Super Micro Computer, Inc 10-Q for FY2021 Q1
Super Micro Computer, Inc. (SMCI)
10-Q
2020-11-06
For: 2020-09-30
View Original
Added on
April 10, 2026
About this 10-Q
Super Micro Computer, Inc filed this 10-Q on November 6, 2020, covering the quarter ended September 30, 2020 (FY2021 Q1).
Headline figures
Quarter ended September 30, 2020, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $762.25M
- down 4.7% from $799.8M a year earlier
- Net income
- $26.6M
- up 1.0% from net income of $26.35M a year earlier
- Diluted EPS
- $0.49
- down 3.9% from $0.51 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________________________________________________________
Form 10-Q
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the quarterly period ended September 30, 2020
or
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the transition period from to
Commission File Number 001-33383
__________________________________________________________________________
(Exact name of registrant as specified in its charter)
| (State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |||||||
(Address of principal executive offices, including zip code)
(408 ) 503-8000
(Registrant’s telephone number, including area code)
__________________________________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol | Name of each exchange on which registered | ||||||
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| x | Accelerated filer | ☐ | ||||||||||||
Non-accelerated filer | ☐ | Smaller reporting company | ||||||||||||
| Emerging growth company | ||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of October 31, 2020 there were 51,782,128 shares of the registrant’s common stock, $0.001 par value, outstanding, which is the only class of common stock of the registrant issued.
SUPER MICRO COMPUTER, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2020
TABLE OF CONTENTS
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| PART II | ||||||||
| ITEM 1. | ||||||||
| ITEM 1A. | ||||||||
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| ITEM 3. | ||||||||
| ITEM 4. | ||||||||
| ITEM 5. | ||||||||
| ITEM 6. | ||||||||
Unless the context requires otherwise, the words “Super Micro,” “Supermicro,” “we,” “Company,” “us” and “our” in this document refer to Super Micro Computer, Inc. and where appropriate, our wholly owned subsidiaries. Supermicro, the Company logo and our other registered or common law trademarks, service marks, or trade names appearing in this Quarterly Report on Form 10-Q are the property of Super Micro Computer, Inc. or its affiliates. Other trademarks, service marks, or trade names appearing in this Quarterly Report on Form 10-Q are the property of their respective owners.
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
(unaudited)
| September 30, | June 30, | ||||||||||
| 2020 | 2020 | ||||||||||
| ASSETS | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
Accounts receivable, net of allowances of $ | |||||||||||
| Inventories | |||||||||||
Prepaid expenses and other current assets (including other receivables from related parties of $ | |||||||||||
| Total current assets | |||||||||||
| Investment in equity investee | |||||||||||
| Property, plant and equipment, net | |||||||||||
| Deferred income taxes, net | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | |||||||||||
| Current liabilities: | |||||||||||
Accounts payable (including amounts due to related parties of $ | $ | $ | |||||||||
Accrued liabilities (including amounts due to related parties of $ | |||||||||||
| Income taxes payable | |||||||||||
| Short-term debt | |||||||||||
| Deferred revenue | |||||||||||
| Total current liabilities | |||||||||||
| Deferred revenue, non-current | |||||||||||
| Long-term debt, net of debt issuance costs | |||||||||||
Other long-term liabilities (including related party balance of $ | |||||||||||
| Total liabilities | |||||||||||
| Commitments and contingencies (Note 11) | |||||||||||
| Stockholders’ equity: | |||||||||||
Common stock and additional paid-in capital, $ | |||||||||||
Authorized shares: | |||||||||||
Issued shares: | |||||||||||
Treasury stock (at cost), | ( | ( | |||||||||
| Accumulated other comprehensive gain (loss) | ( | ||||||||||
| Retained earnings | |||||||||||
| Total Super Micro Computer, Inc. stockholders’ equity | |||||||||||
| Noncontrolling interest | |||||||||||
| Total stockholders’ equity | |||||||||||
| Total liabilities and stockholders’ equity | $ | $ | |||||||||
1
See accompanying notes to condensed consolidated financial statements.
2
SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
Net sales (including related party sales of $ | $ | $ | |||||||||||||||||||||
Cost of sales (including related party purchases of $ | |||||||||||||||||||||||
| Gross profit | |||||||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||
| Research and development | |||||||||||||||||||||||
| Sales and marketing | |||||||||||||||||||||||
| General and administrative | |||||||||||||||||||||||
| Total operating expenses | |||||||||||||||||||||||
| Income from operations | |||||||||||||||||||||||
| Other (expense) income, net | ( | ||||||||||||||||||||||
| Interest expense | ( | ( | |||||||||||||||||||||
| Income before income tax provision | |||||||||||||||||||||||
| Income tax provision | ( | ( | |||||||||||||||||||||
| Share of income from equity investee, net of taxes | |||||||||||||||||||||||
| Net income | $ | $ | |||||||||||||||||||||
| Net income per common share: | |||||||||||||||||||||||
| Basic | $ | $ | |||||||||||||||||||||
| Diluted | $ | $ | |||||||||||||||||||||
| Weighted-average shares used in calculation of net income per common share: | |||||||||||||||||||||||
| Basic | |||||||||||||||||||||||
| Diluted | |||||||||||||||||||||||
See accompanying notes to condensed consolidated financial statements.
3
SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
(unaudited)
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| Net income | $ | $ | |||||||||||||||||||||
| Other comprehensive income (loss), net of tax: | |||||||||||||||||||||||
| Foreign currency translation gain (loss) | ( | ||||||||||||||||||||||
| Total other comprehensive income (loss) | ( | ||||||||||||||||||||||
| Total comprehensive income | $ | $ | |||||||||||||||||||||
See accompanying notes to condensed consolidated financial statements.
4
SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share amounts)
(unaudited)
| Three Months Ended September 30, 2020 | Common Stock and Additional Paid-In Capital | Treasury Stock | Accumulated Other Comprehensive (Loss) Gain | Retained Earnings | Non-controlling Interest | Total Stockholders’ Equity | |||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||||||||||||
| Balance at June 30, 2020 | $ | ( | $ | ( | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Exercise of stock options, net of taxes | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Release of shares of common stock upon vesting of restricted stock units | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||
| Shares of common stock withheld for the withholding tax on vesting of restricted stock units | ( | ( | — | — | — | — | — | ( | |||||||||||||||||||||||||||||||||||||||
| Stock repurchases | — | — | ( | ( | — | — | — | ( | |||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||
| Foreign currency translation gain | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Balance at September 30, 2020 | $ | ( | $ | ( | $ | $ | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Three Months Ended September 30, 2019 | Common Stock and Additional Paid-In Capital | Treasury Stock | Accumulated Other Comprehensive Loss | Retained Earnings | Non-controlling Interest | Total Stockholders’ Equity | |||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||||||||||||
| Balance at June 30, 2019 | $ | ( | $ | ( | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
| Release of shares of common stock upon vesting of restricted stock units | — | — | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||
| Shares of common stock withheld for the withholding tax on vesting of restricted stock units | ( | ( | — | — | — | — | — | ( | |||||||||||||||||||||||||||||||||||||||
| Stock-based compensation | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||||
| Foreign currency translation loss | — | — | — | — | ( | — | — | ( | |||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | — | — | ||||||||||||||||||||||||||||||||||||||||||
| Balance at September 30, 2019 | $ | ( | $ | ( | $ | ( | $ | $ | $ | ||||||||||||||||||||||||||||||||||||||
See accompanying notes to condensed consolidated financial statements.
5
SUPER MICRO COMPUTER, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
| Three Months Ended September 30, | |||||||||||
| 2020 | 2019 | ||||||||||
| OPERATING ACTIVITIES: | |||||||||||
| Net income | $ | $ | |||||||||
| Reconciliation of net income to net cash provided by operating activities: | |||||||||||
| Depreciation and amortization | |||||||||||
| Stock-based compensation expense | |||||||||||
| Allowances for (recovery of) doubtful accounts | ( | ||||||||||
| Provision for (recovery of) excess and obsolete inventories | ( | ||||||||||
| Share of income from equity investee | ( | ( | |||||||||
| Foreign currency exchange (gain) loss | ( | ||||||||||
| Deferred income taxes, net | ( | ( | |||||||||
| Other | ( | ||||||||||
| Changes in operating assets and liabilities: | |||||||||||
Accounts receivable (including changes in related party balances of $ | |||||||||||
| Inventories | ( | ||||||||||
Prepaid expenses and other assets (including changes in related party balances of $ | ( | ||||||||||
Accounts payable (including changes in related party balances of $( | ( | ( | |||||||||
| Income taxes payable | ( | ||||||||||
| Deferred revenue | ( | ( | |||||||||
Accrued liabilities (including changes in related party balances of $( | ( | ||||||||||
Other long-term liabilities (including changes in related party balances of $( | |||||||||||
| Net cash provided by operating activities | |||||||||||
| INVESTING ACTIVITIES: | |||||||||||
Purchases of property, plant and equipment (including payments to related parties of $ | ( | ( | |||||||||
| Net cash used in investing activities | ( | ( | |||||||||
| FINANCING ACTIVITIES: | |||||||||||
| Proceeds from debt | |||||||||||
| Repayment of debt | ( | ||||||||||
| Net repayment on asset-backed revolving line of credit | ( | ||||||||||
| Proceeds from exercise of stock options | |||||||||||
| Payment of withholding tax on vesting of restricted stock units | ( | ( | |||||||||
| Stock repurchases | ( | ||||||||||
| Payments of obligations under finance leases | ( | ( | |||||||||
| Net cash used in financing activities | ( | ( | |||||||||
| Effect of exchange rate fluctuations on cash | ( | ||||||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | ( | ||||||||||
| Cash, cash equivalents and restricted cash at the beginning of the period | |||||||||||
| Cash, cash equivalents and restricted cash at the end of the period | $ | $ | |||||||||
6
| Supplemental disclosure of cash flow information: | |||||||||||
| Cash paid for interest | $ | $ | |||||||||
| Cash paid for taxes, net of refunds | |||||||||||
| Non-cash investing and financing activities: | |||||||||||
Unpaid property, plant and equipment purchases (including due to related parties of $ | $ | $ | |||||||||
New operating lease assets obtained in exchange for operating lease liabilities | |||||||||||
| Unpaid stock repurchases | |||||||||||
See accompanying notes to condensed consolidated financial statements.
7
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1. Summary of Significant Accounting Policies
Significant Accounting Policies and Estimates
No material changes have been made to the significant accounting policies of Super Micro Computer, Inc., a corporation incorporated under the laws of Delaware, and its consolidated entities (together, the “Company”), disclosed in Note 1, Organization and Summary of Significant Accounting Policies, in its Annual Report on Form 10-K, filed on August 28, 2020, for the year ended June 30, 2020. Management's estimates include, as applicable, the anticipated impacts of the coronavirus ("COVID-19') pandemic.
Basis of Presentation
The unaudited condensed consolidated financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the United States Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principals in the United States of America ("U.S. GAAP") have been condensed or omitted pursuant to such rules and regulations.
The unaudited condensed consolidated financial statements included herein reflect all adjustments, including normal recurring adjustments, which are, in the opinion of management, necessary for a fair presentation of the consolidated financial position, results of operations and cash flows for the periods presented. The consolidated results of operations for the three months ended September 30, 2020 are not necessarily indicative of the results that may be expected for future quarters or for the fiscal year ending June 30, 2021.
Investment in a Corporate Venture
In October 2016, the Company entered into agreements pursuant to which the Company contributed certain technology rights in connection with an investment in a privately-held company (the "Corporate Venture") located in China to expand the Company's presence in China. The Corporate Venture is 30 % owned by the Company and 70 % owned by another company in China. The transaction was closed in the third fiscal quarter of 2017 and the investment is accounted for using the equity method. As such, the Corporate Venture is also a related party.
The Company recorded a deferred gain related to the contribution of certain technology rights. As of September 30, 2020 and June 30, 2020, the Company had unamortized deferred gain balance of $2.0 million and $2.0 million, respectively, in accrued liabilities and $0.5 million and $1.0 million, respectively, in other long-term liabilities in the Company’s condensed consolidated balance sheets.
The Company monitors the investment for events or circumstances indicative of potential impairment and makes appropriate reductions in carrying values if it determines that an impairment charge is required. In June 2020, the third-party parent company that controls the Corporate Venture was placed on a U.S. government export control list, along with
several of the parent's related entities and a separate listing for one of its subsidiaries. The Corporate Venture is not itself a restricted party. The Company is working with the Corporate Venture's management to ensure that the Corporate Venture remains in compliance with the new restrictions. The Company does not believe that the equity investment carrying value is impacted as of September 30, 2020. No
The Company sold products worth $0.6 million and $22.1 million to the Corporate Venture in the three months ended September 30, 2020 and 2019, respectively, and the Company’s share of intra-entity profits on the products that remained unsold by the Corporate Venture in the amounts of $2.3 million and $3.0 million as of September 30, 2020 and June 30, 2020, respectively, have been eliminated and have reduced the carrying value of the Company’s investment in the Corporate Venture. To the extent that the elimination of intra-entity profits reduces the investment balance below zero, such amounts are recorded within accrued liabilities. The Company had $0.6 million and $7.8 million due from the Corporate Venture in accounts receivable, net as of September 30, 2020 and June 30, 2020, respectively.
8
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Concentration of Supplier Risk
Certain materials used by the Company in the manufacturing of its products are available from a limited number of suppliers. Shortages could occur in these materials due to an interruption of supply or increased demand in the industry. One supplier accounted for 22.0 % and 28.7 % of total purchases for the three months ended September 30, 2020 and 2019, respectively. Ablecom and Compuware, related parties of the Company (see Note 8, "Related Party Transactions") accounted for 9.8 % and 9.7 % of total cost of sales for the three months ended September 30, 2020 and 2019, respectively.
Concentration of Credit Risk
Accounting Pronouncements Recently Adopted
In June 2016, the FASB issued authoritative guidance, Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments. Under this new guidance, a company is required to estimate credit losses on certain types of financial instruments using an expected-loss model, replacing the current incurred-loss model, and record the estimate through an allowance for credit losses, which results in more timely recognition of credit losses. The Company adopted this guidance on July 1, 2020 using the modified retrospective transition method, which requires a cumulative-effect adjustment, if any, to the opening balance of retained earnings to be recognized on the date of adoption with prior periods not restated. The adoption of the guidance had no material impact on the Company’s condensed consolidated financial statements as of July 1, 2020.
The Company maintains an allowance for credit losses for accounts receivable and the investment in an auction rate security. The allowance for credit losses is estimated using a loss rate method, considering factors such as customers’ credit risk, historical loss experience, current conditions, and forecasts. The allowance for credit losses is measured on a collective (pool) basis by aggregating customer balances with similar risk characteristics. The Company also records a specific allowance based on an analysis of individual past due balances or customer-specific information, such as a decline in creditworthiness or bankruptcy. The new guidance has no material impact on the Company's condensed consolidated financial statements for the three months ended September 30, 2020.
In August 2018, the FASB issued amended guidance, Fair Value Measurement: Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement, to modify the disclosure requirements on fair value measurements based on the concepts in the FASB Concepts Statements, including the consideration of costs and benefits. The Company adopted this guidance on July 1, 2020. As of September 30, 2020, the Company’s investment in an auction rate security is the only Level 3 investment measured at fair value on a recurring basis. Changes to the disclosures in the condensed consolidated financial statements were immaterial. See Note 5 below.
In August 2018, the FASB issued authoritative guidance, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract as well as hosting arrangements that include an internal use software license with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The accounting for the service element of a hosting arrangement that is a service contract is not affected by the new guidance. The Company adopted this guidance on July 1, 2020, prospectively. The adoption of this guidance did not have a material impact on the Company's condensed consolidated financial statements and disclosures.
Accounting Pronouncements Not Yet Adopted
In December 2019, the FASB issued amended guidance, Simplifying the Accounting for Income Taxes, to remove certain exceptions to the general principles from ASC 740 - Income Taxes, and to improve consistent application of U.S. GAAP for other areas of ASC 740 by clarifying and amending existing guidance. The guidance is effective for the Company from July
9
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
1, 2021; early adoption is permitted. The adoption of the guidance is not anticipated to have a material impact on its consolidated financial statements and disclosures.
In March 2020, the FASB issued authoritative guidance, Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The new guidance provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The guidance also establishes (1) a general contract modification principle that entities can apply in other areas that may be affected by reference rate reform and (2) certain elective hedge accounting expedients. The amendment is effective for all entities through December 15, 2022. LIBOR is used to calculate the interest on borrowings under the Company's 2018 Bank of America Credit Facility. As the 2018 Bank of America Credit Facility, as amended, will terminate on June 30, 2021 before the phase out of LIBOR, the Company does not expect the adoption of the guidance to have an impact on its consolidated financial statements and disclosures.
Note 2. Revenue
Disaggregation of Revenue
The Company disaggregates revenue by type of product and by geographical market in order to depict the nature, amount, and timing of revenue and cash flows. Service revenues, which are less than 10%, are not a significant component of total revenue, and are aggregated within the respective categories.
The following is a summary of net sales by product type (in thousands):
| Three Months Ended September 30, | |||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||||||||||||||||||||||||||
| Server and storage systems | $ | $ | |||||||||||||||||||||||||||||||||||||||||||||
| Subsystems and accessories | |||||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | $ | |||||||||||||||||||||||||||||||||||||||||||||
Server and storage systems constitute an assembly and integration of subsystems and accessories, and related services. Subsystems and accessories are comprised of serverboards, chassis and accessories.
International net sales are based on the country and region to which the products were shipped. The following is a summary for the three months ended September 30, 2020 and 2019, of net sales by geographic region (in thousands):
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| United States | $ | $ | |||||||||||||||||||||
| Europe | |||||||||||||||||||||||
| Asia | |||||||||||||||||||||||
| Others | |||||||||||||||||||||||
| $ | $ | ||||||||||||||||||||||
Starting July 1, 2020, the Company no longer separately discloses revenue by products sold to indirect sales channel partners or direct customers and original equipment manufacturers because management does not make business operational decisions based on this set of disaggregation so the disclosure is no longer material to investors.
10
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Contract Balances
Generally, the payment terms of the Company’s offerings range from 30 to 60 days. In certain instances, customers may prepay for products and services in advance of delivery. Receivables relate to the Company’s unconditional right to consideration for performance obligations either partially or fully completed.
Contract assets are rights to consideration in exchange for goods or services that the Company has transferred to a customer when such right is conditional on something other than the passage of time. Such contract assets are insignificant to the Company’s condensed consolidated financial statements.
Contract liabilities consist of deferred revenue and relate to amounts invoiced to or advance consideration received from customers, which precede the Company’s satisfaction of the associated performance obligation(s). The Company’s deferred revenue primarily results from customer payments received upfront for extended warranties and on-site services because these performance obligations are satisfied over time. Revenue recognized during the three months ended September 30, 2020, which was included in the opening deferred revenue balance as of June 30, 2020 of $203.8 million, was $28.6 million.
Deferred revenue decreased $1.9 million during the three months ended September 30, 2020 because the recognition of revenue from contracts entered into in prior periods was greater than the invoiced amounts for service contracts during the period.
Transaction Price Allocated to the Remaining Performance Obligations
Remaining performance obligations represent in aggregate the amount of transaction price that has been allocated to performance obligations not delivered, or only partially undelivered, as of the end of the reporting period. The Company applies the optional exemption to not disclose information about remaining performance obligations that are part of a contract that has an original expected duration of one year or less. These performance obligations generally consist of services, such as on-site integration services and extended warranty services that are contracted for one year or less, and products for which control has not yet been transferred. The value of the transaction price allocated to remaining performance obligations as of September 30, 2020 was $201.8 million. The Company expects to recognize approximately 52 % of remaining performance obligations as revenue in the next 12 months, and the remainder thereafter.
Capitalized Contract Acquisition Costs and Fulfillment Cost
Contract acquisition costs are those incremental costs that the Company incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained. Contract acquisition costs consist primarily of incentive bonuses. Contract acquisition costs are considered incremental and recoverable costs of obtaining and fulfilling a contract with a customer and are therefore capitalizable. The Company applies the practical expedient to expense incentive bonus costs as incurred if the amortization period would be one year or less, generally upon delivery of the associated server and storage systems or components. Where the amortization period of the contract cost would be more than a year, the Company applies judgment in the allocation of the incentive bonus cost asset between hardware and service performance obligations and expenses the cost allocated to the hardware performance obligations upon delivery of associated server and storage systems or components and amortizes the cost allocated to service performance obligations over the period the services are expected to be provided. Contract acquisition costs allocated to service performance obligations that are subject to capitalization are insignificant to the Company’s consolidated financial statements.
Contract fulfillment costs consist of costs paid in advance for outsourced services provided by third parties to the extent they are not in the scope of other guidance. Fulfillment costs paid in advance for outsourced services provided by third parties are capitalized and amortized over the period the services are expected to be provided. Such fulfillment costs are insignificant to the Company’s consolidated financial statements.
11
Note 3. Net Income Per Common Share
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| Numerator: | |||||||||||||||||||||||
| Net income | $ | $ | |||||||||||||||||||||
| Denominator: | |||||||||||||||||||||||
| Weighted-average shares outstanding | |||||||||||||||||||||||
| Effect of dilutive securities | |||||||||||||||||||||||
| Weighted-average diluted shares | |||||||||||||||||||||||
| Basic net income per common share | $ | $ | |||||||||||||||||||||
| Diluted net income per common share | $ | $ | |||||||||||||||||||||
For the three months ended September 30, 2020 and 2019, the Company had stock options, restricted stock units ("RSUs") and performance based restricted stock units ("PRSUs") outstanding that could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net income per share in the periods presented, as their effect would have been anti-dilutive. The anti-dilutive common share equivalents resulting from outstanding equity awards were 1,177,694 and 3,958,789 for three months ended September 30, 2020, and 2019, respectively.
Note 4. Balance Sheet Components
Inventories:
| September 30, 2020 | June 30, 2020 | ||||||||||
| Finished goods | $ | $ | |||||||||
| Work in process | |||||||||||
| Purchased parts and raw materials | |||||||||||
| Total inventories | $ | $ | |||||||||
The Company recorded a (recovery) provision for excess and obsolete inventory to cost of sales totaling $(0.8 ) million and $10.1 million in the three months ended September 30, 2020 and 2019, respectively. These amounts exclude a provision (recovery) for adjusting the cost of certain inventories to net realizable value of $0.9 million and $(1.8 ) million for the three months ended September 30, 2020 and 2019, respectively. The recovery is recognized when previously reserved inventories are sold.
12
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Prepaid Expenses and Other Current Assets:
| September 30, 2020 | June 30, 2020 | ||||||||||
| Other receivables (1) | $ | $ | |||||||||
| Prepaid income tax | |||||||||||
| Prepaid expenses | |||||||||||
| Deferred service costs | |||||||||||
| Restricted cash | |||||||||||
| Others | |||||||||||
| Total prepaid expenses and other current assets | $ | $ | |||||||||
__________________________
Cash, cash equivalents and restricted cash:
| September 30, 2020 | June 30, 2020 | ||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Restricted cash included in prepaid expenses and other current assets | |||||||||||
| Restricted cash included in other assets | |||||||||||
| Total cash, cash equivalents and restricted cash | $ | $ | |||||||||
Property, Plant, and Equipment:
| September 30, 2020 | June 30, 2020 | ||||||||||
| Buildings | $ | $ | |||||||||
| Land | |||||||||||
| Machinery and equipment | |||||||||||
| Buildings construction in progress (1) | |||||||||||
| Building and leasehold improvements | |||||||||||
| Software | |||||||||||
| Furniture and fixtures | |||||||||||
| Accumulated depreciation and amortization | ( | ( | |||||||||
| Property, plant and equipment, net | $ | $ | |||||||||
__________________________
(1) Primarily relates to the development and construction costs associated with the Company’s Green Computing Park located in San Jose, California, and new building in Taiwan.
13
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Other Assets:
| September 30, 2020 | June 30, 2020 | ||||||||||
| Operating lease right-of-use asset | $ | $ | |||||||||
| Deferred service costs, non-current | |||||||||||
| Restricted cash, non-current | |||||||||||
| Investment in auction rate security | |||||||||||
| Deposits | |||||||||||
| Non-marketable equity securities | |||||||||||
| Prepaid expense, non-current | |||||||||||
| Total other assets | $ | $ | |||||||||
Accrued Liabilities:
| September 30, 2020 | June 30, 2020 | ||||||||||
| Accrued payroll and related expenses | $ | $ | |||||||||
| Contract manufacturing liabilities | |||||||||||
| Accrued warranty costs | |||||||||||
| Customer deposits | |||||||||||
| Operating lease liability | |||||||||||
| Accrued cooperative marketing expenses | |||||||||||
| Accrued professional fees | |||||||||||
| Accrued legal liabilities (Note 11) | |||||||||||
| Others (accrued liabilities) | |||||||||||
| Total accrued liabilities | $ | $ | |||||||||
Performance Awards Liability
In March 2020, the Board of Directors (the “Board”) approved performance bonuses for the Chief Executive Officer, a senior executive and two members of the Board, which payments will be earned when specified market and performance conditions are achieved.
The Chief Executive Officer’s aggregate cash bonuses of up to $8.1 million are earned in two tranches. The first 50 % is payable if the average closing price for the Company’s common stock equals or exceeds $31.61 for any period of 20 consecutive trading days following the date of the agreement and ending prior to September 30, 2021 and the Chief Executive Officer remains employed with the Company through the date that such common stock price goal is determined to have been achieved and the date that the payment is made. This payment can be reduced at the discretion of the Board to the extent the Company has not made adequate progress in remediating its material weaknesses in its internal control over financial reporting as determined by the Board. The second 50 % is payable if the average closing price for the Company’s common stock equals or exceeds $32.99 for any period of 20 consecutive trading days following the date of the agreement and ending prior to June 30, 2022 and the Chief Executive Officer remains employed with the Company through the date that such common stock price goal is achieved and the date that the payment is made.
Performance bonuses for a senior executive and two members of the Board are earned based on achieving a specified target average closing price for the Company’s common stock over the specified period as determined by the Board at the grant dates and continuous services through the payment dates. A senior executive earned an aggregate cash payment of $0.1 million when the target average closing price was met in the fourth quarter of fiscal year 2020. The two members of the Board can earn aggregate cash payments of $0.3 million in two tranches if the target average closing price reaches $31.61 for the first tranche
14
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
and $32.99 per share for the second tranche. These awards expire in two equal amounts at September 30, 2021 and June 30, 2022 for the two Board members' awards.
The Company accounts for the outstanding performance bonuses as liabilities and estimates fair value of payable amounts using a Monte-Carlo simulation model. The awards are re-measured at each period end with changes in fair value recorded in the Company’s consolidated statement of operations in operating expenses. The cumulative recorded expense at each period end is trued-up to the expected payable amount vested through the period end. The requisite service periods over which expenses are recognized are derived from the Monte-Carlo model for all performance awards, except for the first 50 % of the Chief Executive Officer’s award that includes a performance condition. The Company estimates if it is probable that the performance condition will be met through the expiration date of this award. If at the measurement date it is determined to be probable, the Company estimates the requisite period as the longer of the service period derived by the Monte-Carlo model and the implicit service period when the Company expects to make adequate progress in remediating its material weaknesses in its internal control over financial reporting, as reported by the Company's Audit Committee. If it is determined to not be probable, then the Company will reverse any previously recognized expense for this award in the period when it is no longer probable that the performance condition will be achieved.
As of September 30, 2020 and June 30, 2020, the fair value of these performance bonuses was $2.2 million and $2.1 million, respectively, of which $2.2 million and $1.5 million, respectively, was recorded within accrued liabilities and $0 .0 million and $0.6 million, respectively, was recorded within other long-term liabilities on the Company's consolidated balance sheet. An unrecognized compensation expense of $2.3 million will be recorded over the remaining service periods from 0.26 years to 0.93 years. The fair value of these awards is remeasured each reporting period. The expense recognized during the three months ended September 30, 2020 and September 30, 2019 was $0.1 million and $0.0 million respectively.
Other Long-term Liabilities:
| September 30, 2020 | June 30, 2020 | ||||||||||
| Operating lease liability, non-current | $ | $ | |||||||||
| Accrued unrecognized tax benefits including related interest and penalties | |||||||||||
| Accrued warranty costs, non-current | |||||||||||
| Others | |||||||||||
| Total other long-term liabilities | $ | $ | |||||||||
Product Warranties:
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| Balance, beginning of the period | $ | $ | |||||||||||||||||||||
| Provision for warranty | |||||||||||||||||||||||
| Costs utilized | ( | ( | |||||||||||||||||||||
| Change in estimated liability for pre-existing warranties | |||||||||||||||||||||||
| Balance, end of the period | |||||||||||||||||||||||
| Current portion | |||||||||||||||||||||||
| Non-current portion | $ | $ | |||||||||||||||||||||
Note 5. Fair Value Disclosure
15
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
The Company’s investment in an auction rate security is classified within Level 3 of the fair value hierarchy as the determination of its fair value was not based on observable inputs as of September 30, 2020 and June 30, 2020. The Company is using the discounted cash flow method to estimate the fair value of the auction rate security at each period end and the following assumptions: (i) the expected yield based on observable market rate of similar securities, (ii) the security coupon rate that is reset monthly, (iii) the estimated holding period and (iv) a liquidity discount. The liquidity discount assumption is based on the management estimate of lack of marketability discount of similar securities and is determined based on the analysis of financial market trends over time, recent redemptions of securities and other market activities. The Company performed a sensitivity analysis and applying a change of either plus or minus 100 basis points in the liquidity discount does not result in a significantly higher or lower fair value measurement of the auction rate security as of September 30, 2020.
Financial Assets and Liabilities Measured on a Recurring Basis
| September 30, 2020 | Level 1 | Level 2 | Level 3 | Asset at Fair Value | |||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Money market funds (1) | $ | $ | $ | $ | |||||||||||||||||||
| Certificates of deposit (2) | |||||||||||||||||||||||
| Auction rate security | |||||||||||||||||||||||
| Total assets measured at fair value | $ | $ | $ | $ | |||||||||||||||||||
| Liabilities | |||||||||||||||||||||||
| Performance awards liability (3) | $ | $ | $ | $ | |||||||||||||||||||
| Total liabilities measured at fair value | $ | $ | $ | $ | |||||||||||||||||||
| June 30, 2020 | Level 1 | Level 2 | Level 3 | Asset at Fair Value | |||||||||||||||||||
| Assets | |||||||||||||||||||||||
| Money market funds (1) | $ | $ | $ | $ | |||||||||||||||||||
| Certificates of deposit (2) | |||||||||||||||||||||||
| Auction rate security | |||||||||||||||||||||||
| Total assets measured at fair value | $ | $ | $ | $ | |||||||||||||||||||
| Liabilities | |||||||||||||||||||||||
| Performance awards liability (3) | $ | $ | $ | $ | |||||||||||||||||||
| Total liabilities measured at fair value | $ | $ | $ | $ | |||||||||||||||||||
__________________________
(1) $0.0 million and $0.4 million in money market funds are included in cash and cash equivalents and $0.8 million and $0.8 million in money market funds are included in restricted cash, non-current in other assets in the condensed consolidated balance sheets as of September 30, 2020 and June 30, 2020, respectively.
(2) $0.2 million and $0.2 million in certificates of deposit are included in cash and cash equivalents, $0.3 million and $0.3 million in certificates of deposit are included in prepaid expenses and other assets, and $0.3 million and $0.3 million in certificates of deposit are included in restricted cash, non-current in other assets in the condensed consolidated balance sheets as of September 30, 2020 and June 30, 2020, respectively.
16
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
On a quarterly basis, the Company also evaluates the current expected credit loss by considering factors such as historical experience, market data, issuer-specific factors, and current economic conditions. For the three months ended September 30, 2020, the credit losses related to the Company’s investments was not significant.
The Company estimated the fair value of performance awards using the Monte-Carlo simulation model and classified them within Level 2 of the fair value hierarchy as estimates are based on the observable inputs. The significant inputs used in estimating the fair value of the awards as of September 30, 2020 and June 30, 2020 are as follows:
| September 30, 2020 | ||||||||||||||||||||||||||
| Stock Price as of Period End | Performance Period | Risk-free Rate | Volatility | Dividend Yield | ||||||||||||||||||||||
| $ | ||||||||||||||||||||||||||
| June 30, 2020 | ||||||||||||||||||||||||||
| Stock Price as of Period End | Performance Period | Risk-free Rate | Volatility | Dividend Yield | ||||||||||||||||||||||
| $ | ||||||||||||||||||||||||||
There was no movement in the balances of the Company's financial assets measured at fair value on a recurring basis, consisting of investment in an auction rate security, using significant unobservable inputs (Level 3) for the three months ended September 30, 2020 and 2019.
There were no transfers between Level 1, Level 2 or Level 3 financial instruments in the three months ended September 30, 2020 and 2019.
| September 30, 2020 and June 30, 2020 | |||||||||||||||||||||||
| Cost Basis | Gross Unrealized Holding Gains | Gross Unrealized Holding Losses | Fair Value | ||||||||||||||||||||
| Auction rate security | $ | $ | $ | ( | $ | ||||||||||||||||||
No gain or loss was recognized in other comprehensive income for the auction rate security for the three months ended September 30, 2020 and 2019.
The Company measures the fair value of outstanding debt for disclosure purposes on a recurring basis. As of September 30, 2020 and June 30, 2020, total debt of $36.0 million and $29.4 million, respectively, is reported at amortized cost. This outstanding debt is classified as Level 2 as it is not actively traded. The amortized cost of the outstanding debt approximates the fair value.
17
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Note 6. Short-term and Long-term Debt
| September 30, | June 30, | ||||||||||
| 2020 | 2020 | ||||||||||
| CTBC Bank term loan, due August 31, 2021 | $ | $ | |||||||||
| CTBC Bank term loan, due June 4, 2030 | |||||||||||
| Total debt | |||||||||||
| Short-term debt and current portion of long-term debt | |||||||||||
| Debt, Non-current | $ | $ | |||||||||
Activities under Revolving Lines of Credit and Term Loans
Bank of America
2018 Bank of America Credit Facility
In April 2018, the Company entered into a revolving line of credit with Bank of America (the "2018 Bank of America Credit Facility"), which was amended on May 12, 2020. The Company paid a fee of $0.7 million and entered into a third amendment of the 2018 Bank of America Credit Facility that extended the maturity of the credit facility to June 30, 2021 and changed certain terms of the original agreement. The amendment was accounted for as a modification and the impact was immaterial to the consolidated financial statements. Under the terms of the May 12, 2020 amendment of the 2018 Bank of America Credit Facility, in the event of default or if outstanding borrowings are in excess of $220.0 million, the Company is required to grant the lenders a continuing security interest in and lien upon all amounts credited to any of the Company's deposit accounts. In addition, the amendment released the real property of Super Micro Computer as a collateral. Interest accrued on any loans under the 2018 Bank of America Credit Facility is due on the first day of each month, and the loans are due and payable in full on the termination date of the 2018 Bank of America Credit Facility. Voluntary prepayments are permitted without early repayment fees or penalties. Subject to customary exceptions, the 2018 Bank of America Credit Facility is secured by substantially all of Super Micro Computer’s assets, other than real property assets. Under the terms of the 2018 Bank of America Credit Facility, the Company is not permitted to pay any dividends. The Company is required to pay 0.375 % per annum on the 2018 Bank of America Credit Facility for any unused borrowings. The 2018 Bank of America Credit Facility contains customary representations and warranties and customary affirmative and negative covenants applicable to the Company and its subsidiaries and contains a financial covenant, which requires that the Company maintain a certain fixed charge coverage ratio, for each twelve-month period while in a Trigger Period, as defined in the agreement, is in effect.
As of September 30, 2020 and June 30, 2020, the Company had no 3.00 3.2 million letter of credit was issued under the 2018 Bank of America Credit Facility and in October 2019, the letter of credit amount was increased to $6.4 million. No amounts have been drawn under the standby letter of credit. The balance of debt issuance costs outstanding were $0.5 million and $0.6 million as of September 30, 2020 and June 30, 2020, respectively. The Company has been in compliance with all the covenants under the 2018 Bank of America Credit Facility, and as of September 30, 2020, the Company's available borrowing capacity was $243.6 million, subject to the borrowing base limitation and compliance with other applicable terms.
CTBC Bank
CTBC Credit Facility
In June 2019, the Company entered into a credit agreement with CTBC Bank, which was amended in August 2020, (collectively, the "CTBC Credit Facility"). The amended credit agreement with CTBC Bank that provides for (i) a 12 -month NTD 700.0 million ($24.0 million U.S. dollar equivalent) term loan facility secured by the land and building located in Bade,
18
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25 % per annum which is adjusted monthly, which term loan facility also includes a 12 -month guarantee of up to NTD 100.0 million ($3.4 million U.S. dollar equivalent) with an annual fee equal to 0.50 % per annum, (ii) a 180 -day NTD 1,500.0 million ($51.5 million U.S. dollar equivalent) term loan facility up to 100 % of eligible accounts receivable in an aggregate amount with an interest rate equal to the lender's established NTD interest rate plus an interest rate ranging from 0.30 % to 0.50 % per annum which is adjusted monthly, and (ⅲ) a 12 -month revolving line of credit of up to 100 % of eligible accounts receivable in an aggregate amount of up to $50.0 million with an interest rate equal to the lender's established USD interest rate plus 0.80 % per annum which is adjusted monthly, or equal to the lender’s established NTD interest rate plus an interest rate ranging from 0.30 % to 0.50 % per annum which is adjusted monthly if the borrowing is in NTD. The total borrowings allowed under the CTBC Credit Facility was capped at $50.0 million. There are no financial covenants associated with the CTBC Credit Facility.
The total outstanding borrowings under the CTBC Credit Facility term loan were denominated in NTD and remeasured into U.S. dollars of $24.0 million and $23.7 million at September 30, 2020 and June 30, 2020, respectively. As of September 30, 2020 and June 30, 2020, the Company did no 0.73 % per annum as of September 30, 2020 and 0.63 % per annum as of June 30, 2020. At September 30, 2020, the amount available for future borrowing under the CTBC Credit Facility was $26.0 million. As of September 30, 2020, the net book value of land and building located in Bade, Taiwan, collateralizing the CTBC Credit Facility term loan was $25.3 million.
2020 CTBC Term Loan Facility
In May 2020, the Company entered into a ten-year , non-revolving term loan facility (“2020 CTBC Term Loan Facility”) to obtain up to NTD 1.2 billion ($40.7 million in U.S. dollar equivalents) in financing for use in the expansion and renovation of the Company’s Bade Manufacturing Facility located in Taiwan. Drawdowns on the 2020 CTBC Term Loan Facility are based on 80 % of balances owed on commercial invoices from the contractor and shall be drawn according to the progress of the renovations. Borrowings under the 2020 CTBC Term Loan Facility are available through June 2022. The Company is required to pay against total outstanding principal and interest in equal monthly installments starting June 2023 and continuing through the maturity date of June 2030. Interest under the 2020 CTBC Term Loan Facility is the two-year term floating rate of postal saving interest rate plus 0.105 % and is established on the date of the drawdown application. If no interest rate is agreed upon, interest shall accrue at the annual base rate for CTBC plus 4.00 %. The 2020 CTBC Term Loan Facility is secured by the Bade Manufacturing Facility and its expansion. Fees paid to the lender as debt issuance costs were immaterial. The Company has financial covenants requiring the Company's current ratio, debt service coverage ratio, and financial debt ratio, as defined in the agreement, to be maintained at certain levels under the 2020 CTBC Term Loan Facility.
As of September 30, 2020 and June 30, 2020, the amounts outstanding under the 2020 CTBC Term Loan Facility were $12.0 million and $5.7 million, respectively. The interest rate for these loans were 0.45 % per annum as of September 30, 2020 and June 30, 2020. The net book value of the property serving as collateral as of September 30, 2020 was $17.1 million. As of September 30, 2020, the Company was in compliance with all financial covenants under the 2020 CTBC Term Loan Facility.
19
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Note 7. Leases
The Company leases offices, warehouses and other premises, vehicles and certain equipment leased under non-cancelable operating leases. Operating lease expense recognized and supplemental cash flow information related to operating leases for the three months ended September 30, 2020 and 2019 were as follows (in thousands):
| Three Months Ended September 30, | |||||||||||||||||
| 2020 | 2019 | ||||||||||||||||
Operating lease expense (including expense for lease agreements with related parties of $ | $ | $ | |||||||||||||||
Cash payments for operating leases (including payments to related parties of $ | $ | $ | |||||||||||||||
During the three months ended September 30, 2020 and 2019, the Company's costs related to short-term lease arrangements for real estate and non-real estate assets were immaterial. Variable payments expensed in the three months ended September 30, 2020 and September 30, 2019 were immaterial.
As of September 30, 2020, the weighted average remaining lease term for operating leases was 4.3 years and the weighted average discount rate was 3.5 %. Future minimum lease payments under noncancelable operating lease arrangements as of September 30, 2020 were as follows (in thousands):
| Fiscal Year: | Minimum lease payments | |||||||
| 2021 | $ | |||||||
| 2022 | ||||||||
| 2023 | ||||||||
| 2024 | ||||||||
| 2025 | ||||||||
| 2026 and beyond | ||||||||
| Total future lease payments | $ | |||||||
| Less: Imputed interest | ( | |||||||
| Present value of operating lease liabilities | $ | |||||||
As of September 30, 2020, commitments under short-term lease arrangements, and operating and financing leases that have not yet commenced were immaterial.
The Company has entered into lease agreements with related parties. See Note 8, "Related Party Transactions," for discussion.
Note 8. Related Party Transactions
20
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Sara Liu do not own any capital stock of Compuware and the Company does not own any of Ablecom or Compuware’s capital stock.
Dealings with Ablecom
The Company has entered into a series of agreements with Ablecom, including multiple product development, production and service agreements, product manufacturing agreements, manufacturing services agreements and lease agreements for warehouse space.
Under these agreements, the Company outsources to Ablecom a portion of its design activities and a significant part of its server chassis manufacturing as well as an immaterial portion of other components. Ablecom manufactured approximately 93.6 % and 92.7 % of the chassis included in the products sold by the Company during the three months ended September 30, 2020 and 2019, respectively. With respect to design activities, Ablecom generally agrees to design certain agreed-upon products according to the Company’s specifications, and further agrees to build the tools needed to manufacture the products. The Company pays Ablecom for the design and engineering services, and further agrees to pay Ablecom for the tooling. The Company retains full ownership of any intellectual property resulting from the design of these products and tooling.
With respect to the manufacturing aspects of the relationship, Ablecom purchases most of materials needed to manufacture the chassis from third parties and the Company provides certain components used in the manufacturing process (such as power supplies) to Ablecom through consignment or sales transactions. Ablecom uses these materials and components to manufacture the completed chassis and then sell them back to the Company. For the components purchased from the Company, Ablecom sells the components back to the Company at a price equal to the price at which the Company sold the components to Ablecom. The Company and Ablecom frequently review and negotiate the prices of the chassis the Company purchases from Ablecom. In addition to inventory purchases, the Company also incurs other costs associated with design services, tooling and other miscellaneous costs from Ablecom.
The Company’s exposure to financial loss as a result of its involvement with Ablecom is limited to potential losses on its purchase orders in the event of an unforeseen decline in the market price and/or demand of the Company’s products such that the Company incurs a loss on the sale or cannot sell the products. Outstanding purchase orders from the Company to Ablecom were $11.1 million and $23.2 million at September 30, 2020 and June 30, 2020, respectively, representing the maximum exposure to financial loss. The Company does not directly or indirectly guarantee any obligations of Ablecom, or any losses that the equity holders of Ablecom may suffer. Since Ablecom manufactures substantially all the chassis that the Company incorporates into its products, if Ablecom were to suddenly be unable to manufacture chassis for the Company, the Company’s business could suffer if the Company is unable to quickly qualify substitute suppliers who can supply high-quality chassis to the Company in volume and at acceptable prices.
Dealings with Compuware
The Company has entered into a distribution agreement with Compuware, under which the Company appointed Compuware as a non-exclusive distributor of the Company’s products in Taiwan, China and Australia. Compuware assumes the responsibility to install the Company's products at the site of the end customer, if required, and administers customer support in exchange for a discount from the Company's standard price for its purchases.
The Company also has entered into a series of agreements with Compuware, including a multiple product development, production and service agreements, product manufacturing agreements, and lease agreements for office space.
Under these agreements, the Company outsources to Compuware a portion of its design activities and a significant part of its power supplies manufacturing as well as an immaterial portion of other components. With respect to design activities, Compuware generally agrees to design certain agreed-upon products according to the Company’s specifications, and further agrees to build the tools needed to manufacture the products. The Company pays Compuware for the design and engineering services, and further agrees to pay Compuware for the tooling. The Company retains full ownership of any intellectual property resulting from the design of these products and tooling. With respect to the manufacturing aspects of the relationship, Compuware purchases most of materials needed to manufacture the power supplies from outside markets and uses these
21
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
materials to manufacture the products and then sell those products to the Company. The Company and Compuware frequently review and negotiate the prices of the power supplies the Company purchases from Compuware.
Compuware also manufactures motherboards, backplanes and other components used on printed circuit boards for the Company. The Company sells to Compuware most of the components needed to manufacture the above products. Compuware uses the components to manufacture the products and then sells the products back to the Company at a purchase price equal to the price at which the Company sold the components to Compuware, plus a “manufacturing value added” fee and other miscellaneous material charges and costs. The Company and Compuware frequently review and negotiate the amount of the “manufacturing value added” fee that will be included in the price of the products the Company purchases from Compuware. In addition to the inventory purchases, the Company also incurs costs associated with design services, tooling assets, and miscellaneous costs.
The Company’s exposure to financial loss as a result of its involvement with Compuware is limited to potential losses on its purchase orders in the event of an unforeseen decline in the market price and/or demand of the Company’s products such that the Company incurs a loss on the sale or cannot sell the products. Outstanding purchase orders from the Company to Compuware were $21.9 million and $45.7 million at September 30, 2020 and June 30, 2020, respectively, representing the maximum exposure to financial loss. The Company does not directly or indirectly guarantee any obligations of Compuware, or any losses that the equity holders of Compuware may suffer.
The Company’s results from transactions with Ablecom and Compuware for each of the three months ended September 30, 2020 and 2019, are as follows (in thousands):
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| Ablecom | |||||||||||||||||||||||
| Purchases (1) | $ | $ | |||||||||||||||||||||
| Compuware | |||||||||||||||||||||||
| Net sales | $ | $ | |||||||||||||||||||||
| Purchases (1) | |||||||||||||||||||||||
__________________________
(1) Includes principally purchases of inventory and other miscellaneous items.
The Company's net sales to Ablecom were not material for the three months ended September 30, 2020 and 2019.
The Company had the following balances related to transactions with Ablecom and Compuware as of September 30, 2020 and June 30, 2020 (in thousands):
| September 30, 2020 | June 30, 2020 | ||||||||||
| Ablecom | |||||||||||
| Accounts receivable and other receivables (1) | $ | $ | |||||||||
| Accounts payable and accrued liabilities (2) | |||||||||||
| Other long-term liabilities (3) | |||||||||||
| Compuware | |||||||||||
| Accounts receivable and other receivables (1) | $ | $ | |||||||||
| Accounts payable and accrued liabilities (2) | |||||||||||
| Other long-term liabilities (3) | |||||||||||
____________________________
(1) Other receivables include receivables from vendors.
(2) Includes current portion of operating lease liabilities.
22
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
See Note 1, "Summary of Significant Accounting Policies" for a discussion of the transactions and balances in the Company’s Corporate Venture.
Note 9. Stock-based Compensation
Equity Incentive Plan
On June 5, 2020, the stockholders of the Company approved the 2020 Equity and Incentive Compensation Plan (the "2020 Plan"). The maximum number of shares available under the 2020 Plan is 5,000,000 plus 1,045,000 shares of common stock that remained available for future awards under the 2016 Equity Incentive Plan (the “2016 Plan”), at the time of adoption of the 2020 Plan. No other awards can be granted under the 2016 Plan. 7,246,000 shares of common stock remain reserved for outstanding awards issued under the 2016 Plan at the time of adoption of the 2020 Plan.
As of September 30, 2020, the Company had 4,593,009 authorized shares available for future issuance under the 2020 Plan.
Share Repurchase Program
On August 9, 2020, the Board approved a share repurchase program to repurchase shares of common stock for up to an aggregate of $30.0 million at market prices. The program is effective until December 31, 2020 or if earlier, until the maximum amount of common stock is repurchased. During the three months ended September 30, 2020, 1,142,294 shares of common stock were repurchased for $30.0 million and the program ended. Repurchased shares were recorded as treasury shares in the Company's condensed consolidated balance sheet.
Determining Fair Value
The Company's fair value of RSUs and PRSUs is based on the closing market price of the Company's common stock on the date of grant. The Company estimates the fair value of stock options granted using the Black-Scholes-option-pricing model. This fair value is then amortized ratably over the requisite service periods of the awards, which is generally the vesting period. The key inputs in using the Black-Scholes-option-pricing model were as follows:
Expected Term—The Company’s expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on the Company's historical experience.
Expected Volatility—Expected volatility is based on the Company's historical volatility.
Expected Dividend—The Black-Scholes valuation model calls for a single expected dividend yield as an input and the Company has no plans to pay dividends.
Risk-Free Interest Rate—The risk-free interest rate used in the Black-Scholes valuation method is based on the United States Treasury zero coupon issues in effect at the time of grant for periods corresponding with the expected term of option.
23
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| Risk-free interest rate | % | % | |||||||||||||||||||||
| Expected term | |||||||||||||||||||||||
| Dividend yield | % | % | |||||||||||||||||||||
| Volatility | % | % | |||||||||||||||||||||
| Weighted-average fair value | $ | $ | |||||||||||||||||||||
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| Cost of sales | $ | $ | |||||||||||||||||||||
| Research and development | |||||||||||||||||||||||
| Sales and marketing | |||||||||||||||||||||||
| General and administrative | |||||||||||||||||||||||
| Stock-based compensation expense before taxes | |||||||||||||||||||||||
| Income tax impact | ( | ( | |||||||||||||||||||||
| Stock-based compensation expense, net | $ | $ | |||||||||||||||||||||
As of September 30, 2020, $7.2 million of unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 2.39 years, $39.7 million of unrecognized compensation cost related to unvested RSUs is expected to be recognized over a weighted-average period of 2.56 years and $0.4 million of unrecognized compensation cost related to unvested PRSUs is expected to be recognized over a period of 0.76 years.
Stock Option Activity
| Options Outstanding | Weighted Average Exercise Price per Share | Weighted Average Remaining Contractual Term (in Years) | ||||||||||||||||||||||||
| Balance as of June 30, 2020 | $ | |||||||||||||||||||||||||
| Granted | $ | |||||||||||||||||||||||||
| Exercised | ( | $ | ||||||||||||||||||||||||
| Forfeited/Cancelled | ( | $ | ||||||||||||||||||||||||
| Balance as of September 30, 2020 | $ | |||||||||||||||||||||||||
| Options vested and exercisable at September 30, 2020 | $ | |||||||||||||||||||||||||
RSU and PRSU Activity
In January 2015, the Company began to grant RSUs to employees. The Company grants RSUs to certain employees as part of its regular employee equity compensation review program as well as to selected new hires. RSUs are typically service based share awards that entitle the holder to receive freely tradable shares of the Company's common stock upon vesting.
24
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
In August 2017, the Compensation Committee granted two PRSU awards to the Company's Chief Executive Officer, both of which have both performance and service conditions. 50 % of the PRSUs vested at June 30, 2018 when performance conditions were achieved, while the remainder vest in equal amounts over the following ten quarters if the Company's Chief Executive Officer continued to be employed during those ten quarters. As of September 30, 2020, an additional 45 % of the PRSUs vested and 5 % are expected to vest in the three months ended December 31, 2020, in accordance with the terms of the grant.
In March 2020, the Compensation Committee granted a PRSU award to one of the Company's senior executives. The award vests in two tranches and includes service and performance conditions. Each tranche has 15,000 RSUs that vest in May 2021 and November 2021 based on service conditions only. Additional units can be earned based on revenue growth percentage in fiscal year 2020 compared to fiscal year 2019, which units would vest in May 2021, and based on revenue growth percentage in fiscal year 2021 compared to fiscal year 2020, which units would vest in November 2021. No additional units were earned for fiscal year 2020 as revenue decreased from fiscal year 2019.
| Time-Based RSUs Outstanding | Weighted Average Grant-Date Fair Value per Share | PRSUs Outstanding | Weighted Average Grant-Date Fair Value per Share | |||||||||||||||||||||||
| Balance as of June 30, 2020 | $ | (1) | $ | |||||||||||||||||||||||
| Granted | $ | $ | ||||||||||||||||||||||||
| Released | ( | $ | ( | $ | ||||||||||||||||||||||
| Forfeited | ( | $ | $ | — | ||||||||||||||||||||||
| Balance as of September 30, 2020 | $ | $ | ||||||||||||||||||||||||
__________________________
(1)Reflects the number of PRSUs that have been earned based on the achievement of performance metrics.
25
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Note 10. Income Taxes
The Company recorded a provision for income taxes of $3.7 million and $8.6 million for the three months ended September 30, 2020 and 2019, respectively. The effective tax rate was 12.7 % and 25.3 % for the three months ended September 30, 2020 and 2019, respectively. The effective tax rate for the three months ended September 30, 2020 is lower than that for the three months ended September 30, 2019, primarily due to decrease in tax reserves for uncertain tax positions after settlement of certain tax audits, and increase in the tax benefit related to employees’ stock-based compensation.
As a result of the 2017 Tax Reform Act, in December 2019, the Company realigned its international business operations and group structure. As a part of this restructuring, the Company moved certain intellectual property back to the United States. This tax restructuring does not have a material impact on the estimated annual effective tax rate.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was enacted. The CARES Act provides temporary relief from certain aspects of the 2017 Tax Reform Act that imposed limitations on the utilization of certain losses, interest expense deductions and alternative minimum tax credits and made a technical correction to the 2017 Tax Reform Act related to the depreciable life of qualified improvement property. The CARES Act does not have a material impact on the Company.
As of September 30, 2020, the Company had gross unrecognized tax benefits of $30.5 million, of which, $14.1 million if recognized, would affect the Company's effective tax rate. During the three months ended September 30, 2020, there was a $3.3 million increase in gross unrecognized tax benefits. The Company’s policy is to include interest and penalties related to unrecognized tax benefits within the provision for taxes on the condensed consolidated statements of operations. As of September 30, 2020, the Company had accrued $2.3 million of interest and penalties relating to unrecognized tax benefits.
Under the 2017 Tax Reform Act, starting on July 1, 2018, the Company is no longer subject to federal income tax on earnings remitted from our foreign subsidiaries. As a result of the 2017 Tax Reform Act, the Company has determined that its foreign undistributed earnings are indefinitely reinvested except for undistributed earnings related to the Company's operations in the Netherlands. The Company may repatriate certain foreign earnings from the Netherlands that have been previously taxed in the U.S. The tax impact of such repatriation is estimated to be immaterial.
In October 2019, the Taiwan tax authority completed its audit in Taiwan for fiscal year 2018 and proposed a transfer pricing adjustment resulting in additional tax liability of $1.6 million. The Company accepted the proposed adjustment in October 2019 and paid the $1.6 million tax liability in February 2020. In February 2020, the Taiwan tax authority completed its audit in Taiwan for fiscal year 2019 and proposed a transfer pricing adjustment resulting in an additional tax liability of $1.0 million. The Company accepted the proposed adjustment and paid the $1.0 million tax liability in February 2020. The impact of these adjustments on the income statement was offset by the release of previously unrecognized tax benefits related to the fiscal years audited in the periods in which the proposed adjustments were accepted.
The Company believes that it has adequately provided reserves for all uncertain tax positions; however, amounts asserted by tax authorities could be greater or less than the Company’s current position. Accordingly, the Company’s provision on federal, state and foreign tax related matters to be recorded in the future may change as revised estimates are made or as the underlying matters are settled or otherwise resolved.
The federal statute of limitations remains open in general for tax years ended June 30, 2017 through 2020. Various states statutes of limitations remain open in general for tax years ended June 30, 2016 through 2020. Certain statutes of limitations in major foreign jurisdictions remain open in general for the tax years ended June 30, 2015 through 2020. It is reasonably possible that our gross unrecognized tax benefits will decrease by approximately $1.2 million, in the next 12 months, due to the lapse of the statute of limitations. These adjustments, if recognized, would positively impact our effective tax rate, and would be recognized as additional tax benefits.
26
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Note 11. Commitments and Contingencies
Litigation and Claims— On February 8, 2018, two putative class action complaints were filed against the Company, the Company's Chief Executive Officer, and the Company's former Chief Financial Officer in the U.S. District Court for the Northern District of California (Hessefort v. Super Micro Computer, Inc., et al., No. 18-cv-00838 and United Union of Roofers v. Super Micro Computer, Inc., et al., No. 18-cv-00850). The complaints contain similar allegations, claiming that the defendants violated Section 10(b) of the Securities Exchange Act due to alleged misrepresentations and/or omissions in public statements regarding recognition of revenue. The court subsequently appointed New York Hotel Trades Council & Hotel Association of New York City, Inc. Pension Fund as lead plaintiff. The lead plaintiff then filed an amended complaint naming the Company's Senior Vice President of Investor Relations as an additional defendant. On June 21, 2019, the lead plaintiff filed a further amended complaint naming the Company's former Senior Vice President of International Sales, Corporate Secretary, and Director as an additional defendant. On July 26, 2019, the Company filed a motion to dismiss the complaint. On March 23, 2020, the Court granted the Company’s motion to dismiss the complaint, with leave for lead plaintiff to file an amended complaint within 30 days. On April 22, 2020, lead plaintiff filed a further amended complaint. On June 15, 2020, the Company filed a motion to dismiss the further amended complaint, the hearing for which was calendared for September 23, 2020; however, the Court held a conference on September 15 to discuss how the Court could efficiently address the recent SEC settlement agreement. The parties stipulated to allow plaintiffs to further amend the complaint solely to add allegations relating to the SEC settlement. On October 14, 2020, plaintiffs filed a Fourth Amended Complaint. On October 28, 2020, defendants filed a supplemental motion to dismiss. The Court has not set a new date for the motion to dismiss hearing, but expects the hearing will be set in late 2020 or early 2021 following completion of supplemental motion to dismiss briefing. The Company believes the claims are without merit and intends to vigorously defend against the lawsuit.
SEC Matter— The Company cooperated with the SEC in its investigation of marketing expenses that contained certain irregularities discovered by Company management, which irregularities were disclosed on August 31, 2015, and the Company cooperated with the SEC in its further investigation of the matters underlying the Company’s inability to timely file its Form 10-K for the fiscal year ended June 30, 2017 and concerning the publication of a false and widely discredited news article in October 2018 concerning the Company’s products. On August 25, 2020, to fully resolve all matters under investigation, the Company consented to entry of an Order Instituting Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Section 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing a Cease-and-Desist Order (“Order”), as announced by the SEC. The Company admitted the SEC’s jurisdiction over the Company and the subject matter of the proceedings, but otherwise neither admitted nor denied the SEC’s findings, as described in the Order. The Company agreed to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act and Sections 13(a), 13(b)(2)(A), and 13(b)(2)(B), of the Exchange Act and Rules 12b-20, 13a-1, 13a-11, and 13a-13 thereunder. The Company agreed and paid a civil money penalty of $17,500,000 during the three months ended September 30, 2020, which was recorded to general and administrative expense in the Company's condensed consolidated statement of operations. In addition, the Company’s Chief Executive Officer concluded a settlement with the SEC on August 25, 2020, as announced by the SEC. The Company’s Chief Executive Officer paid the Company the sum of $2,122,000 as reimbursement of profits from certain stock sales during the relevant period, pursuant to Section 304 of the Sarbanes-Oxley Act of 2002. The settlement amount was paid during the first quarter of fiscal 2021 and the Company recorded the payment as a credit to general and administrative expense.
Other legal proceedings and indemnifications
From time to time, the Company has been involved in various legal proceedings arising from the normal course of business activities. The resolution of any such matters have not had a material impact on the Company’s consolidated financial condition, results of operations or liquidity as of September 30, 2020 and any prior periods.
The Company has entered into indemnification agreements with its current and former directors and executive officers. Under these agreements, the Company has agreed to indemnify such individuals to the fullest extent permitted by law against liabilities that arise by reason of their status as directors or officers and to advance expenses incurred by such individuals in connection with related legal proceedings. It is not possible to determine the maximum potential amount of payments the Company could be required to make under these agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each claim. However, the Company maintains directors and officers liability insurance coverage to reduce its exposure to such obligations.
27
SUPER MICRO COMPUTER, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(Unaudited)
Purchase Commitments— The Company has agreements to purchase inventory and non-inventory items primarily through the next 12 months. As of September 30, 2020, these remaining noncancelable commitments were $119.7 million, including $33.1 million for related parties.
Standby Letter of Credit— In October 2018, a $3.2 million letter of credit was issued under the 2018 Bank of America Credit Facility and in October 2019, the letter of credit amount was increased to $6.4 million. The standby letter of credit is cancellable upon written notice from the issuer. No amounts have been drawn under the standby letter of credit.
Note 12. Segment Reporting
The Company operates in one operating segment that develops and provides high performance server solutions based upon an innovative, modular and open-standard architecture. The Company’s chief operating decision maker is the Chief Executive Officer.
The following is a summary of property, plant and equipment, net (in thousands):
| September 30, | June 30, | ||||||||||
| 2020 | 2020 | ||||||||||
| Long-lived assets: | |||||||||||
| United States | $ | $ | |||||||||
| Asia | |||||||||||
| Europe | |||||||||||
| $ | $ | ||||||||||
The Company’s revenue is presented on a disaggregated basis in Note 2, “Revenue,” by type of product and by geographical market.
Note 13. Subsequent Events
28
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
This section and other parts of this Quarterly Report contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) that involve risks and uncertainties. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology including “would,” “could,” “may,” “will,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” or “continue,” the negative of these terms or other comparable terminology. In evaluating these statements, you should specifically consider various factors, including the risks discussed under “Risk Factors” in Part II, Item 1A of this filing. These factors may cause our actual results to differ materially from those anticipated or implied in the forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. We cannot guarantee future results, levels of activity, performance or achievements.
The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with our condensed consolidated financial statements and related footnotes included elsewhere in this Quarterly Report and included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2020 (the “2020 10-K”), which includes our consolidated financial statements for the fiscal years ended June 30, 2020 and 2019.
Overview
We are a global leader and innovator of application-optimized high performance and high-efficiency server and storage systems for a variety of markets, including enterprise data centers, cloud computing, artificial intelligence, 5G and edge computing. Our solutions include complete servers, storage systems, modular blade servers, blades, workstations, full racks, networking devices, server management software, and server sub-systems. We also provide global support and services to help our customers install, upgrade and maintain their computing infrastructure.
We commenced operations in 1993 and have been profitable every year since inception. Our net income for the three months ended September 30, 2020 increased to $26.6 million from $26.3 million for the corresponding period in the prior year. In order to increase our sales and profits, we believe that we must continue to develop flexible and application optimized server and storage solutions and be among the first to market with new features and products. We must also continue to expand our software and customer service and support offerings, particularly as we increasingly focus on larger enterprise customers. Additionally, we must focus on development of our sales partners and distribution channels to further expand our market share. We measure our financial success based on various indicators, including growth in net sales, gross profit margin and operating margin. Among the key non-financial indicators of our success is our ability to rapidly introduce new products and deliver the latest application-optimized server and storage solutions. In this regard, we work closely with microprocessor and other key component vendors to take advantage of new technologies as they are introduced. Historically, our ability to introduce new products rapidly has allowed us to benefit from technology transitions such as the introduction of new microprocessors and storage technologies, and as a result, we monitor the introduction cycles of Intel Corporation, Advanced Micro Devices, Inc., Nvidia Corporation, Samsung Electronics Company Limited, Micron Technology, Inc. and others closely and carefully. This also impacts our research and development expenditures as we continue to invest more in our current and future product development efforts.
Coronavirus (COVID-19) Pandemic Impact
The global spread of the coronavirus (COVID-19) and the various attempts to contain it have created significant volatility, uncertainty and economic disruption for many businesses worldwide. In an effort to contain COVID-19 or slow its spread, governments around the world have enacted various measures, including orders that govern the operations of businesses, require masks be worn and define shelter in place and social distancing protocols. We are an essential critical infrastructure (information technology) business under the relevant federal, state and county regulations. Accordingly, in late March, we responded to the directives from Santa Clara County and the State of California regarding instructions to combat the spread of COVID-19. Our first priority is the safety of our workforce and we have implemented numerous health precautions and work practices to be in compliance with the law and to operate in a safe manner.
We quickly transitioned most of our indirect labor forces to work from home and continued to operate our local assembly in Taiwan and, after an initial period of disruption, in the United States and Europe. We operate in the critical industry of IT infrastructure and we assessed our customer base to identify priority customers who operate in critical industries. We continued to see ongoing demand and do not have significant direct exposure to industries such as retail, oil and gas and hospitality, which have been impacted the greatest. As time passes, we may discover greater indirect exposure to distressed industries through our channel partners and OEM customers.
29
We have actively managed our supply chain for potential shortage risk by first building inventories of critical components required for our motherboards and other system printed circuit boards in response to the early outbreak of COVID-19 in China. Since that time, we have continued to add to our inventories of key components such as CPUs, memory, SSDs and to a lesser extent GPUs such that customer orders can be fulfilled as they are received.
Logistics has emerged as a new challenge as globally the transportation industry restricted the frequency of departures and increased logistics costs. We experienced increased costs in freight as well as direct labor costs as we incentivized our employees to continue to work and assist us in serving our customers, many of whom are in critical industries. We expect this trend to continue for the duration of the COVID-19 pandemic.
We monitor the credit profile and payment history of our customers to evaluate risk in specific industries or geographic areas where cash flow may be disrupted. While we believe that we are adequately capitalized, we actively manage our liquidity needs. In May 2020, we negotiated an extension of our credit facility with Bank of America to extend the maturity date to June 2021. In June 2020, we entered into a ten-year, non-revolving term loan facility with China Trust and Bank Corp ("CTBC Bank") to obtain financing for use in the expansion and renovation of the our Bade Manufacturing Facility located in Taiwan.
Our management team is focused on guiding our company through the ongoing challenges presented by COVID-19. Currently, we are unable to predict the ultimate extent to which the global COVID-19 pandemic may further impact our business operations, financial performance and results of operations within the next 12 months.
Financial Highlights
The following is a summary of our financial highlights of the first quarter of fiscal year 2021:
•Net sales decreased by 4.7% as compared to the three months ended September 30, 2019.
•Gross margin increased to 17.0% in the three months ended September 30, 2020 from 16.4% for the three months ended September 30, 2019.
•Operating expenses increased by 1.4% as compared to the three months ended September 30, 2019, and were equal to 13.0% and 12.3% of net sales in the three months ended September 30, 2020 and 2019, respectively.
•Effective tax rate decreased from 25.3% in the three months ended September 30, 2019 to 12.7% in the three months ended September 30, 2020.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, net sales and expenses. We evaluate our estimates and assumptions on an ongoing basis, and base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for the judgments we make about the carrying value of assets and liabilities that are not readily apparent from other sources. Because these estimates can vary depending on the situation, actual results may differ from these estimates. Making estimates and judgments about future events is inherently unpredictable and is subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material impact on our results of operations, financial position and statement of cash flows.
There have been no material changes to our critical accounting policies and estimates as compared to those disclosed in our 2020 10-K. For a description of our critical accounting policies and estimates, see Part I, Item 1, Note 1, "Summary of Significant Accounting Policies" in our notes to the condensed consolidated financial statements in this Quarterly Report.
30
Results of Operations
The following table presents certain items of our condensed consolidated statements of operations expressed as a percentage of revenue.
| Three Months Ended September 30, | |||||||||||||||||||||||
| 2020 | 2019 | ||||||||||||||||||||||
| Net sales | 100.0 | % | 100.0 | % | |||||||||||||||||||
| Cost of sales | 83.0 | % | 83.6 | % | |||||||||||||||||||
| Gross profit | 17.0 | % | 16.4 | % | |||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||
Research and development | 7.2 | % | 6.2 | % | |||||||||||||||||||
Sales and marketing | 2.7 | % | 2.5 | % | |||||||||||||||||||
General and administrative | 3.2 | % | 3.5 | % | |||||||||||||||||||
| Total operating expenses | 13.0 | % | 12.3 | % | |||||||||||||||||||
| Income from operations | 4.0 | % | 4.1 | % | |||||||||||||||||||
| Other (expense) income, net | (0.1) | % | 0.2 | % | |||||||||||||||||||
| Interest expense | (0.1) | % | (0.1) | % | |||||||||||||||||||
| Income before income tax provision | 3.8 | % | 4.2 | % | |||||||||||||||||||
| Income tax provision | (0.5) | % | (1.1) | % | |||||||||||||||||||
| Share of income from equity investee, net of taxes | 0.2 | % | 0.1 | % | |||||||||||||||||||
| Net income | 3.5 | % | 3.3 | % | |||||||||||||||||||
Net Sales
Net sales consist of sales of our server and storage solutions, including systems and related services and subsystems and accessories. The main factors that impact our net sales of our server and storage systems are the number of compute nodes sold and the average selling prices per node. The main factors that impact our net sales of our subsystems and accessories are units shipped and the average selling price per unit. The prices for our server and storage systems range widely depending upon the configuration, including the number of compute nodes in a server system as well as the level of integration of key components such as SSDs and memory. The prices for our subsystems and accessories can also vary widely based on whether a customer is purchasing power supplies, server boards, chassis or other accessories.
A compute node is an independent hardware configuration within a server system capable of having its own CPU, memory and storage and that is capable of running its own instance of a non-virtualized operating system. The number of compute nodes sold, which can vary by product, is an important metric we use to track our business. Measuring volume using compute nodes enables more consistent measurement across different server form factors and across different vendors. As with most electronics-based product life cycles, average selling prices typically are highest at the time of introduction of new products that utilize the latest technology and tend to decrease over time as such products mature in the market and are replaced by next generation products. Additionally, in order to remain competitive throughout all industry cycles, we actively change our selling price per unit in response to changes in costs for key components such as memory and SSDs.
The following table presents net sales by product type for the three months ended September 30, 2020 and 2019 (dollars in millions):
| Three Months Ended September 30, | Change | ||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||||||||||||||||||||||||||||||||
| Server and storage systems | $ | 617.8 | $ | 636.0 | $ | (18.2) | (2.9) | % | |||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 81.0 | % | 79.5 | % | |||||||||||||||||||||||||||||||||||||||||||
| Subsystems and accessories | $ | 144.5 | $ | 163.8 | $ | (19.3) | (11.8) | % | |||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 19.0 | % | 20.5 | % | |||||||||||||||||||||||||||||||||||||||||||
| Total net sales | $ | 762.3 | $ | 799.8 | $ | (37.5) | (4.7) | % | |||||||||||||||||||||||||||||||||||||||
31
Server and storage systems constitute an assembly and integration of subsystems and accessories, and related services. Subsystems and accessories are comprised of server-boards, chassis and accessories.
The period-over-period decrease in net sales of our server and storage systems was due to a 19.1% decrease in the number of units of compute nodes sold offset by 20.0% increase in average selling price. The decline in the number of units of compute nodes shipped was primarily due to fewer shipments of multimode systems compared to the same period last year.
The period-over-period decrease in net sales of our subsystems and accessories is primarily due to a decrease in the volume of subsystems and accessories units sold by approximately 24.4% which was offset by an approximately 16.7% increase in the average selling price.
The following table presents net sales by geographic region for the three months ended September 30, 2020 and 2019 (dollars in millions):
| Three Months Ended September 30, | Change | Change | |||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||||||||||||||||||||||||||||||||
| United states | $ | 496.1 | $ | 468.8 | $ | 27.3 | 5.8 | % | |||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 65.1 | % | 58.6 | % | |||||||||||||||||||||||||||||||||||||||||||
| Europe | 112.1 | 128.1 | (16.0) | (12.5) | % | ||||||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 14.7 | % | 16.0 | % | |||||||||||||||||||||||||||||||||||||||||||
| Asia | 126.7 | 161.6 | (34.9) | (21.6) | % | ||||||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 16.6 | % | 20.2 | % | |||||||||||||||||||||||||||||||||||||||||||
| Others | 27.4 | 41.3 | (13.9) | (33.7) | % | ||||||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 3.6 | % | 5.2 | % | |||||||||||||||||||||||||||||||||||||||||||
| Total net sales | $ | 762.3 | $ | 799.8 | |||||||||||||||||||||||||||||||||||||||||||
The period-over-period increase in net sales in the United States for the three months ended September 30, 2020 and 2019 was primarily due to higher sales from the expansion of our customer base. The period-over-period decrease in net sales in Asia was due primarily to decreased sales in China, Japan and Korea and partially off-set by increased sales in Singapore and Taiwan. The decrease of net sales in Europe was primarily due to lower sales in the United Kingdom, Germany, Russia, and the rest of other Europe, partially offset by increased sales in France and the Netherlands.
Cost of Sales and Gross Margin
Cost of sales primarily consists of the costs to manufacture our products, including the costs of materials, contract manufacturing, shipping, personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, equipment and facility expenses, warranty costs and inventory excess and obsolescence provisions. The primary factors that impact our cost of sales are the mix of products sold and cost of materials, which include purchased parts, shipping costs, salary and benefits and overhead costs related to production. Cost of sales as a percentage of net sales may increase over time if decreases in average selling prices are not offset by corresponding decreases in our costs. Our cost of sales as a percentage of net sales is also impacted by the extent to which we are able to efficiently utilize our expanding manufacturing capacity. Because we generally do not have long-term fixed supply agreements, our cost of sales is subject to change based on the cost of materials and market conditions. As a result, our cost of sales as a percentage of net sales in any period can increase due to significant component price increases resulting from component shortages.
We use several suppliers and contract manufacturers to design and manufacture subsystems in accordance with our specifications, with final assembly and testing predominantly performed at our manufacturing facilities in the same region where our products are sold. We work with Ablecom, one of our key contract manufacturers and also a related party to optimize modular designs for our chassis and certain of other components. We also outsource to Compuware, also a related party, a portion of our design activities and a significant part of our manufacturing of components, particularly power supplies.
Cost of sales and gross margin for the three months ended September 30, 2020 and 2019 are as follows (dollars in millions):
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| Three Months Ended September 30, | Change | ||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||||||||||||||||||||||||||||||||
| Cost of sales | $ | 632.3 | $ | 668.9 | $ | (36.6) | (5.5) | % | |||||||||||||||||||||||||||||||||||||||
| Gross profit | $ | 129.9 | $ | 130.9 | $ | (1.0) | (0.8) | % | |||||||||||||||||||||||||||||||||||||||
| Gross margin | 17.0 | % | 16.4 | % | 0.6 | % | |||||||||||||||||||||||||||||||||||||||||
The period-over-period decrease in cost of sales was primarily attributed to a decrease of $17.2 million in costs of materials and contract manufacturing expenses primarily related to the decrease in net sales volume, a decrease of $10.3 million in overhead costs attributable primarily to a recovery of costs paid in prior periods and a decrease of excess and obsolete inventory charge of $9.1 million.
The period-over-period increase in the gross margin percentage was primarily due to sales prices declining at a slower rate than the decline in the costs of components we purchased.
Operating Expenses
Research and development expenses consist of personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our research and development personnel, as well as product development costs such as materials and supplies, consulting services, third-party testing services and equipment and facility expenses related to our research and development activities. All research and development costs are expensed as incurred. We occasionally receive non-recurring engineering funding from certain suppliers and customers for joint development. Under these arrangements, we are reimbursed for certain research and development costs that we incur as part of the joint development efforts with our suppliers and customers. These amounts offset a portion of the related research and development expenses and have the effect of reducing our reported research and development expenses.
Sales and marketing expenses consist primarily of personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our sales and marketing personnel, costs for trade-shows, independent sales representative fees and marketing programs. From time to time, we receive cooperative marketing funding from certain suppliers. Under these arrangements, we are reimbursed for certain marketing costs that we incur as part of the joint promotion of our products and those of our suppliers. These amounts offset a portion of the related expenses and have the effect of reducing our reported sales and marketing expenses. The timing, magnitude and estimated usage of these programs can result in significant variations in reported sales and marketing expenses from period to period. Spending on cooperative marketing, reimbursed by our suppliers, typically increases in connection with new product releases by our suppliers.
General and administrative expenses consist primarily of general corporate costs, including personnel expenses such as salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our general and administrative personnel, financial reporting, information technology, corporate governance and compliance, outside legal, audit, tax fees, insurance and bad debt reserves on accounts receivable.
Operating expenses for the three months ended September 30, 2020 and 2019 are as follows (dollars in millions):
| Three Months Ended September 30, | Change | ||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||||||||||||||||||||||||||||||||
| Research and development | $ | 54.8 | $ | 49.6 | $ | 5.2 | 10.5 | % | |||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 7.2 | % | 6.2 | % | |||||||||||||||||||||||||||||||||||||||||||
| Sales and marketing | $ | 20.3 | $ | 20.2 | $ | 0.1 | 0.5 | % | |||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 2.7 | % | 2.5 | % | |||||||||||||||||||||||||||||||||||||||||||
| General and administrative | $ | 24.4 | $ | 28.3 | $ | (3.9) | (13.8) | % | |||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 3.2 | % | 3.6 | % | |||||||||||||||||||||||||||||||||||||||||||
| Total operating expenses | $ | 99.5 | $ | 98.1 | $ | 1.4 | 1.4 | % | |||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 13.0 | % | 12.3 | % | |||||||||||||||||||||||||||||||||||||||||||
Research and development expenses. The period-over-period increase in research and development expenses was primarily due to an increase of $5.7 million in personnel expenses as a result of an increase in the number of personnel and an
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increase of $1.2 million in costs mainly related to materials, supplies and equipment used in product development offset by an increase of $1.3 million research and development credits from certain suppliers and customers towards our development efforts.
Sales and marketing expenses. The period-over-period sales and marketing expenses for the three months ended September 30, 2020 remained flat as compared to the three months ended September 30, 2019.
General and administrative expenses. The period-over-period decrease in general and administrative expenses was primarily due to decrease of $6.7 million in professional fees incurred to investigate, assess and remediate the causes that led to the delay in filing our periodic reports with the SEC and the associated restatement of certain of our previously issued financial statements and a decrease of $1.0 million in other general and administrative expenses, offset by an increase of $3.7 million in compensation expense due to increased full time personnel and bonuses.
Interest and Other (Expense) Income, Net
Other (expense) income, net consists primarily of interest earned on our investment and cash balances and foreign exchange gains and losses.
Interest expense represents interest expense on our term loans and lines of credit.
Interest and other (expense) income, net for the three months ended September 30, 2020 and 2019 are as follows (dollars in millions):
| Three Months Ended September 30, | Change | ||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||||||||||||||||||||||||||||||||
| Other (expense) income, net | $ | (0.8) | $ | 1.6 | $ | (2.4) | (150.0) | % | |||||||||||||||||||||||||||||||||||||||
| Interest expense | (0.7) | (0.6) | (0.1) | 16.7 | % | ||||||||||||||||||||||||||||||||||||||||||
| Interest and other (expense) income, net | $ | (1.5) | $ | 1.0 | $ | (2.5) | (250.0) | % | |||||||||||||||||||||||||||||||||||||||
The change of $2.4 million in other (expense) income, net was attributable to a decrease of $1.0 million in interest income on our interest bearing deposits and a $1.5 million foreign exchange loss. The period-over-period change in interest expense was due to an increase of $0.1 million in interest expense primarily as a result of increased interest rates on our loans in the three months ended September 30, 2020 as compared to the three months ended September 30, 2019.
Provision for Income Taxes
Our income tax provision is based on our taxable income generated in the jurisdictions in which we operate, which primarily include the United States, Taiwan, and the Netherlands. Our effective tax rate differs from the statutory rate primarily due to research and development tax credits, releases from uncertain tax positions, tax benefits from foreign derived intangible income and stock based compensation.
Provision for income taxes and effective tax rates for the three months ended September 30, 2020 and 2019 are as follows (dollars in millions):
| Three Months Ended September 30, | Change | ||||||||||||||||||||||||||||||||||||||||||||||
| 2020 | 2019 | $ | % | ||||||||||||||||||||||||||||||||||||||||||||
| Income tax provision | $ | 3.7 | $ | 8.6 | $ | (4.9) | (57.0) | % | |||||||||||||||||||||||||||||||||||||||
| Percentage of total net sales | 0.5 | % | 1.1 | % | |||||||||||||||||||||||||||||||||||||||||||
| Effective tax rate | 12.7 | % | 25.3 | % | |||||||||||||||||||||||||||||||||||||||||||
The income tax provision and effective tax rate change for the three months ended September 30, 2020 was primarily due to decrease in tax reserves for uncertain tax positions after settlement of certain tax audits and increase in tax benefit from employees’ stock based compensation.
Liquidity and Capital Resources
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We have financed our growth primarily with funds generated from operations, in addition to utilizing borrowing facilities, particularly in relation to the financing of real property acquisitions as well as working capital. Our cash and cash equivalents were $300.1 million and $210.5 million as of September 30, 2020 and June 30, 2020, respectively. Our cash in foreign locations was $87.7 million and $98.0 million as of September 30, 2020 and June 30, 2020, respectively.
Amounts held outside of the U.S. are generally utilized to support non-U.S. liquidity needs. Repatriations generally will not be taxable from a U.S. federal tax perspective but may be subject to state income or foreign withholding tax. Where local restrictions prevent an efficient intercompany transfer of funds, our intent is to keep cash balances outside of the U.S. and to meet liquidity needs through operating cash flows, external borrowings, or both. We do not expect restrictions or potential taxes incurred on repatriation of amounts held outside of the U.S. to have a material effect on our overall liquidity, financial condition or results of operations.
We believe that our current cash, cash equivalents, borrowing capacity available from our credit facilities and internally generated cash flows will be sufficient to support our operating businesses, continued remediation of the material weakness in the financial reporting, and maturing debt and interest payments for the twelve months following the issuance of these consolidated financial statements. We expect to pay special performance bonuses of approximately $8.6 million to our CEO and certain members of the Board of Directors within the next two years when and if specified market and performance conditions are met. In addition, we made a settlement payment of $17.5 million to the SEC in connection with the conclusion of the investigations in August 2020.
On October 31, 2020, our Board of Directors approved a share repurchase program to repurchase shares of our common stock for up to $50 million at prevailing prices in the open market. The share repurchase program is effective until October 31, 2021 or until the maximum amount of common stock is repurchased, whichever occurs first.
Our key cash flow metrics were as follows (dollars in millions):
| Three Months Ended September 30, | Change | |||||||||||||||||||||||||
| 2020 | 2019 | |||||||||||||||||||||||||
| Net cash provided by operating activities | $ | 120.6 | $ | 5.6 | $ | 115.0 | ||||||||||||||||||||
| Net cash used in investing activities | $ | (11.9) | $ | (13.3) | $ | 1.4 | ||||||||||||||||||||
| Net cash used in financing activities | $ | (19.3) | $ | (1.7) | $ | (17.6) | ||||||||||||||||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | $ | 89.6 | $ | (9.5) | $ | 99.1 | ||||||||||||||||||||
Operating Activities
Net cash provided by operating activities increased by $115.0 million for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019. The increase was due primarily to an increase of cash provided by net working capital of $121.2 million driven by decreased accounts receivable as a result of increased collections, utilization of inventories and prepaid expenses and other current assets. Non-cash charges related to depreciation and amortization expense, stock-based compensation expense and unrealized losses on our foreign currency-denominated credit facilities increased $4.0 million. These increases were offset by a decrease of $9.2 million in the non-cash charges related to excess and obsolete inventories.
Investing Activities
Net cash used in investing activities was $11.9 million and $13.3 million for the three months ended September 30, 2020 and 2019, respectively, as we continued to invest in expanding our manufacturing capacity and office space, including the expansion of our Green Computing Park in San Jose and Bade manufacturing facility in Taiwan.
Financing Activities
Net cash used by financing activities for the three months ended September 30, 2020 was $19.3 million while net cash used in financing activities for the three months ended September 30, 2019 was $1.7 million. The change in cash flows from financing activities was primarily due to stock repurchases of $28.5 million offset by cash received from the exercise of stock options of $5.0 million net of taxes and $6.4 million of debt proceeds from draws on our CTBC credit and term loan facilities.
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Other Factors Affecting Liquidity and Capital Resources
2018 Bank of America Credit Facility
In April 2018, as amended in January and June 2019, we entered into a revolving line of credit with Bank of America (the "2018 Bank of America Credit Facility") for up to $250.0 million. In May 2020, we entered into a third amendment to extend the maturity from June 30, 2020 to June 30, 2021, release the real property as a collateral, modify certain payments and covenants provisions, specify that LIBOR cannot be less than 1% for purposes of determining interest rates, and increase the unused line fee from 0.25% per annum to 0.375% per annum. Interest shall accrue at LIBOR plus 2.00% on outstanding borrowings less than $125.0 million and LIBOR plus 2.25% on outstanding borrowings in excess of $125.0 million. As of September 30, 2020, we had no outstanding borrowings and we had a $6.4 million letter of credit outstanding under this facility. Our available borrowing capacity was $243.6 million, subject to the borrowing base limitation and compliance with other applicable terms. In the event of default or if outstanding borrowings are in excess of $220.0 million, we are required to grant the lenders a continuing security interest in and lien upon all amounts credited to any of our deposit accounts. Interest accrued on any loans under the 2018 Bank of America Credit Facility is due on the first day of each month, and the loans are due and payable in full on the termination date of the 2018 Bank of America Credit Facility. Voluntary prepayments are permitted without early repayment fees or penalties. The 2018 Bank of America Credit Facility is secured by substantially all of Super Micro Computer’s assets, other than real property assets. In addition, we are not permitted to pay any dividends. Under the terms of the 2018 Bank of America Credit Facility agreement, we are required to maintain a certain fixed charge ratio and we have been in compliance with all covenants under the 2018 Bank of America Credit Facility.
CTBC Bank
2020 CTBC Credit Facility
In August 2020, we entered into a credit agreement with CTBC Bank in Taiwan that provides for term loans of up to $50.0 million (the "2020 CTBC Credit Facility") and expires in August 2021. During the three months ended September 30, 2020, we have not borrowed or repaid under the revolving line of credit. There were no outstanding borrowings under the 2020 CTBC Credit Facility revolving line of credit as of September 30, 2020. The total outstanding borrowings under the 2020 CTBC Credit Facility term loan were denominated in NTD and remeasured into U.S. dollars of $24.0 million at September 30, 2020. The amount available for future borrowing was $26.3 million as of September 30, 2020. The interest rate for these outstanding term loans was 0.73% per annum as of September 30, 2020. Term loans are secured by certain of our assets, including certain property, plant, and equipment. There are no financial covenants under the 2020 CTBC Credit Facility.
2020 CTBC Term Loan Facility
In May 2020, we entered into a ten-year, non-revolving term loan facility (the “2020 CTBC Term Loan Facility”) to obtain up to NTD 1.2 billion ($40.7 million in U.S. dollar equivalents) in financing for use in the expansion and renovation of our Bade Manufacturing Facility located in Taiwan. Draw downs on the 2020 CTBC Term Loan Facility are based on 80% of balances owed on commercial invoices from the contractor and are drawn according to the progress of the renovations. Borrowings under the 2020 CTBC Term Loan Facility are available through June 2022. We are required to pay against total outstanding principal and interest in equal monthly installments starting June 2023 and continuing through the maturity date of June 2030. The 2020 CTBC Term Loan Facility is secured by the Bade Manufacturing Facility, including any expansion. Fees paid to the lender as debt issuance costs were immaterial. We borrowed $6.3 million in the three months ended September 30, 2020 with a rate of 0.45% per annum. As of September 30, 2020, the amount outstanding under the 2020 CTBC Term Loan Facility was $12.0 million and the net book value of the property serving as collateral was $17.1 million. We have financial covenants requiring our current ratio, debt service coverage ratio, and financial debt ratio, to be maintained at certain levels. We have been in compliance with all financial covenants under the 2020 CTBC Term Loan Facility.
Refer to Part I, Item 1, Note 6, “Short-term and Long-term Debt,” in our notes to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q for further information on our outstanding debt.
Recent Accounting Pronouncements
For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our condensed consolidated financial statements, see Part I, Item 1, Note 1, “Summary of Significant Accounting Policies,” in our notes to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q.
Off-Balance Sheet Arrangements
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We do not have any off-balance sheet arrangements.
37
Item 3. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
The primary objectives of our investment activities are to preserve principal, provide liquidity and maximize income without significantly increasing the risk. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the fair value of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in money market funds and certificates of deposit. Our investment in an auction rate security has been classified as non-current due to the lack of a liquid market for these securities. Since our results of operations are not dependent on investments, the risk associated with fluctuating interest rates is limited to our investment portfolio, and we believe that a 10% change in interest rates would not have a significant impact on our results of operations. As of September 30, 2020, our investments were in money market funds, certificates of deposits and auction rate securities.
We are exposed to changes in interest rates as a result of our borrowings under our term loans and revolving lines of credit. The interest rates for the term loans and the revolving lines of credit ranged from 0.45% to 3.00% at September 30, 2020 and June 30, 2020. Based on the outstanding principal indebtedness of $36.0 million under our credit facilities as of September 30, 2020, we believe that a 10% change in interest rates would not have a significant impact on our results of operations.
Foreign Currency Risk
To date, our international customer and supplier agreements have been denominated primarily in U.S. dollars and accordingly, we have limited exposure to foreign currency exchange rate fluctuations from customer agreements, and do not currently engage in foreign currency hedging transactions. The functional currency of our subsidiaries in the Netherlands and Taiwan is the U.S. dollar. However, certain transactions in these entities are denominated in a currency other than the U.S. dollar, and thus we are subject to foreign currency exchange rate fluctuations associated with re-measurement to U.S. dollars. Such fluctuations have not been significant historically. Foreign exchange (loss) gain for the three months ended September 30, 2020 and 2019 was $(0.9) million and $0.5 million, respectively.
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Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Under the supervision, and with the participation, of our current management, including our Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO"), we evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of September 30, 2020. Based on this evaluation of our disclosure controls and procedures, our CEO and CFO have concluded that our disclosure controls and procedures were not effective as of September 30, 2020 because of a material weakness in our internal control over financial reporting, as further described below.
Notwithstanding the conclusion by our CEO and CFO that our disclosure controls and procedures as of September 30, 2020 were not effective, and notwithstanding the material weakness in our internal control over financial reporting described below, management believes that the condensed consolidated financial statements and related financial information included in this Quarterly Report fairly present in all material respects our financial condition, results of operations and cash flows as of the dates presented, and for the periods ended on such dates, in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”).
Remediation Plans & Status
As discussed in Part II, Item 9A, "Controls and Procedures," of our 2020 10-K, we have undertaken remedial procedures to address the IT General Control (ITGC) material weakness in our internal control over financial reporting. During the quarter ended September 30, 2020, management re-designed processes and controls related to IT privileged access for our primary accounting system and boundary systems, yet not all anticipated re-designed processes and controls have been implemented during this quarter. While some testing of the re-designed IT privileged access controls was conducted during the quarter ended September 30, 2020, assessing the effectiveness of internal control requires a period of repeatable execution. The re-designed control activities have not been either implemented or in place for a sufficient period of time for management to determine operating effectiveness. The remediation of this material weakness will depend on management’s ability to ensure properly designed ITGC’s are operating effectively as of June 30, 2021.
Changes in Internal Control over Financial Reporting
Under applicable SEC rules (Exchange Act Rules 13a-15(d) and 15d-15(d)), management is required to evaluate, with the participation of our CEO and CFO, any changes in internal control over financial reporting that occurred during each fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Other than the remediation actions described above, there were no changes in our internal control over financial reporting during the quarter ended September 30, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Inherent Limitations on Effectiveness of Controls
The effectiveness of any system of internal control over financial reporting is subject to inherent limitations, including the exercise of judgment in designing, implementing, operating, and evaluating the controls and procedures, and the inability to eliminate misconduct completely. Accordingly, any system of internal control over financial reporting can only provide reasonable, not absolute, assurances that its objectives will be met. In addition, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. We intend to continue to monitor and upgrade our internal controls as necessary or appropriate for our business, but we cannot assure that such improvements will be sufficient to provide us with effective internal control over financial reporting.
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PART II: OTHER INFORMATION
Item 1. Legal Proceedings
The information required by this item is incorporated herein by reference to the information set forth under the caption “Litigation and Claims” in Note 11 “Commitments and Contingencies” and under Note 13 "Subsequent Events" of the Notes to the Consolidated Financial Statements included in this quarterly report.
Due to the inherent uncertainties of such legal proceedings, we cannot predict the outcome of the proceedings at this time, and we can give no assurance that they will not have a material adverse effect on our financial position or results of operations.
Item 1A. Risk Factors
Important risk factors that could affect our operations and financial performance, or that could cause results or events to differ from current expectations, are described in Part I, Item 1A “Risk Factors” of our 2020 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Recent Sales of Unregistered Securities
None.
Issuer Purchases of Equity Securities
During the three months ended September 30, 2020, we repurchased the following shares of our common stock:
| Period | Total Number of Shares Purchased(1) | Average Price Paid per Share(1) | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(2) | Approximate Dollar Value of Shares that May Yet Be Purchased under the Plans or Programs(2) | |||||||||||||||||||
Month 1 (July 1, 2020 to July 31, 2020) | — | $ | — | — | $ | — | |||||||||||||||||
Month 2 (August 1, 2020 to August 31, 2020) | 486,156 | $ | 26.73 | 420,000 | $ | 18,930,102 | |||||||||||||||||
Month 3 (September 1, 2020 to September 30, 2020) | 725,269 | $ | 26.21 | 722,294 | $ | — | |||||||||||||||||
| Total | 1,211,425 | $ | 26.42 | 1,142,294 | |||||||||||||||||||
__________________________
(1)Includes shares withheld from delivery to satisfy tax withholding obligations of recipients that occur upon the vesting of restricted stock units granted under our equity incentive plans.
(2)On August 9, 2020, our Board of Directors approved a share repurchase program to repurchase shares of common stock for up to an aggregate of $30.0 million at prevailing prices in the open market, with such program effective until December 31, 2020 or, if earlier, until the maximum amount of common stock is repurchased. During the three months ended September 30, 2020, we repurchased 1,142,294 shares of our common stock in open market transactions under the share repurchase program. Such shares repurchased during the quarter were recorded as a $30.0 million reduction to stockholders' equity. As of September 30, 2020, the maximum amount authorized under the share repurchase program had been utilized.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None.
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Item 6. Exhibits
(a) Exhibits.
| Exhibit Number | Description | |||||||
| 31.1 | ||||||||
| 31.2 | ||||||||
| 32.1 | ||||||||
| 32.2 | ||||||||
| 101.INS | XBRL Instance Document | |||||||
| 101.SCH | XBRL Taxonomy Extension Schema Document | |||||||
| 101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document | |||||||
| 101.DEF | XBRL Taxonomy Extension Definition Linkbase Document | |||||||
| 101.LAB | XBRL Taxonomy Extension Label Linkbase Document | |||||||
| 101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document | |||||||
| 104 | The cover page from this Quarterly Report on Form 10-Q, formatted in Inline XBRL. | |||||||
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
SUPER MICRO COMPUTER, INC.
| Date: | November 6, 2020 | /s/ CHARLES LIANG | |||||||||
| Charles Liang President, Chief Executive Officer and Chairman of the Board (Principal Executive Officer) | |||||||||||
| Date: | November 6, 2020 | /s/ KEVIN BAUER | |||||||||
| Kevin Bauer Senior Vice President, Chief Financial Officer (Principal Financial and Accounting Officer) | |||||||||||