Earnings Call Transcript - VPG Q3 2020

Operator, Operator

Good day, and welcome to the VPG Third Quarter 2020 Earnings Call. Please note this event is being recorded. I would like now to turn the conference over to Steve Cantor, Senior Director of Investor Relations. Please go ahead.

Steven Cantor, Senior Director of Investor Relations

Thank you, Matt, and thank you, everyone, for joining our call today. Welcome to VPG's 2020 Third Quarter Earnings Conference Call. Our Q3 press release and accompanying slides have been posted on our website at vpgsensors.com. An audio recording of today's call will also 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. I'll now turn the call to Ziv for some prepared remarks. You can refer to Slide 3 of the quarterly presentation. Ziv?

Ziv Shoshani, CEO and President

Thank you, Steve. I will begin with some commentary on VPG's consolidated financial results and sales trends for Q3 and an update of the impact of the COVID-19 pandemic on our business. Bill will provide financial details and our fourth quarter outlook. Moving to Slide 3, third quarter financial highlights. I am pleased with our performance in Q3 as we continue to execute our long-term strategies while managing the challenges of the global pandemic. We achieved growth in sales, operating margin and earnings per share compared to the second quarter and the third quarter a year ago. We generated a positive adjusted free cash flow and continued our investments in our new advanced sensors manufacturing facility. And we are now manufacturing at full capacity levels at our India facility for Force Sensors. Moving to Slide 4, consolidated results and market trends. We achieved third quarter sales of $67.5 million, above the high end of our guidance, which was 14.2% higher than the second quarter and about flat with a year ago. In terms of our business trends, many of our diversified end markets in the third quarter continued to show modest signs of recovery from the pandemic lows earlier in the year. Consolidated orders grew $7.7 million or 13.7% from the second quarter, while we are encouraged by this growth the sequential trends across these markets show different levels of strength. On the positive side, strong demand for consumer applications and precision agriculture was partially offset by lower orders for medical and construction. In the steel-related market, orders were stronger for Dynamic Systems, Inc. or DSI while KELK orders remained flat. Orders in the avionic, military and space and test and measurement markets were strong. However, trends in some end markets were mixed. In the transportation market, orders rebounded from the depressed level in the second quarter, but were still below the pre-pandemic levels in the prior year. Orders in the general industrial markets recovered partially, but demand in this market tends to move in line with general economic or broader GDP trends, which remain muted in many of our geographies. The net result of these trends was a book-to-bill of 0.95 for the third quarter. Moving to Slide 5, segment trends. We achieved sequential growth across all three business segments. For Foil Technology Products, third quarter sales of $32.9 million grew 3.5% sequentially and 2.5% from a year ago. We were pleased with the performance of Advanced Sensors, which grew its sales by 22% from Q2 and by 59% from Q3 of 2019. The strength in advanced sensors was complemented by higher shipments of Pacific Instruments data acquisition systems, while sales of precision foil resistors were softer for the test and measurement applications. Adjusted gross profit: adjusted gross margin for FTP was 41.6%, which was about flat with the second quarter and improved from 37.3% in the third quarter of 2019 due to manufacturing efficiencies and cost controls. Book-to-bill for FTP was 1.01 in the third quarter, driven by another consecutive quarter of significant orders for advanced sensors mainly for consumer applications. We continue to get customer interest for additional applications of our advanced sensor technology that benefit from the flexible design, smaller size and lower power consumption, including for consumer applications such as in the bicycle and indoor exercise markets, as well as for medical applications. While we are currently operating at the maximum capacity for advanced sensors, we are able to keep up with the current demand. With regards to our new facility project, the building infrastructure has been finished, and we have completed the move of our administrative offices. As we move and install the production equipment in stages, we expect to be fully transitioned into the new facility in the early second half of 2021, which will give us the needed capacity to accommodate future growth. For the Force Sensors segment, it was a quarter of continued recovery. Third quarter sales of $13.9 million improved by 55.5% from the second quarter of 2020, driven by our backlog and the return of our India facility to full capacity late in the third quarter. As we discussed in the past quarter, India has been particularly hard hit by the pandemic and our major facility there was constrained by our local government COVID restrictions, which were fully lifted beginning in July. I want to commend our Force Sensors team for their hard work and dedication in ramping up production even as that region faced ongoing pandemic challenges. In the third quarter, we estimated due to the pandemic Force Sensors revenues were adversely impacted by approximately $2.5 million from normalized pre-COVID run rate levels, and its operating income was impacted by approximately $1 million, primarily due to lower revenues. The pandemic has impacted Force Sensors revenue in aggregate for the first nine months of 2020 by approximately $10 million and by approximately $4 million in terms of its operating income from a normalized run rate. In terms of OEM-specific Force Sensors products, which is one of our key growth initiatives, sales grew by 94% sequentially but were below pre-pandemic run rate. Financially Force Sensors performed well, achieving an adjusted gross margin of 31.2% in the third quarter, which compared to 19.6% in the second quarter and 30.4% in the third quarter of 2019. This performance reflects both short-term cost savings measures and the long-term structural cost savings initiatives that we have implemented over the past four years, including the move of the majority of the Force Sensors' manufacturing to India. Compared to the second quarter, the sequential increase in adjusted gross margin was primarily due to higher volume. Book-to-bill for Force Sensors was 0.9 as orders for generic wing applications and OEM products for precision agriculture were higher. This was offset by lower orders for OEM-related products, mainly in the medical segment. Sales of the Weighing and Control Systems in the third quarter of $20.8 million increased 12.5% sequentially and 8.8% higher than a year ago. Sequentially higher sales of DSI and our onboard weighing solutions offset lower sales of KELK systems. Sales of TruckWeigh and VanWeigh rebounded 60% from the second quarter, but were still below a normalized run rate in the third quarter of 2019. We continue to capture aftermarket demand for TruckWeigh and VanWeigh, and we expect additional sales opportunities to emerge as the new EU regulations become effective in mid-2021. Adjusted gross margin in the third quarter for WCS was 44.9%, adjusted for COVID impact, and declined from 47.3% in the second quarter, mainly due to unfavorable product mix and a reduction of inventory, partially offset by higher volume. In terms of sequential trends in the WCS segment, orders for DSI and onboard weighing were higher, while KELK orders were flat and remained below pre-pandemic levels. The results of these WCS orders trends in the third quarter was a book-to-bill of 0.88. Moving to Slide 6, VPG's strategy to contend with COVID-19 impact on its business. In terms of impact from COVID, all our businesses are now operating normally, although we are continuing with measures to protect the health of our employees and our customers. These measures include restrictions on travel, maintaining safe workplace distancing and providing transportation assistance. Given the ongoing economic uncertainties presented by the pandemic and increase in infection rates around the world, we are continuing to maintain tight control of our cost. Nonetheless, we are continuing our long-term strategic initiatives, including deploying our capital prudently to build long-term stockholders' value. As such, we now expect capital spending to be approximately $25 million for 2020, of which $15.8 million has been invested through the first nine months. We are also continuing to look for opportunities to build additional stockholders' value through attractive M&A opportunities. Before Bill provides more details on our third quarter financials, I would like to take a moment to thank VPG's employees around the world for their dedication and customer focus during these challenging times. In summary, our business environment is currently more positive than in the first half of the year, but many of our markets have still not recovered fully to pre-pandemic levels. I will now turn it over to Bill Clancy for additional financial details. Bill?

Bill Clancy, CFO

Thank you, Ziv. Moving to Slide 7, our financial results. Referring to Page 7 of the slide deck. In the third quarter of 2020, we achieved revenues of $67.5 million, gross profit of $27.3 million or 40.5% of sales, operating income of $8.1 million or 12.0% of revenues and net earnings per diluted share of $0.41. On an adjusted basis, which primarily excludes a $320,000 net credit mainly related to a COVID-related subsidy from the Canadian government and an $84,000 restructuring charge, our gross profit was $27.3 million or 40.5% of sales. Operating income was $7.9 million or 11.7% of sales and net earnings per diluted share was $0.40. Our third quarter 2020 revenues increased 14.2% compared to $59.1 million in the second quarter and were slightly above the third quarter a year ago. Foreign exchange for the third quarter of 2020 had a positive effect on revenues by $700,000 compared to a year ago and $1.1 million as compared to the second quarter of 2020. Our gross margin improved in the third quarter to 40.5% from 39.1% in the second quarter. On an adjusted basis, our third quarter gross margin of 40.5% grew from 40.1% in the second quarter of 2020. Our operating margin was 12% for the third quarter of 2020. Excluding the above-mentioned restructuring charge and the COVID-19 subsidy, our third quarter adjusted operating margin was 11.7%, which increased from the 8.4% we recorded in the second quarter of 2020. Selling, general and administrative expenses for the third quarter of 2020 were $19.1 million or 28.4% of revenues. In dollar terms, as a percentage of revenues, this was essentially flat with the third quarter of 2019 and compared to $18.6 million and 31.5% of revenues in the second quarter of 2020. The sequential increase in SG&A of $500,000 was mainly related to the impact of foreign exchange. The adjusted net earnings for the third quarter of 2020 were $5.5 million or $0.40 per diluted share compared to $2.6 million or $0.19 per diluted share in the second quarter of 2020. Foreign currency exchange rates for the third quarter of 2020 increased net income by $200,000 or $0.01 per diluted share relative to the prior year period. We generated adjusted free cash flow of $1.4 million for the third quarter of 2020 as compared to $4.8 million for the third quarter of 2019. We define adjusted free cash flow as cash from operating activities, less capital expenditures plus sale of fixed assets. Our GAAP tax rate in the third quarter was 27.1%. We are assuming an operational tax rate in the range of 26% to 28% for the full year of 2020. Moving to Slide 8, our balance sheet strength. We ended the third quarter with $89.8 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. Despite the ongoing uncertainties and economic impact of the global pandemic, we expect net revenues to grow sequentially and be in the range of $69 million to $75 million for the fourth fiscal quarter of 2020 at constant third fiscal quarter 2020 exchange rates. In summary, we achieved sequential sales growth across all three reporting segments. We delivered solid Q3 margin performance and EPS, 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.

Operator, Operator

Our first question comes from Sarkis Sherbetchyan with B. Riley Securities.

Sarkis Sherbetchyan, Analyst - B. Riley Securities

So first on the fourth quarter sales outlook. I think it's pretty impressive that you guys have guided to sales sequentially better. I just wanted to understand what end markets are driving the quarter-on-quarter fourth quarter growth assumptions, and then which segments are the biggest beneficiaries of your assumptions? I'm looking at the metrics relative to the third quarter here.

Ziv Shoshani, CEO and President

Okay, Sarkis. When we are projecting Q4 sales revenues, we are looking at a few factors. First of all, the dynamic of the company is such that historically two-thirds of the revenues are already in the backlog and are expected to be shipped in the following quarter with firm delivery dates to customers. One quarter are orders that are expected to be booked and shipped within the same quarter. In addition to that, we are cycling project-driven product lines like DSI, KELK, and Pacific Instruments that have specific delivery dates, which are not homogeneous across quarters. If we take into account the number of working days and the expectation, the two-thirds is expected to be delivered given the current environment, including the project-driven cycle product lines. We do believe that this guidance supports that level of revenues. On a high level, we already provided more color regarding the order intake in Q3, which is expected to be delivered in Q4 across the different markets. As we said, consumer on FTP is quite strong. Advanced Sensors is quite strong. We have seen some modest decline on OEM medical sensors. Industrial weighing is much softer. The other product lines are better than the first half of the year, but still fairly flat with respect to pre-pandemic levels. In Q4 of last year, it was pre-pandemic where we took into account certain infrastructure-related projects like building and expanding the India building in order to support more capacity and also expanding other product lines on the infrastructure side. Once the pandemic came and the situation became much more fluid given the uncertainty, and we had to deal with the lockdown in India and in other places, we had to change priorities in order to support current demand, and this is where we shifted capital from product lines that did not show enough demand to support the level of growth. In addition to the India infrastructure, we shifted that to add more capacity on FTP, predominantly for advanced sensors, in order to support the additional growth that we have seen during the COVID period. So it was just a change of priorities given the situation and the uncertainty.

Operator, Operator

Our next question comes from John Franzreb with Sidoti.

John Franzreb, Analyst - Sidoti

I want to start with the cost side of the equation. Can you talk a little bit about the temporary costs that you might have put in place? Are they all now back as part of the P&L? Where do we stand on that front?

Ziv Shoshani, CEO and President

There are two types of cost measures. We have the strategic ones, which are a multiyear program, and we have short-term measures. We have discussed the strategic items, like closing facilities, relocation of products, changing warehouse locations. This is all part of a much bigger plan, which we continue to execute as a multiyear program, in addition to the short-term cost-related measures that we took during the COVID environment. As an example, we have abandoned nonessential travel and minimized other nonessential costs, which supported extra projects that we have pushed out into next year given the pandemic. So this is really a mixed bag of short-term items like travel, which resulted in significant savings, and longer-term strategic initiatives, such as moving product to India or transitioning some legacy production into advanced sensors. So it's really a combination, and these all now flow into the 2020 P&L.

John Franzreb, Analyst - Sidoti

So in aggregate, you're saying that most of the temporary cost measures are still in place, such as the salary freeze, and we shouldn't expect them to materialize in 2021 at the earliest. Is that a fair assumption?

Ziv Shoshani, CEO and President

I have to say that we don't really know how the world is going to change going forward post-pandemic when a vaccine is found and distributed. I would assume that we would increase the level of travel, but I don't think we will return to the same level or cost of travel as pre-pandemic. We found effective ways to communicate via electronic media, so there would be an increase of cost, but I don't think it will return to the pre-pandemic level. Regarding our strategic initiatives, we have not finalized our multiyear plan, and there are more projects to be delivered in 2021 and onwards. We will provide that information once we get closer to execution. But we do have more strategic cost reduction projects to be delivered.

John Franzreb, Analyst - Sidoti

Understood. And regarding Europe, Ziv, I'm kind of interested in your take about what's happening over there, and how much you've baked that into the outlook being, I don't know, worse than expected in your guidance for the fourth quarter?

Ziv Shoshani, CEO and President

I'm sorry, John. I couldn't hear the question clearly earlier. Regarding Q4 range and Europe, as I indicated before, two-thirds of the revenues we are expecting to deliver in Q4 are already baked into the backlog. So we are really looking at one-third of the revenues given the cycle of the end-user projects like DSI and steel. Europe moving into another lockdown introduces a factor of uncertainty. But given our estimation and the assumptions we put in place, I believe this is a very low risk for us with respect to the guidance we have provided. Of course, there is a certain fluidity as the situation keeps changing, but I feel comfortable with the guidance.

John Franzreb, Analyst - Sidoti

Okay. And one last thing: has there been any problems with your supply chain at all? Any issues getting what you need?

Ziv Shoshani, CEO and President

Initially, when the pandemic started, we identified all the key suppliers and worked to ensure we would not face a potential line shutdown. As of today, we have identified and built safety stock and there is no risk for the company to be in a line-down situation. We are secure from a supply chain standpoint.

Operator, Operator

Our next question comes from Patrick Ho from Stifel. Patrick, your line might be muted. Are you able to hear us?

Patrick Ho, Analyst - Stifel

I'm sorry about that, and congrats on the nice quarter and outlook. Maybe first off, in terms of the Force Sensors business, you talked about it being back at full production. Do you see the margin gains in that business segment being sustainable?

Bill Clancy, CFO

Since we implemented a significant cost reduction over the years moving production to India, at this point in time the margins are quite sustainable given the current volume. With a similar level of volumes, we should be able to maintain the same level of margins, and we would expect further improvement in margins as volume picks up and as we continue to execute our strategy on design-in wins with OEMs. To make the long answer short: those margins are sustainable at the level of volume we are running today, yes.

Patrick Ho, Analyst - Stifel

Great. That's helpful. And maybe as my follow-up question, one of the secular growth trends that I cover closely is 5G and the rollout globally that we're starting to see in that marketplace. Can you discuss any of the opportunities in that segment for you both near term as well as over the next several years?

Bill Clancy, CFO

The only product line where we are exploring opportunities related to 5G is precision resistors, which are part of our Foil Technology Products. We have engaged with some large OEMs, and the potential designs are within base stations at this point. We have not disclosed the level of opportunity, but we have made initial contacts and are in a design-win phase regarding those. Again, this is exclusively related to precision resistors and not relevant for the rest of the product lines.

Operator, Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Steve Cantor, Senior Director of Investor Relations, for any closing remarks.

Steven Cantor, Senior Director of Investor Relations

Thank you all for joining our call. We look forward to updating you next quarter, and have a great day.

Operator, Operator

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