Earnings Call Transcript - SMCI Q2 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by. My name is Brent, and I will be your conference operator today. At this time, I would like to welcome everyone to the Super Micro Second Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. Thank you. It’s now my pleasure to turn the call over to Nicole Noutsios, Investor Relations.

Nicole Noutsios, Investor Relations

Good afternoon. And thank you for attending Super Micro’s call to discuss financial results for the second quarter, which ended December 31, 2021. With me today are Charles Liang, Founder, Chairman and Chief Executive Officer; Patrick Wang, President, East Coast and SVP, Strategy and Corporate Development; and David Weigand, Chief Financial Officer. 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 on the IR section of the company’s website under the Events & Presentations tab. We have also published management’s scripted commentary on our website. 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 and expenses, taxes, capital allocation and future business outlook, including guidance for the third quarter of fiscal year 2022 and the full fiscal year 2022, and 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 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 fiscal 2021, and our other SEC filings. All of these documents are available on the IR page of Super Micro’s website. We assume no obligation to update any forward-looking statements. Most of today’s presentation will refer to non-GAAP financial results and business outlook. For an explanation of our non-GAAP financial measures, please refer to the accompanying presentation 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 the supplemental information attached to today’s presentation. 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 call over to Charles.

Charles Liang, CEO

Thank you, Nicole, and good afternoon, everyone. Today, I am pleased to announce our quarterly revenue of $1.17 billion for fiscal Q2 2022, which represented a 41% year-over-year growth, and our sequential growth was 14%. We have seen strong growth in all our key verticals and geographies despite challenges from global component shortages and the impact of COVID-19. More importantly, our Total IT Solutions strategy has been empowering us to continuously gain market share, all thanks to our dedicated employees, powerful server building block solutions, and finally, our fast-growing software products. With the bigger total addressable market (TAM) and potential from Total IT Solutions, I believe our growth trend will continue for many years to come, getting stronger quarter after quarter. Now, let’s look at some key highlights from the quarter. First, our fiscal second quarter net revenue totaled $1.17 billion, up 41% year-on-year and up 14% quarter-on-quarter, at the higher end of our guidance range of $1.1 billion to $1.2 billion. It’s Super Micro’s fourth consecutive quarter of fast revenue progression as we continue our growth trajectory at multiple times the industry’s growth rate. Our fiscal second quarter non-GAAP earnings per share was $0.88, compared to $0.63 in the same quarter last year, which was a 40% growth and at the higher end of our guidance range of $0.70 to $0.90. All our major geographies contributed significantly to our year-over-year growth, especially in the APAC region which grew 76% year-over-year. The Taiwan expansion boosts our APAC and EMEA growth momentum by providing additional capacity and lowering operational costs. We continued to expand the B2B Auto-configurator program to service significantly more customers during the quarter. Our command-center based online business system has been improving our sales, FAE, PM team’s efficiency, as well as our key customer’s satisfaction. Recent market conditions have presented us with better opportunities to accelerate our business transition from a hardware company to a Total IT Solutions company. This transition has enabled Super Micro to offer customers higher value and product availability with optimal hardware, software, services, switches, and more. Our results have shown that we outperform our previous $10 billion annual revenue target timeline we shared a few quarters ago. More encouragingly, we are observing a diversified growth across our target verticals including large enterprise, AI, machine learning, Cloud, 5G/telco, and IoT. Our design wins and engagements with Fortune-listed customers continue to grow quickly with our Total IT Solutions. Our push towards Total IT Solutions is benefiting Super Micro and our customers in multiple ways. Most notably, our customers will receive higher-quality, plug-and-play ready products that are fully optimized, integrated, and validated in-house. This effort is also helping Super Micro and our customers mitigate the impact of global supply chain disruptions by accurately forecasting, building inventories at scale, and prioritizing with our strategic partners. As a result, our Total IT Solutions dramatically improve our customer’s time to market and increase Super Micro’s value. Our Total IT Solutions are built upon a robust knowledge of system architecture and building blocks that can be optimized for most market verticals. With the rise of Omniverse and Metaverse, we have recently introduced several new architectures to enhance our GPU product offerings. Our new Universal GPU architecture allows customers to choose the best CPUs, GPUs, switches, and I/O configurations to truly optimize their applications and workloads, leveraging either Intel Xeon Scalable processors or AMD EPYC processors. The Universal GPU system enables customers to standardize configurations in their clusters for the desired workloads on a single platform. This unique versatile system supports various GPUs, including NVIDIA A100 GPUs, the newly announced AMD MI200 series accelerators, and many FPGA products from different companies. I am glad to announce that we already have many major customers and industry leaders committing to this new platform, and the only limitation is the supply chain challenge. Partnering closely with leading technology providers in the emerging Metaverse and Omniverse ecosystems, Super Micro has doubled our GPU product lines to support these 3D and immersive workloads. Our 2U 2-node GPU system provides an optimal mix of CPU-to-GPU ratio with resource-saving features. Our high performance and highly configurable Hyper and Hyper-E servers support multiple GPUs in a single system and are ideal for use cases such as distributed AI inferencing applications, content delivery, telco micro datacenters, 5G core, and various other mission-critical enterprise workloads. Last quarter, we redefined our growth drivers to speed up our growth strategies, which include Subsystem and Components, Complete Systems, Total IT Solutions, and 5S’s. Our building blocks and complete systems business have been steadily growing over the decades with the help of our partners, and they still serve as the backbone of our revenue growth. With other large enterprise customers and top technology-leading companies and appliance partners engagements, I would like to emphasize again that Total IT Solutions business is our new major growth driver now. Going forward, our investments in software products, services, and networking will be the keys to improve our margins and profitability in the coming quarters and years. In summary, Super Micro is rapidly growing and transforming into a Total IT Solutions company from a server hardware company. We are accelerating our design wins and market share gains at key large global customers including enterprise, AI, machine learning, 5G/telco, Edge, and IoT. We are improving our profitability and replicating our market share success in the U.S. to APAC and EMEA with the completion of our APAC expansions and rapid production ramp in Taiwan. Our new Command Center Based Auto-configurator and B2B Automation platforms are improving our operations effectiveness and customer satisfaction while accelerating our market-share gains. In closing, our 41% year-over-year revenue growth is solid proof that Super Micro’s business is taking off quickly now. I am confident that our market presence, TAM, and profitability will continue to increase strongly as we invest more resources as a Total IT Solutions company. My team and I have been diligently executing our growth strategies and accelerating the timeline to pull in our $10 billion revenue goal. I will now pass the call to David Weigand, our Chief Financial Officer, to provide additional details on the quarter. Thank you.

David Weigand, CFO

Thank you, Charles. I am pleased to report our third consecutive quarter of revenues exceeding $1 billion. We are seeing continued strength across all geographies and strong demand for our products and services, resulting in fiscal second quarter revenue of $1.17 billion, a 41% year-on-year increase and up 14% quarter-on-quarter. Our Q2 revenues were at the higher end of our guidance range of $1.1 billion to $1.2 billion. Revenues for the trailing four quarters in Q3 of fiscal year 2021 through Q of fiscal year 2022 totaled $4.17 billion. Super Micro’s Q2 FY 2022 recorded revenue growth across all three of our market verticals, achieving $756 million in the Organic Enterprise and Channel and AI/ML vertical, $274 million in OEM appliance and large data center vertical, and $142 million in the 5G/telco and Edge/IoT vertical. The 5G/telco and Edge/IOT vertical more than doubled sequentially as new designs went into production. Systems comprised 84% of total revenue and subsystems and accessories represented 16% of Q2 revenues. The volume of systems and nodes shipped, as well as System node average selling prices (ASPs), increased both year-on-year and quarter-on-quarter. On a year-on-year basis, Asia, including Japan, increased 76% as we saw continued growth with both new and existing customers, Europe increased 39%, U.S. increased 38%, and Rest of World decreased 32%. On a sequential basis, Asia including Japan increased 8%, U.S. sales increased 14%, Europe increased 20%, and Rest of World increased 19%. The Q2 gross margin was 14%, which was up 60 basis points quarter-over-quarter from Q1 due to price discipline and a better product/customer mix. This increase was achieved despite our increased use of air freight and higher supply chain costs. On a year-over-year basis, gross margins were down 240 basis points due to a discrete cost recovery event in Q2 of last year and higher freight and supply chain costs in the current year. Turning to operating expenses, Q2 operating expenses on a GAAP basis increased 3% quarter-on-quarter and 14% year-on-year to $113 million. On a non-GAAP basis, operating expenses increased 2% quarter-on-quarter and increased 15% year-on-year to $103 million. The year-on-year and quarter-on-quarter increases on a GAAP basis were driven by higher personnel costs and increased headcount; higher stock compensation expense; and lower research and development NRE credits. Other Income & Expense, including interest expense, was a $1.8 million expense, as compared to a $0.8 million expense last quarter. The sequential change is mostly related to loss from the remeasurement of our Taiwan Dollar loans to a weaker U.S. Dollar, due to foreign exchange. This quarter, the tax provision was $7.6 million on a GAAP basis and $10.9 million on a non-GAAP basis. Our non-GAAP tax rate was 18.5% for the quarter. Our tax rate for GAAP and non-GAAP purposes increased this quarter primarily due to a change in U.S. tax regulations. Lastly, our share of income from our joint venture was $0.2 million this quarter, as compared to $0.4 million last quarter. Q1 non-GAAP diluted EPS totaled $0.88, which was near the high end of the guidance range due to higher revenues and higher gross margins, partially offset by higher operating expenses. Cash flow used in operations was $53 million, compared to cash flow used in operations of $135 million in Q1, as we continued to build inventory to be in a position to meet the increasing levels of large orders from our customers and to mitigate the impact of supply chain disruptions. CapEx totaled $12 million for Q2 resulting in negative free cash flow of $65 million. Key uses of cash during the quarter included increases to inventory and accounts receivable, offset by cash provided from increased accounts payable, customer prepayments, and deferred revenue. We did not repurchase any shares in the quarter. Our closing balance sheet cash position was $247 million, while bank debt was $316 million as we drew down on our bank lines of credit to increase inventory levels as we ramped production of new platforms globally. Turning to the balance sheet and working capital metrics compared to last quarter, our Q2 cash conversion cycle was 98 days, up from 94 days in Q1, which is above our target range of 85 days to 90 days due to higher inventories. Days of inventory was 118 days, representing an increase of four days versus the prior quarter. Days sales outstanding was down by four days to 37 days, while days payables outstanding was down by four days to 57 days. Now turning to the outlook for our business, we note that our Q3 March quarter typically has some seasonal impact from the Lunar New Year holiday, and we are also carefully watching impacts to the supply chain from COVID-19 related disruptions. We expect net sales in the range of $1.1 billion to $1.2 billion, GAAP diluted net income per share of $0.58 to $0.81, and non-GAAP diluted net income per share of $0.70 to $0.90 for the third quarter of fiscal year 2022 ending March 31, 2022. We expect gross margins to be up slightly from Q2 levels. Our GAAP operating expenses are expected to be approximately $118 million and include $8.5 million in stock-based compensation and $1.7 million in other expenses not included in non-GAAP operating expenses. We expect other income and expense, including interest expense, to be a net expense of roughly $2 million and expect a nominal contribution from our joint venture. Non-GAAP operating expenses are forecasted to be up quarter-on-quarter from continued investment in R&D and higher personnel costs. The company’s projections for GAAP and non-GAAP diluted net income per common share assume a GAAP tax rate of 15%, a non-GAAP tax rate of 16.5%, and a fully diluted share count of 54.5 million for GAAP and 56 million shares for non-GAAP. The outlook for Q3 of fiscal year 2022 GAAP diluted net income per common share includes approximately $8.5 million in expected stock-based compensation and $1.7 million in other expenses, net of tax effects, that are excluded from our non-GAAP diluted net income per common share. We are maintaining our revenue guidance range of $4.2 billion to $4.6 billion for the fiscal year 2022 ending June 30, 2022, and our GAAP diluted net income per share outlook of at least $2.77 and non-GAAP diluted net income per share of at least $3.20. The company’s projections for GAAP net income assume a tax rate of 15% and a rate of 17% for non-GAAP net income. For fiscal year 2022, we are assuming a fully diluted share count of 54.1 million shares for GAAP and 55.6 million shares for non-GAAP. The outlook for fiscal year 2022 fully diluted GAAP earnings per share includes approximately $37 million in expected stock-based compensation and other expenses, net of tax effects, excluded from non-GAAP diluted net income per common share. We expect CapEx for the fiscal third quarter of 2022 to be in the range of $5 million to $8 million. Nicole, I will turn it back to you.

Nicole Noutsios, Investor Relations

Operator, we can now open the line up for questions.

Operator, Operator

Your first question comes from Ananda Baruah with Loop Capital. Please go ahead.

Ananda Baruah, Analyst

Yeah. Hey, guys. Good afternoon. Thanks for taking the question and congrats on the ongoing momentum and the nice results. Congratulations on the good execution. A couple if I could. How is linearity through the quarter, revenue linearity and any context around new kinds of customer, customer expansion, workload expansion, things of that nature would be really helpful? And then I have a quick follow up. Thanks.

Charles Liang, CEO

Yeah. Thank you for the question. As you know, we are migrating from a Hardware Solution company to a Total IT Solution company. So lots of customer like our complete solution for the auto-ID need. So we continue to gain some really large customers and some technology leaders. So we are very happy, very excited to service more partners in the industry.

David Weigand, CFO

Okay. I was just going to add that customer-wise, we had really good growth in the telco and the 5G/telco vertical.

Ananda Baruah, Analyst

Okay. Charles, do you think it sounds like Meta, correct me if it’s not an accurate interpretation. But does that to say that telco picked up incrementally in the December quarter and that new energy, you think is going to continue at least kind of March quarter first half of the calendar year here?

Charles Liang, CEO

I mean, March quarter, traditionally, is our kind of soft season, but this year is different because we have very strong demand, especially for GPU, Metaverse, and Omniverse. We already have some large engagements trying to fulfill them.

Ananda Baruah, Analyst

Okay. Great. That’s helpful. A quick follow up, Charles. Any comments on demand after the June quarter? I just asked that since we’re coming up on the second half of the year, any context you can provide on sales demand? Thanks.

Charles Liang, CEO

Yeah. The outlook looks pretty commendable because of our strong product and Total IT Solution; lots of customer now have a bigger back order with us. So we are seeing increased back orders in a commendable way.

Mehdi Hosseini, Analyst

Yes. Thanks for taking my question. Just want to get a further understanding of how you’re managing the inflationary trend in component prices. Your inventory has gone up for two consecutive years and by about $350 million over the past six months. But then I look at your revenue guide for March and implied guide for June taking the midpoint of the fiscal year guide, it does suggest a sequential decline. Is that because you’re not able to pass on extra cost or you’ve just been conservative, despite the fact that you have built inventory, or is there something else that I’m missing here? And I have a follow up.

Charles Liang, CEO

Yeah. Indeed, I’m very happy with our big inventory now, especially with global supply chain difficulties. We build the inventory based on our back order. And at this moment, indeed, our back order has been very strong. The reason why we did not update the whole year revenue and earnings is just because there is still some uncertainty in terms of supply chain. Other than that, we feel very optimistic.

David Weigand, CFO

Yeah. And Mehdi, this is David. Just to answer your question—our ability to pass on costs is really reflected in our increased gross margin. So those increased component costs are being passed on. So, Mehdi, we didn’t go back to the Q2 of last year, I don’t believe, although we have guidance in our slides that we maintain on our website. Absolutely. So our organic enterprise and channel, and AI/ML constitute approximately 65% of our revenues. The OEM appliance bucket comprises about 25%. The 5G/telco and Edge is about 10%. And that’s up from 5% in the prior quarters. The big change though was in 5G, that was some big growth and traction with telco customers.

Charles Liang, CEO

You can say that the back order is stronger now. We tried to be fully conservative in case…

Mehdi Hosseini, Analyst

If I may just quickly, there’s also continued mismatch for components with supply and demand. There’s still some mismatches. Would it be fair to say that you’re also conservative, given the mismatches of availability of components?

Charles Liang, CEO

Indeed, we are seeing a healthy inventory despite being cautious with the back order.

Nehal Choski, Analyst

Yeah. Sorry. Thank you. I was on mute here. Congrats on the solid results and well above difference March Q guidance. This question has already been partially answered by Patrick. But let me put a little finer point on this here. Why not at least narrow the fiscal year 2022 revenue guidance range given that the unchanged midpoint guidance does apply effectively about flat year-on-year for the June quarter?

Charles Liang, CEO

So Nehal, our demand has never been stronger. We have obtained new logos and new customers who have designed in our products. We feel very strong about our back order and our demand, but this is a market where supply also dictates your forecasts. So we have to be careful about forecasting two quarters out on supply, and that’s really the reason for our range.

Nehal Choski, Analyst

Understood. Okay. And then, slide nine is great. I love the fact that we’re getting five-quarter back visibility into these three vertical markets and it certainly does imply that 5G/telco and Edge has significant year-over-year growth. Charles, you’ve mentioned that part of this demand is Metaverse/Omniverse, not sure what Omniverse means, but I do know what Metaverse means. And I guess…

Charles Liang, CEO

Yeah. Today, there are some really large companies coming to the Omniverse or Metaverse, right? We have a very strong engagement with some of them. So in terms of AI, GPU, Metaverse, we have a very strong back order now indeed and are trying to work out components to fulfill the demand.

Nehal Choski, Analyst

Okay. So to be clear then, commentary about the strong demand for Metaverse is not related to 5G/telco, correct?

Charles Liang, CEO

Not necessarily. It’s not much related.

David Weigand, CFO

This is David. So I will add that the large data center vertical is going to vary by digestion, too, because we have some regular customers who may purchase for two quarters or three quarters, and then they will take a pause. But the good thing about our business is that it’s grown to the point where we have enough momentum in all areas to offset that.

Jon Tanwanteng, Analyst

Thank you. Good quarter guys and on the outlook, too, very fast. My question is, are inflation and supply chain headwinds still accelerating in Q3 for you and that’s maybe matched by your pricing or was it roughly the same as Q2?

Charles Liang, CEO

Most of our customers are already used to taking the responsibility for the extra cost. So that’s why our gross margin or net margin is stabilizing right, including a higher transportation charge; customers have accepted it.

Ananda Baruah, Analyst

Okay. Great. Any commentary on where the friction is in components and shipping?

Charles Liang, CEO

Overall, the supply chain situation has been gradually improving. So we are feeling more comfortable than last quarter.

Jon Tanwanteng, Analyst

Got it. Charles, you spent a little time earlier in the call talking about the Total IT Solutions transition. Could you just tell us what the margin is like in a typical Total IT Solution sale versus a historically pure hardware sale?

Charles Liang, CEO

Okay. I mean, our total hardware model is something we have to compete with lots of competition. But with Total IT Solutions, customers need lots of software, lots of security features, and kind of like a cloud plug and play, cloud composite software and utility there. We have invested a lot in this territory in the last three years, and now we start to harvest the results and will continue to invest more in software. Our kind of software value and Total IT Solution value will continue to grow. Over the next few quarters or few years, I would say gradually we may be able to add 1%, 2%, or even 3% actual net profit to our revenue.

Jon Tanwanteng, Analyst

Okay. Great. And that was part of your Investor Day target within the target model, correct?

Charles Liang, CEO

Yes.

Ananda Baruah, Analyst

Hey, guys. Thanks. Thanks for the follow-up. I have a couple if I could. Charles, just going back to your comments just moment ago about imposing constraints that you actually, as you said, they are actually becoming less constrained right now. So just a clarification?

Charles Liang, CEO

Indeed, the data is under control, but still some concern, especially for a complete IT solution. Even sometimes, if you have one component in shortage, you cannot ship the whole product line, whole solution. So that’s why it’s improving, but we still have a lot of concerns.

Ananda Baruah, Analyst

Understood. Understood. Helpful. And then on the gross margin, you guys talked about reaching 14% in June. It sounds like you’re tracking ahead of that and then you guided sort of up sequentially. How should we think about gross margin going forward post the March quarter and what are the put and takes?

Charles Liang, CEO

Yeah. Basically, when our Total IT Solution becomes more mature, gross margin and net margin will consistently grow; that’s benefited very slowly the direction. But in some time, we engage with large scale ASP or OEM in really high revenue deals that may impact our gross margin and net margin. Although it’s tough on our overall margin, when it’s positive for the company overall future, we will still selectively take some deals. Thank you.

Operator, Operator

Your final question comes from the line of Mehdi Hosseini with SIG. Your line is open.

Mehdi Hosseini, Analyst

Yes. Thanks for the follow-up. Just a modeling follow-up. If I take $3.20, the minimum of $3.20 EPS guides for FY 2022 and assume $0.80 for March, then my June EPS would be up over $0.90.

David Weigand, CFO

So—go ahead, Charles.

Charles Liang, CEO

June is usually our kind of harvest season, right? So this year, I believe, we have the same opportunity. June will likely be a very strong quarter, I believe. As to gross margin, maybe a little bit lower. But if that happens, the net profit should be more than $0.90, maybe more than $1.

David Weigand, CFO

Yeah. Mehdi, we’re very comfortable being inside 14% to 17%. That’s our target. We’ve guided up for Q3 at a higher margin, and we said we should be up slightly in Q3 and for Q4 we’re not giving updates on Q4.

Mehdi Hosseini, Analyst

Got it. Thank you.

Operator, Operator

There are no further questions at this time. Ladies and gentlemen, thank you for your participation. This concludes today’s conference call. You may now disconnect.