Flex Ltd. Q2 FY2025 Earnings Call

Thank you for standing by. Welcome to Flex's Second Quarter Fiscal 2025 Earnings Conference Call. Presently, all participants are in listen-only mode. After the speaker's remarks, there will be a question-and-answer session. As a reminder, this conference is being recorded. I will now turn the call over to Mr. David Rubin. Mr. Rubin, please begin.

Thank you. Good morning, and welcome to Flex's Second Quarter Fiscal 2025 Earnings Conference Call. With me today is our Chief Executive Officer, Revathi Advaithi; and Interim Chief Financial Officer, Jaime Martinez. We will give brief remarks followed by Q&A. Slides for today's call as well as a copy of the earnings press release and summary of financials 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. As a reminder, 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. 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, unless otherwise stated, all results provided will be in non-GAAP measures, and all growth metrics will be on a year-over-year basis. 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. Lastly, on October 17, we announced we had entered into a definitive agreement to acquire Crown Technical Systems. The guidance we provide on this call excludes any impact from the pending acquisition. Now I'd like to turn the call over to our CEO. Revathi?

Thank you, David. Good morning, and thank you for joining us today. Starting off with our results on Slide four. We had a solid Q2 with revenue of $6.5 billion. End market trends in the quarter were largely in line with our prior expectations with strength in cloud, power, and medical devices. Our adjusted operating margin came in at a record 5.5% based on the strong mix and effective cost management. And we delivered $0.64 of adjusted EPS, also a quarterly record for Flex. As mentioned last quarter, we have multiple large program ramps across Flex, including cloud, power, and auto. These ramps are progressing well, which contributed to our margin improvement, and we expect this to continue in the back half of the fiscal year. I'm proud of our strong execution this quarter as our team continues to operate in a dynamic macro. Now turning to Slide five. At our Investor Day back in May, we laid out a longer-term strategy to expand our unique portfolio of advanced manufacturing capabilities, innovative power and compute products, and life cycle services, with an ongoing focus towards higher-value markets with strong secular trends. We call this our EMS plus product plus services strategy. We continue to make progress on the strategy across our diverse portfolio. Within each of our six business units, our teams are focused on improving the mix and driving operational productivity of their core manufacturing businesses. Each business unit is also looking for opportunities to add value to our customers through additional services. Our lifestyle business was where we initially proved the value we can create through vertical integration and circular economy solutions. The result is deeper customer relations and improved margins even through the downcycle in durable goods. From this experience, we extended the strategy to CEC with similar results, including the strong growth in our cloud business. In some end markets, such as auto and, of course, cloud, we have built out our own product portfolio. This creates even more value in our relationships. There's been a lot of interest in how our EMS plus products plus services strategy applies specifically to the transformation in the data center. So let me briefly explain. Flex is the only provider that delivers customized, fully integrated data center racked solutions and power infrastructure solutions. Our data center power portfolio spans from the facility power all the way down to components that power the server boards. So, our power portfolio is truly grid-to-chip. You're already seeing the impact of this strategy in our results. For example, in Q2, our data center portfolio, which is a combination of cloud and data center power business, grew 40% year-over-year versus our expected 20% long-term CAGR, and we were also up against a more difficult comp this quarter. Of course, we're constantly working to improve our capabilities, develop innovative products and expand our services. It's been a busy quarter, so I want to talk about some of our progress. We announced our partnership with Musashi Energy Solutions to enhance our Flex design capacitive energy storage solution or CES assets. Our solution is now the leading technology to mitigate the massive power spikes that are disrupting data centers as they add new AI clusters. At this year's Open Compute Summit, we had a few critical announcements highlighting how Flex enables cloud service providers to address power, heat, and scale challenges. We allowed our next-generation compute reference design for AI and high-performance compute applications. We announced our partnership with JetCool to expand our direct-to-chip liquid cooling capabilities, which is able to handle the most advanced AI server specs. Lastly, we showed our liquid cool Flex racked solution integrated with our power shelf, power supply, and busbars, all designed for the higher demands of emerging workloads. This demonstrates a truly vertically integrated solution for our cloud customers that we can manufacture at speed and scale. Now there's a deeper takeaway from these product and capability announcements. Because of our expertise in both power and compute, we are working with our customers earlier in their technology roadmap. Because of that, Flex has the opportunity to drive leading-edge innovation and, in this case, help solve some of the most critical power issues in the evolving data center. As I mentioned, our EMS plus product plus services strategy is about finding higher value opportunities in diverse end markets, and every team at Flex has a role to play in this strategy. Along those lines, we recently announced the acquisition of Crown Technical Systems. There is a strong synergistic effect here. First, Crown has a significant position in the North American power distribution market, which is being driven by grid modernization and data center power trends. Their expertise in medium voltage switchgear also enhances our data center power portfolio, and we believe it will support growth in our Modular Power Pod business, particularly in the U.S. market. This acquisition is another great example of our strategy to grow in higher-value markets tied to our core competencies, and ultimately create long-term shareholder value through margin expansion, EPS growth, and cash generation. With that, I'll pass the call over to Jaime Martinez to take you through our financial update. Jaime?

Thank you, Revathi. Starting with our second quarter performance on Slide seven. It was another solid quarter. Second quarter revenue was $6.5 billion, in line with our expectations. Gross profit totaled a record quarterly level of $554 million and gross margin increased to 8.5%, up 90 basis points. Operating income was $358 million, with operating margins at 5.5%, a substantial year-over-year improvement, up 80 basis points. And as Revathi mentioned, both were record quarterly levels for Flex. Earnings per share increased 12% year-over-year to $0.64 for the quarter, also a record level. Turning to quarterly segment results on the next slide. Reliability revenue was $2.9 billion in the expected range with continued strength in power and medical devices. Operating income was $159 million, and operating margin for the segment improved, both sequentially and year-over-year, to 5.4% on mix and solid execution. In Agility, revenue was flat at $3.6 billion with strong cloud offsetting softer non-cloud-related networking and enterprise IT. Operating income came in at $218 million, with a record 6.1% operating margin based on continued mix improvement in each of the three business units, along with strong execution and effective cost management. Moving to cash flow on Slide nine. Q2 net CapEx totaled $100 million, and we expect to maintain our target of 2% of revenue for the full year. Net inventory was down again this quarter, similar to Q1, down 6% sequentially and 21% year-over-year. Inventory days, net of working capital advances has finally reached a more normalized level in the high 50s. So, we feel much better about where we are. Free cash flow in the quarter was strong again at $219 million. That puts us at $451 million year-to-date, on track to reach our full year target of $800 million plus. In the second quarter, we reported $300 million worth of stock, totaling approximately 10 million shares. Fiscal year-to-date, we have repurchased over $750 million. We exit Q2 with cash balances of $2.6 billion. Some of that will fund the Crown acquisition expected to close by December. Please turn to Slide 10 for our segment outlook for the fiscal third quarter. For Q3, Reliability Solutions, we expect revenue will be flat to down mid-single digits. As we recently mentioned at the Goldman Sachs conference, we have seen some macro related slowing in auto that is muting growth in the second half. Although we still expect to outperform our industry unit expectations in fiscal 2025 based on new wins and content gains. Core industrial demand is a little softer than previously expected. However, the strength in power and medical devices is expected to continue. Agility solutions revenue is expected to be down low to high single digits with continued strong growth in cloud, with other end markets remaining as expected. On to Slide 11 for our quarterly guidance. For Total Flex, we expect Q3 in the range of $6 billion to $6.4 billion, with operating income between $335 million and $365 million. Interest and other expense is estimated to be around $50 million. We expect the tax rate to be around 17% for the quarter. All that translates to adjusted EPS between $0.60 and $0.66, based on approximately 400 million weighted average shares outstanding. Looking at our full year guidance on the following slide. Given some macro pressures, we now expect full year revenue between $24.9 billion and $25.5 billion. However, adjusted operating margin is expected to be between 5.4% and 5.5%, which at the midpoint will be up about 70 basis points year-over-year, and adjusted EPS is now expected to be between $2.39 and $2.51. You can see in our results and guidance how much Flex has changed over the last several years, shifting to higher-value business and improving operations through the cycles. And this is resulting in continued margin improvement and double-digit EPS growth. We believe our EMS plus products plus services long-term strategy represents the best opportunities in the history of Flex. So, we're very excited about our future. With that, I will now turn the call back over to the operator to begin our Q&A.

Thank you. Now begin the question-and-answer session portion of today's call. Our first question today is coming from Ruplu Bhattacharya from Bank of America. Your line is now live.

Hi, thank you for taking my questions. Revathi, I wanted to ask you about the Power business, strong growth this quarter of 40% year-on-year. Is that sustainable? And how do you plan to grow this business? Is it going to be through more M&A? Or is there organic growth possible and who is the target customer? And just on that, I think you said you wanted to create long-term shareholder value. So, should investors see this power business as integral to Flex? Or can this be thought of as a stand-alone business that over time could be a candidate for a spin-off like NEXTracker?

Thank you for the call, Ruplu. I want to clarify that the 40% growth rate refers to our overall data center business, which includes our IT Solutions CEC business, EMS integration, and our power business, covering both embedded power and infrastructure power. This contributes to our 40% growth. Regarding the sustainability of this growth, it's important to consider the broader conversation about data center expansion and the significant capital investments expected over the next decade. We are optimistic about this macro trend. Additionally, it's crucial to recognize that power will play a vital role in the overall growth of data centers. We are unique in our ability to provide both embedded power, which impacts power directly on the chip, and the infrastructure power throughout the grid. As power requirements become more complex, our capabilities will become increasingly important for customers. Thus, being the only company that offers both power infrastructure and IT solutions integration places us in a very favorable position for long-term growth. We have previously mentioned our goal of achieving a 20% compound annual growth rate, and we are currently exceeding that significantly each quarter. This is due not only to our competitive advantage but also to our technology edge. I feel optimistic about the long-term growth potential in the Data Center segment. In terms of growth strategies, we recently announced an acquisition of Crown Technical, which enhances our power capabilities in North America, particularly in the Medium Voltage segment and overall power Pods integration. This is critical, as the simplicity of creating large power pods filled with equipment and positioning them next to data centers for quick startup is essential. We plan to continue pursuing M&A to enhance our data center portfolio. Therefore, we see a combination of both organic growth and acquisitions as our pathway forward, and we are confident in sustaining the 40% growth we've achieved this quarter and the 60% growth from last quarter, along with our long-term target of 20%.

And just on the issue of whether this is an integral part of Flex. Or can we single this as a business that is a stand-alone unit and that could potentially be spun off?

I would think, Ruplu, I'll step back and think about Flex as a portfolio of products, right? So, in our $25 billion, $26 billion of revenue we have, we have many different segments that are growing at different rates, right? Automotive is growing at a different rate with different characteristics. Health solutions is the same way. Data center is the same way. We have created a unique position for ourselves in data center. And what we are planning to do in almost every segment is create these modes of products, services, EMS capability that makes us unique in that portfolio. So, I would think of it as overall synergistic to Flex across the board. This is what we're doing in every segment within Flex. This just so happens to be at a growth rate that is pretty significant and then in an end market that makes it in the news a lot. But I would say, overall, it's very synergistic to the Flex portfolio.

Got it. For my follow-up, I'd like to ask about margins. Despite the near-term revenue challenges, you appear confident in maintaining a full-year operating margin within the range of 5.4% to 5.5%. Jaime, what gives you that confidence? For instance, you mentioned ramps in automotive, but if the volumes are lower, are you worried about under-absorption of costs? What specifically is giving you confidence regarding margins? Thank you.

Yes, Ruplu, thank you for the question. And I would say that for the second half, as you mentioned, right, ramps continue to progress well. And that supports our margin despite even there may be some revenue erosion in some of the projects. The fact that the ramps are going well helps to raise the margins given that it's in our automotive portfolio of data center. And that's the beauty of the portfolio, right? The mix of our portfolio continues to be better and continues to be strong, whether it's in data center or cloud, power. And also, health solutions, medical devices is mixing up better for us. So that's a key strength in our performance. And we continue to manage our cost very well right through operational execution and efficiencies, and that supports our margin expansions and makes you feel very comfortable with that double-digit EPS growth that we're putting out there.

Thank you for all the details. Appreciate it.

Thank you. Your next question is coming from Samik Chatterjee from JP Morgan. Your line is now live.

This is MP on for Samik Chatterjee. Thanks for taking my question. So, my question firstly is around the order trends that you're seeing related to your data center exposure like in compute and power business. So, are you seeing any acceleration in terms of order trends? Or you're seeing the same order trends relative to 90 days ago?

Yes. I would say in terms of we don't talk much about forward-looking orders. But I would say that we are very comfortable with kind of what we have shared as revenue growth. Last quarter was 60%. This quarter is 40%, obviously, in very difficult comps, right? And kind of much higher than what the market overall sees. So, I feel very good about our pipeline of projects that we have and what we are executing to, and have no concerns about that. I think it fits very well with our longer-term thesis that this is a very robust business. So, we don't specifically give order trends, but I think our 40% growth rate should give you a pretty good indication that we have a very strong backlog and orders to execute to.

Okay. I have another follow-up on your margin performance. So, we were able to offset the decline in the outlook for full year in terms of revenue by better margins. So, I was just wondering if the outlook were to deteriorate further in terms of automotive or industrial, how much leverage do we have in terms of increasing operating margins to still maintain the relevant in the EPS guidance? Or when will we start to see a hit on EPS if the revenues for the full year outlook start to deteriorate more?

I will tell you that we are very comfortable with our EPS outlook. And the real thing that you see happening here is the evolution of our transformation that is playing through where we can perform through our cycles, and it happens due to two reasons. One is our mix; we're really growing in high-value segments at a really fast rate. So that's fantastic, and you see that flow through our P&L. And the second is we are great at managing volumes ups and downs in terms of cost efficiency and productivity. So, you put those two together, I would say we are very comfortable with our forward-looking EPS guidance. And we feel like we are always very conservative in terms of our revenue and EPS guidance. And we feel like we have pegged it right, in terms of where the end markets are, so I would say I have no issue with what we are guiding so far, and we expect no erosion from where we are.

Okay, thank you.

Thank you. Our next question is coming from George Wang from Barclays. Your line is now live.

Hey, thanks for taking my question. Hey Revathi, just double-click on this cloud ramp, obviously very impressive strong double-digit versus the long-term 20% growth. And just high level, obviously, you guys don't guide quarter-to-quarter kind of full run rate. Just how to think about the cadence for the double-digit growth for the next couple of quarters, especially kind of as you think about opportunity, whether it's a new logos within the hyperscaler rack integration or whether that's co-location. And maybe you can address some of the potential new logos you guys could be working on or still kind of a bigger-sized opportunity and what is the share within existing kind of top two hyperscales?

Thank you for the question, George. I'll begin by highlighting our extensive portfolio in data centers. In the IT solution EMS segment, we provide IT integration for racks, servers, storage, and networking products tailored for hyperscalers, maintaining strong coverage across the industry. It's crucial to note that we are highly vertically integrated, not only in manufacturing our racks but also in delivering related services. This robust integration allows hyperscalers to rely on us completely. On the power products front, we manage everything from the chip's power supply to the surrounding infrastructure, further distinguishing our portfolio in the industry. This unique position supports our growth, driven by the demand for both our IT solutions and power products, as we engage with colocation services and hyperscalers alike. Instead of focusing solely on acquiring new clients, we prioritize expanding our existing relationships within the already established universe of colocation and data centers where we have extensive familiarity. Our strategy revolves around increasing wallet share through new technologies, innovative products, improved scheduling, and enhanced services. I am confident about our organic growth rates in this domain. Additionally, we've recently announced a new acquisition related to our power products and will pursue further growth through similar acquisitions.

Great. Just a quick follow-up. I want to delve deeper into the owned IT product, which has a much higher margin, potentially reaching double digits. Specifically regarding the liquid cooling aspect. At OCP, you developed a reference design for liquid cooling in partnership with JetCool, and I wonder if you plan to integrate some of your designs in the data center, in addition to the power solutions previously mentioned. Could you elaborate on the outlook for incorporating your designs into traditional data center rack integration and how to view the margin profile in relation to the corporate average?

Yes. So, I'd start with the kind of the partnership with JetCool itself and how I think about the kind of the reference design we talked about. See for us, this is a natural progression, right? Because we make the power that actually works with the chip itself. So now it's all about cooling the chip and the power products that go together in it. So that makes it very appropriate that we think about cold plates and CDUs associated with the product, right, which really leads us to the JetCool partnership. JetCool has a very unique cold plate design that we feel really fits well with what we are trying to do to solve the toughest problems around cooling, and that really drove our partnership with them. And that really gives us our own IP in terms of the reference design that we're using and really solving for both the power needs in the chip itself and the integrated rack solution, which we can make all of it end to end. So, that's what really drove that partnership, and it really makes it very appropriate for Flex considering we are the only ones who have the power needs. So, we make the rack integration fully end-to-end, and then now we have the cooling reference design. In terms of margin, I would say, these are all accretive to Flex overall. Obviously, you see that in our mix, right? And what we are delivering, margin growth through these cycles. The 40% growth in data center really mixes us up in a big way. So, they're margin accretive to Flex, which is really good because that's what you want your transformation to be about is that you're mixing up in the right portfolio where you have strong growth and higher margins, which is what we are doing in data centers.

Okay great. Congrats again on the strong growth in the AI side. I'll go back to the queue.

Thank you. Our final question today is coming from Steve Barger from KeyBanc Capital Markets. Your line is now live.

Good morning. This is Christian Zyla on for Steve Barger. First question, you guys haven't differentiated yourself from your EMS peers with M&A. Thanks for the earlier comments on the data center portfolio. But as you think about other subsegments outside of data center, are there capabilities that you would be interested in adding, specifically thinking about maybe the next-gen mobility portfolio but others as well?

Yes, Christian, I would say that we've been very clear in terms of our acquisition targets will always be things that help from a technology perspective, and that will help in terms of completing a portfolio that we're really interested in. So, the other area we have talked about a lot is automotive in general, right, that it has to be fit with what we are looking to achieve in our automotive portfolio. But so far, we have not needed any acquisitions in that space. We have a fairly comprehensive portfolio that provides a complete EV platform, EV hybrid platform to our automotive customers. So, we feel very comfortable with that. And then we continue to look for acquisitions around services capability that will help any particular portfolio of ours deliver more vertically-integrated services. But we're very thoughtful about acquisitions because financially, as you have seen us, whenever we have announced a deal, it has been financially a good deal for us, and that is also an important part of the overall capital allocation strategy. So that's how I think about M&A.

Great. And then, I guess, going on the margin side. So operating margin expansion has been pretty steady on its upward trend for you guys. And some peers in the industry have hinted at goals of 6% plus. If your reliability subsegments begin to recover, do you think that target is reasonable? And what are the puts and takes that you think about that could get you there? Thank you so much.

Yes, Christian, I'll quickly comment and give it to Jaime. I mean we've already given our long-term target at 6-plus percent. So, we're obviously well in that range, as you can see from where we are today, and we had given that in our last Investor Day. And we said that comes through improved mix, improved portfolio services expansion, all of that. But Jaime, anything you'd add to it?

No, I think Revathi covered most of it. It's important to note that our performance in reliability is significantly improving. The mix in our Power and medical devices is beneficial. For instance, this quarter we experienced a revenue reduction of 11%, yet we still saw a year-over-year growth of 20 basis points. This progress gives us confidence in our ability to navigate through the cycle effectively. Agility is also performing well across our various opportunities, providing higher value along with additional value-added services. Overall, we are quite comfortable with our long-term target of achieving over 6%.

Thank you. We reach the end of our question-and-answer session. I'd like to turn the floor back over to the CEO for closing remarks.

Thank you. So, we look forward to speaking to you again next quarter. Before I close, I just want to thank all our customers and then also all our shareholders for your support, and of course, to the Flex team across the world for all their hard work, their dedication, and their contribution. Thank you all.

Thank you. That does conclude today's conference call. Thank you for joining. You may now disconnect.