Penguin Solutions Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
April 9, 2024

There are 9 speakers on the call.

Operator

Good afternoon, and thank you for joining the Smart Global Holdings Second Quarter Fiscal 20 24 Earnings Call. My name is Kate, and I will be the moderator for today's call. At this time, all lines are in a listen only mode and will be until the question and answer portion of the call. I would now like to turn the call over to Suzanne Schmidt, Investor Relations for SMART Global. Suzanne, you may proceed.

Speaker 1

Thank you, operator. Good afternoon, and thank you for joining us on today's earnings conference call and webcast to discuss SGH's Q2 fiscal 2024 results. On the call today are Mark Adams, Chief Executive Officer Jack Pacheco, Chief Operating Officer and Ken Rizvi, Chief Financial Officer. You can find the accompanying slide presentation and press release for this call on the Investor Relations section of our website. We encourage you to go to the site throughout the quarter for the most current information on the company.

Speaker 1

I would also like to remind everyone to read the note on the use of forward looking statements that is included in the press release and the earnings call presentation. Please note that during this conference call, the company will make projections and forward looking statements, including, but not limited to statements about the company's growth trajectory and financial outlook. Forward looking statements are based on current beliefs and assumptions and are not guarantees of future performance and are subject to risks and uncertainties, including, without limitation, the risks and uncertainties reflected in the press release and the earnings call presentation filed today as well as in the company's most recent annual and quarterly reports. The forward looking statements are representative only as of the date they are made, and except as required by applicable law, we assume no responsibility to publicly update or revise any forward looking statements. We will also discuss both GAAP and non GAAP financial measures.

Speaker 1

Non GAAP measures should not be considered in isolation from, as a substitute for, or superior to our GAAP results. We encourage you to consider all measures when analyzing our performance. A reconciliation of the GAAP to non GAAP measures is included in today's press release and accompanying slide presentation. And with that, let me turn the call over to Mark Adams. Mark?

Speaker 2

Thank you, Suzanne, and thanks to all of you for joining us today for our fiscal 2024 Q2 earnings call. We delivered solid financial results in the Q2 and continued to make great strides in our transformation into a provider of high performance, high availability solutions that enterprise customers need to deploy AI on premise, at the edge and in the cloud. As one of the few players in the industry with decades long experience in high performance compute and specialty memory, SGH is uniquely positioned to help companies manage the complexity of AI implementation at scale. As a total solution provider, we offer our customers and partners innovative technology agnostic hardware configurations, software that manages AI systems for maximum output and availability, and the professional services suite that enables our customers to achieve best in class performance and reliability. Let me summarize our operational results for the quarter.

Speaker 2

Revenues totaled $285,000,000 in line with the midpoint of our guidance range. Although non GAAP gross margin was at the lower end of our guidance due to a higher portion of hardware mix, we achieved non GAAP earnings per share of $0.27 which was above the midpoint of our guidance through better operating expense controls. We exited Q2 with a strong balance sheet. Cash and short term investments totaled 466,000,000 dollars Now let me start our business line review with the Intelligent Platform Solutions Group or IPS. Our IPS team offers a robust solution set of industry leading hardware, advanced cluster management software and best in class professional services.

Speaker 2

This solution portfolio enables our design, build, deploy and manage solutions framework for HPC and AI applications on premise at the edge and in the cloud. In Q2, IPS revenue came in at 141,000,000 dollars up 19% from our prior quarter, representing 50% of total SGH revenue, thus making IPS the largest component of our overall business in Q2. Our vision is clear, partner with our customers and collaborate with them to build the future of AI. The market continues to see strong investment in the deployment of AI infrastructure solutions by hyperscalers and large scale cloud service providers or CSPs. The 1st few months of 2024, however, have confirmed that AI is not just for early adopters anymore.

Speaker 2

We are seeing signs of AI adoption by larger enterprises in markets such as financial, oil and gas, defense, education and digital media as well as Tier 2 CSPs with projects ranging from proof of concepts to large scale deployments. Our engagements with existing and potential AI customers have noticeably picked up in volume over the last few months, reflecting this market dynamic. In our conversations with both current and targeted new clients, they have shared the challenges they are facing in deploying AI, trying to manage the complexity that arises as they integrate advanced compute, memory, networking, storage and cooling and large scale data center rollouts. Our customers ultimately must have high performance compute running workloads at scale in an environment that provides for maximum uptime and overall efficiency. As a total solution provider, we are ready to meet that challenge.

Speaker 2

We offer our customers a complete solution that combines innovative hardware design, software to manage AI infrastructure for maximum output and availability and a suite of professional services all designed to help them achieve best in class performance and reliability. With our customer first approach, we put our customers' priorities at the heart of everything we do, ensuring that each solution we deliver is tailored to their specific requirements and ready to support their success. We believe that AI inferencing at the edge will also be a critical market opportunity because it brings intelligence closer to where the information is most valuable, closer to where decisions are being made. We have expanded our capabilities at the edge with our new next generation fault tolerant computing platform, the Stratus ZTC Endurance Server. We are seeing strong demand for this platform, which enables our customers to run applications with an unplanned target downtime estimated in minutes per year, we are developing an approach to enable our customers to implement AI at the edge with a high performance, high availability platform.

Speaker 2

The ZTC Endurance Server is another example of the investments we have made and continue to make to support the needs of our customers whether on premise, at the edge or in the cloud. Today, we are also announcing a new member of our management team. I am pleased to announce that Pete Manca has joined us as President of IPS. Pete brings a wealth of experience in building businesses that provide high availability, high performance solutions to enterprise customers. Prior to joining our team, Pete served as Senior Vice President and General Manager at Dell Technologies for 5 years, managing several large businesses including converged solutions, OEM Solutions and Apex, Dell's end to end portfolio of cloud offerings ranging from storage to high performance computing to AI services and solutions.

Speaker 2

Prior to Dell, Pete served as President and CEO of Egenera, a leading provider of wholesale cloud computing solutions, underscoring his broad experience and expertise. I am confident that Pete is the right leader to propel the team forward and make the most of the opportunities that are ahead. People work with former IPS President, Dave Lorello, who is transitioning into an advisory role. Dave has been an invaluable partner in transforming IPS. With his guidance, IPS has become more effective and efficient across the board from go to market to engineering to manufacturing.

Speaker 2

He is a leader of high integrity with an execution mindset that we will miss. We wish Dave all the best. Turning now to memory, which operates under the Smart Modular brand name. We provide customers with high performance, high reliability memory solutions for specialty markets such as supercomputing, networking and telecom, storage, data centers, industrial and other specialty applications. For Q2, revenue came in at $83,000,000 or 29% of total SGH sales.

Speaker 2

As expected, sales declined slightly from Q1 levels, primarily due to continued elevated inventory levels at a number of our large customers. We continue to see signs that the memory cycle is turning upwards. However, as mentioned on our last earnings call, near term unit demand still remains challenging at some of our traditional enterprise customers. Nevertheless, we remain confident that business will rebound as we move into the second half of our fiscal twenty twenty four and expect revenues to grow sequentially in the Q3. AI is also reshaping the memory market landscape as the need for higher density and greater bandwidth becomes increasingly critical to system performance required to handle the most advanced compute workloads.

Speaker 2

We are expanding our product portfolio to capitalize on the convergence of compute and memory and system level solutions by leveraging Compute Express Link or CXL memory expansion and switching technology, which allows different parts of a computer memory system to communicate faster and more efficiently. We continue to make progress on CXL product development. We have successfully completed the design of our 8dim DDR5 CXL add in card and anticipate sampling this innovative product to our customers later this year. This high density solution offers 5 12 gigabytes of memory, making the system faster and more capable of handling the complex tasks required by large scale AI and high performance computing workloads. During the Q2, we also shipped initial engineering samples of our 4 DIMM DDR5 CXL add in card to a number of our enterprise customers.

Speaker 2

This product has a unique patented technology that keeps its footprint within a single width PCIe slot. This design is exceptionally beneficial for 1U servers because it optimizes space for other PCIe devices, including accelerators and network interface cards. We expect that revenues will begin ramping from this product in early fiscal 2025. Finally, we introduced our Zephyr ZDIMM memory modules with ultra high reliability for demanding compute applications and our DVR5 SO DIMM products continue to gain market momentum bolstered by our exclusive iTemp and Zephyr testing offerings which significantly enhance reliability. Taken together, these advancements exemplify our ongoing commitment to industry leading innovation, empowering us to address our customers' needs.

Speaker 2

Now turning to Cree LED, which produces application optimized LEDs for products in markets such as specialty lighting, video screens, outdoor, horticulture and architectural lighting. In the Q2 of our fiscal 2024, LED Solutions revenue totaled $60,000,000 or 21% of total SGH sales. As anticipated, 2nd quarter sales were lower sequentially primarily due to seasonality. With the LED demand environment remaining relatively muted in the near term, we continue to manage our Cree LED operations prudently and are aligning our expenses with current business conditions. We are optimistic that demand trends will begin to improve and currently expect revenues to increase sequentially in the Q3.

Speaker 2

Our R and D team has remained diligently focused on driving the technology development needed for Cree to continue leading in high value specialty applications. During this past quarter, we launched the XLAMPP XP G4 high intensity LEDs, which are optimized for indirect directional aftermarket auto and portable applications. We also introduced an extension to our Xlamp S product line, targeting the horticultural sector with products tailored for environments like greenhouses where precision lighting can transform crop growth and yield. As a technology and brand leader with a strong intellectual property portfolio, the Cree LED team continues to lead the charge in lighting innovation. Given our strong R and D and IP portfolio combined with our capital light outsource model, I am confident increased LED competitiveness and prospects for future success.

Speaker 2

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

Speaker 3

Thanks, Mark. I will focus my remarks on our non GAAP results, which are reconciled to GAAP in our earnings release tables and in the investor materials on our website. Now let me turn to our 2nd quarter results. Total SGH revenues were $285,000,000 at the midpoint of our guidance. And non GAAP gross margin came in at 31.5 percent at the low end of our guidance, primarily driven by a higher mix of hardware revenues.

Speaker 3

Non GAAP diluted earnings per share was $0.27 for the Q2, which was above the midpoint of our guidance and helped by better operating expense controls. In the 2nd quarter, our overall services revenue totaled $49,000,000 down from the $55,000,000 in the year ago quarter. Product revenues were $235,000,000 2nd quarter revenue by business unit was as follows: IPS at $141,000,000 memory at $83,000,000 and LED at $60,000,000 This translates into a sales mix of 50% IPS, 29% memory and 21% LED. Non GAAP gross margin for SGH in Q2 was 31.5%, down from 32.1% in the year ago quarter, driven primarily by lower memory volumes that were partially offset by improved mix in IPS. Gross margin was down sequentially from 33.3% in the prior quarter, primarily due to a higher mix of hardware revenue.

Speaker 3

Non GAAP operating expenses for the Q2 were $63,200,000 down from $64,600,000 in the Q1, primarily due to lower variable expenses and cost reduction actions. Operating expenses were also down from $68,700,000 in the year ago quarter. Non GAAP diluted earnings per share for the Q2 of 2024 was $0.27 per share compared to $0.24 per share last quarter and $0.87 per share in the year ago quarter. And adjusted EBITDA for the Q2 of 2024 was $33,000,000 or 12% of sales compared to $34,000,000 or 13 percent of sales in the last quarter and $65,000,000 or 17% of sales in the year ago quarter. Turning to balance sheet highlights.

Speaker 3

For working capital, our net accounts receivable totaled $170,000,000 slightly lower than the $171,000,000 last quarter. Day sales outstanding came in at 41 days, down from 44 days from last quarter, primarily due to the timing of invoicing and collections. Inventory totaled $173,000,000 at the end of the 2nd quarter, lower than the $208,000,000 at the end of the prior quarter. And inventory turns were 6.8x in the 2nd quarter, up from 5.8x in the prior quarter. Consistent with past practice, net accounts receivable, days sales outstanding and inventory turnover are calculated on a gross sales and cost of goods sold basis, which were $375,000,000 $294,000,000 respectively, for the 2nd quarter.

Speaker 3

And as a reminder, the difference between gross and net revenue is related to our logistics services, which is accounted for on an agent basis, meaning that we only recognize the net profit on logistics services as revenue. Cash and cash equivalents and short term investments totaled $466,000,000 at the end of the second quarter, down $88,000,000 from the $553,000,000 in the prior quarter. In the second quarter, we paid down $50,000,000 for the Stratus earn out and retired approximately $37,000,000 of our term loan facility. 2nd quarter cash flows used in operating activities totaled $22,000,000 compared to $60,000,000 provided by operating activities in the prior quarter. 2nd quarter cash flows used for operating activities included the $29,000,000 payment of contingent consideration as part of a total of $50,000,000 cash payment for the Stratus earn out.

Speaker 3

During the second quarter, we repurchased approximately 106,000 shares of our common stock using $1,900,000 Since our initial repurchase authorization in April of 2022, we have used a total of 72,300,000 dollars to repurchase 4,100,000 shares through the end of our second quarter. As of our second quarter, we have a total of $78,000,000 available for future repurchases under our authorizations. And to remind everyone, our capital allocation strategy remains the same. 1st and foremost, we will continue to invest in our business as we see significant opportunities for further organic growth. 2nd, we will continue to evaluate acquisition opportunities in a disciplined manner, such as our most recent acquisition of Stratus.

Speaker 3

And 3rd, the share repurchase authorizations provide us flexibility to return capital to our shareholders in an opportunistic and price sensitive manner. And finally, we look to retire debt to keep our gross leverage at reasonable levels. We retired $37,000,000 of our term loan in the Q2 and subsequent to the quarter end, we retired an additional $75,000,000 of term loan. These payments bring down the principal by $112,000,000 since the Q1 to $425,000,000 outstanding.

Speaker 2

For those

Speaker 3

of you tracking capital expenditures and depreciation, capital expenditures were $5,200,000 in the 2nd quarter and depreciation was $7,200,000 Turning to our 3rd fiscal quarter 2024 guidance. We expect that revenues for the Q3 of 2024 will be approximately $300,000,000 at the midpoint, plus or minus $25,000,000 Our guidance for the Q3 reflects the following. For IPS, we expect revenues to be flat to slightly up at the midpoint, with additional opportunities that may fall in the 3rd or 4th quarter depending on the timing of deployments. For memory, we expect revenues to grow in the high single digit range sequentially at the midpoint. And for LED, we currently expect revenues to be up in the high single digit range sequentially at the midpoint as well.

Speaker 3

Our GAAP gross margin for the 3rd quarter is expected to be approximately 29% at the midpoint, plus or minus 1.5%. Non GAAP gross margin for the 3rd quarter is expected to be approximately 32% at the midpoint, plus or minus 1.5%. Our non GAAP operating expenses for the 3rd quarter are expected to be approximately $66,000,000 plus or minus $2,000,000 and slightly up from the prior quarter, primarily due to variable expenses associated with the higher expected revenue. GAAP diluted earnings per share for the Q3 is expected to be approximately a $0.07 loss plus or minus $0.15 On a non GAAP basis, excluding share based compensation expense, intangible asset amortization expense, debt discount and other adjustments, we expect diluted earnings per share will be approximately $0.30 plus or minus $0.15 Our GAAP diluted share count for the 3rd quarter is expected to be approximately 52,600,000 shares based on our current stock price, while our non GAAP diluted share count is expected to be approximately 54,400,000 shares. Cash capital expenditures for the 3rd quarter are expected to be in the range of $4,000,000 to $6,000,000 And as a reminder, we are utilizing a long term projected non GAAP tax rate of 28%, which reflects currently available information, including the sale of Smart Brazil, which was completed in the Q1, as well as other factors and assumptions.

Speaker 3

While we expect to use this normalized non GAAP tax rate through 2024, the long term non GAAP tax rate may be subject to changes for a variety of reasons, including the rapidly evolving global tax environment, significant changes in our geographic earnings mix or changes to our strategy or business operations. Our forecast for the Q3 of 2024 is based on the current environment, which contemplates the current global macroeconomic headwinds and ongoing supply chain constraints, especially as it relates to our IPS business. This includes extended lead times for certain components that are incorporated into our overall solutions, impacting how quickly we can ramp existing and new customer projects. We continue to manage our operations in a prudent manner as we navigate a challenging environment, while also investing in our long term growth. Please refer to the non GAAP financial information section and reconciliation of GAAP to non GAAP measure tables in our earnings release for further details.

Speaker 3

Now let me turn it over to Mark for a few remarks prior to Q and A.

Speaker 2

Thanks, Ken. As we are still in the early innings of fully operational AI infrastructure being deployed at scale for most enterprise customers, we are seeing an accelerating need by the market for a trusted advisor to help with the challenges of deploying this new AI infrastructure. Our 25 years plus of HPC and memory expertise and deployment know how position us to become a leader in this market by working to solve our customers' most challenging AI infrastructure needs. As our transformation continues, I want to thank our global team members for their efforts this quarter. We feel we are well positioned for the exciting market opportunities ahead.

Speaker 2

Operator, we are now ready for Q and A.

Operator

Absolutely. We will now begin the question and answer session. The first question comes from the line of Quinn Bolton with Needham and Company. Quinn, your line is now open.

Speaker 4

Hey, guys. Congratulations on the nice results and outlook. I guess I want to start on the IPS business. And Mark, maybe just get your thoughts kind of demand across the customer base between large CSPs, Tier 2 CSPs and enterprises where you may be seeing some of the greatest demand for new deployments as you look out into the second half of calendar twenty twenty four? And then I've got a couple of follow ups.

Speaker 2

No problem. Thanks, Quinn, for the question by the way. Yes, so when we think about how our view of the market is, it's based on obviously our kind of executive engagements with the three segments you talked about. Obviously, the early investors in the market were the large hyperscalers of which obviously one is a big customer of ours. And then you have the 2 other segments you mentioned, large enterprises that are kind of have a infrastructure requirement in place for AI to enable their future success.

Speaker 2

And then you have these tier 2, what we call tier 2 CSPs, which are companies that have the infrastructure themselves to offer services that would lead for AI implementations at a number of different type of verticals, so to speak. So those three segments are how we look at the market. And I would say that, the early investors, as I mentioned, were hyperscalers. However, what we've seen a major uptick in is twofold. Marge Enterprises are evaluating their AI strategy.

Speaker 2

And then in that strategy really is do they do it on prem in their environment? Do they do it in a co location model, where they use an outsourced data center provider for the space and power? And do they have someone like Penguin come in and help them deploy? Or do they actually partner with someone in some type of JV structure or co investment structure for a future build? And we're seeing all of those different models.

Speaker 2

But then the level of demand signals from those type of customers on the enterprise side is very high. And then in addition to that, the hyperscalers are largely building to their own requirements. The Tier 2 CSPs are largely investing in infrastructure for enterprises who don't have access to their own infrastructure, mostly around data centers. And one dynamic I just want to reinforce, and if you talk to anyone in the power and data center markets, there's a massive shortage today in available data centers for AI. And the massive shortage really is around the power requirements to run AI.

Speaker 2

And so today, there's a big pent up demand for new data center capabilities to drive AI with gigawattmegawatt type performance that allows you to install these type of large scale cluster AI platforms. That shortfall is causing a lot of activity as far as who can help people enable these systems as quick as possible or in most rapid timeframe possible. And that's where we're seeing a lot of the engagements that we have is where customers are saying, hey, we need this space and we need to be up and running by X. They don't the customers in the enterprise world, they don't typically have the infrastructure that 1 of the big 4 hyperscalers have in terms of deployment. And they really don't even know what they know in terms of performance, uptime, liability, design uptime and optimization.

Speaker 2

These are all things that are critical. So the number of engagements we've had, the designs and the proposals, leading to more clarity around bookings and even future deliveries, it's all heading in the right direction.

Speaker 4

Excellent. The second question is you had mentioned sort of AI at the edge and seem to kind of highlight your Stratus offering. I'm wondering, are there opportunities for AI at the edge also in the traditional sort of Penguin business where you may be setting up larger clusters to run LLMs or other AI infrastructure. So it's not necessarily just a high reliability deployment, but you may also just say, hey, we've got to get the inferencing as closely end user as possible. And you could see some pretty large deployments for inferencing equipment rather than say just training, which I think some of your traditional deployments may have been more focused on?

Speaker 2

I think that's right. So you really you kind of your question really embedded the answer, which is we are now developing solutions and investing in development for future integration into our solution roadmap for providing just that. As you mentioned, if you look at kind of the prior spend in AI, it was more training versus inferencing. And training is never going to go away because when you think about large language models, there's going to be a bunch of large language models that people use to then extract their own version of what they need from that large language model. So the training piece will go away.

Speaker 2

I think as a percentage of the whole, inferencing will obviously take on a greater share in the future. And with that, as you noted, the more speed and information availability there is closer to the decision making that could make or break someone's competitiveness. And so the solutions we're thinking about are how do we not just as you said leverage the platform, but how do we develop and offer our customer base the highest performing, highest reliable systems where there might not be IT resources in that environment. And that's a key part of our strategy. But you could see a day where we might be designing small cluster platforms or single cluster platforms with these platforms from a cost and a reliability and a performance perspective that allows them to be in these end markets, something like oil and gas, maybe on a rig, maybe at a retail store, maybe at an ATM, maybe at a healthcare regional office, what have you.

Speaker 2

It's just these are the way we're thinking about AI. Clearly, AI at the edge has got a bright future. It's just so early. I mean, AI in general is early. So we are investing for tomorrow as we think about that solution platform we're developing.

Speaker 4

Excellent. And then just one last quick one on the memory outlook. You called for growth to be high single digits. We've heard from a lot of folks in the memory industry that pricing for both DRAM and NAND is moving up pretty quickly here, especially after the earthquake in Taiwan. Wondering as you look at that high single digit, is that mostly ASP growth with units still pretty muted?

Speaker 4

Are you starting to see a unit recovery, but pricing benefits may come in future quarters. Just how are you thinking about units versus ASPs? And I'll go back in the queue.

Speaker 2

Thank you. Yes. Let me before I get to the specific answer, I just want to highlight. If you go back and look at memory cycles, unlike the pure play semiconductor companies, we made money through the cycles, okay. And we do that because we have a differentiated business.

Speaker 2

And we also see that if you go back and plot this out, we're kind of slower on the front end of feeling the pain of the downturn. And on the back end, our recovery is a little bit slower because of these inventory corrections of select inventory that customers may be sitting on or holding back from in terms of how they look at acquiring memory. So, we are starting to see pricing benefits in our business overall. And we're seeing corner cases of demand requests. I would say that our demand has been somewhat flat of late, but that's better than declining over the last couple of quarters.

Speaker 2

And if you look back at the last earnings call, I suspected, I projected that my view of the world was that we could probably start to see some more demand in our Q3, Q4 timeframe, because I just thought it was going to be a little slower. And we're starting to see better turnaround. It's just it's not here in the Q2 numbers. I think in Q3, we're starting to see a little bit more of a demand. And I think we'll continue to see that through Q4 and early fiscal year 2025.

Speaker 3

Yes. And Quint, just to highlight Mark's point there in terms of the margins, and you can look at our operating margins for this business. Even in Q2, which was a softer quarter here, off margins were just above 7%. And we're starting to see some expectations for growth. That's what we guided to here for Q3, sequentially for the memory business as well.

Speaker 4

Perfect. Thank you.

Operator

Thank you. The next question comes from the line of Kevin Cassidy with Rosenblatt Securities. Kevin, your line is now open.

Speaker 5

Yes. Thank you for taking my question and congratulations on the quarter. Can you talk a little more about with IPS, you said it would be flat to up depending on at least one order. And does this include services and is this part of what the guidance for gross margin being 1.5% one way or the other? Can you just give a little more details on that?

Speaker 5

Yes, I'm going

Speaker 2

to start and let Ken jump in. As we said originally, if you go back to our Q1 earnings call, we saw a stronger second half and that's in fact what we see playing out. And part of these engagements, the margin move around is kind of muted. It could be mix issues, it could be hardware early configurations that we then convert services to. And if you look at all of that, we're in a good place.

Speaker 2

The margins will move around. As you said, I'll let Ken kind of quantify that a little bit, but margins will move around in our business a little bit. But let's not forget, gross margins are up from 19.5% 3 years ago to where we are today. And if a margin moves around a point in a quarter, it's primarily because of mix of maybe hardware deployments in a quarter and then future quarters where software might be stronger, our services might be stronger. And that's just the nature of the business we're in.

Speaker 2

Very pleased with the team's execution and very confident that we'll continue to see good progress there.

Speaker 3

Yes. And Kevin, if you look at the margin, we provide a little bit more room here in Q4. And part of that's just around the timing of not only the hardware deployments, which we've talked about in the past and making sure we get the appropriate customer acceptance and the like. And those can move between quarters. That's why we outlined that.

Speaker 3

But if you look at the margin for Q4 and the guidance, we have both point in time services and ongoing managed services. And we just wanted to have a little bit more flexibility. My assumption is most of the street will probably end up near the midpoint, but that gives us a little flex around that.

Speaker 5

Okay, great. Thanks for that color. And maybe as you're saying your engagements are increasing, can you talk more about the potential for expanding your customer base for IPS in particular?

Speaker 2

Yes, absolutely. I think, Kevin, as you know, this is a business that we've talked about repeatedly was is a business that we've said it's got customer concentration and can be lumpy. We've invested very heavily over the last fiscal year here, the last 9 to 12 months on bringing on new go to market resources. And to be very honest, I'm super pleased with the progress we're making there in terms of, again, managing major accounts and getting the executive engagement to go market our capabilities to these large enterprises and Tier 2 CSPs. The amount of proposals that we have generated continues to increase with the opportunities we're seeing.

Speaker 2

And we're looking forward to get on a path where those convert into bookings and revenue over time. You think about we get them booked, but again, we have to then go off and then map that out against supply chain, confirmation of what we can do in our configurations and then we talk about deployment schedules and like. And so I do want to call something out because I don't think I've done a good enough job in prior calls. We don't think about our customers like in a buy sell relationship. That's not our business.

Speaker 2

And I know it's hard because we used to be a memory module company only and it was very, very much the industry very much to be transactional. But our transformation that we repeatedly talk about in the market is one of not just going from memory to AI infrastructure and HPC, that's not where it stops. It really is in the terms of how we think about our customer relationships, more in terms of clients and engagements, because we're with them for a while. We're not just selling something and disappearing. We design it, we install it, we manage it, and then we make sure it performs over time.

Speaker 2

And so that relationship, I think again, we have clients and engagements. We don't have transactional customers yet. We have customers obviously, but those are managed as a client and an engagement. And that's where it shows up in the gross margin line when I compare myself to some of the larger competitors we compete against, so to speak. And so, I'm very pleased on how that process is evolving and playing out.

Speaker 2

I've also just like Kevin, if it's okay, just take the opportunity. As we're doing that, what's really become apparent is the need of what we offer is becoming more and more validated every day. What I mean by that is, yes, there's a lot of GPU sales over the last 12 to so months, but as people deploy it, the complexity is not lost on the customers. Where is that complexity? Well, on the design of a data center, how do I get the power to the building, to the transformer, to the main systems?

Speaker 2

How do I design each part of the data center from a cold aisle to a hot aisle? How are my racks designed? How are the GPUs managed? How do I maximize uptime and availability? Can I be proactive in detecting future failures that saves me downtime?

Speaker 2

And then in the future, hey, how do I scale? And so we're in a much different consultative advisory sale. And so these executive engagements I'm talking about are reaffirming that there is a need for this type of trusted Pfizer relationship. And I think we're very well positioned in that after there couldn't be a better precursor to AI infrastructure than HPC. When you think about HPC, it was really helping people build large multiprocessor architectures inside of data centers, albeit not for AI at the time, but it evolved that way as we got closer to 2018, 2019, 2020.

Speaker 2

And so there's just not that many companies out there with 25 plus years and deployment knowledge, both at the hardware, the software and the future add on services. And I think we're doing a better job of articulating that value to these customers.

Speaker 5

Okay, great. Thank you.

Speaker 2

Thank you.

Operator

Thank you. The next question comes from the line of Thomas O'Malley with Barclays. Thomas, your line is now open.

Speaker 6

Hi, this is Scott on for Tom O'Malley. I wanted to touch on

Speaker 2

the services line. So it looks like services down ticked

Speaker 6

pretty meaningfully in the quarter. New run rate level? Or do you expect that it ticks back up? Thank you.

Speaker 3

Yes. So I think as we look at Q4, I would expect the services to tick up. And as we've highlighted before, within that basket of services that we have, there are point in time services, design, implementation and the like, and there are managed services that we have. And so we had fewer point in time services here in Q3. I would expect that number to tick back up here sorry, in Q2.

Speaker 3

I would expect that number to tick back up in Q3, and that was embedded in our guide.

Speaker 6

Thank you. That's helpful. And then one more, if you could touch again on CXL. Could you just give us an idea of when you see the market inflecting more meaningfully there and then the types of customers that you see interested, whether that's AI and more general purpose?

Speaker 2

Why don't I take the first part of that and I'll let Jack talk about more of the productization and the revenue. So if you talk to leading technology executives and engineering executives on the AI kind of performance curve and AI infrastructure, By far at the top of the list is latency and performance issues caused by the lack of bandwidth and availability to memory from the GPU and CPU. And there's an immense amount of capital going into investing in early stage companies as well as some of the larger companies are investing in solutions that help solve this bandwidth issue. Like if you look at the analogy I like to use is, if you think about sharing storage in a network, you can do that today. You can't do that in memory.

Speaker 2

So eventually, you'll have the capabilities, I think it's within CXL 3.0. Out in the future, you'll be able to spool memory. But that's not enough. The transport layer of memory is another issue that people are trying to tackle with optical transport layer with CXL on top of it for just maximizing the speed. High bandwidth memory is not the only solution and there will be other solutions as it relates to how we can enhance the throughput and the latency and the overall systems performance of the compute by having more innovative hardware solutions like CXL and like optical transport integrated into such a solution.

Speaker 2

But I'll let Jack talk about kind of the market dynamics around when we see that starting to be a meaningful contributor. Yes, as Mark mentioned,

Speaker 7

right, we've talked to you talked about the end of kind of this calendar year, we expect to see some meaningful shipments in CXL and some both, we will be shipping it into kind of your standard server companies. We also were in conversations and we're sampling a lot of different folks in AI as well that want to have more memory in their AI servers. And as HBM grows, you need to put more and more normal memory in your server. And to do that, you start running out of room at the DIMM slots, decrease the faster you need to run this memory. So the only way to get that additional memory is really to use CXL and try to pop more memory into that server.

Speaker 7

So we're seeing opportunities in both phases of the market.

Speaker 6

That's very helpful. Thank you.

Speaker 2

Thank you.

Operator

The next question comes from the line of Brian Chin with Stifel. Brian, your line is now open.

Speaker 8

Hi. This is Dennis on for Brian. Thanks for letting me ask a few questions. So regarding IPS, how has interest in generative AI over the last year or so changed the customer acquisition and eventually like product delivery rollout process? Has it become lengthier or more complex?

Speaker 8

And then you had mentioned you have these options like on prem, co location or co investment. How does the customer's choice of 1 of these 3 impact either the timeframe for rollout or kind of your business in general?

Speaker 2

Yes, that's a great question. And let me just kind of step back a little bit. I remain convinced that we are in the super early innings of AI. And all the noise around sales of GPUs and the like, yes, that's a catalyst or a metric for what's ahead. But I would tell you that I think large scale enterprises are still really crafting their strategy on AI.

Speaker 2

I don't think I think a lot of those GPU sales went to people in the middle who are building the infrastructure. And I don't think the large scale enterprises really have fully defined how AI is going to change their business and give them a strategic advantage. So why I say that is, this is all playing out real time in front of us. In addition, this is a brand new architecture for any enterprise outside of the big hyperscalers who've been in this for a few years. But there I mean, there are companies who are household brand names in the industries they compete in that really are struggling with even how to design a data center or how to develop the right solution and why you would do A versus B.

Speaker 2

And so when I think of what your question is getting at is, what is this doing? It's actually made, I think, adoption more of a longer term process. But I also think, as I mentioned earlier in this call, what I have validated through my executive engagements with our sales organization is large enterprises are starting to get it. They're starting to understand that there is a gap between what they have done from an information technology perspective and the capabilities they will need to deploy AI successfully. And that gap is really the opportunity for Penguin.

Speaker 2

And so from our perspective, yes, it might be a little bit longer. There might be more of an education curve, but that's also leading us to get more sticky and really be able to identify the value that we can provide our partners, our clients that need our help in deploying AI. And I think that's where you sense the confidence and the optimism for the second half of our fiscal year.

Speaker 8

Great. Thank you. And then for my follow-up, so we recently heard about memory price increases, both DRAM and NAND from all of the big memory suppliers. If prices were continue to increase, how would you foresee this impacting your future gross margins?

Speaker 2

We're not going to forecast more than we normally do in a given quarter. So Ken kind of giving you the forecast. I will say a couple of things. I think any such benefits that you've alluded to normally will show up in our top line revenue. But as we've been clear on, on prior calls, our gross margins will trickle up or down depending on which way pricing goes.

Speaker 2

Why is that? Because when pricing moves, our value add doesn't change and our customers realize that. And so ironically, when our revenues go down, our margins stay pretty stable, maybe even trickle up a little bit just because of the math of fixed value over a declining revenue stream. And the reverse is true. We might see an impact of down a point or 2 or whatever as recovery happens.

Speaker 2

I don't sense that happening overnight. I don't sense that's something that's going to change the business dynamics because more often than not, in this type of pricing recovery market, the revenue gain and the gross margin dollar contribution mutes out any of the gross margin percentage impact.

Speaker 3

And what I'd add to that is, as we see revenues start to grow, both from units and ASPs over a period of time, where we will see that hit the bottom line is an improvement in operating income percent. And you can see that just in the past couple of years, this business for the memory specific business was running at op incomes north of 10% and we're below that now. So as we start to see unit demand improve as well as ASPs, that should flow to the bottom margin.

Speaker 8

Great. Thank you.

Speaker 2

Thank you.

Operator

Thank you. And team, at this time, we do not have any further questions registered in the queue. So I will turn the call back over for any final remarks.

Speaker 2

Well, great. Thank you all for joining. Before just closing out the call, just wanted to let you know that we have plans for an upcoming IR day in the next few months or so, and details will be coming to you soon. In the meantime, look forward to seeing you at shows and NDRs and the likes. Thanks again for joining today.

Speaker 2

Have a great week.

Operator

That concludes today's call. Thank you all for your participation and you may now disconnect your lines.

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Key Takeaways

  • Smart Global delivered $285 million in Q2 revenue, $0.27 non-GAAP EPS above the midpoint of guidance, and ended the quarter with $466 million in cash and short-term investments.
  • The Intelligent Platform Solutions group grew 19% sequentially to $141 million (50% of revenue), driven by AI infrastructure demand from hyperscalers, Tier 2 CSPs and enterprise clients, and named Pete Manca as IPS President.
  • Memory segment sales were $83 million (29% of revenue), down modestly on elevated customer inventories but poised for sequential growth in Q3, bolstered by upcoming CXL DDR5 add-in cards and new Zephyr ZDIMM modules.
  • Cree LED revenue totaled $60 million (21% of revenue), down seasonally; the business launched the XLamp XPG4 high-intensity LEDs and expanded its XLamp S horticulture series, with a rebound anticipated in Q3.
  • Capital deployment included $72 million in share repurchases and $112 million of debt paydown, with Q3 guidance calling for ~$300 million revenue (±$25 million) and ~$0.30 non-GAAP EPS (±$0.15) amid ongoing macro and supply-chain headwinds.
A.I. generated. May contain errors.
Earnings Conference Call
Penguin Solutions Q2 2024
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