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Jabil Circuit, Inc. (NYSE:JBL)

F2Q10 (Qtr End 02/28/10) Earnings Call Transcript

March 23, 2010 4:30 pm ET

Executives

Beth Walters – VP, IR & Communications

Forbes Alexander – CFO

Tim Main – President & CEO

Analysts

Steven Fox – CLSA

Brian Alexander – Raymond James

Lou Miscioscia – Collins Stewart

Amit Daryanani – RBC Capital Markets

Sherri Scribner – Deutsche Bank

Wamsi Mohan – Banc of America-Merrill Lynch

Matt Sheerin – Thomas Weisel

Joe Wittine – Longbow Research

Amitabh Passi – UBS

Jim Suva – Citi

Kevin Smithen – Aragon

Operator

Good afternoon. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Jabil second quarter earnings 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.

I would now like to turn the conference over to Beth Walters. Please go ahead.

Beth Walters

Thank you. Welcome to our second quarter of 2010 fiscal year call. Joining me on the call today are President and CEO, Tim Main; and our 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 the presentation with the slides that are posted on the website and begin with Slide One now, our 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 2010 net revenue and earnings results, our long term outlook for our company, and improvements in our operational efficiencies and in our financial performance. These statements 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, 2009; on 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.

Please now turn to Slides Two and Three, results for the second quarter of fiscal year 2010. On revenues of $3.0 billion, GAAP operating income was $61.8 million. This compares to $706 million GAAP operating loss on revenues of $2.9 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 $95.6 million or 3.2% of revenue; as compared to $51.2 million or 1.8% for the same period in the prior year.

Core earnings per diluted share were $0.29 as compared to $0.13 for the same period in the prior year. On a year-over-year basis for the quarter, revenue increased 4%, while core operating profits increased 87%. On a sequential basis, revenues decreased by 3%, while core operating income decreased 9%, reflecting the seasonal nature of our consumer division. Of note, this was the lowest second quarter decline in revenue in core operating income since fiscal 2004.

Please turn now to Slides Four and Five for a discussion of revenue by division and sector for the second fiscal quarter. Starting with the EMS division, it represented approximately 61% or $1.84 billion, sequential growth of 10% as compared to the first quarter of fiscal 2010. Core operating income for the division was 4.2% of revenue.

The sequential sector movements are as follows

computing and storage increased 15% from the first quarter, representing 11% of revenue; industrial instrumentation and medical sector increased 14% from the prior quarter as a result of growth across a broad number of customers. This sector represented 23% of revenue. The networking sector levels of production increased by 18% from the previous quarter. This sector represented 18% of revenue in the quarter. Telecommunications sector decreased 6% sequentially, and represented 5% of the second quarter's revenue.

Turning to the consumer division, this division represented approximately 32% or $970 million in the second fiscal quarter, a sequential decrease of 21%, again reflecting the seasonal nature of this division. Core operating income for the division in the quarter was 0% of revenue. Digital home office sector decreased by 7% from the first quarter and represented 15% of revenue. The mobility sector decreased 30% from the prior quarter, reflecting the seasonal nature of these products, and represented 17% of revenue in the quarter.

Turning to the aftermarket services division, it decreased by 2% from the prior quarter to $196 million, and represented approximately 6% of overall company revenue in the second fiscal quarter. Core operating income for the division in the quarter was 10% of revenue.

In the second quarter, two customers accounted for more than 10% of revenue and our top 10 customers in the quarter accounted for approximately 58% of revenue. Selling, general, and administrative expenses increased by approximately $2 million to $119.8 million. Research and development costs were $7.4 million in the quarter. Intangibles amortization was $6.6 million. Stock-based compensation was $26.5 million in the quarter. The increase was primarily related to performance-based equity awards, which were previously deemed unlikely to debt in fiscal 2009, but based on current expectations, are now expected to meet the requirements for at least a portion of the amount to debt. Net interest expense for the quarter was $21 million. The tax rate on net core operating income in the quarter was 16%.

I will now turn the call over to Forbes Alexander.

Forbes Alexander

Thank you, Beth; good afternoon. I would like to ask you to turn to Slide Six through Eight. I will give you some commentary on our balance sheet.

Our sales cycle in the second quarter expanded by one day from the first quarter at 17 days. The increase in days in inventory of five days was offset by an improvement in days sales outstanding of five days, while payables days contracted by one day. While our inventory days expanded, reflective of the constrained materials environment, we remain very pleased with the overall level of working capital performance. We continue to generate cash flow from operations, producing exactly $1 million in the fiscal quarter.

Our return on invested capital was 18% for the quarter. Our cash and cash equivalents were $794 million at the end of the second quarter, with no sums outstanding on our $800 million revolving credit facility. Our capital expenditures during the quarter were approximately $78 million. Depreciation for the quarter was approximately $63 million, with core EBITDA in the quarter being approximately $159 million or 5.3% of revenue.

Cash payments associated with the restructuring plan we announced in fiscal 2009 were approximately $16 million. The majority of payments associated with this plan are now complete. We are also pleased to note that we have recently renewed our Accounts Receivable securitization facilities so that total availability under these facilities of $300 million.

In summary, we are pleased with the quarter's results. The quarter, where our revenue and income streams are typically sequentially done due to seasonal slowdown in consumer spending. We are encouraged that in a constrained materials environment, which we are all facing, such sequential decline at its lowest levels since fiscal 2004. Working capital management remains well under control, and cash flow from operations continues to be positive.

On a year-over-year basis, first half of fiscal 2010 has seen us produce $50 million more in core operating income on a $177 million lack in revenues, reflective of our continued focus in turning the company to produce a long-term positive return level.

I will now ask you to turn to Slide Nine, where I will discuss our third quarter of fiscal 2010 guidance. The overall guidance for the third fiscal quarter is as follows

Revenue in the quarter is estimated grow sequentially in the range of 3% to 10%, or a range of $3.1 billion to $3.3 billion. The EMS division is expected to grow 8% sequentially, while the consumer division is expected to grow 5%. The AMS division is expected to have consistent revenues with those of the second quarter.

Core operating income is estimated to be in the range of $100 million to $120 million. Our guidance reflects approximately $5 million of costs associated with our investments, and new program ramp activity associated with the expansion of process technology capabilities within our Jabil Green Point mechanical operations. I would also like to point out that the mid-point of our guidance reflects revenue growth of approximately $600 million or 22% on a year-over-year basis, while core operating income growth of $80 million represents an 81% growth on a year-over-year basis. A year ago, we discussed that we would expect income leverage of $0.10 to $0.15 per incremental revenue dollar from our low revenue point of $2.6 billion a quarter. At its mid-point, our guidance reflects a cumulative income leverage of $0.14 per revenue dollar. As a result, core operating income margin is expected to be in the range of 3.2% to 3.6% and core earnings per share are expected to be in the range of $0.30 to $0.36 per diluted share.

Our selling, general, and administrative expenses are estimated to be consistent at $120 million. Research and development costs are expected to be approximately $8 million in the third fiscal quarter, while intangibles amortization is expected to be approximately $7 million. Stock-based compensation expense is estimated to be in the range of $15 million to $26 million in the third quarter, depending on company performance in the second half of our fiscal year. Interest expense is estimated to be consistent with that of the second quarter at $21 million, and based upon the current estimates of production and income levels; our tax rate on core operating income is expected to be 20%.

Finally, turning to capital expenditures, we plan to invest an incremental $70 million, which totals $150 million of expenditure in our third quarter. This incremental sum is principally to fund new process technology mechanical capabilities to support numerous exciting program wins within our Jabil Green Point mechanical operations.

Now, I would like to hand the call over to Tim Main.

Tim Main

Thank you, Forbes. The second fiscal quarter started with a great deal of uncertainty, but ultimately provided positive indicators for the course of our business. First of all, year-over-year margin expansion was 180 basis points on the gross margin line, and 170 basis points at the core operating margin line. This is on a relatively modest 4% increase in revenue. We also had two consecutive quarters of gross margins above 7% and core operating income margins above 3%. I believe our focus on efficient operations and realized savings from previous rationalization plans are delivering the expected improvement in our profitability, even more apparent now as we are growing revenue at the same time.

Secondly, the second quarter was the lowest level of seasonality we have seen since fiscal 2004, indicating we are doing a reasonable job of expanding our business and targeted markets as the macroeconomic environment shows some sustained improvement. The industrial instrumentation and medical sector was up 14% sequentially and increased to 24% of our revenue in the second quarter, indicating we are successfully developing our value proposition for important customer relationships in this sector. Business in our enterprise sectors was also strong in the quarter, indicating some tailwinds to demand. The consumer facing parts of our business were down sequentially, a bit more mobility than expected, but our digital and home office sector, which covers displays and set top boxes businesses was only down 7% sequentially, lower than historical averages.

Unbalanced consumer spending is out rebounded by the strength we have seen in other areas; there are positive signs of stability, and even some growth in certain areas. I think it is interesting that business spending appears to be leading a recovery, and businesses really clamped down on IT spending during the two-year recession, so we are seeing some investment to satisfy that pent-up demand. All companies are focused on productivity and in reducing variable expenses such as travel, and investment in a strong IT infrastructure and in products such as videoconferencing really helps companies improve their productivity and reduce costs. And there are some secular trends which favor a high speed, advanced communications infrastructure. Video content over the Internet and the telecommunications infrastructure is increasing at double digit rates. Data storage and management is becoming an enormous and complex task for companies all over the world. So some good reasons we are seeing what we are in enterprise spending.

With all of these positive indicators in mind, we continue to be conservative in our guidance. We will simply earn in the second half of the fiscal year what we earned in the first half. Fiscal 2010 will be a record year for Jabil by a wide margin. Continuity of component supply continues to be initial regroup with and I don't expect a great deal of improvement in the near term. And we would like to see consumer spending rebound and be sustained for several quarters before we become more aggressive in our guidance. For the balance of the year, we will be focusing on customer service, improving our capabilities, reducing our cost structure, and expanding in targeted markets. We feel good about our opportunities and successfully executing these initiatives and deliver a good year for stakeholders in Jabil.

Beth Walters

Operator, we are ready to begin the question and answer portion of the call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Steven Fox with CLSA.

Steven Fox – CLSA

Good afternoon. Can you hear me?

Tim Main

Yes.

Steven Fox – CLSA

Tim, can you just talk a little bit more about the investments going into Green Point? How much is it sort of next-generation type of mechanicals and anything you can expand on there in terms of the product it is going to drive?

Tim Main

Well, there are, as Forbes indicated, some new program wins in new process technology and because of the sensitivity around that, we really can't say much more about it at this point. Hopefully, as time goes on and we get a little bit more traction there, we will be able to provide more information, but for now, we really need to be precursory in what we can say there.

Steven Fox – CLSA

Can you talk about the timing of when the investments turn into programs at all?

Tim Main

It is basically (inaudible) with the investment.

Steven Fox – CLSA

And then just the last question. Can you talk about the components of buy constraints a little bit more in detail; where do you see the most constraints, and what is going to change that from – to get back to a sort of a normal supply environment?

Tim Main

Well, you know, it started with some of the IT spending increasing late last year in October, November and really in the semiconductor area and memory, we are really highly constrained, and actually, some of those areas have improved of that, some of the more responsible semiconductor companies have actually decided to bring additional capacity online. But as the overall economic recovery broadens into some of the other areas and actually starts to touch industrial controls, medical accounts, you know, other areas of consumer spending like printing, and even light goods, we are starting to see some really – type of supply constraints that we haven't seen in a long time, on things like (inaudible), and MOSFETs and even some capacitor types of commodities, which had been in plentiful supply for several years and I think the supply base in some of those lower level areas, I don't mean lower level from a prestige standpoint, it is in terms of lower level or in terms of expense on a typical given material. They are going to lag their investment and capacity a little bit longer, until they actually believe that the economic recovery is sustained. So, you know, what we see is an elongation of lead times, and we will probably continue to see that for a while and it has been difficult to predict what the type of specificity that we would like with customers exactly will be able to ship and when. But I think we are probably looking at a couple of two or three more quarters of a little bit of a dicey supply situation.

Steven Fox – CLSA

Okay. Thank you very much.

Tim Main

Okay.

Operator

Your next question comes from the line of Brian Alexander with Raymond James.

Brian Alexander – Raymond James

Yes, the ramp-up in CapEx to $150 million next quarter for Green Point, what is the pace of investment beyond the May quarter? I think you had previously talked about $200 million to $250 million for the year in CapEx. It seems like you would be well above that. So can you just give us an update there?

Forbes Alexander

Hey, Brian; this is Forbes, I will take that one. I just wanted to be clear in terms of my prepared remarks. The $150 million in our third fiscal quarter is not all related to this mechanical expansion. It is somewhere in the region of $70 million to $80 million associated with that, and the balances are ongoing maintenance-type CapEx levels and IT infrastructure build-out that we talked about in previous quarters. Having said that, our CapEx levels in our fourth fiscal quarter should return to more of a normalized level in that $50 million to $70 million type arena. So that would put us somewhere about $300 million to $325 million, something of that nature for the fiscal year.

Brian Alexander – Raymond James

And how much incremental revenue are we talking about related to these new wins?

Tim Main

Again, it is an area that we can't get into. I would remind you that the mechanical operations though tend to be a much higher value-add revenue stream, and so, the revenue levels are not what you would like to see in the typical printed circuit board assemblies, system integration type of revenue streams. So the revenue levels would be a little bit lower than you typically expect, although with the addition of value-add in the revenue stream, we believe the returns should be good for the company and certainly meeting the guidance that we have.

Brian Alexander – Raymond James

So it seems like the EMS division has really been driving the contribution margins for the last few quarters and they are very healthy at over 4% for the quarter you just reported, with consumer break even. So should we expect a further improvement in contribution margin up to the $3.5 billion per quarter? Should we expect that incremental profitability that largely comes from consumer, given the ramps we are talking about and the breakeven status of that business?

Tim Main

Yes, I think looking at consumer being a break even sector, you know, keep in mind we have some consumer facing businesses in the EMS division, but in a February seasonally down quarter for consumer, you would expect significant margin improvements from consumer in the better quarters, our fiscal quarters of Q3, Q4, and fiscal Q1, so the next three quarters should be progressively better for consumer. I would discourage though people to look at that on a division-by-division basis, and I continue to focus people on the $0.10 to $0.15 of operating leverage per incremental dollar of revenue, right up until the $3.4 billion to $3.5 billion revenue per quarter range, and this is based on the guidance for Q3, that is now four or five quarters in a row of being able to demonstrate that type of operating leverage. So, I think people can still be reasonably comfortable that that is the operating leverage they will see as revenue recovers into that $3.4 billion to $3.5 billion per quarter range.

Brian Alexander – Raymond James

Thanks a lot.

Tim Main

Okay.

Operator

Your next question comes from the line of Lou Miscioscia with Collins Stewart. Mr. Miscioscia, your line is open.

Lou Miscioscia – Collins Stewart

Sorry, I had you on mute. Is this better?

Tim Main

That is better, Lou.

Lou Miscioscia – Collins Stewart

Okay, great. Thank you. Luckily, I figured that one out, I am very technical here.

Tim Main

Well, maybe she was putting your name so badly that you didn't realize it was you.

Lou Miscioscia – Collins Stewart

No, no, I usually pick that one up.

Tim Main

Okay.

Lou Miscioscia – Collins Stewart

Well, stepping out of auto, can you give us your tactical and strategic view on consumers? Is it still an area that you want to heavily pursue or are there pockets that you are more interested in and then, also, could you just comment on the big picture of consumer, you know, is there a lot still to be outsourced to the EMS providers?

Tim Main

That is a great question. I think that we are being a bit more selective in the targeted areas of all of the businesses that we pursue, whether it be the EMS division or the consumer division. I wouldn't say that we are casting a wide net over the consumer electronics industry. I think we are hunting with rifles or spear guns; they use a more nautical theme to it. But, you know, being a little bit more selective, and I think that the mechanics operations in Jabil Green Point clearly is an area that we think merits investment, based on the market opportunity and the return opportunity there. The actual innovation and process technology that is advancing there, which really commands the type of differentiation and the value proposition we present the customers. And we actually think some of those capabilities can be cross-fertilized into some of the other market segments that we participate in, such as medical, so we are looking at that as an investment platform and in the other areas of consumer, where we have an established position, I think we are really looking to be efficient in the employment of our capital, drive margin expansion, drive very high levels of performance and customer satisfaction in the major relationships that we have and it really supports them, but not focus on a great deal of top line expansion. And then in the EMS area, the same types of theme and areas that are relatively mature and that represent large scale commercial relationships, really focusing on being efficient with our capital, deeply satisfying the customers and focusing on margin improvements and in areas that we regard as higher growth like Queen Tech on the SmartGrid and medical industrial instrumentation, defense and aerospace really have those key areas that we will command, and much more, a greater deal of our investment dollars.

Lou Miscioscia – Collins Stewart

Okay. Switching topics a little bit, on the component type mix, can you mention which areas are I guess running to the most difficult to do with?

Tim Main

You know, I am not a supply chain expert. I think about more customers and I am not going to say who the customers are. It really started in A-6 in semiconductors and has gone into lower and lower level components. You know, in some cases, we are even having some constraints in fab supply. But it is a pretty broad spectrum now of challenges. And you also have something that keeps us from being able to run our business effectively, but it is something that, you know causes us not to be able to fully optimize the demand of what we might be able to marshal otherwise, and also, impedes our ability to run with the complete level of efficiency that we might otherwise.

Lou Miscioscia – Collins Stewart

Okay, thank you.

Tim Main

Okay.

Operator

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

Amit Daryanani – RBC Capital Markets

Thanks. Good evening, guys. Just a question on the inventory. It looks like it was up about 10%. Could you just talk about what is driving that? I mean, normally I think inventory growth has seemed to be a reasonable reflection of what you guys expect from next quarter revenue expectations. So I am trying to think if there are any offsets to that part process and because of that maybe you guys are building some buffer inventory?

Tim Main

Well, if you look at our guidance and if you look at our inventory level on a forward basis, we have beat about eight terms. So it is not out of line with what we expect to produce from next quarter. I think we are being relatively conservative in our guidance and yes, it is a little bit tougher to manage the whole supply chain, when there are, again, it doesn't do you any good to have $149.50 of a $150.00 bill of materials, but if the last $0.50 doesn't show up, you can't ship the product. So what we are going to do with that, there is a little bit more of buffer and a little bit more slack in the chain in terms of how effectively we can manage our investment in inventory. You know, that said, we would expect inventory churn rates to improve a bit in the next quarter or two, but I wouldn't expect any breakthroughs in terms of other inventory turnovers. So, I think you are looking at a combination of a growing revenue profile in forward quarters, combined with a component supply marketplace that is being constrained and difficult to manage it. Here you can see, you know, Amit, with the industrial and instrumentation medical segments, up 14% sequentially and some of the other higher mix parts of our business up sequentially. Those tend to be lower inventory turnover businesses, so that kind of (inaudible) a little bit challenged on the inventory side. All that said, I think we ought to be able to manage back to you know, in eight turns at least, and then over the next three or four quarters, get back to that nine level that we have been targeting.

Amit Daryanani – RBC Capital Markets

Got it. And then just a question on the CapEx line, you know, probably Green Point was running around $550 million to $600 million annual revenues. Can you tell us what sort of revenues can you support for Green Point with the current physical capacity that you have, and what sort of incremental dollars can you add to that capacity with the $70 million uptick in CapEx?

Tim Main

Yes, I can't really get into that, we haven't provided any investor transparency to Jabil Green Point, other than what we had in the beginning, because they were a public company. So I would rather not get into that, but you know, at that level of CapEx, it would be about significant growth for their business.

Amit Daryanani – RBC Capital Markets

All right. And then, I am sorry if I missed this, but do you have any customers over 10% of revenues in the Feb quarter?

Tim Main

Yes, we said two. Two customers over 10% and the top 10, 58%.

Amit Daryanani – RBC Capital Markets

Thanks a lot.

Operator

Your next question comes from the line of Sherri Scribner with Deutsche Bank.

Sherri Scribner – Deutsche Bank

Thank you. I had a question about the mobility segment. It seemed like it was a bit weaker than you expected, you commented that it was a bit weaker. But it sounds like you are investing in that. So I am trying to understand, did you see a weakness in the engines pieces of the business, is that something that you are maybe de-emphasizing or was that a customer issue and now you are moving to the mechanic phase and you are focusing on that, or can you may be help us reconcile those two different businesses and the weakness that you saw this quarter?

Tim Main

I think the engines side of it represents the greater part of the revenue stream overall. There are no major particular issues driving mobility being a little bit weaker than expected. A couple of the products that we build were a little bit weaker than the overall mobility marketplace. There is a couple of products that may be going end-of-life relatively soon, but, you know, we have some replacement products to bring back into the revenue stream. So, the customer relationships in the basic program participation is in good health.

Sherri Scribner – Deutsche Bank

So you would expect that to be back to sort of normal seasonality as we move into the third and the fourth quarters?

Tim Main

Yes.

Sherri Scribner – Deutsche Bank

Okay. And then I wanted to dig into the inventory issues a little bit. How much of your revenue would you say was impacted by the component shortages this quarter? Last quarter, I think you said somewhere around $50 million to $100 million, I think you said? $50 million to $75 million?

Tim Main

Yes, we said $50 million to $75 million. We didn't quantify this quarter. We get into some debates around well, what is fair and what isn't, and you can count on the fact that we were gated by materials and revenue could have been higher, although we want to get away from quantifying that.

Sherri Scribner – Deutsche Bank

Okay. And in terms of the inventory that maybe you are building buffer stock, is that primarily semiconductor inventory, is that, I don't know, 50% of it is semiconductor and the rest of it is other components or maybe to get a sense of where the real tightness is?

Tim Main

Well, you know, in terms of our overall spend, I mean semiconductors, memory, those are high price components and end up being a bigger part of our bill material and a material costs anyways. So, to the extent that we have additional inventory levels, those comprised a greater part of it. I say that the way we deal with this type of situation in terms of mature continuity, supply continuity is more around the challenges and more around mix management, and being able to predict and commit to customers reliable schedules, so they can in turn, commit to their customers. So the challenge is really about mix management, not as much as expanding, but for supply. And again, I don't think that that part of the equation is really the bigger part of the equation. You know, if I look inventory turns on a forward basis and where revenue levels are going, you know, it looks to us like although inventory levels are a little bit bumpy and a little bit higher than what we might have expected, they seem to be at reasonable levels as we look forward into fiscal Q3 and we look at the challenges we have to manage mix.

Sherri Scribner – Deutsche Bank

Okay. All right. That is helpful, thank you.

Tim Main

Okay.

Operator

Your next question comes from the line of Wamsi Mohan with Banc of America-Merrill Lynch.

Wamsi Mohan – Banc of America-Merrill Lynch

Thanks a lot. My question is a clarification actually on the midpoint of the guidance. I think I heard you, Forbes, say that the incremental gross margin per revenue dollar the midpoint is $0.14. Is that excluding the $5 million or so of investments that you are talking about for the program ramps related to Green Point?

Forbes Alexander

No, that related to the cumulative impact. On this call a year ago, we talked about $0.10 to $0.15 incremental income leverage per revenue dollar. So that is the actual growth from this time last year is through the end of our third fiscal quarter.

Wamsi Mohan – Banc of America-Merrill Lynch

Okay, thanks. And in terms of the investments in Green Point, why should we not think that your incremental gross margins are actually going to be higher or remain in the 10 to 15 at the higher revenue level, given the mix impact that will potentially come from Green Point?

Forbes Alexander

We previously talked about $0.10 to $0.15 up to that $3.4 billion, $3.5 billion. And to the previous question, we will not be providing any guidance or transparency around these incremental investments in terms of the revenue stream in that regard. We would certainly, there is a higher portion of value-add and that area of the business that would certainly afford us an opportunity to continue to expand our overall corporate operating margin.

Wamsi Mohan – Banc of America-Merrill Lynch

Okay. Thanks a lot.

Operator

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

Matt Sheerin – Thomas Weisel

Yes, thanks. Just a question on the guidance for the EMS sector, up 8%. Is that, are you expecting to see the strength across the board or just a couple of segments continuing to do well like computing and networking?

Tim Main

I think we have to say kind of across the board; one, because we actually we don't want to get into the sectors in terms of guidance, that would be a little challenging for us, but in truth, we are seeing strength across the board.

Matt Sheerin – Thomas Weisel

And Tim, is that just in-demand or are you seeing some new projects come online as well?

Tim Main

It is a combination of both I think in some of the more mature sectors, represents tailwind in-demand and then some of the targeted areas. We are doing a lot better in terms of win rates and expansion of existing relationships and market share.

Matt Sheerin – Thomas Weisel

Okay. Into a bigger picture question, as you expand your business and your headcount over the next few quarters, do you expect to encounter or are you seeing any issues in terms of labor costs, particularly in China or getting headcount back because of some labor shortages?

Tim Main

I think we had some challenges with that, but nothing that isn't manageable.

Matt Sheerin – Thomas Weisel

Okay, thank you.

Tim Main

Okay.

Operator

Your next question comes from the line of Joe Wittine with Longbow Research.

Joe Wittine – Longbow Research

Joe calling in for Shawn Harrison. Can you hear me okay?

Tim Main

You bet.

Joe Wittine – Longbow Research

I wanted to go back to a couple of questions that Wamsi was asking about the incremental margins. I think I understand, Forbes, with the $0.14 you were referring to was on a year-over-year basis what you have done. But am I looking at it right when I strictly look at the May quarter guidance on a sequential basis? It looks like at the mid-point of guidance, you are adding $200 million in sales and at the mid-point of EBIT; we are adding about $15 million in EBIT. So, a lot of incremental EBIT margin of about 7% to 8%, somewhere in there, and then, you know, with the guidance calling for flat operating expenses and flattish R&D, I guess the incremental gross margin is also about maybe 8%. Is that accurate?

Forbes Alexander

Yes, that is absolutely correct and that includes we call about $5 million of investment. Still see it with infrastructure, the hiring of employees and both direct and indirect labor and infrastructure to support these new program ramps and mechanical capabilities.

Joe Wittine – Longbow Research

Okay. So taking into account that $5 million as a key point, then you are probably down at the low end of the 10% or 15% range. So I guess the question is, you know, going forward, you know, seemingly consistent mixes, is that a reasonable level to model kind of taking into account the normal fluctuations from EMS versus consumer that you could see on a margin basis? I guess the 10%, are we assuming that you know, we are kind of at the lower end of the 10% to 15% range going forward from here, now that we have hit these revenue bogies?

Forbes Alexander

Yes, absolutely. Up to the level of $3.4 billion, $3.5 billion, absolutely. You know, we finished it over the last few quarters, this operating leverage and so that is certainly, you know, firmly in play as we move forward here.

Joe Wittine – Longbow Research

Okay. And then just a real quick one. SG&A, you have held pretty firm over the last four quarters now. In fact, in the August quarter, you were doing $117 million; the current quarter guidance is for $120 million. So the question is that level sustainable, assuming these are consistent revenues from here?

Forbes Alexander

Yes, I think, you know, $120 million, give or take $1 million or so, is I think a very sustainable level as we move forward.

Tim Main

I think that should be sustainable beyond the $3.4 billion. We are working diligently to control and compress our SG&A expense, and when we get beyond that $3.4 billion to $3.5 billion per quarter revenue run rate, at which point our capacity absorption has taken place, we will still expect to enjoy operating expense leverage at the SG&A line.

Joe Wittine – Longbow Research

Okay, fair enough.

Tim Main

Okay.

Operator

Your next question comes from the line of Amitabh Passi with UBS.

Amitabh Passi – UBS

Thank you, and apologies for the background noise. Just a clarification, Forbes, what is the best way to look at incremental operating margin, is it more on a sequential basis than a year-over-year basis, because it seems like you look at it across the two different ways and you shouldn't get different levels of drop here and I just wanted to clarify that 10 to 15 more on a year-over-year or on a sequential basis?

Forbes Alexander

Maybe you should look at that on a sequential basis, as we move forward. You know, we do have this incremental investment in terms of this quarter as we have called out, but certainly as we move forward, we should look at that on an incremental basis, as we drive towards revenue levels of $3.4 billion to $3.5 billion.

Amitabh Passi – UBS

Okay, got it. And then just one final one, Tim, perhaps for you. The telecom segment, you have had two quarters now of sequential declines. I was just wondering if it is just a function of your end markets, is there a program just sort of backing away from any additional color on the massive market?

Tim Main

Yes, there is a particular customer program that actually isn't engaged in the GSM fiber optic transmission cycle products that we have been targeting in that area; it is more in terms of mobile communications, network communications that has experienced a severe slowdown in orders, that had a negative impact on the overall revenue levels there. If you look at the areas of our business that we are really targeting, the major telecommunications, particularly in Europe, our customers that we are targeting and the types of wireless and wire-line infrastructure products, we have actually done pretty well there and have actually added some pretty significant new program wins and we would expect to see the performance in that telecommunications sector really start to turn around over the course of the next two or three quarters. So, I am actually fairly bullish about our position there.

Amitabh Passi – UBS

Okay, I appreciate it. Thank you.

Tim Main

Okay.

Operator

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

Jim Suva – Citi

Thank you very much. Forbes, on the traditional investment that you have, should we expect a little bit of a ramping or initial burden on the OpEx line, you know, you typically install the equipment, you put them in and takes your workers a little bit of time to get the yields up. And then, a follow onto that, Forbes, is when you start looking at you know, your revenue outlook of $3.4 billion $3.5 billion and the operating margin associated with it, at what point do you as CFO say, okay, we are getting within a close-enough distance, you know, which your guidance now in the high end is $3.3 billion, but maybe now when you do start installing some more equipment and it seems like we are getting close to that standpoint. And then, maybe a question for Tim; Tim, on this investment in Green Point, is it a single-company specific or is it one that you will be able to leverage across multiple different platforms or how should we think about the risk/reward of that large capital equipment?

Forbes Alexander

Jim, let me try and take the second comment you made and then I will circle back to the first one. But in terms of – I think the question centers around you know when do we start making investment decisions beyond our $3.4 billion to $3.5 billion level, where we see current levels absorbed. You know, given the marketplace today and remembering that November quarter of calendar 2008, you know, before we saw the recessionary environment, most companies in our space were certainly gearing for significant continued growth, and with that, returning those levels of $3.4 billion to $3.5 billion at year end, equipment tends to be pretty readily available.

So we are in a fortunate position today, where we don't need to be making investment decisions much beyond a four to six week time cycle, if you will. I think the biggest concern we have today in terms of making those investments is around material and component availability, which are certainly longer lead times more than equipment. So we need to see some clarity around additional capacities coming on in the various component marketplaces, and you know, once we see some clarity in that regard, we will start considering further investments. But certainly, we are under no pleasure in terms of equipment and testing equipment, anything related to production throughput.

Tim Main

When we talk about OpEx, just in terms of the vernacular, you know, we look at cost of goods sold and sometimes we use operating expenses interchangeably with SG&A. So when you say OpEx, and you know the investment in factory workers, installation, that type of thing, that is roughly cost of goods sold area and you know, the $5 million that we are talking about being devoted to that area and that is that assumption in the guidance. And of course, we will work as diligently as we can to contain and compress our SG&A expense.

You asked a question about the investment being for a single company or a broad-based risk/reward. Not really in a position to provide that level of transparency. I will say generally though, our policy is that when a capital investment is so customer specific to a single customer, we would ask them to invest or buy that equipment or consign it to us, so long term, this is a capability that we think has a broader set of customers and opportunities than a single customer.

Jim Suva – Citi

Great. Thank you very much, Tim and Forbes.

Tim Main

Okay.

Operator

Your next question comes from the line of Mickey Schleien with Ladenburg.

Mickey Schleien – Ladenburg

Thank you. My question has been answered.

Operator

(Operator Instructions) Your next question comes from the line of Kevin Smithen with Aragon.

Kevin Smithen – Aragon

Sorry, I think you have answered it, but just trying to get it quantified, did you break out the inventory between raw materials, components, and then work in progress, and finished goods?

Forbes Alexander

Yes, I don't have that data in front of me right at the moment, but it is in terms of dollar terms, but it is relatively consistent, on a percentage basis, with that of last quarter, which is in our filings, but I can certainly follow with you after the call, I don't have that data in front of me.

Kevin Smithen – Aragon

Okay, great. Thank you very much.

Tim Main

Okay, we appreciate everybody's time on this call. I think that for us the takeaways, we are very pleased with the lowest level of seasonality in fiscal Q2 of 2010 that we have seen since 2004 and we have enjoyed significant margin expansion year-over-year of 170 basis points at the core operating income line and 180 at the gross margin line. We think that is a reflection of the better efficiencies in our business focusing on costs and customers. And we also think it is indicative of the business environment improving in our position to capitalize on an improving business environment in a better functioning engine provides a lot of confidence for us in being able to deliver both revenue growth and margin expansion in the next few quarters; and when we think about inventory or capital investments and the strength of our relationships and businesses and targeted markets, we feel very good about our position and our ability to deliver an excellent record fiscal 2010 and really look forward to continue to build the business in fiscal 2011 and beyond. So thank you, everybody, for your time.

Operator

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

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