Sanmina Corporation (SANM) Earnings Call Transcript & Summary

Thank all of you coming here today on the second day of our Global Technology Conference. My name is Ruplu Bhattacharya, and I'm with the IT Hardware Equity Research team, and I cover electronics manufacturing services companies. And today, we're honored to have the team from Sanmina Corporation. We have CEO, Jure Sola. For those of you who don't know, Jure is the founder of this company, I think it was in 1980 that you founded the company. So he has over 40 years of experience. So he's seen a lot of ups and downs. And so we hope to have a great discussion today with you, Jure.

I sat over when I was 1, so...

And then we also have CFO, Kurt Adzema. Kurt joined the company in October of 2019. And before that, he was at Finisar and he was also at Montgomery Securities, Bank of America Securities and Smith Barney. So he has a lot of experience. So again, guys, thank you for coming today. And maybe I'll hand it over to Kurt to give you the safe harbor statement.

Sure. Just before we get started, again, I would ask everybody to refer them to the safe harbor statement and our SEC documents, if you have any questions, obviously. And with that, I'm going to turn it over to Jure to give just a little bit of an overview before we dive into some questions.

Thanks, Kurt. Ruplu, thank you very much for inviting us. It's good to be here in person. So first of all, yes, I'm one of the co-founders. I started the company in 1980. We're still having fun, it's the most important part. Company's -- if you look at the last 12 months, we shipped approximately $8.9 billion revenue. And if you look at our operating margin, they've been around 5.6%, which are leading in our industry. So with that, we are in [ 24 ] countries. I think if you look at Sanmina, what we offer, where we differ is we focus delivering technology and custom solutions for our customers, all the way from engineering, design, to the full system build and also build to order, configure to order and do that in 24 countries around the world. So we like what's in front of us, and I'm sure the [ group ] will have some good questions. And hopefully, we'll answer all your questions. And hopefully, you have some questions. So with that...

Okay. Well, let's get started maybe with a high-level question. Where are we in the business cycle? And when you look at the different end markets, is outsourcing still happening? Which end markets are the most outsourced and which still have more to go in terms of outsourcing?

Yes. First of all, remember, when we first started the company, outsourcing was really a small percentage of our customers' needs. Today, I would say, still, we have probably 50% to 60% that is not outsourced, okay? Consumer markets are -- which we don't do any, I think it's important to know. We used to be in consumer markets when we acquired SCI in 2001, but we exit that, including the PC market. So what we do today is a very complex, heavy regulated markets, industrial, defense and aerospace, medical. And then we have that 60% of our revenue, and 40% of our revenue comes from communication. Communication today is well outsourced. I mean, if you look at that, I would say 70%, 80%, especially for European and American companies, that's [ outsourced ]. So -- but there's still a lot of upside. I mean, when I look at the demand today, demand for the growth for us, it's -- especially when you look at it 3, 4, 5 years down the line, it's there. It's most important for us, it's choosing the right partnership and also the areas because we've been transferring the company in the last [ 3 ] years to really focus on technology and then also we can deliver the right margin. And as you can see, if you follow Sanmina in the last 3 years, we're able to move those margins in the right direction. And we expect to continue to work hard to do that in the future.

So before we go into the different end markets, talk to us a little bit about the supply chain. I mean over the last couple of years, EMS companies have dealt with component shortages. So talk to us about what parts are still in short supply? How are lead times trending? And did shortages impact your revenues in the last quarter?

Well, first of all, what we went through last [ 3 ] years when it comes to material shortages, I've never seen it. I mean, this business is, as we said, over 40 years, so we learned a lot. We -- our customers learned a lot, we learned a lot. Today, things are getting a lot better, but you still have certain semiconductor products, they have longer lead times. I think this combination, I think they love those longer lead times. Some are semiconductor suppliers, even today, demanding guaranteed orders. And some of our customers are actually meeting those requirements. And some of our customers are not. So I think it's a mixed bag, but the most important to say, things are getting better. I would say in last quarters, we really didn't miss a lot of revenue. There's always -- you'd miss that even in good times, an order here, an order there because you have assortment shortages or things like that. But I would say, we -- a small amount.

Okay. Great. So we're basically, it looks like we're past the major component shortages and the Sanmina procurement team is doing a great job. So that's great.

Definitely, I know our team did a great job in their environment. Unfortunately, they had to work 24/7 a lot of times, but...

Got it. So maybe let's start with communications. When I think about Sanmina's competitive advantage, the communications market really comes to mind. And when I -- the first thing actually, when I think about Sanmina is like these very complex PCBs, like multi -- like 70-layer PCBs. So maybe talk to us about what type of stuff do you build in the communication space? I mean what's your competitive advantage there?

Number one, we kind of grew up that business in communication. When we started the company, telecom was a place to be. So we -- as you mentioned, we were built vertically. We started as a board fabricator. And then from board fabrication, we went into the full system. Today, our company is a different company than what we started. If you look at in the last 4, 5 years, we really went after the markets in that industry that can give us a more sustainable growth and more profitable growth. So if you look at most of our revenue in that business today for us, 80-plus percent is in new products. What I mean, the new products that came to the market in the last few years. As we look at the future, what we bring to our customers some of the most advanced products in networking and optical networks that come to Sanmina because of our engineering capability and also time-to-market capabilities, helping them get their product to the market sooner than our competitors. So technology and time is the key. But we still build some of the most advanced Circuit Boards in the world, is not as big. We were at one time the biggest Circuit Board company in the world. But we -- most of our Circuit Board today has really been focused on defense and aerospace. We still have a 20% or maybe 15%, 20% of the revenue in our Circuit Board business comes in advanced telecommunication, backplanes we're building 50, 60, 70-plus Circuit Boards. And we're starting to invest even more in that. As we go into more regional manufacturing, our customers are really needing some of the suppliers to be in North America or somewhere in the region between Mexico and [ North America ] because they want to decentralize. There are, otherwise, say -- today, they're too much dependent on some of the Chinese suppliers. So they want to be able to diversify that to Europe. They want to come to the United States. And we're playing a big role in that side of the business.

So let's delve a little bit deeper into communications. I mean what are you seeing in terms of end market demand in things like networking versus optical versus wireless communications?

For us, as I said earlier, our main business there is networking part of the business. It's a big part of our revenue. That depends on the customer. We have some customers that we can't ship enough, and there are some customers that are pushing it out. I would say, because in last -- especially last year, we've been trying to catch up a lot of these products because we couldn't get the materials. But things are starting to balance out. Some customers, because they were buying so much inventory, have been pushed around a little bit. Overall, year-over-year -- we look at things year-over-year. When you had our shortages, it was all about catching up. So some quarters, you ship more because your customers were desperate to get the product. But if you look at the last year, we grew around 15%. This year, we said on our last call that we're going to be at mid-teens. So I think if you look at Sanmina, last couple of years, we've grown, let's just say, 14%, 15% on top line for a $9 billion company. We believe that's nice growth. And if you look at our EPS, we've grown over 20-plus percent. So I think we're at that level right now. Year-over-year, if I look at the 3 years out, I think we'll have a better future next 3 years than what we had in the last 3 years. And if you look at Sanmina in last 3 years, I think we've outperformed anybody's expectations out there. So we're working hard. It's hard to figure everything out in this macro environment. We are very careful. We grew up this company with no VC money, and we had to make a payroll every 2 weeks. In old days, we used to pay every week. So I still think about that. We've got to make a payroll every 2 weeks. So we are really focusing on basics and -- but I'm excited about the future. And we're having fun. It's hard to predict everything.

Sure. Let's build on what you just said. I think the last couple of years, you talked about strength and I think the optical market was really strong over the last couple of years. How do you see that market over the next couple of years? I mean we just had Sienna report yesterday. So do you think that, that strength continues? Or do you think that there's now -- you talked about some pushouts. Is that where the pushouts are? I mean, how do you size the market? And how do you see the market?

Yes. I mean if you look at our optical business, our optical business is more into the module and into the full system business, more the latest products that come out to market, and there are some new products that are coming out that we are involved. I think if I look at the next couple of years, I think that business will be fine with the key customers we have. But we might have some bumps in the road, but we have other businesses that we can fill in with.

Okay. And what do you think about 5G? Is that a driver for Sanmina revenues? I mean how do you see those 5G projects, are they coming in?

I think [ pure radio ] itself, I mean that we see a lot of growth in India there right now, especially with our partnership that we just established with Reliance about almost a year ago. We see a lot of upside there. I would say, that's probably the biggest market when it comes to 5G. But other related products that we build around the 5G also has a good potential. But it's not a primary market for us, except in India. I think India has a lot of upside for us.

Well, that's a great segue to the next question, which is maybe, Kurt, can you talk about the JV that you have now with the Reliance? What exactly are you doing for them? How did this JV come about? And if you can help us size, like what's the impact of this on Sanmina revenues and earnings?

Sure. So I think everybody knows there's been a lot of focus in India to build up a manufacturing capacity there that they haven't had in the past. And so we think there's a huge opportunity there. We think there could be a multibillion-dollar market for us. That being said, we didn't think we needed to partner -- we felt like we needed to partner with somebody in India and establish a situation where, in essence, it was an Indian company, which meant we needed to only own 49.9% of it. And so that's the reason why we structured the deal we did. That being said, we run the businesses of it. Nothing has changed. We run the business. It's all part of Sanmina as well. So we're very excited about that. We think there's a huge opportunity there. Like I said, long term, we think it could be a multibillion-dollar opportunity for us, but we don't break that out right now. But we're excited about that. Nothing happens overnight. But as Jure said, we're kind of a little under a year into this, and we're seeing a lot of interest both in terms of Jio and its partners, but just in general, other companies in the Indian domestic market. So we're excited.

Okay.

I'd just add to that. I think if you look at India opportunities, we've been in India over 10 years, and we went there early days when we had to build 3G radios, okay? But if you look at the future of India and what's being done there, what the government wants to do, we believe it's a big, big opportunity in the next 5 years. So that's the reason we're excited about.

Maybe let's turn to the cloud business. I mean that's another area of focus maybe for you guys. Can you talk about what is it that you're building for the cloud? And how do you size this opportunity for Sanmina?

Yes. I mean, for us, cloud and communication kind of mixed together, a lot of the products so-called communication companies ship directly to a cloud today. So that's why we put those two together. So what we built, again, Vermont advanced storage, we build a lot of switches, we build some of the unique modules on top of that, some optical stuff, some obstacle module and that stuff. So we -- that's part of what we call approximately 40% of our revenue between communication and cloud. We see that business for us overall. If you look at the 3 years out, we'll be stable, but we think a lot of our growth will come from industrial, medical, defense and automotive, especially in automotive, in electrical vehicle and alternative energy.

Okay. I want to switch to that end market in just a minute, but let's talk about new ICs. I mean I think you had a storage product that was branded as new ICs. How are those revenues trending? And what do you think is the end game or the -- what's the target for that business? Is this something that you can incubate? And is that an integral part of the company? Or is there something you can spin off at some point?

First of all, that's part of our cloud offering that we do. We do the full design. We'll take AMD platform or Intel platform, we'll design an advanced storage product. We don't sell the [ lexical white ] box. If we do it, it's at such a small percentage, less than probably 5% of their revenue. 95% is a custom build for that specific customer. Now we can take the same design and make some minor changes from a customer A to customer B and so on. So that business has been supporting part of that cloud communication group that we do. We made nice progress there in the last 2 years. We see a lot of upside potential. Sometimes I wish it was growing a little faster, but we've been investing [ money ] in that side of the business. Yes, that business sometime -- if it -- we always look at the stuff. We have so-called -- we call it Viking Enterprise now. We have optical module business. We got a government products under SCI brand. So any of these brands, we're trying to build up to see do we -- are they better to be part of the Sanmina family or are they better off in the future to fly on their own? So at the end of the day, we are full focused. There's no personal attachment to any of these except that we do well. So we always look at what's the best for our shareholders short term and also long term. So all those things, we constantly analyze. But every business that we have has to make money. And I can tell you they are making money. That's the way -- that's part of our DNA. We just don't throw a bunch of R&D. And I've been criticized for that. So maybe we need to invest hundreds of million. But that's not part of my DNA, Sanmina's DNA. So we focus on businesses that they're contributing to the bottom line and also have a growth for potential.

Got it. I want to switch to the next segment that you report, which really is a combination of 4 different end markets. And I want to start maybe with defense because you were talking about businesses that are really stand-alone businesses. So talk to us about Sanmina SCI, I mean what do you do in the defense market? What do you build? And how is that business trending?

Well, first of all, SCI has a brand in a defense and aerospace industry. We've been working very hard in the last 4 or 5 years to build on that brand. That's why we branded SCI [ DaS ] defense and aerospace industry. So we really, how do I say, made SCI well known today. So we have a very strong backlog and potential projects that we won that we believe they have a lot of strong future, if you look at the 5 years, 10 years, even 3, 4, 5, 10 years. That's typically how these military programs go. So we're trying to build, what I call, a defense and aerospace company under SCI. SCI has fair amount of their products. These are the products that SCI designed through -- maybe it's for Army, maybe it's for Marines. Sometimes we sell it directly to the government or we'll sell it to one of those big -- let's say, Raytheon, et cetera, companies like that. So yes, personally, I'm very excited. We are still building SCI. I think the -- we expect to see a lot of great things out of there, but it's going to take probably another 1 year, 1.5 years, 2 years.

Let me ask you another question on end markets, and then I want to switch to some financial questions. What about industrial? I mean that's a big segment for you now. What type of work, what type of end markets -- industrial is the big space. So what do you do? And I think you had one project in there, where you were making radios for police or emergency services. I mean, can you talk about what you do? And how is that project coming on?

Yes. Well, first of all, when you look at industrial, medical, defense and aerospace and automotive, that's what's spread out. It's not only in one bucket, so that 60% is spread out. Specifically, under industrial, we have a big competitive advantage. We do precision machining on a lot of very complicated stuff for oil and gas. We do it for military. We do it for semiconductor. We do it for medical, and we're doing it for defense. Now that industry is changing, where you're basically now integrating electronics and machining together. And a lot of these things now going building a whole systems. And some of these things are long-term programs. And once you get in, it's like a military, you really -- what we call industry -- you got -- you really have to mess it up. I mean trying to -- my English is not the best, so I got to find the right word, to really lose it if you do it. Yes, we have a few customers today that we build, what we call, safety equipment for fire department. It's basically emergency communication. We love those type of customers because they are long term. They're really almost like a defense type of an account. Once you get in, it's all about performance, performance and performance. And we have a lot of volume there. We don't just do just labor part of it, and that's really I want to make sure clear. Sanmina is not selling labor alone anymore. We, Sanmina, sell an end-to-end solution, and we're trying to build the right -- bring the right technology in there to drive the margin. So -- and our strategy is to be a big company. We will be a lot bigger than $8 billion, $9 billion company. And as we see the world today, I think we have a balance sheet to do it right, but most of our growth will come organically. Today, and I'm sure our CFO will tell you, we've been investing, even in this market with a lot of macro going on and not knowing what's going to happen 2 years -- 2 quarters from now, 3 quarters from now. But we are investing because we know we got a fair amount of programs that we need to build more capacity. So we're expanding in Mexico. We're adding Thailand and other places. So we're excited about the future to build on that. But we're going to continue to see what's in front of us on a daily basis to tune things up.

Got it. Maybe let's talk about revenue growth. If I kind of look at your first quarter, you had really strong growth of 34%. Even second quarter was strong at 21%. And you just said your full-year guidance is in the mid-teens. . So if we do the math, that kind of implies you have some deceleration in the second half. I think it's in the single digits that the [ NAND ] would be growing. Talk to us about what's happening in the market. I mean where are you seeing the deceleration? And how do you think about the seasonality, going forward?

Yes. I think if you really look at it, as I said earlier, I think you have to look at where we -- where the industry is coming from. You [ read ] from basically even a year ago, where we just couldn't get enough parts. Our customers were paying, brokers were spending too much money -- in the brokers -- to get the parts in. And they said, "Ship it to me, we'll pay anything to get the product." So we went from that environment. And so we basically -- we're catching up, I would say, in the last four quarter, especially last 2 quarters, we're catching things up. I think that's why I said. I think you have to look at the year-over-year. If you look at the 3 years, we've been growing on average in that -- I just don't know exactly, but 12 to 15-plus percent on a top line. So that's kind of where we are. I know how you add you math, you're good in math, but I'm not bad either. So you got to look at the quarter -- I mean, year-over-year. So that's how I look at it. Unless we fell off the cliff, let's say, as we go into '24, we believe that we're going to have a nice growth in '24. Now, I just want to clarify that, we still take one quarter at a time. We'll tell you a lot more when we announce the numbers in July because we're going to see what's happening for the fourth quarter, but we're also going to see what happens to the rest of the year. But today, what I see, I think we'll have a nice growth this year, and I think we have a potential even to grow next year double digits. As -- when I say next year, '24, so -- but this is -- I just want to clarify, it's based on what we're seeing today, customer base that we have, existing customers and also new customers. That's why if you follow Sanmina, we've been spending more on CapEx, and that purpose of that is really the growth, growth for next 2, 3 years.

Okay. That's helpful. Thanks for giving the details on revenue. Maybe I'll ask you on margins. So you report gross margins for IMS and CPS, the 2 segments that you have. When I look at last quarter, I think your IMS margins were 7.2% and CPS was at 13.2%. Are we at peak margins now? I mean how should we think about the long-term revenue and margin-specific targets for these segments? And what do you need to do to drive these margins higher? I mean 7%, 13%, these are really good margins.

Yes. Thank you. I think we made a lot of progress in the last couple of years to improve the margin. I mean as I said earlier, if you look at the last 12 months, our operating margin of 5.6%, I think last quarter, they were 5.8%. So we are in that range, 5% to 6% right now. I personally believe, as we continue to improve the mix of the business, technology products that we produce, both on IMS, should deliver us higher margin than what we're delivering today. And also in our Components Technology Products such as precision machining, we're building some really complicated stuff from semiconductor to oil and gas, military. We're expanding that part of the business. And then, as we grow our Circuit Board business more into the military, more complex stuff, and then we have some precision [ plastic ] for military, and so we've been expanding those. So we definitely believe especially in Components, Products and Services, our margin longer term, I don't -- not saying what's going to be a quarter at a time, but if I look at 2 years from now, it should be better than what they are today.

Got it. Maybe a question for Kurt. Last quarter, you mentioned an accounting issue. Can you summarize for us what that issue was? What was the impact? And what steps are you taking to ensure that, that doesn't recur?

Sure. So we had one division. It's part of our CPS segment. It's less than 3% of revenue, where basically they enter into long-term fixed-price contracts. And so under GAAP accounting, you basically look at how much are you going to get paid for the life of the contract, how much is it going to cost you for -- to fulfill that contract, and then you basically recognize it over the life of the contract on a pro rata basis. . Well, unfortunately, we had a situation where costs went up significantly on a contract due to higher material costs but as well as additional labor costs. And so under this accounting, what happens is if you have a situation where you go for, let's say, a profitable contract to an unprofitable contract, you have to unwind the profit you've already recognized and then recognize all the losses even for the entire life of the contract. So it's just something, under these accounting rules, you have to do. And so we had a situation with a couple of contracts that, again, we -- now sitting here today, we think we're going to incur additional costs to fulfill them. And so we had to recognize, in essence, the cost of that, including future costs, immediately. And so that was what caused the restatement. Now we're working with our customers in this area to recoup those costs. And when we get the money back, then we will get the benefit of that. But there's a bit of a timing issue between when you got to recognize the incremental costs and when you get the recovery from the customer. So again, it's a very small part of our business, 3% of the revenue. We've put -- we've started remediation actions for those that never happens again. And so we feel comfortable that the issue is largely [ resolved ].

Got it. We've got about a minute left, and I'm going to challenge you to talk about your capital allocation priorities. Talk about like M&A versus buybacks versus levering or delevering. And there have been years where you brought back more than 100% of your free cash flow you've used that for buybacks. So just talk to us about how you're thinking about prioritizing these things.

Sure. So as Jure mentioned, our first priority is organic growth. And you'll see this year that we've spent about $100 million in CapEx in the first half, and we think overall for the year, it's probably going to be about $200 million. And that's really to build capacity to ramp some of these new products and new wins that we've had, Jure mentioned some capacity in Thailand as well as in Mexico. So that's by far our #1 priority. . That being said, we continue to delever our balance sheet. We pay off about $4 million to $5 million in our term loan every quarter. And then we opportunistically repurchase shares and take advantage of the volatility that's in the market. I think what you have to recognize is that if you look at our balance sheet relative to our competitors, we are very delevered, right? So we have the best balance sheet. We've got over $700 million of cash. We've got $300 million in change of debt. The debt is -- we just refinanced it in last September. So we've got a lot of time there. So we feel very good about our balance sheet. And as you've seen, we've continued to generate cash flow from operations consistently every quarter. So we focus on -- as Jure said, we focus on EPS to deliver value to a customer, but we also focus on cash flow because at the end of the day, cash flow is a key indicator of how healthy a business is.

Got it. So we've talked a lot about various different things. I appreciate all the details you've given. Always nice to see you guys. Thanks for coming today.

All right. Thank you very much.

Thanks.