JABIL INC quarterly report, Q3 FY2012

Jabil Circuit, Inc. — Fiscal 2012 Third-Quarter Form 10-Q

Business context and reporting period

Jabil Circuit, Inc. provides global electronics design, manufacturing and product-management services across diversified manufacturing services (DMS), enterprise and infrastructure (E&I), and high-velocity systems (HVS). The unaudited report covers the three and nine months ended May 31, 2012, compared with the corresponding 2011 periods. Jabil operated in 29 countries, with foreign revenue representing 84.4% of quarterly revenue and 85.7% of nine-month revenue.

Financial performance and position

Metric	Three months ended May 31, 2012	Year-over-year change	Nine months ended May 31, 2012	Year-over-year change
Net revenue	$4.251 billion	Up 0.6%	$12.814 billion	Up 4.7%
Gross profit	$329.3 million	Up 3.4%	$991.5 million	Up 7.1%
Gross margin	7.8%	Up from 7.5%	7.7%	Up from 7.6%
Operating income	$156.6 million	Up 2.7%	$477.7 million	Up 15.6%
Net income attributable to Jabil	$101.3 million	Down 3.2%	$311.9 million	Up 16.9%
Diluted EPS	$0.48	Up from $0.47	$1.47	Up from $1.21

Quarterly operating margin was 3.7%, compared with 3.6% in the prior-year quarter; nine-month operating margin was 3.7%, compared with 3.4%. Quarterly net margin was 2.4%, compared with 2.5%, while nine-month net margin was 2.4%, compared with 2.2%. The quarterly effective tax rate increased to 21.2% from 17.6%; the nine-month rate declined to 20.5% from 21.4%.

DMS revenue increased 22% in the quarter and 28% for the nine-month period, while E&I revenue declined 4% and 1%, respectively, and HVS revenue declined 20% and 15%.
Core operating income, a non-U.S. GAAP measure, increased to $190.3 million for the quarter and $561.1 million for nine months, compared with $177.8 million and $528.0 million, respectively.
Core diluted EPS was $0.64 for the quarter and $1.86 for nine months, compared with $0.58 and $1.72, respectively.
Cash and cash equivalents were $742.1 million at May 31, 2012, down from $888.6 million at August 31, 2011. Total assets were $7.373 billion and total equity was $2.016 billion.
Inventory increased to $2.377 billion from $2.227 billion at fiscal year-end, primarily to support transitions of new program wins. Days in inventory increased to 55 from 54 in the prior sequential quarter.
Nine-month operating cash flow was $191.5 million, down from $524.4 million. Investing cash flow was negative $403.8 million, including $291.8 million of capital expenditures and $125.1 million for the Telmar acquisition.
Nine-month financing cash flow was positive $92.7 million, reflecting substantial revolving borrowings and repayments, $71.0 million of share repurchases, and $48.7 million of dividends paid.

Debt, liquidity and capital allocation

Total notes payable and long-term debt was $1.437 billion at May 31, 2012, compared with $1.187 billion at August 31, 2011. Current maturities increased to $296.4 million from $74.2 million. Debt included senior notes due 2016, 2018 and 2020, $290.5 million of credit-facility borrowings and $33.7 million of other loans.

On March 19, 2012, Jabil entered into a new five-year unsecured revolving credit facility with an initial capacity of $1.3 billion and potential capacity of $1.6 billion, expiring March 19, 2017. The company reported compliance with its credit-facility and receivables-program covenants at May 31, 2012.

Management expected $500 million to $600 million of capital expenditures during the next 12 months, principally for DMS equipment, maintenance, information technology and new facilities. Management believed available cash, revolver capacity, receivables programs and operating cash flow would fund expected capital needs, dividends, repurchases and working capital for the next 12 months. Approximately $372.7 million of foreign-subsidiary cash could not be repatriated without potential tax consequences.

Material changes, outlook and unusual items

The company completed the $128.9 million cash acquisition of Telmar Network Technology on December 1, 2011. The transaction added $60.9 million of goodwill and $49.9 million of identifiable intangible assets, assigned primarily to DMS.
Quarterly results benefited from growth in higher-margin DMS activities, new program wins, improved capacity utilization and productivity initiatives. SG&A increased to 3.8% of revenue from 3.6%, partly due to higher headcount and Telmar-related costs.
The quarter included a $10.1 million distressed-customer charge related to a receivable involved in a legal dispute. A full valuation allowance was recorded against the receivable.
Nine-month 2011 results included restructuring and impairment charges, settlement-of-receivables charges and a loss on disposal of subsidiaries that were not recorded in the 2012 nine-month period.
Jabil decreased unrecognized tax benefits, interest and penalties by approximately $20.8 million in the quarter related to an anticipated non-U.S. tax-audit resolution.
The company expected foreign revenue as a percentage of total revenue to decline slightly over the following 12 months and expected to continue paying regular quarterly dividends at amounts similar to prior declarations, subject to board approval.
The company repurchased approximately 3.2 million shares for $71.0 million during the first nine months, with approximately $29.0 million remaining under the authorization at May 31, 2012.

Risks and contingencies

Customer concentration is significant: the five largest customers represented approximately 48% of nine-month revenue, and 53 customers represented approximately 90%.
Customer demand is difficult to forecast, most production commitments are short term, and reductions or delays could create excess capacity, inventory write-downs and margin pressure.
Almost all manufactured products require one or more single-source components, creating exposure to shortages, price increases, quality issues and supply-chain disruption.
International operations expose Jabil to currency, geopolitical, labor, tax, regulatory, infrastructure and economic risks. Foreign-currency contracts had aggregate notional amounts of $178.8 million for designated hedges and $874.1 million for non-designated contracts.
The IRS proposed approximately $69.3 million of additional tax for fiscal years 2003–2005, before potential tax attributes, plus possible interest and penalties. Jabil is contesting the matter; the filing states that an unfavorable resolution, particularly for later years, could materially affect results.
Jabil faced a commercial dispute involving product-warranty claims and a $10.1 million receivable. No warranty reserve was recorded because loss was not considered probable and a range of loss could not be determined.
Debt, variable interest rates, below-investment-grade ratings from Moody’s and S&P, and reliance on receivables securitization and uncommitted sale programs could constrain liquidity if financing markets or customer credit conditions deteriorate.
Management reported effective disclosure controls and no material changes to internal control over financial reporting; however, the Telmar acquisition was excluded from the control-effectiveness assessment under applicable SEC guidance.

Important facts for investors to verify

Reconcile the decline in operating cash flow with the increases in inventory, prepaid assets and deferred purchase-price receivables.
Assess the sustainability of DMS growth and whether E&I and HVS declines reflect temporary demand conditions or longer-term customer and industry shifts.
Review debt maturities, revolver utilization, covenant headroom and the company’s dependence on receivables-financing programs.
Monitor the IRS examination, the customer warranty dispute and the adequacy of related reserves and allowances.
Evaluate the effect of the Telmar acquisition on revenue, margins, goodwill, intangible amortization and internal controls.
Consider customer concentration, component availability, foreign-exchange exposure and the planned $500 million to $600 million of capital expenditures when assessing future liquidity and returns.