Flex Ltd. (FLEX) Earnings Call Transcript & Summary

Thank you for standing by. Welcome to Flex's First Quarter Fiscal 2027 Earnings Conference Call. [Operator Instructions] As a reminder, this call is being recorded. I will now turn the call over to is Michelle Simmons. Mr. Simmons, you may begin.

Good morning, and thank you for joining us today for Flex's First Quarter Fiscal 2027 Earnings Conference Call. With me today is Revathi Advaithi, our Chief Executive Officer; Kevin Krumm, our Chief Financial Officer; and Michael Hartung, our Chief Commercial Officer. Slides for today's call as well as a copy of the earnings press release are available on the Investor Relations section at flex.com. This call is being recorded and will be available for replay on our corporate website. Today's call contains forward-looking statements, which are based on current expectations and assumptions. These statements involve risks and uncertainties that could cause actual results to differ materially. These statements reflect expected results for the whole fiscal year and did not give effect to the planned spin-off of the Cloud and Power Infrastructure segment. For a full discussion of these risks and uncertainties please see the cautionary statement in our presentation, press release or in the Risk Factors section in our most recent filings with the SEC. Note, this information is subject to change, and we undertake no obligation to update these forward-looking statements. Please note, all growth metrics will be on a year-over-year basis unless stated otherwise. Additionally, all results will be on a non-GAAP basis, unless we specifically state it's a GAAP rules. The full non-GAAP to GAAP reconciliations can be found in appendix slides of today's presentation as well as in the summary financials posted on the Investor Relations site. Now I'd like to turn the call over to our CEO. Revathi?

Good morning, and thank you, Michelle. In Q1, our teams delivered another exceptional quarter while continuing to prepare 2 industry-leading companies for the next phase of growth as stand-alone businesses. We delivered strong revenue growth, margin expansion across all 3 segments and record adjusted earnings per share of $1. Our Cloud & Power Infrastructure segment grew 35% year-over-year. And as we stated before, our investments in this business are on track to drive accelerated growth and margin expansion in the second half of the fiscal year. . We also saw strong growth in our communications and industrial business units, driven by high-value market as networking, automation and energy infrastructure. Now we're in the midst of a generational build-out driven by AI and demand is not slowing down. We have built 2 focused companies to win in the AI era, and these results reflect the strength of our strategy. Our results also reflect our focus on long-term execution. Our addition to the S&P 500 last month reflects our progress over the last several years and the enduring strength of our strategy. We also continue to build momentum in some of our fastest-growing markets, expanding our partnership with Cerebras to scale manufacturing of the CS-3, one of the world's most advanced AI accelerator systems right here in the United States. We also launched a new liquid cooling solution through JetCool and showcased our next-generation power and infrastructure technologies at Computex. As we continue executing our long-term strategy for both Flex and SpinCo, I want to reiterate our vision for both companies. We have built 2 great businesses that are entering different phases of growth. The spin allows each company to sharpen its strategic focus, align capital allocation with its growth priorities and create greater value for customers and shareholders. SpinCo requires a capital allocation framework designed for rapid growth as demand for AI infrastructure accelerates. Many people still think about AI as a compute story. I think it's increasingly becoming an infrastructure story and more specifically, a power story. AI may live in the cloud, but the infrastructure behind it is very physical. It must be built, powered, cooled, integrated and deployed at scale. As AI scales, the constraint is no longer just the chip. It's everything around the chip. Power, cooling, electrical systems and ultimately, the grid capacity. That's the challenge customers are trying to solve today. We saw this coming years ago, and that's why we invested in power, compute and thermal management technologies long before AI became front-page news. What started inside Flex as a set of businesses supporting the next generation of data centers has evolved into a leading solutions provider. I want to be very clear. SpinCo is not a data center components company. It's a digital and electrical infrastructure company, built to help customers solve the power, cooling and scaling challenges that come with AI. That's where we believe SpinCo is uniquely positioned to excel. We see our ability to bring together power, thermal management and compute technologies combined with the ability to deploy these capabilities at global scale as a true differentiator in this space. We have spent years working alongside the world's leading technology companies as a design, build and expanded capital infrastructure. That combination of power expertise, systems integration and execution is difficult to replicate. And I would say we're still early. We believe we are at the beginning of one of the largest electrical transformations happening today. What's happening in the data centers is just a starting point. As AI scales, demand will extend far beyond compute, driving investment across power systems, cooling technologies, electrical infrastructure and ultimately the grid itself. That's why we don't view this as a short-term investment cycle. The work required to power the next generation of AI will take years, creating ongoing opportunity across the broader electrical ecosystem with a very long tail. We are building SpinCo to lead that transformation. At the same time, Flex is exceptionally well positioned to drive long-term value creation as a leading global manufacturing platform. Following the separation, Flex will remain a global manufacturing leader with a proven playbook and strategy with deep customer relationships across diversified end markets, and exposure to attractive long-term secular growth trends. These include health care, where an aging population and increasing prevalence of chronic disease are driving demand for medical devices and drug delivery solutions. And robotics and warehouse automation, where regionalization and labor shortages support meaningful operation opportunities for continued growth. While SpinCo will focus on open digital and electrical infrastructure, Flex will continue to benefit from pull-through demand in data centers, providing contract manufacturing services in the advanced networking and energy infrastructure market. What remains underappreciated is the strength of the Flex portfolio and the related opportunity ahead. The same disciplined playbook that has driven our transformation over the last 7 years will continue to guide Flex as it enters this next phase of growth. Ultimately, we are creating 2 distinct and focused leaders, each with the scale, strategy and opportunity to succeed on its own. Now turning to our transaction update on Slide 6. Our dedicated separation management office and cross-functional teams continue to make tremendous progress towards the separation and we are on track for tax-free spin-off in the first quarter of calendar 2027. Today, we're also pleased to announce additional leadership appointments for both SpinCo and Flex, effective upon completion of the separation. Thanks to the strong bench and depth of expertise we have built at Flex in recent years. We have strong leadership teams in place for both companies ready to execute from day 1, providing confidence, clarity and continuity for our customers, employees and shareholders. For more details on the extended leadership teams of each company, please refer to the press release we issued this morning. While it's certainly an exciting and dynamic time at Flex, we're executing from a position of strength. Our teams are winning by delivering incredibly well for our customers and at the same time executing with discipline to deliver exceptional results. We're excited about what's ahead, and we look forward to sharing more in the months to come, including at our Investor Day on November 10 where we will provide additional details on the path forward for both companies. With that, I'll turn the call over to Kevin, who will walk through the financials in more detail.

Thank you, Revathi, and good morning, everyone. I'm honored to be a part of this exciting journey and to work alongside both teams during this transformative period. It has been an incredible journey so far and I'm energized about the opportunities in front of these businesses. I'll now review our results for the first quarter fiscal year '27, which reflects strong execution as we continue preparing for the upcoming spin-off of our Cloud and Power Infrastructure segment. I'll start with our key financials on Slide 8. First quarter revenue came in at $7.9 billion, up 21% year-over-year. Adjusted gross profit totaled $761 million and adjusted gross margin improved to 9.6%, up 50 basis points from the prior year. Adjusted operating profit was $534 million, up 35% year-over-year with adjusted operating margins at 6.7%, up 70 basis points from the prior year, driven by business mix and underlying productivity improvements. Finally, adjusted earnings per share in the quarter increased to $1 per share, up 39% year-over-year. Turning to our quarterly segment results on the next slide. Regulated Manufacturing Solutions revenue were $2.7 billion, up 12% year-over-year, driven by strength in industrial. Adjusted operating income was $176 million and adjusted operating margin was 6.6%, up 130 basis points year-over-year, driven by the aforementioned strong performance in Industrial. Renew from Integrated Technology Solutions segment totaled $3.1 billion, an increase of 20% year-over-year, driven by exceptional growth in communications. Adjusted operating income was $158 million and adjusted operating margin was 5.2%, up 10 basis points year-over-year, driven by the strong performance in communications and offset by weakness in consumer-related end markets. Finally, Cloud and Power Infrastructure revenue totaled $2.2 billion, up 35% from the prior year, driven by strong growth in power as cloud and cooling continues to ramp new programs. Adjusted operating income was $214 million, and adjusted operating margin was 9.7%, up 20 basis points year-over-year, driven by growth and margin expansion in Power. Moving to cash flow on Slide 10. Free cash flow in the quarter was $41 million. Free cash flow was negatively impacted by onetime cash costs of $24 million driven by activity related to the announced spin-off. Q1 inventory was up 10% sequentially and 24% year-over-year, largely driven by revenue growth. Inventory, net of working capital advances was 56 days, an increase of 1 day from the prior year. First quarter net CapEx totaled $235 million or approximately 3% of revenue. Turning to our updated outlook on Slide 11. For fiscal year '27, our expectations are the following. Revenue to be between $33.7 million and $35.2 billion, up 23% at the midpoint. Adjusted operating margin to be between 7% and 7.2%, an increase of approximately 80 basis points year-over-year at the midpoint. We expect an adjusted tax rate of approximately 21%. We expect adjusted EPS to be between $4.42 and $4.74 a share, up 39% at the midpoint. Finally, we expect CapEx to be in the range of $1.5 billion to $1.6 billion. As a reminder, our prior guidance for free cash flow conversion of 60% excluded costs associated with the spin-off of our CPI segment. Incorporating costs associated with the spin-off, we now expect free cash flow conversion to be approximately 40%. Moving to our updated fiscal year '27 segment outlook. For RMS, we expect revenue to be up mid-single digits to high single digits due to continued strength in high-value end markets within industrial, including warehouse automation, robotics and energy infrastructure. For ITS, we expect revenue to be up high single digits to low double digits, driven by continued strong performance in communications. And for CPI, we expect revenue to be up 65% to 75%, driven by both cloud and power with Power's growth rate exceeding Cloud's. Finishing off with our guidance for the second quarter on Slide 13. We expect RMS revenue to be up mid-single digits to high single digits on continued strength in industrial. We expect ITS revenue to be up high single digits to low double digits on continued strength in communications offset by weakness in consumer-related end markets. We expect CPI revenue to be up 45% to 55% as new programs continue to ramp in both cloud and power. For Total Flex, we expect revenue in the range of $7.95 billion to $8.25 billion, up 19% at the midpoint with adjusted operating income between $535 million and $565 million. Interest and other expense is estimated to be around $58 million and the adjusted tax rate to be 21%. Lastly, we anticipate adjusted EPS to be between $1 and $1.07 per share, up 32% at the midpoint based on approximately 375 million weighted average shares outstanding. In summary, we are off to a strong start for fiscal year '27 and we are well positioned to deliver upon the commitments we made at the beginning of the year. With that, I'll now turn the call back over to the operator to begin Q&A.

[Operator Instructions] Our first question today is coming from Ruplu Bhattacharya from Bank of America.

Revathi, my first question is on margins in the CPI segment. Looks like revenues grew sequentially, but op margin was slightly lower, maybe 20 bps. Is that because of program ramps that you're focused on? And in a broader sense, can you talk about growth drivers for margins in this segment? Power has good margins, but today lower than some of its peers. So how do you plan to grow margins in the Power segment? And then for compute, what guardrails do you have to make sure margins remain within your target range as some AI projects could have lower margins? And I have a follow-up.

Yes, Ruplu, thanks for that question. I would say that margins in CPI is pretty much in track with the guidance we gave for the quarter and the year. We said that in the CPI segment that the revenue is kind of back half loaded. We have been making investments in that. And then we also said that we expect to have at least 100 basis points improvement in margin in the CPI segment for the year from a year-over-year perspective and we're on track with that. So we feel very good about that. I would say what guides margins for this segment, obviously, on the compute side, we have been executing on that strategy for a while, and we're fairly mature in these. When there are new programs, which there are always significant new programs, initially, there's some investment, but when the program matures, then kind of the margin flow-through rate is pretty good. So those ups and downs in the cloud side and the computer integration side is part of the game. But as you have seen in our full year results, typically, that through the year, we do pretty well in terms of both revenue and our margin. I'd say on the power side, we have said that, hey, we've built the power business through a whole bunch of acquisitions, which requires investment, particularly when these businesses are growing at 70-plus percent. So we're making those investments, and that drives kind of requirement for the margin to be slightly muted compared to our peers, but we're very comfortable with moving it in the direction of where the peers and the electrical infrastructure are. So I'd say, Ruplu, in summary, CPI is absolutely where we said the quarter would be and where the guide would be for the year. And we're on track to deliver the margin improvement just as we said for kind of our current fiscal year.

Okay. The follow-up maybe is for Michael or for Kevin. When you think about the segments in Remainco, the regulated markets and especially the ITS segment, are you happy with the product portfolio? I mean if the focus is on longer life cycle, higher-margin segments, is there more potential to do more pruning or more optimization of both the portfolio as well as the footprint. So how are you thinking about that as you look out over the next couple of years? .

Yes, thanks for the question. I'd say we're absolutely happy with where we're starting from in the business. And if you might recall, our strategy going forward will be to continue to emphasize the high-value growth markets that are tied to these longer-term secular trends. And these markets exist in both the RMS business and the ITS business. So up to this point in time, we've been deploying capital, both human and financial, towards the highest returns, and that's been the data center. The strategic clarity as a result of the spin enables us to provide greater focus on those high-value growth markets. In terms of optimization, a regular part of our process here in the business is to always look to optimize the portfolio. You've seen the benefits of that in our Q4 results, our Q1 results and our guide and we expect to continue to optimize the portfolio and look forward in the theme of emphasizing high-value markets and deemphasizing value markets along the way. So in short, really pleased with the starting point of where we jump off from on the business.

Our next question today is coming from Mark Delaney from Goldman Sachs.

I was hoping to start on CPI. I think the full year guidance for CPI revenue implies 2H revenue is up closer to 100%, so some acceleration. I know the company has program wins as you were just describing, but can you speak more on your visibility into that acceleration for 2H. And on that kind of broader theme of visibility into the CPI growth, any change in your views for CPI into next year because I think you're expecting an acceleration to over 80% growth for fiscal '28. .

Mark, this is Kevin. From a CPI perspective, yes, directionally, the ramp that you were referring to is what's going to happen as we move through the year. So we started at 35% in Q1. We're guiding to 45% to 55% in Q2 and then still the 65% to 75% for the full year. So certainly, strong growth in the back half of the year, as you referenced, I would say from a visibility standpoint, we've talked about our demand see through in this business, and it remains strong. We're still at that 90% plus booked business at this point for the next 3 quarters. So we feel good and remain confident in our visibility around this business. I would say, as we think about next year, while we're not going to guide here on a quarterly basis, the framework that we offered earlier in the year still holds, and we expect the investments that we're making this year in CapEx and the ramp we see in the back half of the year to continue strong growth performance next year and our visibility next year still remains robust.

That's helpful context. My other question was on cooling and rarity, you mentioned JetCool and you spoke about cooling. So I was hoping you could give a bit more detail on how big that market might be for Flex today. And maybe more qualitatively, if you could speak around the traction that you're seeing in areas like cold plates and CDUs.

Yes. I'd say, Mark, the market itself for cooling, liquid cooling, as you're aware, is growing quite well and the market size is increasing as more air cooling is getting replaced with liquid cooling. I'd say our acquisition with JetCool really got some cold plate capability as to industry-leading cold plate capability, and then we had to develop and introduce CDUs into the market. So we're in the process of qualifying those products with the written customers to scale that business up. . It also gave us kind of manufacturing capability and codesign capability with some customers who already have their cooling product that helps us codesign with them. The way I think about cooling in the CPI portfolio is that it's still nascent, and it will be a pretty important part of our growth strategy overall for CPI within the Cloud segment. So we're pretty bullish about it, I would say, but there's work to be done in terms of scaling that business to where we need it to go.

Our next question today is coming from Tim Long from Barclays.

Just one and then a follow-up, if I could. On the communications business, it sounds like it was really strong in the outlook was very favorable there. Just give us a little bit of color on kind of visibility, sustainability of that strength? How broad-based is it in the customer base. And then I'll come back with a follow-up.

Tim, thanks for the question. Yes, we've identified within our Communications business that our advanced networking business, in particular, is one of those high-value growth markets that we expect to drive growth over a sustained period in our business. And that's being positively influenced by pull-through demand from the data center. So if you step back and think about this business, communications continues to be one of our largest healthiest businesses in RemainCo going forward. It will continue to really spread across not just high-speed switches, but optical switches, network interface cards. So it's fairly broad-based within that advanced networking ecosystem and very much tied to the sustained demand from the data center. .

Okay. Great. Great. And then maybe a follow-up for Revathi. You mentioned kind of being able to bundle or a little bit more, have a full solution power cooling rack. Could you just touch on kind of -- I know it's early on the cooling side. Maybe just give us some examples, there's some thoughts of customer activity where you're seeing the benefit of having these multiple pieces?

Yes. I'd say, Tim, that we are seeing it across multiple customers, hyperscalers without naming any, I would say that you can see that most customers now are quickly thinking about, hey, we need to -- before we deploy the next-generation silicon, we need to be thinking about power capability and power requirements. They're already thinking about how does life look like when we go to an SST technology. So we're seeing a lot of conversations at a very high level and strategic level with customers on kind of silicon, cooling, power, how all that comes together for next-generation products, which we didn't see 2 and 3 years ago because what customers don't want to be is in the situation they are today, where the power requirement becomes an afterthought, and then we are in a struggle to make sure that we have enough power to -- for these data centers. . So I'd say in the last kind of few months, several hyperscaler customers at a very high level, we've had strategic conversations around power cooling and kind of thinking about next-generation silicon. And that really puts us in the unique position of one of the few people who are able to do this. So I feel pretty good that 3 years ago, we thought this is where it would go, but now the conversations are actually heading in that direction. I'd say, from a platform perspective, what we announced with NVIDIA a few months ago in terms of developing an overall modular platform, which encompasses everything that we do is a good example of a customer who's thinking about it and moving it in that direction.

Our next question today is coming from Joseph Cardoso from JPMorgan.

Maybe just for the first one. Relative to the CPI growth outlook that you provided, maybe can you just discuss the constraints that you're seeing just given the current backdrop that we're in? Just interested in hearing potentially what's limiting you from calling for further upside here and where things are maybe more acute in terms of the constraints that you guys are seeing. And how are you thinking about those trending going forward? And any levers you have internally in terms of how you're thinking about offsetting some of them? And then I have a follow-up.

Yes. Joseph, I thought by saying that our guide for CPI for the year was 70%, so growth year-over-year. So it's a pretty strong and robust number in terms of year-over-year growth. So we feel really good about that. I would say we beat the midpoint of our guide for Q1. We said 30%, we came in higher than that. So obviously, the year is accelerating exactly like we planned and Q2 is higher than Q1. And we had clearly mentioned that this is back half loaded, which is mainly driven by the capacity investments we are making. We announced a big CapEx which involves pretty significant investment in terms of facilities, cooling infrastructure, manufacturing infrastructure, all of those are going in place. . And that, combined with the customers' generational shift in platforms is what has driven our -- kind of the way we've given our guidance for the full year. So we feel very good about the 70% guide that we've given for this year and the 80% that we have given for next year because those are pretty significant numbers. I don't see any significant constraints per se other than putting the capacity investments in place and making sure those factories are ramped up, which we know how to manage really well. So Joseph, I feel really good about the guidance we gave, and we're on track to deliver that.

That's great to hear. And then maybe just as my follow-up, you mentioned the engagement with Cerebras. I'm not sure how much you can talk about it. But any way you can kind of frame out how representative this engagement to Flex' broader AI accelerator opportunity. And really, what I'm trying to get at is, for example, it is mostly advanced manufacturing? Or are you also seeing some pull-through around power, cooling and just the portfolio there.

Yes. I would say we've talked -- we have been quite public about it and Cerebras has been about our engagement with them, and we have -- I think there's videos published by us and them in terms of our full engagement. We've been working on this for a while, right, with them. And I would say that it is definitely a manufacturing cooling engagement because those go hand-in-hand. But it is also -- we're also working on things like next-generation power, which is things that we will be thinking about with them in the future. . So it's a pretty holistic partnership with Cerebras. It's going extremely well. We're scaling up a lot for them. So I would say that this is a good example of us diversifying our hyperscaler involvement in our CPI business that we have talked about, and it's a great example of scaling up with another customer.

[Operator Instructions] Our next question is coming from Ruben Roy from Stifel.