Second only to Nvidia, Super Micro is a stock that is reporting real AI revenue. As a percentage of revenue, SMCI is reporting 52% in AI revenue compared to Nvidia’s 76% as a percentage of total revenue (data center segment).

Super Micro is sandwiched in the AI trend between hyperscalers and major chip design companies. The company is a server maker that started off by making motherboards and other components before it began making complete systems. The company is unique in that it sits between being an equipment manufacturer (Dell, HP) and being a design manufacturer (Foxconn). Part of the company’s success is due to liquid cooling, which is a popular alternative to air cooling to sustain maximum performance with the added benefit of driving down costs for supercomputers. Liquid cooling is expected to grow from 10% of supercomputers to the “vast majority” due to improving data center power usage effectiveness (PUE) and total cost of ownership (TCO) “by over 40% on power costs.” Please reference our Super Micro overview here.

The AI and GPU rack-scale revenue accounted for 52% of the recent Q4 FY2023 revenue. It was up from 29% in Q3 FY2023 – so nearly doubling in the span of a quarter (!)

For Super Micro, AI-related revenue is expected to march onward with Barclays analyst George Wang expecting it to rise to 70% of revenue in FY2024 and further rise to 80% in FY2025. The management FY2024 revenue guidance of $10 billion at the mid-point was significantly higher than the estimates of $8.61 billion and represents a YoY growth of 40.45%, up from 37.1% in FY2023.

What could cause Super Micro to miss is supply constraints for components. This was outlined in the last earnings write-up when we stated “Supply is the primary headwind; not demand.” With that said, management seems to be confident in the current guide, with supply more of a factor as to whether they raise revenue guidance in the future. Anything can happen, but that was our interpretation in the last earnings write-up.

Here's a quote from management: “However, given the record high backlog, we see fiscal year 2024 revenue between $9.5 billion to $10.5 billion with room to deliver more depending on availability of supply.”

Revenue and EPS

The company’s Q4 FY2023 revenue grew by 33.6% YoY to $2.18 billion. The management Q1 guidance is in the range of $1.9 billion to $2.2 billion, representing YoY growth of 10.8% at the mid-point. The consensus analysts’ estimate is $2.06 billion, representing a YoY growth of 11.4%. The guidance was lower due to the key component supply shortages, and strong growth is expected for the remaining quarters of the fiscal year.

The management Q1 GAAP EPS guidance is $2.02 to $2.80 and adjusted EPS guidance is $2.75 to $3.50. The consensus adjusted EPS estimate is $3.22, representing a YoY decline of (-5.8%). The EPS also follows a similar trend of solid growth like revenue for the remaining quarters of the fiscal year.

Margins

The adjusted gross margin was 17.1% compared to 17.7% in Q3 and 17.6% in the same period last year. The gross margin was lower as the company focused on market share gains. The management expects the September quarter adjusted gross margin to be similar to Q4.

The operating margin improved 30 basis points YoY to 10.4%. The adjusted operating margin improved 30 basis points YoY and 230 basis points QoQ to 11%. The strong QoQ improvement in margins was due to higher revenues that outpaced increases in operating expenses.

The operating margin guide for the next quarter is 8% and adjusted operating margin is 10.4%. The lower operating margin is due to higher operating expenses from a continued increase in R&D expenses and higher personnel costs.

The net margin improved 30 basis points YoY to 8.9%.

Overall, these margins are slim and this is always a focus in the earnings calls. The 10%+ OM is strong enough to be acceptable on a GAAP basis, yet is also thin enough to have to monitor quarterly.

Cash Flow and Balance Sheet

Operating cash outflow in Q4 FY23 was (-$9 million) compared to cash flow of $198 million in Q3 and cash outflow of (-$25 million) in the same quarter last year. The drop in cash flow was mainly due to higher accounts receivable. We will look for improved cash flow in the upcoming quarter.

The free cash flow outflow was (-$17 million) compared to free cash flow of $190 million in Q3 and free cash outflow of (-$36 million) in the same quarter last year. Lumpy is okay as long as fiscal year is positive. For FY2022, the company reported negative cash flow of (-$485 million). For FY2023 ending in June, the company reported positive cash flow of $626.8 million.

The company has cash of $440 million and debt of $290 million. It has a net cash position of $150 million, down from a net cash position of $176 million in the previous quarter. Per management: “we utilized our bank lines of credit to support higher revenues and accounts receivable as we ramped up production of new AI/GPU design wins.”

Key Metrics:

The AI and GPU rack-scale revenue accounted for 52% of the recent Q4 FY2023 revenue. It was up from 29% in Q3 FY2023. Barclays initiated coverage on the company with an overweight rating citing company’s exposure to AI. "Against the backdrop of AI investment trends, we believe SMCI is well positioned to capture the rising AI server opportunity with more share gains ahead driven by its superior design capability and strong AI partnerships." with more share gains ahead driven by its superior design capability and strong AI partnerships." The analyst also believes that AI-related revenue will increase to 70% in FY2024 and further to 80% in FY2025.

The OEM appliance and large data center revenue of $1.17 billion grew 59% year-over-year and 94% QoQ. The boom in AI-related data center sales helped to push this segment to over 100% growth in FY2023.

The Enterprise and channel vertical, which also includes AI/ML revenue, was up 19% year-over-year and 51% QoQ to $976 million.

What to look for in the earnings report:

1) Visibility on Supply:

Charles Liang, Founder and CEO of the company, said in the last earnings call, “Due to the current key components supply shortages, we forecast revenue in the range of $1.9 billion to $2.2 billion for the September quarter. However, given the record high backlog, we see fiscal year 2024 revenue between $9.5 billion to $10.5 billion with room to deliver more depending on availability of supply.” “Due to the current key components supply shortages, we forecast revenue in the range of $1.9 billion to $2.2 billion for the September quarter. However, given the record high backlog, we see fiscal year 2024 revenue between $9.5 billion to $10.5 billion with room to deliver more depending on availability of supply.”

Regarding the possibility high revenue (all dependent on supply), this was what was discussed on the call – with the CEO making it abundantly clear the revenue will follow the supply outlook.

Ananda Baruah:

“[…] And so I guess the first question is, is what's the opportunity do you see to maybe even do teach stronger than the fiscal '24 guidance. I guess, what would be the puts and takes there? And, if you were to be able to exceed the 2024 guidance, what would be some of the things you think would need to occur?”

Charles Liang

“[..] And for sure, they need 10 times 20 time more system. And we just cannot ship at this moment, because of supply chain […] So I mean, we are on the right track, yes expecting supply chain can improve so that we can grow our revenue.

2) Nvidia Relationship:

You can expect Supermicro to continue to play up its relationship with Nvidia in the upcoming earnings call.

The company recently announced the shipment of Nvidia GH200 Grace Hopper Superchip-based servers. So, there could be more updates in the earnings call regarding the company’s capabilities in AI. In the last earnings call, Charles Liang said, “Couple of months ago, I was honored to have my close friend, NVIDIA CEO Jensen Huang, join me on stage at Computex to highlight our optimized new generation GPU solutions for this AI era. We are deploying not just systems, but complete rack-scale total solutions to large generative AI innovators.”

3) Cash flow and Margins need to be decent.

Cash flow was negative in the recent quarter due to high accounts receivable. However, we will keep an eye on cash flow in the upcoming quarter. There was a question in the earnings call about working capital needs and whether they can generate positive cash flow going forward. Per management: “Yes, John. We see the business generating good cash flows, as it has historically. And we think that the — especially in this constrained supply market, where we could deliver more if we had more supply. But we're so really, the constrained supply ends up moderating the working capital. And so we grew our business last quarter quite a bit and grew our ARR. So that utilized a lot of working capital, but we have no concerns about working capital.”

As stated, operating margins are always a point of focus for SMCI on the earnings calls.

Conclusion:

Investing is a sum of calculated bets. AI will continue to be a powerful trend into the foreseeable future and our plan is to position for this. Supermicro is the #2 company for AI-related revenue (as a percentage of revenue), and this is not an easy achievement given the other companies that are gunning for AI-related revenue are juggernauts with billions in cash. However, we are no stranger to the ups/downs of sentiment in the tech sector. Strong companies with perfect earnings reports will selloff, sometimes drastically, and then often power higher. You can expect us to use all the technical analysis tools at our disposal to manage this position: setting stops, hedging at times, layering in more, trimming at the top. We think SMCI is well worth the effort.

Notably with SMCI and all of our positions, what would get us to change our mind is a material change to the margins and cash flow. We respect the FED, we don’t fight the FED. You can look for our post-ER write-up Wed night!

Read our deep-dive analysis on the company here and our past coverage here and here.

Royston Roche Equity Analyst at the I/O Fund contributed to this analysis

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