Sanmina-SCI (SANM)

Based in San Jose, California, Sanmina-SCI Corporation (SANM) was formed as a result of the merger between Sanmina Corporation and SCI Systems. The company provides end-to-end electronic manufacturing services (EMS) including product design, engineering, testing, volume production of systems, components, and subassemblies, as well as after-market services and support. Sanmina-SCI manufactures complex electronic components like printed circuit boards (PCBs) and backplane assemblies. It also offers product designs, which are branded and/or incorporated by its customers into their own systems. Most of its products are targeted at the communications and computing markets, though the company is increasing its presence in the semiconductor, medical, industrial, defense, multimedia, and automotive sectors as well. EMS accounted for 69.4% of fiscal 2007 (ended September 2007) revenues and the since divested Personal Computing segment accounted for 30.6%. Original equipment manufacturers (OEMs) like IBM, Lenovo, Hewlett-Packard, Cisco Systems, Dell, and Nokia are its largest customers. The company derived 75.9% of fiscal 2007 revenues from its non-U.S. operations.

Although Sanmina-SCI was able to successfully grow its revenue base through the technology and telecom downturn, revenue peaked in 2004 to $12.2 billion, and has declined steadily to $10.4 billion in 2007. Even more troubling is the fact that gross margin peaked in 1999 at 17.4%, falling to 5.3% in fiscal 2007. While Sanmina-SCI has had some company specific problems, we believe that much of what is ailing the company is an industry-wide phenomenon. The industry was able to grow rapidly through the 1990 as EMS companies, including Sanmina-SCI, acquired manufacturing assets of electronics companies that no longer considered manufacturing a core competence and were instead focused on developing intellectual property. On purchasing these factories, the EMS would get in return a purchase commitment from the seller. With a focus on manufacturing, the EMS companies were able to make operations more efficient and achieve greater economies of scale, thus achieving profitable growth. At this point, most potential customers have already sold-off all their manufacturing operations and easy growth has come to an end. In order to grow now, companies in the EMS business must fight amongst each other for market share, resulting in more competition and less profitable programs.

Sanmina-SCI's Personal Computing segment has reported quarterly revenue declines since the loss of IBM's computer business when it was bought by Lenovo in 2005. Sanmina recently sold the assets of its PC business to Lenovo Group and has sold the rest to Foxteq Holdings, a member of Foxconn Technology Group. Together these transactions completely divested Sanmina of the PC business. This business unit includes its personal computing and industry standard server businesses, its related BTO/CTO operations in Mexico and Hungary, and the associated logistics activities. Additionally, Sanmina-SCI has struggled with its enclosures business for over a year now with poor operational efficiencies and weak demand in telecom infrastructure market. Although Sanmina turned a small profit in its enclosures division for the first time in five quarters, we would wait for follow through before becoming more positive. The company exited its enclosure plant in Sweden and consolidated production at the Hungary plant during the second quarter of 2008, which appears to be helping results. Sanmina is highly dependent on a relatively small number of customers. SANM derived 61.5% of its fiscal 2007 net sales from its ten largest customers, three of whom accounted for greater than 10% of sales.

With the sale of the PC business, Sanmina-SCI expects to raise $650 to $750 million in cash in fiscal 2008 that it will use to pay down debt. Sanmina wrapped up much of its restructuring efforts including the closing of inefficient operations such as PCB operations in Phoenix and Arizona and excess capacity during fiscal 2007. In the second quarter of 2008, Sanmina announced the closure of a facility in Western Europe and as a result expects to incur costs of approximately $45.0 million to $50.0 million. During the third quarter of 2008, the company incurred approximately $13.0 million in restructuring expenses of which $8.0 million were cash paid out during the quarter. These expenses were primarily related to reductions and force associated with various corporate functions, as well as plant closures in Sweden, Pheonix, Arizona, Cherbrook, and France, which should result in additional restructuring charges of approximately $10 million to $18 million over the next six months. The company had shut down 70 factories and retrenched approximately 25,000 employees, mainly in North America and Europe. Sanmina plans to ramp up its India operations in the fourth quarter and the first quarter of 2009. With restructuring activities completed, we believe Sanmina has improved its competitive position. However, given our industry-wide concerns, we believe sustained improvements could be hard to come by.

Sanmina has been facing various legal lawsuits relating to its stock option practices. The SEC and the United States Attorney for the Northern District of California are conducting investigations into the company's historical stock option administration practices. Moreover a non-U.S. governmental entity has made a claim for penalties against the company asserting that it did not comply with the bookkeeping rules in accordance with applicable tax regulations.

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