Super Micro Computer, Inc. — Q1 FY2016 Form 10-Q
Reporting period: Three months ended September 30, 2015; comparative period is the three months ended September 30, 2014. The unaudited statements were revised to record an extended-warranty revenue correction identified in November 2015.
Business context and key financial metrics
Super Micro develops and sells server systems, subsystems and accessories. Management attributed revenue growth primarily to stronger sales of OEM- and cloud/data-center-oriented complete systems. Server systems rose to 68.6% of sales from 57.7% a year earlier.
| Metric | Q1 FY2016 | Q1 FY2015 |
|---|---|---|
| Net sales | $519.6 million | $443.3 million |
| Gross profit / gross margin | $72.2 million / 13.9% | $69.2 million / 15.6% |
| Operating income | $21.4 million | $31.6 million |
| Net income | $13.7 million | $20.9 million |
| Diluted EPS | $0.27 | $0.42 |
| Operating cash flow | $20.3 million | $27.0 million |
| Capital expenditures | $7.7 million | $2.8 million |
At September 30, 2015, cash and cash equivalents were $110.9 million, inventory was $461.4 million, and total assets were $1.082 billion. Total debt was $94.8 million, nearly all current; current liabilities were $419.0 million and current assets were $898.2 million. Long-term auction-rate securities of $2.6 million were illiquid. The filing reports $113.6 million of cash and investments at quarter-end.
Changes versus the prior comparable period
- Sales increased 17.2%; server-system sales grew 39.4%, while subsystem and accessory sales fell 12.9%.
- Gross margin declined 1.7 percentage points to 13.9%. Management said it would have been 15.4% absent the $9.3 million out-of-period warranty-revenue correction. Other cited pressures included sales mix and higher cloud/data-center sales.
- Operating expenses increased 35.2% to $50.8 million, with higher R&D, sales and marketing, and general and administrative costs. Operating income and net income fell despite higher sales.
- Operating cash flow declined by $6.7 million year over year. In Q1 FY2016, a $37.7 million decrease in accounts payable partly offset cash generation from collections and earnings.
- DSO increased to 55 days from 43 at fiscal year-end; days of inventory rose to 95 from 83, which management attributed to lower-than-anticipated sales.
Outlook, risks, contingencies and unusual items
- Revenue correction and controls: Extended-warranty revenue had been recognized at product sale instead of deferred over the warranty term. The correction reduced Q1 FY2016 sales by $9.259 million and net income by $5.926 million; the deferred revenue is expected to be recognized through FY2019. Management concluded the prior-year errors were not material to those individual periods and that the current-quarter correction was not material. The filing nevertheless identifies a material weakness in internal control over financial reporting and says disclosure controls were not effective as of September 30, 2015. Remediation steps were implemented, but effectiveness was not yet established.
- Investment and liquidity plans: The company expected to invest approximately $22.1 million through November 2016 in a second manufacturing facility and office remodeling, funded with operating cash and borrowings. Management said cash on hand was sufficient for at least the next 12 months, while also anticipating growing working-capital needs and additional bank financing.
- Credit facilities: At quarter-end, only $2.8 million remained available under the Bank of America revolver and approximately $0.6 million under the CTBC facility. After quarter-end, the Bank of America revolver maturity was extended to February 15, 2016; renewal negotiations with both banks were ongoing. The company reported compliance with Bank of America financial covenants at September 30.
- Commitments and concentration: Purchase commitments totaled $392.0 million, including approximately $201.6 million of hard-drive commitments through December 2016. One customer accounted for 12.2% of quarterly sales. Related-party Ablecom supplied $59.3 million of purchases, and outstanding purchase orders with Ablecom were $60.9 million.
- Other exposures: Gross unrecognized tax benefits were $15.8 million, plus $1.1 million accrued interest and penalties; the IRS had scheduled a pre-examination of 2013–2014 federal returns. Management said pending legal matters were not expected to materially affect the company. The filing also cites demand and quarterly-results volatility, component supply and pricing, inventory obsolescence, customer concentration, competition, and execution of international manufacturing expansion as risks.
- No numerical financial guidance for the next quarter or fiscal year is provided in the filing.
Important facts for investors to verify
- Whether the extended-warranty revenue deferrals and related control remediation are complete and operating effectively, and whether further corrections are required.
- Progress on renewing the Bank of America and CTBC facilities, available borrowing capacity, and near-term debt maturities.
- Whether elevated DSO and inventory days improve, and whether the large purchase commitments align with demand and sales forecasts.
- Customer concentration and the commercial terms, exposure and governance oversight of the Ablecom related-party relationship.
- Whether reported margin trends improve as the warranty correction rolls off and product and customer mix changes.