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BENCHMARK ELECTRONICS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) References in this report to "the Company," "Benchmark," "we," or "us" mean Benchmark Electronics, Inc. together with its subsidiaries. The following discussion and analysis contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). These forward-looking statements are identified as any statement that does not relate strictly to historical or current facts. They use words such as "anticipate," "believe," "intend," "plan," "projection," "forecast," "strategy," "position," "continue," "estimate," "expect," "may," "will" or the negative of those terms or other variations of them or comparable terminology. In particular, statements, express or implied, concerning future operating results or the ability to generate sales, income or cash flow are forward-looking statements. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions, including those discussed under Part II, Item 1A of this report. The future results of our operations may differ materially from those expressed in these forward-looking statements. Many of the factors that will determine these results are beyond our ability to control or predict. Undue reliance should not be placed on any forward-looking statements. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated. The following discussion should be read in conjunction with the Condensed Consolidated Financial Statements and accompanying notes, and our 2013 10-K. OVERVIEW We are a worldwide provider of integrated manufacturing services. We provide our services to OEMs of computers and related products for business enterprises, medical devices, industrial control equipment (including equipment for the aerospace and defense industry), testing and instrumentation products, and telecommunication equipment. The services that we provide are commonly referred to as electronics manufacturing services or EMS. We offer our customers comprehensive and integrated design and manufacturing services from initial product design to volume production, including direct order fulfillment and post deployment services. Our manufacturing and assembly operations include printed circuit boards and subsystem assembly, box build, and systems integration, which is the process of integrating subsystems and, often, downloading and integrating software, to produce a fully configured product. Our precision technology manufacturing capabilities complement our proven EMS expertise by providing further vertical integration of critical mechanical components. These capabilities include precision machining, advanced metal joining, and functional testing for multiple industries including medical, instrumentation, aerospace and semiconductor capital equipment. We also are able to provide specialized engineering services, including product design, prototyping, and test development. We believe that we have developed strengths in the manufacturing process for large, complex, high-density printed circuit boards as well as the ability to manufacture high and low volume products in lower cost regions such as China, Malaysia, Mexico, Romania and Thailand. As our customers have continued to expand their globalization strategy, we have continued to make the necessary changes to align our business operations with their demand. In support of our growth, we make acquisitions from time to time that expand our global reach, customer access and product capabilities. We believe that our global manufacturing presence increases our ability to be responsive to our customers' needs by providing accelerated time-to-market and time-to-volume production of high quality products. These capabilities enable us to build stronger strategic relationships with our customers and to become a more integral part of their operations. Our customers face challenges in planning, procuring and managing their inventories efficiently due to customer demand fluctuations, product design changes, short product life cycles and component price fluctuations. We employ production management systems to manage their procurement and manufacturing processes in an efficient and cost-effective manner so that, where possible, -------------------------------------------------------------------------------- components arrive on a just-in-time, as-and-when-needed basis. We are a significant purchaser of electronic components and other raw materials, and can capitalize on the economies of scale associated with our relationships with suppliers to negotiate price discounts, obtain components and other raw materials that are in short supply, and return excess components. Our expertise in supply chain management and our relationships with suppliers across the supply chain enable us to reduce our customers' cost of goods sold and inventory exposure. We recognize revenue from the sale of manufactured products built to customer specifications and excess inventory when title and risk of ownership have passed, the price to the buyer is fixed or determinable and collectibility is reasonably assured, which generally is when the goods are shipped. Revenue from design, development and engineering services is recognized when the services are performed and collectibility is reasonably certain. Such services provided under fixed price contracts are accounted for using the percentage-of-completion method. We generally assume no significant obligations after product shipment as we typically warrant workmanship only. Therefore, our warranty provisions are generally not significant. Our cost of sales includes the cost of materials, electronic components and other items that comprise the products we manufacture, the cost of labor and manufacturing overhead and adjustments for excess and obsolete inventory. Our procurement of materials for production requires us to commit significant working capital to our operations and to manage the purchasing, receiving, inspection and stocking of materials. Although we bear the risk of fluctuations in the cost of materials and excess scrap, we periodically negotiate cost of materials adjustments with our customers. Our gross margin for any product depends on the sales price, the proportionate mix of the cost of materials in the product and the cost of labor and manufacturing overhead allocated to the product. We typically have the potential to realize higher gross margins on products where the proportionate level of labor and manufacturing overhead is greater than that of materials. As we gain experience in manufacturing a product, we usually achieve increased efficiencies, which result in lower labor and manufacturing overhead costs for that product and higher gross margins. Our operating results are impacted by the level of capacity utilization of our manufacturing facilities. Operating income margins typically improve during periods of high production volume and high capacity utilization. During periods of low production volume, we generally have idle capacity and reduced operating income margins. Recent Acquisitions On June 3, 2013, we completed the Suntron Acquisition, which strengthened our capabilities and global reach to better serve our customers in the aerospace and defense industries. On October 2, 2013, we completed the CTS Acquisition, which expanded our portfolio of customers in non-traditional and highly regulated markets and strengthened the depth and scope of our new product express capabilities on the West Coast. -------------------------------------------------------------------------------- Summary of 2014 Results Sales for the three months ended September 30, 2014, increased 22% to $731.3 million compared to $599.7 million for the same period of 2013. During the three months ended September 30, 2014, sales to customers in our various industry groups fluctuated from the comparable 2013 period as follows: † computers and related products for business enterprises industry decreased by 14%, † industrial control equipment industry increased by 20%, † telecommunication equipment industry increased by 91%, † medical devices industry increased by 12%, and † testing and instrumentation products industry increased by 2%. The overall increase in sales related primarily to increased demand from existing customers, including new programs, new customers and the impact of the CTS Acquisition. Our future sales depend on the success of our customers, some of which operate in businesses associated with rapid technological change and consequent product obsolescence. Developments adverse to our major customers or their products, or the failure of a major customer to pay for components or services, could have an adverse effect on us. A substantial percentage of our sales have been made to a small number of customers, and the loss of a major customer, if not replaced, would adversely affect us. Sales to our ten largest customers represented 51% and 52% of our sales in the three months ended September 30, 2014 and 2013, respectively. Sales to our two largest customers, which individually accounted for greater than 10% of our net sales, represented 25% of our sales during three months ended September 30, 2014. In 2013, our largest customer, the only customer to account for greater than 10% of our net sales, represented 15% of our sales during the three months ended September 30, 2013. For the three months ended September 30, 2014, we incurred a $2.3 million charge for the write-down of inventory associated with the bankruptcy filing of GT Advanced Technologies on October 6, 2014. Including the inventory charge, gross profit as a percentage of sales was 7.6% for the three months ended September 30, 2014. Excluding this inventory charge, gross profit as a percentage of sales increased to 7.9% for three months ended September 30, 2014 from 7.6% for the same period of 2013, primarily due to higher sales volumes, changes in the mix of programs and the impact of the CTS Acquisition. We experience fluctuations in gross profit from period to period. Different programs contribute different gross profits depending on factors such as the types of services involved, location of production, size of the program, complexity of the product and level of material costs associated with the various products. Moreover, new programs can contribute relatively less to our gross profit in their early stages when manufacturing volumes are usually lower, resulting in inefficiencies and unabsorbed manufacturing overhead costs. In addition, a number of our new and higher volume programs remain subject to competitive constraints that could exert downward pressure on our margins. During periods of low production volume, we generally experience idle capacity and reduced gross profit. Selling, general and administrative expenses (SG&A) increased by 27% to $31.2 million in the third quarter of 2014 compared to $24.5 million in the same quarter of 2013. These increases were primarily attributable to the Suntron and CTS Acquisitions, support of increased sales volumes and a $2.7 million charge for provisions to accounts receivable associated with the GT Advance Technologies bankruptcy filing. Including the provisions to accounts receivable associated with the referenced bankruptcy, SG&A as a percentage of sales was 4.3% for the three months ended September 30, 2014. Excluding the provisions to accounts receivable associated with the referenced bankruptcy, SG&A, as a percentage of sales, decreased to 3.9% for the third quarter of 2014 from 4.1% from the same quarter of 2013. The decrease in SG&A as a percentage of sales related primarily to the increased sales volumes. -------------------------------------------------------------------------------- We have undertaken initiatives to restructure our business operations with the intention of improving utilization and realizing cost savings. During the nine months ended September 30, 2014, we recognized $6.2 million of restructuring charges and integration and acquisition-related costs, primarily related to integration costs of the CTS Acquisition. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Management's discussion and analysis is based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. Our significant accounting policies are summarized in Note 1 to the Consolidated Financial Statements included in our 2013 10-K. See Note 11 to the Condensed Consolidated Financial Statements for a discussion of recently enacted accounting principles. RESULTS OF OPERATIONS The following table presents the percentage relationship that certain items in our Condensed Consolidated Statements of Income bear to sales for the periods indicated. The financial information and the discussion below should be read in conjunction with the Condensed Consolidated Financial Statements and Notes thereto in Item 1 of this report. Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Sales 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales 92.4 92.4 92.1 92.8 Gross profit 7.6 7.6 7.9 7.2 Selling, general and administrative expenses 4.3 4.1 4.2 4.0 Restructuring charges and integration and acquisition-related costs 0.3 0.2 0.3 0.4 Asset impairment charge and other - 0.0 - 0.1 Thailand flood related items - (1.6) (0.1) (0.6) Income from operations 3.0 4.9 3.4 3.2 Other income, net (0.1) 0.1 (0.0) 0.0 Income before income taxes 2.9 5.0 3.4 3.2 Income tax expense 0.5 1.1 0.6 0.7 Net income 2.3 % 4.0 % 2.8 % 2.5 % -------------------------------------------------------------------------------- Sales Sales for the third quarter of 2014 were $731.3 million, a 22% increase from sales of $599.7 million for the same quarter in 2013. Sales for the first nine months of 2014 were $2.1 billion, a 19% increase from sales of $1.7 billion for the same period in 2013. The increase in sales resulted primarily from increased demand from existing customers, including new programs, new customers and the impact of the Suntron and CTS Acquisitions. The following table sets forth, for the periods indicated, the percentages of our sales by industry sector. Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Computers and related products for business enterprises 21 % 30 % 21 % 28 % Industrial control equipment 30 31 29 29 Telecommunication equipment 32 20 29 23 Medical devices 10 11 11 12 Testing and instrumentation products 7 8 10 8 100 % 100 % 100 % 100 % Computers and Related Products for Business EnterprisesSales to customers in the computers and related products for business enterprises industry for the third quarter of 2014 decreased 14% to $155.5 million from $180.6 million for the same quarter of 2013, and decreased 12% to $433.9 million during the first nine months of 2014 from $494.3 million in the same period of 2013. The decrease is primarily due to the timing of program transitions as well as lower demand from our customers. Industrial Control Equipment Sales to customers in the industrial control equipment industry (including equipment for the aerospace and defense industry) for the third quarter of 2014 increased 20% to $219.0 million from $181.9 million for the same quarter of 2013, and increased 20% to $615.9 million during the first nine months of 2014 from $512.9 million in the same period of 2013, primarily as a result of increased demand from existing customers, including new programs, and the impact of the Suntron and CTS Acquisitions. Telecommunication Equipment Sales to customers in the telecommunication equipment industry for the third quarter of 2014 increased 91% to $230.8 million from $120.7 million for the same quarter of 2013, and increased 52% to $605.5 million during the first nine months of 2014 from $397.3 million in the same period of 2013. The increase is primarily due to new programs, increased demand from existing customers and the impact of the CTS Acquisition. Medical Devices Sales to customers in the medical devices industry for the third quarter of 2014 increased 12% to $76.0 million from $67.6 million for the same quarter of 2013, and increased 10% to $229.9 million during the first nine months of 2014 from $208.9 million in the same period of 2013, primarily as a result of new programs, and, to a lesser extent, the impact of the CTS Acquisition. Testing and Instrumentation Products Sales to customers in the testing and instrumentation products industry for the third quarter of 2014 increased 2% to $50.0 million from $48.8 million for the same quarter of 2013, and increased 49% to $202.3 million during the first nine months of 2014 from $136.2 million in the same period of 2013 due to new programs, slight improvement in the semiconductor industry, and the impact of the Suntron Acquisition. Sales to our ten largest customers represented 51% and 52% of our sales in the nine months ended -------------------------------------------------------------------------------- September 30, 2014 and 2013, respectively. Sales to our two largest customers, which individually accounted for greater than 10% of our net sales, represented 23% of our sales during the nine months ended September 30, 2014. In 2013, our largest customer, the only customer to account for greater than 10% of our net sales, represented 16% of our sales during the nine months ended September 30, 2013. Our international operations are subject to the risks of doing business abroad. See Part I, Item 1A of our 2013 10-K for factors pertaining to our international sales and fluctuations in the exchange rates of foreign currency and for further discussion of potential adverse effects in operating results associated with the risks of doing business abroad. During the first nine months of both 2014 and 2013, 52% of our sales were from our international operations. Gross Profit Gross profit increased 22% to $55.3 million for the three months ended September 30, 2014 from $45.4 million in the same quarter of 2013, and increased 30% to $164.2 million for the nine months ended September 30, 2014 from $126.6 million in the same period of 2013. For the three months ended September 30, 2014, we incurred a $2.3 million charge for the write-down of inventory associated with the bankruptcy of GT Advanced Technologies. Including the inventory charge, gross profit as a percentage of sales was 7.6% for the three months ended September 30, 2014, and 7.9% for the nine months ended September 30, 2014. Excluding this inventory charge, gross profit as a percentage of sales increased to 7.9% for the three months ended September 30, 2014 from 7.6% in the same period of 2013, and increased to 8.0% for the nine months ended September 30, 2014 from 7.2% in the same period of 2013. These increases are primarily due to higher sales volumes, changes in the mix of programs and the impact of the acquisitions. We experience fluctuations in gross profit from period to period. Different programs contribute different gross profits depending on factors such as the types of services involved, location of production, size of the program, complexity of the product and level of material costs associated with the various products. Moreover, new programs can contribute relatively less to our gross profit in their early stages when manufacturing volumes are usually lower, resulting in inefficiencies and unabsorbed manufacturing overhead costs. In addition, a number of our new and higher volume programs remain subject to competitive constraints that could exert downward pressure on our margins. During periods of low production volume, we generally have idle capacity and reduced gross profit. Selling, General and Administrative Expenses SG&A increased by 27% to $31.2 million in the third quarter of 2014 compared to $24.5 million in the same quarter of 2013, and increased by 25% to $88.1 million in the first nine months of 2014 compared to $70.2 million in the same period of 2013. These increases were primarily attributable to the Suntron and CTS Acquisitions, support of increased sales volumes and a $2.7 million charge for provisions to accounts receivable associated with the GT Advance Technologies bankruptcy filing. Including the provisions to accounts receivable associated with the referenced bankruptcy, SG&A as a percentage of sales was 4.3% for the three months ended September 30, 2014 and 4.2% for the nine months ended September 30, 2014. Excluding the provisions to accounts receivable associated with the referenced bankruptcy, SG&A, as a percentage of sales, decreased to 3.9% for the third quarter of 2014 from 4.1% from the same quarter of 2013. The decrease in SG&A as a percentage of sales related primarily to the increased sales volumes. Excluding the provisions to accounts receivable associated with the referenced bankruptcy, SG&A, as a percentage of sales, was 4.1% and 4.0%, respectively, for the first nine months of 2014 and 2013, respectively. The increase in SG&A as a percentage of sales related primarily to the impact of the Suntron and CTS Acquisitions. -------------------------------------------------------------------------------- Restructuring Charges and Integration and Acquisition-Related Costs During the nine months ended September 30, 2014, we recognized $6.2 million of restructuring charges and integration and acquisition-related costs, primarily related to integration costs of the CTS Acquisition. See Note 12 and Note 16 to the Condensed Consolidated Financial Statements in Item 1 of this report. Thailand Flood Related Items During the three months ended March 31, 2014, we received $1.6 million of insurance proceeds. The recovery process with our insurance carriers is complete. See Note 14 to the Condensed Consolidated Financial Statements in Item 1 of this report. Income Tax Expense Income tax expense of $12.4 million represented an effective tax rate of 17.5% for the nine months ended September 30, 2014, compared with $12.7 million that represented an effective tax rate of 22.6% for the same period in 2013. We had a tax incentive in China that expired at the end of 2012, but was extended in the first quarter of 2014 until 2015 and retroactively applied to the 2013 calendar year. The tax adjustment for the $1.2 million retroactive incentive for 2013 was recorded as a discrete tax benefit as of March 31, 2014. In 2013, we recorded a discrete tax benefit of approximately $0.8 million related to the American Taxpayer Relief Act of 2012 (the ATRA) consisting of research and experimentation credits and decreases in U.S. taxable income related to previously taxed foreign transactions. The ATRA retroactively restored the research and experimentation credit and other U.S. income tax benefits for 2012 and extended these provisions through the end of 2013. Excluding these tax items, the effective tax rate would have been 19.2% in 2014 compared to 24.1% in 2013. The decrease in the effective tax rate results primarily from the new tax incentive granted in China for 2014 and higher taxable income in geographies with lower tax rates. We have been granted certain tax incentives, including tax holidays, for our subsidiaries in China, Malaysia and Thailand that will expire at various dates, unless extended or otherwise renegotiated, through 2015 in China and Malaysia, and 2026 in Thailand. See Note 7 to the Condensed Consolidated Financial Statements in Item 1 of this report. Net Income We reported net income of $58.4 million, or diluted earnings per share of $1.07 for the first nine months of 2014, compared with net income of $43.7 million, or diluted earnings per share of $0.80 for the same period of 2013. The net increase of $14.7 million from 2013 was primarily due to the factors discussed above. LIQUIDITY AND CAPITAL RESOURCES We have historically financed our growth and operations through funds generated from operations and proceeds from the sale and maturity of our investments. Cash and cash equivalents totaled $420.2 million at September 30, 2014 and $345.6 million at December 31, 2013, of which $362.4 million at September 30, 2014 and $307.3 million at December 31, 2013 was held outside the U.S. in various foreign subsidiaries. Substantially all of the amounts held outside of the U.S. are intended to be permanently reinvested in foreign operations. Under current tax laws and regulations, if cash and cash equivalents held outside the U.S. were to be distributed to the U.S. in the form of dividends or otherwise, we would be subject to additional U.S. income taxes and foreign withholding taxes. Cash provided by operating activities was $113.9 million for the nine months ended September 30, 2014, which included $1.1 million of Thailand flood insurance recoveries. The cash provided by operations during 2014 consisted primarily of $58.4 million of net income adjusted for $34.0 million of depreciation and amortization, a $24.7 million decrease in accounts receivable and a $17.5 million increase in accounts payable offset by a $38.6 million increase in inventories. The decrease in accounts receivable was primarily driven by the fluctuation of sales from the fourth quarter of 2013 to the third quarter of 2014. Inventories have increased in support of higher business levels in 2014. Working capital was $1,005.5 million at -------------------------------------------------------------------------------- September 30, 2014 and $944.5 million at December 31, 2013. We are continuing the practice of purchasing components only after customer orders or forecasts are received, which mitigates, but does not eliminate, the risk of loss on inventories. Supplies of electronic components and other materials used in operations are subject to industry-wide shortages. In certain instances, suppliers may allocate available quantities to us. If shortages of these components and other material supplies used in operations occur, vendors may not ship the quantities we need for production and we may be forced to delay shipments, which would increase backorders and therefore impact cash flows. Cash used in investing activities was $24.6 million for the nine months ended September 30, 2014 primarily due to purchases of additional property, plant and equipment totaling $35.7 million offset by $10.1 million from the redemptions of investments. Purchases of additional property, plant and equipment were primarily of machinery and equipment in the Americas. Cash used in financing activities was $13.2 million for the nine months ended September 30, 2014. Share repurchases totaled $25.0 million, and we received $11.7 million from the exercise of stock options. Under the terms of the Credit Agreement, we have a $200.0 million five-year revolving credit facility to be used for general corporate purposes with a maturity date of July 30, 2017. The Credit Agreement includes an accordion feature pursuant to which total commitments under the facility may be increased by an additional $100 million, subject to satisfaction of certain conditions and lender approval. Interest on outstanding borrowings under the Credit Agreement is payable quarterly, at our option, at LIBOR plus 1.75% to 2.75% or a prime rate plus 0.75% to 1.75%, based upon our leverage ratio as specified in the Credit Agreement. A commitment fee of 0.30% to 0.40% per annum (based upon our liquidity ratio) on the unused portion of the revolving credit line is payable quarterly in arrears. As of September 30, 2014 and December 31, 2013, we had no borrowings outstanding under the Credit Agreement, $1.2 million and $0.8 million, respectively, in outstanding letters of credit and $198.8 million and $199.2 million, respectively, was available for future borrowings. The Credit Agreement is secured by our domestic inventory and accounts receivable, 100% of the stock of our domestic subsidiaries, 65% of the voting capital stock of each direct foreign subsidiary, and substantially all of our and our domestic subsidiaries' other tangible and intangible assets. The Credit Agreement contains customary financial covenants as to debt leverage and fixed charges, and restricts our ability to incur additional debt, pay dividends, repurchase shares, sell assets and merge or consolidate with other persons. As of both September 30, 2014 and December 31, 2013, we were in compliance with all of these covenants and restrictions. Our operations, and the operations of businesses we acquire, are subject to certain foreign, federal, state and local regulatory requirements relating to environmental, waste management, health and safety matters. We believe we operate in substantial compliance with all applicable requirements and we seek to ensure that newly acquired businesses comply or will comply substantially with applicable requirements. To date, the costs of compliance and workplace and environmental remediation have not been material to us. However, material costs and liabilities may arise from these requirements or from new, modified or more stringent requirements in the future. In addition, our past, current and future operations, and the operations of businesses we have or may acquire, may give rise to claims of exposure by employees or the public, or to other claims or liabilities relating to environmental, waste management or health and safety concerns. As of September 30, 2014, we had cash and cash equivalents totaling $420.2 million and $198.8 million available for borrowings under the Credit Agreement. During the next twelve months, we believe our capital expenditures will be approximately $45 million to $55 million, principally for machinery and -------------------------------------------------------------------------------- equipment to support our ongoing business around the globe. On June 13, 2012, our Board of Directors approved the repurchase of up to $100 million of our outstanding common shares (the 2012 Repurchase Program). As of September 30, 2014, we had $21.8 million remaining under the 2012 Repurchase Program. We are under no commitment or obligation to repurchase any particular amount of common shares. Management believes that our existing cash balances and funds generated from operations will be sufficient to permit us to meet our liquidity requirements over the next 12 months. Management further believes that our ongoing cash flows from operations and any borrowings we may incur under our credit facilities will enable us to meet operating cash requirements in future years. Should we desire to consummate significant acquisition opportunities, our capital needs would increase and could possibly result in our need to increase available borrowings under our Credit Agreement or access public or private debt and equity markets. There can be no assurance, however, that we would be successful in raising additional debt or equity on terms that we would consider acceptable. CONTRACTUAL OBLIGATIONS We have certain contractual obligations for operating leases that were summarized in a table of Contractual Obligations in our 2013 10-K. There have been no material changes to our contractual obligations, outside of the ordinary course of our business, since December 31, 2013. OFF-BALANCE SHEET ARRANGEMENTS As of September 30, 2014, we did not have any significant off-balance sheet arrangements. -------------------------------------------------------------------------------- |