Super Micro Computer, Inc. — Q1 FY2017 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three months ended September 30, 2016, the first quarter of fiscal 2017. Super Micro develops and sells server systems, subsystems and accessories for cloud, data center, enterprise, HPC and IoT markets. Results are not necessarily indicative of future periods.
Financial performance
| Metric | Q1 FY2017 | Q1 FY2016 | Change |
|---|---|---|---|
| Net sales | $529.0 million | $519.6 million | +1.8% |
| Gross profit / margin | $80.1 million / 15.1% | $72.2 million / 13.9% | Profit +10.9%; margin +1.2 percentage points |
| Operating expenses | $59.9 million | $50.8 million | +17.9% |
| Operating income | $20.2 million | $21.4 million | -5.8% |
| Net income | $13.5 million | $13.7 million | -1.2% |
| Diluted EPS | $0.26 | $0.27 | -3.7% |
| Operating cash flow | $(11.0) million | $20.3 million | Declined $31.3 million |
Revenue growth came mainly from subsystems and accessories, up 4.9% to $171.5 million; server-system sales rose 0.4% to $357.5 million. Server systems were 67.6% of sales versus 68.6% a year earlier. Sales to distributors increased to 50.0% of revenue from 45.6%; U.S. sales fell to 55.9% of revenue from 65.2%, while Europe and Asia gained share.
Research and development rose 17.2% to $33.2 million, sales and marketing rose 11.7% to $15.9 million, and general and administrative expense rose 31.2% to $10.8 million. Management attributed higher expenses principally to compensation and staffing growth. The effective tax rate was 32.0%, versus 35.4%.
Financial position and liquidity
- At September 30, cash and cash equivalents were $146.7 million; cash plus investments were approximately $149.4 million. Cash and cash equivalents were $181.0 million at June 30.
- Current assets were $989.4 million and current liabilities $415.5 million. Inventory was $500.0 million, up from $449.0 million; accounts receivable was $328.3 million, up from $288.9 million. DSO rose to 54 days from 50, and inventory days to 97 from 87.
- Total debt, net of issuance costs, was $98.2 million: $61.0 million current and $37.2 million long-term. The company reported compliance with Bank of America financial covenants at quarter-end.
- Investing cash outflow was $11.5 million, including $11.6 million for property and equipment. Financing cash outflow was $12.0 million, including $18.5 million of share repurchases. Cash declined $34.3 million during the quarter.
- Operating cash use reflected increases in inventory of $54.9 million and receivables of $39.4 million, partly offset by a $43.4 million increase in accounts payable. Management said the working-capital build supported anticipated Q2 sales growth.
Changes, outlook and notable items
- Gross margin improved year over year, but management said the comparison benefited from a $9.3 million out-of-period extended-warranty revenue adjustment: the revenue related to fiscal years ended June 30, 2013–2015 and had been deferred in the September 2015 quarter. Lower cloud/data-center server sales also supported the margin comparison; higher inventory and warranty provisions and lower manufacturing utilization were offsets.
- Inventory provisions were $3.9 million, versus $1.7 million a year earlier; warranty provision was $4.9 million, versus $3.9 million, with management citing increased claims and service costs.
- The July 2016 repurchase authorization permits up to $100 million of buybacks over 12 months. The company repurchased 888,097 shares for $18.5 million during the quarter.
- Management expects continued growth in working-capital needs and capital expenditure, and anticipates using operating cash flow and additional bank financing. It expected approximately $9.5 million of further investment through April 2017 to complete a second San Jose manufacturing facility and remodel an office building. Management stated it had sufficient cash to operate for at least 12 months. No specific revenue or earnings guidance is provided in the filing text.
- After quarter-end, the company drew an additional $30 million on its Bank of America revolving facility to support growth and expansion in the Netherlands. At quarter-end, unused Bank of America revolving capacity was $53.8 million; CTBC availability was approximately $0.1 million.
- Non-cancellable purchase commitments were $354.8 million, including approximately $42.2 million of hard-drive commitments payable through December 2016. Contractual obligations totaled $475.2 million, including debt payments and purchase commitments.
- Ablecom, a related-party contract manufacturer associated with the CEO’s family, supplied $50.2 million of purchases during the quarter; amounts payable to Ablecom were $38.3 million. Outstanding purchase orders with Ablecom were $77.4 million. The filing describes potential pricing, supply and conflict-of-interest exposures.
- Gross unrecognized tax benefits were $17.1 million, including $1.5 million of accrued interest and penalties. Federal returns for 2012 and 2013 were under IRS examination with no adjustment proposed as of quarter-end; Taiwan tax assessments for 2013 and 2014 were under appeal. Management did not expect a material change in unrecognized tax benefits over the next 12 months.
- Management said pending ordinary-course legal proceedings were not expected to materially affect financial condition, results or liquidity. A previously identified material weakness concerning extended-warranty revenue recognition was reported as remediated by June 30, 2016; disclosure controls were assessed as effective at September 30, 2016.
Key facts for investors to verify
- How much of the gross-margin improvement is sustainable apart from the $9.3 million warranty-revenue comparison item, and how warranty and inventory costs evolve.
- Whether higher inventory, receivables and DSO convert into sales and cash, particularly given negative operating cash flow and management’s anticipated growth.
- Whether revenue and margin trends hold across product mix, regions and sales channels, including weaker U.S. and cloud/data-center demand and greater distributor reliance.
- How the $354.8 million purchase commitments, hard-drive obligations, facility spending and subsequent $30 million borrowing affect liquidity and debt capacity.
- Developments in Ablecom-related purchasing and exposures, tax audits and appeals, and continued effectiveness of controls over extended-warranty revenue recognition.