Flextronics fiscal Q409 analysis and EMS outlook

The economy has entered the worst recession since the Second World War. Electronics manufacturing services (EMS) and original design manufacturing (ODM) firms have already seen demand evaporate and have reacted with extreme conservatism regarding inventory -- a key lesson from the dotcom bust.

According to IDC, EMS / ODMs face challenges ranging from other service providers looking to tap into the EMS / ODM opportunity, in addition to:

• OEMs being  concerned with survival and wanting to lower production costs and avoid inventory increases while differentiating their own products to remain viable in the market, plus

• OEMs that still have internal manufacturing capacity wanting to protect their own utilization rates

Flextronics is not immune to these forces taking shape.

The next step for EMS / ODM companies, including Flextronics, is to determine how to navigate the next year of hardship.

Many EMS / ODM firms will be forced to look at survival strategies, reduce costs, investments, and prices to increase utilization.

Other firms (who can look beyond the next year) who can invest in their businesses will look to deepen relationships with OEMs, invest in process expertise, gather assets and experience to be able to take advantage once the market turns.

This second group of EMS / ODM firms will likely be the leaders in 5 years whereas the other firms (those looking to just survive) will likely be out of the business within the same time frame. In a recent IDC report, IDC reiterates advice to EMS / ODMs under the current recession, including:

• Evaluate current product and customer portfolios.

• Ensure strategy, business models, and operations are aligned with each other.

• Revisit value propositions to achieve their ROIC goals.

• Increase investments to improve efficient project ramps and client process improvements.  

EMS/ODMs need to be aware of possible conflicts with OEM priorities, including: conflict over business terms; reorganization and consolidation adding costs to OEMS; increased production costs.

Flextronics
Looking at Flextronics in particular, with regards to the Company's recent fiscal 4Q results, Wall Street seems mixed on the EMS provider's quarterly results.

One investment bank, Needham and Company's Sean Hannan noted that with the challenges of a grueling EMS March quarter now behind Flextronics, the company has 'reset' the level in its business by way of communicating a flattish outlook to Wall Street.

Needham's Hannan goes on to mention in that despite some continued elements of choppiness in underlying segments, Needham views Flextronics favorably due to the company's diverse customer base, program ramp opportunities in the second half of fiscal 2010 and beyond (i.e. notebooks), and restructuring actions that should lend to earnings support and growth.

Other analysts such as CreditSuisse's Will Stein and CIBC's Todd Coupland offer commentary as well. Some favorable, some not.

Some noteworthy points from Flextronics' recent conference call (in addition to findings from discussions with industry contacts) reveal:

• Flextronics Q4 revenue was $5.58 billion, down 32% quarter-on-quarter and down 28% year-on-year.

• Flextronics (FLEX) reported weaker-than-expected Q4/F09 results and guided to a flat Q1/F10 at the midpoint.

• Flextronics' margin was 4.2% (down 70 bps from last quarter) and while SG&A was 3.3% of revenue (versus 2.6% last quarter) it declined 13% quarter-on-quarter as Flextronics has worked to reduce its operating costs.

• Flextronics' operating margin fell to 0.9% from 2.3%.

• Flextronics' top 10 customers were 46% of revenues without 1 customer providing more than 10% of Company revenues. (In the second half of fiscal year 2010, it's believed Hewlett-Packard could emerge as 10%+ as Flextronics' HP notebook business ramps up)

• All of Flextronics' end markets were down significantly this quarter by more than 20% sequentially.

• While Flextronics is seeing some stabilization in end markets, the Company's wide guidance range reflects a high degree of uncertainty. (Flextronics is currently operating at close to break-even but further restructuring actions could help the bottom line next quarter and throughout fiscal year 2010, perhaps even in the face of more challenging end markets)

• Flextronics will require improvements in its end markets to drive revenue growth and significant operating leverage beyond what it is getting from its restructuring actions

• Consumer digital fell the most at 56% quarter-on-quarter. (Q4 is seasonally the worst quarter but was much lower than normal this year as OEMs were reducing inventory after a very weak holiday season and poor visibility on the timing around an end-market recovery)

• Flextronics' infrastructure end-market was down 28%.

• The Company's mobile business segment was down 26%. It is believed perhaps later in the year Flextronic's mobile segment should benefit from ramping its new ramping smart phone customer Research In Motion. (iSuppli comments on mobile outsourcing challenges)

• At the end of the quarter Flextronics had $1.8 billion in cash, flat quarter-on-quarter and $2.97 billion of debt, (down from $3.2 billion last quarter). The Company says it remains focused on improving liquidity and this quarter generated $197 million in free cash flow.

• The company used $200 million of cash to pay down its revolver leaving the company with total liquidity of $3.8 billion. (Its important to note Flextronics does need to keep an eye on its debt-to-capitalization ratio, which could make it more expensive to borrow should it want to do so to pay down further debt)

• Flextronics' cash-conversion cycle increased to 22 days from 18 days which is still considered one of the best in the EMS industry.

Flextronics decreased its inventory by $504 million and inventory turns fell to 6.6x from 7.7x last quarter. Management reiterated its commitment to improving working capital management and driving free cash flow. (Its important to note in the EMS business, EMS tends to be a cash generator when sales decline and a cash user when sales expand due to the heavy working capital requirements needed by EMS).

Flextronics global aftermarket support and service business (including Retail Technical Services), which are by far the largest in the industry, could realize huge growth potential. The business generates reasonably good margins and can be considered somewhat stable by various metrics and, could even expand in this difficult climate (read: recession) as equipment owners try to extend the productive lives of their purchases by buying more services such as repairs.

VentureOutsource.com, April 2009

    

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