SMCI short report

Investment Analysis Clubs Saul’s Investing Discussions
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What makes this delayed annual filing of the 10-K so bizarre is they are reporting from the period of June 30, 2023 to June 30, 2024. Yesterday being August 28, they’ve had two months since the last accounting transaction to be able to figure out how to present their data. They reported earnings on August 6 as well for that quarter ending June 30th, so you wouldn’t expect surprises.

Another possibility is that they only discovered some accounting discrepancy in the last few weeks or days.

I’m also wondering if it ties into this statement the CFO David Weigand had two earnings reports ago (April 30),

So we actually got a substantial amount of inventory in the last week of the quarter, okay, which obviously, we’re not going to be able to ship, but we took in $700 million in the last week of the quarter. So that’s not something – that’s something that has to do with when inventory arrives.
And so we – it hurts our cash flow, but you know what, it doesn’t matter, because we need that inventory for Q4 shipments.

Maybe it is just as simple as they put some revenue into the wrong quarter by mistake, that might be a best case scenario at this point. I’d rather be on the sidelines right now, until we know. Maybe they will have a reasonable reason why they couldn’t file on time and I could be interested to invest again. Still it’s just hard to fathom what the issue can be with the fiscal year that ended two months ago.

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As a former auditor that dealt with this exact sort of situation for years, I can add some context. This situation probably hasn’t been known for the whole past two months

Most likely the auditors started testing this after the company closed it books for the year ended June 30, which probably wasn’t until mid to late July.

They were probably proceeding assuming there wasn’t a new issue especially if this was something the auditors have looked at in years past.

I would bet the audit firm probably didn’t even raise this as a potential issue until mid August and they have probably been looking into it for only the past couple of weeks.

I suspect that, because management chose to delay the filing rather than accept that there is a deficiency or weakness probably means that they think they can provide enough evidence to convince the audit firm that the controls and financials are ok.

But who knows. Maybe they’ve found a problem which will lead to something significant and a restatement of their initial reporting.

We’ll find out in the next few weeks.

I do have a small, less than 1% position that I started earlier this month after stock dropped after the earnings report. I haven’t sold just yet but it’s one that I’m considering selling each day especially given how small my stake is. However I’m not in any hurry to do so without anywhere else that I’m itching to reinvest the funds into

-mekong

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This SeekingAlpha article’s author thinks:

After learning abou the Hindenburg Reserach report, Super Micro’s auditors likely declined to sign off on the company’s annual report without management addressing allegations of improper revenue recognition and circumvention of internal controls.

He goes on to say that he himself wasn’t impressed with the Hindenburg report, but the subsequnt delay is a “major red flag” and it could take several months or quarters to work though all the numbers.

Apparently, there’s an automatic 15-day grace period for filing the 10K. Do we think SMCI will be able file within two weeks now?

As for previous questions on the business survival, the SA author pointed out that SMCI will continue to need additional capital to fund its expansion efforts. That’s going to be a lot harder to raise now.

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My gut (and this is just my gut) would bet that the delay is not related to anything in the short report.

For an auditor to say that we’re holding off our opinion at the last minute due to a partisan report by a firm that didn’t have a fraction of the access or data that the external auditor does seems unlikely to me.

But who knows. Either way not a good look and not a situation where I would want to have a significant amount invested right now.

-mekong

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@mekong22 thank you for your input. That’s very enlightening. I will accept what you contributed at face value. Given your first hand experience, it’s probably safe to assume that SuperMicro management was only put on notice a few weeks ago at most.

Frankly, I had attributed the late filing which called for an examination of financial controls due primarily to the crush of business. SuperMicro has grown exceedingly fast. It does not surprise me that things may indeed have gotten somewhat out of control.

I believe that they went from 1% share in th overall server business to 15% share in something under a year, or pretty close to that. I am quite sure they asserted that they have about 80% share of the DLC business. They are building a new factory in Malaysia and expanding operations in Taiwan and San Jose. They had to pay a lot of expedite costs in the last quarter. I know from my experience at Boeing that severe expedite situations can put a lot of stress on financial systems. It’s not just the cost imposed by suppliers, it impacts production schedules at the assembly factory (which is what SuperMicro does, so far as I know they don’t do any of their own fabrication). It tangles inventories, too much of some components waiting on others to arrive - it can literally overflow storage cribs such that inventory is sitting in bins on the factory floor. Last quarter they claimed claimed that they had to push $800M revenue into the next quarter. They provide a lot of customer specific customization. They gave some customers deep discounts.

Not very long ago this was a relatively small company. I haven’t a clue what business systems they have, my guess, it’s some COTS package designed around classic MRP processes. I doubt that they would have a premier system like SAP due to cost and operational complexity. Most likely whatever software they are using, it did not have the functionality to handle all these abnormalities to standard processes (the beauty of MRP systems is their ability to optimize inventory, but when situations such as those just described occur, they tend to quite literally get confused). In other words, I believe it’s very possible that their financial controls were inadequate to handle the frenzy of all the unplanned activity.

Now, put yourself in the shoes of management. What would you do? Just call a halt to everything until you got it all the financials sorted out, or just do your best to address the demands of the business and figure you can deal with it later when things cooled off?

I know what I would do. I’d be booking orders and filling them to the best of my ability. If the books got out of sync with the activity, so be it.

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Objectively, we have a company whose margins shrunk to 13% during the last reporting period. The company explained the reasons why and said margins would improve. The came the ill-timed announcement of a delay in the 10K filing.
Moving revenue among periods is not a big deal, but shrinking margins are in an industry where the existence of a true moat has been questioned.
I sold my shares, including those that I recently bought after the initial drop after earnings were reported. Having a good feel and confidence in management is important and mine was lost. I wish I had a spider sense to tell me whether to hold (PSTG) or sell (AEHR), but for now, I have to go with that.

VInce

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One of the items the short report was attacking was with the Taiwanese company Ablecom and the circular relationship, where Charles Liang’s brother owns the company and Charles has a 10.5% ownership stake. Apparently Ablecom is directly located in the same campus facility as Supermicro which Hindenburg argues makes the company more like a subsidiary since they sell basically only to Supermicro.

I was surprised to find in the last 10-Q (May 3, 2024) some highlights were a huge portion of the chassis for the solutions come from Ablecom. What the short report alleges is that products went from Supermicro → Ablecom → Supermicro where revenue was recognized at each step. I’m not really sure what to make of this, but this does sound potentially concerning. I’ve highlighted the parts below in the 10-Q which raised questions for me.

Dealings with Ablecom

The Company has entered into a series of agreements with Ablecom, including multiple product development, production and service agreements, product manufacturing agreements, manufacturing services agreements and lease agreements for warehouse space.

Under these agreements, the Company outsources to Ablecom a portion of its design activities and a significant part of its server chassis manufacturing as well as an immaterial portion of other components. Ablecom manufactured approximately 95.2% and 96.3% of the chassis included in the products sold by the Company during the three months ended March 31, 2024 and 2023, respectively, and 92.7% and 93.0% of the chassis included in the products sold by the Company during the nine months ended March 31, 2024 and 2023, respectively. With respect to design activities, Ablecom generally agrees to design certain agreed-upon products according to the Company’s specifications, and further agrees to build the tools needed to manufacture the products. The Company pays Ablecom for the design and engineering services, and further agrees to pay Ablecom for the tooling. The Company retains full ownership of any intellectual property resulting from the design of these products and tooling.

With respect to the manufacturing aspects of the relationship, Ablecom purchases most of materials needed to manufacture the chassis from third parties and the Company provides certain components used in the manufacturing process (such as power supplies) to Ablecom through consignment or sales transactions. Ablecom uses these materials and components to manufacture the completed chassis and then sell them back to the Company. For the components purchased from the Company, Ablecom sells the components back to the Company at a price equal to the price at which the Company sold the components to Ablecom. The Company and Ablecom frequently review and negotiate the prices of the chassis the Company purchases from Ablecom. In addition to inventory purchases, the Company also incurs other costs associated with design services, tooling and other miscellaneous costs from Ablecom.

The Company’s exposure to financial loss as a result of its involvement with Ablecom is limited to potential losses on its purchase orders in the event of an unforeseen decline in the market price and/or demand of the Company’s products such that the Company incurs a loss on the sale or cannot sell the products. Outstanding cancellable and non-cancellable purchase orders from the Company to Ablecom on March 31, 2024 were $113.7 million and $48.4 million, respectively, and outstanding cancellable and non-cancellable purchase orders from the Company to Ablecom on June 30, 2023 were $37.4 million and $23.7 million, respectively, effectively representing the exposure to financial loss. The Company does not directly or indirectly guarantee any obligations of Ablecom, or any losses that the equity holders of Ablecom may suffer. Since Ablecom manufactures substantially all the chassis that the Company incorporates into its products, if Ablecom were to suddenly be unable to manufacture chassis for the Company, the Company’s business could suffer if the Company is unable to quickly qualify substitute suppliers who can supply high-quality chassis to the Company in volume and at acceptable prices.

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With SuperMicro expanding manufacturing in more than than just the US, is AbleCom also setting up facilities near these new Super Micro factories?

At first blush, it does seem odd that SMCI would sell power supplies to a chassis manufacturer, from whom it then buys the completed chassis with power supply, but thinking about it some more, this sounds like SMCI is simply outsourcing “low skill” aspects to another company. That is, the power supply design and manufacturing (does SMCI make its own power supplies or are they made by third party?) is “high skill” since that affects efficiency, but just building a chassis is pretty straightforward (what beyond some welding?). So, makes sense to get those power supplies right and send them the chassis welder to incorporate into a finished chassis that they purchase. I don’t know accounting rules well enough to know this kind of thing is usually handled. Selling only to buy back does seem weird, but accounting is weird.

At any rate, the nepotism and rehiring of execs responsible during the previous delisting are enough to keep me out of this. Funny thing is, my neighbor apparently knows the CEO slightly. Earlier this year we had talked about the company and he told me he had stayed out because of the previous accounting fraud, but that it maybe looked like they had cleaned up their act. Today, he told me he wouldn’t touch the company as long as the CEO is still running it.

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Just out, will need to find link. SMCI does not anticipate any “material changes” to its fiscal 2024 10k

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It’s out on seeking alpha but can’t access it on phone to provide link. So, that takes the steam out of that scare.

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Heres the link from supermicro

https://ir.supermicro.com/financials/sec-filings/sec-filings-details/default.aspx?FilingId=17808886

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I’m not confident that I correctly understand everything in the statement about Ablecom. I’m not totally clear about the relationship. But nothing about this relationship and financial dealings seems unsavory, let alone illegal.

When I worked at Boeing, years ago the company that is now Spirit Aerosystems was Boeing Wichita. In 2005 Boeing sold the facility to an investment firm and it became a separate company and supplier to The Boeing Company of exactly the same products that it produced as a part of The Boeing Company. It was not a legal subsidiary so far as I know. But again, I am not familiar with these business relationships. Given that, Boeing Commercial in Renton Washington would execute purchase orders with Boeing Wichita. And there were agreements about the tooling, most of which “belonged” to Boeing Commercial, but there were tools that “belonged” to Boeing Wichita. Somehow, this all made sense.

There was a lot of analysis and negotiating around what was actually sold to the investment group and what was legally retained by Boeing. I personally was the guy who had the responsibility of identifying what information was subject to negotiation. I did not participate in the negotiations, my job was to identify what the information was and where it was located. For example, virtually all the manufacturing plans and associated engineering drawings were mirrored at a disaster recovery site. There was also on site backup tapes usually retained for 30 days. Every digital transaction had a log entry and so forth. This was the kind of stuff that would most likely be ignored if it weren’t for me and some other IT folks I consulted with. Although in 2005 there was still a lot of hard copy in the form of paper documents on site and at Iron Mountain as well as microfiche/microfilm which also had to be identified.

My point in relating all this is that ostensibly, after Boeing sold the facility, so far as I know not a lot changed with regard to the way Boeing contracted with Spirit Aerosystems. Of course, the accounting changed. What had been Boeing Wichita (BTW, the defense side of Boeing had facilities on the same campus in Wichita, that wasn’t part of the deal.

I don’t know if I have shed any light on this with respect to SuperMicro and Ablecom. Maybe not. To summarize, as best as I can determine based on my experience it doesn’t appear to me that there’s anything untoward about the relationship between the two companies. Maybe @XMFBreakerTinker could chime in with an expert opinion as he’s an attorney.

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The disclosures were made and there is nothing unlawful about this arrangement.

The problem comes in when you play games with the money. As a. Example, Palantir has made equity investments in companies and those companies are required to use Palantir. Not illegal but basically your spending your money to get your money back, but this time as revenue. Investment goes out and comes back in revenue from the very money you invested.

PLTR has disclosed this and provides a separate number excluding these revenues in their earnings calls.

Here, is there some hanky panky? Perhaps distributing cash to family members (eg, politicians use campaign contributions and hire friends and family as high priced consultants) - that would require more research than the publicly available numbers.

But overall, it seems fine. The numbers are small relative to revenue, there is reciprocal accounting that is open to inspection, and would seem to have limited ability to distort actual business results.

SMCI is hardly the first company to miss a 10K filing. NVDA and Netflix are among other companies, which have missed the deadline.

There is a 25 day extension, let’s see if they file on time for that extension.

Other than possible money games this arrangement is legal, and hardly novel. They are outsourcing chassis assembly. Very low value aspect of their product.

It makes sense that this third party would locate at the assembly site as that minimizes costs and maximizes coordination. I mean beats outsourcing this process to say Boston and shipping materials cross country both ways.

No specific wrong doing has been alleged. The company indicated in its updated 10K they expect no material changes to the already announced results. If some money game is being played with the auditors will inquire.

All in all, it looks Iike SMCI got overwhelmed with enormous business growth taking place around the globe and needed to catch their breath and catch up.

Anything is of course possible. Margins will still be an issue (my understanding is Dell made the same report on margin issues and they also expect margins to improve) , and the remnants of this short report will still be in play but should dissipate as each step in climbing the wall of worry proceeds.

Shopify had a similar short report a few years back. No one remembers that report anymore but was quite frightening at the time. I believe NVDA did as well before their business crashed in 2018 or so.

But new disruptive technology is not easy. No wonder NVDA crashed when it moved to ray tracing and data center focus. Here SMCI has overwhelming business demand and moving to liquid cooling. These transitions are never smooth.

Remember Netflix when they gave up their mail order business for streaming.

SMCI is neither a Nvidia or a Netflix but the sentiment still holds here.

Tinker

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15 day extension. Not 25 day. Sorry for that typo.

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Charles Liang, the CEO, just released this letter:

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The letter reads to me like a plea to customers to stick with them, rather than anything too reassuring for investors.

I was going to hang onto my small 1% SMCI stake until they got the 10-K filed and see if the price recovers a bit, but with the stock over $460 up more than +5% this morning, I went ahead and sold today.

It very well may go back higher in coming weeks, but I’m happy to move on for now.

I won’t rule out buying back in in the future if the short report appears to be nonsense and they ultimately conclude there are no significant issues when the filing comes out and still see a big opportunity when NVDA blackwell chips come out. But I’m in no hurry to do anything with Super Micro until we get more data.

At that point, I could miss the first initial large move in the stock price, but I suspect there will be enough room to still do well if they end up being a winner in the next phase of AI buildouts

-mekong

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I see this letter as a positive step forward. Agreed, that it does not tell us everything we need, and would like, to know right now, but it does re-emphasize again that they see no material change to the numbers already presented - and that they see the short report as wrong and misleading and that in due course they will address those points.
These sentences are key:
Importantly, however, when we announced the decision to delay our Annual Report filing, we indicated that based on the work done so far, we don’t anticipate any material changes in our fourth quarter or fiscal year 2024 financial results. This is good news. I continue to have strong confidence in our finance and internal teams.
Separately, you may have also heard about a recent report from a short-seller hedge fund that contains false or inaccurate statements about our company including misleading presentations of information that we have previously shared publicly. We will address these statements in due course.

I continue to hold my large position with increasing confidence going forward after this letter.

Jonathan

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Well, tbf, the relationships cited by Hindenburg might give one pause:

• Ablecom is controlled by Super Micro CEO Charles Laing’s brothers. Laing and his wife are also part-owners (over 10%) in Ablecom.
• Super Micro’s CFO in 2017, Howard Hideshima, was forced to resign in 2018 as the company was actually delisted by NASDAQ. The SEC fined Hideshima personally over $350k. Ablecom hired him in May 2023.
• 99% of Ablecom’s business is with Super Micro.

Just a reminder that Trevor Milton of Nikola said the same things after Hindenburg’s short report on Nikola. Milton’s in jail now.

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Except, Nikola’s business is hydrogen refueling for trucks in Southern California and electrical semi-trucks. Another green energy scam.

But different from a company with billions in sales with a product with real demand.

SMCI indicates they anticipate no material changes to their finances as already stated. If that is true then the business is real as stated and no one is going to jail.

If not true and a lie, then we’ve all been lied to before and someone is going to jail.

I don’t see SMCI as some sort of green energy scam. But I’ve frequently been wrong as we all have.

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Here is Nikola’s current business highlight: “Nikola produced 77 trucks in the quarter compared to 33 a year ago and shipped 73 trucks compared to 45 a year ago.

Nikola said it maintained its dominant market share of HVIP vouchers in California.

At quarter-end, Nikola had 99% of FCEV and 23% of battery-electric vehicle (BEV) HVIP vouchers.”

It barely has business now much less when its founder went to jail.

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