Benchmark Electronics, Inc. (BHE) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to the Benchmark Electronics First Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today’s conference Lisa Weeks, Vice President of Strategy and Investor Relations. Please go ahead, ma’am.

Thank you, Christie and thanks everyone for joining us today for Benchmark’s first 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 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 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.

Thank you, Lisa and good afternoon ladies and gentlemen. If you could please turn to Slide 4, I would characterize Q1 as the solid quarter for Benchmark. We met actually exceeded our commitments on both revenue and EPS. The revenue was $608 million for the quarter up 9% year-over-year. We had good growth across the majority of our segments. Gross margin was 9.5%, 40 basis point improvement year-over-year and non-GAAP operating income was 3.7% or 10 basis point year-over-year improvement. EPS on a non-GAAP is $0.41, $0.09 year-over-year. And our cash cycle days were 16 at the low end of our target range. Operating cash flow was $45 million and our ROIC was 11.2%, a 230 basis point growth from the year ago period. If you turn to Page 5, we are making good progress on bookings. As you all know, revenue growth is critical for us to achieve our long-term financial model and bookings are critical to what we were. In the second quarter, we generated $171 million of bookings. And of those bookings, 63% were in our higher value markets and 37% in traditional markets. I’d like to give you a little color on some of those wins that are related to the quality of the bookings. In industrial, which was 30% of our bookings we had a very nice growth in smart cities as well as a win on electric vehicle charges for electric automobile. In A&D, we have a variety of wins across the board for comms devices, for land vehicles through munitions and for high and specialized filters for military applications. In the medical segment, 17% of our bookings came from medical with two very nice wins, one in device, the other for optical image stabilizer for use of MRI machines. In computing, which was 32% of our bookings we had a high performance for our computing win as well as the ruggedized server. We also had 17 engineering awards. Just a little color on what those awards were in the medical space, we want to design awards to design an optical component for next generation in the scope. In industrial, we have a design to produce some design in deep sea, the deep sea power converter from human power applications. And we are working with a early stage support of the quantum computer design and also good progress made in our engineering and bookings win. Turning to Page 6, clearly as we look at 2018 and we have said this previously in our call for the fourth quarter. 2017 for us was the year of transition. It was the year that repositioning the company and to realign it. As we said last quarter 2018 is the year to leverage of what we did in ‘17 we would optimize, refine our investments and I believe the progress we make in 2018 will shape the trajectory for 2019 and beyond. We have fundamental goal and that fundamental goal is to help our customers to go to market faster and working out of it. And we view that by bringing rich ticket capabilities to them, so we are collaborating with them to solve complex problems, deal with them to operate extremely complex environments and complex product sets and more importantly to work with them, just to an expansion of their own internal organizations. To realize this goal, we are focused on a number of key actions that will leverage our exposure to those companies and provide greater value. We want to give you a little bit of color on those – the key investments that we are making so far in 2018. The center of value proposition we are investing in a number of new offerings. We are expanding and enhancing our key part of the microelectronics. Today we have two sites servicing the telco and industrial and the medical communities both in India [ph] as well in the America. And then we will be opening our new facility in Phoenix, primarily serving our defense customers. We are expanding our RF components. As you remember we had a filter business. We acquired with our Secure acquisition. We have re-missioned that business primarily to serve our defense customers and we are expanding our offerings from high-end filters to include switches converted to multiplexes. And we are seeing good traction in our business over the course of the last several quarters. And finally, we are developing high-speed circuits. Today, we are shipping high-speed circuits to a number of customers. We will have our new facility online in Phoenix by the end of the third quarter and we are currently engaging with a number of customers in regard to leveraging the capacity of that facility. In addition to expanding our value proposition with these kind of offerings, we are also making investments in a number of engineering and technology solution building block. Clearly, our defense investment which originated with our Secure acquisition, we are expanding from primarily a ruggedized computing to include miniaturization and of capabilities in power distribution and other areas in defense community. RF design center in Phoenix is online. We are engaged with a number of existing and potential customers and I expect to see that providing more and more business as we move through the second half of the year. And we are in surveillance, the one as you know. We currently have a contract with border patrol to provide surveillance systems to protect both the Southern border of United States. We are in the final stage in the qualification with the border patrol and we expect to be shipping systems by the end of this year through 2019 and 2020. And finally in our IoT area, we are making good progress in IoT both from defense applications as well as potential commercial customers. And finally in the area of operational execution, it is a key focus item for us, first and foremost to ensure that we have a uniform customer experience for our customers around the globe and secondly to ensure that we are driving more capabilities to serve more complex affecting those customers and across the board we are making good progress in some of these areas. Please turn to the next slide please, which is Slide 8, but despite the progress we are making in these areas, a number of factors are coming together in this quarter that will have a negative effect on our financials. And I’d like to give you a little bit of color on some of these dynamics. First, we are seeing mix shifts both in both products and product transitions primarily to our medical space. That will affect both our revenue and our margins. As you know, we have a broad portfolio of medical products with varying lifecycles. We have several products that are going end-of-life. In a number of cases, we are qualifying new products, working on replacement products. We believe that we could compensate with other products to backfill these losses. But given the FDA cycles and timing, we weren’t able to take that in line. While medical will be down in the second quarter, we expect the return to growth on the second half. In addition to the product transitions we are seeing, we are also seeing customer headwinds as we ramp new customers. As we discussed earlier, revenue growth is the center of our growth in achieving our business model. We have been blessed by the fact that we have seen sequential revenue growth over the past several quarters. As you have grown, you introduced new products and customers into a facility. And a facility has to be able to absorb those customers seamlessly and execute on a high level. Currently, we have two sites, where we are struggling to meet customer demand as volumes increase. Our operational teams are deployed to rectify the situation and I expect meaningful progress by quarter end or the second quarter and full recovery by the third quarter. This reinforces our need for operational excellence, not only to our unified global customer experience, but more importantly to allow our revenue to grow seamlessly in meeting our customer demand. And our operation teams are well aware of that and are working to not only improve processes and onboarding of the two sites mentioned, but it’s all sites across our network. And finally, we have planned investments in engineering solutions. As we have discussed on the previous chart, for us to be more meaningful to our customers we need to invest in things that enhance our value proposition. We are actually in that plan and we expect that these investments be contributing to the bottom line fully by the second half of the year. As a result though, we are providing the following second quarter guidance. Roop will provide more color in his section and then we will hand over to Q&A. By now, I will turn to Slide 8 which our budgets gets our waypoints. As I said earlier, Q1 was a solid quarter and we made progress in metrics. In bookings, we achieved $171 million of bookings and I have line of sight and I am confident that we are going to be $200 million in bookings by the second half. From a revenue perspective, I expect annual revenue to grow year-over-year between 2% to 5%. Now within that revenue, I am confident we will be able to make our mix of greater than 67% of our revenue in higher value market. As we all know, gross margin is critical. In Q1, we achieved our 9.5% gross margin objectives, but unfortunately as our Q2 guidance will reflect we will see decline in gross margins. We believe we have the ability to approach 9.7% in the second half of the year and we are driving the organization to maximize gross margin. And as it relates to SG&A, our SG&A spending will be flat in the second half of the year and within range of $36.5 million to $37.5 million. We believe given the level of revenue growth that we anticipate in the second half that we can approach 5% SG&A either/or by the fourth quarter. And finally as it relates to property per square foot, you can see that the numbers eroded slightly. We have been adding square footage for new facilities. So if the denominator goes up you will see the numerator come down, but we are aware that getting to $29 a square foot is critical and it is top of mind in the organization. I will now turn the call over to Roop who will provide some more color and then we will answer any questions you might have.

Thank you, Paul and good afternoon to everyone. Paul provided recap of the first quarter of 2018 financial summary. I would like to provide a few updates that occurred in the quarter. Effective January 1, 2018, the company implemented ASC 606, the accounting standard governing revenue from contracts with customers using the full retrospective transition method. Under ASC 606 revenues recognized are as or when the customer obtains, controls the goods or services promised in the contract. Given the nature of the terms and conditions in substantially all of the company’s customer contracts, the company now recognizes revenue over time beginning at work in process for the majority of its contract. And with the change in the timing of revenue recognition from a historical perspective, the effect of implementing ASC 606 is a reduction in revenue by less than $500,000 for Q1 2018. As part of ASC 606, we are also required to reclassify finished goods and work in process meeting the over time criteria from inventory to a new line item called contract asset on the face of the balance sheet. Contract assets are defined as the company’s right to consideration, the work completed but not billed. During Q1 the company repatriated approximately $277 million of cash from international locations. We also expect to repatriate additional available funds in the future. As part of our capital allocation strategy during Q1, the company entered into a $50 million ASR agreement with Goldman Sachs. During the first quarter of 2018, the company changed its historical repatriation strategy. We began to repatriate core earnings from our foreign jurisdictions to the U.S. in support of our capital allocation strategy announced in March 2018. As a result, we are required to record estimated foreign withholding taxes and estimated State income taxes to assess the foreign earnings – to access the foreign earnings, excuse me. During the quarter we reported $40 million for these taxes. Now let’s turn to Slide 11 for a recap of our first quarter 2018 financial summary. Revenues of $608 million exceeded our guidance of $585 million to $605 million and were up 9% year-over-year. This marked the fifth straight quarter of year-over-year revenue growth. The increase in year-over-year revenues was driven primarily by growth in our higher value markets. Our Q1 non-GAAP operating margin was 3.7%, which was 10 basis points year-over-year improvement. Non-GAAP EPS of $0.41 was above our guidance of $0.34 to $0.38 as a result of higher than expected revenues at a lower tax rate. Our GAAP loss for the quarter was $0.49 and includes $40 million tax expense or $0.82 per share. The tax expense was for foreign withholding taxes and applicable State income tax effects provided to current and future foreign cash distributions into the U.S. Our GAAP results also included $2.2 million of restructuring and other costs, $341,000 recovery from the sale of inventory that was written down in 2017 due to our customer insolvency. For the quarter our ROIC was 11.2%, up 90 basis point sequentially and 230 basis points year-over-year. Please turn to Slide 12 for our revenue by market sector. Industrial revenues were down 3% quarter-over-quarter from a program delay due to our custom power shortage and softer demand for infrastructure products, but up 6% year-over-year from improved overall demand from new and existing customers. A&D revenues for the first quarter increased sequentially 3%, which was less than expected due to program ramp delay headwinds. Revenues declined 2% year-over-year. Medical revenues were up 15% year-over-year from higher demand and program ramps from new and existing customers. Sequentially, revenues were down 3% from lower than expected demand primarily from customers producing cardiac products. Test and instrumentation revenues remained strong and were up 10% in the first quarter and were up 35% year-over-year from ongoing demand in our precision machining business serving the semi-capital equipment market. Overall, the higher value markets grew 12% year-over-year and 1% sequentially and represented 59% of our first quarter revenue. Turning now to our traditional market, computing was down 40% sequentially from seasonality, but up year-over-year driven primarily by demand increases from data security customers. Telco was up 3% year-over-year and 7% sequentially from demand increases from existing customers in the satellite, edge broadband and network testing space. Our traditional markets which represented 31% of first quarter revenues were up 3% from last year and down 25% from the fourth quarter driven by lower computing. Our top 10 customers represented 44% of sales for the first quarter. Please turn to Slide 14 for a discussion of non-GAAP key business trends. Gross margin for the first quarter was 9.5%, a 40 basis point year-over-year and quarter-over-quarter improvement. The year-over-year improvement is driven by higher revenue, more favorable revenue mix and the result in the improved absorption. The quarter-over-quarter improvement is primarily due to revenue mix driven by reduced computing sector revenue in Q1 2018. Our SG&A was $35.7 million and resulting non-GAAP operating margin was 3.7%, 10 basis point increase from last year. Note that, we had $2.2 million in restructuring for Q1 and we expect to incur additional restructuring charges of approximately $1 million to 1.5 million in Q2 2018. Please turn to Slide 15. For a reminder of our 2018 projected quarterly SG&A run-rate as we shared in our Q4 earnings ball in February, we will continue to add engineering and technology capabilities to support extending our value proposition to customers and we continue to invest in variable reward programs for our employees. It is our goal that the SG&A run-rate will level off by the end of Q2 2018 and it have to be between the range of $36.5 million to $37.5 million. Please turn to Slide 16 where I will provide a few updates on cash flow and working capital highlights. We generated $25 million in cash from operations for the quarter free cash flow was $4 million for the first quarter after capital expenditures of approximately $21 million. Our cash balance was $676 million at March 31 with $238 million available in the U.S. As noted earlier, we repatriated $277 million into the U.S. from foreign locations. Our accounts receivable balance was $404 million, a decrease of $33 million from December 31. Payables were up $6 million quarter-over-quarter. Contract assets were $148 billion at March 31 compared to $146 million at year end. Inventory at March 31 was $306 million, an increase of $37 million from December 31. The increase is primarily raw materials in support of the ramp of new programs. Please turn to Slide 17’s review our cash conversion cycle performance. Our cash conversion cycle was 68 days for Q1, which is consistent with our expectations. Our ongoing cash conversion cycle days will continue to range between 73 days and 68 days to support our long-term revenue growth. Turning to Slide 18 for a summary of the current quarter impact of the U.S. tax reform, as highlighted earlier, during the first quarter, we recorded a tax charge of $40 million or $0.82 per share based on the benefits of the 2017 Tax Reform Act. The expense consists of $31 million for foreign withholding taxes in foreign jurisdictions related to historical earnings with the intention of repatriating cash associated with these earnings in the future, $9 million for the applicable state tax impact of these expected foreign cash distributions. As you can see in Slide 19 during the quarter, we updated our capital allocation strategy, which included announcement of the first quarterly cash dividend of $0.15 per share, increasing our prior stock repurchase plan by $250 million, entering into a $50 million accelerated stock repurchase agreement, which settled the initial delivery of approximately 1.3 million shares for a total of 40 million. The remaining 10 million is expected to settle in shares on completion of the contract. And we completed on open market purchases a little more than 600,000 shares or 18 million. Turning to Slide 20 for a review of our second quarter 2018 guidance, we expect revenue to range from $590 million to $630 million. Our non-GAAP diluted earnings per share are expected to range from $0.26 to $0.34. For sequential modeling information for the second quarter, please turn to Slide 21. Overall, we expect industrial revenues to be up mid single-digits in Q2 led by new and legacy programs within the transportation and infrastructure markets and is expected to be down mid single-digits in Q2 based on several factors including customer new programs put on hold for our component redesign. Cyclical demand from discrete orders and our execution performance issues into location which we are aggressively working to recover. We expect medical revenues to be down low teens based on the timing of customer program transitions for fluidics and cardiac programs. We have new programs with other medical customers that are in early ramp mode that should offset these transitions in the coming quarters. In test and instrumentation, the strong demand we saw in the past four quarters will continue in Q2 and we expect T&I to be up mid single-digits sequentially. Turning now to the traditional markets, we expect computing revenues to increase sequentially by high single-digits based on current customer forecast and a combination of legacy and new programs in the high performance computing. Software revenues should be flat quarter-over-quarter, increased demand from satellite backhaul and edge [ph] device customers do not offset overall moderate demand softness from a variety of customers. Implied in our guidance is a 2.7% to 3.2% operating margin range for modeling purposes. The guidance provided thus excludes the impact of amortization of intangible assets and estimated restructuring charges. Interest expense is expected to be $2.3 million and the effective tax rate is expected to be 18%. Expected weighted average shares for Q2 2018 are 47.69 million. Operator, please open the call for questions.

Thank you. [Operator Instructions] Our first question comes from the line of Sean Hannan of Needham. Your line is open.

Yes. Good evening. Thanks for taking the question here. Just a few things to make sure I can clarify and kind of solidify some of this is modeling as we are looking out at the back end of the year here, just to check in on you the comments on gross margin as well as SG&A, first gross margin hitting 9.7% or approaching, is this a value for the second half or are we talking at some point in the second half to achieve there, now on the SG&A front just want to make sure that I understood correctly where we are looking to get that value down to about 5-ish percent I think by the end of the year, but I may have misheard you?

So I am sure we will take that gross margin point and let Roop talk on the SG&A point. As I have said we believe we have the ability to approach 9.7%, well, that’s going to be probably as we enter the year. Our ability to do that would be a function of two things, okay. How long we can resolve some of these operational issues. And number two, how we can drive or absorb more revenue growth, but the revenue growth would be in that second half end of its net revenue. So we are focused on maximizing gross margin. And the question will be the trajectory of that from the second quarter to the end of the year, but we are going to be relentless on the gross margin line.

And Sean just to add some color on the SG&A regarding your question, obviously in Q1 we were about $35.2 million. And as we think about the range that we provided $36.5 million to $37.5 million, we are going to be in that range overall and so we expect that with the revenue growth of 2% to 5% that we anticipate for the year as we get towards the end of year, we think we will be in that range of approximately 5%.

Okay. So I mean this would imply a very significant back end of the year revenue ramp, I mean I think the mass would suggest and we are probably looking at something close to $700 million type of number for December, am I thinking about this correctly and just kind of make sure I understand this appropriately?

Sean, the answer is yes, you are thinking about it correctly, mostly stronger revenue in the second half than the first. We saw that last year, we expect to see it again this year.

Okay. And then in terms of these customer ramp headwinds, just want to see if we can get a little bit more color in terms of what exactly is occurring here. Do you seem to express a fair amount of confidence you can address this and resolve it operationally is just want to see if we could get a little bit more feedback around what’s occurring?

Sure. Okay, look I mean as you – our factories have multiple customer and local product in every factory. And our job – our job is to absorb customer transitions seamlessly. Now, lot of our factories, haven’t seen growth in a while and it’s like exercise. When you don’t exercise, it’s hard. So, as the volumes increasing, what happens at an organization is it stresses the organization, because these factories have to be like – think about like a NASCAR coming into a pit and the pit crew comes, everybody has got to work in unison to get the car out. Well, when you are not using the volume at the level though, some of these factories are experiencing, we don’t have quite the coordination that you need. We don’t have quite the alignment in terms of processes that you need. And it’s easy to get a little bit out of sequence. If you could add a sequence, it’s tough to recover without either having additional cost or you get crunched on the back end of the quarter to try to get volume and you missed by. So, it comes down to three things. It comes down to ensuring the organization has the right people in place, the right processes and the right tools. Tools are not quite the problem, it’s just getting people and process together and working in tandem, planning accordingly to execute as needed. And so we are working on that. It’s not rocket science but its hard work. And I am confident our teams will resolve work through those issues and get us back on track in a large part maybe in this quarter with most definitely about the third quarter.

Okay.

And just about the fine point in this, I want to make sure you get a fine point. If we are going to see revenue growth as we would like it to be, we must make sure that no matter where you are in our network that you are ready for demand and you catch it flawlessly. That is the mission of Mike and his team and they are off executing that mission.

Okay, fair enough. Let me see if I could just switch gears here and then I will jump back in the queue. Just looking at the program wins, it’s a really wide range this quarter, just want to see if we get a little bit more clarity around that, you are doing a great job in terms of procuring new business so congratulations on that front. Any color would be great on that range and thanks very much for taking the time here?

Okay. So, as it relates to bookings, it’s our objective to have as wider range of new engagements and new bookings as possible. Clearly, we have a model that target for each of the seconds we are going after and our goal is to get customers that require complex, technically rich partners that can deal with a lot of complexity in those volumes. And so they are procuring that. And more importantly, we are doing it in a way that we are trying to engage with customers of our products into the front end of the S curve that see growth. And so if you look at some of the ones we had this quarter in the medical space as the stuff we are doing with [indiscernible] is a really innovative way to do it. We are really excited about that. The stuff we are doing with DC-to-DC power, while it’s different, if you think about energy and energy management, energy storage, it’s going to become a bigger market going forward we want to play in that market. Given budgets for defense, we are going to see fair amount of defense spending over the course of next two years. There is going to be more than we have seen in the past. We engage from munitions to communications, the avionics to land vehicles, so we want to take our fair share, so ypi will see us play across the board. And the old spaces of computing, high-performance computing is our niche and we are pleased we got through in there.

Great, thanks so much, Paul.

Thank you. Our next question is from Jim Suva of Citi. Your line is open.

Thanks very much. Maybe my math is wrong, but does it – notably accounting has the impact of those two, but for the June outlook, is this like the first year of year-over-year declines you have seen in like about 3 years or so and if so did I also hear on your prepared remarks or the Q&A that you expect growth for this year in totality?

So, if you look at our Q2 guidance, revenue range is $590 to $630, I believe we did about 617 last year. So, at the midpoint we are slightly below flat, above the midpoint, we should see growth. Now for the full year – for the full year, we expect to see revenue growth of between 2% to 5%.

Got it. And it feels about there would be obviously second half loaded, would there also be kind of Q4 loaded also just getting the spending now some of the customers if you have in budget flushes and things?

So, if you look at the second half, it was backend loaded. If you look at our 2017 for example, fourth quarter was the highest quarter of the year. I think that is consistent with our friends historically.

Okay, great. Thanks so much for the clarification.

Thank you. And I am showing no further questions. At this time, I would like to turn the call back over to management for any further remarks.

Thank you, operator and thank you for taking the call. Let me just end the call by saying we put guidance out we make a balanced view of what we believe we can do. It is our goal to improve upon the second quarter guidance as we move in the second half of the year. In all the areas we talked about, you have our unrelenting focus to ensure that this is achieved. So, with that, I just want to thank you for listening to the call. We will talk to you in 90 days. Thank you very much.

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