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spk02: Ladies and gentlemen, thank you for standing by and welcome to the Smart Global Holdings first quarter fiscal 2021 earnings conference 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. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Suzanne Schmidt with Investor Relations. Thank you.
spk01: 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 2021 results. On the call with me today are Mark Adams, Chief Executive Officer, and Jack Pacheco, Chief Operating and Financial Officer. This call is being webcast from our website at smartgh.com. In addition, our website contains an accompanying slide presentation and the earnings press release. We encourage you to go to our website throughout the quarter for the most current information on the company, including information on the various conferences that 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 forward-looking statements disclosures in our earnings releases, as well as the risk factors discussed in the documents we file from time to time with the SEC, including our most recent Form 10-K and Form 10-Q. 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 to the comparable GAAP financial measures are included in today's earnings press release. We will begin the call with CEO Mark Adams, who will provide a business update, and then Jack Pacheco, COO and CFO will review the financials and forward guidance, after which we will take questions. Mark?
spk07: Thank you, Suzanne. Happy 21 to all of you. I want to take this opportunity to thank our global team members for their commitment and resilience as we operate in these uncertain times. During my first full quarter at SBH, I've been impressed with the team's work ethic, and I am optimistic about the potential to execute on our growth and diversification strategies. For me, success is largely driven by people, purpose, planning, and process. In my first few months with the company, this is exactly what I had been focused on. Is the organization structure set up for success? Are we aligned as a team on purpose, what we need to do, and equally important, what we need not to do? After alignment of purpose, do we have the right plan to address the company's priorities Or are there some cases where we have aspirations that need more clarity, investment, and commitment? Once we have the right structure in place, aligned on purpose with the right plans, do we have the right process in place to execute and measure our performance to hold ourselves accountable? While we are certainly at work in process in some of these areas, I'm more excited today than I was 120 days ago. Our future at SDH is very bright. Strategically, we continue to focus on providing differentiated solutions across all of our lines of business. We are targeting future expansion into growth markets such as high-performance computing, artificial intelligence, and cloud with Penguin Computing, edge computing with our embedded business, formerly Artisan Embedded Computing, IoT solutions with our smart wireless, formerly Enforce Computing, and advanced package memory, low-density storage, and in-memory computing as part of our memory solutions business, which includes our specialty memory and Brazil memory business. Financially, each of the lines of business has a mandate to improve their profitability. On this and future calls, we will be sharing proof points to demonstrate our progress along the way. Turning to our first quarter performance, Our revenue came in at $292 million, 7% higher than the same quarter in fiscal year 2020. Gross margin came in just above the midpoint of our guidance range, and our non-GAAP earnings per share of 78 cents exceeded the upper end of our guidance. In addition, we continue to strengthen our balance sheet as cash and equivalents increased 9% over the prior quarter and is now at $164 million. Overall, I was pleased with our results as we continue to execute on our transformation into a diversified growth company. Let me now provide some more detail around each of our businesses' performance. Starting with specialty compute and storage, revenue and growth margins were approximately flat with the prior quarter at $66 million and 27% respectively. As I mentioned on our last call, We are conducting a careful review of all of our lines of business, and if warranted, we'll either find ways to improve gross margins or exit those lines of business that don't meet our margin targets. One example of the latter was our recent decision to shut down our battery business in Brazil. We will be aggressive in looking at new opportunities, but prudent in how we invest and monitor success. In specialty compute and storage, we are focused on developing higher margin opportunities as we leverage software and services as part of our solution portfolio. This value-add focus was reinforced by the official launch of Penguin Computing's solution strategy, which encompasses four dedicated solution practices targeted at enabling customers' adoption of artificial intelligence, high-performance computing, cloud, and data analytics. we will be bundling software and services optimized for each of these four practice areas. While growth in the high-performance computing and artificial intelligence market is primarily being driven by new entrants in these disciplines, existing enterprise customers are benefiting from access to these emerging technologies as we help them to bring these capabilities in-house. Validating this new direction, Penguin received the HPC Wire Reader's Choice Award for best HPC solutions and financial services. We were also recognized by our key partners. Intel awarded Penguin Computing with their Executive Summit Award for outstanding platform innovation. And Weka.io selected Penguin as their 2020 Partner of the Year awarded for software-defined storage. Smart's embedded business secured a $30 million order from the US government for ruggedized ATCA system that operates under extreme shock and vibration conditions. On the technology front, our embedded team released a new advanced telecom computing architecture, or ATCA memory blade, targeted at both industrial and military edge computing applications. One example of a customer usage model for this technology was a leading semiconductor company looking to use our memory blade product as part of an edge computing solution to enable on-site maintenance predictability in AI applications. While some of our strategic initiatives in specialty compute are longer term in nature, I am confident in our short-term pipeline demonstrating customer validation of our vision. We are forecasting sales in specialty compute to grow by over 20% as compared with our first quarter. I am excited with our team's focus on solutions and value-add services and see this as a growth engine for the company in the future. Now turning to specialty memory, which achieved revenue of $120.7 million in the quarter, a 16% increase when compared to fiscal Q1 2020. Our DDR3 product portfolio performed well in our first quarter due to increased demand as well as stabilization of demand pricing. We also saw increased demand for our persistent memory or NVDIMM products aimed at storage applications. As we look to broaden our customer base and markets, we are targeting especially solid-state storage, or SSD, as an important growth area. We have customers sampling our newest SSD product, which leverages SmartModular's internally developed controller. The team is focused on expanding into new vertical markets such as surveillance, and transportation and market. Strategically, our specialty memory team is continuing to evaluate ways we can provide higher value memory solutions for customers focused on enterprise, cloud, AI, and industrial applications. Our Brazil business totaled revenue of $105.2 million, an increase of almost 12% compared to fiscal Q1 of 2020. Increasing memory densities led to strong mobile sales in the quarter, which grew by almost 30% compared with a year ago. We also achieved stronger memory sales for notebooks, which grew 27% as compared with the prior year's first quarter, driven by a growing trend of more people working from home. We continue to accelerate new product introductions in support of our Brazilian customers. We qualified a number of high-density products for mobile applications, including a 64 gigabyte and 128 gigabyte EMCP. The team is currently qualifying in-country SSD manufacturing, which leverages our advanced packaging capabilities, strategic customer relationships, and in-country manufacturing capabilities. Now I'd like to provide a brief update on our pending acquisition of Cree LED. We remain very excited about Cree LED joining the smart family. Cree LED's leadership position in the specialty LED segment aligns well with our overall specialty solution strategy, emphasizing growth, margin enhancement, and diversification. I continue to be impressed with their leadership team, culture, and overall operating discipline as we collectively work on a successful integration plan for Cree LED as part of SGH. We have received positive signs on the regulatory front, and the teams are working hard on integration milestones, which we feel will result in a potential close in the late February, early March timeframe. I will now turn the call over to Jack for a closer look at the financials and guidance for Q2. Jack?
spk05: Thanks, Mark. First quarter fiscal 2021 net sales of $291.7 million exceeded the midpoint of our guidance range as our combined memory sales, including specials memory in Brazil, We're up 14 percent from the year-ago quarter. Non-GAAP gross margins came in at 18.6 percent, and non-GAAP EPS exceeded the high end of our guidance range, reaching 78 per share. As Mark briefly alluded to in his comments, our balance sheet continues to strengthen, with cash and equivalents increasing by 13 million in the quarter to reach 164 million, along with our continued focus on increasing our inventory turns, which increased to 10 this quarter. A breakdown of net sales by end market for the first fiscal quarter was as follows. Mobile and PCs, 34%. Network and telecom, 19%. Servers and storage, 17%. Industrial defense and other, 30%. Mobile and PCs, along with servers and storage, as a percentage of sales, were both up from Q4 of fiscal year 20, accounting for 51% of our revenue in Q1, which is 43% in Q4. Networking and telecom, was down 6 percent from the prior quarter, reflecting weaker enterprise spending in our just-completed quarter. Now moving to the rest of the income statement, non-GAAP gross profit for the first fiscal quarter was 54.1 million, or 18.6 percent of net sales, compared with last quarter's 57.8 million, or 19.5 percent of net sales. Non-GAAP gross profit margin by business group was as follows. Specialty compute and storage, specialty memory 15%, Brazil 17%. Non-GAAP operating expenses were $30.4 million compared with $29.4 million in the previous quarter. Non-GAAP net income for the first quarter was $19.6 million, or $0.78 for diluted share compared with $20.4 million, or $0.82 for diluted share in the previous quarter. Adjusted EBITDA totaled $29.5 million, compared with $33 million in the prior quarter. Our non-GAAP effective tax rate for the quarter was 14.1% in line with our expectations. Turning to working capital, our net accounts receivables totaled $212.9 million compared with $215.9 million last quarter. Our day sales outstanding remained similar to last quarter at 46 days. Inventory totaled $147.2 million at the end of the first quarter compared with $163 million at the end of the fourth quarter. Inventory returns were ten times compared with nine times in the previous quarter as we continued to work to increase our material efficiency. 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 $423.2 million and $370.6 million, respectively, for the first quarter. As a reminder, The difference between gross revenue and net sales is related to our supply chain services business, which is accounted for on an agency basis, meaning that we only recognize as net sales the net profit on a supply chain services transaction. We ended the first quarter with $164.1 million of cash and cash equivalents, compared with $150.8 million at the end of the prior quarter. First quarter cash flow from operations more than doubled in the quarter to reach $35.2 million, compared with $16.2 million in the prior quarter. On a trailing 12-month basis, cash flow from operations totaled $88.7 million. For those of you tracking CapEx and depreciation, CapEx was $14.6 million in line with our expectations for the quarter, and depreciation was $5 million. We also increased our source of liquidity by entering into $100 million ABL with Bank of America on December 23rd, It has an effective interest rate of 2.25% plus or minus 0.25% depending on the amount drawn. The line is undrawn at this point in time. We also have a revolver of 50 million, which is also undrawn. Combined with our strengthening balance sheet, we feel we are well positioned for future success. Turning to our fiscal Q2 2021, let me first provide you with some context with respect to our guidance. Our guidance reflects the accounting change we made in our fourth fiscal quarter of fiscal year 2020 for Brazil, which equally decreased our gross profits as well as operating expenses. With that as a backdrop, let me now turn to our guidance for the second quarter of fiscal 2021. We currently estimate that our second quarter net sales will be in the range of 285 to 305 million. Gross margin for the quarter is estimated to be approximately 18% to 20%. Gap earnings per diluted share of is expected to be approximately $0.38 per share, plus or minus $0.05. On a non-GAAP basis, excluding share-based compensation expense, intangible asset amortization expense, and convertible debt discount OID and fees, we expect non-GAAP earnings per diluted share will be in the range of $0.80, plus or minus $0.05. The guidance for the second fiscal quarter does not include any view on the foreign exchange gains or losses and includes an income tax provision expected to be in the range of 10 to 14 percent. The number of shares used to estimate earnings for alluded share for the second fiscal quarter is 25.6 million. Capital expenditures for the second fiscal quarter are expected to be similar to last quarter in the range of 10 to 15 million. Please refer to the non-GAAP financial information section and the reconciliation of non-GAAP financial measures to GAAP results and reconciliation of GAAP net income to adjusted EBITDA tables and earnings press release for further details. Operator, we are now ready to take questions.
spk02: As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Kevin Cassidy from Rosenblatt Securities. Your line is now open.
spk06: Thank you for taking my question. Congratulations on the good results. First question is, in the market, and Mark, you mentioned that the memory market or the DRAM market is stabilizing. In the downturn last time, we found that some of the companies manufacturing smartphones in Brazil decided to build them outside of Brazil. As prices are coming back up, will there be a change? Is there a trend to building more phones within the country?
spk05: Hey, Kevin. It's Jack. I think the phones in the country will continue to build. The ones that are in the country will continue to build in the country. I don't think we'll see any new entrants right now. We're not getting any Anything I made new is going to come into Brazil, so I think you'll tell the current companies will continue to build the phones in Brazil they've been building.
spk06: We don't think it'll... Okay, so it's no change in seasonality, then, I guess, is another way of answering my question.
spk05: And no change in seasonality right now. We're not seeing... Because if you think about the phone, too, there's a lot of flash memory in the phone, and we're not seeing flash memory go up in price, right? Flash memory continues to fall.
spk06: Okay, I see. And maybe, Mark, turning to your comment about the profitability and the Penguin business in particular, as you're leveraging for software and services, Can you say what progress you have and how much interest is there from your customer base and maybe what is the customer base that would be interested in your cloud services or software services?
spk07: Sure. I appreciate the question, Kevin. Thanks. When we look at the elements of what might help us drive these margin opportunities, it's really on strengthening our overall engagement with customers both the federal and our commercial customers. And the way to think about it is there's kind of three buckets. There's kind of, I would say, hardware optimization. There's software. And then there's services that include things like on-demand type offerings, as well as systems implementation, installation, and overall field service. And so in each of those areas, we're kind of investing to strengthen our offering. When we talk about software, most of the software we're referring to are in these few areas around workload optimization, resource provisioning, a concept called data gravity, which comes into play when we start to see customers wanting a hybrid implementation of cloud services for certain workloads and more compute intensive workloads on premise. And so we're developing opportunities and partnerships with software companies in conjunction with Penguin to be able to deliver these types of capabilities on the software side. On the service side, there's obviously presale configuration analysis. systems design work that's done to optimize our platforms for the end market applications that we're looking at. Secondly, there's installation services and post-sale capabilities that we're delivering to the customer. A lot of these customers don't necessarily have the infrastructure and resources in place to be able to manage the hardware side of the data center installation. even post-sales around break-fix opportunities. And then more longer term, I think we've commented in the past, and I want to just kind of reinforce that we're very heavily looking at on-demand services at Penguin and investing in business models that will allow us to extend our current customer relationships as well as engage with new customers on the on-demand side, whether it be multi-cloud or again, a public-to-private or private-to-public type architecture using on-demand models. Some of the infrastructure we already have built out and looking to roll out more in the area of POD, which is the acronym for Penguin On Demand, and then GovPOD for our federal customers. And so that's really kind of how we think about the enhancement model, and it's a partnership that's primarily third parties on the software side today. We're evaluating how we want to play in that piece of it. But a lot of the infrastructure that we have in place that has made Penguin such a strong player in HPC allows us to provide this kind of value add around these systems and on-demand part of the equation.
spk06: Okay, great. Thanks. And maybe if I'll just add on to that, the The sales process for that, is that a six-month or a year? How long is it from the time you land the customer?
spk07: So typically, you're kind of breaking this up because some of this is actually happening. And I think you heard my comments earlier on the call today about our Q2. Some of this is already in play. And a lot of times... systems-level sale will accompany with these new levels of services that we're offering. So we do think margins will improve in the short term. But Jermaine, to your question around sales cycles, it could be anywhere from three to six months on the pre-sale side of getting a customer identified and a live project that is funded, whether it be, again, on the federal side or the commercial side. And then there's this kind of process we go through to understand the customer requirements in a specific vertical and what application they're trying to optimize around. And that's really where our expertise at Penguin comes in because we've been around high-performance computing for so long that we have a skill set and a competency that our customers really value around understanding the system, and the optimization around the systems for those applications. And we're able to kind of emulate that and test that in these different verticals. And so I would say three to six months on the pre-sale side, and then it's probably another six to nine months on a phase one rollout. And so as I talked about in the last call, I was starting to see signs that we have some really good opportunities that are in the funnel, and funnel might mean opportunities we're negotiating for, and the conversion of those has really taken place in a nice way. We entered, Kevin, we entered Q2 with a backlog that was 40% higher, 4-0% higher than the backlog we had entering Q1, and so this process of managing that cycle is obviously, you know, it's kind of an art, so to speak, that we have to keep on but the size of the funnel and the commitments we're getting on this timeline of how we forecast in the quarter is getting more predictable for us as we're scaling the business. Great. Thank you. Thank you.
spk02: Thank you. Our next question comes from the line of Raji Gill from Needham & Company. Your line is now open.
spk04: Yes, thank you, and congratulations as well. Mark, correct me if I'm wrong. You had mentioned that the Penguin computing business for February, you're expecting that business to grow 20% sequentially. I just want to make sure I have that correct. And if that's the case, kind of what's the drivers of that going into February quarter? And Jack, any kind of thoughts in terms of the guidance for the for the Brazil business and for the specialty memory business, the moving pieces there in the February quarter.
spk07: Great. Thanks, Raj. I'll go first. Relative to the 20%, that was our overall specialty compute business, and Penguin's right on that, actually. We've got some very strong backlog, both in the federal business as well as some newly accepted commitments that we're going to be delivering, starting to deliver in Q2 in our Penguin business. So those are the two primary customer types, our federal and our commercial customers. You know, for obvious reasons, we don't like to kind of give the specific customer names out, but I can tell you that each of the orders that I'm referencing are in the tens of millions of dollars. And mind you that they don't all bill in one quarter, but... Given what I said about the healthy backlog, again, up about 40% coming into this quarter when compared to Q1, and a continuing growing funnel, you can see where we're going to end up in a pretty good place in Q2 on the Penguin business. I also wanted to call out and recognize that our embedded business secured a $30 million investment Now that order is to be delivered over the course of the whole fiscal year, which we delivered about 20% in the first quarter. So the combination of the stronger Penguin funnel and some big commitments on the embedded side have us feeling pretty bullish. And I don't think this is a one-quarter phenomenon. We're really feeling pretty good about the continued growth and the execution of our specialty compute business. It's got a long way to go, but I think it's got some really good upside opportunities in the future. Jack, do you want to just address Brazil and specialty?
spk05: Yeah, if you look at where we think they're going to fall in Q2 versus Q1, Raji, I mean, you know, we said Brazil will be seasonally down for Brazil a little bit, so I would expect the memory business to be down, you know, low single-digit percentage for Q1, you know, in that range. So, Not a dramatic difference when we finished Q1, but down a little bit.
spk04: Okay, so the specialty memory kind of down low single digits sequentially and then Brazil seasonally down? Yeah, a little bit, yeah. A little bit. Okay, got it. Okay, got it. And so the specialty memory business, the growth year over year in November, so it was 121 million in November and then – And in November of the year-ago quarter, it was $103 million. So the growth, can you maybe elaborate on what you're seeing there? It looks like there's been some growth in the storage and networking market, but any kind of thoughts on kind of the broader macro trends that's driving the year-over-year growth in specialty memory and how we think about that? And, you know, throughout this year in a potentially, you know, post-COVID recovery. I'm just curious to see how your business could be affected positively if there's a recovery in COVID in that business.
spk05: Sure. I mean, the growth I think you've seen over the last year has really been in the DRAM side. The DRAM side has performed well. You know, Mark alluded to DDR3. We had a good quarter. We continue to get new design wins in DDR3. So the DRAM business is doing well for specialty customers. I think as we go towards the back half of this year, we expect to see the flash business pick up. The flash business has been impacted more by COVID-19. We were trying to get new design wins, and it's been a struggle to get design wins in the COVID-19 era as our customers are not in their labs, so it's been a lot slower process. So those start to kick in. I think if you get the recovery, you'll see the flash business pick up in the back half of the year for the specialty memory business, and I think that will help us you know, back after the year drive up our margin as we talked about for that business as well. So we, we still think that business is on track year. I'm doing really well. And we think the flash business will start to pick up here towards the back half of this fiscal year.
spk04: And my last question on the gross margins. So the, the margins are, are guiding up about 40 bits at the, at the midpoint, um, on slightly higher revenue volume. Um, And you broke out the gross margin split in this quarter. So putting aside Cree, what are going to be kind of the margin levers to push for each of these business lines? And how do we think about, you know, Brazil improving the margins, specialty memory improving the margins, et cetera?
spk05: I'll start with, I mean, I think Brazil – You know, Brazil, we talked about it for a while. We're trying to get to a more fixed price model in Brazil in the unit, our value add per unit in Brazil. And so I think as Brazil grows, you know, gets through this year, you may not see the gross margins in Brazil get that much better, you know, as we're trying to be more, you know, get the gross margins a little bit more stable, right? ASPs go up. If revenues go up, you know, we will get more value add. But I think our gross margin percentage will kind of stay the same. So really not looking to Brazil, have major changes. Specialty, we as we exit the year and we still think we can do that and that's going to be based on flash a lot of new design wins in flash you know and you also return us some more enterprise customers you know on the flash side we've had some weakness in the enterprise which has really impacted our flash business which tends to be a higher margin business we see that coming back as well you know the back half of the year for specialty memory and then on yeah but just one one point of clarification before i come on especially compute uh on the margin side um
spk07: during my comments around profitability, we're not going to jump into flash business just to be a revenue play. And as Jack mentioned, some of our design in, uh, uh, efforts, uh, have taken a little longer than we'd like. But again, the emphasis is going to be on, on specialty flash storage solutions, not just commodity trading of man. Uh, that's not a business I'm going to allow us to get into. So, uh, as he's mentioned, um, Some of the application work we're doing on specialty NAND storage is playing out. It just isn't at the timing that we'd like, but we're going to be very disciplined on how we compete in the NAND space. I think the NAND business is going to be a lot more volatile when compared to DRAM, and we're going to be really careful there, although we expect growth and good performance in the back half. We were just hoping it would be here a little bit earlier. On the specialty compute side, I think I talked about it in the areas of software services, and effectively, as we move into more value-add type applications that we sell into. And I think that's going to be, again, very similar for us going forward. We're going to be a lot more disciplined as we include these as part of the deals we like to go win. We're not looking for just hardware revenue. And, you know, you've already started to see that. Penguin was acquired At the time, the acquisition was like a 15% gross margin business. I think in the quarter, we're above 20% gross margins. And I think I mentioned in the last call, and I'll reaffirm today, I think a next stop for us in the near term over the next quarter or two should be in the mid-20s. And I have a lot of aspirations for a much better gross margin picture in Penguin over the next three years or so. But we're on a good path there, and we're going to be selective Because in this business, you want to get these customers who really need your expertise in all those areas, not just hardware. And we're identifying these customers. And some of these people in these vertical markets we're talking about, such as AI or sophisticated high-end machine learning with utilizing high-performance computing, we've become a lot more important than just a hardware provider. Those are the skills that we're investing in and developing, and I think that's going to show up in the margin as we move forward.
spk04: Last question. In terms of Cree, the shift over to Taiwan in terms of production, any status update there?
spk07: On track. I don't want to say too much because the deal is not closed, and that's for them to comment on. I would just signal that we're very happy with where things are in the process and continue to be very pleased, obviously, with the strategic value that they're going to bring to us. But just as we get to know the team better and their operating philosophy and culture, we're very excited about them joining the team.
spk04: All right, good deal. Thank you, Mark and Zach.
spk07: Thank you.
spk02: Thank you so much. Our next question comes from the line of Brian Chen from Steeples. Your line is now open.
spk03: Hi there. Good afternoon. Happy New Year, and thanks for letting us ask a few questions. Maybe just to kind of keep the discussion back on LED here for a moment, Mark, I heard the timing you kind of updated in terms of closing on the deal. I guess, what are some of those, if you can, indications that you have that you think you'll get that regulatory approval here over the next month or two? And can you just, especially given that I think probably the key hurdle you have there is in China?
spk07: Yeah, I actually, I don't think regulatory approvals are a problem. And when I shouldn't even say problem, there are just a couple things in terms of timing around integration matters with IT systems, because remember, this is a carve-out. And pre-acquisition, Cree LED was part of a broader corporate IT infrastructure that was not being able to be carved out, you know, kind of nice and tidy. And so I think the long pole in the tent, so to speak, is going to be IT. One of our closing conditions was – a third-party audit of the business, again, due to the carve-out nature of this transaction. It was a very important thing for us to get a clearness of opinion of the carve-out financials, and that's on track. But I would tell you, I don't think – I mean, we've gotten positive indication on the regulatory side. That's not the issue that we're dealing with relative to the end of February target.
spk03: Got it. Okay. Thank you. Another question in terms of the Cree business. Under Cree, the LED component business carried a good bit of fixed cost, yet once you close, SMART will no longer have any of the wafer and wafer fabrication assets. So I guess my question is, sort of off the bat, unless you do close, how much higher would the LED gross margins be consolidated under SMART if we were to exclude for the associated depreciation? I think fully loaded is something like 21% gross margins in their fiscal 20 and I think like 22%.
spk07: Yeah, I think just from a modeling perspective, I think it'd be safe to say somewhere in the 400 basis points improvement. Now, yes, on the one hand, the fixed costs go away, but on the other hand, as it relates to cost of goods in an outsourced model, those fixed costs don't necessarily go away. They just may show up in cost of goods relative to your partner's pricing to you. Now, having said all that, we think there's a lot of efficiencies, and we do think there's a margin improvement opportunity with Cree. And, you know, again, we're trying to be careful until we get really inside to understand all of the – upside opportunity, but we're pretty comfortable that there's going to be some gross market expansion on the LED business.
spk03: Got it. So just to make sure I'm clear there, I think you originally said you could be at, you know, in a year's time post-close, something like 200 to 400 basis points of improvement, and that's inclusive of, you know, the fixed cost. You know, maybe it's a little bit of shifting from, you know, in-source to out-source. That's right. all baked in in terms of that plus, you know, other efficiencies you can get.
spk07: I think that's the right zip code at this point.
spk03: Yeah, and maybe even just one last question going back to the prior targets that you had established when you announced the pending acquisition. At the time, I think you said that there was some organic growth sort of dialed in there. But if you look at sort of the Cree business, it's, you know, 400 million plus annualized revenue at the moment. And, you know, if you kind of add that to where your revenues were last fiscal year, it kind of embeds sort of zero-ish growth. And clearly, you know, HPC, especially compute, sounds like it's got a good growth orientation to it, certainly, you know, to start the fiscal year. I'm just wondering to what degree maybe you've re-evaluated those or kind of we could view those as a little bit conservative.
spk07: Fair enough. Although, as I said in my preferred comments earlier, We're continuing to evaluate businesses that, you know, we might have been chugging along in without a lot of, you know, upside potential or gross margin that's not at the level we want to kind of hit as a company or target as a company, I should say. And so I think it's fair as we get a better understanding of what's going on inside of Cree beyond our due diligence and where we're at today. I think there's a potential for that. There's also a potential that if we can't get our arms around the gross margin of some of these lines of businesses that I referred to earlier, we may kind of exit some of those businesses. I don't think it's going to be dramatic. I think I would say the range that we gave initially is certainly something I'm comfortable with today. And kind of towards the end of our calendar quarter, quarter this year, I'll probably be able to give a better update on how we see the operating model, having spent some more time inside of Cree LED and obviously evaluating some of the existing businesses inside of SGH.
spk03: So in terms of that revenue and that margin improvement, some of this addition by subtraction is contemplated, it sounds like.
spk07: Okay. But I think your question is a good one, and I'm not shying away from it. I think I think there is the potential for that. We're not here to comment on that now because I just want to get more clarity on what's underneath the hood at CreeLED on specific product lines and see if there's either a need to reinvest in those businesses and scale them more beyond where they are because you've got to remember they've been pretty limited at some level in their ability to grow given the fixed wafer capacity out of North Carolina. We have a lot to learn about that business. We see how it's operating today, but we want to make sure that we want to invest properly. We think it's a really good acquisition for us, obviously. I'm hedging a little bit because I want to go get those answers done and get back to you towards the end of the first quarter and be able to give you a first quarter calendar to give you a sense on how we look at the combined entity going forward.
spk03: I appreciate the detail. Thanks, Mark.
spk07: Thank you.
spk02: Thank you. Our next question comes from the line of Sydney Ho from Deutsche Bank. Your line is now open.
spk08: Thanks for taking my question. I want to follow up on the gross margin discussion earlier. You talk about this gross margin improvement 200 to 400 basis points a year after the LED deal is closed. I was just hoping you'd give us a sense as to how much of that improvement comes from the inclusion of that business versus coming organically. I know, Mark, you talked about some of the new profitability initiatives, especially in specialty compute. But I was hoping you can help quantify them. The one thing that I noticed is that the specialty memory today is quite a bit lower than what it was a year ago. And I think last quarter you talked about some of the new products having a margin headwind. So I'm just trying to get a sense as to how each segment can grow, what kind of margin profile can it be without the LED side of things.
spk07: Sure. So separate, again, just to your point, separate from the LED discussion that we just had, which I think you're satisfied with, on the organic side within SGH today, I mentioned that specialty compute in the area of software and services, I mentioned some of the examples specifically with Penguin, I think that's inherently a meaningful uptick to their gross margin and have a good impact on our gross margin. On the specialty compute side, you also have to consider that as part of that revenue stream, we have a logistics service business that also has an impact on margin. And so if you separate that out, Jack referred to some of these newer market opportunities that we're investing in for growth around, again, specialty flash, not commodity flash, but specialty flash, lower density, our own controller, individual kind of ruggedized or industrial strength type products. These products that we're aiming at for some of our newer efforts in memory do carry higher margins. And so... I think if you think about gross margin across the table, he already commented on Brazil being relatively flat. I think you'll see, you know, organically a gross margin uptick in an area of, you know, 2% to 2.5% gross margin before Cree. And then, you know, as I said, Cree has some margin opportunities on their own. I think it's going to combine to a pretty good story overall.
spk08: Great. That's very helpful. My follow-up question is on the specialty compute and storage business. Obviously, you made a number of acquisitions in the past two years, but the growth hasn't been – it's just not very consistent for reasons that are out of your control. So as you look forward, now that you have 120 days into your job, what kind of growth rate do you expect that business in aggregate can do organically, and what type of seasonality do you expect going forward?
spk07: Yeah, that's a good question. I think you're kind of hitting a couple points. I do think it's a growth business, to be honest with you. And again, as you said, four months into the job, I think we have to strengthen the leadership team and we'll be doing that. I think we have to keep on investing in not just the people, but the capabilities of the company, whether it be software or integration capabilities or service capabilities. But I do think that I don't think this quarter is an anomaly in terms of our growth opportunity. You know, it's interesting, and I just want to offer this to the people on the team on the call. This is a different business, and so to try to make it look like a smart, modular memory business, it doesn't work that way. And so what I mean by that is it's a design in business that will grow. It's less about seasonality. There is some spending patterns relative to the federal business, for sure, but it's less about seasonality. It's more about design in and wins and delivery schedules. I happen to think, by the way, that will get crowded out by our increasing backlog and growth opportunities. But I think the business, you know, it's not a fulfillment model. It's not a design and model like the memory business. It's more of a point-to-point customer-to-vendor relationship design and sale that is a longer-term sale than, again, per se, the memory model. So it's a long-winded way of saying I think the growth will crowd out. It's not really about seasonality as much as the lumpiness that may exist as we're targeting growth and new vectors and new scale. But coming from where we are coming from, as you noted on your question, I don't think you're going to see that. I think you're going to see continued growth for the foreseeable future, starting with Q2.
spk08: Great. I appreciate it. Thanks, guys.
spk02: Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Our next question comes from the line of Mark Lepashis from Jefferies. Your line is now open. Pardon me, Mark. Your line is now open. Please check your mute button. Mark Lipaceous from Jefferies, please check your mute button. Your line is now open.
spk07: Operator, I think if Mark doesn't join here in a second, we can proceed to anyone left in the queue, or I can start with the commentary.
spk02: At this time, I'm showing no further questions. I would like to turn the call back over to Mark Adams, CEO, for closing remarks.
spk07: Well, thank you again. We started fiscal 21 on a strong footing as we embark on our journey to deliver profitable growth while diversifying our business with a specialty focus. We are doing this through expanded strategic customer relationships that are aligned with growth markets such as cloud and edge computing, IoT, high-performance computing, enterprise storage, and specialty memory solutions. We've transformed our balance sheet for future success, and we're in the process of building out the leadership team to enable this next phase of scaling of our business. We are focused on creating new approaches to extend existing business models that will demonstrate our ability to deliver higher value solutions to our customers with a greater focus on software, services, and on-demand offerings. Included in my list of top priorities is to enhance the diversity of our leadership team and across the company. In addition, we are launching a process around our environmental, social, and governance business practices. I will be commenting more on these in upcoming calls. In closing, I'm very excited for our future at SDH, and I want to thank you for your interest and support of the company. Thank you.
spk02: Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.
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