The Q1 FY23 earnings report of SMART Global Holdings, Inc. (NASDAQ:SGH) was a good one, with the company showing solid growth in its IPS Group, offset by a weaker performance in its Memory Solutions Group and LED Solutions; both revenue and EPS beat expectations.
In its top performing IPS Group the company expects momentum to continue in the first half of calendar 2023, based primarily upon hardware installations from large customers, specifically federal and hyperscale customers.
While not a surprise, its Memory Solutions Group underperformed in the reporting period, as weakening demand and a decrease in pricing resulted in revenue in the segment being down. Expectations are that is likely going to continue for now, although its specialty memory business has been doing better than other parts of Memory Solutions.
Even with the solid performance in the quarter, company guidance for revenue in the second fiscal quarter of 2023 pointed to the probability it may come in lower than Q1 FY23, and possibly much lower if it’s at the lower end of guidance.
In this article we’ll discuss some of the latest earnings numbers, the performances of its two biggest segments, and whether or not the company can maintain momentum now that its latest acquisition – Stratus Technologies – is close to being fully integrated into the company.
Some of the numbers
Revenue in the first fiscal quarter of 2023 was $465.48 million, up 6.3 percent sequentially, but down 0.95 percent from revenue of $469.94 million in the first fiscal quarter of 2022.
Product sales in the reporting period were $390.2 million, down approximately $46 million from product sales of $436.7 million in the first fiscal quarter of 2022. Services revenue was $75 million, up almost $42 million year-over-year.
Operating expenses in the first fiscal quarter of 2023 were $100.8 million, compared to $87.4 million in the first fiscal quarter of 2022.
GAAP gross margin in the quarter was 25.4 percent, up 170 basis points sequentially.
Net income in the reporting period was $5 million or $0.10 per share, compared to net income of $20 million or $0.41 per share in the first fiscal quarter of 2022.
Cash and cash equivalents at the end of the first fiscal quarter of 2023 was $324.8 million, compared to cash and cash equivalents of $363 million as of August 26, 2022.
The company had long-term debt of $797 million at the end of the first fiscal quarter of 2023, up almost $200 million from the long-term debt of $591 million as of August 26, 2022.
Net sales guidance for the second fiscal quarter of 2023 was in a range of $410 million to $460 million, with a midpoint of $435 million. With the top end of revenue guidance being lower than net sales for the first quarter of 2023, it suggests the company sees momentum slowing down some.
As for GAAP gross margin, the company guides for it to be in a range of 25 percent to 27 percent in the second quarter, with diluted EPS to be at about $0.13, plus or minus $0.15. That points to the possibility of net income and EPS possibly being negative in the second fiscal quarter of 2023. But if it surprises to the upside, it could outperform on the upside.
With this wide of a guidance for diluted EPS, it makes me think there is a lack of visibility in some parts of the company.
Performance by segment
In this part of the article, I’m going to focus on the two largest segments of the company: IPS Group and Memory Solutions Group, as in the latest quarter they accounted for 86 percent of company revenue.
IPS Group
Revenue for IPS Group came in at a record $211 million in the first fiscal quarter of 2023, up 46 percent sequentially and 78 percent year-over-year, with 45 percent of that coming from new acquisition Stratus Technologies.
With the integration of Stratus Technologies into IPS, the service part of the company’s business in Q1 FY23 accounted for approximately 16 percent of total revenue for SGH for the reporting period, and 32 percent of overall IPS revenues. That was the primary reason service revenues was up so much in the quarter.
The company continues to guide for IPS to perform well in the first half of fiscal 2023, led by installations from its federal and hyperscale customers. In the second half of fiscal 2023 the company doesn’t have the visibility it does for the first fiscal half.
Memory Solutions Group
Revenue from Memory Solutions Group was $192 million in the first fiscal quarter of 2023, accounting for 41 percent of total SGH revenue in the reporting period.
Based upon weakening demand and a reduction in memory pricing around the world, sales in the quarter were lower sequentially. The softness in the memory market should continue over the next couple of quarters, and possibly longer depending on macro-economic conditions. The strongest category in its memory segment was its core specialty memory business, which remained fairly “stable” in the quarter. The company is positive about the long-term contribution from specialty memory, saying at this time there’s a lot of oversupply in the memory market with capacity adjusting to slower demand at this time.
With weakness in PCs and mobile phones lingering, it had a significant impact on its business in Brazil, and it expects those sectors to continue to soften in the second fiscal quarter of 2023, beyond the normal historically lower demand in the quarter.
Management did say it’s starting to see initial shipments of memory for 5G phones in the Brazilian market and expects in the second half of calendar 2023 for adoption of 5G phones to increase in Brazil. Nonetheless, in the short term, oversupply in the general memory market in the midst of slower demand is going to weigh on Memory Solutions Group for a while. Further out there’s going to be growing demand in the memory segment, but that time isn’t here yet.
If IPS Group underperforms in the near term, it could significantly impact the performance of SGH, and if that happens in the second half of calendar 2023, it’s going to hit the company hard, assuming memory demand and overcapacity have yet to be mitigated.
Conclusion
While the share price of SGH got a predictable bounce from the fiscal first quarter earnings report, it should be understood that almost all of its outperformance came from the acquisition of Stratus Technologies. Without it, it would have been another unremarkable performance from SGH.
That said, Stratus Technologies is now part of the company, and should continue to contribute to revenue and margin improvement going forward, but it’ll be offset for now by weakness in Memory Solutions Group and LED Solutions Group.
I think if the company comes in at the low end of revenue guidance the company is going to take a big hit because it would also mean a further decline in net income and EPS in the second fiscal quarter of 2023. For now, I believe the company will probably have a higher bottom to work from, but once the market digests the overall earnings report, it’s going to find that it was pretty much a Stratus Technologies acquisition story, which does little in regard to organic growth for the company.
Taking everything into account, I lean toward the company probably trading a little higher in the next couple of quarters, but not sustainably breaking out in any way.
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