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Jabil Circuit, Inc. (NYSE:JBL)

JPMorgan TMT Conference Call

May 15, 2012 10:40 am ET

Executives

Timothy L. Main – President and Chief Executive Officer, Director

Analysts

Mark W. Strouse – JPMorgan Securities LLC

Mark W. Strouse – JPMorgan Securities LLC

Good morning, everyone, and thanks for coming. My name is Mark Strouse, I cover applied and emerging tech here at firm. And we are very happy to have Tim Main, CEO of Jabil.

Actually, he don’t cover Jabil at the moment. So this is actually, you can be very interesting and informative from me. So maybe Tim if you can just spend a few minutes for me and kind of assume a few other people in the audience aren’t 100% familiar with the company. Just give an overview of your company and maybe kind of walk through your different operating segments?

Timothy L. Main

Sure. We are a $16.5 billion company in our fiscal 2011 or fiscal year end till August, analysts expectations generally to be in the mid $17 billion range in fiscal 2012, we provided a framework of understanding how to look at this for your $13 billion and $19 billion plus range. So we’re actually a rapidly growing company. We report our business in three areas, a high velocity, which to think about set-top boxes, printing, more commoditized market that makes up about anywhere from 28% to 30% of our business depending on the quarter.

Enterprise infrastructure which is things like networking, high-end enterprise, storage products, telecommunications, wireless infrastructure that makes up again depending on the quarter, 28% to 30% of our business. The big growth story for our company, which is getting a lot of attention now is Diversified Manufacturing Services, which is a group of very high value add, high mix, high complexity businesses comprise of healthcare and instrumentation, industrial and clean tech in an area that we call specialized services, which is that most rapidly growing part of our business, that’s comprised of Materials Technology Group and our Aftermarket Services business.

In the most recent quarter Diversified Manufacturing Services made up 44% of our overall business and in our Analyst Day couple of weeks ago, we talked about a crossover points sometime during fiscal year 2013, where Diversified Manufacturing Services could grow to 50% or more of our business. And at that point in time really the companies are well Diversified Manufacturing business in with deep broad participation in higher value-added industries. So we’re really excited about the growth trajectory there.

Operating margins have been solidly above 4%, which leads our industry significantly return on invested capital in the mid-high 20s, depending on the quarter, that’s also a leading metric for the company. We generate about $1 billion in EBITDA here with the goal of the company being to have a free cash flow yield of about 20% to 30% on that EBITDA level. So company is doing well, growing rapidly, focusing on high growth areas in the Diversified Manufacturing Services, and I think is a great long-term story for investors today.

Mark W. Strouse – JPMorgan Securities LLC

Okay. So maybe digging a little bit deeper into for Group’s high velocity and enterprise and infrastructure into a traditional EMS and then versus the emerging DMS business. Have you given any kind of guidance as far as growth rates for the coming years and maybe talking about the margin differentials?

Timothy L. Main

Sure. In the traditional areas our long-term growth [plot] is 5% to 10% on a compound annual growth rate over that three to five-year period. Operating margins in high velocity have been 4%, that’s above our targeted range of 2% to 2.5%. Enterprising and infrastructure has been below our target range of 4% to 4.5% recently because of some short-term issues that we will work through and recover margins there.

So the differential in growth rate between the traditional area of 5% to 10% in Diversified Manufacturing Services, which is growing at 20% to 30% on a long-term basis. It really drives the business mix to become much greater exposure to the DMS area and lesser on the traditional areas over time, and again we’ve talked about a crossover point in fiscal year 2013, where DMS will become the majority of the Jabil’s business.

We also provided a framework for growth in FY 2013 0% in high velocity, roughly 10% in enterprise and infrastructure industrial and clean tech and healthcare instrumentation at 15%, in the materials technology group at 25%, that results in somewhere in a $19.3 billion, $19.4 billion fiscal year 2013. So we’re actually very optimistic about the prospects both in the near-term and a long-term.

Mark W. Strouse – JPMorgan Securities LLC

Okay. And then within DMS, it seems one of the biggest drivers is where you guys call the Materials Technology Group. To your Analyst Day the other week, you talked about targeting to double their revenue within the next three years. Can you just talk abut what’s driving that, is that pure organic or is there any acquisitions backed into that, what should we expect there?

Timothy L. Main

Our growth has been entirely organic. And our Materials Technology Group is a group of material scientists that have great know-how expertise and some IP and dealing with everything from types of metals, glass, ceramics, plastics, and a lot of process know-how with their primary exposure today being in the from high-end mobility area, so smartphones, tablets, these types of products. But increasingly, we’re seeing a significant contribution in our Materials Technology Group contributing to business growth in our healthcare area.

One of the really [hot themes] in the healthcare area is converged products, products that acquire electronics, the types of materials that we’ve talked about in terms of steel, plastics, others miniaturization and driving our cost. And so our expertise in the mobility market and optics camera modules, our Materials Technology Group along with a world-class capability and manufacturing healthcare products at the quality levels that our customers expect is a great opportunity.

So we see a lot of synergies among the business groups in Diversified Manufacturing Services and ways in which the Materials Technology Group contributes not only to our participation in the high-end mobility area, but also in healthcare industrial and the clean tech area.

Mark W. Strouse – JPMorgan Securities LLC

Okay. And then sticking to second to DMS just, can you talk us through the sales process as far I mean, because it seems that you’re on that side of the house you are more integrated with the design face, so company x approaches you about a particular product to you want to help design. How long is that take to on average to design and then to set up a proto types, the manufacturing then ultimately getting out to in customer?

Timothy L. Main

Right, that’s a great question. I think generally speaking, I think this is an area that the investor community has some misperceptions about how the business operators both in traditional, as well as DMS market to the DMS starting in a minute. But I think the perception is that this heavy, heavy, heavy price competition that programs are put out for bid and they change hands every 90 days, and it’s a very low barriers to entry, so a real cut throw business. And although parts of our business are very competitive, that’s not the way that the industry behaves at all, business rarely moves from vendor to vendor even big customers that dominate in high velocity and enterprise infrastructures areas really changed their supply chain, and in fact the trend has been to consolidate the supply chain to fewer and fewer players. And so, that’s why the leading companies like Jabil in the industry have been able to actually gain market share and continue to have successful businesses.

I think in terms of margin performance, there has been some commoditization and Jabil’s been able to offset that competitive nature with lean manufacturing efficiencies, productivity gains, and actually delivered excellent margins relative to the industry in those areas that are highly competitive. But again, business literally moves from supplier to supplier.

In DMS, that sales cycle takes years. In healthcare for instance, we highlighted a significant pipeline of new product introductions that will rollout, I think, 20 different programs that will rollout in fiscal year 2013, 2014, 2015. The development cycle is as long as two or three years, then you have to go through FDA certifications and approvals, and then into mass production. So, it’s a very long cycle. And I think that the benefit to that cycle is very consistent, sustained results over a long period of time.

This is another investor misperception in terms of our product life; perception is all product lives are very short. While that’s true in some product areas in healthcare, industrial, companies, these products were in production typically for 10, 15 years and then there is a 10, 15 year of service cycle. Even in areas of our business where there’s a lot of short-term product cycles like in the mobility space for instance, we are still providing aftermarket services support to Motorola phones that were sold earlier in the decade.

So, we have, a continuum of services that we can participate in real revenue and earnings stream throughout a product lifecycle and then in the aftermarket services area from short product cycles in the industries and high velocity where the product cycle may only be 12 months, two areas like industrial and healthcare where the product lifecycles seven, 10 years with a 10 year of follow on in terms of post sales support.

Mark W. Strouse – JPMorgan Securities LLC

Okay. And then besides in-house manufacturing, who would you considered to be your biggest customers and what kind of market share?

Timothy L. Main

Biggest competitors?

Mark W. Strouse – JPMorgan Securities LLC

Yeah, biggest competitors and then what kind of market share would you say you have among your biggest segments?

Timothy L. Main

Yeah, I think in Diversified Manufacturing Services, we see different competitors in different spaces and in Diversified Manufacturing Services it’s characterized by very, very high mix, high complexity production. And as you know the kind of the biggest competitors the existing infrastructure that our customers have, but as that’s become more imperative for them to penetrate emerging markets and then come out with these converge products, the level of the interest in partnerships with companies like Jabil is continuously increasing.

And our competitors in that area range from companies like Plexus and Benchmark to, we see Flextronics sometimes and that type of group, really ever see companies like Foxconn or Asian ODMs in that business area.

Enterprise infrastructure is a big business with big customers with big requirements. So, it takes companies of significant scale to accommodate the requirements of the customer base there. And Jabil is one of the three largest companies in the world that participate in that segment along with Foxconn and Flextronics, Jabil is number three. And in high velocity, you have a wide range of ODMs and traditional as well as new EMS companies in that business area. So I feel like our ability to compete is unique and that we have a capability to compete in all three of the business areas that we do business, and that’s relatively rare in our industry.

Mark W. Strouse – JPMorgan Securities LLC

So, I guess, yeah, sure, go ahead.

Question-and-Answer Session

Unidentified Analyst

[Question Inaudible]

Timothy L. Main

Yeah, I think we’re in the final couple of weeks of our quarter, so anything I say around short-term demand will be misconstrued one way or the other. I think our results, our expectations are consistent with what we’ve been saying for the last actually couple of years. And this is a very slow choppy economic recovery from a deep recession. And I think the really interesting thing for investors is Jabil has significantly outperformed most companies in the Fortune 500. As a matter of fact, we’re one of the nine Fortune 500 companies that have grown at our rate in earnings and revenue since 2008. We’re one of the five Fortune 500 companies that have grown at our rate in terms of EBITDA and revenue since we went public in 1993.

So, this is an extraordinary opportunity I think to participate in a long-term growth story that is very fundamental, and has to do with megatrends in the world. The complexity of managing complex global supply chains, Jabil’s ability to really differentiate on the basis of know-how and capability. And that is really driving some great long-term growth. And I think that the short-term variations in demand really just haven’t had much of an impact on our company since the recession and it takes something like a huge economic contraction that really throws up our gain.

The difference between a 1% GDP growth and 3% GDP growth is marginal. We’re still growing, we will still outgrow the market, we’ve significantly outgrown GDP growth for really in entire corporate history.

Mark W. Strouse – JPMorgan Securities LLC

All right. So you are investing pretty heavily in the DMS business right now. I think, for this fiscal year, you’ve talked about generating $500 million in cash from operations, but flowing all of that back into the CapEx next year you’re talking about $1 billion in cash from operations, but then another $500 million in CapEx that, I guess at what point can we, do you start to see some of that CapEx investments scale back and really start leveraging some of that investment?

Timothy L. Main

Well, it’s a $1 billion in cash flow from operations, $500 million in CapEx and the type of growth that we’re going to see by 2013, I mean, I can’t take that, I’ll take that…

Mark W. Strouse – JPMorgan Securities LLC

Yeah.

Timothy L. Main

So, the appetite is for CapEx right now has a really, really good purpose in growing the business profitably. I think our maintenance CapEx, we have very little growth or no growth, our maintenance CapEx will be in the $250 million range. I think kind of our natural appetite in a more moderate growth environment where the company is setting target levels, but not exceeding it in the $350 million to $400 million a year range. As EBITDA continues to move up to $1 billion, $1.1 billion $1.2 billion, $1.3 billion now we’ll continue to, at CapEx levels $350 million to $400 million will produce significant free cash flow.

Mark W. Strouse – JPMorgan Securities LLC

So I think the media might be paying more attention to these investors. But can you just talk about the some of the recent reports in the media as far as work life balance from workers in Chinese factories, and your rising labor cost, how that could potentially impact your business?

Timothy L. Main

Sure. It’s a great question. We’re actually really part of our track record in that area. Again I think we self audit, we’re a founding member of the EICC. We do self audits, we have numerous customer audits and kind of abnormally we exceed industry standards and have had a lot of great feedback. That’s say we don’t have issues from (inaudible) we do and there will be – there continue to be issues for a big manufacturing company. But we think our track record in this area is very good and we’ll continue to focus on that as a differentiator for customers.

I mean we’re in a position to protect not only Jabil’s brand and Jabil’s reputation, but our customer’s reputation and our customer’s brand. And we take that very seriously and take that’s a hard and I think we’ve done a decent job with that, we’ll continue to focus on that as a key part of our business.

Wages are increasing in China that will continue to increase, I think again, we’ll focus on offsetting our cost increases first through productivity gains, lean manufacturing being more efficient with the assets that we have and in cases where wage escalation is exceeding our ability to do that then we will typically adjust the economics with our customer base because that’s just part of, part of what happens in the business.

We have a broad range of facilities around the world. So, in addition to China, in terms of low cost locations, we are also in Vietnam, Malaysia, India or in Singapore, Mexico, other locations in Latin America like Brazil, Eastern Europe, Central Europe and so, we have a lot of choices to offer customers. And I think what we will probably have a Western Central China location and sometime in the next year. That will be more for the availability of capacity people than it will be to mitigate wage increases in china.

But I think this is the China only card that was drove the industry from 1999, 2000 through 2008, 2009 that cards kind of played and played out. Everybody, every leading company in our industry is in every location they need to be. So the differentiator is not about being in the next lowest labor cost location, it’s about capability and managing complexity around the world and that’s what do very well.

Unidentified Analyst

[Question Inaudible]

Timothy L. Main

Yeah. So great questions; one on Enterprise & Infrastructure, the other in High Velocity, rebuilding the margin structure, getting it closer to the target in Enterprise & Infrastructure. We actually did a fairly detailed map on how we rebuild margins in our last conference call. That’s a slide in the slide deck that you can find on our website. We expect about 70 basis points of improvement this quarter, followed by sequential improvements of 50 basis points in the quarter to get us back to the 4% range in the next three, four, five quarters kind of thing.

The issues there have been Western European sites, along with actual revenue levels being lower, particularly associated with programs that are incoming market share gains, and so, somewhat driven by lack of capacity absorption as well as the Western European sites.

So, we feel like we’re on a great path to rebuild margins in that area and expect to be able to do that. We operated Enterprise & Infrastructure, in the targeted range, above the targeted range, for virtually all of 2010 and 2011. So, we’ve got a good track record of rebuilding margins.

In High Velocity, we will address our long-term targets by business area on our September call. I think you could probably expect us to raise the target range of 2 to 2.5, and we definitely can be more selective in the business that we take out in High Velocity. I mean it’s an area where we’re agnostic about growth. We want to do a great job serving the customers that we have and driving profitability and cash flow, but we’re relatively agnostic to whether or not that business area grows so we can be selective in the business relationships that we engage in there.

Unidentified Analyst

[Question Inaudible]

Timothy L. Main

I know this is counter intuitive but in our business contracts just don’t matter. Contracts are typically evergreen documents that specify what happens if the world comes to an end and then day to day business is conducted through collaborative way, pricing and the rest of that, so we really refer to contracts.

Unidentified Analyst

(Inaudible) your use of cash, dividend policy, share buybacks and then M&A, there is any large opportunities or if it’s kind of tuck-ins too there?

Timothy L. Main

I think tuck ins is the more the Jabil’s style, we’ve done a couple of big deals in our history, but we’re definitely look more favorably on tuck-ins we just made a fabulous acquisition Telmar recently which opens up the telecommunications vertical for our Aftermarket Services group. We’re very excited about the prospects there. I think you could anticipate Jabil making an acquisition to bolster our healthcare business and building capabilities in healthcare and kind of widen our lead over the rest of the market as well as addition acquisitions in the Aftermarket Services as they come up. But generally speaking an acquisition or two every couple of years is just kind of the limit for Jabil.

Mark W. Strouse – JPMorgan Securities LLC

Okay

Unidentified Analyst

[Question Inaudible]

Timothy L. Main

Yeah, France and Italy.

Unidentified Analyst

[Question Inaudible]

Timothy L. Main

Yeah, we acquired three sites and we’re now down to two sites, one in Italy and one in France. And the go forward strategy there is to build middle market relationships and use them as NPI sites and give them an opportunity to develop a business plan that can sustain breakeven the profitable performance in those areas and I think we’re on that path.

So that’s kind of the plan for the France and Italy sites. I think it’ll become less and less material over the next year. When we sold the sites we were losing about $40 million a year when we reacquired the sites we are still losing about $40 million a year. And I think we’ll get that down to $5 million quarter range and then from there I think it will be noise level. And hopefully, we will be able to continue to land new business for the sites and give them an opportunity to have continuing sustain business.

Unidentified Analyst

[Question Inaudible]

Timothy L. Main

Yeah, we don’t, it’s company policy not to talk about individual customer relationships, but I think the last 12 to 18 months has been really instructive in terms of the impact that major customers have on Jabil’s results. And we’ve had some enterprise infrastructure customers struggle in fiscal 2011 and 2012 we’ve had, our mobility customer that had some struggles and yeah the company has been very predictable in hitting numbers, has put up a very significant growth over that tight period.

So we think that the notion of our company and this is probably two of some other EMS providers in our industry. The notion that we are derivative, our performances is a derivative function of major customers has become obsolete in a misnomer for our company. So, we love our customers, some of them are big in terms of revenue, but they have a lower and lower impact on the earnings power of the company.

In Diversified Manufacturing Services that makes up 44% of our revenue, makes up 60% of our income. And so and that’s a very, very well diversified business area for us. So the company has become more resilient and sustainable over the last three, four years, remarkably different than the Jabil of 2005, 2006.

At that background, most of the companies’ income and revenue was derived out of high velocity, today that’s completely reversed. And that doesn’t make the company more resilient in a much more sustainable business model.

Mark W. Strouse – JPMorgan Securities LLC

Okay, probably we have time for one more, anybody?

Unidentified Analyst

[Question Inaudible]

Timothy L. Main

So we actually included quite a bit of detail in the stuff for our Analyst Meeting. So if anybody wants to, we might be able to share some of the documentation. You can certainly go to our website and get some of the slideware. But we believe the DMS area is a $500 billion addressable market. And when you look at healthcare, industrial, some instrumentation, these are industries that in terms of outsourcing, penetration in the 10% to 15% range.

And then the dynamics of look all of the growth is occurring in emerging markets, they tend to have all of their capacity in high-cost locations. I talked about converged products, high-mix electronics, global supply chain networks, becoming more and more complex. Jabil’s ability to help customers in diversified manufacturing services sort through the challenges they have in managing those very complex global supply chains, is encouraging them to outsource more and more of their production to Jabil and really partner with Jabil on a long-term strategic basis. So, we think that these growth rates are sustainable for the next five years.

Mark W. Strouse – JPMorgan Securities LLC

Okay. With that, I think we should probably wrap it up. Thank you very much for coming. Thank you, Tim.

Timothy L. Main

Thank you.

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