Vishay Precision Group, Inc. Q4 FY2020 Earnings Call

Good day and welcome to the VPG 2020 Fourth Quarter and Fiscal Year Earnings Conference Call. All participants will be in a listen-only mode. (Operator instructions) After today’s presentation, there will be an opportunity to ask questions. (Operator instructions) Please note this event is being recorded. I would now like to turn the conference over to Steven Cantor, Senior Director of Investor Relations. Please go ahead.

Thank you, operator, and good morning, everyone. Welcome to VPG’s 2020 fourth quarter earnings conference call. Our Q4 press release and accompanying slides have been posted on our website. An audio recording of today’s call will be available on the Internet for a limited time and can also be accessed on our website. 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. And now I’ll turn the call to Ziv for some prepared remarks. Please refer to Slide 3 of the quarterly presentation. Ziv?

Thank you, Steve. I will begin with some commentary on VPG’s consolidated financial results and sales trends for the year and for Q4. Bill will provide financial details and our outlook for the first quarter of 2021. On Slide 3, we ended the year on a solid note. Before discussing the fourth quarter in detail, I want to summarize some of the key highlights of 2020 for VPG. Looking back to the beginning of last year, it is difficult to imagine the human, social and economic impacts from a global pandemic that has touched every part of the world. Despite the challenges, I am proud of how VPG’s team responded and the resilience we demonstrated and continued to demonstrate to this global crisis. I want to list a few of our accomplishments. First, we responded quickly and decisively to the challenges of the pandemic as we put in place measures to protect our employees and our customers. These measures included workplace distancing and enabling employees to work remotely if their job permits it, restricting travel, as well as cost control such as salary freezes. Second, with the exception of our force sensors operation, we continued to operate through the crisis and we were able to seamlessly serve our customers around the world. Third, when government-imposed lockdown in India significantly impacted our operation resulting in $10 million of revenue shortfall for the year, we overcame numerous challenges to return to full production by the end of the third quarter. And fourth, we continued to implement our long-term strategies and investments which included growing our advanced sensors business by 41% to an annualized run rate of more than $35 million and moving forward with adding additional manufacturing capacity to support future advanced sensors growth with the new facility. And most importantly I would like to thank the VPG employees around the world for their dedication and customer focus during the turbulent and challenging 2020. Moving to Slide 4, looking at the fourth quarter we achieved fourth quarter sales of $75.4 million which was 11.7% higher than the third quarter and 9.1% higher than a year ago. Sales grew across our portfolio of businesses and across our end markets with double-digit sequential growth in the test and measurement, transportation and avionics, military and space markets and continued strength in some of our other markets such as consumer, medical and precision agriculture. Orders grew 9.4% from the third quarter of 2020, although trends across our end markets continue to be mixed. The majority of our markets continued to rebound reflecting the improving economic outlook. On the positive side, we had strong sequential orders in the test and measurement, transportation, industrial weighing and general industrial. Although these markets remain below pre-pandemic levels, demand in consumer, precision agriculture and medical also continued at high sustained levels. Our project-driven orders in the steel market and avionics, military and space market remain soft. While demand for the majority of our products is generally driven by economic and industrial activity and our customers' product cycles, our higher average selling price systems like our KELK, DSI and Pacific Instruments products are generally driven by specific customer capital projects in the steel and the avionics, military and space markets. The quarter-to-quarter variability of orders for these products is due to the project-driven nature which is what we experienced in the fourth quarter. The net result of these trends was a book-to-bill of 0.93 for the fourth quarter. Our adjusted gross margin in the quarter was 38.0%, which included headwinds due to unfavorable product mix as well as temporary effects of inventory reductions and certain manufacturing inefficiencies as compared to the third quarter of 2020. However, if these items were at normal levels, adjusted gross margin would have been in the 40% range, similar to the level we reported in the third quarter of 2020. We achieved an adjusted operating margin of 10.7% and an adjusted earnings per share of $0.43 in the fourth quarter which were in line with our quarterly target model. Moving to Slide 5, turning to the results by segment, we achieved sequential growth in the fourth quarter across all three business segments. For Foil Technology Products, fourth quarter sales of $36.5 million grew 10.9% sequentially and 23.1% from a year ago driven by a strong performance in the precision foil resistors, advanced sensors product line and Pacific Instruments product lines. Sequentially, the increase in precision foil resistors reflected growth in the test and measurement market, particularly for semiconductor test equipment. Advanced sensors had another great quarter growing 5% sequentially and 71% year-over-year driven by strong demand for consumer-related applications. Our Pacific Instruments product line grew sequentially and year-over-year in avionics, military and space market. Adjusted gross margin for FTP was 38.9% in the fourth quarter of 2020, declining from 41.6% in the third quarter of 2020, but improving from 34.9% in the fourth quarter of 2019. The sequential decline in adjusted gross margin primarily related to unfavorable product mix, manufacturing inefficiencies and inventory reductions which was partially offset by higher volume. The book-to-bill for FTP was 0.84 in the fourth quarter which reflected a sequential decline of $2.5 million in orders. A portion of the decline related to lower orders for Pacific Instruments’ data acquisition systems. Orders for these systems are driven by specific defense projects which can have longer order cycles. In addition, orders for advanced sensors declined from an exceptionally strong booking quarter in the third quarter of 2020, but remained at a high level given strong demand in its end markets. Orders for our precision foil resistors increased reflecting demand in the test and measurement end markets. The pipeline of opportunities for advanced sensors continues to be robust which underscores our confidence in the investments we have made in this initiative. We are continuing to operate at maximum manufacturing capacity for advanced sensors while we move forward with the installation and qualification of the equipment that will give us the needed additional manufacturing capability at our new facility. We are on track to complete the transition to the new facility in the third quarter of 2021. For the Force Sensors segment, it was a quarter of continued recovery. Fourth quarter sales of $16.3 million improved 17.2% from the third quarter of 2020 driven by orders and backlog as we are operating at pre-pandemic levels at our India facility. In terms of OEM-specific Force Sensors product, which is one of our key growth initiatives, sales grew 27% sequentially. Financially, Force Sensors adjusted gross margin of 29.6% in the fourth quarter declined from 31.2% in the third quarter but grew from 24.2% in the fourth quarter of 2019. The sequential decline in adjusted gross margin was primarily due to a reduction of inventory partially offset by an increase in volume. Book-to-bill for Force Sensors was 1.18 as orders for both industrial weighing applications and OEM product for precision agriculture, medical and construction applications were higher. Sales of Weighing and Control Systems in the fourth quarter of $22.7 million increased 9.4% sequentially, but declined 7.1% from a year ago. Sequentially we had higher sales of our onboard weighing solutions and process weighing solutions in Europe while related sales were flat. Sales of our truck weigh and van weigh rebounded by 46% from the third quarter and we see the potential for the EU regulation-driven aftermarket opportunities for these products to accelerate in the second half of this year. Adjusted gross margin in the fourth quarter for WCS was 42.5%, adjusted for COVID impact and decline from 44.9% in the third quarter, mainly due to unfavorable product mix and inventory reductions, partially offset by higher volume. In terms of sequential trends in WCS segment, orders for on-board weighing and process weighing products were higher. KELK and DSI orders were soft. Demand for KELK products typically have a two quarter lag relative to inflections in the steel market. The result of this WCS orders trend in the third quarter was a book-to-bill of 0.88. As we think about 2021 we are encouraged by the progress being made around the world regarding vaccinations and bringing the rate of COVID infections down. While there is much more to do and there are many risks still remaining before the pandemic is fully under control, we believe that as the world and our market returns to normal, we have the foundation and the ongoing customer opportunities to achieve a year of growth and execution across our businesses. Many of those opportunities are a result of initiatives we have put in place and executed over the past several years such as our advanced sensors initiative and the move to optimize manufacturing footprint for Force Sensors. As part of these long-term strategic initiatives, we expect to continue to implement further organic growth and cost savings projects. We are also continuing to look for attractive acquisition opportunities to add additional high-quality strategic businesses to the VPG platform that will further accelerate our growth and profitability. I will now turn it over to Bill Clancy for additional financial details. Bill?

Thanks, Steve. Referring to Page 6 of the slide deck. In the fourth quarter of 2020, we achieved revenues of $75.4 million, gross profit of $28.7 million with 38.1% of sales, operating income of $5.9 million or 7.8% of revenues and net earnings per diluted share of $0.01. During the quarter however, we had the filing adjustments to our P&L and a non-cash charge of $2.4 million related to the impairment of goodwill and indefinite-lived intangible assets for Pacific Instruments, $0.5 million of net credit mainly related to a COVID-related subsidy from the Canadian government and $200,000 of restructuring charge. In addition, because we maintain operations in Israel and in certain locations in Asia, changes in exchange rates may be a meaningful factor in understanding period-to-period comparisons. Beginning this quarter, we are adjusting our adjusted net earnings and adjusted net earnings per diluted share for the impact of foreign currency exchange rates on our re-measurements of assets and liabilities. These adjustments are reflected on a comparable basis in the non-GAAP reconciliation tables in our press release. Consequently, we recorded a foreign exchange loss of $2.1 million in the fourth quarter, mainly reflecting the strengthening of the shekel relative to the dollar in the fourth quarter which impacted our balance sheet items including our lease liabilities. Considering these adjustments, our adjusted gross profit was $28.7 million or 38% of sales, adjusted operating income was $8.1 million or 10.7% of sales and our adjusted net earnings per diluted share was $0.43. Our fourth quarter 2020 revenues increased 11.7% compared to $67.5 million in the third quarter and increased 9.1% from the fourth quarter a year ago. Foreign exchange for the fourth quarter of 2020 had a positive effect on revenues up by $1.4 million, compared to a year ago and $700,000 as compared to the third quarter of 2020. Our gross margins decreased in the fourth quarter to 38.1% from 40.5% in the third quarter. On an adjusted basis, the fourth quarter gross margin of 38% decreased from 40.5% in the third quarter of 2020. Our operating margin was 7.8% for the fourth quarter of 2020. Excluding the above-mentioned charges and COVID-19 subsidy, our fourth quarter adjusted operating margin was 10.7% which decreased from the 11.7% we recorded in the third quarter of 2020. Selling, general and administrative expenses for the fourth quarter of 2020 were $20.2 million or 26.7% of revenues, compared to $20.2 million or 29.2% of revenues for the fourth quarter of 2019 and compared to $19.1 million or 28.4% of revenues in the third quarter of 2020. Of the $1 million sequential increase in SG&A, approximately $400,000 related to the impact of foreign exchange. The adjusted net earnings for the fourth quarter of 2020 were $5.8 million or $0.43 per diluted share, compared to $5.3 million or $0.39 per diluted share in the third quarter of 2020. We generated adjusted free cash flow of $5.9 million for the fourth quarter of 2020 as compared to $1.4 million for the third quarter of 2020. We define our adjusted free cash flow as cash from operating activities, less capital expenditures plus any sale of fixed assets. Our capital expenditures for the fourth quarter were $7.1 million which relate primarily to the purchases of equipment and related infrastructure for the new advanced sensor facility. For the full-year of 2020, we invested $22.9 million of capital expenditures. As part of our long-term capital allocation strategy, in 2021, we expect CapEx to be in the range of $24 million to $28 million of which approximately two-thirds relate to expansion and cost reduction projects primarily in the FTP segment for advanced sensors and precision foil resistors. We recorded a tax expense of $1.7 million in the fourth quarter of 2020 related to the acquisition of DSI to utilize deferred tax liabilities against deferred tax assets. We are assuming an operational tax rate in the range of 27% to 29% for the 2021 planning purposes. On Slide 7, we entered the fourth quarter with $98.4 million of cash and cash equivalents, an increase of $8.6 million from the third quarter. Our total long-term debt was $40.6 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. The outlook. Given the improving business environment, our strong cash flows, financial positions and strategic investments gives us confidence that we can achieve growth in 2021 as the global economy and our markets continue to recover from the pandemic. For the first fiscal quarter of 2021 at constant fourth fiscal quarter 2020 exchange rates we expect net revenues to be in the range of $63 million to $70 million. In summary, we were pleased with our fourth quarter top line performance despite the impacts to our gross margin. We achieved an adjusted operating margin in line with our targeted model. Our advanced sensor business continues to perform well and the transition to new advanced sensors facility is proceeding on track. And finally we expect our business trends to improve through the year as the global economy and our markets continue to recover. With that let's open the line for questions. Thank you.

(Operator instructions) And the first question comes from John Franzreb with Sidoti & Company. Please go ahead.

I guess I want to start on the advanced sensors. Ziv, you said that the order bookings was down in Q4 versus Q3, but Q3 was much stronger. Could you just elaborate A) a little bit more about that and B) how does the January bookings play out?

Okay. So, regarding advanced sensors as we indicated, there was another record quarter in terms of revenue and we did report the run rate. If we analyze that now we are over $35 million. As we stated already a quarter ago, John, we are running at 100% capacity. The fact that we were running at full capacity in addition to the fact that we had already received very, very high order levels. If we look just at reconciling the orders quarter-over-quarter, the complete gap is a semiannual order that was placed in Q3 that was not placed in Q4 and are expected to continue going forward. So, the environment for advanced sensors is strong based on our consumer products. It continues to be strong with the expectation of other end markets to continue and rebound further along the year. And the fact that we are adding more capacity and transitioning to the new facility only indicates that we would continue to see strength for this product line in 2021.

And Ziv, will that facility be completed by the second quarter of 2021 or is the timeline changed in any way?

As we indicated, the transition as of now is expected to be completed at the end of Q3.

Q3, okay. And regarding the currency — talk a little bit how it's impacted the gross margin line and the operating expenses in the quarter? And what should we be thinking about that on a go-forward basis? I know the shekel is probably at a 10-year high at this point?

Okay so John, two parts. If we look at the currency impact sequentially, the total impact on the operating margin was $200,000 negative and year-over-year — fourth quarter versus fourth quarter, the impact on the operating results was essentially zero.

Okay.

On a sequential basis, the impact of the exchange rate on cost of goods sold was a positive $200,000 sequentially.

Okay.

John, if you are looking just to reconcile the adjusted gross margin quarter-over-quarter, the main effect is not coming from foreign exchange. The main effects — and I would like to state that Q3 was an exceptionally high adjusted gross margin. To reconcile, the impact came from roughly $900,000 from inventory reduction. Then we had an additional unfavorable product mix of about $500,000. We had around $200,000 of additional logistics costs due to the fact that freight forwarders and the capacity constraints of logistics from Asia to the U.S. and to Europe are not back on track. As yields move along we expect those freight costs will go down. And manufacturing inefficiencies of around $300,000 mainly coming from advanced sensors due to the fact that as we are running at 100% capacity every small hiccup can generate a larger effect which is a temporary one. So, all in all I think that by far most of the effect—over $1.5 million—are temporary effects that should not continue through the year, but that's really the gap between adjusted gross margin in Q3 versus Q4.

(Operator instructions) The next question comes from Sarkis Sherbetchyan with B. Riley Securities. Please go ahead.

Just want to touch on the 2021 CapEx guide. I think you mentioned $24 million to $28 million on the year, two-thirds of that relating to the expansion and then cost reduction initiatives at FTP. Can you maybe help us understand the cadence of spend? Is that going to be more loaded towards the first half of the year or is that going to be pretty radial as the year goes by?

Generally speaking, if we take a typical normalized year, given capital equipment lead times, we would always see higher spending through Q3 and generally speaking Q4 would be the highest. This 2021 is kind of a carryover in respect to COVID. Therefore we have been placing orders for equipment where about 25% were not able to ship to us in 2020 and the expectation is to get them in 2021. So, we may still see the second half of the year slightly higher than the first half, but the gap will not be as high as in a normalized year. The other point is that last year the focus was more on infrastructure with the new facility and this year most of the capital investments will be in equipment around FTP. We are also going to invest more in precision resistors for expansion and cost reduction to support organic growth.

Understood and thanks for that. Can you expand on your decision to invest in precision resistors? Is this something that is in conjunction and helpful towards your advanced sensor business or is this something that's more independent and you see clearer trends or a business case to be made? Can you touch upon this?

Sure. FTP consists of two main platforms: one is precision resistors and the other is the strain gage data acquisition platform. Precision resistors are kind of a different business. We have identified opportunities to develop new products and new platforms to reach higher volume applications. Therefore the intention is to expand infrastructure capacity in our Japanese facility mainly to support longer-term plans for higher volume opportunities, which would be mainly around test and measurement applications.

Okay, thanks for that. Just want to switch over to the outlook for the first quarter of 2021. You mentioned a range of $63 million to $70 million sales. I think if I take the midpoint of that guidance it’s down low-single digit year-on-year. I just want to get your sense for the guidance. As we look towards your expectations for growth for the year, would you expect growth early in the year or by the end of the year? Trying to get a sense for reconciling your expectation for growth relative to the guidance we see today.

First it's important to state that orders for the quarter increased 9.4% versus the prior quarter and the backlog is still very strong at $87.6 million. The guidance is driven by our shipment commitments; the backlog reflects our shipment commitments to our customers, which means we have seen some orders placed for the second quarter. In addition, our backlog is also composed of a portion of project-driven orders like KELK and DSI. Given the environment and the expectation for most of our end markets to rebound, except steel which is still soft due to its two-quarter lag, we expect an improving business environment starting in Q1. We should see growth begin to flow through the year gradually rather than waiting until the end of the year.

(Operator instructions) The next question comes from Dick Ryan with Colliers. Please go ahead.

Thank you. So Ziv on the advanced sensors you're running at capacity and expansion coming on in third quarter. Are you losing any opportunities with customers potentially saying the design phase waiting for the expansion is too long? Are you losing out on any opportunities? And maybe an additional question — I think you are building capacity 40% above the run rate — it wouldn't seem unreasonable to think you're going to be knocking on that door as we get toward the end of the year and the first part of next year. What sort of one-timers from an experience or financial resource perspective that you build the initial capacity — won't you have to go through as you expand that facility further over the next few years?

Let me start with the first part. If you are running at 100% capacity, you might worry about losing opportunities. We have been managing customer satisfaction and lead times carefully to deliver to our customers. As we start to put in place new equipment in the new facility, we will run in parallel, ramping up the new facility while maintaining current production, so we will not have to wait until the complete transition to get the additional capacity online. We would expect to see more capacity within two quarters. The designed capabilities of our advanced sensors are such that in many cases the product specs, size and complexity cannot be easily replaced by another supplier; we have a unique and proprietary platform. We are adding capacity as quickly as we can and expect to see the additional capacity before the transition is completed. The new capacity should be around 40% higher than current capacity. Regarding one-time transition costs, we expect to incur about $2 million during the first three quarters to install, qualify and transition equipment — most of that will happen in the second and third quarters. From a reporting standpoint those costs will be reflected in our non-GAAP adjustments. From an overhead standpoint most of the cost has already been reflected in our financials and we expect perhaps an additional overhead increase of around $200,000, but most of the cost was already reflected in Q4 results.

So some of the logistics issues you cited — are you or your customers making any changes within the supply chain? Are there issues that you're looking at specifically so you won't have logistics issues going forward?

The logistics issues are mainly transportation of products from Asia to the U.S. and to Europe due to a lack of capacity from our freight forwarders. This mostly applies to Force Sensors because our largest manufacturing and the highest logistics costs come from Force Sensors where we use sea freight, and to a smaller extent elsewhere because those are very large heavy metal products. At this point we are trying to manage the cost the best we can given timing, but we don't see any showstoppers. There might be some delays and some additional higher costs to a low extent. As the world and freight capacity normalize, we expect this phenomenon to go down significantly in the coming quarters.

(Operator instructions) And the next question comes from Bill Dezellem with Tieton Capital. Please go ahead.

Two questions. First of all, are the inventory reductions that were hurting margins here in this quarter now complete or should we anticipate some more to come? And secondarily you had referenced that you think you will see some strengthening in the truck and van weigh business in the second half of the year. Would you talk in more detail about what you're seeing that leads to that optimism?

Regarding the first part, yes, we should expect the inventory reductions that hurt margins in Q4 to not continue into the coming quarters. Regarding truck weigh and van weigh, Europe was under heavy lockdown, and Q4 reflects that Europe has been reopening and we see more business activity. While we are still below pre-pandemic levels, the expectation that Europe will continue to recover supports an improved environment for truck weigh and van weigh. In addition, we have been speaking about EU regulations that are expected to be in place as of May 2021 and there is an expectation for aftermarket demand related to those regulations, which we are targeting. So those are the two vectors for why we expect improvement particularly in the second half of the year.

Okay. Great. Thank you for the perspective.

(Operator instructions) And the next question is again from John Franzreb with Sidoti & Company. Please go ahead.

Yes. Just want to ask about any kind of additional costs we should be thinking about that we deferred from 2020 which may come on board. I know you already touched on maybe travel will still be weak. Is there anything else that we should be thinking about back in 2020 versus 2021?

So, we implemented a few measures in 2020 given the pandemic; one of them was a salary freeze. We should expect to unfreeze that in 2021, so salary costs will come back. Regarding travel, COVID is not completely over but we expect to see much more travel in the second half of the year as things normalize. There were also other marketing and related costs due to travel restrictions that the company was not able to incur in 2020 which should return to more normalized levels. But the main effects to consider are the salary unfreeze and travel costs.

And one other question, just remind me, do you have any exposure to the mining and metal markets besides steel? Any exposure there given what happened in commodity costs — is there potential for a turnaround?

From a commodity standpoint, the biggest impact is steel. We are not significantly impacted by precious metals and similar commodities. Our primary exposure is to steel.

I just wanted to double check. Thank you for taking my questions.

This concludes our question-and-answer session. I would now like to turn the conference back over to Steve Cantor for any closing remarks.

Before we close, I just want to remind everyone that we will be presenting at the Virtual Sidoti Growth Conference in March and you can see our website for more details on that. Thank you again for joining the call and have a good day.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.