Benchmark Electronics - Q2 2024

Executive Summary

• Q2 revenue was $666M, above the high end of guidance, with non-GAAP gross margin at 10.2% and non-GAAP operating margin at 5.1%; non-GAAP EPS was $0.57, above guidance, driven by A&D (+36% YoY) and Semi-Cap (+5% YoY) strength offsetting Medical (-23%) and AC&C (-26%) weakness.
• Free cash flow was $47M, supported by a $38M sequential inventory reduction; management raised FY24 free cash flow outlook to greater than $120M and noted the company returned to net cash positive in Q2.
• Q3 guidance: revenue $630–$670M; non-GAAP EPS $0.52–$0.58; non-GAAP gross margin ~10%; SG&A $33–$35M; other expenses net ~ $6M; tax rate 22–24%.
• Dividend increased to $0.17 per share from $0.165; buybacks expected to resume in coming periods, while near-term capital allocation emphasizes debt reduction.
• Catalysts: raised FY24 FCF guidance, dividend increase, Semi-Cap share gains and capacity additions (Penang, Mexico, Romania), sequential growth expected in A&D and Semi-Cap into H2; AC&C and Medical remain headwinds near term.

What Went Well and What Went Wrong

What Went Well

• “Total revenue of $666 million was above the high end of our guidance range… non-GAAP operating margin of 5.1%… $0.57 in non-GAAP EPS, also above the high end of guidance”.
• A&D revenue up 36% YoY and +3% QoQ; improving supply chain enabled demand fulfillment; strong wins across defense and commercial aerospace.
• Working capital execution: inventory down $38M sequentially, enabling $56M operating cash flow and $47M free cash flow; FY24 FCF raised to >$120M.

What Went Wrong

• Medical revenue down 23% YoY on OEM inventory rebalancing and end-demand normalization; management expects softness to persist through H2’24 before recovery in 2025.
• AC&C down 26% YoY and 11% QoQ due to completion of several large HPC programs and communications weakness, including customer disengagement; pressures expected through H2’24.
• Industrial down 15% YoY; broad demand softness among existing programs despite new wins; return to YoY growth expected exiting 2024.

Transcript

Operator (participant)

Good day, everyone, and welcome to today's Benchmark Q2 2024 earnings call and webcast. At this time, all participants are in a listen-only mode. Later, you will have the opportunity to ask questions during the question and answer session. Please note, today's call will be recorded, and I will be standing by should you need any assistance. It is now my pleasure to turn the conference over to Paul Manske with Investor Relations at Benchmark Electronics. Please go ahead.

Paul Manske (Investor Relations)

Thank you, Chloe, and thanks everyone for joining us today for Benchmark's Q2 2024 earnings call. Joining me this afternoon are Jeff Benck, CEO and President, and Arvind Kamal, Interim CFO. After the market closed today, we issued an earnings release pertaining to our financial performance for the Q2 of 2024, and we have prepared a presentation that we'll reference on this call. Both are available online under the Investor Relations section of our website at bench.com. This call is being webcast live, and a replay will be available online following the call. The company has provided a reconciliation of our GAAP to non-GAAP measures in this earnings release, as well as in the appendix to the presentation. Please take a moment to review the forward-looking statements disclosure on slide 2 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. Benchmark undertakes no obligation to update any forward-looking statements. For today's call, Jeff will begin by providing a summary of our Q2 performance. Arvind will then discuss our detailed financial results and provide our Q3 guidance. Jeff will then return to share more insight into demand trends by sector, new business wins, and close with some final remarks. If you'll please turn to slide three, I will turn the call over to our CEO, Jeff Benck.

Jeff Benck (CEO)

Thank you, Paul. Good afternoon, and thanks to everyone joining our call today. Our outstanding Q2 results are another proof point of our consistent progress to our long-term operating objectives. We met or exceeded our guidance range for revenue, margin, non-GAAP EPS, and free cash flow. Let me step through a few highlights. Total revenue of $666 million was above the high end of our guidance range. We are pleased with the sequential and year-over-year strength in A&D and Semicap, which, despite anticipated softness in Industrials, Medical, and Advanced Computing and Communications sectors, allowed us to outperform on revenue. Our non-GAAP gross margins again exceeded 10%, marking the sixth consecutive quarter of year-over-year margin expansion. Our non-GAAP operating margin of 5.1% was above the high end of our guidance. This represents a 60 basis points expansion year-over-year.

This margin performance, coupled with the revenue upside, enabled us to deliver $0.57 in non-GAAP earnings per share in the quarter, also above the high end of guidance. At the same time, we continue to benefit from the working capital initiatives we put in place last year. Notably, Q2 inventory was down $38 million versus last quarter, which was a key enabler to us being able to deliver positive free cash flow of $47 million. We have now generated over $230 million in free cash flow over the last four quarters. Although there's work left to be done, I'm pleased with our team's consistent execution and the results that they delivered. Now, let me pass it over to Arvind to share more details on the June quarter and guidance for Q3 2024.

Arvind Kamal (CFO)

Thank you, Jeff, and good afternoon. Please turn to slide 5 for our revenue by market sector. As Jeff mentioned, our total revenue in Q2 was $666 million. Semi-Cap revenue increased 5% year-over-year. We continue to see signs of improvement in the market and are well positioned to capitalize on it. Industrial revenue decreased 15%. The decline was driven by reduced demand from existing customers, partially offset by new program ramps. We believe we'll return to year-on-year growth in this sector as we exit this year. Medical revenue was down 23%. We continue to see inventory rebalancing and end demand weakness impacting Medical devices. This will take at least a few more quarters to work through. A&D revenue was up 36%. Commercial aerospace demand remains strong, both within aviation and space applications.

Meanwhile, we continue to see robust demand within defense, where we're benefiting from existing program ramps and the launch of new programs. We expect this to continue throughout the balance of the year. Finally, as we mentioned last quarter, going forward, we'll be reporting Advanced Computing and Next Generation Communications as one sector or AC&C. This aligns more closely with how we manage these sectors internally. AC&C decreased 26% year-over-year. This decline was driven by several large HPC programs being completed earlier in the year, coupled with continued weakness in our communications business. Please turn to slide 6. Our GAAP earnings per share for the quarter was $0.43. Our non-GAAP EPS was $0.57, which exceeded the high end of our guidance range of $0.48-$0.54.

As a reminder, our non-GAAP results exclude stock-based compensation, amortization of intangible assets, and restructuring expenses. For Q2, our non-GAAP gross margin was 10.2%. This represents a 20 basis points increase sequentially, and a 100 basis points increase year-over-year. Non-GAAP SG&A expense was $33.8 million, down 3% sequentially and down 1% year-over-year. Non-GAAP operating margin was 5.1%, up 20 basis points sequentially and up 60 basis points year-over-year, driven by gross margin expansion. Our Q2 non-GAAP effective tax rate was 4.23%. Non-GAAP ROIC in the Q2 was 9.9%. Please turn to Slide 7 for trended financials on a non-GAAP basis.

Regardless of the level of demand strength in our end markets, we maintain a sharp focus on protecting margin, which continues to expand year-on-year due to our high value focus and expense discipline. Please turn to Slide 8 for a discussion of our cash conversion cycle performance. Our cash conversion cycle days in the quarter were 90 days, compared to 94 days in Q1. This 4-day improvement was primarily driven by a $38 million reduction in inventory during the quarter. Please turn to Slide 9 for an update on liquidity. Free cash flow generation continues to be a key performance metric for the company. In Q2, we continued to execute on our working capital efficiency plan, which, combined with our net income performance, enabled us to generate $56 million in operating cash flow and $47 million of free cash flow in the period.

Given our H1 performance and forecast throughout the balance of the year, we are again raising our full-year 2024 free cash flow estimate. We now expect to deliver greater than $120 million on the year. Our cash balance on June thirtieth was $310 million, a sequential increase of $14 million. In the June quarter, we leveraged our free cash flow performance to further reduce debt by $26 million. As of June thirtieth, we had $126 million outstanding on our term loan, $165 million outstanding against our revolver, and $381 available to borrow under our revolver. As of the end of the quarter, we have returned to being net cash positive.

We invested approximately $9 million in CapEx in Q2 in support of continued growth and enhanced capabilities in both our Mexico and Penang facilities. We expect Q3 CapEx to be between $10 million and $14 million. On a full year basis, we anticipate CapEx to be in the range of $45 million-$55 million. In Q2, we paid cash dividends of $5.9 million. We did not repurchase any shares in Q2. As of June 30, we had approximately $155 million remaining in our existing share repurchase authorization. Please advance to Slide 11. Turning to guidance, we expect Q3 revenue to be in the range of $630 million-$670 million. We expect non-GAAP gross margins to be approximately 10%, consistent with last several quarters. SG&A expense is expected to be within a range of $33 million-$35 million.

Non-GAAP operating margin is expected to be between 4.8% and 5%. As a reminder, non-GAAP operating income excludes approximately $4.5 million of stock-based compensation, $1.2 million of amortization of intangible assets, and $1 million of estimated restructuring and other expenses. Our non-GAAP diluted earnings per share is expected to be in the range of $0.52-$0.58. Other expenses net are expected to be approximately $6 million. Although interest expense is expected to decline sequentially, this will be partially offset by increased foreign exchange headwinds. We expect that in Q3, our non-GAAP effective tax rate will range from 22%-24%, with a weighted average share count of approximately 36.5 million. On a fiscal year basis, we believe the average 2024 effective tax rate should be approximately 23%.

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

Jeff Benck (CEO)

Thanks, Arvind. Please turn to Slide 13. Let me start with some further color on our performance by sector. Within SemiCap, our Q2 performance was up 5% year-over-year and 4% sequentially. A bit better than our expectations entering the quarter as we continue to gain share. We're starting to see signs of recovery from existing programs within key customers, while at the same time benefiting from several new wins which are beginning to ramp. This win momentum continued in the Q2, highlighted by a large new program win at an OEM, where we're becoming a second source to support their projected growth plans. This quarter also saw us continue to build upon our engineering wins, reinforcing that we are not only a trusted supplier in building semiconductor capital equipment, but increasingly as a design partner....

We continue to be optimistic about the multiple catalysts driving future growth in the semi-cap sector, and are pursuing this with continued capital investment, as evidenced by the planned opening of our newest building in Penang, Malaysia, later this quarter. Nearer term, although some customers are still bringing inventory levels down, we believe we are in the early stages of recovery, of the market's recovery, which we will believe will enable us to grow semi-cap revenue in the low double-digit range this year. Looking to 2025, signs are pointing to the potential for a broadly improved demand environment. Given our program wins over the last several quarters, coupled with our capacity expansion, I'm confident we're in a great position to capture this opportunity and continue to gain share.

In medical, as we have seen over the last couple of quarters, end demand softness, exacerbated by OEM inventory consumption, has challenged sector performance, notably in medical devices. Our June quarter revenue is down 23% year-over-year. While in the near term, we expect these headwinds will persist, we continue to secure new program wins in manufacturing and engineering in both the medical device and biotech subsectors. Looking forward, we expect these new programs will begin to contribute as we progress through 2025. In the meantime, we expect medical sector revenue to remain consistent with current levels in the H2 of 2024. Turning to complex industrials, we continue to extend our share in key growth markets with manufacturing wins in the quarter, including test and measurement and automatic ID and data capture solutions.

Very importantly, as a sign of future growth in our industrial business, we secured over a dozen engineering wins this past quarter that we expect will lead to manufacturing wins. Industrials revenue in Q2 was down 15% year-over-year and flat sequentially. Although our new program win momentum continues, we are seeing near-term demand softness impact several of our existing programs. Like many of our peers, we expect these conditions to persist during the September quarter, with early indications of a potential return to growth exiting 2024. Turning to A&D, we had another strong quarter of revenue performance, up 36% year-over-year and 3% sequentially. Our defense business continues to see demand strength from both existing business and ramping new program wins. Continued improvement in our supply chain is also benefiting us as we are more able to fully meet demand.

Within aerospace, demand has stayed strong for several quarters, with a good balance between Commercial Air and Space applications. As an example of this, during the quarter, we won a substantial expansion of existing program with a commercial air customer, while at the same time winning multiple new manufacturing wins within the space subsector. While these are early stage, the breadth of our momentum here is encouraging. Looking at the September quarter, we expect revenue to grow solidly, both on a sequential and year-over-year basis. Given our year-to-date performance and back-half expectations, A&D revenue on a full year basis is expected to grow in excess of 20%. Total AC&C revenue declined 26% year-over-year and 11% sequentially in the June quarter.

We expect sector pressures to persist through the back half of the year, driven by the completion of several high-performance computing programs in the H1, and continued pressure in our communication subsector as a result of significant customer disengagement, as discussed last quarter. Despite the near-term revenue challenges, we continue to win significant new business in the quarter. Just to highlight one, we were awarded manufacturing for a family of wireless transport and access systems, which we expect will contribute to a return to growth in this sector in 2025. In summary, please turn to slide 14. Once again, I want to thank the Benchmark team for another solid quarter built on consistent execution and delivery. Despite the challenging market dynamics, we continue to invest in our customers' success in support of our mutual future growth.

Evidence of this is our ability to build on business with both new logos and expanding our share with existing customers, all while driving operating efficiencies to improve margins while bringing costs down for our customers. As I look at the 2025 objectives we provided back in Q4 of 2022, we continue to make steady progress on almost every metric. The one exception is revenue growth, which has been impacted by the macro environment. Despite this demand volatility, we've delivered year-on-year non-GAAP gross and operating margin expansion every quarter since introducing our 2025 target model. We're well on our way to achieving our goal of greater than 5% non-GAAP operating margin on a full year basis. Also, per our 2025 targets, we remain committed to working down inventory and driving free cash flow.

Our Q2 inventory was down $157 million year-over-year, helping us to achieve our fifth consecutive quarter of positive free cash flow. Our focus on inventory is not letting up, and we expect continued improvement. This provides us confidence to increase our free cash flow forecast for 2024 to greater than $120 million. Lastly, we committed to returning capital to investors. Today, we announced that the board has approved an increase to our regular quarterly dividend to $0.17 per share, effective immediately. Although we did not repurchase shares in the quarter, we intend to do so in coming periods. Looking a bit further out, we are seeing clear indications supporting growth across many, if not all, of our sectors during the course of 2025. A&D remains strong.

Semi-Cap is poised for re-acceleration, and we believe industrials will begin to recover later this year. Medical and AC&C may take a little more time, but we're cautiously optimistic about the growth for each later next year. Meantime, we will remain disciplined operators and steadfast supporters of our incredible set of customers. Only by doing this can we best position ourselves to maximize the opportunities in front of us as the demand environment improves. With that, I'll now turn the call over to the operator to conduct our Q&A session.

Operator (participant)

Thank you. At this time, if you would like to ask a question, please press the star and one on your telephone keypad. You may withdraw yourself from the queue at any time by pressing star two. And once more, for your questions, that is star and one. We'll move first to Steven Fox with Fox Advisors. Your line is open.

Steven Fox (Equity Research)

Hi, good afternoon. I had a few questions. I guess I wanted to start off on the cash flow story. So obviously, like you said, it's been getting better each quarter. If we look back over the last couple of years, there's been some big ebbs and flows. So how do we think about as you, as you get maybe through the end of this year, what a normalized cash flow, free cash flow can look like on the business? And then I had a couple of follow-ups.

Arvind Kamal (CFO)

Yeah, yeah, Steve, hi, this is Arvind. You know, I think, you know, as we had stated in our prepared remarks, you know, through the H1 of the year, we've done $90 million of cash flow. We think, it's gonna be at least $120 million, if not a little bit greater. You know, the inventory reduction is the backbone of that improvement. So I think, you can definitely, you know, see that, you know, $30-$40 million or so, you know, cash flow improvement in the back half of the year. So I think you start there, first and foremost.

When you, when you look, you know, at normalized cash flow, I mean, I think we kind of stood by the $70 million-$90 million on a, on a, you know, go-forward basis. Obviously, we're doing better than that in 2024, but we're also coming off pretty significant inventory balance, and we've kind of driven that down, which has allowed us to free up more cash than we initially projected, and you kind of see us outperforming over the last 12 months. But, you know, we do think at a, a moderate, but still be healthy cash flow in 2025 and beyond.

Steven Fox (Equity Research)

Okay, so 70-90 is kind of a base case going forward, I guess, is that right?

Arvind Kamal (CFO)

That's how we're thinking about it today.

Steven Fox (Equity Research)

Oh, okay, great. And then, Jeff, can you just expand a little bit on the new, new plants opening up? You mentioned Mexico and Penang. And you mentioned a few things going on in Penang, but, like, how are we... You know, as business comes back, sort of, where's capacity? What's capacity being added for right now? And how do you feel-

Jeff Benck (CEO)

Sure.

Steven Fox (Equity Research)

about your need to expand over the next few quarters? Thanks.

Jeff Benck (CEO)

Yeah. Yeah, thanks. I think you see two dynamics with us. We, we're clearly expanding our capacity in low-cost near, you know, regionally and low-cost regions that are close to where consumption is. So recently, actually, our COO was just over in Romania, where we have a facility over there supporting the Europe market, and we just almost doubled the capacity in that facility, and it's just coming online with, you know, the opening or expansion of that. That's on a site that we already, you know, have a footprint on. Correspondingly, in Mexico, we talked about a new building going on there in Guadalajara, so we're excited about that and the potential that we see there.

We still see, you know, many customers want to regionalize and nearshore some back from, you know, China and Asia, but just in general, with the move towards outsourcing, we feel like, you know, it made sense for us to continue to add capacity, and we'll be growing a footprint there. The one other region that we've had quite a bit of investment is in Semicap and in our precision technology group. That's where the new Penang facility sits, that we, I think, referenced in the remarks about that opening, a brand-new building over there in Penang in Q3, which will give us additional machining and clean room and sophisticated assembly capability for the semiconductor market.

That complements an expansion we did here in Phoenix earlier in the year. So, I think we're well situated where this next upswing in semi, you know, will be well-positioned because we invested in the downturn and now, you know, have available capacity as we expand the business.

Steven Fox (Equity Research)

... Great, and if I could squeeze one more in, it sounds like you're kind of calling spring in semi-cap cycle. So I was just curious what kind of spring you're looking at it. Is there frost on the ground or is it, like, sunny and it's baseball season?

Jeff Benck (CEO)

We're, you know, we're incrementally more constructive. You know, we're now talking about double-digit growth this year, in a year that others have said, you know, capital spending will be down. You know, I think that we feel like we've done well with incremental wins, and we're starting to see some recovery there. Kind of been led on the memory side, and, you know, we've been growing our position there. We're probably a little more exposed to logic when you look at it across the mix. But, but we are, you know, there's certainly a set of our customers that are seeing incremental improvement in H2. But then there's a few others that are watching inventory closely.

So, I would, you know, I would say, it's, it's certainly, you know, more than stabilized, and we start to see sequential growth. What 2025 looks like, I'll be interested on how the H2 shakes out and whether we see it be a super growth year or just, you know, incrementally positive. I think it's a little early to call, you know, we're 2025, whether we'll be in the midst of summer by the beginning of 2025. But certainly, we're more constructive on the space.

Steven Fox (Equity Research)

Great. Super helpful. Thank you.

Jeff Benck (CEO)

Sure. Thanks for the question.

Operator (participant)

We'll move next to Melissa Fairbanks with Raymond James. Your line is open.

Melissa Fairbanks (Equity Research Analyst)

Hey, guys, great, great quarter, great results. Really, really good to see progress on the inventories and the free cash flow as well. I also have a few questions for you. Maybe just a-

Jeff Benck (CEO)

Sure

Melissa Fairbanks (Equity Research Analyst)

... quick follow-up on the expansion in Romania.

Jeff Benck (CEO)

Yeah.

Melissa Fairbanks (Equity Research Analyst)

Is there anything we should be assuming for OpEx with the expansion, or would that just kind of flow through as the production and the revenue ramps?

Jeff Benck (CEO)

Yeah, it-

Melissa Fairbanks (Equity Research Analyst)

Have you disclosed which end markets you're servicing from that location? Sorry.

Jeff Benck (CEO)

Um-

Melissa Fairbanks (Equity Research Analyst)

Sorry to cut you off.

Jeff Benck (CEO)

Yeah, I can give you a little color, a little color on both. No, good question. We certainly have really factored that into our operating expense. There's not a big step up there. It's been a benefit that we've been able to expand in the footprint we're in. So, you know, even, it's funny, like, this, the manufacturer has almost doubled, but it was only... We didn't need to add, you know, because there's offices in other parts, so it wasn't. It was a modest, incremental expense, which was great. We're doing a lot in the industrial space in that facility, so I look to industrial as a key kind of growth opportunity there.

We also do support some Semi-Cap from there as well, more on the EMS side of things, not machining, but more, you know, complex assembly. So that's where I would say, you know, most of, most of the effort is. Of course, we do have medical customers in Europe, and there's opportunity there for growth, but those are the three focus sectors for that-

Melissa Fairbanks (Equity Research Analyst)

Okay

Jeff Benck (CEO)

... for that site.

Melissa Fairbanks (Equity Research Analyst)

Great. And then, maybe, Jeff, you highlighted a lot of engineering wins in many of your segments. I was wondering if you could give us a little more color on what that revenue opportunity could be, if that's something that can be quantified at this point, and maybe what the margin profile of that business looks like versus, you know, as compared to manufacturing wins?

Jeff Benck (CEO)

Yeah, we, you know, we track engineering for us, I mean, obviously from a total revenue, it's a smaller percent of the company, and we haven't typically broken it out. But it's meaningful because, you know, we love to get involved early in product realization and help customers design the product. We might be doing engineering for test, but oftentimes we'll be doing product development, and we're a bit unique there. And, you know, at that point when we design it, we tend to be, you know, who better to go build that? So we kind of look at it as a good early indicator of an opportunity that, you know, can grow beyond that.

From a margin standpoint, again, you know, it's pretty competitive space, but it is higher than our corporate gross margin, the engineering work we do, because, you know, customers do keep the IP. They pay us for the work we do, and we'd love to be an extension of their engineering team. And so from that standpoint, it can be, it can be accretive, but it's not so much, you know, I mean, obviously, we want to continue to grow our engineering revenue, but, you know, I'm not sure that that, you know, that's not the only thing we're focused on. We're really looking at helping customers get to market quicker and, and, the opportunity for what the flow-through could be into, into manufacturing.

And yeah, we've certainly have seen quite a bit of design work going on in medical, industrial, and semi-cap, probably more in those segments. But we also look at attach rates, like if we win EMS business, how much of it, you know, involves engineering and vice versa? If we start with engineering, we really want to capture the manufacturing.

Melissa Fairbanks (Equity Research Analyst)

Great. Sounds good. If I can squeeze in one more.

Jeff Benck (CEO)

Sure.

Melissa Fairbanks (Equity Research Analyst)

I think Semi-Cap, just kind of following on that, Semi-Cap is your highest or maybe close to the highest margin business. Nice to see that maybe we're turning the corner there. You know, some at least a spring. It may not be a 10-piece spring, but maybe, you know, a more mild spring.

Jeff Benck (CEO)

Right.

Melissa Fairbanks (Equity Research Analyst)

Is there anything we should be assuming for the margin progression into 2025, or are there still so many moving parts?

Jeff Benck (CEO)

You know, it, it's, it is greater than the corporate average gross margin and kind of depends on the type of business. I mean, if it's clean room, super sophisticated, more value-add, then it might be on the higher end of the corporate, gross margin range. So from that standpoint, it certainly can help us. I mean, obviously, we're you know, we've been north of 10% now, a couple quarters in a row. And really that's by being a bit discriminating of where we play in highly regulated markets. But semi-cap certainly can help us go further, there, and there's opportunity in that. I think, I think it's really gonna depend, do we see a hockey stick, or is it a more gradual ramp?

You know, certainly there's plenty of catalysts out there with the CHIPS Act, and, you know, I know here in Phoenix, there's several of the buildings are just coming out of the ground, and they're gonna buy capital equipment as those come online. I think what probably excites me most about semi is that we've won a fair amount of business, and I think we're gaining share independent of the market recovery, and that's really what's helping us grow in a flatter environment, I'll say. I won't even say down, I'll just say flatter with the double-digit growth. And so is that, as that, if those opportunities kick in and we've invested where some of my competitors have trimmed their capital in semi, we've really doubled down.

So I expect to see that be a larger contributor for both revenue and, and margin as, as we get into 25. Calling exactly where that lands, you know, it's we got work to do still on, on, you know, landing 2024, but, but we're, you know, like I said, pretty constructive on it.

Melissa Fairbanks (Equity Research Analyst)

Okay, great. Thanks very much. That's all for me for now.

Jeff Benck (CEO)

Yeah. Thanks for the questions.

Operator (participant)

We'll move next to Jaeson Schmidt with Lake Street. Your line is open.

Jaeson Schmidt (Director of Research and Senior Research Analyst)

Hey, guys. Thanks for taking my questions. Jeff, just following up on that last question on gross margin. Obviously, based on the guide, Q3 will be the fourth consecutive quarter of double-digit gross margin. Should we think of sort of this double-digit level, the new run rate going forward? I know it's going to be mix dependent, but just kinda given, given the programs you go after, is this sort of the good range to use going forward?

Arvind Kamal (CFO)

Yeah. Hey, Jason, this is Arvind, let me take that one. So, you know, we're definitely pleased with our margin performance, you know, based on our high, high-value focus and expense management. And as we go forward, and certainly not meant to be a guide, but just as we, you know, just give you color and as we think about, you know, how we think about going forward, you know, as we start seeing more volume come through, there's gonna be definitely some opportunity with margin, especially with added factory load and optimization, to see that margin potentially go a little bit higher. You know, same holds for operating margin. You know, once we see that incremental volume and continued focus on operating expenses, we should see, you know, equal or greater margin expansion.

Jeff Benck (CEO)

Yeah, maybe I'd just add a little color to ... I totally agree with Arvind's comments. I think, it—some of it's gonna depend a little bit on loading. You know, we talked about incremental capacity and number of factories, right, even on this call. And so, you know, right now, while we're, you know, seeing a modest decline, given some of the softness in a couple of the macro environments in a couple of sectors, I think really, you know, I think the revenue growth is gonna be meaningful, particularly the right kind of revenue, to see that further progression. We're not certainly looking to step back, but to really take that further, and part of that will also be the semi contribution, as we already talked about.

So, you know, I think that we've done really well in an environment where we have seen softer demand, and we've worked on operational efficiency, and we're gonna continue that cadence. But getting the right incremental business and growth in the wins we already have and the programs we have in the sites that aren't fully loaded will help a lot in that dimension.

Jaeson Schmidt (Director of Research and Senior Research Analyst)

Okay, that's helpful. And then just as a follow-up, you're seeing some nice traction in the A&D segment. Is this momentum really more of a function of the overall demand environment, or is it really being driven by you guys taking share and winning these new programs?

Jeff Benck (CEO)

Couple things there. I mean, we. I would say, certainly, the A&D segment probably was most constrained due to component availability and supply chain challenges. In fact, we heard some of our peers reference that still. I think we've cleared a tremendous amount of that, and so that's allowed us to, you know, to recover. And maybe it was a little bit of backlog there that might have helped, but I mean, obviously, you see we grew more than 30% this quarter. A lot of that is a combination of existing programs and then also some new wins that, that are adding to it as that... It's really a segment that we're, that we're committed to.

The other thing, you know, on the defense side, there's a lot of activity around the world that unfortunately is driving a lot of spending there. I say unfortunate because, you know, they're usually related. Wars unfortunately require a lot of defense spending, and so you know, that's a driver just in the overall demand, and then also just making sure that we're protecting our country and such. So, I think that just the overall market looks to continue to be strong, but then, you know, supported by a mix of new wins as well and better ability to fulfill the demand. So it's more than one factor. A few moving parts on that, Jaeson, but hopefully it gives you some color.

Jaeson Schmidt (Director of Research and Senior Research Analyst)

Okay. No, that's helpful. Thanks a lot, guys.

Jeff Benck (CEO)

Sure. Thanks for the question.

Operator (participant)

... We'll move next to Jim Ricciuti with Needham & Company. Your line is open.

Chris Grenga (Equity Research Associate)

Hi, good afternoon. This is Chris Grenga on for Jim.

Jeff Benck (CEO)

Hey, Chris.

Chris Grenga (Equity Research Associate)

Hey, just wondering if you could elaborate on some of the early indications that you've mentioned about the growth that you're seeing in the specialty industrial. Just wondering if you could just elaborate on what you're seeing there.

Jeff Benck (CEO)

I think there's a number of dynamics going on there. We see continued, you know, focus on automation. Folks are looking at, you know, how do they get more efficient? We also see a lot of effort around energy controls, and we see good growth there. It's interesting, even in... You take the HVAC Market, for example, folks moving from furnaces to heat pumps and variable speed control systems, and as that transition happens in the marketplace, you go from on/off to variable speed, now you've got electronics involved. So see an interesting growth and demand and, you know, electronics adding smartness to a lot of these devices. People want to be more energy efficient, but at the same time also, you know, that variable speed nature is an opportunity for us.

So I think that's, you know, that, that-- we're excited about that, and we're playing in with a number of customers there. We do have a strong pipeline of industrial wins, and it's an area that we've grown our participation, but we think there's a lot more we can do. And so when we look at, you know, David Moezidis came on as our Chief Commercial Officer, has a ton of industrial experience, and he's built out his team. We're putting a lot of energy there just 'cause we think we have, you know, a compelling offer for customers, and we see the opportunity in things like I just described. You know, HVAC is one market there. We also, you know, like the robotic space and like what's happening there.

You know, everyone's trying to be more operationally efficient, and we've got a lot of experience with complex systems and putting those kind of solutions together. So that's playing into our thoughts on industrial a bit.

Chris Grenga (Equity Research Associate)

Got it. Thank you for that.

Jeff Benck (CEO)

Sure.

Chris Grenga (Equity Research Associate)

Within advanced compute, is there any overlap or any exposure to the AI training clusters or any overlap with the high-performance compute franchise? Is that any-

Jeff Benck (CEO)

Yeah-

Chris Grenga (Equity Research Associate)

Is that anything what-

Jeff Benck (CEO)

Yeah, sorry, I didn't mean to cut you off. Did you-

Chris Grenga (Equity Research Associate)

Oh, yeah, just curious what, if any, exposure or overlap there is there?

Jeff Benck (CEO)

Yeah, we, you know, we have built some of the largest, helped build some of the largest supercomputers. You know, if you look at the top 500, a couple of the top 5, we played a key role in, in supporting that. And if you look at where they're going, whether it's National Lab or, you know, to a company that's looking to do large scale simulations and analysis, I mean, it certainly has an AI bent to it. And several of our customers have talked about HPC, you know, these sophisticated, oftentimes water-cooled systems playing into the AI movement. So we think that's an area where we can, you know, participate.

While we don't build the hyperscaler platform, some of the guys in our space do, we certainly have played in the most sophisticated HPC, you know, environments and solutions. We think energy is a natural one, where everybody, you know, is putting a lot of effort around, you know, analysis around the climate and other, you know, complex problems they're looking to solve, and these systems can play into that pretty heavily. Another area that is kind of natural for AI is just semi cap, right? And, you know, when you think about wafer fab equipment and semiconductors going everywhere with the explosion of that, whether it's IoT or just intelligence in EV vehicles or anything else, I mean, we certainly see the semi cap as a bit of an AI play.

But the HPC, I mean, you're hitting on one that we know there's opportunity there. May not be quite the same as the Hyperscaler, but there's a lot of effort going into, you know, how do we just get smarter? Even quantum computing, you could argue, you know, plays a role there, and those solutions can play.

Chris Grenga (Equity Research Associate)

Great. Appreciate the call. Thank you.

Jeff Benck (CEO)

Sure. Thanks, Jim.

Operator (participant)

We'll move next to Anja Soderstrom with Sidoti. Your line is open.

Anja Soderstrom (Senior Financial Analyst and Equity Research)

Hi, thank you for taking my question. Sorry if I missed this, but I heard you talk about a lot of the other end markets, but in terms of the medical, what are you seeing there in that maybe bottoming out in terms of inventory buildup and when do you anticipate that to come back?

Jeff Benck (CEO)

Yeah, I think medical, it's interesting 'cause we're pretty exposed to medical, to the medical device side, as you can imagine. I know we've talked about some of the devices that we build to support. We have seen a softness there, and we know that, you know, there were some inventory buildups coming out of COVID, that we've seen. Our OEMs get more sensitive about, you know, bringing their inventories down. We've also, you know, we also have seen some softness in the across a number of customers. So I can certainly tell you it's not one particular customer, but we've seen that medical softness.

Our thinking right now, we have seen some stabilization, so it's not like anything's falling off the cliff, but we do think through the back end of 2024 that we probably won't see substantial pickup, just based on the signals that we're getting and the visibility, you know, not uncommon to have six months of visibility. We do believe in 2025, we'll see that, you know, turn around, and we believe we'll see recovery there. A little hard to predict if that'll be H1 or H2, but I think medical is one segment that is certainly weighing on our revenue growth in this year. But, you know, everybody has a bit different exposure. I will say we've seen more new opportunity in, like, biotech, and everyone's doing a lot...

You know, it's amazing some of the DNA sequencing and some of the work that's going on, on new drugs and new, really new solutions that are gonna be great for, you know, the industry and, and really for our, our, our collective health, right? But, so we see a lot of growth there, a lot of investment there, and, and that's an area we, you know, see some new wins that are, that are, very exciting to us and, and opportunity there. But in the short term, the medical device area, definitely in, in the customer set we have, which is fairly broad, you know, we have a pretty large medical business, is, is softer, in 2024.

Anja Soderstrom (Senior Financial Analyst and Equity Research)

Okay. Thank you. And again, sorry sir, if you talked about this before, but the cash cycle days, the cash flow has been improving quite a lot. Is there more room there, and do you have a target?

Arvind Kamal (CFO)

Yeah. Hey, Anja, this is Arvind. You know, so we, we talked a little bit about... You know, we, as you've seen or heard from our call today, we raised our free cash flow target to be at least $120 million or greater. And, you know, what's really driving that is the inventory reduction. You know, currently, we're 4 turns of inventory, and we, as we laid out in our long-term plan, you know, for 2025, it—we're looking to be about 5 turns. So yes, there's definitely some in, you know, ways to go there. But, you know, for now, I think you can assume that $70 million-$90 million, on average for the year, type of free cash flow, type of modeling.

Jeff Benck (CEO)

Yeah, and what... You know, I think inventory has been an explicit focus, and it's nice to see the team continue to work on, you know, burning down inventories and working with customers on bringing the inventories down. We, you know, as Arvind said, we still have room to go. You know, we don't think we're done with that journey, you know, as he talked about with the number of turns. So, you know, we certainly have made a tremendous amount of progress, and we're pleased with that, but there, there's more opportunity here. We're not back down to what I would say normal, where we'd expect to be.

Anja Soderstrom (Senior Financial Analyst and Equity Research)

Okay. And then one last question, if I may. What's your practice for the cash on your balance sheet? You didn't buy back any shares this quarter. Is there a reason for that or?

Arvind Kamal (CFO)

Yeah, Anja, you know, well, I think, well, our focus really has been in the short term is to, you know, pay down our, our short-term debt, our revolver. And you've—I think you've seen over the last several quarters, we've been really focused on bringing that balance down, and we'll continue to do that. And as we mentioned in the call today, we've increased the dividend, so with that, but we'll still remain focused on looking at opportunities to repurchase shares, as we outlined.

Anja Soderstrom (Senior Financial Analyst and Equity Research)

Okay, great. Thank you. That was all for me.

Jeff Benck (CEO)

Thank you, Anja.

Operator (participant)

This does conclude the question and answer session. I will now turn it back to Paul for any additional or closing remarks.

Paul Manske (Investor Relations)

Thank you, Chloe, and thank you everyone for participating in Benchmark's Q2 2024 earnings call. As a reminder, we'll be attending the 13th Annual Needham Virtual Industrial, Tech, Robotics, and Clean Tech Conference on August 19. Please check the events section of our IR website at ir.bench.com for updates to coming investor conferences. With that, we thank you again for your support and look forward to speaking with you soon.