Donn Vickrey
Forensic accounting analyst
Super Micro has told investors its internal control over financial reporting is not effective, and has done so for more than a year. It forecast $65bn to $72bn of revenue anyway. Three questions about what that forecast is worth.
Answered · 3 questions
Donn Vickrey co-founded Gradient Analytics and Pacific Square Research, both forensic research firms, and has spent more than thirty years on earnings quality. He taught accounting at the University of San Diego and has published on earnings quality in the Financial Analysts Journal. He holds a PhD, and is a CPA and a Certified Fraud Examiner.
I have not looked carefully at Super Micro in a few years. We make it a practice to avoid battleground stocks. It’s a good way to lose money with shorts! (Lol)
With that said, here’s what I can say about the situation:
Question 1
When a company’s own executives have concluded for over a year that internal control over financial reporting is not effective, how much weight should an investor place on a multi-billion dollar revenue forecast produced by those same systems?
The length of time it takes to remediate control weaknesses is a good proxy for how ineffective the system was when the problems were discovered. This case is unusual in that the company has had two major periods of internal control weaknesses: Back in the 2015-2020 period then again more recently. If I had to bet, controls were probably ineffective in between as well. I can’t say I’ve ever seen a company that has had internal control weaknesses for the better part of a decade. That’s a huge red flag.
How much weight should be placed on revenue estimates? I’d say very little. Wall Street expectations will be what drives the market’s response. And when you have significant internal control weaknesses the risk of missing is substantially greater.
Question 2
“Unable to estimate the possible loss or range of loss” is standard language. Twenty-one months into an SEC investigation, does the passage of time change what that disclosure ought to say, or is it defensible indefinitely?
The “unable to estimate” language is common and I can’t say I’ve ever seen a company change that statement until the amount of the restatement is determined. The fact that there is an SEC investigation and a DOJ investigation make this one particularly problematic. It could take quite a while and it’s really not easy to know how bad it will get for them in terms of losses/restatements. It won’t bankrupt the firm. But will they have to curb sales practices re China? Have sales been inflated by related party transactions. And if so what will the resolution of these issues imply for future sales and profits? (The actual “losses” themselves will likely be ignored by the market. They are only useful as a proxy for how bad the situation might actually be re future sales.)
Question 3
If you were assessing that $65 to $72 billion forecast and could not rely on the controls, what would you look at instead?
Honestly, this is a company I’d avoid like the plague. The forecast is irrelevant IMO. The same CEO has been in charge during both periods of alleged misstatements and other alleged wrongdoing. I just don’t invest in companies with that level of regulatory baggage. There are plenty of companies that don’t have that baggage.
One other thought re question 3. If I were willing to take the risk of investing in a company with that level of executive regulatory baggage, I would attempt to identify and eliminate sales to related parties — especially those that could be responsible for sales of prohibited chips to China. That would not be easy, but it’s probably the crucial missing piece for estimating 26 and 27 revenues.
These answers were reported in Super Micro forecast $72 billion. The number may be irrelevant..