Jabil Circuit, Inc.
JABIL CIRCUIT INC (Form: 10-Q, Received: 07/10/2006 17:14:23)
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-Q

 


(Mark one)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended May 31, 2006

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number: 1-14063

 


JABIL CIRCUIT, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware   38-1886260

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

10560 Dr. Martin Luther King, Jr. Street North, St. Petersburg, Florida 33716

(Address of principal executive offices) (Zip Code)

(727) 577-9749

(Registrant’s telephone number, including area code)

 


Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

Indicate by checkmark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer   x     Accelerated filer   ¨     Non-accelerated filer   ¨

Indicate by checkmark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

As of June 26, 2006, there were 212,288,025 shares of the Registrant’s Common Stock outstanding.

 



Table of Contents

JABIL CIRCUIT, INC. AND SUBSIDIARIES

INDEX

 

PART I. FINANCIAL INFORMATION

  
Item 1.    Financial Statements   
   Condensed Consolidated Balance Sheets at May 31, 2006 and August 31, 2005    3
   Condensed Consolidated Statements of Earnings for the three and nine months ended May 31, 2006 and 2005    4
   Condensed Consolidated Statements of Comprehensive Income for the three and nine months ended May 31, 2006 and 2005    5
   Condensed Consolidated Statements of Cash Flows for the nine months ended May 31, 2006 and 2005    6
   Notes to Condensed Consolidated Financial Statements    7
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations    23
Item 3.    Quantitative and Qualitative Disclosures About Market Risk    47
Item 4.    Controls and Procedures    48

PART II. OTHER INFORMATION

  
Item 1.    Legal Proceedings    49
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds    50
Item 3.    Defaults Upon Senior Securities    50
Item 4.    Submission of Matters to a Vote of Security Holders    50
Item 5.    Other Information    50
Item 6.    Exhibits    51
   Signatures    52

 

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PART I. FINANCIAL INFORMATION

Item 1: FINANCIAL STATEMENTS

JABIL CIRCUIT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands)

(Unaudited)

 

    

May 31,

2006

  

August 31,

2005

 
ASSETS      

Current assets:

     

Cash and cash equivalents

   $ 854,879    $ 796,071  

Accounts receivable, net of allowance for doubtful accounts of $4,424 at May 31, 2006 and $3,967 at August 31, 2005

     1,139,332      955,353  

Inventories

     1,229,704      818,435  

Prepaid expenses and other current assets

     102,443      75,335  

Deferred income taxes

     41,216      40,741  
               

Total current assets

     3,367,574      2,685,935  

Property, plant and equipment, net of accumulated depreciation of $807,499 at May 31, 2006 and $714,149 at August 31, 2005

     963,265      880,736  

Goodwill

     507,425      384,239  

Intangible assets, net of accumulated amortization of $71,763 at May 31, 2006 and $134,367 at August 31, 2005

     140,795      69,062  

Deferred income taxes

     52,898      24,727  

Other assets

     11,638      32,563  
               

Total assets

   $ 5,043,595    $ 4,077,262  
               
LIABILITIES AND STOCKHOLDERS’ EQUITY      

Current liabilities:

     

Current installments of notes payable, long-term debt and long-term lease obligations

   $ 25,149    $ 674  

Accounts payable

     1,790,879      1,339,866  

Accrued expenses

     293,563      224,766  

Income taxes payable

     7,337      2,823  

Deferred income taxes

     975      —    
               

Total current liabilities

     2,117,903      1,568,129  

Notes payable, long-term debt and long-term lease obligations, less current installments

     331,067      326,580  

Deferred income taxes

     8,892      —    

Other liabilities

     51,468      47,336  
               

Total liabilities

     2,509,330      1,942,045  
               

Stockholders’ equity:

     

Common stock

     211      204  

Additional paid-in capital

     1,202,446      1,041,884  

Retained earnings

     1,217,082      1,021,800  

Unearned compensation

     —        (8,774 )

Accumulated other comprehensive income

     114,526      80,103  
               

Total stockholders’ equity

     2,534,265      2,135,217  
               

Total liabilities and stockholders’ equity

   $ 5,043,595    $ 4,077,262  
               

See accompanying notes to condensed consolidated financial statements.

 

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JABIL CIRCUIT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS

(in thousands, except for per share data)

(Unaudited)

 

     Three months ended     Nine months ended  
    

May 31,

2006

   

May 31,

2005

   

May 31,

2006

   

May 31,

2005

 

Net revenue

   $ 2,592,464     $ 1,938,415     $ 7,311,833     $ 5,487,796  

Cost of revenue

     2,404,821       1,776,333       6,743,720       5,030,404  
                                

Gross profit

     187,643       162,082       568,113       457,392  

Operating expenses:

        

Selling, general and administrative

     93,536       71,688       275,141       205,914  

Research and development

     9,578       5,667       24,756       17,761  

Amortization of intangibles

     7,273       11,491       18,791       32,402  
                                

Operating income

     77,256       73,236       249,425       201,315  

Other expense

     3,505       1,116       8,399       2,503  

Interest income

     (4,977 )     (4,214 )     (15,605 )     (9,007 )

Interest expense

     5,818       5,856       15,355       15,537  
                                

Income before income taxes

     72,910       70,478       241,276       192,282  

Income tax expense

     8,684       11,125       31,139       30,967  
                                

Net income

   $ 64,226     $ 59,353     $ 210,137     $ 161,315  
                                

Earnings per share:

        

Basic

   $ 0.31     $ 0.29     $ 1.01     $ 0.80  
                                

Diluted

   $ 0.30     $ 0.29     $ 0.99     $ 0.78  
                                

Common shares used in the calculations of earnings per share:

        

Basic

     210,441       202,666       207,598       202,021  
                                

Diluted

     215,808       207,736       213,299       206,643  
                                

See accompanying notes to condensed consolidated financial statements.

 

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JABIL CIRCUIT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(in thousands)

(Unaudited)

 

     Three months ended     Nine months ended  
    

May 31,

2006

  

May 31,

2005

   

May 31,

2006

  

May 31,

2005

 

Net income

   $ 64,226    $ 59,353     $ 210,137    $ 161,315  

Other comprehensive income (loss):

          

Foreign currency translation adjustment, net of tax

     31,462      (46,937 )     34,423      38,658  

Change in fair market value of derivative instruments, net of tax

     —        659       —        (939 )
                              

Comprehensive income

   $ 95,688    $ 13,075     $ 244,560    $ 199,034  
                              

Accumulated foreign currency translation gains were $124.6 million at May 31, 2006 and $90.2 million at August 31, 2005. Foreign currency translation adjustments primarily consist of adjustments to consolidate subsidiaries that use a local currency as their functional currency.

See accompanying notes to condensed consolidated financial statements.

 

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JABIL CIRCUIT, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

     Nine months ended  
    

May 31,

2006

   

May 31,

2005

 

Cash flows from operating activities:

    

Net income

   $ 210,137     $ 161,315  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     147,793       167,965  

Recognition of deferred grant proceeds

     (504 )     (899 )

Amortization of discount on note receivable

     (1,402 )     (480 )

Recognition of stock-based compensation

     33,137       1,316  

Deferred income taxes

     (16,200 )     6,172  

Provision for doubtful accounts

     1,619       387  

Tax benefit of options exercised

     75       3,913  

(Gain)/loss on sale of property

     (2,333 )     2,053  

Change in operating assets and liabilities, exclusive of net assets acquired in business acquisitions:

    

Accounts receivable

     (155,350 )     25,265  

Inventories

     (354,807 )     (29,101 )

Prepaid expenses and other current assets

     (19,675 )     18,642  

Other assets

     (1,112 )     (694 )

Accounts payable and accrued expenses

     424,789       65,720  

Income taxes payable

     4,030       (4,190 )
                

Net cash provided by operating activities

     270,197       417,384  
                

Cash flows from investing activities:

    

Net cash paid for business and intangible asset acquisitions

     (162,836 )     (212,314 )

Cash disbursements for notes receivable

     —         (16,356 )

Cash held in escrow

     —         (10,000 )

Cash disbursements for purchase option

     —         (3,809 )

Acquisition of property, plant and equipment

     (184,599 )     (164,073 )

Proceeds from sale of property and equipment

     9,760       13,687  
                

Net cash used in investing activities

     (337,675 )     (392,865 )
                

Cash flows from financing activities:

    

Borrowings under debt agreements

     81,148       103,993  

Payments toward debt agreements and capital lease obligations

     (108,299 )     (102,276 )

Net proceeds from issuance of common stock under option and employee purchase plans

     123,705       22,492  

Tax benefit of options exercised

     12,425       —    
                

Net cash provided by financing activities

     108,979       24,209  
                

Effect of exchange rate changes on cash

     17,307       10,992  
                

Net increase in cash and cash equivalents

     58,808       59,720  

Cash and cash equivalents at beginning of period

     796,071       621,322  
                

Cash and cash equivalents at end of period

   $ 854,879     $ 681,042  
                

See accompanying notes to condensed consolidated financial statements.

 

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JABIL CIRCUIT, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary to present fairly the information set forth therein have been included. Certain amounts in the prior periods’ financial statements have been reclassified to conform to current period presentation. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Annual Report on Form 10-K of Jabil Circuit, Inc. (the “Company”) for the fiscal year ended August 31, 2005. Operating results for the nine-month period ended May 31, 2006 are not necessarily an indication of the results that may be expected for the fiscal year ending August 31, 2006.

Note 2. Inventories

The components of inventories consist of the following (in thousands):

 

    

May 31,

2006

  

August 31,

2005

Raw materials

   $ 897,674    $ 573,756

Work-in-process

     180,327      148,455

Finished goods

     151,703      96,224
             

Total inventories

   $ 1,229,704    $ 818,435
             

Note 3. Earnings Per Share and Dividends

a. Earnings Per Share

The following table sets forth the calculation of basic and diluted earnings per share (in thousands, except per share data):

 

     Three months ended    Nine months ended
    

May 31,

2006

  

May 31,

2005

  

May 31,

2006

  

May 31,

2005

Numerator:

           

Net income

   $ 64,226    $ 59,353    $ 210,137    $ 161,315
                           

Denominator:

           

Weighted-average common shares outstanding – basic

     210,441      202,666      207,598      202,021

Dilutive common shares issuable upon exercise of stock options and stock appreciation rights

     5,107      4,645      5,485      4,197

Dilutive unvested common shares associated with restricted stock awards

     260      425      216      425
                           

Weighted-average common shares – diluted

     215,808      207,736      213,299      206,643
                           

Earnings per share:

           

Basic

   $ 0.31    $ 0.29    $ 1.01    $ 0.80
                           

Diluted

   $ 0.30    $ 0.29    $ 0.99    $ 0.78
                           

 

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For the three months and nine months ended May 31, 2006, options to purchase 561,015 and 616,319 shares of common stock, respectively, were outstanding during the period but were not included in the computation of diluted earnings per share because the options’ exercise prices were greater than the average market price of the common shares, and therefore, their effect would be anti-dilutive as calculated under the treasury method promulgated by the Statement of Financial Accounting Standard No. 128, Earnings per Share (“SFAS 128”). For the three months and nine months ended May 31, 2005, options to purchase 656,957 and 5,233,269 shares of common stock, respectively, were excluded for the same reason. In accordance with the contingently issuable shares provision of SFAS 128, 769,726 shares of performance-based, unvested common stock awards (“restricted stock’) granted in fiscal year 2006 were not included in the calculation of earnings per share for the three months and nine months ended May 31, 2006, because all the necessary conditions for vesting have not been satisfied as of May 31, 2006. In addition, for the three months and nine months ending May 31, 2006, 2,532,214 stock appreciation rights were not included in the calculation of diluted earnings per share because the shares considered repurchased with assumed proceeds were greater than the shares issuable, and therefore, their effect would be anti-dilutive.

b. Dividends

On May 4, 2006, the Company’s Board of Directors declared a quarterly cash dividend to common stockholders of $0.07 per share. The cash dividend, totaling approximately $14.9 million, was paid on June 1, 2006 to stockholders of record on May 15, 2006.

Note 4. Stock-Based Compensation

Effective September 1, 2005, the Company adopted the provisions of Statement of Financial Accounting Standard No. 123R, Share-Based Payment , (“SFAS 123R”) for its share-based compensation plans. The Company previously accounted for these plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (“APB 25”) and related interpretations and disclosure requirements established by Statement of Financial Accounting Standard No. 123, Accounting for Stock-Based Compensation, (“SFAS 123”), as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure.

Under APB 25, no compensation expense was recorded in earnings for the Company’s stock options and awards granted under the Company’s employee stock purchase plan (“ESPP”). The pro forma effects on net income and earnings per share for stock options and ESPP awards were instead disclosed in a footnote to the financial statements. Compensation expense was recorded in earnings for restricted stock awards. Under SFAS 123R, all share-based compensation cost is measured at the grant date, based on the fair value of the award, and is recognized as an expense in earnings over the requisite service period.

The Company adopted SFAS 123R using the modified prospective method. Under this transition method, compensation cost recognized in fiscal year 2006 includes the cost for all share-based awards granted prior to, but not yet vested as of September 1, 2005. This cost was based on the grant-date fair value estimated in accordance with the original provisions of SFAS 123. The cost for all share-based awards granted subsequent to August 31, 2005, represents the grant-date fair value that was estimated in accordance with the provisions of SFAS 123R. Results for prior periods have not been restated.

Upon the adoption of SFAS 123R, the Company changed its option valuation model from the Black-Scholes model to a lattice valuation model for all stock options and stock appreciation rights (collectively known as the “Options”), excluding those granted under the Company’s ESPP, granted subsequent to August 31, 2005. The lattice valuation model is a more flexible analysis to value employee Options because of its ability to incorporate inputs that change over time, such as volatility and interest rates, and to allow for actual exercise behavior of Option holders. The Company will continue to use the Black-Scholes model for valuing the shares granted under the ESPP. Compensation for restricted stock awards is measured at fair value on the date of grant based on the number of shares expected to vest and the quoted market price of the Company’s common stock. Compensation cost for all awards will be recognized in earnings, net of estimated forfeitures, on a straight-line basis over the requisite service period. There were no significant capitalized stock-based compensation costs at May 31, 2006.

 

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The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair-value recognition provisions of SFAS 123 to all of its share-based compensation awards for periods prior to the adoption of SFAS 123R, and the actual effect on net income and earnings per share for periods subsequent to adoption of SFAS 123R (in thousands, except per share data):

 

     Three months ended     Nine months ended  
    

May 31,

2006

   

May 31,

2005

   

May 31,

2006

   

May 31,

2005

 
     (Unaudited)     (Unaudited)     (Unaudited)     (Unaudited)  

Reported net income

   $ 64,226     $ 59,353     $ 210,137     $ 161,315  

Total stock-based employee compensation expense included in the determination of reported net income, net of related tax effects of $856 and $82 for the three months ended and $8,934 and $211 for the nine months ended

     7,992       429       24,203       1,105  

Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects of $856 and $767 for the three months ended and $8,934 and $23,927 for the nine months ended

     (7,992 )     (4,026 )     (24,203 )     (125,619 )
                                

Pro forma net income for calculation of diluted earnings per share

   $ 64,226     $ 55,756     $ 210,137     $ 36,801  
                                

Earnings per share:

        

Reported earnings per share - basic

   $ 0.31     $ 0.29     $ 1.01     $ 0.80  
                                

Pro forma earnings per share - basic

   $ 0.31     $ 0.28     $ 1.01     $ 0.18  
                                

Reported earnings per share - diluted

   $ 0.30     $ 0.29     $ 0.99     $ 0.78  
                                

Pro forma earnings per share - diluted

   $ 0.30     $ 0.27     $ 0.99     $ 0.18  
                                

As a result of the Company meeting specific performance goals, as defined in certain stock option agreements, the vesting of 600,000 Options was accelerated in the first quarter of fiscal year 2006. The vesting acceleration resulted in the recognition of approximately $7.7 million in compensation expense during the three months ended November 30, 2005 that would have otherwise been recognized in fiscal years 2007 through 2010.

Cash received from Option exercises under all share-based payment arrangements for the nine months ended May 31, 2006 and 2005 was $123.7 million and $22.5 million, respectively. The Company currently expects to satisfy share-based awards with registered shares available to be issued.

On January 28, 2005, in response to the issuance of SFAS 123R, the Company’s Compensation Committee of the Board of Directors approved accelerating the vesting of most out-of-the-money, unvested stock options held by current employees, including executive officers and directors. An option was considered out-of-the-money if the stated option exercise price was greater than the closing price of the Company’s common stock on the day before the Compensation Committee approved the acceleration, or $23.31. Unvested options to purchase approximately 7.3 million shares became exercisable as a result of the vesting acceleration. The Compensation Committee did not approve the accelerated vesting of out-of-the-money unvested performance accelerated vesting options held by certain officers of the Company as it believed that, notwithstanding the potential additional compensation expense that could be avoided by accelerating such options, the existing stated financial performance criteria should be met before any of such options are accelerated. The accelerated vesting was effective as of January 28, 2005. However, holders of incentive stock options (within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended) to purchase 186,964 shares of common stock had the opportunity to decline the accelerated vesting in order to prevent changing the status of the incentive stock option for federal income tax purposes to a non-qualified

 

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stock option; holders of options to purchase 16,173 shares elected to decline the accelerated vesting. Additionally, holders of certain tax-qualified stock options issued to certain foreign employees to purchase 101,440 shares of common stock had the opportunity to decline the accelerated vesting in order to prevent the restriction of the availability of favorable tax treatment under applicable foreign law; holders of options to purchase 42,400 shares elected to decline the accelerated vesting.

The decision to accelerate vesting of these options was made primarily to avoid recognizing compensation cost in the statement of earnings in future financial statements upon the effectiveness of SFAS 123R. The maximum future compensation expense that was avoided upon adoption of SFAS 123R was approximately $96.0 million, of which approximately $22.7 million was related to options held by executive officers and directors of the Company. The vesting acceleration did not result in the recognition of compensation expense in net income for the fiscal year ended August 31, 2005.

As described in Note 6 – “Commitments and Contingencies,” the Company is involved in shareholder derivative actions and a Securities and Exchange Commission (“SEC”) Informal Inquiry, and has received a subpoena from the U.S. Attorney’s office for the Southern District of New York in connection with certain historical stock option grants. In response to the derivative actions, a Special Committee of the Company’s Board of Directors has been appointed to review the allegations in such actions. The Company has cooperated and intends to continue to cooperate with the special board committee, the SEC and the U.S. Attorney’s office. The Company cannot, however, predict the outcome of those investigations.

a. Stock Option and Stock Appreciation Right Plans

The Company’s 1992 Stock Option Plan (the “1992 Plan”) provided for the granting to employees of incentive stock options within the meaning of Section 422 of the Internal Revenue Code and for the granting of non-statutory stock options to employees and consultants of the Company. A total of 23,440,000 shares of common stock were reserved for issuance under the 1992 Plan. The 1992 Plan was adopted by the Board of Directors in November of 1992 and was terminated in October 2001 with the remaining shares transferred into a new plan created in fiscal year 2002.

In October 2001, the Company established a new Stock Option Plan (the “2002 Incentive Plan”). The 2002 Incentive Plan was adopted by the Board of Directors in October 2001 and approved by the stockholders in January 2002. The 2002 Incentive Plan provides for the granting of Section 422 Internal Revenue Code and non-statutory stock options, as well as restricted stock, stock appreciation rights and other stock-based awards. The 2002 Incentive Plan has a total of 26,608,726 shares reserved for grant, including 2,608,726 shares that were transferred from the 1992 Plan when it was terminated in October 2001, 10,000,000 shares authorized in January 2004 and 7,000,000 shares authorized in January 2006. The Company also adopted sub-plans under the 2002 Incentive Plan for its United Kingdom employees (“the CSOP Plan”) and for its French employees (“the FSOP Plan”). The CSOP Plan and FSOP Plan are tax advantaged plans for the Company’s United Kingdom and French employees, respectively. Shares are issued under the CSOP Plan and FSOP Plan from the authorized shares under the 2002 Incentive Plan.

Generally, the exercise price of Options granted under the 2002 Incentive Plan is to be at least equal to the fair market value of shares of common stock on the date of grant. With respect to any participant who owns stock representing more than 10% of the voting power of all classes of stock of the Company, the exercise price of any incentive stock option granted is to equal at least 110% of the fair market value on the grant date and the maximum term of the option may not exceed five years. The term of all other Options under the 2002 Incentive Plan may not exceed ten years. Effective with Options granted in fiscal year 2006, one-twelfth of the award will vest fifteen months after the grant date with an additional one-twelfth vesting at the end of each three-month period thereafter, becoming fully vested after a 48-month period. Prior to this change, Options generally vested at a rate of 12% after the first six months and 2% per month thereafter, becoming fully vested after a 50-month period.

 

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The following table summarizes Option activity from August 31, 2005 through May 31, 2006:

 

    

Shares

Available

for Grant

   

Options

Outstanding

   

Aggregate

Intrinsic Value

(in thousands)

  

Weighted-

Average

Exercise

Price

  

Weighted-

Average

Remaining

Contractual

Life

Balance at August 31, 2005

   6,749,767     18,932,105        $ 20.51    6.80

Options authorized

   7,000,000     —            

Options expired

   —       —            

Options granted

   (2,578,766 )   2,578,766        $ 30.38   

Options cancelled

   104,119     (104,119 )      $ 22.70   

Restricted stock awards (1)

   (1,636,252 )   —            

Options exercised

   —       (6,181,486 )      $ 19.09   
                    

Balance at May 31, 2006

   9,638,868     15,225,266     $ 189,767    $ 22.70    6.72
                        

Exercisable at May 31, 2006

     12,150,444     $ 166,344    $ 21.50    6.18
                    

(1) Represents the maximum number of shares that can be issued based on the achievement of certain performance criteria.

The weighted-average grant-date fair value per share of Options granted during the nine months ended May 31, 2006 and 2005 was $15.19 and $14.79, respectively. The total intrinsic value of Options exercised during the nine months ended May 31, 2006 and 2005 was $119.0 million and $19.3 million, respectively.

As of May 31, 2006, there was $36.1 million of unrecognized compensation costs related to non-vested Options that is expected to be recognized over a weighted-average period of 2.05 years. The total fair value of Options vested during the nine months ended May 31, 2006 and 2005 was $21.2 million and $129.9 million, respectively.

The Company changed the valuation model used for estimating the fair value of Options granted in the first fiscal quarter of 2006, from the Black-Scholes model to the lattice valuation model. The lattice valuation model is a more flexible analysis to value employee Options because of its ability to incorporate inputs that change over time, such as volatility and interest rates, and to allow for actual exercise behavior of Option holders. The Company used historical data to estimate the Option exercise and employee departure behavior used in the lattice valuation model. The expected term of Options granted is derived from the output of the option pricing model and represents the period of time that Options granted are expected to be outstanding. The risk-free rate for periods within the contractual term of the Options is based on the U.S. Treasury yield curve in effect at the time of grant. Because the lattice valuation model uses different volatilities and risk-free interest rates in calculating the fair value of the Options, ranges are provided only for the Options granted subsequent to August 31, 2005.

Following are the weighted-average and range assumptions, where applicable, used for each respective period:

 

     Three months ended     Nine months ended  
    

May 31,

2006

(Lattice)

   

May 31,

2005

(Black-Scholes)

   

May 31,

2006

(Lattice)

   

May 31,

2005

(Black-Scholes)

 

Expected dividend yield

   0.0 %   0.0 %   0.0 %   0.0 %

Risk-free interest rate

   4.7% to 5.1 %   3.6 %   3.7% to 5.1 %   3.6 %

Expected volatility range

   23.2% to 66.7 %   NA     17.4% to 71.4 %   NA  

Weighted-average expected volatility

   46.54 %   69.5 %   48.7 %   69.5 %

Weighted-average expected life

   5.6 years     5.0 years     6.0 years     5.0 years  

 

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    b. Stock Purchase and Award Plans

The Company’s 1992 Employee Stock Purchase Plan (the “1992 Purchase Plan”) was adopted by the Board of Directors in November 1992 and approved by the stockholders in December 1992. A total of 5,820,000 shares of common stock were reserved for issuance under the 1992 Purchase Plan. As of May 31, 2006 a total of 5,279,594 shares had been issued under the 1992 Purchase Plan. The 1992 Purchase Plan was terminated in October 2001.

In October 2001, the Board of Directors adopted a new Employee Stock Purchase Plan (the “2002 Purchase Plan” and, together with the 1992 Purchase Plan, the “Purchase Plans”), which was approved by the stockholders in January 2002. Initially there were 2,000,000 shares reserved under the 2002 Purchase Plan. An additional 2,000,000 shares were authorized for issuance under the 2002 Purchase Plan and approved by stockholders in January 2006. The Company also adopted a sub-plan under the 2002 Purchase Plan for its Indian employees. The Indian sub-plan is a tax advantaged plan for the Company’s Indian employees. Shares are issued under the Indian sub-plan from the authorized shares under the 2002 Purchase Plan. As of May 31, 2006, a total of 1,699,852 shares had been issued under the 2002 Purchase Plan.

Employees are eligible to participate in the Purchase Plans after 90 days of employment with the Company. The Purchase Plans permit eligible employees to purchase common stock through payroll deductions, which may not exceed 10% of an employee’s compensation, as defined, at a price equal to 85% of the fair market value of the common stock at the beginning or end of the offering period, whichever is lower. The Purchase Plans are intended to qualify under section 423 of the Internal Revenue Code. Unless terminated sooner, the 2002 Purchase Plan will terminate on October 17, 2011.

Awards under the 2002 Purchase Plan are generally granted in June and December. As such, there were no stock purchases under the Purchase Plans during the three months ended May 31, 2006 and 2005. There were 217,380 and 234,475 shares purchased under the Purchase Plans for the nine months ended May 31, 2006 and 2005, respectively.

The fair value of shares issued under the Purchase Plans was estimated on the commencement date of each offering period using the Black-Scholes option pricing model. The following weighted-average assumptions were used in the model for each respective period:

 

     Nine months ended  
    

May 31,

2006

   

May 31,

2005

 

Expected dividend yield

   0.0 %   0.0 %

Risk-free interest rate

   4.4 %   2.6 %

Weighted-average expected volatility

   20.7 %   33.0 %

Expected life

   0.5 years     0.5 years  

In February 2001, the Company adopted a new Stock Award Plan. The purpose of the Stock Award Plan was to provide incentives to attract and retain key employees to the Company, to motivate such persons to stay with the Company, and to increase their efforts to make the business of the Company more successful. A total of 100,000 shares of common stock were registered for issuance under the Stock Award Plan. In October 2005, the Board of Directors approved the termination of the Stock Award Plan. As of October 31, 2005, 11,650 shares had been issued to employees under the Stock Award Plan, of which 5,000 shares had lapsed, leaving 88,350 unissued shares. On November 16, 2005, the Company filed a post-effective amendment to Form S-8 to deregister the 88,350 unissued shares.

    c. Restricted Stock Awards

In fiscal years 2005 and 2006, the Company granted restricted stock to certain key employees pursuant to the 2002 Stock Incentive Plan. The shares granted in fiscal year 2005 will vest after five years, but may vest earlier if specific performance criteria are met. The shares granted in fiscal year 2006 have certain performance conditions that will be measured on August 31, 2008, which provide a range of vesting possibilities from 0% to 200%.

 

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The restricted stock awards granted in fiscal year 2005 were accounted for using the measurement and recognition principles of APB 25. Accordingly, compensation cost was measured at the date of the grant and will be recognized in earnings over the period in which the shares vest. The restricted stock awards granted subsequent to August 31, 2005 were accounted for using the measurement and recognition principles of SFAS 123R. Accordingly, the fair value of the awards is measured on the date of grant and recognized over the requisite service period based on the number of shares that would vest if the Company achieves 100% of the performance goal. If it becomes probable, based on the Company’s performance, that more than 100% of the awarded shares will vest, additional compensation cost will be recognized. Alternatively, if the performance goals are not met, any recognized compensation cost will be reversed.

The following table summarizes restricted stock activity from August 31, 2005 through May 31, 2006:

 

     Shares    

Weighted -

Average
Grant-Date

Fair Value

Nonvested balance at August 31, 2005

   435,000     $ 24.21

Changes during the period

    

Shares granted (1)

   1,643,452     $ 30.93

Shares vested

   (13,500 )   $ 28.41

Shares forfeited

   (7,200 )   $ 30.92
        

Nonvested balance at May 31, 2006

   2,057,752     $ 29.52
        

(1) Represents the maximum number of shares that can vest based on the achievement of certain performance criteria.

As of May 31, 2006, there was $29.2 million of total unrecognized compensation cost related to restricted stock awards granted under the Plan. That cost is expected to be recognized over a weighted-average period of 1.9 years. Pursuant to SFAS 123R, the $8.8 million of unearned compensation recorded as a reduction to stockholders’ equity as of August 31, 2005 was reversed against the Company’s additional paid-in capital.

Note 5. Segment Information

The Company derives its revenue from providing comprehensive electronics design, production, product management and repair services. Management, including the Chief Executive Officer, evaluates performance and allocates resources on a geographic basis for manufacturing operating segments and on a global basis for the services operating segment. Prior to the first quarter of fiscal year 2005, Jabil managed its business based on four geographic regions, the United States, Europe, Asia and Latin America. During fiscal year 2005, the Company realigned its organizational structure to manage the United States and Latin America as one geographic region, the Americas, and to manage the services groups independently of the regional manufacturing segments. Accordingly, Jabil’s operating segments consist of four segments – Americas, Europe, Asia and Services – to reflect how the Company manages its business. All prior period disclosures presented below have been restated to reflect this change. The services operating segment, which includes the Company’s repair, design and enclosure integration services, does not meet the requirements of a reportable operating segment and is therefore combined with the Company’s other non-segment activities, where applicable, in the disclosures below.

Net revenue for the three manufacturing operating segments are attributed to the region in which the product is manufactured or service is performed. The services provided, manufacturing processes, class of customers and order fulfillment processes are similar and generally interchangeable across the manufacturing operating segments. Net revenue for the services operating segment are on a global basis. An operating segment’s performance is evaluated based upon its pre-tax operating contribution, or segment income. Segment income is defined as net revenue less cost of revenue and segment selling, general and administrative expenses, and does not include research and development costs, intangible amortization, stock-based compensation expense, acquisition-related charges, restructuring and impairment charges, other expense, interest income, interest expense or income taxes. Segment income also does not include an allocation of corporate selling, general and administrative expenses, as management does not use this information to measure the performance of the operating segments. Transactions between operating segments are generally recorded at amounts that approximate arm’s length.

 

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The following table sets forth operating segment information (in thousands):

 

     Three months ended    Nine months ended
    

May 31,

2006

  

May 31,

2005

  

May 31,

2006

   

May 31,

2005

Net revenue           

Americas

   $ 1,004,381    $ 675,590    $ 2,755,054     $ 1,804,428

Europe

     783,863      665,448      2,227,278       1,984,634

Asia

     700,486      514,476      2,043,698       1,466,926

Other non-reportable operating segment

     103,734      82,901      285,803       231,808
                            
   $ 2,592,464    $ 1,938,415    $ 7,311,833     $ 5,487,796
                            
     2006    2005    2006     2005
Depreciation expense           

Americas

   $ 15,242    $ 15,694    $ 45,218     $ 45,668

Europe

     10,859      14,835      35,165       41,908

Asia

     10,522      10,346      30,091       31,068

Other

     6,634      5,674      18,528       16,919
                            
   $ 43,257    $ 46,549    $ 129,002     $ 135,563
                            
     2006    2005    2006     2005
Segment income and reconciliation of income before income taxes           

Americas

   $ 30,901    $ 43,446    $ 129,430     $ 109,574

Europe

     60,883      44,268      146,484       132,913

Asia

     48,733      37,429      160,772       102,073

Other non-reportable operating segment

     84      3,291      5,514       11,562
                            

Total segment income

     140,601      128,434      442,200       356,122

Reconciling items:

          

Amortization of intangibles

     7,273      11,491      18,791       32,402

Other expense

     3,505      1,116      8,399       2,503

Net interest (income) expense

     841      1,642      (250 )     6,530

Other non-allocated charges

     56,072      43,707      173,984       122,405
                            

Income before income taxes

   $ 72,910    $ 70,478    $ 241,276     $ 192,282
                            
     2006    2005    2006     2005
Capital expenditures           

Americas

   $ 15,406    $ 11,096    $ 53,018     $ 44,341

Europe

     11,723      8,121      36,178       29,917

Asia

     29,225      28,219      66,351       47,143

Other

     8,667      15,500      29,052       42,672
                            
   $ 65,021    $ 62,936    $ 184,599     $ 164,073
                            

 

    

May 31,

2006

  

August 31,

2005

Property, plant and equipment, net      

Americas

   $ 303,172    $ 294,456

Europe

     197,292      192,060

Asia

     300,876      246,978

Other

     161,925      147,242
             
   $ 963,265    $ 880,736
             

 

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May 31,

2006

  

August 31,

2005

Total assets      

Americas

   $ 1,413,536    $ 1,272,155

Europe

     1,554,142      1,315,079

Asia

     1,667,118      1,116,186

Other

     408,799      373,842
             
   $ 5,043,595    $ 4,077,262
             

Foreign source revenue represented 83.1% and 83.5% of net revenue for the three months and nine months ended May 31, 2006, respectively, compared to 82.0% and 84.4% for the three months and nine months ended May 31, 2005, respectively.

Note 6. Commitments and Contingencies

    a. Legal Proceedings

On April 26, 2006, a shareholder derivative lawsuit was filed in State Circuit Court in Pinellas County, Florida on behalf of Mary Lou Gruber, a purported shareholder of the Company, naming the Company as a nominal defendant, and naming certain of its officers, Scott D. Brown, Executive Vice President, Mark T. Mondello, Chief Operating Officer, and Timothy L. Main, Chief Executive Officer, President and a Board member, as well as certain of its Directors, Mel S. Lavitt, William D. Morean, Frank A. Newman, Steven A. Raymund and Thomas A. Sansone, as defendants (the “Initial Action”). Mr. Morean and Mr. Sansone were the Company’s previous Chief Executive Officer and President, respectively (such two individuals, with the defendant officers, collectively, the “Officer Defendants”). The Initial Action alleged that the named defendant officers and directors breached certain of their fiduciary duties to the Company in connection with certain stock option grants between August 1998 and October 2004. Specifically, it alleges that the defendant directors (other than Mr. Morean and Mr. Main), in their capacity as members of the Company’s Board of Director Audit or Compensation Committee, at the behest of the Officer Defendants, backdated Company stock option grants to make it appear they were granted on a prior date when the Company’s stock price was lower The Initial Action alleged that such alleged backdated options unduly benefited the Officer Defendants, resulted in the Company issuing materially inaccurate and misleading financial statements and caused millions of dollars of damages to the Company. The Initial Action also sought to have the Defendant Officers disgorge certain options they received, including the proceeds of options exercised, as well as certain equitable relief and attorneys’ fees and costs.

Subsequent to the filing of the Initial Action, on May 2, 2006, the Company was notified by the Staff of the SEC of an informal inquiry concerning the Company’s stock option grants. On May 3, 2006, the Company’s Board of Directors had a meeting, which had been arranged prior to the SEC contacting the Company, to discuss the Initial Action. At that meeting, the Board appointed a Special Committee of the Company’s Board to review the allegations in the Initial Action. On May 10, 2006, the law firms representing the plaintiff in the Initial Action, along with two additional law firms, representing a purported shareholder of the Company, Robert Barone, filed a lawsuit in State Circuit Court in Pinellas County, Florida that was nearly identical to the Initial Action (with the Initial Action, collectively, the “Actions”). On May 17, 2006, the Company received a subpoena from the U.S. Attorney’s office for the Southern District of New York requesting certain stock option related material. The Plaintiffs in the Actions have moved to consolidate the two actions.

The Special Committee of the Board is in the process of conducting its investigation and analysis of the claims asserted in the derivative action. The Company is cooperating fully with the Board’s Special Committee, the SEC and the U.S. Attorney’s office. The Company cannot predict what effect such investigations may have. See “Risk Factors - We are involved in investigations of our historical stock option grant practices.”

The Company is party to certain other lawsuits in the ordinary course of business. Management does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the Company’s financial position, results of operations or cash flows.

 

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Table of Contents

    b. Warranty Provision

The Company maintains a provision for limited warranty repair of shipped products, which is established under the terms of specific manufacturing contract agreements. The warranty period varies by product and customer industry sector. The provision represents management’s estimate of probable liabilities, calculated as a function of sales volume and historical repair experience, for each product under warranty. The estimate is reevaluated periodically for accuracy. The balance of the warranty provision was insignificant for all periods presented.

Note 7. Restructuring and Impairment Charges

During fiscal year 2001, a global economic downturn resulted in excess production capacity and a decline in customer demand for the Company’s services. As a result, during the third quarter of fiscal year 2001, the Company implemented a restructuring program to reduce its cost structure. The macroeconomic conditions facing the Company, and the electronic manufacturing services industry as a whole, continued to deteriorate during fiscal year 2002, resulting in a continued decline in customer demand, additional excess production capacity, and customer requirements for a shift in the Company’s geographic production footprint. As a result, additional restructuring programs were implemented during fiscal year 2002.

During fiscal year 2003, the geographic production demands of the Company’s customers continued to shift. In addition to carrying out a worldwide realignment of capacity and consolidating existing facilities, the Company closed manufacturing operations in Boise, Idaho and Coventry, England. As a result, the Company charged $85.3 million of restructuring and impairment costs against earnings. These restructuring and impairment charges included employee severance and benefit costs, costs related to lease commitments, fixed asset impairments and other restructuring costs, primarily related to professional fees incurred in connection with the restructuring activities. For further discussion of the Company’s historical restructuring activities, refer to Note 13 – “Restructuring and Impairment Charges” to the Consolidated Financial Statements in the 2005 Annual Report on Form 10-K for the fiscal year ended August 31, 2005.

There were no restructuring charges incurred during the three months and nine months ended May 31, 2006 and 2005. The table below sets forth the significant components and activity in the remaining restructuring liability during the three months ended May 31, 2006 (in thousands):

 

     Balance at
February 28,
2006
   Cash
payments
    Balance at
May 31,
2006

Lease costs

   $ 2,680    $ (1,192 )   $ 1,488
                     

The table below sets forth the significant components and activity in the remaining restructuring liability during the nine months ended May 31, 2006 (in thousands):

 

     Balance at
August 31,
2005
   Cash
payments
    Balance at
May 31,
2006

Lease costs

   $ 4,924    $ (3,436 )   $ 1,488
                     

At May 31, 2006, the remaining liability of $1.5 million for lease commitment costs is expected to be paid within the next three months.

Note 8. Goodwill and Other Intangible Assets

The Company accounts for its intangible assets in accordance with Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (“SFAS 142”). In accordance with this standard, the Company is required to perform a goodwill impairment test at least on an annual basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable from estimated future cash flows. The Company completed the annual impairment test during the fourth quarter of fiscal year 2005 and determined that

 

16


Table of Contents

no impairment existed as of the date of the impairment test. Recoverability of goodwill is measured at the reporting unit level, which the Company has determined to be consistent with its operating segments as defined in Note 5 – “Segment Information,” by comparing the reporting unit’s carrying amount, including goodwill, to the fair market value of the reporting unit, based on projected discounted future results. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered impaired and a second test is performed to measure the amount of impairment loss, if any. To date, the Company has not recognized an impairment of its goodwill in connection with its adoption of SFAS 142.

All of the Company’s intangible assets, other than goodwill, are subject to amortization over their estimated useful lives. Intangible assets are comprised primarily of contractual agreements and customer relationships, which are being amortized on a straight-line basis over periods of up to ten years. No significant residual value is estimated for the intangible assets. The value of the Company’s intangible assets purchased through business acquisitions are principally determined based on third-party valuations of the net assets acquired. Currently, the Company is in the process of finalizing the value of intangible assets resulting from several acquisitions consummated during the second and third quarters of fiscal year 2006, including the Celetronix International, Ltd. (“Celetronix”) acquisition consummated during the third quarter of fiscal year 2006. See Note 9 – “Business Acquisitions” for further discussion of recent acquisitions. The following tables present the Company’s total purchased intangible assets at May 31, 2006 and August 31, 2005 (in thousands):

 

May 31, 2006

   Gross
carrying
amount
   Accumulated
amortization
    Net
carrying
amount

Contractual agreements & customer relationships

   $ 181,758    $ (70,422 )   $ 111,336

Intellectual property

     30,800      (1,341 )     29,459
                     

Total

   $ 212,558    $ (71,763 )   $ 140,795
                     

 

August 31, 2005

   Gross
carrying
amount
   Accumulated
amortization
    Net
carrying
amount

Contractual agreements & customer relationships

   $ 202,629    $ (133,800 )   $ 68,829

Intellectual property

     800      (567 )     233
                     

Total

   $ 203,429    $ (134,367 )   $ 69,062
                     

Intangible asset amortization for the three months and nine months ended May 31, 2006 was approximately $7.3 million and $18.8 million, respectively. Intangible asset amortization for the three months and nine months ended May 31, 2005 was approximately $11.5 million and $32.4 million, respectively. The increase in the gross carrying amount of the Company’s purchased intangible assets at May 31, 2006 was the result of several acquisitions consummated in the current fiscal year, offset by the write-off of certain fully amortized intangible assets. The decrease in the accumulated amortization of the Company’s purchased intangible assets at May 31, 2006 was due to the write-off of certain fully amortized intangible assets.

The estimated future amortization expense is as follows (in thousands):

 

Fiscal year ending August 31,

   Amount

2006 (remaining three months)

   $ 8,049

2007

     22,987

2008

     18,251

2009

     14,568

2010

     14,415

Thereafter

     62,525
      

Total

   $ 140,795
      

 

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The following table presents the changes in goodwill allocated to the Company’s reportable segments during the nine months ended May 31, 2006 (in thousands):

 

Reportable Segment

  

Balance at

August 31,
2005

   Acquisitions
and purchase
accounting
adjustments
    Foreign
currency
impact
   

Balance at

May 31,
2006

Americas

   $ 119,317    $ (1,257 )   $ 477     $ 118,537

Europe

     175,295      (2,157 )     5,032       178,170

Asia

     65,100      120,058       (339 )     184,819

Other non-reportable segment

     24,527      1,179       193       25,899
                             

Total

   $ 384,239    $ 117,823     $ 5,363     $ 507,425
                             

Note 9. Business Acquisitions

    a. Business Acquisitions

The Company has made a number of acquisitions that were accounted for under the purchase method of accounting. Accordingly, the operating results of each acquired business are included in the Consolidated Financial Statements of the Company from the respective date of acquisition. In accordance with SFAS 142, goodwill related to the Company’s business acquisitions is not being amortized and is tested for impairment annually during the fourth quarter of each fiscal year and whenever events or changes in circumstances indicate that the carrying value may not be recoverable from its estimated future cash flows.

On November 29, 2004, the Company purchased certain television assembly operations of Royal Philips Electronics (“Philips”) in Kwidzyn, Poland. The Company acquired these operations in an effort to broaden its operations in the consumer industry sector and further strengthen its relationship with Philips. Simultaneous with the purchase, the Company amended its previously existing supply agreement with Philips to include the acquired operations. The acquisition was accounted for under the purchase method of accounting. Total consideration paid was approximately $20.1 million, based on foreign currency rates at the date of the acquisition. Based on a final third-party valuation, the purchase price resulted in amortizable intangible assets of approximately $2.7 million, which are being amortized over a period of three years.

On March 11, 2005, the Company purchased the operations of Varian Electronics Manufacturing (“VEM”), the electronics manufacturing business segment of Varian, Inc. VEM derives its revenues primarily from customers in the aerospace, communications, and instrumentation and medical industry sectors. The Company acquired the VEM operations in an effort to enhance customer and industry sector diversification by adding additional competencies in targeted industry sectors. The acquisition was accounted for under the purchase method of accounting. Total consideration paid was approximately $202.2 million. Based on a final third-party valuation, the purchase price resulted in purchased intangible assets of $44.1 million and goodwill of $79.2 million. The purchased intangible assets (other than goodwill) are being amortized over a period of ten years.

Pro forma results of operations, in respect to the acquisitions described above that were consummated in fiscal year 2005, have not been presented because the effect of these acquisitions was not material on either an individual or an aggregate basis.

During the three months ended February 28, 2006, the Company made several immaterial business acquisitions, which were accounted for under the purchase method of accounting. Total consideration paid for these business acquisitions was approximately $12.4 million. Based on preliminary third-party valuations, which are expected to be completed no later than the first quarter of fiscal year 2007, the combined purchase price of the acquisitions resulted in purchased intangible assets of approximately $3.0 million and goodwill of approximately $1.3 million. The purchased intangible assets (other than goodwill) are being amortized over various periods ranging from three to ten years.

During the three months ended May 31, 2006, the Company made an immaterial business acquisition, which was accounted for under the purchase method of accounting. Total purchase consideration for this business acquisition was approximately $10.0 million, based on foreign currency rates at the date of acquisition. Based on management’s preliminary valuation, the purchase consideration resulted in goodwill of $1.6 million. A third-party valuation of the acquired operations is in process and is expected to be completed no later than the third quarter of fiscal year 2007.

 

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Pro forma results of operations, in respect to the acquisitions described above that were consummated in fiscal year 2006, have not been presented because the effect of these acquisitions was not material on either an individual or an aggregate basis.

    b. Celetronix Acquisition

During the third quarter of fiscal year 2005, the Company entered into several related agreements with Celetronix. The agreements included, but were not limited to, a loan agreement and an agreement and plan of amalgamation (“Original Agreement”). Under the terms of the loan agreement, the Company agreed, subject to various conditions, to loan Celetronix a maximum amount of $25.0 million, of which $15.0 million was disbursed upon execution of the agreements. The remaining $10.0 million principal under the loan agreement was transferred to an escrow agent to be disbursed to Celetronix only upon satisfaction of various requirements as defined in the related escrow agreement. These requirements were satisfied during the fourth quarter of fiscal year 2005 and the remaining $10.0 million principal was disbursed to Celetronix. The loan, which was evidenced by a promissory note, accrued interest at a stated rate of 2.5% per annum from the disbursement date. The principal was due and payable in a single payment on November 1, 2006 and interest was payable annually in arrears on November 1 of each year.

The related Original Agreement granted the Company an option to acquire all of the outstanding stock of Celetronix through amalgamation with a newly-formed subsidiary of the Company (“the purchase option”). The purchase option, which was granted upon execution of the loan agreement for no additional consideration, allowed the Company to demand the amalgamation at any time prior to a specific date. The Original Agreement also dictated the initial and contingent purchase consideration payable by the Company upon exercise of the purchase option. Based on the terms of the Original Agreement, the purchase option was to expire on November 1, 2005, subject to certain potential limited extensions. Prior to November 1, 2005, the Company began negotiations toward a potential amendment to the Original Agreement to reduce the minimum purchase price and modify certain other terms of the agreement. A first amendment to the Original Agreement extended the expiration date of the purchase option to November 15, 2005. A second amendment to the Original Agreement further extended the expiration date of the purchase option to December 2, 2005. Subsequent to November 30, 2005, the December 2, 2005 expiration date set forth in the Original Agreement occurred. The Company and Celetronix continued negotiations on the potential transaction and signed a third amendment to the Original Agreement that extended the purchase option expiration date to January 13, 2006.

On January 11, 2006, the Company and Celetronix entered into a new agreement and plan of amalgamation (“Revised Agreement”) to supersede the Original Agreement, as amended. The Revised Agreement was similar to the Original Agreement; however, it reflected a reduced purchase price, eliminated the potential contingent consideration payable, and modified certain other terms of the Original Agreement. Based on the terms of the Revised Agreement, the amalgamation could occur when certain conditions were satisfied.

On March 31, 2006 the Company consummated the acquisition of Celetronix pursuant to the Revised Agreement. The Company acquired the Celetronix operations, excluding the memory business, in an effort to expand its presence in India and enhance customer and industry sector diversification by adding additional competencies in the consumer and peripherals industry sectors. The acquisition was accounted for under the purchase method of accounting. The purchase consideration for the transaction included approximately $152.0 million in cash paid at closing; the $3.8 million purchase option and $23.8 million related to the note receivable owed from Celetronix that were recorded in the Company’s current assets at the acquisition date; approximately $30.2 million outstanding accounts receivable owed from Celetronix to the Company as of the acquisition date; the assumption of certain liabilities; and certain other items. The purchase consideration is subject to change depending on the final purchase accounting adjustments. Based on management’s preliminary valuation, the purchase consideration resulted in purchased intangible assets of $85.0 million and goodwill of $77.8 million. The purchased intangible assets (other than goodwill) are currently being amortized over a period of 10 years. A third-party valuation of the acquired operations is in process and is expected to be completed no later than the third quarter of fiscal year 2007.

 

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Pro forma results of operations have not been presented because the effect of this acquisition was not material on either an individual or an aggregate basis.

Note 10. Accounts Receivable Securitization

In February 2004, the Company entered into an asset-backed securitization program with a bank, which originally provided for net cash proceeds at any one time of an amount up to $100.0 million on the sale of eligible accounts receivable of certain domestic operations. As a result of an amendment in April 2004, the program was increased to an amount up to $120.0 million of net cash proceeds at any one time. As a result of a second amendment in February 2005, the program was renewed and increased to an amount up to $145.0 million of net cash proceeds at any one time. The program was increased to an amount up to $175.0 million of net cash proceeds at any one time by a third amendment in May 2005. A fourth amendment in November 2005 increased the program to an amount up to $250.0 million of net cash proceeds at any one time. As a result of a fifth amendment in February 2006, the program was renewed. The sale of receivables under this securitization program is accounted for in accordance with Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125) . Under the agreement, the Company continuously sells a designated pool of trade accounts receivable to a wholly-owned subsidiary, which in turn sells an ownership interest in the receivables to a conduit, administered by an unaffiliated financial institution. This wholly-owned subsidiary is a separate bankruptcy-remote entity and its assets would be available first to satisfy the creditor claims of the conduit. As the receivables sold are collected, the Company is able to sell additional receivables up to the maximum permitted amount under the program. The securitization program requires compliance with several financial covenants including an interest coverage ratio and debt to EBITDA ratio, as defined in the securitization agreements, as amended. The Company was in compliance with the respective covenants at May 31, 2006. The securitization agreement, as amended, expires in February 2007 and may be extended on an annual basis.

For each pool of eligible receivables sold to the conduit, the Company retains a percentage interest in the face value of the receivables, which is calculated based on the terms of the agreement. Net receivables sold under this program are excluded from accounts receivable on the Consolidated Balance Sheet and are reflected as cash provided by operating activities on the Consolidated Statement of Cash Flows. The Company continues to service, administer and collect the receivables sold under this program. The Company pays facility fees of 0.18% per annum of the average purchase limit and program fees of up to 0.18% of outstanding amounts. The investors and the securitization conduit have no recourse to the Company’s assets for failure of debtors to pay when due.

At May 31, 2006, the Company had sold $342.0 million of eligible accounts receivable, which represents the face amount of total outstanding receivables at that date. In exchange, the Company received cash proceeds of $242.2 million and retained an interest in the receivables of approximately $99.8 million. In connection with the securitization program, the Company recognized pretax losses on the sale of receivables of approximately $3.5 million and $8.4 million during the three months and nine months ended May 31, 2006, respectively, and approximately $1.1 million and $2.5 million during the three months and nine months ended May 31, 2005, respectively, which are recorded as an other expense on the Condensed Consolidated Statement of Earnings.

Note 11. Pension and Other Postretirement Benefits

During the first quarter of fiscal year 2002, the Company established a defined benefit pension plan for all permanent employees of Jabil Circuit UK Limited. This plan was established in accordance with the terms of the business sale agreement with Marconi Communications plc (“Marconi”). The benefit obligations and plan assets from the terminated Marconi plan were transferred to the newly established defined benefit plan. The plan, which is closed to new participants, provides benefits based on average employee earnings over a three-year service period preceding retirement. The Company’s policy is to contribute amounts sufficient to meet minimum funding requirements as set forth in U.K. employee benefit and tax laws plus such additional amounts as are deemed appropriate by the Company. Plan assets are held in trust and consist of equity and debt securities.

As a result of acquiring various operations in Austria, Belgium, Brazil, France, Germany, Hong Kong/China, Hungary, India, Japan, the Netherlands, Poland, and Singapore, the Company assumed primarily unfunded retirement benefits to be paid based upon years of service and compensation at retirement. All permanent employees meeting the minimum service requirement are eligible to participate in the plans. Through the Philips acquisition in fiscal year 2003, the Company also assumed post-retirement medical benefit plans.

 

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The Company uses a May 31 measurement date for substantially all of the above referenced plans. The following table provides information about net periodic benefit cost for the Company’s pension plans for the periods indicated (in thousands of dollars):

 

     Three months ended     Nine months ended  
    

May 31,

2006

   

May 31,

2005

   

May 31,

2006

   

May 31,

2005

 

Service cost

   $ 432     $ 348     $ 1,279     $ 1,044  

Interest cost

     1,171       1,224       3,469       3,645  

Expected long-term return on plan assets

     (994 )     (1,136 )     (2,945 )     (3,378 )

Net curtailment (gain)/loss

     —         —         —         —    

Recognized actuarial loss

     136       22       403       65  
                                

Net periodic benefit cost

   $ 745     $ 458     $ 2,206     $ 1,376  
                                

For the nine months ended May 31, 2006, the Company has made contributions of approximately $1.1 million to its defined benefit pension plans. The Company presently anticipates total fiscal year 2006 contributions to approximate $2.0 million to $2.3 million.

The following table provides information about net periodic benefit cost for the Company’s other benefit plans for the periods indicated (in thousands of dollars):

 

     Three months ended    Nine months ended
    

May 31,

2006

   

May 31,

2005

  

May 31,

2006

   

May 31,

2005

Service cost

   $ 83     $ 36    $ 241     $ 103

Interest cost

     21       15      61       43

Expected long-term return on plan assets

     —         —        —         —  

Net curtailment (gain)/loss

     —         —        —         —  

Recognized actuarial gain

     (1 )     —        (2 )     —  
                             

Net periodic benefit cost

   $ 103     $ 51    $ 300     $ 146
                             

Note 12. Subsequent Event

On June 29, 2006, the Company’s Board of Directors authorized the repurchase of up to $200 million worth of shares of the Company’s common stock during the next year. The shares will be repurchased in open market transactions or privately negotiated transactions at the Company’s discretion, subject to market conditions and other factors. The repurchase will be funded by cash on hand, available borrowings under revolving credit facilities, and funds provided by operations.

 

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JABIL CIRCUIT, INC. AND SUBSIDIARIES

References in this report to “the Company”, “Jabil”, “we”, “our”, or “us” mean Jabil Circuit, Inc. together with its subsidiaries, except where the context otherwise requires. This Quarterly Report on Form 10-Q contains certain statements that are, or may be deemed to be, forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, and are made in reliance upon the protections provided by such acts for forward-looking statements. These forward-looking statements (such as when we describe what “will”, “may” or “should” occur, what we “plan”, “intend”, “estimate”, “believe”, “expect” or “anticipate” will occur, and other similar statements) include, but are not limited to, statements regarding future sales and operating results, future prospects, anticipated benefits of proposed (or future) acquisitions and new facilities, growth, the capabilities and capacities of business operations, any financial or other guidance and all statements that are not based on historical fact, but rather reflect our current expectations concerning future results and events. We make certain assumptions when making forward-looking statements, any of which could prove inaccurate, including, but not limited to, statements about our future operating results and business plans. Therefore, we can give no assurance that the results implied by these forward-looking statements will be realized. Furthermore, the inclusion of forward-looking information should not be regarded as a representation by the Company or any other person that future events, plans or expectations contemplated by the Company will be achieved. The ultimate correctness of these forward-looking statements is dependent upon a number of known and unknown risks and events, and is subject to various uncertainties and other factors that may cause our actual results, performance or achievements to be different from any future results, performance or achievements expressed or implied by these statements. The following important factors, among others, could affect future results and events, causing those results and events to differ materially from those expressed or implied in our forward-looking statements:

 

    business conditions and growth in our customers’ industries, the electronic manufacturing services industry and the general economy;

 

    the results of the review of our past stock option grants being conducted by a Special Committee of our Board and Governmental Authorities and any ramifications thereof;

 

    variability of operating results;

 

    our dependence on a limited number of major customers;

 

    the potential consolidation of our customer base;

 

    availability of components;

 

    dependence on certain industries;

 

    seasonality;

 

    variability of customer requirements;

 

    our ability to successfully negotiate definitive agreements and consummate acquisitions, and to integrate operations following consummation of acquisitions;

 

    our ability to take advantage of our past restructuring efforts to improve utilization and realize savings;

 

    other economic, business and competitive factors affecting our customers, our industry and our business generally; and

 

    other factors that we may not have currently identified or quantified.

For a further list and description of various risks, relevant factors and uncertainties that could cause future results or events to differ materially from those expressed or implied in our forward-looking statements, see “Risk Factors” below, as well as our Annual Report on Form 10-K for the fiscal year ended August 31, 2005, any subsequent Reports on Form 10-Q and Form 8-K and other filings with the Securities and Exchange Commission. Given these risks and uncertainties, the reader should not place undue reliance on these forward-looking statements.

All forward-looking statements included in this Quarterly Report on Form 10-Q are made only as of the date of this Quarterly Report on Form 10-Q, and we do not undertake any obligation to publicly update or correct any forward-looking statements to reflect events or circumstances that subsequently occur, or of which we hereafter become aware. You should read this document and the documents that we incorporate by reference into this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We may not update these forward-looking statements, even if our situation changes in the future. All forward-looking statements attributable to us are expressly qualified by these cautionary statements.

 

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Item 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are one of the leading providers of worldwide electronic manufacturing services and solutions. We provide comprehensive electronics design, production, product management and repair services to companies in the aerospace, automotive, computing, consumer, defense, industrial, instrumentation, medical, networking, peripherals, storage and telecommunications industries. We currently depend, and expect to continue to depend, upon a relatively small number of customers for a significant percentage of our net revenue. Based on net revenue for the nine months ended May 31, 2006, our largest customers currently include Agilent Technologies, Cisco Systems, Inc., Hewlett-Packard Company, International Business Machines Corporation, Network Appliance, NEC Corporation, Nokia Corporation, Royal Philips Electronics, Tellabs, Inc., and Valeo S.A.

We serve our customers primarily with dedicated business units that combine highly automated, continuous flow manufacturing with advanced electronic design and design for manufacturability technologies. Our business units are capable of providing our customers with varying combinations of the following services:

 

    integrated design and engineering;

 

    component selection, sourcing and procurement;

 

    automated assembly;

 

    design and implementation of product testing;

 

    parallel global production;

 

    enclosure services;

 

    systems assembly, direct order fulfillment and configure to order; and

 

    repair and warranty.

We currently conduct our operations in facilities that are located in Austria, Belgium, Brazil, China, England, France, Hungary, Germany, India, Ireland, Italy, Japan, Malaysia, Mexico, the Netherlands, Poland, Scotland, Singapore, Taiwan, Ukraine and the United States. Our global manufacturing production sites allow our customers to manufacture products in parallel in what we believe are the most efficient marketplaces for their products. Our services allow customers to improve supply-chain management, reduce inventory obsolescence, lower transportation costs and reduce product fulfillment time. We have identified our global presence as a key to assessing our business performance. While the services provided, the manufacturing process, the class of customers and the order fulfillment process is similar across manufacturing locations, we evaluate our business performance on a geographic basis. Accordingly, our reportable operating segments consist of three geographic regions – the Americas, Europe, and Asia – to reflect how we manage our business. We have also created a separate segment for our service groups, independent of our geographic region segments.

The industry in which we operate is composed of companies that provide a range of manufacturing and design services to companies that utilize electronics components. The industry experienced rapid change and growth through the 1990’s as an increasing number of companies chose to outsource an increasing portion, and, in some cases, all of their manufacturing requirements. In mid-2001, the industry’s revenue declined as a result of significant cut-backs in customer production requirements, which was consistent with the overall global economic downturn at the time. In response to this industry and global economic downturn, we implemented restructuring programs to reduce our cost structure and further align our manufacturing capacity with the geographic production demands of our customers. Additionally, over the last three years we have made concentrated efforts to diversify our industry sectors and customer base through acquisitions and organic growth. Industry revenues generally began to stabilize in 2003 and companies continue to turn to outsourcing versus internal manufacturing. We believe further growth opportunities exist for the industry to penetrate the worldwide electronics markets.

Summary of Results

Net revenue for the third quarter of fiscal year 2006 increased approximately 33.7% to $2.6 billion compared to $1.9 billion for the same period of fiscal year 2005. Our sales levels during the third quarter of fiscal year 2006 improved across most industry sectors, demonstrating our continued trend of industry sector and customer diversification. The increase in our revenue base year-over-year represents stronger market share with our existing

 

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programs; and organic growth from new and existing customers as vertical companies continue to convert to an outsourced model. Additionally, we continue to enhance our business model by adding services in the areas of collaborative design, system integration, order fulfillment and repair.

Certain of our expenses during the third quarter of fiscal year 2006 were higher than anticipated. Invariably, each quarter, certain expenses are ultimately less than anticipated and certain expenses are ultimately higher than anticipated. While it is difficult to always single out particular types of costs as being the primary cause of higher than anticipated expenses in a quarter, we have identified at least three areas where expenses were significantly higher than anticipated during our recent third quarter of fiscal year 2006. These areas are not the only areas where expenses were higher than anticipated in the quarter. One area involved approximately $6.0 to $7.0 million of higher than anticipated operating losses incurred as a result of delays in the ramp-up of specific electromechanical tooling operations for a customer. These delays were due to resolvable technical and management process software issues. We previously anticipated the customer reimbursing us for the cost of these operations during the quarter, however we were not reimbursed. A second area involved approximately $6.0 to $7.0 million of higher than anticipated material and labor costs associated with our repair and warranty operations in the Americas region. These higher than anticipated costs were primarily a result of ramping a new program with an existing customer and a higher than anticipated rate of product needing repair. A third area involved approximately $6.0 million of higher than anticipated costs associated with operational execution issues encountered by one of our U.S. operations. We are in the process of addressing these and other areas with the goal of reducing the negative impact they may have on future results of operations over coming fiscal quarters. There can be no assurance that our efforts will be successful or that higher than anticipated expenses in these and other areas will not adversely affect our future financial results.

The following table sets forth, for the three-month and nine-month period indicated, certain key operating results and other financial information (in thousands, except per share data).

 

     Three months ended    Nine months ended
    

May 31,

2006

  

May 31,

2005

  

May 31,

2006

  

May 31,

2005

Net revenue

   $ 2,592,464    $ 1,938,415    $ 7,311,833    $ 5,487,796

Gross profit

   $ 187,643    $ 162,082    $ 568,113    $ 457,392

Operating income

   $ 77,256    $ 73,236    $ 249,425    $ 201,315

Net income

   $ 64,226    $ 59,353    $ 210,137    $ 161,315

Earnings per share – basic

   $ 0.31    $ 0.29    $ 1.01    $ 0.80

Earnings per share – diluted

   $ 0.30    $ 0.29    $ 0.99    $ 0.78

Cash dividend per share – declared

   $ 0.07    $ —      $ 0.07    $ —  

Key Performance Indicators

Management regularly reviews financial and non-financial performance indicators to assess the Company’s operating results. The following table sets forth, for the quarterly periods indicated, certain of management’s key financial performance indicators.

 

     Three months ended
    

May 31,

2006

  

February 28,

2006

  

November 30,

2005

  

August 31,

2005

Sales cycle

   19 days    19 days    15 days    17 days

Inventory turns

   8 turns    9 turns    9 turns    9 turns

Days in accounts receivable

   40 days    42 days    41 days    42 days

Days in inventory

   46 days    42 days    38 days    39 days

Days in accounts payable

   67 days    65 days    64 days    64 days

The sales cycle is calculated as the sum of days in accounts receivable and days in inventory, less the days in accounts payable; accordingly, the variance in the sales cycle quarter over quarter is a direct result of changes in these indicators. During the three months ended May 31, 2006, days in accounts receivable decreased two days to

 

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40 days as a result of timing of sales and cash collection efforts during the quarter. Days in inventory increased 4 days to 46 days, while inventory turns decreased 1 turn to 8 turns. The increase in days in inventory was primarily a result of approximately $100.0 million of incremental inventory associated with our partnering with an existing customer in a new initiative to improve the customer’s inventory planning process whereby the company assumes greater supply chain management responsibilities (“new lean manufacturing process”) and our acquisition of Celetronix International, Ltd. (“Celetronix”); and the pre-positioning of inventory in anticipation of forecasted fourth fiscal quarter demand. During the three months ended May 31, 2006, days in accounts payable increased two days to 67 days as a result of timing of purchases during the quarter and continued emphasis on cash management.

Critical Accounting Policies and Estimates

The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and judgments that affect our reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an on-going basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. Management believes that our estimates and assumptions are reasonable under the circumstances; however, actual results may vary from these estimates and assumptions under different future circumstances. We have identified the following critical accounting policies that affect the more significant judgments and estimates used in the preparation of our consolidated financial statements. For further discussion of our significant accounting policies, refer to Note 1 - “Description of Business and Summary of Significant Accounting Policies” to the Consolidated Financial Statements in our 2005 Annual Report on Form 10-K for the fiscal year ended August 31, 2005.

Revenue Recognition

We derive revenue principally from the product sales of electronic equipment built to customer specifications. We also derive revenue to a lesser extent from repair services, design services and excess inventory sales. Revenue from product sales and excess inventory sales is generally recognized, net of estimated product return costs, when goods are shipped; title and risk of ownership have passed; the price to the buyer is fixed or determinable; and recoverability is reasonably assured. Service related revenue is recognized upon completion of the services. We assume no significant obligations after product shipment.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts related to receivables not expected to be collected from our customers. This allowance is based on management’s assessment of specific customer balances, considering the age of receivables and financial stability of the customer. If there is an adverse change in the financial condition of our customers, or if actual defaults are higher than provided for, an addition to the allowance may be necessary.

Inventory Valuation

We purchase inventory based on forecasted demand and record inventory at the lower of cost or market. Management regularly assesses inventory valuation based on current and forecasted usage and other lower of cost or market considerations. If actual market conditions or our customers’ product demands are less favorable than those projected, additional valuation adjustments may be necessary.

Long-Lived Assets

We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of property, plant and equipment is measured by comparing its carrying value to the projected cash flows the property, plant and equipment are expected to generate. If the carrying amount of an asset is not recoverable, we recognize an impairment loss based on the excess of the carrying amount of the long-lived asset over its respective fair value. The impairment analysis is based on significant assumptions of future results made by management, including revenue and cash flow projections. Circumstances that may lead to impairment of property, plant and equipment include unforeseen decreases in future performance or industry demand and the restructuring of our operations resulting from a change in our business strategy. For further discussion of our potential future restructuring program, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Restructuring and Impairment Charges.”

 

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We have recorded intangible assets, including goodwill, principally based on third-party valuations, in connection with business acquisitions. Estimated useful lives of amortizable intangible assets are determined by management based on an assessment of the period over which the asset is expected to contribute to future cash flows. The allocation of amortizable intangible assets impacts the amounts allocable to goodwill. In accordance with SFAS 142, we are required to perform a goodwill impairment test at least on an annual basis and whenever events or circumstances indicate that the carrying value may not be recoverable from estimated future cash flows. We completed the annual impairment test during the fourth quarter of fiscal 2005 and determined that no impairment existed as of the date of the impairment test. The impairment test is performed at the reporting unit level, which we have determined to be consistent with our operating segments as defined in Note 5 – “Segment Information” to the Condensed Consolidated Financial Statements. The impairment analysis is based on assumptions of future results made by management, including revenue and cash flow projections at the reporting unit level. Circumstances that may lead to impairment of goodwill or intangible assets include unforeseen decreases in future performance or industry demand, and the restructuring of our operations resulting from a change in our business strategy. For further information on our intangible assets, including goodwill, refer to Note 8 – “Goodwill and Other Intangible Assets” to the Condensed Consolidated Financial Statements.

Restructuring and Impairment Charges

We have recognized restructuring and impairment charges related to reductions in workforce, re-sizing and closure of facilities and the transition of certain facilities into new customer development sites. These charges were recorded pursuant to formal plans developed and approved by management. The recognition of restructuring and impairment charges requires that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with these plans. The estimates of future liabilities may change, requiring additional restructuring and impairment charges or the reduction of liabilities already recorded. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained and the utilization of the provisions are for their intended purpose in accordance with the restructuring programs. For further discussion of our historical restructuring programs refer to Note 7 – “Restructuring and Impairment Charges” to the Condensed Consolidated Financial Statements. For further discussion of our potential future restructuring program, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Results of Operations – Restructuring and Impairment Charges.”

Pension and Postretirement Benefits

We have pension and postretirement benefit costs and liabilities, which are developed from actuarial valuations. Actuarial valuations require management to make certain judgments and estimates of discount rates and return on plan assets. We evaluate these assumptions on a regular basis taking into consideration current market conditions and historical market data. The discount rate is used to state expected future cash flows at a present value on the measurement date. This rate represents the market rate for high-quality fixed income investments. A lower discount rate increases the present value of benefit obligations and increases pension expense. When considering the expected long-term rate of return on pension plan assets, we take into account current and expected asset allocations, as well as historical and expected returns on plan assets. Other assumptions include demographic factors such as retirement, mortality and turnover. For further discussion of our pension and postretirement benefits, refer to Note 11 – “Pension and Other Postretirement Benefits” to the Condensed Consolidated Financial Statements.

Income Taxes

We estimate our income tax provision in each of the jurisdictions in which we operate, a process that includes estimating exposures related to examinations by taxing authorities. We must also make judgments regarding the ability to realize deferred tax assets. The carrying value of our net deferred tax assets is based on our belief that it is more likely than not that we will generate sufficient future taxable income in certain jurisdictions to realize these deferred tax assets. A valuation allowance has been established for deferred tax assets that we do not believe meet the “more likely than not” criteria established by Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Our judgments regarding future taxable income may change due to changes in market conditions, changes in tax laws or other factors. If our assumptions and consequently our estimates change in the future, the valuation allowances we have established may be increased or decreased, resulting in a respective increase or decrease in either income tax expense or goodwill. For further discussion related to our income taxes, refer to Note 6 – “Income Taxes” to the Consolidated Financial Statements in our 2005 Annual Report on Form 10-K for the fiscal year ended August 31, 2005.

 

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Stock-Based Compensation

In accordance with the provisions of Financial Accounting Standards Board Statement No. 123R, Share-Based Payment, (“SFAS 123R”) and the Security and Exchange Commission Staff Accounting Bulletin No. 107 (“SAB 107”), we began recognizing stock-based compensation expense in our consolidated statement of earnings on September 1, 2005. The fair value of options granted prior to September 1, 2005 were valued using the Black-Scholes model while the stock appreciation rights granted after this date were valued using a lattice valuation model. Option pricing models require the input of subjective assumptions, including the expected life of the option or stock appreciation right and the price volatility of the underlying stock. Judgment is also required in estimating the number of stock awards that are expected to vest as a result of satisfaction of time-based vesting schedules or the achievement of certain performance conditions. If actual results or future changes in estimates differ significantly from our current estimates, stock-based compensation could increase or decrease. For further discussion of our stock-based compensation, refer to Note 4 – “Stock-Based Compensation” to the Condensed Consolidated Financial Statements. As described herein, we are involved in shareholder derivative actions and a Securities and Exchange Commission (“SEC”) Informal Inquiry, and have received a subpoena from the U.S. Attorney’s office for the Southern District of New York in connection with certain historical stock option grants. We cannot predict the outcome of those investigations.

Results of Operations

The following table sets forth, for the periods indicated, certain statements of earnings data expressed as a percentage of net revenue:

 

     Three months ended     Nine months ended  
    

May 31,

2006

   

May 31,

2005

   

May 31,

2006

   

May 31,

2005

 

Net revenue

   100.0 %   100.0 %   100.0 %   100.0 %

Cost of revenue

   92.8 %   91.6 %   92.2 %   91.7 %
                        

Gross profit

   7.2 %   8.4 %   7.8 %   8.3 %

Operating expenses:

        

Selling, general and administrative

   3.5 %   3.7 %   3.8 %   3.8 %

Research and development

   0.4 %   0.3 %   0.3 %   0.3 %

Amortization of intangibles

   0.3 %   0.6 %   0.3 %   0.6 %
                        

Operating income

   3.0 %   3.8 %   3.4 %   3.6 %

Other expense

   0.2 %   0.1 %   0.1 %   0.0 %

Interest income

   (0.2 )%   (0.2 )%   (0.2 )%   (0.2 )%

Interest expense

   0.2 %   0.3 %   0.2 %   0.3 %
                        

Income before income taxes

   2.8 %   3.6 %   3.3 %   3.5 %

Income tax expense

   0.3 %   0.6 %   0.4 %   0.6 %
                        

Net income

   2.5 %   3.0 %   2.9 %   2.9 %
                        

Net Revenue. Our net revenue for the three months ended May 31, 2006 increased 33.7% to $2.6 billion, from $1.9 billion for the three months ended May 31, 2005. The increase for the three months ended May 31, 2006 from the same period of the previous fiscal year was due to increased sales levels across most industry sectors. Specific increases include an 86% increase in the sale of consumer products; a 38% increase in the sale of instrumentation and medical products; a 50% increase in the sale of peripheral products; and a 22% increase in the sale of computing and storage products. The increased sales levels were due to the addition of new customers and organic growth in these industry sectors. The increase in the consumer industry sector was primarily attributable to new and existing program growth resulting from our product diversification efforts within this sector. The increase in the instrumentation and medical industry sector was primarily attributable to increased sales levels as more

 

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vertical companies in this industry sector are electing to outsource their production. These increases were partially offset by a 5% decrease in the sale of automotive products; a 23% decrease in the sale of networking products; and a 14% decrease in the sale of telecommunications products. The decrease in the networking industry sector was primarily attributable to our partnering with an existing customer in a new lean manufacturing process. The decrease in the telecommunications industry sector was primarily due to the end of production for Lucent Technologies, Inc.

Our net revenue for the nine months ended May 31, 2006 increased 33.2% to $7.3 billion, from $5.5 billion for the nine months ended May 31, 2005. The increase for the nine months ended May 31, 2006 from the same period of the previous fiscal year was due to increased sales levels across most industry sectors. Specific increases include a 77% increase in the sale of consumer products; a 48% increase in the sale of instrumentation and medical products; a 35% increase in the sale of peripheral products; and a 17% increase in the sale of computing and storage products. The increased sales levels were due to the addition of new customers and organic growth in these industry sectors. The increase in the consumer industry sector was primarily attributable to new and existing program growth resulting from our product diversification efforts within this sector. The increase in the instrumentation and medical industry sector was primarily attributable to increased sales levels as more vertical companies in this industry sector are electing to outsource their production and the acquisition of VEM in March 2005. These increases were partially offset by a 7% decrease in the sale of networking products; a 4% decrease in the sale of telecommunications products; and a 1% decrease in the sale of automotive products.

The following table sets forth, for the periods indicated, revenue by industry sector expressed as a percentage of net revenue. The distribution of revenue across our industry sectors has fluctuated, and will continue to fluctuate, as a result of numerous factors, including but not limited to the following: increased business from new and existing customers; fluctuations in customer demand; seasonality, especially in the automotive and consumer industry sectors; and increased growth in the automotive, consumer, and instrumentation and medical products industry sectors as more vertical companies are electing to outsource their production in these areas.

 

     Three months ended     Nine months ended  
    

May 31,

2006

   

May 31,

2005

   

May 31,

2006

   

May 31,

2005

 

Automotive

   5 %   8 %   6 %   8 %

Computing and Storage

   12 %   13 %   11 %   13 %

Consumer

   38 %   27 %   37 %   28 %

Instrumentation and Medical

   18 %   16 %   17 %   15 %

Networking

   9 %   16 %   11 %   16 %

Peripherals

   8 %   7 %   7 %   7 %

Telecommunications

   6 %   9 %   7 %   9 %

Other

   4 %   4 %   4 %   4 %
                        

Total

   100 %   100 %   100 %   100 %
                        

Foreign source revenue represented 83.1% and 83.5% of net revenue for the three months and nine months ended May 31, 2006, respectively. This is compared to 82.0% and 84.4% of net revenue for the three months and nine months ended May 31, 2005, respectively. We currently expect our foreign source revenue to remain consistent with current levels.

Gross Profit. Gross profit decreased to 7.2% of net revenue for the three months ended May 31, 2006, from 8.4% of net revenue for the three months ended May 31, 2005. The percentage decrease for the three months ended May 31, 2006 versus the same period of fiscal year 2005 was primarily due to several factors, including a higher portion of materials-based revenue (driven in part by growth in the consumer industry sector). In addition, as described above, certain higher than anticipated expenses were incurred during the three months ended May 31, 2006. These included a delay in the ramping of specific electromechanical tooling operations, which resulted in excess costs; certain material and labor costs associated with the ramping of a new program for an existing customer in our repair and warranty operations in the Americas region; and various operational execution issues in one of our U.S. operations, some of which was associated with strong demand and the ramping of new programs. In absolute dollars, gross profit for the three months ended May 31, 2006 increased $25.6 million versus the same period of fiscal 2005 due to the increased revenue base, offset by the specific circumstances mentioned above. Gross profit decreased to 7.8% of net revenue for the nine months ended May 31, 2006, from 8.3% of net revenue for the nine months ended May 31, 2005. In absolute dollars, gross profit for the nine months ended May 31, 2006 increased $110.7 million versus the nine months ended May 31, 2005 due to the increased revenue base.

 

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Selling, General and Administrative. Selling, general and administrative expenses for the three months and nine months ended May 31, 2006 increased to $93.5 million (3.5% of net revenue) and $275.1 million (3.8% of net revenue), respectively, compared to $71.7 million (3.7% of net revenue) and $205.9 million (3.8% of net revenue) for the three months and nine months ended May 31, 2005, respectively. The absolute dollar increase for the three and nine months ended May 31, 2006 was primarily due to the recognition of stock-based compensation expense resulting from the adoption of SFAS 123R and the acquisitions of VEM in March 2005 and Celetronix in March 2006.

Research and Development. Research and development expenses for the three months and nine months ended May 31, 2006 increased to $9.6 million (0.4% of net revenue) and $24.8 million (0.3% of net revenue), respectively, from $5.7 million (0.3% of net revenue) and $17.8 million (0.3% of net revenue) for the three months and nine months ended May 31, 2005, respectively. The absolute dollar increase is attributed to growth in our product development activities related to new reference designs, including networking and server products, cell phone products, wireless and broadband access products, consumer products, and storage products. We also continued efforts in the design of circuit board assembly, mechanical design and the related production design process; and the development of new advanced manufacturing technologies.

Amortization of Intangibles. We recorded $7.3 million and $18.8 million of amortization of intangible assets for the three months and nine months ended May 31, 2006, respectively, as compared to $11.5 million and $32.4 million for the three months and nine months ended May 31, 2005, respectively. The decrease is attributed to several acquisition-related contractual agreements that were fully amortized prior to the nine months ended May 31, 2006. For additional information regarding purchased intangibles, see Note 8 – “Goodwill and Other Intangible Assets” and Note 9 – “Business Acquisitions” to the Condensed Consolidated Financial Statements.

Restructuring and Impairment Charges. There were no restructuring charges incurred during the nine months ended May 31, 2006 or 2005. As of May 31, 2006, liabilities related to restructuring activities carried out prior to August 31, 2003 total approximately $1.5 million and are expected to be paid out over the next three months for lease commitment costs.

We continuously evaluate our operations and cost structure relative to general economic conditions, market demands and cost competitiveness, and our geographic footprint as it relates to our customers’ production requirements. As a result of this ongoing evaluation, we currently are consulting with our employees and their representatives on our intentions to realign our manufacturing capacity in certain higher cost geographies. Based on preliminary analyses, we currently estimate that the intended realignment could result in restructuring and impairment charges in the range of $200.0 million to $250.0 million primarily related to costs associated with plant closures and headcount reductions. While the formal plans are subject to consultation with employees and their representatives and approval by our Board of Directors, we currently expect a significant portion the restructuring charge to be recorded in the fourth quarter of fiscal year 2006.

Other Expense . We recorded other expense on the sale of accounts receivable under our securitization program totaling $3.5 million and $8.4 million for the three months and nine months ended May 31, 2006, respectively, which is compared to other expense of $1.1 million and $2.5 million for the three months and nine months ended May 31, 2005, respectively. This increase in other expense was primarily due to an increase in the amount of receivables sold under the program during the three months and nine months ended May 31, 2006. Subsequent to January 2005, several amendments increased the net cash proceeds available at any one time under the program from $120.0 million to $250.0 million. For further discussion of our accounts receivable securitization program, see Note 10 – “Accounts Receivable Securitization” to the Condensed Consolidated Financial Statements.

Interest Income. Interest income increased to $5.0 million and $15.6 million for the three months and nine months ended May 31, 2006, respectively, from $4.2 million and $9.0 million for the three months and nine months ended May 31, 2005, respectively. The increase was primarily due to higher interest yields on higher levels of operating cash, cash deposits and cash equivalents. Additionally, interest income was recorded in relation to the Celetronix note receivable from March 31, 2005 through the March 31, 2006 acquisition date. For further discussion of the note receivable, see Note 9 – “Business Acquisitions” to the Condensed Consolidated Financial Statements.

Interest Expense. Interest expense decreased slightly to $5.8 million for the three months ended May 31, 2006 from $5.9 million for the three months ended May 31, 2005. The decrease was primarily a result of less

 

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borrowing under our revolving credit facility, offset by less capitalized interest, during the three months ended May 31, 2006 compared to May 31, 2005. Interest expense decreased slightly to $15.4 million for the nine months ended May 31, 2006 from $15.5 million for the nine months ended May 31, 2005. The decrease was primarily a result of interest capitalized during the nine months ended May 31, 2006 related to construction in China, and less borrowing under our revolving credit facility, offset by higher interest on our fixed 5.875% senior notes issued in July of 2003 due to the termination of our interest rate swap agreement in June 2005. The interest rate swap effectively converted the fixed interest rate of the Senior Notes to a variable rate during the nine months ended May 31, 2005, which was more favorable than the fixed rate for the nine months ended May 31, 2006.

Income Taxes. Income tax expense reflects an effective tax rate of 11.9% and 12.9% for the three months and nine months ended May 31, 2006, respectively, as compared to an effective rate of 15.8% and 16.1% for the three months and nine months ended May 31, 2005, respectively. The decrease is primarily a result of the tax benefit associated with stock-based compensation expense realized in accordance with SFAS 123R, which we adopted in the first quarter of fiscal year 2006, and lower than expected income levels from our operations in the United States and western Europe. The tax rate is predominantly a function of the mix of tax rates in the various jurisdictions in which we do business. Our international operations have historically been taxed at a lower rate than in the United States, primarily due to tax incentives, including tax holidays, granted to our sites in Malaysia, China, Brazil, Poland, Hungary, and India that expire at various dates through 2017. Such tax holidays are subject to conditions with which we expect to continue to comply.

In October 2004, the President signed into law the “American Jobs Creation Act of 2004” (“the Act”). The Act creates a temporary incentive for U.S. multinational companies to repatriate accumulated foreign earnings by providing an 85% dividends received deduction for certain eligible dividends The deduction is subject to a number of limitations and requirements, including a formal plan for domestic reinvestment of the dividends. In December 2004, the FASB issued FASB Staff Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004 (“FSP 109-2”). FSP 109-2 provides guidance under SFAS 109 with respect to recording the potential impact of the repatriation provisions of the Act on enterprises’ income tax expense and deferred tax liability. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS 109. We are currently evaluating the effects of the repatriation provision and have until August 31, 2006 to complete the analysis. The Company is not yet in a position to decide whether, and to what extent, foreign earnings that have not yet been remitted to the U.S. might be repatriated. At this time, the range of earnings that may be repatriated and the potential range of income tax effects of such repatriation cannot be reasonably estimated.

Acquisitions and Expansion

We have made a number of acquisitions that were accounted for under the purchase method of accounting. Our consolidated financial statements include the operating results of each business from the date of acquisition. See “Risk Factors – We may not achieve expected profitability from our acquisitions.” For further discussion of our recent and planned acquisitions, see Note 9 – “Business Acquisitions” to the Condensed Consolidated Financial Statements and Note 12 – “Business Acquisitions and Other Transactions” to the Consolidated Financial Statements in our 2005 Annual Report on Form 10-K for the fiscal year ended August 31, 2005.

During the fourth quarter of fiscal year 2005, we commenced operations in phase one of our new facility in Szombathely, Hungary, which will support our repair services operations in Europe. We expect to complete the second phase of construction in the fourth quarter of fiscal year 2006. We have substantially completed and commenced operations in our new manufacturing facilities in Ranjangaon, India and Wuxi, China, and we will continue to invest in these facilities as production ramps through the remainder of fiscal year 2006 and into early fiscal year 2007. We currently expect to begin construction of a new facility in Uzhgorod, Ukraine late in the fourth quarter of fiscal year 2006 and commence operations in this facility during the third quarter of fiscal year 2007.

Seasonality

Production levels for our consumer and automotive industry sectors are subject to seasonal influences. We may realize greater net revenue during our first fiscal quarter due to high demand for consumer products during the holiday selling season. Therefore, quarterly results should not be relied upon as necessarily indicative of results for the entire fiscal year.

 

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Dividends

On May 4, 2006, our Board of Directors declared a quarterly cash dividend to common stockholders of $0.07 per share. The cash dividend, totaling approximately $14.9 million, was paid on June 1, 2006 to stockholders of record on May 15, 2006. The declaration and payment of future dividends are discretionary and will be subject to determination by our Board of Directors each quarter following its review of the Company’s financial performance.

Liquidity and Capital Resources

At May 31, 2006, our principal sources of liquidity consisted of cash, available borrowings under our credit facilities and the accounts receivable securitization program. The following table sets forth, for the periods indicated, selected consolidated cash flow information (in thousands).

 

     Nine months ended  
    

May 31,

2006

   

May 31,

2005

 

Net cash provided by operating activities

   $ 270,197     $ 417,384  

Net cash used in investing activities

     (337,675 )     (392,865 )

Net cash provided by financing activities

     108,979       24,209  

Effect of exchange rate changes on cash

     17,307       10,992  
                

Net increase in cash and cash equivalents

   $ 58,808     $ 59,720  
                

We generated $270.2 million of cash from operating activities for the nine months ended May 31, 2006. This consisted primarily of $210.1 million of net income, $147.8 million of non-cash depreciation and amortization charges, $424.8 million of an increase in accounts payable and accrued expenses, and $33.1 million of non-cash stock-based compensation expense, offset by $155.4 million of an increase in accounts receivable, $354.8 million of an increase in inventories, $16.2 million of an increase in net deferred tax assets, and $19.7 million of an increase in prepaid expenses and other current assets. The increase in accounts payable and accrued expenses was due primarily to higher inventory levels and the timing of purchases in the third quarter of fiscal year 2006, combined with continued emphasis on cash management. The increase in accounts receivable was due primarily to the increased revenue base, partially offset by the sale of an incremental $67.2 million of receivables under our securitization program. Inventory levels increased during the three months ended May 31, 2006 primarily due to incremental inventory associated with our partnering with an existing customer in a new lean manufacturing process and the prepositioning of inventory in anticipation of forecasted fourth fiscal quarter demand.

Net cash used in investing activities for the nine months ended May 31, 2006 was $337.7 million. This consisted primarily of our capital expenditures of $184.6 million for manufacturing and computer equipment to support our ongoing business across all segments and for expansion activities in China, Eastern Europe and India; and $162.8 million for the acquisition of Celetronix and several other immaterial business acquisitions. These expenditures were offset by $9.8 million of proceeds from the sale of property and equipment.

Net cash provided by financing activities for the nine months ended May 31, 2006 was $109.0 million. This resulted from approximately $123.7 million of net proceeds received upon the issuance of common stock under option plans and employee stock purchase plans; approximately $12.4 million associated with the tax benefit of options exercised; and approximately $81.1 million of proceeds from borrowings under debt agreements, which primarily included $67.0 million of borrowings under our unsecured revolving credit facility. This was offset by approximately $108.3 million of payments toward debt agreements during the nine months ended May 31, 2006, which primarily included $67.0 million toward repayment of borrowings under our unsecured revolving credit facility and $39.7 million toward payment of certain debt obligations assumed in the acquisition of Celetronix.

We may need to finance future growth and any corresponding working capital needs with additional borrowings under our revolving credit facilities described below, as well as additional public and private offerings of our debt and equity. Approximately $855.0 million of securities remain registered with the SEC under our shelf registration statement at May 31, 2006. The Securities Act of 1933 (the “Act”) Offering Reform, which was

 

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effective on December 1, 2005, has significantly modified the registration and offering process under the Act. Based on the new registration and offering regime, we may file a new “shelf” registration statement to replace the existing “shelf.” Under the new rules, we anticipate that Jabil will be classified as a “well-known seasoned issuer,” thereby allowing the Company to take advantage of the simplified registration procedures. At this time, the Company is still evaluating whether to file a new “shelf” registration statement. In the meantime, the Company may still issue securities under its existing “shelf” registration statement.

During the fourth quarter of fiscal year 2003, we amended and revised our then existing credit facility and established a three-year, $400.0 million unsecured revolving credit facility with a syndicate of banks (the “Amended Revolver”). Under the terms of the Amended Revolver, borrowings could be made under either floating rate loans or Eurodollar rate loans. Interest accrued on outstanding floating rate loans at the greater of the agent’s prime rate or 0.50% plus the federal funds rate. Interest accrued on outstanding Eurodollar loans at the London Interbank Offered Rate (“LIBOR”) in effect at the loan inception plus a spread of 0.65% to 1.35%. A facility fee based on the committed amount of the Amended Revolver was payable at a rate equal to 0.225% to 0.40%. A usage fee was also payable if our borrowings on the Amended Revolver exceeded 33  1 / 3 % of the aggregate commitment. The usage fee rate ranged from 0.125% to 0.25%. The interest spread, facility fee and usage fee were determined based on our general corporate rating or rating of our senior unsecured long-term indebtedness as determined by Standard and Poor’s Rating Service (“S&P”) and Moody’s Investor Service (“Moody’s”). The Amended Revolver had an expiration date of July 14, 2006 when outstanding borrowings would then be due and payable. The Amended Revolver required compliance with several financial covenants including a fixed charge coverage ratio, consolidated net worth threshold and indebtedness to EBITDA ratio, as defined in the Amended Revolver. The Amended Revolver required compliance with certain operating covenants, which limited, among other things, our incurrence of additional indebtedness. On March 10, 2005, we borrowed $80.0 million under the Amended Revolver to partially fund the acquisition of VEM, which was consummated on March 11, 2005. This borrowing was repaid in full during the third quarter of fiscal year 2005 from cash provided by operations.

During the third quarter of fiscal year 2005, we replaced the Amended Revolver and established a five-year, $500.0 million unsecured revolving credit facility with a syndicate of banks (the “Unsecured Revolver”). The Unsecured Revolver, which expires on May 11, 2010, may be increased to a maximum of $750.0 million at the request of the Company if approved by the lenders. Such requests must be for an increase of at least $50.0 million or an integral multiple thereof, and may only be made once per calendar year. Interest and fees on Unsecured Revolver advances are based on the Company’s senior unsecured long-term indebtedness rating as determined by S&P and Moody’s. Interest is charged at either the base rate or a rate equal to 0.50% to 0.950% above the Eurocurrency rate, where the base rate, available for U.S. dollar advances only, represents the greater of the agent’s prime rate or 0.50% plus the federal funds rate, and the Eurocurrency rate represents the applicable LIBOR, each as more fully defined in the Unsecured Revolver. Fees include a facility fee based on the total commitments of the lenders, a letter of credit fee based on the amount of outstanding letters of credit, and a utilization fee to be added to the interest rate and the letter of credit fee during any period when the aggregate amount of outstanding advances and letters of credit exceeds 50% of the total commitments of the lenders. Based on the Company’s current senior unsecured long-term indebtedness rating as determined by S&P and Moody’s, the current rate of interest plus the applicable facility and utilization fee on a full Eurocurrency rate draw would be 1.00% above the Eurocurrency rate as defined above. Among other things, the Unsecured Revolver contains financial covenants establishing a debt to EBITDA ratio and interest coverage ratio; and contains operating covenants, which limit, among other things, our incurrence of indebtedness at the subsidiary level, and the incurrence of liens at all levels. The various covenants, limitations and events of default included in the Unsecured Revolver are currently customary for similar facilities for similarly rated borrowers. The Company was in compliance with the respective covenants at May 31, 2006. On March 30, 2006, we borrowed $40.0 million against the Unsecured Revolver to partially fund the acquisition of Celetronix International, Ltd. on March 31, 2006. This borrowing was repaid in full during the third quarter of fiscal year 2006 from cash provided by operations. On May 16, 2006, we borrowed $27.0 million under this facility and repaid this amount in full by May 23, 2006. At May 31, 2006, there were no borrowings outstanding on the Unsecured Revolver.

On December 2, 2005, we renewed our existing 0.6 billion Japanese yen (approximately $5.4 million based on currency exchange rates at May 31, 2006) credit facility for a Japanese subsidiary with a Japanese bank. Under the terms of the renewed facility, we pay interest on outstanding borrowings based on the Tokyo Interbank Offered Rate plus a spread of 0.50%. The renewed credit facility expires on December 2, 2006 and any outstanding borrowings are then due and payable. At May 31, 2006, there were no borrowings outstanding under the existing facility.

 

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During the second quarter of fiscal year 2004, we entered into an asset-backed securitization program with a bank, which originally provided for net cash proceeds at any one time of an amount up to $100.0 million on the sale of eligible accounts receivable of certain domestic operations. As a result of an amendment in April 2004, the program was increased to an amount up to $120.0 million of net cash proceeds at any one time. As a result of a second amendment in February 2005, the program was renewed and increased to an amount up to $145.0 million of net cash proceeds at any one time. The program was increased to an amount up to $175.0 million of net cash proceeds at any one time by a third amendment in May 2005. A fourth amendment in November 2005 increased the program to an amount up to $250.0 million of net cash proceeds at any one time. As a result of a fifth amendment in February 2006, the program was renewed. Under this agreement, we continuously sell a designated pool of trade accounts receivable to a wholly-owned subsidiary, which in turn sells an ownership interest in the receivables to a conduit, administered by an unaffiliated financial institution. This wholly-owned subsidiary is a separate bankruptcy-remote entity and its assets would be available first to satisfy the claims of the conduit. As the receivables sold are collected, we are able to sell additional receivables up to the maximum permitted amount under the program. The securitization program requires compliance with several financial covenants including an interest coverage ratio and debt to EBITDA ratio, as defined in the securitization agreements, as amended. We were in compliance with the respective covenants at May 31, 2006. The securitization agreements, as amended, expire in February 2007 and may be extended on an annual basis. For each pool of eligible receivables sold to the conduit, we retain a percentage interest in the face value of the receivables, which is calculated based on the terms of the agreement. Net receivables sold under this program are excluded from accounts receivable on the Consolidated Balance Sheet and are reflected as cash provided by operating activities on the Consolidated Statement of Cash Flows. We continue to service, administer and collect the receivables sold under this program. We pay facility fees of 0.18% per annum of the average purchase limit and program fees of up to 0.18% of outstanding amounts. The investors and the securitization conduit have no recourse to the Company’s assets for failure of debtors to pay when due. As of May 31, 2006, we had sold $342.0 million of eligible accounts receivable, which represents the face amount of total outstanding receivables at that date. In exchange, we received cash proceeds of $242.2 million and retained an interest in the receivables of approximately $99.8 million. In connection with the securitization program, we recognized pretax losses on the sale of receivables of approximately $3.5 million and $8.4 million during the three months and nine months ended May 31, 2006, respectively, and approximately $1.1 million and $2.5 million during the three months and nine months ended May 31, 2005, respectively, which are recorded as an other expense on the Condensed Consolidated Statement of Earnings.

During the fourth quarter of fiscal year 2004, we negotiated a two-year, $100.0 thousand credit facility for a Ukrainian subsidiary with a Ukrainian branch of a global bank. During the third quarter of fiscal year 2005, this credit facility was increased to $600.0 thousand. During the first quarter of fiscal year 2006, this credit facility was further increased to $900.0 thousand. However, $800.0 thousand of our availability under the facility was restricted for specific purposes. Under the terms of the facility, we paid interest on outstanding borrowings based on LIBOR plus a spread of 1.5%. We also paid a commitment fee of 2.0% per annum for any capacity that was restricted but not outstanding under the facility. The credit facility expired on June 9, 2006.

During the third quarter of fiscal year 2005, we negotiated a five-year, 400.0 million Indian rupee construction loan for an Indian subsidiary with an Indian branch of a global bank. Under the terms of the loan, we pay interest on outstanding borrowings based on a fixed rate of 7.45%. The construction loan expires on April 15, 2010 and all outstanding borrowings are then due and payable. The 400.0 million Indian rupee principal outstanding is equivalent to approximately $8.6 million based on currency exchange rates at May 31, 2006.

During the third quarter of fiscal year 2005, we negotiated a five-year, 25.0 million Euro construction loan for a Hungarian subsidiary with a Hungarian branch of a global bank. Under the terms of the loan facility, we pay interest on outstanding borrowings based on the Euro Interbank Offered Rate plus a spread of 0.925%. Quarterly principal repayments begin in September 2006 to repay the amount of proceeds drawn under the construction loan. The construction loan expires on April 13, 2010. At May 31, 2006, proceeds of 21.3 million Euros (approximately $27.3 million based on currency exchange rates at May 31, 2006) had been drawn under the construction loan.

During the second quarter of fiscal year 2006, we negotiated a short-term, 225.0 million Indian rupee credit facility for an Indian subsidiary with an Indian branch of a global bank. Under the terms of the facility, we pay

 

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interest on outstanding borrowings based on a fixed rate mutually agreed with the bank at the time of borrowing. At May 31, 2006, borrowings of 110.0 million Indian rupees (approximately $2.4 million based on currency exchange rates at May 31, 2006) were outstanding under this facility and incurring interest at a fixed rate of 7.5%.

During the third quarter of fiscal year 2006, we acquired the operations of Celetronix as discussed in Note 9 – “Business Acquisitions.” Through the acquisition we assumed certain liabilities, including a short term financing obligation of approximately $51.1 million at the date of acquisition. This financing obligation was associated with an accounts receivable discounting agreement with a global bank, which was discontinued at the closing of the acquisition on March 31, 2006. Cash collected on the related accounts receivable is remitted to the bank to satisfy the obligation and all outstanding amounts are due and payable by July 15, 2006. Approximately $14.6 million of the acquired financing obligation remains outstanding at May 31, 2006.

During the third quarter of fiscal year 2006, we assumed a short-term Chinese yuan renmimbi credit facility for an acquired Chinese subsidiary with a Chinese bank. Under the terms of the facility, the bank determines the maximum borrowing limit and applicable fixed interest rate at the time of borrowing. At the date of acquisition, there were no outstanding borrowings under this facility. At May 31, 2006, borrowings of 15.0 million Chinese yuan renmimbi (approximately $1.9 million based on currency exchange rates at May 31, 2006) were outstanding under this facility and incurring interest at a fixed rate of 5.4%. The outstanding amount, which was determined by the bank to be the maximum borrowing limit, is due and payable by November 9, 2006.

During the third quarter of fiscal year 2006, we entered into a sale-leaseback transaction involving our facility in Ayr, Scotland. We continue to occupy the facility through a three-year leasing arrangement with the third-party purchaser, which requires quarterly lease payments of 62.5 thousand pounds sterling (approximately $116.8 thousand based on currency exchange rates at May 31, 2006). We received cash proceeds of approximately 2.8 million pounds sterling (approximately $4.8 million based on currency exchange rates on the date of the transaction) and retained a right to receive additional consideration upon resale of the facility at a later date. Due primarily to our continuing involvement in the property, we were precluded from recording the transaction as a sale. Accordingly, as required by relevant accounting standards, the cash proceeds were recorded as a financing obligation. A portion of the quarterly lease payments are recorded as interest expense, based on an effective yield of 5.875%, and the remainder is recorded as a reduction of the financing obligation. At May 31, 2006, the balance of the financing obligation is approximately 2.7 million pounds sterling (approximately $5.1 million based on currency exchange rates at May 31, 2006).

We currently anticipate that during the next twelve months, our capital expenditures will be in the range of $250.0 million to $350.0 million, principally for machinery and equipment across all segments, and expansion in Eastern Europe. We believe that our level of resources, which include cash on hand, available borrowings under our revolving credit facilities, additional proceeds available under our accounts receivable securitization program and funds provided by operations, will be adequate to fund these capital expenditures, the payment of any declared quarterly dividends, the payment of up to $200.0 million for the repurchase of any Company stock under the approved stock repurchase plan, anticipated cash restructuring charges of approximately $150.0 to $200.0 million, and our working capital requirements for the next twelve months. Should we desire to consummate significant additional acquisition opportunities or undertake significant additional expansion activities, our capital needs would increase and could possibly result in our need to increase available borrowings under our revolving credit facilities or access public or private debt and equity markets. There can be no assurance, however, that we would be successful in raising additional debt or equity on terms that we would consider acceptable.

Our contractual obligations for short and long-term debt arrangements, future interest on notes payable and long-term debt, and future minimum lease payments under non-cancelable operating lease arrangements as of May 31, 2006 are summarized below. We do not participate in, or secure financing for any unconsolidated limited purpose entities. We generally do not enter into non-cancelable purchase orders for materials until we receive a corresponding purchase commitment from our customer. Non-cancelable purchase orders do not typically extend beyond the normal lead time of several weeks at most. Purchase orders beyond this time frame are typically cancelable.

 

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     Payments due by period (in thousands)
     Total   

Less than 1

year

   1-3 years    4-5 years   

After 5

years

Contractual Obligations

              

Notes payable, long-term debt and long-term lease obligations

   $ 356,216    $ 25,149    $ 19,190    $ 311,877    $ —  

Future interest on notes payable and long-term debt

     79,423      19,317      38,635      21,471      —  

Operating lease obligations

     190,565      48,311      69,057      39,960      33,237
                                  

Total contractual cash obligations

   $ 626,204    $ 92,777    $ 126,882    $ 373,308    $ 33,237
                                  

 

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RISK FACTORS

As referenced, this Quarterly Report on Form 10-Q includes certain forward-looking statements regarding various matters. The ultimate correctness of those forward-looking statements is dependent upon a number of known and unknown risks and events, and is subject to various uncertainties and other factors that may cause our actual results, performance or achievements to be different from those expressed or implied by those statements. Undue reliance should not be placed on those forward-looking statements. The following important factors, among others, as well as those factors set forth in our other SEC filings from time to time, could affect future results and events, causing results and events to differ materially from those expressed or implied in our forward-looking statements.

Our operating results may fluctuate due to a number of factors, many of which are beyond our control.

Our annual and quarterly operating results are affected by a number of factors, including:

 

    adverse changes in general economic conditions;

 

    the level and timing of customer orders;

 

    the level of capacity utilization of our manufacturing facilities and associated fixed costs;

 

    the composition of the costs of revenue between materials, labor and manufacturing overhead;

 

    price competition;

 

    our level of experience in manufacturing a particular product;

 

    the degree of automation used in our assembly process;

 

    the efficiencies achieved in managing inventories and fixed assets;

 

    fluctuations in materials costs and availability of materials;

 

    seasonality in customers’ product requirements; and

 

    the timing of expenditures in anticipation of increased sales, customer product delivery requirements and shortages of components or labor.

The volume and timing of orders placed by our customers vary due to variation in demand for our customers’ products; our customers’ attempts to manage their inventory; electronic design changes; changes in our customers’ manufacturing strategies; and acquisitions of or consolidations among our customers. In the past, changes in customer orders have had a significant effect on our results of operations due to corresponding changes in the level of our overhead absorption. Any one or a combination of these factors could adversely affect our annual and quarterly results of operations in the future. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Because we depend on a limited number of customers, a reduction in sales to any one of our customers could cause a significant decline in our revenue.

We currently depend, and expect to continue to depend upon a relatively small number of customers for a significant percentage of our net revenue and upon their growth, viability and financial stability. Our customers’ industries have experienced rapid technological change, shortening of product life cycles, consolidation, and pricing and margin pressures. Consolidation among our customers may further reduce the number of customers that generate a significant percentage of our net revenue and exposes us to increased risks relating to dependence on a small number of customers. A significant reduction in sales to any of our customers or a customer exerting significant pricing and margin pressures on us would have a material adverse effect on our results of operations. In the past, some of our customers have terminated their manufacturing arrangements with us or have significantly reduced or delayed the volume of design, production, product management or repair services ordered from us. Our industry’s revenue declined in mid-2001 as a result of significant cut backs in customer production requirements, which was consistent with the overall global economic downturn. We cannot assure you that present or future customers will not terminate their design, production, product management and repair services arrangements with us or significantly change, reduce or delay the amount of services ordered from us. If they do, it could have a material adverse effect on our results of operations. In addition, we generate significant account receivables in connection with providing design, production, product management and repair services to our customers. If one or more of our customers were to become insolvent or otherwise were unable to pay for the services provided by us, our operating results and financial condition would be adversely affected. See “Business - Customers and Marketing” in our 2005 Annual Report on Form 10-K for the fiscal year ended August 31, 2005 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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We are involved in investigations of our historical stock option grant practices.

As described elsewhere herein, we are involved in shareholder derivative actions and an SEC Informal Inquiry, and have received a subpoena from the U.S. Attorney’s office for the Southern District of New York in connection with certain historical stock option grants. In response to the derivative actions, a Special Committee of our Board of Directors has been appointed to review the allegations in such actions. We have cooperated and intend to continue to cooperate with the special board committee, SEC and U.S. Attorney’s office. Such investigations may look at the accuracy of the stated dates of our historical option grants, the Company’s disclosures regarding executive compensation; whether all proper corporate and other procedures were followed; whether our historical financial statements are materially accurate; and other issues. We cannot predict the outcome of those investigations. Regardless of the outcomes of the investigations, it is likely that we will incur substantial costs and that the investigations will cause a diversion of our management’s time and attention, which could have a material adverse effect on our financial condition and results of operations. We can not provide assurances that such investigations will not find inappropriate activity in connection with our historical stock option practices, nor that our historical accounting associated with such stock option grant practices did not result in our issuing materially inaccurate financial statements.

Consolidation in industries that utilize electronics components may adversely affect our business.

In the current economic climate, consolidation in industries that utilize electronics components may further increase as companies combine to achieve further economies of scale and other synergies. Consolidation in industries that utilize electronics components could result in an increase in excess manufacturing capacity as companies seek to divest manufacturing operations or eliminate duplicative product lines. Excess manufacturing capacity has increased, and may continue to increase, pricing and competitive pressures for our industry as a whole and for us in particular. Consolidation could also result in an increasing number of very large companies offering products in multiple industries. The significant purchasing power and market power of these large companies could increase pricing and competitive pressures for us. If one of our customers is acquired by another company that does not rely on us to provide services and has its own production facilities or relies on another provider of similar services, we may lose that customer’s business. Such consolidation among our customers may further reduce the number of customers that generate a significant percentage of our net revenue and exposes us to increased risks relating to dependence on a small number of customers. Any of the foregoing results of industry consolidation could adversely affect our business.

Our customers may be adversely affected by rapid technological change.

Our customers compete in markets that are characterized by rapidly changing technology, evolving industry standards and continuous improvements in products and services. These conditions frequently result in short product life cycles. Our success will depend largely on the success achieved by our customers in developing and marketing their products. If technologies or standards supported by our customers’ products become obsolete or fail to gain widespread commercial acceptance, our business could be materially adversely affected.

We depend on industries that utilize electronics components, which continually produce technologically advanced products with short life cycles; our inability to continually manufacture such products on a cost-effective basis would harm our business.

Factors affecting the industries that utilize electronics components in general could seriously harm our customers and, as a result, us. These factors include:

 

    The inability of our customers to adapt to rapidly changing technology and evolving industry standards, which result in short product life cycles.

 

    The inability of our customers to develop and market their products, some of which are new and untested, the potential that our customers’ products may become obsolete or the failure of our customers’ products to gain widespread commercial acceptance.

 

    Recessionary periods in our customers’ markets.

If any of these factors materialize, our business would suffer.

 

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In addition, if we are unable to offer technologically advanced, cost effective, quick response manufacturing services to customers, demand for our services will also decline. A substantial portion of our net revenue is derived from our offering of complete service solutions for our customers. For example, if we fail to maintain high-quality design and engineering services, our net revenue may significantly decline.

Most of our customers do not commit to long-term production schedules, which makes it difficult for us to schedule production and achieve maximum efficiency of our manufacturing capacity.

The volume and timing of sales to our customers may vary due to:

 

    variation in demand for our customers’ products;

 

    our customers’ attempts to manage their inventory;

 

    electronic design changes;

 

    changes in our customers’ manufacturing strategy; and

 

    acquisitions of or consolidations among customers.

Due in part to these factors, most of our customers do not commit to firm production schedules for more than one quarter in advance. Our inability to forecast the level of customer orders with certainty makes it difficult to schedule production and maximize utilization of manufacturing capacity. In the past, we have been required to increase staffing and other expenses in order to meet the anticipated demand of our customers. Anticipated orders from many of our customers have, in the past, failed to materialize or delivery schedules have been deferred as a result of changes in our customers’ business needs, thereby adversely affecting our results of operations. On other occasions, our customers have required rapid increases in production, which have placed an excessive burden on our resources. Such customer order fluctuations and deferrals have had a material adverse effect on us in the past, and we may experience such effects in the future. A business downturn resulting from any of these external factors could have a material adverse effect on our operating results. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Our customers may cancel their orders, change production quantities or delay production.

Our industry must provide increasingly rapid product turnaround for its customers. We generally do not obtain firm, long-term purchase commitments from our customers and we continue to experience reduced lead-times in customer orders. Customers may cancel their orders, change production quantities or delay production for a number of reasons. The success of our customers’ products in the market affects our business. Cancellations, reductions or delay by a significant customer or by a group of customers could negatively impact our operating results.

In addition, we make significant decisions, including determining the levels of business that we will seek and accept, production schedules, component procurement commitments, personnel needs and other resource requirements, based on our estimate of customer requirements. The short-term nature of our customers’ commitments and the possibility of rapid changes in demand for their products reduce our ability to accurately estimate the future requirements of those customers.

On occasion, customers may require rapid increases in production, which can stress our resources and reduce operating margins. In addition, because many of our costs and operating expenses are relatively fixed, a reduction in customer demand can harm our gross profits and operating results.

We compete with numerous other electronic manufacturing services and design providers and others, including our current and potential customers who may decide to manufacture all of their products internally.

Our business is highly competitive. We compete against numerous domestic and foreign electronic manufacturing services and design providers, including Celestica, Inc., Flextronics International, Hon-Hai Precision Industry Co., Ltd., Sanmina-SCI Corporation and Solectron Corporation. In addition, we may in the future encounter competition from other large electronic manufacturers and manufacturers that are focused solely on design and manufacturing services, that are selling, or may begin to sell the same services. Most of our competitors have international operations, significant financial resources and some have substantially greater manufacturing, R&D, and marketing resources than us. These competitors may:

 

    respond more quickly to new or emerging technologies;

 

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    have greater name recognition, critical mass and geographic market presence;

 

    be better able to take advantage of acquisition opportunities;

 

    adapt more quickly to changes in customer requirements;

 

    devote greater resources to the development, promotion and sale of their services; and

 

    be better positioned to compete on price for their services.

We also face competition from the manufacturing operations of our current and potential customers, who are continually evaluating the merits of manufacturing products internally against the advantages of outsourcing. See “Business - Competition” of our 2005 Annual Report on Form 10-K for the fiscal year ended August 21, 2005.

Increased competition may result in decreased demand or prices for our services.

Because our industry is highly competitive, we compete against numerous domestic and foreign electronic manufacturing services and design providers with global operations, as well as those who operate on a local or regional basis. In addition, current and prospective customers continually evaluate the merits of manufacturing products internally. Some of our competitors have substantially greater managerial, manufacturing, engineering, technical, systems, R&D, sales and marketing resources than we do. Consolidation in our industry results in larger and more geographically diverse competitors who have significant combined resources with which to compete against us.

We may be operating at a cost disadvantage compared to competitors who have greater direct buying power from component suppliers, distributors and raw material suppliers or who have lower cost structures as a result of their geographic location or the services they provide. As a result, competitors may procure a competitive advantage and obtain business from our customers. Our manufacturing processes are generally not subject to significant proprietary protection. In addition, companies with greater resources or a greater market presence may enter our market or increase their competition with us. We also expect our competitors to continue to improve the performance of their current products or services, to reduce their current products or service sales prices and to introduce new products or services that may offer greater performance and improved pricing. Any of these could cause a decline in sales, loss of market acceptance of our products or services, profit margin compression, or loss of market share.

We derive a substantial portion of our revenue from our international operations, which may be subject to a number of risks and often require more management time and expense to achieve profitability than our domestic operations.

We derived 83.1% and 83.5% of net revenue from international operations for the three months and nine months ended May 31, 2006, respectively. This is compared to 82.0% and 84.4% for the three months and nine months ended May 31, 2005, respectively. We currently expect our revenue from international operations to remain consistent with current levels. We currently operate outside the United States in Vienna, Austria; Bruges and Hasselt, Belgium; Belo Horizonte, Manaus and Sao Paulo, Brazil; Hong Kong, Huangpu, Shanghai, Shenzhen, Suzhou and Wuxi, China; Coventry, England; Brest, Lunel and Meung-sur-Loire, France; Jena, Germany; Szombathely and Tiszaujvaros, Hungary; Chennai, Mumbai, Pune and Ranjangaon, India; Dublin, Ireland; Bergamo and Marcianise, Italy; Gotemba, Japan; Penang, Malaysia; Chihuahua, Guadalajara and Reynosa, Mexico; Amsterdam, the Netherlands; Bydgoszcz and Kwidzyn, Poland; Ayr and Livingston, Scotland; Singapore City, Singapore; Hsinchu, Taiwan; and Uzhgorod, Ukraine. We continually consider additional opportunities to make foreign acquisitions and construct new foreign facilities. Our international operations may be subject to a number of risks, including:

 

    difficulties in staffing and managing foreign operations;

 

    political and economic instability;

 

    unexpected changes in regulatory requirements and laws;

 

    longer customer payment cycles and difficulty collecting accounts receivable export duties, import controls and trade barriers (including quotas);

 

    governmental restrictions on the transfer of funds to us from our operations outside the United States;

 

    burdens of complying with a wide variety of foreign laws and labor practices;

 

    fluctuations in currency exchange rates, which could affect local payroll, utility and other expenses; and

 

    inability to utilize net operating losses incurred by our foreign operations against future income in the same jurisdiction.

 

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In addition, several of the countries where we operate have emerging or developing economies, which may be subject to greater currency volatility, negative growth, high inflation, limited availability of foreign exchange and other risks. These factors may harm our results of operations, and any measures that we may implement to reduce the effect of volatile currencies and other risks of our international operations may not be effective. In our experience, entry into new international markets requires considerable management time as well as start-up expenses for market development, hiring and establishing office facilities before any significant revenue is generated. As a result, initial operations in a new market may operate at low margins or may be unprofitable. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources.”

If we do not manage our growth effectively, our profitability could decline.

We have grown rapidly. Our ability to manage growth effectively will require us to continue to implement and improve our operational, financial and management information systems; continue to develop the management skills of our managers and supervisors; and continue to train, motivate and manage our employees. Our failure to effectively manage growth could have a material adverse effect on our results of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

We may not achieve expected profitability from our acquisitions.

We cannot assure you that we will be able to successfully integrate the operations and management of our recent acquisitions. Similarly, we cannot assure you that we will be able to consummate or, if consummated, successfully integrate the operations and management of future acquisitions. Acquisitions involve significant risks, which could have a material adverse effect on us, including:

 

    Financial risks, such as (1) potential known and unknown liabilities of the acquired businesses; (2) costs associated with integrating acquired operations and businesses; (3) the dilutive effect of the issuance of additional equity securities; (4) the incurrence of additional debt; (5) the financial impact of valuing goodwill and other intangible assets involved in any acquisitions, potential future impairment write-downs of goodwill and the amortization of other intangible assets; (6) possible adverse tax and accounting effects; and (7) the risk that we spend substantial amounts purchasing these manufacturing facilities and assume significant contractual and other obligations with no guaranteed levels of revenue or that we may have to close facilities at our cost.

 

    Operating risks, such as (1) the diversion of management’s attention to the assimilation of the businesses to be acquired; (2) the risk that the acquired businesses will fail to maintain the quality of services that we have historically provided; (3) the need to implement financial and other systems and add management resources; (4) the risk that key employees of the acquired businesses will leave after the acquisition; (5) unforeseen difficulties in the acquired operations; and (6) the impact on us of any unionized work force we may acquire or any labor disruptions that might occur.

We have acquired and will continue to pursue the acquisition of manufacturing and supply chain management operations. In these acquisitions, the divesting company will typically enter into a supply arrangement with the acquiror. Therefore, the competition for these acquisitions is intense. In addition, certain divesting companies may choose not to consummate these acquisitions with us because of our current supply arrangements with other companies. If we are unable to attract and consummate some of these acquisition opportunities, our growth could be adversely impacted.

Arrangements entered into with divesting companies typically involve many risks, including the following:

 

    The integration into our business of the acquired assets and facilities may be time-consuming and costly.

 

    We, rather than the divesting company, may bear the risk of excess capacity.

 

    We may not achieve anticipated cost reductions and efficiencies.

 

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    We may be unable to meet the expectations of the divesting company as to volume, product quality, timeliness and cost reductions.

 

    If demand for the divesting company’s products declines, it may reduce the volume of purchases and we may not be able to sufficiently reduce the expenses of operating the facility or use the facility to provide services to other customers.

As a result of these and other risks, we may be unable to achieve anticipated levels of profitability under these arrangements, and they may not result in any material revenue or contribute positively to our earnings.

Our ability to achieve the expected benefits of the outsourcing opportunities associated with these acquisitions is subject to risks, including our ability to meet volume, product quality, timeliness and pricing requirements, and our ability to achieve the divesting company’s expected cost reduction. In addition, when acquiring manufacturing operations, we may receive limited commitments to firm production schedules. Accordingly, in these circumstances, we may spend substantial amounts purchasing these manufacturing facilities and assume significant contractual and other obligations with no guaranteed levels of revenue. We may also not achieve expected profitability from these arrangements. As a result of these and other risks, these outsourcing opportunities may not be profitable.

We face risks arising from the restructuring of our operations.

Over the past few years, we have undertaken initiatives to restructure our business operations with the intention of improving utilization and realizing cost savings in the future. These initiatives have included changing the number and location of our production facilities, largely to align our capacity and infrastructure with current and anticipated customer demand. This alignment includes transferring programs from higher cost geographies to lower cost geographies. The process of restructuring entails, among other activities: moving production between facilities, reducing staff levels, realigning our business processes, and reorganizing our management.

We continuously evaluate our operations and cost structure relative to general economic conditions, market demands and cost competitiveness, and our geographic footprint as it relates to our customers’ production requirements. As a result of this ongoing evaluation, we currently are consulting with our employees and their representatives on our intentions to realign our manufacturing capacity in certain higher cost geographies. Based on preliminary analyses, we currently estimate that the intended realignment could result in restructuring and impairment charges in the range of $200.0 million to $250.0 million primarily related to costs associated with plant closures and headcount reductions. While the formal plans are subject to consultation with employees and their representatives and approval by our Board of Directors, we currently expect a significant portion the restructuring charge to be recorded in the fourth quarter of fiscal year 2006. If we incur additional restructuring related charges, our financial condition and results of operations may suffer.

Restructurings present significant potential risks of events occurring that could adversely affect us, including a decrease in employee morale, delays encountered in finalizing the scope of, and implementing, the restructurings (including extensive consultations concerning potential workforce reductions (particularly in locations outside of the United States)), the failure to achieve targeted cost savings and the failure to meet operational targets and customer requirements due to the loss of employees and any work stoppages that might occur.

We depend on a limited number of suppliers for components that are critical to our manufacturing processes. A shortage of these components or an increase in their price could interrupt our operations and reduce our profits.

Substantially all of our net revenue is derived from turnkey manufacturing in which we provide materials procurement. While most of our significant long-term customer contracts permit quarterly or other periodic adjustments to pricing based on decreases and increases in component prices and other factors, we may bear the risk of component price increases that occur between any such re-pricings or, if such re-pricing is not permitted, during the balance of the term of the particular customer contract. Accordingly, certain component price increases could adversely affect our gross profit margins. Almost all of the products we manufacture require one or more components that are available from only a single source. Some of these components are allocated from time to time in response to supply shortages. In some cases, supply shortages will substantially curtail production of all assemblies using a particular component. In addition, at various times industry-wide shortages of electronic components have occurred, particularly of memory and logic devices. Such circumstances have produced insignificant levels of short-term interruption of our operations, but could have a material adverse effect on our results of operations in the future. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

We may not be able to maintain our engineering, technological and manufacturing process expertise.

The markets for our manufacturing and engineering services are characterized by rapidly changing technology and evolving process development. The continued success of our business will depend upon our ability to:

 

    hire, retain and expand our qualified engineering and technical personnel;

 

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    maintain technological leadership;

 

    develop and market manufacturing services that meet changing customer needs; and

 

    successfully anticipate or respond to technological changes in manufacturing processes on a cost-effective and timely basis.

Although we believe that our operations use the assembly and testing technologies, equipment and processes that are currently required by our customers, we cannot be certain that we will develop the capabilities required by our customers in the future. The emergence of new technology, industry standards or customer requirements may render our equipment, inventory or processes obsolete or noncompetitive. In addition, we may have to acquire new assembly and testing technologies and equipment to remain competitive. The acquisition and implementation of new technologies and equipment may require significant expense or capital investment, which could reduce our operating margins and our operating results. In facilities that we establish or acquire, we may not be able to maintain our engineering, technological and manufacturing process expertise. Our failure to anticipate and adapt to our customers’ changing technological needs and requirements or to maintain our engineering, technological and manufacturing expertise, could have a material adverse effect on our business.

If we manufacture products containing design or manufacturing defects, or if our manufacturing processes do not comply with applicable statutory and regulatory requirements, demand for our services may decline and we may be subject to liability claims.

We manufacture and design products to our customers’ specifications, and, in some cases, our manufacturing processes and facilities may need to comply with applicable statutory and regulatory requirements. For example, medical devices that we manufacture or design, as well as the facilities and manufacturing processes that we use to produce them, are regulated by the Food and Drug Administration and non-US counterparts of this agency. Similarly, items we manufacture for customers in the defense and aerospace industries, as well as the processes we use to produce them, are regulated by the Department of Defense and the Federal Aviation Authority. In addition, our customers’ products and the manufacturing processes that we use to produce them often are highly complex. As a result, products that we manufacture may at times contain manufacturing or design defects, and our manufacturing processes may be subject to errors or not be in compliance with applicable statutory and regulatory requirements. Defects in the products we manufacture or design, whether caused by a design, manufacturing or component failure or error, or deficiencies in our manufacturing processes, may result in delayed shipments to customers or reduced or cancelled customer orders. If these defects or deficiencies are significant, our business reputation may also be damaged. The failure of the products that we manufacture or our manufacturing processes and facilities to comply with applicable statutory and regulatory requirements may subject us to legal fines or penalties and, in some cases, require us to shut down or incur considerable expense to correct a manufacturing process or facility. In addition, these defects may result in liability claims against us or expose us to liability to pay for the recall of a product. The magnitude of such claims may increase as we expand our medical, automotive, and aerospace and defense manufacturing services, as defects in medical devices, automotive components, and aerospace and defense systems could seriously harm or kill users of these products and others. Even if our customers are responsible for the defects, they may not, or may not have resources to, assume responsibility for any costs or liabilities arising from these defects, which could expose us to additional liability claims.

Our increasing design services offerings may result in additional exposure to product liability, intellectual property infringement and other claims.

We have increased our efforts to offer certain design services, primarily those relating to products that we manufacture for our customers, and we now offer design services related to collaborative design manufacturing and turnkey solutions. Providing such services can expose us to different or greater potential liabilities than those we face when providing our regular manufacturing services. With the growth of our design services business, we have increased exposure to potential product liability claims resulting from injuries caused by defects in products we design, as well as potential claims that products we design infringe third-party intellectual property rights. Such claims could subject us to significant liability for damages and, regardless of their merits, could be time-consuming and expensive to resolve. We also may have greater potential exposure from warranty claims, and from product recalls due to problems caused by product design. Costs associated with possible product liability claims, intellectual property infringement claims, and product recalls could have a material adverse effect on our results of operations. When providing collaborative design manufacturing or turnkey solutions, we may not be guaranteed revenue needed to recoup or profit from the investment in the resources necessary to design and develop products.

 

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Particularly, no revenue may be generated from these efforts if our customers do not approve the designs in a timely manner or at all, or if they do not then purchase anticipated levels of products. Furthermore, contracts may allow the customer to delay or cancel deliveries and may not obligate the customer to any volume of purchases, or may provide for penalties or cancellation of orders if we are late in delivering designs or products. We may even have the responsibility to ensure that products we design satisfy safety and regulatory standards and to obtain any necessary certifications. Failure to timely obtain the necessary approvals or certifications could prevent us from selling these products, which in turn could harm our sales, profitability and reputation.

The success of our turnkey activity depends in part on our ability to obtain, protect, and leverage intellectual property rights to our designs.

We strive to obtain and protect certain intellectual property rights to our turnkey solutions designs. We believe that having a significant level of protected proprietary technology gives us a competitive advantage in marketing our services. However, we cannot be certain that the measures that we employ will result in protected intellectual property rights or will result in the prevention of unauthorized use of our technology. If we are unable to obtain and protect intellectual property rights embodied within our designs, this could reduce or eliminate the competitive advantages of our proprietary technology, which would harm our business.

Intellectual property infringement claims against our customers or us could harm our business.

Our turnkey solutions products may compete against the products of other companies, many of whom may own the intellectual property rights underlying those products. As a result, we could become subject to claims of intellectual property infringement. Additionally, customers for our turnkey solutions services typically require that we indemnify them against the risk of intellectual property infringement. If any claims are brought against us or against our customers for such infringement, whether or not these claims have merit, we could be required to expend significant resources in defense of such claims. In the event of such an infringement claim, we may be required to spend a significant amount of money to develop non-infringing alternatives or obtain licenses. We may not be successful in developing such alternatives or obtaining such a license on reasonable terms or at all.

If our turnkey solutions products are subject to design defects, our business may be damaged and we may incur significant fees.

In our contracts with turnkey solutions customers, we generally provide them with a warranty against defects in our designs. If a turnkey solutions product or component that we design is found to be defective in its design, this may lead to increased warranty claims. Although we have product liability insurance coverage, it may not be available on acceptable terms, in sufficient amounts, or at all. A successful product liability claim in excess of our insurance coverage or any material claim for which insurance coverage was denied or limited and for which indemnification was not available could have a material adverse effect on our business, results of operations and financial condition.

We depend on our officers, managers and skilled personnel.

Our success depends to a large extent upon the continued services of our executive officers. Generally our employees are not bound by employment or non-competition agreements, and we cannot assure you that we will retain our executive officers and other key employees. We could be seriously harmed by the loss of any of our executive officers. In order to manage our growth, we will need to recruit and retain additional skilled management personnel and if we are not able to do so, our business and our ability to continue to grow could be harmed. In addition, in connection with expanding our turnkey solutions activities, we must attract and retain experienced design engineers. Competition for highly skilled employees is substantial. Our failure to recruit and retain experienced design engineers could limit the growth of our turnkey solutions activities, which could adversely affect our business.

Any delay in the implementation of our information systems could disrupt our operations and cause unanticipated increases in our costs.

We have completed the installation of an Enterprise Resource Planning system in most of our manufacturing sites and in our corporate location. We are in the process of installing this system in certain of our remaining plants, which will replace the current Manufacturing Resource Planning system, and financial information systems. Any delay in the implementation of these information systems could result in material adverse consequences, including disruption of operations, loss of information and unanticipated increases in cost.

 

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Compliance or the failure to comply with current and future environmental regulations could cause us significant expense.

We are subject to a variety of federal, state, local and foreign environmental regulations relating to the use, storage, discharge and disposal of hazardous chemicals used during our manufacturing process or requiring design changes or recycling of products we manufacture. If we fail to comply with any present and future regulations, we could be subject to future liabilities, the suspension of production or a prohibition on the sale of products we manufacture. In addition, such regulations could restrict our ability to expand our facilities or could require us to acquire costly equipment, or to incur other significant expenses to comply with environmental regulations, including expenses associated with the recall of any non-compliant product. Our procurement and inventory management activities may also be adversely impacted, as we may need to maintain inventories of two versions of a component, one for industries covered by these new requirements and one for industries not covered.

From time to time new regulations are enacted, and it is difficult to anticipate how such regulations will be implemented and enforced. We continue to evaluate the necessary steps for compliance with regulations as they are enacted.

For example, in 2003 the European Union enacted the Restriction on the Use of Certain Hazardous Substances in Electrical and Electronic Equipment Directive (“RoHS”) and the Waste Electrical and Electronic Equipment Directive (“WEEE”), for implementation in European Union member states. RoHS and WEEE regulate the use of certain hazardous substances in, and require the collection, reuse and recycling of waste from certain products we manufacture. We are aware of similar legislation that is currently in force or is being considered in the United States, as well as other countries, such as Japan and China. RoHS and WEEE are in the process of being implemented by individual countries in the European Union. It is likely that each jurisdiction will interpret RoHS and WEEE differently as they each implement them. We will continue to monitor RoHS and WEEE guidance as it is announced by individual jurisdictions to determine our responsibilities. The incomplete guidance available to us to date suggests that in many instances we will not be directly responsible for compliance with RoHS and WEEE, but that such regulations will likely apply directly to our customers. However, because we manufacture the products and may provide design and/or compliance-related services for our customers, we may at times become contractually or directly subject to such regulations. Also, final guidance from individual jurisdictions may impose different or additional responsibilities upon us. Our failure to comply with any of such regulatory requirements or contractual obligations could result in our being directly or indirectly liable for costs, fines or penalties and third-party claims, and could jeopardize our ability to conduct business in countries in the European Union.

Certain of our existing stockholders have significant control.

At May 31, 2006, our executive officers, directors and certain of their family members collectively beneficially owned 13.1% of our outstanding common stock, of which William D. Morean, our Chairman of the Board, beneficially owned 7.7%. As a result, our executive officers, directors and certain of their family members have significant influence over (1) the election of our Board of Directors, (2) the approval or disapproval of any other matters requiring stockholder approval, and (3) the affairs and policies of Jabil.

We are subject to the risk of increased taxes.

We base our tax position upon the anticipated nature and conduct of our business and upon our understanding of the tax laws of the various countries in which we have assets or conduct activities. Our tax position, however, is subject to review and possible challenge by taxing authorities and to possible changes in law. We cannot determine in advance the extent to which some jurisdictions may assess additional tax or interest and penalties on such additional taxes.

Several countries in which we are located allow for tax holidays or provide other tax incentives to attract and retain business. We have obtained holidays or other incentives where available and practicable. Our taxes could increase if certain tax holidays or incentives are retracted (which in some cases could occur if we fail to satisfy the conditions on which such holidays or incentives are based), or if they are not renewed upon expiration, or tax rates applicable to us in such jurisdictions are otherwise increased. In addition, further acquisitions may cause our effective tax rate to increase.

 

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Our credit rating is subject to change.

Our credit is rated by credit rating agencies. For example, our 5.875% Senior Notes are rated BBB- by Fitch Ratings, Baa3 by Moody’s Investor Service (“Moody’s”), and BBB- by Standard and Poor’s Rating Service (“S&P”), which are all considered “investment grade” debt. In response to our earnings release for our third quarter of fiscal year 2006, Moody’s revised its outlook to negative. If in the future our credit rating is downgraded by Moody’s and S&P so that our 5.875% Senior Notes are no longer considered “investment grade” debt, such a downgrade may increase our cost of capital should we borrow under our revolving credit facilities. Additionally, a downgrade of our credit rating with two or more of the credit rating agencies may make it more expensive for us to raise additional capital in the future on terms that are acceptable to us or at all; may negatively impact the price of our common stock; and may have other negative implications on our business, many of which are beyond our control.

We are subject to risks of currency fluctuations and related hedging operations.

A portion of our business is conducted in currencies other than the U.S. dollar. Changes in exchange rates among other currencies and the U.S. dollar will affect our cost of sales, operating margins and net revenue. We cannot predict the impact of future exchange rate fluctuations. We use financial instruments, primarily forward purchase contracts, to hedge U.S. dollar and other currency commitments arising from trade accounts receivable, trade accounts payable and fixed purchase obligations. If these hedging activities are not successful or we change or reduce these hedging activities in the future, we may experience significant unexpected expenses from fluctuations in exchange rates.

We could incur a significant amount of debt in the future.

We currently have the ability to borrow up to $500.0 million under our Unsecured Revolver. In addition, we could incur additional indebtedness in the future in the form of bank loans, notes or convertible securities. An increase in the level of our indebtedness, among other things, could:

 

    make it difficult for us to obtain any necessary financing in the future for other acquisitions, working capital, capital expenditures, debt service requirements or other purposes;

 

    limit our flexibility in planning for, or reacting to changes in, our business; and

 

    make us more vulnerable in the event of a downturn in our business.

There can be no assurance that we will be able to meet future debt service obligations.

An adverse change in the interest rates for our borrowings could adversely affect our financial condition.

We pay interest on outstanding borrowings under our revolving credit facilities and certain other long term debt obligations at interest rates that fluctuate based upon changes in various base interest rates. An adverse change in the base rates upon which our interest rates are determined could have a material adverse effect on our financial position, results of operations and cash flows.

We are exposed to intangible asset risk.

We have recorded intangible assets, including goodwill, in connection with business acquisitions. We are required to perform goodwill impairment tests at least on an annual basis and whenever events or circumstances indicate that the carrying value may not be recoverable from estimated future cash flows. As a result of our annual and other periodic evaluations, we may determine that the intangible asset values need to be written down to their fair values, which could result in material charges that could be adverse to our operating results and financial position.

Customer relationships with emerging companies may present more risks than with established companies.

Customer relationships with emerging companies present special risks because such companies do not have an extensive product history. As a result, there is less demonstration of market acceptance of their products making it

 

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harder for us to anticipate needs and requirements than with established customers. In addition, due to the current economic environment, additional funding for such companies may be more difficult to obtain and these customer relationships may not continue or materialize to the extent we planned or we previously experienced. This tightening of financing for start-up customers, together with many start-up customers’ lack of prior earnings and unproven product markets increase our credit risk, especially in accounts receivable and inventories. Although we perform ongoing credit evaluations of our customers and adjust our allowance for doubtful accounts receivable for all customers, including start-up customers, based on the information available, these allowances may not be adequate. This risk exists for any new emerging company customers in the future.

Our stock price may be volatile.

Our common stock is traded on the New York Stock Exchange. The market price of our common stock has fluctuated substantially in the past and could fluctuate substantially in the future, based on a variety of factors, including future announcements covering us or our key customers or competitors, government regulations, litigation, changes in earnings estimates by analysts, fluctuations in quarterly operating results, or general conditions in our industry and the aerospace, automotive, computing, consumer, defense, instrumentation, medical, networking, peripherals, storage and telecommunications industries. Furthermore, stock prices for many companies and high technology companies in particular, fluctuate widely for reasons that may be unrelated to their operating results. Those fluctuations and general economic, political and market conditions, such as recessions or international currency fluctuations and demand for our services, may adversely affect the market price of our common stock.

Provisions in our charter documents and state law may make it harder for others to obtain control of us even though some shareholders might consider such a development to be favorable.

Our shareholder rights plan, provisions of our amended certificate of incorporation and the Delaware Corporation Laws may delay, inhibit or prevent someone from gaining control of us through a tender offer, business combination, proxy contest or some other method. These provisions include:

 

    a “poison pill” shareholder rights plan;

 

    a statutory restriction on the ability of shareholders to take action by less than unanimous written consent; and

 

    a statutory restriction on business combinations with some types of interested shareholders.

Recently enacted changes in the securities laws and regulations are likely to increase our costs.

The Sarbanes-Oxley Act of 2002 that became law in July 2002 has required changes in some of our corporate governance, securities disclosure and compliance practices. In response to the requirements of that Act, the Securities and Exchange Commission and the New York Stock Exchange have promulgated new rules on a variety of subjects. Compliance with these new rules has increased our legal and financial and accounting costs, and we expect these increased costs to continue indefinitely. We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be forced to accept reduced coverage or incur substantially higher costs to obtain coverage. Likewise, these developments may make it more difficult for us to attract and retain qualified members of our Board of Directors or qualified executive officers.

Due to inherent limitations, there can be no assurance that our system of disclosure and internal controls and procedures will be successful in preventing all errors or fraud, or in informing management of all material information in timely manner.

Our management, including our CEO and CFO, does not expect that our disclosure controls and internal controls and procedures will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system reflects that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur simply because of error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

 

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The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and may not be detected.

If we receive other than an unqualified opinion on the adequacy of our internal control over financial reporting as of August 31, 2006 and future year-ends as required by Section 404 of the Sarbanes-Oxley Act of 2002, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of your shares.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted rules requiring public companies to include an annual report on internal control over financial reporting reports on Form 10-K that contains an assessment by management of the effectiveness of the company’s internal control over financial reporting. In addition, the independent registered public accounting firm auditing the company’s financial statements must attest to, and report on, management’s assessment of the effectiveness of the company’s internal control over financial reporting. The independent registered public accounting firm KPMG LLP issued an unqualified opinion on the adequacy of our internal control over financial reporting as of August 31, 2005. While we continuously conduct a rigorous review of our internal control over financial reporting in order to assure compliance with the Section 404 requirements, if our independent auditors interpret the Section 404 requirements and the related rules and regulations differently from us or if our independent auditors are not satisfied with our internal control over financial reporting or with the level at which it is documented, operated or reviewed, they may decline to attest to management’s assessment or issue a qualified report. A qualified opinion could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements.

There are inherent uncertainties involved in estimates, judgments and assumptions used in the preparation of financial statements in accordance with US GAAP. Any changes in estimates, judgments and assumptions could have a material adverse effect on our business, financial position and results of operations.

The consolidated and condensed consolidated financial statements included in the periodic reports we file with the Securities and Exchange Commission are prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”). The preparation of financial statements in accordance with US GAAP involves making estimates, judgments and assumptions that affect reported amounts of assets (including intangible assets), liabilities and related reserves, revenues, expenses and income. Estimates, judgments and assumptions are inherently subject to change in the future, and any such changes could result in corresponding changes to the amounts of assets, liabilities, revenues, expenses and income. Any such changes could have a material adverse effect on our financial position and results of operations.

Item 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Foreign Currency Exchange Risks

We transact business in various foreign countries and are, therefore, subject to risk of foreign currency exchange rate fluctuations. We enter into forward contracts to hedge transactional exposure associated with commitments arising from trade accounts receivable, trade accounts payable and fixed purchase obligations denominated in a currency other than the functional currency of the respective operating entity. All derivative instruments are recorded on the balance sheet at their respective fair market values in accordance with Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities , as amended (“SFAS 133”).

The aggregate notional amount of outstanding contracts at May 31, 2006 was $513.8 million. The fair value of these contracts amounted to a $2.0 million asset recorded in prepaid and other current assets and a $9.1 million liability recorded in accrued expenses on the Condensed Consolidated Balance Sheet. The forward contracts will generally expire in less than five months, with six months being the maximum term of the contracts outstanding at May 31, 2006. The forward contracts will settle in British pounds, Euro dollars, Hong Kong dollars, Hungarian forints, Japanese yen, Malaysian ringgit, Mexican pesos, Polish zloty, Singapore dollars and U.S. dollars.

 

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Interest Rate Risk

A portion of our exposure to market risk for changes in interest rates relates to our investment portfolio. We do not use derivative financial instruments in our investment portfolio. We place cash and cash equivalents with various major financial institutions. We protect our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by generally investing in investment grade securities and by frequently positioning the portfolio to try to respond appropriately to a reduction in credit rating of any investment issuer, guarantor or depository to levels below the credit ratings dictated by our investment policy. The portfolio includes only marketable securities with active secondary or resale markets to ensure portfolio liquidity. At May 31, 2006, the outstanding amount in the investment portfolio was $0.7 million, comprised mainly of money market funds with an average return of 4.6%.

We pay interest on outstanding borrowings under our revolving credit facilities at interest rates that fluctuate based upon changes in various base interest rates. These facilities include our Unsecured Revolver and our 0.6 billion Japanese yen credit facility. There were no borrowings outstanding under these revolving credit facilities at May 31, 2006.

We pay interest on outstanding borrowings under our 25.0 million Euro loan agreement for a Hungarian subsidiary at interest rates that fluctuate based upon changes in various base interest rates. There was 21.3 million Euro (approximately $27.3 million based on currency exchange rates at May 31, 2006) outstanding under this loan agreement at May 31, 2006.

See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors – We derive a substantial portion of our revenue from our international operations, which may be subject to a number of risks and often require more management time and expense to achieve profitability than our domestic operations, and – An adverse change in the interest rates for our borrowings could adversely affect our financial condition.”

Item 4: CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

We carried out an evaluation required by Rules 13a-15 and 15d-15 under the Exchange Act (the “Evaluation”), under the supervision and with the participation of our President and Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), of the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15 and 15d-15 under the Exchange Act (“Disclosure Controls”). Although we believe that our pre-existing Disclosure Controls, including our internal controls, were adequate to enable us to comply with our disclosure obligations, as a result of such Evaluation, we implemented minor changes, primarily to formalize, document and update the procedures already in place. Based on the Evaluation, our CEO and CFO concluded that, subject to the limitations noted herein, the design and operation of our Disclosure Controls, as described in this Item 4, are effective in timely alerting them to material information required to be included in our periodic SEC reports.

Changes in Internal Controls

The requirements of Section 404 of the Sarbanes-Oxley Act of 2002 were effective for our fiscal year ended August 31, 2005. In order to comply with the Act, we conducted a comprehensive effort to document and test internal controls over financial reporting. Although we received an unqualified opinion on the adequacy of our internal control over financial reporting as of August 31, 2005, our internal control documentation and testing efforts remain ongoing to ensure continued compliance with the Act. During the course of these activities, we identified certain internal control issues which management believes should be improved. However, we did not identify any changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting. We are nonetheless making improvements to our internal controls over financial reporting as a result of our review efforts. These planned improvements include further formalization of policies and procedures, improved segregation of duties, additional information technology system controls and additional monitoring controls. Any further internal control issues identified by our continued compliance efforts will be addressed accordingly.

 

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On March 31, 2006, we acquired Celetronix. As permitted by Securities and Exchange Commission guidance, the scope of our Section 404 evaluation for the fiscal year ending August 31, 2006 will not include the internal controls over financial reporting of the acquired operations of Celetronix. Celetronix is included in our consolidated financial statements at May 31, 2006 and for the period from March 31, 2006 to May 31, 2006. From the acquisition date to May 31, 2006, the processes and systems of the acquired operations were discrete and did not significantly impact internal controls over financial reporting of our other consolidated subsidiaries. Management intends to conduct testing and diligence as part of its ongoing integration efforts; however, no material weaknesses in the design of Celetronix’s internal controls over financial reporting have come to the attention of management.

Limitations on the Effectiveness of Controls

Our management, including our CEO and CFO, does not expect that our Disclosure Controls and internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls may be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control.

The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, a control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

CEO and CFO Certifications

Exhibits 31.1 and 31.2 are the Certifications of the CEO and the CFO, respectively. The Certifications are required in accordance with Section 302 of the Sarbanes-Oxley Act of 2002 (the “Section 302 Certifications”). This Item of this report, which you are currently reading is the information concerning the Evaluation referred to in the Section 302 Certifications and this information should be read in conjunction with the Section 302 Certifications for a more complete understanding of the topics presented.

PART II. OTHER INFORMATION

Item 1: LEGAL PROCEEDINGS

On April 26, 2006, a shareholder derivative lawsuit was filed in State Circuit Court in Pinellas County, Florida on behalf of Mary Lou Gruber, a purported shareholder of the Company, naming the Company as a nominal defendant, and naming certain of its officers, Scott D. Brown, Executive Vice President, Mark T. Mondello, Chief Operating Officer, and Timothy L. Main, Chief Executive Officer, President and a Board member, as well as certain of its Directors, Mel S. Lavitt, William D. Morean, Frank A. Newman, Steven A. Raymund and Thomas A. Sansone, as defendants (the “Initial Action”). Mr. Morean and Mr. Sansone were the Company’s previous Chief Executive Officer and President, respectively (such two individuals, with the defendant officers, collectively, the “Officer Defendants”). The Initial Action alleged that the named defendant officers and directors breached certain of their fiduciary duties to the Company in connection with certain stock option grants between August 1998 and October 2004. Specifically, it alleges that the defendant directors (other than Mr. Morean and Mr. Main), in their capacity as members of the Company’s Board of Director Audit or Compensation Committee, at the behest of the Officer Defendants, backdated Company stock option grants to make it appear they were granted on a prior date when the Company’s stock price was lower The Initial Action alleged that such alleged backdated options unduly benefited the Officer Defendants, resulted in the Company issuing materially inaccurate and misleading financial statements and caused millions of dollars of damages to the Company. The Initial Action also sought to have the Defendant Officers disgorge certain options they received, including the proceeds of options exercised, as well as certain equitable relief and attorneys’ fees and costs.

 

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Subsequent to the filing of the Initial Action, on May 2, 2006, the Company was notified by Staff of the SEC of an informal inquiry concerning the Company’s stock option grants. On May 3, 2006, the Company’s Board of Directors had a meeting, which had been arranged prior to the SEC contacting the Company, to discuss the Initial Action. At that meeting, the Board appointed a Special Committee of the Company’s Board to review the allegations in the Initial Action. On May 10, 2006, the law firms representing the plaintiff in the Initial Case, along with two additional law firms, a purported shareholder of the Company, Robert Barone, filed a lawsuit in State Circuit Court in Pinellas County, Florida that was nearly identical to the Initial Action (with the Initial Action, collectively, the “Actions”). On May 17, 2006, the Company received a subpoena from the U.S. Attorney’s office for the Southern District of New York requesting certain stock option related material. The Plaintiffs in the Actions have moved to consolidate the two actions.

The Special Committee of the Board is in the process of conducting its investigation and analysis of the claims asserted in the derivative action. The Company is cooperating fully with the Board’s Special Committee, the SEC and the U.S. Attorney’s office. The Company cannot predict what effect such investigations may have See “Risk Factors - We are involved in investigations of our historical stock option grant practices.”

We are party to certain other lawsuits in the ordinary course of business. We do not believe these proceedings, individually or in the aggregate, will have a material adverse effect on our financial position, results of operations or cash flows.

Item 2: UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

Item 3: DEFAULTS UPON SENIOR SECURITIES

None.

Item 4: SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS

None.

Item 5: OTHER INFORMATION

None.

 

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Item 6: EXHIBITS

 

3.1(1)   —     Registrant’s Certificate of Incorporation, as amended.
3.2(1)   —     Registrant’s Bylaws, as amended.
4.1(2)   —     Form of Certificate for Shares of Registrant’s Common Stock.
4.2(3)   —     Rights Agreement, dated as of October 19, 2001, between the Registrant and EquiServe Trust Company, N.A., which includes the form of the Certificate of Designation as Exhibit A, form of the Rights Certificate as Exhibit B, and the Summary of Rights as Exhibit C.
4.3(4)   —     Senior Debt Indenture, dated as of July 21, 2003, with respect to the Senior Debt of the Registrant, between the Registrant and the Bank of New York, as trustee.
4.4(4)   —     First Supplemental Indenture, dated as of July 21, 2003, with respect to the 5.875% Senior Notes, due 2010, of the Registrant, between the Registrant and The Bank of New York, as trustee.
10.6.5(6)   —     Form of Jabil Circuit, Inc. Restricted Stock Award Agreement
10.20(5)   —     Amendment No. 4 to Receivables Purchase Agreement dated as of November 11, 2005 among Jabil Circuit Financial II, Inc. as seller, Jabil Circuit, Inc., as servicer and Jupiter Securitization Corporation, the Financial Institutions and JP Morgan Chase Bank, N.A. (successor by merger to Bank One, N.A.) as agent for Jupiter and the Financial Institutions.
10.21(6)   —     Amendment No. 5 to Receivables Purchase Agreement dated as of February 21, 2006 among Jabil Circuit Financial II, Inc. as seller, Jabil Circuit, Inc., as servicer and Jupiter Securitization Corporation, the Financial Institutions and JP Morgan Chase Bank, N.A. (successor by merger to Bank One, N.A.) as agent for Jupiter and the Financial Institutions.
10.22(6)   —     Amendment No. 1 to Receivables Sale Agreement dated as of February 21, 2006 among Jabil Circuit, Inc., Jabil Circuit of Texas, L.P. and Jabil Global Services, Inc. as originators and Jabil Circuit Financial II, Inc. as buyer.
31.1   —     Rule 13a-14(a)/15d-14(a) Certification by the President and Chief Executive Officer of Jabil Circuit, Inc.
31.2   —     Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer of Jabil Circuit, Inc.
32.1   —     Section 1350 Certification by the President and Chief Executive Officer of Jabil Circuit, Inc.
32.2   —     Section 1350 Certification by the Chief Financial Officer of Jabil Circuit, Inc.

(1) Incorporated by reference to an exhibit to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended February 29, 2000.
(2) Incorporated by reference to an exhibit to Amendment No. 1 to the Registration Statement on Form S-1 filed by the Registrant on March 17, 1993 (File No. 33-58974).
(3) Incorporated by reference to the Registrant’s Form 8-A (File No. 001-14063) filed October 19, 2001.
(4) Incorporated by reference to the Registrant’s Current Report on Form 8-K filed by the Registrant on July 21, 2003.
(5) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended November 30, 2005.
(6) Incorporated by reference to the Registrant’s Quarterly Report on Form 10-Q for the quarter ended February 28, 2006.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  Jabil Circuit, Inc.
  Registrant
Date: July 6, 2006   By:  

/s/ TIMOTHY L. MAIN

    Timothy L. Main
    President/CEO
Date: July 6, 2006   By:  

/s/ FORBES I.J. ALEXANDER

    Forbes I.J. Alexander
    Chief Financial Officer

 

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Exhibit Index

 

Exhibit No.      

Description

31.1   —     Rule 13a-14(a)/15d-14(a) Certification by the President and Chief Executive Officer of Jabil Circuit, Inc.
31.2   —     Rule 13a-14(a)/15d-14(a) Certification by the Chief Financial Officer of Jabil Circuit, Inc.
32.1   —     Section 1350 Certification by the President and Chief Executive Officer of Jabil Circuit, Inc.
32.2   —     Section 1350 Certification by the Chief Financial Officer of Jabil Circuit, Inc.

EXHIBIT 31.1

CERTIFICATIONS

I, Timothy L. Main, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Jabil Circuit, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a –15 (e) and 15d –15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15 (f) and 15d-15 (f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: July 6, 2006  

/s/ TIMOTHY L. MAIN

  Timothy L. Main
  President and Chief Executive Officer

EXHIBIT 31.2

CERTIFICATIONS

I, Forbes I.J. Alexander, certify that:

 

1. I have reviewed this quarterly report on Form 10-Q of Jabil Circuit, Inc.;

 

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

 

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

 

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a –15 (e) and 15d –15 (e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15 (f) and 15d-15 (f)) for the registrant and have:

 

  a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

 

  b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

 

  c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

 

  d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

 

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

 

  a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

 

  b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: July 6, 2006  

/s/ FORBES I.J. ALEXANDER

  Forbes I.J. Alexander
  Chief Financial Officer

EXHIBIT 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO SECTION 906

OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Jabil Circuit, Inc. (the “Company”) on Form 10-Q for the fiscal quarter ended May 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Form 10-Q”), I, Timothy L. Main, President and Chief Executive Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

(2) The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: July 6, 2006

 

/s/ TIMOTHY L. MAIN

Timothy L. Main
President and Chief Executive Officer

EXHIBIT 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO SECTION 906

OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Jabil Circuit, Inc. (the “Company”) on Form 10-Q for the fiscal quarter ended May 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Form 10-Q”), I, Forbes I.J. Alexander, Chief Financial Officer of the Company, hereby certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1) The Form 10-Q fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and

(2) The information contained in the Form 10-Q fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: July 6, 2006

 

/s/ FORBES I.J. ALEXANDER

Forbes I.J. Alexander
Chief Financial Officer