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Benchmark Electronics Inc  (NYSE:BHE)
Q3 2018 Earnings Conference Call
Oct. 30, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good day, ladies and gentlemen and welcome to the Benchmark Electronics Third Quarter 2018 Earnings Call. (Operator Instructions) As a reminder, today's conference is being recorded.

I would now like to introduce your host for today's conference Ms. Lisa Weeks, Vice President of Strategy and Investor Relations. Ma'am, please go ahead.

Lisa Weeks -- Vice President of Strategy and Investor Relations

Thank you, operator and thanks to everyone for joining us today for Benchmark's third quarter 2018 earnings call. With me this afternoon I have Paul Tufano, CEO and President and Roop Lakkaraju, CFO. Paul will provide introductory comments and Roop will provide a detailed review of our third quarter financial results and fourth quarter outlook. We will conclude our call with a Q&A session.

After the market close today, we issued an earnings release highlighting our financial performance for the third quarter of 2018 and we have prepared a presentation that we will reference on this call. The press release and presentation are available online under the Investor Relations section of our website at www.bench.com. This call is being webcast live and a replay will be available online following the call.

Please take a moment to review the forward-looking statements advised on slide 2 in the presentation. During our call, we will discuss forward-looking information. As a reminder, any of today's remarks that are not statements of historical facts are forward-looking statements, which involve risks and uncertainties described in our press releases and SEC filings. Actual results may differ materially from these statements and Benchmark undertakes no obligation to update any forward-looking statements. The Company has provided a reconciliation of our GAAP to non-GAAP measures in the earnings release as well as in the appendix of the presentation.

I will now turn the call over to our CEO, Paul Tufano.

Paul J. Tufano -- President and Chief Executive Officer

Thank you, Lisa, and thank you for joining our call today.

I would characterize the third quarter as an in-line quarter. Both revenue and non-GAAP EPS was within our guidance range. Revenue of $641 million was above our guidance at the midpoint and reflects 5% year-on-year growth. This was driven primarily by computing, telco and A&D.

Non-GAAP gross margins improved sequentially by 30 basis points to 8.5%, despite continued softening in the test and instrumentation market which services the semi-cap space. This sector was down 28% quarter-over-quarter.

Our EPS on a non-GAAP basis was $0.33, above the midpoint of our guidance. Our cash conversion cycle days was 74, slightly above the target range due to linearity of shipments. Cash from operations was approximately break-even but we anticipate free cash -- full year operating cash flow to be positive. We have been aggressively buying back shares. As of the end of yesterday, we purchased $152 million worth of stock and we anticipate by year end that that will grow to $200 million. Also, we announced today that our Board has authorized an additional $100 million of share repurchases.

If you turn to slide 6, from a bookings perspective we continue to make good progress on the diversity and size of our bookings which are critical to future revenue growth. This quarter we posted solid bookings of $175 million an year-to-date we have $523 million of bookings which is up 22% on a year-over-year basis. Within industrials, I'm very excited by a new win for advanced robotic platform where we will provide design, support as well as manufacturing.

In medical, we won a number of new projects ranging from a handheld ultrasound device to a fetal monitoring device and a tissue ablation device. We added six new customers in medical space and two of these are for full turnkey design services with future long-term manufacturing. In telco, which has 47% of our bookings, I am very excited by a new customer that has a set of products that are part of the next generation telco endeavor servicing the edge of the network deployments. Here we will provide both design support as well as manufacturing.

And in A&D, we have a very good win for a high-reliability filter component for aviation applications both military and commercial aircraft. In total we had 58 wins for the quarter, 31 in manufacturing and 27 engineering and 11 new customers. And I am extremely pleased by the number of joint engineering and manufacturing engagements.

If you turn to slide 7, I will provide an update on our guidance for the fourth quarter. Our fourth quarter guidance is for revenue to be in a range of $610 million to $650 million with diluted EPS on a non-GAAP basis between $0.32 and $0.40. Our guidance reflects the impacts of mix shifts in both test and instrumentation and computing on our margins.

In test and instrumentation, we expect the sector to decline in the mid-teens, and it will be down year-over-year in a range of 30%. As a reminder our T&I sector is primarily composed of front-end semi-cap machine performed by our Precision Technologies Group. This is more complex manufacturing and consequently has margins higher than our corporate average.

While we're experiencing a short-term pause in semi-cap equipment, we are extremely positive on the fundamentals of the semi-cap sector and are well positioned within it to return -- when it returns to growth. In addition, computing is expected to increase sequentially by high single digits.

Within the computing segment, there is a significant portion of the revenue for high-velocity system integration for legacy storage. Due to the high purchase content and minimum complexity it has margins that are below our corporate average. The impact of these two sectors will have a negative effect on our margins. However, our core business remains solid and we see opportunities for sustained and improved operational performance. As a result, we anticipate sequential improvement in gross margins up 30 basis points to 8.8% at the midpoint of our range.

If we turn to slide 8, I'd like to give some update on our progress toward our milestones. From a bookings perspective, we had a goal to exit this year at $200 million of bookings and for the first three quarters have been averaging about $175 million. Our current funnel supports the target. And it is our go-to-market organization who is tasked with converting this funnel into bookings and I'm extremely confident in their ability to do so.

As it relates to the higher revenue mix, we had a waypoint exit the year at 67% of our revenue at or above from higher value markets. Given the spending cap softness and the increase in compute we think that will now be at (ph) 65%. And gross margin, our waypoint to exit the quarter -- the year was at or above 9.7%. As I just indicated our midpoint of our guidance has gross margins at 8.8%.

As we discussed in the outlook section, the lower mix of T&I revenue coupled with higher percentages of computing has depressed our margins. However we normalize for these mix shifts, our exiting gross margin would have approximated the waypoint.

From an SG&A perspective, our business model calls for us to be between $36.5 million and $37.5 million of spending per quarter. We have been moderating our SG&A spend given the market conditions and we look to reduce our SG&A expense as we go forward.

And finally, our profit per square foot basis you can see that we have a eroding (ph) profit per square foot. This mirrors our ROIC and is a function of the fact that both mix shifts in T&I and computing which are lowering our margins coupled with capacity expansions to support activity primarily in T&I and our RF high-speed design center are generating the gap to target.

If I now turn to slide 9, I'd like to give you some preliminary observations regarding 2019. We anticipate revenue on our current pace of business to grow between 3% to 5%. Within that growth assumption is the assumption that semi-cap returns to growth in the second quarter of 2019 and accelerates through the second half but for the full year will be down to approximately 10%. We remain very positive on the long-term strength of this market and as I said before, are well positioned to benefit from its return to growth. However, against the backdrop of semi-cap softness, we are taking actions to reduce our cost and expense structure. Over the past few months, we have implemented a number of workforce reductions affecting approximately 5% of our population. As of this call, approximately 80% of these reductions have been active. We anticipate annual savings in excess of $10 million associated with the actions we are taking.

As part of our 2019 plan process, we are continuing to examine all facets of our business to further optimize our operations, streamline our cost structure and drive margin expansion. We are also evaluating marginal or dilutive contracts with the aim of further improving margins.

After a year of facilitization (ph) and customer qualification, our RF and high-speed design center in Arizona is ramping. We currently have five customers already qualified and five engineering qualifications in progress. And we have wins within RF like electronics assembly and high-speed circuit design for both the A&D and next-gen telco market.

The pipeline engagements is increasing and I am extremely excited by our prospects in this area not only for expanded customer engagements but also from the margin it will contribute which will be two to three times above that of the corporate average.

Our goal is to return margins -- gross margins to above mid 9%s. To further expand our operating margins, we will also be lowering our SG&A expenses.

In our year-end call, we will give you more updates on the progress we've made against these actions. In parallel, we are aggressively buying back shares and expect over $200 million in share repurchases by the end of the year. And we'll continue to do so at these depressed stock price levels. We anticipate the actions we are taking for margin expansion coupled with our aggressive share repurchases will lead to significant EPS accretion in 2019 and beyond.

With that, I would like to turn it over to Roop who will give you more color on the financials.

Roop Lakkaraju -- Chief Financial Officer

Thank you, Paul and good afternoon everyone. Turning to slide 11 for a recap of third quarter 2018 financial summary. Revenues of $641 million was toward the high end of our guidance of $610 million to $650 million and were up 5% year-over-year. This marked the seventh straight quarter of year-over-year revenue growth. The increase in year-over-year revenues was driven primarily by demand increases in computing, telecommunications and A&D.

Our GAAP EPS for the quarter was $0.17. Our GAAP results also included $1.8 million of restructuring and other costs, $3.3 million net charge due to customer insolvencies. The net charge was comprised of $1.6 million writedown of inventory and a $1.7 million provision for accounts receivable also $2 million write off of existing deferred financing charges due to the refinancing of our credit facilities during the quarter. Our Q3 non-GAAP operating margin was 2.9%, a 20 basis point quarter-over-quarter improvement. Non-GAAP EPS of $0.33 was within our guidance of $0.28 to $0.36. For the quarter, our ROIC was 9.8% down 70 basis points sequentially and 10 basis points year-over-year.

Please turn to slide 12 for our revenue by market sector. Industrial revenues for the third quarter increased 9% sequentially and 2% year-over-year. Sequential growth was from increased demand for process automation and navigation customers and new program ramps. Year-over-year growth was relatively flat and reflects declining revenue from an industrial customer that is now insolvent.

A&D revenues for the third quarter increased 5% sequentially which was less than expected due primarily to the timing of custom component infeed issues with two customers and softer demand across a few of our top customers. Year-over-year revenues increased 9% from greater demand for secured communication devices.

Medical revenues for the third quarter were flat sequentially which was slightly better than our initial expectations due to higher demand from existing programs. Revenues were down 6% year-over-year primarily from the timing of program transitions.

Test and instrumentation revenues were down 28% in the third quarter and 14% year-over-year from declines in semi-cap customers who utilize our precision technology services. Overall the higher value markets represented 63% of our third quarter revenue and were down 4% sequentially and 2% year-over-year primarily from semi-cap softness.

Turning now to our traditional markets. Computing was down 9% sequentially and up 16% year-over-year driven primarily by demand variation from legacy storage products. Telco was up 13% sequentially as a result of the ramp of a new satellite customer program which was delayed from last quarter and up 23% year-over-year due to increased demand from existing customers.

Our traditional markets which represented 37% of third quarter revenues were up 19% from last year and down slightly sequentially. Our top 10 customers represented 42% of sales for the third quarter.

Please turn to slide 14 for a discussion of non-GAAP key business trends. Gross margin for the third quarter was 8.5%, a 30 basis point sequential improvement and a year-over-year decline of 80 basis points. Sequentially Q3 2018 gross margin was up due to improved mix outside of our semi-cap base and continued operational improvements, offset by an adverse impact of a semi-cap market softness.

Our non-GAAP SG&A was $35.9 million which was relatively flat sequentially and resulting non-GAAP operating margins was 2.9%, up 20 basis points sequentially as a result of the higher gross margin. We had $1.8 million in restructuring for Q3. We expect to incur additional restructuring charges of approximately $2 million to $2.5 million in Q4 2018.

Please turn to slide 15 where I'll provide a few updates on cash flow and working capital highlights. We used $1 million in cash from operations for the quarter. Free cash flow usage was $16 million for the third quarter after capital expenditures of approximately $15 million. Our cash balance was $476 million at September 30 with $306 million available in the US. Our accounts receivable balance was $456 million an increase of $11 million from June 30. The increase in accounts receivable is a function of our shipment linearity and mix of customers. Payables were down $10 million quarter-over-quarter. Contract assets were $156 million at September 30 and $148 million at June 30. Inventory at September 30 was $321 million, an increase of $2 million from June 30.

Please turn to slide 16 to review our cash conversion cycle performance. Our cash conversion cycle was 74 days for Q3 which is higher than our expectations due to the mix and timing of our customer revenues. Our ongoing cash conversion cycle days will continue to range between 73 days and 68 days to support our long-term revenue growth. Non-GAAP effective tax rate was 20.7% for Q3 which was higher than forecasted as a result of our income mix being higher in the U.S. than in prior quarters.

Please turn to slide 17 to review an update of our capital allocation strategy. During 2018, we have repatriated $522 million of cash from international locations. We did not repatriate additional cash in Q3. As we move forward, we will continue to evaluate further repatriation opportunities. The repatriated funds have been used for fund share repurchase, working capital, capital expenditures and paying down of our prior Term Loan A facility.

Total repurchases, a combination between ASR and OMR through October 29 was approximately $152 million which exceeded our committed amount of $100 million for the year. We'll continue to repurchase shares in the fourth quarter of 2018 through our OMR program and we expect to repurchase approximately $200 million for 2018. Additionally the Board authorized an expansion of the current program by another $100 million which leaves $262 million available under the expanded share repurchase program. In March 2018, we announced the recurring $0.15 per share quarterly cash dividend. Dividends of approximately $7 million per quarter were paid in April, July and October.

Please turn to slide 18 for a review of our fourth quarter 2018 guidance. We expect revenue to range from $610 million to $650 million. Our non-GAAP diluted earnings per share are expected to range from $0.32 to $0.40. For sequential modeling information for the fourth quarter please turn to slide 19.

Overall we expect industrial revenues to be down mid-teens from softer demand and process controls in industrial transportation products. A&D is expected to be up mid-single digits in Q4 based on correction of custom component issue in Q3 and a new program ramp with the security customer. We expect medical revenues to be up low single digits from the transition ramp of new customer programs for fluidics and cardiac devices. In test and instrumentation, we expect further mid-teen declines from continuing softness in semi-cap.

Turning now to the traditional markets. We expect computing revenues to be up high single digits from a new program ramp and seasonality in legacy storage products. Software revenues should be flat based on current customer demand. Implied in our guidance is a 2.6% to 3.4% operating margin range for modeling purposes. The guidance provided does exclude the impact of amortization of intangible assets and estimated restructuring and other costs. Interest expense is expected to be $1.9 million and the effective tax rate is expected to be 18%. The expected weighted average shares for Q4 are 43.5 million.

Operator, please open the call for questions.

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from the line of Mitch Steves with RBC Capital Markets. Your line is now open.

Mitchell Steves -- RBC Capital Markets -- Analyst

Hi guys. Thanks for taking my question. I just had two, so first on the sort of (ph) the headcount reduction. So when should we expect kind of the OpEx improve on a sequential basis if we think about the next couple of quarters here?

Roop Lakkaraju -- Chief Financial Officer

Yeah, so Mitch this is Roop. So the OpEx improvements, we've already started to moderate, so the actions from Q3 and Q4 guidance reflect some of those moderation of expenses. And as we go toward it, if you remember our range has been $36.5 million to $37.5 million per quarter of SG&A expenses. And as we move forward into 2019, we'll see that moderate down below that range, closer to around $36 million and we'll obviously as part of the 2019 planning process that we're in the midst of we'll look for further potential actions to reduce that further.

Mitchell Steves -- RBC Capital Markets -- Analyst

Okay. And then secondly if I put together kind of all of the items you talked about, semi-cap weakness offset by computing strength. For the full year do you guys expect 2019 will be top line growth year for you guys? I know you guys haven't given the full year guide but is that -- low single digits kind of a fair assumption?

Roop Lakkaraju -- Chief Financial Officer

So, Mitch, we said that on the current base of business we think it's 3% to 5%.

Mitchell Steves -- RBC Capital Markets -- Analyst

3% to 5%. Okay, perfect. And then last one is just on the actual semi-cap side. So you guys were talking about a back half improvement, I guess. What's the rationale behind seeing a snapback up there and why that time frame?

Paul J. Tufano -- President and Chief Executive Officer

So, Mitch, this is Paul. If you look at the semi-cap. First of all, the fundamentals of the semi-cap industry are positive and strong. The demand for chips and semiconductors is only growing. And we view this as a temporary pause (ph). So in our polling of our customers and if we look at what's been written by analysts, we think that you are going to see a return to growth second quarter and then moving -- accelerating in the second half. And as we work through inventory, as we work through the digestion of tools on new fabs it's logical to see (ph) the demand increase.

Mitchell Steves -- RBC Capital Markets -- Analyst

Got it. Thank you.

Operator

Our next question comes from Jim Suva with Citi. Your line is now open.

Jim Suva -- Citi -- Analyst

Thank you so much for the details. A quick question. When we look at your new business wins, specifically year-over-year that way we flush out any seasonality on it, so when we look at new business wins, they've been increasing. Is there anything unique in those new business wins coming in that may pressure margins or anything we should be aware of? And the reason why ask is some of the other competitors in the EMS industry have talked about a little bit higher ramping costs and you should always -- or the EMS companies should always be bringing in new business because things get obsolete now with the old. So can you talk a little bit about that pipeline of new business, whether it's mix, complexity, location anything we should just be aware of?

Paul J. Tufano -- President and Chief Executive Officer

So, Jim, this is Paul. I will start and let Roop kind of add more color. If you look at our -- the predominance of our business wins, a large number of them are targeted into our larger sites within the network. These sites have more capability and broader staff and therefore should be able to ramp these products with minimal transition issues. In addition, we have been redoubling our efforts on our transition plans to make sure that we have safety nets to ensure that we don't have hiccups. So from the standpoint of where they're going, pretty confident. And that's not to say (ph) when they go into our smaller sites there is going to be problems, will be redoubling issue there as well. But these are -- some of these are very large programs that are going into those larger mega sites in our network.

Roop Lakkaraju -- Chief Financial Officer

Yeah, Jim this is Roop. I'll just add one additional aspect. Obviously, with the constrained markets around supply chain, I think as we think about inventory management around supporting those ramps effectively and the timing of those, it's obviously a critical process in collaboration with those customers. And we could see some advanced buys in the inventory in support of those ramps especially for a long lead time items.

Jim Suva -- Citi -- Analyst

Okay. Then a quick follow-up. Anything on mix going forward we should be aware of, say, versus historical year-over-year mixes? It seems like test and measurement will be down due to the softness in that industry but anything about the mix that may impact profitability?

Paul J. Tufano -- President and Chief Executive Officer

So I think specifically related to the test and instrumentation, the mix should be pretty constant. Though we are winning new awards for new tools that will give us opportunity to enhance mix. So we're continuing to ensure that we are on the leading edge of new tool wins and deployment and that usually gives you a better mischaracterization.

Jim Suva -- Citi -- Analyst

Thank you so much for the details. It's greatly appreciated.

Paul J. Tufano -- President and Chief Executive Officer

Thanks, Jim.

Operator

Our next question comes from Sean Hannan with Needham & Company. Your line is now open.

Sean Hannan -- Needham & Company -- Analyst

Yeah, thanks for taking the question here. I was looking to see as you guys have provided some general context for how to think about '19, clearly, semi-cap has been hit on as well as the path of that. So I think that's been well talked about, but when you talk -- when you think about the wins, when we think about the other pieces of your business segments, maybe Paul can you rank order for us where you see those that are perhaps stronger than the what you might see in that 3% to 5% type of range? What's going to be providing really the more material aspects of those lifts? Maybe you can provide a little bit more granularity into what gives you the confidence to get to that aggregate 3% to 5% growth and then the market's driving that? Thanks.

Paul J. Tufano -- President and Chief Executive Officer

Okay (ph). So, Jim, obviously to answer that question, you have to look at --

Sean Hannan -- Needham & Company -- Analyst

Sean.

Paul J. Tufano -- President and Chief Executive Officer

I'm sorry, Sean, I apologize. You have to look at the booking to revenue conversion rate. So, I would look to telco especially next-gen telco products to be a significant impact on positive revenue growth into '19. The reason for that is those products usually come in depending on where they are on the cost cycles for carriers you begin to ramp pretty fast (inaudible). So I think telco will be a driver.

I'm also bullish on A&D. And the reason I'm bullish on A&D is we've been booking A&D wins for the last year and a half. And A&D normally has a 24-month booking to revenue conversion rate. I think we will start to see some of that begin to materialize in 2019. And then after that I would say, our medical revenue growth should be there given the bookings we've booked over the last couple of -- last 18 months or so. And I am pressing, our industrial team to drive more bookings that will drive quicker revenue given the fact that's got a shorter bookings to revenue conversion metric. So on a rank order, I'd say telco, A&D, medical with industrial being the ability to choose it.

Sean Hannan -- Needham & Company -- Analyst

Okay. That's very helpful. And then -- so when we consider all of that, clearly our mix does change and I think to a question that the other Jim had asked a little bit earlier in terms of mix, is -- can you help to just kind of link how to think about then if the telco, the next-gen telco is a bigger factor of our growth, how that then contributes in terms of the mix? Is there a next-gen aspect of the margin profile that allows us to continue to move forward in our aggregate marginal performance or is there anything there that depending on the success that may have some disruption or impacts on how you look to progress the margins from this point? Thanks.

Paul J. Tufano -- President and Chief Executive Officer

Okay. So let me see if I can give you some color on that. If you think about telco, the legacy telco products, base stations, maybe optical transport, those are pretty mature products that have supply chains that are pretty wrung out (ph) with suppliers that have shares that don't ship very much.

Sean Hannan -- Needham & Company -- Analyst

Right.

Paul J. Tufano -- President and Chief Executive Officer

As you look at next-gen telco, these are newer products. They're more at the edge of the network. You have the ability to help them toward the design of those, either through design for manufacturing, design for cost reduction. And as you're putting supply chain in concert with those providers, I think it gives you the ability to have a better margin profile than the legacy that's been run (ph). And so as we have been targeting growth in telco it has been exclusively edge of the network product or products that will enhance network densification for those very reason.

Sean Hannan -- Needham & Company -- Analyst

Very good. Thanks so much folks.

Operator

And I'm not showing any further questions in queue at this time. I'd like to turn the call back to Mr. Tufano for closing remarks.

Paul J. Tufano -- President and Chief Executive Officer

Okay. Well, thank you for joining us on the call. In closing, I just want to make two remarks. First off, I am as confident as ever in our business model and more importantly our strategy to achieve it. First, from a value proposition standpoint, the customers we continue to expand our value proposition and this is leading to continued growth in bookings. That growth in bookings is translating to sequential annual revenue growth. Likely our engineering and solutions offerings are differentiating us in the minds of customers and will grow as our engagements mature. And thirdly, we continue to expand our manufacturing capabilities and drive every increasing operational execution. The result of these three things will be the expansion of our margins and our absolute levels of profitability. When combined with our capital allocation and share repurchases, the impact on EPS accretion will be substantial.

I want to take this opportunity to thank all of our employees for their dedication to the Company and to their commitment to service our customers. And I look forward to talk to you again on our year-end call. Thank you very much.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.

Duration: 34 minutes

Call participants:

Lisa Weeks -- Vice President of Strategy and Investor Relations

Paul J. Tufano -- President and Chief Executive Officer

Roop Lakkaraju -- Chief Financial Officer

Mitchell Steves -- RBC Capital Markets -- Analyst

Jim Suva -- Citi -- Analyst

Sean Hannan -- Needham & Company -- Analyst

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