Sanmina Corporation — Q2 FY2017 Form 10-Q
Reporting period: Second quarter and six months ended April 1, 2017; comparative periods ended April 2, 2016. Amounts below are in millions of dollars unless noted.
Business context
Sanmina provides integrated manufacturing solutions, components, products and related services to OEMs. Its reportable segment is Integrated Manufacturing Solutions (IMS); Components, Products and Services (CPS) comprises other businesses. IMS represented approximately 80% of first-half revenue. The company noted that customer agreements generally do not require minimum purchase quantities.
Financial performance
| Metric | Q2 FY2017 | Q2 FY2016 | Six months FY2017 | Six months FY2016 |
|---|---|---|---|---|
| Net sales | $1,682.3 | $1,611.2 | $3,402.2 | $3,145.9 |
| Gross profit | $133.2 | $136.7 | $265.4 | $260.4 |
| Gross margin | 7.9% | 8.5% | 7.8% | 8.3% |
| Operating income | $58.2 | $61.1 | $116.8 | $115.2 |
| Net income | $31.7 | $30.4 | $76.6 | $57.5 |
| Diluted EPS | $0.41 | $0.39 | $0.99 | $0.72 |
- Q2 sales increased 4.4% year over year, but gross profit declined 2.6% and operating income declined 4.8%. Higher sales did not prevent lower gross margin.
- First-half sales rose 8.1%; gross profit increased 1.9% and operating income 1.4%. Net income rose 33.2%, aided by a lower tax provision and improved interest and other results.
- End-market sales shifted: Q2 industrial, medical and defense grew 12.4%, communications networks grew 7.0%, and embedded computing and storage fell 15.7%. Management attributed the industrial, medical and defense increase primarily to a customer program acquisition; communications growth reflected new program wins and higher demand. Weak demand for customers’ point-of-sale equipment and set-top boxes weighed on embedded computing and storage.
- IMS gross margin was 7.3% in Q2 versus 7.4% a year earlier; CPS was 10.2% versus 10.3%. First-half IMS margin fell to 7.3% from 7.5%, while CPS rose to 9.8% from 9.5%.
Cash flow, liquidity and debt
- First-half operating cash flow was $142.6, versus $205.3 a year earlier. Inventory growth used $73.3 of cash, partly offset by a $46.0 increase in accounts payable. Inventory turns declined to 6.2 from 6.6; days inventory on hand increased to 58 from 55. Cash-cycle days remained 42.
- Investing cash outflow was $51.5, including $55.3 of capital expenditures; financing cash outflow was $58.2. Cash increased $34.2 from fiscal year-end to $432.5 at April 1, 2017. Working capital was approximately $1.1 billion.
- Total debt was approximately $397.2, including $375.0 of senior secured notes due 2019 and $22.2 of non-interest-bearing promissory notes. The company prepaid $40.0 of secured debt due 2017 during the quarter. Cash exceeded reported debt by approximately $35.3.
- No borrowings were outstanding under the $375.0 revolving credit facility; $13.4 of letters of credit left $361.6 available. Foreign short-term borrowing facilities of $74.0 were also undrawn. The company reported compliance with debt covenants.
- Management expected existing cash, available facilities and operating cash generation to meet working-capital needs for at least 12 months. Sixty-two percent of cash was held in the United States; repatriating some foreign cash could incur taxes.
Outlook, commentary, risks and unusual items
- The filing provides no specific revenue, earnings or margin guidance. Management expects gross margins to fluctuate with production volumes, customer and product mix, capacity utilization, component availability, pricing pressure, wage and material costs, and manufacturing transitions.
- Management cited intense competition and continuing difficulty in growing revenue profitably. It identified CPS growth and higher-value offerings as strategic priorities, while noting CPS performance challenges in recent years.
- The first-half tax provision included a discrete tax benefit from a foreign-entity merger that enabled recognition of a U.S. deferred tax asset. The filing does not quantify the benefit separately. The first-half effective tax rate was 31.4%, versus 44.4% a year earlier.
- Q2 2016 gross margin included a $7.6 reduction in contingent consideration related to an earlier acquisition, which management identified as the primary reason for the year-over-year Q2 margin decrease in 2017. Q2 2016 also included a $1.6 bargain-purchase gain.
- Key exposures include customer concentration (the ten largest customers contributed 53.5% of Q2 sales; two customers each represented at least 10%), international operations and currency movements, customer order changes, component shortages, and end-market weakness. Inventory rose partly to support demand and new product ramps amid material shortages and longer lead times.
- Recorded reserves for environmental, warranty, litigation and other contingencies were $41.7. Significant matters include environmental remediation obligations, an appealed dismissal in the Orange County groundwater case, and Brazilian tax and bookkeeping proceedings. The company also recorded a $91.7 liability for uncertain tax positions and could owe up to $18.0 in contingent acquisition payments if earnings targets are met.
- The company said a 10% change in interest rates or exchange rates would not have a significant or material impact, respectively, assuming accurate currency exposure forecasts. It warned that inaccurate forecasts could result in significant foreign-exchange gains or losses.
Important facts for investors to verify
- Whether sales growth can translate into improved gross margins, particularly given Q2 margin compression and IMS ramp-up costs.
- Whether inventory builds and component shortages normalize, and whether operating cash flow recovers from the year-over-year decline.
- Trends in embedded computing and storage, CPS performance, and dependence on a small number of customers and programs.
- Developments in environmental and legal matters, Brazilian tax proceedings, uncertain tax positions, and potential contingent acquisition payments.
- The eventual financial and implementation effects of the new revenue recognition standard: Sanmina expected a timing change for a significant portion of revenue, potentially with a material adoption impact.