Benchmark Electronics Inc (BHE) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Benchmark Electronics Incorporated third-quarter 2016 earnings call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the call over to your host for today, Lisa Weeks, Vice President of Strategy and Investor Relations. You may begin.

Thank you, Sonia, and thanks, everyone, for joining us today for Benchmark's third quarter 2016 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 third-quarter financial results and fourth-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 third quarter, 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 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. I will turn the call over to our CEO, Paul Tufano.

Thank you, Lisa. It is a great pleasure to speak with all of you today. Over the past four weeks since being appointed to the CEO of Benchmark, I have spent my time visiting our sites to better understand our capabilities and to get to know our employees, and to date, I've been [dealing] with 50% of our network and I will visit another 25% within the year. We are also meeting with our customers to get their honest assessment of how well we are doing and more importantly, what we could do better. I thought it would useful to share with you some of my initial observations.

As a board member, I was familiar with our offerings, but seeing some of our capabilities firsthand has been truly impressive. I'd like to share with you some of those impressions. First off, we have a world-class machining -- precision machining group that primarily services the semiconductor capital equipment industry supporting front end processing equipment, [where we fabricate deposition] chambers, heated pedestals, shower heads, and a variety of consumer products. The same business also has a very nice position in grinding and machining of turbine blades for internal components of aircraft engines. A very, very solid operation and one which can be levered in the future.

In defense, we have design and manufacturing capabilities for the production and design of situational awareness systems for Army aviation, as well as cockpit displays and processors for fighter aircraft. And we have a very strong surveillance systems footprint and are deliverer of information assurance products.

In the medical space, our design engineering solutions range from complex cardio to neuro stimulation to dialysis applications. And we have manufacturing and design capabilities for registered class III licensed products. We have strong capabilities in RF, in optical, and in [tests].

What's most interesting to me is the progress that we've made in supporting the connected battlefield. These are high quality assets, and assets which can be levered in the future. From a customer perspective, while there's only things you can do to improve customer relationships, on balance, customer feedback has been positive. Benchmark is a critical supplier and more often than not, they would like us to do more. And finally as it relates to our people, I have found them to be passionate, committed, and dedicated, and I believe up to the challenge at hand.

So as I step back, we have all the ingredients for success. And I think that's a positive statement going forward.

If you turn to slide 4, I will provide a few brief comments on the quarter and Don will cover the details in his presentation. I am pleased we delivered on our guidance, and I understand that our credibility is a function of our ability to deliver on our commitments and that it must be earned. In the third quarter, we were able to achieve our revenue operating margin guidance. We had modest growth in margins both in gross margin OP, albeit on slower revenue growth. We made good progress on working capital and are on track to our 75-day total of exiting the fourth quarter with 75 days cash conversion cycle. This has been a significant focus in the Company, and I know it's been a significant focus in our investor community as well. It is, to me, a major test of our ability to deliver on what we say we can do and we understand the gravity of making that number.

The results of that working capital management was that we generated over $70 million of cash in the third quarter, and that brings our operating cash flow from operations to over $228 million year-to-date. It was our 37th quarter of share buybacks, and since the program has initiated, we returned over $531 million to shareholders in stock buybacks. So overall, I believe this was a solid quarter.

Turning to slide 5, as we look ahead, our greatest opportunity is to unleash and realize the untapped potential of Benchmark. Speed and a sense of urgency are essential to doing this. I believe the Company has the right strategy, and our goal is to extract more value quicker. To do this, we must drive greater operational excellence and leverage the synergy that's in the high-value assets that I talked about earlier. Clearly, revenue growth is a key priority.

We've stated in the past that our goal is to grow over 10% annually at high-value markets. Unfortunately, we're not on pace to do that this year. But without growth, especially in the new segments, it will be difficult to achieve our margin goals. We have the capabilities. We need to see the return on investments we've made in go-to-market resources and increase our order of booking intake. We published long-term target goals. We stated our operating margin should be in excess of 5.5% and our ROIC greater than 12%.

I know a number of you have trouble tracking progress in this industry. But I also know a number of you are very skeptical of our ability to achieve these goals and have asked repeatedly, what are the mechanisms by which you think you will do this and what is the timeline when they will be achieved? And these questions are rightly deserved to be answered. So in the upcoming calls, we will provide a timeline and milestones to track progress on these goals, where our objective is to provide as much transparency as possible.

Before I hand the call over to Don, I just want to summarize by saying that I'm excited by the opportunities afforded to Benchmark. I believe that we have a bright future in front of us. I'm energized by the challenge, but more importantly, I'm confident in the Company and its people's ability to rise to the occasion. And so I look forward to communicating with you more frequently in upcoming calls as to our progress to achieve that. So with that, let me turn it over to Don and he will give you some color on the quarter.

Thank you, Paul, and good morning -- good afternoon, everyone. I'll start on slide 7 and we'll give a recap of our third-quarter income statement. Completed the quarter of revenue of $574 million, which was within our guidance, but below the midpoint primarily from telco product qualification delays, demand in the broadband and optical markets remain strong for these products, which we expect to ship during the fourth quarter.

During the third quarter, our non-GAAP operating margin improved modestly by 10 basis points to 4.3%, on an improving mix even with a sequential quarterly decline in revenue. Our non-GAAP EPS of $0.36 was at the midpoint of our guidance of $0.33 to $0.38. Our GAAP results reflect an $8.3 million discrete tax benefit from reversal of a tax contingency due to the expiration of applicable statute of limitations. This benefit was offset by $520,000 of restructuring expenses and $3 million of CEO transition expenses. The GAAP EPS for the quarter was $0.44. For the quarter, our ROIC was a 8.6%, which is below our 12% long-term target.

Let's turn to slide 8 for our quarterly results by market sector. Industrial revenues were $217 million, up 10% year-over-year and up slightly from the second quarter. These results were slightly below our expectations related to the shipment timing of the current wave of new program ramps.

For medical, revenues were $86 million and were down sequentially but in line with our expectations. Medical was down 2% from last year and 7% from the second quarter. For testing instrumentation, revenues were $66 million, which increased sequentially 9% and 13% year-over-year. Revenues were above third-quarter expectations due to strong demand from our semi cap equipment customers driven by mobility, the Internet of Things, and memory end markets. In summary, our higher value markets represented 64% of our third-quarter revenues, up 7% from last year and 1% for the second quarter.

And turning to our traditional markets, computing revenues of $107 million decreased sequentially 11% from the second quarter and 24% year-over-year, but were slightly better than our estimates, driven by stronger demand for security related computing products.

Telco revenues of $98 million were up 5% from the previous quarter, but lower than expected because of qualification delays in broadband and optical markets for two customers. We expect these to be resolved and shipped during the fourth quarter. Year-over-year, telco was down 33% and as a reminder, we have no remaining revenues from the maturing and not renewing programs from our former top telco customer. In summary, our traditional markets represent 36% of our third-quarter revenues and were down 28% from last year and 4% from the second quarter. For the quarter and for the full year we expect to have no 10% customers and our top 10 customers represented 46% of sales for the third quarter.

Please turn to slide 9 and we'll discuss quarterly business trends. Gross margins improved 50 basis points to 9.2% from the prior year, as we have continued our portfolio transition to a higher mix in our targeted markets, in addition to efforts -- capacity alignment and operational excellence. SG&A expenses of $28.1 million or 4.9% were in line with expectations and down sequentially from planned reductions to offset our investments in our go-to-market efforts. Our non-GAAP operating margin was 4.3% in the third quarter. In alignment with our business outlook, we will drive further improvements as we optimize our manufacturing footprint.

Beyond the $520,000 of restructuring for the third quarter, we still expect to incur restructuring charges of $4 million to $5 million in the coming quarters. These actions should result in the $5 million to $7 million annual savings rate starting in 2017. Our return on invested capital was 8.6% for the third quarter. We are focused on driving a return on invested capital above our cost of capital with a goal of achieving 12%. This includes driving free cash flow which is been off to a good start for the first nine months of the year.

Now let's turn to slide 10 and I'll provide a few updates on our cash flow and working capital. We generated $70 million in cash from operations for the quarter, bringing our year-to-date cash flow from operations to $228 million. Free cash flows were $61 million for the third quarter, our cash balance was $636 million at September 30, which is an increase of $63 million from the previous quarter. Our cash balance available in the US was $44 million.

Total cost of share repurchases were $12 million, inventory at September 30 was $396 million, an increase of $21 million from the prior quarter. The increase was unfortunate, but came primarily from three customers at two sites related to customer component qualification delays and test program implementation delays. Our accounts receivable was $417 million, a decrease of $5 million from the previous quarter, and payables were up from the last quarter at $309 million.

Now let's turn to slide 11 and review our cash conversion cycle performance. Our cash cycle days for the quarter ended at 80, which is an improvement of three days from the second quarter. Accounts payable improved sequentially by six days to 53, while inventory increased sequentially by four days to 68, which related to the issues that I just discussed. The supply chain optimization efforts related to the outsourcing projects remain effective and we expect to exit the year with a cash conversion cycle of 75 days.

Now please turn to slide 12. We remain committed to consistently returning value to shareholders, during the third quarter we invested $12 million to repurchase 483,000 shares for our 37th consecutive quarter of stock repurchases. Since 2007 we have returned $531 million to shareholders. We currently have $94 million remaining for future repurchases.

Let's please turn to slide 13 for a review of our third-quarter new bookings, we won 29 new programs and 20 engineering projects which are expected to result in annualized revenues of $110 million to $135 million when fully released to production. Over the last 12 months bookings in the higher value markets represented 75% of our new program wins which aligns with our longer-term goal of generating more than 70% of our revenues in these targeted markets.

Now let's turn to slide 14 to review our guidance. Looking to the fourth quarter, our revenue is expected to range from $590 million to $610 million. We expect increased revenue in industrials, medical and telco with a slight offset of lower demand in computing. Our non-GAAP diluted earnings per share are expected to range from $0.39 to $0.43 and implied in this guidance is a 4.4% to 4.8% operating margin range. The effective tax rate is expected to be approximately 22%.

Let's turn to slide 15 for a greater look at our revenue drivers for the quarter. Overall we expect industrials to be up mid to high single digits for the fourth quarter, with stronger demand from A&D customers and building infrastructure customers. So sluggish demand remains for a diverse base of other industrial customers that have exposure to the currency effects of a strong US dollar in weaker emerging markets. We expect medical revenues to be up about 5% from the third quarter, driven by new program ramps. After stronger-than-expected demand in the prior two quarters, we expect test and instrumentation to be down approximately 8% for the fourth quarter.

Now turning to our traditional markets, computing revenues will be down slightly in the fourth quarter, based on current customer forecast we expect low single-digit decline. Telco revenue should be up sequentially in the fourth quarter. With qualification delays from the third-quarter resolved from a shipment this quarter, we expect telco to be up greater than 10% over third-quarter levels where demand for these new broadband and optical products remain strong. As Paul stated earlier, overall a solid quarter for Benchmark. We will remain focused on accelerating our initiatives, we look forward to providing our update in February on our fourth-quarter 2016 full-year results. And with that, operator, would you please open the line for Q&A.

Thank you.

(Operator Instructions)

Jim Suva, Citi.

Thank you very much. First a question for Paul for strategy and then a clarification question for Don on CFO. So Paul, when you looked at the strategy that you laid out, you clearly said you want to return to growth. What are the couple of things that you think you can really change or improve or maybe have hindered Benchmark in the past, so we can look for you to address those? And then Don, on the CFO question, you mentioned some program delay ramps. Were those like yield issues within Benchmark or qualifications on the customer side or economic impact that slowed those down? Thank you, gentleman.

Okay, Jim, I'll take the first call. Clearly, we have to grow the top line. And we sit back and give you my assessment after four weeks of where there's opportunities to do that. Number one, clearly we've made investments in go-to-market resource, those investments have to begin to yield more results in terms of quarter bookings and targeted accounts in terms of where we go hunt and where we go [make bids]. More importantly, I think we have got a number of high quality assets in the Company, which I talked about, that are synergistic, and I'm not sure that we are synergistically selling all the capabilities within Benchmark. More importantly, I think that we also are not taking the full value of our network of sites into account as we are communicating with potential customers going forward. So we look to those three areas to drive greater order intake that will manifest itself in revenue in coming quarters.

Great, and Don, that anything on the delays?

Yes, so for the delays we had primarily a couple of issues, some test verification issues, as well as supplier component issues, primarily in the telco and some of the industrial sectors. And those were both customer driven.

Got you. Thanks so much for the details, gentlemen, we appreciate it.

Steven Fox, Cross Research.

Thanks, good afternoon. First question Paul, just on some of the comments you just made, could you just expand a little bit what you mean by leveraging the full value of the network? What do you think is not being utilized as efficiently as it could be and how quickly do you think you're able to leverage those assets better? And then I have a couple of follow-ups.

Sure. If you think about Benchmark, we have almost 20 sites around the world, each of which have a variety of capabilities. And look, my initial impression is that we sell more individual sites than we do the network itself. And what customers want today is, how do you provide them capability to serve global needs, and so how we make sure that we are leveraging the capabilities of all our sites to give customer solutions that are aligned with our requirements as well as theirs. And I think we have opportunities in that area.

Great, that's helpful. And then a couple of quick follow-ups. First of all Paul, can you just comment on the secure -- it seems like you referenced the secure acquisition of something that makes sense strategically, I just would like you to address that specifically since there was an area of controversy as part of the proxy fight.

Look, having secure -- I've visited secure the first week I was in the job, and I spent over a day with the secure team going through their products [going through technology] and I think they provide us substantial opportunity going forward. They have extensive capability in the design of solutions that have highly advanced network protocols, that have encryption, that are [ruggedized] and that are in essence, key components of our military complex. Especially the connected battlefield. Now, when I look at those capabilities, and I look at the problems that they are addressing, I see immediate applications in commercial spaces. And I think that one of our opportunities is to understand, how can we take some of those technology building blocks and look to commercialize them in areas that today we're supporting some of our customers on?

And I think that there is a huge opportunity here, I'm really excited by it. I love secure, when I visit them, tremendously energized. They have some great stuff. But when you deal with the military you look at three to four year cycles. My challenge to them was, how do we take some of these technologies and increase the cycle time, but in the commercial application?

I'd give you an example because I think you want to understand this. They do a lot with sensors, and communication protocols on sensors. That's a hot topic in as you move into the Internet of Things, especially in industrial controls and industrial applications. If you look at one of our target growth markets, it's industrial controls. So I think there's a fair amount of opportunity to say, what do we have that's been primarily a defense-related activity and how can we broaden that into more commercial aspects? So that's just one example.

That's really helpful. And then last question, just really quickly, Don, maybe based on the guidance you just provided for the fourth quarter, can you give a range of your free cash flow expectations as you improve your working capital turns for just a quarter coming up?

For the quarter with 75 days, I'd say $35 million to $45 million.

Great, thank you very much.

Mitch Steves, RBC.

Hey guys, thanks for taking my question. First quick one, so on the telecom side it sounds like the some of the demand got pushed out into December quarter. Is there any way you guys could help us quantify how much that was and what the impact was for the quarter?

I think for the quarter we were down 6%, 7% from Q3 results. So if you look at where our guidance is for the fourth quarter, Mitch, we are largely recovering where we would we thought we would be.

Got it, and secondly on that recovery for the telecom space, is that essentially, you guys have already built the product and you're just simply shipping, or [was it delayed] as in a quarter, or is this going to be a multi-quarter pushout?

I think it was associated with Jim's question in terms of the some of the delays that we've got on the testing side and the component side.

Got it, okay and then --

We expect to ship those during the fourth quarter.

Makes sense, and then last one is just on the capital allocation, that was another hot button topic, I guess when [engaged] got involved beyond the working capital. So is there any change or update there, just given that you had about $44 million in cash in the US? Any idea of if you're going to raise debt or potentially take the repatriation tax?

Yes, we had 37 quarters of consecutive share buybacks and we have an ongoing ASR program, lets be honest. We will continue our share buyback programs. And we'll always open to the effective use of capital in terms of allocation

Got it, thank you.

Herve Francois, B Riley.

So I was going to ask in regards to some of the new bookings that you mentioned, can you talk about what kind of sectors that they were in? You did say that a good three quarters of them came within your high-value markets, can you drill down a little bit more and give us what markets some of those were in? And then when are you going to see the earliest ramping of some of those bookings that you announced this evening? Thanks.

So let me give you the breakout, Herve. On the computing, out of the 49 programs, we had five in computing, telco was seven, industrial controls was 23, medical was 10, and test and instrumentation was four.

Got it. And is some of that ramping going to start here in the fourth quarter?

No, those are typically -- we're probably six to nine months out before they start ramping.

Got it, understood. And then just on the operating margin range that you gave for the quarter, I think you said 4.4% to 4.8%, is it really a function of mix in regards to whether it does come up to 4.4% for the December quarter versus the 4.8%? What would you say is the main driver between that 40 bips swing there?

Well, it's going to be a combination. I think even at the low end we're at [590], which is above the results that we just had, so it'll be a combination of certainly mix as well as volume. Which is going to drive the margins.

Got it, thanks very much. That's all I have, thank you.

(Operator Instructions)

Sean Hannan, Needham & Company.

Great, thanks very much. First question here in terms of the win environment and taking on these new projects and a lot of these the longer cycle markets, are you feeling that the exposure you have to competitors is changing much? Are you seeing some of the other traditional EMS names either on an increasing or decreasing basis? How does that landscape look today because obviously it's been a very common theme for a lot of the players within this space, there's a lot of reason to be there, participate in win.

So Sean, take a stab at this. I think if you look at the presentations of all of our competitors, you would see that they have targets for some of the same markets we do. Test and instrumentation, medical and the like. So I think that everyone has designs on these space. I think the key to -- the ability to win comes down to a couple of factors. First, it's your capabilities that you bring to the table. Especially design capabilities and test capabilities. I think second it's the relative size of the account and whether or not they will get the same level of treatment as they would everybody else. And here I think we have an advantage.

Benchmark $2.4 billion, these kind of customers or these profiles are top of mind for us. In some of our other competitors who are significantly larger than we are, I think that's a concern. In a previous life not too distant from this one, I was with a buyer of these services, and the quantities we were buying were massively different than what we're talking about in these accounts. And I was able to get mind share. I'm not sure that if I was the size of some of these accounts we're talking about, that I would've gotten the same mind share as some of our competitors.

So for us I think what we have to do to compete effectively, we'll have to compete on the following things. Obviously the quality of our service and the quality of the products we produce, our ability to be responsive and order [mid] time, our proactive nature in terms of helping the customers with design services and capability, and making [that] customers feel that they are top of mind. I think if we do that, we can compete very successful of as any of our [EMS] competitors.

That's helpful. I think that following on to that, it would seem that logic dictates, given the long cycles a lot of these programs and the stickiness of those relationships, and you partnered with the fact that Benchmark specifically within medical and industrial tests and instrumentation, the trajectory of the last many quarters of those win rates, has been quite pronounced. And consequently, it seems that the business should have an incremental layering effect year after year, due to some of those tales and due to the incremental wins, and you guys are lying up for a better, longer-term growth factor then we've seen out of Benchmark in the past. Does that logic hold water?

It does. It does. And I'd say that we need to get our order intake up even more so than we can have extra juice on the [growth].

Okay.

Because you're priming the pump, right? So it may take two to three quarters for the order to start to materialize in the revenue. So the more that you get your order intake up, you get that accelerator effect on revenue beyond the line.

Great. Then more of a, I guess an accounting question here for Don. From an SG&A standpoint, seems like you guys did a pretty good job in the quarter and obviously you've been taking some charges and restructuring. What should we expect to continue to see in terms of the contributions to your margin expansion either coming as a consequence of leveraging your OpEx versus what you'd get on the margin for a changing mix as you continue to progress forward?

I think on the OpEx, I would expect that to remain flattish. Certainly we'll get --we'll start seeing some revenue growth, we'll get certainly some leverage off of the OpEx side, so it's going to be a combination. But as I think about OpEx, it should be in that flattish environment.

From a dollar, cents standpoint.

Correct.

Okay. Great, thanks for taking my questions here.

No problem, thank you.

Thank you.

(Operator Instructions)

This does conclude our question-and-answer session. I would like to call back over to Lisa Weeks for any further remarks.

Yes, thank you all for attending today. We will be available for any follow-up questions that you may have and have a great afternoon.

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