Super Micro Computer, Inc. (SMCI) Earnings Call Transcript & Summary

Hi. Good morning, everyone, and thank you for joining us on our Day 2 of our virtual tech conference. I'm Wamsi Mohan, IT hardware and supply chain analyst at BFA. We're delighted to have Super Micro Computer with us today. We -- although we don't actually cover the company today, I actually am reminded a time about 13 years ago when Super Micro went public. And that was a time when we did cover the company for several years post that in the late 2000s. So anyway, we're delighted to have Kevin Bauer, SVP and CFO of Super Micro. So Kevin, welcome, and thank you for taking the time.

Thank you, Wamsi. And to all of our listeners, Good morning.

Good morning Kevin. So maybe to start off, can you give investors a brief introduction to Super Micro, those that might not be quite as familiar with the story. Who do you consider your major competitors? And how you guys drive competitive differentiation versus these competitors?

Sure. So I think it's important to kind of step back a little bit and share what was the genesis of the company's expertise and how has it evolved over the period that, for instance, you were familiar with it. But I think, first and foremost, Super Micro is an engineering-led company. So therefore, product innovation is really our claim to fame since going public and even prior to going public, the company has a tremendous history of growth and profitability and market share gains across that time frame. It is a medium-scale supplier of hardware. And what it tries to do is give the broadest range of application optimized servers and storage. So therefore, that engineering expertise is really deployed towards application-tuned workloads within our company. And part of what Charles did in terms of architecting the company early on was to use a building block approach to be able to efficiently develop those kind of optimized servers for those applications. And what that has allowed us to do is really have the fastest time to market with the broadest array of products, especially during technology changes. And so along with that, the design expertise in the company is really towards making sure that they're most power efficient. And later on, we'll talk a little bit about Charles' passion of being a green supplier. Over the course of time, the company started as basically a motherboard company and has grown in terms of selling systems for quite some time. And we have enhanced our software and service offerings to be able to compete better across the competitive landscape that we'll talk a little bit about now. So major competitors, certainly, domestically, we compete with Dell and HP. And we have been able to, over the course of most of our history, outgrow them and be able to offer services in alignment with their full capabilities, and we continue to grow in that arena and compete with them fairly strongly. As you know, there are companies that have more limited hardware options. We try to compete by having more hardware options to tune to specific challenges that our customers have. On the other side, when it comes to hyperscale, we don't engage too much in hyperscale these days. But certainly, white box manufacturers are on the other side of us in terms of who competitive -- competitors are. So how do we drive our competitive differentiation? It's really on the backs of our hardware engineers in terms of developing products that are keenly tuned towards specific workloads and at that type of advantage, you're really looking at the medium volume customers and where you're able to compete in that arena. So we've been successful in terms of becoming a systems kind of a company. And historically, the company guided its beachhead and systems by working with some internet data center companies. And over the course of years, we've been broadening in terms of a footprint of being able to be successful in enterprise customers who want very high reliability as well as white glove service.

Okay. That's great. No, that's a great introduction. So just a follow-up on that, Kevin. Would you say that when you go into these bids versus Dell and HP, are you focused on the customization element? And which sort of applications and customers value about the most?

So yes, it's true. It's really where customers want some super efficiency in one parameter or another. The company and its past has talked a little bit about its success in the Intel data center. And to use that as an example, we worked very closely with the leadership there at Intel. We're a very close partner with them. And in terms of being able to come up with products that are super efficient and allow for upgrades on future components, we've been able to innovate such that their cost of compute on a go-forward basis was greatly enhanced.

Okay. Great. So Kevin, what are some of the key applications driving your business? And how do you segment your business?

Sure. So I would say that if we look at our current business today, some of the segmentation that investors are aware about is that, certainly, we have compute and storage as well as customers know that we do have a fairly decent business working with other OEMs who compete in the marketplace. One that people know of is Nutanix. So by working with them, certainly, we're able to enter into that market of the hyper converged. We also are oftentimes the hardware supplier of choice of other companies like that, that are building out appliances, and they have great software expertise. So that's a fairly decent part of our business. And all of those things are really the legacy portions of our business. As we look forward to the kind of applications that are going to drive the business in our last quarterly call, Charles outlined the opportunities that are before us in terms of AI and also...

Okay. Kevin, we -- I think your line went on mute, possibly. Operator, can you...

Yes. Sorry.

Oh, okay.

Yes. So certainly, in terms of AI, we are engaging in terms of new products in terms of 5G and edge. So therefore, those are some of the key markets that we think are -- we're able to grow in, in addition to that. Charles had mentioned that we have developed a new line of lower cost products whereby we think that we'll be able to try and engage a little bit more where the growth is in the public cloud. And what he's articulated there is that, that's a place where sometimes it's difficult to make a buck and that we need to be careful in terms of the way that we engage, looking for the right opportunities to be able to, in the future, participate a little bit in that growth.

So Kevin, just a follow-up on that. In the public cloud, right, like you've got part of what the public cloud providers, the hyperscalers need is very customized. But on the other hand, you largely get that done through ODMs out in Taiwan. So how are you guys deciding where in that market is beneficial to compete for Super Micro?

Yes. I think, first and foremost, you called out the ODMs in Taiwan, and it's important to note that, that's where we would seek to be able to produce these products as well at a better cost structure. But as it relates to specific applications and opportunities, we, from time to time, get views of bids that are out there. I can't really divulge exactly where those opportunities are, but we're preparing to be able to address those.

Okay. So let's talk a little bit about the medium and long-term growth opportunities. What do you see as the key areas that you guys are focused on today? And does COVID potentially can reach the trajectory of those opportunities for you?

Yes. So I think in terms of AI opportunities, I believe that the growth in AI is just going to continue on and that our ability to be able to address those with our GPU products is probably going to be unfazed by COVID. I think that, that has its own ability to drive innovation. So therefore, I'm not so concerned particularly about that. As it relates to our ongoing supply of our legacy business, certainly, that has ups and downs as it relates to how COVID could accelerate or decelerate those opportunities. We're lucky in that most of our customer base is really in the IT infrastructure arena. We don't have too much exposure to, like, say, for instance, oil and gas, not too much in terms of retail that have been hard hit by COVID in the immediate impacts of it. I know a lot of our investors view that COVID could accelerate IT requirements in the second half of the year. And I think we subscribe to that theory. But COVID in and of itself is challenging at the enterprise level as well. So certainly, we, like most companies have tried to navigate a number of levels of disruption of COVID. So we talked about the fact that in order to be able to supply those opportunities, we've had to be very careful in terms of management of our supply chain. We've had to address the emerging issues in logistics, being able to get components to us on time. And just here in the last week, COVID has been, I'll say, COVID, but COVID as a baseline to be able to -- on top of the issues that happened in Minneapolis. We now have social unrest that is affecting us here in Silicon Valley in that -- like many cities around the nation. We're subject to curfews, and that's kind of disrupted our evening production flow as well. So those are things that we're trying to deal with in the short-term and in the midterm, I think, over the long-term, it really depends in terms of the level of disruption of COVID as the duration of the disease and any impacts of it resurfacing to have major outbreaks, those are things that are difficult to know.

Okay. So have you attempted to prioritize those growth opportunities in terms of potential impact? And then from a margin perspective, how would these different opportunities contribute towards the growth in operating margin line?

Yes. So I think on all fronts, we're really focused on AI and bringing up very strong products to be able to service both the training and inferencing markets within that. We know that the growth rates expected for that spending is very strong, almost 20% CAGR over the next few years. So certainly, we're focusing very heavily on our GPU products. We have varying expectations in terms of margins in that arena based upon the complexity of those particular products. But I think -- in the end, we think that those would be near to a little bit better the kind of margins that we're putting down today. As it relates to 5G and edge, I think there are some products that we have come out that are pretty innovative. If you were to look at our website, we have some products that are really focused towards being able to be mounted on base stations with all of the weather-related protections that would be needed in that particular environment. We see those as maybe being a little bit slower growth as 5G continues to grow and emerge. But we believe that those are probably going to be a little stronger margins as compared to what we've been able to deliver given the complexity of those products. On the other side of the edge products, where maybe it is retail, obviously, those things are going to be a little bit more cost sensitive and maybe competitive as it relates to margin opportunities on a go-forward basis. But those are kind of how we think about the big things that are our drivers.

Okay. That's helpful. Can you talk a little bit about what you are expecting from a commodity pricing environment? And do you guys do any strategic buys? Or are you planning to do any strategic buys in the near future?

Yes. I think the company historically has done pretty well in terms of its navigation of when commodity prices change up and down. Recently, we've had commodities increase in price, specifically memories. And we're of the same mindset that those may soften a little bit as time goes by, we'll see what happens because there's like there's mixed communications that are out there. But we hold roughly about 90 days of inventory and try to navigate transitions and commodity costs when they arrive by buying ahead when we think that commodities are going to increase and then reverse on the other side. We don't have any long-term contracts, so it's not right to say that we buy at spot, but it's near spot. And we're pretty efficient in being able to most times get those costs passed on to customers. But there's times when we choose not to do so just because we're concerned about the competitive environment. But as I have shared with investors over time, if you were to look at our margins in the 2017 and '18 time frame when there was an extended period of elevated commodity costs, it's harder for the company to make a gross margin number during those times because the oligarchical markets are making a hefty margin during that time frame. And our customers don't care too much for us to take additional markups in that kind of environment, but when it's more modest, like we've seen in the last year or so, we're able to do a little bit better in that arena.

Okay. That's helpful. Can you actually also talk about sort of wafer investors who think about your cash conversion cycle and how you guys are managing that? And are you seeing any -- given what's happening with COVID, are you seeing any of those metrics stretch out?

I'm sorry, the conversion cycle? Which one did you say?

The cash conversion cycle.

Yes. Certainly, I mean, if you break it down by elements, certainly, we are investing in defensive inventories. So there certainly -- that's going to be a negative impact to the cash conversion cycle. There are -- our chief competitors made big announcements about spending payment terms to customers as a way for them to induce them to continue to buy. We haven't had to do that. So on the AR side, I think we're still in pretty decent shape as compared to pre-COVID days. But really, it's -- for us, it's that supply chain defensive tactic of booking of inventory so that we don't -- are not subject to some new disruption that happens.

Okay. That's helpful. When -- if you think about sort of the way a lot of the market is reacting, it is expecting the stock markets reacting. It is expecting an improvement in demand patterns looking out several months, maybe even sooner in some stocks. But how are you guys equipped to handle, let's say, if demand does improve significantly, how would you guys be able to capitalize on that? And can you talk about the status of your manufacturing footprint today?

Sure. So there are certain signs out there that it could improve, and that is just that the demand picture could get stronger. Certainly in the second half of the year, we've got a number of technology refreshes that are on the horizon with Intel, AMD and NVIDIA as well. It's not often that you have 3 technology refreshes occurring roughly in the same time, so we view that as opportunity. So therefore, we have been very, very focused on ensuring that we will have product availability for all of those technology refreshes as it relates to COVID impacting those things. We've had a lot of people work from home. But the key engineers that are designing these products are predominantly on-site actually today, still continuing to work to make sure that we're prepared when that happens. You can imagine that it's not easy for a hardware engineer to be able to do his lab work from home. So kudos to our engineers for coming in and really working to help us be prepared for that second half of that technology change. I think other things that we're looking at too is that if demand picks up, we view that there can be disruption, as we've talked about in the supply chain as well as logistics and within customers as well. And so therefore, we're very mindful of making sure that we protect our customer engagements and potentially look at other opportunities that are out there to engage new customers. And so therefore, our view is that we could maybe take a little bit more aggressive approach in terms of trying to see if there's opportunities to gain share in that meantime as well by being a little bit more aggressive. As it relates to our manufacturing footprint, we have, in terms of building and assembly lines, we have excess capacity right now that we've built out. I don't want -- I shouldn't say excess, we have extra capacity that is built out. We have it Taiwan, we have it in the U.S. and to a lesser extent, in the Netherlands. So therefore, it's a matter of really continuing to build our trained assembly workforce to be able to take advantage of that. So I think from a manufacturing footprint perspective, we're well positioned to be able to dial up production with opportunities that are in front of us.

I'm curious, Kevin, there's been a lot of rhetoric around supply chains starting to decouple in some ways where there is going to be an Eastern supply chain and a Western hemisphere supply chain. There was worries, obviously, about restrictions that are being put on China, certain licensing requirements, that might drive inability to have access to some sort of high-tech IP. Given all these, a, does any of this affect Super Micro? If yes, how? And do you see your manufacturing footprint change in some material fashion where a lot of customers might -- domestic customers might want that production to happen here domestically? Do you think that, that's -- what was the probability you would assign to that? And do you think that, that's a likely scenario and that's what you would be able to manage through?

Yes. So let's talk a little bit about the things that have happened in the past where we've actually landed in a pretty good spot where we are today. So first and foremost, we have transitioned more of our motherboard manufacturing to Taiwan out of China. And some of that was prior to in response to the concerns over what we considered to be the fake news article of Bloomberg a couple of years ago, just so that we can state strongly for our customers that we have a very secured supply line. So as it relates to some of that, as I said, that motherboard manufacturing, we're heavily -- more heavily in Taiwan now than in the past, and we had more content within China itself. Today's footprint is that most of the production for domestic customers already is in the U.S. So we don't necessarily have to bring production back from other sites, so I think that is secure as it is today.

I see. And what percent would you say is that of your total production?

It's certainly over 50%. It's probably 60%, 65% in the U.S. and mostly for domestic customers.

Okay. Great. That's helpful. Your CEO, Charles, has talked about leader list reunite the evolution and Super Micro's resource saving architecture. Can you talk a little bit about that and how that sits into your overall strategy?

Yes. So that's really the convergence of Charles' passion and his engineering expertise. So as a company that leads with hardware advantages and from an engineering perspective, where it's really our design DNA is our competitive advantage. He has merged that with his view of really, really making efficient products. So we have a long history of being innovators in terms of all of the elements of our design to make sure that we take advantage of free airflow and our cooling to having very efficient power supplies that drive the whole server itself, all in the guise of being able to deliver the best performance per watt per square foot in terms of the value of our products. So form factor is very, very important in terms of density. Low power usage is very, very important. And so therefore, that's kind of the way that we have viewed it. And that's why we were so successful in Intel. It's really driving down their usage of energy and design for reuse in some of the components. So that resource savings architecture is one whereby we look to be able to allow customers to not have to replace the entire server as time goes by and be able to take advantage of the fact that some of the components in the system have a longer life than some of the elements like CPUs or whatever where the technology refresh is more frequent. And the driving force behind that is to be able to deliver total cost over the course of multiple generations of systems to be most efficient for our customers. But another driver behind that is that Charles knows that many of the nasty chemicals that are in our landfills are due to our industries, providing or obsoleting printed circuit boards, which have a lot of stuff on there. So that's some of the driving forces behind him. Now how does that fit in our overall strategy? It kind of goes hand-in-hand in terms of being able to deliver the most efficient products to customers, both in energy as well as life cycle cost. And to be able to do that with optimized products for all sorts of applications. So it's on all 3 of those fronts, the kind of the strategies can serve -- converge rather to be able to give the best hardware solution to our customers.

Okay. That's helpful. So I understand you're planning your first Analyst Day. When is it? What kind of information do you plan to provide to investors at that time, particularly as it pertains to your operating model?

Yes. Sure. So I think, first and foremost, we've gone through a couple of year period where we've been kind of quiet as we've -- people -- most people know that we had to go through restatement and get back on the public markets. And during that time frame we weren't communicating an awful lot to investors. We are focused on job one, and it's most important for us to enhance what we've talked about here today, sharpen the strategy, be more clear about the specific growth factors that we have in front of us with more meat in terms of the way that we view our advantages and why is it that we'll be successful in those markets. So you've got a little taste of it today, but not the full element that we hope to be able to provide in that Analyst Day. As it relates to the model, we are working to drive what is the P&L strategies of the company. We're a growth company, and there are some parts of the market where we're able to make good margins, others where it's going to be a little bit thin. And so we're taking the time to determine the path forward in terms of what are our key metrics. So we will, first and foremost, always be a growth company. And as it relates to a lot of questions we get around the gross margin, I think, our focus when we come out maybe more surrounding growth in the gross profit dollars and how that leads to -- is compared to the investments that we're making. What can we do in terms of our operating margins over the course of time? And then you asked earlier about working capital and how can we be more efficient in that arena. So those are some of the things that we mean to come out with in a stronger way in our Analyst Day. At the moment, we're thinking that, that would be after the earnings season in August. We'll have that behind us. We'll be working on our year-end 10-K, but that would be a good time to be able to come out. And if luck would have it, we'd love to be able to do that in person, but we'll see how COVID evolves over the next few months.

Yes. For sure. So we're almost out of time. Any final thoughts you would like to leave investors where as they say, as they consider Super Micro?

Yes. I think we're a story that is emerging once and again. We hope that you'll take some time to be able to look at us. We're refocusing on repriming the search engine for growth after the last 2 years that have been a little bit flat. And we're certainly teeing up to be able to outgrow the market again. So stay tuned.

Perfect. Well, Kevin, thank you so much for your time today. We really appreciate it, and we hope to see you at the upcoming Analyst Day, hopefully, in person. And thank you again for taking the time today.

Thanks for your time.