Flextronics Beats, Guides Lower

Zacks

Flextronics International Ltd. (FLEX) reported third quarter 2013 adjusted earnings per share (“EPS”) of 22 cents, ahead of the Zacks Consensus Estimate of 18 cents as well as the year-ago quarter level of 16 cents, primarily aided by margin expansion.

Revenues

Revenues for the quarter were down 18% from the year-ago quarter to $6.12 billion. Revenues also declined 1% sequentially. The year-over-year decline in revenues was due to the winding down of the assembly business with Research In Motion (RIMM) and exit from the ODM PC business in fiscal 2012. However, reported revenues beat the Zacks Consensus Estimate of $5.98 billion.

The Integrated Network Solutions segment, which was the largest revenue contributor (45% of the total revenue) in the quarter, declined 2% from the year-ago quarter to $2.74 billion; primarily due to a weak demand trend in the telecom and networking sector. However, revenues improved 1% sequentially on better-than-expected growth in the service storage businesses.

High velocity solutions (28% of the total revenue) segment revenues declined a massive 44% from the year-ago quarter to $1.7 billion, reflecting lower revenues from the ODM PC business and the winding down of the assembly business with RIM. Sequentially, the segment recorded a 4% revenue decline due to lower demand.

Revenues from the Industrial and Emerging Industries, which contributed 15% of the total revenue, declined 3% year over year and 6% sequentially to $937 million. High Reliability Solutions revenues (12% of the total revenue) improved 21% from the year-ago quarter and 9% sequentially to $714 million, primarily due to continued strong performance of the automotive business.

Margins

Gross profit (including stock-based compensation) for the quarter declined 10.6% from the year-ago quarter to $344.8 million, due to lower revenue base. However, gross margins improved 40 basis points (“bps”) year over year to 5.6%, reflecting Flextronics’ business transition to the low-volume high-margin segment.

Operating income (including stock-based compensation) declined 2.3% year over year to $137.6 million, primarily due to new program ramp up costs while operating margin improved 30 bps year over year to 2.2%.

Net Income (including stock-based compensation) was $139.8 million compared with $118.9 million in the year-ago quarter.

Balance Sheet

Flextronics exited the quarter with cash and cash equivalents of $1.71 billion compared with $1.56 billion at the end of the previous quarter. Total debt was $2.09 billion versus $2.10 billion in the previous quarter. Free cash flow was $395 million versus $342 million in the previous quarter.

Guidance

For the fourth quarter, management expects adjusted earnings in the range of 11 cents to 15 cents per share. Total revenue is expected in the range of $5.0 billion to $5.3 billion.

Moreover, management expects 30% sequential decline in revenues from High Velocity segment while Integrated Network Solutions revenues are expected to decline in high-single digits and Industrial and Emerging solutions revenues are expected to decline in the mid- to high-single digits.

Moreover, Flextronics expects High Reliability Solutions revenues to increase in the mid-single-digits range, primarily aided by the Saturn acquisition. In the fourth quarter, Flextronics expects to incur an additional pre-tax charge of $100 million - $125 million related to employee severance and benefit costs.

Recommendation

Flextronics has undertaken a number of new initiatives to enhance its competitive edge, which includes divestiture of non-core assets and deployment of new technologies. New programs are expected to boost production volumes by early fiscal 2014, although profitability is expected to remain weak due to continuing investments.

In this regard, we believe that strategic acquisitions and strong new bookings will also drive top-line growth over the long term. However, macroeconomic concerns and weak end-market demands are major concerns in the near term.

Moreover, the portfolio realignment is also expected to hurt Flextronics’ top-line growth in the near term. Further, increasing competition from Jabil Circuit Inc. (JBL) and Plexus Corp (PLXS) remains a concern going forward.

Currently Flextronics has a Zacks Rank #3 (Hold).

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