Q2 2023 SMART Global Holdings Inc. Earnings Call

Good afternoon.

Thank you for attending today's Smart Global Holdings second quarter fiscal 2023 earnings call. My name is Bethany and I will be the moderator for today's call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. If you would like to ask a question, please press star 1 on your telephone keypad. I would now like to pass the conference over to our host.

Suzanne Smith with Smart Global. Please go ahead. Thank you, operator. Good afternoon and thank you for joining us on today's earnings conference call and webcast to discuss SGH's second quarter fiscal 2023 results.

On the call today are Mark Adams, Chief Executive Officer, Jack Pacheco, Chief Operating Officer, and Ken Rizvi, Chief Financial Officer.

You can find the accompanying slide presentation and press release for this call in the Investor Relations section of our website.

We encourage you to go to the site throughout the quarter for the most current information on the company.

I would also like to remind everyone to read the use of forward-looking statements. Note that it is included in the press release and the earnings call presentation.

Please note that certain of the statements made today may constitute forward-looking statements and that these statements are the company's present expectations and that actual events or results may differ materially.

We will also discuss both GAAP and non-GAAP financial measures. Non-GAAP measures should not be considered in isolation from, as a substitute for, or superior to our GAAP results.

We encourage you to consider all measures when analyzing our performance.

A reconciliation of the gap to non- GAAP measures is included in today's press release.

And with that, let me turn the call over to Mark Adams, CEO Mark.

Thanks, Suzanne, and thank you all for joining us today.

Our team at sghh delivered solid results in our second quarter of fiscal 2023, in what has been a challenging macroeconomic environment.

While Ken will review the financials in more detail.

I'd like to call out a few highlights that demonstrate the resilience of our business in times like these, before turning to a review of each of our segments.

SGH achieved record non-gap gross margins of 28.9%.

non-GAAP earnings per share of 76 cents.

Which exceed the high end of our guidance range on sales of $429 million.

We generated strong cash flow from operations, exceeding $1 million in the quarter, and exited Q2 with a strong balance sheet, including $376 million in cash and cash equivalents.

While not immune to market headwinds, SGH continues to execute well throughout the cycle.

With our deep manufacturing expertise, extensive customer relationships, discipline operating model, and strong balance sheet,

I believe SGH will successfully navigate these near-term challenges.

Longer term, we believe we are well positioned for growth and attractive returns as our business is tied to multiple secular tailwinds, including AI, machine learning, data analytics, 5G, enterprise storage and specialty lighting.

Now let me review each of our business lines.

Starting with IPS, which is comprised of our Penguin solutions and Stratos technology brands.

We design, manufacture and deploy hardware, software and services.

for high performance computing, AI, and high availability applications on premise, in the cloud, and at the edge.

In Q2, IPps had another record quarter of sales at two hundred and twenty-two million dollars.

which represented 52% of total SGH sales, reinforcing the transformation we are going through at SGH.

Q2 IPS cells more than doubled versus the year-ago quarter excluding Stratus technologies, and we're up by 170% including Stratus.

As part of SGH, Stratos Technologies has performed very well with revenues and gross margins ahead of the guidance given at the time we announced the transaction.

With the addition of Stratus, the service's portion of IPS sales more than doubled from the year ago period.

This highlights our ability to provide greater value to our customer base, resulting in a higher-margin, more stable revenue stream.

During Q2, we were pleased to see Penguin Computing's Jade system, a 1300 node Intel Xeon based system.

That is among the world's largest open compute platform-based installations.

Receive recognition as one of the two supercomputers to power the recent nuclear fusion ignition breakthrough at Lawrence Livermore National Labs.

This is the first time that more energy was produced by an artificial fusion reaction than was consumed.

This is a historic win that provides important insights into the future of clean fusion energy, and we are proud to be part of this effort.

Also, during fiscal Q2, Stratos was recognized with Processing Magazine's 2022 Breakthrough Product Award in the Edge Computing category.

Our second generation Stratos ZTC edge computing platform offers a zero touch, secure and highly automated system.

which enables digital transformation across multiple industrial segments.

And it's one of the industry's only solutions offering built-in application virtualization.

fault tolerance in an easy to install ruggedized design for the edge.

As we have noted on prior calls, IPS sales can be lumpy due to the deployment cycle of larger customer installations.

Nonetheless, over the mid to longer term, we see significant growth drivers for this segment and remain bullish about our ability to expand our customer engagements. With Penguin's solutions and strata coming together, IPS has the portfolio breadth that can support our customers' compute needs. On-premise?

in the cloud and at the edge.

We are still in the early innings of AI, machine learning, and data analytics.

Given our over 20 years of system design and deployment expertise working with large enterprise customers,

We believe we are well positioned to capture long-term growth.

Now turning to our LED Solutions Group, which operates under the Cree LED brand and produces application optimized LEDs for specialty lighting, video screens, gaming display, horticulture, outdoor and architectural lighting. For the second quarter of fiscal 2023,

LED solution sales totaled $56 million, or 13% of overall SGH sales. Crete LED faced ongoing challenges due to soft demand stemming from the current economic environment.

which was further suppressed as customers continued working down inventory levels.

Given such market conditions, the team is focused diligently on cost controls to tightly manage the business and navigate near-term challenges.

While being mindful of spending, Cre LED continues to invest and strengthen this position as a leader and customer focused innovation.

During the second quarter, Creled introduced three new high-brightness LEDs targeted for large-format video displays such as stadium signs, airport displays, and full-color roadway signs.

Additionally, the team announced the release of its new XLAMP Pro 9 high-efficiency, high-CRI, or color rendering index, LEDs with the industry's highest operating temperature rating, which makes it ideal for commercial indoor lighting applications that require high-quality light.

We believe that our outsourced manufacturing model and continued innovation leadership have us well positioned for recovery in the LED sector. Based on our most recent customer touchpoints, we are starting to see signs of improvement in customer demand and expect revenue to increase modestly in fiscal Q3. Shifting to memory.

Our memory solutions group is made up of two businesses.

Specialty memory which is focused on the enterprise industrial and federal end markets.

which is focused on the enterprise, industrial, and federal end markets, and our Brazil-based module business.

Overall, Q2 memory sales came in at $151 million, or 35% of total SDH sales.

Sales were lower sequentially, primarily due to a continued decline in both worldwide memory pricing.

and the global demand for PCs and mobile phones, the latter significantly impacting our Brazil business.

Focusing first on our specialty memory business.

Sales were slightly down from the first quarter levels.

Slightly down from the first quarter levels, higher sales of our flash-related solutions.

Were offset by weakness in our DRAM-related business.

Our DRAM business faced challenges due to continued downward pressure on pricing and a higher level of inventory at a few key accounts.

As part of our longer-term growth strategy to grow our specialty memory business revenues,

We remain focused on enterprise applications in the data center primarily around DDR5 and compute express link or CXL.

CXL plays into our strength of combining DRAM memory with an intelligent controller to meet the desired requirements of our customers.

CXL is a new interface technology that allows the expansion of memory capacity as well as the ability to share memory among servers.

We believe the result will be an increase in our memory TAM, along with the proliferation of form factors and feature sets that should increase the opportunity for our specialty memory solutions.

In our Brazil memory business, we continue to see downward pressure in what is already a challenging environment for PCs and mobile phones.

Based on our latest customer interactions, we believe our sales in Brazil are starting to stabilize, and we feel that growth from solid-state drives or DS 5, G, and DDR5 applications will drive our recovery over the coming quarters.

Despite the headwinds within memory, we have continued to operate the business well.

Unlike traditional memory semiconductor manufacturers, our business model is different, as we incorporate memory chips as part of the bill of materials and then add value above the core chip technology for our customers.

Therefore, our results have been relatively stable as demonstrated by our segment operating margin for our memory business, which was approximately 10% for Q2.

In addition, we are optimistic that the steps being taken by larger memory suppliers, such as reducing capital expenditure and selectively lowering wafer output, will achieve a better supply-demand balance and ultimately have a positive effect on the recovery of SDH's memory business.

I'll stop here and hand it over to Ken for a more detailed review of our Q2 financial performance and our guidance for the next quarter.

for a more detailed review of our Q2 financial performance and our guidance for next quarter.

Thanks, Mark. I will focus my remarks on our non-GAAP results, which are reconciled to GAAP in our earnings release table. Now let me turn to our fiscal second quarter 2023 results. Despite the continued macroeconomic headwinds, we reported a solid quarter in Q2, helped by an operational discipline, measuring financial Kim prior charge and also adding the loss of business.

the strength of our ITS segment which has both record revenues of 222 million dollars as well as record segment operating income of approximately 38 million dollars.

Total SGH revenues were $429 million and non-GAAP gross margin came in at a record 28.9% above the high end of our guidance rate.

non-GAAP diluted earnings per share was 76 cents for the second quarter, also above the high end of our guidance range. Last quarter, we began providing the breakdown of our overall SGH revenues by products and services.

As a reminder, our services revenue includes longer term services as well as point in time services such as logistics and implementation services.

In Q2, our overall services revenue totaled $55 million, up from $36 million in the year-ago quarter, helped by the inclusion of strategic technologies, which we acquired at the beginning of this fiscal year, and product revenue.

for $374 million. Second quarter revenues by business unit was as follows. IPS had a record $222 million, LED at $56 million, and memory at $151 million.

This translates into a sales mix of approximately 52% for IPPS, 13% for LED, and 35% for memory. For the first time, IPPS represents more than 50% of our total sales.

non-GAAP gross margin for SGH in Q2 was a record 28.9%, up from 26% in the year-ago quarter, helped by the inclusion of Stratos within IPS and higher sales from Penguin Computing.

Non-GAP operating expenses for the second quarter were $72.5 million, down from $74.4 million in the first quarter of 2023.

Operating expenses were down from the prior quarter primarily due to cost containment initiatives. Operating expenses, however, were up from $59.5 million in the year-to-go quarter due to the inclusion of Stratus. In addition, operating expenses benefited in this.

approximately $1 million of benefits in our third quarter of 2023.

non-GAAP diluted earns per share for the second quarter of 2023 was 76 cents, compared with 87 cents per share in the year-ago quarter.

Adjusted EBITDA for the second quarter of 2023 was $63 million, or 15% of sales, compared to $66 million, or 15% of sales in the year-ago quarter.

The adjusted EBITDA for the second quarter of 2023 was $63 million, or 15% of sales, compared to $66 million, or 15% of sales in the year-ago quarter. Now turning to balance sheet highlights.

For working capital, our net accounts receivable totaled $229 million compared with $306 million last quarter.

Day sales outstanding came in at 36 days, up three days from last quarter, primarily due to the timing of invoicing and collections for IPS.

Inventory totaled $294 million at the end of the second quarter, down from $416 million at the end of the prior quarter.

The decrease in inventory as outlined during our last earnings call was driven primarily by higher levels of IPS shipments in our second quarter.

Inventory turns were 6.3 times in the second quarter versus 7 times in the prior quarter.

Consistent with past practice, net accounts receivable, days outstanding, and inventory turnover are calculated on a gross sales and cost of goods sold basis.

Which were $573 million and $463 million respectively for the second quarter, and as a reminder, the difference between gross and net revenue is related to our logistic services which are accounted for on an agent basis, meaning.

We only recognize the net profit on logistics services as revenue. Cash and cash equivalent doubled to $376 million at the end of the second quarter, up $51 million compared with $325 million at the end of the prior quarter.

Second quarter cash flows from operating activities to over $101 million, compared with cash used for operating activities of $74 million into prior quarter.

As a reminder, we used cash in operating activities in the first quarter primarily due to the $101.8 million Earn-Out-Dose from the CRE LED acquisition. We accounted for a majority of this prepayment in our operating cash flow given it was a contingent consideration.

in January of 2023.

To date, we've spent approximately $58 million under our $75 million share repurchase authorization since April of 2022, repurchasing approximately 3.2 million shares in aggregate.

For those of you tracking capital expenditures and depreciation, capital expenditures were $12.6 million in the second quarter and depreciation was $9 million.

In the second quarter of 2023, we strengthen our balance sheet further through privately negotiated exchange agreements with some of our convertible note holders.

We exchange $150 million in principal amounts of our 2026 convertible notes for new 2029 convertible notes.

The new 2029 convertible notes have a slightly lower coupon of 2% as compared to 2.25% for the 2026 notes.

and a slightly higher conversion price of $21.23 as compared to $20.30 for the 2026 note utilisation at $25.punished at $ Wallet Rock CitizenPeterD official name

In addition, they also have a higher cap call, which protects us economically up to $29.14 per share, whereas the 2026 notes are protected economically up to $27.07 per share. Now let me turn to our fiscal third quarter 2020.

For ITS, as we discussed on prior calls, we expect lower sequential revenues.

For memory, we see our business stabilizing from second quarter levels, and for LED, we expect a modest improvement in revenues from the second quarter.

Our gap gross margin for the third quarter is expected to be approximately 26% at the midpoint, plus or minus 1%.

Non-gap gross margin for the third quarter is expected to be approximately 28% at the midpoint, plus or minus 1%.

Are non-GAAP operating expenses for the third quarter expected to be approximately $72 million, plus or minus $3 million, consistent with the prior quarter?

GAAP diluted earnings per share for the third quarter is expected to be approximately negative three cents plus or minus ten cents.

On a non-GAAP basis, excluding share-based compensation expense, intangible asset amortization expense, debt discount, and other adjustments, we expect diluted earnings per share will be approximately 40 cents plus or minus 10 cents.

Our GAAP and non-GAAP diluted share count for the third quarter is expected to be approximately 50 million shares based on a current stock price.

and cash capital expenditures for the third quarter are expected to be in the range of $12 to $15 million.

Our forecast for the third quarter of 2023 is based on the current environment, which contemplates the global macroeconomic headwinds and ongoing supply chain constraints.

We continue to manage our operations in a prudent manner as we navigate a challenging environment, while also continuing to invest in our long-term growth.

Please refer to our non-depth financial information section and reconciliation of GAP to non-GAP measure cables in our earnings release for further details.

And with that, let me turn it back over to Mark for a few comments prior to Q&A.

Thanks, Ken. Despite the near-term economic uncertainty,

We remain optimistic about our competitive positioning in the end markets we serve, which include AI, machine learning, data analytics, 5G, enterprise storage, and specially lighting. I want to thank our global team at SGH for their execution and Q2. To achieve record non-gap gross margins.

exceed our EPS guidance, and strengthen our balance sheet during these turbulent times is a testament to the efforts of our global team.

With that operator, we are now ready for Q&A. Thank you.

If you would like to ask a question, please press star followed by one on your telephone keypad.

If for any reason you would like to remove that question, please press star followed by two. Again, to ask a question, please press star one. Of a reminder, if you're using a speaker phone, please remember to pick up your handset before asking your question.

We will pause here briefly as questions are registered. Our first question comes from the line of Kevin Cassidy with Rosenblatt. Please go ahead....

Thank you for taking my question. With memory solutions stabilizing, that's very good news. Can you give us a little more detail on how that would be split between the specialty memory and the Brazil memory? Are they both stabilizing equally or is one doing better than the other?

One moment.

While the speakers reconnect.

We now have the speakers back on the line.

Hello. Sorry about that. Hey, Kevin. Hopefully you can hear Mark. We had some technical difficulties here. You have Mark and Ken, but can you answer your question again?

or ask your question again.

or ask your question again. Yeah, sure. safety.

I was just asking for the details on the memory solutions. It's great news to hear that it's stabilizing. I just wanted to know how the split is in the stabilization. Is it mostly the specialty memory doing better or is both specialty and Brazil both stabilizing? Thanks, Rick. Thanks, Rick.

Thank you for your patience. Where we've seen just more of what it feels like is kind of a bottoming out on the pricing side of the business, kind of feels like we're bouncing around the bottom on the price side and demand.

Appears to be stabilizing and, as we think about Q3-Q4, hopefully, hopefully, seen that play out as such, as you've kind of heard from some of the more recent announcements of larger semi-IDE memory.

It's been an unprecedented period probably dating back to 15 years or so. And as such, I think the steps being taken to get a better supply and demand balance are in place. And again, we're pretty optimistic that there's a recovery.

forthcoming. It's a little bit hard to call timing wise, but we're seeing some stability in the business.

Our forthcoming. It's a little bit hard to call timing-wise, but we're seeing some stability in the business, okay.

As a follow-up on the IPS business, you've been telegraphing that your visibility beyond the second half of the fiscal year was getting weak. I just want to know if it's clearly your guiding for a lower third quarter. You've been telegraphing that your visibility beyond the second half of the fiscal year has been getting weak.

What are you seeing as far as far as out beyond the third quarter? Do you have backlog buildings or is it still low visibility?

I think that's a good way of putting it. We are in the process of building up our backlog towards the end of our fiscal year heading into fiscal 24. As I commented earlier, the tailwinds on the market environment long term are in good growth markets being AI and machine learning.

that two years ago wasn't making money and I think we're going to report something like 17% operating income for this quarter so it's been an incredible turnaround. But as I would just say that in the middle of April 2023, you know budgets are kind of in process and the one caution I would say there is just we don't we don't know how enterprises will

manage their budget process. We think it's going to be a good year for us but we don't have line of sight yet on fiscal 24 so it might be a little too early for us to call the number so to speak. But in general the customer engagement is good, the backlog building process is on a good path and we feel optimistic but just again normally budgets get set kind of mid

Midsummer to early fall in this business, and we want to just kind of make sure that we can tap into the visibility that we get as we approach our Q4.

Okay, thank you.

Okay, thank you. Thank you.

Our next question comes from the line of Brian Chen with Stiefel. Please go ahead. Your Since stops here you have nowabaitedwrights at Though 1. In Sam.

Either good afternoon. Can you get Remy? Okay, I know it's kind of been over the ain't.

Yeah, Brian , we can hear you. Can you hear us?

Yeah, yeah, I've got you. Well, I'm unclear, thanks.

Yes, I'm curious. First, on the memory business: a pretty big sequential decline in the February quarter - although also a pretty big memory - a pretty big decline in the memory market pricing also over that period. I'm curious.

In terms of the pass-through of lower memory prices, is that kind of a real-time event, particularly on the...

especially memory part of your business. Thus, if the ASP declines do start to lose momentum, I guess that's the right way to put it.

Yes I, that's part of that- reduce head when you're saying yes. So briefly, let me answer it. The exposure we have, so typically on our balance sheet, we carry in the neighborhood of four to 5, four to six weeks.

inventory for memory and so that there is some exposure they're both good and bad depending on where ASPs move but it's fairly limited to that but when you look at our business especially around the specialty segment our customers know for the most part what the pricing is for various memory components

And therefore, that piece is more of a pass-through, and it's really the value-add that we provide on top of the memory for those specific applications. That's why customers work with us, and it's also part of the reason that you saw.

the strong operating margin performance in Q2 from our overall memory segment. So even though we've seen some headwinds in the overall revenues, if you look versus a year ago quarter, or year over year on the quarterly results, the op income percent has still remained fairly healthy, which is a testament to the strength of that business and how we operate.

It looks like most of the sequential revenue decline is going to be from IPS and kind of consistent with what you said about sort of the momentum being a little more physical first half versus second half loaded. I'm curious what kind of went better within that IPS s NICS and fiscal to cue to drive gross margins to nearly 29% and how do you see

And part of that initiative is driven by our commitment to provide value-add managed services to our customers who we engage with. And as we commented on, services continues to be a really strong part of this business. And when you complement our systems and solutions, software solutions, bundled with services.

We think that the gross margin profile of the business continues to be relatively stable and strong. So, that's kind of what's driving it for us, as it's just really been a discipline not to focus on revenue, but to really focus on value-add solutions that we bring to our customers. This, and Brian, as you look at it.

The guidance that we provided, even the strength that we had in Q2, where we had impressive gross margins of 29%, and in our guidance, even though we have revenues coming down in Q3, the margins still remain very healthy at 28% on a non-GAAP basis.

A lot of that is driven by what Mark just mentioned, the combination of solution sales within IPS in a large portion of services, our big services component. Now there's always going to be some lumpiness that we talked about in terms of having hardware sales or more hardware centric quarters.

And that can move the margins around a bit. But I think what you've seen over the last couple of quarters is that we've been able to maintain these margins in part due to the overall services mix which is primarily focused around IPs just clicking on all days, and you mentioned recovery as well.

over the last two quarters and we talked about a couple quarters ago that typically if you look at where we are in the cycle it takes in that neighborhood of two to three quarters to burn down the inventory of the channel. We've seen that over the last two quarters we probably burned down.

close to $12 million of inventory in the channels. That means that the cell in is less than the cell through. As we head into Q3, we are seeing more stabilization. There could be a little bit of channel burn, but back to normalized levels. We should start to get back to a demand environment and a revenue environment where

our revenues equal and demand and we're starting to see an uptick at least as we look at Q3 we're expecting revenues to be modestly up from Q2 levels which is a good time.

Great, thank you.

Great, thank you. Thank you.

Our next question is from the line of Sydney Ho with Deutsche Bank. Please go ahead. Okay.

Thank you. Maybe a couple of questions. First, on the IPS side, I think last quarter you guys talked about first half versus second half being 60, 40, or 55, 45. What is your view now? Maybe you can double click on it and highlight what has changed. Maybe as part of that, you guys are talking about software and services mixes kind of lowered.

is true as we look at the back half of the year, relative to the first half of the year for IPS specifically. We had a number of great projects in Q1 and Q2 and we tried to highlight the fact that it was going to be more of a front half loaded year, although still continued strength in the second half for IPS, especially if you looked at the previous year.

relative to where that business was a year or two years ago. On the services piece, as I mentioned last quarter, is that there's two components. There's some ongoing services where we have visibility, call it up to a year, sometimes even beyond that.

And then there are services that are more what I would classify as point-in-time services. Those can be design, implementation services, and the like. And so that's what adjusted from Q1 levels as we had more point-in-time services.

as a portion of our overall services PICs. Now, as we look at Q3, if you ask me where will that services portion be in terms of dollar figures, I would expect that to be in a similar range as Q2 levels, potentially a little bit higher.

in Q3 versus Q2. Okay, that's super helpful. Switching gears a little bit, you guys talk about DDR5 opportunity. What is your expectation in terms of timing of the RAMP now versus maybe a standard DDR5? I think some of the memory supplies are talking about crossover being mid-calendar 24.

Maybe remind us where you see the strength in DDR5 versus some of the memory manufacturers. Could it be a similar timeline or do you have a different timeline than those guys? Thanks. Thanks for the question. I think by and large it's similar.

We've got kind of the two businesses, right? Brazil more consumer focused. We'll actually see some of that we think in the mid to late 24 time frame, similar time frame that you just talked about. And then in our specialty business it's a little bit less dependent so to speak on leading edge. We have a fair amount of current.

current technology platform solutions and then obviously we have some legacy on some of the more traditional Milero or networking telecommunications solutions that people want continuity of supply of an existing or legacy product. So I'd say specialty is a little bit less dependent on DDR5 although we will have limited or limited Bur..

offerings around the time frames you talked about. And Brazil being more consumer focused, it's gonna be probably more prevalent on leading edge out in the middle of calendar year 24.

the time frames you talked about. And Brazil being more consumer focused is going to be probably more prevalent on leading edge out in the middle of calendar year 24. Okay, great. Thanks.

Thank you. Again, to ask a question, please press star followed by one on your telephone keypad. Our next question comes from a line of Nick Doyle with Needham. Please go ahead.

It isn't a long for. Roger Gil wants to ask a question about the LED business. Great to see that you think you're kind of bottoming there. Maybe some sequential increase.

Brian kind of spoke about how it's made or related to the inventory situation, when you could kind of expand on any demand signals, maybe specific to China, that you're seeing now and if that's contributing to your outlook. Yeah, I'd say it's a combination of those two things that you highlighted. There's a.

Q3 visibility in the business for a modest increase.

Okay, and could you expand a bit on the channel inventory for the memory business? Yes, any kind of timeline there would be great.

Yeah, if you look at the memory business, we don't have a real channel exposure. Many times we're either or sell directly either to the OEMs or the contract manufacturers. And so very limited to know Disney inventory per se. The area that we do have this distribution exposure.

Is really primarily related to the LED business and it comprises the LED business. It's probably about 60% or so, plus or minus, of the LED specific business that we had, just the exposure to.

Thank you.

There are currently no more questions waiting at this time. I would like to pass the conference back to Mark Adams for any closing remarks.

Thank you, and thank you all for joining today. As we mentioned at the outset, we continue to operate the business very well in the Brazilian nature of our business, generating the cash that was alluded to: over $1 million in the quarter with record non-GAAP gross margins.

We continue to be bullish on the secular tailwinds of the markets we serve and we look forward to further growth and expanding our business in the future. Thank you.

That concludes today's conference call. I hope you all enjoy the rest of your day. You may now disconnect your lines.