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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the notes to those statements included elsewhere in this Quarterly Report on Form 10-Q, and with the consolidated financial statements and management's discussion and analysis of our financial condition and results of operations in our Annual Report on Form 10-K for our fiscal year endedAugust 28, 2020 (our "Annual Report"). This discussion contains forward looking statements that involve risks and uncertainties. Our actual results could differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed under the caption "Risk Factors" in our Annual Report and elsewhere in this report. See also "Cautionary Note Regarding Forward-Looking Statements" at the beginning of this report.
Overview
SMART is comprised of business units that are leading designers and manufacturers of electronic products focused on computing and memory technology. The company specializes in application-specific product development and support for customers in enterprise, government and original equipment manufacturer, or OEM, sales channels. Customers rely on SMART businesses as their strategic suppliers with top tier customer service, product quality, and technical support with engineering, sales, manufacturing, supply chain and logistics capabilities worldwide. The company supports customers in markets such as computing, including edge and high performance computing, communications, storage, networking, mobile, industrial automation, industrial internet of things, government and military. SMART operates in three segments: Specialty Memory products,Brazil products and Specialty Compute and Storage Solutions, or SCSS. Recent Developments
The acquisition of
OnMarch 1, 2021 , pursuant to the Purchase Agreement, we and Cree completed the LED Business Divestiture, whereby we acquired Cree's LED Business and assumed certain liabilities related to Cree's LED Business. The purchase price for the LED Business consisted of (i) a payment of$50 million in cash, subject to customary adjustments, (ii) the Purchase Price Note, (iii) the potential to receive an earn-out payment of up to$125 million based on the revenue and gross profit performance of the LED Business during the Earnout Period, also payable in the form of an Earnout Note, and (iv) the assumption of certain liabilities. The Purchase Price Note and the Earnout Note, if earned and issued, will accrue interest at a rate of three-month LIBOR plus 3.0% payable interest only every three months with one bullet payment of principal and all accrued and unpaid interest payable on each note's maturity date. The Purchase Price Note will mature onAugust 15, 2023 , and the Earnout Note, if issued, will mature onMarch 27, 2025 . In connection with this transaction, Cree and SGH-CreeLED also entered into certain ancillary and related agreements, including (i) an Intellectual Property Assignment and License Agreement, (ii) a Transition Services Agreement, (iii) a Wafer Supply and Fabrication Services Agreement, and (iv) a Real Estate License Agreement. The CreeLED Purchase Agreement contains customary representations, warranties and covenants. The Purchase Agreement also requires each of Cree and SGH-CreeLED to indemnify the other party for certain damages that the indemnified party may suffer following the closing of the transaction.
COVID-19[female[feminine
The outbreak of coronavirus disease 2019 ("COVID-19") has resulted in over a
hundred million infections and over two and a half million deaths worldwide, as
of the date of filing of this Quarterly Report, and continues to spread in the
United States , Asia , Europe and Brazil , the major markets in which we operate.
The COVID-19 pandemic has resulted in significant governmental measures being
implemented to control the spread of the virus, and our operations as well as
the operations of our suppliers, customers and third-party sales representatives
and distributors have been and will continue to be disrupted by varying
individual and governmental responses to COVID-19 around the world such as
business shutdowns, stay-at-home directives, travel restrictions, border
closures, and other travel or health-related restrictions as well as by
absenteeism, quarantines, self-isolations, office and factory closures, delays
on deliveries, and disruptions to ports and other freight infrastructure. These
restrictions have caused consumers and businesses to reduce their activities and
their spending, have caused a slowdown in the global economy and have had, and
may continue to have, a negative impact on our sales and marketing, and our
product development activities. While we have not yet experienced a significant
disruption of our operations as a result of the COVID-19 pandemic, the pandemic
has resulted in reduced sales volumes of certain product lines within our SCSS
business in the second half of fiscal 2020 as well as in the first half of
fiscal 2021, and if these conditions continue, or if we have an outbreak in any
of our facilities, such reduced sales volumes may continue or worsen and we may,
among other issues, experience, in any or all product lines, delays in product
development, a decreased ability to support our customers, disruptions in sales
and manufacturing activities and overall reduced productivity each of which
could have a negative impact on our ability to meet customer commitments and on
our revenue and profitability. The reduction of investment in
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new capacity due to the pandemic, coupled with strong demand to expand delivery
and logistics, internet and cloud services as well as a rebound in economic
conditions and general demand at a pace faster than expected, has resulted in
significant supply shortages that may impact our ability to manufacture products
for our customers and may result in rising prices of the materials we need to
manufacture our products. We may not be able to pass on these rising costs to
our customers which could result in a negative impact to our gross margins.
Results of operations
Here is a summary of our operating results for the three and six months ended.
Three Months Ended Six Months Ended
February February
26, % of February 28, % of 26, % of February 28, % of
2021 sales* 2020 sales* 2021 sales* 2020 sales*
(in thousands, other than percentages and per share data) (in thousands, other than percentages and per share data)
Condensed Consolidated
Statements of Operations:
Net sales $ 304,009 100 % $ 272,042 100 % $ 595,705 196 % $ 544,060 100 %
Cost of sales (1)(2) 250,553 82 % 220,536 81 % 489,606 161 % 438,234 81 %
Gross profit 53,456 18 % 51,506 19 % 106,099 35 % 105,826 19 %
Operating expenses:
Research and development
(1) 8,852 3 % 14,702 5 % 15,816 5 % 29,588 5 %
Selling, general and
administrative (1) (2) 31,664 10 % 28,648 11 % 69,720 23 % 62,201 11 %
Total operating expenses 40,516 13 % 43,350 16 % 85,536 28 % 91,789 17 %
Income from operations 12,940 4 % 8,156 3 % 20,563 7 % 14,037 3 %
Other income (expense):
Interest expense, net (4,365 ) (1 %) (4,150 ) (2 %) (7,518 ) (2 %) (8,642 ) (2 %)
Other expense, net (1,531 ) (1 %) (12,386 ) (5 %) (699 ) 0 % (13,226 ) (2 %)
Total other expense (5,896 ) (2 %) (16,536 ) (6 %) (8,217 ) (3 %) (21,868 ) (4 %)
Income (loss) before
income taxes 7,044 2 % (8,380 ) (3 %) 12,346 4 % (7,831 ) (1 %)
Provision for income
taxes 1,200 0 % 1,340 0 % 4,475 1 % 1,665 0 %
Net income (loss) $ 5,844 2 % $ (9,720 ) (4 %) $ 7,871 3 % $ (9,496 ) (2 %)
Earnings per share:
Basic $ 0.24 $ (0.41 ) $ 0.32 $ (0.40 )
Diluted $ 0.23 $ (0.41 ) $ 0.31 $ (0.40 )
Shares used in computing
earnings per share:
Basic 24,217 23,906 24,389 23,809
Diluted 25,203 23,906 25,221 23,809
* Summations may not be calculated accurately due to rounding.
(1) Includes share-based compensation expense as follows: Cost of sales$ 804 $ 731$ 1,641 $ 1,461 Research and development 810 783 1,588 1,527 Selling, general and administrative 3,784 3,133 13,257 7,615 (2) Includes amortization of intangible assets expense as follows: Cost of sales$ 647 $ 647$ 1,294 $ 1,294 Selling, general and administrative 2,766 2,766 5,533 5,533
Three and six months over
Net sales increased by$32.0 million , or 11.8%, during the three months endedFebruary 26, 2021 compared to the same period in the prior year, and by$51.6 million , or 9.5%, during the six months endedFebruary 26, 2021 compared to the same period in the prior year. Net sales were positively impacted by higher SCSS product sales of$22.5 million , or an increase of 35.8%, and$13.9 million , or an increase of 10.1%, for the three and six-month period, respectively, primarily due to increased volume of sales with one of our largest customers in the SCSS segment. In addition, our sales ofBrazil products and Specialty Memory increased by$5.4 million and$4.0 million , or 5.6% and 3.6%, respectively, for the three-month period, and by$16.6 million and$21.1 million , or 8.7% and 9.8%, respectively, for the six-month period, primarily due to higher DRAM revenue and higher average selling prices for mobile memory forBrazil and higher DRAM revenue for Specialty Memory product, resulting from a change in product mix. 42
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Cost of sales
Cost of sales increased by$30.0 million , or 13.6%, during the three months endedFebruary 26, 2021 compared to the same period in the prior year, and by$51.4 million , or 11.7%, during the six months endedFebruary 26, 2021 compared to the same period in the prior year. The increase in the three and six-month periods was primarily due to higher cost of materials of$27.9 million and$48.3 million or 15% and 13%, respectively, due to the higher level of sales. Material costs of ourBrazil products were negatively impacted in the three months endedFebruary 26, 2021 due to a$4.3 million out-of-period adjustment related to import taxes inBrazil . For additional information, see Note 1(i) in our Notes to Unaudited Condensed Consolidated Financial Statements. Included in the cost of sales increases were favorable foreign exchange impacts of$2.4 million and$4.9 million for the three and six-month periods, respectively, due to locally sourced cost of sales inBrazil .
Gross profit
Gross margin decreased to 17.6% during the three months endedFebruary 26, 2021 compared to 18.9% for the same period in the prior year, and decreased to 17.8% during the six months endedFebruary 26, 2021 compared to 19.5% for the same period in the prior year, primarily due to higher material costs for ourBrazil and Specialty Memory products, as well as the out-of-periodBrazil adjustment.
Research and development costs
Research and development ("R&D") expense decreased $5.9 million , or 39.8%,
during the three months ended February 26, 2021 compared to the same period in
the prior year, and $13.8 million , or 46.5%, during the six months ended
February 26, 2021 compared to the same period in the prior year. The decrease
was primarily due to $6.1 million and $14.0 million in the three and six-month
periods, respectively, of Brazil financial credits resulting from amendments to
the IT law implemented in April 2020 . For additional information, see Note 1(i)
in our Notes to Unaudited Condensed Consolidated Financial Statements. Included
in the R&D expense decreases were unfavorable foreign exchange impacts of $1.0
million and $3.0 million for the three and six-month periods, respectively.
Selling, general and administrative expenses
Selling, general and administrative ("SG&A") expense increased by $3.0 million ,
or 10.5%, during the three months ended February 26, 2021 compared to the same
period in the prior year, and $7.5 million , or 12.1%, during the six months
ended February 26, 2021 compared to the same period in the prior year. The
increases were primarily due to higher share-based compensation expense of $0.7
million and $5.6 million in the three and six-month periods, respectively,
resulting from awards acceleration and additional grants, as well as higher
personnel-related and facilities expenses. For additional information, see Note
9 in our Notes to Unaudited Condensed Consolidated Financial Statements.
Included in the SG&A expense increases were favorable foreign exchange impacts
of $0.5 million and $1.1 million for the three and six-month periods,
respectively.
Other income (expenses)
Interest expense, net increased$0.2 million , or 5.2%, during the three months endedFebruary 26, 2021 compared to the same period in the prior year, and decreased$1.1 million , or 13.0%, during the six months endedFebruary 26, 2021 compared to the same period in the prior year, primarily due to lower interest expense resulting from the issuance of our convertible senior notes and the extinguishment of our term loans in the second quarter of fiscal 2020. For additional information, see Note 7 in our Notes to Unaudited Condensed Consolidated Financial Statements. Other income (expense), net decreased by$10.9 million and$12.5 million for the three and six month periods, respectively, primarily due to$6.6 million extinguishment loss of long-term debt and$4.8 million mark-to-market losses on the capped calls in the second quarter of fiscal 2020, as well as foreign currency losses.
Provision for income taxes
Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to SMART, adjusted for certain discrete items which are fully recognized in the period they occur.
The provision for income taxes decreased by
From
43 -------------------------------------------------------------------------------- Determining the consolidated provision for income tax expense, income tax liabilities and deferred tax assets and liabilities involves judgment. SMART calculates and provides for income taxes in each of the tax jurisdictions in which it operates, which involves estimating current tax exposures as well as making judgments regarding the recoverability of deferred tax assets in each jurisdiction. The estimates used could differ from actual results, which may have a significant impact on operating results in future periods.
Liquidity and capital resources
Six Months Ended
February 26, February 28,
2021 2020
(in thousands)
Cash provided by operating activities $ 55,990 $ 48,601
Cash used in investing activities (34,628 ) (9,272 )
Cash provided by (used in) financing activities (30,874 )
11 842
Effect of exchange rate changes on cash and cash equivalents (1,496 )
(7450) Net increase (decrease) in cash and cash equivalents
AT
InFebruary 2020 , we issued$250.0 million in aggregate principal amount of 2.25% convertible senior notes due 2026 for which we received proceeds of$243.1 million , net of issuance costs. We used$204.9 million for extinguishment of long-term debt and$21.8 million for purchasing privately-negotiated capped calls. For additional information, see Note 7 in our Notes to Unaudited Condensed Consolidated Financial Statements. OnMarch 1, 2021 , as part of the acquisition ofCreeLED, Inc. , we paid Cree$50.0 million in cash and issued Cree a$125 million Purchase Price Note. Cree also has the potential to receive an earn-out payment of up to$125 million based on the revenue and gross profit performance of the LED Business during the Earnout Period with a minimum payment of$2,500,000 , payable in the form of an Earnout Note. The Purchase Price Note and the Earnout Note, if earned and issued, will accrue interest at a rate of three-month LIBOR plus 3.0% with interest paid every three months, and one bullet payment of principal and all accrued and unpaid interest will be payable on each of the notes' respective maturity dates. The Purchase Price Note will mature onAugust 15, 2023 , and the Earnout Note will mature on the third anniversary of the completion of the Earnout Period. We expect that our existing cash and cash equivalents, line of credit and cash generated by operating activities will be sufficient to fund our operations for at least the next twelve months. Our principal uses of cash and capital resources are acquisitions, debt service requirements as described below, capital expenditures, R&D expenditures and working capital requirements. We expect that future capital expenditures will focus on expanding capacity of our operations, expanding our R&D activities, manufacturing equipment upgrades, acquisitions and IT infrastructure and software upgrades. Cash and cash equivalents consist of funds held in demand deposit accounts and money market funds. We do not enter into investments for trading or speculative purposes. During the six months endedFebruary 26, 2021 , cash provided by operating activities was$56.0 million . The primary factors affecting our cash flows during this period were$42.1 million of non-cash related expenses,$6.0 million change in our net operating assets and liabilities, and$7.9 million of net income. The$6.0 million change in net operating assets and liabilities consisted of a decrease of$10.1 million in accounts receivable and increases of$39.6 million of accounts payable and$6.3 million in accrued expense and other liabilities, offset by increases of$28.1 million in inventory and$19.1 million in prepaid expenses and other assets and a decrease of$2.8 million of operating lease liabilities. The decrease in accounts receivable was primarily due to timing of sales, and the increase in accounts payable was primarily due to timing of payments. The increase in inventory was primarily due to higher purchases for certain programs. During the six months endedFebruary 28, 2020 , cash provided by operating activities was$48.6 million . The primary factors affecting our cash flows during this period were$44.6 million of non-cash related expenses and$13.5 million change in our net operating assets and liabilities, partially offset by$9.5 million of net loss. The$13.5 million change in net operating assets and liabilities consisted of increases of$4.5 million in accounts receivable and$45.6 million in inventory, and a decrease of$2.1 million of operating lease liabilities, offset by a decrease of$6.5 million in prepaid expenses and other assets and increases of$56.7 million of accounts payable and$2.5 million in accrued expense and other liabilities. The increase in accounts receivable was primarily due to timing of sales, while the increases in inventory and accounts payable were primarily due to the transition of inventory from contract manufacturers to the company due to our recent acquisitions, as well as higher purchases for certain programs. Net cash used in investing activities during the six months endedFebruary 26, 2021 was$34.6 million consisting primarily of purchases of property and equipment and deposits. Net cash used in investing activities during the six months endedFebruary 28, 2020 was$9.3 million consisting primarily of purchases of property and equipment. Net cash provided by financing activities during the six months endedFebruary 26, 2021 was$30.9 million , consisting primarily of$11.4 million proceeds from issuance of the FINEP loan and$5.6 million proceeds from issuance of ordinary shares from 44
-------------------------------------------------------------------------------- share option exercises and employee share purchase plans, partially offset by$44.3 million payment for repurchase of ordinary shares and$3.6 million for withholding tax on restricted stock units. Net cash used in financing activities during the six months endedFebruary 28, 2020 was$11.8 million , consisting primarily of$243.1 million proceeds from issuance of convertible notes and$3.0 million proceeds from issuance of ordinary shares from share option exercises and employee share purchase plans, partially offset by$204.9 million payment for extinguishment of long-term debt,$21.8 million purchase of capped calls,$7.2 million long-term debt payments for both the Amended Credit Agreement and the BNDES Credit Agreement and$0.4 million for withholding tax on restricted stock units.
There have been no material changes to the contractual obligations previously disclosed in our annual report.
Off-balance sheet arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt, and we have not entered into any synthetic leases. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial conditions, net sales or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Recent accounting statements
See Note 1 of our Notes to Unaudited Condensed Consolidated Financial Statements for information regarding the effect of recent accounting pronouncements on our financial statements.
Critical accounting methods
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted inthe United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those listed below. We base our estimates on historical facts and various other assumptions that we believe to be reasonable at the time the estimates are made. Actual results could differ from those estimates.
Our main accounting methods are as follows:
• Revenue recognition; • Inventory valuation; • Income taxes; •Goodwill valuation;
• Impairment of long-term assets and long-term assets to be sold; and
• Remuneration in shares.
Our critical accounting policies are important to the portrayal of our financial
condition and results of operations, and require us to make judgments and
estimates about matters that are inherently uncertain. There have been no
material changes to our critical accounting policies and estimates disclosed in
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations-Critical Accounting Policies and Estimates" and Note 1, Overview,
Basis of Presentation and Significant Accounting Policies, in each case in our
Annual Report.
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