Flex Ltd (FLEX) 2012 Q3 法說會逐字稿

Good afternoon, and welcome to the Flextronics International third-quarter fiscal year 2012 earnings conference call.

Today's call is being recorded, and all lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question-and-answer session.

At this time, for opening remarks and introductions, I would like to turn the call over to Mr.

Kevin Kessel, Flextronics' Vice President of Investor Relations.

Sir, you may begin.

Thank you, Brandon.

And we appreciate you joining the Flextronics conference call to discuss the results of our fiscal 2012 third quarter, ended December 31, 2011.

Joining me on the call today is our Chief Executive Officer, Mike McNamara, and our Chief Financial Officer, Paul Read.

The presentation that corresponds to our comments today is posted on the Investor section of our website, under the Conference Calls and Presentations link, and it can also be accessed from a link directly on our homepage.

The agenda for today's call begins with Paul Read reviewing the financial highlights from the third quarter of fiscal 2012, followed by Mike McNamara, who will discuss the current business environment and trends within our individual business groups.

He will conclude with the guidance for the fourth quarter of fiscal 2012, ending March.

Following that, we will take your questions.

Please turn to slide 2 for a review of the risks and non-GAAP disclosures.

Our call today and our slide presentation contain statements that are forward-looking.

These statements are based on current expectations and assumptions that are subject to risks and uncertainties, which may cause actual results to differ materially from those set forth in this presentation.

Such information is subject to change, and we undertake no duty or obligation to revise, update, or inform you of any changes to forward-looking statements.

For a discussion of the risks and uncertainties, you should review our filings with the Securities and Exchange Commission -- specifically, our most recent annual report on Form 10-K, quarterly reports on Form 10-Q, and current reports on Form 8-K and any amendments thereto.

This call and presentation references both GAAP and non-GAAP financial measures that exclude certain amounts that are included in the most directly comparable measures under GAAP, including stock-based compensation, intangible amortization, net of tax effects, and settlements of tax contingencies.

Non-GAAP financial measures may also be a supplemental measure of financial performance.

Please refer to the Investor section of our website, which contain the reconciliation to the most comparable GAAP measure.

I will now turn the call over to our Chief Financial Officer, Paul Read.

Paul?

Thank you, Kevin.

Please turn to slide 3.

We generated $7.5 billion in revenue for our fiscal 2012 third quarter, ending December 31, 2011, which was at the midpoint of our guidance range of $7.3 billion to $7.7 billion.

Revenue declined $551 million, or 7% sequentially, driven entirely by the exit of our ODM PC business in the quarter.

Our third-quarter adjusted operating income was $150 million, down 15% sequentially, and our GAAP operating income was $138 million, down 14% sequentially.

Our operating performance was significantly impacted by the cost of exiting our ODM PC business, which I will address shortly.

Adjusted net income for the third quarter was $128 million, down 19% from last quarter, and our GAAP net income for the third quarter was $102 million, down 22% sequentially.

We reported adjusted earnings per diluted share for the December quarter of $0.18, which was at the low end of the adjusted EPS guidance of $0.18 to $0.22, and down 18% sequentially.

Our GAAP EPS for the third quarter was $0.14.

Our diluted weighted average shares outstanding, or WASO, for the quarter was 721 million.

This was a reduction of 7%, or 56 million shares, compared with the 777 million shares reported a year ago, which was driven by our share buybacks.

During the quarter, we repurchased approximately 19 million shares, or $110 million, at an average cost of $5.88.

Due to the timing of the repurchases during the quarter, we only realized the reduction in our diluted WASO of approximately 3 million shares.

We will see the remainder of the reduction in our upcoming March quarter.

Please turn to slide 4.

During our third quarter, we completely exited the ODM PC business.

This business generated $187 million in revenue and accounted for a $70 million adjusted operating loss, which was greater than we had projected for the quarter.

This loss reflects some incremental costs related to the wind-down, such as final severance costs, additional supply chain termination costs, excess lease costs, and other final asset impairments.

While the ultimate costs were higher than the $50 million we had originally anticipated, we were pleased with the speed and efficiency that we were able to disengage from this multi-billion dollar business.

We expect no further impairment charges or exit costs associated with our disengagement, and we have successfully redeployed the associated machinery and equipment back into our operations, which is saving us an estimated $50 million in capital expenditures.

As you can see from this slide, excluding the negative impact of the ODM PC business, our adjusted operating margin would have been 3% and our adjusted earnings per share for the quarter would have been $0.27.

Please turn to slide 5.

December quarterly revenue declined sequentially by $551 million.

This decline was entirely due to the exit of the ODM PC business.

Our top-ten customers accounted for 56% of our quarterly revenues, and RIM was our only customer greater than 10%.

Adjusted operating income totaled $150 million, and adjusted operating margin was 2%.

As discussed in the previous slide, our operating earnings performance was significantly burdened by the losses associated with our ODM PC exit.

The Components businesses, excluding some costs we incurred to adjust the footprint of the power business, incurred a small loss for the quarter.

We expect to complete the restructuring activities in our power business over the next six months, and we are excited about the recent new business wins in all three our Component businesses.

Our EBITDA was $264 million in the third quarter, declining $31 million from the prior quarter.

This contributed to our EBITDA margin declining 20 basis points to 3.5%, due to the sharp decline in our earnings.

Our LTM EBITDA declined by approximately $50 million, to $1.15 billion, from $1.2 billion a year ago.

Our adjusted EPS of $0.18 was down 18%, from $0.22 we reported last quarter.

As previously discussed, the ODM PC business losses negatively impacted our adjusted EPS by $0.09.

Please turn to slide 6.

Net interest and other expense was approximately $8 million, up from the $1.5 million last quarter, due primarily to lower FX gains.

Similar to our September quarter, we realized strong foreign currency gains, due primarily to certain strategic renminbi positions, which resulted in $11 million in gains.

We do not anticipate continuing to achieve this level of earnings from favorable foreign currency; and as such, would model a range of $15 million to $20 million for net interest and other expense next quarter and going forward.

The adjusted tax expense for the third quarter was $14 million, reflecting an adjusted tax rate of 10.1%, which approximated our outlook for the quarter of 10%.

For our upcoming quarter, we believe modeling a 10% tax rate is appropriate.

Lastly, turning to the reconciling items between our GAAP and adjusted EPS -- stock-based compensation amounted to $12 million in the quarter, declining $2.2 million, and represented a $0.02 EPS impact.

Intangible amortization net of tax is $13.6 million in the quarter, and represented a $0.02 EPS impact.

Please turn to slide 7.

Inventory declined by 7% sequentially, or $272 million, to $3.6 billion.

This decline was in line with our quarterly revenue decline.

However, our inventory turns decreased to 7.6 turns from 8.1 turns, which equates to an increase in inventory days of three days.

Our inventory turns metric was negatively impacted as a result of the elimination of the high-asset Velocity ODM PC business, which had carried inventory turns in excess of 30 turns.

Our cash cycle expanded 3 days to 22 days sequentially, driven entirely by the increase in the inventory days.

During the quarter, our accounts payable declined $872 million, off 15%, resulting in our DPO increasing 1 day to 69 days.

Offsetting DPO was the one-day expansion of our DSO to 43 days.

We expect to manage our cash conversion cycle in this range going forward.

Now, turning to the net working capital chart on the top right of this slide.

Overall, net working capital remained relatively flat, only increasing $26 million sequentially.

Our net working capital as a percentage of sales, however, increased to 6.3% from 5.8%.

This performance metric also experienced some pressure as a result of our disengagement from the ODM PC business, which had historically operated with neutral net working capital.

The low-volume, high-mix business in our Integrated Network Solutions, High Reliability, and Industrial and Emerging Industries carried net working capital requirements that are greater than 6%.

We believe our business is now structured to run net working capital at a level around 6% of sales, going forward.

Our ROIC for the quarter remained healthy at 22.4%; however, declining from the 25.8% last quarter, reflecting the reduced operating earnings impact of our exit of the ODM PC business this quarter.

Please turn to slide 8.

Cash from operations was a positive $229 million during the quarter.

Our ability to reposition machinery and equipment from our exited ODM PC operations enabled us to begin to realize some CapEx saving this past quarter.

This was reflected in our net capital expenditure amounting to only $93 million for the December quarter.

As a result, we generated free cash flow of $136 million for the quarter and $336 million on a year-to-date basis.

During the quarter, we also spent $90 million repurchasing our stock, and have now spent $396 million year to date.

The difference between the $110 million in stock we repurchased this quarter and the $90 million in cash spend was timing, resulting from a standard three-day trade settlement process.

The other net change in cash for the quarter related to $72 million associated with the purchase of working capital and other assets from a major Integrated Network Solutions customer for a significant new program that we are ramping.

Please turn to slide 9.

We ended the quarter with $1.5 billion in cash, down $50 million versus the prior quarter.

Total debt remained constant at $2.2 billion.

Our net debt increased to $653 million, while our debt-to-EBITDA level increased slightly, but still ended the quarter very healthy -- 1.9 times.

The chart at the bottom of this slide shows our significant debt maturities by calendar compared with our current liquidity, reflecting the completion of our new credit facility we closed in October.

With that, I will turn the call over to our CEO, Mike McNamara.

Thank you.

Before I cover the specifics around the performance of our four business groups, I want to briefly touch on the overall macro climate from a Flextronics perspective, as it helps to set the overall discussion.

In general, the macro backdrop has not changed material since our last earnings call.

We would still characterize the environment as sluggish, but demand has stabilized.

In a theme carried over from our second quarter, we started the third quarter experiencing incremental slowness in demand and forecast.

These trends continued into the middle of quarter, but eventually we saw business firming up in the last month of the quarter.

In fact, the month of December was the first time we haven't seen a forecast reduction in several months.

We still don't expect a major correction on the horizon, but it's fair to say that in the near term the technology supply chain will continue to face uncertainty and certain pockets of demand softness.

In some cases, this is due to inventory adjustments and rebalancing; and in other cases, a result of weakening end-market demand, driven by macro factors or exogenous shocks to the supply chain, such as the recent floods in Thailand.

Our current quarter revenue decline of $551 million was almost entirely driven by our ODM PC exit.

Despite our revenue decline this quarter, the revenue performance amongst our top-ten customers has remained stable.

The working capital management continues to be well-controlled, and quarterly free cash flow of $136 million allowed us to continue to repurchase our stock.

During the quarter, we repurchased $110 million worth of stock, or 3% of our outstanding shares.

As Paul referenced earlier, I think it bears repeating -- in roughly 18 months, we have repurchased 15% of our total outstanding flow.

Turning to our ODM PC business -- we completed our exit of this business during the quarter on time.

We shipped our last units during the month of November, and recorded $187 million in ODM PC revenue for the quarter.

There are no further financial impacts to be sustained by our operations associated with the ODM PC business.

The ODM PC exit is one of the major changes we have been managing for the last couple of quarters, and our profitability will improve significantly going forward as a result of the exit.

I will discuss more of the details when I provide guidance later in the call.

Please turn to slide 10.

Before beginning with the performance of our individual business groups, I want to quickly take a minute to make a few statements about developing trends in our overall portfolio businesses.

In our most recent quarter, revenues from our High Velocity Solutions group amounted to 42% of our total sales, down from 46% a year ago.

The percentage of High Velocity business is expected to further decline, as a result of exiting the ODM PC market and our focused efforts to rebalance our revenue away from High Velocity business.

We are aggressively managing our portfolio of businesses.

We would expect this business segment to potentially decline an additional $1 billion from fiscal 2012 to fiscal 2013 as a result of this shift.

Consequently, you should expect the remainder of our business groups, which accounted for 58% of our sales in Q3, up from 54% a year ago, to grow low double digits collectively, both in fiscal 2012 and in fiscal 2013.

In all these business groups, we continued to generate strong bookings with both existing and new customers, which is supporting their growth rates.

Ultimately, our goal is to rebalance our portfolio to reflect a 70%-30% mix of business, providing a more attractive margin profile and strong free cash flow as we move into fiscal '13.

Our Integrated Network Solutions group totaled 37% of our sales during the quarter, consistent with last quarter.

Revenue was $2.8 billion in the quarter, down 2% year-over-year and down 7% sequentially.

This performance was in line with our expectations for a mid- to high-single digit decline, as we saw weakness primarily attributed to inventory rebalancing across a couple of our largest telecom customers, that was only partially offset by strength in new outsourcing wins and products ramps.

Next quarter, we expect revenue from Integrated Network Solutions to increase low-single digits sequentially, driven primarily by new outsourcing wins and less of a headwind from the effects of inventory rebalancing at a couple of our customers.

Industrial and Emerging Industries comprised 13% of total sales, up from 12% last quarter.

Sales were $955 million, reflecting 4% year-over-year growth and stable performance sequentially.

We tracked slightly off -- behind our outlook of single-digit sequential growth as a result of year-end inventory rebalancing, negatively impacting one traditional industrial customer, and some softness in the office equipment market.

As anticipated, our Capital Equipment business declined again.

However, the decline slowed meaningfully, to the high single digits from the 40% sequential drop the Capital experienced in our September quarter.

We believe our Capital Equipment business may have bottomed out in the December quarter.

Our customers in this area are currently forecasting modest growth next quarter.

This business generates an above-average operating margin, given the product complexity, business cyclicality, and level of capital employed to operate the business.

As a result, demand improvements in this area should translate well into our overall Company profitability.

We continue to see strong levels of activities with customers across our Industrial and Emerging Industries group, and booked roughly $285 million in new wins during the quarter, versus $300 million in new wins booked last quarter -- and now have roughly $1 billion in bookings to date for fiscal 2012.

This compares with the $1.3 billion booked during fiscal 2011.

So, we remain on pace to meet, or slightly exceed, our fiscal 2011 record bookings total.

For next quarter, we believe this group will have stable demand, as a modestly improving capital equipment outlook and strength in various smart grid programs is offset by product transitions within our [solo] portfolio and negative seasonality impacting our point-of sale-customers.

Our Reliability Solutions group is comprised of our medical, automotive, and defense and aerospace businesses.

It comprised 8% of total sales, up slightly from last quarter's 7%.

Sales grew 2% sequentially and 22% year over year, establishing yet another new quarterly revenue record.

Overall sales in this group were slightly above our expectations for flattish performance.

The revenue growth momentum in this group should continue; it remains primarily driven within the medical and automotive areas.

Next quarter, we forecast this business to be in the low single digits sequentially, which equates to approximately 20% on a year-over-year basis.

Our medical business saw healthy single digits sequentially, grew single digits sequentially, and rose roughly 20% year-over-year, led by the strength in diagnostics and medical equipment.

During the third quarter, we booked roughly $120 million in new programs, which brings our year-to-date bookings to $270 million.

In addition, our sales pipeline is holding firm at approximately $650 million, across the various areas of the medical industries we serve.

Our automotive business continues to be a strong performer for us.

While this quarter saw flat revenue levels on a sequential basis, year-over-year growth remains strong, at roughly 20%.

In general, this business is on pace to grow over 30% for this fiscal year, and approach $1 billion in annual sales.

We continued to see signs of improving automotive production.

In addition, we continue to broadly penetrate Tier 1 and Tier 2 OEMs, and our win rate remains strong in areas like in-car connectivity, ambient lighting, LED electronics, and power electronics.

High Velocity Solutions comprised 42% of total sales, down from 44% last quarter, and revenue declined to $3.2 billion from just over $3.5 billion last quarter.

This business group includes our mobile phones, consumer electronics, game consoles, printers, and computing.

And it contains the ODM PC business, which we exited during the quarter, and also includes the EMS PC business that remains.

The business group experienced the largest decline in the quarter, dropping 10% sequentially and 12% year-over-year, due to our ODM PC exit.

Our mobile consumer businesses rose mid- to high-single digits on a sequential basis.

Strength from multiple new program wins with our largest mobile customers, combined with favorable seasonality, positively affected a handful of customers, and consumer electronics drove the majority of the growth.

In computing, our business experienced a significant double-digit sequential decline of over 40%, driven by the planned exit of our ODM PC business.

Overall, next quarter we expect our High Velocity Solutions business to decline 30% to 40% sequentially, due to having no further revenues associated with the exited ODM PC business and the negative impact of seasonality on the mobile and consumer business.

In addition, due to the significant ramp we experienced with our largest customer in the September and December quarters, we are expecting a more significant than usual decline in percentage terms, as production returns to more normalized levels.

Next, I want to provide an update on -- with regards to the operations performance of our other businesses, our Component businesses, which include Multek, Vista Point, and Flex Power, experienced a relatively flat quarter sequentially in terms of revenue, as we expected.

From a profitability perspective, we realized a loss, down from breakeven last quarter, and below our expectations.

While we anticipated roughly breakeven performance this quarter, our Components business profitability reflected mixed performance as our Vista Point business saw slightly higher losses, due to revenue declines.

And within our Power business, we continue to be burdened by taking aggressive actions to further rightsize this business.

In response to the current financial pressures, we elected to take even more aggressive actions in order to drive this business to its appropriate operating earnings levels.

We have focused our efforts on aggressively realigning and optimizing the operations, resulting in various rightsizing activities across these businesses.

These actions include activities such as closing of the facilities to further simplify operations and improve execution.

Overall, we anticipate executing these actions over the next two quarters, with some of these actions impacting this past quarter.

In the March quarter, we expect both Multek and Vista Point to see modest growth, offset by a slight decline in Flex Power, which is coming off a significant quarter of sequential revenue growth.

Bookings at Power are substantial, and optimization activities in the next two quarters will position this business for strong operating results in FY '13.

As a result, overall revenue for the Components will be flat in the March quarter, and we expect to be operating at breakeven.

Our Services business, which is focused on various post-manufacturing and aftermarketing activities, saw its revenue decline single digits sequentially this quarter.

Operating margins remain well above corporate average.

In addition, a number of new significant program wins are set to begin and ramp late in our upcoming quarter, and should position our Services [goal] very well into fiscal '13.

Now, turning to our guidance on slide 11.

For our fourth quarter, revenues are expected to be in the range of $6.3 billion to $6.6 billion.

Our fourth-quarter revenue reflects no revenues from ODM PC, as we have completely exited this business, which had contributed $187 million in revenue in our December quarter.

Our revenue guidance reflects a sequential decline in sales of 12% to 16%, or 14% at the midpoint, which reflects the combination of the reduced revenue contribution from exiting ODM PC and seasonal declines in our High Velocity Solutions business group.

Our adjusted EPS guidance of $0.22 to $0.24 a share, which implies a 3% adjusted operating margin at the midpoint, and is based on an estimated weighted average shares outstanding of approximately 700 million, which incorporates a full-quarter benefit of share buyback we completed during our third quarter.

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

This concludes my comments.

I would now like to open the call for Q&A.

And Operator, can you please begin that process?

(Operator Instructions) Sherri Scribner, Deutsche Bank.

I was hoping to get some more detail on the Network Solutions group, in terms of the inventory correction there.

A lot of companies have talked about an inventory correction.

It sounds like with your guidance, you are expecting some of that inventory rebalancing to be done.

Do you think this quarter was the bottom in that segment?

Do you think inventory has been worked through, or gets worked through in March and returns to normal in June?

Or what is your outlook there?

I think, probably from an industry standpoint, it's going to stay pretty soft.

I actually think the inventory correction piece of it may be over, or at least substantially over.

I think from an industry standpoint, as I mentioned, I think it's probably continuing to be soft in the next quarter.

We actually have -- we guided up single digits at Flextronics into the March quarter, because we have some substantial new bookings.

But I think that is running different than industry itself.

So, we will be up based on new bookings, but I think the industry is going to continue to be soft into March.

Okay, that's helpful.

And then, in terms of the supply disruptions related to the Thailand floods, did you have any impact from that this quarter?

Yes, we did, and we didn't call it out separately.

But we probably lost about $100 million of revenue, we anticipate.

If we think about this next quarter in March as well, we would probably anticipate roughly the same -- maybe slightly less.

But it was about $100 million for the December quarter.

Okay.

And then, just quickly for Paul -- in terms of looking at the guidance, the guidance seems to imply an operating margin of about 3.1% to 3.2%.

Is that the right way to think about it?

Yes, we covered it around about 3.0% to 3.1%, Sherri.

Okay, great.

Thank you.

Shawn Harrison, Longbow Research.

I wanted to first off just get back to the comments on reducing the High Velocity exposure.

Right now you are seeing, I guess what you said, seasonality coupled with return to normal production schedules for your largest customer.

But how do you get that down to 30% of sales, going forward?

Is it not bidding on programs?

Is it cutting back on existing programs?

Any color in terms of how you reduce that mix, in addition to growing the other percentage of the business, would be helpful?

Yes.

I -- well, one thing, it's the other businesses that are helpful.

If we look at FY '13, I mentioned the comments that 70% of the non-High Velocity business we expect to achieve in FY '13, and we do expect that to grow at a double-digit rate as a bundle.

So, that helps it, certainly.

Once we take out the ODM PC, that helps it pretty substantially.

And then we just expect to -- just generally, across the board, expect to be a little bit more picky about that business.

We are unhappy with the variability in the High Velocity segment, and we are looking to reduce the variability as a company directive, as we go into FY '13.

So, I think we will just prune it a little bit.

So, between those three effects, with the 70% growing at a double-digit rate, the ODM PC coming out, and probably a little bit more selective pruning, I think we can move our way to a 70%-30% mix.

Okay.

And then, on the Components business, if we assume revenues are flat into the June quarter -- with the restructuring actions you are taking, what would EBIT margins be if you had all those costs removed from the business?

It certainly moves into a profitable territory from -- for us, post-June.

We will take six months here to finalize the restructuring activity, mostly in the Power division.

And then, the back half of the year, of the calendar year, we should be able to move the profits up toward our goals, which we stated before -- as a bundle, 4%.

Okay.

The June quarter, would you expect the business to be profitable?

No.

Not the June quarter.

June quarter will still have -- well, operationally, it will be profitable.

But we have some restructuring activities in the Power business that we will be executing in the June quarter.

But operationally, they will be profitable.

And I guess unfortunately, it's been a little bit of a broken record in terms of getting to breakeven and surpassing it with this business.

Do you think the cuts you are making right now are going deep enough -- or some of the operational changes you are making?

Or is it something that we get into the summertime and there may be additional actions?

I think the comment about a broken record is certainly appropriate.

It's obviously very, very frustrating for us.

This is a big business group.

If you take the business group in total, it's about 25,000 people, so it's not insignificant.

We have already closed several factories.

We have moved inland with one of the factories, to try to drive costs down.

And as we look at it, we think we can take another couple factories out; and that is not something that we anticipated about a quarter ago.

Parts of the reasons to go take out another couple factories is, we are actually quite pleased with the simplification and the optimization that we are seeing by taking the first couple factories out.

We think we can take another couple factories out and grow the revenue simultaneously in FY '13, which between the two, we think, can have a pretty substantial effect.

So, do we think it's enough?

I kind of hate to -- I think we are just going to have to wait to see, because I don't want to be predictive about it and not make it.

But in the Power business, we are going to go from five factories to two factories; in the camera module business, we are going to take out a factory.

We can't hardly take out any more factories to make them more simple, more easy to execute, more -- improve the operational excellence.

So, I think there is not much else to do once we get beyond this point.

And like I said, we have actually been encouraged -- we feel bad coming into the call saying you have to wait another six months.

But alternatively, we are pretty encouraged by the steps that we have already taken and the fact that we really -- really I'm excited about getting to a world-class operation.

And we think we can take the steps to go do that.

That color is very helpful.

Thanks so much.

Brian Alexander, Raymond James.

Just to follow up on Components -- not to beat a dead horse, but can you size the impact of the charges that you took in the quarter, as well as going forward, so we can better understand the underlying Components profitability, excluding restructuring?

I think last quarter the charges were about $10 million; and then, I think you also said Vista Point lost money too, which I believe was also the case last quarter.

Did those losses get worse?

And could you remind us of the issues that you are having in that part of the business?

Yes the overall restructuring charges, if we include the December quarter and March and June going forward, is roughly $25 million.

We spent probably around about $8 million in the December quarter just past, and we will probably now spend the balance over the next two quarters.

So, that's kind of the size.

These are not massive numbers, considering the size of the Company; but certainly affects their performance significantly as a bundle.

And then, just on the Vista Point business, what is going on there?

And when do you think that can be back to breakeven?

Yes, the Vista Point business really is more of a revenue driven-related activity than it has been more of a restructuring-related issue for them.

The December quarter revenues were light, as it transitioned into some new program wins on some products that will come now through in this next March and June quarter.

So, really, it just had a bit of a pause on the revenue side.

But they have all the new wins now to take the revenues up and the profitability up in the March and June quarters.

Okay.

And if I look at the margins in your core EMS business -- so, excluding ODM and Components, it looks like they would have been about 3.2% in the December quarter.

And if I look a year ago, same quarter, they were around 4%.

And this is while revenue on an apples-to-apples basis -- again, excluding ODM and Components from both quarters, has been pretty consistent.

So, I am just trying to get a sense for why the core business, core EMS, is seeing this level of margin erosion on flat revenue, and what you think are the major reasons why your core EMS margins -- again, 3.2% or so, are well below some of your peers with a very similar mix.

Thanks.

Well, I don't think a year ago we were at 4% margins on the core business.

I think we would have remembered that if it were.

We have always hovered around a core business level of kind of a 3.5% level; but the Components businesses back then were dragging us down a bit.

Flat revenues year over year, but significant changes in terms of mix -- I think that's something that we are always impacted with on a go-forward basis.

We think that will stabilize out, like Mike said, with a 70%-30% split -- you get more stability from the margin base.

Really, to the competitors, they just have a different business profile, I think.

And we are a far bigger Company, and much different issues than what they have.

So, don't really want to call in comparisons with them.

But we think we are well-structured now, now with the exit of the ODM PC business going forward, on the margin side, to get to 3.5% and beyond.

And I think with a 70%-30% split of high-margin/low-margin businesses, we certainly have a business mix that will enable us to do that.

One of the other things that I will add is that in our Industrial and Emerging group, we had a very significant down trend of revenue in the Capital Equipment business.

And we actually called that out and itemized it in the last call last quarter.

It's a pretty significant hit to our profitability.

We had that hit last quarter.

We continued to have that downside to revenue this quarter, where it continued to go slightly down by single digits, as opposed to 40% in the December quarter -- or September quarter, pardon me.

But as we go forward, we see this strengthening pretty significantly; so we actually see that entire business group changing pretty substantially, and I think you will see that will push our margins up pretty nicely, as I mentioned in my prepared comments.

And Mike, the direct from that is like 20 to 30 basis points from that part of the business, relative to where you were a couple quarters ago?

Hold on a second, we're just checking if that's correct.

Yes, it probably is.

Okay.

All right.

Thanks so much.

That's probably correct.

Thanks.

Amitabh Passi, UBS.

Mike -- again, at the risk of beating a dead horse, how long do you think you continue to try with this vertically integrated approach?

And is that still the right approach?

At what point do you say -- it's probably not worth being a components business, and contemplate some other actions, either exiting that business or doing something else with it?

Well, I think we would always consider all the strategic options open to us.

So, I don't ever think we would just not consider the possibilities of doing other things.

It's obviously disappointing in -- and we continue to have very strong bookings where we have gotten into a bad cycle with the camera module business, that's actually reversed itself.

The bookings have been exceptionally strong this quarter -- they have been exceptionally strong, really, across the whole component portfolio.

And that's one of the reasons we are taking actually even more aggressive actions to close and simplify and optimize before that -- before all those revenues start hitting.

But I think per your comments, we for sure will look, and always have continued to look, at the possibilities of -- what are the strategic options we have available to us?

And then, just as a follow-up, I noticed you recently hired a Chief Procurement Officer.

Just wondering -- is that a new position?

Did he replace somebody else?

Any specific mandate for Mr.

Linton?

Well, we just hope to take it to the -- our procurement activities to the next level.

We view him as the top professional in the field.

We did have a Chief Procurement Officer previously, where we have now redeployed him to do some other activities.

And we have given Mr.

Linton the top spot.

So, we are -- actually have very, very high expectations of his ability to contribute to improving our margins.

So, this is just a case of working, as we find the best people we can in industry, to bring them on.

And hopefully it's going to have an operating margin improvement.

Okay.

Thanks.

Sean Hannan, Needham & Company.

You have talked about some more point of restructuring efforts, some of that obviously around Power within Components.

Overall, though, when you step back, can you share with us -- what's your blended utilization right now?

And then, what are the levels at the lower end of the utilized facilities versus the higher end, and what degree can some of your efforts -- or can you actually take some efforts in order to tweak some of those facilities as well?

Yes, that's probably all different answers.

In BPT, we are probably running roughly around 50% utilization, so more load there has a substantial impact.

In Multek, we are probably running 70% to 75% utilization -- so, very, very close to running where -- really should run around 90%.

And again, it would be helpful to have a strong book of business.

One of the things that we saw with Multek is, as revenues for a lot of the companies got slower in the December quarter, we actually had a decelerating book to bill in that business.

So, we are starting to see that reverse, and we actually expect March to be higher than December, which is untypical.

And the last thing is Power.

And to tell you the truth, Power is running at pretty high utilization -- certainly, from an equipment standpoint, it's probably running close to 90% utilization.

So, our activities with Power are really to simplify and optimize and drive to world-class, as opposed to meeting the load to get to a certain utilization.

So, we actually expect Power to even grow a good 25% or 30% next year.

So, we are not closing factories because don't have load; we are closing factories to make them -- to consolidate our efforts so that we can get to a world-class level.

Sure, that makes sense and that's helpful.

Then a follow-up -- in terms of notebook going away, the progress that you intend to make around Components -- at what point do you think, and would this happen at some point, perhaps, in mid-fiscal '13 -- would you have a line of sight to be able to sustainably get your gross margin into that 6% range?

Any thoughts around that would be helpful.

Sean, as we have moved this portfolio and as we approach the 70%-30% split, what I -- last year, when we went into the analyst meeting, we said that to hit 3.5%, we needed $7.5 billion of revenue, a 60%-40% split of high-margin/low-margin business, and Components earning a decent rate of profitability.

We now actually think, as we have changed this, that we can achieve the 3.5% with less revenue -- more like $7 billion a quarter, on a 70%-30% split, high-margin/low-margin business, without Components making the profitability levels that they would.

So, if they did, then that would be over and above the 3.5%.

We certainly -- we don't want them having losing money, so we want to be at a breakeven level.

But $7 billion, 70%-30% split, and 3.5% is very achievable in the second half of the fiscal '13 for us next year.

And that's what we are heading for.

That's very helpful, Paul.

Thanks so much.

Lou Miscioscia, Collins Stewart.

I have two questions.

And let me apologize if I'm repeating someone else's question; I came on the call a bit late.

Can you just give the revenue base of the Component area on a quarterly basis?

I know you had talked a little bit about the margins, but where actually are the margins right now?

Yes, Lou, revenue is at around $500 million a quarter.

We had a slight loss in the December quarter, absent the restructuring that we took, which was around $8 million.

It will break even in the March quarter with about $500 million of revenue again, as a bundle.

Okay.

Switching over to Components, hard disc drives.

Mike, you mentioned that the shortages in Thailand and -- I would guess maybe is mostly in the hard disc drive area.

What products got most affected?

And you mentioned also the shortages continuing in March.

Do you get any visibility when it's going to get better?

Well, we think it's actually going to get a little bit better in March; and I suspect it will get even better in June, from that standpoint.

So, we are anticipating it on a -- while in March it will still be significant, over time I think it's going to start to mend itself.

So, I think it's in the process of being fixed.

And most of the business was in the storage business.

We -- there are hard drives, surprisingly, in a lot of different things, even on down to high-end printers that end up with drives in them.

So, it's interesting how many products really have hard drives in them.

But most of it was in our storage business.

Would you say it was Tier 1 storage kind of products, or more Tier 2 or Tier 3?

Well, I think it's a blend.

Yes, I can't -- I'm looking at my list of which products were affected, and it's kind of a mix.

Okay, great.

That's it for me.

Thank you.

Steve O'Brien, JPMorgan.

Just wanted to ask -- with the handful of EMS companies having reported here over the last couple months, it seems like everybody is talking about program wins and communications, networking, et cetera.

It seems hard to imagine everyone is going to be above average.

But can you talk specifically about whether some of these wins come on line next quarter, the quarter thereafter, in terms of maybe the pace of revenue recovery?

Well, that's hard to gauge, because you have this continuous flow of new wins coming in.

I think it's -- the way to think about it is -- is if you look at the bundle, Paul mentioned the 70%-30%, the 70% is at the more high-complexity businesses and 30% the more High Velocity business, we would expect to finish close to a 10% growth rate for that 70% for FY '12.

And we would expect to be in the double-digit range in FY '13 in that 70% bundle as we go forward.

The variability that we keep trying to explain is kind of the ODM PC, and then there's some product launches in another one of our High Velocity mobile phone customers, that complicate the linearity of our business.

So, once you separate those out, that's -- but if you look at the 70%, you have a kind of a nice linear increase in revenues.

And like I said, it's 10% in FY '12, and it will probably be something similar to that in FY '13.

But it's all different times that those programs hit.

Okay.

Maybe I'm just looking back on the quarter, then.

I think that the INS business was more or less in line with your expectation, whereas others maybe had more challenges.

Would you say that -- could you point out some of the strengths on weaker areas, then, in the December quarter?

Well, if you look at December quarter, we had Industrial and Emerging -- I kind of went through that in my remarks.

No, I guess I was looking specifically just at the INS business.

Yes, the INS business was down like mid-single digits.

Yes.

But we expect it -- almost a full recovery back into March.

So, we expect it to be up mid-single digits in March, and I think that's as a result -- and that's certainly because of a new program win that we have, in particular, that start kicking in.

And then, we would expect June to be a little bit higher.

So, I think from the INS standpoint, we clearly have industry softness, and we clearly have some inventory rebalancing.

I think that's reasonably consistent with some of the comments you have heard at some of the other contract manufacturers, and it's certainly consistent, I think, with the telecom industry.

As we go into March, we have new bookings that drive our numbers up.

We don't think it's necessarily an industry recovery, we just think we have some pretty nice bookings that are helpful there.

And so, we will see some growth in March.

And then, we would expect to see the INS group as a whole for FY '13, relative to FY '12, hopefully run about a double-digit rate -- call it a 10% growth rate.

Okay, great.

Thanks.

Can you just provide a couple more details on this Industrial and Emerging Industries program win and the capital purchase that happened?

What industry are we talking about?

Boy, that one's the hardest one to say, because it's really across the board.

In the September to December quarter, we were roughly flat in revenues.

And then, next quarter we actually expect to go up pretty substantially, kind of like a high-single-digit numbers.

And we would expect to go up high single digits in June.

This has the most variability in the bookings.

It has the most amount of customers.

It has the most amount of unique new wins, and it tends to be the smallest revenue.

So, it really tends to be a blend across a number of different businesses.

We have CleanTech, that we expect to recover pretty nicely.

I mentioned capital equipment, which we expect to recover nicely into March -- and then, also, even more recovery into June.

And so, it's really a blend of a lot of different programs.

That's hard to isolate.

But that entire group, we actually expect pretty nice growth as we go into FY '13.

I guess I thought there was about a $50 million, $60 million purchase this quarter, right, that related to a new program that was in acquisitions on the cash flow?

Yes.

That was in INS.

Oh, okay.

But a large part of what's driving that revenue increase in INS -- because when you get mid single digits in that INS group, which is already about $12 million, it's a pretty substantial amount of revenue.

So what it is, is the purchase of inventory with a customer, basically the -- yes, it's basically almost all inventory with a customer, that we just took on a significant amount of their work very rapidly -- actually, over this quarter.

Okay.

Just lastly on the share count maybe -- I think, Paul, you addressed -- what is the number you are using for the EPS calculation in the next quarter, in terms of the share count?

It's roughly 700 (inaudible).

Thanks.

Jim Suva, Citigroup.

This may be a little bit of a difficult question, but let me set it up by -- I'm looking at year-over-year earnings growth, specifically the March quarter that you forecasted to, to the March quarter a year ago.

And we are kind of looking for improvements at Flextronics and looking for earnings per share growth.

And when we consider March 2011, it included the ODM PC business, which was non-profitable.

And then, this March outlook of 2012, which excludes the PC business, it actually looks like your year-over-year earnings per share would be down if you did not buy back stock.

So, in essence, any EPS growth looks like it's stock buyback-driven, rather than core operations, despite selling the PC business or exiting it.

Can you help me understand if that's correct?

And if so, is that the future of the EPS growth?

Or organically, when should we see core operations start to drive EPS growth?

Yes.

I think you rightly said it, Jim, that fiscal '12 over '11, a large part of the EPS has been as a result of the share buybacks that we have experienced.

Because it was significantly offset -- the core operating performance was significantly offset by the ODM PC losses.

You can see we have had roughly $100 million of ODM PC losses that have impacted us in the year.

So, going forward on '13, we don't see -- obviously, the ODM PC losses drop away, share count is what it is.

And so, the growth really is coming from the core business, which is the profile we would expect for next year.

Jim, the other thing, too, is the fourth quarter of last year had very minor ODM losses.

And I don't know if you're contemplating that in those numbers or not.

Okay.

We can revisit offline, but I believe March last year you missed expectations, so the comparisons look even easier.

But we will take it offline.

My quick follow-up -- Kodak announced bankruptcy today.

Any exposure there?

And the SG&A line came in higher, probably because of the PC ODM business, yet interest income -- or interest expense came in lower.

Can you help us with the Kodak impact and SG&A and interest outlook?

Yes.

On Kodak -- unfortunately, we have been through this play before with a couple of customers, so we have spotted the signals here.

Not a surprise to most people, anyway.

We remain very close with them and very frequent discussions over the last few months, working on ways essentially for ourselves to understand what's going on a little bit better and to somewhat work the exposure.

They're not a very big customer of ours; they're down, I think, number 40-something in terms of customer for us -- 42, I think, in the customer list.

Around about $100 million of revenue for us, so nothing great.

So, our exposure isn't big.

When we looked at it this quarter, we were kind of anticipating something, and with them filing, for their US entities, Chapter 11, our exposure is predominantly not with their US entity.

25% of our exposure is probably with their US entity, 75% is outside the US entity.

And so, we have -- as they have written in the filing, a $3 million or $4 million AR exposure.

And we took an additional reserve in the December quarter for a few million dollars, to make sure we cover anything like that that was going to happen.

So, we think we are well-covered from the AR perspective.

As we -- what worked with the customers in the past that have gone through situations like this, it's the inventory that we have is good inventory.

It's inventory that they want.

They want to keep it, they want to have us keep producing this inventory.

This is also inventory that is more aligned with their non-US subsidiaries; and so, we anticipate having a deal with them where we cannot have any exposure on the inventory side.

So, net-net, Jim, it's a small customer, and negligible exposure that we have covered.

On the SG&A side, you're right, it was up because of the ODM PC cost exit and the increase that we didn't expect.

But that normalizes now back out, and we will be in that kind of $180 million to $190 million range for SG&A going forward.

And interest expense?

Interest expense, $15 million to $20 million.

We are not anticipating any foreign exchange gains.

I know we say that every quarter, but it's not something that we plan on.

And so, $15 million to $20 million is the operating interest and other expense line item.

Thanks, and Happy New Year's, guys.

Amit Daryanani, RBC Capital Markets.

Just a question on the buyback -- you guys have obviously been fairly active on it.

I'm just curious -- how should we think about future capital allocation process?

Is there expectation to commit x percent of your free cash to buybacks, going forward?

No, I don't think so.

For us, very strong free cash flow -- last four quarters we have had positive free cash flow in the range of $550 million.

So, it's very substantial.

And over a 12% free cash flow yield, I think; the year before, it was like an 8% free cash flow yield.

So, the future of the business is, it does throw off strong free cash flows.

And we expect that to continue next year; we expect to increase free cash flow at the rate, if not greater than the earnings increase.

So, our predominant focus for free cash flow is to support the growth of the business, the organic growth of the business -- so, working capital, capital expenditures, et cetera.

And that's what we will continue to do.

However, beyond that, we have some strategic options for us, whether it's divestitures, M&A, those kind of things, they're all pretty small.

They're not big numbers; but nevertheless, that's a priority next.

And then after that, it's going to be looking at some capital allocation with a capital structure, whether that's debt repayment or whether that's share buybacks.

You have seen us be opportunistic in the share buybacks because we have been attracted to the price that's out there.

We have generated strong free cash flow to support it.

And as you can see, we achieved an average price of $5.88 in the quarter, and today's price was substantially higher than that.

So, not only is it good for EPS, you actually get good accretion out of it, because we are very opportunistic.

It's not a buyback program that we initiate as part of future earnings generation; it's more or less just being opportunistic of the price.

Yes.

Fair enough.

And your buyback program has definitely been very successful so far.

Just maybe on the Component business, I want to look at it a different way.

Is there a certain small percent of customers that are potentially driving all the losses in the segments?

I'm trying to maybe get a sense on -- do you think this issue may just be more pricing-driven, versus not having the right cost structure footprint?

No, we actually think the pricing structure is right.

And we think it's more world-class operations, simplicity in operations and utilization.

We actually don't feel that we have a pricing problem.

All right.

Just finally, Paul, the $72 million cash payment for purchase of assets for networking customer, I believe you called out in the earlier part.

Did you guys take on any plant and equipment as well, or was it just purely for inventory?

No, there was some fixed assets unique to this program that we would take on, which is pretty normal for us and our working the whole transition now over the next few months, so great new program.

We're very excited about it, and will provide some meaningful growth for the INS business.

Fair enough.

Thanks a lot, guys.

Brian White, Ticonderoga.

When we look at your largest customer, you said it was over 10% of sales in the quarter, can you give us more of an exact percentage?

More at a 10% to 15%, or 15% to 20% range?

Yes, it's the 10% to 15%.

10% to 15%.

And I'm curious -- smartphone market obviously becoming more competitive.

Number one, do you have protective contracts in place with that customer if challenges occur?

Years ago, there was Nortel.

Second thing is, how involved are you with vertical services with that customer, or is it all assembly?

First of all, I want to say -- I don't want to comment on the specific contract terms with any particular customer.

So, just rest it to say we have very, very normal contract terms with that customer.

But I want to -- I don't want to get into specifics, and I don't think it's appropriate for us to get into specifics.

And I would call the vertical integration of that customer to be not significant.

I mean, there are (multiple speakers).

(Multiple speakers) [for assembly.]

I would call it not significant.

Pardon me?

It's more assembly.

It's very, very heavily assembly.

Okay, great.

Thank you.

Operator, just one final question we can take here.

Craig Hettebach, Goldman Sachs.

Mike, can you touch on trends in customer outsourcing?

We have been through a couple economic cycles here.

And anything you are seeing that points to increased outsourcing in any particular verticals, as we move forward?

I think it's just the same as what you have been hearing for quite some time.

I think industrials and medical continue to look for ways to save money and outsource, as they get under new challenges from industry.

I think outsourcing in the telecom/datacom industry is pretty mature, so there's just not a lot of new outsourcing in those different fields.

You may find additional outsourcing as some of the Chinese telecom and datacom guys become significant, as they penetrate rest of world.

So, I think rest of world provides an opportunity for some of the growth there with the Chinese companies.

But I think it's reasonably mature.

And I think smartphones, as you know, is heavily outsourced today, with the exception of the Koreans, and in some cases, the Taiwanese.

So, on average you find Koreans and Taiwanese viewing manufacturing as a core competence.

And once you get beyond that into US and European companies, they are reasonably heavy outsourced.

So, I don't think there is a trend toward outsourcing, either in networking, datacom, telecom, or smartphones.

And I think the trend that is positive for outsourcing is more reflective in a lot of the industrials, a lot of the clean tech, a lot of the medical, a lot of automotive.

Okay.

And just as a brief follow-up, any update on wage inflation issues and ability to pass that through to customers?

Well, it's the same challenge it always is.

We have wage inflation.

It's relatively significant in China.

We do anticipate -- I think we said this in a call maybe a couple years ago -- we do expect probably 15% wage increase every year, and we do expect probably some currency, negative --- a currency affect associated with that.

I think that's just how we have to deal with products.

They get priced into new products very rapidly.

The ability to change price on existing products is more challenging, and we do the best we can to go and work those price increases.

And once you get outside of China, I think it's more typical.

I think you tend to see 5% or 6% wage increase, in some cases -- like in Mexico, the currency has been very, very weak against the dollar, so it hasn't been an impact.

Obviously, a lot of the currencies in Europe are driven to the dollar, so it's favorable from that standpoint.

So, I think the real challenge is in China, and we are going to have that challenge every year for the next five years -- at least that's how we think about things and how we assume it, and the challenge of passing it on is difficult.

For sure, we get it in the next product run.

Okay.

Thank you.

Okay.

Thank you, everybody, for joining us.

Our transcript will be available on our website tomorrow, as well as the replay.

And if you need anything else, give us a call.

Good-bye.

This now concludes today's conference.

You may disconnect at this time.