Good day, and welcome to Benchmark Electronics Inc. Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. Please, note this event is being recorded. I would now like to turn the conference over to Paul Mansky with Benchmark Electronics. Please go ahead.

Thank you, Betsy, and thanks, everyone, for joining us today for Benchmark's second quarter fiscal year 2023 earnings call. Joining me this afternoon are Jeff Benck, CEO and President; and Roop Lakkaraju, CFO. After the market closed today, we issued an earnings release pertaining to our financial performance for the second quarter of 2023, and we have prepared a presentation that we will reference on this call. Both are available on the Investor Relations section on our website at bench.com. This call is being webcast live, and a replay will be available following the call. The company has provided a reconciliation of our GAAP to non-GAAP measures in the earnings release as well as in the appendix to the presentation Please take a moment to review the forward-looking statements advice on Slide two in the presentation. During our call, we will discuss forward-looking information. As a reminder, any of today's remarks, which are not statements of historical fact are forward-looking statements which involve risks and uncertainties as described in our press releases and SEC filings. Actual results may differ materially from these statements most notably due to ongoing supply chain constraints, macroeconomic conditions and semi-cap equipment spending. Benchmark undertakes no obligation to update any forward-looking statements. For today's call, Jeff will begin by providing a summary of our first quarter results. Roop will then discuss our detailed financial results and our third quarter guidance. Jeff will then return to provide more insight on demand trends by sector, business wins and then closing remarks. If you'll please turn to Slide three, I will turn the call over to our CEO, Jeff Benck.

Thank you, Paul. Good afternoon, and thanks to everyone for joining our call today. The company executed well in the second quarter as we delivered revenue and operating income above the high end of guidance despite continued weakness in the semi-cap market and lingering component availability issues that impacted some output in the quarter. Specifically, we grew revenue 12% year-over-year in the quarter when excluding supply chain premiums or SCP. We believe assessing our revenue growth, excluding the 0 margin pass-through revenue more accurately reflects company performance. As an example, SCP was $17 million in Q2 2023, and $91 million in Q2 2022. This represents a $74 million year-over-year reduction. Excluding SCP, non-GAAP gross margins were 9.4%, up 1.5 points from the prior year, while non-GAAP operating margins were 4.1%, up from 3.6% last year. This enabled us to deliver non-GAAP EPS at the higher end of our guidance range. Inventory came down modestly in the quarter, but we still have more to do to achieve our days of inventory goals. Lastly, we generated positive operating and free cash flow in the quarter. Looking at the drivers of our 12% growth, we saw double-digit year-over-year performance from four of our six sectors, including advanced computing, industrials, medical and next-generation communications. Although our sequential performance in semi cap was encouraging, industry commentary around potential timing of the broader market recovery appears to be shifting deeper into 2024. Nonetheless, we firmly believe in the constructive long-term secular trends underpinning our anticipated future growth in this sector and are investing accordingly. We remain cautiously optimistic on the demand profile across our diversified sectors, which we believe will allow us to weather the current market uncertainty while continuing to deliver to our profitability targets. Before turning it over to Roop, I'd like to highlight…

Thank you, Jeff, and good afternoon. Please turn to Slide five for our revenue by market sector. Total Benchmark revenue was $733 million in Q2, which is 6% higher sequentially and 1% higher year-over-year. As Jeff mentioned, excluding the effect of SCP, revenue was up 12% year-over-year in the period. A reconciliation of this and our sector level performance can be found in the Appendix section of the presentation materials. Turning to Slide six. Medical revenue for the second quarter was up 14% versus the prior year. Our growth was fueled by strength in existing programs and new programs ramping. Semi cap revenue decreased 4% year-over-year, in line with our expectations. A&D revenue was down 10% year-over-year. Defense continues to be challenged by supply availability, coupled with the timing of program ramps. This was partially offset by growth in commercial aerospace. Industrial's revenue for the second quarter increased 28% year-over-year as new customer programs are ramping in areas, including test and measurement and energy efficiency. Advanced computing increased 19% year-over-year as we benefited from the continued execution of mobile high-performance computing programs. In the next-generation communications sector, Revenue was up 53% year-over-year. Our year-over-year performance was driven by continued secular strength in 5G infrastructure and satellite communications. In the second quarter, our top 10 customers represented 52% of total revenue. Please turn to Slide seven. Our GAAP earnings per share for the quarter was $0.39, our GAAP results included restructuring and other onetime costs totaling $3.3 million. For Q2, our non-GAAP gross margin of 9.1%, decreased 10 basis points sequentially and primarily due to lower revenue within our semi-cap sector. Excluding SCP, our gross margin was 9.4%, which was in line with guidance. Our SG&A was $37.7 million, down sequentially because of cost actions taken in the first half, coupled…

Thanks, Roop. Please turn to Slide 13. All metrics I referenced here are related to demand trends we are seeing by sector are excluding the effect of SCP. In medical, we continue to see strong demand from our existing products while also ramping new programs I'm particularly encouraged by the strong demand we are seeing in the defibrillator subsector as the benefits of having these life-saving devices readily accessible are becoming increasingly well understood. We continue to build on our future success during this past quarter, securing new wins across our offerings. For example, in manufacturing, we won a program to deliver subassembly views in medical sterilization equipment. Within engineering, we won an engagement to design fluid pumps used in field applications by the DOD. Lastly, we were pleased to be awarded a collaborative design engagement with the company to develop cardiovascular treatment devices. With the continued underlying medical product demand strength and a steadily improving supply chain, we expect solid year-over-year growth in the period and on a full year basis. Within semi cap, we're encouraged by the better performance in the quarter and believe the March quarter may have been our low point for semi cap revenue in the year. However, as I mentioned earlier, we have heard from several OEMs that the timing of the broader market recovery may be pushed out a bit further than initially anticipated. For Q3, we expect revenue to be relatively flat sequentially. However, the long-term secular growth drivers are still very much intact, including silicon penetration, the quest for ever decreasing node sizes and the global efforts to build a broader foundry ecosystem. We continue to invest in this space to capture disproportionate share as the next upswing commences. Moving to A&D sector. We continue to score new wins in defense.…

[Operator Instructions] The first question today comes from Jim Ricchiuti with Needham & Company. Please go ahead.

Hi, good afternoon. I just had a question on the supply chain premium revenue that you're talking about. You may have given it, but what are you anticipating for Q3? I believe you said $17 million is what it was in Q2?

That's right, Jim. This is Roop, good to have you. So Q2 was $17 million. We actually didn't guide SCP for Q3 or Q4. So the guide we gave is exclusive of any SCP as we've done throughout the year. As we've seen, though, the one thing I guess, I'll comment incrementally is just if you think about going back to Q2 of '22, we were at a high point of $91 million. We've seen it sequentially decline. We do think -- we anticipate that, that should continue to do so in the second part of this year, but we haven't specifically guided to that.

Got it. And any color you can give us on how we should be thinking about gross margins just given some of the mix you're anticipating for the current quarter?

Yes. Actually, gross margins should continue to strengthen as we think about ramp coming through, getting up to more volume level, more distributed revenue throughout our network. We anticipate growing that gross margin towards the high 9s, potentially down at 10% or so. So we feel pretty good about that distribution.

Got it. And Jeff, with respect to some of the market verticals, where do you have the most confidence. I mean you can anticipate -- I think we've all been anticipating a pickup in A&D, but it seems like supply chain has been weighing on that, and maybe it's also your customers just dealing with their own issues. But apart from commercial...

Yes, happy to provide some color a little bit across the verticals. As we talked about semi-cap, maybe initially, we saw a bigger recovery in the second half of '23. And we were talking to our OEMs, we see that pushing into 2024. So we're not expecting a significant step-up in semi. But A&D is improving. Certainly, supply chain is freeing up there, and we're continuing to ramp up there with a number of customers on the commercial side. Seeing particular strength, but even some new defense stuff happening for us. So look for that to be a bit better in the second half. And then medical and industrial are both still good growth sectors for us, held up well in the current environment. We see pockets of depending on the segment the customer is in, where there might be softness, but we also see strength in other areas. We talked a little bit about that with medical around like the defibrillator space, which seems like everybody wants a defibrillator at anywhere you can put it, right, because they're really great life-saving devices. And so see strength there as well. With -- just turning to comms, we've seen some push out of some larger infrastructure deployment that is probably weighing a little bit on that, but we think we're well positioned, and we've had a strong first half. So that's actually going to serve us well, but not -- maybe not as strong in the second half of '23. But hopefully, that color helps.

It does. Thanks. I’ll jump back in the queue.

Next question comes from Jaeson Schmidt with Lake Street. Please go ahead.

Hey guys, thanks for taking my questions. I just want to follow up on the supply chain. I know it was down $1 million sequentially in Q2. And it sounds like you expect further declines from a supply chain premium standpoint in the second half. But just at a high level, has the supply chain environment continued to be a little weaker than you guys originally expected? Or kind of how should we think about the improvement here in the second half in that supply chain premiums?

I would say, broadly, it's continued to improve. Instead of what used to be a year ago with thousands of parts, earlier this year might have been hundreds and now we're -- maybe it's a handful of things that are gating us. We still -- there's still some long lead times there, and there are still pockets where custom ASICs or some, even some of the legacy technology, where all the supply went to some of the newer nodes has been a challenge and continues to be challenging. So it's hard to communicate to customers, Hey, everything is great because there are still areas where we've seen it. What we have seen a significant drop in supply chain premiums, as Roop has talked about it. We kind of see that being sequentially down quarter-to-quarter in Q3. It's getting to the point where it's getting smaller as we go. And so that ability to forecast it perfectly is part of the reason that we're saying, look, let's just guide without it, recognizing that it's a downward trend. It was down over $74 million in Q2. So we're kind of wrapping around where there's not as much need to be leveraging these brokers and going there because the broad-based supply chain has improved.

Okay. That's helpful. And when you look at your backlog or business pipeline, have you seen any significant changes when it comes to kind of decommit or cancellation standpoint?

I mean it's -- broadly, I'd say it's holding very consistent. I mean we talked about a high single-digit growth in the year, which is kind of in line with where our thoughts have been. There are pockets where a customer, depending on what they're participating in or what's going on with them may see some softness. So that's certainly weighing on certain areas. We kind of touched on it a little bit in, for example, in communication, next-gen comps that we've seen, some there. But overall, I would say our diversified portfolio is serving us well. We're seeing that -- we believe when you exclude supply chain premiums from a product shipment, we expect 4 of 6 sectors to grow for the full year. And from that standpoint, we're seeing things hold up pretty well.

Okay. And then just the last 1 for me, and I'll jump back in the queue. Just following up on sort of those comments on your communications segment. I'm correct, I thought you guys originally expected that to be down sequentially in Q2. It obviously was up. What was sort of the primary driver there? Was it just sort of deployment scheduling or shipment timing?

Yes, that's fair to say, Jaeson, it's kind of some one-off. We got some parts that helped us produce a little more in the quarter and got it out the door. So that was helpful for us on that comps. As we indicated in the latest kind of sequential view based on our sector outlook, we are expecting comps to come down from a sequential standpoint. So a little bit of just that timing and seeing how customer demand is profiling through the year.

Got it. Thanks a lot guys.

The next question comes from Steven Fox with Fox Advisors. Please go ahead.

Hi, good afternoon. A couple of questions from me. First off, on the semi-cap comments. Can you just sort of maybe dice it a little bit closer in terms of new programs versus existing programs for the second half of the year? Are you seeing new programs get pushed out or just certain types of new programs get pushed out? Or is it all related to just sort of end markets of existing programs? How would you sort of describe the mix of what you're seeing if things are going to stay flattish?

Yes. I would say it's a little bit of both. And it's good that you kind of -- that you dug into that, a little color, a little bit because we just had a super strong year of bookings last year. And a number of those programs certainly expected a lot of activity in '23 and some of those have pushed out. I will say they're still active in the sense that they are next-generation tools. So there's no fear about losing a win or whatever, but it's like where an OEM might have said, "Hey, let's build six tools this year." Maybe now we're building on, right? So that's weighed a little bit. And we sort of anticipated going when I -- when we kind of recasted in February, we probably anticipated that we would see more activity on the new wind front, building in '23. And I would say, while there's certainly a lot of programs going on, it has moved a bit to the right. And then just -- we have a broader footprint of wins across tool sets, whether it's lithography or deposition or a lot of the front-end processes. And so we have certainly seen from a broad based, right, that, that business came down. And it stabilized and certainly, in Q3, we're guiding kind of sequentially flattish in the third quarter. It's just -- we sort of anticipate initially that fourth quarter, we'd be preparing for a huge ramp up in Q4. And now we're just here and signals that, Hey, it may be a little longer. While there's certainly demand, and we're seeing some strength in some of the areas that are under restriction on some of the legacy nodes. We're seeing people purchase those tools, and there's OEMs who are looking to fulfill that. But I also would say some of the benefits like of the CHIPS Act, I'm not -- I don't see that at the beginning of '24. It just recently was published that some of the builds here in Phoenix Valley are taking longer just because of labor force and such to build those new fabs here in the Valley as an example. So still long in the space and believe that it's -- that the upswing when it happens will be significant. But right now, we're just not calling it in '23.

Understood. And then on the aerospace and defense, if I have this right -- I'm sorry, I don't have the slides in front of me, but it sounded like aerospace and the defense piece was down quarter-over-quarter and commercial aero was better. Do I have that fact right, first of all?

Yes, that's a fair way to characterize it, Steve.

We did have one defense program that we thought would start in 2Q that's push into 3Q. So that was certainly a factor in that weakness in defense.

Okay. And then my other part of that question on that number is just I know that there's very specific part shortages that are especially challenging to get. Do you guys feel like you are performing in line with the market there? The only reason I ask is because it sounds like one of your peers was able to grow in aerospace defense, and you guys seem to have a problem in the defense piece quarter-over-quarter?

Yes. I think it really comes down to program-specific kind of considerations there. And some of our programs, and we've commented in our sector outlook, we got some program ramps that are expected to come later in the year, these sort of things. So part of it is what programs are on specifically, whether it could be growth. The other piece is we've got some new programs, new wins that came in, in previous quarters that are ramping that we expect to see throughout '23. What we can say is commercial aero has performed more consistently through the year so far and has been in an upward trend cycle.

Got it. Thanks all for that. Appreciated.

[Operator Instructions] The next question comes from Anja Soderstrom with Sidoti. Please go ahead.

Thank you for taking my questions. I'm just curious, could you quantify how much revenue do you left behind your -- the supply chain challenges?

I don't know that we specifically called it out, but it was north of $100 million that we've kind of carried over. It's come down some over the last six months. I don't know if we addressed it on last quarter's call. Obviously, as supply chain frees up, we will fulfill more than that, but we still have a fair amount that is unfulfilled rolling into the second half of this year.

Okay. Thank you. And what other opportunities do you have to improve the cash flow other than bringing down inventory?

Well, Anja, I mean, I think we've got a number of items. Part of it is inventory. We have to work with the inventory we have. And so we're actively working with our customers on aligning the inventory levels and the demand schedule to be clear to build these things. And I think those are really the primary. With that said, we obviously make sure that aero collections were on top of these sort of things. The other things we're doing more strategically in terms of strategic suppliers and terms, aligning those terms more effectively as well as finding greater flexibility from that standpoint within those terms. So it's multifaceted kind of a set of challenges to drive that cash flow. But the biggest priority is inventory alignment to clear to build and then just bleeding down that inventory as we continue to grow.

Okay. Thank you. And then just lastly, in terms of the semi-cap and that being pushed out a bit, how do you think that's going to affect your margins in terms of capacity utilization?

Yes. Maybe I'll start in terms of -- from a margin standpoint, maybe Jeff can add incremental color. I think as we've talked about semi-cap, especially the precision and the screening side and semi cap overall for us is a very strong market sector from a gross margin standpoint. We are liking investments on a concurrent basis. That's why CapEx as we've provided the range that we have. And we're going to continue to invest in semi-cap because it is cyclical, and that market upturn is coming. What we have done is paced out those investments effectively such that when they come online, how they might be a drag on margins is reduced or limited. And then, of course, as Jeff said, we've got some new programs that are starting to ramp there. And so all of this, combined with the expectation that it will recover is going to bode well from an overall enterprise margin standpoint. In the interim, we're very cognizant of managing the margin profile as we work through this softness.

Yes. Maybe I would just add, on the EMS side of the business, operational efficiency is improving, which is great. I think the incremental revenue that we've seen in product shipments has given -- helps in areas of absorption. So our margins are performing quite well. You saw that in 2Q, and you'll see that in the guide without the recovery of semi-cap. So we kind of look forward to -- semi-cap is on the higher end of our corporate gross margin. So when we're dealing with the downturn now, that's putting some pressure there that we've been able to successfully kind of overcome. So we're really looking forward to the opportunity to continue to drive that further towards our strategic goal as semi-cap comes back with significant growth. So maybe that's how we think about it.

Okay, thank you. That was all for me.

This concludes our question-and-answer session. I would like to turn the conference back over to Paul Mansky, for any closing remarks.

Thank you, Betsy, and thank you, everyone, for participating at Benchmark's second quarter 2023 earnings call. Before we go, I'd like to remind listeners that we'll be attending the 12th Annual Needham Virtual Industrial Tech, Robotics & Clean Tech one-on-one conference on August 7. With that, thank you again for your support, and we look forward to speaking with you soon.

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