Good morning, and welcome to the Plexus Corp. Conference Call regarding the Fiscal First Quarter 2020 Earnings Announcement. My name is John, and I'll be your operator for today's call. [Operator Instructions]. Please note that this conference is being recorded. And I would now like to turn the call over to Ms. Heather Beresford, Plexus' Senior Director of Communications and Investor Relations. Heather?

Good morning, and thank you for joining us today. Some of the statements made and information provided during our call today will be forward-looking statements as they will not be limited to historical facts. The words believe, expect, intend, plan, anticipate and similar terms often identify forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in the forward-looking statements. For a list of factors that could cause actual results to differ materially from those discussed, please refer to the company's periodic SEC filings, particularly the risk factors in our Form 10-K filing for the fiscal year ended September 28, 2019, and the safe harbor and fair disclosure statement in yesterday's press release. Plexus provides non-GAAP supplemental information such as ROIC, economic return and free cash flow because those measures are used for internal management goals and decision-making and because they provide additional insight into financial performance. In addition, management uses these and other non-GAAP measures such as adjusted operating income, adjusted operating margin, adjusted net income and adjusted earnings per share to provide a better understanding of core performance for purposes of period-to-period comparison. For a full reconciliation of non-GAAP supplemental information, please refer to yesterday's press release and our periodic SEC filings. We encourage participants on the call this morning to access the live webcast and supporting materials at Plexus' website at www.plexus.com, clicking on Investors at the top of that page. Joining me today are Todd Kelsey, President and Chief Executive Officer; Steve Frisch, Executive Vice President and Chief Operating Officer; and Pat Jermain, Executive Vice President and Chief Financial Officer. Consistent with prior earnings calls, Todd will provide summary comments before turning the call over to Steve and Pat for further details. Let me now turn the call over to Todd Kelsey. Todd?

Thank you, Heather, and good morning, everyone. Please begin with our fiscal first quarter results on Slide 3. After the close of the market yesterday evening, we reported results for our fiscal first quarter of 2020. We achieved record quarterly revenue of $852 million, which exceeded the top end of our guidance range of $780 million to $820 million. This revenue represents 11% growth over the comparable period in fiscal 2019 and 5% growth sequentially. Our Healthcare/Life Sciences sector exceeded our expectations coming into the quarter as our team responded to increased demand from several customers. In addition, our Industrial/Commercial sector produced exceptional results as we capitalized on further strengthening in the semiconductor capital equipment market and broad improvements in demand throughout the remainder of the sector. We delivered GAAP EPS of $1.03, including $0.17 of stock-based compensation expense and non-GAAP EPS of $1, both exceeded our guidance range, which was $0.87 to $0.97. The non-GAAP result excluded a net $0.03 benefit due to special tax items. Our global teams continue to prioritize operational excellence and through that focus, delivered fiscal first quarter operating margin of 4.7% at the midpoint of our guidance range and within our target range of 4.7% to 5%. Please advance to Slide 4. Next, I will discuss additional accomplishments within the fiscal first quarter of 2020. I will start with items associated with the balance sheet. We continue to make progress on our working capital initiatives in the fiscal first quarter. We ended the quarter at 87 days of inventory, representing an 18-day improvement from the first quarter of fiscal 2019. Our inventory performance, coupled with improved receivables days and payables days, led to a cash conversion cycle of 71 days. Our cash cycle is down 18 days over the past 2 quarters. The end…

Thank you, Todd. Good morning. Please advance to Slide 8 for a review of our performance by market sector for the fiscal first quarter of 2020, as well as our expectations for the sectors for the second fiscal quarter of 2020. Our Healthcare/Life Sciences revenue was flat in the fiscal first quarter. The result easily surpassed our expectations of a mid- single-digit decline. Our customers' forecast did not show a seasonal strength as we entered the quarter, however, 15 of our top 20 customers in the sector increased forecast within the quarter to meet robust calendar year-end demand. The strong calendar year-end shipments is impacting our fiscal second quarter projections. We expect approximately a 10% decline for our Healthcare/Life Sciences sector in the fiscal second quarter. We believe this demand swing is a short-term correction, and the sector will rebound in the fiscal third quarter. Revenue in our Industrial/Commercial sector increased 17% for the fiscal first quarter. The result was significantly better than our expectations of a low single-digit increase. Although the largest revenue increases were led by our semiconductor capital equipment customers, greater demand from 11 of the top 12 customers and the remaining subsectors contributed to the strong growth. As we look at the fiscal second quarter, we expect that the semiconductor capital equipment subsector will maintain the increased level of demand however, we see a modest pullback in some of the other subsectors. The net result is that we are anticipating revenue to be flat for our Industrial/Commercial sector in the fiscal second quarter. We are in close communication with several of our semiconductor capital equipment customers as there are indications that we may see additional upside to our current forecast for calendar 2020. The obvious questions we're trying to answer is, when and how much? Our…

Thank you, Steve, and good morning, everyone. Our fiscal first quarter results are summarized on Slide 13. Revenue of $852 million was above the top end of our guidance, while gross margin of 9.3% was at our midpoint. Selling and administrative expense of $39.3 million was above our guidance, primarily due to higher variable incentive compensation expense. As a percentage of revenue, SG&A was 4.6%, sequentially improved by 20 basis points and consistent with our expectations. Operating margin of 4.7% was at the midpoint of our guidance and within our target operating margin range. Included in this quarter's operating margin was approximately 60 basis points of stock-based compensation expense. Nonoperating expenses of $5.7 million were slightly above our guidance as a result of foreign exchange losses. Our GAAP effective tax rate for the fiscal first quarter was 10%, which included a net benefit of $800,000 related to special tax items recorded during the quarter. Excluding these items, our non-GAAP effective tax rate was 12%, slightly favorable to our guidance range of 13% to 15%. GAAP diluted EPS of $1.03 included $0.03 per share related to the special tax items. Excluding these items, non-GAAP diluted EPS of $1 was above the top end of our guidance primarily due to the strong revenue results. Turning now to the balance sheet and cash flow on Slide 14. During the quarter, we purchased approximately 91,000 shares of our stock for $6.3 million at an average price of $69.82 per share. At the end of the fiscal first quarter, we had approximately $40 million remaining under the authorization. For the fiscal first quarter, we were pleased with our free cash flow results. We generated $75 million in cash from operations and spent $14 million on capital expenditures, resulting in free cash flow of $61 million.…

[Operator Instructions]. And our first question is from Shawn Harrison from Longbow Research.

Just to say, I know it's a small piece of the mix and so it's probably not the biggest focus, but within the Communications, I think the old goal was to have that business flat potentially for the fiscal year. And with the underperformance last quarter and the decline this quarter, maybe if we could get into just what is the incremental weakness there? I think the thinking was that it had bottomed out, but it clearly hadn't. And maybe what could the back half look like, is there further deceleration in that business?

This is Steve, I can -- I'll handle that one. Looking at this quarter, I think, as you probably know, the MSOs are announcing their first quarter projections today and through the end of next week. And I think we'll get a lot more visibility into what their spending is going to be. So I think people are hesitant to really start building product in advance of those announcements. And so from an architectural standpoint, we do see distributed coming up a bit. We see a little bit of upside in more of the centralized architecture. And so I think people are really trying to figure out what is going to be the winner for the architecture as we go into fiscal '20. And I think that will dictate for us kind of what '20 looks like. As I look towards the back half of the year, we do see some strengthening. And even in Q3, the forecast now are basically holding with what we thought. But again, I think until we see what comes out from the MSOs and our spending patterns and our customers adjust their forecast, where we truly understand what the back half of '20 looks like.

One of the things I'd add, Shawn, is that our expectations for the longer term had been for comps to stay flat. I think for '20, we always expected it to be down because we face a really big headwind from some of the demand that's dropped from a significant customer within that space going into it. As Steve had mentioned, we have a couple of program ramps that could turn the trajectory of the revenue in a different direction in the back half of the year, but we'd still expect it to be a single-digit sector for us.

Okay. And then as a follow-up. I mean, Defense/Aerospace grew 40% in the December quarter, it looks like you have a really bullish outlook for '20 still. Are you seeing any impact from the production stoppage of the 737 Max? Or is it just that you've got so many diversified wins that, that stoppage is not really impacting the business?

Yes, I think it's the latter, Shawn. I mean it's -- we have a very diversified portfolio within aerospace. I mean the indications on our 737 Max program is, there's been no impact as of yet. But even if there is, it will be negligible to our Aerospace and Defense revenue. You won't notice it.

All right. Great. Congrats on the results.

Thank you.

Thanks.

Our next question is from Matt Sheerin from Stifel.

Just a question regarding your operating margin guidance for the coming quarter and for the year. You're still looking at 4.7% to 5% range for the second half, but you did originally guide for the full year. Are you -- is that still something that you could achieve? Or is that, at this point really dependent on how the year shapes out?

Yes. I would say it's a bit dependent right now. I mean we see the back half of the year as being 4.7% to 5% with a pretty strong likelihood. But for the full year, I think it remains a little bit as to how we come through this quarter because this quarter is a bit more challenged than we had anticipated. But we should be right in that area for the full fiscal year.

And you're looking for pretty significant growth based on your wins in the second half wins from some of these sectors, and I know in the past, with some of these programs, there's cost related to that, which is always a little bit of a squeeze on margins. Is that factored into your guidance in terms of expectations because you have visibility on those ramps so you can manage those better?

It is. Yes, it is.

Okay. And then on the inventory side, pretty strong reduction. It sounds like you're going to start to build some inventory backup, are you seeing any signs of component constraints like you have in previous quarters? Or are you able to run relatively lean here?

Yes. Matt, this is Steve. We're not seeing the component constraints we saw in the past. I mean there's always an issue here and there that we'll continue to chase, but nothing compared to what it was in previous quarters.

Our next question is from Jim Ricchiuti from Needham & Company.

Just a question on some of the strength you're seeing in the semi-cap part of the industrial business. You seem to be suggesting that there may be some upside in that area of the business looking out over the balance of the year. Is that coming from multiple customers? And I assume that, that's better margin business, is that correct?

So, to answer the first part of your question, this is Steve. Yes, we see a potential for upside in the coming quarters. The question is -- and it's kind of how I stated it is, how much and when? I think generally speaking across all of the customers, they do expect to see upside in the coming quarters. It's really been hard to predict when that's going to hit. So obviously, this quarter was strong. That strength is continuing into this quarter. But what we see more in the back half of the year is what we're working through. So, we're working very closely with customers to make sure that from a capacity standpoint and an inventory standpoint, we have the right things in place. And then in terms of margin profile, it varies by customer and by program. I mean it's in line with where Plexus' expectations are. So we'll...

Yes. Jim, this is Pat. I think when we see increased volumes from customers, we can gain some fixed cost leverage. But to Steve's point, it doesn't necessarily mean the margins are stronger by customer.

Got it. And just looking at the -- what you saw in the Healthcare/Life Science vertical. I'm just trying to understand, were there some -- was there some potential unexpected pull-ins of business that you might have been anticipating in the fiscal second quarter that benefited you in Q1?

Yes, we did see some pull-in that appears to be Q1 demand -- or first calendar quarter demand shifting into the fourth calendar quarter. So our Q2 shifting into Q1, we hadn't seen that. As we entered the quarter, it didn't appear that our customers we're going to show any end of calendar year strength. But that changed over the course of the quarter, and we do expect it to have an impact on our current quarter.

And Todd, that was from multiple customers?

Multiple customers, yes.

15 of the top 20 had upside in the quarter.

Okay. Got it. And just -- I know you're not giving guidance -- specific guidance looking out to the fiscal second half, but it seems like the -- there's the potential that your SG&A expense going forward is going to be at a slightly higher level? Is that also partly due to some of the mix changes you're seeing in the business?

Not necessarily, Jim. I think we can hold our SG&A to the levels they're at. This past quarter was higher because of higher incentive compensation, and that was a combination of the strong revenue and the return on invested capital. That's what was driving that higher. We do have the merit increases this quarter, but we typically work through those through productivity improvements. So I wouldn't expect it to be any higher than what we're looking at in Q2.

Okay. And then you alluded to some pause in the engineering program. So I wonder if you could just give a -- provide a little bit more color on that.

Yes. Well, we saw a couple of significant programs that paused, and I would call them for different reasons. And I wouldn't call them indications of any market softening, they're pausing because of issues around the customers, and one was with a more significant Healthcare OEM. And they're basically taking a closer look at their business case, balancing features versus development effort within that program. So that's caused them to step back for a bit. And others with a more early-stage customer that's really looking at their overall business model. So we think that there's a reasonable likelihood that both will go forward at some point but right now, it's having a near-term impact for us.

Got it. And that early-stage customers, is that also Healthcare? Or is that in your -- one of your other sectors?

Yes. It is Healthcare. It is Healthcare.

Our next question is from Paul Coster from JP Morgan.

The manufacturing wins trend has been, sort of, slightly down over the course of last few quarters. You sound confident that it's going to rebound pretty quickly. And I'm just wondering what you think the underlying cause might be? Is it the trade uncertainty and disruptions to supply chains? Or is there some other reason for this recent trend and its pending reversal?

Yes. This is Steve. I'll handle that one. And actually, I think I misspoke in the beginning, I think I said our trailing four quarters were $450 million. It's actually $850 million. And so a quick correction on that one. But from a trend standpoint, I think one of the things that we're analyzing and looking at, as we look at the trailing 4 quarters, the Healthcare/Life Sciences and Aerospace and Defense sectors, those trailing 4 quarters -- the revenue levels for those quarters have been the highest they've been in the last couple of years. And so those programs are a bit smaller. But as we're trying to talk about here is the duration of the things that are significantly longer. And as we've basically deemphasized, and we see the Communications numbers coming down, those are historically higher numbers, but the program durations were much smaller. And so as we look forward, we're confident as we're growing in these diversified sectors, and Todd talked about that over 90% of our revenue is going to be in these diversified sectors, that we're generating the wins that we needed to continue to grow. And so I think one of the things we need to do is take a look at the metrics that we're using and make sure that now that we have this different portfolio, the size of the wins that we need, we believe, are supporting the business, and we'll have to make sure that our metrics are measuring the right thing.

Makes sense. You said 15 of the 20 Healthcare/Life Sciences customers pulled forward. Is there an underlying trend to explain that?

From my perspective, if you looked at the beginning of the quarter, we actually talked about the fact that we had historically in the past, seen some seasonal upside in our fiscal Q1 related with the year-end demand. Our customers have not forecasted that as significant as they had in the past. And so we didn't know, quite frankly, if there was going to be softer demand in the Q1 -- in our Q1. But as we came through the quarter, we realized that, that demand was really there and customers needed to pull it in, and so we did that for them. So I don't know there's much more we can read into it. I think the demand was strong at the year-end. Our customers didn't anticipate it. We reacted to it. And again, I think as we look at the forecast going into Q3, we think it's going to rebound back to a normal level. So we do see it as just a 1 or 2 quarter kind of fluctuation.

Last question is, so we're seeing a number of companies in this space following your script a bit, which is to deemphasize the short product cycle business, the volatile business and focus on these long product cycle verticals. And also, we're seeing some pricing discipline. Do you concur that there is, sort of, rational pricing happening in your industry at the moment? And how does that play out over the course of time?

Yes. From our perspective, there is rational pricing in the industry right now. From a competitive standpoint, though, we don't see things as being significantly different. I mean, it's always been competitive in our spaces. We've always, kind of, competed with the same people. That looks rather similar, but the pricing situation is, I would call it, decent right now. So that's certainly a positive for all of us, I think, if we have good pricing discipline and drive to get value out of the services that we're providing.

Yes. And Paul, in some of these complex sectors that we operate within, there is higher working capital requirements. And so we've got to make sure the margins support that higher working capital. And I think our competitors are thinking the same and focusing on the return on invested capital side and ensuring those margins are high enough.

Our next question is from Anja Soderstrom from Sidoti.

Congratulations on the great quarter. And a lot of good questions asked already. I just wanted to follow up on, sort of, the contract wins. How can you bucket that from how much you are winning from existing customers versus winning -- transferring customers from in-house production? And maybe also, how you are comparing to peers?

So if I understood your question correctly, as we look at our wins in our funnel, we traditionally fall from a 60, 70 customer to a 30, 40 target split, both in wins as well as the funnel, and our focus varies by sector. For example, in our Healthcare/Life Sciences sector, we believe the number of logos and the customers that we have, there's a lot of opportunity to continue to harvest from them and support the growth that we need. Again, we're always looking at adding new customers. But again, they believe they have a strong customer base. As we looked at Industrial/Commercial, through fiscal 2019, one of the things we recognize is that we needed to add new customers to the portfolio. And so they focused -- that sector focused heavily on doing that, and made great progress doing it. And so we do look at it by sector, but we think that roughly 70-30, 60-40 split from customers target as a very healthy path forward with us. Obviously, growing with customers is much easier. They ramp quicker than it does with targets. So we like that mix.

Okay. And also, you mentioned that you're moving the -- shifting into the 90% -- over 90% of your revenue in the Healthcare/Life Sciences and Aerospace and Defense and Industrial and Commercial. So -- and their life cycles there are much longer. Can you just remind us how those compare to the Communications? And how much short are the Communications?

Yes, sure. We tend to think of the Communications as being about a 3- to 5-year life cycle on programs. And whereas we look at Aerospace and Defense being in the mid- to -- mid-teens to even 20-year life cycle, and Healthcare and Industrial tending to be closer to a 10-year life cycle. So it's quite a difference in when you're providing solid execution, maintaining the business in the amount of churn that's in the portfolio and the amount of business that you need to win.

Okay. That was helpful. And also, lastly, what are you going to do with all the cash?

Good question. So we'll continue to buyback. We expect to execute that remaining portion of the buyback this year. And we are paying down some of our debt, and we'll continue to do those 2 things and then reevaluate. We continue to see this level of free cash flow moving forward. We'll look at our alternatives around a future buyback or consider the merits of a dividend, too.

And we have a follow-up question from Jim Ricchiuti from Needham & Company?

The repositioning of the Boulder Design Center at Boise. I assume that -- is that something that has been under consideration in the works for a bit?

It's been under consideration for a bit because we saw the advantages strategically of having an Aerospace and Defense center of excellence, as we see Aerospace and Defense as a great growth opportunity for our Engineering Solutions organization, and co-locating those two facilities made a lot of sense strategically. But really, the pauses in the engineering programs, I guess, were the impetus to be able to move forward with it. So what we had considered it, it's a bit I'd call it -- it's taking -- or looking at the situation that we have in front of us and addressing it.

We have started our Boulder Design Center before our Boise operations. And if you had done it reverse, you do exactly what we're doing now, which having that center of excellence with the co-location and the full value stream is a significantly bigger value-add for our customers. And so as Todd said, taking advantage of the situation and making a better long-term strategic alignment is the right way to go for us.

Got it. And maybe you guys -- if you could, maybe just remind us, as you think about some of your other verticals, and to what extent are -- have you adopted this, kind of, a strategy in some of the other verticals with these centers of excellence?

Well, it hasn't necessarily been pegged as centers of excellence, but there's a great deal of co-location between our engineering facilities and our manufacturing facilities, and we found that to be very effective.

And we have no further questions at this time. I'll now turn it back over to CEO, Todd Kelsey, for closing remarks.

All right. Thank you, John, and I just wanted to close briefly by thanking everyone who joined our call today. We appreciate your support. We appreciate your interest in Plexus.

And thank you, ladies and gentlemen. That concludes today's conference. Thank you for participating, and you may now disconnect.