Bel Fuse Inc. (NASDAQ:BELFB) Q2 2019 Earnings Conference Call August 1, 2019 11:00 AM ET
Dan Bernstein - President, Chief Executive Officer
Craig Brosious - Vice President of Finance
Lynn Hutkin - Director of Financial Reporting
Conference Call Participants
Theodore O’Neill - Litchfield Hills Research
Jim Ricchiuti - Needham & Company
Hendi Susanto - G. Research
Good day, and welcome to the Bel Fuse Inc. Second Quarter 2019 Results Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Dan Bernstein, President and Chief Executive Officer. Please go ahead, sir.
Thank you, Shalo. 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. Expect for historical information contained on this call, the matters discussed on this call, such as statements regarding anticipated sales level, gross margin, cost saving, cost reduction measure, 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 involves risks and uncertainties. Actual results could differ materially from Bel’s projection.
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 difficulty; 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 would 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 of 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 the higher material costs, led to a low gross margins this quarter. While we have limited visibility of demand of our products and our customer products our second quarter bookings continued 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 are taking steps to reduce fixed costs and improve efficiencies in each of our facilities worldwide.
During the second quarter, we completed the restructuring of Power R&D resources and the transition of our Signal Transformer operation for Inwood, New York 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 are 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 would be expected to benefit from beginning in the fourth quarter 2019. The global initiative is expected to continue over the next several quarters, as we would complete our strategy that we have put in place.
With the growth of 5G, autonomous and electric vehicles, the cloud data centers and extended in aerospace and military, we still remain very positive of our future growth opportunities. In the short term, the are areas of growth that will offset some of the expected sales decline.
With our Connectivity Solutions group, we expect strong shipments of our micro-miniature ammunition applications as well as increased demand for our high-speed optical transceivers for two new fighter jet programs that are qualified.
Our Power System, 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 with traditional serve applications, which we expect to move into full production by the end of the fourth quarter.
Our Power products sold at eMobility applications, while still small from a dollar perspective, it grew by $700,000, almost 50% from the second quarter of 2018. This area has significant growth potential down the road as some of our startups take hold and move into full production.
And with that, I’d like to turn over the call to Craig, to run through the financials update.
Thanks, Dan. To provide a quick recap on sales, sales during the second quarter were $127.4 million. By a geographic segment, North American sales were $67.1 million, a decline of 6% from last year’s second quarter. European sales were $21 million, down 11% and Asian sales were $39.3 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%, and 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 a translation of our foreign balance sheet accounts, with an exchange gain recognized in 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 cost 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 pretax 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 in 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 2019 as compared with earnings of $0.52 cents per share in the second quarter of 2018. Earnings per share to 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 and other nonrecurring 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.
And 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 2019 as compared to the fourth quarter of 2018.
Inventories were $118.2 million at June 30, 2019, down $1.9 million from December 31, 2018. The decline was primarily in raw materials, as purchases of raw materials slowed while we worked through our inventory on hand. Accounts payable were $42.8 million at June 30, 2019, down $13.4 million from its level at December 31, 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 30, 2019, excluding deferred financing costs. Book value per share, which is calculated as shareholders equity divided by our combined A and B Classes of common stock outstanding, was $14.64 per share at June 30, 2019, as compared to $14.39 per share at December 31, 2018.
One final note on the finance side: 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 the call back over to Dan
Thank you. Shalo, can we open up for questions?
Thank you [Operator Instructions]. We’ll be taking our first question from Theodore O’Neill of Litchfield Hills Research. Please go ahead.
Thank you. Thanks very much. And I’ll vote for a re-class of R&D as a separate line item. The question I have for you, can you hear me okay?
Okay. So, 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 to $21 million, and it came down in this quarter, also, so did sales. And so, 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 are guiding now is slightly below that from a $19 million to $20 million.
So, 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 reoccur in this year’s third quarter unless something drastic happens in August or September.
Okay, okay. And, I do understand what’s going on with the 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, so I get that part of it.
That’s it from me. Thank you.
[Operator Instructions] 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 mostly 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, where, you know that’s our integrated connector modules that we have, which is affected by some very large OEM customers. So it’s not as broad based as some of our other product lines we have.
Got it. And, 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 think we are – I hate to say it, but we hear this too often, but I think we are all very optimistic about the future.
You know, I go back, I hate to say it, but my father was you know the upsurge, everybody went out and bought a color TV, there was a lot of demand, and all of a sudden, we were out of color TV. Then it went down, to mainframe computers, and then minicomputers, then you did networking and high speed.
So, we always see these ups and quick downs as people get, you know buy the new product. But 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. I mean, if you look at Amazon and alike, all that growth you see is coming a large part from the data centers.
How do we penetrate those type of accounts, 5G where if you went to the Consumer Electronics show, everybody is talking 5G, we haven’t seen anything, but everybody’s introducing tremendous amount of new product.
So again, we know it’s going to flush out at a certain point, but we’re really looking at what I guess the term I think, Lincoln [ph] came up with the term Electronics Super-Cycle. Now we just see a wealth of products out there that gives everybody a great level of opportunity, you know 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 came, might have come from product mix?
Sure. So, the majority of it related to the higher material costs. We are estimating about 3.8%, so 380 basis points related to material costs, on the sales declined, just volume decline will have an impact on our margin percentage.
But there was also a shift in product mix, and we’re estimating that, that had about 250 basis point impact on our margins.
And then there were some other favorable factors there, and a more favorable FX environment. So that was an offset to those two unfavorable factors.
Okay. What you’re seeing in higher material cost, 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 and Protection area.
And Jim, as you know as material lead times come down substantially, the pricing will follow close by.
But we haven’t seen pricing return to those like 2017 levels, and we are not expecting that for a little while here.
Okay. And then 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?
Yes. I mean, its – we are looking at, like we mentioned we’re looking at all of our locations who have been in kind of the company structure. I think, you know we can reasonably expect maybe another $3 million to $5 million in fixed costs over a period of time. So these are not going to be short term type fixes, but that I think would be a reasonable expectation.
Understood, okay. Thanks a lot.
Thank you. Appreciate the call.
Our next question comes from Hendi Susanto of G. Research. Please go ahead.
Good morning and thank you for talking my questions. First question, can you characterize about the gross margin pressure due to product mix? And when will it be until we shift to a more favorable mix?
So 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 and on the military side, the timing is unpredictable, it’s based on the timing of the various programs that we’re on.
So, military had a bad quarter in the second quarter, but we do expect that to improve in the third quarter. So we do expect some upside in Connectivity related to the military business in the third quarter, and that’s a higher margin business, so that we do expect some improvement in the third quarter related to product mix.
And then that is big enough to swing the gross margins one way or the other, I assume?
What we’re seeing for the third quarter, based on our existing backlog, kind of, you know basically indicates that we should see an uptick in gross margin percentage for the third quarter.
Got it. And then I want to revisit Jim’s earlier questions. Can, you characterize in which vertical inventory correction is the most significant one? Other companies have talked about excess inventories in hyper-scale and data-center customers. I’m wondering whether you can share some colors how similar your perspective versus others.
I think we’re seeing, large you know inventory correction in our networking equipment end product market. We sell those to large OEMs that are overstocked at the moment. So, I think that one is one of the largest ones.
We also see similar, over inventory situation in our distribution channel, and that’s pretty much across the board in all of our product groups.
And it should be noted that we do $120 million during the distribution channel, so it’s a big chunk of our sales fell through that channel. And if you know, if you’ve seen writings on Arrow and [inaudible], you know what’s going on there, and I think everybody’s worried over inventory situation.
And then Dan, how long do you foresee this inventory correction will last?
What we understand, most people are saying, for the balance of this year. By September, we should get some more visibility, as people assume that September, people order before Chinese New Year. But at this point, I don’t know, I think we don’t see any uptick for balance of the year.
Got it. Okay. Thank you.
Thank you for the questions.
[Operator Instructions] The next caller is from Hendi Susanto of G. Research, 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 are expecting material costs to gradually trend down as there is more capacity and then more throughput. I think we would, you know 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, Shalo. We appreciate everybody joining us today and hopefully things will sort of 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.