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SMART Global Holdings, Inc. (SGH) Q4 2020 Earnings Call Transcript

SGH Earnings Call - Final Transcript

SMART Global Holdings, Inc.  (NASDAQ: SGH) Q4 2020 earnings call dated Oct. 01, 2020

Corporate Participants:

Suzanne Schmidt — Investor Relations

Ajay Shah — Executive Chairman of the Board

Mark Adams — President and Chief Executive Officer

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Analysts:

Rajvindra Gill — Needham & Company — Analyst

Brian Chin — Stifel, Nicolaus & Company — Analyst

Kevin Cassidy — Rosenblatt Securities — Analyst

Sidney Ho — Deutsche Bank — Analyst

Blayne Curtis — Barclays — Analyst

Mark Lipacis — Jefferies — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the SMART Global Holdings’ Fourth Quarter Fiscal ’20 Earnings Conference Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today, Suzanne Schmidt, Investor Relations. Thank you. Please go ahead, ma’am.

Suzanne Schmidt — Investor Relations

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 2020 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-K and Form 10-Qs.

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.

Ajay Shah — Executive Chairman of the Board

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, SMART’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 30 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 you 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 I had 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.

Mark Adams — President and Chief Executive Officer

Thank you, Ajay. First and foremost, I’d like to thank Ajay and the rest of the Board for entrusting me to carry on what he and the team had 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 value customer. So I had a good appreciation of the organization’s core competencies.

What I have grown to appreciate more so during the search process, and even more recently, during my time with the Company is the transformation that Ajay has led along with the management team. SMART Global Holdings is very different than a 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 US, Brazil and Malaysia.

In short, I’m excited to join a Company, and SMART possesses 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 and strategic M&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 an 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 aligned 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 2020 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’ve 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 2018. We now enter fiscal 2021 with a much more balanced mix of businesses. For the full year fiscal 2020, Brazil was 35%, specialty memory was 42% and Specialty Compute and Storage was 23% of overall revenue. Specialty Compute and Storage will continue to grow as a percentage of our overall business in fiscal 2021.

Let me turn to a review of each of our businesses for the fourth quarter. I’ll start with Specialty Compute. Revenues — revenues for Specialty Compute totaled $67 million 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 software and service offerings, which are key areas of our strategic focus.

One good example is Penguin’s recent launch of a solution to meet the demand for real-time applications for memory infrastructure. Penguin’s offering scale cost effectively to many terabytes using Intel’s Optane persistent memory, virtualizing new massive pools of software defined memory. This is a good example of increasing importance of memory as it moves closer to the computing power in 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-19 that we announced in the prior quarter. Just two weeks ago Penguin announced that the first petaflop of compute capacity in its data center is now online and available for researchers. We look forward to continuing to support AMD and the participating 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 reflect 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 million 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-19 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 Western Europe sales operation headquartered in Germany.

Our team on the ground there have 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, they are industry’s smallest and easier to use solution for developing and testing Gen-Z fabric manager 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 million, up 13% sequentially. As we expected, our ASPs improved in Brazil, driven by both an increase in the average density of memory and the recovery in the unit sales. As mobile memory densities 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 2021. We continue to advance our technology development in our Brazil operations which recently began qualification of a 11 die stack technology 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 roles 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?

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Great. Thanks, Mark. We reported a strong quarter with solid improvements in our key financial metrics. Fourth quarter fiscal 2020 net sales of $297 million, was 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 $150.8 million at the end of the fiscal year, which is $20 million 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 the mobile and PCs; industrial, defense, networking and telecom more than offset lower sales to the server and storage end markets.

Now moving to the rest of the income statement. Non-GAAP gross profit for the fourth quarter was $57.8 million or 19.5% of net sales compared with the last quarter’s $55.9 million 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 this related to how the Brazilian Government is encouraging local manufacturing. Without this change, the gross profit and operating expenses would both have been around 2% higher.

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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 and our just completed fiscal quarter resulted in a charge of $3.5 million. Non-GAAP operating expenses were $29.4 million compared with $35.5 million in the previous quarter. Non-GAAP net income for the fourth quarter was $20.4 million or $0.82 per diluted share compared with $17.1 million or $0.70 per diluted share in the previous quarter. And adjusted EBITDA totaled $33 million compared with $25.4 million 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, that 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 where work 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 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 go into our fourth quarter.

Turning to working capital. Our net accounts receivable totaled $215.9 million compared with $223.2 million last quarter. Our days sales outstanding remained essentially flat with last quarter at 45 days. Inventory totaled $163 million at the end of the fourth quarter compared with $180.6 million 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 were $438.2 million and $381.9 million 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 to net profit on a supply chain services transaction. We exited the year with a very strong cash position of $150.8 million of cash and cash equivalents compared with $131.8 million at the end of the prior quarter and $98.1 million at the end of our last fiscal year. Fourth quarter cash flow from operations increased to $16.2 million compared with $13.6 million in the prior quarter. For the year, cash flow from operations totaled $78.4 million.

We exited our fourth quarter with a very strong balance sheet as well as a vastly improved capital structure. Thanks for the convertible notes and subsequent restructuring and repayment of debt that was executed earlier in the year. For those of you tracking capex and depreciation, capex was $7.4 million for the quarter and depreciation was $5.2 million.

And now turning to our fiscal Q1 2021. 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 2021. We currently estimate that our first quarter net sales will be in the range of $280 million to $300 million. 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 $0.05. On a non-GAAP basis, excluding share-based compensation expense, intangible asset amortization expense, convertible debt discounts, OID and fees and other infrequent or unusual items, we expect non-GAAP earnings per diluted share will be in the range of $0.70, plus or minus $0.05.

The guidance for the first fiscal quarter does not include any view of 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 million. Capital expenditures for the first fiscal quarter are expected to be in the range of $10 million to $15 million. Please refer to the non-GAAP financial information section and the reconciliation of non-GAAP financial measures to GAAP results and reconciliation of GAAP net income to adjusted EBITDA tables in our earnings press release for further details.

Operator, we are now ready to take questions.

Questions and Answers:

Operator

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

Rajvindra Gill — Needham & Company — Analyst

Yes, thank you for taking my questions. I appreciate it. Just Jack, a little bit more clarification on the accounting change. Wondering 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?

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Sure, Raji, so I’ll answer the last part of your question, yeah, so we expect this will impact gross margin and operating expenses that we talked about, by about 2%, so we would expect to have a lower gross margin, because of this, in the future and also operating expenses increased. So in Brazil, they’ve been changing the rules, because of the points based system and also to have manufacturing more competitive. So there was a change made to the law to give a — what they call the financial credit, the 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 to reclass between the two, has no impact to net income and we expect it to be, the same impact on a go-forward basis.

Rajvindra Gill — Needham & Company — Analyst

Okay. So just kind of moving it from one bucket to the next product.

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Yeah.

Rajvindra Gill — Needham & Company — Analyst

And that is zero. Okay. Yeah. Okay, thank you. Now I just on, in terms of the fundamentals, and welcome Mark, we look forward to working with you in the future. In terms of the Penguin business, the Specialty SCAS [Phonetic] 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 — as it contains many different segments now, it contains Inforce, Penguin Computing, Artesyn 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 ’21?

Mark Adams — President and Chief Executive Officer

So, I appreciate the question and look forward to working with you as well. I think those questions can actually be broken up, it does come up to Specialty Compute and Storage as a business category. But in each of them, they’re very unique in terms of end markets. And as you noted, we did comment specifically on the call today about the backlog and 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 is using our technology for advanced data analytics.

And as you get closer to edge and on-premise, you see applications in our Artisan business and our Inforce business in terms of SMART embedded and SMART wireless that are driving segments that are more IoT-driven and related, and then having to do with opportunities around commercial, around governments, around education, around manufacturing and supply chain management applications. And so, as you get further away from 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 and providing solutions.

So it’s a broad ecosystem, and that’s why it’s easier probably to break it down in the way the businesses used to work. But having said that, I think one of our biggest opportunities from a solutions 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 are using our high performance compute capabilities for analytics around customer behavior and they’re are using our IoT technology at the point of interface to the customer. And we think that one of the reasons of consolidating a 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.

Rajvindra Gill — Needham & Company — Analyst

Okay, excellent. And then on the specialty memory, you had mentioned a reduction in enterprise spending. We saw this echoed by Micron and 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 network and telco, how are they offsetting it, just any color?

Mark Adams — President and Chief Executive Officer

Good question. And by the way I’d just like to provide a little commentary, because I did have a decade in the memory on the Micron side, and the perspective I had, when COVID hit, I kind of felt like there was a typical reaction by the customers to grab inventory heading into the summer and the fall. And I though, the demand was dropped 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 to 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 is some — been some inventory burn and some usual — unusual dynamics relative to, for example, Huawei and what their demand profile look like going into the back half of their calendar year. So a lot of different dynamics going on. We called it out, because we are seeing maybe some softness in certain areas, but certainly as the number suggest, growth in other — in other areas have put us in a pretty good position for Q1.

Rajvindra Gill — Needham & Company — Analyst

Thank you.

Operator

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

Brian Chin — Stifel, Nicolaus & Company — Analyst

Hi, there. Good afternoon. 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 quarter guidance, maybe just to be a little bit more granular, looking 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 a big order that you’re seeing, is it more directed to the federal or commercial market, kind of what’s the shipment timing against that and what where those other signals that you’re getting Mark that gives you confidence in the near term revenue trend?

Mark Adams — President and Chief Executive Officer

Yeah, good question. The order I referred to was indeed in 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 expenditure. But our funnel, in terms of our backlog is probably to help these ever since, we’ve had the business at SMART and when you think about the competitive landscape there. And you think about our position, you know Penguin had a very long history in its business and as we continue to find new opportunities and scale, the HPC market is kind of on a uptick, because the end segment drivers are there. As I said, as you’re aware, AI is a very hot world right now with people getting out and starting to further develop applications around that. Machine learning for sure and even data analytics that we’re seeing a lot of investment into high performance. 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 want to make sure that as we do that we have a benchmark for you to understand, but we’re not doing that per se. It’s literally — we see a much better funnel the best funnel we’ve had since we own the business. And we are very optimistic about some of the successful implementations we’ve had as kind of a beachhead for further growth.

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Brian Chin — Stifel, Nicolaus & Company — Analyst

Okay. Yeah, thanks. Maybe another question maybe directly at you, Mark. Clearly, the strategic expansion of SMART into the Specialty Compute market has been evident the 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 product services and infrastructure?

Mark Adams — President and Chief Executive Officer

I think that’s right. I think, maybe there’s two areas to think about it. There is — we’ve improved the margins in this business since day one. Day one, I think if I recall, the margins that upon acquisition on day one are roughly 15% plus or minus and those margins are now kind of approaching 20%, 21% gross margins. 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 roadmap 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 develop either through inorganic activities or kind of partner with co-development and existing software platform that’s pretty sophisticated as is.

It’s just — as we think about going up the stack. And that’s a — you said, it’s only 30 days. I’ll tell you, one leg of what I would espouse is going to be a big strategy for us going forward, it’s going to 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.

Brian Chin — Stifel, Nicolaus & Company — Analyst

That’s great. Thanks for that color. Maybe just one quick thing on Brazil, putting with 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. Just curious, what gives you the confidence that the ##phone market in Brazil has turned the corner? And what are you seeing or expecting in the quarters ahead in terms of content growth and also pricing trends?

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Yeah, I mean, we talked about earlier, 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 worth mentioning the call, we’ve developed a 64 gigabytes now 132 gig products. That’s — 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. So our densities are going to go up in Brazil based on these new products that are under all the case. Remember we don’t qualify a product in Brazil and then you go try and sell it, right. We’ve already worked with the cellphone guys, this is on the road map, this is what they need, we go qualify that product. So we know they’re moving to higher density products. And also remember, Brazil lags the world, right. So Brazil is way behind the balance of the world when we’re talking about the densities in the phones. So even if they slowly catch up, our densities will go up.

And we’re seeing improvements. When we look at the data in Brazil, I talked about, the number of cellphones being sold and things like that. It’s turned the corner. They’re starting to go up a little bit from where they were. So we’re seeing — we’re seeing unit growth in cellphones and in PCs down in Brazil. So it’s turned a little bit on both, the demand for both is getting better, down in Brazil.

Mark Adams — President and Chief Executive Officer

Yeah. And you couple that with just raw technology evolution that’s going on globally, the memory requirement is going to get driven up because of performance and expanded use of the platform in the hands of the consumer. So where Brazil may lag, it’s eventually going to drive there and things like 5G and other additional application drivers, we’re going to be in a pretty good position to capture the advantage of the higher ASP trend line.

Brian Chin — Stifel, Nicolaus & Company — Analyst

Great, thank you.

Operator

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

Kevin Cassidy — Rosenblatt Securities — Analyst

Yeah, thanks for taking my question. Welcome, Mark and also congratulations Jack on your promotion. But, Jack, maybe I’ll give you a first question. And 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…

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Definitely, opportunities to increase. I think you’re seeing the gross margin for specialty bottoming out, we’ve had some new products that have been qualified and sometimes when you qualify, new products, you have a higher ASP product which kind of translates into a lower margin. So we’ve had some impact on margins for that, but our, our view is going forward as we go through next year to 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, Kevin.

Kevin Cassidy — Rosenblatt Securities — Analyst

Okay. Thinking like back up to say 21% range or can [Speech Overlap].

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Yeah. I think, maybe the high teens, and then slowly get up there, not get too excited.

Kevin Cassidy — Rosenblatt Securities — Analyst

Okay. And how about the demand in the enterprise, is it an inventory issue or kind of like, what Mark said, is there some reporting that happened early on and now it’s, just have to let that inventory rundown.

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Yeah, I think. So, I mean, you look at some of our customers, right. If you follow some of our large customers in this space, right, they’ve been guiding down what would be our Q1 for demand, right, so our large customers are going to be guiding a little bit down in demand. That’s definitely going to impact the enterprise spend within Specialty Memory. I think they had built up some inventories maybe early in the summer. And so the question is, it’s a little bit demand issue. I think on our customers, which translates back to demand issue for us as well.

Kevin Cassidy — Rosenblatt Securities — Analyst

Okay, great. Thanks. Congratulations on the report for this environment.

Mark Adams — President and Chief Executive Officer

Thank you.

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Thank you.

Operator

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

Sidney Ho — Deutsche Bank — Analyst

Thanks for taking my question. First of all, 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 de-emphasize? 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?

Mark Adams — President and Chief Executive Officer

Of course. Maybe let me take the strategy. I think, at this point, I would say that if you look across all of our businesses, the SMART strategy has been defined market where they can differentiate with the — with delivering Specialty Solutions and to kind of a diverse set of end markets when you think about that the segments in high-performance computing versus the segments in specialty memory. Obviously Brazil is as unique in its own specialization of capabilities that we have. And then you continue with the embedded and wireless business. And so, the common theme around developing special 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, we want to make sure that we’re developing additional capabilities to bring to our customers, allow 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 as I sit here today, but what I would see is, the execution side of the business, leveraging the operating platform and running the companies well. 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 the truth — same is true in our embedded and wireless business. And so, some of it’s more about the execution side and then also, you know, when you think about M&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 the differentiation focus will maintain, as we look at those type of opportunities, we’re not looking just to grow business to grow business, we want to find opportunities where we have. Market leadership and unique application end markets where there is enough differentiation that leverages SMART’s core competency around manufacturing, supply chain and go-to-market.

And so, I don’t think there’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 going to be a critical leg of the stool for us. Yeah, we want to grow, but we want to grow while we expand margins. That’s the message, I would like to give — give today is that we’re not, we’re not exactly satisfied where the margins are. We want to grow them, and we want to find ways to grow them and providing more value. And I think our customers would like that, providing the values tangible and that’s going to 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 in Micron, where we established these business unit mentalities. And I think from an accountability standpoint, a leadership standpoint, Jack had demonstrated over his career that he will be the right person for this Company to deal win in the memory solutions business. And he’s got the support of an outstanding executive in KiWan, that has really crafted a really strong business 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 at Penguin for example, or other businesses, managed services 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 got to go execute. 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 want to have a Jack and KiWan 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 may be focused on a lot of in the next 60 to 90 days.

Also Read:  Cadence Design Systems Inc. (CDNS) Q3 2020 Earnings Call Transcript

Sidney Ho — Deutsche Bank — Analyst

Great. Thanks for the detailed answer. Moving on to the Specialty Compute business, I think, last quarter, you guys talked about the commercial contracts was generally pretty strong maybe with a few pockets of weaknesses in terms of end markets. And in your prepared remarks you talked about federal 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. And lastly, how should we think about the mix between federal and commercial contract in fiscal Q1 versus a normal environment? Thank you.

Mark Adams — President and Chief Executive Officer

I’ll take — I’ll take the second — first part. The federal business per se for us has picked up a bit in terms of some major design wins and inbound orders. Having said that, obviously there is 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 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 specifically, and not just in one area, certainly Penguin’s exciting, but also in terms of our Embedded business, we’ve got some design win opportunities that have come to fruition. And we’re generally bullish, and again with the hesitation that November may in fact, 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.

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Yeah. Back on, I think — I think in Q4, the Penguin business performed as we thought it was. We didn’t, I think federal came in right where we thought. We don’t think it was weaker than we anticipated. And you listen to Mark’s statements, it would tell you that maybe in Q1, potentially a little stronger than we thought. Right. So penguin will be probably doing little bit better in Q1 than we had originally anticipated. I think the some of the business is popping back maybe a little sooner than we thought. So we’re looking for a pretty good Q1 of the Penguin Group.

Sidney Ho — Deutsche Bank — Analyst

Okay, thank you.

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Thank you.

Operator

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

Blayne Curtis — Barclays — Analyst

Hey, thanks for taking my question. That’s actually a good lead in, because I was just kind of curious, looking to November, prior question asked about what the segments will be doing, you said specialty would be good. You just said it would be up. I guess trying to square that with gross margin, which is down and you would think that if mix is moving to the Specialty Compute, the margin would be up. So can you just walk me through that?

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

Sure. So again, the overall, Specialty Compute, yes, we think that will be up. And you’re right that has a higher gross margin, but then, we look at in Brazil, the change with Brazil and all that. So Brazil will potentially be a little bit drag on the margins in Q1 why you’ll see the margin come down a little bit, Blayne, in the quarter potentially. But Specialty Compute will have a — will do better in Q1. And all surplus 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.

Blayne Curtis — Barclays — Analyst

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

Jack Pacheco — Executive Vice President, Chief Operating and Chief Financial Officer and President of SMART Memory

No, it’s fully implemented. It’s just that the Brazil business in Q1 based on some certain fact, we’re anticipating a little bit lower margins in Q1 as we go to market in the quarter, as we’re driving volume down there we expect margins to be impacted little negatively in Q1 in Brazil.

Blayne Curtis — Barclays — Analyst

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 the unit story, there’s density and then there is kind of like the strategic nature of how people use the credits and under 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. So I’m just kind of curious if you look at those factors over the last several quarters, so what do you think has driven the most part of the growth?

And then I guess, as 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 those, just memory.

Mark Adams — President and Chief Executive Officer

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 component in that, which makes us 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 found that over time, the battery business is a difficult one for us to scale. And it’s 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.

Blayne Curtis — Barclays — Analyst

Thanks.

Operator

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

Mark Lipacis — Jefferies — Analyst

Hi, thanks for taking my questions. Ajay, first of all, thank you very much for all the health, and 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&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, the companies to the extent you have an appetite for exploring some kind of a transformative M&A deal like a merger of equals, are you thinking more tuck-ins, and the willingness to lever up with debt or issue equity?

Mark Adams — President and Chief Executive Officer

Yeah, sure. So for those of you who knew me in a prior life and then when you think about how Micron survived, we did four or five major acquisitions in a 10-year period during some really turbulent times in the memory industry. And I would argue that, those acquisitions and with the help of the financial engineering, so to speak to provide us the opportunity gave us great platform that the company is built on, and obviously Sanjay and team has done a great job continuing the growth. I think that the Company, SMART as we sit today could really use some additional inorganic activity, M&A activity around tangential spaces to the core business today.

And so you’ve got compute memory, embedded and 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. I think there’s a lot less to develop and add value to our current businesses. Having said that, adjacencies to what we do well, manufacturing of subsystems in 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 met — 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 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 answer to your question specifically, but I could see some significant transactions and adjacent businesses that take advantage of our operating discipline and platform. 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 specialty solutions at dependable differentiated end markets that require really good operating discipline. And those three criteria for me is what’s SMART been 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. But yet, expand our reach into new markets.

Mark Lipacis — Jefferies — Analyst

That’s very helpful. Thank you. And a follow-up if I may, on Penguin, it looks like there is a view that there is an opportunity for improving the profitability. I believe you mentioned the soft, developing a software application layer capability. And I was wondering to what extent have you explored or do you think that hosting services yourselves are providing the capex yourself investing in the system yourself and offering that as the solution. Also, is that — is that enter into the [Speech Overlap].

Mark Adams — President and Chief Executive Officer

Yeah. I apologize, they didn’t do a good job of calling that out. Sorry about that earlier, when I — as I referring to software and services, the services part of the 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 to 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 that we have in terms of the integration and high performance are under the roof of SMART today. And so what it takes for, though, as I said earlier, about skill sets and leadership, we’re going to 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 and larger companies, these great ideas don’t necessarily pan out because you like them, because they lose focus. And 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 a layered software on top of the Penguin architecture, those are capabilities that we will invest in to grow the margin.

Mark Lipacis — Jefferies — Analyst

Got you. That’s very helpful. Thanks for clarifying that. That’s all I have.

Mark Adams — President and Chief Executive Officer

Thank you.

Operator

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.

Mark Adams — President and Chief Executive Officer

Thank you, operator. In summary, fiscal 2020 has concluded on a strong note amid 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&A in the next phase of SMART’s evolution. Thank you for your interest and in support the Company and I look forward to meeting and working with you in the months ahead.

Operator

[Operator Closing Remarks]

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