Plexus Corp (PLXS) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Plexus Corp. conference call regarding its third fiscal quarter 2006 earning announcement. At this time all participants are in a listen-only mode. After the brief discussion by management, we will open the conference for questions. The conference is scheduled to last approximately one hour.

I would now like to turn the floor over to Mr. Gordon Bitter, Plexus' Chief Financial Officer.

Hello and thank you for joining us this morning.

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. 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 prefer to the Company's periodic SEC filings.

The company provides non-GAAP supplemental information, typically earnings and earnings per share, excluding restructuring cost and charges for the impairments of good will and other long-lived assets. Although the third quarter of fiscal '06 did not include any such special charges in net, the comparable prior year period did. All comments concerning earnings comparisons on this call will refer to non-GAAP earnings. For a full reconciliation of non-GAAP 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; and Paul Ehlers, Senior Vice President and President of Electronic Assembly. This is the Company's manufacturing arm. Today's call will begin with Dean making some brief comments about the quarter, then I will follow up with details on the third quarter financials, and then we'll open the call over for questions.

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

Thank you, Gordon. Good morning, Paul, and good morning to everyone on the call this morning.

Let me begin by making a few comments about what I believe was an exceptional quarter. Last night reported results for our third fiscal quarter, revenues were $397.4 million with GAAP EPS of $0.53, both consistent with our guidance range provided last quarter.

Revenues in the third quarter were up 18% sequentially, led by our wireline networking and defense sectors. The market sector focussed business development strategies that we embarked upon nearly two years ago, coupled with exceptional execution and value-added services, are together delivering expanded relationships with our current customer base, new strategic accounts in our targeted industry sectors, and successful execution of our strategy to significantly increase our share in a newer end market sector, Defense, Security, and Aerospace.

Gross and operating margins expanded again this quarter, demonstrating our commitment to profitably manage our growth. We have developed the competencies necessary to efficiency ramp new programs; we continue to invest in our long-standing lean sigma initiatives; and we are leveraging the strength of our integrated global platform to drive down costs.

The leverage in our operating model, coupled with improved capital employed turnover, is delivering industry-leading return on capital employed. We are gaining profitable share in the EMS industry.

Let me continue by turning to a summary of our third quarter revenues and our outlook for our fourth quarter by end market sector. Our Wireline Networking sector was up strongly, as expected, this quarter, driven by a combination of favorable shifts of programs shared to Plexus, new program ramps, and end-market strength. Looking to the fourth quarter, we currently expect modest single-digit percentage growth as we continue to ramp new programs won in prior quarters, along with anticipated end-market strength across several existing accounts.

Our Wireless Infrastructure sector was down sharply in the third quarter, as expected, and several of our accounts experienced end-market difficulty during the quarter. We currently expect a better result in the fourth quarter, with double-digit percentage growth anticipated.

Our Medical sector returned to growth during the third quarter, consistent with expectations. Improved demand with our leading medical accounts, as well as continuing program ramps with a newer top tier medical account, drove much of the recovery. This newer top-tier medical account provides an excellent example of how we successfully leverage our engineering services capability to penetrate an important growth account.

Plexus Technology Group has provided engineering development services and new product introduction support to transition new products into Plexus's United States and Penang, Malaysia manufacturing operations.

Looking to the fourth quarter for Medical, we currently anticipate a revenue pullback as several of our larger accounts anticipate a more difficult end-market environment.

Our Industrial Commercial sector delivered growth again in the third quarter, driven largely by stronger end-market demand. Our fourth quarter performance will likely be flat to down slightly, with a mixed bag of end-market performances.

As expected, the Defense, Security, and Aerospace sector was up substantially in the third quarter, reflecting 7 consecutive quarters of growth. Our unnamed customer win mentioned in Q2 drove most of the growth. We expect sector revenues to contract in the fourth quarter as a consequence of reduced production levels for programs associated with this important, confidential customer.

Longer range guidance is difficult, as manufacturing volumes ultimately depend upon extremely lumpy product orders from the United States military, unless other end-market opportunities develop.

The scale of the program with our new confidential customer has largely masked the targets we have made with other leading customers in the Defense, Security, Aerospace sector. Although individual program sizes are modest, we've made significant progress penetrating a blue chip list of customers that participates in this end-market sector.

Addressing our overall revenue concentration: Revenue from our top ten customers represented 63% of our total revenues this quarter, up 5 percentage points from last quarter. Juniper Networks represented 19% of the total, down one percentage point from last quarter. Our business with GE, inclusive of multiple GE divisions, stayed level at 11% this quarter. And our new, yet-unnamed defense customer contributed 10% of our sales this quarter.

Turning now to new business wins. During the quarter, we won 9 significant new manufacturing programs, which in total will add approximately $100 million in annualized incremental revenue as these programs begin to ramp during fiscal 2007. All nine of these programs will increase our share with current customers, including two new significant program wins with a leading customer in our Wireline Networking sector. The $100 million of annualized revenue won this quarter represents a significant rebound from our second quarter new win performance, a seasonally slow quarter for new business wins.

Our funnel of opportunities has expanded once again this quarter to a record 1.7 billion of qualified new business. Over half of the opportunities are with current customers, where there is a higher probability of success when compared to winning new customers.

On the Engineering Services front, we won more than $7 [million] in new product development business during the third quarter, a result less than we'd like to see. Once again, we won new opportunities in all of our key sectors, with the Medical sector representing over two-thirds of the new dollar volume.

Addressing capacity, utilization, and global growth investments: Our strong revenue growth in the United States and Asia drove our global as-tooled capacity utilization to approximately 81% as we exited the third quarter. As outlined last quarter, we can add additional equipment and people to increase capacity in the United States, but capacity expansion in Asia requires additional investment in brick and mortar. To address the situation in China, we recently announced our decision to double the size of our existing facility in Xiamen. In conjunction with that expansion and consistent with our integrated global manufacturing services strategy, we are currently planning to install our standard ERP platform in Xiamen during the first quarter of fiscal 2007.

Turning to our other Asia sites, we currently deliver services out of two facilities in Penang, Malaysia. As you may recall, our second facility in Penang began operations in September of 2005. That facility, which houses both manufacturing and engineering services, is currently expected to approach maximum manufacturing capacity levels during the first half of fiscal 2007. Additionally, the success with the Penang engineering services business, which has grown to approximately 45 engineering resources over a span of about 18 months, requires additional ops and lab space to support their growth. To address these constraints, we have identified a suitable third facility in Penang and we are actively engaged in negotiations to acquire this additional site.

Our outlook in the UK is not as rosy as it is for Asia, as evidenced by our announcement to consolidate UK manufacturing into a single facility in Kelso, Scotland. The EMS market in the UK has evolved, which necessitates this reduction in manufacturing capacity. As a consequence, we will close our facility in Maldon, England.

Last, a few comments on our fiscal fourth quarter guidance. For the fourth quarter, we are currently expecting revenue in the range of $390 million to $405 million, with EPS in the range of 46 to $0.50. Our earnings guidance includes about $0.03 for stock-based compensation, $0.02 cents for the initial impact of FASB interpretation FIN47 concerning conditional asset retirement obligation.

Our earnings outlook for the fourth quarter is also tempered by the anticipated shift toward a less favorable revenue mix, with revenue growth limited to wireline networking and wireless infrastructure. Admittedly, our fourth quarter revenue outlook is softer than we implied in our second quarter press release. This is largely a consequence of slightly lower production orders from our defense programs, which we are learning come on lumpy orders.

Overall, our market outlook hasn't changed. We believe our value proposition and targeted end-market sector support revenue growth and the range of 15 to 18% in the coming year, consistent with our performance over the past three years.

Gordon?

Thanks, Dean, and everyone, once again, good morning.

As we anticipated, the third quarter's financial performance set new records for the highest revenues and earnings in the Company's history. Last quarter's record highs didn't have a very long run. We also reported further improvements in our cash conversion cycle and after-tax return on capital employed.

My comments will be relatively brief this morning. Turning first to the third quarter's income statement: As Dean just noted, revenues increased sequentially, by nearly 18%. And the year-over-year improvement was almost 27%. Growth in both instances were paced by the rapid ramp of production for a new defense program, although renewed strength in the wireline sector was also an important contributor.

Gross margins expanded to 11.5% in the quarter, a 50 basis-point improvement from the second quarter of fiscal '06 and dramatically ahead of the comparable prior year period's 8.7%.

Margins have consistently improved since the first quarter of fiscal '05. These improvements arose from, first, higher revenues and the positive effective operating leverage; second, facility closures, which have reduced fixed expenses; and finally, the operating efficiencies obtained from the consistent application of Lean Sigma techniques. I should also mention that the current quarter also benefited from a favorable mix of higher margin revenues.

SG&A expense in the third fiscal quarter of '06 increased by about $2.3 million from the second quarter of fiscal '06. The reasons for the increase include higher accruals for variable incentive compensation -- that's a long-winded way to say bonuses -- and higher stock-based compensation, as well as higher salaries, travel, and relocation costs. Interestingly SG&A expense, excluding restructuring and impairment charges, increased by a similar amount, that is, $2.3 million, from the comparable prior-year period. This year-over-year increase was also due to higher accruals for variable incentive compensation in the current year period and charges for stock-based compensation not required in the prior year.

SG&A expense as a percentage of revenues declined in the third quarter of fiscal '06 to 5.4% of revenues and this provided additional leverage for the expansion of operating margins to 6%.

Let me say a few words about restructuring. Last year's third quarter included some very significant unusual charges. There was a good will impairment in the amount of nearly $27 million for earlier acquisitions in the UK and Mexico. And we provided for additional severance and other expenses for various restructuring actions in the amount of $700,000.

This year, in contrast, there were no net restructuring costs in the current third quarter, despite our decision to close the company's facility in Maldon, England. The initial charge for this action, that is, the closure of Maldon, $0.5 million for severance and asset impairment, was taken in the third quarter of '06. But this charge was offset by favorable adjustments to estimates for earlier restructurings.

You may recall that we closed the Bothell, Washington engineering and manufacturing site at the end of the second quarter of fiscal '05. We had several leased facilities in Bothell. Recently we were able to negotiate settlements on two of these facilities on more favorable terms than originally estimated at the time of the Bothell closure. These favorable adjustments offset the initial accrual for the Maldon closure. And that's why there were no net charges in the current quarter.

The rest of the anticipated Maldon restructuring cost, about a half million dollars, are expected to be incurred in the first and second quarters of fiscal '07. The precise timing of the later restructuring charges will depend on the timing of the actual transition of programs to Kelso, Scotland. Parenthetically, you will find additional information on the Maldon closure in section 2.05 of the form 8-K that we filed with the SEC yesterday.

Let me make a couple of quick points below the operating income line before turning to the balance sheet. Interest expense came down from the second quarter '06 level of over $1 million to the more typical $800,000 level. The preceding quarter's interest expense had included about $200,000 of incremental interest, which was required as part of a state tax settlement. Interest expense should remain at the current quarter's level of about $800,000.

Interest income continued to improve, primarily on higher balances of cash and marketable securities, although interest rates have also moved higher since a year ago. Interest income contributed about $0.03 to the current third quarter's earnings per share.

The changes for miscellaneous income expense, both sequentially and year-over-year, were driven primarily by changes in foreign exchange gains. The year to date tax rate for the nine months ended July 1st, 2006 was adjusted upward to 1% of pretax income from the prior six-month year to date rate of 0.8%, and this had the effect of producing the current third quarter tax rate of 1.3%. I know we're not talking big percentages here. This 1% effective tax rate is our best assumption for the rest of this fiscal year.

I'll return to a further discussion of our overall tax situation in a few moments, but let me first quickly review the balance sheet and cash flow for the third quarter of '06.

Our overall cash conversion cycle improved by three days from the prior quarter, although DSO and receivables worsened by two days as the result of very high shipment late in the final month of the quarter, which distorts the year-end -- quarter-end, rather, DSO statistic. The overall improvement in the cash cycle was driven by a 3-day improvement of days in inventory and a two-day improvement in days in accounts payable.

Our outlook for the end of the year is for the cash conversion cycle to slip by a day or two in accounts payable due to a customer-directed change in sourcing.

Cash flow from operations was a modest $7 million and well below the $39 million generated in the third quarter of the last fiscal year. The key difference between the periods was the much higher incremental investment in accounts receivable in the current year's third quarter as a result of the much higher sequential growth in revenues in the current period.

Cash and marketable securities increased by just over $20 million during the third quarter to a combined balance of just short of $170 million.

Proceeds from the exercise of stock options and employee stock purchases provided nearly $17 million of equity financing in the quarter.

Capital spending was restrained during the third quarter, only approximately $4.8 million. This was less than we expected and reflects delayed payments for earlier purchase committment. Capital spending for the year is now expected to be between 33 to 35 million, lower than we had estimated this time last quarter because of some pushouts in planned spending.

You should note that the capital spending estimate for fiscal 2006 does not include any expenditures to acquire the third facility in Penang that Dean just spoke about. So that is planned for early in fiscal 2007. It is possible, however, that the estimated 10 to $12 million of initial investment for this third Malaysian site could occur late in the current fiscal year, which would, of course, increase total capital spending in fiscal 2006.

Let me conclude with some more comments on the Company's overall tax situation. As a reminder, the Company's current low tax rate arises from two very different factors: One, tax holidays in Asia, which currently extend to 2013 or 2014, and two, net operating losses in the United States, which, when coupled the valuation allowance on the underlined deferred tax asset, result in no tax effect on reported income in the United States. However, as the Company demonstrates a history of consistent profitability on its U.S. tax books, we need to reconsider the appropriateness of maintaining a valuation allowance on the deferred tax asset. Without the valuation allowance, income earned in the United States would be tax affected at approximately the 38% marginal U.S. tax rate, which in turn will increase our overall effective tax rate.

Unfortunately at this time I can provide no better guidance than I have before as to when the valuation allowance will reverse. We continue to review the tax situation with our outside auditors on a quarterly basis, and the best that I can tell you is a decision will most likely occur not later than mid-fiscal '07.

Operator, I think we can now take questions.

[OPERATOR INSTRUCTIONS] We'll pause for a moment to compile the Q&A roster. Our first question comes from Brian White of Jefferies and Company.

Hi, good morning, guys.

Good morning, Brian.

On the engineering front, it seemed to be down from the previous quarter, is that right? Were you surprised by that?

I don't know how surprised I was. It tends to be a little bit volatile, quarter to quarter. Last quarter we had a really nice strong performance. I think our wins are a little more than $10 million of new product development business. Seven is about at a sustaining level, it's not necessarily a growth level, so I wouldn't say I'd raise a caution flag on that, other than to say that we need to, on a consistent basis, be at a higher pace than that to continue growth.

Okay. And on the Malaysia plant, what exactly are you acquiring? Are you acquiring a shell and you're going to put equipment in there?

Well, Paul's sitting right here and he's been a more active participant in that, so I'll let him take the question.

Yes. The building that we're looking at acquiring is basically a fairly significant facility that was set up for another purpose. So we're basically gutting it and upfitting it for our needs.

Okay. And the [inaudible] facility had some issues in terms of start-up costs. Can we think about this facility going through a similar development early on?

I'm not sure which facility you referenced? You cut out just at that time.

Just the Penang --

Oh, the second -- in Penang?

Let me just say, Brian, to be fair, I don't know that I would characterize it as issues, which implies difficulties. I think that facility actually came up very precisely as we had it planned. I think it's fair for you -- I'll turn it to Gordon in terms of how you would want to characterize it.

Brian, I think you can model it very similarly. You may recall, when we started the second facility, we incurred -- I think in the first quarter we turned around losses of about $800,000 and then they were moderated to 4 to 500,000, and then in the third quarter we obtained a break-even and it was profitable thereafter. This will be a somewhat larger facility, but there's going to be some more immediate revenue generated there. So were I to model it, I would use the turn on of the second facility in Penang as the model.

Okay. Thank you.

You're welcome.

Our next question comes from Steven Fox with Merrill Lynch.

Hi, good morning. First of all, can you just maybe just for the record go over your relationship with Juniper now that Flextronics is involved? Obviously there's going to be three different opinions on this, but if you can just go over that.

Well, from my standpoint, I think I would best characterize the announcement that Flextronics is going to be the third supplier, from our perspective was old news. We have been working with Juniper now for well over a year on their kind of global manufacturing strategy. And -- they had kept us apprised of their progress as they were looking at other providers. And so we've known for some time that they had zeroed in on a very short list and it was no surprise to us when they decided it was Flextronics.

So from our perspective, it's old news. We have a pretty good idea. You know, obviously they have a plan and the plans tend to be refined as things move forward, but they have a plan of which products would move to Flextronics, both from us and the other current providers to Juniper. And we also understand which products would likely come to Plexus.

And in terms of that, I mean, when you look at the overall growth rate with that customer, obviously it's dependent on which products are growing and what you're doing. Would you describe the growth rate going forward with Juniper as flat, up, slightly down? How would you talk about that?

The best way that we're calibrated now, and Paul looks like he wants to get into it, because he's got much more of the details. And like I said, it's an evolving plan. So go ahead, Paul.

When we look forward, again, four to five quarters, it's looking slightly up. And that's a combination of kind of mark -- product shifts and end market growth that they're projecting.

Okay. And then, just on the Defense Aero business, if you're looking four or five quarters out in terms of the lumpiness, given this big program, is it safe to say that we should be modeling this business down based on what we know today as this program rolls over, or how would you describe that?

So the difficulty in the major program we're talking about, and I think Dean mentioned it, was that the demand to us comes in very significant discrete orders that we never really have wonderful visibility to. So if you're looking forward several quarters, this could be -- there's kind of a base level of support for this. So this could be kind of a 1% customer for us for next year. Or it could be a greater than 10% customer, depending upon where the demand ends up.

Okay. And then just really quickly, Gordon, do you have the stock option expense in the quarter?

Yes, the stock option expense was 700,000. About 400,000 in SG&A and the rest in costs [inaudible].

Thank you.

You're welcome.

Next question comes from Alex Blanton of Ingalls Snyder.

Good morning. Just to continue briefly about Juniper. Can you comment on why you think they were looking for a third supplier? You mentioned their global strategy you've been helping them with. Does it have anything to do with lower cost in low cost regions that Flextronics might be able to provide? And what would Flextronics, you think, bring to them that you can't provide?

And then you mentioned some products coming to you. Now, where would they be coming from? I assume they don't have much in-house left. So if they're coming to you they have to be new products or coming from the other provider. So could you comment on that?

Well, I think I could get myself in significant hot water by getting into the details of all the transitions too deeply.

I would just say that the products that we know are -- that will migrate from our walls to Flextronics, those products, it wasn't like we were up against Flex in a head-to-head cost bid for those products. This was more of a broader strategy that Juniper has been working on for some time. I think I would say appropriately these products could benefit from manufacturing in China, the particular products that are going to move there from us. And, in fact, even before the changes in kind of operational leadership at Juniper over the last year and a half or so, I had gone on a mission with Paul and Gordon over to Juniper and talked to their leadership about what we thought would be a more appropriate manufacturing strategy for them, including manufacturing in Asia, because at that time they were almost 100% manufacturing in the United States. So this has been an ongoing global fulfillment discussion that's been going on for some time.

We don't -- certainly we'd like to hang on to everything, but the reality is that we know what we're good at and what value proposition we offer to Juniper. And we're not going to hang on tooth and nail to stuff that perhaps makes more sense for Juniper. We want Juniper to be as successful as they possibly can be. And so we're not going to fight for stuff that doesn't make sense at Plexus.

Now, you mentioned that your overall volume with them would probably be slightly up. So some things have to come in and what are those? Coming from the other supplier or new products?

Alex, we really are constrained on what we can say about Juniper's program, so I think we're going to have to move on.

Okay. Another topic: the $1.7 billion of opportunity you mentioned. How has that grown in the past year? What was it last year and how would you characterize the condition of outsourcing trends today? It seems to be accelerating, at least some of the companies, maybe half, two thirds of the companies are reporting accelerated growth, including yourself.

Well, let me just characterize, first, the funnel. I would think if you would go back a year or more and we analyze our funnel, we fairly consistently talked about it as being $900 million to $1 billion in the funnel. But I would say that if you look at the funnel today at Plexus it has grown to, like I said, $1.7 billion, but I think more importantly, the quality of the opportunities in the funnel are better. In other words, as we move to more of our sector-based strategy, we have very good accountability for what goes into the funnel, the vetting of those opportunities is done very well. And we purge things that just don't make sense. So we don't have any consumer kind of super high volume stuff creeping in there. We eliminate all that, we make sure that it makes sense for the value proposition that Plexus delivers.

So I think the sector's approach has gotten us more opportunities in the funnel, and the quality of the funnel is much better. And so -- and in addition to that the increased concentration of opportunities in the funnel with existing customers has gone up. So I think that gives me comfort, I think, in terms of our strategy, continued our growth rate in its 15 to 18% range over the next couple years.

Okay. Thank you.

You're welcome.

Our next question comes from Kevin Kessel of Bear Stearns

Good morning.

Good morning, Kevin.

My question is next quarter you're guiding for Wireline to be up. That's implying, I think, the transition you're speaking about here with Juniper isn't going to necessarily have a big effect on your upcoming quarter. But does the opportunity arise -- I understand over the next 3 to 4 quarters you expect it slightly up, but is there going to be volatility in terms of when things transition out? And then maybe you wait a quarter or two before things transition in? Or do you expect it to be relatively seamless, in terms of things coming in and out?

Well, one thing you can say about transitions is they're never seamless. I think we do a pretty darned good job of it, but that's when we're receiving more so than when somebody else is taking. So I can't speak for how clean the movement of product out of Plexus is necessarily going to be.

I think you could expect that there may be some volatility to the level of business that we have with Juniper over the next couple of quarters. But at this point, we're still rolling our forecast and our plan into '07. We're looking at it as, perhaps, being relatively stable, relatively flat as the transitions occur.

Paul, you might want to provide a little more clarity or insight if you have it.

It's just a guess right now. I mean, there's always this lumpiness as you go through transitions, moving supply chains, especially across geographies. So it's very difficult to say right now.

Okay. And then following up on what you just said, Paul, about the defense customer. Did you say that next year it could be either a 10%- plus customer or it actually could be 1% of sales, if things decline in terms of order rate?

That's the span, yes.

Okay, so it's going to be highly volatile, in terms of --

Again, these come in very large, very significant orders, right? So you could have one order that could potentially make it a 10% customer.

Right. And there's been no update. There was the thinking that maybe that program could expand over time. Is there any update in terms of whether or not a decision has been made, yes or no, on that, in terms of other parts of the government using it?

At this time there's -- again, there's a number of opportunities that we're working very closely with our customer to bid, but we have no other update.

Kevin, just a point. You know, Paul gave you a 1 to 10% range. It's not we're suggesting it's going to go to 1%, that's an extreme case. So don't bake that in. That's certainly not an expected outcome.

Right.

What about for inventory? Your inventory rose, I think inventory across the board in [inaudible] has been up in June. Your inventory is now up year-over-year at a faster rate than your sales of 33 versus -- I think your sales up about 27. So what do you think about inventory and where it's going in terms of September and the rest of the year?

Well, our inventory days improved by a couple of days from the second quarter. I would expect it's going to stay about the same, at around 60 days at the end of the fourth quarter. And as I mentioned in my comments, Kevin, I would expect a little bit of a pullback on accounts payable from 60 to maybe 58 days.

But absolute inventory dollars, do you see that staying also then relatively flat?

Yes. I don't think we're concerned about the inventory, we've got a very high-service model and that requires us typically to carry higher inventory levels than some of our competitors that have a high return.

Okay, thank you very much.

Our next question comes from Thomas Dinges of JP Morgan.

Hi, good morning, guys. Just wanted to talk a little bit about some of the new wins and kind of the pipeline again that you guys are talking about. How much of the new business that you guys are now booking is actually earmarked for start-up actually over in Asia and how much of it is actually earmarked for start-up that's going to happen here? Because obviously filling the capacity in Asia and transitions has been a big priority for you guys for some time now. And then I have a quick follow-up for you.

Well, I don't know that I have a real detailed breakdown here in front of me about what direction all of this stuff is going in.

Maybe qualitatively, compared to, say, what you guys have been doing over the last 12 months. Is it significantly more that's going to be starting over in the Asia facilities as opposed to the starting in the U.S.?

Oh, absolutely it is. Paul just wrote a note to me, he thinks it's roughly 50%. I just did pull out the sheet on all of it and as I'm scanning down the dollar volumes, I would say that quite a significant amount of this is starting up directly over in Asia. And I would also say -- you may not have heard me say this, but essentially the wins this quarter were all concentrated with existing customers. So these are all follow ons, part of new programs, additional share that we have won with our existing customer base. And as I look down the list, a number of these are currently in Xiamen. Some of them are going to come in initially to the U.S. manufacturing footprint and then over time, certain subassemblies are likely to migrate to our Asia manufacturing as product gets stable and as we start to mature the manufacturing model for the product.

Okay. And then just quickly on the engineering business. You'd talked about Malaysia having to find some new space because that obviously is running up against utilization issues with the engineers that you've been hiring over there. Where is the head count in that operation now? And kind of thinking about them similar to like a consulting business, you know, how utilized, roughly how billable are these guys now? Are you running up against issues where perhaps you do have to start incremental hiring there as well in those areas? Or do you still have some room to move in terms of these guys handling even more projects out over the next 12 to 18 months?

Well, the utilization rate can vary quite a bit, quarter to quarter, based -- the business, essentially, is volatile. As [inaudible] says, you don't have a great backlog in this business. You look out a quarter or two and it tails off pretty quickly, because of the nature and the size of the engineering programs.

Head count in the engineering organization is a little shy of 350 folks, and again I want to emphasize this is all folks committed to designing and developing new products and test equipment to support manufacturing. So this is not -- support customers and new product launches. So this is not inclusive of all the manufacturing, quality process engineers that exist within Plexus. When you look over to Asia, we're north of -- 40-some resources, 45 resources in that part of the marketplace. And we are seeing some modest growth of resources in the United States and, of course, some scaling up of resources in Asia as we try to get critical mass over there. Utilization rate in the coming quarter is likely to be a little bit less, unless they can bring in some new program wins here in the next month or so.

And that was still roughly around 3 or 4% of sales?

Yes, closer to 3%.

Okay. Thank you.

You're welcome.

Our next question comes from Amit Daryanani of RBC Capital Markets.

Thanks a lot. Good morning, guys.

Good morning, Amit.

Just a question on fiscal '07 expectations 15 to 18% growth, I'm just trying to understand, what's built into that in terms of end market growth versus wins that you've already had in the bag?

Well, we haven't completely put together a plan for '07, to be fair. I mean, I think there's some credibility here. We grew 29%. And a couple of years ago -- you know, then 18, then we'll do 19 probably plus this year.

If you take a look at the fourth quarter, if you make some assumptions about what we're going to do in the fourth quarter of this fiscal 2006 and annualize that number, you're starting to approach 10% growth for the full year in '07 just based on exiting the year at a higher revenue rate.

Then I would say if you go and look at the existing customer base and look at the programs that we have won over the last couple of quarters and start to layer those in, you're probably going to approach the low teens in terms of growth off of that, off of those programs. So then to scale up to the 15 to 18%, that's going to come largely from additional program wins with the existing customer base, additional program wins with new customers, and perhaps some end-market growth from the programs that we already have.

All right --

Gordon is waving at me, saying, "And don't forget about Defense," which could substantially pop the top in terms of our growth rate overall. So we're not building, necessarily, the higher -- an extraordinary performance out of this particular defense customer into those numbers. So if that program hits the higher run rate that Paul was eluding to, then of course our growth rate in '07 could be quite a bit higher.

I guess since you brought up the defense program, I guess two questions: One, maybe if you could talk about what's built into your 15 to 18% expectation from the defense program. And then secondly, we've actually heard from a few component providers that the OEM involved here has been out with fairly large quantities of RFPs for our follow-on program. Now, clearly, they [inaudible] as yet, but are you seeing a fairly similar activity, in terms of very large quantity of RFP out there?

Yes, and that's why Paul is talking about the higher potential for this program.

And the higher potential would be essentially 2 to 3 times the current ramp that you guys have? Would that be a reasonable characterization of what you're seeing?

Potentially.

As you know, Amit, we're currently producing for one branch of the military. A lot of the upside would come from producing for additional branches of the military.

All right. Thanks, a lot, guys.

You're welcome.

Our next question comes from Reik Read of Robert W. Baird.

Good morning. Can you guys just talk a little bit more about the thought process that you have as you continue to see the operating margins expand and do well and as these programs kick in with what you want to do with expanding the operating margins versus incremental growth opportunities? And can you also just comment on -- as the near-term ramp with the facility in Penang, does that alter your near-term thinking in how you'd approach this?

Well, Gordon's leaning forward like he's going to take a shot at this.

Let me just say this: I think what we have said is we thought that the market, and we've been consistent on this. We thought that the market would support gross operating margins in the range that we are currently performing at. We believe there are opportunities to improve our profitability internally. We still have a fairly significant drag on our performance in Mexico, although the facility is performing very well and the team is performing very well there. We need to bring in additional business there. So that would be essentially accretive to the performance of the company.

But the headwind is, of course, is the competitive nature of the marketplace looking forward and the other headwind, of course, is the start-up cost with the new facility in Penang. And then we have said that we -- even though we like to think of ourselves as addicted to margin internally, we're not desperate for margin. And so we can -- we feel we can afford to be quite aggressive when we're competing for new business. And with particular programs, we can layer in some new programs into our portfolio business and still maintain industry-leading margins.

So obviously the focus now for Plexus begins to shift toward top-line growth and maybe some further leverage on SG&A to improve operating margins a little bit looking forward. But we'll have a little bit more clarity for you, I think, as we finish the fiscal year and begin to look into the new year. Gordon?

Yes, Reik, I think I addressed the likely start-up cost in a previous question. But you may recall, when we started up the second facility in Penang we incurred a penny or two losses for a couple of quarters, and that's kind of what would happen. Of course, back then we were only making 8 or $0.09 a quarter, so it was a much bigger factor than it's going to be, going forward.

But it does sound, Gordon, like that does impact slightly your near-term thinking in terms of how you'd approach playing with margins to go after a competitive business.

The start-up of Penang III? Not really.

Okay.

There's nothing unusual. When you turn on a large factory, you've got to put in a site manager, you've got to put in a site controller, fix manufacturing costs which have to be in place before you have any incremental production. And those are the normal kind of start-up costs associated with something this big.

Okay.

So, it's not really unusual expense.

Yes. And then, so, with respect to the competitive marketplace, are there a key set of markets that you'd like to target from a strategic perspective? Or how are you thinking about where you'd like to deploy that opportunity?

Are you speaking specifically of Penang?

You're talking end-markets?

Correct.

Yes, end markets, I think our breakdown of the end markets that we're currently participating in are the key markets that we're going to continue to aggressively pursue. And so we're not looking to get off track here from our perspective and go after high volume consumer products or any of those kind of things to try to compete with some of our larger competitors. We're going to stay focused on the market that we're participating in now and continue to develop those markets. And we think there's plenty of opportunity within those markets -- defense, medical, industrial, commercial, as well as the strategic opportunities within the communications and technologies space where we can be very competitive.

Okay. Great. Thank you.

You're welcome.

Our next question comes from Carter Shoop of Deutsche Bank.

Great. Good morning.

Good morning, Carter.

Can you just talk a little bit about the wireless end market in the quarter? It was off a little bit more than what I was expecting. Is that broad- based, or is that more concentrated, one or two customers?

It was a couple of things. We gained some newer programs and share with our existing customers, some of our leading existing customers over the last couple of quarters. And then several quarters ago we had one -- a fairly significant new customer. And we're continuing to ramp the business with that customer.

I'm sorry. And then on the wireless side?

I was talking wireline now. I'm sorry, I meant -- was your question all around wireless?

Yes, in wireless, why it was soft.

Yes, wireless was down fairly substantially. And that was really a fairly broad-based decline.

Okay. And then on FASB 47, can you talk a little bit more about that, how long of an impact that would be? And just any more color you could shed on this?

Yes, 10-47, it's for conditional asset retirements, and as we look at our factories and we look at what cost may be incurred on retiring certain equipment, Carter, it really comes down to wave soldering machines and x-ray inspection equipment. They have some issues when those types of equipment are decommissioned. So we're going to set up the initial accrual and then the accrual will be pretty small. Typically about $1 million. It would require some accretion as time goes on, because of the present value. But it would not be a significant effect, once we have the initial charge in the fourth quarter.

Okay. So after the fourth quarter we're not going to really see impact [inaudible] necessarily?

Very de minimis.

Okay. Last question for you on kind of a [bare] case scenario here with the military program. If you did not win a follow-on, would we see the existing program trend from roughly 10% today down to 1% in kind of fiscal 1Q '07? Is that the kind of shape of the curve that investors can think about based on the current program?

No, I think that's far too precipitous a decline. It would take -- [inaudible].

Great. Thanks a lot.

Our next question comes from Todd Coupland of CIBC.

Good morning, everyone.

Good morning.

Thinking about your outlook for 2007, 15 to 18% growth and the various puts and takes you're talking about here in terms of using margin proactively. What type of gross margin assumption is realistic with those types of scenarios?

I think we're getting far too detailed into the '07 financials. We're still in the process of putting their numbers together. As Dean suggested a few minutes ago, though, we're not addicted to gross margins. I think we're prepared to sacrifice some gross margins for top line growth. Keep in mind, our key metric as we look at the financials is after-tax return on capital employed. I think as long as we can continue to book business that earns an ROIC or a return on capital employed that's greater than our cost to capital, I think we can expand the top line and give up some gross margin.

Okay. And the run rate for SG&A that you saw this quarter, is that a reasonable number to use over the next few quarters?

Yes. There is some lumpiness in the SG&A, and we've got occasional arrows, additional bad debt expense or bad debt reversals. But yes, the current rate's not bad.

Okay. And in terms of the wireless decline, when you think about the next quarter or so, I mean, do you expect to see a seasonal tick-up? Was that a seasonal down-tick this quarter? Or is it a fundamental rolling over with the customer base that's going to last for a little while?

I wouldn't characterize it as rolling over of the customer base to a great extent. Really, if there's one thing that's been consistent in the Wireless infrastructure for us, it's inconsistency. And so it has been quite volatile, I think, the orders here tend to be a little bit more lumpy, as well. We're going to see some improvement in the coming quarter with some specific strength for our customer in that sector. I don't know that I would necessarily characterize it as seasonal or just they've done a good job winning a pretty sizable order for them.

So I have a difficult time actually giving you a lot of clarity on Wireless. It's a relatively small sector for us and it just tends to be fairly volatile.

Okay. Great, thanks very much.

Our next question comes from Michael Walker of Credit Suisse.

Thanks. Just one question on the margins, asked another way. I guess in the past you've talked about how your gross margin was getting to a point where it was perhaps awkward with regards to your customers, if you thought that maybe they would start to get a little more aggressive on the pricing and your margins would start to reflect that. I guess I'm asking if you feel like the 11.5 you just printed is going to be the peak. I mean, is it realistic that margins can really get to 12? Or are we probably looking at a flattish gross margin structure, maybe an increasing operating margin structure, that you can get some leverage out of SG&A.

I think it's the latter. I think -- I don't see it going to 12%, Michael. And I think you're absolutely right. I think the additional leverage on the operating margin line is going to come from doing a better job on managing the SG&A.

Okay, that's it. Thanks.

You're welcome.

[OPERATOR INSTRUCTIONS]. Our next question comes from Rich Kugele of Needham and Company.

Thank you. Good morning. And good quarter.

Thank you.

Just one additional clarification on that 15 to 18%conceptual thought for 2007. When you're thinking about that, are you thinking that the initial thought of pricing a little bit more aggressive, leveraging the margin a little bit to drive growth higher, is that incorporated in that thinking? Is that remaining upside to that? Or have you decided that maybe your current course of action is better?

Well, I would say it isn't just -- being more aggressive on pricing isn't really built into that range. I mean, we've been able to perform in that range consistently or better than that range consistently over the last three years. And we haven't gotten to where we are today by buying business. We certainly didn't get our gross margins above 11% by raising prices, either. Essentially we've done a very good job, the person sitting here to my right, Paul, has done just an absolutely fantastic job driving productivity into the manufacturing business units.

And, as I said, I think on the last call, that customers don't award us new business because we're nice guys. The fact of the matter is we have to go out there and be very competitive in price every day, just like everybody else in this industry.

Now, that being said, we think that where our margins are today gives us a great opportunity, one, to defend our turf, because essentially, as I said earlier, we're not desperate for margins, so we can afford to be a little more flexible. And two, when we see strategic new opportunities, where we think we can penetrate a new customer, a significant growth account, we can afford to be very aggressive on the price to get the door open to begin the penetration process with a new account.

So I think the way to look at it is that if we continue rolling it along like we are today, we feel pretty comfortable with that growth range. We think what would give us more -- gives us more comfort is that we are financially healthy and we can afford to be flexible, and two, we've got this significant defense program that could represent some tremendous upside for us in the coming year.

Okay. And then just lastly, following up on that last comment. Your overall utilization today, I know you commented on Penang was pushing up against its own walls, but as you look globally, and then even domestically, because of the lumpy nature of this defense program, does that require you to keep some domestic capacity free just in case? And that is, then, high cost capacity to keep free, right? So just helping me understand that would be great.

Well, essentially we are aggressively going after defense and the defense sector overall, as we are, you know, some of our other, what they refer to as nontraditional sectors. And to a greater extent, those sectors do benefit from a U.S. manufacturing footprint. Of course, defense has to be built in the United States.

So we don't feel today that we're in necessarily an over-capacity situation in the United States. In fact, our capacity utilization in the U.S. on an overall basis is north of 80% as well. On an as-tooled [sic] basis now -- to understand what that means, essentially that means that we do have additional square footage in a couple of locations that would allow us to increase capacity there by adding equipment and people. And we would expect to keep that available. And I would not -- even though it's high-cost capacity from a pricing standpoint when it's tooled, because of the higher cost of people and resources, it's not necessarily high-cost to keep empty square footage or underutilized square footage available.

Okay. That's helpful, thank you.

You're welcome.

Your next question comes from Jim Suva of Citigroup.

Great, thank you. There was a brief comment made in the prepared remarks about a customer change in sourcing. Can you give a little bit of color? Exactly what is that? Is that Juniper or is that something else as far as changing your relationship or terms?

I don't think we want to get into the specifics of it, Jim. Just suffice it to note there's been some change.

Okay. Maybe then as a different question: The impact when you're closing down the Maldon facility and shifting over to Kelso: any anticipated transfer issues, you think? I know that you're in control of this transfer, so it seems like this may be a little more transparent for you to see what the impact would be on you financially or what you anticipate there.

Yes -- this is Paul -- we're hoping that it will be fairly minimal. The way we've got the two plants set up in the UK today is that basically the Kelso facility is feeding board-level product to Maldon for higher level assembly. So it really would be moving most of the finished product assembly up to Kelso. So we're anticipating a fairly minimal impact.

Okay. Great. And are those particularly focussed on a particular end market segment over there?

No, not necessarily.

Okay. Great. Thank you very much for the clarity.

Let me just also, just as a follow-on to that, is to keep in mind the scale of the facilities we're talking about. The facility in Maldon is --

40,000 --

Yes, roughly 40,000 square feet. This is not -- these things are never what I would call easy. And certainly, it puts a lot of strain on the people and things that are in Maldon and I want to be empathetic to that, but in terms of a project for Plexus to consolidate these -- or to bring these two facilities together into a single location is not a significant challenge for us.

And the room in Kelso, is there adequate room to absorb all of that? Or do you need to put in a few more SMT lines or at least ship them over?

No, again, the Kelso -- we're not building any board-level product in Maldon today. That's really the key to why we're not really expecting a significant disruption, because all of the board-level -- most of the board-level product that Maldon is using today comes from Kelso. So we're not transferring any board assembly -- there's no SMT lines to move. There's really almost -- very minimal capital equipment to move, actually.

Okay. So that should make it a little more easier to transfer.

Right.

Great. Thank you, gentlemen.

You're welcome.

Your final question comes from Mark -- Actually, there appear to be no further questions.

There doesn't? Okay. Well, we're at the end of our hour here, so I want to thank everyone for listening in today and thank you for your support of Plexus. Have a good day, everyone.

Thank you, Operator.

Thank you. This does conclude today's teleconference. You may now disconnect.