The common approach to monitoring related-party transactions has been (i) disclosure of potential conflicts of interest in regulatory filings and (ii) financial governance by ‘independent’ directors on the board, representing the outside shareholder interests. Nonetheless, despite the intended transparency, these ‘best practice’ principles do little to stop insiders from enriching themselves at the expense of ordinary stockholders.
Charles Liang and his spouse, Chiu-Chu (Sara) Liu Liang, who co-founded Super Micro Computer (SMCI),
and are currently the Chief Executive Office/ Chairman of the Board and
Vice President of Operations/Treasurer, respectively, of this provider
of high-performance servers and workstation solutions, continue to
financially enrich themselves and their families through stakes in
related-party transactions, according to a proxy statement filed last
week with the Securities and Exchange Commission.
Transactions with Ablecom Technology Inc.
Charles Liang and his wife jointly own approximately 30.7% of Ablecom, a Taiwan-based contract manufacturer that provides product design, outsource manufacturing, and distribution services for SMCI.
Ablecom’s chief executive officer, Steve Liang, is the brother of Charles Liang (and beneficially owns approximately 2.6% of SMCI’s common stock).
In addition, Yih-Shyan (Wally) Liaw, Vice President of International Sales and a third founder of SMCI, and Mr. Charles Liang, Ms. Liang, Mr. Steve Liang, and relatives of these individuals own more than 80% of Ablecom's outstanding common stock.
Ablecom’s net sales to SMCI and its net sales of SMCI products to others comprise a substantial majority of Ablecom’s net sales. SMCI purchased products from Ablecom totaling approximately $95.67 million, which represented about 34% of cost of sales; products sold to Ablecom (for distribution in Taiwan) totaling approximately $7.32 million for the fiscal year ended June 30, 2007.
SMCI intends to increase its business operations in Asia, currently about 14.3% of net sales. In an effort to reduce product costs, the Company plans to expand its warehousing capacity and its manufacturing relationship with Ablecom in China, according to management. This increasing reliance on Ablecom as a limited-source supplier, however, could subject the Company to disruptions in supply, compromising the Company’s ability to satisfy customer orders on a timely basis.
The 10Q Detective is suspect of this ‘cost containment’ defense, for pursuant to contract terms, Ablecom is the exclusive manufacturer of many chassis and power supply products sold to SMCI! In addition, business dealings with Ablecom are not arms-length agreements—which means the commercial terms of these agreements may be less favorable than contracts that might be obtained in negotiations with unrelated third parties.
For the 1Q:08
ended September 30, 2007, cost of sales increased 40 basis points to
80.5% of net sales, driven by an increase in sales of more mature
products (which have a decrease in average selling prices).
10Q Detective is raising a red flag, too, regarding independent
director composition. Although the board is controlled by a slight
majority of independent outsiders (four out of seven), the
founders—Charles Liang, Sara Liu Liang, and Yih-Shyan (Wally)
Liaw—collectively control 41.7% of the common stock outstanding, which
raises additional questions about the oversight effectiveness of the
outside directors in place at SMCI.
There is nothing more corrupting, nothing more destructive of the noblest and finest feelings of our nature, than the exercise of unlimited power. ~ President William Henry Harrison (1773 – 1841)
signings with Ablecom suggest that the independent directors might not
be serving their intended purpose in aligning the interests of
management with those of common stockholders.
The computer server market is highly competitive, with the Company squaring off against hardware giants like Dell (DELL), Hewlett-Packard (HPQ), and IBM (IBM), as well as original design manufacturers like Rackable Systems (RACK) and Quanta Computer.
In business since 1993, Super Micro Computer went public at $8.00 a share (March 29, 2007), hitting a 52-week high of $11.85 (June 5, 2007). Recent price weakness, however, reflects investor skittishness with the overall softness in the market for core server sales.
Cautionary economic indicators and signals that
competitors continue to lower forward revenue guidance would
suggest—that short of take-over rumors—few catalysts exist for a
recovery in SMCI’s share price.
Author David J. Phillips does not hold a financial interest in any stocks mentioned in this article. The 10Q Detective has a Full Disclosure Policy.