Marvell's AI Bookings Are Stellar. But Its Gross Margin Guide Is What Moved the Stock.

Chipmaker Marvell Technology (NASDAQ:MRVL) reported its fiscal second quarter of 2027 results after the market closed on Thursday, and by almost every measure the update was impressive. Revenue marked a quarterly record of $2.739 billion, up 37% year over year, data center revenue grew even faster, and management raised its revenue outlook for both this fiscal year and the next.

Still, the stock fell, dropping about 8% in after-hours trading.

"AI-related bookings remain exceptionally robust, and we expect our revenue growth to accelerate further through the remainder of fiscal 2027," CEO Matt Murphy said in the press release announcing the results.

So what did investors find to complain about in a report like this? I would point to the only figure in the release that moved in the wrong direction: gross margin.

Image source: Getty Images.

Almost everything rose

Overall, the quarter was impressive. Revenue came in $39 million above the midpoint of management's guidance, and the 37% year-over-year growth rate marked an acceleration from the 28% growth in the fiscal first quarter.

Additionally, GAAP earnings per share came in at $0.33, with net income up 58% year over year to $308 million, and non-GAAP (adjusted) earnings per share hit $0.94. The quarter also generated $605.5 million in operating cash flow.

The growth came from the data center end market, where revenue rose 46% year over year to $2.17 billion. That business now accounts for 79% of everything Marvell sells, compared with 74% in the same quarter a year ago.

Moreover, the outlook grew faster than the quarter itself. On the earnings call, Murphy put the company's new revenue outlook for fiscal 2027 at about $12 billion, compared with the previous about $11.5 billion. He also raised the outlook for fiscal 2028 to about $18 billion, from the $16.5 billion he gave just a quarter ago.

So why did the stock fall?

The company's non-GAAP gross margin hit 58.9%, unchanged from the fiscal first quarter but below the 59.4% it reported in the same period a year ago. And for the fiscal third quarter, management guided the number to a range of 57.5% to 58.5%.

In other words, the margin trend here doesn't look good. It went from 59.4% a year ago, to 58.9% in each of the last two quarters, to a forecast centered near 58% -- in a release where every other important number was going up.

Management was direct about the cause.

"Revenue levels and product mix remain key determinants of gross margin in any given quarter," Dan Durn, its chief financial officer, said on the earnings call, pointing to the accelerating custom chip business as the reason. He added that the company expects to keep gross margin in that range in the fiscal fourth quarter as well.

All of this means that the custom chips Marvell designs for large cloud customers are scaling fast enough to tilt the company's sales mix toward lower-margin work. And that ramp is just beginning -- Murphy's release points to significant acceleration in the custom business starting in the second half of fiscal 2027.

In short, the same thing fueling revenue growth is what is pressuring gross margin.

The cost of winning

With this said, demand is clearly extremely robust. Management's forecast calls for fiscal third-quarter revenue of $3.15 billion, about 15% above the quarter just reported. And the company plans to lay out its longer-term strategy at an investor day on Oct. 6, where investors could get a more detailed look at how big management thinks the custom chip opportunity can become.

But on about $3.15 billion in quarterly revenue, each gross margin point the mix takes away costs about $30 million in quarterly gross profit -- and the forecast implies giving up about one point.

Investors, I would say, spent Thursday night repricing what Marvell's custom chip wins cost -- not questioning the strong demand for its custom chips.

The trade-off seems worth it to me. I prefer owning the supplier that wins custom artificial intelligence (AI) contracts with a slightly lower gross margin over one that keeps its margin pristine while losing those designs.

With all of this said, the stock's valuation arguably remains a concern -- even after shares pulled back. Shares now trade at about 35 times expected earnings for the next fiscal year, even after the drop. The stock, after all, has more than tripled from its 52-week low of $61.44. At that price, investors may have assumed growth would come with margins intact.

Daniel Sparks and his clients do not have positions in any of the stocks mentioned. The Motley Fool has positions in and recommends Marvell Technology. The Motley Fool has a disclosure policy.