Bel Fuse [BELFA] Conference call transcript for 2023 q2
2023-07-27 00:00:00
Fiscal: 2023 q2
Operator: Good morning, and welcome to Bel Fuse Second Quarter 2023 Earnings Call. As a reminder, this is begin recorded. I would like now to turn the call over to Jean Marie Young with the Three Part Advisors. Please go ahead, Jean.
Jean Young: Thank you, and good morning, everyone. Before we begin, I'd like to remind everyone that during today's conference call, we will make statements relating to our business that will be considered forward-looking statements under federal securities laws, such as statements regarding the company's expected operating and financial performance for future periods, including guidance for future periods in 2023. These statements are based on the company's current expectations and reflect the company's views only as of today and should not be considered representative of the company's views as of any subsequent date. The company disclaims any obligation to update any forward-looking statements or outlook. Actual results for future periods may differ materially from those projected by these forward-looking statements due to a number of risks, uncertainties and other factors. These material risks are summarized in the press release that we issued after market close yesterday.
Additional information about the material risks and other important factors that could potentially impact our financial performance and cause actual results to differ materially from our expectations as discussed in our filings with the Securities and Exchange Commission, including our most recent annual report on Form 10-K for the fiscal year ended December 31, 2022, ends our quarterly reports and other documents that we have filed or may file with the SEC from time to time. We may also discuss non-GAAP results during this call, and reconciliations of our GAAP results to non-GAAP results have been included in our press release. Our press release and our SEC filings are all available at the IR section of our website. Joining me on the call today is Daniel Bernstein, President and CEO; Farouq Tuweiq, CFO; and Lynn Hutkin, Vice President of Financial Reporting and Investor Relations. With that, I'd like to turn the call over to Dan, Dan?
Daniel Bernstein: Thank you, Jean, and thank you all for joining our call today. We are very pleased to report our seventh consecutive quarter of year-over-year gross margin improvement. Our diversity of products, end markets has served well this year. Connectivity and Power continue to lead the way this quarter and successfully offset the impacts felt within our magnetic group. We've been working in a challenging macro environment, I could be more proud of our global team for their unwavering discipline on margin improvement. On the backlog side, as expected, it continues to normalize. Importantly, the orders in our backlog continue to be strong from a margin perspective. I wanted to take a moment to acknowledge [indiscernible] and other former associates in the Czech Republic.
As we announced in early June, Bell divested its noncore business in the Czech Republic to PEI Genesis, whom we had known for a long time as a distributor of our Czech products. Lastly, as announced in May, June, we closed the sale of our former corporate headquarter building in Jersey City and moved to West Arnan, New Jersey. We're able to sell the building for $5.3 million, resulting in a gain of $3.7 million, which is included in our second quarter results. This move made sense to the current market value of the property and lower annual operating expenses in our new location. With that, I'd like now to turn the call over to Lynn to provide a financial update. Lynn?
Lynn Hutkin: Thank you, Dan. From a financial perspective, the second quarter was very strong for 2 of our 3 product groups with notable gross margin expansion continuing across all 3 groups. Overall, second quarter 2023 sales were $169 million as compared to $171 million in the second quarter of 2022. Gross margin expansion continued and reached 32.9% in the second quarter of 2023 as compared to 26.6% a year prior. By product group, Power Solutions and Protection sales for Q2 '23 were $87.1 million, up 23% from last year's second quarter. This is a new record high for our power group, and they now represent over half of Bell's consolidated sales. Higher demand for our front-end power products serving our networking end market was the largest growth driver. Sales of our e-mobility products also remained strong and helped to offset a decline in scene in circuit protection sales.
Gross margin for this group was 35.7% for the second quarter, a 750 basis point improvement from Q2 '22, largely driven by a favorable shift in product mix, the benefits of pricing actions taken over the past year and favorable FX. Our Power Solutions and Protection group had a book-to-bill ratio of 0.6% during the second quarter of 2023 and a backlog of orders of $285 million at June 30. Our Connectivity Solutions group posted new record sales of $54.8 million in the second quarter of 2023 and an increase of 19% from last year's second quarter, largely due to the continued rebound of the commercial aerospace and military end markets. Gross margin for this group came in at 37.4% for the second quarter of 2023, up from 27.6% in the second quarter of 2022. Our Connectivity Group has transformed financially in 2023 as certain contract renewals, cost actions, efficiency improvements and facility consolidations took effect throughout the first half of the year. These steps were critical in restoring the margin profile of this group, which has been impacted in recent years by higher material and labor costs.
We believe we are now better positioned to meet the current and expanding retirements of our commercial air and military customers in this segment. The Connectivity Group had a book-to-bill ratio of 0.9% during the second quarter of 2023 and a backlog of orders of $112 million at June 30. Lastly, our Magnetic Solutions group had Q2 sales of $26.8 million, down 50% from last year's second quarter. Gross margin for this group was 24.6% in the second quarter of 2023 as compared to 28.2% during last year's second quarter. As noted last quarter, our Magnetics Group is going through a period of transition from both a customer product consumption perspective and on the operations side. We expect this group to be the primary beneficiary of our major facility consolidation that has been underway in China since late 2022. This move is being handled in stages and has been progressing as planned.
The new site has been manufacturing and shipping products in small quantities since late '22 with $5 million being shipped from the new site during the second quarter of 2023. The balance of the transition is expected to be largely complete in the third quarter with full completion by year-end. As customers work through their inventory on hand, bookings within our magnetics group continues to be low in Q2, resulting in a book-to-bill ratio of 0.3% during the second quarter of 2023. This group finished Q2 with a backlog of orders of $53 million.
At a consolidated level, there are still past due orders that were unable to ship in Q2. Though these levels have largely returned to a normal run rate. As expected and indicated last quarter, our overall backlog has continued to decline as component availability eases and lead times begin to normalize. Our consolidated backlog of orders was $450 million as of June 30, down 20% from the 2022 year-end level. We still view this level of backlog is elevated due to lead times and expect it to come down further. Historically, our backlog would represent approximately 1 quarter's worth of sales when lead times for 8 to 12 weeks.
Our current level of backlog represents about 2.5 quarters' worth of sales. So there's still a way to go before it fully normalized. Our selling, general and administrative expenses for the second quarter of 2023 were $25.1 million or 14.9% of sales, up from $24.0 million or 14% of sales in the second quarter last year. Within SG&A, the primary increases were related to salaries and fringe benefits in addition to $1.2 million of litigation planters costs associated with our NPS matter as discussed in our recent filings. We anticipate these litigation costs will continue through the third quarter of 2023. On the tax line, we did have a large SIN 48 reversal of $5.2 million. That was an offset to our regular tax expense during Q2 '23. If you recall, we had a similar tax reversal in Q2 '22 in the amount of $3.6 million. From an EPS perspective, these tax items had a favorable impact of approximately $0.40 per share in Q2 '23 and a $0.30 per share favorable impact in Q2 '22. Turning to balance sheet and cash flow items, we ended the quarter with a cash balance of $65.1 million as compared to $70.3 million at year-end.
We generated $40.7 million in cash flow from operating activities during the first half of 2023. With capital expenditures of $7.1 million, this resulted in free cash flow generation of $33.6 million for the first half of 2023, an improvement of $26 million versus the first half of 2022. Our inventory level decreased by $13.4 million from year-end, resulting in improved inventory turn of 2.9x during Q2 '23 versus 2.6x from year-end. While progress has been made on bringing inventory levels down, this remains a company-wide initiative to restore our inventory turns to our historical range of 4x.
Looking at the second quarter of 2023 specifically, we generated $23.8 million in cash flow from operations. This translated into free cash flow of $20.5 million during the second quarter. Roughly, I wanted to provide an update on our outstanding debt balance. During the second quarter of 2023, we utilized our free cash flow to pay down the variable rate portion of our outstanding debt balance, which was subject to a high interest rate. Following the $40 million pay down in Q2, our outstanding debt balance now sits at $60 million and is effectively subject to a fixed interest rate of 2.5% through our swap agreements that are in place through 2026.
I'll now turn the call over to Farouq for additional color and outlook. Farouq?
Farouq Tuweiq: Thank you, Lynn. The second quarter of 2023 was another busy one for the team. In addition to delivering another solid performance financially, we completed a small divestiture of a noncore business, moved our corporate headquarters, conducted our executive off-site and made continued progress on our various facility consolidations that have been underway. From a management perspective, Dan and I visited our sites in China, something we were able to do in person for the first time since COVID. This was my first time personally visiting our sites from China since joining Bell 2 years ago, and it was exciting to see firsthand our great associates there and the quality of facilities they are managing.
We participated in the formal grand opening ceremony at the new Magnetics factory in early June, and we're able to see firsthand the progress of our facility consolidation there. The team and myself walkaway excited and appreciative of the overall upgrade that we represent to Bell and our customers. As I've stated over the past several quarters, Bell is on a journey to prepare and set its course for an exciting future, and we're seeing this take hold as we have been seeing in the last quarters and this quarter. As we noted in our release, we are expecting Q3 '23 sales in the range of $157 million to $165 million. We view this as a positive given that we have elected to walk away from $9 million of annual low-margin sales to refocus our efforts on more attractive margin opportunities with greater tailwinds.
Also, keep in mind that the check divestiture will have a slight impact on our revenues. On the gross margin side, we expect Q3 '23 margins to be generally in line with Q2 '23. In short, while we expect sales to be behind last year's third quarter, but we expect to be ahead of Q3 2022 on profit margins. Given our first half 2023 actuals and expectations for Q3, we are raising our full year 2020 outlook and are now estimating sales for fiscal year 2023 to be closer to the $650 million that was reported last year, including expedite fee revenue. As mentioned at the start of the call, all of the foregoing expectations and estimates, including guidance for future periods in 2023 or as otherwise discussed on this call are based on information available as of today and upon our current estimates, forecasts, projections and assumptions. The strength seen in our commercial air, military e-mobile markets is expected to continue through the balance of the year.
Certain other areas within the business are still working through their inventory on hand, which is estimated to take another quarter or so. Overall, we are optimistic entering the second half of the year. We believe that profitability will remain strong even in light of some of the movements on the top line. On the facility consolidation side, 2 of our 4 projects are now fully complete with the former connectivity sites in Sudbury, U.K. and Tempe, Arizona having successfully transitioned operations to other existing facilities.
For the magnetic facility consolidation in China, we have started to wind it down in Q2, but expect to be more aggressive with the wind down in Q3. We are still on track to have this one larger compete with some finishing touches that run into Q4. And we spoke about all this means cost takeout in our baseline business. Looking ahead, we will begin executing on the key themes discussed at our recent offsite, which were growth, strengthening the bench and identifying further opportunities for continuous improvement in profitability. The plan is to prudently invest in key areas of the business and to target end markets setting us up for the exciting road ahead.
And with that, I'll turn the call back over to Dan. Dan?
Daniel Bernstein: Yes. Thank you Farouq. The operator, we would like to open up the call for questions now, please.
Operator: [Operator Instructions] Our first question comes from Theodore O'Neill, Litchfield Hills Research, LLC.
Theodore O'Neill: I was wondering if is this the new normal? And what sort of things are you doing to create that better operating margin number?
Daniel Bernstein: Farouq, can you answer that?
Farouq Tuweiq: Yes, so we may have skipped the first [indiscernible] question. Would you mind repeating that?
Theodore O'Neill: Yes. So your gross profit margins were outstanding in the quarter, but also the operating margins were good, too, reflecting expense controls and it looks like you shaved 2 percentage points off your expenses over the last 2 years. I was wondering if you could talk about the things that you've done and whether this is the new normal or there's more to come?
Farouq Tuweiq: Yes. As we've kind of talked about in the past, we are on a journey, right? And we have a list of things that we are trying to get to have been getting to and will continue to get to. So the way we look at it is we're resetting our cost base and structure for the business while prudently investing. So we trim in some places and poly invest in other places. But the net-net of the result of all this is a more favorable operational cost structure. And as we think about the big headline grabbers like facility consolidations and some of the headcount rationalization we're doing, obviously, they get a lot of play, but also down really to the factory floor in terms of our design for manufacturing approach. Are we being more lean in terms of the way we consume materials, down to our procurement processes around raw material, right? So something more small to some extent, such as relocating our corporate headquarters.
So all these things add up. So we do think that we are shrinking our overall cost structure with a key theme of ensure we're lean and ready and invested in the future, right? We want to make sure, obviously, we're not looking to cut our way to growth, that doesn't happen. We need to invest in growth. So we're doing it in some places, but also return back and certain places where it doesn't make sense. Similar to the roughly, call it, $9 million, $10 million that I alluded to earlier of some of the revenue we want to wait from because we're going to redeploy these resources at opportunities that we're seeing, quite frankly, more attractive.
Theodore O'Neill: Okay. Have you disclosed or willing to talk about how much revenue was in the check plant that is not part of the revenue stream now?
Farouq Tuweiq: Yes, it kind of bounced around, but roughly $4 million, $5 million is where it was sometimes a little bit higher than, let's anchor around 5%, give or take.
Jean Young: And that's an annual number to Theo.
Theodore O'Neill: Okay. And on the acquisition front, is that something that you're looking at all?
Farouq Tuweiq: Yes. on the acquisition front, we've always been in the game. We continue to be in the game. Right now, I think because of the interest rate environment or overall environment, we're seeing less assets come to market that generally tends to be the theme. We start seeing a little bit more pickup on maybe not so great quality businesses but our expectations is that we'll see that as some of the class of kind of the macro environment disappear and some of the lending environment. We expect to see more assets come out. I think the good thing for us is we know that they will come and we are setting up ourselves with a super clean balance sheet. And obviously, getting our house in order, will make us a more competitive player as we go after these acquisitions in terms of both closing the deal and just hosting our new partners down the road. So it will come, not yet, but we're always looking.
Daniel Bernstein: But just to add some more color to that, we do meet with our investment makers constantly. So the past over the past 4 weeks, we met with Rothchild, Citibank and Needham to review acquisitions they see in the marketplace, what they see that's going to break loose and how to position ourselves in a proper manner.
Operator: Our next question comes from James Ricchiuti from Needham & Company.
James Ricchiuti: I just want to make sure I'm clear, the $9 billion to $10 billion of lower margin business, that's a quarterly number or annual, I may have misheard.
Daniel Bernstein: Yes, that's a good question, Jim. It's annual.
James Ricchiuti: Got it. And I wonder if you could just shed a little bit of light on which product areas that comes out of.
Daniel Bernstein: Yes. I should kind of also clarify, we're constantly looking to connect trend here and there. This kind of number came out of just some of the bigger highlights that we went through in Q2. So we're constantly it's not a onetime thing. But in terms of where it comes out, I'd say largely magnetics, but a little bit of crossover on a couple of other ones. But this one specifically, this large automagnetics.
James Ricchiuti: Got it. And then just on the topic of magnetics as you go through this facilities transition and benefit from some of the shift to better margin business. I'm wondering do we see this business bottoming from a revenue standpoint? And then how should we think about the anticipated recovery in gross margins. Does that happen in early '24?
Daniel Bernstein: Yes, so we've spoken, I think, a call or 2 ago that generally in our industry, it takes 1 to 2 quarters for things to rebound and inventory levels to normalize. The good news is on magnetics, we're starting to see the recovery. So we believe that we bottomed out and are on the upward side of that curve. And as we look in July, we had a good month. So it's given us more confidence that we're climbing up out of that. So we feel we've bottomed out, and we feel excited about the future. But the other thing of note is given some of the work we have done, we look at the margin profile of what is in backlog that it's healthier today. So there is a scenario where you can have same level of profits on lower revenue.
The other thing I should point out to is magnetic is operating and performing at this gross margin level despite being down 50% of sales and running 3 facilities because of the consolidation, right, ultimately, we're trying to get down to one facility. But right now, as we transition, so it's kind of nice to see that we're going to start exiting and really kind of closing down this consolidation business in Q3 on top of recovery. So that to us a high margin. So we're excited about magnetics, and we think there's a lot of exciting things going on there. And just this quarter kind of hit us, which is also quite frankly, a testament to us as a company.
James Ricchiuti: Got it. And a quick follow-up [indiscernible] but could you give a commercial revenue number in the quarter? It sounds like you're seeing pretty good growth.
Jean Young: Yes, sure. So commercial air for the quarter was $15.9 million.
James Ricchiuti: I'm sorry, $15.9 million?
Jean Young: Yes.
James Ricchiuti: Okay. I'll jump back in the queue. Thank you.
Jean Young: If no one's asking any additional questions, I have one other one, if you could say it.
Daniel Bernstein: Sure. Go ahead, Jim.
James Ricchiuti: So I wanted to dig a little bit more deeply into the strength you're seeing in front-end power. You talked about networking. I'm just wondering if you could elaborate on what you're seeing in the market. And I guess what I'm getting to, also, I'm wondering if you're seeing any early signs of business momentum in this part of the business or elsewhere that may be related to the activity we're all hearing about on the AI front.
Daniel Bernstein: So to kind of the front-end power, obviously, the networking side of it. And if we read some of the public commentary out there, Jim, power and some of the IC supplies have been a little bit of a pain point for those participants in the market. So obviously, the supply chain is easing, but it's not quite there yet. So we continue to see that robustness in demand there as we think about not working. But for us, it gets a little bit confusing because when we look at magnetics, there was a little bit too much inventory in the channel, right? So it's a little bit of a 2-tail cities for the same end market. So we are definitely bullish long term and medium term and near term on all things networking given some of the things that we do hear about in the market data centers, broadly speaking.
To your question around AI, we do think we would be a secondary beneficiary of that. We are a step removed, call it, maybe a little bit behind secondary. The way we kind of think about it is AI will cause a lot of increase in computing power needs and data center requirements, which are all areas that we play in. So we want to be cautious of not drawing a direct line to it, but we do expect that will be an uplift. It's tough to say right now if we're seeing it directly, but we know it's all around us. But it is still a little bit early days from a hardware perspective, price unless you're doing some certain components. Obviously, we're not. So for us, we think it's a great tailwind ahead of us. And we have a couple of segments in our business that will benefit from that.
James Ricchiuti: Last question from me is just wonder how you'd characterize the business activity in the distribution channel? And just maybe more broadly, pricing in general.
Daniel Bernstein: Again, the distribution channel is still working through a lot of inventory, again because of the shortages in ICs and power supplies that the passive side has built up a lot of inventory. So that's been somewhat depleted, we hope, by the end of the third quarter, fourth quarter that they get back to a normal ordering process. So far, we haven't seen much pricing pressure out there today. We still see strong demand for product. But we know as lead times come down, pricing will most likely come down a little bit to reflect that. But overall, if you look at passive component people, most people are predicting a negative 5% growth or possibly on the bright side, maybe plus 2 or 3. And they don't see anything really turning around. And I think everybody is predicting is a safe thing saying the end of this year, hopefully, all the inventories will be cleaned out at to distribute and at the OEM and new orders should be coming in a lot stronger.
Operator: Our next question came from Hendi Susanto, Gabelli Funds.
Hendi Susanto: Dan, Farouq and Lynn, first question in Magnetic, what may recovery look like will be a gradual rebound? And then additionally, what portion of magnetic products have gone through pricing discipline, considering that there were excess inventories. So I'm wondering whether or not the new pricing exercise has been comprehensively executed in magnetic or not?
Daniel Bernstein: Yes. I would say the recovery, like I said, we feel we boots recovering so we do think we're on the mend and we're starting to see kind of positive signs and kind of ordering activities and POS data type stuff. So it's not going to be a one big snapback, right? It will be gradual, but probably a little bit faster than kind of normal, maybe growth rates are. And then to your other question on kind of pricing to magnetics, we are taking a lot of cost out. We're investing in automation, and we're investing in kind of other parts of the business. So that way, when those discussions do come upon us, we're able to kind of react to them a little bit better. So if you're going to see it a little bit on price hair, it's about what new opportunities that are out there and kind of how you're controlling your cost side of the house. So we feel that we will be nicely set up for that, quite frankly.
And we've been kind of through some of these already, and we kind of like the position we came out of. And obviously, as we've talked about, we electively walked away from some revenue because we like the other opportunities coming our way a little bit better than some of this legacy stuff. So it's a little bit of a mixed bag, and it's going to be some puts and takes. But overall, we expect better performance and overall, there are things from our magnetics group and quite frankly, across the business.
Hendi Susanto: And then Farouq, R&D has been running higher this year, like $6 million in the second quarter. Is that a new baseline that reflects like more investment?
Farouq Tuweiq: Yes. So as we look across the business, we said, right, we're not while a big margin focus has been, we obviously are not sleeping on growth. We have some very exciting things in e-mobility and space. And quite frankly, we're seeing so much at in defense and some of the more legacy products on networking and 5G. So we got to make sure that we're on the offense there in terms of talent. Our margin improvement has allowed us to invest both in the businesses at consolidation level and R&D is kind of one of those. There's also probably a couple of other areas in the business that we've been investing in. So we look at that as a good thing. When you look at R&D as a percentage of sales across the business, it's nothing too crazy here, which is great because I think it gives us a little bit of opportunity and flexibility to invest in the right people going after the right things. So I'd probably say it's kind of about kind of where it should be for the time being.
Hendi Susanto: And then would you share the thought process on the shelf of rainfall in last May? And how Bell Fuse may persist with that, specifically what kind of strategic options that Bell Fuse can pursue utilizing that?
Farouq Tuweiq: Yes. So the sale offering has been in place before my time. I think maybe a couple of 2014 or something like that, and it keeps rolling every 3 years thereafter. It was a good kind of financial housekeeping item to have out there to maintain and we can have ultimate flexibility. Obviously, we've had it since 2014, but we haven't executed upon it. So really, the filing was an extension and continuation of what we have been doing to kind of give us flexibility as needed.
Hendi Susanto: And then last question for me. I may miss this earlier, but could you give like more color on the tax in Q2? And then if I see, let's say, like the last like several quarters, there are times when tax reflect the positive like some potentially some potential like tax benefits in Q2 or in certain quarters?
Jean Young: Hendi, on the taxes in Q3, we did have a large FIN48 tax reversal of $5.2 million. That was in Q2 of '23. Last year, we had a similar tax reversal in Q2 '22 of $3.6 million. These items do tend to roll off. So the larger portions have been rolling off in the second quarter of each year. So we would expect not to see this level of benefit in Q3 or Q4, we do expect it to move back to a more normal tax rate.
Operator: [Operator Instructions] There is no further questions at this time. I would like now to turn the floor back over to Mr. Daniel Bernstein for close comments. Please go ahead.
Daniel Bernstein: Thank you very much, and thank everyone for joining our call today, and we look forward to speaking to you in October.
Operator: This concludes today's tele-conference. You may disconnect your lines at this time. Thank you for your participation.
