Flex Ltd (FLEX) 2019 Q1 法說會逐字稿

Welcome to the Flex first quarter fiscal year 2019 earnings conference call.

Today's call is being recorded, and all lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

At this time, for opening remarks and introductions, I would like to turn the call over to Mr. Kevin Kessel, Flex's Vice President of Investor Relations & Corporate Communications.

Sir, you may begin.

Thank you, and welcome to Flex's first quarter fiscal 2019 conference call.

We have published slides for today's discussion that can be found in the Investor Relations section of our website at flex.com.

Joining me on today's call is our CEO, Mike McNamara, and our CFO, Chris Collier.

Following the remarks, we will open up the call to questions.

Before we begin, let me remind everyone that today's call is being webcast and recorded and contains forward-looking statements, which are based on current expectations and assumptions that may -- that are subject to risks and uncertainties, and actual results could materially differ.

Such information is subject to change, and we undertake no obligation to update these forward-looking statements.

For a discussion of the risks and uncertainties, see our most recent filings with the SEC, including our current annual and quarterly reports.

If this call references non-GAAP financial measures for the current period, they can be found in our Appendix slide.

Otherwise, they are located on the Investor Relations section of our website, along with the required reconciliations.

Now, I'd like to turn the call over to our Chief Financial Officer, Chris Collier.

Chris?

Good afternoon, and thank you for joining us for our first quarter results.

Before we get into reviewing our first quarter financial performance, we wanted to provide you with an impact summary of 2 new accounting standards we adopted this period.

Please turn to Slide 2 for a summary of these impacts.

First, we adopted the new revenue recognition standard ASC 606, and did so under the modified retrospective approach, which means we are not restating prior years, but have captured the prior-year income statement impact in our retained earnings.

We had not anticipated a material impact to our income statement or cash flows upon adoption, and that was the case.

Our revenue for Q1 was approximately $102 million less than the revenue without ASC 606 adoption, primarily due to a 1-time reduction of revenue from certain contract amendments for small customers we executed in the quarter.

You'll also note on the face of the balance sheet a new asset called contract assets amounting to $324 million, associated with unbilled receivables as a result of the adoption.

On the right, you can see the impact of new cash flow presentation guidance related to our asset-backed securitizations, or ABS, programs, which we've been using for over 10 years as a strategic source of low-cost funding.

These programs serve as a key part of our working capital management.

This new standard required us to separately report certain cash inflows from ABS programs as investment activities that had historically been treated as cash from operating activities.

As a result of this reclassification, our Q1 reflected decline in operating cash flows of $657 million, despite no change in the economics of our program or cash collection.

As a result, we believe this reclassification impact should be adjusted back to give the true economic picture of our operating cash flows.

We thought it would be beneficial to level-set on these changes and their impacts upfront.

You'll see additional disclosures related to the newly adopted accounting standards in our 10-Q, to be filed next week.

With that, please turn to Slide 3 for our Q1 fiscal 2019 income statement summary.

Our first quarter sales were approximately $6.4 billion, up 7% versus a year ago.

This was within our prior guidance range, and also reflects the 1-time impact of reducing revenue by over $100 million in the quarter associated with the adoption of the new revenue standard that I just mentioned.

Our Q1 adjusted operating income was $188 million, which also was within our guidance range, and adjusted net income was $128 million.

This resulted in adjusted earnings per diluted share of $0.24, which was at the midpoint of our guidance range of $0.22 to $0.26.

First quarter GAAP net income amounted to $116 million, which is lower than our adjusted net income due to several adjustments.

This resulted in a $0.02 reduction from our adjusted EPS, as our first quarter GAAP EPS was $0.22.

I'll discuss these adjustments shortly.

Now, turn to Slide 4 for our quarterly financial highlights.

This was our sixth consecutive quarter of year-over-year revenue growth, which was supported by growth across our IEI, HRS and CTG businesses, reflecting the continued expansion from new customers and programs.

Our gross margin remains pressured as we ramp various new programs, and also due to impacts from a changing mix of our business.

Our Q1 reflects the margin impact from lower profitability on various programs in their ramp phase, as gross profits typically lag revenue growth given higher levels of start-up costs, operational inefficiencies, and under-absorbed overhead during these production ramps.

Also, the mix of our business, with a greater portion of lower-margin consumer products, weighs down our Q1 gross margins.

Our first quarter adjusted SG&A expense totaled $225 million, which was down 3% year-over-year, while we are achieving strong revenue growth.

As highlighted at our investor day in May, we are focused on structurally repositioning our SG&A levels and are confident in our ability to leverage our installed (indiscernible) structure to support our growth in fiscal 2019 and beyond.

We expect that our SG&A expense will decrease, both in terms of dollars and percentage, for the remainder of fiscal this year, and we expect to operate in the range of 3% to 3.2% of revenues this year as we simultaneously leverage our revenue growth while driving productivity gains and operating with a cost discipline.

Our quarterly adjusted operating income came in at $188 million, which was up nearly 6% from the prior year and resulted in an adjusted operating margin of 2.9%.

Our profitability continues to display the dampening impacts from elevated levels of costs and investments we are presently absorbing as we continue to position our company for long-term profitable growth.

Our return on invested capital, or ROIC, was 16%, consistent with last quarter, and while it continues to remain above our cost of capital, it does reflect the impacts from lower profitability combined with higher levels of invested capital, as we have higher net working capital and install capacity requirements in front of anticipated ramp in top-line growth and profit expansion.

Turning to Slide 5 for our operating profit performance by business group.

Our CEC business generated $46 million in adjusted operating profit, resulting in a 2.4% adjusted operating margin.

Our business continues to see improving demand trends as revenue grows sequentially and is only modestly down year-over-year.

We remain focused on making investments in engineering and building out our reference platforms for cloud data center solutions and continue to shift our CEC portfolio in this direction, where we can generate higher returns.

Our CTG business earned $27 million in adjusted operating profit, resulting in an adjusted operating margin of 1.5%, which is below our target range of 2% to 4%.

Our underperformance to target reflects the underlying mix shift, the ramping of new programs, and sustained losses from our strategic partnership with Nike, although we continue to make improvements and track profitability in the second half of this year.

We expect for CTG to expand its adjusted operating margin and move into our target margin range later this fiscal year as our new program's manufacturing volumes increase and our utilization rates and overhead absorption improves and we benefit from the profitability improvement of Nike.

Our IEI business generated adjusted operating profit of $51 million, achieving a 3.6% adjusted operating margin, which fell short of our targeted range of 4% to 6%.

During the quarter, IEI saw distinct pressure from demand softness from new customers in industrial home and lifestyle and reduced demand in semiconductor and capital equipment.

Additionally, its energy business had lower revenue due to certain customer revenue declines and a temporary impact from reduced shipments of solar tracking solutions.

These elements pressured margins during the period.

However, we believe this to be temporary, as we expect IEI to return back to its target margin range next quarter supported by increasing revenue, which will aid in improved absorption benefits.

Finally, our HRS business delivered quarterly adjusted operating profit of $94 million and an operating margin of 7.7%.

As we highlighted at our investor and analyst day in May, we are ramping several new customers and programs and continue to invest in expanding our design and engineering capabilities to support autonomous vehicle and connectivity-focused efforts.

The HRS team is focused on transferring its record $1.3 billion of booked business in fiscal '18 into strong, organic revenue growth, and expect to stay meaningfully within its 6% to 9% target margin range.

Please turn now to Slide 6 to review our other income statement comments.

Net interest and other expense for the quarter was $41 million, and it was up significantly over the prior year, driven primarily by the higher interest rate environment and our higher level of outstanding debt.

And it includes approximately $5 million of non-cash losses from our non-majority owned equity method investments and our platform businesses, such as Elementum and YTWO Formative.

As we look forward, we anticipate our interest and other expense line will be in the range of $40 million to $45 million, reflecting losses from our equity method investments and the impact of our higher interest rate environment.

Our adjusted income tax expense for the quarter was roughly $19 million, reflecting an adjusted income tax rate of approximately 12.8% and within our guidance range.

Our long-term tax range of 10% to 15% remains unchanged, and we anticipate executing to that range in fiscal '19, as previously discussed.

There are several different elements that have an impact for reconciling between our GAAP and adjusted EPS, including a $0.04 impact from $21 million of stock-based compensation and a $0.03 impact from $16 million of net intangible amortization expense.

During the quarter, we realized a net non-cash gain related to our platform business investments of $88 million, or $0.16.

This gain primarily resulted from the creation, spinout and deconsolidation of Autolab AI following the funding from third-party investors and board composition changes.

We excluded this gain from our adjusted results, but it is reflected in our GAAP results.

Mike will expand on this shortly.

Now, going forward, we will reflect our share of Autolab AI's profits and losses in our interest and other line.

Offsetting this gain were costs realized during the quarter totaling approximately $62 million, or $0.11.

These costs included charges for certain distressed customers of over $17 million, employee-related costs of approximately $17 million, $9 million of costs related to the investigation led by our audit committee, and $19 million of other charges.

Turning to Slide 7, let us review net working capital and cash flow generation highlights.

As you can see from the chart on the top left, our adjusted net working capital ended close to $1.8 billion, including the $324 million contract assets.

This amounted to 6.9% of our net sales.

The electronic supply chain environment remains challenging, and we continue to see constraints across several component categories.

The lead times have significantly lessened, and we see increasing shortages in parts that are on allocation.

These constraints, along with our expanding top line in ramping business, have contributed to the expansion of our inventory levels by just under $400 million from a year ago.

We continue to manage the situation well, in part by leveraging our increasing Sketch-to-Scale engagements, where we are now more meaningfully participating with suppliers through design discussions and a different level of partnership, which enables us to secure supply in challenging times.

Optimizing demand fulfillment for our customers remains a priority.

However, the challenging supply environment began to hamper our business late this quarter, as we experienced nearly $70 million of revenue being stranded due to material constraints.

Despite the continued constrained inventory environment and our strong revenue growth, we expect that our net working capital and our percentage of revenue will remain within our targeted range of 6% to 8%.

As planned, we continue to invest to expand capability and capacity this quarter, as our capital expenditures totaled $170 million, exceeding depreciation by $74 million.

This quarter, we heavily invested into both equipment and facility expansions, including in India, as we firmly establish the foundation to support the significant business ramps under way.

Like last year, we continue to invest greater percentages of our CapEx to support our expanding IEI and HRS businesses in Q1.

As we've previously discussed, these investments are supporting products with longer lifecycles, and in many instances, we are required to commit capital investment in advance of production ramps.

The near-term capital intensity of our business remains elevated as we invest in growth, which should be seen in lower adjusted operating and free cash flow generation, where, for Q1, we used $15 million of adjusted operating cash flow, and our free cash flow for the quarter was negative $185 million.

We anticipate that as we move into the second half of this fiscal year, that the capital intensity will abate, both in terms of capital expenditures and the level of net working capital investment required.

Similar to our fourth quarter, we were blacked out from our share repurchase program during Q1.

Our shareholder return commitment of 50% or greater of our annual free cash flow remains, and we intend to resume buying back shares this current quarter and this year.

Please turn to Slide 8 to review our balanced capital structure.

We continue to operate with a balanced capital structure, with no debt maturities until 2020, and have strength and flexibility to support our business over the long term.

Before I turn it over to Mike, I wanted to update you on the investigation the audit committee completed in June.

We filed our fiscal 2018 10-K without any restatements to prior periods.

However, we did conclude that there were material weaknesses in our internal controls or financial reporting.

As a result, we have undertaken and will continue to undertake steps to improve our internal controls to remediate the material weaknesses.

Our efforts have been focused around enhancing controls, procedures and training, as well as expanding resources over critical areas.

We're taking these measures very seriously, and we'll be driving these efforts throughout this year.

Now I'll turn the call over to Mike.

Thank you, Chris.

Please turn to Slide 9 for Q1 business highlights.

Our revenue growth remains a function of new customers and projects that see the value of the Flex platform and its ability to take advantage of a broad collection of assets and capabilities that enable integrated cross-industry solutions.

To that point, our first quarter of fiscal 2019 saw revenue grow 7% year-over-year.

This marked our sixth straight quarter of year-over-year revenue growth, reflecting a balanced and diversified service offering that enables integrated industry solutions.

Our portfolio evolution remains firmly intact.

Over the past 5 years, our focus of strengthening our design and engineering value add has improved bookings and expanded pipelines across all 4 of our business groups, while simultaneously creating differentiation in the marketplace.

HRS and IEI totaled 42% of sales for the quarter and 67% of adjusted operating profit dollars.

HRS achieved its 34th straight quarter of year-over-year revenue growth, where IEI logged its sixth straight quarter of year-over-year revenue growth.

We have successfully diversified our portfolio, achieving substantial scale in our HRS and IEI businesses, which both achieved record Q1 revenue levels.

In addition, both our CEC and CTG businesses are improving because of investments we have made to reposition our offerings around Sketch-to-Scale solutions.

CTG was up 20% year-over-year, and CEC only declined 1% year-over-year, which is significantly better than expected.

As our customers continue to recognize our increasing value as an innovation partner, a growing percentage of them are coming to rely on our Sketch-to-Scale supply team solutions early in their product lifecycles.

Investments we have made in data center solutions, in particular, are yielding strong results.

Some of our key value drivers for shareholders are the platform initiatives that we mentioned during analyst day.

During this past quarter, we had 2 updates that we wanted to share.

The first was a successful series B funding route for Elementum.

The value of the company had greater than $750 million post-money, of which Flex continues to be a significant shareholder.

While we are excited about this development and this is a significant valuation increase, there was no gain recognized in our financial statements.

The second was the creation of an independent company currently operating under the name of Autolab AI, which is a leading-edge, full-staff automation solutions company.

The company was created from a portion of Flex internally-developed automation teams, and with the addition of third-party capital, we'll be accelerating the development of software, artificial intelligence and machine-learning capabilities to optimize manufacturing.

We are thrilled to have recruited a world-class CEO and board of directors over the last few months, and we have successfully raised a significant series A route, which created a non-cash gain for Flex this quarter of $92 million.

Lastly, on March 26th, we announced an agreement to divest the China-based operations of our subsidiary Multek.

This deal closed lastly with proceeds of approximately $270 million net of cash, which we plan to deploy into reinvesting in our business as well as our stock buyback program.

Please turn to Slide 10 as we review revenue by business group in detail.

Before I get into the details, I want to briefly address component shortages and tariffs, 2 issues which we are actively managing.

A number of passive components are in very short supply, are currently on allocation around the world, and this shortage, therefore, is constraining the revenue of many customers.

We believe this constrained environment will continue into 2019, and we expect these impacts to increase over the next couple of quarters.

These shortages will also strand inventory and temporarily pressure cash flow generation, as Chris has already mentioned.

We are actively and aggressively managing this situation, and we are well-positioned to receive a significant allocation of these parts due to our scale, our relationships and our ability to create demand for our suppliers through our Sketch-to-Scale strategy.

For instance, this year, we will purchase over 50 billion MLCC's, meaningfully higher than the 43 billion we procured last year, and we use these components across a very broad portfolio of products, which positions us well with the supply base as we request increased allocations.

But we still anticipate some impact on revenue, operating profit, and, more visibly, on increased inventory levels until this problem dissipates.

A second major topic is tariffs, which will modify the supply chain strategy of many of our customers.

Demand will become more regional as each country works to support its own manufacturing base.

As this distribution of work occurs, we will look forward to being a significant beneficiary of the redistribution, as we are the largest industry provider in every major non-China region.

In the short term, we don't expect much to change, as it will take time for customers to assess and analyze the impact tariffs might have on their business.

Long term, we believe many customers will request a more regional manufacturing footprint to shorten their supply chain and reduce the risk of tariff impacts.

Our first quarter saw year-over-year growth in 3 of 4 of our business groups, and the one that declined slightly, CEC, still outperformed its revenue forecast.

Our diversification remains strong and balanced, winning Q1 with a well-balanced distribution across industries and customers, with no customers above 10% of sales for the tenth consecutive quarter and our top 10 customers totaling 44% of sales.

Our CEC business was down 1% year-over-year to $1.95 billion, versus our expectation for a 5% to 10% decline.

While CEC's legacy end markets remain challenged, its design capabilities continue to improve and expand, which is leading to new customers and business opportunities, particularly in cloud data center solutions, which rose over 25% year-over-year.

For the September quarter, we expect our CEC business to grow year-over-year.

More specifically, we see CEC expanding its revenue by 5% to 10% year-over-year, driven by continued strong growth in cloud data center solutions and year-over-year growth in telecom due to new wins and the beginning of 5G demand.

Our CTG business rose 20% year-over-year to $1.8 million, in line with our guidance range of 15% to 25%.

This growth was mostly driven by strength in products from high growth emerging markets, such as India.

As we mentioned last quarter, this is one region which had already implemented significant tariffs, but we saw a rapid increase in demand for regional manufacturing as a result.

For the September quarter, we are guiding CTG revenue to be up 10% to 15% year-over-year and now planning for the continued expansion of new programs in emerging markets.

On our Nike business, we expect to significant increase revenue over the remainder of the year.

The manufacturing system is rapidly improving productivity, our know-how is accelerating, and our losses are improving.

We remain confident achieving our target for profitability during the second half of fiscal 2019.

To this end, I have personally taken direct ownership for our Nike operations to assure its operational success.

IEI's growth streak continued, up 4% year-over-year to $1.45 billion, a record for Q1 revenue.

However, it was below our expectations for 10% to 20% year-over-year, as lower than expected growth from new programs in home and lifestyle component shortages, lower demand for capital equipment, and the impact of ASC 606 in some of the energy businesses reduced IEI revenue by approximately $150 million.

For the September quarter, we expect the IEI revenue growth to improve by 5% to 10% year-over-year, led by new program ramps in home and lifestyle that are offsetting weakness, capital equipment and energy.

HRS revenue grew for the 34th straight quarter on a year-over-year basis.

Revenue was just over $1.2 billion, also a record for Q1 revenue, up 7% year-over-year versus expectations of 5% to 10% in both automotive and medical group.

Medical in particular saw the best Q1 growth in 2 years and had a spectacular booking level in Q1 of over $500 million, which is higher than all of fiscal 2018, which was also a record bookings year.

All previously-announced bookings are on schedule and will drive strong FY20 and FY21 revenue levels.

In our September quarter, we expect HRS to grow modestly, with the forecast flat to up 5% year-over-year, as medical continues to drive solid growth and automotive is relatively stable.

Let's turn to our second quarter fiscal 2019 guidance on Slide 11.

We expect revenue in the range of $6.6 billion to $7 billion.

Adjusted operating income is expected to be in the range of $200 million to $230 million.

Adjusted EPS guidance is for a range of $0.26 to $0.30 per share, based on weighted average shares outstanding of 536 million.

GAAP EPS is expected to be in the range of $0.18 to $0.22 as a result of stock-based compensation expense and intangible amortization.

With that, I'd like to open up the call for Q&A to the operator, please, operator.

Thank you.

(Operator Instructions) Your first question comes from the line of Amit Daryanani with RBC Capital Markets.

Two questions, if I may.

One, on the September quarter guide, you guys are implying operating margins will improve by 25, 30 basis points, I think, sequentially.

Can you just maybe outline what are the top 2 key levers that enable that margin expansion as you -- incremental revenue growth is one of them, but just what are the levers that are giving you margin expansion as you go into September?

So one of the items, as you quickly highlighted, is the leverage that we'll have in terms of the top-line growth.

You're going to see a continued strong discipline and management over our SG&A.

You're going to see productivity gains as a result of that.

You should be able to expect to see SG&A continuously sitting down around that $220 million level, which will be very beneficial.

Second to that is you're going to see some of the benefits of absorption from the increased revenue at various sites and across various programs as we get deeper into some of the ramps and we have more efficiency and productivity gains through there.

You'll see IEI improving back inside its target margin range.

And we would anticipate also having lower losses.

So those are some of the levers that I can quickly highlight for you that can help build into that improving and expanding both operating profit and margin.

And I guess, Mike, I just want to understand some of these investments Flex has been making in assets like Elementum, YTWO Formative, and I think you talked about Autolab AI right now.

How do you think about these investments, these assets holistically?

And is there a roadmap or timeframe that you would look to monetize these?

Because clearly these things have valuations that have sales multiples that are higher than your P&E, probably.

Well, as we talked a little bit about at investor day, Amit, a large part of our strategy with these investments is basically you leverage the capability and the know-how and the -- even some of the fiscal assets at Flex take outside capital to fund them, and then try to move them into a -- which ultimately maybe they head towards an IPO or some other form of monetization for Flex shareholders down the road.

The timeline is a little bit longer, but they're extraordinary cash efficient, as you can imagine, because our prime objective with these is not to provide a lot of cash to them, but, instead, to provide a lot of know-how and market access and leverage the platform, if you will, on these kinds of assets.

So they have very, very strong theoretical IRR in terms of current valuation.

They require very little cash on an ongoing basis.

In fact, our objective is to take all of them and fund them with outside capital.

And the payoff for Flex shareholders is just going to be down the road.

It's a capital -- it's a very efficient way for shareholders to benefit in equity appreciation over time, and that's something that is using very, very cash -- a lot of cash efficiency.

And one other thing I would add is every one of these things, we're using to leverage capabilities into the Flex system, so whether it's Elementum using very significant supply chain solutions.

I just had a customer today talking about an integrated solution with both Elementum and Flex, and rather than cost us anything, it helps book business for Elementum, and it provides an opportunity for Flex to get value creation off of providing additional solutions for the customer that they wouldn't normally see.

Your next question comes from the line of Mark Delaney with Goldman Sachs.

My first question is an update about how Flex is thinking about the full fiscal year.

I mean, you mentioned some changes, the passive and MLCC shortages, and also maybe some mix changes between some of the segments, more CEC, a little bit less IEI.

So is the company still on track to hit the $1.20 to $1.30 fiscal year EPS guidance?

Mark, thanks for the question.

Certainly, we set out in May and framed out a guidance for the year.

That remains intact.

What you're hearing from us today is clearly a component environment that's changed a bit.

You also heard from us that we believe we have strategic relationships with suppliers that can result in a better allocation than most.

We are very focused around operating in that environment.

Clearly, that puts some pressure on some of the top line and some of the profit performance as we look for the year from where we sat in May, but we're still very laser-focused and confident in the ability to play within the range we set.

The other point you made with a bit more CEC and a bit less IEI, I think that's just kind of looking at what we just had in the current period and the guidance.

I think what we see for the year across each of our business segments is playing out still to the same degree as where we sat in May.

We see a CEC that actually is providing hyper-scale quality data center solutions and getting more and more acceptability there, so that's improving a bit.

And like I said in the prepared remarks, we see IEI coming back into its target margin range and growing each and every quarter as we move forward here.

So there are pushes and pulls in the system, but, going back, we are confident in terms of the guidance we had set.

And my follow-up question is around Nike, and it's certainly nice to hear the company is making some progress on that front.

I think one of the big issues to getting to profitability has been making shoes that were designed to be built with your automated process, so can you just update us about how much of your mix of business is now of that right type of shoes that were designed to use your process?

And how do you think about that mix evolving as you move through the year?

Thank you.

So it's kind of a complicated question to answer.

Some of the automation is not just in certain processes.

We actually have some shoes which are entirely built for the process of automation, so we actually work with Nike to actually do design for automation.

That continues to be like a small focal percentage in terms of a full process of a full shoe.

Now, alternatively, much of the automation that we're putting in place is for any shoe, so how we attach bottoms, how we glue the bottoms to the -- how we do a variety of different process steps all also have automation.

So there's really automation -- incremental automation in virtually every process that we touch, and there's secondarily automation, something that we call the Solamente line, which is actually built for and designed for automation process.

So between the 2, I don't know what percentage it is, but it's almost something that you need to think of as incrementally more and more, both on a process standpoint and in terms of design for automation, every single quarter.

Your next question comes from Matt Sheerin with Stifel.

Just another question regarding the supply chain constraints that you're seeing.

You talked about $70 million or so left on the table in the June quarter.

I would assume that your guidance reflects some confidence in the supply in terms of inventory, that you shouldn't see issues, although there could be issues if there is any potential upside from customers.

How should we think about that this quarter and into the rest of the calendar year?

The guidance implies the most likely outcome of parts that we'll get.

If we get more, we could have upside.

If we get less, I suppose we could have downside, but we have a pretty good idea about those parts.

Most of those parts -- a lot of those parts, we actually have commitments for and have line of sight to, because the quarter ends, obviously, in 9 months -- or 9 weeks.

So I think we've got -- our guidance reflects everything, all the current information that we have available today, which is, I would call, a reasonable, good visibility outlook.

And in terms of the price increases for those parts that you're likely seeing, is that just a pass-through to customers?

Yes, ideally.

Sometimes it's going to be a timing effect on those, and those prices are going to come in.

You'll still have a lot of issues, starting with many inventory effects and FX and such.

But, ideally, as those component prices come into play, it'll be our objective to move those costs and move them right on into the customer base.

I mean, again, timing could be an issue, just in terms of the timing of when we recover it from the customer as opposed to when we get charged it from the supply base, but it is our objective to recover all the costs associated with this.

And in terms of your commentary on some of the weakness in the IEI business, particularly semi-cap, some of your competitors have also called that as a soft patch now.

Is that temporary, or do you see a trend there in terms of across your customer base?

We don't necessarily see an uptick in that business at this point just in terms of our overall profile, so I think at this point, we'd have to say that we're just adjusted to a new level.

So with the semi-cap system, over the last 10 years, it's actually moved from more of a year-long or even a year-and-a-half long kind of down cycle and up cycle to more of a 6-month up cycle/down cycle.

Actually, the waves of up and down have gotten shorter.

So whether or not that will recover, we're not sure yet, but right now we don't see this as temporary and then meaningfully coming up again in another couple quarters.

We just see it right now down at a more stable level.

Your next question comes from the line of Adam Tindle with Raymond James.

I wanted to start maybe on CEC turning a corner there, that declines have bottomed and we're going to see some revenue growth next quarter.

Should we see any fall-off in the third quarter after a very strong 2Q, or do those ramps and strengths continue throughout the year?

And how can we think about the progression of operating margin in the segment as it returns to growth?

So I think what you're going to see is, first of all, as revenue moves into that group, you're going to see absorption of costs and you're going to see margins just naturally trend up a little bit.

So we've been out of our target range for several quarters, and as we go forward, even into this next quarter, we expect to be moving into the target range, and it's mostly on the back of more volume that's coming in.

And whether or not it's just a one-time blip or sustainable, it's something we've been talking about for quite some time.

We actually think data center business and the growth of data center business is going to continue to be robust.

We actually have a very good investment profile for reference designs for those customers, that are actually now being moved into production, and the other thing we have coming along is 5G.

So I think what's different about the last couple years is there are actually structural reasons as to why we would expect this to now turn to a little bit more growth.

So it's still going to be up and down maybe over the next couple quarters and on a quarterly basis, but, structurally, you have higher growth -- you'll have a higher revenue level associated with this business on the back of 5G and data center growth.

Maybe just one follow-up for Chris.

You outlined at the analyst day the $975 million of non-GAAP operating profit dollars for fiscal '19.

This would imply, I think, a high single-digit contribution margin in the back half of the fiscal year.

I know that you're going to, hopefully, get some help with Nike on a year-over-year basis, but it's still pretty strong ex that, so just if you could help me unpack some of the assumptions and moving parts behind that.

Thank you.

Certainly, Adam.

One large lever, again, will be the sustainable discipline and productivity around SG&A, which we have the ability to clearly manage that in a controlled fashion, while simultaneously seeing incremental revenue growth each period, so that's going to be a contributor.

Additionally, you have an improving operating performance out of Nike.

You have the company, across multiple segments, customers and programs, being able to digest the ramps and move into meaningful manufacturing sustained volumes, which will enable greater absorption at site level.

So you'll have a combination of those levers that play back into having a greater contribution in the back half of this year.

Your next question comes from Jim Suva with Citi.

I have one question probably for Mike and then one for Chris, and I'll ask them at the same time so you can pick and choose the order.

Mike, you had mentioned a lot of ramping costs and challenges to margins when you ramp up new programs.

The question is, is this just now the status quo for Flex?

Because you should always be having new business coming in as old business goes out.

And if the answer is no, I guess the question is when all of a sudden do we have a big uptick in margins?

And then probably for Chris, I don't think you bought back stock this quarter.

I assume that's because of the accounting investigation that was going on, that's now been completed.

Can you update us on your thoughts about putting cash to use?

Because I believe you also had negative cash flow this quarter.

Thank you, gentlemen.

So, Jim, let me start.

So ramp costs are a fundamental part of the business, and that's actually, literally, never going to change.

So you just can't ship anything unless you bring on the equipment, you buy the inventory, and you hire and train the people, and it's only then that you can actually have revenue.

So that's never going to change.

If you have very, very low growth rates, it's going to kind of get washed out and you won't really see it.

If you're going to have the growth rates that we're looking at, which is literally -- last year, we saw about a $2 billion growth rate, and we're seeing another $2 billion this year, so you put the 2 years together, you've got a $4 billion level of growth.

These are significant programs that are ramping, that are large in scale.

I think I mentioned on one of the other calls that we expect to add about 40,000 people this year.

We're not going to be able to do that without feeling it in the margins.

And the answer is, yes, after you ramp these programs, you're going to see margins increase, just as a result of the start-up costs dissipating, so we're going to see that actually happen with Flex as we move towards the back half of this year.

We're going to see a lot of those start-up costs go away, and we're going to see the benefits associated with those start-up costs just starting to dissipate.

Simultaneously, we'll see the incremental volumes.

Simultaneously, we'll see the lower SG&A and the cost efficiency around how we're running a very, very disciplined operating expense level, and all that's going to create a margin expansion in the back half of this year.

So that's actually what we're expecting, and we're continuing to see that play out.

So all these ramp costs that were seen at the first part of this year, even though our margins are going out to -- I think the center of the range is about 3.1 or so, which is higher than last year and, obviously, better than this last quarter, but we'll see those improvements happen over -- even then, we're going to see more and more improvements of margin as we go across the next few quarters.

And then, Jim, your question on capital allocation, I would start with the underlying premise for Flex is that we're going to be creating shareholder value with a long-term commitment.

In my prepared remarks, I had highlighted the cash flow pressure at the front end of this year.

I had made a statement that we had anticipated as we move through the second half of this year, our capital intensity will abate both in terms of the capital expenditures as well as the level of net working capital investment that it's carrying for us.

But I also went on to say that, similar to our fourth quarter in 2018, our last quarter in June here, we were blocked out from our repurchase program, and our shareholder return commitment of 50% or more of our annual free cash flow remains, and we intend to resume that this quarter and for the year.

Your next question comes from Paul Coster with JP Morgan.

I'm wondering, Mike, why you started talking about the sort of new tariff regime and your ability to support your customers in the event that they need to sort of rethink the sort of allocation of resources by geography.

Is this something that they're talking about?

And are you already investing in preparation for such developments?

Well, one of the things is India already put a pretty big tariff on incoming PCA's and had already created quite a stimulus and demand for us, as we have a relationship with a lot of those customers that were affected, so that's something that's already in place and happening.

The second thing is are tariffs going to change in the rest of the regions?

The answer is, yes, we're preparing for it.

As we look across the world, we actually expect a redistribution of work to occur.

Whether or not the tariffs happen or whether they don't happen, it's going to create some pause with our customers to rethink their strategy and maybe diversify a little bit about if there's too much manufacturing in China, that they'll distribute it around the world.

So we're preparing for it, because we think it's an inevitable outcome.

We think it's the right strategy for customers to actually move their work around and become a little bit more regional, and so we're preparing our operations to be a recipient of that.

We actually are already seeing a lot of quotes coming in to say -- to basically say if I reduce my exposure in China, how much will it cost, and should I go to Malaysia, should I go to Mexico or Eastern Europe, or where should I see?

We're already seeing those quotes come in.

It's going to take time to move supply bases around, but it's a very -- in our view, it's inevitable that these supply chains are going to become redistributed.

And then a quick question on -- I hate to sort of complain about the possibility that ramping will end, so damned if you do, damned if you don't, but does it actually mean the sort of pipeline of sales are ramping up now and now you've got fewer projects in the background ready to ramp in the next fiscal year?

That's actually a good question.

I mean, I think you have to really dissect it a little bit.

I think you're going to have -- we already talked about India.

I think that ramp and those start-up costs and that sort of thing are going to be done this year, so that is something that's already played out.

The people that want to redistribute the work have already done a lot of activities to go make that happen, and a lot of that work is moot.

So step 2 is you've got, hey, will people just rebalance their system on a regional basis just as an ordinary course of distributing risk and not having so much risk in China?

So that's something that can play out over the next year or so, and it can actually create some incremental demand for us.

So I think there is -- and the other thing is HRS, a lot of the work that we're doing for FY20 and FY21 ramps are actually -- the work is being done this year, so this is a place where we're not even seeing any revenue, because the product lifecycles are longer and the ramp cycles and the qualifications are much longer, so a lot of those ramp costs are playing out this year, which kind of go away the next 2 years.

So I think it's possible we may have more growth.

I think it's great we have another $2 billion of growth, but I think it's probably more likely that we're kind of going through our burst this year, and I think it'll stabilize a little bit as we get into FY20 and FY21, which the downside is maybe there won't be $2 billion of growth, but, alternatively, that will immediately turn into much higher levels of free cash flow.

So it is a little bit of a damned if you do and damned if you don't, but I actually think most of the burst is happening this year.

It started 2 quarters -- the last 2 quarters of FY18, and I think as we get into FY20, we'll have paid a lot of those ramp-up costs, and I think we'll be more of a recipient of higher free cash flows, higher margins and a more stable book of business.

Your next question comes from Ruplu Bhattacharya with Bank of America.

Thanks for taking my questions.

The first one on IEI.

I was wondering if you could give us some more guidance on the expected margin trajectory this year.

Which end markets are you seeing improving in the next couple of quarters?

And exiting the year, should we still think about operating margin more near the low end of the range, or can you get to the 5% midpoint?

This is Chris.

So how I would characterize the IEI is that it's very well-positioned in the wrap of a digitizing industrial market.

We're coming off of several years of very large bookings.

We've seen those bookings manifest themselves throughout this year.

We have new programs that we'll be ramping the latter part of this year.

We have some transitory issues that we're going through in Q1.

We've highlighted how we have growth and return back into the margin range in Q2.

If you look back over the last 4 years, 5 years, you've seen a sequential improvement each year in terms of operating profit, so that trajectory continues.

We go from 3% to 3.4% '15 to '16, then to 3.6%, then we closed out this past year at 3.9%, and we'll be in that range, the low end of our range, this coming year.

We will not be at the 5%, but we will continue to be making structural moves higher inside of IEI's range as we progress forward.

And then just a second question, on CTG.

In general, are the 2 programs, Nike and Bose -- are they tracking as you had expected, or are they tracking slower or faster?

And is Bose now at the target margins that you were trying to get to?

So I would say Bose is tracking reasonably on schedule.

I think there is a lot of ramp issues that we're dealing with right now.

They've got a slew of new products that are coming out that we are actively working to chase quite a bit of upside on.

So Bose is a little bit more of a -- it's extraordinarily season, so I would say we have to -- we have to chase a lot of parts to make Bose really happen.

As far as Nike, I think kind of reset an expect that's going to be a little bit slower and take a little bit longer.

I think it is going to be slower and take longer if I think about the 10-year vision of where Nike is going.

Alternatively, it's tracking exactly to where we thought probably 3 months ago, so we're going to have significant revenue growth this year, and we're continuing to expand productivity.

We expect margins to move to profitability in the second half of the year.

So I would say we're like right on schedule to where we thought we would be 3 months ago.

There are no further questions at this time.

I will now turn the call back over to the presenters.

Thank you very much, operator.

I think Mike just wants to finish up with a concluding statement.

I'd like to first thank everybody for being on the call and the interest in Flex.

We are finding a number of different ways to partner with our customers and enable our innovation by leveraging our deep cross-industry expertise.

So we are very focused, our company, on execution.

We're focused on delivering the opportunities ahead of us and driving sequential and year-over-year improvements.

But thanks, everybody, for their interest in attending.

Thank you.

This concludes the call.

This concludes today's conference call.

You may now disconnect.