Flex Ltd. — Form 10-Q Summary
Business context and period: Flex provides design, engineering, manufacturing and supply-chain services across Communications & Enterprise Compute (CEC), Consumer Technologies Group (CTG), Industrial & Emerging Industries (IEI), and High Reliability Solutions (HRS). This filing covers the fiscal third quarter and nine months ended December 31, 2018; comparisons are with the periods ended December 31, 2017. Deloitte reviewed, but did not audit, the interim financial statements and reported no material modifications were needed.
Key financial metrics
| Metric | Three months ended Dec. 31, 2018 | Nine months ended Dec. 31, 2018 |
|---|---|---|
| Net sales | $6.945 billion; +3% year over year | $20.079 billion; +6% |
| Gross profit / margin | $357 million / 5.1%, versus $446 million / 6.6% | $1.137 billion / 5.7%, versus $1.247 billion / 6.6% |
| Net income (loss) | $(45) million, or $(0.09) per diluted share; prior-year income was $118 million, or $0.22 per share | $158 million, or $0.30 per diluted share; prior-year income was $448 million, or $0.84 per share |
| Cash flow | Not presented for the quarter | Operating cash used: $2.329 billion; company-defined free cash flow used: $126 million, versus $42 million generated |
| Cash, debt and liquidity | At Dec. 31, cash was $1.503 billion; reported bank borrowings and long-term debt totaled approximately $2.950 billion. The $1.75 billion revolving facility was undrawn. Flex reported covenant compliance. |
Reported nine-month operating cash use was significantly affected by working-capital investment and the accounting presentation of deferred purchase-price collections from receivables securitizations. Flex included $2.708 billion of those collections in investing cash flow and in its company-defined free cash flow calculation. Free cash flow is a non-GAAP liquidity measure.
Material changes versus prior comparable periods
- Quarterly revenue rose 3%, led by CEC (+$281 million) and IEI (+$168 million); CTG declined $237 million and HRS declined $18 million. Nine-month sales increased 6%, with growth across all segments.
- Gross margin fell 150 basis points for the quarter and 90 basis points for the nine months. Management cited weaker revenue in some higher-margin automotive and semiconductor-capital-equipment businesses and restructuring charges.
- Quarterly results included $66 million of restructuring charges, $50 million of customer-related asset impairments, and a $70 million investment impairment. These items contributed to the quarterly net loss.
- Nine-month other income was only $9 million, compared with $172 million in the prior year, reflecting a smaller gain on deconsolidation of Bright Machines ($87 million) and a $70 million investment impairment; the prior period included gains from Elementum and Wink.
- Flex adopted ASC 606 on April 1, 2018. For the nine-month period, adoption increased reported revenue by about $32 million and reduced gross profit by about $1 million versus the prior accounting basis. Contract amendments that waived certain termination payment rights reduced revenue by $133 million and gross profit by $9 million versus the amounts otherwise expected under the standard.
Outlook, commentary, risks and unusual items
- No specific financial guidance or forecast was provided. Management said it expects existing cash, operating cash flows and available borrowing capacity to fund operations for at least the next 12 months.
- Management described ongoing portfolio optimization, including completion of the wind-down of NIKE operations in Mexico, targeted headcount reductions, and a focus on better-funded multinational customers in CTG. Further restructuring may occur and could materially affect results.
- Flex is completing its India capacity build-out, expected to be mostly completed in fiscal Q4 2019. Nine-month net capital expenditures were $505 million. Management cited long-term growth opportunities in IEI and HRS and outsourcing of advanced manufacturing, design and after-market services.
- A market-capitalization decline triggered an interim goodwill impairment test. No impairment was recorded; CTG’s estimated fair value exceeded carrying value by 23%, the smallest reported cushion. Management cautioned that failure to improve CTG performance could lead to future material impairment.
- Disclosure controls and procedures were deemed ineffective as of December 31, 2018 because of previously reported material weaknesses in internal control over financial reporting. Remediation was underway, but management could not estimate when it would be complete.
- CEO Michael McNamara retired December 31, 2018; the board was searching for a successor and appointed Scott Offer acting CEO on February 5, 2019.
- Contingencies include a disputed patent-royalty claim for which a material loss is reasonably possible but not estimable; Brazilian tax assessments totaling 346 million reais (about $88.6 million); a shareholder securities class action; and potential SunEdison preference claims. The filing gives no clear estimate of reasonably possible losses for most matters.
- More than half of cash was held outside Singapore; repatriation could incur withholding taxes. Receivables sold under financing programs were not on the balance sheet, and total outstanding sold receivables were $1.5 billion at quarter-end.
Important facts for investors to verify
- Whether gross-margin pressure, customer-related impairments and restructuring costs persist, and whether the stated CTG strategy improves performance.
- Cash conversion and working-capital trends, including the effects of receivables sales, deferred purchase-price collections and the new cash-flow classification.
- Progress in remediating material control weaknesses, and any developments in the CEO search and leadership transition.
- Updates on the CTG goodwill valuation and the investment portfolio, including whether further impairment charges arise.
- Developments and potential financial exposure from the patent-royalty dispute, Brazilian tax assessments, securities litigation and SunEdison-related matters.