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Good afternoon. My name is Rob and I will be your conference operator today. At this time, I would like to welcome everyone to the Sanmina Corporation's Second Quarter Fiscal Year 2018 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] Thank you.
Miss Paige Bombino, Vice President of Investor Relations, you may begin your conference.
Thank you, Rob. Good afternoon, ladies and gentlemen. And welcome to Sanmina's second quarter and fiscal 2018 earnings call. A copy of our press release and slides for today's discussion are available on our website at sanmina.com in the Investor Relations section. Joining me on today's call is Bob Eulau, Chief Executive Officer; and Dave Anderson, Chief Financial Officer. Following their prepared remarks, we will open the call up for questions.
Let me remind everyone that today's call is being webcast and recorded and will be available on our website. You can follow along with our prepared remarks in the slides provided on our website.
During this conference call, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements are just projections. The company's actual results of operations may differ significantly as a result of various factors, including adverse changes to the key markets we target, reliance on a small number of customers for substantial portion of sales, risks arising from our international operations, competition that could cause us to lose sales, and other factors set forth in the company's annual and quarterly reports filed with the Securities and Exchange Commission.
You'll note in our press release and slides issued today that we have provided you with statements of operation for the quarter ended March 31, 2018, on a GAAP basis, as well as certain non-GAAP financial information. A reconciliation between the GAAP and non-GAAP financial information is also provided in the press release and slides posted on our website. In general, our non-GAAP information excludes restructuring costs, acquisition and integration costs, non-cash stock-based compensation expense, amortization expense, and certain other infrequent or unusual items to the extant material. Any comments we make on this call as they relate to the income statement measures will be directed at our non-GAAP financial results. Accordingly, unless otherwise stated in this conference call, when we refer to gross profit, gross margin, operating income, operating margin, taxes, net income, and earnings per share, we are referring to our non-GAAP information.
I would now like to turn the call over to Dave Anderson.
Thanks, Paige, and good afternoon, everyone. Please turn to Slide 3. Revenue for the second quarter was higher than we expected at $1.68 billion. Revenue was sequentially down 4% or $69.2 million and down 0.4%, or $6.6 million from the second quarter of last year. As we commented on January's call, our second quarter tends to be seasonally soft. From a GAAP perspective, we reported net income of $24.6 million, which resulted in diluted earnings per share of $0.33 for the second quarter. Diluted earnings per share were up compared to last quarter by $2.49 per share. As I pointed out during our Q1 earnings call, we had a non-tax; non cash tax charge of $2.27 per share related to the enactment in December of 2017 of the US Tax Cuts and Jobs Act, as well as restructuring cost of $0.33 per share that negatively impacted our Q1 GAAP financial results.
Our restructuring plan is on track and we finalized an agreement in Q2 for the reimbursement of $10 million of severance and retention cost that was recorded as a reduction in our restructuring in the second quarter. My remaining comments will focus on our non-GAAP financials for the second quarter. At $117.3 million, gross profit was up $4.8 million from the prior quarter. Gross margin came in at 7%, which were 60 basis point improvements over the first quarter. Operating expenses were basically flat with the prior quarter $65.2 million. As a percentage of sales, operating expenses were up 20 basis points to 3.9%, largely driven by the lower revenue base.
At $52.1 million, operating income was increased by 9.8% from the prior quarter and was down 26.5% from Q2 of last year. Operating margin was 3.1%, which was up 40 basis points from last quarter. Other income and expense of $7 million was at the high end of our guidance and up $4 million when compared to last quarter and up $5.6 million in the second quarter of last year. The increased quarter-over-quarter partially resulted from higher average borrowings on our credit facility which was used to support a higher level of share repurchases and inventory levels during the quarter. The tax rate for the quarter was 18% of pretax income, which was in line with our expectations.
We earned $37 million in net income with our non-GAAP EPS beating our expectations by coming at $0.50 for the quarter. Non-GAAP EPS was up 4% from Q1 but down 33.7% from Q2 of last year. This was based on 73.6 million shares outstanding on a fully diluted basis.
I'll now discuss the factors impacting our non-GAAP EPS. Please turn to Slide 4, where we are providing more information on the IMS and CPS segments. The Integrated Manufacturing Solutions segment represents printed circuit board assembly and test; final system assembly and test, as well as direct order fulfillment. As you can see from the graph on the left, the IMS segment revenue was down $54.3 million from last quarter at $1.375 billion. Our gross margin increased by 50 basis point from Q1 to 6.3% as gross margin increase was largely driven by expected improvements in our production yields, absorption and cost structure.
On the right is our second segment: Components, Products and Services. Components include printed circuit board fabrication, backplane assemblies, cable assemblies, enclosures. Precision machine and plastic injection molding. Products include computing and storage products, defense and aerospace products, memory and SSD modules, as well as optical and RF modules. Service includes design and engineering, as well as logistics and repair services. In aggregate, the revenue for this segment was down $11 million to $346 million, with gross margin up 70 basis points from Q1 to 9.1%. The CPS segment gross margin improved primarily as a result of a sequential improvement in the gross margin in our components business, including our oil and gas business, which is part of components, and our services businesses. This improvement was partially offset by a sequential decline in the gross margins in our products businesses.
On Slide 5, we are showing you key non-GAAP P&L metrics. Revenue was down 4% from last quarter and down 0.4% compared to Q2 of last year. Gross profit increased 4.3% from last quarter to $117.3 million. Gross margin at 7% was up 60 basis points from last quarter and our operating income increased 9.8% from last quarter to $52.1 million. This led to operating margin of 3.1% and non-GAAP EPS of $0.50. As we announced during our last call, while we expected revenue to be down sequentially, we did take a number of immediate cost optimization actions during the quarter.
In addition, we improved our production yields and productivity. This helped us sequentially improve our gross margins by 60 basis points and drive our non-GAAP EPS to the high end of our guidance range of $0.50. Given the decline in revenue, the whole team did a good job in improving our gross margins and controlling our operating expenses during the quarter.
Now I'd like to turn your attention to the balance sheet on Slide 6. Our cash and cash equivalents were $405 million. Cash was basically flat with the previous quarter, accounts receivable were down $34 million and inventory was up $42 million. We'll talk more about inventory in a moment. From a liability standpoint, we had a decrease of $36 million in accounts payable during the quarter. Our short-term debt was up $75 million from last quarter. And we purchased $75 million worth of common shares during the quarter, specifically; we purchased approximately 2.8 million shares at an average share price of $26.94. As of the end of the quarter, we had $393 million in long-term debt and our gross leverage was approximately 1.9.
During the quarter, we further strengthened our capital structure with the renewal and up sizing of our credit facility. Overall, our balance sheet and capital structure remain in great shape. Please turn to Slide 7, where we will review our balance sheet metrics for the second quarter. Cash was very consistent with prior quarters. Cash flow from operations for the quarter was positive at $25.7 million, up $17.2 million over Q1 and met capital expenditures for the quarter were $22.5 million which ran under our expectations as we continue to drive the optimization of our existing facilities and equipment. While this led to positive free cash flow of $3.2 million, which was up $43.2 million from the prior quarter, we were not satisfied with our free cash flow generation for the quarter mainly due to our lack of progress on reducing our inventory. Inventory dollars were up in Q2 by $42 million, ending the court at $1.12 billion with inventory turns coming in at 5.7 which were down 0.4 of a turn from Q1. Inventory turns continued to be a challenge largely driven by ongoing new product ramps and material shortages, as we saw lead times continued to extend out on certain commodities such as memory, capacitors and discrete semiconductors.
In Q2, 2018, we saw the number of parts with lead times over 20 weeks moved from 19% to 25% while parts in the 16 to 20 week category moved from 7% to 10%. We are seeing component manufacturers adding capacity but not at a rate in line with industry demand and suppliers are generally reluctant to increase capacity for older component technologies. Some component manufacturers are indicating that certain component constraints will continue through the second half of calendar 2018 and possibly further. As our new program ramps are starting to move to volume production, we are experiencing fewer customer design changes, which is starting to help alleviate the need to get certain component parts within a supply constrained environment, and will ultimately improve our inventory.
In the lower left quadrant, we're showing cash cycle days which combines our cycle time for inventory accounts receivable and accounts payable. Overall, cash cycle time increase from 46.1 days last quarter to 51.1 days this quarter. This change was mainly driven by an increase in our accounts receivable days sales outstanding and inventory days. Finally, pretax ROIC increased by 90 basis points from the prior quarter to 15.8%.
Please turn to Slide 8. I would now like to share with you our guidance for the third quarter of fiscal year 2018. Our view is that revenue will be in the range of $1.7 billion to $1.75 billion. On a non-GAAP basis, we expect the gross margin will be in the range of 6.9% to 7.3%. Operating expense should be $65 million to $67 million. This leads to an operating margin in the range of 3.1% to 3.5%. We expect that other income and expense will be in the range of $6 million to $7 million. And our tax rate should be around 18% due to the expected geographic distribution of our profits.
We expect our fully diluted share count to be around 72 million shares plus or minus half a million shares. And when you consider all of this guidance, we believe that we will end up with non-GAAP earnings per share in the range of $0.53 to $0.61. Finally, for your cash flow modeling, we expect the capital expenditures will be around $30 million, while depreciation and amortization will also be around $30 million. Overall, our Q2 results were higher than we expected. We are excited about the new programs moving to volume production. We're also starting to see the benefits of our various initiatives to optimize our cost structure, giving us added confidence that the second half of the year will be stronger than the first half from a revenue, gross margin and cash flow perspective.
And now I would like to turn it over to Bob to provide further comments on our target markets and overall business priorities.
Thanks, Dave, and good afternoon, everyone. At a high level, the second quarter unfolded a little better than we expected. We're making steady progress on the new programs. And I'm confident the second half of fiscal 2018 will be significantly better. Please turn to Slide 10, as I would like to provide a few additional comments on our end markets for the second quarter. Industrial, medical and defense was 45% of our revenue or $757 million, down 4.8% sequentially and down1.2% from the second quarter last year. While industrial was down seasonally as expected both medical and defense were up sequentially and year-over-year. Communications networks were 38% of revenue, or $642 million down 5.4% sequentially, but up 2.8% from the same period a year ago.
Optical products represent over 40% of our communications revenue, and in total we saw some sequential growth in the second quarter. We have a strong value proposition in the optical space and we continue to see good adoption of 400 gigabit products. The communications market continues to be an important market for us as we focus on leading-edge technology with our customers. Embedded computing and storage was 17% of revenue, or $276 million. This segment was up 2.2% sequentially and down 5.3% year-over-year. Within this segment, automotive was up double digits sequentially and year-over-year. This is an exciting and growing market, and we're well positioned for continued growth in automotive. In aggregate, the other products in this segment were down as expected.
In the second quarter, our top ten customers represented 53% of revenue, and we had one customer that was greater than 10% of revenue. Please turn to Slide 11. I'd now like to discuss our outlook for the third quarter by end market. For industrial, medical and defense, we expect to be up sequentially for the third quarter. We're expecting good growth in all three areas. We expect this segment to grow in the second half of the fiscal year and to be up year-over-year for the full year. With communications networks, we expect to be flat sequentially as a result of continued softness in wireless which is consistent with what we have been seeing. We expect the networking and optical businesses will continue to get better as we move forward through the year driven by new program wins.
Finally for embedded computing and storage, we are forecasting this market to be up sequentially and up for the full fiscal year as we continue to ramp a number of new programs. Automotive is a growth opportunity that aligns well with sending a strategy of providing value added services to customers with stringent quality and regulatory requirements. Please turn to Slide 12. In summary, the second quarter of fiscal of 2018 was more challenging than we expected at the beginning of the year. The second quarter is typically a seasonally soft quarter and that is what we experienced this year. I'm pleased that our results came in a little better than we expected, with revenue down almost $70 million, I think we did a nice job of addressing our cost structure while improving our production yields and productivity. Access to critical components continues to be a challenge that our team is focused on the gating items so that we can build more, ship more and bring down our inventory levels.
We expect material constraints to continue longer than we originally anticipated. Finally, in a challenging quarter, we were able to show good sequential and year-over-year growth in the medical, defense and automotive segments.
Now I'd like to make a few comments on the third quarter. We're excited about the new programs we won and continue to win. In spite of the slow start this year, we're expecting that we will grow for the year. We continue to have a very good pipeline of new business opportunities. We expect the supply chain will be an ongoing challenge but we know our team is up to the challenge. We expect that operating margins will continue to improve in the third quarter based on a higher revenue level, improved yields and an improved cost structure. Our long-term strategy is unchanged. We continue to win new business and diversify our customer base with a focus on mission-critical products, where we provide more value to our customers. We view the second quarter as a trough and we're excited about the opportunities ahead. Thank you for your continued interest in Sanmina.
As a reminder, Sanmina will be hosting an Investor and Analyst Day on Tuesday May 22nd in New York, is a great time to meet members of our management and learn more about Sanmina. I encourage you to attend. If you've not already registered, please contact Paige Bambino.
So, operator, we are now ready to open the lines for questions.
[Operator Instructions]
And your first question comes from the line of Ruplu Bhattacharya from Bank of America. Your line is open.
Hi, thank you for taking my questions and Bob Congrats on the quarter. My first question is in the past you've talked about order cancellation rates being a little bit higher and OEMs making design changes. Has the situation improved? Can you talk a little bit about that?
Yes. So I would say on the demand side business is very good. As I mentioned, we've had a number of new program wins and we're not worried about the demand side. The bigger challenge which has been a challenge for six months is on the material side. So I think we're in pretty good shape heading into the second half of the year.
Right. When looking at margins, when we look at the CPS segment margins were up sequentially in the second quarter, but when I looked at the past three years from 2015, 2016, 2017, the third quarter has seen quite a significant decline in CPS margins like anywhere from 100 basis points to 300 basis points. I think you are guiding gross margins up, so can the situation be different in this 3Q and what drives CPS margins higher in this third quarter?
Yes. Let me make a couple comments and Dave may want to add more. So, first of all, I'm really pleased with the past quarter where we had revenue down in both of the operating segments. And we were able to show gross margin improvement. And as we move forward into the third quarter, we're not giving guidance by segments, but it's clearly my expectation that we continue to show improvement in both segments. So I don't know exactly what happened in prior years of the third quarter of CPS, but we're working very hard to improve the situation both in CPS and IMS.
Yes. I think Bob's right. We don't give specific breakdown, the specific guidance for the next quarter by segments, but we and I don't have all the reference point you have to the pass, but definitely we're confident that going into the guidance that we've set for Q3 that both the IMS and the CPS will firm up as we go forward. So anyway without giving specifics I think we're in a better position than maybe in the past/
Okay, thanks for that. And my last question is you've talked about the second half being better than the first half. If I look at last year I think revenues in the second half grew 2% versus the first half of 201. Any guidance you can give on how should we think about revenues for the full year? I think Bob you said that revenues can actually grow year-over-year. So should we think like low single digits? I mean any guidance on what you're expecting in the second half.
Yes. I want to be careful about giving too much guidance beyond the third quarter. But as I indicated last quarter, I just indicated again we really are pretty confident we can grow for the year. As I mentioned, the demand is there. And our team is working hard on securing the material. And that will really in the end determine what our growth rate is.
Okay and if I can just squeeze in one last one. Your inventory was up a little bit. Are you using the strength of your balance sheet to buy some components and stock components? Is that why inventory is up?
No. We really don't buy inventory other than based on a commitment from our customers. So it's really more a function of having a lot of the material we need to build to ensure the component here and there on some of the products.
Your next question comes from the line of Jim Suva from Citi. Your line is open.
Hi. This is Tim Young calling on behalf of Jim Suva. Thanks for taking my questions. Hey, first of all, congrats on the quarter. I guess my question is, my first question is your embedded computing - how did it perform this quarter? Can you provide some color on the key driver of the auto performance? I believe you had automotive ramping issue in the prior quarters. So is that issue largely behind you?
Well, automotive was definitely is becoming a bigger piece of that segment. And so it tends to explain a lot of the changes quarter-to-quarter and overtime. We did see progress in automotive in the second quarter and we as I said in my remarks, I really expect automotive to continue to show very good growth over the next few years actually.
And so are you saying that your ramping issue is resolved or you still have a little bit and you will have more improvement -
I would say that we made good progress and I expect us to make even more progress in the third quarter.
Got you, thanks. And then on seasonality should we expect September quarter normally seasonally increase on quarter-over-quarter basis, compared between quarter?
I'm - September versus June?
Yes, on seasonality.
Yes. I mean, again, I don't want to give too much guidance on September but probably the best thing in absence of guidance is to look at what we've done in the past.
Got you, okay. Last question is our material shortage. I believe that you mentioned the component that you have memory [indiscernible]. They are all in shortage or you miss or is that certain specific component in shortage?
Well, it's still fairly broad based and Dave outlined some of the key component areas where we're having the biggest challenges. But as I said, the teams I think done a really good job of identifying the issues early and I think we're doing the best we can in a really tough environment. But that's where we see the issue right now and when you guys asked me after six months ago and I had hoped it would be resolved by now. We now see a lot of these issues probably extending at least through this year.
And your next question comes from the line of Christian Schwab from Craig-Hallum Capital. Your line is open.
Hey, thanks for taking my call, great quarter. When we look at your comments regarding that demand is not a problem rather than components. If we get a more memory and kind of a loosening of some of the capacitor issues as we kind of exit this fiscal year and go into fiscal year 2019, is it logical for us then with the mix of new programs that are ramping to drive revenue to be able to get back to where we were say fiscal 2015, 2016 kind of back into 8% gross margins plus or minus?
Yes. I mean a lot depends on the mix at that point in time, but whereas I said we've got - we've won plenty of new business. We're working on a number of new programs. I think we're setting a nice platform from which we can go into FY2019. So we're feeling pretty good over the long term in terms of how the business is going, but you never know what's going to happen in short term with all the other various challenges.
Understood. When you talk about things getting better driven by new programs in optical and wireless infrastructure going forward. When you talk about those new programs, are those marker share gains or are they rather new programs with new products that are expected to become the size that other programs where that might have been in kind of a multiyear kind of modest decay? How should we really thinking about those new program wins?
Yes. It's kind of a complex discussion. So on the optical side, I mean I think we continue to have a fantastic footprint there. And I think we'll at least maintain our market share in terms of optical and hopefully overtime gain some share there. On wireless, it's really as I mentioned before been a challenging area I think for us and for all of our competitors. And really we are waiting for the transition to 5G. And I think as that begins to happen we'll definitely benefit from that. And I can't say at this stage whether we'll gain share but I think at that point in time everybody participate in that market will benefit.
And so your confidence in optical and wireless infrastructure getting better throughout the course of the year. Obviously is based upon demand in hand kind of like you said earlier demands not a problem.
Yes. I mean I would say optical and networking again are the stronger part of communications. Wireless is weaker part of communications.
All right. Thanks for that clarity. And can you remind us how much is left on the stock authorization buyback?
We have - Board authorized at this point is $144 million.
Perfect, congrats again. No other questions. Thank you.
Thanks, Christian. I don't know if there any other questions.
There are no further questions at this time. I'll turn it back over to the presenters for closing remarks.
Okay. Well, thanks again. We really appreciate your time and your attention. And those of you that are able I encouraged you come to our Analysts Day in New York and we'll be able to give you even more detailed update. So thanks and have a good day. Thank you.
This concludes today's conference call. You may now disconnect.