Flex Ltd. (FLEX) Earnings Call Transcript & Summary

Okay, everyone, thank you for joining us. My name is Shannon Cross, and I'm the IT Hardware Analyst here at Credit Suisse. So prior to getting started today with Flex, I've been asked to let you know that during this presentation and the meetings that follow, Flex will not be answering any questions on NEXTracker due to its previously announced confidential S-1 on file. Please refer to the Flex Investor Relations site for all appropriate disclosure information. With that, it's my sincere pleasure to welcome Revathi Advaithi, to her first and my almost first fireside chat at this tech conference.

Hello.

So yes, this is my first year. It's exciting. It's going great. So first, can we just talk a bit about the macro, what you're seeing maybe on a segment basis? How you're thinking about planning for various scenarios because, obviously, there's a lot that's up in the air right now?

That's the biggest question now, right. So we participate in 6 end markets. So we have quite a diversified portfolio. So the way we think about it is almost in those 6 end markets. I'd say the one that's obvious and easy to understand is a couple of our end markets, which is consumer devices and lifestyle are more in consumer end markets. So those have been slow for the last, I would say, few quarters. You haven't seen it as much in our numbers just because of market share gains, but those end markets are slower. We'll see what comes out of all the big shopping spree that everybody will be on in Q4. But that typically is slower than what we have expected to see, I would say, even in this quarter. So in general, I would say that's no new news. Everybody is seeing that and that is behaving as expected. And we're just seeing -- not seeing it in our numbers enough just because of some market share gains. I'd say the rest of them, anything that is using kind of lagging edge semiconductor, is still seeing a lot of chip constraints. And that is still focused on trying to meet all the end demand. So automotive demand still looks strong because we haven't seen inventory show up in terms of the car lots, right? So we're still seeing a lot of automotive demand. Industrial, I'd say, if you look at all the recent earnings that have come out from diversified industrials recently, strong backlog in looking forward. So industrial is a lot about focused on meeting demand just because CapEx investments are still strong in the industrial space. So we're seeing strong demand there. Health hasn't seen much of a change at all. We are seeing very good growth in health. And again, it's a little bit focused on demand is constrained by being able to meet it because of the chip shortage, but end market demand is still very, very strong. So I'd say -- and then our largest business, which is our CEC business, focused on networking, cloud and enterprise. I would say networking and cloud is still very strong for us. And we think that will continue to be the case, at least in terms of cloud looking forward. So you bring it altogether, I would say, since we have 6 different end markets, they're all going to behave a little differently over the next couple of years based on where you are in the cycle. But overall, as Flex, last quarter we were around 24% growth. This quarter we expect to be 15%, 16%. Second half, we have said we're going to continue to have strong growth. So we see overall demand still being strong, but each one is behaving a little differently based on which sector you're at.

How much of your growth do you think will be market share gain versus just within the existing programs?

I'd say what is happening in EMS and markets, Shannon, as you know very well, is a couple of interesting macros that is driving growth, right, for EMS as a whole. What is this whole thing about reshoring, onshoring, which has picked up pace over the last year, even through all this noise in terms of supply chain issues, is a significant area for a company like Flex to grow share. So we are seeing customers want to come to a company like Flex to be able to move complex products across the world. So we see market share gains as a result of that. And then couple of end markets, 3 end markets that we really like and we're really focused on. One is everything around electrification. And if you think about electrification, whether our portfolio is to -- on just EV cars or it is on chargers or it is in terms of storage and renewables, so that whole space, electrification to renewables is a space that we're very focused on in terms of market share gain. And our portfolio is really appropriate for that because we have invested a lot in terms of EV, our own products and to manufacture for OEMs. So that is a good market share gain area. I would say the second would be everything around health, particularly around wearables and medical devices, is an area for us if we're focused on in terms of market share gain and then cloud as a whole. Our portfolio is very strong there. So I'd just step back and say, last quarter is a good example of 24% growth. I'd say, at least 15% of that, half of it came from market and half of it came from market share gains. So I'd say it's a good mix of what's happening in terms of macros itself and then where we are investing, which is very thoughtful and very well planned and where we want to grow share.

You've been at Flex almost 4 years now. I'm sure it's been a very uneventful time. Maybe if we take a step back and think about the changes you and your executive team -- and frankly, you've changed out your executive team overtime -- have made and what are sort of the key differences if we think about Flex today versus Flex 5 years ago?

Yes. So first is -- I'll focus a little bit on what we did, but I really want to talk about what I think we'll do moving forward. So 4 years has come and gone with so much going on around us. But I'd say the most -- my philosophy on any business has been always been very simple. One is you have to love your portfolio, right? So you have to get that right. And so the first thing we did is really focus on kind of saying, do we like the 6 end markets we are on, and contract manufacturing as such is very large end market. So you have to parse that down and say, what part of that do you really want to focus on and how do you really grow in that? So we really got -- spend a lot of time on getting mix right across our portfolio, not just in 6 end markets, but within that, there is so much to get done. And so we really said, let's get our portfolio right. Let's decide what we love about this and where we want to grow. So that was one big thing. The second is, I think our 6 markets sometimes behave very differently. Some have more fluctuations in terms of how the end markets behave. Some are more complex, large ramps over a period of time. So getting our operational execution correct based on which end market you are on was also important. So getting your portfolio right, getting your execution right, so really focused on very simply those 2 things and said if we did those 2 correctly, then the business will behave much better than what it has. I'd say as a result of all of that, we have also seen EMS as a whole be more disciplined in how they are behaving. The whole sector itself has become more disciplined in how they are behaving in these end markets. How we decide what is value for customers? So if I look forward, I have to say, we want to take advantage of continuing to improve our mix by making sure customers understand what is the value story that EMS companies bring that Flex brings to the story. Supply chain resiliency is a big conversation for every CEO, CFO. We have to be able to sell why Flex is right at doing that. So looking forward, mix will continue to be an important part of our conversation. I'd say the second, there's so much happening around automation, how you run your factories, AI/ML and really being thoughtful in how you're using those to drive efficiency. I feel like that is just starting in some ways, even though people have talked about it for a long time. So productivity, there's a lot more to gain. So these 2 themes for us, which is mix and portfolio and focus on operational efficiency in some ways was our last 4 years, but will also continue to be our big story moving forward.

And how do you think about margin potential? I think you touched on some of it in terms of mix and also adding more technology and maybe being able to drive, I would assume a better contract value with your customers. But given the macro and the potential for slowdown in that, how do you protect Flex's margins? I'm sure you're running many, many scenarios these days.

Yes. So of course, I think we've become really good at scenario planning. This is the core competency. So like what happened during COVID, I was in my role just for a year, right? The last thing I was thinking about was how do you plan for a pandemic? And suddenly in the quarter, we saw demand just drop so significantly just because you couldn't get people to work. And we developed a very robust methodology for how we think about end market demand and how we should flow that through our factories. So we have done a lot of simulation in terms of how does each of our end markets behave in what time frame and how does that flow into our factories, and at what pace can our factories make changes to meet that end market demand. And so having disciplined thinking in terms of how that behaves I think is important. So for example, what part of our labor can be -- kind of move up and down, right? So what is the right amount of contract labor to have and based on which end market you're in? What kind of skills are important to keep? So we've really flowed this thinking of how our 6 business units will behave, how our 130 factories will behave, Shannon, and we have modeled that across. And we've put all the hard landing, soft landing. Continued growth of 10-plus percent of that scenario continues to play out. How will we behave? And we feel quite comfortable that we will use those triggers effectively as we see what happens as we work through those demand.

Have you changed any of your contract terms with your customers or how to again further protect Flex, especially given some of the inventory increases in that, that have occurred over the last couple of years?

Yes, I see all these as opportunities to really change how you partner with customers. The good news is that our customers have also been very open to understanding what is a better way to partner. So we have. We are focused on changing contract terms to understand if you continue to have these type of supply chain crises, how does working capital behave? Who owns what? And it's an opportunity for us to rethink our contract terms with our customers. They want it to. It's a 2-way street in these conversations. I think for me it always comes down to the discipline of the sector itself. And Flex kind of being one of the top 3 contract manufacturers, it's the right thing to do to figure out how to change these relationships. So we have driven contract changes and we'll continue to do that. And I would say our customers are open to those conversations because they know that it's the right thing to do.

And I wanted to dig a little bit more into the added technology in the manufacturing. It's called Industry 4.0 because everything needs a buzzword.

Yes.

And one of the things that struck me is that the larger EMS companies who can invest $400 million, $500 million a year in terms of just added capabilities, both separate yourself from sort of the pack of smaller companies and also are doing things that I would think in-house manufacturing just can't afford.

Right.

So I mean is that something that -- are there certain areas you would point to that you've been able to again, distance yourself from the pack on just in terms of ways to manufacture, 3D printing. I'm just curious sort of where you think you are.

Yes, so I'd say it comes in many ways, right? Two parts to the question. One is how do you differentiate in manufacturing capabilities to other manufacturers? And then 2 is how do you think about this whole Industry 4.0 and what's the future of manufacturing? I'd say the first part, when customers come to us and they make very complex products and their yield is at 50%, they'll come to a company like Flex because we have the resources to be able to help them redesign that product or rethink how they are manufacturing it, so we can really help improve those yields. So we'll probably say, hey, don't use that set of equipment, we'll bring you a different set of testing equipment that you should be using our manufacturing equipment. So in the day-to-day itself, a company like Flex can take very complex products and do something different for customers than what smaller manufacturing's can do. But what I'm really excited about, I feel like Industry 4.0 is just started because people talk a lot about robots and automation as it relates to the factory floor. But if you think about the kind of software layer of what ties manufacturing together, still a very fragmented space. If you think about the potential of AI/ML and how you can use machine learning to have more proactive ways in terms of how equipment is used and how you can improve equipment utilization, those types of things have just started. Like we were just recently in one of our factories and that particular cell ran through entire Thanksgiving week with almost nobody looking at what was happening in that cell. But think about that being replicated many times over across all your 130 factories and you have the human intervention when you're able to kind of change the programs and change the complexity, but you can also improve machine learning to say, hey, I can take like 2 seconds out of this, right? Because it behaved a certain way when there was an energy fluctuation. So what is so exciting is that we can apply really smart teams to think about what this future is going to look like, and I want Flex to write the book on this the next time, right? Because we want to really lead that side of the thinking. So like 3D printing and all this, like it's almost like old news, right, to some extent, because it's there. It's all about how you can tie all this infrastructure together and drive efficiencies through that is what I'm really excited about.

How much of the software there is available or does it have to be homegrown at this point?

There's many things that I would say that is available. The question is always like how do they talk to each other, how do they interface together? And can you make those interfaces more seamless, so they're more real-time? I love the idea of having a navigation system for a factory when it says that machine is down, so reroute it to the other machine and all that happens automated way. That is not available today. You have to -- some of it will be homegrown, some of it you'll have to piece together. So a lot of, I would say, kind of solutions available, but how you integrate it together is what I think Flex will differentiate itself on.

And I guess just moving to some of the stimulus money that's out there. And some of this does tie a bit to NEXTracker, but we'll keep it away from the IPO. How are you thinking about benefits from the IRA? And are there concerns about the EU and some anti-competitive -- I guess there's -- I think it was written and there's all sorts of complexity in the words that are there or aren't there. So how are you dealing with that?

So we have a very strong and growing renewables business even outside NEXTracker, right? So whether it's NEXTracker itself or that renewables business, where we would be making everything from storage for your house, invertors for residential homes and -- or be tying that together in some kind of a battery management system. So we make all of that infrastructure for renewables, whether it's residential or utility scale. And so for us, when we think about the tailwind from IRA, it is good because there is a focus on some amount of it is made in American manufacturing. So a lot of our customers and us, we're in the middle of either having the conversations or almost starting ramp-ups to say, how do you meet the requirements of that? What does it mean to them? What does it mean to us? Which is an opportunity to win market share because customers want to make sure they're ramping with good EMS companies. So we do see IRA as a whole as a tailwind. One is because renewables has strong macro and strong growth. You just have to look at the price of gas and know that that's going to continue for a while. And that's really driving conversations about where do you make it and why and how do you have a footprint in North America, and we're in the middle of those. We're looking at kind of how do we increase our U.S. footprint more than what we have today, and those ramps are in place or ongoing. So IRA will be a tailwind for all renewables, NEXTracker and the rest of the business. But in terms of the EU itself, I mean, I think there is noise in there. There'll always be anytime we have these types of conversations. I would say we'll see how it goes. It hasn't stopped our customers from moving forward right now.

How much of the right shoring that's going on is actually looking at bringing manufacturing into the U.S. versus Mexico or near-shoring opportunities? I'm just wondering what -- sort of where the conversations are with customers at this point.

I don't know if I would have a percent of how much would go to Mexico or to the U.S. But the way a lot of customers are moving forward or thinking about it is that you may be manufacturing significant parts of the product in Mexico, and you may be bringing it together here to the U.S. for testing or for end market configuration. That's kind of how customers are thinking about it. One is demographics is important. You have to have people to be able to do all this manufacturing also, right? So I love the idea of let's do more, but you have to have the resources to do it. It's always somehow policy is disconnected from the reality of can you find the labor to do all of this stuff. So our customers are very thoughtful about this. Wherever they can, if there's end custom configuration, if there's testing that they want to do closer to their customers, they may bring it into the U.S. and where the skills and labor available, or they may do it in Mexico in terms of doing the larger configurations and then bringing it in here. So I don't know if there's a clear percent, but I would say it depends on how that product is going to behave, and it's availability of resources.

Is there an opportunity to leverage community colleges and vocational training in the U.S. to try to drive more?

A lot, a lot. I think we'd say -- I've been on this committee with Secretary Raimondo on where you develop those skills, where do you drive technical education in the U.S. And I do think it's a huge opportunity to drive more of an apprenticeship program. If we can do more of that, like Europe does well, create hubs, regional hubs across the U.S. for certain skill sets. So if we're going to make a lot of EV products, let's drive a hub, let's drive a technical knowledge and know-how in a certain area. So I'd say there's tremendous opportunity. And there's good public private partnership around this, I would say, that I feel very bullish about.

Good. We need it, definitely. At your Analyst Day, you discussed healthcare, auto and cloud as growth vectors. Has your thinking changed about any of those since then or again, given the macro that's out there, would you deemphasize or maybe spend more in any given area?

No, Shannon, when we talked about it in Investor Day, we were looking at it over a long period of time, right? So if you just piece each one of these out, if you think about cloud, there may be noise about does the rate of hyperscale growth or data center growth or colo growth change from 40% to 35% or 30%. Well, it's still very, very strong growth. You don't see the dynamics of use of data changing anytime in the near term, right? If anything, with all the conversation around Metaverse and everything is going to only become more. So we pick these areas with very long-term views of where these macros are going to go. So our view on cloud is, if anything, let's make our portfolio more robust. Let's look at it more end-to-end, not just storage networking. Let's look at a full integral solution. What cloud customers want is, they want schedule. They want modularity. They want kind of ease of bringing product into and ramping up and ramping down as they add modular growth to their data centers. So Flex wants to be able to do that, right? And so, we're trying to solve the problem thinking about it more holistically as a portfolio. So cloud is still one that we feel strong about. I'd say, electrification, renewables, I mean, it's a no-brainer. It's not going away anytime soon right. So just think about the pace of what's happening with EV. Again, long-term macro, we didn't decide this based on a 1 or 2-year kind of run. We think the next decade this is not going to change. Healthcare, aging demographics, the areas in healthcare we're picking is all around device and particularly wearable devices, very complex to make, very hard to replicate. If anything, that is only going to -- with miniaturization and all that changing, this is going to be kind of a bigger and bigger part of kind of growth in terms of the healthcare space itself. So we're looking at all of these as long-term growth vectors, and we feel those are the best 3 even now today. So there's a lot of others that we are focused on, but these 3, I'd say, holistically as Flex, we feel are the right 3 long-term vectors for us to really focus on.

And how do you think about cash flow? I've got time for a couple of more questions. I wanted to hit on the balance sheet. And just one of the concerns people have is, obviously, what's happened with cash over the -- during the pandemic and increased inventory, and how does it run off and how do your relationships with your customers work with regard to the increased inventory. So what do you think is sort of the normalized cash generation of the company and how do you get there? And how quickly can -- again, inventory clear?

Yes. See, we've always said that at least targeting 85% cash flow conversion is our goal. If you look at the history of how we've performed through the cycles, we've always been 100% conversion to net income. And so, I feel good as if you think about the cycles and you absorb the cycles, that's kind of where we will be. I'd say a lot of noise in the system because of the amount of chip inventory and everything that everyone is caring to meet this demand. So I think that does take some time to absorb. I'd say that and then driving 24% growth a couple of quarters in a row, still at a strong, like mid-teens growth requires some investment in working capital. But I feel very comfortable that through the cycle being north of 85% free cash flow conversion is what this industry, what Flex will perform at. And I don't see that changing anytime soon. I'd say that that's what this business is known for is generating cash through cycle, right? And so yes, a little bit of noise just because of sitting on inventory to meet all those demand that we have, but we're very disciplined about this, right? We will convert that inventory to demand as things start to free up. I would say this noise of how much you order is reducing. I can see that with our customers every day. We help them plan through kind of the next year. So I see working capital as being challenged in the near term, as you have seen, but I don't see this as a longer-term issue.

And how do you think about use of cash? Specifically, I want to talk about M&A and opportunities there. If we are, I said -- I say if we're going to a recession and I got jumped on yesterday, we are in a recession. So anyway, whatever we're in right now, are you seeing better prices for potential acquisitions, are there areas that you would want to augment?

So in my 4 years, I've only done 1 acquisition, which was the Anord Mardix acquisition, which is very focused on improving our portfolio in hyperscale. It's in very complex areas, right, which is more on electrification and hyperscale. So we did one acquisition, which was a fantastic, I would say, return for Flex and has really panned out well. You would think that right now M&A should be a focus just because pricing is going to get better and things like that. But for us, I would say, first is the most important thing is we have to invest in growth. We're growing a lot of share. Our end markets are growing well. So investing in kind of organic growth, particularly around things like efficiency, productivity that we talk about, Shannon is going to be the most important thing for us. You can't continue to grow like 15%, 20% and not really scale up and ramp up your overall investment in your manufacturing footprint, particularly around automation and efficiency. So we will do that first. I would say then focusing on kind of buybacks is going to be important for us. I would say we'll do that because that also seems to be -- it's a good opportunity. So I'd say M&A comes probably last on that list right now for us. But if we see something interesting and fits our portfolio in those 3 areas, yes, we'll always look at it. But for us, it always has to be a good deal, and it has to make sense for us in the long-term. And I'd say the first 2 things come first, organic growth and then focus on kind of buybacks where we see, the opportunity and then we'll look at M&A kind of last.

Great. And then I guess just my last question is, as you -- we've talked a lot about your opportunities but -- and maybe a little bit longer term. But as you look to the next -- I don't know, just through the next year, given all of the noise that's out there, what are you most excited about and see the biggest opportunity for Flex?

I'd say the most -- we can't take our eye off the big price, which is that the world is changing around supply chain and manufacturing. That is changing for the next decades, right? The next world this flat book is going to get written and it's going to look different than what was written a few years ago. So we have to keep our eyes on the long-term as we think about the next year. So for me, still the focus on investing into manufacturing efficiency and automation and productivity. But focusing on these 3 areas that we talked about, such exciting stuff is happening around medical wearables and medical devices. Such cool things are happening around electrification or how cloud and data centers will look like in the future. Those are the things I want to keep us focused on, because by the time we all retire, these spaces are going to grow and look so different. You want to be in it, right? So over the next year, I think still focused on kind of those 2 things would be what Flex is going to be focused on. And I don't think that changes as we look forward, 1, 5, 10 years. I think that's kind of where our eyes are on.

Great. Well, thank you so much for your time. Thank you, everyone, for joining us, and we look forward to continuing to follow.

Thanks, Shannon. Thanks for having me.

Thanks.