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Midtier contractors try to get a grip (Oxygen Electronics featured in Electronic Buyers News)
For immediate release - Friday, August 09, 2002
By Claire Serant
08/09/2002 11:42 AM EST
Under strong pressure to remain financially solvent, several North American midtier EMS providers are beginning to exercise more control over production projects they believe OEMs will eventually want to transfer to lower-cost countries, especially China.

Some contractors are examining major projects on a weekly rather than traditional quarterly basis in an effort to wring out costs. Others are trying to shift expensive production to low-cost sites. The bottom line is that all are trying to back away from unprofitable programs, said Dave Rowen, an analyst at Dlouhy Merchant Group Inc. in Montreal.

SMTC Corp.'s loss-creating contract was with Dell Computer Corp. Unable to negotiate better terms with Dell, SMTC terminated the relationship, according to Rowen.

"Dell has been a good, reliable customer for six years. Obviously, it was a tough decision, but our goal is to return to profitability," said Paul Walker, SMTC's president, during a conference call with analysts earlier this month.

The economic downturn has forced EMS providers of all sizes to scrutinize their client base. However, many midtier contractors with fewer geographic resources than their top-tier counterparts are making tough decisions on whether certain programs make sense in the long run, said Jeff Bloch, an analyst at iSuppli Corp., El Segundo, Calif.

Two weeks ago, SMTC executives told analysts that Dell would contribute less than 12% to the EMS provider's third-quarter revenue. That's a 50% drop from 25% in SMTC's second quarter, which ended in June.

The Markham, Ontario, contractor made and tested motherboards for Dell servers, first at its Austin, Texas, plant and later at its Chihuahua, Mexico, site. Dell will most likely transfer the work to a Taiwan original design manufacturer (ODM) by the end of the year, Dlouhy's Rowen said.

OEMs on the move Dell has already shifted most of its notebook business to Taiwanese ODMs like Compal Electronics Inc. and Quanta Computer Inc. More OEMs are adopting that strategy, leaving midtier EMS companies the task of trying to please customers that are thinking about moving.

The decision to jettison the Dell contract could liberate working capital of between $13 million and $14 million for SMTC, according to Jerry Labowitz, an analyst at Merrill Lynch & Co. Inc., New York, in a report.

In the second quarter of 2002, SMTC posted a $1.8 million net loss, compared with a net loss of $13.8 million in the year-ago quarter. Sales grew 16%, to $161.5 million from $149.9 million.

SMTC executives expect third-quarter sales to drop to between $125 million and $140 million as the company phases out the Dell business.

"SMTC made a courageous decision," Dlouhy's Rowen said, "but at the same time, someone, somewhere misjudged what that new [Dell] business could bring to SMTC."

Industry observers believe SMTC could not survive Dell's aggressive pricing demands because the midsize company did not have a low-cost Asian manufacturing footprint. A Dell spokesman said, "Our roster of suppliers changes from time to time because we must be flexible to meet the needs of our customers."

Frank Burke, SMTC's chief financial officer, said the company would not make any further comments about its relationship with Dell.

"We said everything we had to say during the conference call," Burke told EBN.

Learning from mistakes SMTC is up against the same business conditions that forced its midtier peers ACT Manufacturing Inc. and MCMS Inc. to file for bankruptcy protection last year. Another midtier contractor, APW Ltd., recently emerged from bankruptcy protection with new equity partners.

In Europe this year, several small contract manufacturers have lost their battle for financial solvency, said Mark Padson, co-founder of Oxygen Electronics LLC. The Guilford, Conn., independent distributor has 15 EMS clients that are in receivership or have filed for bankruptcy.

"The top [EMS providers] are suffering and the smaller guys are suffering even more," said Louis Miscioscia, an analyst at Lehman Brothers Inc., New York. "The pricing pressure and low utilization rates the midtiers are experiencing is severe."

In May, financial difficulties surfaced at Pemstar Inc., a contract manufacturer based in Rochester, Minn. The company has taken steps to stem its losses by gaining more influence over its customers' manufacturing decisions.

Pemstar takes steps After careful review of the company's profit and loss statements, executives determined that Pemstar had to shift production for one of its large customers from its San Jose plant to lower-cost Bangkok, Thailand, said Steve Petracca, executive vice president of business development.

"All of us are going through detailed customer portfolio analysis on a site level," Petracca said. "We're [constantly] asking ourselves, 'Are we making money on this?'"

But the mere presence of a plant in a Southeast Asian country like Thailand might not be enough to hold an OEM's interest.

"It might be satisfactory in the short term but not long term, if the OEM really wants to be in China," iSuppli's Bloch said. "The midtier companies have to decide whether they want to be in China or more become niche players [in certain areas like automotive and industrial]."

Some midtier providers like Plexus Corp. are sticking to their tried-and-true customer-profile strategy and not selecting certain popular markets like consumer electronics for the sake of rapid revenue growth.

At Plexus, which posted a profit in its latest quarter after two consecutive quarters of losses, executives try to go after businesses they feel are profitable both for the company and their clients, said treasurer George Setton.

"We've never chased the top line. We look carefully at everything we buy and every labor hour we produce on a customer-by-customer basis," Setton said.

Plexus, Neenah, Wis., has a number of customers that are poised to enter the China market, he said. The contractor has plants in Xiamen, China, and Penang, Malaysia.
Oxygen Electronics LLC
56 Lafayette Ave.
White Plains, NY 10603
Phone: +1-914-289-0202
Fax: +1-914-289-0222