Item 7. Management’s Discussion and Analysis
Item 7. 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 accompanying consolidated financial statements and notes for the year ended August 25, 2023. 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.”
Our fiscal year is the 52- or 53-week period ending on the last Friday in August. Fiscal years 2023, 2022 and 2021 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 amounts are in thousands.
Overview
For an overview of our business, see “PART I – Item 1. Business.”
Acquisition of Stratus Technologies
On August 29, 2022, we completed the acquisition of Storm Private Holdings I Ltd., a Cayman Islands exempted company (“Stratus Holding Company” and together with its subsidiaries, “Stratus Technologies”). At the closing, SGH paid a cash purchase price of $225 million, subject to certain adjustments. In addition, the seller has the right to receive, and SGH is obligated to pay, contingent consideration of up to $50 million (the “Stratus Earnout”) based on the gross profit performance of the Stratus business during the first full 12 fiscal months of Stratus following the closing of the acquisition. The Stratus Earnout is payable in cash, ordinary shares of SGH, or a mix of cash and SGH Shares, at SGH’s election. On June 28, 2023, we provided notice to the Stratus Seller of our election to settle the Stratus Earnout in cash. As of August 25, 2023, current liabilities include $50.0 million for the amount payable for the Stratus Earnout.
Stratus is a global leader in simplified, protected and autonomous computing platforms and services in the data center and at the Edge. For more than 40 years, Stratus has provided high-availability, fault-tolerant computing to Fortune 500 companies and small-to-medium sized businesses enabling them to securely and remotely run critical applications with minimal downtime. Stratus operates as part of SGH’s IPS segment.
See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Business Acquisitions – Stratus Technologies.”
Divestiture of SMART Brazil
On June 13, 2023, we entered into an agreement to sell an 81% interest in SMART Modular Technologies Brasil – Indústria e Comercio de Componentes Ltda. (“SMART Brazil”) to Lexar Europe B.V., an affiliate of Shenzhen Longsys Electronics Co. Ltd. for approximately $205 million. The transaction is expected to close at the end of calendar year 2023 or beginning of calendar year 2024, subject to required regulatory approvals and satisfaction of customary closing conditions.
SMART Brazil operates as a stand-alone business which assembles and tests modules for electronics manufacturers that sell devices to Brazilian consumers. In line with our strategic priorities, the majority divestiture of our standards-based, commodity module business in Brazil will enable us to focus on our strategy of delivering high-performance, high availability solutions to our enterprise customers. This transaction also strengthens our financial position, enabling us to increase our strategic investments into domestic research and development and U.S.-based production of advanced technologies.
Presentation of SMART Brazil as Discontinued Operations : In accordance with authoritative guidance under U.S. GAAP, we concluded that our SMART Brazil operations met held-for-sale and discontinued operations accounting criteria as of the end of fiscal year 2023. Accordingly, we have presented the balance sheets, results of operations and cash flows of SMART Brazil operations in this Annual Report on Form 10-K, including in the accompanying consolidated financial statements and notes, as discontinued operations for all periods presented. Our SMART Brazil operations were previously reported as part of our Memory Solutions segment. Unless otherwise noted, discussion within this Annual Report on Form 10-K relates solely to our continuing operations and excludes our SMART Brazil operations.
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See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Divestiture of SMART Brazil.”
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 and our recently acquired Stratus Technologies 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. 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. In addition, the recent high demand for, and limited supply of, AI components globally, is affecting our sourcing of these components. 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.
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Results of Operations
Year ended August 25,
2023 % of net
sales (1)
August 26,
2022 % of net
sales (1)
August 27,
2021 % of net
sales (1)
Net sales:
Memory Solutions $ 443,264 30.8 % $ 551,705 39.5 % $ 486,205 46.1 %
Intelligent Platform Solutions 749,708 52.0 % 440,986 31.6 % 344,757 32.7 %
LED Solutions 248,278 17.2 % 403,185 28.9 % 224,567 21.3 %
Total net sales 1,441,250 100.0 % 1,395,876 100.0 % 1,055,529 100.0 %
Cost of sales 1,026,079 71.2 % 1,004,831 72.0 % 817,556 77.5 %
Gross profit 415,171 28.8 % 391,045 28.0 % 237,973 22.5 %
Operating expenses:
Research and development 90,565 6.3 % 77,472 5.6 % 59,933 5.7 %
Selling, general and administrative 260,722 18.1 % 204,839 14.7 % 158,174 15.0 %
Impairment of goodwill 19,092 1.3 % — — % — — %
Change in fair value of contingent consideration 29,000 2.0 % 41,324 3.0 % 32,400 3.1 %
Other operating (income) expense 7,047 0.5 % 234 — % 3,172 0.3 %
Total operating expenses 406,426 28.2 % 323,869 23.2 % 253,679 24.0 %
Operating income (loss) 8,745 0.6 % 67,176 4.8 % (15,706) 3.7 %
Non-operating (income) expense:
Interest expense, net 36,421 2.5 % 24,345 1.7 % 17,141 1.6 %
Other non-operating (income) expense 11,837 0.8 % 350 — % (582) (0.1) %
Total non-operating (income) expense 48,258 3.3 % 24,695 1.8 % 16,559 1.6 %
Income (loss) before taxes (39,513) (2.7) % 42,481 3.0 % (32,265) (3.1) %
Income tax provision (benefit) (49,203) (3.4) % 18,074 1.3 % 9,689 0.9 %
Net income (loss) from continuing operations 9,690 0.7 % 24,407 1.7 % (41,954) (4.0) %
Net income (loss) from discontinued operations (195,384) (13.6) % 44,185 3.2 % 64,460 6.1 %
Net income (loss) (185,694) (12.9) % 68,592 4.9 % 22,506 2.1 %
Net income attributable to noncontrolling interest 1,832 0.1 % 2,035 0.1 % 1,196 0.1 %
Net income (loss) attributable to SGH $ (187,526) (13.0) % $ 66,557 4.8 % $ 21,310 2.0 %
(1) Summations of percentages may not compute precisely due to rounding.
Net Sales, Cost of Sales and Gross Profit
Net sales increased by $45.4 million, or 3.3%, in 2023 compared to the prior year, due to strong performance in our IPS business, partially offset by weakness in both our Memory and LED Solutions businesses. IPS net sales increased by $308.7 million, or 70.0%, primarily due to $172.7 million of revenue from our Stratus acquisition in August 2022, as well as higher volumes of sales in our Penguin Computing business. LED Solutions net sales decreased by $154.9 million, or 38.4%, primarily due to continued demand challenges in China. Memory Solutions sales decreased by $108.4 million, or 19.7%, primarily due to lower sales volume and pricing of DRAM products.
Net sales increased by $340.3 million, or 32.2%, in 2022 compared to the prior year, due to an increase of $178.6 million of revenue from our acquisition of the LED Business in March 2021 and to strong performance in our IPS and Memory Solutions businesses. IPS net sales increased by $96.2 million, or 27.9%, primarily due to higher volumes of sales in our Penguin Computing business. Memory Solutions sales increased by $65.5 million, or 13.5%, primarily due to a higher sales volume of DRAM products.
Cost of sales increased by $21.2 million, or 2.1%, in 2023 and by $187.3 million, or 22.9%, in 2022 compared to the prior respective years, primarily due to our acquisition of the Stratus Business and from higher costs of materials and production costs due to higher sales for our IPS segment.
Gross margin increased to 28.8% in 2023 compared to 28.0% in 2022 primarily due to inclusion of higher margin Stratus products, as well as process and efficiency improvements in the Memory Solutions and IPS segments compared to the prior year. Gross margin increased to 28.0% in 2022, compared to 22.5% in 2021 primarily due to the inclusion of higher margin LED Solutions products.
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Non-GAAP Measure of Segment Operating Income
Below is a table of our operating income, measured on a non-GAAP basis, which SGH management uses to supplement SGH’s financial results under GAAP to analyze its operations and make decisions as to future operational plans and believes that this supplemental non-GAAP information is useful to investors in analyzing and assessing the company’s past and future operating performance. These non-GAAP measures exclude certain items, such as share-based compensation expense, amortization of acquisition-related intangible assets (consisting of amortization of developed technology, customer relationships, trademarks/trade names and backlog acquired in connection with business combinations), acquisition-related inventory adjustments, acquisition-related expenses, restructure charges and integration expenses, changes in the fair value of contingent consideration and other infrequent or unusual items. While amortization of acquisition-related intangible assets is excluded, the revenues from acquired companies is reflected in our non-GAAP measures and these intangible assets contribute to revenue generation. See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Segment and Other Information.”
Non-GAAP financial measures should not be considered as a substitute for, or superior to, measures of financial performance prepared in accordance with GAAP, as they exclude important information about our financial results, as noted above. The presentation of these adjusted amounts varies from amounts presented in accordance with GAAP and therefore may not be comparable to amounts reported by other companies.
Year ended August 25,
2023 August 26,
2022 August 27,
2021
GAAP operating income (loss) $ 8,745 $ 67,176 $ (15,706)
Share-based compensation expense 39,228 37,284 30,961
Amortization of acquisition-related intangibles 44,601 23,729 20,255
Flow-through of inventory step up 2,599 — 7,090
Cost of sales-related restructure 6,813 — —
Acquisition and integration expenses 20,869 7,090 5,314
Impairment of goodwill 19,092 — —
Change in fair value of contingent consideration 29,000 41,324 32,400
Restructure charge 7,047 234 3,172
Other 1,800 624 (2)
Non-GAAP operating income $ 179,794 $ 177,461 $ 83,484
Non-GAAP operating income by segment:
Memory Solutions $ 73,639 $ 78,869 $ 19,530
Intelligent Platform Solutions 110,975 49,450 29,658
LED Solutions (4,820) 49,142 34,296
Total non-GAAP operating income by segment $ 179,794 $ 177,461 $ 83,484
Memory Solutions operating income decreased by $5.2 million, or 6.6%, in 2023 compared to the prior year primarily due to lower sales, partially offset by a favorable product mix and lower personnel-related costs driven in part by cost containment actions. Memory Solutions operating income increased by $59.3 million, or 303.8%, in 2022 compared to the prior year primarily due to strong revenue growth and gross margin improvement driven by a favorable product mix, as well as lower personnel-related costs.
IPS operating income increased by $61.5 million, or 124.4%, in 2023 compared to the prior year primarily due to higher sales mainly due to the Stratus acquisition and gross margin expansion, partially offset by higher operating expenses due to the Stratus acquisition as well as personnel-related expenses due in part to increased headcount to support the revenue growth. IPS operating income increased by $19.8 million, or 66.7%, in 2022 compared to the prior year primarily due to strong revenue growth from Penguin Computing and gross margin improvement, partially offset by higher operating expenses mainly driven by personnel-related expenses due to increased headcount to support the revenue growth.
LED Solutions operating income decreased by $54.0 million, or 109.8%, in 2023 compared to the prior year primarily due to lower sales from demand challenges in China, partially offset by lower personnel-related costs driven in part by cost reduction actions. LED Solutions operating income increased by $14.8 million, or 43.3%, in 2022 compared to the prior year as 2022 included a full year of operations compared to half a year in 2021.
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Operating and Non-operating (Income) Expense
Research and Development
Research and development expense increased by $13.1 million, or 16.9%, in 2023 compared to the prior year, primarily due to additional costs from the Stratus acquisition, offset by lower personnel-related expenses mainly driven by bonus and headcount reductions.
Research and development expense increased by $17.5 million, or 29.3%, in 2022 compared to the prior year, primarily due to additional costs from the acquisition of the LED Business, which had a full year of operations compared to a half a year in 2021, as well as higher personnel-related expenses and depreciation.
Selling, General and Administrative
Selling, general and administrative expense increased by $55.9 million, or 27.3%, in 2023 compared to the prior year, primarily due to additional costs from the Stratus acquisition as well as higher acquisition and integration expenses, partially offset by lower personnel-related expenses driven by bonus and headcount reductions.
Selling, general and administrative expense increased by $46.7 million, or 29.5%, in 2022 compared to the prior year, primarily due to additional costs from the acquisition of the LED Business which had a full year of operations compared to a half a year in 2021, as well as higher personnel-related expenses, professional services and acquisition expenses.
Impairment of Goodwill
During the second quarter of 2023, we initiated a plan pursuant to which we intend to wind down manufacturing and discontinue the sale of certain legacy products offered through our Penguin Edge business by approximately the end of calendar 2024. We recorded impairment charges of $17.6 million and $1.5 million in the second and fourth quarters of 2023, respectively, to impair the carrying value of Penguin Edge goodwill. We currently anticipate that the remaining goodwill of the Penguin Edge reporting unit of $16.1 million as of August 25, 2023 may become further impaired in future periods. See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Intangible Assets and Goodwill – Impairment of Penguin Edge Goodwill.”
Change in Fair Value of Contingent Consideration
Our acquisitions of Stratus Technologies in the first quarter of 2023 and our LED Business in the third quarter of 2021 each included contingent consideration. We estimate the fair value of the contingent consideration as of the date of acquisition and subsequently recognize changes in the fair value in results of operations. During 2023, we recorded charges of $29.0 million to adjust the fair value of the contingent consideration from our Stratus acquisition. During 2022 and the second half of 2021, we recorded charges of $41.3 million and $32.4 million, respectively, to adjust the value of the contingent consideration from our LED acquisition. See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Business Acquisitions.”
Other Operating (Income) Expense
Other operating expense in 2023 included restructure charges of $7.0 million primarily for employee severance costs and other benefits resulting from workforce reductions, the elimination of certain projects across our businesses and other costs associated with the wind down of our Penguin Edge business. We anticipate that such activities will continue into future quarters and anticipate recording additional restructure charges.
Other Non-operating (Income) Expense
Other non-operating (income) expense in 2023 included losses of $15.9 million from the extinguishment of debt, partially offset by net gains of $3.0 million from the disposition of assets.
Income Tax Provision (Benefit)
Our provision for income taxes decreased by $67.3 million in 2023, or 372.2%, compared to the prior year primarily due to the tax benefit on the release of the U.S. federal and state valuation allowance in 2023 partially offset by tax addbacks for nondeductible goodwill impairment in 2023 and additional uncertain tax positions recorded in 2023. Our provision for income taxes increased by $8.4 million in 2022, or 86.5%, compared to the prior year primarily due to higher income in non-
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U.S. jurisdictions subject to tax and nondeductible expenses, partially offset by recording less valuation allowance expense in 2022 due to more income in the U.S. jurisdiction.
In 2023, our tax benefit of $49.2 million and effective tax rate of 124.5% was different from the U.S. statutory tax rate primarily due to a release of the U.S. federal and state valuation allowance. The effective tax rate benefit from the valuation allowance release was offset with detriments associated with losses generated in jurisdictions with rates lower than the U.S. statutory tax rate, increases in reserves for uncertain tax provisions, foreign withholding taxes and goodwill impairment for financial reporting purposes with no tax basis.
In 2022, our tax expense of $18.1 million and effective tax rate of 42.5% was different from the U.S. statutory tax rate primarily due to losses generated in jurisdictions with rates lower than the U.S. statutory tax rate, nondeductible expenses and additional valuation allowance recorded against U.S. federal and state deferred tax assets.
In 2021, our tax expense of $9.7 million and effective tax rate of (30.0)% was different from the U.S. statutory tax rate primarily due to losses generated in jurisdictions with rates lower than the U.S. statutory tax rate and additional valuation allowance recorded against US federal and state deferred tax assets.
We have operations in Malaysia, where we have tax incentive arrangements for our pioneer status activities and our global supply chain operations. 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 2023, 2022 and 2021. 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. See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Income Taxes.”
Net Income (Loss) From Discontinued Operations
As discussed above, we have presented the results of our SMART Brazil activities as discontinued operations in our consolidated statements of operations for all periods presented.
As of August 25, 2023, our SMART Brazil operations were classified as held for sale. Accordingly, we evaluated the carrying value of the net assets of our SMART Brazil operations (including $206.3 million recognized within shareholder’s equity related to the cumulative translation adjustment from our SMART Brazil operations), estimated costs to sell and expected proceeds and concluded the net assets were impaired. As a result, we recognized an impairment charge of $153.0 million in 2023 to write down the carrying value of the net assets of our SMART Brazil operations. See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Divestiture of SMART Brazil.”
Liquidity and Capital Resources
As of August 25, 2023, we had cash, cash equivalents and short-term investments of $390.8 million, of which $82.5 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 acquire investments for trading or speculative purposes.
We expect that our existing cash and cash equivalents, short-term investment, 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.
The transaction to sell an 81% interest in SMART Brazil is expected to close at the end of calendar 2023 or early 2024. Upon completion of the transaction, the purchaser will pay to us (i) an up front cash payment of $137.7 million on a cash-free, debt-free basis and subject to certain customary adjustments as set forth in the purchase agreement and (ii) a deferred
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cash purchase price of $28.4 million eighteen months following the closing. We expect to use the proceeds from the sale for general corporate purposes.
Credit Facility
On August 29, 2022, we amended our credit facility and borrowed an additional $300 million, which amount was added to our existing term loan. The incremental term loans are on the same terms as the term loans incurred under the original credit agreement. In addition, we amended certain covenants under the amended credit agreement. In the first quarter of 2023, we applied a portion of the proceeds of the incremental term loans to (i) finance a portion of the purchase price of the acquisition of Stratus Technologies and (ii) pay in full the $101.8 million outstanding under the LED Earnout Note. See “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Debt – Credit Facility.”
Contractual Obligations
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.”
Cash Flows
Year ended August 25,
2023 August 26,
2022 August 27,
2021
Net cash provided by operating activities from continuing operations $ 63,677 $ 38,862 $ 122,840
Net cash used for investing activities from continuing operations (281,184) (21,234) (53,467)
Net cash provided by (used for) financing activities from continuing operations 237,221 60,645 (14,728)
Net increase in cash and cash equivalents from discontinued operations 22,520 61,567 17,376
Effect of changes in currency exchange rates 4,765 239 154
Net increase in cash and cash equivalents $ 46,999 $ 140,079 $ 72,175
Operating Activities : 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 from continuing operations in 2023 was $63.7 million, comprised primarily of a net income of $9.7 million, adjusted for non-cash items of $119.3 million. Operating cash flows were adversely affected by a $65.4 million net change in our operating assets and liabilities, primarily from the effects of decreases of $256.1 million in accounts payable and accrued expenses and other liabilities and the payment of $73.7 million of contingent consideration related to our 2021 acquisition of the LED business, partially offset by the effect of decreases of $162.5 million in accounts receivable and $95.2 million in inventories. The decreases in both accounts payable and accrued expenses and inventories were primarily due to lower inventories in our Memory Solutions and IPS businesses. The decrease in accounts receivable was primarily due to lower gross sales in our Memory Solutions businesses.
Net cash provided by operating activities from continuing operations in 2022 was $38.9 million, resulting primarily from net income of $24.4 million, adjusted for non-cash items of $136.8 million. Operating cash flows were adversely affected by a $122.3 million net change in our operating assets and liabilities, primarily from the effects of an increase of $97.8 million in accounts receivable and a decrease of $44.9 million in accounts payable and accrued expenses and other liabilities, partially offset by a decrease of $30.7 million in inventories. The increase in accounts receivable was primarily due to higher gross sales, primarily in our Memory Solutions and IPS segments. The decreases in both accounts payable and accrued expenses and in inventories were primarily due to lower inventories in our Memory Solutions and IPS businesses.
Net cash provided by operating activities from continuing operations in 2021 was $122.8 million, comprised of a net loss of $42.0 million, adjusted for non-cash items of $104.5 million. Operating cash flows also benefited from a $60.3 million net change in our operating assets and liabilities, primarily from the effects of an increase of $192.5 million in accounts payable and accrued expenses and other liabilities and a decrease of $15.4 million in other assets, partially offset by increases of $99.9 million in inventories and $47.8 million in accounts receivable. The increases in accounts payable and accrued
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expenses and in inventories were primarily due to higher inventories among all business areas. The increase in accounts receivable was primarily due to higher gross sales primarily in our Memory Solutions and IPS segments.
Investing Activities : Net cash used in investing activities from continuing operations in 2023 was $281.2 million, consisting primarily of $213.1 million net cash used for the acquisition of Stratus, $39.4 million used for capital expenditures and deposits on equipment and $25.0 million used for the purchases of investment securities.
Net cash used in investing activities from continuing operations in 2022 consisted primarily of $20.4 million used for capital expenditures and deposits on equipment.
Net cash used in investing activities from continuing operations in 2021 consisted primarily of $35.7 million net cash used for the acquisition of the LED Business and $16.7 million used for capital expenditures and deposits on equipment.
Financing Activities : Net cash provided by financing activities from continuing operations in 2023 was $237.2 million, consisting primarily of $295.3 million in net proceeds from issuance of a term loan and $43.0 million in proceeds from the issuance of ordinary shares from our equity plans, partially offset by $28.1 million payment of contingent consideration related to our 2021 acquisition of our LED business, $24.7 million of payments to acquire ordinary shares (including $13.8 million under our share repurchase program and convertible note exchange), $21.6 million in principal repayment of debt and $14.1 million payment in premium in connection with our convertible note exchange.
Net cash provided by financing activities from continuing operations in 2022 was $60.6 million, consisting primarily of $270.8 million in net proceeds from issuance of a term loan and $12.1 million in proceeds from the issuance of ordinary shares from our equity plans, partially offset by $126.7 million in principal repayment of debt, primarily the LED Purchase Price Note, $57.2 million of payments to acquire ordinary shares (including $50.0 million under our share repurchase program) and $25.0 million in net repayments of borrowings under our line of credit.
Net cash used in financing activities from continuing operations in 2021 was $14.7 million, consisting primarily of $48.5 million used to repurchase our ordinary shares, partially offset by $25.0 million in net proceeds from borrowings under our line of credit and $14.9 million in proceeds from the issuance of ordinary shares.
Critical Accounting Estimates
The preparation of these financial statements and related disclosures in conformity with U.S. GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures. We evaluate our estimates and judgments on an ongoing basis. Estimates and judgments are based on historical experience, forecasted events and various other assumptions that we believe to be reasonable under the circumstances; however, actual results could differ from those estimates. 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.
Our discussion of critical accounting estimates is intended to supplement our summary of significant accounting policies so that readers will have greater insight into the uncertainties involved in applying our critical accounting policies and estimates. For a summary of our significant accounting policies, see “Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Significant Accounting Policies.”
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; and
• Deferred taxes, including projections of future taxable income and tax rates.
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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 various 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 Intangible Assets : 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.
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Revenue Recognition : 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 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.
Noncancellable, nonrefundable customized product sales are recognized over time on a cost incurred basis. In connection with these arrangements, customers obtain control and benefit from products as they are completed. 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 passes 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 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 professional services and supply chain services. Professional services include solution design, system installation, software automation and managed support services related to HPC and storage systems. Supply chain services includes procurement, logistics, inventory management, temporary warehousing, kitting and packaging. 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 and services on behalf of our customers and then resell such materials or services 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 and services 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 the cost of materials and services performed, which remain unpaid as of the end of a reporting period, are included in accounts receivable. Additionally, the 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 (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.
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A portion of our service revenue is from professional 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. 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, 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 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.