Super Micro Computer: Surprise Auditor Resignation Is A Major Red Flag – Sell
Contributor since 2011 / 20395 Followers
Summary:
- On Wednesday, shares of Super Micro Computer experienced renewed selling pressure after the company disclosed the surprise resignation of its audit firm Ernst & Young LLP.
- Apparently, the company’s auditors resigned because of concerns regarding management’s commitment to integrity and the audit committee’s independence.
- As a result of the abrupt resignation, Super Micro Computer may not likely regain compliance with Nasdaq listing requirements anytime soon, thus increasing the risk of a possible near-term delisting.
- In my opinion, with the company likely being required to return to the capital markets in early 2025, audited financials remain an imperative.
- With audited financials being delayed even further and a near-term delisting increasingly likely, I’m reiterating my “Sell” rating on Super Micro Computer’s common shares.
Erik Isakson
Note:
I have covered Super Micro Computer, Inc. (NASDAQ:SMCI) previously, so investors should view this as an update to my earlier articles on the company.
On Wednesday, shares of the high-performance server and storage solutions provider experienced renewed selling pressure after the company disclosed the surprise resignation of its audit firm Ernst & Young LLP (“EY”).
In late July 2024, EY communicated to the Audit Committee concerns about several matters relating to governance, transparency and completeness of communications to EY, and other matters pertaining to the Company’s internal control over financial reporting, and that the timely filing of the Company’s annual report was at significant risk.
In response, the Board appointed an independent special committee of the Board (the “Special Committee”) to review the matters and certain of the Company’s internal controls and certain governance procedures (the “Review”). The Special Committee engaged Cooley LLP, and forensic accounting firm Secretariat Advisors, LLC to perform an investigation on behalf of and at the direction of the Special Committee.
EY and the Board received updates with preliminary information relating to the Review. As of the date of this Current Report on Form 8-K, the Review remains ongoing and final findings and recommendations have not yet been communicated to EY or the Board.
Apparently, the review resulted in EY questioning the company’s commitment to the principles for developing and maintaining effective internal controls released by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”):
After receiving additional information through the Review process, EY informed the Special Committee that the additional information EY received raised questions, including about whether the Company demonstrates a commitment to integrity and ethical values consistent with Principle 1 of the COSO Framework, about the ability and willingness of the Audit Committee and overall Board to demonstrate and act as an oversight body that is independent of the CEO and other members of management in accordance with Principle 2 of the COSO Framework, and whether EY could rely on representations from certain members of management and from the Audit Committee.
Super Micro’s regulatory filing also included a bold quote from EY’s resignation letter (emphasis added by author):
(…) we are resigning due to information that has recently come to our attention which has led us to no longer be able to rely on management’s and the Audit Committee’s representations and to be unwilling to be associated with the financial statements prepared by management, and after concluding we can no longer provide the Audit Services in accordance with applicable law or professional obligations.
Having worked several years at a Big Four audit firm myself, I can safely state that this is a highly unusual and rather concerning development.
However, Super Micro Computer apparently still does not expect to make changes to previously issued financial statements.
In addition, the company will provide a Q1/FY2025 business update next week. However, I’m somewhat surprised about management’s decision not to provide certain preliminary Q1 results alongside Wednesday’s negative news as a decent quarter could have helped to alleviate the severe impact of the abrupt auditor resignation on Super Micro’s stock.
Please note also that the company is approaching the Nasdaq deadline for regaining compliance with listing requirements or submitting a plan to do so.
Given the surprise auditor’s resignation, Super Micro might be challenged to present a credible plan to Nasdaq. As a result, a near-term delisting of the company’s common stock might possibly be in the cards.
To be clear, the resignation of EY comes at the worst possible time for Super Micro as the company’s exponential growth requires billions of dollars in working capital investments.
In my opinion, based on management’s sales projections, FY2025 cash usage could be up to $3 billion, which would likely require the company to raise additional capital early next year.
However, accessing the capital markets without audited financials could prove difficult. A potential funding gap would likely require the company to cede substantial market share to key competitors like Dell Technologies Inc. (DELL) or Hewlett Packard Enterprise Company (HPE).
At least in my opinion, the resignation of EY has further increased the risk of a protracted accounting review which in turn could impact Super Micro’s ability to finance anticipated exponential growth.
Given this issue, it will be imperative for the company to report strong preliminary Q1/FY2025 results and provide a constructive outlook next week.
Bottom Line:
The bad news just doesn’t stop for Super Micro Computer as the company’s auditors resigned on concerns regarding management’s commitment to integrity and the audit committee’s independence.
As a result, Super Micro Computer is not likely to regain compliance with Nasdaq listing requirements anytime soon, thus potentially increasing the risk of a near-term delisting.
However, with the company likely being required to return to the capital markets in early 2025, audited financials remain an imperative.
Should Super Micro Computer lack the funds to finance projected growth, the company would be at risk of losing substantial market share to key competitors like Dell Technologies or Hewlett Packard Enterprise.
With audited financials being delayed even further and a near-term delisting increasingly likely, I’m reiterating my “Sell” rating on Super Micro Computer’s common shares.
Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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