Conference Call, 03/20/97: Solectron Corp. (NYSE: SLR)

FOOL CONFERENCE CALL SYNOPSIS*
By Greg Markus (MF Boring)

Solectron Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLR)") else Response.Write("(NYSE: SLR)") end if %>
777 Gibraltar Dr.
Milpitas, CA 95035
Phone: 408-957-8500
http://www.oakridge.com/Solectron

ANN ARBOR, Mich. (March 17, 1997) -- Solectron is a global supplier of pre-manufacturing, manufacturing, and post-manufacturing services to electronics OEMs. Solectron has U.S. manufacturing operations in California, Massachusetts, North Carolina, Texas, and Washington; European manufacturing operations in France, Germany, and Scotland; and Asian manufacturing operations in China and Malaysia, as well as a program office in Japan.

SECOND QUARTER RESULTS

Following the market close, Solectron announced record sales for its second quarter of fiscal 1997, ended February 28, 1997, of $859 million, up 31% from the second quarter of fiscal 1996. Net income for the quarter was $37.6 million, up 36% from the second quarter of fiscal 1996 and up 6.3% sequentially from Q1 of fiscal 1997. Fully diluted earnings per share for the second quarter were $0.65 compared to $0.52 for the second quarter of last year. Solectron's Q2 operating margin was 6.5% and its annualized return on equity was 18.3%.

For the first half of fiscal 1997, sales were $1.7 billion, up 24% from the first half of fiscal 1996. Through two quarters, fully diluted EPS was $1.22, compared to $1.03 for the first half of last year.

COMMENTS ON FINANCIAL RESULTS

Gross margins improved in the quarter to 11.9%, primarily due to Force Computers's higher margins and a better product mix. Without Force Computers, gross margins would have approximated 10.6%. Operating expenses increased as a percentage of sales, also due to the acquisition of Force Computers. The consolidated operating margin for Q2 was 6.5%. Operating results were particularly strong, considering they included investments in the Mass. and China sites and continued underabsorption of capacity in Malaysia and Bordeaux, France, as well as increased infrastructure expenditures for the company's information systems, processes and management.

The company has improved its cash position and reduced days sales outstanding to below 40. Inventory turns did not improve, however, due to the increase in backlog [detailed below]. The company continues to experience high turns in its high-velocity board and systems projects, ranging from the mid-teens to the low-30s.

Domestic sales accounted for 76% to 77% of the total in Q2, the same as in Q1.

GLOBAL OPERATIONS

Solectron is a global leader, so it can serve customers' needs world-wide and has the capacity to win large global contracts. Customers are particularly interested in volume production in low cost regions of the world and also close to their end markets, to facilitate timely product introduction. Solectron's concept is to be aligned with customers' needs for both low-cost production and also timely delivery.

In that regard, Solectron is searching for a new low-cost location in North America and may be committing capital for that new site. That could very well be in Mexico. Solectron could be making an announcement on this fairly soon.

Solectron is pleased with the start-up of operations in its new Massachusetts location, which shipped its first products during the quarter. Management is also pleased with progress in Suzhou, China, where the company is preparing to begin shipments in Q3.

CUSTOMER BASE

Solectron's top ten accounts represented approximately 65% of total sales in Q2. Top-ten customers include (in no particular order) Hewlett-Packard, Sun Microsystems, Bay Networks, Cisco, Silicon Graphics, and Intel. H-P accounted for approximately 15% of sales in Q2, and Bay Networks accounted for 11%. IBM is still in the top ten, also, even though a number of their projects with Solectron are going through the end-of-lifestage. Other customers include Fore, 3Com, Ascend -- all the major networking companies. Toshiba is among the top 20 customers. Solectron serves all the major networking and workstation customers.

COMMENTS ON BUSINESS SEGMENTS

The breakdown of second-quarter sales by industry was: network and telecommunications, 37% up from 34% in Q1; sales to workstation customers increased to 22% from 20%; PC and peripherals decreased to 24%, from 30% (PC was 14% of sales vs. 17% in Q1 and peripherals was 10% vs. 13% last quarter). All other smaller segments had no appreciable change.

Sales were strong during the quarter for the printed circuit board assembly business. A few key products were substantially increased. Due to material order lead times, some orders did not ship. The resulting backlog will contribute to Q3 performance, especially for the Milpitas site.

Systems integration and test sector work fell to 9% of total sales in the quarter, from 12% in the previous quarter -- below company expectations. Several projects were pushed out and one was eventually canceled, as several customers experienced specific market and inventory issues with respect to products being built by Solectron. Management does not view these experiences as indicative of a downward trend. In fact, they believe that the market continues to be steady or improving. The PC and peripheral assembly business is extremely competitive in pricing. Also, OEMs don't move to outsourcing overnight; they want to become comfortable that there will be no disruption in supply when they hand-off the assembly business. It takes time to develop that comfort. In terms of project wins in this sector, the projects tend to be very large, so wins tend to be lumpy in time.

IMPACT OF FORCE COMPUTERS

Force Computers, which was acquired at the end of Q1, contributed approximately $30 million in sales to Q2 -- short of Solectron's expectations of $35 million. This was due largely to a continued weak European market as well as a strong dollar. Forty percent of Force's business is in Europe, and Europe is rather slow still. Nevertheless, the Force acquisition was accretive to EPS in Q2. Force's operating margins are above the overall corporate average. The outlook for Force Computers is stable for the second half, and management remains excited about the potential synergy of Force and Solectron.

Of the total SG&A expense of $42.5 million, $8 million was Force Computers. Of the $4.1 million in research and development expense, $3 million was Force. Force operates on a business model that is different from Solectron's. There should be no significant change from this model going forward.

FORWARD GUIDANCE

Solectron's business should be stronger in the second half than in the first half, with sequential growth in Q3 and Q4. The company is comfortable with expectations of $3.8 billion in sales for the fiscal year. With Force Computer's full impact, gross margins should level out between 11% and 12%. Next year, that should be more toward 12%, with a full year's impact of Force.

Order backlog has increased from roughly $670 million in Q1 to the $775 million level in Q2. Networking and telecommunications customers contributed heavily to the increase. Solectron defines its backlog very conservatively. Also backlog is heavily dependent on the customers' product needs, and sometimes the lead-times they give Solectron are as short as one to two weeks.

President, CEO, and Board Chairman Ko Nishimura noted that Solectron is engaged in talks that could lead to significant new business, which in turn could require substantial additional investment in capacity. Solectron is in the process of increasing its lending facility to $200 million. They therefore do not anticipate the need to go to the equity market to raise additional capital in the near-term.

The outlook is for capital expenditures of $130-170 million for the full fiscal year. A new North American site will generate expenditures in the second half of the fiscal year, as will continued investment in the Mass. site. Expenditures for the China site will fall mostly into FY98. Depreciation expense was $26 million in Q2; that will stay at approximately that level over the next couple of quarters. Cash flow is expected to turn negative in Q3 as the company funds expansion in the Mass. and China facilities.

Solectron is engaged in new product introductions for a number of new customers, which should follow normal ramp-up to fuller production. Activity in Malaysia should turn up in the second half of the year. In Bordeaux, the hope is that new business will offset the continued decline in IBM business there as the IBM products move through end-of-life.

The company is not ramping-up any large project in the systems assembly business in the next two quarters, but there could be good opportunities after that. All indications are that original equipment manufacturers (OEMs) continue to move toward more outsourcing of assembly. Potential users of Solectron's high-volume systems assembly capabilities are mostly in the low-end PC and peripherals business. The company is looking to move up the product value chain towards work stations, networking, and instrumentation equipment. The profit margin on systems assembly business is somewhat lower than on Solectron's other business, but the increase in overall sales will lead to increases in net income.

* A Fool conference call synopsis represents an effort to highlight the salient points of a conference call and should not be taken as an authoritative accounting or transcription of the entire event. Note: Statements made by a company other than historical information may constitute forward-looking statements for which the company can claim protection under the Safe Harbor Act. Please consult the company's filings with the SEC for information on risk factors which might cause actual results to differ materially from the information contained in these forward-looking statements.