Zacks_Analysts' Blog : Flextronics Reports Weak 3Q - Analyst Blog

Flextronics International Ltd. (FLEX) reported third quarter 2012 earnings per share (EPS) of 16 cents (including stock-based compensation but excluding intangible amortization and restructuring charges), down 30.4% from the year-ago quarter. Reported EPS also missed Zacks Consensus Estimate by a couple of cents.

Quarter Details

Total revenue in the reported quarter decreased 4.3% on a year-on-year basis to $7.49 billion. However, revenues exceeded the lower end of management’s guidance of $7.3 billion–$7.7 billion and inched past Zacks Consensus Estimate of $7.48 billion.

The year-over-year decline was primarily attributed to the company’s exit from the original design manufacturer (ODM) PC business. ODM PC business contributed revenues of $187.0 million in the quarter. As a result, High Velocity Solutions (42% of revenues) decreased 12.0% year over year to $3.17 billion. Integrated Network Solutions (37% of revenues) also fell 2.0% year over year to $2.77 billion in the reported quarter.

The significant decline was partially offset by strong growth in the High Reliability Solutions and Industrial and Emerging Industries groups during the quarter. High Reliability Solutions (8% of revenues) increased 22.0% year over year to $595.0 million. Industrial and Emerging Industries (13% of the total revenue) increased 4.0% year over year to $955.0 million.

Top ten customers accounted for 56.0% of the total third quarter revenue with more than 10.0% of revenues coming only from Research In Motion (RIMM).

Gross profit for the quarter was down 12.0% from the year-ago level of $381.9 million. Gross profit margin decreased 40 basis points (bps) year over year to 5.1%.

Operating income (including ODM PC) decreased 36.9% year over year to $137.9 million. Operating margin was 1.8% in the quarter versus 2.7% in the year-ago quarter, primarily attributed to higher-than-estimated costs related to the exit from the ODM PC business. The loss from the exit was $70.0 million. Excluding this loss, operating income was $220.0 million in the reported quarter.

Net Income increased 35.2% year over year to $115.8 million. Net margin was 1.5% in the quarter versus 2.3% reported in the prior-year quarter.

Balance Sheet

Flextronics exited the quarter with cash and cash equivalents of $1.55 billion compared with $1.59 billion at the end of the previous quarter. Total debt was $2.20 billion, while net debt (debt less cash) came in at $653 million versus $613 million in the previous quarter.

Cash flow from operations was $229.0 million during the quarter. Net capital expenditure for the quarter was $93.0 million and free cash flow amounted to $136 million. During the quarter, Flextronics repurchased 19 million shares for $110.0 million.

Outlook

For the forthcoming quarter, management expects EPS to range between 22 cents and 24 cents. The Zacks Consensus Estimate is pegged at 21 cents. GAAP EPS is expected to be down by approximately 4 cents per diluted share, due to the quarterly intangible amortization and stock-based compensation expense.

Total revenue is expected in the range of $6.3 billion to $6.6 billion. The Zacks Consensus Estimate projects Flextronics to earn $6.9 billion in revenues for the forthcoming quarter.

For the forthcoming quarter, Integrated Network Solutions are expected to increase low single digits sequentially driven by new outsourcing wins. High Reliability Solutions are also expected to grow in the low single digits sequentially. However, High velocity solutions business is expected to decline 30.0% - 40.0% sequentially, primarily due to the winding up of the ODM PC business and negative impact of seasonality in the mobile and consumer business.

Flextronics remains focused on realigning its portfolio and is adopting aggressive measures (such as the exit from the ODM PC business) to boost its profitability over the long term. However, management expects some negative impact from this realignment in the near term.

Flextronics forecasts weak growth for the High Velocity Solutions, with revenues expected to decline an additional billion dollars in fiscal 2013 as compared with fiscal 2012. The remaining segments are expected to grow in low double-digits collectively for both fiscal 2012 and 2013, based on strong bookings.

Our Recommendation

We believe that Flextronics will face significant headwinds over the next couple of quarters due to macroeconomic concerns, weak end-market demand and continuing supply chain related problems. Moreover, the portfolio realignment is also expected to hurt Flextronics top-line growth in the near term.

However, we believe that demand is stabilizing in the traditional sectors (consumer electronics, computing, networking and communications), which will boost Flextronics top line going forward. Moreover, strong demand from emerging markets (automotive, medical, industrial) is also expected to drive growth going forward. Further, the portfolio realignment will likely boost profitability over the long term.

We have a Neutral recommendation on Flextronics over the long term. Currently, Flextronics has a Zacks #2 Rank, which implies a short-term Buy rating (for the next 1-3 months).