Plexus Corp (PLXS) 2008 Q2 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Plexus Corp conference call regarding the second fiscal quarter 2008 earnings announcement. At this time all participants are in a listen-only mode. After a brief discussion by management, we will open up the conference call for questions. The conference call is scheduled to last approximately one hour.

I would now like to turn the call over to Mr. Angelo Ninivaggi, Plexus' Vice President, General Counsel and Secretary. Angelo?

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, particularly the risk factors in our most recent 10-Q filing. The company provides non-GAAP supplemental information, including earnings and EPS, excluding restructuring costs, charges for the impairment of goodwill, and other long-lived assets, and adjustments to the valuation allowance on deferred tax assets. The company also provided supplemental information on return on invested capital, in comparisons excluding our large unnamed defense customer. For a full reconciliation of non-GAAP supplemental information, please refer to yesterday's - press release and our periodic SEC filings.

Joining me this morning are Dean Foate, President and Chief Executive Officer, and Ginger Jones, Vice President and Chief Financial Officer. We will begin today's call with Dean making some comments about the second quarter and the outlook for Q3. Ginger will follow up with details on the financials. We will then open the call up for questions. Please limit your questions to one question and one follow-up. Let me now turn the call over to Dean Foate. Dean?

Thank you, Angelo. And good morning, everyone. Last night, we reported results for our second fiscal quarter of 2008. Revenues were $451 million, with GAAP earnings per share of $0.48. Both revenue and earnings were consistent with the middle of our guidance range. Our second quarter revenue was down approximately 2% sequentially from our first quarter. Our wire line networking and industrial commercial sectors were strong, as expected, and offset modest weakness in our medical sector and the significant $29 million reduction in revenue from our large episodic defense program. Excluding this defense program, revenue grew approximately 5.5% sequentially from Q1 to Q2.

Now for a few details about our revenues by market sector in the second quarter, and our outlook for the third quarter. Our wire line networking sector experienced strong 10% sequential growth from our first fiscal quarter, coming in slightly below our expectations for even stronger growth. While eight of our top 10 accounts were up in the quarter, one newer account, Wilop, missed expectations due to unanticipated end market softness. We currently expect mid single digit growth in our wireline networking sector in the third quarter, driven by the strength of five of our top ten accounts. Our wireless infrastructure structure was flat this quarter as expected. We expect similar performance from this sector in Q3. Our medical sector underperformed our expectations with revenue declining about 2% in the second quarter.

We had expected flat to modest sequential growth. While seven of our top ten accounts in this sector delivered growth, one larger account grew but below earlier expectations due to a slower new product ramp. Consequently, the growth in the seven accounts was not enough to offset the contraction with our leading account that was in line with expectations, and consistent with prior year seasonality. Looking ahead to Q3, we currently expect revenues in our medical sector to be flat to slightly down, as some customers struggle with lackluster end market demand, medical reimbursement issues, and/or ongoing FDA challenges.

The overall performance of our industrial/commercial sector was strong as expected. The sector is up 11% sequentially in Q2. Overall, customer demand held up reasonably consistent with earlier forecasts, and we did benefit from a production ramp with a newer account. Our current forecast indicates flat performance for this sector in Q3. Revenues in our defense security and Europe-based sector delivered declines sharply in Q2, down 37% as expected, driven by the $29 million sequential reduction in revenue from our large episodic defense account. Second quarter revenue for this account was approximately $27 million.

Looking ahead to our third quarter, we expect a $25 million sequential reduction of revenues from this account as we have substantially completed the previously announced production orders. Looking beyond Q2, we currently have little to no visibility into any significant additional orders for this account beyond minimal service and repair orders. While we still are in the early stages of building a team, capabilities and brand to gain share in the defense security and aerospace sector, we are encouraged by the underlying success. Setting the large episodic defense account aside, it is important to note that revenues grew 6% from fiscal 2006 to fiscal 2007. And we expect sequential growth above 40% for this sector for fiscal 2008.

Turning now to new business wins, we won 13 significant new manufacturing programs, which in the aggregate will add approximately $100 million in annualized incremental revenue as they ramp in production during fiscal 2008 and on into fiscal 2009. 10 of the 13 programs increased share with current customers. The balance of the new business went into the targeted account. Our overall funnel of manufacturing opportunities continues to be strong at just under $1.8 billion of qualified new business. Our medical sector funnel and our dental commercial sector funnel each represented one-third of the total. On the engineering serves front, we won approximately $15 million of engineering services business during the quarter with about 60% of the total in our medical sector.

Demand for engineering services has not deteriorated as a result of the current economic turbulence and our funnel of opportunities remains healthy. As a consequence, our engineering services business leader remains quite bullish and continues to execute on a fairly aggressive plan in order to meet the anticipated growth in engineering services, addressing capacity utilization and global growth. As expected, our added tool capacity utilization was at a healthy level in Q2 at approximately 80% overall. As we look forward, we continue to anticipate further investments in equipment, people and physical capacity to support longer term global growth.

Demand for services for our U.S. segment remains healthy and operational performance continues to improve above earlier expectations, necessitating another revision to our full-year expected tax rate, and two footprint additions that we announced in a press release issued during the quarter. First, we announced that our San Jose area facility will relocate from the existing 36,000 square foot site to a larger facility with 46,000 square feet. The newer and larger facility will accommodate better operational flow and improved work environment and investments in manufacturing technology to better serve our customers in this geographically important market. While the facility supports customers in all of our sectors, it has a significant expertise in wire line networking and wireless infrastructure sectors. The site also serves as a new product introduction and production ramp facility for strategic growth customers.

Second, we announced that our Chicago area facility would add approximately 48,000 square feet of production space adjacent to our existing 141,000 square feet, to service increased demand from customers, particularly in the medical sector. We are experiencing growing demand from current customers, and expansion of services to include configurative orders, distribution, and service and repair, for North American end markets. The Chicago area facility is approved by the FDA to manufacture finished class two and class three medical devices. Our previously announced capacity additions in Panang, Malaysia and Xiamen, China continue to track according to plan and we are evaluating further capacity investments in China. Additionally, we are continuing our assessment of market entry alternatives in central and Eastern Europe.

Turning now to our guidance, we currently expect our fiscal 2008 third quarter revenues to be in the range of 430 to $450 million, with EPS excluding any restructuring charges in the range of $0.36 to $0.41. Which includes approximately $0.05 per share of stock-based compensation expense. In summary, our revenue guidance for Q3 is down $11 million at the midpoint from our revenue results in Q2, reflecting the $25 million sequential decline from our large episodic defense customer. Excluding this account from Q2 and Q3 numbers, our business is expected to grow 4% sequentially at the midpoint of the guidance. We're tightening up our target range for the full fiscal year. We currently anticipate that revenues will grow 16 to 18% for the full year, suggesting a strong finish to the fiscal year.

Since our large episodic defense program seems to dominate our discussions with shareholders and rightfully so, I thought it important to point out that the rest of our business, excluding this large program, is growing robustly. In fact, we will grow approximately 15% for the year if we attain overall revenue growth at the midpoint of our revised 16 to 18% range. So we continue to feel very good about our sector-based business development engine. The midpoint of our EPS guidance for Q3 is down $0.095 from our Q2 EPS results. Ginger will provide further details during her comments, but the key drivers is the revenue mixed shift away from the higher margin defense business, higher spending for SG&A and variable incentive compensation, and increased expense for stock-based compensation.

With that I would like to turn the all over to Ginger to discuss the numbers in further details. Ginger?

Thank you, Dean. And good morning everyone. As Dean mentioned earlier in the call, both our revenue and the EPS were consistent with the middle of the guidance range. We did have a few changes in the quarter that impacted EPS that we discussed in the press release.

The tax rate change and the impact of the share repurchase program. Income in the United States for 2008 is now expected to be higher than when we established our Q2 guidance. As a result, we are now expecting a tax rate for fiscal 2008 of 20%. This shift is a result of increased earnings forecast for the remaining quarters of fiscal 2008, from existing and new customers for programs produced in the United States. The quarterly tax rate is based on our estimated pre-tax earnings by taxing jurisdiction for the full year, so this change in forecasted earnings impacts our tax rate for the second quarter. As a result, we recorded an additional $0.03 in EPS of tax expense.

Second, we announced a financial recapitalization plan in February. The resulting share repurchases improved EPS by $0.01. Which was not included in our original Q2 guidance. I will discuss the financial recapitalization in more detail shortly. Without these two factors, EPS would have been $0.02 higher, at the top end of our earnings guidance. We think this demonstrates solid operational performance during the second quarter.

Gross margin was 11.4% in the second quarter, consistent with our expectations for the quarter, but down from the 12.1% gross margin in the first quarter of 2008. The lower gross margin performance was primarily the result of reduced revenue from our large unnamed defense program. We continue to recognize losses in our Mexican facility, with an operating loss of $710,000 in the second quarter. This includes the net benefit of approximately $800,000 of income from the shipment of previously-written-down inventory. The remaining written down inventory for this customer totaled approximately $600,000. We expect that we will recover the majority of this in the third quarter of 2008. If the customer takes delivery of the product, and continues to have the ability to pay for it. As we have discussed previously, the primary issue at this site is obtaining additional revenue. The current revenue at the site is a run rate of approximately $70 million annually, and we believe that this site needs approximately 100 million of revenue to break even. We continue to believe that this site is strategically important for our customers, and that the pipeline of new opportunities for this site is strong. Despite our improved performance at the site and our confidence in our longer term view, our goals of achieving break even by the end of fiscal 2008 may have been overly optimistic and will likely push out to the first half of fiscal 2009.

Moving on to the balance sheet and cash flow, the cash conversion cycle improved by one day compared to the previous quarter. As you saw in the press release, days and receivables improved by four days. Days in inventory increased five days to 72 days. Two factors continue to influence our inventory levels. Having inventories in place for continued revenue growth in the second half of fiscal 2008, and increased finished goods inventory for some customers to enhance their flexibility and to support direct order fulfillment programs. Accounts payable days increased by two days. As a result, the cash conversion cycle improved by one day from the first quarter of fiscal 2008. ROIC for the quarter was strong at 23.4%, well above the targeted 20% from our 20-10-5 model and our weighted average cost of capital. We continue to believe that ROIC is the most important single measure of our business, as it reflects both our performance on the income statement and the investments on the balance sheet.

Turning to a few more details on the financial recapitalization, we announced a financial recapitalization plan on February 25th that included a $200 million share repurchase authorization and $150 million of new long term debt. Under the $200 million share repurchase authorization, we executed $100 million of accelerated share repurchase agreements. I will give you a little more detail on each of these components. Beginning with the share repurchase authorization, we conducted a comprehensive review of our capital structure and determined that a moderate amount of debt was appropriate. We also carefully reviewed our cash projections, including needs for working capital and investments to support future growth. Based on this analysis, we determined that we had excess cash and we believed we would continue to generate cash in the future. We felt that we could support a share repurchase authorization of $200 million or approximately 20% of our market capitalization at the time of the announcement.

As we assessed how to add an appropriate amount of debt to the balance sheet, we found that favorable rates were available for traditional, term A commercial debt. We completed our new unsecured credit facilities on April 4. This included $150 million of long-term debt with a term of five years, and an interest rate of LIBOR plus 125 basis points. The $150 million from the long-term debt was funded on April 4, which was the first week of our fiscal third quarter. Along with the long-term debt, we renewed our existing $100 million line of revolving credit. This credit availability can be increased by an additional $100 million in revolving credit under certain circumstances. There are currently no borrowings under the revolving line of credit.

Moving to the accelerated share repurchase agreement, we wanted to quickly complete a significant portion of our share repurchase authorization so we entered into an accelerated repurchase program with Morgan Stanley, Incorporated. We paid Morgan Stanley $100 million on February 26, and through March 29, they have delivered a total of 2.9 million shares, at an average price of $23.40. The final timing, price, and actual number of shares repurchased will depend on a variety of factors including the market price of our stock through the end of the repurchase period. The accelerated share repurchase program will be completed no later than mid-June, 2008. We currently expect to complete the remaining $100 million share repurchase in the open market by the end of calendar 2008, although there is no firm schedule or commitment for these purchases.

Moving on to the guidance, as our guidance implies, third quarter will be down from the second quarter. As Dean said, it is important to note that the second quarter included $27 million from the large unnamed defense program. Excluding this defense program from both quarters, the guidance for Q3 implies a growth rate of 4% at the midpoint of our guidance. Turning to EPS, as Dean mentioned earlier, the key drivers of the decrease in EPS from Q2 to Q3 were the revenue mix shift away from the higher margin unnamed defense program, higher spending for SG&A, and variable incentive compensation, and our increased expense for stock-based compensation.

Some further comments on our financial model for the second half of fiscal 2008. Gross margins are expected to return to our 10% gross margin target. This is down from the higher margins in the first half of 2008, as we have discussed, in accordance with the large concentration of orders in our unnamed defense program had a positive impact on gross margins. Depreciation expense is expected to be approximately $7.3 million in Q3, up from 7.1 in Q2. SG&A costs were flat from the first quarter of fiscal 2008, to the second quarter. We are currently expecting this to increase in the second half of 2008, from the current run rate of $24 million, to the 25.5, to $26 million per quarter range. This increase from the first half of 2008 reflects investments in our market sector based business development engine, variable incentive compensation, and continued investment to support our planned revenue growth.

The tax rate for fiscal 2008 is currently projected at 20%, up from the 18% discussed in our previous conference call. I will remind everyone that this will likely vary during the year, based on the mix of forecasted earnings between taxing jurisdictions. Earnings in our Asian locations benefit from a negotiated tax holidays in both Malaysia and China, while U.S. earnings are taxed at the full 38% federal and state tax rate. This variance in tax rate means that relatively minor changes in earnings forecast can result in large swings in the tax rate. We will continue to give the best guidance we can on our tax rates on a quarterly basis. It is also worth noting that this is good news for our U.S. locations which continue to recognize good demand from customers and a strong line of new business.

Our expectations for the balance sheet are for cash cycle days in the second half of 2008 to increase, with forecasts of approximately 64 to 66 days. The capital spending projection for fiscal 2008 is unchanged, at 45 to $50 million. We expect to generate positive cash flow from operations in fiscal '08, with levels higher than the cash generated from operations in fiscal '07. With that, I will turn the call back to Angelo.

Thank you, Ginger. As we open the call for questions, we ask that you please try to limit yourself to one question and one follow up. Ray, we will now take questions.

Thank you. (OPERATOR INSTRUCTIONS). We will pause for just a moment to compile the Q&A roster. Our first question comes from Shawn Harrison with Longbow research. Please go ahead.

Good morning. First question, just dealing with what you're seeing in the end markets, maybe if we can delve in a little bit more with the wireline as well as the medical and also what end markets were represented by the 13 program wins this quarter?

Certainly. Let me talk first about the kind of overall kind of what we're seeing in end markets and kind of our feeling about the current economic turbulence. At this point, we see economic turbulence directly impacting only our customers, what we call in semi cap equipment. Beyond that we're not seeing any significant longer term reductions in performance from our customers. If you look at the medical sector, I don't think that the issues that we're facing with those customers today and the challenges that they're having could directly be attributed to the current economic turbulence. It is more related to regulatory issues and perhaps the positioning of their products in the marketplace. And I would say just a general overall change in the competitive profile of their markets where you're seeing more larger health care organizations making purchases of equipment and the way purchases of equipment is changing in that marketplace which is making it more competitive. Beyond that, I don't think that we're seeing anything that is, you know, extraordinarily directional, related to the overall economic issues.

Now, related to the new customers, I think you asked about, another part of your question was what sectors were the new business in, and let me see if I can grab that quickly for you. As we look at it, we had it pretty well planned out across the market sectors and a couple of the wins in wireless sector and a couple in wireless and four in the medical sector and then two of them were in the industrial/commercial, three in the defense security and aerospace sector.

What's the FDA-related issues in the medical sector? Is there a sign that those are going to be resolved and shipments will normalize -- shipments will normalize to those customers any time soon? Maybe just a little bit of visibility there?

I want to be careful not to overplay this because the FDA issues that are affecting our -- affecting one of our customers today, so will is one facility that we ship product into, and we have actually been cleared to ship product into that customer as we talked about on the last conference call, we had understood that the customer was going to be cleared by the FDA to release product out of that facility, as it turns out, if -- as you all know, our larger customers in medical, you know that they had a difficult announcement, and it came clear that they had not been cleared by the FDA to release product out of the facility. So there is another customer of ours that is -- has a challenge at one of our competitors. But I think they're completely unrelated. So --

It sounds like your large medical customer may start shipping again soon.

I would hope so. But our concern, or what we're seeing right now, and suspect is that this has caused some perhaps competitiveness issues with them, and also as we've stated on earlier calls, they took a very proactive approach here, and went and audited all of their facility, the customer audited their own facilities to make sure that their practices were proper, and that essentially slowed down the new product development pipeline, and the launch of new products into the marketplace, which will remain to be seen whether or not that cost them market share by not getting those products out as soon as they perhaps could have.

And just quick follow-up on operating expenses, picking up here in the back half of the year, when should we expect to see some leverage on that operating expense number? Because it has ticked up, you know, it looks like it is going to tick up sequentially almost throughout the year.

John, this is ginger. Did you mean specifically around SG&A or --

SG&A. I mean I know you're making investments in staff and there is more variable p compensation expense this year. But just it seems like it is growing at a relatively quicker clip than most probably had modeled.

We are certainly interested in finding that point in which we can leverage SG&A. Although we think it is important to continue to make investments in our business development organization and to support the revenue growth. We have good revenue growth this year, and we look forward, we think we will continue to need to build that infrastructure. So I have given you the best guidance I have for '08 and certainly as we move closer to '09 we will be able to share some of that as we get closer. At this point I don't have anything to share with you for '09.

I would just say for generally speaking we embarked upon our market sector-based development organizational structure a couple of years ago and we're still in the process of creating the buildout of those teams. We don't need to add significant quantities of people though those organizations once we get the teams fully built out so the rate of growth among head count there would taper off, so I would hope that we would start to see some better leverage in the model as we start to move through '09.

Thank you.

You're welcome.

Thank you. Our next question comes from Amit Daryanani of RBC Capital Markets. Please go ahead.

Thanks a lot. Just looking at your full year guidance and earlier fourth quarter guidance, you're expecting some sequential growth, exit the defense business, 3 or 4% in the next and 6% in fiscal Q4. Can you talk about what is driving that and maybe what you see in your backlog that's actually giving you conviction despite the fact of what I have been reading in the "The Wall Street Journal," which is not good?

Well, I guess you need to stop reading the "The Wall Street Journal" I guess.

That would be a good start.

Just joking. For us, I think that you're right, we do see -- we are predicting obviously growth with the tightening up the guidance range in the -- for the full year. And for us, I think we expect to see the wire line networking sector continue to perform pretty well, and we expect to see that continuing to carry us into the year, and we expect to see believe it or not, later in the year, as we start to come through the year, hopefully some improvement in the medical sector, although I wouldn't hang my hat on having that be real strong, but we're starting to get pretty well positioned there with some newer programs that we have won over the course of time. That may actually take us into early '09 before we start seeing much of an effect there. And then I would say, we will see some modest growth out of industrial commercial again as we come out of the year but I would say the primary driver right now is quite a bit of strength in the communications sector, the networking and kind of infrastructure piece of the business.

A lot of the trends -- is that stemming from just core end market growth, just new programs that you're ramping, offsetting a slower growth environment?

Well, it is a combination of both. But I would say, primarily we're being propelled by new product wins and incremental outsourcing from those customers and new products that they're bringing into the marketplace.

All right. And then just sequentially, from the EPS side, and looking at your guidance, $0.09 head wind, can you break out how much of the impact is from the pre- issue you outlined and I guess one of the offsets you do have a $0.02 tail wind from the buyback, is that correct?

Yes, we think the benefit of the accelerated share repurchase will be modest, so in the $0.01 to $0.02 range. I don't know that I want to break out a lot of that in more detail. You can see the SG&A and we've talked about that a little bit. And the majority of what is left is the change in the mix. So the mix of our customers as we move from Q2 to Q3 has changed pretty substantially particularly related to that large defense program.

All right. And then just finally, could you just touch on what your capacity utilization at this point is across the three geographies? It has been a while since we've seen the EMS number at capacity in North America.

Yes, that is quite an unusual feat though to admit. We typically don't provide detail on breakouts across geographies. We typically just give you kind of a one-number overall. And in fact, we like to point out that these numbers are pretty squishy numbers as they're calculated different ways between the different EMS companies so we calculate ours on an as tool basis not on a raw square footage basis and this is okay, we have a building, we have it tooled up with equipment, and with that equipment set, what do we think we could deliver out of that facility, but clearly, our capacity utilization here in the U.S. is in pretty good shape. From a raw availability of square footage, the biggest raw availability of square footage we have is today over in Malaysia where we have the 364,000 square foot facility that we added there, the third facility, and that one is of course filling up nicely and then we also have the doubling of the size of the building in Xiamen. So we have the floor space available there for additional customers. And the one that is probably the most challenging is the one that we keep talking about is Mexico where we're running substantially under capacity.

Fair enough.

And that will give you a sense directionally of where we're at.

Absolutely. Thanks.

You're welcome.

Thank you. Our next question comes from Steven Fox of Merrill Lynch. Please go ahead.

Hi, good morning. Dean, could you just go back over your outlook for wire line telecom? You're saying it is up mid single digits but that in the quarter you had a small customer that had a miss. Can you just talk about how you get to sort of that mid single digit growth and how much is driven by new programs versus just customer growth, et cetera?

Okay. So I will break it down for you. In the current quarter, and then I will maybe talk a little bit about Q3. We actually had, when I look at our top 10 accounts in that sector, we actually had 8 of the 10 were up. During the quarter. And we had a newer account that had in fact -- that we had in fact forecasted even stronger performance and as I said, it was up but not up as strong as we had hoped which kind of kept it from that sector to delivering even stronger growth that we had talked about on last quarter's call. As we look to Q3, it is a little bit more of a mixed bag. We've got about half of the accounts up, and the other half of them are soft, but I would say the ones that are soft are the -- some of them are some of the newer accounts where they are maybe seeing a little bit of a surge in Q2, moving product out, and then taking a bit of a pause here to see how the market consumes that product.

And then with your largest customer, you're expecting fairly consistent trends?

Largest customer continues to do quite well in the marketplace and we continue to feel really good about the product mix that we built for them.

Okay. And then just Ginger, just a couple quick financial questions, how should we think about the share count this quarter? Should we just assume that the accelerated buyback is completed, and where would that put the average share count do you think for the June quarter?

Yes, I don't have that number with me, I guess the way I would think about that is that there were 2.9 million shares repurchased in the quarter, and so we will have the full benefit of that in the third quarter, and then the remaining amount, which we can't speculate on right now, because it will depend on the share price, will be pro-rated over the third quarter, so it will be some portion of that is how I would model it.

Okay. And then there wouldn't be anything in addition to that? You wouldn't start buying back on your own?

It certainly is possible that we will start purchases in the open market. We would have the ability to do that next week, and we will make that decision opportunistically based on both coordination with Morgan Stanley who is doing an accelerated share repurchase, and the share price at the time.

Okay. And then last question, just to clarify, the option expense, you said it is about $0.05 per share of option expense, in the June quarter. What was it in the prior quarter, in the March quarter?

So in the March quarter, the quarter we just ended, it was $0.04 of EPS, $2.2 million in total. In the third quarter, the June quarter, we're expecting $2.7 million and $0.05 of EPS.

Great. Thank you very much.

You're welcome.

Thank you. Our next question comes from Reik Read of Robert W. Baird and Company. Please go ahead.

Good morning. Can you guys just talk talk a little bit more about the industrial side of things. It seems there are two forces at work as a weakening macro but it also sounds like you guys have some customers with product refreshes that can be helping you out.

Well, this is one of those sectors where we just have a long list of customers and we don't -- we're not heavily concentrated I would say with any particular customer, so it is quite healthy for us, in that regard, in terms of the diversification. So you know, again, as I looked at this, we had really good performance here in Q2, and part of that was driven by a newer account that we won over the last couple of quarters that we started to ramp up their business. As I look forward, it is again, it is Q3, we are saying that I think we said it is going to be relatively flat or so and that is really a consequence of some movement -- I would say not broad-based movement down but more of a, you know, a greater concentration of customers that are seeing a little bit of softness there, although it is not dramatic at this point. I think again, our business there is -- the business that we have with the existing customers appears to be holding up pretty well. We're not seeing any real -- a lot of growth with the current programs that we have, but we are benefiting because we've done a good job going out and winning new accounts, and increasing our share with some of the existing customers that we have and that is what really continues to propel us forward.

And I just want to go back to the spending on the market-based programs, can you guys talk a little bit about -- I take it from what you're saying is that most of this, the bump-up is head count related. And that you expect to lever that head count as you get into '09. But can you talk about what you're seeing that gives you the confidence to make the investments now?

Well, what we're seeing is that our value proposition in the marketplace is really strong. You look at our growth rate over this year, I mean even extracting out that big defense program, we're going to grow 15, 16%, in revenues, sans that large defense program and a lot of that is being delivered because we've got a great value proposition in the marketplace. And we think now is the time to really be quite assertive and quite aggressive at getting great quality people in place, to drive us forward as we look to '09 and '10 and beyond. So we've got a vision in place and an organizational design that we want to build out, so that we can really flex the muscle of our competitive position in the marketplace. So it is a tough call to make. But I think kind of where we see our competitive position, we think now is the time to really do it.

And is what you're seeing in the market, Dean, is 1 that a reflection of smaller competitors that aren't performing the way they need to, larger competitors that are slipping? Or is this basically greenfield opportunities?

I would say it is -- you know, this business, of course, it is usually a combination of all of the above, but there is no question, I think, that we are developing a brand of being really good at this mid to lower volume, higher mix part of the marketplace, and so when we're out competing against the larger competitors, we really -- we really have the mod makes sense to -- model that makes sense to customer, and as we look kind of down at smaller pet tore, the challenge they have is they don't have the global footprint that we have, and the high level capabilities for design services and global fulfillment. So there we have a very strong competitive advantage as well. So we really feel -- we're the game in town when it comes to that kind of business, and we think that the best way for us to gain share is to continue to attract highly talented people which we seem to be able to do now. We're attracting some fantastic talent from across the industry, very experienced people, and coming to join the team. So we think we're really going to leverage that talent to drive some growth here, as we look forward.

Great. Thank you.

You're welcome.

(OPERATOR INSTRUCTIONS). Our next question comes from Kevin Kessel of Bear Stearns. Please go ahead.

Thank you. Ginger and Dean, I just wanted to get a better sense for the sustainability of the cash flow and the free cash flow in the quarter because when I look at it, it is actually pretty substantial. It is more than you generated in the last two fiscal years combined almost and so maybe you could help us think about that. I mean I can see part of it is working capital related but I can't actually tell where it is all being driven from.

We had a good cash generation quarter. We talked in the press release of $42 million of cash generated from operating activities. As we look to the full year, and you're right, some of that was working capital, which performed pretty well in Q2, we think we're going to make some additional investments in inventory primarily in the second half of the year, to support that top line revenue growth. So we women consume some of that cash -- we will consume some of that cash in the back half of the year and I think we will end up the year generating at least as much cash as we did in '07 and slightly more, probably.

Okay. You're talking about cash from operations or free cash flow.

I'm talking about cash from operations.

Cash from operations.

And our investments in fixed assets look to be about the same. '07 to '08. We're currently forecasting 45 to 50 million. We finished '07 at 48 million. So I would imagine that we will do better on a free cash flow basis as well.

Because I mean just for half of the year, you've almost doubled last year's cash flow generation.

Yes. That is absolutely true. And we will consume some of that in the back half. So I certainly would expect that I will double my cash flow for the full year compared to '07. But we think it will be better than '07.

And what about from an inventory perspective, in terms of inventory turns, what do you think is the right level of turns for the model you guys are on and what is actually achievable in terms of turns as a target?

Well, I will talk in days if you don't mind. But I think at the end of the day, Kevin, the way we really encourage people to think about it is not the individual components but the ROIC measure. Because we continue to make investments for our customers. And as long as we also deliver an income statement, a P&L that matches up with that we are continuing to deliver ROIC in excess of our weighted cost of capital. We are seeing inventory days to go up. We have seen that oaf the last couple of quarters and we expect that to continue in Q3 and Q4. That is driven by some of the issues ewe talked about, the our customers are looking at more inventory to support their protects and more direct order fulfillment. And lastly continuing to ramp new customers and customers are brought on, there are inventory investments ahead of those ramps. So we think somewhere in the range of where we're at, plus or minus a few days is a good target for us. And at the end of the day, we will judge that truly by the ROIC that we're able to generate.

And then just looking at again the new business wins, I guess both in the quarter and over the last couple, from what I can calculate, just over the last four quarters, you guys have won about 500, a little over 500 million in new business, and over the last six, it is closer to 750. So how should we think about the time line for when these -- when these different programs make their way into the top line?

Well, some are modestly making their way into the top line now. And you see the evidence of that in our underlying growth rate. This is a difficult thing, because we try to give you an annualized run rate so you get an apples-to-apples every quarter, as to kind of how, you know, from a barometric standpoint, perhaps, how we're doing. And it is also important to understand, as we say, that you can't just lob that on top of the forecast, because there an underlying degradation of the business, as product goes end of life, as you have average selling prices come down, et cetera, et cetera, and that can be 5% to 7% decline in the business that you have to overcome right out of the gate. So other than that, Kevin, I don't know how I -- you know, without starting to give you folks kind of a look at our rolling six-point forecast which I'm loathe to do at this point because of the dynamics in the industry, how I can give you any better clarity on those numbers.

I got it. And then just lastly, on Mexico, so I guess the overall loss seems relatively consistent on the quarter to quarter basis, and excluding reserves, and when you look at it, I think you guys -- it might be pushed out a little bit into the first half of your fiscal '09, so is that being driven by the delay in the ramp of new programs because I know one was kind of slated to go in toward the very end of the fiscal year, or is there something else that might be causing it? Because I know obviously you're real close so maybe there is not a lot that needs to happen. But maybe just timing.

You're right. It is a little bit of demand from some of the customers that are there that are a littling weaker than we had hoped. Obviously, and then you're right, there is another program that is slated to go into that facility, and it is delayed a little bit from what we had anticipated earlier in the year.

Got it. Okay. Thank you very much.

You're welcome.

Thank you. Our next question comes from William Stein of Credit Suisse. Please go ahead.

Thanks, guys. On the new wins, you know, from the quarter, are any of them from your competitor, other EMS companies or are they all kind of new outsourcing or new programs, customers?

Did we take anything from anybody else in the quarter? I actually don't know the answer to that right off the top.

We can get back to you on that.

That would be great. And then on the military, can you handicap for us the chances of getting a repeat order there? I know it is very hard to forecast but do you have -- is there anything to know that would lead to you believe you're really not going to get a new order or is it just kind of very unclear.

Well, yeah, you kind of teed it up for me a little bit, the way to answer it. The way to answer it is to say there is nothing that tells us we would not get another order. But at the same time, there is just nothing tangible to say that we will. Obviously, the conflicts continue to go on around the world. And as we understand it, the technology is delivering value to the U.S. military. And helping save the good guys. So you know, there is demand. But there is also competing technology and of course the whole thing is the whole political environment here is changing rapidly relative to the war with a new administration that is going to be coming into the office. So we're just -- my feeling is right now, is we're trying to plan without it. And if it shows up on our doorstep, then we will respond to it when it does, we've got some little bitty kind of production to finish here, related to the service and repair units and a few other kind of units that we're supposed to finish out, but beyond that, we really don't have anything tangible to hang our hat on at this point.

Do we have a target portion of sales from military end target, and longer term or is that not how you think about the business?

We do, internally we do have a longer range kind of target that we're trying to get to. I don't know that I want to put that out here right now. But clearly, as I said in the discussion, you know, even without that program, we call it -- we actually combine it again, it is defense security and aerospace and within that sector, we expect that to grow north of 40% this year without that large program so clearly we're trying to develop some traction there, and we keep talking about the business development engine and the head count associated with that. Part of that pressure is the resources we brought on to stand up another team to focus on defense security and aerospace. So we're looking at building that into certainly strong kind of double digit percentage of the pie over time.

Great. And then just one other quick one. Can you talk about engineering services, and you guys, you know, despite what might happen next quarter, I mean you still have very high gross margin throughout the rest of the industry, and how big of an influence or -- is your engineering services? Can you give us an idea of percentage of revenues and profitability there?

From percent of revenues standpoint, it is a pretty small business. I think overall, revenues there are roughly 50, $55 million, so it is a couple, 2.5% or something like that. And if you calculate the numbers, maybe I think maybe we will see it at 3% overall for '08, and clearly, the margin story there is, you know, a couple of times, from a gross margin standpoint, what we would achieve, and the rest of the business, so it is an important part of it, but we don't really look at it as a profitability engine. It certainly -- it is certainly accretive to profitability but really what it is, it is the leverage that we get out of it. And you know, the ability to deliver programs in the manufacturing, but importantly is also to have a whole 'nother channel into customers. So we know where -- we get a good view of what the new products are going to look like, how they're going to get launched or engaged much earlier in the discussions and a whole different kind of level within our customer's organizations when we deliver engineering services. So we view it as a very important kind of sticky factor to the relationships we have of customers.

Great. Thanks very much.

You're welcome. Thank you. Our next question comes from Jim Suva of Citigroup. Please go ahead.

A quick clarification question and then I have a real question. Your guidance, that pretty much takes this big lumpiness unnamed defense customer to close to zero or at least no material revenue run rate? Is that correct?

That is correct.

Great. And can you tell us, does the political environment, as far as the elections, have any impact from what you think can be what this type of defense business wins? Well, absolutely, I think it will. Okay. And then last , final question, the demand environment over say the last couple of months, you can give some views about the demand environment, what you've seen to your customer orders to you and also the competitive environment as some of the other EMS companies may have been struggling a little bit more? Are they kind of coming after some of your business a little bit

I don't think that our competitive -- the competitive environment has changed dramatically. I think that when you look at the marketplace today, I mean there are companies that are financially healthy and doing well, and we've been competing against them for a long time you know, in this marketplace and understand how they go to market quite well and what we need to do to compete to win. We have some other larger competitors out there that are challenged financially, and I think at this point, it is very difficult for them to kind of go down in the dirt and buy the business. All that is going to do is make the situation worse. So we really are not seeing a significant change, I think, in the competitive environment at this point. In fact, I think we feel that we're in a stronger position than we ever have, because we actually have, you know, stable capacity and growing capacity around the world, versus the fear of taking capacity out, engaging a customer, and then taking the customer out where you en-- the capacity out where you engage them which is a huge problem for many of our competitors today.

Dean, on the customer demand front, I know you took your guidance up a little bit on the lower end but are you seeing any changes there because all of the headlines in TV we see, we talk about, you know, a slowing enterprise, high end server trends and things like that. Can you comment on your demand orders you're seeing from your customers?

I would say that the demand from customers on programs that we've built for quite some time, I wouldn't call it robust, but I would say that again, I just keep saying what is propelling us is we're doing a good job gaining new products and gaining the right share with products with new customers and overall incremental outsources overall all from new customers and existing customers. But I would not characterize the demand for our customers' products in general as strained. I would say it is not robust. But I would not say it is strained, either. Other than in the semi cap equipment area, which is really, you know, kind of coming through the cycle.

Thank you.

You're welcome.

Your next question comes from Yuri Krapivin of Lehman Brothers. Please go ahead.

Good morning. Good morning.

So Dean, as we look at your defense sector then, excluding this larger-named program, I don't think that you had much growth in that particular segment, and you know, you mentioned that you are bringing your team on board to focus on that particular end market, and I think one other large EMS company recently commented that the whole outsourcing in the defense sector has been below their expectations. So, you know, do you feel that this different company had been reluctant to outsource and, if so, why do you think it is the case? Well, again, I want to be clear that we call the defense security and aerospace. That's the sector for us. And in fact, Yuri, we are going to grow north of 40% this fiscal year in that sector if you remove the large program that we keep talking about. So we actually are seeing decent growth there. And we're seeing a pretty decent and robust pipeline of opportunities there, and it is a little bit more challenging to get these customers outsourced because than of them have not substantially outsourced kind of their internal manufacturing historically, although it also say that their supply chains are, when they do outsource the supply chains are fairly fragmented to a lot of tier three and tier four providers. And we again offer I think a better global value proposition to those customers as they looked to consolidate those supply chains. Okay. I understand. And then with respect to currency movements, you're on -- any look at our financial results as a result of currency.

No substantial impact. We have seen a little bit of appreciation of the Chinese [Remindi] and some of our locally sourced costs of labor and local supplies but nothing that has had a material impact on our results so far.

Great. Thank you.

You're welcome.

Thank you. There appears to be no further questions at this time. I would like to turn the floor back to management for any closing comments.

All right. Well we finished up a little bit early today so I want to thank everyone for their participation in the call, their questions, their interest in Plexus,we appreciate it very much and I would also like to extend a thank you for the employees of Plexus, they've a fantastic job delivering outstanding execution on behalf of our customers. Thank you, everyone.

Thank you. This concludes our Plexus earnings conference call. You may now disconnect. And have a great day.