Business context and reporting period
This is SMART Global Holdings, Inc.’s unaudited Form 10-Q for the quarter ended May 31, 2019 (fiscal Q3) and the nine months then ended. The filing describes a global specialty-memory, supply-chain services, and specialty-compute and storage business; its Penguin Computing acquisition expanded its exposure to high-performance computing, AI and machine learning. The request identifies Penguin Solutions, Inc., but the filing’s registrant is SMART Global Holdings, Inc. (NASDAQ: SGH).
Key financial metrics
Amounts below are in U.S. dollars; financial statement amounts are in millions except per-share data.
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $235.7 | $335.5 | $933.6 | $914.9 |
| Gross profit / margin | $43.0 / 18.3% | $78.1 / 23.3% | $185.2 / 19.8% | $208.9 / 22.8% |
| Operating income / margin | $7.4 / 3.1% | $48.7 / 14.5% | $77.6 / 8.3% | $125.2 / 13.7% |
| Net income | $1.9 | $31.9 | $45.7 | $89.7 |
| Diluted EPS | $0.08 | $1.37 | $1.96 | $3.90 |
| Cash from operations | Not presented for quarter | Not presented for quarter | $120.7 | $77.3 |
- At May 31, 2019, cash and cash equivalents were $126.1 million, including $99.7 million held outside the U.S. Current assets were $520.1 million and current liabilities $232.7 million; the current ratio was approximately 2.2.
- Net cash increased $88.9 million over the nine-month period. Investing used $30.2 million, primarily for capital expenditures of $30.1 million. Financing provided $0.8 million.
- Long-term debt had a $207.5 million net carrying amount, including $19.1 million current and $188.4 million long-term; principal outstanding was $213.5 million before unamortized discount and issuance costs. No revolver borrowings were outstanding; the facility provides up to $50 million. Term-loan rates were 8.79% and 8.86% at period end.
- Capital expenditures were higher year over year; property and equipment, net, rose to $67.1 million from $56.6 million at August 31, 2018. Operating cash flow benefited from an $82.8 million inventory reduction, partly offset by a $44.9 million decrease in accounts payable.
Material changes versus the prior comparable period
- Quarterly sales fell 29.8%, while nine-month sales rose 2.0%. Lower Brazil mobile-memory and DRAM sales reduced revenue by $130.7 million in Q3 and $143.1 million for nine months. Management cited weaker mobile-memory demand and lower average selling prices.
- SCSS, acquired with Penguin in June 2018, contributed $35.9 million of Q3 sales and $131.9 million for nine months. Nine-month specialty DRAM and Flash sales also grew, supported by product mix, new products and customer penetration.
- Gross margin contracted to 18.3% in Q3 and 19.8% year to date. Management attributed the pressure primarily to SCSS’s higher cost of sales and higher fixed manufacturing costs in Brazil.
- Operating expenses rose: Q3 R&D increased 16.1% and SG&A 24.0%; nine-month R&D increased 22.1% and SG&A 31.9%. Management attributed much of the increase to SCSS costs.
- Net income and EPS declined sharply. Nine-month interest expense increased $3.2 million, primarily due to incremental borrowing for Penguin; foreign-exchange losses were lower than in the prior-year periods.
- Reported 2019 results reflect ASC 606 revenue accounting, while 2018 comparatives remain under ASC 605. The filing says ASC 606 increased Q3 2019 net income by $1.8 million and reduced nine-month net income by $0.4 million versus results without adoption.
Outlook, commentary, risks and unusual items
- Management expects cash, operating cash generation and the credit line to fund operations for at least the next 12 months. No specific revenue or earnings guidance is provided.
- Brazil policy is a significant risk. Following a WTO decision, Brazilian authorities revoked 14 PPB/IT Program ordinances effective June 30, 2019 and began issuing replacement rules. Management expected similar support but cautioned that the replacement arrangements might not preserve existing benefits; adverse changes could materially affect Brazil demand, margins and results.
- Customer concentration is notable: one customer accounted for 20% of sales in both the Q3 and nine-month 2019 periods. Four other direct customers together represented approximately 58% of accounts receivable at May 31, 2019.
- The company relies on three suppliers for most raw materials; amounts owed to those suppliers totaled $113.5 million at May 31, 2019. Foreign exchange, variable interest rates, Brazilian tax-credit recoverability and inventory demand or obsolescence are additional exposures. A 1 percentage-point increase in rates on variable-rate borrowings would add about $2.6 million to annual interest expense, assuming the revolver were fully drawn.
- Brazilian ICMS tax credits totaled about $8.6 million at period end and are expected to be recovered over fiscal 2019–2022; timing depends on government approvals and business mix. The remaining import-duty assessment was about $1.4 million; management considered a material charge remote.
- The company disclosed a disputed SanDisk indemnification claim related to a patent matter; the stated contractual cap for intellectual-property claims is $60.9 million, but the company disputes the claim and cannot estimate a likely loss. The Netlist litigation was settled and dismissed with prejudice in January 2019, with no damages paid by either side.
- The filing reports $40.1 million in operating-lease commitments and expects the new lease-accounting standard to have a material financial-statement impact. It also reports no material changes to previously disclosed contractual obligations or risk factors, apart from the Brazil policy update.
- Penguin acquisition purchase accounting was adjusted in Q3 after inventory represented as held by vendors for repair was found not to exist at acquisition; goodwill increased by $0.7 million. The company reported no goodwill impairment.
Important facts for investors to verify
- Confirm the issuer identity: this filing is for SMART Global Holdings, Inc. (SGH), not an entity named Penguin Solutions, Inc.
- Assess whether the Brazil sales decline, pricing pressure and policy changes are temporary or could persist, and whether replacement PPB/IT rules maintain comparable benefits.
- Track SCSS growth and its effect on consolidated gross margins, operating costs and cash generation.
- Review customer and supplier concentration, Brazil ICMS-credit recovery assumptions, and the status and potential exposure of the SanDisk indemnification claim.
- Check debt service, covenant headroom, variable-rate exposure and the effect of lease-standard adoption; compare reported results with ASC 606-adjusted comparatives.