Flex Ltd. (formerly Flextronics International Ltd.) — Form 10-Q
Reporting period: Fiscal third quarter ended December 31, 2015, and nine months ended December 31, 2015. Amounts are in U.S. dollars. Interim financial statements were reviewed, not audited.
Business context
Flex provides design, engineering, manufacturing and supply-chain services to original equipment manufacturers across four segments: Integrated Network Solutions (INS), Consumer Technology Group (CTG), Industrial and Emerging Industries (IEI), and High Reliability Solutions (HRS). The company said it was shifting its portfolio toward longer-life-cycle, higher-margin businesses. During the period, it acquired automotive supplier Mirror Controls International (MCi), solar-tracking company NEXTracker, an Alcatel-Lucent optical transport facility and six smaller businesses.
Financial performance and liquidity
| Metric | Three months ended Dec. 31, 2015 | Prior-year quarter | Nine months ended Dec. 31, 2015 | Prior-year period |
|---|---|---|---|---|
| Net sales | $6.763 billion | $7.025 billion | $18.646 billion | $20.196 billion |
| Gross profit / margin | $452.5 million / 6.7% | $408.7 million / 5.8% | $1.202 billion / 6.4% | $1.167 billion / 5.8% |
| Income before taxes | $126.6 million | $170.5 million | $385.4 million | $514.8 million |
| Net income | $148.9 million | $152.9 million | $382.7 million | $465.7 million |
| Diluted EPS | $0.27 | $0.26 | $0.67 | $0.78 |
| Operating cash flow | Not presented for the quarter | $939.8 million | $669.4 million | |
| Free cash flow | Not presented for the quarter | $525.8 million | $505.0 million |
For the nine-month period, capital expenditures were $418.6 million; acquisitions and divestitures used $900.2 million of cash. Operating cash flow included a $175.1 million benefit from changes in working capital and other items, principally higher accounts payable, partly offset by higher receivables.
At December 31, cash and cash equivalents were $1.634 billion, total debt was $2.807 billion, and the $1.5 billion revolving credit facility had no borrowings outstanding. Current assets were $8.957 billion and current liabilities $7.152 billion. The company reported covenant compliance and said existing cash, expected operating cash flows and available borrowing capacity should fund operations for at least 12 months. More than half of cash was held outside Singapore; repatriation of some foreign cash could incur withholding taxes.
Material changes versus the prior comparable period
- Quarterly sales declined 3.7%; nine-month sales fell 7.7%. The main weakness was CTG, including lower demand from the company’s largest mobile-business customer. Nine-month softness also reflected INS, particularly server and storage.
- Gross margin improved 90 basis points in the quarter and 60 basis points for nine months. Management attributed the improvement to business mix, operational execution, and stronger HRS and IEI contributions, including acquisitions and new program ramps.
- Nine-month net income fell despite higher gross profit, reflecting lower pretax income and the prior-year benefit from a $55 million reversal of a customer-related contractual obligation. The effective tax rate was 0.7% versus 9.5% in the prior-year nine-month period; current-period tax benefits included a $39.3 million valuation-allowance release and a $37.2 million reduction in uncertain-tax-position liabilities.
- CTG quarterly sales decreased by about $589 million; HRS and IEI sales increased. HRS quarterly segment margin rose to 8.1% from 6.1%, and IEI to 4.1% from 2.0%; CTG margin declined to 2.4% from 2.8%.
- Debt increased from $2.084 billion at March 31, 2015, partly following issuance of $600 million of 4.750% notes due 2025 and additional borrowing. The company also spent $331.7 million repurchasing shares during the nine months.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no quantified revenue or earnings guidance. Management emphasized portfolio diversification, innovation and growth in design, engineering and after-market services; it cautioned that interim results are not necessarily indicative of full-year results.
- Unusual charges: Other charges were $44.4 million in the quarter and $46.3 million for nine months, mainly a $26.8 million loss on disposition of a Western European facility (including a $25.3 million noncash currency translation loss) and a $21.8 million impairment of a non-core investment, partly offset by currency translation gains.
- Acquisitions: MCi cost approximately $555.2 million net of acquired cash. NEXTracker involved approximately $238.9 million initial cash consideration and $81.0 million estimated contingent consideration, potentially rising to $97.2 million based on future revenue targets. NEXTracker purchase accounting remained preliminary.
- Customer and operating risks: The ten largest customers generated approximately 46% of sales in both the quarter and nine-month period; Motorola Mobility, including Lenovo, exceeded 10%. Risks include customer order cancellations or delays, short product cycles, demand shifts, distressed customers, component availability, capacity utilization, acquisition integration, labor costs and macroeconomic conditions.
- Contingencies: A Brazilian subsidiary contested a sales/import-tax assessment of approximately 50 million Brazilian reals ($12.8 million at period-end exchange rates), plus interest; the company could not estimate the possible loss range. A separate approximately $100 million Brazilian tax assessment was described as having remote expected losses. The company said other ordinary-course legal matters were not expected to be material beyond amounts accrued.
- Receivables programs: Flex sold receivables through securitization and factoring programs. At December 31, $534.7 million of deferred purchase-price receivables was recorded as an asset; approximately $1.2 billion of sold receivables for cash was not on the balance sheet. These programs support liquidity but involve continued reliance on receivables sales.
- Customer inventory return: Subsequent to quarter-end, Flex agreed in principle to accept approximately $100 million of previously shipped inventory. It reversed $17.9 million of previously recognized revenue and related cost of sales in the quarter; management considered the remaining uncollected customer amount recoverable.
Most important facts for investors to verify
- Whether CTG demand, particularly from the largest mobile customer, stabilizes and whether customer concentration remains elevated.
- Whether improved gross and segment margins persist as acquisitions integrate and new programs ramp, and how elevated SG&A, amortization and acquisition costs affect earnings.
- The final NEXTracker purchase-price allocation and contingent-consideration exposure, and the realized contribution of MCi and other acquisitions.
- Cash conversion and dependence on working-capital timing, factoring and securitization; also monitor capital spending, acquisition spending and debt growth.
- Whether tax benefits are repeatable: the current-period effective tax rate was unusually low and included specified valuation-allowance and uncertain-tax-position releases.
- Recoverability of customer-related receivables and the expected outcome of the Brazilian tax matters and other disclosed contingencies.