Flex Ltd (FLEX) 2020 Q1 法說會逐字稿

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  • Operator

  • Good afternoon, and welcome to the Flex First Quarter Fiscal Year 2020 Earnings Conference Call.

  • Today's call is being recorded.

  • (Operator Instructions) 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.

  • Sir, you may begin.

  • Kevin Kessel - VP of IR & Corporate Communications

  • Thank you, and thank you for joining Flex's First Quarter Fiscal 2020 Conference Call.

  • Slides for today's discussion are available on the Investor Relations section of our website.

  • Joining me on today's call with some introductory remarks will be our Chief Executive Officer, Revathi Advaithi, and our Chief Financial Officer, Chris Collier.

  • Today's call is being webcast and recorded and contains forward-looking statements, which are based on current expectations and assumptions 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 slides.

  • 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 CEO, Revathi.

  • Revathi Advaithi - CEO & Director

  • Thanks, Kevin.

  • Good afternoon, and thank you for joining us on the call today.

  • I'm pleased to have the opportunity to update you on our progress.

  • While the main purpose of the call is to review our financial results, I also want to provide you with some context about how we are managing our business.

  • We have made a lot of progress in the past few months, making critical decisions in managing our portfolio.

  • As a result of this today, we are sharing restructuring actions that'll accelerate our decision to reduce exposure to higher volatility, lower margin products within our business.

  • Our strategy is simple and continues to win more design-led business, which will improve our mix towards higher margin and less volatile business segments.

  • I want to take this opportunity to thank our customers for their trust and our employees for their commitment to delivering results.

  • We have great employees and attractive assets, and that gives me confidence in the path we are taking.

  • I will talk in more detail regarding our progress in the quarter and our go-forward plans, but first let's review our first quarter financial results.

  • Let us turn to Slide 3. I'm pleased with our financial performance this quarter as revenue, operating income and EPS were all within their respective guidance ranges.

  • We had solid results, delivering $0.27 in adjusted EPS, adjusted operating margin of 3.4% and free cash flow of $114 million.

  • Year-over-year revenue growth in both IEI and Health Solutions were led by the successful ramp up of new programs secured to the prior year bookings.

  • We saw slower than expected revenue in CEC and Automotive.

  • CEC was impacted by softness in a few telecom and networking customers, as well as the geopolitical issues in China.

  • CTG was within the expected range as we continue to manage the mix in this segment.

  • 3 out of 4 business groups achieved operating margins within their targeted range.

  • We're also pleased with our free cash flow performance in Q1, and this represented a big swing from prior year.

  • We attribute this change primarily to more disciplined execution, and Chris will provide more details in the financial results.

  • Let's go to Slide 4.

  • I want to talk about our approach to managing the business moving forward.

  • During this quarter, along with visits to many of our customers, as well as major sites, I have done deep dives on our business groups, our sites and our technology centers.

  • The feedback has confirmed the initial assessment that we have a tremendous opportunity to leverage our global capability, and we have to be focused on how we manage the business to deliver consistent results.

  • Like I said in the last quarter, we're concentrating on 4 key areas: managing the portfolio; driving disciplined execution; pursuing design-led manufacturing or Sketch-to-Scale opportunities; and emphasizing free cash flow generation and prudent capital allocation.

  • This will enable us to accelerate our business strategy and improve our financial returns for the long term.

  • Now going to Slide 5. In the 4 areas of focus we have chosen, we have made much progress in a short time.

  • A key priority is managing our portfolio mix, which will enable us to improve overall profitability, as well as the consistency of our execution.

  • During Q1, there was well-publicized action by the U.S. government and significant geopolitical uncertainty that impacted our customer, Huawei.

  • These actions, which were beyond our control, led to a reduction in demand for products we assemble for them in China, and as a result of this, we're scaling down our Huawei-dedicated operations in China.

  • Flex and Huawei have had a longstanding and successful partnership.

  • We have worked with them to find an agreeable solution.

  • This change is unfortunate; however, China is and will remain a very important center of production and market for Flex.

  • We have a significant presence, including tens of thousands of employees in China.

  • We remain fully committed to our valued customers and employees in China.

  • In addition to this action, we have also decided to reduce our exposure to high volatility, short cycle, low-margin businesses in other places like India.

  • These decisions when combined will impact roughly $300 million to $400 million of quarterly revenue and align with our overall strategy to focus on more sustainable and less volatile product categories.

  • It'll also improve our gross margin and operating margin, enabling us to be a more focused and profitable company.

  • These actions are reflected in our forward-looking guidance.

  • I want to reiterate that these actions do not impact the scale and diversity of our footprint.

  • Our global footprint, including our significant presence in China, India and the rest of the world, is a key differentiator for Flex and enables us to deliver value to our diverse customer.

  • While these are big portfolio changes, changing the mix is also important within the segments.

  • We have a very focused effort to improve the performance of our CTG business by reducing high-volatility, low-margin businesses, as well as underperforming and inconsistent businesses.

  • For the quarter, we achieved 2% operating margin in CATEGORY, and we'll continue to assess this portfolio to prune businesses that do not meet our criteria.

  • Next, let me address my favorite topic, which is focused on discipline and sustainable execution, and this involves the entire enterprise.

  • We are reviewing key processes and programs which include contracts, incentives and cost management.

  • Progress is being made in areas such as variance management and program ramp efficiency.

  • For example, in HRS alone, we are currently managing over 200 programs with multi-billion dollar annual future revenue.

  • A recent example is a program in our Health Solutions business where we moved 3 families of medical devices from a customer factory to one of our Mexico facilities.

  • The team achieved the 20-plus milestone on schedule and produced 4x the expected volume in the committed time frame.

  • This type of program launch improves our expected gross margin materially.

  • As you're aware, getting these program ramps right is critical for us not only from the customer credibility perspective, but also to make sure that we don't have financial variances across our factories.

  • We're also driving governance discipline across the organization.

  • For example, one of the major things we have done is to change and align our incentives to drive behavior in our focus areas.

  • Now on the design-led effort side, we know that this is the best way to build customer affinity and deliver greater value to our customers, and in return, this improves our financial performance.

  • Now when I think of design-led manufacturing or Sketch-to-Scale, I think of the strategic customer partnership where we co-create a product that leverages Flex's portfolio of capabilities from design, supply chain, complex manufacturing to aftermarket services.

  • One example from this quarter that I'm particularly excited about, given my background, is a power supply with an integrated battery solution.

  • Now, our global team worked with a customer to define the specifications, design a solution and bring the product to market in high volume.

  • This solution is just one example demonstrating how we are leveraging our expertise to provide value and achieve significant returns.

  • Our goal is to identify more design and engineering-led engagements as these opportunities can capture accretive operating margins, nearly double that of traditional EMS business.

  • By achieving the right portfolio mix, creating a track record of disciplined execution and driving higher margin design-led engagements, we will deliver higher levels of financial performance, including greater and more sustainable free cash flow.

  • We have improved our process and discipline for CapEx management across our enterprise, aligning to our portfolio objectives and improving our returns.

  • For example, this past quarter our CapEx investment was $123 million, which was the lowest level in 7 quarters.

  • This disciplined investment is critical for improving long-term free cash flow generation.

  • So as you can see, we have made a lot of progress in a short amount of time in these 4 areas, and our results are showing this effort.

  • Now turning to Slide 6. I wanted to share with you our framework on how we manage the portfolio going forward.

  • And we will ensure that we're making decisions that align with our strategy.

  • We now evaluate the portfolio through disciplined criteria that cover a wide range of parameters.

  • An example of our criteria is the industry opportunity.

  • For example, we'll not consider an opportunity in another industry that is too far afield from our core business capabilities where we do not have expertise.

  • We'll ensure the business that win or keep in our portfolio meets the financial thresholds for margin, free cash flow and return on invested capital.

  • Every business is managing itself to our criteria to evaluate new opportunities and ensure they're executing with discipline.

  • Turning to Slide 7, I want to share my perspective on capital allocation and a framework for managing it.

  • Our goal is to make capital decisions wisely, which provide future growth by reinvesting organically in our businesses, repurchasing stock to offset share dilution, and continuing to take opportunities to return cash through share repurchase, in line with our prior commitments.

  • At the end of the day, our goal is to maintain a healthy investment-grade rated balance sheet.

  • Overall, I'm really proud with the results.

  • We will continue to make progress across our 4 areas of focus: managing the portfolio, achieving disciplined execution, pursing design-led manufacturing; and emphasizing free cash flow generation and capital allocation.

  • I believe we are building momentum, and the changes we are making will result in a long-term value creation for our shareholders.

  • I'll now turn the call over to Chris who will go through the numbers in more detail, and I'll then come back with some concluding commentary before Q&A.

  • Chris?

  • Christopher E. Collier - CFO

  • Thank you, Revathi.

  • Please turn to Slide 9 for our Q1 income statement summary.

  • Our first quarter revenue was $6.2 billion, down 3% versus a year ago and within our guidance range.

  • Our Q1 adjusted operating income was $208 million, which was within our guidance range and up 11% year over year.

  • Our adjusted net income was $138 million, resulting in adjusted earnings per share of $0.27, which was at the midpoint of our guidance range of $0.25 to $0.29.

  • First quarter GAAP net income of $45 million was lower than our adjusted net income, primarily due to $15 million of stock-based compensation, $15 million in net intangible amortization and $56 million in restructuring and asset impairment charges as we undertook actions to reduce our exposure to high volatility, short cycle products and restructured targeted operations.

  • Now please turn to Slide 10 for quarterly financial highlights.

  • Our adjusted gross profit of $404 million was down slightly year over year, while our adjusted gross margin remained stable at 6.5%.

  • Our first quarter adjusted SG&A expense decline 13% year over year to $196 million.

  • This performance reinforces our intention to continue to operate with a strong cost discipline as we focus on driving productivity improvements and balancing investments into design and engineering capability with the objective of delivering sustainable operating earnings leverage.

  • Our improved cost discipline and business mix are translating into greater profitability.

  • Our quarterly adjusted operating income came in at $208 million, which is up 11% from the prior year.

  • Our year-over-year operating margin expanded 50 basis points to 3.4%.

  • Please turn to Slide 11 for our first quarter business group performance.

  • I'll begin with our highest margin business, High Reliability Solutions, or HRS, which is comprised of Automotive and Health Solutions.

  • HRS revenue was $1.2 billion, down 3% year over year and just below our guided range of flat to up low-single digits.

  • HRS's adjusted operating margin was 7.4%.

  • First quarter revenue in our Automotive business declined 8% from the prior year as it continues to be impacted by market softness, most notably in China, which has directly affected our largest automotive customers.

  • This quarter, we continued to ramp multiple new programs across a diverse set of products such as connectivity, DC/DC converters and smart gateway modules.

  • However, they were not enough to offset the macro weakness.

  • Looking forward, we remain confident with our market positioning as evidenced by securing strong bookings across a broad set of automotive customers and products this past quarter.

  • Health Solutions had a good quarter, growing revenue 4% year over year, marking its eighth consecutive quarter of year-over-year growth.

  • Its growth has been driven by a broad set of new customers and programs in drug delivery, diagnostics and medical devices, which have all benefitted from our prior year investments in design, engineering and automation.

  • It is also worth noting that Frost & Sullivan just named Flex Health Solutions as its 2019 Global Company of the Year.

  • This regarded external award and endorsement serves as another proof point of the value and capabilities that our Flex Health Solutions team brings to its customers in the marketplace.

  • Next, revenue from our Industrial and Emerging Industries, or IEI business, was exceptionally strong at just over $1.6 billion, reflecting an increase of 13% year over year and exceeding our expectations.

  • Driving the strong Q1 sales was the continued ramping of new customers and programs across the portfolio, most notably inside of home and lifestyle, as well as energy, which more than offset the continued softness in semicap equipment.

  • IEI continues to capture strong bookings from some of the world's largest diversified industrial companies, which positions us well for long-term growth.

  • The strong quarterly revenue enabled IEI to grow its adjusted operating profit to $95 million.

  • Its adjusted operating margin was very strong at 5.8%, up substantially from 3.6% in Q1 of the prior year.

  • IEI's profitability continues to benefit from solid operational execution on the new businesses that it is ramping and from greater levels of design and engineering-led engagements.

  • Revenue from Communications & Enterprise Compute, or CEC, was $1.9 billion, declining 5% year over year.

  • This performance fell short of its flat to up mid-single digits guidance.

  • CEC's adjusted operating margin was also below our expectations, coming in at 1.4%, down almost 100 basis points from the prior year.

  • Our Q1 revenue decline in CEC was impacted by reduced demand for certain customers due primarily to 2 factors: one, the significant geopolitical uncertainty that impacted certain customers in China that Revathi highlighted earlier; and two, accelerated telecom and networking declines late in our quarter due to reduced forecasted shipment pulls.

  • The reduction in customer demand as a result of the geopolitical challenges negatively impacted our operating income by creating elevated levels of unabsorbed manufacturing overhead and stranded costs.

  • In our Consumer Technologies Group, or CTG business, revenue was $1.5 billion, down 16% year over year and within our expectation for the group to be down 15% to 25%.

  • CTG's adjusted operating margin was 2.0%.

  • Our Q1 performance reflected our continued repositioning of the CTG portfolio as we continue to rationalize and prune underperforming accounts to improve the mix of this business.

  • As we have highlighted, we are committed to being more selective and focusing on more sustainable and less volatile customers and products in order to drive the right margin and return.

  • This quarter, 3 of our 4 business groups achieved operating margins within their targeted ranges, and we remain committed to achieving our targeted ranges for all business groups.

  • Turning to Slide 12, let us review cash flow generation highlights.

  • As we highlighted last quarter, we expected a return to consistent, positive adjusted operating cash flow and free cash flow generation in fiscal 2020.

  • Our first quarter performance displayed solid cash flow execution.

  • This quarter, we generated $237 million in adjusted cash flow from operations and $114 million in free cash flow.

  • This resulted in a Q1 free cash flow conversion of 83%, which is approaching historical levels.

  • Our capital expenditures totaled $123 million for the quarter, its lowest level in 7 quarters, but still modestly higher than depreciation.

  • We continued to invest in the CapEx necessary to support the underlying higher margin, long-term programs in our IEI and HRS businesses.

  • As we look forward into future quarters of fiscal 2020, we expect that our CapEx will continue to closely align with our annual depreciation level, thereby benefitting free cash flow.

  • We remain firmly committed to our goal of consistently generating positive adjusted operating cash flow and free cash flow as we move forward.

  • Lastly, we remain focused on delivering shareholder return during the quarter as we repurchased roughly 5 million shares for $52 million.

  • Please turn to Slide 13 for our second quarter guidance.

  • Revenue is expected to be in the range of $6.1 billion to $6.5 billion based on the following business group year-over-year revenue expectations.

  • HRS revenue is expected to be down low-single digits to up low-single digits as we anticipate the auto demand environment to remain muted and reflect the impact of normal seasonal summer shutdowns.

  • We continue to see stable demand growth in our Health Solutions business.

  • We expect ongoing strength in IEI with it growing mid- to high-single digits, benefitting from new programs ramping in home and lifestyle and energy, which is more than offsetting continued expected weakness in semiconductor capital equipment.

  • CEC's revenue is expected to be down 5% to 10%, reflecting continued softness in end market demand in our telecom and networking offerings, coupled with distinct reductions in customer demand in China.

  • And for CTG, we expect revenue to be down 15% to 25%, reflecting continued pruning of our consumer portfolio and targeted reductions to high-volatile products in China and India.

  • Our adjusted operating income is expected to be in the range of $220 million to $250 million.

  • Interest and other expense is estimated to be $50 million to $55 million.

  • We expect our tax rate in the quarter to remain in the mid-range of 10% to 15%.

  • Adjusted EPS guidance is for a range of $0.29 to $0.33 per share based on weighted average shares outstanding of 518 million.

  • Our adjusted EPS guidance excludes the impact of stock-based compensation expense, intangible amortization and the impacts from restructuring and other charges.

  • As Revathi explained, we are accelerating our strategic decision to reduce exposure to high-volatile products and align our operating costs.

  • In connection with these actions, we may be incurring restructuring and other charges in a range of $145 million to $265 million.

  • The timing and impact of such items are dependent on future events that are uncertain.

  • However, we expect to complete all the associated actions in fiscal 2020 with the bulk to happen in our second quarter.

  • As a result, we expect a GAAP loss per share in the range from $0.05 to $0.25.

  • With that, let me turn it back over to Revathi for some closing comments before we open the call up to Q&A.

  • Revathi Advaithi - CEO & Director

  • Thank you, Chris.

  • We remain comfortable with the prior fiscal 2020 consensus adjusted EPS range that span from $1.20 to $1.30 as we communicated in April.

  • Our teams are focused on meeting our commitments.

  • We have taken thoughtful but swift action on our portfolio that'll make us more focused and will put us on a path to improving operating margins.

  • We're committed to vastly improving our free cash flow conversion.

  • As I have said, our stated goal is to drive sustainable, disciplined execution that delivers a consistent track record you can have confidence in.

  • I'd now like to have the operator open the line for questions.

  • Operator

  • (Operator Instructions) Your first question comes from Matt Sheerin with Stifel.

  • Matthew John Sheerin - MD & Senior Equity Research Analyst

  • Just the first question relative to the deselecting and walking away from the high-velocity, low-margin business, that $1 billion or so annual revenue run rate.

  • As you get through this quarter, will that be it?

  • Or as you go through the next few quarters, will you still be looking at various segments and will we see more of that?

  • Or is the plan to sort of get the portfolio in the shape that you want by the next quarter or so and then move on from there?

  • Revathi Advaithi - CEO & Director

  • You know what I'd say is we have taken some big actions this quarter, addressing parts of our portfolio that we think are obvious and need to be corrected moving forward.

  • With that I'd say that we're making decisions for long term.

  • So we may continue to prune a few things in CTG and CEC as we have talked about before, but that pruning will continue and that should be part of running our business in a disciplined fashion.

  • So I'd say we're positioned well for long-term growth at this point.

  • We are more focused and we are focused around the right areas that we want to grow in.

  • And I see us leveraging this opportunity and building our business from here.

  • Matthew John Sheerin - MD & Senior Equity Research Analyst

  • Okay, great.

  • And then within the CEC business and the margins below target, Chris, you talked about getting all divisions into their targeted ranges.

  • For CEG, given -- CEC, sorry -- given the headwinds that you're still seeing on the demand front, are we talking a couple quarters or so before you get there?

  • Is there any time frame you could put on that?

  • Christopher E. Collier - CFO

  • What I would highlight is if you were to exclude the impact in this past quarter of the unabsorbed manufacturing and the stranded costs, CEC at its core would have been inside the target range.

  • But as we think about as we move forward here, we'd anticipate that these activities will be largely behind us as we get through this next quarter.

  • And we're very confident and comfortable with the book of business we're operating within CEC that it does return into that target margin range.

  • Revathi Advaithi - CEO & Director

  • And Matt, the only thing I'll add is you can see with 3 of our businesses being in the operating margin ranges that we have talked about, we're really pushing hard to make our business more focused and more profitable.

  • So, our focus on CEC will be the same thing as to work through these customer restructuring actions that we are taking, and we have absorbed some big impacts for it in Q1.

  • And we expect that we'll start pushing into the target margin ranges as we get through the rest of the year.

  • Operator

  • Your next question is from Steven Fox with Cross Research.

  • Steven Bryant Fox - MD

  • Two questions, please.

  • First of all, when I look at the year-over-year sales decline, you still were able to increase your profits.

  • So, I was wondering if you could talk about maybe what the incremental margins of the business look like, whether those have improved or there's some other things that you'll call out in terms of how you were able to achieve such good operating leverage.

  • And then secondly, I was wondering if you could provide some color on exactly what the charges you're looking at are for and how much will be in cash.

  • Revathi Advaithi - CEO & Director

  • Okay, let me start with the first one.

  • And I'd say definitely the mix of the business helped with the overall margins.

  • You can see that with IEI having such strong growth and HRS continuing to be strong for the overall portfolio, mix definitely helped.

  • And the second is we really have good discipline across the business, which for a business like ours is important that as you have revenue volatility, you have to have cost discipline that goes with it.

  • So this all goes to this theme that I've been talking to you about last quarter and this quarter is that we have to be disciplined in all aspects of the business, and you are seeing that played through in us keeping our EPS commitment, even with revenue changes.

  • So I think that's really, really important that you are seeing in terms of overall mix and then cost discipline helping us deliver our Q1 commitments.

  • And then on the restructuring, I'll have Chris give you some color on it.

  • Christopher E. Collier - CFO

  • Certainly.

  • So we're very thoughtful and very disciplined with these decisions here.

  • Near-term actions are underway.

  • As you saw, we had some of those charges inside of our Q1.

  • And as I said in the prepared remarks, a bulk of these charges will be captured in our activities and execution inside of Q2.

  • What we're doing is we're addressing the operating cost structures, and we're going to be working through managing the normal restructuring activities that'll be including people costs, some impairment charges associated with assets.

  • And if you think about the cash aspect for that, I would say it's a little less than half of the range that we have set up both in the low and at the high.

  • So those actions are underway.

  • We'd anticipate being able to execute during this quarter.

  • We've unfortunately done this before and we're focused here, and we're going to be very thoughtful and disciplined with these decisions and actions as we move forward.

  • Steven Bryant Fox - MD

  • And just one quick follow up on all of that.

  • How do you avoid keeping all of the sort of product pruning in a vacuum?

  • In other words, I would imagine you're exiting certain programs where you're trying to stick with some more attractive programs at the same customer.

  • How is that going to play out within the customer base or competitively or is there any concerns we should think of there?

  • Revathi Advaithi - CEO & Director

  • No, I'd said, Steven, the way I think about it is at the end of the day, every customer relationship that we have has to be a win-win for both the customer and for us.

  • I think customers understand that, and our commercial teams are doing a great job of making sure that that story is clear within our organization and to our customers.

  • I think long-term customer partnerships are built on that basis.

  • I don't have any concerns about that looking forward.

  • I think this is just the way good business is run, and we just have to do a better job of making sure we understand where our manufacturing and technology capabilities help us win, and that'll be best for the customers also, and just focus on those areas.

  • I think all our examples in Q1 are really good examples to show that we're well on our way in that direction.

  • Operator

  • Your next question is from Mark Delaney with Goldman Sachs.

  • Mark Trevor Delaney - Equity Analyst

  • First question was on margins.

  • And if my math's right, I believe implied EBIT margin guidance for next quarter is about 3.7% or just over 3.7%, which would be I think one of the best margin percentages the company's put up in some time, despite some of these macro challenges you talked about.

  • So could you maybe just help bridge us from the roughly 3.4% you did this quarter to 3.7%.

  • What are some of the factors in particular helping the margin expansion for next quarter?

  • Christopher E. Collier - CFO

  • Certainly, Mark.

  • Thanks for the question.

  • Yes, if you do interpret the guidance ranges that we set, you will see solid margin expansion on a year-over-year basis, both in terms of gross margin, ultimately into operating margin.

  • And I think that you quantified it correctly.

  • The midpoint would be right around that 3.7%, which is a very strong performance for us.

  • And that's largely on the efforts of the improving mix of business, some of the strength that you're seeing across the IEI portfolio and the contributions inside of HRS, as well as the consistent, sustained cost discipline around our SG&A that provides leverage.

  • So the mix improvements, engaging more design and engineering-led programs that are now reflective inside of our revenue streams, a favorable mix shift in the discipline around our SG&A all contribute to that favorable performance.

  • Revathi Advaithi - CEO & Director

  • And Mark, that's been the thesis of our story.

  • If we do a good job managing our mix, we minimize the variances in our factories.

  • Because we are disciplined, we manage cost.

  • And all that should result in margin movement for this business, and in my view provide long-term customer affinity and growth, and our Q2 guidance should show us heading in that direction.

  • Mark Trevor Delaney - Equity Analyst

  • My follow-up question is on margins, but over the longer term.

  • And I think it was on Slide 6 that there's a comment, and Revathi, you spoke somewhat about this in your prepared remarks.

  • But you talked about operating margins mid-single digits or higher.

  • Can you elaborate a little bit more on what you mean by that?

  • Is that for the company overall or is that on a segment-by-segment basis, and the timing to achieve that mid-single digits or higher EBIT margins that are referred to on Slide 6.

  • Revathi Advaithi - CEO & Director

  • I think that is -- every good business, Mark, as you know, has to set good guidelines and criteria for our commercial teams and our operational teams on kind of deciding what types of business to win.

  • So this is not an aggregate or average.

  • But our goal is for us to be focused on winning commercial programs and incentivizing our teams to look for mid-single digit operating margins as being good business.

  • And that eventually is going to lead to a mix shift and a margin improvement for this business.

  • So, this is not across the board.

  • Obviously all this will vary between segments, within customers, and there'll be a lot of nuances within that.

  • But this is -- and we have this type of guidance and criteria across every segment, across every type of business, and there is a span of ranges that make this up.

  • Operator

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

  • Ruplu Bhattacharya - VP

  • Congrats on the strong margin performance despite the weak macro.

  • My first question is on IEI.

  • You're already at the high end of the guidance range.

  • Within this portfolio even there are different end markets.

  • Do you think that there are certain end markets where Flex has a higher competitive advantage where you want to stress more?

  • Can you give us your thoughts on semicap and how should we think about margin progression in this business going forward?

  • Revathi Advaithi - CEO & Director

  • Ruplu, thanks, and thanks for the comments on margin.

  • Obviously the works of our team is showing here.

  • I would say on IEI, yes, there are different subsegments that make up this business: energy, semicap, home and lifestyle.

  • So, many subsegments within this base core industrial business.

  • Overall, our view is that actually most parts of this business are fairly strong, both from a growth perspective and an operating margin and income improvement perspective.

  • At this point what we have baked into our thinking is that capital equipment continues to be a challenge, and we don't see a visibility yet or a sight of recovery on that.

  • So our forward-looking view on it really builds that into it.

  • So growth is obviously coming from all the other subsegments.

  • In terms of operating margin ranges, obviously too early to call anything on that right now.

  • But our goal for the teams, if they continue to move the mix, they continue to have good design-led wins, we should see that move higher and higher in the direction that we have set for them.

  • So we think that it's heading in the right direction, and at some point it'll be the right time to look at the margin ranges, but at this point we're comfortable with where we are.

  • Ruplu Bhattacharya - VP

  • Okay.

  • That's helpful.

  • Just my second question on CEC.

  • Maybe can you just give us an overall color of what you saw in the various end markets, routing, switching, optical?

  • And is it just that one customer where you're trying to disengage from that is driving the margin performance, and should we see an uptick going in the next couple of quarters?

  • Revathi Advaithi - CEO & Director

  • Yes, let me start with it and Chris can jump in.

  • We definitely saw the customers that we specifically mentioned and called out in our prepared remarks.

  • And other than that, we saw declines in our telecom and networking businesses that we said, and particularly saw it in a few large customers and customer pulls that didn't happen at the end of the quarter.

  • So that's where overall we saw our pluses and minuses, and it came across a varied set of customers.

  • So I think that's the overall view on CEC.

  • Chris, anymore color to add to that?

  • Christopher E. Collier - CFO

  • No, just like we highlighted in the prepared remarks and on an earlier question, in this past quarter, we had to absorb significant manufacturing, unabsorbed manufacturing costs and stranded costs.

  • And if you exclude that impact, we would have been at the low end of the range.

  • In addition, I would just say the lost contribution from lower total revenues pressures margins and profits.

  • So that's kind of the reflection on CEC's margin profile.

  • Operator

  • Your next question is from Steve Milunovich with Wolfe Research.

  • Steven Mark Milunovich - MD of Equity Research

  • Two questions.

  • Number one, what are your intentions in your cloud business?

  • Jabil I believe has about $1 billion of cloud revenue growing double digits, claiming that they're taking share from the ODMs, selling to the hyperscalers and other cloud folks.

  • Can you talk at all about your revenue and margin contribution and is that an emphasis for you?

  • And then the second question is have you made any -- or what management changes, if any, have you made since you've been there?

  • Revathi Advaithi - CEO & Director

  • Yes, let me start with the first part.

  • I would say that we have a very strong cloud business across our portfolio.

  • And our focus on the CEC segment in terms of wins is to be able to not just focus on large customers and win large volume, but really to make sure that we move the mix.

  • But I would say our cloud business is strong.

  • We feel like we are -- have large market share in our cloud business.

  • And there is constant innovation in that business.

  • I talked to you about things like what we're doing around the power supply.

  • Our focus on cloud is not just grow our contract manufacturing side of the business, but really focus on design-led engagements for that business.

  • I'm not going to comment on competitors, but I would say we're very confident in terms of that our cloud market share is strong.

  • And our growth in cloud is coming across a wide range of customers and not just focused on a few big customers.

  • And then in terms of new hires, we've done a really good job of hiring new people.

  • Just talking about cloud, we announced hiring Raejeanne Skillern from Intel with a strong track record in running their cloud business.

  • So we expect Raejeanne will bring a lot of technology background to this and really help in terms of growing this business with the right technology platforms, the right architecture, and we're already seeing the results of this.

  • And then in addition to that, my big focus is always talent, because a good strong business is all about talent and talent management and talent development.

  • So in line with that thinking, we also brought in a new CHRO.

  • So those are the two big changes we have made and several others across the business, but those are the ones that are big ones to share.

  • Operator

  • Your next question is from Paul Coster with JP Morgan.

  • Jeangul Chung - Analyst

  • This is Paul Chung on for Coster.

  • So in the past, Flex has been kind of more about volume, delivering margin in targeted ranges, but the focus on margins is driving nice profits here, despite some revenue headwinds.

  • Do you expect more of the firm to evolve into this more high mix and a lower volume firm over time and kind of in turn raise your overall margin targets?

  • Or should we expect kind of business as usual, as long as it hits your margin ranges for your respective segments?

  • Revathi Advaithi - CEO & Director

  • Paul, I'm definitely not going to help you raise our margin ranges at this point in time.

  • I would say our actions have to speak for itself.

  • But going in line with your question, I'd say this is my fundamentals on how you run any business.

  • I think this doesn't apply just to Flex or to contract manufacturing or this space in general that growth for the sake of growth is never great, right?

  • So growth where it really adds some capability, whether it's in terms of people, product, margins is fundamentally important.

  • So driving that discipline for me is the way any business runs.

  • Not just how Flex should run.

  • It's a history of how all businesses should run.

  • And that's the only way you have sustainable growth and sustainable margin conversion in the long term.

  • So, brining that discipline to Flex to me is a starting point of how this business runs and hopefully how this industry runs, which I think is long overdue.

  • I would say that eventually, if we do this right and we continue to take these types of actions that we are taking, you should see a healthier business that is more sustainable with the right kind of growth and the right kind of incremental margin on that growth, that's what you should see from us going forward.

  • So to me, this is just the fundamentals of how every business should run, and hopefully we're putting ourselves on track to be achieving that.

  • Jeangul Chung - Analyst

  • Great.

  • And then just a follow up on IEI.

  • Is there kind of more design and engineering opportunity that is kind of special to this segment relative to others that's driving that higher margin there?

  • Or do you see other segments where you can apply more of the design and engineering higher margin services to those segments?

  • Revathi Advaithi - CEO & Director

  • Paul, I'd say that IEI has tremendous opportunity because the diverse -- if you look at the portfolio within IEI and how diversified that customer base is, most customers in that customer base want more from their suppliers, and they want more platform help in terms of technology and products.

  • And our team is great at doing that.

  • So, I definitely see the potential to do more of that in IEI, but I also see the potential for collaborating across our businesses in terms of taking that technology and that capability across our business.

  • For example, I talked in my prepared remarks about the integrated battery and the power supply.

  • That's something that applies across all segments.

  • So we should be able to position that kind of capability across all segments.

  • And today, we haven't done as good a job of that, and I see potential for that also moving forward.

  • So if we can do well with increasing our design-led engagements, but also cross collaborate across the segments, I think we build a more stronger portfolio moving forward.

  • Operator

  • Your next question is from Adam Tindle with Raymond James.

  • Adam Tyler Tindle - Research Analyst

  • Revathi, you came out on the March quarter call and talked about being comfortable with the $1.20 to $1.30 Street EPS range for fiscal 2020.

  • I think you're obviously reiterating that view today.

  • There's been a lot of changes to the outside environment.

  • Obviously in the internal restructuring program I think is incremental or wasn't contemplated since then.

  • So the question is EPS is obviously being reiterated or the same, but maybe could you just talk through what has changed in terms of the composition of EPS since the last call?

  • And I have a follow-up.

  • Revathi Advaithi - CEO & Director

  • Yes.

  • I'd say, Adam, if you look at composition of EPS for us, mix definitely plays a role.

  • And so if you're growing in the right segments, that helps significantly and that's an obvious one.

  • Things like stronger growth in IEI does help our overall story, continued growth in Health Solutions.

  • So mix plays a definite role in terms of composition of EPS.

  • And I will say the other thing, I said this in my last quarter call is this idea of being disciplined about how you execute, how you manage variances in the factory, how you manage program ramps, how do you prevent leakage is also important.

  • So the more we can do to take those things out of the equation, that helps in terms of overall improvement of gross margin and then hence operating margin.

  • So, I'd say composition of how things change is basically mix and overall managing our variances much better and having fundamentally good cost management.

  • As you know, we sometimes don't control our revenue.

  • We have a lot of pushes and pulls and things are dynamic in a business like ours.

  • So doing those things well, which is having the right mix, having a good management of variances, having strong cost managements are all fundamentals in how we need to manage this business, and I think that's what you are seeing in our guidance.

  • Adam Tyler Tindle - Research Analyst

  • Okay, that's helpful.

  • Maybe just as a follow up on the restructuring program.

  • Understand it seems to be in obviously lower margin areas that you're moving away from.

  • But just hoping for, number one, more details into that decision.

  • Just to play devil's advocate, I would think scale would be an important characteristic in those areas to still make a good return on capital.

  • You have scale as a competitive advantage, so why exit or move away from them and focus on more lower volume areas where the competitive advantage at scale is arguably less relevant?

  • And secondly, any contemplation on monetizing that versus simply restructuring it?

  • Is there any possibility of divesting or selling or somehow monetizing that?

  • Revathi Advaithi - CEO & Director

  • So Adam, thanks for the question.

  • What I'd say is that first let me start with saying that these decisions are never easy.

  • There are obviously a lot of thought has gone into these decisions that we have taken.

  • Some of these decisions, particularly the one that we talked about in China, is somewhat beyond our control as governments make decisions and our customers make decisions in terms of what they want their supply base to look at.

  • I would say for me if I think about scale, scale is an advantage for sure, but the right type of scale is important.

  • So having scale in high-revenue, but also high-volatile, short cycle business means that you are really moving the business up and down from a revenue perspective quarter over quarter significantly.

  • And then you are working on laser thin margins, there's really not much room to maneuver in terms of managing those businesses.

  • And they're extremely short cycle.

  • Product lifecycle is not too long.

  • So in those cases, scale has a very short cycle advantage, really.

  • It doesn't -- it's not sustainable long term.

  • And I think a lot of history in this business has proven that that is the case.

  • So big ramps, big ups and downs, and that happens constantly and all the time.

  • And I don't think we're well positioned to do that well.

  • And other people may be, that could be the case.

  • But in the case of Flex, we don't think that's something that we should focus on.

  • And I would say this doesn't mean that we're walking away from scale.

  • We have very large customers across other parts of our business which may not be highly volatile and short cycle.

  • So that type of scale is okay and we're perfectly comfortable with that.

  • And kind of that's how we view this segment profile looking forward.

  • Christopher E. Collier - CFO

  • Maybe to just extend a little bit.

  • We looked at many different options.

  • You highlighted could you divest, sell it.

  • We looked at all those options and we assessed those and we took a thoughtful, disciplined approach as to the best way to execute that for our shareholders.

  • And so as we went through that process, we've identified what we think we need to do and are going to be very selective as we move forward in terms of earmarking capacity and capital and really tilting the portfolio towards those higher margin, longer product lifecycle businesses that enable us to operate in a much more stable and predictive fashion.

  • Operator

  • Our last question comes from Jim Suva with Citi.

  • Zhen Yang - Assistant VP

  • This is Tim Yang calling on behalf of Jim Suva.

  • Can you talk about your growth strategy in the near to midterm?

  • I think you have mentioned your focus on execution, margin improvement and the portfolio management, and your performance is showing your progress on the front.

  • But your HRS and IEI have had couple of quarters performing below your 10% growth target, and it sounds like you are reducing CapEx as well.

  • So I wonder if you can provide some color on how should we think about your growth opportunity going forward.

  • Revathi Advaithi - CEO & Director

  • Tim, great question.

  • Let me tell you this.

  • Growth is very important to us.

  • It's never a question that growth is not important to us; it's the right kind of growth.

  • And if you refer to my slide where I talk about the progress to date, I clearly mention about emphasis to grow in the industrial space, capturing new technology trend.

  • I talk about design-led wins across our businesses in CEC, focusing on design-led wins.

  • And then I would just correct you a little bit and say that IEI had a very strong growth quarter.

  • And HRS as an aggregate was okay and was really muted by automotive, but Health Solutions had a very strong growth quarter.

  • So if you peel back the onion, I think there is a very strong focus on growth, and that is not the -- it's not the case at all that we're not looking for growth.

  • I would say that we're looking for the right type of growth where we and the customers can win together and we can provide long-term customer affinity and a long-term relationship that is sustainable, and that's what we're looking for.

  • And I would say examples of IEI and Health Solutions having growth really shows that we're on the right trajectory in terms of managing our overall business from a growth perspective.

  • Zhen Yang - Assistant VP

  • Great.

  • A quick follow-up question on around the mix.

  • With your restructuring in CTG, and maybe CEC a little bit, can you help us understand the size of each segment as a percentage of total revenue in the next 5 years or your target will grow for the revenue mix?

  • Revathi Advaithi - CEO & Director

  • Tim, too early really to say what happens in the next 5 years.

  • I would say that the changes that we're making really impact CEC and CTG today both.

  • Our hope would be that what happens is that HRS and IEI become bigger parts of our portfolio.

  • And our hope would also be that the right subsegments within CTG and CEC continue to grow.

  • Because it's not an overall segment issue.

  • This is fundamentally portions within a segment.

  • And this is not unique to Flex.

  • Every business has that.

  • There is portions of every business where the spread of growth and margin is significant, and we have to move that spread in the right direction in terms of growth and margin.

  • So, I'd say too early to comment about what happens in 5 years, but I think our decisions and actions we have taken and the performance we are delivering in Q1 and committing to in Q2 really shows where we're heading.

  • So hopefully that answers your question, Tim.

  • Operator

  • This concludes the Q&A period.

  • I'll now turn it back over to Flex for any closing remarks.

  • Revathi Advaithi - CEO & Director

  • Thank you everyone for joining us.

  • I just want to close by saying we had a really strong Q1, and we delivered solid adjusted EPS and free cash flow.

  • We are taking thoughtful but swift actions in our portfolio and also driving discipline across all facets of our business.

  • With these actions, we are confident that we're on the right path to deliver consistent and long-term shareholder value.

  • Thanks again for joining us.

  • Operator

  • This concludes today's conference call.

  • You may now disconnect.