捷普科技 (JBL) 2006 Q3 法說會逐字稿

At this time I would like to welcome everyone to this Jabil earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Beth Walters, Vice President of Communication and Investor Relations. Please go ahead, ma'am.

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

During the course of this conference call we will make forward-looking statements including those regarding the anticipated outlook for our business, our currently expected fourth quarter and full fiscal year 2006 results, our first quarter fiscal year 2007 revenues and core operating margins, and our long-term outlook for our company, our industry, our business sectors, and our potential realignment of our manufacturing capacity and the related costs and timing. These statements are based on current expectations, forecasts and assumptions involving risks and uncertainties that could cause actual outcomes and results to differ materially.

These risks and uncertainties include but are not limited to fluctuations in operating results, the results of the review of our past stock option grants being conducted by a special committee of our Board and governmental authorities, the accuracy of the stated dates of our historical option grants and whether all proper corporate and other procedures were followed, the impact of any restatement of financial statements of the Company, or other actions that may be taken as required as a result of such reviews.

Risks and costs inherent in litigation, included that related to the Company's stock option grants or any restatement of the financial statements of the Company, whether we will realign our capacity and any such activity will adversely affect our cost structure, our ability to service customers and labor relations, our ability to effectively address certain operational issues that have adversely affected certain of our U.S. operations, changes in technology, competition, anticipated growth for us in our industry that may not occur, managing rapid growth, managing any rapid declines in customer demand that may occur, our ability to successfully consummate acquisitions, managing the integration of businesses we acquire, risks associated with international sales and operations, retaining key personnel, our dependence on a limited number of large customers, business and competitive factors generally affecting the electronic manufacturing services industry, our customers and our business, and other factors that we may not have currently identified or quantified and other risks, relevant factors and uncertainties identified in our annual report on Form 10-K for the fiscal year ended August 31, 2005, subsequent reports on Form 10-Q and Form 8-K and our other securities filings.

Jabil disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events, or otherwise. As previously announced, the Company's Board of Directors has appointed a special committee of the Board to review the Company's stock option grant practices in response to a derivative lawsuit filed concerning stock option grants. This special committee of the Board is in the process of conducting its investigation and analysis of the claims asserted in the derivative action. Subsequent to the filing of the derivative action the Company was notified by the Securities & Exchange Commission of an informal inquiry concerning the Company's stock option grants. Jabil has since received a subpoena from the U.S. Attorneys office for the southern district of New York requesting certain stock option related material. The Company is cooperating fully with the Board special committee, the SEC and the U.S. Attorney's office. However, because this is an ongoing investigation, we cannot comment further at this time and will not be taking questions on this matter during the call today.

So turning to the results for the quarter, please turn to slides 2 and 3 if you're following along with the slide show posted on the Jabil website. Results for our third fiscal quarter of '06 on revenues of 2.592 billion our GAAP operating income increased 6% to $77.3 million. This compares to 73.2 million in GAAP operating income for the same period in the prior year. Core operating income, excluding amortization of intangibles and stock based compensation for the quarter, was 93.4 million or 3.6% of revenue. As compared to 87 -- excuse me, 84.7 or 4.4 for the same period in the prior year. Core earnings per share were $0.36.

On a year-over-year basis, the quarter represents a 34% growth in revenue and a 9% growth in core operating income. On a sequential basis revenues increased 12%, core operating income declined 3%. As announced last week the decline in core operating income was driven primarily by operational issues within our repair and electromechanical services operations and certain operations in the Americas regions. We will provide further update to the resolution of these issues on today's call.

Please turn to slide 4 for a discussion of results of the quarter looking at revenue by sector. Our third quarter revenues were towards the upper end of our previous guidance which was an increase of 12% from the second quarter. Production levels in the automotive sector increased 13% from the prior quarter reflecting higher than anticipated demand for assemblies in Europe which was offset by lower than expected U.S. volumes. Computing and storage sector increased 9% from the second quarter as a result of higher production levels than forecast. The consumer product sector increased 24% in the quarter from the seasonally low second quarter.

This growth reflects a ramp of existing and new products with our two largest customers in this sector. Instrumentation and medical sector increased 20% from the second quarter reflecting the ongoing growth of assemblies across multiple customers in this sector.

The networking sector levels of production decreased by 21% from the previous quarter. This decrease reflects the result of our partnering with one of our communications customer in a new lean manufacturing initiative. The peripheral sector increased by 11% over the previous quarter. The telecommunications sector decreased 10% sequentially reflecting the end of production for Lucent. Excluding this sector -- excluding this, the sector actually increased 15% as compared to the second fiscal quarter.

If you could please turn to slide 5. Our sector information for the quarter in percentage terms was as follows--automotive, 5, computing and storage represented 12%. The consumer sector represented 38% for the quarter. Instrumentation and medical was 18%. The networking sector was 9%. The peripheral sector was 8% for the quarter. Telecom 6% for the quarter. And our other category represented 4% of revenues for the quarter.

As a result of the lower than expected income levels from our operations in the United States and western Europe, the tax rate on core earnings on a year-to-date basis fell from 16 to 15% at the end of the third fiscal quarter. This has resulted in a year-to-date true-up in the reported quarter or a tax benefit of approximately $3.6 million. The tax rate on core earnings for the fourth quarter and full fiscal year is estimated to be 15%. I will now turn the call over to Forbes Alexander.

Thank you, Beth. I will ask you to please turn to slide 6. The Company's sales cycle in the third fiscal quarter is consistent with that of the previous quarter at 19 days. Inventory turns for the quarter were 8. In absolute dollar terms inventory increased in the quarter by $240 million. Of this increase approximately 49 million is associated with our partnering with one of our communications customers in a new lean manufacturing initiative. The $50 million is associated with the acquisition of Celetronix completed during the quarter. Along with the prepositioning of inventory for our continuing strength and demand in the upcoming fourth fiscal quarter. On a comparable basis to last quarter, inventory turns were consistent at 9.

Day sales outstanding improved by 2 days as compared to the end of the second quarter to 40 days. accounts payable increased by $259 million, an improvement of two days as compared to the end of the second quarter or 67 days. Our return on invested capital was 16% from the quarter as compared to 18% from the same period in fiscal 2005.

Please now turn to slide 7 and 8. Cash and cash equivalents were $855 million as compared to $919 million at the end of the second quarter. The cash balance is net of the $150 million of cash used to acquire the Celetronix operations during the third fiscal quarter. Cash flow from operations was approximately $120 million in the third quarter or 22nd consecutive quarter of positive cash flow. On a year-over-year basis we continue to maintain efficient control in capital deployed while increasing our revenues and operating earnings. Our capital expenditures during the quarter were approximately $64 million. Fiscal year-to-date capital expenditures are approximately $184 million. Depreciation for the quarter was approximately $44 million. Amortization was $7.3 million. EBITDA in the quarter was approximately $137 million.

In the first nine months of the fiscal year, we have generated approximately $270 million of operating cash flow while growing the business at 33% over the same time period. As we move into the final quarter of the fiscal year and beyond, we continue to be well positioned to generate incremental operating cash flow. Based upon the strength of our current and expected future annual cash flows, and as a commitment to working capital discipline, we announced the quarterly dividend on May the 4th, 2006, of $0.07 per share. This was paid on June the 1st, 2006. We are extremely well positioned to produce operating cash flows in excess of our investing activities in fiscal 2006.

I would now like to turn -- to make some comments with regards to our operations. As we announced last week, our operational execution in the quarter did not meet our expectations. I would like to take a few minutes to provide you more details in the challenges we faced within the operations concerned. During the past year we have been establishing a 100 plus people strong electromechanical tooling operation at our Austrian site. As we discussed in our 2005 analyst meeting, we entered into this tooling capability to support a customer in the production of tools for injection motored parts. We have experienced delays in the ramp-up of production due to resolvable technical issues and management process software. During the quarter the operations were not reimbursed by the customer for the costs associated with this operation.

This operation will continue to incur costs in the fourth fiscal quarter in the range of 6 to $7 million that will remain dilutive to our earnings until such time as we see demand levels flow through for tools. This operation is expected to break even by the end of our second fiscal quarter of 2007 versus a previous expectation of contributing to earnings in the fourth fiscal quarter. This operation is expected to contribute to operating earnings during the remainder of fiscal '07.

Secondly, we faced operational execution issues in certain U.S. operations experiencing strong demand and ramping programs. This resulted in approximately $6 million of lost operating income. We have operational development teams currently reviewing and assisting local management in improving operational processes at these sites. Appropriate management changes have been made, and we expect to have these operational issues resolved within the next two fiscal quarters. However, during the fourth fiscal quarter we expect continued dilution to overall core operating earnings as a result of these issues.

Within our repair and warranty operations in the Americas region, we also experienced approximately 6 to $7 million of higher material and labor costs associated with the ramp of a new program for an existing customer. This program will continue to have operational challenges throughout the fourth fiscal quarter and is targeted to provide appropriate levels of return towards the end of the second fiscal quarter of '07. Within our repair and warranty organization, senior management attention is being directed to these operations with appropriate local management changes having been made. We believe that an appropriate operating margin return for our repair and warranty revenue stream is in excess of our targeted company average. We're committed to returning this portion of our revenue stream to such return levels over the course of the next few quarters.

With regards to acquisitions, on March 31, of 2006 we completed the acquisition of Celetronix excluding its memory business in India. During the quarter we began the process of integrating the acquired Celetronix operations and capabilities in India. We are positioned for continued growth in this region with the additional capability and management talent in India. We welcome our new employees to the Jabil team and look forward to your contribution in Jabil's success in the years ahead. These operations will remain dilutive to earnings in the fourth quarter as we continue to integrate the site into Jabil. We expect contribution to earnings in the first half of fiscal '07.

Turning to capacity, as we've announced in our press release, we intend to realign our manufacturing capacity in certain higher cost geographies. To properly size our manufacturing sites with current market conditions. We will begin this consultation with employees in the coming weeks, seek our Board of Directors approval, and finalize these plans. Out of respect for our employees, their families, and the representatives, statutory and consultation periods required we will not be providing details this evening on specific plant sites under consideration. We currently estimate that the realignment could result in approximately 200 to $250 million of charges which would involve plant closings and headcount reductions. It is currently estimated that a significant portion of these charges would be recorded in the Company's fourth fiscal quarter. The cash costs of such charges is currently estimated to be in the range of 150 to $200 million over the course of the next two fiscal years.

I would now like to turn to business update. I would ask you to turn to slide 9. We estimate our fourth fiscal quarter of 2006 our August quarter to be in the revenue range of 2.75 to $2.95 billion or an increase of 16 to excuse me, 6 to 14% from the third quarter. 150 million -- $200 million of this increased revenue is a result of material pass-through on certain programs where we now retain full ownership for materials and the associated supply chain. Core earnings per share for the August quarter are expected to be in the range of $0.30 to $0.35. Research and development costs are expected to be consistent with the third fiscal quarter at approximately $9.5 million reflecting our ongoing investment in design related programs with existing and new customers. Intangibles amortization and stock based compensation are both estimated to be $8 million or $16 million in total. Capital expenditures in the fourth quarter are estimated to be 60 to $90 million giving a range of 240 million to 275 million for the full fiscal year. As previously stated tax rate on core earnings is now expected to be 15% for the quarter.

Turning to revenue by sector for the fourth quarter I ask you to turn to slide 10. The automotive sector is estimated to decrease by 5% reflecting seasonal lower levels of production. The computing and storage sector is estimated to have consistent levels of production with third fiscal quarter as is the consumer sector with consistent levels of production. Instrumentation and medical sector is anticipated to increase by 5% in the third quarter reflecting the ongoing growth of assemblies within this sector across multiple customers. The networking sector is expected to increase by 100% from the third fiscal quarter. This is as a result of a partnering with one of our communications customers in a new lean manufacturing initiative as advised last quarter. Excluding the revenues associated with this lean initiative, we expect this sector to increase by approximately 15% from the third fiscal quarter. The peripheral sector is estimated to decrease by 5% in the quarter, and the telecom sector is estimated to be consistent with the third quarter.

Please turn to slide 11. As you're aware, our strategy has been and continues to be to position the Company to capitalize on the trend to outsourcing. Fiscal '06 to date has demonstrated this to be the case. We now estimate our revenue to be split as follows across industry sectors we serve. The full year, fiscal '06 automotive 5%; computing and storage, 12%; consumer, 36%; instrumentation and medical, 17%; networking, 13%; peripherals, 7%; telecom, 6% and other 4%. As a result, we're revising our revenue estimates up from fiscal '06 from 9.9 billion to a range of 10.1 to 10.3 billion. Core earnings per diluted share will now be in a range of $1.47 to $1.52. This revised guidance represents a 35% growth in revenues and a 15 to 20% growth in core earnings over fiscal 2005.

Looking into the first fiscal quarter of 2007, we see continued revenue growth and believe we will hit revenues in excess of 3 billion for the quarter. Operating margins should recover nicely and be 4% or above. Despite our disappointment over the near-term challenges, the opportunities of outsourcing continue to be strong. I would like to hand the call over to Tim Main.

Thank you, Forbes. From an earnings perspective our third fiscal quarter was a disappointment. We had achieved an excellent track record of meeting or exceeding our guidance for 22 consecutive quarters. Our intent now is to renew that track record beginning with fiscal Q4. As discussed in our call last week and further by Forbes this afternoon, several issues emerged late in the quarter that significantly impacted earnings. We have identified the issues and are working diligently to rectify those specific issues. We expect to have them resolved over the course of the next two quarters. The issues are not associated with the loss of a major customer, chronic, or widespread nor are they associated with a drought of growth opportunity. We take this very seriously and will correct the issues, but I also think some perspective is needed.

We have growth, cash flow, earnings, returns above our cost of capital and a bright long-term outlook. We intend to rationalize our footprint predominantly in certain high cost geographies. While this may appear to be reactionary to this quarter's results, it is not. We are rationalizing to position ourselves for competitiveness in the next three to five years. In years past customers frequently asked for the low cost production locations to be supplemented by higher cost sites which would execute new product introduction and play the role of global air traffic control. In some case we have maintained high cost sites which were largely dedicated to one or very few total customers. In the past this made sense in the customer relationship and in the overall financial performance of the business.

Today we increasingly see new product introduction, design, and global coordination being done within our low cost footprint. Obviating the need for supplemental high cost locations of port. Under this condition, the financial burden associated with maintaining some of the higher cost locations can no longer be accommodated. We see our high cost locations moving the high customer count, high complexity and configuration services largely supporting industry sectors requiring specialized expertise or locality. Our expectation is that the level of specialization will result in margins accretive to the whole otherwise the investment in location cannot be justified. We remain committed to a well diversified portfolio of industry sectors and believe in the merits of a full scale global footprint. However, we will need fewer high cost locations to achieve our objectives. Our rationalization plan will take some time, but in the end it will simplify the business and make it healthier long-term. The conservative approach would be to limit all of our comments to the past quarter and the next 90 day period. However, we believe this would be misleading and even more unsettling than we should be.

Looking into our first fiscal quarter, we see many reasons to be optimistic. Among them we expect over $3 billion in revenue and core operating margin recovery to 4% or better. This will be a great start to a fiscal 2007 we expect to be another year which will place us among the S&P 500's leading growth companies.

Operator, we're ready to begin the question and answer period.

[OPERATOR INSTRUCTIONS] Your first question is from the line of Steven Fox with Merrill Lynch.

Good afternoon, a couple questions. First of all, just since you've been subpoenad by New York, could you just reaffirm or comment on what you said at the analyst meeting regarding stock options? Does that all stand?

Steve, we can't make any incremental comments as I said at the outset because of the investigation is ongoing, but you can assume that everything we said historically still stands.

Okay. And then with regard to the drags on this quarter's earnings, just trying to aggregate how much of the drag would be gone in the next quarter. Sounds like about a third of it would be gone. Is that fair to say? I am not sure if I did my math right.

Steve, it is Forbes. With regards to the upcoming quarter, fourth quarter, the drag remains approximately the same. Overall we've got our hands around these issues. We'll work those. The range of guidance pretty much assumes that the drag is the same. We'll continue to work diligently through that and we'll see how that transpires as we move through the quarter, but roughly the same.

And then lastly, just regarding the charge, can you just maybe make some further comments about the timing of it? Are you saying that this was planned anyway or are you taking the opportunity now to do it given everything else that's going on in the business?

No, Steve. This is a review of our overall capacity. This is not a reaction to an existing -- short-term hiccup in terms of our operations. In terms of the timing of the charges specifically, it is very much dependent upon the consultation process that we have to go through or that we're undertaking with our employees and the representatives and the approval of our Board, but my expectation is that in terms of the actual charges and how those will fall into fiscal years, we could see anywhere between 50 and 60% of those charges in our fiscal fourth quarter and the balance falling into '07, '08. We'll be in a better position to give you definitive bucketing of those costs on our next call in our September call, but that's my best estimate at this point in time.

Thank you.

Your next question is from Scott Craig of Banc of America.

Hi. Good afternoon. Tim or Forbes, a question on the margins. If you look out beyond the next couple of quarters when you think you have the three issues resolved, is there any reason to believe that margins have been quote, unquote, permanently impaired at all or can we get back to levels that we were at prior to these issues? And then secondly, Forbes, on the restructuring side of things, I know you have thrown out numbers for the charges and the cash charges and stuff, but what's your expected payback on those or another way to look at it is how much cost savings do you think you can generate from those? Thanks.

Let me answer the margin part and then I will turn it over to Forbes for the balance of your question. I don't think there is any permanent impairment of our operating margins. I would expect to see operating margin recovery in fiscal Q1 of '07, and I don't see any reason why we can't operate this business in an operating margin range that we've seen over the last couple of years, and potentially even improve on that record. We'll need to continue to leverage down operating expenses as we have in the past. We'll be approaching 3% operating margins. I am sorry, 3% operating expenses, SG&A expenses over the next few quarters, so you've seen us go from 5.5 a few years ago to 4 and 3.5, and we'll be approaching 3 and as we've always said our long-term objective is to get SG&A expenses down below 3%, operating in the 2.7, 2.8 range.

With regards to the second part of your question, this reassignment we expect to take somewhere in the region of 100 to $125 million of costs out over the time frame of this realignment. Obviously we're not going to enjoy the full benefit of that cost out. A portion of that does get passed to customers. As we move this business or these volumes into lower cost sites, production levels, but, and obviously the Company is going to continue to grow over the next fiscal year and beyond. Summarizing all that, I would say over the next couple of years we're probably looking at a 40 to 50-basis point improvement in the overall operating margin over the next two fiscal years.

Thanks.

Your next question is from Tom Dinges with J.P. Morgan.

Just a quick one to start with for Forbes. Forbes, when you look at the revenue for next quarter that comes through because of the shift of lean manufacturing, the additional that you get there, there is some impact there on the margin because that's just material pass through that's coming through there. Can you quantify that at all if there is some impact on the gross margin side, and then I had a quick one on the segments.

Yes. As you say, that is the straight material pass through. The impact on the margins, I am not the math on that, let's see. It is 10 basis points, something of that nature.

Okay. Quickly, the instrumentation and medical was quite a bit better than you guys had expected, maybe just help a little bit if that was all related to new program ramps or if there is some other things going on there and then just a little bit more color on the consumer side. That was expected to be strong and then expected to be kind of flattish for next quarter just a little bit of color there would be helpful as well.

Instrumentation and medical, yes, we've been transitioned our program into our company over the last two or three quarters, and that really continues to grow the last two or three quarters. That's one of the larger drivers, but we're continue to bring in assemblies into this instrumentation or industrial type opportunities that we've been benefiting from over the course of the fiscal year. So again in summary, it is a general growth in assemblies, but one of the larger drivers has been this program we've been bringing into the Company over the last two or three quarters.

The second part of your question was with regard to the consumer. As we move into the fourth quarter, we do have some transition of programs going on with one of our larger customers in the quarter. That really product transitions some assemblies coming off, new assemblies ramping in the quarter. You often see in the latter portions of the summer remembering that our two largest customers are our European OEMs, somewhat of a slowdown in the July and August time frame as we hit the holiday season in Europe. Nothing extraordinary there, and we do expect a strong rebound as we move into fiscal Q1 and the consumer season.

Okay. Thank you.

Your next question is from Lou Miscioscia.

Okay. Thank you. Tim, with the suggestion for revenue in margins for first quarter of fiscal '07, I guess when we look to the full year of '07, does it look like the number that was the prior EPS number on First Call $0.02? Are you comfortable with that or it sounds a little bit like if we start to reramp margins back up, even from a 4% level, unless it is meaningfully over 4, that probably we have to be a little bit more conservative on our bottom line number for the full year for '07.

Yes, Lou, I am sorry, I can't really give you an opinion on guidance and where you should put it for '07. We'll start providing more specificity around the full year on the next call, but I think a return to trend line type of growth I think is a reasonable expectation. I don't see any reason why fiscal '07 can't be on trend line for the Company overall. It is a trend line that's ten years old and in spite of hitting a rough patch here in Q3 and Q4, we feel very good about how fiscal '07 will turn out and that's why we wanted to give you a little preview into fiscal Q1.

Okay. Great. The next question I guess I have is that when I -- at the analyst meeting I think a program that you've had maybe for about a year now is to try to really fill up these U.S. and European sites with high mix kind of work. Would you say that that really hasn't happened as quickly as you thought and that is then also part of the reason why I guess you're taking this restructuring hit here and maybe if you can mention how many square feet it might affect? And then just one more quick one as a follow-up.

Okay. I don't know about square feet or that type of thing, but in terms of the bearing acquisition that we made for instance, that's a very successful model, that has been very good for our business. I think it characterizes for me the style of manufacturing, high cost locations going forward. As I said in my prepared remarks, high cost locations have generally been a mix of MPI centers, global air traffic control centers for global customers, and in some cases fundamentally, subsidized operations from the global business unit as an accommodation to the customer. And as low cost geographies have become more competent at doing new product introduction and providing their own global support and that type of thing, it is really obviating the need to have particularly repetitive manufacturing, high volume applications coordinated or supplemented by high cost locations. It can all be done in low cost areas. So what we're going to see is I think a conversion of high cost capacity to the Varianesque type of model, and we need fewer sites to do that, and they'll be more specialized, and they should in the end contribute to the Company's margins accretively. That would be an expectation.

Okay. One more quick one, maybe a little bit more on a positive note. Any life kicking in from some of the Japanese OEMs either with new programs or existing programs moving stuff to outsourcing? Thank you.

There has been a lot of great stuff for us going on in Japan both in the automotive and display areas as well as ongoing conversations through our Gotemba facility and our Tokyo office. We would expect to see continued growth with our Japan domicile of OEMs in '07 and in '08, and I am pretty optimistic about how that will go.

And then possibly shifting some work or ramping some work with you all in China?

Yes, that will be principally low cost location production, China, India, maybe some eastern Europe.

Thank you.

Your next question is from Kevin Kessel with Bear Stearns.

Just a question again or more of a clarification on the tooling that you spoke about earlier, Forbes. You were mentioning that this operation is expected to be break even here in Q4 and now it is expected to essentially not happen until the second quarter of next fiscal year. You mentioned that the technically resolvable management software issues, but what else is it here? It sounds like there is less volume than expected and as a result that's why these losses will continue.

I think at this point we should simplify the whole scenario there. The operation has taken longer to ramp than expected. Like any activity, whether it is a tooling operation or a core EMS site, if you install significant capacity head count, and there is a significant delay in the ramp of production you're going to run higher operating expenses than anticipated.

Right.

And so that delay has caused us to experience higher operating losses than anticipated. We expected some reimbursement from customers that will not be forthcoming. At this point we are ramping production in a location. We expect it to continue to ramp in fiscal Q4, in fiscal Q1 of '07, and by fiscal Q2 of '07 begin to reach volumes that will either have the operation break even or contributed significantly to the business. We still think the activity is an important activity in terms of our competitiveness and our position in the marketplace, and we also expect when the operations fully ramp that it will contribute significantly to the profitability of the Company. We expect this is not an accommodation site. It isn't a service or an activity that is a sideline. It is something that we fully intend and expect to be profitable and make money in the endeavor.

Right. So in the end I guess the question people have then is if one point you thought it might be reimbursed and now it seems that's not the case, is that simply because the ramp didn't happen according to plan, and maybe it is something that Jabil is going to fix and work on going forward here to ramp it faster?

There is probably nothing -- and I don't mean this to sound glib or dismissive. There is nothing I could say succinctly that would make a [Expletive] of a lot of sense to you. I think you just have to take it on faith. We're a good company. We engage in contracts and customer relationships that make sense. This is something we didn't anticipate. It surprised us, and at this point we just have to move on. He we have to move on. We're going to incur the losses in '04. If we had to go back and do this all again and we knew that this would have happened, we would have forewarned you and said we're going to engage in some activity that is going to cost us 6, 7 million a quarter in operating income and we're going to take our earnings down because of it but it's going to be great for us long-term. All of that is true except for the fact we didn't expect the lesson to be quite as expensive as it is turning out to be. All of that said, should be profitable in '07 and still an important activity for us.

Obviously the confidence is there that it will be profitable and I assume if at some point it wasn't you would have to make other adjustments relative to that operation?

Yes, we would, but at this point we don't expect that to happen. It is ramping production as we speak.

Right. Just from a big picture, I think Forbes addressed this earlier, that in terms of the restructuring here in the U.S. that the costs and cash costs, that the payback is expected to happen approximately when and I think if I am not mistaken you mentioned that the impact on operating margins are 40 to 50 basis points overtime. Is that correct?

I said 40 to 50 basis points over the next two fiscal years.

Okay.

We require to go through various consultation periods with our employees and their representatives, and that will help clearly a baring on the timing of these actions.

When you look at if from a macro level, operating margin and model for Jabil used to be -- the goal was to get it to 5% and you guys are obviously very close to that. Is that still essentially the goal here, obviously the near term it might be a little lower, but, Tim, I think you just said it was 5% still within the realm here?

I think it is still a realistic target. Unfortunately we've got a few steps to go through, a few more steps to get there than what we wanted to have.

I see.

But a realistic point of view of being back in the 4% operating margin range as early as Q1 '07 I think is reasonable. We'll keep working at it.

Got it. Last thing is you typically give your fiscal year guidance when you report your fiscal year end in September. Is there any expected change to giving fiscal year guidance at this point?

I am not going to promise you that we'll provide full year guidance at this point, and we'll have to make that decision over the course of this quarter.

Okay.

We'll let you know in September.

Thank you.

Okay.

Your next question is from Michael Walker with Credit Suisse.

Got through all of that. One quick housekeeping question for Forbes. It looks like the attorney fee impact was part of core EPS in the May quarter?

Yes, it was. Wasn't overly material, Michael. As I look into Q4 it becomes more material. We're trying to get our arms around that but probably in the range of 1 million to $2 million, something of that nature.

And second question for Tim, can you just talk a little bit about the demand environment right now? I know you made a point right up in the title of the press release that demand is good, but just kind of noticing a couple changes at the end market level where in the consumer business you're going to show looks like a lot lower second half growth than you have the last couple years where as in the communications business you printed an organic telecom increase of 15% I believe in the May quarter, and then you're saying that if you back out the fiscal lean and the August quarter, that part would be up 15% as well, and this is two buckets that have been pretty laggards for you in the last couple quarters. So are you seeing a shift -- my question is are you seeing at all a shift in terms of growth opportunities, demand opportunities away from the consumer area and towards more infrastructural areas?

I think it is a great question, and I am not going to say no, there is no movement away from consumer. I think there will be less reliance on consumer to hit trend line growth rate going forward. We enjoyed a very significant ramp of our consumer business, and in '05 and '06, and networking, communications, computing and storage were kind of sleepy sectors. I think we've done some real good for the Company in terms of our business development efforts and our execution actually in those segments. We've said all along that the communications business is still something that we're very interested in pursuing and supporting, and we have a lot of very strong capabilities in that segment. It isn't that we deemphasized anything or over emphasized anything else. The strategy of the Company is to have a diversified portfolio of growth opportunities that make us less reliant on any particular segment quarter to quarter, year to year, and if we execute that properly, you should see ebbs and tides of -- ebbs and flows in any particular segment in terms of being the hot growth this period, or this quarter, or this year, and you should see other segments pick up the slack.

I think that's what you'll be seeing, and again this is why in spite of kind of the negativity around Q3, Q4, we really have a positive outlook. To have in this environment and really best case a stable to slightly positive end market demand environment, to be growing the business at 35% top line growth, and looking forward into Q1 '07 and seeing the year-over-year growth that's outstanding, all we really have to do is get a couple of these identified issues resolved, identified, put to bed, marched through this rationalization process the best we can and come out on the other side of this with a bigger, better machine that's going to continue to print cash flow at some pretty significant levels, so we actually are very positive and optimistic about quality of our business, the direction we're heading, and when we see things like networking and telecommunications really start to grow again, that gets us even more excited. It is even better opportunities for us out there.

Thanks a lot.

Okay.

Your next question is from Brian White with Jefferies.

Tim, when you look at the different end markets, you look back 90 days ago, what has really surprised you the most in terms of strength and in terms of weakness in the end markets?

For the last year really consumer has surprised me a little bit as how strong it is. I think consistently we have exceeded our initial guidance in the consumer segment. Flat screen TV's and handsets and even set-top boxes have been very, very significant [growthtiples] for us, and so historically that's been the case. Over the last quarter I really don't see any surprises from an end market standpoint.

Okay. Even networking and telecom?

No, because I think some of that -- well telecommunications I think has been a bit -- showing signs of life, and you're seeing that show up with the other guys, too, but that's really more about market share, customer penetration, new customers, more so than -- oh, end markets were growing at 3 to 4%, now they're growing at 20%. It isn't a significant end market change.

And then just when you look at the inventory increase, Forbes, ex the lean and the Celetronix acquisition, the $140 million increase, is that tied to the consumer market or is there a specific market it is tied to?

It is not tied to any specific market. We've given a range of guidance with growth as we move into fiscal Q4 without that additional material pass-through. Some of it is associated with that obviously as we've talked about, but I can't tell you -- I can't say it is specifically consumer or anything else, but a number of ramping programs, across the Company, and instrumentation and medical continue, and then also within consumer I talked that out a little bit earlier where we do have some program shifts going on in that area where typically when you do that you do tend to have a slightly higher levels of inventory as you start to ramp these programs in the quarter, but not specifically tied to any one sector.

Just finally on enclosures, tooling, at the analyst day you indicated you were thinking about opening an enclosure operation. It sounded like it was going to be small in India. Is that still the case and would that also include tooling?

I think what we detailed was a campus capability that would provide the electromechanical infrastructure for products we're building in India, particularly important in India because the electromechanical supply base is relatively under developed, and service logistics are difficult, so it makes a heck of a lot of sense for us to have a campus located electromechanical capability. In the case where we cannot obtain supplier support, we may choose to invest in the activity directly because we must ensure we have onsite electromechanical capability within a very brief distance. That's really what we were talking about. We weren't talking about launching a large scale new activity doing our own enclosures.

Would tooling be part of that?

Theoretically tooling in some cases would be part of it although that would not be an early investment. That would be a potentially a little later down the road. We would certainly specifically identify any ramp associated with that tooling capability and incorporate that into our views on the market.

Okay. Thank you.

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

Tim, I have a bigger picture question for you. Given all the issues you're dealing with, the three operational problems in the quarter, the option controversy and now the big restructuring, are you concerned about management being distracted from running the core business and continuing to grow the Company over the next few quarters? Are there any operational changes that you're putting in place to help manage this?

Yes, it would seem that the number of issues that we deal with, they all have happened within a four to five-month period would be, chances of that would be at least a million to one, and so we're dealing with a lot of things at the same time. I have been -- I have been enthralled and captivated and motivated by the looks I see in the eyes of the management team and their commitment to ensure that we get the train, the Jabil train back on the rails, moving the direction we want it to move. The level of commitment is so high and so dedicated, that it is very heartening to see, and again we're not dealing with the business that's shrinking. We're dealing with a business that is growing very rapidly.

Of all the challenges that we have as a business and every business has its challenges, chief among them is accommodating 35% top line growth on a global footprint, and we talk a lot inside our company about let's stay focused on the core business. Everything else can take care of itself. What's happened with the options and investigations and everything, I have said everything I can say on that. You can go back and look at press releases and what we said at the analyst day. That's done with. We need to put that in the past. That will take its own time, its own course, and management has no control over that whatsoever. All we control is the business. Fundamentally the business is in good shape because the operational issues are not chronic. They're not widespread. They're resolvable, and we have customer satisfaction in reasonably good shape, and a great global footprint and a great reputation, and we're going to go out and capitalize on that and make fiscal year '07 a great year.

Okay. Great. And then could you tell us how many management changes you've made as a result of some of these issues that you're dealing with?

There is planted level management changes, and there has been three to five management changes at a plant level, execution level.

Okay. Thanks very much.

Okay.

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

Tim, one more question on the restructuring. The plant that has been the problem, you said strong demand there. Is that going to be part of it?

Again, out of respect for people, their families, and statutory requirements and the need to consult with counsels, we are not going to identify or even imply any operations that might be affected, and I am not trying to dismiss your question. That's just all we can say at this point.

Okay. Let me put it just another way. Resizing the U.S. or the high cost areas implies that you don't have enough demand to fill the plants up, but this particular plant that where there is an execution problem, what is the capacity utilization there? It sounded as if that particular plant is full, and why would it be so unbalanced in the U.S. for example to have one plant really full and the other ones being restructured?

You can have significant ramp-up of new businesses that you underestimated the complexity. You had poor material procurement practices. You didn't follow the Jabil cook book in terms of following the recipe of launching new programs. It could be misprice, misquota, there is a whole range of potential execution pitfalls that confront a fully loaded operation as much as they confront a poorly loaded operation. Again, this rationalization process Alex is really two different things. One is not a result of the other, and I think to some extent we're taking an opportunity here given the environment we're in to be a little bit proactive, but I think the role and responsibility of our high cost locations has been changing, will continue to change, we need to position the Company in the right way to compete in the next five years, and the role of a high cost location when you go through all of our sites and what they're really doing and I think we need to be more affirmative in having them be again I use this word Varianesque in their approach versus doing favors for high volume customers that are principally produced in low cost locations that no longer need new product introduction and air traffic control in the global context. You just don't do that in high cost locations any more. We need fewer sites.

I think you've done a pretty good job of explaining that. I would like to shift briefly to the lean program at Cisco. You mentioned a figure, and I didn't get it. The amount of additional material pass-through in the quarter. Was it 100 to 150 million, was that it?

Alex, it is 150 to 200 million end of fiscal fourth quarter.

150 to 200 million. That is items that previously were on consignment?

That's correct, yes.

Now they're going to turnkey.

Correct.

That's responsible for most of the increase? That's a very large amount. Your total revenue with Cisco, then, as a percent of your sales are going to go up a lot I would guess based on this.

Well, on an annualized basis, yes, the revenue stream would increase anywhere between the 600 to 800 million depending on demand levels.

Right. Okay. And you're not making very much margin on that. Someone mentioned that before, right?

Yes, that's dilutive to margins. It is one of the pressures that we have in terms of getting on this back on this track to 5% truthfully is that we have a lot more material content in our revenue stream. It is not indicative of anything other than that.

Okay. And finally, it has been said that the Cisco lean program will involve pushing inventory back to the EMS companies. How much of the inventory increase that you expect or have had will result from that and won't that eventually go away because isn't Cisco's intention to install a pool system in which everybody has lower inventory? Isn't that the idea here?

Forbes wants to answer that question, but first I want to make very clear to everybody on the call that we're not talking about Cisco.

All right.

We're talking about a customer that's going through a process with us.

Okay.

Okay. Go ahead, Forbes.

Associated with that process we brought about $50 million onto our balance sheet at the end of the quarter was just reported.

Okay.

As we move through the fourth fiscal quarter, I would expect somewhere in the range of 50 to -- another 50 to $100 million of inventory to be added. I would also state that there will be an appropriate equal and offset payable so there won't be any actual expansion of working capital, but you will see an expansion in absolute dollars and inventory. To your point, Alex, about this process and it moving to a pool type basis, yes, that is the ultimate intention. I think it will take a quarter of two which I outlined on last quarter's call for that process process really to bed itself down. You have got inventory we're bringing on, and it has been in place, that will be consumed. We will take control of the supply chain and manage that process from here on out, and you'll see efficiencies in that. But it will take somewhere between one and two quarters to work our way through that.

Eventually this bulge here will disappear is what you're saying?

That's correct, yes.

That's the idea.

Yes, yep. More efficiently right through the supply chain, yes.

Thank you.

Operator, we have time for one more question, please.

Yes, ma'am. Your last question is from Shawn Severson, Raymond James.

Thank you. Good afternoon. Tim, could you just talk a little bit about what happened on a controls basis? A lot of this happened late in the quarter and obviously was a surprise and I understand some of it sort of 11th hour activity. Was it something that was missing in terms of the constant feedback throughout the quarter or are these things that are nearly impossible to figure out until things are rolled up in the final numbers?

I don't think we have significant or material weaknesses in our controls. Clearly we were surprised by it, and therefore by definition I would have to admit we should have known about it earlier, and we are working on our business planning process internally, we're getting back to good kind of dashboard type of discipline to make sure that we're aware of what's going on through all of our operations and what the financial impact will be, so we are taking this as a bit of a wake-up call to get back to basics, but in terms of being out of control in a chronic widespread way, absolutely not. Absolutely not.

Maybe is it more of a human input error? Is that what we're talking about in terms of what people were feeding into the machine, I guess, if you want to look at it that way?

There was an error somewhere, yes.

Shawn, these issues are operational, be it through inefficiencies, through operational processes, be that through yields or just poor planning of material, expediting material into plants and such like in terms of freight costs, and some of those are pretty difficult to get one's arms around. You're in a firefight if you will in terms of an operational scenario, so it is certainly not a widespread epidemic control failure by any means, were very much three isolated instances. We have got our arms around them. Management's attention is focused there, and we will put these to bed in the next couple of quarters and move forward.

Can you explain to me how a typical repair and warranty contract is structured? How does it work and the length of term and renegotiation ability and all of that? Thank you.

Yes, that's changed over time, and I don't really think I can get into all the nuances of the contracts and that type of thing. It is not really a contract issue. It is more of an execution issue and a model change in a new program, and that kind of speaks to the late notice that something was awry, something that ramped during the quarter and got worse as the quarter moved along, and I will just leave it at that. Again, these are issues that we'll be working through in Q4 and Q1, looking forward into a very robust strong Q1 from a growth stand point, and a nice recovery in operating margins as well, so I think the overall tenor of the management group is very optimistic about our outlook in '07 and we'll work through these specific issues as diligently and as rapidly as we can.

Thank you.

Thank you, everyone, for joining us today. Again, the playback will be posted on the Jabil website available for -- available on the Jabil website along with the slide show presentation and press release. Thank you for joining us today.

Thank you. This concludes today's conference call. You may now disconnect.