Jabil Circuit, Inc. F2Q09 (Qtr End 02/28/09) Earnings Call Transcript

Mar.24.09 | About: Jabil Circuit (JBL)

Jabil Circuit, Inc. (NYSE:JBL)

F2Q09 (Qtr End 02/28/09) Earnings Call Transcript

March 24, 2009, 4:30 pm ET

Executives

Beth Walters – VP, Communications & IR

Tim Main – President and CEO

Forbes Alexander – CFO

Analysts

Brian Alexander – Raymond James

Amit Daryanani – RBC

Sherri Scribner – Deutsche Bank

Jim Suva – Citigroup

Matt Sheerin – Thomas Weisel

Joe Wittine – Longbow Research

William Stein – Credit Suisse

Operator

Good afternoon. My name is Christina and I will be your conference operator today. At this time, I would like to welcome everyone to the Jabil Second Quarter 2009 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator instructions) Thank you.

Ms. Walters, you may begin your conference.

Beth Walters

Thank you. Welcome to our second quarter fiscal 2009 conference call.

Joining me on the call today are President and Chief Executive Officer, Tim Main, and Chief Financial Officer, Forbes Alexander. This call is being recorded and will be posted for audio playback on the Jabil website in the Investors section, along with today’s press release and a slide show presentation on the quarter. You can follow our presentation with the slides that are posted on the web site, and begin with slide one now, our second quarter forward-looking statements.

During this conference call, we will be making forward-looking statements, including those regarding the anticipated outlook for our business, our currently expected third quarter of fiscal 2009 net revenue and earnings results, our long-term outlook for our company and improvements in our operational efficiency, and in our financial performance.

These statements and are based on current expectations, forecasts, and assumptions, involving risks and uncertainties that could cause actual outcomes and results to differ materially. An extensive list of these risks and uncertainties are identified in our annual report on Form 10-K for the fiscal year ended August 31, 2008, and subsequent reports on Form 10-Q and Form 8-K and our other securities filings. Jabil disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

I will now turn the call over to Tim Main for some opening remarks.

Tim Main

Thanks, Beth. Over the course of the second fiscal quarter, our first focus was managing working capital and adjusting our infrastructure to the lower demand levels across the board. In this respect, I think we were successful. We generated cash flow from operations of $343 million. We paid down $100 million of debt, reduced inventory levels to $200 million, and ended the quarter with $775 million in cash.

We also successfully renewed our AR securitization facilities of $450 million. Our liquidity position has been enhanced by $224 million in the first quarter. We're reducing our cost structure having announced a $65 million dollar rationalization program in January. This process is under way, and we still expect roughly one-year payback on the cash cost of that rationalization.

The overall business environment remains poor with limited visibility. As expected and previewed in our December earnings call, customers reduced schedules significantly, especially from mid-January to the first two weeks of February. Although the erosion in demand has abated a bit, we remain cautious and wary of further deterioration.

I will turn the call over now to Beth and Forbes before I close with some additional comments.

Beth Walters

Thank you, Tim. If everyone could turn now to slide two and three, the results for our second quarter of fiscal 2009. On revenues of $2.89 billion, our GAAP operating income was a loss of $500,000. This compares to 1.6 million GAAP operating income on revenues of 3.06 billion for the same period in the prior year. Core operating income excluding amortization of intangibles, stock-based compensation and restructuring charges for the quarter was 51.2 million or 1.8% of revenue as compared to 67.8 million or 2.2 for the same period in the prior year. Core earnings per diluted share were $0.13 as compared to $0.20 for the same period in the prior year.

On a year-over-year basis for the quarter, revenue declined 6% while core operating profit declined 25%. On a sequential basis, revenues declined by 15% while core operating income declined 49% reflecting the seasonal nature of the consumers sectors we serve and a reduction in schedules as a result of the global economic recession in which we are operating.

Please turn now to slide four and five. Turning to a discussion of revenue by discussion and sector for the second fiscal quarter, the EMS division represented approximately 58% or $1.67 billion, a decline of 16% as compared with the first quarter of fiscal 2009. Core operating income for the division in the quarter was 1.3% of revenue. Sector movements are as follows. Production levels in the automotive sector declined by 31% sequentially and represented 3% of revenues.

Computing and storage sectors decreased by 6% in the first quarter and represented 12% of revenues. Industrial instrumentation and medical sector declined 10% from the prior quarter and represented 19% of revenues. Networking decreased by 20% from the previous quarter and represented 17% of revenues. Telecommunications decreased by 32% sequentially and represented 5% of revenues in the second quarter.

And the consumer division represented approximately 36% of overall revenues of 1.04 billion in the second fiscal quarter, a sequential decrease of 15%, reflecting seasonal declines offset by the ramp of new business wins in the mobility sector. Core operating income for the division in the quarter was 1.3% of revenue.

Sequential sector movements are as follows. Display sector decreased by 52% from the first quarter representing 4% of revenues. The mobility sector increased by 13% from the prior quarter and represented 21% of revenues. The peripheral sector decreased by 29% in the second fiscal quarter and represented 11% of revenues. The aftermarket services division represented approximately 6% of overall company revenues in the second fiscal quarter. Core operating income for the division in the quarter was 9% of revenue and revenue grew by 4% from the prior quarter.

Turning now to our second fiscal quarter, there were two customers that accounted for more than 10% of revenues and our top 10% customers in the quarter accounted for 61% of revenue. Selling general and administrative expenses declined by 11% to 106 million as a result of restructuring and cost control initiatives in the quarter. Research and development costs were consistent with the prior quarter at 5.7 million. During the quarter, we also reported a distressed customer charge of 7.3 million associated with the filing for bankruptcy by Nortel. This translates to a provision for pre-bankruptcy account receivable.

Stock-based compensation was 5.2 in the quarter reflecting the reversal of some previous expense associated with performance-based equity awards no longer expected to vest. Net interest expense for the quarter was 19 million reflecting reductions of debt and increased liquidity levels during the quarter. Tax rate on net core operating income in the quarter was 17%.

I will now turn the call over to Forbes for a review of our balance sheets and ratio trends.

Forbes Alexander

Thank you, Beth. Good afternoon, everyone.

I will now ask you to follow along on slide six, seven and eight. The company's sales cycle in the quarter contracted by four days to 20 days. Days sales outstanding improved by eight days to 36, while accounts payable days fell by four days to 62 days. Our entry balances declined by $200 million, while days in inventory were consistent with the first quarter of 46 days. Inventory turns remained at eight.

Cash flow as generated from operations were $343 million in the quarter reflective of net working capital contractions. Return on invested capital was 6% in the quarter while cash and cash equivalents increased by $195 million to 775 million. Debt levels are also reduced by $100 million during the quarter and no sums were outstanding in our $800 million revolving credit facility.

Our capital expenditures during the quarter were approximately $70 million. This level of expenditure primarily reflects continued investments in our IT infrastructure and capacity to support new programs being ramped in the mobility sector. Depreciation for the quarter was approximately $64 million with core EBITDA in the quarter being approximately $180 million or 4.1% of revenue.

We are extremely pleased in the manner in which we executed through our quarter’s working capital operational plan in a very turbulent economic and end market environment. Cash flow from operations of $343 million, debt levels being reduced by 100 million with cash levels increasing to 775 million. We shall continue to execute to put our plans in place to reduce inventory levels to reflect forecasted demand to which we are guiding, while continuing to manage our accounts receivables and payables balances.

Capital expenditures will continue to slow through the third quarter given the overall macro demand environment. We expect our sales cycle to remain around 20 days or better in the coming quarter. As a result, cash balances at the end of the third quarter are expected to approximate $900 million while debt levels remain consistent with those at the end of the second quarter.

We're also pleased to note that as we announced earlier today we have renewed our accounts receivable securitization facility with total availability under this facility of $450 million.

I would now like to turn to our restructuring activity. In light of the ongoing economic slowdown, during the second quarter, we announced restructuring activity a total of approximately $65 million over the balance of fiscal 2009 and fiscal 2010. Cash charges associated with such plans are estimated to be $54 million. As a result of such activity, we expect to realize $55 million in annualized cost savings.

During the second fiscal quarter, we recorded charges of $32 million associated with these activities while cash payments associated with these plans were $1 million in the quarter. Discussions with our employees and their representatives continue and we're complying with all statutory and consultation periods required of us. As a result, we currently estimate cash payments totaling approximately $10 million will occur in the third fiscal quarter. We currently expect to record charges of $12 million on a GAAP basis associated with this facility.

Turning to goodwill impairment, due to the recent macroeconomic environment, and in particular, the decline in our equity values as of 28th of February 2009 as compared to that of 30th of November 2008, and the resulting decline in the market capitalization, we have determined that an indicator of potential goodwill impairment is present for the second fiscal quarter. Accordingly, we are performing goodwill impairment analysis using the two step approach as required under SFAS 142.

Any such impairment may also result in deferred tax valuations allowance charge. This analysis is anticipated to be completed in early April. In the event that we determine goodwill is impaired, either in whole or in part, a non-cash charge will reduce reported GAAP net income and earnings per share. The goodwill and net deferred tax asset balances at the end of the second fiscal quarter totaled 731 million and $184 million respectively. Any such non-cash charges will not impact our normal business operations, availability under our credit facilities, or are reflective of our future earnings power.

I'll now turn to slide nine to give you a business update. As a result of the continuing very difficult broad-based macroeconomic environment, we estimate sequential declines across all sectors the serve. As a result, we expect at the midpoint of our guidance 10% sequential decline in revenue. We shall not be providing sector guidance for the quarter.

Overall company guidance for the third fiscal quarter of 2009 is as follows. Revenues is estimated to be in the range of 2.5 to $2.7 billion, core operating income is estimated to be zero to $40 million. As a result, core earnings per share are expected to be in the range of the loss of $0.08 to income of $0.08 per diluted share. Selling general and administrative expenses are estimated to be consistent at $106 million.

Research and development costs are expected to be approximately $7 million in the third fiscal quarter. And tangibles amortization is estimated to be approximately $7 million, and stock-based compensation is estimated to be approximately $14 million in the third quarter.

Our interest expense is estimated to be consistent with that of the second quarter. Based upon the current estimate of production and income levels, tax rate and core operating income is expected to be 20% in the quarter. Our capital expenditures in the third quarter are estimated to be in the range of $40 million to $50 million, reflecting ongoing IT and infrastructure refreshes and maintenance capital expenditures level.

I would now like to turn the call back to Tim Main for some closing remarks.

Tim Main

Thanks, Forbes. At this point, the next 90 days is now really the most important test for our company. I think – I believe we have assured ourselves of adequate liquidity and have solid control of our business. If business stabilizes, our earnings will rebound smartly and we will progress from there. If business deteriorates, we will continue to convert working capital to cash and we will increase our liquidity. We will remain flexible and adapt to the near term challenges we confront.

But with challenges come opportunities and as much as anything we're working to capitalize on the opportunities to increase our long-term earnings power. It doesn't show up easily in this environment, but we have actually enjoyed new business wins in most of the sectors we serve. We are encouraging customers to narrow the supply base to fewer suppliers having sustainable financial strength and an ability to invest in critical core capabilities and technologies. We have reduced our participation in sectors that have lacked growth and return characteristics we expect. And we do think the recession will be a catalyst for more outsourcing from more companies and a broad base of industries. We are stressing customer service and maintaining an aggressive posture to build our business.

Business has been unpredictable over the past year and I don't expect the clouds to break in the next 90 days. But I think people and businesses will continue to need electronic products and adjacent services and I expect much of this to be outsourced to experts like Jabil and a few others in our industry. A severe recession can be transformative and cleansing. With our financial strength, breadth of services and focus on customer service, I think we have a solid future ahead of us.

Beth Walters

Operator, we are now ready to begin our question and answer period.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from the line of Brian Alexander with Raymond James.

Brian Alexander – Raymond James

Thanks. Just on the EMS segment, if I did the math right, it looks like the revenue was down about 18% year-on-year but operating income was down about 66%, so quite a bit more negative leverage than I think some of us were expecting, could you kind of talk about that and relate that to the gross margin weakness that you saw in the quarter? Thanks.

Forbes Alexander

Brian, yes – I mean if you look at where we have come from over the last couple of quarters, it is really about some of the declines we've seen in the EMS sectors we're serving there against the cost base we have in place. So going back, as we had started the beginning of the fiscal year, we are building a footprint, we are in place of about 3.8, $3.9 billion, and the EMS sector being a very large proportion of that, we expect those (inaudible). And as we come through, we have seen somewhere in the region of $300 million to $400 million of revenue peel off there. And it is a case of appropriately bringing our cost base in line as that revenue declines which we are attacking. We have announced a restructuring plan in the quarter. That is in process. We're communicating that to our employees and we should start to see benefits of that moving forward into the back half of the year. The one thing we do need is revenue declines to abate with the end markets we're in. But it is principally around the rate of decline you have seen there. Now as you point out, the consumer division is doing relatively well given the marketplace we are facing here with some sequential growth in our mobility sector, offset by seasonal declines in displays and peripherals. So it is really about appropriately sizing the cost base in the EMS sector and to a degree the consumer sector.

Brian Alexander – Raymond James

And then maybe just comment on the guidance, the pretty tight range of revenue guidance, 2.5 to 2.7 billion, but clearly a wide range of profitability of breakeven to 40 million in terms of core operating income, what is driving such a wide range of operating incomes on such a tight range in revenue outcomes?

Forbes Alexander

Yes. So if you look again, I take you back to the progression of what we've seen in terms of declines in revenues. So what we saw in the second fiscal quarter versus the first fiscal quarter, for every dollar of revenue, we saw approximately a $0.10 of income peel out. The low end of our guidance, as you point out, the range is wider, the low-end of our guidance for fiscal Q3, we suggested $0.12 to $0.13 type decline for $1 revenue. So we're really depending on the mix across our sector base, some of the potential timing of that and our restructuring activities will very much depend where we land in the quarter. So there is some – there is little bit of conservatism built in there at the lower end given that metric that I just quoted of $.10 on the dollar of decline, but we feel it is appropriate given the overall macroeconomic condition in the markets we are serving, so appropriate but I think realistic in terms of the range.

Brian Alexander – Raymond James

Okay…

Tim Main

I think the revenue guidance being a little bit tighter is a little bit of a function of I think the rate of erosion slowdown a bit and I feel a bit more confident that our revenue range is pretty solid. The mix of the business will have a pretty significant impact to the actual profitability levels. And frankly I think we are just being relatively conservative in this environment. Operator, we will take the next question, please.

Operator

Your next question comes from the line of Amit Daryanani with RBC.

Amit Daryanani – RBC

Thanks a lot. Good afternoon guys. In the past, you have talked about I think looking at strategic alternatives on the display and even the auto business. Is that still on the table and do you expect to have some sort of decision on that business in the near term I think given that profitability continues to be an issue in both those segments?

Tim Main

Both segments are much less of an issue than they have in the past. We have really proactively worked those sectors down below 7% of revenue and so I wouldn't expect them to be a significant topic of discussion going forward.

Amit Daryanani – RBC

All right. And then I guess looking to calendar 09, do you get a sense that this should be the low point in terms of the May quarter from a revenue perspective or do you think it remains choppy and will possibly continue to trickle down sequentially on a broader revenue basis?

Tim Main

I don't think our crystal ball is any better than yours and visibility is pretty tough to predict. I think we have just really recently over the last three or four weeks started to see a little bit most stability. And our February report versus our March report, but March reports are really bad. Our February quarter was up a little bit by the fact that December was still a pretty good month in terms of run rate and the consumer season and then the inventory adjustment took place I think customers probably overshot or were a little bit too optimistic in the October, November, December time period. And that was definitely an inventory adjustment in the January, February period. So I think your March reports will probably reflect that as well.

And as well, early, if we were reporting in April, which we would have if we are a March reporting, we might have a little bit in guidance and a little bit more confidence that maybe we were starting to see the bottom. This coupled with recession here, bottoms are unpredictable. They by nature tend to be pretty choppy, but what you will see is revenue levels starting to stabilize overall. The mix will become very unpredictable but the fact that we are winning new business if we gain some stability, the numbers still have to go up, they just have to stop start going down at the rate they have been. Then the new business wins will begin to show positive growth in revenue and will start to enjoy some significant operating earnings leverage.

At this point, we are being – if we had to take a guess, the $2.7 billion range is kind of where we are today. We are guard banding a bit for further erosion down to 2.5. And we will see I think our primary focus right now is to make sure that we have the right liquidity and the right financial flexibility which I think we have done and then when things start to stabilize whether it is this quarter or next quarter, then we will be able to start to grow earnings and margins again.

Amit Daryanani – RBC

Fair enough. Just a final question for me, Forbes, you guys did a pretty good job with cash and ratio in the quarter, could you just update us on your thoughts regarding the debt that comes due next year and is the goal really just to pay it off with the cash you have or roll over the debt with some new issues at some point?

Forbes Alexander

Amit, we will continue to look at that, but certainly with the cash generation that we are seeing, certainly very, very healthy levels as you pointed out this quarter, we expect that to be healthy again at the end of May. But certainly you we will keep an eye on the credit market overall and depending where the bottom is here, we continue to see further cash generation. If this were not the bottom, we all hope that it is, but certainly cash levels with our working capital would remain in that 900 plus type arena.

So we will mark to the credit markets. I think there is opportunity to potentially redeem those but we will wait and see. We will wait and see. Obviously, when we see an upswing, we will be consuming working capital just when that occurs, but there is material in July next year. We have got plenty of runway yet to determine the course of action. Right now, we're focused on liquidity, growing the cash balance and managing working capital.

Amit Daryanani – RBC

Fair enough. Thanks a lot for your time guys.

Forbes Alexander

Thanks.

Operator

Your next question comes from Sherri Scribner with Deutsche Bank.

Sherri Scribner – Deutsche Bank

Hi, thank you. Tim, last quarter you gave a lot of detail in terms of how you thought about revenue in the quarter and the guidance that you gave and then talking about this quarter that you are handicapping the revenue by about 9%. I was hoping maybe you would give us a little bit of detail on how that works out versus – how the quarter played out versus your expectation? Clearly, the revenue was a bit better than the Street was expecting and then also what you see going into the third quarter?

Tim Main

It was a little bit like Q1 in that when we have the conference call, orders really hadn't been cut and we were looking at a forecast which was significantly higher than we were guiding to. And in December, we felt that probably when January rolled around that customers – there was a high probability that customers would come back and cut their forecast and that is what happened. So the same thing again happened in September, we provided guidance, and then mid-October through November, customers cut schedules pretty significantly, so I think it played out pretty close to how we thought it would play out. You know we went into the quarter with a much higher revenue level than 2.88 billion, and experienced the erosion again in mid-January through February. Again the last three or four weeks have been relative to our experience since mid-October has been relatively stable. I wouldn't say numbers have been real good but we have seen a couple of customers here and there enjoy higher sell through rates and a couple of upsides that have offset a couple of downsides so starting to look like we are either there or approaching a bottoming off the recession. But again I think Forbes said and I will say it again I think we are taking – continuing to take a – be wary of additional potential erosion in trying to handicap that into our guidance.

Sherri Scribner – Deutsche Bank

Okay, thanks. That is very helpful. And then, Forbes, in terms of the portion of the debt that is on the – in the current portion, I was hoping you could give us a little detail of what is in that current portion and also give us an idea of what you think your maintenance CapEx is, is that 400 million to 500 million a quarter?

Forbes Alexander

Maintenance CapEx is about $30 million to $40 million a quarter in terms of the maintenance CapEx. In terms of – sorry the first part of your question, I'm sorry, Sherri…

Sherri Scribner – Deutsche Bank

In the current portion of your debt, what is actually in that number right now?

Forbes Alexander

Okay. That is primarily the on balance sheet accounts receivables securitization program.

Sherri Scribner – Deutsche Bank

Okay.

Forbes Alexander

That is a 364 day facility.

Tim Main

There is two. There is a US and European, and the European one is on balance sheet.

Forbes Alexander

European is on balance sheet and the US once is off-balance sheet.

Sherri Scribner – Deutsche Bank

And you renewed both of those?

Forbes Alexander

That is correct, yes.

Sherri Scribner – Deutsche Bank

Okay, thank you.

Forbes Alexander

Okay, thank you.

Operator

Your next question comes from the line of Jim Suva with Citigroup.

Jim Suva – Citigroup

Great, thank you. Tim, last quarter you mentioned that you had a couple customers that were looking at in sourcing a little bit to I believe to fill some of their internal capacity, not have them lay off some of their own employees and shut facilities, have we reached the end of that or are there some more room to go on that, both in terms of those couple of companies as well as are there additional ones?

Tim Main

I haven't heard of any additional ones and I think the process is pretty complete.

Jim Suva – Citigroup

Okay, great. And as a follow-up, the outsourcing trend, which is the Holy Grail of this industry, but yet we are facing a recession, does it take a little bit of stability for the OEMs to start to outsource more or when you think we should start to see a meaningful push to incremental outsourcing?

Tim Main

Well, using the ‘91 recession and the 2001 and 2002 recession as guides – I know it is very hard, and I don't mean to be Pollyanna-ish about it, but we – it is hard to think – not to think in 90 day buckets. Let’s put it that way. These things take more than 90 days to transpire and have position made. So if you looked at the three to four year trend after each of the 2001, 2002 recession, and the ‘91 recession, the next three, four years were extremely robust periods of growth for the entire industry and pretty darn good periods of growth for Jabil as well. And for Jabil, that 2002 to 2006 time period was the most robust period of growth for Jabil and the industrial, instrumentation and medical sector, we opened up consumer electronics and enjoyed some great growth there. So our revenue in 2002 was 3.5 billion, by 2006 it had gone to 10.3 billion, so that is about 190% growth over that four year period, and EBITDA grew substantially as well by 73%.

So the next 90 days are important. I don't mean to minimize that and we're hard at work managing the details in our business to ensure that we manage inventory receivables and the blocking and tackling in our business that is kind of our bread-and-butter that really that is not the most important thing from running a company that intends to create shareholder value long-term. What is really important for us is to make sure that we capitalize on the opportunities. And what we think of it is, we are the best funded and financially strong large-scale global players in the business and using that to our advantage in terms of building market share and opening up new opportunities for our company with the existing and new customers and even those who have not outsourced in the past.

Jim Suva – Citigroup

Okay. And then switching over to Forbes, Forbes, can you may be help us a little bit about post the restructuring efforts, what level of revenue run rate will you be repositioned? And any thoughts on the dividend, is it stable here, you planned it quarter by quarter, because the yield is about 7% if I do my math right, which is quite high?

Forbes Alexander

Yes. In terms of the dividend, I mean we obviously review that with our Board on a quarterly versus. We will continue to do that. Certainly, our cash generation is strong, but yes, we will continue to review that. My sense is that fairly there has not been any discussion about removing that dividend with these types of cash generation and recovery that we expect going forward. Jim, your first question, I didn't quite understand in terms of levels going forward in terms of revenue?

Jim Suva – Citigroup

Yes. Post your restructuring, what fixed costs and footprint run rate of revenues for profitability are you kind of gearing towards?

Forbes Alexander

Yes. So obviously with this guidance you know we're looking at breakeven of 2.5 billion or so. We will get the restructuring complete over the coming months here. Really that would – assuming revenues remained at those levels, that would certainly make us a profitable by that $50 million of annualized savings, if you will. But once the restructuring is complete, I think overall, we expect to see business wins come in and we're planning really around the 2.8 type billion dollar quarters, 2.8 to 3 billion type quarters over the coming six to 12 months.

Jim Suva – Citigroup

Great. Thank you very much for the details.

Operator

Your next question comes from the line of Matt Sheerin with Thomas Weisel.

Matt Sheerin – Thomas Weisel

Yes thanks. Good afternoon. Just a question regarding your guidance and I appreciate the fact that you're not giving specific guidance on your end markets given the lack of visibility but could you give us a sense of I mean I know you are guiding down for each of those areas but a sense of areas that are stronger than others or weaker than others?

Tim Main

In the next quarter?

Matt Sheerin – Thomas Weisel

Yes.

Tim Main

The next 90 days I think mobility will be a little bit stronger than the rest and then some of our IC areas will be relatively weaker. If you were to look at the percentage of our business, kind of select any revenue number, 2.6, 2.7 billion, I think that each sector in terms of the percentage of our overall business will be relatively stable, mobility probably up a little bit and then one or two of the IT areas down a little bit.

Matt Sheerin – Thomas Weisel

And is mobility, Tim, related to more customer wins? Or just strength within existing customers?

Tim Main

That has more to do with volume of existing customers.

Matt Sheerin – Thomas Weisel

Okay. And do you have a sense of inventory issues at customers because I know that some of them have their own inventory issues that they have to work down and how much of that do you see and how much noise do you have to deal with there aside from end market weakness?

Tim Main

In terms of customers managing their inventory?

Matt Sheerin – Thomas Weisel

That is right.

Tim Main

Yes. How that shows up for us generally is a reduction of schedules. I mean I think that had some impact to us in the January, February period. And it depends on the customers and their leverage point with us and it is always negotiation but I think we will continue to work our inventory levels down and continue to strive for lower levels of investments, short-term and long-term in our entry levels, and generally that is good for the customers. I mean if you just look at the last quarter, we did reduce interest expense I mean to the extent that we have a lower-level investment in inventory, that lowers our cost structure and it is good for the customers too. So I don't see that being, it is not like the relationship that might be in place with some d distributors, component distributors and customers and that type of thing works, but it is a straight shifting of ownership responsibilities, more of a focus I think in the industry today. It is looking at total network costs and trying to reduce those network costs and inventories and the costs customers and their EMS providers have, at the end of the day really have a common interest in reducing.

Matt Sheerin – Thomas Weisel

And on that inventory issue, you did a good job of taking inventories down, and should we expect a similar reduction and do you expect to keep your inventory turns at that eight level this quarter as well, in the May quarter?

Tim Main

Keep the inventory levels at eight?

Matt Sheerin – Thomas Weisel

Yes.

Tim Main

I don't see inventories falling below an eight turn level. I think we are on a very good path, we have made a significant progress late in the second half of the second quarter, and that's really where we saw the most pronounced reduction in our orders too. So we are on top of it, I think we will – I think from a modeling moral purposes standpoint I think it would be well advised to stay with eight and maybe you'll get a surprise if it becomes a little bit better but I don't think we need to worry about it being at a lower-level than that.

Matt Sheerin – Thomas Weisel

Okay. And then just lastly, your commentary about increased outsourcing as we get deeper into recession, and that make sense, and the question is, are you having conversations with OEM customers now that may be looking to take some of their own capacity off-line at some point?

Forbes Alexander

Yes. I mean that is consistent with general trends of the outsourcing particularly in these recessionary times, discussions are ongoing. As Tim made in his – said in his earlier remarks, there is no instant gratification, if you will, it is not next 90 to 180 days, but certainly there is some up tick with OEMs looking at their fixed costs base versus moving to a more variable model in the EMS space. So, yes, those conversations continue, but again one has to consider the timeline there in the next 6 to 12 months, but those are continuing across a number of segments.

Matt Sheerin – Thomas Weisel

Okay, thanks a lot.

Operator

Your next question comes from the line of Shawn Harrison with Longbow Research.

Joe Wittine – Longbow Research

Hi. This is Joe Wittine calling in for Shawn. Most of my questions have been answered at this point. I wanted to the drill in on some of the details on the restructuring plan just to be perfectly clear I guess. So the 55 million in savings that you are forecasting, hoping you could give us some guidance for modeling, how to model the quarter by quarter. In fact you had said in the prepared comments that I think restructuring was a favorable – had a favorable impact on SG&A during the quarter, so I'm assuming you saw a little bit of the benefit in the current quarter, but I am just kind of curious how you are modeling those going forward?

Forbes Alexander

Yes. I mean there is probably $0.5 million to $1 million of benefit in the current quarter. The way really to think about this is to follow the cash. So in my prepared remarks, I give some guidance on the cash that we expect to expand next quarter, I think it is up by 10 or $12 million. So that is really tied to employees leaving the company, so as we look forward, having given guidance yet over the next 2 to 3 quarters truly becomes we are still in discussions with employees and their representatives, particularly in Europe. But certainly next quarter I would expect to see $5 million to $6 million of benefit baked into the guidance that we have seen and then you should see that progress towards a double-digit number in the following quarter and beyond to an annualized run rate of about 55 million.

Joe Wittine – Longbow Research

Okay. That is helpful from an accounting perspective. And then what about from a balance sheet – excuse me, from a P&L classification perspective as far as the SG&A versus COGS break down, I'm assuming it will be over weighted in SG&A savings?

Forbes Alexander

It is actually more headed right now towards the manufacturing cost line, primarily because we have announced closure of one site and the scaling of direct labor in other sites. So the majority of that cost currently certainly is within the manufacturing cost line.

Joe Wittine – Longbow Research

Okay, great. And then switching focus I want to ask a I guess a specific end market question, when I was going over your end market versus kind of what you said previously, displays looks it was a little bit better than you had thought, it was down 50% versus 70% and obviously it is difficult to forecast when numbers get that big, but just curious if anything, if there were any positive surprises there, or it was just a difficult number to forecast?

Forbes Alexander

Yes. That is no real positive surprise fortunately there. It is – and the scale of that sector, as we said – we are de-emphasizing that, but the revenue stream in the quarter was $100 million or so, so the actual dollar shift there or surprise if you will are up or down more than that large – I think just generally, it is a little more robust than perhaps we thought in the December period , but no clear indications of positive moment.

Joe Wittine – Longbow Research

Great. And then just lastly if I could a real quick ratification, the Nortel write off, what line on the income statement should that come on, is that in COGS?

Forbes Alexander

It is actually reduction revenue because those were sums that have been built and have been reserved against.

Joe Wittine – Longbow Research

Okay. Thanks very much.

Forbes Alexander

Okay.

Operator

Your next question comes from the line of William Stein with Credit Suisse.

William Stein – Credit Suisse

Thanks. Tim, you spoke about some business wins and also mentioned some customer disengagement, it sounded like you guys initiated maybe because of lack of profitability with them, can you talk about what segment you saw that in and whether there is a broader strategy around that going forward?

Tim Main

Just to be clear, we didn't mention any customer disengagements. What I said is that, specifically that, reduced our participation in sectors that lacked growth and return characteristics that we desire, so no big customer disengagements. We don't expect to have any large customer disengagements actually going forward. I think the reduction in our automotive and display sectors kind of speaks for itself.

William Stein – Credit Suisse

And new wins focused in any particular area, any particular segment?

Tim Main

We certainly have done well in mobility, we continue to target the industrial, instrumentation and medical segment as a key sector that would drive our growth going forward. We intend to be very robust and aggressive in the storage sector and…

Forbes Alexander

We are doing well in the peripheral sector also.

Tim Main

Yes, we have done actually some very significant wins in the peripheral sector both in our traditional markets as well as in set top boxes. So it’s a pretty robust sector there.

William Stein – Credit Suisse

Peripherals, can I take it to mean a customer consolidating into fewer vendors?

Tim Main

That could be part of the benefit that we would expect to see there long-term, but specifically with regard to new business wins, I was thinking more of the set-top box business, but certainly customer consolidating their supply base, we think would be a beneficial process in a lot of cases, in most cases, nine out of ten cases, we expect to be the benefactor.

William Stein – Credit Suisse

Just one other quick one, it has been a while since we talked about Taiwan Green Point, can you – and I know you don't disclose on that separately, but can you talk about status with that part of that business in terms of delivering integrated assembly and componentry in the mobile market?

Tim Main

I think it is a true end to end solution that is still a work in process. I would say that I regard the integration of our traditional EMS services with the technology which includes the capabilities of Taiwan Green Point to be complete within our mobility sector, and it is our intent to drive that end-to-end solution with our customer base. There will be different rates of adoption and different levels of acceptance, customer to customer, depending on what their particular supply chain strategy is. The traditional vertical assets that we have shown very good profitability when loaded more typical for them to earn satisfactory returns in environment like this when numbers go down abruptly.

But as recently as Q1, we have seen significant levels of profitability and we think the overall trend and our strategy is the correct one within the mobility sector. So we intend to continue to press our advantage there and our focus is more in the high range smart phone area and we think there is really know reason to believe that – and our numbers will be up and down and they will be our product and not our product, but we think that consumers overall around the world will continue to migrate to a more integrated device, and we are targeting the best customer in the world in that space, and we intend and have seen good evidence of our ability to earn our fair share or more in that space.

William Stein – Credit Suisse

So higher operating leverage in that business right? So you said…

Tim Main

Much have operating leverage absolutely. So yes, I mean in a stable to positive environment, I think it would be – mobility would be an accretive business to our overall business. In an environment like this, it is pretty tough.

William Stein – Credit Suisse

Okay, that’s what I figured. Thank you very much.

Tim Main

Okay.

Beth Walters

Operator, I understand we have one final question on the line?

Operator

Yes. Your next question comes from Amit Daryanani with RBC.

Amit Daryanani – RBC

Thanks. Just had a couple of quick follow-ups, first on the restructuring side, can you just talk about how much of those savings that we expect would actually flow through Jabil’s P&L versus how much would you have to really share with your customers as you positively transition that work from one region to another?

Tim Main

That's a great question, Amit, and I'm sorry to say I'm unlikely to give you a direct answer to it. We need to adjust our cost – you the kind of the way we look at this, let me put it this way. So we're making a judgment that probability is that we will be running at 2.8 to $3 billion run rate per quarter for the next few quarters. And we have got our cost base. We are trying to adjust our cost base to that level to earn a 3% operating margin on better. If business were worse than that, then we have to reduce our cost structure even more, and if business got better than that, then we will experience positive operating leverage and gets above that 3% level.

We intend to provide our customers the absolute best cost optimized, value optimized solution in the world amount and deliver our shareholders a margin expansion and growth models for their investment in our company. So it is not as easy as black-and-white and when we talk about a 55 million a year cost reduction, that is a cost reduction we expect based on where are margins have been, that is a costs reduction that we need to earn an adequate return on our business.

Amit Daryanani – RBC

Got it. And on the revolver that we have, I think there is a covenant of three and a half times debt to EBITDA on that, and at least if I annualize the guidance we have for May, it looks like you would be breaching that covenant to me. Is that fair and is that an issue? I mean do you have to go restructure it, or do you think you'll just make enough money in the next few quarters?

Tim Main

Now let us be clear on that. If you annualize $118 million of EBITDA…

Amit Daryanani – RBC

I am sorry, I am actually talking about May quarter guidance and annualizing that.

Forbes Alexander

Amit, you're correct. The three and half times debt to EBITA, that is trailing 12 months. So we would have to be in this type of environment for the next year to be and do nothing in terms of cash generation or reduce our levels of debt to be near any beach of any covenants. So we are in particularly good shape, we have very strong cash generation this quarter as we talked about, we expect the same again next quarter. That gives us the flexibility across our capital structure and the overall management of the corporation. So we're in great shape, that covenant is certainly below three times and is anticipated to be so into perpetuity.

Tim Main

I mean if we ran the company for four consecutive quarters to breakeven, that would be a problem. But at the high end of the Q3 guidance, which I consider probably is as bad as we can imagine things getting, we're right about at the covenant. And with the cash flow generation to be over a billion dollars, we would simply go out and retire the bonds and reduce that back down to a manageable level. So let’s be clear that there is really no – there is no refunding debt risk there that we can't manage through. And the other side of it is if we got into the quarter and we thought that instead of running $2.8 billion a quarter, we are actually going to stay at $2.5 billion a quarter for the next few quarters, we have reduced our cost base more so that we can earn money at that level. And we will generate a heck of a lot more cash and actually be in a more liquid position to retire the bonds that would be necessary to stay within the terms of the covenants. We don't really perceive any funding reserve.

Amit Daryanani – RBC

Got it. That is extremely helpful. Hey Tim, just to be clear, did I hear you say that at the high end of your guidance is about as bad as you think it gets?

Tim Main

No. The guidance that we provided for Q3 is about as bad as we can imagine it getting.

Amit Daryanani – RBC

Got it. Thanks a lot.

Tim Main

Okay.

Operator

There are no further questions.

Beth Walters

Great. Thank you very much, operator and everyone, for joining us on the call today.

Operator

This concludes today's conference. You may now disconnect.

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