Good day, and welcome to the Benchmark Electronics, Inc. Fourth Quarter 2019 Earnings Conference Call. [Operator Instructions]. Please note, this event is being recorded. I would now like to turn the conference over to Lisa Weeks, Vice President of Strategy and Investor Relations. Please go ahead.

Thank you, operator, and thanks, everyone, for joining us today for Benchmark's Fourth Quarter and Full Year 2019 Earnings Call. With me this afternoon, I have Jeff Benck, CEO and President; and Roop Lakkaraju, CFO. Jeff will provide introductory comments and thoughts on the coming year, and Roop will provide a detailed review of our fourth quarter and 2019 results and provide an outlook for the first quarter of 2020. We will conclude our call today with a Q&A session. After the market closed today, we issued an earnings release highlighting our financial performance for the fourth quarter of 2019, 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 advice 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 fact 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. With that, I will now turn the call over to our CEO, Jeff Benck.

Thanks, Lisa, and welcome to everyone joining us for this afternoon's call. During today's call, I will first provide a brief overview of our fourth quarter and 2019 full year results, review some key business wins, and Roop will then take you through the financial updates and our guidance for the first quarter. I will then close with a review of our 2020 expectations and key initiatives. Please turn to Slide 4. During 2019, we continue to see momentum in our targeted higher-value markets. Medical revenues were up over 14%, and Aerospace and Defense was up 6% annually. In the fourth quarter, semi-cap results were higher than expected as new order load has continued to grow in this sector across our customer base, signaling a start to the market recovery. Semi-cap results were up 19% sequentially and 17% year-over-year. These results reflect our continued go-to-market progress. Our sector strategies are driving disciplined customer and program selection, and our new key wins reflect customers engaging with Benchmark for the full breadth of our capabilities. We continue to make progress on operational efficiencies, which includes rationalizing our global site footprint. As a result, we announced last summer the planned closure of our San Jose, California and Guaymas, Mexico locations. The San Jose closure plan remains on track with customer transitions in process. For Guaymas, Mexico location, we are pleased to announce that we successfully sold the assets of this location to Libra Industries, which will continue operations and provide services to their customers. While this transaction was not financially significant, it does allow us to save jobs and avoid severance as well as mitigate other shutdown costs. I really appreciate the support and dedication of our employees at both locations during these transitions. In the fourth quarter, we successfully reached a pivotal…

Thank you, Jeff, and good afternoon, everyone. I'll start by providing an overview of the fourth quarter results, then move to the full year. I'll then discuss the Q1 2020 guidance. We'll begin on Slide 7. As we reported in the fourth quarter and updated last week, we were adversely affected by ransomware incident. Even though we restored connectivity and resumed operations quickly, we were unable to fulfill all customer demand in the fourth quarter. We did work with our customers to prioritize critical orders and rescheduled other orders of approximately $25 million to $30 million into the first half of this year. The rescheduling of certain Q4 2019 orders into the first half of 2020 reduced our Q4 2019 revenue and associated profits and the company's diluted GAAP and non-GAAP EPS. Given the ransomware incident was a unique event, certain discrete expenses and related insurance recoveries have been excluded for purposes of reporting the company's diluted non-GAAP EPS. Nonrecurring expenses related to the incident are included in our GAAP results, but excluded from our non-GAAP results. These expenses include consulting fees from third-party experts and advisers, legal fees, IT professional service expenses, in addition to certain direct labor hourly employee-related expenses. We do have insurance coverage, including cyber insurance, and have been working diligently with our carriers through this process. To date, we believe that there is a high degree of certainty that we will receive at least $5 million from our insurance carriers. This amount has been included in our GAAP results and offset against the nonrecurring expenses, which are excluded from our non-GAAP results. We will continue to work with our carriers to recover additional monies for the expenses incurred due to the incident. We expect that the insurance recovery process will be ongoing for months to…

Thanks, Roop. Let's go to Slide 19, where I will share some thoughts about the new year in front of us. As we enter 2020, we expect revenue growth over 2019 results. We are overcoming not renewing the legacy computing contract by growth in higher-value markets and, to a lesser degree, the demand rolled over from Q4. Our higher-value markets are expected to grow greater than 10% over 2019's results, led by new program ramps and increasing demand from our Aerospace and Defense, Medical and semi-cap markets. For 2020, we expect the higher-value markets to represent approximately 80% of our total revenue. We expect gross margins to range between 9.2% to 9.6% for the full year as we offset headwinds from a number of new program ramps with benefits from our operational excellence programs. We are also targeting SG&A expenses to range between $140 million and $145 million. We expect to generate between $70 million to $90 million in cash from operations. We remain committed to sharing a portion of our free cash flow with shareholders. And in fact, earlier this week, we increased our quarterly dividend by 6.7%, as Roop mentioned. Before I discuss our strategic themes for the year, I want to acknowledge the difficult situation in China due to the coronavirus outbreak. Our full support is with our team in Suzhou, China and their well-being and safety is our priority at this time. As Roop stated earlier, we continue daily monitoring of the situation for our team, our valued customers and our suppliers. If you will please turn to Slide 20, I'll conclude with a summary of our 4 strategic themes for the year. Our priorities underpin where we will spend our time this year and how we're building a better Benchmark. First and foremost, it all…

[Operator Instructions]. Our first question comes from Anja Soderstrom with Sidoti.

Can you hear me?

Yes, we can hear you.

So I just want to get some more information on this -- the ransomware and the impact of that and especially the insurance. Will that also cover any revenue loss? Or is it just expenses that was incurred?

Yes, it's really expenses. And the -- obviously, the incurrence of the expenses that we have and the $5 million that we've accrued for in terms of the recoveries to date include some of the costs that I mentioned around forensics and legal fees and these sort of things. There are additional recoveries that we're trying to obtain, which will take a little bit of time around additional lost productivity time and these sort of things, Anja.

Okay. And then some of the orders was pushed out to the first half. So is that going to then affect the gross margin for the first half? Or how do you think about that? Is that creating lack in efficiencies?

No. I mean, I think obviously, our -- that rollover is reflected -- of that $25 million to $30 million is reflected into our first quarter guidance and the gross margins that we've given you in terms of potential range, if you will, right? So the ranges that Jeff spoke about, the 9.2% to 9.6%, contemplate the rollover and the revenue and the productivity we gained from those.

Yes, just to add to that. We work closely with our customers and prioritize critical demand that we needed to fill. And the team did a great job in the fourth quarter overcoming the time that we were out and really doing what we could to recover the revenue. We did have some revenue that we could not recover as you saw and the reason that we came in below our original estimates for revenue. We're fortunate that the large amount of that rolls into the first half of this year. There was a little bit of perishable demand in fourth quarter, as you might expect, just folks had upside that we weren't able to fulfill or they were able to shift demand if there were a few cases where we might have been built a source. But the bulk of that we're able to contain and pick up and capture in the first half of this year.

Okay. And also, I don't know if you maybe mentioned this, but for Medical segment, the sequential weakness, what drove that?

It's not so much sequential weakness really, Anja. It's -- I mean, if you think about Q1's guide that we gave is that there's growing greater than 20%. So it really was related to the incident and the fact that Medical production runs tend to have longer cycles, and therefore, we couldn't complete as much of the production runs within the quarter because of the incident. It's really to just -- yes, it kind of skewed the 2019 results.

It's more a matter of a push up, okay.

Yes, it's a blip, and we still expect, as Jeff pointed out in our guidance, that Medical in Q1 will be a strong contributor to the overall growth in revenue on a sequential basis and throughout 2020.

Yes, Medical was a strong performer in '19, and we look for it to contribute to the growth in 2020, as I mentioned.

Yes. And then in terms of China, I know you have a small footprint there. But did you also close down for the New Year? And do you have to extend that closure due to the virus? Or what's happening there?

Yes. Well, we've been complying with the government regulations regarding operations or any outbreak. So we've been kind of following their guideline there. You could appreciate our focus has been on the well-being and safety of our folks. We are in the same province where the epicenter was here. But that being said, all of China is a bit disrupted, given the outage or given the virus and what's happening there. We -- that being said, we do make some medical products for the China market. We've received some exceptions for shipments during the outbreak to help with these -- actually the recovery efforts. So we're part of the solution here. But more than that, I mean, I think just overall supply chain, we're paying close attention to the fact that there are some components across our network that come through China or come from China. And we're staying close to that. There's a lot of unknowns here, which is kind of why we -- at this point, we didn't say anything specifically different about our guidance, given it because it's kind of developing real-time and every day there's new news. We're staying close to the activity here, and we'll provide updates as we know more about the way this is going to trend.

Okay. And in terms of components, if it should be a bit more prolonged and become an issue, do you have any inventory buildup? Or how badly affected may it be?

So, if you think about it, Anja, for the production runs that we would have and the demand that we have in Q1, we really procure materials coming into Q1. So largely, I would expect us to have the materials. There could be some materials we're still chasing. It really is when you start to look at more extended supply chain considerations into subsequent periods potentially. But to date, and we're working actively with our supply chain as well as our customers to ensure we have continuity of supply to support not just Q1 but Q2 and beyond.

Our next question comes from Jim Ricchiuti with Needham & Co.

This is Mike Cikos, on for Jim. So I wanted to ask you guys about the different end markets. It sounds like semi-cap, I know last time we had spoken, it seemed like you guys were forecasting based on customer conversations that a recovery would look to be happening more in the second half of 2020, and I'm trying to figure out, obviously, Q4 better than expected, and we're seeing some growth on that and sequential growth in Q1. But should we expect this strength to continue throughout 2020 now? Or should we still expect more of a ramp in the back half of the year?

Yes, maybe I'll start and have Jeff jump in as well. I think we saw strength in the fourth quarter and that's reflected in our numbers. We do have some sequential growth that we've noted. The other comment that, Mike, I'll point out is that we are seeing an increase in orders, and we're working actively with our customers currently in terms of understanding how those orders need to be fulfilled. And I think as we continue through Q1 by our April call for the Q1 results, I think we'll have a lot more visibility as to how much does it pull in from the second half into Q2 and how that linearity looks throughout the rest of 2020. So we expected it to come back. We're seeing those signals. So that's very positive from our standpoint.

Not much more to add other than to say, it's encouraging to see the new order load coming in and probably a little bit ahead of the second half anticipation that we saw. But as Roop said, our -- we're building on where we came from fourth quarter and Q1, but there's just some lead time associated with that and that ramp and how we work through that will reflect. But it does seem like we are at the beginning here of what could be a really nice ramp and recovery.

That's good to hear. And then just I guess, jumping over to the Aerospace and Defense segment. Again, nice strength there. And I just wanted to ask you, regarding customer conversations and the program builds that you guys are seeing out there, can you help us better frame the wins and the strengths? Whether it's tied more to the fact that you guys have these engineering services that you're offering and the design services, were the strengths of the market coming from the defense budget? I'm just interested if you could parse out what is driving the strength in that market, because I know that it's been a driver for you guys for a while now.

Yes. Yes. No, good question. We did signal the fact that defense spending was up and we knew there is appropriation and it takes a long time, even when you have a change in leadership and for Congress and everything to pass the bill and then see that in domestic spending. But we're there, certainly, and we see an uptick, and a lot of our customers are announcing very strong demand. So we enjoy a nice footprint across a number of -- a lot of strategic defense suppliers to our government and to others. And so we're certainly going to participate in that. I think why we're winning new business and where we see that is that we really do have very strong design skills. We've been spending a lot of energy and the investment in the Lark technology with RF capability. And that certainly peaked the interest of a number of customers that are engaging us for that. We also had a strong domestic footprint with the capability to meet the stringent certification requirements for the A&D customers and strong eye to our position and just being located where we are geographically with a strong footprint in the U.S. has, I think, worked to our advantage here quite well. But it's as much about having the right capability and been able to do not only microelectronic design and some of the substrate work, but then also be able to do the fully integrated SMT and assembly beyond it. We've really become like a one-stop-shop for a number of these sophisticated customers. So I think it's a great mix of not only our capabilities, but also just with the market being solid, and we see that continuing through 2020 and even through '21 and beyond, so...

Okay. And then just two more items, if I may. The first on your go-to-market strategy and the new Chief Revenue Officer. Just wanted to see if we could get an update on that item. And then the second being, I know you have the new leadership for your Industrial sector, and you guys are in the stages of building the pipeline. Some of the prepared remarks sounded like you guys are making headway, but if you could give us any more color on either of those items, that would be helpful.

Yes. Rob joined us now, I guess, he's not a newbie quite so much anymore, he's been here over 6 months. But he's brought a lot of discipline into that business development sales organization, sort of aligning our strategies by sector with the marketing that we're doing, making sure that our business development leaders are aligned to the target accounts. And then, frankly, just -- that's very much an operational role where you're looking at what's the pipeline and what's my win rate and am I bringing everything I need to bear. I also really specifically like the fact that Rob had both OEM experience as well as EMS experience and so knows how to sell an engineering solution to a Vice President of Engineering as well as handle the EMS side of it. So very pleased with the -- his engagement with his team so far. We've seen some strong design wins both for engineering as well as EMS. We highlighted a number of those in the script and on the charts that we included with it. So in general, I would just say, like, it's been a little bit of wind in the sales. I feel like the pipeline is stronger. It's certainly growing. And we've been winning our share of business. So he's been a really positive add. And then frankly, he's building his team, and he's reinforced the strong folks that were there, and it's all worked out quite well. In terms of the Industrial leader, which -- that runs that segment, she's hit the ground running. Certainly needed some focus here. I think we felt that was an area that we didn't do as good in 2019 as we would have liked. The Rohde & Schwarz win that happened in the fourth quarter that was…

[Operator Instructions]. As I'm showing no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to Lisa Weeks for any closing remarks.

Yes. Thanks to everyone for joining our call today. If you have any follow-up questions, please don't hesitate to contact me, and this will now conclude the Benchmark's Q4 '19 Earnings Call, and I hope you all have a great afternoon.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.