Plexus Corp

NASDAQ:PLXS

Earnings Call Transcript 2021-Q3

[Operator]

Good morning, and welcome to the Plexus Corp. Conference Call regarding its Fiscal Third Quarter 2021 Earnings Announcement. My name is (Rence), and I’ll be your operator for today’s call. At this time, all participants are in a listen-only mode. After a brief discussion by management, we will open the conference call for questions. The conference call is scheduled to last approximately one hour. Please note that this conference is being recorded.

I would now like to turn the call over to Mr. Shawn Harrison, Plexus’ Vice President of Communication and Investor Relations. Shawn?

[Shawn Harrison, VP, Communications & IR]

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 October 3, 2020, as supplemented by our Form 10-Q filings, 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 net earnings per share, to provide a better understanding of core performance for purposes of period-to-period comparisons. 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?

[Todd Kelsey, President & CEO]

Thank you, Shawn. Good morning, everyone. Please advance to Slide 3 for a discussion of our fiscal third quarter results. We delivered fiscal third quarter revenue of $814 million, GAAP operating margin of 4.5%, and GAAP EPS of $0.95. Revenue met the high end of our revised expectation provided at the June 8 Stifel Conference. This result was primarily due to the resilience and outstanding efforts of our team members in Penang, Malaysia, amidst the challenging conditions created by government-mandated workforce reductions, in response to the COVID-19 pandemic. Our team worked tirelessly to meet the needs of our customers, while navigating the required workforce restrictions.

GAAP operating margin and EPS significantly exceeded our updated outlook, as a result of the better than anticipated revenue performance of our Penang operations, and outstanding contribution from our Engineering Solutions team, and lower than anticipated US healthcare costs. Our Engineering Solutions workload is very strong, and the team delivered record operating margin in the quarter. The GAAP EPS result included $0.04 due to a modest restructuring in our Americas region, and $0.21 of stock-based compensation expense. I'm extremely proud of our global Plexus team as they navigated a very challenging fiscal third quarter to deliver results that exceeded expectations.

Next, I will highlight fiscal third quarter business development accomplishments that we expect will enable accelerated future revenue growth. Our team produced another exceptional quarter of wins, delivering approximately $275 million of manufacturing revenue, when fully ramped into production, bringing our trailing four-quarter wins to a record $1.1 billion. The quarterly wins included five new logos, another very strong result that enables further growth as these relationships expand.

Our teams have added 17 new logos this fiscal year, highlighting our increasing differentiation in markets featuring highly complex products and demanding regulatory requirements. Within the wins, were several aftermarket services opportunities, including an expansion of the notable new relationship highlighted last quarter. One of these AMS opportunities ramps very rapidly, and should contribute to fiscal 2022 first quarter results. Given the pace of the ramp, we'll be making sizable near-term investments.

Our Engineering Solutions team had another outstanding wins quarter, exceeding last quarter’s excellent results. Engineering is not only accretive to our operating performance. Strong engineering wins are generally a leading indicator of accelerating manufacturing growth. The efforts of our go-to-market team in leveraging our reputation for delivering customer service excellence, is positioning Plexus for strong growth across all of our service offerings. The wins performance is not only noteworthy because of its magnitude, but also due to the alignment of the new business to our strategy.

Please advance to Slide 4. Our team members in Penang demonstrated extraordinary resilience and tenacity, as the Malaysian government implemented numerous actions and restrictions to combat a sharp rise in COVID-19 infections that began midway through our fiscal third quarter. We were able to continue our operations, given our status as an essential manufacturer, but for the final six weeks of the quarter, we were limited to approximately 60% of workforce capacity, while also managing through strict protocols focused on ensuring social distancing for our team members at our sites. Despite the challenging situation, our APAC leadership team found opportunities to support our customers by operating more efficiently than initially anticipated, upon the announcement of the workforce reductions, driving revenue toward the high end of the expectations we provided during our June 8 update.

Our team also proactively engaged the Malaysian government and Ministry Of Health, with the goal of creating a vaccination center for our team members, customers, suppliers, and other local manufacturers Plexus, along with two other manufacturers in Penang, received approval during late June to create an onsite vaccination clinic. In conjunction with a local healthcare provider and the Malaysian government, which supplied the vaccines, our team began their COVID-19 vaccination clinic on July 14th, administering approximately 1,500 doses daily. Our clinic, which received outstanding positive feedback from the Malaysian Ministry Of Health, is scheduled to provide nearly 17,000 first doses by this upcoming Sunday. Second doses are anticipated by late August, aligning with the Malaysian government's goal of broad vaccination availability by the end of summer. We anticipate over 85% of our Penang team members will be vaccinated.

While vaccination is an important step in supporting our team members and our local community in Penang, COVID-19 infections remain elevated in the near-term in Malaysia. As a result, we expect restrictions on the community and manufacturers to sustain throughout our fiscal fourth quarter. During the first two weeks of our fiscal fourth quarter, the prior reductions continued to limit Plexus to approximately 60% of workforce capacity. In mid-July, the government subsequently eased the reductions applicable to Plexus, allowing our team to operate at 80% of workforce capacity. This workforce level, when combined with operational efficiencies, should allow our operations to function at near-normal output capacity within the fiscal fourth quarter. We anticipate vaccination efforts throughout the country, inclusive of our clinic, will support an eventual easing of restrictions, allowing Plexus to return to typical workforce capacity levels, and to better support the ongoing strong growth outlooks of our customers.

Please advance the Slide 5. As we look to the fiscal fourth quarter, demand remains very robust, particularly within our Healthcare Life Sciences, and Industrial Market sectors. When coupled with the improved output of our Penang operations, we are guiding a sizable sequential improvement in revenue, and are establishing a range of $875 million to $915 million. While we are practical in our revenue guidance, given the current dynamics, should we overcome the workforce limitations at our Penang operations, and the ongoing constrained supply chain, the demand environment supports upside to this range.

We're guiding GAAP operating margin in the range of 4.8% to 5.2%, including 70 basis points of stock-based compensation expense. At these revenue and operating margin levels, we anticipate delivering GAAP diluted earnings per share of $1.13 to $1.29, including $0.22 of stock-based compensation expense. Our guidance assumes that supply chain constraints, and COVID-19, do not materially impact end markets or our operations beyond what is already anticipated.

Next, a few thoughts regarding our longer term outlook. Looking at our end markets, we see broad-based strengthening of Healthcare Life Sciences demand over the next several quarters, led by recovery for equipment related to elective procedures. Likewise, our industrial sector is showing significant broad-based demand increases. Semiconductor capital equipment and communications forecasts, are both robust, while we're anticipating meaningful contributions from program ramps, with industrial and warehouse automation customers. We believe our Aerospace and Defense sector revenue is beginning to inflect higher, driven by improvement in commercial aerospace, and healthy demand from defense and commercial space customers.

In summary, we remain optimistic in our outlook. In addition to strong end market demand, we are major participants in secular growth markets, such as robotic-assisted surgery, warehouse and factory automation, and commercial space. We continue to win significant amounts of new business, aided by our capabilities, expertise, and commitment to our customers through exceptional quality and superior execution. Furthermore, we benefit from the differentiation provided by our engineering and aftermarket services.

Looking into fiscal 2022, we are confident these demand catalysts support double-digit revenue growth, as we continue to drive industry-leading operating performance, with GAAP operating margin consistently above 5%. I'd again like to thank our incredible Plexus team for their unwavering support and dedication. It’s through their efforts and talents that we’re able to further our vision of creating the products that build a better world, while delivering for all of our stakeholders.

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

[Steven Frisch, EVP & COO]

Thank you, Todd. Good morning. Please advance to Slide 6 for a review of our performance by market sectors. As Todd highlighted, our operations in Penang, Malaysia, were significantly impacted by workforce curtailments enacted by the Malaysian government during the fiscal third quarter. In addition, we experienced a program ramp delay due to a supplier quality issue within the quarter. As a result, all the sectors missed expectations in the fiscal third quarter, due to the negative impacts of these factors.

Todd reviewed the actions we are taking to resume more normal operations in Penang, and we have solved the supplier quality issue. Therefore, I will focus on the expectations for the sectors for the fiscal fourth quarter. Our industrial sector is seeing continued strong demand in the semiconductor capital equipment sub-sector. In addition, ramps to warehouse automation programs, and strength with the cable access product, are driving meaningful growth in the sector. As a result, we are expecting a low double-digit increase in our industrial sector for the fiscal fourth quarter.

In our Healthcare and Life Sciences sector, the demand shift from COVID-related products, to elective procedure devices, has accelerated. In addition, new program ramps are gaining momentum. The combination of these events, yields an expectation of a high single digit increase in our Healthcare And Life Sciences sector for the fiscal fourth quarter. Our Aerospace and Defense sector continues to see improving forecast in commercial aerospace. We anticipate the strengthening demand to drive a high single digit increase for our Aerospace and Defense sector in the fiscal fourth quarter.

Please advance to Slide 7 for an overview of our wins performance for the fiscal third quarter. We won 31 new manufacturing programs that we expect to generate $275 million in annualized revenue when fully ramped into production. The market sector teams continued to expand our existing relationships, while establishing new ones. Included in the wins is the addition of five new logos. The continued strong wins performance lifted our trailing four-quarter wins to another record level of $1.1 billion. Our wins momentum, which is the trailing four quarters of wins, divided by the trailing four quarters of revenue, increased to a healthy 31%. The result is above our 25% goal, and supports our fiscal 2022 growth expectations.

If we can advance to Slide 8 to review the manufacturing wins by region for the fiscal third quarter. The Americas region wins were an impressive $162 million in the fiscal third quarter. The strong result drove the region’s trailing four-quarter wins above $0.5 billion to finish at $507 million. With approximately 80% of the fiscal third quarter wins associated with our manufacturing facilities in the United States, we expect meaningful growth and margin expansion in several of our US locations in fiscal 2022.

The APAC region had robust wins of $91 million in the fiscal third quarter. In spite of the distractions created by the pandemic, the team has not lost its focus on delivering customer service excellence. They're being rewarded with new opportunities that continue to keep their trailing for quarter wins in excess of $400 million. The EMEA region wins of $22 million, maintains their trailing four-quarter wins above $140 million. Included in the wins is a meaningful new aftermarket service program that significantly expands this server’s offering in our Oradea, Romania facility.

Please advance to Slide 9 for further insight into the manufacturing wins performance by market sector. The industrial sector wins in the fiscal third quarter were $47 million, including the addition of two new logos. Although the wins result was lower than typical, we expect the fiscal fourth quarter wins to return to a more historical level. Our Healthcare Life Sciences team beat their strong fiscal second quarter wins, by delivering another record wins result of $159 million in the fiscal third quarter. With our trailing four-quarter wins at a record $513 million, we're expecting meaningful growth for the sector in fiscal 2022. The Aerospace and Defense sector had robust wins totaling $69 million in the fiscal third quarter, resulting in trailing four-quarter wins of almost $200 million. Included in the wins is the addition of a new logo in the defense sub-sector.

Please advance to Slide 10 for further insight into some of the fiscal third quarter wins. Included in the Healthcare Life Sciences wins, was a meaningful aftermarket services program that expands our global service and repair to additional products for our current customer. Although we are not the original manufacturer, we are developing solutions in Guadalajara, Mexico, and Oradea, Romania, to service and repair the devices. In addition to this opportunity, the Oradea facility also won the production of an ultrasound machine using cardiac care from an existing customer.

The Healthcare and Life Sciences team also expanded our relationship for the manufacturing of the next generation diabetes monitor for a current customer. In addition to the North American production we announced last quarter, we won the volume production for the Asian markets. The Asia Pacific demand for the new device will be produced by our Penang, Malaysia healthcare facility. Included in the industrial wins is a turnkey manufacturing of a self-service kiosk for a new customer. The complex high level assembly will be produced in our Appleton, Wisconsin facility.

Our industrial team also secured the manufacturing of a next generation industrial controller that is used in artificial intelligence applications. The product will be manufactured by our team in Penang. Malaysia. Included in the Aerospace and Defense wins, is a program with a new defense customer, who is focused on counter-electronic technology. The company selected Plexus’ Neenah, Wisconsin, facility because of the site's ability to support complex prototypes and volume production within the United States. Finally, the Aerospace and Defense team also expanded our relationship with a commercial space customer. The new programs add to the increasing quantity of complex assemblies that Plexus produces that are launched into space. These new assemblies will be added to the current family of products that we build for this customer in our Boise, Idaho, facility.

We can proceed to Slide 11 for highlights of our funnel of qualified manufacturing opportunities. Our funnel grew by $72 million in the fiscal third quarter, to finish at a robust $3.1 billion. Our industrial sector increased their funnel by $90 million to close the fiscal third quarter at $673 million. A meaningful outsourcing opportunity from an existing customer who is reevaluating their internal manufacturing strategy, contributed to the funnel's growth. Even with the strong wins performance in the fiscal third quarter, the Healthcare and Life Sciences sector kept their funnel at a very healthy $1.8 billion.

Four larger manufacturing opportunities, including an ultrasound machine, an insulin pump, a diabetes monitor, and a robotic surgical instrument, were added in the quarter. The product variety of these additions to the funnel, illustrates the broad expertise our engineering manufacturing teams have developed. Our Aerospace and Defense sector finished the fiscal third quarter with a funnel of $671 million. Our multiple design centers and manufacturing facilities in the United States, continue to attract defense and commercial space customers who require domestic capabilities. We expect the need for US manufacturing will continue to be a meaningful part of the sector's funnel.

Next, I would like to turn to operating performance on Slide 12. In spite of the adverse revenue impacts experienced during the fiscal third quarter, the team generated GAAP operating margin of 4.5%. Two exceptional operational efforts contributed to the stronger than anticipated result. First, our manufacturing team in Penang made scheduling adjustments that enabled them to achieve an output level of approximately 75%, with only 60% of the workforce being allowed in the factories during the back half of the fiscal third quarter.

Second, our global engineering team capitalized on the strengthening backlog and strong execution, to achieve exceptional revenue and profitability during the fiscal third quarter. As we look to the fiscal fourth quarter, we are making strategic investments to support growth. Our site, regional, and corporate supply chain teams, have added resources, and we're working tirelessly to mitigate operational inefficiencies and component constraints to meet customer demand. In addition, we are making meaningful investments in new program ramps that we expect to commence in fiscal 2022. Even with these additional investments, the team is committed to delivering solid operating results, with operating margin in the range of 4.8% to 5.2% for the fiscal fourth quarter.

A few final comments. We highlighted some of the great execution that our team in Penang, Malaysia, delivered during the fiscal third quarter. I want to highlight some of their exceptional efforts that are continuing in the fiscal fourth quarter. Although the team is still operating under Malaysia's workforce curtailment that limits our workforce to 80%, they're producing at nearly full output levels. In the first eight days of operation, Plexus’ vaccination center has delivered the first dose of a COVID-19 vaccine to over 6,600 Plexus employees, and over 4,400 employees from our customers, suppliers, and other manufacturers. Assuming the center's allocation of doses follow projections, all Plexus employees who desire to be vaccinated, will receive their first dose by this Sunday, and all would be fully vaccinated by the end of August.

In spite of the many challenges that the pandemic is creating in Malaysia and Thailand, the construction of our new manufacturing facility in Bangkok is progressing. We expect to complete the facility in the third quarter of fiscal 2022 as planned. The team's ability to develop an industry-leading vaccination center, while optimizing production output with a reduced workforce, and keeping strategic initiatives on track in the middle of a pandemic, is remarkable.

I will now turn the call to Pat for an in-depth review of our financial performance. Pat?

[Patrick Jermain, EVP & CFO]

Thank you, Steven. Good morning, everyone. This morning, I want to focus on three areas, our cash flow and balance sheet results for the fiscal third quarter, our working capital trends, and our fiscal fourth quarter guidance. Starting with our cash flow and balance sheet results, which are summarized on Slide 13. We delivered $42 million in cash from operations, and spent $11 million on capital expenditures, resulting in fiscal third quarter free cash flow of $31 million, a result in excess of our net income and our expectations for the quarter.

During the fiscal third quarter, we purchased approximately 292,000 shares of our stock for $27.3 million, at an average price of $93.53 per share. At the end of the fiscal third quarter, we had approximately $26 million remaining under our authorization. We intend to purchase the remaining amount during our fiscal fourth quarter. With our commitment to returning all excess cash to shareholders, we will soon be reviewing, with our Board of Directors, our plans for a new program, once the current authorization is completed.

We believe Plexus is well positioned with a strong balance sheet. At quarter-end, cash totaled approximately $307 million, sequentially higher by $13 million. Also at quarter-end, we had $50 million outstanding under our $350 million revolving credit facility. And our gross debt to EBITDA leverage ratio of one, was at an attractive level.

For the fiscal third quarter, we delivered a return on invested capital of 15.9%. This result generated an economic return of 780 basis points above our weighted average cost of capital, creating solid shareholder value. At quarter-end, we were pleased with our cash cycle, which was consistent with our guidance. With the result of 80 days, our cash cycle was sequentially higher by eight days.

Please turn to Slide 14 for details on our working capital and cash cycle. Sequentially inventory days increased by 19. The increase in days primarily related to the reduced revenue for the fiscal third quarter. In addition, we procured inventory toward the end of the quarter, as we prepare for higher revenue anticipated in the fiscal fourth quarter. Also, with the current supply chain environment, we are experiencing longer lead times for certain components. In order to meet greater demand for certain products and maintain a high level of customer service, we’re procuring components earlier, accepting that inventory dollars will be higher.

Partially offsetting the increase in inventory days, were increases in both payable days and customer deposit days. With elevated purchasing activity to support our revenue demand, payable days sequentially increased by 10 days. Customer deposit days increased by two days, as we worked with customers to secure an offset related inventory.

As Todd has already provided the revenue and EPS guidance for the fiscal fourth quarter, I'll review some additional details, which are summarized on Slide 15. Fiscal fourth quarter gross margin is expected to be in the range of 9.2% to 9.6%. At the midpoint of this guidance, gross margin would be sequentially higher by 30 basis points. We expect to gain better leverage on our fixed costs with the anticipated sequential increase in revenue.

For the fiscal fourth quarter, we expect SG&A expense in the range of $39 million to $40 million. At the midpoint of our revenue guidance, anticipated SG&A would be 4.4% of revenue, slightly improved from the fiscal third quarter. Again, increased revenue should provide added leverage.

Fiscal fourth quarter GAAP operating margin is expected to be in the range of 4.8% to 5.2%, which includes 70 basis points of stock-based compensation expense. At the midpoint of this guidance, GAAP operating margin would be 5% and sequentially higher by 50 basis points. This result would lead to operating margin at or above 5% for five of the last six quarters. With this consistent track record, we remain committed to delivering a GAAP operating margin in excess of 5%. At our Board of Directors meeting next month, we will be revisiting our future operating margin target, and we'll share more details during our October earnings call.

A few other notes for the fiscal fourth quarter. Depreciation and amortization expense is expected to be approximately $15 million, which would be consistent with the fiscal third quarter. Non-operating expenses are expected to be in the range of $3.8 million to $4.2 million. We are estimating an effective tax rate of 13% to 15%, and diluted shares outstanding of approximately 29 million shares.

Our expectation for the balance sheet is that working capital investments will increase, compared to the fiscal third quarter. We expect additional inventory as we increase procurement activity to meet the anticipated demand as we move into fiscal 2022. Based on our revenue forecast, we expect this level of working capital, will result in cash cycle days of 82 to 86 days. At the midpoint of this guidance, cash cycle would increase four days compared to the fiscal third quarter, primarily due to the inventory requirements.

Capital spending for fiscal 2021 is expected to be in the range of $70 million to $80 million, slightly below last quarter’s estimate. For the fiscal fourth quarter, we expect free cash flow to be negative. The tightening supply chain environment, and extended lead times, have required additional investments in inventory to satisfy customer demand. We are working closely with our customers to secure deposits to minimize working capital investments. In addition, we have already started investing in working capital to support the strong demand we anticipate, as we move into fiscal 2022. We want to take the necessary measures now in order to fulfill our customers demand, even if that results in added working capital investments. With that, (Rence), let's now open the call for questions.

[Operator]

Thank you, sir. [Operator Instructions]. Our first question comes from the line of Jim Ricchiuti from Needham & Company. Your line is now open.

[James Ricchiuti, Needham & Company]

Hi. Thank you. Good morning. Just a couple of questions. You highlighted the fact that the industrial wins was down in the quarter sequentially, and you're also suggesting a recovery in fiscal Q4. And I'm just wondering what you're seeing there. And I guess the question, or the broader question I'm having is, do you have any sense if the supply chain issues that we've all been hearing about, are beginning to, or potentially impacting wins in this or any other areas of the business, just because it's been so broadly based across different market verticals, what we're seeing in terms of supply chain. And a follow-up on that is I’m wondering if there's any way of quantifying potentially what type of headwind you might be anticipating from component availability in Q4. Thank you.

[Steven Frisch, EVP & COO]

Sure. Maybe I'll hit the second part first, which is focused on the supply chain impact on wins. I don't believe that the supply chain right now is impacting the funnel or the wins rate. Really couldn't correlate anything happening there. So, I think we're at normal levels. Specifically, as it relates to the industrial wins in Q3, I wouldn't read too much into that either. We do not measure the teams by a quarterly number. For us, it doesn't really matter whether we win at the end of the last day of the quarter or the beginning of the next quarter. And so, we don't incentivize the teams to try and close something to meet a quarterly metric. That's why we focus quite heavily on the trailing four-quarter wins number. So, it was a softer quarter, but like I said, I expect Q4 to come back to a healthy level. So, again, I wouldn't read anything too much into that either.

In terms of headwinds, as we - in terms of the revenue that - or forecast that we have in front of us for Q4, there is a sizeable customer forecast that we’re unable to achieve in Q4 due to component supply chains. Quite frankly, you roll up the numbers, it will be an excess of $100 million. With that said, even if we can procure $100 million worth of components, then we'd have to start talking about the labor and the manufacturing capacity to be able to do that. So, from an overall standpoint, there’s a lot of demand out there. And again, I don't - from an opportunity standpoint, the teams are working aggressively to close it.

[James Ricchiuti, Needham & Company]

Got it. And just want to follow up. I'm assuming you're fairly pleased with what you're seeing in the AMS business. It really seems like you're gaining traction there. The expansion of the new relationship that you highlighted, this is on the medical side, the healthcare side, is that - and I'm wondering what may be driving that, and to what extent you're really beginning to see traction with this in some of your other areas of the business. Thank you.

[Todd Kelsey, President & CEO]

Yes. So you're correct, Jim. The new relationship is on healthcare side and it has the potential, or it will be quite substantial. I mean, we've talked about it a couple of quarters in a row, and both quarters had meaningful programs that we're launching for this customer. And what I would say about the AMS business is, right now we have business across all three of our sectors, but clearly we're gaining the most traction within our healthcare business. And I think it has to do with a lot of our regulatory capabilities that we have within the Healthcare Life Sciences space. So, we're getting some excellent traction there, and the team's doing a great job of building out that business. And when you roll it all up, I mean, it looks like it could be a very substantial growth year in F’22 for our AMS business.

[James Ricchiuti, Needham & Company]

Got it. Thank you.

[Operator]

Thank you. The next question is from the line of Anja Soderstrom from Sidoti. Please go ahead.

[Anja Soderstrom, Sidoti & Company]

Hi, everyone. Thank you for taking my question, and congratulations on the strong quarter, despite the difficult environment. I just had a couple of questions. In terms of Penang, the efficiencies you've been driving there, as we get back to 100% capacity, how are those efficiencies going to play out? And are you going to be able to still benefit from those?

[Steven Frisch, EVP & COO]

Yes. Specifically about the efficiencies, I mean, the efficiencies are being done - or are being achieved because the team is working quite frankly, exceptionally hard and probably at a pace that's not long-term sustainable. So, we are learning things and some of those things will basically be used into the future in terms of how we can be more efficient. But I think, thinking that we're going to run at 15% above where we’re - our work levels, is probably not a realistic thing going. But we are, like I said, learning a few things about how to improve the facilities as we go forward. And you had a follow-up or another question?

[Anja Soderstrom, Sidoti & Company]

Yes. It was in regards to the cash cycle days. And so, I understand they are elevated now because of the supply chain environment. But once we get back to a normal environment, and you have improved your - the systems, I think you've been guiding before to try to be in the low 70s in cash cycle days. Is that still achievable, or could you improve that with this new systems, or how should we think about that?

[Patrick Jermain, EVP & CFO]

Yes. Anja, it's Pat. Yes, I think you're right. We are at a high point right now. And as we look into fiscal ‘22 and move through the quarters, I want to see inventory getting back to the low 90 days, and that would equate to an overall cash cycle in the mid to low 70s. And so, I think that's a reasonable spot to be operating within for most of, or for the latter part of fiscal ‘22.

[Anja Soderstrom, Sidoti & Company]

Okay. Thank you. That was all for me.

[Operator]

Thank you. The next one is from the line of Matt Sheerin from Stifel. Please go ahead.

[Matthew Sheerin, Stifel]

Yes, thanks. Good morning, everyone. Just a question regarding the margins, and you're guiding up sequentially relatively nicely and leverage on that revenue. But it's still - you're still talking down from the peak levels of about 5.5% operating margin, 10% or so gross margin, and relative to the revenue upswing. So, are there some still costs related to COVID labor costs in Malaysia, things like overtime? Steve, you talked about the fact that you're able to basically be at full production levels, despite the fact that you're still at 80% or lower at labor levels. So, are there some costs there that go away at some point and you'll get back to those peak margins?

[Todd Kelsey, President & CEO]

Yes. So, Matt, I'll start on this, and Steve and Pat may want to jump in at some point as well too. But there's a few different factors that are impacting Q4 margins. And we talked to one about program ramps, or in particular around the AMS program ramp. And we typically don't spend a lot of time talking about program ramps impacting margin, because it’s part of what we just build into doing the business. But this is a bit unique in that it’s ramping incredibly fast, and we're adding a lot of resources very rapidly.

So, there's a bit of an impact there. There is the inefficiencies that are occurring yet in our Penang operations that are impacting Q4, and also just some of the intense supply chain efforts that are ongoing right now to secure components. So, those are all having an impact on the cost structure. But when we look further out, we do believe the margins we've achieved in the past, are achievable in the future. And Pat talked about how we'll be discussing our annual operating plan and in our long range plan with our board next month, and we'll come out with a new margin target. It be somewhere north of 5%, is what I'll say as a precursor to that.

[Patrick Jermain, EVP & CFO]

Hey, Matt, one thing I'd add is, you had asked about COVID costs. Just to give you some perspective. In Q3, we had about 1.6 million in COVID-related costs. We expect that to be around 1.3 million in the fourth quarter. Seeing some reduction there as our testing that we're doing of employees, will go down, as more employees are vaccinated. So, we see those costs come down a bit in the fiscal fourth quarter

[Steven Frisch, EVP & COO]

And I'll add one point because Anja kind of asked about it as well, in terms of Penang efficiencies. I think the one thing to keep in mind is, although we have 60% or 80% of the workforce on site that are generating - outperforming and generating higher efficiencies, the reality is, we're still paying 100% of the employees, even if they're not at work. So, our cost structure hasn't really changed as it relates to the labor force there.

[Patrick Jermain, EVP & CFO]

Yes. And then I just had one last thing on the operating margin target. As Todd said, we're going to talk through that with our board next month. But if we would come up with a goal say of mid-5%, really important to keep in mind that that's a GAAP operating margin. And when you add back stock-based compensation, we'd be north of 6% on a apples-to-apples basis with our peers.

[Matthew Sheerin, Stifel]

Understood. Okay. Thanks for that. And then another question on inventory. I guess the fact that you're able to build as much as you did in the quarter, given the supply constraints, is somewhat surprising, although I guess that's primarily a function of the fact that you had lower production levels because of the Malaysia issue. So you were bringing components in. so, I guess the question is, are you seeing areas where things are opening up where you're able to build some inventory, or do you think a lot of this is just kind of tied to backlog that's been building and you're just going to run that through?

[Steven Frisch, EVP & COO]

Yes, it's probably more of the latter. We don't necessarily give you the component constraint issues starting us off until we get into fiscal or calendar ‘22, even. So, we do expect it to be a continued constrained market, hence the reason we are bringing in a little bit more inventory. We also have customers that are a little bit leery about losing - even though there may be from a forecast standpoint, we have a little bit of time to bring it in, the lead times are still there, there's more and more customers that are a little bit leery about not having the inventory on hand, because they're afraid that it might disappear for some reason. And so we have some customers they’re asking us, even though we could potentially get it with lead time to bring it in now, and that's where we're working with them on deposits to help offset that. So there are a few different, I'd say non-normal business things happening as it relates to the inventory management.

[Matthew Sheerin, Stifel]

Yes. And just related to that, on the pricing side, I mean, we know ASPs are going up across the board, semis and components. Are you just able to pass that along to customers, or is that sort of a battle that the suppliers are going through?

[Steven Frisch, EVP & COO]

Yes, we are. I mean, we look at our contracts and the way things are priced is, there's variances in prices and things going up, we’re able to pass those for the most part on to our customers.

[Matthew Sheerin, Stifel]

Okay. Thanks very much.

[Operator]

Thank you. The next one is from Adam Tindle from Raymond James.

[Adam Tindle, Raymond James]

Okay, thanks. Good morning. Just a quick question for either Steve or Todd on the supplier quality issue. It sounds like you said that this is resolved, but I'm just trying to get a sense for what percent of customers are using this part, or is this more of a custom part for that one customer? Just really trying to get a sense of the risk of broader contagion across the customer base from this, or is this really just a one-off?

[Todd Kelsey, President & CEO]

Yes, it's a one-off. It's a custom part for that supplier and it's not an electronic part. So, this is a one-off for that system and it's resolved and we're back in full production for that customer.

[Adam Tindle, Raymond James]

Okay. Got it. So, I really wanted to ask about the fiscal ‘22 comments, Todd. You talked about double-digit growth, and correct me if I'm wrong, I think you had been talking about double-digit growth and in the past, as we think on a go-forward basis. So, I'm wondering, if we add this non-perishable demand on top of that double-digit growth and these more like mid-teens growth, or is there something missing with that logic?

[Todd Kelsey, President & CEO]

Yes, I was intentionally vague with double-digit, Adam. I mean, what I would say is, when we think of our growth number, we're thinking of really what would it be ‘22 over ’21? So, it takes into account the adjustments. But what I can say is, well, we're early in the cycle and it's a long ways to even the start of F’22, let alone the end of F’22. So, things could change. But we wouldn't be talking about double-digit growth unless our forecast comfortably supported that level, is what I would say.

And when you think about the dislocated revenue, here's the way I would look at it. I mean, we had - with the way Q3 ended, we had about $80 million that I would call dislocated, because we performed a bit better than we thought we were going to. Some of that, a small amount is recovered in Q4. There's a small amount that's perished, and you can think of about maybe $50 million or so rolling into the first half of F-22.

[Adam Tindle, Raymond James]

Got it. That's helpful. Just last one for me to clarify on the near-term margin commentary. So, you have the AMS business ramp. I think in the prepared comments, you talked more about that being a Q1 impact. It sounds like some of that may spill into Q4 as well. I'm just trying to understand how much cost is associated with that. And maybe a way to think about it is, you know, how to build off of this 5% or so at the midpoint guide for Q4, as we think about Q1. Are there more headwinds related to the AMS ramp or tailwinds related to Malaysia utilization? Should we be building higher or lower off that? Thanks.

[Patrick Jermain, EVP & CFO]

Yes. Adam, I can take that. So we're doing the investment in the fiscal fourth quarter, and then the revenue will start towards the end of the quarter and into fiscal ‘22. So that investment in fiscal - the fourth quarter, is going to be about a 10-basis point drag on the margin before we start generating the revenue to more than offset that investment.

Okay. So that 10 basis points should be recovered throughout the course - I'm just thinking for Q1 of next year.

[Patrick Jermain, EVP & CFO]

Yes.

[Adam Tindle, Raymond James]

It sounds like there's more tailwinds versus Q4 sequentially.

[Patrick Jermain, EVP & CFO]

Yes

[Adam Tindle, Raymond James]

Okay, got it. Thank you.

[Steven Frisch, EVP & COO]

Yes. To maybe help you understand the ramp, if you look at a circuit card that's ramping, you're typically - there's not a lot of labor involved and it's more about just procuring the components. And we typically have the staff to build more circuit level assemblies. When you're looking at aftermarket services, it’s service and repair. So, it's more about training people to do the service and repair. So, the cost that we're talking about doing is we have to add a significant amount of operators and technicians and train them on how to service and repair, before we can actually start doing the work. And so, that's what - that's why on AMS, the costs are a little bit more front-loaded than what would be normal ramps.

[Adam Tindle, Raymond James]

Helpful color. Thanks, Steve.

[Operator]

Thank you. The next one is from Steven Fox from Fox Advisors. Your line is now open.

[Steven Fox, Fox Advisors]

Thanks. Good morning, everyone. I had a big picture question just on the new wins and how you're going about it. It looks like there's been a bit of a step up on sort of the average size of the wins over the last couple of years, more like 6 or 7 million per win versus 5 or 6 in the prior two years. And I'm just curious to how you would sort of describe why that's happened, whether it's been circumstance sort of an ability to go after bigger wins and how you think about sort of investing in that front-end machine to drive wins in the future. Do you scale that up more? Do you think you can target higher and higher wins per average size window, et cetera? And then I had a follow-up.

[Steven Frisch, EVP & COO]

Yes. So your math on the average wins is correct. We've seen a bit of an uptick over the years into that magnitude. And I would say that it is part of a little bit of a conscious effort to focus on bigger opportunities, but we don't necessarily exclude anything from a size standpoint. I know that some of our competitors have bet thresholds where they say they will only chase a certain size opportunity. For us, it's more about the partnership with the customer. And I think as our relationships have continued to get stronger, we are seeing bigger opportunities across the board. So I don't expect significant increases in the average size in the coming years, but it doesn't surprise me that they will pick up.

[Todd Kelsey, President & CEO]

Yes. Just to add a bit too around investing in our customer-facing team, Steve. That’s something that we continue to make pretty significant investments in. We have - of course, we have our new business development team, as well as our existing customer team. And the existing customer bid scales with revenue, is the way to think of that. The new business development team, we get additional leverage on, but we still continue to invest in there.

And one of the things that I'd point out is just the progress that's been made in that team, and that's being reflected in the new logos that we've been talking about. So, we've had 17 already this fiscal year. A typical year might be 10 to 12 new logos. So, the - we've done a great job of bringing in some new talent, leveraging some existing talent within that organization, building out our processes within the new business development effort of targeting new customers, and it's paying off right now.

[Steven Fox, Fox Advisors]

Great. That's really interesting. And then just as a follow-up, Pat, can you - I don't think you've talked about this one, but you said that engineering services helped margins. Can you put a little bit of math around that? Like how much of a benefit it was, I don't know, quarter-over-quarter, year-over-year, however you want to talk about it?

[Patrick Jermain, EVP & CFO]

Yes. I mean, we really don't break that out, Steve. If I had to look at the different components we had around lower healthcare costs, better engineering, and productivity, maybe it's a third, a third, a third. We haven't really done the math behind it, but that kind of feels right to me that not any one of those three was really dominating the improvement. They're probably pretty equally spread among the three.

[Steven Fox, Fox Advisors]

Okay. That's helpful. I appreciate that. Thank you.

[Operator]

Thank you. The next one is from Paul Chung from JPMorgan.

[Paul Chung, JPMorgan]

Hi. Thanks for taking my question. So, I have a couple. On Aerospace and Defense, nice surge in wins this quarter. Can you expand on the strength there? And as we head into the next 12 months, you have relatively easier comps in that segment and nice momentum and wins. How should we think about the overall growth as we navigate through the next 12 months in Aerospace and Defense?

[Steven Frisch, EVP & COO]

Sure. The wins this quarter, obviously, yes, very healthy size. And one of the things that I talked about in the script a bit was a large defense customer. It was an abnormally large opportunity that we won for a defense side. And so, that definitely helped push the number higher. And then as we've talked about, we are continuing to gain share in the commercial space part. And so, we see meaningful growth in that as we look through fiscal ‘22 with what we've been able to capture and expanding those relationships. So, with the outlook of commercial aerospace starting to rebound, we believe, pretty optimistic in terms of what the sector is going to look like for ‘22.

[Todd Kelsey, President & CEO]

And what I'd say is, we feel good about all three of our sectors for next year now. Obviously, A&D gets a little bit easier comp, but we think they're all going to be strong growth sectors for us in fiscal ‘22.

[Paul Chung, JPMorgan]

Okay, great. And then on CapEx, a little lighter than expected in 3Q, but kind of a big ramp in 4Q, seem to catch up. So are there any delays in the Thailand facility? I think you've mentioned it's on track for next year. And then on the facility itself, is there even more emphasis on automation? How do we think about kind of contribution margin of that facility? I think you've mentioned the Malaysian facility kind of generates relatively higher margins, I assume, given the kind of scale and size of that facility, but how do you expect the Thailand facility margins to kind of shake out? Thank you.

[Steven Frisch, EVP & COO]

Sure. I'll answer the first part, and maybe Pat will jump into the second. In terms of the building, I'm actually generally impressed with the team's ability to keep the project on track. We’re striking right now, it was about a week or two behind what we planned a year ago. And the team is confident they can catch it back up. So, from an expectation standpoint, we do expect the facility to be online in the fiscal third quarter of 2022. We are talking to a handful of customers right now, and there’s some interest in - from a risk mitigation standpoint to have some of our existing business from Penang moved there to help basically build a more robust supply chain for those people. We have hired the GM for the site. It's actually an internal person. We've announced that, and he's building a team. So our plans are going really well.

[Patrick Jermain, EVP & CFO]

Yes. And with the margin, Paul, typically, I mean, we'll see three, four quarters where it'll be a drag on margin, just because of the business ramping up and putting new business in there. What we've got going for us is similar to the campus environment we have in Penang. We’ll be utilizing a lot of the overhead structure we've got in Penang to help support Thailand. So, I think similar to what we saw when we put up our fifth facility in Penang, is that the ramp to our corporate operating margin target, was fairly quick, again like a three to four quarter period. So, I don't think you're going to see much of an impact to the overall results, because typically we do have facilities ramping at one point or another. So, I wouldn't necessarily depress our overall margins just because we're going through a period of ramping with Thailand.

[Paul Chung, JPMorgan]

Got you. And last question. Your diversification in APAC improved kind of post the Thailand facility. Are we done for now, or do you have expectations to kind of grow that footprint even further in ‘23 and beyond? Thank you.

[Todd Kelsey, President & CEO]

Yes. I think when you consider, call it dots on the map, we're not necessarily looking to add new dots on the map, but with the gross projections that we have, I mean, it won't be too far out. We need to be thinking about expanding within the locations where we're at. And a second Thailand facility isn't out of the question somewhere down the road.

[Paul Chung, JPMorgan]

Thanks.

[Operator]

Thank you. I’m showing no further questions at this time. Presenters, please continue.

[Todd Kelsey, President & CEO]

All right. Thank you, (Rence). So, in closing, I'd like to reiterate that we are optimistic about fiscal 2022. It’s shaping up to be a strong growth year, given the exceptional wins performance, the improved end markets we're seeing, and our participation in secular growth markets. We’re also establishing new and higher baseline for our operating margin performance, which all position us well for strong EPS growth within the fiscal year. So, in closing, I'd like to thank you all for joining us on the call today. We appreciate your support and interest in Plexus.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for your participation, and have a wonderful day. You may all disconnect.