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Executives

Paige Bombino – Director of IR

Jure Sola – Chairman and CEO

Bob Eulau – EVP & CFO

Analysts

Jason Brueschke – Citigroup

William Stein – Credit Suisse

Christian Schwab – Craig-Hallum Capital

Lou Miscioscia – Brigantine Advisors

Sherri Scribner – Deutsche Bank

Alex Blanton – Ingalls & Snyder

Joe Wittine – Longbow Research

Sean Hannan – Needham

Brian Alexander – Raymond James

Todd Coupland – CIBC

Sanmina-SCI Corporation (SANM) F1Q10 (Qtr End 01/02/10) Earnings Call Transcript January 26, 2010 5:00 PM ET

Operator

Good afternoon. My name is Chanelle and I will be your conference operator today. At this time, I would like to welcome everyone to the Sanmina-SCI first quarter fiscal 2010 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.

Ms. Bombino, you may begin your conference.

Paige Bombino

Thank you, Chanelle. Good afternoon, ladies and gentlemen and welcome to Sanmina-SCI's first quarter fiscal 2010 earnings call. Today's call is being recorded and is posted along with a copy of the earnings release and slide presentation on the quarter at www.sanmina-sci.com in the Investor Relations section. You can follow along with our prepared remarks in the slide posted on the website.

Please turn to slide two, the Safe Harbor statement. During this conference call, we may make projections or other forward-looking statements regarding future events or future financial performance of the company. We caution you that such statements are just projections. The company's actual results of operation may differ significantly as a result of various factors, including the state of the economy, economic conditions in the electronics industry, changes in customer requirements and sales volume, competition, and technological changes.

We refer you to the documents the company files from time to time with the Securities & Exchange Commission, specifically the company's most recent Report on Form 10-K for the year ended October 3rd, 2009. These documents contain certain and – contain and identify important factors that could cause actual results to differ materially from our projections or forward-looking statements. You'll note in our press release issued today that we have provided you with a statement of operations for the three months ended January 2nd, 2010 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 is posted on our website. In general, our non-GAAP information excludes restructuring and integration costs, impairment charges, gains or losses on extinguishment of the debt, non-cash stock-based compensation expenses, amortization expenses, and other infrequent or unusual items to the extent material.

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, SG&A and R&D expenses, operating income, operating margin, net income and earnings per share, we are referring you to our non-GAAP information.

I would now like to turn the call over to Jure Sola, Chairman and Chief Executive Officer.

Jure Sola

Thanks, Paige. Good afternoon, ladies and gentlemen. Welcome and thank you for joining us today. On this call today with me is Bob Eulau, our CFO. And our President typically joins the call, but today he is travelling in Asia. So he is not able to participate.

I’ll go through the agenda. Bob Eulau will review our financial results for the first quarter of fiscal year 2010. Then I will follow with additional comments relative to Sanmina-SCI results and future goals. Then Bob and I will open for question and answers.

And now, I would like to turn it over – call to Bob.

Bob Eulau

Thanks, Jure. Hello, everyone. It's a pleasure for me to be joining you on today's call. Please turn to slide three.

As you can see, we started the fiscal year with a very good first quarter. Revenue of $1.48 billion was up 9% on a sequential basis. This was above the high-end of our guidance of $1.35 billion to $1.45 billion and follows the September quarter when we had 12% sequential growth.

Jure will discuss revenue in more detail, but we have solid growth across all segments. The revenue growth coupled with the restructuring and other cost reduction actions completed last year led to improved gross margin of 7.6% on a non-GAAP basis. This implies a contribution of 12.4% on the incremental revenue, which was in the range of the 10% to 15% we had expected. This is a good outcome and we think there is still plenty of room for improvement. As our vertical integration initiatives move forward, we continue to contain costs and we leverage our fixed cost structure.

Non-GAAP EPS was $0.23 per share. This was based on 80.6 million shares outstanding on a fully diluted basis. This was better than our guidance due to strong revenue, better mix, and a higher leverage on fixed costs than we had planned. As a result of the margin expansion and good working capital management, cash flow from operations was $13 million, which is a good number given this is our second quarter in a row of strong sequential growth.

Please turn to slide four. I'll start by making a few comments on the GAAP numbers. For the first quarter, we reported a GAAP net income of approximately $59 million, which is equal to $0.74 per share. The GAAP numbers included several, mostly favorable, one-time events including a $35.6 million settlement on a litigation matter and an $11.6 million resolution on an outstanding tax matter.

As we had expected, we also saw a significant decline in restructuring charges relative to the other quarters shown on this slide. Restructuring totaled $3.3 million for the quarter, which is down from $18.3 million last quarter. We will continue to see some minimal restructuring charges on our GAAP P&L of approximately $3 million to $4 million per quarter that relates to costs for past restructuring actions that are booked as incurred in accordance with GAAP. These expenses primarily relate to real estate, which is being held for sale. We expect these expenses to decline over time as properties are sold. This property is listed on the market at over $160 million.

My remaining comments will focus on the non-GAAP financials for the first quarter. At $112 million, gross profit was up 16% over the prior quarter. Gross margin came in at 7.6%, which was a 50-basis point improvement over the previous quarter.

Operating expenses of $63 million increased by $1.1 million when compared to last quarter. Operating expenses were higher than planned, primarily as a result of incentive compensation related to the strong results for the quarter. At $49 million, operating income improved by 42% over the prior quarter. Operating margin was 3.3%, which was a 70-basis point sequential improvement.

The tax rate for the quarter came in at 21.9% of pretax income. We have made good progress in reducing our effective tax rate through operational changes and we continue to work towards our long-term operating structure with the goal of further reducing the actual taxes paid. On a non-GAAP basis, we earned $18.5 million in net income. For modeling purposes, I want to mention that depreciation was $20 million and EBITDA for the quarter was $69 million.

Now, let's move to slide five. Here, we are showing you some of our key non-GAAP P&L metrics. The revenue trend has been very strong in the last two quarters as we have moved out of the recession. We bottomed out in Q2 and revenues climbed 24% since then with 9% sequential growth this quarter.

Gross profit has shown strong improvement since Q2 of last year with growth of 58%. During this period shown, gross margin has improved from 5.9% to 7.6%. We believe this demonstrates how well positioned our cost structure is for the coming quarters.

While revenue and gross profit have grown significantly over the last year, our operating expenses remain well controlled. With relatively flat operating expenses and strong gross profit growth, operating profit has grown even faster since Q2 of FY '09. In fact, it is up over four times what we had reported in the second quarter last year. During this period, operating margin improved from 1% to 3.3%.

I'd like to turn your attention to the balance sheet on slide six. Our cash and cash equivalents were $727 million. This is down primarily as a result of the early redemption of $176 million in debt. Cash flow from operations was positive at $13 million and capital expenditures were also at $13 million. As the company grows quickly, we are working hard to minimize our working capital requirement.

Let's turn to slide seven to discuss some of the balance sheet metrics. In our business, inventory is a key focus. It is a challenging area as economy has improved and part shortages have emerged. The good news is that in spite of the supply challenges, our inventory turns have rebounded sharply from 6.4 turns last quarter up to 7.1 turns this quarter. We still have room to improve and our goal is to get up to at least 8 turns within a few quarters.

In the lower left quadrant, we are showing our cash cycle days which combined our cycle time for inventory, accounts receivable, and accounts payable. Inventory days had a very positive impact as they improved from 56 days last quarter to 51 days this quarter. Likewise, we saw a significant improvement in accounts receivable from 49 days to 43 days. Accounts payable was unfavorable as it declined from 57 days to 54 days. Overall, cash cycle time improved from 48 days last quarter to 41 days this quarter.

Finally, the most important measure for us is return on invested capital. We have made outstanding strides in this measure over the last four quarters. We believe this is an important measure in demonstrating our ability to add value to our shareholders. While we are pleased with an ROI of 14%, we believe there is still room for improvement with both margin expansion and better asset velocity.

At this point, I'll turn the discussion back over to Jure for more comments on the business and our guidance for next quarter.

Jure Sola

Thank you, Bob. Good afternoon again. As you heard from Bob, it was a good quarter. We are pleased with our progress our company is making and we are benefitting from our strategic transformation to a new strategy and improved operational efficiency. Good news, as Bob mentioned, we exceeded our guidance on top and the bottom line.

So now, please turn to slide number eight. On this slide, we are going to talk a little about our first quarter revenue breakdown. As you can see, our overall revenue grew by 9%. We also changed the way we are going to report to you, going from five buckets to four buckets. And we also give you a comparison there from the fourth quarter so you can compare it to our first quarter.

Communication overall was 34% of our revenue and that was 9% up. Enterprise computing and storage, which includes high income enterprise servers and storage was 21% of our revenue, 5% up. Industrial, defense, and medical group, which includes industrial equipment, aerospace, defense, medical equipment such as MRI, CT machines and renewable energy, was 26% of revenue, up 8%. Multimedia, which includes gaming equipment, set-top boxes, cinematography, point-of-sale systems, automotive, electronics, that was 19% of revenue and that was up16%.

What's nice about this quarter is the demand was up nicely across all of our key markets that we serve. Also, as you can see, we diversified the customer base in the market pretty well, today consists of 51% of revenue and top 20 consist of 67% of revenue. Also in this quarter, we have one customer slightly over 10% of revenue. We don't expect this customer will be over 10% for a year, but for this quarter was slightly over. So overall, well diversified customer base that we can build on for many years to come.

Let me talk a little bit more about the market opportunities. Market opportunities continue to be healthy. Book-to-bill for the quarter was 1.1 to 1 and new business wins continue to be strong. Visibility is improving quarterly, as well as outlook for calendar year 2010. So bottom line, the pipeline and new deals, it’s exciting again.

We expect to see nice growth expansion with existing and new customer base and also driving some new exciting market opportunities. So calendar year 2010 at this time looks good. We are optimistic that this year will be a growth year again and continue to improve our margin and sustainable growth.

Now, please turn to slide nine. Now, what I like to do is talk to you about our outlook. Typically, our second quarter, which for us is the March quarter, we see some seasonality in demand, down approximately 10%. But that's not the case this year. Our visibility looks better this year for the second quarter.

So also for second quarter is basically following. Revenue between $1.45 billion to $1.55 billion. Gross margin should continue to improve to 7.7% to 7.9%. Operating expenses should stay flat about $63 million. Interest expense and other should be around 27% – $27 million. Depreciation and amortization is about $22 million.

CapEx for this quarter – second quarter, about $25 million. As Bob mentioned, first quarter was only about $13 million, so there is some catch-up. But if you look at the – for whole year, there is no changes; our CapEx should be around $80 million. Tax rate, about 22% and hopefully lower.

Diluted shares outstanding should be around 82 million shares. And for those that are modeling for a whole year, probably the number is going to average about 83 million shares. Non-GAAP EPS, we are forecasting $0.22 to $0.27.

So in summary again, based on our current demand and visibility what we see today, things are looking up. And 2010 should be a good year for Sanmina-SCI. However, Sanmina-SCI will continue to be cautious and I think we are ready for any economical environment, company is well positioned.

We expect to have a sustainable margin expansion and margins will be driven by more diversified revenue growth and continued improvements in our product mix and services, cost savings from completed restructuring. As our restructuring is basically done today, we have a bright global footprint, we are in 18 countries. We do have a – we do have state-of-art manufacturing capability and strong global engineering and design capability.

So as we look at our global footprint and our operations, we don't see any major changes there. We are also well aligned with our customer base and are a very valuable partner to our customers in our key focus markets. Again, as I mentioned earlier, we have strategically transformed the company to a new market strategy. And this strategy is really focusing on sustainable and more profitable business model in our key growth markets.

Now, I would like to take this opportunity and thank you all for joining us today. We also like to thank our employees for their hard work and dedication and their support. Operator, now we are ready to open the lines for question and answers. Thank you all again.

Question-and-Answer Session

Operator

(Operator instructions) Your first question is from the line of Jim Suva with Citigroup.

Jason Brueschke – Citigroup

Hi, good afternoon. Jason Brueschke stepping in for Jim. Just a couple of clarification questions. First, you had mentioned that seasonality in the March quarter is typically down 10%. Given the current mix of business that you have today, can you perhaps provide some outlook for what seasonality – a normal seasonality might look like now for the rest of your quarters?

Jure Sola

Well, for this quarter – for second quarter I should say, we are forecasting worst case flat plus to a – 5% plus growth. If we look at the rest of the year, everything we see today, we believe we'll continue to be able to grow on a quarterly basis. This time is very hard to predict percentages; we are not ready to predict it.

But as I mentioned in my prepared statements, Jason, we are pretty optimistic about calendar year 2010. I think most importantly that I – new strategy that we are – that we kind of implemented in the last 12 months that is focused on diversifying market segments, focusing on customers and projects that will allow us to have a sustainable growth and most importantly, sustainable margin improvement. We feel very comfortable that as long as economy is holding, if not major improvements, that we should be able to continue to deliver a margin improvement.

Jason Brueschke – Citigroup

In your – I think in the past you've spoken a little bit about what types of margin levels you can get to on certain revenue levels. Do you have any updates there?

Jure Sola

No, it's – basically, it’s the same. We – and our longer-term goal is to – our model is really modeling to 10% gross margins with operating margin better than 6% and a return on investment capital should be better than 25%. That's really the model that we want to get to. And as you can see today, there is a fair amount of leverage. As revenue goes up, we believe that our customer base is probably closer to an $8 billion run rate than what we are shipping today. So – as long as the economy cooperates and our customers are growing, I believe Sanmina will get its share and we are going to get there soon.

Jason Brueschke – Citigroup

Great. I appreciate the feedback. Thank you.

Jure Sola

Thanks, Jason.

Operator

Your next question is from the line of William Stein with Credit Suisse.

William Stein – Credit Suisse

Thanks. Jure, first just a clarification. That long-term goal of 10% gross and over 6% operating, what revenue base do you need to get there?

Jure Sola

Well, I think it's – a lot of this is mix. Basically, what I said in past, as long as we could get to $1.8 billion to $2 billion run rate per quarter, we'll get there. If the mix is better, I think then we can get to the lower number.

William Stein – Credit Suisse

And then just a couple other real quick ones. What happened to the medical end market in this quarter? Did you telegraph that you were going to remove that or is there – ?

Jure Sola

No – no. Medical market is – we put it – we changed the way we report in four buckets for a couple of – I’ll explain my reasoning behind it. So the medical is grouped in with industrial and defense bucket. And as I mentioned earlier, it's – under industrial, defense, and medical, we have a whole industrial equipment including semiconductor, renewable energy, which is a really growing market for us, especially in electromechanical side, aerospace and defense and then of course medical businesses. Those businesses are very similar, they are similar in the margins, they are similar type of equipment we use to get the job done and that's why.

So if you look at all our markets, last quarter really grew up nicely. Only market that was a little bit slow for us and continue to be probably slow in the next quarter is our defense market, because we have a couple of programs there slowed down. But longer term, that market is pretty exciting for us.

William Stein – Credit Suisse

And one other quick one. I think in the past you've talked about a 15% contribution margin on the operating line and clearly, it was a good quarter, but I think the contribution margin was a little light of that. I think we are looking at about 11.5% sequential on the operating line. What should we think about – ?

Jure Sola

Yes, I think I'll turn it over to Bob. But contribution margin for last quarter was 12.5%, but typically we said 10% to 15%. I believe that as we – as our revenue gets to a higher level, I think that contribution margin will be closer to 15% as – and also on top of that, as our component businesses start to have more growth, the number could be even higher.

William Stein – Credit Suisse

Great, thank you.

Jure Sola

Thanks.

Operator

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

Christian Schwab – Craig-Hallum Capital

Thank you. Great quarter, guys. Two questions. The property for sale, the $160 million, do you have any idea or any visibility on how much of that could be sold in 2010?

Jure Sola

Well, we like to tell everything. Now, we have three or four properties where basically we are having offers on them today. They might close in next four to five months. So I'm – I mean, our internal goal is to – right now would be at least $50 million, $60 million this year. But we will – it all depends on the market. These are good properties and we are not ready to give it away.

Christian Schwab – Craig-Hallum Capital

Great. And then my last question. If you look at your implied – we've discussed this before, but your implied interest rate yield masks significant earnings for the company, right? You only have net debt of approximately $534 million, yet you are paying close to $27 million a quarter for that, which depresses earnings by well over $1. Are we working on anything to repurchase debt or run the business with a lower cash balance and take some of that net cash to reduce the debt?

Jure Sola

Well, let me turn it over – let me make a comment and I'll turn it over to our CFO. First of all, as you know, we paid down this quarter $176 million worth of debt. So we have lowered our debt by $176 million. We are definitely well aware of the debt that we have. I think company is in good position to take care of that. We don't have any debts come in next three years, but yes, we will – as we generate more profits, we will be paying debt down.

So I'll turn it over to Bob.

Bob Eulau

Yes. I'm not sure I have a lot to add. I mean, we are definitely looking at what the right moves are long-term to deleverage the company. We are repatriating cash to the U.S. to be able to execute at the right points in time. The thing to bear in mind is we've had two quarters of strong growth as well. And so that does put pressure on us from a working capital standpoint. So we need to balance the cash requirements for the business with the opportunity to deleverage. And we are looking at it all the time.

Christian Schwab – Craig-Hallum Capital

What is the cash position that you think you believe you need to run your business, with the goal it sounds like at some point returning to $1.8 billion to $2 billion in quarterly revenue to support an $8 billion business? How much net cash does the company need, Bob?

Bob Eulau

I don't think that's something that we want to talk about publicly. I mean, it's something we keep a very close eye on and we have, I think, pretty effective models on that front.

Jure Sola

But we definitely have extra cash; let's put it that way, right now to run the business. But as Bob mentioned, Christian, we are well aware of that. I think for us right now, the way we look at this stuff, we – I'm personally now – yes, it's affecting our EPS. I'm really more focused today expanding in the right project and improving the margin. And then as we do that, I think that debt is going to be an easy part.

Christian Schwab – Craig-Hallum Capital

Great. Great quarter again. Thank you.

Jure Sola

Thanks, Christian.

Bob Eulau

Thanks.

Operator

Your next question is from the line of Lou Miscioscia with Brigantine Advisors.

Jure Sola

Hello, Lou.

Lou Miscioscia – Brigantine Advisors

Hi, how are you, guys? Congratulations on getting the numbers going very much in the right direction here.

Jure Sola

Thanks.

Bob Eulau

Thanks.

Lou Miscioscia – Brigantine Advisors

When you look at obviously the numbers you just gave for next quarter from a revenue standpoint and also for the December quarter, can you break down and help us out as much as you can how much of the revenue growth was from new wins and how much of it was just the economy and programs starting to improve and get better?

Jure Sola

Well, all of those. First of all, if you look at – first of all, let me talk about existing customers. The key to our existing customers that I think that – what I like our position there is that we have a lot of new programs with our existing customers. So if you just look at my communication side of the business, we are 34% of the revenue. But most of the products that we ship there is really the networking – high-end networking new products and wireless. And wireless 3G and 4G projects. So we are well positioned with existing customers with – so we were able to win lot of these new programs.

And then you can go into enterprise, industrial. So a lot of our existing customers are new programs. And then last year, as you know, we reported we won about $1 billion worth of new business and most of that stuff was with the new customer – with the new customers that we won. So that's helping out.

And going forward, one of the reasons – if you look at the last quarter, we won substantially better amounts of new business. But for competitive reasons, we don't want to really report those things in a detail as much as we did during the recession. The reason we did during the recession is just to show the world that, "Hey, we are not dead and we are working on a lot of positive things." And now when we are really focused on again the growth now and execution, I think to respect – for competitive reasons and to respect to our customers, we don't want to talk about that.

Lou Miscioscia – Brigantine Advisors

Okay, great. Maybe then just asking a question again – ?

Jure Sola

But I think if you at the lot of growth that we are forecasting for next quarter, is really coming from the new programs with both existing and new customers.

Lou Miscioscia – Brigantine Advisors

Can you give us a thought on just – trying to get a read on the economy in general? How would you say that the customers that were existing ones did in both the December quarter and also March guidance?

Jure Sola

Well, most of our customers were up in December quarter. And as we guide worst case flat to 5% up, I think we have maybe one or two customers that are basically flat that was down. Most of other customers are moving in the right direction.

Lou Miscioscia – Brigantine Advisors

Okay, so –

Jure Sola

So I would say economy – everything that, Lou, tells me today that things are moving in the right direction. You know, I'm not an economist, but as I said earlier, we are going to be cautious. I think we have to – we learn a lot in a recession and I think our company is well positioned to adapt to any environment and I think that's the most important part of what we learned in 2009 is that we have to be ready for any – every environment, but in a good environment, take advantage of the growth. And that's kind of what we are really focused at least in the short period of time.

Lou Miscioscia – Brigantine Advisors

Okay. Good luck on the New Year.

Jure Sola

Thanks, Lou.

Bob Eulau

Thank you.

Lou Miscioscia – Brigantine Advisors

Thank you.

Operator

Your next question is from the line of Sherri Scribner with Deutsche Bank.

Sherri Scribner – Deutsche Bank

Hi, thank you. I was trying to get a sense of as you move towards that $1.8 billion to $2 billion in quarterly revenue, how – can you help us understand how the operating expenses need to move up? We saw SG&A move up a bit, you mentioned some incentive plans. It sounds like that's going to stay flat in the March quarter. But how much additional cost do you need to bring on into the model to hit those higher revenues?

Jure Sola

Yes, Sherri, this is Jure. I think as we get into the – let's say $2 billion run rate, I really don't see major expansion in SG&A might come out of it. A lot of this maybe more out of a little bit sales and marketing, some customer service, some engineering. We think we can be running at $2 billion run rate per quarter and keep our SG&A at $70 million [ph] or less per quarter.

Sherri Scribner – Deutsche Bank

$70 million [ph] or less?

Jure Sola

Yes.

Sherri Scribner – Deutsche Bank

Okay. That's helpful. And then, can you give us – ?

Jure Sola

There is a lot of leverage. I mean, that's what exciting about our new model. The type of customers we focus on is that we have a lot of leverage as we grow revenue.

Sherri Scribner – Deutsche Bank

Okay. And then, can you give us an update on the profitability of enclosures in the components business? How are those tracking? What is the utilization in those businesses?

Jure Sola

Those businesses are improving nicely. As you know, those businesses during the recession got hit the most. We also did a major restructuring in those businesses. So now, all those businesses are moved in a low-cost region. So they are well positioned, we are growing those things and we believe there is a lot more leverage on those. We don't break those separately, but that's one of the biggest leverages that we have. As the demand and economy improves, we believe that those businesses will help us improve our margins and they helped us a little bit this quarter.

Sherri Scribner – Deutsche Bank

Okay. So is it fair to say – trying to understand the leverage of those businesses, is it fair to say from the comment you just made that components and enclosures' gross margins were better than the corporate average?

Jure Sola

No – they are still – they are still below corporate average.

Sherri Scribner – Deutsche Bank

Okay.

Jure Sola

So – but we have – I think it is important to understand, we have both leverage in our system assembly and as we – as the component businesses come up, there is also leverage there. So it's a combination of both.

Sherri Scribner – Deutsche Bank

And what is your total – what was your total utilization this quarter overall?

Jure Sola

Well, if you look at the – based on people, we are running on average 85% to 90%. Based on equipment, we are probably around 70%.

Sherri Scribner – Deutsche Bank

Okay.

Jure Sola

So we still have a lot of capacity. That’s why we don't need to spend a lot on CapEx in short term. We can leverage a lot with what we have.

Sherri Scribner – Deutsche Bank

Okay. Great, thank you.

Jure Sola

Thanks, Sherri.

Operator

Your next question is from the line of Alex Blanton with Ingalls & Snyder.

Jure Sola

Hello, Alex.

Alex Blanton – Ingalls & Snyder

Hi, good afternoon.

Jure Sola

Good afternoon.

Alex Blanton – Ingalls & Snyder

Just wanted to ask this question that Lou asked a little differently. And that is to look forward at the demand for this quarter and the guidance and how much of that do you see coming from the ultimate end market and how much from expanding outsourcing from existing customers? And when I say the ultimate end market, I'm talking about the ultimate customer out there and beyond the inventory buffers that might be in between because those inventory buffers can really distort the sales on a near-term basis.

Jure Sola

Alex, I think it's – yes, I'm very close with our customer base personally and I think we have a – if I look at our top 20, we know much what goes on pretty well with them. But it's still very hard to forecast what's the ultimate end to – end-to-end demand. But I can tell you that I – the most of the stuff that we are building today, I believe, is for direct shipment to the end customer because these customers want it now. As you know, we have a fair amount of material shortages out there. So there is a lot of pushing going on to get these products as soon as possible. So I believe that there is a real demand out there.

Yes, we had a – if you look at our inventory across the whole industry, it's been the lowest levels that I've seen in 25 plus years, but I still believe there is a fair amount of demand going on because today, none of our customers that I'm aware of wants to bring the product and just have it sit around their warehouses, nobody wants to carry inventory anymore. I think if industry learned anything in last 18 months is that you don't buy more than you – than what you need.

So I believe the buy plans are leaner. I think our customers going forward are going to continue to drive the lean pipeline. In other words, order what you need, don't ever have shortages, but don't have anything extra either. So that's the model that most of my customers are operating right now. They might change the model, but that's the model today.

The second question, when you said how much of that demand is coming from outsourcing, more. With my customer base that Sanmina-SCI focuses on, Alex, most of the stuff is – especially in a communication side, enterprise computing and multimedia markets that we focus on is already outsourced. There is a more additional outsourcing going on in the industrial and medical side of the businesses.

Alex Blanton – Ingalls & Snyder

Right.

Jure Sola

And we see that business – that business is going to move slowly. It's just the nature of the business, it's high mix, lower volume, customers are a lot more sensitive because of requirement both from a medical side or whatever. It's moving slower, but definitely even that industry is seeing a huge advantage through outsourcing because we know this model has been proven, it does work for our customers, especially in the tough times.

Alex Blanton – Ingalls & Snyder

Well, when you say the pipeline is exciting, there is more new opportunities available and say a year ago or two years ago, could you tell us where those are? Are those in those new markets like industrial and medical or even aerospace or – or if everything is in the other traditional markets that mostly have been outsourced, how is that that you are having exciting opportunities there?

Jure Sola

Right. So make sure that – to make sure I clarify my pipeline. Pipeline to me means the opportunities that we have with existing customer base and the new customer base; it's not just going out there and buying factories. First of all, we are not interested buying a lot of factories.

Alex Blanton – Ingalls & Snyder

Well, I understand that.

Jure Sola

But the pipeline is really strong from the new products that we have on – that we have, a project that we will be working on in new products in production and then also how much we are able to get involved with the renewable energy and medical side and some of the defense and aerospace industry that we have a strong pipeline. That's really what I'm talking about.

Yes, on top of that, we have medical – I mean, we have a medical customer and industrial customers that want to outsource, but it's a process that, as I said earlier, will be a little bit slower, but we do expect more outsourcing percentage wise from their industry in next 12 months and some other industries.

Alex Blanton – Ingalls & Snyder

Okay. All right, thank you.

Jure Sola

Thanks, Alex.

Operator

Your next question is from the line of Joe Wittine with Longbow Research.

Jure Sola

Hello, Joe.

Joe Wittine – Longbow Research

Hi, good afternoon. Most of my questions have been answered at this point. But I just want to hit on a couple of points that you mentioned in your prepared remarks. The first was regarding component sourcing, you were having some difficulties, which is I guess surprising based on everything we've heard. Just wanted to see if you have any additional details on what type of components, where there is shortage – where there are on shortage, I guess, and whether it prevented you from shipping during the December quarter.

Jure Sola

Yes. Well, first of all, shortage is – you know just as good as I do, most of the shortage is coming from the semiconductor devices side out there and it's across different types, from logics to let's say to discrete capacitors, memory, that's where the majority – especially the custom stuff. I would say that our supply chain did a really good job meeting most of the customer requirements. There were few jobs that were pushed out, which completely without all – how do I say – there is not much we can do when the shortage is out there, but customers understood this problem. So there really – there was no major impact on us.

And I personally believe this will continue to be challenging at least for the next 90 days. It's getting better, but the trends on the economy, we might have this type of challenges for rest of the year because some of the component suppliers are not adding enough capacity because they got burned in 2009. So I think they are – they are moving slow, but the – I would give a lot of credit to our supply chain, working very closely with our customers and our suppliers and I think we did overall a pretty good job.

Joe Wittine – Longbow Research

Great. Thanks for that.

Jure Sola

Thanks. Joe.

Joe Wittine – Longbow Research

And then one more thing real quick. Bob mentioned in his prepared remarks when he was talking about the incremental gross margins in the business. I think there was – there is additional mix improvement ahead due to some vertical – or I'm sorry, vertical integration activity. I just want to see exactly what you meant by that, Bob. Is that – are you just talking about components getting more utilized and the flow through to any of [ph] your other businesses from that?

Bob Eulau

Yes, I think it's – your comment, that's what Jure said earlier. We have a big opportunity with the components businesses. They are still below their corporate average gross margin and we think that eventually they will be above average and we think we can shift to where we get a bigger piece of our revenue from that part of the business.

Joe Wittine – Longbow Research

Okay, guys. Congratulations on the great guidance.

Jure Sola

Thanks.

Bob Eulau

Thanks.

Operator

Your next question is from the line of Sean Hannan with Needham.

Sean Hannan – Needham

Yes. Good afternoon. How are you?

Jure Sola

Great, great, Sean.

Sean Hannan – Needham

On – just if I can follow up on the components topic for a little bit, first off, is there a book-to-bill that you have specifics for that business for the quarter?

Jure Sola

It was better than our corporate average.

Sean Hannan – Needham

Okay. And then separately, is there a way – can you talk a little bit around where the components business becomes increasingly more strategic? So are there specific vertical markets or segments such as industrial, defense or what have you where this capability is perhaps more important to you today as you kind of readdress your business than versus say a year ago?

Jure Sola

Yes. Well, Sean, I think the whole modeling is designed around focusing on infrastructure type of products, okay? So if you look at let's say communication side of the business, it's a networking wireless, wire line infrastructure. These types of products require leading-edge printed circuit boards; they require large backplanes, lot of enclosure, lot of metal, lot of precision machining, lot of optical components and lot of custom memory. We are lined up to support those types of businesses.

Enterprise computing and storage is very similar. It's again – maybe it's not as high a mix as maybe some of the communication, but it requires some leading-edge printed circuit boards, leading-edge backplanes, advanced metal and so on and optics. Industrial, defense, and medial, a similar situation. Here, you have a high mix, low volume. To get into the military business, a lot of times it starts with the bare boards [ph]. We are building some of the very exotic type of materials, we are growing the business and the goal is to take that to the full system assembly as that industry sounds exciting to outsource.

If you look at the renewable energy on mechanical side, well, it requires a lot of machining, lot of sheet metal, lot of cabling. That's the area that we fit in well and the infrastructure of our components is really designed to support those types of products.

Medical, same thing. If you are talking about CT machines or MRI machines, they require a lot of machining both in metal, steel, frame – building the frames, plastic, different electronics and then of course final – that's what – that how we are set up. So our vertical is really very critical to success of our model that we are trying to offer in our customer end-to-end, Sean.

And I know during the – when Sanmina-SCI went through its major restructuring, we had to move for cost reasons a lot of these capabilities from North America and Europe to the low-cost regions. So it took a long time to accomplish that. Now, we are done with that. So really the model now, it’s all about execution and growing the businesses again. But to maximize the margins in a model that we want to go to where we want to be, let's say a $10 billion company and have the best industry margins, we have to have the models of vertical integration.

Sean Hannan – Needham

Sure, Jure. I followed the argument around the value add of the vertical approach. I just was trying to determine around – is there something that has changed strategically for how you've approached the components piece and how that plays into some of these segments? Or is there an increased importance around some of these things where you are going to be able to i.e., some better leverage perhaps based on some of the opportunities that you are seeing?

Jure Sola

Well, definitely. I think we added a lot of capabilities in our optical capabilities today that we did not have let's say 18 months ago. We invested heavily in leading-edge high-tech printed circuit boards. And that's – so we've been really investing in some more leading edge to bring up the technology up to be able to resolve it.

At the same time, we are working very close with our customers, how can we sell more engineering, more value add. So this – strategically, for us to get to the margins and to have a sustainable growth longer term, we have to connect all the dots. You got to sell it at the end to end to maximize that long-term relationship and also the margins.

Sean Hannan – Needham

Okay. Thank you.

Jure Sola

Bye-bye.

Operator

Your next question is from the line Brian Alexander with Raymond James.

Brian Alexander – Raymond James

Yes. Following up on the –

Jure Sola

Hi, Brian.

Brian Alexander – Raymond James

How are you doing? Just following up on a couple of questions that were asked before on contribution margins and I guess what I'm struggling with is you've reported two quarters in a row where your incremental gross profit to revenue is about 12% to 13%. And if we look at your objectives, as $1.9 billion roughly in revenue a quarter and a 10% gross margin; that would imply incremental gross profit of 18.5%.

And I guess I'm struggling with why would we such an acceleration in the incremental gross profit dollar to revenue relationship as you get closer to full capacity, I would think you would actually need to expand capacity and that would actually slow down or accelerate, but I must be missing something.

Jure Sola

Well, Brian, let me give you a couple of facts. First of all, we are long away from full capacity. We don't have to build a new – new factories to be shipping $2 billion a quarter, okay? Well, first of all, my goal is how do I get to $1.8 billion first and then I'm going to worry about $2 billion.

So – but as we – this – we can today be shipping well over $2 billion per quarter with the right mix. Of course, there is never such a thing as a perfect mix and we will continue to invest in a certain unique capabilities to expand, but I think what reasons that we believe that our components business has been underperforming and circuit boards have $0.40 in every dollar contribution margin, okay? As you get into the metal and fabrication and the plastic fabrication and backplanes and so on, contribution margin on that stuff is closer to 20%. So it's – really, it's a mixture of our product mix that we are going after.

Also, as we grow our – the businesses industrial and our defense businesses where the defense margin could be three times better than our – the typical EMS margins. And we've been – and as you get into optical margin, we've been heavily investing into engineering side of the business so that we don't – we do more than just putting a bunch of components on a board.

And that's how – all those things, that's how you get to the margin because we want to be a different EMS company. We purposely brought the company down to be a smaller company so that we can establish the foundation again and have a better control of what we want to take and generate the right financial metrics that our shareholders deserve.

Brian Alexander – Raymond James

On the topic of transparency, are you considering expanding your disclosures on some of those components businesses that have such high contribution margins or no?

Jure Sola

Well, yes. If you look at those businesses today, it's about a $1 billion business. We used to have a $3 billion business in our components business. I mean, we can – we can double that with the existing footprint that we have as we grow. So there is a lot of upside. And I – and we – I feel very comfortable. Let us get to a first of all to over 8% margin, then – and get operating margin over 4%, which I think we are going to accomplish hopefully sooner than later and I think then the story is going to be more believable [ph]. At the end of the day, we have to deliver.

Brian Alexander – Raymond James

Thank you very much.

Jure Sola

Thanks, Brian. We have time for one more question.

Operator

Your final question is from the line of Todd Coupland with CIBC.

Jure Sola

Hello, Todd.

Todd Coupland – CIBC

Yes, good evening, everyone.

Jure Sola

We left the best for the last.

Todd Coupland – CIBC

Excellent, I appreciate it very much. One financial question and then one market question. In terms of your target model of 6% op margins, would the only thing we need to subtract from that is your $100 million plus in interest and taxes of 22%?

Bob Eulau

Yes, that’s correct.

Todd Coupland – CIBC

Okay. So basically, the earnings leverage is, call it $3.50 to $4 a share or something like that?

Bob Eulau

Yes.

Todd Coupland – CIBC

Secondly, when we listened to some of the OEMs report and give guidance for the first quarter and they were received somewhat poorly by the market, IBM and Intel, and I just wanted to try and true that up with your optimism on the overall market. They are basically talking, "We need to get farther into 2010 to see what the markets look like."

And what I'm hearing today from you guys is we are hearing from both enterprise and consumer customers that the turn is happening and we are going to see sequential growth, which is probably going to lead to double-digit minimum revenue growth for us in 2010. And I'm just wondering is it just conservatism of the OEMs or is your – your visibility has just improved that much from where it was a few months ago?

Jure Sola

Todd, I think it's hard to compare the companies that you mentioned. These are multi-billion dollar companies, okay? We are a small company. If you look at our run rate, what we are guiding is a $6 billion run rate company and hopefully, we can be bigger than $6 billion, but that's kind of where we are at. I mean, we are not an expert on economy, I don't think anybody in this room is, even my CFO is smiling at me.

I would say that the – everything that I can see is based on what I'm getting from our customers and we got hit pretty bad in 2009. So we are coming out of that pretty nicely based on information and the forecast that we are getting from our key customers and I – again, Todd, this is also important on what projects you want. Some of our customers – we have customers out there that – to outside world, they are not growing at all, but we have projects internally that are growing 30% a year and these are $100 million projects, for us. And that – so it depends on what programs you involve and are these new programs or old programs.

So all of these things are hard – hard to forecast. But I feel very comfortable that our company, unless a whole disaster in economy comes tomorrow [ph], that we will be able to hopefully show some capacity growth on a quarterly basis for rest of the 2010.

Todd Coupland – CIBC

Okay. And those programs, are you willing to call out a few of the key ones, the product areas or – ?

Jure Sola

No. Well, I can't, Todd – I mean, some of the programs that I mentioned that we have a customer their outside world is growing at all, but internally we have a program of $100 million growing at 30%. It's in the communication side of our business. I mean, we have programs in other buckets too and similar thing. So we can't talk specifically about the customer. I think it's – I think it's hard to compare our business to a multi-billion dollar company. But even if you look at our – I mean, what Apple announced yesterday, I mean, they are very positive about 2010. We don't do any business with them, but they are positive.

Todd Coupland – CIBC

Okay, that's helpful. Thanks very much.

Jure Sola

Thanks, Todd. Well, ladies and gentlemen, that’s the end of our call today. I want to first of all thank you for participating. If you guys have any more questions, please give us a call. Between Paige, myself and Bob, we'll make sure we get back to you. Thanks a lot.

Bob Eulau

Thank you.

Operator

Thank you for joining today's conference call. You may now disconnect.

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Source: Sanmina-SCI Corporation F1Q10 (Qtr End 01/02/10) Earnings Call Transcript
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