Earnings Call Transcript - SMCI Q1 2020

Operator, Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Super Micro Computer Incorporated First Quarter Fiscal 2020 Business Update Conference Call. The company's news release is issued earlier today, is available from its website at www.supermicro.com. During the company's presentation, all participants will be in a listen-only mode. Afterwards, securities and analysts will be invited to participate in a question-and-answer session. But the entire call is open to all participants on a listen-only basis. As a reminder, this call is being recorded, Thursday, November 14, 2019. A replay of the call will be accessible until midnight, Thursday, November 28, 2019, by dialing 1-844-512-2921 and entering replay pin 9981371. International callers should dial 1-412-317-6671. 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, 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 fiscal 2020, which ended September 30, 2019. During today's conference call, Super Micro will address the company's preliminary financial results for the first quarter of fiscal 2020 and the company’s efforts to become current with its remaining SEC filings. 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 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. 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, our most recent 10-K filing for 2017, and our other SEC filings. All of those documents are available on the investor relations page at Super Micro's websites. We assume no obligation to update any forward-looking statements. Most of today's presentation will refer to non-GAAP and natural results and outlook. At the end of today's prepared remarks, we will have a Q&A session for sell-side analysts to ask questions. 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. Our first quarter revenue will be in the range of $788 million to $798 million, which exceeds the midpoint of our quarterly guidance of $780 million. Our non-GAAP gross margin will be in the range of 15.1% to 16.3%. Non-GAAP earnings per share will be in the range of $0.61 to $0.65 compared to the range of $0.66 to $0.70 last year, and the range of $0.57 to $0.61 last quarter. System revenue was approximately 80% of total revenue. System ASPs were lower year-over-year due to lower memory and SSD pricing, which impacts revenue. We see continued demand in the channel. We have upgraded our portfolio and put to market innovations that allow our partners to provide application-optimized solutions to their customers. In addition to seasonality in the September quarter, there were several factors impacting our top-line revenue. There was an industry-wide slowdown due to economic uncertainty, some push in purchasing from major data center customers, and price reductions on key components used in our systems. As indicated by our peers and industry analysts, server revenue has been down in 2019, and we saw that trend continue for our business in the second quarter. However, as we reached the end of this quarter, we’ve begun to see signals of stabilization and early signs of seasonal strength from our key customers, as we begin including our inventory to take advantage of the opportunities. Super Micro has a long history of application-optimized products that will maximize our growth. We continue to develop new products and solutions across major server and storage markets, including total solutions for AI machine learning, 5G, IoT, and data centers. We are combining the advantages introduced by our green computing and resource-saving platform, delivering concrete solution offerings with Red Hat, VMware, Nvidia, and SAP, providing certified and tested configurations that can reduce risk and accelerate ROI for our customers. Our offerings in hyper-converged infrastructure continue to be the most optimized solution for new generation solid customer delivery, supporting NVMe, predictable IO, and high throughput of Intel 2nd Generation Xeon Scalable Processors. With SAP, we delivered the two new four-way super servers as part of our Intel Select Solutions, with up to 12 terabytes of memory that bring the power and cost savings of data center system memory to the SAP HANA platforms. We cooperate with Nvidia to allow customers to manage their AI applications on Super Micro’s extensive edge GPU product line in a cloud-native environment. Moreover, we introduced a new class of 5G-ready software-defined networking platforms that can be optimized to deliver accelerated AI performance. On the AMD side, we started shipping Super Micro systems based on the second-generation EPYC processor, which outperform our previous generation A Plus system while providing much better performance and value. Last but not least, we have begun to deliver a set of optimized system products targeted at mega data centers. These products are uniquely optimized for the specific requirements of high-volume scale data center customers. Our business solutions allow us to leverage our existing product designs and customize performance, efficiency, and cost requirements on demand. We see a similar opportunity for cloud data centers with optimized designs, and thus, we are underway to deliver additional specialized products. Looking ahead, we see the pace of processor refresh cycles accelerating, and we anticipate our sales to repeat our next-level product updates in the coming quarters. We are continuing the development of our next-generation architecture for our complete family refresh. This new architecture will take full advantage of upcoming innovations in Intel's new processors, like PCI Gen-4, more flexible IO, higher performance architecture, and new storage form factors. We have already started engaging with select customers. It’s important to achieving our stated goals that we continue to innovate and improve our operational efficiency and scale, building a stronger global foundation. We have increased our capacity in engineering, manufacturing, operations, and service in our key strategic locations, which includes over 200,000 square feet of new facility space being completed at our headquarters. In summary, although market conditions have been challenging, we continue to deliver significant server and storage innovations to the market. More importantly, we have globalized our R&D, sales, and operations to grow the discipline and focus needed to expand our market share. Fundamentally, we are more confident than ever in the strength of our products and operational improvements, empowering us to achieve our business goals. Now, I hand the section over to Kevin.

Kevin Bauer, Senior Vice President and Chief Financial Officer

Thank you, Charles. First, I will address the current health of the business by providing an overview of our financial performance for the first quarter of fiscal 2020. I will then make a few comments about our progress on our SEC filings. As Charles mentioned earlier, we estimate our fiscal first quarter revenue within the range of $788 million to $798 million. Geographies were lower on a year-over-year basis, with EMEA approximately 21% lower, Asia 22% lower, and the U.S. 18% lower. Our estimated gross margin range on a GAAP and non-GAAP basis grew from 16% to 16.2% and 16.1% to 16.3%, respectively. Our margins improved from last year and benefited from lower key component costs, as well as favorable customer, geographic, and product mix. Our operating expenses were slightly lower this quarter due to lower reserves for bad debt, offset by the effect of annual salary increases and higher research and development expenses. We estimate our non-GAAP diluted EPS range this quarter was from $0.61 to $0.65 per diluted share. Due to the need to rebuild inventory this quarter for seasonal demand, cash flow generated from operations was lower than recent quarters at $5.5 million. After deducting for CapEx and investments of $13.3 million, our free cash flow was negative $7.8 million. Our closing cash position was a robust $239 million. This quarter, our cash conversion cycle was 89 days; the day sales outstanding was 43 days and days payable outstanding was 48 days, with inventory days increasing to 93. Our cash conversion cycle target remains 85 to 90 days. Now, let me comment on the progress of our remaining delinquent SEC filings. Last quarter, we reported that we had submitted our fiscal 2018 financials for audit. We're now able to report that we have also completed work on the fiscal 2019 financials under both the 605 and 606 revenue recognition standards and submitted them for audit at the end of September. Concurrent with the financial statement audit, we have continued the testing and assessment of our internal controls over financial reporting. As a result, we have prepared drafts of our SEC filings. The team remains laser-focused on becoming fully current on our SEC filings, which also includes the 10-Q filing for this first quarter of fiscal 2020.

Perry Hayes, Senior Vice President, Investor Relations

As indicated previously, we will have an abbreviated Q&A, in which sell-side analysts will be permitted to ask questions. Operator, at this time, we're ready for questions.

Operator, Operator

Thank you, sir. And we'll go first to Nehal Chokshi of Maxim Group. Please go ahead.

Nehal Chokshi, Analyst

Yes. Thanks and congratulations on solid results relative to the guidance, especially on the gross margin very nicely done there. On the guidance here, it looks like at the midpoint, you're getting to up 5% quarter-over-quarter. How's that compared to your typical seasonality?

Kevin Bauer, Senior Vice President and Chief Financial Officer

So in general, we believe that it's similar to our normal seasonality. As Charles outlined, we saw some signs of stabilization and a little bit of growth as we enter into the next quarter. So we believe it's in line.

Nehal Chokshi, Analyst

Okay. And I think you gave the color on why the gross margin was up year-over-year. And I think one of the elements was component costs declining rapidly. And that's certainly true on a year-over-year basis, but I was under the impression on a quarter-over-quarter basis there has been some pressure yet you did see strong gross margin on a quarter-over-quarter basis. So could you tease that out as far as why did you also see the strong quarter-over-quarter gross margin?

Kevin Bauer, Senior Vice President and Chief Financial Officer

Yes, I think we had mentioned last quarter that, as compared to the quarter previous to that, there were some mix and customer influences that were in there. And certainly that was the case this quarter as it rebounded back. So, we continue to look at that gross margin, trying to ensure that we make some periodic progress over time that we have talked about in quarters on quarters. But without getting into too specific details, we're really calling out the fact that on a sequential basis, this is really going to be customer- and mix-oriented, and it will be less of the impact on the sequential basis related to the component changes.

Nehal Chokshi, Analyst

Understood. Okay. And looks like there was about $2.5 million of incremental OpEx quarter-over-quarter; A, is that correct? B, can you help guide us which buckets we should attribute those to?

Kevin Bauer, Senior Vice President and Chief Financial Officer

You mean in terms of…

Nehal Chokshi, Analyst

For the September quarter, yes.

Kevin Bauer, Senior Vice President and Chief Financial Officer

Yes, so I called out that the key things in terms of the sequential basis were really that we had less bad debt. And in addition to that, as we go into the September quarter, our annual merit increases are always affected with our fiscal new year on January 1st. And then, as Charles had mentioned, we have some new product development initiatives that were sequentially increased quarter-over-quarter.

Nehal Chokshi, Analyst

Okay, I'm going to yield the floor for now. Thank you.

Operator, Operator

Our next question comes from Aaron Rakers of Wells Fargo. Please go ahead.

Aaron Rakers, Analyst

Yes, thanks for taking the questions. I want to first just ask you about the demand environment. I know you talked about the demand environment being somewhat challenging. But you also mentioned that you started to see signs of improvement. There have been some mixed data points on some of the hyperscale cloud demand, with some suggesting that there might be a push out in server refresh cycles. I'm just curious how you would characterize the cadence of your customers as it relates to server refreshes. Do you think that there could be any kind of a pause in front of some of the timing around things like Cooper Lake from Intel, or even Ice Lake? Just any kind of color on what you're seeing as far as purchasing behavior for customers, particularly some of the hyperscale customers you have?

Charles Liang, Chairman and Chief Executive Officer

It’s a very dynamic market, and as we say, new processors are becoming available. So, as a technology-leading company, we have very strong new products available each month or each quarter. Overall, we feel pretty positive about the macro market and the overall industry demand. At this moment, we feel it's still kind of hard to predict, but overall we feel not too bad.

Kevin Bauer, Senior Vice President and Chief Financial Officer

But I think on the backdrop, we remind you that our exposure to hyperscalers is not nearly as much as some of the other competitors that you may have in mind.

Aaron Rakers, Analyst

Okay. And then as my follow-up on the component pricing dynamics, I know just kind of thinking about the progression as you see going forward between DRAM and SSD pricing, there's been some indication that SSD pricing seems to be stabilizing and maybe turning a bit higher. DRAM, however, continues to be on a downward trend. Just as you think about the current quarter, how would you characterize what you're seeing from a component pricing environment perspective?

Charles Liang, Chairman and Chief Executive Officer

Yes, I mean, after many years of improvement, our procurement department has become much stronger than before. Our economic scale helps us to not only see that NVMe, especially SSD prices are growing while DRAM prices continue to slowly drop. I believe both will offset each other over the next few months.

Aaron Rakers, Analyst

Okay, I'll slip one final one in. There are obviously some changes in the competitive landscape from a server CPU perspective. You mentioned in your prepared remarks the progression with Rome, the second generation AMD processors. How would you characterize your ability to perhaps leverage a bit of a changing competitive landscape in server CPUs? What are you seeing in terms of the demand profile, the appetite for AMD relative to server CPUs versus say Intel?

Charles Liang, Chairman and Chief Executive Officer

As I just stated, our AMD platform outperforms the previous generation AMD solution while allowing for almost double the performance. So we have a performance advantage, making us feel quite positive about the AMD product line. As for the Intel product line, our product lineup has also become stronger than before, giving us good feelings for both.

Aaron Rakers, Analyst

Okay, thank you. I'll leave the floor.

Charles Liang, Chairman and Chief Executive Officer

Thank you.

Operator, Operator

It appears at this time, we have no further questions. 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 for joining us today, and have a great day. See you next time. Bye.

Operator, Operator

Thank you, ladies and gentlemen. That does conclude the Super Micro first quarter fiscal 2020 business update conference call. We do appreciate your participation. You may disconnect at this time. Thank you.