Flextronics International (FLEX) Michael M. McNamara on Q3 2016 Results - Earnings Call Transcript

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Flextronics International Ltd. (NASDAQ:FLEX)

Q3 2016 Earnings Call

January 28, 2016 5:00 pm ET

Executives

Kevin Kessel - Vice President-Investor Relations

Christopher E. Collier - Chief Financial Officer

Michael M. McNamara - Chief Executive Officer & Director

Analysts

Steven M. Milunovich - UBS Securities LLC

Irvin Liu - RBC Capital Markets LLC

James Dickey Suva - Citigroup Global Markets, Inc. (Broker)

Brian G. Alexander - Raymond James & Associates, Inc.

Steven Fox - Cross Research LLC

Austin Bone - Goldman Sachs & Co.

Adrienne Colby - Deutsche Bank Securities, Inc.

Andrew Huang - B. Riley & Co. LLC

Sean K. F. Hannan - Needham & Co. LLC

Operator

Good afternoon and welcome to the Flex Third Quarter Fiscal Year 2016 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. Sir, you may begin.

Kevin Kessel - Vice President-Investor Relations

Thank you, operator, and welcome to Flex's conference call to discuss the results of our fiscal 2016 third quarter ended the December 31, 2015. We published slides for today's discussion that can be found on the Investor Relations section of our new website. Joining me today is our Chief Executive Officer, Mike McNamara and our Chief Financial Officer, Chris Collier.

Today's call is being webcast live 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 those forward-looking statements. For a discussion of the risks and uncertainties, see our most recent filings with the Securities and Exchange Commission including our current, annual and quarterly reports.

If this call references non-GAAP financial measures, these measures are located in the Investor Relations section of our website along with the required reconciliation to the most comparable GAAP financial measures.

Before I hand the call over to Chris, I want to mention a save the date for our investor and analyst day which will be hosted on May 12, 2016. We are particularly excited to be bringing it back to Silicon Valley where we last hosted it two years ago and had a fantastic event. More details will be forthcoming from us via email.

With that, I will pass the call to our CFO, Chris Collier. Chris?

Christopher E. Collier - Chief Financial Officer

Thank you, Kevin, and good afternoon to those joining us on the conference call and also listening in online. We appreciate your time and interest in Flex.

Our third quarter income statement highlights begin on slide three. As you can see, our third quarter financial performance reflects a substantial progress we are making as we continue to evolve our sketch-to-scale portfolio and focus on fulfilling our financial commitments.

Revenue grew $446 million or 7% sequentially to approximately $6.8 billion and it was at the high-end of our guidance range. Every one of our business groups grew sequentially and met or exceeded our expectations. While our revenue declined $262 million or 4% year-over-year, it was entirely driven by a decline in sales to our largest customer. Excluding our largest customer, on a year-over-year basis, every one of our business groups grew, and our overall business rose over 6%.

Our profitability is reflecting a richer mix of business and improving execution, as our third quarter adjusted operating income increased 14% over the prior year to $236 million, which was above the high-end of our guidance range and up 20% sequentially. Our adjusted net income totaled $196 million, reflecting a solid 12% increase year-over-year and a 28% increase sequentially.

Our adjusted earnings per diluted share for our third quarter was $0.35, which represented a 17% year-over-year improvement and a 30% sequential growth. This was above our adjusted EPS guidance range of $0.28 to $0.34 and represents the highest quarterly adjusted earnings per share the company has ever reported.

Turning to slide four, you will see our quarterly financial highlights. Our third quarter adjusted gross profit increased 14% sequentially and 11% year-over-year to $455 million. Our improving operational execution on the many new product ramps coupled with a richer business mix resulted in an adjusted gross margin of 6.7%, expanding 40 basis points sequentially and 90 basis points from the prior year.

Our execution continues to improve across all our business groups, while we simultaneously bring on many new customers across a variety of new technologies and markets. Our margin is fundamentally a function of our business mix and it has been our strategic objective over the past couple years to evolve our portfolio towards a greater mix of businesses that have longer product life cycles and higher margins; and we continue to actively manage our investments and resources to deliver on this commitment.

This quarter, our adjusted operating income increased by $29 million or 14% year-to-year to $236 million. This quarter also represented our ninth straight quarter of year-over-year margin expansion with our adjusted operating margin expanding 60 basis points year-over-year to 3.5%.

Our improved operating profit performance continues to be supported by sustaining a strong discipline over our operating expenses combined with improved operational execution. Our return on invested capital was 22.4% in the quarter, exceeding our targeted level of 20%, and remains above our cost of capital.

Please turn to slide five for our quarterly operating performance by business group. This quarter, every one of our business segments operated at or above their targeted adjusted operating margin ranges.

Our Integrated Network Solutions, or INS business, generated $76 million in operating profit and its operating margin increased to 3.1%, which was within our targeted range of 3% to 4%. This expansion was aided by solid sequential topline growth providing for improved utilization levels and our strong operational execution over the multiple new programs that have been ramping.

Our Consumer Technologies Group, or CTG business, generated $49 million in operating profit, which resulted in an operating margin of 2.4%. This was within our targeted range of 2% to 3% as we continue to drive a deeper consumer engagement model, where we are providing more meaningful product design and innovations in a sketch-to-scale value proposition. We are consciously making investments into our capabilities to support this model today, which should allow us to push our CTG business to a richer margin profile.

Our Industrial and Emerging Industries, or IEI business, produced $49 million in operating profit with a 4.1% operating margin. This fulfilled our expectations for meaningful sequential improvement and now sits within our targeted range of 4% to 6% for this segment. Our margin performance this period reflects the incremental benefit of our new solar tracking acquisition NEXTracker as well as improvement in our operations as we continue to drive further productivity and yield improvements.

Lastly, our High Reliability Solutions, or HRS business, generated $83 million in operating profit, which equates to 8.1% operating margin. Again, this quarter, it exceeded our targeted operating margin range of 5% to 7%, reflecting the continued solid execution of this business while we're managing numerous new programs and product ramps and the successful integration of our MCi acquisition earlier this fiscal year. This performance placed HRS as our highest operating profit business group this quarter.

Let's turn to slide six for some insight around our other income statement elements. Net interest and other expense was approximately $22 million for this quarter, which was better than our guidance of $25 million. For our March quarter, we believe that modeling quarterly net interest and other expense at $25 million remains appropriate.

The adjusted income tax expense for the third quarter was $18 million, reflecting an adjusted income tax rate of approximately 8.4%, which is within our targeted tax rate range of 8% to 10%. Our estimated annual fiscal 2016 effective tax rate remains between 8% and 10%. When reconciling between our quarterly GAAP and adjusted EPS, you'll see an $0.08 impact. This impact relates to a few different elements: $0.03 is driven from $19 million of intangible amortization expense, and $0.04 is the result of $24 million of stock-based compensation expense. The remaining $0.01 comes from a combined impact of a non-cash loss on a small divestiture and investment impairments offset by a tax benefit.

Turning to slide seven, I'll review our cash flows. We continue to operate with discipline. And this quarter we generated $278 million in cash flow from operations, bringing our year-to-date cash flow from operations to $940 million. We efficiently managed our operations as our net working capital decreased by 3% sequentially despite the 7% sequential growth in our business.

Net working capital as a percentage of sales declined sequentially to 6.7%. Most notable for our net working capital was a reduction in inventory days, which we brought down by three days sequentially to 51 days, reflecting inventory turns of 7.2 times. Our cash conversion cycle totaled 24 days, which decreased by one day sequentially.

Given our current and prospective mix of business, we continue to believe that our net working capital as a percentage of sales will remain within our targeted range of 6% to 8%. We remain committed to investing in technologies and capacity that support our future growth. This quarter, our net capital expenditures were $120 million, exceeding depreciation by $10 million, as we continue to invest in additional capability and capacity expansion to primarily support our growing automotive, medical and energy businesses.

Strong sustainable free cash flow generation remains a cornerstone of Flex. We generated $158 million of free cash flow during the quarter, and over the last 12 months our free cash flow generation totaled $575 million. This provides a clear illustration of why we remain fundamentally structured, disciplined and on pace to achieve our commitment to generate free cash flow of $3 billion to $4 billion for the five-year period ending in fiscal 2017.

Lastly, we continue to use our strong cash flow generation to consistently return value to our shareholders through repurchasing our shares. This quarter we invested $90 million to repurchase over 8 million shares or roughly 2% of our ordinary shares during the quarter. Our actions this quarter underscore our unwavering commitment to return over 50% of our annual free cash flow to our shareholders.

Now, turning to slide eight; let's review our balanced capital structure. Our capital structure is sound and provides us with ample flexibility to support our business. We have no significant debt maturities until calendar 2018 and our maximum debt maturity in any given year is below our expected average annual free cash flow generation. We have over $3.1 billion in liquidity, total cash of approximately 1.6 billion, and our debt-to-EBITDA ratio was 2.3 times.

And that concludes the recap of our financial performance for the third quarter. Before I turn the call over to Mike, I would like to summarize that our results clearly demonstrate that we are executing on our strategy, delivering on our sketch-to-scale solutions, transforming our portfolio, and providing our customers with more value than ever before. We continue to be focused on improving our execution, operating with discipline, and consistently delivering on our commitments amid this very dynamic macroenvironment.

Now, I'll turn the call over to Mike.

Michael M. McNamara - Chief Executive Officer & Director

Thanks, Chris. We continue to competitively position our company as a leader in the IoT space, or as we call it, the Intelligence of Things. Our company is well-positioned to take advantage of many new opportunities across multiple industries by providing design, engineering, manufacturing and supply chain solutions for all products. This provides us with new markets and opportunities that will grow our business, diversify, and bring increased value to our customers from sketch-to-scale. This progress is evident in earnings.

Please turn to slide nine for our Q3 2016 highlights and key trends. Our focus strategy and richer engagement model, coupled with our continued diversification in industries, resulted in an exceptionally strong performance in our third quarter of fiscal 2016. This was evidenced by broad sequential growth across all four of our business groups resulting mostly from new program wins. These factors helped us overcome some of the macro headwinds during the quarter.

All four of our business groups grew sequentially and met or surpassed our guidance and revenue projections. We reached the highest levels of quarterly revenue in the company's history in our medical, automotive, industrial and energy businesses.

Our High Reliability Solutions business, which contains automotive and medical eclipsed (15:30) $1 billion in quarterly revenue. The evolving mix of our business and margins continue to improve. All four of our business groups also ended the quarter within or above their respective target adjusted operating margin ranges. In addition, the combined revenue of HRS and IEI rose to 33% of sales, up 11% year-over-year, and above 29% last year. Further, the combined operating profit of HRS and IEI accounted for over 55% of total operating profit up 69% year-over-year and further evidencing our progress in building a more balanced and diversified portfolio.

Lastly, we continue to effectively manage our business and deploy capital in disciplined way, remain focused on driving return on invested capital above our cost to capital. This focus drives free cash flow, which at $526 million, through three quarters of the year, is solid and keeps us on track for a five-year free cash flow commitment of $3 billion to $4 billion.

Our consistent free cash flow generation provide us the business to grow our business through smart capital investments or acquisitions like our recent MCi, NEXTracker and Wink transactions while still continuing to return significant capital to shareholders.

Our capital return to shareholders continued this quarter as we invested $90 million to repurchase 8.4 million shares at an average price of $11.12. Year-to-date, we have bought back $332 million in stock, which equates to 63% of our year-to-date free cash flow. Since beginning our current capital return program in fiscal 2011, we've now repurchased nearly a third of our net shares.

Please turn to slide 10 for a look at revenue by business group. INS increased 12% sequentially and was well above our expectation for a mid to high-single digit increase. Revenue was $2.5 billion, reflecting a $264 million increase from last quarter. With this performance, INS is up over $0.5 billion over the last two quarters, representing over 25% growth. The strong performance is reflective of the significant new business we captured over the past year and outstanding result, given the muted growth environment for our end customers.

In the quarter, all businesses within INS Group were above forecast. Our strength was led by telecom and converged infrastructure, or what we call Ci3. In our fourth quarter, we expect INS revenues to be down mid to high-single digits, primarily driven by general seasonality of a higher revenue base in December and a challenging macro. This guidance reflects the continuation of year-over-year growth for INS.

CTG's revenue was up 2% sequentially, above our expectation for a low-single digit decline. This resulted in revenue of $2 billion. The better-than-forecasted performance in CTG was due to strong demand in connected home and wearables, along with better demand in gaming. Roughly in line with what CTG has experienced in three out of the last four quarters, we're guiding it to decline 30% to 35% sequentially in Q4, as most products we build experience strong seasonality.

We do not expect our largest customer to be a 10% customer in the future. This improves our CTG mix toward products that are more technology-driven and sketch-to-scale businesses with better margin profiles.

IEI rose 6% sequentially to $1.2 billion and saw its year-over-year growth climb to 10%. This performance met our sequential growth expectations of mid to high-single digits. The growth was driven by strong contributions from new business ramps and our NEXTracker acquisition, which we closed earlier in the quarter. However, the broader macro pressures we highlighted last quarter remained present and impact our core business.

NEXTracker is a global market leader, a leading smart solar tracking solutions company that nicely complements our existing $1 billion plus energy business. During its first quarter with us, NEXTracker performed well and met or exceeded all of our expectations. The NEXTracker management team also provided a huge boost to our talent base and ability to drive a stronger Flex energy offering.

For the March quarter, we're forecasting IEI sales to decline mid-single digits sequentially, as we continue to see macro pressures weighing on our IEI business.

Our HRS Group performed exceptionally well, growing year-over-year for its 24th straight quarter. Sales continue to reach record levels, rising 7% sequentially and 12% year-over-year. Growth in our automotive and medical businesses outpaced our expectations on successful new program ramps.

We continue to leverage our strong technology and engineering position within HRS to drive very strong bookings. Our automotive business remains on an upward trajectory and continues to outperform. We now have automotive solutions and content in over 250 different models worldwide.

On the medical front, we had one of the best bookings quarters ever, which bolsters a long-term growth in that business. For the next quarter, we expect HRS to be stable sequentially, as automotive strength is offset by medical seasonality.

Now turning to our March quarter guidance on slide 11. Our expectations are for revenue to be in the range of $5.5 billion to $6.1 billion. This range reflects a sequential increase of 14% at the midpoint, in line with our historical five-year seasonality for the March quarter, as the growth from our new program ramps are offset by macro pressures and seasonality.

Our guidance for adjusted operating income is to be in the range of $175 million to $215 million. This equates to an adjusted EPS guidance range of $0.25 to $0.31 per share based on weighted average shares outstanding of 558 million. The adjusted EPS guidance is expected to be approximately $0.07 per share higher than the quarterly GAAP earnings per diluted share due to intangible amortization and stock-based compensation.

Before I open the call for Q&A, I would like to thank the entire team at Flex. It takes a lot of focus and hard work to deliver the exceptionally strong results we had this quarter despite the challenging macro circumstances.

With that, I would like to open up the call for Q&A. Operator?

Question-and-Answer Session

Operator

And our first question is from Steve Milunovich with UBS. Your line is open.

Steven M. Milunovich - UBS Securities LLC

Thank you very much. Could you talk about your largest customer and what's going on there? You indicated it's going to be less than 10% going forward. Is that a change relative to where you expected it would be three months ago?

Michael M. McNamara - Chief Executive Officer & Director

No. This continues to be kind of at expectations. We've always expected a slight adjustment in terms of the revenue profile, particularly in our China operations. We actually expected around the rest of the world that we would continue to perform well and have quite a bit of business; and we just continued to see that play out as certain products roll off and new products come on board. So it's a continuing of a transition that was well expected. And as a result, the ability to manage down the cost structure as we've moved along has gone very, very well. And we continue to be a very strong partner in Brazil and India; and that's really where we expect it to be when this transaction was announced probably a year-and-a-half ago now.

Steven M. Milunovich - UBS Securities LLC

And regarding IEI, could you talk a bit about the program ramp difficulties that you had the last couple of quarters? How far through those we are? And what's going on in macro? You mentioned macro in a couple categories I think, but particularly in IEI, what are you seeing from the macro side of things and where regionally are you seeing weakness?

Michael M. McNamara - Chief Executive Officer & Director

Yeah. As far as the macro, what we see is kind of broadly across the industrial set of businesses particularly – probably more so in the United States, but also in Europe. We see it's just been a challenge. We've started seeing the macro push probably in the September quarter. We talked a little bit about it – maybe even at the end of the June quarter. We continue to see it going into the December quarter. And our forecast for March reflects kind of a weaker industrial demand pull-through.

Christopher E. Collier - Chief Financial Officer

And then, Steve, with regards to the performance around the operational execution, in the prepared remarks I was highlighting, for the group, OP grew to $49 million; grew over 50% sequentially and rose to the 4.1%, which is inside our target range. That was definitely – a lion's share was built off of the improvements that have been taking shape last quarter that we had actually spent a fair bit of time discussing. It stems from just getting better control over the various programs that we've been driving, whether it's in workforce and material planning, better execution around yield and scrap improvements and even reductions in terms of logistic type fees, freight inbound and outbound. So a whole host of things that the IEI team has

been focused on. And it was great to see the improvement. And we see ourselves fundamentally structured to deliver inside that range as we move forward.

Steven M. Milunovich - UBS Securities LLC

Thank you.

Michael M. McNamara - Chief Executive Officer & Director

Welcome.

Operator

The next question is from Amit Daryanani with RBC Capital Markets. Your line is open.

Irvin Liu - RBC Capital Markets LLC

Hi. This is Irvin Liu calling in for Amit. So first question, within CTG, could you just talk about what you saw in the December quarter? It looks to be a little bit below normal seasonal uptick that we've seen in the past. And your March quarter guide looks consistent with the historical seasonality. Can you just provide some color on what's going on in this business, perhaps within smartphones and other CTG markets?

Michael M. McNamara - Chief Executive Officer & Director

Yeah. Well, we actually were slightly above our forecast for what we thought we'd see in the December quarter. December has usually a small increase than (26:34) what's typical. So if I think about the normal seasonality in the December quarter, it's like 2% growth. Now it's really pretty – yeah, it was a little bit slower this year. So we actually expected low to mid-single digits down. September was very, very strong. A large part of that is basically some the smartphone sell-through, but we kind of expected it to be down. And as far as the rest of the business, they outperformed pretty normally. We have a pretty strong base of business in gaming. We have a pretty strong base of business in wearables, all of which seem to work very, very well and have quite a bit of penetration in the connected home market with a variety of different products.

So I would say everything was pretty much at expectation or typical seasonality. I think our smartphone business was down a little bit maybe partly because of the transition if I think about it from some of the China business with our largest customer. But relative to where we expected the quarter to go, we're actually up a little bit.

Irvin Liu - RBC Capital Markets LLC

Got it. Thanks. I was also wondering if you could just touch on the magnitude of your Brazil exposure from a revenue basis today and what sort of headwind that you may be seeing in the March quarter as it relates to Brazil?

Christopher E. Collier - Chief Financial Officer

So Brazil for us is – it's roughly nearing a, say, $2 billion type of revenue for the region. All of that is primarily consumption within that economy. There is not much export for that. We've seen revenue drop in Brazil this year as everybody, in the range of 30% plus. And even as we move into our Q4, we anticipate seeing a similar type of an erosion year-over-year. It's been a challenged market. It has a lot of different aspects, whether it's the currency, whether it's the general macro softness.

Our larger segment down there is around our consumer side of things and even within our mobile handset side. So that's actually reflected in some of the performance that you're seeing this year. Brazil definitely has an impact on our overall growth in those two segments.

Irvin Liu - RBC Capital Markets LLC

Got it. Thanks.

Operator

The next question is from Jim Suva with Citi. Your line is open.

James Dickey Suva - Citigroup Global Markets, Inc. (Broker)

Thank you and congratulations to you and your team at Flextronics. I have a question and a follow-up and I'll give them both at the same time. On the HRS you had really, really strong execution, I think, you've mentioned auto and medical was just great. Is there anything in there to say, hey, we benefited this quarter and it shouldn't re-occur? Or is this something that we could see re-occurring and maybe that range actually needs to be brought up for your target range given the outperformance there? Or maybe there is something in there we should be mindful of, so we don't put in overly exuberant expectations.

And then my follow-up question is on the stock buyback. You've been very diligent with returning cash to shareholders with your cash flow and stock buyback over the past few years. Given the market volatility, especially calendar year-to-date, past four weeks or so and it's (29:57) that Flextronics stock has been under pressure, have you guys kind of been active in the market and can you help us understand about – if so how should we model in stock buyback for this quarter given the recent pullback? Or you'd be even more aggressive or you more have a (30:12) steady cadence of just every single quarter that x percent of free cash flow? Thank you.

Michael M. McNamara - Chief Executive Officer & Director

Hey, Jim. Let me talk about a little bit of the sustainability of automotive and medical and the range that we have as a target price. We don't have any one-time effects boosting that up. This is basically how this group is performing right now. One of the reasons we like the way the group is performing is because it's actually been very predictable and very stable. And it's one of the reasons that we push so hard to try to tilt some of our acquisitions and as well a lot of the resources internally at Flex into these business groups. So it is sustainable. It doesn't move as much either up or down, quite frankly, across seasonality and it doesn't move that much year-on-year. So it's a very sustainable business.

So the numbers you are seeing are something that we expect to continue to move forward, and I guess evidence of that is, we talked about a few business groups being down in March due to normal seasonality; and HRS, we have relatively flat. So it continues to – we continue to see how this business is going to perform. And whether or not we'll change the range, we'll obviously talk a lot about it when we get to analyst day as to whether or not we'll consider moving that range, but we continue to be really excited about that business and the operating profit year-on-year grew like 48%. So it's a strong driver for us and very stable.

Christopher E. Collier - Chief Financial Officer

And then, Jim, with regards to the inquiry on the share repurchase and the appetite. For us, we've stated all along, we have an unwavering commitment to increase shareholder value. And that's been taking the shape through our share repurchase plans. And so the share repurchase plan has been, is, and will continue to be the key feature in returning value; whether it's last year or over a five-year period, we have been returning roughly 75% of our free cash flow to shareholders.

If you look on a year-to-date basis, we've generated $526 million of free cash flow and we've repurchased $332 million of shares. So we're well north of 60%, 63% in terms of taking that strong cash flow and returning it.

We don't guide to specific quarterly amounts. And I think you're going to see the company continuing to maintain its disciplined approach and optimizing where we see it fit and using the strong cash flow to continue to do an active share repurchase.

James Dickey Suva - Citigroup Global Markets, Inc. (Broker)

Great. And it's good to see you guys hitting corporate-wide operating margins at 3.5%. And so is it fair to say like in your stronger mix quarters that now this is hopefully the new norm? I'm just kind of very encouraged by that (33:13) one-off that should cause that to be a bit above or below of (33:18) this quarter?

Michael M. McNamara - Chief Executive Officer & Director

Yeah. Yeah, Jim, as you know, we've been on the same mission for probably four years now, about moving the portfolio into a more balanced portfolio where a greater percentage of that portfolio is coming from longer product life cycle products with a lot more stability both from a seasonality standpoint and year-to-year.

We're now up to – like 55% of the total operating profit is – are out of our two target business groups, HRS and IEI. If you look across these guys over the last three years, four years, I think you'll see that they're probably running pretty close to double-digit growth on average across that period. So we feel that we've structurally moved the profitability of the company, we've structurally moved the margin profile of the company, and have structurally moved the stability of earning. So this is real.

And what's also really interesting is we've grown compounded 10% growth over the last three years, four years, five years maybe. It's also given us a stronger and stronger position in those industries. So our ability to penetrate even more business in those industries is actually being enhanced every single year. And we feel that we've got a very, very strong profile by which to compete and win going forward. So we actually think, while we've moved the portfolio over to where it's like 33% of the revenue, 55% of the operating profit, we also feel we have moved the portfolio where we can compete even more aggressively and more competitively in the marketplace. And there is no reason for this continued shift to decelerate going forward.

Christopher E. Collier - Chief Financial Officer

And, Jim, just to complement some of what Mike just said, and to address one point. There is nothing unusual inside of the quarter that you saw. And like we've said always, margin is fundamentally the result of the mix of our business.

And if I was actually to point you to the guide next quarter, it's a good example. Even at the midpoint, you see again a healthy return to around a 3.4% margin at the midpoint; year-on-year up over 10 basis points – 10% in operating profit; and again, 40 basis points plus in margin expansion. So you should see another quarter where it'll be our tenth straight quarter of year-over-year margin expansion. And again it goes back to our strategic focus (35:44).

James Dickey Suva - Citigroup Global Markets, Inc. (Broker)

Thank you and congratulations to you and your team at Flextronics. Oh, I guess, I actually should call it the new Flex. Congratulations.

Michael M. McNamara - Chief Executive Officer & Director

Yeah. Great. Thank you.

Christopher E. Collier - Chief Financial Officer

Thank you.

Operator

The next question is from Brian Alexander with Raymond James. Your line is open.

Brian G. Alexander - Raymond James & Associates, Inc.

All right. Thanks. Chris, I just want to follow-up on what you just said. So the margin in terms of the March quarter, you are looking for them to be roughly flattish sequentially. Obviously, mix will help with CTG down, but it implies that you can hold or improve margins in each of the individual segments despite revenue that's going to be flat to down in each of those segments. So can you talk about that a little bit? And just how you're able to hold margins or perhaps even improve them in the individual businesses? What looks to be across the board while volumes are coming down?

Christopher E. Collier - Chief Financial Officer

Certainly, Brian. So actually at the midpoint you'll see a 3.4%. It's actually 10 basis points down. And again, it comes into the implications of the leverage of the downshift in that type of the revenue.

If you look across each of the businesses, IEI we spent a fair amount of the front end of this discussion, first Q&A, talking about its improving operational execution, moving its performance back into that range, so sustaining at the 4% plus. You see in INS business that's now back into its range.

The pressure comes from the CTG group where you see the significant 30% to 35% decline in revenue that puts some leverage pressure on it. But, overall, you're seeing a disciplined approach to the way we invest in our spend. It allows us to sustain within this range. We're feeling very comfortable setting a midpoint at targets around a 3.4% operating margin, which again is 10% in dollars is up year-over-year, will be up 40 basis points from a year ago. So continue to see that improvement.

Michael M. McNamara - Chief Executive Officer & Director

And then, Brian, I'd like to just add a little bit. Independent of the performance of each of the individual business groups, as the mix, which is due to the higher margin businesses, those individual business groups don't even need to have margin improvement in order for the company to have margin improvement, because we'll continue to move the percentage mix in a really positive way. And not just the margin, but I'll also say the stability of earnings. So once you move to those kind of business groups, you have a significantly lower risk profile associated with the business and significantly more predictability.

Brian G. Alexander - Raymond James & Associates, Inc.

Yeah. Makes sense. Just a quick follow-up. Would you break-out how much acquisitions contributed to revenue and operating profits in the quarter? And then, Mike, didn't hear much about NIKE on the call. So I don't know if there's anything new to talk about there?

Christopher E. Collier - Chief Financial Officer

Brian, we're not specifically carving out the impacts of the acquisitions on it. However, in our discussions along the way, it's a combination of the benefits of the strategic investments in these acquisitions, plus an overall improving execution within the business. So it's not slanted to a acquisition-benefited performance here. It's a combination of all that and our execution.

Michael M. McNamara - Chief Executive Officer & Director

And just on NIKE, we continue to make really good progress. I think the relationship with our customer is very, very strong. We're moving to a new way of manufacturing, a new way of managing the supply chain, a new way of delivering products to the marketplace quicker and with more automation. So I do think about this as being kind of a long-term journey and we continue to make really strong progress. And we're very pleased with it. Like I said, I think our customers are very pleased with it. But think about that as being more of a long-term journey that's going to build. It's going to be more like a locomotive.

Brian G. Alexander - Raymond James & Associates, Inc.

Okay. Thank you so much.

Operator

The next question is from Steven Fox with Cross Research. Your line is open.

Steven Fox - Cross Research LLC

Thanks. Good afternoon. Just two questions from me. First of all, I think in the prepared remarks you talked about the deeper engagement model in CTG starting to take hold. I was curious if – and also that it leads to a richer margin profile going forward. I was curious if there's any examples you could provide of some of that success and how that scales? Because, I guess, my understanding is that a lot of the design work is with smaller companies. So I'm curious it eventually impacts the margins?

And then just a second quick question would be around the converged infrastructure wins that you're getting. Can you talk about how you expect it to play out over the next, I don't know, few quarters and how it also affects INS margins? Thanks.

Michael M. McNamara - Chief Executive Officer & Director

Sure. Yeah. So when we think about, what we call, like in CTG, like a much richer engagement model, more sketch-to-scale, more technology-enabled businesses; a lot of those are new companies, but the process technologies and the techniques and the strategies used on those apply across to many different companies. And, in fact, we find consumer being kind of a leading-indicator of bringing technology into marketplace that then can apply across into automotive and medical and industrial.

So we kind of view that. A lot of these small companies, while the individual profitability or the individual operating dollars of the small companies don't add that much, they actually do add a lot in terms of applying them across to every other industry. So that's a huge part of our consumer play. And as we do these new companies, we're still going to have some business segments within those consumer companies that are going to hit pretty high volumes.

And, I guess, a good example of that I might suggest would be Fitbit, where there was a tremendous amount of co-innovation that needed to occur to, in order to bring those products to marketplace. We worked significantly with Fitbit to bring those products to marketplace, to solve some of the technical challenges associated with the wristbands. And it ended up turning into a pretty high volume product.

So there's really two ways to create value out of that CTG engagement model. One is the process technologies we develop as a result of those learnings and apply them across to big companies, and also sometimes the smaller companies will end up taking off.

Steven Fox - Cross Research LLC

Thanks for that. And then just on the converged business?

Michael M. McNamara - Chief Executive Officer & Director

Yes. So on the converged business, we're clearly seeing a transition of products into a place, which everybody calls converged technologies, where you are getting routers and storage and switches, and all integrated into a single box and with software loaded on it.

So a lot of our investment is built around that set of capabilities. It continues to be a small part, but significant, quite frankly, of our business. But it's been growing double-digits for – like the last few years and this is going to continue to build as we move forward.

So I would say this also is going to have better margins. It's going to have better growth rates. And, over time, if you give it a few years, with the solid double-digit growth and the amount of new logos that we're securing, you're going to see a very – it's going to make – well, it's already contributing, but it's going to contribute even more as a percentage of total.

Steven Fox - Cross Research LLC

Great. That's very helpful. Thanks.

Michael M. McNamara - Chief Executive Officer & Director

This is an evolving business trend that we need to be in the middle of.

Steven Fox - Cross Research LLC

Great. Thank you so much.

Michael M. McNamara - Chief Executive Officer & Director

You're welcome.

Operator

The next question is from Mark Delaney with Goldman Sachs. Your line is open.

Austin Bone - Goldman Sachs & Co.

Hi. This is Austin Bone filling in for Mark. Can you help us think about the size of the auto business within HRS? And what's the geographic exposure of the auto business?

Michael M. McNamara - Chief Executive Officer & Director

So it's roughly $2 billion, use some nice round numbers on the automotive. It's obviously grown pretty rapidly over the last four years, five years. We have operations in automotive certified factories in virtually every region. I think we're probably more exposed in the United States market than anywhere else, but we have significant exposure to the European market. I would say China is a little bit less, but I actually don't know the percentage breakthrough – breakout of end demand in that market.

Austin Bone - Goldman Sachs & Co.

Got it. Thanks. That's very helpful. And then, as a follow-up; can you talk about the trends that you're seeing for the energy business that's now surpassed $1 billion? And then, also within that, do you have an estimate of how much you think that business has compressed given the recent headwinds from low oil prices?

Michael M. McNamara - Chief Executive Officer & Director

Yeah. So most of our energy businesses – so we do – to kind of summarize, we have quite a bit of capacity over 1.5 gigawatts of capacity to do solar panels. We do a huge percentage of the micro-inverters today. We do a huge percentage of the smart meters. And now we own the leading tracker system in the world today. We think it probably has more market share than anybody else and a very, very strong and compelling value statement. And we're doing – probably work with eight or 10 different storage companies, energy storage companies, which is also going to be part of that whole renewable thing.

So when we think about electricity generation, which these newer technologies are all built on, focusing on, oil is a very small part of it. So I don't know what percent of the overall energy -electricity generation market oil is, but in the United States it's less than 5%. So the reality is, the lower oil price doesn't really matter that much. But we think the trend over a 10-year period is phenomenal. Because we think technology can solve a lot of the problems with energy generation. It gets 10% to 15% cheaper every year. Once we add on energy storage later on, it's going to even be more compelling and it has a lot of environmental implications. So it's got technology, it's got continuously lower cost, it's got sustainable feature to it. So we think that it's got a long run. And oil doesn't matter that much when it comes to electricity generation.

We also had – something happened this last quarter which was the ITC came back, it was set to expire in 2017, and it was now extended for multi-years which is just going to take what's already a pretty strong double-digit growth business with very strong decade-long macros and it's going to improve it.

So we just think our positioning is very good. We have a management team that's just killer on the energy system, very strong and very broad. And we have all these different technologies and all these different penetrations in the variety of different markets within energy. So we're pretty excited about it.

Austin Bone - Goldman Sachs & Co.

Got it. Thanks very much.

Operator

The next question is from Sherri Scribner with Deutsche Bank. Your line is open.

Adrienne Colby - Deutsche Bank Securities, Inc.

Hi. It's Adrienne Colby calling in for Sherri Scribner thanks for taking my question. Can you comment on how important the absolute volume of global auto sales is for Flex's overall business? Some of the December and January data have suggested a leveling off in U.S. sales. I am just wondering what the implications that might have for the CTG segment?

Michael M. McNamara - Chief Executive Officer & Director

Yeah. Well, yeah, HRS segment but – well, like we talked about the overall automotive business are about $2 billion out of our $25 billion or nice round numbers. So it's small. If those numbers move at the far end up being $17 billion instead of $17.5 billion, it's not going to have a huge impact on us. And remember the volume is just one indication. If we were doing tires, you know, then we'd be real concerned about volume. But as the electrification of the vehicle occurs, as people start heading towards zero emissions and zero accidents and connected cars and more and more technology in those head units, those themselves, even with a flat total vehicle model can continue to be a growth rate.

And those of the areas that we're focused in and where a lot of our bookings have occurred over the last few years. So it definitely impact us a little bit. But again it's $2 billion of the $25 billion and within that $2 billion most of it's driven by new technologies which as a percentage of content of the car, is going to keep going up pretty significantly.

Adrienne Colby - Deutsche Bank Securities, Inc.

Thanks. And as a follow-up, I wanted to go back to the question about the IEI margins, ask maybe slightly differently. If you could just quantify maybe qualitatively how much of the benefit to margin was from the ramping of the new programs versus contribution from NEXTracker? And also too how we should think about the cadence of margin improvement going forward? Just wondering if there's a clear runway now to achieving the higher end of the target range you've given?

Michael M. McNamara - Chief Executive Officer & Director

So, you know, I'm not sure of the exact margin contribution of NEXTracker versus the other. NEXTracker is obviously additive, but to actually – but we moved both the margins of the core business as well as the NEXTracker both went up. And that's how we were able to move this thing all the way into 4.1%, which was a pretty big jump right away in a quarter.

The biggest challenge, we have, of moving that even farther and by the way it would be farther, if it wasn't for the macro. So if we weren't having a number of different slowdowns of the number of different industrial companies – so what's happening is the revenue is coming down in a lot of different customers and we're offsetting that with new program wins. So you've got lower revenue because of the macro, but you have simultaneously more revenue as a result of new programs, which tend to have (49:54). Even with that, we were able to drive the margins higher this last quarter.

So if we had any kind of macro pick up, we would see those margins probably move into the middle of that range relatively quickly. So that's the biggest challenge that we're having right now. A lot of the margin profiles or the start-up costs we're having are very normal and typical and usually can be offset by more and more revenue that absorbs more cost.

So in absence of that more and more revenue absorbing more costs as a result of the weak macro, we're fighting and keeping our revenues even or a little bit even stronger, but it'd be more efficient if we had some help with the core customers and they weren't struggling with revenue on a quarter-on-quarter basis.

Adrienne Colby - Deutsche Bank Securities, Inc.

Thank you.

Christopher E. Collier - Chief Financial Officer

And maybe I'll just try to put it into quantitative terms, north of 50% of the growth, $17 million sequential growth, was due to our own operational execution and the improvements that I had explained earlier.

Adrienne Colby - Deutsche Bank Securities, Inc.

Great. That's helpful.

Operator

The next question is from Andrew Huang with B. Riley. Your line is open.

Andrew Huang - B. Riley & Co. LLC

Thanks for taking my questions. So it seems like you've done a pretty good job preparing for the worse and hoping for the best. So I was curious if you were able to sign any new multi-hundred million dollar outsourcing agreements in the December quarter that could ramp over the next 12 months to 18 months?

Michael M. McNamara - Chief Executive Officer & Director

Yep. We definitely have some. I'm trying to think through those. That's a good question. I'm not sure I can give you the details on that. But without question, we have some; one in INS, we have one in medical, which we're pretty excited about, and have one in Consumer Technologies Group. So I'm just looking at the list, two in Consumer Technologies Group.

So I'd say there's almost no quarter that we don't have a multi-hundred or multi-hundred million dollar win. So – and the medical one will ramp not for 18 months and the consumer one will ramp next year.

So they all have different profiles associated with them. In terms of (52:21), but alternatively one of the things we mentioned like, for example, in medical is that we have very strong bookings. In fact, our medical bookings last quarter were the highest they've ever been. So – but they may not ramp for 12 months to 18 months, but we've been – so a lot of the growth that we're having in all these industries are a function of what we've done a year ago or even two years ago. So...

We continue to make very good progress. Almost never is there a quarter that we don't bring on a couple hundred, some million dollar businesses. And I mean, to me, it wasn't anything more than normal, wasn't anything less normal, it was just a continuous strong quarter for us.

Andrew Huang - B. Riley & Co. LLC

Okay. Thanks. And then kind of on the topic of operating margin improvement streak. It's almost as good as the Warriors' home game streak, but I'm just worried – wondering what you're worried about, like what would cause that streak to end?

Michael M. McNamara - Chief Executive Officer & Director

Well, the one thing I kind of – what I talked about earlier is, I actually think by the time you move your – into the 55% operating profit, you've actually structurally moved into a different margin profile. And we've talked and pushed that a little bit. The HRS business coming in with 8% plus is sustainable. We believe it's sustainable, not one-time hit. It's actually a structurally improved business.

The IEI, we talked a little bit about, it's moved into 4% and it's pressured by the macro. If it wasn't pressured by the macro, I think we'd be more – heading more towards the middle of that range. So – and both of those, this coming year, will again have a target of growing those 10% as a bundle. So we'll continue to – and we believe we have good visibility into these programs. We know what automotive looks like next year, we know what medical looks like next year with some degrees of freedom. And we'll continue to try to drive those into 10% growth next year. So that's something that we can see today already.

So I think we feel really good about it that the operating margin performance is sustainable. And, in fact, we would hope to move it even forward. One of the things about our business, it's not like we are taking an existing business and just grinding productivity and moving the margins up and then margins get stuck, we actually have a belief that we can continually move the portfolio into a continuously higher margin profile and can do this sustainably over the next few years.

Christopher E. Collier - Chief Financial Officer

Operator, we have time for one more question.

Operator

Certainly. The final question is from Sean Hannan with Needham & Co. Your line is open.

Sean K. F. Hannan - Needham & Co. LLC

Thanks. Sean Hannan. So there were a lot of mentionings of new programs in the course of the commentary. Is there a way to mention a little bit more in detail where some of these new programs were ramping perhaps on a sub-segment basis? And then, particularly within the CTG group, are there any types of those sub-segments or ramping programs, I don't know, wearables might be a part of them that are explicitly a part of the net margin profile that you were looking to accomplish over a longer period? Thanks.

Michael M. McNamara - Chief Executive Officer & Director

Okay. That's kind of a tough question. We have such a broad business where the bookings go anywhere from $10 million to $300 million and they ramp anywhere from six months from now to two years from now. So it's hard to draw a direct correlation between each and go through each one of these bookings where we have like hundreds and hundreds of customers and when they actually hit. So...

Sean K. F. Hannan - Needham & Co. LLC

Mike, just to clarify, what I was getting at is the commentary you had provided for the quarter that there was a benefit of ramping programs for each four of your segments. So, for example, if I look at INS the degree of ramping programs may have been particularly more pronounced within telecom and that's where you got the strength. So just trying to get some color in that sense.

Michael M. McNamara - Chief Executive Officer & Director

Yeah. So let me try to answer them kind of segment-by-segment and I'll start with the telecom piece. So we talked about maybe two quarters or three quarters, maybe even four quarters ago that we booked like four multi-hundred million dollar programs that would ramp over the next year to year-and-a-half and that started like a year ago. And what you saw is a lot of strength come into the September quarter where we grew double-digits and then also into the December quarter where we grew double-digits.

Now, those programs offset any kind of macro weakness and provided a tremendous amount of growth. The growth over the last two quarters was like 25%. Those programs largely played their way out in the December quarter. So as a result, what we're seeing is a kind of a normal seasonality going into the March quarter for the INS business. Still nice growth...

Sean K. F. Hannan - Needham & Co. LLC

Okay.

Michael M. McNamara - Chief Executive Officer & Director

...on a year-on-year basis on the background. On the CTG, it's kind of a different kind of style. We ended up having – we'll have less of the larger smartphone business, but we'll have more connected home. We expect to continue to penetrate into wearables, all of which have a little bit more uncertain and longevity to them, but the startup is much quicker.

In IEI, everything that the macro takes us down, we actually offset with new programs; and we're booking those programs in appliances and we're booking those programs in kind of a variety of different things. But those tend to be a lot of singles and doubles just in terms of the type of business it is. They tend to be $20 million, $30 million, $40 million programs on average. And all those things take time to start up. So what we're doing is, we're fighting a bad macro with a nice set of bookings, but they're kind of washing to a certain standpoint.

And then, HRS is just – does really well. So we continue to book very large automotive programs. We continue to book large medical programs. We actually booked those programs even last year and even two years ago. So it's not like that we'll actually see those ramping this coming year. And that's why we believe we can continue to drive a 10% growth rate.

So I think each one, in the same way (59:22), it's just kind of a complicated question to answer because there are so many different puts and takes, there are so many different product life cycles and there are so many different segments that we operate in.

Sean K. F. Hannan - Needham & Co. LLC

That's helpful. I think the perspective is helpful. But it sounds like the new win momentum in winning those programs – with all this momentum that you have over the course of the last couple of years, I think it's been pretty consistent (59:48) folks. The degree and the substance of that new win momentum, it sounds like has continued in the December quarter into present.

Michael M. McNamara - Chief Executive Officer & Director

Yeah. So just to give you some numbers, because we don't really like to talk about bookings, because bookings are complicated, it's hard to drive bookings directly into revenue, because like I said, sometimes it takes 18 months, sometimes it takes three months. So it's hard to draw the causality into revenue. But what I can tell you in this last quarter, three out of four of our business groups, we actually had the highest bookings that we had all year.

Sean K. F. Hannan - Needham & Co. LLC

Okay.

Michael M. McNamara - Chief Executive Officer & Director

And the other one we didn't have the highest bookings was INS and that's the group where we've like booked – booking everything already, I mean a lot of stuff already. But both in IEI, CTG and HRS every one of those things we have out-booked the last five quarters.

Christopher E. Collier - Chief Financial Officer

And then, Sean, maybe just to tie out one last thing. When we talked about the December quarter and the multiple ramps throughout the different businesses in the prepared remarks, we isolated – if you take away the largest customer that had a decline, every single one of our groups grew year-over-year, and as a company we're growing north of 6%.

That same feature set kind of plays its way out when you even think of our March quarter. If you actually take away the largest customer and the declines that we've seen on a year-over-year compare, you actually see the company again growing at its core 6% plus.

Sean K. F. Hannan - Needham & Co. LLC

That's great feedback folks. Thank you.

Kevin Kessel - Vice President-Investor Relations

All right. Thank you for joining the call. We appreciate all the questions and interest. Please remember to mark the calendars for May 12 for our investor and analyst day. And we'll be sending an email with more information soon. This concludes our call.

Operator

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

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