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SMART Modular Technologies (WWH) (SMOD)

Q2 2011 Earnings Call

March 24, 2011 4:30 pm ET

Executives

Iain MacKenzie - Chief Executive Officer, President, Executive Director and Member of Strategy Committee

Suzanne Craig - Managing Director

Barry Zwarenstein - Chief Financial Officer, Principal Accounting Officer and Senior Vice President of Finance

Analysts

Krishna Shankar - ThinkEquity LLC

Jim Suva - Citigroup Inc

Betsy Van Hees - Wedbush Securities Inc.

Alex Kurtz - Merriman Curhan Ford & Co.

Kevin Cassidy - Stifel, Nicolaus & Co., Inc.

Timothy Luke - Barclays Capital

Operator

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the SMART Modular Technologies Second Quarter Fiscal 2011 Earnings Conference Call. [Operator Instructions] This conference is being recorded today, Thursday, March 24, 2011. And at this time, I'd like to turn the conference over to Suzanne Craig, Investor Relations. Please go ahead, ma'am.

Suzanne Craig

Thank you, operator. Good afternoon and thank you for joining us on today's earnings conference call to discuss SMART Modular Technologies second 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, the outlook of our industry 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. 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 annual report on Form 10-K for fiscal year 2010 and the company's Form 10-Q for fiscal 2011. 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 statement.

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 second 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 exclude stock-based compensation expense, restructuring charges, the technology access charge 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 GAAP items to GAAP. An audio replay of this call will be available for two weeks by accessing the Investor Relations page at www.smartm.com or by dialing (303) 590-3030 and using the pass code 4421390. And now, I'd like to turn the call over to Iain MacKenzie, President and CEO.

Iain MacKenzie

Thank you, Suzanne, and welcome to everyone on the call. We are pleased with our second quarter fiscal 2011 results. We believe that we have passed the trough in earnings as DRAM prices appear to have stabilized, feel benefit of Brazil memory business and also considerable investments to address the growing enterprise market and expected to meaningfully increase in the second half of this fiscal year.

Now, let me review the quarter. Net sales totaled $170.5 million, non-GAAP gross profit totaled $28.7 million and non-GAAP diluted earnings per share totaled $0.08. The biggest impact to our business came from greater-than-anticipated downward pressures on DRAM pricing and the resulting reduction in gross profit to our Brazil business. As we mentioned last quarter, this impact is due to module prices adjusting faster than our inventory and work in process turnaround time of approximately six weeks. We are encouraged by the abatement in DRAM price decline since the start of the calendar year and believe a further significant decline in pricing is unlikely. It is important to note that demand in Brazil remains strong. While we have remained capacity constrained, we will support a significantly higher density in coming months with the transition from 1Gb to 2Gb DDR3 underway. This density improvement, in combination with continuing strong end market demand, should lead to improved revenues and results from this region.

With respect to our Flash products in Brazil, we have mentioned over the last few quarters we continue to see increased interest from local customers, and they're selling to both OEMs and the retail channel. Our next steps are to expand this product line towards higher densities and towards a greater variety of solutions, with further trading from SD to SSD, and potentially including securities to USB and USB form factors. With these initiatives underway, we expect to be able to further penetrate Brazil's removable Flash market in the next 12 to 18 months. More generally, we continue to expand our Brazilian footprint. February 1 marked the successful split of our local operations into two operating companies, semiconductor and module. This positions us for meaningful reductions in taxes we pay in Brazil. Our plants are established and our R&D center in Brazil remain on track and we are excited about the corporate-wide opportunities this initiative will provide. Additionally, we have committed to lease an additional 45,000-square-foot space adjacent to our existing Brazil facility. We look forward to significant long-term returns from our deeper and broader penetration into this market as a result of these investments.

Turning to our specialty memory business, the key has been and remains the end user demand. During the quarter, we faced some headwinds due to the world demand from one of our key networking telecom customers. This was partially offset by increased demand for high-value products from other specialty memory customers. Specifically, we've seen significant outside demand to our extended [indiscernible](09:55.8) modules. Demand for our spec solutions, especially Flash, has exceeded our expectations. Our pipeline of new specialty memory product continues to expand, which will allow us to show further strength in our target market. A highlight here is our recently announced nonvolatile DIMM family, powered by our proprietary trademark, SafeStor BICAP engine, which has been favorably received by a number of potential customers.

In our Solid State Storage business, starting with Enterprise, where we've had some exciting developments. Our XceedIOPS 1.8-inch SATA product, which began shipping in limited quantities in the second quarter, is now fully released and ramping. We're advancing well with the qualification of both our SAS and SATA products on a number of different IBM platforms, and we are happy to report that we have a new qualification win with another Tier 1 Enterprise customer and are working with a broad range of other server and storage companies. We expect our Enterprise sales to gain increasing traction as these qualifications convert into volume orders and we believe we are well-positioned to reach a meaningful level of sales in Enterprise storage revenue in our August-ending quarter. Our ability to provide Enterprise class storage solutions with Enterprise class customer support is clearly resonating with our target customer base. With this growing momentum, we continue to invest in the technology development and we'll be broadening our product portfolios and offerings in the coming quarters to offer our Enterprise customers complete solid state storage solutions. With respect to our defense business, SMART's plan to leverage our Enterprise product into the defense market, which we discussed last quarter, is beginning to bear fruit. Over a dozen of our key defense customers have been testing engineering samples of our Xcel-100 drives, which are essentially ruggedized version of our XceedIOPS SATA product. Customers are excited about the potential of a true industrial ruggedized SSD with the outstanding performance of the Xcel-100.

Our embedded storage business remains strong with steady growth. SMART is clearly an industry leader for embedded Flash products in the networking, telecommunications and industrial markets. Qualification of our new embedded SATA SSD and Xceed iSATA products are planned to be completed this quarter. Let me now turn the call over to Barry for a discussion of the financial results.

Barry Zwarenstein

Thank you, Iain. The second quarter fiscal 2011 net sales of $170.5 million were broken down by geography as follows: Brazil 48%, U.S. 20%, Asia 23%, Other America 6%, Europe 3%. Our breakdown of net sales by end market for the second quarter was as follows: PC 39%, servers 20%, network and telecom 18%, storage 13%, logistics 6%, industrial and other 4%. Compared to the first quarter of fiscal 2011, PC-related sales fell 39% in the second quarter due to the reduction in DRAM prices. Network and telecom sales declined 26% in the quarter due to lower demand at a key customer Iain mentioned earlier. However, sales to storage customers increased 26% in the second quarter as increases in embedded and Enterprise revenue were partially offset by lower shipments into a major defense program, which ended during the last quarter.

Server-related sales also increased to 14% in the second quarter, primarily due to increased demand in Brazil. As for our top customers, HP represented 21% of net sales this quarter, followed by Dell at 17% and Cisco at 14%.

Moving to the rest of the income statement, which I will discuss first on a non-GAAP basis, gross profit for the second quarter was $28.7 million, down approximately 35% from last quarter's $44.2 million. As Iain mentioned, this lower gross profit was largely due to the decline in Brazil DRAM pricing. On a percentage basis, non-GAAP gross profit was 16.9% of the net sales compared to 20.5% last quarter. Our second quarter non-GAAP operating expenses totaled $21 million, relatively unchanged from the prior quarter. Non-GAAP R&D expenses were $7.5 million in the second quarter, which was $7.8 million in the prior quarter, while non-GAAP SG&A expenses totaled $13.6 million versus $13.3 million in the prior quarter. Non-GAAP net income for the second quarter of 2011 was $5.2 million or $0.08 per diluted share compared to $17.6 million or $0.27 per diluted share for the first quarter of fiscal 2011. Excluded from non-GAAP net income in the second quarter of 2011 were restructuring charges of $2.8 million related to our Puerto Rico facility closure and stock-based compensation expenses of approximately $200,000 cost of goods sold, $400,000 in research and development and $1.6 million in G&A for a total of $2.2 million, all essentially flat versus the first quarter. On a GAAP basis, net income for the second quarter of fiscal 2011 was $200,000 or $0.00 per diluted share compared to $8 million or $0.12 per diluted share for the prior quarter. Adjusted EBITDA totaled $13.6 million in the second quarter compared to $29.6 million in the prior quarter.

Turning to working capital, our net accounts receivable increased to $184.7 million from $178.9 million last quarter, and our days sales outstanding came to 40 days this quarter compared with 37 days in the prior quarter. Inventory declined to $96.1 million from $103.5 million in the prior quarter and turns came in at 16.4x compared to last quarter's 15.5x. Looking forward, we expect to see increases in the inventory as we enter the second half of our fiscal year for two primary reasons. Inventory to be positioned for Enterprise storage sales and inventory needed to support the anticipated expansion of our logistics business. Please note that any recovery in DRAM pricing will add additional upward pressure to the inventory balances. Approximately 46% of our second quarter inventory was attributable to our logistics business compared with 41% last 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 $423.5 million and $395 million respectively for the second quarter of 2011. Cash and cash equivalents totaled $134.4 million at the end of the quarter, up from $92.9 million last quarter. Second quarter cash flow from operations was $45.1 million compared with an outflow of $16.2 million in the prior quarter. Despite the tougher conditions and a seasonally weak quarter, in the second quarter, we generated $8.3 million in cash flow from the income statement components of the operating cash flow and we enjoyed an additional $36.8 million inflow from lower working capital requirements. In the second quarter of 2011, we spent $5.4 million on CapEx, primarily in Brazil.

And now, let me turn to our guidance. SMART estimates that the third quarter fiscal 2011 net sales will be in the range of $160 million to $180 million. We expect GAAP gross profit to be in the range of $29 million to $33 million. As a result, net income on a GAAP basis is estimated to be in the range of $0.04 to $0.07 per diluted share. On a non-GAAP basis, excluding stock-based compensation expenses and restructuring charges, we expect non-GAAP net income will be in the range of $0.09 to $0.12 per diluted share. The guidance for the third quarter includes an income tax provision expected to be in the range of $2.8 million to $3.1 million. The number of shares used in computing net income per diluted share is estimated to be 66.5 million. Capital expenditures for the third quarter are expected to be in the range of $4 million to $7 million and to range from $25 million to $30 million for the full year 2011. 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 details. This concludes my remarks. Operator, we are now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question comes from the line of Betsy Van Hees with Wedbush Securities.

Betsy Van Hees - Wedbush Securities Inc.

Iain, I wondered if you could start off and talk about the headwinds a little bit more on your telecom customer, that you have with your telecom customer and how you see that moving forward if those have been resolved?

Iain MacKenzie

I think quite simply, in the numbers, you see that our second top customer stayed at 14% quarter-over-quarter with a significant reduction in revenues. So quite simply, Cisco who reported publicly low numbers in their switch in telecom. So really not a headwind. It was a seasonal Q2 and they were much lighter than expected. The good news, as we said, was that we mitigated much of that with the stacking and specialty demand. So really, the results there reflected a lot more of the early reduction in DRAM prices in Brazil for its quarter of November and December, particularly.

Betsy Van Hees - Wedbush Securities Inc.

That was really helpful. So SSD business, can you help us in terms of meaningful, can you give us a sense of how meaningful and what kind of ramp we should be looking for and what are the key drivers that you're expecting from these Enterprise customers?

Iain MacKenzie

It is difficult not to put some numbers around about here. I mean clearly, the good news is getting to commercial release level. And now, the draw through of orders needs to come through. And I think overall for total Solid State Storage, if we leave our Q4 in the $100 million to $120 million, maybe a little bit higher million dollar run rate for the year, so $30 million for that quarter, we'd be fairly pleased. And there's potential to be more and of course programs can be delayed. I really try not to. The good news is getting the progress with calls, getting the progress with the status. And so they were ready to drive through all demand that comes to us. That would be an indication.

Betsy Van Hees - Wedbush Securities Inc.

That was also very helpful in terms of giving us an idea of how we should be modeling that. If we look at the immediate quarter and looking at the businesses, how should we be looking at Brazil knowing that it had a tough quarter in your fiscal Q2? Is it going to be up, meaningfully up or can you help us as we look at that certain business segment?

Iain MacKenzie

Sure. Brazil quarter, which had -- the past quarter was November, December, January, saw us over 50% reduction in DRAM prices and predominantly about 40% or more was in the November, December time scale. So really this year, this calendar year for Brazil, the prices have been fairly stable. I think the revenue will obviously be much lighter because you're dealing with -- the reduction has happened, now have stability. So the three months will be pretty steady. But the margins will return to normal or typical gross margins, which is great. It means you're not losing money on materials. So the purchase price and the sales price are now balanced. So that's a good strong position and the demand continues there. Q3, we were showing they would be back to a full 100% utilization and all of their focus has been on getting the 2Gb IC into our facility and call the OEMs.

Betsy Van Hees - Wedbush Securities Inc.

And I'll just ask one last question and I'll drop out of the queue -- I can get back in the queue. I'm sure there's other questions, but in terms of the DRAM pricing, what are you modeling for DRAM pricing this quarter as you built up your numbers for us?

Iain MacKenzie

Yes, we were modeling nothing. We're modeling stability and clearly then there will be further impacts in Q4 of Japan and appliance sector. But we're modeling absolutely flat for our Brazil quarter.

Betsy Van Hees - Wedbush Securities Inc.

I know I said one question. I am going to ask one more since you brought up Japan. Can you talk to us a little bit about your exposure to Japan and if there's any impact into the guidance you gave and how you see your supply chain?

Iain MacKenzie

I mean I think the two risks have been well spoken about by the analysts of the BT and in particular of wafer supply. So they wouldn't impact -- we don't expect it to impact -- our Q3 as the inventories withdrew the sooner we can get back to production and other facilities supplying more production, working overtime to satisfy some of the 21% shortfall for the few weeks that we've been down with that disaster in Japan. So it could be at Q4. However, with our customers being the very large OEMs, in a shortage-type situation, typically we get some preferential treatment with our 20 years of history, and with the OEMs as are customers that are on the spot market. So we believe that we'll be able to be strong in a shortage and hopefully will get enough recovery and will get everything back to normal and get the reactors under control for everyone's sake.

Operator

Our next question comes from the line of Kevin Cassidy of Stifel, Nicolaus.

Kevin Cassidy - Stifel, Nicolaus & Co., Inc.

What I want to understand is you mentioned the transitioning to 2Gb devices in Brazil. What percentage of your modules were based on 2Gb last quarter, and what will it be next quarter?

Iain MacKenzie

So the last quarter was pretty much zero. It was 100% 1Gb except for the call units and the samples, so pretty much zero. We expect the transition to be fairly quick and move 10% in Q3 and perhaps 25%, 30% throughout Q4.

Kevin Cassidy - Stifel, Nicolaus & Co., Inc.

What does that do for gross margins as you move to 2Gb devices?

Iain MacKenzie

Gross margin doesn't do too much because it looks like we're going to see, we're currently modeling that identities increase significantly. So the ASP will increase and gross profit dollars should be pretty good. Gross margin percentages, we've modeled in the mid-18s for the quarter. And so we don't expect to see too much impact. The good news is putting more density there for the ASP increase for Q4, then the GP dollars have the potential to increase.

Kevin Cassidy - Stifel, Nicolaus & Co., Inc.

Okay, but maybe just one more to understand the Brazil market. OPCs are adding more content for PC?

Barry Zwarenstein

Absolutely. We've dropped them as low as less than 5% content. So the 2Gb quality is a focus to bring that back over that magical 6% to get into the 6% to 12% range. So yes, more content and that's going to mean more density will drive that content higher.

Kevin Cassidy - Stifel, Nicolaus & Co., Inc.

Okay, so that's more like a four gigabyte per PC?

Iain MacKenzie

That's correct. Between three and four, we were -- in Brazil, we're about 3.1 gigabytes per system so far, moving towards four.

Operator

Our next question comes from the line of Tim Luke with Barclays Capital.

Timothy Luke - Barclays Capital

Iain, as you move forward through the year, what are your broad expectations associated with both the DRAM pricing outlook and demand and also as you move into the second half of your calendar year, what are your thoughts with respect to gross margin progression?

Iain MacKenzie

Tim, you always ask the very simple questions. Let me try and answer with some brevity. DRAM prices, I mean, I don't know. I saw your optical wedge just in the last couple of days on the Japan effect in the DRAM prices and the DRAM shortage. So if we ignore that, then previously we were looking at the DRAM prices beginning to kick up, more silicon being used for mobile RAM, more silicon being used for NAND. So DRAM coming into both strength and balance. I don't pretend to have played through the Japan impact to that. From our point of view, we were moving towards higher density, in particular for PC, higher density content for the 2Gb transition, higher density content for our stacking and this comes into the transition season. Our GP -- our gross margin percentages gone from this reported quarter at 17% to, as I mentioned, mid-18% in Q3. We model Q4 roughly back to the 20% kind of corporate average that we had previously been achieving because the impacts of a DRAM price reduction are removed from that model. So could note that 20%, back end of the calendar year getting to, we programmed and modeled this business at about 20% or 22%.

Timothy Luke - Barclays Capital

And then as you think about progressing into the August and November quarters, how should we think about your operating expenses developing and the incremental R&D?

Iain MacKenzie

The incremental R&D Barry can determine. So really operating expenses, excluding R&D, to be very -- fairly flat with a little bit of the sales and marketing expense increase with the increase in our Solid State Storage towards the end of the fiscal year and into the calendar year. But from R&D point of view, Barry, I think it's $500,000 to $700,000 per quarter increase from here on out with Brazil in Solid State Storage.

Barry Zwarenstein

That's exactly right.

Operator

Our next question comes from the line of Jim Suva with Citi.

Jim Suva - Citigroup Inc

Looking at kind of the bigger industry trend that we see about consumers and the adoption of tablets, can you talk a little bit about, and again I'm not that familiar with the Brazil market, but I believe you have a very meaningful exposure to PCs, approximately about 50%. And I think the majority of that is in Brazil, maybe, correct me if I'm wrong. And how should we think about tablets? Is there a little bit of a concern about that market, seeing some structural change there or is just the Brazil market and what you're involved with just structurally different?

Iain MacKenzie

As I said, PC is predominantly in Brazil market and with a little bit of server. This quarter, server was just a little bit higher, probably reaching as high as high teens, 20% of total demand. But yes, the PC story, the good news in Brazil is that the growth of desktop PC, the growth of notebooks and the growth of tablets are all high. It's not like the developed markets who have cannibalization through tablets. So we're in a good position of each of those markets growing in Brazil and again, as I mentioned, going back to 100% utilized in our fiscal Q3. So that doesn't quite have the same impact to developed markets, and I'm sure product development group for the future will be looking at the content of tablets for future product developments.

Jim Suva - Citigroup Inc

Great. And can you just remind us if anything's changed or what the numbers are for your solid state ramp? Maybe it's in a couple of years from now to represent x or y percent of sales or just update us on the roadmap and milestones that we can kind of look to as investors?

Iain MacKenzie

Sure. The high-level roadmap if that grew into north of $6 billion market, and we will capture 5% of market share in that area, then we can clearly see a path to $300 million. We've said something like $200 million to $300 million in a three- to five-year range. It's getting more likes and coming from PowerPoint to reality as we speak and as you see. And I am going to have to say just in the next two quarters, then we'll see that growing, achieving like the $120 million plus run rate. At last it's here, it's been quite the path, and it's a pleasure to see that come into reality. So pretty much on plan with the last analyst day's projection.

Operator

Our next question comes from the line of Alex Kurtz with Merriman Capital.

Alex Kurtz - Merriman Curhan Ford & Co.

Iain, on that $100 million to $120 million run rate, are you saying that you're going to get to that annual run rate by the end of this fiscal year or you got to that in February?

Iain MacKenzie

In our February quarter, I think we reported with just over $20 million. We've been as high as $25 million before with some of that defense contract before it came to an end. So it's another $20 million from last quarter, growing now, and I would like to see $25 million for next quarter, $30 million coming out of the end of the year. To get to that $120 million run rate within our next fiscal year, clearly showing that we have the wins to grow at that rate.

Alex Kurtz - Merriman Curhan Ford & Co.

So that includes Enterprise, as well as embedded defense or...

Iain MacKenzie

Yes. That's inclusive of all of our Solid State Storage business.

Alex Kurtz - Merriman Curhan Ford & Co.

Okay. So if you'll look out next thing in fiscal '12, would you expect maybe half of the SSD business to come from embedded industrial and the other half coming from Enterprise? Is that a good alignment then?

Iain MacKenzie

I think we have the potential for -- in that in our FY '12 and the expectation that Enterprise outstrips both embedded and defense collectively.

Alex Kurtz - Merriman Curhan Ford & Co.

Okay. So Enterprise would be greater than the other two combined?

Iain MacKenzie

That's correct.

Alex Kurtz - Merriman Curhan Ford & Co.

Just on the controller roadmap, I know that you guys are -- use SandForce today. Where are you as far as developing your own controller and when you guys flip to your own internally developed controller from SandForce, whenever that happens, what's the impact to gross margin? How many basis points you think you guys could reclaim within the SSD business?

Iain MacKenzie

Let me clarify quickly. We don't plan on particularly switching from SandForce. SandForce will remain for many of our product solutions and in a similar fashion, as we've done in the past. We will add our controller to our portfolio to bring about different solutions. The margin profile will not be too much different in that model. It just enables us to have more control over the end solution for the customer and to interface and to interact a little bit more with the firmware. But for SATA-level products, really it's native SAS products that our controller will help with. But for SATA-level products, then it's SandForce, and our partnership with SandForce is particularly strong. So I would see that surviving many years and in fact, they have a new product on their roadmap also, which we're excited to develop for further PCI solutions etc. So our controller is working very well. It's on track for being in qualification at the end of this calendar year and that will be for high-end Enterprise SAS product.

Alex Kurtz - Merriman Curhan Ford & Co.

Okay. And last question, maybe Barry can take this. Can you go through again how much -- how many lines and what the facilities are in Brazil, what they are today? And I think you had said you would add 25,000 square feet. Can you just reset us on what that capacity is today and what that's going to be in the next two quarters for the ability to address the Brazil business?

Barry Zwarenstein

Alex, it was my mistake. I started on the 25,000 square feet and corrected that to 45,000-square-feet facility adjacent to our current facility. It's for our R&D center and the expansion of our packaging facility. We're north of up to about 10 million ICs per month in the packaging facility and about 2.4 million, 2.5 million modules per quarter out from that facility, 100%. We're not adding physical capacity through these next six months because you get more density from the 2Gb transition. So we'll be holding on the number of units and increasing the density significantly which does increase the ASP and does increase the content and hence, gives us a little bit better profitability into that region. And then we'll look at the capacity thereafter.

Operator

Our next question is from the line of Krishna Shankar with ThinkEquity.

Krishna Shankar - ThinkEquity LLC

For the consumer Flash business in Brazil, do you have enough capacity to ramp that or is that kind of pushed out a little bit?

Iain MacKenzie

Krishna, the capacity that we installed for the Flash product has not been fully utilized yet. So we installed a certain capacity and with the quals and with the 100,000 -- with the slight slippage in that, then we haven't come to utilize that. We plan in our EOP, our operating plan, starting in fiscal '12 to add more capacity as we see the mix between the retail, in particular for test and the OEM test and the product type between microSD, SD, UFD, USB and SSD. I know that's a mouthful, but it depends which one of them gets traction quickest what kind of capacity we add. The former products are more packaging style and the latter SSD is more of a module in a sandwich style. And as we said, we split the company into two so the capacities will be spoken about separately in the future.

Krishna Shankar - ThinkEquity LLC

Okay. And then do you have a benefit to your DRAM module business from the Sandy Bridge platform ramp at Intel?

Iain MacKenzie

Again, Krishna, all reflects through as density. With Sandy Bridge being able to allow more density into the servers and then to the high-end PCs and the workstations, then clearly, that was in more stakes and address more modules. So it enables this density ramp that we're speaking of. And with the 2Gb transition, then it can put much more content into the system and drive us back from this 5% content back towards the 10%.

Barry Zwarenstein

Krishna, we still believe that memory still curtails the total performance of the processors and the system.

Krishna Shankar - ThinkEquity LLC

Okay. And then my final question. Given some of the disruptions from the Japan earthquake, do you have multiple sources for memory in terms of the need for wafers?

Iain MacKenzie

I don't know the wafer situation, Krishna, apart from -- in Brazil, our entire DRAM wafer supply comes from Samsung, and Samsung definitely has multi-sources including Semco, which has a partial ownership. But I wouldn't pretend to know the exact requirement on Shin-Etsu or MEMC or Semco in percentage of income. And as I have said, I think we'll get some priority with the OEM customers that we serve, then that's a lot of demand and a lot of noise for the large DRAM suppliers to deal with.

Krishna Shankar - ThinkEquity LLC

And then you said you're sort of presuming flattish DRAM pricing for the next quarter. With some of the disruptions, you wouldn't anticipate -- recently pricing has kind of moved up a little bit. You wouldn't anticipate that to continue or what are sort of your longer-term DRAM pricing assumptions for the rest of the year?

Iain MacKenzie

Moved up a little bit in spots, certainly didn't move in contracts, so all seems to be nice and flat in contract. We're already 50% of the way through our Brazil quarter, so it's a good indication for the PC and the mainstream DDR3 parts. Of course, our specialty memory is a high percentage of DDR2, DDR1 and legacy products. So doesn't behave in the same fashion. So for our Q3, I think flat pricing makes sense. For Q4, I mean I hope that people and situation get back under control in Japan and that we can all recover from this very quickly, and I'd rather not plan improved results to the effect of other people. So we will wait and see on that one, and it will be Q4 as we run through the inventories. And I think there's time to replace that supply and get back under equilibrium.

Operator

Our next question is a follow-up from the line of Betsy Van Hees with Wedbush Securities.

Betsy Van Hees - Wedbush Securities Inc.

So you mentioned that inventories went -- well, actually, inventories went down. I was wondering if you could talk about what the drivers were behind the inventories? And then you mentioned that inventories will be increasing and I was wondering if you could give us a little bit more perspective on what type of inventory level increases we should be seeing?

Barry Zwarenstein

Great. So in terms of the inventories, one of the bigger reasons for the sequential decline was indeed the lower DRAM pricing with the associated benefit that we have down in Brazil. And that was really one of the biggest drivers. Looking forward, the reverse situation with respect to Brazil depends on the pricing. We're assuming flat pricing, so really no major change on the Brazil inventories. The two areas where we are increasing is in solid state Enterprise in particular because we have quite a few different requests from a number of different customers for qualification units. And so we need to be able to meet those multiple quals and plan for the associated revenue that will come from that. Then the other area of increase, Betsy, is within our logistics business. We have a number of additional initiatives above our baseline business that we have currently, and that is pretty inventory intensive. As we said in the call, 46% of our inventory in the February quarter was from logistics, and we see that actually edging up this coming quarter.

Betsy Van Hees - Wedbush Securities Inc.

That was very helpful. And you have a tax benefit this quarter, but how should we look at taxes for fiscal Q4? And if you can give us some guidance for next year, that would be helpful as well.

Barry Zwarenstein

Certainly. So looking at the taxes on a non-GAAP basis and essentially what we're talking about then is excluding approximately a little over $2 million per quarter for stock-based compensation. In terms of Q4 and next year, we should be looking at the tax rate in the mid-30s. And that's likely to go down into the 20s next year. Our long-term model is 23% to 28% and we feel pretty confident about that. The GAAP rates in a normal quarter where stock-based compensation would be about 10 percentage points higher.

Betsy Van Hees - Wedbush Securities Inc.

And then last question, can you remind us what your gross margin profiles are for your SSD business, particularly Enterprise?

Iain MacKenzie

Gross margins, we're still planning to get in the 30%, 35% range. It looks favorable. It looks good with advanced pricing. Clearly, at this moment in time, not leveraging that volume, that pricing. But we actually -- looking at the competitive positions and future pricing. It was good to be about 30%, 35%.

Operator

[Operator Instructions] Our next question is from the line of Wynn Kramer with ABM Securities [ph].

Unidentified Analyst

You had stated earlier that part of the reasons for the margin pressure in the quarter was due to DRAM price declines happening faster than you could get product through manufacturing. Wondering if you could provide some color on that timeline? And then also advise if the transition to 2Gb components changes that timeline at all?

Iain MacKenzie

Sure, Wynn. Really, we buy to offset any foreign exchange losses. We actually buy the inventory a bit early as it comes into customs in the country, particularly the DRAM, which is the expensive item. And so we buy them, -- it comes through customs in between six and 11 days. So that portion we're not in a particular control of. And then between the packaging companies, the burning, the tests, the backline getting into inventory then transferring to the module company in this way. It has historically been about three weeks in that transition. And then finally, finished goods and customer inventory of about a week. So that's just six weeks. Just recently, the plant and the site management have done a great job in reducing the work in process to somewhere between six and seven days, which will in the end enable us to take perhaps as many as five days out of this once we reduce the supply with our supplier there. So 2Gb has no impact on it whatsoever. These are more logistics and process times, so there is good news getting the whip down. The two companies, the inventory, will not sit in finished goods of the semiconductor company, it will sit over raw material in the module company, so we'll be able to seek customs for the semiconductor company and raw materials for the module company.

Unidentified Analyst

Great. Then on the SSD side, is your timeline there similar to DRAM in terms of getting it to manufacturing?

Iain MacKenzie

No. Not at all. The module portion is the only portion there. So it's imported ICs for the SSD and for the rest of our business, which is in our standard high-volume manufacturing plant in Malaysia, then it doesn't go through Brazil at all. So no customs, no impact. So really, we hold the material in consigned stock in our warehouses and we can turn that into products no matter what the custom product is and get it to the hands of the customer really within five to seven days. So that's a major advantage of our [indiscernible](0:49:27.8) model.

Operator

And gentlemen, at this time, I'm showing no further questions. I'll turn the conference back over to you for any closing remarks.

Iain MacKenzie

Thanks. So thanks and thank you, everyone on the call for continuing to track SMART Module. I think in conclusion this quarter demonstrated a real ongoing strength in our business model and our performance, the key growth initiatives and the Solid State Storage. We're hitting stride with the customer acceptance and traction. It's exciting in that market. We're fully committed to executing on these growth plans, these transitions. We've executed the plan, optimistic for the future growth of the company. I look forward to updating you at the end of next quarter. Thank you very much.

Operator

Ladies and gentlemen, if you would like to listen to a replay of today's conference, you can do so by pressing -- dialing 1-800-406-7325 or (303) 590-3030 and using the access code of 4421390 followed by the pound key. This does conclude the SMART Modular Technologies Second Quarter Fiscal Year 2011 Earnings Call. Thank you for your participation. You may now disconnect.

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