Good morning, and welcome to the VPG Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today’s presentation there will be a opportunity to ask questions. [Operator Instruction] 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 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, 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 3 of the quarterly presentation.

Ziv?.

Thank you, Steve. I will begin with some commentary on VPG's consolidated financial results and sales trends for the third quarter. Bill will provide financial details and our outlook for the fourth quarter of 2021. Slide 3. 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 1.21 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 $0.52. 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 4. 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 million to $5 million in the third quarter related to FTP. The book-to-bill was above 1 in all the 3 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 shipments 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 Force Sensors OEM business as well as due to the timing of a semi-annual order from a foil resistor's 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 5. 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 level 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 proved to be a headwind. We are not alone in this respect as many companies have reported similar challenges in hiring. We are making progress through 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 position 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 AS to achieve sequential growth in the fourth quarter. The Force Sensors 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 Force Sensors OEM business as OEM revenues grew 43.8% for the first 9 months of 2021 compared to the same period a year ago. Financially, Force 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 for Force 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 KELK products. In the first full quarter, we did -- 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 TruckWeigh, VanWeigh 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 KELK 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 product reflected cyclical pattern as higher orders for KELK were offset by lower orders for DSI. Book-to-bill combined for KELK and DSI was 1.07, which is a positive indicator for revenues for 2022. Before turning the call to Bill, I'll make a few additional comments.

In terms of COVID, all our facilities are currently open and operational, and we continue to be proactive in taking measures where needed to protect our employees and our customers. We believe that our operational focus on excellence and the strategic investments 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 markets and generate attractive returns. I will now turn it over to Bill Clancy for additional financial details.

Bill?.

Thanks, Ziv. Referring to Page 6 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% of sales, operating income of $7.3 million or 8.9% of revenues and diluted earnings per share of $0.39.

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% of sales, operating income was $9.7 million or 11.8% of sales and diluted net earnings per share was $0.52.

Our third quarter 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 it 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 start-up costs for advanced sensors and $100,000 of COVID-19-related cost. 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 onetime 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 7.

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 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..

[Operator Instructions] The first question will come from John Franzreb of Sidoti & Company..

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 million 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, it's got to be addressed one time and then maybe will 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 fill open positions 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 million to $5 million is going to change due to the fact that we have already started to make adjusted to the pay rates to become more competitive and more attractive in those current -- at 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 around about 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. 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 $1 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, $500,000 related to labor inefficiencies due to a fairly high turnover, including constraints on production due to unfilled headcount, as I indicated before, $600,000 in inventory levels in respect to the prior quarter, then we have an exchange rate of $300,000 and $400,000 of unfavorable product mix.

So if we exclude so-called the singularities, the short-term singularities of the $400,000 unfavorable product mix and the fact that the labor efficiencies will start to improve and the inventory effect, I think that you will see at least -- you will see 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 in Q4..

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

No, no. 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 the time line 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 6 months, the integration is with VPG and with, let's call it, with the parent company's policies and standards and the integration with the IT systems and all the remaining group, while the core 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 1 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 strain gages to transducer based companies who are providing infrastructure services if it's for building bridges, concrete, testing of structures.

On the other hand, in Force 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..

[Operator Instructions] The next question comes from Sarkis Sherbetchyan of B. Riley Securities..

Ziv, 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 rebounding back to 40%.

But I guess, as I look at Force Sensors and Weighing and Control Systems, help me understand the evolution of gross margins there, especially in light of the strong backlog and book-to-bill ratios?.

Okay. So let's talk about Force Sensors. I think that -- well, as you may have seen in Force Sensors, already in the last few quarters, we have been reporting a mid-30% gross margin at the level of revenue of $17 million to $18 million, which is a big change from prior years.

At this point in time, given the current revenues, we believe that -- and as we indicated in the past that to support a low 30% to mid-30% gross margin for Force Sensors, it 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 price increases to our customers. So the low to -- low 30% to a mid-30% for Force 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 DSI, DTS, KELK with a gross margin of over 30%, very, very strong in respect to our onboard weighing process wing, 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 40% to low 50% is feasible for this reporting segment going forward..

Got it. That's very helpful.

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 what 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 think 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 this -- 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 manufacturing 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 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 1 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..

Price increases is never popular -- 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 a large -- to at least a large extent, we were able to apply price increases, which we are going to see to some extent.

Naturally, we are not -- 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 are able to increase -- 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 upsides.

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 increased, which we already seen already in the last few quarters..

The next question comes from Dick Ryan of Colliers..

Ziv, Just to refresh on advanced sensors, prior to the expansion you were capacity constrained, now 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 are continuing 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 have 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 are going to -- we have a potential capacity to produce, at this point in time, $50 million in revenue annually.

And as -- and on a need basis, we are going to add equipment at the bottlenecks as and if needed given the backlog and the order intake..

And just looking at your OEM business under Force Sensors, have there been any new wins there? Or can you describe that pipeline of opportunity?.

For the OEM, in Force Sensors, we have seen, as I indicated, an increase for the first 9 months. If I'm looking quarter-over-quarter, at this point in time, most of the first year, customers have softened the demand for Force Sensors, which has been off -- 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 tier OEMs, we have -- they have some inventory, therefore, they have reduced the bookings in Q3..

Okay. Great..

We do not -- we do not see the same level of pressure as we have seen 2 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 and to support them..

[Operator Instructions] The next question will come from Matt Dhane of Tieton Capital Management..

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 advanced sensors -- well, the fact that we are -- that we have opened -- that we have finalized the transition of the advanced sensors facility does not allow us -- 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 demand based on the funnel of those -- of the R&D project in order to support future volume.

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 for the -- 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 rate ramped.

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 high-volume applications. This is why 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.

So we have consumer. We have automotive tooling equipment. We have medical, and we have some other opportunities.

But once we lay down -- 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 those customers..

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