Benchmark Electronics Inc (BHE) 2006 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Benchmark Electronics third-quarter 2006 conference call. At this time all lines are in a listen-only mode. Later there will be a question-and-answer session and instructions will be given at that time. (OPERATOR INSTRUCTIONS). As a reminder, today's conference is being recorded. At this time then I would like to turn the conference over to Ms. Gayla Delly. Please go ahead.

Good morning. Welcome to the Benchmark Electronics conference call to discuss our financial results for the third quarter of 2006. Please let me introduce our team present with me today. I'm Gayla Delly, the CFO of Benchmark Electronics, and I will begin our call with an overview of our most recent announcement, our solid third quarter, and then our expectations for the fourth quarter of the year. With me also is Barbara Sorenson, our Vice President of Finance, who will discuss our financial metrics for Q3 in greater detail; and Cary Fu, our President and CEO, who will follow up providing comments on our strategy and an overview of the current marketplace.

I apologize. I'm a little horse this morning. As you all probably are aware, with our conference call from a couple of days ago we've been quite busy lately with the quarter we had, just announcing and also with our M&A activity. After our prepared remarks this morning, we will take time for your calls and questions in our Q&A session.

During the call this morning, we may make projections or other forward-looking statements regarding future events or the future financial performance of the Company. We would like to caution you that those statements reflect our current expectations and actual events or results may differ materially. We would also like to refer you to Benchmark's periodic reports, which are filed from time to time with the Securities and Exchange Commission, including the Company's 8-K, quarterly filings on Forms 10-Q, and our annual report on Form 10-K.

These documents contain cautionary language and identify important risk factors which could cause actual results to differ materially from our projections or forward-looking statements. And we undertake no obligation to update those projections or forward-looking statements in the future.

I would like to start by saying that we are very pleased about the announcement we made in our press release a couple of days ago on October 17, 2006 related to the definitive agreement to acquire Pemstar Inc. And we believe that the merger of Pemstar and Benchmark is a good strategic combination that will create additional value for our combined base of customers and shareholders.

We expect the merger to be closed during the first quarter of 2007. However, today we are not addressing additional questions on the merger on our call since we just had a call a couple of days ago and spent a good deal of time answering questions on that. And we will be filing an S4 in the upcoming weeks and we do invite you to watch for that coming out. So now we'll begin by discussing her Q3 operating results.

I'm pleased to announce our third-quarter 2006 results. The third quarter of 2006 produced record revenues of $770 million. These revenues are $20 million above the high-end of our guidance, which was $710 million to $750 million, as we provided on our last conference call. And these revenues are up 37.1% year-over-year compared to revenues last year, 2005, of $561 million.

We completed the third quarter of 2006 with continued increases in demand levels and the successful ramp of several new programs. We supported the ramp of these programs to volume during Q3 and continue to support the ramp from previous quarters' new programs, which together with the strength of the overall demand across the board resulted in another very strong successful quarter for Benchmark.

Our overall results were very strong and yet we've built inventory levels based on our customers' forecasts, which proved to be overly aggressive in some cases and also had inaccuracies as to the NICs requirements. These customer forecasting challenges resulted in us having an unusually high level of finished goods inventory on hand at quarter end. Note though that this inventory buildup is a timing issue related to NICs changes and new programs. With additional history as to the shipping and selling patterns for these new programs, we expect improved forecasting accuracy and reduced inventory levels.

During Q3, we saw strong demand across the board. Our teams did an excellent job in meeting the challenges of our customers' increased demand levels and program ramps. And once again, I'd like to thank our dedicated teams and our customers for their support.

The Q3 2006 financial results do contain two special items and they are as follows -- restructuring charges of $448,000, which is $259,000 net of tax; and stock-based compensation expense of $620,000 or $460,000 net of tax related to the implementation of FAS 123(R) during 2006. A portion of the restructuring charges that were originally planned to occur during Q3 were delayed and will be realized in Q4 and the restructuring charges expected in Q4 are approximately $500,000.

During Q4 Benchmark also expects stock-based compensation expenses under the new accounting guidelines of Financial Accounting Standard 123(R) to be approximately $0.01 per share. To help in a more meaningful comparative analysis, we will present certain financial information excluding these items during the conference call today. We will call your attention to the fact that these items are excluded when we do so. In our press release today, we have included a reconciliation of our GAAP results to our results excluding these items.

On a year-to-year date basis -- a year to date basis we experienced double-digit year-over-year growth in each of the industry sectors we serve except for telecommunications. Our operating margin for the third quarter was 4.6% excluding special items noted earlier. This is slightly below the margin for Q2 and this is primarily due to product mix changes and associated inefficiencies in the quarter.

Our GAAP net income for Q3 of 2006 was $29.3 million and this is a 44% increase compared to Q3 of 2005. Excluding special items, net income was $30 million and this is a 48% increase over 2005. Diluted earnings per share for Q3 was $0.45. Diluted earnings per share excluding special items was $0.46, compared to guidance for the quarter which was $0.40 to $0.45 per share. Diluted earnings per share last year for Q3 2005 was $0.32.

The marketplace for outsourcing has remained strong throughout 2006 and we continue to see positive demand conditions throughout our business. OEMs globally continue to seek opportunities to increase their levels of outsourcing and reduce their operating cost. During the third quarter of 2006, our bookings continued to reflect these strong demand conditions and we booked seven new programs with $56 million to $77 million in annual revenues expected. These new program opportunities are both with new and existing customers and represent a mix of the industries we serve including industrial controls, computing, medical and telecommunications. Keep in mind that these are estimates and actual revenues may differ significantly. Our experience has shown that in some cases program revenues exceed our expectations and in other cases the programs never meet the expectations of us or our customers.

As a result of the continuing strong demand from our customers, we currently expect Q4 revenues to be, again, a strong quarter with revenues in the range of $710 million to $740 million. And this is based on the indications from our customers. The corresponding earnings per share is expected in the range of $0.41 to $0.44 excluding the estimated restructuring charges we mentioned before of $500,000 and the stock-based compensation expense of approximately $500,000 also. This guidance for Q4 exceeds the previous guidance that we provided in our last call by over 7% and that is calculated based on the middle of the range that we gave.

Included in our Q4 2006 guidance are several factors. We've included the impact of new programs ramping, the phase-out of the Agilent programs, the potential impact of maturing programs that are potentially encroached upon by new programs, and second sourcing impacts. This updated fourth-quarter guidance results in a revision to our guidance for the full year and our revenues for 2006 are now expected to be in the range of $2.87 billion to $2.91 billion. On a non-GAAP basis, the corresponding earnings per share is expected to be $1.70 to $1.73 which excludes the Q1 tax benefit, restructuring charges and stock-based compensation expenses to be recorded during 2006.

Now I'll turn it over to Barbara to take you through a detailed review of our financial information for the quarter and Cary will follow by providing some comments regarding our year and an overview of the marketplace. We will conclude with both Cary and I answering your questions in the Q&A session and we will try to hold this conference call down to under an house today given that this is our second call this week. So thank you very much and I'll turn it over to Barbara.

Thank you, Gayla. As we reported this morning in our press release, Benchmark had another quarter of record revenue. Q3 of 2006 was completed with revenues of $770 million, a 37.1% year-over-year organic growth increase from the third quarter of 2005. Revenues for Q3 were also increased from our Q2 results.

Diluted earnings per share for Q3 were $0.45 and $0.46 excluding the special items. Diluted earnings per share for Q3 2005 were $0.32. GAAP net income for Q3 of 2006 was $29.3 million; excluding the special items, net income was $30 million. Diluted earnings per share for the nine months ended September 30, 2006 were $1.28 compared to $0.87 for the same period in 2005. GAAP net income for the nine months ended September 30, 2006 was $83.4 million, compared to $55.9 million in 2005.

As Gayla noted, our operating margin for the third quarter was 4.6% excluding the special items discussed earlier, which is slightly below the range experienced in Q2 due to the factors discussed by Gayla. Pre tax margin was 4.86% in Q3, excluding the special items. Our ROIC was 16.1 for the third quarter of 2006, which continues to exceed our weighted average cost of capital.

Interest and other income was approximately $2.7 million for the quarter. Interest expense was $85,000 and other expense, primarily foreign currency related, was approximately $857,000. Our effective tax rate was 19.3 for Q3 and the expected rate for Q4 is approximately 20%. This rate is improved when compared to our effective tax rate for 2005 of 23.8% due to the additional benefits received for negotiating several favorable tax incentives on our expanded business levels in Asia. Our weighted average shares outstanding for the quarter were 65.5 million.

At September 30th our cash and short-term investment balance was $265 million. Customer demand and continuing changing requirements from our customer base caused us to invest further in working capital during the third quarter. These working capital investments were primarily in inventory levels. For the third quarter our cash flow used by operations were $12.4 million. We do believe that our cash flow will improve in Q4 with a reduction in our inventory level and result in approximately breakeven cash flows for the full year.

Capital expenditures for the third quarter were approximately $8.2 million and depreciation and amortization expense was approximately $7 million. Receivables at September 30th were $442 million, a decrease of $1 million from last quarter. Inventory was $532 million at September 30th, an increase of $51 million when compared to last quarter, primarily due to an increase of $29 million in finished goods. Our inventory turns were 5.4 times for the quarter.

Again, during the quarter we did build inventory levels based our customers' forecasts, which proved to be overly aggressive in some cases and also had inaccuracies as to mix requirements. These customer forecasting challenges resulted in us having an unusually high level of finished goods inventory on hand at quarter end. This inventory buildup is a timing issue related to mix changes and new programs and should be reduced with additional history on shipping and selling patterns. Current assets were approximately $1.3 billion and the current ratio was 2.4 to 1 in Q3 compared to 2.3 to 1 in Q2. We have no debt outstanding at this time.

Comparing the nine months ended 2006 to the same period in 2005; we have had dramatic increases across the board in all of the industry sectors that we serve. On a year-over-year basis, revenues for the medical sector increased 50%. Revenues from the computer sector increased 38%. Revenues from the industrial controls sector increased 23%. And the test and instrumentation sector increased 30%. Revenues from the telecom sector increased 7%.

As noted above, we continue to see a significant level of growth in the non-tech industry sectors, specifically the medical and industrial control sectors. The revenue breakdown by industry for this quarter continues to show consistency and reflects our overall broad-based growth. The breakdown for the quarter is as follows -- medical, 13%; telecom, 11%; computers, 60%; industrial controls, 10%; test and instrumentation, 6%. For Q3, our top two customers represented 49% of our total revenue. Now I will turn it over to Cary to provide comments on Q3 and an overview of the marketplace.

Thank you, Barbara. Once again our team did an outstanding job during the second -- another challenging quarter for Benchmark. In the first nine months of 2006, Benchmark has increased revenue by 33% when compared to 2005 and outlook for the remainder of 2006 remains very strong. From the EMS market point of view, we see the demand from broad-based EMS continues and outsourcing opportunity remains very strong. We see the overall market outlook and demand for the second half of 2006 -- it turned out to be better than we expected as we discussed in the last conference call.

As we go forward into Q4, we'll continue to see a strong demand across the board while faced with another challenging quarter to meet our customers' demands. Our Q4 forecast will be on improving our operational efficiency, especially to reduce our inventories. As we grow, we'll continue to address the proper alignment of footprint and resources in accordance with the market demand. We believe our recent announced merger with Pemstar Inc. is in line with our overall strategy as our customers will benefit from the service and footprint of the combined organizations.

Our channel space is on track. We expect to be online sometime during the mid 2007. At this point in time I will turn to open the Q&A session. During the session we request you limit yourself to one question, one follow-up question in order to allow enough time for everyone's questions. Operator?

(OPERATOR INSTRUCTIONS) Carter Shoop, Deutsche Bank.

Overall the OpEx management was pretty impressive in the quarter. Excluding the reduced stock option compensation, can you talk about what drove that investment management and how sustainable that is?

The stock option, as you indicated, was related to a higher than normal expense in the previous quarter, and so that came down. Aside from that, the items specifically that would have been a small recovery on a previously reserved receivable would be the only other item in there and that was under $0.5 million.

And how sustainable is that current rate?

I believe that it will go back up by the amount of the recovery, say, to more like a 17.5 run rate.

Great. And as a follow-up, how many customers were over 10% of revenue and can you disclose what [Sun] was as a percentage of total revenue in the quarter?

No, we discontinued indicating in our call the specific percentage and will include information as required in our SEC filings. But we -- as Barbara indicated, we did have our top to customers which are over 10% representing 49%.

Thank you.

Brian White, Jefferies.

When you talked a little bit about an overly aggressive forecast by a customer and inaccurate mix, what end market is this in?

We aren't disclosing any specifics on it, but on new program ramps, that it's just a matter of probably the number of new programs that are ramping and not a specific single item that's in there.

Okay. And last call you talked a little bit about some macro concerns looking into the fourth quarter. You didn't mention any of those today. Have those gone away?

Well, I guess it seems like it's more positive than I would've expected. As you've seen probably throughout 2006 as we've gone through it has been somewhat surprising how strong it has remained and continued to pick up, in fact, in demand levels across the board. So I would say that based on what we've seen I would be hesitant to indicate at this point that I expect it to fall out for 2006.

Plus if you look at the last quarter, we ended last quarter with quite a bit of mixed signals from tech company announcements. We didn't see that this quarter and the overall demand remains to be pretty decent.

Okay, and just finally the option expense, Gayla. This is going to fall into the SG&A bucket? That's where we take it out?

Yes.

Okay, thank you.

Amit Daryanani, RBC Capital Markets.

Just a question on your gross margins. It went below 7% this quarter. Can you just talk about what drove the downtick sequentially? I would have thought with more volume flowing through your floors and given sales and restructuring the margin should have improved. Could you just address that and maybe talk about some relocation of R&D costs from SG&A to COGS?

Again, I think the common factor that we have when revenue increases and especially above our guidance, you see that there's inefficiencies associated with that. As well you see mix changes always have a level of associated inefficiencies, if you will. The good news is we were able to accommodate the mix changes and support the upside. The flip side is that it did not result in the improved margin impact that you would like to see simply based on the revenue increase.

All right. And just a follow-up question would be on the cash side. You guys have done a pretty good job on the sales front. The cash flow hasn't quite mimicked that growth so far. Could you just talk about what you think needs to be done from cash flow perspective so that you know your cash flow from operations moves more in sync with the sales number? And is there a revenue growth range where you can potentially reach where things would be more sustainable?

When you look at it, typically when you have a 20% growth it will give you a pretty decent cash cycle. When you see Benchmark experienced an over 30% topline increase and combined with the significant new program ramp, could say projections are very difficult to do. It's driving the inventory -- over drive the inventory to support the customer demand. So we anticipate as we improve the sales patterns -- we'll get a better understanding of the sales pattern of the new programs and that's why we're project the cash flows should be improved in Q4 significantly.

So if your ordinary growth is around 15 to 20% in the long run, that's a sweet spot where you can generate a fair amount of cash, is that a reasonable way to look at it in the long run?

Usually below 20% you should have a pretty decent cash flow generation. And above that it is a working capital commitment we had to make to ramping the new programs and invest the inventory to prepare the runs. And we also try to prepare the inventory for the different mix changes. It's somehow difficult, but I think we need much more focus in next quarter to be sure to take advantage of our knowledge of the sales pattern and improve our inventory performance.

Thanks a lot.

Alex Blanton, Ingalls & Snyder.

I noticed a remarkable consistency in your margins in the face of this big ramp up. For example, your operating margins actually went up 15 basis points year-over-year. Sales were up 37%. In the last six months, the sales are up 18%, which is almost that same rate, and there was only a range of 18 basis points in your gross margin. It was down 18 basis points over the six months with this huge ramp up. And the operating margin actually went up excluding the restructuring cost by 10 basis points over that time period.

I think this is remarkable and certainly different than some of your peers. Could you comment on what techniques you've used to keep these ramp up costs under control? And secondly, how much higher would the margins be if you were growing let's say at 10% a year instead of 37%?

That's a lot of numbers thrown at me, so let me tell you kind of how I see what we are doing and what we have done and how we operate that I believe brings the efficiencies about. And although you see it as efficiencies, there are a lot of opportunities and it's probably some costs that come upfront.

If you recall, it was last year or over the last 18 to 24 months we added capacity and probably also have taken out capacity and aligned it in low-cost geographies. As we bring up the new facilities, there's sometimes costs which have some margin pressure, if you will. But we've done an excellent job of managing the bring up of those facilities so that we are not having idle capacity sit around even as we bring up for very long periods of time.

So we get the benefits of those efficiencies as soon as we get the revenue throughput in new facilities. I guess that's a long way of saying it's all about efficiency -- it's capacity utilization, it's equipment utilization, it's people utilization. And the better anyone in our industry including us can do at managing those efficiencies, the better results you will end up having. We don't have a 1 million sq. ft. facility in any one location, which with any change in a specific industry or a specific customer ends up sitting idle.

And probably the real answer is we don't have any major facilities that are a drag on earnings which you will find oftentimes happening with others in our industry. So aligning and realigning our footprint with the needs of our customers has been a critical step that we have been able to keep pace with the customers and understand the direction in which they're going.

Okay, thank you.

Steven Fox, Merrill Lynch.

Just a question on the inventories. Do you have the specific breakdown between work in process, finished goods and raw materials? And then what do you think the impact was on your gross margins from the higher finished goods on your balance sheet?

I don't have a numerical impact. Clearly by not getting the items out the door it does have an inefficiency associated with that building into finished goods versus shipping. But I don't have the breakdown of inventories in front of me. But finished goods was up -- a majority of the overall inventory increase was in finished goods.

And then just on the outlook, Gayla, can you just talk a little bit about where the growth should be coming from in the fourth quarter, how much is it tied to traditional IT versus new program wins in nontraditional areas?

Okay, I don't get that specific in my forecasting to try to identify it by industry. Obviously we take into consideration all of the forecasting and information provided in the different bullet points I identified earlier, but I don't get down to the granularity of a by industry forecast. I'll get really good if I get there one day.

I guess what I was getting at was just seasonality from IT. Do you expect -- from computing and hardware, do you expect it to be normal?

Well, I think what we've seen over the past year is pretty good consistency in all of the industries pretty much ebbing and flowing together. So the marketplace seems to have not differentiated amongst industries as to strengths and weaknesses. So I would expect them generally to stay in tandem unless we see some overall market changes in general. I think it has to do with the overall health of balance sheets and spending patterns more so than an industry phenomenon.

Thank you.

Jim Suva, Citigroup.

Thank you and congratulations to everyone there at Benchmark. When we look at the outlook for Q4, can you comment around a little bit -- quarter-over-quarter it looks like sales are going to be down and historically it doesn't look like they've been down for numerous years, in fact close to a decade. And especially as it looks like your program ramps have been very steady, I'm just wondering if due to the customer aggressiveness and inaccuracies in mix, if some of that is playing into it, or some of the bigger economic factors you're being a little conservative? How exactly do you get to that?

Well, as I indicated, all the four factors that we took into consideration in our fourth quarter, we will have some programs -- new programs coming on and the old programs dwindling, which will have a downward impact. We'll have the phase-out of the Agilent programs. So in general we factored in all of those dynamics and into the fourth-quarter estimate.

It may very well be also that there was some strength in Q3 that was pulling forward some of the demand from Q4. I don't have infinite wisdom on that, but clearly we did see significant increases in demand levels throughout the first three quarters. So I think that it's just kind of a pulling forward of some of the excitement around the new programs and how those have filled up.

Okay. And as a quick follow-up now that we're pretty much a fair way into October and you mentioned that you had some customers last quarter give some overly aggressive orders or lack of visibility into their mix, can you talk about that's been this month for the month of October?

I'd say it's probably too early to see anything of any level of importance. It's only the 19th. I had to think a minute to see what day it is. But it's the 19th and that's probably not enough time to really assess any forecast accuracies. So I don't see any unusual activities. I think people are real focused on it.

Great. Thank you and congratulations.

Kevin Kessel, Bear Stearns.

Just a question here again in terms of the four factors you mentioned, Gayla, is there any way that you can rank them for us in terms of having the most impact?

I don't know that I would specifically rank them other than probably just the phase-out of the Agilent program as probably the single kind of fall-off that happened.

Is there any sort of approximate size that you expect that to have? Or what is the rough size of it, Agilent?

That would probably be about a $20 million impact.

Per year? Annually, right?

No, that would be about probably a quarterly impact.

Okay, and then you mentioned dual sourcing, its affecting the fourth quarter. Is there any sense in terms of the timing of that whether or not that continues into Q1 and Q2 of next year?

No, I don't have any specifics on that.

Okay, then just a clarification here. You said cash flow should be breakeven for the year, or that's the target?

Yes.

So that I guess implies cash flow positive of about $52 million or so in Q4.

That's right. Good you clarified that for all our teams. We're all on board.

Okay. And then last but not least on this inventory, just another clarification. You said the majority of the increase was in finished goods. How much do you think that was the result of you building a buffer inventory as a result of the dual sourcing that's going to end up happening?

I don't have any clarity specifically on any impacts on that.

Okay, thank you.

Thomas Dinges, JPMorgan.

Just to follow-up on the question about how much cash you'll generate next quarter, other than just really asking the team and pushing them to drive some better efficiency on the inventory side, are there any necessary incentives that you have put in place to drive those? If you think about the core business, you guys over the last couple of years have kind of consistently -- I'm not asking for '07 guidance, but you have consistently guided the years usually be up 10, 15% revenue.

You have done much better than that this year, but if we can think about that baseline, are you going to be putting some incentives in place next year as you're going through your budgeting process right now to drive cash flow as one of the major incentives for the whole team here; just because you have generated very good earnings this year, but most of the earnings have been consumed with a lot of cash that has been chewed up. I just wanted to see if we can think about that reversing course next year with maybe some incentives that you put in place. That's all.

Thank you very much. I think our people like to hear that. And as a matter of fact, yes. Inventory level performance is critical for the success of the Company, and driving inventory level to our target which is probably 6 to 6.5 times is our goal, is our operational model. That is something we have to achieve, and the quarter will put operationally -- the incentives accomplish that. That's something we need to do. It is a basic business model we are working towards.

So we are very focused to try to get there, and our team know the importance to get there. And as far as the incentive for our employees, working capital management has always been a part of the incentive anyway. Thank you for the comment, though.

David [Feinberg], Goldman Sachs.

A follow-up on the inventory. I wanted to know next quarter what specific programs or initiatives you have in place that give you comfort that you're going to bring the inventory build down? Is it just a matter of shipping finished goods or are there other things in place? As a corollary to that, do you think you can get to the targeted 6.5 to 7 inventory turns next quarter? And if not what needs to happen? Decreased revenue growth or just a matter of timing?

The inventory level, we pretty much know what the inventory driving for each program. And with a better understanding of the flow and the projection and the history of these projects, we can identify the particular programs to be focused on. That's what we've been working on right at October 1st. So that's something we will be working on and I think we'll get a good handle on the situation. And keep in mind, we have recipients of the forecasts of projections for our customers and we just need to understand that and perform accordingly. So the focus on how to identify the pattern of the inventory, the sales pattern and the work from there.

And you do that with new programs by looking at old programs?

That's correct, yes.

And in terms of getting to the inventory -- your target inventory turns, is that a matter of declining revenue growth or just a matter of better execution?

I think it's better execution. We need to go back a minimum of six times inventory turns right away. And that's what my target is.

And if I can sneak one more question in here, you talked about gross margin pressure coming revenue growth is so high. Just curious, is there a floor at some point? Does it run out of room to go down?

I would view of the range -- our target range for our operating margins is between 4.5 to 5% and that's where (indiscernible) range I'm pretty comfortable. And moving out with even a small percentage in that range is very difficult and we work very hard. Once you get to that range, you have to perform all the way until you improve, there will be efficiency improvements and you really have to be focused on details. And that's what we're focused on.

Great quarter. Thank you.

Mike Marianacci, Ragnarok Capital.

I was just wondering if you could break down the other current assets between pre paids and deferred taxes.

It's your lucky day, I actually have that one. It is about $48 million in pre paid and deferred taxes are about $8.5 million.

Okay. If I look at the pre paids year-over-year, it's up almost 100%. I'm just trying to understand why that would be.

Timing of various items is primarily what's happening and also probably some of our additional -- just items we have whether it be the additional lease facilities, timing of activities on a payment. So I don't think anything significant there.

Okay. And then just going back to looking at the second-quarter transcript of the conference call -- you said given our fourth-quarter forecast I would expect our ending inventory for Q3 to be down. So you guys obviously missed that by miles. Is there anything different than what you've already told us as to why you were so far off from your forecast?

Well, the focus (indiscernible) priority number one is always try to focus for your customer. We see all the forecasts and can't guess the mix changes and it's difficult for us to accomplish our goal. Keep in mind, our revenues went up significantly than what we anticipated too, so I'm not happy with where inventories are, I'll be very honest. And I think most of my teams already know about that. Everybody is focused on this solid growth and it's just -- we just have more focus on it and get a better understanding that the sales pattern from our customers is working.

Okay. And Gayla, I'm sorry, you said you did not have the Sun percentage for the quarter?

No, we'll disclose information in the filing of our 10-Q.

All right. Thank you.

Michael Walker, Credit Suisse.

Just on the inventories, I guess my question is -- is it really up to you guys whether inventories are able to go down next quarter, just given that it's been trouble for the last two years? And a couple other EMS companies have basically come out and said, look, our customers are making us carry more inventories. You don't have Cisco as a customer, but I don't think they're the only ones that are doing it. So I guess I'm just trying to get the bottom of the inventory increase for the last two years and if it's something that's really structural for the EMS industry?

Well, I would say this though, there's two different issues there. Inventory you really prepare your production for the customer demand. What has been changing for the last couple years from an industry practice as a whole, number one we have more inventory, raw material or subassembly being manufactured overseas. Typically those components are heavy. They're put on the waters, so those are -- expand the inventory turns significantly. And number two, there is the scope of outsourcing continued to expand. In the past we only build subassembly and now we do the full box. When you do the full box, you have a more inventory coming from different sources such as the components from Asia or some of the drives we had to build from some other vendors.

So basically the manufacturer cycle extended. Keep in mind -- to give you an example, we only build PCB, inventory turn could be in two or three weeks. When you get in a box build, the manufacturing cycle expanded and that's a part of the cost of inventory goes up. It's just a way when you're expanding your service scope that you have a high inventory flow within your system and the parts -- one more issue would be as customers become more global, you have to deploy inventory in a different location, which is becoming another major test for coordination and driving the inventory up in all of this. And this is the way the this model is right now.

Can you tell us what the mix of your business has been for box build over the past two years percentagewise?

I really don't have it in front of me, but I can get that.

It's probably grown, Michael, and we'll get the specifics, but I would say that it's probably gone from about in the -- 25% has gone up to about a 30% range. So you see more and more -- and I think you've seen that across the board where more outsourcing is done for a full system.

On that front, we also know that box build tends to have a bit lower margin than regular PCB assembly. Has that been a contributor to kind of the flattish to slightly down gross margin trend in the last two years?

I don't think you can very generalize that box being at a low margin, depending on the complexity of the box build. I'll probably segregate the box build from system integration. If you only have a very low-end box build then, yes, you probably have a low margin. But when you get a very high-end system integration, you could have a significant engineering interface, software loading and so on and so forth, the margins are pretty decent.

Okay, thanks a lot.

[Jay Hingurani], Standard & Poor's.

Congratulations on the quarter. Most of my questions have been answered. Just a quick housekeeping. The $0.5 million on FAS 123(R) and restructuring, are those pre or post tax?

Pretax.

Both are pretax, right? That's $0.5 million each?

Yes.

Okay. And just kind of echoing the inventory question, given that there is so much complexity in systems and so on, what specifically do you think is in your control to get closer to the 6 to 6.5 times?

It's always in the details -- execution, understanding the patterns, understanding the commodity nature, and understanding the flows and understanding the logistics. It would combine with a better understanding of projection and the forecast from the customer. It is a very complicated process and we just had to be very focused to try to get there.

Okay. And real quick, on the seasonality, if you look at your guidance and the $20 million upside to the high-end of your Q3 guidance from Q2, if you take that out and if you were say in the midpoint somewhere in the 720 to 730 range, would this be sequentially up then in the fourth quarter? See what I'm saying?

I'm not following the question.

The $20 million upside that you had to your guidance, you came in $20 million above the high-end of your guidance -- if you go back to the midpoint of that guidance would you then be looking at a sequentially up quarter in the fourth quarter?

Yes, okay.

If I understand the question correctly, I think the answer is yes. It would have looked flat to slightly up without having had the upside if we had been kind of midpoint to midpoint.

That's correct, yes.

Okay, great. Thank you.

Thank you, everyone, for joining us on the call this morning and we will look forward to talking to you again as we go through and close the transaction in the upcoming months. Thank you very much.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thanks for your participation and for using AT&T's executive teleconference. You may now disconnect.