Sanmina Corporation (SANM) Earnings Call Transcript & Summary

We had a good lunch listening to NVIDIA. I know it was a packed room. So this is day two of Citi's Conference. My name is Asiya Merchant. I cover tech hardware here and the components at Citi Research. Welcome, we have Sanmina here. We have the CFO, Kurt Adzema here from Sanmina. And before we kick start this with some questions that I have, just some disclosures this meeting or this event is for Citi investors Citi clients only, no media, no press, if you happen to be media or press and you're listening to this on the webcast, please disconnect. If you -- did you guys have any disclosures or safe harbor statements?

We just want to reiterate the typical safe harbor statement. [indiscernible] updating guidance based on anything that's being said, and I'd refer everybody to the risk factors laid out in our SEC documents.

Okay. Great. So with that, I'm going to start off with a few questions that I have. And of course, if you do have any questions, please raise your hand and we'll make sure we bring a mic over to you so we can accurately capture your questions for the webcast. So thanks a lot, Kurt, for being here and also thank you. I know [ Keith ] is here as well from Sanmina. So maybe to kick start this, maybe you can talk about Sanmina's core strengths, what end markets for those who may not be that familiar perhaps with Sanmina. How do you differentiate yourself versus other EMS contract manufacturers the end markets that you really play into?

Sure. So Sanmina has been in the contract manufacturing business for over 40 years. Our founder Jure Sola is still with the company and the CEO. And the reason I bring that up is a lot about this business is about the customer relationships you have. Many of these customers, we've been in some form or fashion working with for decades. I think it's very important to say because I think at the end of the day, and certainly what we've learned over the past 3 to 4 years is how important it is to work collaboratively with their customers to deal with their challenges. First, there is the COVID challenges, and there was obviously the supply chain challenges and now we're doing some of this inventory adjustment that's going on here. So I think, first and foremost, it always comes down to the relationships you have with our customers. If they do really trust you and I think if anything we've learned over the last 3 to 4 years is the importance of the supply chain. So that's the first thing I would say. Secondarily, in terms of products, we focus on high complexity, highly regulated products and markets. Our businesses, we describe our business is roughly 40% communications and cloud and 60% industrial, medical, defense and automotive. And again, we don't do anything on the consumer side. So we're very much focused on these high complexity products, which makes us a little bit different. I also would like to say that we do kind of 80% of our business is traditional IMS -- EMS, 20% of our business roughly is Components, Products and Services. So we still do for certain high complexity products the printed circuit boards, mechanical and other components that then feed into our IMS business. And I think, that is one that vertical integration is also a differentiating factor for our company over some of our peers who actually divested those businesses over time. I think the next thing I would point out is our geographic footprint. And when you look at our geographic footprint, it's really diversed. And we have, we don't have -- it's not just we have 80% of our business in China in the lower-cost areas. So we're well diversified. Yes, we have operations in China, but Malaysia, Europe. Strong presence in North America and our biggest facilities in Mexico. And then recently, we've always been in India, more recently, we entered into a joint venture agreement with Reliance in India as India is one of those markets that I think people have identified there's kind of a great opportunity in the future for the IMS business to grow dramatically. They're based on some of the mandates and encouragement of the government.

All right. So communications and Cloud, I think you referred to as 40% of your business. 40% each? I'm sorry 40%...

No. 40 is [ better ] for same combined. So we combined communications and Cloud just because different people define them differently. So we've got a lot bigger.

All right. And then the other ones, if you can just touch base on the industrial?

Yes. So we, the other 60% industrial, medical, defense and automotive, we don't break out each of those inside of there. I will just say each of those is a material piece of that 60%.

Okay. All right. So maybe we can just, again, now talk about the inventory adjustment that you obviously alluded to earlier. So, how far are we in that? How much longer do we have to go? What are some signs that you're seeing that this will continue for another quarter or 2?

Yes. So again, we've gone through what people say is an unprecedented supply chain issue over the last 18 months. So I think as that started to normalize, and we started talking about this over 6 months ago, how we saw the supply chain normalize, and I think it's caused some of our customers, in particular, in communications to reevaluate key what's the right inventory level that they want to carry. And so I won't go into names, but certainly in the press, many of the communication customers have talked about that. How long that's going to last? its really hard to say. Typically, it's a multiple quarter thing. We certainly think it's going to last through the end of the calendar year and go into next calendar year, but we feel good about the second half of next year for growth back in the business once these inventory corrections or adjustments have happened. You have to remember that during the supply chain crisis, lead times, especially for some of these custom high-end semiconductor components went up to 52 weeks, right? And so that doesn't, you can't fix that overnight. So when you adjust your ordering it takes 52 weeks for that kind of catch up. So that's why it's going to be a multi-quarter adjustment process. And again, we saw some of that last quarter. We saw a little bit of it the quarter before. After what was 2 incredibly strong quarters in our fiscal Q1 and fiscal Q2 from cost.

Okay. Great. And then, what about the demand side? Is it the demand side of the equation and communications end market? Or is there also the inventory? Is it just the inventory adjustment? Because we had some contracts of the people in the ecosystem, I shouldn't say other contract manufacturers. But we had other folks in the ecosystem that we're presenting yesterday that's hard to talk about the demand environment versus the inventory adjustment that's going on?

Yes. So I mean, you guys are probably like listening to the same. You [indiscernible] to a lot of these communication OEMs have actually said the demand is pretty stable and reasonable. And primarily, they're just adjusting the inventory levels. So this is not, does not feel like what we saw, let's say, during the financial crisis where demand went dramatically down, therefore, they had to adjust inventory down. It's because we've just gone through this incredible supply chain constraints for the last 18 months. Now we've got a normalized time. So most OEMs that we've seen have said publicly, it's less on the demand side and more just adjusting inventory.

Right. Adjusting inventory. And then just switching outside of the [ 40% ] market that you guys are in Communications and Cloud, the other 60%. Are we seeing similar dynamics play out in those end markets where there is inventory adjustment, but demand is on a holding steady or something else going on in those end markets?

Yes, I'd say in those end markets have been more stable. And in fact, we feel good, for instance, in automotive. I think you're seeing a lot of continued I'll say, buzz about electric vehicles and automotive and how that could be, help us as we go into next year. Not that that's an industry that's immune to what's going on in the macro economy, but I think it's certainly a situation where the percentage of cars that are EVs versus non EVs are going up in the electric content inside and [ maybe ] is higher, which creates more opportunity for us. So that's one area. I think the other area that we see in the short term that has some growth potential is on the defense side. So the Defense side for us has been slower to recover from the supply constraints, and that's because their volumes tend to be lower, let's say, the communication guys. And so when the semiconductor companies were addressing the capacity constraints, they focused on the high-volume stuff. And so now I will say they're getting around to easing the constraints on the supply chain for guys like defense. And that also tends to be older technologies. And so it's taken longer for the supply chain issue is to resolve as it relates to some of our defense customers compared to our comms customers. So we should see some benefit from that in the coming quarters.

Okay. You talked about as the inventory adjustments happen for your next fiscal year, kind of '24, you see strong growth or maybe you a need to feel good about the second half of fiscal '24?

Yes. I think the next couple of quarters are going to be challenging as the inventory adjusts, but we did feel better that in the second half of fiscal '24, we could start to see.

Good about that growth, and again, if you want to break it down by end markets, that would be great.

Yes. Well, again, I don't want to reiterate. But I think, again, the drivers really come back to, again, I think automotive is going to be a driver. I think defense is going to be a driver. I think you'll start to see again, at least pockets of communications that are going to get stronger. I know there's been a lot of talk about AI feeding into networking space, driving demand. And I think we could ultimately see some benefit, indirect benefit of that as our networking customers benefit and therefore, we benefit from that. So I think there's a lot of reasons to be positive about the future of the company and for growth in the second half of fiscal '24. And we certainly have invested a fair amount in CapEx in fiscal '23 to support our confidence that we're going to grow in '24. We will have spent over $200 million in capital expenditures in fiscal '23 to set ourselves up for growth when this, when we get through these inventory adjustments, so.

Okay. Operating margin improvements. Maybe you can talk a little bit about how your margin profile has been changed through the supply chain issues from normalizing, to now normalizing inventory? Like how are you guys managing your operating margin? And sort of how do you guys think about that target or the target range for operating margins as you go into fiscal '24?

Yes. So first of all, I'd say, despite the tumultuous last 3-plus years, right, I think the company has done a really good job improving margins. And that's not just because of revenue. When I joined, I joined at the beginning of fiscal '20, we had just posted, I think, about a $2.2 billion revenue quarter, but our margins weren't nearly what they are today. And I think, the company has done a good job improving margins despite the challenges of COVID, the challenges on the supply chain, driven by a couple of things. I think, first of all, when COVID hit, nobody knew what that was going to mean. And I think we did a good job of, I would say, getting costs under control. And we did a lot of actions at that time to reduce overhead costs and to make sure no matter what demand looked like we were in a good place. And I think as revenue came back and it wasn't quite as bad as we thought it was going to be, we didn't let those costs get back into the business. And so that resulted in operating leverage in the business. I think also, we've really focused on, again, product mix, favorable product mix. In particular, again, it goes back to some of this industrial, medical, defense and automotive, which tends to be stickier, more complex, highly regulated products, which tend to have a little bit better margins. And so we benefited from that product mix. And so if you look at where we were 3-plus years ago versus now, our margins are a lot better, both our gross margins and our operating margins and candidly revenue that you go all the way back to our fourth quarter of fiscal '19 isn't that much different. And so I think we've done a good job of improving margins. And you've seen our guidance for this quarter that we're finishing up. Is kind of in that 5.5% to 6%, which candidly is industry-leading. What are the levers we can do to further improve this, I think, again, there's been still a lot of, I'll say, inefficiency at our plants, driven by the supply constraints because when you run a plant, you want to level load that plant, right? You want to make a 1,000 units every week, weekend where it go. But the problem is when the supply, the materials aren't coming in like that. You have inefficiencies. You've got people sitting on their hands, one week, the next week, you're running tons of over time. And so I think there's a lot of it as we kind of go through this tough period, next couple of quarters, given the inventory adjustments, I think we can focus on operational efficiencies, given the improvements in the supply chain. So that's kind of one lever. I think the other thing, obviously, is, we'll continue to push for the more complex products, the better product mix. I think that's another thing I think that can drive us. And then again, as we feel like as the growth comes back, after the inventory adjustments, we'll start to get some operating leverage because of that. I think there's a lot of levers that we can pull to further improve margins. We're I'll say, satisfied that we have industry-leading margins, but we're not done yet. And we've got work to do. And we take one quarter at a time of this company, that's the type of business we're in. So.

Okay. Let me just ask the audience if there's any questions here for Sanmina. Okay. Maybe talk about inventories. How are your DOIs trending? How do you see that going forward?

Yes. So we've started to see inventory come down. So we've made some progress over the last couple of quarters. If you look at where we were historically, 3 or 4 years ago, we're still way too high on inventory in my view. And so, but we would expect it's going to take another year or 2 for that to kind of normalize because, again, you go back to the fact that, you've got all this stuff you ordered on a 52-week lead time that has to work its way through the system. So I think in general, we're headed the right way on inventory. We're making progress. It's not an overnight thing. But we feel good. We're headed in the right direction and, we work very closely with our customers. It's in both of our best interest for us to have lower inventories and especially given the fact that cost of capital is increased. It'd be one thing if you've got cost of capital and interest rates of 100 bps, but when you got 500 bps, it's a different story in terms of the cost of carrying that inventory. So I think that's another opportunity for our business model. Our interest expense and other expenses have gone up just because the cost of capital has gone up. Hopefully, as we have less inventory. And as those rates normalize a bit. I think that's an additional leverage point in the model.

And that inventory that you, are you seeing a lot of reductions in terms of? Or pricing actions being taken to clear that inventory out? Or is that inventory you feel good has to work through the system. It's not like you're going to start to see heavy discounts.

Yes. Yes. So the inventory we have it's raw material, it's not finished goods, right? We only make finished goods if the customer demands the finished goods. When we finish the product we issue the customer. So it's raw material. It's good material. The difference in our industry is because the customers told us to order the inventory, they're on the hook for that inventory ultimately. So they think twice about that. So I don't, I'm not worried about obsolescence of that inventory is just going to take time for that inventory to work its way through the system.

Okay. All right. Anything on the competitive nature of the industry that you operate in? Like obviously, you talked a little bit, a lot about your differentiation, but there are competitors in this space. Are you seeing anything irrational or rational from your competitors as we work ourselves through this inventory period coming off the constraints that you talked about, the supply constraints that were a function of the pandemic?

Yes. I think the industry in general has been, if I look back, I don't know if the right thing is 10 years for, 10 years, right? So I've been in the industry for 4 years at Sanmina, but it started before my time, right? So if you look back, I don't know, 8 or 10 years, I think the industry realized -- we don't want to grow just for growth's sake, right? And so I think the industry has really rationalized its behavior a little bit, it's shied away. We don't do anything in consumer. A lot of the other guys are kind of moving away from consumer. We don't do anything in handsets. And so I think the industry itself has taken a more rationalized position over the last 10 years, and I think it's shown in our margins and then shown in their margins. So I think that's healthy for the industry. So I think that's very good. In terms of behavior right now, I haven't seen anything, that said, people are no longer acting rationally because they're worried about inventory or such. So I think in general, I haven't seen any behavioral changes in our competitors. We certainly aren't behaving any differently. I think, like I said, it's very healthy for the industry. And like I said, I feel good about the future. We've invested in the future. Given the money we plowed back in last year in terms of CapEx. And so we feel good. And again, there are levers in our model that we think can make it better in the future once revenue starts to pick back up again.

Any questions? I can continue? Okay. You're making investments. You mentioned that a couple of times. Maybe you can remind investors sort of what's your Cap outlay, CapEx outlay? And where, as you guys are looking at expanding your geo footprint, perhaps, I think you mentioned India, where are these investments being made? Specifically which end markets or geo markets, I think you already mentioned India before as well?

Yes. So again, I think for us, our #1 priority is organic growth. That's usually where you get your best return on invested capital, it's the lowest risk. We've added some capacity recently in Thailand, where we did a lot of work around optical products, and I think there's a lot of, it's generally known, there's a lot of demand to do maybe less optical in China and do more optical in Southeast Asia. And so that's been a real opportunity for us. And so we had started there with a relatively small footprint a couple of years ago, and we've expanded that capacity there for optical. I think the other area where we've expanded is in Mexico. So Mexico is our biggest geography. But as part of the increased demand for electric vehicles, we've expanded our capacity in Mexico, not a surprise given the automotive industry, you want that capacity to be near North America. And so Mexico is the right place there. So, from a facility perspective, those are the main ways we've done that. Our capital allocation is very simple. Like I said, #1 priority is to invest for organic growth in the business. After that, we've looked at acquisitions. We feel, in general, our footprint is very strong, diversified. We don't look at a geography to say, gee, we need more here, well I'll talk about India in a second. But, so we don't, we look all the time. We have a very high hurdle because we feel like there's such a good ROI inside the company for organic growth. But we look at that. And then we have been very opportunistic about buying back shares. The good news about our business is we've generated a good amount of cash flow even in challenging times, even when COVID hit, we were still generating cash flow. So we've opportunistically bought back shares and, we, every quarter, we pay $4 million of our debt off. So even though we have the best balance sheet in the industry. We continue to reduce our debt and improve it further. So those are our capital allocation priorities. Just circling back to India. I think people probably saw we entered -- we'll all -- we've been in India for roughly 12, 13 years now. But that's a tough market to penetrate just as a U.S. company. And so there was opportunity created to partner with Reliance, who obviously is a very well-known company in India has, and really can help us navigate there, and we think there's a huge opportunity for doing more IMS work in India. I think the government there has made it clear. That's one of their industries they're prioritizing. And so we think it's still early days, but we think there's a lot of opportunity to grow that business dramatically, and Reliance made a very large cash injection into that business and we got that capital for a reason. So we hope to grow that business over time.

And that's the, and from a margin perspective, is that more of your higher-margin product, the IMS? The design?

Well, our business historically in India, we focused actually on a lot of the what I'd call the higher complexity products. So we do a fair amount of clean energy, health care, other things there. I do think that we're seeing more interest on the communication OEM side to do more in India, a lot of the players that maybe have done stuff in China before are now interested in doing stuff in India. So I do expect that mix to shift towards some more communications in the future both based on the interest of the OEMs as well as our partnership with Reliance. But I think there's opportunities in all the industries we serve in India. I think it's a huge opportunity. I think with their partnership there, I think it puts us in a unique position, and we're really excited about that.

Okay. What do you think investors are maybe not grasping perhaps? Actually before I go to that one. We have heard a lot about at this conference, not just from the EMS players, but just broadly speaking, we are talking about incremental weakness in China as we're looking through the back half of this year, maybe even the first half of next year, I think the recovery in China seems to be kind of pushed out further and further. So just to the extent that Sanmina obviously has exposure in China from an end market perspective or from your footprint perspective. Maybe if you could talk about how you guys are thinking about the macro environment in China?

Sure. So I would say, first, maybe address our footprint. Our footprint there, perhaps relative to our competitors is relatively small. So if you look at our number of square foot we have all of the competitors and business, it's in the low teens percent of our footprint. And that facility at this point largely does serve that domestic market. But again, it's not focused on mobile handsets and consumer-related stuff like that. So I do think we have less exposure than our competitors. But it's still a very important economy, obviously. And, so I think there are opportunities there beyond Comms. We do a fair amount of medical stuff, for instance, out of that China facility. And I don't think that's going to necessarily be affected by as much by the macroeconomic environment there. So I do think China is obviously a dynamic situation. I don't think we've seen any direct impact on us, but certainly, people are looking to do, in general, less stuff in China.

Okay. And then you just alluded to AI a little bit ahead in the earlier part of a conversation. To the extent that, that maybe it's a long-term driver for you guys. Maybe are you seeing any of that yet? Or whatever it is, it's overshadowed by this inventory adjustment that you guys are going through? The industry is going through I should say. Yes.

Yes. Look, I think, obviously, there's a lot of buzz about AI in the market and in general, and I do think to the extent AI drives the demand for a lot of this networking equipment in these data center stuff, that's going to be a positive to us because we play in that end market. So I do think it can be one of many factors that help drive growth once we get through the inventory adjustment. But it's still pretty early. So for it to offset the inventory adjustment. I think that's probably too optimistic at this point. I also think we're tending to have more direct conversations than we've had in the past with some of those data center players and stuff. So I think that's also a positive. So I think it's going to be a net positive for us. But I still think we're at the tip of the iceberg on that, where I can't sit here and say today, it's going to dramatically affect the quarter we're in the middle of, I still think it's more of a future-looking thing. But it's just another reason to be optimistic about the future we are [indiscernible].

Have you seen any changes in your customers who are approaching you to build something as it relates to Comms within data centers, et cetera, as a result of the Generative AI opportunity? Or is it the same players yes?

I would say it's the similar players. They'd be a little bit careful here. I mean, I think, first of all, our customers want to share a limited information with us. Obviously, there's highly confidential stuff what they're doing. But like I said, I do think we will benefit from that over time, but I think it's a little early to sit there and say, okay, well, now we can bake in, in Q1 this much revenue related to AI. I think that's a bit of guessing game at this point.

Well, right now, there's a lot of supply constraints do in general for that, for those components.

Yes, absolutely. But I think -- look, I think we're all excited about what it could mean for the market. But I think right now, I think our focus is really on getting through these next couple of quarters, positioning ourselves well for the second half of the fiscal year and growth in the second half of the fiscal year on some of these opportunities that we've talked about.

Okay. Great. What do you think investors don't appreciate about Sanmina? Want to wrap it up with that one.

Yes. I think at the end of the day, it's always easy to sit there and say, "Oh, well, in our business is all about scale". So it must be that the guys that are bigger than you are in a better competitive position than you are. I think at some point, I certainly understand that argument. And at some point, the benefit of scale isn't there this much. I mean, we're a very large company with a very large footprint. I think when you're looking at over 30,000 employees here, going from 30,000 to 40,000, you really don't get that much scale by adding 3 more plants in 3 other geographies. So I think if people look at us, they realize, hey, wait, these guys, maybe they aren't the biggest, but they get the best margins. We've got a very good product mix. They've got a very good footprint. And I think they're generating good cash flow. And so I think a lot of times we just get overlooked as we're not the biggest. And at the same time, we're not super focused on just a niche, and we're kind of caught somewhere in between. But I think if people took the time to kind of look at our numbers and look at our performance and what we've done over the last 3, 4 years, and appreciate the fact that candidly, we're not trading at the multiple that others are. I think it's worthwhile.

Well, I know definitely lots of investors are kicking around for new ideas here at this conference starting to look away beyond the bellwether. So good luck with the rest of the conference then.

All right. Well, thank you. I appreciate everybody coming.