Category: AI Stocks

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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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.

Recommended Reading:

Seagate FQ3: Data Center Growth Accelerates to 12% QoQ, Mozaic4+ Ramping

Posted on by io-fund

There was a lot to like from Seagate’s FQ3 report, with the company reporting a material acceleration in Data Center growth, with QoQ growth stepping up from 5% in FQ2 to 12% this quarter. Pricing looked to improve this quarter with Seagate confirming a mid-single digit increase in revenue per TB this quarter, while strong demand trends and the Mozaic4+ ramp present tailwinds for pricing strength into 2027.  

Mozaic4+ began volume shipments at its first two hyperscale customers in March and is expected to see an aggressive ramp through the end of calendar 2026, expected to overtake Mozaic3’s share and drive HAMR to account for a majority of exabyte (EB) shipments. Pricing and margin leverage with the new generation will likely flow disproportionately to Seagate’s bottom line, driving EPS growth at >2X the rate of revenue through the end of FY27.  

Seagate believes that it is entering a period of structural growth with robust market demand, raising its longer-term annual growth forecast from the low to mid-teens to >20% over the next few years. This is underpinned by HDD’s strong value proposition of cost and energy efficiency at scale, with Seagate believing high-capacity HDDs will remain essential for data center architectures as inference, agentic AI and soon physical AI arise.  

Mozaic4+ Ramping to Majority of HAMR Shipments Exiting CY26 

Seagate provided some strong data points for its Mozaic HAMR drives this quarter, noting that it has shipped Mozaic drives to 75% of leading global cloud customers, and remains on track to complete its last two customer qualifications in FQ4 (the June quarter). 

Mozaic4+, providing capacities up to 44TB per drive, is now qualified with the two largest CSPs, with first revenue shipments beginning in March, meaning revenue contribution was likely minimal in this quarter and will become more pronounced through year-end.  

Management is expecting a “quite aggressive ramp” with Mozaic4+, projecting it to crossover Mozaic3 in share and become the majority of HAMR exabyte shipments exiting CY26. HAMR is also expected to reach 70% of nearline exabytes by the end of calendar 2027. These share and growth points are crucial as HAMR enables strong margin expansion as it scales, as Seagate can drive costs lower with Mozaic4+ with little change to its bill-of-materials vs Mozaic3: 

“Cost reduction was coming from mainly 2 items. One is for sure the mix going to higher capacity drives. And second was the full utilization of our manufacturing. When I look into the future, of course, now we are full. So that part maybe will not be so important in terms of cost reduction, but our mix change continued to be very fast. We are going faster than what we were thinking on the transition to HAMR. And now that we have second generation HAMR now, we have a very good increase in terabytes per unit. And of course, this is the driver, not adding more below material to the hard disk, which is the main driver for the future cost reduction.” 

Seagate also likely benefits from higher prices with Mozaic4+ (discussed in more detail in the Pricing section below), but there is also little risk to its ramp, leveraging the same number of disks and heads as Mozaic3. Thus, there is a multi-faceted growth opportunity arising with Mozaic4+ through calendar 2026 and 2027 – the potential to benefit from increased pricing power driving revenues higher, combined with a similar cost profile driving margins higher — disproportionally flowing to the bottom line. For example, current estimates through the end of FY27 (June 2027) project adjusted EPS to increase 45% to 98% YoY, growing at a minimum of >2X the rate of revenue growth each quarter.  

Seagate had also mentioned that it would leverage Mozaic4/5+ (4 to 5 TB per disk) to produce lower capacity products for enterprise data centers and edge IoT applications, though CEO William Mosley noted that “demand for Mozaic 4 at the high end is so high right now that as we look forward” that it may not be worthwhile to pursue 4+ at 20TB yet. Seagate will monitor this market over the coming three to four quarters for potential entry.  

Supply Allocated through CY27 

In our prior analysis for Discovery members in the first week of March, Seagate: Slow QoQ Data Center Growth, 2027 Capacity Under Discussions, we discussed how Seagate’s capacity for calendar 2026 was sold out and how the company was beginning to accept orders for calendar 2027 over the coming months. 

In fiscal Q3’s report, Seagate provided a critical update on this front, noting now that its nearline exabyte supply (ie. for data centers) is largely allocated through calendar 2027 with planning discussions already underway for capacity into calendar 2028 and beyond. Management clarified that they have exabyte-scale supply agreements with nearly all major cloud and hyperscale customers, with the vast majority of nearline capacity allocated through calendar 2027.  

Seagate is finalizing their build-to-order contracts for FY27, which management said enhances demand visibility by defining specific configurations and volumes for customers, along with pricing. This is quite a positive signal for the strength of demand for HDDs, considering just last quarter they had not yet started on CY2027 agreements. 

Considering Seagate is already largely sold out seven quarters in advance, analysts questioned if Seagate would shift to using pre-payments to secure supply, with reports suggesting this is already being implemented by NAND suppliers such as SanDisk and Phison. Seagate said it is not currently looking at pre-payment terms, rather focusing on shipment predictability and optimizing pricing as its new products ramp, but did not rule out pre-payments at some point in the future.  

Pricing Improves in Q3, Not Finalized for Build-to-Order Contracts 

Q3’s call featured quite a bit of prodding from analysts over pricing dynamics, considering only one quarter has passed and Seagate has now allocated a majority of its supply through 2027 and unit volumes are not growing. 

While Seagate emphasized multiple times that it will not be changing its pricing strategy and remain true to its promise of delivering predictable economics for customers, there were a few tidbits that hint that pricing will remain strong(er) moving through calendar 2026 and build off of Q3’s momentum.  

Management explained that they witnessed a mid-single digit YoY increase in revenue per TB in the quarter, and expect this trend to continue, while analysts such as Bernstein’s Mark Newman implied pricing per EB seemed to accelerate mid-single digits QoQ. This likely represents a few points of acceleration from last quarter’s pricing – we had noted in our Western Digital analysis that WDC saw prices up 2-3% QoQ per TB, while Seagate was likely closer to flat as data center revenue (up 5% QoQ) only marginally outpaced exabyte growth (up 4% QoQ).  

Seagate added that pricing will depend both on timing of when new contracts hit as well as product mix, such as customers shifting from one product to a newer one (ie Mozaic3 to Mozaic4+). This is the first clue that Seagate could have stronger pricing levers to pull moving through the rest of calendar 2026 and 2027, stemming from Mozaic4+. 

As noted above, Mozaic4+ only began revenue shipments in late March, meaning its impact on pricing was likely minimal; commentary for similar bill-of-materials and costs as Mozaic3 but improved margins and profitability mean the new generation will very likely carry a higher ASP. Thus, the rapid ramp of Mozaic4+ to overtake 3 and account for the majority of HAMR shipments suggests strong pricing tailwinds may arise each quarter through the end of CY26 and into CY27. 

On this note, JP Morgan’s Samik Chatterjee raised a tough question – “why shouldn't we see pricing maybe accelerate a bit as more new contracts come into play as you go through sort of end of 2026 into 2027, how should we think about pricing? And why should it sort of accelerate more as more new contracts come into the P&L from here on?” 

CEO William Mosley explained that the first way he thinks about pricing “is what is the true demand and I think the demand is rising to your point, further out in time as we roll out of one LTA and into the next, then the market demand dictates what the economics. We talked about this a little bit in the prepared remarks about when we set exact capacity configurations, what products are qualified with what customers and therefore, what price. As we've been rolling forward, though, we have the ability to [add] just a few more drives out of manufacturing or whatever. So we can always test what that demand is and the demand keeps going up. And so we're seeing what the market price, if you will, is.” 

CFO Gianluca Romano followed up by adding that Seagate is “confident in saying that we have a good opportunity to increase our profit and our revenue sequentially through the fiscal '27.” Combined, the two are essentially confirming that demand will be outpacing supply through CY27 and into CY28 (also evident within CY27 already being sold out), and that pricing power will hinge on demand. Remaining true to its stance of predictable economics means Seagate is not likely to price its customers out of the market, meaning there will not likely be 40-100% QoQ growth in prices such as what is being seen in SSDs, but that customers with the most urgent needs will likely pay more to secure supply in a tight environment.  

Morgan Stanley’s channel checks earlier this month already suggest that hyperscalers are leaning into that second point. MS revealed that major hyperscalers are approaching $20 per TB for purchases in 2027 and 2028, compared to current estimates for $13-15 per TB, which the firm says suggests contract negotiations “are starting 30% higher (or more) than current estimates and nearly 20% higher than the bull case.” If true, or even directionally correct, when these new contracts begin to layer in through 2027, there is potential for sequential revenue growth in the data center to remain robust from the pricing uplift.  

Analysts did poke on pricing per EB through the end of FY27 (June 2027) considering the EB-scale contracts mentioned, and if price per EB would be up low, mid or high-single digit YoY. Management said they do not guide that far ahead, but “every quarter, we'll be a little bit better and we expect revenue improvement. We expect profitability improvement. A big part of the profitability improvement is coming from pricing, but is also coming from the change in mix and the reduction costs that the 40 terabyte HAMR drive will give us.” This suggests that the ramp of Mozaic4+ over the next four to five quarters will keep pricing strength intact, especially if per TB negotiations do move ~33% higher from ~$15 to $20 for supply next year.  

Translating this over to Seagate’s Data Center segment, growth meaningfully accelerated this quarter, with the segment seeing 55% YoY and 12% QoQ growth to $2.5 billion, a 27 point acceleration from 28% YoY while QoQ growth accelerated 7 points. Nearline exabyte growth of 6% QoQ and 41% YoY suggests this acceleration was likely predominantly driven by pricing. 

Pricing tailwinds with Mozaic4+ share increasing through year-end, combined with the strong demand backdrop, supports strong data center growth moving forward. Assuming a similar ~80% revenue mix in FQ4, Data Center revenue would project out to 10.4% QoQ to $2.76 billion at the midpoint of the guide. At the high end of the guide at $3.55 billion, data center revenue projects to $2.84 billion, a slight acceleration to 13.6% QoQ.  

Inference, Agentic and Physical AI Tailwinds to HDDs 

In our WDC analysis, we covered some of the inference-based HDD demand drivers, such as multi-modal models requiring significantly large data sets to store queries and prompts, video generation, as well as autonomous vehicles and robotics needing extensive data sets to function in real-world situations. 

Seagate commented on these drivers in Q3, with management expecting demand to accelerate further as AI applications move to the physical world, from autonomous vehicles and robotics to manufacturing automation. Management said this is because physical AI deployments, such as AVs, generate massive data streams from sensors and cameras, such as a single AV producing up to 4TB per hour with compliance requiring data retention (storage) times of several years. When contextualizing this across a fleet such as Waymo’s in San Francisco spanning ~1,000 vehicles, data generated could reach as much as ~3 EB per month, or ~36 EB annualized (or ~5% of Seagate’s current TTM EB shipments).   

Management also commented on inference-based applications and agentic AI, noting that “inference-based applications are creating a growing need for both cloud and local storage,” and agentic AI’s need to reference large data sets to draw conclusions, or create new or unstructured data sets to work through is “where it's actually hitting the storage tiers fairly hard.” These future data and storage growth levers support Seagate’s mid-20% exabyte growth CAGR, similar to WDC’s >25% CAGR over the next five years.  

The challenge here is that unit volumes are not growing – Seagate explained that unit volumes are not increasing, and will likely not “unless we see a resurgence at the edge, and that may be over a long period of time.” This shifts the emphasis to pricing and economics per TB to drive growth.  

Seagate also double-clicked on the HDD versus NAND debate in future inference storage architectures (which we covered in both our prior Seagate and Western Digital analyses), as analysts questioned if the Data Center inflection stemmed from the rising cost differential between HDDs per gigabyte and NAND. Seagate emphasized that it does not see storage architectures changing much at all, and if “anything, because of the economics of what's going on right now, people are coming back to hard drives and saying, what more can you do? … And I see these architectures pretty sticky for a long, long time into the future.” 

Financials 

Revenue Accelerates to 44.1% YoY, Beats Estimates by 5% 

Seagate's Q3 FY2026 ending March revenue accelerated sharply to 44.1% YoY to $3.11 billion, up from 21.5% YoY in Q2, marking a meaningful step-up in the growth trajectory. The company’s revenue beat estimates by a solid 5%. On a sequential basis, revenue grew 10.2% QoQ and was the fourth consecutive quarter of sequential revenue growth, underscoring Seagate's strengthening position as a primary beneficiary of robust cloud and hyperscaler demand for high-capacity hard disk drives (HDDs); management noted that this quarter marked the tenth consecutive quarter of growth from cloud customers. 

For Q4 FY2026 ending June, management guided revenue of $3.45 billion at the midpoint, implying YoY growth of 41.2% and QoQ growth of 10.9%, beating analyst estimates by a wide 9.5% margin. Post-earnings, forward consensus estimates were revised meaningfully higher, with Q4 FY2026 estimates moving to $3.45 billion from $3.15 billion prior to earnings and for Q1 FY2027 to $3.57 billion, up 35.8% YoY. Full-year FY2026 revenue now stands at $12.01 billion, implying 32.1% YoY growth, up from 27.1% pre-report. 

Data Center Revenue Up 55% YoY, HAMR Ramp Gains Momentum 

Data Center revenue was the standout driver, coming in at $2.50 billion in Q3 FY2026, up 55% YoY and 12% QoQ — accelerating sharply from 28% YoY growth in FQ2. This segment represents approximately 80% of total revenue and continues to benefit from sustained hyperscaler capital expenditure, increasing data generation, and AI-driven storage demand. 

Data center shipments reached 175 exabytes in FQ3, up 47% YoY and 6% QoQ, continuing an uninterrupted ramp that has seen volumes rise from 120 exabytes in the same period last year. The ongoing qualification and ramp of Seagate's HAMR tech at major hyperscalers is emerging as a structural tailwind, enabling higher areal density and better economics per TB for cloud customers. 

Edge IoT revenue was $612 million in FQ3, up 12% YoY and 2% QoQ. While this segment remains a smaller contributor, it has witnessed a sequential growth compared to a seasonal decline in the same March quarter last year.  

Margins Continue Structural Expansion 

Seagate's margin profile continued its sharp multi-quarter expansion in Q3 FY2026, reflecting tight HDD supply-demand dynamics, favorable pricing, a richer product mix driven by HAMR, and meaningful operating leverage. Seagate noted that FQ3 saw records for both adjusted gross and operating margin.  

Gross margin reached 46.5% on a GAAP basis in Q3 FY2026, expanding 11.3 points YoY and 4.9 points QoQ.  For comparison, GAAP gross margin was only 23.4% in FY2024 ending June, underscoring the magnitude of the structural turnaround. 

Seagate also reported a 70% incremental gross margin in the quarter, above the 50% level management discussed at Analyst Day last May. Analysts questioned if this was driven by pricing or mix shift to HAMR, and if the 70% incremental margin is the right framework through FY27. CFO Gianluca Romano confirmed that pricing was a bit better and the mix shift to HAMR was a bit faster, but he does not “see a reason why we should not do the same in the future.” 

Operating margin improved 12.1 percentage points YoY to 32.1% primarily driven by operating leverage. Adjusted operating margin improved by 14 percentage points YoY to 37.5% and was better slightly better than the management guidance of mid-thirties percent range. Management guided Q4 FY2026 adjusted operating margin to be in the low-40% range, which would represent yet another step-change expansion. 

Net income grew by 120% YoY to $748 million or 24% of revenue compared to 15.7% in the same period last year. Adjusted net income grew by 129.5% YoY to $934 million with an adjusted net margin of 30% compared to 18.8% in the same period last year.  

Adj. EBITDA was $1.23 billion in FQ3 at a 39.6% margin, up from $563 million or 26.1% of revenue in the same period last year.  

Adjusted EPS grew by 116% 

FQ3 adjusted EPS grew by 115.8% YoY to $4.1 primarily driven by operating leverage, beating estimates by 16.6%. GAAP EPS grew by 108.3% YoY to $3.27 and was in-line with estimates. 

For Q4 FY2026, management guided adjusted EPS of $5.00 +/- $0.20, implying YoY growth of 93.1% and beating estimates by 25.9%. Post-earnings, full-year FY2026 adjusted EPS consensus has been revised to $14.90, up 84% YoY, compared to pre-report estimates of $13.17. FY2027 and FY2028 forward estimates have similarly moved higher, to $24.35, up 63.4% YoY and $34.76, up 42.7%, respectively. 

Cash Flow and Balance Sheet 

Cash flows improved in FQ3 driven by higher profits.  

FQ3 operating cash flow was $1.11 billion or 35.8% of revenue compared to $259 million or 12% of revenue in the same period last year.  

FQ3 free cash flow was $953 million or 30.6% margin compared to $216 million or 10% of revenue, representing a more than 4x YoY increase in free cash flows. On a trailing basis, Seagate has now generated $1.99 billion in FCF over the past three quarters alone (Q1–Q3 FY2026), compared to $818 million for all of FY2025. 

On the balance sheet, cash was $1.15 billion. Debt has been reduced aggressively from $5.7 billion in Q2 FY2025 to $3.9 billion in Q3 FY2026, a reduction of $1.8 billion in five quarters. In the recent quarter the company reduced $641 million of debt. 

The consistent adjusted EBITDA expansion and reduction of debt is also driving the company's net leverage ratio lower at a rapid pace — from 2.5x in Q2 FY2025 to just 0.7x in Q3 FY2026. 

Conclusion 

While HDD pricing continues to lag high-flying NAND and enterprise SSD prices despite tight supply and strong demand dynamics, there was more evidence arising this quarter that HDD pricing is getting more constructive and can remain stronger through the end of the year. Seagate and analysts noted that prices were up roughly mid-single digits both YoY and QoQ, with the upcoming ‘aggressive’ Mozaic4+ ramp likely aiding pricing through year-end as it ramps.  

Fundamentally, Seagate’s FQ3 was solid across the board, with Data Center revenue seeing a meaningful 27 point acceleration to 55% YoY while QoQ growth rebounded to 12%. Seagate noted that adjusted gross and operating margins both reached records while guiding for more expansion in Q4, and cash flows were robust with free cash flow up more than 4X YoY to surpass a 30% margin.  

Seagate also raised its longer-term annual growth forecast from the low to mid-teens to >20% over the next few years, despite unit growth remaining flat. This is supported by strong demand from hyperscalers supported by HDD’s value proposition of cost and energy efficiency at scale, including for upcoming drivers such as inference, agentic AI and physical AI.

Royston Roche and Damien Robbins, Equity Analysts at I/O Fund contributed to this analysis.

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

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Dell Sees AI Servers Doubling to $50B in 2026 

Posted on by io-fund

Dell reported some of the strongest AI revenue numbers in the industry last quarter with AI server revenue up 342% YoY to $9.0 billion, orders up 1,906% YoY to a record $34.1 billion and backlog up 177% QoQ to a record $43 billion. This strong AI momentum in Q4 is underpinning Dell’s FY27 guidance for AI server revenue to more than double to $50 billion, which management believes they can achieve while maintaining margins in the mid-single digits.  

Driven by this AI strength, Dell guided for revenue to accelerate nearly five points to 23.3% YoY to $140 billion, emphasizing that they have the supply to achieve this guide in full for the entire year, despite supply constraints facing the industry, notably in memory. Dell also noted that the demand picture remains robust, and more supply would leave potential for more growth.   

Below, we look into Dell’s AI server metrics, key risks ahead for growth and margins, and potential headwinds on the PC side. 

Robust AI Server Growth, Backlog up 949% YoY 

It’s hard to deny that Dell’s AI server guidance and key metrics were the strongest parts of its Q4 report, with the company guiding for just over 100% growth to $50 billion in AI server revenue this year and both orders and backlog up well over 100% QoQ. However, the predominant question for Dell’s stock is server margins, which Dell stated will be in the mid-single digits. 

Starting with backlog and orders, perhaps the top two metrics this quarter, it’s hard to understate the strength of demand that Dell is seeing. Orders rose 1,906% YoY and 177% QoQ to a record $34.1 billion in the quarter, driving backlog up 949% YoY and 134% QoQ to a record $43 billion.  

Dell clarified that the majority of the backlog consists of Grace Blackwell servers, while Vera Rubin is taking a larger share in its five-quarter pipeline but is not yet appearing in orders, likely due to the system timing in the second half of the year along with potential rumors of slight delays. Management also expects a smoother transition from Blackwell to Rubin, letting them ramp “with more velocity and speed” into calendar 2027. Here is what was stated: “So on the $43 billion backlog, Samik, it is predominantly overwhelmingly Grace Blackwell. There is no Vera Rubin [indiscernible] pipeline. The largest percentage of our 5-quarter pipeline is a combination of Grace Blackwell and Blackwell where we're seeing a rise in x86 Blackwell in the 5-quarter pipeline, driven primarily by enterprise deployment, air being the #1 consideration.” 

Importantly, Dell noted that the dollar value of their five-quarter AI server pipeline has never been larger, despite the robust order activity and $34 billion in orders received, highlighting the breadth of demand from enterprises, CSPs and sovereigns.  

While these both add a large layer of confidence in Dell’s $50 billion AI server revenue guidance for FY27, up 103% YoY, the question moving forward is, what does this mean for growth?   

While Dell did guide for Q1’s AI server revenue to be $13 billion, up 620% YoY and 45% QoQ (some of the strongest growth across AI at the moment), its full year guide says this will be its max quarterly run rate. Management had explained at Morgan Stanley’s TMT Conference after earnings that they have “committed to $13 billion of Q1, which is effectively $1 billion a week of shipments going out the door.” Annualizing that gives $52 billion, which suggests there will be minimal QoQ growth moving forward as the max run rate, or that they will be some degree of lumpiness, potentially tied to the upcoming transition from Blackwell to Rubin.  

There is also potential for orders to normalize lower moving through FY27 – Dell is likely quite capable of handling a high degree of orders, yet its backlog exiting Q4 already represents more than 85% of its AI server revenue guide, meaning continuous orders at this level ($10-30B) each quarter could cause its backlog to grow faster than it can get servers out the door. 

Dell also has made clear that there isn’t enough supply to meet the level of demand they see: “If we were to look at some of the demand asks that we would see from customers today and replicate that for a full 12 months, there isn't enough supply to fulfill that.” While Dell emphasized that it has the supply to satisfy its entire guidance for the year (not just Q1), some of the constraints that we see on the memory side in particular may make it increasingly difficult to ramp server revenue much higher. 

It’s Not Only About the AI Server Margins, but Also Storage 

As mentioned above, Dell’s story mainly circulates around AI server margins, which the company is aiming to maintain in the mid-single digit range. Regardless of where mid-single digit is for Dell (whether it’s 5% or 7%), the fact is that AI servers lag its broader ISG segment on operating margins and could present a larger headwind as its share of revenue increases. However, Dell is offsetting this server drag via storage, its highest margin business where growth has been strong and attach rates are rising.  

COO Jeff Clarke explained that Dell has “operated throughout the quarter and over the course of the year in that mid-single-digit operating income [for AI servers]. With what we see in front of us, there's no reason to change that. That is our guidance of where we can operate this business, and we're going to continue to grow it.”  Clarke emphasized again in a later question that Dell believes it can maintain mid-single digit margins while transitioning from Blackwell to Rubin, noting that the current $43 billion backlog “will ship at mid-single digits” as well.  

Looking more acutely at margins, Dell’s ISG segment operating margin was 14.8%, down 3.3 points YoY, with AI servers accounting for nearly 46% revenue share in the segment, up from less than 18% a year ago; Dell said pricing efforts allowed server margins to stabilize despite higher input costs.  

For the entire fiscal year, ISG operating margin was 11.7%, down 1.1 points, with AI servers accounting for 41% of revenue, up from 21%. Based on management’s guide for $50 billion in AI server revenue and ISG growth of mid-40%, AI servers could exit the year at ~57% of ISG revenue, potentially creating a larger margin overhang by next Q4; quick back-of-napkin math assuming a 6% AI server margin roughly projects ISG operating margin dropping as low as 9.7% in FY27 all else unchanged.   

Another challenge with maintaining margins is that Dell faces intense AI server competition, not only from Super Micro, guiding to a similar $40 billion in revenue with operating margins currently at 3.7%, but also from Taiwanese ODMs. Dell faced a question on the latter at Morgan Stanley’s TMT: 

Erik Woodring, Morgan StanleyErik Woodring, Morgan Stanley 

How do you make sure that you protect yourselves against some of the lower-priced Taiwanese ODMs, making sure that you can defend what you've done and stay with the customers that you have and grow with them? 

David Kennedy, Dell CFODavid Kennedy, Dell CFO 

“Back to your second part of the question, look, again, our value as we look at the production cycle here from the L11 scale and beyond, those engineering standards, those activities, I'm sure we might touch on OpEx in our P&L later. But within our OpEx framework, we are making sure we're investing, investing in our go-to-market teams. So as AI opportunities expand in the enterprise, we're building out the right pod structures and the right capacity to go execute that. But also two, giving Arthur Lewis and his team, the engineering capability, the labs and the investment. So they're not working just on, let's say, Vera Rubin, but the next gen beyond that and beyond that. We're ahead of the game right now. Our job is to stay ahead. So we maintain the value that we can find in our P&L.” 

Dell’s answer here is incomplete without one other quote from management at BofA’s conference, where they explained that they “can deliver hundreds of these racks in a given week like clockwork and have them show up and within 24 to 36 hours, they're up and running and they're generating money for the customer,” where “competitors don't seem to be able to do that reliably.” 

This speed and reliability is key as the Taiwanese ODMs may beat out Dell when it comes to cost at scale, yet Dell’s advantage lies in delivering full rack-scale systems that can almost immediately be monetized by customers. It is also a key advantage in serving the enterprise customer pipeline, now extending to 4,000 customers in its installed base, up from 3,300 in Q3. This also may play a key role in helping Dell mitigate AI server margin erosion moving forward while serving enterprise customers, as competitive pressures on the cost side and potential undercutting to gain share are unlikely to let Dell drive margins higher at the time being.  

However, Dell is leaning on storage to help preserve ISG operating margins in the face of this growing AI-related margin pressure. Dell’s storage IP portfolio, including its PowerMax, PowerScale and PowerFlex, “is the biggest lever as to why we say our core margins, excluding AI, can show a bit of expansion” with ISG operating margin up 2.4 points sequentially to 14.8%. This was driven by storage revenue up 20% QoQ in its seasonally strongest quarter (a slight improvement versus the 18% QoQ last Q4) and 2% YoY, outperforming the market.  

Looking ahead, Dell expects storage to be a primary lever in helping keep margins strong in the face of headwinds from increased AI server share and rising memory costs. This is because Dell is seeing stronger storage attach rates for AI servers in enterprise customers, and strong demand for storage products as inference expands. Management also sees its IP portfolio growing mid-single digit YoY in FY27 and taking a larger mix this year:  

Benjamin Reitzes, Melius ResearchBenjamin Reitzes, Melius Research 

Nice execution here, guys. I'll echo that. My question is on storage. It sounds like it's turning a little bit. You beat the Street by a little bit, 2%. And then you said, I believe that it will grow in the mid-singles for the year, and it looks like it may outgrow servers in the back half of the year. So can you just talk about what's really going on with storage, your highest margin business? Is it really turning? Is it going to be a contributor to mix in the upcoming year that allows you to keep gross margins pretty flat for the year in a tough component environment? 

Jeffrey Clarke, Dell COO Jeffrey Clarke, Dell COO  

Sure, Ben. Look, we're excited about our storage business. Again, we're reporting that on an orders basis, our Dell IP portfolio grew double digits. That's the entire portfolio. PowerMax, PowerStore, PowerScale, ObjectScale and our data domain platforms all grew double-digit demand. Our all-flash grew double-digit demand. It grew in all regions, and we acquired new customers. PowerStore grew its 8th consecutive quarter, 7 of those — the last 7, double digit. 

Half of those new customers that we are winning are new to PowerStore and nearly 30% are new to Dell buying storage. We saw tremendous demand for our unstructured products as AI inference and AI continues to grow, grow, grow. Our Dell IP portfolio is now a greater percentage of the mix year-over-year. We expect it to grow FY '27 over '26, it will be a greater percentage of mix next year than this year. That's part of the profit contribution that David has outlined in our guidance. 

Memory Costs, PC Demand and Pull Ahead Dynamics 

We touched upon some of memory headwinds and potential significant PC unit volume shrinkage the market faces this year in our Silicon Motion analysis, Silicon Motion: Strong Consumer SSD Demand, Trying to Move into AI Enterprise Markets for 2027-2028, with Dell’s management similarly pessimistic on PC growth. 

Management explained that they foresee PC units declining in the range of (11%) to (12%) this year, at odds with the refresh cycle underway, though emphasized that they do “expect the back half of the year to be deeper, probably high teen double-digit negative growth.” To note, this is slightly more pessimistic than estimates from IDC and Gartner calling for (11.3%) and (10.4%) decline in unit volumes this year. Dell also outlined a bit of a pull ahead dynamic, with customers are beginning to understand that quotes tomorrow or next quarter are likely to be higher than price quotes today, spurring some purchasing activity.  

This challenging demand environment has the potential to weigh on CSG growth especially in 2H, though Dell expects its pricing activities to allow them to hit their CSG revenue guidance of 1% YoY even if price increase take unit growth even lower.  

Management pointed out that their price quotes “are valid for the shortest period of time they've ever been. And we're reducing promotions and all sorts of special pricing going forward. … In PCs, we purposely delayed implementing that price move to stay in the hunt to take share and to drive growth, which will serve us for the long run. And then when we made the change on January 6, it wasn't 90 days later, it was that day we stabilized margins.” Management had also clarified that CSG’s higher deal volumes means its repricing efforts take longer to flow through, meaning it will not have as immediate an impact as servers on growth.  

Dell shared a bit on memory costs, noting that Q2 is estimated to rise 20% to 50%, Q3 up 5% to 15%, and Q4 up 5% to 10% for combined DRAM and NAND. Management expects these industry estimates to be in the ballpark, explaining that they have LTAs and capacity agreements in place and that they have experience budgeting prices as needed. However, current forecasts point to conventional DRAM up 58-63% QoQ and NAND up 70-75% QoQ, far ahead of management’s expectations and suggesting that memory prices may still remain a tougher constraint through the summer and beyond. Even if Dell does have the ability within LTAs to avoid some of these increases, broader demand destruction may still occur and impact growth.  

Financials 

Revenue Growth Accelerates to 39.5% in Q4 

Dell’s Q4 revenue grew by 39.5% YoY and 23.6% QoQ to $33.4 billion driven primarily by outperformance in AI servers. Revenue growth accelerated by 28.7 percentage points from 10.8% YoY growth in the previous quarter and significant improvement from the (9.3%) QoQ decline in the previous quarter.  

Management also provided strong Q1 guidance of $34.7 billion to $35.7 billion, implying YoY growth of 50.6% and 5.5% QoQ at the midpoint. Analysts currently expect Q1 revenue to grow by 51.8% YoY to $35.5 billion and will moderate to 17.6% and 26.6% growth in the next two quarters.  

FY2026 revenue ending January grew by 18.8% YoY to $113.5 billion. Management provided a strong FY2027 guidance of $138 billion to $142 billion, implying YoY growth of 23.3%, with one analyst pointing out that Dell is “adding $30 billion more on top line with very little incremental OpEx.” Analysts currently expect FY2027 revenue to grow by 24.8% YoY to $141.7 billion and will decelerate to 6.9% and 4.5% growth in the next two years.  

Key Segments 

ISG Revenue Grew by 73%  

Infrastructure Solutions Group (ISG) Q4 revenue grew by 73% YoY and 39% QoQ to $19.6 billion primarily driven by very strong AI server revenue growth. It marked the eight consecutive quarter of double-digit revenue growth for the ISG segment. ISG revenue is expected to grow over 100% in Q1, primarily driven by strong AI server revenue. 

From Q4, the company has started to bifurcate servers and networking revenue into AI optimized server revenue and traditional servers & networking revenue. Q4 AI revenue grew by 342% YoY and 60% QoQ to $9.0 billion. While the traditional servers & networking revenue grew by 27% YoY to $5.85 billion and storage revenue grew by 2% YoY and 20% QoQ in its seasonally strongest quarter to $4.8 billion.  

Management expects Q1 AI revenue to be $13 billion, implying a YoY growth of about 620% and 45% QoQ. FY2026 AI revenue grew by 166% to $24.68 billion, and management expects AI revenue to grow 103% YoY to about $50 billion in FY2027.  

AI orders grew by 1906% YoY and 177% QoQ to a record $34.1 billion in Q4. While AI shipments grew by 352% YoY and 70% QoQ to $9.5 billion. The company’s AI server backlog grew by 949% YoY and 134% QoQ to a record $43 billion. 

CSG Revenue grew by 14% 

Client Solutions Group (CSG) Q4 revenue grew by 14% YoY and 8% QoQ to $13.5 billion. Commercial revenue grew by 16% YoY and 9% QoQ to $11.6 billion. It was the sixth consecutive quarter of growth and demand up for the eighth quarter. The company is witnessing growth across geographies, with strong large enterprise demand and traction in the lower end of commercial markets. Consumer revenue was flat YoY and up 1% QoQ to $1.88 billion with demand up for the second consecutive quarter, supported by strength in gaming. Management expects CSG revenue to be up roughly 2% YoY in the next quarter. 

Margins 

The market was growing concerned that rapidly rising memory costs would squeeze on Dell’s margins (“you're supposed to miss numbers, by the way, when memory prices go up”), yet Dell’s margins are among the highest they’ve been since we began tracking the stock. This is quite impressive given the AI server and memory headwinds, with storage being a key piece of this margin strength despite being a much smaller portion of revenue at $4.8 billion this quarter.  

  • Q4 gross profits were $6.7 billion or 20.2% of revenue compared to $5.7 billion or 23.7% in the same period last year. The lower margins reflect higher proportion of AI revenue mix.  
  • Q4 operating income grew by 43.2% YoY to $3.1 billion primarily driven by operating leverage. Operating margin was 9.3% compared to 9% in the same period last year.   
  • Q4 net income was $2.3 billion or 6.8% of revenue compared to $1.5 billion or 6.4% of revenue in the same period last year.  

Q4 Adjusted EPS grew by 45.1% 

The company’s Q4 adjusted EPS grew by 45.1% YoY to $3.89 primarily driven by operating leverage. Analysts expect Q1 adjusted EPS to grow by 89% YoY to $2.93 and will decelerate to 27.8% and 20.5% in the next two quarters.  

Looking ahead, FY2027 adjusted EPS is expected to grow by 24.5% YoY to $12.82 and 13.8% in FY2028. 

Cash Flow and Balance Sheet

Similar to margins, Dell’s cash flows were equally as strong, with operating cash flow margin expanding by double digits and free cash flow following. Cash flow margins were also around the highest they’ve been over the last three years. 

  • Q4 operating cash flow was $4.7 billion or 14% of revenue compared to $585 million or 2.4% of revenue in the same period last year.  
  • Q4 adjusted free cash flow was $5.1 billion or 15.2% of revenue compared to $474 million or 2% of revenue in the same period last year. 
  • The company had a high debt of $31.5 billion and cash & investments of $13.3 billion at the end of Q4. The company repurchased shares worth $1.85 billion and paid dividends of $346 million in Q4. 
  • The company’s inventories rose 50.2% QoQ to $10.4 billion in Q4 primarily to support the strong AI demand.  

Conclusion 

Dell’s Q4 saw some of the strongest AI revenue growth across the AI industry with AI server revenue up 342% YoY to $9 billion, while orders surged 1,906% YoY to a record $34.1 billion. This order momentum drove Dell’s AI server backlog to a record $43 billion, with it consisting primarily of Grace Blackwell systems, which could be quite helpful if the upcoming Vera Rubin generation sees a delay. Importantly, Dell also has supply secured to satisfy its guidance in full for the entire year, a key advantage considering the memory and component shortages persisting across the industry. 

Moving down the line, Dell’s margins and cash flows stand out as they both approached the highest levels over the last three years, despite AI server margin headwinds and rising memory costs, with Dell leveraging its IP storage portfolio growth to keep margins strong. Growing storage attach rates through FY27 provides a large lever to keep margins strong through the rest of this year even with AI servers guided to grow >100%.

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

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

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Silicon Motion: Strong Consumer SSD Demand, Trying to Move into AI Enterprise Markets for 2027-2028 

Posted on by io-fund

Leading SSD controller supplier Silicon Motion (SIMO) is forecasting record revenue in 2026, yet the growth story still appears driven primarily by its more established markets across mobile, PC and automotive rather than by a major breakout in AI or data center.  

In the near-term, SIMO is guiding sequential revenue growth throughout the year, primarily driven by the mobile revenue segment with management stating: “We expect continued strength across nearly all our product segments with a particular emphasis on mobile where we expect significant outperformance due to continued market share gains.” 

That said, management has made it clear execution is dependent in part on securing NAND supply on a stable basis, with higher input costs passed through to customers.  

SIMO has a handful of notable customer wins, aside from working with the leading NAND flash and SSD suppliers. The company is supplying controllers for Nvidia’s BlueField DPUs in the second half of the year, along with several NVLink and Ethernet switch solutions. Analysts also implied that the company has won a role in Google’s ASICs project although management did not directly confirm the customer name. 

Today, SIMO appears to be more adjacent to the action around NAND prices surging rather than being in the center of it. While NAND suppliers that own the flash content are seeing the benefits of higher average sales price per gigabyte and higher bit shipments, instead, SIMO sells the controller silicon and firmware that manages the NAND which does not benefit directly from pricing upside. 

Over time, that could change with key products such as enterprise boot drive storage, MonTitan enterprise SSD controllers and PCIe6 MonTitan controllers. Below, we discuss key products that could help SIMO pivot toward the lucrative and highly supply-constrained AI memory market. 

Brief Product Overview 

Silicon Motion supplies a range of high-performance NAND flash controllers, and is the leading global supplier of PCIe Gen4 and Gen5 SSD controllers used in PCs, client devices, and enterprise/data center applications, along with eMMC and UFS controllers for smartphones and IoT devices. The company’s controller chips and firmware help manage how data is stored and accessed across these devices.  

SIMO is heavily exposed to the consumer/client markets, with eMMC/UFS controllers driving 40-45% of revenue in fiscal 2025, with likely a large portion of SSD controller revenue (45-50% of revenue) coming from the two end markets.  

However, Silicon Motion is looking to make solid inroads into the data center heading into 2027, serving merchant GPUs with Nvidia’s new BlueField DPU on its Vera Rubin generation with boot-storage, which helps to start and manage the system. Although this is not nearly as critical (or as valuable) as SSD like what SanDisk offers, which is the main data storage, supplying the boot-storage marks a shift for SIMO as their products will now be in AI servers.  

There are also some other AI-driven tailwinds within compute and enterprise SSDs, being served by its MonTitan platforms in the second half of 2026 for QLC and TLC NAND for AI storage applications. These SSD controllers will help to solve the data storage challenges that AI servers face by helping them feed data and access data efficiently.  

The company supplies the leading flash manufacturers including Kioxia, Micron, SK Hynix/Solidigm, Samsung, SanDisk, and China’s YMTC. Outside of memory suppliers, Amazon is a key customer and Nvidia.  

Moving into Data Center with MonTitan and Enterprise SSDs for AI Servers 

For its AI-oriented product portfolio, SIMO offers a handful of high-performance enterprise SSD controllers in 8-channel and 16-channel configurations, as well as its MonTitan PCIe Gen5 SSD development platform. MonTitan targets data center and enterprise boot drive storage needs, featuring an SSD controller ASIC, reference design kits and enterprise firmware, allowing customers to optimize designs to meet their performance needs.  

SIMO began qualification of high-performance TLC compute SSDs on MonTitan at multiple customers in Q4, with qualification expected to progress through the first half of calendar 2026 and commercial ramp occurring in 2H. Additionally, SIMO expects to begin qualifications with multiple customers this year for QLC storage SSDs. 

MonTitan is expected to be a core growth driver for SIMO once the ramp begins in 2H, with management already guiding for the platform to reach 5-10% of revenue exiting 2026, or ~$60 to $120 million run rate based on current estimates for $1.27 billion annual and $335 million revenue in Q4.  

SIMO is also planning to tape out its first 4nm PCI Gen6 version of MonTitan (as current controllers are 6nm) this year, targeting hyperscalers, NAND flash manufacturers, storage system providers and CSPs. The new 4nm solution is expected to drive growth in 2027 and 2028, with management noting they already have secured a design win expecting to ramp significantly in 2028. 

Ramping for Vera Rubin’s BlueField DPU in 2H 2026 

Silicon Motion is expecting to see tailwinds from merchant GPUs arise in the second half of 2026, from its involvement within Nvidia’s Vera Rubin on DPU boot drives, as well as its NVLink/Ethernet switch roadmap. Management discussed they were involved with other potential customers for enterprise boot drive solutions including a leading search engine firm, with analyst commentary implying that Google may have already been won as a customer, though this was not confirmed. However, SIMO faces two main headwinds at present that could push this growth story to the back burner – timing of the ramp and PC/mobile headwinds, and challenges procuring NAND.  

SIMO explained in Q4’s call that they kicked off volume shipments to Nvidia in the quarter for its current DPU generation, adding that they are also working with the GPU leader “to qualify the next-generation version of their DPU as well as for several NVLink and Ethernet switches of their new GPU/CPU platform that are expected to launch in the second half of 2026.” Management added that the next-gen DPU and switch both require higher capacities, with much higher unit volumes and ASPs, unlocking a new growth opportunity in the back half of the year through 2027. 

This likely corresponds to Nvidia’s upcoming BlueField4 and BlueField4 STX platform announced at GTC, as well as its Spectrum-6 switch family. The STX rack in particular underpins Nvidia’s in-house ‘Inference Context Memory Storage’ platform, an Ethernet-attached flash SSD tier optimized for KV cache at the pod level to accelerate large-context inference. For more on the ICMS platform, refer to our SanDisk analysis here: SanDisk: Shares Up 559% In 2025 On NAND Flash, Enterprise SSD Tailwinds.SanDisk: Shares Up 559% In 2025 On NAND Flash, Enterprise SSD Tailwinds. 

SIMO provided a brief view on the products it is supplying for Nvidia and their role at GTC: MonTitan SSDs for the ICMS platform and KV cache extension, as well as for near-GPU high performance storage; enterprise SSD controllers for compute-optimized, nearline SSD and warm data storage with TLC and QLC SSD support; and PCIe NVMe boot drives and boot drive controllers.  

Given the new nature of this growth opportunity, analysts questioned about the revenue opportunities from BlueField DPUs/boot drives, and how it will play out this year and into next. Management explained that they expect the DPU/boot drive volume to be “very meaningful in 2026” with revenue around $50 million, but next year to be “much higher” as the NVLink and Ethernet switches see “more volume in 2027.”  

This would imply DPU revenue contribution remaining around <5% of revenue in 2026, based on current estimates for $1.27 billion in annual revenue, though commentary for much higher growth with product ramps weighted next year suggests management has already has solid visibility into the business potentially becoming a much more meaningful topline driver by the end of next year.  

However, the discussions also shed light on some primary headwinds SIMO faces. First, the main challenge comes down to timing, with the ramp more weighted in the back half of 2026 and into 2027, whereas SIMO must currently navigate challenging PC and mobile markets. Second, growth depends on NAND procurement which must be bought at market prices, margins must be passed through to customers, and it is not the sole controller supplier for DPUs.  

Headwind #1: Timing 

SIMO did set the stage for a strong year, expecting record revenue and sequential growth in each quarter with Q1 being the lowest for the year, a strong statement considering growth headwinds facing the mobile and PC markets from rising memory costs, with volumes expected to decline YoY in both end markets.  

This is why timing may be the most challenging aspect to SIMO’s thesis, as it is working to ramp its presence in the data center, yet these initial contributions may not be material enough to overcome PC and mobile challenges as the year progresses.  

As noted above, SIMO is forecasting Q1 to be the lowest quarter of the year, primarily impacted by typical seasonal weakness in client SSDs with mobile expected to significantly outperform. Guidance was $292 million to $306 million, or $299 million at midpoint for roughly 7.4% QoQ growth, counter to typical seasonality but decelerating from 15.1% QoQ in Q4.  

Current estimates point to SIMO’s sequential growth decelerating further to 2.7% in Q2 and remaining in the low/mid-single digit range through year-end, overall marking a high teens deceleration from Q3’s peak on current estimates.  

A key factor behind the soft forward QoQ growth is likely the PC/mobile headwinds given the significance of eMMC/UFS controller and client SSDs in terms of dollar growth and revenue contribution.  

Recent projections from Gartner and IDC point to a worsening environment for PCs. IDC had originally forecast an (8.9%) decline in shipments in 2026 in its pessimistic scenario from December 2025, yet it now projects an (11.3%) decrease in shipments this year as rising memory costs force price hikes that bite into demand. Gartner sees a similarly woeful year for PCs, forecasting a (10.4%) decline, with analysts there saying this would represent the “steepest contraction in device shipments witnessed in over a decade.” 

For smartphones, both of the two groups forecast a similarly challenging year. IDC is forecasting a (12.9%) decline in the smartphone market in 2026, a rather substantial revision lower from its December projection for just a (5.2%) decline. For comparison, Gartner projects an (8.4%) decline. This follows low-single digit growth in 2025. 

SIMO does expect to outperform both markets and deliver growth as it benefits from market share gains and improved ASPs, explaining that they will “get the benefit of both higher share and higher ASPs this year in spite of any sort of macro issues around PC unit volumes.” 

However, it is still worth pointing out that there is no guarantee that it will be able to flawlessly navigate what could shape up to be some of the worst growth in PCs more than a decade and potential double-digit unit declines. If these supply chain difficulties persist and cause inventory buildups at OEMs, consumer/client NAND demand could be impacted, and SIMO’s limited data center opportunities (where NAND demand is likely to remain relatively well insulated from rising storage demand) may not be enough to offset growth and margin headwinds.   

Headwind #2: NAND Procurement 

While the PC and mobile headwinds are two challenging external headwinds, perhaps the most challenging internal headwind SIMO will face comes down to NAND supply. This is because the company has to procure NAND itself at market price, and then work to pass the costs on to customers, without benefitting from some of the end-unit pricing power that its customers are seeing: 

“We need to procure the NAND and NAND price at the market price. So we have to work out with the customer, we can pass through the cost increase to the end customer. So it is challenging but ongoing process quarter-by-quarter. It definitely will impact some of our gross margin but we manage the margin pass-through. So I think because even the customers, they have at least 2 to 3 supplier, so they're based on the price and based on the supply and depends the percentage.” 

The challenge here is that NAND prices reportedly rose ~90% QoQ in Q1, and were estimated to increase ~20% QoQ in Q2 in early February, yet the latest data suggests prices could rise 70-75% QoQ in Q2. Recent reports from Korea also suggest Samsung is doubling prices sequentially in the second quarter, implying that pricing is not yet slowing down. Simply put, when input costs rise 70% or 90%, prices must follow at a similar or faster rate in order to preserve margins.  

Considering the boot drive solution is a new product line with minimal revenue contribution until 2H, outsized pricing headwinds this early in its ramp phase could weigh substantially on gross and operating margins, which are already quite thin in the mid-40% and 13% range. This compares to its customers like Micron who are pushing above 80% and 76% next quarter as major beneficiaries of the price increases. 

Management also flagged that growth will be dependent on its ability to secure NAND supply ‘stably’, another major challenge considering SIMO has two NAND suppliers – stated as Kioxia and WDC (though likely to now be SanDisk). Management explained that one of these suppliers is secure, yet the other is not, which could impact their ability to secure stable supply at favorable prices, especially if the second prioritizes allocations to the highest bidder. To note, Kioxia announced in January that its NAND output for 2026 was essentially fully sold out. 

Financials  

Revenue Growth Accelerates to 45.7% in Q4 2025  

Silicon Motion’s Q4 2025 revenue grew by 45.7% YoY and 15.1% QoQ to $278.5 million. Revenue also beat estimates by 6.7%, reflecting the continued strength in mobile business and strong growth in the PCIe 5 SSD business. Revenue growth accelerated by 31.8 percentage points from 13.9% YoY in Q3 2025. Though sequential growth slowed from 21.8% in Q3, it was better than the decline of (10%) in the same period last year.   

Management also provided a strong Q1 revenue guide of $292 million to $306 million, implying a YoY growth of 79.6% and 7.4% QoQ at the midpoint. Management expects continued strength across its products with a particular emphasis on mobile end markets, where it expects significant outperformance driven by continued market share gains.

2025 revenue grew by 10.2% YoY to $885.6 million. Analysts expect revenue growth to accelerate to 43.1% YoY to $1.27 billion in 2026. Management expects 2026 to be a record year, with revenue growing each quarter sequentially, supported by first-half momentum in eMMC and UFS products. To briefly recap, MonTitan enterprise SSD products are expected to scale in the second half of 2026 and contribute 5% to 10% of revenue by the end of the year, with strong growth anticipated in the years ahead. 

Key Segments  

SSD Controllers  

SSD Controller sales increased by 25% to 30% QoQ and 35% to 40% YoY in Q4 2025, compared to an increase of 20% to 25% QoQ and a decrease of 0% to 5% YoY in Q3. Management expects client SSD controllers to ramp throughout the year, though the first quarter is seasonally weaker. They expect the new DRAM-less 4-channel PCIe 5 controller that was introduced last quarter to ramp significantly throughout 2026 and the MonTitan controller ramp is expected in the second half of 2026.  

For the full year 2025, SSD Controllers accounted for 45% to 50% of revenue and revenue declined by 0% to 5% YoY.  

eMMC + UFS Controllers  

The company’s eMMC (Embedded Multimedia Card) + Universal Flash Storage (UFS) controller sales increased by 0% to 5% QoQ and 50% to 55% YoY in Q4 2025, compared to an increase of 20% to 25% QoQ and 35% to 40% YoY in Q3 2025.  

For 2025, eMMC + UFS Controllers accounted for 40% to 45% of revenue and revenue increased by 20% to 25% YoY. Given the current backlog and customer outlook for 2026, management expects to significantly outpace the market and deliver another strong year of growth of the eMMC and UFS business despite the difficult market environment, with the two accounting for 35% to 40% of revenue in 2026. 

SSD Solutions  

SSD Solutions revenue increased by 125% to 130% QoQ and 110% to 115% YoY in Q4 2025 compared to an increase of 15% to 20% QoQ and decrease of 40% to 45% YoY in Q3 2025. For 2025, SSD Solutions accounted for only 5 to 10% of revenue and declined by 10% to 15% YoY.  

The company’s boot drives are part of  its  SSD solutions, and this segment is currently growing rapidly due to the strong AI demand.  

Margins  

The company’s margins are improving; however, management expects slight pressure in Q1 primarily due to product mix, with improvement anticipated as the year progresses.  They expect gross margins to return to the target range of 48% to 50% as the year progresses, as the mix of newer products increases, including the PCIe 5 controllers and enterprise SSD solutions.  

  • Q4 gross profits grew by 56.2% YoY to $136.8 million with a gross profit margin of 49.1%. The adjusted gross margin improved by 320 basis points YoY and 50 basis points QoQ to 49.2%. The improvement in gross margin was primarily driven by the successful ramp of new products and a favorable product mix shift toward client PC products.   
  • The adjusted operating margin came at 19.3%, up 380 basis points YoY and 350 basis points QoQ. Management expects full year 2026 adjusted operating margin to improve despite the higher expenses this year, primarily driven by operating leverage. 
  • Q4 net income came at $47.7 million or 17.1% of revenue compared to $21.6 million or 11.3% of revenue in the same period last year. The company benefited from the realized/unrealized gain on investments of $24.2 million in Q4 2025 compared to $0.1 million in Q4 2024.  

Q4 Adjusted EPS grew by 45%  

The company’s  Q4 adjusted EPS grew by 44.8% YoY to $1.26. Analysts expect strong growth to continue and expect Q1 adjusted EPS to grow by 117.2% YoY and 75.9% in Q2 2026. Looking forward, adjusted EPS is expected to grow by 59.4% YoY in 2026 and 21.9% in 2027.  

Cash Flow and Balance Sheet  

The company’s cash flows have been lumpy, and the increase in inventory to support strong future growth has put pressure on cash flows.    

  • Q4 operating cash flow was $1.6 million or 0.6% of revenue compared to an operating cash outflow of ($6.2 million) or (3.2%) of revenue in the same period last year.   
  • Q4 free cash outflow was ($6.3 million) or (2.2%) of revenue compared to ($17 million) or (8.9%) of revenue in the same period last year.   
  • The company had cash of $201.8 million and no debt at the end of Q4 2025 compared to $198.6 million in cash and no debt at the end of the previous quarter.  
  • Inventories increased by 24.8% QoQ to $421.8 million to support the strong future growth.  

 Conclusion 

 SIMO is guiding for record breaking revenue in fiscal 2026 despite growing headwinds in the PC and smartphone markets from rising memory costs. Q1 is expected to the lowest quarter of the year for revenue with client SSDs seeing typical seasonal weakness, with sequential growth in each quarter thereafter.  The company’s AI opportunities around Nvidia’s BlueField DPUs are expected to arise in the second half of the year and contribute roughly $50 million with a larger impact in 2027, while MonTitan is expected to quickly ramp in 2H to 5-10% of revenue. 

Revenue growth will also hinge on SIMO’s ability to stably procure NAND supply to meet its end market demand, making increasing memory costs a point to navigate for growth.  

An analyst on the call threw out 2027-2028 as potential timing for when the enterprise segment could get interesting. Our analysis points toward something similar, which is that 2026 may be a solid growth year for mobile and also PC yet is unlikely to be the year SIMO breaks out as a major enterprise AI story.  

Given the growth we are seeing in NAND, we felt it was worth our time to look at this stock more closely, yet will put SIMO on the shelf for further review until end of 2026 to see if a few of these green shoots materialize in the AI market.

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

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

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Aehr’s Bookings Surge as Expected in Q3, Book-to-Bill of 3.5X 

Posted on by io-fund

While revenue missed estimates this quarter, and both margins and cash flows remained pressured, Aehr delivered where it mattered most – bookings and backlog. Q3 bookings rose 500% sequentially to $37.2 million, which Aehr says puts it on track to reach the upper end of its $60 to $80 million forecast for 2H. Aehr is continuing to see solid momentum in Q4 with $12.2 million in bookings to date, taking its effective backlog above $50 million and supporting the revenue inflection now becoming more visible in Q4.  

Additionally, Aehr is continuing to expand capacity, tapping into contract manufacturers to support an additional 20 Sonoma systems per month. This comes on top of the capacity expansion we outlined last week in our analysis Aehr Sees 2H Bookings up 4X vs 1H, Supporting Strong FY27 where Aehr explained it could support 20 of both its wafer-level and package-level systems each month if needed. Importantly, Aehr noted this new capacity could be almost immediately available for shipments.  

Aehr had broken out prior to earnings, and using technicals we entered the stock. The same will be true for when we exit the stock. This is not a stock we want to be early to enter or late to exit. Knox will cover more in his upcoming webinar. 

Bookings up 500% QoQ, Book-to-Bill of 3.5X 

As we had covered just last week prior to Q3’s report, Aehr unofficially guided for bookings to rise roughly 4X to $60 to $80 million in 2H FY26, with the company already off to a strong start to potentially exceeding that forecast.  

Bookings rose 500% QoQ in fiscal Q3 to $37.2 million, a fresh quarterly record for the company, and driven by the flurry of orders we covered last week, including the $14 million order from its lead AI processor customer placed one day before quarter-end on February 26. Aehr also offered a look at its book-to-bill ratio, noting it exceeded 3.5X in the quarter, reflecting the strong demand it has been seeing recently across AI processors, ASICs and silicon photonics; while this is not typically a metric provided by the company, combined with the bookings and backlog strength, it reinforces the durability of demand and revenue acceleration in FY26. 

Aehr also pointed out that in the first five weeks of fiscal Q4, it received an additional $12.2 million in bookings, with this related to its two orders announced in March, including the new major SiPho customer. Aehr also stated that on April 6, it received an order from a brand-new customer for Sonoma for reliability qualification of a new AI processor, though no other details were given. This brings Aehr’s effective backlog to $50.9 million (from Q3’s ending backlog of $38.7 million, up 113% YoY and 228% QoQ), a new record for the company and offering strong visibility into Q4 and early FY27 revenue.  

To circle back to the chart we provided last week for bookings and revenue, there are a few new takeaways. Based on management’s commentary to be on the high end of the $60-80 million bookings forecast, or reasonably assumed at $75 million, Aehr’s Q4 bookings would be estimated at $37.8 million, up less than 2% QoQ. Given that Q3 had seen $12.2 million in bookings in five weeks, there will need to be some acceleration through the end of May, or a few larger orders coming in.  

Additionally, we do also see the first sign of revenue inflecting in Q4, with Aehr’s maintenance of 2H revenue guidance of $25 to $30 million implying $17.2 million at midpoint. This still leaves a >$20 million difference between estimated bookings and revenue to flow through to backlog, setting the stage for a strong acceleration into the first half of FY27 as this backlog ships. Further supporting this was commentary we detailed last week on some of the recent orders shipping in FQ1/second half of CY2026, with the AI ASIC customer forecasting “substantial expansion of Sonoma systems purchases beginning in the second half of calendar 2026 and continuing into '27.” 

Brief Customer Update 

While there have been no major new updates since last week, aside from the limited details on the April 6 order noted above, there were a couple of comments from management around AI and SiC that differed a bit from last quarter’s call. 

Aehr said it is actively engaged with multiple additional AI processor companies on benchmarking, and expects “meaningful progress” to be made, though with no clear timeline. Management also said that they have several companies ranging from AI accelerators, edge processors, and CPUs that are providing roadmaps on devices and asking about WLBI capabilities, suggesting there could be some new future engagements or potential orders down the road. Aehr also noted that the benchmark evaluation with a top-tier AI processor supplier is making good progress, but taking longer than expected. 

On memory, Aehr said they are in discussions with key HBM suppliers, and “seeing the added potential for HBM insertions with our FOX multi-wafer test and burn-in system road map that extends to flash, high-bandwidth flash, DRAM and HBM memories,” with these opportunities expected to drive orders in FY27 that ramp in FY28. 

For ASICs, CEO Gayn Erickson said he was “surprised” at how many “ASIC suppliers don't do production burn-in yet or are talking about doing it,” estimating it could be only 5% or 20% that actually get burnt-in. These comments imply that the ASICs opportunity could be increasingly large if burn-in adoption accelerates, as Aehr’s ASICs customer is one of the key anchors to its strong bookings and FY27 growth forecast. 

On SiC, Aehr noted this quarter that they are seeing an uptick in activity and customer forecasts, particularly from Japanese and German OEMs for upcoming EV launches. Management said that while they are “not yet counting on significant revenue from this segment to return yet,” they believe SiC “could still be a very good performing segment for us next year.” 

Aehr Taking Capacity Another Level Higher via Contract Manufacturing 

Aehr’s comments on capacity were some of the most important from last quarter, notably that management highlighted they had the capabilities to ship 20 systems a month at either wafer or package-level and could extend that to 20 of each per month as needed. Commentary from Q3 implied that Aehr’s Fremont facility is capable of supporting that itself, with Aehr now moving to contract manufacturing for an additional leg higher in capacity. 

This quarter, CEO Gayn Erickson explained that “in addition to our Fremont expansion, this quarter, we'll begin shipping Sonoma systems from one of our current contract manufacturers, adding capacity of more than 20 additional Sonoma systems per month. This meaningfully increases our ability to support future growth.”  Erickson further clarified that Aehr the contract facility would support larger volume orders of Sonoma SKUs, while Fremont would still manufacture both Sonoma and FOX products. 

Simply put, turning to these two contract manufacturers for additional production will move Sonoma’s monthly production curve up to 40 per month. One reason for this is that packaged-part engagemetns are implied to be easier to secure, and also can be as large or larger than wafer-level: “the ASP of a production order set in wafer-level burn-in can be $10 million to $20 million in an order, let's say, okay? Package-level can be that big or bigger, too, okay? So when they come in, it looks like, oh, right now, we see demand on both significant. Now the engagement and the work to get a wafer-level burn-in is definitely harder than package level.” This is key as Aehr could now secure and support more large-scale Sonoma deals with a faster shipping cadence, quickly supporting revenue upside.  

While Aehr does not publicly disclose pricing, the $5.5 million order from last quarter for multiple systems implies a reasonable range could be around $1 million for a rough estimate of what this capacity could support; at that estimate, this would be around $40 million per month or $480 million annually. This also does not include the potential wafer-level revenue opportunity that we estimated last week to be as high as $960 million to $1.2 billion at full scale each month.  

Most importantly, Aehr expects this uplift in Sonoma capacity to immediately be available, with the first products ready to ship to customers this quarter (aka May), with management wanting the contract manufacturers to be ready to ship in full volume by the summer when Sonoma is expected to ramp. 

Quick TAM Note 

It’s important to share some of Aehr’s brief discussions on its TAM and growth opportunities from more powerful chips, as it was again hinted that Aehr could potentially vault to hundreds of millions in revenue in the future.  

As we have covered in detail in our power analysis, Why Power is Critical for Data Centers and their Hyperscaler Customers, GPU generations are getting increasingly more powerful with each cycle. Aehr says that this trend, including the upcoming chips on Nvidia’s roadmap, “break the current tools, and so there's a continuous road map” for Aehr’s solutions, such as Sonoma, which is continuously adapting to support higher power and higher current.  

CEO Gayn Erickson also believes there is a natural progression for Aehr offering both wafer and package level, as this versatility “becomes particularly valuable when you have like a package that has multiple processors in it and all the HBM memory, right? So in those particular ones, I mean, the CoWoS substrate is more expensive than the silicon itself or the processor … So I think there's a progression over time where people will move towards wafer-level on the things they can default to package-level where they can't.” 

Overall, Aehr believe that package-level burn in supports a multi-hundred million dollar TAM, while wafer-level is higher. Erickson specifically highlighted memory spend for fabs through 2031 and percentage allocated to test budgets, noting the burn-in allocation could be as high as “multiple billions of dollars per year in the next couple of years on an annual basis.” Given this trend and answering his own question about why Aehr is not at $500 million in revenue , Erickson hinted that Aehr has a “very good opportunity to significantly grow our package-level and wafer-level business across the biggest segments that are driving burn-in,” and why they are increasing capacity to this degree.  

Financials 

Revenue Growth to Accelerate from FQ4

Aehr’s FQ3 revenue ending February was down (43.7%) YoY and up 4.3% QoQ to $10.3 million, missing estimates by (4.9%). The decline was primarily driven by lower shipments of FOX systems and WaferPaks for wafer-level burn-in business, partially offset by stronger demand for the Sonoma systems and burn-in modules from the company’s hyperscaler customer. Systems revenue was down (46%) YoY and up 16% QoQ to $5.8 million. Contactors revenues, which include WaferPak contactors, were down (49%) YoY and (13%) QoQ to $3.0 million. Aehr added that its consumables/WaferPak business “will consistently be at 30% or more of our total revenue, and our margins will increase as sales of these value-add consumables grow.” 

Management reiterated the 2H FY2026 revenue guidance of $25 million to $30 million given during FQ2 results and now expects to be on the high side of the range. The FQ4 revenue estimates have been revised higher by 7.3% since the announcement of results. Analysts expect FQ4 revenue to grow by 22.3% YoY and 67.1% QoQ to $17.2 million. Revenue growth is further expected to accelerate to 44.6% YoY in FQ1, then to 97.8% and 134.4% in the next two quarters.  

Looking ahead, due to the strong AI-related demand, the company’s FY2027 revenue is expected to ramp significantly and accelerate to 71.7% YoY to $83.2 million from an expected decline of (17.9%) for FY2026 ending May. While there will be slight changes to these estimates as the management announced during the earnings call that they will change the fiscal year from the last Friday of May to the last Friday of June effective after the fiscal year ends on May 29, 2026.  

The company’s new FY2027 will begin on June 27, 2026, and end on June 25, 2027. As a result, there will be one month of financial results from May 30, 2026, to June 26, 2026, which will be reported as a transition period when the company files the 10-Q report in the FQ1 ending September 2026. 

Margins 

The company’s margins are under pressure due to the lower revenue and unfavourable product mix. 

  • FQ3 gross profits were $3.4 million or 32.7% of revenue compared to $7.3 million or 39.2% of revenue in the same period last year. The adjusted gross margin was 36.5% compared to 42.7% in the same period last year. The decline was due to lower revenue and a less favorable product mix as last year's quarter included a higher proportion of higher-margin WaferPak revenue. 
  • FQ3 adjusted operating loss was ($2.5 million) or (24.7%) of revenue compared to an adjusted operating income of $1.5 million or 8.2% of revenue in the same period last year. The decrease in margins was primarily due to lower revenue. 
  • FQ3 adjusted net loss was ($1.5 million) or (14.8%) of revenue compared to an adjusted net income of $1.98 million or 10.8% of revenue in the same period last year. Management expects to return to profitability on a non-GAAP basis in FQ4. 

Adjusted EPS beat of 28.6% 

The company’s FQ3 adjusted EPS came at ($0.05) compared to $0.07 in the same period last year and beat estimates by 28.6%. Analysts expect adjusted EPS to be ($0.04) for FQ4, though Aehr expects to return to profitability on an adjusted basis in the quarter. 

Looking forward, analysts expect adjusted EPS to be ($0.11) for the FY2026 ending May and improve significantly to $0.13 in FY2027 and $0.26 in FY2028. 

Cash Flow and Balance Sheet 

The company’s cash flows have been weak due to current losses. However, it should improve in the coming quarters as the revenue is expected to ramp significantly in FY2027. 

  • FQ3 operating cash outflow was ($3.7 million) or (35.8%) of revenue compared to ($1.6 million) or (8.8%) of revenue in the same period last year. 
  • FQ3 free cash outflow was ($3.8 million) or (36.5%) of revenue compared to ($3.3 million) or (17.8%) of revenue in the same period last year. 
  • The company had cash of $36.9 million and no debt at the end of the quarter. During FQ3 the company raised $10.5 million in gross proceeds through the sale of 269,000 shares. Since the end of FQ3, they raised another $19.5 million gross proceeds through the sale of 477,000 shares and thereby increasing the cash to $56.4 million.  
  • On April 8, the company entered into an equity distribution agreement with William Blair and Craig-Hallum Capital Group, in connection with the offer and sale of up to $60 million of the company’s stock through an at-the-market offering program. 
  • Inventories were down (3.7%) QoQ to $41.2 million. 

Conclusion 

Q3’s fundamentals did not improve, yet the signs and signals are flashing for Q4 to be the long-awaited turnaround for Aehr with revenue expected to accelerate sharply to 22.3% YoY and non-GAAP profitability to return.  

Bookings surged 500% QoQ to $37.2 million, with Aehr reporting a book-to-bill ratio of 3.5X in the quarter, underscoring the strength of demand. Q4’s bookings to date of $12.2 million take Aehr’s effective backlog to $50.9 million, and combined with the >$20 million gap between implied bookings and revenue in Q4, Aehr is offering strong visibility into the upcoming revenue acceleration into the first part of fiscal 2027. Capacity expansion further supports this with additional capacity of 20 Sonoma systems per month coming online almost immediately. 

As stated, we will use technicals to guide or entries or exits with this stock reserved for the Advanced tier, which requires strong risk management discipline.

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

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

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Silicon Motion: Strong Consumer SSD Demand, Trying to Move into AI Enterprise Markets for 2027-2028 

Posted on by io-fund

Leading SSD controller supplier Silicon Motion (SIMO) is forecasting record revenue in 2026, yet the growth story still appears driven primarily by its more established markets across mobile, PC and automotive rather than by a major breakout in AI or data center.  

In the near-term, SIMO is guiding sequential revenue growth throughout the year, primarily driven by the mobile revenue segment with management stating: “We expect continued strength across nearly all our product segments with a particular emphasis on mobile where we expect significant outperformance due to continued market share gains.” 

That said, management has made it clear execution is dependent in part on securing NAND supply on a stable basis, with higher input costs passed through to customers.  

SIMO has a handful of notable customer wins, aside from working with the leading NAND flash and SSD suppliers. The company is supplying controllers for Nvidia’s BlueField DPUs in the second half of the year, along with several NVLink and Ethernet switch solutions. Analysts also implied that the company has won a role in Google’s ASICs project although management did not directly confirm the customer name. 

Today, SIMO appears to be more adjacent to the action around NAND prices surging rather than being in the center of it. While NAND suppliers that own the flash content are seeing the benefits of higher average sales price per gigabyte and higher bit shipments, instead, SIMO sells the controller silicon and firmware that manages the NAND which does not benefit directly from pricing upside. 

Over time, that could change with key products such as enterprise boot drive storage, MonTitan enterprise SSD controllers and PCIe6 MonTitan controllers. Below, we discuss key products that could help SIMO pivot toward the lucrative and highly supply-constrained AI memory market. 

Brief Product Overview 

Silicon Motion supplies a range of high-performance NAND flash controllers, and is the leading global supplier of PCIe Gen4 and Gen5 SSD controllers used in PCs, client devices, and enterprise/data center applications, along with eMMC and UFS controllers for smartphones and IoT devices. The company’s controller chips and firmware help manage how data is stored and accessed across these devices.  

SIMO is heavily exposed to the consumer/client markets, with eMMC/UFS controllers driving 40-45% of revenue in fiscal 2025, with likely a large portion of SSD controller revenue (45-50% of revenue) coming from the two end markets.  

However, Silicon Motion is looking to make solid inroads into the data center heading into 2027, serving merchant GPUs with Nvidia’s new BlueField DPU on its Vera Rubin generation with boot-storage, which helps to start and manage the system. Although this is not nearly as critical (or as valuable) as SSD like what SanDisk offers, which is the main data storage, supplying the boot-storage marks a shift for SIMO as their products will now be in AI servers.  

There are also some other AI-driven tailwinds within compute and enterprise SSDs, being served by its MonTitan platforms in the second half of 2026 for QLC and TLC NAND for AI storage applications. These SSD controllers will help to solve the data storage challenges that AI servers face by helping them feed data and access data efficiently.  

The company supplies the leading flash manufacturers including Kioxia, Micron, SK Hynix/Solidigm, Samsung, SanDisk, and China’s YMTC. Outside of memory suppliers, Amazon is a key customer and Nvidia.  

Moving into Data Center with MonTitan and Enterprise SSDs for AI Servers 

For its AI-oriented product portfolio, SIMO offers a handful of high-performance enterprise SSD controllers in 8-channel and 16-channel configurations, as well as its MonTitan PCIe Gen5 SSD development platform. MonTitan targets data center and enterprise boot drive storage needs, featuring an SSD controller ASIC, reference design kits and enterprise firmware, allowing customers to optimize designs to meet their performance needs.  

SIMO began qualification of high-performance TLC compute SSDs on MonTitan at multiple customers in Q4, with qualification expected to progress through the first half of calendar 2026 and commercial ramp occurring in 2H. Additionally, SIMO expects to begin qualifications with multiple customers this year for QLC storage SSDs. 

MonTitan is expected to be a core growth driver for SIMO once the ramp begins in 2H, with management already guiding for the platform to reach 5-10% of revenue exiting 2026, or ~$60 to $120 million run rate based on current estimates for $1.27 billion annual and $335 million revenue in Q4.  

SIMO is also planning to tape out its first 4nm PCI Gen6 version of MonTitan (as current controllers are 6nm) this year, targeting hyperscalers, NAND flash manufacturers, storage system providers and CSPs. The new 4nm solution is expected to drive growth in 2027 and 2028, with management noting they already have secured a design win expecting to ramp significantly in 2028. 

Ramping for Vera Rubin’s BlueField DPU in 2H 2026 

Silicon Motion is expecting to see tailwinds from merchant GPUs arise in the second half of 2026, from its involvement within Nvidia’s Vera Rubin on DPU boot drives, as well as its NVLink/Ethernet switch roadmap. Management discussed they were involved with other potential customers for enterprise boot drive solutions including a leading search engine firm, with analyst commentary implying that Google may have already been won as a customer, though this was not confirmed. However, SIMO faces two main headwinds at present that could push this growth story to the back burner – timing of the ramp and PC/mobile headwinds, and challenges procuring NAND.  

SIMO explained in Q4’s call that they kicked off volume shipments to Nvidia in the quarter for its current DPU generation, adding that they are also working with the GPU leader “to qualify the next-generation version of their DPU as well as for several NVLink and Ethernet switches of their new GPU/CPU platform that are expected to launch in the second half of 2026.” Management added that the next-gen DPU and switch both require higher capacities, with much higher unit volumes and ASPs, unlocking a new growth opportunity in the back half of the year through 2027. 

This likely corresponds to Nvidia’s upcoming BlueField4 and BlueField4 STX platform announced at GTC, as well as its Spectrum-6 switch family. The STX rack in particular underpins Nvidia’s in-house ‘Inference Context Memory Storage’ platform, an Ethernet-attached flash SSD tier optimized for KV cache at the pod level to accelerate large-context inference. For more on the ICMS platform, refer to our SanDisk analysis here: SanDisk: Shares Up 559% In 2025 On NAND Flash, Enterprise SSD Tailwinds.SanDisk: Shares Up 559% In 2025 On NAND Flash, Enterprise SSD Tailwinds. 

SIMO provided a brief view on the products it is supplying for Nvidia and their role at GTC: MonTitan SSDs for the ICMS platform and KV cache extension, as well as for near-GPU high performance storage; enterprise SSD controllers for compute-optimized, nearline SSD and warm data storage with TLC and QLC SSD support; and PCIe NVMe boot drives and boot drive controllers.  

Given the new nature of this growth opportunity, analysts questioned about the revenue opportunities from BlueField DPUs/boot drives, and how it will play out this year and into next. Management explained that they expect the DPU/boot drive volume to be “very meaningful in 2026” with revenue around $50 million, but next year to be “much higher” as the NVLink and Ethernet switches see “more volume in 2027.”  

This would imply DPU revenue contribution remaining around <5% of revenue in 2026, based on current estimates for $1.27 billion in annual revenue, though commentary for much higher growth with product ramps weighted next year suggests management has already has solid visibility into the business potentially becoming a much more meaningful topline driver by the end of next year.  

However, the discussions also shed light on some primary headwinds SIMO faces. First, the main challenge comes down to timing, with the ramp more weighted in the back half of 2026 and into 2027, whereas SIMO must currently navigate challenging PC and mobile markets. Second, growth depends on NAND procurement which must be bought at market prices, margins must be passed through to customers, and it is not the sole controller supplier for DPUs.  

Headwind #1: Timing 

SIMO did set the stage for a strong year, expecting record revenue and sequential growth in each quarter with Q1 being the lowest for the year, a strong statement considering growth headwinds facing the mobile and PC markets from rising memory costs, with volumes expected to decline YoY in both end markets.  

This is why timing may be the most challenging aspect to SIMO’s thesis, as it is working to ramp its presence in the data center, yet these initial contributions may not be material enough to overcome PC and mobile challenges as the year progresses.  

As noted above, SIMO is forecasting Q1 to be the lowest quarter of the year, primarily impacted by typical seasonal weakness in client SSDs with mobile expected to significantly outperform. Guidance was $292 million to $306 million, or $299 million at midpoint for roughly 7.4% QoQ growth, counter to typical seasonality but decelerating from 15.1% QoQ in Q4.  

Current estimates point to SIMO’s sequential growth decelerating further to 2.7% in Q2 and remaining in the low/mid-single digit range through year-end, overall marking a high teens deceleration from Q3’s peak on current estimates.  

A key factor behind the soft forward QoQ growth is likely the PC/mobile headwinds given the significance of eMMC/UFS controller and client SSDs in terms of dollar growth and revenue contribution.  

Recent projections from Gartner and IDC point to a worsening environment for PCs. IDC had originally forecast an (8.9%) decline in shipments in 2026 in its pessimistic scenario from December 2025, yet it now projects an (11.3%) decrease in shipments this year as rising memory costs force price hikes that bite into demand. Gartner sees a similarly woeful year for PCs, forecasting a (10.4%) decline, with analysts there saying this would represent the “steepest contraction in device shipments witnessed in over a decade.” 

For smartphones, both of the two groups forecast a similarly challenging year. IDC is forecasting a (12.9%) decline in the smartphone market in 2026, a rather substantial revision lower from its December projection for just a (5.2%) decline. For comparison, Gartner projects an (8.4%) decline. This follows low-single digit growth in 2025. 

SIMO does expect to outperform both markets and deliver growth as it benefits from market share gains and improved ASPs, explaining that they will “get the benefit of both higher share and higher ASPs this year in spite of any sort of macro issues around PC unit volumes.” 

However, it is still worth pointing out that there is no guarantee that it will be able to flawlessly navigate what could shape up to be some of the worst growth in PCs more than a decade and potential double-digit unit declines. If these supply chain difficulties persist and cause inventory buildups at OEMs, consumer/client NAND demand could be impacted, and SIMO’s limited data center opportunities (where NAND demand is likely to remain relatively well insulated from rising storage demand) may not be enough to offset growth and margin headwinds.   

Headwind #2: NAND Procurement 

While the PC and mobile headwinds are two challenging external headwinds, perhaps the most challenging internal headwind SIMO will face comes down to NAND supply. This is because the company has to procure NAND itself at market price, and then work to pass the costs on to customers, without benefitting from some of the end-unit pricing power that its customers are seeing: 

“We need to procure the NAND and NAND price at the market price. So we have to work out with the customer, we can pass through the cost increase to the end customer. So it is challenging but ongoing process quarter-by-quarter. It definitely will impact some of our gross margin but we manage the margin pass-through. So I think because even the customers, they have at least 2 to 3 supplier, so they're based on the price and based on the supply and depends the percentage.” 

The challenge here is that NAND prices reportedly rose ~90% QoQ in Q1, and were estimated to increase ~20% QoQ in Q2 in early February, yet the latest data suggests prices could rise 70-75% QoQ in Q2. Recent reports from Korea also suggest Samsung is doubling prices sequentially in the second quarter, implying that pricing is not yet slowing down. Simply put, when input costs rise 70% or 90%, prices must follow at a similar or faster rate in order to preserve margins.  

Considering the boot drive solution is a new product line with minimal revenue contribution until 2H, outsized pricing headwinds this early in its ramp phase could weigh substantially on gross and operating margins, which are already quite thin in the mid-40% and 13% range. This compares to its customers like Micron who are pushing above 80% and 76% next quarter as major beneficiaries of the price increases. 

Management also flagged that growth will be dependent on its ability to secure NAND supply ‘stably’, another major challenge considering SIMO has two NAND suppliers – stated as Kioxia and WDC (though likely to now be SanDisk). Management explained that one of these suppliers is secure, yet the other is not, which could impact their ability to secure stable supply at favorable prices, especially if the second prioritizes allocations to the highest bidder. To note, Kioxia announced in January that its NAND output for 2026 was essentially fully sold out. 

Financials  

Revenue Growth Accelerates to 45.7% in Q4 2025  

Silicon Motion’s Q4 2025 revenue grew by 45.7% YoY and 15.1% QoQ to $278.5 million. Revenue also beat estimates by 6.7%, reflecting the continued strength in mobile business and strong growth in the PCIe 5 SSD business. Revenue growth accelerated by 31.8 percentage points from 13.9% YoY in Q3 2025. Though sequential growth slowed from 21.8% in Q3, it was better than the decline of (10%) in the same period last year.   

Management also provided a strong Q1 revenue guide of $292 million to $306 million, implying a YoY growth of 79.6% and 7.4% QoQ at the midpoint. Management expects continued strength across its products with a particular emphasis on mobile end markets, where it expects significant outperformance driven by continued market share gains.

2025 revenue grew by 10.2% YoY to $885.6 million. Analysts expect revenue growth to accelerate to 43.1% YoY to $1.27 billion in 2026. Management expects 2026 to be a record year, with revenue growing each quarter sequentially, supported by first-half momentum in eMMC and UFS products. To briefly recap, MonTitan enterprise SSD products are expected to scale in the second half of 2026 and contribute 5% to 10% of revenue by the end of the year, with strong growth anticipated in the years ahead. 

Key Segments  

SSD Controllers  

SSD Controller sales increased by 25% to 30% QoQ and 35% to 40% YoY in Q4 2025, compared to an increase of 20% to 25% QoQ and a decrease of 0% to 5% YoY in Q3. Management expects client SSD controllers to ramp throughout the year, though the first quarter is seasonally weaker. They expect the new DRAM-less 4-channel PCIe 5 controller that was introduced last quarter to ramp significantly throughout 2026 and the MonTitan controller ramp is expected in the second half of 2026.  

For the full year 2025, SSD Controllers accounted for 45% to 50% of revenue and revenue declined by 0% to 5% YoY.  

eMMC + UFS Controllers  

The company’s eMMC (Embedded Multimedia Card) + Universal Flash Storage (UFS) controller sales increased by 0% to 5% QoQ and 50% to 55% YoY in Q4 2025, compared to an increase of 20% to 25% QoQ and 35% to 40% YoY in Q3 2025.  

For 2025, eMMC + UFS Controllers accounted for 40% to 45% of revenue and revenue increased by 20% to 25% YoY. Given the current backlog and customer outlook for 2026, management expects to significantly outpace the market and deliver another strong year of growth of the eMMC and UFS business despite the difficult market environment, with the two accounting for 35% to 40% of revenue in 2026. 

SSD Solutions  

SSD Solutions revenue increased by 125% to 130% QoQ and 110% to 115% YoY in Q4 2025 compared to an increase of 15% to 20% QoQ and decrease of 40% to 45% YoY in Q3 2025. For 2025, SSD Solutions accounted for only 5 to 10% of revenue and declined by 10% to 15% YoY.  

The company’s boot drives are part of  its  SSD solutions, and this segment is currently growing rapidly due to the strong AI demand.  

Margins  

The company’s margins are improving; however, management expects slight pressure in Q1 primarily due to product mix, with improvement anticipated as the year progresses.  They expect gross margins to return to the target range of 48% to 50% as the year progresses, as the mix of newer products increases, including the PCIe 5 controllers and enterprise SSD solutions.  

  • Q4 gross profits grew by 56.2% YoY to $136.8 million with a gross profit margin of 49.1%. The adjusted gross margin improved by 320 basis points YoY and 50 basis points QoQ to 49.2%. The improvement in gross margin was primarily driven by the successful ramp of new products and a favorable product mix shift toward client PC products.   
  • The adjusted operating margin came at 19.3%, up 380 basis points YoY and 350 basis points QoQ. Management expects full year 2026 adjusted operating margin to improve despite the higher expenses this year, primarily driven by operating leverage. 
  • Q4 net income came at $47.7 million or 17.1% of revenue compared to $21.6 million or 11.3% of revenue in the same period last year. The company benefited from the realized/unrealized gain on investments of $24.2 million in Q4 2025 compared to $0.1 million in Q4 2024.  

Q4 Adjusted EPS grew by 45%  

The company’s  Q4 adjusted EPS grew by 44.8% YoY to $1.26. Analysts expect strong growth to continue and expect Q1 adjusted EPS to grow by 117.2% YoY and 75.9% in Q2 2026. Looking forward, adjusted EPS is expected to grow by 59.4% YoY in 2026 and 21.9% in 2027.  

Cash Flow and Balance Sheet  

The company’s cash flows have been lumpy, and the increase in inventory to support strong future growth has put pressure on cash flows.    

  • Q4 operating cash flow was $1.6 million or 0.6% of revenue compared to an operating cash outflow of ($6.2 million) or (3.2%) of revenue in the same period last year.   
  • Q4 free cash outflow was ($6.3 million) or (2.2%) of revenue compared to ($17 million) or (8.9%) of revenue in the same period last year.   
  • The company had cash of $201.8 million and no debt at the end of Q4 2025 compared to $198.6 million in cash and no debt at the end of the previous quarter.  
  • Inventories increased by 24.8% QoQ to $421.8 million to support the strong future growth.  

 Conclusion 

 SIMO is guiding for record breaking revenue in fiscal 2026 despite growing headwinds in the PC and smartphone markets from rising memory costs. Q1 is expected to the lowest quarter of the year for revenue with client SSDs seeing typical seasonal weakness, with sequential growth in each quarter thereafter.  The company’s AI opportunities around Nvidia’s BlueField DPUs are expected to arise in the second half of the year and contribute roughly $50 million with a larger impact in 2027, while MonTitan is expected to quickly ramp in 2H to 5-10% of revenue. 

Revenue growth will also hinge on SIMO’s ability to stably procure NAND supply to meet its end market demand, making increasing memory costs a point to navigate for growth.  

An analyst on the call threw out 2027-2028 as potential timing for when the enterprise segment could get interesting. Our analysis points toward something similar, which is that 2026 may be a solid growth year for mobile and also PC yet is unlikely to be the year SIMO breaks out as a major enterprise AI story.  

Given the growth we are seeing in NAND, we felt it was worth our time to look at this stock more closely, yet will put SIMO on the shelf for further review until end of 2026 to see if a few of these green shoots materialize in the AI market.

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.

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

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