Sanmina Corporation (SANM) Earnings Call Transcript & Summary

[Audio Gap] started. So thanks, everyone, for attending the second day of our Global Technology Conference. My name is Ruplu Bhattacharya. And at Bank of America, I cover electronics manufacturing services companies as part of our IT hardware coverage. So today, we have the team from Sanmina, and I'm honored to welcome Jon Faust, who is the CFO of Sanmina. Jon joined Sanmina about 1.5 years ago.

That's right.

But he's got 20 years of experience, and he was at another company we cover, HP and different branches of HP, Aruba, HP Inc., HP Enterprise. So he's got lots of industry experience, and so we hope to have a great discussion today.

Yes. Thank you for having me. Happy to be here. So maybe just to start off, I just want to make sure to refer everybody to our safe harbor statement, our risk factors, which are available on our website.

All right, Jon. So I'm going to -- we hope to cover a lot of different things today. So let's start with an overview of the markets. Like how are outsourcing trends? What's strong -- which verticals are strong? Which end markets are weak?

Yes. I mean I think in terms of outsourcing trends, both for us right now are favorable. Whether you think about different industries that are outsourcing, more or less, I think the trends are going more towards it. And I think just the nature of the economy right now is favorable towards outsourcing as well because if you think back during the pandemic, everybody was working with anybody that had supply, had components and can build product for them. But last year, in calendar year '24, when end market demand started to constrict and there was inventory absorption to work through, anybody that was outsourcing or had any sort of internal capabilities to manufacture, they took that in-house. So they were lessening the players that they were working with. But now we're starting to see growth in a lot of the end markets. Even if you look at our results for the last 2 quarters, we've been growing well in line with our guide for the fiscal year. So we're starting to see more activity, more demand and just the trends overall towards outsourcing being favorable.

Got it. I know Sanmina manufacturers for different end markets. So let's start with communications. So can you talk about like what is Sanmina's competitive advantage in that space? And what are the trends happening there with, say, networking or optical or wireless? Like how are things trending?

Yes. So I mean communication networking for -- or communication networks, which is what we call it or the traditional telecom segment has been kind of a stronghold of Sanmina for many years. We were founded about 40 years ago and started off as a PCB company but grew mostly in the telecom segment. And over the last 4 or 5 years, we've diversified the end markets that we play in, but all of our capabilities, a lot of our vertical integration capabilities that we've built over time came in the telecom sector. So when you think about that, whether it's any type of product, any sort of customer, like we're able to do that. Now we focus on highly complex, like highly regulated markets, and we're focused on the programs that more drive towards that end of the spectrum. But we have all the capabilities in place to compete with any company out there. And when you think about the telecom segment and traditional telecom or communication networking players, they're starting to see growth come back as well. So maybe not huge double-digit growth that you see in like the data center space or end market, but definitely seeing growth. But with optical specifically, they're starting to expand into adjacencies, too, like back into the data center space. So we're seeing a lot of programs and having a lot of success with transceivers, with modules, whether it be 800 gig, 1.6. They're starting to be developed. But they're trying to broaden their scope of where they play. And we're looking to help them do that because we think we got all the capabilities to do it.

In the networking space, the whole industry has been going through an inventory correction for the last 1.5 years. So where are we -- what innings are we in? And how are your -- how are Sanmina's revenues growing in that space?

Yes. It's certainly gotten better. So last year, for our -- fiscal year '24 is a transition year for us, and that applied to the majority of our end markets, and communication networks being one of them. But in our last 2 quarters, you've seen our inventory turns get a lot better. We were in the mid-4s. We're back up to 6, and this is Sanmina in aggregate, but we're starting to see things trending better. But I think the more telltale sign for communication networks is just the growth that we're seeing in revenue. So in our Q2 results, we combine communication networks and cloud infrastructure together, but grew about 20%. And both sides -- and it's about 37% of our total business, so almost 40% of total revenue. And that's split roughly equally between the 2, so call it, like 15% to 20% on any given quarter because different programs shift. But -- and both sides are seeing that growth as well of around 20%. So from an inventory turns perspective, at least for the programs that we're involved with and the customers, we've started to turn the corner. I wouldn't say that we're completely out of the woods for all programs, all customers yet, but we're definitely seeing the green shoots and already seeing some good improvements. And it shows in our results.

Okay. Maybe talk to us about your JV in India. What is that about? What are you building for them? And how does that structure work?

Yes. So it was 2.5 years ago that we entered into a joint venture with Reliance. So a pretty unique transaction where they actually purchased 50.1%. So they were the majority owners. But we still control the business and consolidate the results. So it is an Indian company. So when you need to manufacture locally for all the rules and regulations there, that does qualify. So that was part of what was very interesting to us. But again, we still manage and control the entire business. Now they work across all the end markets as well. There was a lot of communication networks business there, but there's also a lot of medical and a couple of other end markets. The one that's growing there is really on the data center side or the cloud infrastructure side of the business, but it's been doing very well. Now we don't guide or talk about the specific like revenue or profit amounts, but I do guide specifically like the adjustment, the noncontrolling interest adjustment that we do to earnings per share. And that's beat for the last couple of quarters. So we are seeing growth there. We're very positive just about the market in general and what India can be and is looking to become in the future. And so much so, we talked recently in our last earnings call about how we're expanding our footprint there. We've got a large campus with 2 large buildings, but we've been building a third, which will be finished towards the end of this fiscal year, maybe the beginning of Q1.

Maybe in this space, we haven't talked about 5G and wireless. I mean do you think that, that market remains weak? Or is it like showing any signs?

Yes, it's definitely showing signs of growth. I mean we look at it more as like wireless infrastructure more broadly. So think about all the elements, not just cellular specific, but we do that, but we do satellite as well and other elements. But yes, we're starting to see growth in that part of the business, too. And that's part of the 37% of our revenue, growing at 20% that we were talking about before. So we're seeing growth and expansion in that space. And it really comes down to even the first question that you mentioned around outsourcing trends and so forth. Like we've been winning programs, winning business and good programs that are accretive to us. So we're very excited about that space.

Okay. Great. All right. Well, let's transition into the cloud business because this has been a focus for investors as well. So talk to us about like how large is your cloud business. And what are you building in that space?

Yes. So cloud infrastructure for us is part of that same segment that we were just talking about. So 37% of the business in Q2, and you can call it roughly about half. Historically, we've been focused on data center networking because, for those that don't know Sanmina as well, our strategy is focused on highly regulated markets, very complex products. So we weren't interested in any products or builds that were more commoditized. So data center networking, so you think like the Aristas, the Junipers of the world, those are the types of businesses that we're interested in. But just a couple of weeks ago, we announced an acquisition of ZT Systems from AMD that's specifically focused on rack cloud infrastructure. So we're very excited about that. We expect to close it by the end of the calendar year. But it's a new TAM. We're unlocking a new TAM for us. I mean again, we played in the cloud infrastructure space, and we'd show a lot in our earnings calls a picture of a rack and all the various different things that we could do from the metal bending, the rack fabrication, the cables, the PCBAs. The one thing that we weren't doing, at least not at scale, was the full system assembly for racks specifically. And that's exactly what ZT Systems' manufacturing does. So it's very attractive to us in that regard. So we're very excited about that as well as the strategic partnership that we put in place with AMD to be their preferred MP, manufacturing partner. So it should drive a lot of growth for us in the future. Right now, we're just focused on getting the transaction closed. But when you think about cloud infrastructure overall in that segment of the business that we have today, was growing about 20% Q2, the same in Q1. But even as we were showing when we announced the transaction, we expect the whole data center cloud infrastructure end market to be growing at least at a 30% CAGR over the next 5 years. That's the intelligence that we've had. So a very attractive end market. You know Jure and I are both very much focused on driving growth, strategic growth that's accretive to our current profile. And that's what we believe ZT Systems and this acquisition is going to help us do.

So when we think about the cloud business overall, you said the market is growing 30%. How should we think about Sanmina's revenue growth and the margin profile in the cloud business overall?

Yes. So when we close the transaction, we'll provide a lot more specifics. But the one thing just about the announcement specifically that we said a couple of weeks back on May 19 is that the current run rate of that business is $5 billion to $6 billion in revenue. But we said that we expect within 3 years to double the size of the company, Sanmina, which would imply about $8 billion, so call it a healthy growth in the 20% or so range. Now the CAGR is more broadly. Hopefully, we do better than that, but it's still early. So we'll come out with a lot more specifics when we close the transaction in terms of the mix of the business, the future growth profile, the gross -- or the margin profile and EPS accretion as well.

In cloud, you also had Newisys, which is a storage -- I think it's your ODM storage business. How is that business trending? And what's the long-term plan for that business?

Yes. So Newisys was the name of the business back when we acquired it. We've rebranded that to be Viking Enterprise Solutions. It's exactly what you say. So white-box offering for storage and even server capabilities as well. And that was something that we had acquired years back as part of one of our customers' requests where they were looking to us to expand. And if you think back to like how Sanmina has evolved over time, we have a very customer-centric culture. So generally, we got into new services, starting from PCBs and backplanes and to other things that we do today based on customer needs. And then Viking Enterprise Solutions, what used to be called Newisys, was part of that strategy. But it very much fits in well with our current strategy for the data center market because we believe that can be a good offering to go along with ZT Systems. And they've got -- we've also got internally great engineering capabilities. Now people have talked a lot about the design engineers that AMD is going to extract from ZT Systems as a part of that overall transaction, which is great. It's a new part of the business for them to get into. But we've got design engineers as well. So having that team in place that came from Viking Enterprise Solutions helps to give us that foundation to be able to make that broader business be even more successful. So we're very bullish on Viking Enterprise Solutions both from a stand-alone basis, but then just fitting into that portfolio of cloud infrastructure.

Okay. Great. So let's move on to the other segment, which is, I call it IMDA, but there are a couple of more end markets in there. So let's talk about each of the end markets. So let's start with industrial. Can you talk about -- what are the trends you're seeing there and some of the main things that you provide in that segment?

Sure. So that segment, for everybody's benefit, is about 63% of our business. We talk communication networks and cloud infrastructure, but this part of the business is industrial, medical, defense and aerospace, automotive. So yes, just to talk about -- and it's growing low single digits. So this last quarter was 2%. And it's because in that part of the business, you still have some of that inventory absorption that needs to be worked through. So I'll give you an example. In industrial, we do different things from like call the police handsets for firemen, policemen, things of that nature. That part of the business is doing very well and growing. I would call it high single digits, in that type of range. But we also do large semi-cap equipment, for example. So you think the Applied Materials, the ASMLs of the world. And that part of the business, we still have -- from a long-term perspective, I think that's a great business to be in. And it fits in very well with our strategy and our set of vertical integration capabilities, but it's still working through some of that inventory absorption. So that's why you see that, that's a little bit mixed. And I would say for that category more broadly, Ruplu, like you see similar types of trends. So medical, similar. Like large hospital-based equipment, very much still under pressure as the hospital network is going through consolidation and just working through how to manage those assets. But we also do things like the equipment for local doctor offices, so think blood testing machines, glucose testing, all the way down to like wearables, disposables, things of that nature, which is a little bit on the lower end. Now those areas are growing well, but the high-end hospital equipment, still a little bit constrained. So similar type of dynamics across that part of the business.

Okay. I know there's a defense business that you have, Sanmina-SCI. So can you talk about like what type of projects that works on? And how is that business trending?

Yes. So that's the part of the business that's focused on aerospace and defense. And we've got 2 plants through the SCI acquisition, which was a little over 20 years ago in the early 2000 time frame, that is based out of Huntsville, Alabama. And we've got 2 plants there. So part of the business focuses on the Department of Defense. So think about those types of programs for military equipment and those types of capabilities and then also the commercial side of the business. So we do both. That also is in like, say, like the 10%, 15% range of like total company revenue. And it's been doing quite well. I mean in that business, the DoD side of it specifically is almost kind of like an annuity, right? When they put a program in place, you think about large military equipment like Apache helicopter, like that's been around for 25, 30 years, right? So once you win in on those programs and you're building components, which is what we do, that go into those types of products, you'll have that for a long time. So it's been a good business for us, still very attractive to us, and we look to continue to invest there.

So does the SCI business have higher margins than the segment overall? And would it be instructive for investors to kind of do a sum of the parts and value that business as a separate business? Is this something you could potentially spin off later on at some point?

So we're -- a lot of what we do in SCI rolls up under the CPS segment. And as you know, the margin profile, that's a little bit different. So we've got our 2 external segments when we report financials and file our financial statements. So IMS is in that -- talking gross margins, 7% to 8% range, but we think that there's more upside potential there. And we're focused on winning the programs that do that. CPS has been more in that 13% to 14% range. And we've done a great job even last year in the down revenue year maintaining that margin profile. So we are looking to grow the overall mix. And to kind of answer your question around SCI, for us, when you think about just the margin profile in general, we're looking to grow CPS and drive our vertical integration to be a bigger part of the Sanmina whole. It's about 20% today. But if we're successful with that, successful with growing parts of the business like SCI, it will become a higher percentage. So I think that's the right way to look at it from a financial perspective.

I think we may have missed automotive in that segment. So talk to us about like what are some of the products you build and what's happening there.

Yes. So automotive, we're very much indexed to the EV side of the house. We're focused on the traditional automakers as well, but like more of our legacy came through EVs. And we started off in the infotainment part of that market, but we've been gradually expanding into more components. And automotive is attractive to us from a long-term perspective, too, because more and more electronics are going into these vehicles. So you think drivetrain components and otherwise. But we've been focused a lot on the U.S. like EV market in particular, and it's done well. It continues to grow for us. I know EVs aren't what they were, say, 1.5 years, like 2 years ago when there was a lot of optimism. But for us, there's still share gain opportunity. And the fact that we're expanding like into different aspects of the portfolio, so beyond just infotainment, is what makes it attractive to us as well.

Okay. It's strange, we haven't talked about tariffs. And every meeting we've been going to is like that's a topic of discussion. So I'll give you the same question. Like have you seen any customer demand impact? Have you seen any pull-ins? And what have people asked for moving their manufacturing footprint?

Yes. I would think as far as pull-ins or shifting programs, like nothing material as of late. I can tell you, ever since the new U.S. administration came in place and tariffs became a hot topic, there's been a lot of dialogue with our customers. So I would say our job and what we look to do is to proactively engage with them to talk about options, help them do ROI analysis because it's not easy. I mean there are some programs, especially if you're manufacturing in multiple locations already, very easy to say, hey, I want to do more volume out of 1 place versus the other. But if they're primarily manufacturing in 1 location, it takes time to be able to move that program, especially if there's specialized equipment. But our job in that regard is to help our customers understand the economics to say, what would it take? How long would it take? Does it make sense for them to do? Because we're always happy to do that. So -- and then also a part of our job with our international trade compliance team is just staying on top of the ever-changing landscape out there to make sure that we're experts because we're a key supply chain partner. If you're going to be manufacturing and there's tariffs on manufacturing providers or just on the business overall, not the provider specifically, then like we need to be experts in that space. So we proactively reach out to our customers. But at this point, nothing's moved materially, I would say. And I think that's because of the on again, off again nature that we've seen. Now that may change. But as far as like the economics, like our business is very much resilient to that because we're not accountable or responsible for the tariffs ultimately. If we're the importer of record, like we might do the cash outlay, but then we go back to our customers to recover that immediately, like within the 8 days that it's required to be paid. So that's -- so we've got good, I guess, resilience, like I was saying before, to the impact of the tariffs ultimately. Now if they stay in place and there's an end market demand impact, like that would be different, right? That, I think, would impact everybody. But right now, it's really just understanding the landscape, staying on top of it and providing optionality. The only other thing I would add for us that's a competitive advantage are 2 things. We've got a large global footprint. I think that's well known. But we've also got a single ERP system, a single shop floor system or MES system. So if you want to move programs, the part numbers are the same. Like there's no sort of translation that needs to take place. So that type of friction that can be put in place, like we don't have that challenge at Sanmina. So we make sure that, that's known to our customers as well.

Yes. Another thing, I think, that differentiates Sanmina is your U.S. footprint. I mean you have a decent-sized footprint here. I mean talk to us about utilization rates. If people wanted to move into the U.S., do you have capacity to support that?

Yes, we do have capacity. I mean the way I would answer that, if you look back to our revenues in fiscal year '23, we were doing about $9 billion in revenue. And we invested pretty heavily in capacity all around the world, but also in the U.S., in the U.S., Thailand, Mexico, back then. So say that you've got capacity up to $10 billion plus. Last year was a transition year because of the inventory absorption challenges that the broader industry was working through in pretty much all end markets. We were down to like $7.5 billion of revenue. This year, we guided high single-digit revenue growth. So if you talk in the $8 billion, low $8 billion range, we still got good capacity in place kind of on a global basis, but in the U.S. as well. But then even this year, we've been making more investments in the U.S., other locations too, India. I mentioned earlier, we talked about this on our last earnings call, both the U.S. and India being part of our guide for Q3 and Q4 for CapEx. It was an area of focus. And then the ZT Systems manufacturing acquisition that I mentioned earlier, they also have a large U.S. footprint. So on the call, when we announced that, we talked about the 3 manufacturing locations that they have: one being in Secaucus, New Jersey, which was their headquarters; a new greenfield facility, like state-of-the-art facility that they built in Georgetown, Texas, which is half an hour north of Austin; and then also in the Netherlands. But that, specifically for the U.S., adds to our footprint in a very interesting end market with a lot of great capabilities.

Okay. So now let's talk about some overall financials for Sanmina. So how should investors think about revenue growth and margins for fiscal '25? And then longer term, for the medium term, how should we think about progression in those 2 metrics?

Yes. So at the beginning of the fiscal year, we took a little bit different approach. Like generally, we've -- historically, Sanmina has guided just 1 quarter at the time. And that philosophy largely isn't changing. But we did get some feedback from investors and analysts such as yourself that said it would be helpful to get kind of building blocks of a full year guide. So Jure and I did do that in our Q4 of '24 earnings call. We laid out a full year guide at a high level and said revenue growth of high single digits and EPS growing faster than that, which implies the margin expansion. And if you look at our Q1 and Q2 results or even the rest of our guide, we've been living up to that. So our revenue growth has been fantastic on the high end of that range in Q1 and Q2. Our gross margin profile beat our guides like above 9% -- at 9% or above in both quarters. So we feel very good about that, everything that we're looking to execute on this fiscal year. If you think about our Q3 guide, and we're in the middle of Q3 right now, we're focused on executing on that. And we even did talk about the full year still being in that 6% to 8% revenue growth range. So we've got a great foundation. And that's what made us feel confident about doing this acquisition as well is just not only do we have a good diversified portfolio of business across multiple end markets. We're growing high single digits. We're expanding margins. We've been generating a lot of cash. The other thing that we haven't talked about is our balance sheet. But as you know and I talked a lot about on our earnings call, we have the best balance sheet in the industry with no net debt, low gross leverage ratio of 0.5x. So that puts us in a position to do strategic acquisitions like the one of ZT Systems and still be able to maintain a healthy balance sheet because that is very important to both Jure and myself, right?

So one of our thesis points on Sanmina has always been operating leverage. So talk to us about like is there still more leverage to be had from the model? Are there things that -- are there levers that you can pull to drive operating leverage?

Yes, absolutely. But even going back to like fiscal year '24, so I talked before about revenue being down about 15% from that $9 billion in FY '23, down to about $7.5 billion. But we actually expanded our gross margins, right? Our operating margins came down a little bit, about 20 basis points, but our gross margins expanded 20 basis points. And the only reason the operating margins came down is because we started making some targeted investments to help set up the company for future growth in divisions like Viking Enterprise Solutions and otherwise. But the fact that we're able to maintain and even improve our gross margin profile in a down year, I think, is a testament to the core business. Now looking ahead, there's multiple levers to get operating leverage. One, just growing the business, growing the top line, the high single digits like we've been doing helps with fixed cost absorption. So that's one. Two, we've been making a lot of investments in the CPS part of the portfolio to drive our vertical integration strategy. And as I mentioned, like the gross margin profile there has been historically in the 13%, 14% range. But we expect to be able to do better there, especially with the investments, and grow that to be a bigger part of the total company mix. So no longer be 20% of the revenue, be something higher than that. And then when you think about our OpEx and our SG&A profile, we've been in the 3% to 3.5% range. And that's more -- 3.5% more in like a down year. And we've made a lot of the investments, more of the onetime investments this past year and the last year or so since I've been here to set up the company for future growth. So there's definitely areas where we're going to want to invest going forward, but not at the same scale of what we think we can do from a revenue growth perspective, organically speaking. So we definitely think that there's room to grow margins. Right now, we're just focused on executing on our Q3 guide and closing out the fiscal year. But we expect as we get to FY '26 or we get to Q4 this year, I'm talking more about full year '26 for the core business. And around that time, we should be close to closing the ZT Systems transaction. And we'll talk a lot more -- in a lot more detail about the mix of business, the revenue the type of business that they're doing, customer set, hyperscalers versus OEMs and then the margin profile, too.

Got it. Can you talk about -- we have about 2 minutes left. Talk to us about capital allocation, your priorities for cash. And then the last question would be, what is the market missing about Sanmina? Why is now the best time to invest in Sanmina?

Yes. So on the capital allocation point, I talked a lot about this back in Q4 at the end of our fiscal year, too. But our priorities haven't changed. And we're very much focused on cash generation, but it's very much ROI based. So when you look over the last year or so, we were doing a lot of share repurchases because we had already invested in the CapEx like to expand our capacity or to build that out. So we didn't really need to do that. We typically spend CapEx or organic investments of that nature between 1% to 2% of revenue. We had been on the higher of that -- end in '23. But then we -- so therefore, we're doing share repurchases because we didn't see a lot in terms of strategic partnerships or M&A. Now that obviously just shifted. When we saw the ZT Systems manufacturing opportunity, we thought that fit in perfectly with our core strategy. First of all, it's a founder-led company. So culture-wise, it's very similar to Sanmina. And I think that's very important when it comes to the success rate of M&A. Second, it's not in an adjacency by any means. It's very much core manufacturing business that just expands our TAM into the accelerated compute and rack-building part of the business. So the ROI there, we're very -- we think that, that's the best ROI, and that's why our capital allocation shifted towards that. But our overall strategy has not changed. But as far as what's been missing about Sanmina, I think part of it -- since becoming CFO 1.5 years ago, I've been trying to get out more of the message about how we're no longer just indexed to a company -- EMS player indexed to the telecom market, but we really do have a well-diversified base. And I think that we proved that in fiscal year '24 when in a down year, we maintained our margin profile and generated great cash while still expanding margins. But now going forward, you think about an acquisition like ZTE Systems, we have set the foundation to drive future growth, and that's really what we're focused on.

Okay. Well, I think we've covered a lot of ground. So thanks, Jon, for being here. We also have Paige Melching in the audience, who's heading IR. So if you guys have any questions, please look us up. Please, you can contact her. And Jon, thanks so much for coming today. Really appreciate [indiscernible].

Always good to see you. Thanks for the time.