Flex Ltd. (FLEX) Earnings Call Transcript & Summary

Good morning, everyone, and thank you for joining day 2 of the UBS Global Tech Conference. I am David Vogt, the hardware and networking analyst here. And we're excited to have with us Flex. So we've got a full panel here. We've got Michael Hartung, Chief Commercial Officer; Jaime Martinez, all the way on the right, Interim Chief Financial Officer; and David Rubin, square in the middle, from Investor Relations. Suzanne is in the back if anyone has any real difficult questions, we can use her later. Just quickly, do you need to make a quick opening disclosure? Or are we good?

Yes. Just go to our disclosure page on flex.com, we're good.

Great. So what we've been doing, I think before we get into the specifics of the business and kind of what's been transpiring with each of these companies is talking about the geopolitical and the macro first. It's been very topical from all our meetings the last couple of days. I know it's a high degree of uncertainty, but maybe can you talk through, one, how you're thinking about the macro in particular, given what happened under Trump 1.0, where we sit today under Trump 2.0, tariffs, footprint, geographic exposure? Maybe we can start there, and then we'll dive into more detail.

Yes. So you're right. It's a very fluid situation. I think it will be tough to know exactly what the outcomes are until we see final policy. That said, I think one of the most important takeaways is that things like tariffs which is one of the big questions right now, that's a pass-through cost for us. And we saw that with Tariffs 1.0 when this first played through. And so again, it's pass-through costs similar to like component inflation, wage inflation. And you saw that over the last number of years where we were continuing our ability to protect margins despite some of these changes. Another point I'd make is Tariffs 1.0 was one of the catalysts for the move to regionalization. And that is something we've helped our customers with a lot, which is moving from one particular region or to multiple regions to move their manufacturing closer to demand and then also to strengthen their supply chains given many of this stuff going on. So as we look at the current uncertainty, we think some of those trends will continue, and so we're very well positioned to help them with that. When we look at our supply chain, which is another question around here is that I think we are well positioned. We have run one of the largest supply chains in the world. And I think if you look back at some of the last 5 years, the flock of black swans. We've also seen whether it was COVID or supply chain crisis. Again, we've helped our customers through that. And just to say that it's an uncertain situation doesn't mean we're standing still. We are doing a lot of scenario analysis as we've done through these past cycles to look at what are potential outcomes. And then we're working with our customers to come up with mitigation strategies both near and long term to help them decide, okay, what is the -- where is the best place to be? What's the best way to optimize your supply chain.

Can I ask a question on that mitigating comment. Is there a degree of fungibility in your footprint for your customers? One of your customers had said to us, if we have an issue in one particular region, we could ask to move to Mexico -- well, Mexico is not a great example today, but Mexico hypothetically. So is there a degree of fungibility or is a very large percentage of your footprint to bespoke to said customer or technology platform that it's a little bit more challenging?

Yes. I think that's part of the foundation for helping customers through this time. If you look for the past 4 or 5 years, as David mentioned, we've had the successive shocks to the system. And it's because our strategies is -- of EMS plus products plus services, is operating at global scale in every region that we can really move our customers to wherever they want to go. It feels like we've been almost preparing for this next moment for the past 4 or 5 years. So the quick answer to your question is yes. All of our solutions are operating at scale in these different regions. So depending on what the economic equation is, depending on what the requirements are from the customer, we can basically take them wherever they want to go.

Got it. All right. So let's talk a little bit about some of the end markets. So data center, AI. The conference was rebranded this year, global tech conference and AI. So I think we have to lead with that. So obviously, you've talked about your capabilities on your last earnings call. Can we just maybe kind of level set in terms of how AI/datacenter investments have changed within Flex in the recent 18, 24 months? And when we think about the data center market, we talk to the networking companies, the optical companies, servers, you name it, we talk to all of them. There's this general perception that the data center market is going to continue to grow from an investment perspective, at least 20%, 30% for the foreseeable future. I'd love to kind of get your perspective on how you see that playing out and kind of where your role fits today and how it evolves over the intermediate term, not necessarily tomorrow, but over the next couple of years?

Yes, for sure. And so first, I think it's important to maybe step back and frame where we're at, right? I think the good news is we're in this really enviable position of growing market share in a rapidly expanding market. So we get the benefit of both. Good news is a lot of agreement that this market will continue to have the strong growth, as you mentioned. We're seeing some of the traditional drivers like migration from the enterprise to the cloud, continued adoption of cloud-based services and certainly a lot of hype around the latest innovations in AI-related applications. What's -- I think interesting is that while this growth is occurring, we're starting to see some real challenges emerge. And the challenges that we're focused on are really around power, heat and scale. And so when you think about those things -- first power, there seems to be this insatiable appetite for power in the data center. So one of our solutions has to help our customers navigate that power journey. Given all the consumption of power, the next challenge we have to help our customers with is how do you manage all the heat that's being generated from this power consumption. And then given the rate of innovation and deployment, how do we help it scale really quickly. And so when you think about our EMS plus products, plus services strategy into the data center solving for power, heat and scale, this is how we think about where we need to take the business. So first, from a power standpoint. What people might not understand real well is that Flex is more than an EMS company today. Over the past 5 years, we've had this really intentional path to create products. And so we're a product company today. We have two different product companies that deliver power solutions to the data center. One is critical power. In our critical power group, we're really providing things like low-voltage switch gear, medium voltage switchgear power pods. Power pods are essentially power solutions in a box. And those -- that goes to the infrastructure of the data center itself, helping provide quick deployed, reliable source of power to the data center. The other power business we have is embedded power. And that's where we take that power from the data center itself and help regulate that power consumption in the rack itself. So solving for power challenges, both critical power and embedded power is part of our approach. And we've really supplemented that with some recent acquisitions. So we did our Anord Mardix acquisition a few years ago. We just completed our Crown Technical Services acquisition that rounded out our power portfolio. So we'll continue to invest in solving power solutions. Another part of our business is around the rack integration services in the data center. And so we leverage our EMS capability already operating at scale. We're in 150,000 people over 100 different factories over 25 countries. Scale is not the issue. What we've done though is we made a recent acquisition of JetCool has proprietary technology for liquid cooling. So now that we're helping our customers with power, we can also help them with thermal management. And so we're really excited about the technology that we've acquired in that space to help with those pooling requirements. And then the foundation of all that is we can take power and heat solutions and scale them globally on the infrastructure that we've been developing for the past 50 years.

So I want to come back to JetCool in a second. When you talk about, obviously, the strategy has evolved from an EMS company to product services. Can you help us understand maybe this is better for Jaime, sort of the margin progression and maybe the delta or the difference between, obviously, being a pure-play EMS company to a more balanced solution product company along with EMS business and how that's transformed the company's profitability and what that means going forward?

Yes. No, no problem. So -- if you step back a little bit, we have two main segments, which is agility and reliability. So we talk about agility. Last quarter, we had a record margin quarter. We were over 6%. And all of that came on the back of that mix shift that we're having in our business. The penetration on value-add services that we just mentioned. And making that a more agile business for us because of the new levels that we're operating. Now all of that mix and strategy that we're putting into the data center is helping us improve that margin in agility. For example, we were 6%. Now this mix last quarter was exceptionally strong. So when you think about agility, we don't see it right now the new norm to be a 6% business. Definitely, we're happy with the result. But as we see the broader end markets recovering there, right, we expect a little bit of moderation. So we think more of [ 5 handle ]. But talking to the margins that you just mentioned, this business only 4 years ago was 2%. So being a [ 5 handle ] is great for us. Now in reliability, in the same case because of the strategy of the data center is helping us as part of the product business. We're seeing also improvement in the mix, operational execution. And last quarter, I think reliability was 11% down, and we expanded margins 20 basis points. All of that came again because of that mix of products that we're having, right, and allowing us to do better. Now if you think about reliability, we still see opportunity to expand more margins because that's where we've seen the most of the softness and the weakness in the market. So as those markets recover, we're going to see a little bit better utilization of our factories so we can better margins. So in both businesses, agility and reliabilities that EMS post for services are affecting us in reliability on the power products, as an example, and an agility over the data centers.

Maybe to paraphrase. If I think about your business from a margin perspective, there's effectively three vectors that can help drive margin, right? Volume leverage as end markets come back, mix as well as your ongoing cost efficiency, and cost improvement strategy. Is that the right way to maybe kind of frame the intermediate term in terms of where margins held?

That's what we see the drivers for us to expand margins, right? Our mix and growth in high value-added business, like the power business, penetration on value-add services, and all these productivity gains that we can find through adoption of technologies like automation, robotics and AI. All of that together give us the framework for a sustainable margin expansion to the 6% plus that we have set in our Investor Day.

And David, maybe if you oversimplify it and step back just a little bit further. EMS operates at what traditional EMS margins do. And certainly, you get the benefit of scale in that business. Our product business though, operates at product level margins. And our services business operates at margins that are incremental or higher than the company average. So think about it from that perspective.

So maybe just pivoting back to AI, JetCool. So the deal fairly recently closed. Can you kind of help us understand -- you talked about power management, thermal management. When a customer is looking for a complete solution, how specifically does JetCool kind of fit into the solution? So is it sort of a bundled sort of offering solution? Is it an attach that's maybe a secondary consideration for a customer historically because there's a lot of other cooling options out in the marketplace. And so how do we think about JetCool's position within the cooling market -- liquid cooling market, excuse me, versus vis-a-vis what else is out in the marketplace today?

Yes. And maybe if you think about, first, the portfolio that we have, you better understand where it fits because I think this is a really important thing to consider is, we're seeing in the neighborhood right now of 15 to 25-kilowatt racks in the data center. But most of that is really service by traditional air cooling technologies, right? Where we're challenged is we actually see that rack power escalating 250 kilowatts. We have got to have some people talking about 1 gigawatt. So the challenge is going to become more severe as we go. Because of that increase, what's really going to be required from customers as more of an integrated solution. There's a lot of point solutions out there right now. Some people might have a liquid cooling solution, but might not have the rack integration capability to scale it. Some people might have cooling but not power. And the more this sort of escalation takes place, the more customers are going to have to start to think about, as we increase power, how do we cool it and how do we scale it. And we think as that curve continues to rise up, we're going to get in a better and better position. So for us, and we're talking to our customers and our customers could be hyperscalers, they could be colos, it could be silicon providers, right? We started the tip of the spear with our embedded power group. As they're starting to design modules for silicon providers, those silicon providers can also now start to think about point solutions for liquid cooling, and we're going to bring those conversations together. But you can also kind of reverse engineer it. If you're a colo developing a data center and you want to be able to provide a full solution that's turnkey to your customers, you're going to want someone that can address critical power, embedded power, cooling and rack integration. So it's certainly going to be part of the total portfolio. We'll be able to offer it as a point solution or part of an integrated solution.

It's a great point. So we've heard from some of the OEMs and other companies that integration is what's going to drive some competitive differentiation. So it sounds like you're in that camp. And so without a potentially integrated -- vertically integrated solution, maybe some of the competitors would have, I think, maybe a little bit of a more challenging time, whether it's with hyperscaler, colo, enterprise, whatever the case may be? Is that kind of your perspective?

That's certainly our thesis, right? And I think if you look at the whole grid to chip ecosystem, we've got a pretty unique offering, right? In EMS, we operate -- we're well recognized as a Tier 1 EMS been in the business for 50 years. Hard to argue with that. But EMS companies don't have power product. Most of them don't have services either. In the power business, we have great competitors in critical power, but they don't do embedded power. We have great competitors in embedded power, but they don't do critical power. So even in the power space, we're somewhat differentiated. And then you add on to that the service capability, we think as the technology challenges get greater and greater, our ability to provide that integrated solution will become a bigger differentiator.

Since you mentioned the increased demand for power, potentially gigawatt locations. How did your power business scale to meet these particular challenges as they evolve over the next couple of years? Because this distributed footprint, larger data centers consuming larger amounts of power, gigawatt power opportunities. Where are we today with your power business from both angles? I mean the embedded is probably easier. But just where -- can you walk us through like how that -- how your leverage to that and how you think about that over the next couple of years? Because I would imagine that's going to be a pretty strong opportunity.

It's a great question because power constraints are driving geographic diversity. And so that's where another differentiator that we think we possess is that we're already operating at global scale that we can tap into for all these relative businesses. If you think about the critical power business, the Anord business gave us low, voltage switchgear and power pods. Power pod manufacturing was really focused around Europe. Low-voltage switchgear was more global in nature. To answer your question, the acquisition of Crown actually rounded out that portfolio, both from a technology standpoint by bringing in medium voltage switchgear globally, but also brought a power pod manufacturing capability into the U.S. So we've created both an ability to accelerate what we have and fill the technology gap at the same time. So from that perspective, already operating at global scale. The embedded power business actually has been more a mature business for us, frankly. It was something that we acquired many years ago that now has become part of our data center portfolio, and it's already operating at global scale. So I think we're in a really good position to service the geographic diversity that's coming. And if more requirements come, I think that puts us in a better position than maybe some others.

That's great. So you mentioned Crown. We talked about JetCool. You've been strategically targeted in terms of buying assets that round out solutions offering, services. Where do we sit today in terms of your appetite for transactions? How important is inorganic opportunity to the model? And as we sit here today, when we look at industrial, we look at AI, data center, where are sort of the hot buttons that you're looking at where you need to add critical capacity, whether it's R&D, whether it's manufacturing capacity, just maybe help investors think through that?

Maybe Jaime can start with our capital allocation plans, and I can come back and talk to you about how we actually within that plan.

Yes. So our capital allocation is -- we think about it three vectors. First is our share buyback where we continue to be opportunistic there, and it's an important part for us. Our organic CapEx investment. We invest around 2% of our revenue every year. And then certainly, the M&A piece, right? Where we going to try to add capabilities and technologies that actually enable those end markets to continue to grow, right? And we will be also opportunistic there and something that we're looking at areas that will help us expand our EBITDA by keeping always our investment-grade rating, right? And our balance sheet is strong for that.

And so within those -- within that structure, right, first, you kind of have to step back and understand that we are very intentional about continuing to migrate towards higher and higher value end markets. A good example for us over the past few years have been the agility business where we've been really methodical about taking down our high-volume ultra-competitive consumer business and replacing that with higher-margin data center business. And so within the confines of that EMS, products plus services strategies, those 2 things really drive both our organic intent and our inorganic intent. So from an organic standpoint, it really helps us select which markets, which customers, which product we want to participate in. And you see some of the shifts that we've seen that I talked about in agility, but it also means that we're really focused on things like medical devices in our health solutions business. We're focused on automotive on transitioning from really a traditional EMS player to more of a Tier 1 with compute and power platforms, more of a product orientation there. So that informs our organic, and it will continue to be the focus of what we do. Our acquisition strategy is really around two fundamentals. One, does it help accelerate the capability that we already have? Or two, does it help fill a capability gap? And I think if you look over the past three transactions, you can see that in action. JetCool filled a capability gap, right? So now we have liquid cooling solutions for data center customers. Crown was an accelerator and a filler because we brought in new products with bolted switchgear, we accelerated scale and power pods. If you go back to Anord, it was a filler. We created a capability. So I think you'll continue to see us primarily focus in the areas of organic growth to drive our growth strategy. But we'll be focused and disciplined on creating new capabilities as long as it fits our financial model and fits within the financial framework that we have.

And so the most recent deals are more data center-centric. Industrial has been a little bit of a headwind, more macro related. Is there an opportunity you mentioned to becoming more of like a Tier 1 supplier in the auto market? Are there capabilities in the industrial sort of verticals that makes sense? Or maybe we can throw in med tech in their devices in there as well? Or is it more strictly you think -- no, I won't hold you to it, but more strictly focused on sort of the data center market because that's where right now, most of the growth is in and seems like a little bit of a greenfield opportunity.

Yes. I wouldn't say it's exclusionary. I just say it's a set of priorities right? So within the capital framework that we have, we get to make certain strategic choices. And right now, the data center choices that we're making seem to have a quicker, higher return on investment, right? But I wouldn't mistake that for -- that's the only thing we're going to invest in. I think you'll see us continue to look at opportunities in those growth markets that we've identified, both in our last Investor Day and the Investor Day before that, you mentioned a couple of them, devices for health, platforms and compute and power for auto. Certainly, we'll be selective in all the growth markets that we've identified. Data center just happens to be the ones that had the quickest opportunity.

Really quick turnaround, right?

Certain I would add just on that that's important. What we've said before is that when you -- data center is hot right now, yes. But when you think about where we've made these investments, power is going to be a long-term trend. You look at Crown extends all the way into the grid. Grid modernization is going to be a long-term trend. And so when you think about these acquisitions or where we're focused, again, you mentioned the medical devices. Medical devices is going to be a long-term trend towards advancement in these technologies. But one thing that is important to point out is that we have to watch the valuation on some of these. Some areas, they've been very expensive, and it's not -- it doesn't make financial sense for us to go after something...

Yes, makes a ton of sense. So can we just maybe touch on industrial in that context as well. So obviously, the market has been difficult. Macro has been a headwind, not just for Flex, but for the industry at large. What are your current expectations in terms of -- obviously, we touched on tariffs earlier and maybe the uncertainty from the macro perspective related to political considerations. But generically, outside of that, what are your kind of baseline assumptions going into next year from a macro perspective? And how it impacts the industrial side of the house. right? So the data center side, I think, in power, I think people understand, it's more of a macro independent vector effectively, if I can say that. But industrial, obviously is governed by some of the conditions in the marketplace today.

So from an industrial perspective, first, you have to realize that it's almost two different businesses. right? That's where our power business resides. It's one of our fastest-growing businesses, one of our most margin-intensive. So if you put that aside and call it core industrial. It's really comprised of what I would say is our renewables business. And what you would consider more of your traditional conglomerate-based industrial-type applications, right? We're not planning on a big macro bump. So we're being very conservative in our outlooks. We've aligned the cost structures accordingly. Good news is we've been able to do that and still deliver margin in a pretty challenging revenue environment. Renewables have been hit significantly. No surprise there. We don't yet know what the policy changes might be. They range everything from pretty draconian sort of measures to more likely maybe trimming some of the incentives that go along with that. When we talk to our customers, there seems to be some confidence in the ability to continue to manufacture for certain areas and certain technologies. So I think we'll be in that business for the foreseeable future. We don't anticipate anything extraordinary in the end markets, though.

Do you get the sense that maybe the inventory, the channel inventory or customer inventory in some cases in your industrial markets are relatively healthier now? Or are we still working through some maybe some digestion as we go into 2025?

I don't want to cop out, but the answer depends.

Renewables, we hear there's a lot of inventory out there.

Even in renewables, it almost on the -- depends on the region that you're ahead, right? So in renewables, we see inventory levels being higher in, say, the European regions versus the U.S. markets. That tends to be good for us because a lot of our business tends to be more focused on the U.S. markets, given some of the incentive structures that are in place. From a traditional industrial perspective, the interesting part is, many of the success factors in that space are actually driven by data center as well, right? So we are still digesting inventory in that space. We are still in what I would consider a relatively recessionary end market condition. We don't yet see a catalyst for something to change there. But those companies are methodically moving through their channel inventory and the outlooks that we have for growth reflect what we're seeing in the channel.

Got it. And then you talked about, obviously -- and I think people who own your stock understand that you're more than an EMS company. You talked about product solutions and services. Where does the portfolio sit today from a core EMS perspective, where maybe there can be some pruning? Is there a providing possible? And migrate the business to a more profitable, faster-growing collection of assets, if you will? I mean, are there anything in the business today that -- mentioned high volume, low-margin consumer related to you've migrated away from. Anything else in the portfolio that potentially needs some attention?

I'll start, and if you guys want to chime in with the framework or the structure around it. But I would say that for the past 3, 4, 5 years, we've had this very methodical approach to doing just that. We don't have any major plans to prune, but we move business around as a matter of fact in the business as requirements change, we'll move customers from one area to another. But we don't have any big pruning objectives left in the portfolio. I would think about this more as a building, right? So we've created over the past 3, 4, 5 years, this really solid foundation in the EMS business that's deliver the kind of returns that you've seen over the past few years. That's a really solid foundation from which to grow our product business. Our product business we said last fiscal year was in the neighborhood of $3 billion in the data center, right? $2 billion of that was in traditional, sort of, rack integration, $1 billion in power. So we'll continue to accelerate growth in our product business. And it also gives us a solid foundation on which to grow our services business. So I would think it more of building as opposed to addition by subtraction.

Got it. Maybe just one final question. We've been asking every management team and company, what has the market missed about the story in the transition? You've had very good financial success, executing on the strategy, moved into better margin, faster growth offerings. What still do you think is misunderstood about Flex where we sit today? And how investors should perceive the business effectively in the strategy?

I'll give maybe the overall story and you guys can follow up with the financial mechanics and fundamentals of that. But I think what's been a challenge for some investors is to follow this migration from who we have been over 50 years to what we've been becoming over the past 5 and what the focus is for the future. And this really does come back to, first, this intention of transitioning to higher value end markets, right? And doing that on the foundation of an EMS plus products plus services strategy. If you were to step back and think about those three businesses individually, you probably have a different valuation thesis than you had on the business for the past 50 years. So getting a better understanding around what our product business is today, where it's going and how it's tied into some of the fastest-growing markets in the industry, I think, is one place. The other is this appreciation for value-added services. Our value-added services capability, both vertical integration, whether it be through sheet metal fabrication, injection molded plastics, private label components or our postproduction business that does nothing but value-added fulfillment and circular economy. The fact that those are differentiators that are operating at global scale and at incremental margin. The additive nature on top of EMS has been something that we're constantly trying to inform our customers and our investors with I think that's really key for us in the near future.

And I will just add that I think our transformation is starting to speak by itself, right? So over the last 5 years or over the last quarters, whether a revenue pressure or whatever, we've been able to expand margins, grow our EPS double digits and generate cash flow. And all of that is just proof of that transformative strategy is working in the end markets, making us more agile company and be able to adjust our costs faster and adaptable, right? So if you see over the last 5 years, this is part of the proof.

Great. I think we're out of time. Michael, Dave, Jaime, thank you very much. Thank you everyone for joining. And if you have any other questions, please feel free to follow up. Thank you, everyone.

Great. Thanks, David. Appreciate it. Thank you.