Flex Ltd. Form 10-Q Summary
Business context and reporting 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 Form 10-Q covers the fiscal second quarter and first six months ended September 28, 2018; the comparable periods ended September 29, 2017. Financial statements are unaudited and were reviewed by Deloitte, which reported no material modifications needed for conformity with U.S. GAAP.
Financial results and liquidity
| Metric | Three months ended Sep. 28, 2018 | Six months ended Sep. 28, 2018 |
|---|---|---|
| Net sales | $6.711 billion, up 7% year over year | $13.135 billion, up 7% |
| Gross profit / margin | $402.3 million / 6.0% (prior year 6.3%) | $780.2 million / 5.9% (prior year 6.5%) |
| Net income | $86.9 million, versus $205.1 million | $202.9 million, versus $329.8 million |
| Diluted EPS | $0.16, versus $0.38 | $0.38, versus $0.61 |
| Segment income | $223.5 million, versus $188.3 million | $411.2 million, versus $366.2 million |
For the quarter, CEC, IEI and HRS generated segment income of $62.9 million, $65.9 million and $89.6 million, respectively; CTG generated $31.2 million. CEC and IEI margins improved, while HRS margin declined and CTG’s was slightly lower. Quarterly SG&A fell to $227.7 million from $274.1 million.
Six-month operating cash flow was a use of $1.708 billion, compared with a use of $2.172 billion in the prior-year period. Investing activities provided $1.703 billion, including $1.813 billion of collections on deferred purchase price receivables and $264 million of net proceeds from the Multek divestiture. Capital expenditures were $363 million. The company’s defined free cash flow was negative $245 million, versus positive $54 million; this non-GAAP measure includes deferred purchase price collections and deducts net property and equipment purchases.
At September 28, cash and cash equivalents were $1.378 billion; total current and long-term debt was approximately $2.925 billion. The $1.75 billion revolving credit facility was undrawn, and the company reported compliance with debt covenants. Management said available cash, expected operating cash flows and borrowing capacity should fund operations for at least 12 months. Net working capital was approximately $1.8 billion, or 6.7% of annualized quarterly sales. Inventories rose $643 million from March 31, 2018, partly to support program ramps amid component shortages and capacity constraints.
Material changes and unusual items
- ASC 606 was adopted April 1, 2018. It established contract asset balances and changed the timing of revenue recognition for qualifying contracts. Adoption increased reported six-month revenue by $27.2 million and gross profit by $0.7 million versus the amounts absent adoption; the opening accumulated deficit increased by $37.9 million. Customer contract amendments also reduced revenue and gross profit by approximately $132.7 million and $9.3 million, respectively, compared with the amounts that would otherwise have been reported under the described scenarios.
- Six-month other income included an $87.3 million non-cash gain from deconsolidating AutoLab, now Bright Machines. The prior-year comparable period included a $151.6 million gain from deconsolidating Elementum.
- Gross profit included $30.1 million of exit costs, primarily an estimated fixed-asset impairment related to winding down Nike footwear manufacturing in Mexico. Customer-related asset impairment charges also reflected provisions for certain financially troubled customers.
- After a significant October 2018 market-value decline, Flex began an interim goodwill impairment test. Preliminary work indicated CTG’s fair value was probably below its carrying value; CTG goodwill was $103 million. No charge was recorded because the analysis was incomplete and any loss was not yet reasonably estimable. The company expected to complete the analysis by December 31, 2018; a material impairment was possible.
- Flex sold its China-based Multek operations during the quarter for approximately $264.4 million net of cash, with an immaterial loss.
Outlook, risks and contingencies
The filing gives no specific forward financial guidance. Management cited growth from cloud and data-center demand, 5G-related programs, new industrial and medical programs, and expansion in India, while noting that program ramps, product mix and start-up costs can affect margins. Key operating risks include customer order cancellations or delays, component shortages, capacity constraints, financially troubled customers, labor costs, demand shifts, trade regulations and dependence on successful customer products. The ten largest customers represented about 43% of sales in the quarter and first half; no single customer exceeded 10%.
Disclosure controls and procedures were deemed ineffective as of September 28, 2018 because of previously identified material weaknesses in internal control over financial reporting. Remediation efforts were underway, but completion timing was not certain. The CEO announced plans to retire effective December 31, 2018, and the board began a successor search.
Contingencies include a securities class action alleging misstatements or omissions in prior company disclosures, a potential intellectual-property royalty dispute for which a loss amount could not be estimated, and six Brazilian tax assessments totaling 346 million reais (approximately $85.2 million). Flex said it would contest these matters. The filing also discusses possible SunEdison-related preference claims; none had been asserted as of the filing.
Most important facts for investors to verify
- Completion and result of the CTG and any other reporting-unit goodwill impairment tests, including any resulting charge.
- Whether gross margins and earnings recover from the year-over-year declines, particularly given customer mix, the Nike wind-down and program-ramp costs.
- Working-capital requirements, inventory levels and cash conversion, including the effects of receivables sales and deferred purchase price collections.
- Progress in remediating internal-control material weaknesses and the effect of the CEO transition.
- Developments and potential financial exposure from the securities action, IP inquiry and Brazilian tax assessments.