Plexus Corp (PLXS) 2005 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Plexus Corporation conference call regarding its fiscal fourth 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. Gordon?

Thank you. Good morning, 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 statements and 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 earnings per share, excluding restructuring and impairment costs, and in the prior year, excluding the valuation allowance on deferred income tax assets. 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.

Joining me today are Dean Foate, President and CEO of Plexus; Paul Ehlers, Senior Vice President and President of Plexus electronic assembly, the Company's manufacturing operations; and Bob Kronser, Executive VP and Chief Technology and Strategy Officer. In his spare time, Bob is also responsible for business development.

Today's call will begin with Dean making some brief comments about the quarter. I will follow up with details on the fourth quarter financials, and then turn it back to Dean for an overview of 2006 before opening the call for questions.

Let me now turn the call over to Dean Foate. Dean?

Thank you, and good morning, everyone.

Last night, we reported results for our fourth fiscal quarter. Revenues were $322.2 million with GAAP EPS of $0.24. I am pleased to note that there were no restructuring or impairment costs in the fourth quarter and therefore, no pro forma disclosures.

Revenues for the quarter were near the high end of the guidance that we provided last quarter, while EPS was significantly above our guidance range of 16 to $0.18. Gordon will provide you with a road map for the better than expected bottom line performance in a few minutes.

Let me continue by providing you with a few details about our fourth quarter and issue a final report card on fiscal 2005 before turning the call back over to Gordon. Once Gordon completes his detailed analysis of the year-end numbers, I will return to outline our priorities for fiscal 2006.

Turning now to our Market sector performance in the fourth fiscal quarter, our wireline networking sector revenues were just about even with the previous quarter, reflecting a general lack of end market excitement. We had expected slightly better performance to be driven by newer program ramps. Looking to the first quarter, we currently expect renewed strength based on improved customer forecasts and new program ramps that are finally underway.

Our Wireless Infrastructure sector was down sharply as expected this quarter. Although we are experiencing growth with some customers, the end market dynamic with others remains lumpy. Additionally, a key end market customer of one of our significant accounts in this sector has exercised their option to manufacture some of our customer's product. Although the impact to us is, as yet, unknown, this event prompts a soft outlook for this sector until the back half of 2006, when our sector concentration shifts to customers with perhaps more stable end market demand.

We expected our Medical sector to be up in the fourth quarter and it did not disappoint. We experienced exceptionally strong performance from our leading customers. However, the exceptional strength is not expected to continue into our first quarter, as we currently expect our Medical sector revenues to decline, countering our past pattern of seasonal strength in the December quarter. Contributing to the overall decline are the continuing difficulties of the larger Medical account in the UK, as we outlined on our third quarter conference call.

Our Industrial/Commercial sector was down in the fourth quarter, as expected. Our first quarter outlook for this sector is essentially flat.

Our Defense, Security and Aerospace sector was up this quarter, as expected. We continue to accumulate new business in this increasingly important sector. We are anticipating growth again next quarter, as we continue to ramp new programs.

Addressing our overall revenue concentration, revenue from our top 10 customers increased slightly to 61% of total revenues this quarter. Juniper Networks represented 18% of the total, while GE advanced to 14% this quarter.

And let me pause to anticipate your question: We did not lose market share with Juniper.

New business wins -- on the business development front, Q4 was essentially a repeat of our solid performance in Q3. During the fourth quarter, we won 16 significant new manufacturing programs, which in total will add approximately $150 million in annualized incremental revenue, as these programs begin to ramp during fiscal 2006 and on into 2007. Four of the programs were with new customers, while the remaining 12 were share gains with existing accounts.

As I will emphasize later, our engineering services business continues to improve. This quarter we won approximately $10 million in new product development business, up from a decent $6 million in new wins last quarter. While we won business in all of our key sectors, the greatest concentration of engineering business continues in our medical sector.

Turning now to report card and how we performed in fiscal 2005, I am pleased to report that for our full fiscal year, we made significant progress in all the key priorities that I outlined for you on our year-end conference call last year. These priorities were intended to drive significant improvement in return on capital employed.

Let me summarize our progress. Our first priority was to drive intelligent profitable growth. We achieved record annual revenues, growing the top line 18%, which was at the top end of our target range of 15 to 18%. Our growth was intelligent in that much of the new business we targeted and won is [sticky] business. These new programs substantially improve the capacity utilization at a short list of sites that were previously operating below critical mass, including our new facility in Panang, Malaysia. We experienced double-digit growth in our key sectors while getting decent traction in an important new sector, Defense. Our sector-based business development strategy is working.

Our second priority was to improve the penetration of Engineering Services and get this important service back on the path to growth. We had a difficult start to the year with Engineering Services, which prompted us to pursue a new approach, namely dedicated resources to develop engineering services opportunities. During each of the last three quarters, we experienced a dramatic improvement in the funnel of opportunities for the Technology group. Very significantly, the win volume in our fourth quarter exceeded our engineering capacity.

Third, and this may be Gordon's favorite, we set out to improve our working capital metrics. We communicated a goal to improve our cash conversion cycle by a minimum of 10 days for the full fiscal year. Perhaps we made the goal too easy. Our Operations and Materials organizations really stepped up big-time. They teamed up on key lean sigma and supply chain initiatives and delivered an outstanding 22-day improvement, which brought our cash conversion cycle down to 53 days as we exited 2005. And I might add that this represented six consecutive quarters of improvement.

Fourth, we remain committed to flawless, agile execution and invested further in several lean sigma and other operational leadership initiatives designed to improve productivity and enhance customer satisfaction. Once again, we won the Circuits Assembly sponsored award for overall customer satisfaction, while improving gross margin performance four consecutive quarters during fiscal 2005, exiting the year at 9.5%, the strongest among our peers.

And last, we said we would moderate the growth in SG&A and demonstrate the operating leverage in our model. Our SG&A grew, admittedly more than desired, driven by spending for IT initiatives, healthcare, and Sarbanes-Oxley 404 certification. However, for the full year, we grew revenues 18% and operating income 59%. We are exiting the fourth quarter with gross margins at 9.5% and operating margin at a much improved 3.4%.

So how did we do on return on capital employed? Working the numerator and the denominator, we improved return on capital employed from 4.5% to 9.5% for the year. I might add that return on capital employed has improved seven consecutive quarters and we exited our fourth quarter at a run rate approaching our target for fiscal 2006.

I am pleased with the progress we made this year. Let me pause here to acknowledge the hard work and dedication of the more than 6700 Plexus people around the world who really pulled together to make it happen for us in 2005. Thank you, and congratulations, everyone.

I will now turn the call over to Gordon for more specific comments on our results.

Thanks, Dean.

As Dean noted, we enjoyed a very strong fourth quarter. Revenues set yet another record and profitability continued to improve. Earnings per share at $0.24 was $0.07 better than the midpoint of our earlier guidance, when we said that we anticipated earnings per share in the range of 16 to $0.18. Most of the $0.07 per share improvement was operationally driven and I'll come back to address that. But we also benefited from a lower effective tax rate and gains included in miscellaneous other income. So let me take care of these nonoperational factors.

First, a lower than anticipated effective tax rate reflects the fact that more of our fourth quarter income was earned in countries where we currently don't pay taxes. In addition, the impact of tax changes in the UK turned out to be less onerous than we originally thought. We had been expecting the 13% tax rate in Q4. Instead, it was only 5%. On a pro forma basis, the lower effective tax rate contributed about $0.02 of the $0.07 favorableness to our previous guidance.

Second, in miscellaneous other income, we had higher interest income on better cash balances than originally anticipated and we also recorded a one-time gain on a real estate transaction, which together, contributed a penny to the bottom line. So about $0.03 of the $0.07 upside surprise in the quarter was nonoperational.

Let's turn to the more important operational issues. As I noted, revenues increased 3% sequentially and gross margins expanded 80 basis points from the third quarter's 8.7% to 9.5% of revenues. The gross margin expansion was due to several factors, which I think I can categorize into three major buckets.

First, as I mentioned at the last conference call, our new factory in Penang got to a break-even position during the prior quarter -- the third quarter, and it operated profitably in the fourth quarter, so that was a key swing.

Second, higher revenues and better capacity utilization also enhanced margins, but perhaps even more important were increased labor efficiencies that we had at several sites. We had better results than originally anticipated, arising from certain lean manufacturing initiatives that had been started earlier in the year, but really kicked in in the fourth quarter.

Third and finally, we had a richer mix of revenues. That is, programs with better pricing and better margins. Some of these were in the Medical and Defense sectors, although an overall greater level of engineering work than expected also contributed to the improved gross margins in the fourth quarter. This third and final factor, that is, the richer mix, will diminish in importance in the first quarter of '06.

SG&A expense for the quarter was $19.7 million, which represented 6.1% of revenues. This level was about 400,000 higher than last quarter and quite frankly, higher than we anticipated when we spoke on the last conference call. The higher number was due to higher accruals required for a number of year-end adjustments, including variable incentive compensation and higher audit costs attendant Sarbanes-Oxley 404. We still expect to get SG&A expense below 6% of revenues during fiscal 2006.

Operating income was $11.1 million in the quarter, which represented 3.4% of revenues, up 90 basis points from the prior quarter. And as I mentioned earlier, we enjoyed in the fourth quarter favorable interest and miscellaneous income compared to the third quarter, as well as only a 5% effective tax rate.

Parenthetically, we expect next year's tax rate to remain low, actually in the 3% to 5% range because of the tax benefits that we have. Although I would caution that expected new rules from the Financial Accounting Standard Boards for accounting for uncertain tax positions will most likely increase the volatility in the effective tax rates, not only for Plexus, but for all of corporate America.

Let me spend a few minutes on the balance sheet and cash flow and, yes, Dean, improved cash flow was my favorite of your achievements. Our overall cash conversion cycle showed a further 9-day improvement, a 3-day improvement in DSO and accounts receivable, and a 6-day improvement in accounts payable. The receivable improvement reflects very strong year-end collections, which were helped by not quite so back-ended -- by a not quite so back-end loaded quarter for revenues. I got that. The improvement in accounts payable reflects the better terms that we have negotiated with our vendors.

Cash flow from operations for the fourth quarter was $46.5 million, which compares very favorably with the 19.6 million generated in last year's fourth quarter.

For the full year, the comparison is even better. Cash flow from operations for all of 2005 was a positive $84.5 million compared with a negative $21.4 million last year. As a result, cash and short-term investments were $108.7 million at the end of fiscal 2005, up nearly $64 million over the prior year-end period. I should mention the capital expenditures for the quarter were approximately $9.8 million, primarily for additional production capacity in Asia, and capital spending for the full year was about $22.4 million.

Incidentally, we expect capital spending to increase in fiscal 2006, once again, to support higher production levels, much of it in Asia, and capital spending for 2006 is expected to be about 30 to $35 million.

In summary, a pretty good conclusion of fiscal 2005. Better operating income and improved balance sheet metrics and positive free cash flow.

Let me conclude with a brief update on Sarbanes-Oxley. As you may recall, this is the first year end that Plexus is required to meet the internal control standards of Sarbanes-Oxley. Although we won't have a final sign-off from our outside auditors until we actually file the 10-K with the SEC in mid December, our preliminary review and assessment with the auditors suggests that we will not have any material weaknesses in internal controls. Complying with Sarbanes-Oxley has been a major initiative for us in fiscal 2005 and I would like to acknowledge the tireless effort of so many Plexus employees who contributed to the successful outcome.

This concludes my comments on the quarter. I will now turn the phone back to Dean for some additional comments on our priorities for fiscal 2006. Dean?

Thanks, Gordon.

Many of the priorities in fiscal 2006 are focused on improving and fine tuning the key initiatives started in 2005, namely, to profitably grow the top line, while delivering further improvement in return on capital employed.

First, you can expect us to continue to deliver profitable revenue growth, leveraging our market sector-based business development engine to generate organic growth in our target range of 15 to 18%. We'll strive for growth in all of our key market sectors and work to gain critical mass in our defense sector. We will focus on increasing share with existing customers who are qualifying and targeting a select list of new accounts that can benefit from our differentiated value proposition. We expect Engineering Services to return to robust growth in 2006.

Second, we will invest to further enhance our integrated global services model as the customers are increasingly taking advantage of our service offerings in multiple geographies. Areas of further improvement and investment include China sourcing and supply chain management, global customer management, and common IT platform rollout, along with the extension of our direct order fulfillment capabilities to our Asian facilities. Additionally, we must plan for further capacity expansion as our utilization rates rise to 80%, our threshold for optimal efficient operations.

Third, we will continue to focus on leadership and employee development to ensure that we have a pipeline of exceptional talent to grow our business globally and maintain the quality of our industry-recognized customer service.

Fourth, you can expect continued focus on improving return on capital employed, working both the numerator, namely operating margin expansion, and the denominator, improving working capital and our cash conversion cycle. To improve the numerator, we'll drive toward our longer-term 1055 model, or, stated more clearly, 10% gross margins, 5% SG&A, and 5% operating margin. To improve the denominator, we'll drive toward a 45-day cash cycle. Our goal is to exit 2006 with an after-tax return on capital employed exceeding our weighted average cost of capital, which we estimate to be around 15%.

Turning now to our guidance: We currently expect revenues for our fiscal first quarter to be in the range of 315 million to $325 million, or about flat with our fourth quarter of fiscal 2005. Consequently, we expect EPS performance in the range of 22 to $0.25, excluding any special items, but including about one penny of expense for stock-based compensation that was previously not required to be expensed.

With that, Brianna, this concludes my comments. We will now open the call up for questions.

Thank you. [OPERATOR INSTRUCTIONS] Our first question is coming from Brian White with Kaufman Brothers.

Hi, good morning.

Hi, Brian.

I'm wondering what you think was the biggest -- you mentioned different reasons why margins were positive in the quarter. What do you think was the biggest swing factor, the biggest surprise for Plexus?

I think the real pull-through on the lean initiatives that we put in place at several sites, Brian.

Okay.

And we got an earlier payoff and a bigger payoff than we had expected when we had the conference call three months ago.

Okay. And maybe talk a little bit about end market trends. Some of your competitors have been talking about a slowdown in October. You know, your EPS outlook is excellent for the December quarter. Revenues are a little bit lower than what I had and I think what the Street has, and flattish is pretty unusual for December quarter. So maybe talk about end market trends in general. What are you seeing?

Well, I think, you know, as I gave you a little bit of a hint on in my script, I think we're going to see our Medical sector actually come down when we normally would see quite a bit of uptick in Medical. Part of that is more related to the -- more related to us having an even better fourth quarter for Medical than we had originally contemplated. We expected it to be up double digits, but not quite as strong as we did. Part of that was related to one of our customers shifting some additional production to us at a rate a little bit faster than we had expected and it was a little bit of a catch-up revenue there that we're not going to see in the first quarter. So -- and of course the customer of our UK operation that continues to be kind of in a holding pattern with some regulatory issues over in the UK, that's bringing down Medical.

So from a medical standpoint, the market is decent and strong. We're just seeing a bit of a strong fourth quarter uptick and a back-off in the first quarter because of the issue over in the UK.

And you feel good about your Communications market? It sounds like maybe have you some new wins, but in terms of end market demands in Communications?

Yes, I think the communication market is-- we expected it to be up a little this quarter. As I said, we thought we were going to get some ramps with some new programs started just a little bit earlier than they actually occurred. We also, because of our 445 quarter, there was a little bit of revenue shift from what would have been our fourth quarter to our first quarter, so we'll see some improvement in uptick in our first quarter, but we're not seeing great excitement in the end markets, but the end markets -- our customers are growing, by and large. So we're doing all right and we're doing a good job of accumulating new business in that sector to drive top line.

Okay, good. Great quarter.

Thank you. It's been a while since we heard that.

Thank you. Our next question comes from Steven Fox with Merrill Lynch.

Hi, good morning.

Good morning.

First of all, on the outlook for this current quarter, could you talk a little bit more specifically about any kind of gross margin impacts and which direction you think those will go, as well as SG&A? Then secondarily, looking for the full year, how much improvement do you think you can get in terms of margins and where specifically do you think it's going to come from?

Yes, I would say, Steve, the first quarter gross margins are coming to come down a little bit. Keep in mind, we typically have a salary increase that's implemented at the start of the fiscal year and the effect of that will be obviously felt mainly in the cost of sales in the first quarter.

On the other hand, as we've noted, there's been a lot of extraordinary costs in SG&A expense, so I would expect SG&A expense to be significantly lower and help -- and compensate, if you will, for the lower gross margins in the first quarter.

I think longer-term, Dean's talking about the 10/5/5 model. 10% gross margin, 5% SG&A, 5% operating income. I don't think we'll get quite to that model in fiscal '06, but we'll make [expletive] good headway.

Okay, thank you.

You're welcome.

Thank you. Our next question comes from Carter Shoop with Deutsche Bank.

Good morning.

Hi, Carter.

Hi. I wanted to briefly talk about the sales guidance for fiscal year '06. You guys did a great job, obviously, for fiscal year '05, hitting that number, but when you actually look at where the growth came from, I estimate that roughly 80% of the year-over-year growth in '05 came from your two largest customers. So the first question would be, one, did you anticipate it being that lumpy or that one sided in regards to those two customers driving that much growth?

Then for fiscal year '06, do you expect a little bit more of a broad based growth across more of our customers or do you look at it, just a handful of customers are going to be driving the majority of that growth?

Well, we did have -- you're right. We had quite a bit of growth from a couple of our top customers, but I would -- and one of those in, of course, our communications space has done a great job in their end markets and we've done a good job for them and have accumulated different -- additional shares. So I look at that as a good thing.

Our other large customer there that grew dramatically, everybody thinks about that customer as only Medical, and in fact, we have done a good job of diversifying our business with them. So we have gained additional share in the healthcare piece, but we've also added a number of other modalities or business units of GE that have contributed, or begun to contribute, quite nicely to top line. So you have to start thinking about that customer as a bit of a diversification play as opposed to just healthcare.

As we look forward, yes, we would hope to grow nicely across all of our sectors and in fact, when we look back on '05, we did actually grow at a double-digit rate in all of our key sectors last year and we would expect to drive toward double-digit increases in the coming year, with a little bit more of a -- hopefully a tilt towards Defense, Security and Aerospace. We hope to -- it's rather small, so you'll see a disproportionate probably growth rate in that sector in the coming year, but we consider that to be quite important to us and we're getting decent traction.

Now, at the risk of going on a little bit too long here, I want to just turn the call to Bob just for a second so he can kind of outline how we're going to get there in the coming year. Bob?

Thanks, Dean. Starting off, as we look at the next year, 2006, if we just look at our existing customer foundation, that alone will result in 13% growth all by itself. The net growth is the most reliable element in our plan because it's with existing customers, we have purchase order schedules in place. And a lot of that growth is actually wins that we incurred in 2005 that are just starting to ramp up now and really impact 2006 and beyond.

Right along with that, we have known opportunities that will get us up into the 15 to 16% growth range and these are essentially wins that we will receive over the next quarter or so here. These are very high likelihood, 90% plus types of wins. These are distributed pretty well across all of our segments as we look at it. Currently, there's about 43 opportunities that will generate the income that we need in that area.

There is a small amount of business that we have yet to identify that we'll go after and primarily we go after that with our existing customers, just as Dean was describing with GE, the deeper and wider activities really are working for us. So the penetration of other modalities within our large customers is going well.

Maybe as a follow-up there, I know this is a little bit difficult to do, but based on your view and your customers' expectations, what is your blended outlook for end-market demand in '06? Are you able to discern that? I think previously you were talking about in '05 you guys weren't really expecting a whole lot of end-market demand growth. And we didn't see a ton. Do you have a sense on what you're expecting for '06?

Well, I think, yes, we do, but, you know, I'm a little bit cautious. We don't really rely a lot on the organic piece when we start to look at our plan for the coming year. And also, Carter, something always to keep in mind is that the headwind of average selling price decreases of products going end of life. All of those things add up anywhere from -- could add up to 4.5 to 5% of a decline in revenue, so we always add that headwind. So, in some respects, the way I think about this is I take that headwind and I essentially say, that's going to negate any real end-market growth.

Okay.

And then we build up from there.

Okay. Fair enough.

Sure.

And then to give you a chance to elaborate on your earlier comment about not losing share with Juniper, it's relatively transparent in regards to what Juniper's doing and then what your sales are doing. Maybe you could flesh that out a little bit more and maybe help us understand the disconnect there.

Well, I think the real disconnect is just the timing at the end of the quarters. We're on the 4/4/5 quarter, our quarters don't end on the same date, and so there's just a little bit of shift in the revenue that takes place quarter to quarter.

Okay. Your expectation is to maintain share in fiscal year '06 -- or maintain or grow share with that customer?

Well, I think there's going to be some share pieces that are likely to shift around, but we would anticipate and we are anticipating gaining additional product lines and essentially growing revenue with that customer in the coming year.

Great. Thank you.

You're welcome.

Thank you. Our next question comes from Thomas Hopkins with Bear Stearns.

Yes, good morning, everyone.

Wonder if you guys could talk about your capital structure a little bit and potentially as it might relate to acquisitions. You have a fair amount of currency in your stock, which has done very well, and you also are building cash share fairly consistently and you have very little debt. Seems to give you the ability to do some things. How would you think about that?

Well, broadly, Tom -- this is Gordon -- we are continuing to focus on organic growth. We, like a lot of EMS companies were pretty active in doing acquisitions five years ago. And our experience I think at best is mixed. We've had some better success growing organically. So quite candidly, we're not looking at acquisitions. Which isn't to say if there was some certain niche company that was out there that made an awful lot of sense, we would look at it. But we're not actively pursuing acquisitions.

I'm also not anticipating any major changes in the capital structure. I know it's conservatively financing, but that's the way I like it.

Okay. So we should just look for cash to continue to build. I mean, is there going to be any significant change in the CapEx budget?

Well, as I mentioned, we're going to kick up the CapEx budget. There was only 22.4 million actual spending in '05. Probably going kick that up to 30 to 35 in '06. A lot of that's going to put in additional production lines and further production capacity expansions in Asia.

Okay. And which of your customers at this point are asking for incremental capacity in Asia? What segments?

Well, we're -- as we look at our business in Asia, we look at it as growing it kind of broad-based for our sectors, with the exception of the Defense piece, which from a regulatory standpoint has to stay here in the United States. So, as we move forward, we would expect that to be diversified capacity.

Okay, great. Thank you.

You're welcome.

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

Thanks a lot. Gordon, let's just talk about the cash cycle. You certainly hit and exceeded your goals here. How much more room do you think you have for full expansion in fiscal '06, and where do you think it would come from? Inventory turns, DSOs or DPOs?

Well, Amit, I don't think it's going to come from receivables, as we've talked about, because of the increased back end loading in quarters because of the 4/4/5 and because of the more direct order fulfillment. I think 48 to 52 is kind of the normal -- it's going to settle down there. I think the further improvement has to come from the inventory side, and on the accounts payable side. I think those will be two key drivers. A lot of the so-called low-hanging fruit I think has been harvested, so I think the progress going forward will be more incremental.

All right. And then CapEx was up this quarter. I'm wondering, did you guys expand the three assembly lines you have in Panang, or are they still at three over there?

No, it's a lot more than that now. We've authorized -- I think there's five.

Why don't I let Paul answer that? I'm just babbling here. He's got the precise number.

Yes, we're authorized for five lines now and have a quarter-over-quarter growth plan for 2006 there. So we'll see incremental lines there, quarter-over-quarter.

All right, and then could you talk about the capacity utilization rates across Plexus?

Well, on a company-wide basis, in the low 70s, 72, 73%, really no change. But keep in mind, we define capacity utilization on an as-tooled basis. As we add production lines to take care of incremental capacity, it tends to stay stable.

All right. And I know a few quarters ago you guys spoke about a $1 billion pipeline that's out there. Could you give us an update on that, has that changed pretty dramatically as you look into fiscal '06? And what sort of end market mix it might have. Thanks.

Sure. The pipe overall sits at about 1.2 billion right now, but if I look back and compare that 1.2 billion to the 1 billion or so we had -- quarter -- each quarter leading up to this one, I would say that the quality of the opportunities and the vetting of those opportunities is much better. So I would say it's a little bit higher and it's a much higher quality pipe.

When you look at the breakdown from a sector standpoint, about 30% of the opportunities there are a mix between wireline and their wireless sectors. About 35% of them are Medical and another 35% are in our Industrial/Commercial space, combined with Defense.

All right. Last question: What percent of your sales came from engineering services this quarter?

Well, on an ongoing basis, we say it's about 3.5% of total revenues.

All right. Thanks a lot, guys.

You're welcome.

Thank you. Our next question is coming from Thomas Dinges with J.P. Morgan.

Hi, good morning, guys. Couple of quick ones for you. You had talked about the engineering resources, then actually the win volume there. If I remember the quote correctly, it was exceeding your overall capacity that you had there. Can you talk about what your hiring plan is there throughout the year? And then I had a quick follow-up.

Sure. We're -- we don't expect to see dramatic hiring early in the year, but we are ramping up our recruiting efforts. The organization does anticipate bringing in additional people, although I'm reluctant to throw out numbers at this point. But we will hire both domestically and for our folks in the UK and in Asia in the coming year, so we're expecting some nice growth there in technology.

Still more on the domestic side than on the international side, you would say?

Well, we've ramped up the resources over in our facility in Panang, to add that important piece to the overall capability that we have, and I would say that -- we're at the point now where we're probably going to see some balanced increases in resources at this point.

Okay. And then quickly, in looking at the outlook for the full year, 15 to 18% top line growth, can you walk through just qualitatively what you think is going to happen based on the business that you've won on the mix that you've got there? It seems like you were more upbeat on some of the things in, say, Defense and that area. That was 5% of sales in the fourth quarter. Where do those numbers shift around? Are we talking kind of plus or minus a couple percentage points at most? Or is there some segments that you think are going to move much more dramatically than that by the time we get to this point next year?

Well, I'm cautious about trying to give you guidance sector by sector for the year. But as we look at the sectors right now, we're expecting strong growth in our wireline networking sector. The wireless infrastructure sector is challenged because of the -- what I outlined already on the script. Medical, we would expect to grow modestly. We have done some harvesting there and some tidying up of our customer list, I'll say, to try to improve the profitability in that sector. So, they have got a little bit of a headwind to overcome. But a number of the wins that we're bringing in are nice Medical sector wins, but we're not going to see the fruits of a lot of that until late in the year.

And then we are putting on a pretty good press here for Industrial/Commercial and in particular Defense. Defense is still small, so you're not going to see a huge shift in terms of its contribution on a percent of revenue basis, but in terms of growth rate, you'll see a pretty dramatic growth rate, I think, in the coming year.

Okay. Thank you.

You're welcome.

Thank you. Our next question is coming from Michael Walker with Credit Suisse First Boston.

Good morning, thanks. Just to confirm on the tax, you said the tax rate for the year you expect to be 3 to 5%.

Yes, for next year, Tom. Or Michael, excuse me.

And I assume there's some NOLs underneath that. Could you confirm that and if so, when would you expect those to start to run out? Because I think you've been mostly profitable now for about two years.

Yes, we have tax holidays in Asia, which will extend for some period of time, 2010 or 2012, something like that. In the United States, we have NOLs and you may recall, we established a valuation allowance on a deferred tax asset at the end of the last fiscal year, the end of 2004. So because of the NOLs, our income in the United States basically falls down to the bottom line untaxed. Certainly, we'll get through 2006 and I expect we'll get through 2007 before we utilize those NOLs, Michael.

Okay. And then on the sales line, just to confirm, someone else talked earlier about the fact that you're still garnering the 15 to 18% revenue growth, which of course is the same as what you did last year, but you are starting out a little bit in the hole, guiding down revenues 1% sequentially. So I just want to confirm that what you're saying is that you really expect a tidal wave, if you will, of new programs to come in and kind of enable Q2, 3 and 4 sequentially to be up in the high single digits.

Yes, I think that's fair, with the exception of how you may think about it, is that this isn't all -- the wins, as Bob outlined, isn't all stuff we've got to go find and win. Quite a bit of this is already stuff that has been won. Last quarter we talked about $145 million in annualized revenue that we won. Those programs have begun to ramp up and then I just said we won another $150 million worth of annualized revenue. Now, we won't get all that 150 in the coming year, but we'll get perhaps 100 million of that. And so there's a fair amount of momentum here already with programs that were already won. So now we got to do a good job here in the next couple quarters and get a few more things in the hopper, but we've got a good start.

And just lastly, on the -- you said 30 to 35 million in CapEx for fiscal '06. Are we talking major expansions in certain facilities, new greenfields, where is most of that CapEx going?

We are contemplating expansion in Asia, but I don't think it will be a greenfields expansion right now. We've got a lot of alternatives on the table. It's, frankly, premature to say.

Okay.

Most of the 30 to 35 is just production equipment, SMT lines and machines like that.

All right, great. Thanks a lot.

Thank you. Our next question is coming from Reik Read with Robert Baird and Company.

Hey, good morning. With respect to Asia, as you guys add capacity and are also adding some revenue, what would you expect utilization to do? Will it stay relatively flat? And then can you talk a little bit about the net impact on profitability? Will that continue to improve here as we go through '06?

Yes, let me just comment a little bit on capacity utilization. I'm sure Paul might want to comment on this as well. We're sort of chasing utilization rates over there, because, as Gordon said, we talk about our capacity utilization on an as-tool basis. So it's not a question of raw square footage. We've been fairly dramatically adding S&T lines. Paul can comment maybe about the different sites and where the capacity is going in.

You know, a significant amount of the capacity will continue to be added in our seaside facilities. We're still right now at less than 50% utilization of that facility. We also have a fair amount of capacity available in Xiamen and we're looking to expand that again fairly significantly through the year.

But I think, as Dean said, remember, in terms of the equipment utilization, we add those lines as we need them, not ahead of time.

But to your broader question, Reik, additional revenues will, in fact, tend to enhance the gross margins and the profitability going forward.

Okay, great. And then, Gordon, on your comment of driving the SG&A levels below 6%, can you give us a little better understanding of how much of that comes from just revenue leverage and how much comes from maybe some of these one or two other components that may start to go away?

Well, it's a combination. Obviously, if we just were to hold SG&A spending level with the 15 to 18% revenue growth, it would come down, but beyond that where we're looking to reduce the absolute level of SG&A, as I said, we spent an awful lot of money in 2005, a lot of it for one-time or consultant costs to get us through the Sarbanes-Oxley 404. Those costs should go away. That could be $1.5 million [plus] at this lower spending for Sarbanes-Oxley.

Is there a particular point in the year that is identifiable that those costs should start to go away?

Yes. First quarter of '06.

Okay. Thanks a lot.

You're welcome.

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

Yes, good morning, everyone.

Good morning, Todd.

Couple questions. Seems like all the Tier 1 EMS guys are talking about industrial/medical, aerospace, and defense, as the other end markets have been pretty lackluster all year. And while your gross margins certainly have done well, I'm just wondering if you can talk about competition there, who you are seeing, or are these just-- is this just more outsourcing that's going on in this sector, so you haven't really been beating each other up. Just talk a little bit about the competitive landscape.

Yes, you're right. There's a lot of talk. There's no question that it's a competitive marketplace. I mean this is -- it's end margin business and we've got a number of our competitors that still have ongoing improvement initiatives underway and some excess capacity. So there's some competitive elements to this market, but we really haven't had a difficult, an exceptionally difficult time competing for business in a rational way. So we're able to go out there and put together good proposals at numbers that are at our targets, accretive to our past numbers, and win that business successfully and keep it.

So, there's a lot of talk. There's no question others are winning business. I think to some extent it is because there's a lot of incremental outsourcing going on. I would also say that we don't look at these sectors as we're trying to serve all kind of subsectors of the sector, and so some of our competitors are focused more on other areas of these broad sectors than we are.

I would say that we probably see more -- I'll call it maybe brutal competition from below than we do from above, in most cases. There are some smaller guys out there that are very competitive and are private companies that have a tendency to perhaps be a little bit irrational in terms of their competitiveness. But by and large, the customers see through that sort of thing and they understand that those programs aren't going to be sustainable.

Okay, great. And just back to this Medical, it sounds like they have a product issue in the UK. Could you just give us an idea of when you might see that sorted and when would you start to think Medical will grow as a segment?

Well, there is a couple things that will drive growth. Obviously, if that turns back on, that would have an incrementally positive impact to us, if it turns on earlier than we would anticipate. We're also working, obviously, hard on a number of opportunities, have won some opportunities that start to ramp more in the back end of the year that are going to have a nice impact, maybe more on '07 as you look at the annualized number, than '05.

Paul or Gordon might have a better update on the regulatory issue with the customer in the UK, but --

I don't think we ought to speculate on that.

It's so uncertain. I mean, this is an issue that's at the top end of their healthcare -- government-controlled healthcare delivery system and it's very difficult to try to pin it down.

Okay. And lastly, you're not getting the seasonality you thought in the first quarter. So what does that mean in terms of how we should think about seasonality through 2006? So should Q2 be down a little bit and then we see the bulk of the strength for the second half of the year? How are you thinking about this thing?

Yes, on the seasonality piece, let me just point out a couple things in Medical. If you look at Q4, it was really a pretty phenomenal quarter for Medical. And like I said, a little bit of that was some -- what I'll call catch-up revenue with the customer transitioning some things to us and we actually ended up having a little stronger build than we would have anticipated, based on the way they laid out the plan.

But if you look at the medical sector also, I think it's important to recognize that even though we expect it to be down in Q1, it's actually up from our third quarter of last year. So it's, you know, kind of on a trend basis, it's still headed in the right direction, and I would expect if I looked out another quarter, it's really too early probably to guide that sector, but we're not expecting any sort of a major setback in our second quarter. Quite frankly, I was always a little perplexed as to why it was so strong in the first quarter anyway. I used to jokingly say that people must buy more ultrasounds for Christmas or something.

It was really driven more, I think, by the incentive programs of our customers and the sales organizations than it was from any sort of natural seasonal rush on medical products. It was more of a budget thing, I think, at the end of the year.

I was actually asking for a seasonal perspective for the entire business, not just - --

Oh, for the entire business? We really don't have a lot of seasonal components to our business because we're just not in the consumer business. I don't think you should really kind of try to look at us like you do many of the others in the industry.

If you're talking about the overall trend, yes, the revenues will certainly trend up in the second, third and fourth quarters.

Okay, great. Thanks a lot.

Sure.

Thank you. Our next question is coming from Chris Lippincott with KeyBanc.

Just wanted to focus on the SG&A for a second. Since I think in the past you have kind of mentioned that the SG&A is typically more of a fixed item, I'm wondering if you're kind of looking at your 10/5/5 model as we go out towards the end of the year, do you still expect the SG&A is going to be pretty flat or given the ramps that we're looking at, is that less of a fixed item now and we're still going to be seeing some higher SG&A?

Hi, Chris. It's Gordon. As I said earlier, I think SG&A is going come down in Q1 and hopefully it will stay down, tend to stay down in Q1 because we get rid of some of these one-time costs that are in there. I'll stick with my earlier comment that there really is a very small variable component in SG&A.

So it sounds like it ought to be fairly similar to sort of the midpoint of '05 then, kind of that 19.2-ish range, is that sort of a comfortable fixed point you were talking about?

19.2?

Well, I guess I'm just looking back in the second, third quarter.

I would hope it would come down from that Chris. It's too high.

Right. But as we kind of go out into -- towards the end of the year. And I guess also sort of going back to the tax question, you still feel that 3 to 5% is realistic, given that you've got all the NOLs and tax holidays, even though this is kind of lower than your prior guidance.

Yes, certainly for '06. But as I mentioned, there's a new interpretation coming around the FASB that will inject more volatility into it. In the past you could basically build cushions into your tax accruals. Your ability to do that now is going to be limited going forward, not just for Plexus, but I think for corporate America. But right now we're pretty comfortable with the 3 to 5% tax rate for '06 and even for '07, although clearly, there's less certainty for the '07 tax rate.

My last question is just on the inventory turns, you said that's perhaps where you might get some incremental benefit on your cash cycle going forward since you've got some hanging fruit there. How much opportunity do you think you've got to improve the inventory turns, given that you're going to be seeing a lot of programs ramping and you'll probably be using some of your inventory, will be floating up on it?

Paul, do you want to take a shot at that?

Yes. We still believe that we will make quarter over quarter improvement in the inventory turns. You're right that the new programs will have some unfavorable impact, but we still think there's room to improve by getting higher velocity through our manufacturing operations, which will allow us to provide more flexibility to our customers. So we'll continue the progress that we've made there during the last year.

Any effort to quantify that?

You know, perhaps a day a quarter, on average, through the year.

Okay. Thanks.

Yes, I would like to just come back to this SG&A thing, just to make a point in terms of the variability of it. I think, and I have tried to set this point a few times, that our SG&A, we did build up our SG&A a little bit dramatically here over the last couple years to put in place a sales and marketing infrastructure that quite frankly did not exist in the company. So we bit the bullet on that, made the investment, and now we have that team, the teams on our sectors, in place. So there's not a heck of a lot of incremental head count that we have to add there in order to continue to drive the growth of the business all the way up to a couple billion dollars. So that infrastructure is in place. We also bit the bullet on some IT initiatives. We have spent most of that money and got a higher percentage of the Company up on a common platform. I said we would spend a little bit more in the coming year to bring our facilities in Asia onto that coming platform, but that is built essentially into our assumptions for SG&A growth.

So we sort of got, you know, we put an infrastructure in place to drive the business and we're going to work hard to keep the growth of that SG&A subdued and get the leverage on it, and I think we've demonstrated some of that leverage here in the last quarter and you can expect us to continue to demonstrate that as we move forward.

Chris, just one other caveat on SG&A. We've given you the guidance that it's going to cost us about a penny a share in Q1 for stock-based compensation. As you know, we did not have to record that as an expense in '05, but we will have to in '06. The board and the compensation committee really have not decided what we're going do with stock options or stock-based compensation going forward.

In '05, we kind of cleared the decks by accelerating a lot of unvested options that were under water. So the penny a share that we're talking about for Q1 really reflects expensing director's options, which were immediately vested in the December period and a little bit of employee.

So there's some uncertainty in the subsequent quarters as to how much of stock-based compensation costs there will be.

Thank you.

Thank you. [OPERATOR INSTRUCTIONS] Thank you. Our next question is coming from Shawn Severson with Raymond James.

Thank you. Good morning, gentlemen. Could you give a little color on the margin profile of the new business pipeline? Should we think of this as an overall better mix of business that's coming in? Or kind of similar to the existing structure? And then just kind of, you know, layering over fixed costs is where you get additional margin expansion?

That's a hard question to answer, Shawn. We're certainly not going out and buying business. That's the thrust of your comment. We're very disciplined, I think. We will walk away from business if it doesn't meet our profit targets. And increasingly, we're looking at the profits on a return on capital employed basis, not just operating income or gross margin.

I think it is fair to say that some of the margin expansion, we're feeling pretty good about our engineering services business, starting to contribute meaningfully, that's going to give us some help. We have pruned out some business that just did not meet our goals. That's given us some help. The pricing environment has gotten better. That has contributed to some of the improvement. And of course just plain old better productivity. We've had a long-standing discipline here with lean sigma. A lot of other folks are talking about it, but we've had this in our culture and in our company for a long time and we're really at the point where we've been able to spend a little bit of money to get better as the company has gotten healthier. So we're starting to see the benefit of a number of those initiatives.

And so I think we've kind of established a new base camp for our gross margins and we're going to work from that new base camp and continue to try to improve elevation there.

Okay. And then, do you have a percentage of system build for the quarter? And also, what do you see there as far as trends and Plexus' role in taking on more complete system build assembly tests, all of that, answer to the complete supply chain work?

There's no question. That's the trend in the industry. If you look at -- you're probably looking at our revenue generation, it's probably north of 50% where we're building either subassemblies to a nearly complete level or complete assemblies and doing direct order fulfillment to our customers. We see this direct order fulfillment model as being something that is really going take off with our customers in general as they work to lean out their supply, their inventory and the overall supply chain. So--

You should mention, Dean, we see that interest also with our existing customers, a lot of existing customers throughout the next year are talking with us about taking on direct order fulfillment for them.

That's a good point to make. And as we talk about sticky business, the direct order fulfillment, when you move to that level of service for your customers, the business really does become sticky.

And is that requiring some more investment, like possibly in low-cost locations in Europe or maybe additional in Mexico, kind of for that final system build and fulfillment? Or with kind of your mix of business, that's not as critical as maybe, say, with some very large form factor stuff?

Well, I don't know that-- we don't really need to invest heavily in order to do the system build itself, but I did mention that we intended to bring up our direct order fulfillment capabilities over in Asia. We're going to bring that capability up in conjunction with bringing up our JD Edwards platform over there. I believe it's scheduled for around February of '06. So that will allow us to bring that capability, but they are already doing system builds in those facilities. We also do system build and fulfillment out of our facilities in the UK as well.

Okay. Then just lastly, are you finding that some of these customers in the Industrial/Medical Aerospace areas, are they very open to kind of that complete supply chain system build work, or do you find that they are sticking initially with just PCBA work?

We've been building medical product to complete assemblies for a long time.

Right, right.

But it is a little bit more common, where you'd ship the medical product back to the customer and they would maintain that kind of close link to their end-market customers. Not in all cases, though. We do some direct order fulfillment there as well. But I think that for products that are essentially a little bit more commoditized within the medical space, I think we'll see that shift.

Okay. Thank you.

All right, thank you. Brianna, I think we're getting to the end of our time slot, so I think we've got time for one more question.

At this time, there appear to be no further questions.

All right.

Talk about perfect timing.

Perfect timing.

Well, it was a nice fiscal 2006. We finished the year, I think, on really a strong note. The Company really pulled together and I am pleased, as I said earlier. We've got, I think, the stage set for a nice fiscal 2006 looking forward as well. So stay tuned.

I appreciate your commitment and attention to Plexus. Thanks, everyone.

This concludes today's Plexus conference call. You may now disconnect.

Thanks, Brianna.