Lisa Weeks - VP, Strategy & IR Paul Tufano - CEO, President & Non-Independent Director Roop Lakkaraju - EVP & CFO.

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

Good day, ladies and gentlemen, and welcome to the Benchmark Electronics' Third Quarter 2018 Earnings Conference Call. [Operator Instructions]. As a reminder, today's conference is being recorded. And now I'd like to introduce your host for today's conference, Ms. Lisa Weeks, Vice President of Strategy and Investor Relations. Ma'am, please go ahead..

Thank you, operator, and thanks, everyone, for joining us today for Benchmark's Third Quarter 2018 Earnings Call. With me this afternoon, I have Paul Tufano, CEO and President; and Roop Lakkaraju, CFO. Paul will give introductory comments, and Roop will provide a detailed review of our third quarter financial results and fourth 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 third 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 thank you for joining our call today. I would characterize the third quarter as the underlying quarter. Both revenue and non-GAAP EPS was within our guidance range. Revenue is $641 million, which is above our guidance at the midpoint and reflects 5% year-on-year growth. This was driven primarily by computing, telco and A&D.

Non-GAAP gross margins improved sequentially by 30 basis points to 8.5%, despite continued softening in the Test & Instrumentation market, which services the semi-cap space. This sector was down 28% quarter-over-quarter. Our EPS on a non-GAAP basis was $0.33, above the midpoint of our guidance.

Our cash conversion cycle days was 74, slightly above the target range due to linearity of shipments. Cash from operations was approximately breakeven, but we anticipate free cash - full-year operating cash flow to be positive. We have been aggressively buying back shares. As of the end of yesterday, we purchased $152 million worth of stock.

And we anticipate by year-end that, that will grow to $200 million. Also, we announced today that our board has authorized an additional $100 million of share repurchases. If you turn to Slide 6, from a bookings perspective, we continue to make good progress on the diversity and size of our bookings, which are critical to future revenue growth.

This quarter, we posted solid bookings of $175 million. And year-to-date, we have $523 million of bookings, which is up 22% on a year-over-year basis. Within Industrials, I'm very excited by a new win for advanced robotic platform design, where we will provide design support as well as manufacturing.

In medical, we won a number of new projects, ranging from a handheld ultrasound device to a fetal monitoring device and a tissue ablation device. We added six new customers in the Medical space, and two of these are for full-term key design services with the future long-term manufacturing.

In telco, which was 47% of our bookings, I am very excited by a new customer that has a set of products that are part of the next-generation telco endeavor, servicing edge of the network deployments. Here, we will provide both design support as well as manufacturing.

And in A&D, we have a very good win for a high reliability filter component for aviation applications for both military and commercial aircraft. In total, we had 58 wins for the quarter, 31 in manufacturing and 27 in engineering; and 11 new customers. And I am extremely pleased by the number of joint engineering and manufacturing engagements.

If you turn to Slide 7, I'd like to provide an update on our guidance for the fourth quarter. Our fourth quarter guidance is for revenue to be in the range of $610 million to $650 million, with diluted EPS on a non-GAAP basis between $0.32 and $0.40.

Our guidance reflects the impacts of mix shifts in both Test & Instrumentation and Computing on our margin. In Test & Instrumentation, we expect the sector to decline in the mid-teens, and we'll be down year-over-year in the range of 30%.

As a reminder, our T&I sector is primarily composed of front-end semi-cap machining performed by our precision technologies group. This is more complex manufacturing and consequently has margins higher than our corporate average.

While we are experiencing a short-term cause in semi-cap equipment, we are extremely positive on the fundamentals of the semi-cap sector and are well positioned within it to - when it returns to growth. In addition, continuing to expect it to increase sequentially by high single digits.

Within the Computing segment is a significant portion of revenue or high velocity system integration for legacy storage. Due to the high purchase content and minimum complexity, you have margins that are below our corporate average. The impact of these two sectors will have a negative effect on our margin.

However, our core business remains solid, and we see opportunities for sustained and improved operational performance. As a result, we anticipate sequential improvement in gross margin, up 30 basis points to 8.8% as a new point of our range. If we turn to Slide 8, I'd like to give some update on our progress toward our milestones.

From a bookings perspective, we had a goal to exit the year at $200 million of bookings. And for the first three quarters, we have an average of about $175 million.

Our current funnel supports the target, and it is our go-to-market organization who is tasked with converting this funnel into bookings, and I am extremely confident in our ability to do so. As it relates to the higher value revenue mix, we had a rate point exit in the year at 67% of our revenue, at or above from high value market.

Given the semi-cap softness and the increase in compute, we think that will now be at 65%. On Gross margin, our waypoint to exit the quarter - the year was at or above 9.7%. As I just indicated, our midpoint of our guidance says gross margin is at 8.8%.

As we've discussed in the outlook section, the lower mix of T&I revenue, coupled with higher percentage of computing, has depressed our margin. However, we normalize for these mix shifts, our exiting gross margin would have approximated the waypoint.

From an SG&A perspective, our business model cost us to be between 36.5% and 37.5% - $37.5 million of spending per quarter. We have been monitoring our SG&A expense given the margin ignition, and we will look to reduce our SG&A expense as we go forward.

And finally, our profit per square foot basis, you can see that we have a loading profit square foot.

This mirrors our ROIC, and it's a function of fact that both mix shifts and T&I and Computing which are lowering our margins, coupled with capacity expansions and support activity primarily in T&I and our RF and high speed design center, are generating this gap to target.

If I now turn to Slide 9, I'd like to make some preliminary observations regarding 2019. We anticipate revenue on our current phase of business to grow between 3% to 5%.

Within that growth presumption is the assumption that semi-cap returns to growth in the second quarter of 2019 and accelerate through the second half, but for the full, year will be down approximately 10%. We remain very proud with our long-term strength of this market, and as I said before, are well positioned to benefit from its return to growth.

However, against the backdrop of semi-cap softness, we are taking actions to reduce our cost and expense structure. Over the past few months, we have implemented a number of workforce reduction, affecting approximately 5% of our population. As of this call, approximately 80% of these reductions have been active.

We anticipate annual savings in excess of $10 million associated with the actions we are taking. As part of our 2019 planned process, we are continuing to examine all facets of our business to further optimize our operations, streamline our cost structure and drive margin expansion.

We are also evaluating marginal or diluted contracts with the aim of further improving margins. After a year of facilitization and customer qualification, our RF and high speed design center in Arizona is ramping.

We currently have five customers already qualified and five engineering qualifications in progress, and we have wins for within RF microelectronics assembly, and high speed circuit design for both the A&D and next-gen telco markets.

The pipeline engagements are increasing, and I am extremely excited by our prospects in this area, not only for expanded customer engagements, but also from the margin it will contribute, which will be 2 to 3x above that of the corporate average. Our goal is to return margins - gross margins to above mid-9s.

To further expand our operating margins, we will also be lowering our SG&A expenses. In our year-end call, we will give you more updates on the progress we've made against these actions. In parallel, we are aggressively buying back shares.

We expect over $200 million in share repurchase by the end of the year, and we'll continue to do so as these depress stock price levels. We anticipate the actions we are taking from margin expansion, coupled with our aggressive share repurchases, will lead to significant EPS accretion in 2019 and beyond.

With that, I would like turn it over to Roop, who'll give you more color on the financials..

Thank you, Paul, and good afternoon, everyone. Turning to Slide 11 for a recap of third quarter 2018 financial summary. Revenues of $641 million was towards the high end of our guidance of $610 million to $650 million, and we're up 5% year-over-year. This marks the seventh straight quarter of year-over-year revenue growth.

The increase in year-over-year revenues was driven primarily by demand increases in Computing, telecommunications and A&D. Our GAAP EPS for the quarter was $0.17. Our GAAP results also included $1.8 million of restructuring and other cost, $3.3 million net charge due to customer insolvencies.

The net charge was comprised of $1.6 million write-down of inventory and a $1.7 million provision for accounts receivables, also $2 million write-off of existing deferred financing charges due to the refinancing of our credit facilities during the quarter. Our Q3 non-GAAP operating margin was 2.9%, a 20 basis point quarter-over-quarter improvement.

Non-GAAP EPS of $0.33 was within our guidance of $0.28 to $0.36. For the quarter, our ROIC was 9.8%, down 70 basis points sequentially and 10 basis points year-over-year. Please turn to Slide 12 for our revenue by market sector. Industrial revenues for the third quarter increased 9% sequentially and 2% year-over-year.

Sequential growth was from increased demand for process automation and navigation customers and new program ramps. Year-over-year growth was relatively flat and reflects declining revenue from an industrial customer that is now insolvent.

A&D revenues for the third quarter increased 5% sequentially, which was less than expected due primarily to the timing of custom component in-feed issues with two customers and softer demand across a few of our top customers. Year-over-year revenues increased 9% from greater demand for secure communication devices.

Medical revenues for the third quarter were flat sequentially, which was slightly better than our initial expectation due to higher demands from existing programs. Revenues were down 6% year-over-year, primarily from the timing of program transitions.

Test & Instrumentation revenues were down 28% in the third quarter and 14% year-over-year from declines in semi-cap customers who utilize our precision technologies services. Overall, the higher value markets represented 63% of our third quarter revenue and were down 4% sequentially and 2% year-over-year, primarily from semi-cap softness.

Turning now to our traditional markets, computing was down 9% sequentially and up 16% year-over-year, driven primarily by demand variation from legacy storage product.

Telco was up 13% sequentially as a result of the ramp of a new satellite customer program, which was delayed from last quarter and up 23% year-over-year due to increased demand from existing customers. Our traditional markets, which represented 37% of third quarter revenues, were up 19% from last year and down slightly sequentially.

Our top 10 customers represented 42% of sales for the third quarter. Please turn to Slide 14 for a discussion of non-GAAP key business trends. Gross margin from the third quarter was 8.5%, a 30 basis point sequential improvement and a year-over-year decline of 80 basis points.

Sequentially, Q3 2018 gross margin was up due to improved mix outside of our semi-cap base and continued operation improvements offset by an adverse impact of the semi-cap market softness. Our non-GAAP SG&A was $35.9 million, which was relatively flat sequentially.

And resulting non-GAAP operating margin was 2.9%, up 20 basis points sequentially as a result of the higher gross margin. We had $1.8 million in restructuring for Q3. We expect to incur additional restructuring charges of approximately $2 million to $2.5 million in Q4 2018.

Please turn to Slide 15, where I'll provide a few updates on cash flow and working capital highlights. We used the $1 million in cash from operations for the quarter. Free cash flow usage was $16 million for the third quarter after capital expenditures of approximately $15 million.

Our cash balance was $476 million at September 30, with $306 million available in the U.S. Our accounts receivable balance was $456 million, an increase of $11 million from June 30. The increase in accounts receivable was a function of our shipment linearity and mix of customers. Payables were down $10 million quarter-over-quarter.

Contract assets were $156 million at September 30 and $148 million at June 30. Inventory at September 30 was $321 million, an increase of $2 million from June 30. Please turn to Slide 16 to review our cash conversion cycle performance.

Our cash conversion cycle was 74 days for Q3, which is higher than our expectations due to the mix and timing of our customer revenues. Our ongoing cash conversion cycle days will continue to range between 73 days and 68 days to support our long-term revenue growth.

Non-GAAP effective tax rate was 20.7% for Q3, which was higher than forecasted as a result of our income mix being higher in the U.S. than in prior quarters. Please turn to Slide 17 to review an update of our capital allocation strategy. 2018, we have repatriated $522 million of cash from international location.

We did not repay/create additional cash in Q3. As we've reported, we will continue to evaluate further repatriation opportunities. The repatriated funds have been used to fund share repurchases, working capital, capital expenditures and paying down of our prior Term Loan A facility.

Total repurchases, combination between ASR and OMR, through October 29 was approximately $152 million, which exceeded our committed amount of $100 million for the year. We'll continue to repurchase shares in the fourth quarter of 2018 through our OMR program, and we expect to repurchase approximately $200 million for 2018.

Additionally, the board authorized an expansion of the current program by another $100 million, which makes $263 million available under the expanded share repurchase program. In March 2018, we announced the recurring $0.15 per share quarterly cash dividend. Dividends of approximately $7 million per quarter were paid in April, July and October.

Please turn to slide 18 for a review of our fourth 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 $0.32 to $0.40. For sequential modeling, information for the fourth quarter, please turn to Slide 19.

Overall, we expect industrial revenues to be down midteens from softer demand and process controls in industrial transportation products. A&D is expected to be up mid-single digits in Q4 based on correction of custom component issue in Q3 and a new program ramp with a security customer.

We expect Medical revenues to be up low single digits from the transition ramp of new customer programs for fluidics and cardiac devices. In Test & Instrumentation, we expect further mid-teen decline from continuing softness in semi-cap. Turning now to the traditional markets.

We expect computing revenues to be up high single digits from the new program ramp and seasonality in our legacy storage product. Software revenue should be flat based on current customer demand. Implied in our guidance, there is a 2.6% to 3.4% operating margin range for modeling purposes.

The guidance provided does exclude the impact of amortization of intangible assets and estimated restructuring of other costs. Interest expense is expected to be $1.9, million, and the effective tax rate is expected to be 18%. The expected weighted average shares for Q4, $43.5 million. Operator, please open the call for questions..

[Operator Instructions]. Our first question comes from the line of Mitch Steves with RBC Capital Markets..

I just had two. So first on the actual, the headcount reduction.

So when should we expect kind of the OpEx to improve on a sequential basis if we think about the next couple of quarters here?.

Yes. So Mitch, this is Roop. So the OpEx improvements, we've already started to moderate. So the actions from Q3 and Q4 guidance reflect some of those moderation of expenses. And as we go towards - and if you remember, our range has been 36.5% to 37.5% per quarter of SG&A expenses.

And as we move forward into 2019, we'll see that moderate down below that range, closer to around the 36%. And we'll - obviously as part of the 2019 planning process that we're in the midst of, we'll look for further potential actions to reduce that further..

Okay. And then secondly, if I put together all the items you talked about, semi-cap weakness offset by some computing strength, for the full year, do you guys expect 2019 to be a top line growth year for you guys? I know you guys hadn't given a full year guide.

But is that in low single digits kind of a fair assumption?.

So Mitch, we said that on the current base of business, we think it's 3% to 5%.

3% to 5%. Okay. Perfect. And then last one is just on the actual semi-cap side. So you guys are talking about a back half improvement.

I guess what's the rationale behind seeing a snapback up there? And why that time frame?.

So Mitch, this is Paul. If you look at the semi-cap, first of all, the fundamentals of the semi-cap industry are positive and strong. The demand for chips and semiconductors is always growing, and we view this as a temporary thought.

So in our pulling of our customers, and if we look at what's been written by Aros, we think that you are going to see a return to growth. Second quarter then moving it - accelerating in the second half. And as we work through inventory, as we work through the digestion of tools on new tabs, it's logical that these demands increase..

Our next question comes from Jim Suva with Citi..

A quick question. When we look at your new business wins, specifically year-over-year, that way we flush out any seasonality on it, so when we look at new business wins, they've been increasing.

Is there anything unique in those new business wins coming in that may pressure margins or anything we should be aware of? And the reason why I ask is some of the other competitors in the EMS industry have talked about a little bit higher ramping costs.

And you should always - or the EMS companies should always be bringing in new business because things get obsolete, not with the old.

So can you talk a little bit about that pipeline of new business whether it's mix, complexity, location, anything we should just be aware of?.

So Jim, this is Paul. I'll start, and I'll let Roop kind of add more color. If you look at our - the predominance of our business wins, a large number of them are targeted into our larger sites within the network. These sites have more capability and broader staff and, therefore, should be able to ramp these products with minimal transition issues.

In addition, we have been redoubling our efforts on our transition plans to make sure that we have safety nets to ensure that we don't have hiccups. So from the standpoint of where they're going, pretty confident. And that's not the same when they go into our smaller sites. There's going to be problems, where we'll be doubling issues there as well.

But these are - some of these are very large programs. They are going into those larger mega sites in our network..

Yes. Jim, this is Roop. I'll just add one additional aspect. Obviously, with the constrained markets around supply chain, I think as we think about inventory management around supporting those ramps effectively and the timing of those, it's obviously a critical process in collaboration with those customers.

And we could see some advance buys in inventory in support of those ramps, especially for long lead-type items..

Okay. Then a quick follow-up. Anything on mix going forward we should be aware of, say, versus historical year-over-year mixes? That seems like Test and Measurement will be down due to softness in that industry.

But anything about mix that may impact profitability?.

So I think specifically in Test & Instrumentation, the mix should be pretty constant, though we are winning new awards for new tools that will give us opportunity to enhance mix. So we're continuing to ensure that we are on the leading edge of new tool, wins and deployment. And that usually gives you a better mix characterization..

Our next question comes from Sean Hannan with Needham & Company..

I was looking to see if you guys have provided some general context for how to think about '19. Clearly, semi-caps has been hit on as well as the path of that. So I think if that's been well talked about.

But if - when you talk - when you think about the wins, when I - when we think about the other pieces of your business and segments, maybe, Paul, can you rank order for us where you see those that are, perhaps, stronger than the - what you might see in that 3% to 5% type of range? What's going to be providing really the more material aspects of those risks? Maybe you can provide a little bit more granularity into what gives you the confidence to get to that aggregate 3% to 5% growth and then the markets driving that..

Okay. So Jim, obviously, the answer to that, we have to look at....

Sean..

Oh, sorry, Sean, I apologize. You have to look at the revenue - bookings to revenue conversion rate. So I would look to telco, expecting next-gen telco products to be a significant impact of positive revenue growth into '19. The reason for that is those products usually come in depending on whether they are [indiscernible] cycles with carriers.

You begin to ramp pretty fast [indiscernible]. So I think telco will be a driver. I'm also bullish on A&D, and the reason I'm bullish on A&D is we've been booking A&D wins for the last 1.5 years. And A&D normally has a 24-month booking to revenue conversion rate. I think we will start to see some of that closing in to materialize in '19.

And then after that, I would say on Medical, revenue growth should be there given the bookings we've booked over the last couple of years or the last 18 months or so. And I am pressing our industrial team to drive more bookings that will drive quicker revenue given the fact that, that's got a shorter bookings to revenue conversion metric.

So from a rank order, I'd say telco, A&D, Medical, with Industrial being the ability to choose it..

Okay. That's very helpful. And then so when we consider all of that, clearly, our mix does change.

And I think to a question that the other Jim had asked earlier in terms of mix, is - can you help to just kind of link how to think about then if the telco, the next-gen telco, is a bigger factor of our growth, how that then contributes in terms of the mix.

Is there a next-gen aspect of the margin profile that allows us to continue to move forward in our aggregate margin performance? Or is there anything there that, depending on the success, that may have some disruption or impacts on how you look to progress the margins from this point?.

Okay. So let me see if I can give you some color on that. So the thing about telco, legacy telco products, either base stations, maybe obstacle transport, those are pretty mature products that have supply chains that are pretty wrung out with suppliers that have shares that don't shift very much. As you look at next-gen telco, these are newer products.

They're more at the edge of the network. You have the ability to help influence the design of those, either through design for manufacturing, design for cost reduction. And as you're putting that supply chain in concert with those providers, I think it gives you the ability to have a better margin profile than the legacy [indiscernible].

And so as we have been targeting growth in telco, it has been exclusively an edge of the network product or a product that will enhance network densification for those very reasons..

And I'm not showing any further questions in queue at this time. I'd like to turn the call back to Mr. Tufano for closing remarks..

Okay. Well, thank you for joining us on the call. In closing, I just want to make a few remarks. First off, I am as confident as ever in our business model and, more importantly, our strategy to achieve it.

First, from a value position standpoint to customers, we continue to expand our value proposition, and this is leading to continued growth in bookings. That growth in bookings is translating to sequential annual revenue growth.

Secondly, our engineering and solutions offering are differentiating us in the minds of customers and will grow as our engagements mature. And thirdly, we continue to expand our manufacturing capabilities and drive every increasing operational execution.

The result of these three things will be the expansion of our margin and our absolute levels of profitability. When combined with our capital allocation and share repurchases, the impact on EPS accretion will be substantial.

I want to take this opportunity to thank all of our employees for their dedication to the company and to their commitments and service of our customers, and I look forward to talking to you again on our year-end call. Thank you very much..

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..