SMART Global Holdings, Inc. (SGH) Q1 2023 Earnings Call Transcript

SMART Global Holdings, Inc. (NASDAQ:SGH) Q1 2023 Results Conference Call January 3, 2023 4:30 PM ET

Company Participants

Suzanne Schmidt – IR

Mark Adams – CEO

Ken Rizvi – CFO

Conference Call Participants

Brian Chin – Stifel

Kevin Cassidy – Rosenblatt Securities

Raji Gill – Needham & Company

Sidney Ho – Deutsche Bank

Operator

Good afternoon. Thank you for attending the SGH First Quarter Fiscal 2023 Earnings Call. My name is Matt, and I’ll be your moderator for today’s call. All lines will be muted during the presentation portion of the call, with an opportunity for questions-and-answers at the end. [Operator Instructions]

I would now like to pass the conference over to our host, Suzanne Schmidt. Suzanne, please go ahead.

Suzanne Schmidt

Thank you, operator. Good afternoon, and thank you for joining us on today’s earnings conference call and webcast to discuss SGH’s first quarter fiscal 2023 results.

On the call today are Mark Adams, Chief Executive Officer; Jack Pacheco, Chief Operating Officer; and Ken Rizvi, Chief Financial Officer.

You can find the accompanying slide presentation and press release for this call on the Investor Relations section of our website. We encourage you to go to the site throughout the quarter for the most current information on the Company. I would also like to remind everybody to read the use of forward-looking statements note that is included in the press release and the earnings call presentation.

Please note that certain of the statements made today may constitute forward-looking statements and that these statements are the Company’s present expectations and that actual events or results may differ materially.

We will also discuss both, GAAP and non-GAAP financial measures. Non-GAAP measures should not be considered in isolation from, as a substitute for or superior to our GAAP results. We encourage you to consider all measures when analyzing our performance. A reconciliation of the GAAP to non-GAAP measures is included in today’s press release.

And with that, let me turn the call over to Mark Adams, CEO. Mark?

Mark Adams

Thanks, Suzanne, and thank you all for joining us today. I hope you all had a nice holiday.

Over the past two-plus years, we have been on a journey to transform SGH from a memory module company into a more diversified set of specialty businesses, spanning compute, LED lighting and memory. While each line of business is unique, SGH benefits from what they all have in common. First, they all developed advanced technology solutions at the system or subsystem level in order to address specific customer requirements. And second, they are all built on SGH’s core competencies in engineering, design and world-class manufacturing.

SGH’s diversified business model has driven higher quality revenue with more attractive gross margins. Our diversity has helped us perform steadily in a challenging macroeconomic environment. For example, in our Q1 earnings, our enterprise-related businesses were able to offset declines in our more consumer-facing businesses.

In the first quarter of our fiscal 2023, revenues totaled $465 million, which exceeded the midpoint of our guidance range. We also achieved record non-GAAP gross margins of 27.8% and non-GAAP earnings per share of $0.79, both of which came in above the high end of our guidance range.

I also want to highlight that with the integration of Stratus Technologies into Intelligent Platform Solutions, or IPS, the services portion of our Q1 business now represents approximately 16% of overall SGH revenues and 32% of IPS revenues, a record achievement and a clear demonstration of the increasing value we are providing our customers.

Now, let me turn to a brief review of each of our businesses, starting with IPS. Our IPS group designs and delivers complete hardware, software and services for high-performance computing or HPC and artificial intelligence or AI applications from the data center to the cloud and at the edge.

In Q1, IPS brands Penguin Computing and Stratus Technologies performed well. And IPS revenue came in at a record $211 million for the first quarter, up 46% sequentially and up 78% compared to our Q1 fiscal ‘22. IPS represented 45% of total SGH revenue, the largest component of our business in Q1.

As we’ve indicated on previous calls, we see the IPS business stronger in the first half of fiscal 2023, driven by large customer hardware installations. In particular, heading into our second fiscal quarter ending in February, we are seeing strong continued demand, driven primarily by installations at some of our hyperscale and federal customers. As you have been hearing from other technology companies of late though, overall visibility for demand out into calendar 2023 remains uncertain.

In November, Penguin Solutions participated in the Supercompute 2022 show, the Annual International Supercomputing Conference, where we demonstrated our strength in HPC and AI-enabled solutions. We made several key announcements, including the launch of Penguin’s new Scyld Cloud Central control plane, which provides management and orchestration across an organization’s on-premise and cloud-based resources to create flexible hybrid HPC and AI environments; a partnership with Google Cloud that gives our customers more choices for rapid cluster deployments with Penguin services; a pay-as-you-go model; and point-and-click integration with dozens of common HPC and AI applications, tools and libraries; and the acquisition of Colorado Code Craft, a small private company specializing in safeguarded remote work and collaboration software solutions. The addition of Colorado Code Craft solutions is expected to enhance Penguin’s virtual desktop infrastructure or VDI capabilities and expand our IP portfolio.

The integration of Stratus Technologies into IPS remains on track. With the addition of Stratus, IPS has a comprehensive portfolio of edge HPC AI and cloud solutions and services to meet the end-to-end needs of an even broader customer base.

Penguin and Stratus are now actively working together to identify new business opportunities and revenue synergies. In addition, one of our top priorities is to increase our recurring services businesses as a larger component of the solutions we offer our customers.

Now, turning to our LED Solutions Group, which produces application-optimized LEDs for products like specialty lighting, video screens, gaming displays, outdoor and architectural lighting.

Cree LED faced continued headwinds in China with COVID-related policies contributing to supply chain constraints and impacting demand for the entire industry. In addition to continuing softening in China, we are also seeing demand weakness in the U.S. and in Europe. For the first quarter of fiscal 2023, LED Solutions revenues totaled $63 million. In Q2, we expect revenue to be lower, driven by declining demand and further channel inventory reductions. Given this challenging macroeconomic environment for the LED business, we have been proactively containing costs and adjusting our ongoing operating expenses accordingly. While optimizing our business for the current environment, we continue to invest in developing innovative technologies for Cree LED’s key target markets of specialty high-value applications, including entertainment and horticulture, premium video applications such as fine pitch outdoor lighting designs and high-performance general lighting applications such as architectural and street lighting.

During the first quarter, the team launched spectrum-optimized photo-fill LEDs across high- and mid-power platforms for horticultural applications and introduced a new XLamp CMB product family with higher power, higher performance COB or chip onboard devices. Cree LED remains a technology and brand leader with strong intellectual property, and we remain confident in the long-term operating performance of the LED business, once macroeconomic headwinds recede.

In our Memory Solutions Group, revenue came in at $192 million or 41% of total SGH sales. As expected, sales declined from Q4 of fiscal ‘22 levels, primarily due to a reduction in the worldwide memory pricing and softening demand. Our core specialty memory business, which is focused on enterprise end markets, remains relatively stable.

Demand remains solid in the Networking and Telecom segments. On the technology front, we continue to see growing interest in SMART’s new family of DuraFlash PCIe NVMe and SATA products across various form factors. Longer term, we remain focused on expanding our memory business into enterprise compute applications to meet the growing demand within the data center and in the cloud for AI and machine learning capabilities.

Customer interest in our Compute Express Link or CXL products continues to grow as we have multiple designs underway in order to support memory expansion and acceleration for data center and cloud service provider applications. We also expanded our DDR5 module lineup for blade storage and computing applications and recently introduced a new family of data center SSDs for hyperscaler, hyper-converged, enterprise and edge computing data center applications.

The global weakness in PCs and mobile phones impacted our business in Brazil. Looking into Q2, we expect further softening, which is historically also a seasonally lower demand quarter. As one of the largest memory companies in Brazil, we continue to invest for the long term. Our Manaus factory has completed a number of key product certifications, and we see ongoing demand in Brazil for locally-produced SSDs with customers preparing to move to the latest Gen 4 products in calendar year 2023. We are also seeing initial shipments of memory for 5G mobile phones with the expectation of increasing market adoption in calendar year 2023.

I’ll stop here and hand it over to Ken for a more detailed review of our Q1 financial performance and our guidance for next quarter. Ken?

Ken Rizvi

Thanks, Mark. I will focus my remarks on our non-GAAP results, which are reconciled to GAAP in our earnings release tables. Now, let me turn to our first quarter fiscal ‘23 results.

Despite the macroeconomic headwinds, we reported a strong quarter in fiscal Q1 helped by the diversification of our business, strong execution and the strength of our IPS segment, which includes our recent acquisition of Stratus.

Net sales were $465 million. And non-GAAP gross margin came in at a record 27.8%, above the high end of our guidance. Non-GAAP diluted earnings per share were $0.79 for the first quarter, also above the high end of our guidance. In addition, beginning in the first quarter of 2023, we will be disclosing our overall SGH revenue and cost of sales by product and services.

Our services revenue includes longer term services as well as point-in-time services such as logistics and implementation services. With the addition of Stratus in the first quarter of 2023 our overall service revenues reached $75 million, up from the $33 million in the year ago quarter.

First quarter revenue by product and services were as follows. Product revenues were $390 million, and service revenues were $75 million.

First quarter revenue by business unit was as follows. IPS had a record $211 million; LED, $63 million; and memory, $192 million. This translates into a sales mix of approximately 45% IPS, 13% LED and 41% memory.

Non-GAAP gross margin for SGH in the first quarter of 2023 was a record 27.8%, up from 27% in the year-ago quarter, helped by the inclusion of Stratus within IPS but offset by lower sales from LED. Non-GAAP operating expenses for the first quarter were $74.4 million, up from $61.1 million in the fourth quarter of 2022 and from $57.9 million in the year ago quarter.

Operating expenses were up primarily due to the inclusion of Stratus, which accounted for $18.7 million of our operating expenses in the first quarter Operating expenses also benefited in the first quarter of 2023 from $2.6 million in financial credits in Brazil, which was up from $2 million in the fourth quarter of fiscal ‘22 but down from $5.9 million in the year-ago quarter. This credit is expected to provide approximately $1 million to $2 million of benefit in our second quarter of fiscal 2023.

Non-GAAP diluted earnings per share for the first quarter of 2023 was $0.79 per share compared with $1.08 per share in the year ago quarter. Adjusted EBITDA for the first quarter of 2023 was $63 million or 14% of sales compared to $77 million or 16% of sales in the year-ago quarter.

And now, turning to working capital. Our net accounts receivables totaled $306 million compared with $410 million last quarter. Days sales outstanding came in at 33 days, down from 14 days (sic) [down 14 days from] last quarter, primarily due to the timing of collections for IPS.

Inventory totaled $416 million at the end of the first quarter, up from $323 million at the end of the prior quarter. This increase outlined during our last earnings call was driven primarily by inventory required to support our IPS revenue in the second quarter. We would expect inventory to come down significantly by the end of the second quarter.

Inventory turns were 7 times in the first quarter versus 8.5 times in the prior quarter. And consistent with past practice, net accounts receivables days outstanding and inventory turnover are calculated on a gross sales and cost of goods sold basis, which were $843 million and $725 million, respectively, for the first quarter.

And as a reminder, the difference between gross revenue and net sales is related to our logistics services, which is accounted for on an agent basis, meaning that we only recognize the net profit on logistics services as net sales.

Cash and cash equivalents totaled $325 million at the end of the first quarter compared with $363 million at the end of the prior quarter. First quarter cash flow used in operations totaled $74 million compared with cash provided by operations of $20.9 million in the prior quarter. The primary reason for this was the prepayment of the $101.8 million earn-out note from the Cree LED acquisition. We accounted for a majority of this prepayment in our operating cash flow given it was a contingent consideration. In addition, in the first quarter, we increased overall inventories to support expected demand for IPS in the second quarter of fiscal 2023.

In the first quarter, we repurchased 182,000 shares spending $2.8 million during the quarter. In aggregate, we have spent approximately $53 million under our $75 million share repurchase authorization through the first quarter, repurchasing approximately 2.8 million shares.

For those of you tracking capital expenditures and depreciation, capital expenditures were $11.6 million in the first quarter and depreciation was $8.9 million.

In the first quarter of 2023, in conjunction with the acquisition of Stratus, we also expanded our existing term loan credit facilities by $300 million. We used the net proceeds to retire the $101.8 million outstanding CRE LED earn-out note, and along with cash on hand, paid for the $225 million purchase of Stratus. The Term Loan A facility bears an interest at SOFR plus 2.25% based on a total leverage grid. For the second quarter, we would expect our total cash net interest expense to be approximately $8 million based on current SOFR rates.

Turning to our second quarter 2023 guidance. We expect that net sales for the second quarter of fiscal 2023 will range from approximately $410 million to $460 million or approximately $435 million at the midpoint. Our guidance for this next quarter incorporates the continued strong demand in our IPS business offset by lower demand in our memory and LNG businesses.

Our GAAP gross margin for the second quarter is expected to be approximately 25% to 27%. Non-GAAP gross margin for the second quarter is expected to be approximately 26% to 28%. Our non-GAAP operating expenses for the second quarter are expected to be approximately $75 million, plus or minus $3 million, and up slightly from the first quarter, in part due to the timing of nonrecurring engineering costs to support our IPS business.

GAAP diluted earnings per share for the second quarter is expected to be approximately $0.13, plus or minus $0.15. And on a non-GAAP basis, excluding share-based compensation expense, intangible asset amortization expense, debt discount and other adjustments, we expect diluted earnings per share will be approximately $0.60, plus or minus $0.15. This also includes the benefit of approximately $3 million from an asset sale accounted for in nonoperating income.

Our GAAP and non-GAAP diluted share count for the second quarter is expected to be approximately 50 million shares based on our current stock price. Cash capital expenditures for the second quarter are expected to be in the range of $12 million to $15 million, in part due to expenditures to migrate Cree LED into its own U.S. facility.

We continue to manage our operations in a prudent manner as we navigate a challenging environment while also continuing to invest in our long-term growth. Our forecast for the second quarter of fiscal 2023 is based on the current environment, which contemplates the global macroeconomic headwinds and continued supply chain constraints. Please refer to our non-GAAP Financial Information section and Reconciliation of GAAP to Non-GAAP Measures tables in our earnings release for further details.

Now, let me turn it over to Mark for a few remarks prior to Q&A.

Mark Adams

Thanks, Ken. We remain very excited about the future of SGH. As we have mentioned, our fiscal ‘23 is front-end loaded with some large IPS installations. And like many technology companies, we have limited visibility into the demand environment in the second half of our fiscal 2023. With that in mind, I want to reiterate our commitment to our shareholders that we will remain vigilant in how we operate the Company in the near term while investing for long-term success.

I do want to highlight that this quarter, despite the macroeconomic headwinds, whether China’s COVID environment weakening consumer demand or increasing interest rates, our team accomplished record non-GAAP gross margins. We credit our CapEx-light model, our diverse set of businesses and our continued focus on delivering value-added differentiated products and services that enabled our solid operating performance in these challenging times.

Operator, we are now ready for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from the line of Brian Chin from Stifel.

Brian Chin

Hi. Good afternoon. Thanks for letting us ask some questions and congratulations on the results. Maybe first question, Mark. It looks like you expect mix in the February quarter to be fairly consistent with the November quarter, and margins down a little bit. Is that just sort of like on service versus hardware mix within IPS, or is there another consideration there? And then, I have a follow-up question.

Mark Adams

Yes. Let me take the first part of the question, which is around just the relative performance of the business. As we go into our second quarter, obviously, we have a very consumer-focused business — facing business in the Brazil mobile phone and PC business, which has historically been a little bit softer in the quarter anyway. And then the LED business is demonstrating very similar characteristics. So, the overall trend line in the business from Q1 to Q2 is kind of on the same trajectory. Relative to mix and margins, I’ll let Ken chime in.

Ken Rizvi

Hey Brian, thanks for the call. Yes, if we look at the trajectory from Q1 to Q2, there’s very little movement in the margin profile, but it’s as Mark highlighted, there’s a couple of factors. One being we’re expecting the LED business to be down slightly Q1 to Q2, and margins will come down given the fixed cost on the back end. And then two, you hit it earlier, which is on the services piece. We have some of the services that are more onetime in nature, so we would expect services revenue overall for the Company to be down slightly. And so those are both mixed related items based on the revenue profile.

Brian Chin

Okay. That’s helpful. And then for the follow-up, are you a little surprised or are you anticipating the softer memory prices and kind of your pass-through to your customers? Do you think that will have become more of a headwind in either the February or May quarters in the Memory Solutions business?

And also, I know you’ve alluded to consistently that the fiscal first half is stronger for IPS based on the way some of those projects are sort of setting up. I know it’s kind of hard to make a firm commitment here. But do you think sort of that first half-second half mix could be something like a 55% revenue first half versus 45% second half? Just trying to get some idea of sort of how severe that first half-second half dynamic could be.

Mark Adams

So, I’ll take the first part relative to the memory market. As you can see from the pure semi players in the memory space, the pricing environment is pretty challenging. And we see that in Brazil. We see it both in terms of the top line revenue and also the overall demand environment from a broader macro. So, it’s kind of a — it’s very challenging in a consumer-facing business like that.

In the Specialty business, actually, we have seen some of the pricing pressures you’re referring to, but less so more stability, not perfect, but more stability in the pricing in memory versus consumer when you look at the specialty pricing. And our margins actually are pretty good in the Specialty Memory business. Gross margins are pretty good as it’s — our pricing — the revenue kind of stabilizes the gross margin contribution for our services that we provide. The value-add we provide actually drive gross margins slightly up in that sense.

And so, I would say consumer pricing doesn’t feel great right now in the memory space if I just listen to the larger semi people in their reports. But in our business, it’s less impactful, and the Specialty business has been more stable.

Ken Rizvi

Yes. Brian, in terms of the IPS breakout, it’s still a little bit too early to call the second half. But if you ask me today, it’s probably in that 55-45 or 60-40 range as we see it today. But as I mentioned, we don’t have clear visibility as we look out 2 quarters. And we had pretty good visibility into Q2 and pretty good visibility in Q3, and we’re still building the backlog and the bookings as we head out into Q4, into 2024 as well.

Brian Chin

Got it. But I guess in terms of component availability, if you did have kind of “turns” business, you’d probably be in a better position to fulfill that now than six months ago.

Ken Rizvi

Yes. That’s right. I would say if you looked at the supply chain today, the supply chain today is much better than it was six months ago. There’s still some components out there in shortages within specific semiconductor and other parts, but definitely much better today than it was six months ago.

Operator

The next question is from the line of Kevin Cassidy with Rosenblatt Securities.

Kevin Cassidy

Yes. Thanks for taking my question. Congratulations on the great results. I’ll stay on the IPS and visibility into the second half of the year. Can you give us a little more description of maybe what you’re seeing as far as RFQs go from both the public and private sector? And then also, are there service contracts that are up for renewal as you go out into the second half of the year?

Mark Adams

Thanks for the questions, Kevin. I think the way I would suggest is that the RFQ process is fairly stable. I wouldn’t say it’s increasing, but fairly stable. Where I think the visibility gets challenged, both in federal and commercial, is the implementation, the project schedules that we just can’t see. We’re just trying to be careful and cautious on better understanding that three quarters out. And so, we’re giving you some guidance on Q2 here, but we’re just trying to be careful in this environment to make sure that the deliveries that we have and we’re looking at the back half will go off as planned. And so, we’re just monitoring that kind of week-to-week, month-to-month. That’s the kind of game we’re in right now.

As it relates to the service piece of the business, a lot of the services we have, not all but a lot of them, are kind of on schedule. I’ll let Ken talk to that in a second, but they’re on schedules. And that’s where we get a little bit more color and predictability on the recurring nature of those services, and that’s really a strength of the business that we’re continuing to look to build.

Ken Rizvi

Yes. So, Kevin, thanks for the call. If we look at the services component and you look at those that have higher visibility, and I would exclude things like implementation services or logistics services that come in but can come in, in any period in a different size, it’s probably in the neighborhood, I would say, in that $50 million range, plus or minus, that are more on an annual recurring basis or we have better visibility even looking out to a year. So, I think that’s one of the things that we’ve highlighted over the last 1.5 years here is trying to build more recurring revenue base. And with Stratus, along with what the team at IPS and even within the memory business has been doing, we have a lot more services, which hopefully provides more stickiness and more value and demonstrates the value we’re providing to our customer base.

Kevin Cassidy

Okay. Maybe turning to the specialty memory. There are two exciting things happening in the memory market with DDR5, and also CXL. You’re still staying as a custom solutions for those products. Is that correct, first? And then, what do you see as activity for custom versions of DDR5 and CXL?

Mark Adams

Look, I think, Kevin, the long-term view of specialty memory for us is really, really pretty positive. Obviously, all of us have seen the cyclicality in the broader memory markets, and we’re kind of in that place today where there’s just a lot of oversupply, pretty much demand-driven. And then the capacity and the memory players are adjusting accordingly.

In the short term, again, as we said, pricing will be a challenge. Demand in the consumer space will be a challenge. But as you’ve noted, there’s a number of trends that speak to a positive demand over a longer-term horizon and that being 5G and mobile, that being enterprise and high-performance specialty computing driven by AI and machine learning. And then, just broader need for high-performance memory, high-bandwidth memory, enabling compute, the challenges that are out there in terms of even high-performance computing that we get pretty good exposure with the Penguin business.

We see the demands on memory. And as you’re referring to controller-based memory, compute Express Link, CXL-like applications. A lot of the DDR5, CXL, 5G, the demands are good, automotive, all of those will be long-term tailwinds on the demand side. But right now, we’re in a market that just is oversupplied, and it’s kind of — they’re not able to call the turn, so to speak. And so, we’re going to be careful on how we see it in the short term.

But we like the Specialty business. We think it’s performed much better over the last couple of years under Jack’s leadership, and we’re pretty positive about that in terms of the long-term prognosis. It’s just the market conditions we’re in are hard to call.

Operator

The next question is from the line of Raji Gill with Needham & Company.

Raji Gill

Yes. Thank you. And congrats again, and happy New Year. Just a question on the good progression in the services revenue. I think based on my numbers, the service revenue has really grown, almost probably doubled or tripled over the last several quarters, and now you’re starting to break it out. Can you talk a little bit about how Stratus is helping, contributing to that?

And then Ken, you mentioned kind of two components of the services, the long-term service contracts. And then you have the point in time, I believe, is what you mentioned. Can you maybe elaborate further on kind of what you’re seeing within the mix of services and how you’re kind of catering the business on a go-forward basis?

Mark Adams

Well, thanks for the question, Raji. I’ll answer the first part, and I’ll let Ken talk to the back half of the question.

Stratus’ business, the value-add has been their ability to maintain high availability, fault tolerant-type availability. The industry called it five nines, which is 99.999% above time. And they do that through a lot of remote monitoring, proactive system management capabilities that they have, and they also have a pretty good software platform for doing so.

And so we are definitely evaluating how we can take advantage of that to scale beyond just their platform, Stratus into more IPS-specific customer environments. And so, the combination of two has really put us in a really good position to drive continued value-added services. Relative to the nature of these agreements, I’ll let Ken comment.

Ken Rizvi

Yes. So Raji, I think we mentioned it. If we look back at the transcript, now a year ago, we had about $33 million of services, and in this quarter, it’s closer to $75 million. And within that, there are, what I would say, longer-term contracts. Those can be up to a year, sometimes even longer than that, where we’re providing a variety of services for our customers, some of which Mark has mentioned just before. And that’s the number I provided to Kevin just a few minutes ago. That’s probably — those longer-term services are probably in that $45 million to $50 million range a quarter, and then there are more kind of onetime or point-in-time type of services that can occur in every quarter. And so, that’s a rough split of services component, but it just shows or hopefully showcases the value that we continue to provide our customers. It’s beyond the hardware, and those services really provide some stickiness with our customer base.

Raji Gill

Yes. I appreciate that. And for my follow-up, on the gross margins, the gross margins I believe have kind of hit close to a record, given the strong mix of services at nearly 28%, and you’re guiding at 27%. I know that the IPS segment is lumpy, and therefore, the margins associated with that revenue stream are also lumpy. But when we go into the May and the August quarter and the November quarter, are there potential offsets to that IPS lumpiness? You talked about obviously more longer-term services revenue, or should we be kind of modeling more seasonality in the margins in the second half, given the kind of a drop-off in IPS? Just kind of curious how you think of short term and long term. Thank you.

Ken Rizvi

Sure. So Raji, I think as you look at the transition from Q1 to Q2, part of that is the mix that I mentioned around services overall, and we’d expect the overall services component to come down a bit Q1 to Q2.

And the other piece that we I think highlighted on the transcript was that the LED business is expected to be down a bit. And therefore, given some of the fixed costs we have on the back end side, even though we have no front-end manufacturing, we have some fixed costs in the back end side, so we would expect margins for that business to come down as revenues come down into Q2. And that is what is driving the margin profile down a bit Q1 to Q2.

But still, if you look back even a couple of years ago, this business was doing 19%, 20% gross margins. And in Q2, we’re guiding to 27% on a non-GAAP basis at the mid. So, very healthy margins, much different business today than it has been in the past.

As we look out in time, there will still be some lumpiness as it relates to IPS. I think we’ve talked about that on a number of our calls based on how much hardware we have, how much services we have, which can be point in time for that business as well. But I feel like we are hopefully at a much healthier state in terms of the margin profile just based on what we’re guiding to for Q2, which is, as I mentioned, 27%, plus or minus a point.

Raji Gill

Got it. And just if I could just squeeze one more and then I’ll step back in the queue. The challenges in the Brazil business, it looks like — I know you don’t break out the Brazil business anymore with respect to specialty. But it looks like Brazil is coming down 40%, 50%, something in that range, and more pressure in the PC consumer. I’m curious, you did then also talk about some trends in 5G and other areas. So, I’m curious, how you’re thinking about the Brazil market, consumer? Are we — do you think we’re approaching a bottom? Is the inventory kind of cleared out there and then we’re going to have a little bit of a rebuild and more of a secular push to 5G as Brazil catches up to the rest of the world? I’m curious how you’re thinking about the Brazil business. Thanks again.

Mark Adams

Yes. I think the way we look at it is the consumer memory business is most aligned with the challenges in the broader memory supply and demand dynamics, just given the end markets and the amount of memory those markets consume in terms of the overall industry supply.

And so, we think that as we sit here today, as the supply and demand balance hopefully normalizes, that business will recover, in addition to, we think we’re pretty well positioned down there. And yes, you looked at the memory competitors or the suppliers of memory semiconductors and their revenue is down significantly, and you see that in our consumer business.

But the dynamics of us with 5G with SSDs coming out of them in house and starting to be able to build that business up as PCs and servers get back into a positive demand, it’s kind of hard for us to say that this next quarter is the bottom. But coming through the holidays and to your point about inventory, I would just say we’re hoping that we’ll bounce around the bottom here and hoping it’s where we start to see an uptick. It’s — but the visibility for us is as tough as it is for the pure memory guys.

Operator

[Operator Instructions] The next question is from the line of Sidney Ho with Deutsche Bank.

Sidney Ho

Great. Thanks for taking my question. Maybe start off with the clarification one. How much does Stratus contribute to revenue in fiscal Q1 versus your expectation of $35 million to $40 million? It looks like the organic business performed better than you expected. And I’ll ask a few more questions about that.

Ken Rizvi

Sure. That revenue came in closer to that $45 million number for Q1. It did very well and the margins were…

Mark Adams

And I would just also comment, Sidney, that we’ve got two parts of the business that we’ve talked about in the past. One is the data center, which is primarily service-driven, and there are some upgrades along the way. And then there’s an edge business. And the growth Ken just highlighted there in his response, the growth really came from upside in their edge business, which is something more broadly, we’re really encouraged about as a long-term play in the fault tolerant high-availability edge products.

Sidney Ho

Great. Maybe just double click on the entire IPS revenue, revenue of $211 million for Q1. Can you give us a rough breakdown by end market between federal spending versus hyperscale customers versus commercial? And are you seeing different trends between these end markets in terms of the ordering patterns?

Mark Adams

I’d say we’re not going to break out as you ask at that level, but we can give you the — the second part of your question more on the trends. I think it goes back to what we’re seeing as stable demand as far as we can see. But certainly, we’ve given — Ken has given guidance for Q2, and the kind of building of our funnel has been relatively stable.

Again, my comment still holds from my earlier — from the earlier question that in these types of market conditions, it’s more around customer project management in terms of what they do in their budget process and do they push things out, do they move things in, what have you.

We see continued investment across the commercial enterprises, and not breaking those out in any particular format. And the government, which had been somewhat muted a little bit during the COVID — the highest point of COVID over the last couple of years, we think this year has been — will be positive in the first half, maybe in the Q3. But again, it’s really hard to see what’s going to happen, and so it has to do with really our customer environments and how they’re going to play their capital dollars and their investments.

Sidney Ho

Okay. That’s helpful. Maybe switching gears to the LED business. You talked about the business being impacted by headwinds in China and maybe in the U.S. and Europe as well. How do you expect the reopening of China going to impact that business positively, I guess? Will you start seeing the benefit in the February quarter or more in the May quarter? And if you can touch on the profitability of the business, what are you doing to contain costs, that would be great.

Mark Adams

Yes. Well, as we’ve talked about, we’re not calling the bottom to show up here in February quarter. We’ve kind of guided that — this is actually because of the holidays and Chinese New Year in the same quarter, given our fiscal quarters, we’re not seeing a bounce in this quarter. So, I would be muted a little bit in terms of our call on the bottom here in the quarter.

We’d like — we think that with distribution burning a fair amount of inventory in Q1 and still in the Q2, and as you said, China is starting to open up a little bit, we could see some of that hopefully in our third quarter.

And then, as far as the things we’re doing to manage our costs, headcount freeze, that type of thing, when we’ve looked at the type of support we have in our back-end facilities and maybe we’re optimizing around the number of lines we’re running and the schedules we’re running there, capital, looking at capital deployment and then how we can move that out in line with the market dynamics and just a number of things. And it’s actually been a pretty meaningful number. But as you’ve highlighted and that people highlighted in the call, LED business has gotten hit very similarly to Brazil. So, we’re balancing out really good efforts on the cost containment with not trying to hurt the business for the long term because we do think it will bounce back at some point here.

Sidney Ho

Okay. Maybe one last one for me. Given the high interest rate, how should we think about interest expense going forward? And what portion of your debt is hedged at this point?

Ken Rizvi

Yes. So, this — I’ll answer that. If you look at our net interest expense in the formal script, we’d expect that to be at about $8 million. So, that’s both the interest expense and interest income on a cash basis, about $8 million, and that’s based on today’s SOFR rate. So, one of the things that we can’t predict is where those rates will go. But what we have been doing a good job is with the cash on hand, getting better and better interest income over time. But for now, I would assume it’s at that $8 million range of cash net interest expense per quarter, and that can fluctuate depending on what the Fed does.

If you look at the kind of floating versus fixed on the debt, it’s about 70% floating and 30% fixed. The biggest piece of the fixed is that convertible note. That’s at a fixed rate of 2.25%. And then our TLA, which is about $570 [million] in size, that’s at SOFR plus 2.25%.

Operator

Thank you for your questions. There are no additional questions waiting at this time, so I will pass the conference back to Mark Adams, CEO, for any closing remarks.

Mark Adams

Well, again, thank you for joining us today. I’d like to thank all of our employees worldwide for a great first quarter, especially in these market conditions. I’d like to thank all of you for attending today and look forward to seeing you at various conferences. And for those of you who will see us at CES, we’ll see you then. Have a great day. Thank you.

Operator

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.