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Super Micro Computer, Inc. (NASDAQ:SMCI)

F2Q2013 Results Earnings Call

January 22, 2013 5:00 PM ET

Executives

Charles Liang - Chairman and CEO

Howard Hideshima - Chief Financial Officer

Perry Hayes - Senior Vice President, Investor Relations

Analysts

Aaron Rakers - Stifel Nicolaus

Mark Kelleher - Dougherty & Company

Glenn Hanus - Needham

Alex Kurtz - Sterne, Agee

Jeff Andry - Wunderlich Securities

Operator

Please standby. Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Super Micro Computer Incorporated Second Quarter Fiscal 2013 Conference Call. The company’s news release issued earlier today is available from its website at www.supermicro.com.

In addition, during today’s call the company will refer to a slide presentation that it has made available to participants, which can be accessed in a downloadable PDF format on its website at www.supermicro.com in the Investor Relations section under the Events & Presentations tab.

During the company’s presentation all participants will be in a listen-only mode. Afterwards securities, analysts and institutional portfolio managers will be invited to participate in a question-and-answer-session. But the entire call is open to all participants in a listen-only basis.

As a reminder, this call is being recorded, Tuesday, January 22, 2013. A replay of the call will be accessible until midnight, February 5th, by dialing 1-877-870-5176 and entering conference ID number 3074743. International callers should dial 1-858-384-5517.

With us today are Charles Liang, Chairman and Chief Executive Officer; Howard Hideshima, Chief Financial Officer; and Perry Hayes, Senior Vice President, Investor Relations.

And now, I’d like to turn the conference over to Mr. Hayes. Mr. Hayes, please go ahead, sir.

Perry Hayes

Good afternoon. And thank you for attending Super Micro’s conference call on financial results for the second quarter fiscal year 2013, which ended December 31, 2012.

Before we begin, I’d like to advise you of upcoming investor conferences in which Super Micro will be participating. On February 6th, we will present at the Stifel Nicolaus 2013 Technology Conference in San Francisco, where we will present and participate in one-on-one meetings.

By now you should have received a copy of today’s news release that was distributed at the close of regular trading and is available on the company’s website. As a reminder, during today’s call the company will refer to a presentation that is available to participants in the Investor Relations section of the company’s website under the Events & Presentations tab. Please turn to slide two.

Before we start, I’ll remind you that our remarks include forward-looking statements. There are a number of risk factors that could cause Super Micro’s future results to differ materially from our expectations. You can learn more about those risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2012 and our other SEC filings.

All of those documents are available from the Investor Relations page of Super Micro’s website at www.supermicro.com. We assume no obligation to update any forward-looking statements.

Most of today’s presentation will refer to non-GAAP financial results and outlooks. For an explanation of our non-GAAP financial measures, please refer to slide three of this presentation or to our press release published earlier today. In addition, a reconciliation of GAAP to non-GAAP results is contained in today’s press release and is in the supplemental information attached today’s presentation.

I’ll now turn the call over to Charles Liang, Chairman and Chief Executive Officer.

Charles Liang

Thank you, Perry, and good afternoon, everyone. Please turn to slide four. First, let me provide you with the highlights of our second quarter. We are pleased that our second quarter revenue was $291.5 million, its 7.7% higher quarter-over-quarter and 16.6% higher year-over-year.

Non-GAAP net income was $7.8 million or 156.5% higher quarter-over-quarter and 29.9% lower compared to last year. Super Micro’s non-GAAP earnings per share was $0.18 per diluted share, compared to $0.07 last quarter and $0.25 last year.

Slide five please. Revenue for the quarter was up 16.6% from last year and was a record high for Super Micro. We are pleased with this growth in sales when overall IT spending continued to be a cautious. With this performance we continue to demonstrate our ability to take market share even during uncertain economical times.

Last quarter’s margins improved quarter-over-quarter. However, we still see opportunity for further improvement. Although, our recent (inaudible) pricing change continued last quarter in hard disk drive. We saw the market for hard disk drive and memory modules stabilized for the most part.

However, because we had record high storage revenue which contained lower margin mix with hard disk drives. Our storage margins were lower than average server margins. As it turned out the overall margin for our storage solution still improved quarter-over-quarter, with the component source and price stability in place, we expect our margin performance to further improve in future quarters.

Geographically, revenue in North America was 537%, Europe was 23% and Asia was 20.7% of total sales. Asia remains our fastest growing region and our Taiwan facility continues to run steadily to meet our growth for the Asian market.

Now Asia revenue gross was 34% over last year, mostly due to high quality products produced from our state-of-the-art equipment at our facility in Taiwan. We continued to instill confidence in our customers and focus on growing our share in dynamical region where different product strategies have been employed on a country-by-country basis.

Last quarter, 45% of our business came from OEM and direct customers, of Which Internet Datacenter were 14.2% of sales. Our computer service systems contribute 43.3% of revenue, where we saw our strongest quarter-over-quarter growth among product lines such as FatTwin, MicroCloud Storage and GPU.

We had experienced a strong customer demand since the FatTwin launch. Customers prefer our efficient power consumption, storage capacity and computer intensity over a competition. The inventory turnover rate for FatTwin have been the highest due to the popularity.

On the year-over-year comparison, our storage product also shows strong growth due to the other ability of hard disk drive compared to last year. MicroCloud has grown strongly since its launch last year and had become one of the biggest product line in only one year.

Also GPU Solution continues to show solid growth along with development of new technologies. Overall, our brand reputation for innovation is greatly helping us and continues our trend of taking much share.

Let me show -- let me now update you with more details on our new and leading technologies. Slide six and seven please. Now, recently launch of FatTwin marks a big new milestone in our five-year history. It further improves system power savings up to 16% when compared with other similar platforms from major competitors, optimize for various applications with features such as 3.5 inch hard swappable hard drive per 1U or 3GPU or core processors per 1U.

More recently the Hadoop optimized the FatTwin features up to 12HS 3.5 inch hard driver in one user base designed basically for Hadoop cloud applications. FatTwin’s high efficiency, high effective shared cooling subsystem and power supply architecture allows the FatTwin to operate at a higher ambient temperatures, free air cooling environment, up to 47 degrees C, providing huge energy cost to the saving and improved TCO, total cost of ownership.

Our new MicroCloud server, 3U 12, hot pluggable nodes had been shipped in volume for customers. It’s a perfect solution for high density and power process sensitive Datacenter environment, along with our order generation, a, hot pluggable node versions that MicroCloud product family now supports the latest Intel and AMD processors. It had benefit many customers in cloud computing, web hosting and IP Datacenter segment.

Our brand new storage A47B product line, one of our big data optimized solutions introduced highly innovative way to increase system storage capacity to support up to 72 external hard swappable 3.5-inch hard drive in 4U space.

High efficiency with some design and optional battery backup power unit, the system specification is not just second to none but eject rate 20% higher in storage density compelled to competition. The product is currently in simple stage and we had received a very positive commitment from our customers.

Our HPC optimized products provide extreme performance in competition and graphic intensive applications. That is the system offering optimized to support us, that is, NVIDIA Kepler K10 and K20 GPU and Intel Xeon-Phi co-processors.

Our new high full speed product line featured in Turbo boost with optimal left hand, global packing capability is optimized for HFT, high frequency trading, high-performance EDA and high end gaming.

BBP, battery backup power module supports brand new Datacenter power supply design concepts in more than Datacenter. It can be used to depress traditional, expensive and inefficient that UPS in a way of putting high efficiency UPS into its system enclosure. It’s in unconventional and yet highly efficient and closely effective way of protecting data and operation investment.

Super Micro Datacenter Management, SDCM short way of course, including in-band and out-band BIOS firmware and software update and system monitoring utility serving several large corporate Datacenters. These software features and supportive abilities have been helping the sales of our hardware computer solutions to these direct accounts. They have also been supporting our channel partners to be more competitive by providing more computer system management solutions to their customers.

Last product, complete rack solutions include high-performance, high-density servers, high-capacity storage, high-performance switch and our Datacenter management software, both designed and supplied by Super Micro. Recently, we expand our solutions by introducing the Hadoop SuperRack for cloud computing and the GPU SuperRack for HPC applications. They are actually cost effective, flexible to scale and among half is the choice for many enterprise customers.

In summary, in second quarter, Super Micro achieved record revenue at top end of our expectations. With our strong foundation in place, we again demonstrate our ability to gain market share even during uncertain economical times. The challenge for Super Micro is to grow even stronger and faster this year and our people are excited of our opportunities.

Our brand and reputation is built on having a product line that are basically in the world in performance per watt, per dollars and per square foot. With this strong product and our dedication to build the base, we are prepared to seize the opportunities for growth and profitability.

For more specifics on the second quarter, let me turn it over to Howard.

Howard Hideshima

Thank you, Charles and good afternoon everyone. I will focus my remarks on earnings, gross margins, operating expenses and similar items on a non-GAAP basis which reflects the adjustments to exclude compensation expenses. Reconciliation of GAAP-to-non-GAAP is included in the financial statements of the company in today’s earnings release and in the supplemental detail in the slide presentation accompanying this conference call.

Let me begin with the review of the second quarter income statement. Please turn to slide eight. Revenue was the record $291.5 million, up 17% from the same quarter a year ago and up 8% sequentially. The increase in revenue from last year was primarily due to strong growth in MicroCloud, Storage and GPU.

The sequential increase in revenue from last quarter was primarily due to seasonal strength in the industry and a growth of some of our innovative product line, offset in part by concerns about our economy.

On a percentage basis, MicroCloud and Storage were the fastest growing product lines from the prior quarter. MicroCloud has been a great product for the internet Datacenter with the density and power efficiency. Storage has been away from the stabilization of hard-disk drive pricing and availability. We continue to see good ramp in the Sandy Bridge products, with an increase of 64% sequentially.

Slide nine, turning to product mix, the portion of revenues from server systems was 43.3% of total revenues, which is down from 44%, the same quarter a year ago and an increase from 39.5% last quarter. ASP for servers was $2,100 per unit, which is up from $1,800 last year and $3,000 last quarter.

We shipped approximately 60,000 servers in the second quarter and 1,086,000 subsystems and accessories. The increase in the server unit is also in part from an increase in our internet Datacenter business.

We continue to maintain a diverse revenue base with over 600 customers and none of these customers representing more than 10% of our quarterly revenues. Internet Datacenter revenue was 14.2%, which was an increase from 8.8% in the prior quarter. Further more, 53.7% of our revenues came from the U.S. and 55% from our distributors and resellers.

During the quarter, we saw strength in the U.S., which offset some of the weakness in Asia while Europe remained about the same on a percentage basis. As we ramp our Taiwan facility and leverage its cost benefits, we are confident that we can continue to expand our presence in Asia.

Slide 10 and 11, non-GAAP gross profit was $40.3 million, down 6% from $42.8 million in the same quarter last year and up 14% from $35.3 million sequentially. Our percentage basis gross margin was 15.8%, down from 17.1% a year ago and up from 13% sequentially.

Price changes from Ablecom resulted in eight basis points favorable change to gross profit in the quarter. The total purchases representing approximately 15.4% of total cost of good sold compared to 18.5% a year ago and 20.9% sequentially.

The year-over-year decrease in gross margin results from price changes in hard disk drives and memory in the current quarter compared to the prior year. December 2011 was right after the October floods in Thailand, which has caused volatility in pricing and supply of hard disk drives over the past year.

Sequentially, gross margins were up almost entirely due to the more stable pricing of hard disk drive offset impart by higher mix of storage products. In general, all other product margins remained stable.

Slide 12, operating expenses were $29.8 million, up from $26.6 million in the same quarter a year ago and down from $30.7 million sequentially. As the percentage of revenues, operating expense was 10.2% down from 10.6% year-over-year and 11.3% sequentially.

Operating expenses were higher on an absolute dollar basis year-over-year and down sequentially. We saw a year-over-year increases in absolute dollars, primarily in R&D as we invest in headcounts to drive our innovation on product portfolio especially in preparation for Romley and FatTwin launches.

Sequentially, operating expenses were down. Reductions in marketing and sales expenses associated with the write-off of marketing materials of about $590,000 in the prior quarter. General and administrative expenses were lower due to lower legal expenses and settlement of patent control case of about $700,000 in the prior quarter.

The company’s headcount increased by 34 sequentially to 1,561 total employees. We continue to control our operating expense while still making strategic investments in our product lines. Operating profit was $10.5 million or 3.6% of revenues, down from $5.7 million or $16.2 million a year ago and up by $5.9 million from $4.6 million sequentially.

Net income was $7.8 million or 2.7% of revenues, down from $3.3 million from $11.2 million a year ago and up $4.8 million from $3.1 million sequentially.

Our non-GAAP fully diluted EPS was $0.18 per share, down from $0.25 per share a year ago and up from $0.07 per share sequentially. The number of fully diluted shares used in the first quarter was 43,666,000.

The tax rate in the second quarter on a non-GAAP basis was 24.5% compared to 30.5% a year ago and 31.3% sequentially. The rate was lower due to the release of liability for Texas and contributed about $0.02 to our EPS.

We expect the effective tax rate on a non-GAAP basis to be approximately 6% for the March quarter, which is down from 26.6% in the same quarter last year. The decrease in tax rate is due to the reinstatement of the R&D tax credit which passed in January 2013. The effect was about 19% reduction to what we would expect our tax rate would be with R&D credits without catch-up for prior periods.

Turning to the balance sheet on a sequential basis, slide 13. Cash and cash equivalents and short and long-term investments were $91.1 million, up from $29.8 -- $61.3 million in the prior quarter and down $15 million from a $106.1 in the same quarter last year. In the second quarter, free cash flow was a positive $30.3 million primarily due to reduction in inventory.

Slide 14. Accounts receivable increased by $6.1 million to $118.9 million and DSOs was 37 days, which is the same as the prior quarter. Inventories decreased by $19.6 million, to $243.6 million with days in inventories decreasing by 12 days to 93 days. The decrease in inventory was primarily due to reductions of our component inventory such as memory, CPU and hard disk drive.

We continue to strengthen our infrastructure in this area to improvement our management of our inventory as well as improve our vendor relationships. Accounts payable decreased by $9.4 million, increased by $9.4 million to $149.4 million, for the days payables outstanding deceasing by eight days to 53 days primarily due to the timing of payments to vendors. Overall cash conversion cycle days were 77 days, a decrease of 4 days from 81 days in the prior quarter.

Now for a few comments on our outlook. As indicated previously, during the second quarter, we continue to see the ramp in our Sandy Bridge product as well as very good interest across our product lines. Hard disk drives have stabilized and we expect this to continue to improve.

March is typically a seasonally weak quarter for the industry, however with the growth of our FatTwin storage and MicroCloud as well as our continued ramp of Sandy Bridge, we feel some strength to offset some of the seasonal weakness. Therefore the company currently expects net sales for the quarter ending March 31, 2013 in the range of $275 million to $395 million.

Assuming this revenue range, the company expects non-GAAP earnings per diluted share of approximately $0.17 to $0.21 for the quarter. Excluding the tax benefit for the R&D credit mentioned above and using a 25% tax rate, the earnings per diluted share would be approximately $0.14 to $0.18.

It is currently expected that the outlook will not be updated until the release of the company’s next quarterly earnings announcement, notwithstanding subsequent developments however, the company may update the outlook or any portion thereof at any time.

With that, let me turn it back to Charles for some closing remarks.

Charles Liang

Thank you, Howard. Super Micro is focused on increasing market share by leveraging our strong advantage of brand recognition for basically in cards product and innovation. Our growth story remains intact. Our people are committed to succeed and our opportunities remain as great as ever.

Operator, at this time we are ready for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll go first to Aaron Rakers of Stifel Nicolaus.

Aaron Rakers - Stifel Nicolaus

Yeah. Thanks guys for taking the question. So, first, I want to make sure I heard you right, 6% tax rate in this March quarter. If you look at that over the trailing -- the apply trailing three quarters then that would be about 19%. What’s the tax rate are you assuming on the forward basis as we think about June and beyond that?

Howard Hideshima

Yeah. Aaron, this is Howard. As I mentioned, it’s not 19%, if we didn’t have the catch-up it would be about the 19% difference, so assumably we’ve about 25%...

Aaron Rakers - Stifel Nicolaus

25% of the rate, okay.

Howard Hideshima

…rate, yeah.

Aaron Rakers - Stifel Nicolaus

And so underneath of that one, when we look at, assuming that you continued to maintain your OpEx discipline that you’ve been doing, are you assuming what looks to be like a 14.5% gross margin? And I think, if that’s true, how are we to think about, what’s been talked about as being a 350 basis points overhang from the hard disk drive and memory pricing, that seems to be lifting here, when you recapture or rather when you get backup into that 16% gross margin range?

Howard Hideshima

Yeah. Aaron, this is Howard. I’d like to say, we’re still working our way. We still believe that there is more to be had there as you back in time. Again, we’re not all the way there yet. We -- the majority of this quarter’s margin improvement was from the hard disk drive. We see that continue to stabilize and hopefully that will continue to improve. So an opportunity is there for us to increase.

Along with that for this quarter, again this is a fairly soft quarter from a seasonal basis. So if you look back historically you’ll see that there has been pressure in our margins between December and March, so we’ve put in some of that into our forecast for this quarter.

Aaron Rakers - Stifel Nicolaus

So taken that what you just said the 80 basis points sequential improvement is pretty much all hard disk drive related, was there no benefit that we saw from the mix shift between the segments?

Howard Hideshima

Well, I think you saw, the mix shift primarily come, as we mentioned, some of that was in storage, which typically has a high content of hard disk drives. In addition to that we are Internet Datacenter which is usually the most competitive area of the business was also up in the quarter.

Aaron Rakers - Stifel Nicolaus

Okay. Final question and I’ll exit the floor, Taiwanese facility, what’s the utilization rate right now.

Charles Liang

Yeah. I mean, our Taiwan facility continue in improving mode. So we had much stronger sales team, supporting team there now and we see that improving trend is there. So it will be quarter-by-quarter getting better.

Operator

And next up from Dougherty & Company, Mark Kelleher.

Mark Kelleher - Dougherty & Company

Great. Thanks for taking the question. Just have a few numbers questions. The -- could you give out the storage as percent of revenue?

Howard Hideshima

No. We can’t Mark. It’s still less than 10% of our revenues.

Mark Kelleher - Dougherty & Company

Okay. And of the server sales, sorry, there is something going on on the line…

Howard Hideshima

Okay.

Mark Kelleher - Dougherty & Company

Yeah. I’m still here. Sandy Bridge as a percent of the server sales?

Howard Hideshima

As a percent of our overall sales we’re probably at about 27% overall.

Mark Kelleher - Dougherty & Company

Okay.

Howard Hideshima

Overall revenue.

Mark Kelleher - Dougherty & Company

Okay. Can you give that in server sales or is that too fine?

Howard Hideshima

We -- no, we haven’t broken it out separately. We gave out previously about what it would be in total.

Mark Kelleher - Dougherty & Company

All right. And free cash flow in the quarter?

Howard Hideshima

Free cash flow in the quarter was 30…

Mark Kelleher - Dougherty & Company

$30 million.

Howard Hideshima

… yeah, $30, I think it was $30.3 million.

Mark Kelleher - Dougherty & Company

Okay. That’s all I got. Thanks.

Howard Hideshima

Yeah.

Operator

And moving on to Glenn Hanus of Needham

Glenn Hanus - Needham

Good afternoon, guys. Well, could you start kind of high level a little bit on the demand environment you feel you’re seeing now U.S., EMEA, APAC. You mentioned, APAC being a little soft this quarter. Can you give some more color around the demand environment you’re seeing for the March quarter and June?

Charles Liang

We still believe our Asia market, we are picking up stably, I mean, in March and June, because now our facility is there and our sales team, support team have been much stronger than before. So we have a pretty strong confidence there.

Glenn Hanus - Needham

How is the U.S. market looking?

Charles Liang

USA market I believe we are improving as well, especially we start to spend more in East Coast and kind of Texas, Chicago area. So we feel at this -- in those new territories we will have a stable again.

Glenn Hanus - Needham

And Europe?

Charles Liang

Europe kind of also consistently growing, we have facility there for system integration and supporting function since about two years ago now. So facility has been very mature and people have been well-trained. So I believe we’ll be continue stably growing in Europe as well.

Glenn Hanus - Needham

And then in terms of your overall financial model of getting to 19% gross margin, 9% operating margin a low end to the range, I think you’ve talked about -- around the end of the year you talked about a one year timeframe to get to that? How are you feeling now about? It’s sound like a pretty aggressive goal but how are you feeling about those numbers for, by the end of 2013?

Howard Hideshima

Yeah. Glenn, we still have lots of opportunities as we talked about before to do that. We’ve looked at basically increasing our scale, obviously stabilization of hard disk drives, Taiwan facility, increasing our content of software and services as part of it. However, we probably will look at with some of this maybe pushing out a quarter, so we’ve said before that’s been calendar end of year we may push out a quarter.

Glenn Hanus - Needham

Okay. Just moving on to the operating expenses a little bit, could you go through some, again, some of the, you mentioned a write-off in the lower legal expenses, could you just kind of go through the OpEx and it seem to come down quite a bit sequentially and then for the March quarter, how should we think about OpEx?

Howard Hideshima

Yeah. We had some unusual items, I think if you want to call those in the September period with regards to product promotions as we launched the FatTwin and Sandy Bridge and what have you, those didn’t reoccur in the December quarter.

We’ll probably have a little bit more expenses with regards to [CBID] and some trade shows that we’ll have during the March quarter here. However, in general, we’ll still keep a tight handle on our op expenses, so we won’t see a large increase in there.

Charles Liang

Yeah. Especially last two and half years, we have almost, I believe growth 60% of our engineering headcount, so now people are watching and we try not to hire too many people in the coming quarters.

Glenn Hanus - Needham

Okay. And on the storage side, could you give a little more color like what vertical perhaps that you are seeing traction on the storage side and how your kind of positioning and differentiating on the storage side where you really getting some interaction? Thank you.

Charles Liang

Cloud and Cloud application and Big Data, especially recently we just announced our Big Data optimizing system the 4U storage with 72 hard drive, all had swappable silicon range supported, that kind of density for sure basically in the world and I would say at least 20% higher density than any competitor.

So those strong products now which we have grow our market share in storage, including effecting 1U (inaudible) hard drive also not competition in the market. So we have a very strong confidence on storages.

Glenn Hanus - Needham

Thank you.

Charles Liang

Thank you.

Operator

And we’ll move next to Alex Kurtz of Sterne, Agee.

Alex Kurtz - Sterne, Agee

Yeah. Thanks for taking the question guys. Just a couple of clarifications, Howard, just when you were talking Aaron, you said 6% non-GAAP for tax rate for this quarter -- for March quarter?

Howard Hideshima

That is correct.

Alex Kurtz - Sterne, Agee

And then roughly 25% sort of go-forward type of framework around tax rate?

Howard Hideshima

Yeah. Take that for the fiscal year for sure, for this fiscal year, we’ll have to review next, but for this fiscal year its looks better that way with R&D credit we have stated.

Alex Kurtz - Sterne, Agee

You see I think the out year to be higher than that or too hard to tell at this point?

Howard Hideshima

Look, it will be a little bit hard to tell at this point, again tax credits only be extended for two years, which means it’s only half of our fiscal year, so we still need to do more work in that area.

Alex Kurtz - Sterne, Agee

Okay. In your presentation, Howard, I missed the number of components, can you reiterate that?

Howard Hideshima

Sure. $1,086,000 subsystems and accessories...

Alex Kurtz - Sterne, Agee

$1 million, okay. Howard, could you just take us through the last year, about all the different, there is no lot of moving pieces on the gross margin, obviously and it will be helpful if you could just recant where the major headwinds have been and I -- and sort of maybe categorized them by weighing them on things -- certain things being bigger than others. I known, obviously, this quarter having the big Internet Datacentre was really -- was probably a headwind, but if you can sort of help us around the impact versus last year that would be great?

Howard Hideshima

Yeah. So, I mean, I guess, if you want to look back during the last year, I think the biggest think we can talk about and those people who understood is basically the hard disk drives and memory have been the largest impact to our gross margin over the past year.

And this past quarter we did start seeing stabilization of that and that’s where we saw some of the recapturing of our -- of gross margin, probably low point in the last the September quarter. And as that continues to stabilize further as we go forward, I think we believe we’ll see additional benefits coming from there. With regards to the…

Alex Kurtz - Sterne, Agee

Yeah.

Howard Hideshima

I’m sorry…

Alex Kurtz - Sterne, Agee

No. Go ahead.

Howard Hideshima

The Internet Datacentre was higher, this period of time it was about 14.8% I think and that’s comparable to about 8% in the prior year. So, again, as you know that is probably the most competitive area in our midst just that we participated, so again, it puts a little pressure on our margins. And then historic -- go ahead.

Alex Kurtz - Sterne, Agee

Yeah. So, just last for me, Howard, getting back to Glenn’s question about getting back to that 17% or 18%, is that still in the cards, is all of that just coming back from the hard disk drive and memory component issues, or there other things have to go right to get back to say 17% just as a bogey?

Charles Liang

Yeah. The question is that, I mean, like what we share, I think, many years ago. We had spend lots of effort in switch especially Datacenter optimizing switch and software -- management software, as well as customer service.

So these are the three areas, I mean, we will have a much higher margin and we have been investing in this area for many years and we start to have some income from three areas, switch, software and service.

Alex Kurtz - Sterne, Agee

So, were you saying, Charles, is that, you think product mix along with the HDD market coming back is going to help you get back to say 17% range?

Charles Liang

Yeah. Kind of switch, yeah, every switch vendor has much bigger margin, right. Management software for sure, we invest in this area for almost 12 years and now we start, we have some income from our management software. Service, customer service on side which also good margin business. And we also invest in this area for many years and now start to see some income.

Alex Kurtz - Sterne, Agee

Thank you, guys.

Howard Hideshima

Yeah. Thank you.

Operator

(Operator instructions) And we’ll go to Jeff Andry of Wunderlich Securities.

Jeff Andry - Wunderlich Securities

Hey guys. This is Jeff in for Brian. Thanks for taking the questions. Can you talk about what kind of HDD and memory pricing assumptions, you’re baking in the guidance and then also you mentioned you continue to better manage inventory and improve relationship with suppliers. Can you talk a little bit about what steps you’ve take in that regard. Thank you?

Howard Hideshima

Yeah. Of course, over the past year, we’ve increased our personnel with regards to managing our components inventory and all -- basically in memory and hard disk drive and other parts of our business. So again we put more emphasis -- and more infrastructure there and that’s part of the investment that Charles has talked about in investing in our infrastructure to basically improve how we manage our inventory and also how we build relationships, straighten those relationship with our vendors and that’s hopefully going to pay dividends for us as we go forward. With regards to the other part -- can you repeat your other question please?

Jeff Andry - Wunderlich Securities

Yeah. I was just wondering what kind of HDD and memory pricing assumption you’re baking in your guidance, just kind of taken the midpoint of the guidance figures. It looks like about a 20 basis point sequential increase in profit margins. So I was wondering what kind of assumptions, you’re kind of baking into that guidance?

Charles Liang

I guess, when we continue to move more complete system, especially storage that into 20, 40 or even 70 to hard drive (inaudible). However, a good thing is, we start to add bed you like to management sort of way that service barrier, so those will help us on the positive side. So that is what, how they may postpone one quarter but now original we use model, financial model, it should be spread in.

Jeff Andry - Wunderlich Securities

Great.

Operator

There appear to be no further questions. I’d like to turn things back over to management for any closing or additional remarks.

Charles Liang

Thank you for joining us today. And we look forward to talking to you again at the end of this quarter. Thank you everyone. Have a great day.

Operator

And again, that’s concludes your conference. Thank you all for joining.

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