Benchmark Electronics, Inc.

Good day and welcome to the Benchmark Electronics fourth quarter and full year 2018 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touch-tone phone. To withdraw your question, please press star then 2. Please note this event is being recorded. I would now like to turn the conference over to Lisa Weeks, Vice President of Strategy and Investor Relations. Please go ahead.

Lisa Weeks Thank you, Operator, and thanks everyone for joining us today for Benchmark's fourth quarter and full year 2018 earnings call. With me this afternoon, I have Paul Tufano, CEO and President, and Rup Lakharaju, CFO. Paul will provide introductory comments and Rup will provide a detailed review of our fourth quarter and full year 2018 results. 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 fourth quarter and full year. 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.bitch.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 statement advice on slide two 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, Paul Tufano.

Paul Tufano Thank you, Lisa, and thank you for joining our call. If you turn to slide five, we capped 2018 with strong results in the fourth quarter. Revenue and non-GAAP EPS were both above our guidance. Revenue in Q4 was $657 million, and for the full year was approximately $2.6 billion, which reflects 5% year-over-year revenue growth. This was driven primarily by strength in A&D, telco, and medical. Non-GAAP operating margins improved 30 basis points to 3.2 percent quarter-over-quarter. This is despite continued softening in our test and instrumentation sector, which was down 25 percent year-over-year. Our EPF on a non-GAAP basis was 41 cents and above our guidance. Our cash conversion cycle days were 62 days and for the full year at 68 days, which is at the low end of our target range of 73 to 68 days. Cash from operations was approximately $94 million in the quarter and $7 million for the full year, which is above our expected $30 to $50 million range that we outlined earlier in 2018. We have continued to aggressively buy back our shares. For 2018, we repurchased $212 million of our stock and reduce our outstanding share count by 17%. We continue to prudently repurchase shares, and through yesterday we repurchased $17 million of additional shares. If you turn to slide six, we continue to make excellent progress on bookings, which as you all know are critical to revenue growth. This quarter, We posted solid bookings of $198 million and $721 million for the full year, which is up 23% year over year. If we reflect back to this time period in the fourth quarter of 2016, bookings are up 55%. We had our strongest number of wins in our medical sector, with 34% of total bookings, seven new customers, five linked to design services, with projects ranging from oral image devices to cardiac monitoring to optical sensor manufacturing to in vitro diagnostic devices. In aerospace and defense, which posted 21% of our bookings for the quarter, we won new programs with existing customers for electronic modules for ground-based vehicles for radar systems, and for RF components for space modules. In computing and telco, we had two new customers, one for antenna module manufacturing, the other for advanced cloud storage products. Overall, we had 51 total wins for the quarter and 13 new customer engagements. I'm extremely pleased by the number of joint engineering and manufacturing engagements and it's a testament to our value proposition to customers. If you now turn to slide seven, as we've discussed over the last two quarters, we have a legacy computing contract which has been diluted to our earnings. If you may recall, this is a longstanding contract with a longstanding customer. When this contract was renewed in early 2016, It was assumed that this product line would go end of life and decline substantially by this time. The opposite has happened. Growth has occurred, increasing over 50% from the 2016 period. Margins, which were once acceptable, have deteriorated due to model mix and supply chain changes. We have been working with this customer since the fall of 2017 to attempt to renegotiate this contract. And we notified this customer that we will be not renewing the contract when it expires in December of this year. Consequently, the customers informed us that they will transition this product outside of benchmark. And I anticipate it moving sometime in the middle of this year. The impact of this contract is significant to our numbers. As you look at the box on the left-hand side of the chart, you can see that it comprises $280 to $320 million of revenue in both 2017 and 2018, respectively. But the gross margin impact of that revenue is substantially dilutive. When you exclude that contract from our results, our gross margins increased 80 to 90 basis points in both those years respectively. By removing this contract, we can reflect the true underlying strength of our business, which is at industry-leading margins and continues to grow at 3% on an annual basis. As we go through the transition with this customer, we will continue to report to you our results with and without this contract until it is totally removed from our actual results. If I turn to the next slide, on slide eight, as we traditionally do, I'd like to talk about our milestones to the waypoints we established earlier this year. In the upper right-hand corner, as it relates to bookings, we established a milestone to achieve $200 million of bookings, eggs in the year. As you can see, we delivered $198 million in the fourth quarter, essentially achieving this target. On the upper right-hand corner of the chart, as it relates to high-value market segments, we had set a waypoint of 67%. Our reported results, including this legacy computing contract, have us several basis points below that waypoint. As we exclude that contract, you can see that we are in the mid-70s for the majority of this year. Turning to gross margin was probably the most watched number in the waypoint section. Our waypoint for the end of 2018 was 9.7%. Given the strength of this legacy computing contract, and the decline in our T&I sector, you can see the reported results are 8.4%. When we normalize for the legacy computing contract, that goes to 9.5%. The difference between the weight point of 9.7 and 9.5 is related to the softening of our T&I sector in the second half of the year. If you look at the first quarter of 18, The dynamics of the weight of T&I and the weight of the legacy contract would have been about the same. And had T&I not softened, we would have been above the 9.7% range, closing in on 10%. And finally, on a profit per square foot percentage, or dollar value, which I use as a surrogate for ROIC. Given the lower utilization of our precision machining group because of semi-cap weakness and the high capital intensive nature of that division, we've seen erosion in profit per square foot. In an attempt to reduce the downward sizing of that, we have taken steps to right size capacity and restructure facilities. Now turning to the next slide, slide nine. I want to reemphasize and reiterate our target financial model. Our goal is to get the non-GAAP operating margins in excess of 5.5 percent and ROIC at 12 percent. To do that, we need a target revenue range of $2.8 to $3.2 billion. and a target gross margin range of 9.8 to 10%. With the transitioning of this legacy computing contract out of our base business, our margins begin to approach the threshold of that target range. But it lays bare the fact that we need to continue to grow revenue. Because with the reduction of that computing contract, we're now about $2.2 billion. 600 million shy of the low end of the model. Our business development teams are well aware of this challenge and are focused on driving bookings that will drive revenue growth to get to the low end of that model. If I turn to the next slide, slide 10, as is normally the case this time of year, I'd like to provide some color on 2019. Excluding the legacy computing contract, we expect year-on-year revenue growth of between 3% to 5%. This assumes that our test and instrumentation sector, which is heavily front-end semi-cap, we saw this in the first half of the year with slight growth in the second half. And we are assuming that on a full-year basis, 2019's results will be 10 percent lower than that of 2018. We are targeting gross margins to be in the 9.5 to 9.8 percent range. This will be achieved by focusing on continued process efficiencies and operational margin improvement in all of our sites around the globe. We will aggressively manage cost and expense structure further rationalizing facilities and labor to balance the load. We will examine our SG&A and take proven actions to reduce SG&A over the year. And lastly, we will drive improving mix of services and solutions, especially related to the ramp of our RF and I-speed design center here in Tempe. From a capital allocation standpoint, we will continue to repurchase shares on the outstanding $200 million authorization that we have. And we will continue our quarterly dividend. Combination of both the operating income growth associated with revenue and the actions we talked about and the reduction of our share count should drive EPS acceleration through 2019. Turn to slide 11. As is traditionally the case in our year-end call, we'd like to provide milestones for 2019. For 2019, from a booking standpoint, we are driving the organization to deliver bookings in the range of $800 to $900 million. That allows about $225 million per quarter. And I assume the linearity of that will be a little bit fluctuating as we go through the course of the year. From a high-value market standpoint, we are targeting 72% to 78% of our revenue from high-value markets. From a gross margin standpoint, as I said before, we are targeting 9.5% to 9.8% gross margins. And from SG&A standpoint, we are looking at a range of quarterly SG&A spending of $34 to $36 million, which is down from our previous guidance to you of $37.5 to $36, and represents at the low end a $10 million improvement from what we previously have done. Obviously, these milestones exclude the legacy computing contract. And we'll be tracking them throughout the course of 2019. Finally, turning to slide 12. In a press release earlier today, we announced my intention to retire this year. The board has a search underway to identify my successor. And upon their appointment, I will remain with the company as an advisor through the end of this year. As you know, I joined the Board of Benchmark in March of 2016 and was subsequently asked to come out of retirement to assume the CEO role in September of that year with the goal of improving operational performance, driving revenue growth, and refining and accelerating the company's strategy. At that time, the Board and I contemplated that I would remain in this role for 24 months or less. And last year, we extended my position by another 12 months. It has been a great privilege to lead Benchmark. And I am very proud of the progress that we have made over the past several years. From an operational standpoint, we have made great strides. We have significantly improved working capital management. Cash cycle days, which were almost 100 days at the beginning of 2016, have been reduced by over 30 percent and have remained at an average of 68 days over the past two years. Cash generated from operations over the three-year period is approximately $500 million, with almost 50 percent of that coming from improvements in working capital. We have renegotiated or exited underperforming contracts. We have transformed a federation of sites into a global market sector network, improving overall execution, and more importantly, providing a uniform customer experience around the globe. We have refreshed the leadership team, not only by direct reports, but several levels below, with nearly 50% of the organization new in the past two years. We have consolidated our decentralized corporate teams and other staff functions into our new headquarters in Tempe, driving not only better speed of decision making, but an environment of collaboration and a focus on the deployment and adoption of common processes and tools. From a revenue growth perspective, after a number of years of revenue decline, we have returned to revenue growth in each of the last two years. in our forecasting continued revenue growth in 2019. We've established our market sector business development organization. This team is tasked with acquiring and growing customers that have technically rich, complex product sets that are aligned to our sector strategies that offer the opportunity to utilize the entire breadth of the benchmark capabilities. Over the last two years, we have seen our investment in this organization drive bookings growth to over $700 million, an historic high for this company, and over a 50% increase from levels seen in 2015 and 2016. These bookings will fuel revenue growth in years to come, and we are driving this organization to a billion dollar booking mark in the next 24 months. We have continued to expand our value proposition to customers. making Benchmark more relevant by growing our engineering and solutions offerings. We've expanded our engineering capabilities in a variety of disciplines, such as fluidics, robotics, and optical systems, growing engineering revenue by 50% over 2016 levels. But more importantly, the level of engineering engagements that lead to manufacturing wins now stands at over a third. We have taken a number of unique capabilities, principally acquired with the secure transaction, and transformed them into a powerful set of solutions offerings that will enable customers to go to market faster and more economically. And finally, from a strategy perspective, I am very proud of the fact that we have repositioned Benchmark from principally a contract manufacturer to an engineering and manufacturing services company. position to take advantage of what I believe is the next great technology transition. I've been in the technology sector my entire career. And over the last 40 years, I have been fortunate to witness the evolution of our sector in what I describe as three technology eras. The first is the era of hardware. where advancements in semiconductors enabled computing power that drove the emergence of the mainframe to distributed computing and to PCs. The second is the area of software. First, enterprise software, then application software, and now cloud and SAS software. The third is the area of the network and wireless transmission, which enabled mobility and access not only to voice, but more importantly, voice and video data on any device anywhere. Each of these technology eras built upon the other and provided capabilities to a broader spectrum of end markets and end users driving new products and new offerings. In my opinion, we are at the beginning of the fourth era of technology, which is the evolution to 5G and the associated speed and connectivity improvements, which will enable new applications across even more diverse sets of end markets and industry verticals. For the past two years, we have been developing capabilities that will make Benchmark a key partner for our customers to capture the opportunities that 5G and high-speed gazool afford. These capabilities range from radio architecture to wireless topology to I.O. front-end architecture to high-speed circuit and RF design manufacturing to associated RF components coupled with advanced manufacturing in microelectronics and traditional SMT. We have both the engineering and the manufacturing capabilities that will tie these all together. When I first came to Benchmark in 2016, I told you that the future for the company was bright and that our job was to unleash its potential. Feedback from customers indicate that we are on the right track. They are excited by our offerings, by our level of engagement, and our desire to help them solve problems so they can go to market faster and capture the opportunities that they see. The foundation is set. Our leadership team is aligned. With this backdrop, it's time for a transition in leadership. To a new CEO that has a time horizon to lead this company to achieve its full potential. I am confident in this organization and its ability to execute and make this a reality. I would like to thank not only my leadership team, but the entire benchmark organization for their support over these past several years. I'd now like to turn the call over to Ruth. Thank you, Paul, and good afternoon, everyone.