Flex Ltd. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2019, the three months ended June 29, 2018; comparable quarter ended June 30, 2017. The current period had 90 days versus 91 days in the prior period. Financial statements are unaudited; Deloitte performed an interim review, not an audit.
Business context
Flex provides product design, engineering, manufacturing, supply-chain and related services. Its reportable segments are Communications & Enterprise Compute (CEC), Consumer Technologies Group (CTG), Industrial & Emerging Industries (IEI), and High Reliability Solutions (HRS).
Financial performance
| Metric | Q1 FY2019 | Q1 FY2018 | Change / context |
|---|---|---|---|
| Net sales | $6.424 billion | $6.008 billion | Up about 7% |
| Gross profit / margin | $378 million / 5.9% | $407 million / 6.8% | Profit down $29 million; margin down 90 basis points |
| Net income | $116 million | $125 million | Down about 7% |
| Diluted EPS | $0.22 | $0.23 | Down $0.01 |
| Comprehensive income | $31 million | $133 million | Lower, including currency translation and derivative losses |
| Cash from operations | $(672) million | $(696) million | Cash use remained substantial |
| Free cash flow, as defined by Flex | $(185) million | $19 million | Non-GAAP measure; includes deferred-purchase-price collections and net capital spending |
Revenue grew in CTG, HRS and IEI, while CEC sales were slightly lower. CTG sales increased primarily on stronger consumer-product sales in emerging markets. Gross margin pressure reflected higher start-up costs, operational inefficiencies, under-absorbed overhead and a greater mix of lower-margin consumer products. Segment income was $188 million (2.9% of sales), compared with $178 million (3.0%).
SG&A was $263 million, or 4.1% of sales, versus $251 million, or 4.2%. Interest and other, net expense rose to $42 million from $27 million, primarily due to higher interest expense, higher average borrowings and foreign-exchange losses. Other income was $87 million, primarily reflecting a non-cash $91.8 million gain from deconsolidating AutoLab. Without ASC 606 adoption effects, the filing reports that quarterly net income would have been about $121 million.
Balance sheet, debt and liquidity
- At June 29, 2018, cash and cash equivalents were $1.255 billion, down from $1.472 billion at March 31, 2018.
- Total debt was approximately $2.920 billion: $43 million current and $2.877 billion long-term. The company reported a $1.75 billion revolving credit facility with no quarter-end borrowings and stated it was in compliance with debt covenants.
- Current assets were $9.685 billion and current liabilities were $7.795 billion. Accounts receivable were $2.890 billion, inventories $3.985 billion, and contract assets $324 million.
- Operating cash use was attributed chiefly to working-capital needs, including higher receivables and inventory. Net working capital was $1.7 billion, or 6.9% of annualized quarterly sales, within the company’s stated 6%–8% target range.
- Cash provided by investing activities was $472 million, including $657 million of deferred-purchase-price collections; net purchases of property and equipment were $170 million. Financing cash flow was immaterial.
- Flex said existing cash, expected operating cash flows and available credit facilities should fund operations for at least the next 12 months. More than half of cash was held by foreign subsidiaries; repatriation could incur withholding taxes.
Material changes and unusual items
- ASC 606 adoption: Adopted April 1, 2018 using the modified retrospective method. Adoption increased opening accumulated deficit by $37.9 million and established contract asset and liability balances. Reported quarterly sales and gross profit were respectively about $102.0 million and $4.8 million lower than they would have been without adoption. Contract amendments reduced revenue and gross profit by about $132.7 million and $9.3 million versus the unamended treatment; accelerated recognition on qualifying contracts partially offset this.
- Cash-flow presentation: Adoption of ASU 2016-15 moved deferred-purchase-price collections from operating to investing cash flows. Flex said it would change its allocation method beginning in the September 2018 quarter and retrospectively apply it; the resulting reclassification could be material, but was not quantified.
- AutoLab: Flex deconsolidated the newly formed automation venture after third-party investment diluted its voting interest below 50%. It retained an equity-method investment valued at about $132 million and recognized a non-cash gain of $91.8 million. Flex also entered a five-year subscription agreement and leased assets to AutoLab.
- Asset sale: Flex had agreed to sell its China-based Multek operations for approximately $273 million, net of cash. Assets and liabilities were classified as held for sale; the filing expected an immaterial gain or loss in the second quarter of FY2019, depending on working-capital levels.
- Other charges: The quarter included $17 million of distressed-customer asset impairments, $9 million of restructuring charges, and $16 million of legal and other costs, primarily related to an Audit Committee investigation and Multek-related charges.
Outlook, risks and contingencies
The filing provides no quantified revenue, earnings or margin guidance. Management described continued investment in design, engineering and manufacturing capabilities, including automotive, medical, footwear and IEI capacity. It cited new-program ramp costs, demand and product mix, capacity utilization, component availability, customer order changes, customer financial distress, labor costs, tax changes and trade regulations as factors that may affect results.
Disclosure controls and procedures were deemed ineffective as of June 29, 2018 because of previously disclosed material weaknesses in internal control over financial reporting. Remediation included strengthened contract review and approval, a centralized Contract Management Office, improved reporting controls and additional training; management could not estimate when full remediation would be complete.
Contingencies include a putative securities class action filed in May 2018 alleging misstatements or omissions in company disclosures; a licensor inquiry about royalties for products assembled in China, for which a material loss was described as reasonably possible if a claim is asserted and Flex is unsuccessful; and six Brazilian sales and import tax assessments totaling 346 million reais, approximately $90 million. Flex said it disputes the assessments. The filing also discusses potential SunEdison-related claims, though none had been asserted as of the report.
Most important facts for investors to verify
- How much of the sales and earnings comparison reflects underlying business performance versus ASC 606 adoption and contract amendments.
- Whether gross-margin pressure from program ramps, product mix and utilization improves in subsequent quarters.
- Working-capital requirements, cash conversion and the company’s dependence on receivables sales and securitization collections.
- Progress in remediating the material weaknesses and whether controls become effective after sufficient testing.
- Developments in the securities litigation, royalty inquiry and Brazilian tax assessments, including any change in estimated exposure.
- Completion and financial impact of the Multek divestiture, and the performance, valuation and related-party arrangements involving AutoLab.