捷普科技 (JBL) 2004 Q4 法說會逐字稿

Good afternoon. At this time I would like to welcome everyone to the Jabil Circuit fourth quarter and fiscal year 2004 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. [Caller Instructions] Thank you. Miss Walters, you may begin your conference.

Thank you. Welcome to our fourth quarter and fiscal year conference call. With me today are Tim Main, our President and CEO; and Forbes Alexander, our Chief Financial Officer. During the course of this conference call we will make projections and other forward-looking statements regarding future events or the future financial performance of the company. We do caution you that such statements are just predictions and that actual events and results may differ materially. We will refer you to the documents that Jabil filed from time to time with the SEC, including our recently-filed 10-K which was filed November 12, 2003. These documents contain and identify important factors that could cause the actual results to differ materially from those contained in our projections and forward-looking statements and comments. This call is being recorded and will be posted for audio play back on the Jabil website in the Investor Relations section, along with today's press release and a slide show presentation on the fourth quarter and fiscal year results. We will be referencing the slides throughout our call today, so we ask you to join us in looking at those slides as we make our presentation.

So, turning to slide 2 on our presentations results for the fourth quarter of fiscal '04 on revenues of $1.626 billion, GAAP operating earnings were $56.9 million. This compares to 27.4 million in GAAP operating earnings for this same period in the prior year. Core operating income -- excuse me, core operating earnings, excluding amortization of intangibles for the quarter, were 67.7 million. Core earnings per share were 27 cents. On a sequential basis, revenues were flat with core operating income increasing 1%. On a year-over-year basis, this represents a 26% growth in revenue and a 28% growth in core operating profits. Revenues for the fiscal year 2004 were 6.253 billion. GAAP operating earnings were 216 million, compared to 4.729 billion and 44.5 million, respectively, in fiscal 2003. Core operating earnings, excluding amortization of intangibles and other charges for the fiscal year, were 261 million as compared to 182 million in fiscal 2003. Resulting in core EPS of $1.01, versus 71 cents. On a year-over-year basis, this represents a 32% growth of revenues and a 43% growth in core operating income and core earnings per share.

Turning to slide 4, we'll look at the results for the quarter by sector. Production levels in our automotive sector were 11% below the previous quarter. This reflects normal seasonal lower levels of production. In the computing and storage sector, we decreased by 8% from the previous quarter, again in line with our previous guidance. The consumer product sector increased by 7% during the quarter. That's a little better than what we had -- or actually a little less than what we had expected. Instrumentation and medical increased 16% sequentially. This reflects a continued organic growth and ramping of programs with multiple customers in this sector. The networking sector decreased by 4% from the previous quarter, a little better than we expected. The peripheral sector was up 10% in the current quarter, reflecting the additional box build business, or assembly production with an existing customer. Again that, was a little better than what we had anticipated for the quarter. The telecommunications sector decreased by 13% sequentially, a little worse than we expected.

Turning to slide 5, to summarize our sectors for the quarter and for the fiscal year. Q4, our automotive sector was 8%; for the fiscal year also 8%. Computing and storage 12% for Q4, 13% for the full fiscal year. The consumer sector was 24% in our fourth quarter and 25% for the full fiscal year. The instrumentation and medical sector was 14% for the fourth quarter, building up throughout the year to represent 12% for the full fiscal year. The networking sector represented 20% of revenues in fiscal fourth quarter and 20% for the full fiscal year. The peripheral sector represented 7% in our fourth quarter and 6% for the full fiscal year. The telecommunications sector was 10% in the fourth quarter and represented 11% of revenues for the overall year. And finally, the other sector was 5% in the fourth quarter and 5% for the full fiscal year. I'll now turn the call over to Forbes Alexander.

Thank you, Beth. Good afternoon. First we'd like to review our balance sheet and racial trends and ask that you turn to slides 6, 7 and 8. Inventory turns were consistent with the previous quarter in terms of turns and dollars, at 9 and 657 million respectively. The Company sales cycle also remained consistent at 26 days. We plan to continue to make progress with inventory, with a near-term goal of reaching ten turns. Our cash balances at the end of the fourth quarter were 621 million compared to 596 million as of the end of the third quarter. Cash flow from operations was approximately $100 million in the fourth quarter. Our 15th consecutive quarter of positive cash flow. For the fiscal year, cash flow from operations was approximately $450 million. The 9th consecutive year of cash flow from operations. This positive cash flow has been accomplished with the Company growing in excess of 30%, clearly demonstrating the ability to generate positive cash flow from operations in a significant growth environment.

Our capital expenditures in the fourth quarter were approximately $77 million with fiscal year expenditure approximately 218 million. Depreciation in the quarter was approximately $45 million, and EBITDA in the quarter was approximately $113 million. Our return on investments capital was 15%, consistent with the previous quarter.

If you'll now turn to slide 9. In fiscal 2004 we generated approximately $480 million in annual EBITDA from a net capital investment of 1.5 billion, for a cash return of approximately 32%. This significant cash return and strong performance with our sales cycle continues to position the Company for continued positive cash flow from operations. Throughout the fiscal year we have maintained efficient control on capital employed while greatly increasing our operating earnings, resulting in a 300 basis point improvement in ROIC for the same period last year; and returns consistency above our weighted average cost of capital.

If you'd now turn to slide 10, I'd like to review our geographic production and capacity. With regards to capacity, our business outlook is for consistent to increasing production across all geographies. Our investments in fiscal 2005 are expected to be related to existing plants and additional expansions in China, Eastern Europe and India; as a result of the needs of our customers and continued secular growth in the industry. Including these expansions, we estimate capital expenditures to be in the range of 150 to $200 million for the fiscal year and depreciation is estimated to be 180 to $200 million.

I'd now like to give you a business update. Referring to slides 11, 12, and 13. We've positioned the Company over the last three fiscal years to capitalize on the trend to outsourcing, diversifying our industry sectors and adding numerous additional customers. The benefits of this strategy, characterized as revenue and earnings expansion, have been clearly evident over this period. While we are entering our fiscal 2005 in a climate of slow end market expansion, an estimated world GDP growth 2.5 to 3.5%, our current estimates are for revenue of approximately 7.2 billion to 7.4 billion and core earnings per share in the range of $1.20 to $1.24; reflecting growth in core earnings of a range of 18 to 22%. We're positioned with numerous new and existing customer wins to allow this growth, with a number of new programs launched and currently launching; serving as incremental growth in the second half of the fiscal year. For sector purposes, we're estimating fiscal '05 to be as follows: automotive 8%, computing and storage 12%, consumer 25%, instrumentation and medical 16%, networking 18%, peripherals 7%, telecom 9%, and other 5%.

In summary, fiscal '05 is well positioned. We should be continuing to build when work is completed in fiscal '04, adding additional customers, leveraging the cost base and infrastructure we have in place. With a prospect of continued operating income growth and return on investment-- invested capital expansion.

Turning to slide 14, I'd like to give you some specific guidance with regards to our first fiscal quarter. We estimate our first fiscal quarter of 2005 -- our November quarter -- to be consistent with the guidance we provided 90 days ago.. That is revenue in the range of 1.75 to 1.85 billion and earnings per share of 30 cents to 32 cents. This represents sequential revenue growth of between 8 and 14% and 12 to 18% in operating earnings; reflecting our usual seasonal ramp in consumer electronics along with growth across all but two of our business sectors. As a percentage of revenue, we're estimating operating margins to be consistent to higher in our first fiscal quarter for approximately 4.2 to 4.6%. Gross margins are expected to be in the 8.3 to 8.6% range. Research & development costs are expected to be $1 million higher in the first fiscal quarter as compared to the fourth quarter. We estimate that research & development costs will be approximately $10 million higher in fiscal '05 as compared to fiscal '04, reflecting our on-going success in design-related programs with existing and new customers.

Finally, turning to slide 15, the breakdown of our revenue by sector for the first fiscal quarter. The automotive sector is estimated to increase by 10%, reflecting seasonal higher levels of production. Computing around storage sector are estimated to have increasing production levels by 5%. Consumer sector is expected to increase in excess of 30% in our first quarter as we enter the peak demand season for consumer products. Instrumentation and medical sector is anticipated to increase in excess of 20%. This sector is anticipated to represent 16% of our revenue stream, or in excess of $1 billion in fiscal 2005. Our networking sector is expected to decline 5% sequentially in our first quarter. The peripheral sector estimated to increase by 15%, this growth occuring prim-- primarily -- excuse me, through additional growth fill of system assembly production; as we've added new business in this area with an existing customer. And finally, the telecom sector is estimated to decline by 15% as a result of lower demand levels from existing customers. I'd now like to hand it over to Tim Main.

Thank you, Forbes. Our fiscal fourth quarter closed with no major surprises relative to our June expectations. As expected, the deceleration in GDP growth was reflected in muted end-market demand over the summer. Inventory levels are being trimmed in an orderly fashion and are coming in line with the more conservative growth expectation for the balance of the year-ended 2005. I would characterize the current environment as stable and steady. From my perspective, the prospects for our business and industry are as good as they've been at any time in the last four years. There are a variety of data points to support this belief, but let's take a look at the fiscal year we just concluded as a starting point.

Twelve months ago, our guidance for fiscal 2004 was 90 to 96 cents EPS on revenue of approximately $5.7 billion. We closed the year at $1.02 EPS on revenue of over $6.2 billion. In fiscal 2004, we generated $1.5 billion in additional revenue, earned $80 million in incremental operating income and 31 cents in additional EPS, all on $26 million less invested capital; 80% of this growth was organic, operating margins improved 33 basis points for the year and return on invested capital is now in the mid-teens and trending up. Over the past eight quarters we have grown revenues 75%, operating income 113%, and EPS 122%, all on a reduced level of invested capital. Fiscal 2005 will be the third year and data point in a healthy growth trend.

Generally speaking, we believe the power of the secular trend to outsourcing and the connection between EMS growth rates, end-market activity, and profitability is poorly understood. For example, a commonly-held view is that margins are directly connected to spot market pricing conditions and, therefore, slower end market activity is accompanied by increased price competition and margin erosion. This is a fallacy. Please turn now to slide 16.

Margins are a function of relative material content, value add, production location, and profit expectations. Pricing, on the other hand, is typically established at the outset of production and tends to be stable for product life. Quarterly adjustments are generally made based upon changes in transparent cost drivers. Primarily the cost of components and possibly production moving from a high cost to a low-cost location. Profitability is generally a function of our productivity and quality levels, cost and process control and asset velocity relative to initial expectations.

Please turn now to slide 17. In order to illustrate these concepts, we exhibit here a simulate comparison pricing model and the resulting P&L for identical business produced in a high cost and low-cost location. Material makes up the largest portion of cost and we would expect some material to be cheaper when procured from a lower-cost location. Cost of goods sold, primarily direct and indirect labor, as well as plant and regional SG&A costs is substantially lower and is reflected in our cost rolloff. IT and corporate SG&A costs are similar regardless of location. We conclude the roll-up with an identical profit from each location. The resulting P&L in the lower portion of the matrix indicates a lower gross margin from the low-cost location of 57 basis points; principally due to the higher relative material content and cost of goods sold. Yet, due to lower regional SG&A costs, operating margin is identical. Of course, pricing approaches differ by customer and industry and this should not be taken as a generic formula. It is, however, a reasonable demonstration of the impact lower-cost locations and relative material content have on margins, irrespective of pricing. The conclusion to be drawn is that gross margins are not a proxy for pricing behavior.

Jabil's results are clearly consistent with this demonstration. As we have moved to lower cost locations and entered more material-intensive sectors, such as consumer electronics, the gross margins have declined; but operating margins have improved. Year-over-year, operating margins improved by 33 basis points. We have consumed less capital and ROIC is dramatically improved. In fact, in fiscal 2004, incremental operating income of $80 million on $1.5 billion in additional revenue results in a 5.3% operating margin. This was accomplished on $26 million less invested capital.

One of the more perplexing misguided notions is that Jabil and EMS industry growth is entirely dependent on end markets. For time horizons longer than the next 90 days, the powerful influence on our growth rate is the secular trend to outsource electronics production and services. Please refer now to slide 18. Here we compare the end market growth rates for OEMs in the sectors Jabil serves today with Jabil sector growth rates. Clearly, our growth rate has substantially exceeded end market activity. Jabil's three highest growth rate sectors: instrumentation and medical, consumer and automotive, are driven largely by vertical OEMs converting to an outsource model. In essence, this is the growth story; for Jabil and every other player in the business.

Turn now to slide 19, please. For another more macro perspective, here we contrast total end market growth rates with our own. In this graph, we have indexed the cost of goods sold for seven major OEMs, indicated at the bottom of the slide, already outsourcing as a proxy for end market growth. We compare this end market growth with our own over the same eight-quarter period. As you can see, end market activity accounts for a very small portion of our growth. The balance is comprised of vertical OEMs converting to an outsource model, serving the expansion with existing customers and market share gains. We also illustrate how our growth substantially exceeded the S&P 500 growth rate of about 15% per year. The conclusion we draw from this data is that end markets influence, but do not determine, our growth in revenue and earnings. We would also conclude that dramatic valuation reactions, based upon quarterly end market changes are, by definition, overreactions.

The EMS market is a growth market, particularly if your horizon exceeds the next 90 days. We are looking forward in fiscal 2005 to the continued growth of our company in the industry. Over time essentially all OEMs will outsource the production of their electronic hardware and they will continue to utilize a broadening set of comprehensive services. The conclusion I draw is the environment is outstanding for continued growth and earnings and shareholder value. Thank you for listening and we are now prepared to take your questions.

[Caller Instructions] Your first question comes from the line of Lou Miscioscia from Lehman brothers. [Caller Instructions]

Thank you. I guess, let me first ask about the slow and steady comment that you had. It seems that we're getting the impression that some of your end markets might be coming in a little bit softer than, I guess, prior thought; even now given seasonality. Maybe if you could just comment on that for, you know, where we are I guess now into the 21st of September and then also I guess just the view looking out into the next couple of months.

Lou, what I said is stable and steady, not slow and steady. I guess that's a semantical difference. I think if you compared the initial guidance for the quarter with where we ended up, telecommunications and networking were a little bit softer than originally anticipated. We knew those segments would be going through somewhat of an inventory correction over the summer months and things are a little bit slower there than the other segments. But my comments are really based on the overall environment. You know, taken in a macro perspective. And the point that we're trying to make there is that we've accomplished a level of diversity that insulates us somewhat from particular slowness in one or two sectors quarter-to-quarter. If they all went south at the same time, we'd feel that for a period of time, but you know, the overall environment is stable and steady.

Okay, great. I was probably using one of my words instead of yours. Sorry about that.

Yeah.

Next question. I guess the chart you put up that shows a good example of, I guess, the-- explaining the gross margin, the operating margin and the different areas. I guess one of the questions I had -- very often when you're moving business like that and you're giving such huge discounts comparatively to your customers, are you able to hold onto a little bit more of the pricing so you're actually getting better margins? Even though you know, let's say, lower revenue, but actual better margins, let's say, in some of the low-cost areas like China? And, I guess, if not just if you could explain why not?

You have to get your mind around the fact that we're not giving the customer a huge discount. You have to get your mind around the concept that the negotiations between the EMS provider and the customer have to do with an appropriate level of profitability. That is operating profit and return on the invested capital relative to the risks that are associated with installing and running that capacity. So, in this example, the slide would be too busy if we put all of the metrics on this slide. But one of the things that you might see here is that return on invested capital, depending how we do on inventory turns, might actually be even better in the low-cost location.

So-- so it really isn't a discount. And the point is, in terms of the most important profitability metrics, -- like operating profit, operating margin and return on invested capital -- we're doing just as well, if not better, in the low-cost location. And then the risk associated with unwinding a manufacturing infrastructure in low-cost location is essentially lower risk. So-- so I don't think it's a process of hanging on to incremental dollars and moving to a low-cost location. I don't think that's an issue for the customer, not really an issue for Jabil and we don't think it should be an issue for investors either.

Okay, great. I'll hold to two questions here. Thank you.

Okay.

Your next question comes from the line of Alex Blanton. [Caller Instructions]

Good evening. Tim that, was a good explanation of the basics of the business. I think we need to be reminded of things from time to time. Um, I have a question on your guidance for the full year. It's basically four times the first quarter. If you took four times the first quarter guidance, it would be $1.22, $1.28, and I'm wondering why that is. Aren't we looking at some sequential growth through the year?

Alex this is Forbes, yeah, you raise a good point. If you remember, as we move into our fiscal first quarter it's a seasonal high in terms of consumer demand. So you will see a drop in revenues in our fiscal second quarter due to that seasonality, effectively, not being there. And then you'll see, you know, continued sequential growth thereafter as we lead into that guidance, of that 7.2 to 7.4 billion.

Okay. Is this seasonality gonna be more than in the past? Because you only dropped a penny this year. From the first--

Yeah, I think in fiscal '03, the consumer sector saw some sustained -- you know, they had a very strong consumer period that ran through into December, I think right up until Christmas. So you know, at this point in time it's, you know, not giving specific guidance for the second fiscal quarter. You know, we'll see how that shakes out as we move through November. But--

I think our internal expectations are that there will be more EPS in the second half of the year than the first half of the year.

Yeah.

And you know, we were helped a little bit last-- you know, last year in the second quarter. So there will be probably a little bit more seasonality there. And I think you could characterize the guidance as reasonably conservative, given the environment that we're in. You know, we'll kinda see how things play out during the year.

Okay. Second question is on the telecom and networking business. Telecom off 13% sequentially fourth quarter, down another 15% first quarter and networking, minus 4 and minus 5 in those two quarters, sequentially. What's going on there? You're making that up in the other sectors, but clearly your results would be substantially better if these weren't going down. Is this inventory correction or something else?

Um, you know, it's hard to say if it's something else. You know, the Federal Reserve obviously thinks the economy is pretty sturdy, and has some traction. A 2% to 3% GDP growth rate would be, you know, just fine overall. You know, I think that the outlook is very conservative from the equipment guys, and we'll see how that plays out as we go forward. You know, people, I think, when we said this back in June, when we provided guidance for Q4. The experience of late '03 and early '04 caused a little bit too much euphoria, I think, in those particular markets and people might have gotten a little ahead of themselves. I don't think it's a widespread pull-back in equipment spending. I think it's still an adjustment to a lower level of demand than was originally anticipated. So I don't think it's an inflection point and downwardly biased from here, Alex.

But you're not picking up a lot of new business to offset these things, it appears.

Not in those particular segments.

Okay, thank you.

Your next question comes from the line of David Pescherine with Smith Barney. [Caller Instructions]

Thank you, Tim. Last quarter you had indicated that your--a new piece of wireless handset business had ramped a little bit slower than you had anticipated. Can we, first of all, assume that that's fully ramped here in this quarter? And then, along the same lines, can you just give us some insight into your goals and objectives for growing your exposure in this market? You know, for example if one of your current handset customers indicated they wanted their manufacturing partners to also have an ODM capability. How long would it take you to establish that capability and what level of investment would be required?

I'll deal with that question backwards. In terms of the ODM question, we have a significant investment in design today. We have over 400 engineers around the world. We've opened up new design centers in China in the past year. We are engaged in home entertainment, consumer and communications products. So you know, to be able to do-- you know, to be able to engage in handset-- we already do collaborative design in the handset area, you know, as it stands. That is not a huge -- would not be a huge uphill battle.

Do we want to do that? No, we don't want to be a handset ODM. We want to be a diversified provider of electronic services to a broad range of customers. And, in terms of the particular handset program that we've referenced, you know, it's in the process of ramping. It's on track, it's coming on-line, and I think that's more a story of, you know, the vertical progression to an outsource model than it is, geez, we're in love with the handset business now. I mean, we love the handset. We think it's a great business. We can get a decent return on invested capital there. To the extent customers in that segment want us to design phones, we'll engage in that activity. But that, in and of itself, is not-- you know, we're not hanging our hat on that peg.

Right, but not adverse to it.

Right, we're not adverse to it, no.

Yeah, and then a question for Forbes. Forbes, you were talking about the expansion into China and Eastern Europe. Specifically on China, we've been hearing more recently that the labor markets have become a bit tighter, especially in coastal regions. We've got a little bit of rising wage costs and some spot labor shortages. Can you first tell us what you guys are actually seeing on the ground and in your business? And you know, how about on the components side? Are you seeing any rise in material input costs in that region relative to your other geographies?

First, on the labor costs and labor availability, to my knowledge, we're not seeing any difficulty in hiring of labor in the region. I think, you know, labor costs are relatively consistent with what we'd expect for that region, be it coastal areas or in the south or inland. So I'm not hearing anything negative in that regard. With regards to material pricing, Tim, do you have a view on that?

Fairly stable. I mean, some of the-- with the ramp-- and cell phones look like they're gonna be 660 million units or something like that this year, that's obviously been a very strong segment. So, you know, there are some-- some flash memory and other passive devices that are in tighter supply than others. But when you get into a market that is a little bit sloggy, a little bit, you know, slower growth, generally materials do not pace production. And you know, on your China question, really the only -- you know, you'll see cost escalation in places like Shanghai and in the cities. And you'll see particular escalation with higher levels of engineering talent, particularly design talent. And so we've seen some of that, but from the standpoint of, is it disruptive to production or our economic models? No.

Right, and then just one final question, then, on China. Obviously a lot of speculation for a long time that China would have to essentially have the currency appreciate. So again, can you kind of give us what the short-term and long-term impact might be for the business? Obviously, your model is much more flexible, that you've got capacity all over the world that you can move programs around. But kinda just give us a flavor, an understanding, of how flexible the model is if you had to do that?

Well, we do have a--our low-cost foot print is pretty well diversified. So we do look at our ability to flexibly move production around the world as an economic advantage, as a mitigation against the risk of an economy experiencing troubles or cost escalation and so on. Having said that, though, there's so much slack in the China chain, and I doubt seriously that they would revalue their currency more than 5 to 10% at a time; and it will take a lot more than that for there to be a dislocation in terms of relative comparative advantage in labor costs.

Great, that's very helpful. Thank you, Tim.

Your next question comes from the line of Steven Fox with Merrill Lynch. [Caller Instructions]

Could you talk a little bit about the full-year outlook in terms of the components from new programs by served markets? Where do you see the bulk of the new programs over the next 12 months? If you could sorta break that down a little bit that'd be helpful, thanks.

Generally, if you look at some of the sector guidance that I gave for '05. See, if you look at instrumentation and medical, in particular. Growing to about 16% of that guidance. That's one of the key drivers, one of the key areas, and I think if you do the math there, you're gonna see that grow in excess of selling 40 to 50% next year. So it's an area we're very, very excited about. A number of new customers that we've added throughout fiscal '04 and a number of programs launched in our fiscal '04 and continue to launch as we move into Q1. So that's one of the primary areas.

We're also are seeing some relative good growth in the peripheral site, where we have won some existing new business with an existing peripheral customer there. So, those areas are the primary drivers with you know, we continue to see automotive and some consumer growth there in the mid-teens. So I think we're relatively well diversified and in relatively good shape.

And we'd ask you not to look at our business any longer in terms of what the new hot program is or what the new hot customer is. It's a portfolio of opportunities that we feel very good about, and I'd redirect your attention to slide 12 again to kind of take a look at the relative contribution between our top 10 customers and the balance of our portfolio of opportunities. Looking back at 2002, when the top ten comprised 75% of our business and the revenue from the next tier of customers comprised in the 25% of our business. Looking into 2005 with the top 10 concentration down to 62% and getting over $2.5 billion from the next 50 customers. So, that's a fairly broad-based portfolio of opportunities for the Company and that's really the way we want you to start looking at us. And we think with good reason.

Thanks. And then just on your incremental returns on capital. It looks pretty consistent with what you were saying at the analyst meeting back in April, which it would be over 30%. If you do that type of incremental returns, if I did my math right, you could be approaching -- depending on how you calculate it -- 18% to 20% total returns on capital. Is that about right?

That should be about right, yeah.

Thank you.

Your next question comes from the line of Patrick Parr with UBS. [Caller Instructions]

Hi, this is Ben Lu for Patrick Parr. There's been a lot of concern in the market right now talking about inventory across the food chain. Can you--and you yourselves talk about inventory adjustments last quarter. Tim, can you talk to what you're seeing currently with inventory at your customer base? Whether you still see some inventory adjustments going on there or do you think that's been largely flushed out of the system?

Well, a couple of segments are a little bit weaker than we'd hoped at this point, but I think, you know, what I said in my prepared comments, I think I'd just reiterate here; is inventory levels are coming in line with a more conservative growth expectation. Customer by customer, there will be differences, but we can not get into customer detail. We can't follow you down that path. From a broader sense, our inventory levels are in decent shape. We're disappointed that we only achieved 9 turns. We'd prefer to be at 10 to 12. We'll continue to effort in that direction in fiscal '05. We don't think any of our customers have serious inventory issues that would have an impact on our guidance or outlook.

Tim, if you see a lot of your customers working their inventories down to historically lower levels and they're holding less and less inventory, what do you think that has in terms of impact on seasonality? Do you think your fiscal 1Q will be seasonally higher than normal and your February quarter will be seasonally higher than normal, as well, in terms of a decline?

I think they're different animals. In equipment manufacturers and networking, telecommunications, higher-end storage, higher-end computing, lower inventory levels are more comfortable for the OEM in periods of slower moderate growth. And when demand snaps back, they'll just--they'll just--they'll add some to that pipeline, and that's kind of a planned process. In the consumer electronics business, they build a bunch of stuff and they send it out to stores and hope it sells. So you know, you're really waiting to see how things go over the Christmas period. And you know, there isn't as much visibility on a realtime basis for us to adjust schedules. So I wouldn't say that the fact that people are running at historically low inventory levels will necessarily result in lower levels of seasonality. We really just won't know until the results are turned in for the Christmas season.

And Tim, I know it may be a little early, but what would you characterize as a typical seasonal decline for fiscal 2Q?

If you use last year as a sense in the consumer electronic area, I think it was down about 30% quarter-over-quarter, and I don't see any reason to think it'll be much different than that. You know, give or take a few points.

Okay, thanks, guys.

Your next question comes from the line of Steve Savas with Goldman Sachs. [Caller Instructions]

Thanks, good evening. I guess a quick question for Forbes. You guys are certainly generating a lot of cash and inventory was even flat sequentially. At some point it would seem that this might start getting a little bit harder to do, just wondering if you have any thoughts for fiscal '05 cash flow from operations? I know you gave us -- I think you gave us CapEx and depreciation already, but just wondering about cash flow from ops.

Yeah, cash flow should still be very strong as we move through '05 with those types of numbers. So, you know, I think you can certainly see similar types of cash generation in '05; '04 was somewhere in the range of 450 million. So you know, I see no reason we shouldn't be able to do 400 million next year.

Okay, that's great. And then quickly, I'm not sure if you gave it -- I think 10% customers for quarter and fiscal year?

We didn't give it, but I can give that to you. In the quarter 10% customers were Phillips, Cisco and Hewlett-Packard. And for the year, the 10% customers were Phillips and Cisco.

Okay, great. Thank you very much.

Yeah.

Your next question comes from the line of Thomas Hopkins with Bear Stearns. [Caller Instructions]

Yes, good afternoon. Tim, I think some of the stuff you have on the slides is born out in the gross margin. I think we have it at 8.47, up about--you know a few bps versus May on a flat-top line with, you know, the telecom down 13%; and I guess you said your consumer was better than you'd thought. So, could you just talk a little bit, you know, you were going over with the business model about, kind of, where that gross margin came in sequentially with the mix of business there.

Yeah, you know, I wish I could. Forbes, you have some comments--

Sure, actually--

9 basis points--

We misspoke. The consumer sector actually came in a little bit worse than we'd expected. I think we guided 10% sequentially up, it came in around 7%. So sorry we misspoke there. But we've also got our telecommunications sector and networking a little bit softer than we thought. You know, we had-- we had some good strength in instrumentation and medical there again, which, you know-- which balanced the whole portfolio, if you will.

Okay, so you know, kind of being up sequentially here on the gross margin on a flat-top line reflects the I & M kind of strength?

Yeah, some of that, yeah.

I think we also did a better job of controlling our manufacturing costs in the quarter. I mean, we really adjusted to the fact that we had a-- really a flat sequential quarter and controlled our costs better.

That's very true.

Okay, and Tim, the -- or Forbes -- the consumer was plus-7 this quarter sequentially and correct me if I'm wrong -- did I hear plus-30 for November?

That's correct, yeah.

So that's the seasonal build, but last quarter, I remember when you guys-- for the quarter ended May, didn't you have a pretty strong growth rate at Phillips in the consumer division?

I doubt seriously we would have said--

Well, what was the consumer-- sequentially the consumer growth rate for the May quarter? I think it was up pretty strongly. I'm just trying to extrapolate, you know, the steady sequential gains throughout the year for the consumer going into this November expectation of plus-30%.

Yeah, we had some growth last quarter of the handset volumes ramp along with, along with the you know, some other elements in that consumer sector.

Okay--

--15%, and that was really new customers.

Okay, so customer was up 15% last year quarter? I mean in the May quarter.

Correct.

And then it was up another 7%, sequentially, this quarter and you got it up 30% for November?

That's correct.

So does this again, Tim, underscore what you were saying about outsourcing or is Phillips just somehow doing a lot better than people think?

Tom, I can't follow you down the customer specific path. We have added new customers in that segment. You know, to the extent that we have 4 or 5 big customers in that segment that tend to offset each other; we feel better about that. Overall, home electronics, particularly TV sets, are not-- not flying off the shelves right now but, again, we've added some new customers in that segment to really fill it out and now we have more growth opportunities.

Okay, great. And any update on Chris?

Chris is having a blast. He's really glad he didn't have to prepare --. [ LAUGHTER ] Always good news.

Great, thanks.

Thanks. Thanks, Tom.

Your next question comes from the line of Matt Sheerin with Thomas Weisel. [Caller Instructions]

Thank you. Tim, in light of comments on the increased R&D expenses, could you just talk about your overall strategy around design services? Is this something that you expect to move the needle in terms of revenue or gross margin, or really just extend relationships with customers and, ultimately, bring in more volume business? And then I know you've also commented about the ODM strategy as something Jabil's not interested in right now, but can you just comment on that again? Thanks.

Yeah, I'd like to just tweak a little bit the last comment on Jabil's not interested in an ODM strategy. I think we have a strategy, and the strategy is premised on the belief that the EMS markets and the ODM markets become indistinguishable from each other over a period of the next three to four years. And that electronic OEMs, that are the big consumers of our services, will be able to flexibly choose the style of production and the style of services from a limited number of electronic hardware providers and producers. Sometimes that will include ODM-level products, and we're prepared to do that in certain industry segments today. So, pursuing an ODM strategy in and of itself, though, in order to enhance our margin structure, because we believe that's the only way that we can; isn't part of the strategy.

We think it's a natural evolutionary trend for EMS providers to be much more engaged in, primarily collaborative design, but sometimes ODM design with their--with their big customers. And I think it's an inevitable trend for ODM providers to receive more and more pressure to provide the types of global supply chain management infrastructure services that we provide. So again, this concept that the markets will continue to mingle and the edges -- the boundaries will become less and less stark and more and more merged.

In terms of our development expenses, virtually -- I mean, most of our design activity today is collaborative design. Cooperating on products. That means, though, sometimes we develop the entire product from a customer specification in cooperation with their, you know, marketing people. So, it can take a number of different forms. I think we'll continue to invest in that area. You know, what you see in terms of $24 million is really the tip of the iceberg because in terms of the revenue stream associated with the collaborative design, it's grown from 10, $15 million a few years ago to 50, $60 million pays today. So it continues to gain a lot of traction and steam with us and I think we'll do a lot more of it. I think in the end, margins will -- operating margins will continue to trend up; again, as we leverage down, SG&A costs. And design will be a part of that because it will contribute to significant volume for us.

Okay, great. And then Forbes, can you just remind us on the SG&A side how much you know, incremental the SG&A will be for every dollar? What is it, about 3% or something like that? Or less than that?

The metric I use -- it's about a, you know, a million bucks on a hundred million of revenue. So 1%, is a reasonable number.

Okay, and that's something we can assume going forward as well?

Yep, that's reasonable, yep.

Okay, thanks very much.

Your next question comes from the line of Bernie Mahone with Morgan Stanley. [Caller Instructions]

Hi, good evening. I just have a quick question on the inventory. So, you're going into the February quarter-- you know, as you go through this November quarter, should we expect you to work down inventory just to get it to lower levels into the, you know, slower February quarter? Or how should we think about that?

Yeah, that would be the expectation, you know, our near-term goal is to drive this to 10 turns.

Okay, and when do you think you could get to 10 turns by?

I would certainly hope within the next quarter or two.

Next quarter or two. And then, didn't you say that your longer term goal was 10 to 12 turns and could we expect 12 turns maybe at the end of fiscal '05?

Yeah, that's, that could be -- you know, that's a challenge for us. We'll see how we work on that. We've got a number of initiatives that we're working through right now, but I'd be happy if we can get to 11 turns by the time, you know, by the time we get to end of fiscal '05.

Great, thanks.

Thanks.

Your next question comes from the line of Shawn Severson with Raymond James. [Caller Instructions]

Thank you. Good afternoon. Tim, I was wondering, could you give a little more color on new business opportunities in telecom and network? I know you say there wasn't a whole lot going on there in this quarter currently. But, I mean, is that still a pretty robust pipeline if we look over a 6 to 12-month time frame or do you think things have kind of cooled off there in general for the time being?

You know, there's not -- and we've added new customers in that space, even in the last quarter. The big players are the guys that drive most of the volume today. I think, Shawn, our bigger opportunities will be activities that aren't currently outsource moving to EMS providers. Take a look at the Nortel deal with Flextronics as an indication of what I'm talking about. There's still some of that available in both of those segments and that'll provide incremental opportunity for us. I wouldn't expect those two segments to be really robust growth drivers for us, at least for the next two or three quarters.

Okay, and then I don't want to beat on the consumer too much, but last quarter you had expected November to be up 20%. Now it's up 30%. Just wanted to clarify -- would you claim that the difference is more from, you know, new business that's come in or just existing business, you know, doing better? If there's any delineation we can get between those?

Well, I would say both. So we do-- you know, we have added two or three new customers in that sector as we move into '05. And, you know, our handset program and the other large consumer customer there, things are going according to plan.

Okay, thank you.

Your next question comes from the line of Michelle Gutierrez with Schwab Soundview. [Caller Instructions]

Great, thanks. I wanted to ask you guys about visibility and order patterns. What are you seeing in terms of improved or reduced visibility and your customers' order patterns?

Michelle, I'm not really sure how to respond to that question. Order patterns haven't changed. Lead times are relatively stable. You know, guidance is what it is. You know, there hasn't been any dramatic changes in customer behavior over the last few weeks.

I guess in the context of one of your competitors preannouncing a significant downfall last week, it's just you know--How is it that Jabil is still seeing very, very stable orders? It's just you know-- that there was significant order reductions there.

Yeah, I guess -- I don't want this to sound antagonistic, but I think for an explanation of what happened with their results, you should ask them about that. And, in our case, what we've talked about a lot today is the growth of the EMS industry, the trend outsourcing and a very rich portfolio of opportunities that we have that mitigate some of the downside risk associated with particular customers in particular segments.

Okay, then referring to that particular area in your presentation, slide 18, you highlighted, I guess, three main areas of very, very strong growth that Jabil's been able to outgrow the underlying industry growth in instrumentation and medical, consumer, as well as auto. Can you describe the sizes of those markets and how much has been outsourced in those markets?

Consumer -- depending on who you talk to -- is anywhere between 120 and $160 billion industry. We think that's 10, 15% outsourced today. The automotive business is anywhere from, again, depending who you talk to, 40 to $60 billion in electronics and-- electronic content and automotive and vehicles is increasing, so that penetration rate continues. Very little of that is outsourced today. I'd say less than--certainly less than 10%. Instrumentation and medical is kinda the big bucket that includes industrial controls, instrumentation as well as medical products. Medical is about a $14 billion industry. Industrial controls I think is around a 20 to $25 billion a year industry along with instrumentation.

Again, those segments have very low levels of penetration in terms of outsourcing. I'd say around 10% roughly. The mature segments, where you see outsourcing in the 50% or more range is really the computing and networking and, now, the telecommunications market. Those are much more mature markets. So I think that is consistent with Jabil seeing more growth in the segments that are primarily vertically integrated.

That's very helpful. Thanks. And I have one more question. On consumer, since it's growing so quickly next quarter, are we going to start seeing -- what's the timing in terms of the back-to-school ramp? It's becoming a bigger part of your business. In terms of seasonality, where did we see the bulk of that, in what month?

Kids are already back to school, so that's over with. That's generally a computing industry question and more of a notebook and desk top issue. We don't really have much participation in those markets, so it's not really an issue for us. The consumer electronics area, primarily the home entertainment area, has a very strong Christmas seasonality to it; around the world, for some reason. Certainly in Europe, United States for obvious reasons, but it also happens in other regions of the world that you might not expect. So anyways, that's a fairly normal pattern. You would typically start to see that build now. You would see new products that are going to be introduced start production in August, September, October, you typically see the peak months in October and November and by December, you know, you know if you're in alignment or you're gonna have a bad season or a good season. So, we really won't be able to make the call on how things turned out until December.

Okay, great. Thank you very much.

Operator we have time for one more question.

Your final question comes from the line of Jeff Rosenberg with William Blair. [Caller Instructions]

Okay, thanks. Tim, I think back around the time of the analyst day, you guys expressed comfort with a 20 to 25% top line-type expectation and as you sit here today you're looking for a more high teens-type number in your guidance. Can you talk about whether or not there's a little bit less of the new programs that you had identified at that time in your expectations now or-- obviously there's probably a different view on end market growth over the next 12 months, but maybe a little commentary there?

Jeff, you're a very good listener and thank you for reminding us of previous statements. You know, in April when we had our analyst meeting, we were coming out of two consecutive quarters of, I think, 6ish or, certainly, 4 to 6ish GDP growth and very strong demand. Things looked a little better then, and there's been a deceleration in growth that the markets are stable, but not growing at that rate. And so, I think Jeff, I would characterize the guidance as conservative and reasonably conservative based on what we see today. And to the extent everything holds it together, end markets are in good shape and that type of thing, then maybe we'll do a little bit better. But from where we are today, we think a company that follows up a 40% growth year with a 20% growth year and the math is pretty easy if we do a$1.22 to a $1.24, it's going to be about a 20% growth rate over the previous year, so we think it's pretty darn good. And, you know, no reason to reach further than that at this point.

That's fair. And can you talk about whether or not you've also sort of ratcheted back what you're expecting in terms of ramp from the new programs you had identified at that time in addition to what you're seeing about how you're assuming end markets behave?

Again, I wouldn't look at our business any longer through the prism of what the hot product is that's gonna breakthrough and drive revenue growth in any particular quarter. You know, overall, if the whole economy slows down a little bit, generally everything slows down a little bit. And there's nothing that we were counting on at that -- to put it this way -- there's nothing that we were counting on at that time that isn't happening. Or anything new negative that has come up since then with anyone in our customer portfolio or the products that we build for them.

Okay, and then just the last question, I guess, would be: on the gross margins, I think, you know, you talked about doing better in terms of managing the costs during a flat quarter. I think you'd also talked about some just cost pressures from new programs; that sort of a thing. I mean, you've definitely drifted up toward the higher end of your range. Did you do much better on that this quarter and, you know, sort of where are you at in terms of getting past those higher expenses from a bulge of new programs?

Yeah, I guess in the quarter we did marginally better, given our comments on some of our cost control initiatives that you know, going into this flat quarter. We do have a number of programs that continue to ramp as we go through the first half of fiscal '05. So you know, those will be marginally dilutive on the margin but, again, I just point you to the operating income, you know, sequential growth there and the actual operating income percentage. Rather than, you know, you should see -- as our revenues drift up and down, as we move through a seasonal high and then down in second quarter, you should see a corresponding movement in our SG&A to match that margin change.

Okay, thanks a lot.

Thank you.

Ladies and gentlemen, this concludes today's Jabil Circuit conference call. Thank you for participating. You may now disconnect.