Benchmark Electronics Inc (BHE) 2018 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Benchmark Electronics First Quarter 2018 Earnings Conference Call. (Operator Instructions) As a reminder, this call is being recorded.

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

Thank you, Christie, and thanks, everyone, for joining us today for Benchmark's First Quarter 2018 Earnings Call. With me this afternoon, I have Paul Tufano, CEO and President; and Roop Lakkaraju, CFO. Paul will provide introductory comments, and Roop will provide a detailed review of our first quarter financial results and second quarter outlook. We will conclude our call with a Q&A session.

After the market closed today, we issued an earnings release highlighting our financial performance for the first quarter of 2018, and we have prepared a presentation that we will reference on this call. The press release and presentation are available online under the Investor Relations section of our website at www.bench.com. This call is being webcast live, and a replay will be available online following the call.

Please take a moment to review the forward-looking statements 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 facts are forward-looking statements, which involve risks and uncertainties described in our press releases and SEC filings. Actual results may differ materially from these statements, and Benchmark undertakes no obligation to update any forward-looking statements. The company has provided a reconciliation of our GAAP to non-GAAP measures in the earnings release as well as in the appendix of the presentation.

I will now turn the call over to our CEO, Paul Tufano.

Thank you, Lisa, and good afternoon, ladies and gentlemen. If you would please turn to Slide 4.

I would characterize Q1 as a solid quarter for Benchmark. We met and actually exceeded our commitments on both revenue and EPS. Revenue was $608 million for the quarter, up 9% year-over-year. We had good growth across the majority of our segments. Gross margin was 9.5%, a 40 basis point improvement year-over-year, and non-GAAP operating income was 3.7%, a 10 basis point year-over-year improvement.

EPS on a non-GAAP basis, $0.41, $0.09 year-over-year. Our cash cycle days were 68, at the low end of our target range. Operating cash flow was $25 million, and our ROIC was 11.2%, a 230 basis point growth from a year-ago period.

If you turn to Page 5, we are making good progress on bookings. As you all know, revenue growth is critical for us to achieve our long-term financial model, and bookings are critical to revenue growth. For the second (sic) [first] quarter, we generated $171 million worth of bookings. And of those bookings, 63% were in our higher-value markets and 37% in traditional markets.

If I could give you a little color on some of those wins as it related to the quality of the bookings. In Industrial, which was 30% of our bookings, we had a very nice win in smart cities as well as a win on electric vehicle chargers for electric [automobiles]. In A&D, we have a variety of wins across the board for comms devices, for land vehicles, for ammunitions and for high-end specialized filters for military applications.

In the Medical segment, we had -- 17% of our bookings came from Medical, with 2 very nice wins, one for an endoscopy device, the other for optical image stabilizer for use on MRI machines. In Computing, which was 32% of our bookings, we had a high-performance computer win as well as a ruggedized server win.

We also had 17 engineering awards. Just a little color on what those awards were. In the medical space, we won a design award to design an optical component for next generation endoscope. In industrial, we have a design to produce and design a DC-to-DC power converter for medium power applications, and we're working with a early-stage support of a Quantum computer design. So all in all, some good progress made in our engineering and bookings win.

Turning to Page 6. Clearly, as we look at 2018, and we stated this previously in our call at the fourth quarter, 2017 for us was a year of transition. It was a year of repositioning the company into realignment. As we said last quarter, 2018 is the year to leverage the work we did in '17. It is to optimize and refine our investments, and I believe the progress we make in 2018 will shape the trajectory for 2019 and beyond.

We have a fundamental goal, and that fundamental goal is to help our customers to go to market faster and more economically. And we view that by bringing rich technical capabilities to them, to work collaboratively with them to solve complex problems, to be able to operate extremely complex environments and complex product sets and more importantly, to work with them as if we're an extension of their own internal organizations.

To realize this goal, we are focused on a number of key actions that will leverage our exposure to those companies and provide greater value. Now I'd like to give you a little bit of color on those, the key investments that we're making so far in 2018.

To expand our value proposition, we are investing in a number of new offerings. We're expanding and enhancing our capabilities in microelectronics. Today, we have 2 sites servicing the telco, industrial, A&D and medical communities, both in Asia as well as in America. In May, we will be opening our new facility in Phoenix primarily serving our defense customers.

We're expanding our RF components. As you remember, we had a filter business we acquired with our Secure acquisition. We have [remissioned] that business primarily to serve defense customers. And we are expanding our offerings from high-end filters to include switches, converters and multiplexers. And we've seen good traction in that business over the course of the last several quarters.

And finally, we are developing high-speed circuits. Today, we are shipping high-speed circuits to a number of customers. We will have our new facility online in Phoenix by the end of the third quarter, and we are currently engaging with a number of customers with regards to leveraging the capacity of that facility.

In addition to expanding our value proposition with these kind of offerings, we are also making investments in a number of engineering and technology solution building blocks. Clearly, our defense investment, which originated with our Secure acquisition, we were expanding from primarily ruggedized computing to include miniaturization and -- of capabilities in power distribution and other areas in the defense community.

RF design center in Phoenix is online. We are engaged with a number of existing and potential customers, and I expect to see that providing more and more business as we move to the second half of the year.

In the area of surveillance, as a lot of you know, we currently have a contract with the Border Patrol to provide local surveillance systems to protect both -- the southern border of the United States. We're in the final phases of qualification with the Border Patrol, and we expect to be shipping systems by the end of this year through 2019 and 2020.

And finally, in our IoT area, we are making good progress in IoT, both from defense applications as well as potential commercial customers.

And finally, in the area of operational execution, it is a key focus item for us, first and foremost, to ensure that we have a uniform customer experience for our customers around the globe. And secondly, to ensure that we are driving more capabilities to serve more complex and technically rich customers. And across the board, we're making good progress in a number of these areas.

If you turn to the next slide please, which is Slide 8. But despite the progress we're making in these areas, a number of factors are coming together in this quarter that will have a negative effect on our financials. And I'd like to give you a little bit of color on some of these dynamics. First, we are seeing mix shifts in both products and product transitions, primarily in our Medical space, that will affect both our revenue and our margins. As you know, we have a broad portfolio of medical products with varying life cycles.

We have several products that are going end-of-life, in a number of cases, are qualifying new products or are working on replacement products. We believe we could compensate with other products to backfill these losses. But given FDA cycles and timing, we weren't able to make that align.

While Medical will be down in the second quarter, we expect to return to growth by the second half.

In addition to the product transitions we're seeing, we're also seeing customer headwinds as we ramp new customers. As we discussed earlier, revenue growth is essential to our growth and achieving our business model. We've been blessed by the fact that we have seen sequential revenue growth for the past several quarters. As you grow, you introduce new products and customers into a facility. And a facility has to be able to absorb those customers seamlessly and execute at a high level.

Currently, we have 2 sites where we are struggling to meet customer demand as volume is increasing. Our operational teams are deployed to rectify the situation, and I expect meaningful progress by quarter-end of the second quarter and full recovery by the third quarter. This reinforces our need for operational excellence, not only for a unified global customer experience, but more importantly, to allow our revenue to grow seamlessly and meeting our customer demand. And our operations teams are well aware of that and are working to not only improve processes in onboarding at the 2 sites mentioned but in all sites across our network.

And finally, we have planned investments in engineering solutions. As we discussed on the previous chart, for us to be more meaningful to our customers, we need to invest in things that enhance our value proposition. We're executing on that plan, and we expect that these investments be contributing to the bottom line fully by the second half of the year.

As a result though, we are providing the following second quarter guidance. Roop will provide more color in his section, and then we'll handle it in your Q&A.

If I now turn to Slide 8, which are progress against our waypoints. As I said earlier, Q1 was a solid quarter where we made progress in a number of our metrics. In bookings, we achieved $171 million of bookings, and I have line of sight and am confident that we will meet $200 million of bookings by the second half.

From a revenue perspective, I expect annual revenue to grow year-over-year between 2% to 5%. So within that revenue, I am confident we'll be able to make our mix greater than 67% of our revenue in higher-value markets.

As we all know, gross margin is critical. In Q1, we achieved our 9.5% gross margin objective. But unfortunately, as our Q2 guidance will reflect, we will see decline in gross margins. We believe we have the ability to approach 9.7% in the second half of the year, and we are driving the organization to maximize gross margin.

And as it relates to SG&A, our SG&A spending will be flat in the second half of the year and within a range of $36.5 million to $37.5 million. We believe given the level of revenue growth that we anticipate in the second half that we can approach 5% SG&A [E to R] -- by the fourth quarter.

And finally, as it relates to profit per square foot, you can see that the number is inverted slightly. We have been adding square footage for new facilities. So as the denominator goes down -- goes up, excuse me, you'll see the numerator come down. But we are aware that getting to $29 a square foot is critical, and it is top of mind in the organization.

I will now turn the call over to Roop, who will provide some more color, and then we'll answer any questions you might have.

Thank you, Paul, and good afternoon, everyone. Before I provide a recap of first quarter 2018 financial summary, I'd like to provide a few updates that occurred in the quarter.

Effective January 1, 2018, the company implemented ASC 606, the accounting standard governing revenue from contracts with customers using the full retrospective transition method. Under ASC 606, revenues recognized or -- as or when the customer obtains control of the goods or services promised in a contract. Given the nature of the terms and conditions in substantially all of the company's customer contracts, the company now recognizes revenue over time beginning at work-in-process for the majority of its contracts. This is a change in the timing of revenue recognition from a historical perspective. The effect of implementing ASC 606 is a reduction in revenue by less than $500,000 for Q1 2018.

As part of ASC 606, we are also required to reclassify finished goods and work-in-process meeting the overtime criteria from inventory to a new line item called contract asset on the face of the balance sheet. Contract assets are defined as the company's right to consideration for work completed but not built. During Q1, the company repatriated approximately $277 million of cash from international locations. We also expect to repatriate additional available funds in the future.

As part of our capital allocation strategy, during Q1, the company entered into a $50 million ASR agreement with Goldman Sachs. During the first quarter of 2018, the company changed its historical repatriation strategy. We began to repatriate foreign earnings from our foreign jurisdictions to the U.S. in support of our capital allocation strategy announced in March 2018. As a result, we are required to record estimated foreign withholding taxes and estimated state income taxes to assess the foreign earnings -- to access the foreign earnings, excuse me. During the quarter, we reported $40 million for these taxes.

Now let's turn to Slide 11 for a recap of our first quarter 2018 financial summary. Revenues of $608 million exceeded our guidance of $585 million to $605 million and were up 9% year-over-year. This marked the fifth straight quarter of year-over-year growth. The increase in year-over-year revenues was driven primarily by growth in our higher-value markets.

Our Q1 non-GAAP operating margin was 3.7%, which was 10 basis points year-over-year improvement. Non-GAAP EPS of $0.41 was above our guidance of $0.34 to $0.38 as a result of higher-than-expected revenues and a lower tax rate.

Our GAAP loss for the quarter was $0.49 and includes a $40 million tax expense or $0.82 per share. The tax expense was for foreign withholding taxes and applicable state income tax effects related to current and future foreign cash distributions into the U.S. Our GAAP results also included $2.2 million of restructuring and other costs, $341,000 recovery from the sale of inventory that was written down in 2017 due to a customer insolvency.

For the quarter, our ROIC was 11.2%, up 90 basis points sequentially and 230 basis points year-over-year.

Please turn to Slide 12 for our revenue by market sector. Industrial revenues were down 3% quarter-over-quarter from a program delay due to a custom part shortage and softer demand for infrastructure products but up 6% year-over-year from improved overall demand from new and existing customers. A&D revenues for the first quarter increased sequentially 3%, which was less than expected due to program ramp delay headwinds. Revenues declined 2% year-over-year.

Medical revenues were up 15% year-over-year from higher demand and program ramps from new and existing customers. Sequentially, revenues were down 3% from lower-than-expected demand, primarily from customers producing cardiac products.

Test & Instrumentation revenues remained strong and were up 10% in the first quarter and were up 35% year-over-year from ongoing demand in our precision machining business started in the semi-capital equipment market. Overall, the higher-value markets grew 12% year-over-year and 1% sequentially and represented 69% of our first quarter revenue.

Turning now to our traditional market. Computing was down 40% sequentially from seasonality but up year-over-year, driven primarily by demand increases from data security customers. Telco was up 3% year-over-year and 7% sequentially from demand increases from existing customers in the satellite, edge broadband and network testing space. Our traditional markets, which represented 31% of first quarter revenues, were up 3% from last year and down 25% from the fourth quarter driven by lower Computing. Our top 10 customers represented 44% of sales for the first quarter.

Please turn to Slide 14 for a discussion of non-GAAP key business trends. Gross margin for the first quarter was 9.5%, a 40 basis point year-over-year and quarter-over-quarter improvement. The year-over-year improvement is driven by higher revenue, more favorable revenue mix and the result in the improved absorption. The quarter-over-quarter improvement is primarily due to revenue mix driven by reduced Computing sector revenue in Q1 2018.

Our SG&A was $35.7 million, and resulting non-GAAP operating margin was 3.7%, a 10 basis point increase from last year. Note that we had $2.2 million in restructuring for Q1, and we expect to incur additional restructuring charges of approximately $1 million to $1.5 million in Q2 2018.

Please turn to Slide 15 for a reminder of our 2018 projected quarterly SG&A run rate. As we shared in our Q4 earnings call in February, we will continue to add engineering and technology capabilities to support extending our value proposition to customers. And we continue to invest in variable reward programs for our employees. It is our goal that the SG&A run rate will level off by the end of Q2 2018 and have -- be between a range of $36.5 million to $37.5 million.

Please turn to Slide 16, where I'll provide a few updates on cash flow and working capital highlights. We generated $25 million in cash from operations for the quarter. Free cash flow was $4 million for the first quarter after capital expenditures of approximately $21 million. Our cash balance was $676 million at March 31, with $238 million available in the U.S. As noted earlier, we repatriated $277 million into the U.S. from foreign locations.

Our accounts receivable balance was $404 million, a decrease of $33 million from December 31. Payables were up $6 million quarter-over-quarter. Contract assets were $148 million at March 31 compared to $146 million at year-end. Inventory at March 31 was $306 million, an increase of $37 million from December 31. The increase is primarily raw materials in support of the ramp of new programs.

Please turn to Slide 17 to review our cash conversion cycle performance. Our cash conversion cycle was 68 days for Q1, which is consistent with our expectations. Our ongoing cash conversion cycle days will continue to range between 73 days and 68 days to support our long-term revenue growth.

Turning to Slide 18 for a summary of the current quarter impact of the U.S. tax reform. As highlighted earlier, during the first quarter, we recorded a tax charge of $40 million or $0.82 per share based on the benefits of the 2017 Tax Reform Act. The expense consists of: $31 million for foreign withholding taxes in foreign jurisdictions related to historical earnings with the intention of repatriating cash associated with these earnings in the future; $9 million for the applicable state tax impact of these expected foreign cash distributions.

As you can see in Slide 19, during the quarter, we updated our capital allocation strategy, which included: announcement of the first quarterly cash dividend of $0.15 per share; increasing our prior stock repurchase plan by $250 million; entering into a $50 million accelerated stock repurchase agreement, which settled the initial delivery of approximately 1.3 million shares for a total of $40 million. The remaining $10 million is expected to settle in shares upon completion of the contract. And we completed on open market purchases a little more than 600,000 shares or $18 million.

Turning to Slide 20 for a review of our second quarter 2018 guidance. We expect revenue to range from $590 million to $630 million. Our non-GAAP diluted earnings per share are expected to range from $0.26 to $0.34.

For sequential modeling information for the second quarter, please turn to Slide 21. Overall, we expect industrial revenues to be up mid-single digits in Q2 led by new and legacy programs within the transportation and infrastructure markets. A&D is expected to be down mid-single digits in Q2 based on several factors, including customer new programs put on hold for a component redesign, cyclical demand from discrete orders and our execution performance issues in 2 locations, which we are aggressively working to recover.

We expect Medical revenues to be down low teens based on the timing of customer program transitions for fluidics and cardiac programs. We have new programs with other Medical customers that are in early ramp mode that should offset these transitions in the coming quarters.

In Test & Instrumentation, the strong demand we saw in the past 4 quarters will continue in Q2, and we expect T&I to be up mid-single digits sequentially.

Turning now to the traditional markets. We expect Computing revenues to increase sequentially by high-single digits based on current customer forecast from a combination of legacy and new programs in the high-performance computing. Software revenue should be flat quarter-over-quarter, increased demand from satellite backhaul and edge device customers do not offset overall moderate demand softness from a variety of customers.

Implied in our guidance is a 2.7% to 3.2% operating margin range for modeling purposes. The guidance provided does exclude the impact of amortization of intangible assets and estimated restructuring charges.

Interest expense is expected to be $2.3 million, and the effective tax rate is expected to be 18%. Expected weighted average shares for Q2 2018 are 47.6 million.

Operator, please open the call for questions.

(Operator Instructions) Our first question comes from the line of Sean Hannan of Needham.

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

So Sean, let me take the gross margin point, and I'll let Roop take the SG&A point. As I said, we believe we have the ability to approach 9.7%. Now that's going to be probably as we exit the year. Our ability to do that will be function of 2 things: a, how well we can resolve some of these operational issues; and number two, how we can drive or absorb more revenue growth but the revenue growth would be in that second half and the mix of net revenue. So we are focused on maximizing gross margin. And the question would be the trajectory of that from the second quarter to the end of the year, but we are going to be relentless on the gross margin line.

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

Okay. So I mean this would imply a very significant back end of the year revenue ramp. I mean, I think the math would suggest, we're probably looking at something close to a $700 million type of number for December. Am I thinking about this correctly? Just trying to make sure I understand this appropriately.

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

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

Sure. I mean, look, our factories have multiple customers, multiple products in every factory. And our job -- let's be really honest, our job is to be able to absorb customer transitions seamlessly. Now a lot of our factories haven't seen growth in a while, and it's like exercise. When you don't exercise, it's hard. So as the volume is increasing, what happens in an organization is it stresses the organization. Because these factories have to be like -- think of it like a NASCAR coming into a pit. When the pit crew comes in, everybody's got to work in unison to get the car out. Well, when you're not using the volume at the level that some of these factories are experiencing, you don't have quite the coordination that you need. You don't have quite the alignment in terms of processes that you need, and it's easy to get a little bit out of sequence. If you get out of sequence, it's tough to recover without either having additional costs, or you get crunched on the back end of the quarter to try to get volume and you miss volume. So it comes down to 3 things. It comes down to ensuring the organization has the right people in place, the right processes and the right tools. Tools are not quite the problem. It's just getting people and process together and working in tandem, planning accordingly to execute as needed. And so we're working on that. It's not rocket science, but it's hard work. And I'm confident our teams will resolve, work through those issues and get us back on track in a large part within this quarter, but most definitely by the third quarter. And just to put the fine point on this, I want to make sure you get a fine point. If we're going to see revenue growth as we would like it to be, we must make sure that no matter where you are in our network that you are ready for demand and you catch it flawlessly. That is the mission of Mike and his team, and they're off executing that mission.

Okay, fair enough. Let me see if I could just switch gears here, and I'll jump back in the queue. Just looking at the program wins, it's a really wide range this quarter. Just want to see if we'd get a little bit more clarity around that. You're doing a great job in terms of procuring new business, so congratulations on that front. Any color would be great on that range.

Okay. So as it relates to bookings, it's our objective to have as wide a range of new engagements and new bookings as possible. Clearly, we have a model, the target for each of the sectors we're going after. And our goal is to get customers that require complex, technically rich partners that can deal with a lot of complexity and low volume. And so they are procuring that. And more importantly, we're doing it in a way that we're trying to engage with customers who have products that are in the front end of the S-curve that see growth. And so if you look at some of the wins we have this quarter in the medical space, the stuff we're doing with endoscopy, excuse me, I can't pronounce that, is really innovative way to do it. And we're really excited about that. The stuff we're doing with DC-to-DC power, while it's different, if you think about energy and energy management, energy storage, it's going to become a bigger market going forward, we want to play in that market. In defense, given the budgets for defense, we're going to see a fair amount of defense spending over the course of the next few years and even more than we've seen in the past. We engage from munitions to communications to avionics to land vehicles. So we want to take our fair share, so you'll see us play across the board. In the old spaces of computing, high-performance computing is our niche, and we're pleased we got a win there.

Our next question is from Jim Suva of Citi.

Maybe my math is wrong, but does it -- and maybe the accounting has an impact to this too. But for the June outlook, is this like the first year of year-over-year declines you've seen in, like, about 3 years or so? And if so, did I also hear on your prepared remarks or the Q&A that you expect growth for this year in totality?

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

Got you. And it appears that, that would be obviously second half loaded. Would it also be kind of Q4 loaded also just given the spending of some of the customers that you have in budget flushes and things?

So if you look at the second half, it will be back-end loaded. Now if you look at our 2017, for example, fourth quarter was the highest quarter of the year. I think that is consistent with our trends historically.

And I'm showing no further questions at this time. I'd like to turn the call back over to management for any further remarks.

Great. Thank you, operator, and thank you for taking the call. Let me just end the call by saying, when we put guidance out, we make a balanced view of what we believe we can do. And it's our goal to improve upon the second quarter guidance as we move through the second half of the year in all the years we talked about.

You have our unrelenting focus to ensure that this is achieved. And so with that, I just want to thank you for listening to the call. We will talk to you in 90 days.

Thank you very much.

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