Bel Fuse (NASDAQ:BELFA) Q3 2020 Earnings Call

0:00 Good day and welcome to the Bell Fusing Third Quarter 2020 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Dan Bernstein, President and Chief Executive Officer. Please go ahead, sir. Thank you, Anna. Joining me on the call today is Greg Brocious, our Vice President of Finance, Lynn Hutkin, our Director of Financial Reporting. Before we begin the call, I'd like to ask Lynn to go over and say a part of the statement. Lynn? Thank you, Dan. Good morning, everybody. Before we start, I'd like to read the following safe harbor statements. Except for historical information contained on this call, the matters discussed on this call, such as statements regarding fourth quarter sales, anticipated cost savings from the closure of our power R&D facility in Easter, Switzerland, and our sales office in Germany, as well as from a streamlining of our North America sales organization and the impact of potential future acquisitions, 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 those projections.

1:08 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 impact of public health crises such as governmental, social, and economic effects of COVID-19, 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 to the Company's New Products and Competitive Responses to those New Products, The impact of changes to U.S.

1:55 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 would now like to turn the call back to Dan for a general business update. Okay. Thank you for joining our call today. I hope you and your families continue to stay healthy during these times. First, I would like to provide an update on the facilities around the world as it relates to COVID. We are pleased to report that all our manufacturing sites globally have been operational throughout the third quarter.

2:46 As always, the situation around COVID remains fluid, especially as we enter the COVID months. who ensure ongoing compliance with local regulations to mitigate our risk. Our production managers, manufacturing associates have shown a relenting dedication to Bell and its customers over these past seven months and we truly appreciate what they do for us each day during this challenging time. Now, turning to our results. We are pleased that our global reduction plan over the past year has gained translated has again translated into meaningful gross margin improvement during the third quarter. The inclusion of sales related to our recently acquired CUR business along with our ongoing strategy to streamline the organization while eliminating certain low margin products has driven much of the improvement in our results.

3:38 Our sales level remains consistent with the pre-COVID level of the third quarter of 2019, while Bell adjusted EBITDA as outlined in our relief improved by 33% during this period. Excluding CUI sales in the third quarter, we were down $10.9 million from last year's third quarter, with declines seen across each of our product groups. The weakness in the commercial aerospace and market accounted for $7 million of the decline. Sales of front-end power products were down $3.1 million from last year's third quarter. Laji Du was not accepting new orders from a low margin data center customer.

4:23 This is partially offset by the growth in our subject protection sales of 1.4 million. Our integrated connective module sales were lower than the prior year by 1.3 million due to a reduction in demand from one of our networking customers. Despite lower sales, We are encouraged to see that each of our three product groups showed improvement in gross margins compared to last year's third quarter as a result of the successive execution of our global cost reduction plan. As visibility remains limited going forward, we anticipate fourth quarter sales to be more comparative to fourth quarter of last year. However, we do have areas of continued strength. State sales into the military segment during the third quarter were up 33%, leading to record shipping quarters for the end markets.

5:16 The growth was seen in both U.S. and European defense markets in the areas of munitions, military avionics, and ground communication programs. The CUI group had a 40% increase in sales of their standalone sales during last year's third quarter. Our circuit protection sales also saw growth in the third quarter with a 43% increase over the last year's third quarter. These are expected to be continued areas of growth for us. There's also been meaningful activity with our e-mobility and markets as we've been shipping power-related prototypes to several new products. Our e-mobility products are expected to be significant contributors to Bell's growth in the long term.

6:01 As part of our global cost reduction plan, the closure of our facility in Ooster, Switzerland in late August has brought our annual fixed costs down by 3 million. With Ooster closing, the R&D activities have been shifted to other existing R&D groups throughout the world. Further, we recently announced anticipated closure of our sales office in Germany and streamlining of our North American sales organization. These auctions are expected to result in incremental $1 million of annual cost savings starting the fourth quarter of 2020. The bail management team remains focused on bottom line growth while actively looking at strategic acquisitions and the better position balance for the future. And with that, I'd like to turn the call over to Craig to go through the financial updates. Craig?

6:49 Thanks, Dan. Sales by product segment for the third quarter of 2020 were as follows. Power solutions and protection sales were $47.8 million, up 18.5% from last year's third quarter. Connectivity solution sales were $38.5 million, a decline of 13.5%. And magnetic solution sales were $38.2 million, down 3.7% from last year's third quarter. On a consolidated basis, Gross profit margin, excluding R&D expense, increased to 26.9% in the third quarter of 2020 as compared with 23% in the third quarter of 2019 as a result of a combination of factors.

7:37 Overhead and indirect labor costs were $3 million lower during the third quarter of 2020, primarily due to restructuring measures implemented during late 2019 and a reduction in the cost structure of our cinch connectivity solution segment to align with current sales volumes within that segment. A portion of the margin improvement in the third quarter of 2020 related to lower material costs as stocks of high cost components that had previously been built up in our supply chain have not been worked through, resulting in significantly lower material costs in the P&L as compared to the same quarter last year. Research and development costs were $5.7 million during the third quarter of 2020, a decline of $450,000 from the third quarter of 2019, primarily due to restructuring efforts implemented during the latter part of 2019.

8:30 Our selling general administrative expenses were $18.9 million or 15.2% of sales as compared with $18.5 million or 14.9% of sales in the third quarter of 2019. Lower travel expenses of $514,000, a reduction in ERP costs of $242,000, and savings from other cost containment efforts largely offset the $1.9 million of incremental SG&A expenses associated with the recently acquired CUI business. SG&A expense also included an incremental gain on the cash surrender value of Coley policies of $408,000 in the third quarter of 2020. compared to the third quarter of 2019.

9:16 On a go-forward basis, we would expect SCNA to run between $19 and $20 million per quarter in the near term, as we expect our T&E spend will continue to be lower than normal for the remainder of the year. These factors resulted in income from operations of $8.8 million in the third quarter of 2020, as compared to a loss from operations of $5.2 million in the third quarter of 2019. If you recall, the third quarter of 2019 included an $8.9 million impairment charge related to our goodwill. Other income expense net was an expense of $1.2 million for the third quarter of 2020 as compared to income of $629,000 during the third quarter of 2019.

10:04 The fluctuation from last year's third quarter was largely related to a foreign exchange loss of $1 million in the third quarter of 2020 as compared to a foreign exchange gain of $600,000 in the third quarter of 2019. Interest expense was $1.2 million in the third quarter of 2020, down slightly from the same quarter last year due to the lower interest rate in effect during the 2020 quarter. We expect interest rates to be lower in the fourth quarter related to the decreases in both LIBOR and in the company's spread on its credit facility, along with a reduction in our outstanding debt balance. We had a benefit from income taxes of $1.1 million in the third quarter of 2020 compared to a provision of $590,000 during last year's third quarter.

10:55 Changes in federal tax law around the GILTI tax, coupled with a reversal of uncertain tax positions, led to a benefit from income taxes in the third quarter of 2020. The tax provision for the third quarter of 2019 was unfavorably impacted by the impairment of goodwill in our North America segment. Earnings per share for the Class A common shares was earnings of 57 cents per share in the third quarter of 2020 as compared with a loss of 51 cents per share in the third quarter of 2019. Earnings per share for the Class B common shares was earnings of 61 cents per share in the third quarter of 2020 as compared with a loss of 53 cents per share in the third quarter of 2019.

11:41 On a non-GAAP basis, which excludes certain unusual and other non-recurring items, EPS for Class A shares was earnings of 58 cents per share in the third quarter of 2020 as compared with earnings of 19 cents per share in the third quarter of 2019. on a non-GAAP basis, EPS for Class B shares of $0.62 per share in the third quarter of 2020 as compared with earnings of $0.20 per share in the third quarter of 2019. And now I'd like to go through some balance sheet and cash flow items. Our cash and cash equivalents balance at September 30th, 2020 was $81.1 million, an increase of $8.8 million from December 31st, 2019. Our cash balance grew by $5.8 million sequentially from the June 30th balance.

12:34 During the first nine months of 2020, we generated cash flows from operations of $34.8 million. We made net payments of $18.2 million towards our outstanding debt balance and used cash for capital expenditures of $4.5 million, dividend payments of $2.4 million, and interest payments of $3.4 million. Accounts receivable were $69.7 million at September 30, 2020, as compared with $76.1 million at December 31, 2019. Day sales outstanding decreased to 52 days at September 30, 2020, as compared to 60 days at December 31, 2019.

13:19 The decrease in our accounts receivable balance is largely due to lower sales in Asia, where payment terms tend to be lowest. Inventories were $103.6 million at September 30, 2020, down $3.6 million from December 31, 2019. The decline in receiving raw materials due to the reduced material intake and anticipation of a slower fourth quarter in 2020. Accounts payable were $40.1 million at September 30, 2020, down $4 million from its level at December 31, 2019, primarily due to lower purchases of raw materials during the third quarter of 2020. Bell's total outstanding debt balance was $125.4 million as of September 30, 2020, net of deferred financing costs, a decrease of $18.3 million since the 2019 year-end balance.

14:18 This primarily reflects voluntary debt repayments of $18.2 million made during the first nine months of 2020. Hook value per share, which is calculated as stockholders' equity divided by our combined A and B classes of common stock outstanding, was $14.46 per share at September 30, 2020, as compared to $13.69 per share at December 31, 2019. And with that, I'll turn the call back over to Dan. Thank you, Craig. At this time, Anna, can we please open the call up for questions? Yes, sir. Thank you. And if you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function has turned off to allow your signal to reach our equipment.

15:08 Again, that is star 1. If you would like to ask a question, we will take a question from Mike Seacrest with Needham & Company. Hey guys, good morning, and thanks for taking the time for the questions today. First thing I wanted to ask you about was this guide for the flat year-on-year revenue as we look to Q4, and I know that you guys are walking away from some of this low-margin business now from two customers, and you have the CUI acquisition under your umbrella now as well. Can you talk to, I guess, some of the puts and takes for the underlying organic business? Just wanted to get a sense of how How do you guys see the different segments playing out in Q4 to help you get to flat revenues from a year-on-year perspective?

15:56 Again, we have certain segments within product groups, as we mentioned, that CUI have had since requiring them. They've done a tremendous job on top-line growth. Our Fuse group has done very well on top-line growth. The Cinch group has really got hit in the stomach pretty hard. because, or yes, one of the major aerospace companies are not, you know, plane is not allowed to fly. We're hoping that they have permission by the end of this year. But once, when they do get permission at the end of the year, how many airlines are going to be buying airplanes? So we are, so we have no idea, you know, at one point they said they would be back in 2024. Now the latest news is 2022. So it just sets limited visibility on the aerospace side to stuff that, to determine how we move forward with top-line growth.

16:49 On the other hand, we did have substantial military growth, and we're really pleased by that, and we think we can maintain that military growth. It would be difficult, you know, offset what we lost in aerospace. Again, with the CUI addition has made that group substantial, the power group substantial, shorter from the top-line growth. Also, circuit protection, as we mentioned, has had 40% growth. We do do a lot with e-mobility. We've probably signed about 50 NDAs a month. So there's a lot of activity. In addition to that, we've been averaging $2 million a week bookings. And this past week, we did about $5 million. So I do not know if that's a good sign or not, but it's the best booking week we had in probably three years. And then I think the magnetic group, I think that has very, of all the groups we have, that probably has the most limited growth potential at this time. because of the limited customer base we have within that group.

17:50 So we still think we still have a lot of potential, again, on the Fitch military side, and then again on the power side, I think we have growth in e-mobility, circuit protection, the adapters, and also we are doing a lot on basic power products we build ourselves before the acquisitions. That's helpful. Thanks for walking me through that. I guess another item I wanted to touch on is Again, these close margins continue to grow and be a positive point for the Bellevue story. Just curious if you could talk to anything that might have been one time in Q3. I know we spoke to the material costs in Q3. Did you guys, were you able to size up what the benefit was for Q3 from those material costs and if that becomes a headwind now in Q4 as well as and many more.

18:46 I believe that those gross margins typically come down sequentially, but any input there would be beneficial. Okay, Craig, do you want to address this or do you want Lyndon to address it? Yeah, I can address part of it. I think with respect to maybe some one-time items that may not continue going forward, we did receive additional subsidies from the Chinese government during the quarter. to the extent of about $900,000. So whether those continue into the new year, we don't know. There will be some impact in the fourth quarter, but not as substantial. We don't expect any one. But I think what we'll see going forward is kind of a continuation of the impact of streamlining our product offerings and so on and so forth.

19:41 So While we, you know, with the sales volume expectation being comparable to last year, I think, you know, we'll see a little bit of margin degradation overall percentage-wise just because of the volume. But I don't know if there's any other significant one-time items that would be rolling through here. Lynn, do you agree with that? Yeah, I agree. And Mike, just to answer the part of the question on material costs, so the lower material cost in Q320 contributed 270 basis points to our gross margin for the quarter. So to put that in perspective, in Q319, our material cost as a percentage of sales was 44.9%, and that declined to 42.2% in Q320.

20:36 If you recall, we still had very high material costs running through our P&L in 2019, so we have seen that come down in the 2020 quarters, and we expect that to stay at generally around this lower level. It may pick up a little bit, but I think the 2019 level was unusually high. That's great. Thanks for all the color there. And then one more, if I may, just to squeeze it in, but question on the streamlining that you're talking about for the North American Sales Organization. I know that you announced that today in conjunction with the closing of the Germany facility. What is it that you guys have to do on that front?

21:21 Just curious from an operational standpoint, the mechanics for that, I guess, million in annualized cost savings to start flowing through the P&L. Thank you. Craig, you want to deal with the cost savings when it starts flowing through the P&L? Craig, I have that. Oh, you have it? Go ahead, Lynn, then. I do. I do. So, the aggregate cost savings for those two actions will be just over $1 million, and we expect that to mostly start in 2021. It's just a small amount, maybe $50,000 or so in Q4-20. Q1-21, we expect about $125,000. And then going forward, it would be $275,000 a quarter in cross-agents through the end of 2021.

22:15 All right. Thanks for all the call, guys. I'll turn it over to anyone else who might have questions. Thank you. Thanks, man. We'll now take a question from Theodore O'Neill with Litchfield Hills Research. Thank you very much. In the prepared remarks last quarter, you talked about a $1.6 million award for power supplies for a cost-effective ventilator. Has that shipped yet, and is there any follow-on business from that? I think we have a positive... I do believe we have other additional orders, but not to the extent we thought probably. And I think the customer there was the Canadian Army.

23:05 Yeah, the Canadian government. We have started shipping. We did start shipping that in the third quarter. Okay, great. Thanks very much. Once again, that is star one if you would like to ask a question. And we'll now take a question from Cindy Sassato with Gabelli Funds. Good morning, Dan, Craig, and Lynn. Good morning. Dan, can you share what you are seeing in China? Other companies have talked about the impact of shipment ban to Huawei, some foreign inventories ahead of the ban.

23:50 So what are you seeing in your market in China now? Dan, for us, Huawei has never been a big customer of us in China. We do see certain customers, minor customers, that are having a difficult time to deal with American-based companies. And we're starting to see some prejudice, but none of our key customers. Most of our major customers in China are the large subcontractors that go for the Cisco HPs of the world. So like Ahanhe slash Foxconn, Offlectronics, Jabil, these type of, you know, these large CEMs You know, generally have to buy off the spec of the American customers or the European customers.

24:41 And that's where a majority of our business goes to China. So there's always some concern about the political situation between China, A, between America and China, B, between Hong Kong and China, and C, between China and India. So again, there's a tremendous amount of uncertainty that we are concerned about. And one of the reasons... You know, we are, you know, looking at other areas of manufacturing besides China that gives us the same low cost. Not to say that we would move out 100% of manufacturing, but I think we would like to get to a point that we're not so dependent on the low cost manufacturing in China. Got it. And then some companies have also talked about inventory or capacity digestion among data centers.

25:33 were all invited to that. About capacity regarding capacitors? No, in data center space, some companies have talked about the fact that sales to data centers have been strong in the first half of 2020, and then now we may see some inventory digestion. No, I don't think we have seen anything yet. Sorry. I think we may have benefited a little bit in the first half from that, Andy. And I think going into the fourth quarter, we have seen our order book soften a little bit with respect to some of those networking data center clients. So I think we are seeing a little bit of that.

26:34 Got it. So then when you share that the growth in magnetic segment is somewhat limited now, what can be the next growth drivers for the magnetic segment? That's a good question. Again, I think our focus would probably, you know, I think the magnetic group, you know, at some point you might fall into the power group. You know, every power supply needs a magnetic group. But I think there's... Again, we make a very specific product that we're the market leader on. We control 70%, a good percentage with high-end customers on that product. So when you control 70% of the market, I think it's very difficult for us to grow it.

27:24 So again... I think what our focus now is how we can combine our magnetics we have there with CUI, with signal transformer, with our power supplies. I think what we're looking at is how better we can solve our customers' problems, but be a one-stop solution company, especially for the second-tier, third-tier accounts. So again, it's how do we bundle all this together? Products we have that are very similar, and the first step with that was combining the sales force. So before we would have a direct signal transformer guy go to New England, then we have a CUI guy go to New England, then we would have a bell guy go to New England. Now we have one point of contact that would go to New England that can sell all these products. So we're hoping by having one point of contact and make it easier for our customers and channel partners to deal with us, that we should get greater sales at these customers.

28:22 I see. And one more question, a question for Lynn. So Lynn, you talk about the benefit of material costs coming down from 2019. Is lower material cost behind now, or do you still have some runway? And then secondly, I think in the past you indicated that the gross margin should normalize between 23% to 25%. Should we still expect the gross margin range? So the first part of your question on the material cost, I think we're probably at where we will land. I think the Q3 material cost, and correct me if I'm wrong, is probably where we will land. If anything, it might go up a little bit.

29:16 I know the cost of some of the precious metals has been increasing, so that might put some additional pressure on it. But I think we can use Q3 as a basis for that. Regarding a normalized gross margin, I mean, really, the only thing that was in our margin this quarter, as Craig mentioned, was the $900,000 of subsidies from China that we received, which would be non-recurring. I'm trying to think. Other than that, you know, the renminbi, we do need to keep an eye on. We did have some higher subsidies. labor costs in Asia in this year's third quarter just due to the unfavorable comps in the FX versus last year. So that is something that will impact our margins going forward if that continues to trend in an unfavorable direction.

30:15 You know, I think if we had to put a range on it, you know, mid-20s, you know, maybe 24% to 26%. Craig, do you have any thoughts on that? No, I think that's right. It's all obviously dependent on the mix of revenue that we have. Obviously, when the commercial aerospace recovers, that will influence margins and how successful we are with some of our other cost actions will influence margins. I think the 24% to 26% range is a reasonable and a reasonable range for projection purposes.

31:02 Got it. Thank you. Thank you, Dan, Lynn and Frank. Thank you. Have a good weekend. Thanks, Andy. We'll now take a question from John Hudson who is a private investor. Good morning. Hi, Dan. Yeah, go ahead. operations in China and I recognize the issues between the Chinese government and the U.S. government and I don't need any further comment on that but I'm interested it appears to me that the relation between the company and the Chinese government has been basically very good over the COVID period and part of that is indicated by the subsidies that the Chinese government has provided.

31:59 And I just wonder, is that your opinion and how do you see specifically the relationship between the Chinese government and the company today? You know, generally when we talk to government, we generally deal with the local because we're not that big of a employer in China. So we generally deal with the local government, and we've been there substantially longer than a lot of other companies. And we are, in the communities we deal with, we are a large employer. So historically, we employ a lot of people in the local town. So we do have a very good relationship with the local community and the town government. And I think that's why we've been able to work so well.

32:45 Our concern, again, is the political unrest and the tariffs. and how the U.S. government views things going forward. And again, we do have a good portion of our activity is done in China. And I spent, you know, before COVID, you know, I did a tour of, you know, the Philippines, Vietnam, Malaysia, you know, looking, you know, for another facility to just as a backstop. And we're hoping that we can have an announcement shortly of one of the things we looked at. But from our standpoint, you know, I think if we had a setting up a greenfield operation from scratch, I think we would be a lot more in the area of acquiring a company that has manufacturing in one of those low-cost areas so we could get up and running very quickly and not worry about the political and, you know, who you have to know to get things done type of situation.

33:41 So, again, you know, at this point, knock on wood, Things are okay, but when it comes to China, it's like COVID. Again, we do have some people. We have 50 people in Hong Kong that work for us. What they're going through now in China is very upsetting. The relationship between the Hong Kong people and the China people is not a good situation. It's something that we do keep a watchful eye on. Sounds good. Thank you. and we'll now take a follow-up from Mike Tsikos with Needham & Company. Hi, guys. Just one more if I could. Thinking about the CUI acquisition, it seems to be going at least better than what we had initially thought, so I'm curious on what your assessment is of that acquisition, and then the follow-up to that would be if you're looking for different opportunities on the M&A front, what kind of technologies would be of interest to you. Would it focus on a specific segment or would it maybe it caters to this diversifying the manufacturing footprint that we were just talking about? I don't know. I'll leave it at that.

35:00 Thanks, guys. Okay. Let's just discuss CUI for a minute first. You know, we've been, it took us three to four years to finally acquire CUI. Again, what we find very interesting with them is it's a different model than the Starfleet Bell has. Bell has always built everything we've sold. CUI doesn't manufacture anything. They private label. They have a very tremendous diversified customer base. What they've done better than any other company out there is more from a marketing, MPI, new product introduction. When I started in the business, everybody wanted to see a sales guy. Everybody wanted to go out for lunch. Now, nobody wants to see a sales guy. Nobody wants to go out for lunch.

35:47 They're just going to go on the Internet and get their products as quick as possible and get it designed in. And this is where CUI really shines. They work with the largest e-commerce catalog houses like the DigiKey Mousers, and they do a great job with them to get their product out there to a diversified customer base. And that customer base could be 4,000 to 5,000 customers. And no customer accounting for more than 5%, and that's why they tend to be – you know very profitable and that's the same model that Signal Transformer has so again we looked at them a you know we're tremendously pleased with their sales growth and the booking growths they had since we acquired them and at this point now what we really have to do is capitalize on their marketing MPI and bring it to the other Bell products and how do we market us as one company to solve customers problems so I think from that side as I mentioned before I think there's tremendous upside that we can penetrate our existing customers.

36:52 And there hasn't been as well as I like on the cross-selling opportunities between our product groups. And that will change very quickly. As we go forward looking at products, again, we like to fill out our portfolio in connectors and power. Again, our goal is very simple. If a customer calls us up, if we can give them all the products they want, We think that's what's going to count going forward. And as I said, again, if we can stop, if they can go to one stop, you know, one stop and find all their magnetic needs, all their power supply needs, all their connector needs, that's tremendous for us as more and more engineers are moving away from dealing one-on-one with, you know, with this one-on-one contact, you know, in-person contact.

37:41 And I think with COVID just escalated, you know, where the world's going and I think instead of saying it's going to be like this in four years, it might be like this in two years. So again, one of the things that we started up is a digital marketing sales transformation of how do we address customers a lot better through Facebook, LinkedIn, and putting a lot more resources in that group than we do with outside salespeople going forward. So again, I think in short, there's a revolution going on, we believe, and we're hoping to do everything to strengthen it so when the world changes, we'll be in a better position than we were a year ago. And any company that can help support us, that's what we're looking at.

38:30 That's great. Thank you, guys. Best of luck. And we have no further questions and that will terminate this conference call. Thank you for participating. Okay, thank you everybody for joining and we look forward to talking to you again.