Earnings Call Transcript - JBL Q3 2022

Operator, Operator

Greetings. Welcome to Jabil's Third Quarter Fiscal Year 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I'll turn the conference over to Adam Berry, Vice President of Investor Relations. Adam, you may now begin.

Adam Berry, Vice President of Investor Relations

Good morning, and welcome to Jabil's third quarter of fiscal 2022 earnings call. Joining me on today's call are Chief Executive Officer, Mark Mondello; and Chief Financial Officer, Mike Dastoor. Please note that today's call is being webcast live, and during our prepared remarks, we will be referencing slides. To follow along with the slides, please visit jabil.com within our Investor Relations section. At the conclusion of today's call, the entirety of today's session will be posted for audio playback on our website. I'd now like to ask that you follow our earnings presentation with slides on the website, beginning with the forward-looking statement. During this conference call, we will be making forward-looking statements including, among other things, those regarding the anticipated outlook for our business, such as our currently expected fourth quarter and fiscal year net revenue and earnings. These statements are based on current expectations, forecasts and assumptions involving risks and uncertainties that could cause actual outcomes and results to differ materially. An extensive list of these risks and uncertainties are identified in our annual report on Form 10-K for the fiscal year ended August 31, 2021, and other filings. Jabil disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise. With that, I'd now like to turn the call over to Mark.

Mark Mondello, CEO

Thanks, Adam. Good morning. I appreciate everyone taking time to join our call today. I'll begin by saying thanks to all of our people here at Jabil. Thank you for the tireless attention you offer our customers, and thank you for the manner in which you care for and accept one another. Let's now turn to Slide 5 and review our third quarter results. Q3 was another strong quarter driven by double-digit revenue growth and outstanding execution. Altogether, the team delivered core earnings per share of $1.72 and revenue of $8.3 billion. This resulted in a core operating margin of 4.2%, a 40 basis point increase year-on-year. All in all, I'm quite pleased with the quarter. We're carrying good momentum as we start to think about FY '23. And when I think about momentum, I think about the primary catalysts behind our business, that being the makeup and scale of our commercial portfolio, which I'll now address on the next slide, Slide 6. The pie chart shown here reflects Jabil's commercial portfolio, which our team has built over the past five to six years, in essence, a large-scale, well-diversified foundation from which we run our business today. And the resulting output in having built this business is threefold. One, a higher level of resiliency for the corporation. Either during trying times of macro and geopolitical disruptions or during more typical times when we're simply faced with never-ending demand fluctuations. Two, Jabil's presence in new markets. Markets that include 5G, electric vehicles, personalized healthcare, cloud computing, and clean energy. Markets that we believe will drive earnings growth, especially when combined with the continued refinement and improvement of our traditional businesses. And finally, the third resultant output of our team's hard work is the assembly and collection of our many capabilities. Capabilities that allow us to simplify the complex for many of the world's most notable brands as we lean into a massive market where things need to be built and supply chains need to be developed or modified. Moving to Slide 7. You'll see management's outlook for the year. We're anticipating core earnings per share to be $7.45, an increase of 33% year-on-year. As for revenue, fiscal '22 now looks to be $32.8 billion, while our outlook for core operating margin remains steady at 4.6%, a 40 basis point improvement year-on-year. In addition, we remain committed to delivering a minimum of $700 million in free cash flow for FY '22. Altogether, this year is a terrific blend of reliable margins and sustainable cash flows. And although we're navigating a tough environment, we have ample opportunities to consider as we formalize our business plan for fiscal '23. With this in mind, we look forward to hosting our fifth Annual Investor Briefing. And consistent with past years, the briefing will be held in late September. Adam will be confirming an exact date later this summer. We'll open the session by reporting our fourth quarter and full-year results, we'll then follow with a complete review of our priorities and explain how these priorities will guide us through FY '23. Management will also share how we plan to further expand our core operating margin while sharing observations on end markets. In wrapping up the September session, Mike will share our capital return framework for FY '23 and FY '24. We have lots to share and a wonderful story to tell financially, operationally, and commercially. With that, let's look at my final slide, where I'd like to talk about the importance of purpose. At Jabil, we act with purpose, and with purpose comes expectations. Expectations around certain behaviors, behaviors such as keeping our people safe, protecting the environment, giving back to our communities and ensuring a workplace of tolerance, respect, and acceptance. Within Jabil, these behaviors have never been as important as they are today. I'm proud of our team as they embrace our purpose, and in doing so, their conduct is exceptional. In closing, I like the decisions we're making. At Jabil, we build stuff, and we do it really, really well. It's why we welcome the challenges put forth by our customers. And when addressing these challenges, we do our best to make the world a little bit better, a little bit healthier and a little bit safer each and every day. As I alluded to earlier in my prepared remarks, the world is a bit messy at the moment. What I do believe is Jabil executes well when times are steady, but I'm even more passionate in my belief that Jabil executes really well when times are difficult. Thank you for joining our call, and thanks for your interest in Jabil. I'll now turn the call over to Mike.

Mike Dastoor, CFO

Thanks, Mark, and thank you for joining us today. Our third quarter was a great illustration of our diversification in action. I'm really pleased with the resiliency of our portfolio and the sustainable momentum at the enterprise level. In spite of a challenging supply chain environment and well-publicized shutdowns in China, the team still delivered exceptional results in revenue, core operating margin, and core diluted earnings per share. For the quarter, revenue was approximately $8.3 billion, ahead of our forecast, driven by very strong demand within EMS, partially offset by sporadic COVID challenges within DMS. Altogether, on an enterprise level, revenue grew by 15% year-over-year and 10% sequentially as demand across end markets remain well ahead of supply. In Q3, our GAAP operating income was $321 million, and our GAAP diluted earnings per share was $1.52. Core operating income during the quarter was $352 million, an increase of 27% year-over-year, representing a core operating margin of 4.2%, up 40 basis points over the prior year. Net interest expense in Q3 came in above expectations at $45 million due to a combination of higher working capital and rising interest rates. Core diluted earnings per share was $1.72, a 32% improvement over the prior year quarter. Now turning to our third quarter segment results on the next slide. Revenue for our DMS segment was $3.8 billion, an increase of 7% on a year-over-year basis. Although upside in the quarter was limited in automotive, healthcare, and mobility, we still experienced year-over-year growth in every end market within DMS. Core margin for the segment came in at 3.8%. Revenue for our EMS segment came in at $4.5 billion, an increase of 23% on a year-over-year basis and well ahead of our plans for March. The stronger year-over-year performance in our EMS segment was extremely broad-based, with strength in our 5G Wireless & Cloud and Networking & Storage businesses, where we gained additional share during the quarter. As a result, our ability to execute in complex supply chains and deliver critical parts and components. Core margin for the segment was 4.6%, up 80 basis points for the prior year, reflecting exceptional cost control on higher-than-anticipated revenue. Turning now to our cash flows and balance sheet. In Q3, inventory days came in at 85 days, down one day sequentially and above our expectations in March, mainly due to the shutdowns in Shanghai which also impacted upstream and downstream supply chains. We offset a portion of higher inventory levels with inventory deposits from our customers, and these deposits reside within the accrued expenses line item on the balance sheet. Net of inventory deposits, inventory days were 70 in Q3, down one day from the previous quarter. As a quick reminder, our business model is designed such that we do not take risk on inventory in anticipation of sales. All inventory orders require a customer purchase order before triggering a purchase request within our MRP system. The majority of our inventory continues to be mainly associated with raw materials as a result of kicking issues and timing of components. At the end of Q3, finished goods represented a very small level at approximately 11% of inventory consistent with Q2. Our third-quarter cash flows from operations were $545 million, and net capital expenditures totaled $324 million. From a total debt to core EBITDA level, we exited the quarter approximately 1.3x and with cash balances of $1.1 billion. During Q3, we repurchased approximately 0.6 million shares for $203 million, and for the year, we've repurchased 7.9 million shares for $475 million as we remain committed to returning capital to shareholders. Turning now to our fourth quarter guidance on the next slide. DMS segment revenue is expected to increase 14% on a year-over-year basis to approximately $4.5 billion, while the EMS segment revenue is expected to increase 11% on a year-over-year basis to approximately $3.9 billion. We expect total company revenue in the fourth quarter of fiscal '22 to be in the range of $8.1 billion to $8.7 billion. Core operating income is estimated to be in the range of $390 million to $450 million, representing a core margin range of 4.8% to 5.2%. At the midpoint, this is an improvement of 80 basis points for the prior year. In Q4, GAAP operating income is expected to be in the range of $367 million to $427 million. Core diluted earnings per share is estimated to be in the range of $1.94 to $2.34. GAAP diluted earnings per share is expected to be in the range of $1.78 to $2.18. The core tax rate in the fourth quarter is estimated to be approximately 17%. Next, I'd like to take a few moments to highlight our dynamic and resilient portfolio of businesses by end market. Across the majority of our end markets, demand has been extremely resilient and continues to outstrip supply across our business, particularly in end markets that continue to benefit from strong secular tailwinds. Markets such as Electric Vehicles, Personalized Medicine and Healthcare, Clean and Smart Energy Infrastructure, 5G Infrastructure, Cloud, and Semi-Cap, these end markets represent a large majority of the overall Jabil portfolio today, and we believe sustained growth in these markets will continue even if overall global economic growth slows from the solid levels over the last few years. The end markets we serve that may be more susceptible to economic slowdowns have been strategically positioned within the portfolio as we partner with market-leading brands to provide key capabilities that are critical and hard to replicate. This product diversification provides resiliency to our portfolio. In summary, Jabil is not only well diversified, but also markedly more resilient due to our multi-year proactive efforts to diversify our business and align to tomorrow's trends. As a result, we feel the outlook for our business is strong and anticipate demand to be resilient for the balance of this year and into FY '23. All in all, our performance during the first 9 months of FY '22 gives us excellent momentum as we look to close out another strong year. We're now anticipating core EPS will be in the neighborhood of $7.45 per share on revenue of approximately $32.8 billion. Notably, we see income and cash flow coming through with the increase to revenue. We now expect strong core margin and free cash flow of 4.6% and $700 million, respectively. With that, I'll now turn the call over to Adam.

Adam Berry, Vice President of Investor Relations

Thanks, Mike. Before we move into Q&A, I'd like to remind all participants that we cannot address customer or product-specific questions. Thank you for your understanding. Operator, we're now ready for Q&A.

Operator, Operator

Thank you. Our first question comes from the line of Ruplu Bhattacharya with Bank of America. Please proceed with your question.

Ruplu Bhattacharya, Analyst

Hi, thanks for taking my questions, and congrats on the strong execution in the quarter. My first question, Mark, is on revenue growth. Revenues in EMS, looks like it saw a much stronger growth than you had expected. Was there any pull forward of revenue from a fiscal 4Q? Or did you just see higher demand in all end markets? And the same question for the DMS segment, where revenue growth was 7% versus your guidance of 17%. Looks like you've reduced your estimate for fiscal year mobility and auto revenues a little bit. So do you see lower end market demand? Or is it that supply constraints are limiting your ability to fulfill the demand?

Mark Mondello, CEO

I believe there are two main questions for the quarter, and there's a lot to unpack. If I missed anything, feel free to bring it up. Regarding DMS, if you compare our performance to what we expected at the beginning of the quarter, we may have been slightly conservative in our guidance considering the current situation. Additionally, our execution throughout the quarter was outstanding and highly effective. A solid reference point would be our presentation from March, which shows annual numbers on the EMS side that reflect our strengths and the exceptional execution we achieved this year. So, to summarize, we started the quarter conservatively due to various factors, executed well, and experienced a slight increase in demand. Customers are now more aware of our capacity to assist with supply chain challenges, which helped us gain market share during the quarter. On the EMS side, I mentioned previously that the global situation is somewhat challenging. However, we managed to control the aspects we can, which is something Jabil excels at, especially in terms of execution, whether in factories or the supply chain. For DMS, the growth was driven by three areas: healthcare, automotive, and mobility. While we were cautious in our guidance, we didn't fully anticipate the prolonged shutdown in Shanghai. Overall, the enterprise results for the quarter indicate we are having a strong year despite significant challenges, including specific silicon shortages that primarily affected the automotive sector. There were also some shifts and timing issues impacting volumes in mobility. This summarizes the outcomes for both EMS and DMS compared to our guidance in March.

Ruplu Bhattacharya, Analyst

Thank you for the information, Mark. That's helpful. Considering the strengths you see in various EMS end markets and DMS, how should we approach CapEx this year? What specific areas do you believe require more investment this year? Thank you.

Mark Mondello, CEO

Well, this year's about over, so CapEx is going to be what it's going to be this year. I think it will be, I don't know, somewhere between 2.5% and 3% of overall revenue. It's probably closer to 2.5%, and I think we talked about that back in September. So the way we're managing CapEx, I think, is exceptional. I actually have an opinion too on the fact that I think our overall capital allocation throughout the year has been quite good. We'll get into CapEx for FY '23 during the upcoming Investor Day in September. I would expect in terms of indexing CapEx off of revenue, FY '23 will look similar to FY '22. In terms of the last part of your question, we'll continue to invest in areas that have great cash flows, sustainable businesses and help drive our margins to 5%.

Ruplu Bhattacharya, Analyst

Thanks for taking the question, and congrats again on the quarter.

Mark Mondello, CEO

Thank you.

Operator, Operator

Next question comes from the line of Matt Sheerin with Stifel. Please proceed with your question.

Matthew Sheerin, Analyst

Yes. Thank you, and good morning. I have a question regarding the guidance, specifically about the margins. It appears you are projecting margins to be around 5%. Is this influenced by product mix? Do you anticipate an improvement in gross margin or continued operating expense leverage? You've mentioned strong operating expense leverage over the last couple of quarters. What factors are contributing to these margins?

Mark Mondello, CEO

I believe we have a diverse performance across the business, which is a core aspect of our current situation. We anticipate solid quarter-on-quarter growth in Auto. Additionally, as long as Shanghai does not experience significant shutdowns, we expect Healthcare and Packaging to perform well. Typically, Q4 is a strong quarter for us due to the mix, which is not intentional in our EMS sector, and the EMS sector is quite significant in this quarter. When I take a step back and consider the overall situation, it's about the health of the business and our execution. I see Q4 as a good indicator of where we aim to head in 2023 and 2024, focusing on achieving 5% operating margins for the entire enterprise annually.

Mike Dastoor, CFO

And Matt, if I could just add. DMS and EMS businesses have slightly different gross margin profiles. I think the EMS, which outperformed in Q3, will have a good quarter in Q4 as well. The gross margin can be low, but the SG&A OpEx can be lower as well and vice versa. On the DMS side, where your gross margin is higher, but your SG&A percentages are higher because of FDA qualification requirements because of regulated industries, sort of the regulations that go around that. So it's a very different gross margin profile for EMS and DMS. I would encourage folks to look at operating margin. That's what we, as a management team, look at internally. We're marching towards 5% and beyond, and we'll continue to deliver that. Gross margin profiles will change up and down quarter-by-quarter depending on the mix, so I just encourage you to focus more on operating margin than gross margin.

Matthew Sheerin, Analyst

Okay. Thank you for that. And then regarding the supply chain headwinds that hit most of your DMS businesses. Are you seeing any signs of easing there, either on the semiconductor supply side or the COVID-related restrictions? And how is that impacting your guidance? In other words, would you have even more upside if there were more available supply or production?

Mark Mondello, CEO

I've mentioned this in previous quarters. Firstly, several factors have affected DMS, yet demand remains robust. This is an important point to note from this call. The difference in DMS compared to our guidance was not solely due to supply chain issues. It was primarily related to timing and shifts in mobility volumes, including the duration of our shutdown in Shanghai. I also acknowledged that we encountered challenges with certain specialized silicon, which affected the automotive sector more than others. However, I believe our supply chain issues are improving overall across the company. It's important to remember that supply chain challenges extend beyond just semiconductors; they affect a wide range of materials we source, from resins and metals to precision machining needs. I still anticipate a normalization of supply chains by the end of this calendar year, though it may extend into 2023. Overall, supply chains are gradually improving, with some ongoing constraints on specific components. Notably, our ability to manage supply chain issues relative to others has contributed positively to our performance in the third quarter and is also supporting our 5% margins in the fourth quarter.

Matthew Sheerin, Analyst

Okay. Thanks so much for the answer.

Mark Mondello, CEO

Yes. Thanks, Matt.

Operator, Operator

The next question is from the line of Steven Fox with Fox Advisors. Please proceed with your question.

Steven Fox, Analyst

Hi, good morning. I have two questions. First, can you discuss how much more potential there is for improving operating margins based on your sales mix, considering your margins increased by 80 basis points year-over-year? I understand you may not want to reveal too much about next year. Then I have a follow-up.

Mark Mondello, CEO

You're right. We don't want to say much about 2023 at the moment. I think we'll discuss that in detail during our Investor Day in September. A few years ago, we experienced about a six-year period of significant growth and diversification, building the platform we have today, and our operating margin was around 3.5%. In 2021, we increased it to 4.2%. This year, we're expecting to deliver around 4.6%. I believe that, looking ahead, the margins for fiscal year 2023 will exceed those of fiscal year 2022, and I think the fourth quarter serves as a good indicator of where the company is heading. Overall, we are managing the various challenges around us reasonably well on an absolute scale, and very well on a relative scale. So, more details will be provided in September.

Steven Fox, Analyst

That's helpful. And then just as a follow-up, you mentioned some market share gains on some of the more mature product areas. I'm just curious if there's any other color you can provide on that? And do we think about that as being sustainable? Or were you feeling sort of an interim gap? And before I forget, I guess I'll wish the Lightning luck in the rest of the Stanley Cup finals.

Mark Mondello, CEO

I was hoping you would say that. Your Rangers are an excellent team, and I believe they will be very strong over the next three to four years. Thank you for that, and we're cheering them on. They had a tough loss last night, but we appreciate the Ranger fans switching to support the Lightning for the next couple of weeks. Regarding the share gain, I'm not sure how to evaluate that. We helped several customers by managing the supply chain and providing support when they needed it. Is that sustainable? I'm not confident. Some aspects will be, and some won’t. However, if you refer to the blue green slide and compare it to what we presented in March, you'll see that Digital Print Retail, 5G Wireless, and Cloud have improved since what we communicated 90 days ago. Networking and Storage also show an increase. This suggests we've gained market share primarily through our efficient supply chain execution and delivering products to our customers. Will some of that continue with us? I believe so, and I think you'll hear more about it in September.

Steven Fox, Analyst

Thanks again.

Mark Mondello, CEO

Yes, you're welcome.

Operator, Operator

Our next question is from the line of Mark Delaney with Goldman Sachs. Please proceed with your question.

Mark Delaney, Analyst

Good morning. Thank you very much for taking the questions. The first one is on the macroeconomic environment. And Mark, you commented on some of these uncertain headlines that are out there. And I'm curious, is this just something you guys are seeing in terms of the economic data points that are being reported? Or are there actual customer schedules for 6 to 12 months out that are starting to slow? And if there are actual customers that are indicating things may be slowing? Are there any end markets you can point to?

Mark Mondello, CEO

I'm not going to discuss customer data specifically. However, I would say that the current situation is challenging for large corporations. Despite this, I'm optimistic about our prospects. Back in September, we anticipated revenues around $31.5 billion, and now we're projecting $32.8 billion. This demonstrates our ability to perform even in difficult conditions, highlighting the strength of our portfolio. While we experience fluctuations, some changes may appear more drastic in this environment. Overall, looking at our current guidance and projections for the year, I'm feeling positive. We've been discussing exciting opportunities for 2023 and 2024 that are beginning to materialize this year. We've mentioned areas like Electric Vehicles, Personalized Healthcare, advancements in connected devices, Automation in retail, new fabs in our Semi-Cap business, and the 5G rollout. While these sectors could be affected by a significant recession, under normal circumstances, they look promising. Additionally, we've made improvements in our more traditional businesses. Overall, I'm optimistic about the fourth quarter and expect to share some favorable updates in September.

Mark Delaney, Analyst

That's helpful. My second question is on the China region, and we're seeing some headlines of business resuming post some of these shutdowns in different parts of China. Could you better characterize to what extent things are back open, maybe relative to March when Shanghai, for example, went into lockdown? To what extent are things back to those sorts of levels? Or is it still 70%, 80%? And if it's not back at full volumes, when do you think you may be back to full volumes in China? Thanks.

Mark Mondello, CEO

I believe we will return to full volumes in China soon. We have adjusted our expectations for the fourth quarter accordingly. We anticipate that our overall capacity in China will operate at around 80% to 85%. Even when there are disruptions, we have enough remaining capacity to quickly recover. For the fourth quarter, we expect our capacity to run at that 80% to 85% level, which seems like a reasonable expectation given the situation. We also do not foresee as many challenges as we faced in the third quarter. This improvement in our assumptions is likely a factor in the higher margins from Q3 to Q4.

Mark Delaney, Analyst

That's very helpful. Thanks for taking the questions. And congratulations on the good results.

Mark Mondello, CEO

Thank you.

Operator, Operator

Our next question is from the line of Paul Chung with JPMorgan. Please proceed with your question.

Paul Chung, Analyst

Hi, thanks for taking my questions. So just on free cash flow, pretty steady guidance here despite tough macro backdrop. Talk about some of the puts and takes there on offsetting some heavy investments in inventory? And then you mentioned some normalization later this year, but are you expecting some structural step ups here on working cap offers maybe moving forward?

Mike Dastoor, CFO

Thank you for the question, Paul. Our earnings have improved since the start of the year and have increased from one quarter to the next. The inventory level was somewhat higher than we anticipated, and working capital saw a slight uptick. The reasons for these changes are quite clear, given the complexities of our supply chain and the impact of COVID shutdowns. However, we remain confident in reaching our free cash flow target. We expect a reduction in working capital in the fourth quarter. Currently, our free cash flow for this year is ahead of last year's figures, which makes me optimistic about achieving that $700 million free cash flow target, Paul.

Paul Chung, Analyst

Great. And then just a follow-up on the automation side. So where are you seeing kind of incremental opportunities for CapEx and M&A to kind of enhance the firm's capabilities? It seems like you have some momentum here at Badger from what I can see. I know that part of the business is small, but how are you kind of leveraging some robotics technology across the business? Thank you.

Mark Mondello, CEO

I think we're doing a really good job of that. One of the things that we spend a lot of time internal about is, A, control what we can control. And if you think about our business, at the very, very core of our business is we build stuff, and it's that simple. And if we're going to build stuff, we should have the best factories in the world. I would say of our overall factory network today, we're really, really proud of about 80% of our factories, and we got 20% of the factories that operate really well, so far from perfect. But also, I would say the OpEx investments we've made along with the CapEx investments both in IT, operations, automation, AI, data analytics, et cetera, are starting to come through in the factories. And we think that will carry through for '23 and '24. And I think overall, we're going to be able to continue to do more with less. And I think that's also reflected in our overall SG&A numbers as well, which I think is a good thing.

Paul Chung, Analyst

Great. Thank you.

Mark Mondello, CEO

Yes, you're welcome.

Operator, Operator

Thank you. We've reached the end of the question-and-answer session. I'll now turn the call over to Adam Berry for closing remarks.

Adam Berry, Vice President of Investor Relations

Thanks, everyone, for joining. This now concludes our call.

Operator, Operator

This will conclude today's conference. Thank you for your participation.