Executives
Suzanne Craig – The Blueshirt Group
Iain MacKenzie – President, Chief Executive Officer & Director
Barry Zwarenstein – Chief Financial Officer, Senior Vice President – Finance
Michael J. Gennaro – Principal Financial Officer
Analysts
Jim Suva – Citigroup
Tim Luke – Barclays Capital
Betsy Van Hees – Caris & Company
Kevin Kessel – J.P. Morgan
Analyst for Gary Hsueh – Oppenheimer & Co.
Bob Gujavarty – Deutsche Bank
Edwin Mok – Needham & Company
[Jeff Bennett – Wade Management Company]
[Fau Camaloden] – B. Riley & Company
SMART Modular Technologies, Inc. (SMOD) F4Q08 Earnings Call September 25, 2008 4:30 PM ET
Operator
Welcome to the Smart Modular Q4 fiscal year 2008 conference call (Operator Instructions) I would now like to turn the conference over to Susan Craig.
Suzanne Craig – The Blueshirt Group
Iain MacKenzie, Chief Executive Officer, Barry Zwarenstein, Senior Vice President and Chief Financial Officer and Michael Gennaro, Principal Financial Officer join me on today’s call.
Before we begin I’d like to make the following Safe Harbor statements. During the course of this conference call Iain, Barry or Mike may make projections or other forward-looking statements regarding future conditions or events concerning our future business, our current and new products and services, and our performance, the size and strength of our market and/or the future financial 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 & Exchange Act of 1934. You should review the managements’ discussion and analysis and related risk factors affecting future results contained in the forms and reports filed with the Securities & Exchange Commission including the company’s 10K for fiscal year 2007 and it’s 10Q for the first, second and third quarters of fiscal 2008.
We caution you that such statements are just projections. Accordingly our future results may differ materially from such projections. These forward-looking statements are made as of today and SMART does not currently intend and has no obligation to update or revise any forward-looking statements. The fourth quarter and full year fiscal 2008 earnings press release is available on the company’s website at www.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 excluded charges related to restructuring goodwill impairment, in process R&D and other infrequent and unusual items as well as stock-based compensation. Please refer to the non-GAAP information section of our earnings press release for future details.
Our agenda for the call today is as follows: Iain MacKenzie will discuss key highlights from the quarter and fiscal year and then Barry Zwarenstein will review the quarter from a financial perspective and provide the forward-looking guidance. A live Q&A session will follow. 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 1-800-405-2236 and using the passcode SMART.
Now, I would like to introduce Iain MacKenzie, President and CEO of SMART Modular Technologies.
Iain MacKenzie
The fourth quarter of fiscal 2008 marked the close of an exceptionally challenging year for SMART. My comments today will be organized as follows: first, I will recap the financial results and then review the restructuring program and the latest development in our various business groups; I’ll next turn the call over to our new Senior Vice President and CFO Barry Zwarenstein who I’m very pleased to have on board as part of our executive team.
Let me first recap the results. In the face of a continued decline in memory component pricing combined with a worsening economy here in the US we reported fourth quarter fiscal 2008 net sales of approximately $161 million, gross profit of about $25 million and net income on a non-GAAP basis of $0.05 per share. The true fiscal year net sales totaled $670 million where gross profit totaled approximately $120 million and non-GAAP net income totaled $35 million or $0.55 per share.
Industry reports of DRAM factory closure, manufacturing capacity cut backs, reduced capital expenditures and increasing [BBRC] applications should contribute to an eventual return to improved market conditions. In the meantime, as we described in the press release we took decisive action performing a companywide review of operations resulting in the restructuring program announced on September 10th which is designed to take prudent and early action to help us remain profitable in fiscal 2009. Specifically, this program when completed is expected to result in an annualized cash savings of $11.8 million. The program encompasses a 19% reduction of our global workforce and is expected to be completed by the end of the next fiscal quarter.
In addition, we continue to serve the Asia market including China and India but have discontinued their manufacturing presence in China and India for business conditions are too price competitive for us to grow profitably. We are also closing our Dominican Republic facility and consolidating that business in to our facilities in Malaysia and Puerto Rico. In connection with this restructuring program, we expect to incur a total of $3.3 million in pre-tax charges. Of this total $1.9 million was recognized in the fourth fiscal quarter and the majority of the balance will be recorded in the first half of fiscal 2009. We expect this plan will help to increase our earnings power by a combination of cost reduction measures and the reallocation of resources to higher growth businesses. We continue to see the results of our investments in our expanding family of high value solid state drive products and growing embedded and display business as well as one of the industries broadest portfolios of specialized DRAM modules for OEM customers around the world.
Turning to a review of our various business lines, I will first address our DRAM business which represented about 83% of our fiscal fourth quarter and 85% of our full year net sales. The well publicized downturn in the DRAM market is categorized as some of the worse seen in 15 years. Since a substantial portion of our products are integrated in to products ultimately sold in to the US market the macroeconomic climate domestically has clearly impacted our sales. That said, from a technology standpoint we are very well positioned. Intel still dominates the server market in terms of market share so whatever it does drives memory demand. We expect the recent release of its Dunnington Xeon 7400 six-core CPU will drive more demand for a high density truly buffered dims as more processing power typically requires a greater amount of memory. So we’ve already expanded our product line in this area with lower power higher density offerings so we were well aligned.
In addition, Intel’s [navel] line based platform is still on track to be released in earlier calendar 2009 which should bode well for high density DDRC modules. We’re also seeing growing interest from networking and telecom customers for smaller form factored DDRC solutions, namely high density eco dims, mini dims and very low profile dims. After completing qualification cycles we expect production volumes to materialize around the second half of calendar 2009. We are also aligned with the increasing market demand for green solutions. In addition to our steady introduction of newer lower power DRAM modules we have recently achieved qualification for halogen free modules. Our global customers are increasingly concerned with the potential harm that halogen poses to the environment and we have made it a priority to lead the industry in transitioning to the use of halogen free materials in our memory modules.
This achievement has taken considerable effort but we believe it is a key differentiator for us amongst our major OEM customers. We continue to be a leader in the value add memory module business and are very well positioned for growth in this area once the market conditions improve.
Brazil performed well particularly in the fourth quarter where sales were robust reflecting the strength of this economic region. While Brazil PC desktop revenue grew moderately, Brazil PC notebook revenue increased significantly in Q4 versus Q3 and the server business continued to develop. Our continued growth is a result of the investments we have made, our early positioning of IC assembly test capabilities and our six year history of doing business in Brazil.
Turning to our non-DRAM businesses, we’re very excited about our new recently announced six industrial grade solid state drive product offerings. Our second generation of both the Ultra and the Lite SATA SSDs. The Lite products still boast the industry’s lower power consumptions and the Ultra is one of the industry’s leaders in sustained performance. On the six new products we announced is the first SSD capable of reaching 128 gigabytes density using SLC flash which is more reliable for our enterprise customers. These products expand our presence in the defense, aerospace, industrial and embedded application areas and address more demanding storage market opportunities.
Our March, 2008 acquisition of Adtron has added nicely to our existing efforts in the high end high volume industrial and enterprise SSD market. Continuing to leverage the developing knowledge, applications, expertise and reliability screening methods produced by our SSD teams we have numerous qualification samples with customers now and the interest level is very high. We remain on track with our plan to expand in to this fast growing market and still believe meaningful revenue contributions will occur in fiscal 2009 and beyond as the market, applications and products continue to develop.
We’ve made significant progress with our display and embedded products. The XceedPC/Dx family of embedded PCs received full FCC, CE and safety certifications in our fourth fiscal quarter and has since transitioned to production status. Coincident with the production release, we began the general sampling program and the Dx is now being evaluated in over 15 customer applications such as informational and transaction kiosks and ATMs. Somewhat ahead of our expectations, several early access customers have already shipped the XceedPC/Dx in their production kiosks.
In our fourth quarter we successfully concluded the stringent testing of the SMART [Touchscape] screen family of 15 inch, 17 inch and 19 inch displays integrating the latest [TFC] LCD displays and touch screen technology, [Touchscape] displays are designed specifically for high usage long life embedded applications. Collectively these products have grossed the highest volume display opportunities in our target markets and we closed the fourth quarter with over 20 customers requesting samples. We expect our general sample program to commence this fiscal quarter.
Both XceedPC and [Touchscape] displays have been well received by our customers and we expect to see a positive revenue impact in the next fiscal quarter and beyond. Now, I would like to formally introduce you to Barry Zwarenstein our newly appointed Senior Vice President and CFO. We’re all extremely pleased to have him as part of our executive team and we look forward to leveraging his extensive knowledge, global expertise including over a decade of experience as a public company CFO to help drive our business going forward.
Barry Zwarenstein
Let me walk you through the details of our income statement and balance sheet and then review our guidance. For the quarter, net sales totaled $160.7 million down 4% from last quarter’s $167.6 million and down 5% from the year ago quarter. For the year, net sales totaled $670.2 million, 21% lower than the $844.6 million in the previous fiscal year. The breakdown of sales by geography for the fourth quarter was as follows: US 48%; other Americas 24%; Asia 17%; and Europe 11%. Our breakdown of sales by end markets for the fourth quarter was as follows: service 31%; desktop PC 26%; network and telecom 22%; industrial 7%; logistic 6%; printers 4%; and storage 4%.
HP continues to be our largest customer with 33% of revenues this quarter, the same percentage as last quarter. This long term relationship encompasses many different types of memory products and services. Cisco remained our second largest customer during the quarter representing 13% of our revenue versus 12% last quarter.
Moving to the rest of the income statement, gross profit for the fourth quarter was $24.9 million down 10% from last quarter’s $27.8 million and down 22% from the fourth quarter a year ago. Gross profit for the fiscal year 2008 totaled $119.7 million, 20% lower than the gross profit of $149.7 million for fiscal 2007. Fourth quarter non-GAAP operating expenses of $18.8 million declined by 2% from the prior quarter and included research and development expense of $5 million and SG&A of $13.8 million. As part of our revenue diversification strategy we continued to invest in targeted research and development activity and grew R&D by 23% in fiscal 2008.
Total non-GAAP adjustments net of tax for the fourth quarter of fiscal 2008 included $3.2 million of goodwill impairment, $1.9 million of stock-based compensation expense and $1.8 million of restructuring charges. For the full year fiscal 2008 non-GAAP adjustments net of tax included $9.6 million for deferred tax asset valuation allowance increase, $7.2 million of stock-based compensation expense, $4.4 million for in process research and development expense related to the Adtron acquisition, $3.2 million of goodwill impairment and $18 million of restructuring charges.
GAAP net loss for the fourth quarter of fiscal 2008 was $3.5 million or $0.06 per share compared to a net loss of $11 million or $0.18 per share for the third quarter of fiscal 2008 and net income of $13.6 million or $0.21 per share for the fourth quarter of fiscal 2007. GAAP net income for fiscal 2008 was $9 million or $0.14 per share compared to net income of $57.7 million or $0.91 per share for fiscal 2007. Non-GAAP net income for the fourth quarter of fiscal 2008 was $3.4 million or $0.05 per share compared to $4.9 million or $0.08 per share in the third quarter and $12.1 million or $0.19 per share for the fourth quarter fiscal 2007. Non-GAAP net income for fiscal 2008 was $35.2 million or $0.55 compared to $58.5 million or $0.92 per share for fiscal 2007.
Turning now to the balance sheet, cash and cash equivalents totaled $16 million at the end of August down slightly from the end of the last quarter. Accounts receivable totaled $193.7 million at the end of the quarter up $7.3 million from the prior quarter. Days sales outstanding were 47 days this quarter compared to 45 days last quarter. Net inventories were $62.4 million at the end of the quarter down from $68 million at the end of last quarter. Inventory turns were 23 times for the fourth quarter compared to 20 times for the third quarter. Going forward, as we increase our flash, SSD and display and embedded product sales, we expect our inventory turnover range will migrate downwards towards 18 to 20 times as there are many more unique materials associated with these types of products. As a reminder, accounts receivable and inventory turnover are calculated on gross sales and cost of goods sold basis.
Depreciation and amortization totaled $3.6 million for the fourth quarter. Capital expenditures during the fourth quarter totaled approximately $1.9 million compared to $1.8 million last quarter and cap ex for the fiscal 2008 year was $13.3 million.
Now, let me turn to our guidance. For the first quarter of fiscal 2009, SMART estimates net sales will be in the range of $157 million to $167 million, gross profit in the range of $24 million to $26 million and net loss per share will be in the range of $0.03 to $0.04 on a GAAP basis. On a non-GAAP basis excluding charges related to stock-based compensation and restructuring, the company expects net income per diluted share will be in the range of $0.01 to $0.02. The guidance for the first quarter for both GAAP and non-GAAP includes an income tax provision estimated in the range of $0.02 to $0.03 and a foreign currency loss related to Brazil estimated at $0.02 per share. Please refer to the non-GAAP information and the reconciliation of guidance sections of our earnings press release for further details.
For fiscal 2009 we estimate cap ex to be in the range of $13 to $18 million. That concludes my remarks now I’ll turn the floor back to Iain.
Iain MacKenzie
Before we begin the Q&A session, I’d like to take this opportunity to recognize and thank Mike Gennaro for his immediate contributions and commitment to SMART and support as interim CFO during our search. He will remain on board as principal financial officer through the filing of our 10K. Mike integrated with our management team very quickly and has been a valuable asset through these past months to the company and to me personally.
In the near term also we will be hosting our 2008 analyst day in New York City on Wednesday, November 19th from 8 am to 1:30 pm eastern time and we’ll be circulating more information on this event shortly. We look forward to meeting with many of you then. Operator, we’re now ready to take questions.
Question-and-Answer Session
Operator
(Operator Instructions) Our first question comes from Jim Suva – Citigroup.
Jim Suva – Citigroup
You’ve talked about in the past that there were about 10% to 15%, I think it was 15% of your revenues at risk from some of the more commodity DRAM makers, Micron, [Kumadin] and such. Can you tell us kind of how much they have I guess targeted or gone after and what’s still remaining if the pricing environment continues to remain extremely competitive.
Iain MacKenzie
The previous data in the last quarter that was 10% was already gone and that last 5% for that one particular customer. Then, we’re seeing certainly the competitive pressures continuing at any space where we have high volume. At this point in time we see a little bit of pressure on gross margin percentage from some of that but it would appear that the major onslaught if you like is over and we believe we’ll have some 3% to 7% still in that area but with different suppliers and different value add propositions.
Jim Suva – Citigroup
As a quick follow up can you let us know for your kind of revenue outlook what type of DRAM ASPs you’re assuming for the quarter?
Iain MacKenzie
We’re planning on it being flat and essentially similar to last quarter and the quarter we’re reporting on was down very slightly about 10% to 15% down.
Operator
Our next question comes from Tim Luke – Barclays Capital.
Tim Luke – Barclays Capital
I’d like if you could just touch on how you perceive the DRAM market developing as you look in to 09 and what sort of your expecting in some of the industry consolidation and whether that’s going to help at all? And also, separately just you’ve seen good momentum in Brazil, what are your expectations for that as you look in to the end of this year and next year in terms of the underlying for the total demand in that region? Then just separate, I was wondering if you could clarify how we should think about tax going forward?
Iain MacKenzie
I’ll take the first two and Tim, you’re right much about the semiconductor market and potentially [inaudible] some of those CEOs. Certainly the capital market continues to – semiconductor capital in particular continues to be off by some 40% to 60%, the density growth has slowed, the back to school seasonality looks like it didn’t happen. But, overall just a softness in market conditions and I think most of that is based around consumer electronics and clearly with what’s happening with some of the financial institutions that you’re well aware of have been clearly impacting the macroeconomics and we did say in the script, much of our product comes in to the US.
Second half of this year, calendar half expect nothing to write home about. Now, in early first half of 09 then we do have a lot to start hitting. Clearly we’ve seen the 200 mil fabs, the 8 inch fabs come offline, the capital spending not going in and stalling and hopefully someone can help in end terror and [inaudible] of that position and perhaps our friends at Micron win that but that’s all speculative and I read the same reports as you do and listen to the same channels. But, with DDR3 coming in at time with – demand does continue to have significant growth at 30% to 40% levels so it has not gone to zero and we’re seeing some more density go in to the parts that really the first half of the 09 then we’re expecting to see the turnaround of good signals in our industry and right some of that.
With respect to Brazil with the second portion of the question, if does continue, the economy continues, servers are beginning to get some traction there, notebooks are growing, Brazil as a country are strongly forcing the local manufacturing of electronics. We’ve forecasted that continues in the double digit growth rate for the future and it looks like we have a great foothold there and a good established baseline.
The last piece is the tax rate going forward and I’ll let Barry answer to the tax rate.
Barry Zwarenstein
With respect to the GAAP tax rate, for the full year, we’re projecting a GAAP tax rate in the very low 30s. Obviously it’s much higher than that in the first quarter because as we alluded to in the guidance we’ve got the charge of $0.02 to $0.03 even though we have a GAAP loss – the equivalent of $0.02 to $0.03. But, going forward in the second, third and fourth quarters that rate will come down to average out in the low 30s.
Tim Luke – Barclays Capital
Lastly, if I may, just how should we think about op ex?
Iain MacKenzie
I think overall Tim what you’ll see is we continually invest in to SSD and Brazil and with our restructuring program what I think that ends up at is op ex essentially remains flat, almost continuing while we invest in growth areas. So, I think we should hold it steady.
Operator
Our next question comes from Betsy Van Hees – Caris & Company.
Betsy Van Hees – Caris & Company
Iain I know it was a really challenging quarter and congratulations on being able to reach you goal of 15% of revenue being non-DRAM. Can you talk about how we should look at fiscal Q1 and also the entire year in terms of what percentage of revenue should we be looking at being non-DRAM as we move forward?
Iain MacKenzie
We’ve decided not to give full year guidance. I think in these, I guess tumultuous times would be kind of subtle way of saying that until the whole overall market climates begin to clarify then we’re not looking to give full year guidance. In Q1 though – Q4 was a peak or Q3 was a peak Q4 was a little bit down but still in that 15% to 20%. It was the goal by the end of the calendar year so we still feel we’re in that range and doing particularly well. We’ll talk more about that at the analyst days where we’ll have some of our technical people present.
Operator
Our next question comes from Kevin Kessel – J.P. Morgan.
Kevin Kessel – J.P. Morgan
Iain I was wondering if you could give us – I didn’t catch it, the non-DRAM business in the actual quarter as opposed to the year? I think it was 19% in the third quarter?
Iain MacKenzie
It was 17% in this quarter with DRAM business being 83% for the quarter. That was actually forecast from the previous quarter because in Q3 we had that launch of the product so you get the instantaneous stocking of a particular part.
Kevin Kessel – J.P. Morgan
In terms of the restructuring so it seems that you guys expect it to be completed pretty quickly here. There’s obviously not going to be any issues it appears in terms of at least getting some of those sites off line. The majority of the cost savings would I assume, happen at the cost of goods sold level? Is there a way to look at that in a relative split of the $11.5 million you’re talking about?
Barry Zwarenstein
It’s split both between operating expenses and COS. Much of the reduction of force was in the production folks so the larger part of it is in cost of sales.
Kevin Kessel – J.P. Morgan
And would you say it’s something like, just roughly speaking, 75%/25% split?
Barry Zwarenstein
I can’t really say that. I don’t know.
Kevin Kessel – J.P. Morgan
Okay but it’s just slanted towards COS more so?
Barry Zwarenstein
Right.
Kevin Kessel – J.P. Morgan
Just so I understand properly, when you were saying you were going to consolidate the Dominican Republic it sounds like in to the Puerto Rico plant and then you’re also closing your China and India facilities and you’re looking to move those in to Malaysia?
Iain MacKenzie
Yes. The Dominican Republic facility goes two ways, it goes to Malaysia and Puerto Rico so that actually split in to both. Then yes, China and India both get serviced from Malaysia.
Kevin Kessel – J.P. Morgan
Is it at all possible the [mod] has any of the China or India assets or are those?
Iain MacKenzie
We did that in a strange way. We did a bit of variable costs in both China and India for all of SMART’s physical assets, SEP systems, management systems and processes so we’re able to easily take that equipment out. We did not own any of the building infrastructure at all, that was with our partners and they continue to operate in those areas.
Kevin Kessel – J.P. Morgan
Just I guess to clarify on the housekeeping, I didn’t catch what cash flow from operations was in the fourth quarter, or cap ex for that matter. I heard the forecast for next year.
Iain MacKenzie
The cap ex for the quarter was $1.9 million for Q4 and the full year finished up at $13.3 million for full year 08 and then we forecasted to be between $13 and $18 million for fiscal 09 going forward. Cash flow from operations?
Barry Zwarenstein
For the fourth quarter about $2 million and then we have this negative $3.8 from investing primarily the fixed asset additions.
Kevin Kessel – J.P. Morgan
Do you also Barry have the depreciation amortization for the quarter handy?
Barry Zwarenstein
Yes. $3.6 million.
Kevin Kessel – J.P. Morgan
Then just lastly in terms of the tax rate, from what I can tell recently before the company went in to a loss position, it looked like the tax rate was running in the mid teens. I’m just trying to understand why it jumped up the way it will in fiscal 09 to the low 30s.
Barry Zwarenstein
Yes, we actually saw some of that starting to develop in fiscal 08 as well and its simply because the parts of the company most notably the US where we have losses we do not take the benefit of those losses because we establish a valuation allowance against them. So, simply stated GAAP taxes reflects that taxes on the [inaudible] entity whereas the pre-tax number is net of those losses, loss making US operations.
Operator
Our next question comes from Analyst for Gary Hsueh – Oppenheimer & Co.
Analyst for Gary Hsueh – Oppenheimer & Co.
Could you explain a little bit what causes the server weakness for the quarter?
Iain MacKenzie
I think overall the server weakness, in particular in the US region, is a high performance computing. Now, in some respect we have the wonderful phenomena in the summer [inaudible] where we certainly have many people taking vacations and some of the worse macroeconomic times that have happened. So, high performance computing installations have been significantly lower through this period. I think with our large serve companies than the demand being almost essentially similar to last quarter.
Analyst for Gary Hsueh – Oppenheimer & Co.
So if I look at the gross profit between this quarter and FQ2 at the same revenue level gross profit actually dropped almost 25%. Could you provide some light on what’s the main reason behind the gross profit drop in the last couple of quarters? I understand the product mix is probably one of the reasons, right?
Iain MacKenzie
Remember in FQ2 we had the market share loss and that reduction due to the significant price pressures. And then, going in to Q3 to Q4 is definitely a little bit of product mix of you’ll see that the desktop PC business was 26% of our mix and servers were down to exactly 1% of the mix. So clearly, that’s a lower gross margin percentage mix although albeit that made up in revenue terms to stay essentially just down a little bit from Q3. So, I think it’s the strong Brazil, the more parts, there was more memory and higher density going in per box in Brazil also to increase that portion holding the percentage down.
Analyst for Gary Hsueh – Oppenheimer & Co.
So the Brazil business while it’s growing it’s still at the low end of the margins compared to other regions?
Iain MacKenzie
The lower end of gross margins but as it should be. It takes a high level of capital equipment investment to run it and its focused towards a very competitive and fast growing high volume PC business. That profiles that business.
Operator
Our next question comes from Bob Gujavarty – Deutsche Bank.
Bob Gujavarty – Deutsche Bank
You mentioned the weakness in servers at HPC. Would you characterize kind of also maybe that there is a mix even within your existing server business to kind of lower end products, was that part of it at all?
Iain MacKenzie
Actually Bob it’s the opposite. As the mix goes towards the higher density, the higher priced parts, if you have a part that is $600 and the value add on that part is $60 then it looks like a 10% growth margin product however at $60 per unit of value add and significant value add. If you take that to the lowest end, if you take a $50 part and perhaps we get $10 of value add, it would appear as a 20% margin product but that $10 then clearly is a sixth of the value add per unit. So, I think the higher density parts actually carry a higher quality of GP dollar but a lower gross margin percentage.
Bob Gujavarty – Deutsche Bank
So you’d characterize actually outside of HPC your mix in server was fine, you actually sold some decent amount of high end products.
Iain MacKenzie
That’s correct.
Bob Gujavarty – Deutsche Bank
Then when I think about it, just going forward, should we think about the gross margins, is it really going to be a function of the mix or is there an opportunity somewhere within the category to grow the gross margin percentage either through value add or through cost reductions? How should I think about it?
Iain MacKenzie
For the DRAM business I think that two years now where it has shown swings from 16%, 21% depending on the price of the DRAM. So, I think the DRAM business, this is as normalized and high capacity slides in as lower density slides out. However, the gross margin enhancers are clearly the SSD and the display and the embedded product all of which are accretive if you like and also our Adtron SSD business then the higher end of that, the medical, the industrial, the defense, then all of those have been accretive so as the diversification continues to grow then clearly it continues to upward pressure on the gross margin percentage.
Bob Gujavarty – Deutsche Bank
So longer term I guess as those other businesses become a bigger part of your mix, we should see some uplift to the gross margin line?
Iain MacKenzie
That’s correct.
Bob Gujavarty – Deutsche Bank
Then just a little question about your cap ex, where is that? Is that pretty much going for Brazil expansion to support the volumes in the business? Is it a cost reduction effort? Can you just talk about why you’re investing and where?
Iain MacKenzie
Very, very simply and I assume you’re talking on a go forward basis, the cap ex probably 60% of that is Brazil and I would say the other 40% is pretty much technology as DDR3 comes in for DDR3 tests and support equipment and a little bit of expansion of our facility in Malaysia to continue to deal with the unit demand. So, we’ll expand that. But really technology and Brazil are the key areas.
Operator
Our next question comes from Edwin Mok – Needham & Company.
Edwin Mok – Needham & Company
Let me start with housekeeping, do you expect any impairment charge for the current quarter? And also, what your expected stock comp expenses in the quarter?
Barry Zwarenstein
With respect to impairment charge, for the first quarter no we do not expect an impairment charge. The second question, I didn’t hear it all, was it the outstanding shares?
Edwin Mok – Needham & Company
The second question is on stock comp expense?
Barry Zwarenstein
Yes, we expect it to be $2 million.
Edwin Mok – Needham & Company
Now, moving on to your product, before you guys talked about 8 gigabyte potentially being a driver and obviously 8 gigabyte is to a very expensive product and 4 gigabyte price has come down quite a bit. How do we visualize the 8 gigabyte ramp, how is that as a percentage of sale going and where is that right now? Do you expect more growth? Can you give some color on that?
Iain MacKenzie
I think until the [net line] platform is introduced in the first half of 09, I think what we have today is related to that high performance computing marketplace so I think the demand in particular [inaudible] the highest population by [E&B]. Then, I think that continues right through the end of this year. What is [inaudible] and should go up with the little bit of seasonality that happens with that business towards the end of any calendar year.
Edwin Mok – Needham & Company
One more question regarding the different end markets [inaudible] desktop, which areas do you think will be driving growth or do you think it will be contracting this quarter?
Iain MacKenzie
In the coming quarter will be network and telecom holding its own staying the same, the server will actually grow a little bit and you’ll see the mix reshuffle between server and desktop PC on a percentage basis. On a volume basis you’ll see desktop PCs continuing at this level and servers will gain strength within Q1 so that the overall mix will move back a little bit more towards last quarter’s mix.
Operator
Our next question comes from [Jeff Bennett – Wade Management Company].
[Jeff Bennett – Wade Management Company]
For your revolving credit agreement you have a LTM maintenance convent of a minimum of $50 million in EBITDA. Can you tell me what the calculation was at the end of the fourth quarter.
Barry Zwarenstein
Yes, it was about $54 million.
[Jeff Bennett – Wade Management Company]
And have you given any thoughts to perhaps how an amendment process would work if you were to drop below $50 million?
Barry Zwarenstein
We have given though to that, yes.
Operator
Our next question comes from [Fau Camaloden] – B. Riley & Company.
[Fau Camaloden] – B. Riley & Company
Just as a quick follow up to the comment about your flash business becoming a meaningful part of your business in 2009 I’m just wondering if you can just walk me through how you’re positioning yourselves right now for that business to get some scale next year? And, in particular, it sounds like you’re targeting some smaller tams for flash so I’m just wondering how you’re expecting to grow that business next year?
Iain MacKenzie
Clearly the high end will continue so it will be the business that Adtron serves through defense, military and industrial, it’s a good growing business and continues. And then, at the other level it will be the Xceed Ultra and Xceed Lite, you see them impacting a fairly wide industrial end market right now so this first stage will be that is the area we will see grow in circuit controllers, PLC controllers, in control systems in fairly distance areas. Then also linked to our kiosk business since kiosks [inaudible] to remote areas then the total cost of ownership is a big part of maintenance for both hard drive failure and fan failures in small form factor PCs as they switch that over then that’s an area of growth.
In terms of getting traction in the enterprise space, some of our current OEMs will jump to a fairly reliable source, in particular at the lowest capacity. The lower the capacity the better the value proposition to get this market spurred in a fairly recent and developing product.
[Fau Camaloden] – B. Riley & Company
Why are you not targeting the [inaudible] a little more aggressively? And by the same token, why not try and make a mark in some of the lower end applications like maybe notebook early on before you commoditize?
Iain MacKenzie
For the long term our focus is clearly we serve the OEM customers and have built a reputation of being a high quality specialized engineered solution type company? I think the commoditization of the MLC in particular drives is going to be extremely rapid and we’ve seen the Intel, Samsung and the large players Micron already make their mark and make their move. I think the same as we play in the DRAM market today which is some $25 to $30 billion and we’re a $600 to $800 million company depending on the pricing then we are the custom and specialized provider. We believe as the SSD market grows to be perhaps a $10 billion market, then again pulling 5% of that market share in to the custom specialty engineered solutions is a very, very good business for SMART and accretive gross margins albeit the gross margin percentage pressures will may come to the 30% to 35% level.
[Fau Camaloden] – B. Riley & Company
Finally, can you just give us a sense of how much revenue the Adtron business generated in the quarter and if not some sense for what the growth rate was year-over-year?
Iain MacKenzie
We said previously that the Adtron business was running at a run rate of around $16 million a year and I would say that that number is still consistent with their particular business going in to the higher end market.
Operator
Our next question comes from Kevin Kessel – J.P. Morgan.
Kevin Kessel – J.P. Morgan
Just another question on Adtron, when you guys did the deal initially I think that there was a stipulation that you would pay an additional $15 million if Adtron was able to meet certain financial and operational goals during calendar 2008?
Iain MacKenzie
That’s correct.
Kevin Kessel – J.P. Morgan
I was just wondering if you could give us any sort of an update in terms of how that’s appearing or where maybe it stands here that we’re three quarters of the way through the year?
Iain MacKenzie
Certainly, Adtron has been integrated for two quarters now, the purchase closed on the 3rd of March. So, in the last quarter I’m happy to report that we recorded a $1.5 million charge for the integration earn out so that’s good news and progress along the way on doing the integration. The next measurement point is not until January of 09 and then time to do the calculations and settle so it’s a little bit too early to make any predictions on any tranches.
Kevin Kessel – J.P. Morgan
But January, 2009 you’re saying is the next point which you’ll access the performance of the business from the time you acquired it through then? Or, just how it’s performed in general?
Iain MacKenzie
That’s correct. And, at the same time we continue to migrate and change how production is done, move production more towards Malaysia and in to SMART’s manufacturing and depending on the success and speed of that and their sales depend on how much that comes. It’s a fairly complex calculation in January.
Kevin Kessel – J.P. Morgan
But it would imply that there’s still another $13.5 million of earn out potential?
Iain MacKenzie
That’s correct.
Kevin Kessel – J.P. Morgan
Then if you could just, if you don’t mind, just reviewing I know you were asked a question just kind of regarding the end markets and your outlook for them in the next quarter with servers and desktops and I think you mentioned a few others I just didn’t catch some of the detail there. I know you said you expect servers to grow a little bit.
Iain MacKenzie
We’re expecting really a little bit of a switch over between servers and the desktop PC and essentially everything else to remain percentage wise as it was in Q4.
Kevin Kessel – J.P. Morgan
As it relates to just kind of enterprise IT spend, your visibility in to that I guess at the end of the day in terms of product that might end up being sold in to the financial vertical, do you have any sense for what your exposure might be?
Iain MacKenzie
We currently seem to have almost none as our datacom and telcom customers are focused on replacements and new systems and quite often emerging markets. The serve [inaudible] has been very low I think in display products in particular. Then, we did publicize that we had a short impact in one of the financial service companies there for multi screens that you probably are very much aware of. So by the way there’s not much exposure to the financial community however it will be interesting to see whether [inaudible] or slowing demand is happening for that quote. We expect it to be somewhere [inaudible] and the server demand typically strengthens in this next quarter.
Kevin Kessel – J.P. Morgan
Then when we just look at the servers again for those quarters, I think on a sequential basis there obviously down close to 20% on the year-on-year basis also down and your largest customer was down about 25% and obviously they’re mainly server. Would it then stand to be true that they’re selling a lot in to the high performance computing market, or at least their servers are that you’re dealing with?
Iain MacKenzie
Yes correct. I think if you go to the website www.Top500.org, I haven’t checked it extremely recently but typically in there you’ll see some of the largest installations in the domestic US and they actually publicize who wins them so yes, you’ll see the high performance players there. Which includes the new renewed efforts by the HPs, IBMs and Dell computing as well as all the rackable variety dedicated and continuous. It shows that everyone has a high performance computing focus.
Operator
Our final question comes from Analyst for Gary Hsueh – Oppenheimer & Co.
Analyst for Gary Hsueh – Oppenheimer & Co.
In discussion with some other DRAM makers they mentioned about some inventory build ups due to poor back to school season. Have you seen any higher than normal inventory levels at your customers?
Iain MacKenzie
We wouldn’t see it at all in our business a whole portion of it is value add and reasons like distances, it’s build to order, it’s pool systems, clean manufacturing and leading supply so we take our [inaudible] straight from the EMs suppliers and in memory we certainly don’t see that. Perhaps that’s more of a commercialized consumer desktop type phenomena so we would not be a good company to be an indicator of that.
Analyst for Gary Hsueh – Oppenheimer & Co.
Just a housekeeping question, in the past you kind of included stock-based compensation expenses in your non-GAAP results. This is probably the first quarter you split it out, any reasons behind this change?
Iain MacKenzie
Basically two main reasons, one is that it’s become a significant number reaching as Barry said $2 million for the next quarter and secondly at the advices that looks like the typical practice is now becoming majority for taking that out in to non-GAAP. What we wanted to do is be very, very transparent in doing that and hence why you got all these clarifications in the accounting.
Analyst for Gary Hsueh – Oppenheimer & Co.
This will be standard practice from now on right?
Iain MacKenzie
That’s correct.
Operator
Our next question comes from Edwin Mok – Needham & Company.
Edwin Mok – Needham & Company
Regarding your restructuring you guys are doing, can you quantify how much savings you expect on your op ex? I know you talked about it being flat in the coming [inaudible] on R&D but are you talking about flat sequentially quarter-to-quarter or are you talking about year-over-year?
Iain MacKenzie
You had a couple of things, one is $11.8 million of annualized savings after the restructuring has been done so not for fiscal 09 essentially but annualized once the restructuring is finished. It’s greater than $9 million of that does impact fiscal 09 completely. And, I really did say flat, we’re taking that restructuring savings and reinvesting it in to Brazil, in to unit capacity manufacturing, in to technology manufacturing for SSD. SSD, Brazil and capacity will take that investment so the good news is taking these restructuring actions fund our growth.
Edwin Mok – Needham & Company
On just kind of related to the inventory question, recently [inaudible] the chip makers are talking about in terms of PC demand the DRAM has slowed down a little bit the OEMs have cut back on orders. Are you seeing something similar in the server side?
Iain MacKenzie
No, nothing. There’s reports that we’re seeing in bit growth but not in core unit demand now excluding what I said about this quarter and servers and high performance computers being a little bit light so it will be good to see how that shapes up in this next quarter. But, demand still seems to be – I mean perhaps a reluctance to spend but not a significant slowdown in spend would be my assessment.
Operator
Mr. MacKenzie I’ll turn it back to you for closing comments.
Iain MacKenzie
Thank you to everyone on the call for your continued interest in SMART. We remain committed to executing on our objectives. We’re optimistic about the future growth and look forward to reporting to you our progress in future quarters to come. Thank you again.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!