SMART Global Holdings, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2019, three months ended November 30, 2018; comparative quarter ended November 24, 2017. The filing is by SMART Global Holdings, Inc. (not a registrant named Penguin Solutions). Unless stated otherwise, amounts are U.S. dollars.
Business context and results
The company designs, manufactures and sells specialty memory products and provides supply-chain services. Following its June 2018 acquisition of Penguin Computing, it also operates Specialty Compute & Storage Solutions (SCSS), serving specialized computing markets. The company reports one operating segment.
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $393.9 million | $265.4 million | +48.4% |
| Gross profit / margin | $85.1 million / 21.6% | $57.8 million / 21.8% | Margin down 0.2 percentage points |
| Operating income / margin | $47.8 million / 12.1% | $31.5 million / 11.9% | +51.9% income |
| Net income / margin | $31.0 million / 7.9% | $21.0 million / 7.9% | +47.5% income |
| Diluted EPS | $1.33 | $0.92 | — |
| Operating cash flow | $35.4 million | $14.3 million | — |
| Capital expenditures | $13.4 million | $6.0 million | — |
Revenue growth reflected $54.7 million from SCSS, higher Brazil DRAM and mobile-memory sales, and growth in Specialty DRAM and Flash. Gross margin edged lower, primarily due to SCSS costs. R&D expense rose 38% and SG&A rose 43%, with new SCSS costs among the main drivers. Interest expense increased $1.3 million, largely due to acquisition financing; income-tax expense increased $4.5 million, reflecting higher taxable income outside the U.S. and expired tax incentives.
Cash, debt and liquidity
- At November 30, cash and cash equivalents were $63.0 million; current assets were $622.2 million and current liabilities $332.8 million, yielding working capital of $289.3 million and a current ratio of about 1.9. Cash included approximately $47.9 million held outside the U.S.
- Operating cash flow of $35.4 million was supported by net income and noncash expenses, partly offset by working-capital movements, notably an $89.4 million increase in receivables. Cash increased $25.7 million during the quarter.
- Debt was $217.3 million in principal outstanding ($210.4 million net carrying value after unamortized discount and issuance costs); no revolver borrowings were outstanding. The $50 million revolving facility remained available, subject to its terms and covenants. Term-loan rates were 8.86% and 8.58%.
- An October 2018 credit-agreement amendment waived scheduled term-loan principal payments and excess-cash-flow repayments for fiscal 2019. The credit group must maintain a secured leverage ratio no greater than 3.5:1.0; the filing does not provide the quarter-end ratio.
Material changes, outlook and risks
- Accounting change: The company adopted ASC 606 on September 1, 2018 using the modified retrospective method. It recorded a $1.0 million increase to opening retained earnings. Current-quarter reported revenue and net income were each $1.312 million higher than they would have been without adoption; the prior-year figures were not recast. The filing attributes changed timing to certain customized-product sales.
- Acquisition: Penguin was acquired in June 2018 for a stated purchase price of approximately $44.6 million, including estimated contingent consideration, and the company assumed approximately $32.3 million of debt that was subsequently repaid. Purchase-price allocation remained preliminary; earn-out payments of up to $25 million were tied to gross-profit targets through December 31, 2018. The contingent consideration fair value was zero at November 30, 2018.
- Management outlook: Management expected existing cash, the credit line and operating cash generation to fund operations for at least the next 12 months. It anticipated capital spending on Brazilian capacity, R&D, manufacturing equipment and IT. No quantitative revenue or earnings guidance was provided.
- Key risks: Three suppliers accounted for most raw-material sourcing and were owed $182.2 million at quarter-end. Three customers generated 51% of quarterly sales; receivables were also concentrated among several customers. Brazil contributed about 51% of sales, exposing results to currency movements and changes to local-content incentives. A WTO appellate decision raised uncertainty over Brazilian incentive programs, which management expected to remain unchanged through calendar 2019 but could be restructured.
- Other exposures: Foreign-exchange losses were $3.4 million, and the company used forward contracts to hedge some Brazilian currency exposure. Brazilian import-duty assessments had a combined balance of about $4.1 million; the company reported favorable rulings on two assessments and considered material losses remote, but further proceedings remained possible. Other disclosed matters included a disputed SanDisk indemnification claim and ongoing Netlist litigation; the filing did not state a reasonably estimable loss range for these matters.
- Operating-lease commitments totaled $18.6 million. The company said adoption of the new lease standard, expected in fiscal 2020, would materially affect its financial statements.
Important facts for investors to verify
- Separate underlying growth from the effects of the Penguin acquisition and the ASC 606 change, especially when comparing reported revenue and earnings year over year.
- Monitor receivables, customer concentration and working-capital conversion; confirm subsequent collections and cash-flow trends.
- Review debt covenant compliance, actual leverage, borrowing costs and the terms of the fiscal 2019 repayment holiday.
- Track the final Penguin purchase-price allocation and any earn-out outcome, and assess SCSS contribution and profitability.
- Follow Brazilian local-content incentives, currency exposure, ICMS tax-credit recoverability and the outcomes of tax and legal proceedings.