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Plexus (NASDAQ:PLXS)
Q2 2020 Earnings Call
Apr 23, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Good morning, and welcome to the Plexus Group conference call regarding its fiscal second-quarter 2020 earnings announcement. My name is Sidney, and I'll 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 Ms.

Heather Beresford, Plexus' senior director communications and investor relations. Heather?

Heather Beresford -- Senior Director Communications and Investor Relations

Good morning, and thank you for joining us today. Some of the statements made and information provided during our call today will be forward-looking statements as they will not be limited to historical facts. The words believe, expect, intend, plan, anticipate and similar terms often identify forward-looking statements. Forward-looking statements are not guarantees since there are inherent difficulties in predicting future results, and actual results could differ materially from those expressed or implied in the forward-looking statements.

For a list of factors that could cause actual results to differ materially from those discussed, please refer to the company's periodic SEC filings, particularly the risk factors in our Form 10-K filing for the fiscal year ended September 28, 2019, as supplemented by our Form 8-K filed with the SEC yesterday and the Safe Harbor and Fair Disclosure Statement in yesterday's press release. Plexus provides non-GAAP supplemental information such as ROIC, economic return and free cash flow because those measures are used for internal management goals and decision-making and because they provide additional insight into financial performance. In addition, management uses these and other non-GAAP measures, such as adjusted operating income, adjusted operating margin, adjusted net income and adjusted earnings per share to provide a better understanding of core performance for purposes of period-to-period comparison. For a full reconciliation of non-GAAP supplemental information, please refer to yesterday's press release and our periodic SEC filings.

We encourage participants on the call this morning to access the live webcast and supporting materials at Plexus' website at www.plexus.com, clicking on Investors at the top of that page. Joining me today are Todd Kelsey, president and chief executive officer; Steve Frisch, executive vice president and chief operating officer; and Pat Jermain, executive vice president and chief financial officer. Consistent with prior earnings calls, Todd will provide summary comments before turning the call over to Steve and Pat for further details. Let me now turn the call over to Todd Kelsey.

Todd?

Todd Kelsey -- President and Chief Executive Officer

Thank you, Heather, and good morning, everyone. Please begin with our fiscal second-quarter results on Slide 3. After the close of the market yesterday evening, we reported results for our fiscal second quarter of 2020. We achieved quarterly revenue of $767 million.

While our revenue result was below our expectations entering the quarter, I commend our teams on their ability to mitigate the impact of COVID-19 related supply chain constraints in 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 quarter. With the exception of our China sites in the month of February, the remainder of our facilities operated near full capacity for the quarter. While each of our locations face challenges resulting from the COVID-19 pandemic, our talented and dedicated team members at all locations remained committed to meeting the essential needs of our customers and communities.

We delivered GAAP EPS of $0.43, including $0.19 of stock-based compensation expense and non-GAAP EPS of $0.61, excluding $0.18 due to the previously announced closure of our Boulder Design Center. Both our GAAP and non-GAAP EPS included $0.14 of cost directly related to some impact of the COVID-19. Please advance to Slide 4. While our results were impacted by the COVID-19 outbreak, our teams demonstrated their ability and resolve to overcome the complexities and challenges of COVID-19. They remain committed to delivering for our customers and helping to create the products that build a better world.

Our efforts supported our 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 COVID-19. This includes products such as infusion pumps, portable ultrasounds, medical bed electronics, portable patient monitors, ventilators, mobile radiography electronics and diagnostic test systems. In addition to supporting the fight against COVID-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 5. Next, I will further discuss the impacts of COVID-19 and highlight our response in meeting the needs of our team, our customers, and our communities.

And given our sizable footprint and supply chain content in China, we realized very early that potential disruption could occur as a result of COVID-19. 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, with an Executive Steering Committee that sets priorities, policies and protocols and regional teams to drive actions in line with these policies, and inform our Executive Steering Committee each day of impacts locally.

As we work through the challenges presented by COVID-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 for our facilities to be the safest place our team members can be when 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 also provide face coverings at all our facilities globally. We implemented multiple procedural changes and 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 to COVID 19. I personally communicate to all employees on at least a weekly basis. Unfortunately, to date, we have had three employees globally test positive for COVID-19. In response to each of the positive tests, we immediately implemented our well-defined crisis management protocol.

We notified employees and customers as well as performed an orderly shutdown of the site within hours. This was followed by a thorough decontamination of the site by a third-party service provider and a multi-day shutdown prior to resuming operations. Please advance to Slide 6. While COVID-19 has produced many challenges, it has also presented opportunities.

Despite the uncertainties and lack of travel late in the quarter, our go-to-market team secured hefty $248 million of manufacturing wins in the fiscal second quarter. This result was dominated by our healthcare/life sciences sector, which posted $102 million of 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 and are ramping five programs across the United States and Europe that are associated with ventilators for COVID-19 testing. The majority of these programs will be reflected in our fiscal third quarter wins.

In addition, we are seeing upside from multiple customers for existing programs that support emergency medical applications. Our team's ability to quickly adapt and persevere highlights our organization's talent, strength and 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 year 2020 on Slide 7.

As we look forward to the fiscal third quarter, and we expect to deliver revenue in the range of $790 million to $830 million. While markets are highly volatile, in aggregate, our demand remains strong. healthcare/life sciences demand and in particular, critical care products is very robust. Semiconductor capital equipment and 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 shift patterns, operating on a 7-day per week schedule, focusing on productivity improvements and having nonproduction employees work from home, our output is now near full capacity.

Our operating margin in the fiscal third quarter will continue to be negatively impacted by challenges and inefficiencies resulting from COVID-19. And 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 $0.72 to $0.82, including $0.21 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 COVID 19. However, our guidance assumes no large-scale closures of our facilities or those of our suppliers or customers due to COVID-19 nor does it assume that the COVID-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 the revenue and EPS expectations occur within the quarter. So 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 be 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're able to deliver life-saving medical devices and other essential products to our customers and our communities.

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

Steve Frisch -- Executive Vice President and Chief Operating Officer

Thank you, Todd. Good morning. The COVID-19 pandemic impacted our fiscal second-quarter operational metrics. To provide better context of the situation, I will start with the status of our global facilities on Slide 8.

All of Plexus facilities have requirements placed upon them by the respective governments 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 inefficiencies due to COVID 19. Our design centers, global headquarters and most office personnel are under these 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 varies by region. Starting in APAC, our China sites experienced a period of very limited production due to the restrictions imposed by their government in response to the spread of COVID '19. However, the team worked 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. And as we announced on March 23rd, our sites in Malaysia are subject to the national movement control order. The current order restricts the number of employees who can work at our sites at 50%. The impact to some of our local suppliers is 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 this 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 health of our employees, Malaysian officials have eased some restrictions. We have been allowed to create new shift patterns that continues the reduction of the number of employees in a facility, but they enable us to achieve nearly full production rates.

In addition, all of our critical Malaysian suppliers 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 COVID 19 through the majority of the fiscal second quarter. That changed late in the quarter as we had one employee test positive for COVID 19 in 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 by our EH&S, 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 sites adjusted their policies and procedures early in the second quarter to ensure employee health and safety as well. Fortunately, they do not have incidents beyond the global supply chain issues associated with COVID 19 that all regions are managing.

Finally, and most importantly, we've made the commitment to our employees to make Plexus the safest environment outside of their homes. Todd highlighted some of the actions we are taking. I want to expand upon one of them, social distancing, in order to illustrate some of the steps we are 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 to prevent close contact situations. We have physically reconfigured workspaces to ensure proper separation and we have changed the layout of common spaces like lunchrooms and break areas to support proper social distancing. As a leadership team, we will 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 has been and will continue to be transparent communications with our employees as well as our customers and shareholders as we adjust to this new environment. Please advance to Slide 9 for a review of the performance by market sector. Three of our market sectors missed expectations in the fiscal second quarter, largely due to the negative impact that COVID-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 sectors for the fiscal third quarter of this 2020. Our healthcare/life sciences revenue is expected to decline over 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 increases with customers that provide products used for the testing, diagnosing and treating of COVID-19 is driving the growth.

Given the urgent need for products we produce that fight COVID 19, we expect our healthcare/life sciences demand to remain robust. Our industrial/commercial sector is anticipating a high single-digit decline of 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 subsectors. Some of the strength in the semiconductor capital equipment subsector is market share gains due to our team's ability to deliver and in spite 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 expensing 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 communications sector is expected to grow almost 30% in the fiscal third quarter. Strong demand for Internet connectivity infrastructure products and the ramping of a new 5G 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 now 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 opportunities virtually. The team is adjusting to travel restrictions as they become a new variable in the sales process. And 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 the $248 million of 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 COVID-19 that we expect to have ramped within the fiscal third quarter.

In addition, we anticipate two new program wins in the fiscal third quarter related to COVID-19. We're aggressively working to ramp and -- on to ramp plans for those programs as well. The APAC region's manufacturing wins at $101 million were the strongest they have been in over a year. The team did an outstanding job of 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 EMEA region wins of $62 million were exceptionally strong. Included in 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 Oradea, Romania facilities.

Please advance to Slide 12 for further insight into the manufacturing wins performance by market sector. Our healthcare/life sciences team had an exceptionally strong wins result of $102 million in the fiscal second quarter. Obviously, we are energized by the program wins for the products that are used in the battle against COVID-19. However, we are also encouraged by the wins that will sustain the growth in the future quarters.

And in addition to the large life sciences program for EMEA, the team added two meaningful imaging programs from a new customer for our China operations. The industrial/commercial sector produced a healthy $60 million of manufacturing wins in the fiscal second quarter. This is the second straight quarter of wins growing over 30% and the sector's strongest quarter in a year. Market share gains with key customers is creating the wins momentum.

The aerospace and defense sector generated $60 million of new wins in the fiscal second quarter. A large space program is the highlight for the quarter. Our demonstrated ability to produce high-quality products for this demanding environment is enabling growth in this subsector. Finally, our communications sector wins of $26 million includes a meaningful new opportunity from some existing customers.

The program expands our customers' communication products into a new market within the transportation industry. A diverse industry knowledge is another example of how Plexus is providing value to our customers. Please advance to Slide 13. We closed the fiscal second quarter with a strong funnel 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 COVID-19 pandemic is creating new opportunities within the sector. Teams are aggressively working with customers to qualify and quantify their needs, supporting our healthcare/Life Science customers, as the world battles the COVID-19 virus, is a top priority for Plexus.

In spite of the robust wins performance, the industrial/commercial sector increased their funnel 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 now creating the new opportunities. The aerospace and defense sectors funnel 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 have been a lot of changes now since the fiscal first quarter earnings call on January 23rd. As I review this morning, the challenges that the pandemic has brought are 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 employees of Plexus have demonstrated is tremendous. And we are solving the problems that COVID-19 creates and working to make a difference with the opportunities it brings. I will now turn the call to Pat for an in-depth review of our financial performance.

Pat?

Pat Jermain -- Executive Vice President and Chief Financial Officer

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 of 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 in COVID-19-related expenses.

Selling and administrative expense of $38.2 million was consistent with our expectations. As a percentage of revenue, SG&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 some -- approximately $6 million and 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. Nonoperating expenses of $3.1 million was better than expectations primarily due to foreign exchange gains. GAAP diluted EPS of $0.43 included a charge of $0.18 per share related to the after-tax restructuring activities. Excluding this item, non-GAAP diluted EPS was $0.61.

Turning now to the balance sheet and cash flow on Slide 15. During the quarter, we purchased approximately 225,000 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 have suspended the repurchase program indefinitely, given the current environment.

For the fiscal second quarter, we used $29 million in cash for operations and spent $17 million on capital expenditures, resulting in negative free cash flow of $46 million. Through the first 6 months of fiscal 2020, we generated free cash flow of $15 million. Despite the impact of COVID-19, we delivered a return on invested capital for the fiscal second quarter of 11.4%. This generated 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 the future challenges presented by COVID-19. As of April 4, 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 of 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. The increases in days primarily related to the reduced revenue for the fiscal second quarter.

In addition, we procured inventory toward the end of 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. So, in order to meet greater demand for certain products and maintain a high level of customer service, we are procuring components earlier, and accepting that inventory dollars will be higher. Days and receivables were 55 days, sequentially higher by six days.

The increase was primarily due to a reduction in receivables sold under our customer factoring program. In addition, the timing of our shipments was weighted more toward the last month of the 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. With an 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 SG&A expense in the range of $35 million to $36 million. At the midpoint of our revenue guidance, anticipated SG&A would be 4.4% of revenue, sequentially improved to 60 basis points.

Impacted by inefficiencies of COVID-19 in fiscal third quarter operating margin is expected to be in the range of 3.8% to 4.2%. This guidance includes 75 basis points of 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 the fiscal second quarter.

Nonoperating expenses are expected to be in the range of $4.8 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 that 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 increased procurement activity to meet the anticipated higher demand. And based on revenue forecast, we expect this level of 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, capital spending estimate for fiscal 2020 is expected to be in the range of $50 million to $60 million, slightly lower than our previous estimate. With that, Sidney, let's now open the call for questions.

Questions & Answers:


Operator

Thank you. [Operator instructions] Our first question comes from Adam Tindle with Raymond James. Your line is open.

Adam Tindle -- Raymond James -- Analyst

OK. Thanks and good morning. Todd, I just wanted to start, you mentioned that guidance does not assume material impact to end markets beyond what has occurred. So just to start maybe can you touch on what has occurred thus far from a product order standpoint? Because it seems like the shortfall in March is largely operational related, which is understandable, but not a material reduction in demand thus far.

So maybe just touch on what you've seen so far in demand reduction?

Todd Kelsey -- President and Chief Executive Officer

Sure. So from a demand standpoint, Adam, probably the biggest impact has been in our aerospace subsector. And defense and space within that entire sector, as we define it, are strong, but aerospace itself is weak. And we're also seeing much of industrial/commercial beyond semiconductor capital equipment is weak.

Now the semiconductor capital equipment demand is holding up rather well right now. I mean, I think there's some question out there in the market as to whether that's going to be a long-term or whether that's a near-term situation, but right now, it's strong.

Adam Tindle -- Raymond James -- Analyst

OK. And if we follow kind of normal downturns, it typically takes a couple of orders of sharp order cuts -- are quarters of sharp order cuts. Are those further downticks in the order cuts contemplated in your guidance?

Todd Kelsey -- President and Chief Executive Officer

For Q3, yes. Yes. One other thing that's worth noting, too, Adam, 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 a number of new programs that are directly related to COVID-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 demand has weakened quite a bit. So there's a bit of a mixture within healthcare as well too.

Adam Tindle -- Raymond James -- Analyst

OK. And maybe just one final one for Pat. You've created positive economic return despite navigating a pandemic. I know you've had some benefit from restructuring, but it's still positive if we factor that in.

Maybe just first touch on how the team adjusted to achieve that. And moving forward, margins are expected to move up, cash cycle down, so expect further improvement. If you could touch on the key drivers of the cash cycle improvement that you're expecting to continue to drive this. Thanks.

Pat Jermain -- Executive Vice President and Chief Financial Officer

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 factor 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 that's where we'll see improvement and 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 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. So we're seeing improvements there. But in this near term, we will see increases in inventory, and those are probably the main components for us of the cash cycle.

Adam Tindle -- Raymond James -- Analyst

Makes sense. Thank you.

Operator

Thank you. And our next question comes from the line of Shawn Harrison with Loop Capital. Your line is open.

Shawn Harrison -- Loop Capital -- Analyst

Hi. Good morning, everybody. It's good to hear your voices. I wanted to delve into, I guess, two topics.

The first being just the incremental outsourcing here, and how much of it, maybe, is a pull forward versus maybe a permanence of incremental outsourcing for a while that we've seen in prior market corrections?

Steve Frisch -- Executive Vice President and Chief Operating Officer

Yes. So I'll take that one. This is Steve. I would say the conversations with customers -- and I want to expand your question a little bit.

The conversations with the 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 COVID going to do for the long term. Today, it's more reactionary, but I do expect that COVID-19 will change the manufacturing strategy for lots of customers. And the ability -- our team's ability to deliver through this crisis is definitely helping us gain market share with some of customers. And as we look at the incremental part of that as it goes into the future quarters, we would expect customers that if the downturn comes or if there's a slowdown, we would expect the opportunity to increase for the number of outsourcing opportunities.

And so it's a little bit early to see what the impacts of COVID-19 are going to be. But to your -- I think your question is kind of focused on, is this going to follow a similar pattern? I guess, our expectation is that it probably will.

Shawn Harrison -- Loop Capital -- Analyst

OK. And then I guess as a follow-up, the strength in the communications business, is that kind of -- and does it 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 all need that signal at home?

Steve Frisch -- Executive Vice President and Chief Operating Officer

Yes. At the beginning of Q2, our forecast for Q3 did show us some strengthening. So we did anticipate some strengthening. COVID-19 has increased that in a substantial way.

We do expect it to stabilize at this level. The question will be is we probably when get into 2021, what does it look like? And obviously, it's a bit early to call that one.

Shawn Harrison -- Loop Capital -- Analyst

OK. That's great, Steve. Thank you.

Operator

Thank you. And our next question comes from the line of Jim Ricchiuti with Needham & Company. Your line is open.

Jim Ricchiuti -- Needham and Company -- Analyst

Thank you. Good morning. I may have missed it, but did you provide any COVID-19 related expense that may be embedded in your gross margin guidance for fiscal Q3?

Todd Kelsey -- President and Chief Executive Officer

So Jim, I'll start with this, and then I'll pass it off to Pat for a bit more specifics as we think about COVID-19. One of the things with regards to our guidance, our demand is higher than our guidance. And so we're staffed for higher demand, but we're -- so that's impacting our margins but we're realistic in knowing that there are significant challenges within the supply chain right now. The ability to be able 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 COVID-19 or if we choose to close a site for a period of time, as a result, we will compensate our employees. So there's some direct costs around that as well as PP&E. So now I'll pass it off to Pat, and he can give you more specifics around the numbers.

Pat Jermain -- Executive Vice President and Chief Financial Officer

Sure. Yes. So Jim, in Q2, we had the $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%. And 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 well still below our target range of 4.7% to 5%. And that's where I think this difference is really in the inefficiencies that we'll see in site as some programs are coming down significantly, and we're managing that labor force, while other programs are increasing and sites need additional headcount and managing through that labor situation. And so I think that, kind of, bridges where we -- so how we get back to our target range in future quarters.

Jim Ricchiuti -- Needham and Company -- Analyst

Yes, that's helpful. If we look at the aerospace and defense segment, is there a way for 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?

Todd Kelsey -- President and Chief Executive Officer

Yes, it will be down for a while, certainly, and that's about half of our business within the sector.

Jim Ricchiuti -- Needham and Company -- Analyst

OK. And then on the on the healthcare/Life Science, I think it's interesting the way -- you're clearly seeing the benefit there from all of the increased demand as it relates to critical care. Do you have any sense as to when that more elective piece that you alluded to might start coming back or is that still a little tougher to tell, given that we're still in the kind of thick of things here?

Steve Frisch -- Executive Vice President and Chief Operating Officer

Yes. So this is Steve. I'll try to answer that the best I can. 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 to our April forecast for Q3, if you look at healthcare, the healthcare portion was actually a 20% increase and life sciences was relatively flat.

If you look at the top 15 customers just within the healthcare subsector, all 15 had double-digit movement from January to April. However, 9 of those were up and six were down. The six that were down were associated with noncritical healthcare products, elective procedures. And so with the -- do we expect the double-digit continue to increase, that will depend a bit on pandemic, but we do expect those elective procedures will return as the economies across the globe get turned back on and the elective procedures will start to happen.

The question that we're asking is, is this -- and is there going to be a pent-up demand? Is it 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 would turn back on and people are basically allowed to move.

Jim Ricchiuti -- Needham and Company -- Analyst

That's helpful. Steve. And last question for me is just on the industrial/commercial side of the business, and this may be tough to call. But do you get the sense that June may be the bottom? Or is this just the visibility, maybe is just too limited here?

Steve Frisch -- Executive Vice President and Chief Operating Officer

I think the -- and again, looking at the changes that we've seen in the forecast from the January cycle to the April cycle, the forecast demands in some of those subsectors that we talked about coming down, and they've come down substantially. And so we do believe that a fair amount of the customers have taken a pretty good look at where their forecasts are going to be for our fiscal Q3. And so they've adjusted pretty well. Is it going to come down more? I think that's a little bit early for us to tell in terms of what's going to happen given the global situation.

Jim Ricchiuti -- Needham and Company -- Analyst

That's fair enough. Thank you.

Operator

Thank you. And our next question comes from the line of Paul Coster with JP Morgan. Your line is open.

Paul Coster -- J.P. Morgan -- Analyst

Yes, thanks for taking my question. Just a quick cluster on the healthcare front, first of all. Are any of the -- is any of this new business from new logos? Is it brand-new products that the customers have kind of devised on the fly or are they existing programs that they're ramping up? And as you ramp up, do the margins kind of are they under pressure initially and then do they improve over the course of time?

Todd Kelsey -- President and Chief Executive Officer

Yes. In general, Paul, the five new wins that I talked about are new programs that are in the process of ramping. I think, though, the margins should be fine with those. I think we'll be able to ramp those at kind of corporate level margins, though.

So I wouldn't expect it to be dilutive during the ramp period.

Paul Coster -- J.P. Morgan -- Analyst

No new logos at this time?

Todd Kelsey -- President and Chief Executive Officer

Yes, there are new logos.

Paul Coster -- J.P. Morgan -- Analyst

Included in that five?

Todd Kelsey -- President and Chief Executive Officer

There are. Yes, correct.

Paul Coster -- J.P. Morgan -- Analyst

Interesting. OK. And then the -- just a quick question on credit risk, are you seeing any issues among your customers that you're monitoring carefully?

Todd Kelsey -- President and Chief Executive Officer

Well, we're monitoring credit really carefully, but we have not seen any concerns at this point. And the benefit is when you look at 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.

Paul Coster -- J.P. Morgan -- Analyst

Sales team is working remotely and virtually at the moment. And I guess it's reasonable to expect that their win rates probably gotten -- or not that they'll lose business to anyone, but just the ability to close deals will be impaired somewhat in this next quarter. Is that a fair assumption? Should we have fairly sort of should we expect the manufacturing wins to be more modest in fiscal 3Q and then maybe pick up in the back end of the calendar year?

Steve Frisch -- Executive Vice President and Chief Operating Officer

I wouldn't assume that just yet. I think opportunities with new logos may be a little bit harder to close. However, we're seeing increased opportunities with the existing customers. And so our expectation with the business development teams is that they're going to continue to deliver.

With that, our corporate communications team is doing a fair amount of work with virtual videos and things to allow and give our sales force the tools that they need to be able to continue to sell our services. And so again, I think new logos may be a little bit more challenging. They may slow down their decision making, but we potentially see our existing customers providing more opportunities, so the split might shift a little bit.

Paul Coster -- J.P. Morgan -- Analyst

Got it. And then last question, going back to Jim Ricchiuti's question around the defense and aerospace segment. So I assume, first of all, that the 50% that was commercial was on a backward-looking basis. Looking forward, I imagine it's going to be a smaller percentage, at least for a while, if you could confirm that.

But also, can you just clarify for us what kind of business you're doing in the commercial aerospace segment? Is it new build, i.e. new aircraft, or is it related to actual air miles traveled and therefore sort of a consumable product?

Todd Kelsey -- President and Chief Executive Officer

Yes. It's a combination of both, Paul. There is -- certainly, it's dominated by the new build, but there is an amount of aftermarket business that we have, and that's obviously taken a near-term hit right now, the aftermarket business. And the 50-50 split, I'd call that a pre-COVID split.

Paul Coster -- J.P. Morgan -- Analyst

Right. So therefore, if there is a recovery in air miles traveled, we should at least see the variable consumable aftermarket business pick up. I hate to be picky, but what percentage of the commercial aerospace businesses is aftermarket versus new build, if you can guess at that?

Steve Frisch -- Executive Vice President and Chief Operating Officer

Yes. Unfortunately, with our customers, we're shipping field units that we don't always get visibility completely what's going into new aircraft versus aftermarket services.

Paul Coster -- J.P. Morgan -- Analyst

OK. Got it.

Steve Frisch -- Executive Vice President and Chief Operating Officer

I would be purely a guess for me.

Paul Coster -- J.P. Morgan -- Analyst

All right. OK. Thank you so much.

Operator

Thank you. And our next question comes from the line of Anja Soderstrom with Sidoti. Your line is open.

Anja Soderstrom -- Sidoti and Company -- Analyst

Hi, everyone. Thank you for taking my question. A lot of good questions asked already. So I'm just going to ask about the SG&A, you're sort of guiding down for the third quarter.

Is that due to the seasonal compensation going down or are there moving parts there? And how sustainable is that for the coming quarters? How should we think about that?

Todd Kelsey -- President and Chief Executive Officer

Yes. So it's not the seasonal cost coming down because those go into effect January 1st. Those are merit increases, so those are carrying through. Some of it is better efficiencies that we're driving, better productivity.

We are seeing some of the COVID expenses that flowed through in Q2 be 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 headcount hires we've delayed.

So Q3 is going to be much smaller and lower. And as we go into Q4, and I expect that to rebound a bit. And probably be closer to $38 million in Q4. Some of that is variable and incentive compensation expense as well.

That's down in the third quarter, but we now expect higher expense in the fourth quarter. So I think going forward, and something in the $38 million range per quarter is probably reasonable.

Anja Soderstrom -- Sidoti and Company -- Analyst

OK. Thank you. And then it seems like your nonoperating expenses are picking up a bit, too. What's the moving parts there?

Todd Kelsey -- President and Chief Executive Officer

Two main things there, Anja. One is, in Q2, we had about $1 million of 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 Q3. Also with the increase in working capital that we started to experience toward the back half of the second quarter, we expect that to continue into the third quarter, so our borrowing is higher than 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 our prior quarters. So removing the FX activity, I think $5 million -- four and a half to $5 million a quarter is a pretty reasonable number, assuming no FX gains or losses.

Anja Soderstrom -- Sidoti and Company -- Analyst

OK. Thank you. And then in terms of inventory and supply chain, I understand that's a bit challenging now. What do you see in the supply chain? How -- do you expect that to be challenging going into next year or do you think it's going to improve? Or just a bit of a color what you're seeing there.

Steve Frisch -- Executive Vice President and Chief Operating Officer

Yes, this is Steve. The supply chain constraints we're seeing now are more associated with facility closures due to COVID-19. And so our expectation is as those facilities come back online, the supply chain constraints will free up. And we've seen that happen with some of our suppliers, particularly in Malaysia and in China that had shut down early, and they've come back online, and the supply chain constraints are starting to disappear.

Obviously, the pandemic is widespread. And so many different companies, both on the customer engineering components as well as electronics have seen different portions of their businesses get shut down for periods of time. And so it's sporadic, but it's meaningful. So again, we'd expect that to return to more normal things as these facilities get back online and the world manages the pandemic.

Anja Soderstrom -- Sidoti and Company -- Analyst

OK. Thank you. And this shutdown is due to the them not being essential businesses or?

Steve Frisch -- Executive Vice President and Chief Operating Officer

No. Well, the facility shutdowns are -- yes, similar to what we faced in Malaysia. Although, we're essential businesses, different governments are making the case -- early for us in the quarter, we 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 their respective governments to basically help them understand that supply chain is critical, and we've been able to get some of those suppliers turn back on. And so I think as this trend continues, and we're seeing it continuing through the fiscal third quarter here, we'll see these suppliers coming back online and reaching more normal levels of production, which will basically free up some of these constraints.

Anja Soderstrom -- Sidoti and Company -- Analyst

OK. Thank you. That was all for me.

Todd Kelsey -- President and Chief Executive Officer

Thank you.

Operator

Thank you. Our next question comes from Matt Sheerin with Stifel. Your line is open.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

Thanks and good morning. I appreciate all the color so far. Just only question for me just regarding the healthcare business and the ramps you're seeing and the COVID-19 related programs. Could you give us an idea of the sustainability of those programs in terms of life cycles or any programs that are more one-off in two or three quarters in terms of getting equipment out there?

Todd Kelsey -- President and Chief Executive Officer

Yes. I would say, Matt, that one or two of these, I'd call one-off programs that probably have a one- to three-quarter duration to them. And the remainder would be sustainable. But I would anticipate that once we get out somewhere from two to four quarters that their volumes would drop a bit.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. And I guess in theory, at that point, you'll see the elective equipment surgery type of programs ramp to offset that?

Steve Frisch -- Executive Vice President and Chief Operating Officer

We believe so, yes.

Matt Sheerin -- Stifel Financial Corp. -- Analyst

OK. That's it for me. Thanks so much.

Todd Kelsey -- President and Chief Executive Officer

All right. Thanks, Matt.

Operator

Thank you, and I'm not showing any further questions at this time. I would now like to turn the call back to CEO, Todd Kelsey, for any further remarks.

Todd Kelsey -- President and Chief Executive Officer

All right. 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. Some of you are probably at a different location than you typically are as you're 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.

Operator

[Operator signoff]

Duration: 57 minutes

Call participants:

Heather Beresford -- Senior Director Communications and Investor Relations

Todd Kelsey -- President and Chief Executive Officer

Steve Frisch -- Executive Vice President and Chief Operating Officer

Pat Jermain -- Executive Vice President and Chief Financial Officer

Adam Tindle -- Raymond James -- Analyst

Shawn Harrison -- Loop Capital -- Analyst

Jim Ricchiuti -- Needham and Company -- Analyst

Paul Coster -- J.P. Morgan -- Analyst

Anja Soderstrom -- Sidoti and Company -- Analyst

Matt Sheerin -- Stifel Financial Corp. -- Analyst

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