Plexus F1Q10 (Qtr End 1/2/09) Earnings Call Transcript

Jan.21.10 | About: Plexus Corp. (PLXS)

Call Start: 8:30

Call End: 9:25

Plexus Corp. (NASDAQ:PLXS)

F1Q10 (Qtr End 1/2/09) Earnings Call

January 21, 2010 8:30 am ET

Executives

Dean Foate - President, Chief Executive Officer, Director

Ginger Jones - Chief Financial Officer, Vice President

Todd Kelsey - Senior Vice President - Global Customer Services

Mike Buseman - Senior Vice President - Global Manufacturing Operations

Angelo M. Ninivaggi - Vice President, Corporate Compliance Officer, General Counsel, Secretary

Michael T. Verstegen - Senior Vice President – Global Market Development

Analysts

Amit Daryanani - RBC Capital Markets

Brian White - Ticonderoga

Shawn Harrison - Longbow Research

William Stein - Credit Suisse

Sherri Scribner - Deutsche Bank

Jim Suva - CIT

Reik Read - Robert W. Baird

Brian Alexander - Raymond James

Sean Hannan - Needham & Company

Alex Langton - Engelhoff and Sneider

Presentation

Operator

Good morning ladies and gentleman and welcome to the Plexus Corp. conference call regarding the first fiscal quarter 2010 earnings announcement. At this time all participants are in a listen only mode. After a brief discussion by management, we will open the conference call for questions. The conference call is scheduled to last approximately one hour. I would now like to turn the call over to Mr. Angelo M. Ninivaggi, Plexus Vice President, General Counsel and Secretary. Angelo?

Angelo M. Ninivaggi

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 historic in nature but statements in the future tense and statements including believe, expect, intend, plan, anticipate, and similar terms and concepts are forward looking statements.

Forward looking statements are not guaranteed as there are apparent difficulties in predicting future results and actual results could differ materially from those expressed or implied in the forward looking statement. 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 Form 10-K filing and Safe Harbor and Fair Disclosure Statement in yesterday’s press release.

The company provides non-GAAP supplemental information. For example, our call today may refer to earnings or EPS excluding restructuring costs or other unusual items. Non-GAAP financial data is provided to facilitate meaningful period-to-period comparisons of underlying operation performance by eliminating frequent or unusual charges. Similar non-GAAP financial measures including return on invested capital are used for internal management assessment because such measures, we believe, provide additional insight into ongoing financial performance. 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 CEO; Ginger Jones, Vice President and CFO; Todd Kelsey, Senior Vice President of Global Customer Services; and Mike Buseman, Senior Vice President of Global Manufacturing Operations. We will begin today's call with Dean providing first quarter commentary about our market sector performance and outlook, our new business wins, capacity utilization and guidance for the second quarter of fiscal 2010. Ginger will follow up with details about first quarter financial performance and make some additional comments about the second quarter of fiscal 2010. Let me now turn the call over to Dean Foate.

Dean Foate

Thank you Angelo, and good morning everyone, and good morning to everyone in the room. Apparently, when things are going well we attract a few more of management to the call. Last night we reported results for our first fiscal quarter of 2010. Revenues were $430 million with EPS of $0.44. Revenue was at the top end of our guidance range while EPS exceeded our guidance range due in part to a legal settlement and other items that Ginger will outline in a few moments.

We were pleased to announce a strong start to fiscal 2010 with overall revenues growing 10% sequentially and strong earnings performance even after adjusting for the legal settlement benefit. Importantly our key financial metric, return on invested capital, improved to 18.1% due to the strong earnings performance, but also due to disciplined work in capital management. A very good result considering our revenue trajectory and the challenging supply chain environment.

The quarter was not without challenges as we continue to experience demand volatility as customers struggle with forecast during the economic recovery. While most of last year the overall forecast volatility was biased negatively, the bias now appears to be turning toward near term forecast increases or what we refer to as drop in demand. Much of this demand occurs inside of component lead times that have in many cases stretched in this constrained supply chain environment.

As discussed before this load and chase challenge where we load the demand into our procurement system and then chase the material so that it all arrives in time to meet production schedules. As you might imagine, drop in demand creates a number of productivity and execution challenges. As our financial metrics suggest, our supply chain organization and operating teams are executing extremely well in this challenging environment, and very important, our customer management organization is doing a great job managing customer requests and expectations so we can execute on aggressive yet realistic commitments. The extended team is demonstrating the agility and flexibility inherent in our operating model, a strong value proposition for our customers as they work to capitalize on opportunities in their end markets. Our expectation is that the choppy demand environment will continue in the near term as will some supply chain constraints.

Turning now to comments on our sector performance in our fiscal first quarter and our current expectations for our second quarter of fiscal 2010, we expected a strong performance from our Wireline/Networking sector in Q1 and it did not disappoint. The sector exceeded our expectations as eight of our top ten accounts beat earlier forecast contributing to a 20% sequential growth in the sector. Looking ahead to Q2, we currently expect low single digit percentage growth for our Wireline/Networking sector as three of our top five customers are forecasting revenues that are sequentially lower than the exceptional levels achieved in Q1.

Our Wireless Infrastructure sector was a disappointment in Q1. We had anticipated modest growth. Instead, three of our larger accounts all missed earlier forecasts, contributing to a 4% decline for the sector. On an encouraging note, we currently expect a much stronger result in Q2. Three of our large accounts are forecasting improved demand including the continuing ramp of a very significant program won during fiscal 2009. While our current expectation for Q2 is that our Wireless Infrastructure sector revenue growth will likely exceed 30% quarter over quarter.

Our medical sector finally returned to growth in Q1 overcoming a long succession of end market difficulties that I have articulated in past reports. As expected our Medical sector grew 15% sequentially due primarily to end market improvement with our larger accounts. Perhaps more exciting, our Q2 forecast for our medical sector indicates revenue growth for all of our top ten accounts. As a consequence, we currently expect quarter over quarter growth in our medical sector to approach 20%.

Overall revenue in our Industrial/Commercial sector was relatively flat in Q1 when compared to the final quarter of fiscal 2009. This was an improvement from the modest sequential decline in revenues that we had anticipated earlier. The better result was primarily driven by a more aggressive ramp of a newer customer program. We currently anticipate a strong result in Q2 as a fairly broad based improvement in customer demand in combination with new program ramps delivers growth in the high teens to, perhaps, 20%.

Our Defense/Security/Aerospace sector was down sequentially as expected in Q1. We currently expect Q2 will be a growth quarter for this sector. Our forecast indicates a mid-teens percentage range increase in revenues as we benefit from newer program ramps.

Turning now to new business wins. Our pace of new business wins continues at a healthy level. During Q1 we won 16 significant manufacturing programs that we currently estimate will deliver approximately $108 million in annualized revenue when the programs are fully ramped in production in the coming quarters. — subject of course to the risks around the timing and ultimate realization of the forecasted revenues.

We won new programs in each of our market sectors. Not included in the $108 million of new wins was a substantial new program win with the Coca-Cola Company. Generally our customer's are sensitive to our disclosures involving new business wins and in all cases we try to accommodate the request to treat the information as sensitive or in some cases as confidential. What we can say is that this program is a follow-on program to the Coca-Cola Freestyle product that we previously announced and currently manufacture we have been awarded the manufacture of the crew serve version of the technology. While the Coca-Cola Freestyle product is designed for self-serve applications, the crew serve product is designed for applications behind the service counter.

While we'll enjoy modest revenues from both products in fiscal 2010, we currently anticipate that we'll ramp to production levels of the Coca-Cola Freestyle program and the crew serve program in fiscal 2011. We believe this significant new win is another indication of the value of our service offerings in complex mechatronics design and manufacturing, a strategy we began pursuing in fiscal 2008. Final assembly of both products is planned at our mechatronics-focused facility in Appleton, Wisconsin with sub-assemblies manufactured at our facility in Juarez, Mexico.

Addressing capacity utilization and global growth, our (inaudible) capacity utilization in Q1 was approximately 76% overall for the company. Utilization rates are trending toward improvement in all of our operating regions. Utilization rates in Asia are higher than the corporate average, an indication that the further capacity expansion in Asia will likely be required to execute our longer term growth strategies.

Turning now to our guidance. Our current expectation is that our second quarter of fiscal 2010 will be exceptional. We're establishing second quarter revenue guidance of $470-$495 million with EPS of $0.44-$0.52 excluding any restructuring charges and including approximately $0.07 per share of stock-based compensation expense. As this report suggests, improving end market conditions across all of our sectors in combination with new business wins that continue to ramp during the quarter should result in sequential revenue growth of approximately 12% at the midpoint of our guidance with strong earnings leverage.

Looking further ahead, while we currently anticipate sequential revenue growth to continue in our third and fourth quarters of fiscal 2010, we expect the rate of revenue growth to moderate in comparison to the growth rate implied by our second quarter guidance.

I will now turn the call over to Ginger for a detailed review of the numbers. Ginger.

Ginger Jones

Thank you, Dean. Good morning, everyone. As mentioned by Dean earlier, revenue is at the top end of the guidance range. GAAP diluted EPS was clearly above our guidance range but excluding the three items discussed in the press release was also at the top of our guidance. Compared to our original guidance for the quarter, diluted EPS was favorably impacted by three items. First, a legal settlement in the amount of $3.2 million which was a $0.05 benefit. Second, our estimated tax rate is now 1% compared to our earlier expectations of 5%, which was a $0.02 benefit associated with the lower tax rate. I will discuss the tax rate in greater detail in a few minutes. And then finally, stock option expense was $0.01 less than expected.

Gross margin was 10.3% for the fiscal first quarter or 9.6% excluding the benefit of the legal settlement. This was in line with our expectations and consistent with the fiscal fourth quarter of 2009.

Selling and administrative costs were $24.3 million in line with our expectations for the quarter and as expected higher than spending in the fiscal fourth quarter of 2009. As we discussed in the year-end earnings call this expected increase in selling and administrative costs was largely the result of higher variable incentive compensation accruals. As we then began accruing for full year fiscal 2010. This increased SG&A during the quarter by approximately $2 million with a similar amount of expending expected in the remaining quarters of the year. This is only in accrual which may be adjusted up or down based on how the fiscal year progresses.

SG&A cost as a percentage of revenue decrease to 5.7%, an expected result as we obtain better leverage from the increased revenue during the first quarter and as we continue to control head counts and discretionary spending.

The last segment for discussion on the income statements relates to our tax rate. The tax rate for the first quarter was 1% which was lower than the 5% we expected when we set the original guidance. This change is primarily the result of changes in revenue and product mix that resulted in shift of earnings between taxing jurisdictions for the full year. Variations in the mix of forecasted earnings between jurisdictions can have a significant impact quarter to quarter on our estimated tax rate.

Earnings in our Asian locations benefit from negotiate tax holidays in both Malaysia and China, while US earnings are taxed at the full 38% federal and state tax rate. This contrast in rates and the volatility we've seen our customers forecast has lead to the variations in tax rate that we have seen in recent quarters.

Moving on to the balance sheet and cash flow, the cash conversion cycle increased by only one day during the quarter's 69 days — a significant achievement given the increase in revenue in the first quarter, anticipated growth in the second fiscal quarter, and the tightening supply chain environment. We consider this an excellent outcome and the result of hard work by our supply chain team. This was significantly better than our expectations for the quarter of 74-76 days.

Days in receivables increased by five days to 50 days based on normal variation and customer payments at quarter end. Days in inventory increased by five days to 88 days. The total value of inventory increased by approximately $50 million or about 16%. This increase in inventory dollars was expected based on increasing revenues for the fiscal year and the lengthening lead times for some components. About 60% of the increase in inventory dollars was for customers in the Wireline/Wireless sector that has seen significant recent improvements in demand.

Finally we have a total of $23 million of cash deposits on our balance sheet equivalent to six days of inventory which helps to mitigate our inventory risk. Accounts payable stays increased by nine days to 69 days. This increase was primarily the result of the timing of inventory purchases late in the quarter which naturally lead to higher AP balances. In addition we saw continued results from our efforts to extend payables terms. We have made significant improvement over the last several quarters in accounts payable days increasing 19 days from the 50 days at the end of fiscal 2008.

Free cash flow for the quarter was negative, primarily based on the investments and working capital during the quarter. We spent $12.3 million in capital expenditures for the fiscal first quarter.

I’ll now turn to some comments on the second quarter fiscal 2010. We are happy to say that with the increase in revenue our internal financial expectations for the quarter trend closer to our long term 20, 10, 5 financial model. For those new to the Plexus story our financial model targets a 20% ROIC, 10% growth margins, and 5% operating margin. The 20% ROIC target is based on a spread of 500 basis points above our estimated weighted average costs of capital of 15%.

So looking specifically to the second quarter, growth margin should be consistent with our model and near 10%. SG&A for the second quarter for the second quarter of 2010 will increase and is expected to be in the range of $26-$26.5 million. As expected this is an increase from spending in the first quarter fiscal 2010. As discussed above, this includes the continuing quarterly accruals for variable incentive compensation. In addition, in the second quarter we will see the impact of annual merit adjustment for our employees. In past years this increase was in the fiscal first quarter.

Finally, we're anticipating modest increases in headcount and discretionary spending as we see higher revenue place additional demands on the organization. We are continuing to be cautious about adding back headcount spending after our strong cost control actions in fiscal 2009. As a result we expect to see leverage on the SG&A line as revenue increases during the year.

Depreciation expense is expected to be approximately $9.5-$9.8 million in Q2, up slightly from the $9.1 million in Q1. The estimated effective tax rate for fiscal 2010 is projected to be in the low single digits. As we have demonstrated in recent quarters, this tax rate can vary significantly during the year based on the mix of forecasted earnings between taxing jurisdiction.

Our expectations for the balance sheet are for the key accounts of inventory, accounts receivable, and accounts payable to increase in dollar terms for the second quarter. Based on the forecasted levels of revenue we expect these increases will result in increased cash cycle days as well. We currently expect cash cycle days of 70-74 days for the fiscal second quarter, a sequential increase from the first quarter. This increase is large as a result of additional inventory for a new program transition and a small decrease in days of payables from the strong results in the first quarter.

Our capital spending forecast for fiscal 2010 is estimated to be in the range of $65-$75 million. This is an increase of $5 million from our estimate last quarter. This estimate does not include any additional manufacturing building but does include equipment needed to support new customers in our existing locations and continued investment in equipment for our new manufacturing locations in Romania and Hangzhou, China.

With the increase in revenue we are actively reviewing potential new footprint requirements particularly in the Asia-Pacific region but to date have not made any final decisions about further investment. This forecast does include approximately $15 million for a new global headquarters building that is under construction in Neenah, Wisconsin. Our full year capital spending forecast will likely continue to vary during the year as we asses our customer's forecasts and capacity needs based on the improving revenue picture.

As always we are balancing our spending, capital expenditures, and working capital investments to support continued growth and current results for our shareholders. As we have demonstrated in the last few quarters we have the ability to aggressively manage both our SG&A and investments in working capital to support our financial model and plans for continued growth.

With that I would like to open the call for questions. We ask that you limit yourself to one question and one follow-up.

Question-and-Answer Session

Operator

(Operator’s Instructions) Your first question comes from Amit Daryanani of RBC Capital Markets.

Amit Daryanani - RBC Capital Markets

Thanks. Good morning, guys. Good job on the quarter. I just had a quick question. When I look at the guidance, you guys are talking about up 12% sequentially, I guess the Wireline probably accounts for about a quarter of that uptick on the sequential sales basis. Is it worth to fit mostly end-market driven in your perspective or is it a lot more new ramp driven?

Dean Foate

Well, first I'd like to point out that right now everyone of our market sectors is expected to be up in the coming quarter, as is every region on which we operate. So we're seeing quite a bit of what I would consider to be very broad based improvement in overall end-market demand that's affecting a lot of our customers. And then in addition to that what's driving some of the outside kind of revenue increases is just the number of new business wins that we accumulated during the later part of fiscal 2009 that are now starting to come to fruition so we're starting to lever some of those new business wins into new revenues.

Amit Daryanani - RBC Capital Markets

All right, but I guess even on an organic basis, existing comp programs that we have, you're seeing a sequential uptick on those at the March quarter, is that fair?

Dean Foate

That's fair, yeah.

Amit Daryanani - RBC Capital Markets

And then I think Dean you talked about some things muted, but still sequential growth for fiscal Q3 and Q4. Even if I use some very low numbers it looks like you'll be pretty close if not at that 15%-18% target that you guys have, probably at the end of it for full year growth. Is that fair or am I missing something on that process?

Dean Foate

You're not really missing anything other than rather than muted I said modest. So the sequential growth in the quarters is modest relative to Q2. That still is a decent growth rate.

Amit Daryanani - RBC Capital Markets

All right, and just finally for me, on the component shortage issue did you guys think you left any revenues on the table exiting the quarter and you're entering fiscal Q2 with a bit more stronger backlog because of that?

Dean Foate

I'll let Mike at global operations here comment a little bit on what the supply chain may have done to us.

Michael T. Verstegen

Yeah. I guess at a high level we certainly are seeing some tightening, some extending of lead times out there in the supply chain. With that said we work those very aggressively, most of our solutions and specifically our supply chain solutions are designed to kind of accommodate the flexibility that the customers are requiring right now. So I think we were very happy with what happened in quarter one. We kind of baked in some of the risk into what we thought was going to happen in quarter one and I'd say we've taken the same approach as we look forward in quarter two. There is challenge and risk, but I think we've appropriately baked those in.

Dean Foate

Yeah. So I think the summary is that I don't know that we have a whole bunch of demand that's flopping over from Q1 to Q2 as a result of a supply chain. There might be a little bit of it in there, but at this point it's a pretty clean Q2 in terms of real demand in the quarter.

Amit Daryanani - RBC Capital Markets

Perfect, thanks a lot.

Operator

Your next question comes from Brian White with Ticonderoga.

Brian White - Ticonderoga

Yeah, good morning. Dean, I'm wondering if you could talk a little bit more about the Wireline networking area. I missed your comments, you said low-single digit growth, but then you provided some commentary on the customer trends in that area.

Dean Foate

Yeah, Brian. I did. Really we saw really a phenomenal demand improvement here in Q1 over what earlier forecasts coming into the quarter suggested. So we had anticipated a pretty strong quarter and it ended up much stronger based on this kind of drop in improvement in demand that we saw unfold through the quarter. So maybe Todd could comment maybe at a higher level in terms of what we're seeing in terms of what elements of Wireline are really causing some of the strength.

Todd Kelsey

Sure. Thanks, Dean. So basically, Brian, what we're seeing is some demand really strengthening in the enterprise area of the Wireline sector. So the demand in the service provider area has not really returned to previous levels yet, but we're seeing a lot of our customers' customers, IT departments, really extend spending at this point. So as Dean mentioned we're not expecting quite as strong a growth of the Wireline sector in Q2, but we're still seeing continued strength as we move forward.

Brian White - Ticonderoga

But it'll still grow, you're saying low single-digits sequentially?

Dean Foate

That's correct.

Brian White - Ticonderoga

Okay. Will the service provider business grow sequentially?

Todd Kelsey

We don't necessarily break it down to that level in our internal numbers, but we are seeing some recovery in the service provider area.

Brian White - Ticonderoga

And I'm curious, on the enterprise networking area, are you winning new programs with existing customers or are those programs that you've been involved with in the past?

Dean Foate

Yes. We are winning a number of significant new programs that impact enterprise so we look good going forward.

Brian White - Ticonderoga

And those are with existing customers?

Dean Foate

Correct.

Brian White - Ticonderoga

Okay great. Thank you.

Operator

Our next comes from the line of Shawn Harrison with Longbow Research.

Shawn Harrison - Longbow Research

Hi. Good morning, everyone. First question just is focused in on Coca Cola. Maybe if you could just provide a little bit more detail on the ramp timeline if that's possible at all. And then within that, the crew serve program, if you had just won that by yourself would it be a top 10 or top five customer in fiscal '11 if it reached its full ramp rate?

Todd Kelsey

Sure. So Shawn, this is Todd. I'll take that question as well too. Dean's giving me the look that that's okay (laughter). So basically, first of all on the ramp, we can't give a lot of specifics on the ramp due to the customer confidentiality issues, but what I can tell you is it's a modest impact to Q1 through Q3 of F10. It has a bit more of an impact into Q4, but it certainly is very early in the ramp stages in Q4. As we look into F11 that's where we see the true ramp on both of these programs with the crew serve may be slightly behind. Now with respect to the size of our crew serve program, again we can't give you exact specifics, but it would certainly classify as top 10 on its own.

Shawn Harrison - Longbow Research

Okay. And then as a followup, the past two quarters, new program win rate has been good, maybe just not what you saw in the first half of 2009. I was wondering if that's just maybe a little bit more timing or is something else going on where you just want significant amounts of share in kind of the early and middle parts of 2009?

Dean Foate

Well, it depends upon how you're going to look at the numbers because we have separated out all the activity here with Coca Cola. So if you fold that back into it it's actually been well above the average.

Shawn Harrison - Longbow Research

I guess if we back out Coca Cola because I think the average was something like $150-$175 million a quarter.

Dean Foate

Right, that's right. Well I'm telling you we're right above the average with that new program.

Shawn Harrison - Longbow Research

Okay. And I guess without that, is it just more timing, things falling out? Is the pipeline getting bigger that you're seeing out there?

Dean Foate

Yeah. In terms of the business out there the pipeline is actually really healthy and I'm not sensing any sort of concern at all relative to the opportunities that are available to us for growth so I'm not concerned at all about where we're headed from a new business wins standpoint and the pace of new business wins. It's a very good situation at this point and a very healthy set of opportunities out in front of us.

Shawn Harrison - Longbow Research

Okay. Thank you and congrats on the guide.

Operator

Your next question comes from William Stein with Credit Suisse.

William Stein - Credit Suisse

Great, thanks. Good morning. First, just to clarify on the Coke program, would you expect, Dena, to be the only manufacturer, the only supplier for this project now that it's so big? I think you said that the original program would be a top 10 and the crew serve stand alone would be a top 10. Would we expect that kind of business to be had by Plexus and shared with another EMS?

Dean Foate

Right now we’re not aware of any dialogue about splitting this business with another EMS company.

William Stein - Credit Suisse

Okay great. Turning to the financial model – if we look at the operating margin you delivered this quarter and what's implied by next quarter guidance and then you start to fold in Coca-Cola, it seems to me that it’s likely that you could exceed the 5% operating target that is part of the financial goal. Maybe you could comment as to whether that is correct or if there are additional costs where we might see less than the expected contribution margin, as revenues grow in this part of the up cycle.

Ginger M. Jones

Thanks for the question Will, this is Ginger. I think that in the long run, Plexus thinks about delivering our model which accommodates growth. Our long term goals are to grow this business 15% year over year and to deliver ROIC 500 basis points above our weighted average cost at capital. As we look at all of that, supporting that growth, supporting that ROIC, the financial model we think that does that best is pretty close to a 5% operating model.

And so even as we see revenue increasing, we are going to manage our business to that 5%, because that allows us to invest in new facilities, in new people and in the working capitals that support that top line revenue growth. Our method has always been consistently to measure the business on the way up and the way down to try and hit that 20/10/5 model, and clearly we are pleased to be back, approaching that level. But I would not recommend investors to build in better than that model in the future, because we absolutely do make investments to support that revenue and will be doing that in the future.

William Stein - Credit Suisse

So in other words, as we grow beyond the march quarter, and as we get to these higher levels of revenue, perhaps the contribution margin is lower than what we might see in the near term, is that fair to say?

Ginger M. Jones

I think there is short term leverage, that’s one of the benefits of our model that we expect that in periods where revenue comes up and we’ve done such a good job at managing our costs that there is going to be modest leverage, but I would expect that to be short term. I wouldn’t expect anyone to build that into a longer term model.

William Stein - Credit Suisse

Just one quick one on the tax rate. I think you said that in the back half of the year it might go from 1% to the mid single digits, and in longer term what is the right rate for us to think about as we move into F11?

Ginger M. Jones

I think F10 is low single digits, and the accounting guidance now is that we estimate the full year and then we use that throughout all the quarters of the year. Our best estimate for F10 is low single digits, and I think a longer term perspective F11 and F12 would be similar, low single digits to 5% tax rate.

William Stein - Credit Suisse

Thank you.

Operator

Our next question comes from Sherri Scribner with Deutsche Bank.

Sherri Scribner - Deutsche Bank

I just wanted to get a sense of the gross margin trends, and also SG&A as we move through fiscal 2010. Ginger, I think your comments were that you would be near the 10% targeted gross margin in the second quarter. It sounded like in past calls we wouldn’t be near that 10%, so we’ve seen an improvement. Would you expect that 10% to carry through into the second half of the fiscal year, and would you expect SG&A to continue to rise, or would you expect that this is the level we should see through the fiscal year?

Ginger M. Jones

We’re happy to say that we are seeing better performance in both gross profit and operating profit than we expected a quarter ago, based on the strengthening revenues. I would expect the Q2 growth margin to hold through the balance of the year, and when I said near, that could be a bit above or bit below and I was not trying to guide the model there.

We also believe that the SG&A levels will be largely in line with what we saw in the second quarter with modest increases as we make modest increases in head count and spending. We are going to continue to be very disciplined in how we spend but given the strong revenue increase we see this year, there will be some increase in SG&A. So I'd say no more step-function increases in SG&A that we saw in the first two quarters from incentive compensation and merit increases, but small sequential growth.

Sherri Scribner - Deutsche Bank

So the merit increases at this point have been fully baked into the numbers.

Ginger M. Jones

Correct.

Sherri Scribner - Deutsche Bank

Can you give us any details on the legal settlement, what is that related to?

Dean Foate

I’d prefer not to disclose the specific nature of the settlement, but you should really think of it as a one-time event, and not as impacting future periods.

Sherri Scribner - Deutsche Bank

Okay. Thank you.

Operator

Your next question is from Jim Suva with CIT.

Jim Suva - CIT

Dean, when we look at your guidance which is absolutely very strong and compare it to a few months ago when you had your investor day, you had mentioned consensus was at 4%-5% for the full year but you guys see the potential where you hope to get closer to 20%. Now looking at your run rate, it looks like you are going to come closer to that 20% so congratulations on that. How do we connect the point of how you were quite a bit more cautious? Was it the overall economy? Was it some of these big mechatronics wins that were just uncertain that they were going to be booked? How do we connect the confidence and posting of results that were spectacular today to just a couple of months ago?

Dean Foate

Well I think the economic recovery was far from a certainty as you go back even just a few months ago, and I would say even now the recovery is somewhat choppy in that we are seeing recovery with many of our customers, but there also are some challenges with some others. We’re not seeing it with all bodes even yet. It gives me an opportunity to remind folks that for us a significant phase for us in terms of setting the stage row 10 started to happen in fiscal 2008 when we had a very strong year. We worked really hard to define ourselves uniquely in the market place around mid to low volume higher complexity, and we developed a substantial momentum with that brand as we entered fiscal 2009. And then of course as you know the recession really started to hit the industry hard. We started to feel that in November of calendar 08 and we saw it kind of bottom out in that April time frame.

Now, I believe that our system of management, our decision tools, the level of accountability we have throughout the company, and our organic growth model had set us up to really be able to execute on some very fast surgical actions around cost containment. We did a very quick adjustment to our cost structure. We did take out some head count, and that was certainly painful, but at the same time we kept our folks whole in terms of compensation and benefits. So for the folks that were still here we kept the morale up quite high. We weren’t in the situation having a fire drill and looking at shutting down facilities all over the world, so for us – to me that entered the next phase which was mid-year 09 when we started to recognize that the recession was creating a real opportunity for us. It was time for us to shift to more of an offensive boat, so we went out and grabbed some great talent in the industry.

We started to add share from our current customers that had businesses, maybe EMS companies that weren’t well suited to them, smaller ones in some cases larger ones in some cases. We added customers where they were exiting manufacturing plants in an effort to adjust their cost structures on a more permanent basis. We were able to invest in growth, so we added some physical capacity in various parts of the world; we attained really high levels of customer satisfaction throughout. So as a consequence in 2009, our revenues were down just 12% for the year while many of our competitors were seeing 20%-30% decline, and we had a stable and growing footprint. And very strong brand, very strong financial strength, of course execution was great and so we started to attract customer attention, new business for the company. That really set the stage for what we are seeing now.

We’re seeing the economy pick up; we’re benefitting from the current customers and maintaining that really strong customer relationship, the additional share that we’ve gained with them and the leverage on the additional new programs that we’ve added. A lot of this we have been talking about for quite some time. We really think we’ve set the table for a very strong 2010; we just weren’t bold enough to go out and say that we thought the economy was going to recover and everything was going to be glorious. But clearly we’re starting to see the benefits of all the hard work. It’s kind of a beautiful thing, frankly, when a plan comes together and we’re starting to see it now.

Jim Suva - CIT

Great, and Ginger can you help us understand a little bit more on the tax rate about, is there any foreseeable future when you think you’re going to pay more normalized tax rate. We think about the mix and some tax holidays in your various Asia jurisdictions, but 1% tax rate just seems for the industry to be a very low tax rate.

Can you help us better understand, are you on tax free holidays in Penang. It just seems like 1% would be as if nothing is happening in (inaudible) in the US and I just simply know that that’s not true. As far as nothing happening in North America, I know you guys are very busy in North America.

Ginger M. Jones

A couple pieces that will help with this. A, you’re right, in Malaysia where we have a significant amount of our Asian manufacturing is on a negotiated full tax holiday that continues for at least five years into the future. So there is a significant portion of our earnings that based on an agreement with the Malaysian government pays no tax.

We have tax holidays in China, where we also have operations, although those are not full tax holidays but they are certainly favorable tax rates, and that is an increasing portion of our business, so if you think about our growth in the future we’ve always said that we hope to grow in all of our regions but the fastest growth over the last three or four years has been in Asia and we expect that that will continue. I would agree that low single digits is not sustainable tax rate, forever. I think it’s a reasonable expectation in the next near- to mid-term, and over the longer term I think there is probably a higher tax rate. But the longer term, I believe is probably four to five years in the future.

Jim Suva - CIT

Okay, thank you.

Operator

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

Reik Read - Robert W. Baird

Good morning. Could you guys just spend a little bit of time talking about the medical business and the growth as it relates to the life sciences and the implantables. How that has come up in talk about the relative stability of where imaging sits today?

Todd Kelsey

With respect to our medical sector, it’s an interesting set of circumstances that are happening right now. As Dean mentioned earlier, we’ve seen some pretty strong growth in Q1 and are expecting a strong Q2 as well. So we are seeing an increase in demand across the board although it’s really mixed as to how this is occurring. We’re seeing improvements in the imaging market, particularly ultrasound but we really don’t expect that to ever reach the historical levels that it had in the past. It’s clearly going to remain depressed. For instance, in the CT market we are still seeing – and this is industry-wide, not just Plexus-wide, but 20% down in CT and about 15% down in MR.

We don’t really see that coming up because the reimbursements and the other situations involving those procedures are not likely to recover. Now you asked about diagnostics and implantables, in that area we are certainly seeing strength in demand. One of the things we’ve talked about on previous investor days and past calls is that really diversifying the customer base into that area, and we’re starting to reap the rewards of that diversification. We are seeing a lot of strength in those areas of the medical sector. So as we look at this going forward we feel good about the customer base, there is still a lot of uncertainty around National US healthcare and that is going to have an impact on spending and devices on the medical sector but we feel good about the customer base that we’ve built over the last several years.

Reik Read - Robert W. Baird

With respect to the CT and MR businesses being down by those amounts industry-wide, when would you see that kind of stabilizing and kind of flattening out?

Todd Kelsey

It’s a bit unclear. It may be stable now and may just stay down at these levels. Again, the reimbursement environment for those procedures is diminishing quite heavily.

Reik Read - Robert W. Baird

So the down numbers you talk about are year over year, sequentially it’s flattening out?

Todd Kelsey

Yes.

Dean Foate

I think one little nugget of interest is that we are seeing some demand improvement that relates to certain countries retooling their medical systems. For instance we saw some demand that generated out of the Ukraine as their government is trying to tool up their medical system there, so it’s these one-off events that are driving some choppier demand for some of those technologies. But clearly the strength of the US demand that carried many of those big ticket imaging technologies for the past several years, our sense is that that is perhaps fully built out and we are just not going to see those levels again.

Todd Kelsey

Another area we are seeing increased demand is in the China market, but again that’s for lower cost items that are specifically designed for that market.

Reik Read - Robert W. Baird

Thanks for the color on that. One question on Asia, you’ve talked about the growth there and potential expansion. What would be the earliest that that expansion might occur?

Michael T. Verstegen

I would say we’ve got multiple phases we’re looking at; quite honestly globally, but Asia specifically. I think we touched this on the last call. The first step that we see ahead of us is probably incremental expansion in Penang where the majority of our footprint is. Where we have our Asia technology center and we’re pretty far down the path of - is it the right thing to do? We’re looking about the right addresses, right form factor, right footprint. So I think decision-wise, probably in the next quarter or two we will seek incremental space there, think about it more and a 12-14 month time frame, probably in the best case.

Reik Read - Robert W. Baird

Thank you, guys.

Operator

Your next question is from Brian Alexander with Raymond James.

Brian Alexander - Raymond James

Just on the quarter you just reported I wanted to understand a little better why the gross margins that you reported didn’t rise more sequentially – I think they were flat, ex the legal settlement. I know you had additional incentive count that was recorded in costs of goods sold, so maybe that explains part of it, but you also had better utilization. So if you could just talk about other factors like N market mix and whether this floating chase inefficiency environment limited further improvement in gross margins in the quarter you just had.

Ginger M. Jones

I would say that the quarter was as we expected it, so flat to our fiscal quarter. We had said that we didn’t expect to be back to 10% until we got north of $450 million of revenue. The 9.6% we thought was a good achievement, given the level of revenue that we had just not reached the leverage point where we were going to get back to our financial model. We don’t really believe that the supply chain had much of an impact on the quarter, we had modest puts and takes which we shared with you including the legal settlement, but I’d say overall there were no other big trends in the quarter. We think it was a very good result.

Brian Alexander - Raymond James

On the cut backs plans for Asia, those aren’t in the numbers you talked about earlier for FY10 and we just got a little color on the timing. Can you also provide a little more color on kind of a range of expectations on what that investment may ultimately look like? Are we talking ultimately tens of millions of dollars or not that significant?

Ginger M. Jones

I think the way to think about this is that CapEx in a year that we’re growing, is going to be somewhere in the range of $60- $70 million. So we’ve spent over the last couple of years around $60 million, I think in years where we’ve put up new footprint it could be closer to the high end of the range of at $70 million. I honestly don’t see it being much higher than that in any year. I think your long term CapEx modeling should be in that $60-$70 million range.

Brian Alexander - Raymond James

Finally, on working capital, the expectation is the trade cycle is going to creep above 70 days in the next quarter. I’m just wondering if and when we might see that normalize back below 70 days, or is the mix of business changing in such that working capital is going to be permanently higher?

Ginger M. Jones

I don’t know that we completely have the answer to that yet. We are happy with the results where they are now in the high 60’s low 70’s, and I would say that that delivers an exceptional ROIC which is our benchmark at the end of the day. So as long as we are delivering that ROIC, that inventory allows us to meet our customers’ expectations and deliver excellent service. I don’t know that we have longer term plans to get below that. We obviously continue to challenge the team to improve working capital wherever we can, but I think high 60’s low 70’s is probably a good spot for us in the model for now.

Brian Alexander - Raymond James

Finally, the clarification on the 20% ROIC target, that assumes low single digit tax rate, as opposed to maybe a higher tax rate that you might see longer term?

Ginger M. Jones

I think we try to manage our model to cover all of that. We have hit 20% when we had a higher tax rate not too long ago. We had a 20% tax rate because we had more North American business. So I’d say that the biggest drivers of that target will be thinking about our weighted average cost to capital, which currently we estimate at 15%, and then our commitment to deliver that 500 basis points above it.

Brian Alexander - Raymond James

Thanks, nice job.

Operator

Your next question comes from Sean Hannan, Needham & Company.

Sean Hannan - Needham & Company

Just to separate some of the forecast from the linearity you demand. Is there a way that you can perhaps provide a little bit of color as we look to the months within the quarter. What was that linearity of demand and actual product pulls, and were there segments perhaps where the trend lines were a little bit more pronounced. Maybe something that may not have been as obvious as where your segment performance actually was sequentially on the quarter.

Ginger M. Jones

I can start on the linearity within the quarter. Our quarters are traditionally pre-back end loaded to the last month of the quarter, and this quarter was no different. About 45% to 46% of our revenue comes in the last month of our quarter. I don’t know what other commentary we’d offer on the sector, it doesn’t seem like anything else.

Just generally speaking we see the customers that are in the configure to order demand pull environment tend to be the ones that load the quarter toward the back end, and those are typically the communications, you know wire line, wireless kinds of customers as they were the ones that pioneered moving to that model earlier than others, although we are seeing that model adopted more and more by customers more broadly speaking across the industry sectors, but I don’t know if there’s really a great take-away from the numbers in terms of N Market demand picking up quickly at the end of the quarter for any particular sector that you can really use as anything informative at this point.

Sean Hannan - Needham & Company

That's helpful. Engineering, did I miss what the wins were for that business and is there a way that you can break down or provide a little color around how much was medical?

Todd Kelsey

It occurs to me I didn’t put anything in the script about engineering, which was a miss on my part. Actually, the engineering organization as we’ve reported at the end of fiscal year 2009 had a record number of new business wins, a record volume of new business wins. This quarter was a little bit softer, but not too far from their average. Not unusual given that you get a little decision paralysis on big development programs around the holidays. We’ve seen the pace pick up again as we’ve started into the second quarter.

We’re quite bullish on the engineering services part of our business. The backlog is very strong. Their back into hiring mode for new talent, and I think this is not unlike past economic cycles where in the recovery, customers start to realize they have to get a lot of stuff done to bring new products to the marketplace and they’re a little more interested in trying to take their engineering capability and move to what is a bit of a variable cost model, which means engaging outsourced engineering and product development. Of course, we believe that we’re the best in the industry, so we’re really bullish on the engineering services as part of the company at this point.

Sean Hannan - Needham & Company

Dean, is there a way to provide a number in terms of what the wins were or in terms of the bias of how much of that was medical?

Dean Foate

I think the wins number was right around $9-$10 million of engineering services work and the bias was heavily towards medical again this quarter.

Ginger M. Jones

50% was medical.

Operator

Our next question comes from Alex Langton with Engelhoff and Sneider.

Alex Langton - Engelhoff and Sneider

Good morning. I’d like to ask you if you have any information about the ultimate market, because you mentioned that you saw an increase in demand for example of the wire line at the enterprise level. But based on what’s been going on in the economy and capital spending, I’m not sure that that reflects an actual increase in expenditures for capital expansion by those companies. It may reflect simply that last year they reduced their inventory with the products that you’re making so that this year you have to supply more just to maintain their production. What information do you have on that?

Dean Foate

That’s pretty easy. The products that we build are not shipped to our customers; they are shipped to our customer’s customers. We have a direct order fulfillment model, so any demand that we are seeing we is demand that is being generated by the end customer.

Alex Langton - Engelhoff and Sneider

Do they represent installations?

Dean Foate

They are the businesses that will utilize the equipment, so yes.

Alex Langton - Engelhoff and Sneider

But do they have any inventory out there of the products you are making? Or do they simply get from you whatever they are installing on a custom basis. Is there any inventory out in the pipeline out ahead of you that is causing some of the demand fluctuation?

Dean Foate

Not for the products we manufacture in this space.

Alex Langton - Engelhoff and Sneider

In which space?

Dean Foate

In the wire line networking space.

Alex Langton - Engelhoff and Sneider

So the demand that you are seeing reflects actual increases in capital spending going into the economy.

Dean Foate

Yes.

Alex Langton - Engelhoff and Sneider

Okay, good thank you.

Operator

There are no further questions at this time.

Dean Foate

All right, I just want to thank everyone for joining us this morning. Some great questions and I always appreciate the probing because it gives us a chance to talk more about the business. I also want to thank the nearly 8000 plexus employees around the world that did just and awesome job this quarter and of course you know what out in front of us in Q2 and I’ve got absolute confidence that we’re going to do another great job this quarter. So thanks to all of you and with that we’ll call it a day.

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