Sanmina Corporation (SANM) Earnings Call Transcript & Summary

All right. So thanks, 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, including EMS companies. Today, we're honored to have Jure Sola, who is the CEO of Sanmina Corporation. As many of you know, I mean, Sanmina is a global electronics manufacturing services company based in San Jose. We also have Kurt Adzema, who is the CFO of Sanmina. What can I say about Jure? I mean he founded the company in 1980. So he has more than 40 years of experience in the business. He has really seen many ups and downs. He has really built this company from the ground up. Kurt also has been with the company -- I think he joined October 2019. And he also has a lot of industry experience. I mean prior to Sanmina, he was the CFO of Finisar, and he's also been at Montgomery Securities, Bank of America Securities and Smith Barney. So I mean, we've got really 2 gentlemen who know the business. So Jure and Kurt, thank you so much for being part of our session today.

Good to be here.

Good to be here.

All right. So we're going to try and cover a lot of different things. But maybe, Jure, I just want to start with an overall picture. Where do you think we are in the business cycle? And when one thinks about outsourcing, do you think there are more opportunities for outsourcing? Or do you think -- or which end markets have more room for you to see more companies outsource their manufacturing?

Okay. Let me, first of all, remind our audience about Sanmina harbor statement. Please look at it and also look at all the risk factors and all the stuff that we file with SEC. So get the legal language out first. The second thing that you forgot to tell that I started this company when I was 1-year-old. Back to the [ silo ], I would say, today, the good thing about -- I remember early days, we had to educate customers, what means outsourcing and why they should outsource. I think today, overall industry itself is matured. I believe that our customers appreciate and also need technology and solution that we bring to the table. But where industry in a cycle comes from an outsourcing point of view, we are sort of the industries where like consumer is fully outsourced. So if you look at industrial, medical, defense, even automotive, there's a lot of room to go in that side of the business. And that is the biggest part of our revenue today, about 58%, 60% last quarter, and we expect to see more and more outsource. On communication side, and when I talk communication and cloud, communication part of it is well outsourced. There's still some done in-house, but I would say 70%, 80% is outsourced. Where cloud computing, it depends where you are at. I think that industry is also well outsourced to critical manufacturers like Sanmina. But I think one thing that I want to remind the audience is that I still believe there's a like maybe not good understanding why EMS industry, I call it integrated manufacturing industry, why we are so important to our customers. I don't think investors really appreciate how important -- if you talk to our customers, first thing they tell you, you have to have the right partners. And there's this perception that customers just back -- jump from one supplier to another supplier. That's not the case anymore. Well, it's more about partnership, building a strong relationship, a relationship that lasts for many years. So I'm really proud that we are part of this industry. And also, if you look at the history of this industry, we're able to get through every cycle and really survive it while we generate respectable margin. But if you look at the rest of the financials like cash flow, free cash flow, it's been really good. I know it's been good for some years. And if you look at the last 5, 6 years, 10 years, we did a lot of great things. So with that, I'm still here and enjoying what I do.

No. I mean you pointed out to the free cash flow and a lot of the achievements you've had over the years. So we'll try and get into a lot of those different points. But maybe also to touch on something more recent. I mean with respect to the COVID-19 pandemic, are you still seeing any lingering impacts from that? Are your factories all up and running? And what percent efficiency are you running at? And also on Malaysia, I think that's a recent -- with the recent lockdown, so what are you seeing there? Any impact from Malaysia shutdowns?

Well, first of all, let me start with overall. Definitely a challenging time. We're a manufacturing company. We have to be on the floor. We have to bring the people inside. So keeping our people healthy around the world, that is priority 1. I think our teams did a great job, [indiscernible] so far. All our factories are running, nothing being shut down. In Malaysia, about a week ago, Malaysian government issued a statement that we're only allowed to work at 60% capacity based on people. And that's what we have. Definitely, there is some impact. It's continuing to -- I think we're driving efficiency to maximize it. Yes, but if there was no COVID, everything was running at the full capacity every day, efficiencies will be up. Percentage-wise, we are probably 10% our normal efficiencies around the COVID. But our biggest challenge, and I'm sure you'll ask this question, is really the material. As much as we like to use COVID as an excuse, and a big challenge and it was, we learned how to work with it. But now it's the material. Getting the material, it's going to be a challenge through the rest of this calendar.

So that is a good segue into the next question, which would be on component shortages. So can you talk about like what parts are in shortage, how are lead times trending? And which end markets is that impacting really?

Well, if you really look, almost everything we have shortages. I would say, any components, including raw material or circuit boards, we have shortages. The biggest impact is on semiconductor, and it's across the board. I mean we are -- as you know, our mix is telecommunication and the industrial, medical and defense, all of those markets are being impacted. But also specifically to -- some customers have a stronger relationship with its key suppliers. And in some cases, that might do a little bit of advantage. Let's say, customer A might do a little better job than customer B. But at the same time, the suppliers of these critical components, they're trying to satisfy everybody. So they're putting basically everybody on our locations. And that's really what we are working with. So we're working very closely between suppliers, customers and ourselves and really trying to figure out how do we make a minimum impact on our customers and end customers.

So related to this, maybe, Kurt, I want to ask you one question, which is are you using the strength of your balance sheet to maintain inventory of components? And I guess what some investors would be concerned about is, does that pose any risk if end demand doesn't pan out as we think it will?

Well, I think, first of all -- I mean, the stuff that is in short supply, we can't build up inventory. We're living hand-to-mouth in terms of some of these semiconductors that Jure is talking about. So certainly, we're placing purchase orders out further, because the lead times are extended. But that liability, based on our agreement, partnership with our customers, is really their liability. The challenge, of course, is on the inventory side is really more about, hey, if you go out and you buy 99 parts, but you don't get the 100th part, and therefore, you don't ship the final product is your inventory going to be higher. So I do think during these challenging times, you're going to err on the side of hoping that the 100th component comes in and you're going to buy some of the -- the other 99. So we may see a little bit higher inventory. But that being said, we have the strongest balance sheet in the industry, and we feel confident that we'll make the right business decision there. Unfortunately, we can't build up buffer of stuff that isn't available to begin with.

Okay. Got it.

But just to add to that, I think it's important to understand, in our business inventory is really the full responsibility of our customer as everything we discussed.

Okay. So customers bear the risk. I mean you have some guarantees that they will take product. Is that how you mitigate the risk?

That's correct.

Otherwise we can't buy.

Okay. Yes, that makes sense. Okay. Jure, another thing that's been in the news lately is that there supposedly is a shortage of labor for manufacturing. Are you seeing anything in terms of issues with availability of labor or labor costs? How are they trending?

Yes. Well, first of all, at a lower level, there are some challenges around the world, always is. The labor costs are slightly going up around the world. So that's something that we manage as part of the business. But I would say, overall, that's not the biggest challenge that we have today. It goes back to the -- really materials number one, COVID number two, and then everything else. The good thing, Ruplu, right now is demand is there. We could be shipping a lot more if the materials were here. So the short-term forecast for us is very high to forecast. We have the demand, if you look at it, the short-term demand is very strong. But the long term, we can look at the -- there's a light at the end of the tunnel, and it looks good, and we know it's not a train. So we are very optimistic about the long term because I believe this material stuff will get resolved by end of this year.

Got it. So maybe just one more question on this, and then we'll move to the end markets. So the availability of components, is that impacting your revenues? Are you missing any revenue because you're not getting end parts? And you don't have to answer if it's -- you don't -- for this quarter, but maybe on the last reported quarter, was there any impact to your revenues? And is the situation getting better or worse?

Well, the last quarter, we had an impact between $50 million and $75 million. We talked about it when we announced the numbers. Today, definitely, there's an impact. We're still expediting, and we still have 21 days to finish the quarter. So we're not giving up. But definitely, there's a moving bar for certain technical [indiscernible] things that we bring in. So it's a challenge here, but we're not ready, because we don't know 100% exactly what's going to happen in the next few weeks. We're working hard to make a minimal impact if any impact comes up.

Okay. Okay. Fair enough. Okay. So now I want to move into talking about each of the different end markets. And I want to talk about communications first, because Sanmina is well known in the industry for your expertise in this space. So maybe, Jure, can you just talk about what is Sanmina's competitive advantage in communications? And what are you seeing in respect to networking, optical, wireless infrastructure, all of the different things that Sanmina does, if you can just touch on them as to what you're seeing and what your advantage -- competitive advantage is?

Yes. When it comes to all of this industry [indiscernible], you asked specifically about communication, let's talk about that. First of all, we have a very strong reputation in that industry. We get involved every stage of that product development. We help the customer, do R&D, new product introduction and then we can take that product, [ innovate ]. We do everything to distribution of that product for our customers. These are -- we talked about higher networking stuff, advanced optical modules and the systems. So when you look at that today, that business for us -- the bucket we talked about, the communication networks and cloud, I guess, around $3 billion run rate right now. And the pure communication product is about 2/3 of that, including 5G, okay? And then 1/3 of that is our cloud infrastructure. So we're well positioned, I would say, technology, flexibility that we give that industry that really had no knowledge of that technology for many years. I believe that's our competitive advantage. Time to market in that industry is very, very critical. So the company that has technical capabilities and that give our customers flexibility have huge advantage. And I believe we're equipped with that.

You mentioned 2 things that I want to drill into a little bit. 5G, I mean, how big an opportunity is this for Sanmina? And are you seeing the projects come in, in the time frame that you had expected? Or are things better than expected? Or are things getting pushed out?

Well, we talked a year ago that it would be a lot earlier, but they're starting to come in and things are moving in the right direction. I don't think that it's full production yet, but definitely, demand is starting to move in the right direction. And for us, yes, there's a good -- we're well positioned with some of those key customers, and I believe that we are well positioned to benefit for many years.

Okay. And then you've benefited from a strong optical end market over the past few years. Do you think optical overall remains strong? And -- or should we expect some moderation in revenues from optical? And is this another area where you have some component shortages?

First of all, where we are involved is more in the latest technology when it comes to the network or IP routing and really the full network that you build around the 5G and so on. Those are all latest technology and have a lot of optical requirements around it. We play a big role at the module and the system business, and that's a big business for us. Yes, when it comes to shortages, anything that takes semiconductor on there, it gets an impact. Like I said earlier, even the raw material for printed circuit boards, they get impact. But as I say going up and the lead time is going up.

Got it. Okay. No, that makes sense. Printed circuit boards, you mentioned that. I mean that had -- in the past, I remember Sanmina building PCBs that were like 40 layers. Is that still a competitive advantage for Sanmina? I mean are you making PCBs only for yourself? Or do you also sell PCBs to other companies?

First of all, we grew up in a PCB. So we love that business. So let me take you back. At one time, 20 years ago, we were the biggest printed circuit board company in the world. All our manufacturing was done in North America and Europe. In early 2000, everything had to be kind of restructured and moved to Asia. So if you look at, today, Sanmina has 2 factories here in North America, 1 factory in Singapore and 1 factory in China. In North America, most of our revenue is through for defense business. And Singapore in Asia is basically all higher-ends. So we do still build 50, 60 70 layer boards with very complicated materials and so on. So when it comes to technology, Sanmina is technology leader. Also, beginning of this year, internally, we report numbers in component, products and services. But internally, we brought a gentleman strictly to run our component business, which includes printed circuit boards, precision machining, the optical cables, backplanes. And the key idea is to regrow those businesses. So we're making a big commitment to regrow our high-technology printed circuit boards bag here in North America and other parts of the world, especially here in North America. So we are committed to that. And we do use a fair amount of the old boards internally for our product, but majority gets sold around the world, including our competitors.

Okay. Got it. Okay. So moving now, I'd like to move into the industrial, medical, defense, automotive. It's a broad segment that you have. So maybe just starting with industrial, maybe can you talk about what are some of the things that you're seeing there? And I mean, I think you had a project, you've mentioned in the past that building radios for police and emergency services. So can you just talk about what you're seeing in that business as well as overall industrial, how that is panning out?

Yes. If you look at that industrial, medical, defense, automotive is about 58%, 60% of our revenue. It did 58% last quarter. I think we're well positioned in that business. We're expanding that business. And if you look at that bucket, the industrial or medical is over $2.5 billion in revenue and growing. When it comes to the police radio, I think we're well positioned there. We continue to deliver the right solution for our key customers in their business, and we believe that business will continue for many years. On the defense and automotive, that business for us is around -- closer to around $1 billion or so. That's also well positioned. Our defense business has been very strong. We've been building a strong backlog, and it looks really promising, if you will, in the next 3 years what we can do in that business. Also around that -- when I talked about creating the value of Sanmina, what is the best for our shareholders. [indiscernible] the total volume, we separated also our defense business internally. We have a President who runs that business to find a way to grow it faster. And we believe there's a lot of capability. So this new management that we implemented in the last 4 months is really going to deliver that. Strong new leadership gives us the flexibility to be able to service our customers faster and lower the cycle time. I think there's a lot of operating leverage in our business model because we have to grow. That's the key to our model. Right now, business has gotten flat. It's been flat more than I like it to be. But the whole focus is internally to leverage and grow, but to grow profitably, something that is repeatable for many years to come. I think if you look at financial results in the last 4 quarters, I think we did very good results, all of them generally respectable results. But we believe the longer term, we have a lot of more upside, but I think it has to be delivered. Our efficiencies will improve and we'll make a little bit extra money, but the growth is what we got to drive to deliver these things. So that's why these businesses are very important. You saw the components, products and services last quarter jumped to 14%. We can get that business about 10% higher, 20% higher to see those margins going in the right direction.

Got it. I want to move into some of the financials, and I have a bunch of questions for Kurt. But before we do that, there's one more end market that we haven't talked about, which is the cloud infrastructure part of your business. And Newisys is part of that, I think. So maybe can you just talk about your business in that area? What are some of the things that you -- that Sanmina manufactures? And what is your overall thought for Newisys? I mean how do you see that business trending? And what is your plan for that business?

Well, [indiscernible] I think a year ago, 1.5 years ago, we thought it's not going to really deliver a lot. I personally took on that project myself in the last 9 months. We were able to show that it's making money now, that's number one. And we believe that we have some unique technology both in our hardware and software there. I think we'll be able to show that we can grow that business and also help us expand more into the cloud infrastructure. And that's the reason there's a lot of focus on that. And that includes hardware, software and services. Because there's a big opportunity for us in the cloud side, expanding our services, and I'm personally driving that. So I don't want to talk too much about it, but there's a lot of good things that I believe that Newisys storage product will help us grow our business.

Okay. Got it. Maybe, Kurt, I want to move a little bit into some of the financial aspects of the business. So maybe, first of all, can you talk about some of the long-term targets for your revenue and margins for the IMS and CPS segments? And CPS margins have been trending really strong over the last couple of quarters. How do you see -- I mean should we expect that to continue? And what are some of the drivers for that?

Sure. So obviously, we're taking one quarter at a time here. It's a very challenging environment to forecast, not only because it's COVID, but as you Jure talked about, the component shortages. But ultimately, we feel like when we get to the component shortages, we're on a good trajectory for growth based on some of the drivers that Jure has talked about. I think in terms of margins, I think we focus primarily on the operating margin at the end of day because that drives profitability. And I think we've done a good job despite COVID delivering 5-or-better-percent operating margin in the last couple of quarters. I think our goal, long term, we've talked about in the past 5% to 6% operating margin. And that's going to be driven by a couple of things. I think, first of all, as Jure talked about, revenue growth is an important part of that. I think the other part is, as the CPS business grows, which we've talked about carries a higher margin, I think that will help drive the overall corporate margin. And I think, again, we've got a pretty lean infrastructure in terms of operating expenses and SG&A. So that shouldn't necessarily scale with revenue. So I think a combination of just revenue growth and favorable mix for CPS, I think, are good. And again, our goal is to get to be between 5% and 6%, obviously. Right now, we're closer to the 5%. But as revenue grows, we should hopefully move more towards the higher end of that range.

Got it. I want to touch on this a little bit more because one of the main thesis points for Sanmina for investors was the operating leverage. Do you think where we are in the business cycle, the fact that you're vertically integrated, does that give you opportunities to drive more leverage? And what are some of the levers you have to drive operating margins in this segment?

So let me, first of all, take you back to when we talk about [indiscernible] to really drive shareholders' value. It's the way we run that, and that's going to drive the leverage [indiscernible]. We have 2 major businesses that we already report, IMS and then Components, Products and Services. And basically, internally, we have 3 presidents that run those businesses. Kurt and I are overhead, you know that. So I believe that we structured it right, and they have now full control of the sales to really focus on the key customers that are going to drive the business. So back to that growth. I think on top of that, we're working on the right mix, improving the mix, that's [indiscernible]. We do a lot of things internally. Especially during the COVID, we learned to do -- we had to do more with less. So we're focusing -- we started that before, but now we have improved efficiency, drive the cost down, output up. And that is -- it requires a fair amount of automation. So we're putting that in there, what we call internally, Sanmina 4.0. We work with our customers together. That's starting to -- and this is one of the reasons we're able to improve those margins that you saw, even with flat revenue, that's [ our focus ]. Continue -- if you look at our operating expenses, our SG&A came down. But we can be a $8 billion, $9 billion plus even a $10 billion company, our SG&A in absolute dollars should be pretty flat, maybe a few dollars up and down, but not very. So there's a lot of leverage there. Capacity utilization. This company is not set up just to do $7 billion or $8 billion. If you look at our IT structure, CFO structure, we really can do a lot more. We're going to get back to the $8 billion run rate. I think at that level, Sanmina, we can slightly improve those margins with the [indiscernible] to bottom line. And then the last one, again, is driving those components margins. We were able to take it from 12% now to 14%. Overall, if you look at the last 4 quarters, I said they've been kind of flat, around 12%, 12.5%. There's a lot of upside. And would those get over 15%, answer is yes. But in order to do that, we have to get more revenue in there. So there's a lot of focus, today maybe more than ever before, to be more laser-focused, focusing on the right partners in each of these businesses to drive that. Defense business, I think, have a lot of upside. Our services business have a lot of upside. And those have a lot better margins than your typical IMS. So those -- we know for fact that Sanmina has a lot of leverage, but we need better growth. I think the challenge short term, first of all, demand is strong. Short-term, driving the growth is going to be difficult because of the components issue. Longer term, I feel very confident that if you look at a year out, 2 years out, you're going to see a lot of growth from us. So I hope that answered the question.

Yes. That makes sense. Maybe a couple of more things on the financials. Kurt, maybe can you talk about the strength of the balance sheet, your liquidity position? Do you have any debt coming due? And how much financial leverage? I know you guys have delevered quite a bit over the last 5, 6, 7 years. But I mean, would you take on more debt to do acquisitions? I mean, what financial leverage are you comfortable with?

Sure. So let's just talk about our current position, right? So we have a strong cash position, more than our debt. We don't -- our debt right now, we pay off all righty. The amortization schedule is roughly $5 million a quarter. And then ultimately, we pay off about $300 million 3 years from now. So very low leverage. Significantly more cash than debt. We also have availability of a $700 million revolver. So our overall liquidity position is close to $1.3 billion. So I think we're in good shape there. We continue to generate cash. Despite COVID, we generated over $300 million of cash flows from operations last year. So I think we have a really strong balance sheet. In terms of would we lever, look, we'll always consider that for the right deal. We feel like there's a lot of opportunities, and you could hear it in Jure's voice, organically to improve the business and continue to invest there. So I think we'll focus on that primarily. But certainly, for the right deal, we'd consider leveraging some more. But it's a pretty high hurdle because we've got a lot of opportunities internally and organically that we can invest that cash. And we get really nice ROIC internally 28% -- I think last quarter it was 28%. So we feel good about our balance sheet. We feel good about our company and where it stands today.

Got it. So one of the things you talked about is investing internally in the business for growth. How should we think about some of the expenditures like R&D, your OpEx spend and also CapEx spend. Can you comment on the levels that we should expect over the next couple of years? I mean do you see any major need for adding more footprint into the business?

Yes. So right now, if you look at it from a pure global footprint, Sanmina is really [indiscernible]. And as you know, we're going through a geopolitical [indiscernible] but we're really set up from a business point to do the right regions. So we can take that Asian customer to a manufacturer in North America and other parts of the world. And we can take American company, a European company, a Japanese company or an Indian company. We can -- that's how we have set up. We're not set up anymore, well, let me fly all over the world to give you the lowest labor cost. Those days are gone, especially in the type of products that we build. We build mission-critical type of products. The technology, time to market and quality of that product when it's delivered to a customer is very, very sensitive. So when it comes to expansion, we're going to look what we have. I mean we are expanding to certain location, but if they are more strategic, you've got -- we have a customer that wants to manufacture in that region, so we meet there. So I don't -- I think organically we might need a -- we're expanding potentially our optical presence, okay? For example, in Southeast Asia, we have a business there already. We might -- we're in the midst of thinking about expanding that. Growth in India is coming. So we say, okay, we have announced -- we got there 10 years ago, but we see a lot more growth now and in the next 5 or few years than maybe last 10 years that we saw. So we might be expanding, adding capacity there. We might be adding some capacity to North America when it comes to some of our components technology that are driven that has to be made in the United States. But I think you're not going to see anything crazy with us. If you look at our CapEx today, we ship more dollar invested than any of our competitors. I still believe that we can grow this company substantially and keep our CapEx, and I'm telling absolute dollars, probably around $80 million, $90 million in the next 3 to 4 years, unless we decided to -- there are some special projects that we've got to invest in. So we're smart. At the end of the day, we're going to be focusing on improving margins and cash flow.

Yes, that makes sense. We have a few minutes left. I want to ask you some questions that we typically get from our clients. How much of your manufacturing footprint is in China? And are you having -- are you seeing any clients asking to move their manufacturing out of China into other regions in Southeast Asia? Or do you think that's not an issue right now? I think -- I mean because of the supply chains being so ingrained, are you seeing any manufacturing shift happen or not?

Well, we already saw that, I would say, in the last probably 1.5 years, over the last 2 years, that some of the manufacturing moved around the world. I think today, I would say it's more stable. If anything, we are actually moving certain medical products into China or Chinese market. And also some of the 5G, we are moving there, because that's for Chinese market. So we really want to go back to the regional part of the business. So -- but if you ask percentage-wise, if you really look at today, we have, in China, approximately less than 20% in total. So we will diversify all around the world, including China. God forbid, if something happens and we have to shut it down, this company can survive, no problem, but that's not the problem. We are committed to that region. We have some great customers in that region, and we expect to really to grow in China at least for the next -- and when I say at least, I can see to the next 2 years, we'll be growing in China. But a different product, a product that will be staying in there for the local customers.

Got it. We just have about a minute left. Maybe Jure, the last question I'm going to ask you is what do you think is most misunderstood about Sanmina? And how do you see Sanmina in 5 years? I mean what is your expectation? What is your target for Sanmina? So just maybe leave us with your outlook and your vision for Sanmina.

Yes. When Board asked me to step back and take this job over, I call this Jure 2.0, okay? So I didn't come here just to get paid good money and run, that's not Jure. I really want to take this company now to the next level. We have a great management team internally. So when I -- what's misunderstood? Really understanding what, why do we deliver and how strong are our relationships. If you talk to our customers, they will tell you, and I usually say that [indiscernible]. I think we can grow that. We are looking at the different businesses. IMS, there's a lot of opportunity on our component businesses and our defense business. So think about Sanmina, we're running basically 3 key businesses in 1 company. But we're servicing these mission-critical markets. And I think the key for us that we've been investing and we'll continue investing, these critical markets that we're going to provide industry-leading end-to-end technology solution. When it comes to technology -- and the product is complicated. We basically can compete with anybody in the world. And that's what I think is misunderstood with Sanmina. They look at so many companies that have 40 buildings and how they [indiscernible]. We don't -- there's a lot of consumer stuff. We don't build set-top boxes anymore. We don't build consumer PCs anymore. We're building something that has last for many years. And if you don't deliver a technology and quality, you're not in the game. Sanmina has a reputation there. We've got to build on that and take advantage in that [market]. So we're going to have fun.

No, that makes sense. Great. Great. Again, we've touched on many different things. We're out of time, but thank you so much for all the details, Jure and Kurt. Thanks for attending our conference. Really appreciate it. And hopefully, next year, we can do this in person. So thank you again for attending. Thanks so much.

All right. Thank you, Ruplu.

Thanks. Bye.

All right.

Bye-bye.

Bye.