Lisa Weeks - Vice President, Strategy and Investor Relations Paul Tufano - President and Chief Executive Officer Roop Lakkaraju - Chief Financial Officer.

Sean Hannan - Needham & Company LLC Jim Suva - Citigroup Inc. Mitchell Steves - RBC Capital Markets, LLC.

Good day, ladies and gentlemen and welcome to the Benchmark Electronics Second Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.

I would like to introduce your host for today’s conference, Lisa Weeks, Vice President of Strategy and Investor Relations. You may begin..

Thank you, operator and thanks everyone for joining us today for Benchmark’s second 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 second quarter financial results and third 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 second 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 advised on Slide 2 in the presentation.

During our call, we will discuss forward-looking information. As a reminder, any of today’s remarks that are not statements of historical 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..

our revenue is expected to be between $610 million and $650 million and non-GAAP EPS between $0.28 and $0.36. Recent softness in mix shift in the semi-cap space, which is reported in our Test & Instrumentation sector create near-term headwinds. Revenues are expected to be down greater than 20% quarter-over-quarter.

We also remain committed to our engineering and solutions investments to better serve our customers. As we expand our customers with these new offerings and ramp new programs, these investments will contribute to our bottom line as we exit the year.

And finally, our third quarter guidance reflects improving operational performance and medical transition execution. While margin impacts lingered in the third quarter, the impacts are less pronounced than expected. And finally, if we turn to Page 10, I'd like to give you an update to our progress through our milestones.

Let me remind you that these milestones started at the beginning of the year and are tied to our long-term model achievement. In the area of bookings, we have achieved $177 million of bookings and are driving to close on our $200 million booking per quarter rate in the back half of 2018.

We expect annual revenue growth year-over-year to be between 2% to 5%. And we believe our target mix of 67% is achievable. We remain focused on growth maximizing gross margins. As I said before, these targets are set to our long-term models and we have not altered targets given current environment.

Our ability to approach our 9.7% goal will be a function of semi-cap demand and product mix, the rate of consumer ramps into our new RF and High-Speed facility as well as the ability to navigate the increasingly elongated supply chain for new and existing customers.

As it relates to yesterday, we are still targeting $36.5 million to $37.5 million of spending per quarter for the second half of the year. And the percentage of revenue would be a function of the size of our topline.

And finally, as it relates to profit per square foot, and this is a metric I use internally to understand the optimization of our factories. It's a simple metric of total profit divided by total square footage.

During the last three quarters, we have been expanding capacity for our RF and High-Speed manufacturing facility in Tempe, and for increased revenue opportunities across the network. With the decline in – the increase in square footage, we are easing pressure on this metric. I will now turn the call over to Roop..

Thank you, Paul, and good afternoon everyone. Turning to Slide 11 for a recap of our second quarter 2018 financial summary. Revenues of $661 million exceeded our guidance of $590 million to $630 million, and we’re up 7% year-over-year. This marks the sixth straight quarter of year-over-year revenue growth.

The increase in year-over-year revenues was driven primarily by demand increases in the computing sector for enterprise storage products. Our GAAP EPS for the quarter was $0.23.

Our GAAP results also included $1.8 million of restructuring and other costs; $330,000 recovery from the sale of inventory that was written down in 2017 due to our customer insolvency. Our Q2 non-GAAP operating margin was 2.7%, which is 100 basis points quarter-over-quarter decline. Non-GAAP EPS of $0.30 was within our guidance of $0.26 to $0.34.

For the quarter, our ROIC was 10.5%, down 70 basis points sequentially and up 90 basis points year-over-year. Please turn to Slide 12 for our revenue by market sector. Industrial revenues for the second quarter decreased 5% sequentially and 6% year-over-year versus the sequential growth we anticipated.

Customer engineering change orders hindered our ability to complete production as planned during the quarter. A&D revenues for the second quarter increased sequentially 5%, which was better than expected from improving operational execution. Revenues increased 2% year-over-year.

Medical revenues for Q2 were flat sequentially, which is better than expected from improved ramp timing amidst a number of program transitions. Revenues were up 12% year-over-year, primarily for new programs.

Test & Instrumentation revenues were up 4% in the second quarter and were up 19% year-over-year from demand in our precision machining area serving the semi-capital equipment market. We’re receiving demand signals the growth will be softening in semi-cap in the second half.

Overall, the higher value markets grew 6% year-over-year or flat sequentially, and represented 64% of our second quarter revenue. Turning now to our traditional markets. Computing was up sequentially by 55% and 13% year-over-year, driven primarily by demand increases from legacy storage and data security customers.

Telco was flat year-over-year and down 7% sequentially, primarily from delayed material and [fees] for custom components. Our traditional markets, which represented 36% of second quarter revenues, were up 8% from last year and up 27% from the first quarter, driven by higher computing.

Our top 10 customers represented 47% of sales for the second quarter. Please turn to Slide 14 for a discussion of non-GAAP key business trends. Gross margin for the second quarter was 8.2%, a 130 basis point year-over-year and quarter-over-quarter decline.

Q2 2018 gross margin was adversely impacted by a higher mix of computing revenue, which is below our corporate average gross margins and anticipated impacts from medical transitions, investments in engineering and solutions and ramp related issues. Our SG&A was $35.8 million and resulting non-GAAP operating margin was 2.7%.

Note that, we had $1.8 million in restructuring for Q2 and we expect to incur additional restructuring charges of approximately $1 million to $2 million in Q3 2018. Please turn to Slide 15, where I will provide a few updates on cash flow and working capital highlights. We used $41 million in cash from operations for the quarter.

Free cash flow usage was $58 million for the second quarter, after capital expenditures of approximately $17 million. Our cash balance was $596 million at June 30 with $419 million available in the U.S. Our accounts receivable balance was $445 million, an increase of $41 million from March 31.

The increase in accounts receivable is a function of our shipment linearity. Payables were up $15 million quarter-over-quarter. Contract assets were $148 million at June 30 and March 31. Inventory at June 30 was $319 million, an increase of $13 million from March 31.

The increase in raw materials in support of ramping new programs accounts for the increase. Please turn to Slide 16 to review our cash conversion cycle performance. Our cash conversion cycle was 69 days for Q2, 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. Our non-GAAP effective tax rate was 16.3% for Q2 2018. Please turn to Slide 17 to review an update on our capital allocation strategy.

During Q2 2018, the Company repatriated approximately $245 million of cash from international locations, bringing the total amount repatriated in 2018 to $522 million. As we move forward, we will continue to evaluate further repatriation opportunities. In July 2018, we completed a $50 million ASR program.

It's stood in March 2018, 2.5 months in advance of the contract termination. In total, the ASR program allowed us to repurchase 1.7 million shares, approximately. During this time, we will continue to repurchase shares under an OMR program as well.

Total repurchase, combination between ASR and OMR, grew mid-July was approximately $78 million or 78% of our committed $100 million of repurchases for fiscal year 2018.

We will continue to evaluate further repurchases in the second half of 2018 through an OMR process to ensure we fulfill our commitment of repurchasing at least $100 million in fiscal year 2018. Please turn to Slide 18. In July 2018, we completed refinancing our existing credit facilities.

Our existing credit facility of $230 million Term Loan A, and $200 million revolver was refinanced into a $650 million set of facilities consisting of $150 million Term Loan A, and $500 million revolving line of credit. We used existing cash balances to paydown the existing Term Loan A to the $150 million.

In March 2018, we announced a recurring $0.15 per share quarterly cash dividend. Dividends of approximately $7 million were paid both in April and July 2018. Please turn to Slide 19 for a review of our third quarter 2018 guidance. We expect revenue to range from $610 million to $650 million.

Our non-GAAP diluted earnings per share are expected to range from $0.28 to $0.36. For sequential modeling information for the third quarter, please turn to Slide 20. Overall, we expect Industrial revenues to be up high single-digits in Q3, led by new and legacy programs within smart buildings, navigation and asset tracking markets.

A&D is expected to be up high-teens in Q3 based on the ramp of new program that completed the qualification of a new component and from the continued improvement in new program ramps. We expect Medical revenues to be down mid single-digits based on the timing of customer program transitions for fluidics and cardiac programs.

We expect the return to growth in the fourth quarter, based on the forecasted timing transitions from our customers. In Test & Instrumentation, the strong demand we have seen in the past five quarters will decline in Q3 that is expected to be down greater than 20% sequentially. Turning now to the traditional market.

We expect Computing revenues to decline sequentially by approximately 20% based on a current customer forecast after stronger than expected demand for enterprise storage products in the second quarter. Software revenues should be up high single-digits quarter-over-quarter, primarily from custom component MP that was delayed in Q2.

Implied in our guidance is a 2.5% to 3% 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 18%.

The expected weighted-average shares for Q3 2018 are $46.9 million. Operator, please open the call for questions..

Thank you. [Operator Instructions] And our first question comes from the line of Sean Hannan from Needham & Company. Your line is now open..

Yes. Thanks for taking the question. Good afternoon here.

First want to see if we can start to probe a little bit around the supply chain and some of the component challenges that you folks are seeing? Is there a way if you can elaborate on that a little bit more? I know that passes were mentioned, but to what degree, I don't know if there was a sense of perhaps quantifying or just providing a little more detail how that may have impacted your ability to ship, and also consequently the inefficiencies impacts to margins in the quarter? That might have been beyond the mix that had been called out impacting gross margin? Thanks..

Sean, this is Paul. If you look at the supply chain, especially the passes, we are seeing lead times up to 52 weeks. Now these are for parts that normally we never think about, multilayer ceramics, parallel capacitors, and so that is presenting a significant challenge for the entire industry.

Now up to this date, we’ve been able to navigate such that we don't have a lot of impact or have not had a lot of impact on revenue gross margin. But as we're getting into the second half where customers are either dropping orders within the lead time or change in mix, it's getting harder and harder to get the components to backlog.

And probably what's more concerning to me is that as we bring more customers on, if that material hadn't already been secured and allocated, it gets very hard to get the allocation to get them to ramp.

So to be honest with you, to-date the impact to us has been not that much as it relates to those components, but as the situation deteriorates and the overall supply chain gets ahead when we had to confront. And it's more about what we do to get upside and what we do to get mix shifts within the base that is it – that’s at risk..

Okay. All right, so if we haven’t had much impact thus far, and also in some other prior quarters, there would have been some tightness in some other areas of challenges, it may not have been all that impactful to you guys and also not necessarily a scenario where you'd have to, perhaps, discount as you forecast and, forecast out and guide for us.

Have you then as you look and to providing this third quarter guidance for us, is there an element that perhaps accommodating a bit more of a discount or we still at this point just we’re just fully looking at this in terms of upside limitation? And I mean, how do we think about that as potentially presenting a risk if we're not discounting perhaps as much as we could or should or otherwise to think about?.

Here's how I would answer that question. Within the forecast, we have this implicit, within that quantity, the ship quantity. We have this implicit in our forecast. We are not clear to build on every product. So we are working to clear to build to the forecast.

As the mix shifts, depending on where it is in the quarter, it can create more headwinds that will prevent us from making some of those numbers. So as we get increase in revenue to back half of the year, you then have more mix shift, you're bound to have more upside to the lead time, that's where the problems that come into play..

Okay. So when you combine that with then kind of a loss leverage around the higher-margin precision machining that's going to be in support with semi-cap, looking at your waypoint goals for then being able to hit in the back end of the year. I mean, I might be misinterpreting the spirit of the commentary.

And I would sense that it's going to be pretty challenging to hit those waypoints? But again, I might be misinterpreting, so just trying to get some better confidence around how we actually get there?.

So Sean that waypoints, as I said before – we said at the beginning of the year and inside the model, we intend to get near that midpoint. It is getting more challenging to do that..

Okay..

I can't tell you how challenging it will be because there's a lot of puts and takes as you go through the next six months or five months..

Okay..

But it is up – we have to be transparent, but we talk we’re going to be transparent. The bar is a little higher. We got to jump higher and jump faster. We’re still going to try to do that..

Okay, fair enough. Last question here, I’ll jump back in the queue. Just now, as I'd suspect while you guys are growing your wins or looking to grow them aggressively, and you're doing a great job with that. I certainly want to make sure that that’s coming out from me. I think that you guys are really doing a fantastic job on the wind front.

I would suspect you're probably also putting in higher levels of those incentives screening some of those wins and what they could mean to you? And especially as we stand today, we’re looking at some of these factors that could impact our margins kind of and then near to medium term.

So just trying to get a perspective, can you share a little bit around what efforts you’ve taken on for how you’re improving or stepping up, the strength of the screening or the assessments looking more deeply into the quality or it's not just in terms of the market exposure, but whether inherent margins, risk profile of the customer and target market, cash inventory needs, those types of things? What adjustments can you talk about? Is that continues to scale up and become increasingly important there? Thanks..

can we help those customers to be successful? Are those products and offerings meet our profile and meet our financial objectives from a margin and a balance sheet standpoint? I hope I answer that question sufficiently for you..

That’s helpful, Paul. Thank you very much for addressing the questions here..

Thank you. And our next question comes from the line of Jim Suva from Citi. Your line is now open..

Thank you very much. I have two questions, and I'll ask them both at the same time, and you can take them at any order as you’d preferred to. First of all, your revenues, you materially upsided and you cited more computing, and I think storage for the strength in that, the softer Q3. But I really struggle to see why earnings per share weren't higher.

And I understand some of them maybe below corporate average, but to have no EPS impact, either you would be manufacturing and doing this for no profit or something else materially drag down the profitability. Then my second question is you've mentioned component shortages, but you also upsided on revenues.

So how can we bridge? How could you upside when you saw component shortages? Thank you..

Okay. So let me address those questions. The computing upside we saw was in the area for legacy storage and the same issue we had or the same phenomena we had in the fourth quarter. Now this business is more of an integration business. And consequently, its margins are very low. And if you ask me today, will I pursue that business today? I would say, no.

But it is with a long-standing customer. And so as that revenue grew and the significance of that revenue was quite high, it was the highest Q2 we've ever seen in recent history for that product line for that customer. It's significantly impacted those margins just as it in the fourth quarter, right.

So hope I answer that question, right?.

Yes. Got it.

And then on the components of how you used to upside…?.

As I said, we’ve done a pretty good job of securing components to meet our shift commitment. And so the team has – got good coverage or line of sight to the revenue growth that we are calling it. Now what happens is if there's a mix shift in there, and it's within the lead time, then we are going to have a trouble responding.

In the past, we could have responded and upsided quickly. We are much more flexible. Our flexibility is being impacted by these component shortages. And we’re at high mix low volume business. So our program managers are out there talking to our customers, explaining the supply chain situations.

We are trying to get them – working with them to secure supply in advance of demand, so that we have ability for flexibility. We are getting longer forecast to ensure that we can get better coverage of materials and it's working in some customers.

Other customers it’s not quite as efficient as I would like to see, and therefore, that's the risk we are calling out..

Thank you so much for the details. That helps a lot. Thank you..

Thank you. [Operator Instructions] And our next question comes from the line of Mitch Steves from RBC Capital Markets. Your line is now open..

Hey guys. Thanks for taking my question. I really just had two kind of – along the lines of components and semi-cap as well. So for the first time, you guys are mentioning at semi-cap, again softness for the entirety of the back half or to be kind of a two-quarter impact.

So, I guess one, is that fair that you guys don't expect recovery in Q4? And then secondly, is there a specific end market that is impacting your memory, foundry or logic? And then finally, just a quick one on the component side.

Who do you believe is gaining the amount of component that you need, meaning who is taking up the supply at this time in your view?.

Okay. Let me talk to the semi-cap situation first. I mean, look we’ve had a fantastic run in semi-cap. If you look at semi-cap growth over the last couple of years, it has been quite phenomenal.

And that growth was in support of full array of end products, from NAND, memory, logic, microprocessors, mobility chips, and now even into sensors using 200-nanometer technology. And so I would look at this as being a pause.

I still personally believe that semi-cap growth will be there, but folks have to digest the equipment they have into their fabs and get them running and then begin to add more. So I believe that semi-cap demand over the next year or two will be – would appear to be strong.

We're in a pause now, whether that pause will be one quarter or two quarters or three quarters. I can't quite tell you, because it's different by each company. And so we'll manage through the pause and be prepared for the continued growth in semi-cap based on just the fundamentals in the market.

As it relates to component issue, I don't think any one group or company is getting more or less than anybody else. I just think that what's happening is very simple.

The manufacturers of these components which – these are passive, so these are penny parts, have reallocated their capacity to higher margin markets like automotive, and they're not adding more capacity. Consequently, there are shortages.

And depending on your relationship with various distributors or directly with those manufacturers, you get an allocation and that allocation maybe altered if there's a better opportunity somewhere else. That means we’ve got in the market today..

Understood. Thank you. End of Q&A.

Thank you. And that concludes our question-and-answer session for today. I'd like to turn the call back over to Paul Tufano for closing remarks..

All right. Thank you, operator, and thank you ladies and gentlemen for joining the call today. We are in a bit of a choppy environment, but we are focused on driving and executing to that business model. And you can rest assured that the entire organization is focused on revenue growth at profitable metrics to get to our long-term model.

We look forward to sharing you the results of the third quarter in next 90 days. And thank you for joining the call..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day..