Ladies and gentlemen, thank you for standing by, and welcome to the SMART Global Holdings First Quarter Fiscal 2020 Earnings Call. At this time, all participant lines are in a listen-only mode. After the speaker's presentation there will be a question-and-answer session. [Operator Instructions] I'd now like to hand the conference over to your speaker today, Ms. Suzanne Schmidt, Investor Relations. Please go ahead, ma'am.

Thank you, operator. Good afternoon and thank you for joining us on today's earnings conference call to discuss SMART Global Holdings first quarter fiscal 2020 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. 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 statements. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections and future market conditions, is a forward-looking statement. Actual results may differ materially from those expressed in these forward-looking statements. For more information, please refer to the risk factors discussed in the documents we file from time to time with the SEC, including our most recent Form 10-K. We assume no obligation to update these forward-looking statements, which speak as of today. Additionally, during this call, our non-GAAP financial measures will be discussed. Reconciliations for those directly comparable GAAP financial measures are included in today's earnings press release. With that, I will now turn the call over to Chairman and CEO, Ajay Shah.

Thank you, Suzanne. And welcome to everyone on the call. We completed the first quarter of fiscal 2020 with our memory businesses, which are Specialty Memory Products and Brazil memory, both performing at or above our expectations. Our Specialty Compute and Storage or SCSS Group came in below expectations for the quarter as we saw delays in some orders in our Penguin Computing government business due to some of the budget delays. As we've communicated previously, some of SCSS is exposed to large government programs, and this area of our business can be lumpy from quarter-to-quarter. In total, net sales for the first quarter came in at $272 million, just slightly below our guidance range and below the previous quarters $278 million revenue. This revenue shortfall contributed to lower than expected profitability resulting in non-GAAP EPS at $0.55 for the quarter, but higher than the previous quarter's $0.50 per share. In this first quarter of fiscal 2020, approximately 38% of revenues came from our Specialty Memory Products business, 35% from our Brazil business and 27% of revenue from Specialty Computing Products, which is a very good balance overall of businesses and provide stability and expands our markets served in a very meaningful way. So, we are well on our way to transforming into a balanced set of businesses that provide solutions for the far edge, components for the enterprise data center, embedded components and systems for a broad variety of telecom, networking, industrial, transportation, and defense applications, as well as large high performance computing systems for scientific and AI development. All these businesses are underpinned by our ability to address our customers' unique requirements through our go-to-market and efficient supply chain and delivery systems. During the quarter, our team here at SGH has made tremendous progress in successfully integrating two…

Great. Thank you, Ajay. Overall, gross revenue for the first fiscal quarter was $418 million, while net sales were $272 million. As a reminder, the difference between gross revenue and net sales is related to our supply chain services business, which is accounted for an agency basis, meaning that we only recognize the net sales, the net profit on supply chain services transactions. Our breakdown of net sales by end market for the first fiscal quarter was as follows: mobile and PC's 30%; network and telecom 23%; servers and storage 10%. With the industrial aerospace defense and other continuing to be our largest end market at 37%. Now, moving to the rest of the income statement. Non-GAAP gross profit for the first quarter was $55.7 million, an increase from last quarter's $53.4 million, primarily due to our memory businesses. Non-GAAP operating expenses were $37.4 million, compared with $35.4 million in the previous quarter. The increase was primarily due to a full quarter of our two recent acquisitions. Non-GAAP net income for the first fiscal quarter was $13.4 million or $0.55 per diluted share compared with $11.9 million or $0.50 per diluted share in the previous quarter. Adjusted EBITDA totaled $23.5 million, compared with $25.2 million in the prior quarter. Turning to working capital. Our net accounts receivable increased to $228.8 million from $217.4 million last quarter and our day sales outstanding increased to 50 days for this quarter, compared with 47 days last quarter. Inventory totaled $160 million at the end of the first fiscal quarter, compared with $119 million at the end of the fourth fiscal quarter. Inventory turns dropped to 9.1 times from 12.5 times last quarter as we added the inventory from our two recent acquisitions and an increase in inventory for some supply chain programs. Consistent…

[Operator Instructions] Our first question comes from the line of Brian Chin with Stifel. Your line is now open.

Hi there. Can you hear me now?

Yes, we can hear you now.

Sorry about that. Hi, good afternoon. Thanks so much for taking our questions. Maybe to start with that – with the Penguin business, in terms of the revenue shortfall. I understand, you, kind of highlighted or lowlighted federal as kind of the reason for that. But Micron did yesterday talk about some shortages of high-density DRAM modules. Just curious whether that was a constraining factor at all in terms of project timing for any of your customers?

No. We – I don't think that that was the issue. What we understand, and I have to say, based on our understanding, many of the labs and government agencies have been waiting for the budget appropriations bill to be passed, which I follow very closely as a result. So, as you can – you might have tracked that, that is going through, I believe, the Senate right now and hopefully will be approved, but through the White House shortly. So, the issue we're talking about is mostly to do with order releases, all these programs have been approved, but they are now waiting for a budgetary green light and that is what has delayed the release of these orders.

Got it. So, maybe this could steer revenues, maybe little more at the back half of the fiscal year. Perhaps?

Yes. It will – our back half of the fiscal year is always stronger in the government anyway. And we don't expect that this means that we will stack this business on top of any other forecast. This will just slide everything out by some period of time, maybe, our best expectation is three, four months, but unfortunately, it's a pen there is – goes all the way to the White House.

I mean, some of these are programs that have to start, but once they start, they go, but you don't, like Ajay said, they don't add on top. So, if you lose X amount this quarter, it starts next quarterly, that doesn't start on top of some amount that's just want to start.

It just pushes out.

Everything just pushes out in another three, four, five, six months to the end of the program.

Sure. Just one more question here and then I have one more question just on other business. But in terms of the operating margins that maybe you, kind of are targeting by the end of this fiscal year. Maybe even given the softer start in terms of the Specialty Compute revenue, what are you sort of targeting exiting the fiscal year in that business?

In the Penguin business?

Yes. The Specialty Compute and Storage business overall.

Yes. I mean, we typically don't break out our margins by the various areas. If you look at the company, I mean, if you look at SMART overall, we'd expect our operating will somewhere end in – maybe the kind of mid-to-high single digits this year with the kind of start we have.

Okay. That's helpful. And then – yeah. I'd say, qualitatively given sort of the flattish plus or minus revenue guide somewhat Specialty Compute down, maybe sequentially, Brazil down sequentially. And then so, especially, memory I guess up Q-on-Q. And so, corresponding to sort of your comment about February quarter could sort of be the bottom in that market? Do you think we already past sort of the bottom in Specialty Memory revenue right now? And did you see sort of right momentum build in the quarter, kind of beginning to end?

Yes. I think, specialty, definitely I – we think in Q1 we're starting to see a little bit of traction as we exited the quarter with some of our larger OEM customers. So, we were – we expect the Q1 was kind of the bottom for that business.

Yes. So, there's two comments here, right? One is to do with the business level at our major customers. Our major customers, we've been expecting a recovery for a couple of quarters and it's been slow in coming to be honest. So, as I was attempting to explain, we have over year ago started to invest in broadening our customer base into Tier 2, Tier 3 customers and our product base. And that is what has allowed us to continue to deliver essentially flat revenues, even in a declining ASP environment, Memory prices continuing to decline. Now, hopefully, the memory prices will stop declining, that's the indication we are getting from the markets. And in fact, it's a pretty specific indication, because our NAND prices are actually going up a little bit and lead times of definitely going out. And so, we are optimistic that our Specialty Memory business with both of those legs, one being new customers, new design wins. And then the other being prices not going down, or maybe even going up. And God knows if our major customers started to be a little stronger then that would be yet another tailwind. I don't know if that's the answer you were looking for. I think it is.

Yes. It's very helpful. Thanks so much.

Our next question comes from Rajvi Gill with Needham & Company. Your line is now open.

Yes, thank you. The question on the gross margin, so the margin came in lower in November because of the lower revenue and are kind of guiding slightly – actually guiding down about 50 basis points sequentially, it came in below expectations. Is this just primarily a function of the lower volume because of the government programs that are being delayed? And if so, once that business returns, do we expect to kind of have an uplifted margin? And any other kind of specific commentary around the drivers of mix as we go into the next fiscal year?

I mean, really, actually the main driver of the gross margin decline that we're forecasting is really Brazil. Brazil, we have a high fixed cost basis in Brazil and Brazil had a – we're saying we're bottoming out in Q2, but Q2 is our seasonally weak quarter in Brazil, right? And so, we – the impact there is, it's enough of an impact on the gross margin where it's taking it down 0.5 somewhere, we had kind of thought it would be. So, it's really more targeted to Brazil than the mix, even in the Specialty Compute business.

Okay. But in Q1 – in fiscal Q1, the gross margins came in below your guidance.

Correct. Yes, that was …

550 basis points.

Correct. That was impacted by this Penguin – this Specialty Compute Group having some orders that we thought we were going to get some business, we didn't get that, it was a higher gross margin kind of business in our forecast.

Right. Okay.

And the underutilization, I mean, the so-called OCOGs, as we call it, the materials costs stay fixed, but the revenue is reduced so you end up with a lower gross margin.

So, it was good to know that you've now have one full quarter of the new content rules, the new point systems in Brazil. And that you said you performed better than you thought. I was wondering, is that – is there potential upside in that business because of the new rules? Is there a better visibility that will be granted to you? Is there upside to drive higher penetration? Or, is the kind of the sequential growth in Brazil, mainly a function of, as you said, a higher unit demand and moderate price declines? I'm just curious about your commentary that if you perform better than you thought, now that you have a full quarter of the new rules. I'm just wondering if the new rules could actually could help your Brazil business going forward or is it just really based on these other factors?

I think the new rules have – I was – I think we were trying to explain the last time as well that the new rules allow us to be much more dynamic in terms of how we address this business. We are no longer constrained by a certain percentage that the customer must buy. And therefore, there was a floor and a ceiling. However, now the customer is not constrained in the same way in terms of a floor, but he is not constrained the same way as in a ceiling if you know what I mean. And so, we've been very active in terms of talking to our customers and persuading them through both our service level, making it easy for them to really concentrate most of their points on memory. And as I've mentioned before, memory turns out to be the lowest cost per point of any major item. So, as a result, we think that that actually gives us the ability to drive the business further. So, to come back to your question, that allows us to figure out how we want to play market share versus revenue growth versus profitability or rather call it gross margin. And we can work with our vendors as well to try and best position ourselves in front of these customers. So, we net-net look at that as good news for various reasons. Increased flexibility, the ability to grow the business further. And so, to try and give you a simpler answer to your question. Yes, I think, it creates some upside possibilities.

And just a housekeeping question, Jack. The tax rate of 4%, how do you think about that going forward? It's been kind of all over the map last year. How do we think about that?

You can thank our accounting regulators for that. Okay. But I think Q2 – we've guided a pretty low tax rate in Q2, but I think, we will go back up to where we kind of thought we should be as we get into Q3 and Q4 just with how our – where we forecast our profits to be.

Okay. We should model a what tax rate in Q3 and Q4, something higher than 4%?

Yes. I mean, back to, I think we said somewhere between 12% to 16% is kind of we talked about kind of for the years. So, we modeled – we started looking at something more in that kind of range to get back to half quarters.

I see. Okay. Thank you.

You're welcome.

Thank you.

Our next question comes from the line of Mark Lipacis with Jefferies. Your line is now open.

Hi. Thanks for taking my questions. First one on the Penguin Computing business. Ajay, you had mentioned the pipeline looked really good, despite some near-term pushouts. Is that – can you give some color on that? Is that due to the consolidation that's happened in the industry? And are you – is there like – do you view this as kind of like a sustainable step function and share gains for you guys as we go through the next several years? Are there new kinds of programs that you guys are able to prosecute because of this? That's the first question and I have a follow-up. Thanks.

Thank you, Mark. Yes. That is exactly right, because of now – really as – we'll take two different – maybe three different sectors. One is sort of government. Government may include AI and may not, but it's certainly a large HPC systems. In the government, as you know, there is a requirement to have more than at least two and maybe three vendors. And so, where we might have been on the customer for cutout, we are now in on many of these programs. So, that is certainly helping the pipeline. And by the way, in some very significant and larger opportunities, hopefully, and I don't want to jinx it. I think we're really well positioned for a couple of very large opportunities. Then that's the government sector. Then in the commercial sector, particularly related to some of the newer systems that are Intel-based, we've been investing a lot of our efforts in developing products around some of the new Intel processors. As I mentioned before, we have shipped one of our largest systems ever, the Magna system. And so, we are seeing increased opportunities through those product areas with particularly the commercial customer base. And finally, AI, I mean, you're seeing – I talked about this and it may not resonate easily, but in the past Penguin has always been simply about integrating solutions that the customer wants. In other words, we were very customer driven in terms of the actual configurations which we ended up creating. However, what we've been doing is, productizing some of these and we now offer what we call solution packs that are for different applications, such as certain AI applications, for example, retail automation. And now those solution packs give us a different kind of a pipeline opportunity. So, that's really helping to build the pipeline as well. Is that along the lines of the question you asked?

Yes. That's very helpful. And a follow-up, if I may, on the battery business in Brazil. Can you give us a sense of where you are in the ramp? How big is that? And does that – does that business grows? Does that help to offset the higher fixed cost, the OCOGs, as you described in Brazil or is there a separate set of OCOGS for battery that you have to absorb separately from your existing memory module business in Brazil?

Yes. I'll take that one. So, yes, I mean, we've kind of said – when you remember way back when we started the thing that we said this is about $25 million to $30 million opportunity in the first year and it's looking to be that kind of an opportunity. And so, Q1, we're well on our way to get in that range for this year on the battery business. On the OCOG it's not – the problem of OCOG for now is the fixed part is really the packaging operation. It has a huge fixed cost to it. And so, when the units go down our seasonally weak quarter, it definitely drags on the gross margin. The battery business is a whole separate set of equipment. It's not anywhere near the fixed cost of a packaging type operation. So, it's impact on OCOG is much lower than what you have from the packaging side of the house.

Okay. That's very helpful. And a last question, if I may. The – can you talk about what you're seeing in inventory, in the supply chain, downstream from yourselves?

When you say downstream, you mean at …

Your customers or like your …

I mean, the issue we've been having is those guys have lots of inventory in their downstream channels and they've been slowly burn it off, but it looks like for some of the increased demand that we're seeing some of our larger specialty customers, they are starting to get more of that through the channel. And so, their inventory should be declining in the downstream.

It should be, but we've been hoping – I mean, and being – frankly being given predictions by some of our major customers that this was going to happen faster than it is happening. So, actually, that's somewhat of a disappointment for us right now.

Yes. Historically it has been a disappointment. We are seeing a little bit of – in some of our supply chain business, we're seeing more shortages and more kind of going out looking for parts, which means that they are building a little bit more maybe in the CM. So, which should translate into less inventory, but we'll wait and see what actually happens there.

Fair enough. Thank you very much.

Thank you.

Our next question comes from Sidney Ho with Deutsche Bank. Your line is now open.

Great. Thanks for taking my question. My first question is, can you help us understand the revenue contribution from the three separate acquisitions in your guidance or in the quarter, what rate you prefer in terms of dollar, or growth rate, something we can use it as an anchor point? And related to that, for the segment as a whole, how should we think about the end market exposure of that segment and what does that mean to seasonality going forward?

Excellent questions. And I'm not sure I want to answer it, but a heck of a good question. I mean – but we said that this new group of companies, right, would be somewhere between $80 million to $100 million type business for us. When we bought them …

On a quarterly basis.

Small note, the two new ones, the $80 million to $100 million, they're tracking a little bit ahead of that, I mean. So, we had a good Q1 with those businesses. Penguin, if you look at Penguin from 2019 to 2020, we said it should grow – it's going to grow 10% to 15%. So, if you took kind of where it is, that's kind of the growth rate of Penguin. So, maybe you can kind of get to where you want to be, but the two business we acquired both came in right where we thought they were for the quarter for plans, they both did very well. The wireless business we said, we would double that revenue of that business, so it should be a $30 kind of million company and we're well on the way to achieving that in the first quarter on the wireless business.

Yes. And …

Overall, the Specialty Computing segments is looking like it's worth $350 million plus for the year, right?

Roughly around there. Yes.

About $350 million for the year for that – those three pieces together. And you will see as we report the Q that we've now decided to give you more visibility into the gross margins for each of our segments, so you'll see that in the Q by tomorrow, I think.

Yes.

Okay. Maybe I'll stay with the Specialty Compute business. In your prepared remarks you mentioned you're working on revenue synergies between the EC and Penguin. Can you elaborate a little bit on what you're doing there? And are there any kind of milestones that you can share with us?

Absolutely. Yes, that's a very interesting area, Sidney. And I'm glad you asked about that one, because it's – the market opportunity has to do primarily with edge computing. So, if you think about what the Embedded Computing business that we acquired used to do, it was mostly focused on the deep embedded systems that were then sort of customized either in mechanical, physical ways or in terms of software or in terms of the high availability aspects for different applications. Meanwhile, Penguin sells large high-performance computing systems, which tend to be racks and racks of servers, sometimes as many as a couple of thousand nodes of servers. So, and often the very latest servers, so now we were able to take those server platforms that we already have, which we are very efficient with and competitive with and be able to customize them as the team at the Embedded Computing side is able to do and has the skill set for into applications. The first interesting area is around edge computing, particularly as we look at a range of applications, gaining payment, retail automation and so on. So, that's the area that has some interesting potential. So, we've got a number of opportunities there that we are trying to – it's only been three months, so it hasn't been long enough to really come back to you and say, Wow, we've been successful with all of this. But very interesting opportunities, lot of customer interest. That's one area. And that synergy is more in the field and in the product, and then we have a lot of synergies in terms of being able to, for example, develop a switch for high performance computing that is – that our Embedded Computing team is a lot of experience with doing. So, we have the ability to now develop particular switching platforms, backplanes that go into high performance computing and AI applications. So, I can go on, but hopefully I give you a flavor there.

Yes. That's super helpful. Maybe one last question from me on the Brazil side. Last quarter you guys mentioned that the – with the new local content rules customers are giving you more and more visibility into their requirements, and obviously, you guys did better than what you thought for the last quarter. How would you characterize that visibility? Is that aboard in a few months? And maybe related to that, ASP has been a big headwind for you guys in the past few quarters. How you think about ASP going forward at this moment?

So, I'll tackle ASP first. So, this quarter, we definitely saw about a 50% drop in ASPs in mobile, but we expect that in Q2, our ASPs will start to go up in mobile as the content per phone is going to start to go up. Yes, we are getting good visibility from our customers. We're getting – we get six months to pretty good visibility and we have to create new products pretty early in the process. And so, we – as we get into our Q2, we will start shipping higher density products to our phone customers. So, we expect our ASPs to start to increase again as we get into Q2.

And that's long overdue, we've been predicting or maybe wishing that as memory prices come down, the amount of memory that goes into a phone will go up, but it hadn't been. Right? And this is the first indication that in Q2 we start to see the densities go up. Now, I just – much as we do get pretty good visibility, obviously, our customers have the ability to move their forecast up and down. So, just to be clear, these are not like fixed six-month forecast, but nevertheless, it's great visibility and it's better than it used to be.

Great. Thank you very much.

[Operator Instructions] Our next question comes from the line of Suji Desilva with ROTH Capital. Your line is now open.

Hi, Ajay. Hi, Jack. To follow up on maybe Sidney's question about Brazil and to ask, now that we have a more normalized pricing environment, you have better visibility. Is there a kind of a thought process for what kind of year-over-year growth we can expect from the current levels now that they've stabilized versus obviously 50% down that came last year given the pricing?

You're saying year-over-year for Brazil?

Correct, correct. Now that you’ve leveled out, what's a more reasonable expectation for year-over-year growth?

Well, I mean, year-over-year if you look at fiscal year 2020 versus fiscal year 2019. I mean, Brazil will not grow. I mean, just remember, in Q1 of 2019 we did almost $200 million of revenue in Brazil, right? And that was a monster quarter. So …

Jack, I was referring more to quarter-to-quarter from this quarter, say, four quarters out kind of …

I mean if you look at it – even Q2. Right? Maybe as we start yet into Q3, Q4 for Brazil, then I think you can start looking out maybe we will start growing that business 5%,10% maybe.

Quarter-over-quarter.

Quarter-over-quarter. I think, the good and bad news is that, Brazil business is dependent on memory ASPs, but as a result, what we really could say is that, if you take out sort of cyclicality, which I don't know how you do that completely, but I think, overall, we're looking at unit growth of 10% to 15% a year, somewhere around that. And we are looking for densities to grow to neutralize the falling cost per bit, at least. And so, we would expect that kind of 15-ish percent type of annual growth. But, of course, the cycles don't show the numbers that way.

Okay. I appreciate now we actually can ask that question. So, it's a better environment that way. And then, also the Specialty Compute businesses you've acquired and put together, where are you in the gross margin improvement versus what you target from acquisition integration, are we already there or is there more room across Penguin, Artesyn and Inforce to expand the gross margin, just on kind of bringing those into the fold and Smart Global?

We've made a lot of progress on Penguin. I mean, gross margins have gone up 600 basis points, 700 basis points. And they look to continue to be in that range. So, we've gotten a large part of kind of efficiency related gross margin improvements. Now, we have to get to business model related gross margin improvements. What that means is that, our services component has to come up as a percent of the revenue. What that means is that, we need to be able to provide more value add to our solutions approach. And so, it's no longer, well, better supply chain management, better manufacturing, better – and so on and so on. And so, that's kind of where we are with respect to Penguin. With respect to the other two businesses, they are still very, very early, but we didn't forecast. I mean, the good and bad news is, we didn't expect huge margin improvement in terms of gross margin for those businesses. We had – through the transfer from external manufacturing for the Artesyn Embedded Computing business to our own factories we gained – we have modeled a gain and which we've already to a good extent accomplished. And that was simply by – we would not add much overhead in our factories where we take out a bunch of third-party costs.

Okay. Helpful. And then one last question, I know you mentioned SSD controllers and can you just recap that the strategy you have there and trying to be neutral to, I guess, certain elements. And then what's the size of that opportunity, is that a small opportunity, is that a meaningful opportunity relative to revenue? Thanks.

It is a seminal opportunity. It is one of our biggest opportunities in a range of applications like industrial, like defense, like networking and telecom, Medical, just a range of applications where you need an SSD that is tuned for that particular requirement. Till this point, including up to today, we've been using not only third-party controllers, but to a good extent did not have control over the firmware. About a year, year and a quarter ago, we started to invest in our own firmware, we've built up a pretty significant team over 40 [strong engineers] have been our investment over the last year plus. And that is starting to now be a product, which is what I was trying to say. So, that significant investment, which has been part of our business, as you've seen it over the last year has now – in the next few months, we will start to introduce specific products and that gives us two benefits. One is, a lower cost, because we control our own destiny with respect to the controllers and framework. And the other is, a much better ability to tailor our products to these different applications, because we control the firmware and we control the functionality of the flash through that. So, it's a very significant milestone for us. Obviously, we then have to get the products out, get design wins, get – before we get to design wins, get the leads, get the marketing machine going, but it's a very meaningful advance in our products.

Very helpful, Ajay. Thanks.

Thank you.

I'm showing no further questions in queue at this time. I'd like to turn the call back to Ajay Shah for closing remarks.

Thank you, operator. Well, thank you all for your interest. We look forward to reporting on our progress in the coming months and to meeting many of you at CES, if you're going to be there or at any of the conferences, like the Needham Growth Conference coming up in January. I wish you all a Happy Holidays and all the best for the coming year. Thank you once again for your interest.

Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.