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Item 7. Management’s Discussion and Analysis

2021-10-25 compared with 2020-10-22 · 278 added, 478 removed, 28 unchanged (96% of the section changed)

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the consolidated financial statements and accompanying notes for the year ended August 27, 2021.

This discussion contains forward looking statements that involve risks and uncertainties.

Our actual results could differ materially from those contained in these forward-looking statements due to a number of factors, including those discussed below and elsewhere in this report.

See also “Cautionary Note Regarding Forward-Looking Statements” at the beginning of this report.

We use a 52- to 53-week fiscal year ending on the last Friday in August.

Unless the context indicates otherwise, whenever we refer in this report to a particular year, with respect to ourselves, we mean the fiscal year ending in that particular calendar year.

Financial information for two of our subsidiaries SMART Brazil and SMART do Brazil is included in our consolidated financial statements on a one-month lag because their fiscal years begin August 1 and end July 31.

For an overview of our business, see “Part I – Item 1.

See also “Cautionary Note Regarding Forward-Looking Statements.”

Our fiscal year is the 52 or 53-week period ending on the last Friday in August.

Fiscal 2021, 2020 and 2019 each contained 52 weeks.

All period references are to our fiscal periods unless otherwise indicated.

All financial information for our subsidiaries in Brazil is included in our consolidated financial statements on a one-month lag because their fiscal years end on July 31 of each year.

All tabular dollar amounts are in millions, except per share amounts.

For an overview of our business, including a discussion of our acquisition of our LED Solutions business from Cree and effects on us of COVID-19, see “PART I – Item 1.

Business – Overview.”

Components of Operating Results

We generate product revenues predominantly from sales of our solutions, which include memory components and modules and specialty compute and storage products, to OEMs, as well as end users that compete in the computing, networking, communications, storage, aerospace, defense, mobile and industrial markets.

Sales of our products are made primarily pursuant to purchase orders and are not based on long-term supply agreements.

We generate service revenue by providing procurement, logistics, inventory management, temporary warehousing, kitting and packaging services.

Our net sales are substantially dependent upon demand in the end markets for our customers’ products and fluctuations in end-user demand can have a rapid and material effect on our net sales.

Furthermore, sales to relatively few customers have accounted for, and we expect for the foreseeable future will continue to account for, a significant percentage of our net sales.

Cost of Sales

The most significant components of cost of sales are materials, fixed manufacturing costs, labor, depreciation, freight and customs charges.

Increases in capital expenditures may increase our future cost of sales due to higher levels of depreciation expense.

Cost of sales also includes any inventory write-downs.

We have in the past, and may in the future, write down inventory for a variety of reasons, including obsolescence, excess quantities and declines in market value below our cost.

A significant percentage of our cost of sales consists of the cost of DRAM and Flash components and wafers.

While we have historically received competitive pricing and have had consistent sources of supply for these supplies, we do not have agreements that provide us with fixed pricing or guarantees of supply.

Increases in DRAM pricing typically improve our margins, at least in the short term and particularly in our operations in Brazil, as we consume previously purchased inventory.

However, declines in DRAM pricing often require us to reduce our prices even as we consume higher priced DRAM inventory, thereby reducing our margins.

Gross profit and gross margin has been and will continue to be affected by a variety of factors, including the average sales prices of our products, manufacturing and overhead costs, the mix of products sold and our ability to leverage our existing infrastructure as we continue to grow.

We expect our gross margins to fluctuate over time depending on the factors described above.

Operating Expenses

Our operating expenses consist of research and development expense, selling, general and administrative expense and management advisory fees.

Personnel costs are the most significant component of operating expenses.

Research and development expense.

Research and development expense consists primarily of personnel costs, consulting costs, allocated overhead and other costs to support our development activities.

To date, we have expensed all research and development costs as incurred.

We expect research and development expense to increase in absolute dollars as we continue to invest in our research and product development efforts to enhance our product capabilities and access new customer markets, although such expense may fluctuate as a percentage of total net sales.

In order to qualify for certain tax incentives under PADIS and PPB/IT Program in Brazil, we are required to expend a minimum amount on research and development in Brazil.

Selling, general and administrative expense.

Sales and marketing expense consists primarily of personnel costs, sales commission costs and allocated overhead.

We expense sales commission costs as incurred.

Sales and marketing expense also includes costs for recruiting and training channel partners, market development programs, promotional and other marketing activities, travel, office equipment and outside consulting costs.

We expect sales and marketing expense to increase in absolute dollars as we expand our sales and marketing headcount in all markets and expand our international operations, although such expense may fluctuate as a percentage of net sales.

General and administrative expense consists primarily of personnel costs, facilities and non-manufacturing equipment costs, allowances for bad debt and other support costs, including utilities, insurance and professional fees.

We have experienced and will continue to experience increased general and administrative expenses as a result of being a publicly-traded company, including significant increased legal and accounting costs related to compliance with rules and regulations implemented by the SEC and NASDAQ, as well as additional insurance, investor relations and other costs associated with being a public company.

Interest Expense, Net

Interest expense, net consists primarily of interest expense on our debt obligations.

Other Expense, Net

Other expense, net includes gains and losses from foreign currency transactions and other non-operating items.

Provision for Income Taxes

We record income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns.

In estimating future tax consequences, we generally consider all expected future events other than enactments or changes in the tax law or rates.

We provide valuation allowances when necessary to reduce deferred tax assets to the amount expected to be realized.

We recognize a tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.

We then measure the tax benefits recognized in the financial statements from such positions based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement.

In the event that we recognize any unrecognized tax benefits, the effective tax rate will be affected.

If recognized, approximately $1.7 million of unrecognized tax benefit would impact the effective tax rate at August 28, 2020.

Although we believe our estimates are reasonable, we cannot assure that the final tax outcome of these matters will be the same as these estimates.

We update these estimates quarterly based on factors such as changes in facts or circumstances, changes in tax law, new audit activity and effectively settled issues.

We follow specific and detailed guidelines in each tax jurisdiction regarding the recoverability of any tax assets recorded on the balance sheet and provide necessary valuation allowances as required.

Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward periods available under the tax law.

We regularly review our deferred tax assets for recoverability based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies.

Our judgments regarding future profitability may change due to many factors, including future market conditions

and our ability to successfully execute our business plans and/or tax planning strategies.

Should there be a change in our ability to recover our deferred tax assets, our tax provision would increase or decrease in the period in which the assessment is changed.

As a result of our recent acquisitions and heightened focus on operational excellence over the past several years, we grew our net sales by 34% to $1.5 billion in 2021 compared to $1.1 billion in 2020.

Over the same period, our total segment operating income grew by 90.9% to $160.8 million, or 10.7% operating margin, in 2021, compared to $84.2 million, or 7.5% operating margin, in 2020.

See table below in “Segment Operating Income” for further details.

Our operating expenses have grown in recent periods as we drive innovation, expand our products and services portfolio and invest in greater operational capabilities to support our growth.

Our total operating expenses grew in 2021, primarily as a result of the addition of the LED Solutions business.

We expect to continue to see increased operating expenses in 2022 as we record a full year of operating expenses for the LED Solutions business, continue to increase our investment in new products and services for the IPS business and experience the phase-out of certain Brazil financial tax credits, which result in an increase in operating expense in Memory Solutions.

Factors Affecting Our Operating Performance

Macro-Economic Demand Factors.

Our business segments each have their own unique set of demand factors.

Demand in our Memory Solutions group is driven by end-market demand from OEMs for customer-specific solutions in vertical markets such as industrial, government, networking, high-performance compute and enterprise storage, as well as from OEMs for memory modules used in desktop and notebook computers, smartphones, IoT and SSD products in Brazil.

In addition, macro-economic factors specific to the Brazil economy affect this segment, given our sales and operations in that market.

Our IPS business is driven by demand for high compute solutions across AI and machine learning initiatives, as well as traditional workload optimization and efficiency applications.

Finally, demand for our LED products is derived from targeted end-market applications, such as general high-power and mid-power lighting and specialty lighting, such as video and horticulture applications.

We believe our diversified business segments may provide a natural hedge against downturns in any particular industry although broader macro-economic trends, such as the COVID-19 pandemic, can adversely affect all three segments concurrently.

Shifts in the Mix of Our Revenue.

Shifts in the mix of revenue from our operating segments, which can vary significantly from period to period, can impact our business and operating results, including gross and operating margins.

For example, our Memory Solutions group, while not party to long-term fixed purchasing commitments, has nonetheless historically seen relatively stable demand and margins.

By contrast, our IPS group has shown solid growth, but is subject to greater variability in its sales and margin profile from period to period, as recognition of revenue is tied to customer decisions as to the completion of delivery and system go-live events, and margin is driven by the extent to which higher margin software and managed services comprise IPS sales.

In addition, while we have experienced favorable demand and overall margin uplift compared to the rest of our businesses from our LED Solutions group to date, this group is the newest segment of our business, and we may be subject to unforeseen changes in its business and operating results.

Our resource commitments and planning for each segment are relatively fixed in the short term, and as such, variability in expected revenue mix will have direct implications for our operating income and margins.

Our Ability to Identify, Complete and Successfully Integrate Acquisitions.

A substantial portion of our growth over the last several years has been driven by acquisitions, and we intend to continue to use corporate development as an engine for growth.

Within our existing segments, we plan to pursue acquisitions to expand features and functionality, expand into adjacent businesses and grow our customer base and geographic footprint.

From time to time, we may seek to expand our addressable market by entering new business segments where, as we did with our LED business, we identify a business opportunity at scale with a path to being accretive to our overall operations in the near term.

If we are unable to identify and complete attractive acquisitions, we may not be successful in growing our revenue and/or expanding our margins.

Any acquisitions we do complete may require us to raise debt or equity financing or may subject us to unforeseen liabilities or operational challenges that in turn impede our ability to realize the expected returns on our investment.

Disruptions in Our Supply Chain May Adversely Affect Our Businesses.

We depend on third-party suppliers for key components of our products, such as commodity DRAM components from offshore foundries that we use in our specialty memory products and third-party wafers that we use in our memory and LED businesses.

We have adopted this “Fab-Light” business model to reduce our capital expenditures and operating expenses, while affording greater flexibility in adapting to shifts in demand and other market trends.

In recent periods, our Fab-Light business model has contributed significantly to margin expansion in our overall business.

However, our reliance on third-party manufacturers exposes us to risk of supply chain disruption and lost business.

For example, the current global semiconductor shortage has adversely affected our operating results.

If such disruptions worsen or are prolonged, or if there is meaningful disruption in our supply arrangement with any of our third-party suppliers, our operating results and financial condition could be adversely affected.

Results of Operations

The following is a summary of our results of operations for the periods presented.

The period-to-period comparison of results is not necessarily indicative of results for future periods.

Fiscal Year Ended

Consolidated Statement of Operations Data:

Memory Solutions

Intelligent Platform Solutions

LED Solutions

Total net sales

Cost of sales

2 unchanged sentences

Selling, general and administrative

Restructuring charge

Change in estimated fair value of

acquisition-related contingent consideration

Change in fair value of contingent consideration

Other operating (income) expense

Total operating expenses

Income from operations

Other income (expense):

Operating income

Non-operating (income) expense:

Interest expense, net

Other expense, net

Total other expense

Income before income taxes

Provision for income taxes

Other non-operating (income) expense

Total non-operating expense

Income before taxes

Income tax provision

Net income (loss)

Earnings per share:

Shares used in computing earnings per share:

* Summations may not compute precisely due to rounding.

(1) Includes share-based compensation expense as follows:

Cost of sales

Research and development

Selling, general and administrative

(2) Includes amortization of intangible assets expense as follows:

Cost of sales

Research and development

Selling, general and administrative

Comparison of the Years Ended August 28, 2020 and August 30, 2019

Fiscal Year Ended

(in thousands, except percentages)

Cost of sales (1)

Includes share-based compensation expense of $3.0 million and $2.5 million, and intangible amortization of $2.6 million and $0.6 million in fiscal 2020 and 2019, respectively.

Net Sales, Cost of Sales and Gross Margin

Net sales decreased by $89.6 million, or 7.4%, during fiscal 2020 compared to the prior fiscal year.

Net sales were negatively impacted by a decrease in Brazil product sales of $147.1 million, or a decline of 27.4% compared to the prior year.

The decrease in Brazil was primarily due to 50.1% and 36.5% lower average selling prices for DRAM and mobile memory, respectively.

Net sales were positively impacted by higher overall revenue from SCSS of $48.6 million, or an increase of 22.4% over the prior fiscal year, primarily driven by our two acquisitions in July 2019 which did not contribute to sales for the full year in fiscal 2019, partially offset by lower Penguin revenue due to lower federal spending as a result of COVID-19.

In addition, our sales of Specialty products increased by $8.9 million, or 1.9% over the prior fiscal year, primarily due to higher Flash revenue resulting from 59.2% higher average selling prices mainly due to increased OEM sales , partially offset by lower DRAM revenue resulting from 18.4% lower average selling prices mainly due to a change in product mix.

Cost of sales decreased by $68.5 million, or 7.0%, during fiscal 2020 compared to the prior fiscal year, primarily due to lower cost of materials of $78.2 million or 9.2% due to lower level of sales, partially offset by higher production costs related to the increased revenue and additional costs from the SCSS acquisitions.

Included in the cost of sales changes was a favorable foreign exchange impact of $4.5 million due to locally sourced cost of sales in Brazil.

Gross margin remained relatively flat at 19.3% during fiscal 2020, compared to 19.6% for fiscal 2019.

Operating Expenses

Fiscal Year Ended

(in thousands, except percentages)

Operating expenses:

Research and development (1) (2)

Selling, general and administrative (1) (2)

Restructuring

Change in estimated fair value of acquisition-

related contingent consideration

Total operating expenses

(1) Includes share-based compensation expense as follows:

Net income attributable to noncontrolling interest

Net income (loss) attributable to SGH

Summations of percentages may not compute precisely due to rounding.

Net Sales, Cost of Sales and Gross Profit

Net sales increased by $378.8 million, or 33.7%, in 2021 compared to the prior year, due to $224.6 million of revenue from our recent acquisition of the LED Business in March 2021 and to strong performance in our IPS and Memory Solutions businesses.

IPS net sales increased by $79.6 million, or 30.0%, primarily due to higher volumes of sales in our Penguin Computing business.

Memory Solutions sales increased by $74.6 million, or 8.7%, primarily due to a 24.7% higher volume of DRAM products and a 39.1% increase in average selling prices for mobile memory.

Net sales decreased by $89.6 million, or 7.4%, in 2020 compared to the prior year, primarily due to $138.2 million lower Memory Solutions revenue, partially offset by $48.6 million higher IPS revenue.

The decrease in Memory Solutions sales was mainly due to lower DRAM and mobile memory product sales, primarily resulting from 32.8% and 36.5% lower average selling prices, respectively, partially offset by higher OEM Flash memory sales resulting from 74.8% higher average selling prices and product mix.

IPS sales increased by 22.4% over the prior year, primarily as the result of our two acquisitions in July 2019, which contributed to sales for the full year in 2020, partially offset by lower Penguin revenue due to lower federal spending as a result of COVID-19.

Cost of sales increased by $286.8 million, or 31.7%, in 2021 compared to the prior year, primarily due to higher cost of materials and production costs, due to a higher level of sales for our Memory Solutions and IPS segments, and from our acquisition of the LED Business.

Cost of sales decreased by $68.5 million, or 7.0%, in 2020 compared to the prior year, primarily due to lower cost of materials and production resulting from the lower level of overall sales, which was partially offset by higher materials and production costs related to the growth in the IPS segment resulting from acquisitions in 2019, for which there was a full year reflected for the first time in 2020.

Included in the cost of sales changes was a favorable foreign exchange impact of $5.9 million and $4.5 million due to locally sourced cost of sales in Brazil in 2021 and 2020, respectively.

Gross margin increased to 20.5% in 2021 compared to 19.6% in 2020 primarily due to inclusion of higher margin LED Solutions products in the second half of the year, as well as process and efficiency improvement in the Memory Solutions and IPS segments compared to the prior year.

Gross margin remained relatively flat at 19.3% in 2020, compared to 19.6% in 2019.

Segment Operating Income

August 27, 2021

August 28, 2020

August 30, 2019

Segment operating income:

Memory Solutions

Intelligent Platform Solutions

LED Solutions

Total segment operating income

Share-based compensation

Change in fair value of contingent consideration

Amortization of intangible assets

Flow through of inventory step up

Restructure and integration expense

Consolidated operating income

Percentages represent segment operating income as a percentage of segment net sales.

In the fourth quarter of 2021, we reorganized SGH into three business units:

Memory Solutions, Intelligent Platforms Solutions and LED Solutions.

Two of our previous segments, specialty memory products and Brazil products, have been combined to become Memory Solutions.

Intelligent Platform Solutions was formerly referred to as specialty compute and storage solutions.

All prior year information in the table above has been revised to reflect the change to our three reportable segments.

Memory Solutions operating income increased by $19.8 million, or 27.6%, in 2021 compared to the prior year primarily due to higher sales, as well as a decrease of $10.8 million in operating expenses mainly driven by lower research and development expense due to Brazil financial credits.

Memory Solutions operating income decreased by $37.4 million, or 34.3%, in 2020 compared to the prior year primarily due to lower sales, partially offset by a decrease of $11.3 million in operating expenses mainly driven by lower research and development expense due to Brazil financial credits and lower research & development spend, travel and personnel-related expenses, as well as favorable currency exchange rates.

IPS operating income increased by $20.6 million, or 166.4%, in 2021 compared to the prior year primarily due to higher sales, partially offset by $4.4 million higher operating expenses mainly driven by personnel-related expenses due to increased headcount to support the revenue growth.

IPS operating income increased by $8.8 million, or 245.4%, in 2020 compared to the prior year primarily due to higher sales, partially offset by $23.5 million higher operating expenses due to the full year inclusion of the operations of companies acquired in 2019.

LED Solutions operating income of $36.1 million in 2021 was due to our acquisition of the LED Business in March 2021.

Operating and Non-operating (Income) Expense

Research and Development

Selling, general and administrative

(2) Includes amortization of intangible assets expense as follows:

Research and development expense decreased by $2.8 million, or 5.3%, in 2021 compared to the prior year, primarily due to an increase of $23.6 million in the Brazil financial credits that are reflected as a reduction of research and development expenses.

The credits result from amendments to the IT law implemented in April 2020.

The increase in credits is partially offset by $16.0 million additional costs from the acquisition of the LED Business, as well as higher personnel-related expenses and depreciation.

In addition, research and development expense was favorably affected in 2021 by $2.7 million from the impact of currency exchange rates.

We expect research and development expense to increase in absolute dollars in 2022 as we include the full year of operations for our LED Solutions segment and the effect of the end of the Brazil financial credits, currently scheduled to occur in January 2022.

Research and development expense increased by $4.1 million, or 8.6%, in 2020 compared to the prior year primarily due to $12.4 million higher costs from the addition of our IPS acquisitions in 2019, partially offset by $6.4 million of Brazil financial credits.

In addition, research and development expense was unfavorably affected in 2020 by $2.2 million from the impact of currency exchange rates.

Selling, General and Administrative

Research and Development Expense

Research and development, or (“R&D”), expense increased by $4.1 million, or 8.6% in fiscal 2020 compared to the prior fiscal year primarily due to $12.4 million higher costs from the addition of our SCSS acquisitions, partially offset by $6.4 million of Brazil financial credits resulting from amendments to the IT law implemented in April 2020.

Included in the R&D expense increase was a favorable foreign exchange impact of $2.2 million.

Selling, General and Administrative Expense

Selling, general and administrative, or (“SG&A”), expense increased by $16.3 million, or 15.8%, during fiscal 2020 compared to the prior fiscal year.

The increase was primarily due to $16.8 million of higher costs from the addition of our SCSS acquisitions (including intangible amortization expense), as well as integration expenses associated with the acquisitions.

Included in the SG&A expense increase was a favorable foreign exchange impact of $1.5 million.

Restructuring Charge

In fourth quarter of fiscal 2020, we made the decision to cease manufacturing and selling of products under the battery product line, the operations of which are reported under the operating segment for Brazil products.

The decision to cease this activity is due to unattractive benefits for our customers in score based PPB which impacts our ability to remain competitive as customers can get these products cheaper from other international sources without having a negative impact on their PPB score.

This action was put into effect as of the end of the fourth quarter of fiscal 2020, and all operations related to this product line ceased as of that date.

All employees associated with the product line were reassigned to other parts of the business.

During fiscal 2020, we recorded restructuring charges amounting to $3.5 million, composed of $2.7 million of asset impairment, $0.4 million of deferred ICMS taxes related to impaired assets, and $0.4 million accrued for contract termination costs.

As of August 28, 2020, the amounts accrued for contract termination costs have yet to be paid.

We do not expect additional costs to be incurred before completion of the restructuring efforts.

We anticipate completion of these restructuring efforts, including payment on all outstanding amounts to be complete by January 2021.

Other Income (Expense)

Fiscal Year Ended

(in thousands, except percentages)

Other income (expense):

Interest expense, net

Other expense, net

Total other expense

Interest expense, net decreased $5.7 million, or 27.6%, during fiscal 2020 compared to the prior fiscal year primarily due to lower interest expense resulting from the issuance of our Notes and the extinguishment of our term loans in the second quarter of fiscal 2020.

For additional information, see Note 7, Long-Term Debt , in our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.

Other expense, net increased by $14.8 million primarily due to $7.7 million mark-to-market losses on the Capped Calls and $6.8 million extinguishment loss on long-term debt and revolver.

Provision for Income Taxes

Fiscal Year Ended

(in thousands, except percentages)

Provision for income taxes

Provision for income taxes decreased by $4.4 million, or 29.4% compared to the prior fiscal year primarily due to lower income in non-U.S.

Selling, general and administrative expense increased by $49.9 million, or 41.8%, in 2021 compared to the prior year, primarily due to $21.5 million of additional costs from the acquisition of the LED Business (including $1.0 million in intangible amortization expense) as well as $14.1 million of higher share-based compensation expense, personnel-related expenses, professional services and acquisition expenses associated with the acquisition.

Included in the selling, general and administrative expense increase was a favorable foreign exchange impact of $1.2 million.

We expect selling, general and administrative expense to increase in absolute dollars in 2022 as we include the full year of operations for our LED Solutions segment.

Selling, general and administrative expense increased by $16.3 million, or 15.8%, in 2020 compared to the prior year, primarily due to $16.8 million of higher costs from the addition of our IPS acquisitions in 2019 (including intangible amortization expense) as well as integration expenses associated with the acquisitions.

In addition, selling, general and administrative expense was favorably affected in 2020 by $1.5 million from the impact of currency exchange rates.

Change in Fair Value of Contingent Consideration

Our acquisition of the LED Business included contingent consideration, which we estimated the fair value as of the date of acquisition to be $28.1 million.

During the second half of 2021, we recorded charges of $32.4 million to adjust the value as of the date of acquisition to the fair value as of the end of 2021.

The change in fair value reflected new information about the probability and timing of meeting the conditions of the revenue and gross profit targets of the LED Business.

See further information in “Item 8.

Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Business Acquisitions – LED Business.”

Other Operating and Non-o perating (Income) Expense

Other operating (income) expense in 2021 and 2020 primarily reflected restructuring activities in our IPS and Memory Solutions segments.

Other non-operating (income) and expense primarily reflected gains and losses from changes in currency exchange rates, a loss in 2020 from the remeasurement of our Capped Calls and losses in 2020 from the extinguishment of debt.

Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Other Operating (Income) Expense” and “– Other Non-operating (Income) Expense.”

Income Tax Provision

Our provision for income taxes increased by $5.0 million in 2021, or 47.2%, compared to the prior year primarily due to higher income in non-U.S.

jurisdictions subject to tax.

Our Malaysian subsidiary was previously approved for income tax holidays for the operations of its Pioneer business and Global Supply Chain (GSC) business.

We have received approvals for a continuation of these tax incentives for up to ten years, subject to certain operating conditions.

The impact of these tax incentives will be recorded in the period in which they become effective.

In general, these future tax holidays will have tax rates greater than our prior approved tax holidays, and therefore we expect that our effective income tax rate in the future may be higher depending on a combination of our overall and jurisdictional profitability.

For additional information, see Note 6, Income Taxes , in our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.

Comparison of the Years Ended August 30, 2019 and August 31, 2018

Fiscal Year Ended

(in thousands, except percentages)

Cost of sales (1)

Includes share-based compensation expense of $2.5 million and $0.6 million, and intangible amortization of $1.3 million and $0 million in fiscal 2019 and 2018, respectively.

Net Sales, Cost of Sales and Gross Margin

Net sales decreased by $76.8 million, or 6.0%, during fiscal 2019 compared to the prior fiscal year.

Net sales were negatively impacted by lower mobile memory and DRAM sales in Brazil in fiscal 2019 of $266.0 million, or a decline of 33.3% from the prior fiscal year.

These decreases were primarily due to lower customer demand for

mobile memory and DRAM products of 25% and 26%, respectively, as well as 22% lower average selling prices for mobile memory.

The decreases in Brazil were partially offset by additional sales from Penguin Computing for the full year in fiscal 2019 compared to just a partial year in fiscal 2018.

Penguin, which was acquired in June 2018, contributed additional revenue of $150.4 million in fiscal 2019 as compared to the prior fiscal year as Penguin’s results were only consolidated into the Company’s results for one quarter in fiscal 2018.

The sales decrease was also offset in part by 7% higher Specialty DRAM sales in fiscal 2019 as compared to the prior fiscal year, which was driven by 8% higher average selling prices due to changes in product mix, as well as sales of new products and increased customer penetration.

Cost of sales decreased by $22.8 million, or 2.3%, during fiscal 2019 compared to the prior fiscal year, primarily due to a decrease of 4.6% in the cost of materials for the lower level of sales, offset by higher production costs related to the increased revenue and additional costs for the new SCSS business.

Included in the cost of sales decreases was a favorable foreign exchange impact of $6.8 million due to locally sourced cost of sales in Brazil.

Gross margin decreased to 19.6% during fiscal 2019, compared to 22.6% for fiscal 2018, primarily due to higher cost of sales for SCSS, as well as fixed manufacturing costs for Brazil.

Operating Expenses

Fiscal Year Ended

(in thousands, except percentages)

Operating expenses:

Research and development (1) (2)

Selling, general and administrative (1) (2)

Change in estimated fair value of acquisition-

related contingent consideration

Total operating expenses

(1) Includes share-based compensation expense as follows:

Research and development

Selling, general and administrative

(2) Includes amortization of intangible assets expense as follows:

Research and development

Selling, general and administrative

Research and Development Expense

Research and development, or R&D, expense increased by $8.1 million, or 20.3% in fiscal 2019 compared to the prior fiscal year mainly due to $7.8 million higher costs from our new SCSS businesses, as well as higher depreciation and share-based compensation, partially offset by lower intangible amortization expense as some intangible assets became fully amortized.

Included in the R&D expense increase was a favorable foreign exchange impact of $2.3 million.

Selling, General and Administrative Expense

Selling, general and administrative, or SG&A, expense increased by $18.7 million, or 22.1%, during fiscal 2019 compared to the prior fiscal year.

The increase was primarily due to $22.8 million higher costs from our new SCSS business, as well as higher share based compensation, partially offset by lower professional services and

personnel-related expenses.

Included in the SG&A expense increase was a favorable foreign exchange impact of $1.4 million.

Other Income (Expense)

Fiscal Year Ended

(in thousands, except percentages)

Other income (expense):

Interest expense, net

Other expense, net

Total other expense

Interest expense, net increased $1.6 million, or 8.2%, during fiscal 2019 compared to the prior fiscal year primarily due to higher interest expense from an incremental loan in connection with the Penguin acquisition.

Other expense, net decreased by $11.1 million, or 83.8% over the prior fiscal year primarily due to $10.1 million foreign currency gains/losses.

Provision for Income Taxes

Fiscal Year Ended

(in thousands, except percentages)

Provision for income taxes

Provision for income taxes decreased by $3.4 million, or 18.8% during fiscal 2019 compared to the prior fiscal year primarily due to lower income in non-U.S.

Provision for income taxes decreased by $4.4 million in 2020, or 29.4%, compared to the prior year primarily due to lower income in non-U.S.

jurisdictions subject to tax.

Our Malaysian subsidiary was approved for income tax holidays for the operations of its Pioneer business and Global Supply Chain (GSC) business.

We have received approvals for a continuation of these tax incentives for up to ten years, subject to certain operating conditions.

The impact of these tax incentives will be recorded in the period in which they become effective.

In general, these future tax holidays will have tax rates greater than our prior approved tax holidays, thus our effective income tax rate in the future may be higher depending on a combination of our overall and jurisdictional profitability.

Effective February 1, 2011, SMART Brazil began to participate in PADIS.

This program is specifically designed to promote the development of the local semiconductor industry.

The Brazilian government has approved multiple applications for different products by SMART Brazil for certain beneficial tax treatment under the PADIS incentive.

This beneficial tax treatment includes a reduction in the Brazil statutory income tax rate from 34% to 9% on taxable income for the Brazilian semiconductor operations of SMART Brazil.

We have operations in Malaysia, where we have tax incentive arrangements for our pioneer status activities and our global supply chain business.

The statutory tax rate for Malaysia is 24%.

These Malaysia arrangements are scheduled to expire in August 2028 and are subject to certain conditions, for which we have complied in 2021, 2020 and 2019.

For additional information, see “Item 8.

Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Income Taxes.”

Liquidity and Capital Resources

Fiscal Year Ended

(in thousands)

Cash provided by operating activities

Cash used in investing activities

Cash provided by financing activities

Effect of exchange rate changes on cash and

cash equivalents

Net increase in cash and cash equivalents

At August 28, 2020, we had cash and cash equivalents of $150.8 million, of which approximately $95.3 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.

We used $204.9 million for

extinguishment of long-term debt and $21.8 million for purchasing privately-negotiated capped calls.

For additional information, s ee Note 7 , Long-Term Debt , in our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K .

In July 2019, we acquired SMART EC and SMART Wireless for purchase prices of approximately $77 million and $15 million, respectively.

We financed these acquisitions using cash from operations, as well as approximately $11 million in SGH ordinary shares attributable to the SMART Wireless acquisition.

In June 2018, we acquired Penguin for a purchase price of approximately $45 million and assumed approximately $32.3 million of Penguin’s outstanding indebtedness.

We financed this acquisition with net proceeds from the $60 million Incremental Amendment.

For additional information, see Note 2, Business Acquisitions , and Note 7, Long-Term Debt , in our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.

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.

At August 27, 2021, we had cash and cash equivalents of $223.0 million, of which $191.8 million was held outside of the United States.

Our principal uses of cash and capital resources have been acquisitions, debt service requirements as described below, capital expenditures, research and development expenditures and working capital requirements.

We expect that future capital expenditures will focus on expanding capacity of our operations, expanding our research and development 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.

We expect that our existing cash and cash equivalents, borrowings available under our credit facilities and cash generated by operating activities will be sufficient to fund our operations for at least the next twelve months.

We may from time to time seek additional equity or debt financing.

Any future equity financing may be dilutive to our existing investors, and any future debt financing may include debt service requirements and financial and other restrictive covenants that may constrain our operations and growth strategies.

In the event that we seek additional financing, we may not be able to raise such financing on terms acceptable to us or at all.

If we are unable to raise additional capital or generate cash flows necessary to expand our operations and invest in continued product innovation, we may not be able to compete successfully, which would harm our business, operations and financial condition.

For information regarding our debt obligations, see “Item 8.

Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Debt.” For our operating lease obligations, see “Item 8.

Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Leases.” For our purchase obligations, see “Item 8.

Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Commitments and Contingencies.”

Net cash provided by operating activities

Net cash used for investing activities

Net cash provided by financing activities

Effect of changes in currency exchange rates

Net increase in cash and cash equivalents

Operating Activities :

During fiscal 2020, cash provided by operating activities was $87.2 million.

The primary factors affecting our cash flows during this period were a $1.1 million net loss, $7.5 million in change in our net operating assets and liabilities and $80.8 million of non-cash related expenses.

The $7.5 million change in net operating assets and liabilities consisted of a decrease of $5.8 million in prepaid expenses and other assets and increases of $70.1 million in accounts payable and $0.5 million in accrued expenses and other liabilities, offset by increases of $12.3 million in accounts receivable and $51.8 million in inventory and a decrease of $4.8 million in operating leases.

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 manufacturing from contract manufacturers to the company due to our recent acquisitions, as well as higher purchases for certain programs.

During fiscal 2019, cash provided by operating activities was $169.7 million.

The primary factors affecting our cash flows during this period were a $51.3 million net income, $71.6 million in change in our net operating assets and liabilities and $46.8 million of non-cash related expenses.

The $71.6 million change in net operating assets and liabilities consisted of decreases of $35.2 million in accounts receivable and $102.1 million in inventory and an increase of $0.4 million in accrued expenses and other liabilities, offset by increases of $1.6 million in prepaid expenses and other assets and a decrease of $64.6 million in accounts payable.

Cash flows from operating activities reflects net income adjusted for certain non-cash items, including depreciation and amortization expense, share-based compensation, adjustments for changes in the fair value of contingent consideration, gains and losses from investing or financing activities and from the effects of changes in operating assets and liabilities.

Net cash provided by operating activities in 2021 was $153.4 million, comprised primarily of net income of $22.5 million, adjusted for non-cash items of $132.6 million.

Operating cash flows were also affected by a $1.7 million increase in our net operating assets and liabilities, consisting primarily of increases of $137.9 million in inventories, $51.4 million in accounts receivable and $17.5 million in other current assets, offset by the effects of an increase of $215.0 million in accounts payable and accrued expenses.

The increase in both inventories and accounts payable and accrued expenses was primarily due to higher inventory along all business areas, and the increase in accounts receivable was primarily due to higher gross sales primarily in our Memory Solutions and IPS segments.

Net cash provided by operating activities in 2020 was $87.2 million, resulting primarily from a net loss of $1.1 million, adjusted for non-cash items of $83.1 million.

Operating cash flows also benefitted from a $5.3 million change in our net operating assets and liabilities, consisting primarily of an increase of $70.6 million in accounts payable and accrued expenses, partially offset by an increase of $51.8 million in inventories and an increase of $12.3 million in accounts receivable.

The increases in accounts payable and accrued expenses and in inventories were primarily due to the transition of manufacturing from contract manufacturers to the company as well as higher purchases for certain programs.

The increase in accounts receivable was primarily due to timing of sales.

Net cash provided by operating activities in 2019 was $169.7 million, comprised of net income of $51.3 million, adjusted for non-cash items of $47.5 million.

Operating cash flows also benefitted from a $70.8 million change in our operating assets and liabilities, consisting primarily of decreases of $102.1 million in inventories and $35.2 million in accounts receivable, partially offset by an increase of $64.2 million in accounts payable and accrued expenses.

The decreases in inventories and accounts payable were primarily due to the reduction of inventory among all business areas as product lead times were reduced.

The decrease in accounts receivable was primarily due to lower gross sales.

The decreases in inventory and accounts payable were primarily due to the reduction of inventory along all business areas as product lead times and average selling prices reduced.

Investing Activities :

Net cash used in investing activities during fiscal 2020 was $32.0 million consisting primarily of purchases of property and equipment.

Net cash used in investing activities during fiscal 2019 was $109.4 million consisting primarily of $76.1 million for the new SCSS acquisitions, net of cash acquired, and $33.4 million used for purchases of property and equipment.

Net cash used in investing activities in 2021 was $84.2 million, consisting primarily of $47.6 million used for purchases of property and equipment and $35.7 million net cash used for the acquisition of the LED Business.

Net cash used in investing activities in 2020 consisted primarily of purchases of property and equipment.

Net cash used in investing activities in 2019 consisted primarily of $76.1 million net cash used for acquisitions and $33.4 million used for purchases of property and equipment.

Financing Activities :

Net cash provided by financing activities during fiscal 2020 was $12.6 million, consisting primarily of $243.1 million proceeds from issuance of convertible notes and $5.5 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, $8.5 million long-term debt payments for both the Amended Credit Agreement and the BNDES Credit Agreement and $0.8 million for withholding tax on restricted stock units.

Net cash provided by financing activities during fiscal 2019 was $0.1 million, consisting primarily of $7.4 million of proceeds from issuance of ordinary shares from share option exercises and purchases

under our employee share purchase plan, offset by $6.8 million of long-term debt payments for the BNDES Credit Agreements and $0.5 million for withholding tax on the vesting of restricted share units.

Contractual Obligations

Our contractual obligations as of August 28, 2020 are set forth below:

Payments due by Period

(in millions)

Interest expense in connection with the Notes

Operating leases

Non-cancellable product purchase commitments

Total contractual obligations

As of August 28, 2020, we had gross unrecognized tax benefits of $16.5 million which includes penalties and interest.

Approximately $0.4 million has been recorded as a noncurrent liability.

At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years in connection with these tax liabilities and therefore such amounts are not included in the above contractual obligation table.

Convertible Senior Notes due 2026

In February 2020, the Company issued $250.0 million in aggregate principal amount of 2.25% convertible senior notes due 2026 (the Notes), in a private placement, including $30.0 million in aggregate principal amount of the Notes that the Company issued resulting from initial purchasers fully exercising their option to purchase additional notes.

The Notes are general unsecured obligations and bear interest at an annual rate of 2.25% per year, payable semi-annually on February 15 and August 15 of each year, beginning on August 15, 2020.

The Notes are governed by an indenture (the Indenture) between the Company and U.S.

Bank National Association, as trustee.

The Notes will mature on February 15, 2026, unless earlier converted, redeemed or repurchased.

No sinking fund is provided for the Notes.

The initial conversion rate of the Notes is 24.6252 ordinary shares per $1,000 principal amount of Notes, which represents an initial conversion price of approximately $40.61 per ordinary share.

The conversion rate is subject to adjustment upon the occurrence of certain specified events as set forth in the Indenture.

The holders of the Notes may convert their Notes at their option in the following circumstances:

during any fiscal quarter commencing after the fiscal quarter ending on August 28, 2020 (and only during such fiscal quarter), if the last reported sale price per ordinary share exceeds 130% of the conversion price for each of at least 20 trading days, whether or not consecutive, during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding fiscal quarter;

during the five consecutive business days immediately after any 10 consecutive trading day period (such 10 consecutive trading day period, the measurement period) in which the trading price per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price per ordinary share on such trading day and the conversion rate on such trading day;

upon the occurrence of certain corporate events or distributions on the Company’s ordinary shares, as provided in the Indenture;

if the Company calls such Notes for redemption;

on or after August 15, 2025 until the close of business on the second scheduled trading day immediately before the maturity date.

Upon conversion, the Company will pay or deliver, as applicable, cash, ordinary shares or a combination of cash and ordinary shares at the Company's election.

The Company’s intent is to settle conversions through combination settlement with a specified dollar amount of $1,000 per $1,000 principal amount of Notes, which involves repayment of the principal portion of such Notes in cash and any excess of the conversion value over the principal amount in ordinary shares, with cash in lieu of any fractional ordinary shares.

Upon the occurrence of a “make-whole fundamental change” (as defined in the Indenture), the Company will in certain circumstances increase the conversion rate for a specified period of time.

In addition, upon the occurrence of a “fundamental change” (as defined in the Indenture), holders of the Notes may require the Company to repurchase their Notes at a cash repurchase price equal to the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any.

If any taxes imposed or levied by or on behalf of the Cayman Islands (or certain other jurisdictions described in the Indenture) are required to be withheld or deducted from any payments or deliveries made under or with respect to the Notes, then, subject to certain exceptions, the Company will pay or deliver to the holder of each Note such additional amounts as may be necessary to ensure that the net amount received by the beneficial owner of such Note after such withholding or deduction (and after withholding or deducting any taxes on the additional amounts) will equal the amounts that would have been received by such beneficial owner had no such withholding or deduction been required.

The Company has a right to redeem the Notes, in whole or in part, at its option at any time, and from time to time, from February 21, 2023 through the 40th scheduled trading day immediately before the maturity date, at a cash redemption price equal to the principal amount of the Notes to be redeemed, plus accrued and unpaid interest.

However, the repurchase right is only applicable if the last reported per share sale price of ordinary share exceeds 130% of the conversion price on each of at least twenty trading days during the thirty consecutive trading days ending on, and including, the trading day immediately before the redemption notice date for such redemption.

In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components.

The carrying amount of the liability component of approximately $197.5 million was calculated by using a discount rate of 6.53%, which was the Company’s borrowing rate on the date of the issuance of the Notes for a similar debt instrument without the conversion feature.

The carrying amount of the equity component of approximately $52.5 million, representing the conversion option, was determined by deducting the fair value of the liability component from the par value of the Notes.

The equity component of the Notes is included in additional paid-in capital in the consolidated balance sheet and is not remeasured as long as it continues to meet the conditions for equity classification, which the Company will reassess every reporting period.

The difference between the principal amount of the Notes and the liability component (the debt discount) is amortized to interest expense using the effective interest method over the term of the Notes.

Debt issuance costs for the issuance of the Notes were approximately $8.0 million, consisting of initial purchasers' discount and other issuance costs.

In accounting for the transaction costs, the Company allocated the total amount incurred to the liability and equity components using the same proportions as the proceeds from the Notes.

Transaction costs attributable to the liability component were approximately $6.3 million, were recorded as debt issuance cost (presented as contra debt in the consolidated balance sheet) and are being amortized to interest expense over the term of the Notes using the effective interest method.

The transaction costs attributable to the equity component were approximately $1.7 million and were netted with the equity component in shareholders’ equity.

The carrying value of the Notes is as follows (in thousands):

Unamortized debt discount

Unamortized issuance costs

Net carrying amount

As of August 28, 2020, the remaining life of the Notes was approximately 66 months.

The unamortized debt discounts and unamortized debt issuance cost are amortized over the remaining useful life, using an effective interest rate of 7.06%.

As of August 28, 2020, the carrying value of the equity component was $50.8 million, net of the issuance costs of $1.7 million.

The following table sets forth the total interest expense recognized related to the Notes (in thousands):

Contractual interest expenses

Amortization of debt discount

Amortization of debt issuance costs

Total interest cost recognized

The total estimated fair value for the Notes was determined to be $221.5 million based on the closing trading price per $100 of the Notes as of the last day of trading for the period.

There are no future minimum principal payments under the Notes until the full amount of $250.0 million is due in fiscal 2026

Off-Balance Sheet Arrangements

As of August 28, 2020 and August 30, 2019, we did not have any off-balance sheet arrangements or relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which are typically established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies

We believe the following critical accounting policies are the most significant to the presentation of our financial statements and they at times require the most difficult, subjective and complex estimates.

Net cash provided by financing activities in 2021 was $2.8 million, consisting primarily of $25.0 million in net proceeds from borrowing under our line of credit, $14.9 million in proceeds from the issuance of ordinary shares and $11.4 million proceeds from issuance of debt, partially offset by $48.5 million used to repurchase our ordinary shares.

Net cash provided by financing activities in 2020 consisted primarily of $243.1 million proceeds from the issuance of our convertible notes and $5.5 million in proceeds from the issuance of ordinary shares, partially offset by $204.9 million in payments for the extinguishment of debt, $21.8 million for the purchase of our Capped Calls and payment of $8.5 million for debt.

Net cash provided by financing activities in 2019 was negligible.

Critical Accounting Estimate s

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures.

Estimates and judgments are based on historical experience, forecasted events and various other assumptions that we believe to be reasonable under the circumstances.

We evaluate our estimates and judgments on an ongoing basis.

Our management believes the accounting policies below are critical in the portrayal of our financial condition and results of operations and require management’s most difficult, subjective or complex judgments.

Business Acquisitions :

Accounting for acquisitions requires us to estimate the fair value of consideration paid and the individual assets and liabilities acquired, which involves a number of judgments, assumptions and estimates that could materially affect the amount and timing of costs recognized in subsequent periods.

We typically obtain independent third-party valuation studies to assist in determining fair values, including assistance in determining future cash flows, discount rates and comparable market values.

Items involving significant assumptions, estimates and judgments include the following:

Fair value of consideration paid or transferred (including contingent consideration);

Inventory, including estimated future selling prices, timing of product sales and completion costs for work in process;

Property, plant and equipment, including determination of values in a continued-use model;

Debt and other liabilities, including discount rate and timing of payments;

Intangible assets, including valuation methodology, estimates of future revenues and costs, profit allocation rates attributable to the acquired technology and discount rates;

Deferred taxes, including projections of future taxable income and tax rates.

The valuation of contingent consideration in connection with an acquisition may be inherently challenging due to the dependence on the occurrence of future events and complex payment provisions.

Estimating the fair value of contingent consideration at an acquisition date and in subsequent periods involves significant judgments, including projecting future average selling prices, future sales volumes, manufacturing costs and gross margins.

To project average selling prices and sales volumes, we review recent sales volumes, existing customer orders, current prices and other factors such as industry analyses of supply and demand, seasonal factors, general economic trends and other information.

To project manufacturing costs, we must estimate future production levels and costs of production, including labor, materials and other overhead costs.

Actual selling prices and sales volumes, as well as levels and costs of production, can often vary significantly from projected amounts.

Income Taxes :

We are required to estimate our provision for income taxes and amounts ultimately payable or recoverable in numerous tax jurisdictions around the world.

These estimates involve significant judgment and interpretations of regulations and are inherently complex.

Resolution of income tax treatments in individual jurisdictions may not be known for many years after completion of the applicable year.

We are also required to evaluate the realizability of our deferred tax assets on an ongoing basis in accordance with U.S.

GAAP, which requires the assessment of our performance and other relevant factors.

Realization of deferred tax assets is dependent on our ability to generate future taxable income.

Our income tax provision or benefit is dependent, in part, on our ability to forecast future taxable income in these and other jurisdictions.

Such forecasts are inherently difficult and involve significant judgments including, among others, projecting future average selling prices and sales volumes, manufacturing and overhead costs and other factors that significantly impact our analyses of the amount of net deferred tax assets that are more likely than not to be realized.

Inventories :

Inventories are stated at the lower of cost or net realizable value.

In our LED segment, cost is determined on a first-in, first-out method or average cost method.

For all other segments, inventory value is determined on a specific identification basis for material and an allocation of labor and manufacturing overhead.

At each balance sheet date, we evaluate ending inventories for excess quantities and obsolescence, including analyses of sales levels by product family, historical demand and forecasted demand in relation to inventory on hand, competitiveness of product offerings, market conditions and product life cycles.

From time to time, our customers may request that we purchase and maintain significant inventory of raw materials for specific programs.

Such inventory purchases are evaluated for excess quantities and potential obsolescence and could result in a provision at the time of purchase or subsequent to purchase.

Inventory levels may fluctuate based on inventory held under service arrangements.

Our provision for excess and obsolete inventory are also impacted by our arrangements with our customers and/or suppliers, including our ability or inability to resell such inventory to them.

Goodwill and I ntangible A ssets :

We test goodwill for impairment in our fourth quarter each year, or more frequently if indicators of an impairment exist, to determine whether it is more likely than not that the fair value of the reporting unit with goodwill is less than its carrying value.

For reporting units for which we conclude that it is more likely than not that the fair value is more than its carrying value, goodwill is considered not impaired and we are not required to perform the goodwill impairment test.

Qualitative factors considered in this assessment include industry and market considerations, overall financial performance and other relevant events and factors affecting the fair value of the reporting unit.

For reporting units for which this assessment concludes that it is more likely than not that the fair value is below the carrying value, goodwill is tested for impairment by determining the fair value of the reporting unit and comparing it to the carrying value of the net assets assigned to the reporting unit.

If the fair value of the reporting unit exceeds its carrying value, goodwill is considered not impaired.

If the carrying value of the reporting unit exceeds its fair value, we would record an impairment loss up to the difference between the carrying value and implied fair value.

Determining when to test for impairment, the reporting units, the assets and liabilities of the reporting unit and the fair value of the reporting unit requires significant judgment and involves the use of significant estimates and assumptions.

These estimates and assumptions include revenue growth rates, forecasted manufacturing costs, budgets and other expenses developed as part of our long-range planning process.

We test the reasonableness of the output of our long-range planning process by calculating an implied value per share and comparing that to current share prices, analysts’ consensus pricing and management’s expectations.

These estimates and assumptions are used to calculate projected future cash flows for the reporting unit, which are discounted using a risk-adjusted rate to estimate a fair value.

We base fair value estimates on assumptions we believe to be reasonable but that are unpredictable and inherently uncertain.

Actual future results may differ from those estimates.

We test other identified intangible assets with definite useful lives when events and circumstances indicate the carrying value may not be recoverable by comparing the carrying amount to the sum of undiscounted cash flows expected to be generated by the asset.

Estimating fair values involves significant assumptions, including future sales prices, sales volumes, costs and discount rates.

Property and Equipment :

We review the carrying value of property and equipment for impairment when events and circumstances indicate that the carrying value of an asset or group of assets may not be recoverable from the estimated future cash flows expected to result from its use and/or disposition.

In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to the amount by which the carrying value exceeds the estimated fair value of the assets.

The estimate of future cash flows involves numerous assumptions which require significant judgment by us, including, but not limited to, future use of the asset(s) for our operations versus sale or disposal of the asset(s), future selling prices for our products and future production and sales volumes.

In addition, significant judgment is required in determining the groups of assets for which impairment tests are separately performed.

Revenue Recognition :

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, compute products 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.

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 transfers 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;

We recognize revenue based on the transfer of control of goods and services and apply the following five-step approach:

(1) identification of a 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 as performance obligations are satisfied.

Applying the five step approach in determining whether to recognize revenue at a point in time or over time requires significant judgement.

A portion of our revenue is from sales of customized product which, in some cases, are non-cancellable and/or non-refundable.

Significant judgement is required to determine when control passes to the customer and whether and when our performance obligations have been satisfied.

This determination can significantly affect the timing of recognizing revenue.

Product revenue :

Product revenue is generally recognized at a point in time when control of the promised goods is transferred to customers.

Contracts with customers are generally short-term in duration at fixed, negotiated prices with payment generally due shortly after delivery.

We estimate a liability for returns using the expected value method based on historical rates of return.

In addition, we generally offer price protection to our distributors, which is a form of variable consideration that decreases the transaction price.

We use the expected value method, based on historical price adjustments and current pricing trends, to estimate the amount of revenue recognized from sales to distributors.

Differences between the estimated and actual amounts are recognized as adjustments to revenue.

Non-cancellable, nonrefundable customized product sales are recognized over time on a cost incurred basis.

In connection with these arrangements, customers obtain control and benefit from the services as they are performed.

The terms for these arrangements provide us with a legally enforceable right to receive payment, including a reasonable profit margin upon customer cancellation, for performance completed to date.

Accordingly, we recognize revenue over time as we complete the manufacture of these products.

A portion of our revenue is derived from the sale of customized products.

In certain cases, we recognize revenue when control of the underlying assets pass to the customer when the customer is able to 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 order or 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.

and we have a present right to payment.

Under the terms of these arrangements, we cannot repurpose products without the customer’s consent and accordingly, we recognize revenue at the point in time when products are completed and made available to the customer.

Service revenue :

Our service revenue is derived from supply chain services as well as professional services.

Supply chain services includes procurement, logistics, inventory management, temporary warehousing, kitting and packaging.

Professional services include solution design, system installation, software automation and managed support services related to HPC and storage systems.

A portion of our product sales include extended warranty and on-site services, subscriptions to our HPC environment, professional services, software and related support.

Agent Services :

We provide certain supply chain services on an agent basis, whereby we procure materials on behalf of our customers and then resell such materials to our customers.

Gross amounts invoiced to customers in connection with these agent services include amounts related to the services performed by us in addition to the cost of the materials procured.

However, only the amount related to the agent component is recognized as revenue in our results of operations.

We generally recognize revenue for these procurement, logistics and inventory management services upon the completion of such services, which typically occurs at the time of shipment of product to the customer.

Amounts we invoice to customers for cost of materials related to services performed, which remain unpaid as of the end of a reporting period, are included in accounts receivable.

Additionally, cost of materials procured for customers under these agent services, but which remain on hand as of the end of a reporting period, are included in inventories.

Amounts in accounts receivable and inventories impact the determination of net cash provided by (or used in) operations.

Determining whether we are the principal or agent in these transactions requires significant judgement.

This determination affects the amount of revenue we recognize;

a principal recognizes revenues at the gross amount received for the goods and services, while an agent recognizes revenue at the net amount.

The impact of this determination significantly impact the amount of revenue and cost of sales we recognize.

Transaction Price :

The transaction price is determined based on the consideration to which we will be entitled in exchange for transferring goods or services to the customer.

We allocate 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 our approved list price.

A portion of our service revenue is from 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.

These services contracts are typically one to three years in length.

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 and services were selected because they reflect a faithful depiction of the transfer of control.

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, kitted or 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.

We allocate the consideration to each performance obligation based on the relative selling price, determined as the best estimate of the price at which we would transact if it sold the deliverable regularly on a stand-alone basis.

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 and handling 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 our gross billings to customers and net sales for services and products (in thousands):

Fiscal Year Ended

Service revenue, net

Cost of purchased materials - service (1)

Gross billings for services

Product net sales

Gross billings to customers

Product net sales

Service revenue, net

Represents material procurement costs of products provided as an agent reported on a net basis.

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

Inventory Valuation

At each balance sheet date, we evaluate our ending inventories for excess quantities and obsolescence.

This evaluation includes analysis of sales levels by product family.

Among other factors, we consider historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles when determining obsolescence and net realizable value.

We adjust the carrying values to approximate the lower of our manufacturing cost or net realizable value.

Inventory cost is determined on a specific identification basis and includes material, labor and manufacturing overhead.

From time to time, our customers may request that we purchase and maintain significant inventory of raw materials for specific programs.

Such inventory purchases are evaluated for excess quantities and potential obsolescence and could result in a provision at the time of purchase or subsequent to purchase.

Inventory levels may fluctuate based on inventory held under service arrangements.

Our provisions for excess and obsolete inventory are also impacted by our arrangements with our customers and/or suppliers, including our ability or inability to re-sell such inventory to them.

If actual market conditions or our customers’ product demands are less favorable than those projected or if our customers or suppliers are unwilling or unable to comply with any arrangements related to their purchase or sale of inventory, additional provisions may be required and would have a negative impact on our gross margins in that period.

We have had material inventory write-downs in the past for reasons such as obsolescence, excess quantities and declines in market value below our costs, and we may be required to do so from time to time in the future.

Our inventory write-downs were $4.7 million, $9.0 million and $5.2 million for fiscal 2020, 2019 and 2018, respectively.

We use 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 or reduced to value tax assets to amounts expected to be realized.

The effect of changes in tax rates is recognized in the period in which the rate change occurs.

The calculation of our tax liabilities involves accounting for uncertainties in the application of complex tax rules, regulations and practices.

We recognize benefits for uncertain tax positions based on a two-step process.

The first step is to evaluate the tax position for recognition of a benefit (or the absence of a liability) by determining if the weight of available evidence indicates that it is more likely than not that the position taken will be sustained upon audit, including resolution of related appeals or litigation processes, if any.

If it is not, in our judgment, more likely than not that the position will be sustained, then we do not recognize any benefit for the position.

If it is more likely than not that the position will be sustained, a second step in the process is required to estimate how much of the benefit we will ultimately receive.

This second step requires that we estimate and measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

It is inherently difficult and subjective to estimate such amounts.

We reevaluate these uncertain tax positions on a quarterly basis.

The total amount of unrecognized tax benefits that would affect the effective tax rate, if recognized, is $1.7 million as of August 28, 2020.

This evaluation is based on a number of factors including, but not limited to, changes in facts or circumstances, changes in tax law, new facts, correspondence with tax authorities during the course of an audit, effective settlement of audit issues and commencement of new audit activity.

Such a change in recognition or measurement could result in the recognition of a tax benefit or an additional charge to the tax provision in the period.

Goodwill Valuation

We perform a goodwill impairment test annually during the fourth quarter of our 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.

When conducting the annual impairment test for goodwill, we compare 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.

We determine the fair value of the our reporting units using the income approach methodology of valuation that includes the discounted cash flow method as well as the market approach which includes the guideline company method.

These approaches use significant unobservable inputs, or Level 3 inputs, as defined by the fair value hierarchy and require us to make significant management judgments and assumptions including, but not limited to, future net sales, earnings before interest, and the selection of the discount rate.

These assumptions consider our budgets, business plans and economic projections, and are believed to reflect market participant views.

Some of the inherent estimates and assumptions used in determining fair value of the reporting units are outside the control of management.

While we believe we have made reasonable estimates and assumptions

to calculate the fair value of the reporting units, it is possible a material change could occur.

If our actual results are not consistent with our estimates and assumptions used to calculate fair value, it could result in material impairments of our goodwill.

For additional information, s ee Note 1(k), Goodwill , in our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K .

Based on the results of the impairment test, the fair values exceed the respective carrying values for each reporting unit.

Accordingly, no impairment of goodwill was recognized through August 28, 2020.

The estimated forecasted results used in the discounted cash flow portion of the impairment analysis reflect our best estimates as of August 28, 2020.

Long-Lived Assets Valuation

We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the future undiscounted cash flows expected to be generated by the asset.

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.

As a practical expedient, we recognize 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, we account for as an expense when incurred.

Additionally, we account for shipping and handling costs, if any, that occur after control transfers to the customer as a fulfillment activity.

We record shipping and handling costs related to revenue transactions within cost of sales as a period cost.

Share-Based Compensation :

We recognize compensation costs related to share-based awards granted to employees based on the estimated fair value of the awards on the date of grant.

We estimate the grant date fair value of options, and the resulting share-based compensation expense, using the Black-Scholes option-pricing model.

The grant date fair value of the share-based awards is generally recognized on a straight-line basis over the requisite service period, which is generally the vesting period of the respective awards.

The Black-Scholes model requires the use of subjective and highly complex assumptions which determine the fair value of share-based option awards.

The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model that uses the assumptions noted in the following table.

The expected volatility is based on the historical volatilities of the common stock of comparable publicly traded companies.

The expected term of options granted represents the weighted average period of time that options granted are expected to be outstanding giving consideration to vesting schedules and the historical exercise patterns.

The risk-free interest rate for the expected term of the option is based on the average U.S.

Treasury yield curve at the end of the quarter in which the option was granted.

We used the following assumptions to value options granted under the SGH Plan during fiscal 2020, 2019 and 2018:

Fiscal Year Ended

Stock options:

Expected term (years)

Expected volatility

46.10% - 57.10%

41.68% - 48.15%

39.00% - 46.27%

Risk-free interest rate

0.40% - 1.68%

1.42% - 2.88%

2.15% - 2.82%

Expected dividends

The following table sets forth our total share-based compensation expense during fiscal 2020, 2019 and 2018 (in thousands):

Fiscal Year Ended

Share-based compensation expense by category

(in thousands):

Cost of sales

Research and development

Selling, general and administrative

Quantitative and Qualita tive Disclosures About Market Risk

Our exposure to market rate risk includes risk of foreign currency exchange rate fluctuations, changes in interest rates and translation risk.

Foreign Exchange Risks

We are subject to inherent risks attributed to operating in a global economy.

Our international sales and our operations in foreign countries subject us to risks associated with fluctuating currency values and exchange rates.

Because a portion of our sales are denominated in United States dollars, increases in the value of the United States dollar could increase the price of our products so that they become relatively more expensive to customers in a particular country, possibly leading to a reduction in sales and profitability in that country.

A significant portion of the sales of our products are denominated in reais.

In addition, we have certain costs that are denominated in foreign currencies, and decreases in the value of the U.S.

dollar could result in increases in such costs that could have a material adverse effect on our results of operations.

We utilize foreign exchange forward contracts to mitigate foreign currency exchange rate risk associated with foreign-currency-denominated assets and liabilities, primarily third party payables in Brazil.

We do not use foreign currency contracts for speculative or trading purposes.

Foreign exchange forward contracts outstanding at August 28, 2020 are not designated as hedging instruments for hedge accounting purposes.

We do not currently purchase financial instruments to hedge foreign exchange risk, but may do so in the future.

As a result of our international operations, we generate a portion of our net sales and incur a portion of our expenses in currencies other than the U.S.

dollar, particularly the reais.

Approximately 35%, 44% and 62% of our net sales during fiscal 2020, 2019 and 2018, respectively, originated in reais.

We present our consolidated financial statements in U.S.

dollars, and we must translate the assets, liabilities, net sales and expenses of a substantial portion of our foreign operations into U.S.

dollars at applicable exchange rates.

Consequently, increases or decreases in the value of the U.S.

dollar may affect the value of these items with respect to our non-U.S.

dollar businesses in our combined financial statements, even if their value has not changed in their local currency.

Our customer pricing and material cost of sales are based on U.S.

dollars, as is the global market for memory products.

Accordingly, the impact of currency fluctuations to our consolidated statement of operations is primarily to our other costs of sales (i.e., non-material components) and our operating expenses as those items are typically denominated in local currency.

Our consolidated statement of operations is also impacted by foreign currency gains and losses recorded in Other Income (Expense) arising from transactions denominated in a currency other than the functional currency of the respective subsidiary.

These translations could significantly affect the comparability of our results between financial periods or result in significant changes to the carrying value of our assets, liabilities and equity.

As a result, changes in foreign currency exchange rates impact our reported results.

During fiscal 2020, 2019 and 2018, we recorded $3.4 million, $3.1 million, and $13.2 million, respectively, of foreign exchange losses.

Interest Rate Risk

We are subject to interest rate risk in connection with our short-term debt under the Amended Credit Agreement as of May 29, 2020.

Although we did not have any revolving balances outstanding as of August 28, 2020, the revolving facility under the Amended Credit Agreement provides for borrowings of up to $50 million that would also bear interest at variable rates.

Assuming that we will satisfy the financial covenants required to borrow and that the revolving loans under the Amended Credit Agreement were fully drawn and other variables are held constant, each 1.0% increase in interest rates on our variable rate borrowings would result in an increase in annual interest expense and a decrease in our cash flow and income before taxes of $0.5 million per year.

Share-based compensation is estimated at the grant date based on the fair value of the award and is recognized as expense using the straight-line amortization method over the requisite service period.

For performance-based share awards, the expense recognized is dependent on our assessment of the likelihood of the performance measure being achieved.

We utilize forecasts of future performance to assess these probabilities and this assessment requires significant judgment.

Determining the appropriate fair-value model and calculating the fair value of share-based awards at the grant date requires significant judgment, including estimating share price volatility and expected option life.

We develop these estimates based on historical data and market information which can change significantly over time.

A small change in the estimates used can result in a relatively large change in the estimated valuation.

We use the Black-Scholes option valuation model to value employee options and awards granted under our employee share purchase plan.

We estimate share price volatility based on an average of historical volatility and the implied volatility derived from traded options on our shares.

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-K

Item 7. Management’s Discussion and Analysis