Q2 2024 Earnings Transcript

Paige Bombino

Thank you, Jenny. Good afternoon, ladies and gentlemen, and welcome to Sanmina's Second Quarter Fiscal Year 2024 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.

Paige Bombino

And Jon Faust, Executive Vice President and Chief Financial Officer.

Paige Bombino

Before I turn the call over to Jure, 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 and take note of our 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 factors set forth in the safe harbor statement. The company is under no obligation 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 second quarter ended March 30, 2024, on a GAAP basis as well as certain non-GAAP financial information. A reconciliation between GAAP and non-GAAP financial information is also provided in the press release and slides posted on our website. In general, our non-GAAP financial 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're referring to our non-GAAP information. I would now like to turn the call over to Jure.

Jonathan Faust

Great. Thank you, Jure, and good afternoon, ladies and gentlemen. Thank you for joining us here today. Before we go through the financial results, I want to acknowledge the entire Sanmina team for executing and delivering financial results in line with the company's outlook and continuing to do an excellent job. Now let's talk about the Q2 results. Please turn to Slide 5. Second quarter revenue was $1.835 billion at the low end of our $1.825 billion to $1.925 billion guidance range, which is down approximately 2% sequentially. We believe the business has leveled out from a revenue perspective, and we expect to see improvements in the quarters ahead as customer inventory absorption headwinds dissipate, which Jure will comment on more in his prepared remarks. Non-GAAP gross margin was 8.9%, which exceeded the high end of our outlook and was up 10 basis points sequentially and 50 basis points compared to the same period last year. We're very pleased with this gross margin result, which is due to a combination of favorable mix, focused execution and strong operating discipline. Non-GAAP operating expenses were $63.6 million, slightly above our outlook of $60 million to $62 million, primarily driven by incremental expense related to our deferred compensation plan which was completely offset by an asset gain in the other income and expense line item. Non-GAAP operating margin was 5.4%, which was at the midpoint of our outlook and down slightly at 10 basis points sequentially and 40 basis points compared to the same period last year. This operating margin result was also impacted by the incremental deferred compensation expense that I noted earlier, but is still solidly in the short-term range of 5% or 6% that we set earlier this year. Non-GAAP other income and expense was $6.5 million, favorable to our guidance of approximately $12 million driven by the asset gain that I mentioned previously as well as higher interest income due to our strong cash generation results and less interest expense due to lower usage of our revolver. Non-GAAP earnings per share came in at $1.30 based on approximately 57 million shares outstanding on a fully diluted basis and at the high end of our outlook. Now please turn to Slide 6 to talk about the segment results. IMS revenue came in at $1.46 billion, down approximately 3% sequentially. However, IMS non-GAAP gross margin was up 10 basis points sequentially to 7.7% due to strong operational execution and our continued focus on driving manufacturing efficiencies. CPS revenue came in at $398 million, up slightly at about 1% sequentially, and non-GAAP CPS gross margin was down 10 basis points sequentially to 12.9% and due to unfavorable mix. While we're pleased with these results, we continue to see opportunity for margin improvement in both the IMS and CPS segments going forward, further supporting our longer-term margin objectives. Now please turn to Slide 7 to talk about the balance sheet. Our balance sheet is a key advantage of the company and a pillar of our value proposition to investors, and the team did a great job managing it again this quarter. Cash and cash equivalents were $651 million. At the end of the quarter, we had no borrowings on our revolver, leaving us with substantial liquidity of over $1.5 billion. We ended the second quarter with inventory of $1.38 billion, down slightly sequentially, and inventory turns were 4.8%, up slightly sequentially. We continue to focus on improving our inventory position and increasing turns. Our non-GAAP pretax ROIC was 22% for the quarter, well above our weighted average cost of capital. We continue to have one of the strongest balance sheets in the industry with a low leverage ratio of 0.57x, which allows us to both navigate complex market environments and capitalize on the long-term opportunity in front of us simultaneously. Please turn to Slide 8, where I'll talk about cash flow and capital allocation. We did a great job managing cash this quarter, and I'm confident we are putting our cash to use in the right areas. To touch on a few highlights. Cash flow from operations was $72 million for the quarter and approximately $200 million for the first half. Capital expenditures were $30 million for the quarter as we continue to make investments in the end markets that will support Sanmina's long-term profitable growth. Free cash flow was $43 million for the quarter and $135 million for the first half. During the quarter, we repurchased 28,000 shares for approximately $1.4 million. And for the first half, we've repurchased 2.2 million shares for approximately $107 million. As of March 30, we have approximately $172 million left on our Board-authorized plan and we intend to continue to repurchase shares on an opportunistic basis. Our focus and execution on cash generation provides us with the flexibility to invest in the business. When making those investment decisions, we look for opportunities to drive shareholder value while taking a disciplined ROI-based approach, which is a practice we will continue to follow going forward. To conclude on the Q2 actual results. Overall, it was a strong quarter as we delivered on what we said we would, and we continue to set up the company for future success.

Jure Sola

Thank you, Jon. Ladies and gentlemen, let me add a few more comments about our second quarter, and I'll review our end markets and outlook for the third quarter and the rest of the fiscal year 2024. Please turn to Slide 11. As you heard from Jon, for the second quarter, we delivered good results. Overall, we met our outlook. We are seeing stabilization in some of our end markets and incremental improvements in demand. Recovery is slightly slower than expected at the beginning of the year, but we are working very closely with our customers as they are burning through their inventory. I can tell you that macroeconomic uncertainty remains. But Sanmina's team continues to demonstrate resilience and deliver good financial results in this environment. So what is Samina advantage in [ this dynamic ] market? I can tell you that we are well diversified in growth markets. Sanmina has a strong customer base of market leaders to help us to get through this environment. We are working very closely with our key customers with existing and new projects to drive growth as market improves. Our business is well aligned to adapt to present market dynamics. We have strong cost management in place. We have aligned our cost to present business demand. And as Jon mentioned, Sanmina Industry's leading balance sheet gives us a lot of flexibility to maximize the shareholder value. So please turn to Slide 12. Now let me talk to you about revenue by end markets. Revenue for second quarter was $1.835 billion, roughly slightly down approximately 2% quarter-over-quarter within our guidance. I can say the forecast were more predictable this quarter. Industrial, medical, defense, aerospace and automotive was 67% of our revenue, slightly down 2.5% quarter-over-quarter. For defense, aerospace and automotive, we saw good demand during this quarter. For communication networks, cloud infrastructure that was 33% of our revenue, slightly down 1.5% quarter-over-quarter. Also, I can tell you that we had a higher demand from new projects in Communication Networks and Cloud segment, but we could not ship it because of material shortages and some testing capacity issues. These issues will be resolved in our third quarter. For second quarter, top 10 customers represented 48.5% of our revenue. We're a well-diversified company. And we have no customers over 10% plus. I can also tell you that the bookings for second quarter improved nicely. Book-to-bill was 1.1 plus to 1. Newer products are driving demand. Please turn to Slide 13. Sanmina has continued to invest in a faster-growing and higher-margin end markets such as cloud infrastructure, defense and aerospace, medical, automotive, renewable energy, industrial and optical advanced packaging. So let me make a few comments on each of them. For cloud infrastructure, AI and ML is driving new opportunities for us. We've been driving -- it's mainly been driven by upgrades in our cloud networks to meet AI traffic needs. Sanmina is well positioned to benefit from growth in AI. We have benefited some right now and the rest of the '24, but we're expecting to see more benefits and bigger opportunities in calendar year 2025. For defense and aerospace, we continue to see solid demand. New program wins are driving our long-term growth. For Medical, our focus is on digital health and medical devices, such as disposable, consumables, drug delivery, surgical, diagnostic imaging and lab diagnostic systems. We have a strong base of customers, and we are well positioned here. We see positive trends long term. For Automotive, we mainly focus on electrical vehicle and electrical charges. Short-term demand is softer but our new opportunities will drive the growth. We see a better forecast for September and December quarter, and we expect to see improvements in demand longer term as we enter fiscal year -- calendar year '25 and beyond. For renewable energy, we continue to win new projects. We've been focusing around generation and storage of power, power controls and management. Here same thing, new opportunities are driving the growth for us. For Industrial, we have solid customer base. We see stable demand. We've been focusing on factory automation, test and measurement and inspection equipment. For semiconductor part of the industrial, we focus on lithography. That business for us has been stable, but we should see more improvements in the second half of '24. Overall, we have solid new projects in the pipeline that will drive the growth longer term. For Optical Advanced Packaging, we expand this optical business for AI applications mainly around 800 gig modules, and we're starting to do the R&D and new product introduction of 1.6 terabytes. Again, good opportunities here. Growth in cloud and data center will drive the growth for this segment for longer term. Please turn to Slide 14. I just wanted to show you a few slides -- I mean a few pictures on this slide to see where Samina participates in AI and ML today. As you can see, for AI and ML -- for infrastructure such as communication, cloud infrastructure across multiple product lines such as servers, IC hardware, software development, semiconductor capital, optical components, such as optical modules, powder controls, power management, networking equipment and service and storage. Consumption of AI and ML is going across all our markets such as automotive, transportation, safety, security, health care, defense and aerospace. And then, of course, what we're doing internally utilizing AI/ML by automating our factories and machine learnings and back office. So as you can see, we are heavily involved in AI, and I believe this will drive a better future for us. Please turn to Slide 15. In summary, for second quarter, we had solid execution, revenue of $1.83 billion, in line with our outlook. Non-GAAP operating margin, 5.4%, non-GAAP diluted EPS of $1.30, high end of our outlook. So overall, respectable quarter. For third quarter, our end market outlook, as Jon mentioned, is what we're seeing from our customers today. The third quarter will have a guidance of $1.8 billion to $1.9 billion. Non-GAAP EPS will be at $1.22 to $1.32. On positive side, our visibility is getting better, and we're starting to see more or I should say, some normalization of supply chain. For fourth quarter, we remain optimistic that we will see sequential improvements as we move into the second half of the year. And we are starting to see stronger forecast for our September quarter as we are getting our forecast in. I can tell you that I'm personally excited about long-term growth for Sanmina. As I said before, fiscal year 2024 is a transition year for us. We are navigating these market dynamics pretty well. Short term, our operating margins are holding and they're stable in the range of 5% to 6%. At the same time, longer term, we are positioning the company by making changes and improvements to drive operating margin to 6-plus percent. We expect that the fiscal year '25 will be a growth year for our end markets, and our focus is to drive the growth in a heavy regulated markets, we believe that's where we have competitive advantage, and we've got positioned there. So in summary, for short term and long term, Sanmina is well positioned to manage through this dynamic market. Ladies and gentlemen, now I would like to thank you all for your time and your support. Operator, we're now ready to open the lines for question and answers. I'd like to say thank you again. Operator?

Operator

[Operator Instructions] Your first question is from Ruplu Bhattacharya from Bank of America.

Jure Sola

Ruplu, thanks for the question. First of all, there's no surprise that communication market has been down now, in my opinion, for the last three quarters, mainly driven by inventory adjustments and some softer demand in certain segments. But you asked the question, when is going to end? I believe we come in to the bottom of it. As I said, we're starting to see some normalization when it comes to supply chain and we're starting to see some more predictable forecast. And most importantly, as I said, I think as we go forward, I think our visibility is better and so on and so on. I think back to -- I think, on the cloud itself is doing better for us. That's about -- if you -- today, if you look at 33% of the revenue, about half of that is cloud and half of it is communication networks. A lot of the business that we do is around the networks and optical networks, Ruplu. But the whole communication demand has got affected, especially around 5G and so on and so on. So -- but it's -- on the positive side, we're starting to see the light end of the tunnel, and it's not a train anymore.

Jure Sola

Yes. We've been in our optical business for a long time, especially optical networks. That business for us is pretty strong. Overall, we have a strong customer base. We started getting involved in optical modules, I would say, last 5, 6 years. We've been investing a fair amount in the last couple of years into optical advanced packaging. We've been doing 400 gig type of product. We're starting to do 800 gig and making some shipments across our optical product line on 1.6 terabyte that's in development with a couple of partners of ours and midst of designs and NPI process.

Jonathan Faust

Yes. Sure, Ruplu. Thanks for the question. So in terms of the cash conversion cycle, we're in the mid 70s right now. But if you look back at the history of Sanmina, we're closer into the 50s. And so that's certainly what we're going to be striving towards, right? And if you break that down between DOI, DSO, DPO, I think we've got a little bit of room to improve across the board. Inventory itself is quite a bit elevated several days beyond what our historical levels have been, DPO is not quite as high. So we're definitely going to be focused on working capital initiatives to bring that back down into line, which should help us generate more cash. And in terms of our priorities for capital allocation, those haven't changed, right? And we've got four of them just to reiterate for you and everybody else on the call. So number one is in organic growth, indeed, the business; two, strategic transactions or inorganic growth; three, paying down our debt, which is at pretty low levels already; and then number four, share repurchases, which, as I mentioned, will continue to do opportunistically.

Jonathan Faust

Yes, absolutely. Yes.

Jonathan Faust

Yes. And as you know, Ruplu, we guide one quarter at a time, but we are guiding cash flow to be positive in Q3. And as Jure mentioned, very pleased with the performance that we saw here in the first half, in the first 2 quarters, and then we expect to generate cash going into Q3 as well.

Steven Fox

A couple of questions, if I could. First of all -- in terms of just -- you mentioned some test capacity issues and some supply chain constraints during the quarter. Can you expand on that and make sure -- I just want to make sure what sort of markets we're talking about and then how you're solving that problem? Then I have another...

Steven Fox

Got it. That's helpful. And then as you mentioned, your gross margins were a little bit better than expected. And do you still see room for gross margin improvement from here. Can you just walk through what you see as the gross margin opportunity, say, over the next, I don't know, 2 to 4 quarters?

Jonathan Faust

I think you said it very well here. I think the only thing I would add on top, Steve, to add to what Jure said, which is all about driving value for our customers within the businesses and driving better segment or mix results. But as we return to growth, we should get some natural operating leverage as well, right? So if you add that on top of everything that Jure was saying, that's why we still believe that there's margin upside in both segments and for the company overall.

Operator

Your next question is from Anja Soderstrom from Sidoti.

Jure Sola

Well, first of all, Anja, thanks for the question, yes, we had a little bit extra. We could have shipped, our revenue would have looked a little bit better than what we delivered. But confidence is really what we are seeing from our customers, what they're telling us right now based on today's information. As we said, we will take one quarter at a time in this environment. I believe that what we've seen through [ forcast], visibility is getting better. I think [indiscernible] burn down with a lot of our key customers. A lot of our customers are telling you the second half of the calendar year will get better and the forecasts are looking better. So combination of all of those things and some of the new programs that we have coming up should allow us to move in the right direction. Jon, anything else?

Anja Soderstrom

Okay. And the joint venture in India, how is that trending? It seems like you had a lower payment for that this quarter?

Jonathan Faust

Yes. I think it's executing well to Jure's point. And if you look at what we guided, Anja, right, we said about $3 million in the distribution, and we did just shy of that. So pretty much right on target, right where we want it to be.

Operator

Your last question is from Christian Schwab from Craig-Hallum Capital Group.

Jure Sola

Well, in a cloud, we did -- in Communication Cloud is about 33% last quarter. About half of that comes from cloud. We don't break it down at that. But definitely, it's more this quarter than the last quarter. It will be more next quarter than what we did last quarter. So definitely it's going in the right direction. And it's really driven with a lot of our customers' new products that are required for upgrades of the data centers.

Jure Sola

Well, I would say -- let me kind of make a comment on a whole that we come in of that bad cycle, if I can way [indiscernible]. I would expect to see some nice improvement in our fourth quarter. We're going to see some this quarter, but really a lot more in our fourth quarter. And like I said, September and December quarter of this year, we definitely forecast are looking up in that segment. And then help from a cloud will help move that in the right direction. Christian. Ladies and gentlemen, I want to again, thank you for your time and your support. If you have any more questions, please get back to us. Otherwise, I appreciate everything, and we'll see you or talk to you in 90 days from now. Bye-bye. Thank you.