Welcome to the twenty-sixth Annual Needham Growth Conference. Our next presentation is gonna be from Vishay Precision Group. Bill Clancy, the CFO, is here. He's gonna be available for Q&A. The presentation's gonna be handled by Steve Cantor, who Senior Director of IR. You know, you guys will go through the slides, and then we'll have some time for Q&A.
Great. Thank you, Jim. I wanna also thank Needham for the opportunity to be here today. The Needham conference is an important one for us, and it's a great opportunity to tell you about the VPG story. We're hoping today you walk away with two things. The first is, we're a leader in our markets with high-value performance products. And second, more importantly, we now see a convergence between a number of secular trends, which have been driving our business, and also our internal capabilities. Now we're at a really important, critical junction point in our company's path to long-term growth. Before starting, I do want to remind everybody that we will be making forward-looking statements today, so you should read our disclosures carefully to understand the risks associated with those statements. Sensors.
So it says on the slide, sensors are everywhere, and they're more important. I don't need to tell you, they're in our homes, they're in our cars, they're in our offices. They're even increasingly, or in the soon-to-be future, in our bodies. So it's a very large and growing market. We estimate it to be somewhere about $350 billion, with a B, growing at attractive rates. We play in a corner of that market, particularly where precision, accuracy, and reliability of the data really make a difference. So at our core, we're a sensor company focused on precision measurement technology. We're focused on high value, high-end, non-commodity applications with very highly differentiated solutions, really across a broad array of markets. We're an established partner to Fortune 1000 companies, and we've been doing this for a while.
Really, our mission is what's on this slide. It's to make our customers' products and processes safer, smarter, and more productive. We do that by addressing some of the most challenging applications for our technology category that really are forming the backbone of the forward economy. Another way to think about it, it's really the first step in the data value stream. The data value stream, meaning when you acquire data from some real-world phenomena, whether it's temperature, force, or pressure, and that you translate that data into a digital form that then gets moved along the way to be processed, packaged, or to drive a particular function. For us, since we address critical applications, if you don't get that first step right, then everything downstream doesn't work to spec and doesn't provide value.
So we do that by helping our customers in a lot of markets, as you can see on this next slide. We have what we believe to be one of the most diversified sets of markets for a sensor company our size. In these niche markets, we generally are number one or number two in terms of market position. These relationships that we have with our customers, we built up over many years. They're very sticky. Our sales engagements are on an engineer-to-engineer basis, so it's a technical sale. And in many instances, we're sole source, we're designed in. Now, our products are often a small part of the bill of materials, but they provide the high value, so a disproportionately high value.
It's really this diversity of end markets that we're showing here, whether it's test and measurement, transportation, avionics, military and space, the industrial weighing markets, and even in that other category, medical, precision ag, consumer. Each of these markets combined give us a balance and a diversity that really provides for consistency of cash flow across cycles, so it's very important. The one thing that I do, hopefully, you take away with today is, there's sort of a lagging perception of VPG as being a sort of a dusty, old, industrially-focused company. But hopefully, as you'll see today, we're much more than that, and we'll continue to grow beyond that. So, how do we grow? We're coming off a record year in 2022, but really, what we're more focused on is what's on the right-hand side of the slide.
These are our three- to five-year long-term targets. As you can see, we're targeting growth in the low teens. We believe that that will allow us to deliver some attractive rates of profitability and returns, gross margin of 45%, adjusted operating margin of 18%, and adjusted EBITDA margins of 22%. Now, these are somewhat aggressive goals, but we see a clear path to getting there, and we have what we believe the pieces in place to achieve them. So how are we gonna do that? Well, this is an important part of the strategy, which is already in place, and it really involves, at its core, moving from legacy, smaller markets, which may be slower growth, to larger, faster-growing ones that are being driven by a number of secular trends.
Really, what's behind this is, and this I'd say is one of the key takeaways, as I mentioned at the outset, is a convergence between the market trends that we see coming towards us, so secular trends externally to our business, really being driven by a number of trends that I'll mention in a moment, with the internal investments that we've been making to build up our capabilities to address them and to address higher volumes ones. I would tell you, a good example of this is one that we've already achieved. It's in our advanced sensor business. Our advanced sensors are a family of sensors which we've been making for some time. They're the highest-performing products in their category.
But about five or six years ago, we elected to totally revamp our manufacturing process to introduce more automation, and that's enabled us to be able to make these products in much higher volumes, more consistently, and at greater cost efficiency. And that was the key to unlock an opportunity in the consumer electronics market that we couldn't have addressed before without those internal investment. And so that's the, that's the template, that's the page from the playbook that we are going to begin to, and we have been, moving it into other parts of our business. And so the takeaway here is really, we have greater capabilities today than ever before to capture larger and faster-growing set of opportunities. So this, this slide is, our business today, and we operate in three segments. They are sensors, weighing solutions, and measurement systems.
One way to think about these is sensors are components, weighing solutions are modules, and measurement systems are really application solutions. They're doing something in a very narrow market, but that it's really a leading and essential product or solution in that area. Each of these has its own strategy. It has its own growth and profit profile. For instance, sensors, we think, grows in the mid- to high-single digits, with gross margins of 40%+. Weighing solutions grows more like a GDP plus kind of business, but has gross margins approaching that of the sensor business, so in the high 30s. Then measurement systems growing in the mid-single digits with a gross margin of 50%+.
So the combination of these is really a very nice balance of profit and growth, and also providing us resilience through the market cycle. So let me talk for a minute about what's driving our business from a market trends point of view. So we're highlighting here four market trends: electrification, industrial automation, digital transformation, and defense and space. And in the next several slides, I'll go through each of these and explain to you what the driver is and what we're doing today in that area. So to begin with, let's start with electrification. So I don't need to explain this to you. You all know very much about this, but the point I wanna make here is that it's not just automobiles, it's bikes, it's aircraft, it's industrial equipment, and it's other applications.
So what are we doing today in electrification? Wanna highlight three applications among many. The first is in e-bikes. So our sensors are being used to maximize the efficiency of the battery of those bikes to extend the range and provide a better user experience. In safety testing, that's the application we're showing here in the middle, our products are used to test automobiles, among which are EV, electric vehicles, as well as not just cars, but what are called eVTOLs, which are electric vertical takeoff and landing vehicles. These are these helicopters that are being developed. They're actually well along the way in terms of their development. And so it's really a broad range of electric-powered vehicles.
Then on the far right is an application where we use our products in the testing for the manufacturing of batteries for EV. So the next trend I wanna touch on is industrial automation. It's not a new trend... We've been on a path as a global economy in terms of industrial automation over many decades, but we believe it's accelerating. And one of the reasons why it's accelerating is that you have AI and greater connectivity on one end, and also you have the experience that the world had coming out of the pandemic with labor shortages and higher cost and global competition.
So we think that the return on investment in this kind of automation now has reached a point where it's become much more compelling for a lot of businesses to really look at industrial automation and technology, and apply that to their business. So I'm highlighting here two applications. The one on the left is robotics. We've served this market for a number of years, but now we're seeing an accelerated opportunity for us. And it's not just with traditional industrial robots, it's with new generations of multipurpose ones, as well as surgical robots. And for industrial applications, it's not just the industrial robotic arm that you see most companies show, it's also humanoid form factor robots.
We just talked about in our last quarterly call that we have an engagement with a leading maker of a humanoid robot, a maker you're probably very well familiar with. And that really is significant to us in two ways. One is it represents the potential of this market, and number two, it's a customer that we really didn't address before, and the fact that we can engage them and get a design win, and that customer is significant to us. The second example I want to touch on is precision agriculture. This is a really exciting place. We were talking earlier with an investor who was at CES and had a chance to see John Deere's mini combine that they had at the show.
These systems are some of the most sophisticated pieces of equipment. We're showing here a drone that is spraying something on a field, and an autonomously driven combine. You know, those are nice applications. We don't really play much in those, but we have been serving this market in other ways in terms of providing a product that enhances the safety of the equipment, and also the efficiency of the farm itself. So one of the applications that we currently address is to help farmers plant seeds in the field at the optimal depth in the soil, and it may be different from one end of the farm to another.
The reason why that's important is because that will allow the farmer then to correlate that information with crop yields, so that the next planting, they can know where exactly to plant the seed and how deep. So it's important and high value application for us. The next, it's not a trend, I wouldn't call it a trend, it's this is more of a need, but it's certainly an important need, a growing need, given the current conflicts and tensions that we're seeing in the world, and that is defense and space technology. So this is a market we've been addressing for a number of years. I'm highlighting four examples of what we do today in defense and space. In the space area, we're involved with systems that are used on satellites for power monitoring or navigation.
In terms of the rocket programs, I'm showing here a re-entry parachute system that we were involved with testing. So this is a very interesting area, particularly because of the strategic value and importance of space now to not only the U.S., but to other countries around the world, and the investment that is being made, not just by governments, but by commercial entities. So this has been a good market for us. The second example I want to highlight is the one just to the right of that. It may be hard to see here in the room, but what it's showing is a family of mannequins or dummies. So this is actually coming from our business, which provides technology that goes into dummies that are used in the crash testing of vehicles.
But in this case, we've been working with the U.S. Army to develop a family of super dummies that they use to develop ways to better protect our soldiers in combat from explosions and other dangers. So it's a good business for us. Each dummy costs about $1 million or more, but the value that it provides, certainly in terms of our armed forces, is very important. We now have the green light by the U.S. Army to begin to market these dummies to other friendly country states, who are also interested in developing similar kinds of programs. To the right of that is a missile system. So we've been involved with missile systems for a number of years.
We currently have design-ins with a number of the contractors who are developing solutions, including hypersonic missile systems. And then to the right of that is unmanned vehicles or drones, not just the ones that fly in the air, but the ones in the land and sea. And so our products are used both in the command and control systems for those drones, but also to test the drone itself in real world conditions to make sure that it can withstand all kinds of forces, including wind and shear, et cetera. So the next trend I wanna talk about is digital transformation, and we've kind of lumped that, it's a big umbrella, which we've lumped a bunch of things in.
The way we think of this trend, it's really about applying and integrating digital technology into physical processes that, you know, didn't use that before to provide some sort of enhanced value. It's not a new trend, but it's one that we see accelerating, particularly with the adoption of AI and machine learning. I'll highlight four examples of what we're doing today. Again, this is what we do today. We have product that's used in consumer electronics as well as in high-end bikes. Our products are used in semiconductor test equipment. They play actually a very important role in that test equipment because they're making sure that the signals, the electric current that's going from the test set to the device or the PC board that's being tested, is consistent from test to test.
That's integral to the quality and value of the test set. To the right of that, data centers and fiber optics is also a market which we've addressed for a number of years, but we're now seeing accelerated opportunities, particularly because our products are known for being and offering the greatest reliability across all kinds of temperature environmental conditions. And if you think about a data center, that's an environment which is tightly controlled in terms of environment, because any even the minutest change in temperature or humidity can affect the performance of that equipment and the performance of those data services that our businesses and we ourselves rely on.
So by putting a high-value resistor component that we provide, we believe that that actually provides great value to those data centers, minimizes maintenance and downtime. And then the fourth example that I'm showing here on the right is medical prosthetics. So our sensors are used by doctors to adjust the prosthesis to make sure that it's optimized for the particular patient. But down the road, we see the potential to take our sensors and actually attach them to implanted devices, such as a shoulder replacement, so that as the surgeon is putting that device in, he could adjust it to minimize the discomfort to the patient and maximize the recovery time or shorten the recovery time for that patient. So it's a really cool application.
So that's sort of the external factors, and I now wanna talk about the other side of that convergence, which is the investments that VPG has been making over the past several years and are continuing to make, in its business and capabilities. So I'm showing in the wheel, there's six competencies that we have been developing and are developing. So beginning with expanding our business development capabilities, using our innovation and technology to drive growth, either through new products or new, new applications. Leveraging the deep technical expertise that we have, and using that as a way of deepening the relationships that we have and engagements we have with our customers. We have an acquisition track record, so to utilize that also as a means to grow the business.
Of course, operational excellence, this is something that the company takes great pride in. I think of all the things that, we do the best, it really is around operations. And then, of course, we wanna make sure that we have a strong sustainability policy and track record. But really, those six things, the reason why they're important is really what's on the right-hand side of the slide, because those are the things that are gonna enable us to scale and grow, or enable us to deliver, good, operating performance and consistent cash flow. If you look at the charts on the right, we're showing seven years of data here, and I think it's, it's not, it's not bad.
So if you think about revenue growth over that period of time, we've grown our sales by 7% annually on a compound-based basis. In terms of our adjusted EPS, we've grown that by 24%, over that period, and then our adjusted EBITDA by 10%. We think that's a good base in which to build off of. One of the strengths of VPG is our cash flow, and we've been able, as I mentioned in the previous slide, we've generated a lot of cash flow, EBITDA, and we're using that cash with a balanced capital allocation strategy that leverages both internal investment, M&A, and share repurchases.
The internal investment I've talked about, we actually are coming off of a period where we've had an elevated level of capital spending in our business to revitalize and adopt more automation in our manufacturing, or to move manufacturing from higher-cost centers to lower-cost centers, and really increase the efficiency of our operating effectiveness. We're seeing that slow down. So you'll see as we move through 2024, barring any additional programs, you'll see our free cash flow start to increase as a percent of our cash flow. The second one, M&A, I think we believe that that's a great lever. We have a solid balance sheet, a net cash position, and a proven track record to add businesses to our platform. And then third, stock repurchases.
We've been buying back our stock since August of 2022. As of the third quarter, we bought back almost four million of stock. We've been in the market in the fourth quarter very actively. So that's another value-added use of our capital. We've also, as a fourth one, more opportunistically been paying down our revolver debt, even though we're in a net cash position, as a way of reducing our interest expense. We bought back seven or paid down $7 million of debt in the third quarter, which should lead to a savings of $500,000 in 2024. So let's focus in on M&A for just a moment.
So M&A, as I indicated, is part of our growth strategy, it's part of our use of capital. And we think we have a good track record of M&A, so we know how to do this, we know how to find and business, we have a great balance sheet. And we're really looking for high-quality, profitable businesses that we could add to our platform, that are leaders in their respective markets. It could either be a bolt-on or a transformational one. But whether it is a large or small one, we're gonna apply the same criteria, very stringent hurdle rates and ROI expectations. That's sort of our perspective on doing M&A. That's how we've always approached it.
So, to summarize, hopefully you have a sense in terms of the changes in our business, our growth strategy, the drivers that we see, and more importantly, the convergence now that we're very much seeing in terms of the secular trends that are driving opportunities and our own ability to address them and capture them. And, now I'd like to see if you have any questions, and thank you for your time.
I guess I've got a question sort of on the sales slowdown. Is it just in-market demand slowing down, or is your business subject to inventory correction, too?
So, Jay, I think it's been a combination of both. We've seen, you know, during the third quarter, a lot of our distributors working through the inventories and destocking. We've seen that. We've also seen a bit of slowdown with our industrial markets. We think that we're close to the end of that, especially with the destockings. We have quite the visibility through our distributors, and we can see that they're coming to a point where the reorder is probably imminent, whether it's in the fourth quarter or early next year, for sure, it's coming back.
Yeah, just to add, I mean, some of the slowdown was in some of the markets which are historically cyclical, such as steel. That's a great market for us, but we saw orders pull back, you know, after a very strong, first half of 2023. Consumer, we saw a little bit of pull back, and semiconductor test, which is another cyclical market. So I, I think, as Bill said, it feels like in some of these areas, they have hit the trough and, and now, you know, we would expect them to rebound. It's not clear when or how fast, but that's sort of our sense based on historical trends.
Right. Quick follow-up. What % of sales go through distribution?
About a third.
About a third.
You may have provided this in the deck. I apologize if I missed it. What was the organic growth rate in 2022? It was 14% was the top-line growth, right?
It's all organic.
That, that'd be all organic in 2022.
Okay. So you haven't done the acquisition then?
Yeah.
Talk to us a little bit about the types of acquisitions you might be looking at, areas you might look to?
Yeah, Jim, no, it's a very, it's a good question. You know, for us, obviously, M&A is truly one of our growth engines. You know, we had five acquisitions as a publicly held company. You know, we're looking. They were all bolt-ons. We're also looking for a large, or what you would call a transformational, that could be anywhere with revenues of, say, $70-$75 million or higher, EBITDA $15 million or higher. And what areas? It could be in our existing areas that we're seeing today, but probably more in the systems related. It could be in or with, for example, like MEMS technology, machine vision, for an example, maybe fiber optics, data center.
So there's many more like sensing opportunities that are growing beyond what we consider to be our legacy, and moving into more major, larger niche markets that would have like double-digit growth opportunities.
What kind of multiples do you see out there? What's the market look like?
I mean, recently, through some of the transactions we've looked at, still pricing was very expensive. You know, some deals that we were, you know, involved in, we're going for 15-17 times EBITDA multiple. But, and, and that is just, just too rich. But we have, we have begun to see prices coming down, people stabilizing. Not so much more with the PEs, but still you have the strategics that are involved.
Is that growth target, is that all organic? I mean, no Ts?
So the growth target would be a combination of organic, which is probably like that 7%-8%, and then the other 5-6 would be M&A opportunities, M&A growth.
But, as you think about those three-five-year targets from an operating basis, they're not that far away. I mean, we got pretty close when, about the fourth quarter of 2022. I think we did about $96 million in revenue. And so I think we had an EBITDA margin of 19%+. So there's a lot of leverage in the existing business that with, you know, some degree of incremental revenue, we could get pretty close without an acquisition.
Which of those verticals that you showed on the slide deck that broke out, you know, the revenue by market vertical, which of those have the strongest growth profile right now? Parts of the industrial automation, and you highlighted one area of robotics. I'm just curious where you're at.
Yeah, and that's a great question. So I would say, you know, we see test and measurement as one of the areas that is growing the fastest, at least for the opportunity set that we're addressing. There's some others that we see within that other category, including precision ag, consumer, and even some medical. And then I would say the slower growth ones are certainly more in the industrial weighing areas, or some of the traditional markets that we address in transportation. They're good markets, but they're growing, you know, GDP plus kinds of rates.
You talked about the advanced sensor example, where you guys automated, you know, a smaller part. That seemed very high margin and very successful. I think you commented on moving it to other parts. What part are you contemplating moving it to next?
Well, we have moved that to our operation in Japan, where we make precision resistors. And so we have some automation in the weighing solutions manufacturing operation in India. But it's now, that piece is sort of behind us, and now we're focused on kind of, you know, filling in other capabilities that we're gonna need, such as business development, which is a very high priority for the company right now, where we have added additional capability over the last year.
Let me just ask another one.
Sure.
Your business has high income margins. Obviously, when sales do turn around, that should flow through. I think historically, it's been in the 40% contribution margin range. Is that still true today, or has that changed, the number changed?
Yeah, James, I would say it's still close to that 40% contribution margin. I know it goes, you know, both ways, but on the downside, we've always have ways for, like, cost reduction programs or, you know, we reduce our spending. But going forward, we would—we still very feel very confident that we'll achieve that 40% contribution margin.
Just on the advanced sensors, where do you guys stand in regards to your capacity? It sounds like consumer electronics has been a little weak, so I'm assuming capacity's come down, but just can you give us an update on that?
Sure. I mean, so from advanced sensors, yeah, the consumer has slowed down. I think we were running at a rate in the low $40 million. You know, a year ago, we were probably closer to $50 million. So we definitely have the capacity, and. But, you know, we have seen signs where some of that consumer that was great in 2022, lagging in 2023, may begin to come back in 2024. And I think, as Steve mentioned, there's also the opportunity with this humanoid that could lead to potentially further, larger opportunities down the road as well.
Is that the number one reason that your revenues seem to have petered out or declined over the past 12 months, so that advanced piece on the consumer electronics?
So I'd say it's a combination of the, the consumer piece, but then also the precision foil resistor with, with test and measurement. I mean, that was so successful. We're running record levels at 2021 and 2022. We saw that in, like, the fourth quarter a year ago, where orders were beginning to slow down, and therefore, we've seen it, like, basically throughout 2023, you know, a slowdown in test and measurement. So within the sensor market, it's the consumer and the test and measurement. That are the two, I'd say, end markets that are driving the, the revenue reduction compared to our, our record year of a year ago. Yeah, Jim?
Do you provide metrics on your design wins?
... No, we do not. We're in the process of gathering, you know, all that information and making sure that we have all our checks and balances in place. But I would see that as we gather more of the information and we get the critical mass, that, like, on our quarterly earnings call or presentations, we'll begin to show more of those design and wins, you know, by segment, by product.
Typically, what does it look like from the time you do design? It probably varies by application.
Right.
Just curious, from the time you get the lead to the scaling of production.
Yeah. So, let me try to answer it this way: so if you think about our distribution channel, so a third being distribution-
Right
... a third being more the OEM, and then a third being direct. So the OEM piece, which has been growing the most rapidly, there's a long lead time-
Yeah
... especially for some of these more advanced applications. Whereas in the distribution, generally, if the customer needs the product, they just pull it down. The other, part, too, in the direct sales, also can have long lead times. For instance, we make a product that's used in the steel production, where they're rolling the steel into sheets, and so our product is used to make sure that the thickness of that sheet is uniform, which is really important, in terms of quality, of that product. Those sales or those orders can take six-nine months to get, because you're working with that particular, customer.
They have a unique setup in terms of how their mill is, and so you get the order, then it takes another six-nine months to install it, because, again, these are highly customized for that particular customer.
That third of the business is distribution?
Yes.
So, do you have a good line of sight into where those, where those markets are, the customers, and... Curious, see, sometimes you do something-
Yes.
Yes, and I would take that and say, Jim, yeah, we have great visibility into our distributors as to how much they've sold over the past month or so, how much inventory they're holding on behalf of us. So we know every month, basically, where we stay in the whole process, and this is why, you know, we feel confident that we're getting to that point of reorder. 'Cause we know the inventory's been working off the last few quarters, and we see that.
We do know, like, the quantities and the demand. We do know the general area, but we may not know the specific customer-
Right, we may not know, but we have enough in our mind and knowledge-
Good
... to know that it's coming.
So if you grow 7% for the next five years and you get your margin targets, so that's like $100 million EBITDA, if I'm doing my math right, what's that worth, do you think?
In terms of what? In terms-
Multiple. Like, what would that, what's-
If we hit 100... I'm sorry, if we hit $100 million of EBITDA?
Yeah.
I think we would be, we should be over a billion-dollar market cap company. If we're going today, and today we're close to, say, $60-$62 million of EBITDA, and we grow that, and we hit over $100 million of EBITDA, there's no reason why we shouldn't be valued at well over $1 billion.
Part of the way we get to that logic is, you know, today, we think, you know, the stock is undervalued, so we're starting sort of behind, in terms of valuation.
What does that mean?
Just a question on that, the sensor companies and M&A you're looking at, you said 15-17x EBITDA. I'm sure there are some that are cheaper.
Mm-hmm.
You guys are seven times, eight times EBITDA than you're looking. Are the ones you're looking at all much faster growing, or, or why do you think there is such a discount?
I mean, well, we probably need more than 45 seconds to answer that question. I would say, yeah, so the ones that the M&A that we're looking at is definitely, majority of them are double-digit revenue growth, good opportunities. And look, Jim, we know most likely we're gonna have to pay more than what we're trading at today, because we truly believe that we're undervalued. But we truly believe that the risk that we would take, the reward would be much, much greater. And, you know, given, you know, depending upon what we acquire, synergies, sales channels, yeah, we think it would be a home run for us.
Right. You also use cash and your balance sheet-
Mm-hmm
... you're not using stock for it, so that, yeah.
Yeah, we would use a combination of cash and debt at this point in time.
Yeah, yeah.
Stock's just too cheap.
Right. At the same time, I mean, debt is not in favor either, right? So I mean, even though you're, you have net cash positive and you have decent cash flow, you, people screen for things that they want to look at and pay for, and if the debt's at a certain level, then the investors shy away from investing in things, right?
But we-
Well, yeah. Go ahead.
I was gonna say, you know, then it becomes a de-leveraging story, and that's a, that could be a really positive thing. Given the cash flow that we throw off, that's not a bad scenario.
De-lever or buyback or?
To basically pay down debt.
Okay.
Just got cut off.
Okay.