Penguin Solutions Inc (PENG) 2017 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter Fiscal Year 2017 Smart Global Holdings Inc. Earnings Conference Call. (Operator Instructions) As a reminder, today’s program is being recorded. And now I’d like to introduce your host for today’s program, Ms. Suzanne Schmidt, Investor Relations. Please go ahead.

Thank you, operator. Good afternoon, and thank you for joining us on today's earnings conference call to discuss SMART Global Holdings' third quarter fiscal 2017 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 website at www.smartgh.com.

Before we begin the call, I would like to note that today's presentation of SMART's results 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 recent IPO. 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'd like to turn the call over to Iain MacKenzie.

Thank you, Suzanne. And welcome to everyone on the call to discuss our third quarter fiscal 2017 financial results. The quarter ended on May 26, 2017 and marks our first earnings call since we completed our IPO on May 30.

Our third quarter came in very strong with net sales of $207 million, which is 20% higher than the previous quarter and 38% higher than the year-ago quarter. These topline results combined with the discipline spending delivered a solid bottom line. Jack will go into more detail on the financials later in the call, but at a high level, the quarter's results were driven by both SMART Brazil and our Specialty Memory businesses.

In particular, the May quarter marked the first full quarter of the step-up in Brazil local content requirements, which increased from 40% to 50% on January 1. This resulted in an increased volume of recently qualified products along with higher ASPs, and density per unit for the mobile memory in Brazil.

Now let me provide a little overview on the market dynamics. Starting with memory market as a whole, we believe that the DRAM and Flash markets are well positioned due to increasing demand for bit growth across a wide range of applications from data centers, server and storage to mobile devices.

And with newer forms of memory being developed such as Intel's 3D XPoint, MRAM, NVDIMM, SMART's value proposition only strengthens as a key partner to OEMs in an increasingly compact supply chain. It appears that DRAM pricing will continue to increase into the back half of the calendar year, and that NAND Flash will continue to be supply-constrained.

Turning to SMART Brazil, which represented slightly more than half of our fiscal Q3 net sales, we continue to benefit from our leadership position as a #1 supplier of mobile memory components and DRAM modules in Brazil. Our business is further enhanced by our capital efficient business model, strategic wafer supplier and differentiated capabilities. In addition, we are tightly aligned in terms of products and qualifications with our long-standing and deep customer engagements, combined with the local content regulations and an expanding product portfolio, we believe this business will perform well in the future.

Despite the most recent political news from Brazil, SMART has successfully grown its business there, as the local content regulations in country have continued to expand both in terms of percentages and IT products and applications.

Turning now to our Specialty Memory business, with our leadership in both specialty Flash and specialty DRAM, we are the go-to supplier to customers for the special and enhanced requirements. As I mentioned earlier, memory is getting more complex and the supply chain is getting more challenging for the OEMs and their suppliers to manage. With our deep engineering and integrated collaboration with our customers, we see a number of key growth drivers, including memory technology transitions, expansion of Flash and DRAM in the server and storage end markets and the adoption of new memory technologies.

Not only has our addressable market continued to expand, but the competitive landscape remains very favorable due to our deep and long-standing relationship with the blue-chip OEM customers across multiple geographies and end markets.

Underpinning the multiple growth drivers ahead of us is our capital-efficient business model, flexible cost structure and operating leverage. We are confident in our ability to deliver strong financial results and believe we're well positioned as we head into the end of this fiscal year and beyond.

And now, I'll hand over to Jack to discuss the financials in more detail.

Great. Thanks, Iain. Gross revenue for the third fiscal quarter was $453.5 million, while net sales were $207 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, the net profit on Supply Chain Services transactions.

The $207 million in net sales was a 20% increase over the previous quarter, mainly due to higher average selling prices, an increase in units sold and a full quarter of the higher local content requirements in Brazil for mobile memory, as Iain mentioned earlier.

The third quarter fiscal 2017 net sales of $207 million were broken down by geography as follows: Brazil, 53%; Asia, 23%; the U.S., 18%; Other Americas, 3%; and Europe, 3%.

Our breakdown of net sales by the end market for the third fiscal quarter was as follows: mobile and PCs, 48%; network and telecom, 25%; servers and storage, 19%; industrial, aerospace, defense and other was 8%.

Compared to the second quarter of fiscal 2017, mobile and PC related sales grew by 41% in the third quarter, due to rise in ASPs, increasing unit sales and the increase in local content requirement rules in Brazil for mobile memory. The networking and telecom sales grew by 11% in the quarter; server and storage related sales grew by 2%; the industrial, aerospace, defense and other sales were relatively flat quarter-to-quarter.

Moving to the rest of the income statement. Gross profit for the third quarter was $47.4 million, up approximately 27% from last quarter's $37.2 million. We achieved great operating leverage in manufacturing as we were able to keep our costs in line with the previous quarter, and we produce more units in Brazil.

Our third quarter non-GAAP operating expenses totaled $22.8 million, as we maintained our expense discipline during the quarter, even as our net sales increased 20%. Non-GAAP, net income to third fiscal quarter was $13.7 million or $0.62 per diluted share on a pro forma basis, compared to $3.5 million or $0.25 per diluted share in the prior quarter. Adjusted EBITDA increased 27% to $29.9 million in the third fiscal quarter.

Turning to working capital. Our net accounts receivables increased to $174.5 million from $138.6 million last quarter, and our days sales outstanding came to 35 days this quarter, in line with last quarter's 34 days.

Inventory increased by $3.6 million to $135.5 million from the prior quarter, and our inventory turns increase to 12x compared with last quarter's 10.3x on our increasing revenue. Consistent with past practice, the accounts receivables and inventory turnover are calculated on a gross sales and cost of goods sold basis, which totaled $453.5 million and $406.1 million respectively, for the third fiscal quarter of 2017.

Cash and cash equivalents totaled $22.3 million at the end of third fiscal quarter. Proceeds from the IPO of $61.1 million were not received until the fourth quarter, and were then used to pay down a portion of our outstanding term loan on June 2.

Third quarter cash flow from operations was $8.7 million compared with $1.4 million of the prior quarter, mainly due to our net income of $8 million in the quarter.

Now let me turn over to our guidance. SMART estimates that fourth quarter fiscal 2017 net sales will be in the range of $205 million to $215 million. And gross margin for the quarter will be approximately 21% to 23%.

Net income per diluted share is expected to be $0.05 to $0.07. On non-GAAP basis, excluding stock-based compensation expense and intangible amortization expense as well as amortization of noncash debt discount due to the issuance of the warrants, we expect non-GAAP net income will be in the range of $0.62 to $0.66 per diluted share. The guidance for the fourth quarter includes an income tax provision expected to be in the range of 20% to 22%. The number of shares used in computing net income per diluted share was $22.4 million.

Capital expenditures for the fourth fiscal quarter are expected to be in the range of $5 million to $6 million. Please refer to the non-GAAP financial information section and the reconciliation of non-GAAP financial measures and the reconciliation of GAAP net income or loss to adjusted EBITDA tables in our earnings press release for further details.

That concludes my remarks. Operator, we are now ready for questions.

(Operator Instructions) Our first question comes from the line of Blayne Curtis from Barclays.

Maybe to start off, Jack, on the gross margin. You had a strong May and the outlook is quite good into August. Maybe just talk about the drivers there and as you look out further, can you just, sort of, refresh everybody's memory in terms of what your model is for gross margin?

Right. I mean, the first one is pretty easy. Our targeted model, I think, was 20% to 23%, so we're -- that's the range where we've kind of, giving 21%, 23% for Q4, so still within our target model. Now I think really in the quarter, couple of things happened. One, we did a really good job at OCOG, so it stayed flat even though we had a lot more units coming out of Brazil and also we achieved some much better yields in Brazil and that, I think, helped drive our gross margins up to the 23% mark, as well as ASPs, right. We've seen ASPs moving up and that's been helping the margin as well in the quarter.

Got you. And then maybe you just talk about on the Brazil business. The DRAM, it's coming off of a very depressed level, but it has had a couple strong quarters here. Just kind of, curious where you're thinking that you are in that recovery versus from a normalized unit number and where ASPs factor into this.

Yes, I mean, we're -- the market's recovered somewhat as we've talked about but I think we're looking at it to be, kind of, going to stay where it is, right? The projections that we're seeing for PC demand in Brazil are not growing tremendously, it's still pretty flat. So I think we are looking at that more as it's just kind of, stay flat where it is and it might go up and down based on the ASPs, but we're not seeing any great growth in demand down there in the future. Now we also talked about the smart TVs when we're out there, so we expect smart TV, which should be basically DRAM ICs that go into smart TVs. We expect that to sort of picking up in our fiscal '18, and so that would probably -- will make up for any downward move into the PC DRAM if ASP starts to decline.

Our next question comes from the line of Sidney Ho from Deutsche Bank.

Maybe a quick question on the memory market itself. It's been well known that there are shortages and price increases in both DRAM and end markets and Iain, you also mentioned that in your prepared remarks, how has that impacted your business? And how do you supply and demand playing out, say over the next 6 to 12 months?

Yes. I mean, Sidney, to be quite honest, your Asia report is one of the freshest out there from June, so you're well, well versed in this. However, to our business, I think the -- it's a surprise to the market that DRAM pricings continue to grow into the second half and we're already looking at [joint] purchases and seeing the single-digit level. And also not seeing any capacity come on board at all in the DRAM's world through really '17 and '18. And then with the expanding requirements driven, as you noticed by servers, in particular, and then by smartphones, which consume 60% of the world's DRAM. So for us, we continue to have a relationship that gets us the parts to satisfy our demand in the market. So for DRAM, it's good. In the NAND world, the getting parts for our ever-increasing density, our density is increasing a little bit faster than we had anticipated a year ago. So we need more bits to satisfy the unit requirements, but -- so I think that the impact for us is just to continue with our relationship to get supply.

Great. Maybe a follow-up question is on the Specialty Memory business. There has some pretty -- wanted to -- maybe it's my understanding is that, that business is relatively stable, but if you look at year-over-year growth, it's more like 40%. So can you talk about what's driving that? And how should we expect that strength -- should we expect that strength to continue?

I mean a couple of drivers of that. One, of course, we are getting helped by ASP, right. I mean, we do have some of the business based on DDR4, prices are going up and they happen to be going up in the storage area. So I think we've seen some decent growth in storage and we've seen growth in networking and telecom, so I think we've been doing a good job taking share in that business and then growing, as we mentioned before, storage and the server area. But I think go forward here, as we talked about, kind of, on the road, I think we still think Specialty is kind of a high single-digit, kind of, growth engine and we think it'll get to that. We won't see these great numbers of growth that we've seen in the past, I think, in specialty. It'll say high single digits as we go forward.

Our next question comes from the line of Delos Elder from Jefferies.

This is Delos on behalf of Mark Lipacis of Jefferies. Congratulations on reporting your first quarter as a public company. I was wondering if you could discuss your outlook by segment. What are your expectations for growth in each for the coming quarter?

I think as we -- especially, we kind of talked about that, right. That's still going to be -- it's going to be a high single digits on annual basis, it's going to grow a little bit quarter-over-quarter. I mean, Brazil, if you look at Brazil, mobile memory, right, it steps up in our Q3. So I think the way we would look at that as we've got the step-up now in Q3 because local content rules have been enacted and as we produce to meet the local content rules, it should be a fairly flat kind of movement for the next couple of quarters in that business, right? Movement -- moves a little bit, but we wouldn't expect to see that kind of growth, step-up of growth until next year when the new local content rules get back up into 60%. And then PC DRAM, as we talked about, that, we view as, kind of, more of a flat kind of business. I mean, when we look at the overall revenue, right, we're only guiding up revenues $5 million to $10 million. And so we're looking at small incremental growth in specialty and maybe a little bit in Brazil. But I think the way the model works now, once you get into Q3 to get the step-up, Q4 is just going to be a continuation of kind of the Q3 step-up.

Great. And then, I was wondering if you could talk a little bit more about your Services business, just some of the dynamics you're seeing in there, trends that customers are working with.

I mean, the trend there -- I mean, that business is a fairly flat, stable. It does well for us, but trends we're seeing, we're seeing some of our customers still are struggling to get parts right so when you look at the thing that, kind of, Sidney mentioned and Iain talked about which is DRAM. The DRAM industry itself and some of our customers still can't get DRAM modules. Some are still not being able to get SSDs and so that, kind of, backs our view that we still have this environment where there is still a shortage of parts that looks like it's going to continue through the first half of this year, based on, kind of, what we see in our supply chain business.

Great. And then, working capital requirements going forward, is there a model for DSOs and days of inventory and whatnot that we can think about?

I think where we are -- I mean, if you look at where we finished this quarter that's a pretty good number, right? DSO, I think was 35. Inventory was 12, inventory turns were 12, our DPO, I think we hit about 47. So I think those numbers there are in the ballpark of where we'd like to see it.

Great. And then, with respect to Brazil and the political situation there, can you talk about any headwinds from currency or any impact there that you might have some insight into at this point?

Yes. I think the only thing was when we were out on the roads, there was that local shift of the Temer news, it was 3.1 to 3.2 trading. It immediately jumped to 3.3 and now since then it's traded in the 3.2s to 3.3s. So really it was less than 10%, 8% movement. As we discussed, it's only an outstanding payables portion for us that affords any risk, and we convert the currency on a daily basis. So I think $1 million here or there is probably the size of the impact. But -- and we -- I saw some recent reports that said this could well drift up to about 3.5 by the end of year, and if it just gives us a benefit in translation costs from local spend.

Yes, we haven't seen any impact on demand, I mean the demand in Brazil has held strong, so the whole Temer news or the currency hasn't impacted our demand at all in Brazil.

Our next question comes from the line of Kevin Cassidy from Stifel.

This week, we had AMD announce their details of their new FX server processor and expecting next month that Intel will launch the Skylake processor. I'm wondering with these new architectures are you getting more requests for Specialty Memory? It seems from AMD's presentation that DRAM was the key feature of that, that it's going to use more DRAM than past processors. Is your pipeline filling up? I guess, is the question for Specialty Memory?

Yes. So Kevin, it's a very solid point. Remember, we are processor agnostic, so the -- our DIMMs are supporting both and moving forward into [pearly gates] You've seen a significant increase in the demand for server memory, especially with virtualization. I saw a report recently that said as much as 24% and 187 gigabytes per system as it goes out the door. So I think that's, as Jack said, it's a fairly -- server and storage together right now is an area of growth for us. So yes, the backlogs and the strength of orders there is very solid and that's where we saw some of the recent growth coming from.

Okay, and you have mentioned that 3D XPoint and MRAM as new memories that are stimulating some demands. Can you give a little more details around that?

Yes. I mean, both, we are -- our business is as specialty and enhanced memory. We actually jointly exhibit with Everspin and their DRAM run technology, but we're not specific to any particular person. But MRAM is coming. Clearly the density is a challenge. The new parts are the challenge, but for us, we take a lot of pride in being early in the cycle. If it adopts into pure volume, we'll probably step out, but then we come back and support technologies for the long time. I think both of them have a place in the market, and happy to partner with both of them to bring solutions to our customers.

(Operator Instructions) Our next question comes from the line of Rajvindra Gill from Needham & Company.

Just a question on the model real quick. So for the guidance for August, if you had mentioned that the tax rate was going to be 20% to 22%, it implies that the OpEx, kind of, stays roughly flat quarter-over-quarter barring any issues with other nonoperating expenses. Is that, kind of, the right way to think about OpEx?

Yes. I think, there's no reason our OpEx can't stay relatively flat as we move on in Q4.

I think, Raji, that's where the leverage comes from, we have a system that's in place that deals with this level of volume.

And the tax rate, should we be focusing on the 21% tax rate going forward?

It'll start to decline. I mean there's -- we can get into why the tax irate's a little higher than we talked about on the road, and main reason of that is, there's a portion of the Brazil mobile memory that we can import and that runs through a higher tax rate company, and so when we get parts, those kind of parts in a quarter, it creates more income at a higher rate. That happened in Q3, we probably produced $3 million in more profits for some parts we brought in because we have a certain allocation of these that we can use. And so I think in Q4 we'll ship more of that but I think as we get into Q1 and Q2 those will probably go down so I would anticipate the tax rate to start to decline probably as we get into Q3 and Q4.

And the growth...

In Q1 -- sorry, Q1 and Q2, I mean.

The growth in mobile memory to the $70 million per quarter run rate is in the company that has a 9% effective tax rate.

I see. Okay. An interesting distinction. And Iain, you had mentioned some interesting commentary about the overall DRAM environment and was touched upon earlier. But you, kind of, mentioned that you don't expect any capacity additions for this year, but also for 2018? Did I hear that correctly and kind of what gives you that insight that would lead us to think that there won't be capacity additions next year in DRAM?

Yes, you did hear that, and really it's from various studies, I don't think I actually have it in front of me. Various studies on the capacity in the interim, I mean, for we have the demise of M10 and the growth of M14, but looking at the wafer starts and also, wafer fab equipment and wafer production itself in 12-inch wafers. And I can't see any of the majors, I mean, DRAM is really consolidated into the Samsung, Micron and hynix. And I can see more wafer output. Now obviously they have the technology transitions, so we get bit growth through the shrinkages, but I don't see starts building.

Okay. And on the Specialty Memory drivers, the technology transition to DDR3, DDR4. Can you talk about, kind of, what percentage of the market you think we are in DDR3, DDR4 and where do you think we're going?

Yes. So for us, we're probably quite opposite to the market, especially in our Specialty business where less than 25% of our business is in DDR4, which gives us some stability of pricing in the legacy. But -- and overall though, in the market, I think I saw the transition as to way over 70% of DDR4. Now all of our PC business is DDR4. So yes, it's an old server business. So I think compute transitioned over very quickly.

Okay, so the other segments are still lagging?

Yes.

Okay, so that's going to be beneficial to ASPs going forward?

It's beneficial to us and it's also beneficial to not only ASP, but to stability of pricing go forward because DDR3 won't fluctuate the same as the headline news of DDR4.

Okay. Got it. And just last question then I'll step back. What is interesting about this whole Brazil mobile memory, so you saw the step-up function from 40% to 50%, the rules you said are on a calendar basis?

That's correct. So we just reported $71 million...

Then the next step-up function is going to be from 50% to 60%, and that should be in the May, August '18 time frame? Is that what we...

That's right. January 1, so yes. Our first [true] reported quarter will be reported in the May.

So we should just kind of model the Brazil mobile memory than from here on out until we get to that point, primarily based on overall units then?

That's right. So those units will be fairly stable but what we've seen, and I think we spoke about was the increase in ASPs because of the increase in densities, not driven by increase in pricing in particular. So we've seen the ASP climb again to over $18.

Okay, so we're at over $18 now, and where do you think that's going to go?

Well, we had forecast that it would level out, as we just introduced the 32 GB, 16 GB eMCP parts, so we thought it would level out but I think the density mix forecast is moving more towards that part, and we've seen in the world moving north of 2 gigabytes, and targeting 3 gigabytes of DRAM, in particular, in the handsets. And so I think, it probably now -- by the end of the year, it probably exits around $20.

(Operator Instructions) Our next question comes from the line of Sujeeva Desilva from Roth Capital.

Jack, looking ahead to the fiscal first quarter November time frame. Can you talk about, what typical seasonality is in that quarter? And then what puts and takes there might be in the coming quarter relative to that typical seasonality? Which you were...

Yes. In this upcoming period, nothing seasonally there. We have the dynamics of growing ASPs of units, but there's nothing seasonality. There's not a particular buildup for the November quarter, either for pre-Christmas sales or things. So don't see anything, there's no summer solstice of Europe or anything so. Yes don't see us in the next couple of quarters to be impacting our results.

Could you care to cite what a typical seasonal quarter is, November quarter is? Do you have that...

Yes. Q2 -- our fiscal Q2 is typically the seasonal quarter. You didn't see it this last year because of the pent-up demand and the increase local content, et cetera. But Q2 often catches Christmas. It can sometimes catch the start of Carnival and there's the -- so there's time off and we do major maintenance in the December time scale and utilities and things. Most -- some of our customer shut down so...

We also have a buildup, right? People build up their inventories and stuff in kind of our Q1-ish time frame, so by Q2 they're not take in as much product, potential in Brazil either.

Got it. And in Brazil you talked about ASP being a tailwind for mobile, what's happening with the share there? I know some of your competitors there had some challenges relative to you guys. Is there opportunity for you to pick up share? Or is that relatively stable metric for you guys?

So should you be careful. So the mobile memory then we already have the 87% share that our customers have of the market. And -- so we're already supplying all of the local requirements and there is -- there are no competitors and -- that we can see in the foreseeable future coming to that very complex product. But you are right. In the DRAM space, we have over 50% market share, and the couple of companies like

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used to build up to 15%, we're not seeing them quite at that rate right now. So we're getting a little bit -- you saw the DRAM results were higher than we anticipated. So we get a little bit of that market share. We don't plan on it to continue, but clearly, we'll satisfy it when it's there. ADATA announced that they are going to be doing DRAM also, but we'll wait and see actual product output and qualifications.

And then last question on the balance sheet side. You talked about reducing the debt here. Can you talk about your further plans for debt reduction and use of cash going forward?

Sure. So, I mean, we're looking at various alternatives to refinance our debt, right? So our goal is to get the debt hopefully refinanced here this quarter, and then use the cash, I think as we've talked about on the road, right? We'll end up looking at potential things that we can -- potentially bolt-on to specialty to help grow in that area. And then there's -- while we will look at Brazil coming down the pike, what do we want to do next in Brazil? The next thing in Brazil will take some CapEx. We end up with a bigger spend in the years that we add a new product in Brazil, so we'll look to use some cash for that. So that's probably the main uses of the cash as we look out in the future here.

This does conclude the question-and-answer session of today's program. I'd like to hand the program back to Iain MacKenzie for any further remarks.

Thanks, Johnson. Well, it's a pleasure to be back, and thank you all for joining us on the call. We look forward to seeing many of you at the various conferences over the course of the next coming months, and speaking with you again when we report our fourth quarter fiscal 2017 results in September. Thank you very much.

Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.