Sanmina Corp (SANM) Q3 2022 Earnings Call Transcript

Good day, and welcome to the Sanmina Corporation Third Quarter Fiscal 2022 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Paige Melching, Senior Vice President of Investor Communications. Please go ahead.

Thank you, Matt. Good afternoon, ladies and gentlemen, and welcome to Sanmina's third 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 with our prepared remarks, let me remind everyone that today's call is being webcast and recorded and will be available on our website. You can follow along with our prepared remarks and our slides provided on our website. Please turn to slide three 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 the 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 annual 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, we have provided you with statements of operations for the quarter ended July 2, 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, acquisitions and integration costs, non-cash stock-based compensation expense, amortization expense and other unusual or infrequent items. Any comments we make on this call as they relate 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're referring to our non-GAAP information. I would now like to turn the call over to Jure Sola.

Good afternoon, ladies and gentlemen. Welcome. Thank you all for being here with us today. First, I would like to take this opportunity to recognize Sanmina's leadership team and our employees for managing successfully around material constraints and navigating challenges in our China operations due to COVID. So to you, Sanmina's team, thank you for delivering strong and consistent results for the third quarter. Let's keep it up. For our agenda, we have Kurt, our CFO, to review details of our results for you. I will follow up with additional comments about Sanmina's results and future goals. Then Kurt and I will open for questions and answers. Now, I'd like to turn this call over to you, Kurt.

Thanks, Jure. Please turn to Slide 5. In the third quarter, our team delivered strong revenue and profit growth as well as cash generation. Q3 revenue of $2.02 billion grew substantially by approximately 5.6% from the prior quarter and exceeded the high end of our outlook of $1.825 billion to $1.925 billion. This was primarily due to strong customer demand and excellent coordination with suppliers and customers to help mitigate material challenges. Non-GAAP gross margin improved to 8.4% compared to 8.1% in the prior quarter, primarily due to higher revenues and a more favorable product mix. Non-GAAP operating margin was 5.5% compared to 5% in the prior quarter. This was primarily due to improved gross margins and operating expense leverage. Non-GAAP fully diluted earnings per share grew significantly by approximately 14.4% to $1.30 compared to $1.14 in the prior quarter and exceeded the upper-end of the outlook range of $1.05 to $1.15 by $0.15. Finally, Q3 GAAP fully diluted earnings per share was $1.29. Please turn to Slide 6. This slide shows the quarterly trends of our financial results. We have delivered consistent financial performance over the last two years, despite challenges associated with COVID and the supply chain constraints. Non-GAAP gross margins have exceeded 8% for the last nine consecutive quarters. In addition, non-GAAP operating margins have been 5% or higher for seven of the last eight quarters. Now please turn to Slide 7. Q3 IMS revenue increased to $1.625 billion, an increase of 4.3% over the prior quarter. This is primarily due to strong customer demand and excellent coordination by the supply chain and operations team, in conjunction with our suppliers and customers to help mitigate these material challenges. Non-GAAP gross margin for IMS improved to 7.3% compared to 7% in the prior quarter, primarily due to higher revenue levels and a more favorable product mix. Components Products and Services revenue grew significantly to $428 million. Non-GAAP gross margin for CPS was relatively flat at 11.9%. Now please turn to Slide 8. We have a very healthy balance sheet which provides us a competitive advantage for our company. Cash and cash equivalents was $493 million. Between cash and the availability under the revolver or other debt facilities, we have approximately $1.3 billion of liquidity. There were no borrowings under our revolver at the end of Q3. Cash generation continued to be strong in Q3. Cash flow from operations was $102 million and free cash flow was $65 million. Our strong balance sheet and cash flow generation allow the company to continue to be opportunistic, as it repurchases shares and returns capital to shareholders. During the third quarter, we repurchased approximately 3.1 million shares bringing the total for the fiscal year through the end of Q3 to 7.4 million shares. At the end of Q3, we had approximately $188 million remaining of share repurchase authorization. Now please turn to Slide 9. Despite the higher levels of inventory, we were able to manage working capital such that cash cycle days remained relatively steady at approximately 56 days. Non-GAAP pre-tax ROIC continued to improve to 31.6%. Now please turn to Slide 10. Let's talk about the outlook for Q4. Overall, customer demand remains strong, but there continues to be supply chain challenges. We expect Q4 revenue to be in the range of $1.95 billion to $2.05 billion for the quarter. We expect non-GAAP gross margins in the range of 8.1% to 8.6% depending on product mix; non-GAAP operating expenses in the range of $61 million to $63 million; and non-GAAP operating margin in the range of 5% to 5.6%. We expect non-GAAP other expenses of approximately $8 million to $9 million, a non-GAAP tax rate of approximately 17.5%, and a non-GAAP fully diluted share count of approximately $61 million. When you consider this guidance, our outlook for our non-GAAP diluted earnings per share for Q4 is expected to be in the range of $1.27 to $1.37. I would note if we achieve the midpoint of our Q4 outlook for both revenue and non-GAAP EPS, fiscal 2022 revenue will have increased over 14% compared to fiscal 2021 and fiscal 2022 non-GAAP EPS will have increased over 20% compared to FY 2021. We expect Q4 CapEx to be approximately $45 million, driven by growth of new programs and to support future growth. We expect depreciation of around $30 million. In summary, demand remains strong across our customer base. We are confident in our business model and expect the company to continue to deliver strong operating leverage and cash flow generation over time. And with that, I'll turn the call back over to Jure.

Thank you, Kurt. Ladies and gentlemen, let me make a few more comments about the business environment in the third quarter. I'll talk a little about the outlook for the fourth quarter and how Sanmina is positioned for the future. As you heard from Kurt, Sanmina delivered strong and consistent results. Key drivers in the third quarter were: growth was broad-based driven by strong demand from all our end markets. Performance of our supply chain organization was excellent by working closely with our customers and suppliers. Lead times for semiconductor components are still challenging, but we saw some nice improvements in the third quarter. And we had great operational execution by creating the right flexibility to build the products in a short cycle time. Through operational flexibility and excellent operational execution, we're able to deliver critical requirements for our customers. I can also tell you that our Sanmina team has done an outstanding job, as we continue to differentiate our industry-leading capabilities, delivering competitive advantage to our customers. Overall, we delivered nice organic growth, quarter-over-quarter growth of approximately 6% and year-over-year growth of approximately 22%. Now please turn to Slide 12. Let me give you some highlights of the revenue for our third quarter by end markets. As you can see on this slide, the top 10 customers accounted for 47.7% of our revenue. Communication networks and cloud infrastructure will continue to see strength in this market segment, which was 40% of our revenue. This segment quarter-over-quarter grew approximately 6% and year-over-year grew 14%. Growth was driven by optical systems, 5G networks, and cloud infrastructure. Industrial, Medical, Defense, and Automotive accounted for approximately 60% of our revenue. This segment grew 5.5% quarter-over-quarter. We see strong demand year-over-year growth, up 27.2% as a result of our efforts to diversify in these segments as we win new programs. Growth was driven by Industrial, Medical, Defense, and Automotive. We nicely saw strong growth across all of these key markets. Let me tell you more about bookings. The third quarter bookings continue to be strong. Book-to-bill was 1.07:1. I can also tell you that the pipeline of new opportunities is solid. Overall, we have strong demand and solid backlog. Please turn to Slide 13. Now, let's talk about revenue outlook by market segments for the fourth quarter. We see strong demand across all end market segments. Sanmina has a healthy backlog for the fourth quarter and beyond. New project wins are driving the growth. We expect supply constraints to continue, and we expect to manage successfully around material constraints. We're forecasting that 40% plus or minus of our fourth quarter revenue will be from communication networks and cloud infrastructure markets, driven by optical systems, 5G networks, cloud networking, and enterprise storage systems. All of these segments we expect to move in the right direction. We're also forecasting that approximately 60% of revenue for the fourth quarter will be from Industrial, Medical, Defense, and Automotive markets. Again, in this segment, we expect to move in the right direction. As you can see, Sanmina does not serve consumer markets. Our focus is on mission-critical, high-complexity, heavily regulated markets. Please turn to Slide 14. For fourth quarter, again, we see nice strong backlog and we're forecasting approximately $1.95 billion to $2.0 billion for revenue. We also expect revenue growth for the year to be around 14-plus percent. For non-GAAP EPS outlook is $1.27 to $1.37. And for the year, we expect non-GAAP EPS growth of approximately 20-plus percent. So the way I would conclude, this was a pretty good year for Sanmina. Now let me talk to you about growth for our fiscal year '23 and beyond. Let's talk about inflation and potential recession. I know this is on everybody's mind, but I want to just remind you I'm not an economist, but I do have a strong foundation and experience in how to manage through this environment. As we all know, inflation is here, a recession may be here already. From Sanmina's management point of view, we are running Sanmina under the assumption that the recession is already here. Most importantly, Sanmina is well positioned for any economic environment. On the positive side, we are excited about Sanmina's future for fiscal year 2023 and beyond. We have been consistent and continue to focus on profitable growth, which is evident in our results despite the challenges of the macroeconomic backdrop. We focus on things that we control, which are the quality of our customer base, building the right partnerships, and focusing on high-complexity products. We concentrate on quality of earnings and consistency, and the growth of the earnings. We focus on quarterly and yearly cash flow that gives us the opportunity to invest in our future that will drive margin expansion. And we are focused on maximizing shareholder value both short-term and long-term. For fiscal 2023, we expect to see nice improvement over fiscal year 2022. Sanmina is in a great position. We have a strong balance sheet and we will continue to generate strong cash flow. Sanmina has a well-diversified customer base in high-complexity and heavily regulated markets, and we can expect to continue to diversify our end markets as we grow. We are going into fiscal year 2023 with strong backlog and strong forecasts from our key customers. New projects will continue to drive growth, and the pipeline of new opportunities is exciting. Let me tell you more about making investments for the future and how we are expanding our capabilities to support new wins for fiscal year '23 and beyond. We're really focused on some key markets that have been successful for us, such as medical, defense, and automotive. We believe we're well positioned and have a fair amount of opportunities in front of us that we believe will continue to drive growth. In Industrial and alternative energy, we're in a great position with some good opportunities to continue to expand. In Communication and Cloud Infrastructure, we have a strong position, so we are focused on the leading-edge technologies here. Overall, we are expanding into more profitable projects by providing industry-leading technical engineering solutions from R&D, advanced components, products, and integrated manufacturing services. All of these opportunities in these key markets are translating to growth and margin expansion for Sanmina in fiscal year 2023. Also, I can tell you that Sanmina still has a lot of leverage in our business model. Please turn to Slide 15. The third quarter was a good quarter for us. Revenue of $2.2 billion exceeded outlook by 5.6% sequentially and approximately 22% year-over-year. Non-GAAP operating margin of 5.5% expanded by 50 basis points. Non-GAAP diluted EPS of $1.30 exceeded our outlook by 14.4% sequentially and approximately 31.7% year-over-year, and we generated strong free cash flow. For the fourth quarter, demand remains strong as we said. We continue to work through supply chain constraints and we will manage this pretty well. We're forecasting solid revenue of $1.95 billion to $2.05 billion supported by a strong backlog, and non-GAAP diluted EPS of $1.27 to $1.37. I can tell you, Sanmina is in excellent shape, and we are well-positioned to manage through this dynamic environment. Now ladies and gentlemen, I would like to thank you all for your time and support. Operator, we're now ready to open the lines for questions and answers. Thank you all.

Thank you. We will now begin the question-and-answer session. And our first question will come from Ruplu Bhattacharya with Bank of America. Please go ahead.

Hi, Jure. Thank you for taking my question. Maybe for the first one, I'd like to ask in the communications end market. Can you help us rank order the strength you saw in networking versus optical versus wireless 5G? Which one was the strongest? Which one was weaker? And then as you look into the fourth quarter, how do you see that playing out in the fourth quarter in terms of relative strength of these end markets?

Yes. As I mentioned, I think that segment for us is we’re in a good position. I think we’re involved in a lot of the leading-edge technology. So with the networking part, as you know, there are optical components and optical parts that go both of those. I would say that the networking was for us very strong. Optical also performed well. In all three segments of 5G, it was a good quarter for us. We grew nicely and we expect to continue to do the same thing.

And so you expect that strength to continue into the fourth quarter as well?

We could have shipped significantly more if we had the necessary parts. We are still facing challenges in acquiring all the components we need. However, we expect to keep receiving what we are looking for, as we have been. I believe things are improving slightly, so we are hopeful for more parts. Overall, we are in a strong position to maintain our performance, and our shipments remain very robust.

Okay. Let me ask you this. The second half of fiscal 2022, when we look at the June quarter and the September quarter that you're guiding, those quarters had easier year-on-year compares on the revenue side. But when we look at the first half of 2023, the December quarter and the March quarter, they have much tougher year-on-year revenue compares. So can you give us your thoughts on the first half of 2023? What are the puts and takes that we need to keep in mind? And how do you think about year-on-year revenue growth first half of 2022 versus first half of 2023?

I believe the first half of 2023 will be strong for us based on our current outlook. As I mentioned in my earlier comments, we anticipate 2023 will be a better year for us. This means we expect to achieve greater growth than in 2022, both in percentage terms and in total revenue. While I won’t share specific percentages, it is clear that we expect to generate more earnings in 2023 compared to 2022. We are looking forward to a solid year. Our company is well-positioned; we are taking a balanced approach by being aggressive while also being cautious. In this market, that's essential for us. We're expanding not solely due to capacity but to introduce new technologies that our customers require and to capitalize on the new opportunities we've secured. We anticipate a positive year ahead but will focus on one quarter at a time.

Okay. I have a couple for Kurt. If we look at inventory, it looks like inventory grew 11% sequentially and it's up like 78% year-on-year. So just over the next couple of quarters, how do you see inventory trending given your forecasting revenue growth? How should we think about cash conversion cycle and free cash flow over the next couple of quarters?

Yes. So as we've said on prior calls, the main reason why inventory has gone up is that we've been buying parts in hopes to get some of these constrained semiconductor or other constrained parts. And therefore, when they haven't come in as expected, we still have that inventory on hand. So I think in terms of how I expect inventory to play out, my expectation is that it will still grow a little bit more in the next quarter or two, but the hope would be as the supply constraints start to become more manageable that inventory would level off and then ultimately decline to get back to a more normalized turns. But I would say we're probably in for another quarter or two of high inventory and perhaps a little bit higher inventory, but that will depend on variables that are hard to predict.

Got it. And maybe for my last one, can I ask you the CPS segment gross margins declined looks like 20 bps on sequentially higher revenues. What were some of the puts and takes in that segment?

Yes. That's really just product mix. As you know, that segment is made up of different businesses separate from Components, Products, and Services. So I think just the mix, even though the revenue grew, was slightly different that quarter. We still believe in that segment. We expect, as Jure mentioned, there's a lot of operating leverage in that segment, so we expect those margins to increase over time, especially as some of these supply constraints resolve.

Yes. If I can add to that, I think if you look at where we are today, we did a lot of work in the last couple of years. The company is positioned to go to the next level. I think a lot of critical components, products, and services have a lot of opportunities. So we believe there's a lot more room there on both that segment and also on IMS. We're not satisfied with our margins. We think we can do better than what we delivered this quarter.

Okay. Thanks for all the details. Appreciate it.

Our next question will come from Jim Suva with Citigroup. Please go ahead.

Thanks. Good evening. Both of you may comment a little bit on the operating margins. Very impressive here. Is it structurally you think it could stay at these levels? Or are you getting a little bit of extra profitability due to higher component costs and expedited shipping to meet customers? I just kind of want to dive into the sustainability of the operating margins and how impressive high they are.

Well, Jim, let me address that and then I'll pass it on to our CFO. Firstly, we believe our minimum operating margin should be between 5% and 6%. As we mentioned at the start of the year, our goal was to exceed 5%, which we've achieved, and we aim to maintain that. Ideally, we want to be closer to the higher end of that range. The improvements we’re implementing are starting to show results. Our daily part supply isn't optimal right now, which has impacted our efficiency, but we anticipate that will improve as we resolve the constraints. This should help us increase our margins. Additionally, we're pursuing higher margin projects that will support margin growth. While we have set higher targets than what we achieved this quarter, we expect it will take about a year to reach our goals, but we are definitely progressing in the right direction.

Yes, Jim, I would say it's a mix of several factors. Gross margin increased by about 30 basis points, driven by higher revenue, which provided more leverage in our model, along with a favorable product mix. However, as Jure noted, we've had better gross margins in the past. We believe that as we become more efficient and the supply chain stabilizes, we will be able to enhance that over time. Regarding operating leverage, we aim to maintain operating expenses around $60 million. While there are fluctuations each quarter with various influences, we anticipate further leverage. So, the improvement stems from better margins due to increased revenue and an improved product mix, alongside operational leverage with stable operating expenses on rising revenue, leading to that 5.5% increase. There will always be some variation from quarter to quarter, but as Jure has emphasized repeatedly, we see ongoing leverage in our model. With revenue growth and a reduction in inefficiencies caused by the supply chain, we expect to continue making progress.

And then as my follow-up, how should we think about uses of cash flow? Obviously, best to fund the current business. But beyond that, how should we think about uses of cash flow? Are there any areas you kind of want to get into? Or you're comfortable with that or geographic footprint? I know you have a global footprint. How should we think about your uses of cash that you could use in the future?

All right. Let me talk from a growth and margin expansion standpoint and then I’ll turn it to Kurt to fine-tune it. Jim, we're planning to invest more probably in the next 12 to 18 months than we did in the last couple of years. Most of this investment is going into some unique capabilities that will drive the expansion of margins. That's really what we want to focus on. We're going to focus on high-complexity in niche market areas that we believe we have a competitive advantage in both technology and execution. So, we're adding capabilities there. And that’s back to your first question. We're going to change the model on this business; it’s no longer acceptable to be at a 4% operating margin. It needs to move up to the 5% to 6% consistently with hopes of being at the high end of 6%.

Yes. I mean I think as Jure said, our priority is organic growth. And part of that organic growth is to continue to add to our capabilities. We’re happy with our geographic footprint; it’s one of the broadest in the industry. But that doesn’t mean we won’t continue to expand existing sites to take on additional growth. So, I think our number one priority has been and will always be organic growth. We continue to pay down our debt, approximately $5 million a quarter. So, we’ve done that. And as you've seen, we've opportunistically bought back shares. So, those are our priorities. Clearly, organic growth above everything else. We feel like there's a lot of opportunity in this business, and we're going to continue to invest in this business to drive profitable growth.

Thank you so much for the details.

Our next question will come from Christian Schwab with Craig-Hallum Capital Group. Please go ahead.

Hey congratulations guys on another great quarter of execution and guidance. I just have a couple of quick questions. Jure, with the mindset that you're running the company as if we're already in a recession, can you talk to us about further clarity and visibility of bookings and backlog? And how many quarters does that extend? You're very optimistic, it sounds like for a continuation of topline revenue growth in fiscal year 2023 over 2022. Is there any quantification you could put around that for us?

Yes. I mean, as I mentioned in our prepared statement, the demand we see today is strong. We have a solid backlog. Our customers are still optimistic about the future. We're well-positioned. We've got a strong pipeline of new wins that are coming up that should be shipping in 2023. The shortage has really hurt us; if we didn't have the shortages, we could have shipped a lot more. As that shortage gets resolved, I think the new programs we have should continue to drive growth.

Great. For my final question, regarding the significant growth in inventory, should investors take your confidence in the backlog, bookings, and new program pipeline as an indication that, even in a possible recession, you are comfortable building inventory while waiting for limited parts, as you believe there is minimal risk of delays or cancellations?

Let me make sure we’re very clear. The inventory that we have is strictly customer guaranteed. We only buy per customer requirement. So we don’t build anything that is not under contract with a customer. The inventory we have is driven by customer requirements. What we see today is that those requirements are firm. And in many cases, they wish we had shipped them last quarter. We are not in the consumer market; our focus is on business-critical sectors.

Yes. Just one clarification on that point. So I think first of all, the inventory that grows is component inventory; that's raw materials. We're not building finished goods that are sitting on docks waiting to get shipped; we add a semiconductor to them as soon as it comes in. Our cycle times are really short. So it's really more raw materials or subassemblies, not finished goods. I think the second thing I would say, as you said, it shows Sanmina's confidence, but it also shows our customers' confidence because at the end of the day, the inventory is driven by our customers' forecast. Those customers are on the hook for that inventory.

That's wonderful. Thanks, guys. That’s it.

Thanks, Christian. Operator, we have time for one more question please.

Our last question will come from Anja Soderstrom with Sidoti. Please go ahead.

Hello, Anja.

Hi. Thank you for taking my question and congratulations on another exceptional quarter.

Thank you.

I'm just curious, what's holding you back is some specific components that you're dependent on to assemble the inventory you have. So what do you see in terms of attaining those components? Is there anything specific that needs to happen? Or...

No, I think a lot of these components are semi-related. The challenges have been present for over a year. I said earlier in the prepared statement that things are getting better. Some of these components were ordered over a year ago. We’re getting our shares. We work closely with our customers; we have many strong connections with component suppliers. We're going through the same challenges as everyone else around the world, but we believe that we are managing it pretty well. We expect to see improvements sometimes in 2023, probably by the middle of 2023; the shortages will continue for the next couple of quarters, however.

Okay. Thank you. Then just the last one; I understand you have a recession-proof end-market that you serve, but is there any area of the end-markets that you see some sort of slowdown?

Not really. We have a few parts that are built around COVID, but that's a small percentage of our business. Overall, we are in a very strong position.

Okay, great. Thank you. That was all for me.

That's all. Well, ladies and gentlemen, I personally want to thank you again for your time. Appreciate it. In this environment we take one quarter at a time. We are excited about what’s in front of us. Now it's all about executing for another good quarter. So with that, thank you very much. We're looking forward to talking to you. If you have any questions, please get back to us. Bye-bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.