The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the condensed consolidated financial statements and the notes to those statements included elsewhere in this Quarterly Report on Form 10-Q, and with the consolidated financial statements and management's discussion and analysis of our financial condition and results of operations in our Annual Report on Form 10-K for our fiscal year endedAugust 28, 2020 (our "Annual Report"). 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 under the caption "Risk Factors" in our Annual Report and elsewhere in this report. See also "Cautionary Note Regarding Forward-Looking Statements" at the beginning of this report.
Overview
SMART is comprised of business units that are leading designers and manufacturers of electronic products focused on computing and memory technology. The company specializes in application-specific product development and support for customers in enterprise, government and original equipment manufacturer, or OEM, sales channels. Customers rely on SMART businesses as their strategic suppliers with top tier customer service, product quality, and technical support with engineering, sales, manufacturing, supply chain and logistics capabilities worldwide. The company supports customers in markets such as communications, storage, networking, mobile, industrial automation, industrial internet of things, government, military, and computing including edge and high performance computing. SMART operates in three segments: Specialty Memory products,Brazil products and Specialty Compute and Storage Solutions, or SCSS.
Recent Developments - COVID 19
The outbreak of coronavirus disease 2019 ("COVID-19") has resulted in several
millions of infections and over one and a half million deaths worldwide, as of
the date of filing of this Quarterly Report, and continues to spread in the
United States , Asia , Europe and Brazil , the major markets in which we operate.
The COVID-19 pandemic has resulted in significant governmental measures being
implemented to control the spread of the virus, and our operations as well as
the operations of our suppliers, customers and third-party sales representatives
and distributors have been and will continue to be disrupted by varying
individual and governmental responses to COVID-19 around the world such as
business shutdowns, stay-at-home directives, travel restrictions, border
closures, and other travel or health-related restrictions as well as by
absenteeism, quarantines, self-isolations, office and factory closures, delays
on deliveries, and disruptions to ports and other freight infrastructure. These
restrictions have caused consumers and businesses to reduce their activities and
their spending, have caused a slowdown in the global economy and have had, and
may continue to have, a negative impact on our sales and marketing, and our
product development activities. While we have not yet experienced a significant
disruption of our operations as a result of the COVID-19 pandemic, the pandemic
has resulted in reduced sales volumes of certain product lines within our SCSS
business in the second half of fiscal 2020 as well as in the first quarter of
fiscal 2021, and if these conditions continue, or if we have an outbreak in any
of our facilities, such reduced sales volumes may continue or worsen and we may,
among other issues, experience, in any or all product lines, delays in product
development, a decreased ability to support our customers, disruptions in sales
and manufacturing activities and overall reduced productivity each of which
could have a negative impact on our ability to meet customer commitments and on
our revenue and profitability.
40
--------------------------------------------------------------------------------Results of Operations
The following is a summary of our results of operations for the three months
ended
Three Months Ended
November 27, % of November 29, % of
2020 sales* 2019 sales*
(in thousands, other than percentages and per share data)
Consolidated Income Statements:
Net sales $ 291,697 100 % $ 272,018 100 %
Cost of sales (1)(2) 239,053 82 % 217,698 80 %
Gross profit 52,644 18 % 54,320 20 %
Operating expenses:
Research and development (1) 6,964 2 % 14,886 5 %
Selling, general and
administrative (1) (2) 38,056 13 % 33,553 12 %
Total operating expenses 45,020 15 % 48,439 18 %
Income from operations 7,624 3 % 5,881 2 %
Other income (expense):
Interest expense, net (3,154 ) (1 %) (4,492 ) (2 %)
Other income (expense), net 832 0 % (840 ) 0 %
Total other expense (2,322 ) (1 %) (5,332 ) (2 %)
Income before income taxes 5,302 2 % 549 0 %
Provision for income taxes 3,275 1 % 325 0 %
Net income $ 2,027 1 % $ 224 0 %
Earnings per share:
Basic $ 0.08 $ 0.01
Diluted $ 0.08 $ 0.01
Shares used in computing earnings
per share:
Basic 24,561 23,713
Diluted 25,103 24,286* Summations may not compute precisely due to rounding.
(1) Includes share-based compensation expense as follows: Cost of sales $ 838 $ 730 Research and development 778 744 Selling, general and administrative 9,472 4,482 (2) Includes amortization of intangible assets expense as follows: Cost of sales $ 647 $ 647 Selling, general and administrative 2,766 2,766
Three Months Ended
Net sales increased by$19.7 million , or 7.2%, during the three months endedNovember 27, 2020 compared to the same period in the prior year. Net sales were positively impacted by higher Specialty Memory product sales of$17.1 million , or 16.5%, primarily due to higher Flash and DRAM revenue resulting from higher average selling prices of 32% and 31%, respectively, mainly due to increased OEM sales as well as a change in product mix. In addition, our sales ofBrazil products increased by$11.2 million , or 11.9%, primarily due to 98% higher average selling prices for mobile memory. The increases in Specialty andBrazil were partially offset by lower revenue from SCSS of$8.6 million , or 11.6%, primarily attributable to lower Penguin revenue, which was in turn primarily due to lower federal spending as a result of the global COVID-19 pandemic.
Cost of Sales
Cost of sales increased by$21.4 million , or 9.8%, during the three months endedNovember 27, 2020 compared to the same period in the prior year, primarily due to higher cost of materials of$20.4 million or 11.1%, due to the higher level of sales, as well as higher production costs related to the increased revenue. Included in the cost of sales changes was a favorable foreign exchange impact of$2.5 million due to locally sourced cost of sales inBrazil .
Gross Profit
Gross margin decreased to 18.0% during the three months endedNovember 27, 2020 compared to 20.0% for the same period in the prior year, primarily due to higher material costs for our Specialty Memory andBrazil products. 41 --------------------------------------------------------------------------------
Research and Development Expense
Research and development ("R&D") expense decreased $7.9 million , or 53.2%,
during the three months ended November 27, 2020 compared to the same period in
the prior year, due to $7.9 million of Brazil financial credits resulting from
amendments to the IT law implemented in April 2020 . For additional information,
see Note 1(i) in our Notes to Unaudited Condensed Consolidated Financial
Statements. Included in the R&D expense increase was an unfavorable foreign
exchange impact of $2.0 million .
Selling, General and Administrative Expense
Selling, general and administrative ("SG&A") expense increased by $4.5 million ,
or 13.4%, during the three months ended November 27, 2020 compared to the same
period in the prior year, primarily due to $5.0 million higher share-based
compensation expense resulting from awards acceleration. For additional
information, see Note 9 in our Notes to Unaudited Condensed Consolidated
Financial Statements. Included in the SG&A expense increase was a favorable
foreign exchange impact of $0.6 million .
Other Income (Expense)
Interest expense, net decreased$1.3 million , or 29.8%, during the three months endedNovember 27, 2020 compared to the same period in the prior year, primarily due to lower interest expense resulting from the issuance of our convertible senior notes and the extinguishment of our term loans in the second quarter of fiscal 2020. For additional information, see Note 7 in our Notes to Unaudited Condensed Consolidated Financial Statements. Other income (expense), net increased by$1.7 million primarily due to foreign currency gains.
Provision for Income Taxes
Income tax expense includes a provision for federal, state and foreign taxes based on the annual estimated effective tax rate applicable to SMART, adjusted for certain discrete items which are fully recognized in the period they occur. Provision for income taxes increased by$3.0 million for the three months endedNovember 27, 2020 compared to the same period in the prior year, primarily due to the profits and related taxes in non-U.S. jurisdictions.
As of
Determining the consolidated provision for income tax expense, income tax liabilities and deferred tax assets and liabilities involves judgment. SMART 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.
Liquidity and Capital Resources
Three Months Ended
November 27, November 29,
2020 2019
(in thousands)
Cash provided by operating activities $ 35,569 $ 25,267
Cash used in investing activities (14,628 ) (5,116 )
Cash used in financing activities (378 ) (4,047 )
Effect of exchange rate changes on cash and cash
equivalents (7,277 ) (2,854 )
Net increase in cash and cash equivalents $ 13,286 $ 13,250 At
InFebruary 2020 , we issued$250.0 million in aggregate principal amount of 2.25% convertible senior notes due 2026 for which we received proceeds of$243.1 million , net of issuance costs. We used$204.9 million for extinguishment of long-term debt and$21.8 million for purchasing privately-negotiated capped calls. For additional information, see Note 7 in our Notes to Unaudited Condensed Consolidated Financial Statements. We expect that our existing cash and cash equivalents, line of credit and cash generated by operating activities will be sufficient to fund our operations for at least the next twelve months. Our principal uses of cash and capital resources are acquisitions, debt service requirements as described below, capital expenditures, R&D expenditures and working capital requirements. We expect that future capital expenditures will focus on expanding capacity of our operations, expanding our R&D activities, manufacturing 42 -------------------------------------------------------------------------------- equipment upgrades, acquisitions and IT infrastructure and software upgrades. Cash and cash equivalents consist of funds held in demand deposit accounts and money market funds. We do not enter into investments for trading or speculative purposes. During the three months endedNovember 27, 2020 , cash provided by operating activities was$35.6 million . The primary factors affecting our cash flows during this period were$23.3 million of non-cash related expenses,$10.3 million change in our net operating assets and liabilities, and$2.0 million of net income. The$10.3 million change in net operating assets and liabilities consisted of increases of$1.9 million in accounts receivable and$9.3 million in prepaid expenses and other assets, and decreases of$1.5 million of operating lease liabilities and$7.9 million in accrued expense and other liabilities, offset by decreases of$12.9 million in inventory and an increase of$18.0 million of accounts payable. The increase in accounts receivable was primarily due to timing of sales, and the increase in accounts payable was primarily due to timing of payments. The decrease in inventory was primarily due to better efficiencies in managing our inventory along all business areas. During the three months endedNovember 29, 2019 , cash provided by operating activities was$25.3 million . The primary factors affecting our cash flows during this period were$0.2 million of net income,$16.4 million of non-cash related expenses and a$8.6 million change in our net operating assets and liabilities. The$8.6 million change in net operating assets and liabilities consisted of increases of$13.7 million in accounts receivable and$42.2 million in inventory, and a decrease of$1.1 million of operating lease liabilities, offset by a decrease of$5.1 million in prepaid expenses and other assets and increases of$60.4 million of accounts payable and$0.1 million in accrued expense and other liabilities. The increase in accounts receivable was primarily due to timing of sales, while the increases in inventory and accounts payable were primarily due to the transition of inventory from contract manufacturers to the company due to our recent acquisitions, as well as higher purchases for certain programs. Net cash used in investing activities during the three months endedNovember 27, 2020 was$14.6 million consisting primarily of purchases of property and equipment and deposits. Net cash used in investing activities during the three months endedNovember 29, 2019 was$5.1 million consisting primarily of purchases of property and equipment and deposits. Net cash provided by financing activities during the three months endedNovember 27, 2020 was$0.4 million , consisting primarily of$3.5 million for withholding tax on restricted stock units, partially offset by$3.1 million proceeds from issuance of ordinary shares from share option exercises and employee share purchase plans. Net cash used in financing activities during the three months endedNovember 29, 2019 was$4.0 million , consisting primarily of$6.4 million long-term debt payments for both the Amended Credit Agreement and the BNDES Credit Agreement, partially offset by$2.4 million proceeds from issuance of ordinary shares from share option exercises and employee share purchase plans.
There have been no material changes to contractual obligations previously disclosed in our Annual Report.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not have any undisclosed borrowings or debt, and we have not entered into any synthetic leases. We are, therefore, not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial conditions, net sales or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.
Recent Accounting Pronouncements
See Note 1 of our Notes to Unaudited Condensed Consolidated Financial Statements for information regarding the effect of recent accounting pronouncements on our financial statements.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted inthe United States of America ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates, including those listed below. We base our estimates on historical facts and various other assumptions that we believe to be reasonable at the time the estimates are made. Actual results could differ from those estimates.
Our critical accounting policies are as follows:
• Revenue recognition;
• Inventory valuation;
43
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• Income taxes; •Goodwill valuation;
• Impairment of long-lived assets and long-lived assets to be disposed; and
• Share-based compensation.
Our critical accounting policies are important to the portrayal of our financial condition and results of operations, and require us to make judgments and estimates about matters that are inherently uncertain. There have been no material changes to our critical accounting policies and estimates disclosed in "Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations-Critical Accounting Policies and Estimates" and Note 1, Overview, Basis of Presentation and Significant Accounting Policies, in each case in our Annual Report.
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