Broadcom Networking Delivers But XPU Story Less Solid

Broadcom (AVGO) Q2 FY25 delivered a slight beat. Total revenue was $15B, up 20% year-on-year. This growth was organic and representative of true growth as Q2 FY24 was the first full quarter with VMware. Revenue was driven by continued strength in AI semiconductors and VMware. The gross margin of 79.4% was better than guided.

Revenue for infrastructure software of $6.6B was up 25% year-on-year and represented 44% of total revenue. Gross margin for infrastructure software was 93% in the quarter compared to 88% a year ago. The growth reflects the success in converting enterprise customers from perpetual vSphere to the full VCF software stack subscription. Of Broadcom’s 10,000 largest customers, over 87% have now adopted VCF.

Semiconductor revenue represented 56% of total revenue in the quarter. Gross margin for the semiconductor solutions segment was approximately 69%, up 140 basis points year-on-year driven by product mix. Semiconductor operating margin of 57% was up 200 basis points year-on-year. The entire semiconductor growth plus some was driven by AI. AI semiconductor revenue of over $4.4B was up 46% year-on-year. Within this, custom AI accelerators grew double digits, while AI networking grew spectacularly over 170%. Much of the growth is likely coming from Broadcom replacing InfiniBand for Hopper-class infrastructure although management talked up Ethernet scale-up (more on this later).

As investors well know, semiconductor industry growth outside of AI has been non-existent. That remains the case at Broadcom. In Q2, industrial and wireless were down sequentially but broadband, enterprise networking and service storage revenues were up. Total non-AI semiconductor revenue of $4B was down 5% year-on-year. Management estimates that non-AI semiconductor revenue is close to the bottom.

Q3 Outlook In-line With Expectations

Management guided Q3 total revenue to be approximately $15.8B, up from $15B in Q2 and up 21% year-on-year. Q3 gross margin is forecasted to be down approximately 130 basis points sequentially, primarily reflecting a higher mix of XPUs within AI revenue.

Management forecasted Infrastructure software revenue is forecasted to be approximately $6.7B, up 16% year-on-year. AI semiconductor revenue is expected to be $5.1B, up from $4.4B last quarter and up 60% year-on-year. Non-AI semiconductor revenue is expected to stay around $4 billion. While enterprise networking and broadband continue to grow sequentially, service storage, wireless and industrial are expected to be largely flat.

Longer Term Forecast Stays But Trends Shifting

Beyond Q3, management noted that the Company is seeing increased visibility and increased deployment of XPUs and networking, much more than they originally thought. The Company is also seeing stronger than expected demand for inference. Overall, management effectively guided to 60% growth in AI this year and next year.

Stacy Rasgon put numbers on the narrative and suggested that it implies $19 to $20 billion in AI revenues in 2025 and over $30B in 2026. While the management commentary suggested a higher SAM, CEO Hock Tan did not want to go into that discussion. Hock Tan presented the updated 2025 and 2026 narrative not as an upside but as a roadmap to previously provided 2027 numbers.

Networking Was The Main Story

The big story of the earnings call was AI networking – both in Q2 and going forward. For Q2, networking represented 40% of AI revenue. This was above management expectations and at the high end of the range that Hock Tan indicated previously. Tan noted that Tomahawk switches, Jericho routers and NICs drove the growth.