Sanmina Corporation (SANM) Earnings Call Transcript & Summary

Thanks, everyone, for joining day 2 of our Global Technology Conference. My name is Ruplu Bhattacharya and I'm a Director with the equity research team covering IT hardware and electronics manufacturing services. Today, we're honored to have Sanmina Corporation, which is a leading EMS company. And from the company, we have CEO, Jure Sola. Jure, as you probably know, founded the company in 1980, and he was CEO from, I think, 1991 to 2017. And then again, from 2000 until today, you've been CEO. So he has lots of experience. He's seen lots of business cycles. And then we also have Jon Faust who joined the company, I think, in January, but he also has lots of industry experience. He -- prior to this, he was with the HP. And prior to that with HP Enterprise, 19 years with the original HP and HP Enterprise. So again, we have lots of talent, lots of experience here, and we hope to have a good discussion. With that, maybe I'll pass it on to Jon to give the safe harbor statement.

Yes. Thank you, Ruplu. So before we get started, just wanted to refer everybody to our safe harbor statement and our risk factors in our SEC filings, both of which you can find on the Sanmina website in the Investor Relations section.

So gentlemen, thank you so much for being here. Jure, thanks for being here today.

Ruplu, It's good to be here, and good morning to everybody.

I'm going to start with an overall general question. Like where are we in the business cycle? Can you talk about overall outsourcing trends, which sectors or outsourcing, which are in-sourcing?

Well, first of all, I grew up in this business when customers were basically manufacturing everything in the house, and they started to outsource, and that's kind of how we build the business around then. Today, if you look at the communications side, that's probably 60-plus percent outsourced. Medical, I would say, probably around 50%. Semiconductor that's probably around 50%, 60%. But some of the components of the semiconductors are outsourced at high level, procedural machining in that that's like 80%, 90%. Industrial, that number is probably around 50%, but it's also -- that area has a lot of upside potential because now you're going with the electromechanical instead of just the mechanical itself. So there's a lot of opportunities for companies like Sanmina because we offer a lot of the vertical integration from machining, printed circuit boards, the system assembly and components assembly. So those are the key areas. And then defense and aerospace, that the area, if you look at it, it's only outsourced 20%, 30%. A lot of our customers still manufacture internally. What we play in that area is really more around providing some of the key components. So we do a lot of design for them and do it for the whole system. And automotive, automotive is more or less, when it comes to the components that we build is high-percent outsourced. We don't build a car, but we build a lot of components inside of the car. And we are focused around the charger and a car itself. So from my perspective, there's plenty of revenue out there. Sanmina is well diversified. So we don't have -- today, I don't think we have one customer over 10%. And we like to keep it that way and the goal is to grow, take advantage and convince these customers to outsource more, right?

No, that makes sense. I want to -- there are many different end markets that Sanmina touches. I want to go through each of them, but another high-level question before we get into that. You talked about components. So what's the situation with components or shortages, lead times? How is that trending? And is that impacting your revenues at all?

No, definitely, material shortages got resolved in the last 12 months. So you're going to always have some shortages, but overall, that's behind us. What we went through 2 years ago, I've been in this business over 40 years, I've never seen anything like it. So that's behind us. I think for us, the lead times on certain components for -- like we do a lot of fair amount of military board. So lead times for military board, these are very high technology boards, have a longer lead time. It can go from 20 to 40 weeks. But the good thing about military, they give you forecast over 2, 3 years. But overall, I would say most of the components today that we can get probably 80% in a quarter.

Okay. Okay. I mean that's good context. Let's start with the communications end market because I think this is a competitive advantage for Sanmina. So talk to us about what you're seeing in the networking, optical, wireless space? What's the trend?

Yes. Well trend for us, we're well established there. We've been for a long time, that's where was one of our core business. If you look at the last 5 years, 40% of our revenue came from what we call communication and cloud enterprise. The last quarter, that number is -- was 33% in total, about half of it for communication networks and other half for cloud. When -- so when you look at what we do in both of these segments is like we focus on optical networks. We focus on advanced IP routers. We build products that are 100 gigs, 400 gig and 800 gig. So we focus on the latest technology when -- I don't talk about my customers. But if you look at everyone, these are leading edge customers in our industry. They also sort of pure telecommunication company they share enterprise, but they also service the cloud. So we are well positioned. And also Sanmina was an optical module business for a long time. If you look at our optical business, this business for us is about $1.5 billion, $2 billion. But -- so we build systems. We built a very complicated systems. But we were building modules for momentum/JDSU for a long time and then they decided to move out of China. So we had operations. We still have -- so we're building capabilities in some in China, some in North America, such as Canada, and Thailand. So today, we are very capable and we are driving that, including helping our customers design products. So we're working with our customers at 400 gig, 800 gig. We do not compete with our customers. But what we do is we help them design a product and pick it to the market. And we're working on 1.6 terabits with a couple of partners right now. We expect that to be to the market the next 6 to 12 months.

So just focusing on the optical market. I mean, how do you see the market progressing over the next couple of years? I mean Sanmina has benefited from a strong optical market for the past couple of years. But do you think is there an inventory correction happening there? Or how do you see this market growing overall?

No, definitely, there's inventory correction across all industries because of the -- what we went through all these shortages and most of our customers build more inventory than needed. And -- so we're going through that right now. And what we've been basically saying what we're seeing, we think that things are getting a little bit better when it comes to the inventory reduction. And we're also starting to see some demand coming back. So I would hope that we see more positive news by end of this year and then the '25 will continue to be positive. But it's going to take a few quarters through that we see more upside.

So in terms of these high-speed switches, are you shipping 400 gig today? Or are you shipping 800? And what's the prognosis like going forward, which technology do you think is coming?

Well, we're shipping 400 switches. I mean, IP routers right now, I mean an 800, but it's -- 800 is more new product development. But definitely, it's going to our customers.

I see. And how broad is Sanmina's reach an optical? I mean do you have a few customers? Or are you pretty much aligned with all of the customers?

We are pretty well aligned with all the leaders in that networking side of the business.

Okay. Okay. Can you talk about the 5G market, the wireless market? Or how do you see that trending? And maybe also touch on your JV with Reliance?

Yes. With the JV market, I mean 5G market, it's not a high percentage of our business. We used to do a fair amount in China, but that business kind of went outside of China. We do a little bit in China, but most of the business that we do in 5G will be done -- that has been done here in Mexico for North America budget -- I mean, customers and a little bit in India. So it's a small percentage. Our Reliance has been great. The reason we went to that JV partnership to build something in India. It's a -- there's a lot of -- people are really good. The workers are really great. They're easy to deal with. It's a bureaucracy that it takes time to do it. So we felt that finding the right partner that understanding -- because we've been there for 13 years on our own, and we attracted a fair amount of great customers. I think with Reliance has been very, very positive. And the way that this deal is done, we are responsible for running this operation. And we are considered like an Indian company. So we see a fair amount of business. We're starting to grow the business nicely and both with Reliance and also diversifying the customer base. What India is going to be for us, and we build in hopefully, you've seen the operation, one day it will be a multibillion-dollar division and is to be a supplier, not just for Indian market, but also to be a supplier for a global market.

Can you talk about what is it that you build for them? Like what is the product that you're building...

Well, we're building Reliance is getting into certain wireless product. So they got some product. They are playing around 5G. They're playing around some Internet stuff. So it's the way Reliance works, it's more like, hey, we got this huge project now most of the business that we work with is through a division called Jio, which is the biggest telecommunications company in the world. I believe they have over 400 million prescribers. And I was actually there 4 weeks ago. It's just a campus like you would think it's in Silicon Valley, 35,000. I don't think anybody was over 25 years old. So a lot of energy. We're really excited what's in front of us. Jon, do you want to add anything to that?

Yes. I mean to Jure's point, to add to his point, India is a super important market to us, right? It's growing tremendously. You've got the government wanting to invest more in manufacturing. So in our space, specifically, that's critical. The partnership with Reliance should just help us to accelerate that, right? They're getting into more businesses, they're looking to expand. So we've been at it for about 1.5 years, and it's been trending on expectations even ahead, right? So we're very excited about what it's going to be able to contribute to the business going forward.

So can you talk to us about the structure of this JV? I mean, do you consolidate results from the JV? And how should we think about impact to the revenue and the P&L?

Sure. Yes. So it's 50.1% for Reliance, we're the other half, but we do consolidate the results. We talk about this in our filings. In the way that the mechanics work. So we guided as an example for Q3, a noncash net income reduction of about $3 million to $3.5 million, right? So we don't really talk about all the revenue details in specific, but we do guide that, right, to be able to give us some insight into the business.

And is this a seasonal business? Or should we think that that's the rate every quarter?

I wouldn't call it -- I mean, Jure can comment on this too. I wouldn't really call it seasonable so much. It's really about the programs that we're involved with, right? And as we expand into different businesses there and just continue to grow it, right? I mean, we see a lot of growth coming from us.

Sure, sure, sure, we expect the growth definitely long term. India is growing for us, I think it's all about right now carrying certain things out.

Okay. So I want to move to the cloud business now. I want to spend some time on that because AI and cloud, these are topics that I ask you about. So can you talk to us about, first, what are the products that you're making? And what is your target customer set?

Yes. First of all, a lot of our key customers, especially in that what we call communication at cloud enterprise are servicing that cloud, okay? So our priority is how do we work with them and give it to them what they are looking for and make sure we have a -- so what we offer, what we delivered to them, we -- a lot of the stuff that goes in file is a high-technology printable, okay? So the Boards, rocks, green supply and rocks some of the hyperscalers for the last 10, 15 years. Now that is going more in a cooling rocks. We just signed a couple of partnership with a couple of different companies to expand that. We're already assembling products, a very complicated product that requires cooling. But in a hyperscale systems in these big rocks, we need a lot more cooling. So -- then we do assembly of the cars that are going side. We have a storage product that -- what we branded under the Viking Enterprise. So we designed some of this product. And we also work with NVIDIA. We work with AMD on the new products. We're coming with those products that we can sell to other players. And some of our key customers will buy that as an ODM product from us, and then we'll go back into the system. And then we do -- we're expanding -- we've been always doing some integration where we build a full systems for some of our key customers in the communications side of the business. And actually, a majority of our business is fully assembled. But on this part, we're expanding more into the rocks and the pool system integration and testing and delivering the -- very similar model with around the -- Viking is very similar to Super Micro. Technology-wise, we have enough there Sanmina can manufacturer, but we're building something that will be very similar to what they have.

So just to understand this better, are you guys building like the servers and the networking and assembling the whole rack and then shipping the rack? Or are you shipping individual [indiscernible]?

Well, typically, in some cases, that I just said that we have -- we built a full rack with all the electronics. We build some of the stuff. We designed some of this stuff. Some of the low-end servers will buy that, but integrate it, but we'll integrate the pool system and ship. Addition to that, we'll ship ala carte let's say, there's a -- you need a storage product that goes to one of our big customers. We'll build that. And they will ask us to go and deliver that to their site with the rock and everything. So when they get it, they plug and play other cars themselves. So these are different, but our capabilities to basically give them an end-to-end.

And when we think about the cloud business, I think the segment is communications and cloud. So Jon, can you tell us like what is the percent of revenues of cloud in that segment? And how do you see those revenues growing over time?

Yes, sure. So I mean, the segment combined is about 35%, 40%. It's been in that 40% range. Last quarter, it was close to about 35%, 36%. Between the two comms and cloud, it's about half and half, roughly speaking, right? And so as we've been working through the inventory absorption challenges, there's certainly been some pressure on the comp side of the house, some in cloud as well, right? But as we were talking about, say, in the last earnings call, we're starting to see in different end markets starting to see some things turn the corner. So a big focus for us right now, as Jure was just saying, is what else can we do for those cloud providers, right, continuing to expand the customers and the programs that we're working with. And same thing with the comms providers. We work very closely with all of our customers. They're more like partners. So when you came into these inventory absorption, challenges, we work with them to figure out how best to do that. But at the same time, we're always looking ahead, right? We build long-term forecasts, right, master demand schedules, if you will, to make sure that we're working closely to figure out how to best do that.

So Jure, how broad are you in this market? Like do you have one large customer? Or do you work with multiple customers for AI systems? And is this a North American business? Or is this global? Or do you have plans to expand the business?

Yes. Most of the stuff to do that we have around AI is North America for us. Okay. There's other parts of the world, especially Europe and India that will be -- we're talking where our Viking product will be built. The key for us is to build a Viking product in India and delivered to Indian customer or even export out of India. Yes, we have more than 5, 6 big customers in the AI space. As I said earlier, every key customer that we do in our communication and cloud that supply products for AI. But so the key for us is that we play on these new programs to grow that business.

P Got it. I want to ask 2 more questions on AI. Some of the clients are concerned about -- that it's a very competitive market. And we've heard from some of the OEMs where is providing servers and storage into this and concern is on margins, how do you see margins in your cloud business? Is this an accretive business? Is it margin dilutive? And over time, how do you think that margin progresses?

Yes. If you go -- if you just look at the hyperscaler now is the AI called for a long time, if you strictly want to focus on revenue, assembled bunch of servers, that's a very competitive market. Our model is to provide a lot of the key components that go into these boxes, okay? As I said earlier, printed circuit board, mechanical boxes that go in there, racks, cooling racks, special cables that go in there. And then integrate, build what we can internally, for example, such as a Viking product around the storage. But everything else, we will buy it from our customer. I think under that model, when you supply more critical parts, you should be able to deliver a better margin than if you just buy everything and just integrate it.

Okay. That makes sense. And then you used to have a business called [indiscernible], maybe that's what's caused Vikings.

Yes, we changed the name.

Well, originally, was the plan to spin off this business? How do you think it's integrated into the company now? And how do you see growth in that store?

Yes. We have actually multiple businesses that one day. If they don't create the volumes in Sanmina, we can go somewhere else. It's our high-technology printed circuit boards. It's our mechanical business, machining business. That's one division. SCI business, which is the defense and aerospace business. And then you mentioned Viking is that we have a lot of hope for Viking to grow, especially in this environment right now, okay, with all the capabilities we have for us. We just need to win one or two big programs there. And then optical margins, we've been investing a fair amount in the last two, three years in optical margins. So we can build a product when it comes to capabilities, technology. No competitor out there can do it more than we do. I think we do more engineering on top of that. I think it's just as we now continue to expand capacity. So all those can be run as a separate units one day. But we run them together. And the way we always run Sanmina is that you have a full control, you have a financial team, you've got an operational team. We have many P&Ls on a weekly, monthly basis. So these are very controlled businesses. And that's an area that we've been investing at. And I hope we're going to see some more better results in the future as the market comes around.

Got it. Let's switch to the IMDA segment, which has many different end markets and -- can you talk about maybe starting with industrial? What is the focus area? What do you do there?

Well, definitely, IMDA is a business that we wanted to for a long time, which includes industrial, medical, when we put in buckets next bucket is in defense and automotive. So when you look at it, it's about 1/3, 1/3, 1/3, okay? So we're able to diversify that pretty well. What we do in the industrial, what's in there is, for example, the chargers. A lot of the heavy equipment like semiconductor, lithography, some of our biggest customers that we build. We invested heavily in that area, including cleaning rooms for the staff. And just a lot of other electron -- is the business is changing just from a pure mechanical to combining mechanical to electronics and industrial side, there's a lot of different industries there. And that business is actually very, very stable for us. On defense and automotive area, we have pure defense. We have a security area, emergency communication in the area, all safety is in that area. That business is doing well. And we expect our defense business to -- we just hired some new management there. We expect that to we're making some big investments in that side of the business. The Medical business rises approximately, we say 1/3 of that, it's around 40-plus percent, plus or minus. Medical business is very critical to us. It takes a long time to get into these accounts. But once you get in, you are there for many, many, many years. And so all these 3 segments we expect to continue to drive. We want to be a lot bigger than a $1 billion company. That's what we want to do. So there's a lot of emphasis. And if you can to offset some of the daily basis, that's the old emphasis. Yes, we'll get through this year. with a very respectable '23. We're going to transition in '24 with revenue down margins still holding pretty well. And as we told the Street, short term, we're forecasting our operating margin to be in the range of 5% to 6%. And we think the longer term as the business comes back, and we start shipping it closer to the $9 billion. I think you're going to see our margins go up, hopefully, there's a lot of discipline in the industry. I think -- and the industry is building today [indiscernible] lot tougher products than probably ever before. And we are a lot more critical to these customers than ever before. It's a partnership. It's not anymore, well, let me see if you can give me the best pricing. You really have to create the value both from an engineering point of view, capabilities point of view, plus as this -- these products have to work. This is not a consumer product. We don't do any consumer. [indiscernible] is a consumer product where you can just build it, it doesn't work, throw away. This stuff has to work for many, many years. And that's where we are focused.

That makes sense. Let's transition some of -- into the finance financial stuff a little bit. So Jon, when we think about this year, right, I mean, fiscal 2Q was towards the lower end of guidance. I think fiscal 3Q was a little bit weaker than what we had expected or the street had expected. So can you give us your thoughts on first half, second half, how do you see revenues and margins progressing this year?

Yes, sure. So like you said, it came in at about $1.835 billion in Q2, guided $1.8 million to $1.9 million in Q3. So midpoint of that site sequential improvement, right? And we also talked about as we get into the back half of the calendar year, both our fiscal and calendar year. We expect that growth to come. A little bit different between the markets based on like what everything urea was just saying, but definitely seeing a lot of the patterns from our customers back to that long-range forecast, right, where we feel confident in that. So the focus right now is just executing on the current quarter, getting that closed, right, and then continuing to win the new programs and expanding our capabilities there.

That makes sense. One thing we haven't talked about is there's also the segmentation of IMS and CPS. Can you maybe talk about like what are the targets for that -- those segments? Like what is the -- I think you disclosed gross margins for each of those segments? But is there also an operating margin target? So what -- how do you look at those businesses?

Yes. So 2 segments, like you say, so IMS and then CPS, which is the consumer products and services, right, margin profile for IMS. Last quarter, we were about 7.7%. That's a little bit lower than what we've been historically. We think that there's still opportunity in there, especially as we return back to growth. So we've got a big focus on the mix of the business back to the program's point, but we see that there's opportunity there. CPS has definitely stabilized. So it was 12.9% last quarter. Historically, it's been lower than that, but we're on a good trajectory and we think that there's upside there as well. And we're also focused on growing CPS as a part of the bigger mix of the overall company. So it's about 80-20 today, 80% on the IMS side, 20% on the CPS side. But as CPS becomes a bigger piece of that, right? We see more margin upside overall. And that's why in the short term, overall operating margin 5% to 6%, but we said longer term 6% over 6%.

If I can add to that. I think there's a lot of focus and investments going on in last year and continue into what we call components, products and services. One of the just big projects that we are putting together, and we just put it together, it's going to go over the next 3 years. It's around power, but a lot of mechanical goes in there. And so in order to do that, you have to -- the good thing about that business is a lot of times, those mechanical parts don't change very often. But you have to have make a right investments ahead of the game. When you're building some of these precision machining for lithography, where you're building product that is 15 feet by 8 feet and 10 feet requires a special equipment, special knowledge. That's the area that we do. I definitely believe our IMS margin should be a lot higher than what they are today and also the CPS.

Yes. I think just to add to Jure's comment, big focus or a big core to our strategy is the vertical integration, right? So if you think about the way that the company operates like IMS is the core there, but the more that we can integrate CPS into that, right? And we've got a lot of great capabilities, a lot of IP. Put that into solutions. So that's why we expect that to grow.

And we sell the -- I'm sorry, let me just add to that. We also sell some of those components to our competitors also directly. So we have no problem -- including PCBs, it can be mechanical, for example, the customer needs to sources, we once or their second source, we will still supply that. We want to supply that. So do we make extra money on that.

We've got about 2 minutes left. And Jon, I want to ask you, this is probably a higher level question, but the way I see the thesis on Sanmina is that there's a lot of operating leverage in the model. Part of it is this vertical integration. You're one of the few vertically integrated EMS companies. But can you talk about what are the drivers that will realize that operating margin? What are some of the things that will drive operating margin leverage? And when do you see that happening?

Yes. I mean a couple of things. So one is growth, right? And so we're very much focused on growth. If you think about our capital allocation strategy, we've got multiple priorities, but Jure and I spent a lot of time talking about where to make the right organic investments. So our CapEx spend, also strategic transactions. And we always make sure that those are complementary, right, not something way outside of our scope. But driving that growth will bring natural operating leverage, continued focus as well on that vertical integration. That will be a big part of it, even selling the components parts of the CPS portfolio to outside providers. That's key as well. And then just the mindset of Sanmina is just a continued focus on operational efficiencies, right? So if you think about in the manufacturing business, having that mindset to that culture where you're always looking to do something better, that's great. It's good for our customers, and it's good for us, too.

Got it. And maybe we've got one minute left. So let's talk about free cash flow, your expectation for inventory. And just uses of cash, how do you see the business growing? Is there M&A or internal investments?

Yes. So back to the capital allocation strategy. I mean inventory is still a big area of focus for us. Opportunity there, we were at about 4.8 turns, right? But we're continuing to bring that down from the peak back in Q1 of about $1.7 billion. Cash flow, we've been doing a great job generating cash. So every single quarter, every single week, on a regular basis Jure and I are talking about how best to use that. So you can see in the front half or in the first half of the year, we did a lot of share repurchases. That was more because we did a lot of capital investments back last fiscal year. So we've got the capacity in place to grow. But right now, our cash balance is great. Our leverage ratio is in a good position. So we're really, at this point, positioned well to take advantage of almost any opportunity as the market starts to come back, we'll be prepared for that.

Okay. All right. So we're out of time. And I think we've got a lot of different things. So Jure, Jon, thank you so much for coming. Really appreciate it. Thank you.

Thank you, Ruplu. Thank you for having us.

Thank you.