Business context and reporting period
Smart Global Holdings, Inc. (NASDAQ: SGH) filed this unaudited Form 10-Q for the 13-week quarter and 39 weeks ended May 28, 2021. The filing identifies the company as a designer and manufacturer of computing, memory and specialty LED products, operating in Specialty Memory, Brazil Products, Intelligent Platform Solutions (IPS) and LED Solutions. Penguin is identified as a subsidiary/borrower in certain financing arrangements; the filer is Smart Global Holdings, not a company named Penguin Solutions.
Key financial metrics
Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
| Metric | Quarter ended May 28, 2021 | Prior-year quarter | Nine months ended May 28, 2021 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $437.7 | $281.3 | $1,033.4 | $825.3 |
| Gross profit / margin | $84.5 / 19.3% | $54.2 / 19.3% | $190.6 / 18.4% | $160.1 / 19.4% |
| Operating income / margin | $2.9 / 0.7% | $10.1 / 3.6% | $23.5 / 2.3% | $24.1 / 2.9% |
| Net income (loss) attributable to SGH | $(7.2) | $0.8 | $0.7 | $(8.7) |
| Diluted EPS | $(0.30) | $0.03 | $0.03 | $(0.36) |
| Cash provided by operating activities | Not presented separately for the quarter | $105.3 | $62.2 |
- Quarterly sales rose 55.6%; nine-month sales increased 25.2%. The Cree LED business contributed $101.8 million in sales from its March 1 acquisition through May 28.
- Quarterly gross margin was essentially unchanged year over year; nine-month margin declined, primarily due to higher material costs in Brazil and IPS. Quarterly operating income fell as operating expenses increased, including a $16.4 million charge from remeasuring acquisition-related contingent consideration.
- Nine-month operating cash flow was $105.3 million. Capital expenditures and equipment deposits were $40.0 million; operating cash flow less these expenditures was approximately $65.3 million, before acquisition spending and other investing flows.
- At May 28, cash was $189.0 million and current assets/current liabilities were $806.2 million/$492.2 million (current ratio approximately 1.64). Inventory was $289.0 million, up from $163.0 million at August 28, 2020.
- Long-term debt carrying value was $338.0 million; an additional $25.0 million ABL borrowing was reported in current liabilities. The filing lists $250.0 million principal on convertible notes, a $125.0 million Cree purchase-price note and $11.2 million outstanding under the Brazilian FINEP loan. These principal amounts total approximately $411.2 million, before accounting discounts and other presentation differences.
- Cash increased $38.2 million from fiscal year-end. Investing used $68.4 million, including $28.6 million for the LED acquisition net of acquired cash. Financing provided $1.3 million, including $25.0 million net revolver borrowings, partially offset by a $44.3 million share repurchase.
Material changes versus prior comparable periods
- Sales growth reflected the new LED segment, higher IPS sales (including increased volume with a large customer), and higher Brazil product volume and average selling prices. LED contributed $101.8 million of nine-month sales.
- Nine-month gross profit grew, but gross margin fell from 19.4% to 18.4%. SG&A rose 28.6% for the nine months, partly due to LED costs, share-based compensation, acquisition expenses and amortization.
- Nine-month R&D expense decreased 26.1%, partly because Brazil financial credits reduced R&D expense by $22.2 million; the corresponding prior-year benefit was zero. The credits depend on Brazilian government programs and eligibility.
- Debt and reported assets increased with the LED acquisition and new FINEP and ABL borrowings. Goodwill was $73.3 million; intangible assets rose to $107.2 million, substantially reflecting acquisition accounting.
Outlook, risks, contingencies and unusual items
- Management said existing cash, available credit and operating cash generation should be sufficient to fund operations for at least the next 12 months. The filing provides no quantified sales or earnings guidance.
- The LED acquisition consideration included $50 million cash, a $125 million note due August 2023, and a potential earn-out of up to $125 million (minimum $2.5 million) payable by note. The earn-out’s fair value was $44.5 million at May 28; its remeasurement generated a $16.4 million operating expense during the quarter. Purchase-price allocation remained provisional.
- Management cited COVID-19 effects on some IPS and LED demand and development activity, industry-wide supply shortages, higher input costs, and uncertainty about passing costs on to customers. Four suppliers accounted for most raw materials; the company reported $180.2 million owed to those suppliers at May 28.
- Customer concentration is significant: two customers each exceeded 10% of quarterly sales (14% and 11%). Three other customers each represented approximately 15%, 13% and 13% of accounts receivable at period-end. Foreign exchange, Brazil’s incentive programs, competition, acquisition integration and debt/covenant risks are also disclosed.
- Internal control over financial reporting remained ineffective due to a material weakness in import-tax accounting. A second-quarter out-of-period correction increased cost of sales by $4.3 million and interest expense by $0.8 million; management said it was not material to the periods identified. Remediation was ongoing.
- The company reported a Brazil import-duty assessment with a balance of approximately $1.1 million, but management considered material charges remote. A separate SanDisk/Western Digital indemnification claim remained disputed; the filing does not quantify a likely loss.
Important facts for investors to verify
- Whether LED acquisition performance meets earn-out thresholds, and the eventual cash/debt impact of the earn-out and purchase-price note.
- Whether growth and margins can be sustained as input shortages, material costs and customer concentration affect results.
- Availability and use of credit facilities, debt maturities, interest-rate exposure and compliance with applicable covenants.
- Realizability and timing of Brazilian tax credits, and progress in remediating the import-tax control weakness.
- Final acquisition accounting, including the fair value of acquired assets and liabilities and contingent consideration.