Fitch Ratings Affirms Solectron at 'BB-'; Outlook Stable.

NEW YORK -- Fitch Ratings has affirmed Solectron Corporation's (Solectron) issuer default rating and senior unsecured debt at 'BB-'. The senior secured bank facility is affirmed at 'BB+', and the subordinated debt has been upgraded to 'B+' from 'B'. The Rating Outlook is Stable. Approximately $700 million of debt is affected by Fitch's action.

The Outlook and ratings reflects Fitch's belief that Solectron's revenue will be flat for fiscal 2006 while operating margins are expected to moderately expand, driven primarily by successful cost restructuring activities. As a result, the company's credit protection measures are expected to improve slightly over the near term. Solectron has the opportunity to further strengthen credit metrics by meeting more than $200 million of debt maturities over the next six quarters with available cash. Fitch also expects the company will continue to generate free cash flow during fiscal 2006, potentially offsetting the current $250 million share repurchase program. Fitch notes, however, the comparatively weak quality of recent free cash flow, which has been driven primarily by lower inventories associated with declining revenues.

While the ratings consider the demand volatility inherent to Solectron's less diversified end-market portfolio and exposure to large customer programs, Fitch believes that continued quarterly revenue declines for the company could result in negative rating actions. The company's revenues decreased more than 10% in fiscal 2005 due primarily to reductions and cancellations of certain customer programs in the consumer electronics market, as well as weaker-than-expected revenues in communications and computing and storage, which continue to represent more than 50% of total revenues. While revenue growth for most North American tier 1 EMS providers is expected to be subdued for 2006 due to a modestly positive overall demand environment and intense competition from Asian providers, Fitch is particularly concerned about the effect of any further meaningful revenue declines on Solectron's competitive position and profitability.

Solectron's capacity utilization rates are expected to remain at less than optimal levels, but Fitch believes the company's operating margins should be flat to slightly higher for fiscal 2006, driven by aforementioned restructuring and efficiency initiatives. However, Fitch does not expect margins will meaningfully improve without a return to robust revenue growth, despite Solectron's efforts to expand into higher value-added service offerings (including design-related and post-manufacturing services). Fitch notes that Solectron's operating margins improved to 1.6% for fiscal 2005 from 1.2% in fiscal 2004 and negative 0.2% in fiscal 2003, which in conjunction with substantial debt reduction has resulted in significantly stronger credit protection measures. Total leverage adjusted for rents declined to 3.0 times (x) for fiscal 2005 from 4.4x for fiscal 2005. At the same time, interest coverage increased to 6.4x in fiscal 2005 from only 2.5x in fiscal 2004.

Liquidity was solid as of Aug. 26, 2005 and consisted of unrestricted cash of approximately $1.7 billion and an undrawn $500 million secured revolving facility expiring August 2007. Given the company's muted demand outlook, Fitch also expects Solectron will support liquidity with free cash flow that will likely exceed $200 million in fiscal 2006, driven in part by more efficient working capital management. The company reduced its cash conversion cycle to a Fitch-estimated 41 days for fiscal 2005 from 50 days for fiscal 2004 and 59 days in fiscal 2003. Modest share repurchase and acquisition activity are factored into the current ratings, but significant shareholder-friendly transactions or debt-financed acquisitions would likely result in negative rating actions. Total debt was $700 million as of Aug. 26, 2005 and consisted primarily of the following:

-- $450 million 0.5% convertible senior notes due February 2034 (convertible any time by the holders if Solectron's stock price reaches $11.60 per share);

-- $150 million 7.375% senior notes due March 2006;

-- $63 million 7.97% subordinated notes due November 2006.

The ratings continue to reflect Solectron's: below industry-average but improving operating performance; customer concentration to traditional end markets (communications infrastructure and computing), which are characterized by more mature growth prospects and have resulted in greater historical operating performance volatility than more diversified competitors; expectations that EBIT margins for the EMS industry will remain thin, despite ongoing efforts to grow higher margin service offerings; and competition from faster growing original design manufacturers (ODMs) and/or the ODM model, particularly in consumer electronics and other nontraditional end-markets with more attractive growth rates.

Support for the ratings centers on the company's: conservative capital structure driven mostly by significant debt reduction over the past few years; meaningfully improved credit protection measures; solid liquidity position, even pro forma current share repurchase programs and near-term debt maturities; and positive long-term trends supporting additional penetration of the design and manufacturing outsourcing model.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria, and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance, and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.