Contract manufacturing financial indicators

By Mark Zetter

When OEMs evaluate contract manufacturers, it's not enough that a particular contract manufacturer has a history or experience in the field of expertise, or product end-markets, the OEM is marketing its products in.

OEM executives must also be comfortable understanding the contract manufacturer's financial position relative to his business profit objectives and, that the contract manufacturer will be around for a while to serve the needs of the OEM.

Below are some of the financial operating and overall company indicators, and a few possibly related causes, OEM executives might want to look into more closely when evaluating contract manufacturers for the purpose of engagement. Naturally, it is easier to gain access to some of this information from publicly traded contract manufacturing companies.

Earnings statements

Inventories
High inventories might possibly indicated the following: quality of the products manufactured by the contract manufacturer has slipped the competition is building a better-quality product for the same customer or end-markets some of the contract manufacturers' customers are financially strapped production costs are out of line the contract manufacturer is no longer price competitive.

One question executives should ask is, "are sales falling or is production rising too fast?" Keep in mind, companies may hold back some inventories while waiting for new product introductions (NPI).

Rising receivables
Most explanations for rising receivables are usually bad if receivables are rising faster than sales (relative percentage for each). Possibilities for this might include: customers are paying the contract manufacturer to slowly (again, due to financial troubles of their own, or business disputes) ‘channel stuffing' or, increased shipments at quarter end to help make the quarter numbers (essentially, stealing from the following quarter) could be talking place.

Extraordinary losses
Look for inconsistencies. In years one through three, for instance, the contract manufacturer reports steadily increasing operating earning profits (with its stock price rising). Then, in year four the company reports an extraordinary loss per share, but adds that operating earnings, before the loss, were healthy. It could be there has been some neglect in capital spending necessary to maintain infrastructure in a high capex industry such as contract manufacturing.

Asset sales
Companies may sell a profitable business segment or division to raise earnings, but this cannot be done each quarter. Executives should place a smaller value on earnings derived from asset sales vs. core operations.

Research
With evolving and emerging technologies such as lead-free SMT PCBA applications and nano technologies, contract manufacturers need to keep up. There should always be a good reason if R&D budgets are cut. Usually, there is not...the company is usually trying to inflate earnings, if only temporarily.

Reduced capital spending
Again, look for reductions. Capital spending is usually necessary to remain competitive. This can be deceiving, however, when reviewed during periods of low utilization rates across the industry.

Earnings growth
For contract manufacturing companies with operations in foreign countries, check to see the growth is ‘true' and not due to a majority of earnings reported under the rate in one particular country - using that country's currency exchange rate. Currency translation effects can end up in the income statement or the equity section of the balance sheet, decided by internal accounting rules. Effects that end up in the income statement are not part of continuing operations.

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