Flex Ltd (FLEX) 2005 Q3 法說會逐字稿

Good afternoon, and welcome to the Flextronics third quarter earnings conference call.

All lines will be on listen-only until the Q&A session of today's conference.

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 Michael Marks.

Sir, you may begin.

Thank you.

Ladies and gentlemen, thank you for joining the conference call to discuss the results of Flextronics' third quarter, ended December 31st, 2004.

On the call with me today is Tom Smach.

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

Go to the investors section of our website and select earnings presentation.

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, future growth and demand trends, opportunities, new categories, seasonality, anticipated revenues, operating margins, profitability, cash flow, working capital, and the expected impact of our pending transaction with Nortel.

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 December quarter reached a record $4.3 billion, which represents an increase of $124 million, or 3 percent over the year-ago quarter.

Slide 4 -- Excluding amortization, restructuring and other charges, our quarterly gross profit also reached an all-time high of $300 million, which represents an increase of $60 million, or 25 percent over the year-ago quarter.

Gross margin for the quarter was 7 percent, the highest level reached in the last 3.5 years.

This represents a 50 basis points sequential improvement and a 120 basis point improvement on a year-over-year basis.

Slide 5 -- Excluding amortization, restructuring other charges, our quarterly operating profit amounted to $156 million, which represents an increase of $39 million, or 33 percent, over the year-ago quarter.

Operating margin for the quarter was 3.7 percent, also the highest level reached in the last 3.5 years.

This represents a 50 basis point sequential improvement and a 90 basis point improvement on a year-over-year basis.

While we are pleased that our operating margin improved significantly from the low of 1.6 percent in the June quarter of 2003 to 3.7 percent in the current quarter, we remain focused on achieving our long-term objective of at least 5 percent.

We outlined the various margin improvement initiatives we have underway during our analyst meeting a few months ago.

And we believe the improvement we have demonstrated during that meeting suggests that our targets should be achievable.

Slide 6 -- Excluding amortization, restructuring, other charges, our quarterly net income amounted to $116 million, which represents an increase of $22 million, or 24 percent, over the year-ago quarter.

This resulted in earnings of $0.20 per diluted share in the current quarter, compared to $0.17 per diluted share in the year-ago quarter.

GAAP net income for the December quarter reached a record $99 million, or $0.17 per diluted share, compared to $21 million, or $0.04 per diluted share in the year-ago quarter.

Slide 7 -- return on invested tangible capital improved to a record 30.5 percent, from 21.6 percent a year ago.

Slide 8 -- We ended the quarter with a record $1.09 billion in cash, up from $615 million at year end and $695 million last quarter.

Our liquidity increased by almost $750 million to a record of approximately $2.2 billion.

This is the first time in our Company's history that cash has exceeded $1 billion and liquidity has exceeded $2 billion.

Slide 9 -- We continue to deliver an industry-leading cash conversion cycle, which came in at an all-time best of 12 days for the quarter, versus 17 days last quarter.

On a sequential basis, inventories turns improved from 11 times to 11.3 times.

And DSO improved from 44 days to 42 days.

Slide 10 -- depreciation and amortization amounted to approximately $87 million.

And net capital expenditures were approximately $81 million in the quarter.

Cash flow from operations generated approximately $523 million, including the incremental benefit of $236 million from sales of accounts receivable.

Slide 11 -- During the quarter, Asia decreased to 48 percent of total production, while the Americas and Europe grew to 17 percent and 35 percent, respectively.

It is interesting to note that revenue continues to increase in the Americas, which is a competitive advantage for Flextronics compared to our Asia-only competitors.

The Computers and office automation segment decreased to 23 percent of total sales, while the consumer segment decreased to 10 percent of total sales as more of these products are being built in and shipped out of Asia during the September quarter in order to be on the shelves for the holiday season.

Slide 12 -- While we haven't been very vocal about the industrial, medical, automotive, and other product segment has more than doubled since the beginning of last fiscal year and the current run rate in this category exceeds $2 billion annually.

We continue to see many more opportunities in this category of products.

Slide 13 -- Sony Ericsson represented approximately 15 percent of revenues.

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

Our top-10 customers accounted for approximately 63 percent of revenues in the December quarter.

Slide 14 -- In addition to world-class working capital management, we continue to improve fixed asset efficiencies as well.

Annual capital expenditures reached a high of $711 million in fiscal 2001 and a low of $181 million in fiscal 2004.

We expect our annual CapEx to increase to approximately $300 million in fiscal 2005 as we buy out some remaining operating leases that expire this year.

We expect to reduce fiscal 2006 CapEx to below $200 million, which will be a source of additional free cash flow next year.

Additionally, CapEx was almost $500 million more than depreciation fiscal 2001, compared to the last 2 fiscal years in which CapEx was less in depreciation.

And we expect this trend to continue for at least the next 2 fiscal years.

We are also increasing the throughput on fixed assets as revenues continue to grow and the fixed asset base continues to decrease.

The fixed asset to sales ratio was 15 percent in fiscal 2001, increased to 16 percent in fiscal 2002, and has since decreased to 11 percent in fiscal 2004.

At the end of the December 2004 quarter, this ratio has declined to 10 percent, and we expect it to fall below 10 percent in fiscal 2006.

Before discussing guidance, I would like to take a few minutes to reflect on the quarter.

In terms of operating metrics, including inventory turns, CapEx as a percent of sales, cash cycle days, operating profits, gross margins, et cetera, we are now operating better than we have in many years.

And in quite a few of these metrics, better than we have ever operated in our history.

A couple of quarters ago I said that I didn't think we could utilize our assets any more efficiently.

And it turns out that we can.

We are not sure if we can improve on some of these working capital metrics much in the future, but we certainly intend to try.

With return on tangible invested capital greater than 30 percent, we are now generating a very good return for our shareholders.

That having been said, we continue to believe that we can increase gross margin and operating profit.

And we think there is still room to reduce SG&A as a percentage of sales.

In addition, as we again move into a mode of reduced capital expenditures, cash flow should continue to increase.

Of course, this all translates into higher returns on capital as well.

Competitively we are in terrific shape.

Our major long-term initiatives continue to work well.

These include our industrial parks, vertical integration, and design activities.

Our pipeline of potential opportunities continues to be quite robust.

We are optimistic that a number of these opportunities will become reality over the next several quarters, and will provide additional growth moving into calendar 2006.

As you know, we have been focused on adding Nortel as a major customer in the coming 2 quarters.

The transition is on schedule, and Nortel revenues should provide substantial growth in the coming fiscal year.

As you can see from our liquidity, there is no need to go back to either the debt or equity market for additional financing to pay for Nortel's assets.

The estimated payment schedule by calendar quarter for Nortel assets is as follows -- $85 million in March 2005, $210 million in June 2005, $210 million in September 2005, and $200 million in December 2005.

Turning to end markets, we believe they are solid but not spectacular.

Fortunately for Flextronics, with the addition of Nortel, we have built-in revenue growth for the coming year.

As I have said, we believe that other sales opportunities we are working on will provide additional growth beyond Nortel.

Despite a generally slow global market, our network services and printed circuit board businesses continue to thrive and are quite profitable for Flextronics.

Slide 15 -- Now, let me turn to guidance.

The March quarter is always a little less fun than the December quarter as revenues and profits are seasonally lower.

And adjustments following Christmas sell through are always less predictable than in other quarters.

While visibility is somewhat limited, we are not changing our guidance for either March or subsequent quarters.

We continue to expect to operate within the ranges we have previously outlined, keeping in mind that these are ranges and not single-point estimates.

As a reminder guidance for March was previously given as revenue between $3.8 billion and $4.2 billion, and diluted earnings per share, excluding amortization, of between $0.15 and $0.18.

With regard to the June 2005 quarter, we think an appropriate range for revenue is $4.1 billion to $4.5 billion, and diluted earnings per share, excluding amortization, of between $0.17 and $0.20.

In conclusion, we continue to believe that Flextronics is leading the industry in just about every metric that matters -- revenue, profits, inventory turns, cash conversion days, low-cost footprint, and perhaps most important, customer satisfaction.

The Company is doing a good job in the economics of value creation, improving returns to our shareholders, leveraging our competitive advantage to gain market share, and by being relentless in our focus to provide customers with low-cost solutions.

While we have never performed this well in many of the important asset utilization metrics, we remain confident that our revenues, margins, profitability, and returns will continue to improve.

The initiatives we have under way to capture these opportunities and realize these improvements are working.

Slide 16 -- There are real risks of operating this business, which includes a macroeconomic or technology slowdown, among other things.

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

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

Please limit yourself to 1 question and 1 follow-up.

Thank you, sir.

If you would like to ask a question at this time, press star, 1 on your touch-tone telephone keypad.

Our first question is from Brian White with Kaufman Brothers.

You may begin.

Good afternoon.

Michael, could you talk a little bit about the revenue schedule from Nortel?

You talked about the payment schedule, how do you think the revenues will pan out for the -- by quarter over the 2005?

I don't actually think we're breaking it out by quarter.

But, do you have information on that, Tom?

Yes.

We actually have broken it out before, Michael.

So, Brian, we expect about $100 million in the March quarter.

In June it'd be around 300 million.

In September, around 500 million.

Okay.

And then something more than that level in the following quarters.

Okay.

And then, could you talk a little bit about your software business.

How big that is today?

How many employees are in that business?

And how many -- how many acquisitions have you made of Indian software companies?

Thanks.

Let's see, the employee base is around 4,000.

We made -- we made, really, 2 acquisitions of any size, there were a couple of small things.

And, you know, the revenue is -- I mean, you know, the major piece of that business, Hughes, which is -- which continues to be a publicly traded company, so, you know, you can go and take a look at the results there, but their business is around 100 million of revenue, and that's the bulk of it.

Okay.

Thank you.

You bet.

Thank you, sir.

Our next question is from Alex Blanton with Ingalls & Snyder.

You may begin.

Good afternoon.

I was surprised, Michael, at the size of the medical, industrial --

Yes.

-- and automotive.

But we don't know very much about who the customers are there.

Could you list off some of the major customers that's part of that?

It's over $2 billion annually.

And there must be some pretty sizable piece there.

Actually it's -- you know, we decided to call it out because some companies -- some companies have made a big deal about that sector.

We haven't really called it out.

We do break it out.

I mean, we breaking it out in quarters, and I called it out separately because it's becoming a pretty sizable business.

And to be honest with you, I cannot break out the individual customers.

What I will do -- the customers are increasingly sensitive about this stuff, as I think you know.

We had some discussion about what we wanted to talk about customers.

And what we'll do in the next quarter, in the March quarter call, we will make an effort to get some approval from some of these customers to be able to talk about them because we'd like to do that.

We'd also like to give you a little bit more information about what's happening from a pipeline standpoint, and we didn't get the approvals necessary to just do that -- to do that ad lib.

But we will take that as an action item for next quarter.

It is a very good business, as you can see.

I mean $2 billion is a substantial part of our business.

And we're making an effort to grow that.

Just a clarification, you gave some numbers for Nortel during your presentation.

Yes.

What were those, 85, 210, 210?

Yes.

That's the cash payment, that's the schedule of cash payments.

That's cash payments.

I will remind everybody that the majority of that, the bulk of those payments are for working capital, which, as we believe we will improve the turns in that business, we'll turn right back to cash, a certain portion of that.

So if according to what Tom just said, you're looking at a $2 billion run rate when this is fully geared up, this would be in the September quarter?

Yes.

We expect that business to run between 2 and $2.5 billion in revenue annually.

Okay.

Thank you.

You bet.

Thank you, sir.

Our next question is from Steven Fox with Merrill Lynch.

You may begin.

Hi, good afternoon.

Good afternoon.

Just looking at your operating margins again.

I'm just curious if there's anything else you would call out that helped, besides, obviously, volumes, during the quarter, whether it was some of the vertical businesses standing out more?

And then secondly, could you just mention what your off balance sheet receivables stood at the end of the quarter?

Thanks.

Yes.

Sure.

Tom, you want to answer that one first?

Yes.

Sure.

So, Steve, the change in the receivables sold was -- let me flip it up here real quick -- provided $235 million of cash flow from operation this quarter.

So that would be the change in the receivables sold.

Okay.

Great.

Okay.

In terms of the operating profit, I'd like to say that it's one thing or another but it's just grinding it out.

I mean, we're just getting better and better at this.

Our operating profit has been more or less going up every quarter now since we bottomed a couple of years ago at 1.6 percent.

Our circuit board business is a good contributor, the software is a good contributor, and the network services business had a record quarter.

But those businesses, in reality, are dwarfed by the size of the EMS business, and we just -- we've improved our performance in the Americas every quarter for about 2 years in a row now.

We continue to perform very well in Asia, as we have for a long time.

Europe is improving slowly.

So, it just all adds up.

That and grinding away at SG&A.

And we're in a tough business, but we're getting better and better at this.

You can see from the asset utilization, it takes less cost -- not only are operating profits going up, but it's taking less capital to run our business all the time.

So, we're feeling good about how -- about how these numbers came in, but it's a lot of hard work.

Okay.

Thank you very much.

You bet.

Thank you.

Our next question is from Shawn Severson with Raymond James.

You may begin.

Good afternoon.

Michael, could you give a quick update on, kind of, the ODM business and how that progressed in the quarter and your outlook and maybe your goal, talk about your goal again for the end of the year?

Yes.

Sure.

The ODM business is more complicated, I would say, than we -- than we had originally expected in the following sense.

The -- we describe ODM as products that we create, platforms that we create that are customized at the final touch.

And more and more, it doesn't look exactly like that.

It's more -- it's more a design services kind of business, where we -- where we design it in collaboration with the customers.

And then do the manufacturing.

The business is going well.

I think as I said last quarter, the same is true this quarter, which we are -- we are doing better in CDMA products today than we are in GSM products.

Our design base, which is around 1,000 people are fully utilized in the number of projects for a bunch of companies.

We will not have -- that business will not be a stable enough business to be satisfactory for us until late summer of this year.

I think I've given that information before, because that's when a number of products will -- will hit the market.

And it's -- before that, in this period of time, and really since we got started in this towards the beginning of last calendar year, it's been very sporadic.

So we've had some good -- some good moments and some bad ones as products have come and gone, products in this -- particularly, in the cell phone category come and go.

We have a target over the next few years of getting to about a $4 billion run rate of products that we have designed one way or another.

And that by the end of this year will be over a billion dollars for sure.

And that's probably the best -- the best characterization I can make.

Thank you.

Fair enough.

Just a quick follow-up, then.

Sure.

What's the general trend that you've seen out there in the business.

I know it's going to vary by segment and end market.

But you think people are feeling better or worse?

Are you feeling better or worse than you did on the last call, as far as, kind of, the longer outlook for '05 for the calendar year?

Yes, I don't think that there's much change.

I mean, I -- there's certainly is no -- as you know, nothing dramatic of an increase to get excited about.

It does vary by segment, for sure.

And you know, more than by segment, I mean, it varies a lot company to company.

And as I talked about it last quarter, I think this is going to continue to be the case.

I mean, the overall -- the overall growth in revenue, the underlying growth in revenue in the industry, I think, is going to be modest this year.

I mean, I -- whether that's 3 percent or 5 percent or 2 percent.

But it's not 10 or 12, there's no raging growth.

And there's certainly no raging disasters.

We're in a marketplace that I think really favors picking companies as opposed to the overall -- as opposed to the overall situation.

I think that's true in almost every category in which we operate.

From the cell phone business, there are share shifts going on.

There are always share shifts going on.

What 1 company will surge or 2 companies will surge with some really cool products and then they'll drop back a bit when some other companies come out with their cool products.

And so -- and there's certainly are long-term trends.

That information is publicly available if you look at the cell phone business.

The printing and imaging sector continues to be reasonable -- well, the cell phone sector in aggregate is pretty good.

As I always say, we don't participate so much in the PC sector or the IT sector.

But we don't have as much information about that.

Clearly, as we talked about earlier, the automotive, industrial, medical sector is increasingly a meaningful part of our business.

And that tends to be very stable business, long product life cycles, slightly better margins I would say.

So overall, I think that we're going -- we're going to continue to grow pretty nicely.

I think we're going to certainly outgrow the end markets, and that's really what we're the most focused on.

I don't think we're going to get a lot of help this year, at least in the near term, I don't think we're going to get help by a -- by a just buoyant end markets.

But, we've got a couple billion dollars of business coming in from Nortel, we're winning some other business, so I think we'll just do fine.

But I don't think end markets are going to be great.

Thank you.

You bet.

Thank you, sir.

Our next question comes from Lou Miscioscia with Lehman Brothers.

You may begin.

Okay.

Great.

I guess, Michael, just keying on the comment you just made, suggesting that the industry probably won't grow by 10 or 12 percent.

Do you think that we're running to a little bit of waiting for some of the new markets to sort of mature, maybe bring bigger chunks out as you pointed in the medical, industrial, automotive, and then we'll get back to maybe 5 percentage points, let's say, above the end markets?

Or do you think that we're in a period where it's only going to add, let's say, 2 or 3 kind of points just because top lines of a number of the EMS companies are starting to get larger.

Okay.

So, let me clarify.

The comments that I was making about market growth were end markets, that was not industry growth.

Then it wasn't EMS industry.

Okay.

Yes.

I wasn't addressing that at all.

So the end -- I'm saying end market growth will be 2 percent or 3 percent or 5 percent.

You guys know better than me.

I mean, we're not -- we don't have economists on our staff, and can't afford it from a margin standpoint.

So, you guys have a better idea than we do.

Industry-wide is something different.

I mean, I don't -- I think you have to make your own judgments, because I don't know what the other -- what the other companies in our industry are saying.

There is absolutely no doubt in our view -- I mean, I've read some analyst reports lately suggesting there's no more big deals, no more business to go out.

I just think that's crazy.

I've been saying that for a long time.

We are in conversations with many, many companies about -- about outsourcing more of their business that's in house.

I mean, Nortel is just 1 example.

So we're going to have much -- we're going to do much better -- Flextronics is going to do much better than 5 percent over end market growth.

I mean, there's next year at 10 or 15 percent over -- over end market growth.

And we for -- we, at Flextronics, do not see any reason to suggest we can't continue to do that.

I mean, we've got lots of customers, lots of work in house.

You have to remember that -- I mean, I think way -- the best way to think about the industry is that, you know, companies that aren't doing that well are the ones that are most aggressive about restructuring their businesses and it has worked very well.

I mean, we've talked about this in the past about Ericsson, which was struggling at the time, is doing extremely we will now.

Xerox was struggling at the time, is doing extremely well now.

Nortel's had their -- their share of struggles, which everybody knows about.

We think that they're going to continue to do well with this.

And if you believe that thesis, then all you have to do is look around the business and see what companies in the industry, or how many companies, what percentage of the companies in the technology space could use some margin improvement, and that will give you an idea of how much business is potentially available to our industry.

And I think it's a lot, really a lot.

And our own conversations with companies suggest that's the case.

So I'm not sure where -- why anybody would be being depressed at this particular moment in time about end of the growth for our sector.

I don't see it.

We certainly don't see it for Flextronics.

We see lots of opportunities.

Okay.

Great. 1 quick follow up.

Sure.

If you could just comment as to why Europe and America is actually look like they, as a percent of the business, actually increased a little more, where obviously -- obviously, you're so strong in Asia, would have thought that that would have maintained more growth.

Yes.

I think that, as I guess I've said for a long time, I mean, I've been a big believer, and we certainly at Flextronics are big believers that customers need a global solution.

That's what we really believe.

And so what has happened is over the last 2 or 3 years is everybody was just moving to China, don't confuse me with any other options.

I have never believed that that was a sustainable trend.

And I think I've talked about this before, but I'm certainly willing to talk about it now.

When Mexico opened up, because of NAFTA, everybody rushed and put a bunch of stuff in Mexico that belonged in Asia, which is essentially consumer products.

Consumer products, small, easily shipped consumer products are going to get made in Asia for, I think, the rest of time.

Just like they have been since World War II.

So a lot of stuff went into Mexico then had to get shipped off to Asia.

But that stuff is all adjusted for now.

What I believe is that manufacturing is going to -- is going to follow end market development to a certain extent.

And so, in Asia, you've got a growth of the market in China, growth of the market in India, those are -- those are big drivers, and includes Thailand, Singapore, and Malaysia.

And so a lot of products will continue to get made there, even physically large ones.

But you have a rapidly developing eastern European marketplace, Poland, Hungary, Czech Republic, the Ukraine as end markets.

As Eastern Europe grows, some of that manufacturing that's been done in Asia is going to come back into those countries and into Europe to serve those countries.

And the Guadalajara sites, if you look at our site, I think of you -- a number of investors, people on this call have been to Mexico in the last 6 months or so.

I mean, everybody is getting busy there again.

And the busy -- getting busy there are physically larger, more complex products that serve the North American market, which is a big market.

So I think these trends are natural.

I don't think there's any -- there's no backlash or anything.

Everybody needs to remember that the drop in the dollar changes where people want to do things.

The fact that there's more taxes in China now, that the cost of oil has gone up, which means transportation costs are greater.

And the take away is that all of these issues, the fact that they keep changing all the time, they favor big, global companies like Flextronics because oil prices go up, transportation's more expensive, customers come back and say, maybe it makes sense to look at this again.

We look at it again.

Maybe it makes sense to do it in Mexico instead of in China.

And that's why I made the remark that this actually favors companies -- this whole thing, this whole discussion favors companies like Flextronics where we don't really care.

We love to do it in Asia, but we certainly love Mexico.

We love Europe.

So we're happy to do it any place.

And I think you're going to see more of that over time, that these global shifts favor the big global companies.

Okay.

Great.

Good luck on the new calendar year.

Thank you.

Thank you.

Our next question comes from Thomas Hopkins with Bear Stearns.

You may begin.

Yes, good afternoon, Michael.

Good afternoon.

First, can you touch base with us or give us a one-on-one on -- on what happens when a large customer may consider divesting a unit where you have a contract.

And I'm speaking specifically about Siemens.

Sure.

I don't know if you can tell us anything specifically about some of the stories about them potentially divesting their handset unit.

But we've seen you go through this before with Sony Ericsson.

Sure.

So, if you could just review what that's like and what people can expect?

Yes.

And I actually appreciate the context in which you put that question, because -- because it's helpful.

I mean, I can't comment about Siemens particularly, I mean, there's news about them all the time.

And they have things to say about their businesses.

And -- which isn't really too different from Nortel or Ericsson or Xerox at the time.

The -- and there've been a lot of -- a lot of rumors around, where you have got lots and lots of calls, what's going to happen with Siemens and stuff like that.

In general, if it's a contractual case, like we had Ericsson, Xerox, and Nortel, where there's an exchange of money, we're buying assets, we have a contract, it's worked all worked out on a return on capital and there's all these deals about who pays for various restructurings, and all that kind of stuff.

Those transactions, 100 percent of the time, the contracts we've done of those types survive any kind of change.

So if a customer -- if -- let's use Xerox.

I mean, you have a multi-year deal, Xerox decides to sell their whole company to somebody else, the deal just goes with it.

So that -- there's really no risk around those deals that way.

With other customers, where we don't have a contract, it's really at-will manufacturing, which means that, depending on who the buyer is, if there's a buyer, of anybody's business, I mean, they can potentially have the right to move it.

I think that investors are more concerned about this than they need to be.

And the reason I say that is because if you look at the big -- at the big contracts, the big companies, they don't move very much, no matter what.

I mean, most of our business, 60 percent, 70 percent of our business is at-will manufacturing.

I mean, companies can decline to give us a new order.

But these projects, these companies' arrangements are big, they're complicated, they're long-term, there's a lot of expertise involved.

Business does not move very easily.

And if you look at all the companies, our competitors as well, they're very little big movement.

And so I think that the concern -- I mean, obviously, a company doesn't do well, that's a drag.

I mean, some of our cell phone customers haven't done as well this year as last year, and that's an impact on us, there's no question.

I mean, the volume goes down.

But in terms of being concerned about some major -- they call up and go, we just did this deal and your business is all going away, that just -- it can happen, but it doesn't, or it certainly -- we haven't had that experience.

We're not overly concerned about that.

And companies are having these discussions all the time, particularly companies that aren't doing well.

And unfortunately, there are a lot of companies in the technology industry that aren't doing that well.

And so these -- these rumors tend to roil the industry because it's just a fact of life.

People are looking at these various combinations.

But we're not overly concerned about it.

Okay.

Then, as a follow-up, just to look at your margin improvement from another angle, almost every quarter, it seems like the market's betting you're not able to improve your margins and they inch up.

This quarter the improvement almost entirely came at the gross margin line.

It wasn't any -- doesn't seem to be much SG&A improvement as a percentage of sales.

Can you talk about it from that point of view?

Yes.

And I tell you; it is very frustrating to be our management team.

I don't mind telling this large group of listeners.

To -- to see people bet against us quarter after quarter after quarter.

I mean, it's sort of depressing.

I mean, we've been -- we have these analyst meetings, we tell you how we're going to do it, we go out and do it, we've been doing this steadily for, it's been almost 3 years now, of doing what we said we're going to do.

And we're going to continue to do that, we believe.

I mean, that's not a -- there's no guarantees about that, but we're at 3.7 percent.

We're at 3.7 percent, which is the best from an operating standpoint we've done in 3.5 years.

But we're using so much less capital than we were using when we were 3.5 years ago that -- that we have cash pouring off the business.

And I just continue to read these reports about how we can't do it, it's not a good business.

And we don't, frankly, understand it.

The gross margins are going up in all the ways that we have expressly explained, which is, we're doing more design work, we're doing more network services work, we're doing more vertical integration work.

We are -- all those things are increasing our margins.

The -- we are driving down -- SG&A as a percent of sales is dropping in the EMS business almost on a continuous basis.

And so the margin -- we're getting margin improvement in the EMS portion.

The reason that the SG&A as a percent of sales has been relatively flat at the whole Company level is because of the increasing business in the higher margin parts of our business, which have higher SG&A with them.

So you just get a single number.

But as you grow the higher margin parts of the business, you have more margin.

And we're growing -- we are improving the business, the profits in the business in every one of higher margin businesses -- network services, printed circuit boards, closure manufacturing, logistics manufacturing, and so on.

So those are all growing, which gives us higher margin contribution from those businesses, which also have higher SG&A.

And then on the EMS business, we're getting the benefits of higher revenue in the same sites.

We've taken a lot of sites out over a period of time.

We continue to work the efficiencies at the factory level.

And you add all that stuff up, and we just keep doing it every quarter.

We have new targets for this quarter, we have new targets for the June quarter, the September quarter, the December quarter, the next year.

We have -- we have told people our expectation is for -- is for EPS growth at 15 to 20 percent.

And we're going to do that at every one of those lines.

And until one of those things falls apart, which we'll tell you, but they'e not falling apart.

And we think -- what we think will happen here is we will continue to get more efficient at the EMS -- in the EMS business, and we will continue to grow the higher margin parts of our business.

If that's true, our margins are going to continue to improve.

If at the same time, we can get more efficient in our use of capital equipment, get more efficient in our cash cycle days, not only will our margins improve, but the return on capital will continue to go up.

I mean, it's -- it's at stunningly high numbers now.

I mean, I think that, as I said, I didn't think we could get this efficient.

I mean, we got to 17 days, and I said, look, expect 20, because I think this is as good as it gets.

Now it's at 12.

I mean, I think you should expect it goes back up because I can't imagine -- certainly once we take on the Nortel, the cash cycle days are going to drop, at least for a while because we're going to have slower turning inventory and a complicated business.

But I don't think there's more magic to it than this, guys.

I mean, I think that we run our business exceptionally well.

We take every single line item of our business, and we drive it metric by metrics, quarter by quarter.

And we're -- I hope we're proving we're good at this, because we've done it now for about 12 quarters in a row and we don't think it's going to change.

It will drop in the March quarter, of course, because revenue will drop, and so you can't get the same efficiency level.

But as Nortel comes in and we make that business more efficient, it's going to go back up again.

So, we think we can get to 5 percent.

We said we could.

We modeled it for you.

We didn't say exactly when, but, clearly, on a steady march in that direction and we think we're going to get there.

And when we do, we're going to have returns on capital that are off the scale.

They're already (multiple speakers).

You bet.

Thank you.

Our next question is from Bernie Mann with Morgan Stanley.

You may begin.

Hi, Good Evening.

Good Evening.

A question for you, Tom.

The Nortel revenues that you gave, the 100 million in March, the 300 million in June, and so on, is that the systems integration part of the business?

Well that's -- that's the incremental revenue, primarily, is the systems integration, yes.

Okay.

Have you already started to bring in house, though, some of the printed circuit board assembly or printed circuit board fabrication?

Sure.

Yes, we have.

Can you estimate, maybe, how much that contributed in the December quarter?

It's not all that much.

I mean, we're, obviously, working as quickly as we can to bring that in.

I wouldn't say it had any significant impact in the quarter.

But there is definitely more than 0 in there on the current quarter.

Okay.

And then just following up on the margin improvements, on the gross margin line.

So for the last 6 quarters you've improved gross margins on a sequential basis.

Do you think you'll be able to continue that in the March quarter, given that utilization is going to fall off a little bit?

Yes.

We won't be able to.

That'll naturally -- that's going to naturally drop every March quarter.

Okay.

And what was the biggest driver of the gross margin improvement?

Is it the business mix into the industrial, medical, the higher utilization in the December quarter, or better pricing?

Yes.

I just think it's not really better pricing.

I mean, it'd be nice if someday there's a better pricing environment.

But, I mean, with the amount of money we're making and the return on capital we're getting, I think you could make an argument that pricing's just fine.

I mean, I'll just reiterate what I said, which is it's a combination of all these things -- greater efficiencies in the factories, it's more business contribution from the higher margin businesses, it's a more aggressive tackling of every -- of every expense line.

It's not -- there's no big bucket.

This is just grinding it out across a whole variety of activities.

Yes.

It was a pretty big improvement on a sequential basis, like 50 basis points.

I'll take that as a compliment, thank you.

All right.

Great.

Thanks.

Thank you.

Let me take 2 more and we'll call it a day.

Thank you, sir.

Our next question is from David Pescherine with Smith Barney.

You may begin.

Good afternoon, gentlemen.

Michael, you spoke a little earlier about market share shifts in the handset market, and there's obviously increasing concerns about price wars with the handset vendors as secular growth rates slow down.

So, can you just give us a little bit of understanding about what you expect to happen in terms of the margin in return dynamics, specifically from that end market?

Then just give us a little bit of insight into are you seeing increasing pieces of potential business?

Or are handset vendors looking to increase the rate of outsourcing?

Or are they maintaining their slow and steady rate of outsourcing to you folks.

Okay.

Couple different questions there.

So let me just -- let me just address the handset market overall.

We -- there's always -- this is another one of those things there always seems to be a lot of concern about it.

We always say how much we like it.

There are -- we do not do manufacturing at all for some of the cell phone -- for some of the handset guys who have a lot of share.

And so it's hard to address that.

But we like the handset market enormously.

And the reason we do -- first of all, we're fairly big in it, very good at it, we get good returns in the business, and we're very efficient.

So we think we can continue to grow that sector over time.

The reason we like it is that, while there's a lot of competition, there's a lot of price competition and all that stuff, in the -- in the low-end segments.

The low-end segments are growing rapidly because there's a lot of developing countries, and then you have an enormous innovation taking place, which is -- which I think is what's good for us and good for the handset guys.

I mean, cameras burst on the scene here over the last year, and cameras are getting much more sophisticated.

That's a big business for Flextronics.

We're continuing to invest and doing very well in that sector, also a higher margin sector for us.

There's TV -- TV is coming to handsets in the next year, 18 months.

I mean, you've already got some Samsung -- some Samsung products that have, sort of, full camcorder capabilities in the handset.

You have Blackberry-type of capability is coming to lots of handsets.

So we see lots of innovation.

And when there's innovation, it drives a -- it drives a need for -- when there's a lot of innovation, it drives a need for a quick time to market, and the margins are a little bit better in the EMS space.

So we -- we're very bullish about that segment, long term.

I mean, obviously we have -- we have -- we're not a perfect play on the market, we don't do work for some of the guys who are taking share, we do do work for some of the guys who are losing share.

And so we just have to see how plays out over time.

Obviously, it's been relatively stable for us because some of our customers are taking share, some of our customers are losing share.

We'll have to see how that plays out over time.

But I think as a -- as an end market, we like that a lot.

And then, I'm sorry, you had asked -- there was a second part of that question.

Well, I guess, in terms of what -- what do you perceive your penetration rate to be?

Oh, right.

So, if you've got some customers who're losing share, and some who are gaining.

Are the customers who are losing share, are you fully penetrated with them, or are they coming back to you and saying, hey, you're only doing 30 percent of our manufacturing, we'd really like to get 70 or 80, and really, really get some better efficiencies out of the manufacturing process?

I mean, what are those conversations like?

Yes.

I think -- I mean, I think the generic answer to your question, because it's true not just of handsets, but the customers that we have that are -- whose businesses are struggling, and that's not just true of some of the handset guys, but it's true of many customers, some of them are not on your guys' radar screens because they are smaller customers or whatever.

But I think that in general, our experience has been that when customers' business is struggling, they tend to look for more dramatic ways to change them than incremental.

So rather than taking, hey, why don't you take a couple more lines, it's like, what would this look like if we didn't have any manufacturing?

We've, obviously, done a number of deals like that.

And we think there are more -- there are more coming, not just in the handset business, but in a bunch of -- in a bunch of different sectors.

So in general, distress of our customer base has not been a negative for us.

Now, that's not a guarantee that one of the guys you're concerned about today won't actually quit the business, go under, all that stuff.

That doesn't happen very often.

So, in general, I would say there is more penetration opportunity for us along the lines you suggested in both handsets and in infrastructure and in consumer and in industrial and medical.

We think there's plenty of opportunities here.

Great.

That's very helpful.

Thank you.

Okay.

You bet.

Thank you.

And our last question is from Todd Coupland with CIBC World Markets.

You may begin.

Yes.

Good evening.

Good evening.

I was wondering if you could give us the core levers that will bring you to, either the high end or low end of the guidance over the next couple of quarters.

Just talk about that, please.

Yes.

Sure.

I think that's a good one.

I mean, I think that the -- how well the Nortel transitions go, how quickly we bring that stuff in could be a driver to the low end of the range or the high end of the range.

I think the cell phone business itself will be a big driver.

I mean, the guys who are struggling can have a big impact one way or the other.

We can -- we can -- the companies that we have that are losing shares are already down, that's already in our numbers.

They could go down further, which would be low end.

They could come back, which is very common in the cell phone business.

You get sort of surprise upsides.

And so, that could drive it to the higher end of the range.

I mean, I think the -- I don't think that there's -- most of our business is pretty stable.

If you look at what we've done over the last 6 or 8 quarters, we've been pretty much right on.

I mean, we're give or take $100 million, which is not that much for our size anymore.

It's reasonable predictable.

I would say those 2 things are probably the biggest drivers.

There are margin issues around our higher margin businesses.

For example, circuit boards, where we've been operating very profitably and very efficiently, that as far as we can see, that business looks like it continues that way.

I mean, there's always a risk that a downturn in the end markets would drive margins down, which would tend to drive you toward the lower end of the range.

Or not a very big upside in demand could also improve the margins in some of those higher margin businesses and drive to the higher end of the range.

So, I'd say it sort of boils down to those things -- what happens with Nortel, what happens with the cell phone business, and then just general margin increases or margin pressures in the -- in the higher margin segments.

The standard, outside of those issues, the standard business is pretty stable, pretty predictable and that's why we feel pretty comfortable not changing the estimates.

Great.

Thanks a lot.

Okay.

Thank you, very much.

We are, as I'm sure you know from my comments, we are pretty pleased with the way we're operating our business.

We don't intend to stop here.

We're going to continue to drive to the 5 percent.

We're going to continue to work with customers to look for some major outsourcing opportunities.

We think we're going to see some more.

We think that, not only will Nortel give us some near-term revenue growth, but we think that 2006 should be a pretty, pretty strong revenue growth year as well from the other customers we're working on now.

So, from our standpoint, everything is sort of steady as she goes.

We think we can continue to deliver the kinds of returns to shareholders that we've been delivering over the last 6 or 8 quarters, and we certainly hope and expect the investment community will reward us for that at some point.

So, thanks for calling in.

Talk to you again at the end of March.

Thanks.

Bye.

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