Flex Ltd. (formerly Flextronics International Ltd.) — Q1 FY2016 10-Q
Reporting period: Three months ended June 26, 2015; comparison is the three months ended June 27, 2014. Flex provides design, engineering, manufacturing and supply-chain services across four groups: HRS, CTG, IEI and INS. Deloitte performed an interim review, not an audit, and reported no material modifications needed for GAAP conformity.
Key financial results
| Metric | Q1 FY2016 | Prior-year quarter |
|---|---|---|
| Net sales | $5.566 billion | $6.643 billion |
| Gross profit / margin | $352.3 million / 6.3% | $380.8 million / 5.7% |
| Income before taxes | $118.6 million | $189.9 million |
| Net income | $110.9 million | $173.9 million |
| Diluted EPS | $0.19 | $0.29 |
| Operating cash flow | $362.3 million | $(81.2) million |
| Free cash flow (company-defined) | $225.4 million | $(154.1) million |
Gross margin was 6.3% and net margin was 2.0%, versus 5.7% and 2.6%, respectively, a year earlier. Free cash flow is a non-GAAP measure, calculated as operating cash flow less net property and equipment purchases.
Liquidity and debt: Cash and cash equivalents were $2.331 billion at quarter-end, up from $1.628 billion at March 31, 2015. Total bank borrowings and debt were $2.677 billion, versus $2.084 billion; approximate net debt was $346 million. Current assets were $9.080 billion and current liabilities $6.496 billion. The company had no borrowings under its $1.5 billion revolving credit facility and reported compliance with credit-facility and indenture covenants. More than half of cash was held by foreign subsidiaries; repatriation could incur withholding taxes.
Operating cash flow included a $141.3 million contribution from changes in working capital and other items. Investing cash use was $162.0 million, including $138.3 million of property and equipment purchases. Financing cash provided was $506.4 million, mainly reflecting net proceeds from new debt, partly offset by $100.0 million of share repurchases.
Changes versus the prior comparable period
- Sales fell about 16%, primarily from lower CTG mobile-device sales and broad declines in telecom, server and storage. CTG revenue declined to $1.565 billion from $2.222 billion; INS fell to $1.967 billion from $2.440 billion. HRS increased to $904.6 million from $855.7 million, while IEI was broadly flat at $1.130 billion.
- Gross profit declined $28.4 million, but gross margin improved 60 basis points, attributed mainly to a higher HRS mix and improved operational efficiency. IEI margin was pressured by underperforming program ramps and higher segment investment.
- Net income decreased about 36%. The prior-year quarter included $44.0 million of net other income, principally a $55.0 million reversal of a previously recorded customer contractual obligation, partly offset by an $11.0 million facility-disposition loss. The current quarter had $0.2 million of net other charges.
- Operating cash flow swung from use of $81.2 million to provision of $362.3 million. Days in inventory rose to 60 from 52 year over year; the cash conversion cycle was 28 days in both periods.
- Ten largest customers accounted for 45% of sales, down from 53%; Motorola Mobility, including sales from Lenovo, represented more than 10% in the current quarter.
Outlook, commentary and risks
- No specific revenue or earnings guidance is provided. Management said existing cash, expected operating cash flows and available credit should fund operations for at least the next 12 months.
- Management expects SG&A to increase as acquisitions are integrated, amortization to rise following acquisitions, and interest expense to increase due to the new 4.750% notes.
- On June 8, 2015, Flex issued $600 million face value of 4.750% senior unsecured notes due 2025, receiving about $595.3 million net proceeds for general corporate purposes. The offering increased reported debt; covenants include restrictions on liens, sale-leasebacks and funded debt, subject to exceptions.
- After quarter-end, Flex paid approximately $555 million, net of cash acquired, for Mirror Controls International, including repayment of its existing debt, and approximately $69.5 million for an Alcatel-Lucent optical transport plant. Their results were to be included from Q2 FY2016.
- Flex repurchased 7.7 million shares for approximately $94.4 million during the quarter; $144.0 million remained available under its $500 million authorization.
- Risks include customer order cancellations or delays, product demand and short life cycles, program execution and capacity utilization, component availability, customer concentration, labor costs, acquisitions and tax changes. Approximately $1.4 billion of receivables had been sold under receivables programs and was off balance sheet; the company retained $516.3 million of deferred purchase price receivables.
- Contingencies include Xilinx litigation, for which management said any probable or reasonably possible losses beyond accrued amounts were not expected to be material, and Brazilian tax assessments. The company could not estimate a loss range for one Brazilian assessment; it considered a separate approximately $100 million assessment against a non-operating subsidiary to have remote loss risk.
- The company reported no material change in market-risk exposure, effective disclosure controls, and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether weaker CTG and INS demand persists, and whether HRS/IEI growth and margin improvements can offset it.
- How acquisition integration, including MCi and the Alcatel-Lucent plant, affects sales, margins, cash needs and debt.
- Whether working-capital cash generation is sustainable, given higher inventory days and reliance on receivables sales programs.
- The effect of the 2025 notes, acquisition spending and any further buybacks on leverage, interest expense and liquidity.
- Developments in the Brazilian tax matters and Xilinx litigation, including any change in estimated exposure.