Super Micro Computer, Inc.

Good day, ladies and gentlemen, and welcome to the Supermicro's second quarter fiscal 2021 financial results conference call. At this time, all participants are in listen-only mode. Later, we'll conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchstone telephone. I would now like to turn the conference over to your host, Mr. James Kistner, Vice President of Investor Relations. Please go ahead, sir.

Good afternoon. Thank you for attending Supermicro's call to discuss financial results for the second quarter of fiscal 2021, which ended December 31st, 2020. 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. 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 note that some of the information you'll hear during our discussion today will consist of forward-looking statements, including without limitation those regarding revenue, gross margin, operating expenses, other income expenses, taxes, capital allocation, and future business outlook, including the potential impact of COVID-19 on the company's business and results of operations. There are a number of risk factors that could cause Supermicro'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 10-K filing for fiscal year 2020, and our other SEC filings. All of these documents are available on the investor relations page of Supermicro's website. We assume no obligation to update any forward-looking statements. Most of today's presentation refer to non-GAAP financial results in Business Outlook. For an explanation of our non-GAAP financial measures, please refer to the accompanying 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. At the end of today's prepared remarks, we'll have a Q&A session for self-taught analysts to ask questions. I'll now turn the call over to Charles Liang, Chairman and Chief Executive Officer. Charles.

Thank you, James, and good afternoon, everyone. Today, we have released our fiscal 2021 second quarter financial results. Now, let's take a look at some highlights from the quarter. Our fiscal second quarter net sales total 830 million, down 5% year-over-year and up 9% screenshot, landing at the midpoint of our guidance range. Our fiscal Q2 non-GAAP earning per share was 63 cents compared to 55 cents in fiscal Q1 of 2021 and 57 cents in the same quarter of last year. As we expected, Q2 improved after a seasonally weak Q1. We are proud that we achieved these results despite a very challenging environment as the impact of COVID-19 was significantly worse since early November, which impacted our operations, especially in the USA headquarters. Over the same period, however, we had significant international growth to offset the weakness in the United States. Quarterly sales in many Asian and European countries were up double digits, and in some cases, very high double digits, which demonstrates the strength and the improvement of our global sales organization and channel partners around the world. I expect this strong international business growth to continue in March quarter and the future. On the topic of our aggressive growth strategy, our new high-profile customers mentioned on our last earnings call digest their recent purchases in Q2, and we remain excited about our relationship with these customers. Additionally, our sales team are continuing their efforts to expand and nurture new opportunities in these accounts for the next few quarters. and EOS. While these efforts have been on track with our internal goal, we have recently speeded up our effort to win new accounts in recent months. We plan to further accelerate these goals with new incentive programs and executive action. The purpose of these actions other than supercharge our sales force, is to restore our original winning culture. We have set a great goal for ourselves, and my team is deeply committed to Supermicro's future with more and more passion. To support this international and global growth strategy, we have aggressively expanded our Taiwan campus capacity and capability in production, operation, engineering, and sales. The new Building 62 at our Taiwan Science and Technology Park will be online early this summer, which will add another 1 million square feet of manufacturing and office space, efficiently doubling our production capacity within next six to eight months. In the short term, this effort will alleviate some logistic production and engineering impact caused by COVID-19. In the long term, I believe that our Taiwan campus start to reach a higher economical scale. Revenue and profitability growth will become much stronger in the coming quarters and years. To complement our effort in Taiwan, our Building 23 in San Jose is on schedule to become online in the next quarter, which will further boost our strong American manufacturing credentials. I'm confident these actions will help us capitalize on many new key market opportunities in our approximately $100 billion tent. Let's move on to our technology and products. With the unique building blocks solution product approach, our R&D organizations are hard at work to expand our optimized Intel, AMD, and NVIDIA portfolios. In addition, we have doubled our software and service headcount and resource over the past two years. These investments are making a great impact on improving customer experience in both solution quality and security. With the upcoming new Intel i7 processor, we again bring the time-to-market advantage, high product quality, and application-optimal solution to our customers. We are pleased to see a strong trend in terms of customer seeding and early deployment requests. And we have started some of our early deployments to our key customers recently. True to our application optimized product strategy, we believe our IceBag product line will provide precisely the best hardware platforms to telco, 5G, and AI, as well as data center applications. As such, we are prepared for our IceBag product line to become a key growth drive in the coming quarters. Although COVID-19 continues to disrupt us badly, our strong foundation has safely supported our company and business. As I have mentioned, we have taken decisive actions to expand our operations, engineering, and sales term our sales team in Taiwan to further reduce the COVID-19 impact. These efforts, together with our application optimization solution, have resulted in great progress with our focused business vertical. First, our organic business gained more than 10% new major customer server account in the last few quarters. benefiting from our strong product line and expanding Taiwan operations. Our B2B automation, auto calculators, as well as software and service enhancements will continue this growth momentum. Second, we start to refocus on our large data center and OEM since about three months ago, right after our 10K was filed. Two high-profile customers have started to ship in small volume recently, and we are ramping up to a larger scale later this calendar year. We plan to add one or two more large DC, large data centers, or OEM customers in this category before the end of this calendar year. Third. On 5G telco and IoT, we have won a handful of new telco customers last year. They are currently starting to ship small volume with upside, and we expect high volume shipment to these customers. We have started this kind of year as well. And number four, our B2B and B2C automation with autocamulator. have been greatly improved in the past three quarters, which is even more critical as COVID-19 forced a more remote working environment for lots of customers and our own employees. We have been developing this powerful project for the past five years, and it will be ready to go live by this quarter end. This will make it much easier to share communication and product configuration among ourselves, engineers, and our customers. As discussed in our last earning call, we believe that Q1 of fiscal 2021 will prove to be a near-term bottom in our business. And our Q2 results are the first proof that Supermicro is indeed back on the growth track. I'm excited that our recent booking activity, along with our new business initiative, give us the confidence to provide Q3 guidance that, if achieved, will reflect a resumption of a quick growth on a year-on-year basis. Furthermore, we are pleased to announce a newly approved $200 million of share repurchase program, which investors should view as a sign of our commitment to enhance stockholder value and our confidence in our long-term business success. I will share more detail about our strong growth plan, business scale, our unique momentum, and when and how will we reach $10 billion revenue in the coming soon investor event. As the only fast-growing server solution hardware design and manufacturer company in the U.S. in the last 27 years, Supermicro 3.0 is nearly 100% ready. That means we are ready to grow quickly. But before I pass on, I'd like to take this chance to announce the appointment of David Wagon as our Senior Vice President and Chief Financial Officer. David joined the company in May 2018 as Senior Vice President and Chief Compliance Officer, a CPA and native of Silicon Valley. David came to Supermicro from HP Enterprise, where he who works as the vice president. He was previously the CFO of Renaissance Electronics America Inc. David succeeded Kevin Bauer, who is our current CFO, and is leaving the company to pursue his passion at a not-for-profit organization at the end of this month. It has been a privilege working with Kevin And I appreciate his great leadership, hardworking, and dedication to Supermicro over the past four years. Kevin is credited for improvement over our financial system and many system automation. I wish him a great success in his new venture. I will now pass the call to Kevin one last time to provide additional detail on the quarter and our

Thank you, Charles. I'd like to say a few words to our employees and investors. I have enjoyed working with Charles and the very dedicated Supermicro team and helping the company through challenging times over the last four years. I am most proud of the work enhancing our company's financial function, providing a stronger foundation for the company to continue to grow, as well as our focus on improving operations to generate cash, which enabled a return of capital to shareholders. To all the Supermicro team, we have accomplished so much together, yet there is unfinished work. Carry on. On a personal note, my new role will be in an area where I have strong passions for and also serves a community that I have a long association with. I'm excited to join as the chief financial officer and key business executive to help this organization to reach its objective of delivering increasing value. When announced, this new role will make sense to you all. Before jumping into the results of the quarter, I'd like to briefly touch on several accomplishments we made this quarter on the environmental, social, and governance, or ESG, fronts. which we recognize is becoming increasingly important to investors. A few of our recent accomplishments include, one, driven by our efforts to comply with social environmental concerns, Supermicro received a near-perfect audit score from the Responsible Business Alliance at our Taiwan manufacturing site in November 2019 with a score of 196.4 out of 200 points. In December 2020, we sent a commitment letter to the Science-Based Targets Initiative and We Mean Business Coalition, indicating we will join other companies in striving to keep global warming to the 1.5-degree goal and create company targets. We also joined other leading companies in the green grid, where we believe our expertise in hardware design and energy-efficient computing can help drive forward the industry. In January 21, Supermicro transitioned its San Jose grid energy sourcing to wind RECs, signifying that in conjunction with our Bloom energy fuel cells, all our use of energy at our new and old San Jose campuses will not result in the burning of fossil fuels. We believe these recent accomplishments and milestones continue a long history of our commitment to green computing, sustainability, and generally making the world a better place for future generations. Now turning back to two key results. Our fiscal second quarter revenue totaled $830 million. This reflects a 5% year-on-year decrease from the same quarter of last year and a 9% increase from the first quarter of fiscal year 2021. Systems comprised 77% of total revenue, and volumes of systems and nodes shipped were up sequentially but down year over year. System ASPs increased year over year but were down modestly quarter on quarter. Turning to geographic performance, our international sales strengthened from two quarters of softness. On a year over year basis, the U.S. decreased 12%. Europe increased 5%. Asia declined 3%, and the rest of the world increased 68%. On a sequential basis, U.S. sales declined 7% quarter-on-quarter, Europe increased 38%, Asia increased 27%, and the rest of the world increased 86%. From a customer point of view, we saw pickup in sales to OEM customers, but this was offset by the expected digestion. after a strong Q1 contribution by new high-profile customers that we mentioned last call. From this point forward, unless otherwise noted, I will be discussing financial metrics on a non-GAAP basis. Working down the P&L, Q2 gross margin was 16.4%, up 50 basis points year-on-year, and down 70 basis points quarter-on-quarter. Recall on our November earnings call, we stated that we expected gross margin to decline 160 to 200 basis points on a sequential basis, chiefly due to the absence of a cost recovery benefit, as well as elevated freight costs. While we did see elevated freight costs, we did, however, benefit from additional cost recovery similar additional cost recovery similar in magnitude to the benefit we experienced in fiscal q1 or about 130 basis points we do not anticipate a similar benefit going forward turning to operating expenses 2q opex on a gap basis decreased one percent quarter on quarter and 11 year on year to 99 million Q1 gap operating expense benefited from a credit of $2.1 million for an executive SEC settlement, and Q2's gap operating expenses contain $2.5 million in special performance bonuses. Without these factors, Q2 gap operating expenses would have been down more significantly quarter-on-quarter. On a non-GAAP basis, operating expenses decreased 5% quarter-on-quarter and 12% year-on-year to $90 million. The sequential decrease in non-GAAP objects was primarily due to lower audit fees, lower R&D expense due to higher-than-normal credits for NRE work performed, and overall expense discipline. Other income and expense... was $13.1 million loss as compared to a $1.5 million loss last quarter. The increase loss was chiefly driven by the remeasurement of our Taiwan dollar loans to a weaker dollar. This quarter our tax expense was $5.1 million on a GAAP basis and $7.1 million on a non-GAAP basis. Our non-GAAP tax rate was 16.4% for the quarter Going forward, we continue to expect our tax rate to be approximately 16%. Lastly, our joint venture contributed a loss of $1.1 million this quarter related to an air pocket in revenue as compared to income of $1.3 million last quarter and a loss of $1 million the same quarter a year ago. Q2 non-GAAP diluted EPS totaled 63 cents as compared to 55 cents in Q1 of fiscal 21 and 57 cents in the same quarter of last year. Cash flow from operations totaled $63 million compared to cash flow of operations of $121 million in Q1. CapEx totaled $14 million, resulting in free cash flow of $49 million. Our closing balance sheet position for cash was $315 million, while bank debt was $45 million, resulting in a net cash balance of $270 million. Please also note that we completed our previously announced $50 million share repurchase program on January 6th, wherein we repurchased 1.68 million shares at a weighted average price of $29.82. As Charles mentioned in our earnings release today, we concurrently announced that we have board level authorization for the company to repurchase up to another $200 million of our common stock in a new share repurchase program. The program is effective until July 31st, 2022. As Charles mentioned, we believe this action reflects our commitment to enhancing stockholder value and our positive long-term view of our business opportunity and cash generation prospects. We expect to execute the program in coordination with our cyclical working capital needs and growth. Turning to working capital metrics, our Q2 cash conversion cycle was 92 days, down from 107 days last quarter, but still outside our target of 85 to 90 days. While the absolute level of our inventory declined, days of inventory at 105 days remains elevated relative to our historical levels as we prepared for the impact of the Lunar New Year, logistic challenges, and some tightening of components. Day sales outstanding was 36 days, while days payable outstanding totaled 49 days. Now turning to the outlook for our business. We expect new sale net sales for the quarter ending March 31st, 2021 in the range of $790 million to $870 million. We expect gross margins to decline approximately 120 to 160 base, sequentially due to the lack of a cost recovery discrete event that we explained earlier over the last two quarters. and also the product mix that we expect to ship in the quarter. We expect our non-GAAP operating expense level to increase quarter on quarter to the mid-90s, driven by payroll taxes in the new year and selective investing in R&D. We continue to anticipate our GAAP and non-GAAP tax rate to be approximately 16% going forward, and we expect other income and expense, including interest expense, to total roughly $1 million and expect a contribution from our JV of roughly a half million dollars. We expect fully diluted GAAP earnings per share to be in the range of $0.22 to $0.42 and fully diluted non-GAAP EPS to be in the range of $0.37 to $0.57. And we continue to expect our CapEx for fiscal 2021 to be in the range of $55 to $60 million, inclusive of our ongoing Taiwan building project mentioned earlier by Charles. James, we're now ready for Q&A.

Thank you, Kevin. One quick announcement before entering Q&A. We will be attending the Goldman Technology Internet Conference on February 11th. and conducting one-on-one meetings with investors. Operator, we're now ready to take questions.

Thank you. At this time, I would like to inform everyone, in order to ask a question, please press star, then the number one on your telephone keypad. Again, that is star one to ask a question. We have your first question from Ananda Barua from Loop Capital. Your line is open.

Hey, good afternoon, you guys. Appreciate you taking the question. Congrats on solid results. And, Kevin, congrats. It's been good working with you. Good luck, and we'll miss working with you. Yeah, I guess a couple if I could. I guess the first one is, just broadly speaking, how would you like us to think about the various catalysts as we move through the year, the things that we should keep an eye out for and what you're expecting to impact the business. You spoke to a number of them on, you know, in the prepared remarks. We would just love to sort of get some more context on how we should think about them layering in. And I have a follow-up or two. Thanks.

Yeah, I believe our business is have been very solid now, except for COVID-19, threatened in the USA still very severely. So we are very carefully taking care of that while kind of aggressively grow our operation and business in Taiwan. So COVID is getting better as now we expect. Our business should be getting into a much smoother, much stronger period. So we have a good feeling about coming quarters or years.

And, Charles, when you think about sort of some of the newer aspects to your business, and you mentioned Ice Lake as well in coming quarters, hyperscale Ice Lake. You mentioned, you know, sort of the 5G systems going into the telcos. Which of those, could you sort of rank for us, even if anecdotal, which ones of those do you think would be the most impactful when you look back on 2021, hyperscale, hyperscale ice lake, the 5G telco business?

Yeah, like I just shared with everyone, we started to focus on large data centers and OEMs since about three months ago. And we already achieved a couple of them. And they started to move, and we believe the volume will increase very soon in this year and next year, I believe. As to 5G telco, again, we already engaged a handful of customers. Kind of they are all-class vehicle company. So the relationship has been created very solidly, and they start to move some small volume, and we also expect some high volume will follow very soon, and it will be long-term partnership. So overall, we are very optimistic for our long-term growth.

Okay, great. I'm going to sneak one last one in here. Charles, I believe it was you in the prepared remarks. You mentioned the analyst event. Do you have a timeframe you're thinking about for that?

Yes. You mean the investor event?

Investor event, yes.

Yeah. I hope within the next few weeks. Because we should have had last quarter, but because the COVID-19 is really coming very bad, so we kind of take a wait and see. But now it looks like things are getting under control. So I hope in the next few weeks, we will have a big investor event. So to share the company plan, the future, the momentum with our investors.

Oh, excellent. So just to clarify for myself, in the next few weeks, do you think you'll be announcing the date of the event, or do you think you may actually be having it in the next few weeks or so?

I guess we will announce it in the next two weeks, for example, and hopefully have that event in three to four weeks.

Thank you. Excellent.

Thanks a lot. Thank you. We have your next question from John Tawantang from CJS Securities. Your line is open.

Hi, guys. Thank you for taking my questions. And this is a very nice quarter. And, Kevin, congratulations on moving on to the next phase. My first question is on, you know, just hearing Intel when they spoke about we're seeing another quarter or two of digestion in the cloud and data center space. It seems like you're not seeing that. I was wondering, what kind of customer are you seeing strengths from that's maybe running counter to what they're saying? Is it maybe just from AMD, or is it another end market? Just give me a sense of why your strength is running opposite to what they're seeing.

Yeah, as you know, we have a very strong Intel product line. At the same time, we also have a pretty big AMD product line. So once the market has a demand, we will grow. And even if the market keeps flat, because our outstanding product, our kind of better solution overall. So we believe once the market is not too bad, we will have a chance to grow. smoothly, kind of, and even the market is growing, I guess our growth will be very significant. And as you know, since the company was founded since 1993 to 2017, our growth has been always much faster than the industry average. And I believe we are getting back to that position very soon.

Okay. Thank you, Charles. And then, Just on the impact that COVID has had on the business, can you call out just the impact on either the margin or the revenue that you had in December and into January so far? You mentioned higher freight expenses, but lockdowns probably had an impact as well. I don't know if you've seen anything else such as employee absenteeism, but if you could kind of quantify or give some color on the impact of the pandemic so far, that would be helpful. Thank you.

yeah it's kind of uh the impact is very bad and very broadly unfortunately in that more than nine months now so a logistical for example uh it's become very uh hard to uh to ship a product even from asia to usa we see the shipping today the coast increase Or even more, logistic time to market delay and logistic cost increase. And then lots of customers work from home and some of our employees work from home. So all of those created a difficulty for business. especially for application optimized solution. And the good thing is our auto configurator, which is a program to help sales, help our engineer, help our customer to work together to make the best optimized solution for them. The tool is getting ready. I believe by end of this quarter, most of our sales engineers and customers will be able to use those tools. So I'm very excited for the tool to be available in this quarter.

Okay, great. If you don't mind me asking one more.

Hello? Yeah, John, this is Kevin. I would just echo what Charles has said is that, you know, when you have work from home, it definitely reduces the coordination of the organization. So, you know, we have to push harder in that arena. And then some other examples like, you know, just having to confirm that, you know, there's someone else on the other side to receive the shipment. Not all companies are open every day. So, There's definitely a lot of little different things like that that make conducting business more difficult, like Charles had said.

Understood. And if I may ask, looking beyond the pandemic, and Charles, I know your new facility is opening up in the second half of this year or earlier this summer. What can margins look like on a normalized basis without all these headwinds when you have new facilities and when you have some more volume in the customer shipping? Maybe share some of the plans you're having for where margins could go.

Yeah, as you know, we have two kinds of customers. One is a high-end enterprise who like our better product, better performance, better service. And then we also have another customer who buy high volume and they want lower cost. So before, most of our operations are tied in the USA. And with COVID-19, the impact was really big. But now we have a Taiwan operation getting ready, especially by early summer. We will have a much bigger capacity. So we can start to service those customers who buy high volume and cost-sensitive. So we are very excited. We start to line up with those customers since about 12 months ago. Now we have some customers, the end-ship is already established. And we already promised them, we are ready to support them. So in terms of how much impact, I would like to say, you know, maybe 2% or a little bit more than that. And 2% for enterprise, some are small. But for high-volume customer, that 2% or 3% indeed is a big difference for them. So we are very happy we have those opportunities now ready from Taiwan.

Great, thank you very much.

Thank you. We have your next question from Nihal Chokshi from Northland Securities. Your line is open.

Thank you. Congratulations on the strong gross margin and very strong revenue guidance. That's a really nice outlook there. On the net income, the midpoint of the net income, that implies about a 9 million QV decline. How should we parse that between gross margin up extra March quarter?

Well, I think we shared that we thought that the gross margin would be declining quarter over quarter because of some cost increases as well as the specific mix of products that we're going to ship. I would say that you would weight it probably towards what the expectations are for gross margin in the immediate quarter going forward. That would be the heavier weight. We'll put it that way.

That's very helpful. Thank you. And then, Charles, could you clarify what you mean by large OEM opportunity?

Okay. I mean, you know, especially after the pandemic, COVID-19 problem happened, all our internet, all our social networking companies have a strong demand. And those high-volume customers, indeed, they move in high volume, but they want no price, right? So before, we kind of did not really focus on those segments of customers. but because our Taiwan operation facility is getting ready. So we start to work with those customers, engage with them, and we got some very good feedback. So we are really engaged with some of them. And like I just mentioned, we ship a small volume now, and the high volume should follow later this year.

Okay. So just to be clear, is there –

a partnership with these uh with the hp and dells to get to the uh social networks or are you just referring to these you know large internet properties as the oems you know the good thing is super micro in last 27 years we already established our brand name and our credibility for quality for service and now especially our management software our services global wide have been well recognized by enterprise account. So we are ready to work with any kind of customer, directly with any customer or go through some OEM. So we open the opportunity.

Okay, thank you. And coming back to Kevin, so over the past two quarters, you guys have returned 50% of the free cash flow to shareholders by share we purchased, which is very good. So I know that you guys said that you wanted to message investors that you're evolving your capital allocation policy, but is that 50% rate at least a good way to think about how that you guys are thinking going forward? And then what about that remaining 50%? Is that basically needed to fuel future growth?

Yeah, so I think what I tried to share was is that In the new $200 million program, it's got roughly an 18-month or so duration, you know, given the date that it's valid through. I think investors that I've worked with know that we take an incremental approach, and we took first two steps in stock buyback. We got feedback that if we feel confident, we should, you know, back that up by maybe a more longer-term program, and that is exactly what we have done. So therefore, you know, it's a step-by-step process. I think the competing forces for the capital allocation is going to be, you know, the rate of our growth. That's the key thing. And we hope to be able to continue to grow strongly and have the adequate cash flow to consume, you know, or to fully execute that $200 million program over the 18-month timeframe. So it's definitely that as well as, you know, the investment. investments we need to continue to make in R&D for, you know, continued product development. Given that, you know, as it relates to Taiwan, we're kind of in the late mid-eatings on the investment there, you know, certainly the building is close to being completed there. I think it's going to be June or something like that, Charles. Yeah, June. And so, therefore, you know, that consumption of cash will abate for a while because our maintenance capital is like $5 million to $7 million a quarter. And so that will help free up some cash, you know, in the second half of calendar 2021. And that's kind of the moving pieces that we're thinking about. And, you know, with the continued cash generation of the company, we felt confident to get $200 million program approved.

Okay, fantastic. And my final question, before I get back into the queue, is that you mentioned that NRE work was part of that R&D queue decline. So what's the decision for when Supermicro accepts this type of work? Can you talk about that real quickly?

Yeah, so we work very closely with some of our chief component suppliers to work on platforms that work with their key components. And so we really look to work with those key vendors to enable platforms that we believe are ones that are going to get traction in the marketplace. So, you know, we look at what's the popularity of likely popularity of those platforms and then enter into those arrangements. They tend to be rather short-term in nature, so I want to share with you that it's not like a multi-year development, but rather, you know, maybe a half-year development. So it's a little bit easier to make those commitments because not only they're not so large, but also, you know, the prospects for the product are pretty close in the future.

And what's the top of that? hosted the face basically we have uh some very uh close partner they really want us to design something unique something outperform for the market and also some customers they want to really uh outstanding uh unique uh platform design so we work with uh both vendors and the customers so for those special designs and usually they pay some mru

What's the type of return in terms of revenue or gross profit dollars you can typically see when you pick this type of NRE product that expects to become a platform that drives future sales?

For sure, our goal is not for NRE data. The really goal is for a partnership. When you work with a vendor to design the really optimized solution, then we together to approach the market. Same thing for customer. Some customer with their special application or data center equipment.