SMART Global Holdings, Inc. (NASDAQ:SGH) Q1 2023 Earnings Call Transcript

SMART Global Holdings, Inc. (NASDAQ:SGH) Q1 2023 Earnings Call Transcript January 3, 2023

Operator: Good afternoon. Thank you for attending the SGH First Quarter Fiscal 2023 Earnings Call. My name is Matt, and I’ll be your moderator for today’s call. All lines will be muted during the presentation portion of the call, with an opportunity for questions-and-answers at the end. I would now like to pass the conference over to our host, Suzanne Schmidt. Suzanne, please go ahead.

Suzanne Schmidt: Thank you, operator. Good afternoon, and thank you for joining us on today’s earnings conference call and webcast to discuss SGH’s first quarter fiscal 2023 results. On the call today are Mark Adams, Chief Executive Officer; Jack Pacheco, Chief Operating Officer; and Ken Rizvi, Chief Financial Officer. You can find the accompanying slide presentation and press release for this call on the Investor Relations section of our website. We encourage you to go to the site throughout the quarter for the most current information on the Company. I would also like to remind everybody to read the use of forward-looking statements note that is included in the press release and the earnings call presentation. Please note that certain of the statements made today may constitute forward-looking statements and that these statements are the Company’s present expectations and that actual events or results may differ materially.

We will also discuss both, GAAP and non-GAAP financial measures. Non-GAAP measures should not be considered in isolation from, as a substitute for or superior to our GAAP results. We encourage you to consider all measures when analyzing our performance. A reconciliation of the GAAP to non-GAAP measures is included in today’s press release. And with that, let me turn the call over to Mark Adams, CEO. Mark?

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Mark Adams: Thanks, Suzanne, and thank you all for joining us today. I hope you all had a nice holiday. Over the past two-plus years, we have been on a journey to transform SGH from a memory module company into a more diversified set of specialty businesses, spanning compute, LED lighting and memory. While each line of business is unique, SGH benefits from what they all have in common. First, they all developed advanced technology solutions at the system or subsystem level in order to address specific customer requirements. And second, they are all built on SGH’s core competencies in engineering, design and world-class manufacturing. SGH’s diversified business model has driven higher quality revenue with more attractive gross margins.

Our diversity has helped us perform steadily in a challenging macroeconomic environment. For example, in our Q1 earnings, our enterprise-related businesses were able to offset declines in our more consumer-facing businesses. In the first quarter of our fiscal 2023, revenues totaled $465 million, which exceeded the midpoint of our guidance range. We also achieved record non-GAAP gross margins of 27.8% and non-GAAP earnings per share of $0.79, both of which came in above the high end of our guidance range. I also want to highlight that with the integration of Stratus Technologies into Intelligent Platform Solutions, or IPS, the services portion of our Q1 business now represents approximately 16% of overall SGH revenues and 32% of IPS revenues, a record achievement and a clear demonstration of the increasing value we are providing our customers.

Now, let me turn to a brief review of each of our businesses, starting with IPS. Our IPS group designs and delivers complete hardware, software and services for high-performance computing or HPC and artificial intelligence or AI applications from the data center to the cloud and at the edge. In Q1, IPS brands Penguin Computing and Stratus Technologies performed well. And IPS revenue came in at a record $211 million for the first quarter, up 46% sequentially and up 78% compared to our Q1 fiscal €˜22. IPS represented 45% of total SGH revenue, the largest component of our business in Q1. As we’ve indicated on previous calls, we see the IPS business stronger in the first half of fiscal 2023, driven by large customer hardware installations. In particular, heading into our second fiscal quarter ending in February, we are seeing strong continued demand, driven primarily by installations at some of our hyperscale and federal customers.

As you have been hearing from other technology companies of late though, overall visibility for demand out into calendar 2023 remains uncertain. In November, Penguin Solutions participated in the Supercompute 2022 show, the Annual International Supercomputing Conference, where we demonstrated our strength in HPC and AI-enabled solutions. We made several key announcements, including the launch of Penguin’s new Scyld Cloud Central control plane, which provides management and orchestration across an organization’s on-premise and cloud-based resources to create flexible hybrid HPC and AI environments; a partnership with Google Cloud that gives our customers more choices for rapid cluster deployments with Penguin services; a pay-as-you-go model; and point-and-click integration with dozens of common HPC and AI applications, tools and libraries; and the acquisition of Colorado Code Craft, a small private company specializing in safeguarded remote work and collaboration software solutions.

The addition of Colorado Code Craft solutions is expected to enhance Penguin’s virtual desktop infrastructure or VDI capabilities and expand our IP portfolio. The integration of Stratus Technologies into IPS remains on track. With the addition of Stratus, IPS has a comprehensive portfolio of edge HPC AI and cloud solutions and services to meet the end-to-end needs of an even broader customer base. Penguin and Stratus are now actively working together to identify new business opportunities and revenue synergies. In addition, one of our top priorities is to increase our recurring services businesses as a larger component of the solutions we offer our customers. Now, turning to our LED Solutions Group, which produces application-optimized LEDs for products like specialty lighting, video screens, gaming displays, outdoor and architectural lighting.

Cree LED faced continued headwinds in China with COVID-related policies contributing to supply chain constraints and impacting demand for the entire industry. In addition to continuing softening in China, we are also seeing demand weakness in the U.S. and in Europe. For the first quarter of fiscal 2023, LED Solutions revenues totaled $63 million. In Q2, we expect revenue to be lower, driven by declining demand and further channel inventory reductions. Given this challenging macroeconomic environment for the LED business, we have been proactively containing costs and adjusting our ongoing operating expenses accordingly. While optimizing our business for the current environment, we continue to invest in developing innovative technologies for Cree LED’s key target markets of specialty high-value applications, including entertainment and horticulture, premium video applications such as fine pitch outdoor lighting designs and high-performance general lighting applications such as architectural and street lighting.

During the first quarter, the team launched spectrum-optimized photo-fill LEDs across high- and mid-power platforms for horticultural applications and introduced a new XLamp CMB product family with higher power, higher performance COB or chip onboard devices. Cree LED remains a technology and brand leader with strong intellectual property, and we remain confident in the long-term operating performance of the LED business, once macroeconomic headwinds recede. In our Memory Solutions Group, revenue came in at $192 million or 41% of total SGH sales. As expected, sales declined from Q4 of fiscal €˜22 levels, primarily due to a reduction in the worldwide memory pricing and softening demand. Our core specialty memory business, which is focused on enterprise end markets, remains relatively stable.

Demand remains solid in the Networking and Telecom segments. On the technology front, we continue to see growing interest in SMART’s new family of DuraFlash PCIe NVMe and SATA products across various form factors. Longer term, we remain focused on expanding our memory business into enterprise compute applications to meet the growing demand within the data center and in the cloud for AI and machine learning capabilities. Customer interest in our Compute Express Link or CXL products continues to grow as we have multiple designs underway in order to support memory expansion and acceleration for data center and cloud service provider applications. We also expanded our DDR5 module lineup for blade storage and computing applications and recently introduced a new family of data center SSDs for hyperscaler, hyper-converged, enterprise and edge computing data center applications.

The global weakness in PCs and mobile phones impacted our business in Brazil. Looking into Q2, we expect further softening, which is historically also a seasonally lower demand quarter. As one of the largest memory companies in Brazil, we continue to invest for the long term. Our Manaus factory has completed a number of key product certifications, and we see ongoing demand in Brazil for locally-produced SSDs with customers preparing to move to the latest Gen 4 products in calendar year 2023. We are also seeing initial shipments of memory for 5G mobile phones with the expectation of increasing market adoption in calendar year 2023. I’ll stop here and hand it over to Ken for a more detailed review of our Q1 financial performance and our guidance for next quarter.

Ken?

Ken Rizvi: Thanks, Mark. I will focus my remarks on our non-GAAP results, which are reconciled to GAAP in our earnings release tables. Now, let me turn to our first quarter fiscal €˜23 results. Despite the macroeconomic headwinds, we reported a strong quarter in fiscal Q1 helped by the diversification of our business, strong execution and the strength of our IPS segment, which includes our recent acquisition of Stratus. Net sales were $465 million. And non-GAAP gross margin came in at a record 27.8%, above the high end of our guidance. Non-GAAP diluted earnings per share were $0.79 for the first quarter, also above the high end of our guidance. In addition, beginning in the first quarter of 2023, we will be disclosing our overall SGH revenue and cost of sales by product and services.

Our services revenue includes longer term services as well as point-in-time services such as logistics and implementation services. With the addition of Stratus in the first quarter of 2023 our overall service revenues reached $75 million, up from the $33 million in the year ago quarter. First quarter revenue by product and services were as follows. Product revenues were $390 million, and service revenues were $75 million. First quarter revenue by business unit was as follows. IPS had a record $211 million; LED, $63 million; and memory, $192 million. This translates into a sales mix of approximately 45% IPS, 13% LED and 41% memory. Non-GAAP gross margin for SGH in the first quarter of 2023 was a record 27.8%, up from 27% in the year-ago quarter, helped by the inclusion of Stratus within IPS but offset by lower sales from LED.

Non-GAAP operating expenses for the first quarter were $74.4 million, up from $61.1 million in the fourth quarter of 2022 and from $57.9 million in the year ago quarter. Operating expenses were up primarily due to the inclusion of Stratus, which accounted for $18.7 million of our operating expenses in the first quarter Operating expenses also benefited in the first quarter of 2023 from $2.6 million in financial credits in Brazil, which was up from $2 million in the fourth quarter of fiscal €˜22 but down from $5.9 million in the year-ago quarter. This credit is expected to provide approximately $1 million to $2 million of benefit in our second quarter of fiscal 2023. Non-GAAP diluted earnings per share for the first quarter of 2023 was $0.79 per share compared with $1.08 per share in the year ago quarter.

Adjusted EBITDA for the first quarter of 2023 was $63 million or 14% of sales compared to $77 million or 16% of sales in the year-ago quarter. And now, turning to working capital. Our net accounts receivables totaled $306 million compared with $410 million last quarter. Days sales outstanding came in at 33 days, down from 14 days (sic) last quarter, primarily due to the timing of collections for IPS. Inventory totaled $416 million at the end of the first quarter, up from $323 million at the end of the prior quarter. This increase outlined during our last earnings call was driven primarily by inventory required to support our IPS revenue in the second quarter. We would expect inventory to come down significantly by the end of the second quarter.

Inventory turns were 7 times in the first quarter versus 8.5 times in the prior quarter. And consistent with past practice, net accounts receivables days outstanding and inventory turnover are calculated on a gross sales and cost of goods sold basis, which were $843 million and $725 million, respectively, for the first quarter. And as a reminder, the difference between gross revenue and net sales is related to our logistics services, which is accounted for on an agent basis, meaning that we only recognize the net profit on logistics services as net sales. Cash and cash equivalents totaled $325 million at the end of the first quarter compared with $363 million at the end of the prior quarter. First quarter cash flow used in operations totaled $74 million compared with cash provided by operations of $20.9 million in the prior quarter.

The primary reason for this was the prepayment of the $101.8 million earn-out note from the Cree LED acquisition. We accounted for a majority of this prepayment in our operating cash flow given it was a contingent consideration. In addition, in the first quarter, we increased overall inventories to support expected demand for IPS in the second quarter of fiscal 2023. In the first quarter, we repurchased 182,000 shares spending $2.8 million during the quarter. In aggregate, we have spent approximately $53 million under our $75 million share repurchase authorization through the first quarter, repurchasing approximately 2.8 million shares. For those of you tracking capital expenditures and depreciation, capital expenditures were $11.6 million in the first quarter and depreciation was $8.9 million.

In the first quarter of 2023, in conjunction with the acquisition of Stratus, we also expanded our existing term loan credit facilities by $300 million. We used the net proceeds to retire the $101.8 million outstanding CRE LED earn-out note, and along with cash on hand, paid for the $225 million purchase of Stratus. The Term Loan A facility bears an interest at SOFR plus 2.25% based on a total leverage grid. For the second quarter, we would expect our total cash net interest expense to be approximately $8 million based on current SOFR rates. Turning to our second quarter 2023 guidance. We expect that net sales for the second quarter of fiscal 2023 will range from approximately $410 million to $460 million or approximately $435 million at the midpoint.

Our guidance for this next quarter incorporates the continued strong demand in our IPS business offset by lower demand in our memory and LNG businesses. Our GAAP gross margin for the second quarter is expected to be approximately 25% to 27%. Non-GAAP gross margin for the second quarter is expected to be approximately 26% to 28%. Our non-GAAP operating expenses for the second quarter are expected to be approximately $75 million, plus or minus $3 million, and up slightly from the first quarter, in part due to the timing of nonrecurring engineering costs to support our IPS business. GAAP diluted earnings per share for the second quarter is expected to be approximately $0.13, plus or minus $0.15. And on a non-GAAP basis, excluding share-based compensation expense, intangible asset amortization expense, debt discount and other adjustments, we expect diluted earnings per share will be approximately $0.60, plus or minus $0.15.

This also includes the benefit of approximately $3 million from an asset sale accounted for in nonoperating income. Our GAAP and non-GAAP diluted share count for the second quarter is expected to be approximately 50 million shares based on our current stock price. Cash capital expenditures for the second quarter are expected to be in the range of $12 million to $15 million, in part due to expenditures to migrate Cree LED into its own U.S. facility. We continue to manage our operations in a prudent manner as we navigate a challenging environment while also continuing to invest in our long-term growth. Our forecast for the second quarter of fiscal 2023 is based on the current environment, which contemplates the global macroeconomic headwinds and continued supply chain constraints.

Please refer to our non-GAAP Financial Information section and Reconciliation of GAAP to Non-GAAP Measures tables in our earnings release for further details. Now, let me turn it over to Mark for a few remarks prior to Q&A.

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Mark Adams: Thanks, Ken. We remain very excited about the future of SGH. As we have mentioned, our fiscal €˜23 is front-end loaded with some large IPS installations. And like many technology companies, we have limited visibility into the demand environment in the second half of our fiscal 2023. With that in mind, I want to reiterate our commitment to our shareholders that we will remain vigilant in how we operate the Company in the near term while investing for long-term success. I do want to highlight that this quarter, despite the macroeconomic headwinds, whether China’s COVID environment weakening consumer demand or increasing interest rates, our team accomplished record non-GAAP gross margins. We credit our CapEx-light model, our diverse set of businesses and our continued focus on delivering value-added differentiated products and services that enabled our solid operating performance in these challenging times. Operator, we are now ready for Q&A.

Q&A Session

Operator: The first question is from the line of Brian Chin from Stifel.

Brian Chin: Hi. Good afternoon. Thanks for letting us ask some questions and congratulations on the results. Maybe first question, Mark. It looks like you expect mix in the February quarter to be fairly consistent with the November quarter, and margins down a little bit. Is that just sort of like on service versus hardware mix within IPS, or is there another consideration there? And then, I have a follow-up question.

Mark Adams: Yes. Let me take the first part of the question, which is around just the relative performance of the business. As we go into our second quarter, obviously, we have a very consumer-focused business — facing business in the Brazil mobile phone and PC business, which has historically been a little bit softer in the quarter anyway. And then the LED business is demonstrating very similar characteristics. So, the overall trend line in the business from Q1 to Q2 is kind of on the same trajectory. Relative to mix and margins, I’ll let Ken chime in.

Ken Rizvi: Hey Brian, thanks for the call. Yes, if we look at the trajectory from Q1 to Q2, there’s very little movement in the margin profile, but it’s as Mark highlighted, there’s a couple of factors. One being we’re expecting the LED business to be down slightly Q1 to Q2, and margins will come down given the fixed cost on the back end. And then two, you hit it earlier, which is on the services piece. We have some of the services that are more onetime in nature, so we would expect services revenue overall for the Company to be down slightly. And so those are both mixed related items based on the revenue profile.

Brian Chin: Okay. That’s helpful. And then for the follow-up, are you a little surprised or are you anticipating the softer memory prices and kind of your pass-through to your customers? Do you think that will have become more of a headwind in either the February or May quarters in the Memory Solutions business? And also, I know you’ve alluded to consistently that the fiscal first half is stronger for IPS based on the way some of those projects are sort of setting up. I know it’s kind of hard to make a firm commitment here. But do you think sort of that first half-second half mix could be something like a 55% revenue first half versus 45% second half? Just trying to get some idea of sort of how severe that first half-second half dynamic could be.

Mark Adams: So, I’ll take the first part relative to the memory market. As you can see from the pure semi players in the memory space, the pricing environment is pretty challenging. And we see that in Brazil. We see it both in terms of the top line revenue and also the overall demand environment from a broader macro. So, it’s kind of a — it’s very challenging in a consumer-facing business like that. In the Specialty business, actually, we have seen some of the pricing pressures you’re referring to, but less so more stability, not perfect, but more stability in the pricing in memory versus consumer when you look at the specialty pricing. And our margins actually are pretty good in the Specialty Memory business. Gross margins are pretty good as it’s — our pricing — the revenue kind of stabilizes the gross margin contribution for our services that we provide.

The value-add we provide actually drive gross margins slightly up in that sense. And so, I would say consumer pricing doesn’t feel great right now in the memory space if I just listen to the larger semi people in their reports. But in our business, it’s less impactful, and the Specialty business has been more stable.

Ken Rizvi: Yes. Brian, in terms of the IPS breakout, it’s still a little bit too early to call the second half. But if you ask me today, it’s probably in that 55-45 or 60-40 range as we see it today. But as I mentioned, we don’t have clear visibility as we look out 2 quarters. And we had pretty good visibility into Q2 and pretty good visibility in Q3, and we’re still building the backlog and the bookings as we head out into Q4, into 2024 as well.

Brian Chin: Got it. But I guess in terms of component availability, if you did have kind of “turns” business, you’d probably be in a better position to fulfill that now than six months ago.

Ken Rizvi: Yes. That’s right. I would say if you looked at the supply chain today, the supply chain today is much better than it was six months ago. There’s still some components out there in shortages within specific semiconductor and other parts, but definitely much better today than it was six months ago.

Operator: The next question is from the line of Kevin Cassidy with Rosenblatt Securities.