Vishay Precision Group, Inc. Q2 FY2020 Earnings Call

Good day, and welcome to the VPG 2020 Q2 Results Conference Call and Webcast. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask a question. Please note this event is being recorded. I would now like to turn the conference over to Steve Cantor, Senior Director of Investor Relations. Please go ahead.

Thank you, operator, and good morning, everyone. Welcome to VPG's 2020 second quarter earnings conference call. Our Q2 press release and accompanying slides have been posted on our Web site, vpgsensors.com. An audio recording of today's call will be available on the Internet for a limited time and can also be accessed on our Web site. Today's remarks are governed by the Safe Harbor provisions of the 1995 Private Securities Litigation Reform Act. Our actual results may vary from forward-looking statements. For a discussion of the risks associated with VPG's operations, we encourage you to refer to our SEC filings, especially the Form 10-K for the year ended December 31, 2019, and our other recent SEC filings. On the call today are Ziv Shoshani, CEO and President; and Bill Clancy, CFO. I'll now turn the call to Ziv for some prepared remarks. Please refer to Slide 3 of the quarterly presentation.

Thank you, Steve. I will begin with some commentary on VPG’s consolidated financial results and sales trends for Q2 and an update on the impact of the COVID-19 pandemic on our business. Bill will provide financial details on our third quarter outlook. Moving to Slide 3. Despite the challenges presented by the COVID-19 pandemic on our businesses, we executed well in the second quarter. We achieved sales in the midpoint of guidance, which reflected operational discipline and manufacturing efficiency. We generated positive adjusted free cash flow, even as we continued our investments in our new advanced sensor manufacturing facility and we’ve adjusted our operations effectively to meet local COVID-related restrictions and continue to take precautions and measures to protect our employees during this epidemic. Moving to Slide 4. Sales in the second quarter were $59.1 million, reflecting the impact of COVID-related closure and restrictions around the world. Although the greatest impact was on our Force Sensors business, which I will discuss in more detail shortly, the majority of our operations were able to adjust and to operate effectively. In terms of sales by end markets in Q2 compared to Q1, sales to avionics, military and space markets continue to be driven by defense spending and sales to the semiconductor test portion of the test and measurement market were strong. In addition, we had higher shipment of KELK products to the steel industry and sales increases in some of our other markets, such as consumer and medical equipment. This contrasted with lower sales in industrial weighing, transportation and general industrial markets. Yet, we saw clear signs of softer orders across several end markets, which contributed to an overall book-to-bill of 0.95. Moving to Slide 5. Turning to our trends by segment. For Foil Technology Products, second quarter sales of $31.8 million grew 4.3% sequentially, driven by strength in the precision foil resistors for defense-related customers and advanced sensors in the consumer and medical markets. We were pleased with the performance of advanced sensors, which grew in sales by 36% from Q1 of 2020. This is offset by weaker sales of other FTP products used in industrial applications. Gross margin for the FTP adjusted for COVID impacts was 41.7%, which improved from 36.7% in the first quarter due to higher volume and improved manufacturing efficiencies. Book-to-bill for FTP was 0.85 in the second quarter, reflecting a softening in orders in the test and measurement and general industrial markets, while advanced sensors recorded another consecutive quarter of significant orders. The demand for advanced sensors products have required us to operate our current manufacturing at a near maximum capacity to meet customer commitments. This validates the traction we were seeing in the market for these products, and it underscores the need for our new FTP manufacturing site to support future growth. Given the production demand on the existing manufacturing site as well as vendor delays in installing and qualifying new equipment due to the pandemic, we expect to be fully operational in the new facility in 2021. For the Force Sensors segment, it was a challenging quarter. Second quarter sales of $8.9 million declined 39.3% from the first quarter of 2020 due to COVID restrictions mandated across much of India, which caused our facility there to operate at partial capacity during the second quarter. This resulted in a revenue shortfall for Force Sensors in Q2 of about $6 million from pre-COVID run rate. The lower revenue impacted in the second quarter operating profit by approximately $2.5 million. Nonetheless, as of July 1, we received the approval from the local Indian authority to operate without limitations. This has allowed us to accelerate efforts to ramp up production to pre-COVID levels, which we expect to achieve in Q4, barring any unforeseen issues. Given the timing of ramping the India facility for the third quarter, we expect Force Sensors revenues to be adversely impacted by approximately $3 million to $4 million from pre-COVID run rate levels and operating profit to be impacted by approximately $1 million to $1.5 million due to lower revenue. Reflecting the abnormally low sales in Q2 and softer orders, book-to-bill for Force Sensors was 1.58. Demand trends were mixed as strong demand for those used in medical applications was offset by slower demand for industrial applications. Weighing and Control Systems in the second quarter of $18.4 million declined 18.1% sequentially. Higher sales of KELK systems were offset by lower sales across the rest of the WCS businesses as COVID-related headwinds impacted many of WCS customers and served markets. For DSI, closures and shutdowns hindered some customers from receiving our systems, which contributed to lower sales. In addition, pandemic-related shutdowns impacted our on-board weighing sales to transportation customers, both in Europe and in North America in the second quarter. Softer orders for WCS in the second quarter resulted in a book-to-bill of 0.82. Gross margin in the second quarter for WCS was 47.3%, adjusted for COVID impacts and declined modestly from 48.0% in the first quarter due to lower volume, partially offset by our cost control measures. Regarding our TruckWeigh and VanWeigh initiatives, the European Union finalized its pending overload protection regulations, with most EU member states opting for the weigh-in-motion platform rather than an onboard weighing solution. While this means the OEM opportunity for us will be less than we expected, the traction we had achieved pre-COVID in the aftermarket in the UK and France gives us confidence in opportunities for our solution. As an aftermarket sale, our TruckWeigh, VanWeigh solution is complementary to the weigh-in-motion platform since it helps fleet operators to optimize the safety and efficiency of their fleet and avoid potential regulatory fines. Moving to Slide 6. Given the uncertainty regarding the arc of the pandemic in the U.S. and around the world, we are continuing with our measures to protect our employees, including workplace distancing and enabling employees to work remotely if their jobs permitted. In terms of the impact on the P&L, in addition to the revenue impact I described earlier due to COVID-19, we incurred a net expense of approximately $443,000 related to employment costs and workplace adjustments. Overall, beyond the short-term measures to control our costs we are continuing our long-term strategic initiatives across the businesses. We believe that these steps will serve us well to not only contend with the COVID impact, but also to maximize our profitability and achieve the margin leverage in our target model when our markets fully recover. At the same time, we are continuing to invest in the company’s future. The new FTP facility is an example of our strategic investments and represents a meaningful portion of our expected capital spending of approximately $30 million for 2020. We also continue to look for opportunities to build additional shareholder value through attractive M&A. Before Bill provides more details on the second quarter financials, I would like to thank the VPG employees around the world for their dedication and customer focus during these challenging times. I will now turn it over to Bill Clancy for additional financial details. Bill?

Thank you, Ziv. Referring to Page 7 of the slide deck. In the second quarter of 2020, we achieved revenues of $59.1 million, operating income of $4.0 million or 6.7% of revenues and net earnings per diluted share of $0.13. On an adjusted basis, excluding $41,000 of acquisition and purchase accounting adjustments related to the DSI acquisition in November of 2019, $499,000 of restructuring costs and $443,000 of COVID-19 impacts, our adjusted gross profit was $23.7 million or 40.1% of sales, operating income was $5.0 million or 8.4% of sales and adjusted net earnings per diluted share was $0.19. Our second quarter of 2020 revenues declined 12.6% compared to $67.7 million in the first quarter and was down 16.5% as compared to $70.9 million in the second quarter a year ago. Foreign exchange for the second quarter of 2020 negatively affected revenues by $700,000 compared to a year ago and $500,000 as compared to the first quarter of 2020. Our gross margin in the second quarter was 39.1%. Our gross margin on an adjusted basis was 40.1%, which improved from 37.8% in the first quarter of 2020. Our operating margin was 6.7% for the second quarter of 2020. Excluding the above-mentioned purchase accounting adjustments, restructuring charges and COVID-19 impacts, our second quarter adjusted operating margin was 8.4%, which increased from the 7.8% we recorded in the first quarter of 2020. Selling, general and administrative expenses for the second quarter of 2020 were $18.6 million or 31.5% of revenues. This compared to $19.9 million or 28.1% for the second quarter of last year and $20.3 million or 30% in the first quarter. The decrease in SG&A expense of $1.3 million as compared to the prior year period related to less travel cost of $1.0 million, reduction of bonus reserves of $500,000 and other fees of $600,000, partially offset by the inclusion of a full quarter of SG&A expense for DSI. The sequential decrease in SG&A of $1.7 million relates to reduction in travel of $600,000, bonus reserves of $300,000, bad debt expense of $300,000, exchange rate impact of $300,000 and other fee of $200,000. The adjusted net earnings for the second quarter of 2020 were $2.6 million or $0.19 per diluted share compared to $4 million or $0.29 per diluted share in the first quarter of 2020. Foreign currency exchange rates for the second quarter of 2020 decreased net income by $1.2 million or $0.09 per diluted share relative to the prior year period. We generated adjusted free cash flow of $3.1 million for the second quarter of 2020 as compared to $6.7 million for the second quarter of 2019. We define adjusted free cash flow as cash from operating activities, less capital expenditures, plus sale of fixed assets. The GAAP tax rate in the second quarter was 28.1%. We are assuming an operational tax rate in the range of 27% to 29% for 2020 planning purposes. Moving to Slide 8. We ended the second quarter with $87.2 million of cash and cash equivalents and total long-term debt of $40.7 million. We believe that we have a strong balance sheet and ample liquidity to support our business requirements and to fund additional M&A opportunities. Regarding the outlook, given our order rates and the ongoing uncertainties and economic impacts of the global pandemic, we expect net revenues to grow sequentially and be in the range of $59 million to $65 million for the third fiscal quarter of 2020 at constant second fiscal quarter 2020 exchange rates. In summary, we executed well despite the challenges of COVID-19. We delivered solid Q2 margin performance on lower revenue. And we continue to move forward with our growth initiatives and investments and to be ready to maximize our performance as conditions return to normal. With that, let’s open the lines for questions. Thank you.

Thank you. We will now begin the question-and-answer session. Operator, please provide instructions. The first question today will come from Sarkis Sherbetchyan with B. Riley FBR. Please go ahead.

Hi. Good morning. Thanks for taking my question here.

Good morning.

So sequentially lower top line. You guys generated a much better-than-anticipated gross margin and clearly the profit flow-through was nice. Can you maybe help us understand the drivers relative to the target operating model you guys have described in a recent investor presentation?

Yes. Sarkis, this is an excellent question. The target model that we have provided was based on prior quarter results and based on our ability to identify the business profile as we move ahead. No doubt that we are living in very challenging times. Therefore, there were very drastic measures that we took which we did not account in the model. Let me go through the big-ticket items. The big-ticket items which would be considered deviation from the model would be: we have $800,000 of favorable product mix; then we are speaking about close to $1 million of manufacturing efficiencies; and then we have another $500,000 of cost control measures such as travel restrictions, utilities, repairs and maintenance, and so on and so forth. Those would be the main items that we did not account for in the model in respect to this quarter.

That’s helpful. Thanks for that. And then just kind of looking at the segment book-to-bill ratios. If you can maybe help us understand how the orders have been progressing in each of the three segments in maybe July and so far in August. So is the activity in the order book improving relative to what we saw exiting 2Q?

Let me maybe start by speaking about the second quarter. If you see the book-to-bill, except for a small net effect, naturally given the limited capacity and the restrictions in India, FTP as well as WCS are below 1. The dynamics for the orders in the second quarter were mixed. We are seeing weaker-than-normal demand in our traditional industrial markets such as general industrial, industrial weighing, transportation and steel, mainly for WCS as well as slowdown in oil and gas and general industrial for FTP; however, sustained strength in advanced sensors, medical and consumer. It’s important to state that the drop in the FTP order intake really represents two effects. One effect is semiannual orders that were placed in Q1 and were not placed in the second quarter, which is around 50% of the gap. And the other 50% really represents the COVID effect. All-in-all, we do feel that we did hit the bottom in a way, and we are more optimistic regarding the second half. Nevertheless, we don’t provide guidance. But so far, I see that the order intake is meeting our expectation in respect to the Q3 guidance that we have provided.

Yes, that’s super helpful. So that’s exactly what I wanted to understand—looking at the book-to-bill ratios for the segments in relation to the guidance. And it looks like you guys are anticipating a better sequential top line and we can maybe play with the model to understand what happens with the operating profits as that happens. And kind of moving to the SG&A expenses for the quarter, $18.6 million. Maybe remind us how much of that was variable, maybe cost action, just trying to get a sense for what the SG&A run rate looks like going forward?

Yes, Sarkis, that’s a very good question. The $18.6 million is a good number to look at going forward. Obviously, we went through and analyzed, like Ziv mentioned, less travel. We had some bonus reserve adjustments, but we continue to believe that that $18.6 million to $18.8 million would be a good number to use going forward.

Thank you. One more for me and I’ll hop back in the queue. So you mentioned, Ziv, for the capital projects kind of ongoing, especially for FTP. It’s good news. And just wanted to understand how we’re tracking against that $30 million budget, maybe what the cadence looks like for the balance of spending and the time to completion?

Sure. As you can recall, Sarkis, initially, during Q4 of last year, we indicated that our projected budget for this year would be around the low $30 million level. Given the COVID situation, we did indicate in the last quarter in Q1 earnings that we were going to cut back our capital spending by around 20% to 30%. What has changed since then is, as I indicated during the call, we are running at close to, if not at, 100% capacity for advanced sensors. And at this point in time, since we wanted to build the buffer stock for transitioning advanced sensor production from the legacy manufacturing facility to the new facility, running at 100% capacity will not allow us to build any buffer stock. In addition to that, given the demand, we may foresee even further expansion from a capacity standpoint. Therefore, the gap was additional spending for advanced sensor equipment capacity, which will be installed in the new facility, which would allow us, on one hand, to increase revenues as demand goes up; and secondly, to allow us to move from the current location to the new location. So the gap is really further equipment for advanced sensors. This is how we get back to the $30 million.

Thank you. That’s super helpful. I’ll go back in the queue.

And the next question will come from John Franzreb with Sidoti & Company. Please go ahead.

Good morning, Ziv and Bill.

Good morning, John.

Ziv, I wonder if you could talk about the India restart. How long do you think it will take to get there? And how easy is it to bring the employees back, because India is still having a second wave or third wave at this point?

Okay. That’s a great question, John. So if you can recall in the last earnings call, we did indicate that India imposed the shutdown. In fact, where we are located was considered a red zone in the country. So we were few weeks under a complete shutdown. While later, we received permission to operate for product deliveries for medical applications. And I would say that during the quarter, we were operating partially. During these times, we did try to reach out to many people as we can and even to accommodate the people that were not allowed to go back to their homes due to the red zone situation. Given the July lifting of the restrictions, we are now currently running at around 80% to 85% capacity. So the fact is that we will see an improvement in revenues in the third quarter, but please bear in mind that given the ramp-up time and the logistics time—because there is a significant amount of goods that were deferred from India to our distribution centers in Europe and the United States—we would see the full recovery in Q4. But currently, we are running at around 85%. There was a certain turnover, but I think that the team in India and the divisional team did a great job and we were able to hire people and we are ramping up fairly quickly.

Okay. So we should allow for some inefficiencies not only on the production, but on the labor force as you get into the fourth quarter, right?

Yes, but I would consider that at this point in time as a second-order effect because they really managed the situation in a professional manner. We see very, very insignificant inefficiencies, which means they are running at a very good level.

Good. And the steel market was strong despite the overall general industrial economy being weak. Could you just talk to that and what drove that?

Sure. So when we spoke about steel, we were referring to revenue, not necessarily book-to-bill. The book-to-bill for steel in the last two quarters was quite modest. For example, in the second quarter, the book-to-bill for steel was 0.64, which means we have seen in the last two quarters an order intake which is much lower than our revenue run rate. So we have been delivering mainly from backlog. We do feel that steel is also one of the end markets that is affected from an order intake perspective and from a business climate perspective by COVID.

So you’re shipping from backlog and it’s a high-margin business for you. When does that backlog kind of run out and you hit equilibrium with the bookings and the shipping?

I would expect that we will see the bigger effect coming into 2021, unless we see much higher order intake in the coming months.

Got it. And you mentioned something in answering one of the previous questions about semiannual orders that have not been renewed or issued. Could you just talk a little bit about that? Do you fully expect them to come? Is it a customer confidence issue? Just elaborate a little bit on that comp?

Yes, sure. This is a pattern. For some of our products, we work with distributors and with contract manufacturers, and the practice is they place large semiannual orders. So they did place semiannual orders in Q1, but we would expect to see the orders coming into the third quarter, again covering for the rest of the year. For example, one of those end markets is test and measurement for precision resistors.

Got it. And I guess one last question. Just clarify on whether— it sounds like you’re going to build inventory in the advanced sensors business and then do the transition. Did I understand that properly? And what’s your expected timeline on that?

So John, let me clarify. Originally, the plan was to build buffer stock in order to allow us to transition the equipment from the current space to the new facility. Due to the fact that we are running at close to 100% capacity, we are not able to build inventory. Therefore, we have ordered more equipment to be installed in the new premises in order to assure us a seamless transition.

Got it. That was actually very helpful. Okay, guys, thank you very much. I’ll get back into queue.

And the next question will come from Patrick Ho with Stifel. Please go ahead.

Thank you very much and nice work on the execution. Ziv, maybe first off, in terms of the advanced sensors, you just mentioned about building some buffer inventory. You saw significant orders in the first quarter. Can you give a little bit of color what’s driving demand for advanced sensors?

Yes. Patrick, for advanced sensors, as I said, we have two end markets which are fairly strong. One is medical and the other one is consumer. They are the driving force behind advanced sensors and the strong order intake for the first quarter and, I have to say, also for the second quarter.

Great. And maybe as a follow up to that question on the consumer and obviously on the technology side of things, there’s some mixed data points clearly, especially as it relates to consumer electronics. Can you just give a little more color of where on the consumer side of things you’re seeing the strength on the advanced sensors market?

Well, Patrick, unfortunately, and we have discussed that in the past, we have very strict NDAs and we are not allowed to divulge any information regarding those specific applications, especially on consumer electronics. On other consumer applications, we have some bicycle-related high-end bicycle applications, which are also doing much better. We see a much more favorable environment there. But regarding consumer electronics, unfortunately we are not able to provide more color regarding the specific applications.

Fair enough. And final question from me. You talked about building core buffer inventory as you transition to the advanced sensors, and that makes complete sense. But maybe for Bill, across your entire product portfolio, given the disruptions that are still out there both in terms of your manufacturing, supply chain and even at customer site. How are you evaluating your internal inventory build across all your products to ensure that you’ll be able to meet your different customers' demand over the next couple of quarters?

Ziv, do you want to handle that one from an inventory perspective?

Yes, absolutely. Patrick, we have identified all the key materials that we would require in order to assure our supply chain. You may have seen that we have a certain increase in inventory quarter-over-quarter, in the second quarter compared to Q1. We have identified the key material which we believe could be under shortage in all our reporting segments and we are trying to assure contract, safety stock and consignment stock with all key suppliers. In addition to that, we have seen, for example, one specific product line where our supplier for subassemblies of electronic equipment was in a shutdown situation as well as limited capacity. For example, some subcontractors are California-based. So in that case, we are trying to build as much inventory as we can. But from a general standpoint, for every business and every product line, we identified all the key material to assure business continuity, and we put the contracts in place.

Great. Thank you very much.

Our next question will come from Bill Dezellem from Tieton Capital. Please go ahead.

Thank you. I was hoping that you would talk a little more about the Truck and VanWeigh market and the rule changes and more details behind the implications for your business, please?

Yes. In July, the European Union finalized its pending overload protection regulation with most EU member states opting for weigh-in-motion platforms. We believe that the main considerations for them to select weigh-in-motion rather than onboard weighing were largely cost related, given that installing weigh-in-motion systems or weighbridges at key highway points is less costly at scale than mandating onboard weighing on every truck and van over 3.5 tons. Given the fact that we are already selling most of our TruckWeigh and VanWeigh revenues to the aftermarket, we do believe that the regulation, which will be effective as of May 2021, still represents a multimillion-dollar aftermarket opportunity for us in the next few years. Our solution is complementary to the weigh-in-motion platform since it offers truck fleet operators value in terms of avoiding possible penalties before detection by weigh-in-motion, in addition to increased safety and efficiency. So at this point in time, the OEM opportunity is not as large as we had hoped, but we still believe there is significant upside in the aftermarket if we achieve similar penetration levels as we did initially in the UK and France.

Thank you, Ziv. I’m going to make sure that I understand this, if I may, that had the rules come out most favorable for you, then all new trucks and existing trucks would have equipment on them to weigh them going down the road just as they come off the manufacturing line and the existing fleet would be retrofitted. But instead, there will be bridges that will be put in place and so none of the operators will be required to have the weighing equipment on their trucks and vans, but you believe that many of them will, since you’ve already been seeing that happen so that they know exactly what their weight is before they come into the weigh-in-motion. Is that the right way to think about this?

This is correct. Given the fact that there will be penalties if you cross a weigh-in-motion point and you are overweight, fleets are incentivized to avoid fines. But for efficiency reasons, fleet operators prefer to optimize loading and avoid unnecessary underloading. Our systems enable truck and van operators to optimize their loading before encountering weigh-in-motion points, and we have seen this trend in France and the UK, which is where much of our current revenue for these solutions originates.

Thank you for the clarification.

This will conclude today’s question-and-answer session. I would now like to turn the conference back over to Steve Cantor for any closing remarks.

Thank you all for joining our call. Before closing, I do want to remind investors that we are participating tomorrow in the Jefferies Virtual Industrials Investor Conference as well as another virtual conference being held by Sidoti in September. Again, thank you all and have a great day.

The conference has now concluded. Thank you for attending today’s presentation. And you may now disconnect.