Business Context and Reporting Period
Company: Sanmina-SCI Corporation (Sanmina-SCI)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: December 30, 2006 (First Quarter of Fiscal Year 2007)
Business Overview: Sanmina-SCI is a leading independent global provider of customized, integrated electronics manufacturing services (EMS). The company serves OEMs in communications, computing, industrial, medical, and automotive sectors. The company is currently reviewing strategic alternatives regarding the separation of its personal and business computing business.
Key Financial Metrics
| Metric (in thousands) | Q1 2007 (Ended Dec 30, 2006) | Q1 2006 (Ended Dec 31, 2005) |
|---|---|---|
| Net Sales | $2,778,790 | $2,861,797 |
| Gross Profit | $168,678 | $168,487 |
| Gross Margin | 6.1% | 5.9% |
| Operating Income | $58,533 | $31,476 |
| Net Income | $28,249 | $17,394 |
| Diluted EPS | $0.05 | $0.03 |
| Cash and Cash Equivalents | $538,828 | $1,011,098 |
| Restricted Cash | $545,915 | $13,751 |
| Total Debt (Current + Long-term) | $2,207,305 | $1,607,353 |
| Operating Cash Flow | $(10,226) | $(66,247) |
Note: Total Debt includes $624,779 current portion and $1,582,526 long-term portion as of Dec 30, 2006. Restricted cash increased significantly due to funds deposited to satisfy 3% Convertible Notes.
Material Changes vs. Prior Period
- Revenue: Net sales decreased 2.9% to $2.78 billion, primarily due to decreased demand in the personal computing ($113M), high-end computing ($54M), and communications ($42M) end markets. This was partially offset by growth in industrial instruments and consumer products.
- Profitability: Operating income increased 86% to $58.5 million, driven by a significant reduction in restructuring costs ($3.2M vs. $35.6M in the prior year) and improved gross margins (6.1% vs. 5.9%).
- Restructuring: Restructuring charges dropped dramatically from $35.6 million in Q1 2006 to $3.2 million in Q1 2007. The company terminated 2,739 employees during the quarter.
- Debt Structure: The company entered a $600 million Senior Unsecured Term Loan in October 2006. Proceeds were used to satisfy the 3% Convertible Notes (resulting in $532.9M restricted cash) and for working capital. Interest expense increased $10.3 million due to the new term loan and higher rates on existing swaps.
- Other Income: Other income turned positive ($11.0M) compared to a loss ($5.7M) in the prior year, largely due to a $6.0M gain on the sale of a European facility and a $1.8M gain on the collection of previously reserved notes.
Guidance, Outlook, Risks, and Unusual Items
- Strategic Initiatives: Management announced plans to realign ODM activities to focus on joint development and to create a more separable personal and business computing business unit. Additional restructuring charges are expected in Fiscal 2007 but are currently not estimable.
- Stock Option Accounting & Litigation: The company is subject to significant risks regarding historical stock option accounting errors. This has led to a material weakness in internal controls, restatement of prior financial statements, shareholder derivative lawsuits, and ongoing informal investigations by the SEC and the U.S. Attorney's office. Management expects to incur significant legal and accounting expenses.
- Internal Controls: As of December 30, 2006, disclosure controls and procedures were deemed ineffective due to the material weakness in stock option administration. Remediation efforts are underway.
- Liquidity: The company believes existing cash resources and liquidity sources are sufficient for the next 12 months. However, a significant portion of cash ($532.9M) is restricted for the satisfaction of the 3% Notes due March 15, 2007.
- Market Risks: The company faces intense price competition, customer concentration (top 10 customers represent 61.1% of sales), and exposure to foreign currency fluctuations (74.6% of sales from non-U.S. operations).
Investor Verification Checklist
- Restricted Cash Status: Verify the status of the $532.9 million restricted cash and the company's ability to access liquidity for operations once the 3% Notes are satisfied in March 2007.
- Legal Exposure: Monitor the outcome of the SEC informal inquiry, U.S. Attorney's investigation, and shareholder derivative lawsuits regarding stock option backdating.
- Internal Control Remediation: Track the progress of remediation efforts for the material weakness in internal controls over financial reporting.
- Restructuring Costs: Watch for the magnitude of "not estimable" additional restructuring charges anticipated for Fiscal 2007 related to facility consolidation and strategic realignment.
- Customer Concentration: Assess the impact of demand fluctuations from the top three customers, who individually accounted for over 10% of net sales in Q1 2007.