Plexus Corp

NASDAQ:PLXS

Earnings Call Transcript 2018-Q4

[Operator]

Good morning and welcome to the Plexus Corp. Conference Call regarding its Fiscal Fourth Quarter 2018 Earnings Announcement. My name is Sylvia and I'll be your operator for today's call. 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. Please note that this conference is being recorded.

I will now turn the call over to Ms. Heather Beresford, Plexus' Senior Director-Communications and Investor Relations. Heather?

[Heather Beresford, Plexus Corp.]

Good morning, and thank you for joining us today. Some of the statements made and information provided during our call today will be forward-looking statements, as they will not be limited to historical facts. The words believe, expect, intend, plan, anticipate, and similar terms often identify 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 factors that could cause actual results to differ materially from those discussed, please refer to the company's periodic SEC filings, particularly the Risk Factors in our Form 10-K filing for the fiscal year ended September 30, 2017, and the Safe Harbor and Fair Disclosure Statement in yesterday's press release. Plexus provides non-GAAP supplemental information, such as ROIC, economic returns, and free cash flow, because those measures are used for internal management goals and decision making, and because they provide additional insight into financial performance.

In addition, management uses these and other non-GAAP measures, such as adjusted net income, adjusted earnings per share, and adjusted operating margin to provide a better understanding of core performance for purposes of period-to-period comparison. For a full reconciliation of non-GAAP supplemental information, please refer to yesterday's press release and our periodic SEC filings.

We encourage participants on the call this morning to access the live webcast and supporting materials at Plexus' website at www.plexus.com clicking on Investor Relations at the top of that page. Joining me today are Todd Kelsey, President and Chief Executive Officer; Steve Frisch, Executive Vice President and Chief Operating Officer; and Pat Jermain, Senior Vice President and Chief Financial Officer. Consistent with prior earnings calls, Todd will provide summary comments before turning the call over to Steve and Pat for further details.

Let me now turn the call over to Todd Kelsey. Todd?

[Todd P. Kelsey, Plexus Corp.]

Thank you, Heather, and good morning, everyone. Please begin with our fiscal fourth quarter results on slide 3. After the close of the market yesterday, we reported results for our fiscal fourth quarter of 2018. We continued to produce meaningful growth finishing with record revenue of $771 million near the high end of our guidance range.

The result was a 15% increase from the comparable quarter last year and a 6% increase from the third fiscal quarter of 2018. We achieved strong sequential growth from our Healthcare/Life Sciences, Industrial/Commercial and Aerospace and Defense market sectors with Healthcare/Life Sciences strengthening within the quarter.

We realized these results while overcoming the impact of the highly constrained supply chain market and minimizing the impact of global tariffs. In addition, as a result of strong execution and operating leverage, we delivered fiscal fourth quarter operating margin of 4.8%, comfortably within our target range of 4.7% to 5%.

Our solid growth in operating performance led to record non-GAAP diluted EPS of $0.96, a result that was above our guidance range. The EPS result included $0.14 of stock-based compensation expense. From a GAAP perspective, we produced fiscal fourth quarter earnings per share of $2.20. This result included $1.24 per share benefit due to a non-recurring tax event.

Please advance to slide 4. Next, I will highlight fiscal 2018 accomplishments starting with our performance to our enduring financial goals of revenue growth and economic return. As we previously communicated, we have an aggressive revenue growth goal of 12% annually. We delivered fiscal 2018 revenue of $2.9 billion, representing a 14% increase over fiscal 2017, exceeding our revenue growth goal.

The following are additional highlights related to our revenue growth. Our Engineering Solutions organization grew over 20% year-over-year. Our customers continue to see the value in this differentiated service offering that generates higher margins for Plexus. Our Healthcare/Life Sciences sector grew over 20% in fiscal 2018 and exceeded $1 billion in revenue. We continue to have exceptional wins performance and funnel growth within the sector as industry leading OEMs are attracted to our strong brand within this end market. We expect continued robust growth in the sector in fiscal 2019.

During fiscal 2018, we grew in each of our three geographic regions while our EMEA region grew an impressive 46%, providing vital leverage leading to improved operating performance. Our fiscal 2018 growth and forward-looking growth projections led to decisions to add new manufacturing facilities in Penang, Malaysia and Guadalajara, Mexico.

In addition, we expanded several of our Engineering Solutions Design Centers in response to the needs of our customers. We target an economic return, which represents return on invested capital less weighted average cost of capital of 500 basis points. In fiscal 2018, our weighted average cost of capital was 9.5%. We delivered return on invested capital of 16.1%, resulting in an economic return of 660 basis points, well above our goal. Fiscal 2018 was the second consecutive year of economic return above our 500-basis point goal.

Please advance to slide 5. Next, I will highlight a few additional accomplishments in fiscal 2018, which position Plexus for meaningful growth in fiscal 2019. In the fiscal fourth quarter, our teams delivered quarterly manufacturing wins of $233 million, which represents a historically strong result. In total, our teams delivered $889 million of manufacturing wins within fiscal 2018, exceeding fiscal 2017 by nearly $80 million.

The profile of our manufacturing wins throughout the fiscal year continues to align with our differentiated portfolio. Further, our teams booked a record $132 million of Engineering Solutions wins, exceeding fiscal 2017 results by over 30% and increased the engineering funnel to record levels.

Our Engineering Solutions team is currently developing several leading edge products, which will transition into Plexus manufacturing. Our global teams continue to stand out in providing superior execution for our customers. We recently completed our semi-annual Net Promoter Survey and achieved our all-time best score of 84%. We believe this result is best-in-class.

Our exclusive focus on mid-to-low volume, high complexity markets and passion for delivering Customer Service Excellence is resonating with current and prospective customers. It is the key to attract, retain and grow our customer base.

We announced our revised capital allocation strategy on February 20, 2018. As of the end of the fiscal year, we have repatriated over $430 million from the APAC region. This cash has been used to fund investments in facilities and working capital, pay down debt, fund a one-time non-executive employee bonus and repurchase shares. In total, we repurchased approximately $137 million of our stock, representing over 2 million shares. We have nearly $180 million remaining on our 2018 share repurchase authorization, which we anticipate executing in fiscal 2019.

Advancing to our guidance for the fiscal first quarter of 2019 on slide 6, we are establishing revenue guidance of $750 million to $790 million. The midpoint of our guidance range suggests approximately 14% revenue growth from the fiscal first quarter of 2018. Within the quarter, we anticipate the growth we are projecting as a result of strength in the Healthcare/Life Sciences sector, new program wins, and largely stable end markets to be offset by softening in the semiconductor capital equipment space. Overall, we expect to return to a solid sequential growth in the fiscal second quarter as we further capitalize from new program launches due to recent wins.

We anticipate strong operating performance consistent with the fiscal fourth quarter as we continue to effectively mitigate the impacts of the constrained supply chain. Our anticipated operating performance strength alleviates the impact of increased tax expenses, which we're estimating to be approximately $0.05 as compared to the prior quarter. Consistent with these beliefs, we are guiding fiscal first quarter GAAP diluted EPS in the range of $0.85 to $0.95. The EPS guide includes $0.15 of stock-based compensation expense.

Please advance to slide 7. I will close with a few thoughts regarding fiscal 2019. I'm excited about the traction our new Plexus brand has gained in the past year. Our commitment to help create the products that build a better world is resonating with current and prospective customers. Our expertise in and an exclusive focus on mid-to-low volume, high-complexity markets provides advantages in operational efficiency and results in a more consistent platform for our customers.

Please advance to slide 8. We continue to make progress in building and leveraging our differentiated portfolio which is unique in the industry. As we exited fiscal 2018, nearly 85% of our revenue was in nontraditional, non-commoditized sectors. These sectors have programs with longer life cycles, in many cases exceeding 10 years. In addition, we have consistently achieved higher growth rates in the nontraditional sectors with our 10-year CAGR excluding Networking at 9%.

We anticipate fiscal 2019 to be another strong growth year as we achieve the full production volumes of recently launched programs and expect to capitalize on our robust fiscal 2018 wins performance. The latter is a direct result of our focused, consistent strategy, commitment to Customer Service Excellence, and expertise within our customers' end markets. Further, we currently see overall strength in our end markets and believe we can navigate the ongoing supply chain constraints.

Operationally, our teams remain focused on providing exceptional service for our customers. In addition, we are confident we have plans that will deliver strong operating results and we expect our operating performance will be within our target range of 4.7% to 5% for the fiscal year as we gain operating and fixed cost leverage.

We continue to believe the leverage benefit could approach 30 basis points as compared to fiscal 2018. We anticipate that the robust growth and strong operating performance in conjunction with our share repurchase program will result in meaningful EPS leverage in fiscal 2019.

I will now turn the call over to Steve for additional insight into the performance of our market sectors and operations. Steve?

[Steven J. Frisch, Plexus Corp.]

Thank you, Todd. Good morning. Please advance to slide 9 for a review of our market sectors performance during the fourth quarter of fiscal 2018 as well as our expectations for the sectors in the fiscal first quarter of 2019. Our Healthcare/Life Sciences sector had a strong finish to fiscal 2018 with revenue growth of 9% in the fiscal fourth quarter. This result exceeded our expectations of a mid-single digit increase and contributed to the sector's outstanding growth of 21% in fiscal 2018. Expansion with new programs in the fiscal fourth quarter and throughout fiscal 2018 fueled the growth.

Continued growth of these programs combined with new wins support the strong start to fiscal 2019. We anticipate a mid-single digit revenue increase in our Healthcare/Life Sciences sector in the fiscal first quarter.

Our Industrial/Commercial sector was up 8% sequentially in the fiscal fourth quarter, which was in line with our expectations of a high-single digit increase. Broad-based increases from 12 of the top 15 customers drove the strong revenue. For fiscal 2018, this sector had exceptional revenue growth of 16%. As we look towards the fiscal first quarter, we are realizing the anticipated softness with some of the semiconductor capital equipment market customers. As a result, we anticipate a mid-single digit decrease in our Industrial/Commercial sector in the fiscal first quarter.

Our Communications sector revenue was down slightly in the fiscal fourth quarter and for the fiscal 2018. These results were in line with our expectations of relatively flat revenue. This sector was impacted the most in fiscal 2018 by the constrained component market. Looking ahead to fiscal first quarter of 2019, we see improved component supply and robust demand from two communications infrastructure customers. However, they're being offset by a program cancellation by the federal agency that another customer supplies. As a result, we anticipate revenue to be flat in our Communications sector for the fiscal first quarter.

Our Aerospace and Defense sector was up 5% in the fiscal fourth quarter, a result that was in line with our expectations of a mid-single digit increase. Robust demand from 9 of our top 10 Aerospace and Defense customers contributed to the growth. As expected, the sector finished fiscal 2018 with double-digit growth of 10%. As we look towards the fiscal first quarter, we are experiencing end market softness with our customer and a security subsector and a ramp delay with a complex space program. We expect these impacts will result in a low-single digit decrease for our Aerospace and Defense sector.

Please advance to slide 10 for an overview of the wins performance for the fiscal fourth quarter. We won 44 new manufacturing programs that we expect to generate $233 million in annualized revenue when fully ramped into production. Engagements with new customers accounted for $145 million of the wins. Our trailing fourth quarter's manufacturing wins, as shown by the red bars, increased to $889 million. The wins momentum of 31% is well above our 25% target and is an enabler for growth in fiscal 2019 and beyond.

Likewise, the positive momentum in our Engineering Solutions group continues. The Engineering team converted the strong wins in fiscal 2018 into a record revenue year. With another strong quarter of wins at $34 million in the fiscal fourth quarter, our Engineering Solutions team is starting fiscal 2019 with a solid backlog and the expectation of continued growth.

Please advance to slide 11 for further insight into wins performance by region. The Americas region had strong manufacturing wins of $141 million in the fiscal fourth quarter. A significant new mechatronics customer for our Appleton, Wisconsin facility and a program with microelectronics content for our Boise, Idaho facility are the highlights for the region.

The APAC region had solid manufacturing wins of $85 million in the fiscal fourth quarter. Included in the wins is the addition of another customer for our new Healthcare and Life Sciences facility in Penang, Malaysia.

The EMEA region's manufacturing wins were light. With run-room (00:16:50) growth of 46% in fiscal 2018, the region's priority is execution. The team did add a new customer with growth potential in the fiscal fourth quarter, but we recognize the need to drive larger wins in order to enable continued strong growth.

Please advance to slide 12 for further insight into the manufacturing wins performance by market sector. The distribution of wins across the market sectors in fiscal fourth quarter was well balanced. The Communications sector had an exceptionally strong result with wins of $94 million. Two meaningful wireless programs and one communications infrastructure program were the main contributors to the solid result. The Healthcare/Life Sciences sector produced $53 million in manufacturing wins in the fiscal fourth quarter. In addition to the customer who will ramp in our new Healthcare/Life Sciences facility in Penang, the team expanded the customer base with two additional new customers.

The Industrial/Commercial sector generated wins of $52 million in the fiscal fourth quarter. The wins include two larger programs from new customers that support our approach to a diversified portfolio. One customer focused on additive manufacturing and another on the heavy transportation industry. The Aerospace and Defense sector wins of $34 million, a result of the addition of a new strategic customer as well as expansion with current customers. We will start to relate revenue in early fiscal 2019 from some of these wins.

Please advance to slide 13. Despite winning almost $900 million of opportunities in fiscal 2018, we exited the year with a healthy funnel of $2.6 billion of qualified manufacturing opportunities. The Healthcare/Life Sciences team had a great year. They won $288 million in the qualified manufacturing opportunities in fiscal 2018 and grew their funnel to a robust $1.5 billion. The Industrial/Commercial team had the highest wins in the fiscal 2018 at $331 million, but it has decreased our funnel to $373 million. The team does have a strong pipeline of opportunities in front of the qualified funnel. So, we anticipate funnel growth in fiscal 2019.

The Communications sector has exceptional wins in the fiscal fourth quarter, lowered their funnel to $232 million. However, they also have a good pipeline of activity in front of their qualified funnel as we enter fiscal 2019. Finally, the Aerospace and Defense sector increased its funnel to $524 million even with the good wins performance in the fiscal fourth quarter. Opportunities that will increase our market share with current customers are providing a solid foundation to the sectors funnel.

Next, I would like to turn to operating performance on slide 14. With record revenue of $771 million and operating margin at 4.8% in the fiscal fourth quarter, the team delivered outstanding results. The fact that they did it in the constrained supply chain environment is exceptional. Although the availability of components continue to create elevated inventories and operational inefficiencies, our teams are addressing the challenges it creates. We expect our days in inventory to peak at 106 days in the fiscal first quarter. Our teams are working closely with our customers to reduce inventory overdrive while maintaining a high-service level.

Returning inventories to a traditional level is the focus for the team in fiscal 2019. The team returned operating margin to our targeted range in the fiscal fourth quarter, we expect to have strong operating performance to continue in fiscal 2019. As a result, we are getting operating margin in the range of 4.6% to 5% for the fiscal first quarter.

A few final comments, I'm proud of the accomplishments the global team has achieved in fiscal 2018. Achieving revenue growth of 14% in the constrained component market was a team effort. Our global market development teams generate the wins required to grow the business, the supply chain teams work tirelessly to ensure continuity of supply, our operations and engineering teams worked aggressively to deliver for our customers, and the corporate teams are true partners in the business. It was a great team effort.

It is this team's demonstrated commitment to Operational Excellence and Customer Service Excellence, that gives me the confidence for a great fiscal 2019.

I will now turn the call to Pat for a detailed review of our financial performance. Pat?

[Patrick J. Jermain, Plexus Corp.]

Thank you, Steve, and good morning, everyone. Our fiscal fourth quarter results are summarized on slide 15. Record fourth quarter revenue of $771 million and gross margin at 9.5% were both at the high end of our guidance. Gross margin was approximately 20 basis points above the fiscal third quarter. Our continuing efforts to manage costs and improve productivity while increasing revenue contributed to the margin improvement.

Selling and administrative expense of approximately $36.3 million was slightly above our quarterly guidance. As a percentage of revenue, SG&A was 4.7%, an improvement of 20 basis points from the fiscal third quarter. Operating margin of 4.8% improved sequentially by 30 basis points. The combination of improved gross margin and better leverage of operating expenses drove this improvement. Including in this quarter's operating margin is approximately 60 basis points of stock-based compensation expense, in line with our quarterly expectations.

Other expense for the fiscal fourth quarter was $2.7 million, which was favorable to our guidance, primarily due to lower interest expense and foreign exchange gains recognized during the quarter. GAAP diluted EPS of $2.20 included a benefit of $1.24 per share related to U.S. tax reform. During the fiscal fourth quarter, the U.S. Department of Treasury released additional guidance regarding the repatriation tax we recorded in the fiscal first quarter.

The benefit resulted from adjustments made in applying the additional guidance as well as our utilization of accumulated U.S. net operating loss carry forwards. Both reduce the repatriation tax due in future years. We also recognize the benefit from the reversal of our valuation allowance previously maintained on our U.S. net deferred tax assets. With future projected taxable income in the U.S., primarily as a result of tax reform, the valuation allowance is no longer required.

Excluding these tax benefits, we recorded a tax rate for the fiscal fourth quarter of 8%, slightly below our earlier expectation of 10% to 12%. Non-GAAP EPS of $0.96 for the fiscal fourth quarter was above our guidance, primarily due to the improved operating performance and lower tax rate.

Turning now to the balance sheet on slide 16. Return on invested capital was 16.1% for fiscal 2018, 660 basis points above our weighted average cost of capital of 9.5%. Each year we recalculate our weighted average cost of capital by using a consistent methodology. With less volatility in our stock price over the past few years, our cost of capital for fiscal 2019 will be reduced from 9.5% to 9%.

During the quarter, we continue to execute on our capital allocation plan outlined earlier this year. In addition to the $380 million of offshore cash brought back earlier in fiscal 2018, we repatriated over $50 million from our APAC region during the fiscal fourth quarter. In total, approximately $430 million was brought back during fiscal 2018.

With a portion of the funds repatriated during the fourth quarter, we purchased approximately 639,000 of our shares for $39.2 million at an average price of $61.32 per share. During the fiscal fourth quarter, we completed the $150 million program authorized in 2016 and commence purchasing shares under the $200 million program authorized earlier this year.

Moving into fiscal 2019, we have approximately $180 million available under the program. We expect to execute this program on a consistent basis; however, we'll take market conditions into consideration. For the fiscal fourth quarter, we generated $25 million in cash from operations and spent $11 million on capital expenditures delivering free cash flow of $14.7 million, slightly better than expected. For the fiscal year, we generated $67 million in cash from operations and spent $63 million on capital expenditures resulting in free cash flow of $4 million.

We ended the year with a strong balance sheet; cash totaled $298 million with approximately 70% of the balance offshore. Sequentially, our cash balance reduced approximately $36 million, primarily due to share repurchase activity. Total balance sheet debt was approximately $190 million and our debt to EBITDA ratio was a healthy 1.1 times at year end. Cash cycle at the end of the fourth quarter was 73 days, favorable to our guidance and consistent with fiscal third quarter.

Please turn to slide 17 for details on our cash cycle. Sequentially, days in inventory improved by 1 day despite increasing inventory dollars to support the ramp of new customer programs, inventory days improved due to the strong sequential revenue growth. Days in receivables of 47 days also improved by 1 day. Payable days were sequentially flat while customer deposit days reduced 2 days as we applied a deposit against a customer's accounts receivable balance.

As Todd has already provided the revenue and EPS guidance for the fiscal first quarter, I will share some additional details which are summarized on slide 18. Fiscal first quarter gross margin is expected to be in the range of 9.3% to 9.6%. At the midpoint of this guidance, gross margin would be consistent with the fiscal fourth quarter. For the fiscal first quarter, we expect SG&A expense in the range of $35 million to $36 million. At the midpoint of our revenue guidance, anticipated SG&A would be 4.6% of revenue, sequentially improved by 10 basis points.

Fiscal first quarter operating margin is expected to be in the range of 4.6% to 5%, which includes approximately 60 basis points of stock-based compensation expense. A few other notes, depreciation and amortization expense for the fiscal first quarter is expected to be approximately $13.5 million, slightly higher than the fiscal fourth quarter. Other expense for the fiscal first quarter is expected to be in the range of $3 million to $3.5 million. We estimate an effective tax rate of 13% to 15% for both the fiscal first quarter and full year.

As I mentioned earlier this year, fiscal 2019 will include a new form of taxable income referred to as Global Intangible Low-Taxed Income. This income and resulting tax will be generated from our earnings in Asia and expect it to add 3-percentage points to 4-percentage points to our effective tax rate. Given our recent share repurchases and our anticipated activity during the fiscal first quarter of 2019, we estimate diluted weighted average shares outstanding to be in the range of 32.4 million to 32.6 million shares.

Our expectation for the balance sheet is for working capital dollars to increase as we begin procuring inventory later this quarter for the fiscal second quarter. Based on forecasted levels of revenue, we expect a higher working capital will result in cash cycle days of 79 to 83 days for the fiscal first quarter. At the midpoint of this guidance, cash cycle days would increase by 8 days. We are currently pursuing customer deposits where appropriate to mitigate a portion of this increase.

I'd like to point out that as we adopt the new revenue recognition standard this quarter, we will see a new category added to our cash cycle referred to as unbilled receivable days. As we reduce inventory days under the new guidance, we'll see an increase to unbilled receivable days. The net impact to our cash cycle will be slightly unfavorable due to the adoption. Capital spending for fiscal 2019 is expected to be in the range of $70 million to $90 million, but the largest portion of capital spending relates to our new facility in Guadalajara.

In the fiscal first quarter, we expect free cash flow to be net negative given the elevated working capital investments to support the anticipated revenue growth, along with higher capital spending anticipated earlier in fiscal 2019. We anticipate generating free cash flow as we move through subsequent quarters and expect to deliver free cash flow in the range of $40 million to $60 million for fiscal 2019.

With that, Sylvia, I will now open the call for questions. We ask that you please limit yourself to one question and one follow-up. Sylvia?

[Operator]

Thank you. We will now begin the question-and-answer session. And our first question comes from Shawn Harrison from Longbow Research.

[Shawn M. Harrison, Longbow Research LLC]

Hi. Good morning, everybody, and congrats on the results.

[Todd P. Kelsey, Plexus Corp.]

Good morning, Shawn.

[Steven J. Frisch, Plexus Corp.]

Good morning, Shawn.

[Shawn M. Harrison, Longbow Research LLC]

I wanted to delve into two different market topics. First, just on the semi cap weakness, what degree of weakness are you seeing in that market? We all know it's obviously weak. And I guess maybe how long do you expect the weaker revenue profile to persist in fiscal 2019?

[Steven J. Frisch, Plexus Corp.]

Hey, Shawn, this is Steve. In semi cap, two things have happened to us through fiscal 2018. One is there is the growth of the market itself, but we're also gaining market share with customers as we move through the year. What we see now is – some of the end markets as we talked about from a softness standpoint, we do see it coming down a bit, but it's kind of being made up by the ramp of new programs. And so, our expectation right now for fiscal 2019 is like in the flat range. Obviously, we'll have to see how it pans out throughout the year, but semi cap for us is looking about flat.

[Shawn M. Harrison, Longbow Research LLC]

Okay. And then as a follow-up just the big win number in the Communications sector. I had to go back a couple of years to find a similar level of wins and particularly wireless I don't think has been you highlighted in a while. So, hoping you'd elaborate just on – is there a bigger total available market that you're now going after in Communications, is wireless now becoming a growth area that it hasn't really been in a number of quarters, and is there a potential for larger wins throughout fiscal 2019 as well?

[Steven J. Frisch, Plexus Corp.]

Yeah. So Steve again. As – if you recall, when we go back to the end of fiscal 2017 and in the early 2018, we talked about realigning kind of our teams in terms of making sure that we're going after markets and subsectors that aligned with our strategy, and the teams have done that. And so, the wins that you see are a result of that. Subsector of wireless is one of the areas that the team has been focusing. These wins I think are a result of what's happened over the hard work by the team through fiscal 2018. I do expect to continue to see decent wins from this team as we move forward. So, it's really a realignment of our strategy and a focus on the subsectors and the team's doing a good job. So, I expect it to continue through 2019 and beyond.

[Todd P. Kelsey, Plexus Corp.]

One of the things I'd add on that, Shawn, too is that if we were going to see growth within the Communications sector, we needed to add new logos and that's where the team was really successful this year, call it three new logos. One we've been doing business for a while but it's been more of an NPI type customer, and then two, our brand new logos that have some people with histories with Plexus in the past, so it was good to see them come back to Plexus.

[Shawn M. Harrison, Longbow Research LLC]

And if you think about, I guess, fiscal 2019 in that business, considering the new wins versus the legacy historical business, do you expect Communications now to be able to grow for fiscal 2019?

[Todd P. Kelsey, Plexus Corp.]

Right now, we're showing it as basically flat and that we were seeing nice growth from the new wins, but we're seeing a few legacy programs trail off and Steve had mentioned too we had a cancellation of a fairly significant program that our customers – end-customer was a federal government agency, decided not to order the product. So, that's having a negative impact for us and is offsetting some of the projected growth from the new wins right now. But there's certainly more potential now that we're adding some new logos there.

[Shawn M. Harrison, Longbow Research LLC]

All right. Thanks so much.

[Steven J. Frisch, Plexus Corp.]

You're welcome.

[Operator]

Our following question comes from Matthew Sheerin from Stifel.

[Matthew John Sheerin, Stifel, Nicolaus & Co., Inc.]

Yes. Thanks. Good morning. Just a question regarding the supply constraints that you and other folks have been seeing for a while. It looks like in some areas lead times are beginning to come in, but there is obviously still shortages of things like MLCC. So, in that environment, are you seeing sort of an imbalance of inventory, if you will, so that you can actually start working on bringing down some working capital as you balance that, or do you just expect that to be tight, or would your customers rather you carry some buffer stock here given the environment?

[Todd P. Kelsey, Plexus Corp.]

So, what we're seeing in general in the supply chain right now is I'd call it stable to maybe modestly improved from what it was a quarter ago. So, if we look at Q4, for instance, fiscal Q4, we were able to pull in and service a little bit of upside that we saw in there and that's where we generated the nice revenue within the quarter. We're also seeing, I would say, less programs in Q1 that have supply chain constraints, but they're still there.

And I would say that when we look at it from a customer standpoint, that's one of the reasons our inventory is a little bit higher as we continue to function in this, call it, load and chase mode, where we're bringing in inventory knowing a few components are at risk, but we'd expect that to start to clear out as we work our way through fiscal 2019 and plus as we drive some processes that are focused on improving inventory and with our customers. But, in general, our customers if I looked at them on aggregate, they're feeling bullish, so they want to see us try to have the parts. So, we're working with them on solutions to be able to do that.

[Matthew John Sheerin, Stifel, Nicolaus & Co., Inc.]

Okay, that's helpful. And you haven't – I don't think you really talked about tariffs and impact there, and I know you have some customers in the Communications sector that are susceptible to some of the tariffs and you have manufacturing obviously in China. So, are there any discussions with customers about actually moving capacity, and obviously, you've been adding in Malaysia and places like that, so what's happening there?

[Todd P. Kelsey, Plexus Corp.]

Yeah. I'll just give you an overall view of how the tariffs are impacting us, and overall, I would say the net impact is a positive for us as we're seeing it right now. If you look at it from a product standpoint, I mean our customers tend to be the importer of record, so they would pay the tariffs on the products that are imported. From a component standpoint, because of the way our business is structured that's passed along to customers any component tariffs.

Now, if we look at what's happening on a customer basis, I mean, first of all, I'd say we're not seeing anything that's really noticeable on a demand front right now of reductions in demand yet as a result of tariffs. We're starting to have some discussions with certain customers that ship out of China, which again remember that's maybe only about half or a little above half of our business in China, but we're starting to have some discussions with them about alternate facilities for their business and I would say that those are active dialogues. There is not active transitions going on at this point, but if the situation persists, I could see that occurring at some point in fiscal 2019.

Now on the positive front, we're seeing new opportunities as a result of the tariffs and some of it's from customer facilities, some of it's are competitors. We've already transitioned or won a small amount of business that is impacted by the tariffs and have opportunities on the order of about $100 million already that we don't believe would be there if it wasn't for the tariff situation. So, we're well positioned with our global footprint, just adding with the capacity we're bringing up in Malaysia and China, as well as our U.S. capacity, so we feel good that we were able to maneuver the tariff situation. I would rather have it go away, but we feel good that we can maneuver it if it continues to persist.

[Matthew John Sheerin, Stifel, Nicolaus & Co., Inc.]

Okay. Thanks a lot.

[Operator]

Our next question comes from Sean Hannan from Needham.

[Sean K. F. Hannan, Needham & Co. LLC]

Yeah, good morning. Thanks for taking the question here. And if I could actually just follow up on that topic, Todd, I think everything you just explained is pretty consistent with what I think a number of us are hearing in these early stages as a result of the tariffs. OEMs are investigating, don't know exactly what's going to happen, but conceptually, if we move a few steps down the road and we do see a lot of these OEMs, ultimately, in the medium – near to medium term, looking to move this business out of China to whether it'd be Guad or whatever else, how do we think about the industry's ability or you guys specifically to manage that? I mean, is this – you're going to have cost inefficiencies that you'll have to digest?

I mean is this something that ultimately the OEMs are going to have to bear in kind of a unique circumstance for transition costs? What do you do with the under absorption, conceptually just wanted to see if we can get some thoughts around how do we work with some of those risks that that could potentially materialize even though we, of course, acknowledge and we've got some opportunities as well, but there are some things that are going to have to be managed here. So, I just want to see if we can get some early views around that.

[Todd P. Kelsey, Plexus Corp.]

Yeah. So, first of all, from a transition or a transition costs standpoint, our approach is that that would be cost neutral to us. So – and if – or if anything be a benefit to us to move the business, so we think there's an opportunity to do that. From a pure move standpoint and the amount of business to move, I think we're in a – if this occurs and as we start to shift business and the industry starts to shift business that exits China or that is imported out of China – or exported out of China, excuse me, I think we're in a better spot than most, given our small amount of revenue that's in China and the small amount that's exported now, there's a (00:40:53) small amount of revenue as a percentage.

So, I think we're well positioned to be able to move whatever business our customers feel that they need to, to be competitive in their market as well as potentially take some share from our competitors, who perhaps have a much greater absolute and relative portion of their business that's in China. From a footprint standpoint, I mean – I guess that just remains to be seen as to how much business has moved out. Right now, nothing has – we feel pretty good about our footprint right now. But we'll just continue to play it out as this whole situation plays out, but – and as of now, there's no evidence that would suggest we're going to be in an overcapacity situation.

[Sean K. F. Hannan, Needham & Co. LLC]

That's helpful and I don't mean to communicate and ask the question with a negative spin. It's more of – this is obviously a point of ambiguity right now and I think that those comments are very helpful. So, next question here, so the wins, the growth for you folks, I mean this just continues to be really remarkable. And you're offsetting the semi-cap weakness, seems like you're even more comfortable with the double digit top line growth here in 2019. So, everything really looks to be lining up great. Just want to see if I could pick on a – what might be a perceivable spot here that could use a little bit more, I suppose, comfort.

So, when I look at the funnel and I realize reading the funnel is not as valuable as wins themselves, but you've been harvesting a good bit now. And that total has been a little bit suppressed the last few quarters versus 2017, so can we get a perspective how do we rebuild that or are we even over interpreting the comparison to where it's historically been and maybe it shouldn't be drawing conclusions like that? Can you help us think about building the funnel, views on where it stands and where you'd like it to be? Thanks.

[Steven J. Frisch, Plexus Corp.]

Yeah. So, this is Steve. I'll try to attempt that to start here. If you look at the funnel and in the historical numbers, the wins and the harvesting is up. It's been a good year. The funnel – the fluctuation in the funnel a bit as we gone through fiscal 2018 is not a concern to us. We don't really necessarily target anything from our quarter-to-quarter basis, that's why we try to stay focused on what kind of the trailing four quarters looks like. And so the fact that the funnel comes up and then down by $100 million or $200 million a quarter is fundamentally not a concern to us.

There is other data that we watch, which is the kind of the leads that are coming into the funnel, that number stays robust. And so, if we saw the funnel come down and that number come down, we'd get more concerned, but we haven't seen that and we don't anticipate to see that. We have the teams focused on doing the right things to win the business. So, I think the indications of what happened in Comm is a good thing in terms of what the teams can deliver. Obviously, the Healthcare/Life Sciences team is doing a phenomenal job. So, in the Aerospace and Defense, we see no ends in terms of what's happening there with the funnel. So, from our perspective, we don't really get too concerned in terms of where it's going up and down because it's – from our perspective, it's heading in the right direction.

[Todd P. Kelsey, Plexus Corp.]

The other thing I'd add on to that, Sean, one of the things we're seeing is a little bit faster velocity through the funnel from our teams. So, I think that would imply they're either driving more aggressively to close business or put in higher quality opportunities into the funnel itself. So, as long as we can continue to keep producing the wins we're producing, we feel pretty comfortable with the funnel, but we continue to monitor the whole package.

[Sean K. F. Hannan, Needham & Co. LLC]

That velocity piece of feedback is actually pretty interesting and very helpful, and Steve, your comments are very helpful as well. Thanks so much folks. Nice job.

[Todd P. Kelsey, Plexus Corp.]

Thank you.

[Operator]

Our following question comes from Jim Suva from Citi.

[Zhen Yang, Citigroup Global Markets, Inc.]

Hi. This is Tim Yang calling on behalf of Jim Suva. Thanks for taking the question. Your CapEx for fiscal year 2019 is higher than 2018. Are you seeing the need of CapEx increase for the next few years given the tariffs and customers might move the outsourcing outside of China? And then on component shortage, can you quantify the revenue and margin impact from the shortage? Thanks.

[Patrick J. Jermain, Plexus Corp.]

Yeah, Tim, this is Pat. I'll start with the CapEx and then maybe hand it off to Steve for the component piece. We're not increasing CapEx necessarily related to any tariff concerns. We had planned over a year ago to add the capacity in Penang, Malaysia, and then make the decision to add the second facility in Guadalajara. So that was in place a year ago and that's really what's impacting the fiscal 2019 CapEx, why that's up as much as it is. The new facility in Guadalajara is going to be about $20 million to $25 million of CapEx in fiscal 2019, and the existing facility as we continue to grow in that existing facility in Guadalajara will need about another $5 million to $10 million. So, those are the largest components of our fiscal 2019 CapEx spending.

[Steven J. Frisch, Plexus Corp.]

Yeah. This is Steve. I'll take the component question. We talked about in the Q3 call, a bit about $10 million opportunity for us that we could have shipped if we would have had the component. That number grew for us a bit in Q4. As Todd highlighted, we were able to pull some of it in, but there was probably about $20 million more that we could have shipped if we would have had components. We see that number coming down in Q1 here, as we've been able to basically resolve a fair amount of issues. And so my expectation is, there's a bit of upside for us if we can clear components, but we're starting to run into the inefficiencies in the factory of when we get them, even if we get the components, if it's at the tail end of the quarter, it's really hard to push them through the factory to get the revenue out.

So, I would expect over the next few quarters the things that bounce around in that area in terms of what potential and opportunity is for us, with a strong expectation now as we get through the first half of 2019 here, though, that we can work with our customers to basically get that aligned and get the supply chain straight.

[Zhen Yang, Citigroup Global Markets, Inc.]

Got you. This is super helpful. Just to clarify, Todd, so there is no need for more CapEx to capture the revenue upside from the tariffs that you mentioned the share gaining from the tariffs, is that right?

[Todd P. Kelsey, Plexus Corp.]

That's correct.

[Zhen Yang, Citigroup Global Markets, Inc.]

Got you. Thank you so much.

[Operator]

Our following question comes from Mitch Steves from RBC.

[Mitch Steves, RBC Capital Markets LLC]

Hey, guys. Thanks for taking my question. A lot of them have been answered, but I just wanted to clarify one point, just maybe help us out a bit on the end market dynamics you guys expect for FY 2019. So, if I assume you guys grow double digits, how would I think about the four end markets where you guys think would be the faster growing and the slower growing of the four groups?

[Todd P. Kelsey, Plexus Corp.]

Yeah. We're expecting strong growth from three of our four end markets. Those would be Healthcare/Life Sciences, Industrial/Commercial, and Aerospace and Defense. And we're thinking of Comms as relatively low growth or relatively flat based off of the dynamics that I mentioned earlier to Shawn Harrison.

[Mitch Steves, RBC Capital Markets LLC]

Okay, yeah. So, I just want to clarify two items there. So, the first one is on the Industrial side, so given that semi cap is probably going to be a little bit weaker given the checks we've seen, what is offsetting that weakness within Industrial? And then secondly, on the Healthcare side, you guys are growing at 20% plus. So, I'm just curious if there's ever going to be an issue of kind of a law of large numbers there as we go forward to the back half of 2019.

[Steven J. Frisch, Plexus Corp.]

Yeah. This is Steve. I'll hit this one. As we talked a little bit about in my portion, the Industrial/Commercial wins were $330 million in fiscal 2018, the strongest sector for wins, and they were pretty diversified. And so, we see – oil and gas is coming back with some customers, we're winning new work in the automated retail space as well as heavy transportation and things. And so for us, it's pretty broad-based new wins and growth that's basically offsetting some of the semi cap and overcoming the semi-cap market, and so, that for us is what's giving us optimism in Industrial/Commercial.

(00:49:28)

[Todd P. Kelsey, Plexus Corp.]

Yeah, on the Healthcare front, we haven't seen the law of large numbers come into play yet. I mean, right now with the wins and the funnel strength that we're showing in that sector, we think we had a lot of runway for growth within Healthcare/Life Sciences yet. Our brand is really strong in the marketplace and the team there is just doing an excellent job.

[Mitch Steves, RBC Capital Markets LLC]

Okay. Great. Thank you.

[Operator]

Our following question comes from Paul Coster from JPMorgan.

[Paul J. Chung, JPMorgan Securities LLC]

Hi. This is Paul Chung on for Coster. Thanks for taking my questions. So just on free cash flow, looks like guidance is lowered a bit, your CapEx levels, expected to increase inventory levels, probably elevated maybe in the first half. I assume your accounts payable might come down from elevated levels. But what could go right for you in the cash cycle days to come down in the second half, is there possible upside to your guidance there?

[Patrick J. Jermain, Plexus Corp.]

Yeah, I think there could be upside. We'll see about the CapEx spending if we're going to need all of that. Sometimes we see some of that shift into the following year, so some of that could push out. But then touching on, I believe, what Todd had talked about around inventory, I think putting in new processes, working with our customers on managing the inventory coming in to support them, I think that's an opportunity for us too. So inventory days would be an area that I think we could improve upon compared to where the forecast is currently.

[Paul J. Chung, JPMorgan Securities LLC]

Okay. And then looking further out, how should we think about CapEx levels beyond this year? I know it's too early to tell on your cash cycle days further out, but I'm just trying to get a sense for when we can hit kind of normalized levels for free cash flow. Thanks.

[Patrick J. Jermain, Plexus Corp.]

Yeah. So, we are having elevated capital spending in fiscal 2019, but that's because of, again, our second facility in Guadalajara. Once we get past that year, I think we'll come back down to a lower CapEx that we've historically seen, maybe around $40 million to $60 million, which includes maintenance capital and any capital to support the new revenue growth that we're expecting. And that would probably carry us through probably a two- to three-year period before we start looking at an additional footprint somewhere.

[Paul J. Chung, JPMorgan Securities LLC]

Okay. And then my last question. So on the win front, can you just talk about the competitive environment? It doesn't look like you're sacrificing much on margins to win these new deals. So, if you could just talk about how you are winning these deals, that would be helpful. Thank you.

[Steven J. Frisch, Plexus Corp.]

Yeah. This is Steve. I'll hit that one. I don't think the overall macro environment in terms of competitiveness has really changed. It's always been a competitive industry. I think the difference for us, and I think the Healthcare/Life Sciences team is benefiting from this, is really our ability to differentiate ourselves in the market with that focus on low-to-mid volume products. People are starting to realize the value of that. I also think our supply chain team has done a phenomenal job this year in terms of being able to deliver for our customers, and I think we're taking market share because of that. So, it's still a competitive market. But I think we've done a really nice job of differentiating ourselves and been able to basically not focus at all on price and focus it a little bit more on value and I think our value proposition is resounding with customers.

[Paul J. Chung, JPMorgan Securities LLC]

Thank you.

[Operator]

Our next question comes from Sean Hannan from Needham.

[Sean K. F. Hannan, Needham & Co. LLC]

Yeah. Thanks for allowing some follow-ups here. Just wanted to dig back into wireless. As you guys are ramping some activity, you're winning some activity. I want to get an understanding, what's the nature of the work that we're looking to be involved with here? As we're specifically adding these new logos, I'm assuming that there's probably more of a domestic focus, a higher end type of quality point product, and just trying to understand how much this plays into 5G as part of the thrust there. Thanks.

[Steven J. Frisch, Plexus Corp.]

Sure. This is Steve. I'll hit that one. The two that I mentioned in terms of wireless, one is focused on more of the business in the large campus environment, so they do more of point-to-point communications as well as large complex infrastructure deployments. So, it's really more – to your point, more of a back office and higher value stuff. That's one of them.

The other one is more focused on delivering a triple play to more remote areas. But again it's more of a back office stuff. So, it's the higher value equipment and those are the two areas. And in terms of 5G, both of these customers have a view on how they're going to address that market, but these products specifically aren't addressing that yet.

[Sean K. F. Hannan, Needham & Co. LLC]

Okay, that's helpful. And then for, Pat, just some accounting questions here. Where do or where can we think about taxes going beyond fiscal 2019 conceptually as your mix geographic production continues to morph here, any thoughts around that? And also can we get any color around accounts receivables factoring in the quarter? Thanks.

[Patrick J. Jermain, Plexus Corp.]

Sure. So, on the tax rate, I think, we're in this range of 13% to 15% for probably the next several years. We do have a tax holiday that comes due in 2024 in Malaysia that we're working through an extension on that. So that's something we're just going to have to work through and see if there's any impact to our tax rate when that comes due. But, apart from that, I think being in this kind of low-to-mid double-digit range is reasonable for us.

On the accounts receivable factoring, we continue that program in the fiscal fourth quarter slightly higher than the fiscal third quarter, still at a discount rate that's actually lower than our borrowing rate on our line of credit. So, it's still positive to be factoring, and again similar level, and I think going into fiscal 2019, we'll see it continuing at that similar level that we've been at.

[Sean K. F. Hannan, Needham & Co. LLC]

Great. Thanks so much for the follow-up, folks.

[Patrick J. Jermain, Plexus Corp.]

Sure.

[Operator]

Our following question is from Matthew Sheerin from Stifel.

[Matthew John Sheerin, Stifel, Nicolaus & Co., Inc.]

Yes, thanks, guys. My questions were just answered. Thanks so much.

[Todd P. Kelsey, Plexus Corp.]

All right. Thanks, Matt.

[Operator]

We have no further questions at this time. I'd like to turn the call over to CEO, Todd Kelsey, for final remarks.

[Todd P. Kelsey, Plexus Corp.]

All right. Thank you, Sylvia. In closing, given it's the end of the fiscal year, I want to take a moment to acknowledge and thank the more than 18,000 Plexus team members globally. You delivered just an outstanding fiscal 2018. You continue to provide exceptional customer service, achieved outstanding revenue growth, produced strong profitability and position Plexus for future success. I'm really proud of your accomplishments. The results of fiscal 2018 made me optimistic that Plexus will have an outstanding fiscal 2019. Keep up the tremendous work.

And then, finally, thank you to everyone who joined us on our call today. We appreciate your support and interest in Plexus.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.