Business context and reporting period
Super Micro Computer, Inc. designs and sells high-performance server systems, subsystems and accessories. This unaudited Form 10-Q covers the quarter and nine months ended March 31, 2016, the third quarter of fiscal 2016 (fiscal year ends June 30). The request metadata says “2015 Q3,” but the filing itself reports fiscal 2016 Q3.
Financial performance
| Metric | Three months ended March 31, 2016 | Nine months ended March 31, 2016 |
|---|---|---|
| Net sales | $532.7 million; up 13.1% year over year | $1,691.3 million; up 19.3% |
| Gross profit / margin | $79.2 million / 14.9% (16.3% prior year) | $257.7 million / 15.2% (16.3% prior year) |
| Operating income | $24.4 million (vs. $31.4 million) | $95.0 million (vs. $106.0 million) |
| Net income | $16.7 million (vs. $23.1 million) | $65.1 million (vs. $75.2 million) |
| Diluted EPS | $0.32 (vs. $0.44) | $1.26 (vs. $1.47) |
| Cash from operations | Not separately reported for the quarter | $92.8 million (vs. $9.1 million) |
Server-system sales grew 23.3% in the quarter and 37.5% for the nine months, while subsystems and accessories sales declined 5.3% and 8.8%, respectively. Complete server systems represented 69.9% of sales in both 2016 periods, up from 64.1% in the prior-year quarter and 60.7% in the prior-year nine months. The United States accounted for 61.3% of quarterly sales and 63.4% of nine-month sales.
Balance sheet, liquidity and cash flow
At March 31, 2016, cash and cash equivalents were $176.4 million, current assets $983.6 million, and current liabilities $434.5 million. Inventory was $479.3 million, up from $463.5 million at June 30, 2015. Management reported 97 days of inventory and 51 days sales outstanding, versus 83 and 43 days, respectively, at fiscal year-end.
Total debt was $93.8 million, nearly all current, compared with $94.4 million at June 30, 2015. Nine-month capital spending was $25.1 million; investing cash outflow was $26.1 million and financing cash inflow was $13.2 million. Cash increased by $81.0 million over the nine months. The $2.6 million auction-rate securities balance is classified as long-term and is not currently liquid.
Material changes and unusual items
- Quarterly gross margin fell 1.4 percentage points year over year, mainly from lower margins on cloud/data-center systems and subsystems and accessories, and lower manufacturing-capacity utilization. Operating expenses rose 20.6% in the quarter and 30.7% for the nine months, including increased R&D, sales and marketing, and general and administrative spending.
- Nine-month sales and net income include a $9.3 million prior-period extended-warranty revenue correction recorded in the quarter ended September 30, 2015; the related prior-period net-income impact was $5.9 million. The company said the errors were not material to the individual prior fiscal years or to the current nine-month period. Without the adjustment, nine-month gross margin would have been 15.7%, management stated.
- Management identified a material weakness in internal control over financial reporting related to identifying extended warranties and other deliverables in sales contracts. It concluded disclosure controls and internal control over financial reporting were not effective as of March 31, 2016. Remediation steps were implemented, but effectiveness had not yet been established.
Outlook, risks and contingencies
Management cited expected growth in working-capital needs and capital expenditures, continued product development spending, and plans to invest approximately $23.2 million through November 2016 in a second manufacturing facility and office remodeling. It said cash on hand was sufficient to operate for at least 12 months and anticipated funding expansion through operating cash flow and bank borrowing. No specific revenue or earnings guidance is provided in the filing text.
Purchase commitments were $341.6 million, including $116.9 million of hard-drive commitments payable through December 2016. Management expects inventory and working-capital needs to rise with growth. Bank of America’s revolving facility was extended after quarter-end to May 31, 2016, with renewal negotiations ongoing; the company also entered a new CTBC credit agreement in April 2016. The company reported compliance with Bank of America financial covenants at March 31. Key risks include margin pressure and volatile component costs, inventory obsolescence, customer and order concentration, reliance on suppliers and related-party manufacturer Ablecom, and the material weakness in financial controls. One customer, SoftLayer, represented 10.2% of quarterly and 12.6% of nine-month sales. Management said pending legal matters were not expected to have a material adverse effect.
Important facts for investors to verify
- Whether the extended-warranty revenue correction and remediation controls are complete and whether the material weakness is effectively remediated.
- Whether gross margins recover as server-system mix and manufacturing utilization evolve, given the quarter’s margin decline.
- Whether inventory, DSO and purchase commitments convert into sales and cash without additional write-downs or working-capital strain.
- Renewal and terms of the Bank of America facility, and the availability and cost of financing for planned capital spending.
- Continuity and arm’s-length terms of the Ablecom relationship, and exposure to SoftLayer and other large customers.