Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion should be read in conjunction with the consolidated financial statements and related notes which appear elsewhere in this Annual Report. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report, particularly under the heading "Risk Factors."
Nasdaq Relisting of our Common Stock
As a result of the delay in filing our periodic reports with the SEC and failure to hold an annual meeting, we were unable to comply with the Nasdaq listing standards and our common stock was suspended from trading on the Nasdaq Global Select Market effective August 23, 2018 and formally delisted effective March 22, 2019. Following the suspension of trading, our common stock was quoted on the OTC Market and traded under the symbol “SMCI.” On January 14, 2020, our common stock was relisted on the NASDAQ Global Select Market under the symbol “SMCI". For further information regarding trading in our common stock, refer to Part II, Item 5, “Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” in this Annual Report.
Overview
We are a global leader and innovator of application-optimized high performance and high-efficiency server and storage systems for a variety of markets, including enterprise data centers, cloud computing, artificial intelligence, 5G and edge computing. Our solutions include complete servers, storage systems, modular blade servers, blades, workstations, full racks, networking devices, server management software, and server sub-systems. We also provide global support and services to help our customers install, upgrade and maintain their computing infrastructure.
We commenced operations in 1993 and have been profitable every year since inception. For fiscal years 2020, 2019 and 2018, our net income was $84.3 million, $71.9 million and $46.2 million, respectively. In order to increase our sales and profits, we believe that we must continue to develop flexible and application optimized server and storage solutions and be among the first to market with new features and products. We must also continue to expand our software and customer service and support offerings, particularly as we increasingly focus on larger enterprise customers. Additionally, we must focus on development of our sales partners and distribution channels to further expand our market share. We measure our financial success based on various indicators, including growth in net sales, gross profit margin and operating margin. Among the key non-financial indicators of our success is our ability to rapidly introduce new products and deliver the latest application-optimized server and storage solutions. In this regard, we work closely with microprocessor and other key component vendors to take advantage of new technologies as they are introduced. Historically, our ability to introduce new products rapidly has allowed us to benefit from technology transitions such as the introduction of new microprocessors and storage technologies, and as a result, we monitor the introduction cycles of Intel Corporation, Advanced Micro Devices, Inc., Nvidia Corporation, Samsung Electronics Company Limited, Micron Technology, Inc. and others closely and carefully. This also impacts our research and development expenditures as we continue to invest more in our current and future product development efforts.
Coronavirus (COVID-19) Pandemic Impact
The global spread of the coronavirus (COVID-19) and the various attempts to contain it have created significant volatility, uncertainty and economic disruption for many businesses worldwide. In an effort to contain COVID-19 or slow its spread, governments around the world have enacted various measures, including orders to close all businesses not deemed “essential,” shelter in place, and practice social distancing when engaging in essential activities. We are an essential critical infrastructure (information technology) business under the relevant Federal, State and County regulations. In late March, we responded to the directives from Santa Clara County and the State of California regarding shelter in place instructions to combat the spread of COVID-19. Our first priority is the safety of our workforce and we immediately began to implement numerous health precautions and work practices to operate in a safe manner.
We quickly transitioned most of our indirect labor forces to work from home and continued to operate our local assembly in Taiwan and, after an initial period of disruption, in the United States and Europe. We operate in the critical industry of IT infrastructure and we assessed our customer base to identify priority customers who operate in critical industries. We continue to see ongoing demand as we enter the first quarter of fiscal year 2021 and do not have significant direct exposure to industries such as retail and oil and gas, which have been impacted the greatest. As time passes, we may discover greater indirect exposure to distressed industries through our channel partners and OEM customers.
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We have actively managed our supply chain for potential shortage risk by first building inventories of critical components required for our motherboards and other system printed circuit boards in response to the early outbreak of COVID-19 in China. Since that time, we have continued to add to our inventories of key components such as CPUs, memory, SSDs and to a lesser extent GPUs such that customer orders can be fulfilled as they are received.
Logistics has emerged as a new challenge as globally the transportation industry restricted the frequency of departures and increased logistics costs. We experienced increased costs in freight as well as direct labor costs as we incentivized our employees to continue to work and assist us in serving our customers, many of whom are in critical industries. We expect this trend to continue for the duration of the uncertainties related to the COVID-19 pandemic.
We monitor the credit profile and payment history of our customers to evaluate risk in specific industries or geographic areas where cash flow may be disrupted. While we believe that we are adequately capitalized, we actively manage our liquidity needs. In May 2020, we negotiated an extension of our credit facility with Bank of America to extend the maturity date to June 2021. In June 2020, we entered into a ten-year, non-revolving term loan facility with China Trust and Bank Corp ("CTBC Bank") to obtain financing for use in the expansion and renovation of the our Bade Manufacturing Facility located in Taiwan.
Our management team is focused on guiding our company through the unfolding and emerging challenges presented by COVID-19. Currently, we are unable to predict the ultimate extent to which the global COVID-19 pandemic may further impact our business operations, financial performance and results of operations within the next 12 months.
Financial Highlights
The following is a summary of financial highlights of fiscal years 2020 and 2019:
Subsequent Events
For details, see Part II, Item 8, Note 20, “Subsequent Events” in our notes to the consolidated financial statements in this Annual Report.
Critical Accounting Policies
General
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amount of assets, liabilities, net sales and expenses. We evaluate our estimates on an on-going basis, and base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making the judgments we make about the carrying values of assets and liabilities that are
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not readily apparent from other sources. Because these estimates can vary depending on the situation, actual results may differ from the estimates. Making estimates and judgments about future events is inherently unpredictable and is subject to significant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material impact on our results of operations, financial position and statement of cash flows.
A summary of significant accounting policies is included in Part II, Item 8, Note 1, “Organization and Summary of Significant Accounting Policies” in our notes to the consolidated financial statements in this Annual Report. Management believes the following are the most critical accounting policies and reflect the significant estimates and assumptions used in the preparation of the consolidated financial statements.
Revenue Recognition
We generate revenues from the sale of server and storage systems, subsystems, accessories, services, server software management solutions, and support services.
Product sales. We recognize revenue from sales of products as control is transferred to customers, which generally happens at the point of shipment or upon delivery, unless customer acceptance is uncertain. Products sold are delivered via shipment from our facilities or drop shipment directly to our customer from our vendor. We may use distributors to sell products to end customers. Revenue from distributors is recognized when the distributor obtains control of the product, which generally happens at the point of shipment or upon delivery.
As part of determining the transaction price in contracts with customers, we estimate reserves for future sales returns based on a review of our history of actual returns for each major product line. Based upon historical experience a refund liability is recorded at the time of sale for estimated product returns and an asset is recognized for the amount expected to be recorded in inventory upon product return, less the expected recovery costs. We also reduce revenue for the estimated costs of customer and distributor programs and incentive offerings such as price protection and rebates as well as the estimated costs of cooperative marketing arrangements where the fair value of the benefit derived from the costs cannot be reasonably estimated. Any provision for customer and distributor programs and other discounts is recorded as a reduction of revenue at the time of sale based on an evaluation of the contract terms and historical experience.
Services sales. Our sale of services mainly consists of extended warranty and on-site services. Revenue related to extended warranty commences upon the expiration of the standard warranty period and is recognized ratably over the contractual period as we stand ready to perform any required warranty service. Revenue related to on-site services commences upon recognition of the product sale and is recognized ratably over the contractual period as the on-site services are made available to the customer. These service contracts are typically one to five years in length. Service revenue has been less than 10% of net sales for all periods presented and is not separately disclosed.
Contracts with multiple promised goods and services. Certain of our contracts contain multiple promised goods and services. Performance obligations in a contract are identified based on the promised goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from us, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. If these criteria are not met, the promised goods and services are accounted for as a combined performance obligation. Revenue allocated to each performance obligation is recognized at the time the related performance obligation is satisfied by transferring control of the promised good or service to a customer.
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price basis. We determine standalone selling prices based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable through past transactions, we estimate the standalone selling price taking into account available information, such as internally approved pricing guidelines with respect to geographies, customer type, internal costs, and gross margin objectives, for the related performance obligations.
When we receive consideration from a customer prior to transferring goods or services to the customer, we record a contract liability (deferred revenue). We also recognize deferred revenue when we have an unconditional right to consideration (i.e., a receivable) before transfer of control of goods or services to a customer.
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We consider shipping & handling activities as costs to fulfill the sales of products. Shipping revenue is included in net sales when control of the product is transferred to the customer, and the related shipping and handling costs are included in cost of sales. Taxes imposed by governmental authorities on our revenue producing activities with customers, such as sales taxes and value added taxes, are excluded from net sales and included in operating expenses.
Product Warranties
We offer product warranties typically ranging from 15 to 39 months against any defective products. These standard warranties are assurance type warranties and we do not offer any services beyond the assurance that the product will continue working as specified. Therefore, these warranties are not considered separate performance obligations in the arrangement. Based on historical experience, we accrue for estimated returns of defective products at the time revenue is recognized. We monitor warranty obligations and may make revisions to our warranty reserve if actual costs of product repair and replacement are significantly higher or lower than estimated. Accruals for anticipated future warranty costs are recorded to cost of sales and included in accrued liabilities and other long-term liabilities. Warranty accruals are based on estimates that are updated on an ongoing basis taking into consideration inputs such as new product introductions, changes in the volume of claims compared with our historical experience, and the changes in the cost of servicing warranty claims. We account for the effect of such changes in estimates prospectively.
Inventories
Inventories are stated at lower of cost, using weighted average cost method, or net realizable value. Net realizable value is the estimated selling price of our products in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Inventories consist of purchased parts and raw materials (principally electronic components), work in process (principally products being assembled) and finished goods. We evaluate inventory on a quarterly basis for lower of cost or net realizable value and excess and obsolescence and, as necessary, write down the valuation of inventories based upon our inventory aging, forecasted usage and sales, anticipated selling price, product obsolescence and other factors. Once inventory is written down, its new value is maintained until it is sold or scrapped.
We receive various rebate incentives from certain suppliers based on our contractual arrangements, including volume-based rebates. The rebates earned are recognized as a reduction of cost of inventories and reduce the cost of sales in the period when the related inventory is sold.
Income Taxes
We account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net of operating loss carry-forwards and other tax credits measured by applying enacted tax laws related to the financial statement periods. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.
We recognize tax liabilities for uncertain income tax positions on the income tax return based on the two-step process. The first step is to determine whether it is more likely than not that each income tax position would be sustained upon audit. The second step is to estimate and measure the tax benefit as the amount that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority. Estimating these amounts requires us to determine the probability of various possible outcomes. We evaluate these uncertain tax positions on a quarterly basis. This evaluation is based on the consideration of several factors, including changes in facts or circumstances, changes in applicable tax law, settlement of issues under audit and new exposures. If we later determine that our exposure is lower or that the liability is not sufficient to cover our revised expectations, we adjust the liability and effect a related charge in our tax provision during the period in which we make such a determination.
Stock-Based Compensation
We measure and recognize compensation expense for all share-based awards made to employees and non-employees, including stock options, restricted stock units ("RSUs") and performance-based restricted stock units (“PRSUs”). We recognize the grant date fair value of all share-based awards over the requisite service period and account for forfeitures as they occur. Stock option and RSU awards are recognized to expense on a straight-line basis over the requisite service period. PRSU awards are recognized to expense using an accelerated method only when it is probable that a performance condition is met during the vesting period. If it is not probable, no expense is recognized and the previously recognized expense is reversed.We base initial accrual of compensation expense on the estimated number of PRSUs that are expected to vest over the requisite service period.
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That estimate is revised if subsequent information indicates that the actual number of PRSUs is likely to differ from previous estimates. The cumulative effect on current and prior periods of a change in the estimated number of PRSUs expected to vest is recognized in stock-based compensation expense in the period of the change. Previously recognized compensation expense is not reversed if vested stock options, RSUs or PRSUs for which the requisite service has been rendered and the performance condition has been met expire unexercised or are not settled.
The fair value of RSUs and PRSUs is based on the closing market price of our common stock on the date of grant. We estimate the fair value of stock options granted using a Black-Scholes option pricing model. This model requires us to make estimates and assumptions with respect to the expected term of the option and the expected volatility of the price of our common stock. The expected term represents the period that our stock-based awards are expected to be outstanding and was determined based on our historical experience. The expected volatility is based on the historical volatility of our common stock. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.
Variable Interest Entities
We determine at the inception of each arrangement whether an entity in which we hold an investment or in which we have other variable interests is considered a variable interest entity ("VIE"). We consolidate VIEs when we are the primary beneficiary. The primary beneficiary of a VIE is the party that meets both of the following criteria: (1) has the power to make decisions that most significantly affect the economic performance of the VIE and (2) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE. Periodically, we assess whether any changes in the interest or relationship with the entity affect the determination of whether the entity is still a VIE and, if so, whether we are the primary beneficiary. If we are not the primary beneficiary in a VIE, we account for the investment or other variable interest in accordance with applicable GAAP.
We have concluded that Ablecom Technology, Inc. ("Ablecom") and its affiliate, Compuware Technology, Inc. ("Compuware"), are VIEs; however, we are not the primary beneficiary as we do not have the power to direct the activities that are most significant to the entities and therefore, we do not consolidate these entities. In performing this analysis, we considered our explicit arrangements with Ablecom and Compuware, including all contractual arrangements with these entities. Also, as a result of the substantial related party relationships between us and these two companies, we considered whether any implicit arrangements exist that would cause us to protect these related parties’ interests from suffering losses. We determined that no material implicit arrangements exist with Ablecom, Compuware, or their shareholders.
We and Ablecom jointly established Super Micro Asia Science and Technology Park, Inc. (the “Management Company”) in Taiwan to manage the common areas shared by us and Ablecom for our separately constructed manufacturing facilities. In fiscal year 2012, each party contributed $0.2 million for a 50% ownership interest of the Management Company. We have concluded that the Management Company is a VIE and we are the primary beneficiary as we have the power to direct the activities that are most significant to the Management Company. For the fiscal years ended 2020, 2019 and 2018, the accounts of the Management Company were consolidated with our accounts, and a noncontrolling interest was recorded for Ablecom’s interest in the net assets and operations of the Management Company. Net income (loss) attributable to Ablecom’s interest was not material for the periods presented and was included in general and administrative expenses in our consolidated statements of operations.
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Results of Operations
The following table presents certain items of our consolidated statements of operations expressed as a percentage of revenue.
Years Ended June 30,
Operating expenses:
Research and development 6.6 % 5.1 % 4.9 %
Sales and marketing 2.5 % 2.2 % 2.1 %
General and administrative 4.1 % 4.0 % 2.9 %
Total operating expenses 13.2 % 11.3 % 9.9 %
Income from operations 2.6 % 2.9 % 2.9 %
Other (expense) income, net — % — % — %
Interest expense (0.1 )% (0.2 )% (0.2 )%
Income before income tax provision 2.5 % 2.7 % 2.7 %
Income tax provision (0.1 )% (0.4 )% (1.1 )%
Share of income (loss) from equity investee, net of taxes 0.1 % (0.1 )% (0.1 )%
Net Sales
Net sales consist of sales of our server and storage solutions, including systems and related services and subsystems and accessories. The main factors that impact our net sales of our server and storage systems are the number of compute nodes sold and the average selling prices per node. The main factors that impact our net sales of our subsystems and accessories are units shipped and the average selling price per unit. The prices for our server and storage systems range widely depending upon the configuration, including the number of compute nodes in a server system as well as the level of integration of key components such as SSDs and memory. The prices for our subsystems and accessories can also vary widely based on whether a customer is purchasing power supplies, server boards, chassis or other accessories.
A compute node is an independent hardware configuration within a server system capable of having its own CPU, memory and storage and that is capable of running its own instance of a non-virtualized operating system. The number of compute nodes sold, which can vary by product, is an important metric we use to track our business. Measuring volume using compute nodes enables more consistent measurement across different server form factors and across different vendors. As with most electronics-based product life cycles, average selling prices typically are highest at the time of introduction of new products that utilize the latest technology and tend to decrease over time as such products mature in the market and are replaced by next generation products. Additionally, in order to remain competitive throughout all industry cycles, we actively change our selling price per unit in response to changes in costs for key components such as memory and SSDs.
The following table presents net sales by product type for fiscal years 2020, 2019 and 2018 (dollars in millions):
Percentage of total net sales 78.5 % 81.7 % 79.3 %
Percentage of total net sales 21.5 % 18.3 % 20.7 %
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Fiscal Year 2020 Compared with Fiscal Year 2019
During fiscal year 2020 we continued to experience a steady demand for server and storage systems, particularly from our large enterprise and datacenter customers. The year-over-year decrease in net sales of server and storage systems was primarily due to a decrease of average selling prices per compute node by approximately 11%, offset by a slight increase in the number of units of compute nodes sold. We typically adjust our prices as component costs rise and fall. The decline in average selling prices was primarily due to substantially lower costs for key components, specifically for memory and storage, as compared to the previous fiscal year. Our services and software revenue, included in server and storage systems revenue, increased by $39.8 million year-over-year. The year-over-year increase in net sales of subsystems and accessories was primarily due to an increase of approximately 19% in the volume of subsystems and accessories sold, mainly due to increased demand from our indirect sales channel offset by an approximately 6% decrease in average selling prices due primarily to the decrease in costs of the components.
Fiscal Year 2019 Compared with Fiscal Year 2018
The year-over-year increase in server and storage systems sales was primarily due to an increase of average selling price per compute node by approximately 15%, offset by a decrease of approximately 8% in the number of units of compute nodes sold. The decrease in the number of units of compute notes was primarily attributable to an overall market slowdown in the second half of fiscal year 2019. The increase in the average selling prices of our server and storage systems was primarily due to higher sales of our complete systems configured with higher density computing and more memory and storage capacity. During the first half of fiscal year 2019, we increased our average selling prices primarily to remain consistent with the increases in the cost of memory and SSDs on a year-over year basis. During October 2018, a 10% tariff was applied to certain key components made in China and was partially incorporated into our average selling prices to the extent that component sourcing alternatives were not available. As costs for memory and SSDs began to decline in the second half of fiscal year 2019, our average selling prices to customers declined accordingly. Our services revenue, included in server and storage systems revenue, increased by $41.6 million year-over-year. The year-over-year decrease in net sales of our subsystems and accessories in fiscal year 2019 was primarily due to a decrease of average selling prices of approximately 8%.
The following table presents the percentages of net sales from products sold through our indirect sales channel and to our direct customers and OEMs for fiscal years 2020, 2019 and 2018 (dollars in millions):
Percentage of total net sales 53.1 % 39.3 % 41.5 %
Percentage of total net sales 46.9 % 60.7 % 58.5 %
Fiscal Year 2020 Compared with Fiscal Year 2019
The period-over-period increase in net sales through our indirect sales channel was primarily due to increased demand from the channel supporting large end users and partially offset by the lower average selling prices for our server and storage systems, caused by lower component pricing. Some direct customers also elected to move a part or all of their purchases to be through an indirect sales channel. The period-over-period decrease in net sales to our direct customers and OEMs was primarily due to a decline in demand from our internet datacenter and cloud customers and our enterprise datacenter customers.
Fiscal Year 2019 Compared with Fiscal Year 2018
The year-over-year decrease in net sales through our indirect sales channel was primarily due to the higher sales to our direct customers and OEMs. The year-over-year increase in net sales to direct customers and OEMs was primarily due to higher sales of our server and storage systems to internet data center and cloud, enterprise and OEM customers.
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The following table presents percentages of net sales by geographic region for fiscal years 2020, 2019 and 2018 (dollars in millions):
Percentage of total net sales 58.6 % 58.1 % 56.6 %
Percentage of total net sales 19.5 % 20.3 % 22.7 %
Percentage of total net sales 17.9 % 17.5 % 16.3 %
Percentage of total net sales 4.0 % 4.1 % 4.4 %
Fiscal Year 2020 Compared with Fiscal Year 2019
The year-over-year decrease in net sales in the United States was primarily due to a decrease in net sales of our server and storage systems to our direct customers and OEMs. The year-over-year decrease in net sales in Asia was primarily due to a decrease in net sales of our server and storage systems to OEMs in China, India and Japan, partially offset by a slight increase in the net sales of subsystems and accessories in China and of server and storage systems in the rest of Asia region. The year-over-year decrease in net sales in Europe was primarily due to a decrease in net sales of our server and storage systems to our direct customers and OEMs in the Netherlands, partially offset by an increase in net sales of our subsystems and accessories to our indirect sales channel in Germany and an increase in sales to our indirect sales channel in France.
Fiscal Year 2019 Compared with Fiscal Year 2018
The year-over-year increase in net sales in the United States was primarily due to the higher sales of our server and storage systems to our direct customers and OEMs. The year-over-year decrease in net sales in Asia was due primarily to decreased sales through our indirect sales channel in China, partially offset by increased sales in Taiwan to enterprise datacenter customers. The increased percentage of net sales in Europe was primarily due to higher sales in the Netherlands to enterprise and cloud computing customers.
Cost of Sales and Gross Margin
Cost of sales primarily consists of the costs to manufacture our products, including the costs of materials, contract manufacturing, shipping, personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, equipment and facility expenses, warranty costs and inventory excess and obsolescence provisions. The primary factors that impact our cost of sales are the mix of products sold and cost of materials, which include purchased parts and material costs, shipping costs, salary and benefits and overhead costs related to production. Cost of sales as a percentage of net sales may increase over time if decreases in average selling prices are not offset by corresponding decreases in our costs. Our cost of sales as a percentage of net sales is also impacted by the extent to which we are able to efficiently utilize our expanding manufacturing capacity. Because we generally do not have long-term fixed supply agreements, our cost of sales is subject to change based on the cost of materials and market conditions. As a result, our cost of sales as a percentage of net sales in any period can increase due to significant component price increases resulting from component shortages.
We use several suppliers and contract manufacturers to design and manufacture subsystems in accordance with our specifications, with most final assembly and testing performed at our manufacturing facility in San Jose, California. During the fiscal years 2020, we continued to expand manufacturing and service operations in Taiwan primarily to support our Asian and European customers and have continued to work on improving our utilization of our overseas manufacturing capacity. We work with Ablecom, one of our key contract manufacturers and also a related party to optimize modular designs for our chassis and certain of other components. We also outsource to Compuware, also a related party, a portion of our design activities and a significant part of our manufacturing of components, particularly power supplies. Our purchases of products from Ablecom and Compuware combined represented 10.1%, 9.2% and 9.0% of our cost of sales for fiscal years 2020, 2019 and 2018, respectively. For further details on our dealings with related parties, see Part II, Item 8, Note 13, “Related Party Transactions.”
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Cost of sales and gross margin for fiscal years 2020, 2019 and 2018, are as follows (dollars in millions):
Fiscal Year 2020 Compared with Fiscal Year 2019
The year-over-year decrease in cost of sales was primarily attributable to a decrease of $214.3 million in inventory costs related primarily to the decrease in the prices of components and a decrease of $14.6 million in the provision of excess inventory and obsolescence due to fewer excess and obsolescence items identified in the fiscal year 2020. This was offset by an increase of $19.6 million in overhead costs attributable primarily to increased tariffs and an increase of $11.3 million in personnel expenses, which included a special performance bonus of $4.1 million. Warranty and repairs costs also increased by $5.7 million in the fiscal year 2020 as compared to the fiscal year 2019.
The period-over-period increase in the gross margin percentage was primarily due to sales prices declining at a slower rate than the decline in the costs of components and due to the increase in services and software revenue which have higher margins than product sales. Since the start of the COVID-19 pandemic, we have experienced an increase in both logistics costs as well as direct labor costs as we incentivize our employees to continue to work and assist us in serving our customers. This increase in costs negatively impacts our gross margins, and we expect these higher costs to continue for the duration of the COVID-19 pandemic.
Fiscal Year 2019 Compared with Fiscal Year 2018
The year-over-year decrease in cost of sales was primarily attributable to an increase of $25.8 million in inventory costs related to the increase in net sales volume, increased expense of $23.3 million in the provision for excess inventory and obsolescence, an increase in overhead costs of $10.7 million attributable to increased tariffs for import of components from China, an increase of $8.6 million in compensation and benefits including stock-based compensation as a result of an increase in annual salaries and benefits and an increase in the number of operations personnel, and an increase of warranty provision of $5.4 million related to the increase in net sales.
The year-over-year increase in the gross margin percentage was primarily due to lower costs of memory and SSDs components in the second half of fiscal year 2019 and the timing of adjusting our average selling prices, as well as the increase in services and software revenue which have higher margins than product sales. In addition, in fiscal year 2020 as compared with fiscal year 2019, we had lower net sales in Asia where pricing is typically lower and the market there is more competitive which resulted in a shift in geographic mix that had a positive impact on our gross margin percentage.
Operating Expenses
Research and development expenses consist of personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our research and development personnel, as well as product development costs such as materials and supplies, consulting services, third-party testing services and equipment and facility expenses related to our research and development activities. All research and development costs are expensed as incurred. We occasionally receive non-recurring engineering funding from certain suppliers and customers for joint development. Under these arrangements, we are reimbursed for certain research and development costs that we incur as part of the joint development efforts with our suppliers and customers. These amounts offset a portion of the related research and development expenses and have the effect of reducing our reported research and development expenses.
Sales and marketing expenses consist primarily of personnel expenses, including salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our sales and marketing personnel, costs for tradeshows, independent sales representative fees and marketing programs. From time to time, we receive cooperative marketing funding from certain suppliers. Under these arrangements, we are reimbursed for certain marketing costs that we incur as part of the joint promotion of our products and those of our suppliers. These amounts offset a portion of the related expenses and have the effect of reducing our reported sales and marketing expenses. The timing, magnitude and estimated usage of these programs
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can result in significant variations in reported sales and marketing expenses from period to period. Spending on cooperative marketing, reimbursed by our suppliers, typically increases in connection with new product releases by our suppliers.
General and administrative expenses consist primarily of general corporate costs, including personnel expenses such as salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for our general and administrative personnel, financial reporting, information technology, corporate governance and compliance, outside legal, audit, tax fees, insurance and bad debt reserves on accounts receivable.
Operating expenses for fiscal years 2020, 2019 and 2018 are as follows (dollars in millions):
Fiscal Year2020Compared with Fiscal Year2019
The year-over-year increase in research and development expenses was primarily due to an increase of $41.3 million in personnel expenses as a result of an increase in the number of research and development employees and a special performance bonus of $17.3 million, a decrease of $0.7 million in reimbursements received for certain research and development costs that we incurred as part of joint product development; an increase of $6.7 million in costs mainly related to materials, supplies and equipment used in product development; and an increase of $1.8 million in facilities expenses. During fiscal year 2020, we also recorded a $9.5 million net settlement fee as a reduction in the research and development expenses related to the reimbursement of previously incurred expenses for one canceled joint product development agreement.
The year-over-year increase in sales and marketing expenses was primarily due to an increase of $8.1 million in personnel expenses as a result of an increase in the number of sales and marketing personnel and a special performance bonus of $1.8 million
The year-over-year decrease in general and administrative expenses was due to a decrease of $33.9 million in professional fees that were primarily incurred to investigate, assess and begin remediating the causes that led to the delay in filing our periodic reports with the SEC and the associated restatement of certain of our previously issued financial statements; a decrease of $10.2 million in bad debt provision expenses due to recovery of previously provisioned receivables from certain international customers, offset by an increase of $17.5 million related to an expense accrual for the settlement with the SEC; an increase of $14.1 million in personnel expenses as a result of an increase in the number of personnel and a special performance bonus of $4.5 million; an increase of $3.2 million in insurance expense; and an increase of $1.7 million related primarily to facilities expenses.
Fiscal Year 2019 Compared with Fiscal Year 2018
The year-over-year increase in research and development expenses was due to an increase of $16.0 million in personnel expenses, an decrease of $3.3 million in reimbursements received for certain research and development costs that we incur as part of the joint development of our and our suppliers’ and customers’ products, offset by a decrease of $6.1 million in product development costs. Our personnel expenses increased primarily as a result of an increase in annual salaries and benefits, and an increase in the number of research and development personnel to support our expanded product development initiatives and to support the growth of our business in many market verticals.
The year-over-year increase in sales and marketing expenses was due to an increase of $6.1 million in personnel expenses, as a result of an increase in annual salaries and benefits and an increase in the number of sales and marketing personnel,offset by a $1.5 million decrease in expenses related to advertising and promotion activities.
The year-over-year increase in general and administrative expenses was attributable to an increase of $31.7 million in professional fees that were primarily incurred to investigate, assess and begin remediating the causes that led to the delay in filing our periodic reports with the SEC and the associated restatement of certain of our previously issued financial statements, an increase of $7.2 million in bad debt provision expenses primarily as a result of our inability to collect receivables from
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certain international customers and an increase of $2.7 million primarily attributable to increase in sales tax accrual and insurance costs.
Interest and Other Income (Expense), Net
Other income (expense), net consists primarily of interest earned on our investment and cash balances and foreign exchange gains and losses.
Interest expense represents interest expense on our term loans and lines of credit.
Interest and other income (expense), net for fiscal years 2020, 2019 and 2018 are as follows (dollars in millions):
Fiscal Year 2020 Compared with Fiscal Year 2019
The year-over-year change in interest expense of $4.5 million is primarily a result of lower interest rates and reduced levels of borrowings in fiscal year 2020 as compared to fiscal year 2019. The change of $2.4 million in other income (expense), net was attributable to an increase of $1.6 million in interest income on our interest bearing deposits and a decrease of $0.8 million in other expenses.
Fiscal Year 2019 Compared with Fiscal Year 2018
The year-over-year increase in interest and other expense, net was primarily due to an increase of $1.0 million in interest expense related to amortization of loan origination fees in connection with refinancing of our debt in the last quarter of fiscal year 2018, an increase in other expense of $2.1 million as a result of an impairment recorded for certain investments, offset by an increase of $1.9 million attributable to increase in interest income on our interest bearing deposits and foreign exchange gain due to favorable foreign currency fluctuations.
Provision for Income Taxes
Our income tax provision is based on our taxable income generated in the jurisdictions in which we operate, primarily the United States, Taiwan, and the Netherlands. Our effective tax rate differs from the statutory rate primarily due to research and development tax credits, releases from uncertain tax positions, tax benefits from foreign derived intangible income and stock based compensation. A reconciliation of the federal statutory income tax rate to our effective tax rate is set forth in Part II, Item 8, Note 15, “Income Taxes” to the consolidated financial statements in this Annual Report.
Provision for income taxes and effective tax rates for fiscal years 2020, 2019 and 2018 are as follows (dollars in millions):
Fiscal Year 2020 Compared with Fiscal Year 2019
The year-over-year decrease in the effective tax rate was primarily due to an increase in tax benefits from research and development tax credits, stock based compensation, releases of uncertain tax positions, and U.S. sales to foreign jurisdictions, partially offset by the tax impact from the non-deductible settlement with the SEC.
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Fiscal Year 2019 Compared with Fiscal Year 2018
The year-over-year decrease in the effective tax rate was primarily due to a reduction of the statutory tax rate from 28.1% to 21% as a result of the tax reform, and a prior year recording of a one-time $12.9 million write down of U.S. deferred tax assets and liabilities, and a one-time transition tax of $2.8 million, all as a result of the 2017 Tax Reform Act.
Liquidity and Capital Resources
We have financed our growth primarily with funds generated from operations, in addition to utilizing borrowing facilities, particularly in relation to the financing of real property acquisitions as well as working capital. Our cash and cash equivalents were $210.5 million and $248.2 million as of June 30, 2020 and 2019, respectively. Our cash in foreign locations was $98.0 million and $124.6 million as of June 30, 2020 and 2019, respectively.
Amounts held outside of the U.S. are generally utilized to support non-U.S. liquidity needs. Repatriations generally will not be taxable from a U.S. federal tax perspective, but may be subject to state income or foreign withholding tax. Where local restrictions prevent an efficient intercompany transfer of funds, our intent is to keep cash balances outside of the U.S. and to meet liquidity needs through operating cash flows, external borrowings, or both. We do not expect restrictions or potential taxes incurred on repatriation of amounts held outside of the U.S. to have a material effect on our overall liquidity, financial condition or results of operations.
We believe that our current cash, cash equivalents, borrowing capacity available from our credit facilities and internally generated cash flows will be generally sufficient to support our operating businesses, expansion of our manufacturing facilities, continued remediation of the causes that led to the delay in filing our periodic reports with the SEC and the associated restatement of certain of our previously issued financial statements, and maturing debt and interest payments for the twelve months following the issuance of these consolidated financial statements. We expect to pay special performance bonuses of approximately $8.6 million to our CEO and certain members of the Board of Directors within the next two years when and if specified market and performance conditions are met. In addition, we made a settlement payment of $17.5 million to the SEC in connection with the conclusion of the ongoing investigations in August 2020.
On August 9, 2020, our Board of Directors approved a share repurchase program to repurchase shares of common stock for up to $30.0 million at prevailing prices in the open market. The share repurchase program is effective until December 31, 2020 or until the maximum amount of common stock is repurchased.
Our key cash flow metrics were as follows (dollars in millions):
Operating Activities
Net cash provided by operating activities decreased by $292.9 million for fiscal year 2020 as compared to fiscal year 2019. While net income increased by $12.4 million in fiscal year 2020 as compared to fiscal year 2019, the decrease in cash flows from operating activities was due primarily to an increase of cash used for net working capital requirements of $281.3 million, including a $181.3 million increase in inventories to meet customer demand, support expected business growth and mitigate supply chain risk due to the COVID-19 pandemic environment. Non-cash charges related to excess and obsolete inventory decreased by $14.6 million, related to bad debt reserve decreased by $10.1 million, related to income (loss) from equity investee decreased by $5.1 million, and related to impairment of investments decreased by $2.7 million in fiscal year 2020 compared to fiscal year 2019. These decreases were offset by an increase of $8.9 million in the non-cash charges related to the change in our deferred income tax assets, unrealized losses on our foreign currency-denominated credit facilities, and depreciation and amortization expense resulting from the amortization of operating lease right-of-use assets.
Net cash provided by operating activities increased by $178.3 million for fiscal year 2019 as compared to fiscal year 2018. The increase was due primarily to a reduction of net working capital of $160.6 million due to improved working capital management and reduced costs for key components in the second half of fiscal year 2019, higher net income in fiscal year 2019 of $25.8 million, the change in the non-cash charges related to an increase in excess and obsolete inventory of $23.3 million for
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aged inventory and $7.2 million for bad debt, partially offset by a reduction of $30.7 million in the non-cash charges related to the change in our deferred income tax assets, primarily as a result of the 2017 Tax Reform Act and a decrease of $8.0 million from the change in deferred revenue compared to prior year, related to the lower growth in services business year-over-year.
Investing Activities
Net cash used in investing activities was $43.6 million, $24.8 million and $25.9 million for the fiscal years 2020, 2019 and 2018, respectively, as we invested in our Green Computing Park in San Jose to expand our capacity and office space we purchased and expanded our Bade Facility in Taiwan and made purchases of property, plant and equipment.
Financing Activities
Net cash used in financing activities decreased by $119.6 million for fiscal year 2020 as compared to fiscal year 2019 primarily due to decreased net repayments of debt of $96.4 million, and cash receipts from exercises of stock options of $28.3 million offset by increased cash payments for withholding taxes from the vesting of restricted stock of $5.2 million. Net cash used in financing activities increased by $45.0 million for fiscal year 2019 as compared to fiscal year 2018 primarily due to increased debt repayments of $43.1 million.
Other Factors Affecting Liquidity and Capital Resources
Activities under Revolving Lines of Credit and Term Loans
Bank of America
2018 Bank of America Credit Facility
In April 2018, as amended in January and June 2019, we entered into a revolving line of credit with Bank of America (the "2018 Bank of America Credit Facility") for up to $250.0 million. In May 2020, we entered into a third amendment to extend the maturity from June 30, 2020 to June 30, 2021, release the real property as a collateral, modify certain payments and covenants provisions, specify that LIBOR cannot be less than 1% for purposes of determining interest rates, and increase the unused line fee from 0.25% per annum to 0.375% per annum. Interest shall accrue at LIBOR plus 2.00% on outstanding borrowings less than $125.0 million and LIBOR plus 2.25% on outstanding borrowings in excess of $125.0 million. As of June 30, 2020, we had no outstanding borrowings and we had a $6.4 million letter of credit outstanding under this facility. Our available borrowing capacity was $243.6 million, subject to the borrowing base limitation and compliance with other applicable terms. In the event of default or if outstanding borrowings are in excess of $220.0 million, we are required to grant the lenders a continuing security interest in and lien upon all amounts credited to any of our deposit accounts. Interest accrued on any loans under the 2018 Bank of America Credit Facility is due on the first day of each month, and the loans are due and payable in full on the termination date of the 2018 Bank of America Credit Facility. Voluntary prepayments are permitted without early repayment fees or penalties. The 2018 Bank of America Credit Facility is secured by substantially all of Super Micro Computer’s assets, other than real property assets. In addition, we are not permitted to pay any dividends. Under the terms of the 2018 Bank of America Credit Facility agreement, we are required to maintain a certain fixed charge ratio and we have been in compliance with all covenants under the 2018 Bank of America Credit Facility.
CTBC Bank
2019 CTBC Credit Facility
In June 2019, we entered into a credit agreement with CTBC Bank in Taiwan that provides for term loans denominated in NTD of up to $50.0 million (the "2019 CTBC Credit Facility") and had an original maturity of June 30, 2020. We have since extended the maturity of the 2019 CTBC Credit Facility to August 31, 2021. During the year ended June 30, 2020, we borrowed and repaid $10.0 million under the revolving line of credit. The total outstanding borrowings under the 2019 CTBC Credit Facility were $23.7 million as of June 30, 2020. The amount available for future borrowing was $26.3 million as of June 30, 2020. The interest rate for these outstanding term loans was 0.45% per annum as of June 30, 2020. Term loans are secured by certain of our assets, including certain property, plant, and equipment. There are no financial covenants under the 2019 CTBC Credit Facility.
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2020 CTBC Term Loan Facility
In June 2020, we entered into a ten-year, non-revolving term loan facility (the “2020 CTBC Term Loan Facility”) to obtain up to NTD 1.2 billion ($40.7 million in U.S. dollar equivalents) in financing for use in the expansion and renovation of our Bade Manufacturing Facility located in Taiwan. Drawdowns on the 2020 CTBC Term Loan Facility are based on 80% of balances owed on commercial invoices from the contractor and are drawn according to the progress of the renovations. Borrowings under the 2020 CTBC Term Loan Facility are available through June 2022. We are required to pay against total outstanding principal and interest in equal monthly installments starting June 2023 and continuing through the maturity date of June 2030. The 2020 CTBC Term Loan Facility is secured by the Bade Manufacturing Facility, including any expansion. Fees paid to the lender as debt issuance costs were immaterial. We borrowed $5.7 million in June 2020 with a rate of 0.45% per annum. As of June 30, 2020, the amount outstanding under the 2020 CTBC Term Loan Facility was $5.7 million and the net book value of the property serving as collateral was $10.1 million. We have financial covenants requiring our current ratio, debt service coverage ratio, and financial debt ratio, to be maintained at certain levels. We have been in compliance with all financial covenants under the 2020 CTBC Term Loan Facility.
Contractual Obligations
The following table describes our contractual obligations as of June 30, 2020:
Payments Due by Period
Less Than 1 Year 1 to 3 Years 3 to 5Years More Than5 Years Total
(in thousands)
__________________________
We expect to fund our remaining contractual obligations from our ongoing operations and existing cash and cash equivalents on hand.
Recent Accounting Pronouncements
For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our consolidated financial statements, see Part II, Item 8, Note 1, “Organization and Summary of Significant Accounting Policies” to the consolidated financial statements in this Annual Report.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
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Item 7A. Quantitative and Qualitative Disclosure About Market Risk
Interest Rate Risk
The primary objectives of our investment activities are to preserve principal, provide liquidity and maximize income without significantly increasing the risk. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the fair value of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash equivalents and short-term investments in money market funds and certificates of deposit. Our investment in an auction rate security has been classified as non-current due to the lack of a liquid market for these securities. Since our results of operations are not dependent on investments, the risk associated with fluctuating interest rates is limited to our investment portfolio, and we believe that a 10% change in interest rates would not have a significant impact on our results of operations. As of June 30, 2020, our investments were in money market funds, certificates of deposits and auction rate securities.
We are exposed to changes in interest rates as a result of our borrowings under our term loan and revolving lines of credit. The interest rates for the term loans and the revolving lines of credit ranged from 0.45% to 3.0% at June 30, 2020. Based on the outstanding principal indebtedness of $29.4 million under our credit facilities as of June 30, 2020, we believe that a 10% change in interest rates would not have a significant impact on our results of operations.
Foreign Currency Risk
To date, our international customer and supplier agreements have been denominated primarily in U.S. dollars and accordingly, we have limited exposure to foreign currency exchange rate fluctuations from customer agreements, and do not currently engage in foreign currency hedging transactions. The functional currency of our subsidiaries in the Netherlands and Taiwan is the U.S. dollar. However, certain loans and transactions in these entities are denominated in a currency other than the U.S. dollar, and thus we are subject to foreign currency exchange rate fluctuations associated with re-measurement to U.S. dollars. Such fluctuations have not been significant historically. Foreign exchange (loss) gain for fiscal years 2020, 2019 and 2018 was $(1.4) million, $0.5 million and $(0.6) million, respectively.
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Item 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Report of Independent Registered Public Accounting Firm 48
Consolidated Balance Sheets 51
Consolidated Statements of Operations 52
Consolidated Statements of Comprehensive Income 53
Consolidated Statements of Stockholders’ Equity 54
Consolidated Statements of Cash Flows 55
Notes to Consolidated Financial Statements 56
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and the Board of Directors of Super Micro Computer, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Super Micro Computer, Inc. and subsidiaries (the "Company") as of June 30,2020 and 2019, the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows, for each of the three years in the period ended June 30, 2020, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended June 30, 2020, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of June 30, 2020, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated August 28, 2020, expressed an adverse opinion on the Company’s internal control over financial reporting because of a material weakness.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current-period audit of the financial statements that were communicated or required to be communicated to the audit committee and that (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Variable Interest Entities and Related Party Transactions - Refer to Notes 1 and 13 to the financial statements
Critical Audit Matter Description
The Company has a variety of business relationships defined by various agreements with Ablecom Technology, Inc. (“Ablecom”) and its affiliate, Compuware Technology, Inc. ("Compuware"). Ablecom is one of the Company’s major contract manufacturers; Compuware is both a distributor of the Company’s products and a contract manufacturer for the Company. Purchases from Ablecom and Compuware were $160.1 million and $131.8 million, respectively, for the fiscal year ended June 30, 2020. Net sales to Compuware as a distributor were $23.9 million for the fiscal year ended June 30, 2020.
The Company concluded that Ablecom and Compuware are variable interest entities (VIEs) and that it is not the primary beneficiary as it does not have the power to direct the activities that are most significant to Ablecom and Compuware. Therefore, the Company does not consolidate Ablecom and Compuware. The Company considered its explicit arrangements with Ablecom and Compuware, including its supplier arrangements, and as a result of the substantial related party relationships between the Company, Ablecom and Compuware, the Company also considered whether any implicit arrangements exist that
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would cause the Company to protect those related parties’ interests from suffering losses. The Company determined that no material implicit arrangements exist with Ablecom, Compuware, or their shareholders.
We identified management’s conclusion that it is not the primary beneficiary as a critical audit matter because of the judgments necessary for management to determine whether any explicit and implicit arrangements exist that would cause the Company to protect those related parties’ interest from absorbing losses. This required extensive audit effort due to the complexity and variety of related party relationships with Ablecom and Compuware and required a high degree of auditor judgment when performing audit procedures to audit the Company’s conclusion that it is not the primary beneficiary.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s conclusion that it is not the primary beneficiary included the following, among others:
Inventories - Excess and Obsolescence Reserve - Refer to Notes 1 and 5 to the financial statements
Critical Audit Matter Description
The Company’s inventories are stated at lower of cost, using weighted average cost method, or net realizable value. The Company evaluates inventory for lower of cost or net realizable value and excess and obsolescence and, as necessary, writes down the valuation of units based upon inventory aging, forecasted usage and sales, anticipated selling price, product obsolescence and other factors. The provision for excess and obsolete inventory for the fiscal year ended June 30, 2020, was $22.6 million.
We identified the excess and obsolescence reserve as a critical audit matter because of judgments made by management in recording the manual adjustments that management may make to estimate the excess and obsolescence reserve. This required a high degree of auditor judgment and an increased extent of effort when performing audit procedures to evaluate the methodology and the reasonableness of the excess and obsolescence reserve.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the Company’s excess and obsolescence reserve included the following procedures, among others:
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/s/ Deloitte & Touche LLP
San Jose, California
August 28, 2020
We have served as the Company's auditor since fiscal 2003.
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SUPER MICRO COMPUTER, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share amounts)
ASSETS
Current assets:
Investment in equity investee 2,703 1,701
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Long-term debt 5,697 —
Commitments and contingencies (Note 16)
Stockholders’ equity:
Common stock and additional paid-in capital, $0.001 par value
Accumulated other comprehensive loss (152 ) (80 )
Total Super Micro Computer, Inc. stockholders’ equity 1,065,540 941,015
Noncontrolling interest 167 161
See accompanying notes to consolidated financial statements.
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SUPER MICRO COMPUTER, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Years Ended June 30,
Operating expenses:
Net income per common share:
Weighted-average shares used in calculation of net income per common share:
See accompanying notes to consolidated financial statements.
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SUPER MICRO COMPUTER, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in thousands)
Years Ended June 30,
Other comprehensive (loss) income, net of tax:
Foreign currency translation (loss) gain (72 ) (245 ) 280
Net changes in unrealized loss on investments — — (38 )
Total other comprehensive (loss) income (72 ) (245 ) 242
See accompanying notes to consolidated financial statements.
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SUPER MICRO COMPUTER, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(in thousands, except share amounts)
Shares Amount Shares Amount
Foreign currency translation gain — — — — 280 — — 280
Foreign currency translation loss — — — — (245 ) — — (245 )
Foreign currency translation loss — — — — (72 ) — — (72 )
See accompanying notes to consolidated financial statements.
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SUPER MICRO COMPUTER, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Years Ended June 30,
OPERATING ACTIVITIES:
Allowance (recoveries) for doubtful accounts (3,081 ) 7,058 (96 )
Impairment of investments — 2,661 —
Share of (income) loss from equity investee (2,402 ) 2,721 3,607
Foreign currency exchange (gain) loss 1,008 (313 ) 171
Changes in operating assets and liabilities:
INVESTING ACTIVITIES:
Proceeds from redemption of auction rate security — — 1,000
Proceeds from sale of investment in a privately-held company 750 — (2,100 )
FINANCING ACTIVITIES:
Payment of other fees for debt financing (650 ) (625 ) (414 )
Proceeds from exercise of stock options 28,343 — 3,043
Payments of obligations under capital leases (138 ) (267 ) (253 )
Net cash provided by (used in) financing activities 23,796 (95,828 ) (50,832 )
Effect of exchange rate fluctuations on cash 376 (119 ) (6 )
Supplemental disclosure of cash flow information:
Non-cash investing and financing activities:
Contribution of certain technology rights to equity investee $ — $ 3,000 $ —
See accompanying notes to consolidated financial statements.
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SUPER MICRO COMPUTER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization and Summary of Significant Accounting Policies
Organization
Super Micro Computer, Inc. (“Super Micro Computer”) was incorporated in 1993. Super Micro Computer is a global leader in server technology and green computing innovation. Super Micro Computer develops and provides high performance server and storage solutions based upon an innovative, modular and open-standard architecture. Super Micro Computer has operations primarily in the United States, the Netherlands, Taiwan, China and Japan.
Basis of Presentation
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”). The consolidated financial statements of Super Micro Computer include the accounts of Super Micro Computer and entities consolidated under the variable interest model or the voting interest model. Noncontrolling interests are not presented separately in the consolidated statements of operations, and consolidated statements of comprehensive income as the amounts are immaterial. All intercompany accounts and transactions of Super Micro Computer and its consolidated entities (collectively, the "Company") have been eliminated in consolidation. For equity investments over which the Company is able to exercise significant influence over the investee but does not control the investee, and is not the primary beneficiary of the investee’s activities are accounted for using the equity method. Investments in equity securities which do not have readily determinable fair values and for which the Company is not able to exercise significant influence over the investee are accounted for under the measurement alternative which is the cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar securities of the same investee.
Use of Estimates
U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Such estimates include, but are not limited to revenue recognition, allowances for doubtful accounts and sales returns, inventory valuation, useful lives of property, plant and equipment, product warranty accruals, stock-based compensation, impairment of investments and long-lived assets, and income taxes. The Company’s estimates are evaluated on an ongoing basis and changes in the estimates are recognized prospectively. Actual results could differ from those estimates. The Company considered estimates of the economic implications of the COVID-19 pandemic on its critical and significant accounting estimates, including an assessment of the collectability of each customer contract as part of the revenue recognition process, assessment of the valuation of accounts receivable, assessment of provision for excess and obsolete inventory and an impairment of long-lived assets.
Fair Value of Financial Instruments
The Company accounts for certain assets and liabilities at fair value, which is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly arms-length transaction between market participants. When measuring fair value, the Company takes into account the characteristics of the asset or liability that a market participant would consider when pricing the asset or liability at the measurement date. The Company considers one or more techniques for measuring fair value: market approach, income approach, and cost approach. The valuation techniques include inputs that are based on three different levels of observability to the market. The Company categorizes each of its fair value measurements in one of these three levels based on the lowest level input that is significant to the fair value measurement in its entirety. These levels are:
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SUPER MICRO COMPUTER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Accounts receivable and accounts payable are carried at cost, which approximates fair value due to the short maturity of these instruments. Cash equivalents, certificates of deposit and the investment in an auction rate security are carried at fair value. Short-term and long-term debt is carried at amortized cost, which approximates its fair value based on borrowing rates currently available to the Company for loans with similar terms.
Cash and Cash Equivalents
The Company considers all highly liquid instruments with an original maturity of three months or less from the date of purchase to be cash equivalents. Cash equivalents consist primarily of money market funds and certificates of deposit with original maturities of less than three months.
Restricted Cash and Cash Equivalents
Restricted cash is comprised of amounts held in bank accounts which are controlled by the lenders pursuant to the terms of certain debt agreements, certificates of deposit primarily related to leases and customs requirements, and money market accounts held in escrow pursuant to the Company’s workers’ compensation program. These restricted cash balances have been excluded from the Company's cash and cash equivalents balance.
Investments in Auction Rate Securities
The Company classifies its investments in auction rate securities ("auction rate securities") as non-current available-for-sale investments. The auction rate securities consist of municipal securities, which are debt securities. The Company uses discounted cash flow to estimate the fair value of any auction rate securities. These auction rate securities are recorded within other assets in the consolidated balance sheets at fair value. Unrealized gains and losses on auction rate securities are included as a component of accumulated other comprehensive (loss) income, net of tax.
Inventories
Inventories are stated at lower of cost, using weighted average cost method, or net realizable value. Net realizable value is the estimated selling price of the Company's products in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Inventories consist of purchased parts and raw materials (principally electronic components), work in process (principally products being assembled) and finished goods. The Company evaluates inventory on a quarterly basis for excess and obsolescence and lower of cost or net realizable value and, as necessary, writes down the valuation of inventories based upon the Company's inventory aging, forecasted usage and sales, anticipated selling price, product obsolescence and other factors. Once inventory is written down, its new value is maintained until it is sold or scrapped.
The Company receives various rebate incentives from certain suppliers based on its contractual arrangements, including volume-based rebates. The rebates earned are recognized as a reduction of cost of inventories and reduce the cost of sales in the period when the related inventory is sold.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost and depreciated using the straight-line method over the estimated useful lives of the related assets as follows:
Software 3 to 5 years
Machinery and equipment 3 to 7 years
Furniture and fixtures 5 years
Buildings 39 years
Building improvements Up to 20 years
Land improvements 15 years
Leasehold improvements Shorter of lease term or estimated useful life
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SUPER MICRO COMPUTER, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
Long-Lived Assets
The Company evaluates its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. When the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition is less than its carrying amount, an impairment loss would be measured based on the fair value of the asset compared to the carrying amount.No impairment charge for long-lived assets has been recorded in any of the periods presented.
Revenue Recognition
The Company generates revenues from the sale of server and storage systems, subsystems, accessories, services, server software management solutions, and support services.
Product sales. The Company recognizes revenue from sales of products as control is transferred to customers, which generally happens at the point of shipment or upon delivery, unless customer acceptance is uncertain. Products sold by the Company are delivered via shipment from the Company’s facilities or drop shipment directly to its customers from a Company vendor. The Company may use distributors to sell products to end customers. Revenue from distributors is recognized when the distributor obtains control of the product, which generally happens at the point of shipment or upon delivery.
The Company applies judgment in determining the transaction price as the Company may be required to estimate variable consideration when determining the amount of revenue to recognize. As part of determining the transaction price in contracts with customers, the Company estimates reserves for future sales returns based on a review of its history of actual returns for each major product line. Based upon historical experience, a refund liability is recorded at the time of sale for estimated product returns and an asset is recognized for the amount expected to be recorded in inventory upon product return, less the expected recovery costs. The Company also reduces revenue for the estimated costs of customer and distributor programs and incentive offerings such as price protection and rebates as well as the estimated costs of cooperative marketing arrangements where the fair value of the benefit derived from the costs cannot be reasonably estimated. Any provision for customer and distributor programs and other discounts is recorded as a reduction of revenue at the time of sale based on an evaluation of the contract terms and historical experience.
Services sales. The Company’s sale of services mainly consists of extended warranty and on-site services. Revenue related to extended warranty commences upon the expiration of the standard warranty period and is recognized ratably over the contractual period as the Company stands ready to perform any required warranty service. Revenue related to on-site services commences upon recognition of the product sale and is recognized ratably over the contractual period as the on-site services are made available to the customer. These service contracts are typically one to five years in length. Service revenue has been less than 10% of net sales for all periods presented and is not separately disclosed.
Contracts with multiple promised goods and services. Certain of the Company’s contracts contain multiple promised goods and services. The Company assesses whether each promised good or service is distinct for the purpose of identifying the performance obligations in the contract. This assessment involves subjective determinations and requires management to make judgments about the individual promised goods or services and whether such goods or services are separable from the other aspects of the contractual relationship. Performance obligations in a contract are identified based on the promised goods or services that will be transferred to the customer that are both capable of being distinct, whereby the customer can benefit from the service either on its own or together with other resources that are readily available from third parties or from the Company, and are distinct in the context of the contract, whereby the transfer of the services is separately identifiable from other promises in the contract. If these criteria are not met, the promised goods and services are accounted for as a combined performance obligation. Revenue allocated to each performance obligation is recognized at the time the related performance obligation is satisfied by transferring control of the promised good or service to a customer.
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price to each performance obligation based on a relative standalone selling price basis. The Company determines standalone selling prices based on the price at which the performance obligation is sold separately. If the standalone selling price is not observable
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through past transactions, the Company applies judgment to estimate the standalone selling price taking into account available information, such as internally approved pricing guidelines with respect to geographies, customer type, internal costs, and gross margin objectives, for the related performance obligations.
When the Company receives consideration from a customer prior to transferring goods or services to the customer, the Company records a contract liability (deferred revenue). The Company also recognizes deferred revenue when it has an unconditional right to consideration (i.e., a receivable) before transfer of control of goods or services to a customer.
The Company considers shipping & handling activities as costs to fulfill the sales of products. Shipping revenue is included in net sales when control of the product is transferred to the customer, and the related shipping and handling costs are included in cost of sales. Taxes imposed by governmental authorities on the Company's revenue producing activities with customers, such as sales taxes and value added taxes, are excluded from net sales and included in operating expenses.
Allowances for Doubtful Accounts
Customers are subjected to a credit review process that evaluates each customer’s financial position and ability and intent to pay. On a quarterly basis, the Company makes estimates of its uncollectible accounts receivable by analyzing the aging of accounts receivable, history of bad debts, customer concentrations, customer-credit-worthiness, and current economic trends to evaluate the adequacy of the allowance for doubtful accounts. The Company's (recovery of) provision for bad debt was $(3.1) million, $7.1 million, and $(0.1) million in fiscal years 2020, 2019 and 2018, respectively.
Cost of Sales
Cost of sales primarily consists of the costs of materials, contract manufacturing, in-bound shipping, personnel and related expenses including stock-based compensation, equipment and facility expenses, warranty costs and provision for lower of cost or net realizable value and excess and obsolete inventory.
Product Warranties
The Company offers product warranties typically ranging from 15 to 39 months against any defective products. These standard warranties are assurance type warranties and the Company does not offer any services beyond the assurance that the product will continue working as specified. Therefore, these warranties are not considered separate performance obligations in the arrangement. Based on historical experience, the Company accrues for estimated returns of defective products at the time revenue is recognized. The Company monitors warranty obligations and may make revisions to its warranty reserve if actual costs of product repair and replacement are significantly higher or lower than estimated. Accruals for anticipated future warranty costs are recorded to cost of sales and included in accrued liabilities and other long-term liabilities. Warranty accruals are based on estimates that are updated on an ongoing basis taking into consideration inputs such as new product introductions, changes in the volume of claims compared with the Company's historical experience, and the changes in the cost of servicing warranty claims. The Company accounts for the effect of such changes in estimates prospectively. The following table presents for the fiscal years ended June 30, 2020, 2019 and 2018, the reconciliation of the changes in accrued warranty costs which is included as a component of accrued liabilities and other long-term liabilities (in thousands):
Years Ended June 30,
Change in estimated liability for pre-existing warranties (115 ) 4,440 1,199
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Research and Development
Research and development expenses consist of personnel expenses including salaries, benefits, stock-based compensation and incentive bonuses, and related expenses for the Company's research and development personnel, as well as materials and supplies, consulting services, third-party testing services and equipment and facility expenses related to the Company's research and development activities. All research and development costs are expensed as incurred. The Company occasionally receives funding from certain suppliers and customers towards its development efforts. Such amounts are recorded as a reduction of research and development expenses and were $2.1 million, $2.8 million, and $6.1 million for the fiscal years ended June 30, 2020, 2019 and 2018, respectively. During the fiscal year ended June 30, 2020, the Company also recorded a $9.5 million net settlement fee as a reduction in the research and development expenses related to the reimbursement of previously incurred expenses for one canceled joint product development agreement.
Software development costs, including costs to develop software sold, leased, or otherwise marketed, that are incurred subsequent to the establishment of technological feasibility are capitalized if significant. Costs incurred during the application development stage for internal-use software are capitalized if significant. Capitalized software development costs are amortized using the straight-line amortization method over the estimated useful life of the applicable software. Such software development costs required to be capitalized have not been material to date.
Advertising Costs
Advertising costs, net of reimbursements received under the cooperative marketing arrangements with the Company's vendors, are expensed as incurred. Total advertising and promotional expenses were $3.0 million, $2.4 million, and $3.5 million for the fiscal years ended June 30, 2020, 2019 and 2018, respectively.
Stock-Based Compensation
The Company measures and recognizes compensation expense for all share-based awards made to employees and non-employees, including stock options, restricted stock units ("RSUs") and performance-based restricted stock units (“PRSUs”). The Company recognizes the grant date fair value of all share-based awards over the requisite service period and accounts for forfeitures as they occur. Stock option and RSU awards are recognized to expense on a straight-line basis over the requisite service period. PRSU awards are recognized to expense using an accelerated method only when it is probable that a performance condition is met during the vesting period. If it is not probable, no expense is recognized and the previously recognized expense is reversed.The Company bases initial accrual of compensation expense on the estimated number of PRSUs that are expected to vest over the requisite service period. That estimate is revised if subsequent information indicates that the actual number of PRSUs is likely to differ from previous estimates. The cumulative effect on current and prior periods of a change in the estimated number of PRSUs expected to vest is recognized in stock-based compensation expense in the period of the change. Previously recognized compensation expense is not reversed if vested stock options, RSUs or PRSUs for which the requisite service has been rendered and the performance condition has been met expire unexercised or are not settled.
The fair value of RSUs and PRSUs is based on the closing market price of the Company's common stock on the date of grant. The Company estimates the fair value of stock options granted using a Black-Scholes option pricing model. This model requires the Company to make estimates and assumptions with respect to the expected term of the option and the expected volatility of the price of the Company's common stock. The expected term represents the period that the Company’s stock-based awards are expected to be outstanding and was determined based on the Company's historical experience. The expected volatility is based on the historical volatility of the Company’s common stock. The fair value is then amortized on a straight-line basis over the requisite service periods of the awards, which is generally the vesting period.
Leases
Recognition of leases for periods after the Company’s adoption of the new leasing standard as of July 1, 2019
The Company has arrangements for the right to use certain of its office, warehouse spaces and other premises, and equipment. As of July 1, 2019, the Company determines at inception if an arrangement is or contains a lease. When the terms of a lease effectively transfer control of the underlying asset to the Company, it is classified as a finance lease. All other leases are classified as operating leases.
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Operating Leases
For operating leases with lease terms of more than 12 months, operating lease right-of-use ("ROU") assets are recorded in long-term other assets, and lease liabilities are recorded in accrued liabilities and other long-term liabilities on the consolidated balance sheet. The Company's lease term includes options to extend or terminate the lease when it is reasonably certain that it will exercise that option. The Company elected to apply the short-term lease recognition exemption and does not recognize ROU asset and lease liabilities for leases with an initial term of 12 months or less and recognizes as expense the payments under such leases on a straight-line basis over the lease term. The Company's leases with an initial term of 12 months or less are immaterial.
Operating lease ROU assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments over the lease term. Operating lease ROU assets and liabilities are recognized at lease commencement based on the present value of the remaining lease payments discounted using the Company’s incremental borrowing rate as the interest rate implicit in the lease arrangements is not readily determinable. The incremental borrowing rate is estimated to be the interest rate on a fully collateralized basis with similar terms and payments and in the economic environment where the leased asset is located. Operating lease ROU assets also include initial direct costs incurred, prepaid lease payments, minus any lease incentives. Operating lease expense is recognized on a straight-line basis over the lease term. The Company accounts for fixed payments for lease and non-lease components as a single lease component which increases the amount of ROU assets and liabilities. Non-lease components that are variable costs, such as common area maintenance, are expensed as incurred and not included in the ROU assets and lease liabilities.
Finance Leases
Assets under finance leases are recorded in property, plant and equipment, net and lease liabilities are included in accrued liabilities and other long-term liabilities on the consolidated balance sheet. Finance lease interest expense is recognized based on an effective interest method and depreciation of assets is recorded on a straight-line basis over the shorter of the lease term and useful life of the asset. The Company's finance leases are immaterial.
Recognition of leases for periods prior to the Company’s adoption of the new leasing standard as of July 1, 2019
Prior to July 1, 2019, leases were evaluated and recorded as capital leases if one of the following was true at inception: (a) the present value of minimum lease payments met or exceeded 90% of the fair value of the asset, (b) the lease term was greater than or equal to 75% of the economic life of the asset, (c) the lease arrangement contained a bargain purchase option, or (d) title to the property transferred to the Company at the end of the lease. The Company recorded an asset and liability for capital leases at present value of the minimum lease payments based on the incremental borrowing rate. Assets were depreciated over the useful life in accordance with the Company’s depreciation policy while rental payments and interest on the liability was accounted for using the effective interest method.
Leases that were not classified as capital leases were accounted for as operating leases. Operating lease agreements that had tenant improvement allowances were evaluated for lease incentives. For leases that contained escalating rent payments, the Company recognized rent expense on a straight-line basis over the lease term, with any lease incentives amortized as a reduction of rent expense over the lease term.
Income Taxes
The Company accounts for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net of operating loss carry-forwards and other tax credits measured by applying enacted tax laws related to the financial statement periods. Valuation allowances are provided when necessary to reduce deferred tax assets to an amount that is more likely than not to be realized.
The Company recognizes tax liabilities for uncertain income tax positions on the income tax return based on the two-step process. The first step is to determine whether it is more likely than not that each income tax position would be sustained upon audit. The second step is to estimate and measure the tax benefit as the amount that has a greater than 50% likelihood of
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being realized upon ultimate settlement with the tax authority. Estimating these amounts requires the Company to determine the probability of various possible outcomes. The Company evaluates these uncertain tax positions on a quarterly basis. This evaluation is based on the consideration of several factors, including changes in facts or circumstances, changes in applicable tax law, settlement of issues under audit and new exposures. If the Company later determines that its exposure is lower or that the liability is not sufficient to cover its revised expectations, the Company adjusts the liability and effects a related charge in its tax provision during the period in which the Company makes such a determination.
Variable Interest Entities
The Company determines at the inception of each arrangement whether an entity in which the Company holds an investment or in which the Company has other variable interests is considered a variable interest entity ("VIE"). The Company consolidates VIEs when it is the primary beneficiary. The primary beneficiary of a VIE is the party that meets both of the following criteria: (1) has the power to make decisions that most significantly affect the economic performance of the VIE and (2) has the obligation to absorb losses or the right to receive benefits that in either case could potentially be significant to the VIE. Periodically, the Company assesses whether any changes in the interest or relationship with the entity affect the determination of whether the entity is still a VIE and, if so, whether the Company is the primary beneficiary. If the Company is not the primary beneficiary in a VIE, the Company accounts for the investment or other variable interest in accordance with applicable GAAP.
The Company has concluded that Ablecom Technology, Inc. (“Ablecom”) and its affiliate, Compuware Technology, Inc. ("Compuware"), are VIEs; however, the Company is not the primary beneficiary as it does not have the power to direct the activities that are most significant to the entities and therefore, the Company does not consolidate these entities. In performing its analysis, the Company considered its explicit arrangements with Ablecom and Compuware, all contractual arrangements with these entities. Also, as a result of the substantial related party relationships between the Company and these entities, the Company considered whether any implicit arrangements exist that would cause the Company to protect these related parties’ interests from suffering losses. The Company determined it has no material implicit arrangements with Ablecom, Compuware or their shareholders.
The Company and Ablecom jointly established Super Micro Asia Science and Technology Park, Inc. (the "Management Company") in Taiwan to manage the common areas shared by the Company and Ablecom for its separately constructed manufacturing facilities. In fiscal year 2012, each party contributed $0.2 million for a 50% ownership interest of the Management Company. The Company has concluded that the Management Company is a VIE, and the Company is the primary beneficiary as it has the power to direct the activities that are most significant to the Management Company. For the fiscal years ended 2020, 2019 and 2018, the accounts of the Management Company were consolidated with the accounts of Super Micro Computer, and a noncontrolling interest was recorded for Ablecom's interest in the net assets and operations of the Management Company. Net income (loss) attributable to Ablecom's interest was not material for the periods presented and was included in general and administrative expenses in the Company's consolidated statements of operations.
Foreign Currency Transactions
The functional currency of the Company’s international subsidiaries is the U.S. dollar, with the exception of Super Micro Asia and Technology Park, Inc., a consolidated variable interest entity. Monetary assets and liabilities of the Company's international subsidiaries that are denominated in foreign currency are remeasured into U.S. dollars at period-end exchange rates. Non-monetary assets and liabilities that are denominated in the foreign currency are remeasured into U.S. dollars at the historical rates. Revenue and expenses that are denominated in the foreign currency are remeasured into U.S. dollars at the average exchange rates during the period. Remeasurement of foreign currency accounts and resulting foreign exchange transaction gains and losses, which have not been material, are reflected in the consolidated statements of operations in other expense, net.
The functional currency of Super Micro Asia and Technology Park, Inc. is New Taiwanese Dollar (“NTD”). Assets and liabilities are translated to U.S. dollars at the period-end exchange rate. Revenues and expenses are translated using the average exchange rate for the period. The effects of foreign currency translation are included in stockholders’ equity as a component of accumulated other comprehensive (loss) income in the accompanying consolidated balance sheets and periodic movements are summarized as a line item in the consolidated statements of comprehensive income.
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The Company has an investment in a privately-held company that is accounted for under the equity method (the "Corporate Venture"). The functional currency of the Corporate Venture is the Chinese Yuan. Adjustments for the Company's share of the effects of foreign currency translation from local currency to U.S. dollars are recorded as increases or decreases to the carrying value of the investment and included in stockholders’ equity as a component of accumulated other comprehensive (loss) income in the accompanying consolidated balance sheets and periodic movements are summarized as a line item in the consolidated statements of comprehensive income.
Net Income Per Common Share
Basic net income per common share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding stock options and unvested RSUs and PRSUs. Contingently issuable shares are included in computing basic net income per common share as of the date that all necessary conditions, including service vesting conditions have been satisfied. Contingently issuable shares are considered for computing diluted net income per common share as of the beginning of the period in which all necessary conditions have been satisfied and the only remaining vesting condition is a service vesting condition.
Under the treasury stock method, an increase in the fair market value of the Company's common stock results in a greater dilutive effect from outstanding stock options and RSUs and PRSUs. Additionally, the exercise of stock options and the vesting of RSUs results in a further dilutive effect on net income per share.
The computation of basic and diluted net income per common share is as follows (in thousands, except per share amounts):
Years Ended June 30,
Numerator:
Denominator:
Basic net income per common share $ 1.65 $ 1.44 $ 0.94
Diluted net income per common share $ 1.60 $ 1.39 $ 0.89
For the fiscal years ended June 30, 2020, 2019 and 2018, the Company had stock options, RSUs and PRSUs outstanding that could potentially dilute basic earnings per share in the future, but were excluded from the computation of diluted net income per share in the periods presented, as their effect would have been anti-dilutive. The anti-dilutive common share equivalents resulting from outstanding equity awards were 2,208,000, 3,758,000, and 2,221,000 for the fiscal years ended June 30, 2020, 2019 and 2018, respectively.
Concentration of Supplier Risk
Certain materials used by the Company in the manufacturing of its products are available from a limited number of suppliers. Shortages could occur in these materials due to an interruption of supply or increased demand in the industry.One supplier accounted for 26.8%, 21.8%, and 26.0% of total purchases for the fiscal years ended June 30, 2020, 2019 and 2018, respectively. Ablecom and Compuware, related parties of the Company as noted in Note 13, "Related Party Transactions,"
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accounted for 10.1%, 9.2%, and 9.0% of total cost of sales for the fiscal years ended June 30, 2020, 2019 and 2018, respectively.
Concentration of Credit Risk
Financial instruments which potentially subject the Company to concentration of credit risk consist primarily of cash and cash equivalents, restricted cash, investment in an auction rate security and accounts receivable. No single customer accounted for 10% or more of the net sales in fiscal years 2020, 2019 and 2018. One customer accounted for 10.1% and 17.0% of accounts receivable, net as of June 30, 2020 and 2019, respectively.
Accounting Pronouncements Recently Adopted
In February 2016, the FASB issued an amendment to the accounting guidance, Leases. The new lease accounting guidance supersedes the existing guidance. Under the new lease accounting guidance, lessees are required to recognize assets and liabilities on the balance sheet for most leases and provide enhanced disclosures. Leases will continue to be classified as either finance or operating. The Company adopted the new lease accounting guidance on July 1, 2019 using the modified retrospective approach, and as a result did not restate prior comparative periods. The Company elected to apply the “package of practical expedients” under the transition guidance of the new standard, which permits it not to reassess under the new lease accounting guidance its prior conclusions about lease identification, lease classification and initial direct costs, for leases that are in effect as of the date of adoption of the new lease accounting guidance. In connection with the adoption of the new lease accounting guidance, the Company recorded a transition adjustment to recognize ROU assets and lease liabilities on the Company’s consolidated balance sheet of $14.8 million and $15.2 million, respectively, on July 1, 2019, primarily related to real estate leases. See Note 12, "Leases," for further details.
In February 2018, the FASB issued Income Statement - Reporting Comprehensive Income: Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows companies to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act ("2017 Tax Reform Act"), from accumulated other comprehensive income to retained earnings. The guidance also requires certain new disclosures regardless of the election. The Company adopted this guidance on July 1, 2019. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements and related disclosures.
In June 2018, the FASB issued amended guidance to expand the scope of ASC 718 - Compensation-Stock Compensation, to include share-based payment transactions for acquiring goods and services from non-employees. The amendments specify that the guidance applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. The Company adopted this guidance on July 1, 2019. The adoption of the guidance did not have an impact on the Company's consolidated financial statements and related disclosures.
Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued authoritative guidance, Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments, that amends the impairment model for certain financial assets by requiring the use of an expected loss methodology, which will result in more timely recognition of credit losses. The amendment is effective for the Company from July 1, 2020. Early adoption is permitted. The adoption of the guidance is expected to result in the presentation of allowances for credit losses separately from the amortized cost of financial instruments that are not classified as available-for-sale debt securities. The adoption is also expected to change the presentation of the Company’s available-for-sale debt securities to include the amortized cost and the allowance for credit losses parenthetically. The adoption will have an immaterial effect on the allowance for credit losses for trade receivables and beginning retained earnings and will have an immaterial effect on the Company’s financial statement disclosures.
In August 2018, the FASB issued amended guidance, Fair Value Measurement: Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement, to modify the disclosure requirements on fair value measurements based on the concepts in the FASB Concepts Statements, including the consideration of costs and benefits. The new standard is effective for the Company from July 1, 2020. The adoption of the new guidance will require the Company to present, on a prospective basis, narrative information regarding the uncertainty of the fair value measurements from the use of unobservable
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inputs used in recurring fair value measurements categorized in Level 3 of the fair value hierarchy, to disclose the amount of gains and losses recognized in other comprehensive income for the period for financial instruments categorized within Level 3 of the fair value hierarchy, and quantitative information for the significant unobservable inputs used to develop the Level 3 fair value measurements. The adoption of the new guidance will also allow the Company to discontinue the presentation of information regarding transfers between Level 1 and Level 2 of the fair value hierarchy. As at June 30, 2020 the only financial instrument of the Company for which the recurring fair value measurements are categorized in Level 3 of the fair value hierarchy is its investment in an auction rate security.
In August 2018, the FASB issued authoritative guidance , Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments. According to the amendments, an entity shall determine which implementation costs to capitalize as an asset related to the service contract and which costs to expense. It requires an entity (customer) to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. The new standard is effective for the Company from July 1, 2020. The Company will adopt the new guidance on a prospective basis for any new hosting arrangement entered into after July 1, 2020 and does not expect the adoption of the guidance to have a material impact on its consolidated financial statement disclosures, results of operations and financial position.
In December 2019, the FASB issued amended guidance, Simplifying the Accounting for Income Taxes, to remove certain exceptions to the general principles from ASC 740 - Income Taxes, and to improve consistent application of U.S. GAAP for other areas of ASC 740 by clarifying and amending existing guidance. The guidance is effective for the Company from July 1, 2021; early adoption is permitted. The adoption of the guidance is not anticipated to have a material impact on its consolidated financial statements.
In March 2020, the FASB issued authoritative guidance, Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The new guidance provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. The guidance also establishes (1) a general contract modification principle that entities can apply in other areas that may be affected by reference rate reform and (2) certain elective hedge accounting expedients. The amendment is effective for all entities through December 15, 2022. LIBOR is used to calculate the interest on borrowings under the Company's 2018 Bank of America Credit Facility. As the 2018 Bank of America Credit Facility, as amended, will terminate on June 30, 2021 before the phase out of LIBOR, the Company does not expect the adoption of the guidance to have an impact on its consolidated financial statement disclosures, results of operations and financial position.
Note 2. Fair Value Disclosure
The financial instruments of the Company measured at fair value on a recurring basis are included in cash equivalents, other assets and accrued liabilities. The Company classifies its financial instruments, except for its investment in an auction rate security, within Level 1 or Level 2 in the fair value hierarchy because the Company uses quoted prices in active markets or alternative pricing sources and models using market observable inputs to determine their fair value. The Company’s investment in an auction rate security is classified within Level 3 of the fair value hierarchy as the determination of its fair value was not based on observable inputs as of June 30, 2020 and 2019. See Note 1, "Organization and Summary of Significant Accounting Policies," for a discussion of the Company’s policies regarding the fair value hierarchy. The Company used discounted cash flows to estimate the fair value of the auction rate security as of June 30, 2020 and 2019. The material factors used in preparing the discounted cash flows are (i) the discount rate utilized to present value the cash flows, (ii) the time period until redemption and (iii) the estimated rate of return.
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Financial Assets and Liabilities Measured on a Recurring Basis
The following table sets forth the Company’s financial instruments as of June 30, 2020 and 2019, which are measured at fair value on a recurring basis by level within the fair value hierarchy. These are classified based on the lowest level of input that is significant to the fair value measurement (in thousands):
June 30, 2020 Level 1 Level 2 Level 3 Asset atFair Value
Assets
Money market funds (1) $ 1,163 $ — $ — $ 1,163
Certificates of deposit (2) — 836 — 836
Liabilities
Performance awards liability (3) $ — $ 2,100 $ — $ 2,100
Total liabilities measured at fair value $ — $ 2,100 $ — $ 2,100
June 30, 2019 Level 1 Level 2 Level 3 Asset atFair Value
Money market funds (1) $ 1,162 $ — $ — $ 1,162
(1) $0.4 million and $0.4 million in money market funds are included in cash and cash equivalents and $0.8 million and $0.8 million in money market funds are included in restricted cash, non-current in other assets in the consolidated balance sheets as of June 30, 2020 and 2019, respectively.
(2) $0.2 million and $0.2 million in certificates of deposit are included in cash and cash equivalents, $0.3 million and $0 in certificates of deposit are included in prepaid expenses and other assets, and $0.3 million and $1.1 million in certificates of deposit are included in restricted cash, non-current in other assets in the consolidated balance sheets as of June 30, 2020 and 2019, respectively.
(3) As of June 30, 2020, the current portion of the performance awards liability of $1.5 million is included in accrued liabilities and the noncurrent portion of $0.6 million is included in other long-term liabilities in the consolidated balance sheets. There was no such liability outstanding as of June 30, 2019.
The performance awards liability consists of one-time employee performance bonuses for the Company's Chief Executive Officer and two members of the Board that are payable when specified market and performance conditions are achieved. The Company estimated the fair value of these performance awards using the Monte-Carlo simulation model and classified them within Level 2 of the fair value hierarchy as estimates are based on the observable inputs. The significant inputs used in estimating the fair value of the awards as of June 30, 2020 are as follows:
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There was no movement in the balances of the Company's financial assets measured at fair value on a recurring basis, consisting of investment in an auction rate security, using significant unobservable inputs (Level 3) for fiscal years 2020 and 2019.
There were no transfers between Level 1, Level 2 or Level 3 financial instruments in fiscal years 2020 and 2019.
The following is a summary of the Company’s investment in an auction rate security as of June 30, 2020 and 2019 (in thousands):
Cost Basis GrossUnrealizedHoldingGains GrossUnrealizedHoldingLosses Fair Value
The Company measures the fair value of outstanding debt for disclosure purposes on a recurring basis. As of June 30, 2020 and 2019, total debt of $29.4 million and $23.6 million, respectively, are reported at amortized cost. This outstanding debt is classified as Level 2 as it is not actively traded. The amortized cost of the outstanding debt approximates the fair value.
Other Financial Assets - Investments into Non-Marketable Equity Securities
The Company's non-marketable equity securities are investments in privately held companies without readily determinable fair values in the amount of $0.1 million and $0.9 million as of June 30, 2020 and 2019, respectively. The Company accounts for these investments at cost minus impairment, if any, plus or minus changes from observable price changes in orderly transactions for the identical or similar investments by the same issuer. During the years ended June 30, 2020 and 2019, the Company did not record any upward or downward adjustments to the carrying values of the non-marketable equity securities related to observable price changes. The Company also did not record any impairment to the carrying values of the non-marketable equity securities during fiscal year 2020. During fiscal year 2019, the Company recorded impairment charges of $2.7 million for its non-marketable equity securities which had an initial cost basis of $2.7 million as it was determined the carrying value of the investments were not recoverable. During fiscal year 2018, the Company did not record any other-than-temporary impairments on financial assets required to be measured at fair value on a non-recurring basis.
Note 3. Revenue
Disaggregation of Revenue
The Company disaggregates revenue by type of product, by geographical market, and by products sold to indirect sales channel partners or direct customers and original equipment manufacturers ("OEMs") that depict the nature, amount, and timing of revenue and cash flows. Service revenues are not a significant component of total revenue and are aggregated within the respective categories.
The following is a summary of net sales by product type (in thousands):
Years Ended June 30,
Server and storage systems constitute an assembly and integration of subsystems and accessories, and related services.
Subsystems and accessories are comprised of serverboards, chassis and accessories.
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International net sales are based on the country and region to which the products were shipped. The following is a summary for the fiscal years ended June 30, 2020, 2019 and 2018, of net sales by geographic region (in thousands):
Years Ended June 30,
The following table presents the net sales from products sold through the Company's indirect sales channel and to its direct customers and OEMs for fiscal years 2020, 2019 and 2018 (in thousands):
Years Ended June 30,
Contract Balances
Generally, the payment terms of the Company’s offerings range from 30 to 60 days. In certain instances, customers may prepay for products and services in advance of delivery. Receivables relate to the Company’s right to consideration for performance obligations completed (or partially completed) for which the Company has an unconditional right to consideration.
Contract assets are rights to consideration in exchange for goods or services that the Company has transferred to a customer when such right is conditional on something other than the passage of time. Such contract assets are insignificant to the Company’s consolidated financial statements.
Contract liabilities consist of deferred revenue and relate to amounts invoiced to or advance consideration received from customers, which precede the Company’s satisfaction of the associated performance obligation(s). The Company’s deferred revenue primarily results from customer payments received upfront for extended warranties and on-site services because these performance obligations are satisfied over time. Revenue recognized during fiscal year 2020, which was included in the opening deferred revenue balance as of June 30, 2019, was $91.9 million.
Deferred revenue decreased during the fiscal year ended June 30, 2020 because the recognition of revenue from contracts entered into in prior periods exceeded the value of the transaction price allocated for service contracts obligations during the current period.
Transaction Price Allocated to the Remaining Performance Obligations
Remaining performance obligations represent in aggregate the amount of transaction price that has been allocated to performance obligations not delivered, or only partially undelivered, as of the end of the reporting period. The Company applies the optional exemption to not disclose information about remaining performance obligations that are part of a contract that has an original expected duration of one year or less. These performance obligations generally consist of services, such as on-site integration services that are contracted for one year or less, and products for which control has not yet been transferred. The value of the transaction price allocated to remaining performance obligations as of June 30, 2020 was approximately $203.8 million. The Company expects to recognize approximately 52% of remaining performance obligations as revenue in the next 12 months, and the remainder thereafter.
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Capitalized Contract Acquisition Costs and Fulfillment Cost
Contract acquisition costs are those incremental costs that the Company incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained. Contract acquisition costs consist primarily of incentive bonuses. Contract acquisition costs are considered incremental and recoverable costs of obtaining and fulfilling a contract with a customer and are therefore capitalizable. The Company applies the practical expedient to expense incentive bonus costs as incurred if the amortization period would be one year or less, generally upon delivery of the associated server and storage systems or components. Where the amortization period of the contract cost would be more than a year, the Company applies judgment in the allocation of the incentive bonus cost asset between hardware and service performance obligations and expenses the cost allocated to the hardware performance obligations upon delivery of associated server and storage systems or components and amortizes the cost allocated to service performance obligations over the period the services are expected to be provided. Such contract acquisition costs allocated to service performance obligations that are subject to capitalization are insignificant to the Company’s consolidated financial statements.
Contract fulfillment costs consist of costs paid in advance for outsourced services provided by third parties to the extent they are not in the scope of other guidance. Fulfillment costs paid in advance for outsourced services provided by third parties are capitalized and amortized over the period the services are expected to be provided. Such fulfillment costs are insignificant to the Company’s consolidated financial statements.
Note 4. Accounts Receivable Allowances
The Company has established an allowance for doubtful accounts. The allowance for doubtful accounts is based upon the age of outstanding receivables, credit risk of specific customers, historical trends related to past losses and other relevant factors. Accounts receivable allowances as of June 30, 2020, 2019 and 2018 consisted of the following (in thousands):
Allowance for doubtful accounts:
Note 5. Inventories
Inventories as of June 30, 2020 and 2019 consisted of the following (in thousands):
During fiscal years 2020, 2019 and 2018, the Company recorded a provision for excess and obsolete inventory to cost of sales totaling $22.6 million, $28.5 million and $9.4 million, respectively, excluding a (recovery) provision for adjusting the cost of certain inventories to net realizable value of $(4.2) million and $4.4 million in fiscal years 2020 and 2019, respectively. The adjustment for lower of cost or net realizable value and lower of cost or market was not material in fiscal year 2018. The Company classifies subsystems and accessories that may be sold separately or incorporated into systems as finished goods.
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Note 6. Property, Plant, and Equipment
Property, plant and equipment as of June 30, 2020 and 2019 consisted of the following (in thousands):
Accumulated depreciation and amortization (126,746 ) (108,775 )
__________________________
(1) Primarily relates to the development and construction costs associated with the Company’s Green Computing Park located in San Jose, California, and, to a lesser extent, in Taiwan.
Note 7. Prepaid Expenses and Other Assets
Prepaid expenses and other current assets as of June 30, 2020 and 2019 consisted of the following (in thousands):
Total prepaid expenses and other current assets $ 126,985 $ 109,795
__________________________
(1) Includes receivables from contract manufacturers based on certain buy-sell arrangements of $83.8 million and $82.0 million as of June 30, 2020 and 2019, respectively.
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Other assets as of June 30, 2020 and 2019 consisted of the following (in thousands):
Operating lease right-of-use asset $ 23,784 $ —
Deferred service costs, non-current 4,632 3,572
Investment in auction rate security 1,571 1,571
Non-marketable equity securities 128 878
Cash, cash equivalents and restricted cash as of June 30, 2020 and 2019 consisted of the following (in thousands):
Restricted cash included in prepaid expenses and other current assets 250 11,673
Restricted cash included in other assets 1,607 2,303
Total cash, cash equivalents and restricted cash $ 212,390 $ 262,140
Note 8. Investment in a Corporate Venture
In October 2016, the Company entered into agreements pursuant to which the Company contributed certain technology rights in connection with an investment in the Corporate Venture to expand the Company's presence in China. The Corporate Venture is 30% owned by the Company and 70% owned by another company in China. The transaction was closed in the third fiscal quarter of 2017 and the investment has been accounted for using the equity method. As such, the Corporate Venture is also a related party.
The Company recorded a deferred gain related to the contribution of certain technology rights of $7.0 million in the third fiscal quarter of 2017. The amortization of the deferred gain is being recognized as a credit to research and development expenses in the Company's consolidated statement of operations over a period of five years which represents the estimated period over which the remaining obligations will be fulfilled. As a result of the adoption of new accounting guidance as of the beginning of fiscal year 2019, the Company recorded an increase of $3.0 million to the investment in equity investee for the contribution of those technology rights, and corresponding increases in deferred gain and retained earnings of $2.1 million and $0.9 million, respectively. As of June 30, 2020 and 2019, the Company had unamortized deferred gain balance of $2.0 million and $2.0 million, respectively, in accrued liabilities and $1.0 million and $3.0 million, respectively, in other long-term liabilities in the Company’s consolidated balance sheets.
The Company monitors the investment for events or circumstances indicative of potential impairment and makes appropriate reductions in carrying values if it determines that an impairment charge is required. In June 2020, the third-party parent company that controls the Corporate Venture was placed on a U.S. government export control list, along with several related entities. The Company is working with the Corporate Venture management to ensure that any future related parties transactions with the Corporate Venture are in accordance with the new restrictions and does not believe that the equity investment carrying value is impacted as of June 30, 2020. The Company did not recognize any impairment in the years ended June 30, 2020, 2019 and 2018.
As of June 30, 2020 and June 30, 2019, the Company's equity investment in the Corporate Venture was $2.7 million and $1.7 million, respectively, and was recorded under investment in equity investee on the Company's consolidated balance sheet.
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The Company's share of income (losses), net of taxes, of the Corporate Venture net of taxes were $2.4 million, $(2.7) million, and $(3.6) million for the fiscal years ended June 30, 2020, June 30, 2019, and June 30, 2018, respectively.
Additionally, the Company sold products worth $61.9 million, $52.2 million, $21.7 million to the Corporate Venture in the fiscal years 2020, 2019, 2018, respectively, and the Company's share of intra-entity profits on the products that remained unsold by the Corporate Venture in the amounts of $3.0 million and $1.7 million as of June 30, 2020 and June 30, 2019 have been eliminated and have reduced the carrying value of the Company's investment in the Corporate Venture. To the extent that the elimination of intra-entity profits reduces the investment balance below zero, such amounts are recorded within accrued liabilities. The Company had $7.8 million and $13.1 million due from the Corporate Venture in accounts receivable, net as of June 30, 2020 and 2019, respectively, in its consolidated balance sheets.
Note 9. Accrued Liabilities
Accrued liabilities as of June 30, 2019 and 2018 consisted of the following (in thousands):
Accrued payroll and related expenses $ 33,577 $ 25,552
Accrued legal liabilities 18,114 —
Operating lease liability 6,310 —
Accrued cooperative marketing expenses 5,925 5,830
Performance Awards Liability
In March 2020, the Company’s Board of Directors (the “Board”) approved $25.3 million of special performance bonuses to employees, which included $8.0 million paid in cash during the fourth quarter of fiscal year 2020 and $17.3 million paid in cash upon the occurrence of the average closing price for the Company's common stock equaling or exceeding $21.39 for any period of 10 consecutive trading days following March 26, 2020. The entire amount of the special performance bonuses to employees was paid in the fourth quarter of fiscal year 2020.
The Board also approved performance bonuses for the Chief Executive Officer, a senior executive and two members of the Board, which payments will be earned when specified market and performance conditions are achieved.
The Chief Executive Officer’s aggregate cash bonuses of up to $8.1 million are earned in two tranches. The first 50% is payable if the average closing price for the Company’s common stock equals or exceeds $31.61 for any period of 20 consecutive trading days following the date of the agreement and ending prior to September 30, 2021 and the Chief Executive Officer remains employed with the Company through the date that such common stock price goal is determined to have been achieved and the date that the payment is made. This payment can be reduced at the discretion of the Board to the extent the Company has not made adequate progress in remediating its material weaknesses in its internal control over financial reporting as determined by the Board. The second 50% is payable if the average closing price for the Company’s common stock equals or exceeds $32.99 for any period of 20 consecutive trading days following the date of the agreement and ending prior to June 30, 2022 and the Chief Executive Officer remains employed with the Company through the date that such common stock price goal is achieved and the date that the payment is made.
Performance bonuses for a senior executive and two members of the Board are earned based on achieving a specified target average closing price for the Company’s common stock over the specified period as determined by the Board at the grant
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dates and continuous services through the payment dates. A senior executive earned an aggregate cash payment of $0.1 million when the target average closing price was met in the fourth quarter of fiscal year 2020. The two members of the Board can earn aggregate cash payments of $0.3 million in two tranches if the target average closing price reaches $31.61 for the first tranche and $32.99 per share for the second tranche. These awards expire in two equal amounts at September 30, 2021 and June 30, 2022 for the two Board members' awards.
The Company accounts for the outstanding performance bonuses as liabilities and estimates fair value of payable amounts using a Monte-Carlo simulation model. The awards are re-measured at each period end with changes in fair value recorded in the Company’s consolidated statement of operations in cost of sales and operating expenses. The cumulative recorded expense at each period end is trued-up to the expected payable amount vested through the period end. The requisite service periods over which expenses are recognized are derived from the Monte-Carlo model for all performance awards, except for the first 50% of the Chief Executive Officer’s award that includes a performance condition. The Company estimates if it is probable that the performance condition will be met through the expiration date of this award. If at the measurement date it is determined to be probable, the Company estimates the requisite period as the longer of the service period derived by the Monte-Carlo model and the implicit service period when the Company expects to make adequate progress in remediating its material weaknesses in its internal control over financial reporting, as reported by the Company's Audit Committee. If it is determined to not be probable, then the Company will reverse any previously recognized expense for this award in the period when it is no longer probable that the performance condition will be achieved.
As of June 30, 2020, the Company's outstanding balance related to performance bonuses was $2.1 million of which $1.5 million is recorded within accrued liabilities and $0.6 million is recorded within other long-term liabilities on the Company's consolidated balance sheet. An unrecognized compensation expense of $3.3 million will be recorded over the remaining service periods from 0.19 years to 1.18 years. The unrecognized expense and remaining service periods will be remeasured each reporting period.
Note 10. Short-term and Long-term Debt
Short-term and long-term debt obligations as of June 30, 2020 and 2019 consisted of the following (in thousands):
Line of credit:
Bank of America $ — $ 1,116
Term loans:
Short-term debt and current portion of long-term debt 23,704 23,647
Debt, Non-current $ 5,697 $ —
Activities under Revolving Lines of Credit and Term Loans
Bank of America
2018 Bank of America Credit Facility
In April 2018, the Company entered into a revolving line of credit with Bank of America (the "2018 Bank of America Credit Facility"), which replaced the then existing credit facility with Bank of America (the "2016 Bank of America Credit Facility"). The 2018 Bank of America Credit Facility provides for a revolving credit line and other financial accommodations of up to $250.0 million extended by certain lenders, including a $5.0 million letter of credit sublimit, which was extended to $15.0 million in October 2019. The 2018 Bank of America Credit Facility was originally set to expire after 364 days and on
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January 31, 2019, the Company paid a fee and entered into an amendment of the 2018 Bank of America Credit Facility that resulted in the extension of the maturity date from April 19, 2019 to June 30, 2019. On June 27, 2019, the Company entered into a second amendment of the 2018 Bank of America Credit Facility that extended the maturity date from June 30, 2019 to June 30, 2020. On May 12, 2020, the Company paid a fee of $0.7 million and entered into a third amendment of the 2018 Bank of America Credit Facility that extended the maturity of the credit facility to June 30, 2021 and changed certain terms of the original agreement. The amendment was accounted for as a modification and the impact was immaterial to the consolidated financial statements. Under the original terms, interest accrued at the LIBOR rate plus 2.75% per annum, while under the third amendment, interest shall accrue at LIBOR rate plus 2.00% on outstanding borrowings less than $125.0 million and LIBOR rate plus 2.25% on outstanding borrowings in excess of $125.0 million. Under the terms of the third amendment of the 2018 Bank of America Credit Facility, in the event of default or if outstanding borrowings are in excess of $220.0 million, the Company is required to grant the lenders a continuing security interest in and lien upon all amounts credited to any of the Company's deposit accounts. In addition, the third amendment released the real property of Super Micro Computer as a collateral. Interest accrued on any loans under the 2018 Bank of America Credit Facility is due on the first day of each month, and the loans are due and payable in full on the termination date of the 2018 Bank of America Credit Facility. Voluntary prepayments are permitted without early repayment fees or penalties. Subject to customary exceptions, the 2018 Bank of America Credit Facility is secured by substantially all of Super Micro Computer’s assets, other than real property assets. Under the terms of the 2018 Bank of America Credit Facility, the Company is not permitted to pay any dividends. The Company is required to pay 0.375% per annum on the 2018 Bank of America Credit Facility for any unused borrowings. The 2018 Bank of America Credit Facility contains customary representations and warranties and customary affirmative and negative covenants applicable to the Company and its subsidiaries and contains a financial covenant, which requires that the Company maintain a certain Fixed Charge Coverage Ratio, for each twelve-month period while in a Trigger Period, as defined in the agreement, is in effect.
As of June 30, 2020, the Company had no outstanding borrowings under the 2018 Bank of America Credit Facility. As of June 30, 2019, the total outstanding borrowings under the 2018 Bank of America Credit facility were $1.1 million. The interest rates under the 2018 Bank of America Credit Facility as of June 30, 2020 and 2019 were 3.0% per annum and 4.5% per annum, respectively. In October 2018, a $3.2 million letter of credit was issued under the 2018 Bank of America Credit Facility. and in October 2019, the letter of credit amount was increased to $6.4 million. The balance of debt issuance costs outstanding were $0.6 million and $0.3 million as of June 30, 2020 and 2019, respectively. The Company has been in compliance with all the covenants under the 2018 Bank of America Credit Facility, and as of June 30, 2020, the Company's available borrowing capacity was $243.6 million, subject to the borrowing base limitation and compliance with other applicable terms.
CTBC Bank
2019 CTBC Credit Facility
In January 2018, the Company entered into a credit agreement with China Trust and Bank Corp ("CTBC Bank") that provided for (i) a 12-month NTD $700.0 million ($23.6 million U.S. dollar equivalent) term loan facility secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum, which was adjusted monthly, which term loan facility also included a 12-month guarantee of up to NTD $100.0 million ($3.4 million U.S. dollar equivalent) with an annual fee equal to 0.50% per annum, and (ii) a 12-month NTD $1,500.0 million ($50.5 million U.S. dollar equivalent) term loan facility with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum, which was adjusted monthly (collectively, the “2018 CTBC Credit Facility”). The total borrowings allowed under the 2018 CTBC Credit Facility was initially capped at $50.0 million and in August 2018 was reduced to $40.0 million. In June 2019 prior to its maturity, the 2018 CTBC Credit Facility was replaced by the 2019 CTBC Credit Facility (defined below).
In June 2019, the Company entered into a credit agreement with CTBC Bank that provides for (i) a 12-month NTD $700.0 million ($22.5 million U.S. dollar equivalent) term loan facility secured by the land and building located in Bade, Taiwan with an interest rate equal to the lender's established NTD interest rate plus 0.25% per annum which is adjusted monthly, which term loan facility also includes a 12-month guarantee of up to NTD $100.0 million ($3.2 million U.S. dollar equivalent) with an annual fee equal to 0.50% per annum, (ii) a 180-day NTD $1,500.0 million ($48.2 million U.S. dollar equivalent) term loan facility up to 100% of eligible accounts receivable in an aggregate amount with an interest rate equal to the lender's established NTD interest rate ranging from 0.30% to 0.50% per annum which is adjusted monthly, and (iii) a 12-month revolving line of credit of up to 100% of eligible accounts receivable in an aggregate amount of up to $50.0 million with
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an interest rate equal to the lender's established USD interest rate plus an interest rate ranging from 0.30% to 0.50% per annum which is adjusted monthly (collectively, the “2019 CTBC Credit Facility”). The total borrowings allowed under the 2019 CTBC Credit Facility was capped at $50.0 million. There are no financial covenants associated with the 2019 CTBC Credit Facility. On June 30, 2020, the maturity date of the 2019 CTBC credit facility was extended to August 31, 2020. On August 24, 2020, the maturity of the 2019 CTBC credit facility was further extended to August 31, 2021.
The total outstanding borrowings under the 2019 CTBC Credit Facility term loan were denominated in NTD and remeasured into U.S. dollars of $23.7 million and $22.5 million at June 30, 2020 and 2019, respectively. As of June 30, 2020 and 2019, the Company did not have any outstanding borrowings under the 2019 CTBC Credit Facility revolving line of credit. The interest rate for these loans were 0.45% per annum as of June 30, 2020 and 0.93% per annum as of June 30, 2019. At June 30, 2020, the amount available for future borrowing under the 2019 CTBC Credit Facility was $26.3 million. As of June 30, 2020, the net book value of land and building located in Bade, Taiwan, collateralizing the 2019 CTBC Credit Facility term loan was $25.4 million.
2020 CTBC Term Loan Facility
In June 2020, the Company entered into a ten-year, non-revolving term loan facility (“2020 CTBC Term Loan Facility”) to obtain up to NTD 1.2 billion ($40.7 million in U.S. dollar equivalents) in financing for use in the expansion and renovation of the Company’s Bade Manufacturing Facility located in Taiwan. Drawdowns on the 2020 CTBC Term Loan Facility are based on 80% of balances owed on commercial invoices from the contractor and shall be drawn according to the progress of the renovations. Borrowings under the 2020 CTBC Term Loan Facility are available through June 2022. The Company is required to pay against total outstanding principal and interest in equal monthly installments starting June 2023 and continuing through the maturity date of June 2030. Interest under the 2020 CTBC Term Loan Facility is the two-year term floating rate of postal saving interest rate plus 0.105% and is established on the date of the drawdown application. If no interest rate is agreed upon, interest shall accrue at the annual base rate for CTBC plus 4.00%. The 2020 CTBC Term Loan Facility is secured by the Bade Manufacturing Facility and its expansion. Fees paid to the lender as debt issuance costs were immaterial. The Company has financial covenants requiring the Company's current ratio, debt service coverage ratio, and financial debt ratio, as defined in the agreement, to be maintained at certain levels under the 2020 CTBC Term Loan Facility.
The Company borrowed $5.7 million in June 2020 with an interest rate of 0.45% per annum. As of June 30, 2020, the amount outstanding under the 2020 CTBC Term Loan Facility was $5.7 million and the net book value of the property serving as collateral was $10.1 million. As of June 30, 2020, the Company was in compliance with all financial covenants under the 2020 CTBC Term Loan Facility.
Principal payments on short-term and long-term debt obligations are due as follows (in thousands):
Fiscal Year: Principal Payments
Total short-term and long-term debt $ 29,401
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Note 11. Other Long-term Liabilities
Other long-term liabilities as of June 30, 2020 and 2019 consisted of the following (in thousands):