Good morning, and welcome to the Plexus Corp. conference call regarding its Fiscal Third Quarter 2022 Earnings Announcement. My name is Latania, and I will be your operator for today’s call. [Operator Instructions] 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 Communications and Investor Relations. Shawn?

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, including without limitation, those regarding revenue, gross margin, selling and administrative expense, operating margin, other income and expense, taxes, cash cycle, capital allocation, future business outlook and the impact of COVID-19 on the company’s business and the results of operations. 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 filings for the fiscal year ended October 2, 2021, as supplemented by our Form 10-Q filings, and the Safe Harbor and fair disclosure statement in yesterday’s press release. 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, Chief Executive Officer; Steve Frisch, President and Chief Strategy Officer; and Pat Jermain, Executive Vice President and Chief Financial Officer; and Oliver Mihm, Executive Vice President and Chief Operating Officer. Consistent with prior earnings calls, Todd will provide summary comments before turning the call over to Steve and Pat for further details. Let me now turn the call over to Todd Kelsey. Todd?

Thank you, Shawn. Good morning, everyone. Please advance to Slide 3. As we establish our fiscal fourth quarter guidance, I’m pleased that Plexus is in position to deliver $1 billion in quarterly revenue, which would be a first for our company. While understanding that the macroeconomic outlook is uncertain and that challenging supply chain conditions remain, we anticipate further revenue growth and GAAP EPS expansion in fiscal 2023. Our customers remain bullish for the products we produce and many report backlogs covering calendar 2023. In addition to the strong demand, our optimism for continued growth stems from the strength of multiple substantial early-stage new program ramps, our leading position in the secular growth markets of commercial space, warehouse and factory automation and robotic assisted surgery, our strong historical wins performance and our commitment to operational excellence including increasing success in resolving supply constraints. Please advance to Slide 4, for a review of our fiscal third quarter results. For the quarter, we achieved record revenue of $981 million, a result that exceeded our guidance range of $885 million to $925 million and represented 21% year-over-year growth. All three of our market sectors were up sequentially in healthcare, life sciences and industrial exceeded our expectations entering the quarter. This was largely a result of our team’s increasing success in mitigating the impact of constrained components supplies through improved processes and the benefit of strong customer partnerships. We delivered GAAP operating margin of 5.1%, a 110 basis point increase from the fiscal second quarter and a result that was above the high-end of our guidance range of 4.4% to 4.9%. This result was achieved through increased volume leverage, returned to normalized operations in Malaysia following the COVID-19 related challenges of the previous quarter, and the team’s success and mitigating the impact of COVID-19…

Thank you, Todd. Good morning. I will start on Slide 6 with a review of performance by market sector for the fiscal third quarter as well as our expectations for the market sectors for the fourth quarter of fiscal 2022. The performance across all market sectors was strong in the fiscal third quarter. Although we still see continued supply chain constraints, especially in higher node lagging edge semiconductors, our efforts in early fiscal 2022 to enhance our processes and to obtain longer-range forecast from our customers are having a positive impact with the materials pipeline. Reviewing the details by sector, I will start with the industrial sector results. The sector grew revenue by 10% in the fiscal third quarter. The exceptional result was significantly above our expectations of a flat to low single-digit increase. Shipments for 16 of the top 20 customers exceeded forecast mainly due to better-than-anticipated material supply. As we start the fiscal fourth quarter, we are mindful of the broader macroeconomic uncertainties. However, customer demand remains robust across most of our industrial subsectors. As a result, we expect a low single-digit increase in the industrial sector for the fiscal fourth quarter. At this level, the sector would achieve solid fiscal 2022 revenue growth in the range of 10%. Our Healthcare/Life Sciences sector achieved exceptional growth of 13% in the fiscal third quarter. The result significantly exceeded our expectations of a mid-single-digit increase in improved materials pipeline for new program ramps as well as for existing programs enabled stronger-than-forecasted shipments for 17 of our top 20 Healthcare/Life Sciences customers. Looking ahead, we expect program ramps to drive further growth in the sector. As a result, we expect a mid-single-digit increase for our Healthcare/Life Sciences sector for the fiscal fourth quarter. Achieving this result would mean the sector sequentially…

Thank you, Steve, and good morning, everyone. Our fiscal third quarter results are summarized on Slide 12. Gross margin of 9.5% was above the top end of our guidance and sequentially higher by 90 basis points. For the fiscal third quarter, we experienced significant fixed cost leverage as revenue increased 10%, while fixed manufacturing expenses remain consistent with the fiscal second quarter. Productivity improvements across all three of our manufacturing regions also contributed to the better results. Selling and administrative expense of $44 million was above guidance primarily due to additional incentive compensation linked to higher revenue and operating performance for the quarter. As a percentage of revenue, SG&A was 4.5%, which was consistent with expectations and sequentially lower by 10 basis points. Inclusive of approximately 60 basis points of stock-based compensation expense, we delivered GAAP operating margin of 5.1%, which exceeded the top end of our guidance. Non-operating expenses were above expectations as a result of foreign exchange losses and higher factoring expenses. GAAP diluted EPS of $1.33 was above our guidance due to the strong revenue and operational performance. Turning to our cash flow and balance sheet on Slide 13. As anticipated for the fiscal third quarter, we made investments in working capital to support our customers’ strong demand and as a result of the continued supply chain constraints. Cash investments in operations and capital expenditures both totaled $21 million, creating a $42 million usage of cash for the quarter. During the quarter, we completed our $50 million share repurchase authorization by purchasing approximately 149,000 shares of our stock for $12 million. Next month, we will review with our Board of Directors the opportunity for a new authorization. Our goal remains to return all excess cash to our shareholders. On June 9, we refinanced our senior unsecured credit…

[Operator Instructions] And our first question comes from Anja Soderstrom of Sidoti. Your line is open.

Yes, hi. Thank you for taking my questions. Congratulations to a great performance here. I’m just curious, and you might have touched on it, but I might have missed your commentary about the lower margins for the fourth quarter and what gives you confidence in your projection for fiscal 2023?

Yes. So Anja, this is Todd. I’ll start this, and then I think Pat is likely going to want to add in some commentary. But if we look at the fourth quarter and again, I mean, at the midpoint, we’re only guiding down 10 basis points, so it’s not much. But the areas where we’re seeing a little bit of pressure is continued growth investments. So, our customer demand remains substantially above what our guidance range is. And then we’re seeing some level of inflationary pressure on both the labor and materials when it’s on spot buys that we have in place with us. And we’re working with our customers, in particular around the labor issue and having good success with that. So that will – we view that as a near-term issue. And the materials will obviously, there will come a time when the supply chain stabilizes. And then the final area is increased incentive compensation costs because of the improving financial performance that we’ve had during fiscal 2022. And maybe I’ll pass it along to Pat to talk about the longer term.

Yes. And just one other comment on Q4. So, I had mentioned gross margin is down 30 basis points. Anja, we are gaining about 20 basis points of operating expense leverage. So to Todd’s point, we’re down about 10 basis points at our midpoint. Longer term, as we move through fiscal 2023 with additional revenue and fixed cost leverage, I think we’ll be approaching our target of 5.5%. So, we do expect to see improvements in margins in fiscal 2023.

Okay, that was helpful. And I think you noted in your press release that EMEA included some strategic opportunities from customers. Can you just elaborate on the strategic opportunities?

Yes. This is Steve. I’ll comment on this one. The EMEA team has been doing an exceptional job through 2020 and 2021 with COVID in terms of driving performance for customers in spite of some of the challenges and that’s paying dividends. They had some pretty significant wins here in the quarter for that team. And it’s all driven from existing customer relationships. So our ability to deliver for these customers in 2021 and in the beginning of 2022, we’re definitely being recognized. The exciting part for us is in all of the wins that I talked about, each of them are either new platforms for where these customers are going with their future products. And so we’re pretty excited about the opportunity of how the team has done to build the relationship with the customers and the fact that we’re winning these new platforms is kind of a leverage point for us as we move forward. So expecting continued good things out of the team and those customers in EMEA.

Okay. Thank you. And then just in general, as we see the weaker economy or a potential recession, what do you see among how has the sentiment or sort of discussions with your customer changed if at all?

Yes. In general, they haven’t changed much. I mean there’s a customer here and there that we’re seeing some impact from, but I would say a typical – I mean, that’s typical in a normal environment that you’re going to see up and downs with customers. And there’s a number of them that just continue to report very strong demand. And as I mentioned in the prepared remarks, we have several customers that are reporting demand or backlog of their product through calendar 2023. So right now, in the markets that we serve, the demand still remains quite strong.

Okay. And just remind us again that your exposure to China and how you might be affected if the cost is more severe there?

Yes, about just a little over 10% of our revenue comes out of China. So it’s a relatively small impact to China. And we’ve had no impact from any of the COVID lockdowns.

Okay, great. Thank you. That’s all for me. Thank you.

[Operator Instructions] And our next question comes from Steven Fox of Fox Advisors. Your line is open.

Thanks. Good morning everyone. First question, I just wanted to get back and talk a little bit about working capital and cash flows. So it sounded like you made some progress on the supply chain front during the quarter, but working capital is still a drag, a little bit worse on inventory days. Pat, can you just sort of talk about the path out of this sort of inventory hole maybe over the next 12-months if that’s a reasonable target? And whether there’s any momentum coming out of this quarter to start generating positive cash flows again? And then I had a follow-up.

Yes, I do see that coming out of this quarter in Q4, we do see positive free cash flow, and that is from an improvement in inventory days. I think as we go through 2023, we’ll see continued improvement. I mean as I mentioned, Steve, we’ve been pretty successful with securing customer deposits to offset that inventory exposure. But I do see improvements as we move through 2023, and I do expect strong free cash flow generation in 2023.

Yes. I’ll just add. This is Oliver. I’ll add something there. I think it’s good to reflect on what’s driving that inventory. You have a number of dynamics. You could be used to offset supply chain risk. It could be used to – it’s certainly being driven by extremely long lead time components and then over that lead time if our customer forecast varies and also in support of new program ramps. And so as those lead times could potentially pull back in the future, you’ll see some change in that dynamic. As Pat mentioned, our customers are quite reciprocating back to us as with customer deposits up $26 million quarter-over-quarter. We are having more success with unlocking supply, as you saw with the strong Q3 revenue performance. And then lastly, I’ll close by noting that we have some internal initiatives that give us optimism that we will be able to drive lower inventory days going forward.

Great. That’s helpful. And then given that maybe healthcare could be the least economically impacted of your business segments. And I’m not saying that the others necessarily have to be cyclical. But can we maybe step back a little bit and just reset on – given all the new wins, et cetera, and market share gains, what are the major sort of macro drivers, equipment versus personal diagnostics, et cetera, et cetera, life sciences. What are we thinking about in terms of what is the growth behind that health care? And where could we still see maybe some CapEx pressure or not, if that makes sense?

Yes. So this is Steve. Two parts to that. One is Todd talked about and I did as well in terms of new program ramps. We do have to those wins, some nice new program ramps that are happening. And so in spite of kind of the – some of the macroeconomic questions, that revenue is growing. And so that’s what’s giving us one part of the optimism. The second part is we talk to our larger health care life sciences customers and they talk to their customers, the inventory for finished goods in a lot of places is still depleted. And so even if there’s a little bit of slowdown from an end market demand standpoint, the CapEx spending, and I think we’ve been hearing this a little bit, the CapEx spending still seems like it’s going to be at a robust level to basically backfill some of those challenges that they’ve had in terms of getting all the equipment they needed over time. And so we’re quite optimistic in terms of the forecast we’re seeing and again, as Todd highlighted, a lot of customers are talking about demand needs going all the way into, in the 2023. And so the secular markets, especially in robotics and stuff like that are all still doing quite well.

Yes. One thing I’d add too, Steve, is if you went back to, call it, in the last recession, the 2008, 2009 timeframe were heavily dominated by imaging within our healthcare business, which I think was probably some of the most economically sensitive pieces of equipment because of the investment that’s there. That’s a significantly lower piece of our business, somewhere around 30% or so of our health care sector. And if you look at now, there’s a significant more life sciences within the portfolio, robotic-assisted surgery, things such as neurology. So the portfolio, I would say, is much more recession-resistant, I think, than it was in the 2008, 2009 time frame, which it didn’t even perform too badly then.

Right, that’s super helpful. Thank you.

And our next question will come from Melissa Fairbanks of Raymond James. Your line is open.

Hi, guys. Great quarter, really impressive execution, and I’m really thrilled to see that. I just had a quick question on the unfulfilled backlog of around $100 million. What are your expectations on when that could be cleared? Is it something that the Thailand facility will help to ease or is this still just a function of supply constraints?

Yes. It’s really a function of supply constraints, Melissa. So I mean, we expect it to continue to roll out. So even though we had good success in the fiscal third quarter of clearing supply issues, which resulted in the revenue upside, we still saw demand that more or less backfilled what we were able to clear. So it continues to roll at this point. And until lead times get to a more normalized level, particularly for those legacy components that Steve had talked about, we’re going to see a backlog.

Okay, great. Then from a modeling standpoint, how should we expect depreciation expense to trend now that Thailand is coming on? And then maybe one last question after that. And then to the extent that you’re funding working capital investments with the balance sheet, would we eventually get to a more normalized interest expense as that inventory is cleared?

Yes. Melissa, this is Pat. So starting with depreciation. We do see that coming up. So in 2023, I think, let me back up, in 2022 I think we’ll be around $63 million of depreciation going into 2023, I think it will be in the low 70s. So we’ll see that ticking up. And then to your point around interest expense, we are seeing a pretty significant impact from rising interest rates. So that’s a large component of the increase. But to your point, as we free up cash through liquidating inventory, we’ll be bringing down our revolving borrowing and that will benefit our interest expense. So I think if – from a modeling standpoint, you want to use something similar to the Q4 – fiscal Q4 guide, maybe on that lower end of $7 million per quarter. I think that would be reasonable at this point.

Okay, great. Thanks very much. That’s all for me.

[Operator Instructions] And our next question comes from Paul Chung of JPMorgan. Your line is open.

Hi, thanks for taking my question. So if you could talk about the kind of revenue boost from the new Thailand facility. What’s the contribution in the September quarter? And how do we think about contribution in kind of the next couple of quarters as well in 2023? And then I guess the new OpEx run rate and CapEx level we move into fiscal year 2023 as the facility ramps. But I think you also mentioned that you may be expanding the Thailand facility. So any initial guide on CapEx for fiscal year 2023 would be helpful.

Yes. This is Steve. I’ll start and then turn it over to Pat for some follow-on. In terms of revenue with customers for the Thailand facility, it’s kind of as Todd highlighted, we successfully passed through our first qualifications with our first product for a customer, and we’ll begin shipments here in late Q4, beginning in Q1. So from a revenue standpoint, it’s minimal at this point. However, with that said, we have several customers and programs that we are looking to transition from our Penang facilities into Thailand. And so as we go through 2023, we expect by the end of 2023, the back half of 2023, that, that facility is from a revenue standpoint, getting to a corporate level where it’s basically absorbing all the expenses that we have that were going in the facility. So the 2023 will be a growth year for us, but again, the prospects are pretty quick here, which is kind of what’s giving us the view and the look. We actually have some visibility to what happens in the 2024 and beyond where that facility, quite frankly could fill quicker than what would be normal for us. And so the strategy planning in terms of looking into 2024 and 2025 and beyond of what we need to do, we do see Thailand as being a growth location for us. We’ve been very happy with the employees we’ve been able to attract. The team has been doing an excellent job with its initial execution. And so kind of a mitigation strategy for Southeast Asia, we see it as a perfect place for us to continue to grow. Pat, may well turn it over to you then.

Yes. From a P&L perspective, Paul, starting with fiscal 2022, there’s about a 10 basis point impact on overall margins from Thailand investments. As we move into 2023, the first half will still be a drag on margins. But as we move into the second half of fiscal 2023, we’ll turn that into profitability for that facility. And then I think you may have been asking about overall OpEx expense. And I had guided Q4 around 4.2%, 4.3%. And as we move into 2023, I think 4.3% of revenue is a good number to use because we’re going to want to still be investing in our people and in our systems. So we’ll see the dollars increase. But I think the additional revenue will keep that percentage around 4.3%.

Okay, great. Very helpful. And then just on the manufacturing wins, you’re still pretty comfortably above that $1 billion level on a trailing four-quarters. It sounds like your visibility into 2023 is quite good. So any comments there on win momentum after kind of record levels in the second fiscal quarter?

Yes. So I think, in general, we feel really good about the wins in the funnel. And I mean we want – because we dropped from the large quarter in Q3, we thought it was important to at least address it. But we tend to not think of the wins as quarterly wins. We tend to look at trailing four-quarters. And we believe we’re positioned well with the size of the funnel to continue to stay above $1 billion and then to drive further momentum as we look out into fiscal 2023.

Yes, this is Steve. One thing that really important to understand is that we do not incentivize the business development teams to a quarterly wins number because the reality is, is that when we win an opportunity, it takes a couple of quarters for it to ramp into revenue. And so if we drove the teams to achieving or quarterly wins number, we believe that would drive bad pricing behavior. And so that’s why we really stay focused on and working with the teams on what a trailing four-quarter and an annual number kind of looks like. And so again, that’s a significant buy design reason why we do that.

Understood. Very helpful. And lastly, you mentioned wins from existing customer’s kind of driving most of the funnel here. Are you displacing mostly kind of in-house manufacturing or are these more competitive wins? And as we think about your longer-term kind of growth outlook, if you could expand on that dynamic between existing customer expansion versus new customers and how that trend would be very helpful. Thank you.

Sure, maybe the second part first. If you go back to 2020 and 2021, we had a pretty conscious effort to add new logos to the portfolio, and we talked about adding, I believe, the number like 2022 in fiscal 2021. And we’re very pleased with that initiative and what we did. We are still looking to add new logos, but maybe not to the same extreme until they’ve come down a little bit. But again, very purposeful and pleased with the way the strategy is being executed. As we look to what are we winning with customers, it is a mix of new program ramps, and that’s really where the execution by our operation has helped significantly. We call that the execution dividend because when you execute really well, you had a really good chance of winning the next programs in the teens, especially like we talked about EMEA this quarter. Their execution through 2022 here and the beginning of 2022 has really helped them drive up their wins performance. We are taking market share gains with customers. I think our execution through COVID is helping us. And then lastly, there are customers that are – continue to look and talk to us about exiting their existing manufacturing. I’d say currently, that’s a little bit lower than what it’s maybe been in historical past. However, with macroeconomic uncertainties, especially as the things start to down turn a little bit, those conversations have a tendency to pick back up, which could be another opportunity for us. And so it’s been a mix between the three. And I wouldn’t say there’s a trend right now in either one, but we’re – it is an active thing that we continue to manage. And we’re pretty pleased with the way our market sector teams are really kind of driving it today. So as Todd kind of highlighted, pretty optimistic in terms of what we look like with our funnel going into 2023.

Great. Thank you so much.

[Operator Instructions] And our next question will come from Matt Sheerin of Stifel. Your line is open.

Yes. Hi, good morning. I wanted to just drill a little bit more into really basically the dramatic change in terms of your operations, your ability to provide a significant upside in revenue in the last two quarters compared to the previous three, where you were missing numbers because of the supply constraints. One difference, obviously, is the fact that you’ve built a lot of inventory, but you also talked in the commentary about changes in processes, changes in supply chain strategies. So could you talk a little bit more about, what changes have been and put into place and how that strategy plays over the next few quarters?

Sure. So one of the things that I just want to bring us back to in some of the quarters that we had challenges, they were kind of twofold. There were some supply challenges, but there was also some pretty significant COVID impacts particularly around Malaysia, which is a big chunk of our footprint. But what I’d say we’ve addressed on the supply issue is we’re taking an approach that’s much more focused around supply versus demand when we look at what our projections are because we’ve historically had really good success at regardless of what the demand is of meeting that demand. And with the current environment being what it is, that just doesn’t occur anymore. So we’re taking a much more supply focused approach with our forecasting. So that’s probably step number 1. Step number 2 is just around the processes that we’re driving in that – we’re using a lot of automation, for instance, to find components on the open market. We’ve got some excellent processes in place with our customers to drive longer-term forecast, put long lead purchase orders in place, things such as that to be able to get supply in earlier. And then the approach we’re taking, I think, it has us focused on escalating the right parts as well too so that we’re focused on the activities that can drive the most impact. So that’s why in the case of this quarter, we far exceeded our guidance. I mean we’re able to drive some components that we didn’t have a line of sight to as we began the quarter because we are focused on the right things.

Okay, great. And you also mentioned on this call that some constraints are easing. Could you talk about areas where you’re still seeing issues, what types of components and where you’re seeing a little bit better supply?

Yes. This is Oliver, Matt. I’ll take that. Candidly, across our commodity base, we’re not really seeing any segments that are easing that I could put a trend to. I think if there was a glimmer of good news in the whole dynamic, I would say it’s not getting worse. And the fact that it’s been consistent here for the past couple of quarters. And then coupled in with the point that Todd made about the pivots we’ve made internally to ensure success, that’s what helped create that revenue upside in Q3.

Yes. The one thing I’d add too that I probably should have earlier is just the efforts of the team. We’ve got an excellent team that’s working incredibly hard. We’ve added some great talent to it as well. So feels really good about the supply chain talent that we have in the organization.

Okay, thanks for that. And I also wanted to talk or ask Pat about the gross margin. One of the other EMS companies last night talked about some gross margin pressure due to the fact that there’s a higher materials pass-through because of the component cost inflation, and that’s just a one-for-one pass-through, which drives up materials as a percentage of COGS. And are you still starting to see that at all as an issue, Pat?

Yes. I mean we saw some of that last quarter too, Matt. And fortunate for us, we’ve been able to earn through that with productivity improvements and the additional revenue with fixed costs, is it 10, 20 basis points, probably margin impact to us because we’re not achieving profit on that inflated price at this point.

But what I’d say is we don’t see that having any further negative impact to us moving forward. It’s – I mean, basically, it is what it is, and it’s factored into our projections.

Yes. And I said earlier of us moving towards that target of 5.5%. We continue to believe that even in this environment.

Got it. Okay. And then on the that, the inventory cash deposits that you’re getting at 25% of inventory, it’s certainly a nice improvement from what we’ve seen historically, but you’re still financing a lot of that inventory and working capital yourself. You’re seeing that impact your bottom line through higher interest expense. So is there other discussions with customers, particularly if these customers want to sort of behave in a more conservative manner going forward where they want to carry more inventory, will you have discussions where maybe that number should go up, maybe you should be 50% or a higher number.

Matt, this is Steve. Most definitely, both in inventory as well as some of the inflationary costs. We’re definitely having conversations with customers that they quite frankly I’ve never had before in our industry as we’re facing these dynamics. So yes, it’s a continuing conversation, but what is the right inventory level? If they want to have a higher regulatory level, there’s a deposit, there’s also conversations about if they – is there a carrying cost that gets associated with some of this. So it varies by customer and different discussions. But yes, we are having those conversations.

Okay, very helpful. Thanks so much.

And I am showing no further questions. I would now like to turn the conference back to Todd for closing remarks.

All right. Thank you, Latania. I would also like to thank everybody who joined our call today. We appreciate your support and your interest in Plexus.

This concludes today’s conference. Thank you for participating. You may now disconnect.