Super Micro Computer Inc

NASDAQ:SMCI

Earnings Call Transcript 2019-Q1

[Operator]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Super Micro Computer Incorporated First Quarter Fiscal 2019 Business Update Conference Call. The company's news releases issued earlier today are available from its website at www.supermicro.com. During the company’s presentation, all participants will be in a listen-only mode. Afterwards securities analysts will be invited to participate in the question-and-answer session, but the entire call is opened to all participants on a listen-only basis.

As a reminder, this call is being recorded, Thursday, November 15, 2018. A replay of the call will be accessible until midnight, Thursday, November 29, 2018, by dialing 1 [phone] and entering the replay pin 3001732. International callers should dial 1 [phone]. 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 of Investor Relations.

And now I would like to turn the conference over to Mr. Hayes. Mr. Hayes, please go ahead, sir.

[Perry Hayes, Senior Vice President-Investor Relations]

Good afternoon, and thank you for attending Super Micro's business update conference call for the first quarter 2019, which ended September 30, 2018. During today’s conference call Super Micro will address the company’s effort to become current with its SEC filings, the business and market trends from the first fiscal quarter of 2019 as well as the company’s preliminary financial results for the first 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 the copy of the news release and 8-K filings that were distributed at the close of regular trading and are 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 and our earlier SEC filings. All of those documents are available from the Investor Relations page at 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 outlooks. At the end of today's prepared remarks, we will have a question-and-answer session with sell-side analysts.

I'll now turn the call over to Charles Liang, Chairman and Chief Executive Officer.

[Charles Liang, Chairman and Chief Executive Officer]

Thank you, Perry, and good afternoon, everyone. Let me first of all comment briefly on our first quarter performance. Our first quarter revenue was in the range of $952 million to $962 million, which compared to our quarterly guidance and represents approximately 20% increase year-over-year. Our momentum in market vertical continues with strong growth, especially in Global 2000, Storage and AI machine learning. Computer system revenue was consistent with last quarter at approximately 34% of revenue and up 56% year-over-year. Our total ASP growth continues with higher add value sale of our industry-leading technology innovation and more high-end computer systems.

Kevin will provide a more detail on our financial results. The focus of our strategy in the past few years had been our Global 2000 business, which grew 132% year-over-year. Now resource-saving architecture had been the key message of that focus, leveraging our breakthrough product and further to mark advantage to deliver significant saving to customers. We've achieved greater success story with company like NASA, Intel and many other industry leaders. The resource-saving architecture reduced TCE, total cost to the environment, which brings significant TCO saving along with environmental benefits. The resource-saving chip operate – that might operate this aggregated design enables the independent upgrade of system components, by navigating and replacing the entire hardware system realizing the customer can save up to 60% in system deflation cost and reduce IT waste up to 50%.

Now resource saving between [indiscernible] could only optimize power-saving design, basically, air cooling including sheer power, and cooling could deliver power with improvement in power efficiency over traditional servers. Now on top NVMe match inside support together with the resource saving feature mixed between one of the highest volume server platform in the industry today. Without stable 1U Petascale all-flash NVMe system, that when combined with high-performance fabric and open rack scale management software can be used to dynamically provision critical assets, such all-flash NVMe, GPUs and [indiscernible] saving cost and reducing e-waste.

We have a broadest portfolio of all-flash NVMe system with more than 150 system model available, making Supermicro the benchmark leader in storage. With that, Storage was again one of our strongest segments that drives revenue across multiple verticals including Global 2000 and next-generation storage. This advanced storage solution provide a real time-to-value competitive advantage for users with data-intensive workload like a Big Data, autonomous driving, AI, and HPC application against traditional SSD.

We recently launched all-flash 32 hot-swappable EDSFF driver in the high-density 1U system designed to deal the way for NVMe technology partially we team there. This means that we should approve full petabyte of high-performance all-flash storage in 1U with an outstanding 30 million IOPS and 52 petabyte per second throughput.

Samsung has also partnered with us to develop 1U NF1 storage server featuring the most power-efficient high-bandwidth loaded density next-generation flash technology, which is the highest storage density and gives higher performance currently available on the market. Deeper learning, machine learning and artificial intelligence that we should grow very well and was up 26% from last year.

At a supercomputing conference in Dallas, Texas, this week, we showcased our cloud server based on the NVIDIA HGX-2 platform. The SuperServer 9029GP combined 16 Tesla V100 32-gigabyte SXM3 GPU, connect via NVLink and NVSwitch to work as a unified to pent up accelerator with half of terabyte of aggregate memory to deliver unmatched computing power.

Moreover, our new SuperServer 6049GP is optimized for the modern AI inference. This 4U system achieves maximum GPU density and performance with the support for up to 20 NVIDIA Tesla T4 GPUs with Turing Tensor Core technology.

Now let me move to other business highlights. This September, Super Micro celebrated our 25th anniversary. The Company was founded in San Jose, California in 1993, in the heart of Silicon Valley. Over last 25 years, we have grown from a Silicon Valley start to a Fortune 1000 company global leader.

As we have grown, we had built our space within the city of San Jose by investing hundreds of million of dollars in local infrastructure and people and had become one of the San Jose's largest employer. We own more than 1.5 million square feet state-of-the-art facility for producing best quality product and improving production efficiency.

We have also recently broken ground on a new business partner, that we are continuing extending our design, manufacturing and business across the valley. More than 70% of our engineers and employees are based in Silicon Valley and we assemble and integrate more than 60% of our servers and storage systems in the U.S. much higher percentage than any of our largest competitor.

Finally, I would also like to comment on a legendary new story. We're feeling confident that recent allegation from a single publication about malicious chip supposedly being imprint on our hardware during manufacturing are not only impossible but also wrong. Over the years, we had produced millions of motherboard, 1.3 million last year alone, yet we have never been contacted by any customer with regard to a malicious chip.

Also we have never been contacted by any U.S. or foreign law enforcement or intelligence agency alerting us of malicious chip on our hardware or of any such investigation. We continue to work with our customers to address any security concerns and to ensure the quality and integrity of our products.

In summary, we are still on a fast pace of growing U.S.-based manufacturer of server and storage. Our first quarter growth of 40% year-over-year is a great start to fiscal year 2019. Expanding and deepening our customer base, we saw this was significant in offering the best of quality products for trusted solution. We'll drive our continuous success.

Also, I want to thank our entire Super Micro team for staying focused on our goal. Many tech companies have been talking about digital transformation across the enterprise. Super Micro is building it every day. It has been great 25 years for Super Micro, and I am looking forward to continue our journey to bigger success. And now, I will hand it over to Kevin.

[Kevin Bauer]

Thank you, Perry. Thank you, Charles. Today, we issued a press release announcing our solid financial results for the first quarter of fiscal 2019. We also filed a current report on Form 8-K disclosing the Company's decision to restate certain prior financial statements.

First, I will address the current health of the business by providing an overview of our financial performance for the first quarter of 2019, and I will then make a few comments about the decision to restate those prior financial statements. Super Micro had a strong first quarter of revenue in net profit.

As Charles mentioned, we estimate first quarter revenue within the range of $952 million to $962 million. It was approximately 40% higher year-over-year and above our guidance range of $810 million to $870 million. We grew revenue in all market verticals with key markets growing significantly year-over-year. Global 2000 grew approximately 130% year-over-year. Internet data center grew approximately 150%. While non-Internet data center grew approximately 95% year-over-year.

Accelerated computing was up 26% and Embedded grew approximately 30%. On a year-over-year basis, U.S. enjoyed the highest growth at nearly 45% followed by EMEA that grew nearly 50% and Asia Pac that was up approximately 30%. Other regions grew approximately 15%.

Our estimated range of gross margin on both a GAAP and non-GAAP basis was from 13.2% to 13.4%. Our customer mix contributed to the rebound in margin this quarter. Compensation costs increased across the board in both manufacturing and operating expense this quarter related to annual merit increases as well as performance bonuses or profit-sharing payments to non-executives. We also celebrated our 25th anniversary in grand fashion. We estimate non-GAAP EPS range this quarter was from $0.66 to $0.70, more than double year-over-year.

For the first quarter, we estimate cash generated from operations was $50 million. After deducting CapEx of $4 million, we estimate free cash flow of $46 million for the first quarter. This quarter, our cash conversion cycle increased seasonally to 92 days from 82 days in the prior quarter. Both day sales outstanding due to collections and inventory days increased to position stock for the second quarter was offset by increasing days payable. Our near-term target is to stay in the range of 85 to 90 days for the cash conversion cycle.

Now let's turn to the progress we are making on the fiscal 2017 Form 10-K. The company has substantially completed its testing and assessments. The day we announced that we are determined to restate prior period financials and provide an estimated adjusted amounts. We are in the final stages of preparation and conclusion, so that we will continue to work with our auditors to complete our 2017 Form 10-K. The core basis of the restatements remains timing of revenue recognition. Based on our assessments to date, the company confirms that although in our restated financials, some revenue recognized in prior periods will be recognized in the subsequent period. All revenues and customer transactions in the period subject to the restatement is valid revenue.

During our review of prior periods, we also discovered additional errors relating to the classification of certain inventory. The number and breadth of the adjustment, coupled with their aggregate magnitude, was significantly enough for us to conclude that restating prior periods was necessary. Today, we believe total cash flows from operating, investing and financing have not been impacted with the exception of certain balance sheet classification errors that have been determined to have an inventory effect on cash and cash flow from operations.

Based on our findings, we expect to material weaknesses over financial reporting. We have, depending on the matter, begun remediation measures to varying degrees. Along the way, we have developed stronger revenue policies, trained employees and developed new standards. There are number of remediation efforts. Let me share a few examples.

We have hired senior revenue talent and grown our revenue team, implemented strong cutoff controls, including walking and shipping dock at the close of the quarter and enhancing our revenue testing. And we've revamped the sales sub-certification process at quarter-end.

In addition, we have formed a new internal audit team that is conducting testing on the second half of 2018 and absorbing the transfer of knowledge from the efforts of our advisers in the process. Our efforts on completing the filings for fiscal year 2018 have been running in parallel and are well underway. We are working diligently to complete this testing and the rolling of the account conclusions from fiscal year 2017 to fiscal year 2018. This should enable us to have the fiscal year 2018 financials and updated assessment on internal controls of our financial reporting ready for audit, largely in parallel.

Lastly, we are guiding net sales for the second quarter in the range of $830 million to $890 million. We note there is much anticipation around slowed IT infrastructure spending, and we have adjusted our guidance accordingly. Also we experienced a pause in October from some customers following the unwanted hardware hacking article. However, we've begun to see those customers returning, but we will not understand the full impact until after the quarter ends. Order to date, compared to last year, we are materially ahead on a billings and open order basis.

As indicated previously, we will have a Q&A session where sell-side analysts will be permitted to ask question. I would like to remind you that your questions should be directed to the business update that we just provided. We may decline to answer questions relating to the Audit Committee investigation or the delayed filing of our 10-K because of pending litigation.

Operator, at this time, we are ready for questions.

[Operator]

Thank you, sir. [Operator instructions] And we’ll take our first question from Nehal Chokshi from Maxim Group. Go ahead, sir.

[Nehal Chokshi, Maxim Group]

Yes, thanks and congrats on an amazing quarter. 41% year-over-year growth on top of 26% year-over-year growth with prior quarter, that's massive, and 15% revenue itself. Congratulations, especially in the face of that Bloomberg Businessweek article. Could you provide some – what was the year-over-year growth for the components in revenue and the percent mix between those two? I'm sorry, between components and systems?

[Perry Hayes, Senior Vice President-Investor Relations]

Yes, just one second. Nehal, this is Perry. The systems was 84% of total revenue.

[Nehal Chokshi, Maxim Group]

Okay. And how we should grow year-over-year?

[Perry Hayes, Senior Vice President-Investor Relations]

That was consistent with the last quarter. I think probably we need to look that one up and get back to you later.

[Nehal Chokshi, Maxim Group]

Okay, all right. And then Kevin, you talked about that the guidance reflects a slowing down IT environment as well as potential impact from the Bloomberg Businessweek article. So there is no potential there having been demand called in from the December to September quarter? That's also part of that weekend guidance or it's completely the first two items that you talked about?

[Kevin Bauer]

Well, I mean, I think there is also possible speculation that customers could have potentially ordered early to try and beat tariffs. We don't have a specific evidence of that but that could be possible.

[Nehal Chokshi, Maxim Group]

Okay, thank you. I’ll get back in the queue.

[Operator]

Thank you. [Operator Instructions] We’ll take a follow-up question from Nehal Chokshi with Maxim Group. Thank you.

[Nehal Chokshi, Maxim Group]

Thanks. All right, so the $50 million cash from operations, that's very impressive. And you mentioned that there was a 10-day increase in the cash conversion cycle, which is indeed seasonal. But I would expect that there would have been a significant consumption of cash then. And so what was the balance sheet item that did actually enable the generation of cash?

[Kevin Bauer]

Yes, we're not disclosing too much more. I think, one thing that has helped and I’ve mentioned this before is that our shipment linearity is much better now, so we are shipping more early in the quarter and have that opportunity to kind of collect that. So I think that's a good portion of that.

[Nehal Chokshi, Maxim Group]

Got it, okay. And then finally, with respect to the 8-K that was filed that shows the ranges of likely restatement. It looks like to me there's about a net $60 million of revenue that's shifting out from those periods of fiscal year 2015 or fiscal year 2017 into fiscal year 2018 and beyond. Is that a correct characterization, I do recognize that's really only 1% of cumulative revenues, but just want to make sure I'm understanding that correctly?

[Kevin Bauer]

So as of late, if you're trying to understand what the impact there will be on fiscal year 2018. That will be limited to table that's shown in fiscal year 2017. And then if you recall that I mentioned that we would be continuing to apply the same procedures as fiscal year 2018, so there will be a continued roll effect.

[Nehal Chokshi, Maxim Group]

Okay. And then finally, if I look at the net income, that's been shifted out. That's $10 million. So if you take that $10 million divide that by $16 million, that's about – 13% net income ratio? That's much higher than what your corporate average was during those periods. So what's the explanation for that? It seems like the revenue that's been shifted out tends to the higher net income margin.

[Kevin Bauer]

Yes. So I think there is other elements in that reduction of income. If you remember, we said that the primary effects are related to sales as well as inventory. So to the extent that there are inventory debits, those won’t move into fiscal 2018.

[Nehal Chokshi, Maxim Group]

Okay, all right. Thank you. That’s it from me. Thank you.

[Kevin Bauer]

Nehal, the system revenues last year in the same quarter was 75%.

[Nehal Chokshi, Maxim Group]

Okay, great. Thank you very much.

[Operator]

Thank you. [Operator Instructions] And next we’ll go to Hosseini with Susquehanna.

[David Ryzhik, Susquehanna]

Hi, thanks so much for taking the question. David Ryzhik here for Mehdi Hosseini. Would love to dive in a little more in storage, can you remind us what you said around NexGen Storage, what the growth rate was and some of the trends you're seeing there? And I had a follow-up.

[Charles Liang, Chairman and Chief Executive Officer]

Yes, we see people really moving in NVMe [indiscernible].

[David Ryzhik, Susquehanna]

Great. What was the growth rate again?

[Kevin Bauer]

I’m looking at my notes. I see didn't share that. It's over 50%.

[David Ryzhik, Susquehanna]

Storage as a whole or NexGen Storage?

[Kevin Bauer]

That’s storage as a whole.

[David Ryzhik, Susquehanna]

Understood. And would love to get your thoughts on the memory components and impact to margins. It seems like things are obviously easing. It was a headwind before. Just how are you guys thinking about the impact of DRAM and NAND flash pricing moving forward and the impact to your business?

[Charles Liang, Chairman and Chief Executive Officer]

Yes, very good question. We expect both SSD and NVMe pricing continuing to be lower and so as DRAM, pricing to become softer and softer in the next few quarters. So from this point of view, we believe all our profit – I mean profit margin will be keeping as same as before or slightly better. However, the revenue maybe slightly lower because of that cost for memory and flash are lower. But basically there are good signs to us, basically.

[David Ryzhik, Susquehanna]

Okay, great. And then just for the outlook for the December quarter. What specifically have you heard? Is it just like broader macro or is it specifically based on just some customer conversations that you have had that has resulted in the lower outlook?

[Charles Liang, Chairman and Chief Executive Officer]

I would have to say it is micro business. IT industry just like I mentioned slowed a little bit over.

[David Ryzhik, Susquehanna]

And just lastly, I – one of your customers in IDC for a while had announced a big acquisition in the cloud space. Just wondering if that, if you view that as an opportunity for Super Micro going forward? Just any thoughts on how that shapes up for you?

[Charles Liang, Chairman and Chief Executive Officer]

Yes, I mean, for change, basically, we see how it is positive to our business.

[David Ryzhik, Susquehanna]

Thank you so much. Thank you.

[Charles Liang, Chairman and Chief Executive Officer]

Thank you.

[Operator]

And next question from Jon Lopez with Vertical Group.

[Jon Lopez, Vertical Group]

Hi, good evening. Can you hear me okay?

[Charles Liang, Chairman and Chief Executive Officer]

Yes.

[Jon Lopez, Vertical Group]

Okay, great. Thanks. I'm wondering, you made a comment in the prepared remarks relative to – it was some reference of the orders or perhaps billings measured year-on-year that you were tracking comfortably ahead. If you remind me just flushing that out a little bit. Just what do refer and just may be some level of magnitude, just given ballpark on a year-on-year basis?

[Kevin Bauer]

Yes. What we were trying to share was that if memory serves me, we did roughly about $851 million in the quarter a year ago. And our guidance is slightly above that range. What we were trying to differentiate here was that given that were macro considerations as Charles mentioned as well as we've had the Bloomberg impact.

The other key thing that we wanted to share is that, even though our guidance range is still within that metric as compared to last year, our quarter-to-date progress is ahead of that. And we think that it is healthy ahead, but we're not going to give our specific metric.

[Jon Lopez, Vertical Group]

Okay, understood. I apologize. Is trying to communicate the business is sort of running better than what the year-on-year guidance implies and you're losing yourselves to account for macro considerations, et cetera?

[Kevin Bauer]

We are saying that we have better identification than last year as it relates to getting to $850 million or $860 million or whatever within our range.

[Jon Lopez, Vertical Group]

Okay, understood. Second question, could you just possibly flush out a little bit the comment you made around the article? May be specifically, just may be offer a bit of a cadence like, I'm assuming that there was sort of all hand on that scramble period directly after the article, but if could you walk us how the interaction has been? And just any anecdotes or offer a little bit more detail on the idea of customers perhaps starting to migrate back, is that sort of appear to have been largely a non-issue? Can you maybe just spend a second on that? Thanks.

[Kevin Bauer]

Yes. So we are not going to get ahead of ourselves in that. I think we've had communications directly with customers and the way that we feel about the business is in relation to those discussions with customers.

[Charles Liang, Chairman and Chief Executive Officer]

From our couple of estimate, we don't believe it happened to our hardware. So basically, we don't believe there is chip.

[Jon Lopez, Vertical Group]

Understood. I guess what I'm just trying to get a little bit sense for is was there a period like a complete freeze up around sort of customer dialogue and then bought out pretty fast or was there not that? I guess, I was trying to get a characterization here that was two months out, if you guys sort of have a feel that the crux of the problem has largely moved passed you. I understand that there is some uncertainty left, but I'm just trying to get a sense of progress, between point A and point B?

[Charles Liang, Chairman and Chief Executive Officer]

I would have to say, I mean, we don't believe their balance sheet and most of our key customers don't believe that too. So at this moment, we feel pretty comfortable for our future business.

[Jon Lopez, Vertical Group]

Okay, understood. Last question, I apologize. On the December guide, can you just offer some qualitative commentary around that cloud vertical? It’s obviously been very strong for a couple of quarters. And I'm just wondering, are you guys factoring in some easing whether that’s project related or potentially pull forward related? Or just any characterization as to what that specific segment is doing as you go from calendar Q3 to calendar Q4?

[Kevin Bauer]

Yes, we don't provide forward guidance by market vertical.

[Jon Lopez, Vertical Group]

Understood. Is it too much to ask just to say whether it would be up, down or flat?

[Kevin Bauer]

I'm not sure what you're trying to get at.

[Jon Lopez, Vertical Group]

I'm just trying to get a sense…

[Kevin Bauer]

Basically, we believe with our macro ITP may slow down relative, basically from a lot of our vendors, our competitors and industry analysis result.

[Jon Lopez, Vertical Group]

Okay, thanks. Just so it's clear what I'm trying to get. That business tends to be a little bit more lumpy and project related and sometimes travel independent macro. It's been very strong for a couple of quarters. So I'm just trying to get a sense of whether you had some temporary pause in some activity that may be contributing to what you're seeing in December?

[Kevin Bauer]

Assign it to macro.

[Jon Lopez, Vertical Group]

Thank you very much for all the thoughts. Really appreciate it.

[Kevin Bauer]

Okay. Thank you.

[Operator]

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

[Charles Liang, Chairman and Chief Executive Officer]

Thank you, everyone, for today. And have a great day. See you next quarter.