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Sanmina Corp (SANM)

February 26, 2013 6:50 pm ET

Executives

Robert K. Eulau - Chief Financial Officer and Executive Vice President

Analysts

Jeremy David - Morgan Stanley, Research Division

Jeremy David - Morgan Stanley, Research Division

All right, let's see if we can get started. Welcome, everybody. My name is Jeremy David. I work on the Communications Equipment team here at Morgan Stanley with Ehud Gelblum, who couldn't be with here us today. This session is for Sanmina. And from Sanmina, we have the CFO, Bob Eulau. Welcome.

Robert K. Eulau

Hey, Jeremy. Thanks for having us today.

Jeremy David - Morgan Stanley, Research Division

So before we get started, I do have to read some disclosures. It will be short. Please note that all important disclosures, including personal holdings disclosure and Morgan Stanley disclosures appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures or at the registration desk.

Question-and-Answer Session

Jeremy David - Morgan Stanley, Research Division

So Bob, just to provide context for our discussion, can you tell us a little bit about your revenue mix by industry, your largest customers within each segment and where do you see the most growth opportunities as you look out for the next couple of years?

Robert K. Eulau

Yes, I'm happy to do that. And I probably should also mention our Safe Harbor, which is I encourage everybody to look at our SEC filings, and obviously may make some forward-looking statements. So please take those for what they're worth. So in terms of the business, we, from a vertical market segmentation standpoint, we do about 45%, 50% of our business in the communications space. And within communications, we've got a very good footprint both from a wireless standpoint and an optical perspective. We've, in the last 2 or 3 years, had a couple of 10% customers in Communications segment, not necessarily both from the same year, but Alcatel-Lucent and Nokia Siemens Networks have both risen to that level at one point or another. And I would say from an optical standpoint, we really have an excellent footprint, probably Fabrinet, and we have the largest optical footprint in the industry. And among the Tier 1 EMS companies, I would say, that we have the largest footprint from an optical perspective. So we're -- we continue to be very excited about communications. We think we can compete with anybody in the Communications segment across the board in terms of the various product areas. And we're working on a number of new programs, and we think we're well positioned there. Another segment that's very strategic for us is Medical, Defense and Industrial. And we've been operating in this segment for a number of years. The one that's the longest is actually defense. And we have both a product and a contract manufacturing business there. And I'll come back hopefully later today to the product side. But we started in defense in the '60s through SCI. And so we've been operating there for a number of years. And we're excited about the possibilities in defense, both from a product and a contract manufacturing standpoint. We'll hopefully see some changes here and some opportunities for more outsourcing over the next few years there. From a medical perspective, we have over 20 factories that are FDA-approved around the world. Again, I think, our medical footprint is very competitive with anybody in the industry. And we focus primarily on larger products, MRI machines, CT scan machines, X-ray machines. And we still do some smaller products like blood glucose meters, et cetera. But I think from a medical standpoint, again, we're very competitive. And then, we think one of the biggest opportunities going forward is industrial. If you look at historically our industrial business, it's largely been semi-cap equipment. But we've been working hard to diversify that into other areas. And depending on how you define industrial, it can be a huge market that is largely unpenetrated from an outsource standpoint. Most large industrial companies still do all their own manufacturing. And we think we're extremely well positioned for that segment with both our electronic manufacturing capability and our mechanical systems capability. So we're strategically very excited about the Medical, Defense and Industrial segment. And we've done -- another segment for us is computing and storage, which we've, again, been in for a number of years. If you go back in time, there's probably more computing than storage. If you look at it today, it's probably more storage than computing. And it's, again, another segment in which we're doing both contract manufacturing work and we have our own ODM product from the storage side, which we're pretty excited about. And hopefully we can come back and talk about that one as well. And then, finally, we have the multimedia segments, which historically, for us, have been very much dominated by set-top boxes. We've been working hard to diversify that segment. I'd say it's still a little over half of the set-top boxes. But we've diversified into cameras, including high-end cinematography, high-end still photography. We have casino gaming consoles in that segment. And then, we also have automotive in the segment, where we're doing multimedia console. So I think we're in better shape today on multimedia than -- from a diversification standpoint than we've been in for many years. So that's kind of from a vertical market standpoint what we're doing. We're -- and hopefully, we'll get to what we're doing. We really are doing segment reporting along 2 different lines. One is Integrated Manufacturing Solutions, and the other is Components, Products and Services.

Jeremy David - Morgan Stanley, Research Division

So maybe we could talk a little bit more about that because I think it speaks about your differentiation in how you compete vis-a-vis the other EMS companies.

Robert K. Eulau

Yes, I'd love to. So -- and we get that question a lot, why are we a unique company? And I think there are a couple different reasons. And if you look at the segments which we started reporting at the end of last fiscal year, the first segment and the largest segment for us is what we call the Integrated Manufacturing Solutions. And this is really the contract manufacturing business. It looks like a lot of other EMS companies with a big exception that we don't do much in the way of consumer products. So we diversified our -- I'm sorry, we divested our personal computing manufacturing. We never manufactured cell phones. We've really focused on infrastructure products, high-mix, lower-volume products on the Integrated Manufacturing Solutions side. So I think for that business, we're unique. And the reason why we go after the more complex products is we think there's more engineering content. We think there's an opportunity over time to add more value and provide -- pride that to our customers. And then, the other thing that makes us very unique is the segment that what we call Components, Products and Services. And from a -- and this is roughly 20% of our revenue. And when we say components, what we're referring to is printed circuit boards, backplanes, cables and mechanical systems, which includes precision machining, plastic injection molding, sheet metal bending, stamping, painting, die casting. So they're component activities. Sanmina was actually founded on the printed circuit board side. We've been in the components area for a number of years. The second area for us is products. And we have 3 branded product areas, I alluded to those earlier. The first one is what we're calling SCI. SCI actually stands for Space Craft Incorporated. That's where SCI was founded in the defense business in the '60s. And we do communications products, both wired and wireless and products that go into vehicles and aircraft. So we're going to continue to have a good, solid product business there for some time. It's a very, very profitable business and one that we feel pretty confident with. The second product area is what we called Newisys, which is an ODM storage business, where we have designed very high-quality, high-performance, reasonably-priced storage products that then we will, in turn, sell to either storage OEMs, system OEMs or directly in the cloud environments. And we're -- we've got in the neighborhood of 40 customers evaluating products at any one time. That business is growing modestly. And we're hoping that at some point, we'll land one of the larger customers. And then the final area for us on the product side is Viking Technology. And this has traditionally been a memory module business for us. And here, again, we don't go after the very high-volume commoditized memory modules. We try to focus on unique niche modules where we can add more value, and we don't end up in competition with the really big guys. But what we've also done over the last couple of years is diversified into solid state drives. So we're doing modules that include solid state drives. And we actually have a product, it's a hybrid product that includes both DRAM and solid state drives. So I think we're in good position there, and that business also benchmarks out pretty well relative to the competition. And then the final area for us in that segment is services, and there are really 2 dimensions to that. One's at the front end of a life cycle with design and engineering services. And here, we get involved in FPGA programming, circuit designs, signal integrity, hardware design and some software as well. And the idea is to really help our customers at the front of the life cycle, help them through new product introduction, through our gateway factories. And if we're involved in design cycle, of course, we have a very, very high rate of retention through the manufacturing process. And then, we have a services business at the other end of the life cycle, which is on the reverse logistics. So this is the repair business. And we've really expanded this footprint; over the last year. We've -- we're now operating our own repair sites in 25 countries around the world, and we have partners in roughly another 25. So we've got a very good reverse logistics footprint. We've roughly doubled the size of that business over the last year. We did that primarily through 2 acquisitions during FY '12. So I think now, we have a reverse logistics platform that is very competitive with anybody in the industry.

Jeremy David - Morgan Stanley, Research Division

Great. So I realized we've covered a lot of ground already. Hopefully, we'll be able to come back to some of these products and lines of businesses that you have.

Robert K. Eulau

Yes, that would be great.

Jeremy David - Morgan Stanley, Research Division

We're definitely very interested in what you actually see on the Communications and network segment side of your business because we're -- that's the space we are primarily covering. And last quarter, you said -- so last quarter, you saw a decline, about 12% sequential decline in that part of your business, and you're getting to a further decline in Q1. What's driving the weakness and when do you think we will see a recovery? Overall, the environment seems to be better in terms of carrier spending, but everybody might see it at a different point in time. So what's your view on that?

Robert K. Eulau

Right. So -- and Communications is really important to us as well. It's about 45% to 50% of our revenue. And I would characterize it over the last few quarters as choppy. And we -- if you look at the seasonality last year in our fiscal year, we had a relatively soft first half of the year, and then things got better in the second half of the year. It's appearing that this fiscal year is shaping up in a similar fashion, where we're seeing softness in the first half of the year. And we believe the second of our fiscal year, which is in September, roughly September 30 year end, will be stronger. Now why do we say that? I mean, one is we saw what happened last year. The other is we do get from most of our customers rolling 12-month forecasts. So we have some visibility in terms of what's going on in the future. And of course, anybody's forecasts are never exactly right, but I would say, generally, they're directionally correct. And so we think things will get a little bit better in the second half of the fiscal year.

Jeremy David - Morgan Stanley, Research Division

How often do we get forecasts from these customers and how often do they revise them? And as of late as if in pre-actuation, it seems -- I mean, sticking to their original forecast?

Robert K. Eulau

Yes. So a bunch of questions there. We -- most of the customers give us an official forecast once a month, that's rolling 12 months. We do get weekly updates from customers. A lot of times it'll be -- there's no change, other times will be slight changes one direction or the other. You're right. Recently, there have been changes. I mean, we saw that at the end of December. That's part of what hurt us last quarter as there were some late changes in terms of demand in December. I would say this quarter, things are, so far, are shaping essentially the way we expected.

Jeremy David - Morgan Stanley, Research Division

Okay. That's good to hear. So last year at your conference, you said you -- and I'm going further into the Communications segment business of ours. You said at a conference that you had been approached by optical component suppliers that potentially were looking to diversify from their current manufacturing provider, EMS provider, in Thailand because -- that was impacted because of the floods. What are your thoughts now a year later? Have you won new programs, if you win new programs? And how do you see this opportunity in optical for you over the next several years?

Robert K. Eulau

Yes. I mean, this was a very hot topic about a year ago following the floods. And it definitely created opportunity for us to have discussions with a number of customers looking for, at a minimum, a second source and perhaps a source that had a more diversified footprint. So it's definitely yielded some opportunity for us. We already had a good position in terms of optical component manufacturing. So I don't know that it's a huge change for us, but certainly added to our customer mix.

Jeremy David - Morgan Stanley, Research Division

Okay, good. So, I think, part of the reason you're positive or cautiously optimistic about the second half of balance is you have new programs on the horizon. Can you help us understand how to frame new programs in terms of when you get your program, how long do they generate revenue for you? Is that just a couple of years, 5 to 10 years? And are you seeing more activity than in the past? And how do you see the new programs shifting potentially your revenue mix? Is that fairly representative of the mix that you currently have or you see those programs taking in a slightly different direction?

Robert K. Eulau

Yes. It's an interesting question. And we're constantly re-earning business with our existing customers. And it seems like a lot of people in the industry always talk about the new programs, and we definitely have won new programs. There's also older technology that's going to the end of life. And we're in a cycle right now where it's pretty favorable. We seem to be on a lot of the right programs with some of the key customers. So we're optimistic about how things look over the next year or 2. In terms of the typical life cycle, that's really hard to say across the segments. It can vary greatly. There -- you can imagine in defense or in medical, life cycles are very long. In some of the other areas, some -- a computer -- a computing-related product could be a very short life cycle. So things can vary greatly. But I think in terms of the new business that we've got, we're very excited about where we stand. Some of what tripped us up last quarter is we're working on some new product introductions, and we encouraged some of the overhead spending without getting the products out the door. So we're looking forward to actually generating some good revenue on some new programs.

Jeremy David - Morgan Stanley, Research Division

Can you give us a sense of the magnitude of the revenue that you're generating today that was won from new programs, let's say, over the next -- over the past 12 months or 24 months to give us an idea of that magnitude of the potential impact?

Robert K. Eulau

Yes. I'd be estimating the number. And so I don't know precisely. I mean, like I said, a lot of times, you'll have -- you have products going through transition. And I'd say -- it's hard to say. I would guess half of our products -- our products that have been introduced in the last couple of years ready to get.

Jeremy David - Morgan Stanley, Research Division

Okay, yes, okay. Talking a little bit about your gross margin on that -- on the IMS business, they've declined to a multi-quarter low. I think they reached 5.8% last quarter. Is that a reflection of your current capacity utilization of the other leverage you can pull? And do you think your utilization compares with the -- with your competitors?

Robert K. Eulau

Yes. So there were a couple of key things that impacted us in that segment in the December quarter. The first one was the one I just mentioned. We had some new products that we were ramping. And we're working closely with our customer, but we did incur some overhead expense and we did not get the revenue out the door. So that affected the numbers. And then, we also, late in December, had drop-offs in demand. And when you get late changes in demand, you're in a window where it's difficult to make adjustments to your cost structure. So those are the 2 key drivers in terms of why the IMS segment gross margin was down. In terms of capacity utilization, I think, right now, given what's -- at least on the infrastructure part of the business, companies that have a lot of communications business, I think, it's been under -- generally been an underutilized area. And that's certainly true for us, and I think that's probably true for most of our competition. But it's obviously not something I have in-depth knowledge of.

Jeremy David - Morgan Stanley, Research Division

Great. So let's shift our gear a little bit to your Components, Products and Services business. So your product business, is it growing faster than the overall company? And how are you looking to expand it going forward, the mix of organically developed product lines acquired business lines? How do you see that as part of your strategy going forward?

Robert K. Eulau

Yes. We're very excited about the product area. And I would say the one that has the most growth potential, perhaps, both short and long term is the storage area. And there's really, as I mentioned, a lot of evaluation of our products going on right now. And we saw some very reasonable growth last year. We could definitely -- if we land a couple of these larger customers, we could really see accelerating growth on the storage side. So we're very excited about that. On the defense product side, that business is sort of flat to slightly up. I think we're well positioned there. It's a very, very solid business. But I don't think you're going to see a lot of growth there, certainly not over the next year or 2. And then, from a Viking standpoint or a memory and SSD module perspective, we're pretty excited about what's going on in the SSD area. And I think we're well positioned there. The team has been working on SSD modules for 2 or 3 years at this point. And we're seeing, again, a lot of evaluation going on with products there. So I'm optimistic that we'll be well positioned for that trend. And it's relatively small today, but I think it will be fairly, fairly good growth on the SSD side.

Jeremy David - Morgan Stanley, Research Division

Can you give us an indication, how big is the products business is today as a percent of revenue and where it might go?

Robert K. Eulau

Yes, I don't think we've split out products specifically. As we've said, Components, Products and Services in aggregate are around 20% of the business. What we said in November is we expect that segment to grow over the next few years from a range of -- roughly from 10% to 20%. And right now, if you look at the end of last fiscal year, I think, it exited at about $1.3 billion in revenue for that segment. And we think, again, over the next 2 to 3 years, we should get to $2 billion or so. And we're excited about that segment. That segment already has much better gross margins, as I'm sure you know. And we think it can deliver even better margins than where it's at today. So we've got some of those businesses that benchmark well today. They're competitive with anybody from a profitability standpoint. And we've got other businesses that clearly have room to improve. And I think as we see that improvement, we'll -- and we see some of the growth we were just discussing, we'll see solid double-digit gross margins out of the Components, Products and Services area.

Jeremy David - Morgan Stanley, Research Division

Okay. So that's very encouraging. I think one area specifically you're making investments into that Components, Products and Services business is the reverse logistics business, and you've made, I think, 2 acquisitions over the past year. What's the margin profile in that business? And are there synergies we've -- are there other assets you currently own?

Robert K. Eulau

Yes. So we're -- thank you for the comments. We're very excited about the footprint we now have on reverse logistics, and it is a solidly profitable business. I don't remember exactly what we said in the Analyst Meeting in November, but I think the target operating margin is in the 15% to 20% range for that business. And for the most part, I think, it benchmarks out reasonably well. So in terms of synergies, we've been doing this business for quite a while. We do a fair amount of medical reverse logistics, which is synergistic, obviously, with our medical manufacturing. So we've been doing this for quite some time. We think that there's opportunity to expand, probably both directions. There may be companies for whom we're doing some reverse logistics that we could do more manufacturing and likewise, companies for whom we're manufacturing their product that we can expand into the reverse logistics area.

Jeremy David - Morgan Stanley, Research Division

Great. So let's shift to the balance sheet. What's -- I think, it has changed substantially over the past couple of years. Are you delevered, are you comfortable with your current debt maturity profile at this point? Are there things that you might do?

Robert K. Eulau

So we're very excited about what we've been able to accomplish and where we stand today. And in fact, tomorrow, we pay off the rest of our 2014 debt. So in the last 3.5 years, following the recession, we've actually reduced our long-term debt by about $900 million. So that's really brought us into a very nice profile from a debt maturity standpoint. At this point, the biggest piece of debt we have outstanding is due in 2019. So there's no short-term maturity issue at all. We've got little -- we got another little piece of long-term debt that's due in a couple of years and then just short-term debt. So I think, we're really in fantastic shape from a maturity profile standpoint. I think we're in a new equilibrium at this stage. We've been on a mission really for the last decade and certainly since the recession to delever the company. And I think for the most part, we've -- we're at a place that we're comfortable. And so now it's making sure that we have the cash we need to grow the business to do small strategic acquisitions like we did last year on the services side. So we're not anticipating something significant, but things that fit well with our articulated strategy. And then with the remaining cash, it's really a question of does it create more shareholder value to repurchase debt or to repurchase equity? And we'll do that analysis as the time comes. But we're generally very happy with where we stand from a balance sheet standpoint

.

Jeremy David - Morgan Stanley, Research Division

And is the dividend on the table? Is that something you consider before share buybacks?

Robert K. Eulau

At this point, it's something that the board will deliberate on. But there's -- it's not something that I am anticipating we'll be doing right away.

Jeremy David - Morgan Stanley, Research Division

Okay. And so at the end of Q1, you had $491 million of cash in the balance sheet. After you pay down your debt, I'm not sure how much you have left. But how much do you need to keep the company running? And does it matter where the cash is if it's overseas or in the U.S.?

Robert K. Eulau

Yes, it's a good question, one we actually don't specifically answer. But I think it's important to understand that our company is financially structured different than most. And by that, what I mean is because of our tax situation in the U.S., we have large U.S. NOLs, our strategy is to drive as much profit back to the U.S. as possible. That has the secondary benefit of allowing us to bring a lot of cash back to the U.S. as well. So relative to most companies, we have very, very little trapped cash around the world. So the cash that you see on our balance sheet is all being -- is all able to be used from an operating standpoint. Now we can operate with a lot less cash than what we have, there's no doubt about that. But I don't want to put a specific number out there.

Jeremy David - Morgan Stanley, Research Division

Okay, great. I want to see if there are any questions in the audience? No? Okay. So I'll keep going. Can you remind us what your targets are in terms of gross margin, operating margin and ROIC, and what the big levers are for you to get to those targets?

Robert K. Eulau

Yes. So -- and I'll do it by segment. What we said in the Analyst Meeting was consistent with the prior year is from an operating margin perspective on the Integrated Manufacturing Solutions, with our mix of business, we think we should be able to get to the 4% to 5% range. And I think -- and we've been there at times in the past. So I think that's an achievable number. And then on the Components, Products and Services business, we think that we should be able to get into an operating margin range of 8% to 10%.

Jeremy David - Morgan Stanley, Research Division

And what's the big lever to get it just top line -- for top line to get there? Or are there some cost fringe in the ring or...

Robert K. Eulau

So again, answering by segment, on the Integrated Manufacturing Solutions side, it's really a matter of getting more volume. I mean, we just need to grow the business more. We don't see any changes to the footprint. We're pretty happy with the footprint we have. And we need to get a little bit of tailwind from the economy. And I think people will be very impressed with the margins we can generate on that part of the business. And then from a Components, Products and Services standpoint, it's a matter of really focusing on each of those businesses. Each of them has a different set of competitors that they compete with and a different set of customers they're servicing. And so it's a matter of executing well in each one of those. We've got new leadership in place. And we expect those businesses to get increasing -- increasingly profitable and larger over time.

Jeremy David - Morgan Stanley, Research Division

So you say you're happy with your current footprint. So you're not anticipating moving plants or manufacturing locations in the short term?

Robert K. Eulau

No. We don't have any further restructuring plan. We did announce late last fiscal year 2 adjustments to our footprint. One is we decided to close a facility in Malaysia, as we were bringing up another factory in China. It was a unique opportunity to redeploy a lot of the fixed assets in that factory into the new China facility. So we made the decision to do that. And then, we're in the process of consolidating 2 facilities in Israel down into 1. So those are the 2 adjustments. There's nothing else on the table, and I don't foresee anything at this point.

Jeremy David - Morgan Stanley, Research Division

Okay. And just going back to your outlook for the year, we have a pickup in the second half. Are you at all concerned by the budget sequestration risk because you have exposure to the defense sector? Is that at all a concern that you have?

Robert K. Eulau

Yes. I mean, we definitely have to pay attention to what's going on there. I think, when I talk to our defense team, I think the biggest concern even more than the sequester is the continuing resolution actually getting the budget in place with the U.S. government. And we're on good programs, we're on funded programs. So I think generally speaking, we'll be okay, but it's definitely something we need to pay attention to. And then the secondary issue, of course, is just the impact on the overall economy. And that could impact a number of our businesses. So hopefully, we -- we'll get through this and not have too much disruption.

Jeremy David - Morgan Stanley, Research Division

Okay. Any questions before we close? Good. Thank you, Bob.

Robert K. Eulau

Well, thank you, Jeremy. Really appreciate it.

Jeremy David - Morgan Stanley, Research Division

Thank you.

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