Plexus Corp (PLXS) 2005 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the Plexus Corp conference call regarding its fiscal second quarter earnings announcement. At this tine all participants are in a listen-only mode. After a brief discussion by management, we will open the conference call for questions. The conference call is scheduled to last approximately one hour. I would like to turn the call over to Mr. Gordon Bitter, Plexus' Chief Financial Officer. Gordon.

Hello and thank you for joining us today. Before we begin, I would like to establish that statements made during this conference call that are not historical in nature are forward-looking statement. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results and actual results could materially differ from those expressed or implied in the forward-looking statements. For a list of major factors that could cause actual results to differ materially from those projected, please refer to the Company's periodic SEC filings. The Company also provides non-GAAP supplemental information, more specifically net income and earnings per share, excluding restructuring and impairment costs. All comments concerning earnings on this call refer to pro forma earnings. For a full reconciliation of pro forma earnings to GAAP results, please refer to our press release and periodic SEC filings. Before we begin I would like to introduce a guest who's becoming a regular on these calls, Paul Ehlers joins us this morning. Paul is Senior Vice President of Plexus and President of Plexus Electronic Assembly, our manufacturing Operations.

Good morning.

Some of you may be wondering what happened to Kristian Talvitie, who usually hosts these calls. I'm pleased to announce that Kristian has been promoted to Sector Vice President for Industrial Commercial Markets, so any investor inquires should now be directed to me. Of course, I get to read the legal boiler plate. Today's call will begin with Dean making some brief comments about the quarter. Then I will follow-up with details on the financials and then we will open up the call for questions. I will now turn the call over to Dean Foate. Dean.

Thank you, Gordon, and good morning, everyone. Last night we reported results for our second fiscal quarter. Revenues were $305 million with pro forma EPS of $0.12. Gordon will get into more details on the financial results in a few minutes. In what has been a relatively challenging environment for the tech industry, solid execution and the strength of our diversified customer base drove better than expected top and bottom-line performances in the quarter. I would like to point out that this quarter marks a significant milestone for Plexus. Is it the first time we have topped the $300 million revenue mark. We continue to remain focused on improving our return on capital employed and cash cycle metrics. Return on capital employed improved another 40 basis points this quarter, representing our fifth consecutive quarter of return on capital employed improvements and our cash cycle improved for the fourth consecutive quarter.

Looking forward, remain on track to be near the high-end of our previously stated range of 15 - 18% revenue growth for the full fiscal year. More specifically, we are looking at revenues for the third quarter of $305 million to $315 million. By implication, we are currently expecting flat to modestly up revenues in the fourth quarter given the unsettled end-market outlook that has developed over the past few weeks. However, and very importantly, we are expecting continued sequential improvements in bottom-line performance and working capital metrics throughout the remainder of the year. We currently expect to deliver third quarter EPS in the range of $0.13 to $0.15, excluding any special items as we realize the benefits of the closure of our Bothell facility that we completed as planned in Q2. As we enter the fourth fiscal quarter, we will begin to benefit from the improving performance of our new facility in Penang, as that operation swings to a modest profitability as planned. We also expect to drive continued sequential improvement to both our return on capital employed and cash cycle metrics over the coming quarters.

Longer term, we continue to believe that our sector team approach to business development will continue to drive strong organic growth. As most of you know, given the length of the sales and production ramp cycles in this industry, it is unlikely that new customer wins will add much more to the top-line fiscal 2005. Most of our business development activity and the resulting program wins will now impact 2006. We have a healthy pipeline of opportunities and I have identified programs worth over $1 billion of analyzed revenue, setting the stage for continuing intelligent profitable growth in fiscal 2006 which should deliver better bottom-line performance as we are able to take advantage of the leverage in our model. Turning to our market sector performance for the second fiscal quarter. Our wireline networking sector revenues were flat in our second quarter, as expected, when compared to the first quarter.

As we look to the third quarter, we are currently expecting renewed revenue growth as programs run over the last few quarters begin to ramp. Our larger customers in this space include Juniper Networks, Harmonic, Motorola and Unisys. Ares Interactive will join the list as we ramp programs with this new customer in the coming quarters. Our wireless infrastructure sector performed better than expected in the second quarter. Our operations team accelerated the ramp of a new customer program while we benefited from another customer's strong end-market demand. Looking at the third quarter, we expect continued growth as the new program continues to ramp and, as anticipated, new term improvement and end-market demand from a number of customers continues in this sector. Our larger customers in this space include Telular, NMS, Airvana and Star. As we anticipated that -- we had anticipated that our medical sector would be down in the second quarter due to typical seasonal weakness. However, broad-based end-market strength drove our medical sector to modest growth in our second quarter.

Looking to the third quarter, we expect the opposite result as end-markets now appear to have weakened for a number of our customers in this sector. The composition of the sector hasn't changed. Our larger customers in this sector include GE Healthcare, Siemens Medical, Patientline and Drager Medical. Our industrial commercial sector was up strong as expected, driven by the ramping of a number of new programs won over the last few quarters, as well as some improvement in near-term end-market demand. We're expecting another double-digit pickup in the third quarter for this sector. Significant accounts in this sector include GE, Elster, BC Centegra, La Croix, KLA-Tencor, AMX and Intermec. Our defense and security aerospace sector was up nicely this quarter. We expect this sector to be flat to up next quarter. Key accounts in this sector include Honeywell and General Dynamics.

Addressing overall revenue concentration, revenue from our top ten customers decreased slightly to 59% of total revenues this quarter. Juniper Networks, with 20% of revenues, was our only customer 10% or greater of total revenues with GE coming in just below the 10% mark. Turning to business development successes. During the quarter we won 11 significant new manufacturing programs which will add approximately $70 million in annualized incremental revenue as these programs begin to ramp in late fiscal 2005 and early 2006. Providing a few names. we won new programs with GE health care, Siemens medical, Juniper Networks, AMX, Telular and Honeywell. We also added over $7 million in new engineering business, as anticipated in our forecast, the majority of these programs wins were in our medical and industrial commercial sectors. Now for a few odds and ends. Our global as-tooled manufacturing capacity utilization was approximately 73% this quarter, about the same as last quarter with the highest utilization rates in the U.K. and United States.

Next quarter we expect global as-tooled capacity utilization to rise to 75% or above as our Bothell manufacturing facility will no longer be in the numbers. We successfully completed two major IT projects in the second quarter. First, our IT and U.K. operations teams installed our JD Edwards ERP system. We now have approximately 70% of our manufacturing revenue on the common platform. Second, our IT and HR teams installed the first phase of our PeopleSoft project to run our HR and payroll functions in the United States. Before I turn the call over to Gordon, I would like to quickly acknowledge the exceptional customer focus of our approximately 6500 Plexus employees worldwide which resulted in our fifth consecutive win of the Circuits Assembly Magazine sponsored Service Excellence Award. Great job, everyone. Gordon.

Thanks, Dean, and once again good morning. As you noted, we set yet another record for revenues in the second quarter, $305.5 million. More interesting perhaps, gross margins advanced 8.4% of revenues, a quarter to quarter improvement of 60 basis points from the first quarter 7.8%, which included a significant inventory loss at the Company's Mexican facility. Gross margins in the current quarter also benefited from higher volumes and better rates of capacity utilization. SG&A expense in the second quarter, on the other hand, was $1.1 million higher than in the first fiscal quarter and $2.8 million higher than in the comparable prior year period. As a reminder, the second quarter of last year had a credit of $1.1 million to bad debt expense as a result of recoveries of previously written off accounts.

The above trend growth in SG&A expense from the first quarter to the second quarter was driven by two main factors. The first was the need to increase our allowance for doubtful accounts by $800,000 to recognize the financial difficulties encountered by one of our smaller customers in the telecom market. This customer, which is not a major account, encountered a liquidity problem early in the quarter that prevented them from paying us and we increased our allowance for doubtful accounts to recognize this exposure. The second factor represent an increased SG&A expense for the second quarter was severance or legally required termination payments for a handful of executives who will be replaced. We also incurred additional expense related to meeting compliance with Sarbanes-Oxley 404. All together these two items, that is the severance and Sarbanes-Oxley compliance, totalled about $400,000. We will continue to drive SG&A expense to less than 6% of revenues.

Let me address the restructuring cost in the second quarter before turning to the balance sheet. The $10.6 million falls into three main categories as noted in the non-GAAP supplemental data presented with the earnings release. Approximately $6 million is to recognized principally the remaining lease obligation for the now closed Bothell, Washington facility. The cash flow implication of this element of the restructuring charge is approximately $1 million per year for the next six years. The second element is a non-cash charge of $3.9 million to write-off previously capitalized software for shop floor control. The purchase system failed to provide meaningful improvements over the Company's current system despite intense efforts by both our IT and operational staffs.

And the final element in restructuring charges is approximately $800,000 to provide for the final severance payments for stay-on bonuses for the prior employees at the Bothell, Washington facility, as well as several severance payments to reduce employment levels at the Company's facility in Juarez, Mexico. These severance expenses, of course, had a immediate cash flow effect and are pretty much behind us. Let me turn to the balance sheet. Our cash cycle improved by approximately 4 days driven primarily by a 12-day improvement in inventories. As expected, inventories were reduced by $26 million during the quarter. Day sales outstanding and accounts receivable, on the other hand, extended from the first quarter's 49 to 51 days at the end of the second quarter. This extension is entirely related to the increased back ending of sales that we are seeing within the quarter and reflects the increased direct order fulfillment that we are providing to some of our customers. Days and accounts payable also moved unfavorably during the quarter, declining six days from the 42 days in the prior quarter to 36 days in the current quarter. This change reflects, of course, the significant reduction in purchases accompanying the reduction in inventories as well as the timing of purchases during the quarter.

Cash flow from operations was a positive $3.9 million compared to a $4.5 million use of funds in the prior quarter. Capital expenditures for the current -- for the second quarter were $4.5 million, so cash-- free cash flow was just about neutral, slightly down. And we used cash to pay down the $7 million that had been outstanding under the back revolving credit agreement at the end of the first quarter. And finally, depreciation for the second quarter was just about $6 million. This concludes my comments on the second quarter financials. Jackie, I think we can now open up the call for questions.

Thank you. [OPERATOR INSTRUCTIONS] Your first question is from Thomas Hopkins of Bear Stearns.

Good morning, Gordon, Dean. I think, Gordon, maybe you mentioned that, or Dean, that the environment was a little challenging recently and then specifically you talked about the medical sector and some end-market demand weakening. Could you give us more color on that?

Yes, certainly. We did see quite a bit of turbulence in revenue projections and forecast from our customers that developed as we came in the later part of the second quarter. We -- that's in contrast to what had really been a little bit more of a stable environment, I would say, in our first fiscal quarter and the early part of the quarter. So in fact, when we had projected, the medical sector in particular, we had projected it to be down in the second quarter, which is typical for us as a seasonal trend. We, in fact, saw a number of customers lift forecasts late in the quarter. Some of it was related to some newer program wins but some of it was just forecast variability. And we saw customers taking revenue back out again in the forward forecast getting a little bit concerned. We are just seeing a little bit of forecast turbulence here as we look out forward, so we are trying to be a little bit cautious here in terms of expectations in the next couple of quarters.

Then just to follow-up on SG&A, there were a number of items, obviously, in the quarter. But going forward, looking sequentially, how should we think about modeling SG&A? Then longer term, what kind of targets are you trying to get to, because it seems to be materially higher than the peer group.

Well, to your first part of your question, Tom, we anticipate SG&A for the remaining two quarters of the year to kind of come back to what we saw in the first quarter, 18.4, 18.5. We certainly are going to moderate, continue to moderate the growth in SG&A. It's our intent to allow it to grow only substantially lower than our revenue growth and I think we have identified 6% as an immediate target. 6% of revenue as an immediate target for the Company and one we should be able to achieve fairly soon.

Great, thanks.

Thanks, Tom.

Thank you. Your next question is from Todd Coupland of CIBC World Markets.

Good morning. Could you just walk us through what you think are the core swing factors in the operating leverage in a flat environment? I guess you are talking about basically improving margins with little sales improvement.

A couple of factors, Todd. First, the Seattle losses are behind us. That will be a good guy going forward. Penang, the second facility in Penang is a very large facility and it's been starting up all year. It continues to track eerily close to plan and -- but it's currently operating at a loss. It's expected to move into a breakeven position probably late in the third quarter and to be modestly profitable in the fourth quarter. So that's the second factor. The third factor is just the better capacity utilization that we will see as a result of some of the higher volume. Plus, I guess the final factor, and then Paul can speak to this, is just better execution, focusing more on lead manufacturing techniques. Paul, I don't know if you want to amplify.

Yes, we are just seeing a, again as Gordon said, kind of a quarter over quarter improvement in our labor efficiencies as we focus very much on more on velocity and moving product through the factories much faster.

And the Penang facility, is that have programs that are set at this point or is it also subject to this forecast volatility that you have seen recently?

Yes, looking at the customer mix that we have at Penang -- you are always subject to potential forecast variability, but as we look at the customers that we have ramping up in Penang has a relatively short list of programs and we have, of course, got the radar pretty tight on those programs. I don't expect any set back there.

Great, thanks a lot.

You're welcome.

Thank you. Your next question is from Brian White of Kaufman Brothers.

Could you talk a little bit about some of the upside you saw in the March quarter? Did that come at the end of the quarter? It looks like industrial commercial was much better than expect. Was that end-markets, was that a surprise ramp in new programs? Early ramp? What was that?

I think in general we saw growth in every one of our sectors as we came through the quarter and that was not certainly expected. We did expect, actually, industrial commercial sector to perform quite well. We had won a number of new programs in the earlier quarters of the year and had expected those to ramp and they in fact did. It was a little bit stronger than expected. I think the real swing here for us that changed the outcome of the second quarter was that medical was in fact up about the same amount we had expected it to be down. And we also had much better performance in the wireless sector because we had a fairly significant new customer win a couple quarters back. We haven't named them, but in fact that business ramped up fairly aggressively in the quarter.

Our operations folks just did a fantastic job bringing that program up faster than we had originally projected. It helped the quarter out. Now, the other part of your question is what happened to forecast perhaps from customers? We did see quite a bit of late quarter uptick from customers dropping in demand on us. And that's why even though we were cautious out in the coming quarters, we are -- it still could happen that we will see that same sort of activity in the coming quarters.

And then just on the outlook, if you take the midpoint, maybe it's 1% sequential growth, I think a lot of people had 10% sequential growth but starting from a lower base. And the same thing for the September quarter, I know you talked about flat to maybe up in the September quarter sequentially and, again, a lot of people have 10% sequential growth. What is the difference there at that end-market? Is that a slower ramp of programs? Or kind of what is the difference in -- if we are starting from a higher base, why aren't we seeing a similar sequential growth rate as I had estimated and others?

It's both of what you just pointed out. We actually got it done a little bit earlier here in the year. Earlier than expected because we did, like I say, get one of our major new program wins ramped up earlier. So we are seeing -- we are still on track for the total year number that we had put out there which is the 15 - 18% and expecting us to be near the higher end. But our cautiousness on the top-line in terms of growth is just that we are a little uncertain here or a little cautious about what's going to happen in our customer's end-markets. And what has given us caution is the volatility that we saw in forecasted demand from our customers as we started to exit the second quarter. Now, we saw customers take down forecast quite substantially and then bring them back up again, somewhat, and so there is just quite a bit of volatility and we are just trying to be cautious about end-market demand.

Okay, thank you.

You're welcome.

Thank you. Your next question is from Steven Fox from Merrill Lynch.

A couple questions. First of all with regard to your sector team approach, is there anyway to say that over the last couple quarters you've won business that if you hadn't been organized the way you are now you wouldn't have won and can you describe what changed?

Well, what has changed is that we've gotten much more disciplined about the kind of business that we are going after. We have this mantra where we keep talking about intelligent, profitable growth, which, for us, really means going out there and identifying the kinds of customers and programs that fit the Plexus value proposition. And so, I think it certainly is, I think -- what has changed is that we have done a better job of getting those right programs into Plexus customers that we feel can be sticky to our model and appreciate our higher value-added service model with engineering services and direct order fulfillment. Some of those elements of the business. So the other part of it is that when you listen to the program wins today, you probably recognize quite a few of those customer names.

We have been heavily focused on trying to accumulate additional share with our existing customer base. We are in the path. We're out there just, really just looking for new customers. Quite a bit of change in focus and I think it's evident that we're starting to see some improvement in the overall performance of the customer base on share gain and based on the right fit of customers and based on what has become a much lower amount of the defection of revenue. So we have been able to really hang on to our customers over the last 18 months to two years.

Thanks. And then just on the end-markets, just to be clear, when you talk about volatility at the customer base you mentioned medical. Would it be across all of the customer end-markets you serve? Or could you just be more specific there?

Well, it has been a reasonably broad-based. You always have more volatility in what I'd say our wireline and wireless sectors. Those are typically quite volatile sectors to begin with. The surprise is really that medical seems to see some jitters, too. So, we would have expected that to actually grow in the third quarter and, as I said, we saw a real strong second quarter and then we had customers kind of soften up and forecast out further. So that one is, I think, the real kind of surprise to us that it softened up somewhat or gotten a little bit uncertain.

Thank you very much.

You're welcome.

Thank you. Your next question is from Jason Gursky of JP Morgan.

I was just wondering if you could quickly walk through your expectations on operating cash flow for the next couple of quarters and capital expenditures for the rest of the year?

Yes, Jason. We expect, I'm going to say, modestly positive cash flow from operations for Q3 and Q4. I would anticipate that we will keep our inventories pretty much flat and we should get some further improvement on the accounts payable side. To your specific question, I think last conference call I indicated CapEx for the year would be about $26 to $28 million. We've re-assessed that, that's probably too high. I'd take CapEx down to probably $20 to $22 million for this year.

Okay, perfect. Thank you.

Thank you. Your next question is from Patrick Parr of UBS.

Morning, guys.

Morning, Patrick.

In the past, and I kind of got you in trouble, I think, you used to talk about long-term or even medium-term gross margin goals. Maybe it was 9, maybe it was 10%, I might forget, but are you at this point prepared to lay out any kind of mid-term or long-term goal again?

Let me -- this is Dean. I would just reiterate that as we look at where we have to price business from a margin target standpoint and from a asset velocity standpoint, the market still supports pricing, again with what we call our intelligent profitable growth targeting, the right programs of Plexus still support pricing that is at our current gross margins or above. And so when we look at the performance of our operating units and we look at the kinds of business that we win, we still expect that we're going to be able to grow gross margins from where we are today north. Not to say that we won't have some volatility in gross margins quarter to quarter as a result of customer mix and program mix, but we still can continue to grow gross margins.

Okay, because at 73% utilization, I would imagine that's reasonably close to optimal for you. Is that true? Or am I wrong in thinking that way?

I think we've talked about optimal utilization be in the low 80s, 80, 83, 85%. The problem of the utilization, the overall utilization it masked the star performance among the various sites. Some are at respectable 100% capacity utilization, others are under-utilized. It's a difficult statistic.

And then one final question. You mentioned Penang, or at least the second facility Penang, still operating at a loss. Could you quantify the impact of that and perhaps give a sense of when that lifts and when that becomes accrete.

In the first half of the year it's about $0.015 for a quarter. It will probably be $0.01 per quarter in Q3. And as I said, late in Q3 early in Q4 it's expected to break into a breakeven and a modest -- and turn to a modest profit late in the fourth quarter.

Okay, great. Thanks.

Thank you, your next question is from Chris Lippincott of KeyBanc Capital Markets.

Just a quick question. In terms of us going back to this customer order volatility, what are your customers looking to, specifically, that they're now seem to be doing this a little bit later and perhaps a little bit more aggressively than we thought in the past? What are they really talking about? And do you see this continuing on in the rest of the year?

Well, I think part of this is a consequence of what they are seeing in their end-markets. The other element of it is a consequence of our rapid order fulfillment model. So they are taking advantage of our performance and our ability to kind of turn on a dime for us late in the quarter. To a greater extent our businesses move more and more toward a build to order, configure to order model. Certainly the wireline networking sector kind of led the way with that model, but we're seeing that model develop more and more with customers in our other sectors as well. Paul, who runs our worldwide manufacturing is sitting right next to me. He can give you a little sense, perhaps, of the back-end loaded nature of the quarter and how customers drop in orders late in the quarter.

So the volatility, I think that last quarter, Q2, we saw a little bit less volatility at the very, very back-end of the last month and a little bit more at the beginning of that month. But we still continue to be -- the revenue continues to push more toward the last month of our quarter where significant amount of our revenue is back-end loaded there. And then second question, just going back to the SG&A comments being clearly the SG&A at this point is, or seems to be at, I think, the highest we have seen perhaps historically.

Clearly you've got a high percentage on the SG&A. Yet, you are talking about SG&A around 6%. Are you looking at that on the calendar -- end of calendar year? Or is that basically your thought?

I think it's entirely possible we can get down to 6% in the fourth quarter of this year.

Fourth quarter.

Yes.

Okay. Thanks.

Thank you. Your next question is from Amit Daryanani of RBC Capital Market

Just looking at -- you have two or three under-utilized facilities that you have out there right now. Given the new business that you are winning and ramping, how successful are you in your ability to transfer these wins and ramps into the under unitized facilities and are you comfortable that these sites will be profitable by the end of fiscal '05?

Well, here I don't think we've talked about whether there's a lack of profitability at under-utilized facilities other than Penang, which was a brand -- the additional facility in Penang that was new and in fact is -- we're bringing revenue and turning it to profitability almost exactly as planned and perhaps maybe a little bit ahead of plan. Now the other facilities that we had talked about that were under, somewhat under-utilized were domestic facilities in the United States. We have just closed one, the one up in Seattle, because we were not able to grow revenues in that site and find customers to stay put in that site. Other facilities in the United States we have seen a pretty good success right here over the year at winning new business into those locations. So they have not been treading water. They have, in fact, seen significant revenue growth. One will see 40% revenue growth this year.

The other one will see revenue growth over 100% as we exit the year. The question is, is really -- the broader question is really as you look out over the next two to three years, what is the necessary capacity in the United States market to support customers that value our business proposition. And that's the broader question that we need to ask. As we see it today, the significant facilities here in the U.S. that have been under-utilized are on a path to recovery.

Can you just give us a breakdown on the engineering piece of your business. How much was that of your total revenues for the quarter?

Engineering was approximately 4% or so of revenues.

Last question. You spoke about a $1 billion pipeline. Is this business that you currently bidding on? If so, what is the expected win rate probably based on the historical performance you've had?

You could probably go back and look at what we have been announcing quarter for quarter for wins. It seems that the pipeline is almost always a billion dollars. There's always a -- and we kind of target it that way. We try to make sure that we have enough opportunities that match up with us in that pipe. They are all at various stages of the win rate. I would be very cautious about trying to give you a win rate and try to have you project how that might fold into '06 and '07 because I think it would be an inaccurate estimation at this point.

Thanks.

You're welcome.

Thank you. Your next question is from Tim Tiberel of Wells Fargo.

Good morning. Your inventory turns have fluctuated over the last several quarters. What should we be modeling as an optimal long-term inventory target going forward?

Some of the volatility reflects winning new programs and perhaps having to take on inventories, initial inventories to support those programs. So you have the inventories before you really have the production or the revenues. But I think to your question long-term, we should be progressing toward six and a half times inventory turns, or perhaps even a little bit better by the end of this year. I think longer term you can expect us to get to seven. I think getting beyond that is not appropriate given the overall marketing model and the manufacturing approach that we have.

Okay, thanks.

Thank you. Your next question is from Dave Miller of Tradition.

Good morning, guys.

Good morning, Dave.

Just to go - going back to the engineering side of the business, what was kind of the utilization there from a man-hour perspective and how is the pricing going these days?

The pricing in engineering hasn't -- really hasn't had a whole lot to do with our ability to win business. So we have been able to manage pricing fairly close to historical rates. Utilization rate, or what we refer to as the billable rate of -- or the billable percentage or efficiency of our engineering organization is about the same as manufacturing, somewhere around 73, 74%. Ideally we would like to have that at about 80% or so, because that gives us the capacity to win new programs and take on more programs.

And do you see yourself getting to the 80% any time soon?

Well, engineering, unlike manufacturing, always has a much shorter -- much -- your pipeline or backlog looking out forward is always much shorter than manufacturing. I would hope -- that is our goal is to drive it up to that. I would say that we anticipate that we're going to be able to get there because we have begun to hire engineers into certain locations where the utilization rates are high. So our confidence level is turning on the engineering front.

And then really, I think, a question for Paul. As you roll out more and more lean manufacturing initiatives, do you think those will help lessen some of the back-end loading that you are seeing in the quarters?

To some extent they will, although, again, the demand on the customers is very, very back-end loaded. So, what it will do is allow us to build the stuff faster. But I don't know that it will lessen the back-end loading of the demand itself. It won't actually.

Okay. Thank you.

Thank you. Your next question is from Chris Whitmore of Deutsche Bank.

Good morning, guys. Following-up on the last question, can you talk about profitability levels in the engineering group? Where are margins today and as you -- as you ramp that $70 million of new business that you mentioned you won, what's the outlook for profitability going forward?

We haven't really said precisely what our margins are in engineering. Only to say that they're substantially accretive to our margin, our gross margin expectations for manufacturing.

Okay. And second question, I'm trying to understand the cash flow model a little bit better. I'm trying to understand if your inventory turns are only going to peak out at maybe seven turns. I'm trying to understand what kind of cash cycle the Company can aspire to longer term and what's that imply for cash flow from operations? Any color would be helpful.

You are asking a very good question because what no one has really asked about here is what happened to our payable base during the quarter relative to inventories. And so as we look toward the cash cycle -- and we don't want to get pinned down too tightly on a specific day. What we did say is we try to drive the cash cycle to a ten day improvement during the fiscal year and we are still on track to do that. Longer term we want to drive it to 60 days and then below. The real opportunity here for us is to get inventory days to around 50 days or so, or better, and that puts us around seven turns. The other opportunity here is for us to work on our relationships with our supply base. We have seen a pretty good improvement in payable base last quarter only to see that back track some this quarter.

Now, essentially that's because we bought $25 million less of inventory during the quarter as we've got our inventory programs now giving us traction. So there is still -- it's quite a bit of opportunity here for us as we have renegotiated our terms or our relationships with our supply chain partners to benefit from some improvement in payable base.

What gives you confidence you will be able to renegotiate those terms and be able to pay later with the supply base?

Because we've already renegotiated the bulk of them. And we are just waiting for those to work through the system and to normalize now as purchases normalize.

What should we expect for a payable days maybe four quarters out?

42, 45.

Great. Very helpful. Thanks, guys.

You're welcome.

Thank you. Your next question is from David Pescherine of Smith Barney.

Thank you, good morning, gentlemen. Dean, I want to just circle back to the $1 billion new opportunities that you talked about. Can you just give us a little bit of color about how that's breaking out by end-markets and maybe which end-markets you are seeing greater urgency to increase outsourcing in?

Well, let me give you just a little bit of a sense because the bulk of them, from a dollar standpoint, certainly, probably 45% or more are combined between our wireline and wireless infrastructure. But the ones that we really are putting a lot of pressure on to accelerate for us is in medical, where we see probably 20 or 22% of that overall $1 billion in the medical market as well as about an equivalent number in industrial commercial market. And, of course, we've in the last couple quarters have kind of indicated that we are interested here in this defense security aerospace business. So we see opportunities that really fit our value proposition as almost a slam dunk in both medical and industrial commercial. As you move to wireline networking wireless infrastructure, we need to be much more careful about the kinds of business that we take on, so that it matches up better with our value proposition.

And then can you talk at all about what the backlog of currently booked new business might look like or still exists that may ramp into '06? Because the question always is you book business a year in advance and then starts hitting your income statement. So any sense about how large that pipeline still is today of existing booked business for Plexus?

I tell you, I would really want to be cautious about providing too much guidance here in what '06 might look like. It certainly is true that business that we have won in this quarter and expect to have successes on the coming quarter are '06 -- is '06 business. And so there is a, certainly a foundation for growth already laid on top of the current run rate in '06. But what we haven't done is really begun to project what we can actually get done in the coming year, although I think the growth rate that we saw this year -- expect to achieve this year, on top of a 29% growth rate last year, gives you some sense that we are quite confident we can grow in the neighborhood of that high teens to 20% clip with the business that we are really targeting.

Great. Thank you very much.

You're welcome.

Thank you. Your next question is from Shawn Severson of Raymond James.

Thank you, good morning.

Good morning, Shawn.

Could you give a little color on the deal flow as far as the possibility of doing any type of asset divestiture of any -- or any larger scale type deal? And if not, it would appear to me that with a pretty good pipeline, you would start to bump up into some capacity issues maybe late this year, early next year and kind of what your plans are for spending there and where the most aggressive development expansion would be?

Well, we really haven't gone after sort of the asset divestiture kind of deals. It really hasn't been our growth model. It's true that a few years back we did a couple of smaller deals that way. Our goal here is to go out and convince the OEMs to let us take on the right kinds of business and bring it into our existing facilities. You're right. As you look at our capacity utilization, if you look at the growth rate that we are looking at, that we may have capacity constraints, perhaps, later this year, early next year. But I would also remind you that when we talk about capacity, we talk about as-tooled capacity. So what we mean by that is based on the people and equipment that we have tooled up in our facilities, what is kind of the revenue number that we can achieve. So we feel we can take on a significant amount of additional revenue by just adding people and additional equipment into our existing addresses.

However, as I started to talk -- as I said earlier, longer range we need to really look at what is the appropriate long-term footprint based on some of the medical business, perhaps some the industrial commercial business that has been stickier maybe to a U.S. model. What is that really going to look like from a fulfillment standpoint further out, as we are starting to see more and more of our customers go toward a -- kind of a multinational fulfillment model where we're building elements of products in multiple geographies. So, projecting longer range capacity is a little bit more of a challenge and it's something we're going to really try to tackle here at our upcoming strategy session with our board in May.

So from a final systems configuration standpoint, Europe would be a place that you'd probably need to do something, would that be kind of a number one priority?

As we look at a significant kind of hole, if we really have one in terms of being able to service our multinational customers, it is potentially in Europe and we were studying that issue.

Okay. And then just lastly, if we look at how quickly the return on invested capital can accelerate here. I know you've talked about some initiatives that should improve margins throughout the year and even a flattish top-line. But, being able to bring in the incremental revenue here without bringing on additional assets, I would assume that the ROIC curve would be relatively steep as you get quickly up to that 80% on up to 85, 87% type cap utilization. Am I thinking about that correctly?

The only thing I would add, Shawn, is the fact that we are not so much fixed capital intensive as we are working capital intensive. So as we grow revenues we do have to add working capital. And that's what Dean's point, we have to tighten up the cash cycle to really make the cash flow work.

Okay. Thank you.

Thank you. Your next question is from Reik Read of Robert Baird.

Dean, you guys had talked about the programs that you have underway to improve inventory. Can you give us a sense as to what some of the specific programs are and how they are in terms of ramping up, where they are in terms of the ramp up?

I'm going to let Paul take that one because he is the guy that's closest to all the inventory programs.

I think the best way, maybe, to give you some idea of what programs drove the improvement last quarter. A big part of the improvement that we saw in inventory really was in the work in process number where we got about two and a half days quarter over quarter improvement there as we got higher velocity through our manufacturing facilities. So that's really two quarters in a row there where we've made very nice improvements there and we expect that to continue. We've got a couple of other sort of big hit opportunities, then I think we'll see sort of more gradual quarter over quarter improvement. We made very substantial progress on raw. That was a combination really of putting in place some of our supplier managed inventory programs. We have other opportunities there, but we made a -- actually a larger than expected impact there since last quarter.

And then if you remember really last quarter what caused the big part of the increase in inventory was sort of a one quarter investment in inventory to try out some new supply chain solutions that will -- that would reduce inventory on an ongoing basis. And that took really good hold in Q2 and we saw significant reductions in inventory because of those. So, we really see some of those-- really all of those initiatives continuing. We talked about the fact that we see finished goods sort of leveling off that the numbers we are at. We believe we can continue to make improvements in work-in-process and in raw inventories.

And, Paul, with the whip you had mentioned that there is a couple of other big hit opportunities. When might you see those come into play?

In the next two quarters.

Okay. Then quickly, Gordon. You had mentioned that you lowered your CapEx forecast. Can you give us a sense for what had changed in your mind?

I just think that the site forecast was just perhaps a little too exuberant at the start of the year and as the year develops you start getting a more practical look at it, Reik.

Thank you. Your next question is from Richard Stice from Standard and Poor's.

A couple of quick questions. First on the revenue performance if you could break that down by major geography. And then secondly, I know you talked about some of the longer term gross margin trend. But if you just look throughout the rest of '05 with the 60 basis point uptick sequentially, can we expect similar performance the rest of the year? Can you just comment on that? Thanks.

This is Dean. I'll take the first part in terms of the geographic performance on revenues. We saw, again, domestically the U.S. was up in the quarter and we had, again, expected to be down somewhat because a lot of our medical manufacturing is done here in the United States. The U.K., which is just under 10% of revenues overall, was up very strong in the quarter, on a couple of really what was end-market strength from about three customers, significant customers that they had there. Mexico was off a little bit. And Asia was up. Again, I think we've had a sequential run of quarters here where our Asian locations have been up. That's gone on here for a couple of years. So, they had a nice upside on what's probably 11% or 12% of overall annualized revenues. I will let Gordon take the second part.

Richard, on the gross margins, gross margins can vary quarter to quarter based on factory performance, based on the mix of products, based on the mix of customers that we have. Essentially for the second half of the year we'd expect an upward trend.

Okay, great. Thank you.

[OPERATOR INSTRUCTIONS] Your next question is from Michael Ellis of Thomas Weisel.

Good morning. I was hoping you could comment on something that I noted as I was listening to your call. You seem to be more able or more willing to comment on some of the new wins that you have had and also identifying the customer programs unlike a lot of your peers. I was just wondering in general how comfortable are your customers when you talk about new program wins, when you kind of talk about your -- the description of your end-market performance.

Obviously, we spend a lot of time, and I spend a lot time, having direct dialogue with our customers at the top level. Quite frankly, if they don't want us to talk about them, we don't. Any customers that we mentioned by name, we have gotten direct -- we've had direct dialog with the customer and they got assurances from them that they are comfortable with us mentioning them by name. Typically, they are less comfortable with us talking about specific programs, for obvious reasons, and so we tend to avoid talking about the specific products and programs that we do for them. We do have a very diversified customer set in each one of our market sectors. So in general, our customers are not too concerned about us talking about what we see from our market sectors in a general sense in terms of strength and market demand, those sorts of things.

I just had one follow-up question, kind of on a different tack. With some of the lead-free and new environmental initiatives taking place next July, how far are you guys along in getting your factories up to compliance and do you see this as an opportunity to offer additional services to customers that would drive more outsourcing?

This is Paul. So from a manufacturing process standpoint we are pretty much there. We've got all the processes validated, we are building product today in that environment. The manufacturing process issue really is a slam dunk. The other part is the supply chain side, we have got some very good tools there and we actually do see opportunities and a number of our customers are very interested in having us help them through this process. So particularly in the next three or four quarters, I think there will be a growing interest in that and opportunities for us to help them through those transfers.

Of course, this is an area where Plexus' value-added services model really does help all of the customers. Our engineering capability and our long history medium will help our customers design, redesign products, do value engineering on products. This is a natural fit for that. We do see, as Paul said, quite a bit of interest here in trying to road map product preparations for Europe. At this time we don't see customers -- they're certainly taking this very seriously. We have a few handful of customers that have stepped to take relatively immediate action to be able to maintain those marketplaces. Other customers, we have a significant number of them that have, I guess, referred to it as exceptions or exclusions to the rules based on the nature of their products. It's a fairly complicated issue based on the technology of the product and how it is moved into the European market.

Thank you.

You're welcome.

Thank you. Your next question is from Scott Craig of Banc of America.

Good morning. Gordon, just a quick question on the SG&A. It looks like you had a couple of expenses in there that are what I would refer to as nonrecurring, first of all on the doubtful accounts, that -- it looks like that's about $700,000. Is that $700,000 incremental above what you would normally put in there? And then if I include some of the severance for a handful of executives that you mentioned, I assume that that's not going to be in there next quarter either, so that sounds like you've almost got $1 million in there that falls out right away and brings you to kind of in the low 18 million number. So what's the -- some of the offset to that that brings you back into the 18.4, 18.5 region that you are talking about?

Your analysis is exactly right, Scott. There was actually was an $800,000 increment to the allowance for bad debt, allowance for doubtful accounts. And the severance for the executives is about $200,000. Just -- they're just normal ongoing expenses. We need to continue to spend some money on Sarbanes-Oxley. We continue to add an occasional person. So it's -- but it should go back to 18, 18.3, something like that.

Okay. And then, Dean, just a quick question. As you look into fiscal '06, not asking for guidance here or anything, but when you're looking at a facility usage and expansion, where do you think as you go farther into '06 that you might need to expand, given that you mentioned some of your facilities are operating pretty close to peak levels or 100% capacity?

Well, as we look at the footprint right now, again, we can add equipment and people into existing addresses, that really I think cover what I would think would be most of our growth in '06. Having said that, it's possible that we would need to do another plan at least to prepare for another incremental expansion in Asia as our business continues to grow. And as I discussed earlier, if we decide to make a stronger push into the European marketplace it's possible that we may need to begin to bring something up in that market. But I would see those as kind of mid to later '06 initiatives, if they happen at all.

Okay, thanks.

Thank you. Your next question is a follow-up from Amit Daryanani of RBC Capital Markets.

This is a quick question regarding taxes. How long do you think NOL's are going to last and what would the expected normal tax rate be after that?

The NOL's in the United States should last at least through 2006. And if I were doing a model, I would assume 20 to 25% as the normal effective tax rate going forward.

Thanks.

Thank you. Your next question is a follow-up from Brian White of Kaufman Brothers.

Dean, could you talk a little bit about headcount? Where do we stand in total? Did we add any people during the quarter? And what's your expectations for addition throughout the year?

Headcount is approximately in the neighborhood of 6500 people worldwide. I believe my memory is correct, we had about 6300 at the end of Q1. I'm actually expecting that to come down a little bit. Gordon just talked about some severance costs for our facility in Mexico. We saw revenues come down there a little bit and we are resetting headcounts. So I'm expecting, more than likely, that we will probably, given ups and downs worldwide, we will probably come down a little bit next quarter and probably end up the year right about at the 6500 mark.

Okay. And Gordon, could you talk a little bit about operating cash flow. what you expect next quarter? I think, maybe expectations with inventories coming down were a little high for this quarter and that was due to the receivable and payable management. But what do you think next quarter looks like?

I think I answered this, Brian. But it's basically we're looking for modestly profitable cash flow from operations in Q3 and Q4. I do not expect to be into the bank revolving credit agreement at the end of any of the quarters for the rest of the year. And, perhaps, you can even add a little bit cash to the balance sheet.

What modest is what, similar to this quarter?

Maybe a little better, couple million better.

Okay, great. Thank you.

There are no further questions. I would like to turn the floor back to management for any closing comments.

All right, I would like to thank everyone for joining us this morning. Certainly great questions and we appreciate your continuing interest in Plexus. Thank you very much.

Thank you. This does conclude today's teleconference. You may now disconnect your lines and have a wonderful day.