Business context and reporting period
This summary covers SMART Global Holdings, Inc.’s unaudited 10-Q for the 13 weeks ended November 29, 2019, compared with the 13 weeks ended November 30, 2018. The filing identifies the registrant as SMART Global Holdings, Inc.; the supplied metadata’s company name, Penguin Solutions, does not match the filing. The company designs and manufactures memory, computing, and storage products and services. It reported three segments: Specialty Memory Products, Brazil Products, and Specialty Compute and Storage Solutions (SCSS).
Key financial results
| Metric | Quarter ended Nov. 29, 2019 | Prior-year quarter | Change |
|---|---|---|---|
| Net sales | $272.0 million | $393.9 million | Down 30.9% |
| Gross profit / margin | $54.3 million / 20.0% | $85.1 million / 21.6% | Margin down 1.6 percentage points |
| Operating income / margin | $5.9 million / 2.2% | $47.8 million / 12.1% | Down $41.9 million |
| Net income | $0.2 million | $31.0 million | Down $30.8 million |
| Diluted EPS | $0.01 | $1.33 | Lower |
| Cash from operations | $25.3 million | $35.4 million | Down $10.1 million |
| Capital expenditures | $5.2 million | $13.4 million | Down $8.2 million |
At November 29, 2019, cash and cash equivalents were $111.4 million, total debt carrying value was $200.3 million, and total assets and liabilities were $782.7 million and $510.9 million, respectively. Debt principal was $205.3 million before unamortized discount and issuance costs; there were no revolver borrowings. The company had $532.3 million of current assets and $300.0 million of current liabilities. Cash included approximately $83.1 million held outside the United States.
Material changes and drivers
- Revenue fell primarily because Brazil product sales declined $105.3 million (52.8%), reflecting lower average selling prices for mobile memory and DRAM. Specialty Memory Products revenue declined $36.4 million (26.0%), also largely due to lower selling prices and product mix.
- SCSS revenue increased $19.8 million (36.3%); the two businesses acquired in July 2019 contributed $27.5 million of quarterly revenue. Segment sales were $103.5 million for Specialty Memory Products, $94.0 million for Brazil Products, and $74.5 million for SCSS.
- Gross margin contracted as lower Brazil revenue left fixed manufacturing costs less absorbed and SCSS cost of sales increased. R&D rose $3.1 million and SG&A rose $8.1 million, with increases principally associated with the acquired SCSS businesses, acquisition integration, and facilities.
- Operating cash flow declined despite positive cash generation. Working capital included a $42.2 million inventory increase, partly offset by a $60.4 million increase in accounts payable. Management attributed higher inventory and payables in part to moving inventory from contract manufacturers following acquisitions and higher program purchases.
- Cash increased $13.3 million during the quarter. The company paid $6.4 million of long-term debt and spent $5.2 million on capital expenditures.
Outlook, commentary, and risks
- Management said existing cash, the credit line, and operating cash generation should be sufficient to fund operations for at least the next 12 months. It described expected capital spending priorities as capacity, R&D, manufacturing equipment, and IT infrastructure; no specific earnings or revenue guidance was provided.
- The credit agreement requires a secured leverage ratio no greater than 3.5:1.0 and contains restrictions on debt, investments, dividends, and certain transactions. Term loans mature in 2022; the $50 million revolver was undrawn. A 1 percentage-point increase in rates on variable-rate borrowings would increase annual interest expense by an estimated $2.5 million if the revolver were fully drawn, with other variables unchanged.
- Foreign-exchange exposure is significant, particularly to the Brazilian real: approximately 35% of quarterly sales originated in reais, versus 51% in the prior-year quarter. The company reported $0.9 million of foreign-exchange losses, and its outstanding forward contracts had a $1.0 million derivative liability.
- Customer and supplier concentrations warrant attention. One customer represented 18% of quarterly sales; three direct customers together accounted for 43% of receivables. Three suppliers accounted for $136.2 million of amounts owed at quarter-end.
- Brazilian ICMS tax credits totaled $7.6 million; recovery timing depends on government approvals, sales, and product and regional mix. The company expects recovery over fiscal 2020–2023, but estimates could change.
- A Brazilian import-duty assessment for 2012–2013 stood at approximately R$5.6 million ($1.4 million) including interest and charges. Management considered material loss remote, but said it could not assure success. The company also disputes SanDisk indemnification claims related to a patent lawsuit; the potential amount is not clearly quantified in the filing.
- Unusual items include adoption of lease accounting, which added $27.2 million of operating lease right-of-use assets and $27.9 million of lease liabilities at quarter-end, and a $2.0 million share-based compensation charge following cancellation of a performance-based option. One performance-unit award’s compensation expense was reduced by $0.8 million after its performance condition was judged not probable.
- Management reported disclosure controls effective at a reasonable assurance level and no material changes in internal control over financial reporting. It reported no material changes to the risk factors in the prior annual report.
Important facts for investors to verify
- Whether subsequent quarters show stabilization in memory pricing and recovery in Brazil and Specialty Memory Products sales and gross margins.
- How much of SCSS growth and profitability is recurring after the July 2019 acquisitions, and the final purchase-price allocations and integration costs.
- Debt covenant headroom, scheduled debt repayments, interest-rate sensitivity, and liquidity available under the revolver.
- Inventory quality and working-capital conversion, especially given the quarter’s inventory build and supplier concentration.
- Recoverability and timing of Brazilian ICMS credits, and the outcome of the remaining import-duty and SanDisk indemnification matters.
- The effect of customer concentration, Brazilian-real movements, and related-party sales, which were $17.0 million for the quarter.