Sanmina Corporation (SANM) Q2 2017 Earnings Report, Transcript and Summary

Good evening. My name is Christelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sanmina Corporation's Second Quarter Fiscal 2017 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. It’s Paige Bombino, Vice President of Investor Relations, you may begin your conference.

Thank you, Christelle. Good afternoon, ladies and gentlemen, and welcome to Sanmina's Second Quarter Fiscal 2017 Earnings Call. A copy of today's release is available on our website in the Investor Relations section. You can follow along with our prepared remarks and the slides posted on our website. Please turn to the Page 2, the 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 of operation may differ significantly as a result of various factors, including adverse changes to the key markets we target, risks arising from our international operations, competition that could cause us to lose sales, reliance on relatively small number of customers for a majority of our sales, and the other factors set forth in the Company's annual and quarterly reports filed with the Securities and Exchange Commission. You'll note in our press release and slides issued today that we have provided you with statements of operations for the three months and six months ending April 1, 2017, 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, non-cash stock-based compensation expense, amortization expense and certain other infrequent or unusual items to the extent material. 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 the conference call, when we refer to our 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, Chairman and Chief Executive Officer.

Thanks, Paige. Good afternoon, ladies and gentlemen. Welcome. Thank you, all, for being here with us. With me on today's conference call is Bob Eulau, our CFO.

Hello everyone.

For agenda we have is that Bob first will review our financial results for our second quarter of fiscal year 2017. Then I will follow up with additional comments about Sanmina's results and future goals. Then, Bob and I will open for Q&A. And now I'll like to turn this over to Bob. Bob?

Thanks, Jure. Please turn to Slide 3. Overall, the second quarter was another solid quarter. Revenue of $1.68 billion was up 4.4% from the second quarter last year and down 2.2% on a sequential basis. Our non-GAAP gross margin was down 10 basis points from the second quarter last year and was up 20 basis points sequentially. Operating margin was up 10 basis points from the second quarter last year and was flat sequentially at 4.2%. Non-GAAP earnings per share was $0.76, which was up $0.13 from a year ago and up $0.01 sequentially. This was based on 77.9 million shares outstanding on a fully diluted basis. Cash flow from operations was good at $89 million for the quarter, and free cash flow was $55 million. I'll discuss cash in more detail in a few minutes. Please turn to Slide 4. From a GAAP perspective, revenue was up 4.4% from the second quarter last year and down 2.2% on a sequential basis to $1.68 billion. Reported net income of $31.7 million, which resulted in earnings per share of $0.41 for the second quarter. This was down relative to last quarter by $0.17. The decline was primarily driven by tax expense. The first quarter included a discrete tax benefit that did not recur in the second quarter. My remaining comments will focus on the non-GAAP financials for the second quarter of fiscal year 2017. At $136.1 million, gross profit was up slightly from the prior quarter. Gross margin came in at 8.1%, which was up 20 basis point when compared to the first quarter. Operating expenses were up $1 million for the quarter at $65.2 million. This was up 20 basis point as a percent of revenue compared to Q2 – I’m sorry compared to Q1 at 3.9%. Spending was up this quarter primarily due to increased payroll tax expense that reset in the United States. At $71.9 million, operating income increased 8.5% from the Q2 last year and decreased 1.1% from the prior quarter. Operating margin at 4.2% was flat with last quarter. Other income and expense at $1.4 million was abnormally low, it declined by $2.4 million when compared with last quarter. This was primarily driven by favorable forward points on foreign exchange hedging and a favorable gain on deferred compensation which was offset in operating expenses. The tax rate for the quarter was 15% of pre-tax income, which was in the range we had expected. On a non-GAAP basis, we earned $59.1 million in net income or $0.76 per share. Diluted earnings per share were up 1.4% when compared to Q1 and up 28.8% from Q2 last year. Please turn to Slide 5, where we are providing more information on the segments that we report. As you can see from the graph on the left, the Integrated Manufacturing Solutions segment was down $32 million or 2.3% from last quarter. Our analysis indicate we could shift roughly $40 million more in revenue had it not been for material shortages that were caused by combination of increased customer demand late in the quarter for new product ramps and longer lead times on certain commodities. The IMS team continue to execute well and delivered solid gross margin of 7.3% for the second quarter. The second segment for us is Components, Products & Services. In aggregate, the revenue for this segment was down slightly with gross margin improves 70 basis points to 10.2%. The improvement was driven by better execution in the Component businesses. On Slide 6, we are showing you our key non-GAAP profit metrics. Gross margin was 8.1% for Q2, our gross profit was flat with Q1. We have been very consistent with our gross margin ranging between 7.7% to 8.2% over the last four years. Our operating income decreased slightly when compared to Q1 and increased $6 million or 8.5% since Q2 last year. This led to $70.9 million in operating income and operating margin of 4.2%. Now I'd like to turn your attention to the balance sheet on Slide 7. Our cash and cash equivalents were $433 million. 62% of this cash was in the United States at the end of the quarter. Overall, the balance sheet was very similar to last quarter. Cash was up $28 million from the previous quarter. Accounts receivable were down $22 million and inventory was up $55 million. Property, plant and equipment, was up $2 million for the quarter. From a liabilities standpoint, accounts payable were up $3 million and short-term debt was down $40 million as we paid off the mortgage on our San Jose campus. Long-term debt was up slightly at $394 million. At the end of the quarter, our growth leverage improved to 1.0, continuing a very positive trend over the last seven years. Please turn to Slide 8 where we will review our balance sheet metrics for the second quarter. Cash was up $28 million from Q1. Cash flow from operations for the quarter was excellent at $89 million and net capital expenditures for the quarter were $34 million. This led to $55 million in free cash flow for the quarter. Inventory turns were impacted by material shortages caused by product ramps and longer lead-times on certain commodities heading into the third quarter. Inventory dollars were up $55 million from last quarter at $1.19 billion, inventory turns were at 6.2. In the lower left quadrant we are showing cash cycle days, which combines our cycle time for inventory, accounts receivable and accounts payable. Overall, cash cycle time increased from 40.4 days last quarter to 41.9 days. This change was primarily driven by a 3.5-day increase in inventory and 1.1-day increase in days sales outstanding, offset by a 3.2-day increase in days payable outstanding. In spite of the inventory challenge, cash cycle days decreased by 2.7 days since Q2 of last year. Finally, pre-tax return on invested capital was good at 24%, pre-tax ROIC was down slightly when compared to the prior quarter were up 1.7 percentage points when compared to Q2 last year. Please turn to Slide 9. I would now like to share with you our guidance for the third quarter of fiscal year 2017. Our view is that revenue will be in the range of $1.7 billion to $1.8 billion. We are using a wider range this quarter because we have a number of new product ramps occurring in an environment or material availability is tightening. We expect the gross margin will be in the range of 7.8% to 8.2%. Operating expense should be $65 million to $67 million. This leads to an operating margin in the range of 4% to 4.4%. We expect that other income and expense will be back in a more normal range of $4 million to $5 million. We expect the tax rate to be around 15%, and we expect our fully dilutive share count to be around 79 million shares, plus or minus 500,000 shares. When you consider all this guidance, we believe that we will end up with earnings per share in the range of $0.72 to $0.77. Finally, for your cash flow modeling, we expect net capital expenditures of approximately $40 million while depreciation and amortization will be around $30 million. Overall, our program wins and geographic diversification positions us very well for the future. Growth continues to be our number one objective, but it's imperative that we grow with the right kind of profitable business. We are confident that we have plenty of opportunity to improve the business. At this point, I will turn the discussion back over to Jure for more comments on our target markets and our business strategy.

Thanks Bob. Ladies and gentlemen, let me review with the business environment for the second quarter, add few more comments in our outlook for the third quarter and the rest of the fiscal year 2017. Overall as Bob mentioned this was a good quarter per our expectations revenue was slightly down quarter-over-quarter but up year-over-year. Revenue was impacted by material shortages, I will say operationally we executed really well, and delivered a consistent solid results. Our customer activities were strong as we continued to grow current relationships and win new programs. We had a strong bookings in the second quarter book-to-bill was positive 1.1:1. Again, overall good quarter as we continue to position our company for a better future. Now please turn to Slide 11. Let me give you some highlights of our revenue by end markets, top 10 customers 53.5% of our revenue. So in summary, I will say overall good demand for the second quarter. 46% of our revenue came from Industrial, Medical and Defense that was down slightly 1.5%. Industrial and Defense was down mainly driven by program delays on some of the new projects. Medical was nicely up on overall good demand. Industrial, Medical and Defense overall strong activities in this business group continue. Communication Networks was 37% of our revenue again down 2.8%, driven mainly by material shortages. The other part of our business in their optical was stable, overall again good demand in this segment. Embedded Computing and Storage was 17% of our revenue down 2.7% again with the material shortages for storage/embedded computing some program delays. Automotive in this group was up on a strong demand. Now please turn to Slide 12. Let me talk to you about revenue outlook by market segments for the third quarter. For the third quarter, forecasting more improvements in demand. For Industrial, Medical and Defense were forecasting to be flat in the third quarter but we do have a good pipeline of new opportunities. For these segments, mainly what we call mission-critical products, we expect to continue to do well. Communications Networks, we’re forecasting for the quarter to be up, we’ve seen a solid demand driven by networking, IP routing and optical products. For mobile networks, mainly broadband, we’re starting to see better demand. Overall for this segment we do have a solid pipeline and new opportunities, both with existing and new customers. Embedded Computing & Storage, we’re also forecasting to be up for a quarter. Computing & Storage we're forecasting to see improvements in the third quarter, as we continue to invest in cloud data businesses. It's a great market opportunity for us. Automotive is doing well, as we continue to have a strong demand driven by new projects. Again bookings for the second quarter were strong, and we expect bookings for the third quarter to continue to be solid. Let me make few more comments about the business environment for the fiscal year 2017. As always, global economy is hard to predict, but business environment is improving for us and continue to expand. In this environment I'm very confident about Sanmina's future. Overall, our customer base continued to be very positive about the rest of the year. So based on that visibility and forecasts we are forecasting that fiscal year 2017 will be a solid and growth year for Sanmina. Pipeline of existing and new opportunity is good and it's expanding, driven by new projects with existing customers, and we do have a strong pipeline or new customer opportunities. I can tell you that our strategy is working and by focusing on providing our right technology for our key customers for mission-critical markets, driven by superior execution and our capabilities. Now please turn to Slide 13. In summary, second quarter, we delivered consistent growth in operating margin. Our non-GAAP EPS continue to expand, we also delivered solid cash flow from operations. For a third quarter, as I said earlier, we see a good demand, we remain focused on quality of the growth which is the key to our strategy, as we continue to have very strong customer base to build on. For fiscal year 2017, so far first six months we delivered a solid result and we do expect stronger demand for the second half of fiscal year 2017. Again, company is doing well. We’re focused on our strength as we continue to drive profitable growth and maximize shareholders volume. So, ladies and gentlemen, now I would like to thank you all for your time and support today. Operator, we are now ready to open the lines for question and answers. Thank you again.

[Operator Instructions] And your first question comes from Steven Fox.

Hi, good afternoon

Hi, Steven, good afternoon.

So just to first start off just on the material shortages, it seems like the $40 million that maybe could have shifted in the past quarter is going to shift in this current quarter, but then you also mentioned that you have new ramps that are also under pressure for you guys to get the materials that are needed. So I'm trying to understand this, it maybe you are still under shipping your potential in the current quarter and when you think some of these shortages may ease for you guys, and then I have follow-up.

Well, Steve, it’s several. I guess at least a couple of questions in there. We wish we knew when the tightening would stop, but mostly what we're seeing is the extension of lead times right now. And we saw pretty good demand in the second half for the quarter and we weren’t able obviously to get that all out. Part of why we used a wider range for our guidance in the third fiscal quarter is because of that uncertainty. And we think we're very confident will be in that range of revenue; where we will be in that range, I can't tell you for sure. As Jure said I mean the demand is pretty solid from costumers. We have several new significant programs that are ramping on the timeframe when at least in the last I’d say three or four months we've seen lead times extending out. So it's a little hard to say where will actually land.

Great. That's very helpful. And then just as a follow-up you highlighted that’s within the components margins you're seeing better performance out of certain components. There's some areas that are sort of still to mature in terms of sales versus areas where you've done really well over the year. So can you just sort of give us a better flavor for where you're seeing some better margins on components? Thanks.

Yes. So just to remind everyone for us component is a printed circuit boards, backplanes, cables and then mechanical systems, which includes sheet metal bending, stamping, painting as well as precision machining. And we've had some challenges in the component area as you know over the last couple of years, because the demand has been relatively soft. And so the first important thing is we're starting to see revenue pick up a little bit in the components area. And so as you know the contribution margins are high there. We said on average for that segment contribution margins are around 25%. So a little bit of improvement in revenue is very beneficial in that segment. And so that's one factor that's helped us. The other one is I think the team is executing well. I mean there's a – we've got our breakeven points down about as low as we can get on there. I think we're executing well based on the demand that we have. So we still think obviously there's clear improvement or we wouldn’t to call that out. We still think there's a lot of room for further improvement in that business.

Great. Thank you very much.

Thanks, Steven.

Thanks.

And your next question comes from Jim Suva with Citi.

Hello, Jim.

Hi, Jim.

Thank you very much. And I appreciate your time today. Jure you made that comment as you expect the second half of the year to be better than the first if I remember correctly.

That’s correct.

Can you help understand about is that – in that kind of normally the change for Sanmina or is it with your business changes over the years is that a segment that we should think about as more positive or how should we kind of look at that and I’ll probably I have a follow-up.

Well, if you just look at our first six months, the growth there is a year-over-year about 8%. So it's a nice step in a right direction. I will say this year is a little bit different. I think when we have a stronger backlog and I most importantly stronger demand from our customers and our customers are more positive and especially in the projects that we are involved in. So yes, typically second half for us will be better than first. And our second quarter this year was better than the typical. So things are moving a positive, but I think it will have to do a lot with what we accomplish. I think that we positioned the company a lot better while we have a stronger customer base. And most importantly we got programs that are young and they have some late, so we are excited about the future.

Great. And then the follow-up questions probably maybe better suited for Bob, but I think interest expense came in a little bit below your guidance last quarter. Was there something there that we should be mindful of or should that continue? I know you typically have been pretty good with driving that or what is kind of the variables that are twining into that?

Yes. So in terms of other income and expense, interest expense is the largest item, but lot of the volatility comes from our hedging activity and we ended up with last couple of quarters maybe in last three quarters we've had favorable results on the hedging side, some of that we think is going to persist in the current environment the way the forward points are going and we have guided down a little bit lower in terms of other income expense and where we've been in the past. So it's – I'd say interest expense is fairly stable and then the uncertainty is mostly around foreign exchange and then there's also an accounting issue around deferred compensation, which impacts the line item, but it's just an offset elsewhere in the income statement.

Great. Thanks so much for your clarifications and details is much appreciated. Thank you.

All right, Jim.

Thanks, Jim.

And your next question comes from Sean Hannan with Needham & Company.

Yes. Hi, Sean.

Hi, Sean.

I think – Hi, good afternoon. Thanks for taking my question here. You folks hear me?

Yes. We can.

Yep.

Okay, great. So I wanted to see if I could ask a little bit about optical, there has been some mixed data points that have been materialized in the little bit in a market. You seem to have indicated that – there is stable to some bit of growth for that within your business. Just want to make sure that I understood that correctly and if you could perhaps, give a little bit of color around what you’re seeing in the landscape there. Thanks.

All right. Sean, first of all an optical business, as I mentioned I think it was a stable during the quarter. Overall, I think we’re well positioned in this business and we expect that this business still be strong for us for the rest of the year. Let me give you some key points. First of all, when comes to optical products we get involved basically at the component level all the way through a full system level. So we have a lot more contacts in this markets than a typical competitor of ours. So we’re well positioned, we continue to invest in this side of business, especially in the engineering side and the system operational side. So we continue to do well and I expect that this market to make an impact for the future.

So just to clarify though is the optimism coming from your ability to being perhaps some market share penetration or your wins. Or is this also across – or optimism more enthusiasm coming from your costumer base.

Well, first of all we do have a strong customer base and I see positive trend there. And number two I think we continue to expand to do more in that side of the business. And as I think, as we continue to do more, we continue to play a bigger roll in development and growth atoptical segment. But overall, Sean, I would say that business will be fine for rest of the year.

Okay, great. And then in terms of the industrial, medical, defense business, can you talk a little bit about the ramps you’re seeing from what extend or duration, when you look at the business you won here. Does this continue to take up through the end this year and forward if I know it’ll take a long time in order to get to full production ramps? Or by the time we get to the end of fiscal 2017, what we’re seeing right now, perhaps through the law of numbers instead kind of indicate a slower growth rate. Any color would be great. Thank you so much for taking my questions there.

Yes, for the industrial, defense and medical and I’ll break them down in a three groups. I think for industrial, we’re well positioned and the customer base that we have is pretty solid and the projects that we involved. So I expect that business will continue to be solid and expand not just for 2017, but also beyond 2017, because we have some programs here that a long, long-term. On medical, I think, we’re well positioned there. We continue to invest in that side of the business, we’re committed to that side of the business. It takes a long time to – we’ve made the right medical projects, especially the ones that we go after which are higher mix lower volume. I think that group is solid, we have a fair amount of new programs in the pipeline and we expect that to really continue to grow beyond 2017. And defense, I think that business for us is coming back. We are best positioned all the way from a component side, product side and we starting to get more involved in a system side of a defense part of the business. I think we have a huge opportunity in defense side of our business. Except it takes a long time to win those projects, but I like the way we are positioned. So back to Sean on the industrial, medical and defense, I think that group for us going to be a solid and in absolute dollars, we like to grow that – continues to grow and I think we will. So with that any other questions.

Thanks so much for taking them. I am okay at the moment.

Thanks, Sean.

Thanks, Sean.

Operator, we have a time for one more question, please.

And your next question comes from Christian Schwab with Craig-Hallum Capital.

Hello, Christian. How you are doing?

Hey, guys. I’m doing, great. Hey, guys. Thanks for squeezing me in. Can you please elaborate on the materials shortages in each business and what’s you’re seeing and how long – what exactly which materials that is and how much longer you would anticipate that being kind of a headwind?

Yes, I’ll take that Christian. I really can’t elaborate much more than what I did before, I can tell you, our supply chain team coupled with our customers have worked really hard on this over the last three or four months. And we definitely had a scenario across multiple commodity types where we’re seeing lead times extend out. So it’s a challenge and particularly as we had demand later in the quarter it was a challenge to get that fulfilled within the quarter. It’s a tight environment, I don’t think it’s dramatic at this stage and we think we can continue to work through it. We are expecting to get most of the revenue we miss this quarter, next quarter.

You don’t want to elaborate of what – whether it’s memory or et cetera, that’s causing a bottleneck in certain applications. You don’t want to talk about what material shortage – what materials that is.

It’s – I mean I have a list of commodities, I mean it’s probably it does in different areas. The one you mentioned is the one that’s very well known. And I would say that’s clearly a shortage in terms of memory and in terms of the NAND flash and that impacted us to some extent. But those are not the only commodities that we had challenges and I think it’s manageable and I think it’s a good problem to have. I mean and so as we’ve got quite a bit of demand and the challenge is getting the material.

Right, right. I’ll ask one more time and maybe still more. How you are going to tell us, you want to elaborate on what those materials are? Or not be?

If I can add to that Christian, I think it’s really across the board I don’t think we’re the expert. I know what question I wish we could tell you exactly how long this going to last but what it is I think it’s just an overall identification, as Bob mentioned planning, I mean demand is stronger, I mean our customers maybe didn’t do as good planning, some of these case there’s a fair amount of custom part, they are harder to get, because of the lead times and things like that. So we do expect this to continue definitely in the short term. And as Bob mentioned, I think we have this thing covered that I think we’ll be able to control what we need to ship.

Great. Good quarter, thank you.

Hey, thanks Christian.

Thanks Christian.

Ladies and gentlemen first of all thanks for your time and listening to us, if we didn’t answer all you’re questions, please contact us and so that we can make sure that you get to a question answered. In the meantime, things are moving in the right direction for us and it’s a one quarter at time, one day at a time, but a lot of positive things. And so hopefully, this will continue and economy will support us. With that thank you very much.

Thanks, everyone.

Bye-bye.

And this does conclude today’s conference call. Thank you for your participation. You may now disconnect.