Super Micro Computer (SMCI) Charles Liang on Q4 2016 Results - Earnings Call Transcript

| About: Super Micro (SMCI)

Super Micro Computer, Inc. (NASDAQ:SMCI)

Q4 2016 Earnings Call

August 04, 2016 5:00 pm ET

Executives

Perry G. Hayes - Senior Vice President-Investor Relations

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Howard Hideshima - Chief Financial Officer

Analysts

Mehdi Hosseini - Susquehanna International Group

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Mark D. Kelleher - D. A. Davidson & Co.

Rich J. Kugele - Needham & Co. LLC

Brian Alger - ROTH Capital Partners LLC

Alex Kurtz - Pacific Crest Securities

Nehal Sushil Chokshi - Maxim Group LLC

Operator

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Super Micro Computer Incorporated Fourth Quarter and Fiscal 2016 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 is 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 on a listen-only basis.

As a reminder, this call is being recorded Thursday, August 4, 2016. A replay of the call will be accessible until midnight, Thursday, August 18, 2016, by dialing 1-877-870-5176 and entering replay pin 1154709. 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 G. Hayes - Senior Vice President-Investor Relations

Thank you. Good afternoon, and thank you for attending Super Micro's conference call on financial results for the fourth quarter and fiscal year 2016, which ended June 30, 2016. 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 these risks in the press release we issued earlier this afternoon, our Form 10-K for fiscal 2015, and our other SEC filings. All of those documents are available from the Investor Relations page of Super Micro's website. We assume no obligation to update any forward-looking statements.

Most of today's presentation we'll 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 in the supplemental information attached to today's presentation.

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

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Thank you, Perry, and good afternoon, everyone. Please refer to slide four through slide six. Let me provide you with the summary of our fiscal fourth quarter. Revenue was $524 million. It's 1.6% lower from last quarter and 8.6% lower year-over-year. Non-GAAP net income was $10.4 million. It's 45.4% lower from last quarter and 65.4% lower year-over-year. Non-GAAP earnings per share was $0.20 per diluted share, compared to $0.36 last quarter and $0.57 last year.

As previously announced, this quarter, our results was below expectation. While we continue to grow in middle-size accounts, our business has become more depend on large datacenter customers. And we had two specific large datacenter customer project that impact the quarter, reduce business from our large datacenter customers result revenue volatility, which in turn lower our manufacturing utilization globally by 14%, which had negative impact to margin and profitability.

We are undergoing the restructure of our operational infrastructure, including our global SAP implementation, new global tax restructure and bonded warehouse. These investments will help to streamline the business, improve efficiency and increase profitability in long-term. But unfortunately, to lower our (05:42) costs from business is traction and slowdown in the quarter, that impact execution and pricing flexibility. We expect to complete the whole restructuring in the December quarter this year, and after that, we will be more efficient than ever before.

Last quarter, system sales were 65.5% of revenue, compared to 61.7% last year, as we continue to see success in our efforts to grow the higher value total system business. The two key vertical that drive our system business are: first, Internet cloud data center, comprise 18% of total revenue, but had been temporarily slow in the past two quarters; and storage, which was 19% of total revenue, down 15% from last year. However, storage sale to hyper-converged and software-defined market was up both sequentially and year-over-year. And with our strong NVMe leadership, we expect continuous strong growth this year.

From a geographical perspective, we saw mixed results. The USA market was 62.2% of revenue, and was flat with last quarter and lower by 8.6% from last year. Europe saw weaker results. It was 17.5% of revenue, slightly lower sequentially, and down by about 16% year-over-year. Asia was in the bright spot last quarter with 15.8% of revenue, up 5% quarter-over-quarter.

While we did not achieve the results we want in Q4, we continue to be focused and confident in the long-term growth of our business. We continue to see the move to carve (7:55) the quick growth of IoT and rapid innovation as the drivers of our long-term growth. Our core strategy remain unchanged.

First, we focus core market with new innovation and deliver the broadest choice of server and storage system in the industry. Second, emphasize strategic relationship in our key verticals and utilize our server building blocks to create the best value on our application-optimized solutions. Third, continue growth of our software and service portfolio to provide the reliable serviceability and quality for our customers.

With the completion of our new global operation foundation, we will target the following specific actions to achieve a stronger growth and financial performance. We are confident that these actions will be successful and will enable us a return to strong growth.

First, we will leverage our increase manufacturing capacity and improve operational efficiency to be a more flexible and competitive in winning business in our current large customers and to ensure new major customer wins. Second, we will expand our current focus on our fast-growing Internet of Things, IoT market, which cover Edge server, networking, appliance, surveillance and other embedded solutions.

Slide six, please. Let me now comment on our product portfolio, which is at the heart of our strategy. Over the last few quarters, we continue to expand the product portfolio ,and we introduced a number of strong new products and innovations.

First, we continue to be the industry leader in NVMe, All Flash NVMe, and hybrid storage solution. We now have more than 60 NVMe server storage systems that deliver orders of magnitude better performance, multiple times the price/performance ratio and efficiency than traditional storage solution, including the Simply Double Architecture and 60 Bay and 90 Bay high-capacity optimized storage platform. We expanded the serviceability and capability of our NVMe system with hot-swappable RAID option and UNO (10:58) dual-port systems.

Second, we are ready to deliver an advanced architecture leverage in software-defined solutions, with the introduction of our Super Rack Scale Design (sic) [Supermicro Rack Scale Design] (11:12). Super Rack Scale Design (sic) [Supermicro Rack Scale Design] (11:15), we call SRSD. Now SRSD architecture leveraging our industry-leading product lines to delivery the ultimate in resource optimization on rack platform, rack form factor. This dynamic management technology will enable our data center and cloud customer, especially private cloud customers, to accelerate deployment time and to simplify their management resource overhead.

We are an integral part of the deep learning, machine learning, and artificial intelligence solutions, which drive the adoption of today's big data universe structure. This quarter, we have introduced systems supporting the new Intel Xeon Phi x200 processor in both 2U, 4-node and tower form factor. When combined with Omni-Path, our EDR fabric, that delivers incredible performance, that made the research effort possible for more students, professors and the industry.

Moreover, we introduced 1U (12:34) NVIDIA Pascal GPU solution, which is capable of supporting up to four P100 GPU – Pascal GPU I mean, in a slim form factor. We recently delivered a solution to rather university, leveraging the Omni-Path networking, that was recognized as one of the best top 500 HPC cluster. This solution also optimized for transcoding and streaming compression.

Our IoT business provides one of the brightest spot this quarter. The worldwide IoT market is growing at about 11%, according to IDC. And our IoT business grew even faster, at about 30% last year, and now account for about 10% of our total revenue, at about $200 million. We can invest R&D resource initially in industrial PC, core IPC, and IoT gateway products. And now we have hundreds of optimized IoT and embedded solutions in just three short years, providing a complete product portfolio from the Edge to the cloud.

Just recently, we increased R&D investment, expanding our product line, providing a new, really low power and really small form factor IoT solutions, which successfully engage with customer in medical image, security, surveillance, manufacturing and retail, automation. In short, we expect to see a hopefully more than 30% growth in IoT and embedded market this coming fiscal year.

In summary, we had never seen a stronger in term of our product portfolio and our global operation in automation have been significantly improving. We know the urgency to improve and we are leveraging all of our strengths and capacity to create a competitive value proposition for our customers. We are investing more effort in our strategic relationship, building stronger presence in key markets and continue to develop a new customer in target vertical. We are confident these action will result in a greater improvement of our financial performance, when we go into the new fiscal year.

For more specific on the fourth quarter, let me turn it over to Howard.

Howard Hideshima - Chief Financial Officer

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 adjustments to exclude stock 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 a review of the fourth quarter income statement. Please turn to slide nine. Revenue was $524.3 million, down 8.6% from the same quarter a year ago and down 1.6% sequentially. The decrease in revenue from last year was primarily due to our decrease in subsystems and accessories, which was down 17.6%, and a decrease in sales to distributors which was down 14.8%. These are offset in part by growth in HPC, cloud Internet datacenter and next-gen storage of 93%, 6% and 9% respectively.

On a geographical basis, we had a decrease in Europe of 15.9%, followed by U.S. at 8.6%, while Asia was about flat. The sequential decrease in revenue was primarily due to weakness in server solutions, which was down 7.8% due to less sales from our cloud Internet datacenter segment, which was down 31%, offset in part by strength in our subsystems business, which was up 12.9%. In addition, next-gen storage grew at 10.8%.

On a geographical basis, we had a decrease in the other regions of 31%, primarily due to our cloud Internet datacenter projects. Europe was down 1.8%. U.S. was flat while Asia was up 5.2%.

Slide 10, turning to product mix, the proportion of revenues from server systems was 65.5% of the total revenues, which was up from 61.7% the same quarter a year ago and down from 69.9% last quarter. ASP for servers was $4,100 per unit, which is the same as last year and down from $4,400 last quarter. We shipped approximately 84,000 servers in the quarter and 1,165,000 subsystems and accessories.

We continue to maintain a diverse revenue base with over 800 customers. No customers represent more than 10% of our quarterly revenues. Cloud Internet datacenter revenue was 18.1%, which was a decrease from 26% in the prior quarter and an increase from 15.5% in the prior year. 62.2% of our revenues came from the U.S. and 46.8% from our distributors and resellers.

Slide 11. Non-GAAP gross profit was $74.1 million, down 17.7% from $90 million in the same quarter last year and down 6.7% from $79.4 million sequentially. On a percentage basis, gross margin was 14.1%, down from 15.7% a year ago and down from 49.9% sequentially. Price changes from Ablecom resulted in no-basis-point change to the gross profit in the quarter, with total purchases representing approximately 12.4% of total cost of goods sold, compared to 11.9% a year ago and 12.2% sequentially.

The year-over-year decrease in gross margin results from lower utilization of our global capacity, which is about 50%, compared to about 70% a year ago. This resulted in appropriately 0.5% effect on gross margins. The other 0.3% is attributable to higher inventory reserves on product transitions. Sequentially, gross margin was down due to about 0.3% from lower utilization of our global capacity, which was about 50% to about 60% last quarter. In addition, 0.3% and 0.2% are attributable to higher warranty and inventory reserves on product transition, respectively.

Slide 12 and 13, operating expenses were $57.9 million, up from $45.3 million in the same quarter a year ago and up from $51.1 million sequentially. As a percentage of revenues, operating expenses was 11%, which is up from 7.9% in the same quarter a year ago and up from 9.6% sequentially. Operating expenses were higher on an absolute dollar basis year-over-year primarily in R&D, as we invested in personnel expenses and materials to support the development of our total solutions.

Sequentially, operating expenses were higher due to higher material and testing fees of about $2.9 million, and higher marketing and trade show cost of $2.7 million to support the development and sale of new products.

The company's head count increased by 88 sequentially to 2,699 total employees, primarily in R&D. Our forecast for the next quarter, we do expect operating expenses to decrease as we expect to leverage the investments we have already made, offset in part by annual salary increases.

Operating profit was $16.2 million down by 63.8% from $44.8 million a year ago and down from 42.8% from $28.3 million sequentially. On a percentage basis, operating margin was 3.1%, down from 7.8% a year ago and down from 5.3% sequentially. We will increase our efforts to add additional value to our solutions for our customers, while at the same time, leveraging investments we have made during the past year.

Net income was $10.4 million, down 65.4% from $30 million a year ago and down 45.4% from $19 million sequentially.

Our non-GAAP fully diluted EPS was $0.20 per share, down from $0.57 per share a year ago and down from $0.36 per share sequentially. The number of fully diluted shares used in the fourth quarter was 52,955,000.

The tax rate in the fourth quarter on a non-GAAP basis was 34.4%, compared to 32.6% a year ago and 32% sequentially. The effective tax rate for the fourth quarter of the fiscal year 2016 was higher due to higher tax expenses associated with the implementation of the company's new global corporate structure on May 1, 2016. The impact was about $0.06 per diluted share.

We expect the impact to be about $0.04 per diluted share in the first quarter of fiscal 2017, and to decline as we continue to grow our business offshore and shift our existing offshore customers, who are serviced from the U.S. to locations overseas. We expect our effective tax rate to be 40% in the first quarter of fiscal 2017, and to decrease as we go forward through the fiscal year.

Turning to the balance sheet on a sequential basis, slide 14. Cash and cash equivalents and short-term and long-term investments were $183.7 million, up $4.6 million from $179.1 million in the prior quarter and up $85.6 million from $98.1 million in the same quarter last year. In the fourth quarter, free cash flow was $5.7 million, primarily due to a decrease in inventory of $27 million, and net income of $7 million, offset in part by a decrease in accounts payable of $31.1 million.

Slide 15. Accounts receivable increased by $3.2 million to $288.9 million due to lower revenue sequentially. Day sales outstanding was 50 days, a decrease of one day from 51 days in the prior quarter. Inventory decreased by $30.3 million to $449 million from the lower forecasted revenues. Days in inventory were 94; a decrease of three days from 97 in the prior quarter. Accounts payable was $249.2 million, which was 53 days, a decrease of seven days from 60 days in the prior quarter. Overall, cash conversion cycle days was 91 days, which is three days higher than the prior quarter.

Now for a few comments on outlook. As we enter fiscal year 2017, we look to leverage the investments we have made in our operations, such as our SAP implementation, global reorganization, and new facilities, while containing through our expenses to drive growth and profitability in a seasonally weak quarter for the industry. Therefore, the company currently expects our net sales for the quarter ending September 30, 2016 in a range of $470 million to $550 million. Assuming this revenue range, the company currently expects non-GAAP earnings per diluted share of approximately $0.15 to $0.30 for the quarter.

At the midpoint of this, it would represent a decrease of 2% of revenue and a 30% decrease in EPS for the prior year. Looking forward beyond this quarter, we have updated our targets for the coming two years to be 15% to 17% in gross margin and 6% to 8% on operating margin. These targets reflect our strategy to take advantage of the opportunities we have to take market share and keep disciplined control of our operating costs.

On July 18, 2016 the company also announced the company's board of directors had adopted a program to repurchase from time-to-time, at management's discretion, up to $100 million of the company's common stock in the open market or in private transactions during the next 12 months at prevailing market rates. To-date, we have purchased 513,194 shares, totaling about $10.3 million at an average price of $19.97. We certainly expect that the outlook will not be updated until the release of the company's next quarterly earnings announcement. Notwithstanding subsequent developments, however, the company will 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 - Founder, President, Chief Executive Officer and Chairman

Thank you, Howard. For the entire fiscal year, we saw 11% revenue growth for the year, which means Super Micro is still one of the fastest-growing company in the IT industry. We are much better positioned with our new global SAP implementation, new global operation, and corporate tax restructure and bonded warehouse.

Despite softening of our revenue and the temporary setback of our operation this quarter, our long-term growth trend remain intact, based on our even stronger product portfolio, and we are looking forward to a strong new fiscal year.

Operator, at this time, we are ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. Ladies and gentlemen, our question-and-answer session will be conducted electronically. And we'll go first to Mehdi Hosseini with SIG.

Mehdi Hosseini - Susquehanna International Group

Yes. Thanks for taking my question. My first question is for Charles. I'm looking at your slide number seven, and I don't see the new server CPU architecture like a Skylake-M. Is that having an impact on your ability to forecast? And how this changes in both CPU and graphics are impacting your server business? And I have a follow-up.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Okay. Thank you. I mean, we have a lots of new design just available like Intel Xeon Phi. We will start to ship high volume now and also like NVIDIA Pascal, we have a product fully ready to ship about this month, I mean, August. And as to Skylake, yes, we have very strong product portfolio, which is also a new architecture. And, unfortunately, it's a product for next year. We have been developing this product line for almost nine months, while daily (28:59) production it will be next year, maybe around summer timeframe.

Mehdi Hosseini - Susquehanna International Group

Okay. And then follow-up question for Howard. Can you please provide some color on a unit and ASP for both server and subsystem segments?

Howard Hideshima - Chief Financial Officer

Sure. On the units side of it, for servers, Mehdi, it was 84,000 units for server units shipped during the quarter. The ASPs were about $4,100. On the units for our subsystem and accessories that was about 1,164,000 and quite frankly, I didn't divide out the numbers there with regards to that. It's a mix of number of different things that's really hard to gauge with the ASP there. So we've never given that out.

Mehdi Hosseini - Susquehanna International Group

Sure. And so, did you 1,160,000 units?

Howard Hideshima - Chief Financial Officer

1,164,000 units.

Mehdi Hosseini - Susquehanna International Group

Okay. Thank you.

Howard Hideshima - Chief Financial Officer

Sure.

Operator

And we'll take our next question from Aaron Rakers with Stifel.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Yeah, thanks. Thanks for taking the questions. Two as well, real quick. So first of all, as you guys go through – it sounds like a realignment and focus on operational efficiencies. Can you just remind us again where you stand in terms of your manufacturing footprint? And whether or not these efforts have included any reduction of that manufacturing footprint at this point?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yes. Thank you for the question. Basically, it's a big transition, right? Not just SAP implementation global-wide, but also a big impact from our restructure for our production, operation and also global tax, new season. And we also created a bonded warehouse, new bonded warehouse that kind of limited a lot of production decision (30:55). And I would have to say that most impact that people had to pay attention to the new system, prepare (31:03) product here and there, and that's why it slowdown our business a little bit.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Okay.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

But as for our position, especially, we already finished, I'd rather say that at least 90% job already finished. And in next few months, we will finish everything. And hopefully, the system becomes perfect in early Q4 this year, and after that, our operations should be much more efficient thereafter.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Okay. Maybe to ask it a little bit differently. Your updated two-year kind of target models 15% to 17% gross margin, can you help us frame of, what it would take to get to the midpoint of that gross margin range from a utilization perspective from your manufacturing?

Howard Hideshima - Chief Financial Officer

So I think – as you look at my utilization numbers this past quarter, we had gone to about 70% last year about the same quarter in the fourth quarter. And that's moving down to about 50%. This past quarter, you saw about 30 basis points of movement there. So as you go forward, Aaron, as we increase our efficiencies and what have you, you can see that type of impact to our margins with regard to as we increase our utilization and improve our utilization. So I'd frame it in that way going forward. Anywhere from 30 basis points to 50 basis points, I think, you see them wide spreads on the – in my commentary on utilization.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Okay. And I'll flip one final thing and just housekeeping, no 10% customers in this quarter, did I hear that correctly?

Howard Hideshima - Chief Financial Officer

That is correct.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Okay. Thank you.

Operator

And we'll take our next question from Mark Kelleher with D.A. Davidson.

Mark D. Kelleher - D. A. Davidson & Co.

Great. Thanks for taking the questions. I want to focus on the storage side. I'm not sure, I heard everything you were saying about that. Down 15% year-over-year, I think you said, and hyper-converged was strong, I think I heard. Could you just review what you're seeing in storage and what your expectations are going forward?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yeah. The drop of overall storage revenue, I believe, major is about two customers. So we compete with aggressive price from our competition. And because of SAP implementation, I would have to say we are a little bit too slow to dynamically respond to the price competition. So we lost to some big peer there. And this will be (33:38) the reason I believe. However, for hyper-converged, in our software-defined storage, we'll be globally (33:48) though basically. And I believe we will continue to grow very strong in hyper-convergence in software-defined storage. Even for regular storage, I believe, we will recover to peak growth very soon.

Mark D. Kelleher - D. A. Davidson & Co.

So that was more of a market share loss there rather than a weakness on the...

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yes. In last quarter, we kind of a little bit too slow in an enterprise response.

Mark D. Kelleher - D. A. Davidson & Co.

Okay. Great. Thanks.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Thank you.

Operator

And we'll take our next question from Rich Kugele with Needham & Company.

Rich J. Kugele - Needham & Co. LLC

Thank you. In terms of the Internet datacenter side, do you believe that now with a different margin profile, you would be able to regain business on that side. And how does it work from an ordering cadence? Do they typically order transactionally active every quarter or is it more lumpy than that?

Howard Hideshima - Chief Financial Officer

Yeah. Rich, this is Howard. With regards to that, we've always said that the cloud Internet datacenter has been more project-based, as we're bringing up datacenters from quarter to quarter, or what have you, so it is project based per se. And some of that accounts for some of the – what range that we put on this quarter. We do have some projects that are either going to be this quarter or next quarter, and we're still waiting to see if – when those are going to occur. But it is project based.

Rich J. Kugele - Needham & Co. LLC

Yeah. And the business that you lost in the quarter, they don't have any issues with your technology or your value proposition right? Is this entirely just basically price or being responsive?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yes. I would like to say in term of technology, in term of product portfolio, we feel much stronger than before. But yes, in term of price competition, especially dynamic price support, dynamic local support we were (35:51) in that quarter.

Rich J. Kugele - Needham & Co. LLC

Okay. And, well, I'll take it – all fine. Thanks. Take care.

Operator

And we'll take our next question from Brian Alger with ROTH Capital Partners.

Brian Alger - ROTH Capital Partners LLC

Good afternoon, guys. Kind of want to follow-up on the same train of thought. Just trying to get an understanding of what really went on in the prior quarter. It sounds as though pricing was the primary issue here and you weren't responsive to the changes in the marketplace. I'm trying to understand what shifted from the competitive landscape and what lesson has been learned that it won't happen in the future?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

I believe the relationship has to be further improved. Kind of when customer asking for lower price, our people did not response quickly enough. And because it's the first time we faced such a big impact, so we then (36:54) – the whole company (36:57). We – come our new system. The good thing is new SAP system now we have with us, much easier to calculate our (37:05), so we can response to customer quicker as well. And with our capacity now much bigger, right, so we are more willing to support certain product much more aggressively.

Brian Alger - ROTH Capital Partners LLC

Okay. So I guess I'm looking at a bit of history here and that the hyperscale customers that have driven a lot of a growth for your company over the past couple of years, they have a track record of being very aggressive on pricing. And what I guess, I'm hearing, and I want to make sure I'm hearing it correctly is that, in the future, you're going to be better positioned to react to that price aggression, which may allow us to retain the revenues but would that not negatively impact the gross margin profile of the future revenues?

Howard Hideshima - Chief Financial Officer

I think – Brian, this is Howard. With regards to that, again, given that we have some excess capacity or additional capacity right now, it allows us to kind of balance out some of those. We may give up a bit on pricing, but we will fill up the plant and reduce the overhead burden that we have by filling it up.

Brian Alger - ROTH Capital Partners LLC

Okay. And, Howard, do you get the sense that anything has shifted from the competitive landscape in that your competitors' ability to customize or to deliver feature-rich products has shifted such that your – the advantages – the strategic advantages of the business and its flexibility have altered at all?

Howard Hideshima - Chief Financial Officer

Yeah, with regards to our products, I think, Charles has said already. We still believe we provide the best solutions and best values out there, bar none, from any of our competitors out there.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Especially, like NVMe, kind of like a dual-port (39:04) NVMe, kind of a like BigTwin (39:06) our new accelerator is coming very soon. And, kind of, I just mentioned that our Super Rack Scale Design (sic) [Supermicro Rack Scale Design] (39:12) [indiscernible] (39:14) and indeed we saw customer engage very well with our new design.

Brian Alger - ROTH Capital Partners LLC

Okay. Great. I appreciate the candor, guys. Thank you.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Thank you.

Operator

We'll go next to Alex Kurtz with Pacific Crest Securities.

Alex Kurtz - Pacific Crest Securities

Hey, guys. Can you hear me, okay?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yes.

Alex Kurtz - Pacific Crest Securities

Okay. Great. I just want to follow-up on Brian's question, because I think it's really important that – well, first of all, was the competitive loss in the quarter really localized to one or two customers? I jumped on the call late, so I'm sorry if I missed that. Or was it misses across a host of customers in the web scale market?

Howard Hideshima - Chief Financial Officer

Yeah. It was just a couple of customers, Alex.

Alex Kurtz - Pacific Crest Securities

Okay. And, Howard, I think, as Brian alluded to, and I think it's a really great question is, historically, you guys have always positioned yourself as the application-optimized technology that would maybe be next to an ODM kind of server, right? And you guys added more value. And I guess, what I'm trying to understand here is, was there some very specific situations with those two accounts in the quarter, or is there a sort of like a bigger trend happening with that business, and with that vertical?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

I guess, for that couple customer, it's purely because of our – I would like to say, a little bit too relax. Sorry to say that, but we should response more aggressively and more dynamically, in term of what customer really need. But to answer your question of application-optimized, yes, we, indeed we've become much stronger than before even, like our NVMe, now the strongest product line in the world, that our (41:13) between the (41:16) design. All kind of, we show customer the advantage from Super Micro.

And also I mentioned about our IoT product line, which we grew about 30% last year. This exactly a better margin, a better profit margin product line. And we started to invest aggressively about three years ago, and last year – first year we see a such a strong growth. And we believe in the next coming many years, we will continue to invest more on IoT embedded.

Alex Kurtz - Pacific Crest Securities

Okay. We'll talk a little bit more offline. Thank you very much.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Thank you.

Operator

And we'll take our next question from Nehal Chokshi with Maxim Group.

Nehal Sushil Chokshi - Maxim Group LLC

Thank you. I do have a few questions, and I will move to the question of the day. But before I do that, I think you did provide some color around what you expect for OpEx for next quarter. Can you just review that again?

Howard Hideshima - Chief Financial Officer

Hi. I mentioned that we are – we do expect to see a decrease in our op expenses for next quarter.

Nehal Sushil Chokshi - Maxim Group LLC

Okay. And so, should we be thinking that gross margin will be effectively flat Q-over-Q, or are you guys trying – still trying to say, given you have a very large range for revenue and EPS, but if we take the midpoint, are you guys trying to imply that we should expect gross margin to move up slightly Q-over-Q, or should that be flat to actually down?

Howard Hideshima - Chief Financial Officer

Well, I think we haven't given gross margin guidance out there. Certainly, we have – we're doing our best to maintain gross margins, but as Charles mentioned, we're going to be looking at our pricing and our flexibility there as well, to grow our market share, as we always have.

Nehal Sushil Chokshi - Maxim Group LLC

Okay.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

But I guess start from December quarter, right? Start from October, for example, as our SAP global re-org become much more stable, become more ready. Our iteration (43:26) will grow and our volume per share will grow.

Nehal Sushil Chokshi - Maxim Group LLC

Okay.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

And that will improve our profit margin...

Nehal Sushil Chokshi - Maxim Group LLC

That's correct.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

...and overall profitability.

Nehal Sushil Chokshi - Maxim Group LLC

Right. And then, you have a wider-than-usual revenue guidance, and I assume that's a result of a reduced visibility. Can you talk about what parts of the business are you seeing that reduced visibility with?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Still, I mean, that our big data center customer, we try to be more cautious this time, because from last quarter, we experienced the first time bigger impact, we tried to be more conservative.

Nehal Sushil Chokshi - Maxim Group LLC

Okay. Now, with respect to the question about being more nimble with your pricing, are you explicitly just simply talking about lowering your pricing, get your utilization up, and therefore that will offset some of your – that will (44:24) allow you to basically have that volume without actually impacting the overall gross margin, because you'll be driving your utilization up, or are you actually talking about more nimbly configuring the products to what the customer needs, to what the competition has out there, to be more optimal in terms of your COGS configuration, and therefore still win the deal?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

I guess it is a combination, plus, now, we have a much stronger manufacture capacity in offshore. So once we are able to leverage that need for CET (45:01) in offshore, then we will know our overall operation and manufacture cost.

Nehal Sushil Chokshi - Maxim Group LLC

Okay, all right. And then Howard, that financial framework that you gave out for gross margin and operating margin, did I hear that correctly, 15% to 17% and operating margin of 6% to 8% over the next two years?

Howard Hideshima - Chief Financial Officer

That's correct.

Nehal Sushil Chokshi - Maxim Group LLC

Okay. And now, when you say over the next two years, are you essentially saying that this is something that we should be thinking about for fiscal year 2018, and fiscal year 2017 will represent an on-ramp towards that model?

Howard Hideshima - Chief Financial Officer

It's a target model out there two years.. now.

Nehal Sushil Chokshi - Maxim Group LLC

Okay. All right. And while you didn't have a 10% customer within the quarter, did you still have a 10% customer for the full fiscal year?

Howard Hideshima - Chief Financial Officer

Yes. We did.

Nehal Sushil Chokshi - Maxim Group LLC

Okay. Thank you.

Operator

And we have a follow-up question from Mehdi Hosseini with SIG.

Mehdi Hosseini - Susquehanna International Group

Yes. Just looking at the revenue mix, your datacenter revenues have been declining and for the two consecutive quarters. And I'm just trying to better understand, is the ASP pressure coming from this is specific segment or is it more in the core server business? And I have one more follow-up.

Howard Hideshima - Chief Financial Officer

Mehdi, this is Howard. With regards to the ASPs, again it's a combination of all of our business. 18% of our business to the (46:34) was Internet datacenter part of it, and you know, there is still another 80%, 82% that's other business areas. So again, it's a combination of all. With regards to that, the last couple of quarters from 26% to 18% (46:49), again we haven't lost any customers, we're still competitive, it's just projects.

Mehdi Hosseini - Susquehanna International Group

Okay. And then...

Charles Liang - Founder, President, Chief Executive Officer and Chairman

And then, we said, we would try to win those customer back and create more new customer.

Howard Hideshima - Chief Financial Officer

That's correct.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

I believe that once our global operations system really stabilize, we will become a bit aggressive in that area.

Mehdi Hosseini - Susquehanna International Group

Okay. And then with the embedded segment becoming 10% of your revenue, are you going break this out going forward so we could better model this?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yeah. IoT will be a very strong territory for us. Again, with our application-optimized as building blocks vision (47:38), we are in a very good position to grow in IoT embedded market. And last year, again, first time we separated product line.

Howard Hideshima - Chief Financial Officer

Yes.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

And we saw a 30% growth. This year, no reason we cannot grow more than 30%.

Howard Hideshima - Chief Financial Officer

So we'll be providing color going forward on and as a separate product line.

Mehdi Hosseini - Susquehanna International Group

Okay. Great. And Howard one for you, the cash cycle went up by three days. Any particular reason here?

Howard Hideshima - Chief Financial Officer

It's more align to the lower balances underneath, the dividers. We had lower revenues.

Mehdi Hosseini - Susquehanna International Group

Okay.

Howard Hideshima - Chief Financial Officer

Yeah.

Mehdi Hosseini - Susquehanna International Group

Got it. Thank you.

Operator

And we have a question from Brian Alger with ROTH Capital Partners.

Brian Alger - ROTH Capital Partners LLC

As a follow-up on the declining revenues from the datacenter segment, that end-market itself hasn't seen a decline in demand. Obviously, it's been one of the fastest-growing segments within IT hardware in general, which clearly implies that you guys are losing share to someone, somewhere, even if it's project oriented. Who is gaining market share at your expense and is it purely on price?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

I guess a combination of price and also our response to customer demand. So we have really learned a big lesson how to work with customer closer to response customer demand quicker. So that area, for sure, we very aggressively done and I believe we are ready for that.

As to the cost price competition, and that's another reason why we restructured our global operation and production facility. And pretty much, we already are, I would like to say 90% finish. So within next few months, we will have a much stronger operation manufacturer facility and cost structure in Asia. So then we will support our growth in large datacenter business.

Brian Alger - ROTH Capital Partners LLC

I guess, Charles, the question I have is, who is winning if you're losing? Is it the traditional large OEMs like Dell and HP that historically have been lethargic and unresponsive and not having dynamic product portfolios? Are they winning now-a-days? Or have we seen the lower, more simpler ODMs, the Compals, Foxconns, Hon Hai et cetera of the worlds improve in terms of their system expertise, moving up the food chain, to be more competitive against you?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Basically we saw some from Asia.

Brian Alger - ROTH Capital Partners LLC

Okay. Thank you. I appreciate the help.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yeah. Thank you.

Operator

And we'll take our final question today from Aaron Rakers with Stifel.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Yeah. Thanks for the follow-up. Two real quick questions. First of all, can you talk – there has been a lot of talk in the market about component pricing, particularly around drives, but also in the memory space. Have we seen pressures and would you expect pressures from an upward pricing environment on the components to the gross margin line over the next couple of quarters?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yeah. We see some change. I mean, it looks like the market is kind of – nothing is stable, right? So Q3, maybe, the cost will be a little bit higher, but how much we are higher and what would be the trend, we still pay a close watch. And we try to – we are prepared, I believe, as the market is changing.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Okay. And then the final question for me would be, in the past, you've talked about kind of the trajectory of how you thought you could grow your revenue. And I think in the framework of the model that you provided 2015 to 2017 at 6% to 8%, I'm curious of how you see, if you look out over the next couple of years, what kind of revenue levels supports let's say the midpoint or even the low-end of that target model range?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yeah, I mean we still are very – we'll try to be very aggressive to grow our revenue, and that's by end of 2017, we still try to (52:15) revenue, and then we'll have the scale, we will have our cost. And also by a transition production, expanding to Asia now we have our cost (52:28) as well.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

So I'm really clear here, so you're saying, you expect to be at an annual run rate of $3 billion exiting fiscal 2017.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

By December, December 2017.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Of the calendar year, okay?

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Calendar year, yes.

Aaron Rakers - Stifel, Nicolaus & Co., Inc.

Yeah, thank you.

Operator

And that does conclude the question-and-answer session of our conference. I'd like to turn the conference back over to Mr. Liang for any closing remarks.

Charles Liang - Founder, President, Chief Executive Officer and Chairman

Yes, 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

Thank you, ladies and gentlemen. That does conclude the Super Micro fourth quarter and fiscal year 2016 conference call. We do appreciate your participation. You may disconnect at this time. Thank you.

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