Super Micro Computer F1Q08 (Qtr End 9/30/07) Earnings Call Transcript

Oct.31.07 | About: Super Micro (SMCI)

Super Micro Computer, Inc. (NASDAQ:SMCI)

F1Q08 Earnings Call

October 31, 2007 5:00 pm ET

Executives

Howard Kalt - Public Relations

Charles Liang - Chairman and Chief Executive Officer

Howard Hideshima - Chief Financial Officer

Analysts

Glenn Hanus - Needham

Joshua Solan - Glacier Bay Capital

Vamzy Mullen - Merrill Lynch

Operator

Good day, ladies and gentlemen. Thank you for standing by.Welcome to the Super Micro Computer Incorporated First Quarter Fiscal 2008Conference Call. At this time, all participates are in a listen-only mode.Following the presentation, we will conduct a question-and-answer session.Instructions will be provided at that time for you to queue up for yourquestion. I would like to remind everyone that today's conference is beingrecorded.

And now I would like to turn the conference over to Mr.Howard Kalt of Super Micro Computer Inc. Mr. Kalt, please go ahead, sir.

Howard Kalt

Thank you, Robbie. Good afternoon and thank you for attendingSuper Micro Computer's conference call on financial results for the firstquarter of fiscal year 2008, which ended September 30, 2007.

With us today are Charles Liang, Chairman and ChiefExecutive Officer; and Howard Hideshima, Chief Financial Officer. By now youshould have received a copy of today's news release that was distributed at theclose of regular trading. A copy of it maybe accessed either on the company'swebsite, www.supermicro.com or by calling 415-397-2687, and a copy will befaxed to you.

Before we begin, please note that during the course of thisconference call management will be making forward-looking statements within themeaning of the Securities Act of 1933, and the Securities Exchange Act of 1934.These forward-looking statements may involve judgments based on informationthat is available now, but is highly likely to change over time.

The company will not necessarily inform you if and whenthose judgments and the underlying information change. Company policy is toprovide material information only in news releases, widely-available conferencecalls, or filings with the SEC. Additional information concerning factors thatcould cause actual result to differ materially from those in today'sforward-looking statements are contained in the company's SEC filings, as wellas in today's news release.

I would add that the company operates under the requirementsof regulation FD. As a result, Super Micro Computer provided advancednotification of this conference call by way of a news release issued on October22, 2007.

Like most companies, today we will be taking questions onlyfrom securities analysts and institutional portfolio managers, but the completecall is open to all interested parties on a listen-only basis. The company willcontinue to talk with investors individually and in small groups, but thosediscusses will be limited to historical and nonmaterial aspects of thebusiness.

If you're interested in such a meeting, please contact me at415-692-3059 or via e-mail on the company's investor relations page of thewebsite.

I'll now turn the call over to Charles Liang, Chairman andChief Executive Officer. Charles?

Charles Liang

Thank you, Howard, and good afternoon, everyone. Thisquarter marks our 14th anniversary since our funding in 1993. It washighlighted by record high in revenue again. Our revenue reach $180 millionwith a growth of $27.8 million, compared with our fourth quarter of fiscal year2007, which is about 30.8% growth.

This quarter net income reach $5.8 million with a growth of$1 million compared with last quarter, which is about a 20% growth. Thecontinued revenue traction of our 1U Twin and Universal I/O solutions, thestart of volume shipment of our SuperBlade servers and the launch of ourinnovative products, such as AMD Barcelona server and Intel quad-core MP Xeonserver solutions sets our table for additional goals in our future.

The 1U Twin continues to gain much share with customers inhigh-performance, high-density, server converting and data center environments.The 1U Twin server require half as many server racks, chassis, power suppliesand power cables, which should reduce customer's TCO.

Additional cost savings associated with this IP spacerequired as well easier maintenance and management make this servers are veryattractive option for almost any high-performance server applications. Our newinnovation Universal I/O architecture has also been increasing in revenueduring the quarter.

Customers appreciated 1U Twin flexibility, cost advantages,and investment protection, which the UIO architecture provides.

Future upgrades can be achieved by replacing the UIO cardand or expansion card instead of replacing entire systems. Even without any UIOmodule or expansion cards, our UIO system functions as an better cost effectiveserver. With the UIO card installed a single UIO server can support a SAS, 10GbEthernet or even InfiniBand. This versatility also minimize the number ofdifferent server models that resellers need to keep in inventory.

During the quarter, we went into volume shipment of ourSuperBlade servers, which implement the very latest advancement in servertechnologies, making them an ideal solution, not just for enterpriseapplications, but also HPC environment.

Taking module computing to another level, our high-densityblade can be optimized for a wider range of applications with exceptionalscalability. Super Micro Blade use 90% SAS, high-efficiency, redundant powersupply to ensure energy efficient operation and reliability.

During the quarter, we also launched innovative productssuch as our AMD Barcelona server solution and a nine of Intel quad-core MP Xeonservers. Most of these products highlight our ability to deliver a variety ofapplications rapidly to market, utilizes our latest in technology.

One of the most innovative products, which we showcased atIntel Developer Forum, was our OfficeBlade server, optimized for officeenvironments and which it is 93% high-efficiency power supply. Our OfficeBladeservers operate at a noise level of less than 50 -TB, which is as quiet as ahigh-end workstation. Now you can have a supercomputer at your desktop.

While this market is more of a niche, it represents anopportunity for additional growth of our SuperBlade platform. Delivering applicationoptimizers, server solutions, and being first to market have been hallmarks ofSuper Micro. The value, which we provide to our customers, has again beenproved by the continuous growth in our revenue and profitability.

We have continued to invest in our infrastructure in orderto support the market's growing needs. We have recently expanded ourengineering employee base, both here in San Jose and in Asia. We have alsoadded more resource to production area in order to meet the demands of our customers.We are continuing to evaluate sites in Asia to expand our manufacturing andwarehousing capacity in the near term, in order to reduce most production andlogistic cost.

All of this is within our plan to grow our technical andoperation capability and capacity to build a stronger foundation for our futuregrowth while maintaining our financial discipline and growing our shareholdervalues.

With that in mind, let me now turn it over to our CFO,Howard Hideshima, who will discuss the financial results and forecast. Thankyou.

Howard Hideshima

Thank you, Charles. And good afternoon, everybody. First letme point out that our GAAP numbers appear in the news release and so I would bediscussing earnings, gross margins, operating expenses, and similar items on anon-GAAP basis, which reflects adjustments to exclude stock-compensationexpenses.

Reconciliation of GAAP to non-GAAP is included in thefinancial statements of the Company in today's earnings release. Let me beginwith a review of the first quarter net income statement.

Revenues of $117.9 million for the quarter, was up 30.8% forthe same quarter a year ago. This growth was lead by the increase in our serversystems business, which increase 43.5% year-over-year or $13.8 million to $45.6million.

Unit volumes on server systems increased 26.7%year-over-year from 30,000 to 38,000 units. ASP for servers also increased onyear-to-year basis, from approximately $1,000 per unit to $1,200 per unit.

The increase in server revenue was primarily due to highersales of our OEM and Series 6000 servers, offset in part by declining AMD-basedservers. Our 1U Twin and UIO products, as well as our enterprise Bladeproducts, continued to gain traction during the quarter.

We continue to maintain a diverse revenue base with none ofour more than 300 customers making up more than 10% of our net sales in thefirst quarter, 61.7% coming from the U.S. and 60.9% coming from ourdistributors and resellers.

Internet data center revenue was 8.6% compared to 3.3% in Q1of fiscal year '07. We started approaching this market about two years ago andhave progressed well in developing solutions which serve this market.

On a sequential basis net revenues were up by $7 million or6.3% from a $110.9 million in Q4. The increase is primarily due to the increasein sales to our OEM customers and continued growth in sales of the 1U Twin andUIO products, offset in part by lower shipments of AMD products. Internet datacenter revenue was 8.6% compared to 6% in Q4.

Non-GAAP gross profit was $23.2 million for the quarter, up28.7% from $18 million in the same quarter last year. Non-GAAP gross margin was19.6% of revenue, down from 20% a year ago. The non-GAAP gross margin declinefrom a year ago reflects higher inventory reserves in Q1 of fiscal year '08 ofapproximately 1%, offset in part by cost reductions in material and freightcosts.

On a sequential basis non-GAAP gross margins increased from18.1% in Q4 to 19.6% in Q1 due primarily to cost reductions on existingproduct, higher gross margins on new products, such as the 1U Twin and UIO andlower inventory reserves.

On a year-over-year basis, non-GAAP operating expensestotaled $13.1 million for the first quarter or 11.1% of revenue, up from 10.6%,a year ago. The year-over-year absolute dollar increase of $3.6 million wasprimarily due to additional R&D, SG&A, head count to support the growthof the Company.

The company's head count grew by 170 from 491 in Q1 offiscal year '07 to 661 at Q1 fiscal year '08, primarily in the areas ofproduction, 207 to 270 and R&D 166 to 236. Overseas head count during thisperiod expanded from 79 to 116.

On a sequential bases non-GAAP operating expenses was up$1.9 million or 16.9%. The increase in operating expenses was primarily due tohigher salaries and payroll expenses associated with increased head count andannual salary increases of about $700,000 and NRE expenses related to our Bladeproduct development of about $700,000.

Non-GAAP operating profit for the first quarter was $10.1million or 8.5% of revenue, up $1.6 million from $8.5 million or 9.4% ofrevenue a year ago. The increase was primarily due to growth in our revenue,offset in part by higher operating expenses to support the growth of thecompany, introduction of new products, and overhead associated with being apublic company.

Non-GAAP operating profit on a sequential basis was up $1.2million or 13.4% from $8.9 million or 8% of revenue in Q4, primarily related tothe higher revenues and gross margins discussed above.

On a year-over-year basis non-GAAP net income for the firstquarter was $6.6 million or 5.6% of revenue, which is up from $5.1 million or5.7% of revenue a year ago. On a sequential basis, non-GAAP net income was up$0.5 million or 8.1% from $6.1 million in Q4.

The tax rate for the first quarter on a non-GAAP basis was36.6%, compared to 37.7% a year ago. The decrease in our tax rate was due toincrease in our benefits from R&D credits.

Our non-GAAP fully diluted EPS for the first quarter was$0.17 per share, compared to $0.16 per share a year ago. Fully diluted sharesused were $38.9 million compared to $32.4 million a year ago.

The fully diluted shares increased by 6.5 million primarily,due to the 6.4 million shares offered in the Company's IPO, which closed onApril 2, 2007. On a sequential basis, our non-GAAP fully diluted EPS increasedby $0.01per share from $0.16 in the fourth quarter.

Turning to the balance sheet on a sequential basis, cash andcash equivalents and short-term investments were $69.4 million, up $3.5 millionfrom $65.9 million in the prior quarter. The increase is primarily due topositive cash flow from operating activities of $4 million in the quarter.

Accounts receivable increased by $7.2 million to $40.7million, DSOs increased by two days to 29 days from Q4, as the company workedto reduce the discount its customers receive from TT and COD payment terms.

Inventories increases by $6.7 million to $73.4 million withthe days in inventory decreasing by three days to 68. The decrease in days wasdue to higher revenues during Q1. Inventory reserves were $10.9 million,compared to $8.9 million in Q4.

Accounts payable decreased by $8.7 million to $70.1 million,with the days payable outstanding decreasing by one day to 64. The decrease indays is primarily, due to the company working with our vendors to gain costreduction and paying on better terms.

Land and building was $27 million, representingapproximately 262,000 square foot of property in San Jose, California at theend of Q1.

As previously indicated in a press release and 8-K filing,the Company closed escrow on a building located in San Jose near close to itsSan Jose facility on October 16, 2007. The building is approximately 90,000square feet and cost approximately $11.3 million.

Historically we have allocated about 70% of the value toland and 30% to building, which is to depreciate over 39 years. Now, for a fewcomments on our outlook.

We have historically seen seasonal revenue growth in ourfiscal Q2 and Q4. We have also seen a historical pattern of increased revenuetraction following the introduction of new products. We believe that thisshould continue this quarter.

New products introduced, during the prior to quarters shouldprovide additional revenue during Q2. As a result, we estimate second quarterfiscal year 2008 revenues to be in the range of $128 million to $135 million.

Let me also say that Charles and I will be at the UBSTechnology Conference on November 15th in New York, presenting at 11:45 a.m.local time. We hope to see you there and we also continue to meet withportfolio managers and security analysts, both on the road and our offices. Ifyou are interested in such a meeting, please contact Howard Kalt at415-692-3059.

With that let me turn it back to Charles for some closingremarks.

Charles Liang

Thank you, Howard. I would like to say that we started thefiscal year 2008 with solid first quarter in which we saw sequential revenue,margin, and net income goals. We continue to work on strengthening ouroperation in the U.S. and abroad and looking forward to and exciting yearfilled with additional innovative products resulting in continued growth inrevenue, profitability, and shareholder value.

We begin our 15 years of operation expecting to continue our14-year tradition of profitability. Thank you all for joining us on ourearnings conference call. With that, we will open the call to questions. Thankyou.

Question-and-Answer Session

Operator

(Operator Instructions) And we'll go first to Glenn Hanuswith Needham.

Glenn Hanus - Needham

Good afternoon. Could you talk -- your gross marginperformance exceeded my model. Could you talk about the sort of relativecontribution of the items you mentioned in your script on the upside there?

And the -- kind of how you’re feeling about thesustainability of gross margins at current levels now going forward?

Howard Hideshima

Okay, very good. I mean, basically because our 1U Twin havebeen growing very well, indeed a bit better than what we thought, and UniversalI/O, UIO product also growing strongly.

Together we started to shipping in production. So all ofthose contributed to our better gross margin. Again, because of new technology,better technology. So it's very important for Super Micro to continue to keepinnovative products and we have a good feeling for those.

However, yes, according to the market, sometime forstrategic reason, we may not gain new market segment or new customer, so inthose cases we may have to be aggressive in price to gain new customer.

So basically we like to control our growth and for sure,control our gross margin.

Glenn Hanus - Needham

And anything on the outlook there, gross margins, do youthink you can hold them here above 19?

Charles Liang

It -- we have options, you know? Basically we try to keep ahalf a number for companies long-term business, and that's good forshareholders long-term future. So from 18 to 19 or something it's all possible.

Glenn Hanus - Needham

I can't quite understand that. It's possible.

Charles Liang

It's possible to keep between 18 or 19 something.

Glenn Hanus - Needham

Okay.

Charles Liang

That's why potable (ph) companies long-term future.

Glenn Hanus - Needham

Okay. That's my question, then. I guess I'll let you move onand circle back. Thank you.

Charles Liang

Thank you.

Operator

(Operator Instructions) And we'll go next to Joshua Solanwith Glacier Bay Capital.

Joshua Solan - Glacier Bay Capital

Hey, guys, how's it going? Just had a question on theoperating expense line. I do think it increased sequentially a little bit morethan maybe I was expecting, and I'm curious if you think can sustain at thatlevel or if we should continue to model growth in there?

Howard Hideshima

Hey, Josh, yes, we -- as I mentioned earlier we had about a$700,000 charge for NRE expenses in our R&D area, and we do -- that was aculmination of probably about three years -- over two years of development workin our Blade server solution business. So again that was a culmination of thatproject. Obviously we'll have other projects going forward, but that was amajor endeavor of the company and we're happy that we went into volumeproduction in that area.

Joshua Solan - Glacier Bay Capital

Is the implication of that that absolute dollar of OpExcould be down next quarter?

Howard Hideshima

Again, we won't see that particular expense incurring, butthere may be other NRE or other charges. But again, that was the $700,000 wasfor the culmination of about a project that lasted over few years.

Joshua Solan - Glacier Bay Capital

I would say even than I though I mean just the other reasonI believe because if I take that out maybe it was up still sequentially morethan I thought. I mean, just --

Charles Liang

The other reason, I believe, because we aggressively growingour foundation in R&D and production. So all of those, including the hiremore people, retrain our people those for long-term a company growth. And Ibelieve it's a very good idea to invest at this moment when company is stronglygrowing.

Joshua Solan - Glacier Bay Capital

That's fair. And on the gross margin line, I think everyoneon the call -- or everyone who follows this because sort of sees you guysgrowing the business 30% a year, at least. You're doing some interesting thingsin Asia as far as assembly there and then a lot of other things to increasegross margin.

And getting back to the last question, I guess, I mean isyour -- and I know there's sort of new products and there are good years andbad years with new products, but I mean is your gross margin sustainably higherbecause of scale and because of all of these other things that you're doingthan it was a year ago or two years ago, on a sort of on a like-for-like basis,assuming new products or not new products?

Howard Hideshima

Yes, Josh, I think we talked quite a bit about buildingeconomic scale being one of our primary short-term goals and I believe thecompany through its revenue performance has continued to build scale. So we'reobviously in better position today as we were in a number of years ago. Andwe'll continue to look at, again, improving and strengthening our position.

Joshua Solan - Glacier Bay Capital

Last question. Could you just give me the absolute dollar onthe inventory write-down number?

Howard Hideshima

About $2 million.

Josh Sloan - Glacier Bay Capital

About $2 million? Okay.

Howard Hideshima

Yes.

Josh Sloan - Glacier Bay Capital

Which again compares to last quarter it was about $2.7million. Is that higher than it should be?

Howard Hideshima

It's what we believe. Obviously, we look every quarter atthe end of every quarter and make our estimates to put what we believe is anadequate reserve.

Josh Sloan - Glacier Bay Capital

No, I was just saying going forward maybe. Is there a way weshould think about it maybe as a percent of sales or something like that?

Howard Hideshima

Again, last year we had about 1.3% for fiscal year '07 wasour inventory provision. Again, this quarter it ran a little higher and again,we'll look at it every quarter.

Charles Liang

In the long term, we hope we can continually improve,though, because in the past couple of quarter, as you people know, TTI won andthose have been issued to lot of company and looking forward to next fewquarter, I believe we have room to improve.

Josh Sloan - Glacier Bay Capital

Well, I mean, I guess all of this really bodes well forgross margins going forward, I imagine. Thanks a lot guys, appreciate it.

Howard Hideshima

Thank you.

Operator

Thank you. We'll go next to Vamzy Mullen (ph) with MerrillLynch.

Vamzy Mullen - Merrill Lynch

Hey, Howard and Charles. Question I had was also pertainingto gross margin. You guys mentioned a higher gross margin from new products,cost reduction and also lower inventory reserves.

If you rank ordered those, Charles, should I take youcomment that new products were the primary driver of the higher gross margin?

Charles Liang

Pretty much new products, especially 1U Twin and UIO.

Vamzy Mullen - Merrill Lynch

Okay. And from a component cost perspective, how much wasthe impact in gross margins was that?

Howard Hideshima

Yes, Vamzy, on a higher gross margins and cost reductions,we had about 1.5% made up by that.

Vamzy Mullen - Merrill Lynch

Okay. Thanks. And can you talk about the impact from Ablecomon your gross margins?

Howard Hideshima

Sure, happy to. It was minimal. It resulted in about eightbasis point increase to our gross profit in Q1, and there are purchasesrepresented about 23%, 23.7% of total cost of goods sold, which is down fromprior quarters and prior year.

Vamzy Mullen - Merrill Lynch

Thanks, Howard. And can you comment on what your, how you'rethinking about balancing between revenue growth and margins? I mean in thisquarter, did you make a conscience decision and walk away from some of thelower-margin businesses? I mean it looks like your Internet data centercustomer percent actually went up, so can you elaborate on that a little bit?

Charles Liang

Indeed, you are right. I mean, in those case we have achoice to upgrade you in some competitive deal or not. So looking forwardagain, we had to keep the company able to grow more than 30% year after year.That’s pretty much our bottom line.

And once above this bottom line, I mean, we try to have adynamic choice to viable basically our company and for our shareholder.

Vamzy Mullen - Merrill Lynch

Thanks, Charles. One more, if I could. How large of animpact were Blades on revenue growth in this quarter and how should we thinkabout it next quarter? Obviously, HPC class is doing really well. IBM's notdoing as well in that particular segment.

Are you seeing, relatively speaking what particularverticals or what particular areas are you seeing opportunities in the Bladeproduct? Thanks.

Charles Liang

Yeah, very good. Basically, we spend almost three years todevelop our progressive product line. Finally we are very happy, it's ready forproduction. However, revenue growth won't be sharply because in our new portalwe try to be conservative, so from some customer, although we shipping in somevolume, but we try to control the growth.

Because overall 30 something percent, again is our bottomline growth rate and in the near future we too feel very exciting for thisstrong product line. We have enterprise Blade server and then coming soonOfficeBlade.

Like I just mentioned, our OfficeBlade perform at about 50TP noise level, which is like a high-end workstation, so very suitable foroffice environment. Before people don't believe Blade is good for officeenvironment. Now we make that product -- that possibility available. So again,in next couple of quarter and near future, we feel very excited for this strongproduct line.

Vamzy Mullen - Merrill Lynch

Thank you.

Charles Liang

Thank you.

Operator

(Operator Instructions) And next we'll take a follow up fromGlenn Hanus with Needham.

Glenn Hanus - Needham

Can you talk, Howard, a little bit more about you mentionedthe discounts and that you're getting better terms are suppliers and with yourcustomers and your suppliers. Can you give us some quantification or some wayto think about how that's progressing and how much more progress might beavailable?

Howard Hideshima

Yes, sure, Glenn. With regards to our days, we went to 29days and previously it'd been in the low 20s and we're working our way upthere. It's primarily because we do have a good portion, the majority of oursales had been in the TT and COD type of terms, which the Company has thetraditionally offered anywhere from a 1.5% to 2% discount for those types ofterms.

So we've been weaning our customers off, trying to move ourcustomers off to more standard terms, like net 30 and what have you, and thathas contributed to the gross margin pickup. As I mentioned the combination ofthe 1.5% for new product introductions, cost reductions, it's all put in tothat bucket.

Glenn Hanus - Needham

Okay. Can you maybe talk about how you're feeling about the impactof server virtualization products on your business?

Charles Liang

Yes, I mean, about 18% of our product application optimizemarket, so we see this segment impact from virtualization is much smaller. Yes,we have some general-purpose server markets where each year faced to a morechallenge with tradition. However, in the more virtualization application,people need really high-performance, high-density system, and as you know, weare very good, very strong in this area.

For example, our Intel MP system, AMD MP systems all aregrowing quickly. And that’s 1U Twin, lots of people use the 1U Twin forvirtualization application as well. So when virtualization become more popular,I do feel very optimistic regarding the impact to our business.

Glenn Hanus - Needham

Any comments you can make on the competitive landscape yousaw in pricing environment through the quarter versus HP, IBM, and DELL?

Charles Liang

Yes, that market, in last quarter from what I observe isquite stable. Again, the market continued to be very competitive, but basicallynot much change in last quarter. And looking forward, I believe our foundationbecome bigger, stronger.

Our market share we're continuing to grow. So the challengewill be continued stronger effort but looks like we should be in better shapethan before.

Glenn Hanus - Needham

And more specifically on the enterprise Blade productsversus HP and IBM, any commentary you want to make there?

Charles Liang

We are new, right, and that's a fact. Now we send a lot ofsystems for customer to start practice our system and order feedback are quitepositive. So we have very good confidence that our Blade will be a successfulproduct, especially our Blade server provided some feature that our competitorscannot beat us. For example, computing, density, high-efficiency power supply,and also very directory. Our cost advantage is quite good in Blade server.

Glenn Hanus - Needham

Thank you.

Charles Liang

Thank you.

Operator

(Operator Instructions) And it appears at this time we haveno further questions. I would like to turn the call back over to Mr. Liang forany additional or closing comments.

Charles Liang

Thank you. Thank you for joining us today. We are pleased tobe a member of the public marketplace, and we look forward to talking to youagain at the end of the next quarter. Thank you, everyone. Have a good day.

Operator

Ladies and gentlemen, this concludes the Super MicroComputer, Inc. first quarter 2008 conference call. We do appreciate yourparticipation. You may disconnect at this time.

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