BENCHMARK ELECTRONICS INC annual report, FY2016

Benchmark Electronics, Inc. — FY 2016 Form 10-K

Reporting period: Fiscal year ended December 31, 2016. This is an annual report, not a standalone fourth-quarter filing; quarterly figures are included below where relevant. Benchmark provides global electronics manufacturing, engineering and precision technology services to OEMs.

Financial performance

Metric	FY 2016	FY 2015
Sales	$2,310.4 million	$2,540.9 million
Gross profit / margin	$213.5 million / 9.2%	$219.3 million / 8.6%
Operating income / margin	$75.6 million / 3.3%	$93.0 million / 3.7%
Net income	$64.0 million	$95.4 million
Diluted EPS	$1.29	$1.83
Cash from operations	$272.5 million	$146.8 million
Capital expenditures on property and equipment	$30.5 million	$37.1 million

Sales fell 9% year over year. Gross margin improved, primarily from a greater mix of higher-value markets and operational and capacity-alignment initiatives; lower utilization from reduced sales partly offset those benefits. Operating income and net income declined despite the higher gross margin. FY 2016 income tax expense was $4.1 million, versus a $5.4 million tax benefit in 2015; the comparison was affected by discrete tax benefits in both years.

Fourth quarter: Sales were $607.5 million, gross profit $57.5 million and net income $18.6 million; diluted EPS was $0.37. In Q4 2015, sales were $625.7 million, gross profit $56.9 million, net income $39.4 million and diluted EPS $0.77. The filing attributes the unusually strong Q4 2015 net income in part to discrete tax benefits; it does not provide a directly comparable adjusted quarterly result.

Liquidity, debt and capital allocation

• Year-end cash and cash equivalents were $681.4 million, including $626.2 million held outside the U.S. and intended to be permanently reinvested abroad. Working capital was $1.12 billion.
• Cash from operations was $272.5 million. Operating cash flow included favorable working-capital movements, notably a $76.0 million increase in accounts payable. Property and equipment additions were $30.5 million.
• Term-loan borrowings were $218.5 million; $197.9 million remained available under the revolving facility, after $2.1 million in letters of credit. The filing reports $223.6 million of total debt and capital-lease obligations net of debt issuance costs on the selected balance-sheet data; the debt note reports $226.6 million of principal, including capital leases.
• The term loan matures in 2020 and bears variable-rate interest; a $163.9 million interest-rate swap hedged part of the exposure. The company reported compliance with its credit covenants.
• Benchmark repurchased 2.0 million shares for $41.9 million in 2016. It had $92.8 million remaining under a separate $100 million repurchase authorization at year-end. It did not pay cash dividends and did not expect to do so in the foreseeable future.
• Management expected 2017 capital expenditures of approximately $45–$55 million and believed available cash and operating cash flows would meet liquidity needs over the next 12 months.

Material changes and management commentary

• Sales to higher-value markets—industrials, medical, and testing and instrumentation—rose to 64% of sales from 55% in 2015. Management’s long-term goal is to exceed 70%.
• Industrials sales increased 7% to $874.5 million, primarily reflecting the Secure Technology acquisition; testing and instrumentation increased 9% to $243.8 million. Telecommunications fell 33% to $401.3 million, largely due to a maturing, non-recurring customer program and weaker orders. Computing declined 19% to $444.6 million; medical decreased 1% to $346.2 million.
• Secure Technology was acquired in November 2015 for an adjusted purchase price of $219.8 million, financed with term-loan borrowings. The acquisition added engineering capabilities and expanded exposure to regulated industrial, aerospace and defense markets.
• Restructuring charges and other costs totaled $12.5 million in 2016. These included $4.7 million of restructuring charges, $4.3 million related to a proxy contest, $3.0 million related to the former CEO’s separation, and integration and other costs.
• Year-end backlog was approximately $1.8 billion, compared with $1.7 billion a year earlier. Management cautioned that backlog is not a meaningful indicator of future results because orders can be canceled, changed or delayed and customers generally do not commit to long-term schedules.

Outlook, risks and contingencies

• The filing gives no specific revenue or earnings guidance. Management’s stated outlook includes 2017 capital expenditures of $45–$55 million and an expectation to fill substantially all year-end backlog during 2017, subject to customer changes and cancellations.
• Key operating risks include volatile customer demand, short order lead times, reliance on major customers, component shortages and price increases, competitive pricing, and underutilized capacity. The ten largest customers represented 43% of 2016 sales; no single customer accounted for 10% or more.
• International operations generated 47% of sales. Risks include currency, political and regulatory changes, trade restrictions, tax exposure, and potential limits or taxes on repatriating foreign cash. The company also noted that proposed U.S. trade or tax changes could affect its global manufacturing model.
• The company disclosed a $4.4 million claim against three subsidiaries in the GT Advanced Technologies bankruptcy proceedings to recover payments as alleged preferential or fraudulent transfers. Benchmark said it intended to defend the claims; the outcome could not be predicted.
• Other significant risks include variable interest rates, government-contract funding and compliance, product defects and regulatory compliance, cybersecurity and business interruptions, natural disasters, and possible impairment of goodwill or other acquired assets.
• A new revenue-recognition standard was expected to change most manufacturing sales from point-in-time to over-time recognition. Benchmark anticipated a potentially material effect on the timing of reported revenue and planned to adopt the standard in 2018.
• KPMG issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal control; no material control change during the final quarter was reported.

Important facts for investors to verify

• Whether the higher-value-market mix shift and margin improvement can continue as lower telecommunications and computing demand evolves.
• How much 2016 operating cash flow reflected sustainable earnings versus working-capital timing, particularly the increase in accounts payable.
• The debt repayment schedule, variable-rate exposure, swap terms, covenant headroom, and restrictions on repurchases or distributions.
• The status and potential financial exposure of the GTAT bankruptcy claims and any subsequent developments.
• The quantified effects and transition presentation for the 2018 revenue-recognition standard.
• The sustainability of foreign tax incentives, the treatment of $846 million in undistributed foreign subsidiary earnings, and potential repatriation costs.