Supermicro, a Silicon Valley-based provider of modular blade servers, motherboards, storage, racks and other data centre equipment, has had a stormy 18 months, there are no two ways about it. Firstly, the company was delisted from the Nasdaq in late 2018 after auditors identified “material weaknesses” in its financial reporting.
Then one of the most controversial technology articles in living memory broke: a blockbuster October 2018 Bloomberg report claiming that “Chinese spies” had seeded tiny chips in Supermicro motherboards that, it alleged, had made their way into the servers of 30 US companies, including those of Amazon and Apple.
The article, by Jordan Robertson and Michael Riley, sent Supermicro’s shares plummeting over 50 percent, set businesses mulling extensive security audits of their supply chains, and resulted in furious, resolute denials all round; publicly backed, if arguably somewhat tepidly, by the Department of Homeland Security
After extensive soul searching, motherboard x-raying, and proof-of-concept wrangling, the security community ultimately concluded – with some exceptions – that while the attack was, in theory, plausible, the story itself was deeply flawed at best. (Others described it as “garbage” with zero evidence to substantiate it. Bloomberg, which cited 14 unnamed sources and featured an illustration, rather than visual evidence, has never retracted the story and has even submitted it for awards.)
A year-and-a-half after the October 4, 2018 article, much has changed for Supermicro, if not its emphatic belief that the report is “utterly bogus”.
Now freshly relisted on the Nasdaq (as of January 14, 2020) it is rolling out new products, including ruggedised edge servers, and working with all the major CPU and GPU makers (Intel, AMD, NVIDIA et al) to build up a hugely diverse portfolio of products. The focus is very much on the future…
Supermicro Looks Ahead
Supermicro veteran Perry Hayes, Senior VP, Investor Relations, is the company’s public face globally as well as head of its EMEA operations, where he has presided over CAGR of 20 percent-plus annually for over a decade.
Hayes joined Computer Business Review on a call this month to discuss the company’s outlook, unique product portfolio and strategy.
(Supermicro’s Taiwan-born founder Charles Liang launched the company in the US as a five-person operation in 1993. He keeps a lower public profile, though he led last month’s earnings call in which he emphasised the start of a “a new era for Super Micro, a stronger company with better financial and operational controls”).
Hayes’ emphasis on the call is very much forward-looking, but given the impact of the delisting and that story, we touch on both which Hayes takes with good grace, although the frustration at Bloomberg is sometimes (arguably understandably) palpable.
Supermicro’s Nasdaq Relisting: “We’ve Improved Internal Oversight”
The delisting: fixing internal management has been an expensive slog.
Supermicro said in late 2019 SEC filings that it has spent upwards of $108 million on “additional accounting, financial and other consulting and professional services” to resolve the revenue recognition and financial reporting issues that got it delisted.
What, exactly, went wrong?
Hayes says that the issue triggering the initial investigation involved a shipment made at the end of a financial quarter that didn’t reach the destination, but was held at a border and only cleared after a new financial quarter began.
After spotting the hold-up, the company chose to recognise the revenue for the month it was actually delivered, rather than shipped; but it failed to highlight this amendment to its public auditors.
“They didn’t find out about that until several months later when they were doing the annual audit, and that lack of internal control was (found to be part of a more) extensive failure. We then came up with a series of similar types of revenue recognition issues; things like maybe we paid for insurance or paid for freight but, if you pay for those things, you retain the title to the goods, therefore you can’t recognise revenue”.
He adds earnestly: “In all of the cases, it was real revenue; it was just the timing of when it was reported. All of it was real cash flow. The restatements (just) had to be shifted from one quarter to another quarter. Today we have much better controls in place.”
None too soon: they seem oddly amateurish failings for a company that sells close to a billion dollars worth of products a quarter, but Supermicro says in regulatory filings that the company has “taken a number of steps in order to strengthen our corporate culture, sales processes, and accounting function so as to allow us to be able to provide timely and accurate financial reporting”.
What’s changed? Hayes says: “Internal management’s changed. We have a chief of compliance officer. We didn’t have a senior level auditor reporting to the board: now we do. We had a CFO change; new staff within the management and the accounting group. We also changed our head of sales.
“In addition to that, we hardwired in some of the internal controls and processes around the revenue recognition to prevent some of those things from happening. Our board of directors has also been changed; we now have three CFOs on the board of directors…”
The company, in short, got its house in order, upgraded its SAP ERP systems, the SEC signed off on belated financial statements, the company returned to the Nasdaq and promptly reported earnings of $871 million, with over 50 percent of sales made via the channel as a result of upgraded partnerships.
And that, hopefully for shareholders, is the start of a new chapter.
But that Bloomberg Story…
Few stories in recent years have left quite such a wake behind them as Bloomberg’s piece, meanwhile. (A vendor using a blow-up of the article at the RSA Security conference in February triggered renewed frustration from security researchers).
Computer Business Review pressed Hayes on the story and how Supermicro responded.
As he tells it: “I had over several months pings from a particular journalist there that made claims and then asked to speak to our CEO.
“The journalist was not well known. They weren’t out of the typical financial-type press or the IT-type press. Looking at the claims that they were they were making, we denied them and denied any knowledge of any contact from any regulatory agency of the government. Because we’d never been contacted. It came out of the blue.
“Obviously one of the things that we did in the very first days was to work with our customer to show them how we secure our supply chain.
“And we’ve retained all those customers. We’ve also improved things internally, as all companies do. Our processes were pretty sound from the beginning, but we also moved to tighten up our own security as a company.”
Pressed on whether Supermicro made any major supply chain changes, for example to suppliers, he says: “Not really, because it was a bogus article to begin with. How do you prove a negative? We reviewed ongoing programs of audit and stuff with our suppliers to ensure on behalf of our customers that, we have an airtight system”
Supermicro did, however, emphasise to customers an ongoing programme to move of manufacturing from China to Taiwan; a project driven by the US-China trade war.
Hayes tells us: “We design motherboards. We share those designs with our CMs (contract manufacturers). Most of our CMs – and this is a key strength of our company – are Taiwanese companies. We already as a company back in those days had less of our products being built in China than any of our competitors.
“One of the things that we did was – and we were already in the process of this, because of the tariff war that had started in the summer prior to that – was to ask our CMs to transition business back to Taiwan from China, to try and reduce tariffs.
“We were at 70 percent – most of our competitors were at 90+ percent – of our motherboards being done in China.
“After Bloomberg, we accelerated that to say, ‘look, we’ve got good product, we’ve got good CMs, we’ve got good processes’.
“Stupid, but let’s just move more offshore, right?
“So today the majority of our stuff is produced in Taiwan. That is not necessarily all to the Bloomberg thing, but it’s also due to de-risking China as a whole. And you see what happened with Coronavirus…”
(Why not sue Bloomberg, if the story was so false, Computer Business Review asks, belatedly, getting an exasperated laugh in return: “That’s ridiculous. We’re not going to do that… Really, we’ve moved on. The markets have moved on. Customers have moved on. Everybody’s moved on because there’s never been anything behind it.”)
OK… Enough of the Bad History
With substantial sales (dominated by the US at 61 percent, followed by Asia at 19 percent and EMEA at 18 percent) Supermicro remains big news for its hugely broad portfolio, and Hayes is bullish both on its outlook and the company’s US-based engineering savvy.
Hayes says: “We bring more products to the market than than any of our competitors probably combined. Supermicro has this terrific resource of engineering talent in the company; just shy of a couple of thousand engineers. For a company that’s 4,000 people in total, you can see it’s very heavily engineering-based, and we spend a super amount of our revenue on R&D. It’s a company that lives and dies on being first to market with the broadest selection of products: that’s been our hallmark.”
“Just to give you an order of magnitude, we have over 400 different motherboard SKUs (stock keeping units) and chassis SKUs, which means that the number of configurations that we can create for our customer base is very high.
“You compare that to an HP, which is one of the top two leaders, the other one being Dell. HP is on record now as saying that they’ve reduced the number of SKUs to eight. We know that Dell has more than that, but not much more. So we are able to appeal to a very broad range of verticals.”
Are there any particular sweet spots for the company that stand out?
“A significant portion of our revenues are based on storage. Companies with software-defined storage, come to Supermicro and use us as a platform for their software. We’ve been consistently growing in that area and working with new technologies and new software in that market.
GPU-Based Accelerated Compute Interest is Rising
“We appeal also to folks who want to do accelerated computing that’s GPU-based. We’re mostly focussed on NVIDIA-based GPUs, but we also deploy some AMD GPUs.
“Initially when I joined eleven years ago, this was all HPC, with university research and national laboratories.
Today we’re talking about automotive guys looking at automated driving. We’re talking about data analytics, about AI for many purposes: it’s a really hot market.
What’s big in the server line right now?
“Small” is the answer.
Hayes notes that “a growing part of our business is small form-factor servers – typically deployed as appliances for various purposes, or at the edge: sometimes as gateways, sometimes accumulating information, storing information. We think we have a real head start here.
“With the 5G revolution that’s upon us, the ability to do low latency workloads at the edge and then transmit data is going to be more and more prevalent. We think that’s going to be a big market for us… For telcos, for example, we’ve just announced a small server that can sit on a pole. It’s a ruggedised server, small form factor, that deal with different thermal pressures.
“Then there’s the rack mount, which has been the bread and butter of the company: the various platforms we have that can fit in enterprise data centers, cloud data centres…”
Supermicro vs. the Cloud?
Where does Supermicro sit vis-a-vis the hyperscale cloud providers that are dominating data centre take-up, in EMEA, particularly?
Hayes says: “Supermicro is different in our go-to-market business strategy by having such wide configurations, but also atypical in that we purposely have not focused on that hyperscale-type market.
He adds: “We see the hardware vendor world divided into two buckets: most everybody else is ‘low tech, high volume’; some of that business is dominated by white box guys, CMs out of Asia, that are happy to sell (because they haven’t spent a lot on R&D like we have) commodity type servers; selling in volume and at very low margins — I’m talking off often in low single digits.
“That just doesn’t work for us, as a public company.
“We have had some high-volume, large data center-type customers, but that’s a rarity for us. Most typically we are working with large data centers in enterprise and some social media-type companies, or commercial and retail large internet sites.
“Hyperscale? That’s a business that down the road, two or three years from now as we build scale, and build up our Taiwanese manufacturing capability, we might address that market more aggressively than we are today. But we really, really just don’t want to compete for two or three percent margins.”
See also: Frankfurt is Europe’s New Data Centre Capital (with Little Sign of Hyperscale Self-Builds)
Asked if Supermicro is not facing a major lost business opportunity, with a reported 80 percent of co-location data centre take-up now being by hyperscale cloud providers like Azure and AWS, Hayes notes: “There’s definitely a lot of smaller companies want to utilise the cloud.
“But the larger companies actually have pulled back a little bit from the cloud as they refine their strategy. “Clouds are less flexible and they often actually cost more.
“Enterprises today are selecting what portion of their workloads they want in the cloud, and what portion of the workload they want on premises. We definitely see a hybrid cloud strategy for most. And the private cloud component can be on-premises or a co-location situation – but with businesses utilising proprietary software for their applications; and that’s across verticals.”
Amid A Turbulent Market, What’s the Outlook?
These are rocky times for many businesses. What does Supermicro make of the outlook for the rest of calendar 2020?
“We think that there are a number of technologies that are transitioning this year, which we think will be good for 2020 as a whole, probably more in the second half of the year than the first half, because obviously there are disruptions going on worldwide in the economy at this point…
“Intel recently launched a Cascade Lake refresh. That’s usually good for our business. AMD is continuing to ramp, as there’s more familiarity with what they’re doing and they get more attention. It looks good there; we do both processor families.
“NVIDIA has some new products coming out this year, and there’s going to be another Intel launch, which would be very interesting. It’s called Cooper Lake. We’re preparing for that. And then we have our normal steady drumbeat of new products coming out.
“We think the markets will strengthen again in the second half.”