Good day, ladies and gentlemen, and welcome to the SMART Global Second Quarter Fiscal 2019 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today's conference is being recorded. I would now like to turn the call over to Ms. Suzanne Schmidt, Investor Relations. Ma’am, you may begin.

Thank you, operator. Good afternoon, and thank you for joining us on today's earnings conference call to discuss SMART Global Holdings second quarter fiscal 2019 results. Ajay Shah, Chairman and Chief Executive Officer, will begin the call with the discussion of the market and the business, followed by Jack Pacheco, Chief Operating and Financial Officer, who will review the financial results in more detail and provide the forward guidance, after which we will open the call to your questions. As a reminder, our earnings press release and a replay of today's call can be accessed under the Investor Relations section of SMART's website at smartgh.com. We encourage you to go to our website throughout the quarter for the most current information on the Company, including information on the various financial conferences we will be attending. Before we begin the call, I would like to note that today's remarks and the answers to questions may include forward-looking statements. Any statement that refers to expectations, projections or other characterizations of future events, including financial projections and future market conditions, is a forward-looking statement. Actual results may differ materially from those expressed from these forward-looking statements. For more information, please refer to the risk factors discussed in the documents we file from time to time with the SEC, including our most recent Form 10-K. We assume no obligation to update these forward-looking statements, which speak as of today. Additionally, during this call, our non-GAAP financial measures will be discussed. Reconciliations for those directly comparable GAAP financial measures are included in today's earnings press release. With that, I will now turn the call over to Chairman and CEO, Ajay Shah.

Thank you, Suzanne, and welcome to everyone on the call. I am pleased to report that our team at SMART Global performed very well under difficult circumstances to close the second quarter of fiscal 2019, which ended February, with net sales of $304.1 million. In an environment where memory prices fell sharply, revenue was a little below expectations. However, we were able to achieve non-GAAP earnings per share of $0.77 per share, which is at the high-end of our guidance range. Overall, our results demonstrate the resiliency of our core business model, which is focused on specialty products in memory, in computing and storage, as well as the early success in our strategy to drive growth in earnings through synergistic mergers and acquisitions. As I said earlier, the memory industry overall is marked by significant pricing pressures. In our Q2, we also faced slowdowns due to the calendar year-end, a U.S. government shutdown for a few weeks early in the quarter, and significant inventory drawdowns by some of our major OEMs in the face of falling prices and more importantly, shorter lead times. That said, in the second fiscal quarter, we made solid progress towards our goal of creating a more diversified and balanced company. In particular, our business in Brazil, which is the only part of our business where we sell standard memory into high volume consumer devices, now totals 48% of the total company sales this past quarter, compared with 66% in the year ago quarter. As a reminder, in the past, a significant amount of our capital expenditures and working capital expenses or buildup has been due to our Brazil business. So we are now generating strong cash flows as a company. And as we cut back on these funding requirements, we are seeing our free cash…

All right, great. Thank you, Ajay. Overall, gross revenue for the second fiscal quarter was $584 million, while net sales were $304 million. 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 the net sales, then it profit on a supply chain services transactions. Our breakdown of net sales by end market for the second fiscal quarter was as follows: Mobile and PCs 45%, network and telecom 19%, servers and storage 15%, industrial, aerospace, defense and other 21%. Now moving to the rest of the income statement, non-GAAP gross profit for the second quarter was $57.8 million, compared with last quarter's $85.7 million, due primarily to lower sales in Brazil. Non-GAAP operating expenses were $30.2 million, down 3.4% from the previous quarter, demonstrating our continuing focus on operational efficiencies. Non-GAAP net income for the second fiscal quarter was $18 million or $0.77 per diluted share and adjusted EBITDA totaled $33.8 million in the second quarter. The second quarter GAAP fiscal 2019 results do not include any material FX related gains or losses. This is compared with approximately $3 million of FX related losses in the previous quarter. Turning to working capital, our net accounts receivable decreased to $326.5 million from $330.5 million last quarter and our day sales outstanding increased the 51 days for this quarter, compared with 42 days last quarter. Inventory levels continue to decline and totaled $172 million at the end of the second fiscal quarter compared with $188 million at the end of the first fiscal quarter and $221 million at the end of the prior fiscal year. Inventory turns decreased to 12x compared with last quarters 13x. Consistent with past practice, accounts…

Thank you. [Operator Instructions] And our first question will come from the line of Suji Desilva with ROTH Capital. Your line is open.

Hi, Ajay. Hi, Jack. Can you talk about in the guidance for the fiscal third quarter? What the implications are on a segment basis, if the Specialty Memory and SCSS businesses are holding up relatively well versus the Brazil business or whether there's weakness from all three? Thanks.

The predominant weakness, Suji, is in the Brazil business. To put in some perspective, we expect our Brazil business to shrink by another 33% quarter-over-quarter, mostly driven by pricing, the average selling price. But we don't want to claim that the Specialty Products business is completely immune. It is largely immune. So price declines there are considerably modest, I mean there maybe in the 10%, 12% range, somewhere in that neighborhood compared to what you're seeing in Brazil. But more importantly for the Specialty Products, it's really more of a question of adjustments, meaning that customers have seen lead times come down from 26 weeks to sometimes six to eight weeks now. By the way, in our business, that’s still six to eight weeks, in most commodity memory, it's – how soon can the shipments can get. So that business is going – is having to work through customers who are looking to reduce their inventory since they don't need to have quite as much inventory with the long lead time. So this is a little bit of an adjustment period there, but we're seeing end demand from those customers still pretty strong. So when we look at it from our logistics business point of view, that end demand is still pretty strong. So we're really just seeing amount of adjustment with respect to inventory in the Specialty Products business. And speaking about our Specialty Compute, which is largely Penguin business that has actually been pretty good. In fact, Q2 bookings were very strong and Q3 is not the strongest seasonal quarter, but Q4 is, so we're looking for a strong Q4 based on where we are today with respect to bookings and indications in pipeline.

Okay. And then my other question is on the Brazil business, the linearity of it. You talked about a recovery. I wasn't sure if you met the second half of the fiscal quarter – fiscal year or the second half of the calendar year and versus a typical year where everybody's kind of pushing out orders, what's the split of kind of first half versus second half this year to meet local content versus a typical year? How back end loaded is this year?

So the first question is the back half of calendar year 2019 right, so it's next – it’s going to be fiscal year 2020.

Yes, just to be clear, the local content requirements or calendar year requirements.

Calendar right.

Right, I mean if you look at this year, right, we talked about before, our customers were talking about 35% to 40% in the first half of the year and 60%, 65% back half of the year and that's what they're sticking to. And so it really depends on the memory market. On a normal year, you would get – you should be closer to, say 50-50 first and second half.

Okay. That's very helpful. Thanks guys.

Thank you. Our next question comes from the line of Kevin Cassidy with Stifel. Your line is open.

Thanks for taking my question. Along the same lines in Brazil, with the phones being built in this – more of them being built in the second half, do you expect – what is the mix, I guess are your clients – are your customers mostly building low-end phones in Brazil now, and then waiting to build the high-end? Or I'm trying to get to what do you expect the mix would do for the average selling price or the content per phone?

Yes, Kevin, let me try and answer that. First of all, the customers practice that we're referring to has more to do with the memory purchase practices rather than what they are manufacturing, just to be clear. The memory procurement practices, if you think about a purchasing manager at a smartphone manufacturer, they'd rather buy the memory later than sooner, right, simply because prices are falling. And so they've been tending to buy local content requirements later in the year rather than early in the year. This is what Jack was referring to in terms of this sort of 60-40 mix, which is what customers are telling us is their intention, 60 being in the second half of the calendar year. So that's been their position with us. And in terms of the density, we're seeing them tending to want to buy lower-density product from us rather than – and importing the higher-density product from their vendors in Korea, China or wherever. But really the statement we've been making is that we expect that for the full-year they've got to sort of figure out their local content, and meet those requirements and that will pretty much be driven by the second half of the calendar year. As you know, our fiscal year is an August year-end, so some of that will fall into our fiscal Q1 2020.

Okay. And maybe – and a follow-up going over to Specialty Memory, all-flash arrays you had pointed to has been an area of strength and shorter lead times, is that affecting that business? Also, all-flash arrays, are they delaying placing orders because of shorter lead times?

No, we're not seeing that. What we are seeing is that in our Specialty Products business, some of the customers – I mean just think about end customer behavior. If they see a lead time of 26 weeks, they probably just keep a safety stock more or like seven to eight weeks instead of your normal what might be three to four weeks. So they build up inventory in that sense as protection against shortages. And now they are unwinding those as they are seeing reliability of supply, that effects – that has an effect on all of the ordering patterns. But it's just a question of the supply chain sort of adjusting through that inventory and then tightening up again.

Okay. Thank you.

Thank you. Our next question comes from the line of Sidney Ho with Deutsche Bank. Your line is open.

Thanks for taking my question. I have a few. My first one is on inventory. You talked about inventory depletion and the customers. I think, Ajay, you mentioned mainly on Specialty, but maybe Brazil has a different dynamics in terms of memory procurement practices. Do you have a sense how much inventory is still in the channel and how long does it take to get back to normalize the level? I think you mentioned by the end of fiscal Q4, but I wasn't sure if that just for the Brazilian customers?

So in Brazil, we encourage our customers to keep very little inventory. We maintain the ability for our customers to have very short lead times. So we don't have great transparency, but we don't think they have too much inventory in Brazil. I don't know, Jack, if you have any other data.

No, I think our customers, they – the parts they purchase from us, they don't stock long.

Yes, they don't stock them actually or they have a very short stocking window, let me say. However, what we were referring to is mostly related to our specialty products business, which is mostly large OEMs in the U.S., Europe, et cetera. And what we're seeing there is really just a question of an adjustment, not so much driven by pricing. Because these products, the pricing hasn't moved quite anywhere near as much. It's just more the impact.

Okay. That’s fair. Yes, I'm just trying to figure how much inventory that you guys have seen at this point. It sounds like it's mainly in specialty and mainly it will done – we'll get through that by Q4, fiscal Q4. Maybe…

Yes, correct. Our expectation is we'll work through it, so…

Okay. Excellent. Maybe another question on the local content rules related to WTO. Can you maybe add some color on what we should be expect of the new compliance method of the local content route that you guys are working on or the Brazilian government is working on? Do you expect a vacuum in the second half of this year because of that change? Or is it the other way around where companies may – your customers may actually accelerate purchases ahead of this change? Any color will be helpful.

Sidney, actually, what we can tell you that we know is that for calendar 2019, there is no change in the local content requirements. The government has made it very clear that there is no change for 2019. And so at least in the case of one of our customers, one of our major customers, we know that there are only, so far to date, that they've been like in the 20s-percent in terms of local content. And so at some point, they're going to have to pick that up to get back in compliance. As to your question about what the new changes will be, this is really a big discussion as to how exactly to implement a compliance system. And I don't know that we have anything that we can tell you right now because we – all we have really is rumor. But what we do know from the government is that they are very keen to make sure that the semiconductor industry and memory manufacturers are able to grow and prosper in the country because that's been one of their big successes. That's what they tell us. But besides that, I don't know how to answer your question.

So you probably don't even have an idea whether that percentage is going to up, down, sideways? At this point, you just don't have any idea?

Well, the only thing the worry is that the effort is to keep it at least the same. But the [indiscernible] is different, and that's unclear.

Okay. Maybe last question for me. Related to the Brazil mobile side, I think you guys talked about your ASP, has gone down last quarter. I wonder how that goes in the February quarter. Maybe you can add some color around the impact of component pricing versus what kind of content growth you're seeing. And I think last quarter, you guys mentioned that there is a – seems that – content growth seems to have slowed down a little bit. Just want to see if that has picked up partly because of that pricing.

Actually, it's been the other way, right. I mean, so if you look at where we expect the density as you go – when we're producing, it's going down in Brazil. So they're purchasing locally right now but lower-density memory, which is driving our pricing down. ASPs are going down because low density is going down. We're seeing basically a 40% decline in ASPs over the last six months in Brazil, right. We're seeing densities. In our densities, we expect the next quarter going to be down another 25% from where we saw them in a Q2 timeframe. So Brazil will really lag. They will lag the rest of the world by a pretty good margin here on the density of the memory.

Got it. Can you maybe talk about ASP at all for – I think it was about $30 last quarter.

Yes, Q2 wasn't dramatically different from Q1.

Okay, great. Thank you very much.

Thank you. And our next question comes from the line of Blayne Curtis with Barclays. Your line is open.

Hey, guys. Thanks for taking my question. Couple more on Brazil. I just want to understand the mechanics here. It sounds – you're saying the customers are delaying purchases, but it will recover in the back half of the calendar year. But I thought I heard you say that Brazil should decline as a percent of total revenue. So I'm trying to reconcile that. And then I'm trying to also understand, is it just pricing? Or do you think any of your customers are holding off given these negotiations post the WTO ruling?

I’ll take the two questions separately. I think the first one was, how do we reconcile that Brazil will recover in the second half versus will go down as a percent of revenues? Is that the question Blayne?

Yes. I'm trying to understand the messaging because it sounds like you're saying the market's not as bad as what you're seeing from fundamentals, and it's really just timing in the markets you come back. But then I thought you said that Brazil was down obviously mathematically now, but then should continue to decline as a percent of that overall mix? I'm just trying to…

The magic answer is pricing. Memory pricing is going down, and I can't predict for you where it will be in calendar fourth quarter. We heard from other industry participants just as early – as recently as last week, predicting that the second half of the year – of the calendar year would be more stable or stronger and inventories will be worked out and so on and so on. Assuming that is the case, which we don't produce the stuff and we don't have inventories of this stuff. So don't know how to predict that exactly. However, what I would say to you is that we're predicting, in our fiscal year, which is the August year-end that prices will continue to decline and even though in the second half of the calendar year, there'll be some recovery, much of that second half of the calendar year falls outside of this fiscal year for us. So we are predicting a reduction. I know it's a little bit nuanced. I hope you will follow me with this. We're predicting that, for example, in our fourth quarter, Brazil will continue to decline as a percent of overall revenue, even though the revenue in Brazil may not decline, because the rest of our businesses doing well. So that’s point number two. One is, we expect pricing to decline in Brazil because of the focus on more commodity products there, and we expect our non-Brazil business to have a much better performance at that point. Penguin is also – the fiscal year-end matches up well with that period. So we've actually – we're not guiding, but we're certainly saying that our first – fourth fiscal quarter is actually significantly improved, because Brazil doesn't decline much or declines or maybe even grows a little and the other products come back, and Penguin has seasonally high quarter. So I don't know if I'm answering your question exactly or maybe – I'm happy to try again.

That’s good. May be on the second part, just the reason for the delay, are the negotiations through 2020, any part of that delay, where are your customer in your view?

I don't think so. We're not hearing that. And the government has made clear that the fiscal – I mean, the calendar 2019 local content requirements are not changing at all.

Yes. The government's come out pretty strong. They're not changing, they have to meet them. So the Company's have to meet the 2019 numbers. So I don't think the future is affecting their performance right now.

Got it. And then just finally on CapEx that goes down to very low levels, I'm just trying to understand, if pricing is the reason, the revenues down, units aren't down as much. And then kind of – I'm just kind of curious. You had some new initiatives on the battery side on maybe connectivity. Have you changed any of those plans?

So our battery related CapEx is largely behind us. So we don't need new CapEx for the batteries – for the battery business. There's almost no new CapEx required for our WiFi, Bluetooth related business. So the main CapEx have been related to expansion in the mobile memory business. And that we have cut back on significantly simply because we are not seeing any pressure on capacity right now. We've built up capacity and right now, units are – by the way, it's another factor that's kind of interesting, not particularly good, but interesting, which is that Brazilian smartphone units are actually predicted to decline this year slightly, not 5%, but predicted the decline this year. PC on the other hand, is predicted to increase a little bit. So the strong dollar relative to the Brazilian reals is, at least we think the main reason why units are not increasing as strongly as you would expect with an economy that is, at least the rumors say, on a better path since the election.

The other thing on the CapEx, Blayne, is we always have CapEx expenditures for new technologies. And where we're seeing – we're seeing the customers stay with these midrange, lower-end products. We're not having to develop new products for them, so that also reduces our CapEx spend.

Got it. Thanks guys.

Thank you. [Operator Instructions] Our next question comes from the line of Rajvindra Gill with Needham & Company. Your line is open.

Yes, thanks for taking my questions. Just a follow-up on the ASPs, I was wondering if you can kind of elaborate further on why the customers are deciding to purchase lower density capacities and buying higher density from Korea or from China. But that's a little bit of – I guess, has to do with the memory pricing dropping, but has a little bit of reversal because you've seen ASPs in your business continue to increase over time. So it's kind of the first time we've seen where – and densities increase over time, but it's the first time we're hearing that customers are buying lower densities. So I was wondering if you can explain that dynamic and the fact that they're importing higher densities from Brazil and China those kind of surprising from my end.

I mean, it's coming back to memory pricing, right. I mean, we're always going to be more expensive building a piece of memory in Brazil than you can import in from Korea, China or wherever. And so if you want to try and have a lowest memory spend, in an oversupplied market where you can buy wherever you want from anywhere you want, you're going to purchase the lower-density stuff locally in Brazil where it's a little bit more expensive than you can import. And you're going to import in the higher-cost memory because it's cheaper than it is from Brazil. And if you're talking to a percentage, right, if you're – say you're, I don't know 10%, 15%, 20% more expensive, that's a lot more than a $30 part than it is on a $15 part.

And on the Specialty Memory, the reduction in the lead times leading to an overbuild. The lead times have been tight for – the lead times have been long for some time. So was this to you a surprise that the lead times have come in so dramatically lower? Was there an anticipation that they had been building too much inventory in the past? So is it fair to assume that the Specialty Memory business, the revenue was inflated in the past? I'm just trying to get a good sense of what the true kind of growth rate is going to be for Specialty Memory because it seems like there might have been some double ordering, obviously.

It's not double ordering. We're thinking about – you've got a 30-week lead time on parts. You've got to place POs out 30 weeks, right? And so you've got to make sure that you can – you're getting these parts in. And so it's hard for you to adjust your manufacturing, right. And you're not perfect out there. And so if you think you need – what if you have an upside? If you only have something on a PO for 30 weeks, you can adjust the upsides and stuff like that. So you may carry a little more buffer stock so you can react to an upside, leave a 30-week lead time. Now when you're into a four to six-week lead time, I mean if you get some upside in this quarter, your suppliers can react and provide you those products so you don't have to carry anywhere near as high of a buffer stock, and so you can reduce that buffer stock down to get your inventories down in a shorter lead time environment. So that's – we weren't saying that they over ordered, but they had to keep more buffer stock to protect themselves so they could shift to customers that have upsides.

Yes, but I’m trying to get the sense then – I mean, I understand that, but I mean, how does that impact the revenue in the past?

I mean, if you normalize it over periods of time, you could argue that one particular quarter was very strong because of building a buffer, and the next quarter was weak because of unwinding a buffer. But if you look at it over a period of time, you smooth out those issues, and memory price declines or ASPs in that market have not changed that much. They're going through their normal declines. I mean, this is the semiconductor industry where prices go down every year. But what I'm saying is that we have not seen double ordering or sort of that kind of behavior. So you're question if I understand it correctly is, that means your past revenue was overstated. And I guess, what I'm trying to say is, no I don't think the past revenue was overstated But yes, you could take one particular quarter and say that was higher because – and then you can take the next quarter and say that was lower because – but overall, as we've said, we're trying to say earlier. We still see a double-digit increase in the overall business in our Specialty Products group.

Yes. I mean just, if you look at the quarter we just finished, Raj, Specialty Memory is still going to come out with revenue of roughly $115 million, $116 million, which if you go back to last year, it's higher than every quarter last year, except for Q4.

Okay, got it. That’s helpful. But on the WTO, can you just maybe give us a little background on why that organizational have influence on the local content rules? And it seems like there's going to be a lot of uncertainty in calendar 2020 because it’s a local content, it’s a customer feel – there might be a possibility of the customers feel, they don't have to buy local content at a premium if they're not going to get any tax benefit. So then that's a key part of the business in Brazil, that tax benefit going forward. So they don't feel that they're going to get it, are they going to continue to do that, so just any background on the WTO and the influence on local content would be really helpful. Thank you.

I can try. I have to admit that I did not – I do not have a fantastic background in what the newest politics are. But essentially, what the WTO said to Brazil and I'm paraphrasing, is that the method by which they implement local content requirements didn't meet our regulations that the WTO has. So as a result, what Brazil has been doing has been redesigning the way WTO – I mean local content requirements are actually enforced or how they are structurally done. There's no – that doesn't seem to be a change in attitude in Brazil in terms of what they want to accomplish. So they – what they are really saying is that we've got to change the methodology by which we implement these local content regulations so as to meet WTO regulations. And that is the process that's undergoing discussion right now. We are not predicting – just to be clear, we are not predicting that there's some change that will completely make it uninteresting to buy locally produced memory. So – and there are hundreds of thousands of jobs in Brazil that are related to this. So the government has a tremendous sensitivity to this whole issue. And they have been consulting with us and with other industry players so as to make sure that the restructured method that they use is both compliant with WTO and is going to be essentially similar in terms of what it means to the local jobs and economy?

And just one last question Jack on the gross margin, to 17% to 19% and with the kind of uncertainty around Brazil in the long-term and these businesses add corporate margin, however, you're improving the margins. Blending all that together, should we be thinking kind of gross margins in this 80% range over the next several quarters, kind of any thoughts there on kind of margins over the long-term? Thank you so much.

No. Yes, I think over the next few quarters, I mean Brazil right now because of its high fixed cost. It's trending in our gross margins down. So I would say, over the next few quarters, we'll probably stay in that range. And then as the business gets – in Brazil gets little bit better in the second half of calendar 2019 that the margins will go back up and then we're taking some cost measures that, kind of on the business, we will hopefully will improve the gross margin in Brazil and in the Penguin business.

Great. Thank you.

Thank you. I’m showing no further questions at this time. I would now like to turn the call back to Ajay Shah, CEO for closing remarks.

Thank you all for joining us on the call this afternoon. We look forward to seeing many of you out on the road in the coming months and to reporting to you on our progress next quarter. Once again thank you very much.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.