Flex Ltd. (FLEX) Earnings Call Transcript & Summary

Good afternoon, everyone, and welcome to the 48th J.P. Morgan TMC Conference first virtual version thereof. And it's my pleasure to introduce Revathi Advaithi, the CEO of Flex, to this call; and Chris Collier, the CFO. Good afternoon -- or good morning to you. I think you're on the West Coast, right?

Yes. Good afternoon.

Hi, Paul.

All right. So before we start, a couple of housekeeping notes. This is a fireside chat Q&A. The audience can participate by contributing Q&A. And you'll see a little button at the top or bottom of your screen, just tap on that, type in your question, and I will do my best to incorporate it into the discussion. The second thing is, as a reminder, forward-looking comments will be made. So please refer to the safe harbor statements that Flex has published and then other disclosures on the IR section at flex.com.

So as I said, good afternoon, Revathi. Thanks so much for joining us. Let's start off with -- well, you reported very recently. So the story is fairly fresh. What -- tell us a little bit about how you closed out the year?

Yes. So it was a strong year for us. Paul, as you know, I started my role last year, the beginning of last year, February. For us, fiscal year goes from March to -- April to March. We started the year kind of saying, "Hey, we'd be in an EPS range of $1.20 to $1.30." And as the year unfolded, we had many events that came our way kind of the big event of the trade issues associated with China, and then most recently, in Q4, the COVID-related issue. And with all of that, we had a very strong performance in the year. We also took several portfolio actions during the year, where we exited around $1 billion of nonstrategic business. And with all of that, we came in within the range of what we said for our EPS commitment at $1.23, which was a record EPS for us. But more importantly, we showed consistent margin expansion quarter-over-quarter. And the company, as a whole, as they performed really strongly from every financial aspect, right, from margin expansion, from EPS, cash was very strong in all quarters, we converted very well. So very pleased with the performance, right set of actions, amazing stability in a time like this and really showing that, as a company, we're executing well with discipline, really managing cost efficiencies while taking portfolio actions, focused on cash. All the things a good company would do, really, Flex is exhibiting. And I would say we're very pleased with fiscal '20 results.

No, I think it was a very purposeful culling of the portfolio. Perhaps you can just remind people what you did and why you did that?

Yes. So it's -- I've said this before many times. If you look at our overall portfolio, very diverse set of end markets, right? We have our health sector, our automotive sector, our industrial business. We have a very strong CEC business, which is our cloud communications business, and then our consumer-end segments, consumer device and segments in lifestyle. So if you think about how we have grown over the years, right, we have had a large portion of our portfolio that is in this kind of very cyclical, lower margin-type business. And what we decided to do pretty early on in the year, that there were some very obvious parts of the portfolio which were very high-cycle and in very sizable scale businesses that we thought we should exit because it was hard to manage those businesses through the cycle. Product life cycles were short, and so we made the decision to exit kind of the consumer device, mobile side of our segment, particularly with certain sets of customers based in China and India and reduced that size of our portfolio pretty significantly. It was a little over $1 billion, so a fairly good size, is what we decided. We also continued to downsize our lifestyle kind of end-consumer segments, smaller customers that were unprofitable. We continued to clean that up. All that being said, Paul, I always say this that our job will continuously be to manage the portfolio and improve the mix. That job never ends. And I always tell my team that our big focus should be to make our good businesses bigger and our not-so-good businesses smaller. So managing mix will be a continued theme for me. Doesn't matter how many years I'm in the job, I think we'll continue to do that and do that well.

Got it. And so a continuous process. But nonetheless, the heavy lifting of the big transformation that you initially wanted to affect has now been done, right?

Right. Yes. That's right.

Yes. Okay. Got it. So within -- you entered fourth quarter and things looked pretty well. And by the way, I think investors were very pleased with the transformation that they've seen so far and the strategy that was outlined at the Analyst Day recently. But nonetheless, noticeably, you got slammed by COVID-19. How did the quarter evolve sequentially?

Yes. So January 10 is the first time we had a conversation on coronavirus when it started in China. Interestingly, parts of our leadership team were in China that day when we had our first conversation. And as Chinese New Year evolved, we thought we had a good handle on it. We managed the China situation very well. And then, of course, Italy started and Europe started in February, and then you all know what happened in March. So it escalated really fast. We initially thought we were managing a China-only situation. But by the time it got to Europe, we knew that we were -- really had to take a lot of actions here because it was going to be a global-scale issue for us. And I'd say February and March were very difficult because on an everyday basis, we were making decisions on which factories to run, which factories to shut down. We have many essential products, particularly around medical and critical infrastructure that had to keep running. We had countries that were shut down, like Malaysia and India, that we had to work through and figure out how to get approvals. So I would say February and March was very confusing in terms of what demand could we ship, what factories could we run, and then at the end of the day, how our supply base was reacting to it. But if you think about that period of time, we first started with, can we keep our operations running? Then we went to, how strong is our supply base? Then we went to, what does the demand cycle look like? So operations, very well-managed, within our control, very quick to react to that. In fact, most governments have kind of benchmarked us as world-class in our response to that. Supply base, our team did an amazing job in looking at alternate sources of supply. So we went from a peak shortage in January to really bringing that down to a normal level by the time we were exiting March. And then it came to figuring out what does demand look like and how do we manage to that. So I would say the quarter was extremely difficult. But because we started in January to really coordinate and collaborate across the enterprise in terms of managing through this, we came out of it fairly well in terms of managing expenses, predicting demand the best we could, managing our supply base and ended up with a quarter that I thought was fairly reasonable.

Every day feels like a week at the moment, every week, a month. And so even though it's so recent that you reported, things have nonetheless changed since then. We've started to see a so-called opening up of economies. We've also seen another sort of echo of the China-U.S. trade dispute. You have a unique view. You're everywhere, and you're real-time. So tell us what is the most recent sort of data points that you're seeing, what they might mean to us all?

Yes. So Paul, you're right that our view of the diverse end markets, the diverse regions we are in, gives us a really good kind of view of almost every segment across the world. I would say the things I'm thinking about, Chris and I are focused on right now, is versus automotive. Automotive, as you all know, has had shutdowns across the globe here in the last couple of months. So a lot of conversation about automotive starting up here in the later part of the month. And that has particular relevance to Mexico. We're also very focused on Mexico and the impact on the automotive segment. As most of you are aware, Mexico is probably going to go through a peak here in the next couple of months in terms of the virus outbreak. So managing our sites in Mexico, starting up automotive during this time frame and making sure we get that segment back on track is really important. IHS is projecting a 20% to 30% down for the year for automotive. And I think a lot of it depends on kind of how the next month comes across for automotive. I think that's going to be important. I would say the rest of the world, if you think about it, the cloud-critical infrastructure side, the demand is fairly robust still. We think enterprise spending will be down in that segment. And we're seeing that in the recent results that our customers have announced. But we do think that's offset some by the cloud infrastructure spend. And even today, the demand for that is sequentially pretty strong. And we think that continues for at least a few months, well, until everybody catches up to what's needed from a critical infrastructure standpoint. And that's still present, I would say, even in the last couple of weeks and today. And so things like industrial, hard to tell because CapEx spending is going to be down as people are conserving cash. But we think that's not a long-term issue because industrials do have to spend cash at some point in time and invest in capital. But that continues to be muted here for, I would say, the next -- for the last few weeks and will continue for us through the cycle. Medical, very strong, right, whether it is on new business or existing business. Medical across-the-board sequentially, year-over-year, all of that is going to be very strong. It's all about a supply issue for medical, how quickly can we ramp up capacity and deliver the products. So if I step back and say, and in the last month, I would say, still a lot of mixed signals about what the future holds. And that's what we're assuming in our planning assumptions for kind of the next quarter and the quarter after. But we see some kind of hope, right? We see some hope in the medical segment. Automotive, coming back, takes it from a really tough quarter this quarter to a better quarter next quarter, but year-over-year, it's still down. And I'd say critical infrastructure has some good spending opportunities there. So that's it. That's kind of net-net of our view today.

Can I just talk to, well, on the auto sector for a moment. What I'm concerned about is that since I understand that your business is very short-cycle in terms of responding to their manufacturing processes, what I'm a little more concerned about is the overall switch from ICE to EV vehicles and whether -- and many of us are expecting supply chains to be transformed as electric vehicles start to ramp up. Is there -- are you getting any sense that auto OEMs, regulators, anyone, is putting on the brakes, so to speak, on that process?

No. You've -- actually, Paul, we're not picking that up yet, okay? And we have had several conversations because we do design and produce product for the EV and the autonomous side, which, of course, is even more interesting because it's further out there, right? We are not picking up at all that there is any change in people's thinking around investment in autonomous, even with gas prices being so low and maybe the economics of that changes to some extent. Most automakers, OEMs, are very committed to their investments on EV, are even committed to their investments in autonomous, which is even further out there in the time frame. And we're not seeing a pullback from that at all right now. So I'm not saying that, that couldn't change, but my belief is that the long-term benefits of that is going to outweigh any short-term decisions on it, and we are hopeful that those investments will continue. And that's what we're hearing from our customers.

Any comments on work-from-home and if that's changed any of your customers' business in a significant manner?

I'd say we aren't. I mean other than, of course, spending on critical infrastructure changing, we aren't seeing any change in how our customers are reacting and responding. They're all doing the same things that we are in terms of being very effective and very productive in the work-from-home strategies. So no significant change as far as we can tell. It's actually working out fairly well, I would say, across all our customer base.

Chris, thank you for joining us as well. I'm sorry you're not sporting your beard. We would have liked to have seen that. But anyway, we'll make do with the headset. The balance sheet and liquidity situation, perhaps you can give us a quick summary of where we stand and how well prepared you are for what's ahead?

Sure. Yes, we've been really focused on the capital structure for well over the last year. And heading into this crisis, we were in really good shape in terms of our liquidity position, cash position as well as we've been operating a very nice capital structure. No near-term maturities, no maturities in any one year that are greater than our annual free cash flow generation, that's expected. So heading in, we felt comfortable. We obviously took some distinct actions in a prudent way, whether it was suspending the share repurchase for a bit, enacting pay reductions and other austerity-type measures, all in a protective lens. If you look to -- or how we completed the year, we closed out with $1.9 billion in cash. It's the second-highest cash position that we closed out a year as a company. Last week, we also completed a new bond offering. We raised $750 million in both the long 5- and the 10-year tranches. That was also part of our efforts to be opportunistic and to extend duration in a very cost-effective way. So heading on in, we're in a good position. As we've made some of these decisions, we fortified that. We have rigorous scenario planning. We have a lot of modeling that we've been doing under any of the scenarios. We have significantly ample cushion in terms of our covenants. Overall, we're very pleased in terms of the position. It's on the back of a lot of disciplined execution and the improving portfolio that we're operating, that's enabling us to also have a strong cash flow generation that bolsters that. So I think, overall, strong balance sheet, very, very prudent measures being taken. In a thoughtful and disciplined way, we're going to continue to operate that.

And how does working capital behave when the top line is pressured?

Yes. I guess -- thanks for highlighting that. Yes. So we're countercyclical. It's been evidenced through every one of the prior down cycles. For us, our capital intensity of our business dramatically lessens when you're into these types of scenarios. Typically, for us, net working capital is, say, 6% to 8% of our revenue. And in this environment, you'll see that slow -- or reduced capital intensity for net working capital, change and reduce, and thus, become a favorable factor in terms of free cash flow. You saw us kind of have an elevated level of inventory as we closed out the year. It was actually up almost $100 million year-over-year, and we're at 67 days. We took some time at our call last week to actually acknowledge that and provide some lens into the activities that are underway already in terms of managing and mitigating that. That will take us over the next couple of quarters to provide another element in terms of a favorable cash-generative aspect, couple that with discipline around CapEx spending. In this environment, we're going to have less CapEx spending. We already were operating a pretty well-built-out system, ample capacity, ample capability. 3 straight quarters, we've been actually underspending depreciation. So that will sustain an improving backdrop, a countercyclical nature. It all enables us to have a lot of confidence in the ability for us to generate cash through this and fulfill an objective that we have, which is we will generate greater than 80% free cash flow conversion. So that's our target. And I think we've been able to demonstrate that time and time again, and we're making distinct actions now to enable that going forward.

It must be frustrating for both of you to have everything just working so well as we rolled into 2020. And it wasn't just you, I think it was across the EMS space. I just felt like it was a new era of a positive momentum, expanding margins, better balance sheets, and then suddenly, you ran into this. But that said, Revathi, we are still seeing some major mega trends that I feel like you're so well-positioned to enable and exploit. And the most obvious one is this radical transformation of the global supply chains, which is going to be complicated and ongoing. Can you talk us through that a little bit, about how you see the next few years playing out and what Flex' role is in that?

Yes. Absolutely. So the conversation of regionalization of supply chain, of shortening the supply chain, bringing it closer to the end customers, has been going on for a little bit, right, particularly with all the trade issues that came our way, and I would say, accelerated to some extent with kind of COVID-19, but again, different by different segments. I would say what we are seeing is -- we have seen it with the trade issues, and we're seeing it again today, is a big acceleration on the medical side in terms of really moving product closer to the end customer. And those are not easy supply chains to move, as you all well know, right? Those are difficult ones to move. But that process had already started, and we are seeing the effect of it as we're adding more resources and capacity to the medical business, closer to end customers. So that's -- we're definitely seeing the effect of that. I would say, in other areas, if you think about places like tech, there is a huge cost productivity benefit involved with the supply chain coming from China. There has been a lot of talk about the regionalization of that supply chain. And I would say some actions have been taken, but it has been slower than kind of other segments just because of the cost benefit of that. I would say that, that conversation is getting accelerated as I am talking to kind of CEOs of our customers. There is a want and need to accelerate it further, maybe less so from their kind of procurement teams and their supply chain teams because they can see the difference in productivity involved in it. But we are seeing the conversation accelerate. The place I'm the most surprised, and I'll tell you, is on the consumer side. On the consumer side, we're definitely seeing a big move and push to say, "Hey, we'd like to move the supply chain away from Asia, more into North America, particularly and parts of Europe." So we have several programs that we have signed up in the last few months that are moving those products closer to the end customer. But regionalization, as a whole, Paul, if I step back and think about regionalization as a whole, I would say that it's almost a no-brainer that it is going to accelerate across every segment to some extent because one is the global cost of logistics and moving product around the world is pretty difficult. We're seeing continued trade issues. And so we think that it's just a matter of time as that continues. You can see the shift in our own PPE across the time frame, just in the last 18 months in terms of where our investments have been and how that has shifted. And I think that's a clear indication of how the world is changing. So -- and we're -- I think we're well positioned for that in terms of taking advantage of that and helping our customers think through that.

Because you can be both regional and global, is that how I should think about it?

That's correct. Absolutely. I think we can be both regional and global, and we can be both cost-effective and deliver the same quality and capability, both regionally and globally, anywhere in the world, right? So when you can do that everywhere from Ukraine to Brazil, to Mexico, to Malaysia, to China, to India. I mean the -- what the customer needs, we can provide no matter where in the world they are. And I think that's what's important.

So one of the things that you've done internally is you've changed the way in which you are about to report the business segments, where previously there were services that are going to be now the agility and reliability segment. I think everyone gets it intuitively. But why did you do this change?

Yes. So previously, there were 4 reporting segments, and we're going to 2. But let me talk through the thinking behind it. If you look at our portfolio of products, right, there clearly are 2 sets of portfolio. If you think about kind of the mega-product capabilities, right, one set of products is short product life cycles, more cyclical, scaling up and down fast all the time. And then the other set of products are high-quality, regulated environment, high-CapEx investment, more stringent in terms of complexity of technology. And at the end of the day, Paul, we are a business that executes to a customer need. So our ability to respond to that business model, those 2 business models, is what really makes us the most effective as an organization. So to me, this was almost a no-brainer when I came and looked at this after a few months and said, "We may not be able to change the customer's business model and how they operate, but we can change our operational model for how we deliver to it." Right? And that's what we're attempting to do with these 2 clearly defined segments. So one is going to look and feel and sound more like a diversified industrial portfolio, right? One is going to have health and automotive and our industrial segment, around a $10 billion segment. And that's how that's going to operate. More capital investment, long life cycles. One, you've invested, it's all about kind of managing it and making it better. Technology investment is going to be more focused. And the other is going to be more like the traditional kind of contract manufacturing space, which is kind of our agility segment, has our CEC business, has our lifestyle business and then our consumer device business. And there, we're going to have to be extremely agile. It's going to be about changing your variable fixed cost, making sure you know how you manage your capital investments in a very sensible way. So to me, this is kind of a no-brainer that we have to figure out how to deliver to these operational models. And then we're also going to have to change how we think about our hurdle rates for both businesses, how we allocate capital for both businesses, right? So that's what we are attempting to do. And I think this is a very important change for us. And I think if you think about how the future will look for us, I think will look like 2 very distinct businesses that function and behave differently, but take advantage of the scale associated with those 2 segments.

Have you already defined different expected returns for the 2 businesses?

Yes. Absolutely. Absolutely. I mean our job, Chris and my job, is all about defining different hurdle rates and allocating capital differently, right? That's what we have to do.

So one is capital-intensive. The other is kind of probably working capital-intensive. One is short cycle, one is long cycle. I can see different risks and puts and takes all across the board here. What are the different hurdle rates? Can you talk us through that?

No. We haven't shared it externally, right? What I have said across the portfolio for -- in terms of my goal longer-term for this business is that I would like for -- if you add it all together, I'd like it to be about GDP, right, in terms of growth. So that means one is going to -- mix is important here, right? I have said before, Paul, is that booking a $1 billion business for the revenue for this business is not hard to do. It has to be the right type of business. So that's why I'm kind of saying about GDP growth is what I'm looking for, which means some will grow, some will not grow that fast, and we'll probably continue to change mix. And then I've said I'd like to get to mid-single-digits operating margin for this business is what I would like to get to. And you should be able to -- I mean I'm sure people have already figured out the math of what that means, right? And it's going to change the hurdle rates pretty significantly for both sets of our business, I would say, to get to that. And then, of course, the cash flow conversion, I think, follows with all of that. So that's kind of in -- at a high level. But individually, within segments, we know what we're trying to do. The important thing, Paul, I would just kind of point out is, our available end markets are pretty big in all these segments. So the opportunity for us to have the right kind of growth is there. It just takes discipline and focus and investment to get there.

We will be shining a light on the fact that mid-single-digits operating margins is proportionately very, very high. I mean people may think, oh, it's not much. But relative to where you currently stand, it's a massive improvement, and obviously, has dramatic impact from cash flow and so. Actually, one quick question on cash that's being generated. What is the current use -- I know there's CapEx, but is there anything else that's planned with that cash at the moment?

Chris, can I hand that to you?

Yes. I mean, right now, the cash on hand is just being prudently positioned. There's really no significant CapEx investments. We haven't even touched on M&A. There's really -- we think we have a well-built-out system in terms of capacity capabilities. We've talked about the positioning across the various industries, where we think we have been able to secure significant bookings along to support future growth. So right now, it's -- we are sitting with an ample amount of cash, and we're going to be very thoughtful in terms of its deployment right now. There's a fair amount still tied up in terms of net working capital that we're going to manage through. But there's nothing that is pressing and requiring that cash distribution right now. It's just going to be very thoughtful. It's an uncertain time. So we're going to be taking the right measures to be properly positioned so that we go through this crisis as well as emerge in even a stronger position.

Right. Got it. So Revathi, we're talking about GDP-plus-type growth from that mid-single-digit operating margins. What is your best guess at what -- how 2020 is going to pan out? So I mean, I guess, it's a slight detour.

Yes. That's right. Paul, I'll be honest with you and tell you that it's hard to predict, right? And because the things that -- and I think by now, most of you know me that I'm very prudent in my -- in our planning assumptions, and I don't like to kind of overstep from a planning perspective. But the things we are thinking about, like most of the world, what we're hopeful is that by the time we exit 2020, 2021 has some recovery in terms of the overall economy. But when we're heading into 20-plus million people with unemployment, with thinking that financial defaults are going to increase here in the next kind of few months in terms of consumers and auto spending, it does give us pause to say that it's a hard-to-predict time. We see everything from a very bullish number from Goldman, to a not-so-bullish number from JPMC, for where the year is going to end to know that it is hard to predict. And we're kind of saying that, at this point, for this quarter and next quarter, most organizations, we think, year-over-year, will continue to see some pretty strong declines. Is that -- is there some recovery in Q4? I'd say it really depends on what happens with kind of defaults and things like that. I think if we come out of this health crisis not going into a financial crisis, we think that we start to see the recovery in Q4 of this calendar year and Q1 of next year. But that's an important thing to watch and see. So I just don't know. I would say our crystal ball is as fuzzy as everybody else's.

All right. Got it. My last question really is sort of big picture-wise if you think long term. Do you see the scope of this business changing, enhancing in some way? I mean I'm always curious about the kind of the nexus between what you do in the T&L industry. It seems like you share a lot of information and I see value points inside their network that you could be occupying and vice versa. So as we think about fulfillments and e-commerce and transportation logistics, do you see the scope of your business changing over the next few years?

Yes. So Paul, we're almost thinking about it in kind of 2 different ways for our 2 segments. For the agility side of our business, we're definitely focused on kind of more -- kind of looking at a circular economy of a full -- making sure that we have a service sector that's providing for not just manufacturing products but then for repair and refurbishment and really driving that side of our business, but then also looking at an overarching supply chain integration and e-commerce and how that plays out. Now I'd tell you that, that's not as clear because there are so many players, it's such a fragmented space. It really needs our customers to participate with us and say, "How important is it for you to improve the efficiency in this value chain?" Right? And where there's tremendous inefficiency in this value chain, if you think about it from suppliers to the end distributor and us and customers in the middle, there's tremendous working capital and efficiency in this. So we need to find customers who are willing to participate in this to be able to improve that working capital efficiency. We think there is room for it. And the way I'll always push to do it is to experiment with a few customers and see if we can really drive that supply chain and e-commerce integration. The data we see is tremendous, right? And the optionality we can give our customers is significant. So I do feel there is room for that, but that requires a rethink of the whole industry that -- and different aspects of the industry that I'm not willing to commit to it yet. But I think if there's an opportunity there that we're -- we'll continue to peel the onion on and see how we can participate.

Revathi and Chris, thank you so much for participating today. We really appreciate you making the time for us.

No problem. Thank you, Paul.

Thank you, Paul.

Okay. All right. Thanks so much.