Business context and reporting period
Flex Ltd. filed this Form 10-K for the fiscal year ended March 31, 2018 (FY2018), not a standalone calendar 2017 Q4 report. Flex provides design, engineering, manufacturing, supply-chain and after-market services across Communications & Enterprise Compute (CEC), Consumer Technologies Group (CTG), Industrial & Emerging Industries (IEI), and High Reliability Solutions (HRS). It operated more than 100 facilities in approximately 35 countries and employed about 200,000 people.
Financial performance and condition
| Metric | FY2018 | FY2017 |
|---|---|---|
| Net sales | $25.44 billion | $23.86 billion |
| Gross profit / margin | $1.60 billion / 6.2% | $1.52 billion / 6.3% |
| Income before tax | $521 million | $371 million |
| Net income / diluted EPS | $429 million / $0.80 | $320 million / $0.59 |
| Cash from operations | $754 million | $1.15 billion |
| Free cash flow | $236 million | $660 million |
| Cash and cash equivalents at year-end | $1.47 billion | $1.83 billion |
| Total debt | About $2.94 billion | About $2.95 billion |
| Working capital | $1.90 billion | $1.88 billion |
Revenue rose about 7%, while gross margin declined 10 basis points. Operating cash flow fell approximately $396 million, and free cash flow declined $424 million, reflecting weaker operating cash generation and higher capital spending. Flex reported $517 million of net capital expenditures in its liquidity discussion. The effective tax rate was 17.7%, versus 13.8% in FY2017. Year-end current assets were $9.17 billion and current liabilities $7.27 billion.
Segment results
- CEC: Sales $7.73 billion, down 8%; segment income $186 million, margin 2.4%.
- CTG: Sales $6.97 billion, up 10%; segment income $112 million, margin 1.6%, down from 2.8%.
- IEI: Sales $5.97 billion, up 20%; segment income $235 million, margin 3.9%.
- HRS: Sales $4.77 billion, up 15%; segment income $381 million, margin 8.0%.
Material changes and unusual items
- FY2018 net income increased 34%, but included a $152 million gain from deconsolidating Elementum and a $39 million gain on the sale of Wink. These non-recurring gains materially benefited reported earnings.
- Sales growth was led by IEI and HRS, while CEC contracted. CTG margin weakened due in part to lower contribution and continued losses from a strategic customer partnership; HRS margin edged down amid investment and program ramps.
- Flex recorded $91 million in restructuring charges, including $79 million of cash charges, primarily severance; approximately 6,203 employee terminations were identified. FY2017 restructuring charges were $49 million.
- Ten largest customers represented about 41% of FY2018 sales, down from 43%; no single customer exceeded 10% of sales. China accounted for 29% of sales by manufacturing location.
- In March 2018, Flex agreed to sell its China-based Multek operations for approximately $273 million net of cash; closing was expected in Q2 FY2019, subject to customary conditions and regulatory approvals.
Outlook, risks and contingencies
- No specific numerical earnings or revenue guidance is provided. Management said cash balances, expected operating cash flows and available borrowing capacity should fund operations for at least the next 12 months.
- Management identified material weaknesses in controls over accounting for accrued customer contractual obligations and in aspects of the control environment and monitoring. Management said no material misstatements were identified for FY2016–FY2018 and described remediation efforts; the weaknesses were not yet remediated. The auditor issued an adverse opinion on internal control over financial reporting, while giving an unqualified opinion on the financial statements.
- A putative securities class action filed in May 2018 alleges misstatements or omissions in company disclosures. Flex also reported a patent-licensor inquiry concerning royalties on products assembled in China; the company could not estimate a potential loss.
- SunEdison’s bankruptcy-related potential claims remain unresolved. Flex cited approximately $167.8 million of transfers identified in bankruptcy schedules as its estimate of maximum reasonably possible contingent loss; no preference claim had been asserted as of the filing.
- A Brazilian subsidiary faces six sales and import tax assessments totaling approximately 346 million reais (about $104 million); proceedings remain at the administrative stage and no final determination had been made.
- Other key risks include customer order cancellations and short commitments, component shortages, low manufacturing utilization, intense competition, foreign exchange and trade-policy exposure, tax uncertainty, and cybersecurity and regulatory compliance.
- Adoption of the new revenue standard in FY2019 was expected to move recognition earlier for certain manufacturing contracts. Flex estimated a $30–$70 million reduction to opening accumulated deficit, $300–$500 million lower finished-goods and work-in-process inventory, and a corresponding $330–$550 million increase in unbilled receivables.
Most important facts for investors to verify
- Whether the material weaknesses are remediated and whether customer-contract accrual controls operate effectively over a sufficient testing period.
- How much of FY2018 earnings growth reflects recurring operations versus the Elementum and Wink gains, restructuring and contingencies.
- Whether cash conversion and free cash flow recover after the FY2018 decline, including the effects of receivables sales and working-capital movements.
- Progress and final proceeds from the Multek divestiture, and the performance and margins of CTG and CEC programs.
- Developments and potential financial exposure from the securities litigation, SunEdison matter, patent inquiry and Brazilian tax assessments.
- The actual balance-sheet and income-statement effects of adopting the new revenue recognition standard.