Benchmark Electronics, Inc.
Q3 2013 Earnings Call Transcript

Published: 24 Oct 2013

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Benchmark Electronics Third Quarter 2013 Earnings Call. [Operator Instructions] And as a reminder, today's conference is being recorded. I would now like to turn the conference over to your host, Ms. Lisa Weeks. Please go ahead.

[Lisa K. Weeks:]

Good morning, everyone, and welcome to the Benchmark Electronics earnings conference call for the third quarter of 2013. I am Lisa Weeks, Benchmark's VP of Strategy and Investor Relations. Thank you for joining our call today. Gayla Delly, our President and CEO; and Don Adam, our CFO, are with me here this morning. After their prepared remarks, we will open up the call for your questions. Following the conclusion of this conference call, an audio replay will be available on our website. Gayla and Don will be referring to specific earnings presentation slides in today's call. These slides, which will be referenced to by page number, are posted under the Investor Relations section of our website. Also please note that Gayla and Don will be referring to non-GAAP measures during their presentations, unless otherwise noted. The company has provided a reconciliation of our GAAP to non-GAAP measures in today's press release, as well as in the appendix of the earnings presentation slides. During our call today, we will be discussing forward-looking information. As a reminder, any of today's remarks that are not statements of historical facts are forward-looking statements and involve certain risks and uncertainties that are disclosed in the Safe Harbor section of our earnings release and SEC filings. Actual results may differ materially from such statements and Benchmark undertakes no obligation to update any forward-looking statements. With that summary, I will now turn the call over to Don Adam.

[Donald F. Adam:]

Thank you, Lisa, and good morning to everyone. Today, we will use a presentation slide deck and we will refer to the slide numbers as we go. So let's begin starting with Slide 3. First, I want to take time to provide a few comments in our third quarter financial performance and metrics. We delivered solid performance with revenue and operating margins in line with our third quarter expectations. Revenues of $600 million were within our guidance of $590 million to $620 million; our non-GAAP earnings per share of $0.31 were at the high end of our guidance for the third quarter and were consistent with the second quarter of 2013, as well as the third quarter of last year. Our GAAP earnings per share were $0.43 versus $0.34 in Q3 of last year. 2013 results include $9.9 million of the Thailand insurance recoveries in addition to $1.2 million in restructuring charges and integration and acquisition-related costs. Our non-GAAP operating margin was 3.5% for the quarter, which was consistent with last quarter. Now moving to Slide 4. You could see the composition of our industry -- our revenue by industry sector. The revenue breakdown by industry for the quarter was as follows

[Gayla J. Delly:]

Thank you, Don, and good morning, everyone. Thank you for joining our call today. Benchmark continues to execute well in a challenging end market environment. Admittedly, our revenues were slightly lower than consensus but within our guidance. Given the weak demand witnessed in the portion of the computing sector and the positioning of inventory for the new telco program ramps in October, we were pleased overall with both our revenues and earnings performance. As we guided last quarter, our third quarter revenues would be, and in fact, were essentially flat, based on slowness in summer spend in Europe, typical third quarter seasonality in IT spend, and customer caution. These scenarios played out much as we expected. We experienced growth in 3 of the 5 sectors we serve during the third quarter, and based on current forecast from our customers, we expect to see growth in all sectors during the fourth quarter. Our performance for the fourth quarter and moving into next year will be driven by translating our bookings over the past 18 months into production revenues and the integration of our recent acquisition. Both of these key activities are well underway. We are also pleased with our operating margin performance this quarter. We are making significant investments. First, in support of further revenue growth as we ramp the sizable number and level of programs that we have booked over the past 6 to 7 quarters, and, in our acquisition and integration activities during the third quarter. We continue to see solid bookings in the nontraditional markets. Many of these we are supporting from design to production and while these programs have a longer ramp phase, they also enjoy a much longer life cycle. We are excited to add these important products to our program mix. As we migrate these programs into production and complete the integration activities, we are currently aligned to achieve our 4% operating margin target in the second half of 2014. This is 2 quarters later than we had anticipated, primarily associated with some timing changes on the ramp moving a bit to the right, and also with our integration efforts. New bookings. Let's turn to Slide 8 for our third quarter 2013 business wins. We had another strong quarter of program bookings with both new and existing customers. Our new bookings represent new products to Benchmark and these do not include revision updates or re-spins of existing products. During the third quarter, our new bookings included 29 new programs, 7 of these are engineering projects. Our new bookings have an estimated annual revenue run rate between $145 million and $170 million. Looking at acquisition and integration focus. As Don noted, we completed the acquisition of the EMS operations of CTS earlier this month. We welcome the customers and employees new to the Benchmark family and we look forward to future growth together. This acquisition supports our strategic commitment to expand our portfolio of leading customers in nontraditional and highly regulated markets, and importantly, strengthen the depth and scope of Benchmark's new product express [ph] capabilities on the West Coast. This is a structural alignment in our combined team's approach with the key focus on customer engagement and serving the customer. We look forward to expanding our global design and solution services with our newest customers. The employee and customer integration process is well underway and we're pleased with the progress thus far. Looking at fourth quarter guidance, let's move to Slide 9. As we discussed last quarter, we will begin to realize revenues from several of our new program ramps during the fourth quarter. Based on the current forecast from our customers, our fourth quarter guidance is as follows

[Operator:]

[Operator Instructions] The first question will come from the line of Sherri Scribner at Deutsche Bank.

[Sherri Scribner:]

I just wanted to get a sense of the acquisition, the CTS acquisition. How much revenue are you expecting from CTS in the 4Q guidance? I think you said in the past, over the long-term, you expect about $220 million on an annual basis, but just want to get a sense of what CTS has in 4Q?

[Gayla J. Delly:]

We expect around $200 million overall and then a strong fourth quarter with kind of similar product mix as we do expect somewhere in the $15 million range. We would expect similar seasonality for Q1 and Q3 being the general quarters that are weaker in comparison to stronger Q2 and Q4.

[Sherri Scribner:]

Okay, that's helpful. And then just, Don, in terms of the SG&A impact, would you expect SG&A to be going up in the fourth quarter and what you think the rate will be in fiscal '14 with the addition of CTS?

[Donald F. Adam:]

Well, I think, in terms of the percentage of sales, you're probably looking at 4, 4.1, pretty consistent. I mean, those are going to be commensurate increase with the acquisition. As we mentioned earlier today, we will be going through and integrating it. So, not a lot to share there, but I would expect to obtain some leverage going forward into next year.

[Operator:]

We'll go next to the line of Amit Daryanani, RBC Capital Markets.

[Amit Daryanani:]

Just a couple of questions from my side. One, speaking of the CTS side, can you talk about -- because I think in their slide, they talked about LTM revenues of $222 million. You're saying 2014 will be $200 million. Why are you doing that business with a decline by 10% rather than grow, traditionally, next year? And then, any color you can give on the accretion side would be helpful, is it going to be more back half loaded and is there a way to think about accretion numbers in absolute dollars?

[Gayla J. Delly:]

I would expect the accretion to be kind of mid-year as we stated that we would expect it to come into play. And as to the revenue, I believe that what you see is some of the programs that they have wound down associated with facilities that they shut down over the past, I would say, 1 year to 2 years, is the primary roll off that you would see.

[Amit Daryanani:]

Got it. And was there -- on the inventory line, you guys talked about the telco ramps that you have in the month of October and you talked about building ahead a stronger Q4. I would imagine CTS added as well, additional month of that inventory line, could you maybe talk about those 3 buckets?

[Gayla J. Delly:]

Amit, I guess, the key point there is -- and we may not have made it clear enough, but the acquisition closed on October 2. So it's not in our balance sheet or income statement as of September 30.

[Amit Daryanani:]

Got it. Fair enough. And then, just finally on the computing side, you talked about, I guess, a couple of customers that were fairly soft in the end of the quarter in the month of September. On an organic basis, has that softness persisted so far for you guys in Q4? Do you expect, on a like for like basis, computing to be challenged partially offset by new ramps? Or has the business stabilized after that cut you got in the month of September?

[Gayla J. Delly:]

The computing sector is generally stronger in Q4, which as we indicated, we do expect that to continue to show strength. Some of the programs, which may not be in a stronger environment, probably will continue to see that -- of similar nature behavior. But the new programs, we do expect to, as we saw in Q3, continue to have stronger growth opportunities than some of the longer-term programs.

[Operator:]

And then next, we'll go to the line of Jim Suva, Citi.

[Jim Suva:]

Gayla, I believe you made the comment of you expect growth next year in 2014. I just want to make sure that, that comment is both including CTS being folded in. Or is it not? And if so, can you help us understand for magnitude so we don't get too ahead of ourselves. Such we just layer in $200 million on top of what's kind of projected for '12 and '13 or layer in growth because you have some really strong wins for the past few quarters?

[Gayla J. Delly:]

So we haven't provided guidance for 2014 and I won't go out providing guidance at this point. But a couple of items. First, our Q4 guidance does incorporate the CTS. So that is kind of a valid starting point. And typically, what we would see is we would expect to grow at or above the overall industry growth, would be probably the key factor. But as you say, we want to make sure that we are acknowledging the environment we're in that isn't strong growth. But we are looking to ramp a number of the new programs. So without giving guidance, I think that the environment would see some kind of single digit growth for next year. But I don't have a true outlook on what the overall marketplace is right now. Importantly though, the Q4 already includes the CTS acquisition.

[Jim Suva:]

And then, I think, it was -- Don, you made the comment on taxes. Can you help us understand the CTS being integrated? Is that 23%, is that a good long-term return rate? Or are there some puts and takes there that we should be conscious of for your tax rate?

[Donald F. Adam:]

As a starting point, 22% or 23% is probably a decent look. But we're going to see variability based on the geographic mix of taxable income, but for a starting point that's probably pretty good.

[Operator:]

We'll go next to the line of Brian Alexander with Raymond James.

[Brian G. Alexander:]

How much was the inventory build for the telecom timing issue that you cited and how much revenue would you say shifted from Q3 to Q4 in relation to that particular ramp? I'm just trying to understand the revenue guidance for Q4 in terms of how much is organic growth versus this particular issue, because it looks like you're guiding up sequentially about 8%, if I back out the acquisition of CTS, which is pretty strong relative to how you've guided in the past and performed in the past. And I'm just wondering how much is timing and how much is actually an improvement in demand?

[Gayla J. Delly:]

I would say that it's really hard to parse as to if you normalized it, how much would they have forecast in third quarter as opposed to fourth quarter when you have a new program ramp. You do have a bolus associated with that. I would estimate -- the best I could say, maybe $10 million associated with that, Brian.

[Brian G. Alexander:]

Okay. And that was the key reason for why your telecom business came in a little bit below expectation for Q3, right?

[Gayla J. Delly:]

Absolutely, in my mind. But I think that one of the key things we have highlighted and do want to highlight is when there are some of the new program ramps, you do experience nonlinearity. You'll have a, I'll just call it a big bang kind of approach to a product launch, which will have lumpiness inherently, so it will potentially starve one quarter, if you will, and provide a bolus in the following quarter. But neither of the 2 quarters is probably representative of true run rate level.

[Brian G. Alexander:]

Right. Okay. And then just on the computing business, if I back out the revenue from your largest customer, which you highlighted, probably didn't perform as well as you expected in the quarter, but the rest of your computing business is actually up close to 50% year-on-year and I think you've had a lot of new programs in computing. But what would be helpful is if you can maybe talk about the composition of your computing business today and how that looks different than it has historically. And give us a sense for what other key drivers of computing that we should be paying attention to, to better be able to predict that business?

[Gayla J. Delly:]

I would think that what you see in the overall market place is probably the key indicator. I wouldn't go into the details of the programs and products we support. But clearly, the on-demand computing and the many different ways in which the convergence of data and data availability is manifesting itself throughout the world, is driving opportunities for many traditional and new customers in serving those needs. So I don't think there's any way we can probably give the level of knowledge you'd like to understand about the whys and wherefores on what's providing them their opportunity. But we're just happy to say that we are participating with a number of new customers and seeing those growth opportunities.

[Brian G. Alexander:]

And then just final one. Could you just give us a little more color on the margin composition of CTS? What is the margin profile of that business relative to Benchmark? What is that going to look like in the early stages of the integration and where do you think that can be in 12 to 18 months? It looks like maybe, initially, it's not adding much to profitability but there's some synergy opportunities as you integrate that business.

[Donald F. Adam:]

Brian, this is Don. That's exactly right. I think there are -- at least, starting off, it's going to be a little bit below what our expectations are, but as Gayla said in her prepared comments, we want to basically get them to our -- that traditional 4% or above.

[Operator:]

We'll go next to the line of Sean Hannan with Needham & Company.

[Sean K.F. Hannan:]

Just a follow-up on that CTS comment, Don. If I think about their business, particularly that mix, the nature of the mix and the margins, and as I think about the comments of getting through a 4% operating margin in the back end of '14, it looks like CTS is helping you to get there in the back half of the year, but I think you probably should've been able to get there on your own. So I'm just trying to reconcile how much of an impact is there, there -- is there in earlier in the year and then to what degree is there actually a profile difference within the margins in the CTS business?

[Gayla J. Delly:]

Well, as we've said, our midpoint of guidance implies 3.7% and barring the number of ramps and the acquisition, we would expect to be much closer to the 4% that we targeted. As to the question of, I guess, the margin before and after, clearly, the margin is not aligned with where we would want it to be. And as we go through the integration process, we will be driving opportunities for improvement associated with that. Help me out on understanding a little bit more about your question. Maybe I didn't capture it all there or if I didn't capture it all there?

[Sean K.F. Hannan:]

Yes. I just -- we're going to be going through 3 quarters of CTS business, that'll be -- once I get -- if I separate out from where we are today versus the second half of '14, we were looking at 3 quarters of CTS business that's in the mix. I think that in general, the mix of that business should be enhancing to your model. So it's unclear to me why we don't see some of that benefit perhaps come through a little bit earlier. And even still, it's unclear why we don't have, organically, some of that Benchmark business being able to get to a 4% level as well, even before the second half of the year. It just -- it seems like the expectations are being set a little bit low for the first half of '14. And I'm just trying to understand that.

[Gayla J. Delly:]

I think, as we noted, with the significant number of program wins and the number of new opportunities and the type of products going from engineering and design, we are seeing that we -- the investment that we are making for future growth is stronger. And we're very pleased with the opportunities that we're seeing on our front lines of opportunities currently, with that level of new program activity and investment we're making, that's why we believe that's prudent to continue to support that growth, to continue to diversify our base of business and expect that it will take the 9 months. I guess it's important to note that at $200 million, it's not having a significant impact on the $2.5 billion business base.

[Sean K.F. Hannan:]

And then when I think about the guidance that you have for the next quarter and given that we do have some contribution coming through from the CTS, of course, realizing this is a much lower scale versus broader Benchmark. But I think they have a good amount of medical business as well as a good amount of industrial business. It would almost seem to imply that perhaps the legacy Benchmark business might be down a little bit quarter-to-quarter and the flattish expectation now is a result of bringing in CTS. Or how do I think about those 2 markets and how CTS has contributed there?

[Donald F. Adam:]

Well, I think, Sean, I think in terms of the customer profile, they're primarily going to fall into industrial controls and telecom for us, very little medical. So I think you are referring to the medical growth. I think -- and we're expecting growth and not much contribution from CTS on that.

[Sean K.F. Hannan:]

Okay. And on the industrial side, we're looking for a flat, so ex CTS, that would be down slightly?

[Donald F. Adam:]

No. I think we said we're going to have growth in all of the sectors next quarter.

[Operator:]

We'll go next to the line of Wamsi Mohan with Bank of America.

[Wamsi Mohan:]

Gayla, I know you're not guiding 2014, but can you just help us conceptually, how you'd expect the mix to evolve. 2013, we saw significant uptake on the industrial side. Your new wins would indicate that industrial should become meaningfully larger even ex CTS, but we don't know necessarily what programs, any meaningful programs, that might be falling off. So any color you can share then and how we should be thinking about the mix in 2014?

[Gayla J. Delly:]

I don't have a lot of color to add there other than I don't see any meaningful industrial programs falling off. The programs that have the shortest life cycle are clearly those in computing and then the next probably is telco, but the other industries typically have longer life cycles. And I'm not aware of any of those that have a significant change in product mix or customers we support. I do think that we would expect to see the impact of the normal macro environment on the industries and the customers, overall. And as I've stated, the most excitement and energy is coming around. The new programs being added to the mix that really will change the dynamics as compared to the overall marketplace.

[Wamsi Mohan:]

Okay. And on Test and Instrumentation, are we -- what are we likely to see at the bottom on that market, in your opinion?

[Gayla J. Delly:]

I think that we have seen growth over the last 2 or 3 quarters and we expect to continue to see that based on program wins. Now, when the market itself sees the bottom, I believe that customers are somewhat optimistic that do not see any significant changes overall. So this may be walking along the bottom right now and our growth is really from new opportunities that we're seeing.

[Operator:]

[Operator Instructions] We have a follow-up from the line of Amit Daryanani at RBC Capital Markets.

[Amit Daryanani:]

I actually have 2 follow-ups. One, the Thailand recovery. It looks you guys have got a $10 million recovery this quarter. Could you just talk about what sort of ongoing potential there, some of the recovery basis, and is there any time line associated with that?

[Donald F. Adam:]

Amit, yes, this is Don. I think we're still working through that process. So, yes, at this point, really nothing additional to add than what we've already disclosed. So what I'll say is process is ongoing.

[Gayla J. Delly:]

And as we've indicated, there is no receivable on our balance sheet and so it's on an as-received cash basis so we continue to work through the finalization of that over the next quarter or June.

[Amit Daryanani:]

Fair enough. And then, I guess, as you look into the fourth -- Q4 [indiscernible] of 2014, is there going to be any restructuring activity associated with CTS? I think there's 5 sites right now, that we should start to think about and potentially factor into our models?

[Gayla J. Delly:]

I think most significant impact there is the integration associated with putting systems and processes in place consistent with Benchmark. As you note, they were part of CTS, which is an ongoing corporation and therefore, we are implementing our systems and processes. So that will be the -- what I would consider the near-term headwinds as we incur cost to do the integration and then the benefits come from having that integration in place and supporting customers going forward.

[Amit Daryanani:]

And is there a way you would quantify for us? For Q4? Also, for the first half of 2014?

[Gayla J. Delly:]

I don't clearly have 2014 ready to indicate there. But as Don indicated in our integration and restructuring costs, we have about $2 million in fourth quarter, which is the finalization of some of our pre-CTS activities, as well as the integration cost activities.

[Operator:]

And we'll go back to the line of Bryan Alexander, Raymond James.

[Brian G. Alexander:]

Just a couple of quick follow-ups. I think you said you had about $57 million left on the buyback at the end of the quarter and your U.S. cash balance is over $100 million, so I was just wondering how quickly do you think you can complete that buyback program? Should we think of the cadence as similar to what you've been performing at, $10 million to $12 million a quarter? Or do you think you could accelerate that? And the second question is, do you have an estimate for what you think the book value is for Benchmark pro forma for the CTS acquisition?

[Gayla J. Delly:]

So on the buyback, we will continue and expect it to be somewhere in the $10 million to $20 million range for the fourth quarter and as we continue to progress through our buyback. And as to the book value, as we said, we -- the -- go ahead, Don.

[Donald F. Adam:]

Yes, the book value is going to pretty much equate to the purchase price, Brian.

[Gayla J. Delly:]

So -- and that's the $75 million?

[Donald F. Adam:]

Right.

[Brian G. Alexander:]

So there's no goodwill associated with that acquisition?

[Donald F. Adam:]

I would not anticipate any significant amount of goodwill.

[Brian G. Alexander:]

Okay. And then just on the 4% operating margin that you expect to achieve in the back half of the year, what kind of revenue level do you think you would need -- minimum revenue you would need to achieve to get to that 4%?

[Gayla J. Delly:]

I think as we've anticipated before, it has a great deal to do with the mix. So it's dependent upon the level of new program and activities in, primarily, computing and telco. That number will move north and probably is in a higher -- without integration and ramp cost at the current level, I would say, clearly, at $700 million even, with 50% to 60% coming from telco and computing you get there. But as we get more of our mix coming from the other diversified market areas, we would expect it to be closer to the $600 million and $650 million. So it really will toggle as we get into higher ramps in the other market areas as we talked about the longer lived products.

[Brian G. Alexander:]

And then the last one for me. If we assume CTS gets through a 4% operating margin and maybe it does a little bit better than that, that would imply overall EBIT contribution of somewhere $8 million or so. And I'm just trying to understand the $75 million purchase price relative to that level of EBIT, it's over 9x, which is much higher than where some of the EMS -- publicly traded EMS stocks are valued. And I'm just wondering, the kind of justification for the price and maybe talk through some of the strategic opportunities that you see and perhaps, maybe, how the margins could go much higher than that to justify the high EBIT multiple?

[Gayla J. Delly:]

So we can go through further discussion and typically, as you know, it usually is an EBITDA multiple and not an EBIT multiple that companies use. But suffice it to say that we have plans and we're not going through the full dissection, but the plans are to have the right geographic footprint, the right opportunities for our customers to drive growth and to drive it beyond the 4%. And that all of our business is geared towards not only just achieving the 4%, but driving past that 4%. And what we were indicating was kind of the near-term goal to get to the 4% that we want to achieve.

[Operator:]

There are no further questions in queue at this time.

[Donald F. Adam:]

Okay. Thank you.

[Gayla J. Delly:]

Thank you, all.

[Operator:]

Thank you. And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and for using AT&T Teleconference. You may now disconnect.