Q2 2020 Earnings Call
Good morning, and welcome to the Plexus Group Conference call regarding its fiscal second quarter 2020 earnings announcement My name is Sydney and I'll be your operator for today's call. At this time all participants are in a listen only mode. After a brief discussion by management, we will open the conference call for questions. The conference calls scheduled to last a proxy.
Let me one hour.
Please note that this conference is being recorded.
I'd now like to turn the call over to Ms., Heather very sport plexus, Senior director of Communications and Investor Relations Heather.
Good morning, and thank you for joining us today.
Some of the statements made in information provided during our call today well be forward looking statement and they will not be limited historical facts.
The words believe expect intend plan anticipate and similar terms often identify forward looking statement.
Looking statements are not guarantees. So there are inherently football season, 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 that was just got please refer to the company periodic SEC filings, particularly the risk factors in our form 10-K filing for the fiscal year ended September 20, 2019, I supplemented by our form 8-K filed with the FCC yesterday and the Safe Harbor in Florida.
And your statement in yesterday's press release.
Next is provide non-GAAP supplemental information such as ROI theme 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. Like this is website at www dot plexus dotcom clicking on investors at the top about page.
Joining me today, our talk healthy President and Chief Executive Officer.
Do you Frisch Executive Vice President and Chief operating Officer impact your name Executive Vice President and Chief Financial Officer.
Consistent with prior earnings calls Todd will provide summary comments before turning the call over to Steven path for further details.
Let me now turn the call over to talk healthy Todd.
Thank you Heather and good morning, everyone.
Please begin with their fiscal second quarter results on slide three.
After the close of the market yesterday evening, we reported results for fiscal second quarter of 2020.
We achieved quarterly revenue of $767 million.
Well our revenue result was below our expectations entering the quarter I commend our teams and their ability to mitigate the impact of Kobin 19 related supply chain constrains.
And government mandated workforce reductions at our facilities in Penang Malaysia.
Our sites in Malaysia operated with 40% of typical workforce for the final three weeks of the corridor.
With the exception of our China sites in the month of February the remainder of our facilities operated near full capacity for the quarter.
Well each of our locations face challenges, resulting from the cold in 19 pandemic, our talented and dedicated team members at all locations remain committed to meeting the essential needs of our customers and communities.
We delivered GAAP bps of 43 cents, including 19 cents of stock based compensation expense.
Non-GAAP EPS of 61 cents, excluding 18 cents due to the previously announced closure of our Boulder design Center.
Both our GAAP and non-GAAP EPS included 14 cents of cost directly related to the impact of Cobot 19.
Please advance to slide four.
Well our results were impacted by the Kobin 19 outbreak our teams demonstrated their ability and resolve to overcome the complexities and challenges of Kobin 19.
They remain committed to delivering for our customers and helping to create the products that build a better world.
Our efforts supported or healthcare life sciences customers and healthcare workers around the globe by delivering critical medical products that are on the front line of the battle against Kobin 19.
This includes products such as infusion pumps portable ultrasound medical but electronics.
Notable patient monitors.
Ventilators.
Mobile radiography electronics and diagnostic test systems.
In addition to supporting the fight against coping 19 plexus continues to produce products for industrial commercial aerospace and defense and communications customers as these products support the essential infrastructure needs of our communities.
Please advance to slide five.
Next I will further discuss the impacts of Kobin 19, and highlight our response in meeting the needs of our team our customers and our communities.
Given our sizable footprint and supply chain content in China, we realize very early that potential disruption could occur as a result of coven 19th.
In response, we established regular global executive calls beginning in late January.
We continue to have these calls each business day.
Internally, we are organized as a team of teams within executive steering committee that such priorities policies and protocols.
And regional teams that drive actions in line with these policies and former executive steering committee each day of impacts locally.
As we work through the challenges presented by Kobin 19, we remain committed to ensuring the safety and well being of our team members as they strive to support the essential needs of our customers.
Our internal stated goal is four facilities to be the safest place our team members can be went away from their homes.
This has resulted in evolving policies and protocols as the virus has become more thoroughly understood.
As examples we put in place international and domestic travel bans well ahead of any government recommendations.
We have mandatory temperature screening at all of our manufacturing sites globally.
We provide face coverings at all or facilities globally.
We implemented multiple procedural changes in reconfigured facilities in order to support social distancing.
We require that all employees, who can work from home do so.
We also provide regular detailed communications and resources to our team members discussing issues relevant Kobin 19.
I personally communicated to all employees on at least a weekly basis.
Unfortunately today, we have had three employees globally test positive for covert 19.
In response to each positive test, we immediately implemented are well defined crisis management protocol.
We notified employees and customers as well as performed an orderly shut down on the site within hours.
This was followed by a thorough did kit contamination of the site by a third party service provider in a multi day shutdown prior to resuming operations.
Please advance to slide six.
Well covered 19 is produced many challenges it is also presented opportunities.
Despite the uncertainty and lack of travel late in the quarter. Our go to market teams secured a healthy $248 billion manufacturing wins in the fiscal second quarter.
This result was dominated by our healthcare life sciences sector, which posted $102 million and manufacturing wins as we leveraged our expertise in supporting the needs of customers within these markets.
As of the time of this call we have secured in a ramping five programs across the United States in Europe that are associated with ventilators Ur Cobot 19 testing.
The majority of these programs will be reflected in our fiscal third quarter wins.
In addition, we're seeing upside from multiple customers for existing programs that support emergency medical applications.
Our team's ability to quickly adapt and persevere highlights organizations talent strengthened focus we have a team that is truly committed to creating the products that build a better world.
Advancing to our guidance for the fiscal third quarter of 2020 on slide seven.
As we look forward to the fiscal third quarter, we expect to deliver revenue in the range of $790 million to $830 million.
What markets are highly volatile in aggregate our demand remains strong.
[noise] healthcare life Sciences demand and in particular critical care products is very robust.
Semiconductor capital equipment in defense demand also remain healthy.
Aerospace is down considerably and on aggregate the balance of our industrial and communications business is mixed.
Currently all of our sites with the exception of Penang are allowed to operate at full capacity.
At our Penang facilities by changing ship patterns operating on a seven day per week schedule, focusing on productivity improvements and having none of production employees work from home our output is now near full capacity.
Our operating margin in the fiscal third quarter, we'll continue to be negatively impacted by challenges in the inefficiencies, resulting from coven 19.
As such we are guiding operating margins in the range of 3.8% to 4.2%.
We anticipate revenue and operating margins at these levels will lead to GAAP EPS in the range of 72 to 82 cents, including 21 cents of stock based compensation expense.
We currently do not anticipate any nonrecurring charges.
In providing this guidance, we have taken into consideration constraints on the global supply chain.
Workforce challenges as well as potential operational inefficiencies that could occur due to coven 19.
However, our guidance assumes no large scale closures of our facilities or those of our suppliers are customers due to covert 19.
Nor does it assume that the coven 19 outbreak will materially impact end markets beyond what has already occurred.
We commit to providing timely and transparent updates should negative material changes to our revenue and EPS expectations occur within the quarter.
As we move forward our team members remain our top priority.
We continue to invest in our policies and protocols to operate in the safest manner possible.
I want to thank our sites, who have quickly adapted to meet the safety needs of our teams.
As well as our team members, who continue to be flexible and patient as we implement change.
I'm proud of the efforts of our entire organization, but particularly those in our manufacturing sites.
It is through their courage and unwavering support that we were able to deliver lifesaving medical devices and other essential products to our customers in our communities.
I will now turn the call over to Steve for additional analysis of the performance of our market sectors and operations.
Steve.
Thank you Todd good morning.
The koeppen 19 pandemic impacted our fiscal second quarter operational metrics.
Divide butter context of the situation I will start with the status of our global facilities on slide eight.
All plexus facilities have requirements placed upon them by the respective governance, where they are located.
However, all of our facilities have been granted permission to conduct business.
Our fiscal third quarter guidance includes the currently anticipated operational offensive inefficiencies due to covert 19.
Our design centers Global headquarters and most office personnel are under mandates to work from home when possible.
Our teams have adjusted to this new paradigm and we believe we can function in this manner for an extended period of time if necessary.
In regards to our manufacturing facilities the status it varies by region.
Starting in APAC are trying to sites experienced a period of very limited production due to the restrictions imposed by their government in response to the spread of over 19.
However, the teamwork significant overtime and overcame supply constraints.
To fulfill most of our customers' orders within the fiscal second quarter.
For the fiscal third quarter, we anticipate full staffing levels and an improved local supply chain in China.
As we announced on March 20, Threerd, our sites and delays are subject to the national movement control order.
The current order restricts the number of employees, we can work at our sites at 50%.
The impact to some of our local suppliers more severe as they were completely closed.
Our revenue softness for the fiscal second quarter can largely be attributed to the situation in Malaysia.
As we start the fiscal third quarter. The order remains in effect and we believe it could be extended past the current expiration date of April 28.
However, as a result of Mitigations, we have put in place to protect the helfer employees.
Malaysian officials have eased some restrictions.
We had been allowed to create new shift patterns that continues the reduction of the number of employees in a facility.
But they enable us achieved nearly full production rates.
In addition, all of our critical Malaysians players have been able to resume some level of production.
We expect the situation in Malaysia to continue to improve throughout the fiscal third quarter.
Our sites in the Americas were largely unaffected by covert 19 through the majority of the fiscal second quarter.
That changed late in the quarter as we had one employee test positive for corporate 19, and our Boise site during the last week of the quarter.
Our crisis management policies and procedures were initiated within minutes of learning of the issue.
The preparation buyer each ines corporate communications and operations teams as well as the execution by our Boise leadership team was exceptional.
Which enabled the site to reopen within a few days.
Our EMEA slates adjusted their policies and procedures early in the second quarter to ensure employee health and safety as well.
Fortunately they do not have any incentives beyond the global supply chain issues associated with code 19 that all reasons are managing.
Finally, and most importantly, we've made the commitment to our employees make flexes the safe as environment outside of their homes.
Todd highlighted some of the actions we're taking.
Want to expand upon one of them social distancing in order to illustrate some of the steps we're taking to deliver on this commitment.
Employees that can work from home are required to do so we have restricted access to buildings to ensure compliance.
We have modified shift patterns in our manufacturing facilities and reconfigured employee entrances for rent close contact situations.
We have physically reconfigured work spaces to ensure proper separation.
And we have changed the layout of common spaces like lunchrooms brick areas to support proper social distancing.
As a leadership team we start each business day, reviewing our global approach to employee safety and to share best practices.
We are making the transition from reacting to a crisis to implementing a new operating rhythm.
Our philosophy hasn't been and we'll continue to be transparent communications for their employees as well as our customers and shareholders as we adjust to this new environment.
Please advance to slide nine for review of our performance by market sector.
Three of our market sectors missed expectations in the fiscal second quarter, largely due to the negative impact that over 19 had on our operations.
Since we just reviewed the events in each of our regions that impacted the fiscal second quarter I will focus on the expectations for the sectors for the fiscal third quarter of 2020.
Our healthcare life Sciences revenue is expected decline or 20% in the fiscal third quarter.
We have seen a 16% net increase in our fiscal third quarter forecast since the end of January.
Significant demand increase with customers that provide products used for the testing diagnosing and treating of covert 19 is driving the growth.
Given the urgent need for products, we produce that fight over 19, we expect our healthcare life sciences demand to remain robust.
Our industrial commercial sector is anticipating a high single digit decline for the fiscal third quarter.
Strong demand from semiconductor capital equipment customers is being offset by weaknesses in the oil and gas automated retail and transportation sub sectors.
Some of the strength in the semiconductor capital equipment sub sector is market share gains do our team's ability to deliver inspite of the supply chain constraints.
Our aerospace and defense sector is forecasting a high single digit decline for the fiscal third quarter.
We had been expecting sequential growth however forecast declines in several commercial aerospace programs have changed that outlook.
In regards to the rest of the sector demand from our defense and space customers remains relatively stable while demand from security customers is mixed.
Our communication sector is expecting to grow almost 30% in the fiscal third quarter strong demand for internet connectivity infrastructure products in the ramping of a new Fiveg wireless program are driving the growth.
Some of the strength is due to the increased bandwidth requirements created by people staying at home and working from home.
Please advance to slide 10 for an overview of the wins performance of the fiscal second quarter.
We won 36, new manufacturing programs that we expect to generate $248 million in annualized revenue when fully ramped into production.
The strong wins were the result of good momentum early in the quarter combined with diligence to close option opportunities virtually.
The team is adjusting to travel restrictions as they become a new variable in the sales process.
Finally, our trailing four quarters of wins at $844 million maintains our wins momentum above our goal at 26%.
Please advance to slide 11 for further insight into the wins results by region.
All regions benefited from a $248 million on total wins.
The Americas regions portion of the wins was a robust $85 million.
Included in the result is a product used in the fight against covert 19 that we expect to have ramped within the fiscal third quarter.
In addition, we anticipate to new program wins in the fiscal third quarter related to covert 19.
We are aggressively working to ramp on ramp plans for both programs as well.
The impact regions manufacturing wins at 100, when min $101 million were the strongest they've been in over a year.
The team did an outstanding job, leading our customers through the adverse conditions of the fiscal second quarter. As a result, they were rewarded with significant market share increases from two large customers in the semiconductor capital equipment industry as well as from a key customer in the communication sectors.
The immediate region winds up $62 million were exceptionally strong including the wins is a large life Sciences program that our Darmstadt design Center has been co developing with the customer this product will be produced in our audio romantic Romanian facility.
Please advance to slide 12 for further insight into the manufacturing winds performance by market sector.
Okay.
Our healthcare life Sciences team had an exceptionally strong winds result of $102 million in the fiscal second quarter.
Obviously, we are energized by the program wins wins for the products that are used in the battle against KOVA 19.
However, we're also encouraged by the wins that will sustain the growth in the future quarters.
In addition to the large life Sciences program for EMEA the team added to meaningful imaging programs from a new customer for our China operations.
The industrial commercial sector produced a healthy $60 million or manufacturing wins in the fiscal second quarter.
This is the second straight quarter of wins growing over 30% and the sector strongest quarter and a year.
Market share gains with key customers is creating the wins momentum.
The aerospace and defense sector generated $6 million from new wins in the fiscal second quarter, a large based program as the highlight for the quarter.
Our demonstrated ability to produce high quality products for this demanding environment is enabling growth in this sub sector.
Finally, our communications sector winds of $26 million includes a meaningful new opportunity from an existing customer.
The program expands our customers communication products into a new market within the transportation industry I.
Our diverse industry knowledge is another example of how plexus with providing value to our customers.
Please advance to slide 13.
We closed the fiscal second quarter with a strong form of qualified manufacturing opportunities totaling $2.4 billion.
Our sector teams are doing an outstanding job of filling the funnel with new opportunities while simultaneously harvesting significant wins.
The healthcare life Sciences funnel continues to be a healthy $1.3 billion.
In addition to the normal business. The coven 19 pandemic is creating new opportunities within the sector.
Our teams are aggressively working with customers to qualify and quantify their needs.
Supporting our healthcare life science customers as the world battles over 19 buyers is a top priority for fluxes.
In spite of the robust when performance industrial commercial sector increase or followed by over $50 million to close the fiscal second quarter at $455 million.
The high quality and exceptional delivery performance of our operations teams is creating the new opportunities.
The aerospace and defense sector Spano at almost $500 million remains strong. In addition to the size the diverse mix of opportunities include significant defense and space programs.
A few final comments.
There's been a lot of changes since the fiscal first quarter earnings call on January 20, Threerd as I review. This morning. The challenges epidemic pandemic has brought our significant I am proud, but not surprised to be able to say that the plexus team is managing through each of them.
The crisis will create more challenges, but it is also creating opportunities.
The commitment that the employ the plexus have demonstrated his tremendous there are solving the problems that cover 19 rates and working to make a difference with the opportunities that brings.
I'll now turn the call that for an in depth review represents financial performance Pat.
Thank you, Steve and good morning, everyone. Our fiscal second quarter results are summarized on slide 14.
Revenue of $767 million was sequentially down 10%, while gross margin, 8% was down 130 basis points.
The lower gross margin was primarily due to the under absorption of fixed manufacturing expenses across all regions seasonal compensation cost increases.
And the incurrence of more than $4 million encoded 19 related expenses.
Selling and administrative expense of $38.2 million was consistent with our expectations.
As a percentage of revenue SGN, a was 5% sequentially higher by 40 basis points due to the lower revenue and seasonal cost increases.
During the fiscal second quarter, we completed all restructuring activities related to the previously announced closure of our Boulder design Center.
These activities resulted in charges of approximately $6 million.
Before consideration of the restructuring charges adjusted operating margin was 3%.
Included in this quarter's operating margin was approximately 75 basis points of stock based compensation expense.
Non operating expenses of $3.1 million was better than expectations, primarily due to foreign exchange gains.
GAAP diluted EPS of 43 cents included a charge of 18 cents per share related to the after tax restructuring activities.
Excluding this item non-GAAP diluted EPS was 61 cents.
Turning now to the balance sheet and cash flow on slide 15.
During the quarter, we purchased approximately 225000 shares of our stock for $13.2 million at an average price of $58.57 per share.
At the end of the fiscal second quarter, we had approximately $27 million remaining under the authorization.
However in March we suspended the repurchase program indefinitely, given the current environment.
For the fiscal second quarter, we used $29 million and cash for operations and spent $17 million on capital expenditures, resulting in negative free cash flow of $46 million.
Through the first six months of fiscal 2020, we generated free cash flow of $15 million.
Despite the impact of Coven 19, we delivered a return on invested capital for the fiscal second quarter of 11.4%.
This generated an economic return of 260 basis points above our weighted average cost of capital, creating solid shareholder value.
We believe plexus is well positioned with a strong balance sheet as we face of future challenges presented by Coven 19.
As of April 4th 2020, cash totaled $227 million, while debt totaled $294 million.
Our gross debt to EBITDA leverage ratio of 1.5 times compared to a covenant limit a 3.5 times.
In addition to our strong balance sheet, we have significant funding available through our revolving credit facility should future needs arise.
Cash cycle at the end of the second quarter was 87 days a sequential increase of 16 days.
Please turn to slide 16 for details on our cash cycle.
Sequentially inventory was higher by $30 million, while days increased by 12 to increase in days primarily related to the reduced revenue for the fiscal second quarter.
In addition, we procured inventory towards the end to the quarter as we prepared for higher revenue anticipated in the fiscal third quarter.
Also in this environment, we are starting to experience longer lead times for certain components.
In order to meet greater demand for certain products and maintain a high level of customer service. We are procuring components earlier accepting that inventory dollars will be higher.
Days in receivables were 55 days sequentially higher by six days. The increase was primarily due to a reduction in receivables sold under a customer factoring program.
In addition, the timing of shipments was late weighted more towards the last month as a quarter compared to last quarter, which contributed to the increase in the days.
As Todd has already provided the revenue and EPS guidance for the fiscal third quarter I'll review, some additional details which are summarized on slide 17.
Fiscal third quarter gross margin is expected to be in the range of 8.2% to 8.6%.
At the midpoint of this guidance gross margin would be approximately 40 basis points higher than the fiscal second quarter.
Within anticipated, 6% sequential increase in revenue, we expect to experience better leverage of our fixed manufacturing expenses. As these expenses are forecasted to remain consistent quarter over quarter.
For the fiscal third quarter, we expect SGN a expense in the range of $35 million to $36 million at the midpoint of our revenue guidance anticipated SG nay would be 4.4% of revenue sequentially improved by 60 basis points.
Impacted by inefficiencies of Covet 19 fiscal third quarter operating margin is expected to be in the range of 3.8% to 4.2%.
This guidance includes 75 basis points stock based compensation expense.
A few other notes for the fiscal third quarter depreciation and amortization expense is expected to be approximately $14 million consistent with fiscal second quarter.
Non operating expenses are expected to be in the range of $4.8 million to $5.2 million at the midpoint of this guidance. These expenses would be sequentially higher primarily due to the absence of foreign exchange gains which were recorded during the fiscal second quarter.
For the fiscal third quarter, we estimate an effective tax rate of 15% to 17%, while we expect a non-GAAP effective tax rate of 12% to 14% for the full year.
In addition, we are estimating diluted shares outstanding of approximately 30 million shares for the fiscal third quarter.
Our expectation for the balance sheet is for working capital dollars to remain relatively consistent.
We expect higher inventory and accounts payable balances as we increase procurement activity to meet the anticipated higher demand.
Based on our revenue forecast, we expect this level working capital will result in cash cycle days of 82 to 86 days.
For the fiscal third quarter, we expect free cash flow around breakeven as we build inventory to support new program ramps.
For the full year, we expect free cash flow in excess of $50 million.
Finally, our capital spending estimates for fiscal 2020 is expected to be in the range of $50 million to $60 million slightly lower than our previous estimate.
With that Sydney, let's now open the call for questions.
Thank you we will now begin the question and answer session. If you have a question. Please press Star then one and your Touchtone telephone.
If you wish to be removed from the Q. Please press the pound Brian or the ASCII.
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Our first question comes from Adam Tindle with Raymond James Your line is open.
Okay. Thanks, and good morning, Todd I just wanted to start you mentioned that guidance does not assume material impact end markets beyond what has occurred.
So just to start maybe can you touch on what has occurred thus far from a product orders standpoint, because it seems like the shortfall in March is largely operational related which is understandable, but not a material reduction that demand. Thus far so it's just touch on what you've seen so far.
In demand production.
Sure so from a demand standpoint, Adam the probably the biggest impact has been in our aerospace sub sector.
No defense and space within that that entire sector as we define it is our strong but aerospace itself is weak and we're also seeing much of industrial commercial beyond semiconductor capital equipment as we now the semiconductor capital equipment demand is holding up rather well right now I mean I think some.
Good question out there.
In the in the market as to whether that's going to be long term or whether that's it.
Nearer term situation, but right now is strong.
Okay and.
To follow kind of normal downturns typically takes a couple orders its short order cuts are quarters of short order cuts are those further down clicks in order cuts contemplated in your guidance.
For acute for Q3, yes, yes.
One other thing that's worth noting to add them as we talk about the strength in healthcare and that's a little bit bifurcated as well too. It's very strong in critical care products and of course, we want to a number of new programs that are directly related to Covidien 19, but when you consider products that we make that are more.
Used in say elective type surgery type applications or things like that the demands we can quite a bit. So so there's a bit of a mixture within healthcare as well too.
Okay, and maybe just one final one curb Pat.
Created positive economic return despite navigating done that.
You've had some benefit from restructuring, but still positive if we factored that in.
Maybe just first touch on how the adjusted to achieve that and moving forward.
Margins are expected to move up class cycle down. So I expect further improvements. So you could touch on the key drivers of the cash cycle improvement that you are expected to continue to strive. This thanks.
Yes, so at the end of the second quarter, we had the negative free cash flow.
And a lot of that was driven by not being able to factors. Some of our accounts receivable and I think we'll see improvement in that area as we progress into the third quarter.
Inventory levels will be more elevated in the third quarter.
As we ramp some of these new programs. So I expect that but also our payable days I think thats, where we will see improvement in offset to the increase in inventory days and we are securing some additional customer deposits because in some of these markets that have upside demand where the customer wants to ensure inventory is on.
On hand, we're requesting customer deposits to help offset that working capital investment. So I think the teams are doing a fantastic job around inventory management.
In all of our regions and so we're seeing improvements there but in this near term we will see some increases in inventory.
Those are probably the main the main components for us of the cash cycle.
Makes sense. Thank you.
Thank you and our next question comes from the line Shawn Harrison looks loop capital. Your line is open.
Hi, good morning, everybody, it's good to hear voices.
Wanted to delve into I guess two topics the first being just.
The incremental outsourcing here and how much of it maybe as a pull forward versus maybe a permanent.
Incremental outsourcing for a while that we've seen in prior market corrections.
Yes, so I'll take that one this is Steve.
I would say the conversations with customers and I'm going to expand your question a little bit.
The conversations with customers is interesting right now because a lot of customers are starting to look at what is from a continuity of supply strategy. What is called we're going to do for long term today, it's more reactionary, but I do expect.
So with 19 will change the manufacturing strategy for for lots of customers and.
Nobody our team's ability to deliver through this crisis is definitely helping us gain market share.
With several customers and as we look at the incremental part of that is it goes into the future quarters.
We would expect customers that if if the downturn comes or if there is a slowdown we would expect the opportunity.
To increase for the number of outsourcing opportunities and so it's a little early to see what the impacts of cobot 19 are going to be but into I think your questions kind of focused on is this going to follow a similar pattern I guess, our expectations is that it probably will.
Okay and then.
Yes, there is a follow up the strength in the communications business.
Is that kind of visit level off here in the June quarter or is this something because of the work from home environment you see.
Multiple quarters of incremental spend by the broadband providers and other kind of internet providers that we only that that that signal at home.
Yes, but at the beginning of Q2 of our forecast for Q3 did show some strengthening so we did anticipate soma strengthening cobot 19 has increased that in a substantial way we do expect it to stabilize at this level. The question will be is probably get into 2021, what does it look like and obviously, it's a bit early to call out one.
Okay, that's great Steve Thank you.
Thank you and our next question comes from the line and Jim Ricchiuti Needham and company. Your line is open.
Thank you good morning, I may have missed it but did you provide any.
So good 19 related expense that may be embedded in your gross margin guidance for fiscal Q3.
So Jim I'll.
I'll start with this and then I'll pass it off to Pat for a bit more more specifics as we as we think about cobot 19.
One of the things that with regards to our guidance.
Our demand is higher than our guidance. So we're staffed for higher demand.
But were right so thats impacting our margins, but we're realistic and knowing that there are significant challenges within the supply chain right now on the ability to be able to.
To get the parts that we need in the time that we need them and it's more certainly more volatile than would be in a normal environment. So we're taking that into account, but beyond that we've taken an approach that if we need to have an employee self quarantine because of kobin 19, or if we choose to.
To close a site for a period of time.
As a result, we compensate our employees so there's some direct costs around that as well as pp any so.
I'll pass it off to Pat and you can give you more specifics around the numbers sure. Yes. So Jim in in Q2, we had to $4.7 million in Q3, we're expecting that to be around $2 million and to Todd's point combination of direct equipment and some labor costs.
And so from a margin standpoint, we're guiding operating margin of 3.8% to 4.2%. So the midpoint is 4%.
Those direct costs that we expect in Q3 are about 30 basis points. So without those you'd be at about 4.3. So we're still below our target range at 4.7 to five and Thats, where I think this difference is really in the inefficiencies that we'll see insights as such.
Programs are coming down significantly and we're managing that labor force, while other programs are increasing insights need additional headcount.
In managing through that labor situation. So I think that kind of bridges, we are well, how we get back to our target range in future quarters.
That's helpful. If we look at the.
The aerospace and defense segment.
Is there are ways. We can you can you size what the commercial aerospace represents of that only because it doesn't sound like that business is coming back anytime soon is that a fair way to think about it.
Yes, it will be down for a while certainly that's about half of our business within the sector.
Okay.
And then on the up.
On the healthcare life Science, I think it's interesting the way you're clearly.
See benefit there from all of the increased demand as it relates to critical care do you have any sense as to when that.
Second where elective PC alluded to might start coming back or is that still a little tougher they tell given that we're still in that and that pickup banks here.
Yes. So this is Steve I'll try to answer about the best again, if you break down healthcare life Sciences, and I talked about the fact that we had a net 16% increase.
From our January forecast for Q3, two our April forecast for Q3.
If you look at healthcare the health care portion was actually a 20% increase in life Sciences was relatively flat.
If you look at the top 15 customers just within the healthcare sub sector. All 15 had double digit movement from January to April.
However, nine of those were up in six were down the six that were down were associated with.
Non critical health care products elective procedures and so.
With the do we expect a double digit continued to increase will depend a bit on pandemics, but we do expect those elective procedures will return as the economies across the globe you turned back on an elective food procedure start to happen. The question that we're asking is this again is there going to be a pent up demand is going to be a slower ramp.
But we would expect those elective programs to come and that demand to come back.
As soon as the economies of the world the turned back on and people are basically a while to move.
That's helpful. Steve last question for me is just of the industrial commercial side of the business and this may be tough the call, but do you get.
This sense that June.
Maybe the bottom or is this just the visibility maybe just to limited here.
I think the again looking at the changes that we've seen in the forecast from the January cycle too.
To the April cycle.
The forecast demands and some of those sub sectors that we talked about coming down the move to come down substantially and so.
We do believe that a fair amount and the customers have taken.
A pretty good look at where their forecasts are going to be.
For.
For our fiscal Q3, and so they have adjusted pretty well is it going to come down more.
I think thats, a little bit early for us to tell.
Terms of what's going to happen.
Given the global situation.
Thats fair enough. Thank you.
Hi.
Thank you and our next question comes from the line.
Paul Coster with JP Morgan Your line is open.
Yes, thanks for taking my questions.
Just a quick cluster on the health care from festival.
How are any of the is any of this new business from new logos is it brand new products.
You know the customers, who have kind of devised still on the fly or all the existing programs that they're ramping up.
As you ramp up does it do the margins.
Kind of although on the pressure initially and then they improve over the course of time.
Yes in general Paul the five new wins is that I talked about our new programs that are in the process of ramping.
I think though the margins should.
Should be fine with those I think we'll be able to ramp those add.
Got a corporate level.
Jens, though so I wouldn't expect it to be dilutive during the ramp period.
No new logos at this time.
Yes, there are new logos.
Included in that five.
Yes, correct, Oh interesting, Okay and then.
The just a quick question on credit risk are you seeing any issues amongst your customers that you're monitoring carefully.
Oh, well we're monitoring.
But it really carefully.
But we have not seen any concerns at this point the benefit is when you look at our our customer list. Our top 10 customers make up 55, or so percent of our revenue all international companies.
So we feel comfortable at this point, but it is something we're going to closely monitor.
Sales team is working remotely and virtually at the moment and I guess, it's reasonable to expect the win rates probably gotten all the they'll lose business to anyone but just the ability to close deals will be impacted somewhat in this next quarter is a a fair assumption should we have said.
The salute should we expect the manufacturing wins to be more modest in fiscal Threeq, two and then maybe pickup in the back into the calendar year.
I wouldn't assume that just yet I think opportunities with new logos may.
Maybe a little bit harder to close however, we're seeing increased opportunities with existing customers and so our expectation with the business development teams that they're going to continue to deliver with that our corporate communications team is doing a fair amount on work with virtual videos and things to allow and give our salesforce the tools that they need.
To be able to continue to seller services and so.
Again, I think new logos, maybe a little bit more challenging may slow down their decision, making but we potentially see.
Our existing customers, providing more opportunities so the split might shift a little bit.
Got it and then last question going back to tumor Shooties question around the.
Defense and aerospace segment, so I assume first of all the 50% that was commercial was one of you know backward looking basis looking forward I mentioned, it's going be a smaller percentage at least for awhile.
Confirm that but also can you just clarify for us what kind of business should doing into commercial aerospace segment is it new builds by new new Croft or is it.
You know it relates its threat show a malls travels and that for some of the consumable products.
Yeah, It's a combination of both Paul there is a I'm certainly it's dominated by the new build but there is an amount of aftermarket business that we haven't and that's obviously taken a near term hit right now the the aftermarket business and the 50 50 split I'd call that.
Pre covitz split.
Right. So this where if there is a recovery them owns travel we should they see the variable consumable aftermarket business pick up.
It's a b picayune, but what percentage of the.
Commercial.
Spice business is aftermarket versus new build if you could just that.
Yeah. Unfortunately, with our customers were shipping fueled units that we don't always get visibility completely what's going into new aircraft versus.
Aftermarket services.
Yeah.
Good take I go ahead.
Yeah.
It would be fairly guests for me alright, okay. Thank you so much.
Thank you and our next question comes from the line of Anja showed a strong with Sidoti Your line is open.
Hi, everyone.
Thank you.
Yes.
Hello, Good question asked already.
Im just going to ask about that.
DNA you're sort of.
Guiding down to first quarter is stuff just today is seasonal compensation going down the other moving parts, there and how sustainable is that coming quarters.
Yes, so it's not the seasonal costs coming down because those go into effect January one those are merit increases so those are carrying through.
Some of it it better in inefficient efficiencies that we're driving better productivity.
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We are seeing some of the covert expenses that flowed through in in Q2.
The smaller in Q3 and.
What we've done from a discretionary spending standpoint is really pulled that back travel as you can imagine is essentially.
Nonexistent and some of our head count hires.
We've delayed so Q3 is going to be.
Much smaller and lower and as we go into Q4, I expect that to rebound a bit.
And probably be closer to $38 million in Q4, some of that is variable incentive compensation expense as well that's down in the third quarter, but we expect higher expense in the fourth quarter. So I think going forward something in that $38 million range per quarter is probably.
Reasonable.
Okay. Thank you and then it seems like tiara and.
Operating expenses are ticking up a bit to watch the moving parts there.
Prior to two main things there on one is in Q2, we had about a million dollars a foreign exchange gains and those were driven by mainly in Mexico the peso devaluation.
Generated some gains for us so that was about $1 million that we wouldn't anticipate recurring in in Q3.
Also with the increase in working capital that we started to experience towards the back half of the second quarter, we expect that to continue into the third quarter sort of borrowing is higher than.
And then the quarter and the interest expense is going to be higher than what we had in the second quarter.
So there again, I think going forward and the.
Kind of the midpoint of that guidance for the third quarter is $5 million that was pretty similar to what we had previously guided for prior quarters.
So removing the FX activity I think $5 million for $4.5 million to $5 million at quarter is a pretty reasonable number assuming no FX gains or losses.
Okay. Thank you and then in terms of the inventory and supply chain understand thats a bit challenging now.
What do you seem to supply chain how.
Do you expect that to be challenging going into next year.
I think it's going to improve.
Just a bit of a color what you're seeing now.
Yeah. This is Steve the supply constrain despite being constraints. We're seeing now are more associated with facility closures due to Kobin 19, and so our expectation is as those facilities come back online.
Supply chain constraints will free up and we've seen that happen with summer suppliers, particularly in Malaysia in China, but had shut down early and they've come back on line and the supply chain constraints are starting to disappear.
Honestly the pandemic is widespread and so many different companies both on the custom engineered components as well as electronics obscene different portions of their business get shut down for periods of times and so its sporadic but it's meaningful.
And again, we'd expect that to return to more normal things as these facilities get back on line.
The World manages the pandemic.
Okay. Thank you and the shutdown is due to them.
Being deemed a essential businesses.
No well the facility shutdowns or yes, similar to what we faced in Malaysia, Although were essential business is a different governments are making the case our early for us in the quarter were only allowed to have 40% of our workforce in the facility and so production for US was limited now some suppliers, including some of ours were.
Deemed not essential and they were forced to shut down completely.
And so we've been working with the respective governments to basically help them understand that supply chain is critical and we've been able to get some of those suppliers turned back on and I think as this trend continues and we're seeing a continuing through the fiscal third quarter here well through the suppliers coming back online in reaching more normal levels of production will which will basically.
Free up some of these constraints.
Okay. Thank you that was all from me.
Thank you. Thank you.
Our next question comes from that sharing with Stifel. Your line is open.
Thanks, and good morning, I appreciate all the colors. So far just the only question for me just regarding the the health care business in the ramps you're seeing in that Colgate 19 related programs could you give us an idea of the sustainability of those programs in terms of the Lifecycles.
Or any programs that are more one off for two or three quarters in terms of getting equipment out there.
Yes, I would say, Matt that one or two of these I would call one off programs that are probably have a.
At a one to three quarter duration to them and the remainder would be sustainable, but I would anticipate that that once we get out somewhere from two to four quarters that their volumes would drop a bit.
Okay, and I guess in theory at that point, you'll see the elective.
Quitman surgery type of.
Programs ramp to offset that.
We believe so yes.
Okay. Okay Thats it for me. Thanks, so much alright, thanks, Matt.
Thank you.
I'm not showing any further questions at this time I would now like to turn turn the call back as CEO Todd Kelsey earnings.
Alright, Thank you Sydney and again I want to thank everyone, who joined our call today, we certainly appreciate your support and interest in plexus.
These are certainly interesting times and I'm sure. It's impacted all of you suddenly are probably at a different locations than you typically ours are listening to this call, but I know I certainly look forward to the day when things are closer to normal and stay safe and stay healthy and we'll talk to you soon.
Thank you ladies and gentlemen. This concludes today's conference. Thank you participating you may now disconnect.
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