Plexus Corp (PLXS) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Plexus Corp. conference call regarding its fourth fiscal quarter 2006 earnings announcement. [OPERATOR INSTRUCTIONS] I would now like to turn the call 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 refer to the Company's periodic SEC filings. The Company also provides non-GAAP supplemental information.

Typically earnings and EPS excluding restructuring costs, charges for the impairments of goodwill and other long-lived assets, and in the case of the fourth quarter of '06 and full-year of fiscal '06, excluding a favorable adjustment to the valuation allowance on deferred tax assets and the initial expense of adopting FIN 47, which concerns additional asset retirements. 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 yesterday's press release in our periodic SEC filings. There.

Joining me this morning are Dean Foate, President and CEO of Plexus; and Paul Ehlers, Senior Vice President and President of Electronic Assembly, which is the Company's manufacturing operations. We will begin today's call with Dean making some brief comments about the final quarter and full year of fiscal 2006. I will follow-up with details on the fourth quarter's financials and then provide some additional color on the first quarter's revenue and earnings guidance that we included in the press release. I'll then turn the call back to Dean for some broader comments on fiscal 2007 before we open the call up for questions. Let me now turn the call over to Dean Foate. Dean?

Thank you, Gordon, and good morning, everyone. Last night we reported results for our fourth fiscal quarter. Revenues were $396.9 million with GAAP earnings per share of $0.91, which included adjustments to our tax provision and the adoption of FIN 47. Gordon will walk you through the details in a few minutes. Let me just say that on apples to apples comparison, our non-GAAP EPS was $0.54 or $0.06 better than the midpoint of our guidance. Let me continue by providing you a few details about the fourth quarter before issuing a final report card on fiscal 2006.

Turning now to our market performance in the fourth fiscal quarter. Our Wireline/Networking sector was unexpectedly flat to down this quarter. Coming into the quarter, we had expected modest single digit growth. With only a few exceptions we experienced broad-based reductions in pushouts of customer orders. Looking to the first quarter of fiscal 2007, we currently expect low double digit percentage growth as a consequence of recent program wins, and the recovery of demand with existing accounts. Our wireless Infrastructure sector was strong this quarter, as expected. A couple of accounts in this sector experienced end market recovery during the quarter. We currently expect modest growth in our fiscal first quarter.

Our Medical sector was down modestly, although slightly less than expected. Performance of accounts in this sector can perhaps be best described as mixed. Looking to the first quarter, we currently anticipate flat to modestly down performance as we execute a product model transition with a large medical account, and again, anticipate mixed performance with other significant accounts. Our Industrial/Commercial sector delivered strong growth again in Q4. The better than anticipated performance was driven largely by stronger end market demand. Unfortunately, we anticipate that trend will end as we currently expect a broad-based decline in customer demand perhaps a developing first quarter seasonal trend for this sector.

As expected, revenues on our defense -- in our Defense, Security, and Aerospace contracted sharply in our fourth quarter reflecting completion of the first production orders from a significant confidential account in this sector. We expect sector revenues to contract once again in our fiscal fourth quarter as the programs with this account decline to minimal manufacturing levels. Long-range guidance for this account remains difficult, as manufacturing volumes ultimately depend upon extremely lumpy purchase orders from the United States military. Our customer contacts assure us that additional orders are pending. This assurance, as well as independent checks of potential demand prompt us to forecast a conservative resumption of production orders beginning in the second quarter of fiscal 2007.

Addressing our overall revenue concentration. Revenue from our top ten customers represented 59% of our total revenues this quarter, down 4 percentage points from last quarter. Juniper networks represented 17% of the total, down 2 percentage points from last quarter. Our business with GE inclusive of multiple GE divisions increased 1 percentage point to 12% this quarter.

Turning now to new business wins. During the period, we won 11 significant new manufacturing programs, which in total will add approximately $112 million in annualized incremental revenue as these programs begin to ramp during fiscal 2007. Seven of these programs increased our share with current customers while four are new customers, including a significant new opportunity for our facility in Mexico, which is currently operating below critical mass in revenues. Our former opportunities remains very healthy at 1.8 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 approximately $10 million in new product development business during the quarter, a level sufficient to sustain a healthy backlog. 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 tool capacity utilization was approximately 82% overall as we exited the fourth quarter, about level with Q3. Utilization rates in Asia are above practical maximum and as discussed last quarter, we are expanding physical capacity in both China and Malaysia. In China the construction project to double the size of our facility in Xiamen has already begun. And in Malaysia, as previously announced, we have acquired a third facility that will add significant capacity to our manufacturing operations in that import and region of the world.

Capacity in the U.S. is about optimal and we can expand with additional equipment and people. In Mexico, we are operating well below optimal levels, and improvement as we add new customers into that facility. In the U.K., we are executing on a previously announced consolidation of our Maldon, England high level assembly and fulfillment center in to our manufacturing facility in Kelso, Scotland. We expect to complete the majority of this effort in fiscal Q1.

Let me now turn to a report card and summary of fiscal 2006, a year that in many ways was a spectacular breakthrough year, a year where we set several records and logged many accomplishments. Revenues for the year hit an all-time high, as did operating profits and shareholder equity. The year's achievements were delivered by the dedication and smart work of the approximately 7800 Plexus people around the world, a historic peak. On our year end call last year, I outlined four key priorities that led to many of the accomplishments in fiscal 2006.

First, we committed to continuing our track record of profitable organic revenue growth with a target range of 15 to 18%. I am pleased to report that we grew revenues 19% over the prior year, by reducing the number of customers we serve in manufacturing from 132 to 107. We focused our business development efforts on gaining share and penetrating our value-added services with our existing strategic accounts. We leveraged our maturing sector base, sales and marketing approach to add strategic new accounts, including gaining scale in a new target sector, Defense, Security, and Aerospace.

Second, we committed to further enhancing our integrated global services model. As a part of this effort, we completed the installation of our standard global IT system in two facilities in Penang, Malaysia, enabling our agile, flexible, direct order fulfillment capability at those sites. Just this week, we completed the installation of the IT system in Xiamen, China. The total number of manufacturing facilities now operating our standard global IT system is 9 of 13 sites. Also this past year, we added a material sourcing operation in [Hangzhou], China to support lower cost materials to Plexus facilities worldwide. To alleviate capacity constraints in Plexus Asia, we initiated the expansion of a facility in China and purchased a third facility in Malaysia. In addition to significantly increasing manufacturing capacity, this new facility in Malaysia will support further growth and provide appropriate lab facilities for our Penang design center.

To offer flexibility to our Medical customers, we achieved [ITO] 13-485 certification at Kelso, Scotland manufacturing facilities and at our Livingston, Scotland design center. We now have five manufacturing facilities and four design centers certified to this medical standard. Additionally, we achieve class 3 medical certification at our Chicago manufacturing facility. To service our defense contractors, we achieved ITO compliance at our facilities 4 and 5 and at our Boise, Idaho, facility, bringing the total number of ITO certified manufacturing facilities up to four. Additionally, we certified our Boulder, Colorado, design center. We now have two design centers ITO compliant with a third soon to follow.

A third priority was to increase our focus on leadership and employee development. While investing in leadership training programs we embarked upon a new conception design as an integrated channel management and organizational approach. This will ensure that we drive organizational performance while identifying and developing high-potential leaders and succession talent. As part of this integrated approach, we worked to improve our selection of recruiting processes to ensure that we add the appropriate mix of new latent into our organization. Last, we're committed to continuing improving return on capital employed by focusing on both the numerator and the denominator.

To deliver on the former, we laid out a commitment to drive toward a longer 10/5/5 model. Meaning 10% gross margins, 5% SG&A, and 5% operating margins. Well, both gross margins and operating margins bettered their respective targets while SG&A provides an opportunity for further leverage. While improving on our metrics, we returned to a few previously troubled sites in the U.S. to solid profitability and we ramped our second facility in Penang, Malaysia, achieving profitability ahead of plan. We increased our overall global manufacturing capacity utilization to a healthy overall 82%, and enjoyed growth and profitability in the Engineering Services business.

Turning to the return on capital employed denominator, our cash cycle improved three days in fiscal 2006 following a tremendous 22 day improvement in 2005. While making prudent investments for the future, we again improved our capital-employed turnover. As a consequence of the improved profitability and capital-employed turnover, our after-tax return on capital employed was well above our weighted average cost of capital to 28.8 result among industry leaders, a spectacular year delivered by Plexus people that should be proud of their results and accomplishments. Gordon?

Thanks, Dean. Let me take a few seconds to address why earnings were better than our earlier guidance. Fourth quarter revenues are very close to the midpoint of our earlier guidance for the quarter, but earnings per share were much better than expected. More specifically, earnings per share for the fourth quarter were $0.06 higher than the $0.48 midpoint of the range of earnings estimate that we had previously provided. About $0.04 of the favorable variance was operational. Mainly better margins as a result of a favorable revenue mix and better than expected operating efficiencies at a number of sites as well as lower than expected SG&A expense. The remaining $0.02 of the favorable $0.06 variance stemmed from nonoperational factors, primarily a small tax credit in the fourth quarter instead of the anticipated 1% effective tax rate. A lower FIN 47 loss, and a lower share count. I'll have more to say about the tax rate in a few minutes. But then again, you knew that.

Taking a look at the fourth quarter numbers, I'm going to limit my comments on the fourth quarter's income statement this morning to comparisons against the third quarter of fiscal 2006. I think the reasons for the significantly improved year-over-year comparisons are by now very well understood. Revenues were essentially flat quarter over quarter, although there was a substantial variation in end market demand. Wireline improved despite some lower sales due to our largest customer, Juniper Networks. The defense sector decline, and that was almost entirely attributable to the large but unnamed program in the defense sector.

Gross margins slipped about 20 basis points from the previous quarter, but SG&A expense declined both in absolute dollars as well as a percentage revenues, and as a result, operating margins in the fourth quarter expanded 20 basis points from the previous quarter's 6% to 6.2%. The modest erosion in gross margins in the fourth quarter was primarily due to the write-down to net realizable value of inventories held for two small accounts where the realization and collection of these inventories became problematic during the quarter. Lower SG&A spending in the quarter resulted from the very careful control of spending primarily for IT sales and marketing. Let me make a couple of points below the operating income line before turning to the balance sheet.

Interest expense remained flat with a typically 800 to $900,000 quarterly level. Interest income improved by nearly $300,000 over the third quarter, primarily on higher balances of cash and marketable securities. Interest income contributed about $0.04 to the current fourth quarter's EPS. The sequential change from miscellaneous income in the prior quarter to miscellaneous expense in the fourth quarter was driven by changes in foreign exchange going from a gain in the prior quarter to a loss in the current quarter.

Getting back to taxes for a moment, first you will have undoubtedly noticed there was a big benefit of $17.7 million from the tax provision from reducing the valuation allowance on the deferred tax assets. Which in the interest of intellectual honesty in reporting non-GAAP adjustment, we had eliminated in the pro forma statements for the fourth quarter. Parenthetically, you'll also notice a $505 adjustment in the non-GAAP reconciliation to eliminate the impact of our initial adoption of FIN 47, which concerns conditional asset retirement obligations. Second on the tax line, there were tax accruals for the U.K. were lower than previously expected, and this brought the nominal affect of tax rate for the year down from 1%, which we anticipated at the end of the June quarter to 0.6%, that is 6/10 of 1%. This year-to-date downward adjustment on the tax rate 6/10 of 1% actually required a small credit in the fourth quarter, which resulted in a negative 0.3% effective tax rate for the fourth quarter, which is the rate that we used in developing the non-GAAP net income in earnings per share, presented as a supplement in the earnings release. That's probably more than enough on taxes. Let me turn to the year-end balance sheet and cash flow.

Our overall cash conversion cycle remained at the prior quarter's level of 50 days, although there were changes within the individual components of the cash cycle. DSO and receivables improved by 2 days. You may recall that last quarter's statistic was unfavorably skewed as a result of very high shipments late in the final month of the quarter. This unfavorable skewness was moderated at year end. There was also a two-day improvement of days in inventories, but the improvements in days in receivables and days in inventories were negated by a four-day slippage in accounts payable, primarily due to a customer directed change in sourcing with less favorable payment terms. Cash flow from operations rebounded in the final quarter to $33.5 million. Cash flow from operations for the full year was $82.8 million. Cash and marketable securities increased by just over $25 million during the quarter through a combined year-end 2006 balance of $194.9 million.

Turning to capital spending, capital spending in the fourth quarter was approximately $8.6 million, which brought our total capital spending for the year to $34.3 million. This is greater than our annual depreciation expense of $23.3 million. Let me segue from capital spending and conclude my discussions on the fourth quarter with a brief update on some of our facilities that Dean's already touched on. Two expansions and one closure.

First, Xiamen, China. As you know, we are doubling the footprint in this facility from 60,000 square feet to about 120,000 square feet. This expansion is on track and we don't expect any disruptions or losses when production begins early in the September quarter. We have determined that this expansion qualifies as a capital as opposed to an operating lease transaction and you will note a small $4.1 million increase in our debt level at year end '06 to reflect an additional capital lease lease obligation required for this accounting treatment.

Second, Malaysia. Once again, as we have previously announced, we are in the process of acquiring a third facility in Penang, Malaysia. You should note that capital spending for fiscal 2006, included only a $1.1 million down payment on this new facility in Penang. We expect to spend about $10.5 million in the December quarter to complete the initial acquisition of the land and building from its current owner. Capital spending for building improvements and additions to this new facility as well as for the initial outfitting of production equipment is expected to result in an additional $26.5 million of capital spending during the last three quarters of fiscal 2007. Modest start-up expenses for this new facility are anticipated in the first fiscal quarter, as we assemble and train a new site management team. Production is currently expected to begin at the third facility in Malaysia in the second quarter, and the start-up losses are expected to widen in that quarter to perhaps $0.01 per share.

And finally, let me say a few words about the closure of the facility in Maldon, England. This is a modest 40,000 square feet facility that until recently was used as a final assembly test and repair center. Currently, these operations are being transferred to our facility in Kelso, Scotland. We are on track to close the Maldon facility by the end of December and we expect to incur approximately 500 to $700,000 of additional severance costs from this restructuring action in the December quarter. I should mention that we have received a lot of interest in this facility, this building, which we own and we would expect to generate some cash from the sale later in the fiscal year. On balance, the closure of Maldon should be cash flow neutral to slightly positive. With that, let me move on and discuss our revenue and earnings guidance for Q1 of fiscal 2007.

As we mentioned in yesterday's earnings release, we currently anticipate revenues in the first quarter of fiscal 2007 to be in the range of 385 million to 395 million and earnings per share before any restructuring charges of $0.31 to $0.35. There are a number of factors influencing earnings in the first quarter which it might be helpful for me to review.

First, although overall revenues for Q1 are anticipated to be just slightly below the fourth quarter of '06, we expect a different revenue mix, the most significant change will be virtually no revenues in Q1 '07 from the major military program that has benefited the last two quarters of fiscal 2006. As production under the original purchase order for this program is essentially completed. We expect to receive new purchase orders for this program and to resume production in the second quarter. However, the lack of revenue from the military program in Q1 will temporarily stall overall revenue growth and lower margins. Second, the Company put in place an approximately 3.5% overall wage and salary increase in the United States effective at the start of the first quarter. This will put additional pressure on both gross margins and SG&A expense.

Third, there are a number of other cost factors which together will impact earning comparisons in the first quarter. These include higher depreciation expense at a number of sites to reflect recent increases in capital spending and the initial start-up losses for the facility in Penang, which I mentioned earlier, as well as higher planned spending for Information Technologies, sales, and marketing. Fourth, we also expect higher stock option expense in the first quarter, as the members of the Board of Directors are normally granted options in November, most of which immediately vest. Finally and perhaps most significantly, taxes. As noted in the press release, we expect the effective tax rate to run about 25% this year, which is substantially higher than the very low, even negative tax rate that obtained in 2006. So although we remain confident for the outlook of fiscal 2007, the year begins on a hesitant note. Let me turn the call back to Dean for some additional comments on the broader outlook for 2007.

Thank you, Gordon. With our three-year compounded annual organic growth rate over 20% and our return on capital employed leaping way above our weighted average cost of capital, I can now declare that the turnaround we embarked upon four years ago is now complete. We are entering a new phase for Plexus, a phase where we can focus all of our attention on developing and executing strategies that will further extend and differentiate our global product realization value proposition to deliver long-term profitable growth and shareholder value. In several ways, fiscal 2007 will be a positioning year, where we are investing in key strategies and infrastructure to support $2 billion in revenue in the following years. Let me outline our priorities.

First, and consistent with the prior few years, we'll focus on profitable organic revenue growth. Our market sector-focused business development approach is maturing and we'll strive for balance growth across our key industry sectors. We'll continue to execute on our deeper, wider account penetration strategies to enhance share and further the value add and global services that we deliver to our customers. We'll intelligently and diligently target new accounts that can benefit from our differentiated value proposition. Consistent with the prior three years, we believe the market supports our targeted fiscal 2007 growth rate of 15 to 18%, after-tax growth remains our key economic driver.

Second, we will continue on our journey to become a Lean enterprise, leveraging the tools and culture nurtured in our manufacturing operations. While continuing to drive productivity and flawless execution in our manufacturing facility, we expect to gain similar productivity and performance benefits in our engineering, administrative, and support functions. We made good progress last year. I expect us to deepen our Lean culture across the enterprise in fiscal 2007. Third, we will further develop our integrated talent management and organizational development approach to ensure that we have a pipeline of talent to lead and grow our organization. I can report that we are developing into an employer of choice for talented resources seeking careers in the EMS industry.

Fourth and last, with the turnaround of Plexus complete, we are entering an exciting new phase for our company. While we must never take our eyes off the pitch thrown our way, we must look to the center field fence from time to time to ensure that we strive for the strategic home run. As we move through fiscal 2007, we'll begin to focus more attention on our long-term strategies and clearly to our vision so that we can better communicate and win the enthusiastic support of all of our stake holders. Gordon already provided you details outlining our guidance for fiscal Q1. Let me continue by outlining our current expectations for the later quarters of fiscal 2007.

We currently anticipate that our second quarter will offer modest revenue growth over our first fiscal quarter as we continue to ramp recent new program wins and resume production of the confidential defense program. We also expect to begin production in our third facility in Penang, Malaysia. The second half of the year should offer more excitement if customer forecast and new program win trends stay intact. We're currently anticipating strong revenue growth in both our third and fourth quarters and we should begin manufacturing in our expanded capacity in Xiamen, China. As the year unfolds, I offer a few indicators to monitor. Revenue estimates of new program wins, additional orders for the confidential defense program, the health of our customers and their end markets, the successful ramp of new and expanded facilities, operating margin performance, inventory trends, and the overall health of our competitive environment. Operator, with that we will now take questions. Thank you.

Thank you. [OPERATOR INSTRUCTIONS] Thank you. Our first question comes from Brian White with Jefferies and Company.

Good morning, guys.

Hi, Brian.

When we look at the outlook, sales outlook as just a little soft, is that all related to debents, or is part of it related to softness you're seeing in areas like communication and Industrial?

Well, as I and Gordon look out, if you look at the downdraft in the large defense program that we experienced in Q4 and the further continuing downdraft that we see in Q1. I think that you'd come to the conclusion that the underlying business was growing. But having said that, we had a soft quarter in Q4 for our wireline sector. Came out roughly flat to down just a little bit. But we're seeing renewed growth in that sector in the coming quarters. There's no question that this large defense program was a significantly good program for us in the earlier quarters of the year, but as it declined, as the orders finished and it declined in the back half of the year, it really caused us to not see any overall top-line growth in the final two quarters of the year and going into the new year.

And the communications market, the Wireline/Networking, you have some new programs you're ramping. If you weren't ramping these programs, would the underlaying business decline in the December quarter?

I would say it would be roughly flat.

Okay. And Industrial would decline, you said?

Industrial is expected to decline, but that's more consequence of end market demand than it is anything else. Just customers that are seeing a soft outlook in Q1.

And when we look at your revenue growth for the year of 15 to 17%, you do have some of the defense ramp embedded in that; is that true?

That is true.

And what percent is that? And the other question would be what percent of the 15 to 17% is just ramping new programs and what percentage end market type growth?

Well, I hate to get into the specific revenue forecast that we have for the defense program, other than to say that if that program would be zero in the coming year versus what we have in the forecast, I would say that you could expect us to be closer to the lower end of our growth range versus the higher end of the growth range.

Okay. Just, finally, gross margins -- did we hit a peak in gross margins over the last couple of quarters, and how should we think about it for the remainder of '07?

As I mentioned Brian -- this is Gordon -- the gross margins were hit by some inventory write-downs in the quarter. I think you ought to go back to our 10/5/5 model that we've espoused for sometime as a long term goal for the Company. It will be up, it will be down, it's not going to be any linear run rate.

Great. Thank you.

Thank you. Our next question comes from Michael Walker with Credit Suisse.

It's Will Stein sitting in for Michael. How you guys doing?

Good.

Good. I just want to touch on that military program one more time. So we're not expecting anything in December, but you say you do expect new POs in production in the March quarter; is that right?

That's right.

Are we expecting to expand sales to other divisions in the military or to other countries? In other words, I guess what I'm getting at, is the potential run rate of that business going to actually increase from the peak it was last quarter, or are we looking at that as the maximum run rate we can hit?

This is Paul. The short-term opportunities for this program right now are really with the U.S. military for the most part. There are small, other opportunities for civilian defense and that kind of thing, but mostly opportunities are with the U.S. military. We're talking about other things longer term, but for '07, it's mostly U.S. military.

And just a question on the taxes, you thought you'd give us enough. But I just have one other question on that. Gordon, you gave the full year rate at 25%. Should we expect that to kick in Q1, or is there going to be a delay possible with the lower tax rate in Q1 and then a bouncing out throughout the year?

No, that's our best estimate. 25% is the best estimate we have for the full year, so that's the rate at which we would be accruing on a quarterly basis. So the short answer is, yes, you should see a 25% tax rate at Q1 to continue through the year.

Just a small housekeeping -- I believe you gave CapEx guidance. Could you talk about what D&A -- first, I'm not sure I have it for September, and then what it might be for next year?

Yes, hang on a sec, we'll -- depreciation for the year was $23 million and CapEx for the year was $34.3. This was the first time in about four years than we have actually spent more on CapEx than we have taken in depreciation expense. The implications are that the depreciation expense is going to go up.

But certainly fiscal '07 you're going to have higher CapEx as well? You got it to double the CapEx?

That's right, we're looking for about $70 million of CapEx in '07.

And what about D&A?

It would kick up to about 30.

Thank you very much.

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

Good morning. Can you just talk about -- since the mix can drive gross margin so much, when you look at the incremental business you've won net of the losses for '07, how does that play out in the margins? And maybe if you talked about whether income dollars are going to grow faster or slower relative to sales next year given all the puts and takes? That would be helpful.

Well, I think operating income will be grow less than sales because of all the puts and takes, as you put it Steve. I've outlined some of the pressures we're going to see in Q1. Some of those pressures will continue for the rest of the year. I would expect operating income growth would moderate.

And how does the new wins affect the metrics you're going to report from a gross margin standpoint?

I think the new wins are consistent with past -- with recent performance on gross margins. I wouldn't go to the peak number, but I would say with the range of the 10/5/5 model, the new wins are consistent with what will support that model overall.

And then lastly, just on -- you mentioned filling up Mexico a little bit better. What type of program is going into there and why is it going to ramp the utilization in that plant?

It's a reasonably significant opportunity, we're build -- I can't identify the customer, unfortunately. But it's a reasonably significant opportunity for them. It will be a direct order fulfillment model off that facility. It will be a good resume enhancer for that site and it's important to recognize that if you've been following our queues that we've been in a loss situation in Mexico. So that piece of business will substantially improve the performance of the Mexican facility.

Can you say what type of industry it's for?

We have it in our Wireline/Networking sector.

Thank you very much.

You're welcome.

Thank you. Our next question comes from Kevin Kessel with Bear Stearns.

Good morning, guys.

Good morning, Kevin.

Just one more question here on this defense business. You say that you expect this to happen in the March quarter in terms of potential follow-on orders. What would that imply in terms of timing? Is this at the very end of the March quarter or is it in the middle or the beginning?

Yes, Kevin, we should add some clarity. We would expect the actual purchase orders for the demand to show up in the December quarter with production beginning in the March quarter, depending upon the actual timing of those purchase orders. Paul might have a better sense of the actual beginning of the ramp of the program, but there's some variability to that.

The timing we're actually still working out. It's a little bit unclear what's being worked for you. But there's a high degree of confidence there will be some pretty significant revenue in Q2. And actually, we do have a pipeline of materials already established a little bit ahead of the orders on the behalf of our customer so that we can support the revenues sooner rather than later. You'll actually see a little bit of an inventory pop at the end of Q1 because of that material being there ready to go.

Okay. So what you're essentially implying then is that Q1 or the March quarter could see pretty much a full ramp -- or a full quarter's worth of production for this?

Could be a full quarter. But right now we're not -- if you look back to our peak quarter in '06, we have not built into our forecast revenues at that peak level. It's a lower level of production than that peak number.

And then I don't know if there's a gating issue in terms of capacity, but when you guys hit the peak there, last quarter, 10% of your sales are roughly 40 million. Is there any sort of timing on this contract given that it's military meaning they want it all completed within a quarter or two or three? And if it's less than typical, does that mean you could actually go north of what your last peak quarter was?

Typically, they want it all very fast. Specific details on this order, again, they have not been worked out yet. We just don't know that piece of it. But the historical stuff has been faster. Faster.

So there's a chance that if that's true, it could be another 10% customer in a future quarter?

Well, we have not put it into our forecast and have not planned upon that in our 15 to 18% growth assumption. Could happen, but right now we're not forecasting it that way.

Right. What about other wins? Based on this product, there's obviously multiple branches of the government looking at this. There's some that even have requests out there for manufacturers. What do you assign the potential or possibility to winning those sort of opportunities in this year?

Well, it's hard for us to assess the probability of that, just because we're a couple layers removed from how the decision process is working. We know that there are competitors with other technologies that are competing with these technologies. We know that some of those technologies have been deployed so it's difficult for us to really give you a real strong indication one way or another where the competitive position of this technology really folds in.

And then just flipping over to Juniper for a second.

Yes.

It was down in the quarter, but what do you anticipate the mix going forward in terms of that program and the revenue impact over the next two quarters, and do you expect any significant changes at all as a result of that third supplier?

Well, yes, let's talk about Juniper a little bit. We did say our Wireline/Networking sector was, of course, somewhat soft in the fourth quarter. None of that was a consequence of the third EMS provider with Juniper. Any softness there was not attributable to that. As we look forward in the year, we are still forecasting growth overall for Juniper. And so we're expecting -- we announced some new program wins last quarter. We continue to have success with Juniper in our new product lines. So we've got multiple product lines with Juniper and we're building product for them in multiple facilities around the world. We believe strongly in our position with Juniper, and we believe strongly even as all the puts and takes happen during the course of the year that we're going to end up with an up revenue forecast for Juniper.

What about mix on the margin side? Do you think that goes -- that improves, it gets worse, stays the same?

That's difficult. I think we're going to end up with a richer product mix, but at the same time, Juniper like all customers like to have cost reductions. Overall, I would assume that we're going to come out about net even before we have them.

Okay. In terms of outsourcing pipeline, Dean, you mentioned 112 in the quarter. If I look at the last five quarters, you're up about $460 million in aggregate. Does that still sound fair, or has a large part of the last, let's say 12 months already ramped?

Well, this is a difficult thing about trying to give you program sizes. I try to talk about them in terms of annualized revenue as they get fully ramped up versus what is actually going to fold into the forecast. There's so much variability program to program. But I think we can continue the pace of that win rate. And that's what I think is very important. As we talked about the wins the last couple of quarters, some of those are still ramping this quarter. They will still ramp next quarter, which gives us a fair amount of confidence in growth in the coming year. The pipeline also, as I said, is about 1.8 billion. I think it was 1.7 last quarter. Half of those are -- half of the opportunities in the pipeline are with existing customers, those kinds of deals tend to get done quicker. We feel quite good about our overall business development approach and our ability to gain share with our existing customer base and feel quite healthy about the overall opportunity for Plexus in the marketplace.

What's the average time for you guys to ramp a program after you announce it on these calls. Is it one quarter, two quarters, three quarters?

Well, again, that depends if it's an existing customer and if it's a derivative product or if it's a brand new product. When you talk about it, you've got to think about in terms of one or two to three quarters depending on how the program really plays out.

And lastly, Gordon, just a housekeeping question, in terms of cash flow and free cash flow, what is your expectation for 2007 as well as your options expense expectation. And then lastly, on the net cash of 359 in the quarter, any expectation there to put that towards acquisitions?

Let me answer your second question. No acquisitions are planned. As Dean said, we continue to focus on achieving organic growth. So unless a strategic home run shows up, we wouldn't be doing any acquisitions, Kevin. I'm embarrassed to say, I don't recall what the share-based costs are expected to be for '07. I'll have to get back to you on that.

What about cash flow, free cash flow for '07, estimates?

I would expect we'll be about cash flow neutral. As you know, we're looking at $70 million of capital spending for the year and of course, working capital will increase with the higher revenues.

Do you mean free cash flow neutral?

Yes.

Okay. Thank you.

Thank you. Our next question comes from Shawn Harrison with Longbow Research.

Good morning. My first question just has to do with Malaysia. Point of clarification, modestly dilutive in this quarter, a $0.01 in the March quarter and then break even by the June quarter, is that a good assumption?

Yes. That's pretty good. We've got existing business that we can move into the third facility in Penang, as soon as it's up and running. We'll probably achieve a break even faster than the second facility we brought online about a year and a half ago.

Just to add some clarity, right now we're operating above 100% capacity utilization in our two other facilities in Penang. We're actually experiencing some productivity inefficiencies because we're so jammed to the walls in those facilities. As Gordon said, we're going to pick up some of the production that's in those other facilities and move it into the new facility to get it out of the gates a little bit quicker than when we added the second facility in Malaysia.

Is the new facility going to be focused in on one specific end markets, or what end markets will be moving in there initially?

Well, it's not focused in on one specific market. We tend to take our facilities and operate with what we call a focused factory model, which allows us to put the right kinds of people, equipment, processes in place and regulatory processes in place that are suitable for customers in multiple industry sectors. I would expect the new facility in Malaysia to operate to that model.

Okay. My second question just has to do with the medical market. The little bit of weakness this quarter. Some mix demand trends looking out into the first quarter. If you could just comment on the overall demand environment in that market, and secondly the conversions you may or may not be getting from the engineering work you're doing in the medical sector.

Well, let me just comment on the demand market, which is somewhat perplexing. In the past, we've had better, consistent performance out of the customers that we do business with in the medical market sector, and over the last couple of quarters, we've seen quite a bit of turbulence in their orders and success in markets. There is some variability there that is starting to come to play, perhaps as a consequence of the medical industry operating a little bit more like a real commercial marketplace versus historically. We are also looking at the Q4. Right now we're estimating it being modestly down, which typically would be more of a seasonal up quarter for us, in particular with one larger account that typically has a very strong December quarter. But with that particular customer, we're undergoing a fairly significant product transition, where there's a fairly new to market technology that was in one of their high end imaging systems that's being flipped over to a newer technology that is going to be manufactured at lower cost. There's a product transition that we have to endure before we get back to the growth in that market sector.

Now, the other part of your question was related to the product development organization and we actually have a great pipeline of newer opportunities coming out of the product development organization technology group that are going to move into manufacturing as we continue to move through '07 and into '08. Now new products to market in the medical space, typically these are not huge revenue numbers when you launch new products in medical. They're typically smaller programs and take time to build, but they're very much like an annuity once you get them in place.

Okay, thank you.

You're welcome.

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

Good morning.

Good morning.

Just a question on your Mexico operations. Just looking at the Q last quarter it's running about negative 9% margins. Can you just talk about what the utilization rates there are and once you ramp a new customer that you spoke about, where does that utilization move?

Hang on a sec, Amit. We're trying to get at the numbers. Needless to stay, our Mexico facility is substantially running under capacity utilization.

I was trying to give Gordon a hand, he thought it meant stop. I was trying to tell him it was about 50%.

I thought you were telling me 5%.

No. The utilization rate is about 50%, but I would remind you, we calculate that on an as-tool basis, that's not a square footage calculation, it's more an equipment and people that we have in the facility. We haven't calculated what the utilization rate will be once this new program is ramped up. Paul may know when we start to hit break even, which I think it--.

Yes. It will get about to break even, it will probably pop utilization about 10%.

I guess the suboptimal margin in Mexico, that's just reflective of underutilization then? Or are there any other issues that we need to address down the road there?

Just a function of not enough revenue, Amit.

All right.

We have a pretty new team down there and they're functioning very, very well. We're really enthusiastic about the prospects from Mexico.

Fair enough. Just excluding the defense business, could you talk about the rest of Plexus' operating model would look like? Are you still comfortable with the 10/5/5 business model X the defense business, or do we need that to sustain 5% plus margins in the long run?

No, the 10/5/5 is independent of the defense business, Amit.

And just to support that, if you go back into fiscal '06 and look at the earlier quarters of fiscal '06, even into the second quarter, where we had very little defense business, very very strong gross margin performance. The 10/5/5 remains intact and I think you look at the defense business, even -- that is good business for us, but I think if you look at other opportunities that we have, in particular getting Mexico up to some profitability as we ramp the new facility in Penang, Malaysia, as we get the consolidation completed over in the U.K., we do have a few arrows in our quiver to help support the operating model of the company asides from just the defense program.

Fair enough. Maybe just moving on to the revenue side, the defense program, it looks like Q1 it should be zero and then start ramping in Q2. Do you expect to see a similar ramp to what we saw in fiscal '06? And what should we build into your 15 to 18% growth expectation for the defense program?

Again, I hate to -- I don't want to give specific guidance as to the revenue from the defense program, as I wouldn't want to give specific guidance to any other particular customer. But I would say that if we make assumptions that the defense program just plain does not happen, then I would suggest at this point that we would be looking probably at the lower end of our growth range for the year. Still very early in the year, obviously, but that's the way I would see it unless we accelerate new business wins from other customers or new customers. If the defense program stays in the forecast the way we have it laid out, which is below -- on a quarterly basis below the peak revenues that we saw in '06, then we got a much better shot at being at the higher end of our growth range. Again, I say that sitting here in early November looking at a full fiscal year. There's a lot of variability and a lot of uncertainty that can come down the way. Given recent new business wins and our track record and trends, I think that those are reasonable expectations for us looking into the coming year.

Fair enough. And then Juniper, sounds like you expect margins from them to be essentially flat and revenues to be up mid-single digits in fiscal '07 in line with Juniper's growth despite all the puts and takes. Is that a reasonable characterization?

I think that's pretty good.

I guess that leads me to the final question. For the last three years at least, a big majority of your growth has really been driven by Juniper or GE Medical Systems. Doesn't sound like Juniper is going to be a big driver this time. The Medical Systems seems to be -- it's been fine, but can be a big driver again. What is going to be the big driver to get you to 15% growth, given the fact that it doesn't sound like you have a lot of expectations in the top two customers at this point.

Well, you go back in our history, it's always been one customer or another that has added a significant amount of the growth and then a whole bunch of new business wins with a long list of customers that we can hopefully align for future revenues. I don't really see this coming year as all that different. We feel very good about our relationship with Juniper, we're looking at GE and you're suggesting maybe we won't see a lot of growth from GE, but I would remind you that we do business with multiple modalities of GE, not just GE Health care, there are a lot of opportunities that we can continue to mine with that customer. So looking at the year, I think there's -- with a $1.8 billion pipeline and a maturing go-to-market strategy that we really have developed over the last three years, I feel pretty good about our prospects in the coming year and our ability to find the next Juniper or the next defense program or a collection of programs that can give us that kind of growth.

So are we to assume that you expect to win the game with a big home run at the end rather than singles and doubles?

When I look at the pipeline and the health of the pipeline, a number of opportunities that are in our sweet spot, I think it's likely we may win the game this year with a whole bunch of doubles and triples versus home runs.

Fair enough, thanks.

Thank you. Our next question comes with Reik Reed with Robert W. Baird and Company.

Can you just talk a little bit more about the wireline space and the order pushouts that you're seeing? And maybe just off of that last question, I guess I look at it from you're seeing some pushouts, you're seeing some medical transitions, you've got an Industrial outlook that's a little bit more flattish. Can you talk a little bit about what the confidence interval is with that 1.8 billion and how back end loaded it might be?

I'll let Paul talk a little bit about our wireline Infrastructure customers because he's been really close to some of the forecast adjustments that have taken place there.

The Q4 number was granted some softness on a part of some customers. Again, Q1 we're expecting that to kind of get a little bit better, particularly with some of our larger customers. And a couple of our customers in particular, we're seeing some very significant upsides. I think you'd be careful about calling it an overall trend and more about how specific customers are doing in the industry. So we're kind of seeing a recovery in Q1 and Q2. Got a couple customers that are really looking like they're doing well and a couple that are struggling a bit.

I would also say that we won a new piece of business that I announced today. It was in the count, that begins to ramp in Q1 as well as in that sector. Now, you had some questions about the other sectors. Could you recover that for me?

Yes, sure. You also had mentioned that this medical product transition which may take a little time, the industrial outlook is a little flat. Those are all things in the near term that sound like they're a little bit more squishy. Can you just talk a little bit about your confidence interval with the $1.8 billion pipeline and how back end loaded it might be?

As I laid out and walked through the fiscal year, it's definitely going to be more of a back end phenomenon. I talked about right now projecting modest growth in our fiscal quarter and more accelerated growth in the back half. And the accelerated growth in the back half is really in part a consequence of business that we won in this past quarter that starts to hit its full run rate in the back half of the year, and then the other part of it is just our confidence and our ability to go out and win new business looking into the pipeline and the quality of opportunities in the pipeline and our confidence probability on bringing those new pieces of business into Plexus.

Can you talk a little bit about, if we were to say 80% confident, what level of -- how much of that 1.8 is at 80% plus?

I don't think I'm going to go there. I think it's too early in the year to start -- to laying down the gauntlet in where I think in terms of probability. I would say that, I don't think -- I feel as good at this point this year as I have at this point the last three years. And you can look at what we've done the last three years.

Okay, great. Thanks.

You're welcome.

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

Good morning, everyone.

Good morning, Todd.

Just going back to the operating margin profile that we should watch for for '07. Can you just give us a sense how much below the 5% you might be in the first half versus being above in the second half to get to 5 for the year? Give us a sense on how that's going to play out?

Well, I didn't mean to suggest we were going to go below 5%, but clearly adjust in the second half will be stronger on revenues and we do have operating leverage. So the operating margins will kick up in the second half.

Okay. So you view the 10/5/5 as sort of a floor which you can build on?

Yes, which isn't to say, it could dip one quarter if something happens. For instance, we had to write off some inventories for a couple of troubled accounts in the fourth quarter, and that affected our gross margins. But 2/10 of a percent, I can't foreclose those things happening. There could be little bumps along the road, but the 10/5/5 is a good enduring model.

Then if we could just step back for a second, in terms of the EMS industry, a lot of the companies have been experiencing pretty good program growth, but they've also seen operating expenses in order to keep up with those programs rise compressing earnings and we've seen that at a number of the companies with some emphasis in Mexico. And I'm just wondering if you could talk about that and how Plexus has, I guess, tried to derisk these program ramp expenses and if you have any opinions on what's going on in the sector, that would be helpful as well. Thanks.

Let me just comment that I think we're probably coming at this from the other direction. When we were at our $1 billion peak just before the dot com bubble blew, we had probably 250 customers in our manufacturing organization. We have taken that customer count down as I said today to about 107 that we are really focused on. We've been actually getting economies of scale by focusing all of our efforts on a more strategic list of key accounts, and that has really helped us. We also -- if you go back in the dot com bubble era, we had no infrastructure to support our go to market strategy and we've invested in that infrastructure. It certainly jacked up our SG&A or operating expenses relative to some of our competitors and we were somewhat criticized for that, but at the same time we felt it was vitally important for us to really build the third pillar of Plexus. We had a great manufacturing organization, a great engineering organization, but we did not have in place a good go-to-market strategy, so we put that in place.

Now we're in a situation where we can leverage those investments and that good customer list and scale we can get with those key customers, and actually lever our operating expenses going forward. We talk about a 10/5/5 model and we're sticking to that story, but I would suggest there's probably actually leverage embedded in the SG&A line yet at Plexus. And I also think, the other part of it is the -- when you bring in new business, it compresses margins. Certainly there's a challenge when you bring in new business, especially if you bring in a lot of it all at once. But at the same time, I kind of like to say, well, we certainly invented that excuse, and then we just said, you know what, this is the way it is. You're constantly going out bringing in new business. You've got to turn transition and integration of new business into a competency so that it doesn't have that sort of affect on your operating model. I think we've done a pretty good job of demonstrating that we're able to grow in the high teens and still maintain really good operating model. That's what we've been focused on here for the last couple of years.

And when you think about that and you put in the infrastructure so Plexus is positioned, is there another pressure point going on from a customer perspective in terms of driving pricing of projects down further here, and that's just complicating those guys who don't have the platform in place? Has the pricing environment gotten more competitive in the last few quarters?

I don't think the pricing environment has gotten any more competitive in the last couple of quarters. What I would say, is that customers have become more selective about who can execute and who's got a strong balance sheet and good financial performance because they want to make sure they're partnered up with someone that's going to be around for the long-term. That to me is the biggest change that we've seen.

And that's been in the last quarter or two, or has that been the last--?

That's been evolving over the last, probably, 18 months or so as customers have really been looking at the industry going, boy, there's a lot of ill companies in this industry and we're tired of getting bounced out of facilities that are getting closed down.

All right, okay. Great.

Operator, I think we've gone well beyond our one-hour time limit. I think we're going to have to end -- I guess we'll take one more question, just to be fair, and then we'll have to end the call. Thank you.

Thank you. Our final question is coming from Jim Suva with Citigroup.

Greet. Thank you very much. Can you give a brief comment on -- in your press release, there's a quick little statement about reinvestment requirements in North America. It seems like a lot of your operations are focused in China and Asia, low-cost areas. But what's that North America inference, seeing how it's higher cost kind of related to?

There's two pieces to North America. One is the United States and I would just remind you that we have been growing in the U.S. over the last couple of years. There are equipment upgrades, technology investments. There's no physical capacity. No new buildings contemplated. Down in Mexico, that facility has undergone quite a renaissance over the course of the last year or so. We've repositioned it and we need to bring in new equipment to support recent new program wins that are coming into that facility.

Beyond that, Jim, as Dean mentioned earlier, we're running about 82% capacity and that's probably a pretty good number for the United States. And we report capacity as tools. So there will be some additional CapEx, be support additional production capabilities within the United States. And since I have the phone, if I could just come back to the earlier question about what was the stock option expense. The stock option expense in '06 was just about $3 million. The projection for '07 really is a function of what the stock price is going to be, keeping in mind that the Board of Directors normally awards stock option grants in the May time frame, but for modeling purposes, you should expect that 3 million to go to at least $7 million for '07.

Great, thank you, Gordon and Dean.

Thank you. I think that's about all the time we have.

Thank you. This does conclude today's Plexus conference call. You may now disconnect and have a wonderful day.

Thank you for participating, everyone.

Thanks, Operator.