Sanmina Corporation — Q2 FY2014 Form 10-Q
Business context and reporting period. The unaudited quarter ended March 29, 2014; six-month results cover the period from the beginning of fiscal 2014 through that date. Sanmina provides electronics manufacturing, components, products and related services, managed through Integrated Manufacturing Solutions (IMS) and Components, Products and Services (CPS).
Financial performance and liquidity
- Quarter revenue: $1.477 billion, up 3.4% from $1.428 billion. Gross profit was $119.0 million and gross margin 8.1%, versus $100.3 million and 7.0% a year earlier.
- Quarter earnings: Operating income was $45.3 million (3.1% margin), compared with $45.8 million. Net income was $20.8 million, or $0.24 diluted per share, versus $21.2 million, or $0.25.
- Six-month results: Revenue was $2.924 billion, essentially flat year over year. Gross profit was $229.8 million (7.9% margin), operating income $84.8 million and net income $43.9 million, or $0.51 diluted per share. Prior-year six-month net income was $21.8 million; comparisons include a $14.9 million swap-dedesignation charge in 2013 and substantially higher 2013 property-sale gains.
- End-market mix: Q2 industrial, defense and medical sales rose 28.3% to $503.3 million. Communications fell 5.7% to $641.5 million; computing and storage fell 4.8%, and multimedia fell 8.4%. For six months, IMS gross sales declined while CPS gross sales increased; reported segment figures are affected by intersegment eliminations.
- Cash flow: Six-month operating cash flow was $46.8 million, down from $161.8 million. Investing used $83.9 million, including $54.1 million for an acquisition and $35.1 million of capital expenditures. Financing provided $25.1 million, including net short-term borrowing and $45.1 million of share repurchases. Cash declined $12.3 million to $390.6 million.
- Balance sheet and liquidity: Current assets were $2.232 billion and current liabilities $1.226 billion; working capital was approximately $1.0 billion. Reported short-term debt was $85.7 million and long-term debt $557.2 million, the latter including a $17.2 million fair-value hedge adjustment. Debt principal was $40 million due 2015 and $500 million due 2019. The company reported $802 million in total liquidity sources, including cash and available borrowing capacity, and said it expected sufficient liquidity for the next 12 months.
- Margins and working capital: Management attributed improved gross margin to better execution and fewer inefficiencies from 2013 program ramps. Days sales outstanding rose to 57 from 55 at fiscal year-end; cash-cycle days increased to 48 from 46.
Material changes, outlook and risks
- Management said interest expense declined to $15.0 million for six months from $23.5 million, primarily following the 2013 redemption of $257.4 million of debt. Since the end of 2012, net debt obligations had declined by $232 million.
- The December 2013 acquisition of an oil-and-gas manufacturing operation cost $54.1 million; purchase-price allocations remained preliminary. Management said the acquisition had not significantly affected six-month results.
- No specific revenue or earnings guidance was provided. Management expects gross margins to fluctuate with volumes, customer and product mix, competition, operational efficiency, component costs and manufacturing transitions. It described growth in higher-margin CPS offerings and diverse end markets as strategic priorities.
- Sales concentration remains significant: the ten largest customers represented 49.1% of six-month sales, and one customer represented at least 10% of sales in the reported 2014 periods. Customer agreements generally do not require minimum purchase volumes.
- Key exposures include intense pricing competition, variable customer demand and operating cash flow, customer credit risk, component shortages and cost increases, foreign currency and interest-rate exposure, international operations, and environmental and regulatory obligations. Forty-seven percent of cash was held by foreign subsidiaries; repatriation could involve taxes.
- A foreign tax authority issued an assessment challenging positions on the company’s 2006 tax return, particularly intercompany transfer pricing. Sanmina disputes it; the outcome could materially affect results if not resolved consistently with its tax positions. The company also disclosed an environmental groundwater-contamination lawsuit for which the potential loss could not be reasonably estimated, and $21.5 million of reserves for environmental, litigation and other contingencies.
- The counterparty may terminate the swap on the 2019 notes beginning May 2014; if terminated, the notes would revert to a fixed 7% rate, potentially above the then-current variable rate. The company was in compliance with debt covenants at quarter-end.
Important facts for investors to verify
- Whether the improvement in gross margin is sustained, and how IMS execution and CPS growth affect future profitability.
- Whether operating cash flow recovers as receivables, inventory and supplier-payment timing fluctuate.
- The final purchase-price allocation and contribution of the oil-and-gas acquisition.
- The outcome and potential cash impact of the foreign tax assessment and environmental matters, including whether recorded reserves prove adequate.
- Customer concentration, program wind-downs, and the effect of demand and pricing changes in communications, computing and storage, and multimedia.
- Debt, borrowing availability, share repurchases and any termination of the 2019-note interest-rate swap.