Vishay Precision Group, Inc.

Good morning and welcome to the VPG third quarter 2021 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Steve Cantor, Senior Director of Investor Relations. Please go ahead.

Thank you, Carrie, and good morning, everyone. Welcome to VPG's 2021 Third Quarter Earnings Conference Call. Our Q3 press release and accompanying slides have been posted on our website. An audio recording of today's call will also be available on the Internet for a limited time and can 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 discussion of the risks associated with BPG's operations, we encourage you to refer to our SEC filings, especially the Form 10-K for the year ended December 31, 2020, and our other recent SEC filings. On the call today are Ziv Shoshani, CEO and President, and Bill Clancy, CFO. I'll now return the call to Ziv for some prepared remarks. Please refer to slide three 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 third quarter. Bill will provide financial details and our outlook for the fourth quarter of 2021. Slide three. We are pleased with our results for the third quarter. We achieved solid sales performance of 82.0 million. We ended the quarter with a book to bill of 121 and a record backlog of 146.7 million. which supports our positive outlook in the fourth quarter. We achieved an adjusted gross margin of 41.8%, adjusted operating margin of 11.8%, and adjusted EPS of 52 cents. We also generated solid cash flow and adjusted EBITDA margin of 16.8%. The integrations of DTS which we acquired in June, is proceeding smoothly. And we completed the move of advanced sensors manufacturing to our new facility. Moving to slide four, looking at the third quarter sales results in more details. Sales grew 21.4% from a year ago and 8.8% from the second quarter, reflecting the strength of the current business environment and the addition of DTS. While we are pleased with our revenue performance, as anticipated, challenges with labor availability at our facilities around the world had constrained our ability to translate our strong orders intake of $98.9 million into revenue. We estimate that the impact of revenue from the hiring challenges was approximately 4 to 5 million in the third quarter related to FTP. The book-to-bill was above 1 in all the three reporting segments and in each of our end markets. In terms of sales trends by market, we grew sales from the second quarter across the majority of our end markets. including transportation and avionics military and space, which increased 14.6% and 28.4% respectively, driven mainly by the addition of a full quarter of DTS. Sales to the steel market rebounded 47%, reflecting the timing of shipment of project-driven orders. In terms of orders, test and measurement grew 9.1%, reflecting continued strong demand, and transportation was up 5.1%. Orders were lower sequentially in our other markets, primarily for our four sensors OEM business, as well as due to the timing of a semi-annual order from a foil resistors customers, which had been placed in the second quarter of 2021. The net result of these trends was a book to bill of 1.21 for the third quarter and a record backlog of 146.7 million, which increased 15.8 million from the second quarter of 2021. Moving to slide five. Turning to the results by segment. Foil technology products third quarter sales of 32.8 million were 1.6% lower sequentially and were essentially even with a year ago. Sales of precision foil resistors remained at sustained levels sequentially, driven by continued good demand from semiconductor test equipment. Advanced sensors achieved another solid quarter as we completed the transition to the new facility. As expected, AS revenue moderated from Q2 due to the facility transition and as a result of fewer working days in the quarter in Israel. In addition, challenges with filling open positions across our FTP operation in Israel and the U.S., also approved to be a headwind. We are not alone in this respect, as many companies have reported similar challenges in hiring. We are making progress to filling these positions in the fourth quarter, and we expect to have the remaining open positions filled in the first quarter of 2022. Adjusted gross margin in FTP of 35.1%, was compared with 42.6% in the second quarter, was impacted by approximately 2.4 million of factors, including labor inefficiencies, a reduction in inventory, and unfavorable product mix, lower volume, and unfavorable exchange rates. In the fourth quarter, we expect gross margin for FTP to recover to close to 40% based on expected volume and inventory levels, and as we make progress, filling open positions and train the new staff. Book-to-bill for FTP was 1.38% in the third quarter, and the backlog grew 19.7% sequentially. which reflected an increase across the FTP product portfolio, including precision foil resistors and advanced sensors. We are in the process of ramping up the new capacity for advanced sensors, and we expect AES to achieve sequential growth in the fourth quarter. The fourth sensor segment reported another quarter of strong performance. Third quarter sales of 17.7 million improved, 2.8% from the second quarter, and were 27.7% higher than a year ago. We continue to be pleased with our initiatives to expand 4Sensor's OEM business, as OEM revenues grew 43.8% for the first nine months of 2021, compared to the same period a year ago. Financially, four sensors continued to execute well, achieving an adjusted gross margin of 35.1% in the third quarter. This declined slightly from 35.4% in the second quarter, but improved from 31.2% a year ago due to higher sales. A book-to-bill report for four sensors of 1.01. Sales for weighing and control systems in the third quarter of 31.5 million increased 26.9% sequentially and 51.7% from a year ago. Sequentially, the higher sales in the third quarter reflected the addition of full quarter of sales for DTS as well as higher sales of DSI and Calc products. In the first full quarter with us, DTS performed well, both in terms of sales and profits. With the integration going smoothly, we are even more encouraged about DTS long-term growth prospects, as it should continue to benefit from a secular trend in safety testing for automotive and military applications. As expected, third-quarter sales from our truckway-vanway initiatives were negatively impacted by approximately 300,000 due to lack of industry-wide supply of new trucks and vans, chassis and components. We expect these shortages to continue to impact revenues and orders by approximately 500,000 in the fourth quarter as we closely monitor chassis and component shortages in Europe. Adjusted gross margin in the third quarter for WCS was 52.5% and improved from 46.6% in the second quarter, mainly due to the addition of DTS, higher revenue of calc and DSI products. and favorable product mix. In terms of order trends in WCS segment, orders declined 7.3% sequentially, while book-to-bill was 1.14%. Our project-driven, steel-related products reflected cyclical patterns as higher orders for calc were offset by lower orders for DSI. Book-to-bill combined for CELC and DSI was 1.07, which is a positive indicator for revenues for 2022. Before turning the call to Bill, I'll make few additional comments. In terms of COVID, all our facilities are currently open and operational, and we continue to be proactive in taking measures were needed to protect our employees and our customers. We believe that our operational focus on excellence and the strategic investment in our businesses will enable us to accelerate our long-term growth, and given our solid cash flow and balance sheet, we believe we can add to that growth with additional acquisitions of high-quality businesses to our portfolio, which will expand our market and generate attractive returns. I will now turn it over to Bill Clancy for additional financial details. Bill?

Bill Clancy Thanks, Yves. Referring to page six and the reconciliation tables of the slide deck, in the third quarter of 2021, we achieved revenues of $82.0 million. gross profit of $31.8 million, or 38.8 percent of sales, operating income of $7.3 million, or 8.9 percent of revenues, and diluted earnings per share of 39 cents. On an adjusted basis, which we lay out in our reconciliation table in the press release, our gross profit was $34.3 million, or 41.8 percent of sales, operating income was $9.7 million, or 11.8% of sales and diluted net earnings per share was 52 cents. Our third quarter of 2021 revenues grew 8.8% compared to 75.3 million in the second quarter and were 27.4% above the third quarter a year ago. Foreign exchange for the third quarter of 2021 positively impacted revenues by 900,000 compared to a year ago and negatively impacted revenues by $500,000 as compared to the second quarter of 2021. The gross margin in the third quarter was 38.8% compared to 39.6% in the second quarter. On an adjusted basis, third quarter gross margin of 41.8% as compared to 42.3% in the second quarter of 2021 which is excluding $1.2 million of acquisition purchase accounting adjustments, $1 million of facility startup costs for advanced sensors, and $100,000 of COVID-19 related costs. Our operating margin was 8.9% for the third quarter of 2021. Our third quarter adjusted operating margin was 11.8%, excluding the adjustments I just mentioned above. Selling general and administrative expenses for the third quarter of 2021 were $24.6 million, or 30% of revenues, as compared to $19.1 million, or 28.3% of revenues, for the third quarter of 2020. The increase in SG&A of $5.5 million mainly relates to $3.8 million for the DTS acquisition, $800,000 for bonus accruals, $500,000 for foreign exchange rate impact, $200,000 of wage increases, and $200,000 of other costs. The adjusted net earnings for the third quarter of 2021 were $7.1 million, or $0.52 per diluted share, compared to $5.3 million, or $0.40 per diluted share in the third quarter of 2020. Adjusted EBITDA was $13.7 million, or 16.8% of revenue compared to 10.6 million or 15.8% a year ago. CapEx was 2.9 million, the majority of which reflects purchases and related infrastructure for the new advanced sensors facility. As a result of these investments, we generated free cash flow of $3 million for the third quarter of 2021 as compared to $1.4 million for the third quarter of 2020. We define adjusted free cash flow as cash from operating activities, less capital expenditures, plus sale of fixed assets. We currently expect purchase capital expenditures to be in the range of $15 million to $17 million for the full fiscal year 2021. The GAAP tax rate in the third quarter was 23.4%, which includes a one-time tax benefit of approximately $600,000 associated with the DTS acquisition. We are assuming an operational tax rate in the range of 25% to 27% for the full year of 2021. Moving to slide seven, we ended the third quarter with $75.5 million of cash and cash equivalents and total long-term debt of $60.7 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, for the fourth fiscal quarter, we expect net revenues to grow sequentially and be in the range of $86 million to $94 million at constant third fiscal quarter 2021 exchange rates. In summary, We've achieved solid results in the third quarter in spite of the hiring challenges in FTP. We've completed the manufacturing transition to our new advanced sensors facility. The integration of DTS is going smoothly and they are performing well. Given our strong backlog and book to bill, we are anticipating a strong fourth quarter and a good start for 2022. With that, let's open the lines for questions. Thank you.

We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you are using a speaker phone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question will come from John Franzreb of Sidoti and Company. Please go ahead.

Good morning, Zeev and Bill. How are you doing today?

Morning, John.

I'm going to start where you left off, Bill. In FTP and the revenue outlook, really strong quarterly guidance for the fourth quarter. But you mentioned earlier, Ziv, that there's about $4 to $5 million, it sounds like, of deferred revenue in FTP that's being pushed into the fourth quarter. So my question is, Is the fourth quarter sustainable at those levels, or is this pent-up demand that's got to be addressed one time, and then maybe we'll soften up as we enter into 2022?

At this point in time, we see a continuation of a very strong business environment in FTP. As I indicated before, John, the tight labor market, particularly in Israel and in the United States, has made it more difficult to to feel open position and to minimize the employee turnover for advanced sensors and for precision resistors. We estimate that the labor availability challenges impacted in Q3 of 4 to 5 million is going to change due to the fact that we have already started to make adjusted to the pay rate to become more competitive and more attractive in those areas. in the current labor market, and we expect to see significant improvements already in Q4 to fill in all the open positions and to start to train the new staff. We expect to have the majority of all the open positions to be filled by the end of first quarter. Please bear in mind that also the transition of advanced sensors to the new facility, we had to slow down manufacturing capacity in order to complete the transition. So the expectation is that as we start to ramp up advanced sensors post transition, we will increase the capacity roundabout to the end of Q4 by 20% in respect to Q3. And of course, this will continue to grow also in Q1. And as we fill in those positions, we are also expecting to ramp up. So given The solid business environment in FTP and the strong and the solid backlog, the expectation is to continue and improve the revenues for this reporting segment.

Got it. So when I look at the adjusted gross margin profile in FTP in the quarter, the sequential 700 basis point drop, It sounds like a million of it was due to the transition. What was the rest of it due for? Can you kind of walk me through that again? I might have missed that.

Okay, very good. So if we look at the adjusted gross margin for FTP, we are looking at an impact of $2.4 million. $500 related to labor inefficiencies due to a fairly high turnover. including constraints on production due to unfilled headcount, as I indicated before, 600 in inventory levels in respect to the prior quarter. Then we have an exchange rate of 300 and 400 of unfavorable product mix. So if we exclude so-called the singularities, the short-term singularities of the 400 unfavorable product mix and the fact that the labor efficiency is will start to improve. And the inventory effect, I think that you will see at least an improvement. And this is why we have indicated that we see an improvement given also the volume increase going back to the 40% range in FTP and Q4.

Got it. Perfect. And just shifting. I'm sorry, I didn't mean to cut you off. Go ahead.

No, no, no, no, no, go ahead. No, I just said adjusted gross margin of 40% in Q4. Perfect.

All right. And just switching over to DTS, can you talk a little bit about how much integration you have that remains at DTS, the kind of timeline you're talking about there? And what was the contribution in DTS on weighing control in the quarter?

All in all, DTS has contributed $7.6 million in the quarter with an adjusted gross margin of 68.7% and an adjusted EBITDA of 27.5%. So it was quite sizable and powerful incremental contribution of DTS to WCS. As I indicated in the prior quarter and post-acquisition, the first six months, the integration is with VPG and with the, let's call it, with the parent companies, policies and standards and the integration with the IT systems and all the remaining group, while the cross-sales synergies would come in the... into next year. So at this point in time, the integration of DTS is with the systems and policies and being applied as part of DTS. So we are on plan as we indicated before.

Okay. I guess just one last question. With the passage of the infrastructure bill, do you see that as a net benefit to your company or is it neutral?

The infrastructure bill, well, we are selling, we have some products that are being sold to the infrastructure-related business. On one hand, we have advanced sensors, which is selling stringages to transducer-based companies who are providing infrastructure services. If it's for building bridges, concrete testing of structures, on the other hand, In four sensors, you may recall that part of our OEM business goes to first-tier, second-tier construction equipment companies. So the expectation is that it would provide us some tailwind when we are going to see larger investments going into the infrastructure in the United States.

Okay, great, Z. Thanks for taking my questions. I'll get back to you.

Again, if you have a question, please press star then one. The next question comes from Sarkis Sherbetian of B. Reilly Securities. Please go ahead.

Hi, thank you for taking my question here. The bill, really strong book to bill and backlog here. I guess it sounds like the expectation is for the tailwinds to kind of continue here in the first part of 22. Part and parcel to that, Can you maybe talk about the evolution of gross margin for each segment? I think if we look at FTP, you said, you know, rebounding back to 40%. But I guess as I look at force sensors and weight and control systems, help me understand the evolution of gross margins there, especially in light of this strong backlog in book-to-bill ratios.

Okay. So let's talk about four sensors. I think that, well, as you may have seen, in four sensors, already in the last few quarters, we have been reporting a mid-30% gross margin at the level of revenue of $17 to $18 million, which is a big change from prior years. At this point in time, given the current revenues, We believe that, as we indicated in the past, to support a low 30% to mid-30% gross margin for four sensors is feasible, and that's the expectation going forward given those sales revenues. The additional tariff costs that we have incurred by manufacturing in China and selling into the United States were offset by additional premiums price increases to our customers. So the low 30% to a mid 30% for four sensors is sustainable. Moving to WCS, WCS, this is really, I mean, we are reporting, I believe, for the first time, gross margins of over 50%, well, 52.5%. and I think this is the first time we see the full effect of DTS. As you know, at the end of the day, the mix effect for WCS, we have the project-driven products like a DSI, DTS, KELC, with a gross margin of over 30%, very, very strong, in respect to our onboard weighing process weighing, which are over 40%. So if those revenue levels given the backlog are sustainable, I think that given the product mix, a gross margin between, and again, it may vary between high 40s to low 50% is feasible for this reporting segment going forward.

Got it. That's very helpful. Thank you for that. And then I guess if I kind of step back and think about the level of CapEx now that you've completed the advanced sensors facility. What would you say would be your kind of normalized CapEx and inclusive of any of the potential positive NPV projects that you'd like to bring on, let's say, for the next year or so? Okay.

So, Sarkis, you may recall that in Q1, when we were speaking about our initial projects and prospects for this year, it was around 9% of revenue, which is fairly high due to some substantial projects. As we are going to finish, as Bill indicated, between 15% to 17%, it takes us to a more normalized level of a 5% revenue, where the company in a normalized time should run between 4% to 5% CAPEX, 4% to 4.5% CAPEX. The fact that the COVID effect has pushed out many of the automation projects for precision. I mean, okay, let me take a step back. One of the major projects was advanced sensors and the infrastructure and the capacity to support 30%, 40% higher capacity, and this has been completed. The next step would be in order to, once we reach the capacity limitation to increase advanced sensors capacity. In addition to that, there was a big part in the original plan in 2021 of precision resistors automation in order to reduce the cost base. Unfortunately, much of those projects were pushed out due to the fact that during COVID, we were not able to get our vendors to travel And lead times for the equipment manufacturer has been extended significantly. So I would say that all in all, the 9% that initially we have been planning to invest this year, which all of them has very good return on investment, probably will be pushed out into 2022 as we are in the process of getting this equipment ready being installed, and now since the situation has been, in a way, improved in the United States and to some extent in Europe, we are able to get vendors installing the equipment and getting those equipment fully operational. So this is a gear shift from 4.5%, 5% this year CapEx of revenue into the 9% next year.

Great. That's super helpful. And one final one for me here. As you think about the environment and as you think about potential headwinds from inflation or supply chain situation, are you able to pass on any of these potential price hiccups to your customers? And how is that conversation going? Is it fairly easy? Is it difficult? Just kind of want to get a sense for that.

You know, price increases is never a popular subject with customers. The fact that we have to make, I would say, some changes in the cost structure in order to hire or to fill in those positions will require us, which we already started to initiate before, to make changes in order to maintain the gross margin that we have been used to, so we were able in FTP, I would say, to at least a large extent, we were able to apply price increases, which we are going to see to some extent. Naturally, we cannot apply it on the backlog, but as new orders are being placed, we will see already some effect already in Q4, and a much larger effect going into next year, offsetting those wage increases. On the other hand, we were able to increase prices in order to offset or to compensate the tariff cost. So we are able to do it in, I would say, in many of our product lines. In some cases, this will offset the cost, the additional cost. And in other cases, we should just enjoy the benefit of those upside. But no doubt that we see some raw material. Price increase, it's not significant at this point in time, which would affect the P&L. And of course, logistics cost increase, which we already seen already in the last few quarters.

Great. Thank you, Zeve.

The next question comes from Dick Ryan of Colliers. Please go ahead.

Thank you. Zeve, just to refresh on advanced sensors, you know, prior to the expansion, you were capacity constrained. Now the, you know, the facility is online. Can you give us what your current capacity is there? how much you're bumping up against that already, and is this allowing you to go to market maybe a little bit more aggressively seeking new business opportunities?

Okay, so that's a very good question, Dick. So let me say that, first of all, the advanced sensors – the book-to-bill was 1.2, so we continue to see a very strong business environment for advanced sensors. We have seen, as expected, Q3 shipments were negatively impacted by approximately 7% compared to the second quarter due to the manufacturing transition and the labor challenges I've been discussing. The intention is I mean, as we continue to ramp up and to hire more people, and we are currently ramping up, the expectation is to see by the end of this quarter a 20% already revenue increase in respect to Q3. And the expectation is to potentially have another 20% increase in Q1. At this point in time, we have the backlog. to support that increase. We would expect to be back in Q4 as we finalize the transition and hire the people back to $40 million annualized. And as we move on, we have a potential capacity to produce, at this point in time, $50 million in revenue annually. And on a needed basis, we are going to add equipment at the bottlenecks as and if needed, given the backlog and the order intake.

Thank you for that. And just looking at your OEM business under four sensors, have there been any new wins there? Can you describe that pipeline of opportunity?

For the OEM in four sensors, we have seen, as I indicated, an increase for the first nine months. If I'm looking quarter over quarter, at this point in time, most of the first tier customers have softened the demand for four sensors, which has been balanced or offset by our more generic part for the weighing business. So... We are having a few opportunities at some new designs, but at this point in time, we do not see, based on the discussions we had with the large first-year OEMs, they have some inventory. Therefore, they have reduced the bookings in Q3.

Okay, great. Okay.

We do not see the same level of pressure as we have seen two quarters ago. But we are very confident that once they will start to deplete their inventory levels, we are going to see the demand coming back. But we are ready with the capacity to support them.

Okay. Appreciate that, Ziv. Thank you.

Once again, if you have a question, please press star, then 1. The next question will come from Matt Dane of Teton Capital Management.

Great. Thank you. I wanted to ask a little bit further around the advanced sensors facility opening up. And beyond the capacity expansion that that facility provides, does that add additional capabilities around your manufacturing where you can tweak the product, say, different ways and potentially address different customer needs in a way that you historically haven't been able to and add additional opportunities like that as you continue to go to market with this product line?

The fact that we have finalized the transition of the advanced sensors facility does not give us any more R&D or design capabilities. The advantages In the advanced sensors platform in respect to design, cost base, and complexity in terms of product already came to fruition as we have developed once and as this platform has been gaining momentum. The main purpose for the new facility is really to meet future demands based on the funnel of the R&D project in order to support future volumes. As I may have indicated in the last quarter, consumer electronics was, for example, part of that, part of this improved environment, and we have added another important customer in the consumer electronics end market. So as we continue and ramp up and provide more I would say capacity, capabilities, we are going to see, I believe, more opportunities becoming and materializing into revenues because now we have the infrastructure, equipment, and as we move along also people in order to support those opportunities.

And Ziv, you highlighted a couple of consumer electronic opportunities or wins that you have that are getting ready to ramp. Is that really an area of opportunity that you see as one of the bigger growth areas for advanced sensors going forward, is consumer electronics and opportunities in that space?

Consumer electronics historically is considered the high-volume applications. This is why it's always... It's always an opportunity as we are looking from a revenue perspective. Another opportunity that we have been working on are few medical opportunities, which to that extent, they may not have the same volume type, but they have much higher selling price due to the complexity and the mission critical of the application. But from a sheer dollar value, they could also turn into significant opportunities. We have consumer, we have automotive tooling equipment, we have medical, and we have some other opportunities. But once we lay out the infrastructure and as we hire the people, I truly believe that we would be much, much quicker to be able to capitalize on those opportunities because we would have the capacity to support them. those customers.

Great. Thank you, Steve.

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

Thank you, Carrie. Before closing, I want to note that we will be presenting at the NEDM conference in January and hope to see you there virtually. Thank you all for joining our call today, and have a great day. Thanks.

Thank you. The conference is now concluded. Thank you all for attending today's presentation. You may now disconnect your lines. Have a great day.