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Jabil Circuit, Inc. (NYSE:JBL)

F1Q07 Earnings Call

December 20, 2006 4:30 pm ET

Executives

Beth Walters - VP, IR

Forbes Alexander - CFO

Tim Main - President and CEO

Analysts

Lou Miscioscia - Cowen and Company

Steven Fox - Merrill Lynch

Shawn Harrison - Longbow Research

Jim Suva - Citigroup

Michael Walker - Credit Suisse

Scott Craig - Banc of America

Bernie Mahon - Morgan Stanley

Brian White - Jefferies Asset Management

Alex Blanton - Ingalls & Snyder

Yuri Krapivin - Lehman Brothers

Kevin Kessel - Bear Stearns

Matt Sheerin - Thomas Weisel Partners

Todd Coupland - CIBC World Markets

Amit Daryanani - RBC Capital Markets

Paras Bhargava - BMO Capital Market

Monish Perry - RF

Presentation

Operator

Good afternoon. My name is Chrystal and I will be your conference operator today. At this time, I would like to welcome everyone to the Jabil First Quarter Fiscal Year 2007 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. Miss Walters, you may begin your conference.

Beth Walters

Thank you. Welcome to our first quarter earnings call. Joining me on the call today are President and CEO, 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 Investor section, along with today’s press release and a slideshow presentation on the first quarter. You can follow our presentation now with the slides that are posted on the website and begin with slide 2 now, our forward-looking statement.

During the call today, we may make forward-looking statements including those regarding our unaudited first quarter fiscal year 2007 net revenues and certain other financial measures, our currently expected second quarter fiscal quarter 2007 and full fiscal year 2007 net revenues, the anticipated completion of the new sites and acquisition of Taiwan Green Point, the anticipated outlook for certain aspects of our business, and our long-term outlook for our company, our industry, our business sectors and our realignment of our manufacturing capacity and the related costs and timing. These statements are based on current expectations, forecasts and assumptions involving risks and uncertainties that could cause actual outcomes and results to differ materially. These risks and uncertainties include, but are not limited to; the finalization of our fiscal year 2006 financial statements and the audit thereof, and our first quarter fiscal year 2007 financial statement and a review thereof.

Including those portions relating to our historical stock option grants; the results of the review of our past stock option grants being conducted by a special committee our Board and governmental authorities; and the review of our historical recognition of our revenue and any other issues by our audit committee with the assistance of independent legal counsel; the accuracy of the stated dates of our historical option grants and whether all proper corporate and other procedures were followed; the impact of any restatement of our financial statements or other actions that may be taken or required as a result of any such reviews; risks and costs inherent in litigation, including that related to our stock option grants or any restatement of our financial statements as a result of the evaluation of our historical stock option practices and financial statement, whether or when we will realign our capacity and whether any such activity will adversely affect our cost structure; ability to service customers and labor relations; our ability to consummate the tender offer for Taiwan Green Point and satisfy the conditions to closing the tender offer and subsequent merger; and our ability to successfully address the challenges associated with integrating this acquisition; our ability to take advantage of the proceed benefits offering customer vertically integrated services; our ability to effectively address certain operational issues that have adversely affected certain of our US operation; changes in technology; competition; anticipated growth for us and our industry that may not occur; managing rapid growth; managing any rapid declines in customer demand that may occur; our ability to successfully consummate acquisitions; managing the integration of businesses we acquire; risks associated with international sales and; retaining key personnel; our dependence on a limited number of large customers; business and competitive factors generally affecting the electronic manufacturing services industry; our customers and our business; other factors that we may not have currently identified or quantified; and other risks, relevant factors and uncertainties identified in our Annual Report on Form 10-K for the fiscal year ended August 31, 2005; 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.

If you could now turn to slide 3, I will turn the call over to Forbes Alexander.

Forbes Alexander

Thank you, Beth. Good afternoon. Revenue for our first fiscal quarter of '07 was in the mid point of guidance at $3.224 billion. The quarter represents a 34% growth in revenue on a year-over-year basis and a 9% on a sequential basis.

Please now turn to slide 4, turning to a discussion of revenue by sector for our first quarter. Production levels in the automotive sector increased 5% from the prior quarter, slightly above expectations, but consistent seasonal patterns in previous years. The computing and storage sector increased 2% from the fourth quarter consistent with expectation. The consumer product sector increased by 25% from the fourth quarter somewhat lower than expectations as end market demand was somewhat softer than initial expectations.

The instrumentation and medical sector decreased by 4% from the fourth quarter as production levels in certain transaction processing and tax automation product categories were below our expectations. Year-over-year this sector enjoyed 31% higher revenue than in the comparable fiscal 2006 period. We remain positive on our growth prospects for this sector.

Our networking sector, levels of production increased by 8% from the previous quarter, as production levels were strong throughout the quarter. The peripherals sector increased 19% over the previous quarter, reflecting strong seasonal demand.

And finally, the telecommunication sector decreased by 23% sequentially as an anticipated short-term demand reduction from an existing customer rebounded earlier than we'd anticipated.

I will ask you now to turn to slide 5. Our sector information for the quarter and the fiscal year in percentage terms was as follows; automotive 4%; computing and storage, 11%; consumer, 36%; instrumentation and medical, 15%; networking, 18%; peripherals, 6%; telecom, 5%; and other, 5%. On a year-over-year basis, we have added revenue of $820 million with all sectors except automotive and telecom enjoying revenue growth of over 30%. Quarter marks our fifth consecutive quarter of year-over-year revenue growth above 30%. For the quarter, three customers exceeded 10% of revenue. And our top ten customers accounted for approximately 68% of revenue.

I will ask you to turn to slide 6. Reviewing our balance sheet. The company's sales cycle in the quarter expanded by 9 days to 23 days due to a higher level of day sales outstanding and a lower level of accounts payable outstanding. Our inventory days declined slightly for the quarter. Inventory turns for the quarter were consistent with the previous quarter at eight. Cash and cash equivalents were $658 million, as compared to $774 million at the end of the fourth quarter.

Our capital expenditures during the quarter were approximately $72 million. And I would just like to update you in terms of our restructuring and rationalization plan.

During the first quarter, we continued to manage our overall rationalization plan consistent with the comments we made in previous quarters. Our initial estimates for total restructuring charges of $200 to $250 million, we now expect to be at the high end of that range. The cash cost of such charges remains an estimate in the range of $150 to $200 million, over the course of the next two fiscal years. Discussions with our employees and their representatives are underway, and we are complying with all statutory and consultation periods required of us.

Turning now to capacity. With regard to our capacity and global footprint, our business outlook shows increasing production levels in Asia and Eastern Europe. As discussed previously, we will be completing and then ramping new sites in Poland, the Ukraine, and India during the course of fiscal 2007. We will continue to ramp significantly higher production levels in our sites in China.

Our investments in fiscal 2007 are expected to be related to the above locations and existing plants as we continue to see increasing levels of production. We estimate capital expenditures to be in the range of $200 and $250 million in the fiscal year.

Now I will like to update you on our recently announced acquisition of Taiwan Green Point. As we have previously disclosed, shareholders controlling over 50% of Green Point have tendered their shares. We fully expect the acquisition to move forward and presently expect the transaction to close during our fiscal second or third quarter of 2007, depending upon timing of government approvals. Upon completion of the tender, we are obligated to purchase those shares tendered for cash consideration has been timely estimated to be in mid January.

At this point in time, it is expected that we shall have controlling interest of Taiwan Green Point and would expect to consolidate their financial results with [our ordering] from that date. There is expected to be some level of minority interest and so we can acquire their remaining shares not tendered prior to the completion of that tender offer.

We are excited to finalize the transaction, and we welcome the people and capabilities of Green Point to Jabil family.

Now I'll ask you to turn to slide 7. Our second quarter revenue update. We estimate our second fiscal quarter of 2007 to be in the revenue range of $2.75 billion to $2.85 billion or a decrease of 10% to 14% from the first fiscal quarter. Our revenue expectations are based upon seasonally lower sales in our consumer sector along with a more muted view of overall end market growth.

I'll now ask you to turn to slide 8 to review revenue by snapshot for the second quarter. Our automotive sector expected to decrease by approximately 6% reflecting seasonally lower sales. The computing and storage section -- sector is estimated to decrease 5% with certain customers' balance inventory levels with lower demand.

The consumer sector is expected to decrease by approximately 33% reflecting normal seasonal patterns and higher than desired inventory levels for certain products.

The instrumentation and medical sector is estimated to be consistent, slightly better than the previous quarter. Networking sector levels of production are expected to be consistent with the first fiscal quarter. The peripherals sector is estimated to be consistent with the first fiscal quarter, and the telecom sector is estimated to increase between 10% and 15% as production levels recover with the major customer.

I would now like to hand over to Tim Main.

Tim Main

Thanks Forbes. Revenue for the quarter was roughly the plan, however, product mix was not in our favor during the quarter, and our revenue stream is more material intensive than expected by approximately 50 basis points. We also noted the demand expectations for this seasonally became more subdue as the quarter unfolded.

During the quarter, we launched a new product in the consumer segment, which was developed by Jabil. Due to technical delays and production ramp issues with the product, we experienced significant cost overruns and lowered forward-looking demand expectations from our customers. Accordingly, we have elected to withdraw the product by business plan. And we will record charges and other expenses of approximately $12 million in our first fiscal quarter. We also continued to experience losses in our electromechanical tooling operation and suffered from certain underperforming sites in the Americas and Europe. Due to these challenges in product development and in certain other operations, we are taking remedial actions that'll include restructuring and the movement of production to other sites and strategic partners.

As discussed in previous calls, we expect the impact of these changes to affect our operations through our second fiscal quarter. We also spent over $4 million during the quarter in legal and accounting expenses related to the options and independent counsel reviews.

We regret that we are not in a position to provide complete financial details at this time as we await the completion of review processes now underway. We acknowledge this is a challenging time for the business and for investors and shareholders. We believe we're taking the correct steps to manage the business and to do with other issues in the most appropriate manner and in a timely fashion. We remain committed to growing Jabil's business and helping in profitable way and are motivated to work in these challenging times.

In spite of the present day challenges, we are enthusiastic regarding our long-term prospects. Overall, we are serving customers well. And in most cases, we're expanding our relationships to include new product lines, services, and geographic locations. Our people are doing remarkably fine job in a high growth and high stress environment, and I thank them all for their efforts.

We are also anxious to consummate an exciting transaction with Green Point and offer our mutual customers a best-in-class end-to-end supply chain solution. We will be sure to focus on preserving the great capabilities and technology of Green Point in maintaining the superb support Green Point has given its customers over the years.

Our revenue growth for the year is expected to be supported by the secular trend to outsourcing service expansion and market share gains with certain new and existing customers. For the year, we anticipate revenue growth of approximately 20%, which we believe to be above our sector growth rate and well above end-market growth. We are experiencing some uncharacteristic challenges at the moment but remain firmly committed to long-term growths and returns in the business.

Beth Walters

Operator, we are now ready for the Q&A session of the call.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Lou Miscioscia with Cowen and Company.

Lou Miscioscia - Cowen and Company

Okay. Thank you. I guess, Tim going into the comments that you just gave about the different issues that you are running into, you went through them a little quick, so I wasn’t sure if I was able to write them all down. Are these all incremental to this quarter that we are talking about or some of them continuation of some of the May operational issues? May be if you could, sort of, help define that a little better?

Tim Main

Yeah. To rephrase a little bit, I mentioned a few areas of concern. One is that the product mix during the quarter was more material intensive than expected by approximately 50 basis points. The demand for the quarter was little bit more subdued than we actually expected in the consumer electronics area. I talked about product that we launched in the consumer segment that we are drawing from our business plan and will take approximately $12 million of charges associated with that product in the quarter. I made some comments regarding electromechanical tooling operation, which we talked about in previous quarters and on previous calls, the expectation was that that would continue to affect us through the second fiscal quarter. I also discussed $4 million in legal and accounting expenses due to the various reviews that we are going through right now that are in the press release.

Lou Miscioscia - Cowen and Company

Okay. Then the electromechanical one, the one you've been working on it seems for us since May, does it seem like now it's going to get extended well beyond the second quarter or may be just a little clarification there?

Tim Main

In summary, I talked about underperforming sites in the US electromechanical tooling operation with remedial actions being restructuring and the movement of production to other sites and to other strategic partners. So, I don't think the expectation is that it will not continue impact our company in a material way in fiscals Q3 and Q4.

Lou Miscioscia - Cowen and Company

Okay. And then my last question, I will pass on to someone else. On the demand issue, I guess just you obviously [correlated] out on your slides, so obviously on the consumer side but it seems that that some of the other areas seem to hold up a little bit better, I guess, in the sense of computing and storage seem to tad better than what your prior thoughts were, and maybe even networking. I mean, would you say the environment is continuing as we were in the late part of December to moderate, I guess, as go into first quarter because you did give your full year guidance for top line?

Tim Main

I think from an end-market standpoint, things are relatively subdued maybe a little less optimistic than earlier this year. Currently, our growth move which we think 20% year-over-year growth in this type of environment is fabulous. But our growth at this point is really depended on the secular trend to outsourcing, gaining new customers and gaining market share and we are doing very, very well on those fronts.

Lou Miscioscia - Cowen and Company

Okay. And the inventory situation you mentioned on the consumer side was that something to do with possibly, could you may define which consumer area that would be in?

Tim Main

I am principally speaking to -- no, I don’t think I will make a comment there. I think there are certain product categories that didn’t have the sell through rate even in the summer and they are kind of extended into the Christmas selling season. I don’t think it's a huge issue. There is not an enormous inventory issue that we see, but sell through rates in the second half of 2006 have not been as robust as original plans for some of our customers in that segment. It is not typical for us to have in the last few years because of end market growth and the addition of customers and continued sell through in December and January to have a steeper decline in revenue from Q1 to Q2. If you look back into -- in the previous years and in '04 there was a 1% sequential decline, in '05 it was about a 6.5% sequential decline, in '06 it was about 3 to 4% sequential decline, and this year we're looking for I think we said 9 to 14% sequential decline. So a little bit steeper decline and that's -- I think that that maybe a more typical seasonal pattern for the consumer electronics area.

Lou Miscioscia - Cowen and Company

Okay. Thank you.

Tim Main

Okay.

Operator

Your next question comes from Steven Fox with Merrill Lynch.

Steven Fox - Merrill Lynch

Hi, good afternoon. Couple of things, just going back to the product launch cancellations, is there any details that you can provide on what type of product it is and what's encompassed in the $12 million charge?

Tim Main

I can't get into details about the product. It's an important area for us. We have made significant investments in our product development capability, as most of you know. We still think that’s a pivotal capability to our solution for customers and still an area that develops or generates significant amount of profitability for the company. This particular experience is a bad experience and the $12 million is associated with what we anticipate to be the final excess inventory numbers tooling and other test equipment and other expenses associated with cancelling the project.

Steven Fox - Merrill Lynch

But the cancellation revolved around technical issues with what you developed, is that fair to say?

Tim Main

No. I think most of the technical core issues are resolved and I think the fact that the product was delayed and the pricing in that area is becoming unattractive to us to continuing the activity and it's less attractive area for some of our customers. I think we are making decision to withdraw from that product category and I think that’s the right thing for us to do for long-term profitability.

Steven Fox - Merrill Lynch

And then lastly, Tim just on -- just to make sure I am clear on the May issues, I don’t want to put words in your mouth, but it sounds like you are resolving them as you planned or are you behind, ahead of where you thought you'd be at this point, can you just sort of clarify that?

Tim Main

On the May issues, typically, I think we are resolving them. I would say, we are a little bit behind where we expected to be at this point in June. And but, I think, ultimately they will all be resolved to plan and particularly as we get into Jabil's fiscal Q3 and Q4 I think we are going to be very pleased with the overall results of our rationalization plan, the collective actions, remedial actions that we are taking and most of mechanical tooling operation in certain sites and high cost geographies and more specifically in the Americas. We have a lot of remedial actions underway right now. I think we are a little bit behind where we expected to be over this summer, but I think ultimately within a core give-or-take two to three months period a quarter they'll ultimately be resolved and we will be able to look to fiscal Q3 and Q4 as more indicative of the earnings, probably the company going forward.

Steven Fox - Merrill Lynch

And then lastly, your 20% outlook for growth does not include the Taiwan Green Point acquisition, is that correct?

Tim Main

That's correct.

Steven Fox - Merrill Lynch

Thank you.

Operator

And next question comes from Shawn Harrison with Longbow Research

Shawn Harrison - Longbow Research

Hi. Good evening. Just on the consumer business, again maybe if you could just talk about the set-top box business, you mentioned last quarter that was an issue. Is it safe to assume that's part of the continuing problem at this point in time?

Tim Main

I am absolutely certain we did not mention the set-top business -- set-top box business as being an issue last quarter, and I would be extremely reticent to discuss any particular product categories in that segment. I think it's pretty well documented that while it seems that LCD, flat panel TVs and other product categories are flying off the shelf, recent results in Circuit City and others are indicating that this Christmas season is going to be relatively soft to the previous few years, and I would like to leave that comment -- that general statement I will just leave it at that.

Shawn Harrison - Longbow Research

Okay. Just moving on to your inventory if we could talk about that for a second, are you comfortable with your inventory position currently in terms of raw and finished goods, or how much maybe in days do you think you need to pull it down if necessary?

Tim Main

I think that we're relatively comfortable with our inventory position being eight turns, I think it's up bit more than we would like to have at this point in the seasonal cycle. But particularly in our networking segment due to some lean inventory, lean management arrangements with customers there, we're actually -- we've actually added probably 3 to 5 days in inventory in that segment. And in fact when normalized, our inventory turns would be more like nine. And I think that with the nine inventory turns, we'll be very comfortable going into Q2, which is typically a quarter where we collect a lot of cash and we normalize our inventory levels and prepare for Q3 and Q4 and Q1, which tend to be growth quarters for us.

Shawn Harrison - Longbow Research

Okay.

Tim Main

So with the exception of inventories being a little bit higher than we like in networking and here or there in small pockets, I think best case we'll be looking at nine turns or more to date. So we feel relatively comfortable.

Shawn Harrison - Longbow Research

And just to be clear, there is no plan at this point in time to draw down your raw material inventory by any significant factor?

Tim Main

I am not sure what you mean by that.

Shawn Harrison - Longbow Research

Just I guess componentary semis, passive components, boards things of that nature, just raw material inventory?

Tim Main

Yeah, just not sure what you mean by draw down?

Shawn Harrison - Longbow Research

I guess reduce the inventory position that you are carrying at this point in time in your hubs or --

Tim Main

Well, those are a couple of different things. I mean we are going to work as a company very hard on improving our inventory turns and days in inventory in coming quarters and in coming years. Generally speaking, I think we have too much capital invested there, but when you compare Jabil's results and the mix of our business with other people in our sector, I don’t think our current levels are unreasonable.

Shawn Harrison - Longbow Research

Okay. Thank you.

Tim Main

Okay.

Operator

Your next question comes from Jim Suva with Citigroup.

Jim Suva - Citigroup

Great. Thank you. First a quick clarification question and sorry about my voice, but on your slides you mentioned revenues should be up approximately 20% year-over-year, and previously you said that they would be up 20%, (inaudible) approximately am I just splitting hairs or we are just looking at just a slightly more subdued outlook that may be we were three to six months ago?

Tim Main

I think the environment is little bit more subdued than six months ago. I still feel like our trend line growth rates of 20% or greater particularly when we talk about long-term growth rates is -- we have every, every confidence that we have ever had in that type of belief in our growth rate approximately 20%. I think given the sector growth rates are very small to negative and end-market growth rates not expected to be more than 1% to 3% this year, that putting up something about 20% growth would be phenomenal for the company.

Jim Suva - Citigroup

Okay. And then [great]. You guys have successfully navigated through the lean initiative by one of your large customers, Cisco. Can you talk a little bit now about, since you've navigated through that kind of your status and ability to start to work down that inventories. I believe Forbes mentioned that at first year the inventory pop and you look to push some of that inventory down into the supply chain. Have we started down that road yet and how is that progressing and what should we anticipate?

Forbes Alexander

Hi Jim, it's Forbes. Let me try and address that for you. That really goes to the previous question that was asked on the call and Tim's comments around, we are carrying a little bit more inventories than we would like and maybe three or four days more than we would really like in terms of our networking sector. We did mention -- I think I mentioned on the previous call that we do need to take control of that supply chain and work that down. The status really hasn't changed that somewhere between one to three quarter process. I think we are now into our second quarter of that initiative. So we've still got some work to do, but as we head through this second fiscal quarter into the third, I am pretty optimistic that we can get in and manage that supply chain and bring benefits to our customers to Jabil and to the whole supply chain.

Jim Suva - Citigroup

Okay, thank you. Happy holidays everyone.

Forbes Alexander

Thanks Jim.

Tim Main

Thank you.

Operator

Our next question comes from Michael Walker with Credit Suisse

Michael Walker - Credit Suisse

Okay. Thanks. I guess, just to kind of tail off the last question, you are essentially maintaining full year growth at 20% and yet demand is weaker now than you would have thought. Does that imply that there are more new programs, I guess, coming into play in the second half of the year that offsets the weaker demand or am I reading too much into that?

Tim Main

No. I think if you look back at Jabil's history over the last couple of years, we've tended to start the fiscal year with relatively low expectations, I believe. We started '06 with an expectation of $8.7 and $9.2 billion in revenue. We ended up with 10.2 and I think we had a similar experience in fiscal '05 with beginning expectations in the $6.5 billion range and we ended up with -- at over 7. So we tend to only count things that are in our parlance in the barn at the beginning of the year and then the effects of end market growth, new customer wins, and how sell through rates grow too in that number as the year unfolds. So hanging onto an approximately 20% growth rate is indicative of I think the underlying strength of our business. We do have new programs that have been awarded but we think that even in times that are relatively soft and relative to fiscal '04, '05, and '06 maybe that our growth rate at 20% is still very doable.

Michael Walker - Credit Suisse

Okay. And then just on the customer business going down 33%, I know that you -- I heard what you've said about inventories, can you just confirm just because in the past there have been some concern about whether some of the bigger customers in there are starting to move some of their programs away, can you confirm that that's not part of that 33% that’s really all seasonality and inventories?

Tim Main

I can confirm that there are no material customer losses in that segment. That is the driver for the sequential decline. I think in previous years, we've not seen the sequential reduction that was originally expected, I think --I believe that almost every year, we predicted the consumer electronic segment is going to decline by 25% to 35% and it's really done that, and it's really done that for two reasons. One, end market growth rate has been better than expected. The sell-through in December and -- is better than expected, and we've had rapidly ramping new programs in market share gains. And so -- no, we don’t have those things this year. So I think what we're seeing is not a more pronounced pull back in that area, I think we are just seeing a more normalized seasonal pattern in consumer electronics.

Michael Walker - Credit Suisse

Okay. And then just my last question on margins, I know we're not talking about margin at least directly on the call. But, not really referring to this quarter or next quarter, in the past you talked about being able to get back to 4% operating margin level, you talked about increasing operating margin by 20, 30 bids per year. Just in light of some of the issues that we talked about this quarter, which basically all sound like margin impacts in terms of the higher material content et cetera, is it still realistic at some point in the future or year out getting back to those historical margin number?

Tim Main

Yeah, I think that’s a great point, Michael, and let's be absolutely clear that we’re not trying to signal any type of permanent change to our objectives or the earnings power of our business. We remain committed to not just 4% operating margin, but moving the business to a 5% operating margin. I think the return on invested capital metrics that we've talked about in the past are still very doable for us. And again, we're dealing with some uncharacteristic challenges that I think will work through, but we are not trying to imply that there is any kind of permanent change to the business that would cause us to back away from what we've talked about in the past.

Michael Walker - Credit Suisse

Okay, thanks a lot.

Tim Main

Okay.

Operator

Your next question comes from Scott Craig with Banc of America.

Scott Craig - Banc of America

Hi, good afternoon, just a couple of questions. Tim, when you talk to your consumer OEMs and they talk about the inventory side of things, how long are you telling that they think this inventory correction is going to go on. If I look at your consumer business and your guidance, it's kind of an implying flat sales for you guys on a year-over-year basis. And then, secondly just a clarification with regards to the material mix increasing, so that's a 50 basis point quarter-on-quarter impact to gross margins, is that essentially what you're saying? Thanks.

Tim Main

I’m saying, -- I really can't talk about gross margins that type of thing, but what I’m saying is that material content of our revenue stream is about 50 basis points higher than what we'd expected.

Scott Craig - Banc of America

I’m not sure -- are you saying that what it looks like for fiscal Q2 '07 would be flat in fiscal Q2 of '06 in the consumer electronics area?

Tim Main

Yeah, roughly.

Scott Craig - Banc of America

Yeah, roughly I think you're roughly correct.

Tim Main

And, Scott I want to make sure that we're not over emphasizing this inventory thing because I think it's a very modest issue. I just think people need to understand, we started the quarter expecting consumer electronics to be up 30%. It was only up 25%. We are seeing a more normalized seasonal pattern and expecting consumer electronics to decline by 33%. So, I don’t think there is any type of very serious inventory issue there. And so to the extent if there is, I think it could be worked through in -- within a quarter.

Scott Craig - Banc of America

Okay. And then just one quick follow-up on the consumer product that you guys were developing. I assume that’s on a basically on an ODM basis. Is there lingering cost issues there, even though you have dropped the product that could potentially impact margins going forward, and how do you think about the ODM model for you guys given that a lot of your counterparts have tried to get in and have had to get out at some point, is this -- we look at the same thing for you guys?

Tim Main

So, it won't be any lingering costs associated with this particular product. So, check that box off and then the whole -- the whole ODM question. No, I think there is couple ways to look at it. We have an excellent product development capability that has been principally directed to collaborative development products and in some cases products which compete directly with ODMs. And we are going to continue to do that and actually we have $800 million roughly in business that’s -- that type of product development relationship with the customer and it's a very profitable business with us. We got off -- this was particular technology that we are very interested in. We thought we had something that was very, very unique and was more challenging than we thought it would be and really it is as much is the challenging the technology is that the marketplace really kind of moved away from this product set. Pricing in competitive technologies declined very rapidly unexpectedly, and so in order for that product to be competitive, the price points came down very dramatically. And so, we made the decision to exit the business.

Typically, we are in much more mainstream applications where things are much more predictable and we aren't exposed to that type of risks. So, I don’t think, this is -- we are certainly not going to back away from our investment in product development and our capabilities there, but we typically do not have this type of risk in the products that we take on. So, I wouldn't expect this to be a recurring thing.

Scott Craig - Banc of America

Okay, thanks Tim.

Tim Main

Thanks.

Operator

Your next question comes from Bernie Mahon with Morgan Stanley.

Bernie Mahon - Morgan Stanley

Hi, good evening. A question for you on the -- could you just go through the three operational issues that you had in the May quarter and just give us an update on each one of them, I mean if you are fully cleared, if you are 90% cleared? It seems like there is still some issues on the tooling side, just so we have that straight?

Tim Main

No, I don't think I'll Bernie -- that's kind of a lengthy time ago. They are essentially on track. I think I talked about earlier in the call maybe a little bit -- taking little bit longer than we originally expected and having an impact to our fiscal Q2, but that's what we expected and so things are contained, things are understood, working on the issues, they will be resolved and we'll able to go in a lot more detail. We can get the published financial statements and we can talk about the impact of these various things in better detail.

Bernie Mahon - Morgan Stanley

So, you can't quantify that are all saying 50% complete, 70% complete, I mean are you comfortable with any of that?

Tim Main

No. I don’t think so.

Bernie Mahon - Morgan Stanley

Okay. How about maybe a follow-up on demand, it looks like the networking segment was a little bit better than planned and the guidance there is seems to be kind of in line with normal seasonality. But you talked about a slowdown in the overall demand environment. Is it safe to assume that maybe you didn’t see that slowdown in the networking segment or their new programs there is it just a pretty healthy demand environment there?

Tim Main

I think there is a pretty good demand environment there and I think we're doing well with our customer base in that segment, and combination of those two things it has been a little bit better than expected.

Bernie Mahon - Morgan Stanley

Okay. Thanks a lot.

Tim Main

Okay.

Operator

Your next question comes from Brian White with Jefferies Asset Management.

Brian White - Jefferies Asset Management

Yes. Tim, if you could talk a little bit about the product that the ODM product that had the issue, when did you start developing this product, how long ago was that and will there be any impact to the quarter other than the charges from this product?

Tim Main

What are the types of impacts, would you be looking for?

Brian White - Jefferies Asset Management

Like an impact to pro forma net income, and then beyond just taking up charge and segmented out as a one-time expense?

Tim Main

I am not sure, I understand that question. I would expect the charges to be the charges, Forbes, do you want?

Brian White - Jefferies Asset Management

Would it be considered one time, Tim, just like a restructuring.

Tim Main

That’s not for me to decide, I don’t know.

Forbes Alexander

We haven’t contemplated that again. We're just -- we're giving you what information we can, but certainly we wouldn’t expect to have any ongoing impact as a result of these charges.

Tim Main

The development of the product started probably over a year ago.

Brian White - Jefferies Asset Management

Okay. And then on Philips, the contract came due in November, you indicated you didn't think it was going to be an issue, would continue as planned. Were there any surprises there on pricing and volumes, anything changed in terms of working with that customer?

Tim Main

Still have a great relationship with Philips that we think will remain strong and continue into -- in the future years.

Brian White - Jefferies Asset Management

Okay. So nothing changed materially with that relationship?

Tim Main

I think they are great customer, strong relationship, and customer we intend to have in coming years going forward.

Brian White - Jefferies Asset Management

Okay. Forbes, operating cash flow do we have at least some type of discussion on that, was it positive, was it negative; and inventories did they go up or down in the quarter?

Forbes Alexander

Unfortunately, my hand is tied in providing you specific detail, but in my prepared remarks we did talk about our sales cycle, and that did increase by approximately nine days in the quarter. So that was a considerable expansion that one day we have earned about $30 million. So right now we have $270 to $300 million of working capital expansion in the quarter. We do expect that to recover [or will] swing back the other way during our second fiscal quarter which is typical for this business given the high seasonality in terms with some of our consumer customers.

Brian White - Jefferies Asset Management

Okay. Thank you.

Operator

Your next question comes from Alex Blanton with Ingalls & Snyder

Alex Blanton - Ingalls & Snyder

Hi, good afternoon. Tim, may be a bit of a philosophical question, but I don’t really understand how the shareholders' interest are served by what your lawyers are requiring you to do, which is to not talk about earnings for months on end and not talk about margins, not even gross margins or cash flow. We have a lot of moving parts that the Green Point coming up, you have got Cisco [lean] impacting you, you have got withdraw of your product, you have got product mix changes, material cost is going up and some disappointment on some of the sales in consumer electronics and so on, and yet we have no indication of how earnings are being affected by any of this. So, I am just wondering, how are the shareholders' interests being served here by these requirements that you can't discuss the earnings effects at all?

Tim Main

I am very, very sympathetic with your frustration. I acknowledge that more information is better for shareholders to make intelligent judgments about whether or not to invest in our company. I think that the reviews that are being conducted are theoretically and in reality intended to be for the benefit of shareholders to ensure from an independent standpoint that the company has high ethical standards and integrity and is reporting financial information accurately. And we have to be in complete support to that and it's very important that these things be allowed to be reviewed and determined and that the company is thoroughly [embedded] for whatever they are looking for, whatever they are looking at. And I want just to remind everybody that this is not something which is under my or Forbes or the Senior Executive management team's direct control. So, I am very, very frustrated with the time. I sympathize with you completely. I would love to give you more information, but these reviews are intended to be for the benefit of shareholders in determining the integrity of the company. And I think that's very, very important to me personally that we get this right, that we do the right thing, and that these things are able to be conducted and reviewed the way they need to be in order to determine with finality exactly what has to be done going forward.

Alex Blanton - Ingalls & Snyder

Well, all right. May be you could explain a little more about why these things that are being reviewed relate to past events? But we are being told that we can have any information on earnings or margins regarding current events or future prospects. I don't understand that why is that? We are not talking about the past here, we are talking about what happened this quarter?

Forbes Alexander

Well, let me try to address that. There are specific regulations that prohibit us from providing information. Those regulations were created a number of years ago, again, in the best interest of shareholders and investing public. The specific regulation I am referring to is Reg G, I believe, which prohibits us from providing information to investors until we can provide it accurately and in timely basis.

Alex Blanton - Ingalls & Snyder

Okay. You provide accurate information about what's going on currently?

Forbes Alexander

We cannot provide you accurate information while these reviews are ongoing as it relates to US generally accepted accounting principal. And that’s what Reg G addressed and so if we ought to give you any information, we must do so with statements under US GAAP.

Alex Blanton - Ingalls & Snyder

Okay. I will have to take this off-line, but I really don’t understand why you can't provide us with information about what is going on currently? The reviews have to deal with past events, past periods.

Forbes Alexander

Okay, I sympathize with your frustration.

Alex Blanton - Ingalls & Snyder

Thank you.

Operator

Your next question comes from Yuri Krapivin with Lehman Brothers.

Yuri Krapivin - Lehman Brothers

Hi, good afternoon. I am looking for additional clarification with respect to your material cost. Did the material cost go up or high than you expected because of the product mix or is it because simply the prices for materials went up?

Tim Main

Not because the price of materials went up, but because of the product mix and the products that we had sell through on for the quarter increased material content in our revenue stream. So it's more of a product mix issue.

Yuri Krapivin - Lehman Brothers

Okay and then with respect to your networking segment, can you confirm that 8% quarter-over-quarter growth that you saw, was it all organic or was there some residual input from the lean initiative?

Tim Main

There is probably a little content from lean initiative but that's principally organic.

Yuri Krapivin - Lehman Brothers

Okay, and finally with respect to the peripherals segment, you experienced strong growth, in November quarter you mentioned that it was seasonal. Is it just seasonality or did you win some incremental business there?

Tim Main

We are relatively successful in the peripheral sector, so there are our business wins. But the first quarter experience was principally very good sell through.

Yuri Krapivin - Lehman Brothers

Okay, and then finally, would you expect additional cost related to stock option investigation in the February quarter?

Tim Main

I’m certain that we'll have additional expenses in fiscal Q2, and we'll see about fiscal Q3 and -- but I have no way of giving you any estimate beyond that but we are experiencing additional costs in Q2.

Yuri Krapivin - Lehman Brothers

Okay. Thank you.

Operator

Your next question comes from Kevin Kessel with Bear Stearns.

Kevin Kessel - Bear Stearns

Thank you. Tim just on the product mix question again just to kind of touch back on that, you've said that. You said that product mix was unfavorable due to the sell through of certain products that are more material intensive, and I imagine in your mix if we look what happened in the peripherals were obviously up much more than expected. Consumer, where I would expect maybe a higher material content potentially, wasn’t up quite as much as you had expected. And then, you obviously had telecom down less. So, I am -- what segment actually drove that mix or the unfavorable mix? What you say?

Tim Main

Even within segments that you might typically characterize as higher margin, generally there are products within those segments that have higher material content. And, the instrumentation medical segment was little weaker than expected, that has a negative impact. And within the consumer segment, we were dealing with higher material content products than others.

Forbes Alexander

In addition, Kevin, within the networking sector, as we have brought in this lean initiative, I think we outlined -- quite frankly, we did that back in I guess for the second or third fiscal quarter, that our expectations would be that -- that would have some 30 to 40 basis points on an overall fiscal '07 margin impact. So clearly as you see -- the some impact as you see, healthier demand perhaps and we first anticipated in that sector, but we are pulling more material through given we are now managing that material base. That has some impact also.

Kevin Kessel - Bear Stearns

But then Forbes, doesn’t the -- I mean the lean initiative is something that’s here to stay, I mean in the sense that the practice of now procuring those components will kind of be the way you do business with this customers. So, is it always going to kind of reflect negatively on mix or -- I mean is there a way to improve that overtime or not really?

Tim Main

There is a way to improve it, but it's more diversification in that segment and dealing with higher-end products that might have a lower material content. In revenue stream again within each segment, there are high-end, mid-range, and higher-end products, or low-end products, mid-range, and higher-end products that all imply different levels of material in the revenue stream, and quarter-to-quarter that mix might change.

Kevin Kessel - Bear Stearns

I got it. And then Tim, in terms of the 4% operating margin that was spoken about back in May, I understand in terms of what you are currently saying on those three issues, but I guess would it be fair to say based on your comments on the negative mix change and some of these other hick-ups that are happening that the 4% operating margin or is it being implied that it's more like a Q3, Q4 event, meaning once these things are essentially behind Jabil, that's when you would expect to break through that level?

Tim Main

Yeah, I can't answer that directly. But I can say that when we look out into Q3 and Q4, we expect to have the rationalization expenses and more so the process, we're moving products around, what we've talked about in terms of remedial actions for certain sites in the Americas in electro-mechanical tooling operation, short-term issues associated with our product that we've withdrawn from our business plan. Those issues will be behind us and the expectations will be that our financial results in fiscal Q3 and Q4 will be much more indicative of what the company is capable of than the uncharacteristic circumstances that we are in today.

Kevin Kessel - Bear Stearns

I got it. And then just a clarification here on the US, I mean it sounded like in your prepared remarks, Tim, you were implying that there would be additional restructuring to take place in the US now and you mentioned also a shift of businesses to strategic partners, maybe you can clarify what you meant by that?

Tim Main

Yeah. I am not really speaking to any additional, incremental efforts. I think all the areas of concerns for the company have already been identified, and we're moving along with that process.

Kevin Kessel - Bear Stearns

And strategic partners, when you mentioned that, how should we bid into that, what does that mean?

Tim Main

Particularly related to electromechanical tooling operation. We've elected to -- we've elected to have that capability resident and low cost locations and rely more on strategic partners for that capability than to try and manifest that entirely internally. It could still be a profitable business for us but we've made this strategic decision to transition some of the production from that side and to rely on our partners to provide that capability to us going forward.

Kevin Kessel - Bear Stearns

You are talking about Austria site then, or no, the one that had the tooling issues?

Tim Main

Yes.

Kevin Kessel - Bear Stearns

Okay. And then lastly, your 20% growth, you mentioned how it doesn’t incorporate Taiwan Green Point, but does it incorporate the expectation of maybe any potential divestitures or OEM divestitures during the year that would be done with customers or new customers?

Tim Main

No, it’s a standard -- with standard Jabil values, it is stuff that we can reach out and touch right now, and our confidence in the underlying strength of our business, our business model, how we've been winning business with customers and the rest of it. I mean that’s still very, very solid for our company. I mean we're still winning. We've become the third largest EMS provider in the world. And we're going to continue to grow the business. Our solution for customers as dark as this may seem and as murky because you don’t have financial statements in your hand and it's getting more and more difficult, more time that goes by to really understand what's going on. I mean, we are winning in the marketplace. We are growing as a company. And our solution as it relates to customers' ability to execute that, that thing is in fabulous shape. It is really, really in good shape.

Kevin Kessel - Bear Stearns

And then just on the divesture front, you mentioned the auto divestitures, maybe you can touch on that because as you know where you've got Delphi coming out of bankruptcy soon, I imagine that a lot of the restructuring that they're going to need to do will be in terms of the way they manufacture because it's been highly inefficient for them and for Visteon.

Tim Main

Right.

Kevin Kessel - Bear Stearns

Any sense on that going forward for the whole industry?

Tim Main

Well I think it is -- I think eventually it would be a very positive thing for the automotive supply business and I think it end up being a positive thing for the EMS business because I think that consistent to what I've said in the past a lot of emphasis really should be on outsource. We can do a faster, better, cheaper and I think that's going to be a good thing. There is a lot of private equity money circling around the automotive supply industry in some circumstances and we can certainly help with taking over the burden of manufacturing product in a more diversified plant in lower cost location, reduced cost. It's kind of a home run value proposition for companies that are supply chain focused and supply chain intensive. So, again, I think, if you get out of the next 90 and 180 day kind of fixation that we all tend to have, and think about it long term, it should be very, very good, it should be an excellent sector for Jabil and other EMS providers to grow. Short term, it's going to be a little bit dodgy. I mean we are going to have to step through the opportunities, make sure we are in the right transactions with the right customers and doing the right thing. And that’s -- I think we are going to have to be highly selective in the types of things that we engage in. But Jabil has a very significant automotive business today, that’s $600, $700 million a year in business. So, we have got a great running start. We have got great capabilities in the Europe and the Americas and we are producing automotive electronics in Asia. And we know how to build automotive electronics that extremely low DPM levels and understand all of the long-term product development requirements that is associated with it. So, I think we are -- I think Jabil Circuit is in a great position to benefit from the automotive supply business long term.

Kevin Kessel - Bear Stearns

And just on the filings, I mean is there any -- what sort of companies most current position in terms of when these would be filed or is there any kind of broad -- like the goal is by January something or by -- I mean, how do we think about this in terms when filings might reasonably be out?

Tim Main

We can't say.

Kevin Kessel - Bear Stearns

Okay. Thank you.

Operator

Your next question comes from Matt Sheerin with Thomas Weisel Partners.

Matt Sheerin - Thomas Weisel Partners

Thank you. Tim, my questions are concerning the Green Point acquisition. You obviously, believe your vertical integration is important to compete in the handset business. Can you tell us other areas within handsets you may be looking to fill in terms of product capabilities? And then from -- aside from that space, are there other segments where you think it make sense to have more vertical integration?

Tim Main

I think that’s a great question, Matt, and we don't have a shopping list of other things that we think we need to buy to support our business in that area. I think we will be opportunistic and we will be selective in the types of technologies and capabilities we invest in. We think that consumer electronics area and more particular mobile products because of style being so important and because of the constraints of the product being so important that that electromechanical design manufacturing and cosmetic treatment capability enhances our value proposition of global supply chain management and electronics production capability and design to a very attractive extent. So, we think that Green Point marriage with Jabil provides a very compelling value proposition for our customers in that segment. And that's really what we are focused on right now. We are not focused on buying a lot of other stuff to add to a basket of capabilities.

Matt Sheerin - Thomas Weisel Partners

Okay, great. And just a quick question, you mentioned three customers above 10%, can you tell us who they are? Thanks.

Forbes Alexander

Yeah. Absolutely. In the quarter that would be Nokia, Cisco, and Philips.

Matt Sheerin - Thomas Weisel Partners

Okay, thank you.

Operator

Your next question comes from Todd Coupland with CIBC World Markets.

Todd Coupland - CIBC World Markets

Hi. Good evening. My question has been answered. Thanks.

Tim Main

Thank you.

Operator

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

Amit Daryanani - RBC Capital Markets

Thanks. I just want to go back to this product mix issue that we are talking about, looks like the 50 basis headwind this quarter, could you just talk about if you expect to recover this headwind next quarter or would it take a little longer to get back to 50 basis points?

Tim Main

That -- that’s going to depend on product mix and we will talk about that in our next conference call.

Amit Daryanani - RBC Capital Markets

But, I mean I guess looking at what you see in terms of now the production schedule that you have, is the product mix improving in your favor in terms of margins or is it staying stagnant the way it was this quarter?

Tim Main

Yeah, I am not -- really not in a position to go there at this point. We’re only two weeks into the quarter and -- or three weeks into the quarter, and a lot of things can change between now and February 28. So, I need to reserve any comments on that, but I wish you could help you more, but --

Amit Daryanani - RBC Capital Markets

Fair enough, and then just looking at the restructuring actions that we're looking take over here, are lot of that charge would happen in the next two fiscal years. When should we start expect to see savings from the most of the P&L there. Is there a timeline on that you could update us on?

Tim Main

Yeah, it's consistent with our previous remarks when we announced this plan couple of quarters ago and we expect to start seeing benefits in our fiscal third quarter and fourth quarter of this fiscal year of '07. We should start seeing results of that and then we should see that continue through fiscal '08.

Amit Daryanani - RBC Capital Markets

Fair enough, just a final question. Given all the issues that you have with regard to the SEC investigation, are you seeing a bit of squeamish suppliers who might be reducing term that we give you at this point, which may explain why the 80 days have moved so much this quarter, or was that -- is this just a timing issue in the quarter?

Tim Main

Not at all, that’s just a timing issue I mean.

Amit Daryanani - RBC Capital Markets

All right, thanks.

Operator

Your next question comes from Paras Bhargava with BMO Capital Market.

Paras Bhargava - BMO Capital Market

Hi, good afternoon gentlemen. Tim, is the demand weakness in consumer only or is it more broad based?

Tim Main

You say a few things to try and give a little bit of color and then it can get blown out of proportion. I think demand was a little bit soft, but still -- it's still okay. I mean it's still a growth environment. Things are relatively stable. I just think that generally speaking our customers and particularly in the consumer electronics area, we had at beginning of quarter expectation of 30%, it was up 25%, still a good season.

And looking forward to the balance of the year, I just think from a tone standpoint and less so from current production scores, I mean really from a tone standpoint, people are a little bit more subdued, a little bit more reserved in their expectations for what things are going to be like in calendar 2007 from a growth rate standpoint. I’m just trying to provide some color in that regard as it relates to what our expectations are for our business. I don’t -- in environment where we're going to see strong end market growth.

Paras Bhargava - BMO Capital Market

No, is it just consumer though, is it across everything is what I’m asking, is that --

Tim Main

It's more the consumer.

Paras Bhargava - BMO Capital Market

Okay, and Forbes it looks like working capital might have chewed up, it's hard to tell with the amount, and I’m guessing as much as 300 million bucks is that -- am I doing my math right, or is that totally off base?

Forbes Alexander

No, that's -- a day as these types of revenue level is round about $30 million, so our sales cycle expanded by approximately 9 days, so maths there is right.

Paras Bhargava - BMO Capital Market

Alright, I just wanted to check is, now where there any other unusual sources or sources of non-operating cash, I’m just trying to reconcile Tim's statements about problems with the cash performance given that working capital drained a bunch of cash and --

Tim Main

I don’t remember saying anything about cash performance. If you --

Paras Bhargava - BMO Capital Market

No, no. I mean in terms of your comments -- sorry about operating challenges, and then it looks like the cash performance given what happened, working capital actually quite good, were there any other unusual sources of cash, Forbes?

Forbes Alexander

No. There were none.

Paras Bhargava - BMO Capital Market

All right. So --

Tim Main

It's a still -- this is still a good, good business. I mean, we can talk -- and again we acknowledge how frustrating this is, we can't publish financial statements, put this stuff in your hands but it's still a very healthy business. I mean two quarters ago, was a investment great company with a great balance sheet, we have record, I mean we are not wrecking the business.

Paras Bhargava - BMO Capital Market

Okay. Well I just --

Tim Main

It's still an excellent business to be in and we are still growing.

Paras Bhargava - BMO Capital Market

Okay. And then, I am just trying of fill in the holes because it's just -- we are trying to -- it is like a jigsaw puzzle here.

Tim Main

No. I understand.

Paras Bhargava - BMO Capital Market

So now the other question, you didn’t buyback any shares. I don’t think you can this quarter, right?

Forbes Alexander

No, no. That share buyback was exhausted in our fiscal '06. We don’t need and have the capability to do that and we are not approved to do that.

Paras Bhargava - BMO Capital Market

Okay. And tax was normal in terms of tax expense and cash taxes, there wasn’t any mismatch there, big mismatch?

Tim Main

I cannot make any comments with regard --

Paras Bhargava - BMO Capital Market

Okay, okay, alright. No, I understand you are little bit hamstrung here. Okay. And then finally, if I just look at your telecom business, it did better and you mentioned, I think, that when your customers is coming back, is that a broad -- like is that a counter trend telecom and networking or may be doing better and the rest of the stuffs doing is soft -- is doing worse, may be just slightly or is that just very customer specific in those two segments?

Tim Main

In telecom sector, our comments indicated that it was customer specific and I think that’s a fair statement. In the networking segment, I think it is what it is. I mean it was little bit healthier for the quarter than we expected and we expect production levels in Q2 to be consistent with the first quarter, so --

Forbes Alexander

Not (inaudible) but going pretty well.

Paras Bhargava - BMO Capital Market

All right. Thanks a lot gentlemen.

Beth Walters

Operator, we have time for just one more question tonight.

Operator

Thank you. Your next question comes from [Monish Perry with RF].

Monish Perry - RF

My question was answered. Thank you.

Beth Walters

Okay. Thank you everyone for joining us on the conference call for today.

Operator

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

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Source: Jabil Circuit F1Q07 (Qtr End 11/30/06) Earnings Call Transcript
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