sgh-10q_20181130.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended November 30, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 001-38102

 

SMART GLOBAL HOLDINGS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

Cayman Islands

98-1013909

( State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer
Identification No.)

c/o Maples Corporate Services Limited

P.O. Box 309

Ugland House

Grand Cayman, Cayman Islands

KY1-1104

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (510) 623-1231

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes      No  

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes      No  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

  

  

Smaller reporting company

 

 

 

 

 

 

 

 

Emerging growth company

 

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

As of December 31, 2018, the registrant had 22,845,331 ordinary shares outstanding.

 

 

 

 

 


 

Table of Contents

 

 

 

Page

PART I.

FINANCIAL INFORMATION

3

Item 1.

Financial Statements (Unaudited)

3

 

Condensed Consolidated Balance Sheets

3

 

Condensed Consolidated Income Statements

4

 

Condensed Consolidated Statements of Comprehensive Income (Loss)

5

 

Condensed Consolidated Statements of Cash Flows

6

 

Notes to Unaudited Condensed Consolidated Financial Statements

7

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

34

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

38

Item 4.

Controls and Procedures

39

PART II.

OTHER INFORMATION

40

Item 1.

Legal Proceedings

40

Item 1A.

Risk Factors

40

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

41

Item 3.

Defaults Upon Senior Securities

41

Item 4.

Mine Safety Disclosures

41

Item 6.

Exhibits

41

Signatures

42

 

 

1


 

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q includes a number of forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, that involve many risks and uncertainties. Forward-looking statements are identified by the use of the words “would,” “could,” “will,” “may,” “expect,” “believe,” “should,” “anticipate,” “if,” “future,” “intend,” “plan,” “estimate,” “potential,” “target,” “seek,” or “continue” and similar words and phrases, including the negatives of these terms, or other variations of these terms, that denote future events. These statements reflect our current views with respect to future events and our potential financial performance and are subject to risks and uncertainties that could cause our actual results and financial position to differ materially and adversely from what is projected or implied in any forward-looking statements included in this report. These factors include, but are not limited to, the risks described under the caption “Risk Factors” in the documents we file from time to time with the Securities and Exchange Commission, including in our Annual Report on Form 10-K for our fiscal year ended August 31, 2018, and in this report, and in Item 2 of Part I – “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this report may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. We make these forward-looking statements based upon information available on the date of this report, and we expressly disclaim any obligation to update or alter any forward-looking statements, whether as a result of new information or otherwise, except as required by law.

 

 

2


 

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

SMART Global Holdings, Inc.

and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands, except per share data)

(Unaudited)

 

 

 

November 30,

 

 

August 31,

 

 

 

2018

 

 

2018

 

Assets

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

62,954

 

 

$

31,375

 

Accounts receivable, net of allowances of $121 and $225 as of November 30, 2018

   and August 31, 2018, respectively

 

 

330,473

 

 

 

237,212

 

Inventories

 

 

188,390

 

 

 

221,419

 

Prepaid expenses and other current assets

 

 

40,351

 

 

 

32,043

 

Total current assets

 

 

622,168

 

 

 

522,049

 

Property and equipment, net

 

 

60,412

 

 

 

56,615

 

Other noncurrent assets

 

 

17,561

 

 

 

22,449

 

Intangible assets, net

 

 

25,279

 

 

 

26,255

 

Goodwill

 

 

45,655

 

 

 

45,394

 

Total assets

 

$

771,075

 

 

$

672,762

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable

 

$

273,655

 

 

$

223,186

 

Accrued liabilities

 

 

49,317

 

 

 

45,190

 

Current portion of long-term debt

 

 

9,868

 

 

 

27,409

 

Total current liabilities

 

 

332,840

 

 

 

295,785

 

Long-term debt

 

 

200,532

 

 

 

184,190

 

Other long-term liabilities

 

 

8,038

 

 

 

5,659

 

Total liabilities

 

$

541,410

 

 

$

485,634

 

Commitments and contingencies (see Note 10)

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

 

Ordinary shares, $0.03 par value. Authorized 200,000 shares; issued and

   outstanding 22,781 and 22,480 as of November 30, 2018 and August 31, 2018,

   respectively

 

 

687

 

 

 

678

 

Additional paid-in capital

 

 

257,607

 

 

 

250,191

 

Accumulated other comprehensive loss

 

 

(172,893

)

 

 

(175,995

)

Retained earnings

 

 

144,264

 

 

 

112,254

 

Total shareholders’ equity

 

 

229,665

 

 

 

187,128

 

Total liabilities and shareholders’ equity

 

$

771,075

 

 

$

672,762

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

3


 

SMART Global Holdings, Inc. and Subsidiaries

Condensed Consolidated Income Statements

(In thousands, except per share data)

(Unaudited)

 

  

 

Three Months Ended

 

 

 

November 30,

 

 

November 24,

 

 

 

2018

 

 

2017

 

Net sales (1)

 

$

393,879

 

 

$

265,409

 

Cost of sales

 

 

308,810

 

 

 

207,573

 

Gross profit

 

 

85,069

 

 

 

57,836

 

Operating expenses:

 

 

 

 

 

 

 

 

Research and development

 

 

11,816

 

 

 

8,550

 

Selling, general, and administrative

 

 

25,454

 

 

 

17,818

 

Total operating expenses

 

 

37,270

 

 

 

26,368

 

Income from operations

 

 

47,799

 

 

 

31,468

 

Interest expense, net

 

 

(5,875

)

 

 

(4,599

)

Other expense, net

 

 

(3,329

)

 

 

(2,715

)

Total other expense

 

 

(9,204

)

 

 

(7,314

)

Income before income taxes

 

 

38,595

 

 

 

24,154

 

Provision for income taxes

 

 

7,619

 

 

 

3,149

 

Net income

 

$

30,976

 

 

$

21,005

 

Earnings per share:

 

 

 

 

 

 

 

 

Basic

 

$

1.37

 

 

$

0.97

 

Diluted

 

$

1.33

 

 

$

0.92

 

Shares used in computing earnings per share:

 

 

 

 

 

 

 

 

Basic

 

 

22,595

 

 

 

21,673

 

Diluted

 

 

23,257

 

 

 

22,715

 

 

(1)

Includes sales to affiliates of $35,297 and $25,969 in the three months ended November 30, 2018 and November 24, 2017, respectively (see Note 3).

See accompanying notes to unaudited condensed consolidated financial statements.

 

 

4


 

SMART Global Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income (Loss)

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

November 30,

 

 

November 24,

 

 

 

2018

 

 

2017

 

Net income

 

$

30,976

 

 

$

21,005

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

Foreign currency translation

 

 

3,102

 

 

 

(7,177

)

Comprehensive income

 

$

34,078

 

 

$

13,828

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5


 

SMART Global Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

 

 

Three Months Ended

 

 

 

November 30,

 

 

November 24,

 

 

 

2018

 

 

2017

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

Net income

 

$

30,976

 

 

$

21,005

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

6,408

 

 

 

6,270

 

Share-based compensation

 

 

4,055

 

 

 

1,605

 

Provision for doubtful accounts receivable and sales returns

 

 

(104

)

 

 

28

 

Deferred income tax benefit

 

 

403

 

 

 

(220

)

Loss on disposal of property and equipment

 

 

3

 

 

 

 

 

Amortization of debt discounts and issuance costs

 

 

685

 

 

 

729

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(89,441

)

 

 

(55,801

)

Inventories

 

 

30,576

 

 

 

(3,746

)

Prepaid expenses and other assets

 

 

(3,182

)

 

 

1,758

 

Accounts payable

 

 

48,574

 

 

 

47,492

 

Accrued expenses and other liabilities

 

 

6,399

 

 

 

(4,863

)

Net cash provided by operating activities

 

 

35,352

 

 

 

14,257

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

Capital expenditures and deposits on equipment

 

 

(13,384

)

 

 

(6,039

)

Proceeds from sale of property and equipment

 

 

21

 

 

 

 

Net cash used in investing activities

 

 

(13,363

)

 

 

(6,039

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

Fees paid for revolving line of credit financing

 

 

 

 

 

(299

)

Long-term debt payment

 

 

(1,657

)

 

 

(6,184

)

Payment of costs related to initial public offering (IPO)

 

 

 

 

 

(1,289

)

Proceeds from borrowings under revolving line of credit

 

 

104,000

 

 

 

105,500

 

Repayments of borrowings under revolving line of credit

 

 

(104,000

)

 

 

(105,500

)

Proceeds from issuance of ordinary shares from share option exercises

 

 

2,402

 

 

 

539

 

Proceeds from issuance of ordinary shares from employee share purchase plan

 

 

968

 

 

 

 

Net cash provided by (used in) financing activities

 

 

1,713

 

 

 

(7,233

)

Effect of exchange rate changes on cash, cash equivalents and restricted cash *

 

 

2,018

 

 

 

(231

)

Net increase (decrease) in cash, cash equivalents and restricted cash *

 

 

25,720

 

 

 

754

 

Cash, cash equivalents and restricted cash at beginning of period *

 

 

37,234

 

 

 

29,463

 

Cash, cash equivalents and restricted cash at end of period *

 

$

62,954

 

 

$

30,217

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

 

Cash paid during the period:

 

 

 

 

 

 

 

 

Cash paid for interest

 

$

4,942

 

 

$

3,523

 

Cash paid for income taxes, net of refunds

 

 

5,869

 

 

 

3,639

 

Noncash activities information:

 

 

 

 

 

 

 

 

Capital expenditures included in accounts payable at period end

 

 

1,147

 

 

 

1,910

 

IPO costs included in accounts payable and accrued liabilities at period end

 

 

 

 

 

302

 

Unpaid debt fees related to term loan and revolver

 

 

 

 

 

469

 

Proceeds receivable from the exercise of stock options

 

 

 

 

 

(383

)

 

 

 

 

 

 

 

 

 

* Cash balance was adjusted to include restricted cash upon adoption of ASU 2016-18 in fiscal 2019.

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6


 

Smart Global Holdings, Inc.

Notes to Unaudited Condensed Consolidated Financial Statements

Note 1. Basis of Presentation and Principles of Consolidation

(a)

Overview

On August 26, 2011, SMART Global Holdings, Inc., formerly known as Saleen Holdings, Inc., a Cayman Islands exempted company (SMART Global Holdings, and together with its subsidiaries, the Company), consummated a transaction with SMART Worldwide Holdings, Inc., formerly known as SMART Modular Technologies (WWH), Inc. (SMART Worldwide), pursuant to an Agreement and Plan of Merger whereby, through a series of transactions, SMART Global Holdings acquired substantially all of the equity interests of SMART Worldwide with SMART Worldwide surviving as an indirect wholly owned subsidiary of SMART Global Holdings (the Acquisition). SMART Global Holdings is an entity that was formed by investment funds affiliated with Silver Lake Partners and Silver Lake Sumeru (collectively Silver Lake). As a result of the Acquisition, since there was a change of control resulting in Silver Lake as the controlling shareholder group, the Company applied the acquisition method of accounting and established a new basis of accounting.

The Company, through its subsidiaries, provides data compute and storage products and solutions sold primarily to original equipment manufacturers (OEMs) as well as end customers for enterprise applications. The Company offers these solutions to customers worldwide and also offers custom supply chain services including procurement, logistics, inventory management, temporary warehousing, kitting and packaging services.  

SMART Global Holdings is domiciled in the Cayman Islands and has its U.S. headquarters in Newark, California. The Company has operations in the United States, Brazil, Malaysia, Taiwan, Hong Kong, Scotland, Singapore and South Korea.

(b)

Basis of Presentation

The accompanying condensed consolidated financial statements comprise SMART Global Holdings and its wholly owned subsidiaries. Intercompany transactions have been eliminated in the condensed consolidated financial statements.

The Company uses a 52- to 53-week fiscal year ending on the last Friday in August. The three months ended November 30, 2018 and November 24, 2017 were both 13 week fiscal periods.

The accompanying unaudited condensed consolidated financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and in conformity with the rules and regulations of the Securities and Exchange Commission (SEC) applicable to interim financial information. As such, certain information and footnote disclosures normally included in complete annual financial statements prepared in accordance with U.S. GAAP have been omitted in accordance with the rules and regulations of the SEC. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary to present fairly the financial position of the Company and its results of operations and cash flows for the interim periods presented. The financial data and other information disclosed in these notes to the condensed consolidated financial statements related to the interim periods are unaudited.

All financial information for two of the Company’s subsidiaries, SMART Modular Technologies Indústria de Componentes Eletrônicos Ltda. (SMART Brazil) and SMART Modular Technologies do Brasil Indústria e Comércio de Componentes Ltda. (SMART do Brazil), is included in the Company’s condensed consolidated financial statements on a one-month lag because their fiscal years begin August 1 and end July 31.

(c)

Use of Estimates

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods presented. Actual results could differ from the estimates made by management. Significant items subject to such estimates and assumptions include the useful lives of long-lived assets, the valuation of deferred tax assets and inventory, share-based compensation, the estimated net realizable value of Brazilian tax credits, income tax uncertainties and other contingencies.

(d)

Revenue

The Company’s revenues include products and services. The Company’s product revenues are predominantly derived from the sale of memory modules, Flash memory cards and storage products, which the Company designs and manufactures. The Company’s service revenues are derived from procurement, logistics, inventory management, temporary warehousing, kitting and packaging services. Also, a small portion of the Company’s product sales include extended warranty and on-site services, subscriptions to the Company’s high performance computing environment, professional services, software and related support.

7


 

The Company determines revenue recognition through the following steps: (1) identification of the contract with a customer; (2) identification of the performance obligations in the contract; (3) determination of the transaction price; (4) allocation of the transaction price to the performance obligations in the contract; and (5) recognition of revenue when, or as, a performance obligation is satisfied.

The Company’s contracts are executed through a combination of written agreements along with purchase orders with all customers including certain general terms and conditions. Generally, purchase orders entail products, quantities and prices, which define the performance obligations of each party and are approved and accepted by the Company. The Company’s contracts with customers do not include extended payment terms. Payment terms vary by contract type and type of customer and generally range from 30 to 45 days from invoice. Additionally, taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction, that are collected by the Company from a customer and deposited with the relevant government authority, are excluded from revenue.

The transaction price is determined based on the consideration to which the Company will be entitled in exchange for transferring goods or services to the customer adjusted for estimated variable consideration.  Variable consideration may include discounts, rights of return, refunds, and other similar obligations. The Company allocates the transaction price to each distinct product and service based on its relative standalone selling price. The standalone selling price for products primarily involves the cost to produce the deliverable plus the anticipated margin and for services is estimated based on the Company’s approved list price.

In the normal course of business, the Company does not accept product returns unless the items are defective as manufactured. The Company establishes provisions for estimated returns and warranties. In addition, the Company does not typically provide customers with the right to a refund and does not transact for noncash consideration.

Standard Products

The Company’s main performance obligations are to deliver the requested goods to customers according to the agreed-upon shipping terms. The Company recognizes revenue when control transfers to the customer (i.e., when the Company’s performance obligation is satisfied). The Company invoices the customer and recognizes revenues for such delivery when control has transferred based on shipping terms.

Customized Products

For customized product sales with terms that require the customer to purchase 100% of all parts built to fulfill the customers forecast, the Company recognizes revenue when control of the underlying assets passes to the customer, as the customer is able to both direct the use of, and obtain substantially all of the remaining benefit from the assets; the customer has the significant risks and rewards associated with ownership of the assets; and the Company has a present right to payment. For these sales, control passes when the Company has made these products available to the customer and under the terms of the agreement cannot repurpose them without the customer’s express consent.  Accordingly, the Company will recognize revenue at the point in time when products made to the customer’s forecast are completed and made available to the customer.

Non-cancellable nonrefundable, or NCNR, customized product sales are recognized over time on a cost incurred basis. The customer obtains control and benefits from the services as they are performed over the period based on the cost input measure in the production process for the NCNR customized product. The terms within the NCNR sales orders provide the Company with a legally enforceable right to receive payment including a reasonable profit margin upon customer cancellation for performance completed to date. Accordingly, the Company recognizes revenue over time as customized products listed within the NCNR orders are completed.

Computing Products and Services

A small portion of the Company’s product sales includes extended warranty and on-site services, subscriptions to the Company’s high performance computing environment, professional consulting services including installation and other services, and hardware and software related support. Each contract may contain multiple performance obligations, which requires the transaction price to be allocated to each performance obligation. The Company allocates the consideration to each performance obligation based on the relative selling price. The Company uses best-estimated selling price, determined as the best estimate of the price at which the Company would transact if it sold the deliverable regularly on a stand-alone basis.  

For services provided to the customers over a period of time, such revenues are recognized over time in line with when the customer receives and consumes the benefit of the services. Extended warranty and on-site services, hardware support, software support, and subscription revenue for access to the Company’s high performance computing environment is deferred and recognized ratably over the contractual period as the Company transfers control as it satisfies its performance obligations over time as the services are rendered.  Subscription revenue for certain customers is recognized based on the contractual fee to use the high performance-computing environment.  Professional consulting services revenue is recognized as the service is performed and the customer obtains control and benefits from the services as they are performed over the period.   The methods of recognizing revenue for each of these products/services were selected because they reflect a faithful depiction of the transfer of control.

8


 

Agency Services

The Company has service performance obligations for agency related services such as procurement, logistics, inventory management, temporary warehousing, kitting and packaging services for certain agency basis customers. The agency services are also known as supply chain services and the performance obligations for these services consist of customized, integrated supply chain services management to assist customers in the planning, execution and overall management of the procurement processes.

For these customers that are accounted for on an agency basis, the Company recognizes as revenue the amount billed less the material procurement costs of products serviced as an agent with the cost of providing these services embedded with the cost of sales. The Company has separate agent performance obligations as follows: (a) procurement, logistics, and inventory management, (b) temporary warehousing, and (c) kitting and packaging services for these customers. Revenue from these arrangements is recognized as service revenue and is determined by a fee for services based on material procurement costs (i.e. fee as a percentage of the associated material being procured, warehoused, or kitted/packaged). The Company recognizes revenue for procurement, logistics and inventory management upon the completion of the services or performance obligation, typically upon shipment of the product, as the criteria for over time recognition is not met.  For temporary warehousing, kitting and packaging services, revenue is recognized over time, but the period of performance is typically very short in duration. There are no obligations subsequent to shipment of the product under the agency arrangements.

Contract Costs

As a practical expedient, the Company recognizes the incremental costs of obtaining a contract, specifically commission expenses that have an amortization period of less than twelve months, as an expense when incurred. Additionally, the Company has adopted an accounting policy to recognize shipping costs that occur after control transfers, if any, to the customer as a fulfillment activity. The Company records shipping and handling costs related to revenue transactions within cost of sales as a period cost.

Gross Billings and Net Sales

The following is a summary of the Company’s gross billings to customers and net sales for services and products (in thousands):

 

 

 

Three Months Ended

 

 

 

November 30,

 

 

November 24,

 

 

 

2018

 

 

2017 (2)

 

Service revenue, net

 

$

14,638

 

 

$

9,842

 

Cost of purchased materials - service (1)

 

 

316,624

 

 

 

228,568

 

Gross billings for services

 

 

331,262

 

 

 

238,410

 

Product net sales

 

 

379,241

 

 

 

255,567

 

Gross billings to customers

 

$

710,503

 

 

$

493,977

 

Product net sales

 

$

379,241

 

 

$

255,567

 

Service revenue, net

 

 

14,638

 

 

 

9,842

 

Net sales

 

$

393,879

 

 

$

265,409

 

 

 

(1)

Represents cost of sales associated with service revenue reported on a net basis.

 

(2)

Amounts for fiscal 2018 are accounted for under ASC 605 (refer to Note 1(u)).

 

9


 

Contract Balances

The Company records accounts receivable when it has an unconditional right to consideration. Contract assets represent amounts recognized as revenue for which the Company does not have the unconditional right to consideration. All contract assets represent amounts related to invoices expected to be issued during the next 12-month period and are recorded as prepaid expenses and other current assets. Contract liabilities are recorded when cash payments are received or due in advance of performance. Contract liabilities consist of advance payments and deferred revenue, where the Company has unsatisfied performance obligations. Contract liabilities are classified as deferred revenue and are allocated between accrued liabilities and other long-term liabilities of our condensed consolidated balance sheet based on the timing of when the customer takes control of the asset or receives the benefit of the service. Payment terms vary by customer. The time between invoicing and when payment is due is not significant. Changes in the accounts receivable, contract assets and the deferred revenues balances during the three months ended November 30, 2018 are as follows (in thousands):

 

 

 

November 30, 2018

 

 

September 1, 2018

 

 

$ Change

 

Accounts receivable

 

$

330,473

 

 

$

240,098

 

 

$

90,375

 

Contract assets

 

$

2,370

 

 

$

1,136

 

 

$

1,234

 

Deferred revenue

 

$

15,036

 

 

$

11,750

 

 

$

3,286

 

 

The increase in contract assets from $1.1 million as of September 1, 2018 to $2.4 million as of November 30, 2018 was primarily driven by the recognition of revenue that had not yet been billed. The increase in deferred revenue from $11.8 million to $15.0 million was due to additional funds collected for hosting and support contracts signed during the quarter in which billing occurred in advance of revenue recognition. During the three months ended November 30, 2018, $1.9 million of revenue recognized was included in the deferred revenue balance at the beginning of the period, which was offset by additional deferrals during the period.

Disaggregation of Revenue

The Company disaggregates revenue by source of revenue and geography; no other level of disaggregation is required considering the type of products, customer, markets, contracts, duration of contracts, timing of transfer of control, and sales channels. The revenue by geography is disclosed in Note 11, and revenue by source is as follows (in thousands):

 

 

Three Months Ended

 

 

 

November 30,

 

 

November 24,

 

 

 

2018

 

 

2017

 

Brazil

 

$

199,279

 

 

$

157,850

 

Specialty Memory

 

 

139,949

 

 

 

107,559

 

Specialty Compute and Storage Solutions

 

 

54,651

 

 

 

 

Total net sales

 

$

393,879

 

 

$

265,409

 

Revenue Allocated to Remaining Performance Obligations

The Company’s performance obligations related to product sales have a contractual duration of less than one year. The Company elected to apply the optional exemption practical expedient provided in ASC 606 and, therefore, is not required to disclose the aggregate amount of the transaction price allocated to those performance obligations that are unsatisfied or partially unsatisfied at the end of the reporting period.

Remaining performance obligations represent contracted revenue related to support services that have not yet been recognized. The Company expects to recognize revenue on the remaining performance obligations as follows (in thousands):

 

 

 

November 30, 2018

 

Within 1 year

 

$

9,384

 

2-3 years

 

 

5,460

 

Thereafter

 

 

192

 

 

 

$

15,036

 

 

(e)

Cash and Cash Equivalents

All highly liquid investments with maturities of 90 days or less from original dates of purchase are carried at cost, which approximates fair value, and are considered to be cash. Cash and cash equivalents include cash on hand, cash deposited in checking and saving accounts, money market accounts, and securities with maturities of less than 90 days at the time of purchase. Due to the adoption of ASU 2016-18 in fiscal 2019, the presentation of the Statement of Cash Flows has been updated with the inclusion of restricted cash – refer to Note 1(u) for details.

10


 

(f)

Allowance for Doubtful Accounts

The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company is aware of circumstances that may impair a specific customer’s ability to meet its financial obligations, the Company records a specific allowance against amounts due and, thereby, reduces the net recognized receivable to the amount management reasonably believes will be collected. For all other customers, the Company recognizes allowances for doubtful accounts based on a combination of factors including the length of time the receivables are outstanding, industry and geographic concentrations, the current business environment and historical experience.

(g)

Derivative Financial Instrument

The Company records the assets or liabilities associated with derivative instruments at fair value based on Level 2 inputs in other current assets or other current liabilities, respectively, in the condensed consolidated balance sheets. The accounting for gains and losses resulting from changes in fair value depends on the use of the derivative and whether it is designated and qualifies for hedge accounting. See Note 4 for further details.

(h)

Inventories

Inventories are valued at the lower of actual cost or market value. Inventory value is determined on a specific identification basis for material and an allocation of labor and manufacturing overhead. At each balance sheet date, the Company evaluates the ending inventories for excess quantities and obsolescence. This evaluation includes an analysis of sales levels by product family and considers historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles. The Company adjusts carrying value to the lower of its cost or market value. Inventory write-downs are not reversed and create a new cost basis.

(i)

Prepaid State Value-Added Taxes (ICMS)

Since 2004, the Sao Paulo State tax authorities have granted SMART Brazil a tax benefit to defer and eventually eliminate the payment of ICMS levied on certain imports from independent suppliers. This benefit, known as an ICMS Special Regime, is subject to renewal every two years. When the then current ICMS Special Tax Regime expired on March 31, 2010, SMART Brazil timely applied for a renewal of the benefit, however, the renewal was not granted until August 4, 2010.

On June 22, 2010, the Sao Paulo authorities published a regulation allowing companies that applied for a timely renewal of an ICMS Special Regime to continue utilizing the benefit until a final conclusion on the renewal request was rendered. As a result of this publication, SMART Brazil was temporarily allowed to utilize the benefit while it waited for its renewal. From April 1, 2010, when the ICMS benefit lapsed, through June 22, 2010 when the regulation referred to above was published, SMART Brazil was required to pay the ICMS taxes on imports, which payments result in ICMS credits that may be used to offset ICMS obligations generated from sales by SMART Brazil of its products; however, the vast majority of SMART Brazil’s sales in Sao Paulo were either subject to a lower ICMS rate or were made to customers that were entitled to other ICMS benefits that enabled them to eliminate the ICMS levied on their purchases of products from SMART Brazil. As a result, from April 1, 2010 through June 22, 2010, SMART Brazil did not have sufficient ICMS collections against which to apply the credits and the credit balance increased significantly.

Effective February 1, 2011, in connection with its participation in a Brazilian government incentive program known as Support Program for the Technological Development of the Semiconductor and Display Industries Laws, or PADIS, SMART Brazil spun off the module manufacturing operations into SMART do Brazil, a separate subsidiary of the Company. In connection with this spin off, SMART do Brazil applied for a tax benefit from the State of Sao Paulo in order to obtain a deferral of state ICMS. This tax benefit is referred to as State PPB, or CAT 14. The CAT 14 approval was not obtained until July 21, 2011, and from February 1, 2011 until the CAT 14 approval was granted, SMART do Brazil did not have sufficient ICMS collections against which to apply the credits accrued upon payment of the ICMS on SMART do Brazil’s imports and inputs locally acquired, and therefore, it generated additional excess ICMS credits.

As of  November 30, 2018, the total ICMS tax credits reported on the Company’s accompanying condensed consolidated balance sheet are R$45.6 million (or $12.3 million), of which (i) R$11.9 million (or $3.2 million) are fully vested ICMS credits, classified as prepaid and other current assets and R$30.2 million (or $8.1 million) are fully vested ICMS credits, classified as other noncurrent assets, and (ii) R$3.4 million (or $1.0 million) are ICMS credits subject to vesting in 48 equal monthly amounts, classified as prepaid expenses and other current assets (R$0.6 million or $0.2 million) and other noncurrent assets (R$2.8 million or $0.8 million). As of August 31, 2018, the total ICMS tax credits reported on the Company’s accompanying condensed consolidated balance sheet are R$45.3 million (or $12.1 million), of which (i) R$16.6 million (or $4.4 million) are fully vested ICMS credits, classified as prepaid and other current assets and R$25.4 million (or $6.8 million) are fully vested ICMS credits, classified as other noncurrent assets, and (ii) R$3.3 million (or $0.9 million) are ICMS credits subject to vesting in 48 equal monthly amounts, classified as prepaid expenses and other current assets (R$0.6 million or $0.2 million) and other noncurrent assets (R$2.7 million or $0.7 million). It is expected that the excess ICMS credits will continue to be recovered in fiscal 2019 through fiscal 2022. The Company updates its forecast of the recoverability of the ICMS credits quarterly, considering the following key variables in Brazil: timing of government approvals of automated credit utilization, the total amount of sales, the product mix and the inter and intra state mix of sales. If these estimates or the mix of products or regions vary, it could take longer or shorter than expected to recover the accumulated ICMS credits, resulting in a reclassification of ICMS credits from current to noncurrent, or vice versa.

11


 

In April and June 2016, the Company filed cases with the State of Sao Paulo tax authorities to seek approval to sell excess ICMS credits. In December 2017, the Company obtained approval to sell R$31.6 million (or $8.5 million) of its ICMS credits.  Once approved, sales of ICMS credits usually take three to six months to complete and typically incur a discount to the face amount of the credits sold, as well as fees for the arrangers of these sales which together aggregate 10% to 15% of the face amount of the credits being sold. Once the sale agreement is complete, the tax authorities usually approve the transfer of credits in monthly installments and the proceeds resulting from the sale of the aforementioned credits shall be received by the Company accordingly. The Company has recorded valuation adjustments for the estimated discount and fees that the Company will need to offer in order to sell the ICMS credits to other companies.  

In the first quarter of fiscal 2019, the Company received the approval to sell R$17.7 million (or $4.7 million) of its ICMS credits. The payments will be received in 22 installments starting in the second quarter of fiscal 2019 through fiscal 2020.

(j)

Property and Equipment

Property and equipment are recorded at cost. Depreciation and amortization are computed based on the shorter of the estimated useful lives or the related lease terms, using the straight-line method. Estimated useful lives are presented below:

 

 

 

Period

Asset:

 

 

Manufacturing equipment

 

2 to 5 years

Office furniture, software, computers and equipment

 

2 to 5 years

Leasehold improvements*

 

2 to 60 years

 

 

*

Includes the land lease for the Penang facility with a term expiring in 2070.

(k)

Goodwill

The Company performs a goodwill impairment test annually during the fourth quarter of its fiscal year and more frequently if events or circumstances indicate that impairment may have occurred. Such events or circumstances may, among others, include significant adverse changes in the general business climate. As of November 30, 2018 and August 31, 2018, the carrying value of goodwill on the Company’s condensed consolidated balance sheet was $45.7 million and $45.4 million, respectively.

When conducting the annual impairment test for goodwill, the Company compares the estimated fair value of a reporting unit containing goodwill to its carrying value. If the fair value of the reporting unit is determined to be more than its carrying value, no goodwill impairment is recognized. The excess of the fair value of the reporting unit over the fair value of assets less liabilities is the implied value of goodwill and is used to determine the amount of impairment.

All of the $45.7 million carrying value of goodwill on the Company’s condensed consolidated balance sheet as of November 30, 2018 is associated with the Company’s three reporting units (Specialty Memory, Brazil and Penguin). No impairment of goodwill was recognized through November 30, 2018.

The changes in the carrying amount of goodwill during the three months ended November 30, 2018 and fiscal 2018 are as follows (in thousands):

 

 

 

Total

 

Balance as of August 25, 2017

 

$

46,022

 

Addition from business acquisition (see Note 2)

 

 

4,575

 

Translation adjustments

 

 

(5,203

)

Balance as of August 31, 2018

 

 

45,394

 

Translation adjustments

 

 

261

 

Balance as of November 30, 2018

 

$

45,655

 

 

12


 

(l)

Intangible Assets, Net

The following table summarizes the gross amounts and accumulated amortization of intangible assets by type as of November 30, 2018 and August 31, 2018 (dollars in thousands):

 

 

 

 

 

 

 

November 30, 2018

 

 

August 31, 2018

 

 

 

Weighted

 

 

Gross

 

 

 

 

 

 

 

 

 

 

Gross

 

 

 

 

 

 

 

 

 

 

 

avg.

 

 

Carrying

 

 

Accumulated

 

 

 

 

 

 

Carrying

 

 

Accumulated

 

 

 

 

 

 

 

life (yrs)

 

 

amount

 

 

amortization

 

 

Net

 

 

amount

 

 

amortization

 

 

Net

 

Customer relationships

 

5 - 7

 

 

$

14,700

 

 

$

(1,006

)

 

$

13,694

 

 

$

37,187

 

 

$

(22,968

)

 

$

14,219

 

Trademarks/tradename

 

 

7

 

 

 

12,200

 

 

 

(835

)

 

 

11,365

 

 

 

12,200

 

 

 

(400

)

 

 

11,800

 

Technology

 

 

4

 

 

 

250

 

 

 

(30

)

 

 

220

 

 

 

5,150

 

 

 

(4,914

)

 

 

236

 

Backlog

 

< 1

 

 

 

400

 

 

 

(400

)

 

 

 

 

 

400

 

 

 

(400

)

 

 

 

Total

 

 

 

 

 

$

27,550

 

 

$

(2,271

)

 

$

25,279

 

 

$

54,937

 

 

$

(28,682

)

 

$

26,255

 

 

Amortization expense related to intangible assets totaled approximately $1.0 million and $1.3 million during the three months ended November 30, 2018 and November 24, 2017, respectively. Acquired intangibles are amortized on a straight-line basis over the remaining estimated economic life of the underlying intangible assets.

 

 

 

Three Months Ended

 

 

 

November 30,

 

 

November 24,

 

 

 

2018

 

 

2017

 

Amortization of intangible assets classification (in thousands):

 

 

 

 

 

 

 

 

Cost of sales

 

$

16

 

 

$

 

Research and development

 

 

 

 

 

245

 

Selling, general and administrative

 

 

961

 

 

 

1,023

 

Total

 

$

977

 

 

$

1,268

 

 

(m)

Long-Lived Assets

Long-lived assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the future undiscounted cash flows expected to be generated by the asset group. If such assets are considered to be impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed are reported at the lower of the carrying amount or fair value, less cost to sell. No impairment of long-lived assets was recognized during the three months ended November 30, 2018 and November 24, 2017.

(n)

Research and Development Expense

Research and development expenditures are expensed in the period incurred.

(o)

Income Taxes

The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and net operating loss and credit carryforwards. When necessary, a valuation allowance is recorded to reduce tax assets to amounts expected to be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income (or loss) in the period that includes the enactment date. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company records interest and penalties related to unrecognized tax benefits in tax expense.

13


 

(p)

Foreign Currency Translation

For foreign subsidiaries using the local currency as their functional currency, assets and liabilities are translated at exchange rates in effect at the balance sheet date and income and expenses are translated at average exchange rates during the period. The effect of this translation is reported in other comprehensive income (loss). Exchange gains and losses arising from transactions denominated in a currency other than the functional currency of the respective foreign subsidiaries are included in results of operations.

For foreign subsidiaries using the U.S. dollar as their functional currency, the financial statements of these foreign subsidiaries are remeasured into U.S. dollars using the historical exchange rate for property and equipment and certain other nonmonetary assets and liabilities and related depreciation and amortization on these assets and liabilities. The Company uses the exchange rate at the balance sheet date for the remaining assets and liabilities, including deferred taxes. A weighted average exchange rate is used for each period for revenues and expenses.

All foreign subsidiaries and branch offices, except those in Brazil and South Korea, use the U.S. dollar as their functional currency. The gains or losses resulting from the remeasurement process are recorded in other income (expense) in the accompanying condensed consolidated income statements.

During the three months ended November 30, 2018 and November 24, 2017, the Company recorded $3.4 million and $2.7 million, respectively, of foreign exchange losses primarily related to its Brazilian operating subsidiaries.

(q)

Share-Based Compensation

The Company accounts for share-based compensation under ASC 718, Compensation—Stock Compensation, which requires companies to recognize in their income statement all share-based payments, including grants of share options and other types of equity awards, based on the grant-date fair value of such share-based awards.

 

 

 

Three Months Ended

 

 

 

November 30,

 

 

November 24,

 

 

 

2018

 

 

2017

 

Stock-based compensation expense by category

   (in thousands):

 

 

 

 

 

 

 

 

Cost of sales

 

$

545

 

 

$

218

 

Research and development

 

 

634

 

 

 

274

 

Selling, general and administrative

 

 

2,876

 

 

 

1,113

 

Total

 

$

4,055

 

 

$

1,605

 

 

(r)

Loss Contingencies

The Company is subject to the possibility of various loss contingencies arising in the ordinary course of business. The Company considers the likelihood of a loss and the ability to reasonably estimate the amount of loss in determining the necessity for and amount of any loss contingencies. Estimated loss contingencies are accrued when it is probable that a liability has been incurred or an asset impaired and the amount of loss can be reasonably estimated. The Company regularly evaluates the most current information available to determine whether any such accruals should be recorded or adjusted.

(s)

Comprehensive Income (Loss)

Comprehensive income (loss) consists of net income (loss) and other gains and losses affecting shareholders’ equity that, under U.S. GAAP are excluded from net income (loss). The Company’s other comprehensive income (loss) generally consists of foreign currency translation adjustments.

(t)

Concentration of Credit and Supplier Risk

The Company’s concentration of credit risk consists principally of cash and cash equivalents and accounts receivable. The Company’s revenue and related accounts receivable reflect a concentration of activity with certain customers (see Note 12). The Company does not require collateral or other security to support accounts receivable. The Company performs periodic credit evaluations of its customers to minimize collection risk on accounts receivable and maintains allowances for potentially uncollectible accounts.

The Company relies on three suppliers for the majority of its raw materials. At November 30, 2018 and August 31, 2018, the Company owed these three suppliers $182.2 million and $138.4 million, respectively, which was recorded as accounts payable and accrued liabilities. The inventory purchases from these suppliers during the three months ended November 30, 2018 and November 24, 2017 were $0.4 billion and $0.3 billion, respectively.

14


 

(u)

New Accounting Pronouncements

In October 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-16, Derivatives and Hedging (Topic 815) Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. This standard amends ASC 815, Derivatives and Hedges, and permits the SOFR OIS rate as an approved rate to be used in valuing derivative instruments. ASU 2018-16 is effective for fiscal years, including interim periods within those fiscal years, beginning after December 15, 2018, on a prospective basis. Early adoption is permitted. At this time, this standard is not expected to have a material impact on the Company’s consolidated financial statements.

In August 2018, the Securities and Exchange Commission (“SEC”) adopted amendments to certain disclosure requirements in Securities Act Release No. 33-10532, Disclosure Update and Simplification. The amendments became effective on November 5, 2018. The SEC staff subsequently indicated that it would not object if a filer’s first presentation of changes in shareholders’ equity is included in its Form 10-Q for the quarter that begins after the final rule’s effective date. Among the amendments is the requirement to present the changes in shareholders’ equity in the interim financial statements (either in a separate statement or footnote) in quarterly reports on Form 10-Q. The analysis should present a reconciliation of the beginning balance to the ending balance of each period for which a consolidated income statement is required to be filed. The Company will include the first presentation of changes in stockholders’ equity on its Form 10-Q in its second quarter of fiscal 2019.

In March 2018, the FASB issued ASU No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118. This standard amends ASC 740, Income Taxes, to provide guidance on accounting for tax effects of the Tax cuts and Jobs Act (the “Tax Act”) pursuant to Staff Accounting Bulletin No. 118, which allows companies to complete the accounting under ASC 740 within one-year measurement period from the Tax Act enactment date. This standard is effective upon issuance. The Company applied the guidance in ASU 2018-05 in the third quarter of fiscal 2018.  

In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Comprehensive Income. The new guidance allows companies to reclassify stranded tax effects resulting from the Tax Act, from accumulated other comprehensive income to retained earnings. The guidance also requires certain new disclosures regardless of the election.  The Company is required to adopt the guidance in the first quarter of fiscal 2020. Early adoption is permitted. The Company is currently evaluating the timing and the impact of these amendments to its consolidated financial statements.

In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which clarifies the inclusion and presentation of changes in restricted cash and restricted cash equivalents in the statement of cash flows. The Company adopted ASU 2016-18 in fiscal 2019 on a retrospective basis.

The following table provides a reconciliation of Cash and cash equivalents as previously reported within the Condensed Consolidated Statements of Cash Flows to Cash, cash equivalents and restricted cash as currently reported in the Condensed Consolidated Statements of Cash Flows (in thousands):

 

 

August 31,

2018

 

November 24,

2017

 

August 25,

2017

Cash, cash equivalents as previously reported in the

   Condensed Consolidated Statements of Cash Flows

$

31,375

 

 

$

23,503

 

 

$

22,436

 

Restricted cash (Other noncurrent assets)

5,859

 

 

 

6,714

 

 

7,027

 

Cash, cash equivalents and restricted cash as currently

   reported in the Condensed Consolidated Statements

   of Cash Flows

$

37,234

 

 

$

30,217

 

 

$

29,463

 

 

In August 2016, the FASB issued ASU No. 2016-15, Cash Flow Statements, Classification of Certain Cash Receipts and Cash Payments. The new guidance is intended to address the diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. The guidance addresses eight specific cash flow classification issues with the objective of reducing diversity in practice. The Company adopted ASU 2016-15 in fiscal 2019 on a retrospective basis. The adoption of this standard did not have a material impact on its consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which modified lease accounting for both lessees and lessors to increase transparency and comparability by recognizing lease assets and lease liabilities by lessees for those leases classified as operating leases under previous accounting standards and disclosing key information about leasing arrangements. ASU 2016-02 will be effective for the Company beginning on September 1, 2019 and early adoption is permitted. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach.  The Company is currently evaluating the impact of adopting ASU 2016-02 on its consolidated financial statements and related disclosures and does not plan to early adopt. As disclosed in Note 10(a), the Company has over $18.6 million in lease commitments at November 30, 2018 and believes that the adoption will have a material impact to the consolidated financial statements.

15


 

In May 2014, the FASB issued a new standard, ASU No. 2014-09, Revenue from Contracts with Customers, as amended, which supersedes nearly all existing revenue recognition guidance. The FASB has issued several amendments to the new standard, including clarification on identifying performance obligations. The amendments include ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606)—Principal versus Agent Considerations, which was issued in March 2016, and clarifies the implementation guidance for principal versus agent considerations in ASU 2014-09. The new standard permits adoption either by using (i) a full retrospective approach for all periods presented in the period of adoption or (ii) a modified retrospective approach with the cumulative effect of initially applying the new standard recognized at the date of initial application and providing certain additional disclosures. The new standard is effective for annual reporting periods beginning after December 15, 2017. The Company has adopted the new standard effective September 1, 2018 using the modified retrospective approach applied to all contracts that are not completed contracts at the date of initial adoption (i.e. September 1, 2018).

The Company has completed its assessment and implemented policies, processes, and controls to support the standard measurement and disclosure requirements. Under ASC 606, the Company recognized a change to the timing of revenue recognition in two areas. The first relates to customized product sales orders deemed NCNR. Under previous accounting standards, the Company recognized revenue and costs related to these sales when products were shipped or delivered to the customers based on the terms of the purchase orders and sales agreements. Under ASC 606, the terms within the NCNR sales orders that provide the Company with a legally enforceable right to receive payment including a reasonable profit margin upon customer cancellation for performance completed to date will affect the timing of revenue recognition. Accordingly, the Company will recognize revenue over time as customized products listed within the NCNR orders are completed.

The second change for the Company under ASC 606 relates to the timing of revenue recognition for customized product sales with terms that require the customer to purchase 100% of all parts built to fulfill the customers forecast. Under previous accounting standards, the Company recognized revenue and costs related to these sales when products are shipped or delivered to the end-customers based on the terms of the purchase orders and sales agreements. Under ASC 606, the Company recognizes revenue when control of the underlying assets passes to the customer, as the customer is able to both direct the use of, and obtain substantially all of the remaining benefit from the assets; the customer has the significant risks and rewards associated with ownership of the assets; and the Company has a present right to payment. For these sales, control passes when the Company has made these products available to the customer and under the terms of the agreement cannot repurpose them without the customer’s express consent.  Accordingly, the Company will recognize revenue at the point in time when products made to the customer’s forecast are completed and made available to the customer.

Results for reporting periods beginning after September 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with the prior accounting under ASC 605. As a result of these changes, the Company recorded a net increase to opening retained earnings of $1.0 million as of September 1, 2018 due to the cumulative impact of adopting ASC 606, with a corresponding increase of $2.9 million in accounts receivables, $1.1 million in contract assets and a decrease of $3.0 million in inventory. Effective September 1, 2018, the Company recognized revenue on NCNR customized product sales over time and customized product sales where control has deemed to pass before shipment at the time that those products are made available to the customer as opposed to at the time of shipment.

The following tables summarize the impacts of ASC 606 adoption on the Company's condensed consolidated financial statements for the quarter ended November 30, 2018 (in thousands).

 

Selected Consolidated Balance Sheet Line Items:

 

 

 

As of November 30, 2018

 

 

 

As Reported

 

 

Adjustment

 

 

Balances

Without

Adoption

 

Accounts receivable

 

$

330,473

 

 

$

(8,820

)

 

$

321,653

 

Inventories

 

$

188,390

 

 

$

8,845

 

 

$

197,235

 

Prepaid expenses and other current assets

 

$

40,351

 

 

$

(2,371

)

 

$

37,980

 

Retained earnings

 

$

144,264

 

 

$

(2,346

)

 

$

141,918

 

 

16


 

Selected Consolidated Statement of Comprehensive Income Line Items:

 

 

 

Three Months Ended November 30, 2018

 

 

 

As Reported

 

 

Adjustment

 

 

Balances

Without

Adoption

 

Net sales

 

$

393,879

 

 

$

(7,169

)

 

$

386,710

 

Cost of sales

 

$

308,810

 

 

$

(5,857

)

 

$

302,953

 

Gross profit

 

$

85,069

 

 

$

(1,312

)

 

$

83,757

 

Net income (loss)

 

$

30,976

 

 

$

(1,312

)

 

$

29,664

 

 

Selected Consolidated Statement of Cash Flows Line Items:

 

 

 

Three Months Ended November 30, 2018

 

 

 

As Reported

 

 

Adjustment

 

 

Balances

Without

Adoption

 

Net income

 

$

30,976

 

 

$

(1,312

)

 

$

29,664

 

Adjustment to reconcile net income (loss) to

   net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

 

 

Change in operating assets and liabilities

 

 

 

 

 

 

 

 

 

 

 

 

Accounts receivable

 

$

(89,441

)

 

$

5,934

 

 

$

(83,507

)

Inventories

 

$

30,576

 

 

$

(5,857

)

 

$

24,719

 

Prepaid expenses and other current assets

 

$

(3,182

)

 

$

1,235

 

 

$

(1,947

)

Net cash provided by operating activities

 

$

35,352

 

 

$

 

 

$

35,352

 

 

 

(2)

Business Acquisitions

On June 8, 2018, SMART Global Holdings entered into an Agreement and Plan of Merger (the Penguin Merger Agreement), by and among SMART Global Holdings, Glacier Acquisition Sub, Inc., a Delaware corporation and a wholly-owned indirect subsidiary of the SMART Global Holdings (Merger Sub), Penguin Computing, Inc., a California corporation (Penguin) and Fortis Advisors LLC, a Delaware limited liability company, solely in its capacity as the representative of the holders of the securities of Penguin. Pursuant to the Penguin Merger Agreement, on June 8, 2018, Merger Sub was merged with and into Penguin, with Penguin surviving as a wholly-owned indirect subsidiary of SMART Global Holdings (the Penguin Merger). SMART Global Holdings through one or more subsidiaries, paid the Penguin equityholders approximately $45 million at closing and assumed approximately $32.3 million of Penguin’s outstanding indebtedness. SMART Global Holdings financed the acquisition with net proceeds of $60.0 million from the Incremental Amendment (as defined in Note 7). Pursuant to the Penguin Merger Agreement, the former equityholders of Penguin were also entitled to cash earn-out payments of up to $25.0 million based on Penguin’s achievement of specified gross profit levels through December 31, 2018. SMART Global Holdings deposited $6.0 million of the purchase price into escrow as security for Penguin’s indemnification obligations during the escrow period of one year. SMART Global Holdings also deposited $2.0 million of the purchase price into escrow as security for customary post-closing adjustments to the purchase price.

Under the acquisition method of accounting, the assets acquired and liabilities assumed of Penguin were recorded as of the acquisition date at their respective fair values. The reported consolidated financial condition after completion of the acquisition reflects these fair values. Penguin’s results of operations are included in the consolidated financial statements from the date of acquisition.

The initial fair value of contingent consideration was estimated at the date of acquisition to be $3.0 million, which was recorded as a current liability. The Company determined the fair value of the obligations to pay contingent consideration using a real options technique which incorporates various estimates, including projected gross profit for the period, a volatility factor applied to gross profit based on year-on-year growth in gross profit of comparable companies, discount rates and the estimated amount of time until final payment is made. This fair value measurement is based on significant inputs not observable in the market, which ASU 820-10-35 refers to as Level 3 inputs. The resulting probability-weighted cash flows were discounted using the US Information Technology B Corporate Bond Yields of 4.06%, which is representative of a market participant assumption.

Subsequent to the acquisition date, the Company adjusted the contingent consideration to its current fair value with such changes recognized in income from operations. Changes in fair values reflect new information about the probability and timing of meeting the conditions of the gross profit target. As of November 30, 2018 and August 31, 2018, the fair value of the contingent consideration was $0.

17


 

A reconciliation of net cash exchanged in accordance with the purchase agreement to the total purchase price as of the closing date of the merger, June 8, 2018, is presented below (in thousands):

 

Net cash for merger

$

42,316

 

Cash and cash equivalents acquired

 

2,769

 

Upfront payment in accordance with agreement

 

45,085

 

Post-closing adjustments in accordance with agreement

 

(3,479

)

Total consideration

 

41,606

 

Estimated fair value of contingent consideration

 

3,000

 

Total purchase price

$

44,606

 

 

The assets acquired and liabilities assumed at the acquisition date are based upon their respective fair values summarized below (in thousands):

 

Tangible assets acquired

$

84,707

 

Liabilities assumed

 

(72,226

)

Identifiable intangible assets

 

27,550

 

Goodwill

 

4,575

 

Total net assets acquired

$

44,606

 

 

Asset categories acquired included working capital, fixed assets, and identified intangible assets. The intangible assets are as follows (in thousands):

 

 

Amount

 

 

Estimated

Useful Life

(in years)

Customer relationships

$

14,700

 

 

7 years

Trade name

 

12,200

 

 

7 years

Technology

 

250

 

 

4 years

Existing order backlog

 

400

 

 

< 1 year

 

$

27,550

 

 

 

 

The excess of purchase price over the fair value amounts assigned to the assets acquired and liabilities assumed represents the goodwill amount resulting from the acquisition. The Company does not expect any portion of this goodwill to be deductible for tax purposes. The goodwill attributable to the Penguin Merger has been recorded as a noncurrent asset and is not amortized, but is subject to an annual review for impairment. Factors that contributed to the recognition of goodwill include the broader reach and capabilities of the Company into new technologies, markets and channels that leverage its existing products and services. Penguin brings an outstanding customer base, solid products and strong supplier relationships to the Company in the specialty compute, storage and networking markets. Penguin will have substantially improved access to capital to drive additional investment in, and further development and growth of its products and services.

As part of the Penguin Merger, the Company recorded a net deferred tax liability of $1.6 million. This amount was primarily comprised of $7.9 million related to non-goodwill intangible assets and other fair market value adjustments, offset by net deferred tax assets including acquired net operating losses and research credit carryovers totaling $6.3 million.

The total purchase consideration has been allocated to the tangible and intangible assets acquired and liabilities assumed based on a preliminary valuation analysis. These preliminary values may change in future reporting periods upon finalization of the valuation and net working capital adjustment, which will occur no later than the third quarter of fiscal 2019. During fiscal 2018 the Company incurred certain costs related to the merger, which are included in selling, general and administrative expense in the consolidated income statements. Merger-related costs include the following (in thousands):

 

 

August 31, 2018

 

Professional fees

$

2,496

 

Employee retention bonuses

 

1,181

 

 

$

3,677

 

 

For the period of June 8, 2018 (date of acquisition) to August 31, 2018, total revenues and net loss for Penguin amounted to $52.5 million and $0.7 million, respectively.

18


 

Unaudited Pro Forma Information

The results of operations related to the Penguin acquisition have been included in our consolidated income statements from the acquisition date. The following unaudited pro forma financial information presents our combined results of operations for the three months ended November 24, 2017 as if the acquisition of Penguin and entering into the Incremental Amendment had occurred on August 27, 2016. The unaudited pro forma financial information is not necessarily indicative of what our consolidated results of operations actually would have been had the acquisition been completed on August 27, 2016. In addition, the unaudited pro forma financial information does not attempt to project the future results of operations of the combined company. The actual results may differ significantly from the pro forma results presented here due to many factors.

 

 

Three Months Ended

 

(In thousands, except per share data)

November 24, 2017

 

Total net sales

$

321,410

 

Net income

$

21,083

 

Earnings per share:

 

 

 

Basic

$

0.97

 

Diluted

$

0.93

 

 

The unaudited pro forma financial information above reflects the following material adjustments:

 

Incremental amortization expense related to the estimated fair value of identifiable intangible assets from the purchase price allocation.

 

Incremental interest expense and amortization of debt issuance costs related to our Incremental Amendment.

 

The adjustments to income tax expense as a result of the consolidation and pro forma adjustments.

(3)

Related Party Transactions

In the normal course of business, the Company had transactions with its affiliates as follows (in thousands):

 

 

 

Three Months Ended

 

 

 

November 30,

 

 

November 24,

 

 

 

2018

 

 

2017

 

Affiliates:

 

 

 

 

 

 

 

 

Net sales

 

$

35,297

 

 

$

25,969

 

 

As of November 30, 2018 and August 31, 2018, amounts due from these affiliates were $11.8 million and $11.7 million, respectively.

(4)

Foreign Currency Exchange Contracts

The Company transacts business in various foreign currencies and has international sales and expenses denominated in foreign currencies, subjecting the Company to foreign currency risk. The Company utilizes foreign exchange forward contracts to mitigate foreign currency exchange rate risk associated with foreign-currency-denominated assets and liabilities, primarily third party payables.  The Company does not use foreign currency contracts for speculative or trading purposes.

Foreign exchange forward contracts outstanding at November 30, 2018 are not designated as hedging instruments for hedge accounting purposes. Accordingly, any gains or losses resulting from changes in the fair value of the non-designated forward contracts are reported in other income (expense) in the condensed consolidated income statements. The gains and losses on these forward contracts generally offset the gains and losses associated with the underlying foreign-currency-denominated balances, which are also reported in other income (expense).  

As of November 30, 2018, the Company’s non-designated forward contacts resulted in a $0.1 million derivative asset and a $1.1 million derivative liability. For the three months-ended November 30, 2018, the Company recognized realized losses in the amount of $1.3 million and net unrealized losses on the change in the fair value of the non-designated forward contracts in the amount of $1.0 million.

 

19


 

(5)

Balance Sheet Details

Inventories

Inventories consisted of the following (in thousands):

 

  

 

November 30,

 

 

August 31,

 

 

 

2018

 

 

2018

 

Raw materials

 

$

91,095

 

 

$

105,017

 

Work in process

 

 

26,214

 

 

 

35,977

 

Finished goods

 

 

71,081

 

 

 

80,425

 

Total inventories*

 

$

188,390

 

 

$

221,419

 

 

 

*

As of November 30, 2018 and August 31, 2018, 23% and 22%, respectively, of total inventories represented inventory held under the Company's supply chain services.

Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets consisted of the following (in thousands):

 

 

 

November 30,

 

 

August 31,

 

 

 

2018

 

 

2018

 

Indemnification claims receivable*

 

$

8,000

 

 

$

8,000

 

Unbilled service receivables

 

 

8,056

 

 

 

5,361

 

Supplier advances

 

 

6,785

 

 

 

 

Prepaid ICMS taxes in Brazil**

 

 

3,369

 

 

 

4,593

 

Prepaid R&D expense

 

 

2,760

 

 

 

2,590

 

Prepayment for VAT and other transaction taxes

 

 

854

 

 

 

2,557

 

Contract assets***

 

 

2,370

 

 

 

 

Prepaid income taxes

 

 

1,704

 

 

 

1,697

 

Revolver debt fees

 

 

952

 

 

 

952

 

Other prepaid expenses and other current assets

 

 

5,501

 

 

 

6,293

 

Total prepaid expenses and other current assets

 

$