Penguin Solutions - Earnings Call - Q4 2020

Transcript

Speaker 0

Ladies and gentlemen, thank you for standing by, and welcome to the SMART Global Holdings Fourth Quarter and Fiscal twenty twenty Earnings Conference Call. At this time, all participant lines are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Suzanne Schmick, Investor Relations.

Thank you. Please go ahead, ma'am.

Speaker 1

Thank you, operator. Good afternoon, everyone, and thank you for joining us on today's earnings conference call to discuss Smart Global Holdings fourth quarter and full year fiscal twenty twenty results. On the call with me today are Ajay Shah, Executive Chairman of the Board 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 financial conferences we will be participating in. 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 press 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 ks 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. With that, I will now turn the call over to Executive Chairman of the Board, Ajay Shah.

Speaker 2

Thank you. Thank you, Suzanne. I'd like to welcome everyone to this call and take this opportunity to introduce you all to Mark Adams, Mark's newly appointed CEO and a member of our Board of Directors. We are very excited that he has joined our team, and I look forward to supporting Mark and the rest of the management team in our in my ongoing capacity as executive chairman of the board. When I stepped into the CEO role about two years back to help lead the transformation of Smart, the company had roughly two thirds of its revenue from memory sales in Brazil.

My goal was to take this base of business that the team had built over the past thirty years to grow and diversify our revenue base into new markets while leveraging our operational strength. Since that time, we've come a long way. We've built up a specialty compute and storage business that has transformed the profile of our revenue mix, improved our gross margins and provided us with exciting new areas in which to grow. At this stage, the company now has a tremendous opportunity to build and scale our organization and to further improve our go to market strength and market positioning. I think he will share the enthusiasm that the Board and I have that Mark is the right person to take this forward as our new CEO.

I have known Mark for many years and have more recently gotten to know Mark much more personally. He brings a wealth of management and technology experience and a tremendous industry network that will be of great benefit to Smart as we move forward. With that introduction, I'll turn it over to Mark.

Speaker 3

Thank you, Ajay. First and foremost, I'd like to thank Ajay and the rest of the board for trusting me to carry on what he and the team have built so far. In my brief time working with our management team and dedicated global team members, I've only become more excited to lead our growth and diversification strategy. I've actually known Smart for many years. When I joined Micron through the acquisition of Lexar, I ran the Digital Media Group, which was a combination of Lexar and Crucial, a competitor with Smart.

And later as I served as President of Micron, Smart was a valued customer. So I had a good appreciation of the organization's core competencies. What I've grown to appreciate more so during the search process and even more recently during my time in the company is the transformation that Ajay has led along with the management team. Core Global Holdings is very different than the memory company I knew in a prior life. Penguin's high performance computing success coupled with smart embedded and wireless computing are growing into strong contributors to our overall business.

I'm also very impressed with the operating platform that Jack runs for the company with world class operations in The U. S, Brazil and Malaysia. In short, I'm excited to join the company in Smart possessive a strong mindset, growth focused on diversification combined with a strong operating discipline. Beyond our operating business, I'm looking forward to leveraging my background in strategic M and A activity during our continued diversification. As I look at the industry landscape today, it is clear that semiconductor companies are facing unique challenges of increasingly more difficult lithographies as well as to develop and use more advanced packaging capabilities.

Additionally, compute resources are taking on a increasingly more critical role in applications such as AI, machine learning and data analytics. When you look at all of these areas in terms of the growth markets and the segments they serve, we align very well with the assets that we have in high performance computing, memory integration capabilities, embedded compute and storage. The future is very bright. SMART is extremely well positioned to grow as a valued ecosystem partner to our customers. Let me now provide a business update, after which I will turn the call over to Jack for a closer look at our financial results and forward guidance.

Fiscal twenty twenty ended on a strong note with net sales and non GAAP earnings per share coming in better than expected, which we believe is a testament to our employees across the globe who have excelled during these unprecedented times. In addition, we have made good progress executing our growth and diversification strategy and remain in an excellent position to capitalize on longer term business trends that play to our strength globally. In particular, our business mix has dramatically transformed over the past several years. Just two years ago, our business was dominated by Brazil at 62% of net sales for fiscal year twenty eighteen. We now enter fiscal twenty twenty one with a much more balanced mix of businesses.

For the full year of fiscal twenty twenty, Brazil was 35%, Specialty Memory was 42%, and Specialty Compute and Storage was 23% of overall revenue. Specialty compute storage will continue to grow as a percentage of our overall business in fiscal twenty twenty one. Let me turn to a review of each of our businesses for the fourth quarter. I'll start with Specialty Compute. Revenues for Specialty Compute totaled $67,000,000 in the quarter, representing an increase of approximately 10% from the prior quarter and comprising 23% of overall fourth quarter revenue.

The increase in the quarter was driven primarily by the resumption of some federal spending and, importantly, a growing contribution from Penguin's software and service offerings, which are key areas of our strategic focus. One good example is Pangolin's recent launch of a solution to meet the demand for real time applications for memory infrastructure. Pangolin is offering scale cost effectively to many terabytes using Intel's Optane persistent memory, virtualizing in massive pools of software defined memory. This is a good example of increasing importance of memory as it moves closer to the computing power and HPC applications, and we look forward to announcing more of these types of successes in the future. In addition, as an update to the partnership between Penguin and AMD around research enabling ways to fight COVID-nineteen that we announced in the prior quarter, just two weeks ago, Penguin announced that the first petawatt of compute capacity in its data center is now online and available for researchers.

We look forward to continuing support of AMD and to participate in universities and labs in this important endeavor. We were pleased to be selected by NVIDIA, the partner network, as the HPC OEM Preferred Partner of the Year, our third year in a row of achieving this distinction. We greatly appreciate such recognition from our strategic partner, which reflects our long history of driving innovation and serving the evolving needs of our customers. Our pipeline continues to strengthen, highlighted by the recent receipt of Penguin's largest order ever just two weeks ago, and we are increasingly optimistic given the demand signals we are getting from our customers going into 2021. Now on to Specialty Memory, which was 42% of our fourth quarter revenue, totaling $125,000,000 in the quarter, roughly in line with the previous quarter.

Some of our enterprise and industrial customers are seeing a reduction in end customer demand due to COVID-nineteen and general macroeconomic weakness. However, our design activity remains strong with new wins in the networking, telecom, compute and defense end markets. We also continue to broaden our reach geographically with the formation of a Western Europe sales operation headquartered in Germany. Our team on the ground now has a deep understanding of the market and the requirements of industrial customers in the region, and we are optimistic about our ability to gain share in this new market for Smart. On the product and technology front, we recently announced a Gen Z development kit, the industry's smallest and easiest to use solution for developing and testing Gen V fabric, managed software for remote and tiered memory.

This demonstrates our ability to deliver more advanced design to our leading OEM customers as we move up the stack and create higher value solutions to meet the increasingly complex needs of our customers. And finally, our Brazil business, which generated approximately 35% of the quarterly net sales and totaled $105,000,000 up 13% sequentially. As we expected, our ASPs improved in Brazil, driven by both an increase in the average density of memory and a recovery in the unit sales. As mobile memory deputies in Brazil still lag world averages, we continue to see ongoing improvement in our ASPs. Additionally, the latest forecast from our customers show a continued recovery in unit sales, positioning us for a solid start to fiscal twenty twenty one.

We continue to advance our technology development in our Brazil operations, which recently began qualification of 11 die stack technologies at our leading mobile customers. Investments like this help provide our in country support of our major customers. As we indicated last quarter, the new points based manufacturing rules have been favorable to memory and less favorable to other parts of the business. We have recently made a strategic decision to exit the battery business and refocus our efforts and investments on two growth areas: IoT and SSD. We will continue to update on our progress there.

Now I will turn the call over to Jack for a closer look at the financials before coming back to provide closing comments. Jack? Great. Thanks, Mark. We reported a strong quarter with solid improvements in all key financial metrics.

Fourth quarter fiscal twenty twenty net sales were $297,000,000 to 5.6% higher sequentially, driven by Specialty Compute and Storage and Brazil. Non GAAP net income increased by 19.5% sequentially, and non GAAP EPS grew by 17.1% over the previous quarter, reaching $0.82 per share, demonstrating the financial leverage in our business model. Cash and equivalents increased to $150,800,000 at the end of the fiscal year, which is $20,000,000 higher than the previous quarter. The breakdown of net sales by end market for the fourth fiscal quarter was as follows: Mobile and PC, 31% Network and Telecom, 25% Servers and Storage, 12% Industrial, Defense and Other, 32%. Strength in Mobile and PC, Industrial, Defense, Networking and Telecom more than offset lower sales for the server and storage end market.

Now moving to the rest of the income statement. Non GAAP gross profit for the fourth quarter was $57,800,000 or 19.5% of net sales compared with the last quarter's $55,900,000 which was 19.9% of net sales. Non GAAP gross profit margin by business group was as follows: Specialty Compute and Storage, 28% Specialty Memory, 16% Brazil, 19%. In our fourth quarter, Brazil margins were lower than expected due to an accounting change that had no impact to net income as it impacted operating expenses in a similar manner. This accounting change is also reflected in our guidance for Q1 and is related to how the Brazilian government is encouraging local manufacturing.

Without this change, gross profit and operating expenses would both have been around 2% higher. As Mark mentioned earlier, the points based system is less favorable to batteries. We have made a decision to discontinue the operation of our Brazil battery business in our just completed fiscal quarter, resulting in a charge of $3,500,000 Non GAAP operating expenses were $29,400,000 compared with 35,500,000 in the previous quarter. Non GAAP net income for the fourth quarter was $20,400,000 or $0.82 per diluted share compared with $17,100,000 or $0.70 per diluted share in the previous quarter. And adjusted EBITDA totaled $33,000,000 compared with $25,400,000 in the prior quarter.

Our non GAAP effective tax rate for the quarter was 25.2%, which was around 5% higher than expected. As many of you know, the way taxes are calculated is based upon an estimate made at the beginning of the fiscal year as to what net income for the full year will be by geography and company within a geography or where profits will be domiciled. There are different tax rates for geographies as well as companies within a geography. Example, in Brazil, our module company has a 40 34% tax rate, while our packaging company has a 9% tax rate. Our full year profits by country and company were different than what we had forecasted to go into our fourth quarter.

Turning to working capital. Our net accounts receivable totaled $215,900,000 compared with $223,200,000 last quarter. Our days sales outstanding remained essentially flat with last quarter at forty five days. Inventory totaled $163,000,000 at the end of the fourth quarter compared with $180,600,000 at the end of the third quarter. Inventory turns remained flat, around 9% for both quarters.

Consistent with past practice, accounts receivable, days outstanding and inventory turns are calculated on a gross sales and cost of goods sold basis, which are $438,200,000 and $381,900,000 respectively, for the fourth 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 exited the year with a very strong cash position of $150,800,000 of cash and cash equivalents compared with $131,800,000 at the end of the prior quarter and $98,100,000 at the end of our last fiscal year. Fourth quarter cash flow from operations increased to $16,200,000 compared with $13,600,000 in the prior quarter. For the year, cash flow from operations totaled 78,400,000.0 We exited our fourth quarter with a very strong balance sheet as well as a vastly improved capital structure, thanks to the convertible note and subsequent restructuring and repayment of debt that was executed earlier in the year.

For those of you tracking CapEx and depreciation, CapEx was $7,400,000 for the quarter and depreciation was $5,200,000 And now turning to our fiscal Q1 twenty twenty one. Let me first provide you with some context with respect to our guidance. Our guidance reflects the accounting change we made in Brazil, which decreased our gross margin as well as operating expenses, with no impact to our net income. With that as a backdrop, let me turn to our guidance for the first quarter of fiscal twenty twenty one. We currently estimate that our first quarter net sales will be in the range of $280,000,000 to $300,000,000 Gross margin for the quarter is estimated to be approximately 18% to 19%.

GAAP earnings per diluted share is expected to be approximately $0.28 per share, plus or minus $05 On a non GAAP basis, excluding share based compensation expense, intangible asset amortization expense, convertible debt discount, OID and fees and other infrequent or unusual items, we expect non GAAP earnings per diluted share will be in the range of $0.7 plus or minus $05 The guidance for the first 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 12% to 16%. The number of shares used to estimate earnings per diluted share for the fourth fiscal quarter the first fiscal quarter is $25,000,000 Capital expenditures for the first fiscal quarter are expected to be in the range of 10,000,000 to 15,000,000 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 in our earnings press release for further details. Operator, we are now ready to take questions.

Speaker 0

Our first question comes from the line of Raji Gill from Needham. Your line is now open.

Speaker 4

Yes. Thank you for taking my questions. I appreciate it. Just, Jack, a little bit more clarification on the accounting change. I wonder if you can go in detail what's driving the accounting change specifically?

And should we be thinking about this type of gross margin and this type of OpEx level on a go forward basis?

Speaker 3

Sure, Roger. So to answer the last part of your question, yes. So we expect gross this will impact gross margin and operating expenses that we talked about, about 2%. We would expect to have a lower gross margin because of this in the future and also operating expenses decreased. So in Brazil, you know, they've been changing their rules because of the point based system and also to to have manufacturing more competitive.

So there was a a change made to the law to give a what they call the financial credit company for local manufacturing to make them more competitive. When the accountants looked at the rule and they came out, they said that you had to adjust and put this credit into as a contra, to your operating expenses. We had to reduce our operating expenses for this credit, which then took it out of other cost of goods sold. And so it is a recap between the two, has no impact to net income, and we expect it to be, you the same impact on a go forward basis.

Speaker 4

Okay. So it's just kind of moving it from from one bucket to the next, but

Speaker 3

Yes. Not a bit of

Speaker 4

Okay. Thank you. Now just in terms of the fundamentals and welcome, Mark. We look forward to working with you in the future. In terms of the Penguin, the specialty SEIS business, you had mentioned that the federal spending has resumed and that drove some growth, but also mentioned some traction with Penguin.

I'm wondering how we should kind of think about that business going forward. Is it contains many different segments now? It contains In Force, Penguin Computing, Artisan and the like. So I'm thinking I'm wondering what are the kind of the growth drivers in that segment as we go into kind of fiscal year 2021?

Speaker 3

So, yes, I appreciate the question and look forward to working with you as well. I think those questions can actually be broken up. You know, it it does come up to specialty compute and storage as a as a business category. But in each of them, they're very unique in in terms of end markets. And and as you noted, we did comment specifically on the call today about the backlog funnel that Penguin has built up, and I mentioned our largest order ever at Penguin.

I think in terms of that, we look at both the government and commercial sector. Within the commercial sector, there are areas like academics, oil and gas, telecommunications, investment banking. We've actually had one of our largest customer opportunities with a hedge fund provider who's using our technology for advanced data analytics. And as you get closer to, you know, edge and and on premise, you see applications in our artisan business and our in force business in terms of smart embedded in smart wireless that are driving segments that are more IoT driven and related and then having to do with, you know, opportunities around commercial, around government, around education, around manufacturing and and, supply chain management applications. And so as you get further away from the the high performance compute environment, it's more IoT driven wireless applications.

Even some consumer, technology applications that are really pretty innovative, we're playing a great role in providing solutions. So, it's a broad ecosystem, and that's why it's easier probably to break it down into the way that businesses used to work. But having said that, I think one of our biggest opportunities from a solution standpoint is that we're now providing an architecture that can go end to end in terms of an application environment for strategic customers. We have a gas customer right now where they're using our high performance compute capabilities for analytics around customer behavior, and they're using our IoT technology at the point of interface to the customer. And we think that one of the reasons of consolidating the strategic development of our solutions is that those assets, high performance computing and IoT, with increasing investment in managed services, can provide a really unique place for SMART to carve out future growth.

Speaker 4

Okay. Excellent. And then on Specialty Memory, you had mentioned a reduction in enterprise spending. We saw this echoed by Micron in specific markets. Can you talk a little bit about your view of enterprise spending and the impact that COVID had and how we're thinking about next quarter.

And the design wins that you're seeing in networking and telco, how are they offsetting it? Any color

Speaker 3

on I have good question. And by the way, I'd just like to provide a little commentary because I did have you know, a decade in in in the memory on the Micron side and the perspective I had. You know, when COVID hit, I kinda felt like there was a typical reaction by the customers to grab inventory heading into the summer and the fall. And I thought the demand was propped up some. Now having said that, as you can see from the projections that Jack provided for Q1, we're pretty confident we're going have a pretty strong, solid quarter.

Now that has not been the case in broader semis that have already announced. And so pertaining to our business, it's not that we see a dramatic softness in demand. We're just seeing that pertaining to COVID. I think there's some been some inventory burn and some usual unusual dynamics relative to, for example, Huawei, and what what their demand profile looked like going into the back half of the calendar year. So a lot of different dynamics going on.

We called it out because we're seeing maybe some softness in certain areas. But certainly, as the numbers suggest, growth in other areas will put us in a pretty good position for Q1.

Speaker 4

Thank you.

Speaker 0

Thank you. Our next question comes from the line of Brian Chin from Stifel. Your line is now open.

Speaker 3

Ajay, first, thank you and best of luck in your new role. And Mark, I just want to welcome you aboard as well. Maybe for my first question, in terms of the November guidance, maybe just to be a little bit more granular, look at your sequential revenue trend, what are you implying in terms of Specialty Compute Brazil and specialty memory? And also, just that's part of the question. The other part is in terms of specialty compute, was that big order that you're seeing, is it more directed to the federal or commercial market?

Kind of what's the shift and timing against that? And what were those other signals that you're getting, Mark, that gives you confidence in the near term? Yes. Good question. The order I referred to was indeed part of our federal spending, and so we're pretty excited about that.

But across both federal and commercial, we're seeing increased spending in this environment and demand, I should say, result of the divestiture. But our funnel, in terms of our backlog, is probably the healthiest ever since we've had the business at at Smart. And when you think about the the competitive landscape there and you think about our position, you know, Penguin's had a very long history in this business. And as we continue to find new opportunities and scale, the HPC market is is kinda on an uptick because the the end segment drivers are there. As I said, you know, as you as you're you're aware, AI is a very hot world right now with people getting out and starting to to to further develop applications around that.

Machine learning, for sure, and and, you know, even data analytics, like, we're seeing a lot of investment into, you know, high performance, quick quick data analysis type models that are providing kind of investment growth in the area resulting in HPC demand. So while we're not giving you necessarily a funnel number per se, I I wanna make sure that as we do that, we have a benchmark for you to understand. But we're not doing that per se specifically. We see a much bigger funnel, the best funnel we've had since we own the business. And we're very optimistic about some of the successful implementations we've had as kind of a beachhead for further growth.

Okay. Yes. Maybe another question, maybe directed at you, Mark. Clearly, the strategic expansion of SMART into the specialty compute market has been evident in past few years. I understand it's early days for you, but looking at high performance compute specifically, to achieve the right balance or mix of customers, do you need to look outside the company to augment sort of the existing offerings with additional products, services and infrastructure?

I think that's right. I think maybe there's two areas to think about it. There's we've improved the margin in this business since day one. Day one, I think, if I recall, the margins that upon acquisition on day one were roughly 15%, plus or minus. And those markets are now kind of approaching 20%, 21% gross margin.

Now having said that, I think, that business is going to be critical for us, to add different capabilities that we don't necessarily have today but have kind of a road map of what we'd like to get to. I think two things. Partnerships, which we think we have a good core set of partnerships with the likes of NVIDIA and AMD and Intel and others, but more so in terms of value add capabilities from a software services and application layer that we'd like to to develop and and either through inorganic activities or kind of kind of partner with co development. An existing software platform that's pretty pretty sophisticated as is. It's just, as we think about growing up the stack, and that's a you know, you said it's only thirty days in.

I'll tell you, one leg of what I was just thought was gonna be a big strategy for us going forward. It's gonna reflect in margin expansion. This is a great opportunity for this company, and we deserve more. We've got to invest more and go get it. And I think we have the opportunity to do that based on, again, services and software layered on top of our hardware architectures at Penguin.

That's great. Thanks for that color. Maybe just one quick thing on Brazil. Putting the local content changes to the side, it's been a while since we had units content and pricing all working together in the company's favor. It's good.

What gives you the confidence that the film market in Brazil has turned a corner? And what are you seeing or expecting in the quarters ahead in terms of content growth and also pricing trends? Yeah. I mean, we we, you know, we talked about early you know, I think last call that we're starting to see the densities grow again in Brazil. Right?

So we've now I think it's Mark mentioned in the call. You know, we've developed a 64 gigabyte, now a 132 gig product that's in fall. So if you look at the 64, it's doubling the amount of flash that we've ever used, and the 132 would be four times. Right? For densities, you're go up in Brazil based on these new products that are under qualification.

Remember, we don't qualify a product in Brazil, and then you go try and sell it. Right? We've already worked with the cell phone guy who's on the road map. This is what they need when we go qualify that product. So we know they're moving to higher density products.

And also remember, you know, Brazil lags the world. Right? So Brazil is way behind the balance of the world when we're talking about, you know, the densities in the phones. So even if the if they slowly catch up, our densities will go up. And, you know, we're seeing improvements.

When we look at the data in Brazil, I talked about a number of cell phones being sold and things like that. It turned the corner. They're starting to go up a little bit from where they were. So we're seeing, you know, we're seeing unit growth in cell phones and in PCs down in Brazil. So it's it's turned a little bit on both.

The demand for both is getting better down in Brazil. Yeah. And if you couple that with just raw technology evolution that's going on globally, you know, the memory requirement is going to get driven up because of performance and expanded use of the platform in the the hands of the consumer. So, you know, where Brazil may lag, it's eventually going to drive there. And things like five gs and and other additional application drivers, we're gonna be in a pretty good position to capture the advantage of the higher ASP top, trend line.

Great. Thank you.

Speaker 0

Thank you. Our next question comes from the line of Kevin Cassidy from Rosenblatt Securities. Your line is now open.

Speaker 3

Yeah. Thanks for taking my question. Welcome, Mark. And also congratulations, Jack, on your promotion. Thank you.

Jack, maybe I'll give you your first question then. On the Specialty Memory, gross margins are seem to be stuck in the 16% range. Can you discuss that a little bit? Is there some opportunity to increase that gross margin? What's to increase.

No. I think you're seeing the gross margins for specialty bottom in out there. You know, we've had some new products that have been qualified. And sometimes when you when you qualify new products, you have a higher ASP product, which kind of translates into lower margins. So we've had some impact on margins for that.

You know, our our view is going forward, you know, as we go through next year and get to the back half of the year, specialty margins will definitely improve and get back closer to where they have been historically. I think we're at the low area right now for specialty margins here in this quarter, maybe next quarter, and they will go they will start to improve again, Devin. Okay. Are are you thinking, like, back up to, say, 21% range? Or can I get Yeah?

I think, you know, up to maybe the high teens and then, you know, slowly get up there. I get too excited. And and how about the demand in in the enterprise? Is is it an inventory issue or, you know, kinda like what Mark said, is there some porting that happened early on and now you just have to let that inventory run down? Yeah.

I think I mean, you look at some of our customers. Right? You look at you know, you follow some of our large customers in this space. Right? They've they've been guiding down what would be our q one for demand.

Right? So our large customers are gonna be guiding a little bit down in demand. That's definitely gonna impact the enterprise spend within specialty memory. You know, I, you know, I think they they had built up some inventories maybe early in the summer. And, you know, the question is is it is a little bit of a demand issue, I think, on our customers, which translates back to demand issue for us, as well.

Okay. Great. Thanks. Congratulations on good report for this environment. Thank you.

Speaker 2

Thank you.

Speaker 0

Thank you. Our next question comes from the line of Suneel from Deutsche Bank. Your line is now open.

Speaker 5

Thanks for taking my question. First off, welcome both, Mark. I'll toss the first question to you. Maybe it's a little early. Are there any changes in strategic direction, whether there are areas that you want to focus more on or areas you want to deemphasize?

And maybe related to that, there are some organizational changes that you guys announced a few weeks ago. Can you talk about the importance of those changes?

Speaker 3

Of course. Maybe let me take the strategy. You know, I think, at this point, I would say that, if you look across all of our business, the smart strategy has been to find markets where they can differentiate with the with delivering specialty solutions into kind of a diverse set of end markets when you think about the the segments in high performance computing versus the segments in specialty memory. You know, obviously, Brazil is just unique in its own specialization of of capabilities that we have. And then you continue with the the embedded and wireless business.

And so the common theme around developing specialty solutions and subsystems is kind of at the core of what our strategy is. Now, as we've talked a little bit on this call, know, we wanna make sure that we're developing additional capabilities to bring to our customers a lot of differentiation. And that will kind of prompt us to look both organically on development, but also more strategically on expansion through inorganic acquisition around both technologies and go to market opportunities. And so from a strategy standpoint, it's not wildly different as I see it, at least not how they sit here today. But what I would see is the, the execution side of the business, leveraging the operating platform and running the company as well.

You know, I think there's an opportunity there. I mean, I am very bullish on Penguin. Yet, over the last year or two, Penguin hasn't really grown for us. I think there's a great opportunity with the right focus and energy to drive that business to a really a much better place on a go forward basis. And that's the true the same is true in our embedded and wireless business.

And so some of it is more about the execution side. And then also, when you think about M and A, the platform that we have and the operating leverage that we have in terms of a low cost operation for specialty business is very unique. And I think that will give us the right platform to go out and acquire accretively and scale the business. And, you know, the the differentiation focus we'll maintain as we look at those type of opportunities. We're not looking just to go business to grow business.

We wanna find opportunities where we have market leadership and unique application end markets where there's enough differentiation that leverages Smart's core competency around manufacturing, supply chain, and go to market. And so I don't think it's a broad strategy change as much as an emphasis on driving differentiation going forward above and beyond to allow us to expand our margins because that's gonna be a critical leg of the stool for us. Yeah. We wanna grow, but we wanna grow while we expand margins. That's the that's the message I would like to give just today is that, you know, we're not, you know, we're not exactly satisfied where the margins are, and we wanna grow them.

And we wanna find ways to grow them and providing more value. And I think our customers would like that, providing the value tangible, and that's gonna drive the strategy. Specific to the announcement on a go forward basis, as you guys know from my past, it's kind of very similar to what we did at Micron, where we established these business unit mentalities. And I think from an accountability standpoint and leadership standpoint, Jack has demonstrated over his career that he he will be the right person to this company to be able win in the memory solutions business. And he's got the support of an outstanding executive in T1 that has really crafted a a really strong business in in Brazil.

And we believe that these leadership positions are well earned and reflect an organization structure as we go forward that we will have outstanding leaderships at the top of these business areas. And we will continue to look for this type of leadership both inside the company and outside the company to put the right team in place because as you might imagine, that's one of my highest priorities as an incoming CEO is to make sure that we have the right leadership in place to drive these businesses. Because when you think of these opportunities with Penguin, for example, or other businesses, managed services in, in the embedded business as an example, these are new capabilities we're trying to establish. And, you know, it's nice to be able to put them on a PowerPoint slide, but you gotta go execute. And on the execute side, we have to have the right leadership in place to build the right plans, develop the right capabilities, and go to market.

And as we think about the expansion capabilities in all of our businesses, we wanna have, you know, a Jack and Kimon clone across the whole, set of businesses we're in and make sure we have the right leadership development for our company. And that's what I'm going be focused on

Speaker 6

a lot of in the

Speaker 3

next sixty to ninety days.

Speaker 5

Great. Thanks for the detailed answer. Then moving on to the Specialty Compute business. I think last quarter, you guys talked about the commercial contracts where it was generally pretty strong, maybe with a few pockets of weaknesses in terms of end markets. And in your prepared remarks, you talked about several business coming back a little bit.

Yes, the fiscal Q4 results came in a little low than I would have expected. So a few questions here. One, can you give us some end market color? Is there was there any kind of negative surprises in terms of end markets? Second, do you have any visibility when some of these federal contracts will come back after the initial pickup that you guys saw in August?

Lastly, how should we think about the mix between federal and commercial contracts in fiscal Q1 versus a normal environment? Thank you.

Speaker 3

I'll take okay. I'll take the the second first part. The federal business per se for us has has picked up a bit in terms of major design win and inbound orders. Having said that, obviously, there's a lot of unknown in the government relative to the administration and what will happen in November. But, you know, what we can see from our demand, that's an area of of great opportunity for this company.

And so and I'll let Jack give a little more color on the specifics, but we're pretty bullish through the cycle because of some of the solutions we have that are specific and not just in one area. Certainly, Penguin's exciting, but also in terms of our embedded business, we've got some some design win opportunities that have come to fruition. And we're generally bullish, again, with the with the hesitation that November may impact the long term prognosis. We just don't know. But we're following that, and we believe we can ride through that with some growth in that area.

Yes, Becca. I think in Q4, the Penguin business performed as we thought it was. We didn't, you know in federal, Kim and Michael, we thought we don't think it was weaker than we anticipated. And you listen to Mark's statements, it would say that maybe in q one, potentially a little stronger than we thought. Right?

So, you know, Penguin, you know, will be probably doing a little bit better in q one than we had, originally anticipated. So think that some of business is popping back maybe a little sooner than we thought. So we're looking for a pretty good q one out of Penguin.

Speaker 5

Okay. Thank you.

Speaker 3

Thank you.

Speaker 0

Thank you. Our next question comes from the line of Blayne Curtis from Barclays. Your line is now open.

Speaker 6

Hey. Thanks for taking my question. That's really good lead in because I was I was just kinda curious. We looked to November, prior question asked about what the segments we're doing. You said specialty would be good, and you just said it would be up.

I guess,

Speaker 3

trying to

Speaker 6

square that with gross margin, which is down. And you would think that if if mix was moving to the especially compute, the margin would be up. So can you just walk me through that?

Speaker 3

Sure. So, I mean, the overall you know, especially compute, yes, we think that will be up. And you're right. That has a higher gross margin. But then, yeah, we look at, in Brazil, the change with Brazil and all that.

So, you know, Brazil will potentially be a little bit drag on the margins in q one while you'll see the margins come out a little bit, Blaine, in the quarter potentially. But, especially compute, you know, we'll have a we'll do better in q one and also help us on the margin side. But Brazil, I think, especially memory a little bit, especially Brazil, will drive that margin down a little bit in the quarter.

Speaker 6

Okay. So the the accounting change is not fully implemented. Is that way the right way to look at it? And therefore, you know, you should see some benefit in OpEx from it as well?

Speaker 3

No. It's fully implemented. It's just that the Brazil business in q one, based on some certain factors, we think we are just spending a little bit lower margins in q one. As we go to market in the quarter. Those are driving volume down there.

We expect margins to be impacted a little negatively in Q1 in Brazil.

Speaker 6

Got you. And then I guess kind of a two part on the Brazil market. You mentioned densities as a driver. I'm just kind of curious, you had good growth in Brazil. I mean, there's unit story, there's density, and then there's kind of like just the strategic nature of how people use the credits and onto the new system.

And you're exiting batteries. So clearly, memory is in the category that you have said people may use more and that would drive growth as well. I'm just kind of curious, if you look at those factors over the last couple of quarters, what you think has driven the most part of the growth? And then I guess if you look out, are there any other segments used to have wireless modules and batteries and other areas? But is there any future areas that you could look at for Brazil?

Or should we just continue to think about memory?

Speaker 3

We commented in the earlier comments around two that we're pretty bullish around. One is around SSD development and IoT. We've actually been in development of those products, and we're starting to get some early revenue traction. I believe SSD is an exciting opportunity for us given the memory, you know, component in that, which makes it a very attractive product for in country. And we're starting to work with our customers on developing some scale in terms of getting share in their memory procurement in country.

So I think SSD first, and then as we develop and cultivate some go to market capabilities around IoT, we'll be able to take some of that product in country as well. So I think where we what we found out, you know, over time, the battery business is a difficult one for us to scale and not as advantaged from a local production standpoint. We think SSD and IoT are more so, and that's where we're shifting our direction.

Speaker 6

Thanks.

Speaker 0

Our next question comes from the line of Mark Lapatis from Jefferies.

Speaker 5

Ajay, first of all, you very much for all the help. Mark, congrats on the new role. I have two questions for Mark. First one, Mark, you started to share a bit of your framework on M and A. I was hoping you could maybe fill that out a little bit more.

Can you talk about like your view on the sweet spot in terms of the size of companies and to the extent you have an appetite for exploring some kind of a transformative M and A deal like a merger of equals? Are you thinking about tuck ins and the willingness to lever up with debt or issue equity?

Speaker 3

Yes. Sure. So for those of you who knew me in a prior life, I mean, when you think about how Micron survived, we did four or five major acquisitions in a ten year period during some really turbulent times in the memory industry. And I would argue that those acquisitions and with the help of some financial engineering, so to speak, to provide us the opportunity, gave us a great platform that the company is built on. And obviously, Sanjay and team have done a great job continuing the growth.

I think that you know, the company, smart as we sit today, could really use some additional inorganic activity, m and a activity around tangential spaces to the core business today. And so you've got confused memory embedded in in in areas of wireless. And so I don't think that the company should be necessarily taking a transformative, massive, merger of equals approach at this point because I think there's a lot left to develop and add value to our current businesses. Having said that, adjacencies to what we do well, manufacturing of subsystems and specialty markets, Well, those could be very interesting because when you think of the holding company model at SMART, you've got these acquisitions that Ajay and team have already consummated. Penguin and memory from a business standpoint, sure, they're overlapping in some areas.

But from a go to market and customer set, not so much. And these unique opportunities to deliver these products to individual, expanding markets is where the growth can come from. So I don't think necessarily a mergers of equal is necessarily what we'd be thinking about, just to just to answer your question specifically. But I could see some some significant transactions in adjacent businesses that take advantage of our operating discipline platform. You know, again, the manufacturing, supply chain expertise, go to market support services, quality.

And as I think about that, there are a number of different industries that we should be exploring that have the same type of criteria that has made these businesses successful at Smart. Again, the criteria I look for are, you know, specialty solutions at, dependable to differentiate end markets, that require really good operating discipline. And those three criteria for me is what's smart and built upon. And I think there's more of those opportunities, out in the industry, and, again, adjacent industries that allow us to take advantage of our capabilities and competencies that we have today to yet expand our reach in the new market.

Speaker 5

That's very helpful. And a follow-up, if I may. On Penguin, it looks like there's a view that there's an opportunity for improving their profitability. Believe you mentioned that soft developing a software application layer capability. And I was wondering to what extent have you explored or do you think that hosting services yourself or providing the CapEx, you're self investing in the system yourself and offering that as a solution also?

Is that entered into the

Speaker 3

Yeah. I apologize. I didn't do a good job of calling that out. Sorry about that earlier. When I as I'm referring to software and services, the services part of business really was a comment based on our desire to develop, POD, Penguin On Demand, as an enhanced business growth driver for the company.

And it's a very unique business for us. But when you think about what would go on with that, that type of service platform, it'd be, high power compute capabilities coupled with, advanced memory technology and storage. Well, those are all those assets we have in terms of integration and high performance are under the roof of of Smart today. And so what it takes for, though, as I said earlier, that skill set and leadership, we're gonna need to make sure we have the right plans in place and the right team in place to go off and execute that. You know, what I've seen in prior lives in larger companies is these great ideas don't don't necessarily pan out as quick as you like them because they they lose focus.

And, you know, my my my commitment to the board and my focus, on a go forward basis is an opportunity like that. We staff it well. We got the right team in place, and we go into these businesses. And, I think that is a good example of a great opportunity that we have to flush out a good plan, which I believe there is, and get the right team in place to go execute and allow them to go run and execute. And, software and solutions services around things like pod or or layered software on top of the payment architecture, those are capabilities that we will invest in to grow the margin.

Speaker 5

Got you. That's very helpful. Thanks for clarifying that. That's all I had.

Speaker 3

Thank you.

Speaker 0

Thank you. 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.

Speaker 3

Thank you, operator. In summary, fiscal twenty twenty has concluded on a strong note amidst these challenging times. We are grateful for the outstanding work of our employees across the globe, and I'm optimistic about the opportunities that lie ahead. With our strong balance sheet, multiple growth vectors and differentiated portfolio of technologies, I believe we are in an excellent position to drive growth both organically and through opportunistic and accretive M and A in the next phase of smart evolution. Thank you for your interest and support of the company, and I look forward to meeting and working with you in the months ahead.

Speaker 0

Ladies and gentlemen, this concludes today's conference call. Thanks for participating. You may now disconnect.