Good afternoon, and welcome to the Flex Third Quarter Fiscal Year 2020 Earnings Conference Call. Today's call is being recorded. [Operator Instructions]. At this time, for opening remarks, I would like to turn the call over to Mr. David Rubin, Flex' Vice President of Investor Relations. Sir, you may begin.

Good afternoon. Thank you for joining Flex' Third Quarter of Fiscal 2020 Conference Call. Slides for today's discussion are available on the Investor Relations section of our flex.com 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. This call references non-GAAP financial measures for the current period that can be found in our appendix slides. Otherwise, they are located on the Investor Relations section of our website along with required reconciliations. Now I'd like to turn the call over to our CEO. Revathi?

Thank you, David, and welcome to your first Flex earnings call. Good afternoon, everybody, and thank you for joining us on the call today. I'm excited to provide some context to our strong results for the third quarter and update you on the progress we're making through this very dynamic and transformational period for Flex. But before I start, I want to thank all our Flex employees who across the globe continue to deliver on our commitments to our customers and who worked really hard to execute with discipline to increase value to all our stakeholders. So I want to express my sincere thanks to our employees for their efforts and also to our customers for their continued partnership. So let's go to Slide 3. So over the last couple of quarters, I've discussed the initial direction of our company strategy and our approach to managing our business. So as promised, we're looking forward to sharing more details on our strategy at our upcoming Investor and Analyst Day on March 11 in New York City. But today, I'll focus on the third quarter financial performance, which I'm very pleased to say delivered on our goals and our guidance. So we'll start with the financials. We achieved a revenue of $6.5 billion. This is a result of our continued growth in our industrial segments, our energy and our automotive businesses and as well as continuing to progress on executing our mix strategy. We realized an adjusted operating margin of 4%, and this reflects our focus on disciplined execution and portfolio management. And we delivered a record level adjusted EPS of $0.38, which was above our Q3 guidance range, and generated an adjusted free cash flow of $238 million, which is a testament to our continued focus on operational discipline and improved…

Thank you, Revathi. Please turn to Slide 6 for our third quarter income statement summary. Our third quarter revenue totaled $6.5 billion and was above our guidance range. Our Q3 adjusted operating income was $256 million, which was above our guidance range and remained roughly the same year-over-year despite a $461 million decline in revenues. Our adjusted net income was $193 million, resulting in adjusted earnings per share of $0.38. This was up 10% year-over-year and was above our guidance range. Third quarter GAAP net income of $111 million was lower than our adjusted net income primarily due to $19 million of stock-based compensation, $14 million in net intangible amortization and $49 million in net restructuring and other charges. Now please turn to Slide 7 for our quarterly financial highlights. Our third quarter adjusted gross profit was up 1% year-over-year to $459 million, while our adjusted gross margin improved a healthy 60 basis points year-over-year to 7.1%. This represents a third consecutive quarter of year-over-year gross margin expansion, reflecting improved operational execution and a richer mix of business. Our adjusted SG&A expense increased 3% year-over-year to $203 million this quarter, resulting in SG&A as a percentage of revenue to be 3.1% as we continue to manage with strong cost which provides us sustainable operating leverage. We continued to improve our profitability and our operating margin by managing portfolio mix, improving operational performance and sustaining cost control. This quarter, our adjusted operating income was $256 million. Our year-over-year adjusted operating margin expanded by nearly 30 basis points to 4%, which reflects our sixth consecutive quarter of year-over-year margin expansion. Now turn to Slide 8 for our third quarter business group performance. Each of our business groups either met or exceeded our revenue guidance. HRS revenue was $1.2 billion, up 3% year-over-year,…

Thank you, Chris. After considering the fourth quarter guidance that Chris just provided, we now expect our annual EPS to be in the range of $1.25 to $1.29, which really nicely aligns with our commitment from April of $1.20 to $1.30. Our GAAP annual EPS is expected to be in the range of $0.26 to $0.30 and includes stock-based compensation expense, intangible amortization and restructuring and other charges. Since last year, the Flex team has been working really hard to establish a consistent and sustainable track record that you can have confidence in. Our results in Q3 and for the first 9 months of our fiscal year are evidence that we're moving in the right direction, and we are focused on the right areas of consistently executing, delivering profitable growth and then meeting our commitments. With that, I'm going to have the operator open the line for questions.

[Operator Instructions]. Your first question comes from the line of Paul Coster with JPMorgan.

A couple. First off, the CEC and CTG businesses. Do you have some sense of when, at least, the portfolio culling will be done in CTG and when you think both segments might stabilize?

Paul, thank you for the question. I'd say though in CTG, we have done a lot of planned actions in terms of changing our mix and changing the size of our portfolio. And I'd say that most of our work is done. But that being said, we should always be looking at our portfolio and trying to figure out the tail of the portfolio and see if there's a way to better manage it. I'd say in CEC, we've had a combination of portfolio actions and the market impact from our networking and telecom customers. From a portfolio action, I'd say in CEC, the majority of our actions have been taken this year. And we're continuing to look at the networking and telecom space from a market perspective and seeing how that plays out for the rest of the year. So as I step back, the one thing I would say from a portfolio perspective, Paul, is that my thinking on how we run businesses is that we should always be looking at parts of our business that will be at the low end of our performance expectation and figuring out what's the right way to manage it because, at the end of the day, we want this relationship to be a win-win for our customers, and we'll be doing that across our portfolio. But I have confidence that we have done a significant amount of our work already, but that doesn't change that we'll be keeping on looking at it on an ongoing basis.

My follow-up question has to do with the auto segment. We're hearing that the auto industry as it transitions from ICE to electric vehicles is interested in the idea of actually transforming its supply chain and moving away from its traditional suppliers to new manufacturing capabilities such as your own or the EMS space generically. Do you concur? And are you seeing a change in the scope of what they are allocating to you as a result of that, maybe a strategic shift?

Yes, Paul, thank you for the question. Yes, I think it's a well-known fact that the automotive space is going through clear market shifts and going through clear shifts in terms of its supply chain strategy. I'd say that Flex is well positioned as the strategy evolves because we have strong manufacturing capability across the portfolio of electrification and autonomous, which are very critical next-generation technology. But also, we have really strong design and domain expertise around these platforms that are really important. So as we see overall the value chain, supply chain getting changed in the automotive space, I would say manufacturers like Flex and us, particularly, is well positioned in this space. And our early investments in autonomous and electrification will also really broadly help this in a significant way. That being said, we're building a very collaborative business model across with all our partners, not just in the hardware space but also the software space in both of these technologies. So Paul, I think we're well positioned and the supply chain in automotive space is going through changes, but we think that's an advantage to Flex.

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

Congratulations on the good results. I have a question on the unfortunate health situation in China, and you certainly realized that coronavirus impact is very certain at this point. But I think about 1/4 of Flex' manufacturing capacity is located in the China region. So maybe just operationally, you can talk about what Flex may be seeing with its own factories at this point in terms of any extended shutdowns? And what percentage of your factories may be impacted at this point?

Thanks, Mark. First, thanks for the comments on our results. We're quite pleased with our performance. I'd say on coronavirus, first, like I said in my prepared remarks, the most important thing is making sure that our colleagues, our employees in our factories in China have the best possible help that we can provide, and we are very focused on that as the most important thing. That being said, our teams really know how to handle this type of situation extremely well. And we have a very disciplined and very detailed plan that we're executing right now for our customers and our suppliers as we're looking at the impact to our factories. If you think about our overall presence in China, we don't have any factories in the Hubei province, where the bulk of the issue is. And also, if you look at China long-term, is that the number of people that we have deployed there and our assets have come down significantly because of all the diversification efforts that we have taken in the past year. But the approach we are taking is a very disciplined approach. We have very detailed plans that are executed across our factories already, and we're working with the government agencies to see what the actual shutdowns are going to be and looking for exceptions wherever possible. So Mark, I'm very comfortable that we have a game plan. That being said, the situation is evolving, and we're dealing with it every day in terms of understanding new information and acting accordingly.

That's very helpful. A follow-up along the same lines. And maybe some of the tariff-related planning the supply chain had to go through over the last year is a reasonable case study for us to think about. But when Flex has had to respond and make shifts in its manufacturing plants, maybe just remind us how long that could take. I know it's a very complex question because you have so many different thousands of products and customers. But just talk about some examples of how quickly Flex may be able to move between factories when it needs to. And is that something that -- usually that needs to go through requalifications with customers or something you can do relatively quickly?

Thanks, Mark. So I will just remind you that most of our supply chain strategies are driven by our customers, right? And we support them and follow them in their supply chain strategy. And as they look at -- in the diversification globally, we have been supporting our suppliers. I'd say some definitely can move faster than the others. So for example, I would say, anything in our consumer segment, maybe our CEC segment, the cycle to pick up factories and move them are much faster than our industrial or our automotive or our medical segment. So I think that, that's, in general, how you should think about our portfolio. But our real focus is on following our customers wherever they want to go. And what we're seeing customers do is really look at driving dual-source strategy and having sourcing from multiple factories to de-risk their supply chain, and we're really well positioned from that because, as you know, our geographic diversity is pretty significant.

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

And again, congrats on the quarter, very strong margins. And so maybe my first question, I'll start with that, is specifically on the IEI segment. You reported, again, a very strong 6.3% operating margin, which is above the long-term range. So I mean, any thoughts on the sustainability of margins at this level? And how do you see penetration -- your penetration into the industrial and energy end markets? Do you think -- do you have any sense of how much more penetration there is to go in these end markets? And how should we think about segment margins over the next couple of quarters?

Well, Ruplu, thank you for your comments on our performance. And we'll say we're very pleased with our IEI performance. And like I said, across our energy segment and our base industrial businesses, we saw really good growth across the board and really good conversion, which also comes from volume increases across this segment. My comment in terms of margins will be that our focus will always be driving the right mix within every segment. The beauty of the IEI space is that the available market is significant. And even today, if you look at vertical integration within customers, it's still quite vertically integrated. So for us to be able to take products from customers and move it across our value chain is a big available opportunity for us. And so our expectation is that IEI will continue to grow because the available market is big and it's right in the spaces that we want to participate in. It has long cycles from a customer affinity cycle standpoint. And we're also seeing growth in the energy sector in IEI, and our hope is that we'll continue to manage mix and find the right kind of pipeline within this segment to improve margins as we go along. So it's a space that we're very excited about, and our performance so far really proves that we can continue to ramp the segment in the future, too.

Okay. And that makes sense. Maybe another question on margins but, this time, for HRS. It came a little bit lower than what we would have expected, but 6.6% is still pretty high margins. But I mean, you talked about some ramping business and some investments you're doing. Can you just kind of elaborate on what those investments are? Or how long -- how much more investment is there to go? And how should we, again, think about segment margins over the next couple of quarters?

Thanks, Ruplu. Yes. I'd say we're very bullish about our HRS segment. If you think about the 2 aspects of our HRS segment, automotive and health, they both are areas that we have amazing expertise in and we have market share leadership. And our automotive segment, despite market headwinds, have continued to perform really well from a growth perspective and continued margin improvement perspective. I'd say, where we have seen some challenges have been in our health business, but that is not as a result of our bookings or our growth in that space. It's more related to how we are ramping the businesses we have booked. As you're aware, we have booked a lot of complex projects in this space. And those programs ramping up means that it is a tremendous amount of work for our operations team to be able to ramp up those programs well, and we're learning through that. But we have a lot of confidence in our -- in this space. We're very excited about the pipeline of bookings we have and the future potential we see for this business. So it's one that we feel very comfortable with, and we continue to focus on accelerating these program ramps and learning from those and doing it well. And we walk away feeling very bullish about the potential for HRS as a whole.

Your next question comes from the line of Jim Suva with Citi.

This is Tim Yang calling on behalf of Jim Suva. My first question is on seasonality. I think December quarter is the first time your performance was above normal seasonality in the past 4 quarters. And you are guiding, I think, March quarter as slightly above seasonal as well. Do you think you have finished most of your portfolio optimization? And how should we think about seasonality going forward?

Chris, do you want to take it?

Yes, sure. Thank you for highlighting that, Tim. Yes, for sure when you think about the guidance that we just set forth, that does reflect a much more muted seasonality than historically. If you look back, the 5-year average is roughly a 10% March quarter reduction and midpoint of our guide is much lower than that. And a lot of that is attributed to -- the dialogue we had -- there's an earlier question around the portfolio mix focus that we've had. We've taken significant efforts throughout this year to reposition ourselves and be thoughtful around the high-volatile short product life cycle businesses, and that's what you've seen in terms of both the CEC and, especially, CTG business repositioning. As a result, you will see a much more balanced depiction of the company's revenue as you move throughout a fiscal year.

Got it. That's very helpful. A quick follow-up question on automotive. I think, Revathi, you mentioned the new program ramps are driving the strength in automotive. And in the past, I think you have relatively high concentration with a couple of auto OEMs. For those new programs you're ramping, is it from your largest customers or from a more diversified customer base?

I'd say, I talked about program ramps in both health and automotive, but automotive growth is definitely because of the market share wins that we have had in this space. I would say we're progressing really well in our overall diversification strategy for automotive, both geographically and across customer base, and that has been a real focus for us as you've heard from us in the past. And then we're also -- the focus on electrification and autonomous is also helping significantly because we're expanding our platform and our content in these platforms. So all of those are helping in terms of changing the mix of our automotive customer base as we have it today. So we feel really good about where we are, and we'll continue on that effort.

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

Chris, I just wanted to start with a comment that you made about this quarter admirably holding profit dollars flat despite a sizable decline in revenue year-over-year. It looks like revenue declines may be attenuating based on your forward guidance and possibly on the path to revenue growth. So on the other side of this, just wanting to understand how you're thinking about leverage for fiscal '21. For example, prior to this quarter, I think we were all embedding double-digit profit dollar growth on low single-digit revenue growth. So just trying to understand how you think about a reasonable incremental contribution margin so that we don't get ahead of ourselves following this quarter and into the Analyst Day?

Thank you, Adam, and thanks for identifying some of the improving performance we have. One of the things is we put an announcement out just a couple of weeks ago that we have our Investor Day on March 11. And that is going to be a perfect time frame for us to get deeper and expand further around the underlying strategies, how we think through each of the businesses' trajectory as well as margin. But what you can see from our performance year-to-date and what is reflected from our guidance for Q4 is an ability for a company to continue to operate with due care and discipline around its cost structure. Our SG&A has been well managed, well positioned. And as I highlighted in my prepared remarks, it enables us some substantial leverage as we move forward. That in terms is, well, to how we continue to shift the business mix. You're seeing us now put a 7 handle in terms of the gross profit -- or gross margin. And I think as you continue to see us operate with discipline, continue to improve our operational execution, you're going to see us continue to put together a trajectory that you can have confidence in. We just do not want to get out in front of a growth trajectory or a margin profile at this stage. We'll be able to unpack that deeper for you in a matter of 6 weeks.

Okay, understandable. Maybe just another question on HRS to put a finer point on it. Last quarter, I know there was a lot of moving parts. You had customer move-outs. You're ramping those very large programs. This quarter, it looks like the revenue was there. The segment did return to growth for the first time and, I think, 4 quarters or so but did get pretty sizable margin erosion. I think the next quarter margin still has a 6 handle on it if I'm embedding your guidance correctly. Please correct me if I'm wrong there. But if you could maybe just unpack a little bit more detail on some of the buckets of investments weighing on margins, and the timing for those to attenuate would be helpful.

For sure. Margin, as I highlighted for HRS, is really a function of the mix of its business. And one of the things we've tried to extend into is we have some meaningful ramps underway in our health solutions. And those are going to be foundational for future growth in revenue for us. And obviously, at the front end of these types of programs, your profitability and margin is much lower than it is once you get up to volume. So we have some shifts going on in terms of that portfolio for sure. Margin for HRS continues to be holding very nicely, if not improving. And again, I'd point you to the total company's picture for Q4 at the midpoint of guidance having a very meaningful gross profit and operating margin expansion year-over-year.

Adam, I would add, the way to think about things in general is that the diversity of our portfolio is important, right? We have the opportunity to put money into program ramps and really focus on these complex programs that we're ramping in our businesses and really move our bookings to revenue in our HRS portfolio, and we'll continue to invest in that. So it's the right thing to do. We can afford to do it, and it plays out well for us in the long term.

Okay. Well, just one quick housekeeping, Chris, on interest and other, it was just significantly better than guidance. So just wanting to understand if something structurally changed there or what the right run rate is for that.

For sure, Adam. So if you think about this past quarter, we actually -- it was broad-based improvement performance in that line item. We did a much better job in terms of managing the debt levels and cash during the period. And so we got several million dollars of improvement from a net interest level. We had a -- recorded several million dollars of currency gains that weren't forecasted during the period, and we did a bit better in terms of some of the reducing of losses and some of the minority investments that are in that same line item. I moved you to a guidance in this next quarter of $40 million to $45 million that kind of sits very similar to how we had guided last quarter. There's nothing fundamentally shifting underneath that outside of a backdrop of an improving interest rate environment, if you will.

Your last question comes from the line of Matt Sheerin with Stifel.

So regarding the CEC business, and you commented about continued softness in networking and telecom. I know you've got some pretty broad exposure there. What's your thinking in terms of the 5G cycle? A lot of your peers had talked about a stall there. Networking, there seems to be inventory issues that have not yet played out. So any commentary or visibility would be helpful.

Yes. So Matt, we overall feel very good about our positioning in CEC, whether it is with 5G in the telecom space or in networking or even in the cloud and data center space. We have said that there is a delay in 5G programs. And I talked about that a little bit last year. If you think about it regionally, Europe and Asia definitely slowed down quite a bit. North America was ramping a little bit faster. But overall, we see 5G being a little slower, which is kind of expected in these large infrastructure rollouts in general. I think that's what we have seen. I'd say networking is probably just a seasonality issue in a moment in time that we continue to see slowness in networking. And you can see that with our customers and what they're calling for. We expect that to continue in Q4. And it's too early for us to call where that changes, I would say. But we think we're really well positioned in all spaces of CEC. We have always been the market leaders in this space. And in networking and 5G and in cloud, we continue to be really well positioned. And then our unique capabilities in service and storage, in wireless and battery management, all of the -- that has really consolidated our position very well in this space. So we'd say some market issues but overall performing well.

Okay. And just lastly, Chris, regarding your OpEx, it was a little bit higher than we had expected. Of course, you had a lot of revenue upside in the quarter. But what should we be thinking about OpEx, as a percentage of sales, for instance? Should you be able to start working that down and get -- as you get leverage on the mix and the better gross margins?

Yes, sure, Matt. The Q3 was at $203 million. It was up modestly year-over-year, say, 3%. What you're seeing is us being able to operate with really good discipline around this line item. It does create meaningful leverage. We are very confident in our ability to operate this in the range of 3% to 3.2% that we've stated before, while doing so, clearly enabling ourselves to support our future growth and the levels of investment necessary. A bit of a step-up this period as we actually did better across the board in terms of revenue and profitability. That leads to a bit higher in terms of some of the incentive compensation. So all around this range is where you should see us, and we have high confidence of being able to operate 3% to 3.2% and provide meaningful leverage. Okay. With that, I'd say thank you for joining us, and we're really pleased with our performance in Q3, and we've been consistent in our performance all through our fiscal 2020. We look forward to seeing you all in March in our Investor Day, and we're looking forward to sharing more insight into the strategy and the future we have for Flex. So thank you, everyone.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.