Sanmina Corporation — Q1 FY2019 Form 10-Q
Reporting period: Three months ended December 29, 2018; comparative period ended December 30, 2017. Amounts below are in U.S. dollars unless stated otherwise.
Business context and reporting period
Sanmina provides integrated manufacturing solutions, components, products and related services to OEMs across industrial, medical, defense and aerospace, automotive, communications networks and cloud markets. IMS accounted for about 80% of revenue; CPS comprises the remaining businesses.
The company adopted ASC 606 at the start of fiscal 2019 using the modified retrospective method. The new standard moved most integrated manufacturing revenue recognition from shipment or delivery to recognition over time. The prior-year comparison was not restated, so reported growth is not fully like-for-like. Adoption increased opening retained earnings by $28 million and created a $376 million opening contract asset, while reducing inventory by $350 million.
Financial performance and position
| Metric | Q1 FY2019 | Q1 FY2018 |
|---|---|---|
| Net sales | $2,188 million | $1,745 million |
| Gross profit / margin | $149 million / 6.8% | $109 million / 6.3% |
| Operating income | $78 million | $14 million |
| Net income (loss) | $38 million | $(155) million |
| Diluted earnings (loss) per share | $0.54 | $(2.16) |
| Operating cash flow | $(78) million | $8 million |
| Capital expenditures | $37 million | $49 million |
Sales rose 25.4%, with increases in communications networks (14.9%), industrial, medical, defense and automotive (33.5%), and cloud solutions (25.3%). Management attributed growth to stronger demand, improved component availability that helped address pent-up demand, and program ramps and wins. Gross margin improved in both IMS (6.2% versus 5.8%) and CPS (8.9% versus 8.4%).
Cash and cash equivalents were $409 million at quarter-end, versus $420 million at fiscal year-end. Working capital was $0.7 billion. Balance-sheet debt was approximately $723 million, including $708 million of current debt; cash less debt was approximately $(313) million. The company had $330 million outstanding under its revolver and $8 million of letters of credit. It reported $162 million of revolver availability, plus $69 million of available foreign short-term facilities.
Material changes versus the prior comparable period
- Revenue, gross profit and operating income increased; net income turned positive. The prior-year loss included an approximately $162 million non-cash tax charge associated primarily with the U.S. Tax Cuts and Jobs Act. Current-quarter income tax expense was $26 million, or 40% of pretax income, versus $166 million in the prior-year quarter.
- Operating cash flow declined to a $78 million use, largely reflecting working-capital investment as business volume increased, including higher receivables and contract assets. The company also reported inventory increases related to demand changes, component shortages and new product ramps.
- Receivables sold under sale programs totaled $561 million, compared with $156 million a year earlier. Such sales are presented as operating cash flow; the RPA is uncommitted and subject to bank approval.
- ASC 606 materially changed the timing and balance-sheet presentation of revenue and inventory. Revenue recognized over time was $2.1 billion this quarter, compared with $22 million in the prior-year presentation; the prior period largely reflected point-in-time recognition. Contract assets were $419 million at quarter-end.
- Restructuring expense was about $2.3 million, versus $24.5 million a year earlier. Existing facility closure and relocation actions are expected to continue through calendar 2019.
Outlook, risks and unusual items
No specific revenue or earnings guidance is provided. Management believes cash resources, borrowing capacity and other liquidity sources will be sufficient for working-capital needs for at least the next 12 months. It expects gross margins to fluctuate with production volumes, customer and product mix, parts availability, pricing pressure, operating efficiency, labor and materials costs, and manufacturing transitions. Management said current IMS and CPS gross margins were below its expectations at current revenue levels due to inefficiencies and other factors.
The company was in compliance with its credit covenants at quarter-end. A $375 million delayed-draw term loan was available through June 30, 2019, solely to repay senior secured notes due in June 2019. The revolver matures in November 2023. The company also disclosed $98 million in liabilities for uncertain tax positions and $36 million of reserves for environmental, warranty, litigation and other contingencies.
Risks include dependence on a small number of customers (the ten largest represented 54% of sales; two customers each represented at least 10%), intense EMS pricing competition, component shortages and supplier concentration, international and foreign-exchange exposure, trade tariffs, customer credit and inventory exposure, and working-capital volatility. Environmental proceedings include a groundwater matter with a trial scheduled for September 2020; the company intends to contest the claims. A foreign agency notified the company in January 2019 that it would not pursue a previously threatened claim of up to $23 million.
Management concluded disclosure controls were not effective as of December 29, 2018 because of a previously identified material weakness involving review of estimates for certain long-term contracts. Remediation was expected by fiscal year-end 2019, subject to effective operation and testing. The filing also notes that adopting the new lease standard in fiscal 2020 is expected to materially affect the balance sheet; the income-statement effect remained under evaluation.
Important facts for investors to verify
- Assess the comparability of reported revenue growth given the first-time ASC 606 adoption, un-restated prior-year figures and substantial increase in over-time revenue recognition.
- Track conversion of contract assets and receivables into cash, working-capital requirements, and reliance on receivables-sale programs for liquidity.
- Monitor gross-margin performance, especially whether improved utilization and program mix can address management’s stated margin concerns.
- Review the June 2019 secured-note repayment and refinancing arrangements, available revolver capacity, and continued covenant compliance.
- Follow remediation and validation of the material weakness, as well as developments in environmental, employment and tax contingencies.