Flex Ltd. — Q1 FY2018 Form 10-Q
Reporting period: Three months ended June 30, 2017; comparison is the three months ended July 1, 2016. The current quarter had 91 days versus 92 days in the prior-year quarter. Flex provides design, engineering, manufacturing, and supply-chain services across CEC, CTG, IEI, and HRS. Interim financial statements were reviewed, not audited.
Financial performance and liquidity
- Revenue: $6.008 billion, up 2% year over year. Gross profit was $406.9 million; gross margin was 6.8%, down 10 basis points.
- Profit: Operating expenses included $250.8 million of SG&A and $19.9 million of intangible amortization. Income before taxes was $145.5 million; net income was $124.7 million, up from $105.7 million. Diluted EPS was $0.23 versus $0.19. The effective tax rate increased to 14.3% from 9.6%.
- Segment income: Total segment income was $177.9 million, down from $190.2 million. CEC sales fell to $1.973 billion and segment margin declined to 2.5%; CTG sales rose to $1.512 billion, but margin fell to 1.2%. IEI sales were $1.391 billion with a 4.0% margin; HRS sales were $1.132 billion with an 8.0% margin.
- Cash flow: Operating cash flow was $138.5 million, down from $263.9 million. Capital expenditures, net of asset-sale proceeds, were $119.4 million; reported free cash flow was $19.1 million versus $120.6 million. Cash and equivalents decreased $248.5 million to $1.582 billion.
- Balance sheet and debt: Total debt was approximately $2.965 billion, implying net debt of about $1.382 billion after cash. Current assets were $8.558 billion and current liabilities $6.758 billion (current ratio about 1.27). Inventory was $3.601 billion. Flex reported no borrowings on its $1.75 billion revolving facility and compliance with debt covenants.
- Working capital: Days sales outstanding were 42, inventory days 57, payable days 76, and the cash conversion cycle 23 days, compared with 39, 59, 71, and 27 days, respectively, in the prior-year quarter.
Changes and notable items
- Sales growth in CTG, IEI, and HRS was partly offset by a $223 million decline in CEC. Management cited stronger connected-living and mobile-device sales in CTG, industrial and solar growth in IEI, and automotive growth in HRS; CEC weakness reflected telecom and legacy server/storage declines.
- Gross margin pressure reflected investment and ramp costs in CTG, material-management costs, labor inefficiencies, and capacity refinements. Management said higher-margin IEI and HRS mix partly offset these pressures. SG&A rose with expanded design and engineering resources and acquisition costs.
- Other charges (income) included a $38.7 million non-cash gain on the sale of Wink, contributing to $36.2 million of net other income for the quarter. The contingent sale consideration was estimated at $59 million, with settlement expected in fiscal Q4 2018.
- Flex acquired AGM Automotive for $213.7 million net of cash acquired, expanding automotive capabilities in HRS. The purchase-price allocation included $108 million of estimated customer-related intangibles and $36.6 million of goodwill; valuation remained subject to completion. AGM’s reported quarter contribution was immaterial.
- Flex entered a new five-year credit facility on June 30, 2017, including a $1.75 billion revolver and a $502.5 million term loan due in 2022, replacing its prior facility. Flex repurchased 4.5 million shares for $73.9 million; $211.5 million remained under the authorization.
- Receivables sold under its programs included approximately $1.2 billion outstanding and excluded from the balance sheet; Flex also held $547.5 million of deferred purchase-price receivables. These programs support liquidity but involve ongoing dependence on receivables funding.
Outlook, risks, and contingencies
Flex gave no specific revenue or earnings guidance in the supplied filing text. Management said existing cash, expected operating cash flows, and available credit were expected to fund operations for at least the next 12 months. More than half of cash was held by foreign subsidiaries; repatriation could incur withholding taxes, while certain foreign earnings were intended to remain invested abroad.
Key stated operating risks include volatile customer demand and order changes, customer product acceptance and short product life cycles, program ramp execution and capacity utilization, component availability, labor costs, acquisition integration, and changes in tax and trade rules. Flex expects the revenue-recognition standard effective in fiscal 2019 to change timing for a significant majority of electronics-manufacturing contracts, generally recognizing revenue earlier; it anticipates related balance-sheet changes, including lower inventory and higher unbilled contract assets. The transition method had not been selected.
Most important facts for investors to verify
- Whether operating cash flow and free cash flow recover from the year-over-year decline, and how working-capital needs evolve.
- Whether CTG ramp costs and weaker CEC utilization improve, and whether segment margins stabilize.
- The final AGM purchase-price allocation and integration performance, and the realization and settlement of Wink consideration.
- How much liquidity depends on receivables sales and deferred purchase-price balances, and whether the new credit facility’s covenants remain comfortably satisfied.
- The eventual timing, balance-sheet effects, and transition method for the new revenue-recognition standard.