Penguin Solutions, Inc. 10-Q

Item 1. Financial Statements INDEX TO FINANCIAL STATEMENTS Page Consolidated Balance Sheets 5 Consolidated Statements of Operations 6 Consolidated Statements of Comprehensive Income (Loss) 7 Consolidated Statements of Shareholders’ Equity 8 Consolidated Statements of Cash Flows 9 Notes to Consolidated Financial Statements 10 4 SMART Global Holdings, Inc. Consolidated Balance Sheets (In thousands, except par value amount) (Unaudited) As of November 26, 2021 August 27, 2021 Assets Cash and cash equivalents $ 233,050 $ 222,986 Accounts receivable, net (1) 344,107 313,393 Inventories 317,851 363,601 Other current assets 48,829 50,838 Total current assets 943,837 950,818 Property and equipment, net 148,897 156,266 Operating lease right-of-use assets 37,723 40,869 Intangible assets, net 95,331 101,073 Goodwill 72,487 74,255 Other noncurrent assets 25,423 21,517 Total assets $ 1,323,698 $ 1,344,798 Liabilities and Equity Accounts payable and accrued expenses $ 426,883 $ 484,107 Current debt 35,802 25,354 Other current liabilities 72,434 74,337 Total current liabilities 535,119 583,798 Long-term debt 341,150 340,484 Acquisition-related contingent consideration 77,700 60,500 Noncurrent operating lease liabilities 29,396 32,419 Other noncurrent liabilities 8,049 8,673 Total liabilities 991,414 1,025,874 Commitments and contingencies SMART Global Holdings shareholders’ equity: Ordinary shares, $ 0.03 par value. Authorized 200,000 shares; 26,137 issued and 24,684 outstanding as of November 26, 2021; 25,770 issued and 24,368 outstanding as of August 27, 2021 784 773 Additional paid-in-capital 411,608 396,851 Retained earnings 204,814 184,787 Treasury shares, 1,453 and 1,402 shares held as of November 26, 2021 and August 27, 2021, respectively ( 53,211 ) ( 50,545 ) Accumulated other comprehensive income (loss) ( 241,055 ) ( 221,615 ) Total SGH shareholders’ equity 322,940 310,251 Noncontrolling interest in subsidiary 9,344 8,673 Total equity 332,284 318,924 Total liabilities and equity $ 1,323,698 $ 1,344,798 (1) Receivables from related parties were de minimus and $ 14,057 as of November 26, 2021 and August 27, 2021, respectively. The accompanying notes are an integral part of these consolidated financial statements. 5 SMART Global Holdings, Inc. Consolidated Statements of Operations (In thousands, except per share amounts) (Unaudited) Three months ended November 26, 2021 November 27, 2020 Net sales (1) $ 469,944 $ 291,697 Cost of sales 347,743 239,053 Gross profit 122,201 52,644 Operating expenses: Research and development 17,657 6,964 Selling, general and administrative 52,550 38,056 Change in fair value of contingent consideration 17,200 — Total operating expenses 87,407 45,020 Operating income 34,794 7,624 Non-operating (income) expense: Interest expense, net 5,106 3,154 Other non-operating (income) expense 1,235 ( 832 ) Total non-operating (income) expense 6,341 2,322 Income before taxes 28,453 5,302 Income tax provision 7,755 3,275 Net income 20,698 2,027 Net income attributable to noncontrolling interest 671 — Net income attributable to SGH $ 20,027 $ 2,027 Earnings per share: Basic $ 0.82 $ 0.08 Diluted $ 0.73 $ 0.08 Shares used in per share calculations: Basic 24,506 24,561 Diluted 27,318 25,103 ( 1 ) Sales to related parties were de minimus and $ 14,975 in the first quarters of 2022 and 2021, respectively. The accompanying notes are an integral part of these consolidated financial statements. 6 SMART Global Holdings, Inc. Consolidated Statements of Comprehensive Income (Loss) (In thousands) (Unaudited) Three months ended November 26, 2021 November 27, 2020 Net income $ 20,698 $ 2,027 Other comprehensive income (loss), net of tax: Foreign currency translation adjustments ( 19,440 ) ( 16,523 ) Comprehensive income (loss) 1,258 ( 14,496 ) Comprehensive income attributable to noncontrolling interest 671 — Comprehensive income (loss) attributable to SGH $ 587 $ ( 14,496 ) The accompanying notes are an integral part of these consolidated financial statements. 7 SMART Global Holdings, Inc. Consolidated Statements of Shareholders’ Equity (In thousands) (Unaudited) Shares Issued Amount Additional Paid-in-capital Retained Earnings Treasury Shares Accumulated Other Comprehensive Income (Loss) Total SGH Shareholders’ Equity Non- controlling Interest in Subsidiary Total Equity As of August 27, 2021 25,770 $ 773 $ 396,851 $ 184,787 $ ( 50,545 ) $ ( 221,615 ) $ 310,251 $ 8,673 $ 318,924 Net income — — — 20,027 — — 20,027 671 20,698 Other comprehensive income — — — — — ( 19,440 ) ( 19,440 ) — ( 19,440 ) Shares issued under equity plans 367 11 5,018 — — — 5,029 — 5,029 Repurchase of ordinary shares — — — — ( 2,666 ) — ( 2,666 ) — ( 2,666 ) Share-based compensation expense — — 9,739 — — — 9,739 — 9,739 As of November 26, 2021 26,137 $ 784 $ 411,608 $ 204,814 $ ( 53,211 ) $ ( 241,055 ) $ 322,940 $ 9,344 $ 332,284 Shares Issued Amount Additional Paid-in-capital Retained Earnings Treasury Shares Accumulated Other Comprehensive Income (Loss) Total SGH Shareholders’ Equity Non- controlling Interest in Subsidiary Total Equity As of August 28, 2020 24,568 $ 737 $ 348,163 $ 163,477 $ ( 2,032 ) $ ( 228,241 ) $ 282,104 $ — $ 282,104 Net income — — — 2,027 — — 2,027 — 2,027 Other comprehensive income — — — — — ( 16,523 ) ( 16,523 ) — ( 16,523 ) Shares issued under equity plans 478 14 3,091 — — — 3,105 — 3,105 Repurchase of ordinary shares — — — — ( 3,483 ) — ( 3,483 ) — ( 3,483 ) Share-based compensation expense — — 11,088 — — — 11,088 — 11,088 As of November 27, 2020 25,046 $ 751 $ 362,342 $ 165,504 $ ( 5,515 ) $ ( 244,764 ) $ 278,318 $ - $ 278,318 The accompanying notes are an integral part of these consolidated financial statements. 8 SMART Global Holdings, Inc. Consolidated Statements of Cash Flows (In thousands) (Unaudited) Three months ended November 26, 2021 November 27, 2020 Cash flows from operating activities: Net income $ 20,698 $ 2,027 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation expense and amortization of intangible assets 15,813 8,367 Amortization of debt discounts and issuance costs 2,332 2,116 Share-based compensation expense 9,775 11,088 Change in fair value of contingent consideration 17,200 — Amortization of operating lease right-of-use assets 2,548 1,413 Other ( 192 ) ( 14 ) Changes in operating assets and liabilities: Accounts receivable ( 36,053 ) ( 1,930 ) Inventories 39,640 12,919 Other current assets ( 932 ) ( 9,277 ) Accounts payable and accrued expenses ( 53,751 ) 10,142 Operating lease liabilities ( 2,141 ) ( 1,504 ) Deferred income taxes, net 209 222 Net cash provided by operating activities 15,146 35,569 Cash flows from investing activities: Capital expenditures and deposits on equipment ( 12,766 ) ( 14,644 ) Other ( 611 ) 16 Net cash used for investing activities ( 13,377 ) ( 14,628 ) Cash flows from financing activities: Proceeds from borrowing under line of credit 60,000 19,500 Proceeds from issuance of ordinary shares 5,029 3,105 Repayments of borrowings under line of credit ( 50,000 ) ( 19,500 ) Payments to acquire ordinary shares ( 2,666 ) ( 3,483 ) Net cash provided by (used for) financing activities 12,363 ( 378 ) Effect of changes in currency exchange rates on cash and cash equivalents ( 4,068 ) ( 7,277 ) Net increase in cash and cash equivalents 10,064 13,286 Cash and cash equivalents at beginning of period 222,986 150,811 Cash and cash equivalents at end of period $ 233,050 $ 164,097 The accompanying notes are an integral part of these consolidated financial statements. 9 SMART Global Holdings, Inc. Notes to Consolidated Financial Statements (Tabular amounts in thousands, except per share amounts) (Unaudited) Significant Accounting Policies Basis of Presentation The accompanying consolidated financial statements include SGH and its consolidated subsidiaries and have been prepared in accordance with accounting principles generally accepted in the United States of America consistent in all material respects with those applied in our Annual Report on Form 10-K for the year ended August 27, 2021. In the opinion of our management, the accompanying unaudited consolidated financial statements contain all necessary adjustments, consisting of a normal recurring nature, to fairly state the financial information set forth herein. These consolidated interim financial statements should be read in conjunction with the consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended August 27, 2021. Certain reclassifications have been made to prior period amounts to conform to current period presentation. Fiscal Year : Our fiscal year is the 52 or 53-week period ending on the last Friday in August. Fiscal 2022 and 2021 each contain 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. Subsequent Event Share Dividend On January 3, 2022 , our Board of Directors declared a share dividend of one ordinary share, $ 0.03 par value per share, for every one ordinary share owned. The share dividend will be payable to shareholders of record as of January 25, 2022 , and will be paid on February 1, 2022 . Ordinary shares and per share data in the accompanying consolidated financial statements and notes have not been adjusted for the impact of the share dividend. Recently Adopted Accounting Standards In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12 – Income Taxes: Simplifying the Accounting for Income Taxes , which simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. We adopted ASU 2019-12 in the first quarter of 2022 on a prospective basis. The adoption of this ASU did not have a significant impact on our financial statements. In June 2016, the FASB issued ASU 2016-13 – Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments , which requires a financial asset (or a group of financial assets) measured on the basis of amortized cost to be presented at the net amount expected to be collected. This ASU requires that the income statement reflect the measurement of credit losses for newly recognized financial assets as well as the increases or decreases of expected credit losses that have taken place during the period. This ASU requires that credit losses of debt securities designated as available-for-sale be recorded through an allowance for credit losses and limits the credit loss to the amount by which fair value is below amortized cost. We adopted ASU 2016-13 in the first quarter of 2021 under the modified retrospective adoption method. The adoption of this ASU did not have a significant impact on our financial statements. 10 Recently Issued Accounting Standards In October 2021, the FASB issued ASU 2021-08 – Business Combinations: Accounting for Contract Asset and Contract Liabilities from Contracts with Customers , to require that an acquirer recognize and measure contract assets and liabilities acquired in a business combination in accordance with ASC 606, Revenue from Contracts with Customers . This ASU is effective for us in the first quarter of 2023 and, if adopted early, requires the retrospective method of transition applied to transactions occurring on or after the beginning of the fiscal year of adoption. We are evaluating the timing and effects of adoption of this ASU on our financial statements. In August 2020, the FASB issued ASU 2020-06 – Debt – Debt with Conversion and Other Options and Derivatives and Hedging – Contracts in Entity’s Own Equity: Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity , which simplifies the accounting for convertible debt instruments by reducing the number of accounting models and the number of embedded conversion features that could be recognized separately from the primary contract. This ASU requires a convertible debt instrument to be accounted for as a single liability measured at its amortized cost, as long as no other features require bifurcation and recognition as derivatives. This ASU requires an entity to use the if-converted method in the diluted earnings per share calculation for convertible instruments. This ASU is effective for us in the first quarter of 2023 and permits the use of either the modified retrospective or fully retrospective method of transition. We are evaluating the effects of adoption of this ASU on our financial statements. Business Acquisition LED Business On March 1, 2021, pursuant to the previously announced Asset Purchase Agreement dated October 18, 2020 , as amended by the Amendment to Asset Purchase Agreement dated March 1, 2021 (as amended, the “CreeLED Purchase Agreement”), (i) we acquired the LED business of Cree, Inc., a corporation now known as Wolfspeed, Inc. (“Cree”), including (a) certain equipment, inventory, intellectual property rights, contracts and real estate comprising Cree’s LED products segment, (b) all of the issued and outstanding equity interests of Cree Huizhou Solid State Lighting Company Limited, a limited liability company organized under the laws of the People’s Republic of China and an indirect wholly owned subsidiary of Cree and (c) Cree’s 51 % ownership interest in Cree Venture LED Company Limited (“Cree Joint Venture”), Cree’s joint venture with San’an Optoelectronics Co., Ltd. (“San’an”) and (ii) we assumed certain liabilities related to the LED business (collectively, (i) and (ii), the “LED Business”). In connection with the transaction, Cree retained certain assets used in and pre-closing liabilities associated with its LED products segment. Purchase Price : The purchase price for the LED Business consisted of (i) a payment of $ 50 million in cash, subject to customary adjustments, (ii) an unsecured promissory note issued to Cree by the Company in the amount of $ 125 million (“LED Purchase Price Note”), (iii) an earn-out payment of up to $ 125 million based on the revenue and gross profit performance of the LED Business in Cree’s first four full fiscal quarters following the closing (“Earnout Period”), with a minimum payment of $ 2.5 million, payable in the form of an unsecured promissory note to be issued by us (“Earnout Note”) and (iv) the assumption of certain liabilities. The LED Purchase Price Note bears interest at LIBOR plus 3.0 % and is due on August 15, 2023 . The Earnout Note will begin to bear interest upon completion of the Earnout Period at LIBOR plus 3.0 % and is due on March 27, 2025 . Contingent Consideration : The Earnout Note is accounted for as contingent consideration. The fair value of the Earnout Note was estimated as of the date of acquisition to be $ 28.1 million and was valued using a Monte Carlo simulation analysis in a risk-neutral framework with assumptions for volatility, market price of risk adjustment, risk-free rate and cost of debt. The fair value measurement was based on significant inputs not observable in the market . The Earnout Note is revalued each quarter and changes in valuation are reflected in results of operations. In the second half of 2021, we recorded charges of $ 32.4 million to adjust the value of the Earnout Note to its fair value as of August 27, 2021, and in the first quarter of 2022, we recorded an additional charge of $ 17.2 million to adjust the value of the Earnout Note to its fair value as of November 26, 2021. The changes 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. As of November 26, 2021, the fair value of the Earnout Note was $ 77.7 million. Unaudited Pro Forma Financial Information : The following unaudited pro forma financial information presents our combined results of operations as if the acquisition of the LED Business had occurred on August 31, 2019. The unaudited pro forma financial 11 information is based on various adjustments and assumptions and is not necessarily indicative of what our results of operations actually would have been had the acquisition been completed as of August 31, 2019 or will be for any future periods. Furthermore, the pro forma financial information does not include adjustments to reflect any potential revenue, synergies or dis-synergies or cost savings that may be achievable in connection with the acquisition, or the associated costs that may be necessary to achieve such revenues, synergies or cost savings. The unaudited pro forma financial information for the first quarter of 2021 combines our results of operations for the quarter ended November 27, 2020 and the results of operations of the LED Business for the quarter ended September 27, 2020. Three months ended November 27, 2020 Net sales $ 390,733 Net loss attributable to SGH ( 128,078 ) Earnings (loss) per share: Basic $ ( 5.21 ) Diluted $ ( 5.21 ) The unaudited pro forma financial information above reflects the following adjustments: • Incremental cost of sales related to the estimated fair value of inventories. • Incremental depreciation expense related to the estimated fair value of property and equipment. • Incremental amortization expense related to the estimated fair value of identifiable intangible assets. • Incremental interest expense related to the LED Purchase Price Note and the Earnout Note. • The impacts to income tax expense as a result of the pro forma adjustments. Inventories As of November 26, 2021 August 27, 2021 Raw materials $ 157,849 $ 163,610 Work in process 66,805 92,901 Finished goods 93,197 107,090 $ 317,851 $ 363,601 As of November 26, 2021 and August 27, 2021, 10 % and 11 %, respectively, of total inventories were inventories owned and held under our supply chain services. Property and Equipment As of November 26, 2021 August 27, 2021 Equipment $ 176,902 $ 182,493 Buildings and building improvements 53,035 53,502 Furniture, fixtures and software 33,309 32,114 Land 16,126 16,126 279,372 284,235 Accumulated depreciation ( 130,475 ) ( 127,969 ) $ 148,897 $ 156,266 Depreciation expense for property and equipment was $ 9.5 million and $ 5.0 million in the first quarters of 2022 and 2021, respectively. 12 Intangible Assets and Goodwill As of November 26, 2021 As of August 27, 2021 Gross Amount Accumulated Amortization Gross Amount Accumulated Amortization Intangible assets: Technology $ 61,925 $ ( 11,540 ) $ 61,307 $ ( 9,142 ) Customer relationships 57,500 ( 24,854 ) 57,500 ( 22,393 ) Trademarks/tradenames 19,200 ( 7,414 ) 19,200 ( 6,628 ) Order backlog 3,400 ( 2,886 ) 3,800 ( 2,571 ) $ 142,025 $ ( 46,694 ) $ 141,807 $ ( 40,734 ) Goodwill by segment: Intelligent Platform Solutions $ 40,401 $ 40,401 Memory Solutions 32,086 33,854 $ 72,487 $ 74,255 In the first quarter of 2022, we capitalized $ 0.6 million for intangible assets with weighted-average useful lives of 8.23 years. Amortization expense for intangible assets was $ 6.3 million and $ 3.4 million in the first quarters of 2022 and 2021, respectively. Amortization expense is expected to be $ 17.6 million for the remainder of 2022, $ 21.9 million in 2023, $ 18.2 million in 2024, $ 15.4 million in 2025, $ 8.4 million in 2026 and $ 13.8 million thereafter. Goodwill of our Memory Solutions segment decreased by $ 1.8 million in the first quarter of 2022 and increased in all of 2021 by $ 0.3 million from translation adjustments. Accounts Payable and Accrued Expenses As of November 26, 2021 August 27, 2021 Accounts payable (1) $ 373,460 $ 429,640 Salaries, wages and benefits 30,633 37,795 Income and other taxes 19,296 14,319 Other 3,494 2,353 $ 426,883 $ 484,107 (1) Includes accounts payable for property and equipment of $ 3.6 million and $ 3.1 million as of November 26, 2021 and August 27, 2021, respectively. Debt As of November 26, 2021 August 27, 2021 Convertible Senior Notes $ 206,202 $ 203,992 LED Purchase Price Note 125,000 125,000 ABL Credit Agreement 35,000 25,000 Other 10,750 11,846 376,952 365,838 Less current debt ( 35,802 ) ( 25,354 ) Long-term debt $ 341,150 $ 340,484 13 Convertible Senior Notes In February 2020, we issued $ 250.0 million in aggregate principal amount of 2.25 % convertible senior notes due 2026 (the “2026 Notes”). The 2026 Notes are general unsecured obligations, bear interest at an annual rate of 2.25 % per year, payable semi-annually on February 15 and August 15, and mature on February 15, 2026 , unless earlier converted, redeemed or repurchased. The 2026 Notes are governed by an indenture (the “Indenture”) between us and U.S. Bank National Association, as trustee. The initial conversion rate of the 2026 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. Conversion Rights : Holders of the 2026 Notes may convert them under the following circumstances: i. during any fiscal quarter commencing after the fiscal quarter ended on May 28, 2020 (and only during such fiscal quarter) if the last reported sale price per ordinary share exceeds 130 % of the conversion price for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the immediately preceding fiscal quarter; ii. 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; iii. on or after August 15, 2025 until the close of business on the second scheduled trading day immediately before the maturity date; iv. upon the occurrence of certain corporate events or distributions on our ordinary shares, as provided in the Indenture; or v. the 2026 Notes are called for redemption. Upon conversion, we will pay or deliver, as applicable, cash, ordinary shares or a combination of cash and ordinary shares at our election. Our intent is to settle in cash the principal amount of our convertible notes upon conversion and may, at our option, settle any excess of the conversion value over the principal amount in cash, ordinary shares or any combination thereof. The closing price of our ordinary shares exceeded 130 % of the conversion price for our 2026 Notes for at least 20 trading days in the 30 consecutive trading days ended on November 26, 2021. As a result, the 2026 Notes are convertible by holders through February 25, 2022 . If we receive a notice of conversion for our 2026 Notes, and we elect to settle in cash any portion of the conversion obligation, the cash settlement obligation becomes a derivative debt liability subject to mark-to-market accounting treatment based on the volume-weighted-average price of our ordinary shares over a period of 40 consecutive trading days, beginning two business days after the holder gives notice to convert. Accordingly, as of the date of our election to settle any part of a conversion in cash, we would reclassify all or a portion of the fair value of the equity component of the converted 2026 Notes from additional capital to derivative debt liability within current debt in our consolidated balance sheet. Other : Interest expense for the 2026 Notes consisted of 2.25% contractual stated interest of $ 1.4 million and $ 1.4 million in the first quarters of 2022 and 2021, respectively, and amortization of discount and issuance costs of $ 2.2 million and $ 2.1 million in the first quarters of 2022 and 2021, respectively, resulting in an effective interest rate of 7.06 %. As of both November 26, 2021 and August 27, 2021, the carrying amount of the equity components of the 2026 Notes, which are included in additional paid-in-capital, was $ 50.8 million. 14 Leases As of November 26, 2021 and August 27, 2021, we had operating leases through which we utilize facilities, offices and equipment in our manufacturing operations, research and development activities and selling, general and administrative functions. Sublease income was not significant in the first quarters of 2022 or 2021. The components of operating lease expense were as follows: Three months ended November 26, 2021 November 27, 2020 Fixed lease cost $ 3,303 $ 1,539 Variable lease cost 368 272 Short-term lease cost 76 58 $ 3,747 $ 1,869 Cash flows used for operating activities in the first quarters of 2022 and 2021 included payments for operating leases of $ 2.9 million and $ 1.6 million, respectively. Noncash acquisitions of right-of-use assets were not significant in the first quarters of 2022 and 2021. As of November 26, 2021 and August 27, 2021, the weighted-average remaining lease term for our operating leases was 6.0 years and 6.1 years, respectively. Certain of our operating leases include one or more options to extend the lease term for periods from two to five years . In determining the present value of our operating lease liabilities, we have assumed we will not extend any lease terms. As of November 26, 2021 and August 27, 2021, the weighted-average discount rate for our operating leases was 6.8 % and 6.7 %, respectively. Minimum payments of lease liabilities as of November 26, 2021 were as follows: Remainder of 2022 $ 9,679 2023 10,560 2024 7,249 2025 4,665 2026 3,584 2027 and thereafter 15,671 51,408 Less imputed interest ( 11,473 ) Present value of total lease liabilities $ 39,935 The table above excludes lease liabilities for leases that have been executed but not yet commenced. As of November 26, 2021, we had such lease commitments relating to operating lease payment obligations of $ 51.8 million for a building lease with a term of 16 years. We will recognize a right-of-use asset and an associated lease liability at the time such asset becomes available for our use . Such lease is currently expected to commence in the second half of calendar 2022. Commitments and Contingencies Contingencies From time to time, we are involved in legal matters that arise in the normal course of business. Litigation in general, and intellectual property, employment and shareholder litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. Additionally, from time to time, we are a party in the normal course of business to a variety of agreements pursuant to which we may be obligated to indemnify another party. It is not possible to predict the maximum potential amount of future payments under these types of agreements due to the conditional nature of our obligations and the unique facts and circumstances involved in each particular agreement. Historically, our payments under these types of agreements have not had a material adverse effect on our business, results of operations or financial condition. We regularly review contingencies to determine whether the likelihood of loss has changed and to assess whether a reasonable estimate of the loss or range of loss can be made. 15 Equity SGH Shareholders’ Equity Ordinary Share Repurchases Ordinary shares withheld as payment of withholding taxes and exercise prices in connection with the vesting or exercise of equity awards are treated as ordinary share repurchases. An aggregate of 51 thousand and 139 thousand shares were acquired for $ 2.7 million and $ 3.5 million in the first quarters of 2022 and 2021, respectively. Noncontrolling Interest in Subsidiary In connection with our acquisition of the LED Business, we have a 51 % ownership interest in the Cree Joint Venture. The remaining 49% ownership interest is held by San’an. The Cree Joint Venture has a five -member board of directors, three of which are designated by us and two of which are designated by San’an. As a result of our majority voting interest, we consolidate the operations of the Cree Joint Venture and report its results of operations within our LED Solutions segment. The Cree Joint Venture has a manufacturing agreement pursuant to which San’an supplies it with mid-power LED products and we and the Cree Joint Venture have a sales agent agreement pursuant to which we are the independent sales representative of the Cree Joint Venture. The Cree Joint Venture produces and delivers to market high performing, mid-power lighting class LEDs in an exclusive arrangement serving the expanding markets of North and South America, Europe and Japan, and serves China markets and the rest of the world on a non-exclusive basis. The 49 % ownership interest held by San’an is classified as noncontrolling interest. Noncontrolling interest increased by $ 0.7 million in the first quarter of 2022 for San’an’s share of net income from the Cree Joint Venture. Cash and other assets of the Cree Joint Venture are generally not available for use by us in our other operations. Government Incentives Brazil Financial Credits Through our Brazil subsidiaries, we participate in two programs (“Brazil Incentive Programs”), pursuant to which the Brazilian government incentivizes the manufacture and sale of certain information technology and consumer electronics products within Brazil. The programs include 1) Lei da Informática – Processo Produtivo Básico Program (aka Informatics Law – Basic Productive Process Program) (“PPB/IT”) and 2) Programa de Apoio ao Desenvolvimento Tecnológico da Indústria de Semicondutores (aka Program of Support of the Development of the Semiconductor Industry) (“PADIS”). The financial credits available through PADIS are currently set to expire in January 2022. The Brazil Incentive Programs provide for reduced import and other transaction-related taxes for certain procurement, manufacturing and sales activities. In exchange, we must invest in certain research and development activities related to semiconductors and displays in aggregate amounts that exceed a specified percentage of our gross revenues recognized in connection with sales in Brazil. Accordingly, financial credits earned in connection with the Brazil Incentive Programs are reflected as a reduction of research and development expense. Financial credits available under the Brazil Incentive Programs are subject to limitations, which range from approximately 11 % to 14 % of gross revenues recognized for sales in Brazil. Pursuant to the Brazil Incentive Programs, we recognized aggregate financial credits, reflected as a reduction of research and development expense, of $ 5.9 million and $ 7.9 million in the first quarters of 2022 and 2021, respectively. Financial credits earned under the Brazil Incentive Programs may be refunded in cash or used to offset liabilities for Brazil federal taxes. As of November 26, 2021 and August 27, 2021, earned but unused financial credits of $ 16.9 million and $ 19.8 million, respectively, were included in other current assets. Financial credits earned but unused as of November 26, 2021 can be utilized through November 2026. 16 Fair Value Measurements Cash and cash equivalents as of November 26, 2021 and August 27, 2021 included money market funds of $ 2.8 million and $ 2.7 million, respectively, which were valued based on Level 1 measurements using quoted prices in active markets for identical assets. Fair value measurements of other assets and liabilities were as follows: As of November 26, 2021 As of August 27, 2021 Fair Value Carrying Value Fair Value Carrying Value Assets: Derivative financial instrument assets $ 1,528 $ 1,528 $ 883 $ 883 Liabilities: Derivative financial instrument liabilities $ — $ — $ 50 $ 50 Convertible Senior Notes 401,283 206,202 335,668 203,992 LED Purchase Price Note 125,000 125,000 125,000 125,000 ABL Credit Agreement 35,000 35,000 25,000 25,000 Debt – other 9,782 10,751 10,702 11,846 Acquisition-related contingent consideration 77,700 77,700 60,500 60,500 The fair values of our derivative financial instruments, as measured on a recurring basis, were based on Level 2 measurements, including market-based observable inputs of currency exchange spot and forward rates, interest rates and credit-risk spreads. The fair value of our Convertible Senior Notes (excluding the value of the equity component of our convertible notes), as measured on a non-recurring basis, was determined based on Level 2 measurements, including the trading price of the convertible notes. The fair values of our LED Purchase Price Note, ABL Credit Agreement and other debt, as measured on a non-recurring basis, were estimated based on Level 2 measurements, including discounted cash flows and interest rates based on similar debt issued by parties with credit ratings similar to ours. Acquisition-related contingent consideration relates to our acquisition of the LED Business and is included in other noncurrent liabilities. The fair value, as measured on a recurring basis, was based on Level 3 measurements, which includes significant inputs not observable in the market. The fair value was estimated using a Monte Carlo simulation analysis in a risk-neutral framework with assumptions for volatility, market price of risk adjustment, risk-free rate and cost of debt. Assumptions used in the determination of fair value also included estimates of future revenue and gross profit of the LED Business in Cree’s first four full fiscal quarters following the closing of the acquisition. Generally, changes in the assumptions for projected future revenue, gross profit and volatility would be accompanied by a directionally similar change in the fair value measurement. Conversely, changes in the discount rate would be accompanied by a directionally opposite change in the related fair value measurement. However, due to the contingent consideration having a maximum payout amount, changes in these assumptions would not affect the fair value of the contingent consideration if they increase (decrease) beyond certain amounts. Subsequent to the acquisition date, at each reporting date, the contingent consideration liability is remeasured to fair value with changes recorded in our results of operations. See “Business Acquisition – LED Business.” Derivative Instruments We use currency forward contracts to mitigate our exposure of certain monetary assets and liabilities from changes in currency exchange rates. Realized and unrealized gains and losses on derivative instruments without hedge accounting designation as well as the changes in the underlying monetary assets and liabilities from changes in currency exchange rates are included in other non-operating (income) expense. For derivative instruments without hedge accounting designation, in the first quarter of 2022, we recognized net realized gains of $ 3.9 million and net unrealized gains on the change in the fair value of the non-designated forward contracts of $ 0.8 million. In the first quarter of 2021, we recognized net realized gains of $ 2.4 million and net unrealized gains on the change in the fair value of the non-designated forward contracts of $ 2.9 million. 17 Equity Plans As of November 26, 2021, 4.3 million shares of our ordinary shares were available for future awards under our equity plans. Restricted Share Awards and Restricted Share Units Awards (“Restricted Awards”) Aggregate Restricted Award activity was as follows: Three months ended November 26, 2021 November 27, 2020 Awards granted 266 548 Weighted average grant-date fair value per share $ 56.04 $ 20.81 Aggregate vesting-date fair value of shares vested $ 11,956 $ 8,370 Restricted Awards include grants with service, performance and/or market conditions with restrictions that generally lapse after a three to four-year service period. Awards with market conditions are based on either the Company’s share price or the Company’s total shareholder return (“TSR”) relative to companies included in a market index. For awards with market conditions, the number of shares that will vest will vary between 0 % and 200 % of target amounts, depending upon the Company’s achievement level over the specified performance period. The fair value of awards with market conditions were fixed at the grant date using a Monte Carlo simulation analysis and were based on significant inputs not observable in the market. In May 2020, we granted a performance-based restricted share award that had both service and performance conditions. As of August 28, 2020, we deemed it was probable that the service condition would be met and the attainment of the performance condition for this award was probable. On October 20, 2020, we modified this award, as well as another time-based award, each for our former CEO, to accelerate the remaining service-based vesting requirements such that they became fully vested as of the acceleration date. These modifications resulted in additional share-based compensation expense in the first quarter of 2021 of $ 5.8 million. As of November 26, 2021, total unrecognized compensation costs for unvested Restricted Awards was $ 93.1 million, which was expected to be recognized over a weighted average period of 2.95 years. Share Options Share option activity and assumptions were as follows: Three months ended November 27, 2020 Share options granted 250 Weighted average grant-date fair value per share $ 13.30 Average expected term in years 6.25 Weighted-average expected volatility 52.07 % Weighted-average risk-free interest rate 0.49 % Expected dividend yield — As of November 26, 2021, total unrecognized compensation costs for unvested options was $ 5.3 million, which was expected to be recognized over a weighted average period of 1.96 years. Employee Share Purchase Plan Under our employee share purchase plan (“ESPP”), employees purchased 67 thousand ordinary shares for $ 3.0 million in the first quarter of 2022 and 87 thousand shares for $ 1.8 million in the first quarter of 2021. 18 Share-Based Compensation Expense Three months ended November 26, 2021 November 27, 2020 Share-based compensation expense by caption: Cost of sales $ 1,731 $ 838 Research and development 1,540 778 Selling, general and administrative 6,504 9,472 $ 9,775 $ 11,088 Income tax benefits related to the tax deductions for share-based awards are recognized only upon the settlement of the related share-based awards. Consistent with our treatment of income or loss from our U.S. operations, our income tax provision in the first quarters of 2022 and 2021 reflects de minimis income tax benefits for share-based compensation expense. Revenue and Customer Contract Balances We disaggregate revenue by segment and geography and by product and service revenue. See “Segment and Other Information.” Net Sales and Gross Billings Net sales by products and services and gross amounts billed for services, including those services in which we act as an agent for our customers, were as follows: Three months ended November 26, 2021 November 27, 2020 Net sales: Products $ 456,425 $ 285,202 Services 13,519 6,495 $ 469,944 $ 291,697 Gross billings in connection with services: Services $ 13,519 $ 6,495 Cost of materials (1) 336,275 131,524 $ 349,794 $ 138,019 (1) Included in gross billings in connection with services are amounts billed to customers for the cost of materials procured in an agent capacity in connection with our procurement, logistics, inventory management, temporary warehousing, kitting and packaging services. While we take title to inventory under such arrangements, control of such inventory does not transfer to us as we do not, at any point, have the ability to direct the use, and thereby obtain the benefits of, the inventory. Customer Contract Balances As of November 26, 2021 August 27, 2021 Contract assets (1) $ 154 $ 4,247 Contract liabilities: (2) Deferred revenue $ 14,888 $ 19,271 Customer advances 15,952 15,835 $ 30,840 $ 35,106 (1) Contract assets are included in other current assets. (2) Contract liabilities are included in other current liabilities and noncurrent liabilities based on the timing of when our customer is expected to take control of the asset or receive the benefit of the service. 19 Deferred revenue related to amounts received from customers in advance of satisfying performance obligations. As of November 26, 2021, we expect to recognize revenue of $ 10.5 million of the balance of $ 14.9 million in the next 12 months and the remaining amount thereafter. In the first quarter of 2022, we recognized revenue of $ 5.8 million from satisfying performance obligations related to amounts included in deferred revenue as of August 27, 2021. Customer advances represent amounts received from customers for advance payments to secure product and services within the next 12 months. In the first quarter of 2022, we recognized revenue of $ 1.3 million from satisfying performance obligations related to amounts included in customer advances as of August 27, 2021. As of November 26, 2021 and August 27, 2021, other current liabilities included $ 25.1 million and $ 24.9 million, respectively, for estimates of consideration payable to customers, including estimates for pricing adjustments and returns. Other Non-operating (Income) Expense Three months ended November 26, 2021 November 27, 2020 Foreign currency (gains) losses $ 1,467 $ ( 642 ) Other ( 232 ) ( 190 ) $ 1,235 $ ( 832 ) Foreign currency (gains) and losses relate primarily to our Brazil operating subsidiaries. Income Taxes Three months ended November 26, 2021 November 27, 2020 Income before income taxes $ 28,453 $ 5,302 Income tax provision $ 7,755 $ 3,275 Effective tax rate 27.3 % 61.8 % Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to us and our subsidiaries, adjusted for certain discrete items which are fully recognized in the period they occur. Accordingly, the interim effective tax rate may not be reflective of the annual estimated effective tax rate. Provision for income taxes for the three months ended November 26, 2021 increased by $ 4.5 million, as compared to the same period in the prior year, primarily due to an increase in the amount of earnings subject to non-U.S. tax. As of November 26, 2021 and August 27, 2021, we had a full valuation allowance for net deferred tax assets associated with our U.S. operations. The amount of the deferred tax asset considered realizable could be adjusted if significant positive evidence increases. Determining the consolidated provision for income tax expense, income tax liabilities and deferred tax assets and liabilities involves judgment. The Company calculates and provides for income taxes in each of the tax jurisdictions in which it operates, which involves estimating current tax exposures, as well as making judgments regarding the recoverability of deferred tax assets in each jurisdiction. The estimates used could differ from actual results, which may have a significant impact on operating results in future periods. Earnings Per Share 20 Three months ended November 26, 2021 November 27, 2020 Net income attributable to SGH – Basic and Diluted $ 20,027 $ 2,027 Weighted-average shares outstanding – Basic 24,506 24,561 Dilutive effect of equity plans and convertible notes 2,812 542 Weighted-average shares outstanding – Diluted 27,318 25,103 Earnings per share: Basic $ 0.82 $ 0.08 Diluted $ 0.73 $ 0.08 Below are potentially dilutive shares that were not included in the computation of diluted earnings per share because to do so would have been antidilutive: Three months ended November 26, 2021 November 27, 2020 Equity plans 143 1,497 We have the option to pay cash, issue shares or any combination thereof for the aggregate amount due upon any conversion of our 2026 Notes. It is our intent to settle the principal amount of the 2026 Notes in cash upon any conversion. As a result, only the amounts payable in excess of the principal amounts upon conversion of the 2026 Notes are considered in diluted earnings per share under the treasury stock method. As a result, the 2026 Notes would be dilutive when the average share price of the Company’s ordinary shares for a reporting period exceeds the conversion price of the 2026 Notes of $ 40.61 per share. See “Debt – Convertible Senior Notes.” Segment and Other Information Segment information presented below is consistent with how our chief operating decision maker evaluates operating results to make decisions about allocating resources and assessing performance. 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 period information in the tables below has been revised to reflect the change to our three reportable segments. • Memory Solutions : Our Memory Solutions group provides high performance and reliable memory solutions through the design, development and advanced packaging of leading-edge to extended lifecycle products. These specialty products are tailored to meet customer-specific requirements across networking and communications, enterprise storage, computing, including desktop, notebook and server applications, smartphones and other vertical markets. These products are marketed to OEMs and to commercial and government customers. The Memory Solutions group also offers SMART Supply Chain Services, which provides customized, integrated supply chain services to enable our customers to better manage supply chain planning and execution, reduce costs and increase productivity. • Intelligent Platform Solutions (“IPS”) : Our IPS group consists of Penguin Computing and Penguin Edge. Penguin Computing offers specialized platform solutions for high-performance computing, artificial intelligence, machine learning and advanced modeling for technology research. We provide these leading-edge solutions to customers in the government, hyper-scale, energy, financial services and education markets. Penguin Edge encompasses the operations of SMART EC and SMART Wireless and offers solutions for embedded and wireless applications, specializing in high-reliability products for a wide range of customers in government, telecommunications, health care, smart city, network edge and industrial applications. • LED Solutions : Our LED Solutions group offers a broad portfolio of application-optimized LEDs focused on improving on lumen density, intensity, efficacy, optical control and reliability. Backed by expert design assistance and superior sales support, our LED products enable our customers to develop and market LED-based products for lighting, video screens and specialty lighting applications. Our LED Solutions is comprised of the LED Business we acquired from Cree, Inc. on March 1, 2021. 21 Segments are determined based on sources of revenue, types of customers and operating performance. There are no differences between the accounting policies for our segment reporting and our consolidated results of operations. Operating expenses directly associated with the activities of a specific segment are charged to that segment. Certain other indirect operating income and expenses are generally allocated to segments based on their respective percentage of net sales. We do not allocate interest, other non-operating (income) expense or taxes to segments. Three months ended November 26, 2021 November 27, 2020 Net sales: Memory Solutions $ 239,401 $ 225,823 Intelligent Platform Solutions 118,654 65,874 LED Solutions 111,889 — Total net sales $ 469,944 $ 291,697 Segment operating income: Memory Solutions $ 36,670 $ 20,861 Intelligent Platform Solutions 14,180 2,881 LED Solutions 18,300 — Total segment operating income 69,150 23,742 Unallocated: Share-based compensation expense ( 9,775 ) ( 11,088 ) Amortization of acquisition-related intangibles ( 6,343 ) ( 3,413 ) Change in fair value of contingent consideration ( 17,200 ) — Other ( 1,038 ) ( 1,617 ) Total unallocated ( 34,356 ) ( 16,118 ) Consolidated operating income $ 34,794 $ 7,624 22