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

F1Q2011 Earnings Call Transcript

December 16, 2010 4:30 pm ET

Executives

Suzanne Craig – IR, The Blueshirt Group

Iain MacKenzie – President and CEO

Barry Zwarenstein – SVP and CFO

Analysts

Jim Suva – Citigroup

Gary Hsueh – Oppenheimer & Company

Tim Luke – Barclays Capital

Betsy Van Hees – Wedbush Securities

Alex Kurtz – Merriman Capital

Rich Kugele – Needham & Company

Neil Mehta – Stifel Nicolaus

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the SMART Modular Technologies first quarter fiscal 2011 conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions)

This conference is being recorded today, Thursday, December 16, 2010. And I would now like to turn the conference over to Suzanne Craig, with Investor Relations. Please go ahead, ma'am.

Suzanne Craig

Thank you, operator and thank you to everyone for joining us on today's earnings conference call to discuss SMART Modular Technologies first quarter fiscal 2011 financial results.

Iain MacKenzie, President and CEO will begin the call with a discussion of market and business development, followed by Barry Zwarenstein, Senior Vice President and Chief Financial Officer, who will review the financial results in more detail and provide the forward guidance. We will then open the call to your questions.

Before we begin, I'd like to make the following Safe Harbor statement. 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 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934. Should you review management – you should review management's discussion and analysis and related risk factors affecting future results contained in the forms and reports filed with the Securities and Exchange Commission, including the company's recently filed annual report on Form 10-K for fiscal year 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 first quarter fiscal 2011 earnings press release is available on the company's website at smartm.com or you may call our Investor Relations office at 415-217-7722 and we will fax you a copy.

Please note that non-GAAP financial results presented excludes stock-based compensation expense, the technology access charge and other infrequent or unusual items. Please refer to the non-GAAP information section of 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 303-590-3030 and using the pass code 4390981. And lastly, SMART will be presenting at the Needham Growth Conference in New York City on January 11th.

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

Iain MacKenzie

Thank you, Suzanne, and welcome to everyone on the call. In the first quarter of fiscal 2011 net sales totaled $216.4 million, non-GAAP gross profit totaled $44.2 million and non-GAAP diluted earnings per share totaled $0.27. We’re pleased with these results given the significant DRAM pricing declines in the latter part of our quarter and weaker end user demand from multinationals.

Compared with year ago period net sales grew by 76%, non-GAAP gross profit increased by 53% and non-GAAP earnings per share increased by over 200%. I will start with a discussion with review of our business in Brazil.

As a reminder, the financial results for Brazil subsidiary are included in one month lag in the fiscal quarters. During Brazil first two months obvious in September, prices from mainstream DDR3 1 gigabit pars declined by 2% and 12%, respectively, according to DRAM exchange.

In October, the third month of the quarter for Brazil places decline by another 14% for a cumulative quarterly decline of 26%. Despite an increase in module capacity in excess of 20%, this greater than anticipated DRAM price declines compressed gross profits in Brazil slightly, because module prices typically just faster than our inventory and working process turnaround time of approximately six weeks.

Since the end of October, however, the rate of DRAM price declines has increased with prices declining by another 24% in November alone and continue to decline rapidly so far in December.

While demand in Brazil remains robust, we are currently evaluating our capacity to address the sizable and sustain DRAM price reduction as well as the implication of upcoming technology transitions with a consequent pressure on revenue and margins in the country. This is reflected in our guidance for second fiscal quarter which Barry will present shortly.

With respect to flash products in Brazil we are now qualified by two customers and as planned we’re seeing initial sales of these consumer products, while continuing to expand our product lines and as a result, we are seeing more interest from local customers.

In addition, our plans to establish a corporate R&D Center in Brazil in the second half of the fiscal year are on target and look forward to significant long-term returns from deeper rather penetration into this vibrant market and as a result of this investment.

With regard to specialty memory business, all the new products that we highlighted last quarter, including the FlashBack DDR3 DRAM Cache product line for rate systems remain on track in terms of qualifications and projected production RAM.

Specifically, we continue to deliver our 8 and 16 gigabyte VLP DDR3 CoolFlex backlog and DDR3 Non-volatile DIMM is also progressing and customer systems integration activity. We have completed our system level verification of two performance of our 16 gigabyte LRDIMM that we mentioned at Analyst Day in October.

This product utilizes a cost effective BGA stacking technology. Our 32, 64 gigabyte LRDIMM design is also progressing well, we expect to have working hardware in calendar Q1 of 2011.

As we have discussed in the past, our specialty memory business is largely insulated from mainstream DRAM price collapses and we buy DRAM at market at value and sell them all our specialty modules. This portion of our business is therefore driven more by unit demand.

However, DRAM price collapses due to secondary impact of causing customers to reduce inventory and sell purchases as way for lower prices. Thus demand appears to be slightly softer than we would anticipate due to combination of seasonal factors and expectation of continuing near time pricing decline.

Now our solid-state storage starting with enterprise. We have some exciting development. You’ll recall that last quarter we mentioned that the 1.8-inch XceedLite to enterprise SATA drive was qualified in shipping in limited release.

In addition, last month we notched up another major design win at IBM in Power7 Supercomputing group selected the 2.5-inch XceedIOPS enterprise fast drive and displayed this at the SC10 show in November. This further reinforces the value proposition created by a combination of performance, price for liability and endurance that XceedIOPS SSDs bring to emerging new class of application platforms.

I'm also pleased that as a result, the 2.5-inch XceedIOPS Enterprise Flash drive has been attracting increase interest from number of other Tier 1 OEM’s and several Tier 2 OEMs. We see this as clear evidence that SMART product are sought after by the most demanding customers and applications in the world.

Attribute SMART growing success to an instinct understanding of the stringent requirements and expectation of the enterprise storage end market we believe provides SMART with competitive advantage over other SSD companies.

With respect to defense business, we mentioned last quarter that we plan to leverage the momentum of our XceedIOPS product line with ruggedized versions for defense and industrial space. We are pleased to report that the resulting Xcel-100 product announced in October is attracting significant interest. This product leverages the best element of SMART’s broad capabilities combining enterprise level performance with more durable components and packaging.

Additionally, this SSD is uniquely suited for the wide range of defense applications including data recording, moving maps and portable computing. We anticipate that in due course the Xcel-100 will replace the Xcel-10 which is winding down with the end of major defense program that we announced several quarters ago.

And also as we reported last quarter embedded storage business reached a new record level of sales in fiscal 2010. We continue to see a growing number of customers qualifying new embedded SATA SSD and Xceed iSATA products. Additionally, we believe standardization will help fuel the growth of these products with major OEM's.

Overall, we look forward to this business as an increasing contributor to overall revenues as we broaden and deepen engagements for top tier customers.

I’ll now turn the call over to Barry for a discussion of the financial results.

Barry Zwarenstein

Thank you, Iain. First quarter fiscal 2011 net sales of $216.4 million were broken out by geography as follows, Brazil 35%, U.S. 20%, Asia 17%, other Americas 5%, Europe 3%.

Our breakdown of net sales by end market for the first quarter was as follows, PC 30%, network and telecom 19%, service 14%, storage 8%, logistics 5%, industrial and other 4%. Another breakdown of our net sales is as follows, Brazil 55%, specialty memory outside of Brazil 33%, storage 12%.

Compared to the fourth quarter fiscal 2010, PC related sales grew by 10% in the first quarter. All other categories by end market declined slightly quarter-over-quarter, as far our top customer’s, HP represented 21% of net sales this quarter, Dell represented 16% and Cisco 14%. All essentially unchanged from last quarter.

Moving to the rest of the income statement, which I will first discuss on a non-GAAP basis, gross profit for the first quarter was $44.2 million, down approximately 11% from last quarter $50 million. As Iain mentioned, this lower gross profit was largely the result of the decline in DRAM prices and somewhat weaker end user demand in specialty memory business.

On a percentage basis, non-GAAP gross profit was 20.5% of sales, compared to 22.9% last quarter and 23.5% a year ago. Our first quarter non-GAAP operating expenses totaled $21.1 million versus $22 million in the prior quarter.

Non-GAAP R&D expenses increased to $7.8 million in the first quarter versus $7.2 million in the prior quarter, due to the continued investment in enterprise SSD. Non-GAAP SG&A expenses totaled $3.3 million, down 10% from the $14.8 million in the previous quarter, primarily due to lower bonus expenses.

Non-GAAP net income for the first quarter of 2011 was $17.6 million or $0.27 per diluted share, compared to $18.8 million or $0.29 per diluted share for the fourth quarter of fiscal 2010, and $5.4 million or $0.08 per diluted share for the first quarter of 2010.

Excluded from the non-GAAP net income in the first quarter of 2011 was stock-based compensation of $2.1 million and $7.5 million of expense related to the technology access charge, as you’ll recall, last quarter we indicated that we expected to incur this one-time charge to gain access to technology in order to accelerate our development of enterprise solid-state drive.

On a GAAP basis net income for the first quarter of 2011 was $8 million or $0.12 per diluted share, compared to $17 million or $0.26 per diluted share for the prior quarter and $4.6 million or $0.07 per diluted share for the first quarter year ago.

Adjusted EBITDA totaled $29.6 million in the first quarter, compared to $33.2 million in the prior quarter and $15 million in the first quarter a year ago.

Turning to working capital, our net accounts receivable decreased to $179 million from $208 million last quarter, as our day sales outstanding came down to 37 days this quarter compared to 40 days in the prior quarter.

Inventory declined to $103 million from $112 million in the prior quarter and turns of 15.5 times essentially flat with last quarter 15.2 times. Approximately 41% of our first quarter inventory was in support of our logistics business, the same percentage as last quarter, as it pointed out in the past, it is important to remember that we have limited exposure to price fluctuation for logistics inventory.

Consistent with past practice, accounts receivable and inventory turnover are calculated on a growth, sales and cost of goods sold basis which totaled $44.5 million or $401 million respectively for the first fist of 2011.

Cash and cash equivalents totaled $90 million at the end of the quarter, down from $115 million last quarter. First quarter cash flow from operations was negative $16.2 million, compared with a positive $18.3 million in the prior quarter. While we generated $16.9 million in cash flow from the income statement components of the operating cash flow, we had a $33.1 million increase in working capital. For the first quarter of 2011, we spent $7.9 million on CapEx.

And now let me turn to our guidance. Given the combination of the substantial DRAM price declines that have already occurred, the anticipation of the additional declines and seasonality, smart estimates that second quarter fiscal 2011 net sales will be in the range of $165 million to $185 million.

We expect gross profit to be in the range of $31 million to $34 million. As a result, net income on a GAAP basis is estimated to be in the range of $0.06 to $0.08 per diluted share. On a non-GAAP basis, excluding stock-based compensation expense, we expect non-GAAP net income to be in the range of $0.09 to $0.11 per delude share.

The guidance for the second quarter includes an income tax provision expected to be in the range of $3.4 million to $3.7 million. Number of shares used in computing net income per diluted share is estimated to be $66 million. Capital expenditures for the second quarter, I expect it to be in the range of $7 million to $10 million and to range from $28 million to $32 million for the full year 2011.

Please refer to the non-GAAP financial information section and the reconciliation on 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. We will now begin the question-and-answer session. (Operator Instructions) Our fist question comes from the line of Jim Suva with Citigroup. Please go ahead.

Jim Suva – Citigroup

Thank you and congratulations, gentlemen on your results. Hey, quick question, when we look at DRAM pricing which has declined most recently and compare that to your outlook, which I know you said you are building in additional price declines, can you let us know so we can gauge what type of price declines you are expected to see, then I probably have a follow up?

Iain MacKenzie

Hi, Jim. Thanks. In the call there, we had given the declining numbers for November and then December so far was to be about further 12%. So with 26% in November and perhaps greater than 10%, then I think that 40% is a good number for this quarter for Q2.

Jim Suva – Citigroup

Great. And then as we think about that, can you let us know about when it starts to be a severe decline, what point does it start to impact your gross profit value add because typically one would always expect DRAM prices to decline over time?

Iain MacKenzie

So we give guidance, Jim, let say, 5% per month would be what we are planning on for 15% to 20% for the quarter. And at that level, then quarterly, we are purchasing as we mentioned the specialty memory and we’re purchasing the parts we are adding the value and we’re selling it at that purchase plus value. Really, 50% or 55% in this quarter's case in Brazil PC, with the six week offset from purchasing to selling really is quite impact.

So we had planned the last quarter and achieved the $0.27 based on 15% reduction. But also we did increase their capacity significantly last quarter by more than 20% to offset this reduction. So I think once it is over 15%, then you begin to get this impact of gross – profit gross margin.

Jim Suva – Citigroup

Great. Thank you very much and congratulations to you and your team and thanks for all the details

Iain MacKenzie

Thanks.

Operator

Thank you. Our next question comes from the line of Gary Hsueh with Oppenheimer & Company. Please go ahead.

Gary Hsueh – Oppenheimer & Company

Great. Thank you for taking my questions. Iain, just a few more questions about the DRAM business relative to the six week turnaround time, I guess that's what was the performance in November quarter going forward to the February quarter, do you see that turnaround time six weeks changing at all and given where DRAM pricing is on the spot market at least at this time, do you foresee or is there any strategy on Smart Modular part in terms of buying up a little bit more inventory?

Iain MacKenzie

So we’re looking at the most recent reports taken that area first then certainly looking at Deutsche Bank, Barclays and certainly the Citi reports most recently. They’re also still destined towards $1.10 and $1 respectively in the reports towards the end of calendar Q1. So not planning – we never really speculate on purchases. All we needed to carry – we needed to stabilize. So we needed to stop reducing significantly.

So once it gets to $1.10, $1, then the gross margin percentages will recover and the model recovers, it’s purely the fact that we buy the parts very early coming in to customs in Brazil to offset any potential foreign exchange losses and gains. And then we have the assembling test packaging in this case and then additionally modules and additionally, we have some finished goods stock and safety stock and logistic stock for the customers.

So that whole cycle be in six weeks when you buy at something like a price of $1.79 and then you are selling at $1.32, $1.10 is where the material cost of sales becomes a higher portion of the revenue.

Gary Hsueh – Oppenheimer & Company

I guess just around a six week turnaround time, do you see that number stretching out in the February quarter?

Iain MacKenzie

We do not. There are no actions in place to reduce that for the February quarter.

Gary Hsueh – Oppenheimer & Company

Okay. And second question just on the NAND Flash business in Brazil, could you help characterize the qualifications that you announced that two qualifications that you announced. Where it lies in terms of retail channel or the OEM channel or the carrier channel and just to kind of level set our expectations on what the Brazil NAND business is. I think you might have given some numbers around that but what it is today and what the expectations are for 2011?

Iain MacKenzie

Yeah. Definitely had to start off with 2011 is a very formative year and from a profitability point of view and we suddenly said the business are not have a planned or heavy contribution to the total bottom line of the company. Where we are right now is got the qualifications in two customers, where the product is really an OEM product but it’s an add-on and going through the retail channel, what apart those, it's almost like bundled with a shelf-type product.

So it's going through the retail industry but qualified with the OEM. The next move and probably we have not announced the win yet is in the cell phone providers and in country, where we also expect it to be a bundled product but in this case bundled product inside the box with the cell phone as opposed to being an add-on product. If you were to buy digital still camera, you maybe get package of smart package Micro SD or an SSD adapter with it that would be the current sales.

Gary Hsueh – Oppenheimer & Company

Okay. And Iain, just last question, I would have thought we would have seen at least a little bit more volume penetration or traction with the NAND business in Brazil this year, might have been my misunderstanding, but at the margin might have pushed that out and how are you going to overcome that sort of hurdle again in 2011?

Iain MacKenzie

Certainly, the NAND business is very formative for us. These are in particular these are all new customers. So it leverages our memory skills capability, supply chain and our finances within the country and our unique position within the country. But these are new customers, new customer calls and this qualifications typically happen out with in major European headquarters exactly and example and U.S. headquarters.

I think that call cycle takes a good six to nine months sometime a year. So this is progressing as planned tens of thousands shipped last quarter, perhaps shipping over 100,000 units this quarter and given good traction.

Gary Hsueh – Oppenheimer & Company

Okay. Great. Thank you.

Iain MacKenzie

Thanks, Gary.

Operator

Thank you. Our next question comes from the line of Tim Luke of Barclays Capital. Please go ahead.

Tim Luke – Barclays Capital

Thanks very much. Iain, Look forward through calendar 2011, what are you guys planning or assuming with respect to the arc [ph] of DRAM pricing what for the time lines you think it might begin to stabilize and then what do you think happens when you get to the middle over there second half of 2011.

And secondly, as you mentioned couple of customers developing on the solid state side, do you have any feel for what you feel is the real differentiation that you are offering customers. Can you just highlight that and talk a little bit about how you see the competitive environment emerge going forward? Thank you.

Iain MacKenzie

Thanks Tim. On the DRAM pricing density increased, I think your report is a place to follow. So $1.10, $1 perhaps in our April time scale, nice balancing through in to the second half we look – still look at some 40% particularly in Brazil for the DDR3 1 Gigabit part or mainstream part actually has more of a play than we are looking at 40% density increase looking at the introduction of the two Gigabit part, which at this one time, quickly gone slightly below parity of the two times the one Gigabit parts.

The last number, I sell, was 1.73 times. So we see a good density shift and clearly we’re seeing some more content requests already as we dip below the 6% PC content and start to add more parts so that density may well accelerate with some units. So we have this technology transition along with the capacity, along with the demand which doesn't really follow the same pattern but clearly the pricing does. So does that answer the DRAM question, Tim?

Tim Luke – Barclays Capital

Yeah.

Iain MacKenzie

So cell storage, clearly, the differentiation is that we create hundreds of millions of gross revenue dollars with this customer base today. We are well known to them. They understand smart-sized scale infrastructure contacts at every level. The product we are putting in to the market, we take all of these known technologies. We have a unique firmware, yet we take a Stanforth and Emulex when we put that together and meet the requirements of the customer.

We have a road map that shows even further specialization, with that IP R&D that shows we are taking known technology and putting that to use to develop our own system. We have proven our own controller to be successful and to work and we’re integrating it in. So I think the competitive differentiation is what a company of size and scale and existing relations, we’ve hired the experienced team in the enterprise storage world and now, we are creating product differentiated personally on firmware and application and then secondly on hardware based to become to make it a unique product offering to each and every customer.

Tim Luke – Barclays Capital

Excellent. Thanks so much.

Iain MacKenzie

Thanks, Tim.

Operator

Thank you. And our next question comes from the line of Betsy Van Hees with Wedbush Securities. Please go ahead.

Betsy Van Hees – Wedbush Securities

Good afternoon. Thanks for taking my question. You commented on several items that were impacting the guidance that you gave. And if we can take out the DRAM pricing trends and look at what’s happening with seasonality, is seasonality in line with expectations or are you seeing a greater than seasonal quarter than you normally do in the February quarter?

Iain MacKenzie

Seasonality for Q2 is normal. So less than 10% to 15% down. But on top of that Betsy, we mention seeing a softening of demand. So an additive, all the prices are going down and presently paying $1.20 and about to pay $1.10, then all of the inventory is getting driven out of the system. And people are leaving their decision until the last possible moment. So I would say that orders have been deferred at this moment in time expecting – waiting for the prices to bottom.

Betsy Van Hees – Wedbush Securities

Just to make sure I understand what you are talking about, you are talking about the demand, the demand remains, you still have demand but it's just been delayed because your customers are waiting to see what's the best price they will get on DRAM or are you also seeing weakness in demand as well?

Iain MacKenzie

The former is correct. I'm not too sure I would be able to differentiate a true weakness of demand in our customer versus that phenomenon.

Betsy Van Hees – Wedbush Securities

Okay. Thanks Iain. One of the guidance was challenging, I mean important thing is that you guys are remaining profitable and you guided for profitability, what factors could potentially cause you guys to not be profitable, in the worst of times you remained profitable. Is that your expectation that you are going to be able to remain profitability over the next couple of quarters while the DRAM market works itself out?

Iain MacKenzie

All the risk and the lawyers jumping up then with forward-looking statements. It's very tough for me to foresee after 20 years of sustained profitability and as you mentioned through some of the worst times I can't imagine seeing non-profitable times and we’ve made certainly made very, very prudent and timely cost action at previous payments when it's been a sustained in the long-term. So, I can really see it. With some of the storage coming on the Brazil traction, as Brazil stabilizes and the margins come back, you cannot decline at this level to get this material cost of sales impact. So, it means model does return as soon as this stabilizes, so I can't – it's tough to consider how we could go to more profitability.

Betsy Van Hees – Wedbush Securities

Thanks Iain. That was very helpful.

Iain MacKenzie

Thanks, Betsy.

Operator

Thank you. And our next question comes from the line of Alex Kurtz with Merriman Capital. Please go ahead.

Alex Kurtz – Merriman Capital

Yeah. Thanks guys for taking the questions. Before I go into the DRAM market, I want to ask Barry if he has a break out a stock based comp on different line items and maybe you could get that at the end. And Iain, could you take us through your capacity in Brazil, how that relates to your CapEx guidance and where the flexibility and what the algebra is there. If DRAM continues to be under pressure, again, obviously through February, what kind of leverage do you have to pull because it seems like heading into this quarter, you’re sort of maxed out down there, I’m wondering if there is something on the horizon that we can look to a thing as sort of a revenue upside if some additional lines come on.

Iain MacKenzie

Hi. It’s Iain. It's a very topical question right now. So, coming into the question, we had pre-spend some CapEx, made some CapEx commitments and for these further commitments of this, you saw we spent almost $8 million in CapEx in Q1. Most of that was all capacity and really geared towards that greater than 20% that we installed. The rest of the capital that we gave guidance for is, really for the R&D center and the technology transitions around the world and keeping pace. So there is no fund capacity if you like right now in that CapEx statement.

However, the transition happening this year, we had planned by the end of the April for Brazil or may quarter to have perhaps more than 15, 20% of the capacity and the output module have been transitioned to use two gigabyte chips, that in itself gives a density and capacity enhancement. So means that this quarter in the middle of Q2 and start up Q3 until that happens, as and we are once again capacity limited, I'm sure it's an evaluation that we are going through right now, should we add even more capacity but we are encouraging up in to the 40s to 50% market share. I don’t know of a clearer answer, it’s tropical with no more classical funds to spend on capacity; we will get more capacity from the two gigabyte transition which happens before the April timescale.

Barry Zwarenstein

And just to respond on the stock based compensation in OCOGS and cost of goods sold, we have $200,000, in research and development, we have $400,000 and in SG&A, we have $1.5 million for the $2.1 million total.

Alex Kurtz – Merriman Capital

Maybe I missed it; did you break out just basic DRAM versus non-DRAM?

Barry Zwarenstein

Yes. The total between Brazil and the specialty DRAM business outside of Brazil, which are respectively 55% and 33%.

Alex Kurtz – Merriman Capital

Right.

Barry Zwarenstein

Means the remaining 12% for the storage business.

Alex Kurtz – Merriman Capital

Yeah. And last question Iain. Could you give us a window in to the inventory that's working its way through customs in Brazil right now and I guess is there anything that you can do to speed that up over time, is it always going to be a six week lag?

And the stuff that's in there right now, I guess that would have been DRAM for about a month and a half ago where, through the acceleration on the downside hasn't really occurred in DRAM. So, how should we think about that inventory working its way through the P&L for the February quarter?

Iain MacKenzie

We gave the November decline. So, really take this as a Brazil comment and 55% of the business. So, the November decline of 26 point is really the inventory that is going be shipping right now. And then further DRAM decline of over 10% this month. So for this quarter, we are almost at the midpoint for that 58%, is the decline that will ship in the balance of this quarter.

So that is kind of in tune. Now, the parts that we are purchasing now for January shipments are at the lower price and the 10% reduction. We don't see going too much further than the 40%, we mentioned at one of the questions. So that's all built into the guidance that we gave.

Alex Kurtz – Merriman Capital

And just what about sort of shorting that window as the inventory works its way through customs. Is that something that just can't be done?

Iain MacKenzie

The customs portion can be done or will continue to want to, but with that in a variation between 9 and 15 days in the hands of country and its customs, but the subsequent four weeks and customer inventory and customer held inventory, can it be shortened and we will be taking actions in that space.

Alex Kurtz – Merriman Capital

Okay. Thanks, guys.

Iain MacKenzie

Thanks.

Barry Zwarenstein

Thank you.

Operator

Thank you. Our next question comes from the line of Rich Kugele with Needham & Company. Please go ahead.

Rich Kugele – Needham & Company

Thank you. Good afternoon. I just wanted to ask about OpEx and in particular on the R&D side related to SSDs, your ability to flex some of that spend, should DRAM pricing continue to erode at levels it was back in November. Any comments there, Barry?

Barry Zwarenstein

Hi, Rich. We do have the ability to flex to some extent through the bonus portion, the variable compensation, and I just saw coming into play between Q4 and Q1. But our strategy with respect to solid state drives where enterprise is firm and clear, we have a huge market and that requires the things that Iain talked about earlier on including our own controller down the road and that takes money and that's with what we committed to and that’s what we are continuing to spend.

Rich Kugele – Needham & Company

Okay. Then just lastly on the specialty memory side, you talked obviously about the customers waiting in case pricing falls further, traditionally, Iain, can you give us any color on how long before or how ahead of the true bottoming of DRAM pricing? Do you start to see them come back because they must have advanced models in themselves about purchasing? So, any sense, or do they wait until it's stable for a period of time before they buy?

Iain MacKenzie

I think there are a few models there. One is takeout about three weeks of wait time and then people are forced into buying because in many respects, they’ve actually taken the order for larger systems and the memory is getting purchased to either wait as we pull a very short wait time. So, once you takeout that’s give you a figure, forced to have to purchase at that level.

So really it's a matter of orders that they have on the books and how they get pushed out. Most of what you are seeing now is really just that delay within wait time of systems or the customers, customer been delaying a major installation and trying to push that out as the push for renegotiating the prices of what already been created. So, it's a matter of a few weeks. But then as the price bottoms then we will probably see some pickup in volume as people replace that inventory and some people try and take positions on inventory as it turns.

Rich Kugele – Needham & Company

So within that context, would you expect to see a greater than normal seasonality in Q3 fiscal Q3?

Iain MacKenzie

We have the potential to go both ways. I think Q3 will be normalized because the inventory will already have been depleted and will be kind of hand to mouth for parts and if that $1.10, $1 kind of rate is achieved and people are feeling good, will be more macro economic impact at that point rather than smart specific.

Rich Kugele – Needham & Company

Okay. Very helpful. Thank you.

Iain MacKenzie

Thanks, Rich.

Operator

(Operator Instructions) And our next question comes from the line of Neil Mehta [ph] with Stifel Nicolaus. Please go ahead.

Neil Mehta – Stifel Nicolaus

Hey, couple of questions. First one on the – are you guys seeing any new PC manufacturers in Brazil outside of the major ones, some incumbent domestic suppliers. And if so, would you guys have to go through a certain qualification process or are you qualified with some of these guys. And the second question is related to Sandy Bridge, how do you guys see that impacting PC sales in Brazil? Thanks.

Iain MacKenzie

No real large PC manufacturers, the regional manufacturers exactly in the positives, the Amazon PC, the next level sub system of PC's then we see them as needing only a local call, so it’s only a global accounts that are the longer cycle rather than the local. So new manufacturers, cm manufacturers then we find that call cycle pretty quick and I did see a report that says we are now shipping to over 100 locations within Brazil, of which will be absolute standard part if you can afford any stocking for them at all. So it's going well. We are not seeing major volume driver PC manufacturer in Brazil.

Neil Mehta – Stifel Nicolaus

Okay.

Iain MacKenzie

Second with Sandy Bridge, I think we get an order of distance in Brazil, we see $13 million or some 10% of service getting sold in Brazil, we have had our numbers here. And I think in the PC level, then Sandy Bridge will continue. But the tablet penetration in Brazil seems to be a little bit lighter and so I wouldn't expect to see for the balance of our financial year although it's certainly got some great cash right now and winning some slots within the business. So, not too sure but certainly not looking at being disruptive in the market.

Neil Mehta – Stifel Nicolaus

Thank you.

Operator

Thank you. Ladies and gentlemen, that does conclude our question-and-answer session for today's call. I would like to turn the conference back to Mr. MacKenzie for any closing remarks at this time.

Iain MacKenzie

Thank you, operator. So to conclude following the challenging, but we have good success in baseline business and in our targeted areas of growth during this first fiscal quarter. We continue to make progress in penetrating the end supplies storage market. Our business in Brazil provides great promise with our new initiatives and flash gaining traction with the growing customer base and they are up – the up and coming R&D center will be established later this fiscal year.

So, thank you for your continued interest in Smart. And we hope over the time you take personal time over the holiday period and relax with family and friends. Perhaps, have one of those other kind of weed runs for me and my kinsfolk and we wish you health, happiness and prosperity going into this new calendar year.

Thank you very much.

Operator

Ladies and gentlemen, this concludes the Smart Modular Technologies first quarter fiscal 2011 earnings conference call. We thank you for your participation. You may now disconnect

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