Electronics manufacturing services (EMS) tier performance, inventory turns, days sales outstanding as markers

According to investment bank Lincoln International, there were 13 completed transactions in the first quarter of 2008, compared to 12 in the last quarter and 14 in the first quarter of 2007.

EMS consolidations decreased from six transactions in the last quarter of 2007, or 50 percent of transactions, to five transactions in this quarter, or 38 percent of transactions. OEM divestitures decreased from four in the last quarter to one in the first quarter of 2008. OEM divestitures represented 8 percent of total transactions.

EMS divestitures were steady with no transactions in the first quarter of 2008 as well as the last quarter of 2007 (excluding pending transactions).

In Q1 2008 there was one transaction that was included in the private equity investment category compared to two in Q4 2007. Private equity investments represented 8 percent of total transactions in Q1 2008.

Only 8 percent of the deals in Q1 2008 were cross border, the lowest percentage in over two years. Within this category, the only transaction was between a high-cost region and a low-cost region. In comparison, three of the transactions in Q4 2007 were between high-cost regions and three were from high-cost regions to low-cost regions.

For Q1 2008, four transactions occurred within the U.S./Canada region compared to one in Q4 2007. Six of the closed transactions in the first quarter of 2008 occurred within Western Europe, the highest total since we began tracking this data, and two occurred within Asia. Transactions for the quarter were led by the Micro Tier (below $150 million in revenue), totaling seven. Large Tier (greater than $3 billion in revenues) EMS companies closed only one transaction.

There were five Mid Tier ($300 million to $1 billion in revenue) transactions and no Small Tier ($150 million to $300 million) transactions.

Terms and turns: revisiting cash cycle conversions

The cash cycle is calculated by adding days sales outstanding (DSO) and days inventory outstanding (DIO) and subtracting from this sum days payable outstanding (DPO). The financial statistic is used to measure how quickly a company can turn sales into cash.

There are two basic disciplines in managing cash cycle: 1) contractual terms with vendors and customers, and 2) inventory turns. Due to the fact that the electronic manufacturing services (EMS) industry is very material intensive, inventory management is the most important factor in achieving cash cycle improvements.

In the Large Tier, two of the companies' cash cycles improved (fewer days) while three companies' cycles lengthened.

Large Tier performance
Celestica improved 12 percent to 34.7 days from 39.4 in Q1-2007 due to higher DPO and lower DIO.

Sanmina-SCI's cash cycle improved from 42.5 days to 36.5 because of higher DPO and lower DSO.

Jabil Circuit saw their cash cycle go from 22.2 days to 24.7, 11 percent higher, due to higher DIO.

For the second year, Flextronics' cash cycle lengthened, this year from 13.4 days to 24.7, an 85 percent increase, because of an increase in both days sales outstanding and days inventory outstanding. Elcoteq's cash cycle increased slightly from 8.5 days to 8.6, a 1 percent rise, because of slightly higher DIO.

Mid Tier performance
EMS providers CTS and Nam Tai both shortened their cash cycles while Benchmark and Plexus both lengthened theirs. Defense contractor Sypris Electronics' cash cycle did not change versus last year. CTS and Nam Tai both increased their days payable outstanding and decreased their days sales outstanding leading to shorter cash cycles, while Benchmark Electronics and Plexus both had higher days sales outstanding leading to longer cash cycles.

Sypris increased its days inventory outstanding and had lower days payable outstanding which was offset by improved days sales outstanding resulting in no change.

Small Tier performance
The Small Tier also had mixed results. SMTC decreased its cash cycle from 58.5 days in Q1-2007 to 56.4 days in Q1-2008 an improvement of 4 percent due to lower days inventory outstanding and higher days payable outstanding. EMS provider LaBarge also lowered its cash cycle because of lower days inventory outstanding and higher days payable outstanding.

The cash cycles of Key Tronic EMS, Raven, SigmaTron and Sparton all lengthened due mostly to higher levels of DSO and DIO. The Small Tier had the highest average plus the four companies with the longest cycles overall for the third year in a row.

Micro Tier performance
The Micro Tier had three companies achieve lower cash cycles while one company's increased. The greatest improvement came from IEC who lowered their cycle 16 percent due to lower days inventory outstanding and higher days payable outstanding.

EMS provider Simclar lowered their cash cycle 14 percent because of increased inventory turns and lower days inventory outstanding. Nortech lowered their cash cycle despite lower DPO. Winland's cash cycle increased due to lower inventory turns.

Importance of inventory turns

Inventory turnover is the most important cash cycle factor, making up the majority of the cycle. For example, the
three companies with the longest cash cycle, LaBarge, SigmaTron and Sparton with cash cycles of 120.1, 110.1 and 108.0, also have the lowest inventory turns with 3.3, 3.6 and 3.9, respectively.

Conversely, the two companies with the shortest cash cycle, Nam Tai Electronics and Elcoteq with cycles of 5.3 and 8.6 have the highest inventory turns of 21.9 and 10.7 respectively.

Inventory turns are also impacted by business type. Low volume, high mix products, for which inventory management is more difficult, generally have lower turns. The cash cycle continues to be a focus for EMS providers due to its significant impact on return on invested capital (ROIC) and the importance of cash flow for growth.

Source: Lincoln International

VentureOutsource.com, April 2008