The Day Ahead: Solectron tempers rosy outlook ... for now

Instead of raising the expectations bar in one swoop, Solectron will boost estimates incrementally
Written by Larry Dignan, Contributor

There'll be some nit-picking over Solectron's fourth quarter results and fiscal 2001 outlook, but the company is playing Wall Street's expectations game well. And Solectron isn't shy about telegraphing its plan to underpromise and overdeliver.

Solectron, one of the largest contract equipment manufacturers, topped fourth quarter estimates with earnings of 28 cents a share on sales of $4.7bn (£3.30bn), officials indicated on a conference call that estimates will be coming up in future quarters.

The big question revolved around Solectron's 2001 outlook. The company projected first quarter sales of $4.8bn to $5.1bn and earnings per share of 27 cents to 28 cents. For the year, Solectron should generate sales of more than $20bn and earnings per share in the range of $1.12 to $1.15.

Although that projection is quite bullish, it was about what analysts were expecting. Solectron, which makes everything from circuit boards to handsets to networking gear, attracts a crowd because it gives a good overview of the tech sector on its conference calls.

So is the relatively conservative outlook a sign of problems to come? No, it's just part of the game -- the expectations game.

Here's how it usually works -- company execs guide analysts so they come up with estimates that are impressive, but attainable. Most of the time, you get this bob-and-weave game, where CFOs tell analysts that they may be "a little high" or "a little low" with their estimates.

Now note Solectron's refreshingly candid approach: "Our choice at this moment is that we are taking a conservative stance toward growth," said CFO Susan Wang, referring to the company's outlook. "We'll be talking you up as we go along."

An analyst's reply? "We look forward to having you talk us up."

The implications are clear: Despite Solectron's issues in the market such as tight component supplies, the company fully expects to crush estimates this year. Instead of raising the expectations bar in one swoop, Solectron will boost estimates incrementally.

Aside from the BS-free zone on Solectron's conference calls, the company gives a nice overview of the tech sector.

Here's a look at some of the issues:

Component shortages: A mixed bag of results. Solectron said supply constraints eased on flash memory and analogue devices as well as selected components. For other components, Solectron was still hampered by shortages. Component shortages -- an ongoing problem -- have hampered previous quarters.

DRAM pricing: In its previous conference call, Solectron noted that DRAM (dynamic random access memory) could be a big problem because shortages would boost prices. Wang changed her projection and said the DRAM market isn't going to be as tight as you would expect. "PC demand is not quite as hot as one would expect this time of the year," said Wang.

What's notable about this is that there's conflicting PC demand data everywhere. PaineWebber analyst Don Young said DRAM prices were stable because PC makers stockpiled DRAM chips earlier in the year in expectation of a shortage. Also note that Solectron isn't the best gauge of PC demand -- 48 percent of its sales come from networking and communications gear.

Keep an eye on other contract equipment companies -- Jabil, SCI Systems and Flextronics -- for their outlook.

Inventory: Solectron said inventory surged sequentially from 69 days last quarter to 79 days in the fourth quarter. Officials said inventory has built up with original equipment manufacturers. In addition, Solectron is digesting the recent manufacturing capacity from Nortel Networks. Wang said the company expects to work off the inventory, but couldn't get specific.

Wireless products: The company said wireless products represented about 15 percent of sales, split between mobile handsets wireless infrastructure.

Largest customers: For the year, Solectron's largest customer was Ericsson, which represented 13 percent of sales, followed by Cisco, which was 12 percent.

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