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Edited Transcript of SANM earnings conference call or presentation 24-Apr-17 9:00pm GMT

Thomson Reuters StreetEvents

Q2 2017 Sanmina Corp Earnings Call

SAN JOSE May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of Sanmina Corp earnings conference call or presentation Monday, April 24, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jure Sola

Sanmina Corporation - Founder, Chairman and CEO

* Paige Bombino

Sanmina Corporation - VP of IR

* Robert K. Eulau

Sanmina Corporation - CFO and EVP

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Conference Call Participants

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* Christian David Schwab

Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst

* Jim Suva

Citigroup Inc., Research Division - Director

* Sean Kilian Flanagan Hannan

Needham & Company, LLC, Research Division - Senior Analyst, Electronic Manufacturing Services and Electronic Components

* Steven Bryant Fox

Cross Research LLC - MD

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Presentation

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Operator [1]

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Good evening. My name is Crystal, and I will be your conference operator today. At this time, I would like to welcome everyone to the Sanmina Corporate (sic - Sanmina Corporation) Second Quarter Fiscal 2017 Earnings Conference Call. (Operator Instructions) Thank you.

Ms. Paige Bombino, Vice President of Investor Relations, you may begin your conference.

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Paige Bombino, Sanmina Corporation - VP of IR [2]

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Thank you, Crystal. Good afternoon, ladies and gentlemen, and welcome to Sanmina's Second Quarter Fiscal 2017 Earnings Call. A copy of today's release is available on our website in the Investor Relations section. You can follow along with our prepared remarks in the slides posted on our website.

Please turn to Page 2, the safe harbor statement. During this conference call, we may make projections or other forward-looking statements regarding future events or the future financial performance of the company. We caution you that such statements are just projections. The company's actual results of operation may differ significantly as a result of various factors, including adverse changes to the key markets we target, risks arising from our international operations, competition that could cause us to lose sales, reliance on a relatively small number of customers for a majority of our sales, and other factors set forth in the company's annual and quarterly reports filed with the Securities and Exchange Commission.

You'll note in our press release and slides issued today that we have provided you with statements of operations for the 3 months and 6 months ending April 1, 2017, on a GAAP basis as well as certain non-GAAP financial information. A reconciliation between the GAAP and non-GAAP financial information is also provided in the press release and slides posted on our website.

In general, our non-GAAP information excludes restructuring costs, acquisition and integration costs, noncash stock-based compensation expense, amortization expense and certain other infrequent or unusual items to the extent material. Any comments we make on this call as it relates to the income statement measures will be directed at our non-GAAP financial results. Accordingly, unless otherwise stated in this conference call, when we refer to our gross profit, gross margin, operating income, operating margin, taxes, net income and earnings per share, we're referring to our non-GAAP information.

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

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [3]

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

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Robert K. Eulau, Sanmina Corporation - CFO and EVP [4]

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Hello, everyone.

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [5]

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

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Robert K. Eulau, Sanmina Corporation - CFO and EVP [6]

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Thanks, Jure. Please turn to Slide 3. Overall, the second quarter was another solid quarter. Revenue of $1.68 billion was up 4.4% from the second quarter last year and down 2.2% on a sequential basis. Our non-GAAP gross margin was down 10 basis points from the second quarter last year and was up 20 basis points sequentially.

Operating margin was up 10 basis points from the second quarter last year and was flat sequentially at 4.2%. Non-GAAP earnings per share was $0.76, which was up $0.13 from a year ago and up $0.01 sequentially. This was based on 77.9 million shares outstanding on a fully diluted basis. Cash flow from operations was good at $89 million for the quarter and free cash flow was $55 million. I'll discuss cash in more detail in a few minutes.

Please turn to Slide 4. From a GAAP perspective, revenue was up 4.4% from the second quarter last year and down 2.2% on a sequential basis to $1.68 billion. Reported net income of $31.7 million, which included -- which resulted in earnings per share of $0.41 for the second quarter. This was down relative to last quarter by $0.17. The decline was primarily driven by tax expense. The first quarter included a discrete tax benefit that did not recur in the second quarter.

My remaining comments will focus on the non-GAAP financials for the second quarter of fiscal year 2017. At $136.1 million, gross profit was up slightly from the prior quarter. Gross margin came in at 8.1%, which was up 20 basis points when compared to the first quarter. Operating expenses were up $1 million for the quarter at $65.2 million. This was up 20 basis points as a percent of revenue compared to Q2 -- I'm sorry, compared to Q1 at 3.9%.

Spending was up this quarter, primarily due to increased payroll tax expense that reset in the United States. At $70.9 million, operating income increased 8.5% from Q2 last year and decreased 1.1% from the prior quarter. Operating margin at 4.2% was flat with last quarter. Other income and expense at $1.4 million was abnormally low. It declined by $2.4 million when compared with last quarter. This was primarily driven by favorable forward points on foreign exchange hedging and a favorable gain on deferred compensation, which was offset in operating expenses.

The tax rate for the quarter was 15% of pretax income, which was in the range we had expected. On a non-GAAP basis, we earned $59.1 million in net income or $0.76 per share. Diluted earnings per share were up 1.4% when compared to Q1 and up 20.8% from Q2 last year. Please turn to Slide 5, where we're providing more information on the segments that we report.

As you can see from the graph on the left, the Integrated Manufacturing Solutions segment was down $32 million or 2.3% from last quarter. Our analysis indicates we could have shipped roughly $40 million more in revenue had it not been for material shortages that were caused by a combination of increased customer demand late in the quarter for new product ramps and longer lead times on certain commodities. The IMS team continued to execute well and delivered solid gross margin of 7.3% for the second quarter.

The second segment for us was Components, Products and Services. In aggregate, the revenue for this segment was down slightly, with gross margin improved 70 basis points to 10.2%. The improvement was driven by better execution in the component businesses.

On Slide 6, we are showing you our key non-GAAP profit metrics. Gross margin was 8.1% for Q2, while gross profit was flat with Q1. We have been very consistent with our gross margin range in between 7.7% to 8.2% over the last 4 years. Our operating income decreased slightly when compared to Q1 and increased $6 million or 8.5% since Q2 last year. This led to $70.9 million in operating income and operating margin of 4.2%.

Now I'd like to turn your attention to the balance sheet on Slide 7. Our cash and cash equivalents were $433 million. 62% of this cash was in the United States at the end of the quarter. Overall, the balance sheet was very similar to last quarter. Cash was up $28 million from the previous quarter, accounts receivable were down $22 million and inventory was up $55 million. Property, plant and equipment was up $2 million for the quarter.

From a liability standpoint, accounts payable were up $3 million and short-term debt was down $40 million, as we paid off the mortgage on our San Jose campus. Long-term debt was up slightly at $394 million. At the end of the quarter, our growth leverage improved to 1.0, continuing a very positive trend over the last 7 years.

Please turn to Slide 8, where we will review our balance sheet metrics for the second quarter. Cash was up $28 million from Q1. Cash flow from operations for the quarter was excellent at $89 million and net capital expenditures for the quarter were $34 million. This led to $55 million in free cash flow for the quarter. Inventory turns were impacted by material shortages caused by product ramps and longer lead times on certain commodities heading into the third quarter. Inventory dollars were up $55 million from last quarter at $1,019,000,000. Inventory turns were at 6.2.

In the lower left quadrant, we are showing cash cycle days, which combines our cycle time for inventory, accounts receivable and accounts payable. Overall, cash cycle time increased from 40.4 days last quarter to 41.9 days. This change was driven by a 3.5-day increase in inventory and a 1.1-day increase in days sales outstanding, offset by a 3.2-day increase in days payable outstanding. In spite of the inventory challenge, cash cycle days decreased by 2.7 days since Q2 of last year.

Finally, pretax return on invested capital was good at 24%. Pretax ROIC was down slightly when compared to the prior quarter, but up 1.7 percentage points when compared to Q2 last year.

Please turn to Slide 9. I would now like to share with you our guidance for the third quarter of fiscal year 2017. Our view is that revenue will be in the range of $1.7 billion to $1.8 billion. We are using a wider range this quarter because we have a number of new products ramps occurring in an environment where material availability is tightening.

We expect that gross margin will be in the range of 7.8% to 8.2%. Operating expense should be $65 million to $67 million. This leads to an operating margin in the range of 4% to 4.4%. We expect that other income and expense will be back in a more normal range of $4 million to $5 million. We expect the tax rate to be around 15%, and we expect our fully diluted share count to be around 79 million shares, plus or minus 0.5 million shares. When you consider all this guidance, we believe that we will end up with earnings per share in the range of $0.72 to $0.77.

Finally, for your cash flow modeling, we expect net capital expenditures of approximately $40 million, while depreciation and amortization will be around $30 million. Overall, our program wins and geographic diversification positions us very well for the future. Growth continues to be our #1 objective, but it's imperative that we grow with the right kind of profitable business. We are confident that we have plenty of opportunity to improve the business.

At this point, I will turn the discussion back over to Jure for more comments on our target markets and our business strategy.

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [7]

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Thanks, Bob. Ladies and gentlemen, let me review the business environment for the second quarter, add a few more comments in our outlook for the third quarter and the rest of the fiscal year 2017.

Overall, as Bob mentioned, this was a good quarter for our expectations. Revenue was slightly down quarter-over-quarter, but up year-over-year. Revenue was impacted by material shortages. I will say, operationally, we executed really well and delivered a consistent solid result. Our customer activities were strong as we continue to grow current relationships and win new programs. We had strong bookings in the second quarter. Book-to-bill was 1.1:1. Again, overall good quarter as we continue to position our company for a better future. Now please turn to Slide 11.

Let me give you some highlights of our revenue by end markets. Top 10 customers, 53.5% of our revenue. So in summary, I will say overall good demand for the second quarter. 46% of our revenue came from industrial, medical and defense. That was down slightly 1.5%. Industrial and defense was down, mainly driven by program delays on some of the new projects. Medical was nicely up on overall good demand. Industrial, medical and defense, overall strong activities in this business group continue.

Communication networks was 37% of our revenue, again down 2.8%, driven mainly by material shortages. The other parts of our business in there, optical, was stable. Overall, again, good demand in this segment.

Embedded computing and storage was 17% of our revenue, down 2.7%. Again, with some material shortages for storage, embedded computing, some program delays. Automotive in this group was up on a strong demand.

Now please turn to Slide 12. Revenue -- let me talk to you about revenue outlook by market segments for the third quarter. For the third quarter, forecasting more improvements in demand. For Industrial, medical and defense, we are forecasting to be flat in the third quarter, but we do have a good pipeline of new opportunities. For this segment, mainly what we call mission-critical products, we expect to continue to do well.

Communication and networks, we're forecasting for the quarter to be up. We're seeing a solid demand, driven by networking, IP routing and optical products. For mobile networks, mainly broadband, we're starting to see better demand. Overall, for this segment, we do have a solid pipeline of new opportunities, both with existing and new customers.

Embedded computing and storage, we're also forecasting to be up for the quarter. Computing and storage, we are forecasting to see improvements in the third quarter, as we continue to invest in cloud data businesses. It's a great market opportunity for us. Automotive is doing well as we continue to have a strong demand, driven by new projects.

Again, bookings for the second quarter were strong and we expect bookings for the third quarter to continue to be solid.

Let me make few more comments about the business environment for the fiscal year 2017. As always, global economy is hard to predict, but business environment is proving -- is improving for us and continue to expand. In this environment, I am very confident about Sanmina's future. Overall, our customer base continue to be very positive about the rest of the year. So based on that visibility and forecast, we are forecasting that fiscal year 2017 will be a solid and growth year for Sanmina.

Pipeline of existing and new opportunity is good and it's expanding, driven by new projects with existing customers, and we do have a strong pipeline of new customer opportunities. I can tell you that our strategy is working and by focusing on providing the right technology for our key customers, for mission-critical markets, driven by superior execution and our capabilities.

Now please turn to Slide 13. In summary, second quarter, we delivered consistent gross and operating margin. Our non-GAAP EPS continued to expand. We also delivered solid cash flow from operations. For the third quarter, as I said earlier, we see a good demand. We remain focused on quality of the growth, which is a key to our strategy, as we continue to have very strong customer base to build on.

For fiscal year 2017, so far first 6 months, we delivered a solid result, and we do expect stronger demand for the second half of fiscal year 2017. Again, company is doing well. We are focused in our strengths as we continue to drive profitable growth and maximize shareholders' value.

Ladies and gentlemen, now I would like to thank you all for your time and support today. Operator, we're now ready to open the lines for question and answers. Thank you again.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from Steven Fox.

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Steven Bryant Fox, Cross Research LLC - MD [2]

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

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Robert K. Eulau, Sanmina Corporation - CFO and EVP [3]

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Well, Steve, there are several -- I guess, at least a couple questions in there. We wish we knew when the tightening would stop. But mostly, what we're seeing is the extension of lead times right now. And we saw pretty good demand in the second half for the quarter, and we weren't able obviously to get that all out. Part of why we used a wider range for our guidance in the third fiscal quarter is because of that uncertainty. And we think -- we're very confident we'll be in that range of revenue. Where we'll be in that range, I can't tell you for sure. As Jure said, I mean, the demand is pretty solid from customers. We have several new significant programs that are ramping all in a time frame when, at least in the last, I'd say, 3 or 4 months, we've seen lead times extending out. So it's a little hard to say where we'll actually land.

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Steven Bryant Fox, Cross Research LLC - MD [4]

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Great. That's very helpful. And then just as a follow-up. You highlighted that, within the components margin, you're seeing better performance out of certain components. I know there's some areas that are sort of still immature in terms of sales versus areas where you've done really well over the years. So can you just sort of give us better flavor for where you're seeing some better margins on components?

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Robert K. Eulau, Sanmina Corporation - CFO and EVP [5]

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

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Operator [6]

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And your next question comes from Jim Suva with Citi.

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Jim Suva, Citigroup Inc., Research Division - Director [7]

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Jure, you made a comment that you expect the second half of the year to be better than the first, if I remember correctly.

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [8]

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That's correct.

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Jim Suva, Citigroup Inc., Research Division - Director [9]

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Can you help us understand about -- is that -- isn't that kind of normally the case for Sanmina? Or with your business changes over years is that a statement that we should think about as more positive? Or how should we kind of bracket that? And I'll probably have up a follow-up.

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [10]

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Well, if you just look at our first 6 months, I think the growth there is, year-over-year, about 8%. So it's a nice step in the right direction. I would say this year is a little bit different. I think we have a stronger backlog, and most importantly, stronger demand from our customers. And our customers are more positive, especially on the projects that we are involved in. So yes, typically, second half for us will be better than first. And our second quarter this year was better than the typical. So things are moving positive. But I think we will have to do a lot with what we accomplished. I think we positioned the company a lot better. We have a stronger customer base. And most importantly, we've got programs that are young and they have some legs. So we are excited about the future.

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Jim Suva, Citigroup Inc., Research Division - Director [11]

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

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Robert K. Eulau, Sanmina Corporation - CFO and EVP [12]

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Yes. So in terms of other income and expense, interest expense is the largest item, but a lot of volatility comes from our hedging activity. And we ended up for the last couple quarters, maybe in the last 3 quarters, we've had favorable results on the hedging side. Some of that we think is going to persist in the current environment the way the forward points are going, and we have guided down a little bit lower in terms of other income and expense and where we've been in the past. So I'd say interest expense is fairly stable and then the uncertainty is mostly around foreign exchange. And then there's also an accounting issue around deferred compensation, which impacts that line item, but it's just an offset elsewhere in the income statement.

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Operator [13]

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

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Sean Kilian Flanagan Hannan, Needham & Company, LLC, Research Division - Senior Analyst, Electronic Manufacturing Services and Electronic Components [14]

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So I wanted to see if I could ask a little bit about optical. There has been some mixed data points that have been materializing a little bit in the market. You seem to have indicated that there's stable to some bit of growth for that within your business. I just want to make sure that I understood that correctly and if you could perhaps give a little bit of color around what you're seeing in the landscape there.

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [15]

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

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Sean Kilian Flanagan Hannan, Needham & Company, LLC, Research Division - Senior Analyst, Electronic Manufacturing Services and Electronic Components [16]

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So just to clarify, though. Is the optimism coming from your ability to gain perhaps some market share penetration or your wins? Or is this also across-the-board optimism or enthusiasm coming from your customer base?

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [17]

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

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Sean Kilian Flanagan Hannan, Needham & Company, LLC, Research Division - Senior Analyst, Electronic Manufacturing Services and Electronic Components [18]

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Okay, great. And then in terms of the industrial, medical, defense business, can you talk a little bit about the ramps you're seeing, to what extent or duration? When you look at the business you've won here, does this continue to tick up through the end this year and forward? I know it can take a long time in order to get to full production ramps. Or by the time we get to the end of fiscal '17, what we're seeing right now, perhaps through the law of numbers, instead kind of indicate a slower growth rate? Any color would be great.

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [19]

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Yes, for industrial, defense and medical, and I'll break them down into 3 groups. I think for industrial, we're well positioned, and the customer base that we have is pretty solid and the projects that we're involved. So I expect that business to continue to be solid and expand, not just for 2017 but also beyond 2017, as we have some programs here that are long, long term. On medical, I think we're well positioned there. We continue to invest in that side of the business. We're committed to that side of the business. It takes long time to win the right medical projects, especially the ones that we go after, which are higher mix, lower volume. I think that group is solid. We have a fair amount of new programs in our pipeline, and we expect that to really continue to grow beyond 2017. And on defense, I think that business for us is coming back. We are best positioned all the way from a components side, product side, and we're starting to get more involved in the systems side on the defense part of the business. I think we have a huge opportunity in defense side of our business, except it takes a long time to win those projects, but I like the way we are positioned. So back to Sean on the industrial, medical and defense, I think that group for us is going to be a solid. And in absolute dollars, we like to grow that, continue to grow, and I think it will. So with that, any other questions?

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Operator [20]

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

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [21]

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Can you please elaborate on the material shortages in each business and what you're seeing? And how long -- what exactly -- which material that is? And how much longer you would anticipate that being kind of a headwind?

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Robert K. Eulau, Sanmina Corporation - CFO and EVP [22]

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Yes, I'll take that, Christian. And I really can't elaborate much more than what I did before. I can tell you, our supply chain team, coupled with our customers, have worked really hard on this over the last 3 or 4 months. And we definitely had a scenario across multiple commodity types where we're seeing lead times extend out. So it's a challenge. And particularly as we had demand later in the quarter, it was a challenge to get that fulfilled within the quarter. It's a tight environment. I don't think it's dramatic at this stage, and we think we can continue to work through it. We are expecting to get most of the revenue we missed this quarter next quarter.

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [23]

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But can you -- you don't want to elaborate on what -- whether it's memory or et cetera, that's causing a bottleneck in certain applications? You don't want to talk about what material shortage -- what materials that is?

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Robert K. Eulau, Sanmina Corporation - CFO and EVP [24]

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

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Christian David Schwab, Craig-Hallum Capital Group LLC, Research Division - Senior Research Analyst [25]

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Right, right. I'll ask one more time, and maybe [some more]. Are you're going to tell us -- do you want to elaborate on what those materials are or not?

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [26]

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If I can add to that, Christian, I think it's really across the board. I don't think we'd export it. I know what questions you -- I wish we can tell you exactly how long this is going to last or what it is. I think it's just an overall -- I think it's a combination, as Bob mentioned, planning. I mean, demand is stronger. I think our customers, maybe didn't do as good planning in some of these cases. There's a fair amount of custom parts that are harder to get because of lead times and things like that. So we do expect that -- this to continue definitely in the short term. And as Bob mentioned, I think we have this thing covered, and I think we'll be able to control what we need to ship.

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

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Robert K. Eulau, Sanmina Corporation - CFO and EVP [27]

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Thanks, everyone.

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Jure Sola, Sanmina Corporation - Founder, Chairman and CEO [28]

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Bye-bye.

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Operator [29]

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