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Good day and thank you for standing by. Welcome to Sanmina Corporation's third quarter fiscal 2021 earnings conference call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions].
I would now like to hand the conference over to Paige Melching. Thank you. Please go ahead.
Thank you Erica. Good afternoon, ladies and gentlemen and welcome to Sanmina's third quarter fiscal 2021 earnings call. A copy of our press release and the slides for today's discussion are available on our website at sanmina.com in the Investor Relations section.
Joining me on today's call is Jure Sola, Chairman and Chief Executive Officer.
Good afternoon.
And Kurt Adzema, Executive Vice President and Chief Financial Officer.
Good afternoon.
Before we began our prepared remarks, let me remind everyone that today's call is being webcasted and recorded and will be available on our website. You can follow along with our prepared remarks in the slides provided on our website.
Please turn to slide three of our presentation or our press release Safe Harbor statement. During this conference call, we may make projections or other forward-looking statements regarding the future events or future financial performance of the company. We caution you that such statements are just projections. The company's actual results could differ materially from those projected in these statements as a result of a number of factors set forth in the company's annual and quarterly reports filed with the Securities and Exchange Commission. The company is under no obligation to and expressly disclaims any such obligation to update or alter any of the forward-looking statements made in the earnings release and the earnings presentation, this conference call or the Investor Relations section of our website, whether as a result of new information, future events or otherwise, unless otherwise required by law.
Included in our press release and slides issued today, we have provided you with statements of operations for the quarter ended July 3, 2021 on a GAAP basis as well as certain non-GAAP financial information. A reconciliation between the GAAP and non-GAAP financial information is also provided in the press release and slides posted on our website. In general, our non-GAAP information excludes restructuring costs, acquisition and integration costs, non-cash stock-based compensation expense, amortization expense and other unusual or infrequent items. Any comments we make on this call as it relates to the income statement measures will be directed at our non-GAAP financial information. Accordingly, unless otherwise stated in this conference call, when we refer to gross profit, gross margin, operating income, operating margin, taxes, net income and earnings per share, we are referring to our non-GAAP information.
I would now like to turn the call over to Jure Sola.
Thanks Paige. Good afternoon ladies and gentlemen and welcome. Thank you all for being here with us today. I would like to make a few comments before I turn it over to our CFO.
First, I would like to take this opportunity to say thank you to our leadership team and our employees for managing around COVID and component shortages. Our team did a great job. And most important, we were able to meet critical needs of our customers. Despite all these changes or challenges, Sanmina delivered strong financial results for the third quarter fiscal year 2021.
So for our agenda today, we have is Kurt, our CFO, will review our detail Q3 results. I will follow-up with additional comments about Sanmina results and future goals. Then Kurt and I will open for question-and-answers.
And now, I would like to turn this call over to Kurt. Kurt?
Thanks Jure. Please turn to slide five. In the third quarter, our team did an excellent job of managing through the increasing prevalence of supply chain constraints leading to strong margins and profitability as well as cash generation. Q3 revenue of $1.66 billion was slightly below our outlook of $1.675 billion to $1.775 billion. Demand was strong. However, we believe revenue was impacted by more than $150 million due to supply chain constraints.
Non-GAAP gross margin was 8.5%. Non-GAAP operating margin was 5%, consistent with the prior quarter. Non-GAAP fully diluted earnings per share of $0.99 exceeded our outlook of $0.84 to $0.94, primarily as a result of better-than-expected gross margin. Finally, GAAP EPS was $1.74.
During the quarter, we had a gain of $43.4 million related to the release of certain foreign tax reserves, a gain of 8.4 million related to the liquidation of one of our foreign subsidiaries, and other income of $15 million related to the sale of IP. Each of these items has been excluded from our non-GAAP results.
Please turn to slide six. This slide shows the quarterly trend of our financial results. You can see our team did an excellent job of managing the business during this dynamic period. Non-GAAP gross margins have exceeded 8% for the last five consecutive quarters. Non-GAAP operating margins have been 5% or greater for the last four consecutive quarters.
If we compare our Q3 FY 2021 results to Q3 FY 2020, you can see on approximately the same level of revenue, gross margin has improved from 8.1% to 8.5%, operating margin has improved from 4.6% to 5%, and non-GAAP EPS has improved from $0.86 to $0.99. We have learned a lot over the last 12 months and the hard work and focus of our team is demonstrated by this year-over-year improvement. Furthermore, we believe our revenue will increase and our margins will continue to improve as material supply chain constraints resolve.
Now please turn to slide seven. IMS revenue was $1.35 billion. The decline in revenue from Q2 was primarily due to the impact of supply chain constraints. Non-GAAP gross margin for IMS improved to 7.6% due to favorable mix and a one-time release of a $2.2 million customer-specific inventory reserve. Components, products, and services revenue declined to $345 million due primarily to the impact of supply chain constraints.
Non-GAAP gross margin for CPS declined to 11.4%, primarily due to the impact of lower revenue, less favorable mix, and costs associated with ramping of several new defense-related programs. We expect non-GAAP CPS gross margin to return to a more normalized level in Q4 and to subsequently improve thereafter. Again, our overall non-GAAP gross margin was 8.5%. In summary, we believe our revenue will increase and our margins continue to improve for both IMS and CPS segments as supply chain constraints resolve.
Now please turn to slide eight. Let's talk about the balance sheet. Our cash flow generation and balance sheet remained strong. We generated $104 million of cash from operations and $92 million of free cash flow in Q3. We have generated $327 million of cash from operations and $279 million of free cash flow over the last 12 months. During the quarter, we repurchased 300,000 shares for a total cost of approximately $12.2 million. At the end of the quarter, we still have remaining repurchase authorization of $113 million.
Q3 net capital expenditures were $17.2 million compared to depreciation of $27.1 million. Cash and cash equivalents increased by $49 million to $624 million. Between cash and availability under our revolver and other debt facilities, we have approximately $1.4 billion of liquidity. Overall, our strong cash flow and balance sheet gives us the flexibility to support our long-term business objectives and to manage in a dynamic market environment.
Now please turn to slide nine. Inventory was up approximately $108 million, given the supply chain challenges. We expect to use this inventory over time and to return to a more normalized level as supply constraints are resolved. Cash cycle days were 58.4. Non-GAAP pre-tax return on invested capital was 25.9%.
If you now please turn to slide 10, we can talk about the outlook for Q4. Overall customer demand is strong but there continues to be supply chain challenges. We expect Q4 revenues to grow and be in the range of $1.65 billion to $1.75 billion. Please note, for comparison purposes Q4 of fiscal 2021 does not have 14 weeks like Q4 of fiscal 2020 did. Non-GAAP gross margin we expect in the range of 8.1% to 8.6%, non-GAAP operating expenses in the range of $57 million to $59 million and non-GAAP operating margin in the range of 4.6% to 5.2%.
We expect non-GAAP other expenses of approximately $4.5 million as well as non-GAAP tax rate of approximately 17% and non-GAAP fully diluted shares of approximately 67.5 million. When you consider all this guidance, our outlook for non-GAAP diluted earnings per share is in the range of $0.93 to $1.03. We expect capital expenditures to be around $25 million, driven by growth of new programs and depreciation to be about $28 million.
Assuming we achieve the midpoint of the EPS outlook for Q4, FY 2021 non-GAAP EPS would be approximately $4. This would compare to FY 2020 non-GAAP EPS of $3.05, which would be approximately a 30% growth year-over-year.
In summary, demand remained strong across our customer base. I am confident that our lean manufacturing business model positions us well, and I expect the company to deliver strong operating leverage and cash flow generation over time as supply chain constraints are resolved.
And with that, I will now turn it back to Jure.
Thanks Kurt. Ladies and gentlemen, let me tell you more about the business environment for the third quarter and I will talk about outlook for the fourth quarter and outlook for fiscal year 2022. Again, as you heard from Kurt, Sanmina delivered respectable results for the third quarter with strong margins and strong free cash flow. Material shortages continue to impact revenue growth, both for IMS and CPS businesses.
Let we talk to you about some key drivers in the third quarter. We had a strong demand. This was broad-based and market demand. Our supply chain team did an excellent job in this environment and we had a great operational execution. Through our operational flexibility, we delivered critical requirements for our customers. And the business mix was good, driven mainly by new projects.
Now let me tell about the new facility that we added in Eastern Europe. During the third quarter, Sanmina expanded Eastern European operations by acquiring a state-of-art manufacturing operations in Bulgaria. It's going to be extension of our Hungarian operations. It is fully operational IMS facility with highly skilled staff and strategically located to serve European customers. This factory was formally owned by a large European technology company. I would like to take this opportunity to welcome the Bulgarian team to Sanmina family. So in summary, Sanmina is executing well in this dynamic environment as we continue to work very closely with our customers and our suppliers.
Please turn to slide 12. Let me tell you more about the third quarter revenue by end markets. Demand for our product and services continues to grow. Top 10 customers were 50.9% of our third quarter revenue. Communication networks and cloud infrastructure was 42% and industrial, medical, defense and automotive were 58% of our revenue. Material shortages did impact third quarter revenue by approximately $150-plus million. Now let me tell you about the bookings. Bookings continue to be strong, both from existing and new projects. Book-to-bill for the quarter was over 1.1.
Please turn to slide 13. Let me give you few comments for the fourth quarter and outlook by market segments. Overall for the fourth quarter, we are seeing a relatively strong demand. For communications networks and cloud computing, which involves networking, advanced optical systems, IP routing, 5G mobile networks and high-end computing and storage, we are forecasting for this segment to be up for the quarter. For industrial, medical, defense and automotive, for this group we are forecasting flat to up. Let me give you more details. For industrial, we see good demand during the quarter. For medical, stable demand, I will call it flat, for the quarter, but we see demand going up. defense, strong demand and that continues to expand. Automotive, we are forecasting for this quarter flat to up but with longer term strong demand.
Despite challenges around supply chain, we expect to finish fourth quarter strong. As Kurt mentioned, based on present customer forecast, we expect to finish our fiscal year 2021 strong by delivering non-GAAP EPS growth for the year approximately 30%. We also will deliver nice expansion of margins and strong cash flow. I can also tell you that the pipeline of growth opportunities remain very healthy. The key for us is to continue to manage the supply chain and work around the COVID daily challenges. I are very confident in our management team that we will manage through this successfully.
Please turn to slide 14. Let me highlight few things when it comes to elements of a long term margin improvement for fiscal year 2022 and beyond. As you look at Sanmina, we have a lot of operating leverage left in Sanmina's business model. I can tell you that Sanmina's strategy is working. We are delivering competitive advantage to our customers around the world. We are focused on driving sustainable and profitable revenue growth. For fiscal year 2022, we expect to see nice growth in IMS and CPS. Growth in IMS and CPS will be driven by ramp-up of new programs in our targeted markets. We also believe that we will continue to improve margins in fiscal year 2022 and beyond by improving efficiencies. As the supply chain improves, we believe that efficiencies will go up, our capacity utilization will go up and we can leverage our OpEx as drive the growth. Again, we expect to see growth in revenue and margin expansion in fiscal 2022.
Please turn to slide 15. In summary, for third quarter, we delivered respectable results. Revenue impacted by supply chain constraints, as you heard from Kurt and myself. We delivered consistent operating margin around 5%. Non-GAAP diluted EPS of $0.99 exceeded our outlook. We delivered strong free cash flow in the quarter of $92 million and non-GAAP ROIC of 25.9%. So overall, as I said, very respectable quarter.
So for the fourth quarter, I can tell you the fourth quarter demand remains strong. We are working closely with our customers and suppliers to meet critical requirements. Revenue outlook will grow between $1.65 billion and $1.75 billion. And non-GAAP diluted EPS outlook at this time is $0.93 to $1.03.
So now, ladies and gentlemen, I would like to thank you all for your time and support. Operator, now we are ready to open the lines for question-and-answers. Thank you again.
[Operator Instructions]. Your first question is from Ruplu Bhattacharya with Bank of America.
Hi. Thank you for taking my questions. Jure, most of the companies that we have heard from, they are talking about component shortages lasting well into next year. So can you give us an idea for fiscal 4Q, how much of an impact on revenues have you baked into the guidance? And what is giving the confidence in CPS margin improvement if revenue constraints are still there, then what is giving the confidence that next quarter the CPS margins can be better?
Okay. Ruplu, first of all, when it comes to knowing what's going to happen with material supply at this time, it is very hard to forecast. We think definitely it's going to continue to be challenging through the rest of this calendar year. We hope to see some improvements after that. So, if you look at the fourth quarter, we can definitely ship more than what we guide and if we can get material. So, our forecast includes all the potential shortages that we have. We talk to our customers, suppliers. So we feel very confident about our guidance, but we definitely could ship a lot more.
When it comes to the margin on CPS, is that definitely if you look at, let's look at the product services. Those margins run around 20%-plus potentially. I think in the short term, we see nice improvements in our component businesses on our high technology circuit boards. We see in our optical components improvements. We expect to see nice improvements in our defense group. And as you put those together, I believe you are going to see nice improvements in the fourth quarter. And longer term, we expect those to continue to move in the right direction, and our internal goal on that is to be over 15%.
Got it. Thanks for the details on that, Jure. In terms of just building on the component shortages, can you talk about which components you are seeing shortages in? And is it impacting any one end-market more than the other?
Well, most of the products that we are doing is, we do a lot with a lot of custom products and a lot of them are single sourced. So, the biggest issue is the custom around semi. And that's what has been a challenge for us, and it's been a major impact in some of the high end companies in the military side of our business, in security and networking and optical side of the business. So that's been a biggest impact for us.
Got it. And just talking on optical, Jure, can you give us some details on the communications end-market? Last quarter, you had expected that that market would have strong demand and would be up sequentially. Can you just tell us what you saw in networking, optical, IP routing, all of the different components within that? Was there any strength or weakness in any of these segments?
Actually, for us, it was really strong demand across all those segments. As we said earlier, we missed approximately $150 million in revenue because of material. So, that was across all our markets, but a fair amount was around that segment in our communication networks.
Got it. And maybe the last one, if I can ask. Kurt, can you give us your thoughts on working capital management? You talked about inventory being sequentially up. But then as we look forward, any guidance you have? What is your target on in terms of cash conversion cycle for this year? Should we think about free cash flow for this year? Thank you.
Sure. Let's focus on inventory first. I think the key to when we said we would return to more normalized levels of inventory when the supply chain constraints are resolved. So, if you look at what Jure talked about, we expect that to go into early part of next year. So it's going to take multiple quarters. That being said, we are running inventory turns in the high sevens. And so, I would expect to get back in that range as supply chain constraints resolve. That being said, I think you asked a question about cash flow and cash cycle days. Our cash flow remains incredibly strong. And I expect that to continue. We talked about CapEx being a little bit higher this quarter just because we are ramping some new programs, but still less than depreciation. So, I expect cash flow generation to continue to be really strong even with the challenges that we are seeing. And then obviously, as the supply chain constraints get resolved, and therefore we have higher revenue and hopefully better margins, then it will get even better. But I think we can continue to generate strong cash flow even at these levels.
Okay. Thanks for all the details. I appreciate it.
Thanks a lot.
Your next question is from Jim Suva with Citigroup Investment.
Hello Jim.
And congratulations to your team in such a challenging environment.
Thanks Jim.
Given that environment is quite challenging, are you having to like renegotiate price or put in cost-adders. I know you do also metal products and a lot of components whether it's copper, aluminum, steel, plastic, resins, have going up. Can you talk a little bit about your contracts with customers or do they have like cost-plus for the most part? Just trying to see how protected you are in a component raising cost environment?
Yes. Jim, it's excellent question. First of all, let me kind of give you a summary answer. On most of those, the answer is yes, that we get covered when materials go up, we are covered in most of our contracts. We have few contracts that is our responsibility, especially on the products that we design and build that comes to Sanmina. On our government contracts, it's cost-plus. So, overall we are well covered on that stuff. But unfortunately, it takes time to increase those adders, as you mentioned. Everything then comes to raw material to chemicals to semiconductors, prices are up. But our customers are being fully flexible. They understand what's going on, and I think our competitors are doing the same thing.
And then my follow-up question is on your new facility. I believe you said it was Bulgaria. I may have had that wrong.
That's correct.
Does it also come with production agreements or equipment? Or what's it kind of set up for? And again any revenue run rate that came with it? Are is it kind of starting from scratch?
Definitely, let me just tell you a little overview. This factory was built about three years ago. It's a state-of-art factory. It's designed for high technology IMS manufacturing, end-to-end. It does come with some business. It's not material, but it really helps us because you know, we have approximately 700 people in the plant that are well-trained. So overall, we like this project. We needed expansion in Eastern Europe. So it's a perfect fit.
Okay. My last question. Can you talk a little about what type of end-markets it serves so we can just kind of be aware about that.
Right now, a fair amount is a automotive part of the business. But we are adding other parts to it. As I said earlier, this will be extension of our Hungarian operation. So we have a fair amount of business that we can be overflowing to this factory in the near future.
Thank you so much for additional clarification and details. It's appreciated.
Thanks Jim.
[Operator Instructions]. Your next question is from Christian Schwab with Craig-Hallum Capital Group.
Hi. Congrats guys on another good quarter on gross margins.
Thanks Christian.
I just have one quick question regarding the custom semiconductor use in a lot of your different products that you are making for people. Is there any one area that you guys are sitting here and thinking it might open up for you specifically faster? I know some of your leading communication customers have multiple vendors for their chipset now. But I also know there is a lot of scrambling going on in every area. Is there one area or another that you think opens up first? Or do you think it all gradually improves at the same pace?
First of all, I like your words, there is a lot of scrambling going on around, Christian, right now. It depends on our customers. Some customers have a lot stronger relationship with some certain semiconductor companies. Some customers ordered some of these things long time ago. So we are getting better flexibility. And some of these, we just have to chase everyday. But overall, I just don't see major improvements in the short term. We are hoping that we are going to see some in the fourth quarter. But we will see how things shake out. I think overall we are getting a little bit better because we have been chasing some of these parts for the last six-plus months. So in some cases, we can see visibility is a little bit better. At the same time, our customers are working with us and they have given us a longer forecast and longer commitments where there are some guaranteed contracts going on. So we can go an make a commitment on these component. So hoping, combining all of this through better planning, better commitments that material overall will improve. But as I said earlier, a lot of the stuff that we buy is custom and single source. So that becomes a bigger impact.
Right. And then I just wanted to clarify, the $150 million that you kind of lost in potential revenue this quarter due to material shortages, we shouldn't assume any of those as lost demand, right? That's, we are just waiting on components, given the fact that a lot of stuff you doing this is sole-source work? Is that fair?
Yes. That's a fair statement. We don't expect that as lost. They have just been pushed out from last quarter to this quarter. And hopefully, I know there will be some push-out in quarter because of not getting enough material. But overall, it will just kind of move to the next quarter at this time.
Great. No other questions. Thank you.
Well, thanks. Well, ladies and gentlemen, thanks for your time and I appreciated all your comments. If you have any more questions, please let us know. In the meantime, we will be talking to you 90 days from now. Thank you very much. Bye-bye.
Thank you.
This concludes today's conference call. Thank you for participating. You may now disconnect.