Benchmark Electronics Inc (BHE) 2016 Q4 法說會逐字稿

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

(Operator Instructions)

I would now like to introduce your host for today's conference, Ms. Lisa Weeks, Vice President of Strategy and Investor Relations. Please go ahead, ma'am.

Thank you, operator. Thank you, everyone, for joining us today for Benchmark's fourth-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 2016 fourth-quarter financial results and 2017 first-quarter outlook. We will conclude our call today with a Q&A session.

Before the market opens today, we issued an earnings release highlighting our financial performance for the fourth 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 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 Paul Tufano.

Thank you, Lisa. Good afternoon, everyone. Thank you for joining us for the earnings call today. I am pleased with the Company's performance. As I stated in our last earnings call, we have credibility that must be earned, and it is the function of delivering on our commitments.

I'm pleased that we did that this quarter, meeting or exceeding our guidance across the board. Revenue was $608 million this quarter, at the high end of the guidance. Earnings per share was $0.45, which is $0.02 better than the guidance. Our gross margins were 9.5%, a 30 basis point improvement quarter over quarter and an historical high.

The thing I'm probably most happy about is that we viewed our cash conversion cycle to be a target of 75 days. We achieved 74 days in the quarter, which is a 20 day improvement over the same period in the fourth quarter of 2015. And as a result of that, we generated operating cash flow for the full year of $273 million.

I would be remiss if I didn't thank the many Benchmark employees whose hard work allowed this to happen, and I want to celebrate their achievements. We now turn to page 5. As it relates to bookings, as you all know, bookings are fundamental to revenue growth. And for the past two years, we have been flatlined at about $125 million of new bookings every quarter.

Clearly, this is not acceptable but is a key focus area for the Company, and we are driving to $150 million of bookings by the second half of 2017. However, while our 2016 bookings were not at the level we'd like them to be, the mix was appropriate. As you can see from the chart, we had 68% of our total bookings for 2016 in higher value markets, and that is progressing us to our target of 70%.

Now, in the fourth quarter, we had a number of interesting and promising wins, and I'd like to give you a little bit of color on a few of them. In medical, where we have a new customer, a new product where we will design and manufacture a dialysis product. I think this is a testament to our engineering capability, extremely excited about our contributions in this area.

In industrial, we have two new aerospace and defense programs that were won by our precision technology division. That is our machining group, in the turbine business unit, the little [careers] blades and vanes for two commercial projects. And finally in telco, we have a new customer, a new product that is in the next generation of telco.

It is embodying active antenna technology. So very pleased by the types of wins we are getting, and as we go through the course of 2017 as said before, our focus is to increase this level of bookings to $150 million a quarter run rate. We turn to the next slide, which slide 6, for the full year of 2016.

The chart in front of you is with regards to the overall performance. We generated $100 million of non-GAAP operating margin, $100 million of non-GAAP operating margin. But if you look at the revenue, we have a serious decline of $231 million -- (inaudible) almost 9% year over year. Clearly, we are not happy with this level of performance, and that revenue decline resulted in EPS of $1.45, which is $0.22 below the prior year and even more so a deterioration ROIC of 100 basis points to 8.4%.

So clearly not what we would like and also disappointing. But as I have examined these numbers, I think after closer examination, the performance instituted in 2016 reveals a path of coming and going forward. I'd like to share with you my observations on that on the next slide.

So if you turn to page 7, what we have done here as we've decomposed the drivers of our performance in 2016. So the upper left-hand box, you can see revenue gross margin, clearly revenue decline $231 million. If you decompose that, that was $300 million of revenue decline in our traditional markets. Approximately $100 million in computing being softness of demand for mature products that we're building, and approximately $200 million in telco.

We actually saw $70 million of growth in our higher-value segments, but despite that $231 million decline, we saw gross margins expand by 60 basis points to 9.2% for the year. And this expansion was based on the shift to the higher-value segments. In 2015, we had 55% of our total revenue in high-value; that moved to 62% in 2016. So clearly, the ability to move to higher-value segments tends to be margin expansion.

Now if you look at SG&A, you can see that SG&A grew by approximately $6 million and cost us 70 basis points on either level. That growth in SG&A is really investments in engineering and go-to-market solutions. And you have to invest in front of the curve to grow the revenue. And you will see us continue investment in 2017.

Now because of that gross margin improvement, the absolute effect on operating margin was not off more than 10 basis points. And so the value of the model shows in the value of the accelerated move to higher-value segment. Now from the return on invested capital standpoint, you can see that we posted a 8.4% for 2016, 180 basis point reduction.

On the chart, we tended to identify the two drivers of that. Clearly, as you have margin erosion, you see non-operating profit after tax. The road on that was an erosion of $12 million. Additionally, we saw invested capital increase by $52 million. Part of that is retained earnings from the year. Part of it is additional debt, and that drove the decline.

Now I believe that the fourth quarter of 2016 should be the low water mark for ROIC for the Corporation. But what I have taken away from this analysis are what I think are the keys to the path going forward, and the levers that we must pull are the following. First, we must drive to revenue growth at the right balance of mix with the right profitability.

Secondly, we must optimize our base. We must optimize our current book of business in terms of profitability and [active lofly]. And we must optimize our network of sites. And lastly, we must continue to improve our cash conversion cycle as we go forward. These three levers will be the fundamental foundation for our plan in 2017 and beyond.

So then turn to the next slide on page 8. I think it's only appropriate that I share with you my observations after being on the job for four months. When I last spoke to you, I was here for four weeks. I'm now here four months.

Since then, I have visited every one of our sites around the world. I've spoken to in excess of 40 customers, and I met with a number of existing and prospective investors. And I want to tell you that I am more enthusiastic today about our opportunities as a Company as I was four weeks ago. Or four months ago, excuse me. And I believe that Benchmark is one of the best positioned companies in the industry.

Now like any company, we have a number of our positives, we have a number of our weaknesses. Now on our positives, I think we have a unique set of highly leverageable assets. We made our engineering solutions and are building to design products in the medical arena, industrial arena, defense products, to our capabilities and precision machining, to our RF capabilities, our optical capabilities.

I believe we have a great set of assets that we can leverage. As I've spoken to our customers, while they always would like me to do more or asking things better, by and large our engagements are strong and our relationships are strong are such that they want us to do more, and I think we can build on that. And we have a dedicated and motivated workforce. So, those are great positives to have.

Like any company, we have some things we have to work on, and I think we have to couch that in the context of how Benchmark was built because it was built very different than most EMS companies. Benchmark was built by the acquisition of distressed assets, and they were managed independently.

This Company was managed as a federation [of sites], and it was extremely successful. But, we were an [ested] to regional Company. And as a result of the that, we have not invested in go-to-market resources appropriately. We have not invested in transversal functions that can drive commonality of process so that customer experience is uniform region to region.

And we have not leveraged our capabilities. To me, these are the opportunities that we need to lever to unleash and realize the untapped potential of the Company. And I believe that 2017 is a springboard for this activity.

So if you turn to page 9, these are our priorities for 2017. 2017 is a transition year. It is a springboard for growth in 2018 and beyond. But to do that, we must and we are focusing on a number of very clear priorities. The first is long-term revenue growth. We must invest in the enablers of revenue growth. Those enablers are quite simple.

It's engineering solutions in terms of increasing number of our design engineers, increase the number of our records platforms that we can sell to customers. It is an increase in our go-to-market sales organization in terms of people, structure, and material. When we approach customers with engineering, when we lead with engineering, we have a high probability of winning.

So as we invest in those two areas, our next focus will be to drive the return from that investment to see increased pipeline generation and more importantly, increased order bookings. And we in the Company have plans to do that, and that is a key focus as we go forward. While we are investing in revenue and waiting for that revenue to materialize, we have to optimize our base.

That means we must optimize the current book of business in terms of margin return as well as asset velocity, and we must ensure that we are acquiring appropriate customers with the right profiles and the right target markets as we build our customer base. And finally, we have to elevate our execution level.

We have to accelerate our operational execution programs. We have to drive consistency in almost all of our sites throughout the world so customer experience is seamless. We have to load our network to maximize profit per square foot, which to me is an indication of the effectiveness of the organization, to generate maximum profit per square foot by utilizing space and equipment in the most effective way.

And finally, we must continue to make improvements in our asset velocity programs and drive our cash conversion cycle days below where we are in the fourth quarter. If we do these things, I am confident in our ability to achieve our financial goals. Now as I spoke to a number of you over the past four months, it was apparent that you are skeptical about our ability to achieve these goals. And I committed to provide more transparency going forward.

So hopefully, the next couple of slides will do that, so turn to slide 10. What we've laid out for you is our target business model. And obviously, our key financial metric that we have committed to are operating income greater than 5.5% and ROIC greater than 12%. To achieve those two metrics, we would need to generate or operate within this target business model, which calls for revenue between $2.8 billion and $3.2 billion, gross margins between 9.8% and 10%, and SG&A between 4.8% and 4.5%.

If you do the math, that gives you 5% to 5.5%. And we must drive our cash conversion cycle below 70 days. If we achieve this model, I believe that we can get into the ROIC range probably earlier than the non-GAAP operating profit, but it is eminently doable. Now if you look at the chart, the big driver on the chart is revenue growth.

From where we ended the 2016, that's a growth of $500 million to $900 million over the period. So clearly, this won't be done tomorrow. But over the course of the next several years, it is our intent to do that. Now the question is, how do you monitor progress to this business model.

On the next page, which is page 11, we've attempted to illustrate for you some of the tracking points or waypoints to allow you to track our progress. These are the same metrics we are using internally. As I said before, as it relates to revenue, the earliest indication of your ability to generate revenue is if you are increasing bookings every quarter.

As you just saw in the presentation earlier, our current level of bookings is about $125 million a quarter. We expect to get to $150 million or greater by the second half of 2017 and are targeting for $250 million a quarter of bookings beyond 2017. If we can get those bookings with the right mix of customers with 70% higher-value markets, that will drive the gross margin.

Today, we are at about a 63% of our revenue mix in terms of bookings or in higher-volume segments, we have to be at 66% or greater in the second half of 2017. Gross margins are in the range indicated. Clearly, we did 9.2% for the year. We need to be approximately 9.5% or better in the second half.

SG&A we think will be flat at 5% but I will tell you that SG&A will probably bubble up in the first half as we are adding more people but then normalize as revenue begins to materialize. And last thing on profit per square foot. Our target is to get to in essence in greater than $45 of profit per square foot in the business, and that takes a simple calculation.

Take our total profit divided by our total square footage, whether it is manufacturing, office, engineering, that gives you the number. Today, we are at $27. Our goal is to try to get to approximately $32 by the second half of 2017 on a run rate basis. I like profit per square foot because I think it is a good indication of asset efficiency. It talks about space and equipment efficiency in one level, and when you couple it with cash conversion cycle improvements, I believe you can get to the right tracking of where you would go from an ROIC standpoint.

These are the milestones. These are the waypoints. We will update you on our progress as we go through the course of our earnings calls starting in the first quarter. And finally as I conclude, I would like to just now close by sharing our thoughts on capital deployment.

First and foremost, we will continue to be focused on the generation of cash from operations and asset velocity improvements. The hallmark of a well-run company is your ability to generate high levels of operating cash flow, and we will be focused on that. In 2017, we anticipate cash from operations to be the range of $125 million to $150 million for the full year.

From a balance sheet standpoint, we are blessed with a strong balance sheet. Our current leverage ratio of 1.6 times debt to EBITDA is reasonable in our standpoint and consistent with peers. And as we think about capital allocation, which I know is on a lot of your minds, I will tell you that the key determinant of capital allocation of the ROIC as we move forward and from a philosophical standpoint, we are not implying to do large M&A or buy revenue from M&A.

Our focus is on capability and capability enhancements and organic growth. And we will continue our share repurchase programs as we are allowed under applicable law and as is based on the cash that we generate in the United dates. So with that, let me conclude by saying I am truly enthusiastic about our opportunities and the path ahead. And I look forward to sharing our progress in the coming quarters with you.

And I will now turn the call over to Don who will give you some color on the fourth quarter.

Thank you, Paul, and good afternoon, everyone. I want to start on slide 14. Revenues of $608 million were at the top end of our guidance and up 6% quarter over quarter and down 3% from the last quarter based on significantly lower computing revenue. Our fourth-quarter GAAP operating margin improved sequentially by 50 basis points to 4.8% on higher revenues.

Our non-GAAP EPS of $0.45 exceeded our guidance of $0.39 to $0.43 due to better absorption during the quarter and slightly lower tax rate. Our GAAP EPS for the quarter was $0.37. Our GAAP results reflect $2.7 million of restructuring and other costs.

For the quarter, our ROIC was 8.4%, which is below our 12% long-term target and driven by the reduction in absolute profit and lower year-over-year revenues, as well as an increase in the invested capital from $924 million to $986 million. Turn to slide 15 and I'll look at our quarterly results by market sector.

Industrial revenues for the fourth quarter were in line with expectations. We grew 6% quarter over quarter and modestly 3% year over year. Medical revenues for the fourth quarter were forecasted at $90 million but were lower than expected primarily due to some regulatory delays. Test and instrumentation revenues were flat in Q3 but grew 26% year over year from share gains [and it was some account] customers where our demand is strong.

In summary, our higher-value markets represented 63% of our fourth-quarter revenues. Overall, the higher-value sectors grew 3% sequentially and 4% year over year, which is well below our overall 10% target. As we turn to our traditional markets, computing continues to be challenged by the maturity of our product portfolio. In Q4, telco revenues were up 2% year over year and 8% sequentially from the strength of production with optical and broadband customers.

Our traditional revenue markets represent 37% of fourth-quarter revenues and were down 13% from last year but up 10% from the third quarter. For the full year, we did not have any 10% customers, and our top 10 customers represented 45% of our sales for the fourth quarter.

Now let's look to slide 16 where we will discuss our quarterly business trends. Gross margins improved 30 basis points quarter over quarter to 9.5%, an historical high for Benchmark, which is based on better absorption by managing our capacity and operational execution, and 40 basis points year over year based on better mix.

SG&A of 28.4% was up slightly from the previous quarter, and higher than last year due to the investments in our go-to-market initiatives and engineering solutions. Operating margins increased 50 basis points over Q3 primarily due to the improved gross margins and better operating level. Operating margins were flat with last year.

Let's turn to slide 17 for a discussion of our annual results. For 2016, results showed significant revenue growth of 9% year over year driven by a $300 million reduction in lower-margin traditional revenues. Our improved sales mix offset the absorption impact of the revenue decline which resulted in a modest operating margin reduction of 10 basis points. Beyond the $2.7 million in restructuring for Q4, we still expect to incur restructuring charges over the next two quarters of about $2 million to $2.5 million.

Now we turn to slide 18 for a discussion of our annual results by market sector. For the year, revenues from our higher-value markets increased from 55% in 2015 to 63% in 2016. Higher-value markets grew year over year of 5%, which significantly less than or 10% annualized growth target due to soft demand in industrials and medical growth below our expectations.

Test and instrumentation revenues grew 9% year over year from continued strong semi-cap demand and share gains with some of our top semi-cap customers. Revenues in the traditional markets were down 26%.

Two-thirds of the $300 million reduction were from two customers, one in telco and one in computing. Revenues in telco were also impacted by declines of broadcast and network monitoring customers. Looking ahead, we expect further declines in computing but expect to offset this with further growth in higher tech telco products.

Now turn to slide 19 where we will talk about cash flow and working capital. We generated $44 million in cash from operations for the quarter bringing our year-to-date cash flow from operations to $273 million. Free cash flows were $38 million for the fourth quarter and $240 million for the full year. Our cash balance was $681 million at December 31, and our cash available in the US was $55 million.

Let's turn to slide 20 for our cash conversion cycle performance. As Paul indicated earlier, we exceeded our cash conversion cycle target by one day ending the year at 74 days and generating again, full-year operating cash flows of $273 million. This is a six-day improvement overall from the third quarter and 20 days since the fourth quarter of last year. We continue to execute ongoing supply chain optimization efforts and are targeting between 73 and 68 days for our cash conversion cycle with a year end target of 70 days.

Slide 21, we remain committed to consistently returning value to our shareholders. Fourth quarter was our 38th consecutive quarter of stock repurchases, and since 2007, we've returned over $532 million to shareholders. We have $93 million remaining for future repurchases.

If you turn to slide 22, I will recap our first-quarter guidance. Looking at the first quarter, our revenue is expected to range from $530 million to $550 million. We expect increased revenues in medical and test and instrumentation with seasonal declines in our traditional base of revenues.

Our non-GAAP diluted earnings per share are expected to range from $0.24 to $0.28 and implied in this guidance is a 3% to 3.4% operating margin range. The implied operating margin reflects the absorption of impact of lower revenues as well as SG&A increases for our go-to-market build out and expansion of our engineering capabilities.

From modeling information for the first quarter, please turn to slide 23. Overall, we expect industrial revenues to be down high-single digits for the first quarter based on seasonality and cyclical demand from some of our [NED] customers. We expect medical revenues to be up about 5% for the fourth quarter due to product ramps. In the test and instrumentation space, we continue to see strong demand with the ramp of new programs which should result in the increase of 10% or more.

Computing revenues will be down over 30% from the fourth quarter due to seasonality and the maturity of our product portfolio. And finally with telco, we expect it to be down over 15% from seasonality and decreased demand from some of our customers. Interest expense is expected to be $2.3 million for the quarter, and the expected effective tax rate is 19%.

The weighted average shares for the first quarter is 50.2 million. As Paul stated earlier, we had an overall solid fourth quarter. We remain focused on accelerating our initiatives, and we look forward to our next update in April on our Q1 2017 results. And with that, operator, please open the line for Q&A.

(Operator Instructions)

Steven Fox, Cross Research.

Thanks. Just a couple questions for me to start off. I guess first off, you did mention how the gross margins have improved. I was curious if you could break that down for 2016. How much was related to acquisitions versus internal improvements?

And then going forward, sort of a similar question. When you target gross margins improving by another 60 to 80 basis points, is that all predicated on buying more mix or do you see some operational improvement in the assets that you can also run through the gross margin? And then I had a couple quick follow-ups. Thanks.

So if you look at the gross margin expansion, I think that it will come from two different flavors. Obviously, operational execution improvements will be a driver. The second driver will be as we get more revenue and more load in our plants, we'll get absorption. And those are the two things that we will focus on.

And then in terms of looking back on the year, how much was due to some of those things versus just the acquisition that you did?

I think the acquisition helped in terms of the mix because it had a higher margin profile. But I think that you really -- it's that shift of 8 full percentage points in the higher-value segments that drove the majority of it.

Okay. Just going forward in terms of looking at the improvement in orders that you are targeting by the second half and then longer term, is there anything other color you can add in terms of where maybe the target markets are, what you think you can correct immediately in order to maybe accelerate some order wins and what might be some longer-term solutions that you can put into place? In other words, how do you plan on controlling your own destiny around those? Thanks.

First off, the target markets are pretty simple. They are the higher-value segments. So be it A&D, industrial, medical, and those are the key ones. Obviously, we're not going forgo compute or telco, but when you look at what I will call next-generation telco -- I'm a big fan of next-generation telco, telco for 4.5G and 5G.

The key is we have realigned our go-to-market organization into a market segment organization. We have market segment leaders for each of those specific markets. We are now staffing those market segment organizations, and so they now have the task. I say it's a task because they are currently now formulating it from the level of granularity that will drive more funnel.

Who are their target accounts? Why those target accounts? How are they going to attack those target accounts? And how do they leverage off our current book of business in terms of capability? Now, it takes a while to build a funnel, and you can't get orders once you have an appropriate funnel.

So we are now in the process of final development. I would hope that as we move into the second quarter of this year into early third quarter, that funnel development allows us to generate that $25 million more of additional bookings per quarter. And so if you work on better qualified funnel, the target account attack plans that are linked to the segment strategies, that is how we will do to this. Now the easy thing to do is to buy revenue by just lowering the price. We will not do that as we drive this order book.

Okay, that's really helpful. And then just one clarification on all of that, Paul. When you talk about staffing sort of the segmented organizations, is that mainly internal or does that reference when you mentioned that SG&A may have to creep up a little bit in the first half that you are going to do some external hires?

There will be external hires in there as will. I think predominately our conditions will be external hires.

Got it. Thank you very much. I will get back in the queue.

(Operator Instructions)

Jim Suva.

Thank you very much. Paul, you mentioned about a desire to have higher profitability, yet we look at actually the Company is among the higher operating profit margins in its peer group. So can you help us understand about what you envision as higher or what is the pipeline you saw going forward that may have faced some headwinds so we can help understand about what you kind of mean by higher in magnitude when you are already outperforming peers from a profitability standpoint?

Okay, Jim. That's a good question. I will be happy to answer that. Clearly, we did 9.2 points of gross margin in the -- for the full year. And we were at 9.8 at the fourth quarter. Exciting as that is, that's pretty good shooting for this industry, but we have one peer that's higher. And so our goal is 9.8 to 10, which puts us on top of that peer.

I think when you look at the type of businesses we do and the type of work we do that the ability to get there is not unreasonable. Because we are really doing highly complex products that have a lot of engineering. And our target model range of 9.8 to 10 I think is realistic. Now, I talk about optimizing the base. Over the course of the last several months, we have dissected the Company. We have cut every account by every site, looked at what its gross margin and OI and [mona] is and when you do that, you always find opportunity. We found opportunity we are going to go prosecute it.

Great. That makes a lot of sense. And for your SG&A, am I correct you said higher in the first half and then will it level off for the second half or kind of go back down or stable at those levels or even higher during the second half? I'm just trying to think about the linearity of your SG&A. I think you mentioned the word double down or double up or refocus more. I'm just trying to figure out if it's a part of [mix] or timing? Thank you.

Clearly, I was talking about the ER percentage. I think as we staff our engineering organization and we invest in reference designs and as we bring on more go-to-market resources, you will see the E to R be pressed higher in the first half than it would be in the second half. That's what I'm referring to.

Got you. Thanks so much for the clarification and details. We appreciate it.

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

Thank you very much for joining.