Buried within Supermicro's record-breaking Q3 2024 earnings call lies a tantalizing hint at a potential margin expansion story that seems to be flying under the radar: **the aggressive adoption of direct liquid cooling (DLC).** While analysts are understandably focused on the top-line explosion fueled by the AI gold rush, this strategic shift towards DLC could be the key to unlocking a new era of profitability for the company.

Supermicro's founder and CEO, Charles Liang, didn't mince words during the call, highlighting DLC as a "long-term high volume mission" and even going so far as to declare "Green Computing can be free with a big bonus." This fervent advocacy for DLC isn't just marketing fluff; it's backed by significant investments in production capacity and a compelling value proposition for their customers.

The company is on track to produce over 2,000 DLC racks per month, with each rack capable of supporting 100 to 120 kilowatts. To put that in perspective, a single DLC rack can house 64 of NVIDIA's latest H100 GPUs, which are the beating heart of the AI boom. Supermicro is already preparing to deliver over 1,000 of these racks to three industry-leading customers in Q4 alone, signifying a major shift in adoption.

While the company is emphasizing the energy savings of DLC, potentially reducing costs by up to 40% compared to air-cooled deployments, there's a compelling financial angle for Supermicro itself: **margin expansion**.

Why DLC Could Drive Margin Expansion for Supermicro

As DLC becomes the dominant cooling solution for power-hungry AI servers, Supermicro will be able to leverage its early mover advantage and vertical integration to command higher margins compared to air-cooled solutions. This could lead to a gradual but significant expansion in their gross margins over the next few quarters and years.

Hypothetical Gross Margin Trajectory

The following chart illustrates a potential gross margin trajectory for Supermicro, based on the assumptions outlined below. This is a hypothetical scenario and actual results may vary.

Assumptions:

This analysis suggests a potential for gross margins to reach 15% to 16% by the end of fiscal 2025, driven by DLC adoption and related efficiencies. This represents a significant upside compared to the current baseline and could further accelerate if DLC adoption surpasses expectations.

**Important Note:** This hypothesis is based on several assumptions. The pace of DLC adoption, the competitive landscape, and the company's ability to execute on its ambitious production plans will all play a crucial role. However, the pieces are in place for Supermicro's "green computing" strategy to become a powerful margin expansion engine, and it's a story worth watching closely.

"Fun Fact: Supermicro's dedication to green computing extends beyond DLC. The company is also known for its focus on energy-efficient designs and the use of recycled materials in its products. They even have a program where they refurbish and resell used servers, further reducing their environmental footprint. This commitment to sustainability is not only good for the planet, but it could also be good for their bottom line, as environmentally conscious customers are increasingly willing to pay a premium for sustainable products."