Benchmark Electronics, Inc. (BHE) Q1 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Benchmark Electronics Incorporated First Quarter 2017 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to introduce your host for today’s conference, Ms. Lisa Weeks. Ma’am, you may begin.

Thank you, operator and thanks, everyone for joining us today for Benchmark’s first quarter 2017 earnings call. With me this afternoon, I have Paul Tufano, CEO and President; and Don Adam, CFO. Paul will provide introductory comments and Don will provide a detailed review of our first quarter financial results and second quarter outlook. We will conclude our call with a Q&A session. After the market closed today, we issued an earnings release highlighting our financial performance for the first quarter and we have prepared a presentation that we will reference on this call. The press release and presentations are available online under the Investor Relations section at 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.

Thank you, Lisa and good afternoon, everyone and thank you for joining us. I am extremely pleased with the performance of the company in the first quarter. This is the third consecutive quarter that we have met or exceeded our commitment. Now as we discussed before, this is a major focus for the organization and an endeavor to establish creditability. In this quarter, the company posted revenue of $567 million, a 3% growth year-on-year. This is the first quarter in over 11 quarters where the company has posted year-on-year revenue growth, and hopefully this will continue as we move forward through the course of this year. Gross margins were 9.3%, a 10 basis point improvement year-over-year. Our cash cycle days were 67 days, a quarter-on-quarter improvement of 7 days and a very impressive 32 day improvement from the same period a year ago. That drove operating cash flow of $78 million, which puts us on a very good start to achieving our guidance of 125 million to 150 million of operating cash flow for the year. And our ROIC was 9%, an increase of 60 basis points quarter-over-quarter. As we discussed last quarter, we felt the fourth quarter would be the low watermark and ROIC would improve throughout the course of 2017 and I am pleased to see that it is going in that direction. We now turning to Slide 5. Let's [indiscernible] through commentary on bookings. As you know, this is a major focus area of the company. Last quarter, we were very upfront in the fact that we need to increase our bookings on a quarterly basis to drive revenue growth. And we set a target of $150 million of quarterly bookings by the second half of '17. This quarter, we made modest progress in that endeavor. As you can see, as you can see we generated $134 million of bookings, up modestly about $125 million run rate that we've seen for the last seven quarters, and included in that 134 of bookings, 68% of which are which are in high value markets, which is an improvement of almost 8 full percentage points from the quarter before. If you look at those bookings I'll provide a little bit of color, we had some interesting bookings that relates to a number of our market segments. As I look at Industrial, we had a very nice swing from the Tier 1 customer to be engaged in a smart city projects. In Telecom we've received an award for next generation satellite program. And in Medical received an award from a brand new customer in the oncology space. So extremely pleased with these awards going forward, as you can see from the chart we had 21 engineering awards, we believe that approximately 50% these awards will lead to manufacturing business in the future. If we now turn to Slide 6, I'd like to give you a little bit of color on our progress and our key priorities. As we discussed last quarter, our primary goal is to drive revenue growth at the right balance and mix of profitability and as we do that to improve the execution and speed of the company. And we outlined three initiatives that we would be following to facilitate that, the first was the optimization of our global network and the improvement of our operational excellence, the second was the implementation of our market sectors sales organization and third was the expansion of our engineering capabilities and solutions. For the last 60 days we made progress in each of these fronts and I would like to give you a little color on what has happened. From an execution standpoint, a number of programs have been launched throughout the company to drive increased speed and greater execution. This ranges from the education and training of the entirety of the program management teams in Benchmarks, almost 150 people, to increase emphasis on operational excellence program. As it relates to our market effective sales organization we're approximately 85% staffed and we've implemented additional structures and vigorous in those organizations to drive better quality of bookings and size of bookings. And lastly yesterday, we announced the relocation of our corporate headquarters to Arizona and the consolidation of our corporate staff. I think this is the key milestone in the history of Benchmark. Maybe you know where we've discussed in the past that Benchmark had a virtual management team with a very few of the senior leaders actually living in Texas. With the move to Arizona we will consolidate all the senior staff, plus their support staffs into one headquartered location under one roof. This will drive greater efficiency, greater rigor and improve speed and I'm extremely excited with the move to Arizona. In addition to the consolidation of the headquarter staffs, we will establish two new engineering design centers in Arizona. The first will be an RF and high speed design center, which will focus on providing our customers complex and ruggedized RF and high speed designs. And we'll drive the expansion of our large filter business and additional micro-engineering, micro-remanufacturing capabilities for integrated micro assembly [ph]. The second will be an Internet of Things design center, which will integrate and optimize sensor interconnect products to our customers. And we will use our proprietary low power Wideband Wireless Internet technologies to do this, which was developed by our advanced technology groups in Southern California and Arizona. These three design centers will complement our existing design centers in Rochester, which focuses on medical and in Ermelo [ph] in the Netherlands which is a mechatronic design center of excellence. As we've said in the past increasing our engineering capabilities and leading with engineer will allow us to drive greater revenue growth with the right mix. And I am also pleased to say that we will enter into a partnership with Arizona State University in a number of areas to enhance these engineering capabilities. We believe this is the first step in many to consolidate and drive better focus, better execution and better speed within the company. And we will keep you posted over the course of the next several quarters on additional progress that we’re making. Now as I turn to Slide 7. Last quarter, we were very articulated in providing you a business model that supported our financial objectives of achieving operating margins greater than 5.5% and ROIC greater than 12%. We also provided you waypoints or milestones to track our progress on our path to achieving those goals. The chart in front of you illustrates what we have achieved in the first quarter as it relates to our second half of '17 milestones. As you can see from the chart bookings had improve modestly to 134 million, we would have a $16 million gap in bookings in our quarterly basis. Our objective is to close that gap and exceed 150 in the second half of '17. From a gross margin standpoint, we were at 9.3%, about 50 basis points -- 20 basis points delta from our target of 9.5% or better. From SG&A, SG&A increased quarter-on-quarter as planned. In Don’s presentation, he will provide you additional color as to the drivers of SG&A and what to expect going forward. Revenue mix is 58% generated by our high value segments, that's currently above the rate point target and as we look at the second quarter, we believe we will be at or above the rate point target. Then finally profit per square foot on a trailing 12-quarter basis is about flat and as we move to the course of the year, we believe we will be within that range. So we’ll update you every quarter on our progress towards these way points to ensure that we are communicating effectively. So that you can understand how we are going to achieve our ultimate goals and financial targets. With that, I’m going to turn it to Don, who will provide few color on the quarter and then we’ll open up the Q&A.

Thank you, Paul. I'm going to start on Slide 9 with a recap of our first quarter income statement. We have revenues of 567 million, which exceeded the high-end of our guidance and are up 3% year-over-year. And again as Paul mentioned, our first quarterly increased in the 11 quarters. The first quarter non-GAAP operating margin was 3.8% and down from the fourth quarter on lower revenues. Our non-GAAP EPS of $0.34 was above the high end of our guidance of $0.24 to $0.28 primarily due to better absorption and higher than expected revenues. We also had a lower than expected tax rate which contributed about $0.01 per share to EPS. GAAP EPS for the quarter was $0.19, our GAAP results include a $5.1 million charge or $0.10 per share for the write down of inventory and a provision to accounts receivable associated with the insolvency of a customer. These charges increase cost of sales by 3.4 million and SG&A by 1.7 million. It also includes 1.5 million of restructuring and other costs. For the quarter, our ROIC was 9%, up 60 basis points from the last quarter, and our long term target is 12%. Please turn to Slide 10 for a quarterly result by market sector, note that we are now separately reporting our Aerospace and Defense sector revenues. Industrial revenues for the quarter were slightly above our expectations and were down 2% quarter-over-quarter and down 14% year-over-year due to continued soft demand for our industrial customer base. Aerospace and Defense revenues were up 2% quarter-over-quarter and 14% year-over-year driven by demand in the Defense sector. Medical revenues were flat quarter-over-quarter and up 4% year-over-year. Medical revenues were adversely impacted by approximately 3 million due to the insolvency of a customer previously noted. Test and Instrumentation revenues grew 18% quarter-over-quarter and 45% year-over-year from share gains in our semi-cap customers where demand continues to remain strong. In summary, our higher value markets represented 68% of our first quarter revenues, overall the high value sectors grew 3% sequentially and 5% year-over-year which is still below our overall 10% target. Strength in A&D and Test and Instrumentation did not offset the headwinds associated with the overall soft industrial demand. Now turning to our traditional markets, computing was up 10% year-over-year driven by strength from new and existing customers. Telco was down 13% year-over-year primarily due to the reduction in revenue from a formal Top 10 customers, as well as declines in demand for optical products. Our traditional markets which represented 32% of first quarter revenues were down 1% from last year and 22% from the fourth quarter. Our Top 10 customers represented 44% of sales for the first quarter. Turning to Slide 11, we will have a discussion on the quarterly business trends. Overall again a very good quarter, gross margins for the quarter were 9.3% and improved 10 basis points year-over-year on higher revenues and a better mix. SG&A of 30.9 million excludes the $1.7 million charge for the provision for doubtful [ph] accounts related to the insolvent customer. As Paul indicated, we will provide some additional color on SG&A shortly. Our non-GAAP operating margins decreased 20 basis points last year due to the additional SG&A cost. Beyond the 1.5 million in restructuring for the first quarter, we still expect to incur restructuring charges of about 1.5 million to 2 million in the coming quarters. Turning to Slide 12, we are providing a bridge of our SG&A expenses from 2016 to the 2017 projected run rate. So let me take a minute to explain this chart. Our quarterly SG&A expenses averaged about $28.5 million last year, over the course of the year we reduced our SG&A through previously announced restructuring activities which have yielded about -- yielded savings of about a $1 million per quarter. We've reinvested those savings in our go to market and engineering investments which add about $1.8 million a quarter. As we've noted in prior quarter we believe these investments are essential to driving future revenue growth for the company. In addition our employee expenses have increased about a $1.5 million per quarter and include merit increases as well adding talent to other areas of the company. We also expect higher variable employee expenses which include bonuses and are subject to company, the company hitting its financial targets and finally stock compensation expenses expect to be increase about 3.6 million -- 3.6 million for the year or about 900,000 per quarter this year. Last year's stock compensation was lower than expected as performance year grant targets were not achieved. Please note that we include stock compensation expense in our SG&A and non-GAAP operating income. Most companies exclude stock compensation when reporting non-GAAP operating income, as a remainder for 2016 we're expecting we expect total stock compensation expense to be about 8.9 million or approximately $0.14 per share. Now let's turn to Slide 13, where I will provide a few updates on cash flow and working capital. We generated 78 million in cash from operations for the quarter, based on the solid execution of our working capital initiatives. Free cash flows were 70 million for the first quarter. Our cash balance was 752 million at March 31, with 93 million available in the U.S. Inventory at March 31 was 404 million, an increase of 23 million from year end. Our accounts receivable balance was 381 million a decrease of 59 million from year end and accounts payable increased to 344 million. Let’s turn to Slide 14 to review our cash conversion cycle performance. We exceeded our cash conversion cycle target by six day, ending the quarter at 67 days, this is a seven day overall improvement from the fourth quarter and 32 days compared with the first quarter last year. You will note that our cash conversion cycle now includes customer deposits. Over the last year we have focused on increasing customer deposits to improve our working capital performance, these deposits have become more meaningful and therefore we will now report these deposits in determining our cash conversion cycle performance. Let's turn to Slide 15 for a review of our second quarter guidance. Looking to the second quarter, our revenue is expected to range from 565 million to 585 million. Our non-GAAP diluted earnings per share is expected to range from $0.31 to $0.35 per share and implied in this guidance is a 3.6% to 3.9% operating margin range. For modeling information, for the second quarter, please turn to Slide 16. Overall, we expect industrial revenues to be down slightly in the second quarter based on cyclical demand and persistent softness from our customers in this area. Aerospace and Defense is expected to be up modestly based on increased demand across multiple platforms and programs within our customer base. We expect medical revenues to be up low single digits from the first quarter. In Test and Instrumentation, we expect strong demand to continue and revenues are expected to be up in the low single digits from the first quarter. Now turning to traditional markets, we expect computing revenues to be up about 20% in the first quarter due to higher demand of storage and high performance computing from a number of our customers. Telco work revenues should be down greater than 10% due to weak demand from our optical and broadband customers. Interest expense is expected to be 2.3 million and the expected effective income tax rate is expected to range from 18% to 19%. The expected weighted average shares for the second quarter of 50.5 million. As Paul said earlier, overall a solid quarter for Benchmark and a great way to start the year. We remain focused on accelerating our initiatives and look forward to providing you an update on our Q2 results in July and with that operator, please open the lines for Q&A.

[Operator Instructions]. Our first question comes from Jim Suva from Citi. Your line is now open.

Hi. This is Tim Young on behalf of Jim Suva. Thanks for taking the question. I guess, my question is on top-line growth. You highlight that the first quarter, in March quarter year-over-year revenue growth was impressive and of course year-over-year growth in the 11 quarters. But in June quarter revenue guidance implies flattish growth. Can you just -- is there like a demand forming in March quarter? Can you just provide some color on that? Thanks.

Well, I think we are in the range. The range goes from -- up to 5 -- 85 [ph]. So that would imply growth at the top end of the range. So I think, as you look at the demand profile for the second quarter, it’s kind of mixed, we’re seeing some strength in certain sectors and that strength is to some degree being offset [indiscernible] from a few others. And as we go through the course for the quarter, I think we’ll get better feel for now customer demand fills in and I’m hopeful that we can again post quarter-on-quarter growth.

Got you. Thanks. And then the customer resolves the issue? Can you provide some color on that as well? Thanks.

Well, we can’t go into the name of the customer. Unfortunately, we had one customer who has run into some business issues. We took a reserve against it. We’re working with that customer.

And our next question comes from Mitch Steves from RBC Capital Markets. Your line is now open.

Just had a quick question on the networking side. It sounded like you guys are talking about an optical slowdown or is that broad based or was that a customer specific issue you're calling out there?

Well, I think that, I would characterize the optical market as seeing a little bit of weakness. And for those customers that we’re supporting, we’re seeing some of that as well.

Got it. And then secondly the semi-cap side, it sounds like we’re just given the fact that we’re seeing good numbers certainly [ph] that as well. It sounds like that hasn’t slowed down and the year-over-year is still growing. You guys have expected to grow throughout the full year?

So in semi-cap, we are expanding our customer based, and with some of our key customers, they’re seeing what I would say greater than industry demand, industry average demand.

And our next question comes from Steven Fox from Cross Research. Your line is now open.

I was wondering first half, if you could talk a little bit about your Internet of Things initiatives. You mentioned some proprietary technologies that you’re featuring at unique design center and you also mentioned smart city win. So is there a way to sort of tie those two comments together in a more strategic fashion and talk about what exactly is proprietary and how are you going about running some of those businesses? And I have a follow-up. Thanks.

Sure. Let me take the first question. We have been investing in a series of technologies that allow you to have low power radio networks, that will enable sense integration. This technology pretty much came from some of our Defense application and we are now courting it over to commercial application. And it is perfect for sensor network infrastructure. As you know sensors are pretty dumb devices right, and as you interconnect them, unless it's one sensor to the one device, it's pretty difficult to do an interconnect. We believe we have a technology that allows us to interconnect sensors, utilizing nine different types of functionality that will provide extensive array of capabilities for application developers and end users. We are now promoting that technology with our customers and as we do so we will use our new Arizona design center to prototype and to extend that technology working with customers and their solutions.

And in terms of the smart city, when was that related to this technology or is that a sort of leveraging different capabilities?

Leveraging different capability.

Okay. And then just -- I am sorry go ahead.

No, the point I want to make is, today it's leveraging different capabilities. I believe in the future as we get some traction with this technology that there will be a fair amount of leverage and synergy with our existing and more importantly future customer base.

Great thank you. And then just in terms of just this salesforce reorganization, I think you said you are at 80% through that transformation and it looks like if you were to -- not this is easy, to continue to improve your order book. At the progress you made in Q1, you hit your bookings target for the second half. But I guess I was curious whether you saw some of that improvement in the quarter, what markets you thinking are maybe the low hanging fruit where you can reorganize successfully or any other color on how confident you are in getting to that sort of bookings target by the second half? Thanks.

Look our objective is to hit the number, and anything less than that is not going to be expectable, look at it that way.

Okay.

Now, we will see what kind of progress we make in the second quarter. As we look at our various market segments, we have different time to, from time to initial contact with the customer to time to quote, is a little bit elongated. And so what we have to do and what we are doing today is we are managing portfolio of sectors and a portfolio of accounts within each sector to try to drive, such that we have enough pipeline in those longer times to quote segments, such that we can get to that 150 and above it. And quite honestly we're making progress at different rates and paces in each sectors, but the objective is to get everybody to the same level of maturity and the same level of pipeline growth and more importantly quality of pipeline to allow us to get to 150 and beyond with the right mix. And I think in two to three more quarters, I think we will give you a more definitive state about how well we believe we are along that path.

Great, thank you very much.

[Operator Instruction] And our next question comes from Sean Hannan from Needham & Company. Your line is now open.

Just wanted a follow up on some of the comment that you provided as well as some of the responses you've provided for questions a little bit earlier. The optical side of the exposure that you have within the communications business, how big is optical for you folks, I have not had the impression that it was really that substantial. Is this -- at this point today is this kind of 5% of revenue? How large should we be thinking about that given that were we're calling out some of the temporary weakness here?

Shawn first of all just and -- if you're looking at year-over-year comparisons really the driver in why we're down is the former Top 10% customer that we had is really driving most of that. So in terms of the optical, it's probably in the 20% to 30% range on the Telco side.

20% to 30% of the Telco segment, okay alright.

Let me be clear, on Q1 versus Q1 last year, this year that’s driven by the former Top 10% customer.

Right absolutely, that I follow up. Calling out the optical as an incremental was more of a quarter-to-quarter observation.

Looking forward correct.

Okay and in term of the design centers, how have you folks kind of come to a decision to go after an IoT design center and all that high speed design center, what drove the thinking to go at, number one, two different centers and then specifically within those specific areas, how is that ultimately being justified over driven even by your customers, a little bit more prospective around that would be fantastic. Thanks.

We have a number of different -- I've always said the company has a number of outstanding capabilities that need to be leveraged, as I said that's just the beginning, since the day you heard my first call, right? One of those points of leverage is some of the technologies we have surrounding, we have low power sensory networks and [indiscernible] band radios. We're seeing a lot of traction with that in certain points of our Defense portfolio. But the applicability to other parts of the markets and especially other customers is extremely broad in my opinion. And so the reason to invest in it is because we believe we can provide solutions to customers that have them, not only cut development time, but also time to market. And so, we'll be foolish not to leverage it. And so we're doing that. Now we have been over the course of last six months refining it and we're now at the point where we're engaged with customers in this area and as we look to engage with more customers we need to have more capability in terms of prototyping and additional solutions and so its time put that center in place. So that’s the rational for the IoT center of excellence. As it relates to the RF center of excellence, we've always had grid RF capabilities, and I've stated that in my first call. We did or what kind of satellite work, microwave. So there is a lot of high-end RF skills that we have. We also have a high-end filter business, that in my opinion has been woefully underutilized. And so as we attempt to take our high-end filter business, extend it with additional RF capability and bridge into some microelectronics work that our customers are demanding, I think it forms another capability to leverage with existing customers and new customers. And so that’s the rationale for that second center of excellence. What I’ll tell you is that these are nice Greenfield groups, we have critical mass in both of them. I think that, we've never really elevated it or marketed it appropriately to our customers, we are in the process of doing that now. And as a result, we have to extend capabilities to support those customers and drive revenue growth. So we chose to do that and we've chosen the Phoenix area to do it because of proximity to the existing design capabilities, existing support organization for those two areas.

Sure. Okay. Make sense. Thanks very much for the feedback here.

And at this time, I’m showing further questions. I’d now like to turn the call back over to Lisa Weeks for any closing remarks.

Thank you all for joining us today. Please feel free to give us a call if you have any follow-up questions and we look forward to speaking to you in July. Thank you.

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may all disconnect. Everyone have a great day.