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Jabil Circuit, Inc. (NYSE:JBL)

F2Q07 Earnings Call

March 22, 2007 4:30 pm ET

Executives

Beth Walters - VP, IR

Forbes Alexander - CFO

Tim Main - President and CEO

Analysts

Lou Miscioscia - Cowen and Company

Jeff Rosenberg - William Blair

Steven Fox - Merrill Lynch

Thomas Dinges - J.P. Morgan

Shawn Harrison - Longbow Research

Kevin Kessel - Bear Stearns

Matt Sheerin - Thomas Weisel Partners

Yuri Krapivin - Lehman Brothers

Jim Suva - Citigroup

Amit Daryanani - RBC Capital Markets

Alex Blanton - Ingalls & Snyder

Brian White - Jefferies

Scott Craig - Banc of America

Will Stein - Credit Suisse

Reik Read - Robert Baird & Company

Long Jiang - UBS

Carter Shoop - Deutsche Bank

Bernie Mahon - Morgan Stanley

Andrew Huang - American Technology

Presentation

Operator

Good afternoon. My name is Celina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Jabil's Fiscal Year 2007 Second Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). Thank you.

Ms. Walters, Vice President of Investor Relations and Communications, you may begin your conference.

Beth Walters

Thank you. Welcome to our second quarter call. Joining me on the call today are President and CEO, Tim Main and our Chief Financial Officer, Forbes Alexander. This call is being recorded and will be posted for audio playback on the Jabil website in the Investor section, along with today’s press release and a slide show presentation on the quarter.

You can follow our presentation with the slides that are posted on the website, and if you could, please begin with the first slide, our forward-looking statements for the quarter.

During this conference call, we will be making forward-looking statements, including those regarding our unaudited second quarter fiscal year 2007 net revenues and certain other financial measures, our currently expected third and fourth fiscal quarters of 2007 net revenues, core operating margins, and core earnings per share; as well as the acquisition of Taiwan Green Point; estimated capital expenditures for fiscal 2007; 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 the finalization of our first and second quarter fiscal year 2007 financial statements and the 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 of our Board and governmental authorities and the review of our historical recognition of our revenue by our Audit Committee; the accuracy of the measurement dates we used for accounting purposes for our historical option grants and whether all proper corporate and other procedures were followed; the impact of the restatement of our financial statements and any other actions that may be taken or required as a result of any such reviews; risks and costs inherent in litigation, including any pending or future litigation relating to our stock option grants, the restatement of our financial statements as a result of the evaluation of our historical stock option practices and financial statements or declines on the price of our stock; 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; and our ability to successfully address the challenges associated with integrating our acquisition of Taiwan Green Point; our ability to take advantage of perceived benefits of offering customers vertically integrated services; 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 operations; retaining key personnel; our dependence on a limited number of large customers; business and competitive factors generally affecting the electronic 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.

I would now like to turn the call over to Forbes Alexander, our Chief Financial Officer.

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Forbes Alexander

Thank you, Beth. Good afternoon. We regret that we are not in position to provide GAAP results and full financial statements at this time, as we await the completion of the ongoing review processes.

We shall be able to file our 2006 Form 10-K once our Board of Directors' Audit Committee has concluded the evaluation of historical financial statements. And Jabil's independent registered public accounting firm is able to complete its audit of the financial statements to be included in Form 10-K.

However, we are pleased to be able to provide full forward-looking guidance. The ongoing inquiries have reached at a stage where we are reasonably comfortable with the impact that it will have on the third and fourth quarters.

With that, I would like to ask you to turn to slide 2, please. Revenue for the fiscal second quarter of 2007 was at the high-end of our previous guidance at $2.935 billion. This includes revenues from our Taiwan Green Point acquisition for the period of 15th of January to 28th of February 2007 of approximately $59 million.

The quarter represented a 27% growth in revenue on a year-over-year basis and a 9% decline on a sequential basis, reflecting the seasonal nature of our consumer sector. Excluding Green Point revenues, our revenues declined 11% sequentially.

Now, I’ll ask you to turn to slide 3 and turning to a discussion of revenue by sector for the second quarter. Production levels in the automotive sector decreased 5% from the prior quarter, slightly better than expectations and consistent with the seasonal patterns of previous years.

The computing & storage sector decreased 5% from the first quarter, consistent with our expectations. The consumer product sector, including revenues associated with Taiwan Green Point, decreased by 31% from the first quarter, reflecting traditional, seasonally lower demand levels for consumer products.

While the overall sector met our expectations in terms of total revenue, we did experienced lower unit volumes offset by additional LCD panel flowing through the revenue stream.

The instrumentation & medical sector was better than our expectations and increased 4% from the first quarter. Networking sector increased by 1% from the previous quarter, and the peripherals sector was consistent with the first quarter as expected. And finally, the telecommunications sector increased 16% sequentially as production levels with a major customer recovered.

Our sector information for the quarter in percentage terms is as follows. To remind you, the consumer sector includes revenues associated with Taiwan Green Point. Automotive was 5%, computing & storage 12%, consumer 29%, instrumentation & medical 17%, networking 20%, peripherals 7%, telecom 5%, and other 5%.

On a year-over-year basis, we have added revenue in the quarter of $560 million with all segments, except consumer and telecom contributing to this growth. Over the last three fiscal years, we've seen an average of approximately 3% decline in revenues from our first fiscal quarter, reflecting the seasonal nature of the consumer sector.

For the first time, since our entry into the consumer sector, we've seen double-digit sequential declines in our overall revenues, which is more representative of our current revenue profile. Bringing along with it dilution for the operating income as a result of the semi-fixed nature of costs supporting the seasonal demand.

For the second quarter, two customers exceeded 10% of the revenue stream. Our top five customers, Cisco, Nokia, Hewlett-Packard, Philips, and IBM, accounted for approximately 51% of our revenue. And our top ten customers accounted for approximately 65%.

I'd now ask you to turn to slide 4, reviewing our balance sheet trends. Excluding Taiwan Green Point, the company's sales cycle in the quarter expanded by two days. An improvement in the level of days sales outstanding was offset by two additional days in inventory and a reduction in accounts payable days outstanding.

While inventory fell in dollar terms, days was at 48 days in the quarter or 7.4 turns. With the consolidation of Green Point, the sales cycle at the end of the second quarter was 29 days.

Cash and cash equivalents were $559 million as compared to $651 million at the end of the first quarter.

Current debt at the end of the second quarter totaled approximately $1 billion, as a result of drawing down approximately $870 million to fund the tender of Taiwan Green Point shares and draws of the combined companies' revolving credit facilities to fund operational activities.

Our capital expenditures during the quarter were approximately $74 million.

Now I would like to take a moment to discuss some operational issues, restructuring, and our Taiwan acquisition.

Firstly, I know many of you have been inquiring as to the impact of the three operational execution issues we identified in June of 2006. Two of these items have been fully resolved. And the third, the electromechanical tooling capability, had a smaller impact on our second fiscal quarter and is expected to continue to decline in importance in our future quarters.

With regards to restructuring, during the second quarter we continued to manage our overall rationalization plan, consistent to our previous comments. We continue to expect our total restructuring charges to be at the high end of the $200 million to $250 million range we have previously announced.

The cash costs of such charges for this plan remain an estimate in the range of $150 million to $200 million. Discussions with our employees and their representatives continue, and we are complying with all the statutory and consultation periods required of us.

With regards to capacity, as we've previously discussed we are adding additional floor space and capacity in Poland, Ukraine and India. These facilities are expected to ramp production levels during the balance of calendar 2007. We continue to ramp significantly higher levels of production in our existing Chinese sites.

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

With regards to the Green Point acquisition, on January 15, 2007, shareholders controlling over 97% of Taiwan Green Point shares tendered their shares. The minority interest shares will be repurchased with finalization of the acquisition, which we expect to close during the last week of April 2007, subject to the timing of the government approvals.

Our transition plans have been running smoothly, and we continue to see very bright prospects for this new part of our service offering for the consumer sector.

As of January 15th, we drew down approximately $870 million from our bridge facility to fund the tender. The balance of this facility shall be drawn down upon purchase of the minority shares in late April.

In addition, as of January 15th, Taiwan Green Point's results have been consolidated with those of Jabil's for U.S. GAAP reporting purposes, excluding the minority interest element.

Now let's turn to business update. I will ask you to turn to slide 5. Third quarter of fiscal 2007 shorter term revenue guidance continues to reflect a more muted view of end market growth, along with our deliberate and disciplined actions in pricing. This allows us to move towards our targeted operating income levels over the course of the next two to three quarters.

I would like to remind you all that comments with regards to our guidance for future periods, reflect the consolidation of Jabil and Taiwan Green Point. We estimate revenues in our third fiscal quarter of 2007 to be in a range of $2.9 billion to $3 billion, consistent at the midpoint of this range with our second fiscal quarter.

Our core operating income is expected to be in the range of 2.5% to 3%. Our core earnings per diluted share are expected to be in the range of $0.17 to $0.23. This reflects higher levels of interest expense associated with the acquisition of Taiwan Green Point and utilization of the revolvers to fund the working capital needs during the quarter.

Now I'd ask you to turn to slide 6, discussing revenue by sector for the third quarter. Our automotive sector is expected to increase by approximately 5% for the quarter. Computing & storage sector is estimated to be consistent with the second quarter. The consumer sector is expected to decrease by approximately 10%, reflecting the timing of product transitions set in consumer products offset by revenues associated with the Green Point acquisition.

The instrumentation & medical sector is estimated to be consistent to slightly better than the previous quarter. The networking sector is expected to increase by approximately 7% from the first quarter, reflecting the award of new assemblies within the sector.

The peripheral sector is estimated to increase by 15% in our second quarter reflecting new business awards with existing customers. And the telecom sector is estimated to be consistent to slightly better in the second quarter.

Now, I'd ask you to turn to slide 7. Our current estimates for revenue guidance for the fourth quarter are consistent with those of the third. That is a range of $2.9 billion to $3 billion.

This guidance shows the revenue growth for the fiscal year 2007 at a range of 17% to 18% including revenues from our Green Point acquisition in the fiscal year. Green Point's revenue is estimated to be in the range of 4% to 6% of the second half of the year's revenue guidance.

We now estimate our revenues to be split as follows across the industry sectors we serve. I'd remind you that the consumer sector does include revenues associated with Taiwan Green Point. The automotive sector 5%, computing & storage 11%, consumer 29%, instrumentation & medical 17%, networking 20%, peripherals 8%, telecom 5%, and the other sector 5%.

Core operating income for the fourth quarter is expected to be in the range of 3.25% to 3.75% of revenue, with core earnings per diluted share to be in the range of $0.28 to $0.34.

While it is too early to provide you with specific guidance for fiscal 2008, we are optimistic that revenue growth will be strong. We have won new business in the storage, automotive, peripherals, instrumentation and networking sectors, all anticipated to ramp over the course of the next three quarters.

I'd like to remind you that our short-term revenue guidance does reflect a somewhat more muted view of the end-market growth along with our deliberate and disciplined actions in pricing, allowing us to move towards our targeted operating income levels over the course of the next two to three quarters.

Thank you. And now I'd like to hand the call over to Tim Main.

Tim Main

Thanks, Forbes. There are a few areas I would like to cover before we go to Q&A. I will provide some color on the overall end-market demand, Jabil's growth profile short- and long-term, as well as our anticipated margin profile.

Overall, end-market demand for most of our sectors is relatively weak when compared to previous quarters. However, I think we're now entering a period of relative stability and are at a somewhat lower risk of significant further erosion.

I believe my comments to be consistent with the economic press in recent weeks. There was a discernible slowdown in demand in late 2006, but I am now actually feeling better about our prospects for the balance of 2007.

Jabil's growth over the next two quarters will be below our previous expectations, principally due to a few isolated factors within our consumer sector. Revenue in our consumer sector is expected to decline sequentially for the balance of 2007. There are several reasons for this.

One, we're positioned with one of our largest customers in one of their weakest product areas.

Two, we're transitioning our business model with two large customers in this sector. We're moving to a more product development based relationship with one customer and with another customer from our historical horizontal supply chain strategy to a more vertical solution integrated with our recent acquisition.

Three, we are committed to margin expansion and are exercising tighter pricing discipline, exiting areas with poor returns, and targeting areas in the sector that align well with our value proposition and the needs of our customers.

In the short term, the impact of our actions in the consumer sector will inhibit our overall revenues growth for the next two quarters. This transition in our consumer sector will conceal strong growth in the balance of our business.

Excluding the revenue impact of certain top five customers in our consumer sector, and excluding Green Point, revenue in the balance of our business is expected to increase approximately 17% in the second half of '07 over the second half of '06.

We also expect the profitability of this additional revenue to be at or above our targeted long-term profitability objectives.

Additionally, we have been awarded sizeable new business wins in the networking, automotive, storage, instrumentation, and peripherals segments. This is a mix of significant market share gains with existing customers, as well as new customers to Jabil.

Revenue contribution from these new business wins will become increasingly material in fiscal 2008.

As we transition the business mix of our consumer sector, our operating margin expansion will be a bit slower than desired due to lower operating leverage. However, if end market demand remains stable, we expect our margins to recover sequentially over the next two quarters.

This is an important point. We also expect revenue in the consumer sector to rebound and regain growth as we exit fiscal 2007 and move into 2008.

We anticipate our business relationships to expand, and our business volume to grow with all of our present top five customers. In fact, we've recently been awarded new programs with all of our top five customers in the consumer sector, including vertical integration wins with our recent acquisition of Green Point.

In summary, we are in an excellent position to grow profitably with a wide range of customers over the long term.

Beth Walters

Operator, we're ready to begin the question-and-answer session. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Lou Miscioscia.

Lou Miscioscia - Cowen and Company

Yes, thank you. It's Lou Miscioscia from Cowen and Company. I guess, Tim, when you look back over the last four quarters, can you sort of sum up maybe what's going on under the covers? Do you think with the option situation maybe it took some focus off of things? Or do you think that given such incredible revenue growth rates over fiscal ‘06 that you just grew too fast? Is there anything that you could try to pinpoint for the operational issues of last May and the last couple of quarters and obviously here now too?

Tim Main

Well, I think it's important to distinguish between things that happened in late ‘06 and things that are happening now. We’ve put the operational execution issues pretty much to bed, the issues that we identified last year. The option enquiry and the overhang on the company, I can't argue that it hasn’t been a distraction for management, but I think we are doing a relatively good job of working through it.

The current margin issues are, as I explained, we will expand margins. We will exit areas that are unprofitable for the business. We will target profitable pockets of revenue in the consumer segment. We will be successful doing it. We are successful doing it and we are still growing.

So, when I kind of look at those issues, I think that over the last few quarters, we seem to have a recurring one-time issue that we've talked about. I think those are behind us. I think we have our arms around the business. And, I think we'll be able to grow revenue and the margins from here.

Lou Miscioscia - Cowen and Company

Okay. One quick follow-up. Historically, obviously you are trying to pin top-line growth at 20%. Do you think that just getting maybe to the law of large numbers here, it’s more likely going to be a 10% to 20% or 15% kind of top-line growth expectations, just long-term company goals?

Tim Main

No, and I'm sure I'll be criticized for not backing off of a 20% top-line growth rate, but I think that there is ample opportunity in the marketplace to do that. Were it not for the transition in our consumer sector, we would be able to do almost 20% in an environment where our market growth is just terrible.

And I think if we were to put up a 17% year-over-year revenue growth rate, which is what we're growing excluding Green Point. And excluding the pockets of issues that we have in the consumer segment, that’s what we would have. So, there is plenty of opportunity in the marketplace for us to grow.

Lou Miscioscia - Cowen and Company

Okay. Good luck turning things around.

Operator

Your next question comes from Jeff Rosenberg with William Blair.

Jeff Rosenberg - William Blair

Forbes, I think you guys said that you are expecting sequential operating margin improvement over the next couple of quarters. So, does that mean we can infer that the operating margin guidance for Q3 is up sequentially over what things look like to you in the quarter that just ended?

Forbes Alexander

I am sorry, Jeff, I can't comment on that.

Jeff Rosenberg - William Blair

Okay. And then can you talk a little bit about the timing of when the transition in the consumer business came about? And maybe just looking at the overall effect of the fact that we can now assume that the margins for the second half are no longer affected by the operational issues and what the margin effect is of this transition specifically? And a little bit more color about the connection between that transition and your commentary about you needing to take more disciplined pricing stance?

Tim Main

The timing of the transition of the consumer segment -- things happen relatively quickly in that marketplace. We've been making long-term investment decisions. That’s where our acquisition of Green Point comes into play. So, I think short term, it will inhibit our revenue growth. Longer term will be very good for the business. And I think we will experience a lot of growth in the segment in both our mobile product areas as well as our home electronics area.

In terms of where things are and in terms of operational execution issues, again, I think those are relatively understood and we are looking more in the rearview mirror at those types of issues. So, going forward in terms of margin expansion, we'll have operating leverage from continuing revenue growth and a more favorable mix of business.

Jeff Rosenberg - William Blair

Okay. And I guess my last question is, Tim, you've talked about a target margin and returning to that, but can you quantify what that number is in your mind today?

Tim Main

We are still at a targeted operating margin of 5%, and we are a little bit farther away from that than where we would want to be at this point. But I think we’ll see sequential improvement in our margins from here on now.

Jeff Rosenberg - William Blair

Okay. Thanks.

Operator

Your next question comes from Steven Fox with Merrill Lynch.

Steven Fox - Merrill Lynch

Can you hear me?

Beth Walters

Yes, we can hear you.

Forbes Alexander

Yes.

Steven Fox - Merrill Lynch

Okay. A couple of questions. First of all, can you comment at all on the revenue recognition issue?

Tim Main

No, we can't.

Steven Fox - Merrill Lynch

Okay. And then I’ll try another one. You mentioned a weak product with one of the largest customers. Can you describe what kind of product that was?

Tim Main

No.

Steven Fox - Merrill Lynch

Okay. And then I'll try one more, Tim. Not to be the first to criticize you on the 20% goal, but if you look at your comment around pricing discipline, I am interpreting that to mean that you have others in the industry pricing irresponsibly which makes it harder to grow. Can you sort of comment on what the industry dynamics are like and whether that conclusion is accurate?

Tim Main

That comment was directed specifically at the consumer electronics segment. We are talking about our transition of two very large customers to essentially what is a different business model. In one case it is to a more vertically integrated model where the value proposition is much better for us. We have to find the right opportunities with those customers. We awarded new programs and have rolled those into the revenue stream.

The other customer, we're moving to a more product development focus and product platform focus relationship. Again, that means we are exiting some of the unprofitable EMS areas and moving into areas where there is much more collaborative design and a much richer value proposition for Jabil.

Steven Fox - Merrill Lynch

So, you're saying this is just a shift of your own strategy with those customers, not necessarily something that was brought on or forced by the competition?

Tim Main

That’s actually correct, yes.

Steven Fox - Merrill Lynch

Thank you.

Operator

Your next question comes from Thomas Dinges with J.P. Morgan.

Thomas Dinges - J.P. Morgan

Hi, good afternoon, guys. Tim, just another one for you on the consumer side to help me understand this a little bit better. If you look at the delta between where you guys are putting revenue over the next couple of quarters relative to where you expect it to be, you talked about several different factors. Can you quantify as best you can, which one of these was the most impactful?

It's the transition of business that you talked about, the pricing discipline and/or the end-market demand. Because especially in the end-market demand side, the earlier commentary was that it's weaker than we expected. And then I think the word you used to describe it was terrible. So, a little bit of help there would be great. And then I will have a quick follow-up for Forbes.

Tim Main

I don’t think I can quantify the three issues. I think generally --

Thomas Dinges - J.P. Morgan

Maybe just which one is probably a bigger factor in your mind right now over the next couple of quarters would help.

Tim Main

Over the next couple of quarters, I would say the transition to a vertically integrated model with one of our top five customers in that area is probably more significant. Over that in the second half of '07, we'll have a decline year-over-year of a fairly significant level. And again, I think that is masking or concealing the fact that in the balance of our business, we will have approximately 17% growth.

So longer term, we are moving the business to what we think is a more stable platform, better value proposition for our customers in the consumer segment with a much more stable stream of products and programs for us.

And in the balance of our business when we look at peripherals, computing, storage, automotive, networking, we are winning big deals. That part of the business is growing very, very well. So, I don't want to sound pollyannaish, but we have 2.5% to 3% margins next quarter, 3.25% to 3.75% in Q4, and I think we will continue to see sequential improvement from there.

And so I think we are doing the right things with the business and I think that's what investors in a long term want.

Thomas Dinges - J.P. Morgan

Okay. And then, Forbes, just a quick one for you on the cash cycle. As you said, inventory was an impact, payables was an impact, but maybe just a bit of a longer-term question if you are willing to go there. You look at it year-on-year, up almost 50% in terms of days. I think you have probably reached an all-time low at that point. But where do you think this settles out as you look out a little bit further considering acquisition of Green Point and some of the transitions in the business that you guys are doing?

Forbes Alexander

Yes, longer term, I think that the sales cycle in the low 20s is a reasonable target. As you pointed out, the acquisition of Taiwan Green Point offers us some opportunities there to facilitate a reduction in working capital to bring some of our metrics and systems to their operations.

So, I think there is a good opportunity there. We are working hard in terms of opportunity around our inventory levels and getting those where we want them to. So, I think a reasonable level is in the low 20s as we look forward over the next two to three quarters.

Thomas Dinges - J.P. Morgan

Okay, thank you.

Forbes Alexander

Thanks.

Operator

Your next question comes from Shawn Harrison with Longbow Research.

Shawn Harrison - Longbow Research

Hi, good evening. First question is just on Taiwan Green Point, is it safe to assume that the EBIT margins in the business are still in north of 10%?

Tim Main

We will not be providing margin information on Green Point. We are not going to break that out. I will say though that we have been very pleased with the performance of Green Point for a very short time, brief time that we have had a majority interest. We are very excited about the business.

Shawn Harrison - Longbow Research

Okay. And secondly maybe just a different way if we can potentially talk about margins. The last known EBIT margin data point we had was at 3.6% in May of '06. With most of the operational issues behind you at this point in time, it sounds like if you could maybe segment out what is leading to the decline year-over-year in EBIT margins? Where the biggest chunks of margin degradation are coming from, and that way we can get an idea of how to model the rebound?

Tim Main

It's really a function of much lower revenue in these quarters than we expected. I mean, you need to listen to that part of the story here. We are transitioning the consumer segment. The consumer segment is going to sequentially decline in fiscal Q3 and Q4 as we have indicated in this call, whereas the typical seasonal pattern would be sequentially up from our Q2.

The last known data point was 3.6%. You are saying it is 3.6% in fiscal Q3 of '06. I think we have done as much as we can over the last couple of quarters to give investors an idea about where we are. Certainly, our EBIT margins are lower than where we would like them to be. But with the operating leverage being much, much lower given our lower revenue stream, it's a big challenge for us to have 3.5% to 4% margins at this point.

I think, given the guidance we have given you looking at fiscal Q4, the 3.25% to 3.75% range, we will be showing demonstrable progression to our previous levels.

Shawn Harrison - Longbow Research

Okay. Is there a revenue level that we should look for Jabil to achieve to get back to a 4% operating margin?

Tim Main

If we hit this level we will get to 4%. But I think that once we get above $3 billion, it will be much, much easier for us to get closer to that level. I would say by the time we get to a $3.2 billion or $3.4 billion level, we should be there controlling for all of the other things in the business that might or might not go wrong. But based on the portfolio of business we have and the growth we are seeing, I need to emphasize two things. One is, again, the rest of our business is growing at 17%, excluding Green Point and excluding the consumer segment.

We do expect that we are not losing a customer in the consumer segment. It's not happening. We've been awarded new programs and we expect our inflection point in the consumer segment to occur over the next couple of quarters. And we will see a rebound in growth there. So, that will be good too.

Shawn Harrison - Longbow Research

Alright, thanks a lot.

Tim Main

Okay.

Operator

Your next question comes from the line of Kevin Kessel with Bear Stearns.

Kevin Kessel - Bear Stearns

Thanks. Can you guys just give us a little bit of detail in terms of what is left to still accomplish in Europe in terms of the restructuring? What has maybe been closed to date and what you still plan to close, or what you still plan to do?

Forbes Alexander

Kevin, I can't talk to what is going on there out of respect for our employees and discussions going on with our employees' representatives. I can tell you that we are probably about halfway through our plans in Europe with certain facilities. Discussion is ongoing and announcements have been made in Italy, in Belgium and in Scotland, and I believe in our facility in Ireland.

Kevin Kessel - Bear Stearns

Okay. And then, could you just remind us in terms of the cost savings, because as I recall, the cost savings were originally expected to help in the second half of this fiscal year. Have they been pushed out at all, or are they part of the margin recovery?

Forbes Alexander

They are part of our margin recovery, Kevin. As I said, we are on track with our restructuring activity. And over the back half of the period, we are giving guidance deciding probably somewhere in the region of 25 to 30 basis points as we see that costs leaving our manufacturing and SG&A cost base.

Kevin Kessel - Bear Stearns

That would be in the second half of this fiscal year?

Forbes Alexander

That's correct, within the period that we have given guidance till today.

Kevin Kessel - Bear Stearns

And is there any additional that would be expected for fiscal '08 or not?

Forbes Alexander

Yes, there will be and that very much depends upon the continuing negotiations and discussions across our various sites. But, we certainly expect to see somewhere in the region of another 20 to 30 basis point improvement during fiscal '08. It is a little bit difficult at this time to pin that at an exact quarter for you. Again, it really depends upon the discussions underway.

Kevin Kessel - Bear Stearns

Lastly, could you address the inventory? I think you said that dollars were down in the quarter. But can you address, where you kind of see it now for Jabil and where you can imagine you can get it to in turns, for example, over the next couple of quarters?

Forbes Alexander

Sure yes. Inventory was down in terms of dollars, remembering also that it does include the acquisition of Taiwan Green Point. So, we did consolidate their full inventory balance at the end of the quarter also. So, overall we are taking that down.

In terms of overall turns, certainly the next milestone is of course to get it back to eight during the next quarter, and a little bit beyond that. And certainly as we move into fiscal 2008, drive that towards nine turns. We have got a number of planning processes and activities in place and we're certainly driving hard towards that.

Kevin Kessel - Bear Stearns

Thank you.

Operator

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

Matt Sheerin - Thomas Weisel Partners

Yes, thanks. I'd like to go back to that issue of your consumer revenue guidance, the one area where you talked about the transition from volume to product development focus. Is that where you are losing most of the revenue and is that a conscious decision on your part or are there any share issues there?

Tim Main

Again, we're not quantifying the three elements that I mentioned. Moving from an EMS model to more of a product development based model is something that is reflective of the overall industry in that sector. In terms of share, I think that plays very, very little in that particular relationship.

Matt Sheerin - Thomas Weisel Partners

Okay. And you talked about gaining share or gaining wins with all of your top five customers. So, you're not telling us that you're losing share significantly with any of those customers, right?

Tim Main

We're saying that we're not losing any customers in the top five. And in fact, we've been awarded new programs with all of our top five customers.

Matt Sheerin - Thomas Weisel Partners

Okay. And you talked about seeing sequential gains in operating margin over the next couple of quarters, getting to around 3.75. Is it still within reach of getting to 4% by the end of calendar '07 then?

Tim Main

We'll provide guidance for fiscal Q1 of '08 in a quarter or two, depending on how things go. We do expect continued growth and with top line growing and getting additional operating leverage, I think we will continue to move to that 4% range.

Matt Sheerin - Thomas Weisel Partners

Okay. And Forbes earlier talked about the capacity expansion plans still being on track. So you haven't backed off of that despite the slower revenue growth. Is that right?

Forbes Alexander

That's correct. Yeah. I mean we are continuing to see expanding revenues streams across in my comments related to our Chinese operation. And we continue to see demand profile for Philippines and Ukraine. We are adding capacity in Poland and it's doing very nicely. So yeah, things are looking good in those regions.

Matt Sheerin - Thomas Weisel Partners

Okay. And just lastly, could you remind us, Forbes, what the interest rate on that bridge loan is?

Forbes Alexander

I don't have it exactly at hand, but it’s approximately 6.5%, I believe.

Matt Sheerin - Thomas Weisel Partners

Okay. Thank you.

Operator

Your next question comes from the Yuri Krapivin with Lehman Brothers.

Yuri Krapivin - Lehman Brothers

Good afternoon, everybody. Another question on operating margins, maybe you can indicate to us what the operating margin would have been for Q3 and Q4 if you exclude the consumer business? Is it possible to indicate that to us?

Tim Main

I don't know if that's possible. I don't have the numbers in front of me. So, I don't want to speculate.

Yuri Krapivin - Lehman Brothers

Okay. But is it fair to say that other segments are performing more or less in line with your exceptions, margin wise?

Tim Main

I think that's fair, and I did make a statement in my prepared remarks. And I’ll reiterate it that the 17% growth we are pursuing in the balance of our business is part of our business, which is not consumer or not Green Point. 17% growth in the second half of '07 over '06 is at or above our long-term profitability objectives. So, that's a very good business, consistent with what's going on with many other sectors.

Yuri Krapivin - Lehman Brothers

Right. You mentioned you had two 10% customers, can you name them?

Tim Main

We named our top five. And --

Forbes Alexander

Bear with me and I will get those for you. That would be Cisco and Nokia.

Yuri Krapivin - Lehman Brothers

Okay. And then my last question is on free cash flow. Based on your comments about cash cycle and based on your cash balances, it appears that you've generated negative free cash flow for the first half of fiscal ‘07. What’s your expectation for the second half?

Forbes Alexander

Yeah, I think, for the second half, you’ll see us generate positive cash flow, particularly in terms of the guidance we've given here in terms of the range of EPS. And also we should start to see continued improvement in our inventory levels and reduction of working capital levels. So, I think there’s a very good opportunity for positive cash flow, and we expect that in each of our third and fourth fiscal quarter.

Yuri Krapivin - Lehman Brothers

Okay. And lastly, Forbes, can you indicate what kind of restructuring expense have you incurred to date out of this $200 to $250 million?

Forbes Alexander

I don’t have that number at hand. I think certainly in the fourth fiscal quarter of last year we did make filings that indicated we've incurred about $84 million. So, certainly, I can tell you it's that much. And looking forward, our GAAP guidance anticipates a restructuring the range of $45 million to $60 million on a pre-tax basis.

Yuri Krapivin - Lehman Brothers

Thank you.

Operator

Your next question comes from Jim Suva from Citigroup.

Jim Suva - Citigroup

Great, thank you very much. Tim, last time you were very blunt about returning component of operating margins of 4% to 5% in the next few quarters. And even with Taiwan Green Point who had, as you stated, about 11% operating margins. It appears that the 4% to 5% in the next couple of quarters as you detailed is not going to happen. I appreciate your color on the lower volumes and exiting the lower profitable work. I wonder was this structural change all brought about in the last couple of quarters, or have you been thinking about it for quite sometime?

Tim Main

It sounds like a psychological question to me. I don’t want to be flippant with you, but this is the best information we have at this point. Our margin recovery is a bit slower than what we would have liked. I think I've gone through the reasons why we are faced with a little bit slower margin progression with Q4 being in the 3.25 to 3.75 range, and expected additional operating leverage from growing revenue.

And I think there is very ample evidence that revenue outside of the consumer segment is growing very well. We feel very confident about getting our margins sequentially improving and continuing to sequentially improve as we get into fiscal '08.

Jim Suva - Citigroup

Okay. But with revenues actually being up year-over-year and margins and EPS both being down year-over-year, is it attributed to your strategy shift then, because you mentioned the operational issues are resolved. Is that the best way to think of it?

Tim Main

There are a lot of factors and I appreciate that it has been difficult, particularly without the benefit of historical financial statements. But also remember in fiscal '07, we went through a lean initiative with a customer that added a lot of material based revenue to our company. Forbes talked about a mix in the consumer segment being more material intensive.

We've ended up with more material intensiveness in our business than we've ever anticipated. And that’s not necessarily a bad thing, because we are providing valuable services to customers. We will be able to take those revenue streams and improve their profitability going forward and I have every expectation that we will.

So, that’s been happening and there is a lack of revenue leverage, operating leverage. Because of the revenue means, we have quite a bit of infrastructure in place. We are $200 million to $300 million short of revenue in order to adequately provide for the infrastructure that we have. So, we are little bit heavy there, and I think we will grow our way out of that over the next couple of quarters.

Jim Suva - Citigroup

Great. Thanks for the details. As a quick follow-up, Taiwan Green Point, if you exclude the revenues for year-over-year, does it now look like your full year will be up approximately 15%, is that math about right?

Forbes Alexander

That’s about right, Jim. Yeah.

Jim Suva - Citigroup

Okay. Well, thank you and last question. Philips used to be greater than 10%, now it's not. And I noted the contract renewal was set for around November. Is it fair to say they are still an important customer and growing? Are we seeing them as, I guess, just being outgrown by others as opposed to losing?

Forbes Alexander

Yeah. Jim, as I said earlier, Philips is one of our top five customers, a very, very important customer to Jabil. I would point out while Philips is not a 10% customer in this fiscal quarter; this is the seasonal low for the consumer. In case, if you go back, I think, last quarter, we had indicated they were a 10% customer.

So, again, don’t read into my comment that Philips is not a 10% customer in this quarter. Don’t read that there is any loss of revenue, a material loss of revenue or deterioration in the relationship.

Jim Suva - Citigroup

Okay.

Forbes Alexander

Very important customer and one of our top five.

Jim Suva - Citigroup

Okay. Great. Thank you for clarifying that. I think that was very important. Thank you everyone.

Operator

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

Amit Daryanani - RBC Capital Markets

Thanks. Forbes, just a quick question. Under purchase accounting, did you have to mark-to -market any of the TGPs or work-in-progress? And if so, how much of an impact did that have on your margins?

Forbes Alexander

No, we did not.

Amit Daryanani - RBC Capital Markets

You did not. All right. And how much of an incremental headwind did you have from a legal and audit expenses this quarter.

Forbes Alexander

In this quarter, I believe we spent approximately $3 million.

Amit Daryanani - RBC Capital Markets

And just kind of going back to the margin question. Next quarter, we are looking about 2.75%, that's still 125 basis below the long term target. I know you've talked about the buckets that can get us to 4%. Could you just quantify which is the most important bucket and talk about the three or four variables there?

Tim Main

Revenue is the most important factor.

Amit Daryanani - RBC Capital Markets

All right. And what about the transitions on the consumer segment, does that play on the margin side or is that just more of a revenue driver?

Tim Main

That's costing us a little bit, but I think the most important thing is to get the new product platforms that we've been awarded into the revenue stream, continue to build that capability, continue to build our vertical solution and the other parts of our business in that sector and continue to grow. And we have concrete evidence and visibility that that's going to take place at this point.

Amit Daryanani - RBC Capital Markets

All right. And then --

Tim Main

What we need really is just to grow the revenue stream. And the thing that gives me very, very good confidence about that is that the rest of our business is growing well, and we are winning new customers and winning market share with existing customers. And, we'll go through this process and start to rebuild our business in consumer and get the revenue and the top-line growing again. We will get the margins up as a result.

Amit Daryanani - RBC Capital Markets

All right. Thanks.

Operator

Your next question comes from Alex Blanton with Ingalls & Snyder.

Alex Blanton - Ingalls & Snyder

Hi, good afternoon. Tim, am I correct that we don't have any numbers for the first and second quarter earnings?

Tim Main

That's correct.

Alex Blanton - Ingalls & Snyder

Okay. So, we're in a curious situation here in which we have guidance for the third and fourth quarter, but no actual numbers for the first and second. Is that the way it is?

Forbes Alexander

Alex, this is Forbes. Yeah, it is.

Alex Blanton - Ingalls & Snyder

Can you give us any guidance for the first and second quarters?

Forbes Alexander

No, we can't. I'm sorry.

Tim Main

That's a nice plan. I think we will try that on our various advisors in the legal and accounting community.

Forbes Alexander

Alex, we've reached a stage in the ongoing inquiries where our Board, the Audit Committee, and the various counsel and committees that are reviewing these matters are reasonably comfortable with the impact that they may have on the third and the fourth quarter. Given that, we've been able to give you some forward-looking guidance. And ultimately, once we conclude these reviews, we will be able to file our 10-K and quickly thereafter our second quarter Q.

Alex Blanton - Ingalls & Snyder

Okay. I guess from a legal point of view because you have already completed the first and the second quarter and they are in the past and you can't say anything about them, very curious.

I think the second question is, it's sort of been asked before, but not exactly. To get to the 5% ultimate target for operating margins, what would be the components of gross margin and operating expense as a percent of sales?

Tim Main

It depends on the revenue mix and a lot of other variables. I think that as we continue to grow revenue depending on how large consumer and higher material intensive industries that we play in for us to get to that 5%, is going to take additional revenue operating leverage and SG&A expenses in the low 3s, high 2s.

Alex Blanton - Ingalls & Snyder

In what?

Tim Main

Low 3s, high 2s.

Alex Blanton - Ingalls & Snyder

On the OpEx side.

Tim Main

That's correct.

Alex Blanton - Ingalls & Snyder

And what about the 4% figure?

Forbes Alexander

Alex, Tim was referring to the SG&A number.

Alex Blanton - Ingalls & Snyder

Yes, I know. But to get to 4%, what do you need there?

Tim Main

It could be 100 basis points less.

Alex Blanton - Ingalls & Snyder

On the gross margin?

Tim Main

Yes. We are not indicating on gross margin.

Alex Blanton - Ingalls & Snyder

Alright. Well, if you get 4% and 3% OpEx, that's 7%. Or if you get 5% and 3%, that's 8%. So that's what I am trying to get at. Okay. And finally given what's happened in the consumer sector, and the fact that you are growing 17% in everything else? Looking ahead from a marketing standpoint and from a utilization of scarce resources standpoint, would you necessarily deemphasize consumer and seek to get business other than consumer to any degree compared with the past?

Tim Main

Alex, we believe that a diversified portfolio of growth opportunities is best for our company. We believe that maximizing our exposure to industries that are going through a process of vertical to virtual outsourcing is important for us. We think the consumer electronics today is built principally, vertically integrated. We think we have an excellent value proposition for them. We have very significant resources and a good management team to pursue consumer electronics segment as well as pursue instrumentation and medical segments. And so we have no intention at all to pull away or exit consumer electronics.

We think that our business in consumer electronics meet our long-term profitability objectives. And to be a contributing, accretive part of our business mix, we need to have solutions that are different than what we have had two, three or four years ago. Part of that includes vertical integration, particularly in our mobile communications segment. And part of that includes additional reliance on our product development capabilities, which I think are very strong and have expanded it to three or four different customers.

Some of them are very, very big customers. They are some of the largest home electronic OEMs in the world today. We do business with them on the basis of significant product development content. And so that segment will not behave the same way in terms of relationship style and engagement style. As customers in instrumentation, medical, industrial controls and others are very well supported and developed using our historical business unit model and EMS operating style.

So, we are seeing a change in our business in consumer electronics and some of the very higher volume commoditized industries. We are employing a different type of solution in order to gain business and build business relationships that we think will be profitable for us long term and deliver the type of profitability that we think will be accretive to the business overall.

At the same time, we will be pursuing these vertically integrated industries such as medical and instrumentation that provide us very good opportunities to grow profitably on the basis of a typical EMS model.

Alex Blanton - Ingalls & Snyder

Okay, thank you.

Tim Main

Okay.

Operator

Your next question comes from Brian White with Jefferies.

Brian White - Jefferies

Okay. Tim, when you talk about the vertical integration in the mobile business, when is that exactly going to hit? When are you going to start providing that service and what percent of your existing business will you move to vertical with the casing business?

Tim Main

I think eventually, particularly in mobile communications, most of our business will end up being vertically integrated. The process has already started. I mentioned in my comments that we've already been awarded programs on a vertically integrated basis through our Taiwan Green Point acquisition. And I think, we will continue to see that.

Over the next couple of years, I would say, we will see more and more of our business transitioning in that direction. I would say by the end of fiscal '08, I would expect that most of our mobile communications business will be on a vertical basis.

Brian White - Jefferies

Okay. And then when you talk about product development, can you just define exactly what you are going to be doing there? Is that ODM, JDM, you will also do some volume production or maybe just breakdown what you're going to be doing there?

Forbes Alexander

I think it will be primarily collaborative joint. I think that's what you mean by JDM.

Brian White - Jefferies

Yes.

Forbes Alexander

We call that CDM, but we both, I think, get the point. In some cases, the customers would be providing screen technology and some firmware, software technology. Jabil will be the primary provider of mechanical design, electronic hardware design, and then the full system integration and test of the product and volume.

Brian White - Jefferies

And just finally, if we look out over the next 12 to 18 months, what market are you most excited about in terms of outsourcing wins, in terms of end markets? You mentioned a few, but what are you most excited about?

Tim Main

I don't know what I'm most excited about any of the segments. I think that in terms of dollar revenue, consumer electronics represents the largest overall opportunity for the company. But we are seeing very good wins and very attractive wins in storage. Our peripherals segment is growing again and I think we have an excellent solution there. Our automotive segment, I think will recommence a growth profile, particularly in '08.

And, the medical instrumentation will continue to grow, but defense and aerospace is an area that I think will start actually to be material to our business. And by material I don't mean 20% customers. I am not trying to portend some giant win that we'll have. But we've been steadily building a defense and aerospace business over the last couple of years. And I think that could actually move the needle a little bit for us in fiscal '08.

Brian White - Jefferies

Okay. Thank you.

Tim Main

Okay.

Operator

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

Scott Craig - Banc of America

Hey, good afternoon. I have a quick question with regards to the Lean initiative. You discussed a little bit about the impact on the margins and what happens with inventory and stuffs like that. But there is a positive revenue impact if I remember correctly. Can you quantify that on a year-over-year basis, Forbes? How much the accounting change there adds to your top line?

Forbes Alexander

Scott, I can't quantify it exactly. But previously we had indicated on a year-over-year basis, we expected that to be around $600 million, so $800 million in total for the year. If I remember, there was $200 million or thereabout in fiscal '06, so $600 million incrementally.

Scott Craig - Banc of America

Okay. That's it for me. I am sorry and just on the tax rate, I know it's tough to discuss some of the stuff, but is there any change or should we think about any changes to the tax rate now that you have pulled the Taiwan Green Point into the equation?

Forbes Alexander

Not at this point, I will continue to use 16% at the moment.

Scott Craig - Banc of America

16%. Okay, thanks.

Operator

Your next question comes from Will Stein with Credit Suisse.

Will Stein - Credit Suisse

Thanks. Forbes, can you go over the CapEx guidance? I'm not sure I understood. I thought I saw $200 million for the year, which appears to be very low given what we've seen in the first two quarters? Is that right?

Forbes Alexander

Yes, $250 million is reasonable based on our current expectation. In some of the front portion of the year, I've included some initial construction costs that have gone up in the sites I mentioned. The first half of the year is approximately at about $140 million or thereabout, but $250 million --

Will Stein - Credit Suisse

So that is right. We haven't seen CapEx that low since early '04. That's interesting.

Forbes Alexander

In the last two- or three-year period, we have been putting a lot of that real estate up, if you will, with additions throughout China and ongoing additions in Eastern Europe. While this year, we are putting up a facility in India, we're actually leasing a facility in the Ukraine and some expansion in Poland. It's somewhat less than in previous years.

Will Stein - Credit Suisse

Okay, great. Tim, I'm wondering if you can comment about any vertical integration, either more of a design activity or component integration outside of the consumer end-market?

Tim Main

In terms of product development, product development has been a part of our business for a long time. And in terms of historical approach and collaborative design, that’s still ongoing. And it's very important in our storage segment and to many customers across the board. It gets to a much higher level of integration, design integration capability in the consumer segment. So I’d characterize it that way. The capability continues to grow within Jabil and continues to be an important part of our value proposition for many customers. But when we get into the consumer segment, we are really talking about doing more of a complete product design.

Will Stein - Credit Suisse

And is there anything in Taiwan Green Point that could be leveraged to any of the other segment or is that really strictly for the consumer electronics market?

Tim Main

Yeah. I think they have capabilities that could be leveraged in other segments. I think we will focus on the cross-selling opportunities that are most apparent and most urgent in the beginning. It's a great company with tremendous capability. But they have a limited amount of bandwidth to go pursue many, many opportunities at once.

We're going to try and make sure that we continue to support Green Point customers in the same excellent fashion as Green Point supported them over the last 15 years. And that would be priority one. Priority two will be cross-selling opportunities between Jabil’s customers and Green Point customers. We've seen some positive progress already there. And then priority three will be kind of expanding global footprint. Four will be where else we can go with that capability.

Will Stein - Credit Suisse

Okay. Thank you.

Operator

You next question comes from Reik Read with Robert Baird & Company.

Reik Read - Robert Baird & Company

Hi. You guys have mentioned a couple of times on the call that margin improvement will really be predicated on revenue improvement. But you have flat revenue third quarter to first quarter and yet you have the margins going up. Can you comment on what the factors are there? Is that mix plus Europe and are there some other things as well?

Tim Main

Yeah, there is some mix there and the Europe rationalization is also helping. When we, Forbes and I, were talking about, it was about margin being reliant on revenue growth. That was in response to questions around how do you get to 4, and then how do you get above 4. And how do you get up to 5?

And really getting to 4 and above and approaching 5 is based on the current mix of business. It is probably a revenue growth factor and will be the dominant need that we have to get to 4 and above. But in terms of the margin progression over the next couple of quarters, yeah, there is a more favorable mix there. There is the European rationalization and other vicissitudes in the business that we've been gaining.

Reik Read - Robert Baird & Company

Okay. And then, Tim, can you just give us a comment on the businesses that you're looking to exit? Can you give us a sense for how much business that might be and an example of what areas that might be in?

Tim Main

Yeah. I don’t want to give you any examples. But if you look at Q3 and Q4, our revenue levels are several $100 million per quarter less than what we had originally planned.

Reik Read - Robert Baird & Company

Okay.

Tim Main

I would to give you an idea about magnitude of what we are talking about.

Reik Read - Robert Baird & Company

Okay. And then just a last question on the guidance here with EPS. Understanding that you're prohibited from giving us the past but now what you're giving us guidance in terms of EPS, are you going to be able to report against that in the future?

Forbes Alexander

Yeah. As soon as we have been cleared to file our 10-K and sequentially it would be our restatement 10-K, our Q1 and Q2. And yes, the sequential problem we’ve to follow.

Reik Read - Robert Baird & Company

So, if you can't do that, the expectation should be that you will just continue to report revenue and then provide EPS guidance?

Forbes Alexander

That’s correct assuming all conditions being constant today, yes.

Reik Read - Robert Baird & Company

Okay. Great. Thank you.

Operator

Your next question comes from Long Jiang with UBS.

Long Jiang - UBS

Yes, Hi. I have a question about the consumer business, about the vertical integration. And do you think that would be limited to the electromechanical casing business of Taiwan Green Point? Or do you think that you are required to expand into other vertical areas of the consumer business?

Tim Main

I don’t think we will be required to do other areas to be successful on the short term. I think long term, we may elect to engage in other areas. But I don’t think that they would require us to acquire another business.

Long Jiang - UBS

Okay. And also you commented about, you expect to have substantial part of your consumer business to be vertically integrated a year from now. Now, in terms of your design capability, do you think that you need to make additional investment in order to beef up your design capabilities so that you can facilitate vertical integration for your consumer business?

Tim Main

I don’t think that we need to. We are making additional investments in our design capability. We are actually struggling to keep up with the amount of demand that we have on the product development front. It's called the home electronics consumer segment. And our vertical integration is with our comments about being primarily vertically integrated by the end of fiscal '08 was primarily directed to the mobile communications area.

Long Jiang - UBS

Okay. And can you comment about the EPS impact from Taiwan Green Point embedded in your 3Q guidance?

Forbes Alexander

We are not going to break that out on a go-forward basis. So, we're going to be reporting consolidated numbers.

Long Jiang - UBS

But can you at least provide some color in terms of how to think about the profitability levels of Taiwan Green Point, because you pay 14 times earnings for that business? And I guess, it would be useful for us to keep track of the performance of that business unit.

Forbes Alexander

Yeah. When we announced the acquisition, I think we talked about the publicly traded company on the Taiwanese Stock Exchange. Their numbers are publicly available. On a US GAAP adjusted basis, I think we've talked about operating levels or income levels of round about 11%. So, clearly incremental to our revenue stream on a go-forward basis. But we don’t intend to break that out quarter-by-quarter.

Tim Main

Just to refresh you though, I think we've said we expect it to be neutral in '07 and to be accretive in '08. And we are very pleased with the progress of the business.

Long Jiang - UBS

That’s on track against your expectation?

Tim Main

Yeah. We are very pleased. There is no reason for us to change our previous statements. We are very pleased with the direction of the business.

Long Jiang - UBS

Great. Thanks very much gentlemen.

Tim Main

Welcome.

Operator

Your next question comes from Carter Shoop with Deutsche Bank.

Carter Shoop - Deutsche Bank

I wanted to focus one question here on operating income and operating margins, kind of, on a go-backward basis here instead of focusing on going forward. You suggested that operating margins would be up sequentially in 3Q. So, at minimum, it looks like on flat revenue year-over-year if you exclude the impact of Lean initiative at Cisco, your revenue is down about $20 million, or about 25% year-over-year on flat revenue there. Can you talk a little bit about the drivers behind that? I know that the tooling investment is somewhat of the lingering problem. Can you also break out some of the other factors there in regards to the decrease in operating margins and operating income?

Forbes Alexander

Carter, we are not at liberty to discuss historical financial detail that we have not published. So, I can't really answer your question in that regard. Our indications are that on a go-forward basis, we are going to see incremental margin improvement as you go through the back half of the year. But beyond that, I really can't give you any color on our historical position until we do file our 10-K.

Tim Main

We actually provided a lot of detail in each of the call. So, I would encourage you to go back and take a look at that.

Carter Shoop - Deutsche Bank

Yeah. I mean the other two issues were resolved by the February quarter, is that correct? Was the tooling issue the only problem in the February quarter?

Forbes Alexander

Yeah, our comments said that --

Tim Main

I think there have been three calls since then. And in each call we've provided quite a bit of detail around issues that we had in the business. So, I would ask you to go back and review the comments that we made in the three quarterly calls that we've had since then.

Carter Shoop - Deutsche Bank

I'm sorry. Maybe you misunderstood me. I guess I was looking at just on a year-over-year basis. So, if you look in between the two, we've had issues between February '06 and February '07 two of which appear to be resolved. And I assume those are no longer issues. And then there is only one lingering problem. So, I am just trying to understand on a year-over-year basis, not necessarily --

Tim Main

Yeah. But you can't analyze year-over-year results without looking at the progression of the three or four quarter since. So, we're not going to go back and reconcile the margins between the theoretical margins in fiscal Q2 of '07 with the margins in fiscal 2006.

Carter Shoop - Deutsche Bank

Fair enough. Another question here on potential acquisitions on a go-forward basis. Would you look to be either: A) further develop your vertical capabilities, or B) diversify away from the consumer market any time over the next 6 to 12 months, or do you feel like your hands are full here with TGP?

Tim Main

In terms of additional acquisitions in the area?

Carter Shoop - Deutsche Bank

Yes.

Tim Main

I think we're where we want to be in terms of the capability and where we need to be to be competitive in the consumer space. We can always be opportunistic and if something came up that we thought made sense for our business, we would be more than happy to take a look at it and make additional acquisitions.

I think in terms of digestion point of view and make sure that the wheels are on and bolted on tight and the business is in good shape. Yeah, we're going to be relatively conservative in doing big acquisitions and major acquisitions. And we are going to focus on cash flow and balance sheet and making sure that we get back to the Jabil metrics of very strong return on invested capital, free cash flow, cash flow from operations, and a very strong balance sheet.

Carter Shoop - Deutsche Bank

Great. Thanks a lot.

Operator

Your next question comes from Bernie Mahon with Morgan Stanley.

Bernie Mahon - Morgan Stanley

Good evening. Just a question for you. You talked a lot about the weakness in the guidance on the consumer side of the business. It sounds like there are probably some company specific issues. Can you talk about just the demand environment and what you are seeing? If you exclude kind of these product transitions, what are you seeing in the demand environment for the May quarter in the two bigger segments of your consumer segment?

Tim Main

Demand is okay, relatively stable. We are not laying this off on end market demand. There are some product categories that are softer than others and some other stronger than those. But overall it's pretty good.

Bernie Mahon - Morgan Stanley

Okay. Thanks. And then just a quick question on the margins. In the November quarter, you had talked about the gross margins being negatively impacted by 50 basis points because of, I think, higher material cost or mix shift. Could you just give an update on that issue? Was that kind of a one-time issue for November and it reversed again in the February quarter? Or have you found that that's more of a secular issue for the business?

Forbes Alexander

Yes. Bernie, I talked about it in my comments, within our consumer product sector this quarter in terms of more material based revenue flowing through the revenue stream. As we are providing, what we believe are, valuable services to our customer base in that particular area. So, I have commented on that a little bit in the prepared remarks. But we did see some of that in the second fiscal quarter.

Also in our second fiscal quarter, let me remind you that this is typically a very seasonal section of our fiscal year. And sequentially, our revenues did fall 11% if you excluded Taiwan Green Point. And to support the seasonal business, there is a semi-fixed cost there, if you will, that in the consumer sector runs through December and early January period. And unfortunately, our fiscal quarters don't align with the calendar quarters. So you will naturally see some impact there on the margin which then falls out and back into Q3 in the back half of the year.

Bernie Mahon - Morgan Stanley

Okay. That's helpful. And then just on inventory. Last quarter you said you had probably 3 to 5 days of excess inventory in the networking segment. Were you able to work that down this quarter, or do you think you will be working that down over the next couple of quarters? Where does that stand?

Forbes Alexander

Yes. I think we are making some pretty decent progress in that regard. You'll continue to see us work through that as we move through the balance of the fiscal year, certainly Q3 and continuing into Q4.

Bernie Mahon - Morgan Stanley

Okay. Thanks a lot.

Forbes Alexander

Okay.

Operator

Your next question comes from Andrew Huang with American Technology.

Andrew Huang - American Technology

Thanks. I just had a question on the consumer business again. When you said that you expect the revenue in your consumer sector to decrease sequentially for the balance of '07, is that calendar '07, or your fiscal '07?

Tim Main

Fiscal.

Andrew Huang - American Technology

Fiscal, okay. And then you talked about the second reason about, I guess, one of your large customers going to more of a product development based relationship. Does that mean that you were doing traditional EMS business with this customer, and now going forward you are going to do more R&D for this customer?

Tim Main

That's correct.

Andrew Huang - American Technology

So, if that's the case, does that imply that that customer is taking that EMS business to one of your competitors, or are you not doing it any longer?

Tim Main

It's probably a little bit of both. I think the implication there is the style of engagement, the style of relationship that that customer needs is changing. It has been in observation that we have made, and it seems like it has happened relatively abruptly, and from a revenue standpoint it has. But we have been cognizant of the move, particularly in the consumer area. Customers there want to have outsourcing providers that can do product development, complete product platforms, and certainly in the area of mobile communications provide technology and capability and enclosure and decorative external material like plastics.

So I think from an EMS standpoint in the consumer segment, you don't have significant capability in product development and can work with customers on complete product platforms. And in some cases if you are not vertically integrated, you are competing on a basis of a very narrow value proposition, then we don't think it will provide the types of returns that we want from that business. So, we think a product development rich, vertically integration rich value proposition for customers in that segment will provide us more stable, a greater number of relationships and certainly better long-term value proposition and profitability.

Andrew Huang - American Technology

Okay. And then I guess with the second customer, when the customer is going from a horizontal strategy to more vertical, does that imply that the customer is bringing box-build or board assembly in-house? I am not exactly sure what that mean.

Tim Main

It means that we have historically used horizontal supply chain strategy, in which case we are doing assembly work primarily for that customer. What is the right value proposition for that customer is a full vertical integration model that incorporates not only our global footprint and assembly services, but also the value that we can bring in electric-mechanical components particularly in decorative areas.

That value proposition is more meaningful for that customer. In long term, our ability to continue to secure substantial material wins with that customer will depend on our ability to provide that vertically integrated solutions. I think that we can provide that in spades and we will be very, very competitive.

I have also said in the prepared remarks, and a couple of times in response to questions that we're already seeing business awards in that basis. So, our confidence level is actually increasing.

Andrew Huang - American Technology

Okay. So, the customers, they used to use you on a horizontal basis. They are moving to a competitor that has a more vertical solution. But, in the future do you expect to get more of that business going forward with your Taiwan Green Point acquisition?

Tim Main

That's not what I have said.

Andrew Huang - American Technology

I am sorry. So, I mean if you have business with them on a horizontal basis and they want to have more vertical solution, does that necessarily mean that you have to lose that horizontal business with them?

Tim Main

I am not sure why we are painfully going through this question again and again and again. Our revenue in the consumer segment will be lower than originally anticipated. And the reason is transitioning from horizontal supply chain strategy to a vertical strategy. That means we will have less business in the very short term, which would be in the next couple of quarters. And probably more business than we ever would have had, long term, when we talked about the back half of '07 and certainly when we look at fiscal '08.

We are building a capability that is not only applicable to one customer, but is applicable to a big industry that is growing very rapidly. In mobile communications there is over a 1 billion mobile communication devices sold or will be sold in 2007. We'd expect the growth rate in that industry to continue to increase. And more and more convergence of not only voice and the types of things that you see today, but other types of entertainment are delivered through our mobile communication devices. And so, this is the broad based strategy not narrowed to a single customer.

Andrew Huang - American Technology

Okay. Thanks for your patience.

Forbes Alexander

Okay.

Operator

You do have a follow-up question from Lou Miscioscia with Cowen.

Lou Miscioscia - Cowen and Company

I thought it would circle back around to me. I guess just one last quick question, Tim, as you move to this new strategy and especially given last quarter when you had to write-off that product development costs. Can you just give us a comment on the risk level? How much higher do you think the risk level goes up? Do you think you can talk about how much more margins you can get that try to compensate for that? Thank you.

Tim Main

I definitely can't talk about how much margins we can obtain. The proof will be in the in future quarters how we do. I will kind of have to leave it at that and I'll say that it's a better value proposition for the customer. The product development category that we exited in fiscal Q1 that we talked about on our last call was a very narrow opportunity. It was a vintage of decisions that were made a year and half or two years ago, a particular technology and a narrow product category in the market. The market changed on us and we elected to exit it.

The areas that we're focusing are on very large scale OEMs that have very well developed markets and we're sticking to product categories that are in very, very large volume, where the product development capability is relatively well understood. We think that by sticking with mainstream products in which we understand very well what the product development needs are, the risk factor will be no different or only slightly higher than what our core businesses represented over the years.

Lou Miscioscia - Cowen and Company

Okay, thank you.

Tim Main

Okay.

Beth Walters

Operator, we have time for one more question tonight.

Operator

(Operator Instructions). Your last question comes from Kevin Kessel with Bear Stearns.

Kevin Kessel - Bear Stearns

Yes, just a housekeeping question. Forbes, you mentioned that the tax rate going forward would be 16%. Can you give us some sort of a ballpark for what interest expense level the guidance is based on for the next couple of quarters?

Forbes Alexander

Sure Kevin. For fiscal Q3, the interest expenses are expected to be in the range of $25 million to $30 million and $20 million to $25 million in Q4.

Kevin Kessel - Bear Stearns

And is there any way for us to think about the plans in which to pay down the bridge loans as we go in to fiscal '08?

Forbes Alexander

No we haven't developed those plans fully. But we will certainly invite everyone once we get to that point. Our key focus right now is to improve the operating margin performance here and look forward to having our financial statements filed, and then we can start at our process.

Tim Main

Okay.

Forbes Alexander

Okay.

Beth Walters

Thank you, operator and thank you everyone for joining us for our conference call today.

Operator

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

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