Business context and reporting period
This is SMART Global Holdings, Inc.’s unaudited Form 10-Q for the quarter ended May 29, 2020 (fiscal Q3 2020), filed July 7, 2020. The filing identifies the registrant as SMART Global Holdings, Inc., not Penguin Solutions; Penguin Computing is discussed as an acquired subsidiary. The company reports three segments: Specialty Memory Products, Brazil Products, and Specialty Compute and Storage Solutions (SCSS). Amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net sales | $281.3 million | $235.7 million | $825.3 million | $933.6 million |
| Gross profit / margin | $54.2 million / 19.3% | $43.0 million / 18.3% | $160.1 million / 19.4% | $185.2 million / 19.8% |
| Operating income | $10.1 million | $7.4 million | $24.1 million | $77.6 million |
| Net income (loss) | $0.8 million | $1.9 million | $(8.7) million | $45.7 million |
| Diluted EPS | $0.03 | $0.08 | $(0.36) | $1.96 |
| Operating cash flow | Not separately presented | Not separately presented | $62.2 million | $120.7 million |
- Q3 sales rose 19.4% year over year; nine-month sales fell 11.6%. Q3 net income was positive, but the nine-month period was loss-making.
- Q3 operating expenses were $44.2 million, versus $35.6 million a year earlier. Nine-month operating expenses increased to $136.0 million from $107.6 million.
- Nine-month investing cash outflow was $16.7 million, mainly capital spending; financing provided $12.8 million. Cash increased $33.7 million to $131.8 million, including a $24.5 million adverse currency translation effect.
- At May 29, 2020, current assets were $567.1 million and current liabilities $306.3 million. Inventory was $180.6 million, up from $118.7 million at August 30, 2019.
- Debt included $250.0 million principal of 2.25% convertible notes due 2026 and $0.6 million of BNDES debt. The notes’ net carrying amount was $193.5 million; cash was $131.8 million. The company reported no revolver borrowings and a $50 million revolving facility.
Material changes versus comparable periods
- Q3 growth reflected higher SCSS revenue, including contributions from the 2019 SMART EC and SMART Wireless acquisitions, and higher Specialty product sales. Brazil Products revenue declined.
- For the nine-month period, SCSS revenue increased, but Brazil Products sales declined $163.0 million, more than offsetting growth elsewhere.
- Reported Q3 gross margin improved to 19.3% from 18.3%; nine-month gross margin was approximately 19.4%, compared with 19.8%.
- Higher acquisition-related operating costs contributed to increased R&D and SG&A. Nine-month operating income fell substantially versus the prior year.
- In February 2020, the company issued $250 million of convertible notes and used proceeds principally to repay its former term loans and purchase capped calls. Nine-month results included $6.8 million of debt-extinguishment loss and $7.7 million of capped-call mark-to-market loss.
- The company adopted operating lease accounting in fiscal 2020; at May 29, 2020, reported lease liabilities were $27.2 million and right-of-use assets were $26.3 million. Prior-year balance-sheet amounts were not restated.
Outlook, commentary, risks and contingencies
- Management stated that existing cash, the revolving line and operating cash generation should fund operations for at least the next 12 months. No quantified revenue or earnings guidance was provided.
- COVID-19 had reduced sales in certain SCSS product lines, though the company had not yet experienced significant operational or supply-chain disruption. Management warned that prolonged disruption could affect demand, manufacturing, development, customer support and cash flows.
- Brazil incentive programs changed effective April 1, 2020, replacing certain tax reductions with financial credits. The company cautioned that benefits could differ from prior arrangements and that compliance and program changes could affect Brazilian demand, margins and taxes.
- Foreign-exchange exposure is significant: approximately 35% of nine-month sales originated in Brazilian reais, versus 48% in the prior-year period. Nine-month foreign-exchange losses were $2.6 million. The filing also highlights reliance on a limited number of customers and suppliers.
- Two customers each represented at least 10% of nine-month sales (18% and 11%); three customers accounted for 47% in the prior-year period. Three suppliers represented most raw-material purchases, with $149.3 million owed to them at May 29, 2020.
- A Brazilian import-duty assessment of approximately $1.1 million remained disputed; management considered material charges remote. The SanDisk indemnification dispute followed a May 2020 court-approved dismissal of the underlying Netlist/SanDisk case.
- Management reported disclosure controls and procedures were effective at a reasonable assurance level and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Confirm the intended issuer: the supplied filing is for SMART Global Holdings, Inc.; “Penguin Solutions” does not appear as the registrant name in this 2020 filing.
- Assess whether the nine-month revenue decline and net loss are temporary or reflect continuing weakness, particularly in Brazil Products.
- Review inventory growth, working-capital needs and the factors behind operating cash flow falling by nearly half year over year.
- Verify note terms, potential cash settlement or repurchase obligations, dilution exposure, and continued access to the $50 million revolver.
- Monitor COVID-19 impacts, Brazil incentive-program implementation and foreign-exchange movements, as well as customer and supplier concentration.
- Check resolution of the Brazilian tax assessment and other indemnity or legal matters; the filing does not quantify a probable loss for several contingencies.