What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-11-06 compared with 2020-05-11 · 170 added, 213 removed, 93 unchanged (80% of the section changed)

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We cannot guarantee future results, levels of activity, performance or achievements.

The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with our condensed consolidated financial statements and related footnotes included elsewhere in this Quarterly Report and included in our comprehensive Annual Report on Form 10-K for the fiscal year ended June 30, 2019 (the “2019 Comprehensive 10-K”), which includes our consolidated financial statements for the fiscal years ended June 30, 2019 and 2018.

Nasdaq Relisting of Our Common Stock

On January 14, 2020, our common stock was relisted on the NASDAQ Global Select Market under the symbol “SMCI.”

We are a global leader and innovator of high-performance, high-efficiency server and storage technology.

We develop and provide end-to-end green computing solutions to the cloud computing, data center, enterprise, big data, artificial intelligence ("AI"), High-Performance Computing ("HPC"), edge computing and Internet of Things/embedded (“IoT”) markets.

Our solutions range from complete server, storage, modular blade servers, blades and workstations to full racks, networking devices, server management software, server sub-systems and global support and services.

The following discussion and analysis of the financial condition and results of our operations should be read in conjunction with our condensed consolidated financial statements and related footnotes included elsewhere in this Quarterly Report and included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2020 (the “2020 10-K”), which includes our consolidated financial statements for the fiscal years ended June 30, 2020 and 2019.

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.

Our net sales for the three months ended March 31, 2020 increased to $772.4 million from $743.5 million for the corresponding period in the prior year, and our net income for the three months ended March 31, 2020 increased to $15.8 million from $10.6 million for the corresponding period in the prior year.

We seek to increase our sales and profits every quarter.

We believe that to do so, 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 our customer service and support offerings, particularly as we increasingly focus on larger enterprise customers.

Additionally, we focus on development of our sales partners and distribution channels to further expand our market share.

Our net income for the three months ended September 30, 2020 increased to $26.6 million from $26.3 million for the corresponding period in the prior year.

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 incorporating 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 product introduction cycles of Intel Corporation, Advanced Micro Devices, Inc., Nvidia Corporation, Samsung Electronics Company Limited, Micron Technology, Inc.

and others carefully.

This also impacts our research and development expenditures as we continue to invest significantly in our current and future product development efforts.

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 “essentia l,” shelter in place, and practice social distancing when engaging in essential activities.

We are an essential business under the relevant 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 workforc e 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, to a lesser extent, in the United States and Europe.

In an effort to contain COVID-19 or slow its spread, governments around the world have enacted various measures, including orders that govern the operations of businesses, require masks be worn and define shelter in place and social distancing protocols.

We are an essential critical infrastructure (information technology) business under the relevant federal, state and county regulations.

Accordingly, in late March, we responded to the directives from Santa Clara County and the State of California regarding instructions to combat the spread of COVID-19.

Our first priority is the safety of our workforce and we have implemented numerous health precautions and work practices to be in compliance with the law and 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 fourth quarter of fiscal year 2020 and do not have significant direct exposure to industries such as retail and oil and gas, which have been impacted the greatest.

We continued to see ongoing demand and do not have significant direct exposure to industries such as retail, oil and gas and hospitality, 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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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.

We are monitoring the changes in liquidity a nd payment patterns of our customer base to evaluate risk in specific industries or geographic areas where cash flow may be disrupted.

While we believe that we are adequately capitalized, we are actively managing our liquidity needs and working to expand our access to credit facilities.

We are in the process of negotiating an extension of our credit facility with Bank of America and expect this process will be completed by the end of May, 2020.

Looking forward, logistics has emerged as a new challenge as the transportation industry restricts the frequency of departures and increases logistics costs.

We expect increased costs in freight as well as direct labor costs as we incentivize our employees to continue to work and assist us in serving our customers, many of whom are in critical industries.

Our management team is focused on guiding our company through the unfolding and emerging challenges presented by COVID-19.

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 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 ongoing 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 our financial highlights of the third quarter of fiscal year 2020 :

Net sales increase d by 3.9% as compared to the three months ended March 31, 2019 .

The increase was mainly due to an increase in the sales of subsystems and accessories and an increase in the volume of server and storage systems sold, partially offset by lower average selling prices per system.

Gross margin increased to 17.3% in the three months ended March 31, 2020 from 15.1% for the three months ended March 31, 2019 , primarily due to a favorable geographic, customer and product mix.

Operating expenses increased by 18.4% as compared to the three months ended March 31, 2019 , and were equal to 15.3% and 13.4% of net sales in the three months ended March 31, 2020 and 2019 , respectively.

Effective tax rate decreased from 4.3% in the three months ended March 31, 2019 to (5.6)% in the three months ended March 31, 2020 .

Revenues and Expenses

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 are the number of compute nodes sold, the average selling prices per node for our server and storage system sales and units shipped and the average selling price per unit and units shipped for our subsystem and accessories.

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, and 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, and due to price transparency of certain higher cost components, we must

actively change our selling price per unit in response to changes in costs for key components such as memory and SSDs, and actively adjust our procurement practices in anticipation of near term fluctuations in market prices for key components.

Cost of sales .

Cost of sales primarily consists of the costs to manufacture our products, including the costs of materials, contract manufacturing, shipping, personnel and related expenses including stock-based compensation, 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, 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 a number of factors, including 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.

Beginning in fiscal year 2019, we expanded manufacturing and service operations in Taiwan and the Netherlands primarily to support our Asian and European customers and have continued to work on improving our utilization of our overseas manufacturing capacity.

We continue to enhance our Taiwan manufacturing operations to increase the diversification of our manufacturing capabilities in order to strengthen our business continuity and better position the Company to respond to challenges, such as those arising from COVID-19.

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 ou r manufacturing of subsystems, particularly power supplies.

Our purchases of products from Ablecom and Compuware represented 9.4% and 9.9% of total cost of sales for the three months ended March 31, 2020 and 2019 , respectively, and 9.8% and 9.4% for the nine months ended March 31, 2020 and 2019 , respectively.

For further details on our dealings with related parties, see Part I, Item 1, Note 9, “Related Party Transactions.”

Research and development 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 other 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.

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 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.

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 and outside legal, audit, tax fees, insurance and bad debt.

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.

Interest expense represents interest expense on our term loans and lines of credit.

Income tax provision.

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 the benefit of research and development tax credits and the domestic production activities deduction which were partially offset by state taxes and unrecognized tax benefits related to permanent establishment exposures.

The following is a summary of our financial highlights of the first quarter of fiscal year 2021:

• Net sales decreased by 4.7% as compared to the three months ended September 30, 2019.

• Gross margin increased to 17.0% in the three months ended September 30, 2020 from 16.4% for the three months ended September 30, 2019.

• Operating expenses increased by 1.4% as compared to the three months ended September 30, 2019, and were equal to 13.0% and 12.3% of net sales in the three months ended September 30, 2020 and 2019, respectively.

• Effective tax rate decreased from 25.3% in the three months ended September 30, 2019 to 12.7% in the three months ended September 30, 2020.

Critical Accounting Policies and Estimates

Our financial statements are prepared in accordance with generally accepted accounting principles in the United States.

The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses and related disclosures.

We evaluate our estimates and assumptions on an ongoing basis.

Our estimates are based on historical experience and various other assumptions that we believe to be reasonable under the circumstances.

Our actual results could differ from these estimates.

Except for the changes to our accounting policy as a result of the adoption of the new lease accounting guidance on July 1, 2019, there have been no material changes to our critical accounting policies and estimates as compared to those disclosed in our 2019 Comprehensive 10-K.

For a description of our critical accounting policies and estimates, see Part I, Item 1, Note 1, "Organization and Summary of Significant Accounting Policies" in our notes to the condensed consolidated financial statements in this Quarterly Report.

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 assumptions that affect the reported amounts of assets, liabilities, net sales and expenses.

We evaluate our estimates and assumptions on an ongoing 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 the judgments we make about the carrying value of assets and liabilities that are not readily apparent from other sources.

Because these estimates can vary depending on the situation, actual results may differ from these 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.

There have been no material changes to our critical accounting policies and estimates as compared to those disclosed in our 2020 10-K.

For a description of our critical accounting policies and estimates, see Part I, Item 1, Note 1, "Summary of Significant Accounting Policies" in our notes to the condensed consolidated financial statements in this Quarterly Report.

Results of Operations

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Three Months Ended

Nine Months Ended

September 30,

Net sales 100.0 % 100.0 %

Cost of sales 83.0 % 83.6 %

Gross profit 17.0 % 16.4 %

Operating expenses:

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Income tax provision (0.5) % (1.1) %

Share of loss from equity investee, net of taxes

The following table presents net sales by product type for the three and nine months ended March 31, 2020 and 2019 (dollars in millions):

Three Months Ended March 31,

Nine Months Ended March 31,

Share of income from equity investee, net of taxes 0.2 % 0.1 %

Net income 3.5 % 3.3 %

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 subsystems and accessories can also vary widely based on whether a customer is purchasing power supplies, server boards, chassis or other accessories.

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.

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 the three months ended September 30, 2020 and 2019 (dollars in millions):

Three Months Ended September 30, Change

2020 2019 $ %

Server and storage systems $ 617.8 $ 636.0 $ (18.2) (2.9) %

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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.

Comparison of Three Months Ended March 31, 2020 and 2019

The period-over-period decrease in net sales of our server and storage systems was due to a slight decrease in the number of units of compute nodes shipped and a 3% decline in the average selling prices per node.

The decline in the number of units of compute nodes shipped was due to fewer shipments of multimode systems, such as blades and twin systems, compared to the same period last year.

The period-over-period increase in net sales of our subsystems and accessories is primarily due to an increase in the volume of subsystems and accessories units sold by approximately 38% mainly due to increased demand from our indirect sales channel, which was offset by an approximately 5% decrease in the average selling price.

Comparison of Nine Months Ended March 31, 2020 and 2019

The period-over-period decrease in net sales of our server and storage systems was primarily due to a decrease in average selling prices per compute node by approximately 13% as well as a slight decrease in the number of units of compute nodes shipped.

The decline in average selling prices was primarily due to substantially lower costs for key components in the first two quarters of the fiscal year.

The period-over-period increase in net sales of our subsystems and accessories is primarily due to an increase in the volume of subsystems and accessories sold by approximately 35%, partially offset by a decrease in the average selling prices per unit by approximately 12%.

The following table presents net sales from products sold through our indirect sales channel and to our direct customers and OEMs customers for the three and nine months ended March 31, 2020 and 2019 (dollars in millions):

Three Months Ended March 31,

Nine Months Ended March 31,

Indirect sales channel

Percentage of total net sales

Direct customers and OEMs

Percentage of total net sales

Total net sales

Comparison of Three Months Ended March 31, 2020 and 2019

The period-over-period increase in net sales through our indirect sales channel was primarily due to increased demand from indirect sales channel partners supporting large end users and the lower average selling prices for our server and storage systems, caused by fewer multimode systems shipped and slightly lower component pricing.

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.

Comparison of Nine Months Ended March 31, 2020 and 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 the lower average selling prices for our server and storage systems, caused by lower component pricing.

The following table presents net sales by geographic region for the three and nine months ended March 31, 2020 and 2019 (dollars in millions):

Three Months Ended March 31,

Nine Months Ended March 31,

Subsystems and accessories are comprised of server-boards, chassis and accessories.

The period-over-period decrease in net sales of our server and storage systems was due to a 19.1% decrease in the number of units of compute nodes sold offset by 20.0% increase in average selling price.

The decline in the number of units of compute nodes shipped was primarily due to fewer shipments of multimode systems compared to the same period last year.

The period-over-period decrease in net sales of our subsystems and accessories is primarily due to a decrease in the volume of subsystems and accessories units sold by approximately 24.4% which was offset by an approximately 16.7% increase in the average selling price.

The following table presents net sales by geographic region for the three months ended September 30, 2020 and 2019 (dollars in millions):

Three Months Ended September 30, Change Change

2020 2019 $ %

United states $ 496.1 $ 468.8 $ 27.3 5.8 %

Percentage of total net sales 65.1 % 58.6 %

Europe 112.1 128.1 (16.0) (12.5) %

Percentage of total net sales 14.7 % 16.0 %

Asia 126.7 161.6 (34.9) (21.6) %

Percentage of total net sales 16.6 % 20.2 %

Others 27.4 41.3 (13.9) (33.7) %

Percentage of total net sales 3.6 % 5.2 %

Total net sales $ 762.3 $ 799.8

Comparison of Three Months Ended March 31, 2020 and 2019

The period-over-period decrease in net sales in the United States for the three months ended March 31, 2020 and 2019 was primarily due to lower sales of our server and storage systems to our direct customers and OEMs.

The period-over-period increase in net sales in Asia was due primarily to increased sales in Singapore, Taiwan and Korea, partially offset by decreased sales in Japan and China.

The increase of net sales in Europe was primarily due to higher sales in the United Kingdom, Germany, Hungary and the Netherlands, partially offset by decreased sales in France and Turkey.

Comparison of Nine Months Ended March 31, 2020 and 2019

The period-over-period decrease in net sales in Asia was due primarily to decreased sales in China, Indonesia and Japan, partially offset by increased sales in Taiwan, Korea and Vietnam.

The decrease in net sales in Europe was primarily due to lower sales in the Netherlands, United Kingdom and France, partially offset by increased sales in Russia, Germany and Hungary.

The period-over-period decrease in net sales in other countries was due to decreased sales in Australia and Israel, partially offset by increased sales in Mexico and Saudi Arabia.

We determined that COVID-19 has impacted certain of our customers’ ability to pay on a timely basis.

Our collectibility assessment resulted in delaying revenue recognition of $3.4 million for certain orders shipped during the three months ended March 31, 2020.

The impact of COVID-19 on future revenue may be more significant.

The period-over-period increase in net sales in the United States for the three months ended September 30, 2020 and 2019 was primarily due to higher sales from the expansion of our customer base.

The period-over-period decrease in net sales in Asia was due primarily to decreased sales in China, Japan and Korea and partially off-set by increased sales in Singapore and Taiwan.

The decrease of net sales in Europe was primarily due to lower sales in the United Kingdom, Germany, Russia, and the rest of other Europe, partially offset by increased sales in France and the Netherlands.

Cost of Sales and Gross Margin

Cost of sales and gross margin for the three and nine months ended March 31, 2020 and 2019 are as follows (dollars in millions):

Three Months Ended March 31,

Nine Months Ended March 31,

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.

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 final assembly and testing predominantly performed at our manufacturing facilities in the same region where our products are sold.

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.

Cost of sales and gross margin for the three months ended September 30, 2020 and 2019 are as follows (dollars in millions):

Three Months Ended September 30, Change

2020 2019 $ %

Cost of sales $ 632.3 $ 668.9 $ (36.6) (5.5) %

Comparison of Three Months Ended March 31, 2020 and 2019

The period-over-period increase in cost of sales was primarily attributable to an increase of $6.4 million in costs of materials and contract manufacturing expenses primarily related to the increase in net sales, an increase of $4.8 million in personnel expenses as a result of an increase in the number of personnel and a one-time performance bonus of $2.9 million, an

increase of $1.0 million in product service costs and an increase of $2.0 million in manufacturing and other costs, offset by a decrease of $6.6 million in inventory obsolescence costs.

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 we purchased.

We expect that an increase in logistics costs and additional inducements for employees to continue production will negatively impact our gross margins due to the COVID-19 pandemic.

Comparison of Nine Months Ended March 31, 2020 and 2019

The period-over-period decrease in cost of sales was primarily attributable to a decrease of $259.5 million in costs of materials and contract manufacturing expenses primarily related to the decrease in net sales and the decrease in the cost of key components primarily associated with server and storage systems and a decrease of $6.5 million in inventory obsolescence costs, offset by an increase of $7.2 million in personnel expenses as a result of an increase in the number of personnel and a one-time performance bonus of $2.9 million, an increase in overhead costs of $10.2 million primarily attributable to increased tariffs, an increase of $1.8 million in product service costs, an increase of $1.4 million in warranty expense and an increase of $3.8 million in manufacturing and other costs.

Gross profit $ 129.9 $ 130.9 $ (1.0) (0.8) %

Gross margin 17.0 % 16.4 % 0.6 %

The period-over-period decrease in cost of sales was primarily attributed t o a decrease of $17.2 million in costs of materials and contract manufacturing expenses primarily related to the decrease in net sales volume, a d ecrease of $10.3 million in overhead costs attributable primarily to a recovery of costs paid in prior periods and a decrease of excess and obsolete inventory charge of $9.1 million.

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 we purchased.

We expect that an increase in logistics costs and additional inducements for employees to continue production will negatively impact our gross margins due to the COVID-19 pandemic.

Operating Expenses

Operating expenses for the three and nine months ended March 31, 2020 and 2019 are as follows (dollars in millions):

Three Months Ended March 31,

Nine Months Ended March 31,

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 trade-shows, 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 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 the three months ended September 30, 2020 and 2019 are as follows (dollars in millions):

Three Months Ended September 30, Change

2020 2019 $ %

Research and development $ 54.8 $ 49.6 $ 5.2 10.5 %

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Percentage of total net sales 13.0 % 12.3 %

Comparison of Three Months Ended March 31, 2020 and 2019

Research and development expenses.

The period-over-period increase in research and development expenses was primarily due to an increase of $13.0 million in personnel expenses as a result of an increase in the number of personnel and a one-time performance bonus of $5.3 million, a decrease of $0.5 million in reimbursements received for certain research and development costs that we incur as part of the joint product development and an increase of $0.8 million in facilities and other expenses.

During the three months ended March 31, 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.

We expect that research and development costs will increase as a result of additional inducements for employees who must work on-site to further our new product development for the duration of the “shelter in place” directives issued by the local authorities during the COVID-19 pandemic.

Sales and marketing expenses.

The period-over-period increase in sales and marketing expenses was primarily due to an increase of $3.0 million in personnel expenses as a result of an increase in the number of personnel and a one-time performance bonus of $1.0 million.

General and administrative expenses.

administrative expenses, offset by a decrease of $13.8 million in professional fees 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.

Comparison of Nine Months Ended March 31, 2020 and 2019

Research and development expenses.

The period-over-period increase in research and development expenses was primarily due to an increase of $23.7 million in personnel expenses as a result of an increase in the number of personnel and a one-time performance bonus of $5.3 million, a decrease of $1.2 million in reimbursements received for certain research and development costs that we incur as part of joint product development, an increase of $2.8 million in costs mainly related to materials and supplies used in product development, and an increase of $1.9 million in facilities and other expenses.

The period-over-period increase in research and development expenses was primarily due to an increase of $5.7 million in personnel expenses as a result of an increase in the number of personnel and an

increase of $1.2 million in costs mainly related to materials, supplies and equipment used in product development offset by an increase of $1.3 million research and development credits from certain suppliers and customers towards our development efforts.

Sales and marketing expenses.

The period-over-period increase in sales and marketing expenses was primarily due to an increase of $5.7 million in personnel expenses as a result of an increase in the number of personnel and a one-time performance bonus of $1.0 million, an increase of $0.8 million related to participation in trade shows and an increase of $1.1 million in expenses related to advertising and promotion activities.

The period-over-period sales and marketing expenses for the three months ended September 30, 2020 remained flat as compared to the three months ended September 30, 2019.

General and administrative expenses.

The period-over-period increase in general and administrative expenses was primarily due to the expense accrual in the quarter ended March 31, 2020 for a potential SEC settlement fee of $17.5 million, an increase of $7.7 million in personnel expenses, including an increase in the number of personnel and a one-time performance bonus of $1.1 million and an increase of $2.5 million in insurance expense, offset by a decrease of $26.4 million in professional fees 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.

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.

The period-over-period decrease in general and administrative expenses was primarily due to decrease of $6.7 million in professional fees incurred to investigate, assess and remediate 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 a decrease of $1.0 million in other general and administrative expenses, offset by an increase of $3.7 million in compensation expense due to increased full time personnel and bonuses.

Interest and Other (Expense) Income, Net

Other (expense) income, 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 the three and nine months ended March 31, 2020 and 2019 are as follows (dollars in millions):

Interest and other (expense) income, net for the three months ended September 30, 2020 and 2019 are as follows (dollars in millions):

Three Months Ended

Nine Months Ended

Other income (expense), net

September 30, Change

2020 2019 $ %

Other (expense) income, net $ (0.8) $ 1.6 $ (2.4) (150.0) %

Interest expense (0.7) (0.6) (0.1) 16.7 %

Interest and other income (expense), net

Comparison of Three Months Ended March 31, 2020 and 2019

The period-over-period change in interest expense was due to a decrease of $0.8 million in interest expense primarily as a result of lower interest rates in the three months ended March 31, 2020 as compared to the three months ended March 31, 2019.

The change of $1.0 million in other income (expense), net was attributable to an increase of $0.3 million in interest income on our interest bearing deposits and a decrease of $0.6 million in other expenses.

Comparison of Nine Months Ended March 31, 2020 and 2019

The period-over-period change in interest expense was due to a decrease of $3.9 million in interest expense primarily as a result of lower interest rates in the nine months ended March 31, 2020 as compared to the nine months ended March 31, 2019.

The change of $1.4 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 $0.6 million in other expenses, offset by change of $(0.9) million related to foreign exchange losses due to unfavorable foreign currency fluctuations.

Provision (Benefit) for Income Taxes

Provision (benefit) for income taxes and effective tax rates for the three and nine months ended March 31, 2020 and 2019 are as follows (dollars in millions):

Interest and other (expense) income, net $ (1.5) $ 1.0 $ (2.5) (250.0) %

The change of $2.4 million in other (expense) income, net was attributable to a decrease of $1.0 million in interest income on our interest bearing deposits and a $1.5 million foreign exchange loss.

The period-over-period change in interest expense was due to an increase of $0.1 million in interest expense primarily as a result of increased interest rates on our loans in the three months ended September 30, 2020 as compared to the three months ended September 30, 2019.

Provision for Income Taxes

Our income tax provision is based on our taxable income generated in the jurisdictions in which we operate, which primarily include 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.

Provision for income taxes and effective tax rates for the three months ended September 30, 2020 and 2019 are as follows (dollars in millions):

Three Months Ended

Nine Months Ended

Income tax (benefit) provision

September 30, Change

2020 2019 $ %

Income tax provision $ 3.7 $ 8.6 $ (4.9) (57.0) %

Percentage of total net sales 0.5 % 1.1 %

Effective tax rate 12.7 % 25.3 %

Comparison of Three Months Ended March 31, 2020 and 2019

The income tax benefit and effective tax rate change was primarily due to a tax benefit from the disqualified disposition of incentive stock options for the three months ended March 31, 2020.

Comparison of Nine Months Ended March 31, 2020 and 2019

The period-over-period decrease in effective tax rate was primarily due to a tax benefit from the disqualified disposition of incentive stock options for the nine months ended March 31, 2020.

The income tax provision and effective tax rate change for the three months ended September 30, 2020 was primarily due to decrease in tax reserves for uncertain tax positions after settlement of certain tax audits and increase in tax benefit from employees’ stock based compensation.

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 $300.9 million and $248.2 million as of March 31, 2020 and June 30, 2019 , respectively.

Our cash in foreign locations was $90.2 million and $124.6 million as of March 31, 2020 and June 30, 2019 , respectively.

Our cash and cash equivalents were $300.1 million and $210.5 million as of September 30, 2020 and June 30, 2020, respectively.

Our cash in foreign locations was $87.7 million a nd $98.0 million as of September 30, 2020 and June 30, 2020, respectively.

Amounts held outside of the U.S.

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to have a material effect on our overall liquidity, financial condition or results of operations.

We believe that our current cash, cash equivalents, credit lines and internally generated cash flows will be generally sufficient to support our operating businesses, remediation efforts, maturing debt and interest payments for the twelve months following the issuance of these condensed consolidated financial statements.

We are in the process of negotiating an extension of our credit facility with Bank of America and expect this process will be completed by the end of May, 2020.

Expected uses of our cash over the short term include our continued development of our innovative and resource saving products, manufacturing expansion in the United States and Taiwan and ongoing remediation of our material weaknesses in internal controls over financial reporting.

We expect to pay one-time performance bonuses of approximately $25.3 million to employees in the fourth quarter of fiscal year 2020 and $8.5 million to other executives and members of the Board of Directors within the next two years when and if specified market and performance conditions will be met.

In addition, we expect to make a one-time settlement payment of $17.5 million to the SEC in connection with the conclusion of the ongoing investigations.

We believe that our current cash, cash equivalents, borrowing capacity available from our credit facilities and internally generated cash flows will be sufficient to support our operating businesses, continued remediation of the material weakness in the financial reporting, 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 investigations in August 2020.

On October 31, 2020, our Board of Directors approved a share repurchase program to repurchase shares of our common stock for up to $50 million at prevailing prices in the open market.

The share repurchase program is effective until October 31, 2021 or until the maximum amount of common stock is repurchased, whichever occurs first.

Our key cash flow metrics were as follows (dollars in millions):

Nine Months Ended

Three Months Ended

September 30, Change

Net cash provided by operating activities $ 120.6 $ 5.6 $ 115.0

Net cash used in investing activities $ (11.9) $ (13.3) $ 1.4

Net cash provided by (used in) financing activities

Net cash used in financing activities $ (19.3) $ (1.7) $ (17.6)

Net increase (decrease) in cash, cash equivalents and restricted cash $ 89.6 $ (9.5) $ 99.1

Operating Activities

Net cash provided by operating activities decreased by $115.0 million for the nine months ended March 31, 2020 as compared to the nine months ended March 31, 2019.

The decrease was due primarily to an increase in net working capital of $129.7 million driven by increased inventories and prepaid expenses and other current assets, offset by an increase in net income for the current period of $17.7 million .

Net cash provided by operating activities increased by $115.0 million for the three months ended September 30, 2020 as compared to the three months ended September 30, 2019.

The increase was due primarily to an increase of cash provided by net working capital o f $121.2 million d riven by decreased accounts receivable as a result of increased collections, utilization of inventories and prepaid expenses and other current assets.

Non-cash charges related to depreciation and amortization expense, stock-based compensation expense and unrealized losses on our foreign currency-denominated credit facilities increased $4.0 million.

These increases were offset by a decrease of $9.2 million in the non-cash charges related to excess and obsolete inventories.

Investing Activities

Net cash used in investing activities was $34.1 million and $15.8 million for the nine months ended March 31, 2020 and 2019, respectively, as we continued to invest in expanding our capacity and office space, including the expansion of our Green Computing Park in San Jose and offices in Taiwan.

During the nine months ended March 31, 2020, we received $0.8 million from the sale of our investment in a privately held company.

Net cash used in investing activities was $11.9 million and $13.3 million for the three months ended September 30, 2020 and 2019, respectively, as we continued to invest in expanding our manufacturing capacity and office space, including the expansion of our Green Computing Park in San Jose and Bade manufacturing facility in Taiwan.

Financing Activities

Net cash provided by financing activities for the nine months ended March 31, 2020 was $25.4 million while net cash used in financing activities for the nine months ended March 31, 2019 was $95.9 million .

The change in cash flows from financing activities was primarily due to decreased debt repayments of $101.9 million and cash received for exercise of stock options of $23.1 million .

Net cash used by financing activities for the three months ended September 30, 2020 was $19.3 million while net cash used in financing activities for the three months ended September 30, 2019 was $1.7 million.

The change in cash flows from financing activities was primarily due to stock repurchases of $28.5 million offset by cash received from the exercise of stock options of $5.0 million net of taxes and $6.4 million of debt proceeds from draws on our CTBC credit and term loan facilities.

Other Factors Affecting Liquidity and Capital Resources

2018 Bank of America Credit Facility

We have a revolving line of credit with Bank of America (the "2018 Bank of America Credit Facility”) for up to $250.0 million, which expires in June 30, 2020.

Prior to its maturity, if certain conditions are satisfied, we may convert it into a five-year revolving credit facility for up to $400.0 million.

As of March 31, 2020, we had no outstanding borrowings and we had a $6.4 million letter of credit outstanding under this 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 September 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.

The 2018 Bank of America Credit Facility is secured by substantially all of Super Micro Computer’s assets and we are not permitted to repurchase our shares or pay any dividends.

We were in compliance with all covenants as of March 31, 2020.

We are in the process of negotiating an extension of our credit facility with Bank of America and expect this process will be completed by the end of May, 2020.

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.

2020 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 and expires in June 2020.

During the three months ended March 31, 2020, we borrowed $10.0 million under the revolving line of credit.

The total outstanding borrowings under the 2019 CTBC Credit Facility were $33.2 million with maturity on June 30, 2020.

The amount available for future borrowing was $16.8 million as of March 31, 2020.

The interest rate for these outstanding term loans was 0.91% per annum as of March 31, 2020 .

Term loans are secured by various Company’s assets, including certain property, plant, and equipment.

In August 2020, we entered into a credit agreement with CTBC Bank in Taiwan that provides for term loans of up to $50.0 million (the "2020 CTBC Credit Facility") and expires in August 2021.

During the three months ended September 30, 2020, we have not borrowed or repaid under the revolving line of credit.

There were no outstanding borrowings under the 2020 CTBC Credit Facility revolving line of credit as of September 30, 2020.

The total outstanding borrowings under the 2020 CTBC Credit Facility term loan were denominated in NTD and remeasured into U.S.

dollars of $24.0 million at September 30, 2020.

The amount available for future borrowing was $26.3 million as of September 30, 2020.

The interest rate for these outstanding term loans was 0.73% per annum as of September 30, 2020.

Term loans are secured by certain of our assets, including certain property, plant, and equipment.

There are no financial covenants under the 2020 CTBC Credit Facility.

Refer to Part I, Item 1, Note 7, “Short-term Debt,” in our notes to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q for further information on our outstanding debt.

2020 CTBC Term Loan Facility

In May 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.

Draw downs 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 borrowe d $6.3 million in the three months ended September 30, 2020 with a rate of 0.45% per annum.

As of September 30, 2020, the amount outstanding under the 2020 CTBC Term Loan Facility was $12.0 million and the net book value of the property serving as collateral was $17.1 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.

Refer to Part I, Item 1, Note 6, “Short-term and Long-term Debt,” in our notes to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q for further information on our outstanding debt.

Recent Accounting Pronouncements

For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our condensed consolidated financial statements, see Part I, Item 1, Note 1, “Organization and Summary of Significant Accounting Policies,” in our notes to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q.

For a description of recent accounting pronouncements, including the expected dates of adoption and estimated effects, if any, on our condensed consolidated financial statements, see Part I, Item 1, Note 1, “Summary of Significant Accounting Policies,” in our notes to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q.

Off-Balance Sheet Arrangements

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What changed 10-Q

Item 2. Management’s Discussion and Analysis