Plexus Corp (PLXS) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Plexus Corp. conference call regarding its fiscal third quarter earnings announcement. At this time 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 now like to turn the call over to Mr. Gordon Bitter, Plexus' Chief Financial Officer.

Thank you. Hello and thank you for joining us today. Before we begin, of course, I would like to establish that the statements made during this conference call that are not historical in nature are forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results and actual results could differ materially 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. In addition, the Company provides non-GAAP supplemental information, more specifically net income and EPS, excluding restructuring and impairment costs.

All comments concerning earnings on this call refer to non-GAAP, that is pro forma earnings. For a full reconciliation of pro forma earnings to GAAP results, please refer to our press release and periodic SEC filings. Well that's over. Joining me today are Dean Foate, President and CEO of Plexus, and Paul Ehlers, President of Electronic Assembly, the Company's manufacturing operations. Today's call will begin with Dean making some brief comments about the quarter and I will follow-up with details on the financials and then we will open the call up for questions. I'll now turn the call over to Dean Foate. Dean?

Thank you, Gordon, and good morning, everyone. Last night we reported results for our third fiscal quarter. Revenues were $313.7 million with pro forma EPS of $0.16. As usual Gordon will get into more details on the financial results in a few minutes. I would like to take a moment to run through a few highlights for the quarter. First on the revenue front, revenues came in near the high-end of our guidance, setting another record this quarter. We had robust business development activity this quarter, winning a number of programs of both manufacturing and engineering with both new and existing customers. Additionally, our business development pipeline has strengthened in quality and quantity for both engineering services and manufacturing services providing assurance that our sector base strategy is working. We've set the stage for continued growth in fiscal 2006.

Second, on the margin front, this was the third consecutive quarter of gross margin improvement. Our new facility in Penang, Malaysia achieved a modest profit toward the end of the quarter as planned. We continue to manage down SG&A as a percentage of revenue during the quarter and demonstrating the leverage in our model, we delivered better than anticipated pro forma EPS in the quarter. And last on the balance sheet front, we continue to remain focused on improving our cash conversion cycle and return on capital employed metrics. At the onset of our fiscal year we set a goal to improve our cash cycle by a minimum of ten days. This quarter our cash cycle improved for the fifth consecutive quarter, exceeding our goal for the year.

The improvement in earnings, working capital management and adjustments to goodwill this quarter improved return on capital employed 120 basis points, representing the sixth consecutive quarter of improvement. Turning now to our market sector performance in the fiscal third quarter. Our wireline networking sector revenues were up modestly in the quarter as the strength of a new customer program ramp was offset by mixed performance among a number of other customers in this sector. As we look to the fourth quarter we expect stronger revenue growth as programs won over the last few quarters continue to ramp. Our larger customers in this base include Juniper Networks, Harmonic, Motorola, Unisys and, as announced last quarter,Harris is now contributing nicely to the sector's performance. Our wireless infrastructure sector performed better than expected in the third quarter as we continue to ramp a new customer program and a couple of customers experienced exceptionally strong end market demand.

Looking at the fourth quarter, we expect this sector to experiences a double-digit percentage decline as several customers are forecasting lower end market demand. Our larger customers in this space include Motorola, Airvana, Harris, NMS Communications and Telluler. Our medical sector was down in the third quarter, although not as sharply as we had anticipated, as we experienced somewhat better demand from many of our larger customers in this sector. Looking to the fourth quarter, we expect this sector to swing back to growth with a combination of improved demand and new program ramps offset by difficulties with a larger medical account in the UK. Our larger customers in this sector include GE Healthcare, Siemens Medical Solutions, Drager Medical, and Patientline. Our industrial commercial sector was up strongly as expected in the third quarter, driven by new program ramps and end market strength.

Next quarter we expect this sector to climb as a couple of accounts are forecasting softer demand. This sector has a broad-based customer list. Significant accounts include Intermec, Elster, VT Syntegra, AMX, GE, LaCroix and KLA-Tencor among many others. Our defense and security and aerospace sector was approximately flat this quarter. We expect this sector to be up again next quarter. Key accounts in this sector include Honeywell and General Dynamics. Addressing overall revenue concentration. Revenue from our top ten customers increased slightly to 60% of total revenues this quarter. Juniper represented 20% of the total while GE advanced 12% this quarter. Providing a few details on our business development successes. During the third quarter we won 16 significant new manufacturing programs which will add approximately $145 billion in annualized incremental revenue as these programs begin to ramp during fiscal 2006. Providing a few names, we have won new programs with GE Healthcare, GE Infrastructure, Semen's Medical Solutions, Juniper Networks and Visual Networks.

In addition, we added a significant new medical account that could advance to our top ten list in fiscal 2006. Our renewed focus on engineering services penetration resulted in another strong quarter of business development activity adding over $6 million of new programs as anticipated in our forecast. Our investment in our global engineering services capability is proving to be an attractive model for our customers. The majority of these program wins were in the medical, industrial, commercial sectors with encouraging momentum in our defense, security and aerospace sector. Commenting on capacity utilization, our global as-tooled manufacturing capacity utilization was approximately 72% this quarter as we increased capacity in Asia as well as three sites in the United States. Next quarter we expect our global as-tooled capacity utilization to rise slightly driven primarily by increased utilization rates in Asia.

Our engineering services utilization also improved with the new program wins. Looking forward to our fiscal fourth quarter, we currently expect revenues in our fourth quarter to be in the range of $315 million to $325 million, an improvement over the outlook provided last quarter. Our fourth quarter results should put us at the high-end of our previously stated goal of 15% to 18% revenue growth for the full fiscal year. We also expect continued sequential improvements in bottom-line performance and working capital metrics in the fourth quarter. EPS in the fourth quarter is currently expected to be in the range of $0.16 to $0.18, excluding any special items. Peering ahead to fiscal 2006, we are still constructing our plan for fiscal 2006, but I thought I would provide a few thoughts about the upcoming year. First, you can expect us to continue to deliver profitable revenue growth as our market sector base business development engine generates industry leading organic growth.

We will continue to focus on market sectors and customers that benefit from our differentiated value for proposition. The market should support growth comparable to fiscal 2005. Second, you can expect continued focus on improving return on capital employed, both working the numerator, namely margin expansion, and the denominator, improving the working capital and our cash cycle. Third, you can expect investments that support the increasing sophistication, complexity and higher level services demanded by our customers, namely global direct order fulfillment and global engineering services. I look forward to providing a few more details about our fiscal 2006 plan during our fiscal 2005 year-end call. I will now turn the call over to Gordon for a more detailed review of the numbers. Gordon.

Thanks, Dean. And once again, everyone, good morning. This quarter marks the third consecutive quarter for record revenues. Perhaps more importantly, it marks the third consecutive quarter for improved gross margins and earnings. Gross margins in the third quarter advanced 8.7% of revenues, a quarter to quarter improvement of 30 basis points from the prior quarters 8.4%. Gross margins in the third quarter benefited from incremental production and consequently a better rate of capacity utilization as well as a much smaller loss at the Company's new facility in Penang. The startup operation attained essentially a breakeven position in the second month of the quarter which turned into a modest profit in the final month of the quarter.

Going forward the new facility in Penang will no longer be a drag on overall earnings. SG&A expenses for the third quarter remain roughly at the prior quarter's level of $19.2 million. You may recall that the prior quarter included approximately 800,000 for additional bad debt expense and I was anticipating a reduction of SG&A expense in the third quarter. In fact, however, we had to increase accruals for variable incentive compensation and additional bad debt expense, so SG&A did not decline as I had originally anticipated. SG&A did decline slightly as a percentage of revenue and I remain optimistic that we can drive this ratio to less than 6% in the near-term. Operating margins for the third quarter improved to 2.5% from the prior quarter's level of 2.1%. EPS for the third quarter advanced to $0.16 from the prior quarter's $0.12. About $0.01 of the $0.16 was due to a lower tax rate.l So without the change in tax rate, we would have earned $0.15 per share which was the high-end of our earlier guidance. Perhaps a few words about taxes may be helpful.

We adjusted the year-to-date pro forma tax rate from 8% to 5.5% to reflect the fact that a greater percentage of our income is a rise in tax jurisdictions in which we do not currently incur income tax liabilities, namely Malaysia, China and, in the case of the United States, because we have NOLs. This change on a year-to-date basis had the effect of lowering the pro forma tax rate in the third quarter to only 2%. The difference between the prior 8% and the 2% pro forma tax rate, which is applied to the third quarter, is a difference of $430,000 or about $0.01 per share. But this lower tax effect is expected to be short lived. What financial accounting standards 109 giveth, it also taketh away. There's been a change in the UK tax legislation.

On July 20th there was a change in the UK, the so called Finance Act of 2005, which interestingly was retroactive back to March of 05. That will bring our year-to-date tax rate back, by coincidence, to the prior 8% effective tax rate. This will kick up the fourth quarter tax rate to about 13% and will give back the $0.01 that we gained in the third quarter. Our EPS guidance reflects the return to the 8% pro forma tax rate on a year-to-date basis. That's clear, right? Let me address this quarter's special items before turning to the balance sheet. The largest of the special charges for the third quarter was the 26.9 million goodwill impairment. This completely eliminates the previous goodwill associated with the Mexican acquisition and most of the goodwill associated with the acquisition in the UK.

The goodwill remaining on the balance sheet is approximately $7 million and is entirely related to the UK acquisition. So the value of the goodwill account from now on will fluctuate with the dollar sterling exchange rate. In addition to the goodwill impairment, we provided for additional severance and other costs associated with previously announced site closures as well as to provide severance for additional anticipated work force reductions in the final fiscal quarter. Let me turn to the balance sheet. I think we had a terrific quarter for balance sheet management. Our cash conversion cycle improved by nine days, primarily as a result of negotiating better terms with our principle suppliers. Days in payables went from 36 days at the end of the second quarter to 44 days at the end of the third quarter.

Inventory days in the cash conversion cycle remained at the prior quarter's level of about 56 days. You may recall that in the last quarter, that is the second quarter, we actually reduced inventories by $26 million and had a 12 day improvement. So it was difficult to repeat that dramatic improvement and at the same time gear up for higher sales in the current quarter and the planned transfers of certain programs to different sites within the Company. Such transfers typically involve temporarily higher inventory levels to insure a smooth transition. Day sales outstanding and receivables improved by one day from 51 to 50. Keep in mind that the increased back ending of sales was in the final month of the quarter, which we are witnessing this year, sort of stresses this statistic which historically has been in the high 40s. I think we will continue to run in the low 50 range.

Cash flow from operations was a positive 39.1 million. This compares very favorably to the 3.9 million of cash flow from operations in the second quarter and the negative quarterly cash flow from operations that were typical last year. Capital expenditures for the quarter were quite restrained, only $4.6 million, and remain less than depreciation for the quarter of $6 million. There are a couple of large projects, however, that I expect will be funded in the fourth quarter of the year and I'm expecting CapEx in the final quarter of the year to be in the range of $8 to $10 million for total capital spending in '05 of somewhere between $22 to $24 million. Cash and short-term investments increased by $34.1 million during the quarter and really represented our free cash flow. There were no amounts outstanding under the Company's $150 million bank credit facility. All in all a pretty good quarter. Enhanced profitability over earlier quarters of the year and much improved balance sheet metrics. Operator, Maria, this concludes my comments on the quarter, we will now open the call for questions.

Thank you. The floor is now open for questions. If you have a question please press star, one on your touchtone telephone at this time. If at any point your question has been answered, you may remove yourself from the queue by pressing the pound key. We do ask that while you pose your question that you please pick up your handset to provide optimum sound quality. Once again, ladies and gentlemen, that is star then one on your touchtone telephone at this time. Your first question is coming from Brian White with Kaufman. Please pose your question.

Good morning. When we look at end market trends for the September quarter, how would you characterize them in general? It sounds like wireless is a little softer, industrial's a little softer, have you seen a slowdown that some of the other EMS companies have spoken about recently?

It's difficult to necessarily line up our customers side by side with our competitors. I think that in wireless, in particular for us, our customer list is not quite as deep as it is in some of the other sectors, so we're not as well diversified. These customers that we are working with tend to experience a little bit more lumpy demand. A couple of them had a really exceptional quarter in Q3. Now we are seeing some pull back in Q4. Whether that's going to remain at this point is a little hard to predict. But I attribute the wireless piece to just more lumpy demand. I think industrial commercial the story is a little bit different.

We are seeing some customers that are experiencing some excellent end market demand and growth in their business. We have a few others that are going to pull it down in the quarter, that are a little bit more significant for us. I don't know that I would necessarily say that that's a broad market indicator. But the ones that are growing, I think we're gaining share with those customers, perhaps that's at the expense of some of our competitors.

How was semi cap equipment within industrial?

Semi cap equipment is relatively small percentage of the overall total.

There's really only one or two accounts, Brian, probably shouldn't comment any more than that.

Okay, good enough, thank you.

Thank you.

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

Hi, good morning. First of all Gordon, would you step out and comment on next year's tax rate?

Well, as Dean indicated, we're in the process of putting together the financial plan for '06. The best guidance I can give you right now is just to keep it at 8 to 10%. As we have talked on other conference call, I think over time, when the United States returns to a tax paying situation, if you're doing longer turn modeling assume that the effective overall tax rate of about 20%, but that won't happen in 2006.

Then when I look at the new business you talked about with the programs it looks like it's averaging like 9 or 10 million per program. How many of those are just existing customers as opposed to devoting resources to a new customer with a small program hoping it's going to get larger over time?

Yes. The breakdown between new customer, what I call gain share, was approximately nine of the 16 programs were actually additional assemblies, different additional product lines with customers that we already were doing some business. Seven of them were actually -- excuse me it's just the other way around, nine were new customers and seven were gain share with existing customers.

Great, thank you.

You're welcome.

Thank you. Your next question is coming Amit Daryanani from RBC Capital Markets.

I know you probably don't want to provide fiscal '06 guidance, but it appears from your expectations that you should see comparable 18% growth in fiscal '06. Is that reasonable and how much do you anticipate coming from new ramps of the wins your've had were end market growth?

I'd probably feel a little more comfortable giving you a little more precision here at the end of the next quarter here. Clearly right now we think we got a market growth engine here that can generate somewhere -- revenue growth somewhere in the neighborhood of what we did this year in terms of the range. So we have been seeing 15% to 18% for fiscal 2005 and we think that the market supports it and that our value proposition is appreciated by the customer base, so we think it's somewhere in that neighborhood that we can grow. And we will provide you more detail in terms of what's already kind of in the bag based on customer wins in the later half of this year versus what's going to be new business that we have to accumulate.

Today we just announced about $145 million in annualized revenue. Those programs will ramp, you know, begin to ramp at various points in the coming couple of quarters. And so from that number alone you can see we got a nice chunk -- we laid the foundation here with a nice chunk already. I wouldn't say the whole 145 will necessary affect '06, you can't just stack it on top, but certainly a pretty strong percentage of that will be in the '06 number.

All right. Gordon, just a question on the cash flow from operations, you guys did a pretty good job there, on the AP days there's been a pretty good increase there. Could you just talk about some of the steps you have taken on this front and especially if this is going to be more for a structural shift and enhance (inaudible) more visible as we go through the year?

Well, we have been taking a lot of actions to expand accounts payable. As I mentioned, we have gone back to our major suppliers and negotiated better terms. We have also put in line side stocking at some of our sites, more supplier managed inventories. We are working on many, many handles. Paul, I don't know if you want to comment further on that.

The other fairly significant issue again is as we continue to be pretty back end loaded in the quarter, we are working much more on manufacturing velocity. So we basically received the material later in the quarter with the demand being later in the quarter and therefore don't necessarily pay for that material by the time the quarter ends. All of what Gordon said plus that are really the contributors.

Amit, this is Dean. I would just comment that we have worked hard to put this in place, it doesn't happen instantaneously as you have to work down materials that are already in the pipeline here before you begin to experience a longer payment days. We still think there's probably a little bit of opportunity here to continue to improve upon this metric some more.

Thanks a lot guys.

Thank you.

Thank you. Your next question is coming from Chris Lippincott with Keybanc Capital.

Yes, I was wondering if you could go back to the tax question. Just wanted to see if I could make sense of what you were saying. Were you saying that the fourth quarter should go back to a 14% level and then that would essentially get your pro forma for the full year back to a normal level, I just want to clarify the quarter.

Yes, it's confusing, Chris. What I'm saying is that the year-to-date -- at the end of the year you will look back and I think you will see an 8% effective tax rate. But that's going to cause -- in order to get that it's going to bump to a 13% tax rate in the fourth quarter.

Okay. So we should be modeling about a 13 or 14% tax rate for the quarter.

13% for the fourth quarter.

Okay. All right. And then just kind of turning to the SG&A, you mentioned that you're looking to see within the near-term get down to that 6% level. Is this something that we should be thinking that is perhaps by a calendar year-end that we can -- a little bit more comfortable with these levels, just as you go through more efficiency or is this also through volume, how should we think about that?

There's not a lot of variable component in our SG&A expense and we think that the staffing that we have and the expense structure that we have can support a much higher revenue level. So part of it is just growing into the SG&A that we have. Secondly, there's a lot of incremental expense that's been incurred this year mainly to help us get through Sarbanes-Oxley 404 and I'm not getting on my soap box, Dean, don't worry. A lot of that additional consulting cost will fall away. There will be ongoing expenses associated with maintaining 404 and they, of course, will continue with us. But (inaudible) some one-time costs that should not recur in the next year. So I'm optimistic that next year we should get down below the 6%.

So it sounds like the SG&A ought to be relatively flat on an absolute basis for the quarter.

That would be conservative, I would hope.

And now I guess the last question. Just with the demand level, I was wondering if you could perhaps try to -- you touched base on the markets themselves, but as you begin to look out just over the next quarter or so, clearly there is some bifurcation between the different markets. I was wondering if you could comment just on the amount of growth you're seeing from the end markets themselves versus your programs actually ramping during the quarter.

Well, I'll try to help you as best I can. It's a little bit difficult for us because we have such a broad customer list and we try to get at this number a little bit. But I would say that it is -- you used the word bifurcate. I would say that that's not a bad word to describe it. I think we are seeing some customers that are seeing decent and strong end market growth. Others, where our growth is really being driven in the sector more by accumulating additional product lines and gaining share with customers and adding new customers. I would say if we looked back on the year overall when we get to the end of the year and look back and analyze it, I would say it was probably overall somewhat of an uninspired year for overall end market growth. And that the growth that we're going to see is going to be because we've accumulated new business. It's not to say there weren't come some really strong growers in there, there certainly were.

But overall I would say it's probably going to be a fairly muted year. We'd hope that, of course, that the end market's going to get stronger as we move into next year.

Thanks.

Thank you. Your next question is coming from Reik Read with Robert W Baird.

Good morning. Dean, last quarter you guys had talked about turbulence in your customer revenue projections and this quarter it sounds like you are a little bit more confident with your pipeline, which has increased, as you put it, in quantity and quality. Can you talk a little bit about what has changed there?

I think when I was talking about turbulence I was more focusing on the medical market sector which was surprisingly expected to be down and in fact was down for the quarter, which is not a typical pattern that we would see. The good news is that it wasn't down nearly as much as we had expected. So some of the larger -- a number of the larger accounts in that quarter actually experienced better end market demand than they had originally anticipated. I'm not sure what initially caused them to sort of pull back at the beginning of the quarter, but they did begin to recover as we moved through the quarter and we saw, as I say, a little bit better performance out of that sector than I would have expected and now we're starting to see that sector return back to growth in the coming quarter.

Now, medical for us has usually been relatively strong in our first fiscal quarter of the annual -- the year ending quarter. So I would anticipate that we'll continue to see strength through Q4 and into Q1 from end market growth activity and a strong kind of seasonal trend as well as a pretty significant new program that we won in the current quarter.

Okay. And then can you guys just comment -- you know it's been about a year since you changed your performance metrics to more of grading people on return on invested capital. Can you just talk about what the impact has been in the organization in the last year and where that kind of stands now?

Sure. I really need to credit Gordon for driving us in this direction. I think that we're still part way through the journey. I think we typically have incentivized people on revenue performance and EPS as well as what we call our objectives piece of our compensation strategy and we began to -- we shifted last year toward revenue and return on capital employed as the two biggest weights in the variable incentive plan. And that's pushed all the way down through the Company, everywhere we can push it. And any upside to the variable plan is solely based on proven return on capital employed.

We went through a fairly aggressive kind of educational process in the organization. I referred to Gordon as Professor Gordon as he was working to try to get the entire management team down a couple levels to understand this and help them internalize this so they could take it forward to the rest of the organization. I think we are starting to see behaviors that have changed, the way we price. Business has certainly changed for quite some time now and we are starting to see the way people approach acquiring new equipment, the way they make decisions is driven more around utilization of capital and return on that capital. I think there's still some legs under that to see improvement as the organization continues to learn and educate themselves on that metric.

Great, thank you.

You're welcome.

Thank you, your next question is coming from Todd Coupland with CIBC World Markets.

Good morning, everyone. If I could just ask two questions. Firstly, when you think about 2006 and your customer concentration, do you, for planning purposes, assume that the quarters are going to be lumpy or do you think it could be a linear year?

Well, as best we can we try to plan for some linearity throughout the year. But that's rarely the way it works out because, unfortunately, customers' forecast are not linear.

Real life intrudes.

When you look at us relative to a number of our larger brethren in the industry, obviously they have much higher concentrations of more consumer products, more commodity based products and they will of course see much bigger swings in terms of seasonality. We tend to anticipate a little bit of seasonality here in our first quarter because medical has been, but generally we tend to have more of a linear year. And typically, internally, we probably get a little bit excited about the back end of the year where you tend to have a little bit more of a muted hockey stick on the back end of the year in our planning.

And the second question is, there's been in the tier ones a fair bit of discussion around some programs that have been shifting, some OEM EMS supplier consolidation. And I'm just wondering, are you seeing that in any discussions with your customers? Can you just talk about that and set us up for anything that may or may not be happening with your customer base?

I think for us, I think that we have actually - you know, you go back a couple years and we were more on the pain end of that than we were on the benefit end of it, not to say we didn't benefit in a few cases. But as we've begun to buildout our global model and focus on customers and programs that benefit from our value proposition, I think we have been more on the benefit end than anything. So we have been accumulating share with our customers. We don't anticipate any significant consolidations or shifts away from Plexus. I think that we would anticipate continuing to grow with the customers that we have. What I would say, if we have got anything in motion, we have got probably more business in motion from a global fulfillment standpoint than we ever have.

So customers that are taking a more intelligent look to their fulfillment model and asking us to work with them to build certain subassemblies or certain assemblies in various geographies around the world and integrate those pieces together and do direct order fulfillment for their customer base. That's the complexity that we see in our business in the coming year and the pieces in motion that we would anticipate.

When you see the share gains, where is it primarily coming from? Is it out sourcing, is it tier twos and threes or is it from the tier ones? Could you just give a sense on that.

It comes from all directions. I think we have successfully taken business away from a number of the tier ones at facilities that were -- that they had that maybe were not strategic or stressed or were just customers that were not a good fit for them. And of course we have taken it from down below and pulled it up as well.

Great, thanks a lot.

Thank you. Your next question is coming from Carter Shoop with Deutsche Bank.

Good morning. A couple quick questions here. On margins for the engineering division, could you provide us a little color in regards to if that's below or above the Company average? And expectations for that going forward.

Right now the engineering margins are below the Company average, but we have got a lot of programs to focus on engineering. As you know, the engineering certainly has the potential to have much higher margins than the basic manufacturing.

Thanks. During the quarter I'm under the belief that your Senior VP of Sales, Mike McGuire, left the firm. Can you confirm that and also talk about A, how that's going to impact your pipeline for new deals, and B, if you guys plan on replacing him or absorbing that internally?

Yes, I would confirm that Mike did leave, I believe it was at the end of May. I would just say that Mike was brought on to help us buildout the sector based strategy. Mike did a good job of bringing in some very capable leaders to lead each one of those sectors and helped us greatly retool some of the resources within those sectors. But I think Mike's experience level has been more rounded in activity based broad sales organization regional structure and we were really moving more toward kind of a lean and mean targeted team selling approach in each one of our sectors. And increasingly Mike was not getting personal fulfillment out of that structure as his role was less significant in doing deals with our customers. So Mike decided to move on. So we have taken that organizational structure and have it report to Bob Krosner who is our Chief Technology and Strategy Officer.

Bob is a 20 plus year veteran of the Company and has worked on a number of different assignments, including running some of our largest manufacturing facilities and working in the engineering organization. And also running, temporarily, sales and marketing at one other time. So he is a very capable leader over this organization. But more importantly, we really have given the autonomy and hold accountable the leaders of the individual sector teams for their performance.

Great.

Carter, this is Gordon. But to your broader question is this going to impair any customer relations, the answer is no.

Maybe a last question -- I was wondering, if -- I'm not sure if you have this data available, but if you do, if you could kind of walk through different utilization rates by geography and maybe even characterize, if you have say -- I don't know exactly how many facilities you have, but say if you have 10 facilities, maybe breakout the facilities by utilization, maybe, three are below 50% and the other seven are above 50%. Do you have any kind of breakout there in regards to how evenly loaded your facilities are across the globe?

Carter, we're not going to get into specifics of that. I can say that there is wide variation in the various degrees of capacity utilization. But I don't think it's appropriate to get into the specifics.

I guess I'm looking at maybe potential future restructuring. The Penang facility is obviously relatively low. When you look at the global footprint, are there a lot of other facilities which are not at breakeven or are they all in the black?

I would say that they're not all -- not all performing up to the expectations that we would have. Although I would say if you look back a year we have significantly improved the outlook on a number of them. Some of them that were quite stressed have gotten a significant improvement in overall performance. Some of them are -- those facilities that were stressed a year ago now are performing above the kind of number that we're putting out there. So they're accretive to overall gross margins at this point.

Okay, thanks.

But it's variable. I just say it's variable. Let me just comment that the industry continues to evolve. The nature of global fulfillment continues to evolve. It's at different points in that life cycle depending upon the industry sector. We have got some customers that if you talked to them a year ago and said gee, we would like to build part of your products in Mexico or part of your products in Asia or complete product in Asia, they would have said we're out of our minds and now they have, you know, essentially changed position and are running fast down that path.

It really is quite variable industry sector by industry sector, customer by customer. The nature of where you fulfill isn't necessarily based on lowest total cost, there are people and emotions and individual performance metrics at customers that impact these decisions. And so trying to forecast what the footprint is going look like three or four years out can be a little bit difficult. I think we will continue to essentially mark our footprints and our services to match the ever changing needs of the customer base.

Thanks.

You're welcome.

Thank you. Your next question is coming from Thomas Dinges with JP Morgan.

Dean, to just follow-up on that last one real quick and then take a little bit of a different slant with it. You're obviously expecting a very strong growth year next year from what you have put out there from a sales perspective. Do you think that changes the dynamics and some of those facilities that are a bit under performing, are you able to load those a little bit better based on some of the commentary you just gave in terms of your customer base is more comfortable with producing product maybe in regions that they weren't thinking that a year ago they were all that comfortable producing product in? And then secondly, as you look at the mix of new programs that you won this quarter, talking about say profitability in terms of ramp costs and those kinds of things, can you just characterize how much -- if it is easier or a little bit less taxing to ramp with existing customers, because maybe you have got shared training and that kind of stuff amongst employees versus bringing on an entirely brand new customer? That would be very helpful.

Sure. Let me just say, if you look at the business wins that we just brought on board, a number of those business wins came into what I would consider to be under-utilized facilities both domestically and abroad. So we are looking at our individual market sectors, where we think we can grow the business and particularly here domestically, we look at the medical marketplace, we look at defense, security, aerospace, industrial commercial as markets that in many cases have programs that are intelligently supported by domestic manufacturing. Not to say that all programs in those sectors are, but there are more of them than perhaps the other sectors. We continue to look at our global market strategy, our sector teams and try to balance the evolution of global fulfillment with where we think we can grow our business in each one of those sectors and realign the footprint to match up with that. What was the second part of your question? I'm sorry I lost track.

Sorry, the second part was just characterizing programs and obviously in the industry you've even heard some of the larger companies now starting to talk about program costs being a tax on margins and so forth and you guys have obviously loaded a lot of new programs in over the last year. It seems that you would have a better chance of kind of rationalizing and getting some leverage off the infrastructure you have got when you have got an existing customer because you have got employees that are already in place and trained and so forth versus a new one. And just sort of characterize the difference maybe between those two.

It can be quite different, particularly if you're bringing in additional assemblies into a facility that's already fulfilling for that customer, you can leverage the customer team and the assets, you know, the relationship that you have to manage a very smooth transition and bring up product. Now, you know, the way new assemblies come in from existing customers can vary. It could be new program launches that are coming right out of their engineering organization or they can be takeaways from competitors or they can be movement of product lines out of the customer's own manufacturing organization. Of course the burden to accomplish those things is different. But there's no question that we focus quite heavily on gaining share with our existing customers because of the leverage that you have with the existing teams. But also existing customer programs could go into a completely different facility somewhere else in the world. In that case you have some benefit from the team but it can be very much like just winning an absolutely new program with a new customer as well.

So, you know, gaining new share -- gaining additional share with the existing customer base is always the preferred, I think, method to grow. But we also have to make sure that we are adding new customers that have, you know, a significant market availability for us so that we can grow in years two and three and four and continue to accumulate from them. That's the way we look at the business.

Okay, thank you.

Thank you. Your next question is coming from Jim Savage with Wells Fargo Securities.

Morning, gentlemen.

Hi, Jim.

I've got a couple of questions. First on the -- on your target program size you have been getting average programs of about 10 million. Is that what you're targeting, are you looking at trying to bring in bigger programs which again would leverage your SG&A expense a little bit better? Let's start with that.

Let me just say that we target -- typically we're targeting programs that are probably in the under $100 million range, Jim. When we look at the count, you looking at average size. A number of these in the count can be under $10 million programs that are additional product line wins or additional assemblies. Within the count today there was a couple of programs that were in the $10 to $20 million range, one that was in the $20 to $50 million range. So we are targeting programs that, you know, that are in that, you know, 30, 40, 50 and upper range as well. But as you target your existing customers to gain share, you many times get it in -- you accumulate it in pieces, a little piece every quarter.

Right, they give you what they give you.

Right.

Now a couple of questions about the model. With its site transfers coming, what is the near-term impact on margins that you're anticipating from that? Do you expect there to be any margin erosion as a result of the site transfers?

Let me just say, I don't think you should look at the site transfers coming as a new event. I think the site transfers are going on every quarter. This is just the nature of the business. You win new programs in -- you know, customers re-evaluate the fulfillment model. So if you look at our business today versus three years ago where we brought in new programs and they kind of stayed put, today we have got stuff in motion every quarter and we just got to stop using that as a big excuse. I mean it's just a part of the business and we have to plan it in.

Okay. And I would assume then that 12 or 18 months from now you would think that your production levels in Asia would be higher as a percent of your overall sales?

You can certainly expect that, yes.

Okay. Just a couple of more things. You have had a great improvement in inventories one quarter, you had a nine day improvement in cash cycle this quarter, Gordon, should we continue to believe that there's going to be significant improvements in your cash cycle going forward and what are going to be the big drivers of that?

Well, I think we're going to continue to work both the inventory and the accounts payable, Jim. I think we have pushed accounts payable pretty hard. I think it's probably going to plateau for a couple of quarters. And we're going to continue to work on inventory. We have got to get our inventory turns to seven, at least seven. That's not going to happen overnight, but I hope we will be making progress towards that in fiscal 2006. If Dave Clark's listening, I hope you heard that.

Okay. So then the likelihood then is that this 39 million in cash flow from operations this quarter and substantial free cash flow from operations should probably, even with a strong quarter next quarter, would decline somewhat because you're not going to get the same sort of improvement in the -- ?

That's exactly right Jim. I think there's a real pop in the third quarter. I would expect positive cash flow from operations of maybe $5 to $6 million in the fourth quarter. But, as I mentioned, we're expecting higher than -- higher CapEx in the fourth quarter, so it may be modestly $2 or $3 or $4 million negative free cash flow in the fourth quarter.

One last question. In terms of the NOLs that are remaining, you have given the guidance that the longer term you're expecting to go back to a 20% tax rate. Can you quantify the NOLs that are remaining in the U.S.?

Not right now. We have got NOLs that will probably take us out, I'm going to say two years, Jim, in the United States.

Okay, great. Unless you're really profitable?

Yes.

That would be a good problem.

That would be first class problem. Have to report a higher tax rate because we got the higher profits in the United States than we expected.

Wouldn't that be tough.

Yes, wouldn't know how to deal with these conference calls.

Okay, thank you.

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

Thank you, good morning.

Morning, Shawn.

Could you talk about kind of your strategy for engineering and how you plan to use that as a tool within Plexus and sort of a 50,000 foot view, how it's been maybe in the past and then today and what you plan for it in the future?

I don't know that our strategy for engineering has changed all that much. The engineering has always been a great tool for us to penetrate new customers and it's always been a great tool for us to add additional value to our existing customers. And essentially I call it a great sticky factor because we get much closer to the customers, we get a much better idea of where their product road maps are going, we get much better visibility to the top level of management within our customers' organizations and we can pride them that value. That really hasn't changed from day one with the Company. I would say what has changed over the last several months here is that as we began to get our new sales structure executing better, we began to redouble our efforts and refocus our efforts on growing the engineering business and dedicating some resources specifically towards working with our customers in developing new business with those customers.

So we have seen some success from that already and over the last two quarters now we have substantially improved our win rate, we have substantially improved the quality and, like I said, the quality in the pipeline for engineering services. So we feel we have got some decent momentum there. The other element that's changed is that we have had to address the low cost engineering equation. So we started to run into some competition from ODM's from standalone engineering organizations in other parts of the world. We had customers that were seeing variability in their success with those sorts of engagements, so we invested quite heavily in bringing up an engineering capability in Penang, Malaysia. I think the headcount there is roughly at 30 folks and we have begun to essentially use that capability in sort of a blended model, where depending upon the location of the customer whether they're in Europe or in the United States, we'll front end the relationship with resources in the geography where the customer is.

We'll assign certain resources or certain technical capabilities to those programs, project managers, but we also leverage the very strong and talented capability we have in Malaysia to bring down the average cost per hour of engineering services. And that seems to be a value proposition that makes a lot of sense to our customers. They feel more comfortable with that model. They feel their IP is better protected and they feel that they're getting essentially a better deal on the engineering services capability. And it's a good trade off toward just picking the whole program up lock, stock and barrel and trusting it to somebody in another part of the world.

Just kind of a two pronged question. What percentage of your business today is system build and then following into that, how much hubing are you doing for customers of finished goods and is that some of the reason it's getting more back end loaded? Or do you think that is going to change over the next couple quarters with the push towards more hubing of products?

Let me just say this, I think -- maybe Gordon or Paul want to address the kind of quantity in what you would hubing -- but essentially for us our model is built around just a tremendous -- but I would say accelerated build cycles. So we have as a process, we're very lean in manufacturing and we're able to execute on orders directly from our customers' order management systems and ship product directly to our customers' customers. So in many cases there is zero inventory in what you would consider to be hubing. So you asked about a percentage on system build. That maybe is a little fuzzier statistic.

I would say a better statistic for us is to tell you that probably somewhere in the neighborhood of 45% of our revenues comes today from direct order fulfillment. And I would expect that trend to continue. That trend is some of what's pressing us toward this back end loaded quarter that Gordon mentioned earlier.

And then in following on that, I mean, basically then you're not ever having to hold that inventory or having them put a -- customers having put a stop on it. So once you get the order it's manufactured and out the door and you're not dealing with the inventory?

There's a minimal amount of inventory, Shawn, that we maintain for our customers. But it's about a 1.2 million.

Thank you.

You're welcome. Let me just comment here in general. I think Shawn touched on a really good point and it's a really good value process that we have. And that's our ability to execute very fast on manufacturing orders. This direct order fulfillment piece that we have, we're not shipping to warehouses and hubs somewhere, we are delivering products directly to our customers' customers. Many times we are getting orders in the morning and delivering them in the afternoon.

It's definitely a capability that we have really nurtured and developed here over the last couple of years and it really is a competitive advantage for us to be able to do this the way we do on order quantities that are in thousands, hundreds and single units. We have got a capability here that is designed to be very competitive and is really in the sweet spot for many of our customers.

Your next question is coming from David Pescherine with Smith Barney. Sir, your line is live, did you have a question? We will go on to the next question, which is coming from Scott Craig with Banc of America.

Good morning. Gordon, just a quick question on the capital structure. It looks like you guys have gotten the cash flow obviously in a much better situation than it was six to 12 months ago. And you're managing your growth quite well now with the cash flow positive, even though you're growing pretty fast. Is there any thoughts to changing the capital structure or what do you need to see to make you guys comfortable in changing the capital structure to get a little bit more debt on your balance sheet?

We're not anxious to change our capital structure. I think this year we have drawn down our working capital to provide financing for growth and we have had some success, as you know, cash is now up to $72 million, cash and investments are up to $72 million. There's a little bit more we can do, I think, to continue to improve our working capital metrics and provide the incremental financing for growth. We have available for us -- to us $150 million bank facility, which is untapped. And I think we would get into that for incremental growth financing and, as Dean mentioned, we continue to focus on return on capital employed working both -- driving higher operating income and reducing our capital employed. I would expect when our return on invested capital or return on capital employed starts to approach our weighted average cost to capital, we will be pretty much self financing. So I'm not anxious to do any external financing at this point.

Okay, thanks.

You're welcome.

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

Thank you, gentlemen. I think I got disconnected before and I just heard the tail end of that question. It sounds like you don't want to add any additional financial leverage to the balance sheet to increase the leverage and maybe grow a little bit faster, is that correct?

Well, partly. It's correct in the sense we don't want to add debt to the balance sheet, but right now financing is not constraining our growth so it's not an issue.

Right. Gordon, can you talk a little bit about what incremental operating margins are looking like on new business that you're booking and how realistic is the 5% operating margin goal over the next 12 to 24 months?

I'm not going to get into the contribution margins on specific projects or programs or business we're bidding. I don't think we're going to get to a 5% operating return on sales next year, but I think we're going to make good headway toward getting there. Dean is giving me daggers so maybe he has a different opinion.

Dean, any different of opinion?

Well, as I said, we're still working on next year's plan. But, you know, we want to be as aggressive as we can to continue to, you know, grow at a decent rate, but also make sure that we deliver earnings to the bottom. And so, you know, I feel that those numbers are still within the realm of possibility within our model and we need to drive toward those numbers as aggressively as we can.

Right. Gordon, you're not willing to talk about specific incremental operating margins for specific customers, but are you seeing any of your business actually delivering incremental operating margins north of 5% today?

Oh, sure, absolutely. It's today's point, the model can work. I mean, we certainly can demonstrate that.

Okay. And then in terms of incremental working capital, what do you need to support an incremental dollar of revenue roughly?

Well, you see our cash cycle days, that's roughly it.

So 20%, 30%, and there's $0.20 for a new dollar of revenue? You have got days payable and receivables moving around just because you're back end loaded or front end loaded, but what do you need in terms of working capital for a new dollar?

56 days of inventory, 50 days of accounts receivable less 44 days in accounts payable.

So that's the go forward model for cash cycle?

Best I can give you.

Okay, great, thank you.

Thank you. Your next question is coming from Tim Caberio(ph) with Wells Fargo.

Hi, Tim. Changed his mind.

Mr Ciberio, your line is live, did you have a question? We will move on to the next question, which is coming from Mark Hassenburg with Nottingham Capital.

Good morning.

Morning, Mark.

Wanted to get a little more detail on Penang in terms of the type of products, industries that are being served there, the geographic of the customers that are coming in. It sounded from your earlier comments that you're following the same approach of having differentiating yourself engineering wise. But the thing that I'm trying to understand is how important a delta can Penang be in 2006 versus 2005 and longer term?

Well, Mark, let me take a shot at that. Maybe Paul will amplify it. Financially the start up of Penang, the second facility in Penang cost us about $0.01a share and that was moderated in the third quarter to less than half that. And then going forward it should be modestly profitable and its profits will increase as the revenues ramp up. So it did get to a breakeven in the third quarter and it should be positive going forward.

In terms of sectors served, we're building products, really, for all those sectors in the new facility today and there's significant capacity, obviously, available there yet so we expect to continue to grow the facility during the next year.

Paul makes a good point, we only have three lines up and running in the new facility.

Barely three.

And it has the capability of ten lines, so as we need incremental production capacity in Malaysia it's not a matter of adding brick and mortar, but just putting more S&P lines in.

Are the customers geographically from everywhere, from Asia, from Europe, from the U.S.? Is it focused on any particular industries or is it the same type of mix that you see domestically?

It's not a dissimilar mix, so we have got a medical customer in there from Asia, we have got North American and Asian industrial sector wireless and wireline customers. So it's not a dissimilar mix from really any of our other facilities. Which is really the way we positioned it, really is as a Asia solution for higher technology manufacturing and lower cost solution for our global customers.

Hopefully the goals and profitability wouldn't be dissimilar from what you would expect in the rest of the world?

That's correct.

Thank you, great progress this quarter.

Thank you.

Operator, I think we have time for just one more question.

Sir, I'm showing no further questions.

Well, that worked out.

I want to thank everyone for joining us today. We had some great questions and thank you, we very much appreciate your interest in Plexus. Have a nice day, everyone.

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference, you may disconnect your lines at this time and have a wonderful day.