Sanmina Corp Q1 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to the Sanmina First Quarter Fiscal 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Paige Melching. Please go ahead.

Thank you, May. Good afternoon, ladies and gentlemen, and welcome to Sanmina’s first quarter fiscal 2022 earnings call. A copy of our press release and slides for today’s discussion are available on our website at sanmina.com in the Investor Relations section. Joining me on today’s call is Jure Sola, Chairman and Chief Executive Officer, and Kurt Adzema, Executive Vice President and Chief Financial Officer. Before we begin our prepared remarks, let me remind everyone that today’s call is being webcasted and recorded and will be available on our website. You can follow along with our prepared remarks in the slides provided on our website. Please turn to Slide 3 of our presentation or the press release safe harbor statement. During this conference call, we may make projections or other forward-looking statements regarding future events or future financial performance of the company. We caution you that such statements are just projections. The company’s actual results could differ materially from those projected in these statements as a result of a number of factors set forth in the company’s annually and quarterly reports filed with the Securities and Exchange Commission. The company is under no obligation to and expressly disclaims any such obligation to update or alter any of the forward-looking statements made in this earnings release, the earnings presentation, the conference call or the Investor Relations section of our website, whether as a result of new information, future events or otherwise, unless otherwise required by law. Included in our press release and slides issued today, I have provided you with a statement of operations for the quarter ended January 1, 2022, on a GAAP basis as well as certain non-GAAP financial information. A reconciliation between the GAAP and non-GAAP financial information is also provided in the press release and slides posted on our website. In general, our non-GAAP information excludes restructuring costs, acquisition and integration costs, noncash stock-based compensation expense, amortization expense and other unusual or infrequent items. Any comments we make on this call as it relates to the income statement measures will be directed at our non-GAAP financial results. Accordingly, unless otherwise stated in this conference call, when we refer to gross profit, gross margin, operating income, operating margin, taxes, net income and earnings per share, we are referring to our non-GAAP information. I’d now like to turn the call over to Jure Sola.

Thank you, Paige, and good afternoon, ladies and gentlemen. Welcome and thank you all for being here with us today. I’d like to make a few comments before I turn it over to Kurt. First, I would like to take this opportunity to recognize our leadership team and our employees for managing successfully around material shortages and navigating around COVID. So to our Sanmina team, you are doing an excellent job, and I’d like to thank you. Despite all these challenges, Sanmina delivered strong results for the first quarter of fiscal year 2022. For agenda, we have Kurt, our CFO, to review the details of our results for you. I will follow with additional comments about Sanmina’s results and future goals. Then Kurt and I will open for question and answers. And now I’d like to turn this call over to Kurt.

Thanks, Jure. Please turn to Slide 5. In the first quarter, our team did an excellent job of managing through the impact of the supply chain constraints, delivering strong revenue growth, margins, and profitability as well as cash generation. Q1 revenue of $1.76 billion grew approximately 7% from the prior quarter and exceeded our outlook of $1.6 billion to $1.7 billion. This was primarily due to strong execution by our supply chain and operations teams. As Jure mentioned, demand continued to be strong. However, the impact of supply chain constraints also continued. Non-GAAP gross margin improved to 8.5% compared to 8.2% in the prior quarter, primarily due to higher revenues. Non-GAAP operating margin improved to 5% compared to 4.8% in the prior quarter, primarily due to better gross margin. Non-GAAP fully diluted earnings per share grew approximately 13% to $1.08 compared to $0.95 in the prior quarter and exceeded the upper end of our outlook of $0.90 to $1. Finally, Q1 GAAP EPS was $0.89. Please turn to Slide 6. This slide shows the quarterly trends of our financial results. You can see our team has done an excellent job of managing the business through this dynamic period. Non-GAAP gross margins have been very consistent, exceeding 8% for the last seven consecutive quarters. In addition, non-GAAP operating margins have been 5% or higher for five out of the last six quarters. We believe our revenue will increase and our margins will expand as material supply chain constraints resolve. Now please turn to Slide 7. Q1 IMS revenue increased to $1.43 billion, primarily due to strong execution by our supply chain and operations team. Non-GAAP gross margin for IMS improved to 7.5% from 6.8%, primarily due to higher revenues. Components, Products, and Services revenue increased to $367 million. Non-GAAP gross margin for CPS declined to 11.6%, primarily due to product mix. Again, overall non-GAAP gross margin improved to 8.5%. In summary, we believe our revenue will grow and our margins improve for both IMS and CPS as the supply chain constraints are resolved. Now please turn to Slide 8. Let’s talk about the balance sheet. Cash and cash equivalents were $628 million. Between cash and the availability under our revolver and other debt facilities, we have approximately $1.4 billion of liquidity. At the end of Q1, there were no borrowings outstanding under our revolver. We believe we have a strong cash position to help us manage through the current market dynamics. Inventory increased due to an increase in the level of unconstrained parts resulting from the impact of the supply chain constraints. This inventory increase was driven based on conversations with our customers. We expect this inventory will be consumed in the balance of inventory to normalize as supply chain constraints are resolved over time. Despite the higher levels of inventory, we were able to manage working capital such that cash cycle days remained steady at approximately 57 days. Non-GAAP pretax ROIC improved to 26.4%. Now, if you please turn to Slide 9. Our cash generation remains consistently strong. We generated $68 million of cash from operations and $51 million of free cash flow in Q1. We continue to remain focused on cash generation and expect to continue to generate cash going forward with cash being used primarily to invest in the business to drive organic growth. In addition, during Q1, we repurchased 1.55 million shares for a total cost of approximately $60 million. At the end of the quarter, we had remaining purchase authorization of approximately $220 million. Now, please turn to Slide 10. Let’s talk about the Q2 outlook. As Jure mentioned, overall customer demand is strong, but there continue to be supply chain challenges. We expect Q2 revenue to be in the range of $1.7 billion to $1.8 billion; non-GAAP gross margin in the range of 8% to 8.5%, depending on product mix; non-GAAP operating expenses to be in the range of $59 million to $61 million; and non-GAAP operating margin in the range of 4.5% to 5.1%; non-GAAP other expenses of approximately $5 million; non-GAAP tax rate of approximately 17%; non-GAAP fully diluted share count of approximately 66 million shares. When you consider all this guidance, our outlook for non-GAAP diluted earnings per share is in the range of $0.95 to $1.05. We expect capital expenditures to be approximately $30 million, driven by growth of new programs, and depreciation for the quarter to be around $28 million. In summary, demand remains strong across our customer base, and we are confident in our lean manufacturing business model and expect the company to deliver strong operating leverage and cash flow generation over time as the supply chain constraints resolve. With that, I’ll turn it back to Jure.

Thank you, Kurt. Ladies and gentlemen, let me make a few more comments about the business environment for the first quarter, an outlook for the second quarter, and outlook for the rest of the fiscal year 2022. Key highlights for the first quarter. As you heard from Kurt, Sanmina delivered strong results for the first quarter. Despite material and COVID challenges, I can tell you, our team is executing very well in this environment. Key drivers in our first quarter were: excellent supply chain by working closely with our customers and suppliers; great operational execution, creating the right capability to build up products; through operational flexibility, we’re able to support critical requirements for our customers. Overall, we’re off to a good start for fiscal year 2022. Let me give you a few highlights of revenue for our first quarter by end markets. Demand for product was strong across all markets. We delivered nice growth quarter-over-quarter. For the first quarter, our top 10 customers represented 48% of revenue. Communication networks and cloud infrastructure comprised 40% of our revenue. Revenue was slightly down about 3%, impacted by material shortages in this segment. Industrial, medical, defense, and automotive constituted 60% of our revenue, and that was nicely up 15%. Also here, we experienced material shortages. Let me talk about bookings. Bookings for our first quarter continued to be strong. Book-to-bill was 1.2 to 1. Please turn to Slide 13. Now let me talk to you about revenue outlook by market segments for the second quarter. For the second quarter, short-term, quarter-over-quarter, we are forecasting flat growth. We do have upside potential across all the market segments, but it’s limited by component constraints. The good news is that our customers’ demands continue to be strong. For the second quarter, we’re forecasting that 40% of our revenue will come from communication networks and cloud infrastructure markets. It’s driven by optical systems, 5G networks, cloud networking, and enterprise storage systems. We are forecasting that approximately 60% plus of revenue will be generated from industrial driven by security and safety products, renewable energy systems, test and measurement and semiconductor equipment products; medical driven by lab diagnostics, ventilators, patient monitoring systems, and ultrasound systems; defense and aerospace driven by technical communication, military aircraft equipment, unmanned aerial systems, and satellite equipment; and for automotive, it’s driven by LiDAR and radar systems, electrical motor power management systems, safety systems, and electronic control systems. Now let me talk about the future. I can tell you the future is more exciting. The most important is we are established in these mission-critical, high-complexity, and heavily regulated markets. Sanmina is recognized as a leader in these markets by our customers. So let’s talk about the rest of fiscal year 2022. Based on our current market visibility and customer forecast, I feel very positive about the rest of fiscal year 2022. Materials and COVID challenges will continue throughout calendar year 2022, but we do expect to see some improvement in the second half of the year. Sanmina is executing well in this dynamic environment as we continue to work closely with our customers and suppliers to resolve these supply chain shortages, especially in the short term. Now let me talk to you about growth. I can tell you that Sanmina is well-positioned for growth. The pipeline of growth opportunities remains healthy. We continue to expand existing customer partnerships, and we continue to invest in leading technologies to drive growth in our key markets, such as medical, defense, industrial, and automotive focusing on electrical vehicles, communications, and cloud infrastructure. The key focus for our management is to continue to expand into more profitable projects and new market opportunities by delivering a competitive advantage to our customers. I am optimistic that all of these opportunities will translate into growth and margin expansion. So for fiscal year 2022, we do expect to deliver solid results. Please turn to Slide 14. So in summary, for our first quarter, I would say this was a good result, revenue above our outlook, strong execution. Non-GAAP operating margin was 5%, and we continue to focus on this. Non-GAAP diluted EPS of $1.08 exceeded our outlook, and we reported strong free cash flow of $51 million. For the second quarter, we expect to also have a good quarter. Demand remains strong, and we expect supply constraints to continue, but we believe it is manageable. In this environment, we’ll continue to operate with agility and successfully navigate market dynamics. Our revenue outlook is stable, ranging from $1.7 billion to $1.8 billion for this quarter, and the outlook for non-GAAP diluted EPS is between $0.95 to $1.05. So, ladies and gentlemen, now I would like to say thank you all for your time and support. Operator, we’re now ready to open the lines for question and answers.

Absolutely. Your first question comes from the line of Ruplu Bhattacharya of Bank of America. Your line is open.

Thank you for taking my questions.

Hello, Ruplu.

Hi, Jure. You had guided each of the end markets, the communication networks, cloud as well as the IMDA, those four end markets to be up slightly. Obviously, it looks like IMDA performed much better than that. It was up 15% sequentially. Can you help us parse within that how the industrial, medical, defense, and automotive? What did you see in the quarter, which one was stronger, which one was weaker? And the same for Communication Networks, it came a little bit; it was down 3%. So what was weaker than you had expected? Can you just talk about the optical networking wireless, just getting into more details in each of these end markets?

Yes. Let me cover your first question regarding industrial, medical, defense, and automotive. First of all, overall, demand was there. Our biggest challenge was getting the materials. We had better luck in this segment, and that was nicely up 15%. When I say better luck, it’s just getting more materials. On the communications side, again, demand was actually very strong in all our key markets, such as cloud networking systems, IP routing, optical systems, and 5G. It was all challenging to get the right material on time. So the good thing, as I said in our prepared statement, the demand is there; it’s all about working very closely with suppliers and our customers to get enough material. But the good thing is demand is there. It’s all about our execution.

Got it. Maybe the second one, I’ll ask a question to Kurt. It looks like inventory was up 20% sequentially. How much of that inventory increase, Kurt, would you say is because of the component costs still going up in the December quarter versus actual pieces of inventory going up in your inventory? Meaning like is it – is that increase really just because of inflation and because of cost increases from the suppliers? Or are you actually holding more inventory that will help you in shipments going forward?

Yes. So, yes, I think it’s a good question, Ruplu. I think it’s a bit of both, honestly. First of all, we are out there buying inventory, hoping that some of the really constrained parts will come through. And sometimes they don’t, so we tend to, through our conversations with our customers, err on the side of the fact that some of the most constrained parts will come through. And so we have to ensure we have what I’ll call it the secondary or the tertiary bottlenecks in the BOM covered. So part of it is the number of units, but you’re absolutely right. Those units that we are tracking down are costing more. So consequently, it’s not just the number of units; it’s also the cost of those units, particularly some of these harder-to-find units that aren’t the primary bottleneck but are, what I call, the secondary or the tertiary bottleneck in the BOM. So it’s a combination of both.

Okay, thanks for the details on that, Kurt. I appreciate it. Maybe just for my last question. Let me ask you on CPS segment margins. It looks like sequentially, they were down about 120 basis points. Just what were some of the reasons for that? And can you help us think about, as we come out of COVID, how should we think about seasonality in the CPS business because it has components, it has products and services? How should we think about revenue seasonality and margin seasonality in fiscal 2022 going from one quarter to another?

Yes, sure. So let’s take the seasonality question first, and then I’ll circle back to the CPS question. Overall, historically, seasonality, we’ve been down about 3% to 5% in our second quarter due to seasonality. There probably will be some of that. It’s hard to tell given the backdrop of the supply constraints. Our hope, and as you can see based on our guidance, is to the extent we do experience some seasonality in certain parts of our business, we’ll be able to make up for that in terms of revenue by chasing down more parts and being able to deliver more units of other products. So I don’t think there’s zero seasonality, but we hope, to the extent there is seasonality, that we can help offset that through more shipments of products. On the CPS question, again, when you think about CPS margin, you have to remember that it’s a diverse set of businesses inside of there. The biggest driver around margin is really around mix. A lot of times, we’ll have lumpiness inside of any one of those businesses, and that will drive margins. We hope over time, obviously, we expect those margins to go up. But it just so happens this quarter, the mix wasn’t what we had hoped for, and consequently, our margin was down a bit.

Okay. Thanks for all the details, and congrats on the strong execution in the quarter.

Thank you.

Thanks.

Your next question comes from the line of Jim Suva of Citigroup. Your line is open.

Hello Jim.

Good evening. Thank you so much. I can’t remember if my memory is right on this, but am I right that it was around $200 million or just more than that of supply constraints that you could have shipped last quarter? Is my memory right on that? If so, do you have a number of this quarter? Just curious about how much more you could have shipped?

Jim, your memory is better than an elephant’s, okay? You’re 100% correct. It was about $200 million last quarter, and we think the best in our analysis last quarter was similar, we call it 10% plus but similar to the quarter before.

Okay. And when you talked about your forward quarter growth of revenues kind of flattish. I do note that the EPS looks a little lower quarter-over-quarter. Is that due to higher compensation, employee inflation costs, or more mix? I’m just trying to get my hands around why EPS wouldn’t also be kind of flat?

Yes. So let me try that one, and then Kurt, you can add to it more. First of all, as we look at the quarter out there, we have plenty of revenue across all the markets, and most of our customers want more than what we’re able to ship today. So it’s all going to come down to how the mix comes through in that segment. That’s what we are guiding today. But if we can get more revenue out, a lot of those things get fixed.

Yes, I’d say Jure is absolutely right. It always comes down to mix. What we can ship depends on what we’re able to get from a supply chain perspective. There are two other things to be mentioned. First of all, in our fiscal Q1, we typically have some benefit from holiday shutdowns, especially in the United States. You have that in Q1; you don’t have that in Q2. The other thing is that you typically have in Q2 is the resetting of the payroll tax, right? It usually gets capped out in the U.S. towards the end of the calendar year, and it restarts at the beginning of the calendar year. So that affects Q2, our second fiscal quarter. In addition to mix, which Jure mentioned, I think those are two other factors that have an impact on our Q2 margin guidance.

Great. And then, things with the supply chain still tight and stable tight, or actually getting looser from where you’re sitting at and getting closer towards a resolution?

I think there’s a lot more planning going on. As we know, we’ve been in this scenario for almost a year plus. So there are a lot of works being done between customers and us and our key suppliers. We’re working out to get some kind of normality into this. But Jim, as I said in our prepared statements, this will continue. We believe that we’re going to see some improvements in the second half. I mean we’re starting to see some improvements in certain components. Right now, you have shortages almost on anything, from pure raw materials like aluminum and steel to semiconductors. Carrying everything when you need is a critical issue. We’re learning to work with it now. We have a strong supply chain management in place. We’ve got one global IT system. We connect with our customers, and we talk to them and suppliers daily. Efficiency is not very good because we’re not getting proper loading on a daily basis. We’re hoping that as we improve on some of the materials, we can be a lot more efficient. So we’re just learning how to work with it, both with material shortages and COVID. This is now our normal.

And so, if that’s normal now, Kurt mentioned working down inventory when things normalize. Why not hold some buffer inventory in case there’s a – hopefully this doesn’t happen, a COVID issue in 2023 or 2024 or 2025, an earthquake, or a strike, or trade wars, or who knows what?

When it comes to inventory, we are working very closely with our customers in this. We just don’t bring in inventory for inventory’s sake. This is 100% coordinated with each of our customers, understanding exactly what we need to bring in, and this is guaranteed by contract or a purchase order.

Yes, Jim, I just want to clarify. As Jure said, the supply constraints, we expect to go through the end of this calendar year. It’s really an opportunity at this point to even build a buffer of any sort of critical components. So, I’m not sure. Down the road, that may be an option in 2023, or that our customers choose to do, but in these times, there’s still very much a constraint in terms of especially some of these custom semiconductors.

Yes, that’s correct.

Well, congratulations to you and your team for managing through such a challenging time. Thank you so much.

Thanks, Jim.

Your next question comes from the line of Christian Schwab of Craig-Hallum Capital. Your line is open.

Hello, Christian.

Hey Jure. So, just one quick question or maybe two here. But one, as far as clarity, some of the component shortages that you alluded to, you said in the second half of 2022 that you expect some improvement in components. Can you elaborate on what you specifically see? Did some of your customers get better allocated wafer starts that could lead to complex silicon helping them? Or is that a raw materials comment? Any type of clarity would be great.

So let me make something clear. I’m not an expert regarding forecasting what is going to happen. Some of it, when I say we hope the second half will be better, is probably wishful thinking. Some customers are getting better allocations; we know that some customers were hurting really bad for the last two quarters, and now they’re getting more parts. It really varies from customer to customer, especially around the custom products. Everything else is just better planning and working with the supplier much closer. A lot of these allocations don’t depend who calls us, customer or anybody else; we’re getting the same answers. We are working with it. We can improve definitely. How much better depends on many questions.

Okay. That makes sense. And then as far as the inventory is concerned, what percentage of inventory is WIP versus finished goods? And how does that compare to, say, 2019 levels?

Well, definitely we are carrying more raw material now than we did in 2019, percentage-wise based on projects that we have. The reason is exactly what Kurt was talking about a few minutes ago because there are certain parts we bring in, while there is something like 5% to 10% that we have to wait an extra month or two, or three to get it. That’s really what’s happening now. At the same time, we are bringing in critical parts as soon as they’re available to us, and that also drives the inventory. So, I would say work in process today is really fast; our cycle time for work in process is very short because we are, in the environment that we operate, creating a lot more flexibility. We’re doing things that I didn’t know we could do a couple of years ago. We have learned a lot because we have to create flexibility to be able to deliver these critical components to our customers.

Okay. That’s great. And then, I guess, my last question has to do with potential M&A. In this environment, scale is becoming even more important, and supply chain partners are becoming front and center in everybody’s mind. Can you give us an update if you guys are looking at different things or different geographies or different applications? Or are there just not a lot of things for sale?

So first of all, we are focused on growth. We believe that we did a lot of work in the last 18 months really looking at what we need to do, what direction we go in. We believe that we have a strong pipeline of organic opportunities in front of us. We’ve been focusing on expanding present relationships. There’s still a lot of growth in the existing customer base that we have. We are looking at some new markets that I believe fit what we offer. We’ve been investing in unique capabilities to expand and win in all these critical markets, as I mentioned earlier, like medical, defense, industrial, and communication. There are many opportunities there. Yes, we are looking at M&A options to see what’s available, what makes business sense for us, but Sanmina has to grow. We have to grow right now, and that’s my personal focus and the focus of the rest of the management.

Great. Congrats on a good quarter. Thanks.

But Christian, a lot of good stuff is going on. So anyway, operator, we have time for one more question, please.

Your next question comes from the line of Anja Soderstrom of Sidoti. Your line is open.

Hello, Anja.

Hi, Jure. Hi, Kurt. Thank you for taking my question. A lot of my questions have been asked already. But I just wanted to get a sense of when you talked about for the full fiscal 2022, you’re talking about solid growth. Before, you were talking about good growth. What’s the nuance between good growth and solid growth there? Are you signaling better this quarter?

As I said, my English is not the best. So good growth was trying to say we feel we can do better than we did. Yes, we had a strong quarter, but I don’t think we will say that we definitely could have done better if we got more materials in. Internally, when you have power shortages all the time, your efficiencies are not very good. We know we can do better. At the same time, Anja, we’ve been planning to really find a way to grow this company. There’s a lot happening behind the scenes. Hopefully, we’ll be able to show more of that as we resolve some of these material shortages.

Okay. Thank you. And then also, if you’re talking about the backlog. But do you see – I think you talked before about not thinking any of that is nonperishable. Do you still see that? Or do you think some – is there any risk to that backlog?

Yes. Well, Anja, we work very closely with our customers, especially right now to understand exactly what their real demand is. In certain programs, we know – and our customers communicate with us – they’re buying a little bit more than they need today, but we see that plans for long-term. So, I would say, if I look at our backlog out, that 80% to 90% of our backlog looks pretty comfortable. I think we know enough in detail. We’re very close to our customers that I feel comfortable that it looks good, and it will continue to look good at least for the rest of 2022.

Okay. Thank you. That was all for me, and congratulations on the great execution.

Hey, thanks a lot. I appreciate it. Well, ladies and gentlemen, that’s all we have for today. If we didn’t answer all the questions, please reach back to us, and we’ll definitely get back to you. With that, we’ll talk to you in 90 days from now. Bye-bye.

This concludes today’s conference call. Thank you for participating. You may now disconnect.