SMART Global Holdings, Inc.
Q1 2018 Earnings Call Transcript

Published: 21 Dec 2017

[Operator:]

Good day, ladies and gentlemen. And welcome to the SMART Global Holdings’ First Quarter of Fiscal 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode [Operator Instructions]. Later, we will conduct the question-and-answer session and instructions will follow at that time. As a reminder, today’s conference is being recorded. I would now like to introduce your host for today’s conference, Ms. Suzanne Schmidt, Investor Relations. Ma’am, please go ahead.

[Suzanne Schmidt:]

Thank you, Operator. Good afternoon, and thank you for joining us on today’s earnings conference call to discuss SMART Global Holdings’ first quarter fiscal 2018 results. Iain MacKenzie, President and CEO, will begin the call with a discussion of the market and the business; followed by Jack Pacheco, Chief Operating and Financial Officer, who will review the financial results in more detail and provide the forward guidance. We will then open the call to your questions. As a reminder, our earnings press release and a replay of today’s call can be accessed under the Investor Relations section of SMART’s Web site at www.smartgh.com. We encourage you to go to our Web site throughout the quarter for the most current information on the Company, including information on the various financial conferences we will be attending. Before we begin the call, I would like to note that today’s remarks and the answers to questions may include forward-looking statements. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections and future market conditions, is a forward-looking statement. Actual results may differ materially from those expressed from these forward-looking statements. For more information, please refer to the Risk Factors discussed in documents we file from time-to-time with the SEC, including our most recent Form S-1, which was filed in conjunction with the Company's recently completed secondary offering. We assume no obligation to update these forward-looking statements, which speak as of today. Additionally, during this call, non-GAAP financial measures will be discussed. Reconciliation for those directly comparable GAAP financial measures are included in today's earnings press release. And now, I'd like to turn the call over to Iain MacKenzie.

[Iain MacKenzie:]

Thanks, Suzanne. Welcome to everyone on the call. Well, fiscal 2018 is off to an excellent start with Q1 net sales of $265.4 million and non-GAAP diluted earnings per share of $1.05. This performance reflects the strength of our growing portfolio of differentiated products and services into a healthy customer demand and the improving financial leverage in our operating model. The economy in Brazil continues to recover and the ongoing positive dynamics in the global memory market are providing tailwinds to our business momentum. Outside of Brazil, both storage and network telecom markets remain areas of strength for our Specialty Memory business as the competitive landscape remains in our favor with our focus on these solutions with long product life cycles. And for a few comments on the overall memory markets a number of industry reports point to the continuation of a more balanced supply demand dynamic for the year in our market and demand continues to be robust from servers and smartphones, at the same time, as net wafer capacity additions remain limited due to the fab conversions. As for the NAND, demand is expected to continue to outpace supply despite new capacity ramping in 2018 and yields improving on the capacity that was added and committed in 2017. This demand is predominantly being driven from both enterprise storage and smartphone memory needs. At this time, we expect normal price declines for calendar 2018 as additional supply comes online, however, NAND price declines may result in some unit increases through elasticity of demand. Turning to SMART Brazil. We just completed our 9th consecutive quarter of growth. We’re benefiting from our unique position as the only player of scale in Brazil with DRAM and the only provider of semiconductor packaging, programming and test for the eMCP components for the mobile memory market in Brazil. We have continued to strengthen our long-term strategic wafer supply and technology partnership, providing us with access to stable and competitively priced wafers. Additionally, the micro environment continues to improve. Not only do we expect the unit demand for our products to increase, but as the memory densities are growing ahead of expectations, our ASPs are being positively impacted. As customers are pulling in product deliveries to meet their calendar year 2017 local requirements, we continue to step up our manufacturing capacity for mobile smartphone memory in calendar 2018. And beyond 2018, we expect to continue to benefit as the local requirements continues to expand and we evaluate entry into new end markets, such as wireless communication modules. We believe there is significant runway for future growth ahead of us. As for our Specialty Memory business, we see growth ahead in both DRAM and Flash as we have increasingly diversified our business and products. We have a 30 year history of delivering innovation in specialty Flash and DRAM products to meet the needs of our OEM customers. The long designing cycles of our products with deep engineering collaboration result in sticky customer engagements to support the product lifecycles that can span up to 10 years or longer. Our differentiated position results in a long-term strategic relationship with our customers and provide the relatively predictable revenue stream. So now, I hand you over to Jack to discuss the financials in more detail.

[Jack Pacheco:]

Great, thank you Iain. As Iain mentioned, we just completed our ninth quarter in a row growth in Brazil. Now the Brazilian economy is beginning to grow as well; GDP growth is expected to be close to 1% this year and over 2.5% next year; inflation is dropping as well; and the Brazilian Central Bank has also lowered it's over net rate called the [Selec] to 7%, it is over a 12% a year ago. All these signs point an economy on the rebound and we are seeing that in our results. Gross revenue for the first fiscal quarter was $494 million, while net sales were $265.4 million. The difference between gross revenue and net sales is related to our supply chain services business, which are accounted for an agency basis meaning that we only recognize as net sales but net profit on the supply chain services transactions. Net sales increased 19% over the previous quarter as unit sales increased and the average selling prices remained favorable. First fiscal quarter 2018 net sales were broken down by geography as follows; Brazil 60%, Asia 19%, U.S. 17%, other Americas 2%, Europe 2%. Our breakdown of net sales to end markets for the first fiscal quarter was as follows; mobile and PCs 56%, network and telecom 18%, service and storage 17%, industrial aerospace, defense and other 9%. Moving to the rest of the income statement, non-GAAP gross profit for the first quarter was $58.1 million, up 20.5% as compared with last quarter's $48.2 million. Non-GAAP operating expenses increased 2.6% quarter-over-quarter to $23.4 million as we maintained our expense discipline during the quarter. Non-GAAP net income for the first fiscal quarter was $22.8 million or $1.05 per diluted share compared to $17.4 million or $0.79 per diluted share in the prior quarter. Adjusted EBITDA increased 18% to $36.9 million in the first fiscal quarter. Turning to working capital. Our net accounts receivable increased to $236.2 million from $183.3 million last quarter and our day sales outstanding was 42.5 days for this quarter compared with 38 days last quarter. The Thanksgiving holiday, customer collections upon the Q2 as our quarter ended on Friday of Thanksgiving week. Inventory increased slightly to $128.2 million from $127.1 million in the prior quarter, while inventory turns of 13.6 times was up 11% from last quarter's 12.3 times, which is an outstanding performance in the current memory environment. Consistent with past practice, accounts receivable and inventory turnover are calculated on a gross sales and cost-of-good sold basis, which totaled $494 million and $436.1 million respectively for the first fiscal quarter of 2018. Cash and cash equivalents totaled $22.5 million at the end of the first quarter. First quarter cash flow from operations was $14.3 million compared with $6 million in the prior quarter. Now, let me turn you over to our guidance. While we previously indicated we expected our second quarter to be in line with our first fiscal quarter, we now believe that our second fiscal quarter will be ahead of what we accomplished in the first quarter of fiscal 2018. SMART estimates that our second quarter fiscal 2018 net sales will be in the range of $280 million to $300 million, and gross margin for the quarter will be approximately 21% to 23%. GAAP earnings per diluted share is expected to be between $1.18 to $1.24 on a non-GAAP basis, excluding stock based compensation expense and intangible amortization expense, we expect non-GAAP earnings per diluted share will be in the range for $1.30 to $1.36. The guidance for the second fiscal quarter includes an income tax provision expected to be in the range of 14% to 18%. The number of shares used in computing earnings per diluted share was $23 million. Capital expenditures for second fiscal quarter are expected to be the range of $14 million to $16 million. Finally, a quick note on tax reform. We’re still evaluating its impact but we do not believe it will have a significant impact through FY18 tax rate. As further clarity around this legislation develops, we will provide appropriate updates. Please refer to the non-GAAP financial information section, and the reconciliation of non-GAAP financial measures to GAAP results, and the reconciliation of GAAP net income loss adjusted EBITDA tables in earnings press release for the details. That concludes my remarks. Operator, we’re now ready for questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Sidney Ho with Deutsche Bank. Your line is now open. Please go ahead.

[Sidney Ho:]

Given the tight supply demand, how do you monitor the level of double ordering that you may have received? And on the flip side, do you see any of your segments that suggest supply could be easing but that, I mean DRAM versus NAND in Brazil versus numbers by end markets?

[Iain MacKenzie:]

Yes, Sydney, we’re seeing no evidence of inventory building type, our own inventory was particularly right at the end of that quarter, seeing that nothing in our customers that suggest a build at all.

[Jack Pacheco:]

No, customers are still screening for parts. I mean you saw inventory numbers are low, so we’re shipping as fast so we can build the parts for the customer base. So there is no evidence of double ordering at all from them.

[Iain MacKenzie:]

And then supply, we have a particular dynamic. So DRAM continues to be tight and has a small single digit price increase into this quarter, so that continues. And basically in NAND, we’ve new book to trend a little bit Sidney, because most of the press you’re hearing is on 3D NAND and [invite], we don’t plan in the first six months of this calendar year to really use any 3D NAND although versus planar if we titrate the capacities and the supply is reducing. So I think we would see a slightly different dynamic from the headwind.

[Sidney Ho:]

Well, with regards to your guidance for next quarter. Do you think the midpoint is plus 9% quarter-over-quarter? And that’s a lot better than what typically the February quarter would be. How should we -- I think part of that has to deal with maybe not as much shutdown, the factory shutdown that you used to do. How should we think about your growth in the may quarter relative to little more seasonality?

[Iain MacKenzie:]

Yes, let me clarify. So not only the May quarter would be the step up, that would be the first step up, again, year and year into calendar year, local content that requirements in Brazil. So it would be the step up. And actually what has happened here from last quarters’ $0.79 is, we’ve pulled in December it was particularly, particularly busy. So we’re shipping over to the Kansas, people try and maximize the vocal content requirements for 2017. And then immediately in January, we were saying to people, because we have capacity restricted and supply restricted, you need to be more linear with your demand. So we’re starting out January at full strength. And actually and that’s quite this time, we’re seeing the step up having majoritively happened in this Q2, and then it will continue with that as we go forward. So that’s why you're seeing the strength in the numbers.

[Sidney Ho:]

If I can squeeze in one more, your guidance suggest your gross margins slightly higher than your target range of 20% to 23%, I think in the midpoint. But your operating margin is already at the high end. Do you think you'll continue to run 200-300 basis points above your operating margin target? Or will OpEx normalize sometime in the future?

[Iain MacKenzie:]

I think for the near term even that on -- we will continue to get leverage in the model but I don't see any reason why our OpEx should increase, and knock operating margins down. So I think operating margins should stay high.

[Operator:]

Our next question comes from the line of Blayne Curtis with Barclays. Your line is now open.

[Blayne Curtis:]

I was wondering maybe you guys if you could just walk us through from the preannouncements to now obviously the current quarter, was higher and then obviously you thought flat and then are seeing growth. Maybe just from a very high level if you walk through or you just been conservative at the time or have things continue to improve?

[Iain MacKenzie:]

I mean, clearly, we preannounced, yes and believe we'd still have some room. However, the walk through really is density, density moves forward in the quarter by much more. We were planning and looking at 20% year-over-year, I remember saying that we had a last year of $19.80 and then we were looking towards $24. But I think we're almost there at $24 in this quarter so that continues -- then that would be the surprise. So we have some units and certainly a strong mix, so I would say, its mix and ASP. But now in Q2 we’ll step up the number of units to supply to the market to meet the next step and local content requirements.

[Jack Pacheco:]

And also we saw really strong shipments from specialty the last week of the quarter. So in the earlier question of the double ordering, I mean the customers are pulling parts very strongly, which means it shows that they're not double ordering. So the strength of specialty also help contribute to this the over performance first of the guidance that we had preannounced.

[Blayne Curtis:]

And then maybe just following up on that, you had a specific issue in specialty, it came back quite strong in the November and maybe just overall your perspective in the February between the two segments, Brazil and Specialty and then maybe just little color as to what drove the strength in Specialty?

[Iain MacKenzie:]

Yes, I mean specialty, we said that Q4 was a down quarter in Specialty. We thought that we can bring back and it came running back here in Q1, and it was really due to the strength and the server storage markets are very strong for us in Q1, and we expect to see continue that strength in the Q2 for Specialty as well. So that helped drive the growth in the Specialty really came out of that server storage area. And, yes, we think we'll see continue to see that demand -- we've been talking about the all-flash arrays and so we're seeing good demand from the people in the all-flash array area and good overall demand from server and storage customers, and so compute is doing very well for us.

[Operator:]

Our next question comes from the line of Kevin Cassidy with Stifel. Your line is now open.

[Kevin Cassidy:]

Iain, you mentioned that you already have the $24 of content in the smartphone. Is that -- will that be constant then through 2018 and we have to wait for next generation of smartphones be designed? Or what we look at for going forward?

[Iain MacKenzie:]

It doesn’t appear that way, Kevin. What appears is that since it would really a fixed cost per bit in the NAND space then we'll say this is continuing to grow and the step function, especially NAND from 16 gigabytes to 32 is such a big jump that has taken as opposed to be in the old last couple of years 8 gigs to 16 gigs. So 16 to 32 is standard static cost per bit so I would think we're still going see through 2018 a further growth of the expected 20%. This really has been a very strong point, and we're going to start to ship more units.

[Kevin Cassidy:]

And these are all planars. Is there any concern for supply of planar as the manufactures are moving towards 3D, moving more of their output to 3D?

[Iain MacKenzie:]

Yes, I think so. However, for 2018, we have contracted our volume and fully proven over the years, but this relationship is that when we contractor our volumes then that’s what comes. As the market releases slightly then we can get more than we can always do more. So I am not too worried about getting our plant base enhanced meeting and beating our overall numbers. But I think the overall situation is that we're really doing someone to create a substitute gigabyte 3D NAND product, so that we can use that and begin to infuse that into the compute side, the processing side of smartphones.

[Operator:]

Our next question comes from the line of Suji Desilva with Roth Capital. Your line is now open.

[Suji Desilva:]

In the quarter here that we had somewhat Specialty than we had in Brazil mobile grow by the similar pace, looking at February. What do you think -- are they both going to be as strong or is one going to be favorite there? Thanks.

[Iain MacKenzie:]

So we’re seeing growth in both but clearly Specialty is back to -- it recovered back to its high-single-digit growth. But here because of the density growth on top of a unit growth then Brazil is going to grow more. So I think even now we’re reporting 60%, 40% Brazil to Specialty. And hence Suji that’s why we had the discussion about should we look to add something on the Specialty side as a company to maintain some more of that balance.

[Suji Desilva:]

So double positive lining for Brazil there. And then on the Specialty Memory, is very strong growth here, I’m wondering how the NVDIMM part of the business is doing. I think you gave an 18 expectation of $20 million there. Or is that something you want to revise at this point? Or is that tracking the prior expectations?

[Jack Pacheco:]

Doing very right now, probably, we're on our way to that path. I don't want to give too much of an annual indication. But yes, what’s of qualifications and what’s of in place and competitive landscape is not changing, so it doesn’t look like this is ever going to go mainstream. So, yes, it look solid.

[Suji Desilva:]

And then real quick on the Brazil PC market, the DRAM strength there, the pricing is obviously a factor. What’s going on in the underlying units in PC and then the demand just to understand dynamic there?

[Jack Pacheco:]

Yes, that’s what we mentioned. We have an overall growth in unit demand by the market getting better itself, the economy getting better. So we’ve seen forecast increase by as much as 10% of the units going up. So every quarter as the research companies are increasing their forecast for annual units.

[Jack Pacheco:]

In fact in the quarter, Suji, our ASP in the PC DRAM side is flat to down, and so all our growth really came from units. There wasn’t any growth from an ASP on the DRAM side.

[Operator:]

[Operator Instructions] Our next question comes from the line of Robert Mertens with Needham & Company. Your line is now open.

[Robert Mertens:]

Just as a follow-up for the Specialty Memory business. You spoke towards strengthening the telecom and networking markets. Could you just elaborate what you're seeing there and any products that are growing in that business? And as a follow-up, do you break Specialty Memory down by all that are in markets? Thanks.

[Jack Pacheco:]

We don’t break them out separately. But I mean it’s -- you have to think it, right. I mean, Specialty -- if you’re thinking about the non-Brazil piece of the business, being 40% of the business and Specialty was -- telecoms it was roughly about 18% of the whole business then you can come to what it is in Specialty.

[Iain MacKenzie:]

Yes, we don’t do too much network and telecom in Brazil.

[Jack Pacheco:]

Yes, I mean most of our facilities -- all of that is -- all with networking and telecom, you’re seeing that all of that is Specialty, a little bit, most of the server storage, as well as all Specialty. But I mean the strength network and telecom is great in the quarter, strength across most of the customer base. I mean just we sell thousands of products into that space. And so we’ve got products in most of the major players in network and telecom and so for us, they continue to do well. Our products are continuing to get qualified and so we're growing that business.

[Robert Mertens:]

And if I can just squeeze another question in, Brazilian DRAM, it looks like the quarterly growth stepped down a little bit compared to fourth quarter 2017, which I know came in better than expected due to some of the smart TV revenue and strong unit sales growth. How should we think about that business, going forward? Obviously you mentioned that ASPs are flat to down this quarter. Should we expect this to climb throughout the year or are you estimating those to be flat and a big driver being unit growth and just overall recovery in the…

[Jack Pacheco:]

Yes, we think units will continue to grow. So I think it’s a flattish business if units grow at whatever ASPs decline go down, would be taken up by the unit growth. So when we look at that business, we’ve always said that this is just kind of a flat business this year for us.

[Iain MacKenzie:]

Plus you do have a little bit of mix of what goes into the PC with these prices and in Brazil that can have an impact on a quarter-over-quarter basis. So I think this is just the natural variance.

[Operator:]

And I am not showing any further questions in queue, at this time. I would like to turn the call back to Mr. MacKenzie for any closing remarks.

[Iain MacKenzie:]

Thanks, Liz. So we're certainly off to a very strong start in 2018. It’s a strong foundation and we’re stepping up from here, improving business conditions in Brazil, overall memory market combined with our unique competitive position and our constant execution is serving us well. So we’re looking forward to a great year ahead of us and I finish by wishing all very happy holiday season, hope you get a break with family and friends. And we will talk to you in the New Year. Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone, have a great day.