Flex Ltd. (FLEX) Earnings Call Transcript

Greetings, and welcome to Flex's Second Quarter Fiscal Year 2027 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. [Operator Instructions] It's now my pleasure to turn the call over to Michelle Simmons, Senior Vice President, Global Investor Relations and Public Relations. Michelle, please go ahead.

Good morning, and thank you for joining us today for Flex's Second Quarter Fiscal 2027 Earnings Conference Call. With me today is Revathi Advaithi, our Chief Executive Officer; Kevin Krumm, our Chief Financial Officer; Michael Hartung, our Chief Commercial Officer; and Amy Schwetz, who we previously announced as the expected CFO of Flex post spin, will give brief remarks followed by Q&A. Slides for today's call as well as a copy of the earnings press release are available on the Investor Relations section of flex.com. This call is being recorded and will be available for a replay on our corporate website. Today's call contains forward-looking statements, which are based on our 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 full fiscal year and did not give effect to the planned spin-off of the Cloud and Power Infrastructure segment. Any references to the planned spin-off, including its timing, Form 10 status and the leadership of each company following the separation are forward-looking and remain subject to applicable approvals and completion of the spin-off. For a full discussion of these risks and uncertainties, please see the cautionary statements 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 result. The full non-GAAP to GAAP reconciliations can be found in the appendix slides of today's presentation as well as in the summary financials posted on the Investor Relations website. Now I'd like to turn the call over to our CEO. Revathi?

Thank you, Michelle. Good morning, and thank you for joining us to discuss Flex's Second Quarter Fiscal 2020 Results. Before I begin, I'd like to start by welcoming Amy Schwetz to the team, who will become the Chief Financial Officer of Flex after the spin-off. I look forward to working with both her and Michael Hartung, who will lead Flex as CEO through this transition and to seeing Flex continue to excel under their leadership. Now I'll start with our performance for the quarter. We delivered another fantastic quarter in Q2 revenue growth accelerated. We expanded margin across all 3 segments and earnings reached a new record of $1.18 per share. Our results reflect continued execution across the portfolio and demonstrate the strength of our strategy, our diversified end markets and our ability to help customers navigate an increasingly dynamic environment. At the same time, we continue to make significant progress on one of the most important milestones in our company history, the planned spin-off of our Cloud and Power Infrastructure segment now known as Axiom. Since our last earnings call, we have reached several important milestones as we've moved from announcing the transaction to building 2 focused industry-leading companies. Last month, Axiom filed a Form 10 registration statement, providing a more detailed view of Axiom's strategy, financial profile, leadership team and growth opportunities. That filing marked an important step forward and reflects the tireless work of our teams have been doing behind the scenes to prepare for the separation. We also announced the expected leadership teams for both Flex and Axiom. One of the things that gives me great confidence in this next chapter is the strength of our leadership bench. Across both organizations, we have experienced leaders with deep expertise in technology, in manufacturing, operations, customer engagement and innovation who are ready to lead from day 1. And perhaps most exciting for me, we officially unveiled the Axiom name and brand. Building a new company is a rare opportunity. Over the past several months, we have spent a great deal of time defining not only what Axiom will do, but what it will stand for. For me personally, the name review was a meaningful milestone because it made something we've been building become more tangible. Axiom is no longer just an idea. It's taking shape as a company with its own identity, leadership team, culture and purpose. It has been incredibly rewarding to share that vision with employees, customers, partners and our investors. As we've discussed before, we believe Axiom is uniquely positioned to lead the next generation of critical digital and electrical infrastructure. By bringing together power, thermal management and compute expertise Axiom helps customers deploy increasingly complex infrastructure with greater speed and scale as AI demands more of the physical infrastructure behind it. The future of AI infrastructure goes beyond the chip itself. It depends on power, cooling, compute and the ability to deploy and operate infrastructure at scale. Those are the capabilities we've spent years building and honing and they're the reason we believe the company is uniquely positioned for the opportunities ahead. We have outlined our strategy for Axiom, and we are working diligently through the spin-off to position the company for further success. Earlier this month, we announced the closing of our acquisition of EPC Power which further strengthens Axiom's portfolio of end-to-end solutions and EPC's engineering expertise complements our existing research and development into 800-volt architecture and solid-state transformers, technologies that will define the next-generation data center. The success of this strategy is evident in the results we are producing even before the spin. Our CPI segment grew 54% year-over-year in Q2 and delivered margin expansion of over 200 basis points. At OCP, earlier this month, we introduced prefabricated AI modules, which help accelerate AI factory deployment by up to 50%. The work we're doing leading up to the spin is building upon the strength of what is already an incredibly successful business. The spin is about creating 2 stronger companies with distinct identities focused strategies and ability to pursue their respective opportunities. While Axiom will be purpose-built to help power the AI infrastructure revolution Flex will emerge as a more focused industrial technology, manufacturing and supply chain leader. I'm extremely excited about what Flex will become after the spin. Flex enters this next chapter from a position of strength with leadership positions in attractive end markets and a proven track record of profitable growth and cash generation. In Q2, our RMS and ITS segments together grew 16%, representing the fourth consecutive quarter of year-over-year growth. Over the last several years, we have transformed Flex into a stronger, more focused companies with higher margin, improved returns and a more attractive portfolio. Under Michael's leadership, Flex will build on that transformation. The company will be focused on markets for its engineering, vertically integrated manufacturing and supply chain capabilities create meaningful competitive advantage and long-term value for customers. As a stand-alone company, Flex will have greater ability to continue evolving its portfolio and allocating capital towards its highest return opportunities. Many of the markets where Flex has been investing in building leadership position over time sit at the intersection of a long-term technology and industrial trends, including health care, energy, infrastructure and communications. We believe these are attractive markets where complexity, reliability and speed matter and where our capabilities can continue to drive differentiated growth and returns over time. These businesses are supported by durable secular growth drivers strong customer relationships and capabilities that are difficult to replicate. Combined with our financial discipline, our cash generation ability, productivity culture and commitment to shareholder returns we believe Flex is exceptionally well positioned for its next chapter. At Innovation Day, you will directly hear from the Flex leadership team, where they will take Flex from here. What excites me most is that we're not creating 2 companies searching for their future. We are creating 2 industry leaders, each with clear purpose, differentiated capabilities and substantial opportunities to create value. As we look ahead, I believe both companies are entering some of the most exciting periods in their history. And we're looking forward to sharing much more on November 10 at our Innovation Day, where investors will hear directly from the expected leadership teams of both Flex and Axiom, and we'll provide a deeper look at the strategies, the market opportunities and long-term plans that will guide both companies going forward, including how each intends to strengthen its competitive position and create long-term shareholder value. Most importantly, we'll show why we believe both companies are built to win, built with clear purpose built with the right capabilities and leadership and build to create long-term value for customers, employees and shareholders. 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. Before I go through the quarter, I'd also like to welcome Amy Schwetz to the team. I'm confident in her leadership and her impact, and I'm excited to be working with her through the remainder of the spin-off process. I'll now review our results for the second quarter of fiscal year '27. We are continuing to execute well. We've got a great group of businesses and a great team and all are performing at a high level as we approach the spin-off in early 2027. I'll start with our key financials on Slide 8. Second quarter revenue came in at $8.5 billion, up 25% versus the prior year. Adjusted gross profit totaled $842 million, and adjusted gross margin improved to 9.9%, up 60 basis points year-over-year. Adjusted operating profit was $607 million, up 48% from the prior year, with adjusted operating margins at 7.1%, up 110 basis points year-over-year, driven by continued productivity improvements as well as business mix. Finally, adjusted earnings per share for the quarter increased to $1.18 per share, up 49% versus the prior year. Turning to our quarterly segment results on the next slide. Regulated Manufacturing Solutions revenue was $2.7 billion, an increase of 9% versus the prior year driven by industrial. Adjusted operating income was $172 million adjusted operating margin was 6.4%, up 50 basis points year-over-year, primarily driven by industrial. Revenue from our Integrated Technology Solutions segment totaled $3.3 billion, up 22% versus the prior year, driven by continued strong growth in communications. Adjusted operating income was $181 million and adjusted operating margin was 5.5%, an increase of 20 basis points year-over-year driven by communications and offset by weakness in consumer-related end markets. Finally, Cloud and Power Infrastructure revenue totaled $2.5 billion, up 54% versus the prior year, driven by continued strength in both Power and Cloud and cooling. Adjusted operating income was $268 million and adjusted operating margin was 10.7%, and up 240 basis points year-over-year driven by margin expansion in both power and cloud and cooling as well as favorable mix impacts from power growth. Power segment operating margin increased to approximately 16% and up roughly 550 basis points year-over-year driven by strong volume growth and the benefits of scaling the investments we made last year. Moving to cash flow on Slide 10. Free cash flow in the quarter was $261 million and was negatively impacted by onetime cash costs of $61 million, driven by activity related to the announced spin-off. Q2 inventory was up 13% sequentially and 39% year-over-year, driven by revenue growth. Inventory net of working capital days was 60 days, an increase of 5 days from the prior year. The increase in inventory is primarily mix related, reflecting the inventory required to support our higher growth, higher value programs. Second quarter net CapEx totaled $240 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 $34.9 million and $35.9 billion, up 27% at the midpoint. Specifically, we expect CPI revenue to increase between 75% and 85%, while we expect combined RMS and ITS revenue to increase between 8% and 11%. Adjusted operating margin is expected to be between 7.6% and 7.8%, an increase of approximately 140 basis points year-over-year at the midpoint. For CPI, we expect adjusted operating margin to be between 11.5% and 11.7%. And for combined RMS and ITS, we expect adjusted operating margins to be between 5.9% and 6.1%. We expect an adjusted tax rate of approximately 21%. We expect adjusted EPS to be between $4.84 and $5.16 per share, up 52% at the midpoint. Finally, we expect CapEx to be in the range of $1.5 billion to $1.6 billion, and we expect free cash flow conversion of approximately 40%. As previously announced, we completed our acquisition of EPC Power on October 14. We also announced on October 5, an agreement to sell $2 billion of Axiom convertible preferred stock. The net proceeds of which will repay approximately $2 billion of the $4.4 billion in debt incurred as part of the EPC acquisition. As such, we expect elevated interest expense associated with debt from the acquisition in the short term, which will be reduced upon completion of the convertible preferred equity transaction. Despite the increased interest expense, we expect the EPC power acquisition to be accretive in fiscal 2027. Moving to our updated FY '27 segment outlook. For RMS, we expect revenue to be up mid-single digits to high single digits driven by strength in industrial, including energy infrastructure, warehouse automation and robotics. For ITS, we expect revenue to be up low double digits to low teens on continued strong growth in communications. As previously referenced, for CPI, we expect revenue to be up 75% to 85% and driven by both power and cloud and cooling with power growing faster than cloud. This guidance now includes our acquisition of EPC Power, which closed on October 14. We now expect CPI operating margins to expand approximately 240 basis points year-over-year, assuming the midpoint of our guidance, up from our prior expectation of approximately 100 basis points. Looking ahead, we expect continued margin improvement supported by volume growth, productivity gains and the contribution from EPC power. Finishing off with our guidance for the third quarter on Slide 13, we expect RMS to be up low single digits to mid-single digits, driven primarily by industrial and health care. We expect ITS revenue to be up mid-single digits to high single digits as strong growth in communications is offset by weakness in consumer-related end markets. We expect CPI revenue to be up 105% to 115% and as recent investments in both cloud and cooling and power contribute to strong growth. For Total Flex, we expect revenue in the range of $8.87 billion to $9.17 billion, up 28% at the midpoint, with adjusted operating income between $685 million and $715 million. Interest and other expense, which now includes debt associated with the EPC acquisition is estimated to be around $120 million and the adjusted tax rate to be around 21%. Lastly, we anticipate adjusted EPS to be between $1.19 and $1.25 per share up 40% at the midpoint based on approximately 375 million weighted average shares outstanding. In summary, we delivered a strong first half of fiscal year '27 and we are carrying that momentum forward into the second half of the year. With that, I will now turn the call back over to the operator to begin Q&A.

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

Kevin, maybe we could start with some of the guidance commentary and the fiscal '27 guide, you've got a $950 million increase from the prior guide. Can you help us out with organic growth embedded in that increase versus the acquisitions, EPC and others, et cetera.

Yes, Ruben. So for the full year, we increased -- I'll talk first with CPI because that's where the line -- all the acquisitions this year have happened. So we guided to an increased range of 75% to 85% for the year. And inside of that, I would say about 10 percentage points of that is going to be growth related to acquisitions we've completed during the year. So you can -- the 2 that we've completed are the EP Squared acquisition, which we announced in the first quarter and then EPC recently.

Right. But I was wondering if you could kind of split that. So I guess what you're saying is that there's not a lot of...

I think, Ruben, your question is only EPC power, right?

Yes. I guess, is there any way to think about the contribution from PTC?

Okay. Yes. So we've talked about EPC next year in our announcement and the growth that we were going to have, which was approximately $800 million this year growing next year inside of our guide -- increase guide to guide, if that's your question, we increased about $950 million of which, I would say, approximately half of that is underlying improvement in Flex and the other half would approximately would be the EPC acquisition we brought in.

Perfect. And Revathi, for a follow-up, let me ask a sort of a bigger picture question here. You've done a few acquisitions now. You're spanning the embedded to critical power [Indiscernible] power conversion. And a lot of investors asked us about the power strategy longer term. But there's a lot of other things going on, cooling, compute, et cetera. How are you thinking about sort of having a broader set of technologies combined with Power? Is that showing up in your win rates and customer economics from a margin perspective? Or should we still focus mostly on power is sort of the key area of the strategy going forward?

Yes, Ruben, say, we'll talk a lot more about this on November 10 in our Innovation Day. But when I think about CPI or Axiom moving forward, I'd say all 3 compute, cooling and power, all 3 are important in terms of how we are building up the overall systems capability. Today our areas of strength where we are market share leaders and our technology leaders are both in compute and in power. I'd say cooling, our presence is still nascent. It is something that we are growing into with new product launches that are planned over the next 6 months. So that I believe will accelerate in our overall capability. But both compute and power are pretty integral to our overall strategy, both from where we stand today as market share leaders and where we move forward with in terms of our overall capability.

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

So I'm going to start on the power business and putting the EPC deal aside for the moment, can you share more on the competitive positioning of Flex in the power portfolio? And has there been any meaningful change in the company's market share for either fiscal '27 or beyond? And then more broadly on CPI, how is that segment tracking relative to the prior [Indiscernible] outlook for fiscal '28?

Yes, I'll start off, Mark. I would say if you think about power overall, both our embedded power and our Critical Power business are both fantastically positioned from a technology perspective and a growth perspective. If you think about our Power segment growth this year and even what we'll share later in Innovation Day, I'd say well about its peers in our existing segments. And it's a good indication of where our technology stands and kind of how the teams are performing with our capacity execution we talked about that happened last year. So feel really good about our positioning, both in embedded power and in critical power. As you know well, embedded is all about technology and where we are positioned in the technologies. So right now, embedded is all about continuing to execute on capacity and additions to drive the growth. CPI, I would say, performing extremely well. So both businesses, I feel really good about overall in terms of the position. I'd say for -- your second part of your question on CPI for next year. Kevin, do you want to handle that in terms of the 80%?

Yes, sure. So as we move through -- we started the year mark 65 to 75. We increased that -- so underlying there, there is -- even excluding the EPC acquisition, we've been performing well. And our momentum this year has been north of our original expectations in CPI. While we're not going to offer a new guide for FY '28 right now, I would just say that momentum we expect it to carry through. And of course, as time has passed, we have better line of sight into next year, and we'll update you on that at Investor Day.

Understood. My other question was also on CPI. I mean the incremental EBIT margins in the just completed quarter were very strong and accelerated. I don't know if you could double click a bit more on what was driving the strong incremental margins and just how you see the potential for CPI organic EBIT margins going forward?

So yes, in the quarter, we talked about a strong quarter. We finished with power margins in the mid-teens. The power growth is a big piece of the incremental margins you're seeing there. Although our cloud business continues to perform with different expectations with good incrementals as well. Across the board, we saw mix favorability, pricing and volume leverage. We talked about the investments we made last year. We're scaling through those, and we're seeing that volume leverage pull through from an incremental perspective as well. So those are the really the big drivers. As we go forward here, again, expectations on the power side of the business continue to drive margins up. Cloud and cooling, as we talked about it, we had expectations there. We just don't expect them to move sequentially at the same rate as power as we continue to climb towards industry averages.

Your next question is coming from Ruplu Bhattacharya from Bank of America.

I have 2. Revathi, it was interesting to hear Chris and Rob at OCP. I think their presentation was stressing that you can achieve 97% power efficiency to the rack even without [Indiscernible]. So as you start off as a new company, where do you see Axiom focusing on in terms of R&D and development? Is 800-volt and SSD development a priority for you? And just as you look at your competitors, which are larger companies, how do you see yourselves attacking this market? And how do you see yourself focusing on R&D versus acquisitions?

Yes. I'd say, Ruplu, first is, we are very, very committed to and focused on both the 800-volt technology. We're the market leaders in that, as we have talked about before, there's a couple of players who are very strong in this space. And Flex or Axiom is definitely one of them. Solid-state transformers. We've talked about we had our own organic program that was going on, which will now get added on to with the EPC power acquisition with their own organic technology development program that was going on. But the way I think about this having done this for a very long time, Ruplu, is that it is important to drive incremental efficiency in the overall powertrain value without waiting for the SST transition to happen. And I think that's important to really have the focus on that because as most of you know, electrical transitions take a long time because of the regulatory and safety environment associated with it. So our view is, in the meantime, you can achieve the 97% power efficiency with digital rectifiers that exist in the marketplace today, which is a huge part of the reason why we bought the EPC acquisition because it provides a transition technology solution that is very strong and can get deployed today, while we wait for things like SSDs and all of that to show up. So we feel very good about both but feel even strongly about the fact that we can deploy that power efficiency today, which a lot of customers are very excited about, Ruplu.

My follow-up is for Kevin or Michael. RMS revenues were flat sequentially, but margins declined 20 bps sequentially. Can you maybe just talk about the puts and takes and which segments, which end markets are coming back, Michael, and what the levers do you have for margin improvement going forward?

Thank you for the question, Ruplu. Probably the easiest place to start is to really look at the business overall when you think about RMS and ITS combined. So as Revathi mentioned in her prepared remarks, Q2 actually represents the fourth consecutive quarter where both RMS and ITS delivered year-on-year growth. Because that growth was driven by our higher value markets, we are also able to expand margins at a higher rate than we were growing revenue. So the business is in very good shape and positioned from strength. When you think about Q2, very strong result, high-value markets driving that growth across both RMS and ITS. As Kevin mentioned, on the ITS side, communications continues to be strong on the RMS side, Industrial continues to be strong. And so when you think about where we were at the beginning of the year, a couple of things are important to note. In the first half, we performed better than we expected across both ITS and RMS. Again, in ITS Communications driving that strength, but primarily from our advanced networking business which is one of our high-value markets and are tied to those AI-related trends for data center buildout. RMS also over-delivered in the first half. Automotive performed as expected in a stable environment. Health care grew as expected, which should be no surprise. These are longer product life cycle businesses to perform on a consistent, steady basis. And then as mentioned, industrial over delivered primarily on the strength in our energy infrastructure business where those businesses are tied to the AI and data center build-out, but also our robotics business was strong. And those things are tied to the deployment of physical AI and regionalization of the supply chain. Now as you look forward into the second half, keep in mind, we also highlighted that we're going to be lapping stronger comparables given that the second half of last year is really where that momentum started to build. And so in the second half, we're still delivering growth on top of growth. Now there is some nuance to that. And underlying that, we are seeing incremental weakness in lifestyle, but that is being offset by communication in the ITS business. And in RMS, we are continuing to see consistent performance. And although it might not be linear in every single quarter, you can rest assured that when we think about the guide for the year, we expect both revenue growth and margin expansion.

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