Flex Ltd. (FLEX) Earnings Call Transcript & Summary

Hello, everyone. It's so great to see you again. My name is Jim Suva. I am the IT, Hardware and Tech Supply Chain Analyst here at Citi. And we're having our Global Tech Conference, which of course is virtual. We have over 200 companies participating in this. A few housekeeping items. First, if you're media or press, please disconnect. No media or press are allowed on this. Second, if you are subject to MiFID II, make sure you have those research agreements in place. Third, we want to mention there are disclosures associated with this. First, at the Citi Velocity website as well as when you're registered. And also we do want to encourage you to take a look at the Flex Investor website where they have safe harbor risks and forward-looking statements associated with the comments, which may or may not be made today. [Operator Instructions] I'm very pleased to announce today that we have both the Chief Financial Officer, Paul Lundstrom, as well as the Head of Investor Relations, David Rubin, joining us from Flex.

To kick things off, I wanted to kind of talk a little bit about you guys are right in the midst of everything as a contract manufacturer putting everything together, sourcing everything, taking in the orders, quite a dynamic spot, especially given COVID, but now we layer on the additional items of the semiconductor chip and the shortages with it. Can you talk about these bottlenecks and kind of maybe it's by product or end markets or just kind of talk about the landscape because you touch on both the incoming and outgoing supply and demand dynamics?

Yes. Happy to do that, Jim. And first of all, just thanks for having us, appreciate it. So good morning and good afternoon to everyone, depending on where you are here in the world. So thanks again, Jim, for having us. And in terms of supply chain, you're right. A company like Flex is right in the middle of it all and a lot of talk over the last couple of quarters really about semiconductors, it kind of started there and has turned into more of an overall global component shortage challenges, overseas logistics challenges. We're seeing all of that. We really started getting visibility to some of these headwinds in November of last year. And to your point, we've got tentacles into all sorts of different industries, different end markets and certainly we're -- at the end of the day we're a supply chain and logistics expert. And so we have lots of access to data on our supply chains and how they're performing and where we see constraints. And so we have started to see some of these pressures late last year. And as we moved through the first calendar quarter, our March quarter, we did have some pressure. Moved into the June quarter, we saw more of the same. And what we told investors and our customers is that the good news was between that first calendar quarter and the second calendar quarter, we really saw no material deterioration in the overall environment. And so I sort of took that as a positive. The situation hadn't gotten worse. And sort of maybe just to give you an update on where we are thus far here in the third calendar quarter, this is our fiscal Q2, nothing has significantly changed. There have been a couple of good guys, a couple of bad guys. But on balance, I would say the situation has not continued to erode. And so, I view that as a positive, it's sort of in line with our expectation. If there is a couple of good guys, the good guys would be, it seems like overall component suppliers are getting a better handle on their ability to generate output. That's a plus and it's a plus for a company like us and I'll tell you why. As this challenging environment began, I don't want to say crisis because I wouldn't say crisis, but as this -- as the challenges started to unfold over the last couple of quarters, we would see last-minute component decommits, supplier decommits. And the way that works is, let's say, you're 99% ready with a bill of material, but you can't assemble until you have the whole thing. You're waiting on just one part. And you have a commitment from a supplier that says, we're going to have this in 3 weeks. Then they say, we're going to have it in 2, then in 1, we're going to have it day after tomorrow. And then at the very last minute, at the 11th hour, they decommit and extend. That is devastating to a company that's trying to assemble in a just-in-time environment and at rate. And so the good news, Jim, is, we've seen a lot less prevalence of that. So it seems like component companies are getting their arms around it. That's the plus. The negative is, we continue to see persistent waves of COVID. You're seeing it all over the place. Vietnam, Thailand, Malaysia continue to see case rates rising. That's a little frustrating. I would say that was contemplated when we gave guidance. Malaysia, for example, has been a country that over the last couple of quarters has essentially forced mandatory factory shutdowns. That has -- that puts a little bit of pinch on our component suppliers. We also produce in Malaysia. But all of that, again, was fully contemplated in our guidance. If there is a silver lining, Jim, to this whole component shortage challenge, it's that for a company like Flex, I think it really has put us in a favorable light. We get a lot of compliments from our customers for our ability to navigate this situation and we have been able to draw on our supply chain expertise, alternate suppliers run the surplus markets, find ways to just cobble things together so that we can meet our output requirements. And again, we've really gotten customer compliments in our ability to do that. And so I think that bodes well for a company like Flex long term because what customers want more than anything else from a contract manufacturing company is continuity of supply chain. And I think we've demonstrated over the last couple of quarters that we're pretty good at that.

Speaking of which, Paul, has this impacted your backlog, meaning are companies double or triple ordering or saying, "Hey, I may not double or triple order, but I'll give you visibility instead of 3 to 6 months down the road, 6 to 12 months down the road?"

Yes. I think the whole -- and this isn't just a Flex phenomenon, Jim, we're seeing this in the industry and we call it load versus commit. Load is customer gives you a forecast that's a really high number and then they give you a commit which is now we have a contractual PO and the gap between the 2 has been quite high. So if you purely take the forecast value, you could low yourself into, I guess, a false sense of security in terms of just an absolutely ridiculously high backlog number. We've got lots of intelligence on end market demand and what's real and what's not. And so I think we're managing that well. We're not going to get over our skis, but it is something that we're seeing in the industry, Jim.

And then what about -- compared to 3 or 6 months ago, what end markets have done better and which ones have done worse compared to 3 or 6 months ago?

Let's see. So you look back 6 months ago and at least for me personally, if you had asked me if I thought underlying demand would be healthy in all of our markets coming into the end of year 2 of a global pandemic, I would have said definitely not. There would be something that would have rolled over. And so what I would say is great news versus my expectations anyway of 6 months prior and that's that underlying demand in all of our end markets right now is strong. If there is a disappointment or a frustration point, it's the component shortages challenge, but I think we adequately covered that. But if you maybe want to peel the onion a little bit on that, a couple of end markets in particular where I've been pleasantly surprised. One would be our industrial markets or our industrial business. Within our Reliability segment, we've got 3 big market focuses. One is Health Solutions, one is Automotive, the other one is Industrial. Within Industrial, think about things like industrial measurement systems, capital equipment, electric vehicle support in terms of charging stations, renewables, grid. What we're seeing in all of those end markets is very strong performance internally, I think we're getting share, but also strong end market demand. And so, to me that's been a bright spot in the business, more than what I expected, frankly. Last quarter, the industrial business was up 20%, and by the way, up over the 2-year-ago compare as well. So that market is doing quite well, better than what I had originally expected. That's a plus. Another one that's done better than what I expected, particularly if you look back 6, 9 months prior my expectations anyway, would be within our Agility segment we've got a market focus called lifestyles. Lifestyle business think very high end appliances, high end floor care, high end audio, high end beverage machines, those markets have continued to be very strong. I think this work from home, learn from home environment that we've been operating in over the 1.5 years helped that particular segment, but we're also winning share. I think we're winning share because the brands we support have been winning share, they have strong positions and we tend to focus more on the premium brands. But we're also winning a greater share of that customers' wallet, given all the trends that we're seeing right now and things like regionalization. So I'm quite bullish on the lifestyles business. That lifestyles business last quarter was up 36%. So that's quite strong there. And I think the outlook continues to be pretty good for that particular business, Jim. Just a little anecdotal here, but I was on a call with another investor last week and one of the questions they were asking was specifically about the lifestyles marketplace. And their question was, are you worried about the cycle rolling over. This work from home, learn from home phenomenon has it played out? And upon a little reflection, I'll say, I don't think so, but even if it did, I still think that lifestyles business could grow the top line because of what I just mentioned. We're winning share in the markets where we participate, not only are our end customers winning share or our customers winning share, but we're winning share of our customers' wallet with additional content getting pulled into the Flex system. So I would say I'm upbeat on both of those and both have been a pleasant surprise, both industrial and lifestyles.

And Paul your CEO, she has been doing a transition away from consumer, high fashion, what's cool and what's not, more towards the Agility and Reliability Solutions. Have you fully transitioned to the new focus areas or there is still more action, just trying to get up to speed about that?

Well, that was a great segue question because I was just talking about the lifestyles business which is more of a consumer end-market type of business. So maybe to answer your question, the business is organized in 2 big segments. We've got an Agility segment and we have a Reliability segment. The Agility segment, think of that as high-velocity businesses, a little higher churn businesses, high volume, players come in, players come out, great business, just a little bit different than the reliability side of the business. Reliability side of the business tends to be a little bit longer cycle. You tends to have a little bit more regulation in some of the end markets. A good example of that would be Health Solutions. Health Solutions where we participate, particularly where some of the end products are either implanted in a human or awfully close to it. That sort of changes the dynamic. You start talking about FDA certifications to produce. And so that's -- it's a little bit different business model on the Reliability side than what we see on the Agility side. To your point on Revathi's approach to the business, as she came into the company she looked at the portfolio and there were a couple of areas that she wanted to de-emphasize. Those areas were within a business in Agility that we call the Consumer Devices business. Consumer Devices end product, think cellphones, think notebooks or laptop computers, in those markets end consumer, you and me, we've got lots of choices. Our customers, in terms of selection of a contract manufacturer, also -- they also had lots of choices. And so what you see in those market is -- markets is quite a bit more churn, you see product life cycles are much shorter. Quite frankly, it's a difficult business to make money in unless you really focus in certain areas, focus on certain geographies where you have presence and certain products or customers that have strong positions to assure you a little better margin rate. All of that is behind us. Revathi deemphasized that part of the business a couple of years ago. And so not only is that behind us, I would say the comps are well behind us as well. And what you have left today within that consumer devices business in Agility, it's about a $2.7 billion business. It's the smallest business within the Agility segment. What you have left today is a pretty good core with a pretty nice profit contribution to overall Agility. So I like where we are on consumer devices. That's one of those 2 more consumer-type businesses. The other one is Lifestyle. Lifestyle is one I just mentioned and I kind of told you my views on Lifestyle. It's been better than what I had initially expected. I like the dynamics in that particular market. It's a little different than the consumer devices business. I mentioned before, it's not cellphones and laptops. It's more very high-end appliances, high-end audio. We tend to focus on the very premium brands. And what I like about that particular segment is how that marketplace for contract manufacturers has evolved over the last several years. And so let me kind of talk about that. So if you look in years past, a lot of those consumer products, contract manufacturing supply chains, it was all about labor arbitrage. It was lots of factories in Asia. What's changed over time is the profile of the customer. The customer, and when I say customer, I mean the brands that we support. No longer is labor arbitrage the end all be all. They are asking for more and more from their subcontractors. And so now we're starting to see design elements, not only front-end design but also design for manufacturability. And so our customers are saying, "Hey, look, I know you can do -- I know you can do high rate volume production. I know you can do at low cost. I know you're in the right places, but can you also do some design-led work, and by the way, designed for cost?" Sure, absolutely, that's the capability that Flex has. And if you look at the overall pool of available subcontractors or contract manufacturers, when you start bringing in design that pool starts to shrink. Then they say we not only want you to do design, but we also need you to more vertically integrate. We need somebody who can do very high-end injection molded plastics. We need somebody who can do metal. We need somebody who can do PCBA, printed circuit board assembly. By the way, we also want you to assemble all these stuff and we needed to be able to do it very, very fast. Okay, well, again, the pool of potential -- sorry, we got our [indiscernible] here -- our pool of potential suppliers starts to shrink. And so again, this is an area where Flex can compete. And then if you look more recently, and I say more recently as in the last couple of years, the whole economy has seen 3 big, part on the expression, 3 big punches in the face. The first one is global trade disputes, tariffs and all the geopolitical drama that has ultimately affected supply chains. Second one obviously is COVID shutdowns around the world. And now what we're dealing with is component shortages. So a company like Flex can help solve that problem with regionalization. And so what we're getting now is we're having customers say, look, I can no longer produce only in Asia. I need to produce in Asia for Asia, I want to produce in Europe for Europe and I want to produce in the Americas for the Americas. And back to the pool of potential contract manufacturing, it just -- as the capability requirements has gone up, your pool keeps getting smaller. And so what I love about this particular consumer-facing market, that lifestyles business, is that we're winning and growing share, not because of price wars, but because of the right reasons. We believe we can add value here. And I think that bodes well for top line growth and I think that bodes well for profitability.

Well, Paul, I'm glad we're not doing any punching in the face because I'm definitely not a violent person. But what I can say is that violence is the price of raw materials lately, shipping costs. I mean, those have been up and down and talk about punching in the face or the guts, aluminum, copper, boats from around the world, air shipment. Typically, I think about contract manufacturing is a cost-plus model. Is that the case? Then maybe let's take it also to your area of solar, is it different there for contracts versus assembling servers and high-end Agility and Reliability Solutions?

Well, thanks for sticking with the analogy, Jim, and let's just keep it going. And so you have a punch from commodities inflation. What you need to do is you need to block. And so we do that with our supply chain organization. And so you take steel, which has gone up significantly, you have aluminum, which -- same thing. It's just generally commodities inflation that we've seen over the last several quarters even. What we do is we block and we can block in a number of different ways. You take our NEXTracker business, for example, which does use metals, as we take a contract, our process is to as quickly as possible, lock in our supply chain. So the timing between when we're taking a contract and when we're entering into contracts to secure supply, very, very small time window there. And so that essentially blocks. And so that has helped for sure. There are some elements in this more inflationary environment that are more difficult to block. You take, for example, overseas shipments. We have partnerships. We can secure shipping lanes. We can secure births. But it's not 100% blockable. And so we have seen some cost pressure. The whole industry has seen some cost pressure. There's plenty of disclosure out there for other companies. You mentioned solar specifically. And I think that industry did get a little bit of pressure. But the way it will work is, ultimately, those costs will get passed along. In the areas where we have fixed-price contracts, you do have to work through your backlog over a number of quarters. But as we rebid, of course, we're rebidding at the higher rates. You mentioned solar, my personal opinion on that renewable space right now is that the commodity cost inflation that we're seeing won't ultimately affect demand. I think there's just much too much momentum in that space right now, both internationally and domestically. I don't see that rolling over. It might be a little bit more expensive in the short term to do the work, but quite confident that that industry is going to continue to see growth.

And then, Paul or David, whichever it's more appropriate, in the past, I've written about Flex unlocking some hidden value within it whether it be through solar or things like that. Can you give us an update about what you can or maybe what you can't say? And kind of about why, some people say, "Hey, the company has been pretty keen on this."

Do you want to take that one?

But maybe, David, I know you and I talked about it a little bit earlier. David, do you want to kind of update us on that and what you can and can't say and why? And people, I don't think you might be trying to be cagy, but I think you're a little bit buttoned up about what regulators will let you say.

Yes. So where we're at in the process is with NEXTracker, we filed the confidential S-1, that release is public. And what that means is we fall under SEC Rule 135, which is a very specific rule that governs basically 3 points that you can't talk about anything forward-looking. You can't talk about pricing of a deal, a deal composition, meaning, if we were to IPO via the S-1, would it be all or part and anything about that. And then the big one is the deal timing. We can't allude at all to what might -- or when the timing might be. The things -- the disclosure specifically says, on timing, it's governed by SEC regulation or market dynamics. So thinking about those 2, we do what we're supposed to do to make sure our SEC filings remain up-to-date and we look to the market dynamics to guide that. And so, yes, it's not us being coy. We want to unlock the value that we believe is there. As Paul talked about, we're very bullish about the solar space. Even if you take conservative estimates out there that's been done in the public domain, this is going to be a very good space for many years to come. Paul can talk more about why it's a -- we see as a premium asset. We are, as defined by third-party analysts or research out there, the market leader by way of installations, both in the U.S. and in many geographies globally, particularly the top geographies where there's the most growth and pricing is stable. So I think there's a lot of reasons to be very optimistic about the mid- to long term.

Yes. I agree.

Well, maybe, Paul, let me circle back to you. You're hitting -- you just hit your 1-year anniversary and you joined the time with the new CEO changing no longer consumer fickle going after high fashion consumer items and stuff and going after agility and reliability, a change there and then COVID hits you. So quite a dynamic time to be a new CFO. Can you talk a little bit about, as you sit there, kind of what's changed? And then of course, kind of capital allocation as CFO, that's a key topic that people should be asking about.

Yes. It's -- to your point, my 1-year Flex birthday was September 1. And the -- kind of a weird time to come into the company, to be honest, 6 to 8 months into this pandemic. The company at the time was in full cash conservation mode. So we had paused stock buyback. We were not active in M&A. I think like most other companies in our position, we were trying to get the lay of the land and just figure out this pandemic. I think we've got that well under control. We understand the ins and outs much, much better. I think we've demonstrated our ability to execute and to continue to perform and continue to generate strong top line, strong bottom line and generate cash through that cycle. So we've started to relax that cash conservation mode, I guess, I'll call it. And so if you look back at the first calendar quarter, the March quarter that ended back a few months ago, the -- if you look at the June quarter, I think we bought back 8 million shares, stock buyback in that March quarter. We bought back 9 million shares in the June quarter. And so between those 2, that's north of $300 million spent on share repurchases. So clearly, we're sort of getting back into the market. I'm not sure if everyone picked up on this. I was a little surprised there wasn't more of a reaction. But following our annual shareholders' meeting in August, we did announce that the board had upsized our stock buyback authorization to $1 billion. If you look at the last few years, this is typically when we do our share authorization. It typically comes in and around the annual shareholders' meeting. Last few years, it's been $500 million. And so at $1 billion, I would say we have plenty of flexibility to get into the market and buy back stock opportunistically and as aggressively as we see fit. I think we've got plenty of flexibility there. But our capital allocation framework is not all about stock buyback. Our intent is to be quite balanced. Certainly, that's a lever for us, particularly at the valuations we see today. I personally think that Flex is cheap. There's a one handle on the stock that doesn't make sense to me. I don't see any reason why there wouldn't be a 2 or 3, particularly given our outlook and the potential of the business and our demonstrated performance. But there's other levers that we can pull as well. We are certainly going to continue to invest internally. We look at the markets where we participate. We think there's a lot of potential. We're going to make some select CapEx investments, more on internal R&D to grow our position in those markets. And I'm highly confident in investments like that just because I can see the path to a low-risk, high-return projects. Areas specifically that we'll invest in on the CapEx side, and just to kind of give you a framework for this, Jim, I think we've talked publicly about 2% of sales is probably a good guidepost on what we could potentially spend on CapEx here. But we're going to continue to invest in our own facilities, continuing to do more with automation and robotics and advanced manufacturing. We want to be as -- remain at the leading edge of manufacturing capability and we're going to need to continue to invest in that and we will. But we also have some nice next-gen program ramps that we need to and want to support. It supports top line growth in attractive areas. And so a little bit of facility expansion in a couple of areas, adding some technology in some areas. Health Solutions businesses, for example, you have to be very specific on certain things like sterilized environments and clean rooms and that sort of thing. And so there is a little bit of CapEx there. But that's high calorie programs with great margins. So I'm -- I'll do that investment in any day of the week. The other lever we have is M&A. We essentially were out of the M&A markets when Revathi came into the company. She wanted to get it all sorted out and get the company focused on the right things. Now that we have that focus, I do think we have appetite for some M&A. We're going to be very judicious about this. We have a process. We have a pipeline. It's all about long-term shareholder value creation. We're not going to go out and do deals just so we can say we did deals. To me, it's all about the -- it's the financial metrics that have to support the deal. But I would say, Jim, we've got a lot of levers. We've got a lot of capacity on the balance sheet right now. Last quarter, we were sitting on order of $2.7 billion and this is a business that continues to generate cash. So I think we've got lots of capital allocation optionality and we hope to keep it that way.

Well, as we kind of wrap up, we still got about 8 minutes, but I want to ask both David and Paul, the same question about kind of what investors you think are not fully appreciating our grasp? And I know David is Head of Investor Relations. You get a lot of inbound calls. This is also a great forum or opportunity for you to clarify any common questions you get asked or misperceptions. And then, Paul, I'll let you wrap it up about what investors don't fully appreciate, but first, David.

Yes. I think the biggest one that I'm getting now is, especially as we see a lot of new investors or investors that haven't looked at Flex in the EMS space in a while and see the opportunity here, there is a legacy view of the EMS space in general where they still see the bulk of our business as tied to core tech trends, server and storage and those things and that's not true. It is not the majority of our business and the majority of our business is moving towards other areas, as Paul has outlined, reliability and then areas like lifestyle, which are more interesting, complicated businesses. And so it's important when people look at the EMS space that there's a bifurcation of the traditional EMS space, the contract, just pure -- does it build a design -- or I'm sorry, not designed by business, but just pure EMS where there isn't much value-add to that. And then there is the more advanced areas that only a few players are involved in. And these are more complex business, they're often regulated. And there is a -- now a table stakes level of design and engineering for you to even get involved in many of these businesses, such as part of autonomous or electrification or certain parts of medical devices, same with industrial, where you're not going to be even invited to the table if you don't have these very distinct capabilities. So what that means is that there are parts of the business that a few of us are focused on that are -- it's higher value or it's structurally higher-margin business and the dynamics -- the competitive dynamics are much different. So it's not a zero-sum game. We all -- we few may play in these markets for many years to come. And while we all may play in healthcare, rarely we will even see each other because there's such big heterogeneous market. So I think the first thing, again, is for people to understand that the EMS space, there is a bifurcation. There are a few players that have the capabilities to go after these higher-value markets and it's going to be that way for the decades to come.

And then I'll maybe just add. This is a leadership team that's going to do what they say. You look back at comments that Revathi made when she came into the company. We're going to be a GDP-plus top line growth company. We expect to be mid-single digit margins. You look at what we've done over the last 4 quarters, we've done what we said. And this is a business that never saw 4% op margins. And now we've got 4 quarters in a row at 4% plus. And that's Flex Core as well. And that's not bolstered by higher-margin NEXTracker business. And so last quarter, for example, 4.6% op margin rate, Flex Core was 4.4%. So you're seeing a business with good top line dropping through to good bottom line with nice margin expansion and a company that has a whole lot of capital allocation optionality, oh, by the way, with, I would argue, discounted value with the NEXTracker asset in the portfolio. So it seems like a lot of upside for a company like Flex and particularly if you have confidence that we're going to do what we say and I think that we've demonstrated that we will.

Well, I want to thank Flex for sending the Chief Financial Officer, Paul Lundstrom as well as the Head of Investor Relations, David Rubin, for our Global Tech Conference. And we sincerely hope that next time that we do our Global Tech Conference is in person as well as our Silicon Valley Bus Trips because [ gentlemen there ] has been a lot of virtual meetings and hopefully as we're getting past this, but I want to thank you for your time.

I echo that, Jim. And thanks for having us. Much appreciate it.

Thanks, Jim.