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Broadcom (AVGO) is set for strong AI-driven revenue growth in Q3 FY2025, but investors should watch for near-term margin compression due to product mix and management’s cautious long-term outlook.

# Broadcom Inc. (AVGO): AI Momentum Meets Margin Headwinds – Q3 FY2025 Earnings Outlook

## Executive Summary

We maintain a **Bullish** outlook for Broadcom Inc. (AVGO) heading into Q3 FY2025, underpinned by accelerating AI semiconductor demand and robust infrastructure software adoption. **Management’s Q3 revenue guidance of ~$15.8B** (up from $15.0B in Q2) and a projected **AI semiconductor revenue surge to $5.1B** (+46% YoY) signal continued top-line momentum. However, the market may be underestimating the near-term **margin compression risk**—with gross margin expected to decline by **~130 bps QoQ** due to a higher mix of lower-margin XPUs. While the software segment’s high margins and recurring revenue base provide a buffer, investors should closely monitor the evolving product mix and regulatory landscape.

## Recent Trends Signal What’s Next

Broadcom’s last two quarters have demonstrated sequential revenue growth and stable profitability, setting a strong foundation for Q3. **Q1 FY2025 revenue was $14.9B, rising to $15.0B in Q2**, with Q3 guidance at **$15.8B**. Gross margin, while robust at **68% in Q2**, is guided to compress in Q3 due to product mix. Operating margins remain resilient, supported by the software segment’s **76% margin**. EPS has tracked these trends, with Q2 EPS at $10.96 and consensus for Q3 in the $11.20–$11.40 range.

### Quarterly Financial Trend Table

| Quarter      | Revenue ($B) | Gross Margin (%) | Operating Margin (%) | EPS ($) |
|--------------|--------------|------------------|----------------------|---------|
| Q4 FY2024    | 14.6         | 67.5             | 58.0                 | 10.45   |
| Q1 FY2025    | 14.9         | 68.2             | 59.1                 | 10.80   |
| Q2 FY2025    | 15.0         | 68.0             | 59.0                 | 10.96   |
| Q3 FY2025E   | 15.8         | 66.7             | 58.5                 | 11.30   |

**Trend:** Revenue and EPS are rising sequentially, but gross margin is set to dip in Q3.

## Management’s Forward Tone and Positioning

Management’s Q2 call and recent filings reflect a **cautiously optimistic** stance. CEO Hock Tan stated, “We’re seeing strong momentum in AI semiconductors and infrastructure software,” but also noted, “We remain cautious on projections beyond FY2026.” This is a shift from the more unequivocally bullish tone of prior quarters, where management emphasized “unprecedented demand visibility.” The current language—“visibility strong for near term” and “adjusting mix due to lower-margin XPUs”—signals confidence in Q3 drivers but a more measured approach to long-term forecasting.

## KPI Trends & Upcoming Quarter Drivers

Three KPIs are central for Q3:

- **AI Semiconductor Revenue:** Expected to jump from **$4.4B in Q2 to $5.1B in Q3** (+16% QoQ, +46% YoY), driving overall revenue growth.
- **VMware Cloud Foundation Adoption:** Now at **87% penetration among top 10,000 customers**, supporting recurring ARR and margin stability.
- **Working Capital Efficiency:** Continued reduction in working capital liabilities, improving liquidity and supporting EPS resilience.

### KPI Movement Table

| KPI                        | Q2 FY2024 | Q2 FY2025 | Q3 FY2025E | YoY Change | QoQ Change |
|----------------------------|-----------|-----------|------------|------------|------------|
| AI Semi Revenue ($B)       | 3.0       | 4.4       | 5.1        | +70%       | +16%       |
| VMware Cloud Penetration % | 80        | 87        | 89         | +9 pts     | +2 pts     |
| Working Capital ($B)       | 2.1       | 1.7       | 1.5        | -29%       | -12%       |

**Implication:** AI revenue is the primary growth lever; software adoption and working capital gains help offset margin headwinds.

## Missed by the Street

A subtle but important signal: **Management’s defensive tone on long-term demand**—“non-committal on projections beyond FY2026”—suggests that product mix and regulatory risks could impact profitability sooner than consensus expects. Additionally, a footnote in the Q2 10-Q highlights “increased inventory commitments with TSMC,” hinting at potential supply chain bottlenecks if demand forecasts are not met.

## Scenarios for the Upcoming Quarter

### Scenario Table

| Scenario | Revenue ($B) | EPS ($)      | Operating Margin (%) | Key Assumptions                                      |
|----------|--------------|--------------|----------------------|------------------------------------------------------|
| Bull     | >15.8        | >11.40       | >59.0                | AI demand outpaces, favorable product mix, no supply issues |
| Base     | 15.8         | 11.20–11.40  | 58.5                 | As guided, steady software, margin compression as forecasted |
| Bear     | <15.8        | <11.20       | <58.0                | Supply chain or regulatory headwinds, sharper margin decline |

**Most Likely:** The **Base case** is most probable, given current order visibility, management’s tone, and the balance of AI growth with margin pressure.

## Appendix – Data Tables & Management Quotes

### Quarterly Financials Table

| Quarter      | Revenue ($B) | EPS ($) | Gross Margin (%) | Operating Margin (%) |
|--------------|--------------|---------|------------------|----------------------|
| Q4 FY2024    | 14.6         | 10.45   | 67.5             | 58.0                 |
| Q1 FY2025    | 14.9         | 10.80   | 68.2             | 59.1                 |
| Q2 FY2025    | 15.0         | 10.96   | 68.0             | 59.0                 |
| Q3 FY2025E   | 15.8         | 11.30   | 66.7             | 58.5                 |

### KPI Movement Table

| KPI                        | Q2 FY2024 | Q2 FY2025 | Q3 FY2025E | YoY Change | QoQ Change |
|----------------------------|-----------|-----------|------------|------------|------------|
| AI Semi Revenue ($B)       | 3.0       | 4.4       | 5.1        | +70%       | +16%       |
| VMware Cloud Penetration % | 80        | 87        | 89         | +9 pts     | +2 pts     |
| Working Capital ($B)       | 2.1       | 1.7       | 1.5        | -29%       | -12%       |

### Key Management Quotes

1. **“We’re seeing strong momentum in AI semiconductors and infrastructure software.”**  
   – Q2 FY2025 Earnings Call  
   *Signals confidence in near-term growth drivers.*

2. **“We remain cautious on projections beyond FY2026.”**  
   – Q2 FY2025 Earnings Call  
   *Implies uncertainty about long-term demand and potential headwinds.*

3. **“Visibility strong for near term, but adjusting mix due to lower-margin XPUs.”**  
   – Q2 FY2025 Earnings Call  
   *Indicates margin pressure from product mix shift.*

4. **“Over 87% of our top 10,000 customers are now on VMware Cloud Foundation.”**  
   – Q2 FY2025 Earnings Call  
   *Highlights software adoption and ARR stability.*

5. **“We have increased inventory commitments with TSMC to support anticipated demand.”**  
   – Q2 FY2025 10-Q  
   *Points to potential supply chain risk if demand softens.*

6. **“Adjusted EBITDA margin expected to remain above 66% of revenue.”**  
   – Q2 FY2025 Earnings Call  
   *Sets a floor for profitability despite margin headwinds.*

7. **“We are seeing early signs of normalization in demand for legacy networking products.”**  
   – Q2 FY2025 Earnings Call  
   *Suggests some segments may face growth deceleration.*

---

**Bottom Line:** Broadcom’s Q3 FY2025 is set for another quarter of strong revenue growth, led by AI semiconductors and resilient software. Margin compression is a real risk, but the company’s diversified model and operational discipline should keep earnings on track. Investors should watch for any further shifts in management tone or regulatory developments that could alter the margin trajectory.

AVGO: AI Growth Outpaces Margin Pressures