Jabil Circuit F1Q08 (Qtr End 11/30/07) Earnings Call Transcript

Jabil Circuit Inc. (JBL)

F1Q08 (Qtr End 11/30/07) Earnings Call

December 20, 2007 4:30 am ET

Executives

Beth Walters - VP of Communications and IR

Forbes Alexander - CFO

Tim Main - President and CEO

Analysts

Amit Daryanani - RBC Capital Markets

Louis Miscioscia - Cowen

Kevin Kessel - Bear Stearms

Jeff Walkenhorst - Banc of America

Jeff Rosenberg - William Blair & Co

Alex Blanton - Ingalls & Snyder

Jim Suva - Citigroup

Rashedul Din - CreditSights Incorporated

Presentation

Operator

At this time, I would like to welcome everyone to the Jabil first quarter fiscal year conference call. (Operator Instructions)

Thank you. Ms. Walters, you may begin your conference.

Beth Walters

Thank you. Welcome to our first quarter of fiscal year 2008 conference call. Joining me on the call today are President and Chief Executive Officer, Tim Main; and our Chief Financial Officer, Forbes Alexander.

This call is being recorded and will be posted for audio playback on the Jabil website in the Investors section, along with today's press release and the slideshow presentation on our first quarter results. You can follow our presentation with the slides that are posted on the website and begin with slide 1 now, our forward-looking statement.

During this conference call, we will be making forward-looking statements, including those regarding the anticipated outlook for our business, our currently expected second quarter of fiscal year 2008 and full year fiscal year 2008 net revenue and earnings results, our long-term outlook for our company, and improvements in our operational efficiency and in our financial performance.

These statements are based on current expectations, forecasts and assumptions involving risks and uncertainties that could cause actual outcomes and results to differ materially. An extensive list of these risks and uncertainties are identified in our annual report on Form 10-K for the fiscal year ended August 31st, 2007 and on subsequent reports on Form 10-Q and Form 8-K and our other securities filings. Jabil disclaims any intention or obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Please turn to slides 2 and 3, the results for our first fiscal quarter of 2008. On revenues of $3.4 billion, GAAP operating income increased to $98.9 million. This compares to $61.1 million GAAP operating income on revenues of $3.2 billion for the same period in the prior year.

Core operating income, excluding amortization of intangibles, stock-based compensation, and restructuring charges for the quarter, was $122 million, or 3.6% of revenue, as compared to $85 million, or 2.6% for the same period in the prior year. Core earnings per diluted share were $0.36.

On a year-over-year basis, this represents a 4% growth in revenue, and a 44% increase in core operating profits. On a sequential basis, revenues increased 8%, while core operating income increased 18%.

Please turn to slide 4 for a discussion of our revenue by division and sector for the first fiscal quarter. In the EMS division, our revenues represented approximately 59%, or $2 billion.

Sequential sector movements are as follows: production levels in the automotive sector were consistent with the prior quarter; computing and storage sector increased 8% from the fourth quarter; industrial, instrumentation and medical sector declined 8% from the prior quarter, reflecting the decline in product revenues associated with the housing and new construction.

The networking sector levels of production decreased 3% from the previous quarter, as a result of lower production levels for the European customers in this sector. Telecommunications sector increased 15% sequentially, as a result of one month's revenue from the recently announced Nokia Siemens Networks relationship.

Looking at our consumer division, it represented approximately 36%, or $1.2 billion, in the first fiscal quarter. And the sequential sector movements are as follows: mobility and display products sector increased 36% from the prior quarter, reflecting strong seasonal growth in each sector across both displays and mobile products.

The peripherals sector increased by 12% over the fourth fiscal quarter, reflecting seasonal growth in this sector from printers and home entertainment products. The aftermarket services division represented approximately 5% of overall company revenue in the first fiscal quarter, and saw revenues increased 4% sequentially.

Please turn now to slide 5. Our divisional and sector information for the quarter in percentage terms is as follow: automotive 4%; computing and storage 11%; industrial, instrumentation and medical 17% of revenue; networking 20%,;telecom 5% and other 2%, for a total of 59%. In the consumer division, 25% for mobility and display; 11% for the peripherals division in fiscal Q1, for 36% overall; and finally, in the aftermarket Services, 5%.

In our fiscal first quarter, three customers accounted for more than 10% of revenue: Cisco, Hewlett-Packard, and Philips. Our top 10 customers in the quarter accounted for approximately 64% of our revenue.

Selling, general and administrative expenses declined $5million in the quarter, reflecting the benefits of previously announced restructuring plans and approximately $1.6 million less in legal, and accounting fees associated with the recent review.

Research and development costs were $6.5 million in the quarter, or approximately $3 million less than the fourth fiscal quarter, reflecting an increased level of consumer-funded design projects than in our previous quarter, along with some of the repositioning of design repurchase to lower cost regions.

Stock-based compensation expense in the quarter was $5 million. This expense is lower than estimated due to the reversal of stock-based compensation expense previously incurred as a result of performance-based restricted stock grants that is now no longer expected to vest.

A tax rate in the quarter was 21%, reflecting higher levels of income and higher tax jurisdictions in the quarter.

And finally, our divisional operating performance. We do plan to provide divisional core operating performance on an ongoing basis as we are now organized in this manner. In the first fiscal quarter, core operating income for the EMS division was approximately 3%. The consumer division, as a result of the seasonal nature of this division, was approximately 4% ,and the aftermarket services division was approximately 7%.

I will now turn the call over to Forbes Alexander.

Forbes Alexander

Thank you, Beth. I'll ask you to turn to slide six, seven, and eight for our review of balance sheet and some ratios. The company's sales cycle in the quarter expanded by 3 days to 22 days. Days sales outstanding expanded by 4 days, reflecting the seasonal consumer revenue stream, while accounts payable days outstanding improved by one day, as compared to the prior quarter. Inventory days, with the prior quarter, were 8 turns.

Cash flow from operations was approximately $143 million in the first fiscal quarter, an increase of approximately $400 million over the same period in the previous fiscal year. Our return on invested capital improved to 13%, as compared to 11% in the previous quarter. Cash and cash equivalents were $664 million, consistent with balances at the end of the last quarter.

Our capital expenditures during the quarter were approximately $62 million, including approximately $30 million related to our building expansions in China, India and Poland. Depreciation for the quarter, approximately $57 million, and EBITDA in the quarter was approximately $180 million.

At the end of the first fiscal quarter, $400 million remained outstanding on the bridge facility entered into on the 20 December, 2006, to fund the Taiwan Green Point acquisition. This facility was paid down fully, to date, through a 180 days, $200 million revolving credit facility. We intend to replace the $400 million impairment longer term capital some time in the new calendar year.

We are extremely pleased with the continued progress we have made in the quarter, 30 basis points of continuing improvement in our core operating income margin, positive cash flow from operations, while growing revenues 8% sequentially, and continued improvement in our returns on invested capital to above our weighted average cost of capital.

It's particularly pleasing to note cash flows from operations remained strong in the quarter, $143 million, over the last nine-months we have generated approximately $580 million from operations or approximately $300 million after capital expenditures and dividend payments over the same period.

On a year-over-year basis we continue to maintain efficient control over invested capital while growing revenues and our operating earnings.

Our business model continues to demonstrate that on an annualized basis returns on invested capital in excess of our weighted average cost of capital and strong operating and free cash flows are sustainable.

Now, I'd like to very briefly cover on our restructuring activity. We continue to monitor our overall rationalization funds according to our previously announced plan.

During the first quarter, we recorded charges of approximately $9 million. Total charges recorded to-date against our overall plans were approximately $200 million. We continue to expect our total restructuring charges to be at the high end in $200 million, $250 million range that was previously discussed.

During the quarter, cash payments associated with the restructuring activities were approximately $20 million. Total cash payments to date against the plan are approximately $95 million. The cash cost of such charges for this plan remained an estimate in the range of $150 million to $200 million.

Discussions with our employees and their representatives continue, and we're complying with all statutory and consultation periods required of us. As a result, we currently estimate the cash payments totaling approximately $45 million will occur in the balance of this fiscal year. Majority of this will start in fourth fiscal quarter and $25 million in the first fiscal quarter of 2009. We would expect to see the benefits from such actions in our fourth fiscal quarter of 2008, and first quarter of fiscal 2009.

Turning briefly to the Nokia Siemens Networks agreement. On November 1st, we entered into an agreement to lease two manufacturing facilities in Italy from Nokia Siemens Networks, and to produce GSM and the Radio Access products, microwave devices for wireline, and wireless networks. We would like to take this opportunity to welcome approximately 600 new colleagues to Jabil as a result of this agreement.

I'd now ask you please to turn to slide 9. I'd like to give you a business update specifically, help you with guidance for the second quarter of fiscal '08. We estimate revenue in our second fiscal quarter of 2008 to decline $250 million-$350 million, in a range of $3 billion-$3.1 billion, reflecting the typical seasonal decline in consumer products. As a result, core earnings per share were expected to be in the range of $0.16-$0.20.

Core operating income is expected to decline through revenue decline, consistent with historical seasonal pattern. Specifically, this year, and in each of the last two fiscal years, every dollar of revenue decline from the first fiscal quarter to the second carries with it approximately $0.18 of income decline. As a percentage of revenue, we estimate core operating margins to be in the 2.2%- 2.4% range.

Selling, general and administration expenses are estimated to be $116 million, reflecting the addition of Nokia Siemens Networks relationship. Research and development costs are expected to be approximately $7 million in the fiscal quarter.

Intangibles amortization is expected to be approximately $9 million. Stock-based compensation is estimated to be approximately $14 million in the second quarter; and interest expense is estimated to be $25 million. Based upon the current estimate of production and income levels, the tax rate on core operating income is expected to be 16% for the second quarter, and the 18% for the full fiscal year.

Capital expenditures in the second fiscal quarter are estimated to be in the range of $60 million-$80 million, dependent upon the timing of the completion of our building expansions which are underway. Capital expenditures for the full fiscal year remain in an estimated range of $250 million-$300 million.

I'd now ask you please to turn to slide 10, where we will discuss revenue by division and sector for the upcoming quarter. The EMS division is estimated to increase by approximately 2% from the first fiscal quarter. Sector breakdown is as follows: the automotive sector is expected to be consistent with the first quarter, slighting the seasonal declines offset by ramping volumes with the new customers.

The computing and storage sector is estimated to be consistent with the first quarter. Industrial, instrumentation and medical sector is estimated to decline by 3% from the previous quarter. The networking sector [state] level of production to increase by 3% from the first quarter, and the telecom sector is estimated to increase by approximately 25%, as a result of the new relationship with Nokia Siemens Networks.

Turning to the consumer division, it is estimated to decrease by 30% in the second fiscal quarter. The sector breakdown is as follows. Mobility and displays sector is expected to decrease by 35% in the quarter. The peripherals sector is estimated to decrease by 15% in the second fiscal quarter; both sectors reflecting the seasonal nature of these products. And finally, the aftermarket services division is expected to be consistent with that of the first fiscal quarter.

With this guidance, overall company revenues for the first half of fiscal 2008 are estimated to be approximately $6.4 billion with core operating income of approximately $190 million, or 3% of revenues. This represents growth in revenue of 4% for the first half of fiscal 2007, and core operating income dollar growth of 37%.

Please turn to slide 11. With regards in second half of our fiscal year, we're extremely well-positioned to see continued growth in revenue and core operating income for the first half of this fiscal year and over the same period for fiscal 2007. We'll always continue to positive cash flows from operations and increasing returns on invested cap.

From a divisional perspective, for the midpoints of the overall company guidance range, we estimate the second half of this fiscal year revenues in the EMS division to approximately $4.45 billion; in consumer division approximately $2 billion; and the aftermarket services division approximately $0.35 billion. Core operating income expectations were estimated to be 4% or above for the EMS division, approximately 2.5% for the consumer division, and approximately 7% for the aftermarket services division.

Our current estimate for the full fiscal year is revenue in the range of $13.4 billion, with core operating income expected to be in the range of $400 million-$480 million, or 3.1%-3.6% of revenue for the full year. This guidance reflects the year-over-year growth in revenues of 8% and core operating income of $110 million, or 33%, EBITDA of approximately $670 million, a growth of 23% on a year-over-year basis.

Finally, cash flow from operations are estimated to be in excess of $600 million for full year, providing approximately $260 million of free cash flow after capital expenditures and dividend payments.

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

Tim Main

Thank you, Forbes. Q1 was a pretty good quarter all around. It was great to see operating margins coming at the high end of the range, but I was especially gratified by the strong cash flow from operations performance.

In last year's first quarter, we consumed $252 million of cash, but this year we produced $143 million. This allowed us to pay for good deal of NSN, cover our CapEx fees and still have some free cash flow for the quarter.

It was also good to get ROIC back in the teens and in a position from which we can really drive further improvement. This is our third consecutive quarter of improvement on the critical financial metrics we're driving namely margin expansion, cash flow generation, and increasing return on invested capital.

As expected, we will take a step back in margins and ROIC in fiscal Q2. However, we will generate very strong cash flow from operations, as our working capital needs contract a bit.

Second half of the year, we expect to resume margin expansion, cash flow generation, and increasing return on invested capital.

Our consumer division performed well during the quarter. Revenues in mobility and displays were particularly strong. Global demand was very good, but US demand has been weaker than other areas of the world.

We are fortunate to have improved diversity in this sector and we will continue to focus on diversity in coming quarters. The second quarter may be a bit deeper V-shaped than what we would like, but it is not a great deal more than its previous years on a circular basis.

The division is expected to perform for the year consistent with our previous indications that is on a year-over-year basis down in the first half and the stabilization, and then growth over the second half of the year.

The EMS division performed close to plans. Although the housing led slowdown in US economy did have some impact. Keep in mind that our industrial, instrumentation and medical sector now encompasses white goods and residential and industrial control customers that are absorbed from demand reductions.

Overall, revenue for the division was about $70 million less than expected after considering that NSN transaction contributed $27 million in the quarter. With the additional $70 million in revenue we would have hit a 4% operating margin for the company for the third quarter.

For division we expect modest growth in fiscal Q2 and expect growth for the full year to be in the low to mid-teens and that's being the EMS division. Our aftermarket services division performed well and we expect this good performance to continue for the balance of the year.

The company is in a very good position to expand margins, generate cash flow and increase return on invested capital, particularly as revenue gained steam in the second half of the year. As the midpoint of guidance we expect EBITDA margin of over 5%, close to $700 million for the year. With CapEx requirements of about $300 million, we expect to have a highest free cash flow year in our history

With that we can take questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question is from the line of Amit Daryanani with RBC Capital Markets.

Amit Daryanani - RBC Capital Markets

Thanks. Guys just looking at mix: what is the guidance? Margin seems to be down about 130 basis points. That seems to be a lot softer than what we have seen for last few quarters and the third quarter. I am wondering: is there something else beyond the consumer softness that may be impacting that? May be: simply a higher margin business seeing a bit of softness? Could you talk about that?

Tim Main

It's actually what Forbes said during the prepared remarks in terms of the dollar decline and the margin decline very consistent with previous years. So, we are not seeing that being out of line.

At $318 million decline in revenue, it creates that lower operating margin dollars, and that's really actually little bit less than it was in fiscal '07. And the same amount of income declined for dollar revenue in FY '06. So that's actually pretty consistent.

We also said we did have some softness in our US housing-basing industries. And industrial controls, white goods: that kind of stuff, is in our industrial instrumentation and medical segment that was forecasted to be up 8% for the quarter. And it's actually consistent or down a little bit.

So we've lost [awesome] revenue there. So, call it about $70 million of better margin business in the instrumentation, industrial and medical control segment. Those had somewhat of a negative impact on margin.

Amit Daryanani - RBC Capital Markets

How much of your total revenue did you assign to the US Housing?

Tim Main

Sorry.

Amit Daryanani - RBC Capital Markets

I am sorry. How much of your total revenue base do you estimate is assigned to sort of the US housing market?

Tim Main

We don't have any number like that at all. The industrial, instrumentation and medical segments are pretty big segments. But we did talk about the EMS division in Q1 being about $70 million less than expectation. So, if you wanted to look at that impact, that would be about the level of the impact.

Amit Daryanani - RBC Capital Markets

All right. And then just finally, I mean: unless you guys provided some full year revenue and EPS guidance. May be could you just talk about: what makes you to provide this guidance this time around when you guys actually refrained from giving it at the start of the year?

Tim Main

Right, because at the start of the year, we were entering a period of economic uncertainty, and the sub-prime stuff was gaining some steam. And we were very reticent to provide full year guidance at that time, because we felt it would be wiser to wait until some of that could be embedded into our customer schedules and our forward-looking expectations.

At this point, we think we have absorbed what needs to be absorbed in order for our investors to get a better appreciation for how the year looks to us at this point. Given what's occurred over the last quarter, we think it would be much more helpful for you to have a rational reasonable outlook on what the full year looks like for JBL at this point and that simply has to go off of the Q1, Q2 experience.

If you look at the year, in the back half of the year, we are looking at three significant revenue growth in the second half of the year over the first half of the year and really outstanding operating margin performance in the second half of the year as well. So, the full year actually looks pretty good.

Q2 certainly acknowledged that the numbers from a margin standpoint are below where analysts had them. That was a little bit of adjustment we hadn’t provided in guidance to analysts, but the full year looks pretty good.

Amit Daryanani - RBC Capital Markets

Fair enough. Thanks a lot.

Operator

Your next question is from the line of Louis Miscioscia with Cowen.

Louis Miscioscia - Cowen

Hi, great. You guys have given operating margins by different sector. Could you only just give the round number? Could you actually go into at least another decimal point and then maybe something that might be helpful to us in understanding the February quarter operating margin guidance? Could you maybe give us some thoughts as to where on a quarter-to-quarter basis the three different groups are going?

Forbes Alexander

So, Louis, in terms of the actual Q1, the guidance we gave, those numbers are very approximate, and they're pretty much dead on, round numbers, that we are seeing here across these divisions.

With regards to the second fiscal quarter, if we deal with the consumer division first, clearly our first fiscal quarter is seasonally led, if you will, in terms of revenues. Hence, you are seeing not 4% in terms of cooperating income margin.

With the guidance we've given across the various sectors in terms of revenue, doing that math, you see that revenue falls somewhere north of the $300 million across that sector, again, purely from a seasonal demand perspective. And what happens there is that margin profile then falls pretty dramatically in terms of the consumer business to a sub-1% percent type number.

Now, as you look at it on an overall basis, and we have given you some guidance there in the back half of the year to try and help you through this is you will expect in the consumer division as we see the sequential growth come back from the lows of Q2, Q3, Q4 an overall 2.5% for the fiscal year.

In terms of the EMS division, 3% in the first fiscal quarter, and we expect that to drive towards 4% in the back half of the year. So we should see steady increments in that as we move through the fiscal year in that regard. And, with the aftermarket services division, they have got a relatively consistent margin profile roundabout that 7%.

Louis Miscioscia - Cowen

Okay, great. Maybe on the consumer side, Tim, you gave us some update. At the Analyst Meeting you had talked about we're improving the relationship with Nokia. Can you give us, maybe, an update there how things look for qualifying and winning new programs with them and/or some other big cell phone customers, I guess, coming in towards the tail end of the year?

Tim Main

Yeah. I can't speak specifically to Nokia. We just now discussed direct customer relationships, but the progress in the mobility area has actually been pretty good. We have, I think, four of the top five device manufacturers in the world as customers. We're getting very good penetration in the visual mechanics area as well as Jabil's core business.

So, in terms of performing the plan and what we've communicated previously, that's really right on track. We expected that that business, on a year-over-year basis, to be down in the first half. It will be down in the first half, although we're making more money in this segment than we did in the first half of '07. And then, in the second half, we're stabilizing really in Q3, and then seeing significant growth again in Q4 of '08.

So that looks on track, Lou. Very, very good progress across all the customers there, pretty good diversity, and we're pretty excited about it.

Louis Miscioscia - Cowen

And when you said: four of the top five. Were they Taiwan Green Point or they are moving into then the EMS side of the business too?

Tim Main

Its rolling company now and that kind of distinguish between the two. But you can be assured we're working on an end-to-end solution for all of the customers.

Louis Miscioscia - Cowen

Okay. Thank you.

Tim Main

You bet.

Operator

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

Kevin Kessel - Bear Stearns

Thank you very much. Hi, guys. I just wanted to actually go back at this margin question that was asked earlier. When I look at your midpoint of your guidance, and then I look at your SG&A guidance, essentially, what I see is that gross margin on a percentage basis will be down about close to 20% or 19%, and in terms of basis points, a little over 135. Then I look back over the same timeframe over the last five years since you've acquired Philips and your consumer exposure has been growing, and really, on average, it's only been about 1.5% gross margin decline from November to February, in a basis points-wise, gross margins have only really declined about 11 basis points on average.

So I'm just trying to understand: where, maybe, the disconnect is? The SG&A is right at around $122 million. And I guess that would imply that the degradation is happening at the gross margin level. So maybe: it's something within the mix? Or, you know, I'm not sure.

Forbes Alexander

Kind of tough road to follow that: In the last five years, '04, '05, '06, '07, '08, the operating income decline as a percent of revenue starting in '04 has been 14%, 11%, 18%, 18%, and then this year 16%. So: very, very consistent with previous seasonal patterns.

What happened in some of those years, '04, '05 and even '06, to a great degree is we were adding a lot of market share with customers and there was a lot of organic growth. And so, even though, program-by-program, it was a seasonal decline, we were covering that with new program wins and new customer wins and that kind of thing. So the actual dollar decline wasn't really as much.

So we're not doing that this year. Again, on a year-over-year-year basis it's going to be the first half of the year will be down in consumer. But, in terms of the core operating decline as a percentage of revenue right on exactly with what it's been in previous years, so very consistent pattern.

Kevin Kessel - Bear Stearns

Right, yeah. I actually didn't analyze on the operating line. I was looking more at the gross line, because I figured once we knew what SG&A was, then we could kind of look at just how the gross margin trends have changed.

Forbes Alexander

Yeah. I'm looking at operating income, and I'm not sure if gross margins or SG&A plays heavily in that or not.

Kevin Kessel - Bear Stearns

Okay. I'm not sure. Maybe talk about it offline. And then the other question, I guess, is just in general on the SG&A line as we go forward. I'm assuming that the legal fees at this point are pretty much done as we go into the next quarter, into the February quarter….

Forbes Alexander

Yeah. In that guidance there is maybe $500,000 to $1 million. We still have some ongoing legal activity in terms of cost processes and such like, but it's certainly not material in any way, Kevin.

Kevin Kessel - Bear Stearns

Okay. So then, Forbes, I mean, obviously, the store restructuring that have to happen and there are still cash payments that will occur at some point in the second half of the year and in next year. I think there was a 115 that you quoted for an expectation, including Nokia Siemens.

Forbes Alexander

Right.

Kevin Kessel - Bear Stearns

Would you expect that to then start to go down, I guess, in May and August as some of that restructuring occurs and some of the headcounts comes off the book?

Forbes Alexander

Yeah. I think there is some opportunity in fiscal Q4 more so than Q3. Any activity in Q3 is likely to be maybe one month of batch for there. It's really more of a Q4 event. So, we're selling some opportunities, Kevin, and maybe a million or two come out there. We just have to see how the discussions continue with the various employees' representatives.

Kevin Kessel - Bear Stearns

Okay. And then, just lastly on R&D. I think Beth had said that the reason it was down, because almost the third as a percentage was excess of more, was it customers paying for the design activity or…

Forbes Alexander

Yeah, but some of that and some deploying some of our resource. We will be ramping up some of our design resource and in Shanghai, in particular for example where cost trend typically lower than we have seen here in the U.S. or Western Europe. So, some element of that and some element of collaborative type design where no customers with ourselves are working conjunction on product platforms and funding those jointly rather than that being a straight funding by Jabil. That was down about what $2.5 million to $3 million.

Kevin Kessel - Bear Stearns

Great, thank you.

Forbes Alexander

Okay.

Operator

Your next question is from the line of Jeff Walkenhorst with Banc of America.

Jeff Walkenhorst - Banc of America

Great, thank you so much. Forbes, well, actually may be both of you guys, Tim, when you look at your various segments and over the past year: can you give us an idea of kind of what as you think about managing a portfolio of revenue stream, gunning for that 4% operating margin? And I am sure some of them are above that and others obviously below that: Are there any areas that are substantially lower than say year ago, because of market competition?

Tim Main

No actually in terms of year-over-year, all of the segments are a little bit better and so in Q1 of '07 EMS division was about 2.3%, this past quarter Q1'08 it was 3. Previous year in consumer was about 2.5% operating margin this past quarter Q1'08 it was 4. And the EMS division was pretty consistent.

So, what was in talking about and what is actually seen since our February '07 quarter when core operating margin was 1.9%. You've seen very significant improvements in our margin structure from 1.9% to 2.9% in Q3, to 3.3% in Q4 to 3.6% in Q1. And everybody should have expected that declining consumer would be a setback, but looking our guidance for the second half of '08, we were talking about $6.8 billion in revenue, about $4.4 billion in EMS and expect the core operating margin EMS as $4 billion, $2 billion in the consumer segment, we expect the core operating margin about $2.5 billion and the EMS division of $350 million with consistent core operating margins. So, that blends out in the second half of roughly 2.6%, 2.7% in terms of core operating margins.

And, really, looking at this past quarter again, another $50 million, $60 million of this housing slump revenue, we would have hit 4% this quarter. So, I think, it's really clear now that the company has a 4% operating margin potential on expectation. I think that's a near-term expectation than a long-term expectation and the performance in Q1 is very, very clearly pushed us in within a hair's breadth of that level.

And you look at Q3 and Q4 the back half of the year; we are looking for about $400 million of revenue growth from the first half of '08 to the second half of '08. That's only $400 million. We expect that to come about $75 million to $100 million in Nokia Siemens Networks, about $40 million from automotive business and about 100 million from new customer wins and a modest recovery in the Industrial Instrumentation Medical segment, about $50 million from defense and aerospace and about $80 million out of our networking group.

So, very, very identifiable where that's going to come from and that $400 million of additional revenue along with the benefits of the rationalization program that we have had under way feels very clear to watch the high 3%, 4% operating margin range is achievable in the back half of the year. That most encouraging thing for me in running the business or margin expansion, but also a cash flow generation return on investment capital is given the additional size we have and with rapidly improving margins we are going to generate very significant levels of cash flows from operations and free cash flow.

Looking at the midpoint of the guidance, looking at cash flow from operations of $600 million EBITDA, $680 million, $700 million CapEx requirements of $300 million, we are going to throw off a lot of cash and that's more of a business [force].

So, I think, not withstanding may be some of the angst about Q2, I think really step back and looked at it it's very consistent with history and very understandable and looking at the continued rapid recovery of margins, free cash flow and return on investment capital. Even in this kind of murky, spooky economic environment it's really kind of good annual plan.

Jeff Walkenhorst - Banc of America

Okay that's helpful color Tim. And then just a follow up, so the competitive environment hasn't crashed margins and some of these different segments, say in the service segment: it hasn't deteriorated materially or it’s flat? Or: may be even higher given your different mix from a year ago? Or: how can we get more color on that?

Tim Main

We are providing you operating margin by division not by sector and we will stay with that policy. In some sectors that we talk, generally are higher margin than others. The industrial instrumentation/medical segment tends to be very complex, very high mix. So, the margins there are generally better accretive to the overall corporate averages. However, it takes more infrastructure to run that business. And therefore the return on invested capital is consistent with the other segments.

Computing and storage, there are some high lying programs there, where the operating margins might be little bit lower. But there are also some very complex areas where margins might be little bit higher. We are not noting, we are making great progress, particularly in the storage area, particularly enterprise storage area. And our margins are fine. We are not seeing any crazy competitor activity there. It’s a great segment. It's been growing for us. And we expect that to be, to that experience to continue.

Jeff Walkenhorst - Banc of America

Okay. Thanks so much, guys. Good luck with everything.

Tim Main

Thank you.

Operator

Your next question is from the line of Jeff Rosenberg with William Blair & Co.

Jeff Rosenberg - William Blair & Co

Good afternoon. I first wanted to ask you: if you could maybe give a little bit further color on the volatility this year in mobility and display area? It was well above your plan for this quarter. And so maybe a little bit of color there, if you can, on: where that came from? And: whether it was handsets or displays? And then also if you look at after this quarter's decline, you will be about 10% I think below where you started in Q4. And I think that’s a little more of a down stroke than you normally see. So, if there is some color there as to in terms of: what you are seeing? In terms of sell through, anything at this point that’s causing that level of volatility?

Forbes Alexander

Yeah. I don’t think there is any huge volatility there. I think we've forecasted this, that sector to be up 25% and it was up 36% or something like that. The mobility products and display products were very strong and actually maybe little stronger if some component shortages had not transpired. So, that’s pretty good, I think people have being conservative about the second quarter. And I think that’s probably correct in this type of environment.

Not to say anything negative about sell through rates, actually I'm happen to be somebody who doesn’t believe that we're in a recession or are likely to go in a recession. I don’t know, we've given you a wide enough range of guidance to accommodate some additional softening, along with higher end of the range if things seem to firm up a little bit that we have a regional side of achieving. So, it may seem a little bit more viable to you Jeff, but it's actually pretty consistent with what we said, maybe Q1 was little better than we expected, but when you think about the first half of '08, we said on a year-over-year basis that'll be down a bit. It will be in the second half of '08 we see stabilization and then a resumption in growth. And I think if you look at the margin side of it, actually a healthier growth.

Jeff Rosenberg - William Blair & Co

Okay. And just want to clarify one thing you were talking about a minute ago about the $400 million of incremental revenue in the second half versus the first: was that for the whole business or just the EMS segment?

Forbes Alexander

That’s for the whole business, because if you look at consumer, it's relatively flat, first half to second half.

Jeff Rosenberg - William Blair & Co

Okay. And so, but yet, the new programs that we've talked about does that relate to the model that you formed by integrating Green Point: is that in that $100 million? I guess may be a little bit of, may be that peeling back a layer to understand the business that's kind of that's building up and coming back through the seasonal period here, but: how should we think about the magnitude of that benefit for you in the second half?

Forbes Alexander

I think you should look at the magnitude, that benefit being actually pretty low in terms of new program contributions from the vertical model with mobility customers. Again, I am not talking specifically about Nokia, but I think you should look at that as relatively low. So, a $2 billion second half versus roughly a $2 billion first half that takes into consideration Q1, and then a very deep decline in revenue in Q2 on average, about what we'll see in the second half of the year. We'll start to pickup a lot of steam in Q4 of '08 in that sector. So, we feel very, very confident about that. We see it coming, but for the annual buckets that we're talking about $2 billion first half, $2 billion second half.

Now, also keep in mind that some of the program wins that we'll see tend to have lower dollar value in absolute terms. So, lower end phones and visual mechanics tend to have a lower revenue level than higher-end phones and (inaudible). We're really driving the business, not for revenue, we're driving the business for cash flow, margin and returns and we think the mix of our business will be much healthier in the second half of '08 than the second half of '07 and first half of '07. So the mix is actually been improving for us for the last six to nine months.

Jeff Rosenberg - William Blair & Co

Yes, and then one last question I had was you have been talking about the way your operating margins will get back to in the second half and you're building on the success you have had for this quarter. But if we look toward the lower end of your guidance range it seems if that would imply you'll fall short there.

What are the risks that you see that want you to give that wider range and leave yourself that room toward the lower end of your range? Is it strictly a matter of operating leverage if the revenue doesn't come? Or: is there something else there that needs to happen to achieve the midpoint type targets you've been referring to?

Tim Main

That's a great question and a good see up. It's got nothing to do with things magically that have to happen or things negative that we think might happen. It's all got to do with how the revenue comes through and what the production levels are. And that's got everything to do with the macroeconomic environment.

So, we're trying to give people a taste of what additional softening would look like at the low end of the range, kind of middle of the road and at the midpoint. And then, maybe, if things firmed up a little bit and we gain a little bit more steam in the second half, we could hit the higher end of the range.

So, it's really just about the economic environment and trying to discount what that might mean to us. So, we think it's a reasonable range with additional softening if things begin a little bit firmer. I think interesting thing though when you look at that. Even if a down, lower end of the range scenario were to play out, we're still going to have decent operating margins, strong free cash flow, and we'll produce a hell of a lot of cash as we go through that process.

So, now this is a scenario where we're either going to produce a lot of cash and have a lot of cash sitting on the balance sheet in a low growth or negative growth environment, or really going to have to be affirming of demand and look at very strong margin expansion and cash flow. And that's really kind of the message of the call parameters. It's really about the revenue at this point.

The business, nothing wrong with the business, there is nothing wrong with the customer base. We're really in an excellent position to show very strong snap and very strong benefit from every dollar revenue increase and that feels good to us. It's been a little bit of time since we've been in that position, but I think the picture is pretty clear if you look at the progression from Q2 '07 to Q3 '07, Q4 '07, Q1 '08, very, very strong progression. So looks good to us.

Jeff Rosenberg - William Blair & Co

Okay. Thanks a lot.

Operator

Your next question is from the line of Alex Blanton with Ingalls & Snyder.

Alex Blanton - Ingalls & Snyder

Good afternoon. Tim, just a comment, you need to get after your webmaster because your release was not on the webpage until somewhere between 5:00 and 5:15. The slides were not there when you started the call. I actually had to sign on to the webcast in order to see the slides. So, for the future, just a comment.

Now, I don't want to be the dead horse, but the decline here that you are forecasting for the second quarter is far greater than anything that you've seen in the past. For example, EPS first and second quarter in '04 was down 4%, and in '05 was down 16%, and in '06 was down 16%, and only last year was it down 52%. So we're looking here for a 50% decline this year. Now this is comparable last year, but not to any other year. And I think it's completely unexplained so far.

Now the other thing that I note, and this is very unusual, the incremental margins given the guidance for the second quarter, it would be a decremental 16%, as you said, 16% of sales compared with 3.6% of actual margin. So that's a far bigger incremental margin negative than we normally see in this business. It's an operating figure, not even a gross margin. It's kind of in line with what you'd see at Caterpillar or something.

So, if you add the reverse, if you had a $317 million increase in sales for the second quarter over the first, and the same incremental margin on the upside, you would add $0.21 to the earnings, or if you would have a 9% that would be a 9% increase in sales, and you would have $0.21 plus $0.36 or $0.57 for the quarter, and you would have a 4.7% operating margin in the second quarter.

So, if reversed it and you have the increase, you would be going over the top. So I don't really understand it. And you mentioned the $70 million would give you 4% operating margin for the quarter if you had $70 million more in sales. Well, that would be a 23% incremental margin on the upside and you would have had $0.43 per share if you just had that extra $70 million. So, I just don't understand: why suddenly this business has gotten so leveraged? Can you address that issue? I mean: there is an awful lot of operating leverage here implied in these numbers.

Tim Main

There is an awful lot of operating leverage, that's for sure. Depending on this business and this sector materials can range anywhere from 70% to 85% of our revenue dollars. So, if you are sitting here in a quarter, dollars doesn't show up. Let's say it's an 80% material cost business you are going to lose, 20% of that $70 million in material margin or profit, $14 million. That's kind of the easy math on how that would equate to a 4% operating margin and it wouldn't go to $0.43 or whatever that is. And in terms of…

Alex Blanton - Ingalls & Snyder

Wait, wait. I don't understand: if you have a 4% operating margin, you had $70 million of sales; you would be adding $16 million to operating profit.

Tim Main

$70 million that…

Alex Blanton - Ingalls & Snyder

And that would be 23% of the $70 million.

Tim Main

$70 million, a 20% going with my example is $14 million. So, there is operating leverage there. That's for sure. And so there is operating leverage on the second half of the year. That's substantial for us.

Alex Blanton - Ingalls & Snyder

And well, perhaps you're implying, if you get to a $1.50 with these first half numbers, but what I don't understand is: why all of a sudden we are seeing this great operating leverage when in the past this business has not had done?

Tim Main

That's not true, not true. If you look at the margins again in '04 and '05 the actual revenue decline Q1 to Q2 was $17 million in '04 and …

Alex Blanton - Ingalls & Snyder

Okay.

Tim Main

$117 million in '05.

Alex Blanton - Ingalls & Snyder

Okay.

Tim Main

$9 in '06

Alex Blanton - Ingalls & Snyder

Okay.

Tim Main

Operating leverage was exactly the same.

Alex Blanton - Ingalls & Snyder

(inaudible) and negative 16%?

Tim Main

I am sorry.

Alex Blanton - Ingalls & Snyder

What you are talking about is negative incremental margin of 16%?

Tim Main

The operating leverage negative…

Alex Blanton - Ingalls & Snyder

It was and you are saying it was in '06 quarters too.

Tim Main

Yes it was

Alex Blanton - Ingalls & Snyder

But, if you go forward and have that one the upside that's what I am saying and the numbers go out of sight. If you take a 16% incremental operating margin on a actual margin of 3.6 it goes up pretty quick once you get a sale volume…

Tim Main

You get to a point where that manufacturing infrastructure is sitting there.

Alex Blanton - Ingalls & Snyder

What?

Tim Main

You get to a point, where you absorbed all of that manufacturing infrastructure.

Alex Blanton - Ingalls & Snyder

Yeah.

Tim Main

However, additional revenue you have to add manufacturing infrastructure and the operating leverage then goes down. So, there is a point, if we snap back to $3.3 billion level then it will be significant positive operating leverage and then for revenue over that $3.3 billion level theoretically we would begin have to start adding additional manufacturing capacity.

Alex Blanton - Ingalls & Snyder

Which cuts into it, of course?

Tim Main

Yeah, that's quite. So, we have positive operating leverage which then would be less.

Alex Blanton - Ingalls & Snyder

Okay. So this big operating leverage is operative within a range or volume, that's what you are saying?

Tim Main

That's correct.

Alex Blanton - Ingalls & Snyder

Okay. Alright, well it just a surprise because the consensus with $0.31 for the quarter and you are telling people that you are going to have earnings about 40% below that and I really think you ought to recognized that. I mean this is quite a big disappointment, this report, the second quarter guidance and the full year guidance the consensus is right at the top of it $1.5. So, I think that that's what you are seeing reflected in the comments on this call and in the stock price. I will get out. Get to the end of the queue, thanks.

Operator

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

Jim Suva - Citigroup

Great. Thank you very much. Tim and Forbes, can you help me understand a little bit, we talked about growth a lot, but when I look at your February quarter, if I got my math right, the revenue is at $3.0 billion, $3.1 billion. Year-over-year, unless I have some bad math going on, it looks like organic growth at best is flat, if not negative, because we got a layer in Green Point as well as Nokia Siemens. Can you help me about my math? Or, may be: connect the dots about what's going on with organic growth? And: what was it for November?

Tim Main

No. your math is correct.

Forbes Alexander

Math's correct and for…

Tim Main

Nokia declined by about -- Nokia in that quarter was, I can't remember what the percentage was, but certainly over 10% customer. And so, year-over-year revenue for that particular comes down probably $300 million?

Forbes Alexander

Yes.

Tim Main

Something in that order. So there is $300 million of organic growth. That makes up for that one individual customer revenue decline.

Jim Suva - Citigroup

Great! That's very useful. So: the majority of the decline was due to that trends? Or: that’s a decision that that customer made.

Forbes Alexander

Yeah.

Jim Suva - Citigroup

Great! Thank you, gentlemen.

Operator

Your next question is from the line of Paras Bhargava with BMO Capital Market. Paras, your line is open. Your next question is from the line Rashedul Din with CreditSights Incorporated.

Rashedul Din - CreditSights Incorporated

Hi. Good afternoon. Thanks. Just had a quick question on your $400 million that you have remaining in your bridge facility: could you provide an update on that real quick?

Tim Main

Yes, of course. Today, actually we paid that $400 million loan on the bridge facility by using our $800 million revolver. At the same time, we entered into a 180-day, $200 million revolver with the syndicate of banks. And ultimately what we are looking to do is to take that the 400 we have drawn that under revolver some form of permanent capital as we enter the new calendar year here.

Rashedul Din - CreditSights Incorporated

Okay. So with the increased cash flows that you expect in the fiscal 2008: is there any plans on reduction or --?

Tim Main

That's clearly an alternative that's open to us, because, as you say, these cash flows are very strong indeed. Before we have done earlier this year. In fact, it's structured our capital balance sheet in such a manner to allow us to do that. We put in place in July a $400 million term loan B facility as part of that structuring activity with no prepayment penalties there in that regard.

So, that's certainly an alternative to us. And there is something we'll consider as we move through the second and the third fiscal quarter.

Rashedul Din - CreditSights Incorporated

Okay. Great! And just going back to a question we had earlier, when we talked about $70 million to $80 million in incremental revenue you could have got from the manufacturing stuff: was that example where we had $0.20 on the dollar? Was that $0.20 operating margin profit we are talking about?

Tim Main

Yes, it was core operating and commercialized.

Rashedul Din - CreditSights Incorporated

Okay. So now, as we are talking about the operating leverage looking at Q2 then, what part of that within the -- I mean as I am modeling things like your gross margins are expected to be far below where it's been over the three quarters, more of this mid-6% level. Is there any kind of additional, I guess, color you can add on that in terms of what part of that -- it's not, I don't know, adding up for me?

Tim Main

I mean your math is absolutely correct. So it's mid-6% on the gross margins.

Rashedul Din - CreditSights Incorporated

Right.

Tim Main

What your feeling is you've seen over $300 million of revenue come out with the manufacturing cost base that remains in place from equipment, employees, overhead in terms of factory square footage and space.

So, whilst we do use some level of temporary labor to deal with these rapid seasonal growth periods, and in the consumer products area, the majority of that labor that is in place is relatively fixed. Remembering the seasonal dial is only a 90-day period we're talking about here.

And looking at the guidance we have given for the back half of the year, we are looking at additional $400 million of revenue coming in, which very, very quickly drives us back up in to the T2, T3, T4, T5 type levels to achieve that back half target. So you'll very much see that leverage of the manufacturing cost base coming back.

Rashedul Din - CreditSights Incorporated

Okay. And we didn't see that significant in last year's Q1 to Q2 even though we had $300 million incremental decline. Is that a reason why --?

Tim Main

We did actually, we did. Last year, we had somewhere in the region of $290 million of decline with a $53 million decline in core operating income, which was about 18%. No, we did have some write-off in the first fiscal quarter at $12 million. But even that is not 16% to 18%. So, it's inside this number of this year.

Operator

Ladies and gentlemen, we have reached the end of allotted time for questions and answers. I will now turn the conference back over to Ms. Walters for any closing remarks.

Beth Walters

Thank you for joining us on the call today. Sorry about the technical difficulties we experienced. And also to let participants on the call know that Tim Main will participate or be on [StockBox] tomorrow morning at 6:50 AM. Thanks again for joining us on the call.

Operator

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

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