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Flextronics International Ltd. (NASDAQ:FLEX)

F2Q08 Earnings Call

October 23, 2007, 4:30 PM ET

Executives

Michael M. McNamara - CEO

Thomas J. Smach - CFO

Analysts

Amit Daryanani - RBC Capital Markets

Matthew Sheerin - Thomas Weisel Partners

Louis Miscioscia - Cowen And Company

Thomas Dinges - J.P. Morgan

Alexander Blanton - Ingalls & Snyder LLC

Steven Fox - Merrill Lynch

Jeff Walkenhorst - Banc of America Securities

Todd Coupland - CIBC World Markets

William Stein - Credit Suisse

Kevin Kessell - Bear Stearns

Presentation

Operator

: Good afternoon and welcome to the Flextronics Second Quarter Results Conference Call. All lines will on a listen-only until the question-and-answer session of today's conference. [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.

Michael M. McNamara - Chief Executive Officer

Yes. Thank you. Ladies and gentlemen, thank you for joining the conference call to discuss the results for Flextronics's second quarter ended September 28, 2007. To help communicate the information on the call, we have provided a presentation on the internet. Please go to the Investors section of our website and select Calls and Presentations. You will need to clip through the slides, so as a reference we will indicate the slide number we are referring to.

On the call with me today is our Chief Financial Office, Tom Smach. I will turn the first part of the call over to Tom to go through the financial portion of our prepared remarks. Go ahead, Tom.

Thomas J. Smach - Chief Financial Officer

Thanks, Mike, and good afternoon ladies and gentlemen. Slide 2. Please note that this conference call contains forward-looking statements within the meanings of the U.S. securities laws, including statements related to the future revenue and earnings growth, the success of our vertical integration strategy, new customer programs, expected improvements in SG&A expense levels, inventory management, operating margin, future cash flows and ROIC; the success of our long-term initiatives and related investments; and our expectations, other benefits, cost savings and revenues to be obtained from the acquisition of Solectron by Flextronics.

These forward-looking statements involve 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 14 of this presentation, and in the risk factors in the 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 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 tax schedules to the earnings press release. Slide 7 of this presentation in the GAAP versus non-GAAP reconciliation in the Investors section of our website, which contain the reconciliation to the most directly comparable GAAP measures.

I would like to remind everyone that the September quarter results reflect Flextronics' pre-acquisition performance and do not include Solectron, which was acquired after quarter end.

Slide 3. Quarterly revenue increased $855 million or 18% from the year-ago quarter to a record high of $5.6 billion, while quarterly adjusted net income increased 25% from the year-ago quarter to a record $146 million.

Slide 4. Revenue from the computing segment comprised 13% of total September quarterly revenue and increased 41% sequentially and 35% from the year-ago quarter. Products in this category include desktops, notebooks, servers and electronic gaming consoles.

Revenue from the consumer digital segment comprised 21% of revenue and increased 9% both sequentially and on a year-over-year basis. Products in this category include cameras, copiers, printers and other consumer electronic devices.

Revenue from the infrastructure segment comprised 27% of revenue and increased 1% sequentially and 36% from the year-ago quarter. Products 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 28% of revenue and increased 2% on both the sequential and year-over-year basis. Products 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 6% sequentially and 29% from the year-ago quarter. Products in this category include appliances, capital equipment, controls, meters, kiosks, car infotainment, navigation, marine equipment and blood glucose monitors.

Our top 10 customers accounted for approximately 60% of revenue in the September quarter with Sony Erickson being the only customer that exceeded 10% of quarterly revenues.

Slide 5. Adjusted operating profit increased 20% from the year-ago quarter to a record high of $172 million. Adjusted operating margin increased 10 basis points to 3.1% from 3.0% last quarter. SG&A as a percentage of sales improved 10 basis points sequentially to 2.6%.

Slide 6. Adjusted net income in the September 2007 quarter amounted to a record high of $146 million, which is 25% increase over the year-ago quarter. This resulted in a record high adjusted earnings per share of $0.24, which is 20% increase over the year-ago quarter.

Slide 7. After tax, intangible amortization and stock-based compensation amounted to $15 million and $11 million respectively in the September 2007 quarter compared to $12 million and $8 million respectively in the year-ago quarter. Additionally, in the year-ago quarter, the company recognized $83 million of after-tax restructuring charges, as well as an after-tax gain of $171 million on the divestiture of its software business. There were no restructuring charges in the September 2007 quarter.

After reflecting these items, GAAP net income was $121 million compared to $185 million in the year-ago quarter. This resulted in GAAP earnings per share of $0.20 in September 2007 quarter compared to $0.31 in the year-ago quarter.

Slide 8. Return on invested capital improved 80 basis points to 11.2% in the September 2007 quarter from 10.4% last quarter.

Slide 9. We ended the quarter with $1 billion in cash, which is a sequential increase of $236 million. Net debt, which is total debt less total cash, was reduced by $225 million sequentially to $494 million at quarter end. Including our un-drawn revolver, total liquidity was in excess of $3 billion and the debt-to-capital ratio was 90%, which is a record low.

Slide 10. Cash conversion cycle improved two days sequentially to 11 days, which continues to be industry leading. On a year-over-year basis, inventory turns improved from 7.3 times to 8.0 times. Days sales outstanding improved 2 days to 33 days and accounts payable days decreased 3 days to 68 days.

Slide 11. During the September 2007 quarter, cash flow from operations generated $371 million. CapEx amounted to $74 million and free cash flow amounted to $297 million. Depreciation and amortization was $84 million in the quarter. On a year-to-date basis, cash flow from operations generated $516 million. CapEx amounted to $146 million and free cash flow amounted to $370 million. Depreciation and amortization was $171 million on a year-to-date basis.

Slide 12. As previously announced, the Solectron acquisition closed on October 1st, 2007. As of closing, Solectron had 918.4 million shares outstanding, which were converted into 221.8 million shares of Flextronics and $1.07 billion in cash, which was financed through an unsecured term loan at an interest rate of LIBOR plus 2.25%.

We also announced our redemption repurchase offer of Solectron's $150 million, 8% senior subordinated notes, and their $450 million, 0.5% convertible senior notes. We will refinance these notes during the September quarter to an unsecured term loan at LIBOR plus 2.25%. Thank you very much, ladies and gentlemen. As you turn to slide 13, I will now turn the call over to Mike McNamara.

Michael M. McNamara - Chief Executive Officer

Thank you, Tom. I am very proud of the dedication and the hard work of our employees and management across the globe in making this a very, very successful quarter for Flextronics. 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 of Solectron.

The overall demand in the September quarter was stable. Our September quarterly revenues and earnings were at the high end of our guidance range. Actual revenue in the September quarter was $5.6 billion versus our guidance of $5.3 billion to $5.6 billion. And adjusted EPS was $0.24 versus our guidance of $0.22 to $0.24. We are thrilled with the operating results for the quarter.

Quarterly revenue increased $855 million or 18% from a year-ago quarter, while quarterly adjusted net income increased 25% over the same timeframe. We believe we are executing very well on the controllable aspects of our business, which should provide an excellent foundation to have the capability as in Solectron into the Flextronics framework.

We are very excited about this acquisition and our confidence level and our ability to successfully integrate it into Flextronics was extremely high. We expect to realize all of the anticipated benefits and synergies within the previously discussed timeframe. We continue to maintain a strong financial position with $1 billion in cash, no short-term debt maturities and a record low debt-to-capital leverage ratio of 19%.

Inventory in terms improved 8 times while cast conversion cycle improved by 2 days sequentially to an industry leading 11 days. Fixed asset throughput remained below 10% of sales. We remain intensely focused on generating a higher return on capital while growing our business. As evidence by the 80 basis points sequential increase in return on invested capital to a 11.2% which approximates our cost-to-capital.

Operating cash flow was $371 million in the quarter and $516 million in the first half of our current fiscal year. Free cash flow amounted to $297 million in the quarter and $370 million in the first half of our current fiscal.

Before I move into the Q&A segment of our call, I want to reiterate our previous announced communication plans to the investment community. We are currently not issuing guidance at this time. We will do so at our analyst and investor meeting on November 6 in New York City where our senior management team will present our strategy and vision as well as the company's revised financial guidance for the remainder of fiscal 2008 to reflect the Solectron acquisition. All of the details of this acquisition will be provided during this meeting along with longer term financial targets for Flextronics.

Slide 14. There are real risk from operating in this business, which includes a macroeconomic of technology slowdown among other things. Please pay particular attention to the side and not at current market condition.

I will now turn the conference call over to Holly for questions. Please limit yourselves to one question and one follow-up. Only the actual results for the September quarter, all forward-looking questions need to be saved for our November 6th presentation. Go ahead Holly.

Question And Answer

Operator

: Thank you. [Operator Instructions]. Amit Daryanani from RBC Capital Markets, your line is open.

Amit Daryanani - RBC Capital Markets

Thanks. Good afternoon, guys. Just a really quick question. Just some news out of Asia earlier this month, I think regarding FLEX signing a MOU with Oryema [ph]. Could you just update us on that and what would make that asset attractive to FLEX?

Michael M. McNamara - Chief Executive Officer

Yes. We do not have a definitive agreement yet but we've been in talks and have a MoU with Oryema. The prime objective for us there is to start penetrating more into the server market, where we've made a number of steps last year to get into that marketplace through the acquisition of IWILL and have had that quite good success subsequently to that. They have a very good position in... a position in developing OEM service but in particular with attractive growth is to begin penetration into the notebook market where we do not have as much of... well, we don't really have much of a position at all and it's a rapidly growing market.

Amit Daryanani - RBC Capital Markets

All right. And then just secondly, looking at the strength on computing segment, can you just talk about what drove that. I assume the Xbox throughout the year and seasonality helped you quite a bit. Was there any other product lines that were pretty strong in the quarter there?

Michael M. McNamara - Chief Executive Officer

Yes. Kind of across the board, we've done very well there. As you mentioned the X-box is a very significant seasonal ramp that occurs in September, which ramps quite high from June and than actually it's even a better ramp in September than it does in the December quarter. We also have some server business that we've been ramping. That's now starting to come online and generate some pretty good revenues. And also we have a number of different miscellaneous accounts, which are also generating quite a bit of revenue. So this is difficult route that we have been anticipating to be one of the stars for us this year, and it has been a little bit slower than anticipated for a number of different reasons. But it's now starting to kick in and it's a group that we anticipate to aggressively pursue as we look to grow our business in the future.

Amit Daryanani - RBC Capital Markets

All right. Thank you.

Operator

Matt Sheerin with Thomas Weisel Partners, your line is open.

Matthew Sheerin - Thomas Weisel Partners

Yes, thanks. Your handset business was up just slightly sequentially and normally you see pretty big build seasonally. Could you just talk about the environment there specifically one of your big customers that had some issues, demand issues early in the year on some signs from suppliers that customers started to come back. Could you just tell us what you are seeing in that market?

Michael M. McNamara - Chief Executive Officer

Yes. So the big thing for us is we look at some of the sequential bills we normally anticipate a substantial pick up during this timeframe. As you mentioned, we've had some customers that have had some growth problems and maybe even struggled in the marketplace from a market share standpoint. So that's not more than anything else is kicking in. But also a little bit of a transition. We have acquired a couple of more handset customers over the last... basically last quarter. Some of those are ODM products and new products that we are designing, so it takes a little bit of time to ramp. And I think to a certain standpoint, some of the product to mix that we have is going... is off a little bit, just in terms of which models and the timing of when those models kick in. So we are a little bit flat year-on-year. As you said, it's just up 2% and so as we look through a couple of these different transition elements, we do expect next year to be again growing in the low double-digits as we bring on some of these new customer wins that we have.

Matthew Sheerin - Thomas Weisel Partners

Okay, great. And then just as a follow-up regarding some of the vertical components areas you have been moving into like flexible circuits and power supplies, etcetera, some of which drive in your opportunities in handsets. Could you update us on that?

Michael M. McNamara - Chief Executive Officer

Yes. You know, I'd say we are making progress on those things. We had a little bit of dense also due to do some of the customer issues that we are very, very strong with. We've recovered from that. We've diversified that business and right now, we're starting to... we crossed over the EMF margins in most of those businesses. If I take them as a bundle, we kind of crossed the EMF margin position and now are heading into more positive territory. Our power business is ramping very substantially, so this year we expect to do maybe about $80 million in our power systems business and we probably have enough design wins and new business books to generate about $250 million going on into next year. So we have quite a bit of step up coming up, but that's not till next year. We are investing pretty heavily as you can imagine. So we're struggling a little bit on profitability on the power systems just because we are ramping so nicely. So we expect that to be a contributor next year. But all in all, I think the revenues went a little bit flatter than we anticipated due to customer mix and quite alternatively, the profitability will increase and be higher than last year's profitability. So all in all, we are starting to build a more stable business and broadening our customer base. So I think a little bit of a slowdown this year, but we are bullish about it going forward.

Matthew Sheerin - Thomas Weisel Partners

Okay, thanks.

Operator

Louis Miscioscia with Cowen And Company. Your line is open.

Louis Miscioscia - Cowen And Company

Okay, thank you. You mentioned for the quarter that demand was stable. Can you just give us an outlook for, I guess the different industries that you are seeing just on a demand standpoint. Does it seems like it's changing at all since obviously, it looks like the environment is somewhat uncertain?

Michael M. McNamara - Chief Executive Officer

Yes. Well, year-on-year, you saw some of those numbers and you saw some of the sequential numbers. We're seeing infrastructure go a little bit flat even though we are up 36% year-on-year, and probably for FY08 versus FY07, we will probably be up about 20% on that segment, so we're pretty happy with it of course. But at the same time, you can see some of the slowness in the industry. On mobile, we talked a little bit about industrial, medical and automotive continues to clink along. It was only up 6% sequentially but year-on-year, it's up 29% and we do anticipate very nice growth for that for the year. Again, we probably see some softness in some of the existing customers, but at the same time, we are growing our market share very nicely, which is kind of offsetting some of that softness that we are seeing in the industry itself. I think consumers are a little bit softer than we anticipated. And with that said, we'll probably be up close to 10% year-on-year, but we can see some of the flatness in each of those different industries. So, computing is growing very, very nicely for us. So, all in all, we kind of view the market as being somewhat stable. We're seeing a lot of growth but I attribute this back to a lot of new wins and a lot of market share gains, but going forward, we'll continue to see our overall business being pretty much in expectation.

Louis Miscioscia - Cowen And Company

Okay, great. Maybe a question for Tom. It looks like CapEx is coming in lower than I guess the expectations when you had at the beginning of the year, and is that actually the case and is that part of obviously the synergies that you expect to get as you forecast Solectron into your plans and obviously, you'll comment about that on November 6th?

Thomas J. Smach - Chief Financial Officer

Yes. I would say Louis it's more just a function of timing than the Solectron acquisition. Certainly, we do expect some post-integration synergy, but I would say for the first half of this fiscal year, it's more timing than anything else. Excluding the Solectron acquisition and on a standalone basis, our objective was to keep CapEx for Flextronics imparity with depreciation, and I would say for the year that would continue to be our expectation before any of the acquisition synergies that lay on top of that.

Louis Miscioscia - Cowen And Company

Okay. Thank you.

Operator

Tom Dinges with J.P. Morgan, your line is open.

Thomas Dinges - J.P. Morgan

Hi. Maybe a quick one to follow-up on the consumer commentary that you made. One of the things that we have been hearing from a number of other companies is folks talking about the consumer build season being a little bit shorter and a little bit maybe more intense than it's been in prior years with customers trying to push the supply chain even faster to respond to fill shelves, and then sort of waiting in the wings as to what you are going to see from the sell through going out after that. Could you just kind of comment on that characterization and then I have a quick follow-up for Tom.

Michael M. McNamara - Chief Executive Officer

Yes. It's hard to get. I would say we quite don't have enough detail to be able to comment that specifically. We don't have a broad enough product range and enough experience to really say... to be able to pick up those subtleties. A lot of that business is going to imaging and we see that as being pretty typical with the two seasons; the back-to-school season and the Christmas season, although not real robust pick up, but kind of a little bit slower. And as far as some of our new businesses that we are looking at, things like some of the... we're starting to penetrate TV a little bit and digital cameras and some other audio devices. Some of them are very new to the marketplace. As you know there was an announcement about June, which hit that numbers with is all incremental upside for us. But I don't know that we can say that there is a different characteristic in terms of the buying patterns that... I think we just have to pass on that. Any other comment beside what I just gave.

Thomas Dinges - J.P. Morgan

Okay. And then a quick one for Tom. Inventory was up maybe a little bit more than I had anticipated, maybe separate between just pre-positioning for the next quarter that you may have done and was there any impact from ForEx translation or anything there that was material?

Thomas J. Smach - Chief Financial Officer

No. Nothing material relating to foreign currency translation or anything like that. I would say inventory turns did go up quite nicely in the quarter. They are all the way up to 8.0 turns up from 7.3 last quarter. And the dollar build, I believe is primarily related to just the expected ramp in the December quarter.

Thomas Dinges - J.P. Morgan

Okay. Thank you.

Operator

: Alex Blanton with Ingalls & Snyder, your line is open.

Alexander Blanton - Ingalls & Snyder LLC

Thank you. I don't know whether this is a permissible question on this call or not, but you did mention as you were closing your remarks that you expect to realize all the synergies that you have forecast for Solectron in the timeframe that you had given. However, as you know there in lot of skepticism about that. Can you say anything on this call that will provide more confidence to investors as to whether you can do that or not? I mean, what can you add to that statement? I don't know whether you want to on this call or not.

Thomas J. Smach - Chief Financial Officer

Well, we are going to get into it in a little bit more detail in November, but I could add some comments. We developed a plan about what this integration should look like in terms of timing and in terms of facilities, locations, operations, strategies, expectations around customers and products, and we developed ourselves over the summer and we are kind of itching to get them launched by the time October 1 came, and now that it's come, we're moving right along the original plan to go execute those. And I would say... the only thing I would say is that we haven't found anything to be out of line, at normal. We didn't have any major surprises. There's always a surprise here and there, but we leave them as minor. So the key thing is that we are just moving right along and we're moving as aggressively as we ever anticipated, and I know some of you guys and you in particular Alex, follow some of the announcements that are going on out there in the marketplace. So we are just moving along at the good integration activities that we anticipated for this quarter, and we view them to be aggressive and quick and we are just not finding anything that causes us to believe our plans are to not be able to realize the original synergies. So we'll continue to be quite confident.

Alexander Blanton - Ingalls & Snyder LLC

Okay, thank you. On the Arena subject, Taiwan is now doing about 90% of all the laptops. It strikes me that North Americans only might not really like that much dependence by Taiwan for their notebook supply. I mean that's tremendous potential vulnerability there, so I mean clearly you are not buying Arena for its business, current business, gateway, which is already purchased by Acer. Is your strategy to provide a second source to Taiwan for North American OEMs and what do you hear from them as to their desires in that regard?

Michael M. McNamara - Chief Executive Officer

Yes. I think that's quite astute. We're excited to have Acer as a customer just so you know they continue to grow their market share and that's flat, so hopefully we'll be able to maintain our position with Acer and be able to sell them more and more products over time as we complete this transition. But the real thing is we're looking to create the capability to go to notebooks. If you're going to be in the notebook business, you have to be in the OEM business. If you look at the percentage of notebooks out there, which like you said is about 90% Taiwan, the percentage of them coming out of utilizing the design of the Taiwanese companies is extremely high. So you have to have that know-how in order to participate. When we look at it, we have power supplies, we have plastics, metals, we probably repair more laptops than anyone in the world today with the Solectron acquisition and we have last minute BTO, CTO configuration capabilities in all the regions. So we already have a lot of pieces, vertical pieces that we can apply to the notebook business. And I think the fact that 90% of the business is in Taiwan is probably concerning to the big multinationals, in particular the U.S. guys. I think that presents an opportunity for us to the extend that we can execute. So certainly there is a number of reasons that we would go after this market besides the fact that it's growing 20% in the year and it's perhaps the biggest market in the world or it maybe will be in the year. There is a reason we're going after it and that is for sure consideration. And as to what they would say about it, I think the main position seems to be is they would move on products, they want capacity, they want know-how and they want the right products at the right time, and to the extension it has been delivered, I think that's the supply they are going to use. But I think diversifying their portfolio into a variety of different suppliers, I think, is valuable and in particular, I think that some of the Taiwanese companies have demonstrated that once given the opportunity, they have to know-how that goal and planning on business is definitely within their business strategy, and it's not in our businesses strategy. So I would view that as probably going to positive for the American OEMs.

Alexander Blanton - Ingalls & Snyder LLC

Okay. Finally real quickly, there was a report on the internet that had a telecom company ECI where as it was going to transfer 700 employees to Flextronics along with business? Could you comment on that?

Michael M. McNamara - Chief Executive Officer

Yes. ECI has been a customer of us for many, many years. We have a very significant presence in Israel and this is in an operation of Flextronics executes extraordinarily well. And it continues to grow very rapidly and it's a pretty sufficient, pretty large in size, so when we look at ECI and what we're trying to do is to build a stronger relationship with them over time and help them with their supply chain and just try to be a better supplier. So to me, this is just normal course of business as we look to continue to expand the business and our presence in Israel is already very, very large. So we view this as just another way to continue to add value to our customer.

Alexander Blanton - Ingalls & Snyder LLC

Okay, thank you.

Operator

: Steven Fox with Merrill Lynch, your line is open.

Steven Fox - Merrill Lynch

Hi, Good afternoon. A couple of questions. Just on new programs, given all the changes in the economy over the last couple of months. I was wondering if it effected any conversations you were having with customers about outsourcing? And then secondly, is there any other sort of new business glimpse you can highlight in general that you have secured over the last few months.

Michael M. McNamara - Chief Executive Officer

Yes, I would say in terms of talking about new programs, I think we will probably going to get a little bit more data on that when we get to the analyst meeting coming up. And I think it's an opportunity for you to meet each of our Presidents and have been talk a little bit about some of their customers and how they are penetrating, and what kind of advantages they have. So I would say let's leave it for that. We didn't prepare any or get any approval from customers to get any new information out and let's handle that in November. As far as you know any of the new programs affecting really an outsourcing strategy or the outsourcing strategy changing any of the... some of the new programs that you want, maybe you can clarify what you mean by that.

Steven Fox - Merrill Lynch

No. I am just wondering if things have been put on hold as some of your customers or potential customers reassess their own profit picture or whether it's maybe done the opposite, accelerated some talks with any customers. Just something like that what the economy has meant in terms of the conversations you are having?

Michael M. McNamara - Chief Executive Officer

I don't think so. I think there is already puts and takes. There is always slowdowns or pick ups depending on the economy and also depending on the customers' individual profit picture and strategy. So I don't know that anything has changed materially from our business as usual kind of approach, though I think it's pretty normal. I don't see a significant change.

Steven Fox - Merrill Lynch

Okay, thanks.

Operator

Gary Crapperson [ph] with Leman brothers, your line is open.

Unidentified Analyst

Good afternoon. Question regarding your mobile segment. You already commented as to why the growth rate on mobile is currently relatively slow. The question is really more about the December quarter because December tends to be very strong for mobile and just started, December was up nicely for September for that segment. In light of your comments on this call, should this mobile business to be relatively flat sequentially and then really expect the growth to resume in '08?

Michael M. McNamara - Chief Executive Officer

Yes. Well, I would expect... we would probably expect December quarter to be a modest improvement. I don't view it as being significant at all. Some of the past quarters we've had a real big pop-up in December and we don't anticipate that this year. Part of it is just the way the customers and the timing. I mentioned we're ramping up a couple of new customers, which were not hit in the December quarter. And also in terms of December, the product trends... the product timing for some of our existing customers, sometimes products come in and go out and sometimes we have brought the phone, sometimes someone else has the phone. So in general, I would say there is a little bit of a little transition period going on for the entire year and I think that transition period is really going to carry on through the December quarter. So I'd say we are going to see a modest improvement in the December quarter but not a significant step up that we would expect as a result of some of the investments we made this year with new customers, we would expect next year to grow nicely in the double digits... in the low double digits.

Unidentified Analyst

Okay. And then could do you please reveal your current position and strategy in the flat panel TV assembly markets. You know one of your competitors at the recent analyst meeting discussed the opportunities in that particular space and they seem to be significant although Taiwanese companies appear to be growing quite aggressively already in the flat panel TV market?

Michael M. McNamara - Chief Executive Officer

Right. Well, I think the volumes are... there is a lot of opportunity as it relates to volumes. I think it's a very, very competitive market and I think it's, but we're just going to find attaining access, real good profitability and those segments are going to be though. That being said, you can turn your inventories pretty high and we thinking you can get a pretty good ROIC. So we are actively working our TV strategy. We're actively working... working to put in on mechanical capacity around the world to be able to... and some of the verticals for the TVs. We're looking to expand some of the repair activities we're doing, and we're also investing pretty significantly in some of the ODM aspects of designs for these customers. So this has been a mission we have been on for about a year now, and we hope to have this be reasonably significant product category for us next year. I mean it's going to be minimal this year, but we would expect to kick up next year. We know that's too big of a market, and we have too many vertical potential opportunities in this space to ignore it. So we're actively looking at.

Unidentified Analyst

Thank you.

Michael M. McNamara - Chief Executive Officer

You're welcome.

Operator

Jeffrey Walkenhorst with Banc of America Securities. Your line is open.

Jeff Walkenhorst - Banc of America Securities

Hi, good afternoon. I was wondering if you could talk. I think in the last call you talked about the set-top box, which is now into the infrastructure segment being around more than $50 million in the June quarter and about a run rate about $1 billion per year. Can you give us an indication where that's headed in the September quarter, and kind of... is that I know you not giving guidance but is that an area where we could see continued growth like the conceding segment?

Michael M. McNamara - Chief Executive Officer

Yes. Our position in set-top box is pretty strong, particularly when you had that Solectron piece, and you think about going forward. The Solectron customers are pretty much the customers that FLEX did not have and so we expect to own that very, very, very significant share of the overall set-top box market going forward. But we knew this is a market that's growing 15% to 18% a year. We view it as pretty significant. We view our position extremely well. Solectron have designed resources in this space. We have about 110 designed resource in that space over India and putting the two together, we think it's quite formal position and yet down to that some of the verticals that we have with the mechanicals in the power systems in such and I think we've got a real good strategy going forward. So this is a market that I view as... we will have a very, very nicely dominant position and be able to grow it consistent with the market. We are very bullish on it. I mean this quarter was down a little bit just due to some product transitions but we anticipate that coming right back.

Jeff Walkenhorst - Banc of America Securities

Okay. Thanks Mike. That's helpful. And then as you think about the total portfolio, I am sure you are going to talk a lot more about the... but has Flextronics achieved kind of the level of vertical integration where you have always different products offerings and service offerings where it is easier to win business. I know it is a hard competitive business when you talk about having go out there everyday and win these programs, but is it getting a little bit easier and how is pricing environment in today?

Michael M. McNamara - Chief Executive Officer

Yes, so I think it gets a little bit easier because of the vertical that we bring to bear, we continue to get better and better at and more of them are pre-located in our big industrial parks in the right location as the years go by. So we continue to work and refine that model and put more and more confidence in each of the verticals. And also to co-locate them in the right way and having the whole package that creates the value of verticals. And just having verticals is not enough, but if they are co-located and they are generally world class in themselves. That creates a benefit for the verticals and that's when it becomes easy to sell.

So I would say it just continuously gets easier because ours just keeps getting better and we keep building our portfolio of these and we keep moving more and more of them, so they are in the right location at the right time. So I think it continues to get better. As far as the pricing environment, I would view it to be very, very aggressive but I no longer talk generically about the business. I think that the pricing characteristics of the mobile phone are very different than the pricing characteristics in the medical market or industrial or other markets. So I think they each have their individual competitiveness. They have their each individual characteristics associated with the capacities in the industry and then less in rest of the players in the industry. And I... so I think each one is different. So I think it's hard to generalize. But [indiscernible] continues to be a very competitive market and we are excited about having the verticals because they enable us to be able to compete when business even in a very, very competitive marketing environment and still maintain the margins.

Jeff Walkenhorst - Banc of America Securities

Okay, great. Thanks. Good luck guys.

Michael M. McNamara - Chief Executive Officer

Yes, thanks.

Operator

Next question is Todd Coupland with CIBC World Markets. Your line is open.

Todd Coupland - CIBC World Markets

Hi. Good afternoon everyone. Just a follow-up on the computing segment. Would you say the strength quarter-to-quarter was better than you thought or in line with the seasonal ramp up that you normally experienced?

Michael M. McNamara - Chief Executive Officer

Yes. So I think partly it's the seasonal ramp up particularly in Microsoft, it's the seasonal ramp up. But in some of the other projects like in servers that original seasonal ramp, it's new business. So I think a little bit of both. So one is the seasonal piece picked up quite nicely but at the same time, we actually added a number of different customers or I think we added a number of customer but a number of our other customers also ramped up their business and partly that's just us winning some new programs. So I think and was it expected? Yes, it was expected. So I don't know if there was a call probably two quarters ago where I anticipated computing to be up about 40% this year and in fact it was pretty flat during the June quarter, so I actually expected it to be quicker sooner but we are now starting to get the kick up in September and that will carry through into next year. So we view this as being one of our stronger areas of growth over the next year even without doing notebooks with Oryema.

Todd Coupland - CIBC World Markets

And just a follow up to the extent you are comfortable in answering this question. From a seasonal point of view, was it stronger than you've seen in the past? Is there any color you can add on that?

Michael M. McNamara - Chief Executive Officer

Not really. We, if you think about us last year in computing business, most of our computing business was Microsoft maybe some graphics cards. It really wasn't the core computing business that you guys more traditionally attract. And it's actually an objective for us to go get into that business, so we almost view most of our server storage business is pure upside from where it was last year, so really understanding the characteristics of the seasonality we just haven't had to get into it, and we do very, very little in terms of almost nothing in computers and notebooks. So we don't pick up any of that seasonality. It's really... what we do with Microsoft and we have a very big position with customer in video, which is doing very well for us. And also some of these new wins. So I don't know that we have a characteristic pattern of seasonality in computing that I think you are looking for.

Todd Coupland - CIBC World Markets

Okay. That's great. Thanks very much.

Michael M. McNamara - Chief Executive Officer

Welcome.

Operator

Bill Stein with Credit Suisse, you line is open.

William Stein - Credit Suisse

Thanks. So we heard you guys talk about relatively flat demand but of course, the sales rise 1% in the quarter. I am wondering if you kind of break that up attributing it to end market demand or seasonality versus converting customers to outsource model versus competitive wins taking away business from other EMS companies?

Michael M. McNamara - Chief Executive Officer

That's a tough one to answer right off the top of our head here, but you know the one thing I could say in terms of generalities is we grew the business pretty substantially. So we grew the business at 18% year-on-year. And the business is not growing that fast. So the underlying business is... as you heard from a number of the other EMS manufacturers, is a little bit soft even the last quarter. We've grown at 18%. So for sure we have to be picking up some additional wins and some additional business and gaining market share. So I have to assume the delta between what you are hearing in terms of averages from the other manufacturers and the other industries, the delta between that and 18% is the market share gain. And like I said, in some cases, we actually are picking up new business to what we had last year things like computing, our whole set-top box business. This year relative to the last year, we will probably triple. So we are having a lot of growth in industrial, medical and others where we are growing pretty substantially, where we start to ramp up some new programs like CISCO and Kodak, which we didn't have last year. So we actually have a lot of little business that we are ramping in, so I think 18% is not represented of the market for us and we are achieving it, so I think we are being pretty successful from that standpoint.

William Stein - Credit Suisse

That's clear. I am just trying to get a sense as to whether it's more winning business away from other EMS companies or converting previously vertically integrated offerings like the set-top boxes, CISCO. I believe that's converting a vertically integrated customer. Can you give us a rough idea as to which endeavor you are more successful at these days?

Michael M. McNamara - Chief Executive Officer

We are kind of successful in both to tell you the truth, but if I think about some of the conversions that we did, I think some of the Motorola set-top box business came on the markets out of their own facility. I think some of the Kodak business that we're came out of their own facility and particularly in light of what you mention. But we don't actually track one versus the other. We just want to go figure out how to create a value statement that we go figure out how to go win the business, and whether it comes from a competitor or whether it comes from the OEM, we're happy to take both. So I don't have a quantitative number except I can say we're probably making progress on both ends. I am sure the amount of business that's being outsourced from OEM factories continues to be on the rise. The outsourcing market continues to grow beyond just the rate of electronics growth because more and more business does come out to the EMS guys, and we're really well positioned when that happens because we have such broad capabilities in everything that we do.

William Stein - Credit Suisse

Thanks. Just one more quick one. So we saw the sales grow about 8% sequentially, gross margins were flat and we saw a little bit of leverage on the operating line. Is that how we should think about the model going forward? Is there any leverage on the growth line at this point or is it all in the SG&A line?

Michael M. McNamara - Chief Executive Officer

Yes. So we do think that there is more leverage there. So first of all taking leverage on operating expenditures works for us. The lower we get our operating expenditures and still be able to execute. That creates competitive advantage, so we like that a lot first of all. But at the end of the day, our objective is to get our operating profit higher and higher. The gross margin is... we talked a lot about our gross margin being struggling a little bit just because we continue to ramp. As we continue to ramp, we bring on new programs and new... and we have to relocate the products and there's just a lot of cost associated with that and that continues to weigh down a little bit on the gross margin standpoint. But we are just starting to catch up to that. We saw a little bit of improvement in the operating profit this quarter by 10 basis points and we're actually always talked about having 10% growth in operating profits. This year, we got delayed a little bit mostly due to some customer issues. But we said we probably hit it towards the end of the year, and we're actually continuing to see that. So from the Flextronics standalone standpoint, we actually are starting to see the margins and we would have actually liked to anticipate that we are going to have a margin kick up to where we saw that is 10% towards the back half of the year just as anticipated. And the other that's going to drive margins... so we actually are going to see some improvements and that's not going to be our operating expenses. The only thing that is going to help out a lot is the Solectron acquisition. So Solectron has a number of... we talked last time on the call and also made a lot of comments about why aren't the gross margin higher as Solectron because it seems like it ought to be a product set that has higher gross margins and I think what we saw at that time is we didn't separate out gross margins. But I agree with those comments a 100% and believe there is no reason we can't be able to find a way as a result of that product mix to create higher gross margins. So would I want to have that under our belt to drive margins, so I think going forward, we are very optimistic that we will see both margin and operating profits start to creep up.

William Stein - Credit Suisse

Great. Thank you.

Michael M. McNamara - Chief Executive Officer

You're welcome. I'll take one more caller.

Operator

Kevin Kessell with Bear Stearns, your line is open.

Kevin Kessell - Bear Stearns

Thank you. Yes, I don't know, Mike maybe if you're comfortable answering this question but is there a way without giving a lot of the specific details, can you just give us a sense in terms of a preview at a high level what you guys plan to cover I guess at the analyst day as it relates to Solectron. Is it going to be around what you were just discussing the overall integration plan or is it more about the different verticals, and how they kind of form together and so on and so forth?

Michael M. McNamara - Chief Executive Officer

Yes, sure. I will answer and let Tom fill in what I missed. But for sure we will update you just on the general strategy of Flextronics and it's not going to be a whole lot different than the path that we have been going down. But we will pursue update you our strategy as it relates to how we think about design? How we think about verticals? How we think about investing? How... we will talk a little bit about acquisition strategy? We will talk a little bit about how we plan to use... how we think about the use of our cash that we are going to generate as we anticipate a very, very strong cash flow as a result of this combined deal. And from the Solectron standpoint, we do expect to give you some additional guidance for FY08 and we do expect to give you a high level of yield what FY09 looks like. And then we will also talk little bit about what are some of the restructuring activities and implications that we anticipate. So we probably go into a little bit of detail in terms of how we are thinking about which factor is where they are located and what's they are going to cost to go adjust. So hopefully, it's going to be a complete comprehensive with you on Flextronics strategy but we will have the same kind of strategy or format as last year. We will time and I'll do some of the high level strategy presentations and financial numbers and then we will drop into... have you go into the boost with to the operating guys so you can ask him more in detail what it all means. So that's kind of the deal. I don't know if missed --

Thomas J. Smach - Chief Financial Officer

No. it's perfect. I think it is something very comprehensive review of the strategy along with financial expectations for the remainder of this year and some longer term initiatives targets. So I think this is a very material acquisition and we need to give you guys some real detailed guidance as to how to reach that expectations and hope you build out your models. And I'll build the P&L and the margins and the cash flows, and so on and so forth.

Kevin Kessell - Bear Stearns

Okay, great. And then on the cash flow subject, I think you know the standalone structure to your guidance was, if I am not mistaken, like $300 million to $400 million free cash flow for fiscal '08 and so far first half of the year, you have already... you are almost at 400 now. So how do we think about that? Is it... was it, should we expect similar performance here in the second half or do you think it was more for whatever reason front end loaded here because of the quarterly --?

Michael M. McNamara - Chief Executive Officer

No. I just think we've done a superb job of managing cash conversion cycle. You saw it drop 2 days during the quarter to 11 days. And I think we are just reluctant to continue to forecast Flextronics standalone at that level and every time we are conservative around that, we continue to beat those conservative expectations. So I just think Kevin, we continue to do a great job managing cash conversion cycle, managing CapEx. We have kept it in line with depreciation as our objective was. We had a heavy investment cycle last year. We said we would leverage those investments into this year. We're doing that successfully and our fixed assets throughput as a percent of sales continues to improve. So there is no reason Flextronics standalone wouldn't be able to continue managing its business like we have. And in fact we think we can layer in Solectron and start bringing some improvements to the way they've managed their business and some of those similar metrics we think, we can drive some significant improvement through the combined company. So I just think with... we worked really hard as this stuff with an extensive level of focus, and I think the results are speaking for themselves.

Kevin Kessell - Bear Stearns

Right.

Michael M. McNamara - Chief Executive Officer

With that, we will wrap it up. Thanks everybody for attending and we will look forward to seeing everybody at the analyst day in a couple of weeks.

Operator

Thank you. This does conclude today's conference call. You may disconnect at this time. Have a great day.

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Source: Flextronics International Ltd F2Q08 (Qtr End 9/28/07) Earnings Call Transcript
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