Lisa K. Weeks - Vice President of Strategy & Investor Relations Donald F. Adam - Chief Financial Officer and Principal Accounting Officer Gayla J. Delly - Chief Executive Officer, President and Director.

Brian G. Alexander - Raymond James & Associates, Inc., Research Division Sherri Scribner - Deutsche Bank AG, Research Division Jim Suva - Citigroup Inc, Research Division Amit Daryanani - RBC Capital Markets, LLC, Research Division Steven Bryant Fox - Cross Research LLC Todd A. Schwartzman - Sidoti & Company, LLC Sean K.F.

Hannan - Needham & Company, LLC, Research Division.

Ladies and gentlemen, thank you for standing by, and welcome to the Benchmark Electronics Third Quarter 2014 Earnings Conference Call. [Operator Instructions] And as a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Lisa Weeks. Please go ahead..

Good morning, everyone. I'd like to welcome you to the Benchmark Electronics Earnings Call for the Third Quarter of 2014. I am Lisa Weeks, the VP of Strategy and Investor Relations, and thank you for joining us. Earlier today, we issued a press release highlighting our financial performance for the third quarter.

If you did not receive a copy, you may obtain it from the Investor Relations section of our website at www.bench.com. This call is being webcast live, and a replay will be available on our website following the call. Gayla Delly, our President and CEO; and Don Adam, our CFO, are with me this morning.

After their prepared remarks, we will open the call over for your questions. For your information, Gayla and Don will be using a slide presentation, which is also available on our website. The company has provided a reconciliation of our GAAP to non-GAAP measures in the press release as well as in the appendix of the presentation slides.

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 disclosed in the safe harbor section of our earnings release and SEC filings.

Actual results may differ materially from these statements, and Benchmark undertakes no obligation to update any forward-looking statements. If you will, please turn to Slide 3 in our presentation, and I will turn the call over to Don Adam, Benchmark's CFO..

Thank you, Lisa, and good morning to everyone. I appreciate you joining us for today's call. In the third quarter, we generated revenues of $731 million, which exceeded our guidance of $670 million to $700 million.

Quarterly revenues increased $14 million or 2% from the second quarter of 2014 and increased 14% organically from the same quarter last year. The upside for the third quarter was associated with accelerated market acceptance of our customers' new products in both computing and telco.

Also reflected in our Q3 results is a $5 million charge or $0.09 per share for the write-down of inventory and provisions to our accounts receivable associated with the October 6 bankruptcy filing of our customer, GT Advanced Technologies. These charges increased cost of sales by $2 million and SG&A by $3 million.

Our non-GAAP net income was $23 million for the quarter compared to $17 million last year. Net income was $17 million for the quarter compared to $24 million last quarter. Our non-GAAP earnings per share were $0.43 versus $0.31 in the third quarter last year. Our GAAP earnings per share were $0.32 compared to $0.43.

Our non-GAAP operating margin was 4% compared to 3.5% during the third quarter last year. Third quarter operating margin was down 10 basis points compared to last quarter, attributable to revenue mix, and to a lesser degree, the impact of a new program ramps.

Our consistent operating margin of 4% reflects the focus of our teams on productivity improvements and cost -- effective cost controls.

During the quarter, third quarter 2014, we incurred approximately $2.2 million of restructuring and integration-related costs, primarily due to the closure of our Matamoros, Mexico facility, which was acquired in October of 2013. The third quarter non-GAAP effective income tax rate was 16.2%. Our expected tax rate for the fourth quarter is 19% to 20%.

The diluted weighted average shares outstanding for the third quarter are 54.3 million. Please turn to Slide 4 to review our revenue by industry sector. Computing represented 21% of third quarter revenues and was up 5% sequentially.

Computing was above our forecast across multiple customers and products in the high-performance computing storage and enterprise. Revenues from our largest computing customer was 11.8% -- were 11.8% of third quarter revenues. For the full year, we continue to expect computing to remain at approximately 20% of revenues.

Industrial control revenues were 30% of quarterly revenue, which is consistent with the second quarter and up 20% year-over-year. Industrial controls were up 4% sequentially, slightly lower than expected due to the timing of new program ramps. Telecom revenues were up 13% from the second quarter and 91% year-over-year.

We continue to see robust demand from our largest customers in cellular and infrastructure, wireless networking and optical networking as well as strength from our top customer in the space, ARRIS, which we currently expect to be a 10% customer for the year.

We saw demand levels accelerate through end of the quarter as we supported multiple strong new program launches. Our medical revenues were up 12% year-over-year to slightly down sequentially due to the slight timing shift with new program ramps moving into the fourth quarter.

Finally, testing and instrumentation revenues were down quarter-over-quarter, as we expected. Year-over-year, demand was flat in the sector. Now turning to Slide 5. Our cash balance at September 30 was $420 million with $58 million of this in the U.S. During the quarter, we generated $28 million in cash from operations.

Capital expenditures were $6.3 million. Depreciation and amortization expense was $11.8 million. We anticipate capital expenditures for the full year to range between $45 million to $50 million. Our accounts receivable balance was $534 million, an increase of $35 million from the last quarter, and our accounts receivable days were 66.

Inventory at September 30 was $434 million, an increase of $13 million from last quarter. Inventory turns were 6.2. In the third quarter, we repurchased 545,000 common shares at a cost of $13 million and have 22 million remaining in our authorized share repurchase program, which we expect to complete over the 3 to 6 months.

For near-term capital allocation, we will continue to invest CapEx in the business for operational excellence and execute our share buyback program. Now please turn to Slide 6 to review our guidance. We expect fourth quarter revenues to range between $710 million and $740 million.

Diluted earnings per share, excluding restructuring and integration costs, are expected to range of from $0.41 to $0.45. Estimated restructuring and integration costs of approximately $1 million to $1.5 million are excluded from our guidance. At the midpoint, the guidance reflects a 4% operating margin.

Now if you will turn to Slide 8, I will turn the call over to Gayla..

our portfolio management, our operational excellence and our customer focus. First, portfolio management. Where we choose to participate in the traditional markets of telco and computing, we remain a preferred and important supplier for customers that value our supply chain and technical solutions.

We also continue to win new business in the nontraditional markets of industrial, medical and testing and instrumentation where we lead with a strong and differentiated offering in our engineering services. We remain excited about the opportunities in front of us. As our results show, we continue to succeed and execute in each of our chosen markets.

Second, operational excellence. The foundation of our operational excellence programs is the ongoing development of our team of best practices for process innovation and manufacturing efficiency. We continue to invest in our team.

Our all-employee engagement programs to support continuous improvements are active in each of our manufacturing facilities, including our acquired facilities. Regarding our acquisitions, we look forward to completing our integration activities on schedule as planned for 2014. We expect to experience the full benefit of the integrated sites in 2015.

Finally and importantly, customer focus. We place a major emphasis on the design-to-production needs of our customers. The results are evident with the 16 new engineering wins for the quarter. When we engage early, we are able to support our customers bring their new products to market more quickly and efficiently.

Our customers are investing and winning in their chosen markets, and our stronger bookings reflect their confidence in Benchmark to be their solutions provider of choice. As we look ahead to next year, we believe our ongoing focus on our strategic priorities provides a strong platform for steady operating margin improvement.

In accordance with our current plan, we remain confident that our growth strategy and our business model support long-term profitable growth, and we expect margins to continue to expand compared to current levels as we head into 2015. Our longer-term operating margin target is 4.5%.

In closing, I want to thank our customers, shareholders and employees for their continued support. With that, I'll turn the call over to the operator now to begin our Q&A session.

Operator?.

[Operator Instructions] And our first question comes from the line of Brian Alexander with Raymond James..

Gayla, could you just talk a little bit more about the strength you're seeing in telecom? I know there's been a lot of mixed data points in terms of CapEx from the communication space, and your growth was very impressive. Some of that, I believe, was influenced by acquisition, but even without that, still very strong. You mentioned ARRIS.

Your outlook, I think, for Q4 still suggests you'll be up double digits in telecom. So maybe just give us a sense for what you're seeing out there and your confidence in growth going forward..

Brian, as you may recall, as we indicated last quarter, we support a number of customers and programs here with backhaul and trunking, optical transport, broadband and data-on-demand activities, routers, transporters, gateways. And really, what we see is our customers are benefiting from the rapid pace of change in technology.

And really, it's consumer behavior, I think, at the end of the line that's driving this. Technology and -- is really stressing the network and the network capacity, and CapEx is really what is required to support the growth that this creates.

And so we believe our customers are benefiting from that growth, and our alignment with them and ability to have the agility and the support infrastructure they need to bring their products to market has really benefited us in this area to be able to support a number of customers with a variety of points where they support the infrastructure build-out.

And I might have exhausted a lot of my knowledge there, so beyond that, you'd really have to understand more about our customers..

No, that makes sense. And maybe just for Don. You guys are going to be at 4% operating margins in the second half as you said you would be. The 4.5% goal, maybe just remind us or update us on what sort of the minimum revenue level you think you need to be at to hit the 4.5%. I know it's mix-dependent, but maybe just give us kind of a range..

Yes, yes, as you said, it's going to mix-dependent. It's going to factor in some revenue growth, and that will be it. We don't anticipate hitting that in 2015. It's a longer-term goal. But depending on mix, it's -- you probably have a range.

I mean, you certainly have to grow over -- you're going to have to have some level of modest growth over what we're doing this year to achieve 4 -- to drive the margin up..

I would expect, Brian, although we are hesitant to put numbers around it, as always, because of the mix changes that may occur. And really, it -- in simple math, it was probably somewhere near the 3 billion, 3.2 billion, somewhere in that range, given the mix of customers that we support.

But we do hear a lot of hesitation for us to try to put a specific number around that because it is hard to project the timing of growth in some of the different industries that we participate in. We've certainly seen kind of outpaced strength, as you noted, in telco, and we've seen strength that exceeded our expectations in computing.

So our customers continue across all industries to invest very heavily in R&D, and we're very pleased to be supporting them. And some of their products are clearly exceeding their own expectations..

So just one last clarification. The revenue came in well above expectations this quarter. And as I look at the sort of profit upside, even backing out the bankruptcy charge and restructuring, it looks like the incremental profitability on the revenue upside was very modest in terms of incremental margin.

So is that just a function of where the upside came from in computing and communications and the low-margin nature of those businesses? Or is there something else that accounted for that?.

That's correct. It was largely mix-dependent, and as we indicated, they really are the -- it was -- there were some costs associated with some ramps also, but primarily mix..

Our next question comes from the line of Sherri Scribner with Deutsche Bank..

I just wanted to dig a little bit into the compute segment. You saw a pretty strong quarter and you're expecting a flat performance in December. Overall, the segment declined this year. Just trying to think about how you're -- just trying to understand how you're thinking about compute in 2015 given some of the headwinds in the industry..

We continue to participate at the high end of computing, and I believe that there are opportunities given some of the security and other issues that we see and the level of investments that our customers are making in R&D. We believe that there's continued opportunity for strength there.

I don't -- we aren't giving guidance for 2015, and I don't have an estimated outlook for growth or otherwise an industry breakdown. But I would say that we're very pleased with this participation with our customers in R&D activities. Beyond that, we'd really have to look at what each of the customers are doing.

Again, though I think what we had seen is very positive impacts from the investments they've made in recent quarters..

Okay, great. And then, Gayla, I was hoping you would give us some thoughts about what you're seeing from customers in terms of their forecast. You guys have had very strong performance. Just wondering, are customers keeping their forecast the same? Longer-term? Are you seeing any uncertainty related to macro? I just wanted to get your thoughts..

An interesting conversation that we've had is that they -- and you've heard me refer to this, I'm sure, in the past. But once again, there seems to be a disconnect between what we are seeing from our customers and their behaviors as opposed to what you read in the newspaper.

And the news has probably all a little bit alarmed by the micro environment, but I don't see that manifesting itself in actions and behaviors in our customers. Not saying that the macro can't change behaviors or not saying that it can't change very quickly, but have not seen that..

And our next question comes from the line of Jim Suva with Citi..

When we think a little bit about computing, it's normally extremely strong in Q4, and I think you guided to flattish, if I'm correct. And if so, can you help us better understand that? When we think about rebates and year-end budget flush, typically it's up, and I think a couple of financial crises every year has been the case.

So if you could help us better understand that.

Is it share losses? Is it customer challenges? How should we think about that in the segment that is traditionally quite strong in the Q4?.

I believe we're primarily seeing that to be a mix of products. It is not share loss. We haven't seen programs go away. We did see strength in Q3, though, so we believe some of that was some successful bookings that occurred in Q3 that we otherwise would have anticipated in Q4. Some of those are late quarter, very strong orders that came in.

And so that is the primary change that we see, is just kind of an exceptional level of strength in Q3 for compute, which was above our expectations, beyond what was planned, and don't know that we'll see that same kind of strength in Q4.

It's always hard, and I think that the one thing that you see is there are areas that can surprise that we don't expect that there's going to be a significant upside if you read the news and activities around the compute. We just don't have a reason to believe that it's going to have the same kind of momentum in Q4 that it has had in the past years..

Okay. That makes a lot of sense with the Q3 strength.

Is there any way to quantify how much last bit of the quarter came in that you think may have been the pull-forward from Q4 into Q3?.

No, I don't have that. And again, that's just our take on it. That is not something that has been signaled from many customers. I'm sure that they are working all quarter long every quarter for their bookings, but it just seems that the strength that we saw was something that's usually reserved for Q4.

So I don't really know if they changed any behaviors or activities, but that's our take on it. It is clearly not something that was signaled or directed in commentary from customers..

Okay.

And just housekeeping, tax rate outlook, what we should expect there? And customer concentration that you may have had this quarter?.

So tax rate going for Q4, Jim, we're modeling 19% to 20%. In terms of concentration, we had -- as we indicated in our prepared comments, we had 2 customers over 10%..

And our next question comes from the line of Amit Daryanani with RBC Capital..

A couple of questions. I guess maybe to start with on the telco side, maybe talking about high single-digit decline as you get into Q4.

Is that just reflective of maybe some of these ARRIS ramps that peaked in Q3 and now they're going to head down? Or is there something more than just some seasonal headwind that's playing out in Q4 on the telco side specifically?.

Well, I think there are some seasonal headwinds that I would expect. And as I mentioned in the prepared comments, I believe that in some years, not even every year, in some years, there's a budget flush in telco in our customers' customers.

And that isn't anticipated this year as well as potentially, there's some M&A or transition in activities along the telco supply chain that don't directly impact us but may impact the infrastructure sense that -- and the timing thereof.

So those are kind of the backdrop against what we have in our Q4 guidance, but no other real underpinnings that are of significance. Just again, consistent with compute, we saw phenomenal performance in Q3 and then not putting a budget flush, those 2 things combined..

Got it.

And then a reasonable thing, when you talked -- when you mentioned that you think there was a bit of pull-in happening in Q3 and Q4, your belief is that may have happened in the telco and compute segments? Or is it, do you think, more broader across all the other segments as well?.

I only saw it specifically in telco and compute. And remember, our frame of reference is primarily based on that which we expected, right? So it was kind of forecast to actual performance continue to go strong through quarter-end..

Got it.

And just finally, the charges you took for the GT Advanced bankruptcy, is this the maximum amount of exposure you have for this company? Or there something else we should start to think about as well? And then on the inventory side, is the inventory very specific to this company so it's impossible for you to reuse it for some other customer?.

The course of bankruptcy it gets pretty complex but it is our best estimate of our reserve, but I'll let kind of Don -- required for this. But I'll let Don speak further on that..

Yes. Again, it's our estimate of the potential loss. The actual loss is going to -- may differ from the provisions that we have established. In terms of the inventory, that is specific to this customer..

[Operator Instructions] And our next question comes from Steven Fox with Cross Research..

Just one question, actually. Just -- you brought up mix a couple of times in relation to margin expansion.

Can you talk about how big of an influence mix can be in the coming calendar year and also to the extent you're willing to dive into what would be the most attractive mix of products we're talking about?.

Well, I think if you -- Steven, if you look at the -- really look at last quarter, I think we had, for 3 or 4 quarters in a row now, where we had what I'd call our nontraditional revenue being non-compute, non-telco exceeded 50%. Our gross margins came in north of 8%, 8.1% for the first half of the year.

Excluding the bankruptcy charge where we saw telco and computing climb up, I think it was 52%, 53% of our revenues this quarter, we saw the gross margin decline about 7.9%. So that's a pretty good representation right there, just looking back to Q2, of the impact on mix.

So as you go forward, some of the margins are going to being impacted by the mix, but in terms of the impact, I think Q2 to Q3 is a pretty good example..

And then is there any area you would call out specifically where the new programs could be most impactful in the coming quarters on mix?.

Well, as Gayla noted in her comment, I think we've had, what, 8 quarters in a row where industrial controls have been our largest -- we've seen the largest amount of bookings and if you -- in general, if you look at the trends that we've seen over the last 18 months, the 2 years, we've had -- the majority of our program -- new program bookings have been in the nontraditional areas..

And our next question comes from the line of Todd Schwartzman with Sidoti & Company..

How much revenue goes away with GT Advanced Technologies?.

We have no revenue included in our Q4 guidance and really nothing of any significance in Q3..

And just -- what were they doing on an annual run rate basis in the last couple of years?.

They were not a disclosable customer, so we won't share details of that. But I think the important thing is that we don't have them in our guidance going forward, and they were not a significant customer. It would be clearly below 2%..

Okay, I understand.

Could you speak to the change, if any, in the degree of visibility of your customers in their business forecast by sector or if you care to generalize?.

Wait, if you repeat that -- you -- say that again, please..

The visibility into the customers' business that -- their own forecast, has there been any reduction in their ability to forecast? Or not really? Or does that depend on the sector?.

I would say we haven't seen any changes, but this goes back to -- along the lines of what Sherri was inquiring about, if the macro environment was manifesting itself in any -- either behavior change or forecasting changes from our customers. No, no, I don't see that our customers have modified their forecasts.

When it comes -- if you come back to accuracy of customer forecast, I would say that they're constantly working to improve on their forecast accuracy.

And the more successful their sales teams are, the less successful they are on being able to anticipate that, which requires us to have a significant level of agility to be able to support a quarter such as what we did this quarter..

So are those customers who normally speak to you in terms of more than just 3 months out, they continue to do so, it sounds like?.

Yes..

Okay.

The 16% tax rate in Q3, was that country mix, mostly?.

Yes, that's primarily country mix. That's exactly correct..

Okay.

That seems evident somewhat in your Q4 guidance as well so you expect that to continue?.

Well, for Q4, it's going to be a little bit higher. We're factoring it 19% to 20% or estimating it..

Great, but no longer [indiscernible] I think you're previously speaking to 20%, 22%, perhaps. Is that....

Correct. We were 21% and then yes, certainly, the impact the last couple -- this quarter is -- we're expecting that to drive a little lower this quarter..

Got it. And what are you seeing as far as the impact of this strength in U.S.

dollar versus the euro?.

We had a little bit of -- we did have a little -- a larger-than-expected FX loss, as you see in other income or other loss. But other than that, most of the transactions we have are U.S. dollar-denominated anyway. So generally, the impact to us is not that significant..

And how much was that FX loss, Don?.

Well, for the quarter, it was $1 million..

So I was going to say -- because I consider that more significant than Don did. But compared to others this year, you're hearing reports, it's clearly insignificant but it is still insignificant to us and we primarily are using that for hedging..

We do have another question, and that comes from the line of Sean Hannan with Needham & Company..

So I just wanted to see if I could ask a little bit or see if you could talk a little bit more about your new program wins. When I look at the trailing 12 months for you folks, for this quarter, last quarter, I mean, really, through the course of the last 4 quarters, that metric's been above $600 million. It's a pretty, pretty strong number.

So as I look at that and then I think about what that really should suggest for growth as we look forward to the next 12-plus months, just wanted to get a little bit more perspective from you folks in terms of what level of optimism we have at this point outside of some of the macro concerns that we might be more -- might be monitoring more? What can we think about for growth next year? And just in general context and where are we more positive in some of our subsegments?.

I think as we previously indicated, we are optimistic for profitable growth. And next year, we are not providing specific guidance for the year. But again, if we go back to where we have seen strong wins and where we continue to have some ramps in front of us that we're excited about. We see that in industrial controls. We see that in medical.

And we expect to continue to gain momentum there. We do have program wins across all of our industries, and what becomes difficult to see is given the complexity of the product is the timing with which of those are ramped and brought into the revenue line.

So we are excited with the momentum we have gained with bookings, and at the same time, as you mentioned and as others have pointed out, the macro environment has not translated into what I would consider a headwind. But at any time, that potentially could be something that would impact our business.

And we would have to factor that in as we get visibility to any impact that would have. So we are cautiously but very optimistic given what we have been able to control in our bookings. So feel very good about what we have seen in our bookings activity..

And at this time, there are no other questions in queue..

Thank you, everyone, for joining us today, and we look forward to following up with any other questions you may have. Have a good day..

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