捷普科技 (JBL) 2005 Q2 法說會逐字稿

Good afternoon. My name is Kelly and I will be your conference facilitator today. At this time I would like to welcome everyone to the Jabil Circuit second quarter fiscal 2005 earnings release 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. If you'd like to ask a question during this time simply press star then the number 1 on your telephone keypad. If you'd like to withdraw your question press the pound key. Thank you. I would now like to introduce Ms. Beth Walters, Vice President of Corporate Communications and Investor Relations of Jabil Circuit. Ms Walters, you may begin your conference.

Welcome to our call. With me today are Tim Main, our President and CEO, and Forbes Alexander, our Chief Financial Officer. During the course of our call today we will be referring to a slide presentation on the quarterly results that is posted on our website, jabil.com. Turning to slide 1. Throughout this conference call we will make projections or other forward-looking statements regarding future events or the future financial performance of the Company. We caution you that these statements are just predictions and that actual events or results may differ materially. We refer you to the documents that we file with the SEC including our most recent 10-K filed November 55, 2004. [Inaudible] identify important factors that could cause the actual results to differ materially from those contained in our projections or other forward-looking statements.

This call is being recorded and will be posted for audio playback on the Jabil website in the Investor Relations section along with the first quarter press release and slide show presentation. Turning to slides 2 and 3. The results for our second fiscal quarter of 2005 on revenues of $1.7 billion, GAAP operating income was $57.8 million. This compares to 50.2 million in GAAP operating income for the same period in the prior year. Core operating income excluding amortization of intangibles for the quarter was 68.1 million or 4 percent of revenue. Core earnings per share were $0.27. On a year-over-year basis this represents a 15 percent growth in revenue, 10 percent growth in core operating profit. On a sequential basis revenues and core operating income declined 7 and 18 percent respectively, in line with our previous guidance.

Turning to slide 4, a discussion of our results for the quarter. I'm looking at our revenue by sector. [Inaudible] levels in the automotive sector came in as expected, consistent with our first quarter. The computing and storage sector was stronger than our prior expectations and increased 10 percent from the previous quarter. The consumer products sector is also somewhat stronger than our prior expectations, decreasing by 25 percent in the quarter which does reflect seasonally lower levels of production. The instrumentation and medical sector performed somewhat less than our prior guidance and was consistent with the first quarter. The networking sector, the peripheral sector and the telecommunications sector all were consistent with the prior quarter and our prior expectations for each of those sectors. Turning to slide 5 and looking at each of our sectors in percentage for the quarter. The automotive sector was 8 percent of revenues, the computing and storage sector 14 percent of revenues. The consumer sector was 25 percent of revenues for the quarter. Instrumentation and medical was 15 percent of revenues. The networking sector represented 17 percent. The peripheral sector accounted for 8 percent of revenues. The telecom sector was 9 percent of revenues and our other accounted for 4 percent of our overall revenues. I'll turn the call over to Forbes Alexander to review our balance sheet and ratio trends.

Thank you, Beth. Good afternoon. I would like you to refer to slides 6, 7 and 8. The Company's sales cycle improved by 5 days to 23 days in the quarter. Days sales outstanding improved by 10 days to 42 days. Payable days contracted by 7 days to 58. In both of these metrics, days sales and payables days, 6 days of that reduction was associated with the liquidation of receivables and payables that were assumed as part of the Phillips Poland final assembly transaction made at the end of our November quarter. Our inventory declined by $74 million as compared to the first quarter. Days of inventory and turns remained consistent with the previous quarter, turns were 9. Our cash flow from operations was approximately $200 million in the second quarter, our 17th consecutive quarter of positive cash flow. As a result cash balances were $780 million as of the end of the quarter.

Our capital expenditures during the quarter were approximately $45 million. Depreciation was approximately $46 million with EBITDA in the quarter at $114 million. Our return on investment capital, as was anticipated, was 15 percent as compared to 17 percent in the previous quarter. As we operate throughout the balance of our fiscal year we are in excellent position to continue to produce solid positive cash flow from operations while producing good incremental returns on our capital deployed. I would now like to update you in terms of our acquisitions, capacity and operations and I would ask you to refer to slide 9. We are pleased to note that we completed the acquisition of the electronics manufacturing business of Varian, Inc on March 11, 2005. The purchase price being $195 million as previously announced. This acquisition will add low volume high mix capacity to our capability set in the United States across instrumentation, medical and military aerospace sectors. With regards to capacity, our business outlook is for consistent to increasing production levels across all geographies.

As we ramp through the balance of the fiscal year and into fiscal '06 we will be challenged in numerous plants with rounding requirement but are in a position to have adequate capacity. As we discussed in our previous quarter's call our capital investments in fiscal 2005 are expected to be related to existing plants and additional expansion in China, eastern Europe and India. Ground breaking has taken place in China and India and we expect these plants to be completed during our first fiscal quarter 2006. We also plan to add additional capacity for our Jabil global services group for repair business in Hungary. As a result of increasing levels of production we have now revised our estimates of capital expenditures to be between 200 million and 225 million for the fiscal year 2005. Depreciation is estimated to be between 180 million and 200 million. I would now ask you to refer to slides 10 and 11.

With regards to our third quarter '05 guidance and full year we are guiding to an overall revenue range in the third quarter of 1.9 to $1.95 billion, or an increase of 12 percent from the second quarter. We expect overall revenue levels to be approximately $200 million higher for the full year than the mid point of our previous estimates of 7.5 billion as compared to the previous guidance of 7.2 to 7.4 billion. This estimate reflects the completion of the Varian acquisition and current demand basis, taking into account the various assembly ramps and additional organic business wins in the second half of our fiscal '05. Core earnings per share for the May quarter are expected to be in the range of $0.32 to $0.34. Core earnings per share for the full fiscal year are estimated to be in the range of $1.27 to $1.29 as compared to the previous guidance of $1.20 to $1.24. As a percentage of revenue we estimate operating margins to be in the 4.3 to 4.5 percent range.

Research and development costs are expected to be consistent with the second fiscal quarter reflecting our ongoing success in design related programs with existing and new customers. The tax rate is expected to be 16 percent consistent with that of the second quarter. I will now ask you to refer to slide 12. Revenue by sector for the third quarter. The automotive sector is estimated to increase by approximately 10 percent reflecting seasonal higher levels of production and the addition of a new customer in the sector. Computing and storage is estimated to have production levels lower by 5 percent from the second quarter. Our consumer sector is expect to increase by 10 percent in the third quarter reflecting the ramp of new assemblies within the sector. Our instrumentation and medical sector is anticipated to increase by 25 percent reflecting the addition of new assemblies within the sector and the addition of new customer revenues associated with the recently completed Varian transaction. Our networking and peripheral sectors are estimated to increase by 5 percent over the second fiscal quarter.

And lastly, our telecom sector is estimated to increase by 10 percent in the third quarter. In summary, we are pleased with the first half of our fiscal '05. Having executed -- executed to expectations while maintaining control of our capital deploy. And continuing to produce returns on investor capital in excess of our weighted average cost of capital. We are very well positioned for revenue and core earnings growth in the second half of our fiscal year and continuing into our fiscal '06. The benefits of our strategy over the last 3 fiscal years positioning the Company to capitalize on the trend to outsourcing, diversifying our industry sectors and adding additional customers are evident. Our revised estimates for the current fiscal year reflect growth in revenue of approximately 20 percent and core earnings per share growth of 25 percent. With this guidance we shall be reflecting over $0.5 billion in EBITDA on an average net capital investment of $1.6 billion for a cash return of approximately 30 percent. I would now like to hand the call over to Tim Main.

Thanks, Forbes. It is pretty clear we are on a very solid growth trajectory. For perspective, we make the turn of the second half of the year with revenue for the 6 month period already exceeding what we posted for all of fiscal 2002. Our earnings for the first 6 months are already 22 percent higher than we earned in all of 2002 with margins of return on invested capital continuing to rise. Jabil's 10 year compound annual growth rate in revenue, operating income and earnings is above 25 percent, placing us in the top decile of S&P 500 companies. Our operating income and EPS growth have been above this 10 year trend line for fiscal years 2003 and 2004 and we expect fiscal 2005 to be as well. In fact, we have every reason to believe fiscal 2006 will get off to a great start on this trendline. With this perspective it would be absolutely impossible for end markets alone to be driving this growth. The S&P 500 average annual growth rate is under 10 percent and technology end markets have been stable but muted since mid-calendar 2004.

I've read a number of analyst reports in recent months speculating on large-scale new business wins. While I applaud analyst diligence to get to the bottom of our growth story I think the big event orientation is well intentioned but misleading. A single 200 to $400 million program would move our needle less than 5 percent and take multiple quarters to ramp into full production. Further more, we cannot talk about individual customer programs or business plans. The reasons for this are obvious, inconsistent with our past policy regarding disclosure. However, we do understand the need for additional insight to the sources of our growth. Please turn to Slide 13 and we will try to help you with that. Here we dramatically display the sources of growth for fiscal 2005. The categories are expressed as a percent of fiscal '05's year-over-year revenue growth of approximately $1.25 billion. By far the primarily contributors are vertically integrated OEMs converting to an outsource model. The secular trend to outsource manufacturing continues to underpin growth. For example, in fiscal 2002 the instrumentation and medical sector and the consumer sector combined were less than $500 million in revenue.

For fiscal 2005 we expect these segments to represent approximately $3.1 billion in total revenue. These segments are densely populated with customers going through the conversion process. The next largest category is what we characterize as vendor consolidation. Theses are customers with an existing outsource manufacturing strategy now electing to reduce their supply base to a few strategically positioned providers. New customer contribution makes up a fifth of our growth. These are customers new to Jabil in the past 4 to 5 quarters. We expect our Varian acquisition to contribute approximately $100 million and this will represent all of the 6 percent growth we expect from acquisitions. And finally the smallest contributor at 4 percent is everything else including end markets. We have provided some additional highlights regarding the sources of our growth at our upcoming analysts meeting. However, we do see a continuation of growth into fiscal 2006 from all sources. Beth?

Operator, we're ready for our question and answer period.

At this time I would like to remind everyone in order to ask a question please press star then the number one on your telephone keypad. If you are using a speakerphone please pick up the handset before asking your question. We will pause for just a moment to compile the Q&A roster. Your first question comes from the line of Brian White. Please be sure to pick up your handset before asking your question. Mr. White you line is now open. Please proceed with your question.

Good afternoon. Could you talk a little bit about margins in the quarter? It seemed like, you know, gross margins down ticked a tad. Operating margins also decreased and were kind of at the lower end of your range. Can you talk about some of the dynamics there, because I know the consumer business showed pretty significantly so I would think that would help your margins a bit.

Actually, you take a look at our operating margins and consumer was actually a little bit stronger than originally forecasted. So there is some mix contribution happening there from consumer. It was a more -- on a year-over-year basis comparing fiscal '04 the second quarter to the second quarter of this year there was really a more normalized seasonal ramp down. There was unusually more robust Q2 last year and then if you look at the sector that we are moving -- quarter that we'ver moving into Q3 is a very, very strong revenue growth quarter. So we are really keeping some -- retaining some manufacturing resources in order to hit higher revenue levels in Q3 and Q4.

Okay, fair enough. Can you talk a little bit about what Varian adds next quarter to earnings and then for the entire year?

Brian, it's Forbes. It is like any other customer we are not going to specifically breakout Varian's revenue stream or margin profile going forward. It is baked into the guidance that we have given here. In terms of revenue overall, you know, it is about a 200 to $225 million business a year and we are going to pick up certainly 5 months in this fiscal year.

Okay. Good enough. Thanks a lot.

Your next question comes from the line of Scott Craig with Banc of America Securities. Mr. Greg, please go ahead.

Tim, can I ask a margin question in a little bit of a different way? You guys are ramping a lot of new business as you work into the back half of the year. How much do you think the margins are being impacted by the fact that you are ramping this new business? And then secondly when you look in some of the individual end market segments the instrumentation medical area actually was a little bit worst than expected and the computing segment was a little bit better. Can you provide a little more color around those 2 areas? Thanks.

Looking at operating margins, operating margins are in great shape. Looking at fiscal 2005 based on the guidance we provided operating margins will be up 20 to 25 basis points over fiscal '04. That's a continuation of the trend established in '03 to have operating margins sequentially rise year-over-year and this will be another great year so actually operating margins are in great shape. Instrumentation and medical segment now $1 billion segment, with Varian a 1.2 billion segment. It's going to be a little harder for us to grow it at about 65 percent a year. Quarter to quarter we will see some changes based on semiconductor test equipment, a new customer may be shifting some programs to the right as there might be a design delay here and there. That was a little weaker but no major problems in the segment and certainly looking, aside from Varian, looking for sequential growth in Q3 and Q4 of mid to high single-digits. So resumption of that growth trend.

Your next question comes from the line of Lou Miscioscia with Lehman Brothers.

Thank you. Tim, I do like the chart that you have here about the sources of growth and I know this isn't an easy question, I'm not really necessarily look for guidance. Just looking for maybe a swag. Where do you think fiscal '06 will do? Do you think it's going to be the same type of pie or maybe if you could compare and contrast and give us some thoughts?

I think we will provide that at the analyst meeting the end of the month. We know what it is today, we will get -- we will get some contribution from all sources. It will change a little bit but, you know, the picture is -- the picture is very, very similar.

Okay. Great. Going on to the next one. Some of the -- 3 of the other largest EMS providers are really only getting about, at least currently to my model, about that 4 percent end market growth. I don't know is there not that much new EMS business out there? And I guess, what is out there are you just winning it all?

There is a lot of new business out there. The vertical conversion stuff is all fresh to the space. And I, you know, I would imagine a lot of the guys in our industry are seeing the same type of growth. You know, you look at vendor consolidation and, you know, it -- that includes business that is coming up from -- some customers have 40-50 suppliers. A lot of them are Mom and Pop places so this is not simply tier 1 to tier 1 kind of stuff. This is a collection of business that comes out of the more geographically challenged kind of players in the smaller leagues. And you look at end market, Lou, it is really everything else. We are characterizing it as end markets but with -- with normalized material price erosion, that materials, you know, component prices, normalized erosion of 8 to 10 percent a year and materials comprising 75 to 80 percent of our revenue, end markets really have to grow at 5 to 8 percent just to be neutral. Really there is decent unit volume growth there and end markets aren't in horrible shape. They are actually stable and trending up a little bit. But, you know, with -- with component prices on a normal price erosion trend, you know, you got to grow that pretty fast to stay neutral. Thankfully there is lots of vertical capacity out there. The penetration rate we estimate is still, you know, less than 30 percent so there is a lot of vertical capacity through yet.

Okay. Great. Just a -- Soleskis[ph], Solectron and Sanmina all have about 4 to 5 percent top-line growth expectations from the analysts out on the street for '05. Thank you.

Okay.

Your next question comes from the line of Steven Fox with Merrill Lynch. Please be sure to pickup your handset if you're on a speakerphone. Please go ahead.

2 quick questions. First of all when you look out to the new business wins over the next 12 months is there any area that you think is dominating from an end market or from a conversion standpoint? And then secondly, just real quick, Forbes if you have the off balance sheet receivables number at the end of the quarter.

Sure, let me give you that number. It's consistent with the last couple of quarters actually. It's $120million.

On the conversion side, the 2 segments that we have done the best in in that space are the instrumentation and medical segment and the consumer segment which really puts -- given those are really primarily vertically integrated segments. Having said that, I think computing and storage could have some vertical capacity that could convert to an outsource model and I think the automotive segment continues to be a very interesting space for us to play in.

Okay. Thank you very much.

Okay.

Your next question comes from the line of per ras with BMO Nesbitt Burns.

Good afternoon. Tim, a question on the chart you put up. I know you don't -- the vertical conversions you're saying are basically people that haven't outsourced yet. What percentage of the new customers would be people that you are stealing from other vendors. There was a question earlier that said you are going to be growing a lot faster and it is a sense that you may be taking share from some of the other folks? Is there a way that you could help us with that. The second questions is in terms of the Varian business do you see moving a lot of that offshore or from Forbes comments its sounds like you are not going to be moving it offshore and if you are not moving it offshore I wonder if the operating margins on that business that we should continue to see them as strong as they were.

Start with the first part of that, then we'll get to Varian. The new customers are customers that have an existing outsource manufacturing strategy that, you know, are growing and they might be bringing us on as a supplier. If they were -- if they were an existing customer for a long period of time and they were reducing their supply base and we are winning new programs we'd put that into better consolidation. Just to kind of characterize that for you. Some of the divisions can be a little bit arbitrary but this really paints in a big picture sense a picture of where the growth is coming from. On the Varian side, Varian lives in the ultrahigh mix ultrahigh complexity business. There are parts of that business that really can't go offshore. You know, specifically some areas of defense and aerospace, medical customers and I think that we will be able to retain the bulk of that business in the United States. And what the interesting part of Varian is that not only do we -- do we gain some know how in these ultra high mix ultrahigh complexity areas, but we give those customers, and there is not a lot of customer overlap between the 2 companies, we give those customers a grow path for their existing business and other business that they may have wanted to give to Varian but couldn't because Varian didn't have a global footprint.

So you would see the operating -- sounds like the operating margins ought to continue to be as healthy as they were?

Well, I would hope so at least for the areas that are consistent with their past practices.

Well, I mean it doesn't sound like that kind of stuff is going to get the component reductions that networking or telecom does or the kind of simplification that those two segments do or even consumer. Sounds like these are very low volume high complexity and probably even high or longer design cycle things that don't get -- you know, don't get simplified so you don't really get, you know, crunched on the operating margin side. That's what I'm hearing from you. Is that a good characterization?

That's a decent characterization, sure.

Thank you.

Yes.

Your next question comes from the line of Patrick Parr with UBS.

A question about your guidance. You include some pretty strong growth numbers in teleco and relatively weak trends in computing and storage where you did reasonable well this quarter, Just wondered if you could give us a little more color as to why these would be the case.

Let me address the computing and storage. Computing and storage increased 10 percent and we are actually expecting that to come down a little bit. And then it sort of flip flop between the 2 quarters if you will. We just had a particular customer I think, you know, move things forward 90 days so that really covers the computing and storage. Generally in telecom as we're moving into Q3 we are just seeing a little bit of a healthier picture across a couple of customers there, you know, resulting in that 10 percent sequential growth.

Forbes, is it coming more on the infrastructure, I mean wireless infrastructure side or wireline or is it kind of mixed?

We are really not in a position to provide any more color than we have. I think that sector overall is getting a little bit better, I said this on the last call, a little better than people expected. I think that will be borne out this year. I'm not sure if I'm just myopic and all I can see is what's in front of me or that is a broader industry trend. But it looks like that business will be a little more stable than people expected.

A quick question on options in the future with FASB now requiring expensing, does this change anything in terms of your views on compensations expenses or options or things related to that?

We are going to -- we haven't made any final decisions on our compensation approach so we, in terms of the impact of existing options, I think that will be about $0.05 a share, Forbes, in fiscal '06.

That's correct.

We'll take a look at new policies. Certainly it doesn't make sense to award options at the levels that we have in the past and we will look at different vehicles for folks.

Would you, just out of curiosity, would you intend to report another type of pro forma number going ahead or have you given that much thought?

We haven't at this stage, Patrick. We've still got some work to do internally with our board and compensation committee and we'll come to conclusion as we do that over the next quarter or so. One thing I will add to Tim's comments is that we -- we -- we have moved slightly some of our compensation in terms of options and this year actually, as we move into fiscal '05, issued some forms of restricted stock which were expensed and continue to be expensed through these numbers that I'm giving you the guidance for. They are encompassed within this guidance. In that regard we not breaking out numbers separately.

Okay, thank you much.

Your next question comes from the line of David Pescherine with Smith Barney.

Can you start by giving us a sense or quantify what the additional opportunities are with the 18 customers that your bringing over from Varian? Because you've talked about those customers only having a smaller relationship with Varian because they couldn't move offshore. Have you been able to quantify how much is still at those customers?

The transaction has been closed for a few days. And so we are working through those plans. It is unlikely that we will be able to provide you specific customer color. Again, we really are precluded from providing any customer information. I think generally from a big picture standpoint we are very excited about the knowhow that we've acquired and the opportunity to build larger relationships with Varian's current customer base particularly since there is not a lot of overlap and some of the customers actually do have requirements that are much larger than what Varian builds for them today.

I mean, that is the question. Not for any specific customer, but as a group the 18 customers was Varian producing 20 percent of that capacity or were they doing 70 or 80 percent. If you don't have the numbers understood. I would like to go back to the operating margin question because I think that some folks maybe are looking at it a little negatively. It looks like the 20 basis point decline in operating margin year-over-year is really substantially accounted for by your higher R&D expenses as a percentage of sales, that was up about 15 basis points year on year. So, can you talk about the new initiatives maybe in the R&D space over the past year and what impact maybe that is having on new business generation and then the impact it might have on future margins?

Sure. The whole product development and design area, particularly in the collaborative design or CDM activity, has been in a state of explosive growth for the last 24 months. And from a level of 100 engineers a couple of years ago to well over 500 we are now designing and shipping complete products that we have designed in consumer electronics and communications and I think this gives us -- it is unlikely that we will ever break that out the way some of the other guys might in terms of what is a OEM revenue and what is the EMS revenue because for one thing we -- increasingly we won't see much of a distinction between those 2 markets and for another reason collaborative design and kind of the center of the space I think will continue to be the meat and potatoes of our development activity. But it opens up significant new growth opportunities for us. There is an increasing appetite -- in the old days OEMs outsourced the physical manufacturing infrastructure to get people like Jabil and the other guys in our industry to manage their factory and plant resources more efficiently. And now they are outsourcing the development side of their business in order to more rapidly bring commoditized technology into a product and to the marketplace. And so it is a -- it is another phase of outsourcing and you know we are playing in it and developing our skill set there and I think it will be -- represent great growth opportunities for us going forward.

Tim, then, going forward should we expect that that dollar actually scales pretty aggressively over the next couple of years or will it stay pretty stable around the 6 - $7 million range?

I don't think you will see it scale aggressively. I think we are within 0.5 million or $1 million of what we originally anticipated for the year. What you don't see is the amount of -- of development activity that is NRE based and that has quadrupled in the last few years and so there is a $60 million NRE basis behind that 25. So the level of activity is very high. Even though, David, you won't see it ramp up 20 percent a year and that type of thing what you are not really seeing is that it is -- it is ramping aggressively. It is just getting paid for in the collaborative design environment as NRE.

Great. Thanks a lot.

Okay.

Your next question comes from the line of Alex Blanton with Ingalls and Snyder. Please be sure to pick up your handset before asking your question. Your line is now open. Please proceed with your question.

Hello. Tim, on the margin side again, you have indicated exiting the year at 4.3 to 4.6 percent operating margin. Where do you see -- can you breakdown the -- that 30 to 60 basis point change between gross margin and your selling and research expenses?

The gross margins, you know, will be relatively consistent but I don't talk about gross margins because I really don't think they matter. From an SG&A standpoint as we ramp up revenue into the 1.9 to $2 billion range we certainly will not scale SG&A at that rate so we will get additional operating expense leverage there of, you know, 30 - 40 basis points probably.

And the gross margin side that will be driven by what in the second half of the year?

You missed our tutorial from last quarter. I look at gross margins as really a reflection of the relative contribution of materials versus manufacturing value-add. And as we have moved more and more of our production to lower cost locations and as we ramped up business in -- in very competitive areas like consumer electronics that tend to have a very high material content the relationship between materials and value-add has changed for us so the material content in our revenue stream has increased for those 2 reasons. The ramp up of commoditized industry segments and the move of production to low cost locations. That said -- and that will make gross margins decline just -- just as a function of how much manufacturing value-adds in our cost. At the same time, though, we are controlling SG&A expense and profitability or the pricing in the marketplace has been relatively stable, giving us the opportunity to leverage operating expenses to a lower level percentage of our overall revenue. And so on a year-over-year basis last year and fiscal 2004 operating margin was 4.17 percent. And like I said this year nearly 20 basis point improvement in overall operating margins is very -- is very doable for us.

Okay. Thank you. One more thing on the collaborative design I suppose you saw the Business Week cover story on that? And Jabil and most of the other traditional EMS companies were not included in that article. But I would assume that you feel that you are doing as much as other people relative to your size or in that space or do you expect to -- to ramp it even stronger in order to catch up should you feel like you are behind?

Well, I think it is -- in some ways it is comparing apples and oranges because there are -- there are -- ODMs in the space today are really product companies and we are a service company that develops products and I think there is a big difference. And when you do collaborative design it really is annoying and irritating to the customer to see you out there bragging in the press about what a great job you are doing. So I think you can expect us to continue to have a relatively low profile from a publicity standpoint about what we are doing there. Customers need to feel comfortable in sharing their IP with us and sharing their product plans with us and not have us out there blabbing about it to the street, hamming it up in magazine articles. I think it's a great question. We are ramping this area of our business very rapidly. Like I said to David, it's an area that what you're seeing is 20, $25 million in R&D expense. But behind that there's another 60, $70 million of stuff that's getting paid for that you are not seeing. And that's actually more than a 4 fold increase over the last few years. So it is a rapidly growing area.

Okay. Thank you, Tim.

Okay.

Your next question comes from the line of Shawn Severson with Raymond James.

Tim, I was just wondering if you could give a little more color on the type of deals that you see going forward. I know you have been very successful at winning kind of the singles and doubles and stuff that you mentioned. They're not needle movers. If you do look out in the landscape there what do you see as far as big deals and the opportunities out there and what type of deals do you think they -- that would interest Jabil?

You know, I -- Shawn, I think there are some deals out there that are interesting that the type of activity -- you know, the pipeline of potential deals out there is okay. But it -- there is always stuff out there and we look at those and we will continue to be selective the way we have been in the past. I don't think you should expect our behavior to change. I think that we will try and modify our appetite depending on how much we can really consume. So when you are growing the business organically at 20 to 30 percent, biting off too much more could actually upset the performance applecart. We still believe that performance and execution is the foundation of our business, the foundation of success in our industry.

And that rate is perfectly sustainable in your mind without doing any large -- large-scale stairstep type deal?

That's right. When I look at the business I look at a 20 percent growth rate as the baseline. I think there is a baseline opportunity to grow year-over-year at that rate and then depending on how we do with acquisitions, new deals, that kind of stuff, it can -- it can improve from there.

Okay. And then --

You're looking at a couple of year time frame.

And lastly, do you have a number today of percentage of your business that is complete system build?

No, we don't. We don't break that out.

Thank you.

Okay.

Your next question comes from the line of Thomas Hopkins with Bear Stearns.

Good afternoon, Tim, Beth, Forbes.

Hi.

Tim, so just to kind of summarize here as we stand, as we sit here March 17th if you strip out all of your outsourcing and Varian and your acquisitions and you look here into the May quarter and the August quarter, is the core growth accelerating, decelerating or staying the same?

I'm not sure what you are stripping out.

Well, let's say if we take out Varian for example or any other meaningful new outsourcing ramp and just look at kind of your core growth from -- your baseline from the November quarter, are you more optimistic? Are you kind of the same sentiment or are you at a worst sentiment in terms of the baseline growth?

Well, not to be contentious with you but you can't strip everything out because big vertical conversion outsourcing is part of the whole story so I can't strip that out. If you looked at the second half of the year, just trying to be specific with you, the second half of the year our overall if you took the -- the previous guidance of 7.2 to 7.4, took a mid point of 7.3 the current guidance at 7.5, that is a $200 million upside to revenue. About half of that is coming from Varian, which means that in the -- in the final 2 quarters of '05 we are adding $100 million of -- of quote upside end quote revenue and from that perspective growth is accelerating and I think as we -- you know, that gives a very nice platform to continue that acceleration in '06.

Great. And then just a quick housekeeping question with Forbes. The other interest expense quarter to quarter, can you talk about the change there?

The other interest expense --

I'm sorry the interest expense net.

The net number, yeah. It was slightly lower than, what, $300,000, something of that nature, and it's really on the higher average cash balances during the quarter. In our cash balances we ended the quarter what 780 million previously 620 million. So it's overall about another 100 million average carried during the quarter.

And do you have any currency changes in that line item or -- ?

No, no. Currency was pretty consistent throughout the quarter, actually.

Great, thanks.

Thanks.

Your next question comes from the line of Bernie Mahon with Morgan Stanley.

Hi, good evening. A question in the handsets. You were ramping a new program and I believe the second part of that was supposed to be ramped in the May quarter. Is that going to be complete then as we exit kind of the May quarter or is there still going to be kind of additional programs or lines there?

We didn't provide any of that detail. You know in terms of how it -- you know, things phase or anything. Consumer electronics, looking at that as a segment, is populated with white goods, handsets and home electronic type of stuff. And you know this year it will be $2 billion segment. I think we will get growth from all sources. And we are not in a position to discuss specifically any individual programs.

All right. And then just on Varian. How much inventory did you acquire there?

I believe, again it is only a few days old, I believe it was around about 40 to $50 million. Something of that nature.

All right, thanks.

Your next question comes from the line of Michael Walker with First Boston.

Thanks. If I could ask one more question on the margin front. Your guidance does imply a pretty hefty bump in margins in the second half. Obviously we know Varian is accretive to your margin structure but my question is is is all of that margin increase attributable to Varian or do you expect your organic margins to increase as well?

No, it really isn't all that huge of a jump. We did 4.41 percent operating margin in Q1, that's on $1.833 billion of revenue. And we are looking at revenue levels above $1.9 billion in Q3 and Q4. So just out of, you know, getting back to a Q1 level and then some capacity absorption and efficiency and using capacity and expenses that we put in place all year for the back half of the year will provide some margin lift and then Varian helps -- helps as well.

Okay. And my second question is on slide 13, I needed some help understanding it a little bit. You have new customers at 20 percent and you also have market share, vendor consolidation and new outsourcing. I guess, can you define for me what exactly is a new customer that is not either a vendor consolidation or a vertical conversion, i.e. how can you have a new customer that's not either market share win or a new outsourcing customer.

Well, vendor consolidation doesn't mean market share win.

Okay.

It means it is an existing customer that we have had for longer than 4 to 6 quarters.

Okay.

That has specifically made the effort to reduce their supply base and that is where the incremental revenue is coming from. In new customers what we are talking about are new customers to Jabil that we have obtained in the last 4 to 6 quarters, roughly. And although some of that could be vendor consolidation I've elected to put that in new customers because they are new to Jabil. They could be customers that had 8 suppliers and they still have 8 suppliers, it's just that they've changed one out that they didn't like or could be a new customer that is growing has 3 suppliers and needs a fourth. That kind of thing. That kind of thing.

Got it. Thanks a lot.

Okay.

Your next question comes from the line of Jeff Rosenberg with William Blair. Please remember to pick up your handset before asking your question. Your line is now open. Please proceed with your question.

I will use the source as a growth chart, too. Tim, if you were going to look at roughly half of your business that represents traditional EMS computing and communications, how different would the chart look? Would you still see a fair amount of vertical conversion there or are you really heavily weighted to vendor consolidation and new customers there?

Sorry, could you repeat the first part of that. I lost it. It was a little garbled.

I was asking about if you use the sources of growth chart and you focused on the half of your business, or thereabout, that is the traditional EMS markets of communications and computing I'm wondering how different the picture would look?

All right so computing and communications now makes up about 40 percent of our business. I believe. And would it look a lot different?

Yeah, is there still much vertical conversion opportunity there or are we really looking for -- ?

Well, there is less because they are more mature industries in terms of their outsourcing although there are significant opportunities in computing and storage to get vertical space. So I will use an obvious example is a flex deal with Nortel. If that were to happen I would consider that to be a vertical conversion as opposed to a vendor consolidation or a new customer kind of thing. There are pockets of capacity that are vertical today that are still eligible to be outsourced even in these mature markets. But again, having -- just looking at instrumentation and medical and consumer electronics -- I'm sorry to keep going back to those but they are very, very easy examples. Under $500 million in 2002, $3.1billion in 2005. So from a vertical conversion standpoint there is still a lot of capacity there.

And --

We're trying to win business in all of the segments, though. Want to stay diversified.

Well, and maybe ask differently, if you look at that 40 percent of your business do you think when you think about that 20 percent baseline growth rate is that achievable in that 40 percent as well, do you think? Or how much less would you feel like you expect that 40 percent that traditional segments to grow?

I don't think I can answer that because I don't know. I haven't analyzed the numbers and I'm not sure. It might be useful to you but I'm not sure if it's useful to our story because we are a diversified Company today and about 60 percent of our business are in those other markets and so whether or not that 40 percent can grow at the same rate the other of 60 percent can I'm not sure is useful or relevant to investors because the full picture is very strong.

Okay. Thanks.

Operator we have time for one more question tonight.

Your last question comes from the line of Jesse Pichel with Piper Jaffray.

Forbes, you were clearly disappointed with turns in your fiscal Q1. I would like to know what specific actions you took and what your outlook is for turns in the second half? And Tim, if I could follow-up with a question there is do you have customers lined up for the new China and India facility? And if not, how do you manage that process of ramping up business without hurting your overall margins?

Hi, Jesse, this is Forbes, I'll address the inventory one. This quarter we did a great job. $75million out of inventory. Kudos to the operations teams there. You know, a number of initiatives, you know , I will not bore you with them all but some good tractions and initiatives we got underway. Obviously we burned off some of the consumer inventory that was on hand at the end of the quarter. And that, you know, the consumer demand continued, you know, relatively healthily excuse me, in through December. So overall, you know, really good job, really pleased with that and as we lean into sequentially up 10, 12 percent quarter, you know, the numbers, you know, look actually even better than the raw dollar number there and in fact if you look year-over-year, there's an additional $200 million worth of revenue there which was basically being produced off the same inventory base, if you will. It's almost dollar for dollar if you go back and look at that. So, you know, really pleased with that. As we look out and towards the back half of the year, you know, we do have this sequential growth and in double-digit sequentially growth as we move out.. I think there is opportunity towards the back half of the year to -- to ease that into 10 turns so, you know, very optimistic in that regard. The second part of your question related to new customers in China and India and I'll let Tim answer that.

The long polling [ph] attempt with regard to capacity expansion. Our buildings they really have to decide about 18 months in advance. Having said that, building expense makes up a very, very small of our cost of goods sold. One of the more immaterial line items. It is really what goes inside of the buildings that matter from a capacity standpoint in terms of an expense level and we can match those -- we can match those in -- essentially contemporaneously with the advent of business. The lead time for [Inaudible] equipment is 4 to 8 weeks depending on the gear that we are buying and we can hire people pretty much when we know the demand is there. And just to put things in perspective, 3 factories may sound like a lot but we have 41 sites around the world. It is less than an 8 percent increase in capacity. We're clearly leaning into a very strong growth environment so I don't -- we don't feel over exposed from a capacity standpoint.

Great, thank you very much.

Okay. Thank you.

Thank you, operator. This concludes our call.

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