e10vq
Table of Contents

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
     
(Mark One)    
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the quarterly period ended December 31, 2005
Or
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
    For the transition period from          to          
 
Commission file number 0-23354
 
FLEXTRONICS INTERNATIONAL LTD.
(Exact name of registrant as specified in its charter)
 
     
Singapore   Not Applicable
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
One Marina Boulevard,    018989
#28-00 Singapore   (Zip Code)
(Address of registrant’s principal executive offices)
   
 
(Registrant’s telephone number, including area code)
(65) 6890 7188
 
 
Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.  Large accelerated filer þ     Accelerated filer o     Non-accelerated filer o
 
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
As of February 3, 2006, there were 577,515,610 shares of the Registrant’s ordinary shares, no par value, outstanding.
 


 

 
FLEXTRONICS INTERNATIONAL LTD.
 
INDEX
 
             
        Page
 
  Financial Statements   3
    Report of Independent Registered Public Accounting Firm   3
    Condensed Consolidated Balance Sheets — December 31, 2005 and March 31, 2005   4
    Condensed Consolidated Statements of Operations — Three and Nine Months Ended December 31, 2005 and December 31, 2004   5
    Condensed Consolidated Statements of Cash Flows — Nine Months Ended December 31, 2005 and December 31, 2004   6
    Notes to Condensed Consolidated Financial Statements   7
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   28
  Quantitative and Qualitative Disclosures About Market Risk   50
  Controls and Procedures   51
 
  Legal Proceedings   51
  Unregistered Sales of Equity Securities and Use of Proceeds   51
  Exhibits   51
  53
 EXHIBIT 15.01
 EXHIBIT 31.01
 EXHIBIT 31.02
 EXHIBIT 32.01
 EXHIBIT 32.02


2


Table of Contents

 
PART I. FINANCIAL INFORMATION
 
ITEM 1.   FINANCIAL STATEMENTS
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Shareholders of Flextronics International Ltd.:
 
We have reviewed the accompanying condensed consolidated balance sheet of Flextronics International Ltd. and subsidiaries (the “Company”) as of December 31, 2005, the related condensed consolidated statements of operations for the three-month and nine-month periods ended December 31, 2005 and 2004, and related condensed consolidated statements of cash flows for the nine-month periods ended December 31, 2005 and 2004. These interim financial statements are the responsibility of the Company’s management.
 
We conducted our reviews in accordance with standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
 
Based on our reviews, we are not aware of any material modifications that should be made to such condensed consolidated interim financial statements for them to be in conformity with accounting principles generally accepted in the United States of America.
 
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of the Company as of March 31, 2005 and the related consolidated statements of operations, shareholders’ equity, and cash flows for the year then ended (not presented herein); and in our report dated June 14, 2005, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of March 31, 2005 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
 
/s/  DELOITTE & TOUCHE LLP
 
San Jose, California
February 7, 2006


3


Table of Contents

FLEXTRONICS INTERNATIONAL LTD.
 
CONDENSED CONSOLIDATED BALANCE SHEETS
 
                 
    December 31,
    March 31,
 
    2005     2005  
    (In thousands, except
 
    share amounts)
 
    (Unaudited)  
 
ASSETS
Current assets:
               
Cash and cash equivalents
  $ 1,083,637     $ 869,258  
Accounts receivable, net of allowance for doubtful accounts of $21,687 and $31,166 as of December 31, 2005 and March 31, 2005, respectively
    1,615,900       1,842,010  
Inventories
    1,659,050       1,518,866  
Deferred income taxes
    11,161       12,117  
Other current assets
    622,812       544,914  
                 
Total current assets
    4,992,560       4,787,165  
Property and equipment, net of accumulated depreciation of $1,221,277 and $1,245,217 as of December 31, 2005 and March 31, 2005, respectively
    1,600,999       1,704,516  
Deferred income taxes
    599,647       684,952  
Goodwill
    3,101,938       3,359,477  
Other intangible assets, net
    169,039       142,712  
Other assets
    466,847       328,750  
                 
Total assets
  $ 10,931,030     $ 11,007,572  
                 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
               
Bank borrowings and current portion of long-term debt and capital lease obligations
  $ 10,469     $ 26,166  
Accounts payable
    2,872,527       2,523,269  
Accrued payroll
    206,112       285,504  
Other current liabilities
    896,390       1,045,255  
                 
Total current liabilities
    3,985,498       3,880,194  
Long-term debt, net of current portion:
               
Zero Coupon Convertible Junior Subordinated Notes due 2008
    195,000       200,000  
1% Convertible Subordinated Notes due 2010
    500,000       500,000  
61/2% Senior Subordinated Notes due 2013
    399,650       399,650  
61/4% Senior Subordinated Notes due 2014
    396,366       490,270  
Other long-term debt and capital lease obligations
    9,536       119,650  
Other liabilities
    131,185       193,760  
Commitments and contingencies (Note L)
               
Shareholders’ equity:
               
Ordinary shares, no par value; 577,320,294 and 568,329,662 shares issued and outstanding as of December 31, 2005 and March 31, 2005, respectively
    5,566,518       5,489,764  
Accumulated deficit
    (284,386 )     (382,600 )
Accumulated other comprehensive income
    36,085       123,683  
Deferred compensation
    (4,422 )     (6,799 )
                 
Total shareholders’ equity
    5,313,795       5,224,048  
                 
Total liabilities and shareholders’ equity
  $ 10,931,030     $ 11,007,572  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 


4


Table of Contents

FLEXTRONICS INTERNATIONAL LTD.
 
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
    (In thousands, except per share amounts)
 
    (Unaudited)  
 
Net sales
  $ 4,186,891     $ 4,276,614     $ 11,968,653     $ 12,295,311  
Cost of sales
    3,927,459       3,976,832       11,167,801       11,477,733  
Restructuring charges
    63,115       24,076       129,150       70,771  
                                 
Gross profit
    196,317       275,706       671,702       746,807  
Selling, general and administrative expenses
    109,816       143,330       404,582       423,948  
Intangible amortization
    11,693       9,201       40,943       26,545  
Restructuring charges
    5,442       6,583       22,442       16,978  
Other charges (income), net
    7,705       (14,906 )     7,705       (14,906 )
Interest and other expense, net
    22,692       27,240       71,727       67,955  
Loss (gain) on divestiture of operations
    3,126             (67,569 )      
                                 
Income before income taxes
    35,843       104,258       191,872       226,287  
Provision for (benefit from) income taxes
    (6,111 )     5,575       93,658       (39,340 )
                                 
Net income
  $ 41,954     $ 98,683     $ 98,214     $ 265,627  
                                 
Earnings per share:
                               
Basic
  $ 0.07     $ 0.18     $ 0.17     $ 0.48  
                                 
Diluted
  $ 0.07     $ 0.17     $ 0.16     $ 0.46  
                                 
Weighted average shares used in computing per share amounts:
                               
Basic
    574,635       562,200       572,112       548,234  
                                 
Diluted
    599,761       594,081       600,068       581,433  
                                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.
 


5


Table of Contents

FLEXTRONICS INTERNATIONAL LTD.
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 
                 
    Nine Months Ended
 
    December 31,  
    2005     2004  
    (In thousands)
 
    (Unaudited)  
 
CASH FLOWS FROM OPERATING ACTIVITIES:
               
Net income
  $ 98,214     $ 265,627  
Depreciation and amortization
    246,789       259,026  
Change in working capital and other, net of effect of acquisitions
    301,962       263,610  
                 
Net cash provided by operating activities
    646,965       788,263  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchases of property and equipment, net of dispositions
    (151,880 )     (228,415 )
Acquisitions of businesses, net of cash acquired
    (622,961 )     (374,113 )
Proceeds from divestiture of operations
    518,505        
Other investments and notes receivable
    4,426       (204,927 )
                 
Net cash used in investing activities
    (251,910 )     (807,455 )
                 
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Proceeds from bank borrowings and long-term debt
    2,180,689       1,454,060  
Repayments of bank borrowings and long-term debt
    (2,425,195 )     (1,261,381 )
Repayments of capital lease obligations
    (11,094 )     (8,094 )
Net proceeds from issuance of ordinary shares
    47,132       330,976  
                 
Net cash (used in) provided by financing activities
    (208,468 )     515,561  
                 
Effect of exchange rates on cash
    27,792       (25,320 )
                 
Net increase in cash and cash equivalents
    214,379       471,049  
Cash and cash equivalents at beginning of period
    869,258       615,276  
                 
Cash and cash equivalents at end of period
  $ 1,083,637     $ 1,086,325  
                 
 
The accompanying notes are an integral part of these condensed consolidated financial statements.


6


Table of Contents

FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
NOTE A — ORGANIZATION OF THE COMPANY
 
Flextronics International Ltd. (“Flextronics” or the “Company”) was incorporated in the Republic of Singapore in May 1990. The Company is a leading provider of advanced electronics manufacturing services (EMS) to original equipment manufacturers (OEMs) for a broad range of products in the following industries: handheld devices, computers and office automation, communications infrastructure, consumer devices, information technology infrastructure, industrial, automotive and medical. The Company’s strategy is to provide customers with a complete range of vertically integrated global supply chain services through which the Company designs, builds and ships a complete packaged product for its OEM customers. OEM customers leverage the Company’s services to meet their product requirements throughout the entire product life cycle. The Company also provides after-market services such as repair and warranty services.
 
In addition to the assembly of printed circuit boards and complete systems and products, the Company’s manufacturing services include the fabrication and assembly of plastic and metal enclosures and the fabrication of printed circuit boards and backplanes. The Company also provides contract design and related engineering services offerings to its customers, from full product development to system integration, industrialization, product cost reduction, software application development and multiple component product offerings. These services include industrial and mechanical design, hardware design, embedded and application software development, and system validation and test development.
 
The Company also offers original product design and manufacturing services, where the customer purchases a product that was designed, developed and manufactured by the Company (commonly referred to as original design manufacturing, or “ODM”). ODM products are then sold by the Company’s OEM customers under the OEM’s brand name.
 
During the second quarter of fiscal year 2006, the Company sold its semiconductor division. In addition, the Company merged its network services division with Telavie and now retains a 35% ownership stake in the merged company. Refer to Note M, “Business and Asset Acquisitions and Divestitures” for further discussion of the divestitures of operations.
 
NOTE B — SUMMARY OF ACCOUNTING POLICIES
 
Basis of Presentation and Principles of Consolidation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and with the instructions to Form 10-Q and Article 10 of Regulation S-X for interim financial information. Accordingly, these statements do not include all of the information and footnotes required by GAAP for complete financial statements, and should be read in conjunction with the Company’s audited consolidated financial statements as of and for the fiscal year ended March 31, 2005 contained in the Company’s Annual Report on Form 10-K and all of the Company’s other reports filed with the SEC after such date and through the date of this report. In the opinion of management, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation have been included. As discussed further in Note H, certain prior year amounts have been reclassified to conform to the current period presentation. Operating results for the three- and nine-month periods ended December 31, 2005 are not necessarily indicative of the results that may be expected for the fiscal year ending March 31, 2006.
 
The Company’s fiscal year ends on March 31 of each year. The first and second fiscal quarters end on the Friday closest to the last day of each respective calendar quarter. The third and fourth fiscal quarters end on December 31 and March 31, respectively.
 
Amounts included in the financial statements are expressed in U.S. dollars unless otherwise designated as Singapore dollars (S$), Euros (€) or Indian Rupees (Rs).


7


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The accompanying unaudited condensed consolidated financial statements include the accounts of Flextronics and its majority-owned subsidiaries, after elimination of all significant intercompany accounts and transactions. The Company consolidates all majority owned subsidiaries and investments in entities in which the Company has a controlling influence. For consolidated majority-owned subsidiaries in which the Company owns less than 100%, the Company recognizes a minority interest for the ownership interest of the minority owners. As of December 31, 2005 and March 31, 2005, this minority interest totaled $28.4 million and $40.8 million, respectively, which is included in other liabilities in the condensed consolidated balance sheets. The associated minority interest expense has not been material to the Company’s results of operations for the three-and nine-months ended December 31, 2005 and 2004, and has been classified as interest and other expense, net, in the condensed consolidated statements of operations. Non-majority-owned investments are accounted for using the equity method when the Company has an ownership percentage equal to or greater than 20%, or has the ability to significantly influence the operating decisions of the issuer, otherwise the cost method is used.
 
Use of Estimates
 
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Estimates are used in accounting for, among other things, allowances for doubtful accounts, inventory allowances, useful lives of property, equipment and intangible assets, asset impairments, fair values of derivative instruments and the related hedged items, restructuring charges, contingencies, capital leases, and the fair values of options granted under the Company’s stock-based compensation plans. Actual results may differ from previously estimated amounts, and such differences may be material to the condensed consolidated financial statements. Estimates and assumptions are reviewed periodically, and the effects of revisions are reflected in the period they occur.
 
Translation of Foreign Currencies
 
The financial position and results of operations for certain of the Company’s subsidiaries are measured using a currency other than the U.S. dollar as their functional currency. Accordingly, all assets and liabilities for these subsidiaries are translated into U.S. dollars at the current exchange rates as of the respective balance sheet date. Revenue and expense items are translated at the average exchange rates prevailing during the period. Cumulative gains and losses from the translation of these subsidiaries’ financial statements are reported as a separate component of shareholders’ equity.
 
Revenue Recognition
 
Manufacturing revenue is recognized when the goods are shipped by the Company or received by its customer, title and risk of ownership have been passed, the price to the buyer is fixed or determinable and recoverability is reasonably assured. Service revenue is recognized when the services have been performed.
 
Allowance for Doubtful Accounts
 
The Company performs ongoing credit evaluations of its customers’ financial condition and makes provisions for doubtful accounts based on the outcome of those credit evaluations. The Company evaluates the collectibility of its accounts receivable based on specific customer circumstances, current economic trends, historical experience with collections and the age of past due receivables. Unanticipated changes in the liquidity or financial position of the Company’s customers may require additional provisions for doubtful accounts. On October 8, 2005, Delphi Corporation (“Delphi”), a customer of the Company, filed for Chapter 11 bankruptcy, which resulted in the Company providing a bad debt provision of $15.0 million as a charge to selling, general and administrative expenses during the three months ended September 30, 2005. The Company reversed this $15.0 million bad debt


8


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

reserve as a credit to selling, general and administrative expenses during the three months ended December 31, 2005, as the related accounts receivable were substantially collected.
 
Inventories
 
Inventories are stated at the lower of cost (on a first-in, first-out basis) or market value. The stated cost is comprised of direct materials, labor and overhead. The components of inventories, net of applicable lower of cost or market write-downs, were as follows:
 
                 
    December 31,
    March 31,
 
    2005     2005  
    (In thousands)  
 
Raw materials
  $ 806,422     $ 711,251  
Work-in-progress
    336,725       306,833  
Finished goods
    515,903       500,782  
                 
    $ 1,659,050     $ 1,518,866  
                 
 
Property and Equipment
 
Property and equipment are stated at cost. Depreciation and amortization is recognized on a straight-line basis over the estimated useful lives of the related assets (three to thirty years), with the exception of building leasehold improvements, which are amortized over the term of the lease, if shorter.
 
The Company reviews property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of property and equipment is measured by comparing its carrying amount to the projected undiscounted cash flows the property and equipment are expected to generate. An impairment loss is recognized when the carrying amount of a long-lived asset exceeds its fair value.
 
Goodwill and Other Intangibles
 
Goodwill of the reporting units is tested for impairment on January 31st and whenever events or changes in circumstances indicate that the carrying amount of goodwill may not be recoverable. Goodwill is tested for impairment at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. Reporting units represent components of the Company for which discrete financial information is available and regularly reviewed by management. For purposes of the annual goodwill impairment evaluation during the fiscal year ended March 31, 2005, the Company identified two separate reporting units: Electronic Manufacturing Services and Network Services. The Company sold its Network Services division in the second quarter of fiscal year 2006 and subsequently identified its Software Services division as a new operating segment and reporting unit during the third quarter of fiscal year 2006 (see Note K for further discussion). If the carrying amount of the reporting unit exceeds its fair value, the amount of impairment loss recognized, if any, is measured using a discounted cash flow analysis. Further, to the extent the carrying amount of the Company as a whole is greater than its market capitalization, all, or a significant portion of its goodwill may be considered impaired.


9


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The following table summarizes the activity of the Company’s goodwill during the nine months ended December 31, 2005:
 
         
    Nine Months
 
    Ended
 
    December 31,
 
    2005  
    (In thousands)  
 
Balance, beginning of the period
  $ 3,359,477  
Additions
    310,873  
Goodwill related to divested operations(1)
    (452,046 )
Reclassification to other intangibles(2)
    (22,201 )
Foreign currency translation adjustments
    (94,165 )
         
Balance, end of the period
  $ 3,101,938  
         
 
 
(1) See Note M, “Business and Asset Acquisitions and Divestitures.”
 
(2) Reclassification resulting from final allocation of the Company’s intangible assets acquired through certain business combinations completed in a period subsequent to the respective period of acquisition, based on third-party valuations.
 
The Company’s acquired intangible assets are subject to amortization over their estimated useful lives and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable. An impairment loss is recognized when the carrying amount of an intangible asset exceeds its fair value. Intangible assets are comprised of contractual agreements, customer relationships, developed technologies, patents and trademarks, and other acquired intangibles. Contractual agreements, developed technologies, and patents and trademarks, are amortized on a straight-line basis over a period of up to ten years. Other acquired intangibles related to customer relationships and favorable leases are amortized on a straight-line basis over three to ten years. No residual value is estimated for intangible assets. During the nine-month period ended December 31, 2005, there were approximately $94.2 million in additions to intangible assets, primarily related to contractual agreements, customer relationships and developed technologies as a result of acquisitions. The components of acquired intangible assets are as follows:
 
                                                 
    December 31, 2005     March 31, 2005  
    Gross
          Net
    Gross
          Net
 
    Carrying
    Accumulated
    Carrying
    Carrying
    Accumulated
    Carrying
 
    Amount     Amortization     Amount     Amount     Amortization     Amount  
    (In thousands)     (In thousands)  
 
Intangible assets:
                                               
Contractual agreements
  $ 102,668     $ (30,845 )   $ 71,823     $ 104,383     $ (58,221 )   $ 46,162  
Patents and trademarks
    8,082       (2,624 )     5,458       8,082       (1,688 )     6,394  
Developed technologies
    12,341       (4,108 )     8,233       11,812       (1,231 )     10,581  
Customer relationships
    96,674       (13,742 )     82,932       71,353       (4,342 )     67,011  
Other acquired intangibles
    26,230       (25,637 )     593       32,619       (20,055 )     12,564  
                                                 
Total
  $ 245,995     $ (76,956 )   $ 169,039     $ 228,249     $ (85,537 )   $ 142,712  
                                                 
 
In September 2005, the Company reduced intangible assets by approximately $18.4 million, primarily related to contractual agreements, developed technologies and customer relationships, as a result of the divestiture of certain operations, see Note M, “Business and Asset Acquisitions and Divestitures.” The Company recognized $11.7 million and $40.9 million, respectively, of total amortization expense during the three- and nine-month periods ended December 31, 2005, respectively, and $9.2 million and $26.5 million during the three- and


10


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

nine-month periods ended December 31, 2004, respectively. The estimated future annual amortization expense related to acquired intangible assets is as follows:
 
         
Fiscal Years Ending March 31,
  Amount  
    (In thousands)  
 
2006
  $ 11,601 (1)
2007
    35,800  
2008
    29,749  
2009
    23,843  
2010
    22,790  
Thereafter
    45,256  
         
Total amortization expense
  $ 169,039  
         
 
 
(1) Represents estimated amortization expense for the three month period ending March 31, 2006.
 
Deferred Income Taxes
 
The Company provides for income taxes in accordance with the asset and liability method of accounting for income taxes. Under this method, deferred income taxes are recognized for the tax consequences of temporary differences between the carrying amount and tax basis of existing assets and liabilities by applying the applicable statutory tax rate to such differences.
 
Derivative Instruments and Hedging Activities
 
All derivative instruments are recorded on the balance sheet at fair value. If the derivative instrument is designated as a cash flow hedge, the effective portion of changes in the fair value of the derivative instrument is recorded in shareholders’ equity as a separate component of accumulated other comprehensive income, and recognized in the statement of operations when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges are recognized in earnings immediately. If the derivative instrument is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in earnings in the current period.
 
Restructuring Charges
 
The Company recognizes restructuring charges related to its plans to close or consolidate duplicate manufacturing and administrative facilities. In connection with these activities, the Company records restructuring charges for employee termination costs, long-lived asset impairment and other exit-related costs.
 
The recognition of the restructuring charges requires the Company to make certain judgments and estimates regarding the nature, timing and amount of costs associated with the planned exit activity. To the extent the Company’s actual results differ from its estimates and assumptions, the Company may be required to revise the estimates of future liabilities, requiring the recognition of additional restructuring charges or the reduction of liabilities already recognized. Such changes to previously estimated amounts may be material to the condensed consolidated financial statements. At the end of each reporting period, the Company evaluates the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with developed exit plans.
 
Accounting for Stock-Based Compensation
 
The Company applies the intrinsic value method of accounting under Accounting Principals Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related interpretations in accounting for its


11


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

stock-based compensation plans. As a result, generally no compensation expense is recognized for options granted under these stock incentive plans because typically the option terms are fixed and the exercise price equals or exceeds the market price of the underlying stock on the date of grant. The Company applies the disclosure only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”).
 
In December 2004, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share Based Payment” (“SFAS 123(R)”) which (i) revises SFAS 123 to eliminate the disclosure only provisions of that statement and the alternative to follow the intrinsic value method of accounting under APB 25 and related interpretations, and (ii) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments, including grants of employee stock options, based on the grant-date fair value of the award and recognize that cost in its results of operations over the period during which an employee is required to provide the requisite service in exchange for that award. The Company is required to adopt this statement beginning April 1, 2006. Companies may elect to apply this statement either prospectively, or on a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods under SFAS 123. The Company has elected to apply the provisions of this statement prospectively, and will continue using the Black-Scholes option valuation model to estimate the fair value of its stock-based awards, and will also continue to recognize the related expense under the straight-line attribution method. Although the pro forma effects below may be indicative of the Company’s adoption of SFAS 123(R), the actual expense will be dependent on numerous factors including, but not limited to, the selection of assumptions used to fair value stock-based awards granted subsequent to April 1, 2006, policy decisions regarding accounting for the tax effects of share-based awards, and assumed award forfeiture rates. Assuming that no holders of ISOs elect to decline the acceleration of unamortized compensation resulting from the acceleration of vesting on certain outstanding options discussed below, unamortized compensation is estimated to be approximately $34.0 million on April 1, 2006, based on currently outstanding unvested options to purchase ordinary shares of the Company, of which approximately $16.0 million is expected to be recognized during the 2007 fiscal year.
 
In October 2005, the FASB issued FASB Staff Position FAS 123(R)-2, “Practical Accommodation to the Application of Grant Date as Defined in FAS 123(R)” (“FSP 123(R)-2”). FSP 123(R)-2 provides guidance on the application of grant date as defined in SFAS No. 123(R). In accordance with this standard a grant date of an award exists if a) the award is a unilateral grant and b) the key terms and conditions of the award are expected to be communicated to an individual recipient within a relatively short time period from the date of approval. The Company will adopt this standard when it adopts SFAS No. 123(R), and does not anticipate that the implementation of this statement will have a significant impact on the Company’s results of operations.
 
In November 2005, the FASB issued FASB Staff Position FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123(R)-3”). FSP 123(R)-3 provides an elective alternative method that establishes a computational component to arrive at the beginning balance of the accumulated paid-in capital pool related to employee compensation and a simplified method to determine the subsequent impact on the accumulated paid-in capital pool of employee awards that are fully vested and outstanding upon the adoption of SFAS No. 123(R). The Company is currently evaluating this transition method.


12


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The following pro forma information reflects net income and earnings per share as if the Company had accounted for its stock-based compensation plans using the fair value method. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period on a straight-line basis. Forfeitures are recognized as they occur, and compensation previously recognized is reversed for the forfeitures of unvested options.
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
    (In thousands, except per share amounts)  
 
Net income, as reported
  $ 41,954     $ 98,683     $ 98,214     $ 265,627  
Add: Stock-based employee compensation expense included in reported net income, net of tax
    589       579       1,745       1,607  
Less: Fair value compensation costs, net of tax
    (12,716 )     (21,131 )     (31,578 )     (65,126 )
                                 
Pro forma net income
  $ 29,827     $ 78,131     $ 68,381     $ 202,108  
                                 
Basic earnings per share:
                               
As reported
  $ 0.07     $ 0.18     $ 0.17     $ 0.48  
                                 
Pro forma
  $ 0.05     $ 0.14     $ 0.12     $ 0.37  
                                 
Diluted earnings per share:
                               
As reported
  $ 0.07     $ 0.17     $ 0.16     $ 0.46  
                                 
Pro forma
  $ 0.05     $ 0.13     $ 0.11     $ 0.35  
                                 
 
The Company accelerated the vesting of all out-of-the-money unvested options to purchase the Company’s ordinary shares held by current employees and executive officers on January 17, 2005, primarily to eliminate future compensation expense attributable to these options upon adoption of SFAS 123(R). All options priced above $12.98, the closing price of the Company’s ordinary shares on January 17, 2005, were considered to be out-of-the-money. The decrease in the pro forma expense in fiscal year 2006 is primarily the result of the acceleration of vesting during January 2005 and, to a lesser extent, the reduction in the Company’s estimated volatility discussed below.
 
For purposes of the pro forma presentation, the fair value of each option grant was estimated at the date of grant using a Black-Scholes model with the following weighted-average assumptions:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
 
Volatility
    39%       82%       39%       82%  
Risk-free interest rate
    4.3%       3.2%       3.9%       3.0%  
Dividend yield
    0.0%       0.0%       0.0%       0.0%  
Expected option life
    4 years       3.8 years       4 years       3.8 years  
 
The fair value related to shares issued under the Company’s employee stock purchase plan was estimated using the Black-Scholes model with the following weighted-average assumptions:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
 
Volatility
    48%       43%       33%       41%  
Risk-free interest rate
    2.1%       1.6%       1.9%       1.5%  
Dividend yield
    0.0%       0.0%       0.0%       0.0%  
Expected option life
    0.5 years       0.5 years       0.5 years       0.5 years  


13


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The Company has never paid dividends on its ordinary shares and currently does not intend to do so, and accordingly, the dividend yield percentage is zero for all periods. Beginning on January 1, 2005, in accordance with the guidance under SFAS 123 for selecting assumptions to use in an option pricing model, the Company reduced its estimate of expected volatility based upon a re-evaluation of the variability in the market price of its publicly traded stock. Prior to this date, the historical variability in daily stock prices was used exclusively to derive the estimate of expected volatility. Management determined that a combination of implied volatility related to publicly traded options together with historical volatility is more reflective of current market conditions, and a better indicator of expected volatility.
 
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. Consequently, the Company’s estimate of fair value may differ from other valuation models. Further, the Black-Scholes model requires the input of highly subjective assumptions and because changes in the subjective input assumptions can materially affect the fair value estimate, the existing models do not necessarily provide a reliable single measure of the fair value of stock-based compensation awards. Accordingly, pro forma net income and earnings per share as disclosed above may not accurately depict the associated fair value of the outstanding options.
 
The Company will continue to evaluate its assumptions used to derive the estimated fair value of options granted under its stock-based compensation plans as new events or changes in circumstances become known.
 
The Company grants key employees rights to acquire a specified number of ordinary shares for no cash consideration under its 2001 Equity Incentive Plan and its 2002 Interim Incentive Plan (“restricted stock units”) in exchange for continued service with the Company. Restricted stock units awarded under the plan generally vest in installments over a five-year period and unvested units are forfeited upon termination of employment. During the first nine months of fiscal year 2005, 85,000 restricted stock units were granted with a weighted average fair value on the date of grant of $14.66 per ordinary share. During the first nine months of fiscal year 2006, 35,000 restricted stocks units were awarded with a weighted average fair value on the date of grant of $9.37 per ordinary share. Grants of restricted stock units are recorded as compensation expense over the vesting period at the fair market value of the Company’s ordinary shares at the date of grant. During the three- and nine-month periods ended December 31, 2005, compensation expense related to restricted stock units was approximately $589,000 and $1.7 million, respectively. During the three- and nine-month periods ended December 31, 2004, compensation expense related to the restricted stock units was approximately $579,000 and $1.6 million, respectively. Unearned compensation associated with restricted stock units was $4.4 million and $6.8 million as of December 31, 2005 and March 31, 2005, respectively, and is included as a component of shareholders’ equity in the condensed consolidated balance sheets.
 
On February 7, 2006, the Company’s Board of Directors approved accelerating the vesting of unvested options to purchase the Company’s ordinary shares held by current employees, including executive officers, priced at or above $12.37. No options held by non-employee directors were subject to the acceleration. The acceleration is effective as of February 7, 2006, provided that holders of incentive stock options (“ISOs”) within the meaning of Section 422 of the Internal Revenue code of 1986, as amended, have the opportunity to decline the acceleration of ISO options in order to prevent changing the status of the ISO option for federal income tax purposes to a non-qualified stock option.
 
The acceleration of these options was done primarily to eliminate future compensation expense the Company would otherwise recognize in its income statement with respect to these options upon the adoption of SFAS 123(R). In addition, because these options have exercise prices in excess of current market values and are not fully achieving their original objectives of incentive compensation and employee retention, management believes that the acceleration may have a positive effect on employee morale and retention. Assuming that no holders of ISOs elect to decline the acceleration, the maximum future expense that is eliminated is approximately $35.3 million (of which approximately $12.8 million is attributable to options held by executive officers). The impact of the


14


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

acceleration will be reflected in the pro forma footnote disclosure of the Company’s fiscal year 2006 financial statements under current accounting guidance.
 
Recent Accounting Pronouncements
 
In May 2005, the FASB issued SFAS Statement No. 154, “Accounting Changes and Error Corrections” (“SFAS 154”). SFAS 154 is a replacement of Accounting Principles Board Opinion No. 20 (“APB 20”) and FASB Statement No. 3. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal year 2007. The Company does not expect that the adoption of SFAS 154 will have a material impact on its consolidated results of operations, financial condition and cash flows.
 
In March 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”) as an interpretation of FASB Statement No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). This interpretation clarifies that the term conditional asset retirement obligation as used in SFAS 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. The Company is currently assessing the impact of the adoption of FIN 47.
 
NOTE C — EARNINGS PER SHARE
 
SFAS No. 128, “Earnings Per Share” (“SFAS 128”) requires entities to present both basic and diluted earnings per share. Basic earnings per share excludes dilution and is computed by dividing net income by the weighted-average number of ordinary shares outstanding during the applicable periods.
 
Diluted earnings per share reflects the potential dilution from stock options, restricted stock units and convertible securities. The potential dilution from stock options exercisable into ordinary share equivalents and restricted stock units was computed using the treasury stock method based on the average fair market value of the Company’s ordinary shares for the period. The potential dilution from subordinated notes convertible into ordinary share equivalents was computed using the if-converted method.


15


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The following table reflects the basic weighted-average ordinary shares outstanding and diluted weighted-average ordinary share equivalents used to calculate basic and diluted net income per share. Earnings per share amounts for all periods are presented below in accordance with the requirements of SFAS 128:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
    (In thousands, except per share amounts)  
 
Basic earnings per share:
                               
Net income
  $ 41,954     $ 98,683     $ 98,214     $ 265,627  
Shares used in computation:
                               
Weighted average ordinary shares outstanding
    574,635       562,200       572,112       548,234  
                                 
Basic earnings per share
  $ 0.07     $ 0.18     $ 0.17     $ 0.48  
                                 
Diluted earnings per share:
                               
Net income
  $ 41,954     $ 98,683     $ 98,214     $ 265,627  
Shares used in computation:
                               
Weighted average ordinary shares outstanding
    574,635       562,200       572,112       548,234  
Weighted average ordinary share equivalents from stock options and awards(1)
    6,554       12,833       9,177       13,384  
Weighted average ordinary share equivalents from convertible notes(2)
    18,571       19,048       18,779       19,815  
                                 
Weighted average ordinary shares and ordinary share equivalent outstanding
    599,761       594,081       600,068       581,433  
                                 
Diluted earnings per share
  $ 0.07     $ 0.17     $ 0.16     $ 0.46  
                                 
 
 
(1) Ordinary share equivalents from stock options to purchase 39,877,878 and 31,911,895 shares during the three- and nine-month periods ended December 31, 2005, respectively, and 25,156,633 and 25,026,554 shares during the three- and nine-month periods ended December 31, 2004, respectively, were excluded from the computation of diluted earnings per share primarily because the exercise price of these options was greater than the average market price of the Company’s ordinary shares during the respective periods. Ordinary share equivalents relating to restricted stock units that were excluded from the computation of diluted earnings per share primarily when the grant price was greater than the average market price of the Company’s ordinary shares during the respective periods were not material.
 
(2) During the three- and nine-month periods ended December 31, 2005, 18,571,429 and 18,778,999 ordinary share equivalents related to the zero coupon convertible junior subordinated notes were included as common stock equivalents, respectively. During the three- and nine-month periods ended December 31, 2004, 19,047,619 ordinary share equivalents related to the zero coupon convertible junior subordinated notes were included as common stock equivalents. Because the Company has the positive intent and ability to settle the principal amount of the 1% convertible subordinated notes due August 2010 in cash, 32,206,119 ordinary share equivalents related to the principal portion of the notes are excluded from the computation of diluted earnings per share. The Company intends to settle any conversion spread (excess of conversion value over face value) in stock. During the three- and nine-month periods ended December 31, 2005 and the three month period ended December 31, 2004, the conversion obligation was less than the principal portion of the convertible notes and, accordingly, no additional shares were included in the computation of diluted earnings per share. During the nine month period ended December 31, 2004, 767,450 ordinary share equivalents related to the conversion spread were included as common stock equivalents for the computation of diluted earnings per share.


16


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
NOTE D — OTHER COMPREHENSIVE INCOME
 
The following table summarizes the components of other comprehensive income:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
    (In thousands)  
 
Net income
  $ 41,954     $ 98,683     $ 98,214     $ 265,627  
Other comprehensive income (loss):
                               
Foreign currency translation adjustment, net of taxes
    (20,114 )     67,820       (93,891 )     96,015  
Unrealized holding gain on derivative instruments, net of taxes
    3,860       2,590       6,293       1,625  
                                 
Comprehensive income
  $ 25,700     $ 169,093     $ 10,616     $ 363,267  
                                 
 
NOTE E — LONG-TERM DEBT
 
During the nine months ended December 31, 2005, the Company repurchased approximately $97.9 million principal amount of its 6.25% senior subordinated notes due 2014, and repaid approximately $106.1 million of other long-term debt.
 
NOTE F — FINANCIAL INSTRUMENTS
 
The carrying amount of the Company’s cash and cash equivalents, investments, accounts receivable and accounts payable approximates fair value. The Company’s cash equivalents are comprised of cash deposited in money market accounts and certificates of deposit. The Company’s investment policy limits the amount of credit exposure to 20% of the total investment portfolio in any single issuer.
 
The Company is exposed to foreign currency exchange rate risk inherent in forecasted sales, cost of sales, and assets and liabilities denominated in non-functional currencies. The Company has established currency risk management programs to protect against reductions in value and volatility of future cash flows caused by changes in foreign currency exchange rates. The Company enters into short-term foreign currency forward contracts to hedge only those currency exposures associated with certain assets and liabilities, primarily accounts receivable and accounts payable, and cash flows denominated in non-functional currencies. Gains and losses on forward contracts generally offset losses and gains on the assets, liabilities and transactions hedged, and accordingly, generally do not subject the Company to risk of significant accounting losses. The Company hedges committed exposures and does not engage in foreign currency speculation. The credit risk of these forward contracts is minimized since the contracts are with large financial institutions.
 
As of December 31, 2005 and March 31, 2005, the Company recognized approximately $8.0 million in other current liabilities and $13.4 million in other current assets, respectively, to reflect the fair value of these short-term foreign currency forward contracts. As of December 31, 2005 and March 31, 2005, the Company also recognized an immaterial amount of deferred gains and deferred losses of approximately $6.3 million, respectively, in other comprehensive income relating to changes in fair value of these foreign currency forward contracts. These gains and losses are expected to be recognized in earnings over the twelve month period subsequent to recognition in other comprehensive income. The gains and losses recognized in earnings due to hedge ineffectiveness were immaterial for all periods presented.
 
On November 17, 2004, the Company issued $500.0 million of 6.25% senior subordinated notes due in November 2014. Interest is payable semi-annually on May 15 and November 15. The Company entered into interest rate swap transactions to effectively convert a portion of the fixed interest rate debt to variable rate. The swaps,


17


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

having notional amounts totaling $400.0 million and which expire in 2014, are accounted for as fair value hedges under SFAS 133. Under the terms of the swaps, the Company pays an interest rate equal to six month LIBOR, (4.7% at December 31, 2005), set in arrears, plus a fixed spread ranging from 1.37% to 1.52%, and receives a fixed rate of 6.25%. As of December 31, 2005 and March 31, 2005, the Company recognized $5.7 million in other current liabilities and $9.7 million in other current assets, respectively, to reflect the fair value of the interest rate swaps, with a corresponding decrease to the carrying value of the 6.25% senior subordinated notes.
 
NOTE G — TRADE RECEIVABLES SECURITIZATION
 
The Company continuously sells a designated pool of trade receivables to a third party qualified special purpose entity, which in turn sells an undivided ownership interest to a conduit, administered by an unaffiliated financial institution. In addition to this financial institution, the Company participates in the securitization agreement as an investor in the conduit. The Company continues to service, administer and collect the receivables on behalf of the special purpose entity. The Company pays annual facility and commitment fees of up to 0.24% for unused amounts and program fees of up to 0.34% of outstanding amounts. The securitization agreement allows the operating subsidiaries participating in the securitization program to receive a cash payment for sold receivables, less a deferred purchase price receivable. The Company’s share of the total investment varies depending on certain criteria, mainly the collection performance on the sold receivables. In September 2005, the Company amended the securitization agreement to increase the size of the program to $700 million and extend the expiration date to September 2006. The unaffiliated financial institution’s maximum investment limit was increased to $500 million. The amended securitization agreement also includes two Obligor Specific Tranches (OST) which total $200 million. The OSTs are part of the main facility and were incorporated in order to minimize the impact of excess concentrations of two major customers.
 
As of December 31, 2005 and March 31, 2005, approximately $257.1 million and $249.9 million of the Company’s accounts receivable, respectively, had been sold to the third party qualified special purpose entity described above which represent the face amount of the total outstanding trade receivables on all designated customer accounts on those dates. The Company received net cash proceeds of approximately $183.6 million and $134.7 million from the unaffiliated financial institutions for the sale of these receivables during the three months ended December 31, 2005 and March 31, 2005, respectively. The Company has a recourse obligation that is limited to the deferred purchase price receivable, which approximates 5% of the total sold receivables, and its own investment participation, the total of which was $73.5 million and $123.1 million as of December 31, 2005 and March 31, 2005, respectively.
 
The Company also sells its accounts receivable to a banking institution with limited recourse, which management believes is nominal. During the three months ended December 31, 2005, the Company sold $254.6 million. The outstanding balance of receivables sold and not yet collected was $251.0 million as of December 31, 2005.
 
In accordance with SFAS 140 “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” the accounts receivable balances that were sold were removed from the consolidated balance sheet and are reflected as cash provided by operating activities in the consolidated statement of cash flows.
 
NOTE H — SHAREHOLDERS’ EQUITY
 
Effective January 30, 2006, the Singapore Companies Act was amended to, among other things, allow Singapore companies to repurchase outstanding ordinary shares subject to certain requirements and eliminate the concepts of par value, additional paid-in capital and authorized share capital. As a result of the Companies Act amendments, effective January 30, 2006, the outstanding shares of the Company are no par value ordinary shares. As of December 31, 2005 and March 31, 2005, the Company had $3.4 million par value recorded for its ordinary shares, and $5.6 billion and $5.5 billion, respectively, recorded as additional paid in capital related to its ordinary shares. Additionally, the Company had 1.5 billion authorized ordinary shares during these periods. As a result of the


18


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

amendments to the Singapore Companies Act, the Company has combined the par value of its ordinary shares together with additional paid in capital into one account for the purposes of balance sheet presentation. The March 31, 2005 balances were reclassified to conform to the current period presentation.
 
NOTE I — RESTRUCTURING CHARGES
 
In recent years, the Company has initiated a series of restructuring activities, which are intended to realign the Company’s global capacity and infrastructure with demand by its OEM customers and thereby improve operational efficiency, include reducing excess workforce and capacity, and consolidating and relocating certain manufacturing and administrative facilities to lower cost regions.
 
The restructuring costs include employee severance, costs related to leased facilities, owned facilities that are no longer in use and are to be disposed of, leased equipment that is no longer in use and will be disposed of, and other costs associated with the exit of certain contractual agreements due to facility closures. The overall impact of these activities is that the Company has shifted its manufacturing capacity to locations with higher efficiencies and, in some instances, lower costs, and is better utilizing its overall existing manufacturing capacity. This has enhanced the Company’s ability to provide cost-effective manufacturing service offerings, which enables it to retain and expand the Company’s existing relationships with customers and attract new business.
 
Liabilities for costs associated with exit or disposal of activities are recognized when the liabilities are incurred.
 
As of December 31, 2005 and March 31, 2005, assets that were no longer in use and held for sale totaled approximately $40.6 million and $59.3 million, respectively, primarily representing manufacturing facilities located in the Americas that have been closed as part of the facility consolidations. For assets held for sale, depreciation ceases and an impairment loss is recognized if the carrying amount of the asset exceeds its fair value less cost to sell. Assets held for sale are included in other assets on the condensed consolidated balance sheet.
 
Fiscal Year 2006
 
The Company recognized restructuring charges of approximately $32.7 million, $50.3 million, and $68.6 million during the first, second, and third quarter of fiscal year 2006, respectively, related to the impairment of certain long-term assets and other costs resulting from closures and consolidations of various manufacturing facilities. The Company has classified $27.6 million, $38.5 million, and $63.1 million of the charges associated with facility closures as a component of cost of sales during the first, second, and third quarters of fiscal year 2006, respectively.
 
The Company currently anticipates that the facility closures and activities to which all of these charges relate will be substantially completed within one year of the commitment dates of the respective activities, except for certain long-term contractual obligations. During the first, second and third quarters of fiscal year 2006, the Company recorded approximately $14.5 million, $12.8 million, and $11.5 million respectively, of other exit costs primarily associated with contractual obligations. As of December 31, 2005, approximately $6.7 million is classified as long-term obligation and will be paid throughout the term of the terminated leases.


19


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The components of the restructuring charges during the first, second, and third quarters of fiscal year 2006 were as follows:
 
                                 
    First
    Second
    Third
       
    Quarter     Quarter     Quarter     Total  
    (In thousands)  
 
Asia
                               
Severance
  $     $     $ 1,312     $ 1,312  
Long-lived assets impairment
                1,912       1,912  
Other exit costs
                       
                                 
Total restructuring charges
  $     $     $ 3,224     $ 3,224  
                                 
Americas
                               
Severance
  $ 2,442     $ 6,546     $ 1,719     $ 10,707  
Long-lived assets impairment
    3,847       7,244       1,951       13,042  
Other exit costs
    6,421       836       10,957       18,214  
                                 
Total restructuring charges
  $ 12,710     $ 14,626     $ 14,627     $ 41,963  
                                 
Europe
                               
Severance
  $ 11,483     $ 16,669     $ 47,689     $ 75,841  
Long-lived assets impairment
    456       7,125       2,497       10,078  
Other exit costs
    8,040       11,926       520       20,486  
                                 
Total restructuring charges
  $ 19,979     $ 35,720     $ 50,706     $ 106,405  
                                 
Total
                               
Severance
  $ 13,925     $ 23,215     $ 50,720     $ 87,860  
Long-lived assets impairment
    4,303       14,369       6,360       25,032  
Other exit costs
    14,461       12,762       11,477       38,700  
                                 
Total restructuring charges
  $ 32,689     $ 50,346     $ 68,557     $ 151,592  
                                 
 
During the first nine months of fiscal year 2006, the Company recorded approximately $87.9 million of employee termination costs associated with the involuntary terminations of 4,312 identified employees in connection with the various facility closures and consolidations. The identified involuntary employee terminations by reportable geographic region amounted to approximately 78, 1,010, and 3,224 for Asia, Americas, and Europe, respectively. Approximately $74.2 million of the net charges were classified as a component of cost of sales.
 
During the first nine months of fiscal year 2006, the Company recorded approximately $25.0 million for the write-down of property and equipment associated with various manufacturing and administrative facility closures. Approximately $23.3 million of this amount was classified as a component of cost of sales. The restructuring charges recorded during the first nine months of fiscal year 2006 also included approximately $38.7 million for other exit costs, of which, $26.7 million was classified as a component of cost of sales. This amount was primarily comprised of facility lease obligations of approximately $10.8 million, customer disengagement costs of approximately $11.9 million, and facility abandonment and refurbishment costs of approximately $1.9 million.


20


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The following table summarizes the provisions, the respective payments, and the remaining accrued balance as of December 31, 2005 for restructuring charges incurred in the first, second and third quarters of fiscal year 2006 and prior:
 
                                 
          Long-Lived
             
          Asset
    Other
       
    Severance     Impairment     Exit Costs     Total  
    (In thousands)  
 
Balance as of March 31, 2005
  $ 13,551     $     $ 24,337     $ 37,888  
Activities during the first quarter:
                               
Provision for charges incurred in first quarter
    13,925       4,303       14,461       32,689  
Cash payments for charges incurred in first quarter
    (2,163 )           (1,100 )     (3,263 )
Cash payments for charges incurred in fiscal year 2005
    (3,426 )           (472 )     (3,898 )
Cash payments for charges incurred in fiscal year 2004
    (1,179 )           (2,386 )     (3,565 )
Cash payments for charges incurred in fiscal year 2003 and prior
    (24 )           (684 )     (708 )
Non-cash charges incurred in first quarter
          (4,303 )     (3,421 )     (7,724 )
                                 
Balance as of June 30, 2005
    20,684             30,735       51,419  
Activities during the second quarter:
                               
Provision for charges incurred in second quarter
    23,215       14,369       12,762       50,346  
Cash payments for charges incurred in first and second quarters
    (24,950 )           (4,475 )     (29,425 )
Cash payments for charges incurred in fiscal year 2005
    (2,120 )           (401 )     (2,521 )
Cash payments for charges incurred in fiscal year 2004
    (579 )           (1,445 )     (2,024 )
Cash payments for charges incurred in fiscal year 2003 and prior
    (73 )           (875 )     (948 )
Non-cash charges incurred in second quarter
          (14,369 )     (6,450 )     (20,819 )
                                 
Balance as of September 30, 2005
    16,177             29,851       46,028  
Activities during the third quarter:
                               
Provision for charges incurred in third quarter
    50,720       6,360       11,477       68,557  
Cash payments for charges incurred in first, second, and third quarters
    (20,276 )           (7,427 )     (27,703 )
Cash payments for charges incurred in fiscal year 2005
    (1,315 )           (3 )     (1,318 )
Cash payments for charges incurred in fiscal year 2004
    (548 )           (2,083 )     (2,631 )
Cash payments for charges incurred in fiscal year 2003 and prior
    (18 )           (1,329 )     (1,347 )
Non-cash charges incurred in second quarter
          (6,360 )     (4,313 )     (10,673 )
                                 
Balance as of December 31, 2005
    44,740             26,173       70,913  
Less:  
                               
Current portion (classified as other current liabilities)
    (43,840 )           (10,442 )     (54,282 )
                                 
Accrued facility closure costs, net of current portion (classified as other long-term liabilities)
  $ 900     $     $ 15,731     $ 16,631  
                                 
 
Fiscal Year 2005
 
The Company recognized restructuring charges of approximately $95.4 million during fiscal year 2005 related to severance, the impairment of certain long-term assets and other costs resulting from closures and consolidations of various manufacturing facilities, of which $78.4 million was classified as a component of cost of sales during fiscal year 2005.


21


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The Company currently anticipates that the facility closures and activities to which all of these charges relate will be substantially completed within one year of the commitment dates of the respective activities, except for certain long-term contractual obligations. During fiscal year 2005, the Company recorded approximately $16.3 million of other exit costs associated with contractual obligations.
 
The components of the restructuring charges during fiscal year 2005 were as follows:
 
                                             
    First
    Second
    Third
    Fourth
           
    Quarter     Quarter     Quarter     Quarter     Total     Nature
    (In thousands)
 
America:
                                           
Severance
  $ 1,793     $     $     $     $ 1,793      
Long-lived assets impairment
    365       125             5,300       5,790      
Other exit costs
    1,598       321       170             2,089      
                                             
Total restructuring charges
  $ 3,756     $ 446     $ 170     $ 5,300     $ 9,672      
                                             
Asia:
                                           
Severance
  $     $ 872     $     $     $ 872      
Long-lived assets impairment
          267                   267      
Other exit costs
          1,220                   1,220      
                                             
Total restructuring charges
  $     $ 2,359     $     $     $ 2,359      
                                             
Europe:
                                           
Severance
  $ 17,447     $ 15,613     $ 29,092     $ 1,515     $ 63,667      
Long-lived assets impairment
    100       5,743             795       6,638      
Other exit costs
    2,285       9,341       1,397             13,023      
                                             
Total restructuring charges
  $ 19,832     $ 30,697     $ 30,489     $ 2,310     $ 83,328      
                                             
Total:
                                           
Severance
  $ 19,240     $ 16,485     $ 29,092     $ 1,515     $ 66,332     Cash
Long-lived assets impairment
    465       6,135             6,095       12,695     Non-Cash
Other exit costs
    3,883       10,882       1,567             16,332     Cash & Non-Cash
                                             
Total restructuring charges
  $ 23,588     $ 33,502     $ 30,659     $ 7,610     $ 95,359      
                                             
 
During fiscal year 2005, the Company recorded approximately $66.3 million of employee termination costs associated with the involuntary terminations of approximately 3,000 identified employees in connection with the various facility closures and consolidations. Approximately $54.7 million of the charges were classified as a component of cost of sales. The identified involuntary employee terminations by reportable geographic region amounted to approximately 300, 200, and 2,500 for the Americas, Asia and Europe, respectively. As of December 31, 2005, approximately 2,989 employees have been terminated under these plans, while approximately 11 employees have been notified but not yet terminated. The Company also recorded approximately $12.7 million for the write-down of property and equipment associated with various manufacturing and administrative facility closures. Approximately $11.2 million of this amount was classified as a component of cost of sales. The restructuring charges recognized during fiscal year 2005 also included approximately $16.3 million for other exit costs. Approximately $12.5 million of the amount was classified as a component of cost of sales. Of this amount, customer disengagement costs totaled approximately $5.5 million; facility lease obligations totaled approximately $2.3 million and facility abandonment and refurbishment costs totaled approximately $3.7 million. As of December 31, 2005, accrued facility closure costs related to restructuring charges incurred in fiscal year 2005 were approximately $0.8 million, net of $2.8 million classified as current.


22


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The following table summarizes the provisions, payments, and the accrual balance relating to restructuring costs incurred during fiscal year ended March 31, 2005:
 
                                 
          Long-Lived
             
          Asset
    Other
       
    Severance     Impairment     Exit Costs     Total  
    (In thousands)  
 
Activities during fiscal year 2005:
                               
Provision
  $ 66,332     $ 12,695     $ 16,332     $ 95,359  
Cash payments
    (57,758 )           (6,977 )     (64,735 )
Non-cash charges
          (12,695 )     (6,624 )     (19,319 )
                                 
Balance as of March 31, 2005
  $ 8,574     $     $ 2,731     $ 11,305  
                                 
 
Fiscal Year 2004 and 2003
 
As of December 31, 2005, accrued facility closure costs related to restructuring charges incurred in fiscal year 2004 were approximately $4.5 million, net of $5.8 million classified as current. As of December 31, 2005, accrued facility closure costs related to restructuring charges incurred in fiscal year 2003 and prior were $4.7 million, net of $0.3 million classified as current.
 
For further discussion of the Company’s historical restructuring activities, refer to Note 10, “Restructuring Charges” to the Consolidated Financial Statements in the Company’s Annual Report on Form 10-K for the fiscal year ended March 31, 2005.
 
NOTE J — OTHER CHARGES (INCOME), NET
 
During the three- and nine-month periods ended December 31, 2005, the Company incurred approximately $7.7 million in severance charges related to the retirement of Michael E. Marks from his position as Chief Executive Officer, of which approximately $5.9 million was paid during the quarter, and the remaining amount is due in July 2006. In connection with his retirement and appointment to serve as Chairman of the Company’s Board of Directors beginning January 1, 2006, the Company also accelerated the vesting and continued the exercise period of certain stock options held by Mr. Marks. The modifications to his stock options did not result in any incremental non-cash stock-based compensation expense under APB 25 because the exercise price of the affected options was less than the market price of the underlying shares on the date of the modifications.
 
During the three- and nine-month periods ended December 31, 2004, the Company realized a foreign exchange gain of $29.3 million from the liquidation of certain international entities, offset by a loss of $6.8 million for other than temporary impairment of its investments in certain privately-held companies and $7.6 million of charges relating to the resignation of Robert R.B. Dykes from his position as Chief Financial Officer. In connection with his termination of employment, the Company amended certain of Mr. Dykes’ stock option agreements to fully accelerate the vesting of approximately 1.2 million of Mr. Dykes’ outstanding, and previously unvested stock options, and to extend the expiration date of approximately 1.5 million stock options to five years after his employment termination date. Such options would otherwise have expired ninety days after the termination of employment. This resulted in a non-cash charge of approximately $5.6 million. In addition, the Company made a lump-sum cash payment of approximately $2.0 million to Mr. Dykes.
 
NOTE K — SEGMENT REPORTING
 
The Company operates and internally manages two operating segments that are combined for operating segment disclosures as they do not meet the quantitative thresholds for separate disclosure established in Statement of Financial Accounting Standards No. 131, “Disclosures about Segments of an Enterprise and Related Information” (“SFAS 131”). In August 2005, the Company sold its Network Services division, one of the two previously


23


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

identified segments. During the quarter ended December 31, 2005, the Company commenced a regular evaluation of the performance, and allocation of resources for its Software Services division, and as a result has identified this division as a new operating segment. Operating segments are defined as components of an enterprise for which separate financial information is available and is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company’s chief operating decision maker is the Chief Executive Officer.
 
Geographic information is as follows:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
    (In thousands)     (In thousands)  
 
Net sales:
                               
Asia
  $ 2,607,166     $ 2,200,960     $ 7,097,927     $ 6,386,913  
Americas
    856,524       739,175       2,290,658       1,992,623  
Europe
    759,506       1,546,174       2,691,900       4,558,629  
Intercompany eliminations
    (36,305 )     (209,695 )     (111,832 )     (642,854 )
                                 
    $ 4,186,891     $ 4,276,614     $ 11,968,653     $ 12,295,311  
                                 
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
    (In thousands)     (In thousands)  
 
Income before income taxes:
                               
Asia
  $ 90,902     $ 83,122     $ 286,099     $ 253,689  
Americas
    (57,858 )     1,411       23,525       20,436  
Europe
    24,104       29,094       (21,814 )     234  
Intercompany eliminations
    (21,305 )     (9,369 )     (95,938 )     (48,072 )
                                 
    $ 35,843     $ 104,258     $ 191,872     $ 226,287  
                                 
 
                 
    December 31,
    March 31,
 
    2005     2005  
    (In thousands)  
 
Long-lived assets:
               
Asia
  $ 857,748     $ 806,617  
Americas
    403,008       422,644  
Europe
    340,243       475,255  
                 
    $ 1,600,999     $ 1,704,516  
                 
 
Revenues are attributable to the country in which the product is manufactured.
 
For purposes of the preceding tables, “Asia” includes Bangladesh, China, Japan, India, Indonesia, Korea, Malaysia, Mauritius, Pakistan, Singapore, Taiwan and Thailand; “Americas” includes Argentina, Brazil, Canada, Colombia, Mexico, Venezuela, and the United States; “Europe” includes Austria, the Czech Republic, Denmark, Finland, France, Germany, Hungary, Ireland, Israel, Italy, Netherlands, Norway, Poland, Portugal, Scotland, South Africa, Sweden, Switzerland, Ukraine, and the United Kingdom.


24


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
During the three- and nine-months ended December 31, 2005, net sales generated from Singapore, the principal country of domicile, were approximately $68.2 million and $193.9 million, respectively. During the three- and nine-months ended December 31, 2004, net sales generated from Singapore were approximately $59.1 million and $170.9 million, respectively.
 
NOTE L — COMMITMENTS AND CONTINGENCIES
 
On June 29, 2004, the Company entered into an asset purchase agreement with Nortel providing for Flextronics’s purchase of certain of Nortel’s optical, wireless, wireline and enterprise manufacturing operations and optical design operations. The purchase of these assets will occur in stages, with the first three stages completed in November 2004, February 2005 and August 2005. The final asset transfer is expected to be completed in the June 2006 quarter. Refer to Note M, “Business and AssetAcquisitions and Divestitures” for further discussion.
 
The Company maintains a $1.35 billion amended revolving credit facility consisting of two separate credit agreements, one providing for up to $1.105 billion principal amount of revolving credit loans to the Company and its designated subsidiaries; and one providing for up to $245.0 million principal amount of revolving credit loans to a U.S. subsidiary of the Company. This amended credit facility expires in May 2010. Borrowings under the amended credit facility bear interest, at the Company’s option, either at (i) the base rate (the greater of the agent’s prime rate or the federal funds rate plus 0.50%) plus the applicable margin for base rate loans ranging between 0.0% and 0.125%, based on the Company’s credit ratings; or (ii) LIBOR plus the applicable margin for LIBOR loans ranging between 0.625% and 1.125% based on the Company’s credit ratings. The Company is required to pay a quarterly commitment fee ranging between 0.125% and 0.250% per annum on the unutilized portion of the credit facility and, if the utilized portion of the facility exceeds 33% of the total commitment, a quarterly utilization fee ranging between 0.125% and 0.250% on such utilized portion, in each case based on the Company’s credit ratings. The Company is also required to pay letter of credit usage fees ranging between 0.625% and 1.125% per annum (based on the Company’s credit ratings) on the amount of the daily average outstanding letters of credit, and issuance fees of 0.125% per annum on the daily average undrawn amount of letters of credit. The Company has no borrowings outstanding under this facility as of December 31, 2005.
 
The amended credit facility is unsecured, and contains certain restrictions on the Company’s and its subsidiaries ability to (i) incur certain debt, (ii) make certain investments, (iii) make certain acquisitions of other entities, (iv) incur liens, (v) dispose of assets, (vi) make non-cash distributions to shareholders, and (vii) engage in transactions with affiliates. These covenants are subject to a number of significant exceptions and limitations. The amended credit facility also requires that the Company maintain a maximum ratio of total indebtedness to EBITDA (earnings before interest expense, taxes, depreciation and amortization), and a minimum fixed charge coverage ratio, as defined, during the term of the credit facility. Borrowings under the credit facility are guaranteed by the Company and certain of its subsidiaries.
 
The Company is subject to legal proceedings, claims, and litigation arising in the ordinary course of business. The Company defends itself vigorously against any such claims. Although the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on its consolidated financial position, results of operations, or cash flows.
 
NOTE M — BUSINESS AND ASSET ACQUISITIONS AND DIVESTITURES
 
Business and asset acquisitions
 
On June 29, 2004, the Company entered into an asset purchase agreement with Nortel providing for Flextronics’s purchase of certain of Nortel’s optical, wireless, wireline and enterprise manufacturing operations and optical design operations. The purchase of these assets will occur in stages, with the first three stages completed in November 2004, February 2005 and August 2005. The final asset transfer is expected to be completed in the June 2006 quarter.


25


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 
The Company anticipates that the aggregate cash purchase price for the assets acquired will range from approximately $575 million to $625 million. As of December 31, 2005, the Company has made aggregate payments of $379 million to Nortel. The total purchase price will be allocated to the fair value of the acquired assets, which management currently estimates will be $340 million to $390 million for inventory, $35 million for fixed assets, and the remaining amounts to intangible assets, including goodwill. The Company completed the closing of the optical design businesses in Canada and Northern Ireland on November 1, 2004. On February 8, 2005 and August 22, 2005, the Company completed the closings of the manufacturing operations and related assets (including product integration, testing, repair and logistics operations) in Montreal, Quebec, and Châteaudun, France. The purchases to date have resulted in purchased intangible assets of $26.9 million and goodwill of $187.4 million, based on third-party valuations.
 
In October 2004, the Company acquired approximately 70% of the total outstanding shares of FSS. In September and December 2005, the Company acquired an additional 18% and 6% incremental ownership, respectively, for cash consideration of approximately $106.5 million and $42.9 million, respectively. The incremental investment of approximately $149.4 million reduced other liabilities by approximately $28.5 million primarily related to minority interests net of increases in deferred taxes and other liabilities. The incremental investment also resulted in purchased identifiable intangible assets of $16.7 million and goodwill of $104.2 million, based on third-party valuations.
 
The Company now owns approximately 94% of the total outstanding shares of FSS as of December 31, 2005 and is in the process of delisting FSS from India’s stock exchanges. Trading of FSS shares on the Indian exchanges was discontinued on February 3, 2006 and the company will be officially delisted from the exchanges on February 10, 2006. Once the shares have been delisted, any shareholders whose shares have not been acquired (approximately 2.2 million shares as of December 31, 2005) may offer their shares for sale to the Company at the exit price of Rs. 725 per share (approximately US$16.10 per share) for a period of six months following the date of the delisting.
 
The following table reflects the pro forma consolidated results of operations for the periods presented, as though the acquisitions of Nortel’s operations in Canada, Northern Ireland and France and the acquisition of FSS had occurred as of the beginning of periods presented, after giving effect to certain adjustments and related income tax effects:
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
    (In thousands, except per share amounts)
 
    (Unaudited)  
 
Net sales
  $ 4,186,891     $ 4,668,114     $ 12,212,653     $ 13,301,890  
Net income
  $ 42,504     $ 101,134     $ 100,358     $ 273,123  
Basic earnings per share
  $ 0.07     $ 0.18     $ 0.18     $ 0.50  
Diluted earnings per share
  $ 0.07     $ 0.17     $ 0.17     $ 0.47  
 
During the nine months ended December 31, 2005, the Company completed certain acquisitions that were not individually significant to the Company’s results of operations and financial position. The aggregate cash purchase price for these acquisitions totaled approximately $142.2 million, net of cash acquired. Goodwill and intangibles resulting from these acquisitions during the nine months ended December 31, 2005, as well as from contingent purchase price adjustments for certain historical acquisitions, totaled approximately $193.4 million. The purchase price for these acquisitions has been allocated on the basis of the estimated fair value of assets acquired and liabilities assumed. The Company has not finalized the allocation of the consideration for certain of its recently completed acquisitions pending the completion of third-party valuations. The purchase price for certain of these acquisitions is subject to adjustments for contingent consideration, based upon the businesses achieving specified


26


Table of Contents

 
FLEXTRONICS INTERNATIONAL LTD.
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

levels of earnings through December 31, 2010. The contingent consideration has not been recorded as part of the purchase price, pending the outcome of the contingency.
 
During the nine months ended December 31, 2005, the Company paid approximately $61.7 million in cash, and issued 2.2 million ordinary shares, for contingent purchase price adjustments relating to certain historical acquisitions.
 
Divestitures
 
During the September 2005 fiscal quarter, the Company merged its Flextronics Network Services (FNS) division with Telavie AS, a company wholly-owned by Altor, a private equity firm focusing on investments in the Nordic region. The Company received an upfront cash payment and also retained a 35% ownership in the merged company, Relacom Holding AB (“Relacom”). The Company is entitled to future immaterial contingent and deferred purchase price payments and is committed to certain future immaterial investments in Relacom. The Company accounts for its investment in the common stock of Relacom using the equity method of accounting. The associated equity in the net income of Relacom has not been material to the Company’s results of operations for the three- and nine-months ended December 31, 2005, and was classified as a component of interest and other expense, net, in the condensed consolidated statements of operations. The initial carrying value of the equity investments was $116.8 million based on a third party valuation adjusted for the Company’s economic interest in the gain on divestiture. The excess of the carrying value of the investment and the underlying equity in net assets is attributable to goodwill and intangible assets.
 
During the September 2005 fiscal quarter, the Company sold its semiconductor division to AMIS Holdings, Inc. (AMIS), the parent company of AMI Semiconductor, Inc.
 
As a result of these two transactions, the Company received aggregate cash payments of approximately $518.5 million and other consideration valued at $38.3 million. The aggregate net assets sold in the divestitures were approximately $573.0 million. The Company recognized an aggregate pretax gain of $67.6 million during the nine months ended December 31, 2005, net of approximately $3.0 million in expense for accelerated deferred compensation and various post closing purchase price adjustments. The divestitures of semiconductor and network services divisions resulted in a tax expense of $98.9 million during the nine months ended December 31, 2005 associated with the gain on the sale, and differences between the recorded book and tax basis of the entities sold as well as the recognition of a valuation allowance relating to the remaining deferred tax assets. There was no revenue related to the divested businesses for the three month period ended December 31, 2005. Revenue related to the divested businesses was $228.4 million for the three month period ended December 31, 2004. Revenue related to the divested businesses for the nine month periods ended December 31, 2005 and 2004 was approximately $317.0 million and $610.1 million, respectively.


27


Table of Contents

 
ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Unless otherwise specifically stated, references in this report to “Flextronics,” “the Company,” “we,” “us,” “our” and similar terms mean Flextronics International Ltd. and its subsidiaries.
 
This report on Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. The words “expects,” “anticipates,” “believes,” “intends,” “plans” and similar expressions identify forward-looking statements. In addition, any statements which refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. We undertake no obligation to publicly disclose any revisions to these forward-looking statements to reflect events or circumstances occurring subsequent to filing this Form 10-Q with the Securities and Exchange Commission (“the SEC”). These forward-looking statements are subject to risks and uncertainties, including, without limitation, those discussed below and in “Risk Factors.” Accordingly, our future results may differ materially from historical results or from those discussed or implied by these forward-looking statements.
 
OVERVIEW
 
We are a leading provider of advanced electronics manufacturing services (EMS) to original equipment manufacturers (OEMs) of a broad range of products in the following industries: handheld devices; computer and office automation; communications infrastructure; information technology infrastructure; consumer devices; and a variety of other industries, including the industrial, automotive and medical industries. We provide a full range of vertically-integrated global supply chain services through which we design, build, and ship a complete packaged product for our OEM customers. Customers leverage our services to meet their product requirements throughout the entire product life cycle. Our vertically-integrated service offerings include: design services; printed circuit board and flexible circuit fabrication; systems assembly and manufacturing; logistics; after-market services, multiple component product offerings, and software services.
 
We are one of the world’s largest EMS providers, with revenues of $15.9 billion in fiscal year 2005. As of December 31, 2005, our total manufacturing capacity was approximately 12.8 million square feet in over 30 countries across four continents. We have established an extensive network of manufacturing facilities in the world’s major electronics markets (the Americas, Europe, and Asia) in order to serve the growing outsourcing needs of both multinational and regional OEMs. For the nine-month period ended December 31, 2005, our net sales in the Americas, Europe, and Asia represented 22%, 22% and 56% of our total net sales, respectively.
 
We believe that the combination of our extensive design and engineering services, global presence, vertically-integrated end-to-end services, advanced supply chain management and operational track record provide us with a competitive advantage in the market for designing and manufacturing electronic products for leading multinational OEMs. Through these services and facilities, we simplify the global product development process and provide meaningful time and cost savings for our OEM customers.
 
We have actively pursued acquisitions and purchases of manufacturing facilities, design and engineering resources and technologies in order to expand our worldwide operations, broaden our service offerings, diversify and strengthen our customer relationships, and enhance our competitive position as a leading provider of comprehensive outsourcing solutions. We have completed numerous strategic transactions with OEM customers over the past several years, including Nortel, Xerox, Casio and Ericsson. These strategic transactions have expanded our customer base, provided end-market diversification, and contributed to a significant portion of our revenue growth. Under these arrangements, we generally acquire inventory, equipment and other assets from the OEM and lease or acquire their manufacturing facilities while simultaneously entering into multi-year supply agreements for the production of their products. We will continue to selectively pursue strategic opportunities that we believe will further our business objectives and enhance shareholder value.
 
On June 29, 2004, we entered into an asset purchase agreement with Nortel providing for our purchase of certain of Nortel’s optical, wireless, wireline and enterprise manufacturing operations and optical design operations. The purchase of these assets will occur in stages, with the first three stages completed in November 2004,


28


Table of Contents

February 2005 and August 2005. The final asset transfer is expected to be completed in the June 2006 quarter. We anticipate that the aggregate cash purchase price for the assets acquired will be in the range of approximately $575 million to $625 million. As of December 31, 2005, we have made aggregate payments of $379 million to Nortel. The total purchase price will be allocated to the fair value of the acquired assets, which management currently estimates will be $340 million to $390 million for inventory, $35 million for fixed assets, and the remaining amounts to intangible assets, including goodwill. We completed the closing of the optical design businesses in Canada and Northern Ireland on November 1, 2004. On February 8, 2005 and August 22, 2005, we also completed the closing of the manufacturing operations and related assets (including product integration, testing, repair and logistics operations) in Montreal, Quebec, and Châteaudun, France, respectively. We intend to use our existing cash balances, together with anticipated cash flows from operations to fund the remaining purchase price for the assets yet to be acquired.
 
Subject to closing the remaining asset acquisitions, we will provide the majority of Nortel’s systems integration activities, final assembly, testing and repair operations, along with the management of the related supply chain and suppliers, under a four-year manufacturing agreement. Additionally, under a three-year design services agreement, we will provide Nortel with design services for end-to-end, carrier grade optical network products.
 
Although we expect that our gross margin and operating margin on sales to Nortel will initially be less than that generally realized by us in fiscal year 2005, we also expect that we will be able to increase margins over time through cost reductions and by internally sourcing our vertically integrated supply chain solutions, which include the fabrication and assembly of printed circuit boards and enclosures, as well as logistics and repair services. Additionally, the impact of lower gross margins may be partially offset by the effect of anticipated lower selling, general and administrative expenses, as a percentage of net sales. There can be no assurance that we will realize lower expenses or increased operating efficiencies as anticipated.
 
The completion of the Nortel transaction is subject to a number of closing conditions, including regulatory approvals and conversion of information technology systems. As with other strategic transactions, we believe the completion of this transaction may have significant impacts on our sales, end-market diversification, margins, results from operations, financial position and working capital.
 
The EMS industry has experienced rapid change and growth over the past decade. The demand for advanced manufacturing capabilities and related supply chain management services has escalated, as an increasing number of OEMs outsourced some or all of their design and manufacturing requirements. Price pressure on our customers’ products in their end markets has led to increased demand for EMS production capacity in the lower cost regions of the world, such as China, Mexico, and Eastern Europe, where we have a significant presence. We have responded by making strategic decisions to realign our global capacity and infrastructure with the demand of our OEM customers so as to optimize the operating efficiencies that can be provided by our global presence. The overall impact of these activities is that we have shifted our manufacturing capacity to locations with higher efficiencies and in some instances, lower costs, thereby enhancing our ability to provide cost-effective manufacturing service in order for us to retain and expand our existing relationships with customers and attract new business. As a result, we have recognized $95.4 million, $540.3 million and $297.0 million of restructuring charges in fiscal years 2005, 2004 and 2003, respectively, in connection with the realignment of our global capacity and infrastructure. During the nine months ended December 31, 2005 we recognized $151.6 million of restructuring charges. Additionally, we expect to recognize restructuring charges in the range of approximately $10 million to $30 million during the remainder of fiscal year 2006 and we may be required to take additional charges in the future as a result of these activities.
 
Our revenue is generated from sales of our services to our customers, which include industry leaders such as Casio Computer Co., Ltd., Dell Computer Corporation, Ericsson Telecom AB, Hewlett-Packard Company, Kyocera Wireless Corporation, Microsoft Corporation, Motorola, Inc., Nortel Networks Limited, Sony-Ericsson, and Xerox Corporation. We currently depend, and expect to continue to depend, upon a small number of customers for a significant portion of our revenues. For the nine months ended December 31, 2005, our ten largest customers accounted for approximately 62% of net sales. Sony Ericsson and Hewlett-Packard each accounted for more than 10% of our net sales. For any particular customer, we may be engaged in programs to design or manufacture a


29


Table of Contents

number of products, or may be designing or manufacturing a single product or product line. In addition, our revenue is generated from a variety of industries. For the nine months ended December 31, 2005, we derived:
 
  •  approximately 27% of our revenues from customers in the handheld devices industry, whose products include cellular phones, pagers and personal digital assistants;
 
  •  approximately 25% of our revenues from customers in the computers and office automation industry, whose products include copiers, scanners, graphic cards, desktop and notebook computers, and peripheral devices such as printers and projectors;
 
  •  approximately 22% of our revenues from providers of communications infrastructure, whose products include equipment for optical networks, cellular base stations, radio frequency devices, telephone exchange and access switches, and broadband devices;
 
  •  approximately 9% of our revenues from the consumer devices industry, whose products include set-top boxes, home entertainment equipment, cameras and home appliances;
 
  •  approximately 6% of our revenues from providers of information technologies infrastructure, whose products include servers, workstations, storage systems, mainframes, hubs and routers; and
 
  •  approximately 11% of our revenues from customers in a variety of other industries, including the medical, automotive, industrial and instrumentation industries.
 
Our operating results are affected by a number of factors, including the following:
 
  •  our customers may not be successful in marketing their products, their products may not gain widespread commercial acceptance, and our customers’ products have short product life cycles;
 
  •  our customers may cancel or delay orders or change production quantities;
 
  •  our operating results vary significantly from period to period due to the mix of the manufacturing services we are providing, the number and size of new manufacturing programs, the degree to which we utilize our manufacturing capacity, seasonal demand, shortages of components and other factors;
 
  •  our increased design services and component offerings may reduce our profitability as we are required to make substantial investments in the resources necessary to design and develop these products without guarantee of cost recovery and margin generation;
 
  •  our ability to achieve commercially viable production yields and to manufacture components in commercial quantities to the performance specifications demanded by our OEM customers;
 
  •  integration of acquired businesses and facilities; and
 
  •  managing growth and changes in our operations.
 
We also are subject to other risks, including risks associated with operating in foreign countries, changes in our tax rates, and fluctuations in currency exchange rates. Please see “Risk Factors.”
 
We continuously evaluate the strategic and financial contributions of each of our operations and focus our primary growth objectives on our core EMS vertically-integrated business activities. We also assess opportunities to maximize shareholder value with respect to our non-core activities through divestitures, initial public offerings, spin-offs and other strategic transactions.
 
Consistent with this strategy, during the September 2005 fiscal quarter we merged our Flextronics Network Services division with Telavie AS, a company wholly-owned by Altor, a private equity firm focusing on investments in the Nordic region. The Company received an upfront cash payment and also retained a 35% ownership in the merged company, Relacom Holding AB (“Relacom”). The Company is entitled to future immaterial contingent and deferred purchase price payments and is committed to certain future immaterial investments in Relacom. During the September 2005 fiscal quarter, we sold our semiconductor division to AMIS Holdings, Inc. (AMIS), the parent company of AMI Semiconductor, Inc. As a result of these two transactions, we received aggregate cash payments of approximately $518.5 million and other consideration valued at $38.3 million. Aggregate net assets sold on the


30


Table of Contents

divestitures were approximately $573.0 million. We recognized an aggregate pretax gain of $67.6 million during the nine months ended December 31, 2005, net of approximately $3.0 million in expense for accelerated deferred compensation and various post closing purchase price adjustments. The divestitures of semiconductor and network services divisions resulted in a tax expense of $98.9 million during the nine months ended December 31, 2005 associated with the gain on the sale, and differences between the recorded book and tax basis of the entities sold as well as the recognition of a valuation allowance relating to the remaining deferred tax assets. There was no revenue related to the divested businesses for the three month period ended December 31, 2005. Revenue related to the divested businesses was $228.4 million for the three month period ended December 31, 2004. Revenue related to the divested businesses for the nine month periods ended December 31, 2005 and 2004 was approximately $317.0 million and $610.1 million, respectively.
 
In September and December 2005, we acquired an additional 18% and 6% incremental ownership in FSS, respectively, for cash consideration of approximately $106.5 million and $42.9 million, respectively. We own approximately 94% of the total outstanding shares of FSS as of December 31, 2005 and are in the process of delisting FSS from India’s National Stock Exchange. Trading of FSS shares on the Indian exchanges was discontinued on February 3, 2006 and the company will be officially delisted from the exchanges on February 10, 2006. Once the shares have been delisted, any shareholders whose shares have not been acquired by Flextronics (approximately 2.2 million shares as of December 31, 2005) may offer their shares for sale to Flextronics at the exit price of Rs. 725 per share (approximately US$16.10 per share) for a period of six months following the date of the delisting.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements. For further discussion of our significant accounting policies, refer to Note 2, “Summary of Accounting Policies,” of the Notes to Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended March 31, 2005. See also the Notes to Condensed Consolidated Financial Statements in this report on Form 10-Q.
 
Long-Lived Assets
 
We review property and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An impairment loss is recognized when the carrying amount of a long-lived asset exceeds its fair value. Recoverability of property and equipment is measured by comparing its carrying amount to the projected discounted cash flows the property and equipment are expected to generate. If such assets are considered to be impaired, the impairment loss recognized, if any, is the amount by which the carrying amount of the property and equipment exceeds its fair value.
 
We evaluate goodwill and other intangibles for impairment on an annual basis and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable from its estimated future cash flows. Recoverability of goodwill is measured at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit. If the carrying amount of the reporting unit exceeds its fair value, the amount of impairment loss recognized, if any, is measured using a discounted cash flow analysis. If, at the time of our annual evaluation, the net asset value (or “book value”) of any reporting unit is greater than its fair value, some or all of the related goodwill would likely be considered impaired. To date, we have not recognized any impairment of our goodwill and other intangible assets in connection with our impairment evaluations. However, we have recorded impairment charges in connection with our restructuring activities.
 
Allowance for Doubtful Accounts
 
We perform ongoing credit evaluations of our customers’ financial condition and make provisions for doubtful accounts based on the outcome of these credit evaluations. We evaluate the collectibility of our accounts receivable based on specific customer circumstances, current economic trends, historical experience with collections and the age of past due receivables. Unanticipated changes in the liquidity or financial position of our customers may require additional provisions for doubtful accounts.


31


Table of Contents

On October 8, 2005, Delphi Corporation (“Delphi”), a customer of the Company, filed for Chapter 11 bankruptcy, which resulted in the Company providing a bad debt provision of $15.0 million as a charge to selling, general and administrative expenses during the three months ended September 30, 2005. The Company reversed this $15.0 million bad debt reserve as a credit to selling, general and administrative expenses during the three months ended December 31, 2005, as the related accounts receivable were substantially collected.
 
Inventory Valuation
 
Our inventories are stated at the lower of cost (on a first-in, first-out basis) or market value. Our industry is characterized by rapid technological change, short-term customer commitments and rapid changes in demand. We make provisions for estimated excess and obsolete inventory based on regular reviews of inventory quantities on hand, and the latest forecasts of product demand and production requirements from our customers. If actual market conditions or our customers’ product demands are less favorable than those projected, additional provisions may be required. In addition, unanticipated changes in liquidity or the financial position of our customers and/or changes in economic conditions may require additional provisions for inventories due to our customers’ inability to fulfill their contractual obligations with regard to inventory being held on their behalf.
 
Restructuring Charges
 
We recognized restructuring charges during the first nine months of fiscal year 2006, and in each of fiscal years 2005 and 2004, related to our plans to close or consolidate duplicate manufacturing and administrative facilities. In connection with these activities, we recorded restructuring charges for employee termination costs, long-lived asset impairment and other restructuring-related costs.
 
The recognition of the restructuring charges required that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with the planned exit activity. To the extent our actual results in exiting these facilities differ from our estimates and assumptions, we may be required to revise the estimates of future liabilities, requiring the recognition of additional restructuring charges or the reduction of liabilities already recognized. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with developed exit plans.
 
Refer to Note I, “Restructuring Charges,” of the Notes to Condensed Consolidated Financial Statements for further discussion of our restructuring activities.
 
Deferred Income Taxes
 
Our deferred income tax assets represent temporary differences between the carrying amount and the tax basis of existing assets and liabilities which will result in deductible amounts in future years, including net operating loss carryforwards. Based on estimates, the carrying value of our net deferred tax assets assumes that it is more likely than not that we will be able to generate sufficient future taxable income in certain tax jurisdictions to realize these deferred income tax assets. Our judgments regarding future profitability may change due to future market conditions, changes in U.S. or international tax laws and other factors. If these estimates and related assumptions change in the future, we may be required to increase or decrease our valuation allowance against the deferred tax assets resulting in additional or lesser income tax expense.
 
Recent Accounting Pronouncements
 
In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections”. SFAS 154 is a replacement of Accounting Principles Board Opinion No. 20 (“APB 20”) and FASB Statement No. 3. SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the latest practicable date, as the required method for reporting a change in accounting principle and the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December  15, 2005 and is required to be adopted by us in the first quarter of fiscal year 2007. We do not expect the adoption of SFAS 154 will have a material impact on our consolidated results of operations, financial condition and cash flows.


32


Table of Contents

In March 2005, the FASB issued No. 47, “Accounting for Conditional Asset Retirement Obligations” (“FIN 47”) as an interpretation of FASB Statement No. 143, “Accounting for Asset Retirement Obligations” (“SFAS 143”). This interpretation clarifies that the term conditional asset retirement obligation as used in SFAS 143, refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. The obligation to perform the asset retirement activity is unconditional even though uncertainty exists about the timing and/or method of settlement. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. This interpretation also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is effective no later than the end of fiscal years ending after December 15, 2005. We are currently assessing the impact of the adoption of FIN 47.
 
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (Revised 2004), “Share Based Payment” (“SFAS 123(R)”) which (i) revises SFAS 123 to eliminate the disclosure only provisions of that statement and the alternative to follow the intrinsic value method of accounting under APB 25 and related interpretations, and (ii) requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments, including grants of employee stock options, based on the grant-date fair value of the award and recognize that cost in its results of operations over the period during which an employee is required to provide the requisite service in exchange for that award. We are required to adopt this statement beginning April 1, 2006. Companies may elect to apply this statement either prospectively, or on a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required for those periods under SFAS 123. We have elected to apply the provisions of this statement prospectively, and will continue using the Black-Scholes option valuation model to estimate the fair value of our stock-based awards, and will also continue recognizing the related expense under the straight-line attribution method. The actual expense we will recognize upon our adoption of SFAS 123(R) will be dependent on numerous factors including, but not limited to, the selection of assumptions used to fair value stock-based awards granted subsequent to April  1, 2006, policy decisions regarding accounting for the tax effects of share-based awards, and assumed award forfeiture rates. Unamortized compensation is estimated to be approximately $34.0 million on April 1, 2006 based on currently outstanding unvested options to purchase our ordinary shares, of which approximately $16.0 million is expected to be recognized during the 2007 fiscal year.
 
In October 2005, the FASB issued FASB Staff Position FAS 123(R)-2, “Practical Accommodation to the Application of Grant Date as Defined in FAS 123(R)” (“FSP 123(R)-2”). FSP 123(R)-2 provides guidance on the application of grant date as defined in SFAS No. 123(R). In accordance with this standard a grant date of an award exists if (a) the award is a unilateral grant and b) the key terms and conditions of the award are expected to be communicated to an individual recipient within a relatively short time period from the date of approval. We will adopt this standard when we adopt SFAS No. 123(R), and do not anticipate that the implementation of this statement will have a significant impact on our results of operations.
 
In November 2005, the FASB issued FASB Staff Position FAS 123(R)-3, “Transition Election Related to Accounting for the Tax Effects of Share-Based Payment Awards” (“FSP 123(R)-3”). FSP 123(R)-3 provides an elective alternative method that establishes a computational component to arrive at the beginning balance of the accumulated paid-in capital pool related to employee compensation and a simplified method to determine the subsequent impact on the accumulated paid-in capital pool of employee awards that are fully vested and outstanding upon the adoption of SFAS No. 123(R). We are currently evaluating this transition method.


33


Table of Contents

RESULTS OF OPERATIONS
 
The following table sets forth, for the periods indicated, certain statements of operations data expressed as a percentage of net sales. The financial information and the discussion below should be read in conjunction with the condensed consolidated financial statements and notes thereto included in this document. In addition, reference should be made to our audited Consolidated Financial Statements and notes thereto and related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended March 31, 2005.
 
                                 
    Three Months Ended
    Nine Months Ended
 
    December 31,     December 31,  
    2005     2004     2005     2004  
 
Net sales
    100.0 %     100.0 %     100.0 %     100.0 %
Cost of sales
    93.8       93.0       93.3       93.3  
Restructuring charges
    1.5       0.6       1.1       0.6  
                                 
Gross profit
    4.7       6.4       5.6       6.1  
Selling, general and administrative expenses
    2.6       3.4       3.4       3.4  
Intangible amortization
    0.3       0.2       0.3       0.2  
Restructuring charges
    0.1       0.1       0.2       0.2  
Other charges (income), net
    0.2       (0.3 )     0.1       (0.1 )
Interest and other expense, net
    0.5       0.6       0.6       0.6  
Loss (gain) on divestiture of operations
    0.1       0.0       (0.6 )     0.0  
                                 
Income before income taxes
    0.9 %     2.4 %     1.6 %     1.8 %
Provision for (benefit from) income taxes
    (0.1 )     0.1       0.8       (0.3 )
                                 
Net income
    1.0 %     2.3 %     0.8 %     2.1 %
                                 
 
Net Sales
 
Net sales for the third quarter of fiscal year 2006 totaled $4.2 billion, representing a decrease of $89.7 million from the third quarter of fiscal year 2005, primarily due to the divestitures of the semiconductor and network services divisions in September 2005, which generated revenues of $228 million in the third quarter of fiscal year 2005. Net sales for the third quarter of fiscal year 2006 declined by $674.5 million in Europe, offset by an increase of $433.3 million and $151.5 million in Asia and the Americas, respectively. The decrease in net sales was primarily attributable to (i) a decrease of $113.3 million to the customers in the industrial, medical and automotive industries as a result of the divestiture of our semiconductor division, (ii) a decrease of $100.2 million to customers in the handheld device industry primarily due to two handset customers divesting their handset businesses to Asian suppliers, offset by new program wins from various customers, and (iii) a decrease of $31.6 million to providers of IT infrastructure products. The decrease in net sales was offset by an increase of $154.4 million to providers of communications infrastructure products, which was primarily the result of our Nortel transaction offset by the reduced business resulting from the divestiture during the September 2005 fiscal quarter of our network services business.
 
Net sales for the nine months ended December 31, 2005 totaled $12.0 billion, representing a decrease of $326.7 million from the same period in fiscal year 2005, primarily due to the divestitures of the semiconductor and network services divisions in the September 2005 fiscal quarter, which accounted for $293.1 million of the decrease. Net sales for the first nine months of fiscal year 2006 declined by $1,659 million in Europe, offset by an increase of $666.5 million and $666.1 million in Asia and the Americas, respectively. The decrease in net sales was mainly attributable to (i) a decrease of $870.7 million to customers in the handheld device industry, which is primarily attributable to two customers divesting their handset businesses to Asian suppliers, offset by new program wins from various customers, (ii) a decrease of $94.6 million to customers in the consumer industry, and (iii) a decrease of $23.4 million to the customers in the industrial, medical and automotive industries as a result of the


34


Table of Contents

divestiture of our semiconductor division. The decrease in net sales was offset by an increase of $665.3 million to providers of communications infrastructure products, which is primarily the result of our Nortel transaction.
 
Our ten largest customers during the three-month periods ended December 31, 2005 and 2004 accounted for approximately 64% and 63% of net sales, respectively. Sony-Ericsson and Hewlett Packard each accounted for more than 10% of our net sales during the three-month periods ended December 31, 2005. Sony-Ericsson is the only customer that accounted for more than 10% of our net sales during the three-month period ended December 31, 2004. Our ten largest customers during the nine-month periods ended December 31, 2005 and 2004 accounted for approximately 62% and 63% of net sales, respectively, with Sony-Ericsson and Hewlett Packard each accounting for more than 10% of our net sales.
 
Gross Margin
 
Our gross profit is affected by a number of factors, including the number and size of new manufacturing programs, product mix, component costs and availability, product life cycles, unit volumes, pricing, competition, new product introductions, capacity utilization and the expansion and consolidation of manufacturing facilities. Typically, a new program will contribute relatively less to our gross margin in its early stages, as manufacturing volumes are low and result in inefficiencies and unabsorbed manufacturing overhead costs. As volumes increase, the contribution to gross margin often increases due to our ability to leverage improved utilization rates and overhead absorption. In addition, different programs can contribute different gross margins depending on factors such as the types of services involved, location of production, size of the program, complexity of the product, and level of material costs associated with the associated products. As a result, our gross margin varies from period to period.
 
Gross profit in the third quarter of fiscal year 2006 decreased $79.4 million to $196.3 million, or 4.7% of net sales, from $275.7 million, or 6.4% of net sales, in the third quarter of fiscal year 2005. The 170 basis point decrease in gross margin was mainly attributable to a 90 basis point increase in restructuring charges. An additional 80 basis points of the decrease in the gross margin was attributable to the divestitures of our higher margin semiconductor and network services divisions during the September 2005 fiscal quarter, significant investments we made in the development of our component and ODM capabilities, facility expansions and personnel requirements, and the start up and integration costs incurred associated with our new programs in fiscal year 2006. Restructuring charges relate to the consolidation and closure of various facilities and are described in more detail below in the section entitled, “Restructuring Charges.”
 
Gross profit in the first nine months of fiscal year 2006 decreased $75.1 million to $671.7 million, or 5.6% of net sales, from $746.8 million, or 6.1% of net sales, in the first nine months of fiscal year 2005. The 50 basis point decrease in gross margin was mainly attributable to an increase in restructuring charges. Restructuring charges relate to the consolidation and closure of various facilities and are described in more detail below in the section entitled, “Restructuring Charges.”
 
Restructuring Charges
 
In recent years, we have initiated a series of restructuring activities, which are intended to realign our global capacity and infrastructure with demand by our OEM customers and thereby improve our operational efficiency, include:
 
  •  reducing excess workforce and capacity;
 
  •  consolidating and relocating certain manufacturing facilities to lower-cost regions; and
 
  •  consolidating and relocating certain administrative facilities.
 
The restructuring costs include employee severance, costs related to leased facilities, owned facilities that are no longer in use and are to be disposed of, leased equipment that is no longer in use and will be disposed of, and other costs associated with the exit of certain contractual agreements due to facility closures. The overall impact of these activities is that we have shifted our manufacturing capacity to locations with higher efficiencies and, in some instances, lower costs, and are better utilizing our overall existing manufacturing capacity. This has enhanced our


35


Table of Contents

ability to provide cost-effective manufacturing service offerings, which enables us to retain and expand our existing relationships with customers and attract new business. Although we believe we are realizing our anticipated benefits from these efforts, we continue to monitor our operational efficiency and capacity requirements and will utilize similar measures in the future to realign our operations relative to future customer demand. We expect to recognize restructuring charges in the range of approximately $10 million to $30 million during the remainder of fiscal year 2006 and we may be required to take additional charges in the future as a result of these activities, which could have a material adverse impact on our operating results, financial position and cash flows. We cannot predict the timing or amount of any future restructuring charges.
 
During the third quarter of fiscal year 2006 and 2005, we recognized restructuring charges of approximately $68.6 million and $30.7 million, respectively. Restructuring charges recorded by reportable geographic region totaled $3.2 million for Asia, $14.6 million for Americas, and $50.7 million for Europe in the third quarter of fiscal year 2006, and $0.2 million for Americas and $30.5 million for Europe in the third quarter of fiscal year 2005. The involuntary employee terminations identified by reportable geographic region amounted to approximately 78, 557, and 967 for Asia, Americas, and Europe, respectively, in the third quarter of fiscal year 2006. The involuntary employee terminations identified by reportable geographic region were approximately 241, 270 and 2,030 for Asia, Americas, and Europe, respectively, in the third quarter of fiscal year 2005. Approximately $63.1 million and $24.1 million of the restructuring charges were classified as a component of cost of sales in the third quarter of fiscal year 2006 and 2005, respectively.
 
During the first nine months of fiscal year 2006 and 2005, we recognized restructuring charges of approximately $151.6 million and $87.7 million, respectively. Restructuring charges recorded by reportable geographic region amounted to $3.2 million for Asia, $42.0 for Americas, and $106.4 million for Europe in the third quarter of fiscal year 2006, and $4.4 million for Americas, $2.4 million for Asia and $81.0 million for Europe in the third quarter of fiscal year 2005. The involuntary employee terminations identified by reportable geographic region amounted to approximately 78, 1,010 and 3,224 for Asia, Americas, and Europe, respectively, in the first nine months of fiscal year 2006. The involuntary employee terminations identified by reportable geographic region were approximately 270, 241, and 2,030 for the Americas, Asia, and Europe, respectively, in the first nine months of fiscal year 2005. Approximately $129.2 million and $70.8 million of the restructuring charges were classified as a component of cost of sales in the first nine months of fiscal year 2006 and 2005, respectively.
 
We believe that the potential savings in cost of goods sold achieved through lower depreciation and reduced employee expenses as a result of our restructurings will be offset in part by reduced revenues at the affected facilities. In addition, we may incur further restructuring charges in the future as we continue to reconfigure our operations in order to address excess capacity concerns, which may materially affect our results of operations in future periods.
 
Refer to Note I, “Restructuring Charges,” of the Notes to Condensed Consolidated Financial Statements in Item 1, “Financial Information” for further discussion of our restructuring activities.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses, or SG&A, in the third quarter of fiscal year 2006 amounted to $109.8 million, or 2.6% of net sales, compared to $143.3 million, or 3.4% of net sales, in the third quarter of fiscal year 2005. SG&A amounted to $404.6 million, or 3.4% of net sales, in the first nine months of fiscal year 2006, compared to $423.9 million, or 3.4% of net sales, in the first nine months of fiscal year 2005. The decrease in SG&A in the third quarter of fiscal year 2006 was primarily attributable to the divestitures of the semiconductor and network services divisions in the September 2005 fiscal quarter, and the reversal of a $15.0 million bad debt provision previously recorded in the second quarter of fiscal year 2006 associated with accounts receivable from Delphi, which were substantially collected. The decrease in SG&A in the nine month period was primarily attributable to the divestitures of the semiconductor and network services divisions in the September 2005 fiscal quarter.


36


Table of Contents

Intangible Amortization
 
Amortization of intangible assets in the third quarter of fiscal year 2006 increased to $11.7 million from $9.2 million in the third quarter of fiscal year 2005. Amortization of intangible assets in the first nine months of fiscal year 2006 increased to $40.9 million from $26.5 million in the first nine months of fiscal year 2005. The increase is due to the amortization expense associated with intangible assets acquired through various business acquisitions during the fourth quarter of fiscal year 2005 and first nine months of fiscal year 2006.
 
Other Charges (Income), Net
 
During the three- and nine-month periods ended December 31, 2005, we recognized $7.7 million of charges related to the retirement of Michael E. Marks from his position as Chief Executive Officer, of which approximately $5.9 million was paid during the quarter, and the remaining amount is due in July 2006. In connection with his retirement and appointment to serve as Chairman of our Board of Directors beginning January 1, 2006, we also accelerated the vesting and continued the exercise period of certain stock options held by Mr. Marks. The modifications to his stock options did not result in any incremental non-cash stock-based compensation expense under APB 25 because the exercise price of the affected options was less than the market price of the underlying shares on the date of the modifications.
 
During the three- and nine-month periods ended December 31, 2004, we realized a foreign exchange gain of $29.3 million from the liquidation of certain international entities, offset by a loss of $6.8 million for other than temporary impairment of our investments in certain privately-held companies and $7.6 million of charges related to the resignation of Robert R.B. Dykes from his position as Chief Financial Officer. We amended certain of Mr. Dykes’ stock option agreements to fully accelerate the vesting of approximately 1.2 million of Mr. Dykes’ outstanding and previously unvested stock options, and extended the expiration date of approximately 1.5 million of stock options to five years after his employment termination date. Such options would otherwise have expired ninety days after the termination of employment. These amendments resulted in a non-cash charge of approximately $5.6 million. In addition, we made a lump-sum cash payment of approximately $2.0 million to Mr. Dykes.
 
Interest and Other Expense, Net
 
Interest and other expense, net was $22.7 million and $71.7 million for the three- and nine-month periods ended December 31, 2005, respectively, compared to $27.2 million and $68.0 million for the three and nine month periods ended December 31, 2004, respectively. The decrease in interest and other expense, net for the three month period ended December 31, 2005 primarily resulted from a decrease in interest expense principally related to lower sales of our receivables under our trade receivable securitization program and a reduction in other debt balances.
 
Provision for (Benefit from) Income Taxes
 
Certain of our subsidiaries have, at various times, been granted tax relief in their respective countries, resulting in lower income taxes than would otherwise be the case under ordinary tax rates.
 
Our consolidated effective tax rate was a 17.1% benefit and a 5.3% expense for the three months ended December 31, 2005 and 2004, respectively, and a 48.8% expense and a 17.4% benefit for the nine-month periods ended December 31, 2005 and 2004, respectively. The tax benefit for the quarter ended December 31, 2005 includes a $12.2 million benefit resulting from a reduction in previously recorded valuation allowances off-setting deferred tax assets based upon management’s current analysis of the realizability of such amounts. The tax expense for the nine-month period ended December 31, 2005 includes $98.9 million of tax expense associated with the gain on the sale, and differences between recorded book and tax basis of the entities sold, as well as the recording of valuation allowance relating to the remaining deferred tax assets in connection with the divestitures of our semiconductor and network services divisions. The tax expense for the nine-month period ended December 31, 2005 was partially offset by the $12.2 million reduction in our previously recorded valuation allowance discussed above, and a one-time tax benefit of $3.2 million in the first quarter of 2005 as a result of renewing our Malaysian pioneer tax status for the next 15 years. The tax benefit for the nine-month period ended December 31, 2004 was primarily due to the establishment of a $25.0 million deferred tax asset in the first quarter of 2004 resulting from a change in tax law in Hungary which replaced a tax holiday incentive with a tax credit incentive, and a $34.1 million tax benefit recorded


37


Table of Contents

in the second quarter of 2004 as a result of a reduction in previously recorded valuation allowances off-setting deferred tax assets.
 
The consolidated effective tax rate for a particular period varies depending on the amount of earnings from different jurisdictions, operating loss carryforwards, income tax credits, changes in previously established valuation allowances for deferred tax assets based upon management’s current analysis of the realizability of these deferred tax assets, as well as certain tax holidays and incentives granted to our subsidiaries primarily in China, Hungary, India and Malaysia.
 
In evaluating the realizability of the deferred tax assets, management considers the recent history of operating income and losses by jurisdiction, exclusive of items that it believes are non-recurring in nature such as restructuring charges and losses associated with early extinguishment of debt. Management also considers the future projected operating income in the relevant jurisdiction and the effect of any tax planning strategies. Based on this analysis, management believes that the current valuation allowance is adequate.
 
LIQUIDITY AND CAPITAL RESOURCES
 
At December 31, 2005 we had cash and cash equivalents of $1.1 billion and bank and other debts of $1.5 billion. We also had a $1.35 billion revolving credit facility, under which we had no borrowings outstanding as of December 31, 2005. The credit facility is subject to compliance with certain financial covenants and expires in May 2010. As of December 31, 2005, we were in compliance with the covenants under our indentures and credit facility.
 
Cash provided by operating activities was $647.0 million and $788.3 million during the nine months ended December 31, 2005 and 2004, respectively. During the nine months ended December 31, 2005, cash provided by operating activities was primarily generated by net income of $98.2 million, $246.8 million of depreciation and amortization, an increase in trade payables and other accrued liabilities of approximately $409.1 million and a decrease in accounts receivable of approximately $117.0 million, offset by increases in inventory of approximately $134.1 million and other current and non-current assets of approximately $207.1 million. The increase in accounts payable and other current liabilities was primarily attributable to the increase in inventory and timing of purchases near quarter end. During the first nine months of fiscal year 2005, cash provided by operating activities reflects the net income of $265.6 million combined with an increase in trade payables and other current liabilities of $676.1 million, offset by an increase in inventories of $209.2 million. The increase in accounts payable and other current liabilities reflects the higher level of business in the third quarter of fiscal year 2005.
 
Cash used in investing activities was $251.9 million and $807.5 million during the nine months ended December 31, 2005 and 2004, respectively. Cash used in investing activities during the nine months ended December 31, 2005 primarily related to the following:
 
  •  net capital expenditures of $151.9 million for the purchase of equipment and for the continued expansion of various manufacturing facilities in certain low-cost, high-volume centers, primarily in Asia;
 
  •  payments amounting to $269.7 million associated with our Nortel transaction, $149.4 million for the acquisition of additional shares in Flextronics Software Systems and $203.9 million for various other acquisitions of businesses and contingent purchase price adjustments relating to certain historic acquisitions;
 
  •  net payments of $39.5 million for investment in certain non-publicly traded technology companies, offset by;
 
  •  $518.5 million of proceeds from the divestitures of our semiconductor and network services divisions; and
 
  •  $43.9 million of proceeds from our participation in our trade receivables securitization program.
 
During the first nine months of fiscal year 2005, cash used by investing activities reflects (i) our payments, net of cash acquired for FSS (approximately $250.2 million) and other acquisitions (approximately $123.9 million), (ii) net capital expenditures of $228.4 million for the purchase of equipment and for the continued expansion of various manufacturing facilities in certain low-cost, high-volume centers, primarily in Asia, and (iii) net payments of $204.9 million for investments and notes receivable primarily due to our trade receivables securitization program.


38


Table of Contents

Cash used in financing activities during the first nine months of fiscal year 2006 amounted to $208.5 million, as compared to cash provided by financing activities of $515.6 million in the comparable period in fiscal year 2005. Cash used in financing activities during the first nine months of fiscal year 2006 primarily related to net repayment of bank borrowings and repurchases of our senior notes amounting to $244.5 million and repayment of capital leases obligations of $11.1 million, offset by proceeds of $47.1 million from the sale of ordinary shares under our employee stock plans. During the first nine months of fiscal year 2005, cash provided by financing activities reflects (i) proceeds from the public offering of approximately 24.3 million ordinary shares, which generated approximately $299.5 million, and (ii) the proceeds from the issuance of $500 million of 6.25% senior subordinated notes due in November 2014, offset by the repayment of borrowings under our revolving credit facility and other bank borrowings of $469.0 million.
 
On June 29, 2004, we entered into an asset purchase agreement with Nortel providing for our purchase of certain of Nortel’s optical, wireless, wireline and enterprise manufacturing operations and optical design operations. The purchase of these assets will occur in stages, with the first three stages completed in November 2004, February 2005 and August 2005. The final asset transfer is expected to be completed in the June 2006 quarter. We anticipate that the aggregate cash purchase price for the assets acquired will be in the range of approximately $575 million to $625 million. As of December 31, 2005, we have made aggregate payments of $379 million to Nortel. We completed the closing of the optical design businesses in Canada and Northern Ireland on November 1, 2004. On February 8, 2005 and August 22, 2005, we also completed the closing of the manufacturing operations and related assets (including product integration, testing, repair and logistics operations) in Montreal, Quebec, and Châteaudun, France. We intend to use our existing cash balances, together with anticipated cash flows from operations to fund the remaining purchase price for the assets yet to be acquired.
 
In September and December 2005, we acquired an additional 18% and 6% incremental ownership in FSS, respectively, for cash consideration of approximately $106.5 million and $42.9 million, respectively. We own approximately 94% of the total outstanding shares of FSS as of December 31, 2005 and are in the process of delisting FSS from India’s stock exchanges. Trading of FSS shares on the Indian exchanges was discontinued on February 3, 2006 and the company will be officially delisted from the exchanges on February  10, 2006. Once the shares have been delisted, any shareholders whose shares have not been acquired by Flextronics (approximately 2.2 million shares as of December 31, 2005) may offer their shares for sale to Flextronics at the exit price of Rs. 725 per share (approximately US$16.10 per share) for a period of six months following the date of the delisting.
 
Our working capital requirements and capital expenditures could continue to increase in order to support future expansions of our operations. In addition to the Nortel acquisition discussed above, it is possible that future acquisitions may be significant and may require the payment of cash. Future liquidity needs will also depend on fluctuations in levels of inventory, accounts receivable and accounts payable, the timing of capital expenditures by us for new equipment, the extent to which we utilize operating leases for the new facilities and equipment, the extent of cash charges associated with future restructuring activities and levels of shipments and changes in volumes of customer orders.
 
We believe that our existing cash balances, together with anticipated cash flows from operations and borrowings available under our credit facility will be sufficient to fund our operations and anticipated transactions through at least the next twelve months. Historically, we have funded our operations from cash and cash equivalents generated from operations, proceeds of public offerings of equity and debt securities, bank debt, sales of accounts receivable and capital equipment lease financings. We anticipate that we will continue to enter into debt and equity financings, sales of accounts receivable and lease transactions to fund our acquisitions and anticipated growth. The sale of equity or convertible debt securities could result in dilution to our current shareholders. Further, we may issue debt securities that have rights and privileges senior to those of holders of our ordinary shares, and the terms of this debt could impose restrictions on our operations. Such financings and other transactions may not be available on terms acceptable to us or at all. We are continuing to assess our capital structure, and evaluating the merits of redeploying available cash to reduce existing debt or repurchase our ordinary shares.


39


Table of Contents

CONTRACTUAL OBLIGATIONS AND COMMITMENTS
 
Information regarding our long-term debt payments, operating lease payments, capital lease payments and other commitments is provided in Item 7, “Management’s Discussion and Analysis of Results of Operations and Financial Condition” of our Annual Report on our Form 10-K for the fiscal year ended March 31, 2005. There have been no material changes in contractual obligations since March 31, 2005 other than the net repayments of our bank borrowings, other long term debt and repurchases of our senior notes as disclosed in Note E, “Long-Term Debt” of the Notes to the Condensed Consolidated Financial Statements. Information regarding our other financial commitments at December 31, 2005 is provided in Note L, “Commitments and Contingencies” of the Notes to the Condensed Consolidated Financial Statements.
 
RELATED PARTY TRANSACTIONS
 
Since June 30, 2003, neither we nor any of our subsidiaries have made or will make any loans to our executive officers. Prior to June 30, 2003, in connection with an investment partnership, we made loans to several of our executive officers to fund their contributions to the investment partnership. Each loan is evidenced by a full-recourse promissory note in favor of us. Interest rates on the notes range from 5.05% to 6.40%. The remaining balance of these loans, including accrued interest, as of December 31, 2005 was approximately $1.7 million.
 
RISK FACTORS
 
We depend on industries that continually produce technologically advanced products with short life cycles; in addition, our business would be adversely affected if our customers’ products are not successful or if our customers lose market share.
 
We derive our revenues from the following industries:
 
  •  handheld devices, with products such as cellular phones and personal digital assistants;
 
  •  computer and office automation, with products such as copiers, scanners, graphics cards, desktop and notebook computers, and peripheral devices such as printers and projectors;
 
  •  communications infrastructure, with products such as equipment for optical networks, wireless base stations, access/edge routers and switches, and broadband access equipment;
 
  •  consumer devices, with products such as set-top boxes, home entertainment equipment, cameras and home appliances;
 
  •  information technology infrastructure, with products such as servers, workstations, storage systems, mainframes, hubs and routers; and
 
  •  a variety of other industries, including the industrial, automotive and medical industries.
 
Factors affecting any of these industries in general, or our customers in particular, could seriously harm us. These factors include:
 
  •  uncertain economic and geopolitical conditions;
 
  •  rapid changes in technology, evolving industry standards and requirements for continuous improvement in products and services, result in short product life cycles;
 
  •  demand for our customers’ products may be seasonal;
 
  •  our customers may fail to successfully market their products, and our customers’ products may fail to gain widespread commercial acceptance;
 
  •  our customers may experience dramatic market share shifts in demand which may cause them to exit the business; and
 
  •  there may be recessionary periods in our customers’ markets.


40


Table of Contents

 
Our customers may cancel their orders, change production quantities or locations, or delay production, and the inherent difficulties involved in responding to these demands could harm our business.
 
As a provider of electronics design and manufacturing services and components, we must provide increasingly rapid product turnaround time for our customers. We generally do not obtain firm, long-term purchase commitments from our customers, and we often experience reduced lead times in customer orders which may be less than the lead time we require to procure necessary components and materials.
 
Cancellations, reductions or delays by a significant customer or by a group of customers have harmed, and may continue to harm, our results of operations by reducing the volumes of products we manufacture and deliver for these customers, by causing a delay in the repayment of our expenditures for inventory in preparation for customer orders and by lowering our asset utilization resulting in lower gross margins.
 
The short-term nature of our customers’ commitments and the rapid changes in demand for their products reduces our ability to accurately estimate the future requirements of those customers. This makes it difficult to schedule production and maximize utilization of our manufacturing capacity. In that regard, we must make significant decisions, including determining the levels of business that we will seek and accept, setting production schedules, making component procurement commitments, and allocating personnel and other resource, based on our estimates of our customers’ requirements.
 
On occasion, customers require rapid increases in production or require that manufacturing of their products be transitioned from one facility to another to achieve cost or other objectives. These demands stress our resources and reduce our margins. We may not have sufficient capacity at any given time to meet our customers’ demands, and transfers from one facility to another can result in inefficiencies and costs due to excess capacity in one facility and corresponding capacity constraints at another. In addition, because many of our costs and operating expenses are relatively fixed, a reduction in customer demand, or transfer of demand from one facility to another, harms our gross profit and operating income.
 
Our industry is extremely competitive; if we are not able to continue to provide our services at competitive prices, we may lose business.
 
We compete with a number of different companies, depending on the type of service we provide or the location of our operations. For example, we compete with major global EMS providers, other smaller EMS companies that have a regional or product-specific focus, and, with respect to some of the services we provide, ODMs. Our industry is extremely competitive and many of our competitors have achieved substantial market share and some may have lower cost structures or greater design, manufacturing, financial or other resources than we do. We face particular competition from suppliers in Asia, including Taiwanese ODM suppliers, which have a substantial share of the global market for information technology hardware production, primarily relating to notebook and desktop computers and personal computer motherboards, and which manufacture consumer products and provide other technology manufacturing services. Some of our competitors may have lower cost structures or greater value-added performance, such as in their design or engineering capabilities, which may cause us to lose business. If we are unable to provide comparable manufacturing services and improved products at lower cost than the other companies in our industry, our net sales could decline.
 
Our operating results may fluctuate significantly due to a number of factors, many of which are beyond our control.
 
Some of the principal factors that contribute to the fluctuations in our annual and quarterly operating results are:
 
  •  adverse changes in general economic or geopolitical conditions;
 
  •  changes in demand for our products or services;
 
  •  our effectiveness in managing manufacturing processes and costs;
 
  •  our increased design services and components offerings may reduce profitability as we continue to make substantial investments in these capabilities;


41


Table of Contents

 
  •  the mix of the types of manufacturing services we provide, as high-volume and low-complexity manufacturing services typically have lower gross margins than lower volume and more complex services;
 
  •  changes in the cost and availability of labor and components, which often occur in the electronics manufacturing industry and which affect our margins and our ability to meet delivery schedules;
 
  •  our ability to achieve commercially viable production yields and manufacture commercial quantities of our components;
 
  •  the degree to which we are able to utilize our available manufacturing capacity;
 
  •  our ability to manage the timing of our component purchases so that components are available when needed for production, while avoiding the risks of purchasing inventory in excess of immediate production needs;
 
  •  local conditions and events that may affect our production volumes, such as labor conditions, political instability and local holidays; and
 
  •  changes in demand in our customers’ end markets.
 
Two of our significant end markets are the handheld electronics devices market and the consumer devices market. These markets exhibit particular strength toward the end of the calendar year in connection with the holiday season. As a result, we have historically experienced stronger revenues in our third fiscal quarter as compared to our other fiscal quarters. Economic or other factors leading to diminished orders in the end of the calendar year could harm our business.
 
The majority of our sales come from a small number of customers and a decline in sales to any of these customers could adversely affect our business.
 
Sales to our ten largest customers represent a significant percentage of our net sales. Our ten largest customers accounted for approximately 62% of net sales during the nine months ended December 31, 2005, 62% of net sales in fiscal year 2005, and 64% of net sales in fiscal year 2004. During the nine months ended December 31, 2005, and in our fiscal years 2005 and 2004, our largest customers, Sony-Ericsson and Hewlett-Packard, each accounted for greater than 10% of net sales.
 
Our principal customers have varied from year to year. These customers may experience dramatic declines in their market shares or competitive position, due to economic or other forces, that may cause them to reduce their purchases from us, or, in some cases, result in the termination of their relationship with us. Significant reductions in sales to any of these customers, or the loss of major customers, would seriously harm our business. If we are not able to timely replace expired, canceled or reduced contracts with new business, our revenues could be harmed.
 
We may encounter difficulties with acquisitions, which could harm our business.
 
We have completed numerous acquisitions of businesses and we expect to continue to acquire additional businesses in the future. We are currently in preliminary discussions with respect to potential acquisitions and strategic customer transactions, and we are in the process of completing the acquisition of Nortel’s optical, and wireless and enterprise manufacturing operations and related supply chain activities, as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview.” Any future acquisitions may require additional debt or equity financing, which could increase our leverage or be dilutive to our existing shareholders. As a result, we may not be able to complete acquisitions or strategic customer transactions in the future to the same extent as in the past, or at all.
 
To integrate acquired businesses, we must implement our management information systems, operating systems and internal controls, and assimilate and manage the personnel of the acquired operations. The difficulties of this integration may be further complicated by geographic distances. The integration of acquired businesses may not be successful and could result in disruption to other parts of our business.
 
In addition, acquisitions involve numerous risks and challenges, including:
 
  •  diversion of management’s attention from the normal operation of our business;
 
  •  potential loss of key employees and customers of the acquired companies, which is a particular concern in the acquisition of companies engaged in product and software design;


42


Table of Contents

 
  •  difficulties managing and integrating operations in geographically dispersed locations;
 
  •  lack of experience operating in the geographic market or industry sector of the acquired business;
 
  •  the potential for deficiencies in internal controls at acquired companies;
 
  •  increases in our expenses and working capital requirements, which reduce our return on invested capital; and
 
  •  exposure to unanticipated liabilities of acquired companies.
 
These and other factors have harmed, and in the future could harm, our ability to achieve anticipated levels of profitability at acquired operations or realize other anticipated benefits of an acquisition, and could adversely affect our business and operating results.
 
Our new strategic relationship with Nortel involves a number of risks, and we may not succeed in realizing the anticipated benefits of this relationship.
 
The final stage of the transaction with Nortel described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview” is subject to a number of closing conditions, including the conversion of information technology systems. Some of the processes involved in converting information technology systems (including the integration of related systems and internal controls) are complex and time consuming, and may present unanticipated difficulties. As a result, we currently expect that this transaction will be completed in the June 2006 quarter. Further delays may arise if the conversion of information technology systems requires more time than presently anticipated.
 
The success of the Nortel transaction will depend on our ability to successfully integrate the acquired operations with our existing operations. This will involve integrating Nortel’s operations into our existing procurement activities, and assimilating and managing existing personnel. In addition, this transaction will increase our expenses and working capital requirements, and place burdens on our management resources. In the event we are unsuccessful in integrating the acquired operations, we would not achieve the anticipated benefits of this transaction, and our results of operations would be adversely affected.
 
As a result of the new strategic relationship, we expect that Nortel will become our largest single customer, and will represent over 10% of our net sales. The manufacturing relationship with Nortel is not exclusive, and they are entitled to use other suppliers for a portion of their requirements of these products. Although Nortel has agreed to use us to manufacture a majority of its requirements for these existing products, for so long as our services are competitive, our services may not remain competitive, and there can be no assurance that we will continue to manufacture a majority of Nortel’s requirements for these products. In addition, sales of these products depend on a number of factors, including global economic conditions, competition, new technologies that could render these products obsolete, the level of sales and marketing resources devoted by Nortel with respect to these products, and the success of these sales and marketing activities. If demand for these products should decline, we would experience reduced sales and gross margins from these products.
 
We have agreed to cost reduction targets and price limitations and to certain manufacturing quality requirements. We may not be able to reduce costs over time as required, and Nortel would be entitled to certain reductions in their product prices, which would adversely affect our margins from this program. In addition, we may encounter difficulties in meeting Nortel’s expectations as to product quality and timeliness. If Nortel’s requirements exceed the volume we anticipate, we may be unable to meet these requirements on a timely basis. Our inability to meet Nortel’s volume, quality, timeliness and cost requirements could have a material adverse effect on our results of operations. Additionally, Nortel may not purchase a sufficient quantity of products from us to meet our expectations and we may not utilize a sufficient portion of the acquired capacity to achieve profitable operations, which could have a material adverse effect on our results of operations.
 
We completed the closing of the acquisition of Nortel’s optical design operations in November 2004, and as a result we employed approximately 150 of Nortel’s former optical design employees. In addition, in February 2005 and August 2005, we completed the closing of the manufacturing operations and related assets (including product integration, testing, repair and logistics operations) in Montreal, Quebec, Canada and in Châteaudun, France. We may fail to retain and motivate these employees or to successfully integrate them into our operations.


43


Table of Contents

One of our anticipated benefits from this transaction is our ability to increase the gross margins of the operations acquired from Nortel over time through cost reductions and by internally sourcing through our vertically integrated supply chain solutions. However, we may be unable to realize lower expenses or increased operating efficiencies as anticipated, and as a result our business could be harmed.
 
Our strategic relationships with major customers create risks.
 
Over the past several years, we have completed numerous strategic transactions with OEM customers, including, among others, Casio, Ericsson, Xerox and Kyocera, and we are currently in the process of completing a strategic transaction with Nortel. Under these arrangements, we generally acquire inventory, equipment and other assets from the OEM, and lease or acquire their manufacturing facilities, while simultaneously entering into multi-year supply agreements for the production of their products. We intend to continue to pursue these OEM divestiture transactions in the future. There is strong competition among EMS companies for these transactions, and this competition may increase. These transactions have contributed to a significant portion of our revenue growth, and if we fail to complete similar transactions in the future, our revenue growth could be harmed. The arrangements entered into with divesting OEMs typically involve many risks, including the following:
 
  •  we may need to pay a purchase price to the divesting OEMs that exceeds the value we may realize from the future business of the OEM;
 
  •  the integration of the acquired assets and facilities into our business may be time-consuming and costly;
 
  •  we, rather than the divesting OEM, bear the risk of excess capacity at the facility;
 
  •  we may not achieve anticipated cost reductions and efficiencies at the facility;
 
  •  we may be unable to meet the expectations of the OEM as to volume, product quality, timeliness and cost reductions;
 
  •  our supply agreements with the OEMs generally do not require any minimum volumes of purchase by the OEMs, and the actual volume of purchases may be less than anticipated; and
 
  •  if demand for the OEMs’ products declines, the OEM may reduce its volume of purchases, and we may not be able to sufficiently reduce the expenses of operating the facility or use the facility to provide services to other OEMs.
 
As a result of these and other risks, we have been, and in the future may be, unable to achieve anticipated levels of profitability under these arrangements. In addition, these strategic arrangements have not, and in the future may not, result in any material revenues or contribute positively to our earnings per share.
 
If we do not effectively manage changes in our operations, our business may be harmed; we have taken substantial restructuring charges in the past and we may need to take material restructuring charges in the future.
 
We have experienced growth in our business through a combination of internal growth and acquisitions, and we expect to make additional acquisitions in the future, including our pending completion of the acquisition of assets from Nortel described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Overview.” Our global workforce has more than doubled in size since the beginning of fiscal year 2001. During that time, we have also reduced our workforce at some locations and closed certain facilities in connection with our restructuring activities. These changes have placed considerable strain on our management control systems and resources, including decision support, accounting management, information systems and facilities. If we do not continue to improve our financial and management controls, reporting systems and procedures to manage our employees effectively and to expand our facilities, our business could be harmed.
 
We plan to continue to transition manufacturing to lower-cost locations and we may be required to take additional restructuring charges in the future as a result of these activities. We also intend to increase our


44


Table of Contents

manufacturing capacity in our low-cost regions by expanding our facilities and adding new equipment. Acquisitions and expansions involve significant risks, including, but not limited to, the following:
 
  •  we may not be able to attract and retain the management personnel and skilled employees necessary to support newly-acquired or expanded operations;
 
  •  we may not efficiently and effectively integrate new operations and information systems, expand our existing operations and manage geographically dispersed operations;
 
  •  we may incur cost overruns;
 
  •  we may incur charges related to our expansion activities;
 
  •  we may encounter construction delays, equipment delays or shortages, labor shortages and disputes and production start-up problems that could harm our growth and our ability to meet customers’ delivery schedules; and
 
  •  we may not be able to obtain funds for acquisitions and expansions on attractive terms, and we may not be able to obtain loans or operating leases with attractive terms.
 
In addition, we expect to incur new fixed operating expenses associated with our expansion efforts that will increase our cost of sales, including increases in depreciation expense and rental expense. If our revenues do not increase sufficiently to offset these expenses, our operating results could be seriously harmed. Our transition to low-cost manufacturing regions has contributed to significant restructuring and other charges that have resulted from reducing our workforce and capacity at higher-cost locations. We recognized restructuring charges of approximately $151.6 million in the first nine months of fiscal year 2006, and $95.4 million and $540.3 million of restructuring charges in fiscal years 2005 and 2004, respectively, associated with the consolidation and closure of several manufacturing facilities, and related impairment of certain long-lived assets. We expect to recognize restructuring charges in the range of approximately $10 million to $30 million during the remainder of fiscal year 2006 and we may be required to take additional charges in the future as a result of these activities. We cannot assure you as to the timing or amount of any future restructuring charges. If we are required to take additional restructuring charges in the future, it could have a material adverse impact on operating results, financial position and cash flows.
 
Our substantial investments and start-up and integration costs in our design services business may adversely affect our margins and profitability.
 
As part of our strategy to enhance our vertically-integrated end-to-end service offerings, we are actively pursuing the expansion of our design and engineering capabilities. Providing these services can expose us to different or greater potential risks than those we face when providing our regular manufacturing services.
 
Although we enter into contracts with our design services customers, we may design and develop products for these customers prior to receiving a purchase order or other firm commitment from them. We are required to make substantial investments in the resources necessary to design and develop these products, and no revenue may be generated from these efforts if our customers do not approve the designs in a timely manner or at all, or if they do not then purchase anticipated levels of products. Our design activities often require that we purchase inventory for initial production runs before we have a purchase commitment from a customer. Even after we have a contract with a customer with respect to a product, these contracts may allow the customer to delay or cancel deliveries and may not obligate the customer to any volume of purchases. These contracts can generally be terminated on short notice. Some of the products we design and develop must satisfy safety and regulatory standards and some must receive government certifications. If we fail to obtain these approvals or certifications on a timely basis, we would be unable to sell these products, which would harm our sales, profitability and reputation.
 
Due to the increased risks associated with our design services offerings, we may not be able to achieve a high enough level of sales for this business, and the significant investments in research and development, technology licensing, test and tooling equipment, patent applications, facility expansion and recruitment that it requires, to be profitable. Due to the initial costs of investing in the resources necessary to expand our design and engineering capabilities, and in particular to support our design services offerings, our profitability during fiscal year 2005 was


45


Table of Contents

adversely affected. We continue to make investments in these capabilities, which could adversely affect our profitability during fiscal year 2006 and beyond.
 
Our components business is dependent on our ability to quickly launch world-class components products; investments, and start-up and integration costs in our components business may adversely affect our margins and profitability.
 
Our components business, which primarily includes camera modules and power supplies, is part of our strategy to improve our competitive position and to grow our future margins, profitability and shareholder returns by expanding our vertical integration capabilities. The camera module and power supply industries have experienced, and are expected to continue to experience, rapid technological change. The success of our components business is contingent on our ability to design and introduce world-class components that have performance characteristics that are suitable for a broad market and that offer significant price and/or performance advantages over competitive products.
 
To create these world class component offerings, we must make substantial investments in the development of our component capabilities, in resources such as research and development, technology licensing, test and tooling equipment, facility expansions and personnel requirements. We may not be able to achieve or maintain market acceptance for any of our components offerings in any of our current or target markets. The success of our components business will also depend upon the level of market acceptance of our customers’ end products, which incorporate our components, and over which we have no control.
 
In addition, OEMs often require unique configurations or custom designs which must be developed and integrated in the OEM’s product well before the product is launched by the OEM. Thus, there is often substantial lead time between the commencement of design efforts for a customized component and the commencement of volume shipments of the component to the OEM. As a result, we may make substantial investments in the development and customization of products for our customers and no revenue may be generated from these efforts if our customers do not accept the customized component at all, or do not purchase anticipated levels of products.
 
Our achievement of anticipated levels of profitability in our components business is also dependent on our ability to achieve commercially viable production yields and to manufacture components in commercial quantities to the performance specifications demanded by our OEM customers.
 
As a result of these and other risks, we have been, and in the future may be, unable to achieve anticipated levels of profitability in our components business. In addition, our components business has not, and in the future may not, result in any material revenues or contribute positively to our earnings per share.
 
Intellectual property infringement claims against our customers or us could harm our business.
 
Our design and manufacturing services and components offerings involve the creation and use of intellectual property rights, which subject us to the risk of claims of intellectual property infringement from third parties, as well as claims arising from the allocation of intellectual property rights among us and our customers. In addition, our customers may require that we indemnify them against the risk of intellectual property infringement. If any claims are brought against us or our customers for such infringement, whether or not these have merit, we could be required to expend significant resources in defense of such claims. In the event of such an infringement claim, we may be required to spend a significant amount of money to develop non-infringing alternatives or obtain licenses. We may not be successful in developing such alternatives or obtaining such licenses on reasonable terms or at all.
 
The success of certain of our activities depends on our ability to protect our intellectual property rights.
 
We retain certain intellectual property rights to some of the technologies that we develop as part of our engineering and design activities in our design and manufacturing services and components offerings. As the level of our engineering and design activities increases, the extent to which we rely on rights to intellectual property incorporated into products is increasing. The measures we have taken to prevent unauthorized use of our technology may not be successful. If we are unable to protect our intellectual property rights, this could reduce or eliminate the competitive advantages of our proprietary technology, which would harm our business.


46


Table of Contents

If our products or components contain defects, demand for our services may decline and we may be exposed to product liability and product warranty liability.
 
Defects in the products we manufacture or design, whether caused by a design, engineering, manufacturing or component failure or deficiencies in our manufacturing processes, could result in product or component failures, which may damage our business reputation, and expose us to product liability or product warranty claims.
 
Product liability claims may include liability for personal injury or property damage. Product warranty claims may include liability to pay for the recall, repair or replacement of a product or component. Although we generally allocate liability for these claims in our contracts with our customers, even where we have allocated liability to our customers, our customers may not, or may not have the resources to, satisfy claims for costs or liabilities arising from a defective product or component for which they have assumed responsibility.
 
If we design, engineer or manufacture a product or component that is found to cause any personal injury or property damage or is otherwise found to be defective, we could spend a significant amount of money to resolve the claim. In addition, product liability and product recall insurance coverage are expensive and may not be available with respect to all of our services offerings on acceptable terms, in sufficient amounts, or at all. A successful product liability or product warranty claim in excess of our insurance coverage or any material claim for which insurance coverage is denied, limited or is not available could have a material adverse effect on our business, results of operations and financial condition.
 
We are subject to the risk of increased income taxes.
 
We have structured our operations in a manner designed to maximize income in countries where:
 
  •  tax incentives have been extended to encourage foreign investment; or
 
  •  income tax rates are low.
 
We base our tax position upon the anticipated nature and conduct of our business and upon our understanding of the tax laws of the various countries in which we have assets or conduct activities. However, our tax position is subject to review and possible challenge by taxing authorities and to possible changes in law, which may have retroactive effect. We cannot determine in advance the extent to which some jurisdictions may require us to pay taxes or make payments in lieu of taxes.
 
Several countries in which we are located allow for tax holidays or provide other tax incentives to attract and retain business. These tax incentives expire over various periods from 2005 to 2010 and are subject to certain conditions with which we expect to comply. We have obtained tax holidays or other incentives where available, primarily in China, Hungary, India and Malaysia. In these four countries, we generated an aggregate of approximately $7.6 billion and $10 billion of our total revenues for the nine months ended December 31, 2005 and fiscal year ended March 31, 2005, respectively. Our taxes could increase if certain tax holidays or incentives are not renewed upon expiration, or tax rates applicable to us in such jurisdictions are otherwise increased. In addition, further acquisitions or divestitures may cause our effective tax rate to increase.
 
We are exposed to intangible asset risk.
 
We have a substantial amount of intangible assets. These intangible assets are attributable to acquisitions and represent the difference between the purchase price paid for the acquired businesses and the fair value of the net tangible assets of the acquired businesses. We are required to evaluate goodwill and other intangibles for impairment on at least an annual basis, and whenever changes in circumstances indicate that the carrying amount may not be recoverable from estimated future cash flows. As a result of our annual and other periodic evaluations, we may determine that the intangible asset values need to be written down to their fair values, which could result in material charges that could be adverse to our operating results and financial position.


47


Table of Contents

Our exposure to financially troubled customers, particularly in the automotive industry, may adversely affect our financial results.
 
We provide EMS services to the automotive industry, which has been experiencing significant financial difficulty. Our largest customer in the automotive industry is Delphi, which filed for bankruptcy on October 8, 2005. There can be no assurance that we will be able to maintain the same level of business with Delphi as we did prior to Delphi’s bankruptcy. If other customers in the automotive industry or in other industries file for bankruptcy, we could have difficulty recovering amounts owed to us from these customers, or demand for our products from these customers could decline, either of which could adversely affect our financial position and results of operations.
 
If OEMs stop or reduce their manufacturing and supply chain management outsourcing, our business could suffer.
 
Future growth in our revenues depends on new outsourcing opportunities in which we assume additional manufacturing and supply chain management responsibilities from OEMs. Current and prospective customers continuously evaluate our capabilities against other providers and the merits of manufacturing products themselves. To the extent that outsourcing opportunities are not available, either because OEMs decide to perform these functions internally or because they use other providers of these services, our future growth would be limited.
 
We may be adversely affected by shortages of required electronic components.
 
From time to time, we have experienced shortages of some of the electronic components that we use. These shortages can result from strong demand for those components or from problems experienced by suppliers. These unanticipated component shortages have resulted in curtailed production or delays in production, which prevented us from making scheduled shipments to customers in the past and may do so in the future. Our inability to make scheduled shipments could cause us to experience a reduction in sales, increase in inventory levels and costs, and could adversely affect relationships with existing and prospective customers. Component shortages may also increase our cost of goods sold because we may be required to pay higher prices for components in short supply and redesign or reconfigure products to accommodate substitute components. As a result, component shortages could adversely affect our operating results for a particular period due to the resulting revenue shortfall and increased manufacturing or component costs.
 
We conduct operations in a number of countries and are subject to risks of international operations.
 
The distances between the Americas, Asia and Europe create a number of logistical and communications challenges for us. These challenges include managing operations across multiple time zones, directing the manufacture and delivery of products across distances, coordinating procurement of components and raw materials and their delivery to multiple locations, and coordinating the activities and decisions of the core management team, which is based in a number of different countries. Facilities in several different locations may be involved at different stages of the production of a single product, leading to additional logistical difficulties.
 
Because our manufacturing operations are located in a number of countries throughout the Americas, Asia and Europe, we are subject to the risks of changes in economic and political conditions in those countries, including:
 
  •  fluctuations in the value of local currencies;
 
  •  labor unrest and difficulties in staffing;
 
  •  longer payment cycles;
 
  •  cultural differences;
 
  •  increases in duties and taxation levied on our products;
 
  •  imposition of restrictions on currency conversion or the transfer of funds;
 
  •  limitations on imports or exports of components or assembled products, or other travel restrictions;
 
  •  expropriation of private enterprises; and
 
  •  a potential reversal of current favorable policies encouraging foreign investment or foreign trade by our host countries.


48


Table of Contents

 
The attractiveness of our services to U.S. customers can be affected by changes in U.S. trade policies, such as most favored nation status and trade preferences for some Asian countries. In addition, some countries in which we operate, such as Brazil, Hungary, Mexico, Malaysia and Poland, have experienced periods of slow or negative growth, high inflation, significant currency devaluations or limited availability of foreign exchange. Furthermore, in countries such as China and Mexico, governmental authorities exercise significant influence over many aspects of the economy, and their actions could have a significant effect on us. Finally, we could be seriously harmed by inadequate infrastructure, including lack of adequate power and water supplies, transportation, raw materials and parts in countries in which we operate.
 
Fluctuations in foreign currency exchange rates could increase our operating costs.
 
Our manufacturing operations and industrial parks are located in lower cost regions of the world, such as Asia, Eastern Europe and Mexico; however, most of our purchase and sale transactions are denominated in United States Dollars or Euros. As a result, we are exposed to fluctuations in the functional currencies of our fixed cost overhead or our supply base relative to the currencies in which we conduct transactions.
 
Currency exchange rates fluctuate on a daily basis as a result of a number of factors, including changes in a country’s political and economic policies. Volatility in the functional currencies of our entities and the Euro or United States Dollar could seriously harm our business, operating results and financial condition. The primary impact of currency exchange fluctuations is on our cash, receivables, and payables of our operating entities. As part of our currency hedging strategy, we use financial instruments, primarily forward purchase contracts, to hedge United States Dollar and other currency commitments in order to reduce the short-term impact of foreign currency fluctuations on current assets and liabilities. Additionally, we manage our foreign currency exposure by borrowing money in various foreign currencies. If our hedging activities are not successful or if we change or reduce these hedging activities in the future, we may experience significant unexpected expenses from fluctuations in exchange rates.
 
We are also exposed to risks related to the valuation of the Chinese currency relative to other foreign currencies. The Chinese currency is the renminbi yuan (RMB). The Chinese government relaxed its control over the exchange rate of the RMB relative to the United States Dollar by managing the fluctuation of the RMB within a range of 0.3% per day and pegging its value to the value of a basket of currencies, which currencies have not been identified. The RMB was previously pegged to the value of the United States Dollar. There is no certainty as to whether the Chinese government will elect to revalue the RMB again in the near future, or at all. A significant increase in the value of the RMB could adversely affect our financial results and cash flows by increasing both our manufacturing costs and the costs of our local supply base.
 
We depend on our executive officers and skilled management personnel.
 
Our success depends to a large extent upon the continued services of our executive officers. Generally our employees are not bound by employment or non-competition agreements, and we cannot assure you that we will retain our executive officers and other key employees. We could be seriously harmed by the loss of any of our executive officers. In order to manage our growth, we will need to recruit and retain additional skilled management personnel and if we are not able to do so, our business and our ability to continue to grow could be harmed. In addition, in connection with expanding our design services offerings, we must attract and retain experienced design engineers. There is substantial competition in our industry for highly skilled employees. Our failure to recruit and retain experienced design engineers could limit the growth of our design services offerings, which could adversely affect our business.
 
Our failure to comply with environmental laws could adversely affect our business.
 
We are subject to various federal, state, local and foreign environmental laws and regulations, including regulations governing the use, storage, discharge and disposal of hazardous substances used in our manufacturing processes. We are also subject to laws and regulations governing the recyclability of products, the materials that may be included in products, and our obligations to dispose of these products after end users have finished with


49


Table of Contents

them. Additionally, we may be exposed to liability to our customers relating to the materials that may be included in the components that we procure for our customers’ products. Any violation or alleged violation by us of environmental laws could subject us to significant costs, fines or other penalties.
 
In addition, we are responsible for cleanup of contamination at some of our current and former manufacturing facilities and at some third party sites. If more stringent compliance or cleanup standards under environmental laws or regulations are imposed, or the results of future testing and analyses at our current or former operating facilities indicate that we are responsible for the release of hazardous substances, we may be subject to additional liability. Additional environmental matters may arise in the future at sites where no problem is currently known or at sites that we may acquire in the future. Our failure to comply with environmental laws and regulations or adequately address contaminated sites could limit our ability to expand our facilities or could require us to incur significant expenses, which would harm our business.
 
The market price of our ordinary shares is volatile.
 
The stock market in recent years has experienced significant price and volume fluctuations that have affected the market prices of technology companies. These fluctuations have often been unrelated to or disproportionately impacted by the operating performance of these companies. The market for our ordinary shares may be subject to similar fluctuations. Factors such as fluctuations in our operating results, announcements of technological innovations or events affecting other companies in the electronics industry, currency fluctuations and general market conditions may cause the market price of our ordinary shares to decline.
 
It may be difficult for investors to effect services of process within the United States on us or to enforce civil liabilities under the federal securities laws of the United States against us.
 
We are incorporated in Singapore under the Companies Act, Chapter 50 of Singapore. Some of our officers reside outside the United States, and a substantial portion of our assets is located outside the United States. As a result, it may not be possible for investors to effect service of process upon us within the United States. Additionally, judgments obtained in U.S. courts based on the civil liability provisions of the U.S. federal securities laws may not be enforceable against us. Judgments of U.S. courts based on the civil liability provisions of the federal securities laws of the United States are not directly enforceable in Singapore courts, and Singapore courts may not enter judgments in original actions brought in Singapore courts based solely upon the civil liability provisions of the federal securities laws of the United States.
 
ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
There were no material changes during the nine months ended December 31, 2005 since the end of fiscal year 2005 to our exposure to market risk for changes in interest rates and foreign currency exchange rates.
 
We have a portfolio of fixed and variable rate debt. Our variable rate debt instruments create exposures for us related to interest rate risk. A hypothetical 10% change in interest rates from those as of December 31, 2005 would not have a material effect on our financial position, results of operations and cash flows over the next twelve months.
 
We transact business in various foreign countries and are, therefore, subject to risk of foreign currency exchange rate fluctuations. We have established a foreign currency risk management policy to manage this risk. Based on our overall currency rate exposures, including derivative financial instruments and nonfunctional currency-denominated receivables and payables, a near-term 10% appreciation or depreciation of the U.S. dollar from the rate as of December 31, 2005 would not have a material effect on our financial position, results of operations and cash flows over the next twelve months.


50


Table of Contents

 
ITEM 4.   CONTROLS AND PROCEDURES
 
(a)  Evaluation of Disclosure Controls and Procedures
 
We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2005, the end of the quarterly fiscal period covered by this quarterly report. The evaluation was conducted under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2005, our disclosure controls and procedures are effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.
 
(b)  Changes in Internal Control Over Financial Reporting
 
There were no changes in our internal control over financial reporting that occurred during the quarter ended December 31, 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
PART II. OTHER INFORMATION
 
ITEM 1.   LEGAL PROCEEDINGS
 
We are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. We defend ourselves vigorously against any such claims. Although the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.
 
ITEM 2.   UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
On December 7, 2005, we issued an aggregate of 1,853,659 ordinary shares in consideration for the acquisition of certain of the shares of a privately-held company that provides flexible circuit assembly and other circuit products pursuant to the exemption from registration provided by Section 4(2) of the Securities Act of 1933.
 
On November 15, 2005, we issued an aggregate of 393,820 ordinary shares relating to the acquisition by merger of a privately-held company that provides advanced multimedia software products and services. The ordinary shares were issued pursuant to the exemption from registration provided by Section 3(a)(10) of the Securities Act of 1933.
 
ITEM 6.   EXHIBITS
 
         
Exhibit
   
No.
 
Exhibit
 
  10 .01   Agreement, dated as of November 30, 2005, between Michael E. Marks and Flextronics International USA, Inc.*
         
     
  10 .02   Flextronics International USA, Inc. Amended and Restated Senior Executive Deferred Compensation Plan.**
         
     
  10 .03   Flextronics International USA, Inc. Amended and Restated Special Deferred Compensation Plan.**
         
     
  10 .04   Compensation Arrangement between Flextronics International Ltd. and Michael McNamara and Thomas J. Smach.**
         
     
  15 .01   Letter in lieu of consent of Deloitte & Touche LLP.
         
     
  31 .01   Certification of Principal Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
         


51


Table of Contents

         
Exhibit
   
No.
 
Exhibit
 
  31 .02   Certification of Principal Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
         
     
  32 .01   Certification of Chief Executive Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***
         
     
  32 .02   Certification of Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***
 
 
* Incorporated by reference to the Company’s Current Report on Form 8-K/A filed with the Securities and Exchange Commission on December 1, 2005.
 
** Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on December 23, 2005.
 
*** This exhibit is furnished with this Quarterly Report on Form 10-Q, is not deemed filed with the Securities and Exchange Commission, and is not incorporated by reference into any filing of Flextronics International Ltd. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing.

52


Table of Contents

 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
FLEXTRONICS INTERNATIONAL LTD.
(Registrant)
 
Date: February 8, 2006
/s/  Michael M. McNamara
Michael M. McNamara
Chief Executive Officer
(Principal Executive Officer)
 
Date: February 8, 2006
/s/  Thomas J. Smach
Thomas J. Smach
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)


53


Table of Contents

EXHIBIT INDEX
 
         
Exhibit
   
No.
 
Exhibit
 
  10 .01   Agreement, dated as of November 30, 2005, between Michael E. Marks and Flextronics International USA, Inc.*
         
     
  10 .02   Flextronics International USA, Inc. Amended and Restated Senior Executive Deferred Compensation Plan.**
         
     
  10 .03   Flextronics International USA, Inc. Amended and Restated Special Deferred Compensation Plan.**
         
     
  10 .04   Compensation Arrangement between Flextronics International Ltd. and Michael McNamara and Thomas J. Smach.**
         
     
  15 .01   Letter in lieu of consent of Deloitte & Touche LLP.
         
     
  31 .01   Certification of Principal Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
         
     
  31 .02   Certification of Principal Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
         
     
  32 .01   Certification of Chief Executive Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***
         
     
  32 .02   Certification of Chief Financial Officer pursuant to Rule 13a-14(b) under the Securities Exchange Act of 1934 and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.***
 
 
* Incorporated by reference to the Company’s Current Report on Form 8-K/A filed with the Securities and Exchange Commission on December 1, 2005.
 
** Incorporated by reference to the Company’s Current Report on Form 8-K filed with the Securities and Exchange Commission on December 23, 2005.
 
*** This exhibit is furnished with this Quarterly Report on Form 10-Q, is not deemed filed with the Securities and Exchange Commission, and is not incorporated by reference into any filing of Flextronics International Ltd. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date hereof and irrespective of any general incorporation language contained in such filing.