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Jabil Circuit, Inc. (NYSE:JBL)

F3Q 2014 Earnings Conference Call

June 18, 2014 16:30 ET

Executives

Beth Walters - Senior Vice President, Communications and Investor Relations

Mark Mondello - Chief Executive Officer

Forbes Alexander - Chief Financial Officer

Analysts

Mark Delaney - Goldman Sachs

Amitabh Passi - UBS

Wamsi Mohan - BoA Merrill Lynch

Jim Suva - Citi

Steven Fox - Cross Research

Sherri Scribner - Deutsche Bank

Operator

Ladies and gentlemen, thank you for standing by and welcome to Jabil’s Third Quarter 2014 Fiscal Year 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 today’s conference over to Beth Walters, Senior Vice President of Communications and Investor Relations. Please go ahead.

Beth Walters

Thank you very much. Welcome to our third quarter of 2014 earnings call. Joining me today are CEO, Mark Mondello; and our Chief Financial Officer, Forbes Alexander.

This call is being recorded and will be posted for audio playback on the Jabil website, jabil.com, in the Investors section. Our third quarter press release, slides and corresponding webcast links are also available on our website. In these materials, you will find the financial information that we will cover during this conference call. We ask that you follow our presentation with the slides on the website, beginning with Slide 2, our forward-looking statement.

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 2014 net revenue and earnings results, the financial performance of the company and our long-term outlook for the company. 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, 2013, 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.

Today’s call will begin with opening remarks from Mark. We will then move on to the third fiscal quarter results and guidance on our fourth fiscal quarter of 2014 from Forbes Alexander. We will then open it up to questions from call attendees.

I will now turn the call over to Mark.

Mark Mondello

Thanks, Beth. Good afternoon. I appreciate everyone taking time to join our call today. I’d like to begin by recognizing all of our people here at Jabil. Thank you for your commitment.

On to the quarter, the results were largely as planned. We delivered $45 million in core operating income on revenues of $3.8 billion and ended the quarter with a strong cash balance. Forbes will provide more detail and discuss our Q4 guidance during his prepared comments. As I think about where we stood today, a significant catalyst for future growth is the continued advancement of our capabilities. Our organizational structure intentionally houses our broad-based capabilities in an independent, standalone group led by our COO. Commercial leaders across our company leverage these capabilities to best serve their respective customers and end markets. This approach drives valuable collaboration and minimizes parochial behavior.

I’d like to share a few examples of the solutions and activities ongoing within our capabilities group today. Advanced planning and supply chain optimization tools, which combined proprietary business intelligence with big data. Our continued acceleration and implementation of advanced automation and robotics across a large percentage of our factory floors. Expansion of our advanced design services such as enhancing the consumer experience by improving the interface with product packaging and/or product specific industrial designs. The last example specific to capabilities is the advanced modification made to our ubiquitous SAP platform combined with virtualization of our IT backbone. This results in better security, higher flexibility, and faster information flow across our Jabil network. These limited examples are a modest illustration of the type of outstanding work taking place within our capabilities group.

With that, let me shift focus to our independent operating units. Our Nypro team has delivered ahead of plan. They are completing their integration into Jabil from a systems perspective all while driving creative solutions for their customers. In addition, they are adding square footage in anticipation of growth, growth in the areas of healthcare, big pharma and consumer packaging. Our Enterprise & Infrastructure segment continues to gain market share albeit in a continued challenging environment. The team continues to deliver high complex, high technical products with near perfect quality. In addition, there is acute awareness by the team of the cloud-based transformation currently underway in networking and storage.

Our High Velocity segment has booked new revenue streams in the areas of automotive, consumer electronics, point-of-sale, printing and digital home. The team’s innovative solutions combined with their optimized cost base offer a value proposition that is well aligned to the end markets in which they serve. Our industrial division continues to grow while taking tremendous care of the brand companies they serve. The team delivers an endless number of products produced in a complicated low volume, high mix environment. Inside of Jabil Green Point, our team is focused on engineering intensive high-volume programs. The combination of technical expertise, massive scale and operational excellence makes all this possible. We anticipate a solid recovery in this area of our DMS business.

I would like to move my prepared comments to share a few thoughts as I think about fiscal year ’15. First and foremost I am highly energized and enthused by our outlook. I remain confident in our ability to deliver core earnings per share in the range of $1.65 to $1.95 as previously communicated during our March call. My confidence is reinforced by share of wallet expansion and new bookings which have occurred within our High Velocity and our Enterprise & Infrastructure segments combined with the sheer magnitude of product ramps in process within our DMS segment. These product ramps include areas in healthcare, packaging, mobility, industrial, wearable computing and consumer lifestyle.

As we enter fiscal year ’15, it’s my belief that our DMS revenues will recover and we will experience near double-digit leverage as the existing cost base is absorbed. Furthermore our FY ‘15 core EPS guidance includes approximately $25 million to $30 million of new OpEx investment. This investment is focused on future growth as we look to expand into large non-traditional, non-DMS markets, markets which align with longer term trends such as energy, aging population, environmental preservation and sensors. This organic investment carries manageable risk and if successful will deliver further diversification to future Jabil earnings.

As I look across our broad range of commercial activities, I remain highly confident that the collective portfolio will deliver an ROI in excess of our weighted average cost of capital. As I think about the next 3 to 4 years, I believe our portfolio strategy provides a solid foundation for the business moving forward. As I have stated previously, it’s my belief that Jabil will deliver strong operational cash flows over the longer term. Relative core EPS will be determined by our capital structure, which I believe will improve over time. Our tax rate and thoughtful decisions we make around capital allocation. As a corporation, we are most fortunate to have a unique combination of scale, innovative capabilities and experienced leadership. This affords us a credible path to pursue many business opportunities in various end markets as we look ahead.

Thank you. And with that, I will now turn the call over to Forbes.

Forbes Alexander

Thanks Mark. Good afternoon, everyone. Before I begin with reviewing the results for our third fiscal quarter, I’d like to remind everyone that during the quarter we did finalize the divestiture of our aftermarket services business. And all results associated with this business are reflected as discontinued operations. And as such, our results for the third fiscal quarter of 2014 and all comparative periods and discussion reflect this treatment.

I’d now ask you to turn to Slide 3 of the presentation deck. Net revenue for the third quarter was $3.8 billion, a decline of 10% on a year-over-year basis. Our GAAP operating loss was $1.6 million during the quarter. Our GAAP net income was $188.3 million. GAAP net diluted earnings per share were $0.93 during the quarter. GAAP net earnings in the quarter included $12 million of restructuring and associated charges, $6 million associated with the amortization of intangibles and $15 million of stock-based compensation, along with a gain on sale of our aftermarket services business of some $240 million.

Core operating income, excluding the gain on sale of discontinued operations, amortization of intangibles, stock-based compensation, restructuring and certain other expenses was $45.3 million and represents 1.2% of revenue. Core diluted loss per share was $0.06. As anticipated, our core diluted earnings per share negatively impacted by an elevated effective tax rate relative to historical levels. The core effective tax rate during the quarter was 188% or $24 million in tax expense. As I discussed in our last call, the higher rate driven by geographical mix of our profits and losses during the quarter is expected to continue into our fourth fiscal quarter. We would anticipate our tax rate to return to historical levels for the period of fiscal 2015.

If you will now turn to Slide 4 for a segment discussion. In the quarter, our diversified manufacturing services segment increased 6% on a year-over-year basis driven largely by solid performances by our Nypro industrial and instrumentation businesses. Revenue for the segment was approximately $1.6 billion, representing 43% of total company revenue. Operating income was 1.1% of revenue during the quarter, well below our targeted range and reflective of the cost infrastructure in place within Green Point. As you will recall, we have chosen to maintain the levels of cost infrastructure within this business as we prepare for return to more historical levels of production in fiscal ‘15 and beyond.

The Enterprise and Infrastructure segment decreased 3% on a year-over-year basis, reflecting continued declines in enterprise spending partially offset by strength in telecom. Revenue was approximately $1.3 billion, representing 35% of total company revenue in the third quarter. Core operating income for this segment was 2% of revenue.

The High Velocity segment decreased 45% on a year-over-year basis as a result of our Blackberry disengagement. Revenue was approximately $850 million representing 23% of total company revenue in the quarter. Core operating income for this segment was 0.2% of revenue. On a sequential basis total company revenue increased 6% with all three segment showing modest improvements.

If you will now, please turn to Slide 5, we ended the fiscal quarter with cash balances of $1.3 billion and debt levels were consistent at $2.2 billion. Cash flow from operations through the first nine months for our fiscal year were $409 million. Core EBITDA for the quarter was approximately $159 million representing 4.2% of revenue, while core return on invested capital was 3%. During the third fiscal quarter we repurchased approximately 3.6 million shares at a total cost of approximately $65 million. We have approximately $70 million available under our $200 million repurchase authorization. Year-to-date, net capital expenditures totaled $274 million. Consistent with our discussion of last quarter, we expect total capital expenditures to track to $350 million for the full fiscal year. As we look to bring on our first tranche of capacity in Chengdu and to support new Nypro ramps during early fiscal 2015.

If you will now, please turn to Slide 6, where I would like to give you an update on restructuring activity, our broad capacity alignment plan announced in the third quarter of fiscal 2013 remains on track to deliver $65 million of benefit in 2015. As a reminder our plan outlined $188 million of costs to be recognized over a seven quarter period. Since its inception, we have recognized $122 million of those costs with cash I believe to-date of $67 million. The balance of $66 million of charges and $84 million of cash is anticipated to occur over the next two quarters. The restructuring activity associated with our Blackberry disengagement is anticipated to be concluded in the coming quarter. Total charges are now expected to be in the range of $42 million to $70 million.

And I will ask you to turn to Slide 8 and 9 and I will discuss our fourth quarter 2014 guidance. In the fourth quarter we expect revenue on a year-over-year basis to decline approximately 15% and to be in the range of $3.7 billion to $3.9 billion or at its midpoint consistent sequentially. Consistent with our guidance of 90 days ago, core operating income is estimated to be in the range of $40 million to $80 million and core operating margin in the range of 1.1% to 2.1%. Interest expense is estimated to be $32 million, while tax dollars are estimated to be $30 million. Thus we estimate our core earnings per share will be in the range of $0.10 to negative $0.10 per diluted share. Net GAAP loss per share is expected to be in the range of $0.30 to $0.05 per diluted share based upon our diluted share count of 201 million shares.

Turning to our segments on a year-on-year performance basis, the Diversified Manufacturing Services segment is expected to decrease 6% to approximately $1.7 billion in revenue, an increase sequentially of 7%. Enterprise & Infrastructure segment is expected to decrease 7% on a year-over-year basis reflective of end market conditions. And finally, our High Velocity segment is expected to decrease 38% on a year-over-year basis reflecting the wind down of our Blackberry relationship. We are well-positioned as we move towards fiscal 2015.

Our balance sheet is strongly positioned to provide both financial and strategic optionality, positioned to support the business with further investment, seek acquisitions which will continue to enhance our capabilities in key areas and return capital to shareholders via our ongoing dividend and stock repurchase programs.

I’d now like to hand the call back to Beth.

Beth Walters

Great. Thanks Forbes and Mark. Before we begin the question-and-answer session, I’d like to remind our call participants that in customary fashion, we will not address any customer or product specific questions out of respect for our customers and their specific products. Thank you so much for your cooperation. Operator, we can begin the question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mark Delaney with Goldman Sachs.

Mark Delaney - Goldman Sachs

Thanks very much for taking the question. I was hoping first, Mark or Forbes, if you could elaborate on the outlook in fiscal ‘15 and if you could talk a little bit more about the DMS segment and if you could talk a little bit more about what gives you the confidence in those ramps and if you could just give us sense on the timing for some of those ramps and maybe when you can have the capacity more fully utilized?

Mark Mondello

Mark, I think based on my prepared comments, I just tell you that the color we have around the ramps today and it’s a multitude of ramps. I just – I’d leave it as we just feel comfortable that the ramps are going well and we are comfortable with the guidance provided.

Mark Delaney - Goldman Sachs

Okay. For a follow-up question, you mentioned some new OpEx investments for some new end markets and I think you mentioned NRG as one of those, does that imply that the core business was actually tracking above your guidance for fiscal ‘15 because of the incremental OpEx that you talked about today on the call this brings it back in mind?

Mark Mondello

No. What I think it means is that the business, the earnings are strong enough in ‘15 to where we are going to have $25 million to $30 million of planned OpEx, which will take earnings down. So, we will still be in the $1.65 to $1.95 range, but we are going to make $25 million to $30 million in investments for the future. That’s correct.

Mark Delaney - Goldman Sachs

Okay. I will turn it over. Thank you very much.

Mark Mondello

Yes, thank you.

Operator

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

Amitabh Passi - UBS

Hi, thank you. Mark, maybe if I could try this slightly different way, I think if you look at the Street consensus estimates, everybody is assuming a pretty nice inflection in the November quarter with earnings, call it somewhere in the $0.35 to $0.40 range. I am not expecting to give us guidance for the November quarter, but I am just trying to figure out is that the right way to think about how we should plan to get to the $1.80 middle point for EPS guidance for next year? Is it a more gradual ramp? Any help you can give there just in terms of the trajectory?

Mark Mondello

Yes. I think what I would rather do is provide a little more color on that come September.

Amitabh Passi - UBS

Okay. And then I wanted to just clarify on your $200 million buyback, can you remind us and I apologize if you said this, how much is still left in the program?

Forbes Alexander

Yes. There is $70 million left. We did use $65 million during the third fiscal quarter.

Amitabh Passi - UBS

Okay. Alright, thanks. I will step back in queue.

Operator

Your next question comes from the line of Wamsi Mohan with BoA Merrill Lynch.

Wamsi Mohan - BoA Merrill Lynch

Mark, can you talk a little bit about the DMS guidance here for the next quarter down year-on-year obviously adjusted for the MS divestiture, but is that more about tough comps from last year in specialized services or is it being driven more by a disproportionate decline on the industrial, clean techs, or non-specialized services area?

Mark Mondello

No, it’s not industrial clean tech, it’s just the overall product ramps we are going through heading into ‘15.

Wamsi Mohan - BoA Merrill Lynch

Okay, thanks. And as a follow-up, can you talk about the DMS margin profile, I mean given you EPS guidance which would probably still be expecting DMS margins below your longer term range at least for the August quarter, but is it fair to assume that as we go into the next fiscal year, we should start to think about DMS margins back into your long-term range?

Mark Mondello

That’s a fair assumption, yes.

Wamsi Mohan - BoA Merrill Lynch

Thank you.

Mark Mondello

You’re welcome.

Operator

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

Jim Suva - Citi

Thank you very much. It sounds like if I heard correctly that we should wait for September I just want to ask the question about market and the step increase from basically breakeven now to a linear year of next year $0.45 per quarter, $0.40 per quarter you are saying just hold off until September because when we look at the restructuring it looks like some of the benefits should start meaningfully kick in, can you just kind of help us a little bit around if indeed we should expect to go up to that level or is it going to be more gradual or the timing, maybe you can talk about the timing of the benefits from the restructuring?

Forbes Alexander

Yes. Jim, it is Forbes, in terms of the restructuring, we are well down the path to execute on that front. And I ask everyone to follow the cash if you will rather than the GAAP bookings. So we formerly announced a closure of a site in the United States that will be closed in August, so we will see some really positive results of that in our first fiscal quarter. And then as I look through the back half it will be more linear as we take costs out of Western Europe. So we don’t want to get into the particular quarter-by-quarter or EPS guidance at this stage. And as Mark said in his prepared remarks we got a large number of program ramps as we are moving into ’15. So we don’t control when those products are launched in the marketplace, we will see how that pans out and we certainly feel very well positioned to deliver a strong ’15.

Mark Mondello

And Jim, one thing to help you maybe a little bit in your model is if I had to guess I guess that the earnings would have a shape to them similar to what we delivered in FY ’13 on a quarter-on-quarter basis.

Jim Suva - Citi

That’s very helpful. And then as we take a big step back and it’s a strategically big picture of Jabil, you are really changing the character of your company with Nypro and the acquisitions you have done, is it fair to say that that character post the restructuring once you come out that the operating margins would be materially higher because if we look at say a sales run rate of $16 billion to $16.5 billion which I believe you guided to and then your EPS that is meaningfully below what you have done at $16 billion to $16.5 billion of revenues and the EPS is kind of a disconnect I assume it’s masked by the restructuring and you should come out even much stronger profitability because of Nypro and the other options is that fair long-term?

Mark Mondello

Certainly, that’s what we are efforting towards. I think it’s too early to tell right now Jim, but yes, that’s what we are efforting for.

Jim Suva - Citi

Great. Thanks a lot guys.

Mark Mondello

Yes.

Operator

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

Unidentified Analyst

It’s Bob. Thanks a lot guys. Two questions for me. One, I guess Mark on the fiscal ’15 guide that you are reiterating today maybe just talk about are you more comfortable with those numbers today versus you were 90 days ago and it almost sounds like the Enterprise and High Velocity segment revenues could be better than what you thought 90 days ago, but it’s getting offset by this $25 million OpEx investments, is that the right way we are going to read the change in our assumptions of that fiscal ’15 guide?

Mark Mondello

We will talk more about that in September. Right, but it’s hard to address that this far out but let’s have that conversation in our September call.

Unidentified Analyst

And then I guess if I just look at your August quarter guide right, you are looking for flattish growth on a sequential basis at least right now, if I look at the last few years when you had the big ramp with your customer, August tends to be up mid-single digits for you guys typically. So what is the offset from historically August being up mid-single digits to the guidance of flat, is it that you don’t have visibility or there any offsets to that?

Forbes Alexander

Right. Amit, it’s Forbes I think it’s not that we don’t have visibility, I think it’s the offset is such that as we talked about a couple of quarters ago unfortunately the programs that we had geared up for this fiscal year didn’t come to fruition in terms of sell through. So it’s really that impact more than visibility.

Unidentified Analyst

Got it. And we will look forward to the September call. Thanks a lot guys.

Forbes Alexander

Thank you.

Mark Mondello

Thank you.

Operator

Your next question comes from the line of Steven Fox with Cross Research.

Steven Fox - Cross Research

Thanks. Good afternoon. First question, I was wondering Mark without getting into numbers of course if we look at what you are kind of looking at on the DMS business for next couple of quarters smoothed out and compare it maybe to the ramp that you have had in the last couple of years in the back half of the calendar year. How is it different, how is it the same, whether it’s on the level of complexity you are doing to serve markets, new programs versus maybe just second generation programs? I am just trying to get a handle on how different this is going to be and the challenges you may have or may not have for the rest of the calendar year with DMS?

Mark Mondello

Wow, good question. Challenges are – I mean, challenges are comparable. None of this is easy. Better diversification and I say better diversification and maybe some tweaks to overall business terms from a ROIC perspective. Other than that, it’s similar.

Steven Fox - Cross Research

Okay. And then secondly just in terms of looking at the OpEx investments that you mentioned obviously aimed at like you said diversifying. What like if you invest a dollar on – today in OpEx, like what kind of return are you looking at to actually see revenues? Is this something that could pay off in the next fiscal year or is this something that is entering new markets and we may have to wait until maybe a year plus out to actually see revenue?

Mark Mondello

Yes. I think it would be aggressive to think about this having a big impact in ‘15. If it did, it would be Q4ish timeframe. So, think about it for future investment.

Steven Fox - Cross Research

Okay. And is there a lot of real new markets that you are entering or is it sort of doubling down on some of these diversified efforts that you made over the years?

Mark Mondello

The 25 to 30 I talked about is all new markets.

Steven Fox - Cross Research

Okay, alright, great. I appreciate that. Thanks.

Mark Mondello

Yes, thank you.

Operator

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

Sherri Scribner - Deutsche Bank

Hi, thanks. I just was looking at the E&I segment and it looks like that was a little bit worse than expected, you mentioned server and storage and the guidance suggests that we see a deceleration in growth or as the declines get worse. Can you give us a little bit of color on what you are seeing in that segment?

Mark Mondello

Sherri, segment remains difficult, but I think what you are seeing in our results isn’t about the difficulty in the market, because the team is doing a great job. It’s about corporate allocation and the fact that we are slugging it through two tough quarters.

Sherri Scribner - Deutsche Bank

And would you expect those margins to start to improve in fiscal ‘15 or would you expect them to improve this year, because you’ve sort of seen those coming down over the past couple of quarters?

Mark Mondello

Yes, they won’t improve next quarter, but we do anticipate they will improve in ‘15.

Sherri Scribner - Deutsche Bank

Okay. And then, Forbes, a quick question, I think on the last call you said that you would finish the $200 million in buybacks this fiscal year, is that still your plan?

Forbes Alexander

Yes. As we said today, we are methodically working our way through that at a pace of $65 million to $70 million a quarter. Yes, we see how that plays out as we move through the coming couple of months, yes.

Sherri Scribner - Deutsche Bank

Okay, thanks.

Operator

(Operator Instructions) And at this time, we have no further questions. I would now like to turn the conference back over to Beth Walters for any closing remarks.

Beth Walters

Okay, thank you very much. Thank you everyone for joining us on the call today. As always, we will be available for any follow-up questions you have during the rest of the evening and the rest of the week and thank you for joining us today.

Operator

Thank you for participating in today’s conference. You may now disconnect.

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