What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-04-06 compared with 2021-01-05 · 63 added, 40 removed, 88 unchanged (54% of the section changed)

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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 communications, storage, networking, mobile, industrial automation, industrial internet of things, government, military, and computing including edge and high performance computing.

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 – COVID 19

The outbreak of coronavirus disease 2019 (“COVID-19”) has resulted in several millions of infections and over one 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.

Recent Developments

Acquisition of CreeLED, Inc.

On March 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 on August 15, 2023, and the Earnout Note, if issued, will mature on March 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.

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 quarter 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.

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

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

The following is a summary of our results of operations for the three months ended November 27, 2020 and November 29, 2019:

The following is a summary of our results of operations for the three and six months ended February 26, 2021 and February 28, 2020:

Three Months Ended

Six Months Ended

(in thousands, other than percentages and per share data)

Consolidated Income Statements:

(in thousands, other than percentages and per share data)

Condensed Consolidated Statements of Operations:

Cost of sales (1)(2)

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Interest expense, net

Other income (expense), net

Other expense, net

Total other expense

Income before income taxes

Income (loss) before income taxes

Provision for income taxes

Net income (loss)

Earnings per share:

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Selling, general and administrative

Three Months Ended November 27, 2020 as Compared to the Three Months Ended November 29, 2019

Net sales increased by $19.7 million, or 7.2%, during the three months ended November 27, 2020 compared to the same period in the prior year.

Net sales were positively impacted by higher Specialty Memory product sales of $17.1 million, or 16.5%, primarily due to higher Flash and DRAM revenue resulting from higher average selling prices of 32% and 31%, respectively, mainly due to increased OEM sales as well as a change in product mix.

In addition, our sales of Brazil products increased by $11.2 million, or 11.9%, primarily due to 98% higher average selling prices for mobile memory.

The increases in Specialty and Brazil were partially offset by lower revenue from SCSS of $8.6 million, or 11.6%, primarily attributable to lower Penguin revenue, which was in turn primarily due to lower federal spending as a result of the global COVID-19 pandemic .

Three and Six Months Ended February 26, 2021 as Compared to the Three and Six Months Ended February 28, 2020

Net sales increased by $32.0 million, or 11.8%, during the three months ended February 26, 2021 compared to the same period in the prior year, and by $51.6 million, or 9.5%, during the six months ended February 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 of Brazil 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 for Brazil and higher DRAM revenue for Specialty Memory product, resulting from a change in product mix.

Cost of Sales

Cost of sales increased by $21.4 million, or 9.8%, during the three months ended November 27, 2020 compared to the same period in the prior year, primarily due to higher cost of materials of $20.4 million or 11.1%, due to the higher level of sales, as well as higher production costs related to the increased revenue.

Included in the cost of sales changes was a favorable foreign exchange impact of $2.5 million due to locally sourced cost of sales in Brazil .

Gross margin decreased to 18.0% during the three months ended November 27, 2020 compared to 20.0% for the same period in the prior year, primarily due to higher material costs for our Specialty Memory and Brazil products.

Cost of sales increased by $30.0 million, or 13.6%, during the three months ended February 26, 2021 compared to the same period in the prior year, and by $51.4 million, or 11.7%, during the six months ended February 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 our Brazil products were negatively impacted in the three months ended February 26, 2021 due to a $4.3 million out-of-period adjustment related to import taxes in Brazil.

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 in Brazil .

Gross margin decreased to 17.6% during the three months ended February 26, 2021 compared to 18.9% for the same period in the prior year, and decreased to 17.8% during the six months ended February 26, 2021 compared to 19.5% for the same period in the prior year, primarily due to higher material costs for our Brazil and Specialty Memory products, as well as the out-of-period Brazil adjustment.

Research and Development Expense

Research and development (“R&D”) expense decreased $7.9 million, or 53.2%, during the three months ended November 27, 2020 compared to the same period in the prior year, due to $7.9 million of Brazil financial credits resulting from amendments to the IT law implemented in April 2020.

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 increase was an unfavorable foreign exchange impact of $2.0 million.

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 Expense

Selling, general and administrative (“SG&A”) expense increased by $4.5 million, or 13.4%, during the three months ended November 27, 2020 compared to the same period in the prior year, primarily due to $5.0 million higher share-based compensation expense resulting from awards acceleration.

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 increase was a favorable foreign exchange impact of $0.6 million.

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 (Expense)

Interest expense, net decreased $1.3 million, or 29.8%, during the three months ended November 27, 2020 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.

Interest expense, net increased $0.2 million, or 5.2%, during the three months ended February 26, 2021 compared to the same period in the prior year, and decreased $1.1 million, or 13.0%, during the six months ended February 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 increased by $1.7 million primarily due to foreign currency gains .

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.

Provision for income taxes increased by $3.0 million for the three months ended November 27, 2020 compared to the same period in the prior year, primarily due to the profits and related taxes in non-U.S.

Provision for income taxes decreased by $0.1 million and increased by $2.8 million for the three and six months ended February 26, 2021, respectively, compared to the same period in the prior year, primarily due to the profits and related taxes in non-U.S.

jurisdictions.

As of November 27, 2020, SMART has a full valuation allowance for our net deferred tax assets associated with our U.S.

As of February 26, 2021, SMART has a full valuation allowance for our net deferred tax assets associated with our U.S.

The amount of the deferred tax asset considered realizable could be adjusted if significant positive evidence increases.

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Liquidity and Capital Resources

Three Months Ended

Six Months Ended

(in thousands)

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Cash used in investing activities

Cash used in financing activities

Cash provided by (used in) financing activities

Effect of exchange rate changes on cash and cash equivalents

Net increase in cash and cash equivalents

At November 27, 2020, we had cash and cash equivalents of $164.1 million, of which approximately $119.3 million was held outside of the United States.

Net increase (decrease) in cash and cash equivalents

At February 26, 2021, we had cash and cash equivalents of $139.8 million, of which approximately $80.8 million was held outside of the United States.

In February 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.

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For additional information, see Note 7 in our Notes to Unaudited Condensed Consolidated Financial Statements.

On March 1, 2021, as part of the acquisition of CreeLED, 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 on August 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.

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 three months ended November 27, 2020, cash provided by operating activities was $35.6 million.

During the six months ended February 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 $10.3 million change in net operating assets and liabilities consisted of increases of $1.9 million in accounts receivable and $9.3 million in prepaid expenses and other assets, and decreases of $1.5 million of operating lease liabilities and $7.9 million in accrued expense and other liabilities, offset by decreases of $12.9 million in inventory and an increase of $18.0 million of accounts payable.

The increase in accounts receivable was primarily due to timing of sales, and the increase in accounts payable was primarily due to timing of payments.

The decrease in inventory was primarily due to better efficiencies in managing our inventory along all business areas .

During the three months ended November 29, 2019, cash provided by operating activities was $25.3 million.

The primary factors affecting our cash flows during this period were $0.2 million of net income, $16.4 million of non-cash related expenses and a $8.6 million change in our net operating assets and liabilities.

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 ended February 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 three months ended November 27, 2020 was $14.6 million consisting primarily of purchases of property and equipment and deposits.

Net cash used in investing activities during the three months ended November 29, 2019 was $5.1 million consisting primarily of purchases of property and equipment and deposits .

Net cash provided by financing activities during the three months ended November 27, 2020 was $0.4 million, consisting primarily of $3.5 million for withholding tax on restricted stock units, partially offset by $3.1 million proceeds from issuance of ordinary shares from share option exercises and employee share purchase plans.

Net cash used in financing activities during the three months ended November 29, 2019 was $4.0 million, consisting prim arily of $6.4 million long-term debt payments for both the Amended Credit Agreement and the BNDES Credit Agreement, partially offset by $2.4 million proceeds from issuance of ordinary shares from share option exercises and employee share purchase plans.

Net cash used in investing activities during the six months ended February 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 ended February 28, 2020 was $9.3 million consisting primarily of purchases of property and equipmen t.

Net cash provided by financing activities during the six months ended February 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

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 ended February 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 contractual obligations previously disclosed in our Annual Report.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis