Attached files
file | filename |
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EX-32 - EXHIBIT 32 - SMART Modular Technologies (WWH), Inc. | c15003exv32.htm |
EX-31.1 - EXHIBIT 31.1 - SMART Modular Technologies (WWH), Inc. | c15003exv31w1.htm |
EX-31.2 - EXHIBIT 31.2 - SMART Modular Technologies (WWH), Inc. | c15003exv31w2.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended February 25, 2011
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from
to
Commission file number 000-51771
SMART MODULAR TECHNOLOGIES (WWH), INC.
(Exact name of registrant as specified in its charter)
Cayman Islands | 20-2509518 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) |
39870 Eureka Drive, Newark, California 94560
(Address of principal executive offices, zip code)
(Address of principal executive offices, zip code)
(510) 623-1231
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days: Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act
(Check one):
Large accelerated filer o | Accelerated filer þ | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act): Yes o No þ
The number of registrants ordinary shares outstanding as of March 28, 2011: 63,481,863.
SMART MODULAR TECHNOLOGIES (WWH), INC.
INDEX TO QUARTERLY REPORT
TABLE OF CONTENTS
Page | ||||||||
3 | ||||||||
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20 | ||||||||
29 | ||||||||
29 | ||||||||
29 | ||||||||
29 | ||||||||
29 | ||||||||
31 | ||||||||
32 | ||||||||
Exhibit 31.1 | ||||||||
Exhibit 31.2 | ||||||||
Exhibit 32 |
2
Table of Contents
PART I. FINANCIAL INFORMATION
Item 1. | Financial Statements |
SMART MODULAR TECHNOLOGIES (WWH), INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Unaudited)
February 25, | August 27, | |||||||
2011 | 2010 | |||||||
(In thousands, except | ||||||||
share data) | ||||||||
ASSETS |
||||||||
Current assets: |
||||||||
Cash and cash equivalents |
$ | 134,426 | $ | 115,474 | ||||
Accounts receivable, net of allowances of $1,863 and $1,660 as of
February 25, 2011 and August 27, 2010, respectively |
184,724 | 208,377 | ||||||
Inventories |
96,087 | 112,103 | ||||||
Prepaid expenses and other current assets |
29,108 | 33,488 | ||||||
Total current assets |
444,345 | 469,442 | ||||||
Property and equipment, net |
52,996 | 46,221 | ||||||
Other non-current assets |
26,066 | 21,217 | ||||||
Other intangible assets, net |
5,980 | 6,460 | ||||||
Goodwill |
1,061 | 1,061 | ||||||
Total assets |
$ | 530,448 | $ | 544,401 | ||||
LIABILITIES AND SHAREHOLDERS EQUITY |
||||||||
Current liabilities: |
||||||||
Accounts payable |
$ | 118,840 | $ | 151,885 | ||||
Accrued liabilities |
24,649 | 29,318 | ||||||
Total current liabilities |
143,489 | 181,203 | ||||||
Long-term debt |
55,072 | 55,072 | ||||||
Other long-term liabilities |
6,225 | 4,546 | ||||||
Total liabilities |
204,786 | 240,821 | ||||||
Commitments and contingencies |
||||||||
Shareholders equity: |
||||||||
Ordinary shares, $0.00016667 par value;
600,000,000 shares authorized; 63,382,037
and 62,740,650 shares issued and outstanding
as of February 25, 2011 and August 27, 2010,
respectively |
11 | 10 | ||||||
Additional paid-in capital |
124,892 | 118,123 | ||||||
Accumulated other comprehensive income |
18,832 | 11,658 | ||||||
Retained earnings |
181,927 | 173,789 | ||||||
Total shareholders equity |
325,662 | 303,580 | ||||||
Total liabilities and shareholders equity |
$ | 530,448 | $ | 544,401 | ||||
See accompanying notes to unaudited condensed consolidated financial statements.
3
Table of Contents
SMART MODULAR TECHNOLOGIES (WWH), INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(In thousands, except per share data) | ||||||||||||||||
Net sales |
$ | 170,549 | $ | 160,110 | $ | 386,908 | $ | 283,203 | ||||||||
Cost of sales (1) |
142,024 | 118,097 | 314,374 | 212,424 | ||||||||||||
Gross profit |
28,525 | 42,013 | 72,534 | 70,779 | ||||||||||||
Operating expenses: |
||||||||||||||||
Research and development (1) |
7,852 | 5,219 | 16,012 | 10,949 | ||||||||||||
Selling, general and administrative (1) |
15,169 | 14,331 | 30,017 | 27,697 | ||||||||||||
Restructuring charges |
2,831 | | 2,831 | | ||||||||||||
Technology access charge |
| | 7,534 | | ||||||||||||
Total operating expenses |
25,852 | 19,550 | 56,394 | 38,646 | ||||||||||||
Income from operations |
2,673 | 22,463 | 16,140 | 32,133 | ||||||||||||
Interest expense, net |
(230 | ) | (1,163 | ) | (941 | ) | (2,826 | ) | ||||||||
Other income, net |
285 | 3,225 | 835 | 4,517 | ||||||||||||
Total other income (expense) |
55 | 2,062 | (106 | ) | 1,691 | |||||||||||
Income before provision for
income taxes |
2,728 | 24,525 | 16,034 | 33,824 | ||||||||||||
Provision for income taxes |
2,557 | 8,433 | 7,896 | 13,150 | ||||||||||||
Net income |
$ | 171 | $ | 16,092 | $ | 8,138 | $ | 20,674 | ||||||||
Net income per share, basic |
$ | 0.00 | $ | 0.26 | $ | 0.13 | $ | 0.33 | ||||||||
Net income per share, diluted |
$ | 0.00 | $ | 0.25 | $ | 0.12 | $ | 0.32 | ||||||||
Shares used in computing net income
per ordinary share |
63,178 | 62,211 | 63,039 | 62,092 | ||||||||||||
Shares used in computing net income
per diluted share |
66,087 | 65,010 | 65,923 | 64,513 | ||||||||||||
(1) Stock-based compensation by category: |
||||||||||||||||
Cost of sales |
$ | 223 | $ | 162 | $ | 461 | $ | 319 | ||||||||
Research and development |
398 | 307 | 784 | 604 | ||||||||||||
Selling, general and administrative |
1,627 | 1,370 | 3,148 | 2,562 |
See accompanying notes to unaudited condensed consolidated financial statements.
4
Table of Contents
SMART MODULAR TECHNOLOGIES (WWH), INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(Unaudited)
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
(In thousands) | ||||||||||||||||
Net income |
$ | 171 | $ | 16,092 | $ | 8,138 | $ | 20,674 | ||||||||
Other comprehensive income: |
||||||||||||||||
Net changes in unrealized
gain or loss on derivative
instruments accounted for
as cash flow hedges |
| 513 | | 988 | ||||||||||||
Foreign currency translation |
2,630 | (6,465 | ) | 7,174 | (1,094 | ) | ||||||||||
Comprehensive income |
$ | 2,801 | $ | 10,140 | $ | 15,312 | $ | 20,568 | ||||||||
See accompanying notes to unaudited condensed consolidated financial statements.
5
Table of Contents
SMART MODULAR TECHNOLOGIES (WWH), INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Unaudited)
Six Months Ended | ||||||||
February 25, 2011 |
February 26, 2010 |
|||||||
(In thousands) | ||||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 8,138 | $ | 20,674 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
11,483 | 7,525 | ||||||
Stock-based compensation |
4,393 | 3,485 | ||||||
Provision for (recovery of) doubtful accounts receivable and sales returns |
203 | (711 | ) | |||||
Amortization of debt issuance costs |
199 | 722 | ||||||
(Gain) loss on sale of assets |
511 | (3 | ) | |||||
Deferred income tax provision |
286 | | ||||||
Gain on early repayment of long-term debt |
| (1,178 | ) | |||||
Changes in operating assets and liabilities: |
||||||||
Accounts receivable |
24,032 | (50,406 | ) | |||||
Inventories |
17,085 | (27,825 | ) | |||||
Prepaid expenses and other assets |
(3,990 | ) | (4,932 | ) | ||||
Accounts payable |
(31,042 | ) | 48,317 | |||||
Accrued expenses and other liabilities |
(2,343 | ) | 9,249 | |||||
Net cash provided by operating activities |
28,955 | 4,917 | ||||||
Cash flows from investing activities: |
||||||||
Capital expenditures |
(12,342 | ) | (7,991 | ) | ||||
Cash deposits on equipment |
(623 | ) | (2,107 | ) | ||||
Proceeds from sale of property and equipment |
| 276 | ||||||
Net cash used in investing activities |
(12,965 | ) | (9,822 | ) | ||||
Cash flows from financing activities: |
||||||||
Repayment of long-term debt |
| (25,000 | ) | |||||
Proceeds from issuance of ordinary shares from stock option exercises |
2,377 | 663 | ||||||
Net cash provided by (used in) financing activities |
2,377 | (24,337 | ) | |||||
Effect of exchange rate changes on cash and cash equivalents |
585 | 259 | ||||||
Net increase (decrease) in cash and cash equivalents |
18,952 | (28,983 | ) | |||||
Cash and cash equivalents at beginning of period |
115,474 | 147,658 | ||||||
Cash and cash equivalents at end of period |
$ | 134,426 | $ | 118,675 | ||||
Supplemental disclosures of cash flow information: |
||||||||
Cash paid during the year: |
||||||||
Interest |
$ | 1,653 | $ | 2,866 | ||||
Taxes |
11,483 | 11,311 | ||||||
Non-cash activities information: |
||||||||
Change in indemnification receivable and payable for ICMS assessment |
$ | 1,336 | $ | | ||||
Change in fair value of derivative instruments |
| (755 | ) |
See accompanying notes to unaudited condensed consolidated financial statements.
6
Table of Contents
SMART MODULAR TECHNOLOGIES (WWH), INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Unaudited)
NOTE 1 Basis of Presentation and Principles of Consolidation
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of SMART Modular
Technologies (WWH), Inc. and subsidiaries (SMART or the Company) are as of February 25, 2011
and August 27, 2010 and for the three and six months ended February 25, 2011 and February 26, 2010.
These unaudited condensed consolidated financial statements have been prepared by the Company in
accordance with generally accepted accounting principles in the United States (U.S. GAAP). The
results of operations for the interim periods shown in this report are not necessarily indicative
of results to be expected for the full fiscal year ending August 26, 2011. In the opinion of the
Companys management, the unaudited interim financial statements reflect all adjustments,
consisting only of normal, recurring adjustments considered necessary for a fair statement of the
financial position, results of operations and cash flows for the periods indicated. The interim
unaudited condensed consolidated financial statements should be read in conjunction with the
Companys audited consolidated financial statements as of and for the fiscal year ended August 27,
2010, which are included in the Annual Report on Form 10-K filed with the Securities and Exchange
Commission (SEC).
The accompanying unaudited condensed consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiaries and operations located in Phoenix, Arizona; Newark
and Irvine, California; Westford, Massachusetts; South Korea; Scotland; Puerto Rico; Malaysia; and
Brazil. The financial information for one of the Companys subsidiaries, SMART Modular
Technologies Indústria de Componentes Eletrônicos Ltda. (SMART Brazil) is included in the
Companys consolidated financial statements on a one month lag.
The preparation of unaudited condensed 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
consolidated financial statements and reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates and assumptions.
Product and Service Revenue
The Company recognizes revenue in accordance with ASC 605, 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 of
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 revenues in the consolidated
statements of income.
In addition, the Company has classes of transactions with customers that are accounted for on
an agency basis (that is, the Company recognizes as revenue the net profit associated with serving
as an agent with immaterial or no associated 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 post-shipment
obligations subsequent to shipment of the product under the agency arrangements.
7
Table of Contents
The following is a summary of our gross billings to customers and net sales for services and
products (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Service revenue, net |
$ | 9,586 | $ | 9,790 | $ | 20,072 | $ | 17,742 | ||||||||
Cost of sales service (1) |
252,955 | 211,390 | 481,323 | 364,994 | ||||||||||||
Gross billings for services |
262,541 | 221,180 | 501,395 | 382,736 | ||||||||||||
Product net sales |
160,963 | 150,320 | 366,836 | 265,461 | ||||||||||||
Gross billings to customers |
$ | 423,504 | $ | 371,500 | $ | 868,231 | $ | 648,197 | ||||||||
Product net sales |
$ | 160,963 | $ | 150,320 | $ | 366,836 | $ | 265,461 | ||||||||
Service revenue, net |
9,586 | 9,790 | 20,072 | 17,742 | ||||||||||||
Net sales |
$ | 170,549 | $ | 160,110 | $ | 386,908 | $ | 283,203 | ||||||||
(1) | Represents cost of sales associated with service revenue reported on a net basis. |
Recent Accounting Pronouncements
With the exception of those discussed below, there have been no recent accounting
pronouncements or changes in accounting pronouncements during the six months ended February 25,
2011 that are of significance, or potential significance, to the Company.
In January 2010, the FASB issued ASU 2009-16, Accounting for Transfers of Financial Assets
(FASB Statement No. 166, Accounting for Transfers of Financial Assets), or ASU 2009-16, which
eliminates the concept of a qualifying special-purpose entity (QSPE), revises conditions for
reporting a transfer of a portion of a financial asset as a sale (e.g., loan participations),
clarifies the derecognition criteria, eliminates special guidance for guaranteed mortgage
securitizations, and changes the initial measurement of a transferors interest in transferred
financial assets. ASU 2009-16 is effective for financial statements issued for fiscal years, and
interim periods within those fiscal years, beginning after November 15, 2009. The Company adopted
the provisions of this ASU in fiscal 2011 and it did not have a material impact on its consolidated
results of operations and financial condition.
In January 2010, the FASB issued ASU 2009-17, Improvements to Financial Reporting by
Enterprises Involved with Variable Interest Entities (FASB Statement No. 167, Amendments to FASB
Interpretation No. 46 (R)), which revises analysis for identifying the primary beneficiary of a
variable interest entity, or VIE, by replacing the previous quantitative-based analysis with a
framework that is based more on qualitative judgments. The new guidance requires the primary
beneficiary of a VIE to be identified as the party that both (i) has the power to direct the
activities of a VIE that most significantly impact its economic performance and (ii) has an
obligation to absorb losses or a right to receive benefits that could potentially be significant to
the VIE. ASU 2009-17 is effective for financial statements issued for fiscal years, and interim
periods within those fiscal years, beginning after November 15, 2009. The Company adopted the
provisions of this ASU in fiscal 2011 and it did not have a material impact on its consolidated
results of operations and financial condition.
In October 2009, the FASB issued Accounting Standards Update (ASU) 2009-13, Revenue
Recognition (Topic 605) Multiple-Deliverable Revenue Arrangements. This guidance modifies the
fair value requirements of FASB ASC subtopic 605-25, Revenue Recognition-Multiple Element
Arrangements, by allowing the use of the best estimate of selling price in addition to vendor
specific objective evidence and third-party evidence for determining the selling price of a
deliverable. This guidance establishes a selling price hierarchy for determining the selling price
of a deliverable, which is based on: (a) vendor-specific objective evidence, (b) third-party
evidence, or (c) estimates. In addition, the residual method of allocating arrangement
consideration is no longer permitted. ASU 2009-13 is effective for fiscal years beginning on or
after June 15, 2010. The Company adopted ASU 2009-13 in fiscal 2011 and it did not have a material
impact on its consolidated results of operations and financial condition.
In October 2009, the FASB issued ASU 2009-14, Software (Topic 985) Certain Revenue
Arrangements that Include Software Elements. This guidance modifies the scope of FASB ASC subtopic
965-605, Software-Revenue Recognition, to exclude from its requirements non-software components of
tangible products and software components of tangible products that are sold, licensed, or leased
with tangible products when the software components and non-software components of the tangible
product function together to deliver the tangible products essential functionality. ASU 2009-14 is
effective for fiscal years beginning on or after June 15, 2010. The Company adopted ASU 2009-14 in
fiscal 2011 and it did not have a material impact on its consolidated results of operations and
financial condition.
8
Table of Contents
NOTE 2 Stock-Based Compensation
The Company accounts for stock-based compensation under ASC 718, Compensation Stock
Compensation, which requires companies to recognize in their statement of operations all
share-based payments, including grants of stock options and other types of equity awards, based on
the grant date fair value of such share-based awards.
Total stock-based compensation expense for options, restricted share units and other awards
recognized for the three months ended February 25, 2011 and February 26, 2010 was approximately
$2.2 million and $1.8 million, respectively. Total stock-based compensation expense for options,
restricted share units and other awards recognized for the six months ended February 25, 2011 and
February 26, 2010 was approximately $4.4 million and $3.5 million, respectively.
Stock Options
The Companys stock option plan provides for grants of options to employees and independent
directors of the Company to purchase the Companys ordinary shares at the fair value of such shares
on the grant date. The options generally vest over a four-year period beginning on the grant date
and have a 10-year term. As of February 25, 2011, there were 12,831,334 ordinary shares reserved
for issuance under this plan, of which 2,467,687 ordinary shares represented the number of shares
available for grant.
For stock options, excluding restricted share units and other awards, the stock-based
compensation expense recognized for the three months ended February 25, 2011 and February 26, 2010
was approximately $1.4 million for each period. For stock options, excluding restricted share units
and other awards, the stock-based compensation expense recognized for the six months ended February
25, 2011 and February 26, 2010 was approximately $2.7 million for each period.
Summary of Assumptions and Activity for Stock Options
The fair value of each option grant is estimated on the date of grant using the Black-Scholes
option-pricing model that uses the assumptions noted in the following table. Expected volatility
for the six months ended February 25, 2011 is based on the Companys historical common stock
volatility, compared to prior periods when the Company used a weighted average of the Companys
historical common stock volatility (80% weighting) together with the historical volatilities of the
common stock of comparable publicly traded companies (20% weighting). The expected term of options
granted represents the weighted average period of time that options granted are expected to be
outstanding giving consideration to vesting schedules and our historical exercise patterns. The
risk-free interest rate for the expected term of the options is based on the average U.S. Treasury
yield curve at the end of the quarter. The following assumptions were used to value stock options:
Six Months Ended | ||||||||
February 25, | February 26, | |||||||
2011 | 2010 | |||||||
Stock options: |
||||||||
Expected term (years) |
4.7 | 4.7 | ||||||
Expected volatility |
81 | % | 78 | % | ||||
Risk-free interest rate |
2.16 | % | 2.33 | % | ||||
Expected dividends |
| |
9
Table of Contents
A summary of option activity as of and for the six months ended February 25, 2011 is presented
below (dollars and shares in thousands, except per share data):
Weighted | ||||||||||||||||
Average | ||||||||||||||||
Weighted | Remaining | |||||||||||||||
Average | Contractual | Aggregate | ||||||||||||||
Exercise | Term | Intrinsic | ||||||||||||||
Shares | Price | (Years) | Value | |||||||||||||
Options outstanding at August 27, 2010 |
8,434 | $ | 4.39 | |||||||||||||
Options granted |
892 | 6.34 | ||||||||||||||
Options exercised |
(571 | ) | 4.16 | |||||||||||||
Options forfeited and cancelled |
(327 | ) | 6.70 | |||||||||||||
Options outstanding at February 25, 2011 |
8,428 | $ | 4.52 | 6.56 | $ | 23,193 | ||||||||||
Options exercisable at February 25, 2011 |
5,000 | $ | 4.03 | 5.51 | $ | 16,746 | ||||||||||
Options vested and expected to vest at February 25, 2011 |
8,140 | $ | 4.47 | 6.47 | $ | 22,807 | ||||||||||
The Black-Scholes weighted average fair value of options granted during the three months ended
February 25, 2011 and February 26, 2010 was $4.17 and $4.59 per option, respectively. The
Black-Scholes weighted average fair value of options granted during the six months ended February
25, 2011 and February 26, 2010 was $3.86 and $2.69 per option, respectively. The total intrinsic
value of employee stock options exercised during the six months ended February 25, 2011 and
February 26, 2010 was approximately $1.6 million and $1.9 million, respectively. Upon the exercise
of options, the Company issues new ordinary shares from its authorized shares.
A summary of the status of the Companys non-vested stock options as of February 25, 2011, and
changes during the six months ended February 25, 2011, is presented below (shares in thousands):
Weighted | ||||||||
Average | ||||||||
Grant Date Fair | ||||||||
Shares | Value Per Share | |||||||
Non-vested stock options at August 27, 2010 |
3,739 | $ | 2.61 | |||||
Stock options granted |
892 | $ | 3.86 | |||||
Vested stock options |
(877 | ) | $ | 2.16 | ||||
Forfeited and cancelled stock options |
(327 | ) | $ | 3.89 | ||||
Non-vested stock options at February 25, 2011 |
3,428 | $ | 2.93 | |||||
As of February 25, 2011, there was approximately $9.2 million of total unrecognized
compensation costs related to employee and independent director stock options. Such cost is
expected to be recognized over the weighted average period of 2.4 years. The total fair value of
shares vested during the six months ended February 25, 2011 was approximately $1.9 million.
Restricted Share Units (RSUs)
The Companys equity incentive plan also provides for grants of RSUs, and, beginning with the
first quarter of fiscal 2009, the Company began issuing performance-based and time-based RSUs.
The time-based RSUs vest over a period ranging from one year to four years and their fair
value is determined by the closing price of the Companys ordinary shares on the date of grant.
The Company has issued two types of performance-based RSUs, one based on an internal metric
and the other based on an external metric, the Russell MicroCap index (IWC).
The performance-based RSUs containing an internal metric which were issued in fiscal 2009
would have vested in fiscal 2011 if the Company achieved its fiscal 2009 adjusted EBIT target as
approved by the Board of Directors. In the first quarter of fiscal 2010, these performance-based
RSUs were not awarded because the target was not met.
In the first and second quarters of fiscal 2010 and the first quarter of fiscal 2011, the
Company issued performance-based RSUs that contained an external stock market index as a benchmark
for performance (market-based RSUs). The number of market-based RSUs awarded will depend upon the
Companys stock performance compared to an external stock market index on a date three days before
the date set for vesting. The ultimate number of market-based RSUs awarded will then vest three
years after the grant date. The fair value of market-based RSUs is determined by using a Monte
Carlo valuation model.
10
Table of Contents
A summary of the changes in RSUs outstanding under the Companys equity incentive plan during
the six months ended February 25, 2011 is presented below (dollars and shares in thousands, except
per share data):
Weighted | ||||||||||||
Average | Aggregate | |||||||||||
Grant Date | Intrinsic | |||||||||||
Shares | FairValue | Value | ||||||||||
Awards outstanding at August 27, 2010 |
1,153 | $ | 5.25 | |||||||||
Awards granted |
895 | 7.01 | ||||||||||
Awards vested |
(70 | ) | 5.09 | |||||||||
Awards forfeited and cancelled |
(42 | ) | 6.43 | |||||||||
Awards outstanding at February 25, 2011 |
1,936 | $ | 6.42 | $ | 13,650 | |||||||
The stock-based compensation expense related to RSUs for the three months ended February 25,
2011 and February 26, 2010 was approximately $0.9 million and $0.5 million, respectively. The
stock-based compensation expense related to RSUs for the six months ended February 25, 2011 and
February 26, 2010 was approximately $1.7 million and $0.8 million, respectively.
As of February 25, 2011, the Company had approximately $6.8 million of unrecognized
compensation expense related to RSUs, net of estimated forfeitures and cancellations, which will be
recognized over a weighted average estimated remaining life of 2.1 years.
NOTE 3 Goodwill and Other Intangible Assets, net
In accordance with ASC 350, Intangibles Goodwill and Other, 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
include significant adverse changes in the general business climate, among others. There were no
events or circumstances in the fiscal quarter ended February 25, 2011 indicating that impairment
may have occurred. As of February 25, 2011, the carrying value of goodwill on the Companys
unaudited condensed consolidated balance sheet was $1.1 million.
The Company operates in one reporting unit, one operating and reportable segment: the design,
manufacture, and sale of electronic subsystem products and services to various segments of the
electronics industry.
The Company reviews its long-lived assets for impairment in accordance with ASC 360, Property,
Plant and Equipment. Under ASC 360, 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.
The following table summarizes the gross amounts and accumulated amortization of other
intangible assets from the Adtron acquisition by type as of February 25, 2011 and August 27, 2010
(in thousands):
Weighted | Value at | As of February 25, 2011 | As of August 27, 2010 | |||||||||||||||||||||
Avg. Life | Date of | Accumulated | Carrying | Accumulated | Carrying | |||||||||||||||||||
(years) | Acquisition | Amortization | Value | Amortization | Value | |||||||||||||||||||
Amortized intangible assets: |
||||||||||||||||||||||||
Customer relationships |
10 | $ | 3,700 | $ | 1,110 | $ | 2,590 | $ | 925 | $ | 2,775 | |||||||||||||
Technology |
7 | 2,800 | 1,200 | 1,600 | 1,000 | 1,800 | ||||||||||||||||||
Company trade name |
20 | 2,040 | 306 | 1,734 | 255 | 1,785 | ||||||||||||||||||
Leasehold interest |
3 | 260 | 244 | 16 | 203 | 57 | ||||||||||||||||||
Product names |
9 | 60 | 20 | 40 | 17 | 43 | ||||||||||||||||||
Total |
$ | 8,860 | $ | 2,880 | $ | 5,980 | $ | 2,400 | $ | 6,460 | ||||||||||||||
Amortization expense related to identifiable intangible assets totaled approximately $0.2
million and $0.3 million for the three months ended February 25, 2011 and February 26, 2010,
respectively and $0.5 million for both six-month periods ended February 25, 2011 and February 26,
2010. Acquired intangibles with definite lives are amortized on a straight-line basis over the
remaining estimated economic life of the underlying intangible assets.
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Estimated amortization expenses of these intangible assets for the remainder of fiscal 2011,
the next four fiscal years and all years thereafter are as follows (in thousands):
Fiscal Year: | Amount | |||
Remainder of fiscal 2011 |
$ | 455 | ||
2012 |
879 | |||
2013 |
879 | |||
2014 |
879 | |||
2015 |
678 | |||
Thereafter |
2,210 | |||
Total |
$ | 5,980 | ||
NOTE 4 Net Income Per Share
Basic net income per ordinary share is calculated by dividing net income by the weighted
average of ordinary shares outstanding during the period. Diluted net income per ordinary share is
calculated by dividing the net income by the weighted average of ordinary shares and dilutive
potential ordinary shares outstanding during the period. Dilutive potential ordinary shares consist
of dilutive shares issuable upon the exercise of outstanding stock options and vesting of RSUs
computed using the treasury stock method.
The following table sets forth for all periods presented the computation of basic and diluted
net income per ordinary share, including the reconciliation of the numerator and denominator used
in the calculation of basic and diluted net income per share (dollars and shares in thousands,
except per share data):
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Numerator: |
||||||||||||||||
Net income |
$ | 171 | $ | 16,092 | $ | 8,138 | $ | 20,674 | ||||||||
Denominator: |
||||||||||||||||
Weighted average ordinary shares, basic |
63,178 | 62,211 | 63,039 | 62,092 | ||||||||||||
Effect of dilutive securities: |
||||||||||||||||
Stock options and RSUs |
2,909 | 2,799 | 2,884 | 2,421 | ||||||||||||
Weighted average ordinary shares, diluted |
66,087 | 65,010 | 65,923 | 64,513 | ||||||||||||
Net income per ordinary share, basic |
$ | 0.00 | $ | 0.26 | $ | 0.13 | $ | 0.33 | ||||||||
Net income per ordinary share, diluted |
$ | 0.00 | $ | 0.25 | $ | 0.12 | $ | 0.32 | ||||||||
The Company excluded 3,926,619 and 4,169,503 weighted shares from stock options and RSUs from
the computation of diluted net income per share for the three and six months ended February 25,
2011, respectively, as the effect of their inclusion would have been anti-dilutive. The Company
excluded 4,134,283 and 4,646,930 weighted shares from stock options and RSUs from the computation
of diluted net income per share for the three and six months ended February 26, 2010, respectively,
as the effect of their inclusion would have been anti-dilutive.
NOTE 5 Balance Sheet Details
Inventories
Inventories consisted of the following (in thousands):
February 25, | August 27, | |||||||
2011 | 2010 | |||||||
Raw materials |
$ | 38,243 | $ | 44,180 | ||||
Work-in-process |
8,552 | 13,309 | ||||||
Finished goods |
49,292 | 54,614 | ||||||
Total inventories * |
$ | 96,087 | $ | 112,103 | ||||
* | As of February 25, 2011 and August 27, 2010, inventory held under service
arrangements was approximately 46% and 41% of total inventories, respectively, and
is primarily classified as finished goods. |
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Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consisted of the following (in thousands):
February 25, | August 27, | |||||||
2011 | 2010 | |||||||
Prepaid ICMS taxes in Brazil * |
$ | 3,958 | $ | 11,277 | ||||
Indemnification receivable for ICMS assessment * |
4,473 | 4,115 | ||||||
Prepayment for property and equipment taxes |
2,393 | 2,122 | ||||||
Unbilled receivables |
7,515 | 6,182 | ||||||
Receivable from subcontractors |
2,228 | 3,594 | ||||||
Deferred and other income taxes |
897 | 1,197 | ||||||
Other prepaid expenses and other current assets |
7,644 | 5,001 | ||||||
Total prepaid expenses and other current assets |
$ | 29,108 | $ | 33,488 | ||||
* | See Note 9 Commitments and Contingencies. |
Property and Equipment, net
Property and equipment consisted of the following (in thousands):
February 25, | August 27, | |||||||
2011 | 2010 | |||||||
Office furniture, software, computers, and equipment |
$ | 6,774 | $ | 5,751 | ||||
Manufacturing equipment |
90,517 | 78,901 | ||||||
Leasehold improvements |
19,280 | 18,317 | ||||||
116,571 | 102,969 | |||||||
Less accumulated depreciation and amortization |
63,575 | 56,748 | ||||||
Property and equipment, net |
$ | 52,996 | $ | 46,221 | ||||
Depreciation expense totaled approximately $5.3 million and $11.0 million for the three and
six months ended February 25, 2011, respectively. Depreciation expense totaled approximately $3.6
million and $7.0 million for the three and six months ended February 26, 2010, respectively.
Other Non-Current Assets
Other non-current assets consisted of the following (in thousands):
February 25, | August 27, | |||||||
2011 | 2010 | |||||||
Prepaid ICMS taxes in Brazil * |
$ | 12,194 | $ | 6,358 | ||||
Judicial deposit and indemnification receivable related to Brazil ICMS assessment * |
5,809 | 4,115 | ||||||
Prepayment for property and equipment taxes |
4,487 | 4,114 | ||||||
Deposits on property and equipment |
623 | 3,076 | ||||||
Other |
2,953 | 3,554 | ||||||
Total other non-current assets |
$ | 26,066 | $ | 21,217 | ||||
* | See Note 9 Commitments and Contingencies. |
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Accrued Liabilities
Accrued liabilities consisted of the following (in thousands):
February 25, | August 27, | |||||||
2011 | 2010 | |||||||
Accrued employee compensation |
$ | 7,891 | $ | 15,406 | ||||
VAT and other transaction taxes payable |
5,210 | 5,966 | ||||||
Accrued restructuring |
2,831 | | ||||||
Accrued warranty reserve |
1,097 | 732 | ||||||
Income taxes payable |
788 | 3,145 | ||||||
Other accrued liabilities |
6,832 | 4,069 | ||||||
Total accrued liabilities |
$ | 24,649 | $ | 29,318 | ||||
NOTE 6 Income Taxes
The provision for income tax expense is summarized as follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Current |
$ | 2,409 | $ | 8,443 | $ | 7,610 | $ | 13,171 | ||||||||
Deferred |
148 | (10 | ) | 286 | (21 | ) | ||||||||||
Total |
$ | 2,557 | $ | 8,433 | $ | 7,896 | $ | 13,150 | ||||||||
Income (loss) before provision for income taxes for the three and six months ended February
25, 2011 and February 26, 2010, consisted of the following components (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
U.S. loss |
$ | (6,108 | ) | $ | (1,731 | ) | $ | (18,495 | ) | $ | (5,994 | ) | ||||
Non-U.S. income |
8,836 | 26,256 | 34,529 | 39,818 | ||||||||||||
Total |
$ | 2,728 | $ | 24,525 | $ | 16,034 | $ | 33,824 | ||||||||
The effective tax rates for the three months ended February 25, 2011 and February 26, 2010
were approximately 94% and 34%, respectively. The effective tax rates for the six months ended
February 25, 2011 and February 26, 2010 were approximately 49% and 39%, respectively. The increase
in the effective tax rate for the three months ended February 25, 2011, as compared to the three
months ended February 26, 2010, and for the six months ended February 25, 2011, as compared to the
six months ended February 26, 2010 is primarily due to an increase in losses in the U.S. and Puerto
Rico (including restructuring charges) that provide no tax benefit and a decline of income being
generated in non-U.S. tax jurisdictions that are subject to lower tax rates.
Effective February 1, 2011, the Company started to participate in a Brazilian government
investment incentive program, known as PADIS. This program is specifically designed to promote
the development of the local semiconductor industry. The Brazilian government approved our
application for certain beneficial tax treatment under the PADIS system. This beneficial tax
treatment includes a reduction in the Brazil statutory income tax rate from 34% to 9% on taxable
income from the semiconductor portion of our operations. In order to receive the expected
benefits, the Company is required to make significant investments in research and development
activities, which investments are determined by the amount of sales. In computing the tax expense
for the three months and six months ended February 25, 2011, the Company estimated its annual
effective tax rate incorporating the anticipated impact of beneficial tax treatment under the PADIS
system, which included the reduction in the Brazil statutory income tax rate from 34% to 9% on
semiconductor operations in Brazil.
At February 25, 2011, the liability for uncertain tax positions was $0.2 million.
As of February 25, 2011, the Company evaluated its valuation allowance on deferred tax assets
to determine if a change in circumstances caused a change in judgment regarding the realization of
deferred tax assets in future years. The Company has a cumulative loss for the U.S. in recent
years and projects a tax loss for the U.S. in the current fiscal year and for the foreseeable
future. A cumulative loss in recent years within the U.S. represents significant evidence in
evaluating the need for a valuation allowance on U.S. net deferred tax assets. As a result, the
Company continues to record a full valuation allowance on its U.S. deferred tax assets. The Company
also projects a tax loss for Puerto Rico in the current fiscal year. During the second quarter of
fiscal 2011, the Company initiated a restructuring plan to close its Puerto Rico facility. As of
August 27, 2010, the Company had net deferred taxes of approximately $48 thousand at its Puerto
Rico facility. The Company anticipates no future taxable income to realize the tax benefit of
existing Puerto Rico deferred tax assets. As a result, the Company has recorded a full valuation
allowance on its Puerto Rico deferred tax assets.
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NOTE 7 Indebtedness
On March 28, 2005, the Company issued $125.0 million in senior secured floating rate notes due
on April 1, 2012 (the 144A Notes) in an offering exempted from registration under the Securities
Act of 1933, as amended (the Offering). The 144A Notes were jointly and severally guaranteed on a
senior basis by all of our restricted subsidiaries, subject to limited exceptions. In addition, the
144A Notes and the guarantees were secured on a second-priority basis by the capital stock of, or
equity interests in, most of our subsidiaries and substantially all of the Companys and most of
its subsidiaries assets. The 144A Notes accrued interest at the three-month London Inter Bank
Offering Rate, or LIBOR, plus 5.50% per annum, payable quarterly in arrears, and were redeemable
under certain conditions and limitations. The 144A Notes were then registered and exchanged for the
senior secured floating rate exchange notes (the Notes) on October 27, 2005. The terms of the
Notes are identical in all material respects to the terms of the 144A Notes, except that the
transfer restrictions and registration rights related to the 144A Notes do not apply to the Notes.
On August 13, 2008, the Company de-registered the Notes with the SEC to suspend on-going reporting
obligations to file reports under Sections 13 and 15(d) with respect to the Notes. The indenture
relating to the Notes contains various covenants including limitations on our ability to engage in
certain transactions and limitations on our ability to incur debt, pay dividends and make
investments. The Company was in compliance with such covenants as of February 25, 2011.
The Company incurred approximately $4.9 million in related debt issuance costs, the remaining
portion of which is included in other non-current assets in the accompanying unaudited condensed
consolidated balance sheets. Except for the portion written off in connection with the repurchase
discussed below, debt issuance costs related to the Notes are being amortized to interest expense
on a straight-line basis, which approximates the effective interest rate method, over the life of
the Notes.
On October 13, 2009, the Board of Directors approved up to $25.0 million to repurchase and/or
redeem a portion of the outstanding Notes, excluding unpaid accrued interest. On October 22, 2009,
using available cash, the Company repurchased and retired a portion of the Notes representing $26.2
million of aggregate principal for $25.0 million; at 95.5% of the principal or face amount. In
connection with the repurchase, a gain of $1.2 million was recognized in other income (expense) in
fiscal 2010, offset by a $0.4 million write-off of debt issuance costs. As of August 27, 2010, the
aggregate principal amount of Notes that remained outstanding was $55.1 million. As of February
25, 2011, the fair value of the Notes that remained outstanding was estimated to be approximately
$55.1 million.
The Company also has a senior secured credit facility in the amount of $35 million with Wells
Fargo Bank. As of April 30, 2010, SMART Modular Technologies, Inc., SMART Modular Technologies
(Europe) Limited, and SMART Modular Technologies (Puerto Rico) Inc., as borrowers (the
Borrowers), entered into the Third Amendment to Second Amended and Restated Loan and Security
Agreement (the Third Amendment), with the lenders identified therein (the Lenders) and Wells
Fargo Bank, National Association, as the arranger, administrative agent and security trustee for
the Lenders. The Second Amended and Restated Loan and Security Agreement dated April 30, 2007, as
amended by the First Amendment dated November 26, 2008, the Second Amendment dated August 14, 2009
and the Third Amendment dated April 30, 2010, is referred to as the WF Credit Facility. The WF
Credit Facility is jointly and severally guaranteed on a senior basis by all of our subsidiaries,
subject to limited exceptions. In addition, the WF Credit Facility and the guarantees are secured
by the capital stock of, or equity interests in, most of the Companys subsidiaries and
substantially all of the Companys and most of its subsidiaries assets. As a result of the Third
Amendment, the Maturity Date, as defined in the WF Credit Facility, was extended to April 30, 2012,
and the Company is again required to comply with certain financial covenants as modified and as set
forth in the WF Credit Facility. The Base Rate Margin and LIBOR Rate Margin, as defined in the WF
Credit Facility, were changed to 1.25% and 2.25%, respectively. The Company has not borrowed under
the WF Credit Facility since November 2007 and had no borrowings outstanding as of February 25,
2011. While the Company was in compliance with the financial covenants required to borrow funds
under the WF Credit Facility as of February 25, 2011 and expects to be able to satisfy the
financial covenants in the future, it may not meet the financial covenants or financial condition
test during all periods before it expires on April 30, 2012 and therefore may not be able to borrow
funds if and when it needs funds in the future.
NOTE 8 Fair Value Measurements
Effective in the first quarter of fiscal 2010, the Company adopted the provisions of ASC 820,
Fair Value Measurements and Disclosures, for all non-financial assets and non-financial
liabilities.
The fair value of the Companys cash, cash equivalents, accounts receivable, accounts payable
and WF Credit Facility approximates the carrying amount due to the relatively short maturity of
these items. Cash and cash equivalents consist of funds held in general checking and savings
accounts, money market accounts and certificates of deposit with an original maturity on the date
of purchase of three months or less. The Company does not have investments in variable rate demand
notes or auction rate securities.
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The FASB guidance establishes a fair value hierarchy that prioritizes the inputs to valuation
techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted
quoted prices in active markets to identical assets or liabilities (level 1 measurements) and the
lowest priority to unobservable inputs (level 3 measurements). The three levels of the fair value
hierarchy are described below:
| Level 1. Valuations based on quoted prices in active markets for identical assets or
liabilities that an entity has the ability to access. The Companys Level 1 assets include
money market funds and certificates of deposit that are classified as cash equivalents. |
| Level 2. Valuations based on quoted prices for similar assets or liabilities, quoted prices
for identical assets or liabilities in markets that are not active, or other inputs that are
observable or can be corroborated by observable data for substantially the full term of the
assets and liabilities. The Company does not have any assets or liabilities measured under
Level 2. |
| Level 3. Valuations based on inputs that are supported by little or no market activity and
that are significant to the fair value of the assets or liabilities. The Company does not
have any assets or liabilities measured under Level 3. |
Assets and liabilities measured at fair value on a recurring basis include the following (in
millions):
Quoted Prices in | Observable/ | |||||||||||||||
Active Markets | Unobservable | |||||||||||||||
for Identical | Inputs | Significant | ||||||||||||||
Assets or | Corroborated by | Unobservable | ||||||||||||||
Liabilities | Market Data | Inputs | ||||||||||||||
Level 1 | Level 2 | Level 3 | Total | |||||||||||||
Balances as of February 25, 2011: |
||||||||||||||||
Assets: |
||||||||||||||||
Cash |
$ | 76.8 | $ | | $ | | $ | 76.8 | ||||||||
Money market funds |
54.6 | | | 54.6 | ||||||||||||
Certificates of deposit |
3.0 | | | 3.0 | ||||||||||||
Total assets measured at fair value (1) |
$ | 134.4 | $ | | $ | | $ | 134.4 | ||||||||
Balances as of August 27, 2010: |
||||||||||||||||
Assets: |
||||||||||||||||
Cash |
$ | 45.7 | $ | | $ | | $ | 45.7 | ||||||||
Money market funds |
69.8 | | | 69.8 | ||||||||||||
Total assets measured at fair value (1) |
$ | 115.5 | $ | | $ | | $ | 115.5 | ||||||||
(1) | Included in cash and cash equivalents on the Companys condensed consolidated balance sheets. |
NOTE 9 Commitments and Contingencies
Product Warranty and Indemnities
Product warranty reserves are established in the same period that revenue from the sale of the
related products is recognized, or in the period that a specific issue arises as to the
functionality of a Companys product. The amounts of the reserves are based on established terms
and the Companys best estimate of the amounts necessary to settle future and existing claims on
products sold as of the balance sheet date.
The following table reconciles the changes in the Companys accrued warranty reserve (in
thousands):
Six Months Ended | ||||
February 25, | ||||
2011 | ||||
Balance of accrual at August 27, 2010 |
$ | 732 | ||
Settlement of warranty claims |
(489 | ) | ||
Provision for product warranties |
854 | |||
Balance of accrual at February 25, 2011 |
$ | 1,097 | ||
Product warranty reserves are recorded in accrued liabilities in the accompanying unaudited
condensed consolidated balance sheets.
In addition to potential liability for warranties related to defective products, the Company
currently has in effect a number of agreements in which it has agreed to defend, indemnify and hold
harmless its customers and suppliers from damages and costs which may arise from product defects as
well as from any alleged infringement by its products of third-party patents, trademarks or other
proprietary rights. The Company believes its internal development processes and other policies and
practices limit its exposure related to such indemnities. Maximum potential future payments cannot
be estimated because many of these agreements do not have a maximum stated liability. However, to
date, the Company has not had to reimburse any of its customers or suppliers
for any losses related to these indemnities. The Company has not recorded any liability in its
financial statements for such indemnities.
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Technology Access and Development Agreements
During the first quarter of fiscal 2011, the Company entered into a strategic joint
development project with a semiconductor company. On November 24, 2010, the Company signed a
Technology Access Agreement (TAA) with this strategic partner which allowed the Company access to
certain in-process technology as developed to date by the semiconductor company in order to
accelerate the development of the Companys solid state drives (SSDs). In connection with the
TAA, the Company also entered into a development agreement under which the Company will compensate
the semiconductor company for the development of this in-process technology into a commercially
viable product. The total consideration to be paid by the Company to the semiconductor company
under the access and development arrangements is $10 million, of which $7 million was paid on
November 29, 2010 and the remaining $3 million will be paid in installments as milestones are
achieved under the development agreement. The Company determined that the relative fair value of
the technology access charge and the development agreement was approximately $7.5 million and $2.5
million, respectively based on the terms and conditions of the agreements and the expected future
discounted cash flows of the SSD products.
In the first quarter of fiscal 2011, the Company recognized a technology access charge of $7.5
million associated with the TAA since the technological feasibility associated with this in-process
technology had not yet been established and there were remaining development costs to be incurred
to complete the development of this technology into a commercially viable product. In addition, the
access and use of this in-process technology was restricted only to this development project and
thus, there were no alternative future uses by the Company of this in-process technology. The
Company also recognized research and development expenses of $1.2 million and $0.7 million during
the first and second quarters of fiscal 2011, respectively, associated with the development
agreement, which represented the effort incurred by the semiconductor company under the development
agreement during the respective periods.
Legal Matters
From time to time the Company is involved in legal matters that arise in the normal course of
business. Litigation in general and intellectual property and employment litigation in particular,
can be expensive and disruptive to normal business operations. Moreover, the results of complex
legal proceedings are difficult to predict. The Company believes that it has defenses to the cases
pending, including those set forth below. Except as noted below, the Company is not currently able
to estimate, with reasonable certainty, the possible loss, or range of loss, if any, from such
legal matters, and accordingly no provision for any potential loss which may result from the
resolution of these matters has been recorded in the accompanying consolidated financial
statements. In the Companys opinion, the estimated resolution of these disputes and litigation is
not expected to have a material impact on its consolidated financial position, results of
operations or cash flow.
Tessera
On December 7, 2007, Tessera, Inc. filed a complaint under section 337 of the Tariff Act of
1930 (Tariff Act), 19 U.S.C. § 1337, in the U.S. International Trade Commission (ITC) against a
subsidiary of the Company, as well as several other respondents. Tessera alleged that
small-format Ball Grid Array (BGA) semiconductor packages and products containing such
semiconductor packages, including memory module products sold by the Company, infringe certain
claims of United States Patent Nos. 5,697,977; 6,133,627; 5,663,106 and 6,458,681 (the Asserted
Patents). On January 3, 2008, the ITC instituted an investigation entitled, In the Matter of
Certain Semiconductor Chips with Minimized Chip Package Size and Products Containing Same (III),
Inv. No. 337-TA-630. In May 2008, Tessera withdrew one of the four Asserted Patents (U.S. Patent
No. 6,458,681) from the ITC investigation. On December 29, 2009, the ITC issued a final
determination stating that there has been no violation of §337 of the Tariff Act, and that it had
terminated the investigation (the Final Determination). In the Final Determination, the ITC
found no infringement by the Companys subsidiary. As the 627 and 977 patents expired in
September 2010, Tessera is only appealing the Final Determination as to the 106 patent.
Tessera also filed a parallel patent infringement claim in the Eastern District of Texas, Case
No. 2:07-cv-534, alleging infringement of the same patents at issue in the ITC action. The
district court action seeks an unspecified amount of damages and injunctive relief. The district
court action has been stayed pending the completion of the ITC action.
The Company believes that it has meritorious defenses against Tesseras allegations and that
the likelihood of any material charge for this matter is not probable.
Creative Mobile Technologies
On March 7, 2011 Creative Mobile Technologies LLC (CMT) filed a complaint in the Supreme
Court of the State of New York, County of Queens, alleging, among other things, breach of contract,
fraud and fraud in the inducement, and negligent misrepresentation. The allegations are in
connection with the sale of certain display and embedded products starting in calendar year 2008,
and a settlement agreement and release entered into between CMT and the Company in December 2009
(the CMT Settlement Agreement). CMT is seeking a rescission of the CMT Settlement Agreement and
punitive and other damages not less than $7.5 million.
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The Company believes that it has valid defenses against CMTs claims, which claims the Company
believes are without merit. The Company intends to vigorously defend this lawsuit and to file
counterclaims against CMT to, among other things, seek to recover moneys owed to the Company by
CMT. The Company believes that the likelihood of any material charge for this matter is remote.
Contingencies
Brazil ICMS Assessment
On October 3, 2008, the Companys subsidiary in Brazil (SMART Brazil) received a notice from
the Sao Paulo State Treasury Office providing an assessment for the collection of State Value-Added
Tax (ICMS) as well as interest and penalties (collectively the Assessment) related to the
transfer of ICMS credits during 2004 between two Brazilian entities. These transfers occurred prior
to the acquisition in April 2004 of SMART from Solectron Corporation (Solectron). Solectron was
subsequently acquired by Flextronics International Ltd. (Flextronics). The Company believes that
the Assessment is covered by indemnification pursuant to the Transaction Agreement dated February
11, 2004 dealing with the acquisition of SMART from Solectron, and pursuant to the Flextronics
Settlement Agreement described below, and, under the terms of the Transaction Agreement,
Flextronics elected to assume responsibility to contest the Assessment on SMART Brazils behalf. In
June 2010, the Company was advised by tax counsel that the efforts to contest the Assessment in the
administrative level were unsuccessful. In October 2010, the attorneys appointed by Flextronics
filed a proceeding in the judicial sphere aiming, among other things, to: (i) dispute the
enforceability of the state legislation that is involved in the Assessment; and (ii) dispute the
penalties against SMART Brazil.
As of February 25, 2011, the Companys unaudited condensed consolidated balance sheet reflects
both a long-term liability for the Assessment and a corresponding long-term indemnity receivable
from Flextronics for approximately $5.8 million (or 9.7 million Brazilian Reais BRL) which is
based on an amount set forth on a government website where assessments are listed and includes
interest on the tax, punitive penalties, interest on the penalties, and attorneys fees. The
balance of the assessment increases daily. The Company believes that the Assessment, as revised, is
covered by the indemnity from Solectron and/or Flextronics discussed herein and as such, it is not
likely to have a material adverse effect on the Companys cash flows, results of operations or
financial condition. While the Company believes that the Assessment as revised is subject to the
indemnity, there can be no absolute assurance that Solectron and/or Flextronics will comply with
their contractual indemnity obligations in this regard.
Prepaid ICMS Taxes in Brazil
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 Ruling, is subject to renewal every two years and
expired on March 31, 2010. SMART Brazil applied for a renewal of this benefit, but the renewal was
not granted until August 4, 2010. The Company was originally advised by tax counsel that the
renewal of the benefit would be denied if SMART Brazil did not post a deposit against the
Assessment for the benefit of the tax authorities in the event that the tax authorities prevail on
any contests against the Assessment. In order to post the deposit, SMART Brazil instituted a
judicial proceeding requesting an injunction which was granted on June 16, 2010. In connection with
this injunction, on June 17, 2010, SMART Brazil made a judicial deposit (the deposit, as may be
increased from time to time is referred to as the Judicial Deposit) in the amount of the
Assessment at that time which totaled $4.1 million (or 7.2 million BRL). As of February 25, 2011,
the Judicial Deposit increased to $4.5 million (or 7.5 million BRL) due to the effect of exchange
rate fluctuations. On March 8, 2011, the Company and certain of its subsidiaries entered into a
Private Deed of Settlement and Release with Flextronics (the Flextronics Settlement Agreement)
pursuant to which Flextronics agreed to pay to SMART Brazil $4.5 million (or 7.5 million BRL) as a
reimbursement of the Judicial Deposit balance which was received by SMART Brazil on March 24, 2011.
The Judicial Deposit is classified in other non-current assets in the accompanying condensed
consolidated balance sheet.
On June 22, 2010, the Sao Paulo authorities published a regulation allowing companies that
applied for a timely renewal of an ICMS Special Ruling, such as SMART Brazil, 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. The payment of ICMS generates tax credits that may be used to offset ICMS generated from
sales by SMART Brazil of its products, however, the vast majority of SMART Brazils sales in Sao
Paulo are either subject to a lower ICMS rate or are made to customers that are entitled to other
ICMS benefits that enable 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 accrued upon payment of the ICMS on
SMART Brazils imports. Although the renewal has been granted, there was no refund of ICMS tax
credits that accumulated during the period when the Company was waiting for the renewal.
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As of February 25, 2011, the amount of accumulated ICMS tax credits reported on the Companys
unaudited condensed consolidated balance sheet relating to the April 1, 2010 through June 22, 2010
period was $16.2 million (or 27.0 million BRL), with $4.0 million (or 6.6 million BRL) classified
as other current assets and $12.2 million (or 20.4 million BRL) classified as other non-current
assets. It is expected that $4.0 million of the excess ICMS credits will be recovered during the
next twelve
months, with the remainder of $12.2 million being recovered primarily in fiscal 2012 and 2013.
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 inter-state mix of sales, the timing of fixed asset
purchases and the amount of semiconductor component imports. These expectations are based on
various estimates including the mix of products and regions where the Companys sales will occur.
If these estimates or the mix of products or regions vary, it could take longer or shorter than
expected to fully recover the ICMS credits accumulated to date, resulting in a reclassification of
ICMS credits from current to non-current, or vice versa. The accumulation of the excess credits had
an adverse impact on the Companys cash flows and there can be no absolute assurance that the ICMS
credits will be fully recoverable.
NOTE 10 Segment and Geographic Information
The Company operates in one operating segment: the design, manufacture, and sale of electronic
subsystem products and services to the electronics industry. The Companys chief operating
decision-maker, the President and CEO, evaluates financial performance on a company-wide basis.
A summary of the Companys net sales and property and equipment by geographic area is as
follows (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Geographic net sales: |
||||||||||||||||
U.S. |
$ | 38,813 | $ | 47,950 | $ | 87,026 | $ | 91,054 | ||||||||
Brazil |
82,821 | 66,668 | 202,229 | 110,673 | ||||||||||||
Asia |
38,861 | 30,984 | 76,307 | 55,876 | ||||||||||||
Europe |
5,554 | 9,832 | 12,102 | 18,462 | ||||||||||||
Other Americas |
4,500 | 4,676 | 9,244 | 7,138 | ||||||||||||
$ | 170,549 | $ | 160,110 | $ | 386,908 | $ | 283,203 | |||||||||
February 25, | August 27, | |||||||
2011 | 2010 | |||||||
Property and equipment, net: |
||||||||
U.S. |
$ | 6,300 | $ | 6,298 | ||||
Brazil |
38,788 | 32,175 | ||||||
Malaysia |
7,712 | 7,705 | ||||||
Other |
196 | 43 | ||||||
$ | 52,996 | $ | 46,221 | |||||
NOTE 11 Major Customers
A majority of the Companys net sales are attributable to customers operating in the
information technology industry. Net sales to SMARTs major customers, defined as net sales in
excess of 10% of total net sales or those who have outstanding customer accounts receivable balance
at the end of each fiscal period of 10% or more of total net accounts receivable, are as follows:
Percent of Net Sales | ||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Customer A |
21 | % | 22 | % | 21 | % | 22 | % | ||||||||
Customer B |
14 | % | 18 | % | 14 | % | 18 | % | ||||||||
Customer C |
17 | % | 13 | % | 17 | % | 12 | % |
As of February 25, 2011, approximately 53%, 20% and 6% of accounts receivable were
concentrated with Customer A, B and C, respectively. As of August 27, 2010, approximately 42%, 26%
and 9% of accounts receivable were concentrated with Customer A, B and C, respectively. The loss of
a major customer or a significant reduction in revenue from a major customer could have a material
adverse effect on the Companys business, financial condition and results of operations.
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NOTE 12 Restructuring
During the second quarter of fiscal 2011, the Company initiated a restructuring plan to close
its Puerto Rico facility as a result of a continuing long-term decline in production at the
location. Charges resulting from the restructuring plan are expected to be between $3.6 million to
$4.0 million and will include severance payments, severance-related benefits, lease costs
associated with the closure of the Puerto Rico facility and other exit costs.
The following table summarizes the restructuring accrual activity for the six months ended
February 25, 2011 (in thousands):
Severance and | ||||||||
Benefits | Total | |||||||
Accrual as of August 27, 2010 |
$ | | $ | | ||||
Restructuring charges |
2,831 | 2,831 | ||||||
Payments |
| | ||||||
Accrual as of February 25, 2011 |
$ | 2,831 | $ | 2,831 | ||||
All severance payments and severance-related benefits accrued as of February 25, 2011 are
expected to be paid by August 2011. Total restructuring costs accrued as of February 25, 2011 are
recorded in accrued liabilities in the accompanying condensed consolidated balance sheets. There
were no restructuring activities for the three months ended February 26, 2010.
NOTE 13 Other Income, net
Other income, net consisted of the following (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Foreign currency gains (losses) |
$ | (45 | ) | $ | 2 | $ | 88 | $ | (48 | ) | ||||||
Gain on legal settlement* |
| 3,044 | | 3,044 | ||||||||||||
Gain on early repayment of long-term debt |
| | | 1,178 | ||||||||||||
Other |
330 | 179 | 747 | 343 | ||||||||||||
Total other income, net |
$ | 285 | $ | 3,225 | $ | 835 | $ | 4,517 | ||||||||
* | In December 2009, the Company received this settlement as a non-active
participant, class member in a class action against certain component suppliers
initiated in 2002. |
Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations |
This Quarterly Report on Form 10-Q, including this Managements Discussion and Analysis of
Financial Condition and Results of Operations, contains forward-looking statements regarding future
events and our future results that are subject to the safe harbors created under the Securities Act
of 1933, as amended (the Securities Act) and the Securities Exchange Act of 1934, as amended (the
Exchange Act). These statements are based on current expectations, estimates, forecasts and
projections about the industries in which we operate and the beliefs and assumptions of our
management. Words such as expects, anticipates, targets, goals, projects, intends,
plans, believes, seeks, estimates, continues, will, may, and variations of such words
and similar expressions are intended to identify such forward-looking statements. In addition, any
statements that refer to projections of our future financial performance, our anticipated trends in
our businesses, and other characterizations of future events or circumstances are forward-looking
statements. Readers are cautioned not to place undue reliance on any forward-looking statements as
these are only predictions and are subject to risks, uncertainties, and assumptions that are
difficult to predict, including those identified elsewhere herein, and those discussed in Part I,
Item 1A, Risk Factors in our Annual Report on Form 10-K for the fiscal year ended August 27, 2010
filed with the SEC on November 3, 2010 as revised in Part II, Item 1A, Risk Factors in our
Quarterly Report on Form 10-Q for the three months ended November 26, 2010 filed with the SEC on
January 4, 2011, as well as in Part II, Item 1A, Risk Factors in this Quarterly Report on Form
10-Q below. Therefore, actual results may differ materially and adversely from those expressed in
any forward-looking statements. We undertake no obligation to revise or update any forward-looking
statements for any reason.
The following discussion should be read in conjunction with our unaudited condensed
consolidated financial statements and notes thereto included elsewhere in this Quarterly Report on
Form 10-Q.
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Overview
We are a leading independent designer, manufacturer and supplier of value added subsystems
sold primarily to Original Equipment Manufacturers (OEMs). Our subsystem products include memory
modules, flash memory cards and other solid state
storage products such as embedded flash and solid state drives or SSDs. We offer our products
to customers worldwide. We also offer custom supply chain services including procurement,
logistics, inventory management, temporary warehousing, kitting and packaging services. Our
products and services are used for a variety of applications in the computing, networking,
communications, printer, storage, aerospace, defense and industrial markets worldwide. Products
that incorporate our subsystems include servers, routers, switches, storage systems, workstations,
personal computers (PCs), notebooks, printers and gaming machines.
Generally, increases in overall demand by end users for, and increases in memory or storage
content in products that incorporate our subsystems should have a positive effect on our business,
financial condition and results of operations. Conversely, decreases in product demand should have
a negative effect on our business, financial condition and results of operations. Generally,
declines in DRAM pricing reduce our sales and gross profit margins particularly in our operations
in Brazil due to on-hand inventory purchased when prices were higher, and conversely, increases in
DRAM pricing have the opposite effect. We cannot predict when DRAM price declines will occur, how
severe the declines will be and for how long the periods of decline will last and conversely, we
cannot predict when DRAM price increases will occur, by how much they will increase or for how long
the periods of increase will last. In a declining DRAM pricing environment, our specialty memory
business outside of Brazil can also be adversely impacted when customers slow their purchases and
reduce inventory as there is usually excess product availability and customers wait to see if
prices on these products will decline. We are somewhat insulated from volatility in DRAM pricing on
our specialty memory products because a substantial portion of this business involves legacy DRAM
which has less price volatility. In addition, the specialty modules that we sell to our customers
incorporate DRAM components acquired at market prices and include substantial value added features
such as custom or semi-custom design, thermal analysis, unique testing, application integration,
signal integrity analysis, different form factors and high density packaging, which also results in
less price volatility.
Our business was originally founded in 1988 as SMART Modular Technologies, Inc. (SMART
Modular) and SMART Modular became a publicly traded company in 1995. Subsequently, SMART Modular
was acquired by Solectron Corporation (Solectron) in 1999 and operated as a subsidiary of
Solectron. In April 2004, a group of investors led by TPG, Francisco Partners and Shah Capital
Partners acquired SMART Modular from Solectron (the Acquisition), at which time we began to
operate our business as an independent company under the name SMART Modular Technologies (WWH),
Inc. incorporated under the laws of the Cayman Islands. In February 2006, SMART again became a
publicly traded company.
Since the Acquisition, we have repositioned our business by focusing on delivery of certain
higher value added products, diversifying our end markets and our capabilities, extending into new
vertical markets, creating more technically engineered products and solutions, migrating
manufacturing to low cost regions and controlling expenses. In fiscal 2006, we completed a new
manufacturing facility in Atibaia, Brazil where we import finished wafers, package them into memory
integrated circuits and build memory modules. In fiscal 2008, we acquired Adtron Corporation
(Adtron), a leading designer and global supplier of high performance and high capacity SSDs for
the defense, aerospace and industrial markets which we renamed to SMART Modular Technologies (AZ),
Inc. In fiscal 2010, we expanded our development of SSD products and expect to continue to do so in
fiscal 2011 to address the significant growth opportunities in the enterprise market. Also in
fiscal 2010, we invested in our Brazilian operations to launch initial flash production in fiscal
2011.
We operate in one reportable segment: the design, manufacture, and sale of electronic
subsystem products and services to various sectors of the electronics industry. The Companys chief
operating decision-maker, the President and CEO, evaluates financial performance on a company-wide
basis. In April 2010, we sold our display business for net proceeds of $2.2 million and incurred a
loss of $0.5 million in the third quarter of fiscal 2010. Managements decision to exit display and
embedded products was based on a determination that the market for these products was not scalable
to significant revenue growth by the Company. These non-core product lines accounted for only three
percent or less of net sales for each of the five fiscal quarters prior to the sale of the display
business and therefore we do not believe that exiting these product lines had a material impact on
our sales, operating results or our financial condition. We concluded that the display business
was a business component that did not require separate reporting of its activities under
discontinued operations.
In February 2011, we announced the closure of our Puerto Rico facility as a result of a
continuing long-term decline in production at this facility. In the second quarter of fiscal 2011,
we recognized restructuring charges of $2.8 million for severance and severance-related benefits
which will be primarily paid out during the third quarter of fiscal 2011. In the third quarter of
fiscal 2011, we expect to record additional restructuring charges of between $0.8 to $1.2 million,
consisting of lease exit costs associated with the closure of the Puerto Rico facility and other
exit costs. Our Puerto Rico product lines, which are all non-core products, accounted for five
percent or less of net sales for fiscal 2011 and 2010. Products that we manufacture in our Puerto
Rico facility can be transitioned to our other facilities if necessary; therefore we do not believe
that closing this facility will have a material impact on our sales, operating results or our
financial condition.
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Table of Contents
Key Business Metrics
The following is a brief description of the major components of the key line items in our
financial statements.
Net Sales
We generate product revenues predominantly from sales of our value added subsystems, including
memory modules, flash memory cards and other solid state storage products, principally to leading
computing, networking, communications, printer, storage, aerospace, defense and industrial OEMs.
Sales of our products are generally made pursuant to purchase orders rather than long-term
commitments. We generate service revenue from a limited number of customers by providing
procurement, logistics, inventory management, temporary warehousing, kitting and packaging
services. Our net sales are dependent upon demand in the end markets that we serve and fluctuations
in end-user demand can have a rapid and material effect on our net sales. Furthermore, sales to
relatively few customers have accounted for, and we expect will continue to account for, a
significant percentage of our net sales in the foreseeable future.
Cost of Sales
The most significant components of cost of sales are materials, fixed manufacturing costs,
labor, depreciation, freight, and customs charges. Increases in capital expenditures may increase
our future cost of sales due to higher levels of depreciation expense. Cost of sales also includes
any inventory write-downs. We may write down inventory for a variety of reasons, including
obsolescence, excess quantities and declines in market value to below our cost.
Research and Development Expenses
Research and development expenses consist primarily of the costs associated with the design
and testing of new products. These costs relate primarily to compensation of personnel involved
with development efforts, materials and outside design and testing services. Our customers
typically do not separately compensate us for design and engineering work involved in the
development of custom products.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of personnel costs, including
salaries, bonuses, commissions and benefits, facilities and non-manufacturing equipment costs,
allowances for bad debt, costs related to advertising and marketing and other support costs
including utilities, insurance and professional fees.
Critical Accounting Policies
Managements Discussion and Analysis of Financial Condition and Results of Operations is based
on our financial statements which have been prepared in accordance with accounting principles
generally accepted in the United States. The preparation of these financial statements requires us
to make certain estimates that affect the reported amounts in our financial statements. We evaluate
our estimates on an ongoing basis, including those related to our net sales, inventories, asset
impairments, restructuring charges, income taxes, stock-based compensation and commitments and
contingencies. We base our estimates on historical experience and on various other assumptions that
we believe to be reasonable under the circumstances. Actual results may differ from these
estimates under different assumptions or conditions.
We believe the following critical accounting policies are the most significant to the
presentation of our financial statements and they at times require the most difficult, subjective
and complex estimates.
Revenue Recognition
Our product revenues are predominantly derived from the sale of value added subsystems,
including memory modules, flash memory cards and solid state storage products, which we design and
manufacture. We recognize revenue when persuasive evidence of an arrangement exists, 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 of the goods. Amounts billed to customers related to shipping and handling are classified as
sales, while costs incurred by us for shipping and handling are classified as cost of sales.
Taxes, including value added taxes, assessed by a government authority that are both imposed on and
concurrent with a specific revenue producing transaction are excluded from revenue.
Our service revenues are derived from procurement, logistics, inventory management, temporary
warehousing, kitting and packaging services. The terms of our contracts vary, but we generally
recognize service revenue upon the completion of the contracted services. Our service revenue is
accounted for on an agency basis. Service revenue for these arrangements is typically based on
material procurement costs plus a fee for the services provided. We determine whether to report
revenue on a net or gross basis depending on a number of factors, including whether we are the
primary obligor in the arrangement, have general inventory risk, have the ability to set the price,
have the ability to determine who the suppliers are, can physically change the product, or have
credit risk. Under some service arrangements, we retain inventory risk. All inventories held under
service arrangements are included in the inventories reported on the accompanying condensed
consolidated balance sheets.
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Table of Contents
The following is a summary of our gross billings to customers and net sales for services and
products (in thousands):
Three Months Ended | Six Months Ended | |||||||||||||||
February 25, | February 26, | February 25, | February 26, | |||||||||||||
2011 | 2010 | 2011 | 2010 | |||||||||||||
Service revenue, net |
$ | 9,586 | $ | 9,790 | $ | 20,072 | $ | 17,742 | ||||||||
Cost of sales service (1) |
252,955 | 211,390 | 481,323 | 364,994 | ||||||||||||
Gross billings for services |
262,541 | 221,180 | 501,395 | 382,736 | ||||||||||||
Product net sales |
160,963 | 150,320 | 366,836 | 265,461 | ||||||||||||
Gross billings to customers |
$ | 423,504 | $ | 371,500 | $ | 868,231 | $ | 648,197 | ||||||||
Product net sales |
$ | 160,963 | $ | 150,320 | $ | 366,836 | $ | 265,461 | ||||||||
Service revenue, net |
9,586 | 9,790 | 20,072 | 17,742 | ||||||||||||
Net sales |
$ | 170,549 | $ | 160,110 | $ | 386,908 | $ | 283,203 | ||||||||
(1) | Represents cost of sales associated with service revenue reported on a net
basis. |
Accounts Receivable
We evaluate the collectability of accounts receivable based on several factors. When we are
aware of circumstances that may impair a specific customers ability to meet its financial
obligations, we record a specific allowance against amounts due, and thereby reduce the net
recognized receivable to the amount we reasonably believe will be collected. Increases to the
allowance for sales returns or credits are offset against the revenue. Increases to the allowance
for bad debt are recorded as a component of general and administrative expenses. For all other
customer accounts receivable, we record an allowance 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.
As a result of the macroeconomic environment and associated credit market conditions, both
liquidity and access to capital have impacted some of our customers. We have continued to closely
monitor our credit exposure with our customers to anticipate exposures and manage our risk.
Inventory Valuation
We evaluate our inventories for excess quantities and obsolescence. This evaluation includes
analyses of sales levels by product family. Among other factors, we consider historical demand and
forecasted demand in relation to the inventory on hand, competitiveness of product offerings,
market conditions and product life cycles when determining obsolescence and net realizable value.
We adjust the carrying values to approximate the lower of our manufacturing cost or net realizable
value. Inventory cost is determined on a specific identification basis and includes material, labor
and manufacturing overhead. From time to time, our customers may request that we purchase and
maintain significant inventory of raw materials for specific programs. Such inventory purchases are
evaluated for excess quantities and potential obsolescence and could result in a provision at the
time of purchase or subsequent to purchase. Inventory levels may fluctuate based on inventory held
under service arrangements. Our provisions for excess and obsolete inventory are also impacted by
our arrangements with our customers and/or suppliers, including our ability or inability to sell
such inventory. If actual market conditions or our customers product demands are less favorable
than those projected or if our customers or suppliers are unwilling or unable to comply with any
arrangements related to their purchase or sale of inventory, additional provisions may be required
and would have a negative impact on our gross margins in that period. We have had material
inventory write-downs in the past for reasons such as obsolescence, excess quantities and declines
in market value below our costs, and we may be required to do so from time to time in the future.
Income Taxes
We use the asset and liability method of accounting for income taxes. Deferred tax assets and
liabilities are recognized for the future consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and their respective tax
basis and net operating loss and credit carryforwards. When necessary, a valuation allowance is
recorded or reduced to value tax assets to amounts expected to be realized. The effect of changes
in tax rates is recognized in the period in which the rate change occurs. U.S. income and foreign
withholding taxes are not provided on that portion of unremitted earnings of foreign subsidiaries
that are expected to be reinvested indefinitely.
After excluding ordinary losses in a tax jurisdiction for which no tax benefit can be
recognized, we estimate our annual effective tax rate and apply such rate to year-to-date income,
adjusting for unusual or infrequent items that are treated as discrete events in the period. We
also evaluate our valuation allowance to determine if a change in circumstances causes a change in
judgment regarding realization of deferred tax assets in future years. If the valuation allowance
is adjusted as a result of a change in judgment regarding future years, that adjustment is recorded
in the period of such change affecting our tax expense in that period.
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The calculation of our tax liabilities involves accounting for uncertainties in the
application of complex tax rules, regulations and practices. We recognize benefits for uncertain
tax positions based on a two-step process. The first step is to evaluate the tax position for
recognition of a benefit (or the absence of a liability) by determining if the weight of available
evidence indicates that it is more likely than not that the position taken will be sustained upon
audit, including resolution of related appeals or litigation processes, if any. If it is not, in
our judgment, more likely than not that the position will be sustained, we do not recognize any
benefit for the position. If it is more likely than not that the position will be sustained, a
second step in the process is required to estimate how much of the benefit we will ultimately
receive. This second step requires that we estimate and measure the tax benefit as the largest
amount that is more than 50 percent likely of being realized upon ultimate settlement. It is
inherently difficult and subjective to estimate such amounts. We reevaluate these uncertain tax
positions on a quarterly basis. This evaluation is based on a number of factors including, but not
limited to, changes in facts or circumstances, changes in tax law, new facts, correspondence with
tax authorities during the course of an audit, effective settlement of audit issues, and
commencement of new audit activity. Such a change in recognition or measurement could result in
the recognition of a tax benefit or an additional charge to the tax provision in the period.
Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed
We review our long-lived assets for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to
be held and used is measured by a comparison of the carrying amount of an asset to the future
undiscounted cash flows expected to be generated by the asset. If such assets are considered to be
impaired, the impairment is measured by the amount by which the carrying amount of the assets
exceeds the fair value of the assets. Assets to be disposed are reported at the lower of the
carrying amount or fair value, less cost to sell.
Stock-Based Compensation
We account for stock-based compensation under ASC 718, Compensation Stock Compensation,
which requires us to recognize expenses in our statement of operations related to all share-based
payments, including grants of stock options and RSUs, based on the grant date fair value of such
share-based awards. The key assumptions used in valuing share-based awards are described in Note 2
to the Unaudited Condensed Consolidated Financial Statements.
Results of Operations
The following is a summary of our results of operations for the three and six months ended
February 25, 2011 and February 26, 2010 (in millions):
Three Months Ended(1) | Six Months Ended(1) | |||||||||||||||||||||||||||||||
February 25, | % of | February 26, | % of | February 25, | % of | February 26, | % of | |||||||||||||||||||||||||
2011 | sales | 2010 | sales | 2011 | sales | 2010 | sales | |||||||||||||||||||||||||
Net sales |
$ | 170.5 | 100 | % | $ | 160.1 | 100 | % | $ | 386.9 | 100 | % | $ | 283.2 | 100 | % | ||||||||||||||||
Cost of sales |
142.0 | 83 | % | 118.1 | 74 | % | 314.4 | 81 | % | 212.4 | 75 | % | ||||||||||||||||||||
Gross profit |
28.5 | 17 | % | 42.0 | 26 | % | 72.5 | 19 | % | 70.8 | 25 | % | ||||||||||||||||||||
Research and development |
7.9 | 5 | % | 5.2 | 3 | % | 16.0 | 4 | % | 10.9 | 4 | % | ||||||||||||||||||||
Selling, general and administrative |
15.2 | 9 | % | 14.3 | 9 | % | 30.0 | 8 | % | 27.7 | 10 | % | ||||||||||||||||||||
Restructuring charges |
2.8 | 2 | % | | | 2.8 | 1 | % | | | ||||||||||||||||||||||
Technology access charge |
| | | | 7.5 | 2 | % | | | |||||||||||||||||||||||
Total operating expenses |
25.9 | 15 | % | 19.6 | 12 | % | 56.4 | 15 | % | 38.6 | 14 | % | ||||||||||||||||||||
Income from operations |
2.7 | 2 | % | 22.5 | 14 | % | 16.1 | 4 | % | 32.1 | 11 | % | ||||||||||||||||||||
Interest expense, net |
(0.2 | ) | 0 | % | (1.2 | ) | -1 | % | (0.9 | ) | 0 | % | (2.8 | ) | -1 | % | ||||||||||||||||
Other income, net |
0.3 | 0 | % | 3.2 | 2 | % | 0.8 | 0 | % | 4.5 | 2 | % | ||||||||||||||||||||
Total other income (expense) |
0.1 | 0 | % | 2.1 | 1 | % | (0.1 | ) | 0 | % | 1.7 | 1 | % | |||||||||||||||||||
Income before provision for income taxes |
2.7 | 2 | % | 24.5 | 15 | % | 16.0 | 4 | % | 33.8 | 12 | % | ||||||||||||||||||||
Provision for income taxes |
2.6 | 1 | % | 8.4 | 5 | % | 7.9 | 2 | % | 13.2 | 5 | % | ||||||||||||||||||||
Net income |
$ | 0.2 | 0 | % | $ | 16.1 | 10 | % | $ | 8.1 | 2 | % | $ | 20.7 | 7 | % | ||||||||||||||||
(1) | Summations may not compute precisely due to rounding. |
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Three and Six Months Ended February 25, 2011 as Compared to the Three and Six Months
Ended February 26, 2010
Net Sales
Net sales for the three months ended February 25, 2011 were $170.5 million, a 7% increase from
$160.1 million for the three months ended February 26, 2010. Net sales for the six months ended
February 25, 2011 were $386.9 million, a 37% increase from $283.2 million for the six months ended
February 26, 2010. These increases were primarily due to strength in PC and notebook end-user
demand in Brazil and increased demand for our solid state storage products. Investments to
increase capacity at our Brazil operations have enabled us to meet strong end-user demand by
substantially increasing volume. These unit volume increases offset the decrease in net sales due
to declining DRAM prices during these periods. Our solid state storage products also grew
significantly due to increased demand for our enterprise products, defense products and embedded
flash drives. The increases in net sales were partially offset by decreased net sales from display
and embedded computing products, which we exited in the third quarter of fiscal 2010. We believe
that pricing in the DRAM market appears to have stabilized when compared to the substantial
declines in DRAM pricing we experienced throughout the first six months of fiscal 2011.
Cost of Sales
Cost of sales for the three months ended February 25, 2011 was $142.0 million, a 20% increase
from $118.1 million for the three months ended February 26, 2010. The increase in cost of sales was
primarily due to an $18.9 million increase in the cost of products resulting from the increase in
net sales as discussed above. In addition, our factory overhead and other components of cost of
sales increased by $5.0 million, primarily due to increased volume, especially in Brazil, including
increased depreciation expense of $1.4 million primarily due to our continued capital investment to
expand capacity primarily in Brazil.
Cost of sales for the six months ended February 25, 2011 was $314.4 million, a 48% increase
from $212.4 million for the six months ended February 26, 2010. The increase in cost of sales was
primarily due to a $90.7 million increase in the cost of products resulting from the increase in
net sales as discussed above. Our factory overhead and other components of cost of sales also
increased by $11.2 million, primarily due to increased volume, especially in Brazil, as well as
higher import duties and customs charges and increased depreciation expense of $3.4 million
primarily due to our continued capital investment to expand capacity primarily in Brazil.
Gross Profit
Gross profit for the three months ended February 25, 2011 was $28.5 million, a 32% decrease
from $42.0 million for the three months ended February 26, 2010. The decrease in gross profit was
primarily due to the fact that our Brazil modules pricing adjusts faster than our inventory,
partially offset by volume increases as described above. Gross profit for the six months ended
February 25, 2011 was $72.5 million, a 2% increase from $70.8 million for the six months ended
February 26, 2010. The increase in gross profit was primarily due to higher net sales as explained
above, significantly offset by the rapid decline in the DRAM module selling prices as previously
discussed.
Gross profit percentage decreased to 17% for the three months ended February 25, 2011 from 26%
for the three months ended February 26, 2010. Gross profit percentage decreased to 19% for the six
months ended February 25, 2011 from 25% for the six months ended February 26, 2010. These decreases
in gross profit percentage were primarily due to increased cost of products as a percentage of net
sales resulting from the rapid decline in DRAM prices which reduced the selling prices of our
modules in Brazil. In addition, gross profit percentage was also negatively impacted by an
unfavorable mix of products sold during the periods.
Research and Development Expenses
Research and development (R&D) expenses for the three months ended February 25, 2011 were
$7.9 million, a 50% increase from $5.2 million for the three months ended February 26, 2010. R&D
expenses for the six months ended February 25, 2011 were $16.0 million, a 46% increase from $10.9
million for the six months ended February 26, 2010. These increases were primarily due to increased
spending on development of enterprise SSDs, which included $0.7 million and $2.0 million of R&D
expenses incurred under a development agreement with a strategic partner for the three and six
months ended February 25, 2011, respectively, as well as higher payroll and other employee-related
expenses due to a significant increase in R&D headcount, partially offset by lower bonus expense.
During the balance of fiscal 2011, we expect to further increase R&D spending on enterprise SSDs
and to initiate spending on our recently announced corporate R&D center in Brazil.
Selling, General and Administrative Expenses
Selling, general and administrative (SG&A) expenses for the three months ended February 25,
2011 were $15.2 million, a 6% increase from $14.3 million for the three months ended February 26,
2010. Sales and marketing expenses decreased by $0.2 million primarily due to lower payroll and
other employee-related expenses resulting from decreased headcount, partially offset by higher
commissions resulting from the growth in sales. General and administrative expenses increased $1.1
million primarily due to higher professional services, mostly relating to our implementation of the Brazilian
government investment incentive program known as PADIS, as well as increased
payroll and other employee-related expenses and increased stock-based compensation expense, all
partially offset by lower bonus expense.
SG&A expenses for the six months ended February 25, 2011 were $30.0 million, an 8% increase
from $27.7 million for the six months ended February 26, 2010. Sales and marketing expenses
increased by $0.3 million primarily due to higher commissions resulting from the growth in sales,
partially offset by lower bonus expense. General and administrative expenses increased $2.0
million primarily due to increased payroll and other employee-related expenses, higher professional
services mostly in Brazil, and increases in stock-based compensation expense, all partially offset
by lower bonus expense.
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Restructuring Charges
During the second quarter of fiscal 2011, the Company initiated a restructuring plan to close
its Puerto Rico facility as a result of a continuing long-term decline in production at the
location. Charges resulting from the restructuring plan are expected to be between $3.6 million to
$4.0 million and will include severance payments, severance-related benefits, lease exit costs
associated with the closure of the Puerto Rico facility and other exit costs. In the three months
ended February 25, 2011, we recognized restructuring costs of $2.8 million for severance and
severance-related benefits, which will be primarily paid out during the third quarter of fiscal
2011. There were no restructuring charges in the three and six months ended February 26, 2010.
Technology Access Charge
A one-time technology access charge of $7.5 million for the six months ended February 25, 2011
was incurred to gain access to in-process technology in order to accelerate our development of
enterprise SSDs. Please refer to Note 9 of our Notes to Unaudited Condensed Consolidated Financial
Statements for additional detail.
Interest Expense, net
Net interest expense for the three months ended February 25, 2011 was $0.2 million compared to
$1.2 million for the three months ended February 26, 2010. The decrease in net interest expense
was primarily due to a $0.6 million decrease in interest expense mostly resulting from the
expiration of an interest swap agreement in April 2010, as well as a $0.3 million increase in
interest income due to higher amounts on deposit.
Net interest expense for the six months ended February 25, 2011 was $0.9 million compared to
$2.8 million for the six months ended February 26, 2010. The decrease in net interest expense was
primarily due to a $1.8 million decrease in interest expense resulting from lower outstanding
long-term debt and the expiration of an interest swap agreement in April 2010.
Other Income, net
Net other income for the three months ended February 25, 2011 was $0.3 million compared to
$3.2 million for the three months ended February 26, 2010. Net other income for the six months
ended February 25, 2011 was $0.8 million compared to $4.5 million for the six months ended February
26, 2010. These decreases were largely due to a $3.0 million gain from a legal settlement in the
second quarter of fiscal 2010 and a $1.2 million gain on the partial repurchase of a portion of our
long-term debt in the first quarter of fiscal 2010, both of which did not recur in fiscal 2011.
Provision for Income Taxes
The effective tax rates for the three months ended February 25, 2011 and February 26, 2010
were approximately 94% and 34%, respectively. The effective tax rates for the six months ended
February 25, 2011 and February 26, 2010 were approximately 49% and 39%, respectively. The increase
in the effective tax rate for both the three and six month periods was primarily due to an increase
in losses in the U.S. and Puerto Rico (including restructuring charges) that provided no tax
benefit and a decline of income being generated in non-U.S. tax jurisdictions that are subject to
lower tax rates.
Liquidity and Capital Resources
Our principal sources of liquidity are cash flows from operations and borrowings under our
senior secured floating rate notes that remain outstanding. We also have an unutilized senior
secured line of credit facility available. Our principal uses of cash and capital resources are
debt service requirements as described below, capital expenditures, potential acquisitions,
research and development expenditures and working capital requirements. From time to time,
surplus cash may be used to pay down long-term debt to reduce interest expense.
Cash and cash equivalents consist of funds held in demand deposit accounts, money market funds
and certificates of deposit. Cash is held in multiple jurisdictions outside the United States.
There are no significant restrictions or tax costs on the transfer of or repatriation of such
assets.
Debt Service
As of February 25, 2011, we had total long-term indebtedness of $55.1 million, which
represents the aggregate principal amount outstanding under the Notes (defined below) that remain
outstanding.
Senior Secured Floating Rate Exchange Notes Due April 2012 (the Notes). As of February 25,
2011, the Notes bear an interest rate of 5.80%, which is equal to LIBOR plus 5.50% per annum, and
are guaranteed by most of our subsidiaries. The interest rate is reset quarterly. The guarantees
are secured on a second-priority basis by the capital stock of, or equity interests in, most of our
subsidiaries and substantially all of our and most of our subsidiaries assets. Interest on the
Notes is payable quarterly in cash. The Notes contain customary covenants and events of default,
including covenants that limit our ability to incur debt, pay dividends and make investments. We
were in compliance with such covenants as of February 25, 2011.
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Senior Secured Revolving Line of Credit Facility. The Company has a senior secured credit
facility in the amount of $35 million with Wells Fargo Bank. On April 30, 2010, the Third Amendment
to Second Amended and Restated Loan and Security Agreement (the Third Amendment) was entered into
by and among SMART Modular Technologies, Inc., SMART Modular Technologies (Europe) Limited, and
SMART Modular Technologies (Puerto Rico), Inc., as borrowers (the Borrowers), and Wells Fargo
Bank, National Association, as arranger, administrative agent and security trustee for the Lenders
named therein. The Second Amended and Restated Loan and Security Agreement dated April 30, 2007, as
amended by the First Amendment dated November 26, 2008, the Second Amendment dated August 14, 2009
and the Third Amendment dated April 30, 2010, is referred to as the WF Credit Facility. The WF
Credit Facility is jointly and severally guaranteed on a senior basis by all of our
subsidiaries, subject to limited exceptions. In addition, the WF Credit Facility and the
guarantees are secured by the capital stock of, or equity interests in, most of the Companys
subsidiaries and substantially all of the Companys and most of its subsidiaries assets. As a
result of the Third Amendment, the Maturity Date, as defined in the WF Credit Facility, was
extended to April 30, 2012, and the Company is again required to comply with certain financial
covenants as modified and as set forth in the WF Credit Facility. The Base Rate Margin and LIBOR
Rate Margin, as defined in the WF Credit Facility, were changed to 1.25% and 2.25%, respectively.
While the Company was in compliance with the financial covenants required to borrow funds under the
WF Credit Facility as of February 25, 2011 and expects to be able to satisfy such financial
covenants in the future, we may not meet the financial covenants during all periods. If we do not
meet the financial covenants or financial condition test, we will be in default of the WF Credit
Facility and, among other things, we will be unable to borrow under the WF Credit Facility if and
when we need the funds in the future. We have not borrowed under the WF Credit Facility since
November 2007 and we had no borrowings outstanding as of February 25, 2011.
Capital Expenditures
We expect that future capital expenditures will primarily focus on our Brazil operations,
establishing our corporate research and development center in Brazil, manufacturing equipment
upgrades and/or acquisitions, IT infrastructure and software upgrades. The WF Credit Facility
contains restrictions on our ability to make capital expenditures. Based on current estimates, we
believe that the amount of capital expenditures permitted to be made under the WF Credit Facility
will be adequate to implement our current plans.
Sources and Uses of Funds
On October 13, 2009, the Board of Directors approved up to $25.0 million, excluding unpaid
accrued interest, to repurchase and/or redeem a portion of the outstanding Notes. On October 22,
2009, using available cash, we repurchased and retired $26.2 million of aggregate principal amount
of Notes for $25.0 million; at 95.5% of the principal or face amount. As of February 25, 2011, the
aggregate principal amount under the Notes that remain outstanding was $55.1 million which is due
April 2012. We may, however, repurchase additional Notes prior to this maturity.
In Brazil, an ICMS Special Ruling tax benefit received from the Sao Paulo State tax
authorities expired on March 31, 2010. Even though we filed a timely application for renewal with
the appropriate authorities on January 27, 2010, the renewal was not received until August 4, 2010.
As a result, starting on April 1, 2010, we began accruing excess ICMS credits. On June 22, 2010,
the Sao Paulo tax authorities published a regulation allowing companies that applied for a timely
renewal of an ICMS Special Ruling to continue utilizing the benefit until a final conclusion on the
renewal request was rendered. For the period April 1, 2010 through June 22, 2010, SMART Brazil was
required to pay ICMS taxes on imports for which we received related tax credits. As of February
25, 2011, we had a balance of $16.2 million (or 27.0 million BRL) of ICMS credits which we expect
to recover over a period of time through fiscal 2013. It is expected that $4.0 million (or 6.6
million BRL) of the ICMS credits will be recovered during the next twelve months, with the
remainder of $12.2 million (or 20.4 million BRL) being recovered primarily in fiscal 2012 and 2013.
Please refer to Contingencies under Note 9 of our Notes to Unaudited Condensed Consolidated
Financial Statements for more details.
We anticipate that our existing cash and anticipated cash generated from operations will be
sufficient to meet our working capital needs, fund our R&D and capital expenditures, and service
the requirements on our debt obligations for at least the next 12 months. Our ability to fund our
cash requirements or to refinance our indebtedness beyond the next 12 months will depend upon our
future operating performance, which will be affected by general economic, financial, competitive,
business and other factors beyond our control.
From fiscal 2004 through fiscal 2009, our annual capital expenditures were 3% or less of net
sales. In fiscal 2010, our capital expenditures were 4% of net sales due to capacity expansion and
the initiation of flash packaging in Brazil. In fiscal 2011, we expect our capital expenditures to
be approximately 4% of net sales primarily due to our Brazil operations, establishing our corporate
research and development center in Brazil, manufacturing equipment upgrades and/or acquisitions, IT
infrastructure and software upgrades.
From time to time, we may explore financing options in order to fund cash flow requirements
for internal growth, to repay existing indebtedness, and/or to fund any future acquisitions. This
additional funding could include additional share issuances and/or debt financing or a combination
thereof. There can be no assurance that additional funding will be available to us on acceptable
terms or at all.
Historical Trends
Historically, our financing requirements have been funded primarily through cash generated by
operating activities. As of February 25, 2011, our cash and cash equivalents were $134.4 million.
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Cash Flows from Operating Activities. Net cash provided by operating activities of $29.0
million for the six months ended February 25, 2011 was primarily comprised of $8.1 million from net
income, $17.1 million from non-cash expenses and $3.7 million from changes in our operating assets
and liabilities. The $3.7 million change in operating assets and liabilities includes cash
generated from a reduction in accounts receivable of $24.0 million and an inventory decrease of
$17.1 million. The reduction
in accounts receivable was mostly due to improved collections. In addition, both the accounts
receivable and inventory decreases were related to lower gross sales during the second quarter of
fiscal 2011. This was partially offset by cash used for a decrease in accounts payable of $31.0
million, a decrease in accrued liabilities of $2.3 million and an increase in prepaid expenses and
other assets of $4.0 million. The decrease in accounts payable was primarily due to reduced
inventory purchases, as well as increased early payment discounts taken during the period.
Net cash provided by operating activities of $4.9 million for the six months ended February
26, 2010 was primarily comprised of $20.7 million of net income and $9.8 million of non-cash
related expenses, offset by a $25.6 million change in our net operating assets and liabilities.
The $25.6 million change in operating assets and liabilities includes an increase in accounts
receivable of $50.4 million, an inventory increase of $27.8 million and an increase in prepaid
expenses and other assets of $4.9 million. The increase in accounts receivable was primarily due to
increased gross sales, as well as slower collections resulting from the Chinese New Year holidays
in February 2010. The increase in inventory was mainly due to our positioning in a shortage market,
as well as to prepare for increases in demand for our logistics business. Cash used in the period
was partially offset by cash generated from increases in accounts payable of $48.3 million and an
increase in accrued expenses and other liabilities of $9.2 million.
Cash Flows from Investing Activities. Net cash used in investing activities of $13.0 million
for the six months ended February 25, 2011 was primarily due to purchases of $12.3 million in
property and equipment and $0.6 million of cash deposits on equipment. Net cash used in investing
activities of $9.8 million for the six months ended February 26, 2010 was primarily due to
purchases of $8.0 million in property and equipment and $2.1 million of cash deposits on equipment,
partially offset by proceeds from sales of property and equipment of $0.3 million.
Cash Flows from Financing Activities. Net cash provided by financing activities of $2.4
million for the six months ended February 25, 2011 was due to proceeds from ordinary share
issuances through option exercises. Net cash used in financing activities of $24.3 million for the
six months ended February 26, 2010 was primarily due to $25.0 million used for the partial
repurchase of the Notes, partially offset by $0.7 million provided by proceeds from ordinary share
issuances through option exercises.
Contractual Obligations
There have been no material changes to contractual obligations previously disclosed in our
Annual Report on Form 10-K for the year ended August 27, 2010.
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, revenues or
expenses, results of operations, liquidity, capital expenditures or capital resources.
Inflation
We do not believe that inflation has had a material effect on our business, financial
condition or results of operations. If our costs were to become subject to significant inflationary
pressures, we may not be able to fully offset such higher costs through price increases. Our
inability or failure to do so could adversely affect our business, financial condition and results
of operations.
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.
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Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
Our exposure to market rate risk includes risk of foreign currency exchange rate fluctuations
and changes in interest rates.
Foreign Exchange Risks
We are subject to inherent risks attributed to operating in a global economy. Our
international sales and our operations in foreign countries subject us to risks associated with
fluctuating currency values and exchange rates. Because sales of our products are denominated
mainly in United States dollars, increases in the value of the United States dollar could increase
the price of our products so that they become relatively more expensive to customers in a
particular country, possibly leading to a reduction in sales and profitability in that country.
Some of the sales of our products are denominated in foreign currencies. Gains and losses on the
conversion to U.S. dollars of accounts receivable arising from such sales, and of other associated
monetary assets and liabilities, may contribute to fluctuations in our results of operations. In
addition, we have certain costs that are denominated in foreign currencies, and decreases in the
value of the U.S. dollar could result in increases in such costs that could have a material adverse
effect on our results of operations. We do not currently purchase financial instruments to hedge
foreign exchange risk, but may do so in the future.
Interest Rate Risk
We are subject to interest rate risk in connection with our long-term debt of $55.1 million
under the Notes that remain outstanding as of February 25, 2011. Although we did not have any
balances outstanding as of February 25, 2011 under our WF Credit Facility, this facility provides
for borrowings of up to $35 million that would also bear interest at variable rates. Assuming that
we will satisfy the financial covenants required to borrow and that the WF Credit Facility is fully
drawn, other variables are held constant and the impact of any hedging arrangements is excluded,
each 1.0% increase in interest rates on our variable rate borrowings would result in an increase in
annual interest expense and a decrease in our cash flow and income before taxes of $0.9 million per
year.
Item 4. | Controls and Procedures |
(a) Evaluation of Disclosure Controls and Procedures. Our President and Chief Executive
Officer and our Senior Vice President and Chief Financial Officer, after evaluating the
effectiveness of the Companys disclosure controls and procedures (as defined in the Exchange Act
Rules 13a-15(e) or 15d-15(e)) as of the end of the period covered by this quarterly report, have
concluded that our disclosure controls and procedures are effective based on their evaluation of
these controls and procedures required by paragraph (b) of Exchange Act Rules 13a-15 or 15d-15.
(b) Changes in Internal Control Over Financial Reporting. There were no changes in our
internal control over financial reporting identified in connection with the evaluation required by
paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during our last fiscal quarter
that has materially affected, or is reasonably likely to materially affect, our internal control
over financial reporting.
PART II. OTHER INFORMATION
Item 1. | Legal Proceedings |
See Note 9 of our Notes to Unaudited Condensed Consolidated Financial Statements for
information regarding legal matters.
Item 1A. | Risk Factors |
There have been no material changes from the risk factors previously disclosed in our Annual
Report on Form 10-K for the year ended August 27, 2010 that was filed on November 3, 2010 and in
our Quarterly Report on Form 10-Q for the three months ended November 26, 2010 that was filed on
January 4, 2011, except for the risk factors below which have been updated as follows:
Worldwide political conditions, civil unrest, armed conflicts and threats of terrorist attacks may
adversely affect our business, the cost of and demand for our products and our results of
operations.
The occurrence or threat of terrorist attacks may in the future adversely affect the cost of
and demand for our products. In addition, such attacks may negatively affect our operations
directly or indirectly and such attacks or other armed conflicts may directly impact our physical
facilities or those of our suppliers or customers. Such attacks may make travel and the
transportation of our products more difficult and more expensive, ultimately having a negative
effect on our business.
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Also, any armed conflicts around the world, including current tensions and/or hostilities in
the Korean Peninsula, could have a substantial impact on our sales, our supply chain and our
ability to deliver products to our customers. Political and economic instability, civil unrest and
armed conflicts in some regions of the world including Libya and the Middle East and their effect
on the price of oil could also have a negative impact on the cost of our products and on our
business in general. More generally, various events could cause consumer confidence and spending to
decrease or result in increased volatility to the U.S. and the worldwide economies.
Any such occurrences could have a material adverse effect on our business, our results of
operations and our financial condition.
Natural disasters in certain regions could adversely affect our supply chain which, in turn, could
have a negative impact on our business, the cost of and demand for our products and our results of
operations.
The occurrence of natural disasters in certain regions, such as the recent earthquake and
tsunami in Japan, could have a substantial negative impact on our supply chain, our ability to
deliver products to our customers and on the cost of and demand for our products. These events
could cause consumer confidence and spending to decrease or result in increased volatility to the
U.S. and worldwide economies. Any such occurrences could have a material adverse effect on our
business, our results of operations and our financial condition.
Our dependence on a small number of sole or limited source suppliers and technology partners
subjects us to certain risks and our results of operations would be materially and adversely
affected if we are unable to obtain adequate supplies and technology development in a timely
manner.
We depend on a small number of sole or limited source suppliers and technology partners for
certain materials and technology, including critical components and technologies that we use or
intend to use in manufacturing and/or developing our products. We purchase almost all of our
materials from our suppliers on a purchase order basis and generally do not have long-term
commitments from suppliers. Our suppliers are not required to supply us with any minimum quantities
and there is no assurance that our suppliers will supply the quantities of components we may need
to meet our production goals. Our major suppliers include Hynix, Micron, Elpida and Samsung. Since
a large percentage of our purchases are from a small number of major suppliers, these suppliers are
able to exert, have exerted, and we expect they will continue to exert, pressure on us with respect
to pricing and purchasing practices which pressures can adversely affect our business, our results
of operations and our financial condition.
The markets in which we operate have experienced, and may experience in the future, shortages
in components. These shortages cause some suppliers to place their customers, including us, on
component allocation. As a result, we may not be able to obtain the components that we need to
fill customer orders. Furthermore, if any of our suppliers experience quality control or
intellectual property infringement problems, we may not be able to fill customer orders. Similarly,
if any of our technology partners are unable to successfully complete development of expected
technologies, or their developed technologies experience quality control or intellectual property
infringement or other problems, we may not be able to fill customer orders and may not recoup the
investments and expenses incurred in the development of the relevant technology. For example, in
the first half of fiscal 2011, we recognized a technology access charge of $7.5 million as well as
R&D expenses of $2.0 million associated with a development project with a technology partner to
accelerate the development of our SSD products. There could be significant additional costs
incurred before the relevant technology is developed into a commercially viable product, and the
feasibility associated with the relevant technology has not yet been established and may never be
established. Additionally, we have no alternative use for the relevant technology as the access
and use of the technology is restricted only to this development project. There is no guarantee
that this development project or other similar projects will be successful such that we can recoup
the expenses and investments associated with such efforts. Furthermore, our products that utilize
components from a supplier or technology partner that has quality, infringement or performance
issues may be disqualified by one or more of our customers and we may not be able to fill orders
from those customers. The inability to fill customer orders could cause delays, customer
cancellations, disruptions or reductions in product shipments or require product redesigns and/or
re-qualifications which could, in turn, damage relationships with current or prospective customers,
increase costs or prices and have a material adverse effect on our business, results of operations
and financial condition. The failure of performance or acceptance of developed technologies can
also result in write-offs of investments in research and development.
If one of our suppliers or technology partners were to be acquired by a competitor, that could
result in a disruption or termination of a key source of supply. A disruption in or termination of
a supply relationship or a technology partnership, by acquisition or otherwise, with any of our
significant suppliers or technology partners, or our inability to develop relationships with new
suppliers or technology partners, if required, would cause delays, disruptions or reductions in
product manufacturing and shipments or require product redesigns which could damage relationships
with our customers, increase our costs or the prices of our products and materially and adversely
affect our business, our results of operations and our financial condition.
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New product development, particularly our solid state storage products, requires significant
investment and if we fail to develop new or enhanced products and introduce them in a timely
manner, this could have a material adverse impact on our competitiveness, our results of operations
and our financial condition.
The markets in which we compete are subject to rapid technological change, product
obsolescence, frequent new product introductions and feature enhancements, changes in end-user
requirements, and evolving industry standards. Our ability to successfully compete in these markets
and to continue to grow our business depends in significant part upon our ability to develop,
introduce and sell new and enhanced products on a timely and cost-effective basis, and to
anticipate and respond to changing customer requirements. More specifically, the solid state
storage industry is an emerging industry with several different technology platforms each of which
has significant costs of entry. We are a relatively new entrant into the solid state storage
industry and have limited experience in this market. We have experienced, and may experience in the
future, delays and unanticipated expenses in the development and introduction of new products. A
failure to develop products with required feature
sets or performance standards, or a delay as short as a few months in bringing a new product
to market could significantly reduce our net sales which would have a material adverse effect on
our business, our results of operations and our financial condition.
Delays in the development, introduction and qualification of new products could provide a
competitor a first-to-market opportunity and allow a competitor to achieve greater market share or
permit a customer to cancel orders without penalty. Defects or errors found in our products after
commencement of commercial shipment could result in delays in market acceptance of these products.
Lack of market acceptance for our new products for any reason would jeopardize our ability to
recoup substantial research and development expenditures, hurt our reputation and have a material
adverse effect on our business, our results of operations and our financial condition. Accordingly,
there can be no assurance that our future product development efforts will be successful or result
in products that gain market acceptance. We have supported in the past and expect in the future to
support new technologies and emerging markets. If these new technologies and emerging markets fail
to gain acceptance or grow, this would have a material adverse effect on our business, our results
of operations and our financial condition.
In particular, we have made and expect to continue to make in the future, significant
investments in SSDs and other solid state storage products through research and development and
other expenditures. Substantially all of our investments to date in research and development and
other expenditures with respect to enterprise SSDs have been focused on a limited set of customers.
Lack of acceptance, for any reason, of our new products by these customers upon whom we are
initially depending would jeopardize our ability to recoup substantial research and development
expenditures and would damage our reputation. While we believe that our investments in solid state
storage will enable us to participate in several important growth markets, there is significant
competition in these markets and there can be no assurance that the products we develop and
introduce will be timely, will gain any market acceptance or will result in any significant
increase in our net sales. If these investments fail to provide the expected returns this would
have a material adverse effect on our business, our results of operations and our financial
condition.
Industry consolidation and company failures could adversely affect our business by reducing the
number of potential customers, increasing our reliance on our existing key customers, reducing the
competitiveness of our supplier base and/or increasing the competitive advantages of our
competitors.
Some participants in the industries which we serve have merged and/or been acquired and this
trend may continue. In addition, there have been company failures among both our customer and
supplier base. Industry consolidation and company failures will likely decrease the number of
potential significant customers for our products and services. The decrease in the number of
significant customers will increase our reliance on key customers and, due to the increased size of
these companies, may negatively impact our bargaining position and thus our profit margins.
Consolidation and company failures in some of our customers industries may result in the loss of
customers. The loss of, or a reduced role with, key customers due to industry consolidation and
company failures could negatively impact our business, our results of operations and our financial
condition.
Consolidation and company failures in our supplier base could reduce our purchasing
alternatives and reduce the level of competition to win our business resulting in higher cost of
goods and less availability of components which would have a negative impact on our business, our
results of operations and our financial condition.
Consolidation of our competitors has been occurring and the trend is expected to continue.
Consolidation by our competitors may enhance their resources, capacity, capabilities and purchasing
power and lower their cost structure, causing us to be less competitive.
Item 6. | Exhibits |
The following exhibits are filed herewith:
Exhibit No. | Exhibit Title | |||
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |
|||
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |
|||
32 | Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 |
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SMART MODULAR TECHNOLOGIES (WWH), INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, SMART Modular
Technologies (WWH), Inc. has duly caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
SMART MODULAR TECHNOLOGIES (WWH), INC. |
||||
By: | /s/ IAIN MACKENZIE | |||
Name: | Iain MacKenzie | |||
Title: | President and Chief Executive Officer (Principal Executive Officer) |
|||
By: | /s/ BARRY ZWARENSTEIN | |||
Name: | Barry Zwarenstein | |||
Title: | Senior Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) |
|||
Date: April 1, 2011 |
32
Table of Contents
EXHIBIT INDEX
Exhibit No. | Exhibit Title | |||
31.1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) or
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |
|||
31.2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) or
15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002 |
|||
32 | Certification of Chief Executive Officer and Chief Financial Officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002 |
33