In our last write-up, we called Super Micro the “AI Bullet Train” due to neck-breaking growth rates. Last quarter, the company reported a notable 103% year-over-year growth, with revenues surging to $3.66 billion. Management's projections are for nearly double the growth, anticipating Q3 revenues to range between $3.7 billion and $4.1 billion, or growth of 204.7% year-over-year at the midpoint. Consensus estimates are for $3.92 billion, for 206.3% growth expected in tomorrow’s print.
Such predictions underscore a consistent upward revision in earnings guidance, reflecting anticipated strong growth for the remainder of the fiscal year and extending into 2025.
To understand how we got here, it was through multiple analyst revisions. For example, the March quarter started with estimates of $2.1 billion in August for growth of 45% but were revised by 160 points (!) to $3.92 billion for growth of 205.7%. The June quarter was seen upward analyst revisions increase by 92 points, and the September quarter’s numbers revised by 82.7 points in the span of one quarter!
Here's what that looks like:
The takeaway is that Super Micro’s bullet train-like price action is based on upward revisions, which is unique from earnings beat/raise or simply strong estimates. In fact, the stock was down (-12%) following its last earnings report and is now up 80% since that call with gains as high as 135%. This is a stock that does not rely on earnings pops, like most growth stocks, and rather, it requires a bit of tenacity as the intra-quarter changes have been quite profitable.
With that said, below is a deeper look into SuperMicro, including the underlying factors contributing to these impressive figures ahead of tomorrow’s Fiscal Q3 results and the risks that accompany this high beta stock.
Revenue and EPS
Last quarter, the company’s Q2 FY2024 revenue grew by 103% YoY to $3.66 billion. Management Q3 guidance is in the range of $3.7 billion to $4.1 billion, representing YoY growth of 204.7% at the mid-point. The consensus analysts’ estimate is $3.92 billion, representing a YoY growth of 206.3%. The guidance has increased consistently through recent months as strong growth is expected for the remaining quarters of the fiscal year and into 2025.
The drop off in Q2 FY25, which is calendar year Dec 2024, will be key to keep an eye on following this earnings report. It may seem far off but this is a high beta stock that gets slammed on any weakness. The opposite can also happen, which is that we see more revisions which supports the price action extending, as outlined in the introduction above.
Fiscal year estimates were revised upward over the past year by 87.8 points for growth of 105.5% and revenue of $14.6 billion. This is higher than the midpoint of management guidance for revenue of $14.5 billion, at the midpoint. Next fiscal year ending June 2025 has been revised upward 33 points to 44% growth. We will be watching these estimates closely as we manage our position intra-quarter throughout the next few months.
GAAP EPS for December was $5.10 compared to analysts’ consensus of $4.90. This is nearly 80% higher sequentially with $2.85 GAAP EPS in the previous quarter and is 62% growth from the year-ago quarter. Adjusted EPS was $5.59 for similar YoY and QoQ growth.
Looking forward, next quarter’s GAAP EPS is expected to be between $4.79 and $5.64 for over 240% growth from the year-ago quarter. Adjusted EPS of $5.60 at the midpoint will see similar YoY growth.
Note: Normally, we’d be hesitant to see the slowing growth on both top line and bottom line pictured above as moving from hypergrowth to average growth tends to cause a re-rating in valuation. However, we’d like to see if SMCI will continue its pattern of seeing upward revisions given the strength of the AI trend.
Margins
- Gross margin was 15.4% in Q2 for gross profit of $564.4 million
- Operating margin was 10.1% for operating profit of $371.5 million and adjusted OPM was 11.3%
- Net margin was 8% for net profits of $295 million. Adjusted net margin was 9%
Adjusted gross margin was 15.5% for Q2, compared to 17% in Q1 and 18.8% in the same quarter a year ago. On the gross margin declines, management stated: “in order to take market share, we will take opportunities by being more competitive on pricing.”
The gross margins guide for Q3 is expected to be “slightly lower than Q2 levels.” This indicates another YoY and QoQ decline in gross margins if the management’s guide is correct. The goal is that margins will return to baseline once the company is operating at scale. However, it’s worth mentioning that stocks with thin margins tend to underperform in a Fed-driven market. This is one reason we will adhere to stops with SMCI.
Margins on SMCI tend to be thinner than most semiconductors, which is a key topic of analysts’ focus during each earnings call. The CFO has stated the target margin is between 14% and 17%.
Cash Flow and Balance Sheet
Operating cash flow reached (-$595) million, with a margin of (-16.2%). This performance contrasts with the positive margins of +12.8% and +9% reported in the September quarter and the June quarter, respectively.
The CFO explained that the cash outflow in operations for Q2, totaling (-$595) million, was a shift from the $271 million generated in the prior quarter. Despite robust profitability and an increased level of accounts payable, this was counterbalanced by a rise in inventory and accounts receivable, driven by preparations for Q3 and shipment timings in Q2.
Cash flow will be a primary focus on the call as any additional quarters that report negative free cash flow will force investors to price-in future stock dilution and cash raises. This line item can cause the stock to be re-rated should it continue to be weak.
Free cash flow was also negative at (-$610) million, representing a (-16.6%) margin, compared to positive margins of +12.7% last quarter and +8.4% in the corresponding quarter of the previous year.
On its balance sheet, the company reported $726 million in cash and $376 million in debt, up from $543 million in cash and net debt of $146 million in the previous quarter. Consequently, the net cash position stood at $350 million, slightly down from $397 million in the last quarter.
The company boosted its cash reserves with an equity offering. As stated by the CFO, the proceeds from the equity offering will be used to strengthen working capital, continued investments in R&D and expand global capacity.
Key Metrics:
In the latest quarterly financial update, the OEM Appliance and Large Data Center segment led the company's revenue streams, contributing $2.15 billion, which accounts for 59% of total revenue. This segment saw significant growth of 175% year-over-year and 83% quarter-over-quarter.
The Organic (Enterprise & Channel), AI/ML segment followed with $1.48 billion, making up 40% of the revenue and growing by 55% year-over-year, fueled by enterprise AI initiatives and CPU upgrade programs. The 5G, Telco, and Edge/IoT sectors, however, represented just 1% of revenue at $35 million.
In terms of the revenue mix, server and storage systems generated $3.4 billion and comprising 94% of the quarter's revenue, reflecting a year-over-year growth of 107%. Subsystems and Accessories contributed $229 million, accounting for the remaining 6% of revenue and marking a 61% increase from the previous year.
Inventory management improved, with inventory days reducing to 67 from 91 in the previous quarter, indicating a tightening of supply as noted by the management.
What to look for in the earnings report:
1) Declining margins are going to be a key focus of analysts.
Notably, Super Micro has weaker margins than Wall Street prefers and tend to be weaker amongst its peers. It’s no surprise when analysts pick up on this during the call and slide in a question or two on it.
Last quarter, there was a large revenue beat that did not flow through to a higher gross margin or operating margin, and in the following Q&A session, the CFO stated: “And so, at this time we are we are growing really quickly. And in order to do that and in order to take market share, we will take opportunities by being more competitive on pricing.” The CEO followed up with: “The good thing is that when we continue to grow our economies of scale, our operation margin indeed will be still able to keep in healthy position.”
2) Nvidia Relationship – Liquid Cooling Reaches Inflection with Nvidia’s B100s
Super Micro is primarily air cooled right now, yet liquid cooling is growing. Per the CEO in the opening remarks, we can expect major updates in the coming quarters on their progress: “By this June quarter, we will have high volume, dedicated capacity for manufacturing 100 kilowatt to 120 kilowatt racks with liquid-cooling capabilities, providing DLC, direct liquid cooling racks capacity up to 1,500 racks per month and our total rack production capacity will be up to 5,000 racks per month by then.” To read more on liquid cooling, reference our previous Super Micro analysis here.
3) Conservative Commentary by Management
This word, “conservative,” has been continually referenced by management in recent quarters. We hope to continue to hear the twelve-letter C-word from SMCI tomorrow evening!
David Weigand
“[…] And so really as Charles mentioned earlier, our only constraint is supply. However, the good news is, the supply is improving. And so, to your point, we have to be somewhat conservative, because we are constrained still by supply.”
Conclusion:
Despite facing declining gross margins, the firm's substantial year-over-year revenue and EPS growth underscore its product strength and positioning in a fiercely competitive environment. In case it’s not clear, Super Micro is an outlier and it all comes down to product differentiation, which you can read about here.
The stock seems to be on a never-ending winning streak, however, what could be Super Micro’s Achilles heel is the cash issue — as the company must grow capacity to keep up with the revenue growth, yet to do so will require cash.
Due to the high beta nature of Super Micro, I foresee us trying to ride this wave a few more times in the coming years. We will play this one with the understanding that volatility goes both ways, armed with the information that it’s the upward revisions that reward this stock (mainly intra-quarter), and it’ll be negative cash flow margins and/or dilution that penalizes the stock.
Overall, for our risk profile, entries in high beta stocks are accompanied by a strategy and with predetermined stops. You can read more about our line in the sand here along with upper price targets.
Chad Shoop, Equity Analyst for the I/O Fund, contributed to this analysis
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