Q3 2022 SMART Global Holdings Inc. Earnings Call
S G H.
In less than two years.
We have grown top line revenue from $1 1 billion to over one 8 billion over the last four quarters.
Expanded our gross margins from 19, 8% to over 25%.
Diversified our revenue with the organic growth of Ips and with the acquisition of Cree Leds.
Strengthen our balance sheet, leveraging our strong cash flow generation.
And continue to invest in our long term success as.
As demonstrated by our announcement today of the planned acquisition of Stratus technologies more on that in a bit.
Now, let me turn to a brief review of each of our businesses.
Starting with Ips.
Revenue came in at $95 million for the third quarter up 16% sequentially and approximately flat for the third quarter of 2021.
In addition.
We expanded service revenue in the third quarter to $34 million up 105% compared with Q3 of the prior fiscal year.
<unk> revenue represented approximately 36% of Ips revenue in Q3 of 2022.
A record for services as a percent of total revenue for Ics.
Heading into our fourth quarter.
We are seeing strong sequential demand for Ics, driven primarily by growth in sales to our commercial customer base.
Based on our backlog our Q4 top line is anticipated to grow north of 30% sequentially quarter over quarter.
While we benefited from a strong mix of services in Q3, our growth in Q4 is driven by new product rollout more hardware intensive.
Looking out into the first half of fiscal 2023.
We are seeing strong demand continue as we ramp new customers and expand projects at our existing customers.
While we are not providing guidance.
<unk> current backlog is approximately half of the $1 billion, an all time high.
Now turning to our OLED solutions group.
<unk> had another strong quarter of operating performance.
Revenue was $101 million in Q3 helped by strong performance in the Americas, and EMEA, which partially offset demand softness in the greater China Southeast Asia region.
<unk> continues to be hampered by COVID-19 related policies affecting supply chain networks.
Cree Leds continues its focus on innovation by delivering differentiated solutions with.
Our strong technology and value proposition to its customers just last week at light fair 2020 to Cree Leds.
Last G. The family of products were recognized by the Edison report as a top 10 must see product.
Delivering significant performance advantage in color mixing applications.
We remain confident in the long term operating performance of the led business.
And our memory solutions group operating under the Smart modular brand name <unk>.
Revenue came in at $266 million, a year over year growth of 11%.
Demand for our core specialty memory offerings, such as <unk>, III, DDR, four and flash memory products from customers in the enterprise computing.
Networking telecom and storage segments was key to our strong performance.
In Brazil, we experienced softness driven by a decline in consumer demand for smartphones and Pcs.
And we anticipate this will persist into the fourth quarter.
We remain disciplined in managing our operating expense and capital expenditures as we continue to focus on generating cash from our Brazil operations.
Our consolidated results for the third quarter demonstrate the benefits of our growth and diversification strategy.
We believe we are in the right markets benefiting from long term secular growth drivers such as AI.
Gene learning data analytics cloud and high performance computing.
I wanted to recognize our nearly 4000 employees worldwide for a strong third quarter.
We are in the beginning stages of a major transformation and I couldnt be more excited about the future of sch.
And now I'll hand, it over to Ken for a more detailed review of our Q3 financial performance and our guidance for next quarter.
We will then provide an overview of our announced acquisition of Stratus.
Before opening the lines for Q&A.
Ken.
Thanks, Mark I'll focus my remarks on our non-GAAP results, which are reconciled to GAAP in our earnings release table.
The third quarter of 2022.
<unk> consecutive quarter of year over year growth for sch, demonstrating how our strategy continues to yield positive results and benefits from our diversified revenue stream.
We see tremendous opportunities ahead for <unk> to deliver advanced technology solutions for our customers across all three of our businesses.
Now, let me turn to our detailed results for the third quarter of fiscal 2022.
We reported another strong quarter.
Net sales were $463 million.
6% increase year over year from the third quarter of fiscal 2021.
In addition, non-GAAP gross margin came in at 25, 7% at the high end of our guidance range.
And non-GAAP diluted earnings per share was 87.
For the third quarter above the high end of our guidance.
Our gross margin and earnings per share were higher in the third quarter in part due to the timing of higher margin service revenue for Ics, which was originally expected in the fourth quarter.
For the third quarter Ips had revenue of 95 billion.
Up approximately 16% sequentially driven by growth in commercial and federal sale.
In addition, we had record services revenue in Ips in the third quarter, which helped the overall margin profile for FCA.
We continue to see strong demand for Ics into the fourth quarter of 2022 and demand trends remained strong as we look into the first half of 2023 as Mark highlighted earlier.
We expect fourth quarter Ics revenue to have a greater mix of hardware.
Our led solutions group had revenue of $101 million in the third quarter, which was relatively flat with the same quarter a year ago.
Sales were impacted from lower demand in the greater China, and Southeast Asia region, which represented over 35% of <unk> sales this quarter.
Our memory solutions group had revenue of $256 million.
In the third quarter, which was 11% higher than the third quarter of the previous fiscal year driven by growth in our specialty memory business.
non-GAAP gross margin for <unk> in the third quarter of 2022, or 25, 7% up from 21, 9% in the year ago quarter.
non-GAAP operating expenses for the third quarter was $64 6 million.
Up from approximately $52 million.
In the third quarter of 2021.
Operating expenses were up primarily due to the continued investments across all three of our businesses as well as a reduction from financial credit in Brazil.
Operating expenses benefited in the third quarter of 2022 from $3 3 million in financial credits in Brazil, which was down from $6 million in the second quarter.
This credit is expected to provide approximately $2 million of benefit in our fourth quarter of 2022.
non-GAAP diluted earnings per share for the third quarter of 2022 was <unk> 87 per share.
Up 24% from 77 per share in the year ago quarter.
Adjusted EBITDA for the third quarter of 2022 was $64 million or 14% of sales.
Third to $51 million.
Or 12% of sales in the year ago quarter.
Now turning to working capital our net accounts receivable totaled $357 million.
Third with $386 million last quarter.
And days sales outstanding came in at 31 days down 13 days from the last quarter.
Inventory totaled $365 million.
At the end of the third quarter.
Up from $334 million at the end of the prior quarter.
This growth was driven primarily by higher inventory for IPF as we prepare for billed in the fourth quarter and into the first half of fiscal 2022.
Inventory turns were 10, one times in the third quarter versus eight one times in the prior quarter.
And 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 one.
$3 7 billion and $922 million, respectively for the third quarter.
As a reminder, the difference between gross revenue and net sales is related to our logistics business, which is accounted for on an agency basis, meaning that we only recognize the net profit on the logistics services as net sale.
Cash and equivalents totaled a record $387 million at the end of the third quarter compared with $366 million at the end of the prior quarter.
Third quarter cash flow from operations totaled $36 7 million.
Compared with $32 2 million in.
In the prior quarter.
With the continued global electronic supply chain constraints.
As well as the inventory required to support Ips demand more of our capital has been tied up in working capital over the past year.
For those of you attracting capex and depreciation Capex was $9 2 million in the third quarter and depreciation was $10 6 million.
In the third quarter, we repurchased 448000 shares spending approximately $10 2 million during the quarter.
There are $75 million share repurchase authorization.
And we continue to repurchase shares into the fourth quarter.
As a reminder, our capital allocation strategy is as follows first and foremost we will continue to invest in our businesses as we see significant opportunities for further organic growth in each of our three business segments.
We will continue to review and seek acquisition opportunities such as Stratus for further scale and diversification in a disciplined manner.
And finally, the share repurchases provide us flexibility to return capital to our shareholders in an opportunistic and price sensitive manner.
With the opportunity ahead of us to acquire Stratus technology, we have suspended our share repurchase authorization effective today.
To align our capital resources towards this strategic acquisition.
Now, let me turn to our fourth quarter guidance.
We expect that our net sales for the fourth quarter of 2022 will range from approximately $420 million.
The $460 million.
For approximately $440 million at the midpoint.
Our guidance incorporates the strong demand in our Ics business, but an offset primarily by slower demand in memory are.
GAAP gross margin for the fourth quarter is expected to be between 22, five and 24, 5%.
non-GAAP gross margin for the fourth quarter is expected to be approximately 23.5 to 25, 5%.
In part due to the greater mix of hardware in our Ips business in the fourth quarter as mentioned earlier.
Our non-GAAP operating expenses for the fourth quarter are expected to be approximately $62 million to $66 million.
GAAP diluted earnings per share for the fourth quarter is expected to be approximately 22.
<unk> or minus <unk> 10.
On a non-GAAP basis, excluding share based compensation expense intangible amortization expense that discount and other adjustments, we expect non-GAAP diluted earnings per share will be approximately 65.
Plus or minus <unk> 10.
Cash capital expenditures for the fourth quarter.
<unk> to be in the range of 9% to $12 million.
And approximately $38 million to $41 million for fiscal 2022.
Our GAAP diluted share count for the fourth quarter is expected to be approximately 55 million shares.
On our current stock price.
And our non-GAAP diluted share count is expected to be approximately 53 million shares as it includes the benefit of our convertible note capped call.
Our forecast for the fourth quarter of fiscal 'twenty. Two is based on the current environment, which contemplate the global economic environment.
And ongoing supply chain constraints, please refer to our non-GAAP financial information section and the reconciliation of GAAP to non-GAAP measures table in our earnings release for the further detail.
Now, let's turn to the exciting news regarding the announced acquisition of Stratus.
Thanks, Ken.
I would like to discuss today's announcements that we have entered into a definitive agreement to acquire Stratus technologies a.
A global leader in simplified protected and autonomous computing solutions in the data center and at the edge.
Today's presentation is on our IR website.
For those following the presentation, please turn to slide three.
We believe that the acquisition of Stratus will be a significant milestone in <unk> transformation into a growth oriented diversified company.
The business its products customers financials and leadership very much in line with our acquisition framework.
Specifically, we expect stratus to expand our presence in high value specialty markets with differentiated solutions in the data center and at the edge.
Lead the industry and high availability.
Color and platforms software and services.
Bolster our existing Ips technology offerings, allowing us to more comprehensively address our customer needs increase our services capabilities and infrastructure.
Resulting in an additional $80 million of higher margin recurring revenue for Ips strengthen SDH as large scale customer base as stratus serves a global set of customers, including more than 50% Fortune 100.
At an estimated $150 million in annual revenue.
And to be immediately accretive to non-GAAP gross margin non-GAAP , EPS and free cash flow.
Let me turn you to slide four.
Over the last four years.
SGA.
It's had a successful track record of M&A, allowing us to diversify our revenue streams and scale our overall business.
Leveraging our <unk> operating system.
Effectively integrated three acquisitions, which make up our intelligent platform solutions group.
By strengthening our IP leadership team focusing on development of more differentiated technology and products.
And investing in the scaling of our services organization.
Ips business has grown top line revenues more than 30% in fiscal 2021 as compared with fiscal 2020.
And have made similar gains in the first half of 'twenty two compared to the first half of 'twenty one.
The acquisition of Cree Leds has been a great success as well.
Our team has managed a complex manufacturing transformation, leading to gross margin expansion of close to 1000 basis points in less than 18 months.
We believe the acquisition strategy presents another exciting opportunity.
Create value for our shareholders as we continue to transform SDH.
Now on to slide five.
Through our growth and diversification strategy.
CHF transform from our specialty memory products manufacturer.
To a developer of differentiated value add solutions for computing memory and led specialty end markets. Our revenue has nearly tripled.
And the mix has changed dramatically as well memory solutions was 57% of our overall sales in Q3 2022 down from 100% in fiscal 2016.
And Brazil was less than 25% of overall sales this past Q3 down from 46% in 2016.
Our adjusted EBITDA and free cash flow are significantly higher.
And our leverage on the balance sheet is significantly less.
And in fiscal 2021.
<unk> sold its remaining stake in <unk>.
And we have simply brought to a fully independent public company with a board comprised of exclusively independent directors.
For myself, given my role as SDH as CEO .
Next slide please.
Stratus based in Maine, and Massachusetts was founded 1980.
The company is a longtime leader in developing high availability fault tolerant platform software and services, serving fortune 500 enterprise customers.
Stratasys nearly 500 employees 17 locations around the globe and brings approximately $150 million in high margin revenue as part of the acquisition.
It is also a recognized innovator with over 70 patents and applications that will add to the SDH IP portfolio.
Let's turn to slide seven.
Stratus develops and markets high availability fault tolerant computing solutions for large scale enterprises, and the data center and at the edge.
The company has offerings, specifically to address the information technology or it.
And the operational technology or ots.
Stratus is truly global with nearly 60% of its revenue outside of the U S.
There are customers, which include more than 50% of the fortune 100.
Operator, and a diverse set of vertical markets, such as financial systems retail oil and gas telecommunications transportation and government.
Turning to slide eight.
The planned acquisition will both complement and strengthen Ips's current offerings in operations Ips is focused on developing differentiated solutions for the edge core and cloud strife.
Strategy offers application specific products at the edge with their ft server and DTC edge products.
As these theories and server DC product lines complement our Ips high performance computing platforms software and service portfolio.
And we have noted on prior calls growing our services offerings has been a high priority for Ics.
We set a record for services as a percentage of Ips revenue in our third quarter.
Stratus will bolster our services scale, adding roughly $80 million.
The maturing revenue.
In addition, we see potential for significant revenue synergies and the cross selling of Ics and strategy products and services to the future combined customer set.
We believe the acquisition of Stratus will drive further growth and profitability as part of our Ips business.
The addition of new technologies and services the.
The expanded reach to a global set of new enterprise customers.
The higher gross margin model and our leadership with a proven track record gives us the confidence that this can be another winning acquisition for the company and our shareholders.
Now, let me turn the call back to Ken for a transaction overview.
Thanks Mark.
Let's turn to slide nine the transaction overview slides.
We expect the purchase strategy for $225 million.
Cash at closing.
There is the potential for an earn out of up to $50 million, which.
Which can be paid in cash or stock or any combination thereof at our option.
The earn out is also subject to stratus, achieving certain gross profit targets 12 months post closing.
We remain focused on maintaining a prudent balance sheet as we continue to scale and diversify SBA we.
We exited the third quarter with cash and equivalents of a record $387 million.
And we intend to finance this transaction with cash on hand, and up to $125 million from our revolving credit facility.
Pro forma leverage is expected to be two five times on a gross basis and up less than a quarter turn compared to our gross leverage prior to this transaction.
And we expect to close this transaction by the second half of calendar year, 2022 subject to regulatory approvals and other customary closing conditions.
Now turning to slide 10.
As Mark highlighted earlier this transaction expands our capabilities in high value specialty market in the data center and at the edge and aligned to our growth and diversification strategy from.
From a financial standpoint status fits well within our acquisition framework it adds more than $150 million of annual revenue, including more than $80 million of higher margin recurring revenue.
It improves <unk> overall non-GAAP gross margins by more than 150 basis points and is expected to be immediately accretive to our non-GAAP EPS.
The Stratus acquisition is a significant milestone for <unk> and its business products customers and leadership further transform <unk> into a growth oriented diversified company.
On a pro forma basis. The addition of <unk> further strengthens Ics.
Our Ips segment becomes a larger part of the FCA story with revenues, becoming 27% of our LTM sales up.
Up from 21% prior to the acquisition.
With that let me open the call to questions operator.
Certainly.
To ask a question. Please press star followed by one on your telephone keypad.
If for any reason you had that trend move that question. Please press star followed by two again to ask a question press Star one.
As a reminder, if you are using a speakerphone. Please remember to pickup your handset before asking your question.
The first question is from the line of Tom O'malley with Barclays. Please proceed.
Hey, good afternoon, guys and thanks for taking my questions. My first one is just into the August outlook, you guys have talked about a sustained amount of time here of year over year growth in August it looks like from a year over year perspective, with the guidance ex growth you mentioned really strong ips of greater than 30%, but could you just walk us through you called out memory.
As a as a weaker segment can you talk about whats driving that is it just the consumer business in Brazil, and then you also Didnt mentioned anything on the LNG business could you give a little color on what that business is doing into August .
Sure Tom. Thanks. This is mark and thanks for the question before I asked but I just want to make a clarification I think.
Ken Might've missed stated we did not suspend our share repurchase program and we are continuing to repurchase shares in the fourth quarter I caught that but didn't want to interrupt.
The presentation, but again, we did not suspend share repurchase and we are continuing to repurchase.
Back to Tom's question.
The way I look at our fourth quarter guide.
Is that the biggest.
Headwind were facing at SDH.
Through the impact of the consumer demand environment in Brazil tied pretty much exclusively to mobile phones and notebooks.
And that impact.
Again, a headwind when considered against the Ips.
Positive forecast.
In the led side Tom.
So there's a lot less severe but still a little bit of a headwind given that about 30, 35% of the business is in our Asia Pacific region.
We've got some supply chain issues as well as demand side issues, primarily due to Covid lockdown.
End of the quarter and so I think.
Got it.
Sure.
The led business, maybe flat to down single digits and.
And.
The Brazil business.
<unk>.
Relative to the broader.
Trends I discussed again offset by some of the strength in <unk>.
And Tom just to highlight there if you look at Ips, we've been talking about it and there is.
Some variability quarter to quarter, but we saw great growth Q3 to Q2 record services.
We printed which is fantastic the margin profile, we're going to see strong growth here into Q4, and as we look at the demand trends for that business into the first half of next year. They look fantastic. So.
Those are specific to Ips and specific to <unk> in terms of what we're seeing and so.
A lot of good opportunity for us in that segment.
Just another follow up I guess on the memory LNG businesses.
Generally you are seeing weaker data points on consumer facing applications can you just comment I mean, I don't see is there any reason why that would improve for both the led and the memory solutions business into the first half of next fiscal year or do you have any commentary would deteriorate further.
Well, obviously, the environment's, a little bit tougher to predict given the volatility in the markets.
We think led is relatively stable plus or minus from where we are today.
I think that again, depending on how things play out.
In China, because I guess actually Tom just as a data point or two.
The U S and European markets were actually growth segments, China was down which offset that growth. So.
Some positives on the led demand is just the China thing was was bigger.
As we entered the quarter and again appropriately setting expectations.
On the.
The consumer business in Brazil.
That's a hard one to call. However, I think what we're seeing is a little bit of inventory work through that reduce some of the customer demand.
This global.
Global demand issues on mobile notebook and I think.
Some of our customers are working through.
Inventory that minimize their forecast for us in the quarter, which is impacting our forecast.
I think I don't think.
They are working through a ton of inventory, but a significant enough to impact Q4, we will watch it and try to be kind of as transparent as we can.
I don't I don't have much more than that because it just it's kind of an.
Uncertain to be able to predict.
Yeah.
Yeah.
Thank you Mr. Mali.
The next question is from the line of Brian Chen with Stifel. Please proceed.
Hi, there good afternoon, and thanks for letting us ask a few questions and congratulations on the acquisition.
Yes, maybe the first question again kind of more near term, but kind.
Kind of building off of that commentary Mark.
Yes, I think there's a lot of reports in recent weeks about one of the big handset companies cutting.
Cutting back on some of their production to realign with weaker demand. It seems like that would the expectation was that would largely be over kind of towards the latter part of July and so that would seem to fall well within the fiscal <unk> and so is there any optimism there that that off kind of the shoe tops that business in Brazil, maybe you could rebound.
A little bit rebound is maybe not the right word, but maybe kind of kind of would be at a low this quarter and sort of what the trend more towards the normalization.
And early next year.
Yes, I think it's obviously again I want to be careful but I would say the argument there that makes sense to me is that it's not like they are sitting out there our customers are sitting on.
Months of inventory I think what there has been it's been a little bit of concern on the demand side.
Has built up some shorter term supply inventory within their own.
Our system, our balance sheet, so to speak so I think.
My sense is that it should get better from here.
From Q4 into Q1 Q2, but.
We're just we're trying to be careful given that we don't know where we go from here and the broader demand.
The consumer product, but.
But I do believe that.
The inventory isn't as severe as I've experienced in other times in the memory business I think it's real but it's not as significant.
As some other cycles I've been through so I think the argument is it could be shorter and we just don't know enough to predict Q1 yet.
Yes.
That's fair enough.
To clarify.
You send it out to the specialty memory to Ips, which sounds pretty strong and then led with the exception of the supply chain in China. It sounds like you have seen good demand there any other sort of <unk> indications of maybe downward changes in demand in those other markets. It doesn't sound like it but wanted to clarify yes.
Yes. Thanks for the question no I mean thats the I mean, we're.
Kind of its strength.
Because as.
As we're sitting here, telling you a little bit about the <unk> in China, and Brazil, and the consumer business.
We've got a record backlog and Ips.
Half a billion dollar backlog and quarter.
Quarter over quarter growth of 30 plus percent. So it is.
Mixed demand signals I think by the way.
I think that's kind of what's going on in the broader markets I think consumer has been hit.
Primarily.
Even if you look at some of the major retailers in their more recent announcements.
And then down into the technology sector, I think consumer tech and hit a little bit.
But the enterprise space.
And especially I think some of these long term markets. These broader secular investments that the large scale enterprises are making in terms of AI and machine learning and what have you I think people are going to invest through the cycle with a strong balance sheet.
Yes, we are.
Your line of sight, there is pretty good so that's how we look at our business today.
Great if I could ask one question about sort of the Stratus acquisition.
Can you provide any more details about I think the $150 million it sounds like you've bifurcated through what the hardware versus software and services looks like.
So can you give any indication of what the recent annual growth rates have been for stratus sort of what the Delta is in the margin profile for its software services versus hardware.
I also want to comment on in terms of how it really meshes are synergize as well with the Penguin solutions business, maybe I'll take the second maybe I'll take the second part first and then I'll hand, it over to Ken for some of the.
Financial metrics that you asked about.
As many of you know we've been.
Investors and Ips since I joined the company and after a few years of some declining business at Ips.
The business has had 30% growth 'twenty one over 'twenty.
30%, roughly a little bit more than that in 'twenty, two first half versus 'twenty, one first half and we are very bullish about the business.
Stratus.
Innovator strong patent portfolio.
And especially provider of.
Fault tolerant high availability.
Platforms software and services.
It's very similar strategy in terms of the data center, all the way out to the edge and building custom solutions for their end customers and again as I mentioned the customer base at Stratus.
50% of the Fortune 100, and the customers and their loyalty to Stratus has been fantastic as we think about building out.
Our capabilities and our scale at Ips the service infrastructure that stratus brings to our ability to serve our customers and to scale into high performance compute and edge applications and their customer base.
It's significant.
If you take a look at the combined.
Service businesses of the two companies Youre, well over 150 $160 million, Ken can talk to that in a little bit.
So the overall solutions mindset service orientation differentiation, serving enterprise customers.
It's going to scale Ips and also allow us to expand our gross margins in the process to make this a winning transaction Ken maybe you can take it from here.
Ryan and then just on the financial side. This is a fantastic transaction for <unk>, you talked about the revenue to $150 million plus of <unk>.
Revenues, we think we're going to do better than that.
On the recruiting margin profile that just adds great visibility to us as we look out over a 12 month 24 month window in terms of both the revenue and the margins.
Back into the gross margin percent here this business is $45, 50% plus.
Type of gross margin and we think it can be it can do better than that.
And at the end of the day, it's going to produce a lot of great cash flow from a financial perspective. My guess is we will do north of a 10% cash on cash return.
For this investment if you looked at what we've done in the past you look at Cree as an example that has high teens low 20% cash on cash returns and so our recent acquisition history has been been good.
We are focused on generating positive and strong cash flows and this should be similar.
Results in terms of great cash on cash returns in terms of the growth profile just to answer your first question.
When we look at this business you have two segments in one of the areas that we've talked to and spoken at even at your conference was a focus on the edge and that's where we can differentiate as we look out over the next 135 years and in that specific space. If you look at the <unk>.
<unk> business that part of the business has been growing in that high single digit range, we think that can get up to that low double digit range over time.
Which will be fantastic, but overall revenues.
Relatively flat with that bifurcation of strong growth in the edge market.
Okay, great. Thanks for all the color. Thanks.
Thank you. Thank you.
Thank you Mr. Chen.
The next question is from the line of Kevin Cassidy with resin block. Please proceed.
Yes, Thanks for taking my question and congratulations on the acquisition.
Just one thing you didn't mention much about the supply issues that you talked a lot about last quarter.
Ips growing.
30% quarter over quarter, all the issues resolved or is that still limited.
Kevin Thanks for the question I think.
First to say that some of the demand that pushed out from Q3 pushed into Q4.
Similarly to Q2 to Q3 and we've had this dynamic.
I would say theres been some mild improvement, but we're not out of the woods yet.
I think as you can tell from the broader backlog.
Remember this is a business that was doing roughly around $248 million less than two years ago and we've.
Got a backlog of $5 billion.
So we're still working through that.
We're confident in our Q4 guidance that considers contemplates that but.
Think the business is still constrained.
Okay, great. Thanks.
And just on strategy.
What's their engagements with their customers.
You mentioned, 50% of the top 100 or fortune 100 companies.
How long is their engagements and those services are they are they schedule out for five years or three years at a time.
Yes, it's interesting and.
And we had a chance to.
Talk with a number of their customers in the process.
Yeah.
This is a company I've known for a long time since my time at NCR and their customer relations chips.
Chips are really just best in class. They are in these large customers because they serve.
A very specific and need relative to mission critical applications that require this fault tolerance high availability type of.
Architecture and software platforms and so.
These agreements do go out I think the average customer life lifespan is somewhere around eight to 10 years somewhere in that neighborhood and so.
If these applications like for credit card processing is a good example of one retail operation financial institutions. The end markets, we talked about are very sticky.
<unk>.
Really allowing us to think about how to engage further and you might imagine.
That with these type of customers that the type of.
Names and logos that they have in their user base you might imagine that there's a lot of.
Investment in terms of AI and machine learning that will open the doors for us to go market our high performance compute.
<unk> portfolio of products and services, which is I think is really the revenue synergies I'm, referring to we haven't even contemplated when we talk about the transaction. So we think this is a great transaction that light.
A company like Stratus has just got such a long history of customer service and mission critical applications at.
At large enterprises, and we really we're really anxious to take the next step and try to expand those relationships.
Okay. It sounds great. Thanks.
Thanks, Kevin.
Thank you Mr Cassidy.
The next question is from the line of Sidney Ho with Deutsche Bank. Please proceed.
Thanks for taking my question and congrats on the deal and it's great to see it immediately accretive just a couple of quick follow up here. It sounds like gross margin expansion is a key consideration here can you talk about gross margin and a 45% 60% range and you think you can do better what's driving the expected gross margin.
And secondly can you walk us through how you think about this cross selling between organic exploration strategy I assume theres not much product service overlap in the stand much customer overlap and do you have to significantly expand your sales force to address that.
Okay. Thanks.
And I'll try to address them in that order.
Yes.
As far as the.
Gross margin expansion from the 45% to 50%.
Uh huh.
Range that Ken gave in terms of his discussion of the overview of the transaction.
Like to walk you through kind of where we came from.
The <unk> transaction, we did back in March of 'twenty, one when we close that.
That was a carve out in nature.
Stratus will be a major part of intelligent platform solutions.
And so this is less of a carve out more of a combination.
And in light of that.
We have some opportunities to take advantage of the strengths of each of our mission.
And there is certainly strength on both sides of the table. So this is more a combination and less of a carve out. So there is opportunities in there to be more efficient as we think about the new combined entity of IPF.
Secondly.
When you think about the.
Combined operating expense of the two businesses today Ips as it exists in stratus.
<unk> got an opex somewhere in the neighborhood of $140 million to $150 million.
And conservatively, we think theres probably over 12 to 18 months is probably 10% is how we're looking at it modeling above and beyond they want accretion and that would come in the area of.
Shared services in finance HR, it legal corporate marketing those types of things and then as we think about.
The overlap in terms of some of the customer engagements as well as.
Our go to supply chain management and <unk>.
There's opportunities there and so when we look at our overall model going forward, we think with scale and the continued growth remember this is a growth business.
We see pretty good.
Opportunities to leverage that scale as this business continues to grow over the long term.
And finally, I just want to repeat what I just said.
You mentioned.
Stratus has account team serving the existing customers.
And obviously on the Ips side, we have our own sales organization supporting our customers, but we haven't modeled in as far as the accretion that Ken discussed we haven't modeled in any revenue synergies of which we think there is relatively strong.
Opportunities to convert and really market.
Into stratasys customer.
Customer base.
High performance compute and some of our hedge portfolio and likewise, we think theres opportunities to do the same with Stratasys technologies into Ips as customer base. So all in all this deal.
With the scale opportunities, there I mentioned and efficiencies relative to a growing business as well as the revenue synergies, which we haven't really quantified because we're trying to be heart dollar in terms of our analysis.
We think this is going to get better from here substantially and Brian just I mean, just to reiterate in terms of some of the customer opportunities.
60% of the Fortune 100, which Mark mentioned three of the four largest credit card companies.
Five of the largest 10 retailers in the world over 11000 systems deployed over 4000 customer support.
Customers, so it's really a fantastic opportunity.
To cross sell across Ips and between Penguin solutions and strengths and there is very limited overlap today, especially if you look at the product portfolio.
<unk> is really complementary to what we have today and so there's some great opportunities that hopefully we'll be able to share with you over the next 12 to 24 months.
Great.
Very helpful. Maybe switching gears, a little bit bigger picture question and Thats, just a generally worried about recession in the upcoming quarters. If there is a slowdown in global demand which of your business.
Do you expect to see the impact first and which business do you think has the most staying power. It sounds like you are quite confident with Ips business, but what are some of the key metrics that you're watching and how quickly can you adjust your cost structure to protect your overall profit pool.
I think there is.
Good question and something that we look at on a on a weekly and daily basis, and we see the markets, we know where they're at.
I'd say the area that we're seeing it the most is what we discussed earlier today is really more in that consumer oriented market.
That primarily for US is Brazil, because what we sell into that market is Pcs and handsets or into the PC and handset supply chain.
The rest of our business. If you look at where that is today, its primarily to enterprise or enterprise spending and there are some specific growth trends that we do have now I can't call something 12, or 24 months out, but but if we look at Ips as an example, and we look out not only into.
The fourth quarter, but into the first half of next year, we do see great demand trends for Ips and these are specific to large scale.
High performance compute systems, and so that will have some nice tailwind for us in specific to that business line in terms of spending.
I've been in semi for longtime marks.
Micron another semiconductor is a long time as well and so.
If there is a cycle obviously there are a lot of knobs that can be turned.
Variable expenses that come down.
Travel expenses that come down there are other actions that we can take and we would take and will take if we see a more challenging environment to ensure that we generate good EBITDA and good cash flow and I would say the one.
Benefit if you will if things do get soft over the next 12 months would be in terms of working capital. That's been an area that we've talked about where we've invested quite heavily here over the last 12 months and typically if things get a little bit more soft.
We will get a positive benefit to our working capital, which <unk> cash and cash flow to the balance sheet. So those are all things that we're going to be cognizant of.
And we monitor.
And we'll take the correct actions as needed Brian .
Okay, great. Thank you very much.
Thank you.
Thank you Mr Huh.
The next question is from the line of Rajiv Gill with Needham <unk> co. Please proceed.
Yes. Thank you for taking my questions and congrats as well on the acquisition.
Just a couple of questions on the near term and then maybe one question on strategy.
If we're looking at kind of the near term outlook.
August with the sequential growth in Ips and led being down kind of low single digits. It implies.
Overall memory being down roughly 19% to 20% sequentially and I just wanted to kind of break down break that out a little bit further between Brazil and specialty memory.
Given the fact that.
To your previous commentary.
You are trying to focus more on enterprise spending so I wanted to get a sense of are you seeing also a sequential decline in the specialty memory, which is tied to storage and is tied to server in tight tight to data center and networking or is the majority of the decline sequentially within memory Prime.
Maryland related to Brazil.
Yes.
Yes, good question.
I from a magnitude perspective, it's certainly more on the consumer facing business in Brazil.
I would say that the other thing I would say is that.
As we ran the business in Q3.
<unk> had some customer shipments in Q3.
The quarter, we just announced.
We pulled into the quarter, because our customers needed it.
We're more service that way in terms of our mindset of just doing the right thing and so.
It might be a little bit of that on timing on specialty but in general as you know, especially has been a huge over performer for us this year.
And.
It's really more of an emphasis on the consumer space.
There might be some timing issues that Q3 Q4 revenue that was pulled in because again, having outstanding quarter in Q3, and some of that did come in relative to customer requirements.
I would say that.
Very heavily on the consumer facing business in Brazil.
Puts and takes.
It could be flat to maybe down but puts allied can talk to that but I guess I would just say we haven't seen the demand signals shifting in the enterprise, especially space for us it's been again, primarily Brazil.
So.
Rajeev on that one it is as Mark highlighted if we see where.
That demand is softening it is primarily that consumer oriented spend which is Brazil, it's essentially PC and mobile handsets in that market.
Where we're seeing softness into Q4.
Okay, great. Thanks for that distinction and just on the inventory the absolute dollar of inventory.
Increase.
If you look at on a year over year basis for the may quarter, it looks like.
Absolute dollar inventory increased 26% year over year in May.
And the revenue grew overall revenue grew 6%.
So inventory growth is far outpacing the revenue growth and I know that.
Important to for the preparation of the IPF build but wanted to get a sense of.
About youre kind of you talked again about your working capital management.
Any risks there in terms of an overbuild.
Or is it almost all related to Ips is there some built in excess build that you had for Brazil or for.
Maybe the proportion of the specialty memory that you could see some sort of correction there.
Yes, I'll give you a little bit of color. There. It's a great question. If you look even in Q2 two.
Two our Q3 more than 100% of our inventory build was specific to Ips. So if you looked at the other two segments their inventory went down quarter on quarter, but that Ips segment. We're building. These large systems, we've talked about that we're going to.
C <unk>.
<unk>, 30% plus growth quarter on quarter, and you can order it and when we can ship it out in the next week, that's just not the business profile and so we are building for not only for Q4, but that demand is there and these are specific systems either custom systems.
For large enterprises as we look out into Q1 and Q2.
And so we have to prepare and to have a little bit of inventory in order to satisfy that demand, but it's something we always look at we have to.
Weekly meetings looking at the inventory, making sure we ended the supply.
To meet our customer needs and also making sure we're not over ordering so there's line of sight into that spend the only thing I would add there is that.
Given the supply environment we're in.
And the backlog that we referenced both Ken and I referenced.
When you're when you're able to get parts to take them right now as you know from the broader semiconductor supply chain issues and so that only further has impacted our positioning on inventory.
And again, largely Ips, which is exciting for us as that business continues to grow.
And a quick question on Ips.
Services revenue as you mentioned was $35 million of the $95 million in the may quarter.
Almost.
37% of the Ips revenue.
Yeah.
Even though Ips and growing in August 30%, you mentioned it'll be more hardware new hardware installations.
Versus services do we expect then that the services related to those kind of new hardware installations, and new contracts will come into play.
In the February May August quarter, whats the lag in terms of.
The services revenue kind of you'd be overlaid on those kind of new contracts.
Yes, it's a good question as we've talked about I think youre pointing out to the nature of the business, especially as we are growing right because.
It's quite possible.
As we've talked about the growth in topline revenue.
The mix as a percentage will change, but I think you asked your question more specifically around win.
Our service base and increases from these new installations is normally they got one to two quarter lag in terms of.
The service contracts and agreements because a lot of what we do upfront.
<unk> engineering, what have you in manufacturing the system investment and systems and then.
The service element and then kind of kicked into a higher portion of the transaction mix. If you will.
Got it and just one question I want to emphasize.
Sorry.
Because you can kind of.
Another thought is I thought about the question you asked.
We are in a business, where there are some some of our competitors in some of our customers who are kind of more hardware hardware mindset.
<unk> said, all along and <unk> teams executed really well in this way.
We're not looking for hardware only transactions. So that's not how we're going to grow in.
Outgrowing the industry today and focused on delivering high value services, and Thats kind of what sets us apart I think from our.
Our competitors in the business and so as we scale and as we grow our capabilities and services I think youre going to see that become more important to the profile of this business.
Yes, that's super helpful to understand that and just a quick question on status.
Based on your commentary so it appears like the main differentiation.
And value add for this company brings us against deploy mission critical applications.
For a lot of these customers you talked about just wondering how long is this company been around.
And what's kind of the competitive landscape.
In that market for mission deployment of mission critical applications.
For the data center to the edge.
So stratus has been around since 1980 and at the risk of.
Daily myself I used to compete against Stratus when I was at NCR because it was.
Tandem Stratus Unisys.
NCR to the extent that fault tolerant architecture and the.
Data center mainframe part of the market and this is for again these.
Fortunately the enterprise applications for mission critical.
Needs and.
100% targeted uptime 90, 90, 990, 999, and so they have a 40 year history of serving the world's largest companies and missile critical mission critical applications.
And when you think about the Nextgen a generation of mission critical applications.
We're on the cutting in and out of that with payment solutions.
So the combination of customer relationships existing service relationships hardware installations platforms, and it's just a fantastic combination.
<unk> been doing this for nearly four decades with the innovation that a company like Penguin solution offers and I think that is just a great marriage.
We can go do at large scale customers.
As we grow and expand the business from here.
That's great I appreciate it thank you.
Thank you.
Thank you Mr Gal.
There are no additional questions waiting at this time, so I will turn the call back over to Mark Adams CEO for closing remarks.
Okay.
Thank you operator.
We are focused on building long term value for our shareholders, we are well positioned and attractive end markets such as artificial intelligence machine learning data analytics high performance computing and cloud solutions, each with compelling long term growth potential.
I am confident that we can continue to invest in our business, while operating the company to maximize shareholder value.
We operate with a capital light model and.
And are able to generate positive cash flows more effectively throughout market cycles, when compared to more capital intensive businesses.
We will be disciplined in our approach to ensure strong continued strong financial performance and cash flow generation.
While investing for our long term success.
In short I continue to be very excited about our future at MGH.
We appreciate all of you for joining today's call.
That concludes the SGA Aztec corner fiscal 2020 to your earnings call. Thank you for your participation you may now disconnect your lines.
Okay.