Sanmina Corporation — Q3 FY2017 Form 10-Q
Reporting period: Third quarter ended July 1, 2017; year-to-date period covers the first nine months of fiscal 2017. Comparisons are with the periods ended July 2, 2016, except balance-sheet comparisons, which are with October 1, 2016. Sanmina provides integrated manufacturing solutions and related products and services; IMS is its sole reportable segment.
Financial performance
| Metric | Q3 FY2017 | Q3 FY2016 | 9M FY2017 | 9M FY2016 |
|---|---|---|---|---|
| Net sales | $1,711.4m | $1,669.5m | $5,113.6m | $4,815.4m |
| Gross profit | $130.7m | $126.7m | $396.1m | $387.0m |
| Gross margin | 7.6% | 7.6% | 7.7% | 8.0% |
| Operating income | $66.6m | $54.6m | $183.4m | $169.7m |
| Net income | $36.4m | $29.5m | $113.0m | $87.0m |
| Diluted EPS | $0.47 | $0.38 | $1.45 | $1.10 |
- Q3 sales rose 2.5% year over year; nine-month sales rose 6.2%. Q3 operating margin was about 3.9%, versus 3.3% a year earlier.
- Q3 industrial, medical and defense sales increased 4.9%, and communications networks sales increased 10.2%; embedded computing and storage sales declined 16.7%. For the first nine months, those markets changed by +14.3%, +7.8% and −13.0%, respectively.
- Q3 IMS gross margin improved to 7.6% from 7.2%, while CPS gross margin fell to 7.3% from 8.8%. Management cited customer mix as favorable for IMS; CPS was affected by new-program ramp costs, lower yields, higher inventory reserves and operational inefficiencies. Nine-month CPS gross margin also declined, with depressed oil and gas conditions contributing.
- Q3 operating expenses fell $8.0m to $64.1m, partly due to a $4.4m change in estimate for an environmental remediation matter, lower R&D and lower professional fees.
Cash flow, balance sheet and liquidity
- Cash and cash equivalents were $435.5m at July 1, 2017, up from $398.3m at October 1, 2016. Working capital was approximately $1.1bn.
- For the first nine months, operating cash flow was $201.7m, down from $286.8m. Inventory growth used $100.6m and receivables growth used $62.7m, partly offset by a $112.9m increase in accounts payable. Inventory turns declined to 6.1 from 6.6; days inventory on hand increased to 60 from 55.
- Capital expenditures were $86.8m. Investing cash outflow was $82.9m; financing cash outflow was $82.5m. Sanmina repurchased $37.6m of stock, repaid $43.4m of long-term debt and made net repayments of $25.0m on short-term borrowings.
- Total debt was approximately $394.4m, down from $462.5m at October 1, 2016, following prepayment of $40.0m of secured debt due 2017 and other repayments. The $375m senior secured notes mature in 2019. No revolver borrowings were outstanding; $361.4m was available under the $375m revolving facility, net of letters of credit. Foreign short-term borrowing facilities of $74.1m were also undrawn.
- Sanmina reported compliance with debt covenants and said existing cash, available facilities and operating cash generation should meet working-capital needs for at least the next 12 months. It reported no material off-balance-sheet arrangements.
Outlook, risks and unusual items
- No numerical revenue or earnings guidance is provided. Management expects margins to fluctuate with volume, capacity utilization and customer/product mix, among other factors.
- Management identified CPS execution as a challenge: despite higher sales, CPS gross profit declined in both the quarter and nine-month period. The company’s strategy depends partly on growing higher-value CPS offerings.
- Customer concentration remains significant: the ten largest customers represented 52.6% of sales in both the quarter and nine-month period; two customers each accounted for at least 10% of sales. Sanmina also manufactures about 80% of sales outside the United States.
- Other key risks include demand and pricing pressure, customer order cancellations, component shortages, foreign exchange exposure, international operating and trade risks, and customer credit or inventory exposure. The company uses foreign-exchange forwards but does not hedge every exposure.
- Environmental and legal matters include remediation obligations in Canada and groundwater claims in California. A potential liability for one Northern California landfill matter could not be estimated; an appeal in the Orange County Water District case had been heard, with no ruling reported. Reserves for environmental, warranty, litigation and other contingencies were $35.4m, excluding uncertain tax positions.
- Sanmina reported a $93.6m liability for uncertain tax positions and could owe up to $13.5m in contingent acquisition payments if specified earnings targets are achieved. A first-quarter tax benefit from a foreign-entity merger reduced the nine-month effective tax rate to 35.0%, versus 43.1% a year earlier; the Q3 effective rate was 41.5%.
- The company expects the new revenue standard, effective for it in fiscal 2019, to materially change timing of revenue recognition for a significant portion of sales, primarily increasing contract assets and reducing finished-goods and work-in-process inventory at adoption. It had not selected a transition method.
Most important facts for investors to verify
- Whether revenue growth and improved IMS margins continue, and whether CPS ramp costs, yields and reserves improve.
- Whether inventory and receivables growth converts to cash without impairments; operating cash flow fell materially year over year.
- Customer concentration, exposure to weaker embedded-computing demand, and the effect of customer mix on margins.
- Developments in environmental proceedings, Brazilian tax disputes and the $93.6m uncertain-tax-position liability, including potential cash timing and reserve adequacy.
- Debt repayment capacity and refinancing plans for the $375m notes due 2019, alongside continued covenant compliance and share repurchases.
- Implementation effects and costs of the material fiscal 2019 revenue-recognition change.