Flex Ltd. — Form 10-Q Summary
Reporting period: Third quarter and first nine months of fiscal 2017, ended December 31, 2016. Comparisons are with the corresponding periods ended December 31, 2015, except balance-sheet comparisons, which are with March 31, 2016. Flex provides design, engineering, manufacturing and supply-chain services across four segments: Communications & Enterprise Compute (CEC), Consumer Technologies Group (CTG), Industrial & Emerging Industries (IEI), and High Reliability Solutions (HRS). Deloitte performed an interim review; the statements were not audited.
Key financial metrics
| Metric | Three months ended Dec. 31, 2016 | Prior-year quarter | Nine months ended Dec. 31, 2016 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $6.115 billion | $6.763 billion | $18.000 billion | $18.646 billion |
| Gross profit / margin | $416.5 million / 6.8% | $452.5 million / 6.7% | $1.136 billion / 6.3% | $1.202 billion / 6.4% |
| Net income | $129.5 million | $148.9 million | $232.7 million | $382.7 million |
| Diluted EPS | $0.24 | $0.27 | $0.42 | $0.67 |
- Quarterly sales fell 9.6% and net income fell 13.1%; gross margin improved 10 basis points. Quarterly pretax income rose to $140.2 million from $126.6 million, partly reflecting much lower other charges than in the prior-year quarter.
- Nine-month sales declined 3.5% and net income declined 39.2%. Nine-month gross margin decreased 10 basis points, while reported earnings included significant solar-related charges.
- Cash flow, nine months: Operating cash flow was $1.013 billion, versus $939.8 million. Capital expenditures were $413.6 million; company-defined free cash flow was $627.6 million, versus $525.8 million. Investing activities used $579.4 million, including acquisitions and capital spending; financing activities used $204.6 million.
- Liquidity and debt: Cash and equivalents were $1.857 billion; total reported bank borrowings and long-term debt were $2.867 billion, implying approximately $1.010 billion of net debt. Current assets were $8.614 billion and current liabilities $6.878 billion. The $1.5 billion revolving facility had no outstanding borrowings. Flex reported compliance with debt covenants.
- Balance sheet: Total assets were $12.803 billion, versus $12.385 billion at March 31, 2016. Inventory was $3.494 billion, broadly unchanged. Long-term debt, net of current portion, was $2.798 billion.
Material changes and business performance
- Quarterly CEC sales decreased $366.8 million, driven largely by lower networking and legacy server/storage sales. CTG sales decreased $208.9 million, principally due to lower demand from Lenovo/Motorola and Flex’s exit from a China operation dedicated to that customer. IEI sales decreased $73.9 million amid delays in large solar-tracking projects; HRS sales were essentially flat.
- For the nine-month period, CTG sales fell $806.4 million and CEC sales fell $240.4 million. Growth in HRS and IEI partly offset the declines. Segment income for the nine months increased to $610.3 million from $591.5 million, with total segment margin of 3.4% versus 3.2%.
- Quarterly segment margins were 3.0% for CEC, 3.2% for CTG, 3.5% for IEI and 8.1% for HRS. CTG benefited from a richer product mix and exit from lower-margin business; HRS benefited from higher-value programs and acquisitions. Lower capacity utilization pressured CEC, while project delays weighed on IEI.
- Flex completed three acquisitions during the nine months, including manufacturing and development facilities acquired from Bose for $161.9 million net of cash acquired. It also invested $60 million for a noncontrolling interest in a joint venture with RIB Software AG. Two nonstrategic businesses were divested for approximately $33 million in proceeds.
Outlook, commentary, risks and unusual items
- Management said its portfolio strategy emphasizes longer-life-cycle, higher-margin businesses and design- and engineering-led “Sketch-to-Scale” services. It cited improved segment margins despite lower sales and continued investment in innovation and engineering. The filing provides no specific revenue or earnings guidance.
- Flex expects its footprint and corporate cost rationalization plan to be completed by fiscal year-end 2017. Estimated fiscal 2017 costs are $40 million to $50 million; approximately $29 million had been recognized in the first nine months.
- A $92.9 million charge was recorded in cost of sales for the nine months related to solar inventory write-downs ($60 million), solar equipment impairment ($16 million), and other solar-related costs ($16.9 million). The filing links the exposure to falling solar-module prices, delayed projects and former customer SunEdison’s bankruptcy. Flex had previously recorded a $61 million reserve for SunEdison receivables.
- Other risks highlighted include customer order cancellations or delays, demand and product-mix shifts, capacity utilization, component availability, customer financial distress, acquisition integration, labor costs, tax changes, and trade regulation changes. The ten largest customers represented 43% of nine-month sales; no customer exceeded 10% in the current quarter or nine-month period.
- Brazilian subsidiaries face three sales/import tax assessments totaling approximately $90 million at the stated exchange rate. Flex intends to contest them, but cannot estimate the likelihood of an unfavorable outcome or a reasonably possible loss range; resolution may take years. A separate approximately $100 million Brazilian tax assessment received a final favorable judgment in the first quarter of fiscal 2017.
- Foreign-currency translation reduced other comprehensive income by $36.4 million in the quarter and $22.3 million in the nine months. Flex reported no material change in interest-rate or foreign-exchange market-risk exposure. Approximately half of cash was held by foreign subsidiaries; repatriation of some funds could incur withholding taxes, while management intends to keep certain foreign earnings permanently reinvested.
- Management stated that cash, expected operating cash flows and available borrowing capacity should fund operations for at least 12 months. The company extended a $700 million term loan’s maturity to November 2021 and borrowed an incremental $130 million; a separate €100 million five-year term loan was entered into after quarter-end, on January 23, 2017.
Most important facts for investors to verify
- Whether the solar-related inventory, project-delay and SunEdison exposures lead to further charges or cash-flow pressure.
- Whether sales declines in CEC and CTG stabilize, and whether the improved CTG, IEI and HRS segment margins persist.
- Actual restructuring costs and benefits compared with the $40 million–$50 million fiscal 2017 estimate.
- Working-capital and cash-flow quality, including reliance on receivables sales and the $668.9 million deferred purchase-price receivable held in current assets.
- Debt maturities, covenant headroom, foreign-cash accessibility, and outcomes of the unresolved Brazilian tax assessments.