Benchmark Electronics, Inc. (NYSE:BHE) Q2 2019 Earnings Conference Call July 24, 2019 5:00 PM ET
Lisa Weeks - VP, Strategy and IR
Jeff Benck - President and CEO
Roop Lakkaraju - CFO
Conference Call Participants
James Ricchiuti - Needham & Company
Good afternoon. And welcome to the Benchmark Electronics Incorporated Second Quarter 2019 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.
I would now like to turn the conference over to Lisa Weeks, Vice President of Strategy and IR. Please go ahead.
Thank you, operator, and thanks everyone for joining us today for Benchmark’s second quarter 2019 earnings call. With me this afternoon, I have Jeff Benck, CEO and President; and Roop Lakkaraju, CFO. Jeff will provide introductory comments, and Roop will provide a detailed review of our second quarter results and third quarter outlook. We will conclude our call today with a Q&A session.
After the market close today we issued an earnings release, highlighting our financial performance for the second quarter of 2019, and we have prepared a presentation that we will reference on this call. The press release and presentation are available online under the Investor Relations section of our website at www.bench.com. This call is being webcast live, and a replay will be available online following the call.
Please take a moment to review the forward-looking statements advice on slide 2 in the presentation. During our call, we will discuss forward-looking information. As a reminder, any of today’s remarks that are not statements of historical fact are forward-looking statements, which involve risks and uncertainties described in our press releases and SEC filings. Actual results may differ materially from these statements, and Benchmark undertakes no obligation to update any forward-looking statements.
The company has provided a reconciliation of our GAAP to non-GAAP measures in the earnings release as well as in the appendix of the presentation.
I will now turn the call over to our CEO, Jeff Benck.
Thanks, Lisa, and welcome to everyone joining us for this afternoon’s call. I've been on the job for four months now and I've learned a lot about our strength, our unique capabilities and where we have room to improve, and importantly I have had the opportunity to hear from many of our customers, what their needs are going forward and how we can help them accelerate their business and in turn grow our.
I’m energized by the opportunities in front of us and we are in the process of transforming our organization to ensure we capitalize on this opportunity. During the call today I will first provide a brief overview of our second quarter 2019 results and introduce the new executives I have added to our team. Roop will then take over and talk through the financial update and I will close with a review of the key strategic initiatives we will be driving in the coming year.
Please turn to slide 4. In the quarter ended June 30, 2019, we delivered revenues of $602 million which was beyond the high-end of our guidance and we achieved $0.36 of non-GAAP EPS, which was at the high end of our guidance range. Revenue was higher than our expectations driven by year-over-year increases in the higher value A&D and medical market, along with higher than expected revenues from the legacy computing contracts.
Our non-GAAP gross margins improved 10 basis points sequentially to 8.9% on a higher value market mix, despite continued softness in the semi cap market sector which was down 41% from the second quarter of 2018. More importantly non-GAAP gross margin were over 10% when you exclude the legacy computing contract revenue, which reflects the potential leverage in our model with an improving portfolio.
Please turn to slide 5. I've been very focused on building our leadership team and I’m excited about the recent additions that we've announced will be instrumental and helping us execute our strategy. First, we've added Rob Crawford as the company's first Chief Revenue Officer. In this role Rob will direct our global go to market strategy with explicit attention on sector strategies, portfolio optimization, marketing execution and revenue realization to ensure we achieve our growth objectives.
Rob brings over 25 years of combined EMS and OEM experience from his prior leadership role in other technology company, making him a perfect fit for this new role at Benchmark. Furthermore his engineering background enables him to not only understand our unique capabilities, but be able to articulate to customer's the differentiation we bring. I am confident that Rob will do great job spearheading our in-flight go to market transformation.
Second, we've added Rhonda Turner as the Chief Human Resources Officer to replace the vacancy left by the previous HR leader who departed before I joined. Rhonda will oversee all functions of our HR team, including talent acquisition, employee engagement, organizational design, comp and benefits and lead the deployment of our new HR shared services model. She comes to us from the University of Technical Institute, where she was SVP of HR with the past leadership position at ConocoPhillips and Circle K.
In our service business people are critical to the company's success. Rhonda has demonstrated her ability to globally align people and business strategy and I'm energized by Rhonda's ideas on how to support our talented and diverse workforce. Rhonda will be a change agent in our organization and a key contributor to our centralization, standardization and scalability initiative.
Now if you please turn to slide 6, I will turn the call over the Roop to discuss our financial results for the quarter.
Thank you, Jeff and good afternoon everyone. We’ll start at slide 7 for a discussion of our second quarter 2019 financial summary. Revenues of $602 million was above the high end of our guidance of $555 million to $585 million. The higher revenue performance against guidance was primarily driven by the substantial completion of a long standing legacy computing contract versus our previous expectations wherein the contract would be completed in Q3 2019. The final activity in Q3 on the contract will be to complete the remaining inventory transfer.
Our GAAP EPS for the quarter was $0.24. Our GAAP results also included $3.4 million of restructuring and other costs due in part expenses associated with various site restructuring activities and our go to market changes. $800,000 for a legal settlement with a customer and $1.1 million of funds received from a favorable legal settlement.
Our Q2 non-GAAP operating margin was 3.1%, a 20 basis points quarter-over-quarter and 40 basis points year-over-year improvement due to our improved operational efficiency and slightly lower SG&A. Non-GAAP EPS of $0.36 was at the high end of our guidance range of $0.28 to $0.36. For the quarter, our ROIC was 8.2% down 10 basis points sequentially, and 230 basis points year over year.
Please turn to slide 8 for revenue by market sector for the three months ended June 30. For your awareness and clarification, we have renamed the test and instrumentation sector, to semi cap, the more accurately reflect the revenue mix in this sector. This change does not affect historical comparative revenue.
Industrial revenues were up slightly from our expectations and flat from Q1. Revenues were down 3% year-over-year from softer demand from customers in the industrial transportation market and ramp delays from previously booked new programs. A&D the revenues were up 3% quarter over quarter and 7% year a year from overall demand strength for existing products, the ground based and airborne vehicles.
Medical revenues were 10% higher quarter-over-quarter and 18% year over year. We saw increased demand for existing renal fluidic and cardiovascular programs and program ramps from imaging and patient monitoring. Semi cap revenues declined 5% sequentially, and were down 41% year-over-year from continued semi cap softness.
Overall the higher value markets represented 66% of our second quarter revenue. And we're up 3% sequentially and down 5% year over year. Excluding the legacy computing contract, our higher value markets represented 76% of revenue in Q2.
Turning down to our traditional market. Computing was up 7% sequentially and higher than expected to support the final build for our legacy computing contract. Telecommunications was down 20% sequentially, primarily from a design delay for a satellite program and a customer program in the blind and 10% year over year from software demand from legacy broadband products and advanced telco program ramp delay.
Our traditional markets which represented 34% of second quarter revenues were down 15% from last year and down 5% sequentially. Excluding the legacy computing contract our traditional markets represented 24% of revenue in Q2. Our top 10 customers represented 41% of sales for the second quarter.
Please turn to slide 9. Bookings for the quarter were $130 million. We continue to have strong medical and A&D bookings, and win market share in semi cap. However, we are disappointed in our overall bookings achievement in the quarter, which was driven by the lower than expected performance in our industrial sector.
Industrials were only 6% of bookings with a new manufacturing win for transportation infrastructure program, and an MPI project for a connected asset IoT sensor. Q2 wins were strong again in medical with 27% of total bookings. We were awarded the design and manufacture of a new biometric monitoring system and manufacturing for a fluidic management product.
Semi-cap we continue to win new precision technology programs in the semi-cap space for critical wafer processing components used in multiple steps throughout the fab. We continue to expand A&D wins with new programs with existing customers, including PCBI manufacturing and precision technology wins, ramps with existing customers, including TCPA manufacturing and precision technology win for radar systems and electronics for ground and airborne vehicles.
Computing and telco were a combined 33% for the quarter. In computing we were awarded to new supercomputing programs and in legacy telco a new satellite electronics manufacturing program. We have 53 total wins for the quarter, 28 manufacturing and 25 engineering.
Please turn to Slide 11 for a discussion of non-GAAP key business trends. Gross margin for the second quarter was 8.9%, a 10 basis point sequential improvement and year-over-year improvement of 70 basis points. Year-over-year gross margin improvement is attributable to operational improvements throughout our global network and better mixed from higher value market revenue.
Without the legacy computing contract, our gross margin would have been 10.1% versus the reported 8.9%. Our non-GAAP SG&A was $35.3 million which is in line with our Q2 guidance in Q1 2019. Non-GAAP operating margin was 3.1%, up 20 basis points sequentially. We had $3.4 million in restructuring and other costs for Q2, including expenses associated with various site restructuring activities, and our go to market changes.
We expect to incur additional restructuring and transition charges in Q3 of approximately $2 million to $3 million that are related to various employee -related activity.
Additionally, as we stated in our press release we have elected to close to two sites with customer transitions expected into other locations in the benchmark network by mid-2020. Restructuring charges associated with these closures are expected to be between $6 million and $8 million of which $1 million to $2 million will occur in Q3. Once the site closures are completed we expect annualized savings of approximately $5 million. Jeff will cover the strategic rationale for these activities shortly.
Please turn to slide 12 where I will provide a few update on cash flow and working capital highlight. We generated $52 million in cash from operations for the quarter, free cash flow was $47 million for the second quarter after capital expenditures of approximately $5 million. We now estimate that we will generate between $75 million to $85 million in cash flow from operations compared to our previous estimate of between $40 million and $50 million.
We now expect CapEx range for the year between $45 million to $50 million, which is trending towards the higher end of our prior range due to additional investments required for new business plans. Our cash balance was $397 million at June 30 with $217 million available in the US. Our accounts receivable balance was $363 million a decrease of $42 million for March 32. Payables were flat quarter over quarter.
Contract assets were $156 million at June 30, a decrease of 1 million from March 31. Inventory at June 30 was %316 million, which is flat quarter over quarter.
Please turn to slide 13, to review our cash conversion cycle performance. Our cash conversion cycle was 65 days for Q2, slightly below our range of 68 days to 73 days driven by the lower AR balance.
Turning to slide 14 for our capital allocation update, In March 2018, we announced a recurring $0.15 per share quarterly cash dividend. $5.9 million dividends were paid in Q2, 2019. Total share repurchases during Q2 were $39 million or 1.5 million shares. Year-to-date we have repurchased approximately $100 million or 3.9 million shares at an average price of $25.58. We will continue to evaluate further share repurchases in Q3 2019. If we repurchased shares will do so through our open market repurchase program. As of the end of June, we had approximately $102 million available under the current share repurchase program.
Please turn to slide 15 for a review of our third quarter 2019 guidance. We expect revenue to range from $525 million to $555 million. This guidance reflects the essential completion of the legacy computing contract and then muted demand from the semi-cap sector.
Our non-GAAP diluted earnings per share is expected to be in the range of $0.33 to $0.39, which results in the midpoint of the guidance range of $0.36 if achieved this would result in flat sequentially EPF even on the lower revenue.
For sequential modeling information for the third quarter, please turn to slide 16. Overall, we expect industrial revenues to be flat with persistent demand softness in the transportation and facility infrastructure market and lack of growth from new programs. And these expected to be high single digits and Q3 based on continued strength across multiple new and existing programs supported by the strong by strong us defense budget. We expect medical revenues be up low single digits, driven from sustained demand with existing customers and the continued ramp of a new imaging program. Semi-cap is expected to be flat.
Turning now to the traditional market, we expect computing revenues to be down greater than 50% due to our exiting from our legacy computing contract. We expect telco to be flat strengthen existing programs is offset by end of life programs. Implied in our guidance is a 3.1% to 3.7% non-GAAP operating margin range for modeling purposes. The guidance provided does exclude the impact of amortization of intangible assets, and estimated restructuring and other costs.
Interest expense is expected to be $1.8 million, and the effective tax rate is expected to be 21%. The estimated weighted average shares for Q3, 2019 are approximately 37.8 million. Exiting 2019 and the legacy computing contract, we believe that our higher value market revenue mix will be between 72% 78%. Our gross margin will be between 9.5% to 9.8%, and our SG&A will remain in the range of $34 million to $36 million. Based on our bookings year-to-date, we do not expect to reach our range of $800 million to $900 million for the year. As Jeff indicated, we are making changes in our go to market organization that we believe will improve future bookings level and revenue realization.
I will now turn the call back to Jeff for detailed look at our strategic initiative. Jeff.
Thanks, Roop. Let's go to slide 18. During the past quarter working with my leadership team, we have refined our strategic priorities for the coming year. In fact, we've already made progress on these new initiatives in the quarter. The one thing I want to reinforce is that our strategic initiatives are prioritized with a customer centric mindset.
The first initiative is optimizing our go to market organization and customer coverage strategy. Our strategy is built around addressing the future needs of our targeted customers with a partnership strategy that will help them win in the marketplace. If our customers win with us, we will accelerate our revenue growth.
Go to market has been an important area of investment over the past several years to drive booking, which would in turn drive revenue growth. Certainly progress has been made. But the organization needs to mature at a faster pace. This quarter, we have realigned our go-to-market organization under a new CRO role, which we have filled with Rob Crawford. The new organization merges our sector leadership, business development teams, marketing and sales operations under one leader. The purpose of this new organization is to facilitate more effective customer and sector coverage, reduce complexity in the selling process and improve revenue conversion.
Rob will play a key role in optimizing our sector and customer portfolios and enhancing the sales process to expedite time to market for our customers and time to revenue for benchmark. Part of the process focus will be on the bookings methodology. As Roop communicated earlier, we were down quite a bit this quarter from where we expected to land. While we anticipate a recovery in bookings in 3Q given our pipeline, it's a challenge to time customer communication of awards to a specific date and the quarter. Beyond that, as they look at our competition, I am finding that EMS competitors have a slightly different approach to how they communicate their booking, if at all.
Having said that, our new bookings are an indicator of future revenue growth, as illustrated by our growth in A&D and medical. So we will continue to incentivize our business development teams to pursue them. I am also charging our new CRO to develop a revenue roadmap process across the sectors with accountability for converting bookings to revenue. Given these changes, we don't intend to report our quarterly bookings performance going forward. We will come up with a revised reporting methodology aligned with our new processes once in place.
In addition to bringing on a new CRO we have also hired an industry veteran as our new industrial sector leader in the quarter.
The second initiative is driving operational efficiencies and process consistency across our site. This strategy considers our customers geographic requirements for our capability and the ability for them to move seamlessly across our network. It also comprehends the need for us to rationalize our strategic footprints and address utilization challenge. We are refreshing our global manufacturing services network strategy considering many factors such as utilization, scale, geographic placement, cost and most importantly our customers' long-range need for volume manufacturing.
As part of this process we have decided to close our San Jose California and Guaymas Mexico operations with a target closure date of Q1, 2020. As a result of these actions we're reducing approximately 3% of global workforce and 4% of our global footprint. We will consolidate many of these programs at the sites in others manufacturing location in our network, which will in turn improve their asset utilization and efficiency. I want to thank our loyal employees at these locations for the past service and dedication to Benchmark and our customers for their ongoing support while these transitions are completed.
Across our network we are also focusing on consistent process deployment and cycle time reduction programs from productivity improvement to increase margins and asset utilization. We have early proof point, but these accelerated productivity initiatives can drive benefit and I expect further progress in the coming quarter.
The third initiative is creating a centralized G&A organization to accelerate our ability to efficiently deliver and scale our support organization service. This updated structure will enable us to deliver cost-effective shared services to the benefit of our internal teams as well as our customer.
We've kicked off process to functionally realign our finance, human resources, legal and IT teams by end of the year. We expect this realignment to accelerate business execution by deploying scalable processes and tools across Benchmark. The ultimate objective of this activity is to increase efficiency and scalability as we drive our next period of growth.
And finally the fourth initiative is focus on accelerating engineering and services solutions to help solve our customers, most complex challenges. Over the past several years, we've continued to make investments in rich technical capability. In our engineering organization we've invested in a number of advanced technology including fluidic, connected device expertise, as well as optical packaging and microelectronic. We've invested in our large RF and high-speed design center. Process capabilities for circuit and filter component which fit nicely with our microelectronic and mixed S&P manufacturing capability.
We're building these capabilities with customer input to align our roadmap and investments where we can demonstrate an advantage for customers to partner with us. We're investing and winning new business with these investments. With the optimization of our go to market team we will improve on the integrated sales of all Benchmark services and better communicate the value of our differentiated capability. We believe these are the right priorities for where we are as an organization and our executive leadership team is aligned and engaged in driving these initiatives throughout the organization.
Now if you please turn to slide 19 I will provide a brief summary. Roop provided an update on the near term view of our sectors but I want to provide a broader sector outlook. Looking at semi cap, since April I've met with our Semi cap customer the general view is that 2020 will be improved from 2019, but the magnitude is still in question. We believe that the improvement will be more back end loaded in 2020.
Having said that, we are continuing to invest in this segment. And we believe we are gaining share in a down market as we have won new design programs, as well as picked up existing production from supplier consolidation.
Now, looking at medical and A&D, I remain pleased with the performance of these two target growth sector. We expect continued growth in the second half of ‘19. Our teams are doing a great job growing our business and these two highly regulated market, with very complex product.
Industrial, our industrial sector growth has not achieved the expectations we had hoped for. And the near term outlook is relatively flat. We believe this is an important sector that fits well with our capabilities. And we believe our new sector leader will bring a fresh perspective and a renewed focus to the space.
Turning to computing and telco. With our legacy computing contract complete, we will continue to focus on our remaining portfolio of higher complexity computing programs in selected sub sectors, and next generation telco. I also wanted to provide an update on our target business model. While I would love to adopt the former CEO's target model, it's clear with the semi-cap weakness our performance in the industrial vertical and the transition out of our large legacy compute customer we are now on a path to achieve the $2.8 billion revenue objective within the target business model by 2020.
However, we are in the process of analyzing our three year business outlook, which is being updated through our fall planning cycle. We'll provide updates on this effort in the 2019 year end call.
Our near term focus is on the strategic objectives and initiatives I highlighted. And these will provide meaningful benefit as we execute our high priority action. Over time, these actions will enable us to focus our efforts and resources on our optimized portfolio, while creating meaningful value for shareholders. We will continue to make steady progress on these initiatives to fully unlock the potential of our business.
We look forward to providing updates on our progress in the coming quarter. And with that, I will turn the call over to the operator to conduct the Q&A.
We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jim Ricchiuti with Needham & Company. Please go ahead.
Thank you. Good afternoon. First question I had was just with respect to the performance in the industrial vertical, I wonder if you could maybe shed a little bit more light because I assume that, that vertical encompasses a number of different customers and maybe some subsets. So where are you seeing some of the weakness and/or where has it fallen short of your expectation?
Yeah, so this is Jeff, I'll take the lead and then I'll let Roop add some color. We -- there's a number of factors, as you said that that's contributing to it. If you look at our current, quarter revenue and the outlook was flatter, we believe there's growth opportunity here. So when we say we didn't perform as expected, we really intended to see growth here and expect to be able to grow it in the future. But we have had a number of customer wins that we've had here that have taken longer to ramp for a number of issues. Sometimes it's a design issue with a particular customers' product that they're trying to develop, in some cases the company dynamics and their plans to go to market. So we have seen some elongated programs that have not ramped as quickly. So that's certainly one factor.
When you look at our bookings performance, because they were -- industrial is certainly a contributor to a weaker bookings quarter. I think some of that, execution on our pipeline, and our ability to do have the right interactions to close that. And we made a number of changes there. We have a new industrial sector VP coming on board that I think is -- I'm excited about and think that's going to help quite a bit there.
In general we don’t see really an industry economic slowdown per se in industrial, but just when you look at our participation and where we play there, we were trying to expand into other areas. We were strong in the oil and gas measurement area and some of the segments that we're in may not have the highest growth profile for the complete sector. And as we have expanded it we have gotten these wins but that's certainly taken longer. You want to add to that.
No I think you covered it well, Jeff.
And Jeff just with respect to Semi-Cap have you basically now met with all of your major customers and it sounds like the way you're thinking about the recovery is the way we're hearing a lot of folks talk about it, more second half of 2020. But by the same token it sounds like you get any indication as to particular leading indicators that you're looking at that might signal when this is actually really starting to happen?
So let me comment on that and go a little deeper. I have that a lot of customer interaction here. So that’s been given [ph] -- that I was go after that. I haven't met with every customer we have here, so I got more work to do there but from the discussions I have had with some of the really important ones, there is definitely a belief that 2020 will be better than 2019 and you know we feel pretty strongly and I think it's been pretty consistent that we will see improvement in 2020.
But we also we kind of look for where does the bookings in the quarter will start to happen? We are also sort of saying which we think is consistent with what we've seen in and heard from the customer that it's probably more back end loaded in 2020, second half 2020.
That being said I really like this space, I like our strategic position. We have strong bookings in this segment, we believe that we're gaining share. We've seen some consolidation of suppliers that has come to us and we also been asked by customers that hey, we want you there as a strategic supplier when this recovery happens. And it could be pretty significant as we seen in the past.
So from that standpoint we're still bullish on the segment and our position. But it is definitely taking longer than a more pronounced downturn here. And we always -- last quarter, I think we said second half of '19, probably wasn’t going to be there and we're just reconfirming that that is very flat for us in '19. And frankly it might have down further had we not gained some ground.
Jim, just I'll probably add two additional things. I think to your question of leading indicators obviously the comments that our customers who are some of the leading companies there what they might say will give us better indication of customer conversations. The other thing as Jeff mentioned I'll just echo is kind of the order load and how that profiles in will obviously give us confidence as to when we start to see that recovery and we will obviously communicate that at the appropriate time.
Thanks. I'll jump back in the queue.
[Operator Instructions] The next question is a follow-up from Jim Ricchiuti with Needham and Company. Please go ahead.
Just with respect to the facility consolidation, I wonder if you could talk a little bit about the types of customers you are servicing in those two facilities and I just want to again go over the timeline for closing those facilities. And when we might anticipate some of the benefits from a cost savings start to flow in?
Yeah, so let me talk about the strategic context and then I will have Roop comment on the financial impact. This is a tough decision and we don’t want to impact our team but we been going through this strategic assessment and looking at a lot of utilization, the scale of our sites, geographic placement, cost and customer needs, I think I mentioned that in the script.
These sites do support really all sectors. So it's not, specific to a sector. They even have some semi-cap business there as well, but it's small. But when we just looked at our strategy and looked at the network, considering all those elements, we made the decision that we would that we would close the site.
It's not a tremendously large number of customers. We're talking less than 20 customers across both sides. But we really are looking to move a majority of the programs with those customers to other sites where those customers already -- many already exist. And we can kind of consolidate with program teams and be more efficient and yet still serve those customers in a great way.
When you look at the actual timeline, our communication is very much about having the customers' transition in the first quarter of 2020. Then Roop maybe you can comment a little bit on…
Yeah, just to finish off the thought there. As Jeff said, the timing is for customers to be transitioned by the end of Q1 2020. We expect final closure details to be in Q2 2020. In terms of lease termination, these sort of things. Jim, I think you asked also about savings and timing. As we indicated, as I indicated in my prepared comments, we expect the annualized $5 million savings. We think those savings will start to kick in in the Q3 timeframe of 2020.
Great, okay, thanks a lot.
This concludes our question-and-answer session. I would like to turn the conference back over to Lisa Weeks for any closing remarks.
Yes, I just wanted to put a reminder, that Benchmark will be supporting the Needham advanced industrial tech day on August 14 this year, and also the Sidoti Fall Conference in September, September 25. So both of those will be in midtown New York, and we look forward to seeing you there. And with that we thank you all for joining our call today. And if you have any questions, please feel free to reach out to me and I will be happy to follow up with anything that you need. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.