Sanmina Corporation (SANM) Earnings Call Transcript & Summary

Okay. I think we'll get started. So thank you, everyone, for attending day 2 of Bank of America's Global Technology Conference. My name is Ruplu Bhattacharya, and I'm part of the equity research team at the bank, covering IT hardware and technology supply chain companies. This year, we're hosting the conference virtually. And we've had a great turnout. We've had over 150 corporates and about 800 clients attending the conference. For those of you who are listening in, you can e-mail me your questions during the fireside chat via the chat box that's on your screen. So in real time, you can message me any questions you have. So today, we're honored to have with us the team from Sanmina, we have Hartmut Liebel, who is the CEO of Sanmina Corporation. As you all know, Sanmina is a leading electronics manufacturing services company based in San Jose. We also have Kurt Adzema, who is the CFO of Sanmina. Now both Hartmut and Kurt are fairly new to the company, but both of them are bringing a lot of industry experience with them. I think each of them has about 20 years of experience in the business. Hartmut, for those of you who don't know, joined Sanmina as President and Chief Operating Officer in July of last year, and he was appointed CEO in September. And prior to that, he was CEO of iQor and prior to that, he was the CEO of the aftermarket services segment of Jabil. So again, a lot of industry experience comes with him. And Kurt was appointed CFO in October of 2019. And prior to that, he was CFO of Finisar Corporation. And prior to that, he held various positions at SVB Alliant, Montgomery Securities, Banc of America Securities and Smith Barney. So both of you, Hartmut and Kurt, thank you so much for being part of our call today.

Thank you, Ruplu. And this is Kurt. I just -- before we dive into the questions, I just want to make the standard safe harbor statement here. Obviously, to the extent we make any forward-looking statements, they are subject to the risks as outlined in our 10-K. And anything we say, we're not updating any sort of guidance or any sort of forward-looking statements in this presentation. Thank you.

Got it. So maybe Hartmut, just to start off with COVID-19 has obviously impacted our industries. Maybe can you just talk about the impact of COVID-19 on supply and demand, talk about your factories, what are -- what is up and running and any component shortages you might be seeing?

Sure. Sure. Yes. Great question. So the COVID pandemic has impacted this entire industry. And if you would have asked me in the January, February time frame, when we first saw the initial outbreak in our Chinese facilities, I actually expected later on perhaps a more severe impact on the entire company. And so far, as we all certainly reported in our numbers recently, I think the -- even though revenues are lower, they're probably not as low as I had originally feared they would be. So the company is holding up and the business is holding, the revenue is holding up very, very, nicely, and I think it's a reflection of the fact that we are producing predominantly, what we like to call mission-critical products in regulated -- semi-regulated markets. And across our entire product line, we have been able to continue production. I think it's being manifested by the fact that all of our facilities, with the exception of a handful that were maybe down for a day or a couple of days or a few hours, all of our facilities have been up and running during the COVID pandemic situation. And again, I think that's a reflection of the fact that we are in the business of providing certain manufacturing essential products that are need on an [ ongoing ] basis. So we've managed through the situation. And I think we're quite happy with the outcome so far, given the amazing constraint that this entire industry had to deal with.

Okay. Yes, that makes sense. And maybe just as a high-level question, I mean, given this economic environment that we're in, can you talk -- maybe both of you, can you talk about your top 2 to 3 focus areas for the next 12 months?

Sure. So right now, we are trying to stay obviously very, very close to our customers and also, obviously, staying very close to our employees to make sure that our operational efficiency and the safety of our employees is absolutely secured. And then we have a history as a company to grow with our customers and to invest with our customers. And right now, our customers are looking for solid partners that allows them to optimize their network. I think they're looking at our history of us being around for 40 years. They look at our strong balance sheet right now. And they're looking at us as an excellent partner to perhaps consolidate some of the networks into fewer partners going forward. So we are focusing -- quickly now focusing on 2 things. Number one is staying very close to our customers, capturing market share opportunities through good execution. At the same time, while revenues may be a little bit muted right now, it's focused on additional operational efficiencies and focus predominantly cash flow generation. We are very happy with our -- recently happy with our cash flow generation last year and also in the last couple of quarters, and that will remain a very, very strong focus for us for the upcoming quarters. Kurt, anything you want to add in terms of how you see our focus economics here for the next...

No. I think that's great. And I think the hope as you talk about leaning up the cost structure is when the recovery comes, we want to be well positioned. And if we do our jobs right, then we should see some operating leverage as revenues recover.

Okay. Yes. No, that makes sense. And the strategy seems sound for this economic environment. One thing you just mentioned when you were talking about the factories, have you guys seen any component shortages in the last quarter? Did you talk about any component shortages? And is that impacting the business at all?

It -- we have seen some constraints from our suppliers. It's a very different situation than what this industry experienced in 2018. So I would not call this a broad-based component shortage whatsoever. It is more driven by some of our suppliers, they have their own constraints in terms of bringing employees back and having the right setup to be at full production because of COVID. We're staying very, very close with them. We have a really very robust monitoring system. So there has been maybe a handful or a dozen or so of suppliers who are experiencing some delays, but I would not call this a broad-based component shortage. And we've been able to manage through those pretty effectively, stay in close communication with them, and it has been maybe a modest -- small to modest impact on the industry and on us so far.

Yes. Ruplu just to modify that, I mean, certainly, at the beginning of COVID, right, as we saw it roll out in China, there was an impact in terms of component availability coming out of China. But I think Hartmut's comments are correct, is we kind of see this moving forward and as China has "recovered," it's been a lot less and has a lot less impact.

Got it. No, I think you guys have done a great job in keeping the factories up and running, which is different from some of your competitors, they've had to shut factories, but the fact that you guys were able to keep running, that's -- actually speaks well to the -- to how you guys manage this. So good job on that. I want to touch on each of the end markets that Sanmina provide services for because I think there are -- it's a very diverse kind of end market set. But before we get into each of the end markets, when I think of Sanmina and when I talk to investors who've invested in Sanmina over the years, what comes to mind is PCB manufacturing, because I remember coming to one of your Analyst Days and Jure was talking about you guys making over PCBs that have 40 layers plus. So do you think that is still a competitive advantage for the company? I mean, do you still make complex PCBs? And do you use all of them for your own internal consumption? Or is this something that you're also providing PCBs to competitors as well?

Yes. So the complexity and our capabilities in highly complex multilayered PCB manufacturing is still there. And perhaps even stronger than it ever has been. So I'd say, it's a very fine business. And it's both for -- maybe we definitely, obviously, have relatively thriving direct business, even to some of our competitors, but we have -- the PCB business has its own customer base. And it also opens up other opportunities, exactly because of its strong technical foundation. So here and there, we also -- it opens up opportunities with maybe more traditional EMS manufacturing sourcing opportunities and it's a fine business. And we are looking forward to keeping our strong market position there and quite happy with the performance of that segment in our business so far.

Got it. One of the end -- one of the key end markets for Sanmina, where you probably use these PCBs is the communications end market. And I've always thought of Sanmina having a competitive advantage in this space. But maybe for the listeners, can you talk about what is it that Sanmina provides to the communication space? I mean what are you doing in networking, optical and wireless infrastructure? And just if you can talk about the trends you've seen in these 3 areas.

Sure, sure. Yes. So within communications, it's important for our listeners to understand that we are in the infrastructure part of the communication business. So we are not engaged in the handset or mobility or consumer electronics-related activity that might fall under the communication. So we're happily in the infrastructure, in the backbone, and there, we are particularly thrilled about the opportunities that the evolving 5G network market and the [ commercialization ] of that market is representing for us. That's where we have today relationships with some of the most dominant players in this end market. Everybody is obviously watching very carefully here the rollout, and the speed of the rollout of the 5G market. But we are very, very well positioned. These are very big technical products. Some similar comments that you maybe have made about the PCB market is also true here in the operator networking business. So very, very high engineering content, very strong relationships with the key players in this industry. And I'm just very, very happy for us to have this exposure especially as 5G is probably coming our way at a nice pace. We don't have exact timing yet and visibility precisely of when the market takes up. But I'm very, very happy in terms of how we position that.

So I just want to build on that because 5G, a lot of people think that, that's going to drive another leg of growth for the communications end market. In general, I mean, are you -- do you think that COVID-19 has impacted the 5G builds? Are you seeing projects getting delayed? Or is everything on track? So just give us your thoughts on how big an opportunity 5G is for Sanmina and what exactly are you seeing in terms of the 5G projects?

Yes. So kind of referring to some of the third-party research that out's there, without naming particular sources, the commercialization opportunities and what's happened in the -- with some of the wireless providers. I'm pleased about the speed and acceleration that's happening with the end market. So add to that enhanced digitization and communication trends, as a result, perhaps also of COVID. So I think this is actually positive trends that the industry and we should benefit from. That might be offset by that -- the actual spending purse of individuals or enterprises might be somewhat compromised, if we're kind of going into a recessionary environment as a result of COVID and other developments. So those -- I think the positive effect in terms of increased digitalization, increased need for high-speed communication might be somewhat offset by the, so to speak, the commercial purse of the end users might actually be compromised and maybe a little bit smaller than we thought would be just a little while ago. How that exactly offset each other, I don't know yet, but that will be my initial comment here in terms of the speed of the rollout and the economic benefit we could gather from that.

Got it. And then just in terms of how Sanmina is involved, are you making like 100 gigabit per second or 400-Gb line cards and boards? I mean is that -- are you involved in the high-speed products? Or what exactly are you building? Are you building the base station infrastructure? Are you making the networking gear? So how is Sanmina involved in 5G?

Yes. So we are engaged in this entire spectrum. And what I'm particularly pleased, obviously, is that the design and production wins and the latest product ventures and product releases that we are participating also are very effectively. And that's why I'm very, very pleased about and hopeful that we're going to have a nice participation as and if 5G accelerate, and we can participate in that. So it is across the entire spectrum that you outlined, yes.

Got it. Got it. Just taking a step back, if I think about the optical end market, right, I think that end market over the past few years certainly has been very strong, and it's helped your -- the Sanmina's growth as well. But do you think that in general, optical can remain strong over the next few years? Or should investors expect some level of slowdown in the growth of this end market?

So my perspective is that the end market probably has a beautiful growth rate ahead of us here. And so I'm very excited about the overall application of 5G across different sectors and the impact that it has on the entire infrastructure refresh. And as long as we are participating here with the right market leaders, and I believe that's -- and when I look at the portfolio of customers that we have today, I'm optimistic, I'm cautiously optimistic that we have a chance to participate in excellent market growth opportunities. And again, it comes down to making sure that you have the right market leaders in our portfolio. And I think broadly speaking, we are there today. So I'm very, very pleased for us to have this exposure to this end market, and I think the best opportunities, I think, for us in this sector is still ahead of us.

Okay. Great. Maybe just one more question on the communications side. A couple of quarters ago, management had talked about some component shortages and there was an inventory correction happening in this end market. Do you think we're past these at this point? Or is there still some inventory correction that needs to happen?

Yes. I think it's still the latter. We're observing it very, very carefully. But it's -- I think it's still something to be worked through. And that's what we see in the end market demand that we're monitoring. And that's the feedback we are recapturing from our customer contacts. So still some work to be done on the inventory front.

Got it. And components, I mean, are you getting enough components that you need?

Broadly speaking, yes. Again, we are in a much better position than we were just 2, 3 months ago. Thank you, Kurt, for clarifying some of the challenges that we saw in the January, February time frame, coming out of some of the key suppliers in China. But broadly speaking, we -- I think we have our hands around those. And there's -- well, it always has to be very, very finely managed. But right now, I believe that's very manageable, and we should be in good shape when demand comes through in a more significant way.

Got it. Got it. Okay. I want to make sure that I cover some of the key end markets that you're playing in. So industrial is another broad end market that you guys have exposure to. Maybe talk about some of the focus areas within industrial, what specific type of products are you building? And is this an end market which you would like to increase your exposure to? I know you had a strong exposure to communications, but is industrial also a market that you want to increase your presence in?

Yes. So what is very interesting for us about the industrial market, it has to do also with kind of how we have approached the successfully other markets and other customers in the past, is the propensity and -- so the current status and then the propensity of in-house versus external manufacturing. So broadly speaking, the industrial market still has a very high propensity of more outsourcing opportunities depending on what segment we're talking about. They're still between 60% to 90% of the manufacturing capacity is in-house. As those end markets and our customers experiencing their own economic and commercial pressures, they're looking for opportunities to move their fixed cost structure to a more variable cost structure. And that much higher propensity for outsourcing and I think that's a wonderful secular trend. That's why I'm so excited about the industrial segment that we are playing in and should give us, as well as for the rest of the EMS industry, some beautiful growth opportunities going forward. So propensity for outsourcing is a big factor and that's where we very much like the industrial sector as well.

Got it. You also have Sanmina SCI, which is in the aerospace and defense business. Can you just talk about what is that -- what are some of the things you manufacture in that area? And how is that business trending?

Sure. No, that's a very, very fine business. It has also fantastic history. As you mentioned that it's connected to the original SCI business, which has been engaged in highly technical engineering projects with NASA, going back 40, 50 years. So it's a very rich engineering-based division inside of our company. And right now, being in the defense, so a significant portion of that business is exposed to the defense and aerospace business. And that is right now, in the current economic environment, a very, very healthy market. SCI also has its own product line. And it's just really, really well positioned with the market leaders and their customer base in the aeronautics and in the defense space. It's also a great fit because it's a business that is highly regulated. The facilities where we manufacture these products have to be ITAR certified. So it's a great fit with our focus on regulated or semi regulated mission-critical markets and it's the business that we want to continue to support and invest in for a long time to come.

Okay, great. There are a lot of end markets that I want to touch, but maybe at this point, I'm going to switch a little bit to the balance sheet because I know that we get a lot of questions for every company and including Sanmina about the strength of the balance sheet, your liquidity position and any debt that is coming due. So maybe, Kurt, if you can just talk about what your thoughts are on your liquidity? And do you -- on your debt towers, and how should we think about -- maybe if you can also include your priorities for use of cash?

Sure. Thanks. So I'll say a couple of things about the balance sheet. So I think, again, if you kind of look back on in the pre-COVID time, kind of our December balance sheet, we had kind of over $400 million of cash, and we had a term loan for about $366 million term loan with quarterly payments of a little under $5 million, with the remaining $300 million balance payable in November 2023. So very long-term maturity for the vast majority of the term loan. We did make a decision kind of the third week of March, given the uncertainty around COVID at that time, to draw down our revolver by $650 million. We have a $700 million revolver, just to put the cash in the bank, just Hartmut and I decided, and with the Board, to sleep a little bit easier that we felt better with the cash in the bank as opposed to just having a revolver to drawdown. There wasn't a need for the cash. In fact, we generated $119 million of free cash flow last quarter. So it was really just a precautionary measure. As we all recall, what was happening in the market in the third week of March, the Fed had not done its actions. The government hadn't started its stimulus plan, and we just felt like that was a good thing to do. But again, we didn't use any of the cash then. We don't anticipate using the cash this quarter. We expect this quarter to generate additional free cash flow. And my assumption is that at some point, we will pay back that revolver sometime this calendar year. In terms of cash, uses of cash, a couple of things, I think, really 4 different areas. I think, first of all, obviously, organic growth, we continue to invest in the business. Yes, we've cut down on our levels of CapEx, given the uncertainty around COVID, but we continue to invest and look for organic growth long-term in our business. And we're spending CapEx, for instance, on 5G and the ramp of 5G for the second half. The second area I would say is we do look at M&A. I'd include inside of M&A, OEM divestitures. I think as Hartmut talked about earlier, I think more and more companies over the next couple of years, as they look to go to more of a variable structure, are going to look to outsource more, especially in these key industries that Hartmut talked about. And so I do think there will be situations where we will use cash. Typically in these situations, you'll take over a facility, take over employees with the eye of either filling up that facility with other products or candidly, moving those products to our existing facility. So I think we'll continue to look at M&A, but I think probably OEM divestitures is just one area that I think there'll be a lot of opportunities over these next couple of years, and that's an area where we would use cash. The third area, we talked a little bit about that. Again, it's not a lot, a 4.7 -- roughly $4.7 million a quarter. So there'll be a little use of cash there, but not a lot. And then finally, share repurchases. So we've been active in the market in our Q2, which ended the end of March. We bought back about 2.4 million shares for $61 million, and we'll continue to be opportunistic. We're generating cash. Our intent is to return some of that cash to shareholders, tax efficiently through buybacks. So I'd say those are kind of the 4 ways that we plan to use our cash that we continue to generate despite the challenges of the environment.

Got it. Yes. No, that makes sense. Another question in the time that we have remaining that I want to ask you is that a lot of investors are looking at China, right, given all of the tariff situation with the U.S. as well as the manufacturing hiccups that happen. How much of your manufacturing footprint is in China? And if OEMs were to want to move product lines out of China, would you say that Sanmina has the white space to support such moves? So trying to understand if Sanmina can be a beneficiary of manufacturing moves out of China?

Sure. Sure. Good question. I can take that. So our presence in China is very relatively small, to your point, compared to the competition. Probably in the 10% range in terms of footprint, depending on how you define footprint or usage itself. And we have a -- we enjoy a beautiful regional setup in all 5, 6 continents around the world where we have presence. And I believe that the 25-year low, low cost China area is probably coming to an end or slowly coming to end or changing or at least where we're seeing increased demand from our customers to have much more of a regional-centric supply chain, less of a China owning-centric supply base. And that plays, I believe very, very nicely into our footprint and how we run our company. We have exceptionally strong local management team and regional management team. And we have the capacity and investment dollars to support our customers as a trend towards regionalization, closer to end customers, more optionality, I think that's going to be the matter for many of our customers going forward. And I think we're quite well positioned to support them in that regard.

Okay. That makes sense. One end market that we didn't touch when we were talking about the end markets, is the cloud solutions aspect of the business. So Hartmut, do you think that there's an opportunity for Sanmina and maybe EMS in general to take share from ODMs? I mean what is Sanmina doing with respect to making stuff for the hyperscale cloud providers? And do you see any opportunity in making white box servers or switches? Is that something that Sanmina can benefit from? So just talk about your cloud business and how you see that progressing.

Yes. So that's a fine business. It's not a very, very -- it's not a very large business within Sanmina. We're looking at this as a project-based business with a fair bit of software engineering content as well. There are big projects that are available out there. But we like to pick one, so we can have particular strong value-add service opportunities. And I don't expect for us to -- any time soon to go into large-scale white box support of some of our customers and new customers. But we'll continue to focus on small niche opportunities, and that's going to be our focus for the time being as it relates to cloud. That has been our approach. And for the time being, that's how we're going to tackle this market, again, on a quarterly basis, to make sure it fits our financial and operational criteria.

Got it. Something related to this is your product business, which is Newisys, the storage business that you have. Can you talk about how that has progressed over the years? And what is sort of the end game for that business? Is this something that you, maybe Sanmina, incubates and then spins off? Or do you see that as an integral part of the business? And how do you see growth in that area?

Yes, it's a fine business. Again, it's similar to my previous comment to say it's a relatively small part of the overall Sanmina. It's a fine team, they're doing well in the marketplace. Today, it is absolutely an integral part of Sanmina. But to state with any other business opportunity, if we have a customer comes forth and comes up with suggestions of how we can provide more value to those customers, so maybe partner with somebody else, we can always have those conversations. But today, it's a completely integral part of our business, and we're quite happy to have it.

Got it. We're almost out of time. I'm just going to take a few minutes. One of the main thesis points for investing in Sanmina has been the operating leverage that you have, especially in the CPS segment. So maybe, Kurt or Hartmut, if you can just talk about do you see that as still a competitive advantage? And how should people think about operating leverage? And if you want to share any long-term targets, or do you think vertical integration is an advantage that you have by having a components business?

Yes. So the way I look at this is it almost depends, not just by market segment, but also by individual customers. Some customers, they are buying -- they very much buying vertical integration, some other ones, they want to have all the optionality and they're kind of putting best practice plays together into their portfolio. So we have -- for each of our large customers, we have our own strategy. And that's kind of how we look at it. So I think maybe a number of years ago, vertical integration was the absolute final objective for this industry. I think it has shifted, it very much depends. And vertical integration, I think, has been a success for some customers and some other customers, they haven't been happy with that at all because, as I said, they actually value optionality. And that's how we're also deploying our CPS business here. As I said earlier, they have their own customer base, independent from the manufacturing business or the EMS business. In some cases, we have customers that are going our entire -- across our entire product portfolio, and they greatly appreciate that we have these very strong vertical integration capabilities. So it's -- I've come more and more to the realization over the years that it very much depends, actually almost by customer to customer. And there are some similarities inside of the market segment, but it very much depends on what each customer's philosophy is of what type of optionality versus kind of package they prefer to add for the company like us.

Got it. Okay. Great. I mean it's been a great discussion. We've had a good turnout. So thank you, both Hartmut and Kurt, for attending today. I mean thanks for giving all of these details. And for those of you who -- the attendees who are dialed in, if you still have any further questions, please feel free to e-mail me, and we'll pass them on to management, and we'll try and get them answered. So thanks, everyone, for attending today. Thank you.

Bye. Thank you, Ruplu.

Thanks. Bye-bye.