Vishay Precision Group, Inc. (VPG) Q3 2018 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the VPG Third Quarter 2018 Results Conference Call. [Operator Instructions]. And please note that today's event is being recorded. I would now like to turn the conference over to Reynee Tung. Please go ahead.

Thank you, Operator. Good morning, everyone. Welcome to VPG's 2018 Third Quarter Earnings Conference Call. An audio recording will be made of the conference call today, including any questions or comments that participants may contribute. By now you all should have received the earnings press release, and we hope you've taken the time to read through it as it contains important information. You can find it, including relevant non-GAAP reconciliations, on VPG's website at vpgsensors.com. An audio recording of today's call will be available on the Internet for a limited time and can be accessed on the VPG website. The content of this conference call is owned by VPG and is protected by U.S. and International Copyright Law. You may not make any recordings or other copies of this conference call, and you may not reproduce, distribute, adapt, transmit, display or perform the contents of this conference call in whole or in part without our written permission. Today's remarks are governed by the safe harbor provisions of the 1995 Private Securities Litigation Reform Act. Actual results, performance or achievements may turn out significantly better or worse than indicated by any forward-looking statement that we may make today. For a more complete discussion of the risks associated with VPG's operations, please refer to our SEC filings, especially the Form 10-K for the year-ended December 31, 2017, and our other SEC filings. And now it's my pleasure to introduce the host for today's call, Ziv Shoshani, CEO and President; and Bill Clancy, CFO. Bill?

Thanks, Reynee. Good morning, everyone, and thank you for joining us on our call today. I would like to start by reviewing a few highlights and then summarizing the financials. Following that, Ziv will provide his view of the results and the global business environment. Referring to Page 3 of the slide deck, we had a good third quarter of 2018 with revenues of $75.5 million, gross margins of 40.5%, operating income of $10.6 million, operating margin of 14.1% and earnings per diluted share of $0.56. We are also pleased with our quarterly performance and with our third quarter free cash flow of $6.8 million. On Slide 4, we grew our third quarter of 2018 revenues by 20.2% to $75.5 million, up $12.7 million compared to $62.8 million of revenues in the third quarter of 2017. The negative impact of foreign exchange rates to revenues for the third quarter of 2018 as compared to the third quarter of 2017 was $700,000. We increased our gross profit margin to 40.5% in comparison to 38.6% in the third quarter of 2017. The increase in gross profit of $6.3 million for the third quarter of 2018 as compared to the third quarter of 2017 was primarily attributable to an increase in volumes of $8.1 million, partially offset by $700,000 related to reduction in inventory, $400,000 related to wage increases, $300,000 related to the U.S. imposition of tariffs on goods from China and $200,000 related to negative impact of foreign exchange rates. Selling, general and administrative expenses for the third quarter of 2018 were $19.7 million or 26.1% of revenues compared to $18.3 million or 29.2% for the third quarter of 2017. The increase in selling, general and administrative expense was related to $700,000 in bonus reserve adjustments, $300,000 in commissions and $300,000 in fees. Looking at operating income on an adjusted basis, we increased our adjusted operating margin by 81% to $10.9 million or 14.4% as compared to $6 million or 9.5% in the third quarter of last year. The adjusted net earnings attributable to VPG's stockholders for the third quarter of 2018 increased 111% to $7.7 million or $0.57 per diluted share compared to $3.6 million or $0.27 per diluted share in the third quarter of 2017. Foreign currency exchange rates for the third quarter of 2018 as compared to the third quarter of 2017 had a small negative impact of net income of $100,000 or $0.01 per diluted share. Excluded as an adjustment to net earnings attributable to VPG's stockholders for the fiscal quarter ended September 30, 2017, were net proceeds of $1.5 million related to a one-time lease termination payment at the company's Tianjin, Peoples Republic of China location. We generated free cash flow of $6.8 million for the third quarter of 2018 as compared to $6.4 million for the third quarter of '17. We define free cash flow as the net of cash generated from operations, which was $10.6 million for the third quarter of 2018, less capital expenditure, which were $3.8 million for the third quarter of 2018, net of any proceeds from sale of assets, which were de minimis in the third quarter of 2018. Our GAAP tax rate for the first 9 fiscal months ended September 29, 2018, was 27.1%. We anticipate that the operational tax rate for the year will be in the range of 27% to 29%. We are closely monitoring the developments relating to the U.S. imposition of tariffs from China and trade regulations and the response by other countries related to the U.S. tariffs. In mid-July, the tariffs went into effect, and we incurred $300,000 of cost related to the tariffs on goods from China in the third quarter of 2018. For those products that are impacted, we have been working closely with our customers to minimize the impact. And given our current backlog, we should expect to see offsetting effects in the coming quarters. On Slide 5. We remain focused on the execution of our basic strategy, which continues to prove very effective in achieving these goals. With that, let me pass further comments on to Ziv.

Thank you, Bill. An important part of our strategy is to go by developing new product offering. A great example of this is our advanced sensor line, which continues to gain adoption. We developed this platform as part of our Foil Technology Products' segment and it has been growing nicely as more customers include it in their product design. We saw our Advanced Sensor revenues increased approximately by 63% in the third quarter of 2018 versus the third quarter of 2017. We are pleased with the continued acceptance of this new sensor platform and are proud to provide enhanced performance to customers. We are also pleased to be manufacturing on an efficient platform. The second example of our innovation is our value-added OEM transducer business. As part of our Force Sensors segment, for the third quarter of 2018, its revenues increased by 54% compared to the third quarter of 2017. A fine example is in our Weighing and Control Systems segment. Our TruckWeigh and VanWeigh on-board weighing business revenues increased by 75% in the third quarter of 2018 as compared to the third quarter of 2017. We are pleased to see a stable trend continuing in some important end markets for our business, in particular I'll note aerospace and defense, steel and test and measurement. The semiconductor manufacturers continue to proactively retarget the supply-side plans in order to maintain disciplined supply/demand profitability, free cash flow profile. The fundamentals is to be relatively balanced over the next 12 to 18 months. Defense looks to be an anchor in a volatile market. The expectation is to materialize the strength of the sector in revenues, growth, bookings and backlog, and would note that despite recent market volatility and the increasing presence of global macroeconomic risk factors, the fundamentals' demand backed up for the sector remains robust. Finally, turning to the steel market. In 2018, global steel demand continued to show resilience, supported by the recovery in investment activities in developed economies and improved performance of emerging economies. Demand for steel is expected to remain positive into 2019, growing at 1.4% globally. All these are good indicators for the major end markets within our business and gives us ongoing confidence. Moving to Slide 6. The company's overall book to bill was 0.98% in the third quarter of 2018 compared to 1.12% in the third quarter of 2017, and 1.13% in the second quarter of 2018. We believe this reflects sustained business environment in our markets as well as our focus on execution. Total orders for the third quarter of 2018 were $74.0 million, an increase of $3.7 million or 5.2% from $70.3 million in the third quarter of 2017, and a decrease of $10.0 million or 11.9% from $84.0 million in the second quarter of 2018. The sequential decrease in orders is across all regions, with the largest impact attributable to Pacific Instruments' products, which is a project-oriented business and recently delivered orders for some large projects. Our backlog at September 29, 2018, decreased to $99.4 million compared to $101.0 million at June 30, 2018, and an increase compared to $76.2 million for the third quarter of 2017. Moving to Slide 7, some details on our reporting segments. The Foil Technology Product segment had a book-to-bill ratio of 0.95 for the third quarter of 2018 compared to 1.03 for the third quarter of 2017 and 1.24 for the second quarter of 2018. Sequentially, orders decreased by $8.3 million or 19.5% from the second quarter of 2018 across all regions, with the largest decrease coming from Pacific Instruments' products in the Americas within the avionic, military and space end markets. Additionally, we saw a decrease in the precision resistor product line, primarily in the test and measurement end market in Asia due to large semi-annual orders placed in the second quarter of 2018. The Foil Technology Products segment gross profit margin was 43.9% for the third quarter of 2018, up from 41.7% in the third quarter of 2017 and down from 46.1% in the second quarter of 2018. The year-over-year gross profit increase of $3.5 million was by - was primarily due to the increase in volume of $3.9 million across all regions. Our growth in Asia was primarily within the test and measurement market for precision resistors, in addition to the force measurement market for advanced sensor products. Our growth in Europe was primarily within the test and measurements market for precision resistors. In the Americas, the growth was primarily coming on the Pacific Instruments' product within the avionic, military and space end markets and test and measurement market for strain gages. Partially offsetting the volume increase was a decrease in inventory of $0.3 million. The sequential gross profit was flat despite an increase in volume of $1.3 million, which was offset by manufacturing inefficiencies of $0.6 million, a reduction in inventory of $0.4 million and $0.1 million negative impact of foreign exchange rates. The Foil Technology Products segment backlog was 4.4 months compared to 3.6 months last year and 4.8 months in prior quarter. Looking at the Force Sensors segment, the book-to-bill ratio was 0.98 for the third quarter of 2018 compared to 1.25 in the third quarter of 2017 and 0.88 for the second quarter of 2018. Sequentially, orders increased by $0.3 million or 1.7% in Asia and the Americas within the force measurement end markets. The gross profit margin for the segment was 25.9% in the third quarter of 2018, down from 28.6% in the third quarter of 2017 and 29.4% in the second quarter of 2018. The gross profit decrease of $0.2 million compared to the third quarter of 2017 was due to an increase in manufacturing inefficiencies of $0.3 million, a reduction in inventory of $0.3 million and $0.2 million related to U.S. imposition of tariffs on goods from China, offset by an increase in volume of $0.7 million for force measurement and distribution customers mainly in the Americas. The gross profit decrease of $1.1 million compared to the second quarter of 2018 is due to volume decrease of $0.7 million across all regions, with the largest decrease in the Americas within the precision weighing and force measurement end markets, in addition to the reduction in inventory of $0.2 million and $0.2 million related to the U.S. imposition of tariffs on goods from China. The Force Sensors segment backlog was 2.9 months compared to 3.3 months in the third quarter of 2017 and 2.7 months in the second quarter of 2018. For the Weighing and Control Systems segment, the book-to-bill ratio was 1.02 for the third quarter of 2018 compared to 1.15 for the third quarter of 2017 and 1.18 for the second quarter of 2018. Sequentially, orders decreased by $2.0 million or 8.1% across all regions. The largest decrease in orders is primarily attributable to the steel product in the America and the seasonality effect in Europe for process weighing. The gross profit margin for the segment was 46.6% in the third quarter of 2018 versus 43.1% in the third quarter of 2017 and 48.0% in the third quarter of 2018. Weighing and Control Systems gross profit increased by $3.0 million from the third quarter of 2017 due to an increase of - in volume of $3.5 million, mainly for steel products in all regions, on-board weighing products in Europe and the Americas and process weighing products in the Americas. The increase in volume was partially offset by $0.2 million of manufacturing inefficiencies and $0.2 million related to a reduction in inventory and $0.1 million related to U.S. impositions of tariffs on goods from China. The sequential gross profit increase of $0.3 million compared to the second quarter of 2018 was primarily due to an increase in volume of $0.9 million, mainly from the steel product line in Europe and in the Americas, partially offset by $0.3 million related to manufacturing inefficiencies, $0.2 million related to a reduction in inventory and $0.1 million related to the U.S. imposition of tariffs on goods from China. The Weighing and Control Systems backlog was at 4.0 months compared to 4.0 months in the third quarter of 2017 and 4.2 months in the second quarter of 2018. Moving to Slide 8. In light of the continued solid business environment, at a constant third quarter fiscal 2018 exchange rate - rates, we expect net revenues in the range of $73 million to $80 million for the fourth fiscal quarter of 2018. With that, let's open the lines for questions. Thank you.

[Operator Instructions]. And our first questioner here will be John Franzreb with Sidoti.

Okay, I guess I want to start with the revenue line. On your guidance, the midpoint, would suggest sequential improvement, but your book to bill at 0.98, certainly weaker than we saw a quarter ago. Could you talk a little bit about that? You've mentioned in the past that you have some longer-tail projects that kind of aided the book-to-bill outlook and the backlog outlook. Are those coming fruition in the fourth quarter? Or is it something changing now with some of the timing of deliveries that they're becoming shorter across all product lines?

Okay, John, regarding the guidance and for Q4, as we did in prior months, our age backlog, which is the backlog that we expect to deliver in Q4, is 66% of the complete backlog and I would say covers around 80% to 85% of the midpoint of our guidance. This is in line with the prior quarter dynamics. So we feel confident that we would be able to achieve our guidance target. In regards to the changes of backlog order intake, we don't see - the fact that the book-to-bill ratio was 0.98, we should bear in mind that Pacific Instruments play a significant role. As a matter of fact that this is - as you know, this is a project-driven business that we do get the booking in one quarter and deliver the products within the next few quarters. So if we would exclude the effect of this specific product line, the book-to-bill ratio for the quarter would be close to 1. So in that regard the sentiment is that our end markets are still performing well and we feel confident about that.

Okay. Then you mentioned as a margin headwind, manufacturing inefficiencies in two of your segments. I believe it was FTP and Weighing and Control. Could you talk a little bit about what those manufacturing inefficiencies were and all your...

Yes, yes, absolutely. The manufacturing inefficiencies that we have incurred in the third quarter was mostly related to the - to - in regards to FTP to the number of working days we had in Q3, primarily needs help due to the holidays. And some of it is related to some changes that we have made to improve the efficiency in one - in the Weighing and Control System. I can tell you that most of the inefficiencies that have been related to process improvements and hiring more people are behind us, and we don't expect this effect to repeat itself. Or if it would repeat, it would repeat to a much, much, much lower magnitude in Q4. So to the largest extent, the inefficiencies should be behind us already.

Okay. And just because you brought it up, I've heard another company mention that the fourth quarter working days is actually an impact for them. Is there any impact we should be aware for you guys in the fourth quarter as far as working days company-wide?

Yes. In regards to working days, we should expect mainly for the FTP. This is mostly relevant for the FTP, we should expect to have another around 10% more working days.

More working days, okay.

In Q4, in respect to Q3.

No, no, that actually kind of makes sense a little bit. And one last question, I'll get back into queue. You mentioned in 2 of the businesses inventory reduction, can you talk a little bit about why you have inventory reduction going on in force and FTP?

The inventory reduction in the Force Sensors is part of our attempt to be more efficient and to introduce newer lean manufacturing in order to improve - in order to streamline the manufacturing and to improve our lead time. So this is a strategy that we are pushing across the company, and since we are - since we have a very - our - we have a very large manufacturing on Force Sensors, we are moving in that direction and we have seen because we have taken more steps in order to reduce lead time and to be more efficient. In regards to FTP, I would say that the main reason for the drop in inventory was part of the fact that despite the fact that we had less working days in FTP, 10%, we still were able to deliver high revenues. And the only way to do that is shipping out of inventory finished goods. So in essence, the reduction in inventory for FTP was to offset the lower, or I would say, the less number of working days in order still to meet the sales target and to deliver to our customers on time.

Okay. And in force, are you at equilibrium in your inventory levels at this point? Or is there still some headwinds in Q4?

The expectation would be that we would expect to continue and streamline the operations and be more efficient and to reduce lead times. So I would expect [indiscernible], which, as a result - excuse me, as a result of that, part of this our operational results and part of the reduction of inventory, we were able to reach our highest level [indiscernible] from operations of over $10 million. So part of it is for the reduction of inventory contribution.

And our next questioner today be Sarkis Sherbetchyan from B. Riley FBR.

So first question is around the advanced sensor's revenue growth. Ziv, I think you mentioned 63% year-on-year growth here in 3Q. Mind disclosing what the year-to-date revenues of that product line is? Or perhaps your annual kind of run rate?

We have not disclosed the quarterly run rate of this product line. We always give rough estimation regarding this product line. And I would say that this is already - if I may say, at the - on a high level at $10 million to $20 million run rate.

Understood. And if I recall correctly...

Excuse me, annual run rate, just to be more accurate.

Right, thank you. And if I recall correctly, the margin profile of that advanced sensor's line is different than your FTP segment margins, right? So can you remind us what the accretion is from a margin perspective?

The contribution margin of this product line is higher, as you indicated, higher than the average and is around, I would say high 50s, around 60% contribution margin, while the complete segment is lower than that.

Got it, that's helpful. And I suppose $10 million to $20 million annual run rate in that slice of the pie, how large would you expect this business to be over time given the consistent growth rates that we're seeing here?

This is a very good question. I have to say that it depends on the - we are - this is a very good question. In regards to advanced sensor, there are few factors that is driving the growth. One is the end market condition. But on the other hand we are working very, very diligently with some key OEMs to designing those products. Once they gain momentum, and we see the full extent of the - and we - I would say, and we leverage on the full extent of the potential, we should expect to see more revenues. I have to say that there are some other projects that we are growing in the upcoming years that we are going to introduce for the advanced sensor line for other types of applications. So it to that extent, I would say, it is quite how to put our hands around that, but I definitely see based on the current run rate that we would - we should expect to increase the revenues also in the future. I cannot indicate that we will be able to continue or sustain the growth, which was enormous in the last few years. This was close to 50% to 100%. But definitely this product line and this platform should take the company forward in the years to come.

Got it. And along those thoughts, what type of additional kind of capital expenses would you foresee to build the platform?

I would say that at this point in time we are not running at 100% capacity for advanced sensors, which means we have more capacity, we have more demand, more demand to materialize if orders would come. Therefore, we still have room to produce many more products within our existing capacity. In order to move to the next level in respect to revenues and capacity, I would expect on a - roughly, we would have to invest another few more millions of dollars in regards to capital investment to support the future growth of advanced sensors. But this is in the millions of dollars, which I have to say we have been doing that for the last few quarters.

Got it. Thanks for the additional color there. Just switching gears here, with regard to the lease termination payment, I think you mentioned in the China location, does that strategy align with kind of adjusting the supply chain in response to some of the tariff talk? Can you maybe help us understand what's going on there?

Okay, the lease termination, which happened a year ago, was part of our global strategy to continue and restructure, harmonize and the overall improvements of our operational structure, which we started way before the tariffs. As I stated already in prior quarter, we have a plan to continue the relocation of products, streaming line production in order to reduce cost and to make it more efficient, also, in the upcoming years and part of that was - and as a result of that, we had the lease situation in Tianjin. Bill, would you like to add something?

Yes. I mean, with that, Sarkis, you would recall a year ago we were in a location and we're basically forced to relocate due to certain arrangements and because of that they gave us, because we left early and went to another location, a one-time payment.

Okay, understood. So this is...

That has nothing to do with the tariffs. This is from a year ago 2017, the third quarter.

Okay, understood. And then I suppose, in response to kind of the tariff situation, you mentioned some actions that you're taking with your customers, can you maybe elaborate a little bit on that?

Yes, absolutely. Once we realize that the impact of the tariffs of mainly goods coming from China to the U.S., we has - we have started discussions with our customers and also some internal discussions, how we can improve or optimize our supply chain in order to minimize the effect. I have to say that based on those discussions, we were able to increase the prices in order to offset the tariffs' effect. Since we have a backlog, the price increase is already in our backlog, but we'll go into effect to the end of Q4 and beginning of Q1, which should offset the tariffs' cost.

And the next question today will be a follow-up from John Franzreb with Sidoti.

I got a couple. I guess, first thing on advanced sensors, just a follow-up on the previous discussion. Is there some cannibalization involved in that product line? And if so, when you talked about that 63% revenue growth, is that net of - would you might have sold some other product lines or is that just a stand-alone number?

Okay. When we speak about - when we reported Advanced Sensor Product line, we reported complete revenues. The complete revenues, as we provided some information in prior quarters, is consisting of transitioning of existing products into the new, I would say, current product - our legacy product into the new platform in order to be more efficient, in conjunction with new application and new business. I have to say that way - I would say that, at least, 50% to 60% is new business. Opportunities that the company never had, this is in addition to the transitioning the legacy business. So it's a combination, the reporting number is the combination of both.

Perfect, that helps clear that up a little bit. And secondly, if I look at how the midyear kind of numbers looked out, can you talk a little bit about the larger buckets of business? What's doing well through the 9-month process? What's going on in test and measurement? It was up pretty strongly in the first part of the business. Can you talk about the larger end markets and how they're performing well relative to they were, say, 3 months ago?

Yes, absolutely. We do continue to have confidence in the avionics, military and space market. We - all signs show and we see it also very well in the Pacific Instruments' product line, which exclusively is selling into that market. This market is solid and has been solid for the last few quarters. Also, our test and measurement end market is performing very well. We are selling into the equipment manufacturers, which are selling automatic testing equipments for the front end and back-end market at this point in time. We do see that market continues to perform well. I have to say, and I did indicate, that from an order intake, Q3 was slightly lower than the second quarter order intake due to the semi-annual orders that has been placed in the second quarter. In regards to oil and gas, we - the demand for equipment and manufacturers, for the oil and gas industry, and we have been providing components and sensors to the onshore and offshore. We have seen stronger onshore end market demand rather than offshore, but this has been growing quite well for the last 9 months. And for us, it's still considered as solid. In regards to where we have since solved the end markets, maybe a little bit softening is on the OEM side for Force Sensors, in particular, precision agg and to some extent the construction. They have been retrofitting, the new platforms with our products and at this point in time they built some inventory, and they are waiting to deplete that before they will start placing larger orders again.

Perfect. And maybe just can you talk a little bit about the M&A environment, what are you seeing out there? Have valuations improved? Or are they still not very attractive?

And excuse me, John, as I indicated, also, the steel market demand is going quite well and it is basically being reflected in our still - in our KELK - in the performance of KELK - of our company KELK. In regards to M&A, M&A has been a focus for the company since we were not able to execute the deal in the last, I would say, slightly over 12 months. The valuation as you know were very, very high and to an extent unreasonable, if you are in very, very disciplined in order to meet your financial target. I - we have been discussing with some companies, and we do believe that as interest rates are going up. We feel that the valuations are - will become more reasonable, and we will see more opportunities coming in the near future.

Okay, perfect. And one last question on the tax line. Can you just give us a sense what you would expect the fourth quarter tax line would look like? Maybe it's for Bill and maybe it's for modeling purposes. What should we think about in 2019?

Yes, sure, John, I mean, it's always based on, like, your current mix and where the products are being made. So to the extent that for the 9 months we're running at slightly over 27%. If we maintain that same geographic of the income going forward, I would think the fourth quarter would be somewhere and within that 27%, 28% range. And now I don't have a crystal ball for 2019, but if we continue to maintain or at least have similar profit mix, it should be comparable to what we were for 2018, also.

[Operator Instructions]. And this will conclude our question-and-answer session. I would now like to turn the conference back over to Bill Clancy for any closing remarks.

Okay, I appreciated very much everybody dialing in today and listening to a very good performance from VPG. And just to let you know, we will be presenting at the Baird Conference tomorrow in Chicago. And we look forward to talking to everybody in near future. Thank you very much.

The conference has now concluded. Thank you for attending today's presentation, and you may now disconnect your lines.