Flex Ltd. — Form 10-Q Summary
Reporting period: Fiscal second quarter and six months ended September 30, 2016. Comparisons are to the periods ended September 25, 2015. Flex provides design, engineering, manufacturing and supply-chain services across High Reliability Solutions (HRS), Consumer Technology Group (CTG), Industrial & Emerging Industries (IEI), and Communications & Enterprise Compute (CEC). The interim financial statements were reviewed, not audited.
Financial performance and liquidity
| Metric | Quarter ended Sep. 30, 2016 | Six months ended Sep. 30, 2016 |
|---|---|---|
| Net sales | $6.009 billion, down 4.9% | $11.885 billion, essentially flat |
| Gross profit / margin | $313.7 million / 5.2% | $719.7 million / 6.1% |
| Income before tax | $14.7 million | $131.7 million |
| Net income (loss) | $(2.5) million; diluted EPS $0.00 | $103.2 million; diluted EPS $0.19 |
| Operating cash flow | Not presented for the quarter | $543.6 million |
| Free cash flow | Not presented for the quarter | $264.2 million |
- Quarterly gross profit fell $83.2 million from the prior-year quarter; gross margin decreased 110 basis points. Six-month gross profit declined $29.6 million and margin decreased 20 basis points.
- SG&A rose to $243.9 million for the quarter and $483.5 million for six months, reflecting stock compensation, NEXTracker-related costs, and investment in design and engineering. Intangible amortization also increased.
- At September 30, cash and equivalents were $1.537 billion; balance-sheet debt was approximately $2.744 billion, including current debt. Net debt was approximately $1.207 billion. Current assets were $8.459 billion and current liabilities $6.854 billion.
- Six-month operating cash flow declined to $543.6 million from $662.0 million, and free cash flow to $264.2 million from $368.0 million. Capital expenditures, net of disposals, were $279.4 million. Cash declined $70.5 million from March 31.
- The $1.5 billion revolving credit facility had no borrowings outstanding; Flex reported compliance with debt covenants. Management said available cash, operating cash flows and borrowing capacity should fund operations for at least 12 months.
Material changes and operating drivers
- Quarterly sales fell mainly from a $346.4 million decline in CTG, primarily tied to lower Lenovo/Motorola demand and exit from a China operation, and a $103.0 million decline in CEC, largely in legacy server and storage. HRS and IEI sales increased.
- For the six-month period, CTG sales declined $597.5 million, offset by increases in the other three segments. HRS and IEI segment income improved; CEC segment income declined. Total segment income rose to $196.9 million for the quarter from $196.3 million and to $387.2 million for six months from $355.4 million. Segment income is a company-defined measure that excludes several expenses.
- Flex recorded $92.9 million of solar-related charges in cost of sales in both the quarter and six-month period: a $60.0 million solar inventory write-down, $16.0 million equipment impairment, and $16.9 million of other solar costs. Management attributed the write-down to falling module prices amid oversupply and weaker demand. The charges materially reduced reported gross margin.
- Six-month investing cash use was $412.8 million, including $189.9 million for three acquisitions, principally Bose manufacturing and development facilities. Flex also received $36.1 million from divestitures and asset sales. It repurchased 14.2 million shares for $181.0 million during the six-month period; $450.2 million remained available under the current $500 million authorization at quarter-end.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided in this filing. Flex expects to complete its footprint and corporate-cost rationalization plan by the end of fiscal 2017; estimated fiscal 2017 costs are $40–$60 million, including approximately $11.5 million recognized in the quarter.
- Management cited portfolio diversification toward longer-life, higher-margin businesses and investment in design, engineering and advanced manufacturing as strategic priorities. It noted improved segment margins despite lower quarterly sales, while reported GAAP profitability was burdened by solar charges and other expenses.
- Key risks include demand and product-mix changes, customer order cancellations or delays, short product life cycles, customer financial distress, capacity utilization and component availability, production yields, labor costs, acquisition integration, and tax-law changes. The ten largest customers represented 42% of quarterly and 43% of six-month sales; no customer exceeded 10% in either 2016 period.
- Two Brazilian sales/import-tax assessments total approximately $34 million plus interest; Flex disputes them, cannot estimate the likelihood of loss or a reasonably possible loss range, and expects resolution to take years. A separate approximately $100 million Brazilian tax assessment was reversed by a final favorable judgment and closed in the quarter.
- Flex sells receivables through securitization and other sale programs. Approximately $1.2 billion of receivables sold for cash was excluded from the balance sheet at September 30; the related deferred purchase price receivable was $461.5 million. These arrangements are relevant to assessing working-capital liquidity.
Important facts for investors to verify
- Whether the solar-market downturn and $92.9 million charge are isolated or continue to affect inventory, margins, and cash generation.
- Whether lower Lenovo/Motorola demand and CEC legacy-business declines stabilize, and whether higher HRS and IEI contributions persist.
- Progress and total costs of the $40–$60 million fiscal 2017 restructuring and footprint plan.
- Cash conversion, receivables-sale dependence, debt repayment needs, and the availability of cash held outside Singapore, where repatriation may involve withholding taxes.
- Developments in the Brazilian tax assessments and the recoverability of customer-related exposures, including the legacy SunEdison receivable reserve.