Perry Hayes - SVP of IR Charles Liang - Founder, Chairman of the Board, CEO and President Howard Hideshima - CFO and SVP.

Joseph Quatrochi - Stifel, Nicolaus & Company Mark Kelleher - D.A. Davidson & Co. David Ryzhik - Susquehanna Financial Group David Kurtz - Pacific Crest Securities Nehal Chokshi - Maxim Group Brian Alger - Roth Capital Partners.

Welcome to the Super Micro Computer, Inc. Third Quarter Fiscal 2017 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 it has made available to its 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. [Operator Instructions].

As a reminder, this call is being recorded, Thursday, April 27, 2017. A replay of the call will be accessible until midnight, Thursday, May 11, 2017, by dialing 1 (844) 512-2921 and entering replay pin 7820076. International callers should dial 1 (412) 317-6671.

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 would like to turn the conference over to Mr. Hayes. Mr. Hayes, please go ahead, sir..

Good afternoon and thank you for attending Super Micro's conference call on financial results for the third quarter fiscal 2017 which ended March 31, 2017. 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. 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 2016 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 will refer to non-GAAP financial results and outlooks.

For an explanation of our non-GAAP financial measures, please refer to Slide 3 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.

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

Thank you, Perry and good afternoon, everyone. Let me summarize our third quarter. Revenue was $631.1 million. It's 18.5% higher year-over-year and 3.2% lower than the previous quarter. Non-GAAP net income was $20.3 million. Non-GAAP earnings per share was $0.38 per diluted share compared to $0.48 last quarter and $0.36 last year.

It was 5.6% higher year-over-year and 20.8% lower than last quarter. Overall, we exceeded our previous financial guidance and achieved our highest financial fiscal third quarter revenue ever. In many ways our revenue result was exceptional. We saw double-digit revenue growth overall and triple-digit growth in some key segments.

Our revenue growth was exceed despite of this seasonally challenging quarter. Revenue were achieved despite continuing shortage for memory and SSDs, resulting in a significant components price increase. Compared to last year, our revenue was more broadly distributed across our customer base without relying on any single 10% customer.

On the product side, we continue to offer the industry's largest portfolio of server and storage systems and to be first to market with new products and technologies. Customer are anticipating the technology transition to the next-generation Intel Xeon processor-based platforms, codenamed Skylake.

We're ready to deliver a comprehensive portfolio of next-generation X11 systems, supporting new features and higher performance offered by the Skylake processor and our new innovations. Early shipments of X11 solutions will begin in early May.

We introduced a new fifth-generation print design, a 2U 4-node, BigTwin, delivering the highest performing Twin multiple-node system supporting 205 watt 2U Xeon processors, 24 DIMMs and All-Flash NVMe per node.

We anticipate the new 8U SuperBlade leveraging the advantage of blade computing with other traditional blade cost of premium and proprietary knock in. Looking at our core markets.

We saw strong distribution in -- we saw strong contribution in storage and IoT and achieved triple-digit growth in our enterprise and accelerated computing segment from last year. Storage was, again, our strongest segment with 22.5% of total revenue, up 28.7% from last year.

Our next-generation storage partners account for 53.2% of this storage revenue and grew a strong 74.2% year-over-year. Our customers choose Super Micro based on the advanced features and capability of our All-Flash and hybrid NVMe SSD systems.

We also saw strong growth in our traditional enterprise storage from the capacity maximized top-loading 4U 90-bay and 60-bay solutions. And coming soon, we will introduce a volume-centric, 45-bay system to the portfolio. Internet data center was 10.7% of total revenue, down 51.4% from last year which included 10% customer.

We're working closely with large and medium-sized private and public cloud customers on the new-generation agreements and implementing our super rack scale design solutions. IoT embedded was 10.5% of total revenue and was up 38% from last year. We saw a $10 billion estimated addressable market from age to cloud across the traditional embedded demand.

Our IoT embedded portfolio will see continued strong growth. Enterprise private cloud is the key to our revenue and margin growth strategy and grew 578% year-over-year from a relatively small base.

Our engagements with the leading Global 1000 companies increased to the highest level ever, including a Silicon Valley Fortune 100 enterprise company with over 30,000 MicroBlades. That is one of the world's largest and most efficient data center with a PUE of 1.06 and 280 nodes per rack LSP.

Our management software and global service grew 87% year-over-year, providing the ability, serviceability and quality for our rapidly growing -- expanding enterprise customer base. Accelerated computing solutions for AI people learning, machine learning and HPC was 5.9% of total revenue and saw triple-digit growth of 176% from last year.

We offer the most advanced NVIDIA, Tesla and Intel Xeon-Phi and air PGA designs, including 1U 4 Tesla P100 solution and the new 4U design that support 10 GPUs with direct BMA support. New air PGA-based solutions provide compression, encryption and visualization are emerging and we have several air PGA customer design wins underway.

Finally, from a geographic perspective, Asia was our strongest geography for growth last quarter and up 92% over last year and reaching 23.9% of total sales. China revenue grew triple-digits, up 138.9% year-over-year.

Looking ahead, our previous strategy for long term investment in global service, management software, engineering, product solution, operation and worldwide manufacturing capacity are finally providing leverage and better economics of scale for continuous revenue, profit and max share growth.

We will continue to lead with innovation and being first to market with the most advanced solution for the next-generation processor, new NVMe, new storage architecture, rack design and cloud scale architectures.

In summary, we're getting recognized as the new model for Tier 1 solution provider and have been the fastest-growing server and storage systems company in the world for multiple years.

Our double-digit revenue growth demonstrates that we're on the right path and our triple-digit growth in key segments and markets demonstrated that our business model and strategy is working well. I'm pleased with the growth in our business opportunity as we enter the new technology driven cycle.

For more specifics on our third quarter, let me turn it over to Howard..

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 third quarter income statement. Please turn to Slide 5. Revenue was $631.1 million.

It's a record third quarter for Super Micro, up about 18.5% from the same quarter a year ago and down 3.2% sequentially. The increase in revenue from last year was widespread in terms of market verticals. We saw growth in storage, enterprise, IoT and accelerated computing. This was offset in part by decline in Internet, data center and cloud.

On a geographic basis, we had strong growth in Asia of 92%, followed by Europe at 23.1% and the U.S. at 2.3%, while the other was down by 8.5%. The 3.2% sequential decrease in revenues was less than seasonal declines we experienced over the past 2 years of 6% and negative 17%.

The improvement over normal historical seasonality was primarily driven by our strength in Asia, up 9.4%; and in other regions, up 20.5%. In particular, China was up 29.3%, as we leverage our growing partnerships. Slide 6. Turning to product mix.

Proportion of revenues from server systems was about 70% which is comparable to 69.9% the same quarter a year ago and from 68.1% last quarter. We shipped approximately 139,000 nodes in the quarter which compares to 145,000 in the prior quarter and 126,000 in the prior year.

ASPs per compute node was about 3,200 per node versus 3,100 per node last quarter and 3,000 per node last year. We shipped approximately 1,085,000 subsystems and accessories which is up from 950,000 last year and down from 1,214,000 last quarter. We continue to maintain our diverse revenue base with over 700 customers.

No customers represented more than 10% of our quarterly revenues. Cloud, Internet, data center revenue was 10.7% which was a decrease from 13.8% in the prior quarter and a decrease from 26% in the prior year. 52.9% of our revenues came from the U.S. and 46% from our distributors and resellers. Slide 15.

Non-GAAP gross profit was $88.7 million, up 11.6% from $79.4 million in the same quarter last year and down 5.4% from $93.7 million sequentially. On a percentage basis, gross margin was 14%, down from 14.9% a year ago and from 14.4% sequentially.

Price changes from Ablecom resulted in no basis point change to the gross profit in the quarter, with total purchases representing approximately 11.5% of total cost of goods sold compared to 12.2% a year ago and 11.6% sequentially.

The year-over-year decrease in gross margin of 90 basis points was primarily due to the cost increase of memory and SSD components which we could not pass on to some of our server customers as well as many of our systems being based on mature late life-cycle processors such as Grantley which means lower prices.

Geographically, we had higher sales in Asia where pricing is typically more competitive. Utilization on a global capacity basis was lower at about 54.6% compared to about 63.9% a year ago. This resulted in approximately 20 basis points of negative effect on gross margin.

Sequentially, gross margin was down 40 basis points primarily due to the cost of memory and SSD components continuing to rise during the quarter which in some cases was over 30% which we could not pass on to some of our server customers.

In addition, lower utilization of our global capacity which was 54.6%, down from 65.8% last quarter, resulted in 10 basis points gross margin decrease. Slide 16. Operating expenses were $61.4 million, up from $51.1 million in the same quarter a year ago and from $57.2 million sequentially.

As a percentage of revenue, operating expenses were 9.7% which is up from 9.6% in the same quarter a year ago and up from 8.8% sequentially.

Operating expenses were higher on an absolute dollar basis year-over-year by 20.1%, primarily in R&D as we invested in personnel expenses to support the development of our total solutions and rollout of new products for the upcoming technology refresh cycle. We increased 157 headcounts in R&D which is about a 14.9% increase.

Sequentially, operating expenses were higher by $4.2 million or 7.3%, primarily due to translation foreign exchange loss of $1.5 million which is a $2.1 million delta from last quarter and $1.2 million higher R&D component -- compensation expense. In authorical the $1.5 million foreign exchange loss represented about $0.02 in fully diluted EPS.

The company's total headcount increased by 168 sequentially to 2,965 total employees primarily in operations to support the growth of the business. Operating profit was $27.2 million, down by 3.8% from $28.3 million a year ago and down by 25.3% from $36.5 million sequentially.

On a percentage basis, operating margin was 4.3%, down from 5.3% a year ago and down from 5.6% sequentially. Net income was $20.3 million, up 7% from $19 million a year ago and down 18.8% from $25 million sequentially.

On a non-GAAP fully diluted basis, EPS was $0.38 per share which is up from $0.36 per share a year ago and down from $0.48 per share sequentially. The number of fully diluted shares used in the third quarter was 52,978,000. The tax rate in the third quarter on a non-GAAP basis was 23.7% compared to 32% a year ago and 30.5% sequentially.

The effective tax rate for the third quarter of fiscal year 2017 was lower than last year due to the release of liability for completion of a tax audit in foreign jurisdiction. We expect our effective tax rate to be about 32% in the fourth quarter of fiscal 2017. Turning to the balance sheet on a sequential basis, Slide 17.

Cash and cash equivalents, short and long term investments were $110.5 million, down $21 million from $131.5 million in the prior quarter and down $68.6 million from $179.1 million in the same quarter last quarter.

In the third quarter, free cash flow was a negative $41.3 million, primarily due to an increase in inventory of $44.8 million, an increase in AR of $24.7 million, offset in part by an increase in accounts payable of $7 million and net income of $16.7 million.

Accounts receivable increased by $24.4 million to $391.3 million due to higher revenue at the end of the quarter as customers came back from the Lunar New Year holiday. DSO was 54 days, an increase of 5 days from 49 days in the prior quarter. Inventory increased 43 days to $642.3 million.

Days in inventory were 103, an increase of 12 days from 91 in the prior quarter and an increase of 6 days from 97 in the prior year. The increase is primarily to support the continuing tight supply of memory and SSD and sourcing for new product lines related to the Skylake launch as well as for the upcoming seasonally strong quarter.

Had we excluded the increase in SSD and memory from September quarter and -- of about $62.7 million, our days of inventory would have been 93 days. Accounts payable was $6.8 million -- up $6.8 million which was 57 days, an increase of 5 days from 52 days in the prior quarter and down 3 days from 60 days in the prior year.

Overall, cash conversion cycle days was 100 days which is 12 days higher than the prior quarter and the same quarter of last year. Adjusting for the effect of the increase in inventory in SSD and memory, as noted above, the cash conversion cycle days would have been 90. Now for a few comments on our outlook.

As we enter the last quarter of fiscal '17, we see strong growth opportunities from a technology refresh cycle, especially in the Skylake launch. We continue to see strong traction for our leading solutions in our growing customer base especially in large enterprise.

These factors, coupled with investments we have made during the past year, put us on our strongest position to accelerate our growth in the many market verticals we serve. Therefore, the company currently expects net sales for the quarter ending June 30, 2017, in a range of $655 million to $715 million.

Assuming this revenue range, the company expects non-GAAP earnings per diluted share of approximately $0.40 to $0.50 for the quarter. At the midpoint, this would represent an increase of 31% in revenue and 125% in EPS from the prior year.

It is currently expected that outlook will not be updated until the release of the company's next quarterly earnings announcement. Notwithstanding subsequent developments, however, the company may update the outlook or any portion thereof at any time. With that, let me turn it back to Charles for some closing remarks..

Thank you, Howard. We're now reaping the benefits of our very strong ambitions that we have built over a long period of time. This quarter's revenue was the strongest third quarter in our history and again, demonstrates the advantages of our product portfolio across many different verticals, especially among our enterprise customers.

With that, I'm very confident that our strong foundation and products will make Super Micro one of the most successful companies in the IT industry. Operator, at this time, we're ready for questions..

[Operator Instructions]. And we'll go first to Aaron Rakers with Stifel..

Okay. Great. This is Joe Quatrochi on for Aaron. I was just curious. I wanted to kind of double click on the SSD constraints that you're still seeing.

Did that impact your ability to fulfill or rather recognize additional revenue in the quarter?.

I guess it's both. Because of that shortage, we saw some [indiscernible] relationship and the other reason is that because the price rose, so we had to raise the price to customer. So that, too, did impact our business..

Okay.

And how do you think about that going into the current quarter? Do you see a similar impact?.

Looks like both fee dwen and flash memory, SSD will continue to rose in price, but where we also get in accessorized. So won't grow that much as the last few quarter. I would have to say, for example, in module. In last 3 quarter, the price had been grow almost double. So next quarter or 2 quarter I guess, the growth will be slower..

Okay. And then just for follow up. Can you talk about the timing of Skylake relative to what Mellanox had kind of talked about last night? It seemed like they might be seeing a little bit of a pushout. I was just curious if you're seeing any difference from what we talked about 90 days ago..

Yes, the good news is Skylake, our product have been developing very smoothly. So today, we have almost complete product line ready to ship and we already promised to some customer start ship early next month. And India official launch, I believe, is still early July..

And we'll go next to Mark Kelleher with D.A. Davidson..

Howard, I want to talk a little bit about the gross margins.

Is this the low point, do you think, the 14%? Or do the continued price hikes in the memory mean we're going to dip below that?.

Mark, this is Howard, thanks. Again, December as a quarter, we don't typically guide gross margin. But December as a quarter is usually a very seasonally strong quarter compared to -- I'm sorry. The June quarter is particularly a strong quarter compared to the March quarter. So typically, it's not as competitive as the March quarter.

So we get usually a margin boost from that. However, as Charles alluded to, the tightness in SSD and memory is still out there. We're saying we're doing our best to manage our way through that and have done better, I think, probably in the last quarter versus the September quarter. So we're -- December quarter.

So we're going to continue to do that as well..

And are you going to continue to build inventory of memory to stay ahead of this? And when do you have the cash, kind of burning some cash here? How do you feel about your cash position?.

We're okay with regards to cash position, Mark and we have lines of credit that we can draw upon and can expand it and access the capital there..

But inventory is still going to go up or putting more memory in?.

We're preparing right now for the launch -- for the Skylake launch coming up here. So some of the inventory build from this last quarter was for a part of that per se and then part of that was for the larger quarter.

So if you look at the end of the June quarter, typically, you'll see a decline in our inventories because we come out of a seasonally strong quarter going into somewhat of a seasonally weak quarter..

And we'll move next to Mehdi Hosseini..

This is David Ryzhik for Mehdi Hosseini. So it is already almost a quarter of overall revenue and you guys delivered some strong growth in China. What areas of the product portfolio are most responsible for that growth? And I had a follow-up..

For China, I believe still our NVMe and SSD product line have been very attractive in the market. And also, kind of high-density storage as well as GPU for AI, I mean, machine learning, people learning, those areas have been growing very strongly in China market..

Great. And for next-gen storage, obviously very impressive growth. So 2 questions. Is this an above gross margin business for you? And the other one is just wanted to understand. It seems like some of the larger storage OEMs are pivoting to this supply model for third-party sourcing for hardware.

How big of an opportunity do you view this to be? And are you selling any next-gen storage into the enterprise opportunity? And do you see that as an opportunity for you?.

Yes. Indeed, next-gen storage will continue to grow customers. And also, our customer are growing. Plus, we have a more -- new architectural advantage for the market. For example coming soon, Op10 from Intel and as well as the people -- some people call JBOF -- JBOD for fresh solution.

So we have a very strong product and lots of new architecture is coming..

Great.

And would this be an above gross margin business for you?.

Theoretically it will, but because memory and SSD prices are rising very fast, so that may offset our margin for short term. But long term, yes..

And we'll take our next question from Alex Kurtz with Pacific Crest Securities..

Could you take us through the dynamics again, Howard, on the data center -- the Internet, data center business? And it looked like one of your strategic 10% data center customers was talking about expansion recently.

So that's question one, sort of what are the dynamics in the June quarter guidance around that vertical and what happened in March? And then also, one of your strategic, emerging storage partners was acquired by one of your competitors and was just wondering what the plan is there as far as working with that emerging storage vendor going forward now that they're part of a larger entity?.

Okay. Alex, thanks. With regards to the Internet, data center, cloud area, we noted in the call that represented about 10.7% of our revenues in the previous quarter, in the March quarter. That's down from 26% last year. You'll recall that we had about a 12% customer last year that we did in the greenfield opportunities and build-outs there.

But that's a customer -- still purchasing from, but that's majority of the decrease that happened between years per se. As we talk about going forward, we're still selling to that customer.

And again, with the technology refresh cycle coming up, it presents opportunities for us to do, again, not just refreshes with them but with other customers as well. So we're pretty bullish on the Internet, data center vertical for ourselves going forward as well as we enter there..

And the good thing is we start again impede to say lots of new customers, new private cloud especially that help our business grow for long term. And as to the, you just mentioned some of our customer was bought by a big company. We're improving that relationship. So it looks like so far so good..

Okay.

So there's no plans on them moving to their own contract manufacturer partners? Immediate plan is to keep it with you guys?.

So far we feel pretty good..

We'll move next to Nehal Chokshi from Maxim Group..

On the gross margin, however, just to be clear, the component charges or price increases rather, if it had not been for that, it sounds like then you would've actually had a gross margin uptick Q-over-Q? Is that the correct way to interpret this?.

Yes, there's still pressure out there, yes. I mean, if you look at the 40 basis points of decline in our gross margin sequentially, 10 basis points was attributable to the utilization per se. If there was not any of this memory type stuff, I believe it's fair to say that we would have gotten most of that back..

So then it would have been flat Q-over-Q had it not been for utilization decline and component price increases then?.

It could have been higher. I mean, we also had the geographic that was in there that weighed us down a bit..

Okay. And then data center was already talked about a little bit on the prior question. But that was down Q-over-Q and in the last quarter, there was I think a good amount of excitement of having a more diversified base of hyperscalers.

And I think that large prior 10% customer that had gone from greenfield to just sort of maintenance increases, that had already kind of petered out.

So I guess my question is that the decline on a Q-over-Q basis of the hyperscalers, was that a surprise?.

Well, I think if you look at the decline quarter-over quarter, again, it went from about 13.8% of revenues in the prior quarter to about 10%. If you look at our seasonality again and not to say that they're totally tied to seasonality, you'll see us anywhere from 6% to 17% down sequentially over the last couple of years.

So some of this has to do with seasonality. I wouldn't say that it was a decline or a loss of opportunities. I think we feel pretty good that we have more opportunities going forward and stronger in that segment than we have in previous quarters..

Okay. Very good. By my math, the revenue from the channel, it accelerated quite significantly.

Can you put a narrative behind that?.

The revenue from the channel, again, the percentage of revenues, again, we're -- fairly stable there with regards to our -- them being about 46% this current quarter and then 46% in the prior quarter. So on an overall percentage basis, they were fairly stable..

And we will take our next question from Brian Alger with Roth Capital Partners..

I guess if we're looking at the quarter, there's -- this time of the earnings season, there's always a bit of mixed news.

I'm wondering if the strength relative to expectations from a demand standpoint, was it all attributable to your 2 primary competitors going through major mergers in the past quarter? And if so, if you expect to be seeing any snap-back or any normalization of market share that may have been gained..

Yes, Brian, this is Howard. If you talk about like, for example -- one person talked about Nimble and HP in the storage area, our storage area is very strong still. And if it's EMC you're referring to with regards to Dell, going back, it's -- again, in the storage area, we're continuing to do great in the storage area, as Charles alluded to.

And we're getting more customers in that base as we go. So again, we're not seeing it slow down or just being -- because of our partners doing mergers that we're gaining more traction in that area..

Okay. I guess it's sort of what I was getting at. It wasn't as much focused on the storage side of it, but rather just whenever a major merger is going through, there tends to be an opportunity to gain share as channels oftentimes get conflicted. But it's good to hear you guys are gaining on the merits of the product portfolio.

Moving forward, you guys, it seems as though, are getting some good traction from the AI push and certainly, there is a lot of attention being put towards the GPUs. And I noticed you highlighted the NVIDIA solutions as well as Intel's.

How -- do you have a sense for how you stand relative to the competition there? Is there an advantage that you guys might have over, call it, the slower-moving OEMs in this space for that type of a customer?.

Indeed, for both storage and GPU as well as Xeon-Phi total market share, I believe we will continue to grow in 2 area. One is we continue to have more customer, especially enterprise corporate customer. And also, we're working with a superscale company as well. So once we have good product, I mean, we're openminded to work with any customer..

[Operator Instructions]. And we'll move next to Mehdi Hosseini from Susquehanna Financial Group..

It's Dave Ryzhik again for Mehdi. Howard, can you talk about -- how can we think about OpEx rolling over the balance of the year? Obviously, your enterprise remains very small as a percentage of overall revenue and we'd assume that you guys are continuing to invest in that in the sales and support effort.

Just any way to think about OpEx over the balance of the year would be great..

This is Howard again. The OpEx this quarter was affected primarily -- one of the major increases was basically the translational ForEx gain/loss. So again, that would -- you can -- we don't predict that per se or fill that into our planning. But again, excluding that, I think the first quarter is always the toughest at tax rates.

Our people's tax deductions get reset and what have you. So that rolls into the compensation expense. As we go throughout the year, that gets filled up and it gets taken off from there. Apart from that, we're still focused on leveraging our op expense investment that we have made.

So again, grow our revenues faster and we're going to roll our operating expenses and see that leverage drop to the bottom line..

Great.

And just to clarify, the 30,000 MicroBlade deployment, is that in the enterprise revenue category?.

Yes, for corporate private cloud basically..

And this does conclude the question and answer session of our conference call. I would now like to turn the conference back over to Mr. Liang for any closing remarks..

Thank you for joining us today and looking forward to talking to you again at the end of this quarter. Thank you, everyone. Have a great day..

Thank you. Ladies and gentlemen, that does conclude the Super Micro Third Quarter Fiscal Year 2017 Conference Call. We do appreciate your participation. You may now disconnect at this time. Thank you..