Super Micro Computer - 10 Years Of Growth

| About: Super Micro (SMCI)

Summary

10 years of strong revenue growth since becoming a public company in 2007.

Consistent profitability each year since inception in 1993.

Rapid growth in sales from 2013 to 2015 caused large increase in working capital, but now cash flow is positive (nine months of fiscal 2016).

Super Micro Computer, Inc. (NASDAQ:SMCI) is a global leader in high-performance, high-efficiency Green ("energy saving") Information Technology (IT). It is a premier provider of end-to-end green computing solutions for Data Center, Cloud Computing, Enterprise IT, Big Data, High Performance Computing (HPC) and Embedded Systems worldwide. The company has grown from a very small base in 1993 and has been consistently profitable every year. It continues to grow by offering "state-of-the-art" products, incorporating the latest processors from Intel (NASDAQ:INTC) optimized for various applications as shown above.

I have been following the company's progress for several years now, and am a former shareholder and options player with Super Micro. With the share price near solid support at $24.00, in my opinion, my near-term price target would be $32.00 (short term) and $40.00 longer term. The shares rose strongly from a low of around $8.00 per share in November 2012 to $42 per share in February 2015, amid strong growth in revenues and profits.

I have reprinted some quotes from the 2011 Annual Report, specifically the "Letter to Our Shareholders."

Each year, Charles Liang, the president and CEO, writes a one-page summary of what the company has been doing to continue growing and developing itself for the ever-changing IT landscape. I focus on 2011 because it is a midpoint from when the company went public in 2007 and the latest fiscal-year 2015. What I am focused on is the track record of Super Micro as a public company since April 2007. 2011 is the midpoint between 2007 and 2015.

Letter to Our Shareholders (from fiscal 2011 Annual Report):

"For fiscal year 2011, we recorded our highest annual revenue ever and maintained a 31% growth trend. Again, we outgrew the rest of the server market and continued to take market share because of our strong, expanding product lines. In particular, our year over year growth was 47% in Storage, 186% for Blades and 103% growth in GPUs.

In the last fiscal year, we broke ground on our new Taiwan Science and Technology Park. We completed the construction in December 2011, and we had our official Grand Opening on January 6, 2012. This eventual two million plus square foot campus will house Systems Integration facilities, Logistics and Operations, and a new Research and Development Center.

Strategically, our Taiwan investment is important for several reasons: first, reduced production costs will enhance our margins; second, reduced logistical costs to support Asian as well as European sales; third, faster time to market for Asia, and worldwide due to the close proximity to our Asian vendors; and fourth, favorable tax conditions.

We have made strong moves in fiscal 2011 to invest in our future growth and future profitability. We expect to be in full production by the first half of calendar 2012. The full benefits of our Taiwan investment will begin in fiscal 2013.

Last year, we continued to invest in our people, growing our headcount by approximately 23%. The largest areas of headcount growth occurred in Sales and R&D. We continue to grow headcount globally as we extend the reach of our sales force, particularly in the Asia market. In addition, we grew sales to address new technology markets that are more suited for application optimized solutions, such as cloud and other direct customers.

For R&D, we invested in our technology future. Today we offer the broadest and most complete product solutions in our history, including Server, Storage, Blade, GPU, Racks, Switch and management software. We continue to invest in our engineering talent to extend our technology leadership.

In summary, with our enhanced product lines and now our Switch and system management software, we have improved the Supermicro brand as a complete solution based company. As we leverage our global operations and roll new products out in high volume, we are confident that Supermicro will experience our strongest growth ever in 2012 and beyond.

Thank you,

Charles Liang,

President and CEO; Super Micro Computer Inc.;

January 2012."

Super Micro Computer

Year

Ending

30-June

Est.

Actual

Total

2010

2011

2012

2013

2014

2015

FY2016

Net Sales

721

943

1,014

1,163

1,467

1,991

2,312

Cost of Sales

606

791

848

1,003

1,242

1,671

1,952

Gross Profit

115

151

165

160

226

320

360

R&D Expense

37

48

64

75

84

100

122

Sales and Marketing

20

27

33

34

38

49

61

General and Admin.

16

17

22

24

23

24

38

Total Operating Expenses

74

92

119

133

145

174

221

Income from Operations

41

59

46

27

80

147

139

Interest Expense, Net

0

-1

-1

-1

-1

-1

(2)

Income before Taxes

40

58

45

27

80

146

139

Income Tax Provision

14

18

15

5

25

44

43

Net Income

27

40

30

21

54

102

96

Basic EPS

$0.73

$1.04

$0.72

$0.50

$1.24

$2.19

$2.00

Diluted EPS

$0.65

$0.93

$0.67

$0.48

$1.16

$2.03

$1.84

Basic Shares

35.88

38.13

40.89

41.99

43.60

46.43

48.00

Diluted Shares

40.74

42.40

44.15

43.91

46.51

50.09

52.00

Gross Margin % of sales

15.9%

16.0%

16.3%

13.8%

15.4%

16.1%

15.6%

Sales Growth year/year %

30.7%

7.6%

14.7%

26.2%

35.7%

16.1%

Click to enlarge

Net sales have risen from $942.6 million in fiscal 2011 to $1.99 billion for fiscal 2015, an increase of 111% and are projected to rise to $2.3 billion for fiscal 2016 (ending June 30th, 2016). For the nine months of fiscal 2016, sales were up to $1.69 billion from $1.42 billion, an increase of 19% year over year (y/y). With roughly $600 million in sales projected for Q4 2016, total net sales for fiscal 2016 will probably be above $2.3 billion - growth of 16% y/y.

Fully-diluted earnings per share (FD-EPS) has grown from $0.93 in fiscal 2011 ($40 million net income/42.4 million shares outstanding) to $2.03 in fiscal 2015; an increase of 118%. Quarterly results have been somewhat uneven "momentum-wise," but the Annual numbers show strong growth, especially since 2012 when the stock price had fallen to a low around $8.00 per share. During 2013 and 2014, the share price rose strongly on higher sales and profits, hitting a peak of $42 in early calendar 2015. Since then, however, the share price has been weak amid growth concerns.

One inflection point for sales growth was the completion of the new Asia Science and Technology Park in Taiwan, which allowed sharply higher shipments in 2013 through 2015.

In 2014, Super Micro purchased a new 36 acre property in the heart of Silicon Valley for expansion purposes, just five minutes from its current campus in San Jose, CA. This is for future growth while the investment made several years ago in Taiwan is now paying off for the company and its shareholders. Super Micro went public in 2007 at a price of $8.00 per share, and the share price has been volatile over the years, as can be seen in the chart below:

Click to enlarge

Cash Flow Concerns

Total assets topped $1 billion at the end of Q4 2015, and shareholders' equity was around $600 million. The growth in "working capital" namely inventory and accounts receivable (A/R) has strained the balance sheet. Net income has increased from $20 million in 2013 to $54 million in 2014 and to over $100 million in fiscal 2015, and all this cash has been retained to fund future growth of the company. Free cash flow was squeezed in 2015 by working capital demands.

Cash flow from operations became negative in 2015 from the large increases in working capital to finance the increases in sales up to a $2 billion per year run-rate. In fiscal 2015, inventory rose $153 million and A/R was up $110 million from year-end 2014 levels. Accounts payable rose $75 million y/y, partially offsetting the increase in "working capital." Super Micro may choose to raise additional capital for expansion purposes. Up until now, all growth has been financed by internally generated funds and from proceeds from the exercise of stock options (roughly 2.5 million shares per year in some past years), plus roughly $100 of bank borrowings. See below for details on the line of credit from Bank of America (NYSE:BAC).

Quote from the Form 10-Q filed May 6th, 2016, covering the first nine months of fiscal 2016 (to March 31st, 2016):

"In June 2015, the Company entered into an amendment to the existing credit agreement with Bank of America N.A. ("Bank of America") which provided for (i) a $65,000,000 revolving line of credit facility that would have matured on November 15, 2015 and (ii) a five-year $14,000,000 term loan facility. The term loan is secured by the three buildings located in San Jose, California and the principal and interest are payable monthly through September 30, 2016 with an interest rate at the LIBOR rate plus 1.50% per annum. In April 2016, the Company extended the revolving line of credit to mature on May 31, 2016..."

Accounts receivable (A/R) and inventory levels have increased as sales have increased to over $2 billion per year. In fiscal 2016, sales are expected to rise roughly from $2 billion to $2.3 billion, an increase of 15%. Rapid growth in sales will need more cash around to fund operations. There is always a lag between building products and selling them. In fiscal 2015, A/R and inventory increased by $250 million compared to fiscal-year 2014, offset only partially by accounts payable increasing by $75 million. Net cash flow from operating activities was negative $45 million for fiscal 2015, mainly from the large increases in working capital.

Howard Hideshima - CFO on Q3 2016 Conference Call - (April 28th, 2016):

"In the third quarter, we grew about 13% in a seasonally weak quarter in which we continued to expand our product lines, went live on SAP overseas and compared for corporate reorganization. Year-to-date our revenue growth is 19% (for the first nine months) and we see ramping of the Broadwell launch in a traditionally seasonally strong revenue quarter..."

"However, we are cautious of the current macroeconomic environment. Therefore the company currently expects net sales for the quarter ending June 30, 2016 in the range of $580 to $640 million (midpoint = $610 million) and assuming this revenue range the company expects non-GAAP earnings per diluted share of approximately $0.46 to $0.58 (mid-point = $0.52) per share for the quarter."

"At the midpoint this will represent a growth of 6% of revenue and negative 9% in EPS from the prior year. This will also represent a growth of 16% in revenues and negative 11% in EPS for the fiscal year 2016 compared to fiscal year 2015…"

"We have made many investments during the past year on our structure; SAP Enterprise Resource Planning (ERP) software implementation and in our corporate reorganization. Two additional facilities were brought in domestically to technology to broaden our solutions, software and service platforms. We believe that many of these investments will put us in a great position to capitalize on the opportunities we see ahead and further expand our business and grow the profitability globally…"

Conclusion

I am looking for a gross profit margin of just under 16% of sales for the full fiscal-year 2016. In Q1 of fiscal 2016, Super Micro reported a gross margin of 15.6%. Sales were up 20% year over year, but profits were basically flat at $20 million for each quarter. In Q2 2016, sales were up 27% from the year-earlier period, and then for Q3 2016, sales were up only 13% y/y. Revenue growth has clearly slowed and that has caused a lot of concern about what the future growth rate will be.

Amid weaker-than-expected sales growth, profits dropped to $65 million for the first three quarters of fiscal 2016 versus $75 million earned in the year-ago period. Management projections of "better than 20% revenue growth for fiscal 2016" and talk about when a $3 billion run-rate in revenue could be achieved were too optimistic, and doubts remain about the ultimate trajectory of this company.

This company is an example of alpha; although since peaking at $42 in early 2015, the share price has declined 40% from the peak value. Super Micro and its founder Charles Liang have compiled a strong track record of growth since the company went public in 2007. That kind of sustained growth plus consistent profitability, year after year, is solid evidence to me that this company has potential to be a long-term outperformer compared to the NASDAQ Composite Index.

Since the stock price has "corrected" from $42 to $24 recently, I say "buy and hold the common" or buy some longer-dated calls and just hang on for a wild ride!

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.