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PLXS > SEC Filings for PLXS > Form 10-K on 22-Nov-2013All Recent SEC Filings

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Form 10-K for PLEXUS CORP


22-Nov-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

OVERVIEW
Plexus Corp. and its subsidiaries (together "Plexus," the "Company," or "we") participate in the Electronic Manufacturing Services ("EMS") industry. We deliver optimized Product Realization solutions through a unique Product Realization Value Stream services model. This customer focused services model seamlessly integrates innovative product conceptualization, design, commercialization, manufacturing, fulfillment and sustaining services to deliver comprehensive end-to-end solutions for customers in the Americas ("AMER"), Europe, Middle East and Africa ("EMEA") and Asia-Pacific ("APAC") regions. Customer service is provided to over 140 branded product companies in the Networking/Communications, Healthcare/Life Sciences, Industrial/Commercial and Defense/Security/Aerospace market sectors. Our customers' products typically require exceptional production and supply-chain flexibility, necessitating an optimized demand-pull-based manufacturing and supply chain solution across an integrated global platform. Many of our customers' products require complex configuration management and direct order fulfillment to their customers across the globe. In such cases we provide global logistics management and after-market service and repair. Our customers' products may have stringent requirements for quality, reliability and regulatory compliance. We offer our customers the ability to outsource all phases of product realization, including product specifications; development, design and design verification; regulatory compliance support; prototyping and new product introduction; manufacturing test equipment development; materials sourcing, procurement and supply-chain management; product assembly/manufacturing, configuration and test; order fulfillment, logistics and service/repair.

We provide most of our contract manufacturing services on a turnkey basis, which means that we procure some or all of the materials required for product assembly. We provide some services on a consignment basis, which means that the customer supplies the necessary materials, and we provide the labor and other services required for product assembly. Turnkey services require material procurement and warehousing, in addition to manufacturing, and involve greater resource investments than consignment services. Other than certain test equipment and software used for internal operations, we do not design or manufacture our own proprietary products.

The following information should be read in conjunction with our consolidated financial statements included herein and "Risk Factors" included in Part I, Item 1A herein.

Recent Developments

As previously disclosed, in fiscal 2013, Juniper Networks, Inc. ("Juniper") disengaged from Plexus. Production for Juniper concluded at the end of our third fiscal quarter of 2013 and sales of inventory concluded in our fourth fiscal quarter of 2013. We incurred approximately $0.6 million of severance and asset impairment costs in connection with the disengagement in the third quarter of fiscal 2013; no further related costs are expected. Sales to Juniper were 13% of our net sales in fiscal 2013 as compared to 16% in fiscal 2012, and were from the Company's AMER and APAC segments. We expect no further shipments to Juniper in fiscal 2014.

Our new Neenah, Wisconsin manufacturing facility, which will replace one owned and two leased facilities, opened in the fiscal first quarter of 2014. Consolidation of the three other facilities into our new facility is expected to result in approximately $3.0 to $4.0 million of restructuring charges in the first half of fiscal 2014.
RESULTS OF OPERATIONS

Consolidated Performance Summary
The following table presents selected consolidated financial data for fiscal
2013, 2012 and 2011 (dollars in millions, except per share data):

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                                               2013                 2012                2011
Net sales                                $    2,228.0         $    2,306.7         $    2,231.2
Gross profit                                    213.2                219.9                214.7
Gross margin                                      9.6 %                9.5 %                9.6 %
Operating income                                 96.6                104.2                101.2
Operating margin                                  4.3 %                4.5 %                4.5 %
Net income                                       82.3                 62.1     *           89.3
Earnings per share (diluted)             $       2.36         $       1.75     *   $       2.30
Return on invested capital                       14.0 %               15.5 %               15.6 %

*See Note 7 in Notes to Consolidated Financial Statements for discussion regarding the fiscal 2012 valuation allowance for deferred tax assets.

Net sales. Net sales for fiscal 2013 decreased $78.7 million, or 3.4 percent, as compared to fiscal 2012. The net sales decrease was primarily the result of a $113.6 million decrease in net sales for one of our larger customers in the industrial/commercial sector, as a result of its decreased end-market demand, as well as an $85.3 million decrease in net sales to Juniper, as a result of its disengagement and lower end-market demand for the products we produced for Juniper. These decreases were partially offset by a $102.4 million increase in net sales to various significant customers in all sectors.
Net sales for fiscal 2012 increased $75.5 million, or 3.4 percent, as compared to fiscal 2011. The net sales increase resulted from higher net sales in all of our market sectors, except for a decrease in the networking/communications sector. The net sales increase primarily related to the continued ramp of production for a significant industrial/commercial sector customer and $81.9 million of incremental revenue from the strategic arrangement with Kontron (the "Kontron arrangement"), as well as program ramps from several other existing customers. These increases in net sales were partially offset by decreased sales in the networking/communications sector due to lower end-market demand and two customer disengagements as a result of the acquisition of such customers by other companies.
Our net sales by market sector for fiscal 2013, 2012 and 2011 were as follows (in millions):

Market Sector                   2013         2012         2011
Networking/Communications    $   826.3    $   903.6    $ 1,029.9
Industrial/Commercial            551.0        670.8        528.0
Healthcare/Life Sciences         563.2        494.4        470.2
Defense/Security/Aerospace       287.5        237.9        203.1
                             $ 2,228.0    $ 2,306.7    $ 2,231.2

Networking/Communications. Net sales for the networking/communications sector decreased $77.3 million for fiscal 2013 compared to fiscal 2012. The change was primarily the result of an $85.3 million decrease in net sales to Juniper, related to its disengagement, partially offset by increased sales to existing customers in this sector as well as program ramps with new customers. Net sales for the networking/communications sector decreased $126.3 million for fiscal 2012 compared to fiscal 2011. The decline in the sector was primarily the result of the $74.9 million impact from the fiscal 2011 disengagement of two significant customers noted above and overall unfavorable end-market trends reflecting global economic uncertainty. Net sales to Juniper in fiscal 2012 did not change significantly from fiscal 2011.
Industrial/Commercial. Net sales for the industrial/commercial sector decreased $119.8 million for fiscal 2013 compared to fiscal 2012. The decrease was primarily a result of decreased end-market demand for one of our larger customers in the sector, which accounted for $113.6 million of the decreased net sales as compared to the prior year.
Net sales for the industrial/commercial sector increased $142.8 million for fiscal 2012 compared to fiscal 2011. The increase was primarily attributable to the continued ramp of a significant customer and $81.9 million of incremental revenue related to the Kontron arrangement, as well as the addition of a new customer in this sector.


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Healthcare/Life Sciences. Net sales for the healthcare/life sciences sector increased $68.8 million for fiscal 2013 compared to fiscal 2012. The increase was primarily due to market share gains and new program ramps with existing customers.
Net sales for the healthcare/life sciences sector increased $24.2 million for fiscal 2012 compared to fiscal 2011. The increase was primarily due to market share gain and new programs with existing customers.
Defense/Security/Aerospace. Net sales for the defense/security/aerospace sector increased $49.6 million for fiscal 2013 compared to fiscal 2012. The increase was the result of new program ramps as well as increased end-market demand for the products we produce for our customers.
Net sales for the defense/security/aerospace sector increased $34.8 million for fiscal 2012 compared to fiscal 2011. The increase was primarily due to stronger end-market demand in the aerospace market as well as the addition of a new customer in this sector.


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The percentages of net sales to customers representing 10 percent or more of net sales and net sales to our ten largest customers for fiscal 2013, 2012 and 2011 were as follows:

                   2013   2012   2011
Juniper            13%    16%    17%
Top 10 customers   55%    60%    55%

Juniper disengaged from Plexus in fiscal 2013 and we expect no further shipments to Juniper in fiscal 2014.
Gross profit. For fiscal 2013, gross profit decreased $6.7 million, or 3.1%, compared to fiscal 2012 primarily due to decreased net sales, increased fixed expenses related to site expansions in Penang, Malaysia, Xiamen, China and Oradea, Romania and unfavorable changes in customer mix. The decrease was partially offset by the sale of certain inventory that had previously been written down. A slightly larger percentage decrease in revenue as compared to the decrease in gross profit for fiscal 2013 led to an increase in gross margin to 9.6 percent for fiscal 2013 from 9.5 percent for fiscal 2012.

For fiscal 2012, gross profit increased $5.2 million compared to fiscal 2011 primarily due to the net sales increase. The increase was partially offset by increased fixed expenses related to higher headcount to support the revenue growth, costs related to the addition of a fourth facility in Penang, Malaysia of approximately $5.9 million, transition costs due to the Kontron arrangement, and an unfavorable change in customer mix. Customer mix negatively impacted gross profit due to a higher portion of sales from new programs, which tend to be inherently less profitable during early production stages than mature programs. Gross profit was also negatively impacted by escalated pricing pressure, particularly in our networking/communications sector. These factors led to the reduction in gross margin to 9.5 percent for fiscal 2012 from 9.6 percent for fiscal 2011.
Operating income. For fiscal 2013, operating income decreased $7.5 million compared to fiscal 2012. The operating income decrease reflected the $6.7 million decrease in gross profit described above as well as a $0.8 million increase in selling and administrative expenses ("S&A"). The dollar increase in S&A was primarily due to approximately $2.4 million of recoveries of receivables previously at risk in the prior fiscal year, with no such recovery in the current fiscal year, and approximately $0.8 million of additional amortization expense in fiscal 2013 related to the Kontron arrangement. These increases were partially offset by a $1.3 million decrease in incentive compensation expense and additional reductions due to focused cost management efforts. As a result of the factors discussed above, for fiscal 2013 compared to fiscal 2012, operating margin decreased from 4.5 percent to 4.3 percent.
For fiscal 2012, operating income increased $3.0 million compared to fiscal 2011. The operating income increase reflected the $5.2 million increase in gross profit described above, partially offset by a $2.2 million increase in S&A. The dollar increase in S&A was primarily due to a $1.5 million increase in stock-based compensation expense, $1.3 million of amortization expense resulting from an intangible asset related to the Kontron arrangement and an increase in other personnel expenses. These increases were partially offset by approximately $2.4 million of recoveries of receivables previously at risk. As a result of the factors discussed above, for fiscal 2012 compared to fiscal 2011, operating margin remained at 4.5 percent.

Other income (expense). Other expense decreased to $11.6 million for fiscal 2013 from $12.9 million for fiscal 2012. The decrease in expense was largely due to $3.4 million of decreased interest expense related to our term loan. Interest rate swaps associated with the original term loan expired in fiscal 2013. This resulted in lower floating interest rates prior to the establishment of a new interest rate swap agreement and lower fixed interest rates subsequent to the establishment of the new interest rate swap agreement. This decrease was offset by a $1.4 million increase in foreign exchange losses and a $0.8 million increase in other expense as the result of an accrual for property-related expenses related to the termination of an agreement for additional land in Hangzhou, China.
Other expense increased to $12.9 million for fiscal 2012 from $9.1 million for fiscal 2011. The increase in expense was largely due to $4.4 million of increased interest expense primarily related to the $175 million of borrowings under the Note Purchase Agreement that the Company entered into during the third quarter of fiscal 2011, as discussed in "Liquidity and Capital Resources" below.


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Income taxes. Income taxes and effective annual income tax rates, with and without the annual valuation allowance, for fiscal 2013, 2012 and 2011 were as follows (dollars in millions):

                                               2013        2012        2011
Income tax expense, as reported              $  2.7      $ 29.1      $ 2.8
Valuation allowance (expense)                  (7.0 )     (24.1 )     (1.2 )
Income tax (benefit) expense, as adjusted*   $ (4.3 )    $  5.0      $ 1.6

Effective annual tax rate, as reported          3.2  %     31.9  %     3.1  %
Impact of valuation allowance                  (8.2 )%    (26.4 )%    (1.4 )%
Effective annual tax rate, as adjusted*        (5.0 )%      5.5  %     1.7  %

*The Company believes that the non-GAAP presentation of income tax expense and effective annual tax rate excluding the impact of the valuation allowance provides a more accurate representation and allows for a more meaningful comparison of reporting periods.
Income tax expense for fiscal 2013 was $2.7 million compared to $29.1 million for fiscal 2012 and $2.8 million for fiscal 2011. The Company's effective annual tax rates primarily vary from the U.S. statutory rate of 35 percent as a result of the mix of earnings from U.S. and foreign jurisdictions and tax holidays granted to our subsidiaries in China and Malaysia, where we derive a significant portion of our earnings. The effective tax rate for fiscal 2013 is significantly lower than the effective rate for fiscal 2012 primarily as a result of the additional valuation allowance recorded in fiscal 2012 on deferred tax assets in the U.S. and discrete tax benefits recorded in 2013, which are further discussed below.
During the preparation of the fiscal 2012 consolidated financial statements, the Company performed an analysis of all available evidence, both positive and negative, regarding the need for a valuation allowance against our U.S. deferred tax assets, consistent with the provisions of ASC Topic 740, "Income Taxes." Accordingly, as of September 29, 2012, the Company established an additional valuation allowance against the U.S. deferred tax assets, impacting the tax provision by $22.8 million. The additional $1.3 million of the $24.1 million valuation allowance shown above for fiscal 2012 relates to operating losses in Germany and Romania. The Company continues to assess the need to maintain the valuation allowance established on the U.S. deferred tax assets. At the close of fiscal 2013, using the measurement criteria found in ASC Topic 740, the Company believes that the positive evidence does not outweigh the negative and the valuation allowance should remain in place.
In fiscal 2013 the Company recorded an additional valuation allowance of $7.0 million for the full year. During the fourth quarter of fiscal 2013, the Company identified and recorded a discrete tax adjustment placing a full valuation allowance on the net deferred tax assets of our U.K. operations, which increased tax expense by $1.8 million ($0.05 per diluted share). Our analysis found that in the fourth quarter of fiscal 2013, the U.K. operations experienced an unanticipated material decline in sales resulting in a loss in fiscal 2013; losses are forecasted to continue into fiscal 2014. While we expect our U.K. operations to regain profitability, the current, forecasted and cumulative losses are substantial negative evidence. The remaining $5.2 million of the $7.0 million valuation allowance shown above for fiscal 2013 relates to operating losses, primarily in the U.S., Germany and Romania. Having examined the evidence, both positive and negative, it was determined that it is more likely than not that these deferred tax assets will not be utilized and should have a valuation allowance placed against them.

In the fourth quarter of fiscal 2013 the Company identified and recorded several out-of-period tax errors that reduced tax expense by $3.2 million ($0.09 per diluted share). The Company believes these out-of-period tax errors were not material to the fiscal 2013, or previously issued, financial statements. We currently expect the annual effective tax rate for fiscal 2014 to be approximately 8 to 10 percent.
The Company has been granted tax holidays for its Malaysian and Xiamen, China subsidiaries. These tax holidays expire in fiscal 2024 and 2014, respectively, and are subject to certain conditions with which the Company expects to comply. The expiration of the tax holiday in China is not expected to have a material impact on the effective tax rate or on the results of operations. However, we cannot provide any assurances as to the effect and will continue to monitor the projected impact. In fiscal 2013, 2012 and 2011, these subsidiaries generated income, which resulted in tax reductions of approximately $22.7 million ($0.66 per basic share), $17.5 million ($0.50 per basic share) and $21.7 million ($0.57 per basic share), respectively.
Net Income. Net income, with and without the annual valuation allowance and out-of-period tax adjustments, for fiscal 2013, 2012 and 2011 was as follows (dollars in millions):


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                                2013      2012      2011
Net income, as reported       $ 82.3     $ 62.1    $ 89.3
Valuation allowance              7.0       24.1       1.2
Out-of-period tax adjustments   (3.2 )        -         -
Net income, as adjusted*      $ 86.1     $ 86.2    $ 90.5

*The Company believes that the non-GAAP presentation of net income excluding valuation allowances and out-of-period tax adjustments provides a more meaningful comparison of reporting periods.
Net income for fiscal 2013 increased by $20.2 million, or 32.5 percent, to $82.3 million from fiscal 2012. This increase was primarily as a result of the net $17.1 million year-over-year valuation allowance adjustment. Excluding the valuation allowance and fourth quarter tax out-of-period adjustments, fiscal 2013 net income decreased by $0.1 million, or 0.1 percent, from fiscal 2012 to $86.1 million.
Primarily as a result of the $24.1 million valuation allowance adjustment, net income for fiscal 2012 decreased by $27.2 million, or 30.4 percent, to $62.1 million from fiscal 2011. Excluding the valuation allowance adjustment, net income was $86.2 million, a decrease of $4.3 million, or 4.8 percent from fiscal 2011 as a result of higher fixed expenses and increased interest expense, partially offset by the effect of higher net sales.
Diluted earnings per share. Diluted earnings per share, with and without the annual valuation allowance and out-of-period tax adjustments, for fiscal 2013, 2012 and 2011 was as follows:

                                           2013      2012      2011
Diluted earnings per share, as reported  $ 2.36     $ 1.75    $ 2.30
Valuation allowance                        0.20       0.68      0.03
Out-of-period tax adjustments             (0.09 )        -         -
Diluted earnings per share, as adjusted* $ 2.47     $ 2.43    $ 2.33

*The Company believes that the non-GAAP presentation of diluted earnings per share excluding valuation allowances and out-of-period tax adjustments provides a more meaningful comparison of reporting periods.
Diluted earnings per share increased to $2.36 for fiscal 2013 from $1.75 for fiscal 2012 primarily as a result of the impact of the valuation allowances and fourth quarter out-of-period tax adjustments discussed above. Excluding the impact of the valuation allowances and out-of-period tax adjustments, diluted earnings per share increased by $0.04 in fiscal 2013 as compared to fiscal 2012. The increase in diluted earnings per share, as adjusted was primarily due to the positive impact of fewer outstanding shares in 2013 due to the stock repurchase program.
Diluted earnings per share decreased to $1.75 for fiscal 2012 from $2.30 for fiscal 2011 primarily as a result of the valuation allowance adjustment discussed above. Excluding the $0.68 per share impact of the valuation allowance adjustment, diluted earnings per share increased to $2.43 for fiscal 2012. The increase in diluted earnings per share excluding the valuation allowance adjustment was primarily due to the effect of a decrease in diluted weighted average shares outstanding as a result of our share repurchases completed late in fiscal 2011, partially offset by lower net income.
Return on Invested Capital ("ROIC"). We use a 5-5 financial model which is aligned with our business strategy, and includes a ROIC goal of 5% over our weighted average cost of capital ("WACC") and a 5% operating margin target. Our primary focus is our ROIC goal, which is designed to create shareholder value and generate enough cash to self-fund our targeted organic revenue growth rate of 15%. For fiscal 2014 and forward, we have reduced our targeted organic revenue growth rate to 12% to reflect opportunities in the markets we serve. We review our internal calculation of WACC annually; at the end of fiscal 2013 we reduced our estimated WACC from 12.0% to 11.0% for fiscal 2014. By exercising discipline to generate ROIC in excess of our WACC, our goal is to create value for our shareholders. ROIC was 14.0%, 15.5% (excluding $20.6 million net deferred tax asset reduction) and 15.6% for fiscal 2013, 2012 and 2011, respectively. The decrease in ROIC in fiscal 2013 from fiscal 2012 was due to lower operating income and an increase in average invested capital as a result of capital expenditures for facility expansions. See the table below for our calculation of ROIC (dollars in millions):


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                                    2013       2012       2011
Operating income (tax effected)   $ 89.9     $ 96.9     $ 98.1
Average invested capital           642.1      623.0      627.6
After-tax ROIC                      14.0 %     15.5 %     15.6 %

We define ROIC as tax-effected annualized operating income divided by average invested capital over a rolling five-quarter period for the fiscal year. Invested capital is defined as equity plus debt, less cash and cash equivalents. Other companies may not define or calculate ROIC in the same way. ROIC is a non-GAAP financial measure which should be considered in addition to, not as a substitute for, measures of our financial performance prepared in accordance with United States generally accepted accounting principles ("GAAP").

Non-GAAP financial measures, including ROIC, are used for internal management assessments because such measures provide additional insight into ongoing financial performance. In particular, we provide ROIC because we believe it offers insight into the metrics that are driving management decisions because we view ROIC as an important measure in evaluating the efficiency and effectiveness of our long-term capital requirements. We also use a derivative measure of ROIC as a performance criteria in determining certain elements of compensation. For a reconciliation of ROIC to our financial statements that were prepared using GAAP, see exhibit 99.1 to this annual report on Form 10-K, which exhibit is incorporated herein by reference.

REPORTABLE SEGMENTS
A further discussion of our fiscal 2013, 2012 and 2011 financial performance by
reportable segment is presented below (in millions):

                                        2013          2012          2011
Net sales:
AMER                                 $ 1,062.8     $ 1,255.9     $ 1,304.9
APAC                                   1,146.3       1,110.4       1,063.1
EMEA                                     122.5          95.4          92.2
Elimination of inter-segment sales      (103.6 )      (155.0 )      (229.0 )
                                     $ 2,228.0     $ 2,306.7     $ 2,231.2
Operating income (loss):
AMER                                 $    70.9     $    91.1     $    68.7
APAC                                     116.3         101.9         118.1
EMEA                                      (3.1 )        (2.3 )        (3.0 )
Corporate and other costs                (87.5 )       (86.5 )       (82.6 )
                                     $    96.6     $   104.2     $   101.2

Americas (AMER):
Net sales for fiscal 2013 decreased $193.1 million, or 15.4 percent, from fiscal 2012, due primarily to $113.6 million of decreased sales resulting from lower end-market demand from a significant industrial/commercial sector customer as well as a $71.1 million decrease in net sales due to a drop in demand from Juniper related to its disengagement and lower end-market demand for the products we produced for Juniper. Operating income for fiscal 2013 decreased $20.2 million from fiscal 2012 due primarily to the decrease in net sales. Net sales for fiscal 2012 decreased $49.0 million, or 3.8 percent, from fiscal 2011, primarily as a result of decreased end-market demand in the networking/communications sector, which included the loss of two significant networking/communications customers, one as a result of a customer disengagement and the other as a result of a drop in end-market demand for the mix of products we produced for that customer. These decreases were partially offset by the ramp . . .

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