Earnings Call Transcript - BELFA Q4 2022

Operator, Operator

Good morning and welcome to the Bel Fuse Fourth Quarter 2022 Earnings Call. As a reminder, this conference is being recorded. I'd now like to turn the call over to Jean Marie Young. Please go ahead, Jean.

Jean Marie Young, VP of Investor Relations

Thank you and good morning, everyone. Before we begin, I'd like to remind everyone that this conference call contains certain forward-looking statements regarding the company's expected operating and financial performance for future periods. These statements are based on the company's current expectations. Actual results for future periods may differ materially from those expressed or implied by these forward-looking statements due to a number of risks and other factors. Additional information about factors that could potentially impact our financial results is included in yesterday's press release and is discussed in our filings with the Securities and Exchange Commission, including our most recent annual report on Form 10-K and our subsequent quarterly reports and other filings with the SEC from time to time. We may also discuss non-GAAP results during this call, and reconciliations of our GAAP results to non-GAAP results have been included in our press release. Our press release and our SEC filings are all available at the IR section of our website. Joining me on the call today is Dan Bernstein, President and CEO; Farouq Tuweiq, CFO; and Lynn Hutkin, Vice President of Financial Reporting and Investor Relations. With that, I'd like to turn the call over to Dan. Dan?

Daniel Bernstein, President and CEO

Yes. Thank you, Jean. We're very pleased to report a strong finish to a record-breaking year at Bel, where we demonstrated that even during a year with a challenging supply chain environment, our team's dedication and hard work has paid off. We would like to thank all our associates for allowing us to reach these milestones. Each of the three product groups shows a double-digit top line growth this year, with our Power group leading the way with a 32% increase in sales year-over-year. Excluding the $32.5 million of raw materials surcharge invoicing during 2022, Power sales were up 17% over '21. Sales of our circuit protection products and CUI and EOS Power products have all had record sales in '22, reflecting double-digit growth over the respective '21 levels. Over the past 3 years, the Power group has been a major focus. Through a combination of strategic acquisitions, targeted investments in EV and a thorough review of SKU profitability, this group closed '22 with sales up $288 million at a gross margin of 30.5%. Even within the '22 fiscal year, this product group showed substantial margin expansion every quarter, starting at 27.1% in quarter 1, 28.2% in quarter 2, 32.4% in Q3 and finishing quarter 4 at 33%. Our Connectivity Solutions group saw a 30% increase in sales in '22 over '21. With this segment, commercial aerospace revenue closed at $31 million for the year, up 75% over '21, highlighted by a jump in aftermarket revenue as well as continued support on new aircraft production. Shipments through our distribution partners remain strong throughout '22, with some offsetting softness noted in our military and network end markets. Our Magnetic Solution group posted an 11% increase in sales in '22 versus '21, largely due to high demand from our networking customers, particularly during the first half of the year. Further, our Signal Transformer business had an increase in sales of $6.8 million in '22, primarily due to price increases taken earlier this year and a higher demand from its medical industrial customers. Lead initiatives were also implemented at Signal's factory in the Dominican Republic during the year. The combination of these actions resulted in $3.2 billion of EBITDA in '22 versus what was previously a breakeven business in '21. The balance of the Magnetic Solutions group is going through a major facility consolidation project in Asia as announced last quarter. Through the year, we recorded $7.1 million in restructuring costs related to this move and anticipate an additional $3 million to 4 million in costs to be incurred through the third quarter of '23. There are currently 180 associates at our new BGX facility, and we expect the headcount to double during the first quarter of '23. The transition is being aided by approximately 10% of the indirect staff from our previous facility agreeing to work at the new facility going forward, providing continuing manufacturing practices and knowledge. This project is scheduled to be completed by the end of Q3 '23. Even with the best financial results in our history, we will continue to strive for improvement, particularly on the margin side, and recognize that more work needs to be done here. On the HR side, our new Global Head of People joined the company in November. Suzanne Kozlovsky has been driving continuous improvement around values and culture, compensation programs, talent recognition, development, and of course retention. Our people are our most important asset. Based on the culture assessment performed in late '21, we understand there are a variety of changes that need to take place within Bel in order for our associates to thrive. Changes take time and require steady progress and debate on this front throughout 2022. But more is to come throughout '23 with Suzanne now fully up to speed. In '22, our management team engaged in an executive offsite session where we discussed our near- and long-term strategies, free from the interruptions of our day-to-day responsibilities. It was from these discussions that we assessed our global footprint and made a difficult decision related to operational restructuring. The four facility consolidation projects announced last quarter are all progressing as planned and are targeted for completion later this year. Our objective strategy sessions will continue into '23 with a focus on further improving the company's bottom line. We're proud of all our associates for a job well done this past year and how that collaborative effort translates into our best results. This is significant progress that should be celebrated. The past 2 years have been focused on righting the ship, strengthening Bel's foundation as a business. Many of these initiatives identified will be completed by the end of '23 so that we are now in the position to be more fully focused on Bel's future as an organization. At this point in time, I would now like to turn the call over to Lynn to update us on the financials. Lynn?

Lynn Hutkin, VP of Financial Reporting and Investor Relations

Thank you, Dan. Overall, fourth quarter sales were $169 million, an increase of 15% from the fourth quarter of 2021. Gross margin for the quarter increased to 31% as compared to 26.7% a year prior. By product group, Power Solutions and Protection sales were $82.1 million, up 39% from last year's fourth quarter, primarily led by an $11.1 million increase in sales of our front-end power products, $4.1 million of higher sales of industrial power products, and $2.8 million of growth in EV sales. Of these increases, $10.5 million is related to invoicing of premium charges on materials. Gross margin for this group was 33% for the fourth quarter, a 210 basis point improvement from Q4 '21, largely driven by a favorable shift in product mix, the benefits of pricing actions taken over the past year, and some favorable impact from foreign exchange. Our Power Solutions and Protection group had a book-to-bill ratio of 1.0 during the fourth quarter of '22 and a backlog of orders of $356 million, an increase of 48% from the 2021 year-end. Turning to our Connectivity Solutions Group, sales were $47 million, an increase of 8% from last year's fourth quarter, mostly due to the continued rebound of commercial aerospace and strong sales through our distribution channels. Military sales continued to be challenged this past quarter, resulting in a 12% year-over-year decrease in the defense end market. Gross margin for this group came in at 23.6% for the fourth quarter of 2022, down slightly from 23.7% in the fourth quarter of '21. Throughout the majority of 2022, this group had been impacted by inefficiencies related to a ramp-up in the workforce needed to accommodate the rebound in commercial air. The Connectivity Solutions group had a book-to-bill ratio of 1.06 during the fourth quarter of 2022 and a backlog of orders of $119 million at December 31, an increase of 40% from the 2021 year-end. Lastly, our Magnetic Solutions group had Q4 sales of $40.1 million, down 10% from last year's fourth quarter. Gross margin for this group improved significantly to 29.5% in the fourth quarter of 2022 from 22.9% a year prior. Margins for this group benefited from pricing actions taken over the past year and a favorable shift in the exchange rate of the Chinese Renminbi versus the U.S. dollar, which lowered our labor costs in China compared to 2021. Our Magnetic Solutions group had a book-to-bill ratio of 0.49 during the fourth quarter of 2022 and finished the quarter with $91 million worth of orders in backlog, down 37% from the 2021 year-end level. The reduction in backlog for our magnetic products is largely driven by lower demand from networking customers as they work through their inventory on hand. At the consolidated level, there were $27 million of orders that were scheduled to ship in Q4, which did not primarily due to component availability. Our selling, general and administrative expenses were $25.1 million or 14.8% of sales, up from $21.9 million in the fourth quarter last year, but down slightly as a percentage of total sales. Within SG&A, the primary increases were related to salaries, fringe benefits, and rep commissions. Turning to balance sheet and cash flow items, we ended the quarter with a cash balance of $70.3 million, an increase of $8.5 million from the 2021 year-end. Our working capital increased by $28.1 million during 2022. We saw a $20.1 million increase in our accounts receivable balance. Our days sales outstanding were 58 days at December 31, 2022, compared to 54 days at December 31, 2021. Inventories increased by $33.1 million from last year-end. While there was continued investment in inventory during the second half of 2022, it was to a lesser extent compared to the first half of 2022. In addition to changes in working capital, other items impacting cash flows for the full year of 2022 included capital expenditures of $8.8 million, and our continued dividend program, where we made payments of $3.4 million. Cash paid during 2022 for income taxes was $14.6 million, and interest payments totaled $3.4 million. I'll now turn the call over to Farouq for additional color and outlook on 2023. Farouq?

Farouq Tuweiq, CFO

Thank you, Lynn. Hello, everyone, and nice to speak with everybody. Looking back at 2021 and 2022, we recognized a tremendous amount of contribution and work that has gone into getting Bel to this point in our journey. This has truly been an all-hands-on-deck effort across our global team members and locations. As Dan mentioned, we're happy to close out 2022 with the wind at our backs and to head into 2023 and beyond with a sharpened sense of focus and direction in our pursuit. As we look out to 2023, we see a good amount of opportunity for both growth in certain areas and margin improvements. While managing continued supply chain constraints in certain components, inflationary pressures, COVID restrictions easing in China, and our previously announced facility consolidation plans, we will continue to pursue growth in certain end markets, lean out the cost structure, and position Bel to capture the long-term positive tailwinds related to our products broadly speaking. Pivoting to backlog for 2023 – as we enter 2023, this quarter, in 2024, we saw a sub-1 book-to-bill for the first time in a while as we have been working on reducing our lead times and getting deliveries out of the factory. We're working with our customers to rationalize this as it relates to their needs today versus what they thought 6 to 9 months ago. While we see some softness in demand in consumer-facing end markets, we believe the larger factor here is customers needing to work through their high levels of inventory and adjusting to the reduction in lead times across most of our products. This is particularly the case for magnetics. On the other hand, we are seeing robust demand in the areas of commercial, aerospace, military, and e-mobility. To that end and as noted by Lynn, we're seeing a rotation in contribution of where the bookings are coming from. Power has been steady, connectivity is growing, while magnetics is slowing. On new orders that when all are added together, our backlog is relatively flat. In short, lead times in certain areas are coming down and other areas increasing, and bookings that are coming in are of higher quality on margin. Using backlog as a basis for our assumption regarding the 2023 revenue outlook, first, we want to level set on the starting point as it was alluded to earlier in some of the commentary. 2022 total revenue was $654 million. But when normalized for the raw material surcharge invoicing, revenue was closer to $622 million. To the best of our knowledge and using $622 million as the base, we expect top line to be flat to plus or minus low single digits on either side of that, given the number of moving pieces in either direction. To give you a little more insight and highlight a few key areas, our commercial air business should be one of our leaders of growth this year given some of the key positions we are in, coupled with overall growth. Our key acquisition of RMS in early 2021 has set us up to capture this growth cycle in a very nice way, both on the top line and margin side. Q4 direct sales into commercial air customers were $8 million, up 55% from Q4 2021, and we expect sales to grow in 2023 to fall into the double-digit territory. This is a great testament to our team and their ability to strengthen Bel's position in the commercial aerospace end market. On the defense side, following a few years of low order volumes, the current global affairs in Europe have been beneficial to us. We expect top line growth in the Defense segment to be in the double-digit range for our full year 2023 as well. For both commercial air and defense, we have spent a lot of time improving them last year as they sit within our connectivity group. As you recall, we have previously spoken about the significant ramp in headcount that occurred in Q1 2022 that adversely impacted our margins throughout last year. For 2023, we expect to have a meaningful reversal here and see the team's hard work pay off. On the mobility side, we nearly doubled the growth in 2022 over 2021 to $20 million. We would not be surprised if we achieved another double again in 2023 and have committed new CapEx dollars in 2022 to expand production and meet this robust demand. We also doubled down on strategic investment in Innolectric, where we now have a 1/3 minority stake with the ability to expand our ownership if certain profitability thresholds are retained. Innolectric consists of a highly skilled engineering team focused on onboard fast-charging technology for commercial vehicle use. They are very similar to Bel in terms of customers and market focus, which we believe is the right place to be. Through this partnership, we expect to jointly grow and channel real revenue synergies. We want to welcome our new partners and are looking forward to an exciting road ahead. On the networking and data center side, we remain bullish in the medium term, given all the secular tailwinds in that end market. But for 2023, we will see an overall slowdown as it digests the ramp in growth since 2020. We serve this market out of both our Power and Magnetics group. The supply chain in magnetics has smoothed out given there are fewer components in this product set, and this is where we are seeing the reduction of the longer-term backlog. Lead times for our magnetics products are currently running at 20 weeks, which is half of what they were this time last year. On the power side, and given the constraints on certain ICs, demand here remains robust. So net-net, this market is a tale of two cities for us in 2023. We strongly believe in the medium to long-term prospects of this business. This is also a testament to our product strategy diversity. Of course, while no business is immune to adverse economic cycles, our business is highly diversified and aligned with secular trends and megatrends in certain areas. Looking ahead, we continue to see strength in Bel as the breadth and depth of our portfolio, our deep customer collaborations, cost takeout initiatives, and doubling down in key areas underpin our profitable growth. For Q1 2023, it's off to a good start with strong January numbers. Today, we believe Q1 2023 will be up mid to high single digits over Q1 2022. We expect better performance on the margin side as well compared to Q1 2022, though down from Q4 2022 due to the usual seasonal impact of the Chinese New Year on our business. For 2023, we're also focused on getting our previously announced consolidation plan to fruition while continuing to look for areas of improvement. To sum it up, we're excited about 2023 and believe we're in a great position to perform well due to our focus on continuous improvement and diversity of product offerings and end markets, even with an uncertain macro backdrop. With that, I'll turn the call back over to Dan. Dan? Sorry. Claudia, can we open up the call for questions, please?

Operator, Operator

The first question comes from Theodore O'Neill from Litchfield Hills Research.

Theodore O'Neill, Analyst

Congratulations on the good quarter. A couple of questions about Innolectric. Not clear, is this a customer, or are you selling the product to them, or both?

Farouq Tuweiq, CFO

So, they are a manufacturer of a product. They have a complementary product set. It's its own business. We took an equity stake in the business. And we think we bring a complementary skill set on the operations and business side of it in terms of sales and marketing, customer connectivity, and manufacturing side that would be additive. They have a great product set with a lot of nice software and packaging capabilities, but it is an ownership stake.

Daniel Bernstein, President and CEO

Farouq, just a little bit more clarification. I wouldn't call it a manufacturer at this time. We see it more as a technology product portfolio. They're in the process now of building up their sales. So they're at an initial stage. We felt very strongly that their product portfolio will align very nicely with our product portfolio going forward. So for us, it was more of an extension of our R&D and their R&D capabilities and how we believe that they have the best products going forward in the EV marketplace where we participate.

Theodore O'Neill, Analyst

Okay. That makes sense. And what sort of milestones are you looking for to take a further investment stake in the company?

Farouq Tuweiq, CFO

Yes. So it's really a revenue and certain profit thresholds that will be the key guiding post there.

Theodore O'Neill, Analyst

Okay. And Farouq, you mentioned sort of leveling out the revenue for this year and talking about how there was expedited costs, et cetera; there was about $32 million of revenue in the year. I would have thought those would be like super high margin part of the business. Was it not?

Farouq Tuweiq, CFO

No, it's not margin. It's actually lower than our typical gross margin. So it brings us down as a percentage of sales. However, these are not meant to be high-margin revenue generators. This is really a convenience expedite fee aimed at getting products out the door, partnering with our customers, and incurring some atypical costs given the current situation. Therefore, from a percentage of sales perspective, they are actually dilutive.

Theodore O'Neill, Analyst

Okay. And Lynn, the $27 million in orders that didn't ship due to component availability, is that in some specific area?

Lynn Hutkin, VP of Financial Reporting and Investor Relations

It's really widespread, Theodore. It's probably mainly in power and magnetics, but not as much on the connectivity side.

Operator, Operator

The next question comes from James Ricchiuti from Needham & Company.

James Ricchiuti, Analyst

I just was hoping to get a little bit more color on the Q1 outlook. Are you assuming that there's still this relatively high level of raw material surcharges in the quarter? And then is this a case where you see that gradually dissipating as we go through the year and eventually going away in Q2, Q3?

Farouq Tuweiq, CFO

Yes. Yes, I would say we start really seeing this in a noteworthy amount in Q2 last year. We thought it would slow down into Q3, Q4, but it actually didn't. So it's really tough to predict that, but we don't think they are going to be around here because these are not part of the normal way of doing business. As for Q1, we are seeing still some PPV surcharges in there, but it's really hard to take a guess at what that would be. So we generally are not going to try to guess it, given that we do know this is not usual.

James Ricchiuti, Analyst

Got it. You've shared some percentage growth in e-mobility. I might have missed it, but have you quantified the e-mobility sales for the quarter? I'm trying to understand the outlook for this business, as it seems there are significant growth opportunities not only in this current quarter but also looking ahead to 2023.

Lynn Hutkin, VP of Financial Reporting and Investor Relations

So, Jim, I can take that one. So e-mobility sales for Q4 were $6 million, and that was up from $3.2 million in last year's fourth quarter. And just to clarify, we did have additional sales out of our e-mobility group throughout the year, but these numbers are just looking at products that go into actual EV and applications. So $6 million for Q4 versus $3.2 million in last year's Q4, and on an annual basis, it was right around $20 million versus $10 million last year.

James Ricchiuti, Analyst

And just with respect to the line of sight you have in this business, it sounds like this is an area of the business you feel still has some pretty good growth prospects for this year. Is that fair to say?

Farouq Tuweiq, CFO

Yes. We do have significant growth prospects for this year. I think it would not be unreasonable to say we definitely see the potential for it to double again this year. We have committed CapEx dollars to expand our production capacity. And I think we just ideally need to get a little bit of help from the component shortages that will help us to get product out the door. So it's a very rapidly growing line for sure. I don't know, Dan, if you have any more insight on that, but that's kind of my insight.

Daniel Bernstein, President and CEO

No.

James Ricchiuti, Analyst

Got it. And just on the Magnetic Solutions group, there obviously are some puts and takes in that area. And I guess what I'm wondering is, do you have a sense as to when some of these customers will be working through the inventories that they have? And I have one quick follow-up.

Daniel Bernstein, President and CEO

Okay. We are in close contact with the networking teams, but they are facing challenges since they cannot obtain power supplies from us due to the IC issues. Some customers are paying expedited fees to us, while at the same time, they are canceling magnetic orders because we aren't able to supply the ICs effectively. We believe there is still a long lead time ahead. To clear out the inventory for the magnetic sector, we anticipate it will take at least six to nine months, with six months as the best-case scenario and nine months as the worst-case scenario.

James Ricchiuti, Analyst

Got it. And the follow-up is that you're still experiencing strong demand from this segment of the market for power. As things begin to normalize, do you anticipate that the demand level in this part of the business might decrease slightly?

Daniel Bernstein, President and CEO

I believe that the sales are affected by the constraints we have. The difference now is that instead of receiving four orders from our bar over the year, we are currently receiving only one order annually. Consequently, we have dedicated significant time to focusing on the backlog and how it compares to our bookings. On the Power side, the backlog remains strong. We have a lot of new product revenue arising from the acquisition of CUI, which has been a significant growth driver, along with electric vehicles that are notably boosting our sales growth. We still see great growth opportunities ahead for Power.

Operator, Operator

The next question comes from Hendi Susanto from Gabelli Funds.

Hendi Susanto, Analyst

Farouq or Lynn, can we go over the math for the commercial aerospace market? Like where the current run rate is versus the pre-pandemic level. And then I think it is reasonable to assume that based on past acquisitions, when things go back to the baseline, your new baseline should be higher than the pre-pandemic level?

Lynn Hutkin, VP of Financial Reporting and Investor Relations

On the commercial air side, we finished the year with direct sales to customers, excluding any distribution sales. Year-to-date, sales reached $31 million, an increase from $18 million last year, representing a 75% growth. Pre-pandemic levels were approximately $40 million to $45 million for our Cinch business and RMS combined, so we have not yet returned to that level. However, we certainly hope to exceed that in the next year or two. Farouq, do you have any additional comments?

Farouq Tuweiq, CFO

Yes, we'll surpass into your point, Hendi. I think there will be a new baseline. So I think that number, the $45 million, is kind of the 3- to 4-year-ago baseline. So I do think we're discovering what that baseline is.

Hendi Susanto, Analyst

And then similarly for the defense market, would you be able to share what the current run rate versus historical baseline?

Lynn Hutkin, VP of Financial Reporting and Investor Relations

Sure. So for the military market, that was around $38 million for the year. And that was down slightly. It was down about $1.5 million from the prior year on a year-to-year basis. I know that military has been running low the last few years. I don't have the historical view at hand, looking back to 2019-2020.

Daniel Bernstein, President and CEO

I think I can help you, Lynn, if you want. If you go to 2020, defense was $34 million, '21 was $32 million, and then I have $30 million for 2022. Based on your email, so I assume it's correct.

Hendi Susanto, Analyst

And then one additional question on the data center market. Any expectation how long customers will digest their inventories? Some companies see an expectation that there may be some turnaround or return to growth in the second half of calendar year 2023, whether you have any type of that market view?

Daniel Bernstein, President and CEO

Maybe I can address that question. A few years ago, the data center market was significant for us, as we provided services to companies like Facebook and Google. However, due to pricing pressures in that sector, we decided it was not the right fit for our portfolio. Currently, it has turned into more of a niche market, and we are concentrating on other areas where we achieve better profit margins. However, we do not view the cloud as networking from our perspective.

Hendi Susanto, Analyst

I see. And then Dan...

Daniel Bernstein, President and CEO

Does that help you or no?

Hendi Susanto, Analyst

Yes, I think that's helpful. Any information on the current run rate for the data center market?

Daniel Bernstein, President and CEO

I can't provide specific details on that. I don't believe it's significant enough to make a substantial impact. Perhaps we have three or four key customers in that marketplace.

Hendi Susanto, Analyst

Okay. And how...

Daniel Bernstein, President and CEO

But none of the big players, again, not Amazon, not Microsoft, not Google or Facebook.

Hendi Susanto, Analyst

I see. And then, Dan, any insights on the networking market?

Farouq Tuweiq, CFO

Hendi, is your question about how big our exposure to the networking data center is?

Hendi Susanto, Analyst

No, no, like the state of the networking market. I think in the magnetic networking, customers are working down on their inventories. So whether there's any outlook like when customers will fully digest their excess inventories previously on the data center market and then now in the networking market?

Daniel Bernstein, President and CEO

I believe it should be indicative. Data resembles networking in that people often mention a six-month timeframe in our industry. Whenever an issue arises, they tend to say six months. Everyone seems to anticipate clearing out their inventories over the next six months. The challenge has been that they ordered too much material but lacked the integrated circuits to utilize it. Now that they are receiving the integrated circuits, they are addressing the excess material, and the integrated circuits will be combined with the other materials. From what we understand, please proceed.

Farouq Tuweiq, CFO

Sorry, Dan, go ahead.

Daniel Bernstein, President and CEO

No, that's it.

Operator, Operator

The next question comes from William Kim from Presidio Asset Management.

William Kim, Analyst

And good job seeing to improve those margins. I was wondering, going forward, could you guys provide a cash flow statement for the quarterly earnings releases? And if you could give us an idea of what free cash flow was for the year and the quarter.

Daniel Bernstein, President and CEO

Farouq?

Lynn Hutkin, VP of Financial Reporting and Investor Relations

Yes, we can certainly look to do that going forward. For the year, cash flows from operations were $40.3 million, and we had $8.8 million in capital expenditures. If your definition of free cash flow is cash provided by operations minus capital expenditures, it amounts to about $31 million to $32 million.

William Kim, Analyst

Okay. And I guess I'm assuming there's more capital usage there. Is that going to continue to be a significant use of cash as you grow? And how can we think about free cash flow conversion, I guess, from an EBITDA perspective and a net earnings perspective, considering that it seems free cash flow is significantly lower than even your net earnings numbers?

Farouq Tuweiq, CFO

A significant amount of effort last year went into improving our profit and loss, specifically focusing on increasing our EBITDA and overall profit margins. We noticed sequential growth in these areas throughout the year, which was just the first step. However, we also experienced a rapid increase in cash consumption and working capital investment, particularly concerning inventory and related issues. As a result, our working capital is currently elevated, and under normal circumstances, it shouldn't require this level of cash. Historically, we have maintained around $10 million in capital expenditures, which is typically appropriate for us. This upcoming year, we plan to increase spending due to ongoing consolidation efforts. Our interest rates, cash taxes, and dividends remain relatively stable. We have successfully reduced our debt amid the current interest rate environment. The main focus now is on enhancing profitability and improving margins, a goal we have been actively pursuing and intend to continue. We also recognize the need to reduce our inventory levels, which we believe will happen as conditions stabilize.

William Kim, Analyst

So when you say normalized, are you talking about a normalized working capital environment? Or are you talking about kind of the slowing growth environment?

Farouq Tuweiq, CFO

I would say the easing of the supply chain and availability of materials. As we consider work-in-progress and finished goods that we were supposed to ship, there were about $27 million worth of orders that couldn't go out due to missing components or our customers lacking other parts of the order. This resulted in us holding larger amounts of inventory. As the supply chain stabilizes and becomes more predictable, allowing us to procure raw materials, manufacture products, and ship them out, inventory levels will decrease. We have invested significantly in our inventory over the past couple of years, partly due to supply chain disruptions.

Operator, Operator

The next question is a follow-up question from James Ricchiuti from Needham & Company.

James Ricchiuti, Analyst

I'm wondering if you could perhaps size the impact of the dilution to gross margins in the quarter from some of the material surcharges that you alluded to.

Lynn Hutkin, VP of Financial Reporting and Investor Relations

From a gross margin perspective, it's less than 100 basis points.

Farouq Tuweiq, CFO

I think it's 10 bps. Yes, it's right 10 bps. And to say it differently, our gross margin would have been higher as a percentage of sales if that was removed. So just a point of clarification there.

James Ricchiuti, Analyst

Farouq, maybe you could also talk to the pricing environment. And maybe more broadly, I think Bel has talked about going through the product portfolio, looking more closely, not only at pricing, but perhaps going through the SKUs and seeing what makes sense and what doesn't make sense. I wonder, as we think about the way you're characterizing the year, to what extent do these pieces play into the overall outlook for the business?

Daniel Bernstein, President and CEO

Farouq, do you want me to take that? I'll do the overall pricing. Again, very simply in our industry. As longer lead times go out, pricing tends to be firmer or higher. As lead times come down, pricing does become a little bit more competitive. We're just starting to see it in some of our product lines. We don't think there will be any pricing pressure overall based on past history. If you look at our military aerospace business plus our power business, we think the pricing overall should be pretty firm or strong. On the magnetics and the circuit protection group, they might face pricing pressure that they haven't seen post-COVID going forward. Our major focus now is if we do face that, are we getting our cost of line to address it properly? So we're doing everything we can to maintain and improve our current margin structure. And we know that we have to do a better job of really streamlining the organization. So when these price pressures do come in, then we can handle it a lot better. And again, not walking away from something because of lower margins. Farouq, can you add some more color to that?

Farouq Tuweiq, CFO

No, I think that covers it. Obviously, we're focused on profitable growth with healthy margins. We understand that it's a price and a cost game. On the price, we talked about it already, I think, a lot last year. We're doing a lot on the cost side of it. At least if we do get those phone calls, depending on what part of the business it is and the profitability profile, as Dan noted, we will have a cleaner cost structure to make an educated decision on where to concede and where not to. In some cases, maybe the answer is no. Maybe in some cases, we are sole position. And then that's a different discussion on our commodity-based stuff. So because of the diversity of our portfolio, Jim, I don't think it's a one-size-fits-all. But I think the guiding post is to get our costs in order, add value to the customer, and try to resist price downs. But we know we're not going to be successful at 100% of our SKUs.

Operator, Operator

At this time, there are no further questions. I'd now like to turn the call back over to Mr. Dan Bernstein for closing remarks. Thank you, sir.

Daniel Bernstein, President and CEO

Thank you, Claudia. Farouq, just a clarification. I misspoke when the question was asked about the impact of the surcharges. I had said 10 bps on gross margin, but it was really closer. It was a little bit under 100 bps. So our gross margin would have been a bit higher if it was removed. So just a point of clarification there. Sorry, Dan, go ahead. No problem. Thank you for joining our call today. And we're looking forward to reporting our results in April. I wish everybody a good day and a nice weekend. Thank you.

Operator, Operator

Thank you very much. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.