Super Micro Computer, Inc. (SMCI) Q3 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Super Micro Computer Inc. Third Quarter Fiscal 2019 Business Update Conference Call. The company's news releases issued earlier today are available from its website at www.supermicro.com. [Operator Instructions] Afterwards, securities analysts will be invited to participate in a question-and-answer session, but the entire call is open to all participants on a listen-only basis. As a reminder, this call is being recorded, Friday, May 17, 2019. A replay of the call will be accessible until midnight, Friday May 31, 2019, by dialing 1 (844) 512-2921 and entering replay pin 3378860. International caller should dial 1 (412) 317-6671. With us today are Charles Liang, Chairman and Chief Executive Officer; Kevin Bauer, Senior Vice President and Chief Financial Officer; and Perry Hayes, Senior Vice President, Investor Relations. And now we would like to turn the conference over to Mr. Hayes. Mr. Hayes, please go ahead, sir.

Good morning, and thank you for attending Super Micro's business update conference call for the third fiscal quarter 2019, which ended March 31, 2019. During today's conference call, Super Micro will address the company's filings of the Form 10-Q/A and Form 10-K for 2017 and efforts to become current with its remaining SEC filings and the company's preliminary financial results for the third quarter of fiscal 2019. References to any financial results are preliminary and subject to change based on finalized results contained in future filings with the SEC. By now, you should have received a copy of the news release from the company that was distributed at the close of regular trading and is available on the company's website. 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 most recent Form 10-K filing for 2017 and our other SEC filings. All of those documents are available from the Investor Relations page of Super Micro's website. We assume no obligation to update any forward-looking statements. Most of today's presentation will refer to non-GAAP financial results and outlook. At the end of today's prepared remarks, we will have a Q&A session for sell-side analysts to ask questions. I'll now turn the call over to Charles Liang, Chairman and Chief Executive Officer.

Thank you, Perry, and good afternoon, everyone. Let me first comment on our 10-K filing. We are pleased to have filed our fiscal 2017 10-K. Not able to ensure the accuracy of our financial reporting has taken more than 18 months of focus and collaborative work between Super Micro's team and our outside adviser teams. It became clear through this effort that some of our process and procedures had not kept up with our faster growth, the size of our company and the pace of our business. The team acknowledged that necessary internal control need to be strengthened for precise revenue recognition quarter-by-quarter. Despite all of our business, transaction result in eventual revenue. Most importantly, I would like to thank all of our Super Micro employees, partners, customers and investors for their dedication and support during this period. Although our sales effort had been certainly impacted by our 10-K filing delay and fourth negative place [indiscernible] last year. This did not affect our growth plan, and our foundation had been the strongest in our 25 years history. Now let me comment on the March quarter. Our third quarter revenue will be in the range of $742 million to $752 million, which is below our quarterly guidance and represents approximately 5% year-over-year deduction. The main reasons had been the key components price drop and volatile microeconomic condition. Earnings per share will be in the range of $0.48 to $0.52 compared to the range of $0.48 to $0.52 last year and the range of $0.57 to $0.61 last quarter. System revenue was approximately 81% of total revenue for at least last year. Both system and node ASP were higher year-over-year due to mutual mix of computer system. Revenue from Global 2000 accounts and accelerated computing were higher year-over-year, offsetting lower storage and IoT revenues. We are increasing our capacity for future growth. As our business continue to rapidly scale with over 1.2 million servers and storage systems shipped globally last year, increasing our production and service capacity and capability is vital. We recently held groundbreaking ceremony for our Asia's Science & Technology Park expansion. It was attended by over 200 business and government officials. The new 800,000 square feet building will expand our production capacity, hardware and software R&D and our RSD2 methodology based on our resource saving design and rack scale design technologies. RSD2 will enable us to provide a more power efficient, cost effective and flexible data center Building Block Solutions to the market, including application optimized solutions for medium and small-sized customers in data centers. We are also expanding our Silicon Valley stakeholders. Building 23 is the third of 5 new facilities in our San Jose Green Computing Park as the only global Tier 1 server and storage provider to manufacturing Silicon Valley. We are aware of producing to provide the best possible solutions to the most innovative enterprise, data centers, channel and cloud customers. Super Micro leads the industry with the second-generation Intel Xeon Scalable processor efforts. The recently launched Xeon processor known as Cascade Lake is a refresh of Skylake launch last year. The frequency of CPU and memory module refresh highlights the importance of our resource saving design to the industry and to the environment. Supporting new CPU with new technology, including Intel Optane DC persistent memory NVMe, NF1, and EDSFF. The new Super Micro X11 generation [indiscernible] put online again is offering leading performance in the base of TCO and TCE, total cost to environment, for all of our data centers around the world empowered by highly efficient, longevity subsystem that lasts over 12 years, the recent service system especially optimum for feed deployment on edge [indiscernible] and remote micro data centers. Our high-density systems such as BigTwin when you cannot scale NVMe storage, resource saving SuperBlade and MicroBlade have been the preferred choice for many public and private cloud customers. This low-latency, high-frequency, high-density, high-capacity system are exactly the basis of solutions for supporting the strong wave of 5G, deep learning, AI and cloud age applications. With that, I expect that this optimal server solutions will show strong growth momentum in a way our market growth time faster than the IT hardware industry average. In summary, we are pleased to have filed the 2017 10-K and began the process of improving our internal controls. Now we are able to focus more on the bright future and tremendous opportunities ahead of Super Micro. We are moving towards the meeting with our increased global manufacturing capacity and innovation such as the resource saving design. I'm fully confident that we will continue to rule the market and to provide the best server installing solutions for today and tomorrow's demanding workload. With 25 years of strong foundation paved by the best engineering minds, enhanced operations and focused sales force, Super Micro is on the rise again. For the fourth fiscal quarter ending June 30, 2019, we are guiding net sales in the range of $770 million to $830 million with great position to start our faster growth trend again. And now, I will hand the section over to Kevin.

Thank you, Charles. First, I will address the current outlook of the business by providing an overview of our financial performance for the third quarter of 2019. I will then make a few comments about our progress on our SEC filings. As Charles mentioned earlier, we estimate our fiscal third quarter revenue was within the range of $742 million to $752 million. On a year-over-year basis, EMEA was the weakest geography with a decline of approximately 21% followed by a 10% decline in Asia, offset by a 7% increase in the U.S. Our estimated range of gross margin on both the GAAP and non-GAAP basis was from 15.5% to 15.7%. Our margin benefited from improved customer and product mix, partially due to lower sales to Asia, lower storage revenue and better component pricing. Operating expenses were lower this quarter due to lower employee bonuses, offset by an increased reserves for bad debt. In this quarter, we released $3.2 million tax reserve related to a lapse in the statutes of limitation in the tax jurisdiction. We estimate non-GAAP diluted EPS this quarter was within the range of $0.48 to $0.52. We continued to generate cash and estimate cash generated from operations was approximately $112 million. After deducting CapEx of $7 million, we estimate free cash flow of approximately $105 million for the quarter. On a cumulative basis over the last 3 quarters, we estimate free cash flow of approximately $189 million that has allowed us to pay down our loans and reach a positive cash position. This quarter, our cash conversion cycle increased to 106 days. The increase is primarily due to an increase in inventory days. Based on the methodology of averaging with the previous strong quarter, actual inventory declined sequentially. Our cash conversion cycle target remains 85 to 90 days. Now let me comment on the filing of our fiscal 2017 10-K. We are very pleased to have filed our Form 10-K of -- for 2017 that included the restatement of our financial statements for fiscal 2015 and 2016. This was a comprehensive undertaking that involved a detailed and thorough examination of our historical financial statements as well as our accounting policies and procedures and our internal controls. The primary cause of restatements and adjustments was the timing of revenue recognition and certain changes to accounting for inventory and other adjustments. All the sales that we examined will be ultimately recognized as revenue. As Charles said earlier, in our 2017 Form 10-K, we acknowledge weaknesses in our internal controls that existed as of June 2017. I encourage everyone to fully read our report on internal controls over financial reporting where we articulate our remediation plan and progress to date. We're a different company today and are better able to address our remaining challenges. So to close, I would like to thank the extended team of devoted employees who put in countless hours to achieve this goal. We are turning our attention to finishing fiscal 2018 for audit and are remain focused on becoming fully current on our SEC filings. And to our shareholders, we appreciate your support through this long process and look forward to updating you again next quarter.

As indicated previously, we will have a Q&A session next where sell-side analysts will be permitted to ask questions. Operator, at this time, we are ready for questions.

[Operator Instructions] And we'll first go to Mehdi Hosseini with Susquehanna Financial Group.

This is David Ryzhik for Mehdi Hosseini. First off, congrats on the 10-K filing for fiscal '17. So I just wanted to understand March quarter. In mid-February, you offered the target of $800 million to $860 million and it came out materially lower. What happened between mid-February and end of March? Was it just customers pulling orders? Or just wanted to learn more about what happened there? And I have a follow up.

Kevin, you want to take that one?

Yes, sure. So certainly, as we went through the quarter, we saw the same softening that the rest of the industry saw. We did observe customers' behavior towards the end of the quarter. We've gotten some feedback that they were digesting purchases as regard towards the end of the quarter. And so that was news that we found in that second part of the quarter. And as Charles articulated earlier, we're giving similar guidance a little bit lower as we go into the next quarter. So we think that the first half, we will have to go through a period of digestion in the industry that maybe we didn't fully comprehend 90 days ago. And certainly, we look forward to the second half of '19 depending upon how the macro situation clears up over time.

Okay. And in storage, Charles, you touched on storage maybe a little softer. Can you elaborate on the trends there? Was it end demand driven macro or market share driven? Just would love any more info on the storage business?

I guess, the macroeconomic in the lower key components price as well as the tariff that will have some impact. At the same time, we are aggressively moving to a new NVMe storage solution, and we see some signal to recover gradually.

Got it. And then on gross margins, it looks like a pretty sizable uptick. Perhaps, maybe you can rank the drivers, mix, components or geographic mix, would love a little more detail there?

Kevin, you want to take that one?

Yes. In rank order and don't know about the relative materiality of these in the way that they are ranked, but I think really the product mix in terms of storage was probably the most large impact than probably the customer mix and then lastly, the component pricing changes over time.

And is it safe to say that we can anticipate this type of level for the June quarter and the balance of the year?

Yes. I wouldn't necessarily say that. I think we have a very good alignment of vectors in this particular quarter to the extent that we have continued decline in component costs in terms of memory and NVMe. We will have some continued improvement over the quarter that we have before, which was roughly about 14% or so. But certainly, I don't expect that it'll be up to this level. I think we had a great confluence of events this quarter that put us 1 quarter ahead of what we expect to do in terms of some sustainable, modest improvement in our gross margin profile that -- from our historical patterns over the course of time.

And we'll take our next question from Nehal Chokshi from Maxim Group.

Based on the gross margin approximation and the EPS, it sounds like OpEx was down significantly Q-over-Q, is that correct?

It was modestly down. So as we said, the key things were that since we had smaller revenues, we made a lower purchasing for employee bonuses, suffered a little bit in terms of some bad debt, but not significantly on a non-GAAP basis. There are a little bit more spread on GAAP basis and that we had some costs associated with the restatement as well as last quarter's activity related to responding to the article that were less in this quarter.

Right. So on a non-GAAP basis, R&D would have been about flattish Q-over-Q? And therefore, that's one of the reason why you remain confident in the long-term outlook?

If I recall correctly, R&D grew a little bit, but it wasn't tremendous.

Okay. And then there've been some reports, I think, from Bloomberg that Super Micro has asset suppliers to move their supply chain out of China, is that true? And is that -- first address that maybe.

Yes. Basically to fulfill our increasing the business, we believe that demand from the market will continue to be strong. So we are indeed growing our capacity goal in Silicon Valley, in Taiwan and in Netherlands. So it's part of our long-term growth plan.

Nehal, I think that those articles that you've referenced were not accurate in reporting. We are increasing our capacity, as we mentioned, in our Taiwan facility, primarily for growth as well as for the Building 23 that we're building here in San Jose, again primarily growth, for future expectation on our growth.

Okay. To be clear, I think that the article was saying that Super Micro was asking its motherboard suppliers to move manufacturing out of China, not so much Super Micro's assembly and internal manufacturing capacity. So...

Yes. We are not going to comment on the stories. Can you have another question?

Sure. You have thoughts on how HP Enterprise buying Cray may change the competitive dynamics for the high-performance computing portion of Super Micro's business?

Indeed, our overall business still are growing well. And we believe with the new Cascade Lake solution, NVMe, as you may know, we are truly build for new generation memory, NVMe, NF1, EDSFF. So we do believe our growth will be strong in the coming future.

Okay. And can you give approximate performance by verticals, those being storage, data center, IoT, high-performance computing, enterprise and channel?

Nehal, we are not going to break that out at this time.

Okay. All right. And can you provide some guidance as far as what was actually the fully diluted shares outstanding for the March quarter?

I will provide that to you after the call.

Okay.

Yes, it's still roughly about $50 million or so.

And we will take our next question from Michael Staiger with Odeon Capital.

On the gross -- just kind of a clarification on gross margins. Are we -- should we expect a similar level? Or is there a range that you think you can provide movement into the next few quarters? And on top of that if you are expanding capacity, are you expecting, let me just say, radical shift in demand? What was the demand pressure look like into the next few quarters?

Yes. So as I said earlier, we certainly had a great confluence of events this quarter that led us achieve the gross margin results for the quarter. We had been, not too many quarters ago, in the mid-13s and last quarter, I think, we hit 14.1%. This quarter we had that sizable jump because of all of those events. We do have the ability to get cheaper cost for a moment in time before they are passed on to customers and the ramp and severity of those price changes could occur into the future, but maybe not to the extent. So to kind of give you some kind of a feeling for that, I think grounding ourselves in that low 14% gross margin and then modest improvement over that is really good trend that we had articulated last quarter. And I think that, that's still the case today.

And just as a quick follow-up. Can we expect the cash flow performance to be in a similar range going forward?

Our cash flow is very much tied to our working capital means. So the cash flow probably will consistently work along those lines that we have today until we start to show significant growth. And when we have significant growth, we will have to reinvest in working capital in order to achieve that.

And we'll take our next question from John Lopez with Vertical Group.

My first question, I think, the first half weakness is certainly understandable given the confluence of things happening around you. As far as my question for you here is, as you think about the second half of the calendar year and particularly about the Cascade Lake pipeline, can you just categorize how things are shaping up? I mean one way to look at this is Intel's implied guidance suggests a very strong second half of the calendar year. I'm wondering if that's consistent with how you guys think about the second half of the year or is there something either customer related, mix related, geographically related that may make you marginally different from that implied outlook?

Yes. We believe second half will be stronger this year for a couple of reasons, one is Cascade Lake system [indiscernible] already qualify and it's much better performance [indiscernible], which will move that aggressively. And second is the second-generation storage, NVMe including EDSFF and NF1. We see customer start to ready to move [indiscernible] and together with our 10-K delayed program had been almost fit. So that will be a positive trend for us.

Excellent. My second question is, again, I'm obviously not looking for guidance here, but just conceptually, you guys are pretty comfortably outpaced the server market in aggregate for the last multiple quarters. I'm wondering as you think about, say this calendar year, would you expect to continue to be able to do that. Or again sort of same question there may be some geographical product exposure things that may make that different or more difficult in this calendar year versus the prior 2?

Yes, we are prepared for the tariff, the trailer program and continue to make our capacity, our capability and product line ready. So we believe the near future and [indiscernible] and yet to come future will be great thing for us, especially our internal control system have been tremendously improved and new SAP implement has been much stable now. So our business is getting ready for another trend of faster growth, I believe.

Okay. Helpful. A quick question, I haven't gotten through the refiled document entirely, but my recollection was counter Q3 or so of 2017, China was about 10% of your total revenues. I'm wondering: a, can you just update us at least directionally on what your China exposure is right now? And b, well, I guess, b and c; b, any thoughts, I know you just referenced tariffs, but any thoughts in terms of local consumption, what if anything recent developments mean? And I guess, c, Huawei is, obviously, I believe, the fourth-largest server rendered by units as in the last quarter, not a lot in the U.S., but certainly a lot of European exposure for them. I am wondering, just conceptually, what do you think the current developments may mean for perhaps share potential for you in geographies where you overlap?

Basically, we continue to grow globally. I mean U.S.A. and Russia are our main market, but Europe, Asia, including the Japan, China, we continue our plan to global -- to grow globally. And we are much [indiscernible] forever to grow globally.

That's helpful. Would you mind just updating on that China exposure specifically though?

China market, indeed, we feel nothing really has changed. So we just continue to rollout stable plan and our partnership there also is stable growing.

John, our China exposure can be in any quarter somewhere between 10% to 15% of the overall revenue. As you know, the March quarter, there is a lot of seasonality with the China's lunar New Year, et cetera, that impacts our revenue for China.

Sure. That's helpful. So my very last question, I understand that -- I don't understand entirely, but it sounds like there's clearly been some working capital held on the cash balance, and I think you guys started to get a bit more proactive on some of those metrics. At the moment you've got over $160 million of cash on the balance sheet and I realized, what you are, I think, effectively telling us is that, that's going to reflect around a little bit as working capital trends up, but I'm wondering just in light of events over the last 2 years or so, any higher appetite for things like share repurchase or some amount of capital return or is that tables until we get some level of visibility into what maybe more sustainable free cash generation looks like?

Yes, I think we had a good run over the course of the last 4 or 5 quarters. And as you said, we've paid more attention to it. We have been able to drive cash flow. I think we need more time to make sure that we go to a few cycles to get a real confident and grow our cash flow and then I think it would be only some later date that we would look to think about those things as being potentials on the table. But at the moment, we don't foresee any repurchase plans that we would take to the Board or suggest to them.

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

Yes, thank you for joining us today, and have a great one. Thank you.

Thank you, ladies and gentlemen. That does conclude the Super Micro Third Quarter Fiscal 2019 Business Update Conference Call . We do appreciate your participation. You may disconnect at this time. Thank you.