Business context and reporting period
Flex Ltd. 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 second quarter and first six months of fiscal 2018, ended September 29, 2017; comparisons are to the periods ended September 30, 2016.
Financial performance and liquidity
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $6.27 billion, up 4% | $12.28 billion, up 3% |
| Gross profit / margin | $393 million / 6.3%, versus $314 million / 5.2% | $800 million / 6.5%, versus $720 million / 6.1% |
| Net income (loss) | $205 million, versus a $3 million loss | $330 million, versus $103 million |
| Diluted EPS | $0.38, versus $0.00 as reported | $0.61, versus $0.19 |
| Operating cash flow | Six-month cash provided: $281 million, versus $544 million | |
| Free cash flow | $53 million, versus $264 million |
At quarter-end, cash and equivalents were $1.37 billion and total borrowings were approximately $2.96 billion. The $1.75 billion revolving facility had no borrowings outstanding, and Flex reported compliance with its debt covenants. Cash declined $461 million during the six months. Current assets were $8.87 billion and current liabilities were $7.23 billion.
Material changes versus the prior period
- Sales growth came from IEI, CTG and HRS; CEC sales declined. For the quarter, CEC revenue fell $201 million, while IEI rose $212 million, HRS $161 million and CTG $90 million.
- Gross margin increased, but comparison benefited substantially from $92.9 million of prior-year solar inventory, equipment and related charges. Flex also cited higher material-management costs, labor inefficiencies and capacity-refinement costs during a CTG customer production transition.
- Quarterly segment income declined to $188 million from $197 million; total segment margin fell to 3.0% from 3.3%. CTG and CEC margins weakened, while IEI improved and HRS was broadly stable.
- Reported earnings included significant non-operating gains: a $152 million non-cash gain from deconsolidating Elementum and a $39 million gain on the Wink disposition. These gains materially affected the year-over-year net-income comparison.
- Operating cash flow and free cash flow decreased year over year. Management attributed working-capital use in part to the production ramp into the third quarter; six-month investing outflows included acquisitions, capital spending and the Elementum deconsolidation.
Outlook, risks and unusual items
- The filing provides no specific numerical revenue or earnings guidance. Management said cash, expected operating cash flows and available credit were expected to fund operations for at least the next 12 months.
- Management described ongoing investment in design, engineering, innovation, automotive and medical capabilities, and a strategic shift toward businesses with longer product life cycles and higher margins.
- Flex expects adoption of the new revenue-recognition standard in fiscal 2019 to change timing for a significant majority of manufacturing-services contracts, generally recognizing revenue earlier than under current shipping-and-delivery practices. It expects related balance-sheet changes, including lower inventory and higher unbilled receivables.
- Risks cited include customer order cancellations or delays, product acceptance and short life cycles, component availability, capacity utilization, customer financial distress, labor costs, acquisition integration, and changes in tax or trade rules. Brazil subsidiaries faced six sales and import tax assessments totaling approximately $91 million; Flex said it intends to contest them. No preference claim had been asserted in the SunEdison bankruptcy matter; the company estimated a maximum reasonably possible exposure of $98.6 million for specified transfers.
- Flex recorded $43.9 million of contingencies and other charges in the quarter, including charges related to loss contingencies and damage from a typhoon at a China facility. The filing says accrued legal loss contingencies were not material, but actual losses could exceed accruals.
- Flex repurchased 8.9 million shares for $145 million during the six months. The new authorization was for up to $500 million, with $445 million remaining at quarter-end. The filing also notes that substantial foreign cash could incur withholding taxes if repatriated; management intended to keep certain foreign earnings invested abroad.
Important facts for investors to verify
- How much of the earnings improvement reflects recurring operating performance versus the Elementum and Wink gains and the prior-year solar impairment charges.
- Whether CTG’s customer production transition, CEC utilization and the related margin pressures improve in subsequent quarters.
- Whether working-capital needs and capital spending recover enough to strengthen operating and free cash flow.
- The resolution and potential financial impact of the Brazil tax assessments and other disclosed contingencies.
- The eventual valuation and settlement of Wink consideration, and the effects of fiscal 2019 revenue-recognition adoption on reported results and the balance sheet.