Super Micro Computer, Inc. (SMCI) Q1 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Super Micro Computer, Incorporated first quarter 2015 conference call. The company's news release, issued earlier today, is available from its website at www.supermicro.com. In addition, during today's call, the company will refer to a slide presentation that has been made available to participants, which can be accessed in a downloadable PDF format on its website at www.supermicro.com in the Investor Relations section under the Events & Presentations tab. [Operator Instructions] With us today are Charles Liang, Chairman and Chief Executive Officer; Howard Hideshima, Chief Financial Officer; and Perry Hayes, Senior Vice President, Investor Relations. And now I would like to turn the conference over to Mr. Hayes. Mr. Hayes, please go ahead, sir.

Good afternoon, and thank you for attending Super Micro’s conference call on financial results for the first quarter fiscal year 2015, which ended September 30, 2014. By now you should have received a copy of today’s news release, that was distributed at the close of regular trading and is available on the company’s website. As a reminder, during today’s call, the company will refer to a presentation that is available to participants in the investor relations section of the company’s website, under the Events and Presentations tab. Please turn to slide two. Before we start, I’ll remind you that our remarks include forward looking statements. There are a number of risk factors that could cause Super Micro's future results to differ materially from our expectations. You can learn more about these risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2013, and our other SEC filings. All of those documents are available from the Investor Relations page of Super Micro's website at www.supermicro.com. We assume no obligation to update any forward-looking statements. Most of today's presentation will refer to non-GAAP financial results and outlooks. For an explanation of our non-GAAP financial measures, please refer to slide three of this presentation or to our press release published earlier today. In addition, a reconciliation of GAAP to non-GAAP results is contained in today's press release and in the supplemental information attached to today's presentation. I'll now turn the call over to Charles Liang, Chairman and Chief Executive Officer.

Thank you, Perry, and good afternoon everyone. Please turn to slide four. First, let me provide you with the highlights of our fiscal first quarter. We are pleased that our first quarter revenue was $443.3 million. It’s 3.6% higher quarter over quarter, and 43.5% higher year over year. This result was another record high for Super Micro. Non-GAAP net income was $23.2 million, or 19.5% higher quarter over quarter and 134.8% higher compared to last year. Super Micro’s non-GAAP earnings per share was $0.46 per diluted share, compared to $0.40 last quarter or $0.22 last year. Please turn to slide five. Last quarter, we achieved our fourth consecutive record high revenue, which was 43.5% higher than last year. Many growth factors contributed to these impressive achievements. First and foremost, our services contributed 57.7% of our total revenue, which is another record high for our system business. 44% of our business last quarter came from our building block solution, OEMs, and direct customers. [unintelligible] solution and storage [unintelligible] were significant barriers, while internet data center [unintelligible]. Moreover, we introduced our brand new X10 generation of products based on the latest Intel Haswell [DP] processors. We exercised our engineering expertise and turned it into a first to market product advantage from early delivery programs. The [unintelligible] revenue in North America was 54.9%. Asia was 19.9%, and Europe was 20.2% of total sales. Our growth in North America continued to be strong, where Asia grew slightly and Europe [rebounded] from last quarter. Notably we [unintelligible] the green computing park project in the heart of Silicon Valley last quarter. The expansion will provide additional production and operation capacity as we expect more aggressive growth from the domestic market in the near future. As I have mentioned before, systems solutions have grown to dominate our revenue because of our optimized design for unique customers in areas like storage, cloud, HPC, and high-density multiple node systems. Last quarter, our storage revenue grew 63% year over year, and 1% sequentially. GPU Xeon Phi solutions continued their momentum with 95% higher growth year over year and 52% higher sequentially. Multiple node systems such as MicroCloud grew 60% year over year and 71% sequentially. Our Twin solutions, including FatTwin, TwinPro and [Twinsquared] product lines grew 73% year over year and 23% sequentially. On these trends, we are pleased to see the performance per [watt] and computing density continue to [ship] the [unintelligible] as we anticipated. In addition, our service, software, and networking solution offers are growing consistently to help us win new total solution customers. Slide six [unintelligible]. Continuing our momentum from our X9 generation of products, we launched our [unintelligible] X10 Haswell [unintelligible] product line that this year Intel’s [IPF]. Along with the launch, we unveiled our industry leading brand new Haswell architecture, which delivers the highest performance per watt and most flexible I/O on the market today. These [unintelligible] service can support the latest [unintelligible] processors, up to 165 watt [TDP], I mean thermal design power, 1.5 terabytes of [CD] alpha memory intended for [dims], plus [unintelligible], which I will discuss later for increased storage bandwidth and energy efficiency, 96% plus [titanium] level power supplies. We removed our traditional I/O rigidity and bottlenecks by developing a set of new multiple function I/O modules that can accommodate full 10G [unintelligible], full 10G [SLP plus], full 40G Ethernet, multiple channel [FBR] [InfiniBand] options and beyond. Also included in this launch was our [unintelligible] Memory Express technology [unintelligible] NVMe. It’s the next [big leap] in storage performance and Super Micro is again the first to implement this latest technology and deliver it to the market. Our testing indicates that the NVMe system provides almost six times the bandwidth and approximately 7 times the latency improvement over standard SSDs. Moreover, we have the most extensive hot swappable NVMe product lines in the industry, and we are shipping to our customers today. As our technical expertise matured, we want to offer more value beyond just hardware systems. Many years of preparation and investment have gone into Super Micro’s cloud solution business. Our cloud solutions consist of complete racks of servers, switches, and storage, combined with software and service intended for both large scale public and small scale private clouds. These solutions are essentially plug and play with complete care by Super Micro, which represents our continuous effort to provide the customer with optimized high-value turnkey solutions with peace of mind. To summarize, we have begun fiscal 2015 with a very strong first quarter results, which carries our faster pace momentum toward an exciting new year. Our strong global foundation is based on years of innovative product leadership and expanding worldwide operations. We continue to see opportunity in the server and storage market by leveraging our unique [unintelligible] approach, and now delivering optimized, complete solutions, with service and software. We believe this new enhanced business capability will [unintelligible] our strong growth, momentum, and gain market share. For more specifics on our first quarter, let me turn it over to Howard.

Thank you, Charles, and good afternoon everyone. I will focus my remarks on earnings, gross margins, operating expenses, and similar items, on a non-GAAP basis, which reflects adjustments to exclude stock compensation expenses. Reconciliation of GAAP to non-GAAP is included in the financial statements of the company in today’s earnings release and in the supplemental detail in the slide presentation accompanying this conference call. Let me begin with a review of the first quarter’s income statement. Please turn to slide eight. Revenue was a record $443.3 million, up 43.5% from the same quarter a year ago and up 3.6% sequentially. The increase in revenue from last year was primarily due to our increase in service solutions sales, particularly in our Twin solutions, which we pioneered over seven years ago. [unintelligible] GPU products continue their strong growth as well. On a geographical basis, we had strong growth around the world with Asia again leading the way at 60.9% growth followed by the U.S. at 38.9% and Europe at 25.8%. The sequential increase in revenue in a seasonally weak quarter was primarily due to our strength in Europe and Asia. Our Twin products led the way, along with GPU and MicroCloud. Slide nine. Turning to product mix, the proportion of revenues from server systems was 57.7% of total revenues, which was up from 46.4% the same quarter a year ago and from 55.2% last quarter. ASP for servers was $3,600 per unit, which is up from $2,600 last year and up from $3,300 last quarter. We shipped approximately 71,000 servers in the first quarter and 1,254,000 subsystems and accessories. We continue to maintain a diverse revenue base with over 700 customers and none of these customers representing more than 10% of our quarterly revenues. Cloud and internet data center revenue was 13.7%, which was a decrease from 17.8% in the prior quarter and an increase from 8.3% in the prior year. 54.9% of our revenues came from the U.S. and 56% from our distributors and resellers. Slide 10. Non-GAAP gross profit was $69.4 million, up 47.6% from $47 million in the same quarter last year and up 4.2% from $66.6 million sequentially. On a percentage basis, gross margin was 15.7%, up from 15.2% a year ago and from 15.6% sequentially. Price changes from Ablecom resulted in a no basis point change to the gross profit in the quarter with total purchases representing approximately 14.5% of total cost of goods sold, compared to 17.3% a year ago and 15.7% sequentially. The year over year increase in gross margin resulted from increased complete server sales, strong vendor relationships, and increased utilization of our Taiwan facility, offset in part by higher cloud internet data center sales. Sequentially, gross margins was up due to more complete server solutions and lower cloud internet data center sales. Slides 11 and 12. Operating expenses were $34.8 million, up from $32.4 million in the same quarter a year ago and down from $37.2 million sequentially. As a percentage of revenue, operating expense was 7.9%, down from 10.5% year over year and from 8.7% sequentially. Operating expenses were higher on an absolute dollar basis year over year, primarily in R&D, as we invest in personnel expenses to support the development of our solutions. Sequentially, operating expenses were lower due to a $1.9 million of value-added tax refund from Taiwan, which we received during the quarter. The company’s headcount increased by 62 sequentially to 1,931 total employees. Operating profit was $34.6 million, up by 136.5% from $14.6 million a year ago and by 17.6% from $29.4 million sequentially. On a percentage basis, operating margin was 7.8%, up from 4.7% a year ago and from 6.9% sequentially. We continue to focus on the many market opportunities in front of us while leveraging the investments we have made in our infrastructure to drive our operating margins and profits. Net income was $23.2 million or 5.2% of revenues, up 134.8% from $9.9 million a year ago and 19.5% from $19.4 million sequentially. Our non-GAAP fully diluted EPS was $0.46 per share, up from $0.22 per share a year ago and up from $0.40 per share sequentially. The number of fully diluted shares used in the first quarter was 50,305,000. The tax rate for the first quarter on a non-GAAP basis was 32.7% compared to 31.7% a year ago and 33.6% sequentially. The rate was lower sequentially due to an increase in profitability overseas, which had the effect of lowering our overall corporate tax rate. We expect the effective tax rate on a non-GAAP basis to be approximately 33.5% for the December quarter. This rate assumes no reinstatement of the R&D tax credit. Turning to the balance sheet, on a sequential basis, slide 13, cash, cash equivalents, and short and long term investments were $120.2 million, up $20.6 million from $99.6 million in the prior quarter and up $6.1 million from $114.2 million in the same quarter last year. In the first quarter, free cash flow was a positive $24.3 million, primarily due to the increase in accounts receivable, offset in part by increase in inventory to support the continuing growth of revenue. Slide 14. Accounts receivable decreased by $18.4 million to $194.4 million. DSOs was 42 days, which was the same in the prior quarter. Inventories increased by $25.7 million to $341.5 million to support the forecasted revenue increase and a transition to Grantley-based products. Days in inventory was 81, an increase of four days from 77 in the prior quarter. Accounts payable was $222.6 million, which was 54 days, an increase of one day from 53 days in the prior quarter. Overall, cash conversion cycle days was 69 days, which is three days higher than in the prior quarter. Now for a few comments on our outlook. During the first quarter, we continued our strong growth, leveraging the foundation we have built over the years and executing our strategy to provide optimized solutions to our customers. As we enter the second quarter a new technology refresh cycle has started, with many new technologies being introduced. We look to take advantage of our engineering and the broad breadth of solutions to drive our strong growth and profitability. Therefore, the company expectations net sales for the quarter ending December 31, 2014 in a range of $440 million to $480 million. Assuming this revenue range, the company expects non-GAAP earnings per diluted share of approximately $0.44 to $0.50 for the quarter. At the midpoint, this would represent a growth of 29% and 57% in revenue and EPS respectively, from the prior year. It’s currently expected that the outlook will not be updated until the release of the company’s next quarterly earnings announcement. Notwithstanding subsequent developments, however, the company may update the outlook, or any portion thereof, at any time. With that, let me turn it back to Charles for some closing remarks.

Thank you, Howard. The first quarter was another record high for Super Micro, with growth of 43.5% higher year over year. And that, again, outpaced more than multiple times the industry growth rate. Through our innovative product strategy, quality and service, we are in a unique position to take market share, grow revenue, and achieve strong operating income. With that, we are on track to reach our $2 billion run rate milestone very soon. Operator, at this time, we are ready for questions.

[Operator instructions.] We’ll go first to Mark Kelleher with D.A. Davidson.

Wanted to look at gross margins from a couple of angles. First of all, can you tell us what percent of revenue in the quarter or of server sales came from the Grantley launch? Is it still very small?

Yes, it’s just ramping now. However, we’re seeing that the ramp is probably about over 50% better than what it was when the Sandy Bridge launch occurred during a similar period.

And that’s carrying higher gross margins, right?

Yes.

And your tilt toward servers is a benefit to gross margins, right?

It depends on the mix of the servers. During the quarter, we had, again, our storage solutions were a higher mix of our products, and they were more complete systems with that. So again, they can be somewhat lower at times too. It depends on the mix [unintelligible].

With the internet data center revenue declining as a percentage of revenue in this quarter from last quarter, with Taiwan manufacturing increasing with the overall service percentage growing, and with Grantley into the mix, where can we get some more gross margin? I’m surprised gross margin didn’t boost up a little bit more. What’s the pullback on that? What’s the offset?

One thing you’ve got to remember also, this is a seasonally weak quarter typically, and we’ve gone through and grew right beyond those seasonal trends that we’ve had in the past. It’s usually a very competitive time in the industry. So again, that’s part of, what you want to call a put or take, a take from the margin side of it. You know, the internet data center is historically competitive for us, and that is a positive for it when it goes down, but then you’ve got the total server solutions mix and quite frankly, like I said, as we ship more complete server solutions, with regard to in the storage area, they can tend to drag our margin out a little bit because of higher content of hard disk drives and other types of components.

We’ll go next to Aaron Rakers of Stifel.

Going back to the gross margin discussion, it looks like, on the past six quarters, I think your average growth in storage has been over 40% year over year. Can you help us understand maybe that mix effect to the gross margin? How meaningful is storage today as a percentage of revenue, and is there a point in time where you start breaking that revenue stream out to give more visibility to that mix dynamic?

As you know, we ship more and more storage to special OEM accounts, and sometimes that cloud business is ramping up very well to us, including [unintelligible], and those are the sharing resource for private section or kind of some small public cloud. And the new technology [unintelligible] mentioned Haswell and together with our new architecture [unintelligible] rack. And coming soon, [unintelligible] Twin, that will contribute to higher profit margin.

And then as a follow up, your Asia Pacific revenue growth was very impressive. Obviously there’s been some changing dynamics in the competitive landscape with obviously Lenovo closing their transaction and then HP looking to leverage their partnership with Foxconn. Can you just remind us how meaningful China is with regard to your Asia Pacific growth and how you view the competitive landscape going forward relative to those two vendors?

Yeah, they have some impact for sure. However, our growth has been getting even in other countries like Japan, other countries in Asia. And the ramping of Haswell and [unintelligible] and total solution, that all help us move profit margin.

The operating expense number was quite impressive, but I think I heard you say that there was a $1.9 million benefit from tax. I’m assuming that that’s in the G&A line. With that said, how do we think about operating expense? Is that true, that’s in that G&A line and that should be adjusted. And should we use that as kind of a run rate going forward, or do you expect opex to creep higher as we move out over the next several quarters?

It’s actually in the R&D line, and it’s a $1.9 million credit that came back. It’s basically one single time item, so you would put that back, as you look forward, into our numbers.

We’ll go next to Rich Kugele with Needham & Company. Rich Kugele - Needham & Company : Going back to Grantley, just wanted to get a little more feedback, specifically with regard to the availability or lack thereof, I guess, of competing solutions relative to your own in the marketplace.

As you know, whenever there’s a new technology refresh, we have a good chance. This time, Haswell especially is a big chance to us. [unintelligible] is a new [BDR] for more challenging technology. We introduced NVMe, especially pretty much in our first hot-swappable NVMe solution provider. All those will help us. And also, our micro [unintelligible] other storage product available one by one. So all those help. Rich Kugele - Needham & Company : And historically with these new processor launches, how long is I guess the gap between when the new processor is released and when that becomes a majority of your shipments?

It depends. Basically from Intel, we should launch [unintelligible] in the first six months for a nice period we have growing business, both revenue and profitability.

And next, we have Mike Staiger with Roth Capital Partners.

Just wanted to get a couple of thoughts on linearity within the quarter, and if your success here moving forward, should we think linearity would change historically speaking?

With regard to our linearity, it hasn’t really changed. We’ve said we’re pretty linear throughout our quarter, throughout our history, indicating around 30% to 40%, that kind of spread in our business. However, we still are a turns type of business.

And then just one follow up. You have a new partnership in this EVO: RAIL and it looks like you made a couple of announcements on that. Was there any contribution in the quarter from that particular program?

As you know, we have a complete storage and cloud solution [unintelligible], and that for sure will create a positive impact to our business. And it’s happening now, and will be gradually growing. I would like to say it will take a few quarters or many quarters to ramp up.

Up next we have Nehal Chokshi with the Maxim Group.

The 79% year over year growth in systems, even when I take out the internet data center portion, which appears to account for all the direct increase, it looks like the systems grew 55% year over year. I believe this is all channel driven. Is this a correct interpretation of the data? If so, what is driving the strong traction in the channel? Is it all product driven, or is there some increasing brand awareness that you think is driving this as well.

Quite frankly, usually our service solutions go through to our direct customers and our OEM solutions customers. Again, that’s where usually you see a lot of similarities to the percentages between our complete server solutions business and those other two. It goes less to the channel, although recently, again, you’ve seen those percentages go higher than our distributor reseller business, because the channel is now starting to begin to take our complete server solutions, because, quite frankly, these systems are getting more complicated to put together, and for quality reasons and reliability reasons, they’re looking for us to be putting the systems together. So I think it’s a little bit of the opposite.

And then with data management starting to move back to internal application servers, such as with the EVO: RAIL or the new [unintelligible], is there an opportunity for Super Micro to develop some IP here, or will it be Super Micro’s strategy to be a partner of choice for the independent storage vendors who are seeking to move their data management stacks from external to internal to application server?

Yeah, we are doing both. One is working with our close partners. The other one is trying to develop some of our own IP as well.

And then finally, could you talk about where’s the utilization on the Taiwan facility?

About 50% now.

Yeah, but it will consistently grow, basically.

And up next we have Aaron Rakers of Stifel.

First of all, you’ve talked about your $2 billion target the last couple of quarters now. Can you just remind us when you think you can attain that target?

I believe it’s coming very soon. Maybe a quarter or a couple of quarters.

. :

Like I said, last time I [attributed] about 4.4% to the R&D tax credit coming back. So again, you’d be around 30 to just below that.

And it appears at this time we have no further questions. I’d like to the call back to Mr. Liang for any additional or closing comments.