Earnings Call: Q2 2019

Aug 1, 2019

Good day, welcome to the Bel Fuse Inc. second quarter 2019 results conference call. Today's conference is being recorded. At this time, I would like to turn the conference over to Daniel Bernstein, President and Chief Executive Officer. Please go ahead, sir. Thank you, Shiloh. Joining me on the call today is Craig Brosious, our VP of Finance, and Lynn Hutkin, our Director of Financial Reporting. Before we begin the call, I'd like to ask Lynn to go over the safe harbor statement. Lynn? Thank you, Dan. Good morning, everybody. Before we start, I'd like to read the following safe harbor statement. Except for historical information contained on this call, the matters discussed on this call, such as statements regarding anticipated sales levels, gross margins, cost savings, cost reduction measures, demand for our products, and the impact of long-term growth drivers, are forward-looking statements as described under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Actual results could differ materially from Bel's projections. Among the factors that could cause actual results to differ materially from such statements are the market concerns facing our customers, the continuing viability of sectors that rely on our products, the effects of business and economic conditions, difficulties associated with integrating recently acquired companies, capacity and supply constraints or difficulties, product development, commercialization, or technological difficulties, the regulatory and trade environment, risks associated with foreign currencies, uncertainties associated with legal proceedings, the market's acceptance of the company's new products and competitive responses to those new products, the impact of changes to U.S. trade and tariff policies, and the risk factors detailed from time to time in the company's SEC reports. In light of the risks and uncertainties, there can be no assurance that any forward-looking statement will in fact prove to be correct. We undertake no obligation to update or revise any forward-looking statements. We also may discuss non-GAAP results during this call, and reconciliations of our GAAP results to non-GAAP results have been included in our release. I'd now like to turn the call back to Dan for a general business update. Thank you, Lynn. Before going through the financials, I would like to provide a brief update on how the business did from an operational standpoint this quarter and what we see going forward. Overall, our second quarter was challenging, one, both from the top-line sales perspective and the impact on margins. As mentioned in the first quarter, we saw a decline in bookings as some of our customers are currently in an over-inventory position. Customers brought additional products into inventory throughout 2018 in response to material shortages and the tariff increases that took effect in 2018 and 2019. This led to a $13 million year-over-year decline in our sales during the second quarter, which impacted each of our product groups. The lower sales, based on higher material costs, led to low gross margins this quarter. While we have limited visibility of demand of our products and our customer products, our second-quarter bookings continue to be soft, indicating flat to lower sales substantially in the third quarter. We have accelerated our effort to align our costs with our current business level and actively taking steps to reduce fixed costs and improve efficiencies at each of our facilities worldwide. During the second quarter, we completed the restructuring of power R&D resources and the transition of our single transformer operation from Inwood, N.Y., to other existing Bel facilities. These initiatives are expected to result in annual cost savings of $2.1 million beginning in the third quarter of 2019. We're currently in the process of streamlining our operations in Asia to enhance productivity at these factories. To date, we have identified and substantially completed measures that will result in incremental annualized cost savings of $1.4 million, which we expect to benefit from the beginning in the fourth quarter of 2019. The global initiative is expected to continue over the next several quarters as we complete our strategy that we have put in place. With the growth of 5G, autonomous and electric vehicles, the cloud data centers, and spending in aerospace and military, we still remain very positive about our future growth opportunities. In the short term, there are areas of growth that will help offset some of the expected sales decline. With our Connectivity Solutions Group, we expect strong shipments of our micro-miniature copper assemblies for, I'm sorry, ammunition applications, as well as increased demand for our high-speed optical transceivers for two new fighter jet programs that are qualifying. Our Power Solutions and Protection group is seeing more near-term upside in power supply demand for use in heavy-duty steel cutting equipment and high-performance computing applications. The Power group has also recently project wins with traditional server applications, which we expect to move into full production by the end of the fourth quarter. Our power products sold in e-mobility applications. While still small from a dollar perspective, it grew by 700,000, or almost 50% from the second quarter of 2018. This area has significant growth potential down the road as some of the startups take hold and move into full production. With that, I'd like to turn over the call to Craig to run through the financials update. Thank you, Dan. To provide a quick recap on sales during the second quarter were $127.4 million. By geographic segment, North American sales were $67.1 million, a decline of 6% from last year's second quarter. European sales were $21 million. $3 million, down 14% from last year's second quarter. By product group, Power Solutions and Protection sales were $44 million, down 5% from last year's second quarter. Connectivity Solutions sales were $42.5 million, a decline of 13%. Magnetic Solutions sales were $40.9 million, down 10% from last year's second quarter. Gross profit margin declined to 15.6% in the second quarter of 2019 as compared with 20.6% in the second quarter of 2018, as lower sales in 2019, combined with higher material costs and an unfavorable shift in product mix, had significant downward pressure on our gross margin during the second quarter. Our selling, general, and administrative expenses were $18.8 million, or 14.7% of sales, as compared with $18.3 million, or 13% of sales, in the second quarter of 2018. This increase primarily related to foreign exchange fluctuations on the translation of our foreign balance sheet accounts, with an exchange gain recognized for the second quarter of 2019 of $450,000, compared to an exchange gain of $1.9 million in the second quarter of last year. This unfavorable variance was partially offset by a reduction in ERP implementation costs of $484,000, lower bad debt expense of $345,000, and reduced sales and marketing expenses of $273,000 compared to the second quarter of 2018. On a go-forward basis, we would expect SG&A to run between $19 million and $20 million per quarter in the near term, barring any significant fluctuations in foreign currency. During the second quarter, we closed on the sale of a property in Inwood, New York, which resulted in a pre-tax gain of $4.3 million. As a result of these factors, we generated income from operations of $5 million in the second quarter of 2019, as compared to $10.7 million in the second quarter of 2018. Interest expense was $1.4 million in the second quarter of 2019, up slightly from the same period last year due to the higher interest rate in effect during the 2019 period. Our provision for income taxes was $421,000 for the second quarter of 2019, compared to $2.4 million during last year's second quarter. The provision for income taxes during the second quarter of 2019 was lower due to a reduction in overall taxable income and less GILTI tax incurred in the U.S. during the second quarter of 2019 versus the 2018 period. Earnings per share for the Class A common shares was $0.23 per share in the second quarter of 2019, as compared with earnings of $0.52 per share in the second quarter of 2018. Earnings per share for the Class B common shares was $0.24 per share in the second quarter of 2019 as compared with earnings of $0.56 per share in the second quarter of 2018. On a non-GAAP basis, which excludes certain unusual other non-recurring items, EPS for Class A shares was $0.03 per share in the second quarter of 2019, as compared with earnings of $0.58 per share in the second quarter of 2018. On a non-GAAP basis, EPS for Class B shares was $0.03 per share in the second quarter of 2019, as compared with earnings of $0.62 per share in the second quarter of 2018. Now I'd like to go through some balance sheet and cash flow items. Our cash and cash equivalents balance at June 30, 2019, was $58.4 million, an increase of $4.5 million from December 31, 2018. During the first half of 2019, we made net payments of $1.5 million towards our outstanding debt balance. We also used cash for capital expenditures of $5.3 million, dividend payments of $1.6 million, and interest payments of $2.5 million. Accounts receivable were $84.2 million at June 30, 2019, as compared with $91.9 million at December 31, 2018. Day sales outstanding were 60 days at June 30, 2019, as compared to 59 days at December 31, 2018. The reduction in our accounts receivable balances was largely due to the lower sales volume in the second quarter of 2019 as compared to the fourth quarter of 2018. Inventories were $118.2 million at June 30th, 2019, down $1.9 million from December 31st, 2018. The decline was primarily in raw materials as purchases of raw materials have slowed while we work through our inventory on hand. Accounts payable were $42.8 million at June 30th, 2019, down $13.4 million from its level at December 31st, 2018, primarily due to lower raw material purchases during the quarter. Bel's total outstanding debt was reduced by $1.5 million during the first half of 2019, bringing the balance down to $113 million as of June 30th, 2019, excluding deferred financing costs. Book value per share, which is calculated as shareholder's equity divided by our combined Class A and Class B common stock outstanding, was $14.64 per share at June 30th, 2019, as compared to $14.39 per share at December 31st, 2018. Our R&D expenses have historically been part of our cost of sales, and therefore are a factor in arriving at our gross margin. This is still the case in the second quarter 2019 financials presented in our earnings release today. This classification is different than the majority of our peers, and investors should keep this in mind when comparing our gross margins to our peers. We are currently evaluating potential reclassification of this expense presentation for future periods. With that, I'll turn the call back over to Dan. Thank you. Shiloh, can we open up for questions? Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal star one for questions. We'll be taking our first question from Theodore O'Neill of Litchfield Hills Research. Please go ahead. Thank you. Thanks very much. I'll vote for a reclass of R&D as a separate line item. The question I have for you. Yes, we hear you. Can you hear me okay? Yes. Okay. Craig, the question I have for you is that in the last quarter, in your prepared remarks, you guided SG&A to run at $20 million-$21 million, and it came down in this quarter. Also, so did sales. I'm wondering why would you guide for it to go up in the third quarter if you're looking for sales to continue to be flat to down? I think we guided last quarter in the $20 million range. I think what we're guiding now is slightly below that, around $19 million-$20 million. Theo, if you're comparing it to the third quarter of 2018, just keep in mind the third quarter of 2018 had a $1.5 million FX gain in that number, which we don't expect to recur in this year's third quarter unless something drastic happens in. Okay August or September. Okay. I do understand what's going on with inventory, and I don't think some of the distributors helped by making an online tool so we could calculate in advance how much the tariffs were going to be and sort of scare everyone into buying in front of it. I get that part of it. That's it for me. Thank you. Thank you. Thanks, Theo. If you find that your question has been answered, you may remove yourself from the queue by pressing star 2. Once again, if you would like to ask a question, please signal by pressing star 1. We will now take our next question from Jim Ricchiuti of Needham & Company. Please go ahead. Thank you. Good morning. Couple of questions. Wondering which of the product areas are being most impacted by the excess inventory in the OEM and channel. Is it mainly in Magnetic Solutions, or is it carrying over into some of the other product areas? It's hitting us across the board, but the major area is the Magnetic, that's our Integrated Connector Module that we have, which is affected by some very large OEM customers. It's not as broad-based as some of our other product lines we have. Got it. Dan, you've seen a few of these. How would you characterize the current inventory correction relative to some others that you've seen over the years? Don't ask. No, to be honest, I hate to say it, but we only had this to offer, but I think we are very optimistic about the future. I go back, I hate to say it, with my father when the upsurge, everybody went out and bought a color TV. There was a lot of demand, all of a sudden everybody had a color TV. It went down, then mainframe computers, then mini computers, then you did networking and high speed. We always see these ups and quick downs as people buy the new product. Now we just see so many products that are being introduced from electric cars going from 16 million to 25 million, from data centers, what Facebook, Google, and Amazon need. You look at Amazon, all that growth you see is coming a lot apart from the data centers. How do we penetrate those type of accounts? 5G, where if you went to the Consumer Electronics Show, everybody was talking 5G. We haven't seen anything, but everybody's introducing tremendous amount of new product. Again, we know this is going to flush out at a certain point, but we're really looking at what I guess the term, I think Lincoln came up with the term electronic super cycle. We just see a wealth of products out there that gives everybody a great amount of opportunity to really grow the industry. Got it. Looking at that sequential decline that you experienced in gross margins, can you give us a sense how much of that came from the higher material costs and relative to how much might have come from product mix? Sure. The majority of it related to the higher material costs. We're estimating about 3.8%, so 380 basis points related to material costs. On the sales decline, just volume decline will have an impact on our margin percentage. There was also a shift in product mix, and we're estimating that that had about a 250 basis point impact on our margins. Got it. There were some other favorable factors. We were in a more favorable FX environment, so that was an offset to those two unfavorable factors. Okay. What you're seeing in higher material costs, is that primarily in the Power Solutions and Protection area? I think it's across the board, but I think probably the majority of it is in the Power Solutions and Protection area. Jim, as you know, as material lead times come down substantially, the pricing will follow close by. We haven't seen pricing return to those 2017 levels, and we're not expecting that for a little while yet. Okay. One final question, I'll jump back in the queue. Just regarding the cost actions that you alluded to in the report, the earnings report today, I'm just wondering, you also are suggesting that you're reviewing some other potential initiatives. How should we think about those other potential cost savings, maybe in aggregate, over and beyond what you've already done? Yeah. Like we mentioned, we're looking at all of our locations and kind of the company structure. I think, we can reasonably expect maybe another $3 million-$5 million in fixed costs over a period of time. These are not going to be short-term type fixes, but that, I think, would be a reasonable expectation. Understood. Okay. Thanks a lot. Thanks, Jim. Appreciate the call. Our next question comes from Hendi Susanto of Gabelli Funds. Please go ahead. Good morning. Thank you for taking my questions. First question, can you characterize about the gross margin pressure due to product mix? When will it be until we shift to a more favorable mix? In the second quarter, the product group that experienced the highest year-over-year decline was the Connectivity business, and most of that is military aerospace driven. On the military side, the timing is unpredictable. It's based on the timing of the various programs that we're on. Military had a bad quarter on the second quarter, but we do expect that to improve in the third quarter. We do expect some upside in Connectivity related to the military business in the third quarter, and that's a higher margin business. And then- We do expect some improvement in the third quarter related to product mix. Right. That is big enough to swing the gross margin one way or the other, I assume? What we're seeing for the third quarter, based on our existing backlog, basically indicates that we should see an uptick in gross margin percentage for the third quarter. Yeah. Got it. I want to revisit Jim's earlier questions. Can you characterize in which vertical inventory correction is the most significant ones? Other companies have talked about excess inventories in hyperscale and data center customers. I'm wondering whether you can share some color, how similar your perspective versus others. I think we're seeing a large inventory correction in our networking equipment end product market. We sell to large OEMs that are overstocked at the moment. I think that one is one of the largest ones. We also see a similar over inventory situation in our distribution channel. That's pretty much across the board in all of our product groups. It should be noted that we do $120 million through the distribution channel. It's a big chunk of our sales go through that channel. If you know, if you see the writings on Arrow and Avnet, you know what's going on there. I think everybody's in a very over inventory situation. How long do you foresee this inventory correction will last? From what we understand, most people are saying for the balance of this year. By September, we should get to more visibility because people assume that in September, people order before Chinese New Year. At this point, I think we don't see any uptick for the balance of the year. Got it. Okay. Thank you. Thank you for the questions. If you would like to ask a question, please press star one on your telephone keypad. We'll pause for just a moment to allow everyone an opportunity to signal. The next caller is from Hendi Susanto of Gabelli Funds again. One moment, please go ahead. You implied that the impact of higher material costs will continue into the second half. What will it look like beyond the second half? I'm wondering how you mitigated the higher material costs in 2020, whether that will come mainly from the cost-saving initiatives or whether there are other sources to mitigate that. I think the bulk of the offset would be from our cost reduction initiatives. We're expecting material costs to gradually trend down as there's more capacity in the market. I think we would primarily offset the increases with our cost reduction efforts. Got it. Thank you. It appears there are no further questions at this time. I'd like to turn the conference back to you. Thank you, Charlotte. We appreciate everybody joining us today and hopefully things will soon improve. Have a nice summer and thank you. This concludes today's Bel Fuse Q2 Financial Update Call. Thank you again for your participation. All participants may now disconnect.