Business context and reporting period
Flextronics International Ltd. (now branded Flex) filed this unaudited Form 10-Q for its second quarter of fiscal 2016, ended September 25, 2015, and the six months then ended. Flex provides design, engineering, manufacturing and supply-chain services across four segments: Integrated Network Solutions (INS), Consumer Technology Group (CTG), Industrial & Emerging Industries (IEI), and High Reliability Solutions (HRS). Deloitte & Touche conducted an interim review, not an audit, and reported no material modifications needed for GAAP presentation.
Key financial results
| Metric | Quarter ended September 25, 2015 | Six months ended September 25, 2015 |
|---|---|---|
| Net sales | $6.317 billion | $11.883 billion |
| Gross profit; gross margin | $396.9 million; 6.3% | $749.3 million; 6.3% |
| Income before taxes | $140.3 million | $258.9 million |
| Net income; diluted EPS | $123.0 million; $0.22 | $233.8 million; $0.41 |
| Operating cash flow | Not provided for the quarter | $662.0 million |
| Free cash flow | Not provided for the quarter | $368.0 million |
At September 25, cash and cash equivalents were $1.668 billion; total debt was $2.666 billion, implying approximately $998 million of net debt. Current assets were $8.985 billion and current liabilities $7.033 billion. The $1.5 billion revolving credit facility had no borrowings outstanding, and the company reported compliance with credit-facility and note covenants. Six-month capital expenditures were $296.4 million.
Material changes versus the prior comparable period
- Quarterly sales fell 3.2% year over year, from $6.529 billion; six-month sales declined 9.8%, from $13.171 billion. CTG and INS softness drove the declines, including lower demand from the largest mobile customer and declines in server, storage, telecom and networking.
- Quarterly gross profit rose $19.8 million and gross margin improved 50 basis points to 6.3%. Six-month gross profit decreased $8.6 million, while gross margin also improved 50 basis points. Flex attributed stronger margins to business mix and improved HRS and INS performance.
- Quarterly net income decreased from $138.9 million to $123.0 million; six-month net income fell from $312.8 million to $233.8 million. Prior-year six-month results included $55 million of other income from reversal of a customer contractual obligation, making comparisons less favorable.
- Six-month operating cash flow increased to $662.0 million from $306.2 million, helped by working-capital movements, including higher accounts payable. Free cash flow increased to $368.0 million from $167.9 million.
- Segment performance was mixed. Quarterly HRS sales increased to $954.9 million and segment margin rose to 7.5%; INS sales fell to $2.205 billion but margin improved to 3.0%. CTG sales declined to $2.011 billion and margin fell to 2.0%; IEI sales rose to $1.146 billion while margin fell to 2.8%.
Outlook, management commentary, risks and unusual items
- Management said existing cash, expected operating cash flows and available credit were sufficient to fund operations for at least the next 12 months. No specific revenue or earnings guidance was provided in the filing.
- Management expects SG&A and intangible amortization to increase in subsequent periods as acquisitions are integrated. Flex’s strategy is to increase its mix of longer-life-cycle, higher-margin businesses.
- Flex paid approximately $555.2 million, net of acquired cash, for automotive supplier Mirror Controls International (MCi), completed June 29; it also acquired an Alcatel-Lucent optical transport facility for approximately $67.5 million and completed three smaller acquisitions. MCi contributed to HRS and raised goodwill and intangible assets. On September 28, after quarter-end, Flex acquired NEXTracker for approximately $245 million net of acquired cash, with up to $97.2 million of contingent consideration.
- Flex issued $600 million of 4.750% senior notes due 2025. Six-month share repurchases totaled $242.0 million; $422.5 million remained available under the current authorization at quarter-end.
- Customer concentration remains relevant: the ten largest customers represented 47% of quarterly sales and 46% of six-month sales. Motorola Mobility, including sales from Lenovo, accounted for more than 10% in both periods.
- Key risks identified include customer demand changes, order cancellations or delays, short product life cycles, customer concentration and financial distress, production yields and capacity utilization, component availability, labor costs, acquisition integration, and tax changes. The company also described Brazilian tax assessments of approximately $12 million plus interest and approximately $100 million; it contests both and says outcomes remain uncertain. A Xilinx lawsuit was settled and dismissed in August 2015 on terms not material to the financial statements.
- More than half of cash was held by foreign subsidiaries; repatriation could incur withholding taxes. Flex also relies on receivables-sale programs: approximately $1.4 billion of receivables sold remained off balance sheet at quarter-end, alongside a $537.6 million deferred purchase-price receivable included in other current assets.
Important facts for investors to verify
- Whether lower CTG and INS demand, particularly from the largest mobile customer, persists and how customer concentration evolves.
- Whether margin gains continue as HRS/INS performance and higher-margin portfolio mix offset weaker IEI and CTG trends.
- Cash-flow quality and sustainability, including working-capital timing, capital spending, and ongoing use of receivables-sale programs.
- Acquisition integration, including MCi’s contribution and NEXTracker’s post-quarter acquisition costs, contingent consideration and operating results.
- Debt-service capacity, future borrowing and repurchase decisions, and the accessibility and tax consequences of overseas cash.
- Developments in the Brazilian tax matters and other disclosed contingencies.