Penguin Solutions Inc (PENG) 2018 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Third Quarter Fiscal 2018 SMART Global Holdings Incorporated Earnings Conference call.

(Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Ms. Suzanne Schmidt, ma'am you may begin.

Thank you.

Good afternoon, everyone, and thank you for joining us on today's earnings conference call to discuss SMART Global Holdings Third Quarter Fiscal 2018 Results.

Ajay Shah, Chairman and Chief Executive Officer 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 after which we will open the call to your questions.

Also in attendance and available for the Q&A portion of the call is Iain MacKenzie, our outgoing CEO.

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 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 statement.

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 that we file from time to time with the SEC, including our most recent Form 10-K.

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 Ajay Shah.

Thank you, Suzanne, and welcome to everyone on the call.

I'd like to begin by saying I'm very pleased to be here.

My first full quarter as CEO at SMART.

As we continue an exciting phase of growth, and also continue to broaden our offerings and customer base.

I am very honored to take this position from Iain MacKenzie who served as SMART CEO for the past 13 years.

Under his leadership, SMART has grown into a great leader and a valued partner to our OEM customers worldwide.

With the company's tremendous success to date, we now have the opportunity to continue building on this position and to pursue many exciting new opportunities.

I am looking forward to continuing to work closely with Iain as he remains on the Board of Directors at SMART.

Turning to the business.

The third fiscal quarter which we concluded late in May, marked a turning point in terms of our longer-term strategic direction.

Meanwhile, while we made these strategic moves we continue to execute well by leveraging our business model and unique competitive positioning across all of our different business units.

We reported another strong quarter with net sales of $335 million or about 62% higher than the year before.

Non-GAAP operating income of $53.8 million was 117% higher than a year ago.

And non-GAAP diluted EPS came in at $1.84 per share or roughly 2x over the year-ago period.

Our results continue to be driven by both our Specialty Memory business and our growing business in Brazil.

I'll cover each of these areas, and also comment on our recently acquired -- announced acquisition of Penguin Computing, which puts us in a new business, before turning the call over to Jack for a more detailed review of the financials and our guidance for the fourth fiscal quarter.

Moving to our Specialty Memory business.

We had another very solid quarter with net sales in excess of $100 million for the third consecutive quarter.

Our extensive knowledge of the memory markets and our deep customer relationships, provide us the visibility to drive sustained and predictable growth in this area.

Underpinning this outlook are several factors.

We continue to be the key supplier to our major OEM customers that require application-specific DOM and flash-based memory product.

And we're a trusted partner and supplier to these customers for a whole range of different specialized solutions.

Additionally, as we have mentioned in past quarters, newer nonvolatile NVDIMM solutions utilizing all-flash arrays within servers and storage equipment is driving increased demand for both our Flash and DRAM solutions.

In the backdrop of the health of the overall memory market, we continue to see a constructive supply/demand dynamic with multiple demand drivers along with orderly supply expansion.

In particular, relevant to us, prices of DRAM devices, such as DDR3, that are major part of our DRAM product mix, have been very steady.

Also, while many of the new designs we have utilize 3D NAND, our shipping mix today for NAND Flash continues to be based on the stable market for SLC and MLC technologies.

Moving now to our recent acquisition of Penguin Computing.

Through this acquisition we're greatly increasing both the markets and the technologies that we participate in and serve, and also, the types of customers we reach via Penguin's leading position in specialty compute and storage solutions.

These products and services target applications in artificial intelligence, machine learning and high-performance computing using state-of-the-art open technologies and advanced architectures.

We are very excited to have Penguin as the cornerstone of our new business unit, which we call the SMART Specialty Compute & Storage Solutions or SCSS business, which will serve as a broad platform for us to further build on by leveraging our shared infrastructure and proven ability to integrate and scale businesses.

Finally, referring to our business in Brazil.

We had another extremely strong quarter, which came on top of the exceptionally strong fiscal second quarter.

In our third fiscal quarter that we concluded, we had stronger-than-expected results, thanks in part to pull-ins as our customers prepare for the production slowdown during the World Cup event by building a little early.

Building on our success in the memory markets in Brazil, we have recently partnered to create a new business unit in Brazil focused on batteries for smartphones.

We have been investing in this in terms of the manufacturing lines and processes as well as the staffing that is required for the business.

And we expect first shipments to begin our fiscal 2019.

Longer term, we continue to target other areas in Brazil, including communications devices such as Wi-Fi, Bluetooth modules, and other products to support the Internet of Things or IOT markets.

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

Thank you, Ajay.

As Ajay mentioned, top line results were driven by both our Specialty Memory and our Brazil businesses, supported by continued healthy dynamics in the global memory market.

Overall gross revenue for the third fiscal quarter was $593.6 million while net sales were $335.5 million.

As a reminder, the difference between gross revenue and net sales is related to our supply chain services business, which is accounted for on an agency basis meaning that we only recognize as net sales the net profit on the supply chain services transactions.

Net sales increased by 7% over the previous quarter, and by 62% over the year-ago quarter.

Our breakdown of net sales by end market for the third fiscal quarter was as follows: mobile and PCs 61%; network and telecom, 17%; servers and storage, 14%; industrial, aerospace, defense and other, 8%.

As Ajay mentioned earlier, we have launched a new business in Brazil to focus on battery assembly for smartphones.

We expect to invest approximately $2 million to $3 million in startup costs along with R&D in the fourth fiscal quarter to support this new initiative, and expect this to contribute to revenue in our Q1 -- contribute to revenue on our Q1 of FY '19.

With this investment, we're leveraging our 15 year proven track record of establishing and growing businesses in Brazil.

Similar to our mobile memory and DRAM initiatives, we have secured a partnership with a leader in the space, Samsung SDI.

We are utilizing our in-country manufacturing expertise along with the advantages for our customers of having local manufacturing.

Now moving to the rest of the income statement.

Non-GAAP gross profit for the third quarter was $78.5 million, up 7% as compared with last quarter's $73.2 million while non-GAAP operating expenses of $24.7 million remained unchanged from last quarter.

Non-GAAP net income for the third fiscal quarter was $43 million or $1.84 per diluted share compared to $37.7 million or $1.64 per diluted share in the prior quarter and $14.6 million or $0.92 per diluted share in the year-ago quarter.

Beginning this quarter and continued forward, we've excluded from our non-GAAP net income and non-GAAP earnings per share the effect of foreign exchange gains or losses.

Adjusted EBITDA was $51.5 million in the third fiscal quarter compared to $56.2 million in the prior quarter and $29.9 million in the year-ago quarter.

Included in our third quarter GAAP fiscal 2018 results, our FX related losses that contributed approximately $6.9 million.

Compared to last quarter, when we had FX-related gains of $2.4 million and FX-related loss of $1 million in the year-ago quarter.

Turning to working capital.

Our net accounts receivables increased to $262.1 million from $223.5 million last quarter as our days sales outstanding increased to 40.2 days for this quarter compared with 37.5 days last quarter.

Inventory decreased slightly to $147.9 million from $148.6 million in the prior quarter, while our inventory turns were 13.9x compared with last quarter's 12.6x.

Consistent with past practice, accounts receivable days outstanding and inventory turnover are calculated on a gross sales and cost of goods sold basis, which were $593.6 million and $515.5 million, respectively, for third fiscal quarter of 2018.

Cash and cash equivalents totaled $64.5 million at the end of the third fiscal quarter.

Third quarter cash flow from operations was $28.3 million compared with $34.7 million in the prior quarter.

We had a very strong fiscal Q3, which was made even stronger as we saw some pull-ins from Q4 due to the World Cup.

Our mobile customers are setting down for a couple of weeks in Q4, so they pulled in some of their demand.

Our second half revenues were grew over 14% from the first half with gross profit growing over 17% and our non-GAAP EPS over 23%.

This will be a record year for SMART in terms of revenue and profitability.

Now let me turn to our guidance.

Our guidance includes a recent acquisition of Penguin Computing, which we closed on June 8 that Ajay discussed earlier.

We currently estimate that our fourth quarter fiscal 2018 net sales will be in the range of $360 million to $380 million.

Gross margin for the quarter is estimated to be approximately 22% to 23%.

GAAP earnings per diluted share is expected to be between $1.41 to $1.50.

On non-GAAP basis, excluding stock-based compensation expense, acquisition expense and intangible amortization expense, we expect non-GAAP earnings per diluted share will be in the range of $1.62 to $1.71.

The guidance for the fourth fiscal 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 16%.

We also have not reflected any purchase price adjustments will be needed for the Penguin acquisition as we're in the initial stage of determining the appropriate adjustments.

The number of shares used in computing earnings per diluted share in the fourth fiscal quarter was 23.4 million.

Capital expenditures for the fourth fiscal quarter are expected to be in the range of $10 million to $14 million.

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 to adjusted EBITDA tables on earnings press release for further details.

That concludes my remarks.

Operator, we're now ready to take questions.

(Operator Instructions) Our first question comes from Kevin Cassidy with Stifel.

In your guidance, can you break it down for us a little bit of what -- at least what Penguin is in your guidance?

How much revenue is included in that?

Right now we're not quite prepared to do that.

We have been trying to figure out all the different adjustments that are related to the Penguin acquisition.

So as Jack said earlier, we have made the best estimations we can but it's hard to give you a lot of detail there right now.

We're using very high-level estimates right now, Kevin, but nothing that we want to kind of firm up in detail yet.

Okay.

And maybe if you can -- also the change in reporting of FX as a GAAP only and not GAAP.

Can you say what was in that decision?

Sure.

I mean, we don't guide the -- we can't guide FX gains or losses, it was never in our guidance, and so we had this -- the non-GAAP EPS, didn't have it in the guidance and we'd have it in the results, and it was just -- it started to cause a confusion with some investors and other people.

And we kind of looked at our peers in the space, and our peers don't include it in their non-GAAP calculations, so we just thought it made more sense for the investors to take it out it would make it easier for them to look at the comparison on a quarter-over-quarter basis.

Just to add to that.

Sorry, Kevin.

If you think about -- you're looking for our operating results and this gives you a very clear view of our operating results.

Now every quarter the exchange rates move and you get a gain or a loss.

Actually, our analysis shows that over multiple years, they more or less even out, but in each quarter they do provide volatility.

So we're trying to provide a look which will reduce that volatility.

And then of course there is some volatility from the currency movement.

Okay, understood.

Yes.

And maybe if I can even ask one more just on Brazil.

Are you seeing any change in the economic atmosphere, are any of these -- the inflation rate picking up?

Is that going to affect your operating expenses in Brazil?

Kevin, look when I look at the indicators down in Brazil, I mean, inflation still in May, it was only 2.86%, so, I mean, it picked up a tad, really very small.

So they kept their bank rate at 6.5%.

So we really aren't seeing any indicators in Brazil slowing down or really changing, right?

I mean, the real has been kind of moving -- weakening but the other indicators have stayed strong.

I mean, the inflows of the [vespa] are on pace to be the same as it was last year.

So there's nothing there that tells us there's any real issues in the country.

Our next question comes from Blayne Curtis with Barclays.

Curious, obviously, it's hard to track seasonality given some of the ramps you had, particularly lately in mobile.

I'm just curious the comments about the pull-in, if you can quantify that, and maybe what August seasonality is minus all of these content gains you've had in mobile over the last 2 years?

Yes, we wouldn't say that.

Typically, we have a seasonality in this quarter, but what we have seen is that our customers who produce mobile phones are shutting down for a couple of weeks a piece in the month of July, right?

So when they shutdown we're going to lose a couple of weeks of revenue in this quarter and we -- our sales, we think, picked up last quarter because people were building ahead in anticipation of the shutdown.

Got you.

Okay.

And then I do want to ask you on the battery investment and to the extent that there would be potential that would be included in some of the content framework.

And then just -- with that, also, just the step-up in CapEx, I was just curious what that investment is.

Yes.

So in the -- I mean, the battery business and cost -- in Q4, they're just pure cost, right?

So we're going to have about $2 million or $3 million extra cost in the P&L from the battery business.

Well, we won't have any revenues until next year on that business.

I mean, the $10 million to $14 million is in line with our CapEx plan for the year, just happens to be little bit back-end loaded.

We're still way into our 2%, 4% of revenue as far as our CapEx guidance.

It's just when the CapEx comes in when we have to pay for it, kind of, put a little bit about more back-end loaded.

And then we did have some CapEx for the batteries business that we spent, we're going to spend in Q4 as well.

Our next question comes from Sidney Ho with Deutsche Bank.

Just following up with the previous question on Penguin.

You guys disclosed the Q1 numbers.

Can you at least talk about what do you believe it will be up or down versus the calendar Q1 just totally based on seasonality?

And can you also talk about whether on a non-GAAP basis, are you expecting that to be margin and/or EPS accretive in the next quarter?

Let me try a part of that.

From a revenue standpoint, we do expect there revenue.

So the comparisons are difficult.

Let me explain first that Penguin is operated on a calendar fiscal quarter, and we have operated, as you know, on a fiscal quarter which would end a year in August.

So you're now comparing their previous quarter with having now been restated into our fiscal quarter.

So when we reported, we reported their fiscal quarters as opposed to our fiscal quarters.

So I know this is a little more difficult to model exactly right now, but this is just the -- we're literally 1 week and a few days away from that acquisition having closed.

And so we're trying to restate everything into our fiscal quarters because that's what you would all expect us to do.

So really at this stage, providing you with a lot of guidance as to exactly what Penguin is expected to be would be a little premature.

As we get those numbers a little more firmed up, we will be happy to get it for you.

We have tried to be careful in terms of how we looked at the overall revenue numbers as a result.

Okay, that's fair.

Maybe switching subject to the battery business again.

Can you give us an idea how to think about the size of that market going forward?

And are there any local content requirement similar to the memory side of things that you expect that will kind of help you guys?

Yes, I mean, that market of course has local content regulations around 60% today.

And we've pegged that market -- ASPs are lower than -- we peg the market as probably a couple of hundred million dollar of market in total today.

So hopefully.

Yes.

I mean, just in the smartphone category, there are 55 million smartphones.

And the average selling prices are, what, in the $10 range?

$8 to $10?

Yes.

A lot lower ASPs than we see today so...

Yes.

So that gives you around, the overall market being $500 million, $600 million, and we hope to get our unfair (sic) [fair] share.

Okay.

If I can squeeze in one more on the Brazil mobile side.

ASPs are certainly trending in the right direction.

And you talked about $30 ASP is possible by the end of this year.

One is, is that still true?

And two, are you seeing any signs that the memory modules are getting too expensive as a percentage of building materials?

And content are not moving as quickly?

Any color will be great.

Well, I have never had a conversation with the customer who didn't complain about the price.

So I -- I'll start with that.

We are not -- we continue to see applications driving the memory requirement rather than prices because people are using applications that require the memory.

But of course, there are different price points for different customers and there continue to be some segments where they're going to look for less memory and other segments, but overall we're not seeing those segments change so far.

With the -- the only thing that kind of worry about and keep an eye on is the exchange rate.

The exchange rate so far has moved within the range, not enough to really change the big picture.

But if the exchange was to change in a dramatic way, that affect the affordability.

That's probably the bigger question than memory content.

And last quarter, Sidney, we had the highest -- we shipped the highest percentage of our high memory content in eMCPs in Brazil ever.

So they were buying more and not less last quarter.

Our next question comes from Rajvindra Gill with Needham & Company.

Question also on the local content rules.

You mentioned that you're targeting Wi-Fi, Bluetooth modules and IoT products in Brazil.

Do those specific products also have local content rules similar to memory and mobile phones and PCs?

And you mentioned 60% for batteries, I believe?

Can you maybe expand on that?

So the little Wi-Fi, Bluetooth thing that we build today, which is just a little -- board-based solution does have some local content rules for PCs and -- but it's not a lot.

But as we talk about getting more into -- more of the IoT stuff, we would anticipate that as, we ramped up our capabilities and production and the country grew that they would probably enact some type of rules around that.

There's been a lot of interest from particularly government related agencies in promoting IoT for a variety of verticals.

So they have actually put out a white paper related to IoT for agriculture, smart cities, energy management in a couple of different areas.

So there's actually a lot of interest in that area and they want to make sure that they have domestic providers for these.

And just going back to Penguin.

And I understand the dilemma that you're in.

But we're trying to get a sense of what the core business is doing and forecasting in the future and not just the quarter.

So it does look like the OpEx kind of moved up.

If I -- the implied OpEx is up about, call it, $10 million increase.

And I'm looking at the revenue in fiscal year '17 for Penguin, what you said is a $166.5 million.

I don't know what the growth rate will be next year.

But any kind of color as we look at -- I mean, how do we model OpEx in November, February, May, August?

How we model revenue for the future quarters?

That was going to be a guess, we're going to take $166 million that you did and fiscal '17 grow by 20%, otherwise you're going to have a model that -- so I was wondering if you could provide any more detail on that?

Yes, I mean the numbers you saw are probably in the first quarter.

Aren't the most worst numbers to use on a quarterly basis for Penguin.

But you -- they have a little bit more variability in their quarters, so that's what we're trying to get -- really get our hands on, right?

I mean, our business tends to be a little more stable on a quarterly basis, they have a little more peaks and valleys and we're trying to get our handles around that, and once we get our handles around that then we definitely will come out with more information as to what's going on with that business.

But you want -- if you need something today, I'd say, their first quarter numbers probably aren't the worst thing to use.

Okay, got it.

That's helpful.

And in terms of the currency.

So the real depreciating against the dollar making the phones more expensive, PCs more expensive in Brazil.

It doesn't appear to be that, that has had an effect on the unit demand of people buying phones and PCs.

I mean, obviously from a P&L perspective, you're putting in GAAP as a loss.

So I'm just wondering did you see any impact from demand -- from a demand perspective?

Were you able to offset that by the pull-in?

Or the higher density funds?

Just wondering if you can talk about that.

We had good demand in the quarter.

And it was higher than we anticipated from the pull-ins.

So we did not see any perceived weakness in demand in the quarter due to the real.

And we talked about the facts that the real weakened enough, demand could slow down.

In this quarter now we've got this -- we've got the shutdown for the World Cup, so it's kind of an anomaly in this quarter.

I think it's going to take a little while to see what happens with the demand based on the real.

Yes.

I mean, so far we're not -- anecdotally, we're not hearing any -- let me put some perspective, the Brazilian real is off by about 12% year-to-date.

And when we look at that in advance scheme of things that's not going to completely change the demand picture.

If the real were to significantly weaken from here, it would force manufacturers to change the prices on the shelf.

And that then might have an impact both in terms of which kind of phone the customer chooses as well as the total unit count, it's possible.

But it's purely speculative at this point, we're not seeing a specific impact from what has happened so far.

Yes, I mean, what you think might happen as you might see lower cost sell -- as Ajay mentioned, sell more than the higher ones.

The last quarter, we sold more higher in memory than we have.

And if you know -- if you look at our -- the results we expect, if you look at the second half results versus the first half, I mean, we expect that overall we'll grow the business as we talked about in the call, right?

So overall, our business will be up in the second half of the year versus the first half even though the second half the real would have weakened so...

Our next question comes from Mark Lipacis with Jefferies.

Jack, maybe could you just review for us the exposure you have on the top line, the COGS and the OpEx to the real, what percentage of your cost structure is exposed to the real?

And just spell out -- perhaps that just the mechanics of how the Forex losses is manifest on them -- on that line item?

Sure.

I mean -- right.

So on the FX loss, so as I said, I mean, where we are exposed really to the real from an FX perspective as that we purchased all of our wafers in dollars.

And if I take those invoices, convert them into real, when we get them, and then when we go to pay them, we have to convert them back into USD.

And so if the real has moved in that time period, we're either are going to get an FX loss like we did in Q1, it goes right we had an FX gain in Q2 because it went the other way.

Now this quarter, it dramatically weakened, and we've shown a much bigger FX loss than we had before.

That's really our biggest exposure from a pure FX loss standpoint.

Now on the P&L, we price to our customers in dollars, so our exposure there was -- we do have to convert, of course, from dollars to real.

If the real weakens or strengthens, I mean, it will have some impact on revenue but not a dramatic amount.

And then if you look at our cost structure, our local cost that are in real, when it weakens, in theory, we would get little bit of a benefit in the rest of the P&L with the weaker real.

Okay.

And so is the COGS mostly dollar based?

And is it the OpEx that is more heavily weighted to the real?

85% of our COGS is raw material based, right?

Materials are all going to be -- most of that for Samsung, wafers coming in based on USD.

(Operator Instructions) Our next question comes from Suji Desilva with Roth Capital.

A couple of questions on Penguin.

Did you have any inventory that had been mark up with the acquisition that needs to flow through that might dampen gross margin the next few quarters or was that raw material?

We will have to do that, we haven't -- that's some of the stuff we haven't determined yet, Suji.

But we know we have inventory we'll have to get marked up we're just not sure how much of it and where it has to go.

So your gross margin guidance does not encompass that effect at this point?

Correct.

Okay.

Good.

Got it.

And then also -- and I think this may be premature as well but I'll ask anyway.

This segment reporting the way it is now, will it stay this way?

Will you have a separate SCSS line will it be combined in a Specialty Memory?

Any thoughts there and how you report segments will be helpful.

Yes.

That's premature as you said, Suji.

We thought about it.

We haven't come to a definite conclusion yet.

We're still -- we have -- there is a lot analysis you have to do to determine, from a segment perspective, what you have to do.

And so we're starting that analysis now.

Okay.

Great.

And last quick question on Specialty Memory.

What percent of DDR4 versus DDR3 today?

Is that shifting dramatically or staying stable?

It's about 30% DDR4 today.

I'm not showing any further questions at this time.

I would now like to turn the call back over to Ajay Shah for any further remarks.

Well, again thank you, operator.

Thank you to all of you for joining us on this call this afternoon.

We look forward to seeing you out on the road in the coming months and to reporting on our progress next quarter.

Once again, we thank you for your interest and goodbye.

Ladies and gentlemen, thank you for participating in today's conference.

This does conclude today's program, and you may all disconnect.

Everyone, have a great day.