Flex Ltd (FLEX) 2005 Q1 法說會逐字稿

Welcome to the Flextronics first quarter earnings conference call.

At this time all participants are in a listen only mode.

At this time all participants are in a listen mode.

After the presentation, we will conduct a question and answer session. [Operator instructions].

Today's conference is also being recorded and if you have any objections you may disconnect at this time.

I will now turn the call over to Mr. Michael Marks, the CEO.

Sir, you may begin.

Okay.

Ladies and gentlemen, thank you for joining the conference call to discuss the results of Flextronics's first quarter ended June 30, 2004.

On the call with me today are Bob Dykes and Tom Smach.

Whilst we communicate the data in this call, you can also view a presentation on the internet.

Go to the Investor section of our website and select Earnings Presentations.

You will need to click through the slides, so I will give you the slide number I am referring to.

Slide 2.

Please note that this conference call contains forward-looking statements within the meaning of the Federal Securities laws, including statements related to trends in our industry and end markets, changes in customer demand, future growth and demand trends, utilization rates and capacity, improved pricing, existing and new customer activities, seasonality, ODM activity, anticipated revenues, earnings leverage, operating margins and results, cash flows, profitability, inventory levels and the expected impact of potential new programs on our anticipated revenues and earnings.

These statements are subject to attendant risks that can cause actual results to differ materially.

Information about these risks is noted in the earnings press release and in our SEC filings.

Slide 3.

Revenue in the June quarter amounted to $3.88 billion, which represents an increase of $774 million, or 25% over the year ago quarter.

Excluding amortization, restructuring and other charges, net income for the quarter nearly quadrupled to $78 million, or 14 cents per diluted share, compared with $20 million, or 4 cents per diluted share in the year ago quarter.

GAAP net income for the June quarter was $74 million, or 13 cents per diluted share.

That compares with a loss of $290 million, or a loss of 56 cents per diluted share in the year ago quarter.

Slide 4.

Excluding restructuring and other charges, gross margin in the June quarter increased 110 basis points to 6.4%, SG&A decreased 10 basis points to 3.6% of sales and operating margin increased 110 basis points to 2.7% compared to the year ago quarter.

Return on invested capital improved to 18.2% from 7.7% a year ago.

Slide 5.

Inventory turns improved to 11.3 times from 10.3 times in the year ago quarter, DSO was 44 days compared to 43 days a year ago and BPO is 57 days compared to 54 days in the year ago quarter.

We ended the quarter with $665 million in cash, which includes $83 million that is the net gross to our mandatory offer to purchase an additional 20% of Hughes Software Systems.

Our leveraged ratio is 31% with liquidity of approximately $1.2 billion.

Slide 6.

We continue to deliver an industry leading cash conversion cycle which came in at 19 days for the quarter versus 25 days in the year ago quarter.

Slide 7.

Depreciation and amortization were approximately $86 million and net capital expenditures were approximately $60 million in the quarter.

Cash flow from operations generated approximately $166 million.

Borrowings increased by $273 million, primarily relating to the $260 million of acquisition payments most of which relates to our previously announced acquisition of 55% of Hughes Software Systems.

Slide 8.

Production in the Americas has continued its trend, increasing a bit this period to 16% of global production.

We also experienced expansion of production in Asia which increased to 46%, while Europe decreased to 38%.

We continue to believe that as the economy and the industry pick up and because freight rates are increasing, the emphasis on proximity is becoming increasingly important to our customers.

It is a significant benefit to Flextronics because of the global nature of our manufacturing and logistics footprint.

With regard to the end market breakdown, handhelds were exceptionally strong this quarter.

We are particularly pleased that we were able to improve margins slightly on a sequential basis given our product mix for the quarter.

Slide 9.

For the first quarter, Sony-Ericsson represented approximately 15% of revenues.

There were no other customers in excess of 10% of revenues in the quarter.

Obviously, Sony-Ericsson has gained a sizeable share of the cell phone market in the past few quarters.

Our top 10 customers accounted for approximately 64% of revenues in the quarter.

Slide 10.

The quarter turned out pretty much as expected from a revenue, operating margin and profitability perspective.

As noted earlier, earnings leverage continued to be significant again this quarter as June quarter revenues grew 25% while net income nearly quadrupled on a year-over-year basis.

This earnings leverage resulted from restructuring and cost reduction efforts, combined with better demand, which improves factory utilization and increases overhead absorption.

Additionally, we have been successful in passing along some price increases.

We expect these trends to continue.

We have received many questions about the pricing environment and we have heard comments from many North American based companies and analysts that refer to pricing pressures.

From our perspective, the pricing environment is stable, but not improving.

We believe that many companies primarily have a North American footprint are forced to lower prices because of their uncompetitive cost structures.

We have spoken about this many times in the past.

Being the most vertically integrated and the lowest cost MS company in the industry, has a significant competitive advantage for Flextronics.

With regard to the demand environment, we believe some customers are becoming more cautious because of the many conflicting messages about the strength of the technology industry.

We are not seeing any meaningful cancellations, so we believe we will continue to see steady growth as we characterize the adjustments in order patterns that we are seeing as seasonal summer adjustments.

Slide 11.

Because there is so much concern about inventory growth and what it might mean, I will spend a little extra time on this issue.

We believe that the supply chain inventory levels having reached their lowest point in 13 years, had to increase.

And they have.

We think this is a normal part of an industry recovery.

Following that, will be some of the inventory builds reflect a seasonal summer slowdown for some customers and perhaps even some extra caution, we believe this will settle out pretty quickly.

In terms of Flextronics's inventory, we continue to manage churns quite well.

However, the dollar value of the inventory we are carrying increased by $206 million on a sequential basis.

Almost half of this increase is associated with new business we have won which requires hubbing and de-transportation.

As we increase our business with new customer programs, our inventory will build as we fill the pipeline.

That's exactly what took place in the June quarter as we ramped up the significant new order for motherboards.

In addition, our previous goods inventory levels have been increasing over the past few years.

This is a direct result of the growth in our logistics business.

We work very hard to control cash cycle days.

We are constantly working on ways to reduce the impact of these two issues.

Overall, I would characterize our inventory gain during the quarter as in the ordinary course of business and we also reduced inventory in the September quarter as we expect to continue to maintain our high inventory turns.

Slide 12.

I have shown here once again the long-term financial model that we have been discussing for approximately the past 2 years.

It shows revenue of $21.5 billion and operating profit of 6% and earnings per share of $1.80.

I would like to take a few minutes to provide you with a strategic view of our business and why we think we are making good progress for this model, which we think is achievable within the next few years.

We understand that investors and analysts have, over the past few years, become increasingly interested in, and focus on very short-term results, and even subdivide issues and the very small movement in inventory, receivables and pretend to business with customers whose business is improving, or decreasing etc.

We don't see anything wrong with that unless we forget the big picture.

Let me outline the many reasons why we believe Flextronics is better positioned today than at any time in our history and why we believe our company will continue to outperform.

First, we recently announced the largest program in the history of our industry and one of the largest business awards ever in any industry.

There is no need for me to go into the details of the Nortel deal any more today other than to tell you that we are already in preliminary discussions with a number of other companies that are directly involved in the Nortel announcement.

This is just what we expected.

At the same time, we have a very robust pipeline in almost all of our businesses.

We are currently finalizing the terms of two business relationships with companies that have not previously done business with us.

Right behind those are many others of various sizes, which is why we continue to be comfortable with our growth prospects despite some investor concern about potential and market softening.

We expect to grow this year and next at pretty substantial year-over-year percentages regardless of end market demand patterns because of the secular trend towards outsourcing and our competitive position.

The reason we are outpacing our industry in terms of growth is that our service offering is second to none.

We almost never win a PTBA only program any more.

In fact, we've rarely been on any programs any more that are limited just to PTBA manufacturing.

As a result of our recent new customer wins and most of our pipeline of opportunities, improved vertical integration and logistics capabilities.

As we really have no competition that can offer this breadth of service on a truly global business, we are better positioned than ever before.

Of course, not all customers require this offering, but nearly every large company does.

Let me drill down one more layer and focus on printed circuit boards for just a moment.

That business is extremely healthy, very profitable and capacity is virtually solely utilized at this point.

As a result, we are adding some capacity which includes expansion partly paid for or secured by volume contracts by customers.

We invested heavily during the downturn and restructured aggressively.

Now that is paying off.

Once again, we have very few competitors that can offer what we can in this space and the strategy is working well and the business is performing very nicely.

In Enclosure, we have a global business which created $1.5 billion in revenue this year across a broad variety of capabilities in plastics, sheet metal and tooling.

We're building a new state of the art tooling facility in Shenzen, China and are expanding capability in Enclosure on three continents.

While there are few companies that can compete with us on this front, none of them have their facility as tightly integrated with their manufacturing operations as Flextronics.

Again, we have a strong competitive cost and service offering advantage.

We had previously announced we are entering the power supply business and we are extremely busy designing new programs in building that organization.

Strongly believe that this business will be in the same position in a year or so as our quoted businesses today.

Then there is the ODM offering.

As we have said all along, this was an imperative offering for our company because we believe design would be central to the competitive positioning of the MS companies in the future and we entered the ODM arena aggressively.

They've had strong early success in both cell phones and related camera modules.

Today, our designers are fully booked and we have won many new programs for the second generation of products in both categories.

By this time next year, we will have many more products in the market place and we are in early stages of investment in a number of other product areas.

Finally, we are making excellent progress on our long-term strategy to build a design organization that is very broad and is well integrated with manufacturing, which we believe will create a sustainable, competitive advantage well into the future.

We are fortunate to be acquiring control of Hughes Software Systems in India, which we believe is the best independent software design company in the world for telecom products.

Coupled with the resources we're getting from Nortel, as well as our own substantial capabilities in Enclosure, printed circuit boards, power supply, and or course manufacturing, we believe this is another area that in the next year or so will be extremely difficult for other companies to compete with us.

In short, we are a tough company to compete against and we're speeding up, not slowing down.

We could increase earnings even more than analysts and investors expect if we weren't building up resources and capabilities in each of these areas.

But our growth in revenue and earnings is already substantial and we are determined to put the pieces in place to allow us to compete effectively for years to come.

We are currently searching for four new executives to run various businesses for us.

The biggest effort to add management capacity we have ever undergone at one time.

Of course all this is added expense, but we think the investment will pay off as early as our next fiscal year.

Slide 13.

Okay.

That's about it.

In terms of guidance, we're not changing our previous guidance.

However, we do think it is important to provide a range for guidance rather than providing a one number estimate.

We think an appropriate EPS range is 15-18 cents in September on revenues of $4.1-$4.4 billion and 21-24 cents in December on revenues of $4.4-$4.7 billion.

We see no reason for analysts to adjust their estimates if they are inside of this range, as is the case with most analysts.

But overall we are comfortable with these ranges.

Slide 14.

There are real risks of operating this business which includes among other things a macro economic or technology slowdown.

Please pay particular attention to this slide in light of current market conditions.

With that, let me turn the conference over to the Operator to poll for questions.

Please limit yourself to 1 question and 1 follow up.

Thank you sir.

We will now begin the question and answer session. [Operator instructions].

One moment for our first question.

Our first question comes from Stephen Savas with Goldman Sachs.

You may ask your question.

Thanks.

Good afternoon.

I've got to figure out where to begin.

But maybe I'll start with I guess handsets.

You mentioned were particularly strong in the quarter.

It looks like Sony-Ericsson were certainly up a lot sequentially.

Just wondering I guess the overhanging people's concerns and fears about handsets and your high exposure there.

How you kind of plan for handsets going forward?

Can you give us some comfort that that's not something given inventory levels in the supply chain?

It's not something that might end up hurting you later this year with growth decelerating despite the fact that you've got a couple of big customers that are gaining share like Sony-Ericsson?

Yes, I mean you know it's just hard for me to believe that I continue to answer this question in this way, but let me do this as directly as I can.

We love the handset business.

We are really good in the handset business.

We have been growing our revenue, profit margins, vertical integration handset business steadily for the last 3 years.

And everybody seems to be concerned about it.

Frankly, I don't really understand it and let me tell you why.

The handset business overall is very robust.

It has been robust.

The numbers that people are expecting for this year are up substantially from the year before.

It is one of the biggest, probably the single biggest, volume business in the world today in terms of electronic product and we are all over it.

We are in the EMS space.

We are in the ODM space.

We are in the component space.

You know plastics, camera modules, printed circuit boards and we're taking share day in and day out.

We love the business.

We think we're going to continue to grow this business pretty well.

So this quarter, Sony-Ericsson took market share and they're doing a fabulous job.

We have a great relationship with them.

We love the business.

You know the first 4 quarters that we took over the Ericsson business, which was a couple of years ago now, the first 4 quarters of that business, the Ericsson business went down like shockingly.

It was just you know when we took over, it was almost -- I think it was $2.2 billion of revenue when we took it over.

It dropped down as low $1 billion.

Now they're on the rise again and all during that period we just kept growing our penetration in the cell phone business and we think we're going to continue to.

The cell phone business in addition to being very robust is one of the technology areas where there is an incredible amount of innovation taking place.

Huge amounts of innovation.

There is, besides all the different mixes that are growing here, all these new capabilities that are coming which includes camera modules and global positioning and gaming.

Now you're looking at camcorders and television capabilities coming to cell phones.

We love this market segment.

We are the dominant player in the world in the market segment.

We have opportunity not only from all the existing customer bases we have.

We're designing products for almost everybody.

We are doing work for Japanese cell phone companies.

We are doing work for Chinese cell phone companies and increasing our penetration in every place.

So my simple answer to your question is we think we're going to continue to grow our business in the category regardless of what happens with Sony-Ericsson, regardless of what there is in inventory.

We obviously can't predict, protect against a big macro economic slowdown, but we don't see it.

We are so busy designing and developing components and products to the cell phone industry that we couldn't be less concerned about any business segment we're in than that one.

I would also add that this is a business where it is a product business.

Some products are up.

Some products are down.

So during this quarter for example, you're concerned about will there be a slowdown.

The fact is that we actually had more products slow down during this quarter than speed up.

So there is -- we're already seeing the results of a lot of that and there are some negative numbers in there.

So we're able to grow despite the negatives that happens from one competitor to another.

We service so many we're able to offset that.

Okay.

Then Michael just on overall tone, is it fair to say that you're a little more I won't say cautious, conservative in looking forward versus what you'd be feeling mid quarter update or last conference calls that you've had?

If that is the case, is it something that you're seeing in your business, or is your business fine and you're planning on reinvesting any upside?

Or is it concerns on what you're reading in the press from other companies pre-announcing and taking a more conservative?

Yes, it is really frankly that.

I mean it would be inappropriate for a CEO of a major player like me not to acknowledge that everybody is nervous about the environment.

I mean you know everybody is in this environment.

Read the articles every day.

But what I'm trying to do is to give it balance [indiscernible].

We are comfortable with our estimates going forward.

We think that there is as much upside going forward as there is downside.

We think that the world has gotten kind of silly from an analyst standpoint in the following sense, which is that everybody is trying to hone in on one thing.

If you look at the analyst community, their following is quite strong, to whom there are at least 20, 25 like that.

I mean everybody thinks, everybody is down to 1 cent almost in terms of their viewpoint and it is inappropriate to consider that we can forecast our business down to 1 cent in the next 2 quarters.

That having been said, we are unbelievably bullish about our business today.

It is like every time we announce something good, the fact that we've down some more.

I don't know, what everybody is thinking out there, so I'll try to say this again.

Our business is in very, very good shape.

We are taking market share.

Our designers are solidly booked.

Our book of business is good.

We have 2 more companies we expect to announce before this quarter is over.

Relationships which are in the hundreds and hundreds of millions of dollars of new business.

Our pipeline is as full as it ever is.

We've got programs all around the world.

The design business is good.

So every place, all our static capacity in the printed circuit board area, we're winning vertical integration activities everywhere.

We are beginning to ramp up our activities for the Nortel business which is just an enormous upside for our company coming with good profit opportunities.

But we are acknowledging that there is clearly concern out there about the overall business.

We don't really see it in our book of business.

We do a forecast every month.

We've just done another forecast.

It just came in.

Our own expectations based on our latest numbers are very solid growth.

They are in the middle of the ranges of expectations that everybody has.

We continue to believe that we have as much upside to those numbers as we have downside and so I'm not sure, at least where Flextronics is concerned, what all this in aid of.

Thank you.

You're welcome.

Our next question comes from Alex Blanton from Ingalls and Snyder.

You may ask your question.

Hi Michael.

Hi.

Could you repeat the sales guidance for the second quarter and third quarter?

That isn't on the slide.

Okay, sure I can.

It is about the ranges that are been -- let me grab the numbers for you again.

For September $4.1-4.4 billion in revenue. 15-18 cents. 21-24 cents in December on revenues of $4.4-$4.7 billion.

Okay.

Let me reiterate that we're comfortable with the consensus range and we're not attempting to change guidance here at all.

Okay.

On that point about the TCBs, you said that that was very profitable, fully utilized.

On June 30 Merricks announced that they were unprofitable and would be so in the first quarter as well and at the same time they said that they aren't seeing any competition from Asia.

Do you know how that could be?

I mean the average of their accounts is 12.5 they said.

So a lot of it has to be below that.

How could they not be seeing competition from Asia and particularly you and you're making money?

Could you comment on that?

It's not my business to comment on Merricks business other than to say that we stated the fact that we see them.

We are very busy.

We are very profitable.

Let me underline this.

That business has for us has returned to historical profitability, great cash flow and you know we're full.

I mean we'd actually gone to customers and said we're not going to stand capacity unless you want to make take-or-pay contracts or you want to provide the capital for expansion.

And they're doing that.

I mean we're an unbelievably strong competitive position.

I don't know how Merrick can't feel that.

I don't know.

But our business is great.

Okay.

Secondly, on this inventory point, they talked about an inventory build of reducing their orders.

Cable talked about it in May.

Selectron said there wasn't any.

You're saying there might be.

But Plexus in April said you know our customers want to reduce inventory whether or not sales are rising, or their sales.

Their end market sales are rising or falling because they want to reduce their assets and improve their asset returns.

So do you see any of your customers doing that just keep reducing their inventory regardless of where the end market demand is going?

Do you see that?

We do.

Let me take another minute to talk a little bit about inventory because you know again I think that you pointed out exactly right Alex.

I mean you know some companies say we see inventory building and that's why customers are reducing.

I will try to speak a little bit more into the microphone.

Other companies have said we don't see any inventory.

We said maybe.

Let me remind everybody that inventory is something nobody wants and I think everybody is clear about this.

Nobody wants it.

During the last 4 years we've taken inventory turns from 5.5 to 11.5 and we're not the only guys trying to do that.

Part of the inventory build that we had this quarter, as I pointed out in my prepared remarks, was companies increasingly wanting us to hub their inventory.

So their inventory can go down and our inventory can go up.

At the same time we're increasingly asking our own suppliers to hub their inventory and so you do have a shift around in the supply chain.

We believe that our customers are asking us to hub inventory more than we think is good for our business and some of that business you know we're going to turn away, or we are negotiating consignment inventory and other things.

So there is a lot of movement around in the inventory chain.

Overall it is Flextronics's perspective that the amount of inventory build that you all see and hear about is not problematic.

That is our position.

It is seasonal slowdowns.

Right now we're into July and August.

Everybody tries to be as lean as they can because of the slowdowns in Europe and all that.

We've done a lot of analysis about the inventory channel.

We don't think that there is anything going on here at least in terms of Flextronics's business that indicates anything other than a little bit of seasonal change and some build backs at very, very low levels in the past.

Okay.

Thank you.

You're welcome.

Our next question comes from Brian White with the Kaufman Brothers.

You may ask your question.

Okay.

Michael, does the outlook take into consideration any sales or accretion from either the Hughes or the Nortel transactions that are pending?

Not to the December quarter because the Nortel -- right now Nortel is an expense because we're not into revenue yet and we're spending a lot of -- we have a lot of teams that are working around the world to get set up for the transfers and all that kind of stuff.

We don't actually take over any of the Nortel, the factories and the majority of the business - it doesn't come over until November 1.

So what we have said is that Nortel will not add anything in the December quarter, or the March quarter.

We are hopeful that it will just so everybody is clear.

But we don't plan for it because there is just a lot of expense that goes into getting these things off the ground.

So we've added nothing for that.

Hughes could be very slightly accretive, but right now we don't know how much of Hughes we're going to own.

You know we're pretty sure we own 55%.

We could own only 55%.

We could own 75%.

We could own more and we don't really know.

So it is that the position we're in right now.

We're assuming that we will own 55% and we're assuming that it will not be additive this year.

Okay and when you look at the month of June and there is various software vendors that talk of slowdown at the end of June.

IBM said their software business slowed at the end of June, but their hardware didn't.

How did you play out in the month of June with your customers?

You know they've met expectations almost exactly and you know we still see expectations more or less exactly the same as we saw them at the beginning of the quarter and at our mid quarter call.

So we don't really see any change in that.

You know I was around seeing investors and stuff in the last week or so and there's a lot of talk about the financial industry you know and merges and reducing software demand.

And you know none of that has anything to do with us frankly.

So we just don't see much change to our business outlook than we did 6 weeks ago.

Okay.

Thank you.

You're welcome.

Our next question comes from Stephen Fox with Merrill Lynch.

You may ask your question.

Hi, good afternoon.

On the acquisition front, was there any benefit to revenues this quarter from acquisitions and when is the Hughes transaction expected to be completed?

No impact from acquisitions in this quarter and can you answer the question about Hughes?

September, early October.

Late September, early October Stephen.

Thanks and then just on inventories, is it possible given that your December quarter rather is so important that you could still build inventories heading into the December quarter during the current quarter?

I mean towards the end of the current quarter, I mean you know manufacturing is starting you know now about this time frame for December in any case.

We try not to keep that inventory on our books of course and we try to get that transferred to the customers.

We have to build inventory between now and Christmas.

So we could have a little bit of inventory build, but hopefully not.

Okay.

Thank you very much.

Our next question comes from Thomas Hopkins from Bear Stearns.

You may ask your question.

Yes, good afternoon.

Michael, on the IT infrastructure it looks like it was up materially sequentially about 18%.

Can you just remind us first what you classify in that category and what was going on with that sequential improvement?

So for IT infrastructure that includes guys like Extreme Networks and [Interatis] and those kinds of customers.

It includes [Cowex](ph.), Quantum, those kind of companies.

And I'm sorry what was the other question?

It was just what was behind the 18% sequential growth rate in that segment?

The infrastructure side of our business appears to be picking up a bit as I've said on previous calls.

I can't really drill down any more than that other than to say that the companies we have in that category are picking up.

We are not the biggest player in our industry in that segment.

So it's probably more company specific than it is an industry trend.

Okay.

Great.

Just looking again into the second half of the year, it looks like the operating margin picked up about 9 or 10 BPs including the intangibles and the gross margin is basically flat against SG&A.

How do you see, as you ramp into the holiday season over the next 2 quarters September and December, given your mix on handsets?

How do you see the operating margin?

You've obviously given your guidance, the 15-18 cents and 21-24 cents, but how do you see the margins there?

Well I mean we believe without trying to drill down on our income statement forecasting, we believe that gross margins are going up.

They have been going up.

They've been going up year-on-year.

We think that they're going to continue to go up year-on-year.

That's why I put the model in again that we've talked about, which is a higher margin model.

Internal needs, quarterly, you have different issues about what the mix of the products will look like, where the quarter is from a seasonal standpoint.

But despite a considerable amount of angst in the investor and analyst community around pricing issues, we believe that we're getting in a stronger position from a pricing standpoint.

We are not able to forecast exactly what each customer is going to do and what each sector is going to do.

One of the things I pointed out in the June quarter that we're so pleased with is that the margins went up despite a higher mix in the consumer products, which are typically lower margin.

So we expect that margin - both gross margins and operating profit margins - are going to be higher the next fiscal year than they are this fiscal year.

They're higher this fiscal year than they were last fiscal year and drill it down in more detail.

Other than that I don't think is appropriate.

Okay, great.

Thanks Michael.

You're welcome.

Our next question comes from David Pashran with Smith Barney Citigroup.

You may ask your questions.

Thank you Michael.

I do want to explore just the margins a little bit further if I may.

So while the margins are improving nicely on a year-over-year basis, it looks like the sequential improvements are slowing down.

So I guess I'm trying to understand really how responsive the EMS model is to generate and pass along incremental savings to the OEMs on a quarter-over-quarter basis?

Maybe you can give us a sense as to whether or not Flextronics, and is just the industry generally able to pass on the types of cost savings that your customers are asking for on a quarter-over-quarter basis?

I'm not really sure how to answer that.

We are, I mean margins is a complicated mix right.

I mean it is a complicated mix of what the products are like, how efficient we are as a company.

I mean you know in terms of how full our factories are.

It is a mix of the overall pricing environment and so on.

I mean you'd be amazed when you look at the numbers and you see how gross margins were up a tenth of a percent this quarter over the last quarter.

If you saw the tens of thousands of transactions underneath that you'd just be amazed.

I mean we have 250,000 part numbers and the prices of every one of those parts changes every quarter.

This is our business.

I mean quarter-by-quarter on quarter on quarter we are passing along cost reductions to our customers and that's part of the business we've just been doing relentlessly for 11 years.

So you'd be amazed to see how many price reductions we've passed along, which is the business we're in and still gross margins went up a tenth of a percent sequentially.

It went up 1.1% year-over-year, which is a tremendous improvement in our margins as a company and this is why we're taking share.

When we pass along cost reductions and yet we're growing margin, growing profitability.

I'm not sure that I can add much more to that.

Well maybe I can ask it another way.

I guess I'm trying to understand your business is obviously passing on those cost savings every quarter.

I guess I'm wondering how much of the cost savings both in terms of being able to procure components and just for manufacturing cost savings, how much is Flextronics actually being able to hold on its margins because it looks like you're essentially giving any upside has to be given away to the OMs.

I'm just trying to understand if maybe you are giving more than you normally would have given away in the past?

Absolutely not.

In fact I really don't even understand the question from the standpoint.

A year in this quarter our margins were 1.1% lower than they are this quarter.

So year-over-year we added 110 basis points to gross margins and in your question you say that you don't see that we're able to keep any upside.

I'm talking about on a sequential basis.

Maybe I can just ask another question then about the ODM business.

With the Asians looking to actively diversify away from the PC market and stem their margin erosion that they've seen over the past couple of years, can you maybe give us a sense as to whether or not the 8% plus margins that you've been talking about for the ODM business may actually be a little bit more difficult to achieve or maintain than you maybe originally thought?

I don't think so.

Yes I mean in any given product area, or particular kind of product, some of them will be less than that.

We have some ODM business that has run well into double-digit.

So again I think there is going to be some mix issues there, but overall we are very comfortable with the model that we've displayed today.

Our margins are up over a percent year-over-year.

We think we're going to continue to raise those over time through a variety of techniques.

Through the vertical integration.

Through the increases in integration on our campuses, to growing the business and being able to spread costs over higher revenues, including the design business and so on.

I mean our margins - look at this.

Our margins are up 1.1% year-over-year.

We are at sort of mid single digit profitability on our design business.

We expect that that becomes double-digit.

We're at breakeven as we've indicated in our Network Services business.

We think that that business is going to return to profitability.

It's not like we are quaking on all thunders here.

We have been averaging that 2 quarters 20% return on invested tangible capital which we think is a very good number and we've got lots of upside to the profit side of our business.

We believe that this is just part of a longer term trend.

We've made tremendous improvement since last year and we think we're going to continue to do so.

ODM is one part of that mix.

We're comfortable with the numbers we put out so that we can achieve.

Thank you.

Michael, maybe I can try to summarize some stuff on margins here and just to reiterate some of the things Michael said.

So year-over-year our revenues grew 25% and earnings grew 283%.

That's enormous earnings leverage.

He referred that printed circuit board businesses full utilization and our profitability is very, very good in printed circuit boards.

In Enclosures he referred to was operating very efficiently and effectively and our profitability in Enclosures is very, very strong.

ODM, we said that we're still tracking toward our operating profit of just over 8%.

We're certainly not there today, but we expect that to continue to improve.

The SG&A percentage of revenues will lever down as revenues grow.

So by definition that will improve operating margins just through additional SG&A leverage.

The acquisition of Hughes, while we're not certain exactly the percentage of ownership, is probably the highest margin business unit that we will have.

They're a standalone public company.

Their net margins after tax is 21%.

Very, very high margin business.

Then you have Nortel that we said initially will just contribute revenues in the December and March quarters with really neutral profitability and that will dilute margins a little bit.

So you have a lot of moving pieces here going on inside the margins.

Net net we would expect operating margins to go up a little bit in September, go up very nicely in December and then probably be around flattish in March generally speaking for operating margins.

We're very comfortable.

We understand all the moving pieces and feel very comfortable we're tracking toward the long-term model that Michael presented in his slide of 6% operating margins in a few years.

So with that I think we will take the next question.

Our next question comes from Todd Coupland from ERBC.

You may ask your question.

Good evening everyone.

I was wondering if you could just update us on your financing plans with respect to the acquisitions that you have to deal with in the next couple of quarters?

Yes.

This is Tom again.

We've said for several months and a few quarters here when and if we decide to do a financing we will announce it and we're leaning on a revolver which is its intended purpose right now.

If and when those plans change we will let you know.

Great.

Thank you.

Our next question comes from Scott Craig with Morgan Stanley.

You may ask your question.

Good afternoon.

Michael can you provide a little more flavor around the communication infrastructure businesses down slightly this quarter.

It sounded like things started off the quarter a little bit better than that and you guys are pretty optimistic in that segment.

Did something happen there to turn things a little bit lower later in the quarter?

It is true that that business is flattish.

I mean the order prospects there I think that's as seasonal as anything else.

I mean talking to all the customers we believe that that business is going to grow.

We think that the tone of the business there is a bit better.

So I don't think that.

I think that the shifts there are nothing more than sort of seasonal and company specific stuff.

That business is flat to up.

Okay.

Then when you look at the ODM business, you talk about some specific goals that you had in fiscal 2005 of sort of $1 billion in sales and towards that 8% margin.

Do you still think those are more nearer term goals are achievable versus the longer term goals?

Well what we said was that they were profitable and that we're tracking to $1 billon of revenue.

Both of those are true.

We are marginally profitable.

You know, for that business to get towards the 8% we have to have a much more robust set of products which we're going to have mid next year.

I mean to add a little bit of a flavor to this, we couldn't be busier.

Every able bodied person is working on projects with one master program.

We started out with a first generation of ODM products and you know those aren't anywhere near optimized in the sense that we didn't have very much experience with it.

We didn't have the building blocks both with in terms of creating new products.

We didn't have the value across certain of the product categories that we will by next year.

As far as we are concerned, that business is doing just fine.

We've got, as I said, we are designing products today for a dozen companies and across a variety of products.

And as those products get into the market and we get a more steady business - right now it's very lumpy which is very common in the beginning.

So we're not going to reshape percent this year.

We will probably take percent next fiscal year maybe.

We certainly expect to do much better next year than we're doing this year.

We have a lot of cool products under development.

They will hit the market -- you will see those a bit later this year.

More of them next spring and summer and so by next fall, next Christmas I think we're going to have quite a good set of products that should be additive to margins over where we are today.

Just a quick clarification.

The December quarter revenue guidance, does that include both Hughes and Nortel?

That's it.

Thanks.

Yes.

Hughes is not in the September quarter.

It is a $100 million company, so it's in the noise in terms of the ranges.

It's like $25 million a quarter.

Nortel I think we put $100 million in the December quarter.

Thanks.

In that range.

Yes.

Our next question comes from Shawn Severson with Raymond James and Associates.

You may ask your question.

Thank you.

Good afternoon.

Michael, could you give us an update?

I know you mentioned you were doing some building of motherboard products and inventory hubbing.

Can you just give a little bit color on that and exactly what you're doing in the motherboards and what the build was for specifically?

Yes, I can't do that.

I can tell you that as a part of my opening comment we don't do very much PTBA work only.

We're not [an amateur] with the motherboard business.

It is a business that requires hubbing and de-transportation.

So it's one that's not particularly additive to what we're trying to achieve from margin and cash flow standpoint.

We added a couple of motherboard programs this quarter with customers that we do the rest of the PCs for and it's really a matter of accommodating a full product to build.

But we don't think the dynamics of that business are particularly good for us for the reasons that I've said.

So we will not likely build on that business much going forward.

Then just lastly, could you talk about the business trends from customers?

I know you said that you haven't seen a lot of cancellations.

But if we look at orders and outlooks for growth from your customers, has there been any discernible trend, or more importantly, change in trend over the last 3, 4 months?

Or has it pretty much been a steady state growth pattern forecast over the immediate term?

Well I mean I don't think I can give any more color than I already have, which is that people who run companies read magazines and newspapers and read the news like everybody else.

Me too.

I am more cautious personally only because you read all this stuff about business getting worse.

We are not seeing it reflected in our book of business and we're not really reflecting it.

We're continuing to work with our customers.

Continuing to place orders.

We think people are cautious to see what's happening.

But everybody is going ahead with the plans that they have got.

We don't see any major change to that.

I mean today, our rolling forecast which we just completed was just about exactly the same as it was last month and the month before.

So that's the only more data I can give you guys, which is if we were seeing any kind of a major change, it would show in those numbers and so far it doesn't.

Okay.

Thank you.

You're welcome.

I'll take one more question.

Our last question comes from Michael Walker from Credit Suisse First Boston.

You may ask your question.

Thanks a lot.

Good afternoon.

Just to attack the margin question one more time if I could.

In your long-term financial model slide you've got a total sales rate of $21.5 billion running at 6% EBIT margin.

Street numbers already have close to $21.5 billion in there for fiscal 2006.

So that's 7 to 8 quarters away.

I know you're not giving guidance for that, but it would help me a little bit if I can understand how we get from 2.7% today to 6% 6, 7 to 8 quarters away from now.

If I could know which of these four businesses was running at least kind of close to that target EBIT margin currently as opposed to has the most upside?

Yes.

Sure.

I think that is a good point because what we did was reproduce the chart that we showed 2 years ago.

I think the reality is because of the Nortel transaction and you know how quickly the cell phone business has grown for us, that 6% is not going to happen with that mix of $21.5 billion.

Because we're going to hit those kinds of numbers faster based on the EMS portion of that model, you know growing faster than the other portions of it.

So we will re-spin that model from a timing standpoint, from a mix of business standpoint when we have our analyst meeting this fall.

But I think you're exactly right.

If you look at that mix of business, the revenue will hit that sooner than we expected.

When we first put that chart up there we thought that was 5 years away.

I think that revenue number in 3 years instead of 5.

But it still is going to take us the full 5 to be able to develop those other businesses - the ODM business, Enclosure business and so on.

You know the mix is changing a bit because the design side of the business with the acquisition of Hughes and some other things is going to be a bigger business probably than we thought before.

So we're not going to get 6% operating profit next year, but if you add where the margins are going up from and I think we've pointed out all of that.

So the ODM business margins will get better.

The vertical integration portion of our business is growing.

All that side has better margins.

The Network Services business, which isn't profitable, is going to get profitable.

So each of these pieces we've talked about on the call are where the upside is going to come from.

We don't see deterioration in any other parts of the business.

So we think the margins will continue to increase and I think something like 1% a year like we've done this year over last is a reasonable way to think about that.

So at 2.7% we'd hope to be into the mid 3% this time next year and into the mid 4% the next year.

I mean that's the kind of way to think about it because we don't really forecast our business closely out more than a couple of quarters.

So that's the trend.

The trend is up and we think it is going to continue to be up.

I was out on Wall Street talking to people and everyone is going they think it is going to go down.

You read analyst reports saying that these are peak earnings for the MS industry and I don't think anything could be further from the true.

I don't know where this stuff comes from, but in fact we don't think it is anywhere close to peak earnings.

I think it is the reverse.

We think that earnings are just starting to recover in the USA and I have consistently said that I think that we've got 3 or 4 or 5 years now where I think the margins are going to increase in the MS space.

They are now and we believe ours are going to continue to increase and we think the whole industry is going to increase.

So let me be on record as saying that this is not going to be the peak period of earnings for the MS industry.

Okay with that let me close.

You know it is funny because I talked, listened to the questions and talking to people on Wall Street and all that kind of stuff and you know there is, without any doubt, a clearly negative paw hanging over the market.

If you were in our management meetings, or in our Board meetings, you would have exactly the reverse.

It is what I put in my original comments.

We are investing heavily.

We're growing rapidly.

Our margins are going up.

We are getting to be a tougher and tougher company to compete with.

We've got a great backlog of business opportunities.

Our designers on the ODM side are as busy as they can be and today, management of this Company is more bullish about our prospects and our competitive position than we've been in the 11 years that I have been here.

I can't in phone calls change the overall perception that people have in the market place other than to tell you we're getting more bullish by the day, not less.

And with that we will talk to you in 6 weeks and we will see if business has gotten better or worse.

Thanks for listening in.

Bye now.

That concludes today's conference call.

Thank you for your participation.

You may disconnect at this time.