Flextronics International Ltd. — Form 10-Q Summary
Reporting period: Fiscal third quarter ended December 31, 2013; results are compared with the three and nine months ended December 31, 2012. Balance-sheet comparisons are with March 31, 2013. Dollar figures below are in millions unless stated otherwise. Interim statements are unaudited; the independent accountant conducted a review, not an audit.
Business context and financial performance
Flextronics provides design, manufacturing, supply-chain, logistics and after-sales services to OEMs across High Velocity Solutions (HVS), Integrated Network Solutions (INS), Industrial and Emerging Industries (IEI), and High Reliability Solutions (HRS). Its acquisition of certain Motorola Mobility manufacturing operations expanded HVS.
| Metric | Three months ended Dec. 31, 2013 | Prior-year quarter | Nine months ended Dec. 31, 2013 | Prior-year nine months |
|---|---|---|---|---|
| Net sales | $7,183 | $6,123 | $19,385 | $18,274 |
| Gross profit | $399 | $246 | $1,078 | $971 |
| Gross margin | 5.5% | 4.0% | 5.5% | 5.3% |
| Income from continuing operations | $145 | $55 | $323 | $352 |
| Net income | $145 | $47 | $323 | $326 |
| Diluted EPS | $0.23 | $0.07 | $0.51 | $0.48 |
- Quarterly sales rose 17.3%; HVS revenue increased about $1.0 billion, largely reflecting the Motorola operations acquired in April 2013. Motorola-related operations were 12.6% of quarterly sales and 10.1% of nine-month sales. Google, including Motorola, exceeded 10% of sales in both current periods.
- Nine-month sales rose 6.1%, as HVS and HRS growth was partly offset by weaker INS sales. INS softness was attributed primarily to telecom and connected-home businesses.
- Quarterly gross margin improved 150 basis points, mainly because the prior-year quarter included $98.3 million of restructuring charges and the company benefited from associated cost reductions. Nine-month margin improved 20 basis points.
- Quarterly pretax income was $154 million versus $46 million. Nine-month pretax income was $342 million versus $372 million. Prior-year interest and other income included a substantial gain on supplier warrants; in the current nine-month period, Flextronics exercised and sold the warrants, recording a $7.1 million loss. This comparison affects the interpretation of earnings trends.
Cash flow, liquidity and debt
- Nine-month operating cash flow was $1,118 million, versus $1,006 million. Capital expenditures were $526 million; net purchases of property and equipment were $461 million. Company-defined free cash flow was $657 million, compared with $678 million.
- Cash and equivalents were $1,617 million at December 31, 2013. Total debt was approximately $2,056 million, implying net debt of about $438 million. Current assets were $9,693 million and current liabilities $8,064 million (current ratio approximately 1.20).
- Debt increased in noncurrent classification: current debt was $55 million, compared with $417 million at March 31, 2013. Flextronics raised a $600 million unsecured term loan due in 2018 and used proceeds to refinance earlier-maturing term loans. Weighted-average debt interest rate was 3.2%. The company reported compliance with its debt covenants and no borrowings under its $1.5 billion revolving facility.
- Working capital needs increased; inventory rose to $3,972 million from $2,723 million. Flextronics received approximately $700 million in customer advances during the nine months, recorded as current liabilities, generally reduced as related inventory is consumed. Management stated that cash, operating cash flow and available facilities should fund operations for at least 12 months.
- Receivables financing is material: at December 31, approximately $1.2 billion of receivables had been sold under asset-backed programs, with $529 million of deferred purchase-price receivables retained. Another $517 million of receivables sold to third-party banks remained uncollected. These sold receivables were removed from the balance sheet.
Outlook, management commentary and risks
- Management expects HVS to represent roughly 30%–40% of revenue going forward. Programs launched in fiscal 2013 and 2014 are expected to ramp in volume during fiscal 2015 and beyond; management cautioned that startup costs, inefficiencies and under-absorbed overhead may pressure margins until volumes grow.
- For fiscal Q4 2014, management expected workforce reductions and other cost actions with $30–$35 million of pretax cash charges, primarily severance and benefits, and potential annualized savings of about $60 million, principally in SG&A and operating costs. This is forward-looking guidance, not a reported-period result.
- Customer concentration increased: the ten largest customers generated 54.2% of quarterly sales and 51.6% of nine-month sales, compared with 48.6% and 48.1% in the prior periods. Management identifies customer order changes or cancellations, product acceptance, demand, component availability, capacity utilization, labor costs and acquisition integration as business risks.
- Restructuring charges for the nine months were $40.8 million, including costs associated with 5,106 identified employee terminations; no restructuring charges were recorded in the December quarter. Unpaid restructuring costs were $52.6 million at quarter-end.
- A Xilinx lawsuit filed in December 2013 alleges, among other matters, fraud and breach of contract and seeks unspecified damages and other relief. Flextronics said it could not estimate a reasonably possible loss range. Management did not expect other ordinary-course legal and tax matters, beyond amounts accrued, to be material in aggregate.
- The nine-month effective tax rate was 5.6%. A $14.1 million valuation allowance release related to Brazilian deferred tax assets was recorded in the quarter; Mexican tax reform resulted in a $4.3 million discrete tax expense. The company noted possible withholding taxes if certain foreign cash is repatriated.
Most important facts for investors to verify
- Whether Motorola-related revenue and the elevated HVS contribution persist, and how customer concentration—especially Google/Motorola—develops.
- Whether new program ramps achieve expected volumes and improve margins after startup costs and overhead under-absorption.
- Whether operating cash generation remains robust after considering inventory growth, customer advances, capital spending, and the scale of receivables sales.
- Debt repayment capacity, covenant headroom, refinancing needs, and any restrictions or tax costs affecting access to overseas cash.
- Actual costs and realized savings from the planned Q4 restructuring, and developments in the Xilinx litigation.