10-Q 1 c95158e10vq.txt QUARTERLY REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Under Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the Quarter ended April 2, 2005 or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission File Number 000-14824 PLEXUS CORP. (Exact name of registrant as specified in charter) Wisconsin 39-1344447 (State of Incorporation) (IRS Employer Identification No.) 55 Jewelers Park Drive Neenah, Wisconsin 54957-0156 (Address of principal executive offices)(Zip Code) Telephone Number (920) 722-3451 (Registrant's telephone number, including Area Code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 under the Exchange Act). Yes [X] No [ ] As of May 6, 2005 there were 43,358,354 shares of Common Stock of the Company outstanding. PLEXUS CORP. TABLE OF CONTENTS April 2, 2005 PART I. FINANCIAL INFORMATION.................................................................................. 3 Item 1. Consolidated Financial Statements............................................................. 3 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)............... 3 CONDENSED CONSOLIDATED BALANCE SHEETS......................................................... 4 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS............................................... 5 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.......................................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 13 "SAFE HARBOR" CAUTIONARY STATEMENT............................................................ 13 OVERVIEW...................................................................................... 13 EXECUTIVE SUMMARY............................................................................. 13 INDUSTRY SECTORS.............................................................................. 14 RESULTS OF OPERATIONS......................................................................... 15 LIQUIDITY AND CAPITAL RESOURCES............................................................... 19 CONTRACTUAL OBLIGATIONS AND COMMITMENTS....................................................... 20 DISCLOSURE ABOUT CRITICAL ACCOUNTING POLICIES................................................. 20 NEW ACCOUNTING PRONOUNCEMENTS................................................................. 22 RISK FACTORS.................................................................................. 23 Item 3. Quantitative and Qualitative Disclosures about Market Risk.................................... 31 Item 4. Controls and Procedures....................................................................... 31 PART II - OTHER INFORMATION..................................................................................... 33 Item 4. Submission of Matters to a Vote of Security Holders........................................... 33 Item 6. Exhibits...................................................................................... 33 SIGNATURES...................................................................................................... 34
2 PART I. FINANCIAL INFORMATION ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS PLEXUS CORP. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (in thousands, except per share data) Unaudited
Three Months Ended Six Months Ended ------------------------ ------------------------ April 2, March 31, April 2, March 31, 2005 2004 2005 2004 --------- --------- --------- --------- Net sales $ 305,486 $ 254,272 $ 592,966 $ 492,735 Cost of sales 279,941 233,091 545,126 451,927 --------- --------- --------- --------- Gross profit 25,545 21,181 47,840 40,808 Operating expenses: Selling and administrative expenses 19,243 16,422 37,317 32,778 Restructuring and impairment costs 10,634 - 11,518 - --------- --------- --------- --------- 29,877 16,422 48,835 32,778 --------- --------- --------- --------- Operating income (loss) (4,332) 4,759 (995) 8,030 Other income (expense): Interest expense (891) (730) (1,762) (1,393) Miscellaneous 376 310 1,195 826 --------- --------- --------- --------- Income (loss) before income taxes (4,847) 4,339 (1,562) 7,463 Income tax expense (benefit) (388) 868 (125) 1,493 --------- --------- --------- --------- Net income (loss) $ (4,459) $ 3,471 $ (1,437) $ 5,970 ========= ========= ========= ========= Earnings per share: Basic $ (0.10) $ 0.08 $ (0.03) $ 0.14 ========= ========= ========= ========= Diluted $ (0.10) $ 0.08 $ (0.03) $ 0.14 ========= ========= ========= ========= Weighted average shares outstanding: Basic 43,315 42,962 43,252 42,806 ========= ========= ========= ========= Diluted 43,315 44,157 43,252 43,969 ========= ========= ========= ========= Comprehensive income (loss): Net income (loss) $ (4,459) $ 3,471 $ (1,437) $ 5,970 Foreign currency translation adjustments (2,982) 1,752 1,314 6,575 --------- --------- --------- --------- Comprehensive income (loss) $ (7,441) $ 5,223 $ (123) $ 12,545 ========= ========= ========= =========
See notes to condensed consolidated financial statements. 3 PLEXUS CORP. CONDENSED CONSOLIDATED BALANCE SHEETS (in thousands, except per share data) Unaudited
April 2, September 30, 2005 2004 ----------- ------------- ASSETS Current assets: Cash and cash equivalents $ 36,119 $ 40,924 Short-term investments - 4,005 Accounts receivable, net of allowance of $2,800 and $2,000, respectively 171,458 148,301 Inventories 172,379 173,518 Deferred income taxes 208 1,727 Prepaid expenses and other 10,070 5,972 ----------- ----------- Total current assets 390,234 374,447 Property, plant and equipment, net 122,497 129,586 Goodwill 35,199 34,179 Deferred income taxes 1,210 - Other 8,101 7,496 ----------- ----------- Total assets $ 557,241 $ 545,708 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current portion of long-term debt and capital lease obligations $ 2,077 $ 811 Accounts payable 109,905 100,588 Customer deposits 11,303 11,952 Accrued liabilities: Salaries and wages 19,758 26,050 Other 22,167 19,686 ----------- ----------- Total current liabilities 165,210 159,087 Long-term debt and capital lease obligations, net of current portion 22,638 23,160 Other liabilities 14,911 12,048 Deferred income taxes 1,760 - Commitments and contingencies (Note 10) - - Shareholders' equity: Preferred stock, $.01 par value, 5,000 shares authorized, none issued or outstanding - - Common stock, $.01 par value, 200,000 shares authorized, 43,330 and 43,184 shares issued and outstanding, respectively 433 432 Additional paid-in capital 269,356 267,925 Retained earnings 69,823 71,260 Accumulated other comprehensive income 13,110 11,796 ----------- ----------- 352,722 351,413 ----------- ----------- Total liabilities and shareholders' equity $ 557,241 $ 545,708 =========== ===========
See notes to condensed consolidated financial statements. 4 PLEXUS CORP. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Unaudited
Six Months Ended --------------------------- April 2, March 31, 2005 2004 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (1,437) $ 5,970 Adjustments to reconcile net income (loss) to net cash flows from operating activities: Depreciation and amortization 12,435 12,821 Non-cash asset impairments 4,292 - Deferred income taxes, net 405 8,647 Income tax benefit of stock option exercises - 1,117 Changes in assets and liabilities: Accounts receivable (22,222) (24,256) Inventories 2,029 (59,855) Prepaid expenses and other (2,959) (343) Accounts payable 8,817 18,947 Customer deposits (675) 1,067 Accrued liabilities and other (1,389) 2,293 ----------- ----------- Cash flows used in operating activities (704) (33,592) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES Sales and maturities of short-term investments 4,005 11,622 Payments for property, plant and equipment (8,601) (6,338) ----------- ----------- Cash flows provided by (used in) investing activities (4,596) 5,284 ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES Proceeds from debt 15,000 73,752 Payments on debt (15,961) (58,151) Payments on capital lease obligations (684) (450) Proceeds from exercise of stock options 214 2,987 Issuances of common stock 1,218 974 ----------- ----------- Cash flows provided by (used in) financing activities (213) 19,112 ----------- ----------- Effect of foreign currency translation on cash and cash equivalents 708 1,589 ----------- ----------- Net decrease in cash and cash equivalents (4,805) (7,607) Cash and cash equivalents: Beginning of period 40,924 58,993 ----------- ----------- End of period $ 36,119 $ 51,386 =========== ===========
See notes to condensed consolidated financial statements. 5 PLEXUS CORP. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS FOR THE THREE MONTHS AND SIX MONTHS ENDED APRIL 2, 2005 UNAUDITED NOTE 1 - BASIS OF PRESENTATION The condensed consolidated financial statements included herein have been prepared by Plexus Corp. ("Plexus" or the "Company") without audit and pursuant to the rules and regulations of the United States Securities and Exchange Commission. In the opinion of the Company, the financial statements reflect all adjustments, which include normal recurring adjustments necessary to present fairly the financial position of the Company as of April 2, 2005 and its results of operations for the three and six months ended April 2, 2005, and the three and six months ended March 31, 2004 and its cash flows for the same three month and six month periods. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to the SEC rules and regulations dealing with interim financial statements. However, the Company believes that the disclosures made in the condensed consolidated financial statements included herein are adequate to make the information presented not misleading. It is suggested that these condensed consolidated financial statements be read in conjunction with the financial statements and notes thereto included in the Company's 2004 Annual Report on Form 10-K. Effective October 1, 2004, the Company's fiscal year now ends on the Saturday closest to September 30 rather than on September 30, as was the case prior to fiscal 2005. In connection with the change to a fiscal year ending on the Saturday nearest September 30, the Company also changed the accounting for its interim periods to adopt a "4-4-5" accounting system for the "monthly" periods in each quarter. Each quarter therefore ends on a Saturday at the end of the 4-4-5 period. The accounting periods for the second quarter of fiscal 2005 and 2004 each included 91 days. The accounting periods for the six months ended April 2, 2005 and March 31, 2004 included 184 days and 183 days, respectively. NOTE 2 - INVENTORIES The major classes of inventories are as follows (in thousands):
April 2, September 30, 2005 2004 -------- ------------- Raw materials $104,392 $115,094 Work-in-process 32,262 32,898 Finished goods 35,725 25,526 -------- ------- $172,379 $173,518 ======== ========
NOTE 3 - LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS The Company is a party to a secured revolving credit facility (as amended, the "Secured Credit Facility") with a group of banks that allows the Company to borrow up to $150 million and expires on October 31, 2007. Borrowings under the Secured Credit Facility may be either through revolving or swing loans or letter of credit obligations. As of April 2, 2005, we had no borrowings outstanding. The Secured Credit Facility is secured by substantially all of the Company's domestic working capital assets and a pledge of 65 percent of the stock of the Company's foreign subsidiaries. The Secured Credit Facility contains certain financial covenants, which include certain minimum adjusted EBITDA amounts, a maximum total leverage ratio (not to exceed 2.5 times the adjusted EBITDA) and a minimum tangible net worth, all as defined in the amended agreement. Interest on borrowings varies depending upon the Company's then-current total leverage ratio and begins at the Prime rate, as defined, or LIBOR plus 1.5 percent. The Company is also required to pay an annual commitment fee of 0.5 percent of the unused credit commitment. Origination fees and expenses totaled approximately $1.3 million, which have been deferred and are being amortized to interest expense over the term of the Secured Credit Facility. Interest expense related to the commitment fee, amortization of deferred origination fees and borrowings totaled approximately $0.3 million and $0.6 million for the three and six months ended April 2, 2005, respectively, and $0.2 million and $0.3 million for the for the three and six months ended March 31, 2004, respectively. 6 NOTE 4 - EARNINGS PER SHARE The following is a reconciliation of the amounts utilized in the computation of basic and diluted earnings per share (in thousands, except per share amounts):
Three Months Ended Six Months Ended ---------------------- ---------------------- April 2, March 31, April 2, March 31, 2005 2004 2005 2004 --------- --------- --------- --------- Earnings: Net income (loss) $ (4,459) $ 3,471 $ (1,437) $ 5,970 ========= ========= ========= ========= Basic weighted average common shares outstanding 43,315 42,962 43,252 42,806 Dilutive effect of stock options - 1,195 - 1,163 --------- --------- --------- --------- Diluted weighted average shares outstanding 43,315 44,157 43,252 43,969 ========= ========= ========= ========= Basic and diluted earnings per share: Net income (loss) $ (0.10) $ 0.08 $ (0.03) $ 0.14 ========= ========= ========= =========
For both the three and six months ended April 2, 2005, stock options to purchase approximately 4.7 million shares of common stock were outstanding but not included in the computation of diluted earnings per share because there was a net loss in the period, and therefore their effect would be anti-dilutive. For both the three and six months ended March 31, 2004, stock options to purchase approximately 1.8 million shares of common stock were outstanding, but not included in the computation of diluted earnings per share because the options' exercise prices were greater than the average market price of the common shares and therefore their effect would be anti-dilutive. NOTE 5 - STOCK-BASED COMPENSATION The Company accounts for its stock option plans under the guidelines of Accounting Principles Board Opinion No. 25. Accordingly, no compensation expense related to the stock option plans has been recognized in the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The Company utilizes the Black-Scholes option valuation model to value stock options for pro forma presentation of income and per-share data as if the fair value-based method in Statement of Financial Accounting Standards ("SFAS") No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of SFAS No. 123," had been used to account for stock-based compensation. The following presents pro forma net income (loss) and per-share data as if a fair value based method had been used to account for stock-based compensation (in thousands, except per-share amounts): 7
Three Months Ended Six Months Ended --------------------- --------------------- April 2, March 31, April 2, March 31, 2005 2004 2005 2004 -------- --------- -------- --------- Net income (loss) as reported $ (4,459) $ 3,471 $ (1,437) $ 5,970 Add: stock-based employee compensation expense included in reported net loss, net of related income tax effect - - - - Deduct: total stock-based employee compensation expense determined under fair value based method, net of related tax effects (782) (975) (2,941) (2,928) -------- --------- -------- --------- Pro forma net income (loss) $ (5,241) $ 2,496 $ (4,378) $ 3,042 ======== ========= ======== ========= Earnings per share: Basic, as reported $ (0.10) $ 0.08 $ (0.03) $ 0.14 ======== ========= ======== ========= Basic, pro forma $ (0.12) $ 0.06 $ (0.10) $ 0.07 ======== ========= ======== ========= Diluted, as reported $ (0.10) $ 0.08 $ (0.03) $ 0.14 ======== ========= ======== ========= Diluted, pro forma $ (0.12) $ 0.06 $ (0.10) $ 0.07 ======== ========= ======== ========= Weighted average shares: Basic, as reported and pro forma 43,315 42,962 43,252 42,806 ======== ========= ======== ========= Diluted, as reported 43,315 44,157 43,252 43,969 ======== ========= ======== ========= Diluted, pro forma 43,315 43,466 43,252 43,623 ======== ========= ======== =========
On May 11, 2005, the Compensation Committee of the Company's Board of Directors approved accelerating the vesting of approximately 660,000 shares of unvested stock options with exercise prices per share of $12.33 or higher outstanding under the Company's stock plans. The options have a range of exercise prices of $12.53 to $27.37 and a weighted average exercise price of $15.18. The closing price of the Company's common stock on May 11, 2005, the effective date of the acceleration, was $12.33. The primary purpose of the accelerated vesting was to avoid recognizing compensation expense associated with these options upon adoption of SFAS No. 123(R), "Share-Based Payment: An Amendment of FASB Statements No. 123 and 95" (see Note 11). The aggregate pre-tax expense associated with the accelerated options would have been approximately $5.0 million, of which $2.8 million and $1.0 million would have been reflected in the Company's consolidated statements of operations in fiscal years 2006 and 2007, respectively. NOTE 6 - GOODWILL AND PURCHASED INTANGIBLE ASSETS The changes in the carrying amount of goodwill for the fiscal year ended September 30, 2004 and the six months ended April 2, 2005 are as follows (amounts in thousands): Balance as of October 1, 2003 $ 32,269 Foreign currency translation adjustments 1,910 --------- Balance as of September 30, 2004 34,179 Foreign currency translation adjustments 1,020 --------- Balance as of April 2, 2005 $ 35,199 =========
The Company performs goodwill impairment tests annually during the third quarter of each fiscal year and more frequently if an event or circumstance indicates that impairment has occurred. 8 NOTE 7 - BUSINESS SEGMENT, GEOGRAPHIC AND MAJOR CUSTOMER INFORMATION The Company operates in one business segment. The Company provides product realization services to electronic original equipment manufacturers ("OEMs"). The Company has three reportable geographic regions: North America, Europe and Asia. As of April 2, 2005 the Company had 18 active manufacturing and/or engineering facilities in North America, Europe and Asia to serve these OEMs. The Company uses an internal management reporting system, which provides important financial data to evaluate performance and allocate the Company's resources on a geographic basis. Interregion transactions are generally recorded at amounts that approximate arm's length transactions. The accounting policies for the regions are the same as for the Company taken as a whole. The table below presents geographic net sales information reflecting the origin of the product shipped and asset information based on the physical location of the assets (in thousands):
Three Months Ended Six Months Ended -------------------------------- ---------------------------- April 2, 2005 March 31, April 2, March 31, 2005 2004 2005 2004 ------------- ---------- ----------- ----------- Net sales: North America $ 241,071 $ 202,310 $ 472,089 $ 396,005 Europe 29,740 26,598 53,360 53,751 Asia 34,675 25,364 67,517 42,979 ------------- ---------- ------------ ----------- $ 305,486 $ 254,272 $ 592,966 $ 492,735 ============= ========== ============ ===========
April 2, September 30, 2005 2004 ----------- ------------- Long-lived assets: North America $ 101,122 $ 108,697 Europe 37,096 35,837 Asia 19,478 19,231 ----------- ------------- $ 157,696 $ 163,765 =========== =============
Long-lived assets as of April 2, 2005 and September 30, 2004 exclude other non-operating long-term assets totaling $9.3 million and $7.5 million, respectively. Juniper Networks, Inc. ("Juniper") accounted for 20 percent of net sales for both the three months and six months ended April 2, 2005. In addition, General Electric Corp. accounted for 10 percent of net sales for the six months ended April 2, 2005. Juniper accounted for 13 percent of net sales for both the three months and six months ended March 31, 2004. No other customers accounted for 10 percent or more of net sales in either period. NOTE 8 - GUARANTEES The Company offers certain indemnifications under its customer manufacturing agreements. In the normal course of business, the Company may from time to time be obligated to indemnify its customers or its customers' end-customers against damages or liabilities arising out of the Company's negligence, breach of contract, or infringement of third party intellectual property rights relating to its manufacturing processes. Certain of the manufacturing agreements have extended broader indemnification and while most agreements have contractual limits, some do not. However, the Company generally excludes from such indemnities, and seeks indemnification from its customers for, damages or liabilities arising out of the Company's adherence to customers' specifications or designs or use of materials furnished, or directed to be used, by its customers. The Company does not believe its obligations under such indemnities are material. In the normal course of business, the Company also provides its customers a limited warranty covering workmanship, and in some cases materials, on products manufactured by the Company for them. Such warranty generally provides that products will be free from defects in the Company's workmanship and meet mutually agreed-upon testing criteria for periods generally ranging from 12 months to 24 months. If a product fails to comply with 9 the Company's warranty, the Company's obligation is generally limited to correcting, at its expense, any defect by repairing or replacing such defective product. The Company's warranty generally excludes defects resulting from faulty customer-supplied components, design defects or damage caused by any party other than the Company. The Company provides for an estimate of costs that may be incurred under its limited warranty at the time product revenue is recognized and includes reserves for specifically identified product issues. These costs primarily include labor and materials, as necessary, associated with repair or replacement. The primary factors that affect the Company's warranty liability include the value and the number of shipped units and historical and anticipated rates of warranty claims. As these factors are impacted by actual experience and future expectations, the Company assesses the adequacy of its recorded warranty liabilities and adjusts the amounts as necessary. Below is a table summarizing the activity related to the Company's limited warranty liability for the six months ended April 2, 2005 and March 31, 2004 (in thousands):
Six months ended --------------------------- April 2, March 31, 2005 2004 ---------- --------- Balance at beginning of period $ 933 $ 985 Accruals for warranties issued during the period 41 55 Settlements (in cash or in kind) during the period (20) (174) ---------- --------- Balance at end of period $ 954 $ 866 ========== =========
NOTE 9 - CONTINGENCIES The Company (along with many other companies) has been sued by the Lemelson Medical, Education & Research Foundation Limited Partnership ("Lemelson") related to alleged possible infringement of certain Lemelson patents. The complaint, which is one of a series of complaints by Lemelson against hundreds of companies, seeks injunctive relief, treble damages (amount unspecified) and attorneys' fees. The Company has obtained a stay of action pending developments in other related litigation. On January 23, 2004, the judge in the other related litigation ruled against Lemelson, thereby declaring the Lemelson patents unenforceable and invalid. Lemelson has appealed this ruling and the initial appeal hearing is set for June 6, 2005. The lawsuit against the Company remains stayed pending the outcome of that appeal. The Company believes the vendors from which the alleged patent-infringing equipment was purchased may be required to contractually indemnify the Company. However, based upon the Company's observation of Lemelson's actions in other parallel cases, it appears that the primary objective of Lemelson is to cause other parties to enter into license agreements. If a judgment is rendered and/or a license fee required, it is the opinion of management of the Company that such judgment or fee would not be material to the Company's financial position, results of operations or cash flows. In addition, the Company is party to other certain lawsuits in the ordinary course of business. Management does not believe that these proceedings, individually or in the aggregate, will have a material adverse effect on the Company's financial position, results of operations or cash flows. NOTE 10 - RESTRUCTURING AND IMPAIRMENT COSTS For the six months ended April 2, 2005, the Company recorded pre-tax restructuring and impairment costs totaling $11.5 million, of which $10.6 million and $0.9 million was recorded in the second quarter and first quarter of fiscal 2005, respectively. The Company's most significant restructuring costs in the first six months of fiscal 2005 were associated with the closure of its Bothell, Washington ("Bothell") engineering and manufacturing facility, which was announced in September 2004. The Company transferred key customer programs from the Bothell facility to other Plexus locations primarily in the United States. This restructuring reduced the Company's capacity by 97,000 square feet and affected approximately 160 employees. The Company substantially completed its consolidation efforts during the second quarter of fiscal 2005. The Company incurred total restructuring and impairment costs associated with the Bothell facility closure of approximately $9.2 million, which consisted of the following: 10 - $1.8 million was recorded in the fourth quarter of fiscal 2004 and consisted of $1.5 million for employee terminations and $0.3 million for fixed asset impairments; - $0.7 million was recorded in the first quarter of fiscal 2005, and primarily represented additional severance in the form of retention bonuses for key individuals to assist in an orderly transition of programs to other sites; - $6.7 million was recorded in the second quarter of fiscal 2005 and consisted of approximately $6.2 million for the facility lease, $0.4 million for additional severance in the form of retention bonuses and $0.1 million for other closure costs. The liability for the facility lease was recognized and measured at fair value for the future remaining lease payments subsequent to abandonment, less any estimated sublease income that could reasonably be obtained for the property. During the second quarter of fiscal 2005, the Company recorded a $3.8 million impairment related to the remaining elements of a shop floor data-collection system. The Company recorded a $1.8 million impairment related to the shop floor data-collection system in the fourth quarter of fiscal 2004 when the Company determined that certain elements would not be utilized in any capacity. During the first quarter of fiscal 2005, the Company extended a maintenance and support agreement through April 2005 to provide the Company additional time to evaluate the remaining elements of the shop floor data-collection system. Based on the Company's evaluation, and as part of the preparation of the financial statements, the Company determined that the shop floor data-collection system was impaired. The Company determined it would abandon deployment of these remaining elements of the shop floor data-collection system because the anticipated business benefits could not be realized. During the second quarter of fiscal 2005, the Company also recorded other restructuring and impairment costs of approximately $0.5 million, which consisted of $0.4 million associated with a workforce reduction and $0.1 million in asset impairments in the Juarez, Mexico ("Juarez") facility. The Juarez workforce reduction affected approximately 50 employees. The second quarter fiscal 2005 restructuring costs were offset, in part, by a $0.4 million reduction in an accrual for lease exit costs associated with a warehouse located in Neenah, Wisconsin ("Neenah"). The Neenah warehouse was previously abandoned as part of a fiscal 2003 restructuring action; however, during the second quarter of fiscal 2005, the Company reactivated use of the warehouse. In the first quarter of fiscal 2005, the Company recorded pre-tax restructuring costs of $0.9 million, of which $0.8 million was primarily associated with the planned closure of the Bothell facility, as noted above, and $0.4 million represented additional impairment on the Company's closed San Diego facility, partially offset by a $0.3 million reduction in lease obligations for one of the Company's other closed facilities near Seattle, Washington ("Seattle"). The Company closed its San Diego facility in fiscal 2003; however, part of that facility was subleased prior to its closing. The San Diego facility was acquired under a capital lease. Accordingly, the subleased portion of the facility was recorded at the net present value of actual future sublease income. The remainder of facility that was available for subleasing was recorded at the net present value of estimated sublease income. During the first quarter of fiscal 2005, the Company subleased the remaining part of the San Diego facility, which resulted in an additional $0.4 million impairment to adjust the carrying value of the remaining part of the San Diego facility to its net present value of future sublease income. Finally, in the first quarter of fiscal 2005, the Company was able to sublease one of its two closed Seattle facilities, both of which were accounted for as operating leases. Lease-related restructuring costs for the Seattle facilities were initially recorded in previous periods based on future lease payments subsequent to abandonment, less estimated sublease income. As a result of the new sublease, the Company reduced its lease obligation for these facilities by $0.3 million. EITF Issue No. 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" is applicable to restructuring activities initiated prior to January 1, 2003, including subsequent restructuring cost adjustments related to such activities. Fiscal year 2004 restructuring activities that occurred subsequent to March 31, 2004 and remaining fiscal year 2003 restructuring activities for which a liability remained at September 30, 2004 included severance costs associated with the planned closure of the Company's Bothell facility, lease obligations associated with the Company's Seattle facilities, and other costs associated with refocusing the Company's PCB design group. 11 The table below summarizes the Company's restructuring obligations as of April 2, 2005 (in thousands):
EMPLOYEE LEASE OBLIGATIONS TERMINATION AND AND OTHER EXIT NON-CASH ASSET SEVERANCE COSTS COSTS WRITE-DOWNS TOTAL --------------- ----------------- -------------- -------- Accrued balance, September 30, 2004 $ 2,019 $ 9,760 $ - $ 11,779 Restructuring costs 732 28 - 760 Adjustment to provisions - (308) 432 124 Amounts utilized (569) (963) (432) (1,964) ---------- --------------- --------- -------- Accrued balance, January 1, 2005 2,182 8,517 - 10,699 Restructuring costs 782 6,358 3,923 11,063 Adjustment to provisions 23 (389) (63) (429) Amounts utilized (1,408) (803) (3,860) (6,071) ---------- --------------- --------- -------- April 2, 2005 $ 1,579 $ 13,683 $ - $ 15,262 ========== =============== ========= ========
As of April 2, 2005, all of the accrued severance costs and $4.5 million of the lease obligations and other exit costs are expected to be paid in the next twelve months. The remaining liability for lease payments is expected to be paid through October 2012. NOTE 11 - NEW ACCOUNTING PRONOUNCEMENTS In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4" ("SFAS 151"), which indicates that abnormal amounts of idle facility expense, freight, handling costs, and wasted material be recognized as current period charges. In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The Company will be required to adopt this statement in its first quarter of fiscal 2006. The Company does not anticipate that the implementation of this standard will have a material impact on its financial position, results of operations or cash flows. In December 2004, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004," (the "Jobs Act"). The Jobs Act became law in the U.S. in October 2004. This legislation provides for a number of changes in U.S. tax laws. FSP SFAS No. 109-2 requires recognition of a deferred tax liability for the tax effect of the excess of book over tax basis of an investment in a foreign corporate venture that is permanent in duration, unless a company firmly asserts that such amounts are indefinitely reinvested outside the company's home jurisdiction. However, due to the lack of clarification of certain provisions within the Jobs Act, FSP SFAS No. 109-2 provides companies additional time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. Management is presently reviewing this new legislation to determine the impacts on the Company's consolidated results of operations and financial position. In December 2004, the FASB issued SFAS No. 123(R), "Share-Based Payment: An Amendment of FASB Statements No. 123 and 95." This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award at the grant date (with limited exceptions) and recognize the compensation cost over the period during which an employee is required to provide service in exchange for the award. In March 2005, the U.S. Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 107 ("SAB 107"), which expresses views of the SEC staff regarding the application of SFAS No. 123(R). Among other things, SAB 107 provides interpretive guidance related to the interaction between SFAS No. 123(R) and certain SEC rules and regulations, as well as provides the SEC staff's views regarding the valuation of share-based payment arrangements for public companies. The Company is required to adopt SFAS No. 123(R) in its first quarter of fiscal 2006. Currently, the Company accounts for its stock option 12 awards under the provisions of APB No. 25, which to date has not resulted in compensation expense in the Company's consolidated results of operations. At the time of adoption, companies can select from three transition methods, two of which would allow for restatement of certain prior periods. Management anticipates selecting the transition method in which prior period financial statements would not be restated. The adoption of SFAS No. 123(R) is not expected to have a significant effect on the Company's financial condition and will not affect consolidated cash flows, but it is expected to have a significant adverse effect on its consolidated results of operations if stock options remain an important element of long-term compensation. In March 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"), which clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated even though uncertainty exists about the timing and (or) method of settlement. The Company is required to adopt FIN 47 by the end of fiscal 2006. The Company is currently assessing the impact of FIN 47 on its results of operations and financial condition. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS "SAFE HARBOR" CAUTIONARY STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995: The statements contained in the Form 10-Q that are not historical facts (such as statements in the future tense and statements including "believe," "expect," "intend," "anticipate" and similar words and concepts), including discussions of periods which are not yet completed, are forward-looking statements that involve risks and uncertainties, including, but not limited to: - the continued uncertain economic outlook for the electronics and technology industries - the risk of customer delays, changes or cancellations in both ongoing and new programs - our ability to secure new customers and maintain our current customer base - the results of cost reduction efforts - the impact of capacity utilization and our ability to manage fixed and variable costs - the effects of facilities closures and restructurings - material cost fluctuations and the adequate availability of components and related parts for production - the effect of changes in average selling prices - the effect of start-up costs of new programs and facilities - the effect of general economic conditions and world events - the effect of the impact of increased competition - other risks detailed below, especially in "Risk Factors" and otherwise herein, and in our Securities and Exchange Commission filings. OVERVIEW Plexus Corp. and its subsidiaries (together "Plexus," the "Company," or "we") is a participant in the Electronic Manufacturing Services ("EMS") industry. We provide product realization services to original equipment manufacturers, or OEMs, in the wireline/networking, wireless infrastructure, medical, industrial/commercial and defense/security/aerospace industries. We provide advanced electronics design, manufacturing and testing services to our customers with a focus on complex, high technology and high reliability products. We offer our customers the ability to outsource all stages of product realization, including: development and design, materials procurement and management, prototyping and new product introduction, testing, manufacturing, product configuration, logistics and test/repair. The following information should be read in conjunction with our condensed consolidated financial statements included herein and the "Risk Factors" section beginning on page 22. EXECUTIVE SUMMARY Overall revenues in the second quarter of fiscal 2005 increased approximately $51.2 million, or 20 percent over the comparable prior year period. Overall revenues throughout the first six months of fiscal 2005 increased approximately $100.2 million, or 20 percent, over the comparable prior year period. Although all end-markets showed an increase, the largest net sales gains were in the wireline/networking, wireless infrastructure and medical 13 industries in the three months and six months ended April 2, 2005. (See below for a description of our revised customer industry analysis.) Our largest customer remains Juniper Networks Inc. ("Juniper"), which represented 20 percent of our overall net sales for both the three and six months ended April 2, 2005. This was a significant increase from the 13 percent of our overall net sales that Juniper represented in both of the comparable prior year periods. This increased percentage stemmed from new programs related to an acquisition made by Juniper. In addition, General Electric Corp. ("GE") accounted for 10 percent of net sales during the first six months of fiscal 2005. The percentage of net sales represented by our ten largest customers rose to 59 percent for both the three and six months ended April 2, 2005 compared to 55 percent and 56 percent for the comparable prior year periods. Although net sales were substantially ahead of the comparable prior year period, the increase in gross profits in the second quarter of fiscal 2005 was moderated by manufacturing inefficiencies at certain of our sites and start-up costs of $0.4 million related to a new facility in Penang, Malaysia, which commenced manufacturing activities in the first quarter of fiscal 2005. Additionally, manufacturing inefficiencies and incremental costs associated with transitioning programs from the closure of the Bothell facility and continued near-term weakness at certain of our sites have also impaired our overall profitability in the first half of fiscal 2005. Selling and administrative expenses for the three months ended April 2, 2005 included $0.8 million in bad debt expense associated with an increase in our allowance for doubtful accounts for a small customer that encountered a liquidity problem during the quarter. The comparable prior year period included a $1.1 million recovery of accounts receivable that had been either written off or reserved in prior periods. During the second quarter of fiscal 2005, we incurred $10.6 million of restructuring and impairment costs, the largest element of which was $6.7 million associated with the accrual of lease obligations and additional severance costs related to the closure of the Bothell facility. In addition, we recorded a $3.8 million impairment related to the remaining elements of a shop floor data-collection system, as the anticipated benefits of this software could not be realized. The income tax rate in the first six months of fiscal 2005 was 8 percent, which compared favorably to the 20 percent effective tax rate in the comparable period of the prior year. The low income tax rate in the current year is primarily due to the prior year establishment of a full valuation allowance on U.S. deferred income tax assets, as well as tax holidays in Malaysia and China. The low income tax rate in the comparable period of the prior year reflects tax holidays in Malaysia and China as well as our utilization of net operating loss carry-forwards in the U.S. During the balance of fiscal 2005, our primary objective remains to improve profitability. We remain intensely focused on working capital utilization and return on capital employed. Based on customer indications of expected demand and management estimates of new program wins, we are increasingly confident about achieving near the high end of our previously announced net sales growth target for full fiscal 2005 of approximately 15 percent to 18 percent over fiscal 2004. We currently expect third quarter of fiscal 2005 sales to be in the range of $305 million to $315 million; however, our results will ultimately depend on actual levels of customer orders. These future orders may be less than we expect due to many factors, including those that we discuss under "Risk Factors" below. We expect our overall profitability to continue to be affected through the third quarter of fiscal 2005 by manufacturing inefficiencies at certain of our sites. In addition, the initial stages of production in the new facility in Penang have affected our overall profitability through the second quarter of fiscal 2005, and the effects are expected to continue into the third quarter, but to a lesser extent. INDUSTRY SECTORS We recently realigned our end-market sector analysis to better reflect our business development focus. Consequently, our comparative net sales by end-market, or industry, as shown in the Results of Operations section herein, have been reclassified to reflect the new sector categorization, which we previously disclosed [ in our Quarterly Report on Form 10-Q for the quarter ended January 1, 2005], and which is described below: - the previously reported networking/data communications sector has been disaggregated into two sub-sectors: 14 - wireline/networking - technology to transmit and store voice, data and video electronically using wire conductors and/or optical fibers. Examples include routers, switches, servers, storage devices, gateways, bridges, and hubs, internet service and optimization gear. - wireless infrastructure - Technology to support the management and delivery of wireless voice, data and video communications. Examples include cellular base stations, wireless and radio access, broadband wireless access, networking gateways and devices. - sales previously reported as computing have been grouped into wireline/networking, although a relatively few accounts that were only peripheral to the computer industry have been included in industrial/commercial. - medical remains as previously identified and defined. - industrial/commercial remains as previously defined, other than the minor additions discussed above. - transportation/other has been re-characterized as defense/security/aerospace to more accurately depict the types of product manufactured for this sector and to indicate the marketing focus for future business development efforts. RESULTS OF OPERATIONS Net sales. Net sales for the indicated periods were as follows (dollars in millions):
Three months ended Six months ended ------------------- --------------------- April 2, March 31, Increase/ April 2, March 31, Increase/ 2005 2004 (Decrease) 2004 2003 (Decrease) -------- --------- ----------- -------- --------- ----------- Sales $ 305.5 $ 254.3 $ 51.2 20% $ 593.0 $ 492.7 $ 100.2 20%
Our net sales increase for both the three and six month periods, reflect increased end-market demand in all sectors, but particularly in the wireline/networking, wireless infrastructure and medical sectors. The increase in net sales also reflects new program wins from both new and existing customers. The net sales growth in the wireless infrastructure sector was broadly based, while the net sales growth in the wireline/networking and medical sectors was primarily associated with Juniper and GE, respectively, our largest customers. The percentages of net sales to customers representing 10 percent or more of net sales and net sales to our ten largest customers for the indicated periods were as follows:
Three months ended Six months ended ------------------------- ------------------------ April 2, March 31, April 2, March 31, 2005 2004 2005 2004 -------- --------- -------- --------- Juniper Networks 20% 13% 20% 13% General Electric Corp. * * 10% * Top 10 customers 59% 55% 59% 56%
* Represents less than 10 percent of net sales Sales to our customers may vary from time to time depending on the size and timing of customer program commencement, termination, delays, modifications and transitions. We remain dependent on continued sales to our significant customers, and our concentration has somewhat increased. We generally do not obtain firm, long-term purchase commitments from our customers. Customers' forecasts can and do change as a result of changes in their end-market demand and other factors. Any material change in orders from these major accounts, or other customers, could materially affect our results of operations. In addition, as our percentage of sales to customers in a specific sector becomes larger relative to other sectors, we become increasingly dependent upon economic and business conditions affecting that sector. As noted in the Industry Sector section above, we recently aligned our sector analysis and business development focus. Utilizing the revised sectors, our percentages of net sales by sector for the indicated periods were as follows: 15
Percentage of Net Sales ------------------------------------------------- Three months ended Six months ended ------------------------ ------------------- April 2, March 31, April 2 March 31, Industry 2005 2004 2005 2004 -------- -------- -------- ------- --------- Wireline/Networking 37 39 38 40 Wireless Infrastructure 11 9 11 7 Medical 30 29 31 31 Industrial/Commercial 17 18 16 17 Defense/Security/Aerospace 5 5 4 5 --- --- --- --- 100 100 100 100 === === === ===
Gross profit. Gross profit and gross margins for the indicated periods were as follows (dollars in millions):
Three months ended Six months ended -------------------- ---------------------- April 2, March 31, Increase/ April 2, March 31, Increase/ 2005 2004 (Decrease) 2005 2004 (Decrease) -------- --------- ---------- -------- --------- ---------- Gross Profit $ 25.5 $ 21.2 $ 4.4 21% $ 47.8 $ 40.8 $ 7.0 17% Gross Margin 8.4% 8.3% 8.1% 8.3%
The improvements in gross profits in both periods were primarily due to higher net sales. For the three months ended April 2, 2005, gross profit and gross margin improvements were moderated by manufacturing inefficiencies at certain of our sites, plus start-up costs of $0.4 million related to a new facility in Penang, Malaysia, which commenced manufacturing activities in the first quarter of fiscal 2005. For the six months ended April 2, 2005, the gross profit improvement was moderated and the gross margin declined as a result of manufacturing inefficiencies at certain of our sites, $0.9 million in net inventory adjustments at our Juarez, Mexico facility due to the loss of inventory from theft and other causes, $0.9 million of start-up costs at a new facility in Penang, Malaysia, and only a nominal profit at our Bothell site due to transition expenses and manufacturing inefficiencies related to the phase-out of that facility. Gross margins reflect a number of factors that can vary from period to period, including product and service mix, the level of new facility start-up costs, inefficiencies attendant the transition of new programs, product life cycles, sales volumes, price erosion within the electronics industry, overall capacity utilization, labor costs and efficiencies, the management of inventories, component pricing and shortages, the mix of turnkey and consignment business, fluctuations and timing of customer orders, changing demand for our customers' products and competition within the electronics industry. Additionally, turnkey manufacturing involves the risk of inventory management, and a change in component costs can directly impact average selling prices, gross margins and net sales. Although we focus on expanding gross margins, there can be no assurance that gross margins will not decrease in future periods. Most of the research and development we conduct is paid for by our customers and is, therefore, included in both sales and cost of sales. We conduct our own research and development, but that research and development is not specifically identified, and we believe such expenses are less than one percent of our net sales. Selling and administrative expenses. Selling and administrative (S&A) expenses for the indicated periods were as follows (dollars in millions):
Three months ended Six months ended -------------------- ---------------------- April 2, March 31, Increase/ April 2, March 31, Increase/ 2005 2004 (Decrease) 2005 2004 (Decrease) -------- --------- ---------- -------- --------- ---------- Sales and administrative expense (S&A) $ 19.2 $ 16.4 $ 2.8 17% $ 37.3 $ 32.8 $ 4.5 14% Percent of sales 6.3% 6.5% 6.3% 6.7%
16 The dollar increase in S&A in both periods was due to a combination of factors, but the primary factor was a $1.9 million increase in bad debt expense. The three months and six months ended April 2, 2005 included $0.8 million in bad debt expense associated with an increase in our allowance for doubtful accounts for a small customer that encountered a liquidity problem during the second quarter, whereas the three months and six months ended March 31, 2004 included $1.1 million of recoveries of accounts receivable that had been previously either written off or reserved for. Other factors contributing to the dollar increase in S&A in both periods included: increased spending for information technology systems support related to the implementation of an ERP platform; internal and external resources to comply with Section 404 of the Sarbanes Oxley Act of 2002; and additional personnel and other administrative expenses to support the revenue growth in Asia. The decrease in S&A as a percent of net sales was due primarily to the 20 percent increase in net sales in each of the three months and six months ended April 2, 2005 over the comparable prior year periods. Our common ERP platform is intended to augment our management information systems and includes various software systems to enhance and standardize our ability to translate information globally from production facilities into operational and financial information and create a consistent set of core business applications at our worldwide facilities. We converted one more facility to the common ERP platform in the second quarter of fiscal 2005 and now manage a significant majority of our net sales on the common ERP platform. Training and implementation costs are expected to continue over the next couple of quarters as we make system enhancements to the common ERP platform. The conversion timetable for other Plexus locations and project scope remain subject to change based upon our evolving needs and sales levels. In addition to S&A expenses associated with the common ERP platform, we continue to incur capital expenditures for hardware, software and certain other costs for testing and installation. As of April 2, 2005, net property, plant and equipment includes $22.4 million related to the ERP platform, including $0.5 million and $1.1 million capitalized in the three and six months ended April 2, 2005. We anticipate incurring at least an additional $0.5 million of capital expenditures for the ERP platform through fiscal 2005. See "Restructuring Actions" below for discussion of a second quarter of fiscal 2005 impairment of a shop floor data-collection system, which we determined to remove from the common ERP platform. Restructuring Actions: For the six months ended April 2, 2005, we recorded pre-tax restructuring and impairment costs totaling $11.5 million, of which $10.6 million was recorded in the second quarter of fiscal 2005. Our most significant restructuring activities and costs in the first six months of fiscal 2005 were associated with the closure of our Bothell, Washington ("Bothell") engineering and manufacturing facility, which was announced in September 2004. We transferred key customer programs from the Bothell facility to other Plexus locations primarily in the United States. This restructuring reduced our capacity by 97,000 square feet and affected approximately 160 employees. We substantially completed the consolidation efforts during the second quarter of fiscal 2005. We incurred total restructuring and impairment costs associated with the Bothell facility closure of approximately $9.2 million, which consisted of the following elements: - $1.8 million was recorded in the fourth quarter of fiscal 2004 to provide $1.5 million for employee terminations and $0.3 million for fixed asset impairments; - $0.7 million was recorded in the first quarter of fiscal 2005, and primarily represented additional severance in the form of retention bonuses for key individuals to assist in an orderly transition of programs to other sites; - $6.7 million was recorded in the second quarter of fiscal 2005, to recognize approximately $6.2 million for the remaining facility lease obligation, net of estimated sublease income, $0.4 million for additional severance in the form of retention bonuses and $0.1 million for other closure costs. During the second quarter of fiscal 2005, we recorded a $3.8 million impairment related to the remaining elements of a shop floor data-collection system. We recorded a $1.8 million impairment related to the shop floor data-collection system in the fourth quarter of fiscal 2004 when we determined that certain elements would not be utilized in any capacity. During the first quarter of fiscal 2005, we extended a maintenance and support agreement through April 2005 to provide additional time to evaluate the remaining elements of the shop floor data-collection system. Based on that evaluation, and as part of the preparation of our financial statements, we determined that the shop floor data-collection system was impaired. We determined that we would abandon deployment of the remaining elements of the shop floor data-collection system because the anticipated business benefits could not be realized. 17 During the second quarter of fiscal 2005, we also recorded other net restructuring and impairment costs of approximately $0.1 million, which consisted of $0.4 million associated with a workforce reduction and $0.1 million in asset impairments in our Juarez, Mexico ("Juarez") facility. The Juarez workforce reduction affected approximately 50 employees. The second quarter fiscal 2005 restructuring costs were offset, in part, by a $0.4 million reduction in an accrual for lease exit costs associated with a warehouse located in Neenah, Wisconsin ("Neenah"). The Neenah warehouse was previously abandoned as part of a fiscal 2003 restructuring action; however, during the second quarter of fiscal 2005, we reactivated use of the warehouse. In the first quarter of fiscal 2005, we recorded pre-tax restructuring costs of $0.9 million, of which $0.8 million was primarily associated with the planned closure of the Bothell facility, as noted above, and $0.4 million represented additional impairment on our closed San Diego facility, partially offset by a $0.3 million reduction in lease obligations for one of our other closed facilities near Seattle, Washington ("Seattle"). The San Diego facility, which was closed in fiscal 2003, is financed by a capital lease. Part of that facility was subleased prior to its closing and was recorded at the net present value of its future sublease income. The remainder of the facility that was available for subleasing was recorded at the net present value of estimated sublease income. During the first quarter of fiscal 2005, we subleased the remaining part of the San Diego facility, which resulted in an additional $0.4 million impairment to adjust the carrying value of the remaining part of the San Diego facility to its net present value of future sublease income. In the first quarter of fiscal 2005, we subleased one of our Seattle facilities held under operating leases. Lease-related restructuring costs for the Seattle facilities were initially recorded in previous periods based on future lease payments subsequent to abandonment, less estimated sublease income. As a result of this new sublease, we reduced a lease obligation for these facilities by $0.3 million. Pre-tax restructuring charges for the indicated periods are summarized as follows (in millions):
Three months ended Six months ended -------------------------- ------------------------ April 2, March 31, April 2, March 31, 2005 2004 2005 2004 -------- --------- -------- --------- Lease exit costs and other $ 6,358 $ - $ 6,386 $ - Asset impairments 3,923 - 3,923 - Severance costs 782 - 1,514 - Adjustments to lease exit costs (389) - (697) - Adjustments to asset impairment (63) - 369 - Adjustment to severance 23 - 23 - -------- --------- -------- --------- $ 10,634 $ - $ 11,518 $ - ======== ========= ======== =========
As of April 2, 2005, we have a remaining restructuring liability of approximately $15.3 million, of which $1.6 million represents a liability for severance costs associated with the closure of our Bothell facility and a workforce reduction in Juarez, and $13.7 million represents a liability for lease obligations and other exit costs primarily associated with our Bothell and Seattle facilities. As of April 2, 2005, the $1.6 million liability for accrued severance costs and $4.5 million of the liability for lease obligations and other exit costs are expected to be paid in the next twelve months. The remaining liability for lease payments is expected to be paid through October 2012. Income taxes. Income taxes for the indicated periods were as follows (dollars in millions):
Three months ended Six months ended -------------------------- ------------------------ April 2, March 31, April 2, March 31, 2005 2004 2005 2004 -------- --------- -------- --------- Income tax expense (benefit) $ (0.4) $ 0.9 $ (0.1) $ 1.5 Effective annual tax rate 8% 20% 8% 20%
18 The decrease in the effective tax rate is due primarily to the use of our net operating loss carry-forwards in the U.S. Although we established a full valuation allowance on our U.S. deferred income tax assets in the fourth quarter of fiscal 2004, we expect to be able to utilize our net operating loss carry-forwards to offset taxable income in the U.S., thereby contributing to the lower effective tax rate in the current year. Expanding operations in Asia, where we benefit from tax holidays, also contributed to the lower effective tax rate in the current year. We were advised by the Malaysian government that our tax-free status in that country had been extended until December 31, 2014. LIQUIDITY AND CAPITAL RESOURCES Operating Activities. Cash flows used in operating activities were $(0.7) million for the six months ended April 2, 2005, compared to cash flows used in operating activities of $(33.6) million for the six months ended March 31, 2004. During the six months ended April 2, 2005, cash used in operating activities was primarily driven by increased accounts receivable and prepaid expenses, offset in part by earnings (after adjustment for the non-cash effect of depreciation and amortization and non-cash asset impairments), decreased inventory and increased accounts payable. As of April 2, 2005, annualized days sales outstanding in accounts receivable increased slightly to 53 days from 52 days at the prior year-end. Annualized inventory turns declined to 5.9 turns for the three months ended April 2, 2005 from 6.2 turns for the prior year-end, primarily as a result of the higher average inventory levels utilized in the calculation of inventory turns in the current period as compared to the prior year period. Inventories decreased $1.1 million from September 30, 2004, mainly because of a reduction in raw materials, offset in part by an increase in finished goods inventory. The raw materials inventory reduction was due to the establishment of certain new supply chain programs, while finished goods inventory increased as a result of certain new customer programs that required us to maintain finished goods. Investing Activities. Cash flows used in investing activities totaled $(4.6) million for the six months ended April 2, 2005, which primarily represented additions to property, plant and equipment, reduced by sales and maturities of short-term investments. We utilized available cash and our revolving credit facility as the primary means of financing our operating requirements during the first six months of fiscal 2005. The average amounts outstanding under the revolving credit facility were $5.1 million and $4.5 million during the three and six months ended April 2, 2005, respectively. We utilize operating leases primarily in situations where concerns about technical obsolescence outweigh the benefits of direct ownership. We currently estimate capital expenditures for fiscal 2005 to be approximately $20 million to $22 million, of which $8.6 million were made through the six months ended April 2, 2005. Financing Activities. Cash flows used in financing activities totaled $(0.2) million for the six months ended April 2, 2005, and primarily represented payment on debt and capital lease obligations, offset, in part, by proceeds from issuances of common stock through an employee stock purchase plan. Our secured revolving credit facility, as amended (the "Secured Credit Facility"), allows us to borrow up to $150 million from a group of banks. Borrowing under the Secured Credit Facility may be either through revolving or swing loans or letters of credit. The Secured Credit Facility is secured by substantially all of our domestic working capital assets and a pledge of 65 percent of the stock of each of our foreign subsidiaries. Interest on borrowings varies with our total leverage ratio, as defined in our credit agreement, and begins at the Prime rate (as defined) or LIBOR plus 1.5 percent. We also are required to pay an annual commitment fee of 0.5 percent of the unused credit commitment. The Secured Credit Facility matures on October 31, 2007 and includes certain financial covenants customary in agreements of this type. These covenants include a minimum adjusted EBITDA, a maximum total leverage ratio (not to exceed 2.5 times adjusted EBITDA) and a minimum tangible net worth, all as defined in the agreement. We believe that our Secured Credit Facility, leasing capabilities and cash and short-term investments should be sufficient to meet our working capital and fixed capital requirements, as noted above, through fiscal 2005. However, the growth anticipated for fiscal 2005 may increase our working capital needs. As those needs increase, we may need to arrange additional debt or equity financing. We therefore evaluate and consider from time to time 19 various financing alternatives to supplement our capital resources. However, we cannot be sure that we will be able to make any such arrangements on acceptable terms. We have not paid cash dividends in the past and do not anticipate paying them in the foreseeable future. We anticipate using any earnings to support our business. CONTRACTUAL OBLIGATIONS AND COMMITMENTS Our disclosures regarding contractual obligations and commercial commitments are located in various parts of our regulatory filings. Information in the following table provides a summary of our contractual obligations and commercial commitments as of April 2, 2005 (in thousands):
Payments Due by Fiscal Period ------------------------------------------------------------------------ Remaining in 2010 and Contractual Obligations Total 2005 2006-2007 2008-2009 thereafter ----------------------- -------- ------------ --------- --------- ----------- Long-Term Debt Obligations $ - $ - $ - $ - $ - Capital Lease Obligations 40,290 1,744 6,122 6,346 26,078 Operating Lease Obligations* 71,317 7,499 23,926 15,291 24,601 Purchase Obligations** 201,077 201,077 - - - Other Long-Term Liabilities on the Balance Sheet*** 13,741 2,950 4,664 1,165 4,962 Other Long-Term Liabilities not on the Balance Sheet**** 1,500 250 1,000 250 - -------- ------------ --------- --------- ----------- Total Contractual Cash Obligations $327,925 $ 213,520 $ 35,712 $ 23,052 $ 55,641 ======== ============ ========= ========= ===========
* - As of April 2, 2005, operating lease obligations include future payments totaling $13.7 million related to lease exit costs that are included in other long-term liabilities on the balance sheet. The lease exit costs were accrued as a restructuring cost. ** - As of April 2, 2005, purchase obligations consist of purchases of inventory and equipment in the ordinary course of business. *** - As of April 2, 2005, other long-term obligations on the balance sheet include: deferred compensation obligations to certain of our former executives, executive officers and other key employees and restructuring obligations for lease exit costs. **** - As of April 2, 2005, other long-term obligations not on the balance sheet consist of a salary commitment to an officer of the Company under an employment agreement. We did not have, and were not subject to, any lines of credit, standby letters of credit, guarantees, standby repurchase obligations, or other commercial commitments. DISCLOSURE ABOUT CRITICAL ACCOUNTING POLICIES Our accounting policies are disclosed in our 2004 Report on Form 10-K. During the three and six months ended April 2, 2005, there were no material changes to these policies. Our more critical accounting policies are as follows: Impairment of Long-Lived Assets - We review property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of property, plant and equipment is measured by comparing its carrying value to the projected cash flows the property, plant and equipment are expected to generate. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying value of the property exceeds its fair market value. The impairment analysis is based on significant assumptions of future results made by management, including revenue and cash flow projections. Circumstances that may lead to impairment of property, plant and equipment include decreases in future performance or industry demand and the restructuring of our operations. See 20 Note 10 in Notes to Condensed Consolidated Financial Statements for discussion of additional asset impairments recorded in the six months ended April 2, 2005. Intangible Assets - Under SFAS No. 142, "Goodwill and Other Intangible Assets," beginning October 1, 2002, we no longer amortize goodwill and intangible assets with indefinite useful lives, but instead test those assets for impairment at least annually, with any related losses recognized in earnings when incurred. We perform goodwill impairment tests annually during the third quarter of each fiscal year and more frequently if an event or circumstance indicates that an impairment has occurred. We measure the recoverability of goodwill under the annual impairment test by comparing a reporting unit's carrying amount, including goodwill, to the estimated fair market value of the reporting unit based on projected discounted future cash flows. If the carrying amount of the reporting unit exceeds its fair value, goodwill is considered impaired and a second test is performed to measure the amount of impairment, if any. Revenue - Net sales from manufacturing services is generally recognized upon shipment of the manufactured product to our customers, under contractual terms, which are generally FOB shipping point. Upon shipment, title transfers and the customer assumes risks and rewards of ownership of the product. Generally, there are no formal customer acceptance requirements or further obligations related to manufacturing services; if such requirements or obligations exist, then a sale is recognized at the time when such requirements are completed and such obligations fulfilled. Net sales from engineering design and development services, which are generally performed under contracts of twelve months or less duration, are recognized as costs are incurred utilizing the percentage-of-completion method; any losses are recognized when anticipated. Sales are recorded net of estimated returns of manufactured product based on management's analysis of historical returns, current economic trends and changes in customer demand. Net sales also include amounts billed to customers for shipping and handling, if applicable. The corresponding shipping and handling costs are included in cost of sales. Restructuring Costs - From fiscal 2002 through fiscal 2005, we have recorded restructuring costs in response to reductions in sales and/or reduced capacity utilization. These restructuring costs included employee severance and benefit costs, and costs related to plant closings, including leased facilities that will be abandoned (and subleased, as applicable). Prior to January 1, 2003, severance and benefit costs were recorded in accordance with Emerging Issues Task Force ("EITF") 94-3 and for leased facilities that were abandoned and subleased. The estimated lease loss was accrued for future remaining lease payments subsequent to abandonment, less any estimated sublease income. As of April 2, 2005, we have one significant Seattle facility remaining which has not yet been subleased. In fiscal 2004, based on the remaining term available to lease two of our Seattle facilities and the weaker-than-expected conditions in the local real estate market, we determined that we would most likely not be able to sublease the Seattle facilities. Accordingly, additional lease-related restructuring costs were recorded in fiscal 2004. If we were able to sublease the remaining Seattle facility, we would record a favorable adjustment to restructuring costs, as was the case in the first six months of fiscal 2005, when we recorded a $0.3 million favorable adjustment to restructuring costs as a result of entering into a sublease for one of the Seattle facilities. See Note 10 in Notes to Condensed Consolidated Financial Statements. Subsequent to December 31, 2002, costs associated with a restructuring activity are recorded in compliance with SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." The timing and related recognition of recording severance and benefit costs that are not presumed to be an ongoing benefit as defined in SFAS No. 146 depend on whether employees are required to render service until they are terminated in order to receive the termination benefits and, if so, whether employees will be retained to render service beyond a minimum retention period. During fiscal 2003, we concluded that we had a substantive severance plan based upon our past severance practices; therefore, we recorded certain severance and benefit costs in accordance with SFAS No. 112, "Employer's Accounting for Postemployment Benefits," which resulted in the recognition of a liability as the severance and benefit costs arose from an existing condition or situation and the payment was both probable and reasonably estimated. 21 For leased facilities abandoned and subleased, a liability is recognized and measured at fair value for the future remaining lease payments subsequent to abandonment, less any estimated sublease income that could reasonably be obtained for the property. For contract termination costs, including costs that will continue to be incurred under a contract for its remaining term without economic benefit to the entity, a liability for future remaining payments under the contract is recognized and measured at its fair value. See Note 10 in the Notes to Condensed Consolidated Financial Statements for discussion of a lease liability recorded for the six months end April 2, 2005 associated with the closure of our Bothell facility. The recognition of restructuring costs requires that we make certain judgments and estimates regarding the nature, timing and amount of costs associated with the planned exit activity. If our actual results in exiting these facilities differ from our estimates and assumptions, we may be required to revise the estimates of future liabilities, requiring the recording of additional restructuring costs or the reduction of liabilities already recorded. At the end of each reporting period, we evaluate the remaining accrued balances to ensure that no excess accruals are retained, no additional accruals are required and the utilization of the provisions are for their intended purpose in accordance with developed exit plans. Income Taxes - Deferred income taxes are provided for differences between the bases of assets and liabilities for financial and income tax reporting purposes. We record a valuation allowance against deferred income tax assets when management believes it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Realization of deferred income tax assets is dependent on our ability to generate sufficient future taxable income. Although we recorded a $36.8 million valuation allowance against all U.S. deferred income tax assets in the fourth quarter of fiscal 2004, we expect to be able to utilize our net operating loss carryforwards to offset taxable income in the U.S. NEW ACCOUNTING PRONOUNCEMENTS In November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 151, "Inventory Costs, an amendment of ARB No. 43, Chapter 4" ("SFAS 151"), which indicates that abnormal amounts of idle facility expense, freight, handling costs, and wasted material be recognized as current period charges. In addition, this statement requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. We will be required to adopt this statement in the first quarter of our fiscal 2006. We do not anticipate that the implementation of this standard will have a material impact on our financial position, results of operations or cash flows. In December 2004, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") FAS 109-2, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004" (the "Act"). The Act became law in the U.S. in October 2004. This legislation provides for a number of changes in U.S. tax laws. FSP SFAS No. 109-2 requires recognition of a deferred tax liability for the tax effect of the excess of book over tax basis of an investment in a foreign corporate venture that is permanent in duration, unless a company firmly asserts that such amounts are indefinitely reinvested outside the company's home jurisdiction. However, due to the lack of clarification of certain provisions within the Act, FSP SFAS No. 109-2 provides companies additional time beyond the financial reporting period of enactment to evaluate the effect of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. We are presently reviewing this new legislation to determine the impacts on our consolidated results of operations and financial position. In December 2004, the FASB issued SFAS No. 123R, "Share-Based Payment: An Amendment of FASB Statements No. 123 and 95." This statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award at the grant date (with limited exceptions) and recognize the compensation cost over the period during which an employee is required to provide service in exchange for the award. In March 2005, the U.S. Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 107 ("SAB 107"), which expresses views of the SEC staff regarding the application of SFAS No. 123(R). Among other things, SAB 107 provides interpretive guidance related to the interaction between SFAS No. 123(R) and certain SEC rules and regulations, as well as provides the SEC staff's views regarding the valuation of share-based payment arrangements for public companies. We are required to adopt SFAS No. 123(R) in our first quarter of fiscal 2006. Currently, we account for stock option awards under the provisions of APB No. 25, which to date has not resulted in compensation expense in our consolidated results of 22 operations. At the time of adoption, companies can select from three transition methods, two of which would allow for restatement of certain prior periods. We anticipate selecting the transition method in which prior period financial statements would not be restated. The adoption of SFAS No. 123R is not expected to have a significant effect on our financial condition and will not affect consolidated cash flows, but it is expected to have a significant adverse effect on our consolidated results of operations if stock options remain an important element of long-term compensation. In March 2005, the FASB issued Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"), which clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value can be reasonably estimated even though uncertainty exists about the timing and (or) method of settlement. We are required to adopt FIN 47 by the end of fiscal 2006. We are currently assessing the impact of FIN 47 on our results of operations and financial condition. RISK FACTORS OUR CUSTOMER REQUIREMENTS AND OPERATING RESULTS VARY SIGNIFICANTLY FROM QUARTER TO QUARTER, WHICH COULD NEGATIVELY IMPACT THE PRICE OF OUR COMMON STOCK. Our quarterly and annual results may vary significantly depending on various factors, many of which are beyond our control. These factors include: - the volume of customer orders relative to our capacity - the level and timing of customer orders, particularly in light of the fact that some of our customers release a significant percentage of their orders during the last few weeks of a quarter - the typical short life cycle of our customers' products - market acceptance of and demand for our customers' products - customer announcements of operating results and business conditions - changes in our sales mix to our customers - business conditions in our customers' industries - the timing of our expenditures in anticipation of future orders - our effectiveness in managing manufacturing processes - changes in cost and availability of labor and components - local events, such as holidays, that may affect our production volume - credit ratings and securities analysts' reports and - changes in economic conditions and world events. The EMS industry is impacted by the state of the U.S. and global economies and world events. A slowdown or flat performance in the U.S. or global economies, or in particular in the industries served by us, may result in our customers reducing their forecasts. The demand for our services could weaken or decrease, which in turn would impact our sales, capacity utilization, margins and results. Historically, we have seen periods, such as in fiscal 2003 and 2002, when our sales were adversely affected by a slowdown in the wireline/networking and wireless infrastructure sectors, as a result of reduced end-market demand and reduced availability of venture capital to fund existing and emerging technologies. These factors substantially influence our net sales and margins. Net sales to customers in the wireline/networking and wireless infrastructure sectors have increased significantly in recent quarters. When an increasing percentage of our net sales is made to customers in a particular sector, we become more dependent upon the performance of that industry and the economic and business conditions that affect it. Our quarterly and annual results are affected by the level and timing of customer orders, fluctuations in material costs and availabilities, and the degree of capacity utilization in the manufacturing process. THE MAJORITY OF OUR SALES COME FROM A RELATIVELY SMALL NUMBER OF CUSTOMERS, AND IF WE LOSE ANY OF THESE CUSTOMERS, OUR SALES AND OPERATING RESULTS COULD DECLINE SIGNIFICANTLY. Sales to our largest customer for the three months ended April 2, 2005 represented 20 percent of our net sales, while net sales to our largest customer in the comparable period of the prior year represented 13 percent of net sales. We had no other customers that represented 10 percent or more of net sales in either period, although another 23 customer represented 10 percent of our net sales for the six months ended April 2, 2005. Sales to our ten largest customers have represented a majority of our net sales in recent periods. Our ten largest customers accounted for approximately 59 percent and 55 percent of our net sales for the three month ended April 2, 2005 and March 31, 2004, respectively. Our principal customers have varied from year to year, and our principal customers may not continue to purchase services from us at current levels, if at all. Significant reductions in sales to any of these customers, or the loss of major customers, could seriously harm our business. If we are not able to replace expired, canceled or reduced contracts with new business on a timely basis, our sales will decrease. OUR CUSTOMERS MAY CANCEL THEIR ORDERS, CHANGE PRODUCTION QUANTITIES OR DELAY PRODUCTION. EMS companies must provide rapid product turnaround for their customers. We generally do not obtain firm, long-term purchase commitments from our customers. Customers may cancel their orders, change production quantities or delay production for a number of reasons that are beyond our control. The success of our customers' products in the market and the strength of the markets themselves affect our business. Cancellations, reductions or delays by a significant customer or by a group of customers could seriously harm our operating results. Such cancellations, reductions or delays have occurred and may continue to occur. In addition, we make significant decisions, including determining the levels of business that we will seek and accept, production schedules, component procurement commitments, facility requirements, personnel needs and other resource requirements, based on our estimates of customer requirements. The short-term nature of our customers' commitments and the possibility of rapid changes in demand for their products reduce our ability to accurately estimate the future requirements of those customers. Because many of our costs and operating expenses are relatively fixed, a reduction in customer demand can harm our gross margins and operating results. Customers may require rapid increases in production, which can stress our resources and reduce operating margins. We may not have sufficient capacity at any given time to meet all of our customers' demands or to meet the requirements of a specific program. WE INVEST IN TECHNOLOGY FOR OUR OPERATIONS; DEVELOPMENTS MAY IMPAIR THOSE ASSETS. We are involved in a multi-year project to install a common ERP platform and associated information systems at most of our manufacturing sites. Our ERP platform is intended to augment our management information systems and includes various software systems to enhance and standardize our ability to globally translate information from production facilities into operational and financial information and create a consistent set of core business applications at our worldwide facilities. As of April 2, 2005, facilities representing a significant majority of our net sales are currently managed on the common ERP platform. The conversion timetable and project scope for our remaining facilities is subject to change based upon our evolving needs and sales levels. During the second quarter of fiscal 2005, we recorded a $3.8 million impairment related to the remaining elements of a shop floor data-collection system. We partially impaired the shop floor data-collection system in the fourth quarter of fiscal 2004 when we determined that certain elements would not be utilized. During the first quarter of fiscal 2005, we extended a maintenance and support agreement through April 2005 to provide additional time to evaluate the remaining elements of the shop floor data collection system. Based on our evaluation, and as part of the preparation of our financial statements, we determined that the shop floor data-collection system was impaired. We determined that we would abandon deployment of these remaining elements of the shop-floor data-collection system because the anticipated business benefits could not be realized. As of April 2, 2005, overall ERP investments included in net property, plant and equipment totaled $22.4 million and we anticipate incurring at least an additional $0.5 million in capital expenditures for the ERP platform through fiscal 2005. Changes in our technology needs may affect the utility of our ERP platform and require additional expenditures in the future. FAILURE TO MANAGE CONTRACTION AND GROWTH, IF ANY, MAY SERIOUSLY HARM OUR BUSINESS. Periods of contraction or reduced sales, such as the periods that occurred from fiscal 2001 through 2003, create challenges. We must determine whether all facilities remain productive, determine whether staffing levels need to be reduced, and determine how to respond to changing levels of customer demand. While maintaining 24 multiple facilities or higher levels of employment increases short-term costs, reductions in employment could impair our ability to respond to later market improvements or to maintain customer relationships. Our decisions to reduce costs and capacity, such as the recent closure of the Bothell facility in the second quarter of fiscal 2005 and the related reduction in the number of employees, can affect our expenses and, therefore, our short-term and long-term results. Due to the rapid sales growth in fiscal 2004, we experienced a significant need for additional employees and facilities. We added many employees around the world, and we have expanded our operations in Penang, Malaysia. Our response to these changes in business conditions in fiscal 2004, compared to the two previous fiscal years, resulted in additional costs to support our growth. If we are unable to effectively manage the growth anticipated for fiscal 2005, our operating results could be adversely affected. In addition, to meet our customers' needs or to achieve increased efficiencies, we sometimes require additional capacity in one location while reducing capacity in another. Since customers' needs and market conditions can vary and change rapidly, we may find ourselves in a situation (such as occurred in the first six months of fiscal 2005) where we simultaneously experience the effects of contraction in one location while incurring the costs of expansion in another. We completed the closure of our Bothell facility in the second quarter of fiscal 2005. Although we worked to minimize the potential effects of transitioning customer programs to other Plexus facilities, there are inherent risks that such a transition can result in the continuing disruption of programs and customer relationships. OPERATING IN FOREIGN COUNTRIES EXPOSES US TO INCREASED RISKS. We have operations in China, Malaysia, Mexico and the United Kingdom. As noted above, we expanded our operations in Malaysia, and we may in the future expand in these and/or into other international regions. We have limited experience in managing geographically dispersed operations in these countries. We also purchase a significant number of components manufactured in foreign countries. Because of these international aspects of our operations, we are subject to the following risks that could materially impact our operating results: - economic or political instability - transportation delays or interruptions and other effects of less-developed infrastructure in many countries - foreign exchange rate fluctuations - utilization of different systems and equipment - difficulties in staffing and managing foreign personnel and diverse cultures and - the effects of international political developments. In addition, changes in policies by the U.S. or foreign governments could negatively affect our operating results due to changes in duties, tariffs, taxes or limitations on currency or fund transfers. For example, our Mexican-based operation utilizes the Maquiladora program, which provides reduced tariffs and eases import regulations, and we could be adversely affected by changes in that program. Also, the Malaysian and Chinese subsidiaries currently receive favorable tax treatment from these governments for approximately 10 years and 9 years, respectively, which may or may not be renewed. WE MAY NOT BE ABLE TO MAINTAIN OUR ENGINEERING, TECHNOLOGICAL AND MANUFACTURING PROCESS EXPERTISE. The markets for our manufacturing and engineering services are characterized by rapidly changing technology and evolving process development. The continued success of our business will depend upon our ability to: - retain our qualified engineering and technical personnel - maintain and enhance our technological capabilities - develop and market manufacturing services which meet changing customer needs - successfully anticipate or respond to technological changes in manufacturing processes on a cost-effective and timely basis. 25 Although we believe that our operations utilize the assembly and testing technologies, equipment and processes that are currently required by our customers, we cannot be certain that we will develop the capabilities required by our customers in the future. The emergence of new technology industry standards or customer requirements may render our equipment, inventory or processes obsolete or noncompetitive. In addition, we may have to acquire new assembly and testing technologies and equipment to remain competitive. The acquisition and implementation of new technologies and equipment may require significant expense or capital investment that could reduce our operating margins and our operating results. Our failure to anticipate and adapt to our customers' changing technological needs and requirements could have an adverse effect on our business. OUR MANUFACTURING SERVICES INVOLVE INVENTORY RISK. Most of our contract manufacturing services are provided on a turnkey basis, where we purchase some or all of the required materials. These services involve greater resource investment and inventory risk than consignment services, where the customer provides these materials. Accordingly, component price increases and inventory obsolescence could adversely affect our selling price, gross margins and operating results. In our turnkey operations, we need to order parts and supplies based on customer forecasts, which may be for a larger quantity of product than is included in the firm orders ultimately received from those customers. For example, fiscal 2004, and the first three months of fiscal 2005 saw a significant increase in inventories to support increased sales and expected growth in customer programs. Customers' cancellation or reduction of orders can result in additional expense to us. While most of our customer agreements include provisions that require customers to reimburse us for excess inventory specifically ordered to meet their forecasts, we may not actually be reimbursed or be able to collect on these obligations. In that case, we could have excess inventory and/or cancellation or return charges from our suppliers. In addition, we provide a managed inventory program under which we hold and manage finished goods inventory for some of our key customers. The managed inventory program may result in higher finished goods inventory levels, further reduce our inventory turns and increase our financial risk with such customers. Even though our customers generally will have contractual obligations to purchase the inventory from us, we may remain subject to the risk of enforcing those obligations. WE MAY NOT BE ABLE TO OBTAIN RAW MATERIALS OR COMPONENTS FOR OUR ASSEMBLIES ON A TIMELY BASIS OR AT ALL. We rely on a limited number of suppliers for many components used in the assembly process. We do not have any long-term supply agreements. At various times, there have been shortages of some of the electronic components that we use, and suppliers of some components have lacked sufficient capacity to meet the demand for these components. At times, component shortages have been prevalent in our industry, and in certain areas recur from time to time. In some cases, supply shortages and delays in deliveries of particular components have resulted in curtailed or delayed production of assemblies using that component, which contributed to an increase in our inventory levels. We expect that shortages and delays in deliveries of some components will continue from time to time, especially as demand for those components increases. An increase in economic activity could result in shortages, if manufacturers of components do not adequately anticipate the increased orders and/or have previously excessively cut back their production capability in view of reduced activity in recent years. World events, such as terrorism, armed conflict and epidemics, also could affect supply chains. If we are unable to obtain sufficient components on a timely basis, we may experience manufacturing and shipping delays, which could harm our relationships with customers and reduce our sales. A significant portion of our sales is derived from turnkey manufacturing in which we provide materials procurement. While most of our customer contracts permit quarterly or other periodic adjustments to pricing based on decreases and increases in component prices and other factors, we typically bear the risk of component price increases that occur between any such repricings or, if such repricing is not permitted, during the balance of the term of the particular customer contract. Accordingly, component price increases could adversely affect our operating results. 26 START-UP COSTS AND INEFFICIENCIES RELATED TO NEW OR TRANSFERRED PROGRAMS CAN ADVERSELY AFFECT OUR OPERATING RESULTS. Start-up costs, the management of labor and equipment resources in connection with the establishment of new programs and new customer relationships, and the need to estimate required resources in advance can adversely affect our gross margins and operating results. These factors are particularly evident in the early stages of the life cycle of new products and new programs or program transfers. The effects of these start-up costs and inefficiencies can also occur when we open new facilities, such as our additional facility in Penang, Malaysia, which began production in the first quarter of fiscal 2005, or when we transfer programs, such as in connection with the closure our the Bothell facility. These factors also affect our ability to efficiently use labor and equipment. Due to the improved economy and our increased marketing efforts, we are currently managing a number of new programs. Consequently, our exposure to these factors has increased. In addition, if any of these new programs or new customer relationships were terminated, our operating results could be harmed, particularly in the short term. WE ARE SUBJECT TO EXTENSIVE GOVERNMENT REGULATIONS. We are also subject to environmental regulations relating to the use, storage, discharge, recycling and disposal of hazardous chemicals used in our manufacturing process. If we fail to comply with present and future regulations, we could be subject to future liabilities or the suspension of business. These regulations could restrict our ability to expand our facilities or require us to acquire costly equipment or incur significant expense. While we are not currently aware of any material violations, we may have to spend funds to comply with present and future regulations or be required to perform site remediation. Our medical device business, which represented approximately 30 percent of our net sales in the second quarter of fiscal 2005, is subject to substantial government regulation, primarily from the federal FDA and similar regulatory bodies in other countries. We must comply with statutes and regulations covering the design, development, testing, manufacturing and labeling of medical devices and the reporting of certain information regarding their safety. Failure to comply with these rules can result in, among other things, our and our customers being subject to fines, injunctions, civil penalties, criminal prosecution, recall or seizure of devices, or total or partial suspension of production. The FDA also has the authority to require repair or replacement of equipment, or refund of the cost of a device manufactured or distributed by our customers. Violations may lead to penalties or shutdowns of a program or a facility. In addition, failure or noncompliance could have an adverse effect on our reputation. In addition, there are two European Union ("EU") directives which could affect our business and results. The first of these is the Restriction of the use of Certain Hazardous Substances ("RoHS"). RoHS becomes effective on July 1, 2006, and restricts within the EU the distribution of products containing certain substances, lead being the most relevant restricted substance to us. Although all implementing details of the directive are not yet known, it appears that we will be required to manufacture RoHS compliant products for customers intending to sell into the EU after the effective date. The second EU directive is the Waste Electrical and Electronic Equipment directive, effective August 13, 2005, under which a manufacturer or importer will be required, at its own cost, to take back and recycle all of the products it manufactured in or imported into the EU. Since both of these directives affect the worldwide electronics supply-chain, we expect to make collaborative efforts with our suppliers and customers to develop compliant processes and products. The cost of such efforts, the degree to which we will be expected to absorb such costs, the impact that the directive may have on product shipments, and our liability for non-compliant product is not yet known, but could have a material effect on our operations and results. In recent periods, our sales related to the defense/security/aerospace sector have begun to increase. Companies such as Plexus that design and manufacture for this sector face governmental and other requirements that could materially affect their financial condition and results of operations. 27 PRODUCTS WE MANUFACTURE MAY CONTAIN DESIGN OR MANUFACTURING DEFECTS THAT COULD RESULT IN REDUCED DEMAND FOR OUR SERVICES AND LIABILITY CLAIMS AGAINST US. We manufacture products to our customers' specifications that are highly complex and may at times contain design or manufacturing defects. Defects have been discovered in products we manufactured in the past and, despite our quality control and quality assurance efforts, defects may occur in the future. Defects in the products we manufacture, whether caused by a design, manufacturing or component defects, may result in delayed shipments to customers or reduced or cancelled customer orders. If these defects occur in large quantities or too frequently, our business reputation may also be tarnished. In addition, these defects may result in liability claims against us. Even if customers are responsible for the defects, they may or may not be able to assume responsibility for any costs or payments. OUR PRODUCTS ARE FOR THE ELECTRONICS INDUSTRY, WHICH PRODUCES TECHNOLOGICALLY ADVANCED PRODUCTS WITH SHORT LIFE CYCLES. Factors affecting the electronics industry, in particular the short life cycle of products, could seriously harm our customers and, as a result, us. These factors include: - the inability of our customers to adapt to rapidly changing technology and evolving industry standards that result in short product life cycles - the inability of our customers to develop and market their products, some of which are new and untested - the potential that our customers' products may become obsolete or the failure of our customers' products to gain widespread commercial acceptance. OUR BUSINESS IN THE WIRELINE/NETWORKING AND WIRELESS INFRASTRUCTURE SECTORS COULD BE SLOWED BY FURTHER GOVERNMENT REGULATION OF THE COMMUNICATIONS INDUSTRY. The end-markets for most of our customers in the wireline/networking and wireless infrastructure sectors are subject to extensive regulation by the Federal Communications Commission, as well as by various state and foreign government agencies. The policies of these agencies can directly affect both the near-term and long-term consumer and provider demand and profitability of the sector and therefore directly impact the demand for products that we manufacture. INCREASED COMPETITION MAY RESULT IN DECREASED DEMAND OR PRICES FOR OUR SERVICES. The electronics manufacturing services industry is highly competitive and has become more so as a result of excess capacity in the industry. We compete against numerous U.S. and foreign electronics manufacturing services providers with global operations, as well as those who operate on a local or regional basis. In addition, current and prospective customers continually evaluate the merits of manufacturing products internally. Consolidations and other changes in the electronics manufacturing services industry result in a continually changing competitive landscape. The consolidation trend in the industry also results in larger and more geographically diverse competitors that may have significantly greater resources with which to compete against us. Some of our competitors have substantially greater managerial, manufacturing, engineering, technical, financial, systems, sales and marketing resources than we do. These competitors may: - respond more quickly to new or emerging technologies - have greater name recognition, critical mass and geographic and market presence - be better able to take advantage of acquisition opportunities - adapt more quickly to changes in customer requirements - devote greater resources to the development, promotion and sale of their services - be better positioned to compete on price for their services. We may be operating at a cost disadvantage compared to manufacturers who have greater direct buying power from component suppliers, distributors and raw material suppliers or who have lower cost structures. As a result, competitors may have a competitive advantage and obtain business from our customers. Our manufacturing 28 processes are generally not subject to significant proprietary protection, and companies with greater resources or a greater market presence may enter our market or increase their competition with us. Increased competition could result in price reductions, reduced sales and margins or loss of market share. WE DEPEND ON CERTAIN KEY PERSONNEL, AND THE LOSS OF KEY PERSONNEL MAY HARM OUR BUSINESS. Our success depends in large part on the continued service of our key technical and management personnel, and on our ability to attract and retain qualified employees, particularly those highly skilled design, process and test engineers involved in the development of new products and processes and the manufacture of existing products. The competition for these individuals is significant, and the loss of key employees could harm our business. EXPANSION OF OUR BUSINESS AND OPERATIONS MAY NEGATIVELY IMPACT OUR BUSINESS. We have expanded our presence in Malaysia and may further expand our operations by establishing or acquiring other facilities or by expanding capacity in our current facilities. We may expand both in geographical areas in which we currently operate and in new geographical areas within the United States and internationally. We may not be able to find suitable facilities on a timely basis or on terms satisfactory to us. Expansion of our business and operations involves numerous business risks, including: - the inability to successfully integrate additional facilities or capacity and to realize anticipated synergies, economies of scale or other value - additional fixed costs which may not be fully absorbed by the new business - difficulties in the timing of expansions, including delays in the implementation of construction and manufacturing plans - creation of excess capacity, and the need to reduce capacity elsewhere if anticipated sales or opportunities do not materialize - diversion of management's attention from other business areas during the planning and implementation of expansions - strain placed on our operational, financial, management, technical and information systems and resources - disruption in manufacturing operations - incurrence of significant costs and expenses - inability to locate sufficient customers or employees to support the expansion. WE MAY FAIL TO SUCCESSFULLY COMPLETE FUTURE ACQUISITIONS AND MAY NOT SUCCESSFULLY INTEGRATE ACQUIRED BUSINESSES, WHICH COULD ADVERSELY AFFECT OUR OPERATING RESULTS. Although we have previously grown through acquisitions, our current focus is on pursuing organic growth opportunities. If we were to pursue future growth through acquisitions, however, this would involve significant risks that could have a material adverse effect on us. These risks include: Operating risks, such as the: - inability to integrate successfully our acquired operations' businesses and personnel - inability to realize anticipated synergies, economies of scale or other value - difficulties in scaling up production and coordinating management of operations at new sites - strain placed on our personnel, systems and resources - possible modification or termination of an acquired business's customer programs, including cancellation of current or anticipated programs - loss of key employees of acquired businesses. Financial risks, such as the: - use of cash resources, or incurrence of additional debt and related interest expenses - dilutive effect of the issuance of additional equity securities 29 - inability to achieve expected operating margins to offset the increased fixed costs associated with acquisitions, and/or inability to increase margins at acquired entities to Plexus' desired levels - incurrence of large write-offs or write-downs - impairment of goodwill and other intangible assets - unforeseen liabilities of the acquired businesses. WE MAY FAIL TO SECURE NECESSARY FINANCING. We maintain a Secured Credit Facility with a group of banks, which allows us to borrow up to $150 million depending upon compliance with related covenants and conditions. However, we cannot be sure that the Secured Credit Facility will provide all of the financing capacity that we will need in the future. Our future success may depend on our ability to obtain additional financing and capital to support increased sales and our possible future growth. We may seek to raise capital by: - issuing additional common stock or other equity securities - issuing debt securities - modifying existing credit facilities or obtaining new credit facilities - a combination of these methods. We may not be able to obtain capital when we want or need it, and capital may not be available on satisfactory terms. If we issue additional equity securities or convertible debt to raise capital, it may be dilutive to shareholders' ownership interests. Furthermore, any additional financing may have terms and conditions that adversely affect our business, such as restrictive financial or operating covenants, and our ability to meet any financing covenants will largely depend on our financial performance, which in turn will be subject to general economic conditions and financial, business and other factors. RECENTLY ENACTED CHANGES IN THE SECURITIES LAWS AND REGULATIONS ARE LIKELY TO INCREASE COSTS. The Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") has required changes in some of our corporate governance, securities disclosure and compliance practices. In response to the requirements of the Sarbanes-Oxley Act, the SEC and the NASDAQ Stock Market have promulgated new rules on a variety of subjects. Compliance with these new rules has increased our legal and accounting costs, and we expect these increased costs to continue indefinitely. These developments may also make it more difficult for us to attract and retain qualified members of our board of directors or qualified executive officers. IF WE REACH OTHER THAN AN AFFIRMATIVE CONCLUSION ON THE ADEQUACY OF OUR INTERNAL CONTROL OVER FINANCIAL REPORTING AS OF SEPTEMBER 30, 2005 AND FUTURE YEAR-ENDS AS REQUIRED BY THE SECTION 404 OF THE SARBANES-OXLEY ACT, INVESTORS COULD LOSE CONFIDENCE IN THE RELIABILITY OF OUR FINANCIAL STATEMENTS, WHICH COULD RESULT IN A DECREASE IN THE VALUE OF THE OUR COMMON STOCK. As required by Section 404 of the Sarbanes-Oxley Act, the SEC adopted rules requiring public companies to include a report of management on the company's internal control over financial reporting in their annual reports on Form 10-K; that report must contain an assessment by management of the effectiveness of the company's internal control over financial reporting. In addition, the public accounting firm auditing a company's financial statements must attest to and report on both management's assessment as to whether the company maintained effective internal control over financial reporting and on the effectiveness of the company's internal control over financial reporting. We are currently undergoing a comprehensive effort to comply with Section 404 of the Sarbanes-Oxley Act. If we are unable to complete our assessment in a timely manner or if we and/or our independent auditors determine that there are material weaknesses regarding the design or operating effectiveness of our internal control over financial reporting, this could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements, which could cause the market price of our shares to decline. A weakness in our stock price could mean that investors may not be able to sell their shares at or above the prices that they paid. A weakness in stock price could also impair our ability in the future to offer common stock or convertible securities as a source of additional capital and/or as consideration in the acquisition of other businesses. 30 THE PRICE OF OUR COMMON STOCK HAS BEEN AND MAY CONTINUE TO BE VOLATILE. Our stock price has fluctuated significantly in recent periods. The price of our common stock may fluctuate significantly in response to a number of events and factors relating to us, our competitors and the market for our services, many of which are beyond our control. In addition, the stock market in general, and especially the NASDAQ Stock Market, along with share prices for technology companies in particular, have experienced extreme volatility, including weakness, that sometimes has been unrelated to the operating performance of these companies. These broad market and industry fluctuations may adversely affect the market price of our common stock, regardless of our operating results. Our stock price and the stock price of many other technology companies remain below their peaks. Among other things, volatility and weakness in Plexus' stock price could mean that investors may not be able to sell their shares at or above the prices that they paid. Volatility and weakness could also impair Plexus' ability in the future to offer common stock or convertible securities as a source of additional capital and/or as consideration in the acquisition of other businesses. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We are exposed to market risk from changes in foreign exchange and interest rates. To reduce such risks, we selectively use financial instruments. FOREIGN CURRENCY RISK We do not use derivative financial instruments for speculative purposes. Our policy is to selectively hedge our foreign currency denominated transactions in a manner that substantially offsets the effects of changes in foreign currency exchange rates. Presently, we use foreign currency contracts to hedge only those currency exposures associated with certain assets and liabilities denominated in non-functional currencies. Corresponding gains and losses on the underlying transaction generally offset the gains and losses on these foreign currency hedges. Our international operations create potential foreign exchange risk. As of April 2, 2005, we had no foreign currency contracts outstanding. Our percentages of transactions denominated in currencies other than the U.S. dollar for the indicated periods were as follows:
Three months ended Six months ended ----------------------- ----------------------- April 2, March 31, April 2, March 31, 2005 2004 2005 2004 -------- --------- -------- --------- Net Sales 10% 10% 9% 11% Total Costs 14% 14% 13% 14%
INTEREST RATE RISK We have financial instruments, including cash equivalents and short-term investments, which are sensitive to changes in interest rates. We consider the use of interest-rate swaps based on existing market conditions. We currently do not use any interest-rate swaps or other types of derivative financial instruments to hedge interest rate risk. The primary objective of our investment activities is to preserve principal, while maximizing yields without significantly increasing market risk. To achieve this, we maintain our portfolio of cash equivalents and short-term investments in a variety of highly rated securities, money market funds and certificates of deposit and limit the amount of principal exposure to any one issuer. Our only material interest rate risk is associated with our secured credit facility. A 10 percent change in our weighted average interest rate on average long-term borrowings would have had a nominal impact on net interest expense for both the three months and six months ended April 2, 2005 and March 31, 2004. 31 ITEM 4. CONTROLS AND PROCEDURES Disclosure Controls and Procedures: The Company maintains disclosure controls and procedures designed to ensure that the information the Company must disclose in its filings with the Securities and Exchange Commission is recorded, processed, summarized and reported on a timely basis. The Company's principal executive officer and principal financial officer have reviewed and evaluated, with the participation of the Company's management, the Company's disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act") as of the end of the period covered by this report (the "Evaluation Date"). Based on such evaluation, such officers have concluded that, as of the Evaluation Date, the Company's disclosure controls and procedures are effective in bringing to their attention on a timely basis material information relating to the Company required to be included in the Company's periodic filings under the Exchange Act. Internal Control Over Financial Reporting: As previously disclosed, the Company commenced a phased implementation of a global Enterprise Resource Planning (ERP) platform in fiscal 2001. Through April 2, 2005, five facilities have been converted to the ERP platform, including one facility converted in the second quarter of fiscal 2005. The conversion of the facility in the second quarter of fiscal 2005 and the related changes to the Company's internal control (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) did not have a material effect on, nor is it reasonably likely to materially affect, the Company's internal control over financial reporting. There have been no other significant changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company's internal control over financial reporting. The Company is currently undergoing a comprehensive effort to comply with Section 404 of the Sarbanes-Oxley Act of 2002. Compliance is required as of our fiscal year-end September 30, 2005. This effort includes documenting and testing of internal controls. During the course of these activities, the Company has identified certain other internal control issues which management believes should be improved. The Company is making improvements to its internal controls over financial reporting as a result of its review efforts; however, we do not believe these improvements represent a significant change that would have a material affect, or that would reasonably likely to materially affect, the Company's internal control over financial reporting. These planned improvements include additional information technology system controls, further formalization of policies and procedures, improved segregation of duties and additional monitoring controls. The matters noted herein have been discussed with the Company's Audit Committee. The Company believes that it is taking the necessary steps to monitor and maintain appropriate internal control during periods of change. 32 PART II - OTHER INFORMATION ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Item 4. Submission of Matter to a Vote of Security Holders At the Company's annual meeting of shareholders on February 9, 2005, the seven management nominees for re-election to the board were re-elected by the shareholders. The nominees/directors were re-elected with the following votes:
Authority for Director's Name Authority Granted Voting Withheld --------------------- ----------------- --------------- Ralf R. Boer 36,852,465 1,736,876 Stephen P. Cortinovis 36,541,641 2,047,700 David J. Drury 36,541,928 2,047,413 Dean A. Foate 36,786,929 1,802,412 John L. Nussbaum 36,783,297 1,806,044 Thomas J. Prosser 36,053,338 2,536,003 Charles M. Strother 36,548,979 2,040,362
In addition, the shareholders approved the Plexus Corp. 2005 Equity Incentive Plan. The vote on the proposal was as follows: For: 27,768,909 Against: 4,248,681 Abstain: 595,919 Broker Non-votes: 5,975,832
In addition, the shareholders approved the Plexus Corp. 2005 Employee Stock Purchase Plan. The vote on the proposal was as follows: For: 30,962,303 Against: 1,071,274 Abstain: 579,932 Broker Non-votes: 5,975,832
In addition, the shareholders ratified the selection of PricewaterhouseCoopers LLP as the independent auditors for fiscal 2005. The vote on the proposal was as follows: For: 36,462,286 Against: 2,079,973 Abstain: 47,082
ITEM 6. EXHIBITS 31.1 Certification of Chief Executive Officer pursuant to Section 302(a) of the Sarbanes Oxley Act of 2002. 31.2 Certification of Chief Financial Officer pursuant to section 302(a) of the Sarbanes Oxley Act of 2002. 32.1 Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 33 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant had duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Plexus Corp. ------------------------------------- (Registrant) 5/12/05 /s/ Dean A. Foate ------- ------------------------------------- Date Dean A. Foate President and Chief Executive Officer 5/12/05 /s/ F. Gordon Bitter ------- ------------------------------------------------- Date F. Gordon Bitter Senior Vice President and Chief Financial Officer 34