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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon. My name is Erica 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 2019 earnings conference 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.
Ms. Paige Bombino, Vice President of Investor Relations, you may begin your conference.
Thank you Erica. Good afternoon ladies and gentlemen and welcome to Sanmina's second quarter fiscal 2019 earnings call. A copy of our press release and slides for today's discussion are available on the website at sanmina.com in the Investor Relations section.
Let me remind everyone that today's call is being webcasted 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, significant uncertainties that can cause our future sales and net income to be variable, reliance on a small number of customers for a substantial portion of our sales, risks arising from our international operations and other factors set forth in the company's annual and quarterly reports filed with the Securities and Exchange Commission.
You will note in our press release and slides issued today that we have provided you with a statement of operations for the quarter ended March 30, 2019, 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 the 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 extent material. Any comments we make on this call as it relates to 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 financial information.
I would now like to turn the call over to Michael Clarke, Chief Executive Officer.
Thank you Paige and good afternoon everyone. Thank you for joining the call today. With me on the call is Dave Anderson, our CFO.
Welcome everyone.
Just a few comments on the quarter before I turn the call over to Dave. We are real pleased with the quarter and can see some of our operational efforts materializing. Congratulations and thank you to our team for their hard work and dedication on exceeded our expectations in this quarter.
Revenue came in above our outlook, primarily driven by the ability to catch up with demand ramp up new programs. Non-GAAP earnings came in above our outlook at $0.91, delivering solid cash flow as we made positive strides to reduce inventory.
With that, I will now turn the call over to Dave to go through our financial results. Then I will provide more insight on the business and our end-markets followed by Q&A. Dave?
Thanks Michael. Please turn to slide three. Overall, our second quarter revenue and non-GAAP diluted earnings per share exceeded our expectations. Revenue exceeded the high-end of our outlook by $126.6 million ending at $2.13 billion. Revenue was down sequentially 2.8% and up 26.9% from the second quarter of last year. Our strong second quarter revenue was driven by our catching up to our customers' demand as supply continued to stabilize as well as the ongoing ramp of new programs to volume production.
Non-GAAP diluted earnings per share at $0.91 exceeded the high-end of our outlook by $0.11 and was up 9.1% sequentially and 81.1% over the second quarter of last year. I will discuss our end market revenue, non-GAAP margin and non-GAAP diluted earnings per share performance in more detail in a few minutes.
Please turn to slide four. From a GAAP perspective, we reported net income of $40.9 million which resulted in diluted earnings per share of $0.57 for the second quarter. This was up $0.04 sequentially and $0.24 from Q2 of last year. The sequential improvement in GAAP diluted earnings per share was largely driven by an increase in gross profit resulting from operational improvements. The improvement over Q2 of last year resulted from higher gross profit driven by the contribution margin flow-through on the increased revenue.
My remaining comments will focus on the non-GAAP financial results for the second quarter of fiscal 2019. At $155.1 million, gross profit was up $4 million from the prior quarter. Gross margin came in at 7.3%, which was 40 basis points higher than Q1. Operating expenses were up sequentially, in line with our Q2 outlook of $67.7 million. As a percentage of sales, operating expenses were up 20 basis points to 3.2%, but down 70 basis points from 3.9% in Q2 of last year.
Operating expenses were up sequentially mainly due to lower billable customer engineering projects and higher labor and benefits costs that were partially offset by lower net incentive costs. Operating expenses continue to be one of our key operating levers and we are focusing on containing operating expenses as a percent of sales. Operating margin was 4.1% which was up 20 basis points sequentially at the high-end of our outlook and up 100 basis points compared to Q2 of last year.
In Q2, we achieved our goal, which we mentioned during our last call, of getting our operating margins back to the 4% range as quickly as possible. Other income and expense at $9 million was down $5.1 million when compared with last quarter and up $2 million from the second quarter of last year. OIE dropped sequentially largely due to a swing in deferred compensation assets. This has no net impact on non-GAAP diluted earnings per share as changes in deferred compensation are equally offset in gross profit and operating expenses.
Net interest expense was basically flat quarter-over-quarter. The tax rate for the quarter was 17% of pretax income, which was slightly better than our expectations of 17.5% as a result of a slightly more favorable geographic distribution of our profits. We earned $65 million in net income with our non-GAAP diluted earnings per share coming in at $0.91, which was above the high-end of our outlook for the second quarter. Non-GAAP diluted earnings per share were up $0.08 or 9.1% from Q1 and up $0.41 or 81.1% from Q2 of last year. This was based on 71.4 million shares outstanding on a fully diluted basis for Q2.
Please turn to slide five. I will now give you some color around our end market segments for the second quarter. The second quarter continued our solid start to fiscal 2019 with better-than-expected revenue across each of our end markets. Communications networks was $760.9 million or 35.8% of Q2's total revenue. This was down 2.4% sequentially and up 18.5% year-over-year. Industrial, automotive, defense and medical was $1.16 billion or 54.7% of revenue for the quarter. This was down 1.7% on a sequential basis and up 35.1% compared to the same period a year ago. Revenue was up year-to-date across all four subsegments.
Cloud solutions consists of cloud computing, storage systems, point-of-sale, casino gaming and set-top boxes. This segment was $203.2 million or 9.5% of revenue in the second quarter, down 10% sequentially and up 17.7% compared to the same period a year ago. While aggregate customer demand remained fairly stable, a key contributor to the better-than-expected Q2 end market revenue and yearly growth was the continued stabilization of component lead times and our team's ability to partner with our customers and suppliers to catch up on our customers' demand requirements.
Please turn to slide six. 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 flat with last quarter at $1.79 billion, which was higher than we expected. IMS gross margin was up 20 basis points to 6.4% compared to the prior quarter and was also better-than-expected. IMS gross profit margins came in better-than-expected, largely driven by the profit contribution flow-through on the better-than-expected revenue and the resolution of certain cost recoveries from our customers.
On the right is our second segment, components, products and services. Components include printed circuit board fabrication, backplane assemblies, cable assemblies, enclosures, precision machining 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. Services include design and engineering as well as logistics and repair services.
In aggregate, the revenue for this segment was down sequentially by $60.8 million to $395 million, with gross margin up 130 basis points from Q1 entering double digit territory at 10.2%. CPS segment gross margins improved sequentially across all the components, products and services subsegments that was mainly driven by operational improvements in our components subsegment.
Please turn to slide seven. Here we are showing you the quarterly trend in our key non-GAAP P&L metrics. Revenue was down 2.8% from last quarter and up 26.9% over Q2 of last year to $2.13 billion. Gross profit increased 2.6% from last quarter to $155.1 million. Gross margin, at 7.3%, was up 40 basis points from last quarter. Our operating profit increased 1.9% from last quarter to $87.4 million and this led to operating margin of 4.1%, a 20 basis point improvement compared to Q1.
In Q2 we achieved our goal, which we mentioned during our last call, of getting our operating margins back to the 4% range as quickly as possible. Non-GAAP diluted earnings per share grew 9.1% sequentially to $0.91. The 9.1% sequential improvement resulted from operational improvements across our IMS and CPS segments that include a catching up with demand requirements of our customers as lead times continued to stabilize.
Please turn to slide eight. Our balance sheet remains strong. Our cash and cash equivalents were $405.5 million at the end of the quarter. Cash was down $3.8 million from the previous quarter. Accounts receivable was down $31.6 million. Contract assets were down $17.8 million. And inventory was down $47.6 million. We will talk more about contract assets and inventory in a moment.
From a liability standpoint, we had a $92.5 million decrease in accounts payable during the quarter. Our short-term debt was down $65 million from last quarter to $643.4 million. Our short-term debt includes the $375 million notes due in June 2019 that are classified as current on the balance sheet. On April 5, we entered into an amendment to our cash flow revolver to increase its size from $500 million to $700 million. The increase will be effective once we retire our 2019 senior secured notes.
The retirements of these notes will happen on June 3, 2019 and will be funded through the exercise of a delayed draw term loan that is available under our cash flow revolver. We also retain the right to seek commitments to increase the cash flow revolver by $200 million in the future. The revolving commitments under the amended cash flow revolver agreement including the delayed draw term loan expire and must be repaid on November 30, 2023.
In conjunction with setting up of the delayed draw term loan, we have entered into forward interest rate swap agreements that effectively convert our variable interest rate obligations to fixed interest rate obligations through December 1, 2023. Through March 30, 2019, we had entered into interest rate swaps with an aggregate notional amount of $350 million that had an effective interest rate of approximately 4.3%.
We did not repurchase shares during the second quarter. We have approximately $101 million available under our Board authorized share repurchase plan that is subject to compliance with our debt covenants. As of the end of the quarter, we had no long-term debt and our gross leverage was approximately 1.7, based on our total debt. Overall, our balance sheet and capital structure remain in great shape.
Please turn to slide nine. Here we are showing you the quarterly trend in our balance sheet metrics. Cash was consistent with prior quarters in the $400 million range. Cash flow from operations for the quarter was a positive $105.7 million. Net capital expenditures for the quarter were $35.2 million, which was down slightly from Q1 and below our expectations for the quarter.
We ended the quarter with positive free cash flow $70.5 million, which was above our expectations. Our cash generation for the second quarter was positively impacted by strong cash collections coupled with our team's focus on reducing our inventory levels. In the upper right quadrant, we are showing the trend in inventory turns and dollars with the first and second quarters of 2019 shown on the old versus new basis for comparative purposes.
As I mentioned on last quarter's call, Sanmina adopted the new revenue recognition standard, commonly referred to as ASC 606, on a modified retrospective basis. As I previously indicated, we did not expect the adoption of ASC 606 to materially impact our revenue or earnings per share which was again the case for our second quarter of 2019. However, ASC 606 does have an impact on our balance sheet.
With the recording of revenue on an overtime basis for the majority of our non-product revenue stream, we are required to reflect work in progress and finished goods inventory along with a profit element as contract assets which is essentially unbilled receivables. As a result, at the end of Q2 we had $401.7 million of contract assets and $1 billion of inventories on the balance sheet. For comparative purposes, from an inventory turns perspective, we have provided the inventory turns calculation for Q1 and Q2 under the old and new methodology.
We made some progress in reducing our inventory during Q2. Our inventory dollars under the old methodology were down $56 million sequentially to $1.39 billion and our turns were 5.5 times. Inventory continues to be a challenge largely driven by ongoing material shortages on certain commodities such as resistors, capacitors and discrete semiconductors. While we saw continued stabilization of lead times during Q2, lead times are still extended compared to a normal market. As we indicated on our last call, we still anticipate that the supply environment will remain constrained, particularly on legacy technology commodities, at least through the remainder of calendar 2019.
We continue to work with our customers to better understand the demand outlook so that we can plan for the requirements with our suppliers. Our supply chain organization has done a good job partnering with our customers and suppliers to secure constrained parts to help catch up with our customers' demand requirements which was instrumental in our ability to ship $126.6 million above the high-end of our guidance. We will continue to work with our customers and suppliers to maximize the fulfillment of our customers' demand while also working on addressing our inventory levels and the negative impact on our cash flow.
We also expect to continue to make improvements in our operational efficiencies and materials execution in the areas that we can control in spite of this supply constrained environment. In the lower left quadrant, we are showing cash cycle days which combines our cycle time for inventory, contract assets, accounts receivable and accounts payable. Overall, cash cycle time was up sequentially to 52.5 days largely driven by unfavorable customer payment terms mix.
Finally, pretax ROIC decreased by 1.1 percentage points to 23.1% from the prior quarter. Compared to the second quarter of last year, pretax ROIC improved 7.3 percentage points.
Please turn to slide 10. I will now share with you our outlook for the third quarter of fiscal 2019. Our view is that revenue will be in the range of $1.925 billion to $2.025 billion. GAAP diluted earnings per share will be between $0.60 to $0.70. This includes estimated stock-based compensation expense of $0.12 per share. On a non-GAAP basis, we expect that gross margin will be in the range of 7.2% to 7.6%. Operating expense should be $67 million to $69 million. This leads to an operating margin in the range of 3.8% to 4.2%. We expect that other income and expense will be in the range of $11 million to $12 million. Our tax rate should be around 17.25% and we expect our fully diluted share count to be around 71.5 million shares, plus or minus 0.5 million shares.
When you consider all of this guidance, we believe that we will end up with non-GAAP earnings per share in the range of $0.72 to $0.82. For your cash flow modeling, we expect that net capital expenditures will be around $40 million while depreciation and amortization will be around $30 million. We expect net capital expenditures for 2019's fiscal year to be in the range of $120 million to $230 million. We expect to generate positive cash flow from operations in Q3 as we continue to drive better materials planning and execution, partnering with our customers in this supply constrained environment that is expected to lead to a reduction in our working capital.
Overall, we delivered solid results in the second quarter of fiscal 2019. Our revenue exceeded our outlook. We were at the high-end of our outlook on our operating margins of 4.1% and non-GAAP diluted earnings per share of $0.91 exceeded the top end of our outlook by $0.11. Our ability to control our costs, drive efficiencies, leverage our operating model and reduce our inventory levels drove our operating margins to 4.1%, our non-GAAP diluted earnings per share to $0.91 and free cash flow to $70.5 million.
We don't typically provide full year guidance. However, given the continuing supply constrained environment and our solid results over the first half of fiscal 2019, some of which was driven by our catching up with our customers' demand, we feel it is important to provide you with our view on fiscal 2019's full year sales growth. Based on our current pipeline and assuming continued growth in the global economy, we are cautiously optimistic that fiscal 2019 revenue will grow in the mid-teens. We will continue to focus on our operational execution, productivity and cost structure that will leverage our operating model and help further expand our operating margins earnings and free cash flow.
I will now turn the call over to Michael to further comment on our outlook for fiscal 2019.
Thanks Dave. Thank you. Dave provided comments about our overall outlook for the company. Now I would like to provide you with additional color around the end market outlook for the third quarter and FY 2019.
The communications networks is made up of wireless, network and optical products. We continue to see strong demand in the communications market gaining traction in such programs as 5G, IP routing that we are working on. The 5G market is exciting for us. As it matures and the products moved from NPI to volume production, Sanmina will benefit from this going forward. We expect third quarter to be down sequentially as we have caught up with demand that helped drive first half results. However, we expect our growth for the full year to be great, incidentally the strongest we have seen in a long time.
Industrial, defense, medical and automotive. While this segment was slightly down for the second quarter, it is better-than-expected with all subsegments up year-to-date and solid growth in automotive. We continue to benefit from progress we have made and won and continue to win that will support our growth in markets in the future. Our customers recognize our capabilities more so now and the value-add that we offer. We are well positioned in the market for the long-term. Based on the forecast from our customers, we expect our third quarter to be down sequentially, but up over the prior quarter last year. And as like with the communications, we expect nice growth for the full year.
Cloud solutions. Based on the forecast, we foresee the cloud solutions segment to be down sequentially for the third quarter and flat for the full year.
We are really excited about the opportunities ahead of us in all segments and subsegments with most of them up for the full year. We have a healthy pipeline driven by a great and strong customer base, the continuous improvements we are making in operations and new program wins.
In summary, Q2 was another solid quarter. We continue to improve our operational margins. We have a healthy pipeline going into the second half of the year. We remain confident in our ability to drive profitable growth and positive cash flow from operations over the remaining fiscal year 2019. Our third quarter outlook, revenue at $1.925 billion to $2.025 billion and non-GAAP EPS of $0.72 to $0.82. Based on our results for the first half and our outlook for the third quarter, we expect for the full year to be in the mid-teens based on continuous growth in the global economy.
I sincerely thank our employees worldwide for their hard work and dedication, to our customers for their support, without them, we would not be here and to our shareholders for their continuous confidence in Sanmina.
With that, operator, I would now like to open the call up for questions.
[Operator Instructions]. and your first question comes from Jim Suva.
Hi Jim.
Jim?
Sorry, I was on mute. Hi. This is Tim Young, call on behalf of Jim Suva. Thanks for taking the question. On your communication segment, you had strong double-digit growth for the March quarter. Can you talk about how much is that driven by the optical strengths? And how much is driven by non-optical product? And then I have a follow-up.
We don't usually split that up. But generally speaking, when we look at the communications market, it's made up of like for example the 5G. It's also made up of the optical as well as the IP network. So we experienced growth in all of those areas.
A couple of your peer EMS companies mentioned that they have seen some softness in router and switches products. So I wonder if you are seeing a similar thing? Or what you are seeing in the marketplace is different?
No. We are not exactly seeing that as we are now.
Yes. Sorry go ahead.
Yes. Please go ahead.
Yes. Like Michael said, we aren't right now seeing that in terms of the routing and the networking piece. So we are not quite sure what you are commenting on about our competitors.
Got you. And then my last question is on your revenue seasonality. It appears you are your June quarter guidance is a little bit below seasonal. So how should we think about the seasonalities for going forward, especially for the next year as well? Thanks.
Yes. We didn't really talk about that in terms of seasonality. What we are really seeing as we talked about just through the early part of this call is that continuing through Q2, we kept seeing a good catch up in the demand requirements of our customers. So we are seeing for Q3, as we guided, as you can see we are seeing a more, not necessarily in relation to seasonality as per se, just that we have in the first half of the year, caught up with the demand of our customers.
Got you. Thanks for the color. Thank you.
Thanks Tim.
Thanks Tim.
And your next question is from Christian Schwab.
Great. Thanks for taking my question. Just on the last question by the gentlemen before, he was kind of talking about seasonality and he also kind of mentioned on a yearly basis, which I think you guys failed to answer, so I will give you a chance to do that quick, if you guys want to talk about a multiyear kind of growth rate or what we should be thinking about growth rates going into 2020?
Yes. Chris, we aren't giving out growth rates beyond what we have done for the full year 2019. So we are not going to talk about 2020 at this point. But what guess I just answered to Tim was that, what we saw so far in the first half of the year has been the catch up of the demand because of the supply constrained environment. And that flowing through to the full year, we are cautiously optimistic, as we said, that the growth rate for the full year will be in the mid-teens.
Okay. Fantastic. Can you talk about structurally what you guys did or Michael, what you did coming in potentially to improve the gross margins on the components, products and services business so dramatically over a two quarter timeframe?
Well, I don't know whether it was dramatically an improvement but the company is a solid company. We have a solid infrastructure. We just kept focusing on the right parts of the business that focus that's going to change the needle. When you start looking at the supply issue, we have got a real strong organization that I think the momentum was building up to be able to get the supply constraint sorted out. We also booked a lot of new programs past year or so and focused on them to get them full, get them full prototypes, get the yields up. If I could say this, it's just like basically blocking and tackling. We have got all the bells and whistles in the company. We just kept focusing on the things that can change the needle.
Great. And then, thank you for that. my last question has to do with operating margins. When you first came in, you said, we are going to drive the company as fast as possible to the 4% plus operating margin range. And then in your slides here, we are still focused on operating margin improvement. After you have now had a chance to be there for a few quarters, are you prepared to give a multiyear objective of what you think this business can drive above 4% on operating margin basis or not quite yet?
Probably not quite yet. But obviously, we are not satisfied with where we are. We have had operating margins larger than that in the past and that's where we have got our focus. I am not prepared at this time. But you and a lot of our investors can be assured that's a big focus for us going forward.
Yes. I think, Christian, just to add to that, as you know, we have been heavily focused on improving the operational efficiencies as we have been in this supply constrained environment and we are trying to get the leverage out of our model which we have shown you in the past. So our first goal was to get to that 4% and obviously we are trying to get to continue to improve on that going forward.
Great. No other questions. Thank you.
You are welcome. Thanks.
[Operator Instructions].
Operator, we have time for one more question, I guess.
It appears there are no further questions at this time.
Okay. In closing, I would just like to comment again, look, Sanmina has a strong foundation. We have got good results this past couple of quarters. We have got an experienced talented employee base, solid customer base with great target markets, leading technologies, global footprint. We are well positioned for the future in the company. So I thank all of you for joining the call today and we look forward to providing an update on the business on our next earnings call. Thank you very much.
Thank you.
Thank you and this does conclude today's conference call. You may now disconnect.