| Basis of Presentation and Principles of Consolidation | Note 1. Basis of Presentation and Principles of Consolidation
(a)
Overview On August 26, 2011, SMART Global Holdings, Inc., formerly known as Saleen Holdings, Inc., a Cayman Islands exempted company (SMART Global Holdings, and together with its subsidiaries, the Company), consummated a transaction with SMART Worldwide Holdings, Inc., formerly known as SMART Modular Technologies (WWH), Inc. (SMART Worldwide), pursuant to an Agreement and Plan of Merger whereby, through a series of transactions, SMART Global Holdings acquired substantially all of the equity interests of SMART Worldwide with SMART Worldwide surviving as an indirect wholly owned subsidiary of SMART Global Holdings (the Acquisition). SMART Global Holdings is an entity that was formed by investment funds affiliated with Silver Lake Partners and Silver Lake Sumeru (collectively Silver Lake). As a result of the Acquisition, since there was a change of control resulting in Silver Lake as the controlling shareholder group, the Company applied the acquisition method of accounting and established a new basis of accounting. The Company, through its subsidiaries, provides specialty memory solutions sold primarily to original equipment manufacturers (OEMs). The Company offers these solutions to customers worldwide and also offers custom supply chain services including procurement, logistics, inventory management, temporary warehousing, kitting and packaging services. SMART Global Holdings is domiciled in the Cayman Islands and has its U.S. offices in Newark, California. The Company has operations in the United States, Brazil, Malaysia, Taiwan, Hong Kong, Scotland, Singapore and South Korea.
(b)
Basis of Presentation The accompanying condensed consolidated financial statements comprise SMART Global Holdings and its wholly owned subsidiaries. Intercompany transactions have been eliminated in the condensed consolidated financial statements. The Company uses a 52- to 53-week fiscal year ending on the last Friday in August. The three months ended May 25, 2018 and May 26, 2017 were both 13 week fiscal periods. The accompanying unaudited condensed consolidated financial statements and related notes have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP) and in conformity with the rules and regulations of the Securities and Exchange Commission (SEC) applicable to interim financial information. As such, certain information and footnote disclosures normally included in complete annual financial statements prepared in accordance with U.S. GAAP have been omitted in accordance with the rules and regulations of the SEC. In the opinion of management, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting of normal recurring accruals, necessary to present fairly the financial position of the Company and its results of operations and cash flows for the interim periods presented. The financial data and other information disclosed in these notes to the condensed consolidated financial statements related to the interim periods are unaudited. All financial information for two of the Company’s subsidiaries, SMART Modular Technologies Indústria de Componentes Eletrônicos Ltda. (SMART Brazil) and SMART Modular Technologies do Brasil Indústria e Comércio de Componentes Ltda. (SMART do Brazil), is included in the Company’s condensed consolidated financial statements on a one-month lag because their fiscal years begin August 1 and end July 31.
(c)
Use of Estimates The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods presented. Actual results could differ from the estimates made by management. Significant items subject to such estimates and assumptions include the useful lives of long-lived assets, the valuation of deferred tax assets and inventory, share-based compensation, the estimated net realizable value of Brazilian tax credits, income tax uncertainties and other contingencies.
(d)
Revenue Recognition Product revenue is recognized when there is persuasive evidence of an arrangement, product delivery has occurred, the sales price is fixed or determinable, and collectability is reasonably assured. Product revenue typically is recognized at the time of shipment or when the customer takes title to the goods. All amounts billed to a customer related to shipping and handling are classified as revenue, while all costs incurred by the Company for shipping and handling are classified as cost of sales. Sales taxes collected from customers and remitted to governmental authorities are accounted for on a net basis and, therefore, are excluded from net sales in the condensed consolidated statements of operations. In addition, the Company has classes of transactions with customers that are accounted for on an agency basis (i.e., the Company recognizes as revenue the amount billed less the material procurement costs of products serviced as an agent with the cost of providing these services embedded with the cost of sales). The Company provides procurement, logistics, inventory management, temporary warehousing, kitting and packaging services for these customers. Revenue from these arrangements is recognized as service revenue and is determined by a fee for services based on material procurement costs. The Company recognizes service revenue upon the completion of the services, typically upon shipment of the product. There are no obligations subsequent to shipment of the product under the agency arrangements. The following is a summary of the Company’s gross billings to customers and net sales for services and products (in thousands):
Three Months Ended
Nine Months Ended
May 25,
May 26,
May 25,
May 26,
2018
2017
2018
2017
Service revenue, net
$
11,270
$
9,869
$
30,746
$
27,853
Cost of purchased materials - service (1)
258,098
246,498
714,883
648,886
Gross billings for services
269,368
256,367
745,629
676,739
Product net sales
324,207
197,105
884,105
510,419
Gross billings to customers
$
593,575
$
453,472
$
1,629,734
$
1,187,158
Product net sales
$
324,207
$
197,105
$
884,105
$
510,419
Service revenue, net
11,270
9,869
30,746
27,853
Net sales
$
335,477
$
206,974
$
914,851
$
538,272
(1)
(e)
Cash and Cash Equivalents All highly liquid investments with maturities of 90 days or less from original dates of purchase are carried at cost, which approximates fair value, and are considered to be cash. Cash and cash equivalents include cash on hand, cash deposited in checking and saving accounts, money market accounts, and securities with maturities of less than 90 days at the time of purchase.
(f)
Allowance for Doubtful Accounts The Company evaluates the collectability of accounts receivable based on a combination of factors. In cases where the Company is aware of circumstances that may impair a specific customer’s ability to meet its financial obligations, the Company records a specific allowance against amounts due and, thereby, reduces the net recognized receivable to the amount management reasonably believes will be collected. For all other customers, the Company recognizes allowances for doubtful accounts based on a combination of factors including the length of time the receivables are outstanding, industry and geographic concentrations, the current business environment and historical experience.
(g)
Sales of Receivables Designated subsidiaries of the Company may, from time to time, sell certain of their receivables to third parties. Sales of receivables are recognized at the point in which the receivables sold are transferred beyond the reach of the Company and its creditors, the purchaser has the right to pledge or exchange the receivables and the subsidiaries have surrendered control over the transferred receivables. See Note 3 for further details.
(h)
Inventories Inventories are valued at the lower of actual cost or market value. Inventory value is determined on a specific identification basis for material and an allocation of labor and manufacturing overhead. At each balance sheet date, the Company evaluates the ending inventories for excess quantities and obsolescence. This evaluation includes an analysis of sales levels by product family and considers historical demand and forecasted demand in relation to the inventory on hand, competitiveness of product offerings, market conditions and product life cycles. The Company adjusts carrying value to the lower of its cost or market value. Inventory write-downs are not reversed and create a new cost basis.
( i )
Prepaid State Value-Added Taxes (ICMS) Since 2004, the Sao Paulo State tax authorities have granted SMART Brazil a tax benefit to defer and eventually eliminate the payment of ICMS levied on certain imports from independent suppliers. This benefit, known as an ICMS Special Regime, is subject to renewal every two years. When the then current ICMS Special Tax Regime expired on March 31, 2010, SMART Brazil timely applied for a renewal of the benefit, however, the renewal was not granted until August 4, 2010. On June 22, 2010, the Sao Paulo authorities published a regulation allowing companies that applied for a timely renewal of an ICMS Special Regime to continue utilizing the benefit until a final conclusion on the renewal request was rendered. As a result of this publication, SMART Brazil was temporarily allowed to utilize the benefit while it waited for its renewal. From April 1, 2010, when the ICMS benefit lapsed, through June 22, 2010 when the regulation referred to above was published, SMART Brazil was required to pay the ICMS taxes on imports, which payments result in ICMS credits that may be used to offset ICMS obligations generated from sales by SMART Brazil of its products; however, the vast majority of SMART Brazil’s sales in Sao Paulo were either subject to a lower ICMS rate or were made to customers that were entitled to other ICMS benefits that enabled them to eliminate the ICMS levied on their purchases of products from SMART Brazil. As a result, from April 1, 2010 through June 22, 2010, SMART Brazil did not have sufficient ICMS collections against which to apply the credits and the credit balance increased significantly. Effective February 1, 2011, in connection with its participation in a Brazilian government incentive program known as Support Program for the Technological Development of the Semiconductor and Display Industries Laws, or PADIS, SMART Brazil spun off the module manufacturing operations into SMART do Brazil, a separate subsidiary of the Company. In connection with this spin off, SMART do Brazil applied for a tax benefit from the State of Sao Paulo in order to obtain a deferral of state ICMS. This tax benefit is referred to as State PPB, or CAT 14. The CAT 14 approval was not obtained until July 21, 2011, and from February 1, 2011 until the CAT 14 approval was granted, SMART do Brazil did not have sufficient ICMS collections against which to apply the credits accrued upon payment of the ICMS on SMART do Brazil’s imports and inputs locally acquired, and therefore, it generated additional excess ICMS credits. As of May 25, 2018, the total ICMS tax credits reported on the Company’s accompanying condensed consolidated balance sheet are R$44.4 million (or $12.8 million), of which (i) R$16.6 million (or $4.8 million) are fully vested ICMS credits, classified as prepaid and other current assets and R$24.5 million (or $7.0 million) classified as other noncurrent assets, and (ii) R$3.3 million (or $0.9 million) are ICMS credits subject to vesting in 48 equal monthly amounts, classified as prepaid expenses and other current assets (R$1.1 million or $0.3 million) and other noncurrent assets (R$2.2 million or $0.6 million). As of August 25, 2017, the total ICMS tax credits reported on the Company’s accompanying condensed consolidated balance sheet are R$40.9 million (or $13.1 million), of which (i) R$38.4 million (or $12.3 million) are fully vested ICMS credits, classified as other noncurrent assets, and (ii) R$2.5 million (or $0.8 million) are ICMS credits subject to vesting in 48 equal monthly amounts, classified as other noncurrent assets (R$0.6 million or $0.2 million) and prepaid expenses and other current assets (R$1.9 million or $0.6 million). It is expected that the excess ICMS credits will continue to be recovered in fiscal 2018 through fiscal 2022. The Company updates its forecast of the recoverability of the ICMS credits quarterly, considering the following key variables in Brazil: timing of government approvals of automated credit utilization, the total amount of sales, the product mix and the inter and intra state mix of sales. If these estimates or the mix of products or regions vary, it could take longer or shorter than expected to recover the accumulated ICMS credits, resulting in a reclassification of ICMS credits from current to noncurrent, or vice versa. In April and June 2016, the Company filed cases with the State of Sao Paulo tax authorities to seek approval to sell excess ICMS credits. In December 2017, the Company obtained approval to sell R$31.6 million (or $9.1 million) of its ICMS credits. Once approved, sales of ICMS credits usually take three to six months to complete and typically incur a discount to the face amount of the credits sold, as well as fees for the arrangers of these sales which together aggregate 10% to 15% of the face amount of the credits being sold. Once the sale is complete, the tax authorities usually approve the transfer of credits in monthly installments and the proceeds resulting from the sale of the aforementioned credits shall be received by the Company accordingly. The Company has recorded valuation adjustments for the estimated discount and fees that the Company will need to offer in order to sell the ICMS credits to other companies.
(j)
Property and Equipment Property and equipment are recorded at cost. Depreciation and amortization are computed based on the shorter of the estimated useful lives or the related lease terms, using the straight-line method. Estimated useful lives are presented below:
Period
Asset:
Manufacturing equipment
2 to 5 years
Office furniture, software, computers and equipment
2 to 5 years
Leasehold improvements*
2
*
Includes the land lease for the Penang facility with a term expiring in 2070.
(k)
Goodwill The Company performs a goodwill impairment test annually during the fourth quarter of its fiscal year and more frequently if events or circumstances indicate that impairment may have occurred. Such events or circumstances may, among others, include significant adverse changes in the general business climate. As of May 25, 2018 and August 25, 2017, the carrying value of goodwill on the Company’s condensed consolidated balance sheet was $42.9 million and $46.0 million, respectively. When conducting the annual impairment test for goodwill, the Company compares the estimated fair value of a reporting unit containing goodwill to its book value. The estimated fair value is computed using two approaches: the income approach, which is the present value of expected cash flows, discounted at a risk-adjusted weighted average cost of capital; and the market approach, which is based on using market multiples of companies in similar lines of business. If the fair value of the reporting unit is determined to be more than its book value, no goodwill impairment is recognized. The excess of the fair value of the reporting unit over the fair value of assets less liabilities is the implied value of goodwill and is used to determine the amount of impairment. All of the $42.9 million carrying value of goodwill on the Company’s condensed consolidated balance sheet as of May 25, 2018 is associated with the Company’s single reporting unit. No impairment of goodwill was recognized through May 25, 2018. The changes in the carrying amount of goodwill during the nine months ended May 25, 2018 and fiscal 2017 are as follows (in thousands):
Total
Balance as of August 26, 2016
$
44,976
Translation adjustments
1,046
Balance as of August 25, 2017
46,022
Translation adjustments
(3,150
)
Balance as of May 25, 2018
$
42,872
(l)
Intangible Assets, Net The following table summarizes the gross amounts and accumulated amortization of intangible assets from the Acquisition by type as of May 25, 2018 and August 25, 2017 (dollars in thousands):
May 25, 2018
August 25, 2017
Weighted
Gross
Gross
avg.
Carrying
Accumulated
Carrying
Accumulated
life (yrs)
amount
amortization
Net
amount
amortization
Net
Customer relationships
5
$
24,256
$
(23,328
)
$
928
$
26,971
$
(22,844
)
$
4,127
Technology
4
4,900
(4,655
)
245
4,900
(3,920
)
980
Total
$
29,156
$
(27,983
)
$
1,173
$
31,871
$
(26,764
)
$
5,107
Amortization expense related to intangible assets for the three and nine months ended May 25, 2018 totaled approximately $1.2 million and $3.7 million, respectively, and $3.0 million and $9.0 million, respectively, for the corresponding periods of fiscal 2017. Acquired intangibles are amortized on a straight-line basis over the remaining estimated economic life of the underlying intangible assets.
Three Months Ended
Nine Months Ended
May 25,
May 26,
May 25,
May 26,
2018
2017
2018
2017
Amortization of intangible assets (in thousands):
Research and development
$
245
$
1,224
$
735
$
3,672
Selling, general and administrative
976
1,774
2,992
5,296
Total
$
1,221
$
2,998
$
3,727
$
8,968
(m)
Long-Lived Assets Long-lived assets, excluding goodwill, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset group may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to the future undiscounted cash flows expected to be generated by the asset group. If such assets are considered to be impaired, the impairment is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed are reported at the lower of the carrying amount or fair value, less cost to sell. No impairment of long-lived assets was recognized during the nine months ended May 25, 2018 and May 26, 2017.
(n)
Research and Development Expense Research and development expenditures are expensed in the period incurred.
(o)
Income Taxes The Company uses the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and net operating loss and credit carryforwards. When necessary, a valuation allowance is recorded to reduce tax assets to amounts expected to be realized. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income (or loss) in the period that includes the enactment date. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. The Company records interest and penalties related to unrecognized tax benefits in tax expense.
(p)
Foreign Currency Translation For foreign subsidiaries using the local currency as their functional currency, assets and liabilities are translated at exchange rates in effect at the balance sheet date and income and expenses are translated at average exchange rates during the period. The effect of this translation is reported in other comprehensive income (loss). Exchange gains and losses arising from transactions denominated in a currency other than the functional currency of the respective foreign subsidiaries are included in results of operations. For foreign subsidiaries using the U.S. dollar as their functional currency, the financial statements of these foreign subsidiaries are remeasured into U.S. dollars using the historical exchange rate for property and equipment and certain other nonmonetary assets and liabilities and related depreciation and amortization on these assets and liabilities. The Company uses the exchange rate at the balance sheet date for the remaining assets and liabilities, including deferred taxes. A weighted average exchange rate is used for each period for revenues and expenses. All foreign subsidiaries and branch offices, except those in Brazil and South Korea, use the U.S. dollar as their functional currency. The gains or losses resulting from the remeasurement process are recorded in other income (expense) in the accompanying condensed consolidated statements of operations. During the three and nine months ended May 25, 2018 and May 26, 2017, the Company recorded $6.9 million and $7.3 million, respectively, and $1.0 million and $0.7 million, respectively, for the corresponding periods of fiscal 2017, of foreign exchange losses primarily related to its Brazilian operating subsidiaries.
(q)
Share-Based Compensation The Company accounts for share-based compensation under ASC 718, Compensation—Stock Compensation
Three Months Ended
Nine Months Ended
May 25,
May 26,
May 25,
May 26,
2018
2017
2018
2017
Share-based compensation expense (in thousands):
Cost of sales
$
414
$
176
$
859
$
444
Research and development
325
(22
)
887
423
Selling, general and administrative
2,558
1,235
4,853
2,666
Total
$
3,297
$
1,389
$
6,599
$
3,533
(r)
Loss Contingencies The Company is subject to the possibility of various loss contingencies arising in the ordinary course of business. The Company considers the likelihood of a loss and the ability to reasonably estimate the amount of loss in determining the necessity for and amount of any loss contingencies. Estimated loss contingencies are accrued when it is probable that a liability has been incurred or an asset impaired and the amount of loss can be reasonably estimated. The Company regularly evaluates the most current information available to determine whether any such accruals should be recorded or adjusted.
(s)
Comprehensive Income (Loss) Comprehensive income (loss) consists of net income (loss) and other gains and losses affecting shareholders’ equity that, under U.S. GAAP are excluded from net income (loss). The Company’s other comprehensive income (loss) generally consists of foreign currency translation adjustments.
(t)
Concentration of Credit and Supplier Risk The Company’s concentration of credit risk consists principally of cash and cash equivalents and accounts receivable. The Company’s revenues and related accounts receivable reflect a concentration of activity with five customers (see Note 11). The Company does not require collateral or other security to support accounts receivable. The Company performs periodic credit evaluations of its customers to minimize collection risk on accounts receivable and maintains allowances for potentially uncollectible accounts. The Company relies on five suppliers for the majority of its raw materials. At May 25, 2018 and August 25, 2017, the Company owed these five suppliers $218.4 million and $153.7 million, respectively, which was recorded as accounts payable. The inventory purchases from these suppliers during the three and nine months ended May 25, 2018 were $0.4 billion and $1.2 billion, respectively, and $0.3 billion, and $0.9 billion, respectively for the corresponding periods of fiscal 2017.
(u)
New Accounting Pronouncements In March 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2018-05, Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 Income Taxes In February 2018, the FASB issued ASU No. 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Comprehensive Income In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment In November 2016, the FASB issued ASU No. 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash In August 2016, the FASB issued ASU No. 2016-15, Cash Flow Statements, Classification of Certain Cash Receipts and Cash Payments In March 2016, the FASB issued ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting
•
The guidance requires excess tax benefits and tax deficiencies to be recorded as income tax benefit or expense in the statement of operations when the awards vest are settled, and eliminates the requirement to reclassify cash flows related to excess tax benefits from financing activities to operating activities on the statement of cash flows. The Company adopted the guidance prospectively effective August 26, 2017, and there was no impact to its consolidated financial statements.
•
The guidance eliminates the requirement that excess tax benefits must be realized (through a reduction in income taxes payable) before companies can recognize them. The Company applied the modified retrospective transition method upon adoption. The previously unrecognized excess tax effects were recorded as a deferred tax asset in the amount of $0.9 million, which was fully offset by a valuation allowance of the same amount as of August 26, 2017, resulting no impact to opening retained earnings.
•
In accordance with the guidance, the Company has elected to make an entity-wide accounting policy change to account for forfeitures when they occur. There is no cumulative-effect on opening retained earnings. In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes In May 2014, the FASB issued a new standard, ASU No. 2014-09, Revenue from Contracts with Customers, Revenue from Contracts with Customers (Topic 606)—Principal versus Agent Considerations A change for the Company under ASC 606 relates to the timing of revenue recognition for customized product sales orders deemed not cancellable and nonrefundable (NCNR). Under current accounting standards, the Company recognizes revenue and costs related to these sales when products are shipped or delivered to the customers based on the terms of the purchase orders and sales agreements. Under ASC 606, the terms within the NCNR sales orders that provide the Company with a legally enforceable right to receive payment for performance completed to date will affect the timing of revenue recognition. Accordingly, the Company will recognize revenue over time as customized products listed within the NCNR orders are completed. The Company is in the process of finalizing its assessment and implemented policies, processes, and controls to support the standard measurement and disclosure requirements.
(v)
Subsequent Events Acquisition of Penguin Computing, Inc. On June 8, 2018, SMART Global Holdings entered into an Agreement and Plan of Merger (the “Merger Agreement”), by and among the SMART Global Holdings, Glacier Acquisition Sub, Inc., a wholly-owned indirect subsidiary of SMART Global Holdings (“Merger Sub”), Penguin Computing, Inc., (“Penguin”) and Fortis Advisors LLC, solely in its capacity as the representative of the holders of the securities of Penguin. Pursuant to the Merger Agreement, on June 8, 2018, Merger Sub was merged with and into Penguin, with Penguin surviving as a wholly-owned indirect subsidiary of the SMART Global Holdings (the “Merger”). The aggregate consideration payable by the Company for the Merger is up to $85 million, which includes up to $25.0 million of potential cash earn-out payments based on Penguin’s achievement of specified gross profit levels through December 31, 2018, pursuant to the provisions of the Merger Agreement. The Company paid $60 million at closing (subject to certain adjustments as provided in the Merger Agreement), which included the assumption by the Company of Penguin’s outstanding indebtedness. At the closing of the Merger, the Company deposited $6.0 million of the purchase price into escrow as security for Penguin’s indemnification obligations during the escrow period of one year. The Company also deposited $2.0 million of the purchase price into escrow as security for customary post-closing adjustments to the purchase price. The Merger Agreement contains customary representations and warranties of the Company and Penguin. The parties have agreed to indemnify each other for certain breaches of representations, warranties and covenants. Incremental Facility Amendment On June 8, 2018, the parties to the Amended Credit Agreement (as defined in Note 6) entered into an Incremental Facility Amendment (the “Incremental Facility Amendment”) which provides for, among other things, an incremental $60.0 million term loan facility (the “Additional Term B Loan”). On June 8, 2018, SMART Modular Technologies (Global), Inc. (“Global”) borrowed pursuant to the Incremental Facility Amendment, $60.0 million in aggregate principal amount of Additional Term B Loan under the Amended Credit Agreement, a portion of which was used to fund the cash purchase price of the Merger. The terms and provisions of the Additional Term B Loan are, in all material respects, substantially consistent with the terms and provisions of the other term loans currently outstanding under the Amended Credit Agreement. |
