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Flextronics International Ltd. (FLEX - Snapshot Report) reported strong second quarter 2013 results with earnings of 26 cents, which beat the Zacks Consensus Estimate by 4 cents. The better-than-expected result was primarily driven by robust margin expansion in the quarter.

Quarter Details

Total revenue plunged 23% year over year to $6.17 billion, inching past the Zacks Consensus Estimate and was within the management’s guided range of $5.9 billion–$6.3 billion.

The year-over-year decline was primarily due to change in business mix as a result of Flextronics’ exit from the ODM PC business in fiscal 2012. Flextronics continues to wind down the assembly business with its largest mobile customer Research In Motion , which also significantly hurt revenue growth in the quarter.

The Integrated Network Solutions segment was the largest revenue contributor (44% of total revenue) in the quarter, despite a 9% annual decline in revenue. The decline was primarily due to a weak demand trend in the telecom sector.

High velocity solutions (29% of total revenue) segment revenue declined a massive 48% from the year-ago quarter, reflecting the lack of revenue from the ODM PC business and continued reduction of business from Flextronics’ largest mobile customer.

The significant year-over-year decline in these two segments were partially offset by strong performance from Industrial and Emerging solutions (16% of total revenue) and High Reliability Solutions (11% of total revenue), which improved 3% and 9%, respectively from the year-ago quarter.

The year-over-year improvement in Industrial and Emerging solutions revenue was primarily due to healthy double-digit growth in the appliances business and better-than-expected performance from capital equipment and kiosks, which fully offset a weak performance from the energy-related business.

High Reliability Solutions segment revenue jumped owing to improving performance from medical and automotive (up 20% year over year) business.

The ongoing transition to low volume high margin business helped Flextronics to expand its gross margin in the reported quarter. Although gross profit (including stock-based compensation but excluding amortization) decreased 1.5% from the year-ago quarter to $366.8 million, gross margin expanded 120 basis points (“bps”) to 5.9%.

Further, significantly lower selling, general and advertisement expense (down 8.6% year over year) helped operating income (including stock-based compensation but excluding amortization) to jump 7.7% year over year to $174.6 million. Operating margin improved 80 bps to 2.8% in the quarter.

Net income (including stock-based compensation but excluding amortization) was $167.4 million or 25 cents compared with $144.8 million or 20 cents in the year-ago quarter.

Flextronics exited the quarter with cash and cash equivalents of $1.56 billion compared with $1.29 billion at the end of the previous quarter. Total debt was $2.10 billion versus $2.19 billion in the previous quarter.

Outlook

For the third quarter, management expects earnings in the range of 18 cents to 22 cents per share. Currently, the Zacks Consensus Estimate is pegged at 23 cents. Total revenue is expected in the range of $5.8 billion to $6.2 billion.

Management expects stable revenue growth for High velocity solutions and High Reliability Solutions. However, the other two segments Industrial and Emerging solutions and Integrated Network Solutions are expected to decline in mid-single digit range.

Our Recommendation

We believe that strong new bookings will continue to boost top-line growth over the long term. However, macro-economic concerns and weak end-market demands are the 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 spending related to new program ramp-ups will hurt profitability going forward.

We have a Neutral recommendation on Flextronics over the long term. Currently, Flextronics has a Zacks #4 Rank, which implies a short-term Sell rating (for the next 1-3 months).

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