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SMART Modular Technologies (WWH), Inc. (NASDAQ:SMOD)

F4Q2010 Earnings Call Transcript

September 30, 2010 4:30 pm ET

Executives

Suzanne Craig – IR, The Blueshirt Group

Iain MacKenzie – President and CEO

Barry Zwarenstein – SVP of Finance and CFO

Analysts

Jim Suva – Citigroup

Kevin Cassidy – Stifel Nicolaus

Tim Luke – Barclays Capital

Krishna Shankar – ThinkEquity

Alex Kurtz – Merriman & Company

Rich Kugele – Needham & Company

Adam [ph] – Oppenheimer & Company

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the SMART Modular fourth quarter and fiscal year 2010 earnings conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator instructions)

This conference is being recorded today, Thursday, September 30, 2010. I would now like to turn the conference over to Suzanne Craig of Investor Relations. Please go ahead ma'am.

Suzanne Craig

Thank you, operator. Good afternoon everyone and thank you for joining us on today's earnings conference call to discuss SMART Modular Technologies fourth quarter and fiscal year 2010 financial results. Iain MacKenzie, President and CEO and Barry Zwarenstein, Senior Vice President and CFO join me on today's call.

Before we begin, I would like to make the following Safe Harbor statements. During the course of this conference call, Iain or Barry may make projections or other forward-looking statements regarding future conditions or events concerning our future business, our current and new products and services, the size and strength of our markets and/or the future performance and outlook of the company.

These statements are forward-looking statements within the meaning of section 27-A of the Securities Act of 1933 and Section 21-E of the Securities and Exchange Act of 1934. You should review management's discussion and analysis and related risk factors affecting future results, contained in the forms and reports filed with the SEC, including the company's annual reports on Form 10-K for fiscal year 2009, and the quarterly reports on Form 10-Q for the first, second and third quarters of fiscal 2010.

We caution you that such statements are just projections. Accordingly, our future results may differ materially from such projections, and investors are cautioned not to place undue reliance on any forward-looking statements. These forward-looking statements are made as of today and SMART does not intend and has no obligation to update or revise any forward-looking statements.

The fourth quarter of fiscal 2010 earnings press release is available on the company's website at smartm.com or you may call our Investor Relations office at area code 415 217-7722, and we will fax you a copy.

Please note that non-GAAP financial results presented exclude stock-based compensation expense, restructuring charges, goodwill impairment charges, net gain on the repurchase of notes, gains from a settlement, display business divestiture, and other infrequent or unusual items.

Please refer to the non-GAAP information section and the reconciliation of non-GAAP financial measures table of our earnings press release for further detail and for a reconciliation of such items to GAAP.

An audio replay of this call will be available for two weeks by accessing the Investor Relations page at smartm.com or by dialing area code 303 590-3030, and using the pass code 4364370. I would also like to remind everyone of our upcoming Analyst Day in New York on Tuesday, October 12, from 10 A.M. until 2 P.M. Eastern Time, where a number of SMART senior management team will review the company’s business areas and strategies for growth.

Now I would like to introduce Iain MacKenzie, President and CEO of SMART Modular.

Iain MacKenzie

Thank you Suzanne, and welcome to everyone on the call. Fiscal 2010 was a very positive year for SMART. We demonstrated continued improvement of our key financial metrics in each quarter during the year, and we have started to see meaningful progress in our targeted new areas of expansion and diversification.

I believe the results demonstrate the strength of our business model, and our ongoing operational excellence, both of which are solid foundations for future growth. But it is an exciting time in the company’s history positioned as we are to successfully move to the next growth stage of our solid state storage products for enterprise applications and for our Brazil flash initiative, along with continued expansion of our capacity for specialty memory manufacturing and design.

I will first review the full fiscal year followed by a look at the fourth quarter and the latest business developments. Barry Zwarenstein, our CFO, will then continue with a more detailed review of our financial performance, as well as our forward guidance, after which we welcome your questions.

Our net sales for fiscal 2010 were $703 million, approximately 59% higher than the prior year. Gross profit for 2010 was $166 million, which was 85% higher than last year, and non-GAAP net income for 2010 totaled $56.4 million or $0.87 per diluted share, compared with $11 million or $0.17 per diluted share in fiscal 2009.

In fiscal 2010 we also generated $106 million in adjusted EBITDA. We have clearly navigated through the challenges facing the global economy quite successfully during fiscal 2010 and are poised to continue our momentum into this next fiscal year.

In the fourth quarter of fiscal 2010 net sales totaled $219 million, a 9% increase over the third fiscal quarter, and 119% over the same quarter last year. Non-GAAP gross profit was $50 million, 9% higher than the previous quarter and more than double the year ago quarter. Non-GAAP earnings totaled $0.29 per share for the fourth quarter of fiscal 2010 compared to $0.26 per share in the third quarter, and $0.05 per share in the fourth quarter of last year.

These better-than-expected results are attributable to the continued success of our strategic initiatives, and the strength of our business model and market position, all of which were enhanced by the ongoing strength of PC unit demand in Brazil, robust demand for our specialty products, and increased demand for our defense and embedded flash drive products. Our DRAM or specialty memory business exceeded expectations primarily due to the strength in networking and telecom and market demand.

Now we will turn to a discussion of each of our businesses beginning with memory. Our specialty memory business continued to benefit from increased spending on the global Internet infrastructure, driven by growing demand for streaming video services and expanded web-based applications, as well as the unabated pace of equipment replacement with newer, better performing and much more power efficient systems.

These developments have resulted in increased sales of our value-added and cost-effective memory modules for networking, telecom and computing end markets as well. The customer demand trends that we reported in the previous quarter for our high density CoolFlex pins, stacked [ph] memory modules, customized small form factor module, and enhanced test solutions showed continued strength in Q4. In particular, sales of specialty DDR3–based modules have been growing steadily along with significant ongoing demand for legacy technologies, especially those employing density enhancements, including our stacked memory product.

Sales of 2 gigabit-based DDR3 modules have been growing much of late as a result of the increased demand for modules using stacked 2 gigabit devices. In addition, we sampled the initial offering of our flash backed DDR3 DRAM [ph] product line for rate systems in Q4, and we expect to see production orders by the end of Q1 or early Q2 of our fiscal 2011, pending completion of customer qualification.

I will next turn to Brazil, where as you know we’re enjoying a significantly differentiated position, which continues to fuel growth for the economy and for the company. In the fourth fiscal quarter, SMART sales in Brazil continued to post strong increases as the capacity we had previously added came online. Our timely investment in increased capacity enabled us to meet strong unit demand and more than offset the impact of moderating DRAM ASP.

In fact, during the fourth fiscal quarter, SMART Brazil achieved another new record level of local package production, module production and unit sales. We intend to continue to invest in Brazil in order to increase production and keep pace with the strong demand. Turning to the progress we are making our emerging flash business in Brazil, we have recently qualified micro SD internally, and have had these validated by an external test house, and are qualifying other flash products to expand our offering to meet the needs of our customers.

In recent weeks, we have received customer acceptance of our 2 gigabit product used in digital still cameras. We continue to anticipate that initial sales of our flash related products in Brazil will continue in the first half of fiscal 2011.

And now let me turn to solid-state storage. First, let me update you on the tier 1 customer design win that we have been discussing in the past. We are very pleased to report that over the last several months, this engagement has broadened and deepened. We are now expanding our footprint with this customer into multiple divisions for both SATA and SASS products. Our XceedLite 1.8 inch SATA drive has been released for limited usage at this customer to ensure that it is robust and stable, and we look forward to the customers’ volume launch. We are very excited to be at this advanced stage with this product. We are working closely with a number of other OEMs on designing SSDs that enhance the value of their product lines. We expect that this process will capture a greater portion of increased demand for solid state drives through each OEM’s quest for higher performance, higher reliability and lower power consumption in data centre environment, and this will demonstrate the foothold that we have achieved in the $1.6 billion mass [ph] market.

The move to MLC flash in the enterprise is also accelerating. With improved control of technology and drive architectures optimized for the use of MLC, the industry has taken the necessary technological steps to leverage MLC in the enterprise. Our XceedIOPS line of enterprise grade MLC flash or EMLC is helping the industry to lead the charge towards utilizing higher endurance specification.

With respect to defense, we had higher demand in the quarter for supply of XL products to a defense project. We are planning to leverage the momentum of our XceedIOPS product line into the defense and industrial space with ruggedized versions. This new product line should deliver higher levels of performance to both industrial and military applications fuelling growth in these sectors.

Lastly, our embedded storage business reached a new record level of sales in FY 2010, more than doubling over fiscal 2009 levels. We are capitalizing on two main factors. First, a new industry standard for an embedded SATA SSD that is expected to contribute to increased revenues, and second, the reduced focus on the embedded storage market by many of our traditional competitors. SMART has also designed and successfully qualified a high-performance and high density custom SSD product for a new platform of a leading network vendor, which is planned for introduction in calendar 2011.

To wrap up my comments, this quarter was an excellent finish to a very good year for SMART. Our businesses are performing very well and driving ongoing profitability. Our growth within the robust Brazilian market continues to ramp and our enterprise storage initiatives remain very promising. The success of our internal diversification strategy and the broadened market for specialty memory products is enabling SMART to differentiate itself from the volatility inherent in the DRAM industry.

As we have said in the past, SMART’s operational excellence, established customer relationships, and recognized manufacturing and technology expertise have resulted in significant improvements in our performance.

Now I will turn the call over to Barry for a discussion on the financial results.

Barry Zwarenstein

Thank you, Iain. Fourth quarter net sales of $218.7 million were broken down by geography as follows: US, 24%; Other Americas, 54%; Asia, 18%; Europe, 4%.

Our breakdown of net sales by end market for the fourth quarter was as follows PC, 45%; Network and telecom, 20%; Servers, 15%; Storage, 11%; Logistics, 5%; Industrial and other, 4%.

Compared to the third quarter of fiscal 2010, PC related sales grew 12%, storage grew 51%, and Logistics grew 11%.

Our sales to HP continued to grow, up 15% in the quarter mainly due to the PC business in Brazil, and HP remains our largest customer, representing 22% of sales this quarter. Cisco and Dell each represented approximately 15% of sales in the quarter, approximately the same percentage as last quarter.

Moving to the rest of the income statement, which I will discuss first on a non-GAAP basis, gross profit for the fourth fiscal quarter was $50 million, up approximately 9% from last quarter's $45.7 million. This higher gross profit was driven by improved mix, including the strength in our logistics business.

On a percentage basis, gross profit was 22.9% of sales compared to 22.7% last quarter, and 21.5% a year ago. Our fourth fiscal quarter non-GAAP operating expenses totaled $22 million versus $20.8 million in the prior quarter.

Non-GAAP R&D expenses increased to $7.2 million in the fourth quarter, versus $6.3 million in the prior quarter, due to the continued investment in enterprise SSD. Non-GAAP SG&A expenses totaled $14.8 million, up slightly from $14.5 million in the previous quarter.

Non-GAAP net income for the fourth quarter of fiscal 2010 was $18.8 million, or $0.29 per diluted share, up from $17.3 million or $0.26 per diluted share for the third quarter of fiscal 2010 and $3.1 million or $0.05 per diluted share for the fourth quarter of fiscal 2009. Excluded from non-GAAP net income in the fourth quarter was stock based compensation expense of $1.8 million.

On a GAAP basis, net income for the fourth quarter of fiscal 2010 was $17 million, or $0.26 per diluted share, compared with $14.9 million or $0.23 per diluted share for the prior quarter and a net loss of $300,000 million or $0.00 per share for the fourth quarter a year ago.

We had our third consecutive record quarter in terms of adjusted EBITDA, generating $33.2 million during the fourth quarter, or 15% of net sales.

Switching to the full-year results, non-GAAP net income for fiscal 2010 was $56.4 million or $0.87 per diluted share compared with $11 million or $0.17 per diluted share for fiscal 2009. The non-GAAP adjustments are detailed in the GAAP to non-GAAP reconciliation table included in our press release.

On a GAAP basis, net income for fiscal 2010 was $52.6 million, or $0.81 per diluted share compared to a loss of $11.4 million, or $0.18 per diluted share for fiscal 2009. We remain very pleased with our strong balance sheet and working capital metrics. Our net accounts receivable decreased slightly to $208 million, from $212 million last quarter, as our days sales outstanding came down to 40 days this quarter compared to 42 days in the third fiscal quarter.

Inventory and turns were essentially flat with the last quarter at $112 million and 15.2 times respectively. As expected, in the fourth fiscal quarter we increased our inventory for logistic services, which continued to slightly outperform our expectation. Approximately 41% of our fourth quarter inventory was in support of our logistics business compared to 38% in the third quarter. As pointed out in the past, it is important to remember that we have limited exposure to price fluctuations for our logistics inventory.

Consistent with past practice, accounts receivable and inventory turnover are calculated on a gross sales and cost of goods sold basis, which totaled $476 million and $426 million respectively for the fourth quarter of fiscal 2010, and $1.6 billion and $1.4 billion respectively for fiscal 2010.

Cash and cash equivalents totaled $115 million at the end of the quarter, up from $106 million last quarter. Fourth quarter cash flow from operations was $17.7 million. For the year we generated $15.4 million in operating cash flow, despite a $52 million increase in working capital due to the 49% increase in gross sales. It is interesting to note that in each of the last three quarters we have generated over $20 million in cash flow from the income statement components of operating cash flow.

Capital expenditures for the full fiscal year 2010 totaled $27.8 million. As discussed last quarter, the main driver was the $22.6 million investment in Brazil, which contributed to our increased capacity, enabling us to accommodate the strong demand.

And now, let me turn to our guidance. For the first quarter of fiscal 2011, SMART estimates that net sales will be in the range of $210 million to $230 million. We expect gross profit to be in the range of $47 to $50 million. In the first quarter, we expect to incur a one-time charge to gain access to technology in order to accelerate our development of enterprise solid state drives. This technology access charge is currently estimated to be approximately $7.5 million.

As a result, net income on a GAAP basis is estimated to be in the range of $0.09 to $0.11 per diluted share. On a non-GAAP basis, excluding the technology access charge and stock-based compensation expense, we expect non-GAAP net income will be in the range of $0.23 to $0.25 per diluted share.

The guidance for the first quarter of fiscal 2011 includes an income tax provision, expected to be in the range of $7.7 million to $8 million. The number of shares used in computing net income per diluted share is estimated to be 66 million.

Capital expenditures for the first quarter of fiscal 2011 are expected to be in the range of $10 million to $12 million. Please refer to the non-GAAP financial information section and the reconciliation of non-GAAP financial measures table in our earnings press release for further detail.

That concludes my remarks. Operator, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. (Operator instructions) The first question is from the line of Jim Suva with Citi. Please go ahead.

Jim Suva – Citigroup

Thank you, and congratulations gentlemen, and your profitability is very impressive.

Iain MacKenzie

Thank you.

Jim Suva – Citigroup

can you give us a couple of items here, one is a clarification on what type of DRAM ASPs you are kind of basing your guidance on, because there is a lot of debate out there about kind of where DRAM pricing should go, and as you did give some guidance on sales we want to see what is built into that. And the second item, in your press release you talked about that you are going to plan to further accelerate some R&D activity, I would assume that means that there is going to be some more R&D hiring, or higher R&D expenses, can you may be give us some guidance on that line-item? Thank you and congratulations.

Barry Zwarenstein

Thanks Jim. DRAM ASP, in the quarter itself, then of course, the Brazil business is more susceptible to. So, the desktop PC business about 12% to 15% in Brazil and certainly go forward US, and we are seeing 15% to 20% reduction in this quarter, and much of which as Brazil is a little bit advanced, we are already seeing. So, the rest of the business, as you know, not too impacted by the standard parts.

So, specialty, legacy are not particularly impacted by ASP decline. On the R&D, yes as well as the IP R&D charge then, within this quarter itself, then we will see over $2 million worth of both labor cost, but also in addition we are spending money on NRE and technology application on core, on amassing all of the pieces for us to bring our native SAS product to market later in the year.

Jim Suva – Citigroup

Okay. So just to clarify for the R&D part at about $2 million for the next quarter, and should we expect that to continue at that steady rate or maybe add a little bit more in the next quarter?

Barry Zwarenstein

I think, yes, certainly it is just over $2 million, which is kind of $0.04 or so into this Q1, and we think perhaps somewhere about $1 million per quarter thereafter. So, a little bit less accelerated.

Jim Suva – Citigroup

Okay. Last question from me, when should we then expect to see these additional workers translate into revenues, is there like a trailing 3 to 6 month benefit from the cost to recognize into sales?

Barry Zwarenstein

So, I would say the R&D costs are actually in design creation and product creation. So it doesn’t really have that – it is a planned release of SATA product, 2.5 inch SAS product, then the 6 gigabit product and then onto the 12. So, really it is our investment in R&D, just trying to accelerate that and the time is now, and to maximize our product development in the next year.

Jim Suva – Citigroup

Thank you and congratulations again gentlemen.

Barry Zwarenstein

Thanks, Jim.

Iain MacKenzie

Thanks.

Operator

The next question is from the line of Kevin Cassidy with Stifel Nicolaus.

Kevin Cassidy – Stifel Nicolaus

Thanks for taking my questions. Congratulations on great results.

Iain MacKenzie

Thank you.

Kevin Cassidy – Stifel Nicolaus

I’m wondering with the prices coming down in DRAMs, are you seeing content in PCs increasingly maybe just say what the dynamics are with that?

Iain MacKenzie

Yes, so again with focus – it is a bit conflicted because it is the Brazil business. So, we have Brazil units growing, we have Brazil growing – I saw a recent article at some 20% in the emerging countries. So the PC demand is growing, and now with the prices going down then we have come off of that despecking into – being able to put in a little bit more content. So we have been able to offset [ph] the effect of the DRAM pricing by increasing the number of units, because we did put in that capacity. So, we have had to grow units significantly to offset the declines, but a few – so, more units whether it be in more content or in more demand.

Kevin Cassidy – Stifel Nicolaus

Okay. And maybe in the past quarters you have said what percentage of revenue was DRAM, I wonder if you could split that out?

Iain MacKenzie

Yes, in total it is 84% for this quarter, which includes Brazil and our specialty DRAM.

Kevin Cassidy – Stifel Nicolaus

And for the outlook, how much I guess, how much flash would be built into that number?

Barry Zwarenstein

No, this will be steady as those moves. So over – I think it was 15% last year, and 16% this quarter. So, that is about the right area for Q1.

Kevin Cassidy – Stifel Nicolaus

Okay. And maybe just one other around the flash, you still think the SATA drive will be the first to ramp into production?

Iain MacKenzie

Yes, that is correct. In particular, the 1.8 inch SATA drive and the 2.5 inch is in qualification right behind this.

Kevin Cassidy – Stifel Nicolaus

Okay, great. Thanks again.

Iain MacKenzie

Thanks, Kevin.

Operator

The next question is from the line of Tim Luke with Barclays Capital. Please go ahead.

Tim Luke – Barclays Capital

Thanks so much. Iain, I was wondering if you could give some color on how you see the mix developing between the segments of PC, networking, server, going forward. Obviously, it seemed like HP was strong this quarter, but that is Brazil. Any color going forward how you see the PC segment, and then more broadly having seen memory price become lower, what is your expectation now for where that may trend, do you expect it to remain – to continue softening through until the calendar second quarter. Thank you so much.

Iain MacKenzie

Thanks Tim. With the mix in our end market, actually with the significant growth with us adding the capital into Brazil, actually the margin between desktop and PC accelerating faster than our other pieces of business and trending towards 50% of our business, especially as we have the product traction to gain in storage. And I think the rest of our business has shown just very good, robust demand.

So as far as DRAM prices, we are forecasting 15% down this quarter. I think, yes, that does continue right through until April refresh time. That is what we have planned into our numbers, and increasing our unit. And then second half of next year, probably a little bit more of supply and demand balance.

Tim Luke – Barclays Capital

Could you just give some color as well, it sounds like you have flat inventory, how do you see the inventory levels generally in the memory arena, and also could you give some color on the factors that may be influencing your gross margin? Thanks.

Iain MacKenzie

So, on the inventory – I mean, inventory should go up. We are forecasting increased revenue, increased cost of sales, inventory should go up. The good news is as we have had the last two quarters 15 tons. It is going to be fairly difficult to hold on to 15 tons as the storage business really develops because I would imagine the tons in there as we order those parts in advance et cetera. And in terms of sales, should be in the single digit.

So I would think inventory and obviously it fluctuates at the end of the quarter with how much logistics inventory is in place, which we don’t have any liabilities, or limited liabilities for. So inventories in our business in the core specialty DRAM business, and most of it is legacy parts and new parts. So, I’m not too sure what a good indicator for inventory, but we should see an increase.

And the second part on gross margins, you have seen our gross margins sitting in this 22.7%, 22.9% range. Our guidance, the midpoint is somewhere around about 22%, the top end is 23%. So this has obviously expanded slightly probably a year ago we were reporting at the 20% level. So it is clearly expanding as we develop the new products and the value add. Now with the DRAM pricing going down in Brazil, then one would expect that the margin percentage would actually increase slightly.

Tim Luke – Barclays Capital

Great. Thank you so much.

Iain MacKenzie

Thanks.

Operator

The next question is from the line of Krishna Shankar with ThinkEquity. Please go ahead.

Krishna Shankar – ThinkEquity

Yes, congratulations on a nice quarter, can you give us some sense for the ramp of the consumer flash business in Brazil which is the enterprise SSD business, and collectively what could this represent as a percent of revenues in fiscal 2011?

Iain MacKenzie

So, for the consumer flash in Brazil, not being in too much focus – I think we spoke last quarter by putting in a capacity of about $50 million to $75 million annualized. It is very, very dependent upon density. So the 2 gigabit end product levels and that would be more towards the 75, but with more migration towards 4 gigabit parts, it will be more towards the $50 million. So, $50 million run rate by Q4 would really infer a $12.5 million exit rate of Q4. It really is qualification and enabling year for Brazil flash, and really it is something that is exciting for the future, but it takes a year to introduce, develop, build up the product portfolio, because customers really want us to have 2, 4, 8, and 16 gigabit products, and a full product of micro SD and SD cards before getting a real launch. But it was great to get our first qualification part through.

Krishna Shankar – ThinkEquity

And SSD, can you give us a sense for how that revenue might ramp through the year?

Iain MacKenzie

So, SSD, we continually struggle to say what it is going to be. I think, I read all sorts of different reports, the $1.6 billion NAS market really I think is dangerous to take – in the enterprise space; I think it is very dangerous to take a snapshot. We have a 1.8 inch SATA product. We will have a 2.5 inch SATA product. We will have a 2.5 inch SAS product. We will have 3 gigabits move into 6 gigabit per second within our fiscal 2011. And if all those products are positioned correctly and are built to order, then we will be able to sell as many as the capacity of the customer. Sorry, I know it is a non-answer but we cannot foreshadow something that isn’t there.

Krishna Shankar – ThinkEquity

Great, and my final question, can you give us a little more color on the $7.5 million one-time sort of technology license charge in Q1?

Iain MacKenzie

Yes, certainly. We were developing our product, as I said, and still are moving forward with the native product. So, really it takes technology that has already been developed out there in the marketplace. It takes existing reference codes, cores, perhaps some SATA interface technologies, and it buys access to be able to use that. Then what happens is we will be able to add our firmware creation and the code that we developed in Phoenix from our Adtron acquisition. We will take all of that to create our own unique controller for the future on top of the hardware. So, it buys access to existing technologies that will accelerate our creation of a unique control for native SATA.

Krishna Shankar – ThinkEquity

Great. Thank you.

Iain MacKenzie

Thanks.

Operator

The next question is from the line of Alex Kurtz with Merriman & Company. Please go ahead.

Alex Kurtz – Merriman & Company

Yes, thanks for taking the question. Just to lead off, Iain, if you look at the pipeline of the OEMs you are looking at on the solid state drive side and the enterprise side, did that number of qualifications grow quarter-over-quarter or is it roughly about the same?

Iain MacKenzie

And resulting qualification is roughly about the same in engagements, interest, samples, wider and deepened and widened. And now, as we said, in that call there, more products and more divisions of the OEMs. So, I think, I wrongly classified an OEM as one entity before, whereas now it has become obvious that we need to repeat that sale into multiple divisions, which is pretty exciting really.

Alex Kurtz – Merriman & Company

So, would you say during the quarter your view about the opportunity of that OEM has expanded as far as dollar potential in fiscal 2011?

Iain MacKenzie

Yes, it has definitely expanded and a little bit more confidence because we are seeing the products going into thousands of parts, and achieving that limited usage shipment which is critical in getting towards the final release.

Alex Kurtz – Merriman & Company

Would you want to take a stab at when you might see initial revenue from that OEM?

Iain MacKenzie

We are seeing revenue now. I mean there are already paying for the product now. No, it is very difficult to say. When it goes from limited use into clear commercial status, then I guess that will be another highlight point.

Alex Kurtz – Merriman & Company

And is the expectation right now that that is probably calendar Q1 type period where that could start to reach volume with them?

Iain MacKenzie

I would like to be – get that clearance within the balance of this calendar year, and then we don’t know what volume means now as against traction. But I would like to be in the clear somewhere the first part of qualification that happens, and the just have the part on the shelf, waiting for them to be pooled into end customer end system. I think the customer system will want some volume this year.

Alex Kurtz – Merriman & Company

Okay and just the transition of the Brazil real quick, obviously a very strong quarter there, the government is doing a lot of programs to drive demand there. Is there any seasonality or upcoming sort of pockets of weakness just because of sort of that market down there that we should be aware of? Is there anything coming up that either on the upside or downside we should be thinking about which is already in that market?

Iain MacKenzie

Yes, definitely. On this season that we are in right now, so for this quarter, with DRAM prices going down, we are increasing units. So it is kind of a confusing picture for SMART. We can certainly hold flat and grow somewhat because of the capacity expansion that we did in the last quarter. So that capital is coming online. In Q2, for our Brazil business, our fiscal Q2 is seasonally weak. We typically can hit the front end of carnival and hit the Christmas season in Brazil. And then Q3 becomes I think Brazil’s weakest quarter before building up again Q4 and Q1.

So Brazil has a particular profile, but we are changing that as you watch the technology migrations and the unit migrations, and the density migrations, which is actually catching up very quickly in Brazil to somewhere over – we are already over 3 gigabit per system of module content per PC.

Alex Kurtz – Merriman & Company

Okay, thanks Iain, and just to finish off real quick, could you break out the stock based comp by the COGS and the two OpEx lines, and also maybe take a stab at what – as you think about the non-GAAP tax rate for the rest of the year if possible?

Barry Zwarenstein

Absolutely. So I will give you the breakout both for Q4 ’10 and Q1 ’11. For Q4 ’10, COGS of 1.8 million was rounded to $200,000, R&D $300,000, SG&A $1.3 million. For Q1, the $2.2 million that we have included in our guidance is COGS $200,000, R&D $400,000, and SG&A $1.6 million with total of $2.2 million.

With respect to the tax rate Alex, the non-GAAP tax rate for this past quarter was 31%, and we would see it for each of four quarters in fiscal 2011 to be in the low 30s. With respect to the GAAP tax rate, Q1 will be an anomaly because that 7.5 million technology access charge has no tax benefit, but does have reduction in the GAAP pre-tax income. So you could see a GAAP tax rate in the first quarter in the order of 50% or so. For the rest of the year for the GAAP tax rate it will be in the mid-30s, may be a bit higher than that.

Alex Kurtz – Merriman & Company

And just to clarify what I think Iain said earlier, R&D is to go up about $2 million in Q1, is that $1 million incremental from there out?

Barry Zwarenstein

Yes, a little over $2 million in Q1 in fact. And then, maybe another million or so in Q2 and then, moderating after that.

Alex Kurtz – Merriman & Company

All right. Thank you, guys.

Iain MacKenzie

Okay.

Operator

(Operator instructions) The next question is from the line of Rich Kugele from Needham & Company. Please go ahead.

Rich Kugele – Needham & Company

Thank you. Good afternoon. Can you hear me all right?

Iain MacKenzie

Yes, thanks Rich.

Rich Kugele – Needham & Company

Hi, so just a few questions from me, I guess first I want to get into this technology license a little deeper, so this is not necessarily next generation technology, this is more existing interfaces that you plan on integrating into your own controller technology for the next gen product?

Iain MacKenzie

That is absolutely correct.

Rich Kugele – Needham & Company

So you have…

Iain MacKenzie

We have development required to finish that product and put it into our product, migrating and mixing existing technologies with the controller technology that we have proven from our Phoenix operation.

Rich Kugele – Needham & Company

Why from an accounting standpoint would it not just follow with units going forward, why expense it all at once?

Iain MacKenzie

The accounting that we have been through says that this is predeveloped capabilities that preexists that we’re getting access to. So there is actually some completion cost, and our redevelopment costs to finish our controller, which is the increased R&D that you see going through the future. So we will spend cost to complete and certainly expands until the product comes to market, but this is in process R&D that has already been developed, and therefore it is seen as an access to it, and has already been spent.

Rich Kugele – Needham & Company

Okay, and then just as a follow on to that, are you willing or you feel it is necessary to make further technology driven acquisition or technology licenses to accelerate this even faster?

Iain MacKenzie

At this point in time, we don’t see one as large as that. So that is why it's a stand out. The rest will be in the development cost, but yes there are small pieces of technology, access to technology or joint partnerships we would take through the silicon level to do perhaps mask layers, et cetera, and changes that will be part of our ongoing R&D expenditure. So there are a few more smaller ones.

Rich Kugele – Needham & Company

Okay. And then, one last question before I get into very favorite topic, taxes, I want to talk about the OEM that is pulling the SSD today, some of your smaller competitors on the private side for example have had difficulties, where they sit in their – spooling, spooling, waiting to get real volumes units and then the customer says, you know what, I really like your next gen. Do you think that we actually get to ramp the 3 gig version before the demand environment shifts to 6?

Iain MacKenzie

Well, we are not too sure about that. We have all of them in sequence and going through the qual cycles and stages. It would appear that the 6 gigabit per second doesn’t matter to some of the applications, it doesn’t matter at all. So in some applications it is all IOPS, it is all transactional processing power. In other applications, really sensitive to power rate, so actually throttle the power back.

So, I think there is room for all, Rich, and it doesn't all need to move to the latest technology immediately. And we certainly have a decent road map and pipeline to satisfy the customer, and it would appear that each different division and application have picks on different ones. So, there are some today that cannot use the current offering of 1.8 inch SATA, and they will be on the pipeline for the 2.5 inch SATA. And each of them have a place to play, but I think there is definitely use for the current ones for longer than you would think.

Rich Kugele – Needham & Company

Okay. Just one last question then on the tax situation in Brazil, Barry, any update on being able to make some progress on lowering the overall rate, what is the status there and the government situation?

Barry Zwarenstein

Things, Rich, are continuing on track and we are optimistic about being able to lower our tax rate in the not too distant future. We are waiting on some additional steps, and we look forward to updating you soon.

Rich Kugele – Needham & Company

Okay. Thank you very much.

Iain MacKenzie

Thanks Rich.

Operator

The next question is from the line of Gary Hsueh with Oppenheimer. Please go ahead.

Adam – Oppenheimer & Company

Hi guys. This is Adam [ph] for Gary. A couple of quick questions, you guys may be kind of see any kind of share shift into SMART products from Oracle, kind of all you have lost to especially Micron?

Iain MacKenzie

Sorry Gary, not too sure quite – Adam, sorry. Not too sure of what you mean, can you just say a little bit more?

Adam – Oppenheimer & Company

We could just take it offline, it is no worries, just a couple of quick ones, I think I missed your guidance on outside of Q1 the tax rate?

Barry Zwarenstein

So, outside of Q1 Adam for the balance of the year, the non-GAAP rate would be somewhere in the low 30s, and the GAAP rate would be in the mid to high 30s.

Adam – Oppenheimer & Company

Okay, great. Thanks.

Operator

We do have a follow-up question from the line of Kevin Cassidy with Stifel Nicolaus. Please go ahead.

Kevin Cassidy – Stifel Nicolaus

Hi, thanks for taking my follow-up, in your guidance, the telecom and datacom, the networking business, are you seeing any weakness there based on Cisco’s comments on uncertainty, I just want to know what you are seeing in the end market.

Iain MacKenzie

Absolutely not. Good ongoing demand, good profile, good demand profile, and no reason. As you see, we’ve given guidance at increased revenue and you know good GP. So, no, it is looking good from here.

Kevin Cassidy – Stifel Nicolaus

Okay, great. Thanks.

Iain MacKenzie

Thanks, Kevin.

Operator

And Mr. MacKenzie, I’m showing that there are no further questions at this time, I will turn it back over to you for any closing remarks.

Iain MacKenzie

Thank you, operator. To conclude, this quarter has been an excellent finish to a very good year, and it marks a turning point for SMART, demonstrated ongoing improvement in financial performance, set the stage for continued success, and with our growth initiative, our emerging business in solid state storage, our solid foundation in Brazil, and the excellent performance of our specialty memory business leave us well positioned to start up this next new year.

As always, we maintain our position of disciplined focus on execution. We are optimistic about SMART’s future. I appreciate your interest and support. I also like to thank our customers, our suppliers. We are grateful to the hard work and dedication of all of our employees around the world, and for their contribution in this past year and going forward. So thank you for your participation in today’s call and we look forward to seeing many of you at our Analyst Day in New York on October 12. Thanks very much.

Operator

Ladies and gentlemen, this concludes the conference call. If you would like to listen to a replay of today's conference please dial 1-800-406-7325 or 303-590-3030 and entering in the access code of 436-4370. ACT would like to thank you for your participation. You may now disconnect.

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