Benchmark Electronics, Inc. (NYSE:BHE) Q3 2023 Earnings Call Transcript

Benchmark Electronics, Inc. (NYSE:BHE) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good day, and welcome to Benchmark Electronics Inc. Third Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. Please, note this event is being recorded. I would now like to turn the conference over to Paul Mansky with Benchmark Electronics. Please go ahead.

Paul Mansky: Thank you, Betsy, and thanks, everyone, for joining us today for Benchmark’s third quarter fiscal year 2023 earnings call. Joining me this afternoon are Jeff Benck, CEO and President; and Roop Lakkaraju, CFO. After the market closed today, we issued an earnings release pertaining to our financial performance for the second quarter of 2023, and we have prepared a presentation that we will reference on this call. Both are available on the Investor Relations section on our website at bench.com. This call is being webcast live, and a replay will be available following the call. The company has provided a reconciliation of our GAAP to non-GAAP measures in the earnings release as well as in the appendix to the presentation Please take a moment to review the forward-looking statements advice on Slide two in the presentation.

During our call, we will discuss forward-looking information. As a reminder, any of today’s remarks, which are not statements of historical fact are forward-looking statements which involve risks and uncertainties as described in our press releases and SEC filings. Actual results may differ materially from these statements most notably due to ongoing supply chain constraints, macroeconomic conditions and semi-cap equipment spending. Benchmark undertakes no obligation to update any forward-looking statements. For today’s call, Jeff will begin by providing a summary of our first quarter results. Roop will then discuss our detailed financial results and our third quarter guidance. Jeff will then return to provide more insight on demand trends by sector, business wins and then closing remarks.

If you’ll please turn to Slide three, I will turn the call over to our CEO, Jeff Benck.

Jeffrey Benck: Thank you, Paul. Good afternoon, and thanks, everyone, for joining our call today. The third quarter was another period of solid execution for the company. Despite the dynamic market environment, we met or exceeded expectations in the quarter. This is a direct reflection of our purposeful focus on complex and often highly regulated markets and team-wide emphasis on operational execution. Let me highlight a few key accomplishments in the quarter. Total revenue was $720 million. Although down year-over-year, recall that in Q3 2022, we had $74 million in zero margin supply chain premiums. In Q3 2023, supply chain premiums were less than $16 million, down $58 million versus a year ago. Excluding SCP, we grew revenue by high single digits or more in four of our six sectors, the exceptions being semi-cap and advanced computing, which were down as expected.

Whether including or excluding SCP, we expanded gross margin both sequentially and year-over-year, primarily through operational improvements we put in place over the last few quarters. This enabled us to grow non-GAAP operating income an impressive 22% year-over-year. I want to congratulate the entire team for delivering such a strong set of results, which was key to allowing us to report $0.57 in both GAAP and non-GAAP earnings. This was above the high end of our GAAP guidance range and 10% above the non-GAAP consensus. Finally, over the last few quarters, we’ve highlighted steps we’ve taken to return to positive free cash flow. I’m pleased to report that we delivered this for the second quarter in a row, aided largely by reductions in inventory.

We have generated over $34 million in free cash flow over the last two quarters. Considering that and our continuing focus, we feel confident we are on a trajectory to achieve greater than $70 million in annualized free cash flow, which is in line with the targets we provided. Now let me pass it over to Roop to share more detail on the September quarter and our guidance for Q4.

Roop Lakkaraju: Thank you, Jeff, and good afternoon. Please turn to Slide five for our revenue by market sector. Total Benchmark revenue was $720 million. Excluding the effect of SCP, revenue was up 1% year-over-year in the period. Reconciliation of this and our sector level performance can be found in the appendix section of the presentation materials. Turning to Slide six. Medical revenue for the third quarter was up 8% versus the prior year. Growth was fueled by strength in existing programs, coupled with improved supply availability, allowing us to more fully meet demand. Semi-cap revenue decreased 10% year-over-year, in line with our expectations. This compares favorably to industry estimates, which have the wafer fab equipment market declining 20% or more in 2023.

A&D revenue was up 20% year-over-year due to continued strength in commercial aerospace defense programs that continue ramping and improved supply availability, enabling us to address more of our previously unmet demand. Industrials revenue for the third quarter increased 9% year-over-year, driven by strength with existing customers and new customer programs ramping in energy efficiency. Advanced computing decreased 30% year-over-year due to the completion of multiple high-performance computing programs in the first half as expected. In the next-generation communications sector, revenue was up 20% year-over-year. Our year-over-year performance was driven by growth in broadband infrastructure programs. Please turn to Slide seven. Our GAAP earnings per share for the quarter was $0.57.

For Q3, our non-GAAP gross margin was 9.6%, a 50 basis point sequential increase and a 100 basis point improvement year-over-year due to our mix of revenue and improved operational utilization. Excluding SCP, in Q3, our gross margin was 9.8%, which was in line with guidance. Our SG&A was $35.5 million, down sequentially due to the cost actions taken in the first half of the year, coupled with lower variable compensation. Non-GAAP operating margin was 4.7%, up 70 basis points sequentially and 110 basis points year-over-year as a result of improved gross margin. Excluding SCP, operating margin was 4.8%. In Q3 2023, our non-GAAP effective tax rate was 19.4%, consistent with our expectations. For Q3, non-GAAP EPS of $0.57 was $0.02 higher than the midpoint of our guidance.

Non-GAAP ROIC in the third quarter was 9.4%. Please turn to Slide eight to discuss the effects of SCP on a trended basis. In Q3, SCP declined to $16 million versus $17 million in Q2 2023 and $74 million in Q3 2022 and continues to decline consistent with expectations. Excluding this, our revenue in the third quarter was $704 million, a sequential decrease of $12 million or 2% and a year-over-year increase of $6 million or 1%. Please turn to Slide nine to review our cash conversion cycle performance. Our cash conversion cycle days were 105 in the third quarter compared to 103 days in Q2. Our inventory decreased sequentially by $31 million. However, the linearity of customer shipments and inventory receipts adversely affected our accounts receivables and accounts payable days.

Please turn to Slide 10 for an update on liquidity and capital allocation. In Q3, we generated $38 million of cash from operations and $18 million of free cash flow. Our CapEx spend is supporting continued growth in our Mexico facilities and enhanced capabilities in our Precision Technologies business unit. We expect our CapEx spending in Q4 2023 to be between $10 million and $15 million. This would equate to full year 2023 CapEx in the range of $70 million to $75 million. Our cash balance on September 30 was $261 million, a sequential increase of $16 million. As of September 30, we had $129 million outstanding on our term loan, $305 million outstanding borrowing against our revolver and $241 million available to borrow under our revolver. In Q3, we paid our recurring quarterly cash dividend of $5.9 million.

Please turn to Slide 11 for a review of our fourth quarter 2023 guidance. We expect revenue, excluding SCP, to range from $675 million to $725 million. SG&A expense will range between $35 million and $38 million. Excluding SCP, our non-GAAP operating margin range is forecasted to be 4.8% to 5%. As a reminder, this includes approximately 55 basis points of stock-based compensation. Our non-GAAP guidance excludes the impact of $1.2 million in amortization of intangible assets and $800,000 to $1.2 million of estimated restructuring and other costs. Our non-GAAP diluted earnings per share is expected to be in the range of $0.54 to $0.60. Other expenses net are expected to be approximately $9 million due to primarily interest expense. We expect that for Q4, our non-GAAP effective tax rate will be between 19% and 21% for the weighted average share count of 35.9 million.

And with that, I’ll turn the call back over to Jeff.

Jeffrey Benck: Thanks, Roop. Please turn to Slide 13. Again, all commentary related to demand trends by sector are excluding supply chain premiums. In medical, this past quarter, we did a good job meeting demand as the supply chain continues to improve. Partially offsetting this, however, is demand softening from some customers as they rebalance going into year-end. Considering all of this, we’re expecting medical sector revenue to likely decline sequentially in Q4, while still growing nicely on a full year basis. We continue to build on our future success in medical during this past quarter, securing new wins that we expect to ramp in 2024 into 2025. For example, we expanded an existing relationship with a key customer in the heart valve market, with several new manufacturing wins at both the subassembly and system level.

Elsewhere, we had another existing customer award us the opportunity to provide subassemblies that will be integrated into their anesthesia and respiratory devices. Within semi-cap, we believe our semi-cap sector likely bottomed earlier in the year. However, based on public commentary from many of our customers, we expect semi-cap revenue to remain roughly consistent with current levels through at least the first half of 2024. Our expectation is to continue to outperform the broader WFE market growth rates, driven by our unique customer exposure and new program wins. For example, in Q3, we were awarded an opportunity to manufacture assemblies and fully integrated modules for an epitaxy tool used in the transistor device fabrication process.

We also won both the engineering and manufacturing business at another customer that is in support of high-end lithography platform. While the current downturn in the market appears poised to last longer than recent cycles, the long-term growth drivers are undeniable. As the market ultimately recovers, we fully expect to participate in more than our share of semi-capital equipment growth given our significant investment during this down cycle. Within A&D, commercial aerospace has been improving for us for the last few quarters. We are now more optimistic about future growth within defense, which is both a reflection of both strong demand and improving supply chain. At the same time, we continue to secure new wins in the past quarter. This includes engineering services for test development in the commercial aerospace market.

Yet another engineering services win was with the defense program where we’re helping on the development of an RF module. Meanwhile, in manufacturing, we won a nice piece of business where we’ll be providing a sensor module into a commercial aerospace application. Again, we’re pleased with the momentum we’re seeing in A&D. In fact, we expect year-over-year growth to accelerate in Q4. With the strong second half expected, we anticipate A&D sector revenue has the opportunity to grow double digits on a full year basis. Turning to complex industrials. We continue to extend our footprint in key growth markets, including automation, test and measurement and energy efficiency solutions. Examples of this include both manufacturing and engineering wins for several next-generation energy efficiency solutions for residential HVAC applications.

Another manufacturing win I’d like to highlight is in the transportation space where we’ll be providing next-generation radios used for locomotive control and communications. Our industrials sector domestically continues to show resilience. However, this demand is being offset some by softening international markets. As such, we’re expecting industrial revenue to be down sequentially in Q4, while still growing solidly in the double digits year-over-year, both for the quarter and full year. In advanced computing, revenues were consistent with our guidance provided last quarter. Recall, we completed a significant high-performance computing project in the first half that’s being deployed by our customer at a federal agency. As previously shared, after a pause in Q3, we’re delivering upon a new HPC program that will contribute to our growth in the fourth quarter.

Finally, the next-generation communications, last quarter, we highlighted some risk of infrastructure deployment delays amid macro sensitivity. We saw this begin to materialize in Q3, which we expect to continue in Q4. As such, sector revenue is expected to be down sequentially and year-over-year in Q4, albeit still up on a full year basis given the strong first half performance. Looking forward, we are seeing a few more customers across a number of sectors begin to moderate their forecast, while others, specifically in A&D, are seeing incremental strength. On balance, we expect this to translate to total revenue remaining flat at current levels through the first half of 2024. While soon we’ll provide color on full year growth rates, we’re going to maintain our focus on operational execution and productivity improvements as we progress to the profitability targets reflected in our long-term model.

In summary, please turn to Slide 14. I’m pleased that, once again, we were able to exceed the midpoint of guidance and deliver a 10% upside to non-GAAP earnings estimates. We again delivered solid growth in four of our six sectors. At the same time, we grew non-GAAP operating margin by better than one point year-over-year. Excluding SCP, non-GAAP operating margin was up 80 basis points to 4.8%, which includes approximately 55 basis points in stock-based compensation. Non-GAAP operating income growth in the third quarter was 22%, which was our 10th consecutive quarter of double-digit growth year-over-year. Turning to working capital and free cash flow, aided by our continued focus on reducing inventory, we delivered the second consecutive quarter of positive free cash flow and expect this trend to continue.

Finally, it’s true we’re heading to a more uncertain economic environment. Based on this, we’re being judicious about where we’re making investments and managing our expenses closely. I remain confident that our diversified portfolio will help us to weather this and come out stronger as the market turns. We will maintain a sharp focus on investment in future growth while protecting our ability to continue to deliver positive operating leverage and cash flow. With that, I’ll now turn the call over to the operator to conduct our Q&A session.

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Q&A Session

Operator: [Operator Instructions] The first question today comes from Max Michaelis from Lake Street Capital Markets. Please go ahead.

Maxwell Michaelis: Hey, guys. I want to make sure I didn’t hear you incorrectly, but did you note that revenue was expected to be flat through the first half of 2024? I know you didn’t give 2021 guidance, but I just want to make sure I heard that correctly?

Roop Lakkaraju: Yes, that’s right. Hey, Max, this is Roop. That’s right. We kind of indicated that based on kind of macro and different sector kind of trends. Right now, we expect it to be generally flat through the first half.

Maxwell Michaelis: And is that based off of Q4 numbers or Q3 revenue?

Roop Lakkaraju: No. I think it’s Q4 effectively.

Maxwell Michaelis: Okay. And then — so my second question is going to be just looking at medical, wasn’t that expected to be down quarter-over-quarter? I was wondering if you’re seeing any slowdown or maybe pushouts from electrosurgeries and then maybe that’s playing a part in the sequential decline?

Jeffrey Benck: There’s a couple of dynamics still on in medical. We’ve seen — obviously, through the pandemic, there was quite a bit of slowdown in that area. And then after that, we saw a lot of catch-up in places where we play, for example, in the defibrillator market as well, which really is an electro-surgery related. But stadiums, airports, places that people aren’t going really wasn’t seeing the demand, right, for those kind of devices. Well, that’s an example where there was quite a catch-up, and we saw really substantial growth over the last two years as we got more normalized. So I think what we see is just sort of a modulation here where it’s still — demand is still solid, but we do see pockets where folks who have been a little more careful given the macroeconomic and they’re saying, okay, we’re going to watch this closely and maybe rebalance a little bit.

But I won’t say we see electro-surgery devices that might play in there necessarily being uniquely slower than previously. I think there’s a little bit of — there was an element of catch-up and now we’re sort of catching our wind here and things are flattening a bit, and then we’ll see where we go from here. But we feel — we’re bullish long term on the sector just given the growth in outsourcing that it really is poised to continue.

Maxwell Michaelis: And then just looking at supply chain premiums, they were down, I think, about $1 million from Q2. Was just wondering if you’re seeing any material changes going into Q4, maybe if that’s more of a first half 2024 story. It just doesn’t seem like the macro is picking up — the supply chain, I should say, is picking up as quick as maybe we thought it was more or less in the first half of the year?

Roop Lakkaraju: Yes, Max. I mean supply chain premiums, we anticipated coming down. They have come down sequentially throughout 2023, and obviously, on a year-over-year basis, are considerably down. So we do expect that to continue into the future in terms of that supply chain premium value coming down.

Jeffrey Benck: I also would just add to Roop’s comments. This is Jeff. Really just customers — the supply chain is incrementally better. It’s better this quarter than it was last quarter. We see less need for customers to necessarily have to look at paying a premium to get a product that others would have got. So we still that modulate. There’s still some areas where there’s constraints. It’s hard to believe that two years later, we do still see supply chain constraints in some small pockets here and there, but it’s dramatically better, which is really a direct reflection, as Roop said, of why we see those supply chain premiums going down so substantially. As we think about next year, we think we could see things really get back to normal where it’s a few million a quarter, not anywhere near where we’ve been.