Tepid 1Q for Flextronics

Zacks

Flextronics International Ltd. (FLEX) reported first quarter 2013 earnings of 21 cents per share (including stock-based compensation but excluding intangible amortization and tax adjustment), which beat the Zacks Consensus Estimate by a penny and increased 5% from the previous-year quarter. The year-over-year increase in earnings was primarily driven by modest margin expansion.

Revenues

Total revenue in the reported quarter decreased 20.0% on a year-over-year basis to $5.99 billion and missed the Zacks Consensus Estimate of $6.07 billion. However, revenue was slightly above the lower end of management’s guidance range of $5.9 billion–$6.3 billion. The results were primarily impacted by transition of business model towards low volume high margin business.

Segment Details

High Velocity Solutions revenue (26% of the total revenue) decreased 48.0% year over year to $1.54 billion due to continued reduction of business from the Flextronics’ largest mobile customers.

Revenue from Industrial and Emerging solutions (17% of revenues) decreased 10.0% year over year to $1.01 billion. Integrated Network Solutions (46% of revenues) reported revenues of $2.77 billion, down 2.0% year over year as lower-than-expected spending from top customers fully offset the new outsourcing wins. 

However, High Reliability Solutions (11% of revenues) posted a revenue growth of 20.0% year over year to reach $671.0 million in the quarter primarily driven by robust growth in the medical and automobile space.

Operating Results

Gross profit (including stock-based compensation but excluding amortization) dropped 10.6% from the year-ago quarter to $358.3 million in the reported quarter. However, gross profit margin expanded 60 basis points (bps) year over year to 5.9% driven by prudent business mix.

Operating income (including stock based compensation but excluding amortization) decreased 11.1% year over year to $167.3 million. Operating margin was up 30 basis points to 2.8%, primarily due to the 10.2% year-over-year decline in selling, general and administrative expenses.

Net Income from continuing operations (including stock based compensation but excluding amortization) decreased 1.5% year over year to $146.1 million. Net margin was 2.4% in the quarter versus 2.0% reported in the prior-year quarter.

Balance Sheet & Cash Flow

Flextronics exited the quarter with cash and cash equivalents of $1.29 billion compared with $1.52 billion at the end of the previous quarter. Total debt was $2.19 billion versus $2.20 billion in the previous quarter, while net debt (debt less cash) came in at $912 million versus $682 million in the previous quarter.

Cash flow from operations was $45.6 million during the quarter. Capital expenditures were $105.0 million in the quarter.

Outlook

For the forthcoming quarter, management expects earnings per share in the range of 21 cents to 25 cents. Currently, the Zacks Consensus Estimate is pegged at 23 cents. Total revenue is expected in the range of $5.9 billion to $6.3 billion.

For the second quarter of 2013, Flextronics forecasts High Reliability Solutions to be benefited by the acquisition of Stellar. Further, expansion in the aerospace and defense business will improve the top line. Management expects Industrial and Emerging solutions, Integrated Network Solutions and High Reliability Solutions to be flat or increase modestly in the forthcoming quarter, while the High Velocity Solutions business is expected to benefit from consumer seasonality and register sequential increase.

Moreover, strong bookings across business segments are expected to be the growth catalysts for the forthcoming quarters. 

Our Recommendation

We believe that Flextronics will face significant headwinds over the next couple of quarters due to macro-economic concerns, weak end-market demand and continuing supply chain related problems. Increasing competition from Jabil Circuit Inc. (JBL) remains a concern. 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) and the company is experiencing strong demand from the emerging markets (automotive, medical, industrial). 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 #3 Rank, which implies a short-term Hold rating (for the next 1-3 months).

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