SMART Global Holdings, Inc.
Q2 2018 Earnings Call Transcript

Published: 23 Mar 2018

[Operator:]

Good day, ladies and gentlemen and thank you for your patience. You have joined the Q2 Fiscal 2018 SMART Global Holdings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct the question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference maybe recorded. I would now like to turn the call over to your host, Ms. Suzanne Schmidt, Investor Relations. Ma’am, you may begin.

[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 2018 results. Iain MacKenzie, President and Co-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 and then we will hear a few words from the company’s recently announced successor CEO, Ajay Shah. 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 website at www.smartgh.com. We encourage you to go to our website 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 the 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. Reconciliations for those directly comparable GAAP financial measures are included in today’s earnings press release. And now, I would like to turn the call over to Iain MacKenzie.

[Iain MacKenzie:]

Thank you, Suzanne and welcome to everyone to this call. We are very pleased to report another quarter of excellent financial results with net sales of $314 million and non-GAAP diluted earnings per share of $1.73. We continue to benefit from three main growth drivers, ongoing strength in global memory market, favorable dynamics in Brazil, and strong demand for SMART’s Specialty Memory solutions. We are in an exciting period for our company as we surpassed $1 billion of net sales on a trailing 12-month basis and continued to execute on our growth strategy. Our unique competitive position in Brazil as the only scale provider of mobile memory products in country, our 30-year track record of providing specialized flash and DRAM-based solutions to OEMs outside of Brazil and our capital efficient business model to offer significant operating leverage all position us for continued success. Additionally, the announcement of Ajay Shah coming on board as President and CEO ensures an experienced and orderly transition. Now, a few comments on the overall memory market, we continue to see favorable supply/demand dynamic with robust demand drivers coupled with orderly supply expansion. Consumption of DRAM and flash continues to increase as OEMs find more end-user applications for these products. In particular, cloud and data center demand across the compute, storage and networking end markets as well as smart phones are driving higher than average DRAM and NAND bit demand. This is leading industry expert to comment that the memory industry is evolving into a less cyclical industry as we accelerate the move to a more data intensive economy. Turning to SMART Brazil, in the second fiscal quarter, Brazil mobile memory performed exceptionally well with net sales rising 33% driven by rising unit shipments, increasing average memory densities and favorable ASP trends. I would like to remind you that SMART uses 2D NAND in Brazil mobile memory. And 2D NAND ASPs have remained relatively stable due to the limited capacity as the memory industry is ramping 3D NAND production. Additionally, the benefits from local manufacturing increased as of January 1. Beyond mobile memory in Brazil, we are also seeing raising forecast for PC shipments benefiting our DRAM business in Brazil which rose 50% in the quarter. Looking ahead, we continued to evaluate new end markets beyond mobile memory and DRAM such as wireless communication modules. We have proven our ability to execute in Brazil having been in this market for 15 years and believe there is substantial potential for growth ahead of us as related to our established position or in-country manufacturing know-how and the benefits of having local manufacturing. Turning to the specialty memory business, we had another strong quarter with net sales coming in once again over the $100 million in total. Looking ahead, we remain positive about our prospects for growth fueled by several dynamics in the specialty memory business. First, technology transitions tend to benefit us and with the transition underway from DDR3 to DDR4, we have a meaningful proportion of our customer base that still requires specialized solutions using DDR3 and even DDR2 memory. Second, newer non-volatile NVDIMM solutions are being introduced and the growing trend towards the use of all-flash arrays within servers leads to increased demand for our flash and DRAM products. As a management team we have been in the memory business for a very long time and we understand it well. We have established track record of delivering innovative solutions in flash and DRAM over long design end periods, but a very long product life cycle gives us confidence in our ability to drive sustainable unpredictable growth in this part of business going forward. I will hand you over to Jack to discuss the financials in more detail.

[Jack Pacheco:]

Great. Thank you, Iain. As Iain mentioned top line strength in the quarter was primarily driven by our results in Brazil along the robust global memory market. The Brazilian economy is improving every quarter which is helping to drive our end unit demand. In addition, we saw yields in our Brazil memory business continued to improve. Overall, gross revenue for the second fiscal quarter was $542.2 million while net sales were $314 million. As a reminder the difference in gross revenue and net sales is related to our supply chain services business which accounted for an agency basis meaning that we only recognized as net sales, net profit on the supply chain services transactions. Net sales increased 18.3% over the previous quarter as unit sales increased and average selling prices remained favorable. Second quarter fiscal 2018 net sales were broken down by geography as follows; Brazil 67%, Asia 17%, U.S. 12%, other Americas 2% and Europe 2%. Our breakdown of net sales by end market for the second fiscal quarter was as follows; mobile and PCs 57%, network and telecom 17%, servers and storage 17%, industrial aerospace defense and other 9%. Moving to the rest of the income statement, non-GAAP gross profit for the second quarter was $73.2 million, up 26.2% as compared with last quarter’s $58.1 million. Non-GAAP operating expenses increased 5.6% quarter-over-quarter to $24.7 million as our R&D expenses increased from the prior quarter as we drive spend to meet our Brazilian R&D requirements. Remember, we need to spend 3% to 4% of our revenues in Brazil on R&D to insure our PPP and PADIS tax benefits. Non-GAAP net income for the second fiscal quarter was $39.9 million or $1.73 per diluted share compared to $23.8 million or $1.05 per diluted share in the prior quarter. Included in these results for the second fiscal quarter are FX related gains that contributed approximately $2.4 million or 0.10 or $0.10 per share compared to last quarter’s FX related loss of $2.7 million or $0.12 per share. Adjusted EBITDA increased 52.2% to $56.2 million in the second fiscal quarter compared to $36.9 million in the prior quarter. Turning to working capital, our net accounts receivables declined to $223.5 million from $236.2 million last quarter as our day sales outstanding decreased to 37.5 days for this quarter compared with 43.5 days last quarter. Inventory increased to $148.6 million from $120.2 million in the prior quarter, while our inventory turns were 12.6x compared with last quarter’s 13.6x. The increase in inventory is due to the support of our increased sales activity. Consistent with past practice, accounts receivable and inventory turnover are calculated on a gross sales and cost of goods sold basis, which are $542 million and $469.2 million respectively for our second fiscal quarter of 2018. Cash and cash equivalents totaled $51.8 million at the end of the second fiscal quarter. Second quarter cash flow from operations was $34.8 million compared with $14.3 million in the prior quarter. Now, let me turn to our guidance, we currently estimate that our third quarter fiscal 2018 net sales will be in the range of $320 million to $340 million and gross margin for the quarter will be approximately 21% to 23%. GAAP earnings per diluted share is expected be between $1.61 to $1.69. 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 of $1.74 to $1.82. The guidance for the third quarter does not include any view on foreign exchange gains or losses and includes an income tax revision expected to be in the range of 14% to 18%. The number of shares used in computing earnings per diluted share for the third fiscal quarter was 23.2. Capital expenditures for the third fiscal quarter are expected to be in the range of $10 million to $15 million. On December 22, 2017, new U.S. federal tax legislation commonly known as the Tax Act and Jobs Act was signed into law. Certain key changes introduced by the tax acts that would impact the company in the current fiscal year include the reduction of the U.S. federal corporate tax rate from 35% to 21%, acceleration of expensing of certain business assets and the elimination of the alternative minimum tax system for corporations. We do not expect a material impact to the company’s quarterly and annual consolidated financial statements because of these changes. Please refer to the non-GAAP financial information section and reconciliation of non-GAAP financial measures to GAAP results and reconciliation of GAAP net income loss to adjusted EBITDA tables on our earnings press release for further details. That concludes my remarks. I will now turn the call over to our new incoming CEO, Ajay Shah for some additional comments.

[Ajay Shah:]

Thank you, Jack and thank you Iain. As is evident from these results, you both and the rest of the team here at SMART have done an outstanding job at driving tremendous achievements. SMART is truly a world class organization. So looking ahead, I am excited about the opportunity at SMART to further leverage on the strong execution capability that we have demonstrated so well to target additional lines of business and achieve growth and to diversify our business over time. I will be transitioning into the role fully over the next few months and look forward to speaking with all of you in the future. Operator, we are ready to take questions. Thank you.

[Operator:]

Yes, sir. [Operator Instructions] Our first question comes from the line of Blayne Curtis of Barclays. Your line is open.

[Blayne Curtis:]

Hey, guys. Thanks for taking my question and nice results. So, maybe just from a high-level you just talked about the guidance for May, is there any difference between segments? And then if you could just talk about you mentioned the diversification efforts obviously with the strength you have seen in Brazil that’s proving quite difficult, just kind of thoughts about organic versus inorganic diversification?

[Jack Pacheco:]

So, the Q3 guidance by segment, I mean, I think we are continuing to see growth, Brazil continuing to grow. Our specialty business, I think you will see some – this has been growing, but Brazil will continue to outgrow the specialty business as we go into Q3.

[Iain MacKenzie:]

On the diversification front, Blayne then as we have said we have been working diligently in this area. It takes a while to get that started and get up to speed, but yes, we do plan to make inorganic efforts to keep the company nicely balanced.

[Blayne Curtis:]

Okay, thanks. And then maybe just one follow-up, in Brazil it’s been a big content story, I was wondering you just talked about the strength you saw in February unit versus content?

[Iain MacKenzie:]

Yes, Blayne, I think in the last conference call we had mentioned that at the end of last year, the end of 2017 calendar, we had an increase in units as people tried to finish up the year and get to the local content and that continued into the start of this year. So units in particular and then been of course local content weren’t changing increased units by almost 20% in January alone from January 1. So in this case we had over 10% increase in ASP because of the density increase of over 10% also in the fixed price per bit. And then we saw more sales going to the higher end forms, so with the higher density selling through and then clearly with the units were strong as people finished off the year, so really in all the three there and hence the result.

[Blayne Curtis:]

Great. Thanks guys.

[Operator:]

Thank you. Our next question comes from Rajvindra Gill of Needham & Company. Your question please.

[Rajvindra Gill:]

Yes. Thank you and congratulations on great results, great visibility into the business. I am wondering Iain and Ajay if you could maybe talk a little about what are the ASPs that you are seeing right now kind of on the dollars side, what’s the dollar amount and how do you see them increasing throughout the year and going into calendar ‘19?

[Iain MacKenzie:]

So, on the last call we had mentioned that we are in the 20-23 range and certainly by the end of calendar year we were headed towards 30. So I think that’s there, so at just over 10% in this quarter in ASP growth. It’s – we just introduced the substitute gigabyte of flash and 24 gigabit of LPDRAM in the same package. So clearly the average density is growing now to although just over 1.5 of LP and these 16 gigabytes of flash. So I am getting only if there, I think there is a pretty smooth curve to or smooth line to the end of the year.

[Rajvindra Gill:]

On the specialty memory side, it was down a little bit sequentially, better than seasonality, but can you talk a little bit about the drivers of that business this year versus say last year?

[Iain MacKenzie:]

Yes. Nothing really there I mean we have strong, very strong first half, so I mean the fact that – or clearer quarter end. And in fact we are still constrained by supply and especially the timing of supply, so when we will get our parts for the month, but if they come in on the 20th of the month and then it’s tough to catch up. So just I really think that they gives us over $210 million for first half. And so we are seeing that is particularly strong.

[Rajvindra Gill:]

Alright. Thank you and congratulations.

[Iain MacKenzie:]

Thanks Raj.

[Operator:]

Thank you. Our next question comes from the line of Kevin Cassidy of Stifel. Your line is open.

[Kevin Cassidy:]

Thanks for taking my question and congratulations on the great results. On the specialty memory, maybe can you help us get a better understanding of your design win pipeline, how many I guess how much of your revenue was from designs that were say 2 years old versus your more than 5 years old, I think you have said in the past that the specialty memory has a very long design cycles or production cycles, can you just let us understand how that pipeline is filling up and can we expect growth for the next many years?

[Jack Pacheco:]

Sure Kevin. I mean we don’t track as much by our current design wins versus past design wins from revenue, because we ship from different products in the specialty, but we continued to get wins, we continued to increase products into our customer base, so we would expect special just to continue to grow over time as we continue to get these wins. I mean we have – the weather in the last six months was nice growth over the last six month of fiscal year ‘17, so we are seeing great growth in the specialty business and there is no reason that with our pipeline we want to continue to see grow in that business.

[Kevin Cassidy:]

Okay. Maybe turning over to the wireless communication modules that you have mentioned, when do you think they will be qualified for shipments on those and maybe can you give us an idea what the average selling price would be for those?

[Iain MacKenzie:]

Well, I think we mentioned before average selling price is $5, be careful of this year remember the initiative is to have a miniaturized wafer-based solution in our FY ‘20 so – and be careful about getting carried away with this one. We have qualified, Kevin, at 3, I believe customers with the current module, but really this is just for us a means to an end for us to show capability, develop the design skills, develop the test skills and then get the license agreements, which I am happy to say that it’s slightly ahead of where we expected to be by this time. So, going well in all ready sales, but I don’t know the sales number will probably be less than $5 million at the moment.

[Kevin Cassidy:]

Okay, great. Thank you.

[Iain MacKenzie:]

Thanks, Kevin.

[Operator:]

Thank you. Our next question comes from the line of Sidney Ho of Deutsche Bank. Your line is open.

[Sidney Ho:]

Thanks for taking my question and congratulations on strong results and welcome, Ajay. My question is on the mobile DRAM side, can you update us the roadmap and timeline for using 3D NAND and eMCPs and how should we think about the impact on pricing and content going ahead when you start making that transition?

[Iain MacKenzie:]

Right. So as you well know, we have been asking and have noticed in new orders, very timely that you ask the question, because our supplier has just put a 32 gigabyte 3D NAND on the roadmap. Before this, there was never a 256 gigabit component in 3D. So that is planned to qualify in the third quarter of this calendar year. So, we have got a long time to go. The 2D NAND capacity reportedly as we see it is down by 50%, so that’s going to bring stability there. Once we transitioned, it looks like the continual growth of what we are hearing and perhaps you heard Micron say going towards 6 gigabytes in the high-end phone, then we are currently reporting 1.6 gigabytes average. So I think we like that point slightly. So, I think we have a long way to go. So density growth, we expect to outpace any price reduction, but the LPDRAM continues also with no price reduction, so overall the ASP of our eMCP we forecast to grow.

[Sidney Ho:]

That’s helpful. And then the next question I have is in terms of feasibility, Jack I know like 6 months ago you have suggested DRAM pricing is likely to go up for through the first half of this year, which looks like you are right on track. How would you characterize your feasibility today, is it better worse and how do you see pricing going forward in the next call it next two to three quarters?

[Jack Pacheco:]

I mean, I think our visibility on pricing is the same as it was about 6 months ago. I mean, we have our forecast and we are talking with the semiconductor companies out kind of trying to see where it’s coming from, but I think our view today on DRAM pricing is it’s probably going to be maybe flat maybe goes up a little bit, but we are not seeing any sharp declines or increases on pricing I think over the next couple of quarters.

[Sidney Ho:]

Okay. Maybe I can squeeze in one more question on the Specialty Memory side, I think last quarter you suggested server and storage were strong, I guess maybe quarter-over-quarter may not be the right way to think about it, how should we think about the different segments which one is stronger than others?

[Jack Pacheco:]

By far the networking, telecom is our strongest segment in specialty right. I mean, we have talked about that, the largest segment in specialty. We talked about the server storage segment being the growing portion of specialty right. So, I think in the quarter we had a very good performance from the both sectors I mean revenue for the first 6 – if you look at the 6 months of this year versus 6 months of last year, we are up almost 14% on revenue right, which shows very strong growth if you look at it 6 month by 6 month is kind of what we talked about last – in Q4 was to kind of look at specialty and kind of these 6-month buckets. So, I think specialty I guess this telecom networking had very strong quarter. Servers, storage had a good quarter, but as Iain mentioned earlier, we are a little supply constrained and it might have impacted some of the revenues in the storage and server segment.

[Sidney Ho:]

Okay, thank you very much.

[Iain MacKenzie:]

Thanks.

[Operator:]

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

[Suji Desilva:]

Hi, Iain, hi Jack, hi Ajay, congratulations on the strong results here. In the prepared remarks, I believe you mentioned Brazil smartphone you saw a mix shift to the high-end, was that a temporal effect there or any color there, do you expect that to continue or was it one-time?

[Iain MacKenzie:]

Yes. So as we said we are kind of – the good news is that the same wafers go into all of the end products. So, it’s a different mix of structure, so you don’t have an inventory issue. And we really just respond to what gets pulled through. Last quarter, we had said it was very well balanced third to third and a third between high, middle and low with this thing and as you fight most of the growth will be the mid and low stayed the same maybe almost 60% growth came into the high end. I think that is over seeing the thing that’s find the ASPs continued to surprise us a little bit because that density in the higher end is what brings the performance.

[Suji Desilva:]

Okay, that’s helpful color there. And then just in seasonality for specialty memory is there any notable seasonality there as we go into the second half of the fiscal year into August?

[Iain MacKenzie:]

No there is nothing until last Christmas time or December time, so the issue goes.

[Suji Desilva:]

Okay. And then last question on NVDIMM and as an early segment here, but is that tracking to your expectations or perhaps tracking ahead? Thanks.

[Iain MacKenzie:]

Yes. Perfectly on track, we had said the calendar year will be about $20 million and we are getting good news that we will have DDR3 design wins, we got DDR4 design wins and now we are on the table. As we have mentioned it takes a long time to design and to make sure that these are robust solutions for our customers, but yes definitely see more adoption.

[Suji Desilva:]

Great. Nice job on the quarter guys.

[Iain MacKenzie:]

Thanks, Suji.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Robert Mertens of Needham & Company, your line is open. Mr. Mertens your line is open, please make sure your line is un-muted. [Operator Instructions] And gentlemen it appears there to be no further questions, I would like to turn the call back over to Iain MacKenzie for any closing remarks.

[Iain MacKenzie:]

Thanks. Our business conditions continue in our favor and we will work hard to provide our customers with these differentiated solutions that are required. Our business model also continues to improve and we look forward to the next chapter of the company’s evolution and to reporting our progress in the next quarter. So thank you all for joining us today.

[Operator:]

Ladies and gentlemen, that does conclude your program. Thank you for your participation. Have a wonderful day.