Flex Ltd (FLEX) 2007 Q1 法說會逐字稿

Good afternoon, and welcome to the Flextronics first quarter earnings conference call. (OPERATOR INSTRUCTIONS).

Today's call is being recorded.

If you have any objections, you may disconnect at this time.

I would like to turn the call over to Mr. Mike McNamara, Chief Executive Officer.

Thank you, sir.

You may begin.

Ladies and gentlemen, thank you for joining the conference call to discuss the results of Flextronics' first quarter ended June 30, 2006.

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 calls and presentations.

You will need to click through the slides, so we will give you the slide number we're referring to.

On the call with me today is our Chief Financial Officer, Tom Smach.

I will turn the first part of the call over to Tom to go through the financial portion of our prepared remarks.

I will then provide some commentary, along with our guidance for next quarter and the current fiscal year, and then open it up to questions.

Before I turn the call over to Tom, there is one housekeeping item to cover.

We are planning on hosting an analyst day in New York City in the afternoon of October 26th.

Additional details will be sent out when finalized, but in the meantime, please save the date.

Go ahead, Tom.

Thanks Mike, and good afternoon, ladies and gentlemen.

We are on slide 2.

Please note that this conference call contains forward-looking statements within the meaning of the federal securities laws, including statements related to potential growth opportunities in our core EMS business, the success of our market focused approach and our vertical integration and accelerated growth strategies, revenues and earnings growth, the success of our long-term initiatives and related capital expenditures, the proposed divestiture of our software development solutions business and the expected gain on returns from the divestiture, new customer opportunities, profitability, and anticipated use of available cash.

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

Information about these risks is noted in the earnings press release, on slide 16 of this presentation, and in the risk factors and MD&A sections of our latest annual report filed with the SEC, as well as in our other SEC filings.

These forward-looking statements are based on our current expectations and we assume no obligation to update these forward-looking statements.

Investors are cautioned not to place undue reliance on these forward-looking statements.

In addition, throughout this conference call we will use non-GAAP financial measures.

Please refer to the schedules, to the earnings press release, slide 8 of the slide presentation, and the GAAP versus non-GAAP reconciliation in the investors section of our Website, which contains the reconciliation to the most directly comparable GAAP measures.

Slide 3.

Revenue from continuing operations in the June quarter was $4.1 billion, an increase of 6%, or $236 million, over the year ago quarter.

Revenue for the core EMS business, which excludes software, semiconductor, and network services, increased by $422 million, or 12%, from $3.6 billion in the year ago quarter.

On a sequential basis, revenue from continuing operations grew $528 million, or 15%, and exceeded our previously communicated guidance for this quarter.

Slide 4.

As discussed on the last couple of calls, our strategy is to accelerate revenue growth and enhance profitability in the core EMS business by organizing resources through a market-focused approach.

This is designed to bring more value and innovation to customers, improve our competitiveness, and to increase market share with customers.

As a result, senior executives have been added from the outside or promoted internally to lead each segment.

Beginning with the June quarter, we have changed the market segments in which some of our products are classified, as illustrated by this slide.

Slide 5.

The information from prior periods shown on this slide has been revised to conform to the new market segment categories, as shown in slide 4.

Computing increased by $63 million sequentially and represents 15% of total June quarter revenue.

Consumer digital increased by $111 million sequentially and represents 22% of total June quarter revenue.

Infrastructure increased by $105 million sequentially and represents 25% of total quarterly revenue.

Mobile increased $188 million sequentially and represents $28 million of total June quarter revenue.

Industrial, automotive, medical and other increased by $61 million sequentially and represents 10% of total June quarter revenue.

Sony Ericsson, Hewlett-Packard and Nortel all individually exceeded 10% of total revenue in the June quarter.

Our top 10 customers accounted for approximately 65% of revenue in the quarter.

On a geographical basis, Asia increased on a sequential basis to 59% of total revenue, while Americas decreased to 22% and Europe decreased to 19%.

Slide 6.

On a sequential basis, gross margin decreased 20 basis points to 5.8%, SG&A as a percentage of sales decreased 30 basis points to 2.8%, and operating margin improved 20 basis points to 3.1%.

Slide 7.

Excluding amortization, restructuring and other charges, including stock-based compensation, quarterly net income amounted to $104 million.

This resulted in earnings of $0.18 per diluted share in the current quarter, compared to $0.17 in the year ago quarter.

Slide 8.

After-tax amortization, restructuring and other charges amounted to $19 million in the current quarter, compared to $41 million in the year ago quarter.

It is important to note that effective April 1st, other charges includes stock-based compensation expense of $7.4 million in the June 2006 quarter.

There were no restructuring charges for the current quarter.

After reflecting these charges, GAAP net income for the current quarter amounted to $85 million, compared to $59 million in the year ago quarter.

This resulted in earnings of $0.14 per diluted share in the current quarter, compared to $0.10 in the year ago quarter.

Slide 9.

Return on invested tangible capital improved to 30%, from 26% in the year ago quarter, while return on invested capital has improved to 10%, from 9% in the year ago quarter.

Slide 10.

We ended the quarter with $886 million in cash, up from $830 million at June 30, 2005, while total debt has increased by $22 million since that time.

Including our revolver availability, total liquidity was in excess of $2 billion and debt to total capital ratio was 25% at quarter end.

Slide 11.

Cash conversion cycles came in at an industry-leading 12 days, versus 20 days for the year ago quarter.

Important to note that $175 million of the sequential increase in our inventory balances is attributable to the acquisition of the Nortel Calgary facility in May 2006.

Slide 12.

In the June quarter, depreciation and amortization amounted to $81 million and net capital expenditures were $82 million.

Cash flow from operations used $98 million in the current quarter.

Slide 13.

As previously announced, we've entered into a definitive agreement to sell our software business to KKR in a transaction valued at approximately $900 million.

Upon closing, Flextronics expects to receive in excess of $600 million in cash and will hold a $250 million face note with a 10.5% paid-in-kind interest coupon, which matures in eight years.

Flextronics will also retain a 15% equity stake in the business.

The gain on sale is expected to be approximately $150 million.

This transaction is expected to close during the September quarter and we will update you on the specific impact on our balance sheet and income statement at that time.

Once the transaction closes, net income from discontinued operations will cease, and is replaced by interest income on the PIK note and the investment returns on the cash proceeds.

Thank you very much, ladies and gentlemen.

As you turn to slide 14, I will now turn the call over to Mike McNamara.

Thanks, Tom.

Before discussing guidance, I would like to take a few minutes to reflect on the results of our quarter and our outlook.

As we have stated many times, we believe there has been a re-acceleration of significant growth opportunities in our core EMS business, which includes designed, vertically-integrated manufacturing services, components and logistics.

Fiscal 2006 was a very strong year in terms of incremental business wins from both new and existing customers.

As a result, we exceeded revenue and earnings expectations in the June quarter.

I think you should begin seeing even higher revenue growth rates in the second half of calendar 2006.

We continue to make considerable investments to support the growth in our core EMS business.

The ability to provide vertically-integrated EMS services from our industrial parks remains a big competitive advantage for Flextronics.

We remain firmly committed to the concept of vertical integration and the competitive advantages we will realize from it.

We are continuing to add manufacturing capacity in China, India, Malaysia, Ukraine, Brazil and Mexico, to enhance our position and competitiveness in the marketplace.

Multek's printed circuit board operation continues to perform very well.

Multek is expanding its rigid circuit capacity in China with two new factories that we expect to come online by the December 2006 quarter.

The new flexible circuit factory in China is beginning volume production ramp in the September quarter.

Obviously, we're making significant investments in our future.

We expect CapEx to be in the range of $450 million and depreciation to be approximately 325 million in fiscal 2007.

We think these investments will not only help us meet our revenue growth expectations, while yielding better profits and returns for shareholders, but we will also improve our competitiveness and enhance our capabilities.

As a result of focusing our efforts and resources on improving the customer's overall profitability, and the significant growth opportunities in the core EMS business, we divested the network services and semiconductor businesses and have a definitive agreement to sell the software business.

By monetizing these non-core assets at substantial gains over carrying values, Flextronics will have generated cash proceeds in excess of $1 billion, assuming the software transaction closes as expected this summer.

These proceeds provide necessary funds to support our accelerated growth strategy.

Other substantial benefits from these divestitures include $135 million of deferred tax assets and a $1 billion reduction in goodwill and intangibles, which significantly increases the Company's tangible equity, and therefore enhances our financial position.

In addition, we will have retained ownership interest in both the software and network services business, which should provide additional cash and potential future upside when monetized.

Slide 15.

For the September 2006 quarter, we are currently expecting revenue from continuing operations to grow 25 to 30% on a year-over-year basis, in the range of 4.7 billion to 4.9 billion, and earnings per share to grow 10 to 25% on a year-over-year in the range of $0.19 to $0.21 per diluted share.

We have typically provided guidance for only one quarter at a time; however, we will change that policy today in order for people to better understand our fiscal growth rate expectations.

For the fiscal year ended March 31 2007, we are currently expecting revenue from continuing operations to grow somewhere in the range of 25% on a year-over-year basis to approximately 19 billion, and EPS to grow in the range of 15% on a year-over-year basis to approximately $0.80 per diluted share.

Obviously, there is a range around these numbers, and we urge you to be conservative, as the economy and demand trends are dynamic.

GAAP earnings per diluted share are expected to be lower than the guidance provided herein by approximately $0.03 per diluted share per quarter for quarterly intangible amortization expense and stock-based compensation expense.

In addition, our guidance does not include the gain on the disposition of software net of charges.

Slide 16.

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

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

I will now turn the conference call over to the operator for questions.

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

(OPERATOR INSTRUCTIONS).

Bernie Mahon, Morgan Stanley.

A question for you on the demand trends.

It's just a little confusing, the way that you reclassified.

So I was just wondering -- you were up 200 million versus kind of the midpoint of your guidance.

Your results came in better.

Could you kind of break that out, how much of that was from closing Nortel a little bit earlier versus where you saw -- like, what markets you saw the upturn in demand?

That's kind of a tough question.

Nortel pretty much happened as expected.

So I think we kind of anticipated the numbers that did come in for Nortel, so I don't think there was much of a trend there.

Mobile had the biggest jump of 188 million -- I think it was 188 million -- 188 million, which was the biggest jump in terms of total dollars.

So a lot of our cellphone customers have done well during the quarter.

But if you look at -- across the sequential growth in each of the difference seven segments which we itemized, I think each and every one of them was up pretty significantly and pretty evenly.

So it's really a broad-based kind of a well-diversified increase across all of our market segments.

When you look out to the September quarter, obviously, the revenue guidance there is a little bit stronger than what most people had anticipated.

Where are you seeing that strength?

Is that broad-based, or is that more in ramping a consumer program?

Or what are you seeing there?

We see a lot of the same things.

You'll get some products that are very traditionally the seasonally ramping products, so things like mobile, and also the printer kind of products that we typically see very seasonal activity.

But we actually, again next quarter, expect each of the different categories to grow and expand.

So we would again expect it -- outside of the normal seasonality of kind of the usual product categories, we also expect a continuing broad-based, well-diversified growth across all segments.

Todd Coupland, CIBC World Markets.

Wondering if you'd just talk a little bit about the difference in the spread between the revenue growth that you expect in '07 and the EPS growth.

Wondering how you expect that to profile over the course of the year.

I guess I would have thought with that type of revenue growth, you might have seen stronger EPS growth.

Just talk us through that.

Thanks.

So one thing, it tends to be somewhat dependent on the different kind of products that we would be booking.

Some products are going to have a little bit higher revenue and earnings per share, and some are going to be a little bit lower.

It really is a function of the asset turns associated with those programs.

So outside of the mix issue, the real key is startup costs more than anything else.

The fact that we are ramping as rapidly as we are has caused us to accelerate a lot of the building investments that we're doing around the world.

It's caused it to accelerate the amount of equipment that we have got coming in place, and the amount of people we're hiring right now is at a pretty fierce rate.

So, between all those things, actually the accelerated growth puts a little bit of a damper and a downturn on the earnings as a result of these startup costs.

If the growth rates were more moderate, those startup costs would be absorbed.

But the fact that we're growing upwards of 25% is going to make it a little more challenging for us to completely absorb those startup costs.

So we will expect that to take down the margin slightly, although not much, but it kind of explains the earnings per share mismatch with revenue growth.

And then we would expect to catch up on it next year.

So would you expect the new program costs to impact results fairly equally throughout the year, and then it's an '08 leverage story?

Yes.

What I think what you'll see is you'll see March have the usual seasonality down.

And then I think once you hit June, we'll be back at pretty normal levels, and hopefully achieving better than 3% operating margins at that point.

Alex Blanton, Ingalls & Snyder.

Just pushing a few numbers, the next nine months, if you make $19.1 billion, which represents a 25% increase, would be just over 15 billion, or about a 32% increase from last year's period, similar period of nine months.

So, that's an average of about 5 billion a quarter.

Could you give us some idea of what's in there?

What is responsible for the increase?

What kinds of products, what kinds of new business you might have won that would be in there, and so on.

We've made some announcements of new business, which will (multiple speakers) somewhat.

And beyond that we don't -- either don't have authorization from the customer, or maybe it's just existing customers that we're ramping.

The biggest element again is going to be mobile phones.

We've grown that substantially.

Year on year, we'll achieve growth rates that could be as high as 40% or 50% on a year-over-year basis.

For the whole year, or for just the next nine months?

Yes.

Year over year;

I didn't look at the nine months.

But that's a huge part of it.

We're having a lot of success in the phone business, and we also have pretty good traction in our ODM business, as we talked about before.

So that business is growing on all fronts.

We also have the Nortel business, which is at full ramp this year as opposed to last year, where all the factories are now transitioned across.

So that's also pretty significant.

But again, we anticipate, as a result of these seven markets we're going after, that each and every one of them will have solid growth.

And I don't think there's any one of those markets that we don't anticipate double-digit growth in.

Is any of the Lego business in there?

Yes, but (technical difficulty) not a huge number.

When does that start?

Some of it started already.

So it's going to end up being probably on an 18-month kind of ramp plan.

Our first shipment to Lego was probably -- we may have even had a few shipments in June.

But substantially they're starting this quarter.

Is there any new set-top box business in there?

Yes.

Quite a bit.

Can you say anything about that, where that came from?

No.

We'd have to check with the customer on that, so we -- but there's some more set-top box business in there.

Carter Shoop, Deutsche Bank.

Wanted to touch on the inventory and then also the pricing environment.

First on inventory, Nortel closed relatively early in the quarter, so I figured that wouldn't be too much of a drag.

What are your expectations now that we've seen inventory velocity come down quite a bit?

Can we expect to see inventory turns start to increase throughout the remainder of the year, or do you expect them to stay where they are now?

We actually probably anticipate them to stay pretty flat.

So, the impacts of inventory right now are, as we mentioned, $175 million with Nortel.

That comes with real low turns as that's being transitioned over us, and the vertical integration kind of aggravates that a little bit.

The other key is that we're ramping, and we're growing pretty substantially.

So between those two effects, I actually think it's going to be roughly the same as it is now, and then I would expect to make, again, meaningful contributions to that probably as we come out of the March quarter into June of next year.

Same question on the pricing environment in the industry.

Can you comment on that?

Has that changed at all the past three, six months?

I don't think so.

It's the same.

It's tough.

It's a competitive environment, and you just need a lot of tools to be able to compete in it.

But I don't think it gets any harder or any easier as -- I think it's about the same.

Lou Miscioscia, Cowen & Co.

Mike, if you could go back to, I guess, the analyst meeting in May of last year, just to sort of see if we could slice this a different way.

You guys talked about $4 billion of business that you won. (indiscernible) seems like now some of it's, obviously, hitting in, coming in.

I think the main categories you talked about were servers, cellphones, printers, and then other probably was like more in the industrial category.

Is it still that same business that you talked about back then that you're talking about that's ramping up now, or is there other things that have come in and other things maybe that maybe fell off?

Yes.

I think if you look across that group, I would say cellphones are relative to expectations last May. (multiple speakers).

Cellphones are very, very strong, so they've come through as anticipated, and our programs have held up pretty nicely, that we've done the designs on.

Servers and printers I would say are substantially below original expectations.

So while there's some in there today, I would say what we originally communicated in terms of how big those programs are as a bundle are probably no more than half of what we anticipated.

And we kind of mentioned one of the problems with getting involved so early in the cycle is you get certain indications of what those programs might look like, and you're so far in the beginning of the cycle that -- and in the middle of the design cycle, it's really hard to have reliability for those.

So I would say those are half of expectations.

So, a lot of what you're seeing as a result are a lot of new things that have kicked in, or market share increases with existing customers, or just some of our customers having good success in the marketplace.

That's actually helpful.

Let me go back to the demand question one more time.

Just from any organic demand with your customers, obviously, it looked like numbers are pretty good here and you are getting positive seasonality.

But would you characterize, as we go into the summer months here, that in general, demand is about where you expected, or you think that tech is weakening?

Or on the other end, do you think it's actually strengthening as we go into the September quarter here?

I don't -- looking across the whole base, I don't know that we see it strengthening or weakening either one.

We have had pretty solid demand trends through the first half of the year, we thought.

And it seems they're maintaining those pretty solid demand trends through the back half of the year.

I think relative to overall macro demand, I think we're pretty much on target for what our expectations were, and [to us they're] pretty steady growth.

Thank you.

Good luck with the job ahead.

Jim Suva, Citigroup.

Congratulations.

Can you give us a little bit update on the traction you're getting on your vertical model, kind of the PCB and the enclosures in that business?

One of your competitors is having a little bit of difficulty.

And maybe let us know kind of where you're at, the traction you're getting, and what some of the CapEx -- are you doing anything new in these areas?

We brought on the -- in terms of what we have new -- so, we've brought on the flex circuit assembly business.

That's a new business for us that we've not participated in in the past.

Basically, the metals, demand is solid.

We see no decreases.

We have actually got our first -- potentially our first award to go into India with metal that we're looking forward to, which we've not had in the past.

We are adding -- we'll be adding plastics capability quite substantially.

A lot of that is just our core business keeps going up, our cellphones plastics keep going up, and also the Lego business itself adds that -- adds capacity to the plastics very significantly.

So I would say we're -- I don't know metal, in amongst itself, how much that's going up, but plastics is probably going to go up close to 50% over an 18-month timeframe.

And I suspect metal is up well into the double digits, as we're expanding capacity there pretty substantially.

So overall we see the trends as being pretty solid.

Those trends kind of go along with our overall revenue growth rates, because typically we sell multiple verticals simultaneously with the customers.

So they tend to go hand in hand.

As a follow-up, can you touch up on the status you have had with the RoHS transition with you and your customers?

Is it pretty much any bumps taken care of, or have we still got a few more programs transitioning over?

We think we're pretty much intact on the RoHS.

We've tracked each one of our different factories.

We track what we have as a certain amount of compliance that they're -- each site is required to have.

We're at virtually 100% compliance for each one of those sites.

We've been working with our customers a lot.

We're not anticipating inventory impacts or end-of-life inventory.

There probably will be some, but we expect it to be very, very minor.

In all, I think the program management that we've done on this program, and the working with the customers and the proactivity that we've encountered has been very strong.

And we're pretty positive on this not creating an issue, and our readiness for our customers, we think, is exceptional.

Thank you and congratulations.

Kevin Kessel, Bear Stearns.

Just a question, Mike, on what you were talking about last quarter in terms of the profitability in the ODM business.

I think you guys were expecting that to become breakeven and then profitable here in fiscal '07.

And the same in terms of the camera modules.

I was expecting maybe that to have more of a leverage impact in terms of your EPS.

Can you talk to that?

Keep in mind, the ODM business, we were losing some money, and we're kind of breakeven in the camera modules.

And what we anticipated is that about now, for the second half of the year, we anticipated both those turning profitable.

Alternatively, we didn't anticipate camera modules being anything more than EMS averages, which is what we talked about.

So the impact is not enormous.

And part of those benefits are really making it such that the startup costs we're incurring going through this 25% growth be actually mitigated somewhat.

So I think they're pretty much on track, both the ODM and the camera modules.

I think it's mitigating what would have been even potentially higher startup costs of the other business.

But we weren't anticipating really breakthrough years this year, but we are actually expecting this to be a transition year for both the ODM and the camera modules.

So, to the extent that we actually accomplish our transition year, we would expect a nice margin impact next year, because at that point we would expect to be fully profitable for the entire year and not be in a transition year.

That's our expectation.

Maybe this question is for Tom.

Tom, in terms of stock option expense, I think this is the first quarter you guys expensed stock options.

Can you give us a sense of where you expect stock option expense to be for a full-year basis?

And then just talk in terms of the recent stock option backdating discussions.

I think your name has come up maybe once.

And when looking at your -- some of your grants back in the 2000, 2001 timeframe, maybe you can just refer to -- in terms of what the policy and procedures were, and if anything has changed.

In terms of the first part, our stock option expense was 7.4 million in the current quarter.

I would annualize that to maybe around $30 million for the year.

So, more or less flat.

We'll grant some new options along the way, but it will be about $30 million for the year.

With regard to the other issue you mentioned, I'm actually not really aware of any identification by any analyst or research firm or financial presses as having unusual grant practices.

We certainly have not been contacted by any regulatory authority, as far as I know, and I think I would know.

And we're not aware of any improprieties in our past stock option practices.

We have not conducted an investigation, so I really can't comment on any specific grants in the past or anything like that.

But to our knowledge, we're not aware of any issues in our past practices.

Speaking of your interest expense, I think that in [other], that came in quite a bit higher than I was expecting.

Can you talk to that, and why it was up so much on a sequential basis, where you expect it to be going forward in your guidance?

It was definitely up more than what we had expected as well.

Interest rates are going up.

And on the sequential basis, I think it was up about $8 million.

Half of that is strictly due to interest rates and higher average balances of the revolver during the quarter.

We do use the revolver during the quarter.

And then the other half was losses on foreign currency transactions.

The U.S. dollar exchange rate was pretty volatile during the quarter, so we incurred about a $4 million loss on FX transactions.

Steven Fox, Merrill Lynch.

Going back to the handset business, last quarter you talked about 5 billion-plus in sales, 17 new ODM wins.

Has there been any change in either the number of wins that you're going to be ramping up this year, or what type of revenues you're looking for from handsets for the full year?

The wins that actually hit revenue this year, I would say not.

They take some time to fall in, and all the new wins that we get this year are really going into next year.

For ODM?

For ODM.

So I think that's pretty much on track.

We described last time we also anticipated pretty substantial increase next year.

We think that's on track.

So the design wins are coming in for next year as anticipated.

So we feel we're pretty much on track there; not above or below, just on track.

We think the overall mobile phone business [will] probably be coming in higher than anticipated, so that's actually a little bit above expectations, and tends to creep up a little bit every quarter for the last couple of quarters.

So we're anticipating that business to even be over 5 billion this year.

In terms of just getting some more leverage, you mentioned that some of the startup costs are hurting you in fiscal '07, and that you could get some of that back in fiscal '08 and see some leverage.

But theoretically, you'd still be getting wins in fiscal '08.

So I'm just curious why won't those startup costs from successive wins hurt leverage in fiscal '08?

Is there something specific in '07 going on?

It's just the inflection of the growth rate.

So we basically -- our revenues have been flattish for the last three years.

And now we have hit the step function, where we're going from a 0% growth rate to a 25 to 30% growth rate.

And there's an enormous amount of startup costs associated with that.

So as the growth rate steps up, our startup expenses likewise have stepped up.

In fact, the startup expenses are incurred before the growth actually occurs.

So the growth lags the startup costs.

So what will happen next year is, if the growth rate flattens out or reduces, then your startup costs are going to flatten out, be consistent, or reduce along with the growth rate.

So that's where the earnings leverage is.

However, if our growth rate is higher next year then what we expect this year, then are incremental startup costs will be higher.

So it's just a function of the growth rate.

And then -- the other thing that lags the growth rate is vertical integration.

So, we transfer over EMS business that immediately contributes to higher growth rates, and then over time we work in vertical integration sometimes.

So there is a lag effect to both vertical integration and those startup costs in terms of driving higher margins.

So we do think it's a function of the growth rate.

EPS is not deteriorating, obviously.

We think we've made a conscious decision to grow that topline to drive higher earnings, higher earnings dollars.

And once that growth rate flattens out, then we will go to work on the earnings leverage to get those margins to start improving as well.

Fair enough.

Thank you very much.

Thomas Dinges, JP Morgan.

A question for Tom.

Tom, last year, as you looked at the operating expense line and the progression that you guys saw there, you did a nice job starting off the year at kind of a peak and reaching a trough in the fourth quarter.

And obviously, inherent in leverage is both gross margin improvement, but also is some leverage off the OpEx.

Kind of what's the expectation there?

Because I would assume that most of the major hiring that you guys are doing is in lower-cost regions, and that would include both floor employees that go in the COGS line, but also the overhead and support that probably goes in the SG&A line.

You're exactly right, which I should have mentioned, so I'm glad you brought that up.

The other thing that occurs with the higher revenue is the leverage on the SG&A side.

So the SG&A dollars do not grow in proportion to the revenue growth.

So you're going to see that SG&A expense come down as the revenues continue to grow.

So short-term, product mix and startup costs are going to pressure gross margins, but you're going to pick up a lot of that back in the SG&A line, as SG&A as a percentage of sales will lever down, because we do have very tight spending controls, as you pointed out.

So while SG&A dollars will grow a little bit, the percentage as a percentage of sales will come down, and that's why we think we can hold operating margin at around 3%, plus or minus a little bit.

But that's the objective, is to go through this whole -- this high growth rate while holding operating margins around flat.

Just two quick housekeeping items.

One, I didn't catch it if you give it -- tax rate expectations for the full year.

Has that now ratcheted down to kind of around where you guys reported this quarter?

I think we were thinking somewhere between 5 and 10 for the year before, and it seems like maybe the lower end of that.

And then also, in the outlook for next quarter, are you also expecting -- does that include a couple of pennies like it did this quarter from the divested ops?

So the question -- so our earnings guidance for next quarter certainly includes any earnings from the divested ops, up until the day that they are disposed of.

Now, after that transaction closes, the income from discontinued operations will be replaced with interest income and the investment proceeds on how we utilize the cash.

So we think that -- the lower net interest will offset the loss of income from discontinued operations.

So it will just be more a reclassification than anything else.

With regard to the tax rate, we're still projecting a 7 to 10% tax rate for the year.

In the first quarter it is a little confusing because of discontinued operations.

But if you were to break out pre-tax income from discontinued operations, along with continuing operations, our first-quarter tax rate was 7%.

And it's hard to see that because the discontinued operations has some tax expense embedded in that line as well.

But for the first quarter it was around 7%, and for the year we continue to project 7 to 10%

Michael Walker, CSFB.

Just one question left, which is on cash flow.

Obviously, you're going into a growth phase here.

The preliminary results, i.e. the first quarter's worth of the growth, showed that inventories look to be growing at about the same rate as revenue.

So you're going to have cash consumed there.

Margins under pressure a little bit from the ramps.

So my question is, are we probably looking at a negative cash flow year, or do you expect that to revert to positive in the second half of the year?

And what's the long-term strategy on that front?

So for the year -- again, going from a step function in the growth rate, from 0% last year to 25, 30% this year -- as you pointed out, working capital is going to be required to fund that growth.

So I think cash flow from operating activities we expect to be around neutral.

We don't expect it to consume or provide any cash.

And then longer-term, again, it's just a function of the growth rate.

If we level out growing somewhere between 20 and 30% on a longer-term basis, then most definitely you could expect positive cash flow from operating activities.

It's just this step function of the growth rate that's going to consume capital to fund the growth.

And just a follow-up question on inventories, specifically.

Looks like you've ramped inventories.

In accordance with the revenue growth you expect to have next quarter -- and I think earlier you said you expect turns to kind of hang in about the same over the course of the year -- are you seeing customers sort of change their strategy with regard to how EMS companies are handling inventories?

You don't have Cisco as a customer, but Cisco is obviously very publicly shifting inventories onto EMS balance sheets.

Is that something that you're seeing play out with other customers at all?

Is there a secular change going on?

I think it's been a trend that's been going on for years, to be honest with you.

But the responsibility of the -- kind of your inventory as it feeds your customer, it's more and more popular, then that becomes your responsibility, which is, I guess, the Cisco model, where more and more -- and that is one of the issues that we have in terms of inventory turns and ramping new programs.

A lot of times we have to feed the pipe, and the pipe being the raw material, the work-in process and the factory.

And very often we have to have a hub right in front of the point of use for our customers.

So I think that's -- I actually don't think that's that new;

I think it's been kind of a long-term trend.

Maybe there's a little bit of acceleration on it recently, but I just think it's part of a long-term trend that's been going on for a while.

Does it create a fundamental shift?

And our objective is just to push this right on back in the same way for the companies that supply us products.

We need to go push that back into them and just kind of have it flow right on through in the supply chain, which is just a more efficient use of capital by pushing it all the way back to the beginning of the chain.

So as our customers do it, we just do it a little bit more aggressively.

We tend to get a bit of a lag, because it's kind of easy for our customers to do it because there's just one of us.

And a lot of times we have to go to hundreds of suppliers or a couple of hundred suppliers and go work the programs individually.

So the time when those programs are implemented actually takes us longer to catch up.

But fundamentally, we do expect to improve turns over time -- not this year -- but we do expect to improve turns over time, and expect to catch that in due course.

So I actually don't think there's that fundamental of a difference in the amount of inventory we're going to carry over time.

Maybe a little bit.

I want to clarify and emphasize one thing on your cash flow question.

I said operating activities would be neutral, which means earnings, depreciation and amortization will offset working capital used to fund the growth.

Now, free cash flow, which is after CapEx, would mean that we're going to be negative $450 million on a free cash flow basis after paying for CapEx.

Brian White, Jefferies.

I'm wondering if you could talk a little bit about the PCB fab market, maybe some of the pricing trends you're seeing, utilization rates, (indiscernible) flux in the industry, and maybe material pricing trends.

Without a doubt, the material pricing trends are a substantial increase.

So all the raw materials associated with printed circuit boards are going up.

In some cases we're having good success passing those on to customers, because we're trying to maintain that same ratio.

And I would say we're having reasonable success at doing that.

So that's -- and we don't anticipate about-face in that characteristic either.

In terms of -- and one of the biggest impacts there is the copper that's used in the printed circuit boards.

The utilization rates for us, we're running very, very high utilization rates.

In fact, that's why we are adding all the capacity right now, because we're actually capacity-constrained, and have the ability to produce -- and basically capacity-constrained in all our factories.

So, some of our factories have a tendency to produce more of the mobile phone-type products, and others are more focused on the high-end complex printed circuit boards.

And both those classes of factories are at full utilization, and we are adding capacity in both.

So we see it as a great market right now.

We think the copper -- the raw materials pricing negatives is being offset by some increases in prices.

But what's not coming off of prices, we're growing our business pretty substantial year on year, and that's offsetting a lot more in terms of overhead savings and such.

So we're pretty positive on the industry, and doing well to keep our factories full.

Mike, when we look at the flexible plant that opens in the September quarter, how big is that in terms of square feet, what type of revenue do you think it can support, and what's the real market that's going to be using that facility?

That's going to be handsets, or what do you think?

First, let me answer the capacity question.

It's hard to say; there's really facility capacity and there's equipment capacity, and we're only trying to bring on the equipment capacity as the business comes on.

But let's say we can do close to 50 or $60 million per year in that factory at what's hopefully -- margins that run close to 20%.

We think that's pretty positive.

What was the other part of your question?

I'm sorry.

What market will it focus on?

It will help mobile phones a lot.

There's -- probably mobile phones more than anything else.

Our exposure to mobile phones is very, very high.

We have the ability to put them into our camera module business and actually vertically integrate our camera business.

The mobile phones is a great one.

It's right next to our factory that does the actual rigid flex -- the rigid boards, and -- but those will probably be the dominant players.

Matt Sheerin, Thomas Weisel Partners.

Mike, I have a bigger-picture question for you.

Given the return to very strong revenue growth, are you concerned at all about potential growing pains and execution risk?

We've seen that at some of your competitors recently.

So, have you put any mechanisms in place to manage that growth?

We're very wary of that.

One of the things I can say about ourselves is that we already run an extraordinarily complex company.

We already have a massive percentage of our business in low-cost regions.

And we just run a complex business.

When you think about -- taking into consideration all the verticals, all the design businesses we have, the continuous investment that we have around those pieces, we're already pretty complex.

So our ability to -- the challenge associated with becoming a much more complex company we've kind of already done.

So I think the growth is coming on a team that has -- that has been having to execute in a very, very complex environment in a large environment.

So I think that helps us a little bit.

But without question, we worry about it.

And without question, we're anticipating those growing pains as much as we can.

And we will have some, and it's going to be a question of how well we can fix those problems as they occur.

But we're doing the best job we can worrying about it and anticipating them.

And I think we're pretty comfortable that the ramps that we're going under right now are actually executing pretty well.

So I'm comfortable with where we stand, our ability to execute, but we do already operate an extremely complex company.

And I actually think that's a competitive advantage.

Just back to the issue of margins, you talked about startup costs and other near-term pressure over the next two or three quarters.

But could you talk about what the margin profile should look like in the next year or so as those programs ramp, and given the change of customer mix here?

As I said earlier, I think, for the remainder of the fiscal year, as we work through this 25%, 30% growth rate, our objective is to keep the operating margin around 3%.

A quarter might be a little less than that, another quarter might be a little bit higher than that, but our objective for the year is to have operating margins be around 3%.

And as I said, next year, the following year, fiscal '08, depending on the growth rate as startup costs level out, if the growth rate flattens out to 25% a year or so, and we work through the startup costs and start penetrating vertical integration at a higher rate, then we think that operating margin will start to increase.

I think for the year you should consider it around 3%.

But looking into FY '08 -- I know it's a long way off -- but in the past you've talked about 5% or so as a target.

Is that still feasible?

No, it's not.

We've divested a lot of the higher-margin businesses, as you know.

That 5% operating margin included the software business, included the network services business, included the semiconductor businesses.

All those are out.

So, we do have a significant change in the product mix that we have.

So as Mike opened his comments, he referred to an analyst meeting at the end of October in New York.

At that time we would be introducing some of the new, longer-term financial metrics.

But for sure, I think a 5% operating margin needs to go down.

More importantly, our return on invested capital, our ROIC objective, continues to be 15%.

So that is slowly increasing over time.

We think we'll continue to increase that.

And all new business wins that we're quoting and booking today, we're looking for an incremental ROIC of above 15%.

So I think that's the most important metric, more so than operating margins, because that normalizes mix changes.

So below 5%, but you're not yet ready to give a specific number?

No, but we will do that in the October meetings.

We can take one more question.

Yuri Krapivin, Lehman Brothers.

The first question is on restructuring.

There are no restructuring charges in the quarter, which is certainly great to see.

And you previously indicated that you are done with large-scale restructuring.

However, a couple of your peers recently indicated a need for further restructuring in the EMS industry.

So I'm just curious whether you are rethinking your restructuring plans for the balance of this year.

No.

We feel we're pretty comfortable with the level of restructuring that we've taken.

Being a company that has -- operating 100,000 people in 30 countries, we're for sure always going to have adjustments here and there.

But in terms of the grand scale restructuring, we don't think it's necessary.

Our revenue growth rates are going up pretty nicely.

And what problems we do have, we fully intend to absorb it into operating profit.

And occasionally from time to time we'll have gains in terms of other businesses, and we may end up offsetting some charges against that.

But we just -- what we see for the future, even if we look at kind of a negative case, we see it as a very manageable amount that we can just absorb, and not really have it impact our shareholders.

Thanks very much for all the questions and your attendance today, and we'll look forward to having you attend again next quarter.

Thank you.