SMART Global Holdings, Inc.
Q2 2021 Earnings Call Transcript

Published: 6 Apr 2021

[Operator:]

Thank you for standing by, and welcome to the SMART Global Holdings Second Quarter Fiscal 2021 Earnings Call. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded I would now like to hand the conference over to your speaker today, Suzanne Schmidt, in Investor Relations. Thank you. Please go ahead, ma’am.

[Suzanne Schmidt:]

Thank you, Operator. Good afternoon. And thank you for joining us on today’s earnings conference call to discuss SMART Global Holdings second quarter fiscal 2021 results. On the call with me today are Mark Adams, Chief Executive Officer; Jack Pacheco, Chief Operating Officer; and Ken Rizvi, Chief Financial Officer.

[Mark Adams:]

Thank you, Suzanne, and thanks to all of you on the call for joining us today. We’ve had a very successful second quarter of our fiscal year operationally as well as strategically, where we continue to make significant strides on our growth and diversification initiatives. We believe we are set up for a great remainder of our fiscal year ‘21 and beyond. During our last earnings call, I highlighted my personal philosophy that performance is driven by people, purpose, planning, and process. At SGH, we are continuing to invest in these pillars to drive a new chapter for the company and in all of our key constituents including our employees, customers, suppliers, and shareholders. We made significant progress in terms of strengthening our management team this past quarter with the addition of several key leaders. I’m very pleased with the level of talent we’ve been able to attract to the company. Since our last earnings call, we have hired Ken Rizvi as our CFO, allowing Jack to focus on the joint roles of Chief Operating Officer and President of the Memory Solutions Group. Thierry Pellegrino is President of Intelligent Platform Solutions Group, formerly known as Specialty Compute and Storage Solutions. As you’ll recall, Thierry comes to us from Dell, where he led their HPC and AI business.

[Ken Rizvi:]

Thanks, Mark. First, let me begin by saying how excited I am to take on the CFO role at such a pivotal time at SGH. I’m grateful for Jack’s continued guidance and look forward to working with Mark, Jack and the rest of the team at SGH as we execute on our growth and diversification strategy. As Mark mentioned earlier, we reported a strong quarter with all key metrics at the high end of our guidance range. Net sales for the second fiscal quarter of 2021 were $304 million, an increase of approximately 12% year-over-year from the second quarter of fiscal 2020. In addition, non-GAAP gross margin came in at 19.5% and non-GAAP earnings per share was $0.87 for the second fiscal quarter of 2021. Our year-over-year revenue growth was driven primarily by high sales from our Intelligent Platform Solutions Group, formerly known as Specialty Compute and Storage Solutions, which saw 36% year-over-year growth to $85 million in the second fiscal quarter of 2021 from $62.9 million in the second fiscal quarter of 2020. In addition, our Memory Solutions Group revenue, which includes Specialty Memory and Brazil, increased by approximately 5% on a year-over-year basis. Specialty Memory reported revenues of approximately $116 million in the second fiscal quarter of 2021, which was an increase of approximately 4% year-over-year, while Brazil reported revenues of $103 million in the second fiscal quarter of 2021, which was an increase of approximately 6% year-over-year. Our acquisition of Cree LED closed on the 1st of March and we will begin reporting Cree LED results from the third fiscal quarter of 2021. Non-GAAP gross margins for the second fiscal quarter of 2021 was 19.5% and flat with the second quarter of 2020. Non-GAAP operating expenses for the second fiscal quarter of 2021 was approximately $32.1 million, down from $35.6 million in the second fiscal quarter of 2020. Operating expenses were lower and benefited from $6.2 million in financial credits in Brazil. This helped to offset our Brazil R&D spending, which is required to benefit from this credit. The current law related to these specific financial credits is expected to expire in the beginning of calendar year 2022. We plan to offset the vast majority of the expected decrease in financial credits through cost reductions, including our move to Manaus, reduce spending in Brazil R&D along with other cost savings programs. In addition, we plan to modify our pricing as the supply chain adjust to the expected reduced credits.

[Operator:]

Thank you, presenters. Your first question comes from the line of Tom O’Malley with Barclays. Your line is open.

[Tom O’Malley:]

Good afternoon, guys, and congrats on really nice results, and welcome Ken. I just wanted to ask on the segments heading into Q3 here, I think you gave us some great color on the Cree contribution, but on the two other segments, the Memory Solutions and the Intelligent Platform Solutions, can you give us a little more color on where you’re seeing strength because you’re obviously indicating a pretty strong guide here with the midpoint of the range being at $415 million?

[Mark Adams:]

Yeah. Thanks for the question. Well, primarily, we’ve seen strength. I’ve been pretty bullish in the past calls on our -- what now we’re calling Intelligent Platform Solutions, primarily driven by strength in our Penguin business as well as Embedded space. And the end markets really are met around AI driven workloads and the cloud data center segments as well as oil and gas, energy, and in our federal business. Between those three segments, they are driving a lot of the upside growth. As mentioned in our pre-recorded scripts, that segment was up 30% quarter-over-quarter, and margins were up and we remained bullish in Q3 and Q4. On the Memory Side, we also were slightly ahead of our forecast for the quarter in our Specialty business, and we’re starting to see some return from our industrial customers in the telecommunications and network space, as well as we’re getting some design wins and very much of the same type of segments that I mentioned relative to the computing environment, HPC, AI, and compute intensive workloads where memory is taking on a different role. On the Brazil front, as we mentioned, the mobile memory, the density we benefit from increasing densities down in Brazil, and that environment and also notebook memory unit sales are growing. And so the combination of that, if you exclude it, our end of life of the battery business was up about 12%, and so if you sum all that together, all three right now of the business units are operating in a growth environment.

[Tom O’Malley:]

Great. That’s helpful. I guess my follow up was around the LED business. Obviously, in the deck you guys put out, you talked about 200 bps to 400 bps of margin improvement. Could you talk about the transition? You mentioned 18 months was kind of the timeframe for what you kind of saw as the initial transition. But can you give us a little more color on the gross margin profile there and how quickly can you ramp that up to the high 20s, low 30s? And can you give us a little extra color on the timeframe that you think you can get there?

[Mark Adams:]

Of course. If you go back to Cree’s last reports on Cree LED, which wasn’t their December call, it was actually their September call, because that was not classified as a reporting unit in December. If you go back to September, I believe the gross margins were roughly 22%. And I articulated at the time of the acquisition and I reinforced on our last call that we expect over the next kind of 18 months or so in the area 400 basis points to 500 basis points improvement in gross margins. You’re going to see -- start to see some of that in Q2, and I’ll let Ken discuss this in a second, but a lot of it is dependent on a number of factors in turn -- including the silicon carbide to sapphire transition, the transition to an outsourced manufacturing partner and other efficiencies that team is driving in their manufacturing transformation. Specific to the short-term, I will let Ken just talk a little bit about the gross margin outlook in the short-term.

[Ken Rizvi:]

Sure. Thanks, Mark. If we look at the gross margins for Cree in the near-term, as Mark had mentioned, we’re probably looking at somewhere in the mid-20% range on a non-GAAP basis. Now, the reason I say, non-GAAP is that, as part of the purchase price accounting, we will expect to step up the inventories on day one of Cree’s opening balance sheet. So, that will go through the P&L that should go through in the Q3 timeframe. But on a non-GAAP basis, those margins should be in that 25% range plus or minus a bit, and then we will work to try to improve those over time.

[Tom O’Malley:]

Great. Thanks guys, and congrats again.

[Mark Adams:]

Thank you.

[Operator:]

Your next question comes from the line of Brian Chin with Stifel. Your line is open.

[Brian Chin:]

Hi, there. Good afternoon. Welcome to the call, Ken, and thanks for letting us ask a few questions.

[Ken Rizvi:]

Sure.

[Mark Adams:]

Okay.

[Brian Chin:]

I -- may be first to follow up on the last question about LED. Thanks again for the revenue break out and then I guess the gross margin in the fiscal third quarter. I am also curious what sort of -- at a starting point the OpEx might look like against that and how that -- how you can maybe lean that out over time or a certain timeframe.

[Ken Rizvi:]

Yeah. So as we’ve discussed, Brian, earlier on the call, we’re going to have a shorter week or we’ll be one week short here in Q3 for Cree LED; and then from Q4, we’ll have the normal 13-week quarter. So for this quarter, for Q3, I would expect that non-GAAP OpEx to be in the neighborhood of $18 million for that Cree business. Going forward, we will not break out the OpEx for each of the businesses, but just to give people some context in terms of the starting point, given this is the first quarter with Cree LED. That’s what we’re expecting to get. In Q4, that will uptick given that there’s an additional one week for Cree LED.

[Brian Chin:]

Okay. Yeah. Thanks. That’s very helpful. Maybe to circle back to Brazil for a moment, there was a recent announcement that one of the larger handset companies LG is exiting the handset market, they have a big base in Brazil, obviously. I’m just curious, are you seeing any discernible impact from that in your fiscal third quarter guidance and this does seem more like a temporary effect, you ultimately just use this as washing out in another quarter or two as other OEMs, like Samsung, absorb that market share?

[Mark Adams:]

Correct. I think your assumptions spot on. Remember, we’re the largest memory manufacturer down in Brazil. And so as we supplied many of the largest handset makers in the country, whether the share of shift is from A to B to C to D, we anticipate very little impact and it’s also any of that would be contemplated in the guidance that Ken provided.

[Brian Chin:]

Okay. Great. Maybe one more question is maybe towards the balance sheet and maybe towards Ken, accounting for the -- your cash after the March 1st close of the Cree acquisition? Can you just remind us what minimum cash on hand is needed to run the business?

[Ken Rizvi:]

Yeah. If we look at the business itself, the minimum cash that we need to run the business is probably in that $80 million range if you look on a normalized basis. We exited Q2 with about $140 million of cash on the balance sheet, just as a reminder.

[Brian Chin:]

Great. Thank you.

[Operator:]

Your next question comes from the line of Kevin Cassidy with Rosenblatt. Your line is open.

[Kevin Cassidy:]

Yeah. Thanks for taking my question and congratulations on the great results, and also welcome Ken. Good to talk to you again, Ken.

[Ken Rizvi:]

Good to talk to you again.

[Kevin Cassidy:]

The -- in this environment, I see your inventories are up quarter-over-quarter. So that seems like that’s a very good accomplishment. Can you talk about what -- how you’re handling the shortage that’s so well publicized in the long lead times and also what kind of visibility you’re getting from your customers?

[Mark Adams:]

Yeah. So if we look at our inventories, Kevin, you’re spot on. As we looked at Q1 to Q2, we did grow inventories strategically in part due to the constrained supply environment and then also we are seeing a nice uplift in demand not only Q1 to Q2, but as you can see by our guidance into Q3. And so the supply chain team has done a great job under Jack and the overall team to secure that supply for those projects, we are working with our customers who are fairly large in size and have a good footprint and are able to help us in terms of securing that supply, especially as we move into Q3 and Q4 of this year.

[Kevin Cassidy:]

Okay. Great. And maybe I was a bit surprised when you talked about the Brazil market. You’re seeing the growth is going to come from units and we’ve been talking about it for a few quarters of the memory content increasing per phone, but there wasn’t any mention of average selling price increases. And I was just a bit surprised that that’s not a factor in part of the growth. Can you discuss that? Is that going to happen later in the year?

[Jack Pacheco:]

Sure, Kevin. Hey. This is Jack. How are you doing?

[Kevin Cassidy:]

Good, Jack.

[Jack Pacheco:]

Yeah. On the ASP for Q3 for Brazil priced around $20. We think we finished Q2 at around $19 something, so still fairly flat. So we are still not seeing a huge growth yet and the content of memory on the phones that we expected and part of it is the reality we getting phone a little more expensive. We will expect to see the density start to go up a little bit more probably get into early next year for phones in Brazil. Right now those units are driving the growth in Brazil.

[Kevin Cassidy:]

Okay. But DRAM prices going up, isn’t helping in the…

[Jack Pacheco:]

We’ve just started the amount…

[Kevin Cassidy:]

…3Q?

[Jack Pacheco:]

Yeah. Q3 we’re just starting to see some price increase. Remember Brazil for Q2 we didn’t see anything. So ASPs was up a little bit in Q3 for DRAM, but it’s still more of a unit base broke down there than it is anything from DRAM on the ASP front.

[Kevin Cassidy:]

Okay. Great. Thanks for clarifying that.

[Mark Adams:]

And a bit -- just one other classification, remember the accounting for the Brazil business is one month earlier in the quarter. So, any of that pricing that you’re implying probably wouldn’t show up in Brazil in the Q2 numbers.

[Kevin Cassidy:]

Okay. Thank you.

[Mark Adams:]

Thank you.

[Operator:]

Your next question comes from the line of Raji Gill with Needham & Company. Your line is open.

[Raji Gill:]

Yes. Thanks for taking my questions and Congrats, and welcome, Ken. Question, Ken, on the LED business, you indicated that for the May quarter, it will be about $90 million to $95 million and you talked about the different timing? How do we think about kind of a normal -- normalized quarterly LED business kind of going forward, particularly with some of the piece parts of LED, some areas I think you’ve talked about, you might want to exit out of, some areas you might want to keep? So how do we think about kind of the normalized quarterly kind of run rate for LED?

[Ken Rizvi:]

Okay. We’re happy to provide a little context and color, although we will not be guiding on a long-term basis for any one of our business segments. But if we look at that business for Q3, as I mentioned, $90 million to $95 million in terms of the range and that’s based on a 12-week quarter here in Q3. So our expectation as we head into Q4 is we should be more closer to $100 million normalized run rate plus or minus a bit. And as we get into the end of Q3 and on our next earnings call, we’ll provide a fuller guidance on the Cree business and in terms of the -- in terms of both the revenue and outlook.

[Raji Gill:]

Okay. That’s helpful. And in terms of kind of gross margins by segments, could you just highlight again the gross margin by segment. I think you said Intelligent Platform Solutions are the formal SGH’s business was 29% gross margin. What was the Brazil gross margin, Specialty margin and how do we think about the gross margin drivers for those three segments?

[Ken Rizvi:]

Yeah. Sure. No problem. So if we look at Brazil, Brazil in Q2 was about 15.2% on a gross margin basis, Specialty Memory was about 16.1% in terms of gross margins, and as you mentioned earlier, the Intelligent Platform Solutions Group at about 29.3% in Q2 of ‘21. I would give you some ranges and contexts on a go-forward basis. So for both the Specialty business, sorry, Specialty Memory and Brazil, I would think those margins will be reasonably flattish plus or minus a bit Q2 to Q3 and the range I will provide for Intelligent Platform Solutions would be in the mid-to-high 20% range. Now, just to put into context for the Intelligent Platform Solutions, there is a bit of lumpiness based on the services component that we can see in any given quarter, so that may move around a bit, that’s why I gave you a broader range there.

[Raji Gill:]

That’s really helpful. Thank you. And Mark, on -- if you’re looking at kind of the -- last quarter you talked about kind of a 40% increase in backlog driven by oil and gas, cloud, some of these other markets? How do we think about the backlog as we go into May? Is it going to the back half of the of the summer and the year? How is that backlog being converted over to revenue and kind of what’s driving those end markets? Thank you.

[Mark Adams:]

Well, I mean, I think, it’s the same drivers that I’ve mentioned either early on the call and I’m happy to repeat them again. In high performance computing, the key segments for us today are cloud, federal and energy with oil and gas. I think and that’s not exclusive, but those are the big three contributors for us in high performance computing. In the Embedded space is primarily federal plus transportation and telecommunications. So for us, the drivers continue, our backlog is actually healthier going back -- going into Q3 and really the back half of the year, that’s very, very strong in that business, which is why we got it as such. I think Ken referenced and if he didn’t reference it, let me just clarify that, coming off a 30% sequential growth Q2 over Q1, we’re continuing to forecast an increase in that business in the area of high-single digits, low-double digits off of that quarter. So we remain very confident in the back half of the year in the topline growth for the AI, the Intelligence Solutions Group.

[Raji Gill:]

Thank you.

[Operator:]

Your next question comes from the line of Sidney Ho with Deutsche Bank. Your line is open.

[Sidney Ho:]

Great. Thanks. Thanks for taking my questions and welcome Ken as well. Maybe follow up with a Cree business, not trying to steal any thunder from your Analysts Day, but Mark, can you talk about your general philosophy related to that business. What are your priorities there, is that mostly the two technology transitions that you talked about in your prepared remarks? And Ken related to that, you talk about the gross margin goal in the near-term, maybe little longer term. But at the operating margin level, that line, the fiscal Q3, will be more like mid single-digit range, just based on numbers you gave. How you are thinking about that operating margin line over time?

[Mark Adams:]

Great question. Thank you for asking. There’s a couple of things. In addition to the manufacturing transformation we’ve discussed. We see improvements in demand. We see more of a -- more focused initiative in the topline growth on strategic projects out 12 months to 18 months. So the team is now not limited by the manufacturing capacity in their captive environment, North Carolina. We have the ability to grow from just a sheer capacity perspective. And so I think you’ll see better opportunities in terms of these differentiated markets that the team is driving. In addition to the go-to-market piece, we see the opportunity for, as I mentioned on the earlier calls, somewhere in the area of 10% to 12% operating synergies over the next 18 months. And if I look at gross margins, I would suggest that these 400 basis points or 500 basis points over the next 12 months to 18 months also fit in well. So the culmination of that, I think, would drive significantly better operating results then you’re referring in your question.

[Sidney Ho:]

Okay. That’s helpful. Thanks. Maybe my follow up question is related to the supply shortage that was discussed in the Q&A. Can you talk about building strategic inventory for yourself, but are you assuming any kind of chip shortages impacting your revenue guidance in the near-term? And have you seen any changes in your customers buying behavior in anticipation of memory chip component pricing going up?

[Mark Adams:]

That’s a good question. So I think we’ve contemplated that in our guidance as we look at Q3. I think the reality is there could have been or there could be some upside if we’re able to get all of the supply that we want for specific chips and parts. But in general, we are comfortable in terms of the supply we need to meet our Q3 guidance in the range we’ve provided. I would say as well, given that lead times have moved out a bit, customers are placing backlogs up -- further out. So we are starting to see a bit more visibility, especially as it relates to the Specialty Memory business and to some extent in Brazil.

[Sidney Ho:]

Great. Thank you.

[Operator:]

Thank you. Your next question comes from the line of Mark Lipacis with Jefferies. Your line is open.

[Mark Lipacis:]

Hi. Thanks for taking my question, and Ken, good to talk to you again. First question on the Intelligent Platform, really nice high sequential your growth, and I wonder Mark, if you could just -- you shared a little bit of this. But I understand that this is from -- a lot of this from software and services. To what extent is that the big jump in the sequential growth from pent-up demand versus a new trajectory and I appreciate you’re saying, high-single, low-double digits is kind of how you’re thinking about it near-term? But maybe you could just talk about, share a little color on the capacity of that business, I guess, software has unlimited upside potentially. But on the services side or the product side, how should we think about, any kind of capacity constraints you might have them? And then I have a follow up.

[Mark Adams:]

Sure.

[Mark Lipacis:]

Thank you.

[Mark Adams:]

Great. Yeah. Notwithstanding Ken’s commentary around some of the mix issues we’ll see guiding the gross margin between mid-to-high 20% gross margins on the software and services, implying that there’s a mix sometimes, because depending on the amount of hardware we ship in a quarter versus how much of the software and services we sell in that period. Notwithstanding all that, we see significant upside in the business and we are a little bit constrained, as Ken noted, relative to some of the key components in Q3. We’ll get a better handle on Q4. That’s all contemplated in this guidance. But these workloads that we’re working on in the different segments, I’ve identified, the top three in HPC are primarily in our cloud service providers in terms of federal business, as well as oil and gas, those represents some of our largest customer engagements. And I tried to describe this on our last call to give another shot here. What happens in some of these installations is that we begin with a development platform that is in development to work on a specific application at a given customer. And oftentimes, once we get through the development phase, it goes into production phase and that represents a pretty attractive rollout opportunity for us with the customer. And that is what you’re starting to see in some of our larger customers are add-on opportunities, as well as new customer development, but add-on opportunities at an increased scale. So the coming off of a 30% growth in the business in Q2, Q3 and Q4 still represents some upside growth from where we are today and we’re pretty excited about the opportunity.

[Mark Lipacis:]

Great. That’s a very helpful. Thank you, Mark. And I’ve a follow up for Ken and then maybe for Jack. Ken on the capacity constraints, can you describe the extent that the constraints are more on the material side or is there support services that you guys look to? And then a question for, Jack, I think, Jack, and you had I think previously described that SMART did not have a lot of exposure between the time that you purchase raw materials from memory modules and the time you sell them. But I believe there was some exposure, but I don’t know if it was three days or five days or something like that, could you -- and could you just remind us of that? And I guess my understanding that pricing is going higher during that time then that accrues to a slight benefit to your profitability and if it’s going lower, it hurts a little bit? If you could just remind us of those dynamics and how they hit your profitability and that’s all I had? Thank you very much.

[Ken Rizvi:]

Sure. Let me start and then Jack will chime in here. So if we look, just to be clear, we’re not constrained from a capacity standpoint. And even as we look at our Q3 guidance in the range we’ve provided, we feel very comfortable based on the inventory we have on hand and inventory that we will receive we can achieve that guidance range as of today. So we feel comfortable from that standpoint. As it relates to a specific surrounding inventory and the second part of the question, maybe I’ll turn it over to Jack to answer those.

[Jack Pacheco:]

Sure. Thanks, Ken. Yeah. So I think Brazil markets where we have the most risk of the inventory. In Brazil, we will own the inventory anywhere from four weeks to six weeks that we process it into either a module into a multi-chip package. When pricing starts going down, we can shore that up to four weeks and now we’re probably a little bit longer. But we don’t see any issue in Brazil, the inventory is ample for what we’re trying to do and as pricing is going up, that will benefit us a little bit in Brazil. On the Specialty business, we typically don’t take a risk on inventory. So the inventory we have we will -- we pretty much have sold without the price we need to sell it out. So we really don’t have a risk on it when you look at it from a Specialty standpoint.

[Mark Lipacis:]

Great. Thank you very much.

[Mark Adams:]

No problem.

[Operator:]

There are no further questions at this time. I would now like to hand the conference over to Mark Adams, Chief Executive Officer for closing remarks.

[Mark Adams:]

Thank you, Operator. And thank you again to all of you on the call, as well as to our global team at SGH for their outstanding contributions to our second quarter results. Given the most strong momentum in our business, we remain confident in our growth and diversification strategy as we embark on this exciting new chapter at SGH. Thank you.

[Operator:]

This concludes today’s conference call. Thank you for participating. You may now disconnect.