Super Micro Computer, Inc. (SMCI) Earnings Call Transcript & Summary

Sorry, it's standing room only, but that tells you how important AI and this particular company is to AI. Thanks, everyone, for attending day 1 of our Global Technology Conference. My name is Ruplu Bhattacharya. I'm a Director with the Equity Research team covering IT hardware and electronics manufacturing services companies. We're starting the session today with Super Micro Computer, and we're honored to have CFO, David Weigand here. David has been with Super Micro since 2018, and he was appointed CFO in February of 2021. But before that, he's had lots of industry experience with companies like HPE, NEC, Renesas. So I'm sure we're going to have a great discussion today. And also in the audience, we have Krishna Shankar and Michael Staiger from IR as well. So David, thank you for attending our conference today.

I want to start by saying investors should refer to safe harbor statement regarding risk factors and forward-looking comments, which are available from the Super Micro IR website.

So great. So obviously, artificial intelligence is on everyone's mind. Maybe talk to us about how you see the market for AI servers evolving over the next couple of years? And do you think the market is missing something here?

The way we see market [indiscernible] global. So in Europe, the -- and then we also see the inferencing. So I think those are some of the general trends that we see. I think in terms of maybe what the market could be missing is that AI, accelerated computing really represent the delivery of the promise that big data put out, which was [indiscernible] okay. So big data promise to deliver better factories, better cities, better homes, and we do the analysis of the data. But what AI is doing is delivering. And that's the difference between the long-term -- the bubble and long-term plan. And you think back to some of the long-term plays like databases or like an [ SAP ], they really -- they took hold long ago and they're still with us. And we see AI as really the delivery of the [ prompts ] to big data. Now we understand big data [indiscernible] much faster in solutions [indiscernible], which gives you a stronger, better forecast for whether it gives you reduced times for drug delivery, the ability to offer security in cities and things like that. So there's a lot of -- a lot use cases that are out there. And really, the next development is really the software, which will help to further utilize the capabilities of these AI machines.

All right. So maybe David, if you can talk about your target customer segments, just for the people in the audience who don't know what your focus areas are.

Sure. We're principally split between what we call our enterprise and what we call enterprising channel. So that means we address the enterprise through both channel partners and also direct. And our business has tended to go more direct. And then on the other side, we have large data centers and what we call OEM appliances. OEM appliances are really software packages like -- that are being made by Nutanix. They sit on top of our hardware to help them to deliver their solutions.

So you've had great success with the Tier 2 CSPs. But one investor concern that I've heard is, can we expect demand to sustain at that customer set? Maybe give us your thoughts on that.

Well, the CSPs are one of the best places to deliver AI as a service. And the reason for that is they are solely focused on developing the software stack necessary to enable the use cases for speed and for flexibility that are required by AI labs, enterprises and also large cloud providers. So their focus in that area has enabled them a strong place in the marketplace, and we think that will continue.

Okay. Maybe talk to us about hyperscale. I mean how do you see that segment as a customer set? And is that a target segment for you? And is any of your guidance based on revenue from hyperscale?

Yes. Well, there is -- first of all, a lot of people don't appreciate how much money and effort that the hyperscalers spend, especially money, how much they spend in enabling their AI solutions. You can think about the amount of money that Microsoft spent on AI, on the software side, but also developing chips and all that takes a tremendous amount of investment. So when they are able to develop their own reference designs, then they can -- they often will take those to a CM, to a manufacturer at the lowest possible cost. So we are not interested in that -- in the race to the bottom for reference designs. However, a lot of times, they may have need for either overcapacity or there's some place in the market where we can play. And so in those instances -- and that includes, by the way, sometimes they will use capacity through the CSPs. So therefore, there's different places that we can play. We're glad to do that as long as we can deliver the return to our shareholders that we're trying to deliver.

Okay. Maybe I want to talk about some recent media articles and some chatter about Super Micro losing share to Dell. And really, we hear about CoreWeave and we hear about Tesla. Can you give us your thoughts on that? Do you agree with that? And what is your strategy for gaining share in the market?

Sure. If you look at our sales performance, for the 9 months ended March 31 fiscal year '24 versus fiscal year '23, our revenues are $9.6 billion, which is up about 95% over the prior year. And I think that kind of establishes the case that we're obviously gaining share at a rate that's pretty much faster than the industry. And by the way, if you look at our EPS on a non-GAAP basis at $15.77 in the 9 months, that's about a 90% increase over the prior year. So we're doing that comfortably. And so the only thing that has restrained us to date is supply. And so if somebody else is able to take share, it's probably because they have to go to their second or third choice, because we don't -- because we only have -- we can only get so much supply. So supply has definitely restrained our growth. And there's no question that we would be further ahead in the numbers, because that's why what's caused our backlog to grow. We'd be further ahead if we had more supply.

One of the things that we've heard is Dell has a financing arm. Do you think that gives them a competitive advantage? How do you see that? And how important an issue is funding for Tier 2 CSPs?

But I think if you look at the amount of funding that CSPs for instance, have been able to obtain, I mean, you're talking about billions of dollars in capital and multibillions of dollars in debt that's been available to fund GPUs. And so whether you're talking about Blackstone, BlackRock, Macquarie, Magnetar, there's a lot of people, there's a lot of finance companies that are ready to back -- and this, we're talking about in the U.S., by the way, that are ready to back the proliferation of AI as a service and of GPUs. So they're willing to finance that. So the money is already -- the money is out there. And so that's not -- that's really not a -- not been a case, an issue for us.

David, I want to go back to the target customer segments. At some point, enterprises will start inferencing. Do you think Micro needs to reorganize itself as you target that segment, especially maybe in aftermarket services? Typically, you would think of Dell and HPE as companies who are more into enterprise. So what is your strategy for gaining share in that market? And do you think you need to do any reorganization of the company?

Yes. So first of all, we're -- enterprise represents 50% of our business. So the 2 verticals that I gave you were roughly 50-50. So we're already entrenched into the enterprise and with a lot of different use cases. And so we -- what we need to do is we need to continue to do what we've been doing for the last 31 years, which is bringing the very best AI solutions to market. And by the way, at GTC, Jensen Huang was in our booth. And this is on our YouTube, and he said if you want the very best AI solutions, buy Super Micro. And as far as I know, the very best means only one.

In terms of spending, do you think AI spending on servers is cannibalizing other areas of IT spend, such as on industry standard servers? How do you see that market evolving?

Yes. There are industry experts, like IDC, like Accenture, which have told companies besides the fact that they're putting their money where their mouth is in their requisitioning, I don't know, some 80,000 employees, I heard to work on AI. But they've told companies that if you don't figure out your AI strategy, you could be finished essentially. And so yes, a lot of companies are -- have decided to take a look, okay, let's make sure we have our AI strategy in place. And we can do our refreshes later, because you know what, there's a lot of new processors that are coming out. So we can sort that out later. We want an Intel or an AMD or an NVIDIA CPU and GPU, so we can figure out that later. But let's -- right now, we'll focus on the AI strategy. So yes, there is some of that that's going on for sure.

David, one thing you mentioned just now is that some of the constraints on your growth is availability of components. Let me just talk a little bit about that. Is your growth constrained by how customers are putting in data centers availability of our space and other components? So just talk about the environment there.

Yes. So we have started to ship liquid cooling at -- really at scale, at larger volumes in this quarter. And so there's no question that, that industry is coming up to speed with the reality of where we're going, which is the fact that power is constrained all around the world. And therefore, when you build these large data centers, you're going to have to think twice now about using liquid cooling, because by using liquid cooling, you can not only -- we say that it's free with a bonus. And that's because -- it's free because you're not only having to put in smaller chillers. You don't have to use air conditioning if you have really liquid cool racks, but you can put more dense racks and more racks into a data center. So it's more efficient if you're using liquid cooling. And so it's really the cutting-edge companies right now that are putting in liquid cooling, liquid-cooled racks into their data centers. So that's -- the huge use of power right now is going to really drive liquid cooling as much as the fact that the -- all the GPUs and CPUs are running at higher wattage. As they go over 1,000, it's going to start to become painfully obvious.

I'll ask one more question on competition. Overall, if I look at this space, the AI server market is becoming really competitive. I mean, there are lots of companies who are making AI servers. And when I look at it, just about everyone has their own flavor of liquid cooling, right? So talk to us about whether you think Super Micro still has a competitive advantage in this space. And what do you think is the competitive advantage for Super Micro even in this competitive market?

So the competitive advantage, to figure out what the competitive advantage is, you just really have to look at our financial statement in the last few years. Because what we said, we were announcing many quarters ago, I think I'd have to look back, it was 7 quarters approximately, when we said that AI is driving our growth. And we then started to give a number. We started to say 20%. And then we said 28%. And then we said 50%. Now we just say over 50%. So our competitive edge is that we were -- our CEO, who is one of the best engineers in the world, first of all. And he developed a supercomputer for Jensen Huang at NVIDIA over 10 years ago to work on AI. So AI is not something that is new to us. We were working on that a long time ago. That's why a couple of years ago, we had -- we started to come out with a full suite of product offerings. That's driven our growth. So now, of course, everyone is running and rushing to the party. This is nothing new to us. It's really a lot of the same players out there because with the number of employees that we have, we're half engineers, okay? We're very focused on what we do. We're not trying to be all things to all people. We're trying to build the very best customized servers and for some of the best companies in the world. And we -- it's taken us 30 years. We -- a lot of our engineers are well tenured. We probably have 40,000 years of experience in hardware and software design. So that's all going into bringing the best products to market.

So you just said maybe more than 50% of your revenues are tied to AI. The market share data in the AI server space is hard to come by. Do you have an estimate for what your market share is in the AI server market?

We don't try to come out with market share data. We really just are focused on trying to do the very best that we can to raise shareholder value, bring good products to market.

Okay. David, maybe I want to move to the topic of margins, because I think recently, that's come up, some of your competitors have reported. You've talked about gross margin staying in the 14% to 17% range. But when we think about new accelerators that are coming out from NVIDIA, AMD, when we think about the GB -- the new Blackwell, the GB200 systems, is that reasonable to think that you can maintain gross margin in the 14% to 17% range? And also, when you think about operating margins, you've been able to maintain your overall operating margin in the 10% to 11% range. So is this something that you can maintain? Or do you think because of competition, we should expect margins to erode over time? So just talk to us about your general thoughts on margins, gross and...

Yes. So on operating, yes, the last 4 quarters, we've been between 10.8% and 11.3%. Our OpEx as a percentage of revenues, if you look at the last fiscal year, the year ended 2022, I think it was about around 7%. And in '23, it went down to -- actually, I guess, it's gone down to about 4 -- about 4.5% for the 9 months. You take 9 months of fiscal year '24 versus 9 months of fiscal '23, it's come down from 7% to 4.5%. So that's really just leverage increasing revenues 95%, you're getting a much better lift on operating. Now on the gross margin, again, we've been doing this for 31 years, and we've been competing against a lot of the same companies. We believe that we charge a very fair margin. We're not charging 50%, 60%, 70% margins, we're down there in that 14% to 17% and working very hard, because we manufacture right here in the South Bay area, 70% of our manufacturing right now. We have moved more over to Taiwan, and we're building a new -- a very large facility in Malaysia in an attempt to lower our manufacturing costs and not stop doing so much around shipping of components. So imagine, a lot of components, of course, come from Asia, so we're bringing them over to the U.S. We're doing assembly tests here. We're shipping back out to Europe and to Asia, very inefficient. So manufacturing more in Asia is going to help us out.

Just keeping on margins, I think the guidance for fiscal 4Q implies gross margins less than that 14% to 17% range. So what's happening in the near term in the June quarter? And how quickly can margins get back into the range?

Yes. So I don't want to update any guidance that I've given. But I'll just say that we've been successful at keeping our margins in 14% to 17%. That is our target. We're going to do everything that we can to keep them there. Yes, it is very competitive out there. And there will always be companies that are trying to buy their way in using margin. However, one thing that you can't dispute, that is Super Micro brings not only the best performing products, but also very reliable products and the lowest total cost of ownership. So with -- we designed our service to be very energy efficient, which means they manage heat really well. And so that goes into the design of our chassis, which we do and the design of our motherboards, which we do. And the design of those things greatly affects energy consumption. You add on top of that our expertise in liquid cooling and the fact that our company is -- has been devoted long before it became popular to being a green computing company and promoting low-power computing. The fact that our CEO has a foundation, it's committed to propagation of drought-tolerant trees. So we're -- everything that we do is geared toward energy reduction, right? So I guess that was it. So that's part of our DNA.

David, another investor concern that we've heard is that [ Basel III ] Super Micro was not one of the reference manufacturing partners for the NVIDIA GB200 NVL72 reference rack. So a couple of questions on that. First, now that NVIDIA has a reference design for racks, do you think that more people will just go to NVIDIA and buy the racks? I mean, what value add can Super Micro provide? Does this -- and maybe related to that is, does this suggest anything about the evolving relationship with NVIDIA? How strong the relationship do you still have with NVIDIA? And so why don't you answer those for now, and I'll ask you some more.

Sure. There's a few questions in there. We'll take them one by one. So first of all, if you talk about the relationship, our CEO, Charles Liang, will be speaking at Computex at 6:30 p.m. tonight, California Time, which is 9:30 a.m. over in Taiwan. So he'll be speaking and his on-stage guest will be Jensen Huang. So maybe they'll address some of the things that you might be interested in. But again, when you talk about that relationship, it goes back 10 years. The fact that we were very close to their engineers, we have no concerns. Some people do like a reference design. Some people like a house that's fully furnished. They want to go in and they don't mind paying more to have all of the furniture in place and the art work in place and all the lighting fixtures chosen by someone else. But there's a lot of people we found over the last 30 years that actually don't like that. And they come in and they say, you know what, I don't like that painting, and I don't like the carpet. And they want things done their way. And I think if you look at, say, Microsoft, for example, they have announced that they're going to offer different CPU, GPU offerings because people do like choices. And so -- but you know what, we're glad to build anything that's out there, and we can build anything that's out there faster than anyone else because we have an engineering-centric company, and that starts from the top. And so Charles studied engineering down in UT Arlington and took his master's degree there, but came over to the U.S. to work on expert systems, oddly enough, which is really kind of now one of the deliveries of AI.

David, another concern we've heard from clients is you have a lot of backlog, but do you have the capacity to actually get the revenues to actually do the manufacturing? Talk to us, how much revenue can your existing footprint support? And how do you see that capacity growing over the next couple of years?

Sure. So if you look at the guidance that we gave for revenue in the June quarter, we gave a guide of $5.1 billion to $5.5 billion. Now that would suggest a run rate. I'm just talking -- we're talking about capacity, would suggest a run rate of $20 billion, right? So we also talked last quarter about a path to $25 billion. And we said we're finishing out Malaysia, and we're working on other sites as well. So we certainly would aspire to get to $25 billion and beyond. But that's all I'll say about that.

Speaking in Malaysia, I mean, is it that -- will it be dilutive to margins initially because I think you're building components and not full racks in Malaysia? And how do you see that impact evolving over time?

Yes. Actually, we're not building components in Asia. We will be building complete servers, and we will be building as soon as possible, complete racks and even liquid cool racks. So our intentions there are to ramp that side up as quickly as possible over in Johor, Malaysia, which is about 25 minutes from Singapore. So it's a very good location in Southeast Asia. And so we have great hopes for that site. And -- but it will be a full service location.

Maybe, David, I want to ask you about sovereign AI because this seems to be -- have the potential for large buys. The sovereign entities have a lot of money. So talk to us about how you see Super Micro benefiting from sovereign AI. Are you talking to any sovereign entities? And are there any specific requirements for sovereign AI which makes Super Micro better suited for servicing that?

Well, I think besides what we believe is providing the best products, I think that's a good start. But we also think that we're uniquely focused because of our emphasis on engineering and on the ability to provide unique solutions. So we not only build servers for very large enterprises, but we also build very small servers that go into, say, restaurant chains across the U.S. And in fact, we were awarded Supplier of the Year a couple of years ago, got by Yum! Brands. And so we build a lot of different types of servers across the board. And so we think that, that's a strength.

I want to come back to margins, specifically on liquid cool racks because I think this is something that most data centers will need over time as the GPUs consume a lot of power and heat. So is the margin range still 14% to 17% for liquid cool systems? And why is that? I mean can you give us some details on what is it that you're making versus what are you going to third-party providers for? And why wouldn't you be able to charge more for a liquid-cooled rack?

So we absolutely -- liquid cooling is definitely an uplift, but it's only going to be in that 5% to 10% range, depending on the configuration of the rack. So it's not a huge uplift in cost. It does cost more, and it takes a little bit longer to assemble and test and -- but the answer is that we will charge more for that. And we also still expect to get our margins because we put a lot of engineering into the design of that liquid cooling. And we think that it's one of -- it's a best-in-class solution. So -- and by the way, there's a lot of people that are talking about liquid cooling and having liquid cooling solutions. And then there are people like us that are actually shipping it. And so that will soon come out with who's talking about it and who's actually shipping it and at what numbers, because we will be ready to talk about how many we were actually able to ship. Of course, as I mentioned, we're still in -- we still have supply constraints that we face every day. But we think that, again, that does not change our target margin at all with liquid cooling.

David, let's talk about working capital. So to support growth, you need to support a lot of working capital. When do you make the determination or how do you make the determination that you need to raise more capital? And how should investors think about your trade-off between using more debt or using -- doing another equity raise?

Yes. So we've had to do a couple of raises in the past 6 months because we saw that the permanent level of our business was going up higher. So it wasn't temporary. Now remember, as a manufacturer, if we sell $1 billion, an additional $1 billion in a quarter, we have to -- and remember, when I first started, we were doing about $3.5 billion a year. And now we're doing more than -- well more than that per quarter. So if you -- when you're increasing by $1 billion in a quarter, you've got to go out and you've got to -- let's say, even if your margin is 20%, you've got to -- you have to buy 80% of materials. And you've got to -- you have to carry those through inventory, you have to carry them through accounts receivable until they convert to cash. And so it becomes an immediate problem. And we've had some very large customers come -- I've sat across the table from them and they say, we have 2 questions. Do you have the capacity? Do you have the capital to take this project on? And so we had to go out and get some more permanent capital so we could answer that question, always yes. So we finished out with $2 billion at the end of the last quarter. We think that the things that we've done in terms of raising the visibility of the company, raising the profits, raising the sales have been good for our shareholders. And we want to continue to balance that because we don't like dilution. We previously used to repurchase shares. That's not -- that's still in our tool bag. But right now, it's about being able to deliver against our backlog. And so therefore, we want -- we will get as much capital as we need to in order to do that. And so it's really about whether you see with short-term debt, we can address temporary increases. But if we see sustained orders, such as we have seen, then we're going to have to do more and some more permanent debt raises like we've done with the convertible bonds and also with the common stock equity raise...

David, I've got lots of questions, but we're almost out of time. So maybe talk to us about your guidance philosophy. I mean it seems to me that the stock can have major wild swings with you just putting out a press release announcing the earnings date. So talk to us about what is your philosophy for setting guidance. And how do you think about pre-announcements, either positive or negative?

Sure. So obviously, even if you look at NVIDIA, there's swings because the market wants to know, is AI here to stay, okay? And so that is gradually, we think, being established. But in the time being, in the near term, we -- there's going to be some fluctuations, but we're not concerned about that. We've been here for 31 years. And by the way, we've been profitable for 31 years. And so -- and we have one of the lowest OpEx anywhere at 4% right now. And so we run very responsibly. We watch our costs very closely. And so we think that we have the right model. And we think that the time will -- the time that it takes to establish AI, it will quickly be evolving soon. But on forecasts and on guidance, we try to preannounce if we have -- if we have either a downside or an upside, overachievement or underachievement. But if we're within our range, then there's really nothing to report. So that's kind of our overall philosophy.

All right. So I think we covered a lot of different topics. David, thank you so much for joining us today. Really appreciate all the information.

Thank you.