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Flextronics International Ltd., (NASDAQ:FLEX)

F1Q07 Earnings Call

July 26, 2007 5:00 pm ET

Executives

Mike McNamara - CEO

Tom Smach - CFO

Analysts

Lou Miscioscia - Cowen

Jim Suva - Citigroup

Kevin Kessel - Bear Stearns

Steven Fox - Merrill Lynch

Tom Dinges - J.P. Morgan

Jeff Rosenberg - Banc of America Securities

Brian White - Jefferies and Company

Bernie Mahon - Morgan Stanley

Alex Blanton - Ingalls & Snyder

Long Jiang - UBS

Yuri Krapivin - Lehman Brothers

Presentation

Operator

Good afternoon and welcome to the Flextronics First Quarter Results Conference Call. All lines will be on listen-only until the question-and-answer session of today's conference call. (Operator Instructions) Today's call is being recorded. If you have any objections, please disconnect at this time.

I would now like to turn the call over to Mr. Mike McNamara, Chief Executive Officer. Thank you. Sir, you may begin.

Mike McNamara

Ladies and gentlemen, thank you for joining the conference call to discuss the results of Flextronics first quarter ended June 29, 2007. To help communicate the data in this call, you can also view our presentation on the Internet. Go to the Investors section of our website and select 'Calls and Presentations'. You will need to click through the slides, so we will give you the slide number we are referring to.

On the call with me today is our Chief Financial Officer, Tom Smach. I will turn the first part of the call over to Tom to go through the financial portion of our prepared remarks. I will then provide commentary along with the guidance and open it up to questions.

Go ahead, Tom.

Tom Smach

Thanks, Mike and good afternoon, ladies and gentlemen. Please note that this conference call contains forward-looking statements within the meaning of the US Securities Laws, including statements related to revenue and earnings growth, the success of our vertical-integration strategy, our ability to add capacity, new customer programs, expected improvements in our SG&A levels, inventory management, operating margin, future cash flows, and ROIC. The success of our long-term initiatives and related investments and expectations as to the closing of the acquisition of Solectron by Flextronics. These forward-looking statements involves risk and uncertainties that could cause the actual results to differ materially from those anticipated by these statements.

Information about these risks is noted in the earnings press release on slide 16 of this presentation, and in the Risk Factors and MD&A sections of our latest annual report filed with the SEC, as well as, in our other SEC filings. These forward-looking statements are based on our current expectations, and we assume no obligation to update these forward-looking statements.

Investors are cautioned not to place undue reliance on these forward-looking statements. In addition, throughout this conference call we will use non-GAAP financial measures. Please refer to the schedules for the earnings press release, slide seven of the slide presentation, and the GAAP versus non-GAAP reconciliations in the investor section of our website, which contain the reconciliation to the most directly comparable GAAP measures.

Slide three. Quarterly revenue increased from $1.1 billion or 27% from the year-ago quarter to a first quarter record high $5.2 billion. Well, quarterly adjusted operating profit increased 23% from the year-ago quarter to a first quarter record high of $153 million.

Slide four. Revenue from the computing segment comprised 10% of total June quarter revenue and decreased 11% from the year-ago quarter. Profit included in this category includes desktops, notebooks, servers and electronic gaming consoles.

Revenue from the Consumer Digital segment comprised 20% of revenue, and increased 21% over the year-ago quarter. Products included in this quarter include cameras, copiers, printers and other consumer electronic devices.

Revenue from the Infrastructure segment comprised 29% of total revenue and increased 42% over the year-ago quarter. Products included in this category include enterprise, networking, telecommunication infrastructure for wireline, wireless and optical equipment as well as set-top boxes.

Revenue from the mobile segment comprised 30% of revenue and increased 33% over the year-ago quarter. Products included in this category include cell phones and other handheld devices.

And lastly, revenue from the Industrial, Automotive, Medical and other segments comprised 11% of revenue and increased 39% over the year-ago quarter. Products included in this category include appliances, capital equipment, controls, meters, kiosks, car entertainment, navigation, marine equipment and blood glucose monitors.

Our top 10 customers accounted for approximately 62% of total revenue in the June quarter and Sony Ericsson is the only customer that exceeded 10% of the June quarter revenue.

Slide five. Adjusted gross and operating profit increased 23% from the year-ago quarter. Gross margin declined 10 basis points from the year-ago quarter, which was offset by a 10 basis point improvement in SG&A as a percentage of sales, which was 2.7% in the June quarter. As a result operating margin was 3.0% in the June 2007 quarter.

Slide six. Adjusted net income amounted to a first quarter record high $134 million, which is a 29% increase over the year ago quarter. This resulted in a first quarter record-high adjusted earnings per share of $0.22, which is a 22% increase over the year-ago quarter.

Slide seven. After-tax amortization and stock-based compensation amounted to $17 million and $9 million respectively in the June 2007 quarter compared to $12 million and $7 million respectively in the year-ago quarter. After reflecting these items, GAAP net income increased by 26% to $107 million compared to $85 million in the year-ago quarter. This resulted in GAAP earnings per diluted share of $0.17, which is a 21% increase over the year-ago quarter.

Slide eight. Return on invested capital improved 40 basis points to 10.4% in the June 2007 quarter from 10.0% in the year-ago quarter.

Slide nine. We ended the quarter with $770 million in cash, which is a sequential increase of $55 million from last quarter. Total debt was reduced to $1.49 billion at quarter end, which is the lowest level in almost 4 years.

Net debt, which is total debt less total cash, was reduced by $68 million to $719 million at quarter end. Including the revolver, total liquidity was in excess of $2.7 billion and the debt-to-capital ratio was 19%, which is a record low.

Slide 10. Cash conversion cycle was reduced to two days sequentially to 13 days, which continues to be industry leading. Inventory decreased to $47 million sequentially, even though sales increased by more than 10% sequentially. Inventory turns increased to 7.7 times in the June quarter from 6.9 times in the March quarter.

Receivables increased to $182 million sequentially, day sales outstanding improved three days sequentially to 33 days. While accounts payable increased $243 million sequentially, and days payable outstanding decreased seven days sequentially to 67 days.

Slide 11. Cash flow from operations generated $145 million during the quarter and CapEx amounted to $72 million. As a result, free cash flow amounted to $73 million in the quarter. Depreciation and amortization amounted to $88 million in the quarter.

Total cash increased by $55 million during the quarter to $770 million at quarter end. I would like to thank you very much, ladies and gentleman.

As you turn to slide 12, I will now turn the call over Mike McNamara.

Mike McNamara

Thanks Tom. Before discussing guidance, I would like to provide some comments on our June quarter performance. I am very proud of the dedication and hard work of our employees and management across the globe in making this a very successful quarter for Flextronic.

I remain confident that our organization will continue to execute on a normal day-to-day operation, and customer service requirements as we work through the integration planning associated with our previously announced acquisition of Solectron. The overall demand environment in the June quarter was very stable which I would characterize as improvement from the March quarter.

June quarter revenues are $5.2 billion, significantly exceeded our revenue guidance of $4.8 to $5.0 billion, while adjusted EPS of $0.22 was at the high end of our range. All in all, we are extremely happy with the operating results in the quarter.

Quarterly revenue increased $1.1 billion or 27% from the year-ago quarter, while quarterly adjusted net income increased 29% over the same timeframe. We continue to maintain a strong financial position with $770 million in cash, no short-term debt maturities and a record low debt-to-capital leverage ratio of 19%. We decreased our inventory balanced by $47 million sequentially and increased our inventory turns from 6.9 to 7.7.

Our fixed assets throughput remained below 10% of sales. We remain intensely focused on generating a high return on capital while growing our business as evident by our 40 basis point increase in return on invested capital from the year-ago quarter. We continue to lead the industry with a cash conversion cycle of 13 days, which resulted in our operations generating positive cash flow of a $145 million for the quarter.

Even though revenues grew 27%, we still generated $73 million of free cash flow. Excluding the impact from the Solectron acquisition, we continue to expect positive free cash flow in the range of $300 million to $400 million in fiscal '08, which is after estimated CapEx of approximately $350 million.

Slide 13. On June 4th, we announced that we entered in to a definitive agreement to acquire Solectron. We do not plan on providing any financial guidance until the transaction closes, but I will provide an update on a few things. While we have received U.S. antitrust clearance, we have not yet received all outstanding regulatory approvals. Assuming no complications in the remaining approvals required we now feel as though we can close the transaction in October.

The first time I visited almost everyone at Solectron's factories around the world. Overall, I am pleased to say that their factories and capacities exceeded our regional expectation. I was extremely impressed with the operations and the people and look forward to work with how much we reshape our industry.

Our integration planning has been further developed since the announcement. We feel that we should not take 18 to 24 months to achieve our targeted $200 million of annual after-tax savings. We are comfortable reducing this estimated timeframe to 12 to 18 months.

And lastly and perhaps more importantly the consumer feedback has been positive and even better than anticipated. We are very excited about this acquisition and our confidence level about our ability to successfully integrate into Flextronics is extremely high and it continued to increase as we dive into details and further develope integration plans.

Page 14. With the fiscal year ending at March 31, 2008, we continue to expect revenue to increase 10% to 15% and adjusted EPS to increase approximately 15% to 20%. Fiscal 2008 guidance excluded any impacts from the Solectron acquisition.

Slide 15. We expect September quarter revenue to be approximately $5.3 billion to $5.6 billion and adjusted EPS to be in the range of $0.22 to $0.24 .We would like to reiterate that our September quarter visibility is always limited, as the quarter is traditionally back-end loaded due to summer holidays in July and August. Visibility historically doesn't improve until the month of September and we don't expect anything different this summer.

However, there is nothing specifically that we are currently aware of that give us any cause for concern, but being cautious over the summer months is always a prudent thing to do.

Quarterly GAAP earnings per diluted share are expected to be lower than the guidance provided herein by approximately $0.04 per quarter for intangible amortization expense and stock-based compensation expense.

Before I moved into the Q&A segment of our call, I'd like to set forth our communication plans for next quarter. Assuming the Solectron acquisition closes in October, we will issue a press release with no conference call on the day it closes. We are planning on releasing our September quarter results on October 23rd. We are currently not planning on issuing guidance for the combined company at that time, rather we will wait until our Analyst and Investor Meeting on November 6th in New York city, where we will have our senior management team present our strategy and vision including the combined companies financial assessments for the remainder of fiscal 2008, along with longer-term financial targets.

All the details of the acquisition will be provided during this meeting. Please mark your calendars and save the date for this extremely important meeting, which is again scheduled for November 6th in New York City.

Slide 16. There are real risk factors operating in this business, which includes the macro economic and technology slowdown among other things. Please pay particular attention to this slide in light of the current market conditions.

I will now turn the conference call over to the operator for questions. Please limit yourself to one question and one follow-up call.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. Our first question comes from Lou Miscioscia with Cowen. Your line is open, sir.

Lou Miscioscia - Cowen

Okay, thank you. Obviously looking forward to that November 6th date. I guess, as we start to have our model for '09, should we think that Solectron and the merger arranged is going to be the main task that guys are going to be focusing on or do you also think that, you are going to continue your 10% to 50% desire for a top line growth?

Tom Smach

Well I think if by the time we get into FY ’09 we could potentially have six months behind us in terms of doing the integration and the acquisition of Solectron. So I think we’ve already had a pretty good head start on those activities. So, I would like to see FY '09 as being kind of beginning to tail down some of the integration activities with -- I would actually hope that we are pretty focused on growth of that kind.

First thing, I might focus everybody on, as it relates to our business, there are a lot of segment as we built this company, we built this for scale and we built 7 different market segments, then we have three or four different business units. Not all of those segments and units are really affected by this acquisition. We have good examples of our mobile phone division where we have close to $6 billion of business. Solectron does not have many mobile phone businesses, so these guys are running their business. They are aggressively going after new business. They are not de-focused, they are not involved in the acquisition, don’t participate in it.

And the same is true for much of the consumer business which is a big segment for us. It’s well over $4 billion then. So there’s a lot of segment that are really not even impacted by this. So I would like to think that the -- and we’ve have built our company the way we have for reasons, that is to provide the scalability, and to be able to do these kind of integration without missing a beat. So, I would expect to carry along, running our business as that’s required. I do not expect that much of a slowdown.

And that there is at least, I would say, at least pretty close to two-thirds of our business which is minorly impacted by the activities with Solectron. So, why should people get carried right on it, and it will be our expectation to continue the growth rate.

Lou Miscioscia - Cowen

Okay. Great. Quick follow-up for Tom -- good job of getting the inventory going in the right direction. Last quarter, you didn’t really want to give us a comment, but now since it seems like it’s going in the right direction, just any thoughts for the next quarter or your long-term target again for inventory returns?

Tom Smach

Well unfortunately, I guess I would answer it in the same way I did last quarter. We certainly have internal targets that we are working to improve inventory returns and reduce our overall inventory levels. Alright, I just think it’s an awfully difficult thing to manage quarter in and quarter out because things can change right at the last quarter. You might expect an inventory full from a customer that doesn’t happen the way the quarter ends, maybe it happens a couple days and to the new quarter. So, I don’t really want to put for a quantified estimate other than tell you, for sure, we are internally continuing to work toward an improvement in inventory turns and a reduction in inventory levels.

And I might add that, I think we kind of hit bottom in that March quarter. We did a lot of -- we increased our business pretty substantially with some of the infrastructure businesses that we brought on during FY ’07, and we have now absorbed those increases in inventory for those infrastructure business, and we are now starting to roll them off, and make some progress. So with our expectation that we kind of hit bottom last year -- last fiscal year in March, and we will continue to recover from that in order to get, that’s pre-Solectron, if you will.

Operator

We'll go next to schedule from Jim Suva with Citigroup. Your line is open.

Jim Suva - Citigroup

Great, congratulation guys, it looks like everything is on track or better than track are expected. A quick question, when you look at your profitability, how we should kind of look at that going forward. I know you have your EPS goals, but as far as the operating profit line at 3%, I guess some people have already, normally how come it wasn’t higher or more throughout. Should we kind of continue to expect it to be more of a revenue and dollar flow through profitability as opposed to moving operating margin difference 3% to 3.3%?

Mike McNamara

Well, we've been very flat at 3% for many quarters now, as you know and we kind of view that and kind of set that as a target for ourselves, as during this growth rate and the growth rate continues very high and every time the growth rate goes way up like this we carry, start up cost and new people we have to pick up on board and that sort of thing. So, we are pretty pleased we’ve been able to maintain then, going forward we are still committed to increasing our margin rate. We still expect some improvement in margins in the back half of the year, which we communicated previously and I think your proceed continuously that leverage up or leverage our best will earned a little bit better on the SG&A dollars going forward and I think we are going to get some more attraction on our component of businesses. So, we are still positive about the back half of the year improving margin a little bit. But in the meantime, if we can keep growing, even flattish at 3% if we keep growing that thing at 20% plus per year and we review that as a good win. But what I can tell you, we are really, really committed to and working hard at been able to drive those market up as the back half of the year.

Jim Suva - Citigroup

Okay. Great and then quick follow up.

Tom Smach

Jim, let me just reiterate, as Mike said we still think we are going to improve operating margins but the goal is to grow earnings per share of more than 20% a year while increasing our return on invested capital. That's a goal, that being said we think given the growth rate we can still improve operating margin in the back half of the year.

Jim Suva - Citigroup

Okay, great. And a quick follow-up to Tom, Tom I noticed that there is a little bit about stock investing or stock issuance to some people. How should we think about stock comp as a dollar amount for like EPS going forward is, because a lot of your peers are now including stock comp or EPS, if they can do for EPS in quarter?

Tom Smach

Yes. So, as we said in the guidance section, stock compensations and intangible amortization will impact EPS by about $0.04 a quarter. Now that includes intangible amortization in Jim. So, if you can look at those two items together, I would model $0.04 of an impact per quarter.

Jim Suva - Citigroup

Okay, great. And congratulations guys.

Tom Smach

Thanks.

Operator

We go next to Kevin Kessel with Bear Stearns. Your line is open.

Kevin Kessel - Bear Stearns

Thanks. And my question actually is on the revenue attrition; I guess, as it relates to the Solectron acquisition, I think you guys initially thought maybe $1.5 billion. Is that still whole true?

Mike McNamara

Yeah. I don't know, who gave this for the record, I am not for sure we think we are going to lose 1.5, we certainly, when we looked at the accretion, everything else we model that in just it was very prudent and conservative. Now that we've got into the transaction and we actually wouldn't have done this deal because it's going to be negative to customers. As we get into the transaction, we have more and more input from customers in terms of their plans they have had opportunities to absorb the impact of the combined company the benefits they may have and we are just exceedingly positive, that it's going to be a good thing. We actually can't see a $1.5 million or $1.5 billion gone out at all. So I think that's we are going to beat that number very substantially. And as far as you know, it's really hard to put your figure on it, but we are very, very confident after being in this now for whatever ten weeks.

Kevin Kessel - Bear Stearns

Okay. Mike, and then --

Mike McNamara

We will beat that number pretty nicely.

Kevin Kessel - Bear Stearns

And Mike, so you said, you obviously went to all these factories and gone around and seen them all and their capabilities. At this point is there any sort of a sense for how many factories kind of ballpark, might have to come off line or be consolidated, whether it may be in close proximity to one and other, like that in terms of?

Mike McNamara

Yeah, I mean, nothing that we would hear, we are still working on it. And it would be premature to even suggest anything at this point, but because we are making a lot of progress, which we will be able to give you very, very good indication of all the impacts by the time we get to our November 6, Analyst Meeting.

Kevin Kessel - Bear Stearns

Okay. And then last question here is on Cisco, Cisco was a one that, you had begun to ramp up. Has there been any slowing at all in that relationship as a result of the pending deal?

Mike McNamara

In the Flextronics portion of the Cisco?

Kevin Kessel - Bear Stearns

Right, your specific portion of that relationship.

Mike McNamara

Again, it's -- I actually don’t think there any impact... There was a set of products that we are working on at Cisco before this was announced there was a little bit of road map for us to go after. That road map continues to be in place, we continue to grow the revenue with Cisco. And I think, everything is on track per plan.

Again, I think Cisco’s would view this as a kind positive transaction and comfortable with maintaining the path that we are on.

Kevin Kessel - Bear Stearns

Great. Thank you very much.

Mike McNamara

Yeah.

Operator

Your next comes from Steven Fox, Merrill Lynch. Your line is open.

Steven Fox - Merrill Lynch

Hi, good afternoon. When you look at the $1.1 billion increase in sales year-over-year, can you just go back and review the new program, means how much was related to that and anything you can call out or one of those ones will be great.

Tom Smach

Yeah, it's really hard to get into very, very specific programs that drives this because we are such a broadly diversified company with so many different technologies. There is new technologies we added since last year which includes machining and LCD display and OEM products for service and there is -- it’s hard to pinpoint it and particularly the key thing is that we try to work really hard at diversifying our business and building a very scalable operations that can grow across multiple market segments. And then if you look at the earlier comments, our consumer digital business grew like 21%, and our construction business grew 29%, our mobile business grew 33%.

Our industrial, medical, automotive grew 39% of it. Every one of these are in the solid double-digits with the exception of Flex Circuit business. And on year-on-year, we actually do affect -- all of these segments to deliver a double-digit growth rate, so I think it's really broadly diversified. It's hard to identify it with different customer, but as you know in the March quarter we obviously made a lot of progress with Motorola because they became our 10% customer, we did a pretty sizeable transaction of Kodak. As you know we started ramping the Cisco business last year and the Sun business.

Our biggest customer is Sony Ericsson. They have continued to performance very, very well in the marketplace as we did a pretty big deal with the old Verity which does test of some sort of semiconductor business. So those are kind of the key ones but it's pretty broadly diversified set up business, set up customers and intercross multiple production technologies.

Steven Fox - Merrill Lynch

Okay. And then just one quick question on the Solectron deal, you sort of touched on in a number ways customer reaction being positive. I don't know if there is anything else you could share in terms of details on what you have told them or what they have found most exciting about transferring business to Flextronics going forward.

Mike McNamara

Well, I think we told them the same thing that we have told you guys. Although, I think they have a pretty good idea of what is Solectron, what is Flextronics, most of them. And I think what they look at is the broadest range of capability and the broadest geographic footprint and many things in the industry.

So as these big multi national companies look for a solution to deliver to the world whether India, Brazil or Europe or Americas or anywhere it's hard to find anybody who has this the scale of services that we bring and I think they look at that, I think they always we at Flextronics being a little bit on the lower end with a lot of verticals and lot of worldwide presence but with Solectron they are undoubtedly and having bit of lot of their factories they are undoubtedly the highest in EMF manufacture in the world today. And I think it put all those together and they leverage up to verticals that we have and it's a very powerful story.

So and at the same time we built our company around market segments where we just lot service in the guidance that $10 million that need the local solution whether it's in the United States or Europe or else where. So, we built, everything that's what they see and kind of same thing we have communicated to you guys.

Steven Fox - Merrill Lynch

Great. Thank you very much.

Operator

And your next question comes from Tom Dinges with J.P. Morgan.

Tom Dinges - J.P. Morgan

Hi good afternoon guys. Maybe along those same lines in terms of what has changed from when you guys announced the deal, that made you guys confident announced that you could pull forward, the cost savings and just remind us again, I think you guys said originally you expected to get somewhere 70% of the savings will probably come out of the SG&A, and duplicate of manufacturing and so forth, and roughly about 30% of that would come from supplier savings and is that ratio change is that one of the reasons there, a little bit help there will be great? And then I have a quite follow-up for Tom.

Mike McNamara

Yeah, I think that the confidence comes, as we got into the details of the capabilities, the confidence and the status of Solectron, I mean, the status isn't the right word. But the condition of the factories, the quality team that's in place, how well implemented things like remanufacturing and such, where those kinds of activities were above expectations. And the result to that it gives us great confidence that the integration is going to go better. And a validation that the services that we offer are truly in fact better and really do create value for the customer, which just mean, we are very, very -- tremendous amount of confidence that the customers are going to go stay with us, we think we've got few more offering and I think most customers have said that. And we've just got into the details and we feel that basis that we've identified were benefits occurred are really out there. And we can know how to get to them, so we validated the fact that we can get to the savings and we become more and more comfortable with the $200 million.

Tom Dinges - J.P. Morgan

Okay. And then Tom just a quick one, tax rate if I calculated, I came in little later than I think your tone as to have for this quarter what's the expectation, as you look out for the rest of the year?

Tom Smach

Right Tom, so it is little lowered the guidance is a 7% tax rate for the year, and as we move through each and every quarter some quarters might be a little less then 7%, some might be a little more. But I am comfortable that for year we are still talking somewhere around the 7% tax rate.

Tom Dinges - J.P. Morgan

Okay. Thank you.

Tom Smach

Thank you.

Operator

Your next question comes from Jeff Rosenberg of Banc of America Securities.

Jeff Rosenberg - Banc of America Securities

Hi. Thanks for taking my question. Looking at the segment revenues where the numbers came in the infrastructure sector was much higher then we had anticipated. Is there something, was it new programs or was this step up? Seasonally a little bit stronger but is there something -- how do we, how would -- going forward is there or do we think it drops back down or there are new programs that were done?

Tom Smach

Yeah, so for the year that division grow above 20% and its kind of a broad range of programs, but in particular we give the infrastructure segment, I don’t know if – when you are doing your comparisons, I mean, when we give the infrastructure we give it all the way from the set top box in the home hallways as to the wider area networks. So we do that whole segment as per the whole part of the product line, as part of infrastructure, I don't know how you used to look at it, but we have a tremendous amount of growth in our set top business in particular.

And in fact the infrastructure itself, what I would call the more core infrastructure kind of business, more traditional is also growing. But a large part of that growth has come down from set box which is part of category we’ve focused on very heavily last year, and in fact brought on several new costumers that grew very, very rapidly.

Jeff Rosenberg - Banc of America Securities

Right. Okay. That makes sense, being on the FSA, and so but that’s good even in a while it's stronger there. Second question is, I know you have hired a lot of folks in Taiwan for the ODN business, how is that, how’s that unit shaping up for you in terms of utilization and pipeline of new products?

Tom Smach

Yeah, we continue to invest in their capabilities. This is another piece which we’re very, very proud of, to be able to hold their earnings, and the growth and the earnings, and at the same continue to make very, very aggressive investments in our future.

And Taiwan is one of those places that we’ve been investing a lot and it's going extremely well. So we’ve worked hard to get the capabilities and last year cornered, [Centrigo Valna] a small acquisition we did. We have done a lot of organic growth around that acquisition in terms of capabilities and we have come out with some new products. Numbers of new products, but platform, if you will, that demonstrate confidence and be able to work with the customers on, and we are getting very, very strong interest from our customers. So, I would call that we’re like extremely pleased with all that shaping up.

Jeff Rosenberg - Banc of America Securities

Then, you could relatively gear about the near competitive position relative to Hon Hai and the other guys in that markets?

Tom Smach

You know we are new in it, we are smaller in it, but what we’ve done with that is we’ve tried to find a place in the market place where we can compete, and at the same time be able to make some money. So we just didn’t clamor to just say, okay, we did computing. We well, and said work we make money, work and we create value in the market place and how do we do it in the most cost effective way?

And we are really pleased with those results. So I won’t say we’re ready to take on Taiwan, because as we are not, but by the way we’re very pleased that we are going to go find some niches to go operative and then we are going to be profitable and we then can exploit growth. But as you know, the computing market is a place where we’ve not participated very much on this enormous markets in the world. And it's a place where we are trying to move little bit more aggressively into.

Jeff Rosenberg - Banc of America Securities

Very good. Good luck guys.

Tom Smach

Thanks.

Operator

Your next question comes from Brian White with Jefferies and Company. Your line is open.

Brian White - Jefferies and Company

Hi, yes, good afternoon. When we look at the mobile phone market, clearly a bit of disappointment is that really just driven by one customer or with the market soft in general?

Mike McNamara

I think different customers at different OEMs have different market share and I think you guys know a lot of what they are. Our mobile business grew 33% year-over-year, so we are pretty happy with that and we are still coming up a real strong year. Last year, where we grew about 60% to our FY '07 our FY'06 was up about 60%. This quarter here like I mentioned 33, so we are pretty happy about the mobile phone market. We have some customers that have had some share losses and we are certainly suffering with that but even despite that we have got nicely diversified portfolio and despite some of the heck ups with some of our customers we're still grown 33% so we are not.

Brian White - Jefferies and Company

Okay. I was just looking at sequentially? Do you think in the September quarter, what type of growth do you expect for mobile phone market in the September quarter?

Mike McNamara

September quarter?

Brian White - Jefferies and Company

Sequentially.

Mike McNamara

We look that up. One other thing I might add about the mobile businesses is that we continue to invest in our ODM business and that market continues to grow for us. We continue to have more and more program wins and we are very, very pleased how that's get everything as well. So to the worst there are some heck ups with some of the customers but at the same time, you know, still forward down a little bit but its more like slower growth as oppose to really taken us down. September quarter will be like mid single-digits for September to September growth rate.

Brian White - Jefferies and Company

Okay, thank you.

Operator

Thank you. Our next question comes from Bernie Mahon with Morgan Stanley.

Bernie Mahon - Morgan Stanley

Hi, good evening. Tom a question for you on the gross margin, I was a little surprised, I guess that they sell 20 basis points sequentially despite the revenue growing 10% was this something the mix shift to the infrastructure that have lower gross margin business or I thought you made a lot of investments in the second half of last year and there was just kind of full cost absorption that you are going to be able to improve the margin, gross margins over kind of this year, could you just talk about what happened there?

Tom Smach

Yeah, sure. So, the June quarter is always a difficult sequential comp on gross margins because typically the March quarter is the highest gross margin quarter because of the products mix shift. In the March quarter seasonally consumer and mobile phones are down and as you saw this quarter, we had significant growth and both of the consumer in mobile business and therefore the product mix shift as you going back to more higher volume, lower margin product. So, I would say seasonally Bernie, there is nothing unusual about how our gross margin increased in March and then pulled back in the June quarter. That was very much in line with expectation.

Bernie Mahon - Morgan Stanley

Okay. So we expected to increase in the September quarter then or would it stay more flattish?

Tom Smach

Yeah, so as Mike said we think in the first half of this fiscal year margins are going to be a little bit flat, there will be a little bit improvement in the September quarter and mostly improvement would be coming in the December and March quarters with regard to margins. So, I would expect a flattish to a little bit of improvement in September

Bernie Mahon - Morgan Stanley

Okay. That's great. Thanks.

Mike McNamara

Thank you.

Operator

Thank you. Our next question comes from Alex Blanton with Ingalls & Snyder. Your line is open.

Alex Blanton - Ingalls & Snyder

Hi, good afternoon. You've done a good job of telling us about some of the surprises that you found at Solectron, as you got into the integration and visited their plants and met the people and their customers. But my question relates to them -- to what Solectron ought to be able to earn on its own? You’ve told us 200 million in synergies that you expect coming from the combination of the two companies, and the combined resources of the two companies. But given what you've seen at Solectron now, were Solectron to stay as an independent company what should the margins be? They have been in the range of 5.1% to 5.5% recently having come down from 6%, I am talking gross margin now, at the beginning of calendar 2003 when my accountant came in.

So gross margins went down during his reign, but what should they be given the fact that you -- they have this high end product line that they are very good at, and they should be able to price it well because it’s a proprietary skills that they have, and as you said and their margin, their product mix is actually richer than Jabil's, and Jabil up until the last year has been able achieve 8% gross margin. So given what you have seen, what do you think they should do their own? And now that’s not a theoretical question because after you two companies merge they should be able to achieve that, I would think, in addition to or before synergies, before the kinds of savings that can be accomplished by combining the two companies, now did you follow that? It’s a long question, but I think it’s the most important question here.

Mike McNamara

Yeah. One thing I can say is, we never ever modeled the Flextronics community by their products because it just didn’t matter to us. What really mattered to us is what we can achieve together. Now –

Alex Blanton - Ingalls & Snyder

That’s part of the dose, isn’t it, Mike, I mean what they could achieve on their own and then what you can achieve on top by combining the two companies. Isn’t that really there two parts to, aren’t they?

Mike McNamara

Well I think we just went right to the final step, I think, for remodeling. We just went in to set up. We are running this, here is the overhead structure that we would need here, the factories we wanted here, how we would run it, how we would do the integration, how we would try to some procurement leverages and things like that. I mean, we actually went and modeled it like that. Now, to get back to your question now, while we haven’t modeled it and why didn’t they achieve in all those you know those higher margins, I guess, we can ask ourselves those questions, but I fundamentally believe that the margin structure of a company that does higher end product like Solectron should be higher than a company like Flextronics which has substantially more consumer production.

Alex Blanton - Ingalls & Snyder

Yes.

Mike McNamara

So I think I’ll switch the premises and I actually agree with that we didn’t’ model it individually. We are actually, you know, if we also think that’s the a premise that should be should be achieved, you can imagine that we are going after that, and we would certainly hope to try not to be true, and if that isn’t the way we are running it, then I would expect our profits to go up overt time.

I kind of agree with you we have not modeled it right? I fundamentally agree with you premise.

Alex Blanton - Ingalls & Snyder

Okay. Yeah I have modeled it and it looks pretty good. Now the second question is, the quarterly revenue by segment compared with last year and with March, I don't know that you really explained some of these things. The Computing business was down, although it was up from March, it was down year-over-year. That was one big change and then the Infrastructure was up 35% from the March quarter even though infrastructure are to be relatively strong in that quarter and it was up 42% year-over-year. So, what occurred there, what are the new programs you are ramping in that sector that they are brining out about?

Tom Smach

Yeah, the biggest thing is the set-top boxes. So, when we look at Infrastructure we think about the end-to-end from the wide area network all the way to delivery to the home. That's how we can classify Infrastructure and we run that as a business unit. We've had a tremendous amount of growth in that whole last mile in the set-top box area, in the channel going into the home. And we've had more traditional, more modest growth I would say in the kind of insurance infrastructure business but we saw the growth.

But the biggest we think that kicked the 42% more than anything else is the set-top box business more than anything else. But pretty much everything was hitting on also under, so we are getting some good market share gains in that segment. We are pretty happy about it and…

Alex Blanton - Ingalls & Snyder

Who is there coming from the market share, I mean, Solectron is large net sector and so as the [Saint Mena] because you cannot say where you are getting the share?

Tom Smach

Well, we probably got some from Nortel. Sony Ericsson is a very, very big customer of ours. They are doing extremely well in the market place and we are gaining some share on their base. They have acquired some businesses that we participated in as well. And I know that probably the biggest in terms of the raw infrastructure and that coming from the set-top box.

Alex Blanton - Ingalls & Snyder

All because of set-top box, I mean, where are you getting that share?

Tom Smach

Well set-top box, we do Scientific Atlanta, and we do Motorola and we have actually settled all this. We participate in the top five or six set-top box guys. We do work for probably four of them.

Alex Blanton - Ingalls & Snyder

Okay.

Tom Smach

Varity of regions and it's a business that went from virtually zero what's being any of last year to, which is roughly a roughly $13 million business today.

Alex Blanton - Ingalls & Snyder

Right.

Tom Smach

We have had an enormous amount of success in penetrating that marketplace and that's something gives us. We did a little acquisition to get a hold of some technology and we just focus after going after that business and just did a real good job of going after it and the leveraging of the verticals which you can imagine.

Alex Blanton - Ingalls & Snyder

Okay. Finally can you touch on the computing thing down 11%?

Tom Smach

Yeah computing is, that's the only thing that went down. Everything else is pretty spoken growth rates we would say. One of the things that we got a little slowdown on some of the Xbox that occurred during the period. And some of you guys, I am sure, lot of you heard some of the announcements of some of the challenges that Microsoft had with their product. And so, we had a little bit of slowdown in terms of the revenue in that period which took us down kind of substantially. But again alternatively going forward its turned to ramp up very, very nicely again. They fixed all their problems like it's a great solution. And in addition to the revenue increase that we'll see in the seasonality we'll also see some benefit at the repair business. So, all in all that's going to turn pretty substantially for us, so, I think year-on-year you are still going to see computing go up in a very, very healthy double-digits, like you see on slide four, you know, we will expect computing the end of the year in real in the same kind of format.

Alex Blanton - Ingalls & Snyder

Thank you. Thank you very much.

Mike McNamara

We'll take two more questions.

Operator

I think our next question comes from Long Jiang with UBS.

Long Jiang - UBS

Yes. Hi, good afternoon. My question again is related to profit margin. I think we haven’t talked about components business profit margins for a while. Could you update us in a way you are standing in terms of components profit margins and whether they are to your expectation, and with any question related for this quarter, I think somebody else asked this question before I just want further clarify that, I mean what’s impeding the gross margin performance this quarter given a pretty strong revenue sequential growth and apparently a better sales mix this quarter? Thanks.

Mike McNamara

To an components business I am not sure which you are looking at, but maybe I will address two particular businesses and that one is the PCB business [Multech] and Multech continues to have a pretty good growth rate, also into the double digits, but the margins have tightened a little bit in the industry.

We continue to have very, very good margins but they have come down little bit and that is a fact that we are working through and we had a lot of pricing and the underlying materials go up and some challenging competition in that region, but still a very, very healthy margins in the double digits. And the other piece of the component businesses are what we traditionally talk about components business and relative to the expectations FY ’06 we did zero profit which probably nowhere -- our target in FY ’07 was to do roughly the same as the EMS margins. We ended up doing about 2% in FY ’07 instead of the 3% that we anticipated, got off a little slower and then we anticipated in FY '08 we’ll get up to the 5% or 6% level. So we are moving right along, we had a real good quarter this last quarter, closed to those numbers and so we should actually see this year kind of fill out at around 5% to 6% rate or so.

Long Jiang - UBS

We have added to gross margin, sequential trend?

Mike McNamara

And gross margins, so we've still carry a very, very high level of what I would call volume consumer business. And so we still have a tremendous amount of our consumer digital business which we view as volume consumer business with a little bit higher inventory turns went about $4 billion and cell phones still are fulfilling are run rate. Our cell phone business runs very, very high and our cell phone business is running at about a $6 billion run rate. So its still towards the company in terms of where our margins are, and its one of the reasons that we are looking forward to, a company like Solectron that gives us a little bit more balance because that product mixes is going to be a little bit more beneficial to us, we think as it relates to margins.

But the other thing that we are still driving some learning curve costs. Its just hard to grow 27% across a broad portfolio of products and the complexity of the products that we do, and the amount of different locations we do, it's hard to grow at 27% and not have an impact in any -- some of the learning curve and therefore are going to experience. And we continue to invest very, very heavily in our future and invest in new technologies and design resources and new product categories. And we have not embedded in any way those investments and between all those it keeps margins a little bit a little bit down.

And well, of course, the margin improvement later in the year, as we discussed earlier.

Long Jiang - UBS

Do you continue to speak to a 10% operating margin improvements year-over-year for the whole year '08?

Mike McNamara

We won't do the whole year-over-year, one other thing that we said as when March quarter got became much soft on us and June got a little soft we said we are going to have six months delay in achieving those numbers. So, I would call it, we are still working hard to get up to those numbers, but it's very much affected by product mix, very much affected by the startup cost in such but we do adjust rate of margins going up at the back half of the year, but I think there was like six months slip to that expectation just as a result of the -- more of the economic slowdown that we saw starting to happen in February, March then anything else.

Long Jiang - UBS

Great. Thanks much.

Tom Smach

I just want to kind of reiterate something to keep in mind and to keep in perspective. Improved revenues 27%, okay, so, we cannot continue to grow revenues to 27% a year. Once that growth rate, our longer term revenue growth target is 10% to 15 % growth with earnings growing 15% to 20%. So, while we continue to grow revenues in excess to 20% it's going to be very difficult to improve margins. We will continue to grow earnings in excess to 20% at that level. But the margin improvement and the leverage that everyone is looking for, I don't want a positive turned into a negative. The positive is we are growing revenues well in excess to 20% a year and we are growing earnings well in excess to 20% a year. When that revenue growth rate flattens out just a little bit that is when that margin leverage will present itself. So, the good news is earnings and profits and revenues are growing in excess of 20% a year. And we think we can continue to grow earnings in excess to 20% a year on a lower revenue growth. So with that we would like to take one more question and then we will end the call.

Operator

Thank you. Our last question comes from Yuri Krapivin with Lehman Brothers. Your line is open.

Yuri Krapivin - Lehman Brothers

Yes, good afternoon. Mike, maybe you can just talk a little bit about the overall business environment. I think commentary from various companies so far, this earning season is that, some believe that trends remain subdued, other companies actually seeing some pick-up in the end market demand and believe that the business momentum is improving. So, how do you see sort of maybe the second half of calendar '07 versus the first half of calendar '07 for you, just from the kind of underlying market demand perspective?

Mike McNamara

Well, in the first half, we saw it was pretty soft. We ended up getting a little bit soft in February and March. And then, we saw some, maybe a little bit more stable trend April, May, June. So, we feel that we have been very, very consistent over the last say, three months. That consistency is not built around really robust growth, it's just like okay growth.

In the second half, it's always hard for us to sort through that, because we get a little softer information in the July, August timeframe. Really, when everybody gets back in September, when we really get a look at what the orders look like going into the December quarter.

So, it's really hard for us to predict going into the future. It feels like it's a pretty stable, but kind of slow if you will type of economic environment and we don't see any robust pick-up of any kind. But it's been very, very stable for at least three months now, and maybe in our view. But we will have to wait till September before we get any kind of indication what really, what the back half of the year looks like.

Yuri Krapivin - Lehman Brothers

Okay, thank you. And then, I noticed that you had currency exchange gain on the sale of some assets basically offset by restructuring so if -- excluding the integration of Solectron which may necessitate some significant restructuring charges, is it your philosophy going forward to basically using any non-operating gains for to offset restructuring charges?

Mike McNamara

Yeah, we first -- actually articulated that strategy on more than one occasion yearly, so that’s absolutely right. From time to time we'll have to -- recalled for practice, as Michael said we run a very large complex multinational company here, and from time to time we will have non-operating gains and we will look to try to use those to pay for any non- operating restructuring charges we may have. As you pointed out correctly -- they were very minor in the quarter, about $10 million each, so very low level as for a company. But that should be your expectation. From time to time, you will see some non-operating gains and expenses and vis-à-vis they will be approx to 100. Okay.

Okay, so with that we'll end the call and thanks to everybody for attending.

Operator

Thank you. This concludes today conference. You may disconnect at this time.

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Source: Flextronics International F1Q07 (Qtr End 6/29/07) Earnings Call Transcript
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