Flextronics International Ltd. — Form 10-Q Summary
Business context and reporting period
Quarterly report for the three months ended June 27, 2014, the first quarter of fiscal 2015. Flextronics provides global supply-chain, design, manufacturing, logistics and after-sales services to electronics OEMs across four business groups. The interim financial statements are unaudited; Deloitte & Touche conducted a review, not an audit.
Financial performance and liquidity
| Metric | Q1 FY2015 | Prior-year quarter |
|---|---|---|
| Net sales | $6.643 billion | $5.791 billion |
| Gross profit / margin | $380.8 million / 5.7% | $311.0 million / 5.4% |
| Net income | $173.9 million | $59.3 million |
| Diluted EPS | $0.29 | $0.09 |
| Operating cash flow | $(81.2) million | $198.6 million |
| Free cash flow | $(154.1) million | $57.2 million |
At June 27, 2014, cash and cash equivalents were $1.348 billion, total debt was approximately $2.129 billion, and the company had an undrawn $1.5 billion revolving credit facility expiring in March 2019. Management reported compliance with debt covenants. Total assets were $12.068 billion and shareholders’ equity was $2.301 billion. The effective tax rate was 8.4%, compared with 0.5% in the prior-year quarter.
Material changes versus the prior-year quarter
- Sales increased 14.7%. Consumer Technology Group (CTG) revenue rose to $2.160 billion from $1.546 billion, primarily reflecting the Motorola Mobility manufacturing operations acquired in fiscal 2014 and their subsequent ramp. Industrial & Emerging Industries revenue rose to $1.134 billion from $906 million; Integrated Network Solutions was slightly lower at $2.502 billion versus $2.532 billion.
- Gross margin improved 30 basis points, partly because the prior-year quarter included $35.1 million of restructuring charges in cost of sales. Management noted that CTG generally has lower margins than other groups.
- SG&A declined to $209.3 million from $223.6 million, which management attributed primarily to cost-reduction and rationalization measures.
- Net income benefited from $44.0 million of other income, principally the reversal of a $55.0 million customer-related charge after a contract amendment, partly offset by an $11.0 million loss on the sale of a western European facility.
- Operating cash flow moved to a use of cash from positive cash generation, mainly due to a $376.6 million outflow from working-capital changes and other items, predominantly reductions in customer deposits received in prior periods. Cash declined by $246.0 million during the quarter.
Outlook, commentary and risks
Management expected programs launched during fiscal 2014 to ramp to higher production volumes during fiscal 2015 and beyond. It cautioned that gross and operating margins could be pressured before volumes increase, owing to start-up costs, inefficiencies, under-absorbed overhead and low initial production; margins were expected to improve as volumes and cost controls take effect. The filing provides no specific earnings or revenue guidance.
Management said cash balances, anticipated operating cash flows and available borrowing capacity should fund operations for at least 12 months. Risks include customer order cancellations or delays, product acceptance and short life cycles, component availability, capacity utilization, customer concentration, acquisition integration, labor costs, foreign exchange and tax changes. The top ten customers represented approximately 53% of sales, and Google, including Motorola, exceeded 10%.
The company faced a Xilinx lawsuit seeking unspecified damages and other relief; management said the outcome was not determinable and expected any probable or reasonably possible losses beyond accruals not to be material. A non-operating Brazilian subsidiary received an approximately $100 million tax assessment; the company said it believed the assessment lacked legal basis and considered losses remote. Receivables sold under sales programs were excluded from the balance sheet; outstanding sold receivables were approximately $1.2 billion at quarter-end. More than half of cash was held by foreign subsidiaries, and repatriation of some foreign earnings could incur withholding taxes.
Key facts for investors to verify
- Whether CTG program ramps deliver the expected volume and margin improvement, particularly given CTG’s lower-margin mix.
- Whether working-capital requirements normalize and operating cash flow recovers; assess the company’s reliance on receivables sales and customer advances.
- The sustainability of reported earnings excluding the $55 million customer-charge reversal and the facility-disposition loss.
- Developments in the Xilinx litigation and the approximately $100 million Brazilian tax assessment.
- Debt, covenant and liquidity position, including the location and potential tax cost of accessing foreign cash.