Flex Ltd. (FLEX) Earnings Call Transcript & Summary

Great. Good morning, everyone. Thank you again for joining the UBS Technology Conference. I'm David Vogt. I'm the UBS hardware networking analyst here, and we're excited to have with us today Flex. I believe Flex was here -- yes, Michael we were here last year. So with the company, we have on the far left or far right from your perspective, Kevin Krumm, Chief Financial Officer; Michael Hartung, Chief Commercial Officer. We're excited to have you.

So what I thought we would do in the 30 minutes is kind of maybe touch on kind of the big picture topics of the business. We've gotten a lot of questions in the last month or so about your business, what's going on in the world of EMS and supply chain. So maybe if we can just start with, if we look at kind of the big picture drivers of your business, we can start with maybe agility first. kind of how should investors think about longer term, the big drivers in agility and then we can jump into reliability after.

Okay. Great. So if we're going to talk about the long-term drivers, maybe we start with what the secular trends are, what the megatrends are, how they flow through to the different businesses that we have. And so the first one is going to be really obvious. The first driver of demand for us is anything related to AI or data center. We expect that to continue to be a strong driver of growth for us. and it actually impacts multiple businesses of ours as well. The first area it impacts is in our cloud business. In our cloud business, that's where we do all of the vertically integrated data center racks. So we fabricate our own sheet metal. We do final integration and test. We also do all of our accelerator hardware manufacturing in that space as well. And so the cloud business will be the recipient of that growth trend. Also, our power business in our Industrial business unit will be the recipient of that too. So as you might remember, we have 2 different product businesses in power. One is our critical power business and one is our embedded power business. From a critical power perspective, think about that as being everything that is around and above the rack in a data center, in the facility itself, things like low-voltage switchgear, medium-voltage switchgear, busways, bus ducts, power ponds, those types of things above and around the rack. The second product business for us is our embedded power business. And that essentially takes that power from above the rack into the rack and then down to the board level. And so both of those businesses will be a good positive driver of growth due to the data center and AI. I'd say the next big trend to think about would be around digital infrastructure. And we have that separate from data center. We narrowly define our data center business as being very core to hyperscalers, colos and silicon providers. So digital infrastructure is another area of growth for us. That will positively impact our networking business. Think about high-speed networking, think about satellite communications. We expect those to be nice growth drivers for us into the future as well. Another trend to think about would be around automation. So for us, think about things that improve productivity in an industrial or production environment. So it could be robotics, it could be warehouse automation. Again, anything driving efficiency and production is an area that we expect to continue to grow as well. And maybe the fourth trend worth mentioning is around the growing prevalence of diabetes. So that does have a positive impact on our Health Solutions business. We're a large manufacturer of continuous glucose monitors. We announced a recent win around GLP-1. So both of those things are aligned nicely to the trends in the marketplace as well. So those are probably the big 4 areas.

So within agility, right, so that is heavily exposed to the cloud hyperscaler market. Maybe if you can touch on like what you've seen in your business trends -- every company that we've talked to you this week, as you can imagine, has seen an acceleration in demand trends, order rates, other metrics that you want to look at other KPIs. Maybe can you share with investors like what you're seeing -- like let's go back 12 months ago when we had this conversation 12 months ago versus today. How is the arc of that trend changed? And what are you seeing from key customers within -- let's start within the agility related to the hyperscaler business?

Yes, sure. So if you step back first and think about the exposure that we have to the data center, we really get exposed through 3 different customer categories, the hyperscalers, the colos and the silicon providers. And so we're coming off a year where we ended, what, $4.8 billion on a 50% growth rate. We said we'd grow to about 35% or more this year, right? That would put us at about a $6.8 billion data center business. I'd say the trends continue to be positive. The demand continues to be really strong across all areas. And I think we've indicated in the past that, that 35% growth rate, all of our businesses are in and around that number, right? I think the power business is a little bit higher. The Rack business is a little bit lower. But again, the Rack business is bigger, so it's a harder comp year-over-year, but very healthy even growth has been happening, and we expect to continue. From a hyperscaler perspective, we continue to see a lot of interest, not just for discrete solutions, but for integrated solutions. And so one of the reasons behind releasing the AI infrastructure platform at the recent OCP conference was because this whole migration towards integration is becoming more and more prevalent. Compute requirements continue to increase. Power consumption continues to increase, heat generation continues to become a problem. We really believe like the future is now for the 1-megawatt rack where you're going to have stand-alone compute racks, stand-alone power racks, stand-alone cooling racks that need to be integrated. And the more complexity that's required, the more customization we think, the better positioned we are for that growth. So very strong signals.

Has that -- to your point about the integration of compute, cooling, power, have those conversations changed in the last 12 months given this incredible dynamic of just megawatt -- like just the amount of power consumption that people are expecting over the next 3 to 5 years. So have the pace of your conversations or the tone or tenor of your conversations changed with partners in terms of like, hey, we're going into this integrated solution route because we have to effectively.

Yes. Absolutely, the conversation has changed to the better for us at least. I think 2 years ago at Investor Day, we were talking about working on architectures of 20-volt racks, right? And we articulated a vision where in 3 to 5 years, we were going to be at a 1-megawatt rack, and we couldn't have been more wrong. That future is actually right now today where we're talking about 1 megawatt racks on 800-volt architectures, right? So more and more our customers, particularly the hyperscalers, are asking us to reimagine how we deploy data centers to think beyond the traditional way and think about things like modular, to think about PO, to think about how to bring up these data centers faster quicker, more reliably than we have in the past because every day that they delay is the day they can't generate revenue on a new product or service. And so for that reason, we've really been able to leverage our capability in the power space primarily where we do power pods today, where you have a complete critical power solution in a box that can land in a parking lot and fire up a data center almost immediately. We've seen 30% reduction in lead times as a result of that. So if we can take that baseline and extend that into compute and cooling and maybe get that similar improvement in lead time, now you're talking about being able to monetize speed. So for sure, we're seeing those conversations really pick up in intensity and [ opportunity. ]

So does that mean -- obviously, those conversations are picking up and obviously, the lead times need to shrink, which you're helping enable from a construction perspective. So does that mean the overall lead times that you're getting from your partners are compressing as well because they're seeing out over the next 2 to 3 years or maybe it's not lead times, maybe the better word is visibility because they're seeing what their road map looks like from a build perspective, infrastructure allocation perspective, they need to be more aggressive. They need to be faster, to your point, to stand these up quicker to start generating revenue given the massive capital commitments that have been sort of promised over the next 3 to 5 years. So are you seeing your customers asking for more faster? Or is it just really as they're moving as quickly as they can already and it doesn't really change kind of the dynamic that you're seeing?

I think customers will always ask for more faster. I would say that the dynamics are -- the input lead times aren't changing, right? The visibility is improving though for a lot of the reasons that you articulated. First, we get visibility from 3 different categories of customers that we get to reconcile and to determine what's real and not. Our partnerships with Silicon providers were out 2, 3 years because they develop technology that require our modules to regulate power. So we see that visibility. From a data center infrastructure standpoint, whether it be a colo who books out real estate years or months in advance or a hyperscaler who's trying to figure out how to reimagine this, we also get multiple years of visibility into what they're looking for. The real lead time savings isn't happening yet in the inputs. It's happening in how you kit together modules. Today, it's power. In the future, it's likely going to be power, compute and cooling, all in one module that you can deploy much more quickly than you can through a traditional construction cycle. So you'll address lead time through construction without any change in input.

So it sounds like that's about -- that would be not a bottleneck per se, but something that's difficult to improve upon from an input perspective. Is that fair?

I think that's fair. And I think given that demand is outstripping supply, and we expect that to continue, I wouldn't expect dramatic improvement on the input. But if we can reduce lead time of construction for data center by 30% by starting to pull these things together into a modular form to bypass the traditional construction time line, then you're talking about time being less.

Got it. And you mentioned visibility for each of the different components, so silicon providers, colo, hyperscalers. From a silicon provider perspective, is it just the fact that the compression of the cycle in compute and silicon improvement has compressed that's giving you that degree of visibility from the silicon provider? Or you're just being brought in sooner earlier than maybe in historical cycles as we go from generation to generation to generation of silicon? I'm just trying to think about -- because it feels like the accelerated compute cycle is increasingly compressed. So just is that factoring into kind of the visibility and those lead times that you're getting and the visibility?

Yes, I think all of those things are happening, right? I think the innovation cycle is shortening. I think the visibility is improving. And I think the requirements are continuing to increase. And so you have to bring all those things together because as the cliche goes, you can only ship a product if you have 100% of the parts. Well, you can only bring up a data center, you have everything. The data center is in place, the power is in place, the cooling is in place, the compute is in place, the chips that support compute are in place. So more and more, we're talking about integrated solutions even at the silicon level because that's what it takes to deploy those hardware.

Got it. And so one final point on sort of the data center market holistically. There's been a lot of discussion, market speculation about different partnerships, different relationships, equity investments in different partnerships and relationships, this kind of holistic circular kind of dynamic. How does that affect Flex in any way? I would imagine it doesn't. Maybe it accelerates innovation, it accelerates deployment. But from your perspective, I would imagine that you're somewhat agnostic, kind of an arms dealer, if you will, to what's happening. But so I just want to make sure I understand kind of -- is there any sort of -- outside of increasing the opportunity set for you, is there any sort of relationship to these types of relationships that affect sort of what you're trying to do at Flex?

Yes. And I'll pass it to Kevin maybe in a minute and talk about maybe the broader implication of what we're seeing in the data center. But I think it's safe to say that the level of investment that we're seeing now is unparalleled. At least in my career, I've been at the company for 20 years now, and I've never seen a cycle like this. And I suspect I may never see another cycle like this again. So the magnitude of investment and the speed at which we want to deploy that capital is unique. Now for us, I mean, we're technology agnostic. We have multiple hyperscaler relationships, multiple colos, multiple silicon providers. But what that is doing for us is it's giving us more visibility, but it's also creating the opportunity for different commercial structures, right? Because although we want to invest in productivity and expansion, capital dollars are finance. Fortunately, our partners have really deep capital pockets. So what that's enabled to us is more and more look at things like co-investment, look at different commercial models to protect the investments that we make. So it's really just impacted how we think about the commercial relationship with our customers. But I think there's probably a broader implication in the market in general that is really addressing this real thirst for capital.

Yes. I mean the only thing I would add is, so first, yes, we're largely agnostic to what's going on. We continue to make sure that we have capacity and capital available to exercise against any of these opportunities that may present themselves. We stay very close to it. From how we think about investing, there are multiple opportunities in the space for us to invest and go after opportunities. Obviously, we still stay disciplined, as you would expect, the capital returns and what we're expecting in cash flow and some things like that as well as long-term opportunities with that customer set. And that's sort of how we're going to look at it. Things are going to keep moving around for sure. We're going to stay disciplined in how we think about growing with our customers and how we think about capital return.

And maybe just as a follow-up, Kevin. So you talk about staying disciplined in maintaining metrics and operating ratios and ROI. But given the wealth of opportunities that seemingly should present itself to a company like Flex over the next 3 to 5 years, is there a little bit of financial maybe wiggle room or flexibility. I know Michael just smiled on that question regarding -- so the opportunities seem to be fairly large to the cycle point that Michael made. Should investors think that, look, there's -- if it's a significantly compelling opportunity that has an incredibly long tail that fits into your return characteristics, maybe it's not perfectly into that box, if you will, but it's still value enhancing in other ways to the business. Is that something that you're thinking about and contemplating as we move forward?

Absolutely. Like I said, it's a dynamic spot. So we -- or space. So we're staying disciplined in how we think about it, but we're looking at all the options that are out there. And for sure, we're not -- we're willing to invest, especially if it's going to be a longer-term relationship at really solid returns at this point.

Because we get asked by investors all the time, there's just a wealth of new programs that have been discussed, talked about, chatter from cooling, accelerators, traditional compute within accelerators.

And the only thing I would add is we have a portfolio and included in that are businesses that aren't in the data center space that are still presenting great returns, too. So capital is not -- are not finite. It's fine in our portfolio. And so we're looking at across the space of that. And what that does is that requires that these investments in the data center space are still deliver a great return, right, because they're competing for capital against other opportunities in our portfolio.

Well, since you mentioned other businesses, so like within reliability, obviously, these are good businesses, currently do not have the same kind of growth dynamics that the data center, colo silicon markets afford you. How do we -- how do investors -- how should investors think about kind of the those end market growth, your competitive positioning there, to your point, capital is not fine -- if capital is not infinite. Obviously, I think most people in this room here are much more technology-centric versus, let's say, industrial EV centric. So maybe just give us a sense for how you're thinking about the trends and the dynamics in those end markets in reliability, how we should think about that moving forward without getting to specifics quarter-to-quarter.

Yes, sure. So if you think about the Reliability business, that tends to be our more regulated businesses. So that includes our industrial business, our Health Solutions business and our automotive business. And although you haven't seen as aggressive top line growth as you have seen in the data center as an example, we're still constantly mixing up in that portfolio. So what do I mean by that? So when you think about our Health Solutions business as an example, our Health Solutions business is comprised of 3 different types of businesses. It's got our really traditional capital equipment business. It's got medical devices and it's got drug delivery. So within those 3 categories, how I would think about growth is we'll definitely over-index into medical devices and drug delivery. That doesn't mean we're not going to do equipment business, but when you talk about mixing up your portfolio, not only do we want to do more health solutions business, we want to do more devices or more drug delivery. We're already a large manufacturer of continuous glucose monitors. We're already a large manufacturer of GLP-1 type devices. We expect to continue to invest and deploy capital against those growth opportunities. When you think about automotive, look, once you get past the near-term volatility, which is hard not to acknowledge, I think we're really well positioned in the long term. We've talked a lot about really 2 areas of emphasis for us, one around our compute platform. So when you think about automotive and OEMs really emphasizing things like ADAS, the software-defined vehicle, they need a hardware compute platform, which they can combine with their own software stack. More and more OEMs think software is their secret sauce. It's their core competency because they're creating differentiation through that software. So they want a hardware platform that they can rely on and marry with that. So we'll grow in compute within automotive. When you think about power, whether it's EV or hybrid, we have a power platform as well that actually, in that case, combines both hardware and software that our OEM customers can take, could be DC to DC converters, could be onboard chargers. Those are areas that we'll deploy capital against and that will grow within the portfolio. On the industrial side, you have the power businesses. Both product businesses are in that portfolio. They'll continue to grow at really healthy rates. But within that, we're also seeing really good signs around areas like automation that we talked about earlier, robotics, could be warehouse automation, those things that are driving productivity in the factory. So when you think about those 3 businesses, there are definitely areas within each one of those businesses that we'll deploy capital against and overemphasize from a growth perspective.

And then along those lines, obviously, they have different supply chains, different commodity input issues. But I think most people in this room are focused on the supply chain implications for the data center side. I know auto EV, industrial automation is critical to the story. But for the sake of this audience, maybe what are you seeing from a supply chain perspective today given sort of the unevenness or maybe the variability in commodity costs? How is that affecting sort of your ability -- you mentioned input earlier, but your ability to scale up deliver at scale for your customers? And what is it doing for sort of the economics from the Flex perspective? And is basically everything to be able to pass through to the customer?

Yes. I'd say that, first, if you step back and think about what's happened over not just the past year, but the past 5 years...

A couple of years.

Right. I mean you can go back to, say, the first Trump administration when the initial trade policies changed and created a whole different dynamic in the marketplace, being followed by global pandemic, being followed by a material constraint, real wars in areas where we manufacture and now the next wave of trade restrictions. So I feel like we've been practicing for this moment for 5 years now. It's been an ongoing dynamic environment. And really what that's done is created the real need for regionalization. So fortunately, for us, the more complex the environment gets, the better positioned that we are because our portfolio of products and services is already operating at scale in each of these major geographies. So we can take our customers wherever they want to go. What ends up happening, I mean, if you think about where the movements are taking place, certainly, we're seeing less interest in China, right? But we're seeing a lot more interest in places like North America and more recently, a lot of interest in U.S.-based manufacturing. We're also seeing interest in Eastern Europe as well as Southeast Asia. So again, this is not a new environment for us. The value that we bring to our customers is an ability to navigate those challenges.

Does it change the [ BOM ] effectively, right? Regionalization, I would imagine bringing more to U.S. is more expensive than relying on China and Southeast Asia. So how do you think about that in that context?

Yes. I think that there's always trade-offs. On the one hand, you might have higher input costs from a material standpoint. But on the other side, you might have lower output costs and how you land that product into the fulfillment zone that it's going. But even if costs do increase, those are largely from our model perspective, pass-throughs, and we'll make the same sorts of margins that we had made before in that environment. the real trick for us is we want to keep mixing up the portfolio into higher-margin end markets, and some of those happen to be more complex.

So since you mentioned margin pass-through, how are you thinking about sort of the competitive landscape on program wins, profitability by end market, if you will, like cloud, it's a very competitive market. There's a lot of well-capitalized companies that are in kind of the same let's call it, circle of what Flex does, both domestically and outside of the United States. Any change in like the pricing dynamic, what that means for margins in data center and cloud, just to start?

Yes. So maybe take that in layers there. The first point that I think a lot of people miss is our fastest-growing business is our highest margin business, right? And somehow that tends to get lost. But if you think about our data center business, right, it's a business that's going to be $6.5 billion at the end of this fiscal year, coming off 50% growth, 35% growth. And we've long said that this is a business that operates at margins that are higher than our corporate average. And within that data center business, too, you have this fast-growing power business that's operating at product level margins. So the first headline there is our fastest-growing business by far is our highest margin business. So that's one element. The other thing I think about is we've got two different reporting segments, agility and reliability. And we now have both of those businesses operating at or above 6% operating margin, right? And that's a year earlier than we had committed. So we're seeing a lot of good, healthy balance between the portfolios. Now we get there in different ways potentially. On the reliability side, we've got product margins, and we've got high complexity, higher margin, higher regulated industries. But on the agility side, although that base margin might be slightly lower, we have very high penetration of our value-added services. So we get to the same place in different ways. But we see that as being, first, on plan, in fact, a year earlier, and we still see a lot of gas need to.

So I know you're there now. So that is a sustainable, both above 6% number going forward without any degree of like cyclicality or variability quarter-to-quarter. So are we sustainably above that 6% margin for both?

So if you look back over the last 4 quarters, we've stayed at or around that 6% level. We're not going today sort of guide to FY '27. But when you think about the drivers that got us to 6%, frankly, when you think about the drivers that got us from 3% coming out of COVID to 6%. They're the same ones that we're going to be pulling on as we go into next year and the following years. So Michael talked about it. Products business continues to grow at above-average growth rates, clearly, right, because he said it's a little north of 35% and those margins are mid-teen margins. So that's going to be a margin tailwind as we go forward. services also continues to grow at above Flex averages, and they produce margins at above flex averages. So those 2 things as we go into next year are going to continue to be margin uplift. And I would only say that the other levers that we've pulled, which is productivity at our scale is something we can continue to drive as we go forward. And then the automation that you're seeing in our supply chain is something we're going to have. So we believe that as we go forward here, we're not done expanding margins. There's still opportunity to drive margins because of those levers that I talked about.

And so you're operating at margins given the mix in your business and above, let's say, other regional competitors or domestic competitors. Is there an opportunity for the entire industry to continue to mix higher and maybe be a little bit less you've done a really good job. I'm trying to use the right words without imputing the business, like being less commodity-centric, right? Is there anything else in the portfolio that's maybe a little bit too commodity-centric where you're not getting the appropriate value for what you provide to a customer that helps drive incremental, to your point, incremental margins higher going forward?

Yes. I still think that -- first of all, I think the good news is the industry is doing a lot better on the whole, right? And we've always said we want to be the best house in a great neighborhood, right? And so that's good for the industry. It's good for us, and I think the industry will continue to move forward. I would say some of our success has been our ability to mix up in that portfolio. I think the best example of that has been we have intentionally taken down our high-volume, high-volatility, low-margin consumer devices business. I think we've taken it down to the tune of $2 billion over the past few years, and we've replaced that with higher-margin, longer product life cycle business, which has improved our margins. I think that there's still opportunity to mix up from that perspective. But also, I think just the natural growth rates of the portfolio that we have is going to lead to some margin improvement as well as our products continue to increase, as our value-added services continue to increase. And as we really methodically mix up into those higher-value segments, you'll see just a natural progression there.

One question I have that we get asked a lot is capacity. How do you think about additional capacity in the context of obviously meeting the demands of customers, but also managing the margin dynamics that we're talking about. You're mixing up, you're decreasing your reliance on lower-margin products, but capacity is obviously a key consideration as we think about this over the intermediate term. So how do we think about where your capacity focus is going forward and what that might mean for margins?

So you can talk about capital deployment here in a second. But I'd say that our capacity mirrors what our customers want us to do. And we talked about how that dynamic environment is trending across regions. And I'd say that we continue to invest in capacity. We'll continue to invest in capacity. We're certainly just out ahead to make sure we continue to grow. We made some really big announcements in the past year or 2, right? One is we announced a really large expansion in Dallas, as an example, to grow our power business. We've announced a strategic investment in South Carolina to grow our lifestyle business. We've made expansion announcements in Poland to grow our power business. We've expanded in the U.K. to grow our power business. We recently announced an expansion of our automotive business in Hungary. So in line with what we're seeing from our customer geographic wish you're seeing investments in North America really coming up in the United States, but also in Europe and Southeast Asia. And that's all within the capital deployment.

Yes. I mean, Michael said it well, he said a critical point there was slightly out ahead, right? We've learned from the sins of the past of the industry, if you will, and we're not going to get way out in front of our capacity needs. He talked about it a little earlier. We have a good line of sight as well, especially in the places that are growing significantly that allow us to understand where we need to make those capital investments and ensure that they're delivering the returns that we would expect.

Got it. Maybe just in the final minute or 2. I'd like to ask companies like what is least understood, what is misunderstood about the story at this point? Demand is great. Performance has been great from an execution perspective, margin accretion. What's maybe not quite fully appreciated about the Flex story at this point in your journey?

So I'll start and maybe you can follow up with that. I think the first one is one that I already mentioned, and that is this realization that our fastest-growing business is our highest margin business. I think that gets lost in the noise on occasion. I'd also say that the intentional choices we've made to grow the business are unique, right? EMS plus products plus services is something that you have -- you can't see in -- of some of our peer group. EMS certainly is something that other people can provide. Our constant -- our conscious choice to invest in 2 different power product businesses, Mirror Controls business products is another intentional choice and then our value-added services. The combination of those 3 things is something that we think is unique and positions us really well for the future.

On the financial side?

I would say we talked about it, it's really this margin opportunity and where we are today and the opportunities as we go forward and what that ceiling could look like. We'll continue to talk about it as we go forward. But we're excited about our ability to continue to expand margins as we go forward due to some of the things Michael talked about.

Great. I think we are out of time. Thank you, everyone. Thank you, Michael. Thank you, Kevin.

Thanks, David.