Business context and reporting period
This is SMART Global Holdings, Inc.’s unaudited Form 10-Q for the fiscal quarter ended May 25, 2018 (13 weeks), with nine-month comparisons to May 26, 2017. The filing describes a specialty-memory and supply-chain-services business; it is not a filing by Penguin Solutions. SMART acquired Penguin Computing after quarter-end, on June 8, 2018.
Financial performance and liquidity
Amounts are in U.S. dollars; financial statement figures below are in millions except per-share data.
| Metric | Three months ended May 25, 2018 | Prior-year quarter | Nine months ended May 25, 2018 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $335.5 | $207.0 | $914.9 | $538.3 |
| Gross profit / margin | $78.1 / 23.3% | $47.4 / 22.9% | $208.9 / 22.8% | $114.2 / 21.2% |
| Operating income / margin | $48.7 / 14.5% | $20.4 / 9.8% | $125.2 / 13.7% | $33.3 / 6.2% |
| Net income | $31.9 | $8.0 | $89.7 | $2.4 |
| Diluted EPS | $1.37 | $0.50 | $3.90 | $0.16 |
- Quarterly sales rose 62.1%; nine-month sales increased 70.0%. Management attributed growth mainly to higher Brazil mobile-memory sales and pricing, and stronger Brazil DRAM volume and pricing. Gross margins improved year over year.
- Operating cash flow was $77.3 million for the nine months, versus cash used of $6.9 million a year earlier. Receivables grew $86.7 million and inventory $27.9 million, partly offset by an $83.9 million increase in payables. Capital expenditures were $18.3 million.
- Cash and equivalents were $64.5 million at May 25, up from $22.4 million at August 25, 2017; current assets were $494.8 million and current liabilities $307.8 million. The company also held $6.3 million of restricted cash.
- Reported long-term debt, including current maturities and net of unamortized discounts and issuance costs, was $158.7 million; principal outstanding was approximately $165.8 million. No revolving borrowings were outstanding. Term-loan interest was 8.62%; the credit agreement includes a 3.5:1.0 secured leverage covenant.
- Accounts receivable were $262.1 million and inventory $147.9 million. Accounts payable was $265.0 million. Five suppliers accounted for $218.4 million of payables.
Material changes, outlook, and risks
- Management cited Brazil mobile-memory volume increases of 127% for the quarter and 130% for the nine months, with higher average selling prices; local-content requirements for smartphone memory rose from 30% to 50% effective January 1, 2018. Brazil accounted for about 66% of nine-month sales.
- Foreign-exchange losses were $6.9 million for the quarter and $7.3 million for the nine months, materially higher than in the comparable periods. Management says it does not currently hedge foreign-exchange exposure. A 1-percentage-point rise in rates on variable-rate debt, assuming the revolver is fully drawn and other factors are unchanged, would add an estimated $2.1 million in annual interest expense.
- Management expects existing cash and operating cash generation to fund operations for at least 12 months. No specific revenue or earnings guidance is provided. Planned capital spending includes Brazil capacity, R&D, manufacturing equipment, and IT.
- On June 8, 2018, SMART acquired Penguin Computing for $60 million at closing, including assumed debt, with total consideration up to $85 million and up to $25 million contingent on gross-profit targets. SMART also borrowed $60 million under an incremental term-loan facility to help fund the transaction.
- The filing reports significant customer concentration: the largest customer represented 42% of quarterly sales and 36% of nine-month sales; the three largest represented 70% of nine-month sales. Brazilian ICMS tax credits totaled $12.8 million, with recovery dependent on sales mix and tax-authority processes; management expects recovery through fiscal 2022.
- Contingencies include Netlist litigation and Brazilian import-duty assessments. Management considers a material charge from the disputed Brazil assessments remote; the disclosed combined assessment balance was $4.3 million. The filing states it cannot reasonably estimate possible losses for certain legal matters. It also describes customer and supplier indemnities for which maximum future payments cannot be estimated.
- After quarter-end, CEO Iain MacKenzie resigned effective June 22, 2018; Ajay Shah was to become sole CEO. The board approved an approximately $360,000 separation payment, subject to a release. Management reported disclosure controls effective at a reasonable assurance level and no material change in internal control during the quarter.
Key facts for investors to verify
- Whether the sharp Brazil-led sales growth and margin improvement are sustainable, and the extent to which growth depends on a concentrated customer base and local-content rules.
- Receivables, inventory, and payables trends, customer collections, and supplier concentration given the substantial working-capital demands.
- The impact of the Penguin acquisition, earn-out conditions, assumed debt, and the incremental $60 million borrowing on leverage and future results.
- Foreign-exchange exposure, variable-rate debt costs, and compliance with the credit agreement’s leverage covenant.
- Recoverability and timing of Brazilian ICMS credits, and developments in Netlist litigation and import-duty tax disputes.
- The filing’s stated 12-month liquidity expectation and actual cash generation after acquisition and debt service.