Flex Ltd. (FLEX) Earnings Call Transcript & Summary

Okay. Great. Thank you, everybody, for joining us. My name is Mark Delaney, and I cover Flex for Goldman Sachs. I'm very pleased to have Revathi Advaithi, the CEO of Flex with us today. Thanks for joining.

Thanks, Mark.

As many of you know Flex is one of the largest manufacturing companies in the world with about $30 billion of annual revenue. Flex reports in 2 segments that are about similar in size, the utility Solutions segment serves end markets including communications, enterprise and cloud, lifestyle and consumer devices and then also the reliability segment serves in markets such as automotive, medical and industrial. I thought Revathi to start, you could speak to some of your key priorities and your focus items currently.

Yes. I think, Mark, I think top of mind for everyone, of course, is what's happening in terms of end markets, right? We have 6 very distinct end markets within our 2 businesses that we participate in. So just keeping an eye on how those end markets are doing, how we react to that. And we have very 6 distinct end markets. So consumer is behaving in a certain way. Automotive is behaving in a different way. So top of mind, of course, is for us making sure that we are agile in terms of our responses. We are reacting to market requirements and needs really quickly. So that's a top of mind key priority. And then the second is even as those changes are happening, we have a lot of key new programs that are kind of going through their ramping processes across our businesses. So making sure that those are well established and well running is top of mind for us. They're particularly big in terms of our automotive and industrial businesses, which are complex programs to ramp. And then lastly, I would say keeping our eye on in between all of this and the technology trends that are happening, whether it is in the renewable space or everything that's happening in cloud, making sure that we're committed to the things we said we would do in the renewable space and in the EV space. So keeping our eye on that and making sure those priorities are continuing. So I'd say those 3 are top of mind for us and that's kind of the direction we're heading in right now.

Maybe we can dig into some of those end market trends in a little bit more detail and starting with the reliability solutions market. Can you remind us what the key drivers are for Flex in those areas and what you're seeing in areas like automotive, health solutions and industrial.

Yes. So all 3, I'd say automotive, a lot -- I mean you're reading everything in terms of what's happening with automotive markets. We have a good balance of new growth coming in terms of our EV platforms, our existing business in terms of the traditional ICE business. So EV is seeing strong growth resulting from the new bookings we've had and the ramp that you're seeing in terms of electric vehicles globally. We call that next-gen mobility. So I'd say those end markets also catching up from the supply chain crisis a little bit because that was a harder time in terms of shortages. So automotive business, I would say, is still running strong. Health care has been -- depends on which part of health care, we've said in the past, outside of kind of big hospital investments, we have seen health care continue to be fairly robust in terms of growth, particularly in the areas we are, which is medical devices like CGM equipment. Healthcare has been fairly, I would say, consistent in these kind of volatile markets. Industrial, which has a wide array of products within it, it has everything from renewables to traditional power products, I'd say it depends on those end markets. Renewables, if you're in the home renewable space, those are more challenged if you're in the utility renewable space, it's doing fairly well. If you're in power products, I would say investments are very strong across the U.S. So industrial is a mixed bag based on which particular end market you're focused on. So I'd say each one is behaving independently in terms of -- in these types of environment, which you would expect.

On the topic of automotive, you mentioned next-gen mobility and electric vehicles, also ADAS applications. Can you remind us how much of your automotive revenue is coming from those sorts of areas and how you see that progressing over time?

So our base business in automotive is still mainly from ICE applications. But the reminder I would give is, even within the ICE applications, we don't do anything in the traditional kind of transmission power products and things like that, that is in the traditional ICE products. So even within ICE, we are in the electronic space [indiscernible] ADAS space. So most of our business, I would say, while it's still with ICE, our new businesses are mainly ramping up in the kind of EV next-gen mobility space. So we haven't publicly split that number, but I would say we're in the majority ICE, but mainly in the electronic space, which is where you want to be. So we don't see any reduction in that only continued growth. And then we're shifting our new bookings more into the traditional next-gen -- in the new next-gen mobility spaces.

Have you been able to quantify or put a rough range around how much more content there may be on an electric vehicle relative to an ICE vehicle?

Yes, I'd say those numbers get thrown around quite a bit. And I'd say no -- I haven't seen consistent apples-to-apples comparison on this. So whatever number I give you is going to be different from what anybody else says. I think what we have traditionally said that is in the ICE business, maybe it's around more $300 per vehicle content for us. And then in the new next-gen mobility will be north of $1,000 and increasing. And so -- but I'd say it's hard to put an apples-to-apples comparison to that. But 1,000 is a fairly conservative number in terms of content per vehicle, I would say.

Okay. One of the other interesting growth vectors within reliability has been renewables. You talked a little bit about trends between utility and residential types of programs? Do you think some of the inverter companies have recently seen some weakness. So maybe that's what you're alluding to, but could you talk a little bit more on what you're seeing within the inverter business?

Yes. So renewables, as we all know that renewables is in the right space in terms of long-term macro and the growth trends associated with it, right? So anybody who's been following renewables for the last 10 years know that the tipping points of what makes sense for renewable investments is finally reached and things like IRA and all, of course, help it a lot. And I think what we're seeing in terms of residential investments on renewables is probably a lot to do with interest rates. Of course, I think that higher interest rates means it's harder for homeowners to invest in renewables. And so I think as a result of that, you'll see some slowness in terms of the residential inverter business. But I would say it's a lot more than just that. The utility grade, I would say, renewables is going fairly well. Power Products is going fairly well even in renewables because you have to keep investing for efficiency. And we make inverters, we make storage, a lot of homeowners are adding storage. I'd say I'm very bullish about the renewable segment overall and things like IRA does help and -- but who knows what the focus of homeowners are right now as interest rates are pretty high, right? So -- but we feel very good about the long-term trajectory of kind of residential solar as a whole.

Again, I think if I'm remembering correctly, renewables had eclipsed $1 billion of annual revenue even excluding Nextracker.

Yes, that's right. And we said that a couple of years ago or a year ago, whenever we did our last Investor Day is that renewables is the right long-term trajectory for Flex to invest in, and it has turned out to be the right area of growth for us, and we feel very bullish about kind of renewable as a whole. And not only do we have inverters, but we also have all the charging stations and all that associated with it is also in our renewables business and so much infrastructure investment is going on in terms of charging stations. We feel good about the growth of that business, too.

That's been a really nice driver to see as an analyst over the last several years. Another growing business for you has been cloud and touches both the reliability and the agility segment. Maybe remind investors how the cloud is for Flex and where you participate?

So in our CEC business, which is the largest business for Flex, it's around 30% of Flex's revenue. Our enterprise segment is still the largest within that then comes to our Communications segment. And then last is our cloud business within that, but it is the fastest growing within that segment. So we haven't directly shared the breakout of each of those, but cloud is the largest growing part of the CEC business. Of course, with cloud, every time there is capacity investment, there is pause as you digest it, then there's more capacity investment. And I'm sure we're not going to end this conversation without talking about Gen AI somewhere. But that is definitely driving new investments in cloud and which we're quite happy to participate and be the beneficiary of that.

You took my next question, which was on AI. Maybe talk a little bit more around what you do with an AI, the different products and capabilities that Flex maybe offers and any revenue step-up on an AI rack relative to a traditional workload that you may be able to share?

So the -- I will start by defining in cloud. Again, it is not an apples-to-apples comparison to what Flex does versus other EMS companies do. So it is we have a different portfolio. So we have 2 parts of our portfolio in the cloud. The first is what we do in our CEC business, which is providing more integrated cloud solution. So taking a rack, fully populating it, fine-tuning it for what the customer needs and delivering it as a fully ready product for the cloud customers. So that's one part of what we do. And then the second part is in our industrial business, where we do 2 things. We design and build embedded power modules for the cloud business. And then we also, through our Anord acquisition, participate in facilities power for cloud businesses. So we have 3 very distinct parts of a solution for our cloud business. And most EMS customers will do the first one in terms of some rack solutions, but not the second part, which is more the power side. So I would step back and say, so it's hard to give you a comparison of content in cloud. But the biggest difference we're seeing right now is the consumption -- 2 things. One is the consumption of power in what is required for GPU compute is pretty significant. And so when we have custom-designed embedded power modules that go into the GPU compute racks, which obviously are doing well and would continue to grow and do well. And then there's a lot of power requirements to run the integrated Rack solution. So from our critical power side, capacities are only constrained, the more we can add facilities powered to cloud solutions, it will be helpful. I would say on the integrated rack solution, which is part of CEC, the complexity of the boards are changing, which is required for the GPU compute intensity. And then, again, the scale of building these integrated rack solutions and providing that at scale to customers, hyperscale customers who are participating in GenAI is a significant part of what we do. So all of those are seeing through some significant growth as expected and we'll continue to benefit from that.

Mentioned in the opening response about being focused on program ramps is one of the key things that top of mind for you. I believe you've got a pretty meaningful cloud programs trying to ramp in the second half of this year. Operationally, do you think the company is ready to support that?

Oh, yes, absolutely.

And then maybe talk about the breadth of Flex's exposure to hyperscale and whether you're penetrated pretty broadly across the main cloud service providers? Or do you think it's a little bit more targeted and narrow and breadth at this point?

I'd say it's fairly distributed. I think what I like about how we are in the cloud businesses. We are fairly distributed across hyperscale customers. That being said, some more than the others, so there's room for growth. And also geographically, I would say we're fairly well distributed. So I like both elements of it. And -- but we're mainly focused on hyperscale. We don't do a lot of colo and things like that.

One of the discussions I've had with investors is around how will AI impact not just hyperscale, but perhaps enterprise as well and traditional enterprise data centers do some of the same sort of investments. I'm curious, are you seeing any investment in interest from your enterprise accounts within CEC and these sorts of AI rack?

Yes, not yet. I do think that eventually comes scaling for these Gen-AI, power-hungry data center. It is not an easy thing to do. That is going to require a different skill set even from our enterprise customers to make that happen. We do think that happens eventually, but I don't think we're ready for that yet.

I think with all of the complexity and innovation you can bring to these sorts of workloads related to AI, I imagine that's a margin opportunity as well. But can you talk about how margins maybe are impacted by some of these solutions as you maybe can address these things in cloud with AI.

I would say the biggest margin opportunities for us in cloud is 2 things. One is definitely in our power business, right? Like I said, in our embedded power business, we design and codesign with our customers. So it's a Flex solution that is then designed specifically for a particular and chip design. So we work specifically with that. So the margin profiles on that are different. And as that continues to ramp up significantly, you'll see that help us. And then, of course, our Anord business, which is in facilities power has a different margin profile altogether. And again, as I said before, in that capacity is our limitation. So we have to add more capacity and continue to ramp up for these power-hungry gen-AI data centers that we'll continue to see build up. And that's our margin opportunity. I said, but Flex has always been focused on when we do complex things, we want to make sure we get paid for it. So the integrated rack solution, large-scale very power hungry, very complex distribution boards populated and fine-tuned to an end customer. So if our commercial teams are doing their job right, they should be getting margin opportunities for that, too.

Well, I think the margin expansion of the company as reported over the last few years would suggest they've been doing their jobs pretty well. Maybe we could shift gears to Agility Solutions. I think on the last earnings call, Flex very similar to a number of companies in the tech industry has reported some weakness in some of the consumer and enterprise comes in for structure sort of end markets. Can you maybe talk about what you're seeing there and perhaps when you think revenue trends could bottom in those end markets?

So in our Agility Business, I mentioned in the beginning, there are 3 major components to our business units there. Our CEC business, which is the cloud communication enterprise business. And then the other 2 lifestyle and consumer devices are more focused on the consumer end markets. And in that, we have been saying this for, I think, the last year or even longer that those businesses have been declining for a while. I do not like to call bottom because I just have never been right. So you might as well look at it in the hindsight and then comment on it. But what we have seen in those businesses is the impact of interest rates. We've seen the impact of who knows. Maybe like all of us, we are investing more in travels and services than in hardware products. So we definitely have seen the impact of that. I don't know if it's bottomed or not, but I feel like we're seeing fairly stability in that from where we were a year ago. So I feel kind of good about the end consumer markets and how we have managed that. So -- and then CEC, we talked a lot about, right? I think there is some conversation about inventory digestion and all our tech customers and your seeing that being talked about a lot in this conference, too. And I think the predictions has been based on each customer communications has been a little different. The networking companies have talked about digestion for the next kind of 6 to 12 months, clouds in a different place. So I'd say each one is talking about inventory digestion in a different way. We definitely see the impact of that. But I wouldn't be brave enough to call where all that is heading. I'd say what is important to us and I've said this in my last, what is going to be 5 years here very soon as Flex's CEO is the Agility business is all about being able to react and do well in terms of our overall operating margins to how the end customer moves. And we have shown our ability to do that. The whole operating model of this company was built around. Be sure to react well to Agility's ups and downs. And what we have seen is that we have done really, really well. And so our focus is react to your customers need, be agile about it, make sure you maintain and keep improving your operating margins for that business, and I think that has gone fairly well.

Yes. That's helpful. Maybe shifting gears a bit to the business more holistically thinking about North America. There's been a lot of investment and media reports around pretty significant shifts in manufacturing profiles. Companies wanting to do a lot more in North America, some of it's spurred by the CHIPS Act and the IRA. How does that impact Flex?

I'd say I've been working for the last, what, 30-plus years, not dating myself here, but what the trend shift going from decades of globalization to where we are today, which is have a regionalized supply chain closer to home, make sure there's resiliency in your supply chain have more control over it is a true phenomenon. I never thought in my career, I would see the reversal of what we've taken years to build up. And a good example is Flex's growth in North America, if you think about U.S. and Mexico has been north of 30% last year. That is pretty significant, right? So when was the last time you would see those kinds of numbers. And so that is driven mainly by customers wanting a footprint and the ability to manage the supply chain closer to your end consumer. And -- so we're definitely the beneficiaries of it. I would say, but it's not just a North American phenomenon. For example, even our Malaysia grew by 30%, right? So we're seeing that even in Southeast Asia. Europe had pretty decent growth last year for us. So it was all about derisking from certain parts of the world in terms of seeing -- building supply chain resiliency. I don't think this phenomena changes anytime soon. It's obviously spurred by things like IRA. But the base of it is built by this innate need to create supply chain resiliency and as long as that conversation is still sitting within C-suites across America, people have long memories. Nobody is going to want to repeat what happened in the last couple of years. I would say companies like Flex will definitely benefit from it because what customers want is a global company that can do the same thing for them in 3 parts of the world and do it really well. And there are very few companies that can do that.

Yes. And I think maybe another benefit to you of being closer to where some of your customers and suppliers are helps with some of the emissions reduction targets. I know you guys have done a lot of work on that as well a lot of your customers with their sustainability report?

Yes. We -- I mean, I always say that we don't do sustainability because it's like a cool thing to do. We just believe it's the right thing do. And it's a passion for our employees. We just published our sustainability report, I think, yesterday. So if anybody has some nighttime reading, I would love for you to read it but it matters. Flex is a large company with a big manufacturing footprint. And if people like us can't focus on what needs to be done for sustainability, then it's not right in terms of where our goals can take us. We have done a lot, it does help, I would say, in terms of having a more balanced footprint but you really see it eventually in terms of freight reduction and those kinds of things that will build out eventually is where you'll see it.

I'd be remiss if I didn't bring up Nextracker and that the business has done very well since it was acquired by Flex many years ago. In July, Flex sold down as percentage to 51%. Can you talk about how you think about your ex strategy. I think you've said you think it should be a stand-alone company. So anything you can share on your thought process with that?

So we've been very consistent with our views on Nextracker. And I would say we've done really well with managing what we do with that business. When we sold down our latest tranche and we filed an S-1, we said we have a private letter with the IRS, which is looking for their feedback on a tax-free spin for the remaining portion of the business. And we have to work through that. We have to work through the same with the Singapore government, right? So and then we have to work through some SEC issues. So we just have to work through all those elements to get to what we have said is the end goal, which is for Nextracker to be an independent company. So once we do all of that, it's in the hands of the board to make the board to make the final decision but we have been very, very consistent and I would say they have done very well in terms of managing the Nextracker business overall.

Some of the acquisitions the company has done, that we've spoken about Nextracker, Anord Mardix, those aren't just assembly businesses. Those are full products that you can sell to customers. How should investors think about the progression of your business? And do you think Flex will do more on a full solutions and product space going forward?

I'd say in the end markets we're interested in, I said this a couple of years ago. So in NextGen mobility, which we're very interested in, in renewables, which we have talked about, we're very interested in those types of end markets. If a full product helps the overall solution for that end customer, then yes, we will do it. When we bought Anord, we bought a facilities power business because we knew that hyperscale cloud growth was going to be really important. So we said NextGen mobility renewables cloud is important. And we knew that all of these are going to be power hungry products, right? And so when a company like Anord came up with a great valuation that made sense for Flex, and it fit the cloud story, we were looking for and completing that portfolio, we went and bought that. So it will have to fit that thesis. I think all of you know by now that I'm quite prudent in my approach of how we do things. So if it fits that thesis of fitting in those 3 businesses and completes their portfolio, yes.

Maybe we could talk on supply chain, and we touched a little bit on this already and some of the regionalization trends. But maybe just in terms of your own ability to procure the parts that you need, are there still shortages that Flex is contending with, if so what areas? And how do you see that evolving in the coming quarters and years?

Yes. So people are talking about that the chip shortage is all gone and things like that. Yes, in a large portion of what you see in terms of the smaller size, chips, I would say, in kind of 45 and higher, it's still there in terms of some level of shortages just because those investments are still catching up. So we still do see fits and starts in our -- particularly in our automotive and our industrial business. And we expect that continues for a bit, but it doesn't show up in the news as much because those are a smaller part of kind of the overall economy and things like that. But we see still starts and stops in automotive and industrial as a result of kind of the larger size kind of investments still slowly ramping up. There's a commitment to do it, but it's still taking time.

I think Flex's had more inventory on hand than it ran with historically, in large part because of the supply chain shortages and some inefficiencies with respect in completing and then I suppose inflation is maybe a role as well. How does that trend in the future? And can you start reducing inventory over time? Or is it this the new normal for your inventory levels?

Absolutely not the new normal. We have been very clear about this that these inventories were bought on behalf of our customers for a certain reason. And we'll continue to see that come down, not only just shortages get better, but typically, even as end markets come down, where we see some reverse cyclicality in terms of our cash flow and how that generates. So we'll see inventory wind down as a result of it. And so we absolutely see that happening. And we've committed to an 80% cash flow conversion and we feel like inventory reduction as part of that. And so I feel very comfortable that, that will continue to wind down.

We talked a little bit around margins hoping to speak a little bit more on that topic. The company has a 5.0% to 5.2% adjusted EBIT margin target for this fiscal year. Maybe talk to some of the puts and takes around EBIT margins for fiscal '24.

Yes. So fiscal '24 EBIT margins, one was -- again, we said in our end market growth reliability is growing a little faster, though Agility margins are pretty good these days. So I can't comment it in terms of a mix shift or anything like that. But was some of this was mix change that we expect to see. Some of it was definitely focused on kind of pricing due to inflation and things like that, that we were recovering. We feel comfortable about the EBIT margin. I think even if we see kind of puts and takes in terms of the top line, I think what we have shown the ability to do is manage economic ups and downs really well. So we feel quite good with terms of our EBIT target and our ability to hit that.

I've been following this industry long enough to remember when EBIT margins in Agility segment ran more like 2% to 3%, not mid-single digits. How -- do you think these sort of agility margins are sustainable?

Absolutely. Absolutely. Because this is not about the industry. This is about how you run a business. The ability to continue to make mix shift, I think, super important. And every business needs to do that. It doesn't matter which industry we're in. We have shown the discipline and the industry has followed. So I think it continues. The second is so much still to do in terms of factory automation and everything associated with that, that the productivity benefits long tail there. So between those 2, I would say, absolutely.

One of the drivers of your earnings has been higher margins and the company had articulated at its last Investor Day for fiscal '25, excluding Nextracker, a target for $2.65 of earnings. Is that still achievable? Or have some of the macro factors and headwinds in certain markets made it more difficult to get to that kind of a level.

That's definitely still achievable. But like you said, there's so much that has happened since the time we gave that information, right, a supply chain crisis, more COVID, a war and then now a recessionary environment. But even with all that, I think we do a really good job of how we manage the business. Our mix shift has helped I'd say, how we generate productivity has been really good. And so I feel good about that target that we have given. And I think that would be quite a good thing for us to hit that number considering we said that 2 years ago and I think we're headed in the right direction.

Yes. We have time for a couple of more questions. I wanted to give folks in the audience the opportunity if they have any questions. Maybe we've got a mic coming, if you don't mind waiting just for webcasting.

I have 2, if you don't mind. First, on the enterprise data center side. I was curious if you guys have sized that opportunity given compute demands and the power constraints in North America, more specifically the U.S. and Western Europe. It seems like the rip and replace opportunity for existing enterprise data centers is underappreciated, and we'll need those more sophisticated solutions that you had highlighted earlier. And then to maybe piggyback on one of Mark's questions on near and reshoring just maybe some -- if there are any inorganic growth opportunities you're looking at. There are certainly quite a number of private platforms in the U.S. that have blue-chip customers that would complement your existing health care and industrial business, particularly on the robotics side, but also offer some newer growth vectors that are low volume but high margin like aerospace and defense. I was just curious if you had any update there.

Thanks, Eric. So on the first one, I would say, we aren't ready to kind of give any numbers in terms of sizing the enterprise opportunity, but I would totally agree with you that it has to be significant. But even hyperscale customers are still struggling to size and the growth opportunities associated with AI, right? And you're seeing a lot of difficulty in terms of finding the right power base and things like that to even scale up what we see for cloud customers. But definitely, enterprise in the long run has to be pretty significant because we see it even for our own investments within companies like Flex, right? And I think the biggest constraint will be power and figuring out how to deal with that constraint will be big on our mind. So we are thinking about kind of what does this mean to future footprint? How does it look like? What are the places that will be the most power-efficient but we haven't sized it yet to be able to at least publicly talk about it. I would say in the second part, what was your second question? Opportunities. We have said before that we've looked and continue to look quite a bit in terms of health solutions. We don't like the multiples there, and so we struggle to make it work. We do feel areas where there is opportunities for miniaturization and things like that are big for us. And so if we find the right fit in terms of valuation, we'll continue to look at that. On industrial, the same way. We feel there is clearly opportunities for us, but it has to fit the right multiple. But both of those segments are big interest. We're very active. We talk to a lot of people, but it has to just fit our valuation model, too.

We're going to have to end it there unfortunately. Revathi, thanks so much for joining us.

Thanks, Mark. Thanks for having me.