CEO offered more color regarding margins, stating the executional challenges were primarily in the EMEA region: “The temporary costs of the supply chain and manufacturing transition to tariff-optimized footprint are higher than we initially estimated. We're also experiencing some temporary costs to deliver a steeper growth than expected and some executional challenges in EMEA. We expect all these factors will significantly moderate during the year, and we believe they will be materially resolved by year-end.” 

He also concluded the call stating: “We are vigorously addressing the temporary margin challenges. This has my and my team's full attention. I'm confident we will see constant improvement.” 

Quite a few analysts asked about margins during the Q&A, showing how nervous analysts can get about this line item even when management guides for healthy margins by year-end. Of the many questions on margins, the following Q&A exchange stood out as it discusses why management has confidence margins can expand into H2.  

Nicole Sheree DeBlase, Deutsche Bank  

I just had a question on margin. So the guidance implies like a 10 basis points year-on-year decline in margins in the third quarter, and then a pretty big step-up to like over 200 basis points of expansion in the fourth quarter. So probably a question for David. But can we kind of walk through some of the puts and takes that give you guys confidence in that step-up?  

David J. Fallon, CFO: 

Yes. I think it's 2 things, Nicole. Number one is the benefit of operational leverage. And you can get our exact Q4 numbers in the appendix, but there's over $200 million increase in sales expected in Q4 versus Q3. So that definitely provides the benefits of operational leverage.  

And the other bucket is simply addressing the operational inefficiencies and execution challenges that we've seen in Q2 into Q3. Once again, we believe all of these should be resolved in Q4. So it may be oversimplifying things, but I think those are the 2 buckets that drive the improvement from Q3 to Q4.” 

New Reporting Metric Starting in Q4 

Vertiv will no longer report on quarterly orders and backlog information, and instead will report a new metric “projected full year orders.” 

The following was stated on the call: “Beginning on our Q4 and full year 2025 earnings call, we will provide projected full year orders rather than quarterly orders and backlog information. We believe this better aligns with how we run our business. We will provide updates on the full year projections quarterly as we progress through the year and as we deem necessary.” 

This could create a boost to Vertiv’s stock to remove the lumpiness from quarterly reports and to also be more forward looking in terms of visibility offered to investors. 

AWS announcement sent shares tumbling in early July 

Recently, an announcement that AWS is pursuing their own thermal management solutions caused weak price actionin the stock.  

Management used the words “co-engineering” when asked about the announcement, implying they stand to profit regardless of how each hyperscaler uniquely approaches cooling solutions. 

“So I don't think there should be any scare. This is not an anomaly in the way the market works. And we are here to scale with our hyperscale customers. We are here to co-engineer with them.” 

Great Lakes Acquisition  

Vertiv’s is acquiring Great Lakes Data Racks & Cabinetsfor $200 million for its portfolio of high-end rack solutions, including custom racks, integrated cabinets, heavy-duty designs, and advanced cable-management systems. The acquisition will help Vertiv to deliver AI-ready solutions to hyperscalers and neoclouds. According to Vertiv, they are paying 11.5X projected 2026 EBITDA.  

Perhaps most importantly, the deal will be able to increase Vertiv’s capacity quite quickly: 

“With manufacturing and assembly facilities in the U.S. and Europe, we anticipate Great Lakes will enhance our ability to serve customers with speed and scale.” 

The deal is expected to close in Q3. Vertiv has $1.7B in cash on its balance sheet and $2.9B in debt. 

DCD Modular AI Infrastructure 

In a previous analysis we pointed toward AI factories as a catalyst for Vertiv: 

“Prefabricated infrastructure where the thermal management and power specialists assemble the infrastructure could become a path to faster, more successful deployments.  

Per Vertiv’s comments: “Now let me share some exciting news about our projects with iGenius. Here, NVIDIA and Vertiv are delivering a fully prefabricated AI factory. This is a very important sovereign AI supercomputer and we provide everything infrastructure from liquid cooling to heat rejection, grid to chip power in a very rapidly deployable modular infrastructure. All leveraging our NVIDIA codeveloped AI reference designs. What makes this truly special is how it brings together all our core Vertiv strengths. Our ability to deliver complex solutions at scale, our deep technical expertise and our commitment to innovation. We're not just providing infrastructure, we are enabling iGenius to deploy advanced AI models in a highly regulated industry.”  

Often times, CEOs use earnings calls as a marketing tactic and it can be difficult to sort through dozens of product releases to identify which ones are important catalysts. I believe the iGenius deployment will (in time) prove to be an important deployment for Vertiv – perhaps the largest catalyst ever for the company – as it transitions Vertiv from being a solutions supplier to building end-to-end modular infrastructure with substantial cross-sell opportunities. These modular AI factories also serve the massive market of sovereign AI by reducing the dependency on cloud providers such as Amazon, Google or Microsoft.” 

DCD stands for data center dynamics and refers to modular infrastructure that is desirable for its rapid and efficient data center buildouts. The pre-engineered and factory-built modules offer power, cooling and IT equipment that can be deployed much faster than traditional data centers. 

In this earnings report, the CEO discussed DCD modular AI infrastructure, stating: “That is certainly a trend that we see. We know that the industry needs speed, and speed in construction is paramount, full success for our customers. But also, as I said several times, this is a construction industry. And if you have to build very, very complex systems like data centers, on site, at speed, then there certainly are challenges, shortages, manpower, skilled labor shortages, and surely things can be done better in a prefabrication setup and mode.” 

For AI, where compute density and thermal loads are significantly higher, modular solutions are particularly ideal as they offer optimized power distribution, advanced liquid cooling integration, and scalable “white space” that can be expanded in phases without disrupting existing operations.  

Ultimately, this reduces deployment from years to months and positions Vertiv as a choice partner for the physical layer (power and cooling) for those that specialize in the logic layer (compute and networking). 

Conclusion: 

Given the margin improvement expected in Q4, Vertiv will likely see a second wind come H2 – especially if the top line holds a surprise or two as it did this past quarter with an 11% top line beat.  

Modular AI infrastructure continues to be a primary catalyst for Vertiv, and a viable path for the company to exceed the stated CAGR of 15% to 17% through 2029 (and potentially make its way into the I/O Fund’s portfolio).

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

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• Innodata: Early-Stage AI Data Engineering; Lumpy Growth

Innodata is a company that has lumpy growth yet is also centered in the surging trend of AI data engineering, known as data-as-a-service (DaaS) which offers curated and synthetic data to augment large language models (LLMs). Notably, the company is a small cap, high risk stock. 

Complex reasoning models require an expanded data set, such as dozens of foreign languages or multi-step problems within math and chemistry, for example. This is in contrast to a static data set, which often produces too many hallucinations and can be inaccurate at times. For example, if a Big Tech company only used its proprietary social data to train LLMs, this may not be broad enough to prevent hallucinations since social data is limited in its context and scope. In many cases, additional data points are sought out to improve the accuracy of the model. 

In order to move toward general artificial intelligence (AGI), which is defined as AI models that think for themselves similar to a human, companies like Innodata are also tapped for their ability to augment accuracy through reinforcement learning and direct preference optimization, which utilizes subject matter experts to annotate data and to also stress-test the models for accuracy.  

Overview of Innodata’s Solutions: 

The problem Innodata aims to solve is to help generative AI improve its multimodal reasoning skills and to help the accuracy of agentic models. The definition of an agentic model is when the model is more proactive, has multi-layered memory for knowledge across sessions, and eventually will work across a multi-agent ecosystem with an orchestrator. Although very few enterprises use agentic models today, Big Tech and other enterprises rely on data solutions such as Innodata’s to build out the next level of complex problems that AI can solve. 

The CEO stated the following on the most recent earnings call in terms of the problem their solutions are aimed to solve: “As models grow more sophisticated, their performance hinges not just on raw computational power, but also on the breadth, depth and quality of the data they are trained on. Continuous data acquisition enables the models to better understand nuance, context, and intent across languages and domains.” 

Here is an overview of Innodata’s solutions and how they’re used: 

• Fine tuning is using curated and synthetic data to expand the list of tasks and subtasks to where Innodata offers hundreds of capabilities through its data sets, such as programming tasks (coding), content creation (emails, papers, checklists), logic and semantics (sentiment analysis), multi-modal reasoning (input from audio, visual and text for more nuanced comprehension), etc. The list is quite long as to how synthetic data can augment proprietary data.
• Model scoring, risk mitigation and red-teaming refers to stress-testing AI systems for vulnerabilities. It’s a common practice in cybersecurity that Innodata provides for generative AI models to help surface any biases or inaccuracies. Model scoring helps to rank a model compared to frontier models (i.e., your model is X% less accurate than Chat-GPT 4o).
• Reinforcement learning from human feedback (RLHF): Generative AI requires human feedback to spot inaccuracies with expert annotators to help LLMs reflect the complexity of human interactions. The company advertises that it has 5,000 subject matter experts located globally who oversee a reward model.
• Direct Preference Optimization (DPO) also uses feedback but is a more refined process due to optimizing models by assigning high probability or low probability to two outcomes. This offers a faster feedback loop as the model can more quickly learn from the higher probabilities to improve accuracy.  

Partnership with Nvidia’s NIM Microservices: 

Although very early stage and still in beta testing, Innodata announced a new platform at Nvidia’s GTC 2025 Conference. The company is partnering with Nvidia’s NIM microservices to help facilitate LLM development across enterprises. 

Nvidia’s NIM microservices is essentially an app store for LLMs, which offers foundation models, inference engines and APIs in out-of-the-box software containers for enterprises to easily build and deploy customized LLMs. Innodata helps by providing stress-testing and reinforcement learning/direct preference optimization to fine tune the models. 

Meta Invests $14.3 Billion into Scale AI 

Scale AI is a major competitor to Innodata that also annotates data with a global team of contractors. Scale AI was recently in the news following a $14.3 billion investment by Meta, which helps to underscore the importance of data engineering platforms and Data-as-a-Service (DaaS) for the purpose of fine-tuning large language models.  

Scale AI has a particular specialty in autonomous vehicles as the company helps companies like Waymo and Tesla label objects from lidar sensors and video frames. Reinforcement learning from human feedback (RLHF) — discussed above – is then used to improve the quality of the response. 

Following Meta’s investment, it was rumored that Google, OpenAI and Tesla are looking elsewhere to avoid strengthening Meta at the cost of their proprietary data. Although it’s speculative, the exodus of major players from Scale AI could become a tailwind for Innodata.  

While Innodata’s partnership with Nvidia is a boon, one reason that Innodata may struggle to capture the business is the company is vintage with an inception date in the 1980s. The other data labeling/tooling companies are native AI companies with API-first data pipelines. To contrast, Innodata has roots in legal, healthcare, publishing and PR content whereas these other companies were founded with natural language processing (NLP) in mind. 

For example, there are other private companies that stand to benefit as well, such as Labelbox, Appen (public company in Australia) and SuperAnnotate. From there, startups such as SnorkelAI also compete by relying on automated labeling, although it’s likely the workforce behind companies like Scale AI and Innodata is what's attractive to Big Tech given automation is an area where they lead. 

ScaleAI is valued at $29 billion compared to Innodata’s $1.5 billion market cap with last year’s reported revenue of $870 million last year. If we assume Scale AI is at $1 billion revenue now, that would be a 29X compared to Innodata’s 6X forward sales. 

Big Tech Seeking Data Quality as Differentiator  

If we read between the lines on the Meta $14B investment into Scale AI, then what we see is an emphasis on data quality as a key differentiator for frontier LLMs, such as Meta’s Llama, OpenAI’s Chat-GPT or even proprietary models for Waymo and Tesla’s autonomous vehicles. While we’ve heard companies like Palantir state LLMs will become commoditized, I will stick my neck out here to say I think Alex Karp is oversimplifying the quality of LLMs.  

Last month, I asked a question of Chat-GPT 4.1 about export licensing under the Trump Administration to help ascertain if a specific semiconductor was subject to export licensing due to manufacturing partners in Hong Kong and this was the response: 

Pictured above: Chat-GPT4o hallucination on simple, basic facts from a query dated May 20th, 2025 

Chat-GPT updates its training data about once per year with this example showing the limitations of lower quality data in terms of frequency of updates and/or limited resources for new data. 

As with all technologies, we are in the hype cycle for LLMs which precedes a period of mass consolidation. Meta knows it must be competitive on data quality, and clearly, its proprietary social data is not able to produce a broad level of intelligence in order to compete with a company like Google or OpenAI when comparing recent benchmarks  

Source: CapeStart 

Innodata’s Financials: Triple-Digit but Lumpy Growth; Anything Could Happen  

Innodata is a high beta stock with a $1.5B market cap and $241M estimated for fiscal year 2025 revenue. The company reported three consecutive quarters of triple-digit topline growth in Q1 with revenue rising 120.1% YoY to $58.3 million, marginally ahead of estimates for $57.6 million. Although revenue growth slowed by over 6 percentage points sequentially, it is expected to decline even more sharply in the coming quarters.  

For Q2, analyst estimates point to revenue growth decelerating nearly 50 points to the 73% range, before slowing to the low double-digits against peak growth comps. Management did not provide any quarterly guidance for Q2, though they maintained FY25 revenue growth guidance of 40% YoY, suggesting that with what management knew at the time of the earnings call, revenue growth is expected to follow this trajectory of a sharp back-half deceleration. 

However, it is important to keep in mind the fluid nature of Innodata’s business, and that any new contractual agreements or expansions could have a large and/or immediate impact on revenue. For example, in FY24 Innodata had originally guided for 20% YoY revenue growth, before raising that to >40% in Q1, then >60% in Q2 and ultimately to 88% to 92% YoY by Q3. Such a dynamic occurring again this year cannot be quickly written off, given that management is upfront about current engagements and prospective discussions with Big Tech customers. 

Customer Update: “Mag 7” and “Big Tech” Mentioned Repeatedly on ER Call 

Management provided a handful of updates on existing Big Tech customer expansions (which includes five of the Mag 7) and discussions with prospective customers in Q1. Keep in mind, the fiscal year revenue estimates right now are for $241 million yet discussions around SOWs present a strong case for Innodata exceeding this estimate as the year plays out: 

• Innodata signed a second statement-of-work (SOW) with its largest customer, which as of Q4, was contributing revenue at a $135 million annualized rate, up more than 22% in two quarters on new expansions in Q4 and January.  
• A Big Tech customer (noted to be one of the most valuable software companies in the world) was said to have a late-stage pipeline potentially valued up to “more than $25 million of bookings this year and continued growth over the next several years.” This customer began working with Innodata in Q2 ’24 and contributed just $0.4 million in revenue in FY24.  
• Another Big Tech customer recently signed one expansion deal and is expected to soon sign a second expansion, worth a combined $1.3 million in potential revenue. Management said there is another opportunity with this customer worth up to $6 million, and for comparison, the customer generated just $0.2 million in FY24. 
• Management said they signed a deal in Q1 with “one of the most highly regarded generative AI labs” worth $0.9 million, with expansion potential worth double that figure. 

To note, Innodata’s largest customer is by far its most important, as a $135 million annualized rate implies this customer is contributing nearly $34 million quarterly, or around 58% of Q1’s revenue. This is a rather significant customer concentration, in that any lost revenue from this customer would not easily be made up from others, as deal sizes touted by management in Q1 pale in comparison.  

With that said, the shakeup around Scale AI and the growing importance around data engineering, plus Innodata’s partnership with Nvidia would help level out the customer concentration by attracting more large customers.  

On the call, it was stated that Innodata is working on building 200 autonomous agents with its largest customer worth approximately $6 million at the onset: 

“With one of our smaller big tech relationships, one that I discussed a few minutes ago, we have begun a collaboration around both AI agent data set creation and AI agent building. The work we are hoping to kick off with them this quarter will involve creating approximately 200 conversational and autonomous agents across multiple domains.” 

Key Segments 

Innodata’s Digital Data Solutions (DDS) segment is the primary driver of this sharp growth acceleration and improvement in profitability in FY24 and FY25. The segment handles AI data preparation, labeling and annotation, AI training and related services.  

The Synodex segment transforms medical records into usable digital data for customers, while its Agility segment provides a platform for PR and communications professionals to target and distribute content to journalists and influencers globally. 

• DDS revenue in Q1 rose 158% YoY to $50.8 million, accounting for more than 87% of revenue. This marked the third consecutive quarter with revenue growth above 150% YoY. However, given that Innodata’s revenue is expected to decelerate sharply by Q4, it’s likely DDS is behind this as the core growth driver, and could see growth return to Q3 23’s levels.  

• Synodex revenue rose 7.6% YoY to $2.0 million, decelerating from 14.6% YoY growth in Q4. 
• Agility revenue rose 11.6% YoY to $5.5 million, decelerating from 24.9% YoY growth in Q1.  

GAAP Profitable with Adjusted EBITDA Growth of 236% 

Considering Innodata has a mere $58.3 million in estimated quarterly revenue, plus $241B in estimated annual revenue, the margin profile is quite impressive since most companies operate at a loss until they reach scale. 

Margins weakened slightly sequentially in Q1, though the rapid ramp of DDS revenue that really accelerated in Q2 has driven margins down the line much higher on a YoY basis. 

• Q1 GAAP gross margin was 39.9%, down 5.3 points sequentially but up 3.5 points YoY. Adjusted gross margin was 43.2%, up 1.8 points YoY. Innodata shared that it is targeting an adjusted gross margin of 40%, with this result being above expectations. 
• GAAP operating margin was 14.4%, down 4.8 points sequentially but up more than 9 points YoY. 
• GAAP net margin was 13.4%, down 4 points sequentially but up nearly 9.7 points YoY, benefiting from the increased operating leverage driven by improving DDS profitability. 

Innodata did not provide any clear guidance on Q2’s margins, though management noted that they plan to invest ~$2 million in Q2 to support the new SOW with its largest customer, which will occur ahead of associated revenue and thus impact margins.  

Turning to adjusted EBITDA, management forecast YoY growth for the metric, though it is not clear to which degree, given that there was no supporting commentary. Adjusted EBITDA for FY24 was $34.6 million for a 20.3% margin, with Q1’s 21.8% margin already positioning Innodata for growth. Adjusted EBITDA was up 236% YoY (although on small numbers). 

• DDS adjusted EBITDA was $11.5 million for a 22.7% margin. This marks a substantial improvement from the 11.0% margin a year ago. 
• Synodex adjusted EBITDA was $0.4 million for a 20.8% margin, down nearly 4 points from a 24.7% margin a year ago. 
• Agility adjusted EBITDA was nearly $0.8 million for a 13.7% margin, down nearly 10 points from a 23.3% margin a year ago. 

EPS 

Despite Q1 starting off with triple-digit topline growth and a rather strong >40% guide for FY25, EPS growth is expected to be negative this year. This is primarily due to two factors: a $5.9 million income tax benefit in Q3 and strong outperformance in margins in Q4.  

In Q1, Innodata reported $0.22 in GAAP EPS, ahead of estimates for $0.17 and representing growth of 633.3% YoY.  

However, for Q2, analysts are currently expecting EPS of $0.11, down (50%) sequentially, before ticking higher to $0.17 in Q3. This would be a decline of nearly (67%) YoY versus $0.51 in Q3 2024, due to the income tax benefit. Q4 is not expected to bring any relief, with current estimates pointing to a (38.5%) YoY decline to $0.19.  

For the entire year, Innodata is expected to report a (22.0%) YoY decline to $0.69, before rebounding 46.3% in FY26 to $1.02. 

Cash and Balance Sheet 

Cash flows have improved significantly as revenue ramped, allowing Innodata to add significant cash to its balance sheet through 2024. As a result, Innodata has a relatively healthy balance sheet with no debt and an undrawn $30 million credit facility. 

• Operating cash flow was $10.9 million for an 18.6% margin. This was lower than the 25.5% margin in the year ago quarter, with the strong print driven by a $3 million QoQ increase in deferred revenue. 
• Free cash flow was $8.5 million for a 14.6% margin. This was lower than the 20.5% margin from the year ago quarter due to the relatively stronger OCF. 
• Cash and equivalents on hand were $56.6 million, up from $46.9 million in Q4 and a substantial improvement from $19.0 million a year ago.  
• Debt remained zero, with Innodata still having access to its undrawn $30 million credit line should it need extra funding. 
• Deferred revenue was approximately flat QoQ at $8.03 million. 

Cash flow is a line item to watch as the company stated they plan to re-invest OCF and this could lead to debt or stock dilution: “Accordingly, we intend to reinvest a meaningful portion of our operating cash flow into product innovation, go-to-market expansion and talent acquisition, while still delivering adjusted EBITDA above our 2024 results.” 

Earnings Call:  

Largest Customer to be down 5% 

In the opening remarks, the CEO stated the largest customer would be down 5% going into the next quarter: “Inevitably, customer concentration can result in quarter-to-quarter volatility. For example, with our largest customer, we exited 2024 at an annualized revenue run rate of approximately $135 million. In Q1, we were running higher than this by about 5%, and in Q2, we anticipate that we could be lower by about 5%, but the customers' demand signals are updated continually and are highly dynamic.” 

An analyst asked about this in more detail during the Q&A when it was stated the new statement of work with the customer will provide “additional share of wallet that we can tap into.” Management is referring to 200 autonomous agents discussed above under the customer section, yet at the onset this is worth $6 million. 

Risks: 

There have been short reports on the company that led to a 30% drop in share price in one day. You can read the report from Wolfpack Research here   and a second short report from J Capital can be read here. These are worth a read for anyone seriously considering the stock. We utilize proper risk management in these cases, which includes a stop on the position – should we enter. We would also only buy on a breakout when technicals provide a green light.  

One of the primary risks to Innodata’s revenue acceleration and growth trajectory is We’ve already seen one large customer termination with Innodata, though that was attributed to Musk’s publicized take-over of xAI (Innodata said this customer “dramatically cut spending after a significant and highly publicized management change” in 2022). There is no guarantee that customer spend with Innodata will expand beyond the scope of the current deals, though the view that a majority of the Magnificent 7 are rapidly adopting generative AI products and will spend hundreds of millions on generative AI and LLM development over the next few years bodes well for future growth, both in terms of expanding the scope of deals and landing deals with new customers.  

Another risk presents itself in the volatile swings in share price that Innodata sees – as a small cap, it’s much more likely to see these substantial moves in such a brief period. For example, there have been multiple weeks and many days in which Innodata has seen moves in excess of +/- 10%. This level of volatility is not typically seen with large or mega-cap stocks and requires prudent risk management. Institutional ownership is also relatively low for a high-beta AI small cap at just 36%.

Conclusion: 

The takeaway is that as LLMs continue to fiercely compete, companies like Innodata will become force extenders in the race for more accurate and reliable output. Although Innodata has many competitors, consider that Meta’s investment into Scale AI is 14X larger than its acquisition of Instagram at $1 billon, which puts into perspective the importance of data quality for Big Tech companies. 

In the closing remarks, the CEO stated “we believe our business right now is on fire. The growth we're seeing year-over-year is just the beginning. What's happening now inside the Company is really like or unlike anything we've seen before.”  

Investors will have to get comfortable with early-stage tech given Innodata’s new product-market fit is very early stage. Scale AI provides a decent comp in terms of the value of a strong AI data engineering company. Innodata’s solutions will be put to the test now that Scale AI customers will be unwinding their partnerships. Anything could happen. If we were to enter, it would be with a tight stop, and we would raise our stop as the stock price increases. 

For stock setups including a potential entry price for Innodata, consider upgrading to our Advanced tier with real-time trade alerts and weekly webinars held on Thursdays at 4:30 p.m. EST. To receive $100 off our Advanced tier use ADVANCED100 or click here and email your request to upgrade.ADVANCED100 or click here and email your request to upgrade.

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

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• TSS Inc. is an AI systems integrator partnered with a large U.S.-based OEM generating 99% of their 2024 revenue, presumably Dell Technologies for AI-enabled rack construction and integration. 
• TSSI’s revenue grew 523% to $99 million and adjusted EBTIDA grew 11X from $0.48 million to $5.2 million. Management's outlook indicates H1 2025 revenue will exceed H2 2024, with projected 50%+ year-over-year growth in Adjusted EBITDA for 2025.  
• TSSI stock surged from $0.24 to $14.49 in just over a year as it uplisted to the NASDAQ. The stock then cratered to as low as $6.24 during the tariff rout. Following its earnings report last week, the stock popped 70% — helping to illustrate the $300M market cap stock can be a wild ride.  
• TSSI more than doubled its headcount in 2024 and is doubling the size of its factory and headquarters as it moves into a 212,793-square-foot building in Q1 2025 to handle the extra capacity needed for its multi-year contract with its OEM partner (Dell Technologies) with guaranteed minimums. 
• There is speculation that TSSI is working on Elon Musk’s xAI Colossus supercomputer project through Dell Technologies, but the company won’t comment for the sake of confidentiality.    
• RISK: TSSI stock has a tiny 13 million share float and 25 million shares outstanding, which is at a high risk of material dilution as the company filed a $150 million shelf registration on January 7, 2025.    
• RISK: TSSI has no analyst coverage and 11.08% institutional ownership as of March 27, 2025, 
• RISK: Similar to crypto, TSSI requires technical analysis to be at the forefront of all buying and selling decisions. This stock is for advanced day traders who are comfortable with managing stocks daily due to high customer concentration and other notable risks.

The name TSS is an acronym for Total Site Solutions, which describes the nature of their business. The Texas-based distributor/reseller provides on-site installation, integration, deployment and confirmation services for data centers. Currently, the company is the partner of choice for Dell’s Integrated Rack Scalable Solutions business (IRSS). 

TSS is situated in the sweet spot of the AI boom, helping customers build out their AI infrastructure. As Blackwell begins to ship in 2025, the complexity of the systems means that OEM companies like Dell and large AI companies like xAI will need assistance in integrating server racks, which includes sourcing components, assembling and integrating the racks, making sure the power needs are well balanced between liquid cooling and air cooling, and lastly, testing these systems and providing site surveys. All of this falls right into TSS's wheelhouse. 

Company Background and Strategic Transformation (2019–Present)

Historically TSSI provided various data center solutions (integration, facilities management, and procurement of IT hardware), but they struggled to grow in any meaningful way. Gross profits increased from $7.21M in 2016 to $8.91M by 2022. The stock was around $.30 per share starting 2024 and had barely changed price since 2016.

In late 2022, TSSI began a major transition as Darryll Dewan became CEO and immediately focused on the high-value systems integration business. He was formerly a VP of global sales and marketing at Dell. Gross profits surged, with each quarter of 2024 seeing gross profit growth of 58.1%, 40.7%, 178.0%, and 122.9% YoY. 

 By the end of 2024 revenues reached $148M (up 172% YoY), gross profits reached $22M (up 100% YoY) and net income was $6M (versus essentially breakeven in 2023), all marking record highs for the company.

On November 14th 2024 TSSI announced a record 3Q and a multi-year agreement with their only customer, Dell. To support the multi-year agreement and Dell’s end market demand for AI servers, TSSI doubled its production footprint – relocating from its ~105,000 sq ft Round Rock facility to a new ~212,793 sq ft state-of-the-art integration center in Georgetown, TX (a 103% increase in space). Part of the agreement with Dell effectively guarantees that TSSI will at a minimum break even on the new expansion investment.  

The new site offers a massive upgrade in power and cooling infrastructure to handle next-generation racks that will consume up to 6x more power than prior generations. TSSI invested ~$25–30 M in this build-out to future-proof its operations with liquid cooling test stations, heavy-duty flooring and lifts, and redundant power – all aimed at meeting the demands of AI racks at scale. 

Management expects initial production in the new Georgetown facility by April 2025 and full production capacity by June 2025. The challenge and opportunity now will be scaling efficiently and executing to maintain their competitive position. 

Due to the AI-fueled transformation TSSI underwent last year, the stock surged over 5000% from Jan 1st 2024 at $0.30 per share through its peak on Jan 23rd, 2025 at $15.22 per share before falling to $6.24 in April. 

Background on Dell’s Rack Scale Solutions 

Dell’s Integrated Rack Scale Solutions (IRSS) multi-year agreement essentially makes TSSI an extension of Dell’s manufacturing operations for AI servers. This is the primary driver to TSSI’s remarkable gross profit inflection in 2024. Thus, it is important to look more closely at TSSI's 99% customer. 

Dell customers include tier 2 CSP’s like CoreWeave or Denvr Dataworks, the federal government, and large enterprises looking to build out on-prem data centers. Dell is not exposed to the traditional hyperscalers and so the growth forecast is not as correlated to hyperscale capex – although this could change and likely will given the rumors that Dell is working with xAI and also considering Super Micro may struggle to raise cash to quickly increase capacity (whereas Dell has operated at scale for decades). 

Hyperscalers tend to do business for more customized AI server solutions rather than the turnkey solutions that Dell provides. Hyperscale vendors include companies like Taiwanese-based Quanta Computer or Wistron affiliate Wiwynn. However, it is interesting to consider the potential positive impact that tariffs may have on where hyperscalers source their AI servers going forward. 

We still think that on-prem, tier-2 CSP’s and the federal government will drive a significant growth inflection for Dell’s AI server business in the near-term and durably grow for the foreseeable future. Dell’s calendar 2025 sales run rate is already trending to 50% YoY growth and 2x’d sequentially throughout FY2025. As such Dell’s AI server revenue could reach $20–30B by 2027, a ~40% CAGR from 2024 ($9B in AI server related sales). 

While this multi-year agreement significantly reduces the uncertainty of TSSI’s future profits and revenue, the agreement can be terminated for convenience, meaning any party can opt out provided with 180 days written notice. Furthermore, if Dell terminates, Dell is no longer obligated to provide the minimum monthly volumes after the 180-day notice period, but they remain financially obligated to cover some of the costs associated with the Georgetown facility investment. In our view, the Dell agreement also comes with other limitations.  

For one, it is unlikely that TSSI will have much negotiating leverage to increase prices. While they are investing in a new and upgraded facility, the reported $25-$30 million investment is a rounding error for companies like Dell or other large VAR’s/Distributors; hardly considered a barrier to entry given the cost and caliber of labor needed to assemble servers.

At the expiration of the multi-year agreement, there is a chance Dell does not renew or goes with another vendor. The investment provides TSSI some near-term advantages, yet the competitive positioning of TSSI is minimal.  

SNX located in Taiwan is a significant competitor, for example, with $58.5 billion in annual revenue. The Hyve business has a large, global footprint that competes with TSSI. Perhaps Dell initiated an investment in TSSI to further localize systems integrations and procurement well ahead of tariffs (time will tell). 

Dell to See Calendar Year H2 2025 Ramp: 

The IOF Fund article, “Dell Q4: Projects $15 billion in AI shipments this year”, Dell Q4: Projects $15 billion in AI shipments this year”, noted that Dell’s FQ1 2026 (ending May 2, 2025) revenue guidance missed consensus analyst estimates by 3% and EPS guidance of $1.65 missed analyst estimates for $1.78. In its FQ4 2025 (ending January 31, 2025 calendar year), Dell shipped $2.1 billion in AI servers (down 28% QoQ), with orders at $1.7 billion (down 53% QoQ) and a backlog of $4.1 billion. 

Management guided AI shipments of $15 billion in FY F2026 as AI server backlog doubled to $9 billion in FQ4, primarily driven by recent deals, including xAI. Management’s $15 billion FY F2026 shipments guidance implies the NVL delays will make it a second-half story for AI ramp-up:

“Where Dell and Super Micro may both be seeing lower growth than expected likely goes back to the delivery of key Nvidia systems, where the larger systems lead to higher revenue (and you’re aware by now these were delayed by “couple months”). It’s also perhaps due to Nvidia’s partnership with Foxconn, who has seen more news lately than peers Dell and Supermicro in terms of shipping Blackwell systems. According to a news report from Economic Daily the GB200 was shipped by Foxconn in small quantities at the end of Dec and is expected to be shipped in large quantities at the end of January.”were delayed by “couple months”). It’s also perhaps due to Nvidia’s partnership with Foxconn, who has seen more news lately than peers Dell and Supermicro in terms of shipping Blackwell systems. According to a news report from Economic Daily the GB200 was shipped by Foxconn in small quantities at the end of Dec and is expected to be shipped in large quantities at the end of January.”

Across the board, key Nvidia suppliers like Dell should see a strong ramp into the second half of the year, with this flowing down to TSSI, especially as projects ramp in size (such as xAI’s Colossus). 

Elon Musk’s xAI Supercomputer Project  

TSS CEO Darryll Dewan, formerly VP of Global Sales and Field Marketing at Dell from 2012 to 2022, commented in the Q2 2024 conference call, “Demand increased in Q2, and we began delivering complex AI integration solutions on time, and I want to stress, on time, including the first stage of a highly publicized program. That initial program began in June and is being carried out into Q3 [2024]. As a result, we finished a quarter with a record run rate of rack integration revenue.” Dewan stated that the volume ramp they had been anticipating was underway, and its Q2 results were a harbinger of things to come. Dewan also would not confirm during the Q&A session when asked directly if xAI was one of their projects.

The “highly publicized program” is speculated to be Elon Musk’s xAI supercomputer “Colossus” project. The xAI data center houses 100,000 GPUs comprised of over 1,500 racks and received approval for 150MW of power, enabling all GPUs to run concurrently.  

Dell Technologies is Involved in Assembling Half of xAI’s Racks 

Musk already revealed in June that Dell Technologies is assembling half of the racks going into the supercomputer project and Super Micro Computer would also be involved. It's been speculated Elon Musk shifted $6 billion in AI server orders for xAI to Dell Technologies and away from Super Micro Computer due to their accounting issues. This trickles down to TSS. 

Musk had also announced the expansion of Colossus to 200,000 GPUs in October, and there is growing speculation at the moment that xAI is currently exploring a fundraise of tens of billions of dollars for the buildout of “Colossus 2’, which is rumored to include as many as 1 million GPUs, or 10x the size of the original Colossus supercomputer.  In February, it was rumored that Dell had won a $5 billion AI server deal with xAI for Nvidia’s GB200 platform, though it is unclear whether this is for Colossus or Colossus 2.

TSS’s Q3 2024 is assumed to have contained a whole quarter’s worth of xAI business, which could be a sign of things to come. As Dell’s AI Factory server business ramps up, so does TSS’s business, as evidenced by Dewan’s statement, “Volume expectations are dependent on sales execution by our OEM partner, but our partner has shown great confidence in TSS by committing to help to smooth what otherwise could be a feast or famine business.” 

Upgraded Headquarters to New Site: 

Similar to other AI-driven companies, TSS insists it does not have demand issues. Rather, it's a question of how quickly capacity can be added, with TSS upgrading its facilities for AI rack integration services. TSSI expects the new facility to reach full production capacity in June 2025. 

On January 5, 2025, TSS announced it signed a long-term lease for a larger facility with 212,793 square feet, essentially doubling its earlier space, which was 105,000 square feet. TSS is moving its headquarters to the new factory located in Georgetown Logistics Park in Georgetown, Texas, which will be online in Q1 2025. In the six months leading up to its August 14, 2024, conference call, CEO Dewan confirmed they have more than doubled their headcount. 

The company has stated site plans call for a $25 million to $30 million investment for improvements to bring additional power to the building which will provide greatly expanded cooling capacity for its rack testing and validation stations. It will triple the capacity to test and validate direct liquid-cooled racks in addition to traditional air-cooled racks. There is no doubt the industry is migrating to liquid-cooled rack technology.

CEO Dewan commented, "Continuing our rapid growth trajectory was centered around two key drivers: signing a long-term agreement with our primary customer, which we completed and announced in October, and building capacity to deliver the demand driven by AI infrastructure needs in the market. Our new facility more than doubles our square footage and positions TSS to continue our rapid growth. We are beginning the required fit-out immediately and expect to be operational in the new building in the first quarter of 2025." Management updated in Q1 that the buildout was progressing according to its plan, and that the built-out capacity was higher than current demand, allowing them to scale higher in the future.

When asked if capacity is a limiting factor, the management team stated they “…have the capacity to grow 10X” and “so, the timeline, a couple of years may be before we start to get a little tight.” That is music to an investor’s ears, yet power requirements remain a constraint (and perhaps a tailwind for TSSI).  

The Role TSSI Plays in Increased Power Consumption of AI Data Centers 

The new facility building was originally planned for 4.5 MW but will now begin with 6 MW and 15 MW by early summer, and 40 MW over time. The 15 MW timeline for early summer was reiterated in Q1, with management noting this would be ~6x their current facility in Red Rock.  Just as with upgrading the power, the cooling situation also had to be upgraded. CEO Daryll Dewan said this in their Q4 2024 conference call.

“Cooling is in a similar situation. When we began the fit-out of our facility, it was anticipated we would integrate a mix of chilled air and direct liquid-cooled technology. However, the adoption of emerging chip families so quickly has resulted in an accelerated shift to direct liquid-cooled. This impacts everything from our chiller capacity to the diameter of the pipes coming into the facility and distributing water within the facility. And again, this rethinking has all occurred in weeks.”

AI is causing an unprecedented surge in power density at data centers with current AI racks pushing 80 kW, moving to 120 to 150 kW, and eventually 200 kW in the next few years. The I/O Fund has covered the generational leap in power consumption in our blog article, ”AI Power Consumption: Rapidly Becoming Mission-CriticalAI Power Consumption: Rapidly Becoming Mission-Critical.”

Rapid increases in power requirements not only create potential failures and raise costs but there is also the challenge of increasing compute density in data centers. TSS is positioned to help customers make nimble, on-the-fly architecture changes, including cooling options, thanks to its rapid testing capabilities, which can narrow configuration options. CEO Dewan stated in its Q2 2024 conference call, “But importantly, the next generation of racks will consume up to 6x more power than those being produced today.”

Note on Modular Data Centers: 

Modular data center revenue grew 13% in 2024. In addition to integrating a combination of air-cooled and liquid-cooled racks, TSS has also configured and deployed over 350 modular data centers (MDCs), which are pre-fabricated and scalable portable data centers. Due to the long lead times to build and deliver specialized data centers, the demand for MDCs is expected to grow as AI adoption grows. These carry gross margins north of 50% and grew 13% YoY in 2024, as it’s a predictable revenue stream.

Here is what was stated in the earnings call:

“We're also very excited about some of the conversations we're having about different design points on the modular unit. I'd like to go into a little bit more detail, but I don't think it'd be appropriate. But I think where we can provide an AI solution to an enterprise to deploy a certain amount of power cheaper, better, faster than their alternative. And that alternative could be a co-lo, could be a hyperscaler, could be expanding their own existing data center space.” 

Financials Overview: Revenues Accelerate in Q1

Q1 revenue nearly broke into the triple-digits as it accelerated significantly from Q4’s 105% YoY growth to 523% YoY growth. This was driven primarily by Procurement revenue, which rose nearly 7x YoY, while management stated that there was incremental contributions from AI rack integration services. This is only the third full quarter of contribution from AI rack integration services after commencing this in June 2024.

While TSSI did not provide a guide for Q2, management stated that they expected 1H 2025 revenue to outpace 2H 2024, where they generated just over $120 million in revenue. As it stands, Q2 would need to have just $22 million in revenue to meet that forecast, though underlying business momentum suggests that is far too low.  

Key Segments

Here’s how TSSI’s revenue by segment looks, with the AI rack-driven System Integration segment beginning to perk up though Procurement revenues drive the bulk of TSSI’s revenue. 

Procurement Services Revenue Surges 676% 

This segment consists of sourcing and selling third-party hardware, software, and services to customers – effectively acting as a value-added reseller (VAR) or distributor. It is TSSI’s largest segment by revenue but lowest by margin. It is a very lumpy business due to seasonal spending trends by the federal government being 2H weighted, and not expected to be a major profitability driver for TSSI due to its thin margin profile. Management sees Procurement as a strategically important complement to Systems Integrations, as deals “often bundle or precede integration projects.”

Procurement is uniquely impacted by how deals are recognized, either as gross or net: a gross deal occurs when TSS takes ownership of the hardware as they transform the product and record the gross value of the transactions as well as the gross cost of the goods, resulting in higher gross revenue but lower gross margins between 3% to 4%. A net deal is when TSS acts only as an agent in buying and selling the product, as they only record the agency fee, resulting in a 100% margin. TSSI added that there was also a higher mix of gross deals in the quarter, which weighed on margins.

Procurement revenue accounted for more than 91% of revenue in Q1, as it surged 676% YoY to $90.2 million, aligning with management’s Q4 projection that revenue would remain elevated for 1 to 3 quarters. This was driven by increased purchases by the federal government, as well as a few individually large sales to commercial enterprises in the quarter to support AI workloads. Additionally, some, not all, of Procurement revenue flows through to Systems Integration as it relates to components needed for AI and non-AI server racks.  

Systems Integration Revenue Ramping 

Systems Integration (SI): This is TSSI’s flagship segment and growth engine, encompassing the design, assembly, and testing of integrated technology solutions – most notably high-performance computing racks for AI and other advanced workloads. This business involves taking servers, GPUs, networking gear, power/cooling components, and software, and building turnkey rack systems to customer specifications. It is a project-based, engineering-intensive service and carries higher margins. This segment functions similarly to a company like Super Micro in that TSS assembles servers and server racks as a vendor.

The higher-margin, AI rack focused System Integration segment is beginning to see growth ramp in the third quarter of AI rack integrations, operating currently at a ~$30 million annual run rate. This builds on strong growth from 2024, which saw segment gross profit rise 480% YoY on a 157% YoY increase in revenue.

Q1 revenue increased 252% YoY to $7.5 million, its third consecutive quarter of >200% YoY growth driven by AI rack integrations. TSSI says that it receives both fixed monthly fees as agreed upon in the multi-year agreement, as well as “payments that scale depending on the volume of AI racks integrated and for which we are prepared to integrate.” TSSI’s order pipeline from Dell remains “extremely robust.”

For the non-AI rack integration side, TSSI noted in the 10-Q that it may be impacted by supply chain issues or lulls in demand, impacting revenue as it waits for delivery of certain required components. TSSI said that its vendors and partners expect “supply-chain issues to continue for at least the next several quarters, though they appear to be improving in general.”

Management said in Q1’s call that they “expect sustained high growth in this area as customers ramp-up investments to meet evolving compute demands over the coming quarters and years,” with this segment expected to become the primary growth driver.

According to an internal model, by the end of 2027, SI could be roughly 63% of total gross profits, up from 15% of total gross profits in 2023. As a precaution, we’ve modeled 62M in revenue and 30M in gross profits in 2027 for the SI segment. This is at the low end of the 2-4x capacity comment and assuming a 1:1 relationship between volume and sales, but this forecast could have significant variability due to high customer concentration.

In this internal forecast, there is a degree of conservatism given the project-based nature of this business and the range management provided of 2-4x 2024 peak volume capacity. Dell is guaranteeing at least as much volume as TSSI’s peak quarterly run-rate in 2024 for the SI segment. For context, TSSI’s peak in 2024 was around Q4 when SI revenue hit $7.9M. Assuming that there is a 1:1 relationship between volumes and revenues, this could translate to a baseline of $31M in annual systems integration sales and $13M gross profits which is based on the 2H2024 run-rate.

As such, the incremental sales potential for SI is $62M–$124M in sales and $26M–$52M gross profits. Again, this is with what we know today, yet carries significant variability due to reliance on one OEM. 

Facility Management Revenue Declines 

This segment involves data center facilities services – including maintenance contracts, on-site support, and deploying modular data centers. It provides a steady, recurring revenue stream, and while it has high gross margins, it is not going to be the real driver of TSSI’s profitability inflection, which squarely falls onto the SI segment. It has grown in the 10% revenue range over the last several years. Modular data centers are important and they will grow in volume, but this segment is more of an indirect beneficiary of the AI boom. Furthermore. TSSI is not constructing these data centers, but rather maintaining them, fixing them, and monitoring them.

Facility management revenue declined (40%) YoY to $1.3 million, with management noting they are currently optimizing this unit to focus on high-growth opportunities. Facility management had grown just 13% YoY in FY24, a far cry from System Integrations’ 157% growth and Procurement’s 205% growth. 

Management added that they “anticipate more robust growth over the next 12 to 18 months” as medium and large enterprise customers “increasingly adopt modular data centers as a cost-effective solution to leverage AI technologies.” For 2025, we estimate $8.7 M (+9% YoY), assuming TSSI continues to win small expansions or projects. Management mentioned a couple of projects drove 46% growth in Q2 2024 facilities revenue, but on a normalized basis, mid-single digits is more in-line with their historical multi-year rate of growth. 

Margins Weighed Down by Procurement Growth 

TSSI has noted previously that margins are likely to fluctuate quarter-to-quarter as revenue mix shifts, and Q1’s heavy concentration of Procurement revenue with higher mix of gross deals weighed on gross margin, though operating margin felt less of an impact. This is because a portion of Procurement revenue flows through to the Integration segment, which carries far higher margins. 

Q1’s gross margin was 9.3% as a result of this mix shift, down more than 5 points sequentially and nearly 8 points YoY. 

• Procurement GAAP gross margin was 7.8%, flat YoY; on a non-GAAP basis, which strips out gross vs net deals, gross margin was 6.6%, up 2 points YoY. 
• Systems Integration gross margin was 22%, down 6 points YoY due to a $0.8 million rent expense for the new Georgetown facility; stripping out this noncash rent impact, gross margin was 32%. Management said that they expect gross margins in the segment to improve in the last three quarters in FY25. 
• Facility management gross margin was 41%, down 15 points YoY on lower revenue. 

Q1’s operating margin was 4.2%, down only 1.3 points QoQ and up 2.6 points YoY. Should Systems Integration begin to grow its share of revenue with margins growing, TSSI should theoretically see some gross and operating margin expansion as the year progresses. 

GAAP EPS Expanding 

Q1’s GAAP earnings were $0.12 per share,  surpassing Q3’s earnings of $0.10 despite a thinner margin profile this quarter. This was a notable improvement from the break-even quarter last Q1. 

There’s also a notable inflection in earnings power since the start of AI rack integrations in June 2024, with EPS over the past three quarters of $0.30, up 10x from $0.03 in the comparable period last year.  

Cash and Balance Sheet 

Cash flows have been quite variable, with Q3 2024 and Q1 2025 seeing large positive operating cash flow while Q4 saw a large outflow. 

• Operating cash flow was $20.6 million in Q1, up nearly 8x YoY and a stark contrast to the ($21.6) million outflow in Q4 2024. OCF margin was 20.9%, up more than 4 points from 16.7% a year ago. 
• Free cash flow was $5.8 million, up ~2.2x YoY and again a stark contrast to the ($28.4) million from Q4. FCF margin was 5.9%, down from 16.4% a year ago due to the rapid revenue growth. 
• Adjusted EBITDA was $5.2 million for a 5.3% margin in Q1, up from $0.5 million for a 3% margin in the year ago quarter. Management reiterated its view for >50% growth in adjusted EBITDA for 2025, signaling they expect at least $15.3 million this year.  
• Cash and equivalents totaled $27.3 million, while debt was $8.2 million. Debt is likely to be higher next quarter as TSSI said it drew down the remaining $11.3 million on its construction loan just prior to Q1’s call. 

Factoring Receivables is an Expensive Payday Loan Approach to Stabilize Cash Flow  

TSSI sells Dell’s invoices/receivables to a third-party factoring company at a slight discount and interest in exchange for immediate cash, similar to a payday loan. This is a common strategy to improve cash flow with large clients, the largest client in this case, with longer payment terms. It’s an expensive way to get paid sooner. TSSI sells Dell’s invoices to the factoring company at a small discount, and the factoring company immediately wires over cash to TSSI. Interest is applied to the wired funds until Dell pays off the invoice with the factoring company, which then wires the remaining balance back to TSSI.

In Q3, the net interest expense was exclusively the cost of factoring Dell’s accounts receivables, which has an effective interest rate of 6%, a lower rate than a bank loan. In Q4, factoring interest expense was $721,000, before more than doubling QoQ to $1.5 million in Q1. This continues to illustrate how vital Dell is to TSS’s future and the leverage it holds. 

Conclusion 

TSSI’s tie-ins with Dell and ramping AI server rack integrations as more production capacity comes online support strong revenue growth, and the company remains profitable despite high Procurement mix weighing on margins. While AI servers have the potential to drive meaningful growth for TSSI, the small float and market cap lead to increased volatility, requiring active management.

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