Flex Ltd. (FLEX) Earnings Call Transcript & Summary

Hello, everyone, and thank you so much for joining us here at Citi's day 2 Global Technology Conference. I'm Jim Suva, Head of IT Hardware and Technology Supply Chain as well as Telecom Equipment. This is the fireside chat with Flex, stock ticker FLEX. A few logistical items I'd like to talk about is, first of all, please see the Flex Investor Relations website for their safe harbor and forward-looking cautionary statements as well as risks. There's also a lot of information that's quite handy on their Investor Relations site. We also do want to note Citi has disclosures associated with this. And if you are a MiFID II investor, make sure you have that agreement in place. This is broadcast to institutional investors. It is not meant for any media or press. Any media or press should immediately disconnect. As we go through the list, if you are media or press, we will disconnect you from this. This is again for institutional investors only. I'm very pleased to have the Chief Executive Officer, Revathi, to be joining us here today. And to both of her sides are the Investor Relations team, both David and Katherine. So thanks so much for joining us here today.

And maybe if you can kick things off, talking big picture about demand trends and maybe let's call in the next 6 to 12 months, because as we look at this year, a lot has changed in 2020 given the pandemic has spread globally. And now it actually looks like you're physically back to work at Flex Headquarters there in the room, while I'm in my home office. So maybe if you can update us on these demand trends in the pandemic, and what you're seeing there as Chief Executive Officer.

Thanks, Jim, and thanks for having us on this call today. So let me just start by saying is that demand trends is a perfect question for us because as you know, we're in so many different and diverse end markets. So what we see kind of touches a little bit of all different types of end markets. And I'll start by saying is that what -- for us, we're in a different fiscal year calendar, but I'll talk about it in terms of calendar year 2020. What started in Q1 really has changed quite dramatically in Q2. So we're seeing end markets really start to pick up in most of our 6 end markets as we classify them. Health care, as all of you know, is really strong, whether it's driven by underline trends of medical devices, in general, having strong growth or everything associated with what's happening in the health care industry. So we see overall demand for health care being strong. We already had a strong pipeline coming into this crisis. We have seen that improved significantly, and we're pretty confident in terms of driving double-digit growth in our health care space. I think that's probably the easiest of these conversations is what's happening there. If you think about all the other businesses, automotive obviously started with a very difficult year, particularly in the last quarter. As you saw, automotive businesses across the world shut down, and we saw the effect of it. We're seeing strong underlying trends with automotive returning back. We still think that automotive will be a decline year-over-year basis, as you can see from the IHS trends. But sequentially, quarter-over-quarter, we're seeing demand coming back. Industrial is still positive growth driven by some CapEx coming back in industrial investments. But we don't expect it to be significant growth in the year, but still year-over-year growth then we see demand returning back for industrial. So if you think about our reliability businesses, all strong sequentially, all showing growth from a year-over-year basis. I'd say where we see challenges would be on the agility side of the business. So obviously, consumer is difficult as consumer spending has reduced. But even there, we see pockets of real strong strength like floor care, anything to do with sanitation, coffee machines are showing strength. But our consumer business overall is sequentially stronger, but year-over-year will show a decline. And then we're seeing return in our consumer devices portfolio, which has some underlying mobile devices just because, again, Q1 was a difficult quarter and sequentially all coming back in Q2. Our CEC business, which is our largest business, is showing investment in critical infrastructure, networking and cloud. We expect that to continue at least for through the end of the calendar year as demand catches up with capacity investments that are going on in the industry. So if I step back, I would say, Jim, that the picture was very unclear 3 months ago. Today, we see sequentially demand growing through all of our end segments. We see strong return in segments like automotive. And our overall kind of planning purposes, what we're thinking is that sequentially, all quarters in 2020 will look stronger from Q1. And from a year-over-year basis, I would say, some segments will be lower, like automotive, like consumer will be lower than what we started the year with. So we're feeling positive in terms of how the quarter is looking from a sequential basis, and how demand is looking.

And since your company interacts with customers or those who design items very early and Flex has a sketch-to-scale model of helping those customers, has the -- how do you think the pandemic has shaped the underlining drivers for growth in the outlook of your end markets, maybe in the midterm kind of next 2 to 3 years? Has the pandemic had an impact? Are they looking to design things with more technology or faster go-to-market? Or say, for example, risk mitigation of produce more locally. Can you talk about that a little bit about how the pandemic has shaped the underlining drivers?

Absolutely. I would say that there is some fundamental changes in how customers are behaving and how we're behaving in terms of flexibility. So let me start with the design end of it. We've talked a lot about the health care side of it and the medical device business. We're seeing significant change in this space, which is a regulated space, which has strong approval cycles that's required in terms of flexibility to get faster approvals, to rethink design in a quicker way. And as you know, we participate in the pharma space, in the med devices space and in the medical equipment space, and in all of them, we're seeing just a faster go-to-market than it's been traditionally been in this particular industry. So that requires us to be quicker in terms of thinking about what kind of equipment we bring on board or helping customers rethink and redesign how they're testing for vaccines, or how they are thinking about ventilator production. So I'd say a lot of change in terms of design cycle in the health care space, flexibility, faster to market. And hopefully, this is a trend that sticks, right? Because it's definitely something that we shouldn't change in the long term. I'd say in other spaces, if you think about automotive, right? If you think -- automotive practically shut down for 2.5 months. So our ability to bring things back to the market quicker, for customers to be faster in terms of thinking about demand cycles and being flexible in terms of how they think about planning and inventory, I'd say those have changed pretty significantly. So I see really good changes, which are all about flexibility, whether it's in your design cycle, or flexibility in your planning and management of your end-to-end supply chain that I think are all good behaviors. And hopefully, these are things that stay with the industry long term. In terms of source local or make local or regionalization, whichever way you want to call this trend, it started a while ago, Jim, as you're well aware, right? It started with the trade wars. It started with a conversation about total cost of ownership changing as logistics costs have become longer -- have become higher. And so I'd say that, that trend had started a while ago. Some have accelerated. Medical was already in a pretty fast pace because they had tax incentives a few years ago, which drove the localization. But the real elephant in the room is, when you think about sourcing and manufacturing local, is end segments like consumer and like the tech space, right, which your conference is all about today. I'd say in consumer, because of the effect of tariffs, we are seeing a faster move in terms of regionalization or manufacture locally. And we're seeing in that acceleration of those decisions. And so that is something we're strongly participating. Our footprint is strong in North America or Europe to support those decisions. I'd say in the tech space, a little different. That's where a lot of the conversation is but the reliance on supply chain that is still sitting in China is significant. So even if you manufacture end products differently or closer to end markets, you have a long and deep supply chain that is still very, very dependent on what's being manufactured in China. So thinking through that and the effects of that is significantly important. So I'd say a lot of conversations in the tech space, but a little bit slower in terms of decision-making on really making big moves for manufacturing locally.

You actually led into my next question about manufacturing locally, but can you talk about -- are there pricing implications to that? Like a lot of the things that I have in my house are typically built in lowest total cost places. But now when we deal with trade wars and manufacturing and local as well as risk mitigation, I wonder, is there an impact to pricing that you as CEO or your business leaders need to have with customers? And how is that going? Because I'm sure they don't want to pay more, but it may be more expensive.

Jim, and that's the elephant in the room, right? Because there is going to be pricing implications, whether it is driven by lower labor cost or whether it's driven by some of these supply chains being more efficient through long cycles of making them more efficient, total cost of ownership is going to go up in the near term. And who pays for it is going to be the question, right? There's going to be end customer pricing impact, I'm sure. Our view in Flex is that we have to be strong in terms of showing customers the value we bring, how -- what our pricing equation is all about. And we should be able to provide them the best solution, and somebody has to pay for that -- for that change in the value chain. And we're very clear that, that is not going to be us, but I'm sure every other person in the value chain thinks about it the same way. Now over time, there will be efficiencies that will make this better. But the supply chain for some of these products have been driven through years of very efficient, and making moves associated with them is going to have some impact on productivity efficiency and henceforth, price. Our view on it is that's not us, and that has to be somebody else. But I think time will tell how these moves happen and who actually pays. I think end customer is going to pay the effect of it.

If my memory is right, I think you joined as CEO of Flex about 1.5 years ago. I'm not sure on that, but maybe you can correct me. Can you talk about what you've seen so far in this 1.5 years or 2 years, and the things that you want to be known for, your vision for Flex and the stamp that you'd like to put on Flex as being the CEO?

Yes, Jim. It has been 1.5 years, I think a little over that. And the reason -- my background, as you know, Jim, is from industrial end markets, right? And that's kind of where I grew up and grew up through the shop floor, but in all industrial end markets like Eaton and Honeywell. And when I took a look at Flex and the product portfolio, my first excitement about Flex was the technology that exists in this -- in the company itself, and the focus on technology and design was very impressive for me. And that too in all these diverse end markets. So that was one thing. And then the second was, obviously, our manufacturing capability is world-class. And being a person who loves manufacturing, I was excited about continuing to harness the potential of what manufacturing changes we're going to see in this age of digitalization. So those were the 2 reasons I joined Flex, was technology and the manufacturing capability. But what I thought that we could do in Flex itself was transform the company and the industry itself. My view, and I've said this several times before, Jim, is that the industry itself needed to transform in terms of understanding and pricing for value is really driving the change of bringing technology into the conversation and understanding how you own that technology, and how you price for that technology. And Flex, over a period of time, had very nicely diversified in health care, automotive and industrial spaces, spaces I'm super excited about. And I wanted to take a advantage of that growth and make that even stronger. So as a set up to that, 6 months ago, we announced a kind of separation or grouping of the business into 2 end segments that we call reliability and agility. Reliability, in my view, should work more as a diversified industrial group of end markets. Our agility space works more as a traditional EMS business, but with a focus on design, and we really wanted to drive an operational model that makes it more flexible, takes advantage of the supply chain, is more faster and agile to market. So I look back at Flex and say, the goal was to transform the company itself to really focus on running 2 different business models catered to those end segments and make sure that the value we get from our investors and from our customers really supports those 2 end markets. And I'm so excited about that. In fact, we're even more stronger today than when we were 18 months ago. We have kind of operationalized our 2 end markets. We're seeing strong growth in terms of pipeline in the reliability business as we wanted to. We're being more disciplined in managing our agility business. So the beauty of running 6 unique end markets and getting the right value for it, that transforms this company, but also this industry is what really excited me about, Jim, and that piece is even more valid today.

Now when we think about your past background and coming into Flex, how should we think about as we fold in your vision, say, for the example, the next 5 years or so? Should we expect reliability solutions, which I believe is where industrial sits, to be a much bigger portion of your revenues? You'd mentioned the company has diversified a lot in the past, which is the case, but you're coming in with a really good experience on the industrial side. And I think the size of the business is around 47% of revenues, but how should we think about that, say, over the long term, maybe next 5 years or so?

I would say that we should definitely think about reliability business as getting a bigger share of our investments and our resources, whether it is on capital or whether it's our technology investments, and all 3 aspects of reliability. I'm very excited about the medical space. I'm very excited about the Tier 1 disruption that's happening in automotive. And industrial is obviously a space, I know. But all 3 of them, Jim, add up to a little around $10 billion of our overall portfolio. Very strong, healthy operating margins. Our focus is going to be on growing all 3 aspects of that portfolio in terms of making sure that we're getting the value from our end customers. We are following the right type of growth, but also looking at how we can add to technology plays in that space that makes us a stronger kind of product and design play than what we are today. So reliability is definitely going to be the focus of our attention. It is the place that Flex diversified. I think by separating it out the way we have done and really bringing a different culture in how we run that business and really focusing on technology and growth is going to drive how we really grow the reliability business in the future.

And what if we switched over to health care? I believe it's a much smaller part of your business, ballpark, just under 10%, if that's correct. How should we think about health care and maybe the impact and looking forward for the growth rates and focus of that segment?

Yes. So where -- health care is around $2 billion of our business. But really, the focus on health care, if you think about it, is one, we're in the top 15 medical device manufacturers in the world. So in terms of scale and capability, in the health care space, we have significant capability in that space. Our 3 end markets in health care is in pharma, is in medical devices and in medical equipment. And in all 3 of them, we have strong device capability and strong software capability. Our pipeline already was very strong, and our bookings was very strong in this space. And we had said that we wanted to see around 10% growth in medical. Obviously, that has accelerated with what's happening here with COVID. In the past, we have talked about complex projects like the continuous glucose monitoring project that were of [ W ] ramped up, which eventually will be a $400 million annual revenue type of product for us. But those types of products, which are transforming the combination of sensors, devices, software, where we can bring an end-to-end partnership with a customer is the kinds of projects that we're driving in health care -- in all 3 parts of our end market in health care. So we're very excited about it. A $2 billion health care business is a very strong and sizable business. And it's in the right end markets. We're really not interested in kind of slower growth or end markets in health care, where we -- the technology focus is not as significant like orthopedics. Our focus is more on drug delivery, where there is clear combination of sensors and devices and software. And similar in pharma and med equipment. So it's -- while the overall percent of revenue is not significant for Flex, it -- in health care standards, it's a pretty strong business, and we'll continue to focus on growing that business.

I know you don't like to talk about customers, which is fair, but I think most people would know you have a great long-term relationship with Cisco, but the company recently indicated a softer demand environment in communication space. Can you kind of comment on what you're seeing on that end market or the order trends there? Or are you actually gaining share to offset it? Or it seems like that would be a bit of a headwind?

Let me talk more about tech in general, Jim, is that so some critical end market trends happening, right? Without commenting on specific customers per se, I would say that networking is showing growth in terms of end markets. So if you look at our overall portfolio of customers in that space, we're seeing growth in that space with the investment that is happening through the pandemic. We're seeing the same in cloud. So as specific customers go through their own transformation, I think our focus has to be, how do we support customers? How do you focus on the right end markets within the subsegments we're in? And so while we see a few customers going through their own changes, overall for us, CEC is growing very well, both sequentially and on a year-over-year basis. And I think how we're focusing on this space is really driving for growth in the right subsegments within that. Our CEC subsegment also has 5G as an example, where 5G is showing strong growth in areas like Asia, may not be as much as Europe and North America. So I'd say, yes, there may be a few customers who have few issues today, but our overall CEC business is sequentially growing. And we are showing that the right subsegments are growing, which is both networking and cloud are growing within our subsegments.

Can we maybe switch over to another segment, and that is, one, automotive? In the past, the automakers haven't done a lot of outsourcing. Now whether it be brake lights or driver in console or safety telemetrics, things are becoming outsourced a little bit more. Can you talk about automotive, and how we should think about it kind of longer term? And of course, near term, many of us are not driving much, and many of the auto factories were closed for a while and now they're coming back. But maybe focus on the auto sector and give us your thoughts on that.

I'd say Jim, the automotive sector, probably if you think long term, is going to see the most transformation from a mechanical, hardware, software, electronics capability. You already see that today, right, in terms of that transformation going. The difference in a traditional car to an electric vehicle to a full autonomous vehicle in terms of content -- value of content and hardware-software is pretty significant and electronics is pretty significant. So for us, as you know, we already have made a strong play in autonomous. If you think about every autonomous end customer out there today, we're doing something with them. And that's driven by our huge capability in terms of electronics development, our ability to take what we do in our CEC business and bring that expertise to our autonomous capability. So we're already seeing a pretty significant play in that. Now we're really doubling down on the EV space, because that's another area that in the near term is going to be stronger growth than autonomous. But long term, when you think about those players who are going to win in the automotive space are the ones who have strong electronics capability and the ability to design complex systems like what's required as a supercomputer for an L4, L5 autonomous space. What’s required in the electric vehicle space, whether in terms of full platform integration and software capability. And the value of the car itself is going to be driven by electronics and software integration. So the change is very significant. That's why you're seeing the disruption that is happening between end automakers, Tier 1s and manufacturers like us and the whole space is changing. So our view in automotive is that it's a great time for us to focus on the automotive space because one is we have fundamentally strong capabilities in our ACES platform, but we also feel like it's -- the design capability we have, the software capability we have is what end automakers are looking for. And so we feel that transformation is the right path for us to be in, both for the industry and for us and what's happening with the Tier 1 disruption is an interesting time to be in this space and in this end market.

And your exposure right now to autos and maybe looking ahead, any thoughts on that? Is it mainly North America? Is it with a lot of companies when they start to grow and seeing green shoots, they have one customer like a Ford that really catches on and then they broaden it? How should we think about your exposure right now to the automotive sector?