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Jabil Circuit Inc. (JBL - Analyst Report) reported second quarter 2012 earnings of 48 cents per share, missing the Zacks Consensus Estimate by a penny. Earnings per share (EPS) increased 8.1% year over year from 45 cents (including stock-based compensation but excluding amortization), primarily driven by solid top-line growth.

Revenue

Revenue increased 7.8% year over year to $4.24 billion and was in line with the high end of management’s guided range of $4.0 billion to $4.2 billion. Quarterly revenue surpassed the Zacks Consensus Estimate of $4.10 billion. Higher quarterly revenues were attributable to market share gains, new customer wins and strong growth from the emerging markets.

Diversified manufacturing revenue (44.0% of the total revenue) increased 33.0% year over year to $1.9 billion. Enterprise and Infrastructure revenue (29.0% of the total revenue) was down 2.0% year over year to $1.2 billion. High velocity sales (27.0% of the total revenue) decreased 10.0% year over year to $1.2 billion.

Operating Performance

Gross profit was $329.2 million, up 8.7% year over year while gross margin increased 10 basis points year over year to 7.6%. This was primarily driven by a favorable product mix.

Operating income (including stock-based compensation) increased 4.8% year over year to $155.1 million in the reported quarter. Operating margin was 3.7% compared with 3.8% in the year-earlier quarter. Segment-wise, Diversified manufacturing operating margin was 5.9% in the quarter. Core operating margin for the Enterprise and Infrastructure segment was 1.7%. High velocity posted an operating margin of 4.0% in the quarter.

The nominal decline in operating margin was primarily attributable to a higher-than-expected rise in selling, general and administrative (SG&A) expense offset by a lower research and development (R&D) expense in the quarter. SG&A expense increased 13.4% year over year to $160.8 million, while R&D declined 4.2% year over year to $6.3 million in the quarter.

Net income increased 3.8% year over year to $102.6 million. Net margin contracted 10 bps on a year over year basis to 2.4%.

Balance Sheet & Cash Flow

Exiting the second quarter of 2012, cash and cash equivalents were $707.4 million, down from $861.9 million in the prior quarter. Jabil’s debt level increased significantly in the second quarter. Total debt, as of February 29, 2012, was $1.39 billion compared to $1.19 billion at the end of last quarter.

The company’s net cash balance (cash less debt including the current portion) was a deficit of $686.7 million or $3.24 per share in the second quarter of 2012 compared with $334.4 million or $1.59 per share in the first quarter of 2012.

Cash outflow was $109.3 million in the quarter, primarily due to higher working capital requirement in the quarter. The sales cycle was 11 days while annualized inventory turns were 7 in the quarter. Capital expenditures were $77.3 million, while core return on invested capital was 26.0% in the reported quarter. During the quarter, Jabil repurchased 1.7 million shares at an average price of $22.73 per share.

Acquisitions

During the quarter, Jabil completed the acquisition of Texas-based Telmar Network Technology, Inc., a global provider of after market services to communication network service providers, enterprise and original equipment manufacturers (OEM) for $128.0 million in cash.

The acquisition will enable Jabil to develop a multi-vendor after-market services platform, which will provide end-to-end network maintenance services, thereby enhancing the operating efficiency of its customers.

Guidance

Jabil expects net revenue in the range of $4.2 billion to $4.4 billion for the third quarter of 2012 (up approximately 2.0% on a year-over-year basis). Diversified Manufacturing is expected to grow 25.0% year over year, Enterprise and Infrastructure is anticipated to decline 8.0% year over year, while High Velocity is forecast to decline 14.0% on a year-over-year basis for the third quarter.

Jabil projects operating income (excluding stock-based compensation) in the $185.0 million to $205.0 million range (10.0% year-over-year increase) for the third quarter of 2012.

Jabil expects non-GAAP earnings per share to be between 60 cents and 70 cents for the third quarter. The Zacks Consensus Estimate is currently pegged at 51 cents (Zacks Consensus Estimate includes stock-based compensation).

For the second half of fiscal 2012, capital expenditures are expected to be $320.0 million. Capital expenditure for full year 2012 is expected to be approximately $500.0 million with roughly 75.0% allocated for the diversified manufacturing segment.

Recommendation

Jabil provided an optimistic third quarter outlook, anticipating strong top-line growth on the back of a mix shift toward high-margin diversified manufacturing systems. We believe Jabil is well poised for growth given the in vogue adoption of clean technology and alternative energy. Moreover, the lean cost structure will also drive operating profit going forward.

However, the company faces strong competition from Flextronics Inc. (FLEX - Snapshot Report) and Sanmina-SCI Corp. (SANM - Snapshot Report), which along with the high debt level and sluggish economic conditions in Europe and the U.S. may hurt its profitability going forward.

We maintain a Neutral recommendation on Jabil over the long term (6–12 months). Currently, Jabil has a Zacks #3 Rank, which implies a Hold rating on a short-term basis.

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