BEL Fuse Inc: Form 10-Q for the period ended Mar 31, 2024

The information in this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with the Company’s condensed consolidated financial statements and the related notes set forth in Item 1 of Part I of this Quarterly Report on Form 10-Q, our MD&A set forth in Item 7 of Part II of our 2023 Annual Report on Form 10-K and our consolidated financial statements and related notes set forth in Item 8 of Part II of our 2023 Annual Report on Form 10-K. See Part II, Item 1A, “Risk Factors,” below and “Cautionary Notice Regarding Forward-Looking Information,” above, and the information referenced therein, for a description of risks that we face and important factors that we believe could cause actual results to differ materially from those in our Forward-Looking Statements. All amounts and percentages are approximate due to rounding and all dollars in the text are in millions, except per share amounts or where otherwise noted. When we cross-reference to a “Note,” we are referring to our “Notes to Condensed Consolidated Financial Statements” included in Part I, Item 1, of this Quarterly Report on Form 10-Q, unless the context indicates otherwise. All amounts noted within the tables are in thousands and amounts and percentages are approximate due to rounding.

Overview

Our Company

We design, manufacture and market a broad array of products that power, protect and connect electronic circuits. These products are primarily used in the networking, telecommunications, computing, general industrial, high-speed data transmission, military, commercial aerospace, transportation and eMobility industries. Our portfolio of products also finds application in the automotive, medical and consumer electronics markets.

We operate through three product group segments. In the three months ended March 31, 2024, 47% of our revenues were derived from Power Solutions and Protection, 42% from Connectivity Solutions and 11% from our Magnetic Solutions operating segment.

Our operating expenses are driven principally by the cost of labor where the factories that we use are located, the cost of the materials that we use and our ability to effectively and efficiently manage overhead costs. As labor and material costs vary by product line and region, any significant shift in product mix can have an associated impact on our costs of sales. Costs are recorded as incurred for all products manufactured. Such amounts are determined based upon the estimated stage of production and include materials, labor cost and fringes and related allocations of factory overhead. Our products are manufactured at various facilities in the United States, Mexico, Dominican Republic, United Kingdom, Slovakia, India and the People’s Republic of China (PRC).

We have little visibility into the ordering habits of our customers and we can be subjected to large and unpredictable variations in demand for our products. Accordingly, we must continually recruit and train new workers to replace those lost to attrition and be able to address peaks in demand that may occur from time to time. These recruiting and training efforts and related inefficiencies, and overtime required in order to meet any increase in demand, can add volatility to the labor costs incurred by us.

Key Factors Affecting our Business

We believe that in addition to recent global inflationary pressures on the costs of goods and services in general, and ongoing conflicts/political unrest including in or near the countries in which Bel operates, the key factors affecting and/or potentially affecting our results for the three months ended March 31, 2024 and/or future results include the following:

• Revenues – Our revenues in the first three months of 2024 were down $44.3 million, or 25.7% as compared to the same period of 2023. The decrease was driven by our Power Solutions and Protection and Magnetics Solutions segments and largely related to lower demand from our networking customers and distribution partners as we believe they continue to work through inventory on hand. These decreases were offset in part by a modest increase in sales at our Connectivity Solutions group, driven by increased sales to customers in the commercial aerospace and military end markets.
• Backlog – Our backlog of orders amounted to $350.3 million at March 31, 2024, a decrease of $22.8 million, or 6.1%, from December 31, 2023. From year-end 2023 to March 31, 2024, we saw a 12.9% decrease in the backlog for our Power Solutions and Protection business, a decline in backlog of 0.4% in our Magnetic Solutions business and a 5.5% increase in backlog level at our Connectivity Solutions business. Order volumes in general have been lower in recent quarters which we believe to be due in part to our customers' working through inventory on hand.
• Product Mix – Material and labor costs vary by product line and any significant shift in product mix between higher- and lower-margin product lines will have a corresponding impact on our gross margin percentage. In general, our Connectivity products have historically had the highest-contribution margins of our three product groups given the harsh environment and high-reliability nature of these products and the end markets they serve. Our Power products have a higher-cost bill of materials and are impacted to a greater extent by changes in material costs. As our Magnetic Solutions products are more labor-intensive in nature, margins on these products are impacted to a greater extent by minimum and market-based wage increases in the PRC and fluctuations in foreign exchange rates between the U.S. Dollar and the Chinese Renminbi. Fluctuations in revenue volume among our product groups will have a corresponding impact on our profit margins. See "Results of Operations - Summary by Operating Segment - Revenue and Gross Margin" below for further details.
• Pricing and Availability of Materials – There has been some stabilization of raw materials pricing since the second half of 2023; however overall our cost of materials remains elevated. Supply constraints have eased related to components that constitute raw materials in our manufacturing processes, particularly with capacitors, resistors and copper. Lead times are still above normal though suppliers are now meeting the agreed delivery deadlines with more regularity. In addition, COVID remains a potential supply continuity risk due to the unknown nature of future outbreaks including potential further variants.
• Labor Costs – Labor costs represented 8.0% of revenue during the first three months of 2024 as compared to 6.8% of revenue during the same period of 2023. The increase in labor costs as a percentage of sales for the first three months of 2023 was largely impacted by the retention of a certain level of direct labor associates within our Magnetic Solutions business to accommodate the anticipated rebound within this segment. In addition, effective January 1, 2024, the statutory minimum wage rate in Mexico was increased by 20%, impacting labor costs at our Reynosa and Cananea, Mexico factories. We estimate the additional cost associated with this increase will be approximately $1.4 million annually. Also effective January 1, 2024, minimum wage increases which went into effect at our factory in Slovakia are expected to result in approximately $0.3 million of higher labor costs at that facility in 2024 as compared to 2023. This and any future increases in minimum wage rates will have an unfavorable impact on Bel's profit margins. The preceding four sentences represent Forward-Looking Statements. See "Cautionary Notice Regarding Forward-Looking Information."
• Inflationary Pressures - Inflationary pressures could continue to result in higher input costs, including those related to our raw materials, labor, freight, utilities, healthcare and other expenses. Our future operating results will depend, in part, on our continued ability to manage these fluctuations through pricing actions, cost savings initiatives and sourcing decisions. The preceding two sentences represent Forward-Looking Statements. See "Cautionary Notice Regarding Forward-Looking Information."
• Restructuring – In late 2023, we initiated a restructuring initiative within our Connectivity segment related to the transition of certain manufacturing from our Glen Rock, Pennsylvania facility to other existing Bel sites (the “Glen Rock initiative”). During the first quarter of 2024, the Company incurred $0.2 million, primarily severance costs, related to this initiative. We anticipate annualized cost savings of approximately $1.0 million in connection with the Glen Rock initiative to be realized gradually over the course of 2024. The Company will continue to review its operations to optimize the business, which may result in restructuring costs being recognized in future periods. The preceding sentences represent Forward-Looking Statements. See "Cautionary Notice Regarding Forward-Looking Information."
• Impact of Foreign Currency – As further described below, during the three months ended March 31, 2024, labor and overhead costs were less than $0.1 million lower than the corresponding 2023 period primarily due to a favorable foreign exchange environment involving the Chinese Renminbi, largely offset by an unfavorable foreign exchange fluctuations in the Mexican Peso, as compared to the prior year period. We realized foreign exchange transactional gains of $0.6 million during the three months ended March 31, 2024, due to the fluctuation of the spot rates of certain currencies in effect when translating our balance sheet accounts at March 31, 2024 versus those in effect at December 31, 2023. Since we are a U.S. domiciled company, we translate our foreign currency-denominated financial results into U.S. dollars. Due to the changes in the value of foreign currencies relative to the U.S. dollar, translating our financial results and the revaluation of certain intercompany as well as third-party transactions to and from foreign currencies to U.S. dollars may result in a favorable or unfavorable impact to our consolidated statements of operations and cash flows. We were favorably impacted by transactional foreign exchange gains in the three months of 2024 due to the depreciation of the Chinese Renminbi against the U.S. dollar, which was largely offset by an appreciation of the Mexican Peso against the U.S. dollar, as compared to exchange rates in effect during 2023. We have significant manufacturing operations located in in the PRC and Mexico where labor and overhead costs are paid in local currency. As a result, the U.S. Dollar equivalent costs of these operations were approximately $0.5 million lower in the PRC, largely offset by higher costs in Mexico of approximately $0.4 million, in the three months ended March 31, 2024 as compared to the comparable period in 2023. We monitor changes in foreign currencies and have historically implemented foreign currency forward contracts, and may continue to implement pricing actions to help mitigate the impact that changes in foreign currencies may have on our consolidated operating results. The preceding sentence represents a Forward-Looking Statement. See "Cautionary Notice Regarding Forward-Looking Information."
• Effective Tax Rate – Our effective tax rate will fluctuate based on the geographic regions in which our pretax profits are earned. Of the geographic regions in which we operate, the U.S. and Europe’s tax rates are generally equivalent; and Asia has the lowest tax rates of our three geographical regions. See Note 12, “Income Taxes”.

Results of Operations - Summary by Operating Segment

Revenue and Gross Margin

Our revenue and gross margin by operating segment for the three months ended March 31, 2024 and 2023 were as follows:

Power Solutions and Protection:

Sales of our Power Solutions and Protection products were lower by $22.9 million (27.6%) during the first quarter of 2024 compared to the same period of 2023. The decrease in the first quarter of 2024 resulted primarily from a decline in sales of our power products into networking applications of $17.4 million and a reduction in sales of our CUI products (consumer/distribution) by $4.8 million and $1.2 million of lower sales of our power products into eMobility applications as compared to the first quarter of 2023. Further, raw material expedite fee revenue for our Power segment totaled less than $0.1 million in the first quarter of 2024 as compared to $7.8 million in the first quarter of 2023. These areas of decline were partially offset by a $3.5 million (51%) increase sales of our rail products during the first quarter of 2024 compared to the same period of 2023.

Despite the overall decline in sales, this segment posted a gross margin of 44.0% in the first quarter of 2024, reflecting an 830 basis point improvement from the first quarter of 2023. Approximately half of this improvement in Power margins is viewed as sustainable, as it was driven by more permanent factors including cost reduction efforts, both on the procurement side and headcount side, the lower volume of low-margin expedite fees and overall product mix. The balance of the basis point improvement in gross margin versus the first quarter of 2023 relates to items that are either non-recurring or in the case of favorable FX, temporary in nature.

Connectivity Solutions:

Sales of our Connectivity Solutions products increased by $1.0 million (1.7%) during the three months ended March 31, 2024 as compared to the same period of 2023. This increase was primarily due to an increase in sales into the military end market which grew by $0.3 million (3.2%) during the first three months of 2024 as compared to the same period of 2023. We also experienced an increased volume of Connectivity Solutions products sold through our distribution channels during the first quarter of 2024, providing incremental growth of $0.5 million (2.8%) versus the first quarter of 2023. These sales increases were offset in part by a decline in sales of passive connector and cabling products used in the industrial premise wiring and 5G/IOT markets of $1.1 million (14.1%) during the three months ended March 31, 2024 as compared to same period of 2023. Gross margins for the 2024 period presented above were favorably impacted by pricing actions on certain contract renewals and operational efficiencies from the facility consolidations completed in 2023, partially offset by higher wage rates in Mexico and an unfavorable fluctuation in exchange rates between the U.S. dollar and Mexican peso in the 2024 period as compared to the 2023 period presented.

Magnetic Solutions:

Sales of our Magnetic Solutions products declined by $22.2 million (62.1%) during the three months ended March 31, 2024, as compared to the same period of 2023. Reduced demand for our Magnetic Solutions products from our networking customers and through our distribution channels has been the primary driver of the lower demand as we believe by these customers continue to work through inventory on hand. The lower sales volume, partially offset by favorable exchange rates with the Chinese Renminbi versus the U.S. dollar, were the primary drivers of gross margin reduction for this product group from last year's corresponding period.

Cost of Sales

Cost of sales as a percentage of revenue for the three months ended March 31, 2024 and 2023 consisted of the following:

Material costs as a percentage of sales during the three months ended March 31, 2024 were lower compared to the first quarter of 2023, due to the stabilization of raw material pricing, shorter lead times, a shift in product mix and better procurement efforts. Labor costs in 2024 as a percentage of sales have increased compared to the first quarter of 2023 due lower sales volume, a shift in product mix, an unfavorable fluctuation of the Mexican Peso exchange rate versus the U.S. Dollar in 2024 compared to the previous year, and the increase in statutory minimum wage rate in Mexico. This increase in labor cost was partially offset by lower labor costs in China due to the favorable fluctuation in the Chinese Renminbi exchange rate versus the U.S. Dollar.

The other expenses noted in the table above include fixed cost items such as support labor and fringe, depreciation and amortization, and facility costs (rent, utilities, insurance). The percentage of other expenses as a cost of sales has increased during the three months ended March 31, 2024, as sales volume decreased by 25.7% compared to the first quarter of 2023.

Research and Development ("R&D") Expense

R&D expense amounted to $5.2 million for each of the three month periods ended March 31, 2024 and 2023.

Selling, General and Administrative Expense (“SG&A”)

SG&A expenses were $24.9 million for the first quarter of 2024, down from $25.3 million in the first quarter of 2023. This decrease in SG&A was largely the result of a $1.2 million decline in legal and professional fees, as the first quarter of 2023 included costs associated with the MPS patent infringement lawsuit further described in Note 15, "Commitments and Contingencies", which did not recur in the first quarter of 2024. Commissions were also lower by $0.5 million in the first quarter of 2024 as compared to the first quarter of 2023 due to the lower sales base in the 2024 period. These declines were largely offset by higher salaries and fringe benefits of $0.9 million and an increase of $0.4 million in a variety of other expenses, including amortization, advertising and travel.

Other Income/Expense, Net

Other income/expense, net was $1.8 million and less than $0.1 million for the three months ended March 31, 2024 and 2023, respectively. The year-over-year change within this line item was largely driven by the market fluctuations in our SERP investments which resulted in a gain of $0.6 million and $0.4 million during the three months ended March 31, 2024 and 2023, respectively. The Company also recorded $0.2 million of income associated with its investment in innolectric during the first quarter of 2024. Due to the timing of this investment, no gains/losses were recorded during the first quarter of 2023. We also realized foreign exchange transactional gains of $0.6 million during the three months ended March 31, 2024, due to the fluctuation of the spot rates of certain currencies in effect when translating our balance sheet accounts at March 31, 2024 versus those in effect at December 31, 2023. This compares to foreign exchange transactional losses of $0.2 million recorded during the first quarter of 2023.

Provision for Income Taxes

The Company’s effective tax rate will fluctuate based on the geographic regions in which the pretax profits are earned. Of the jurisdictions in which the Company operates, the U.S. and Europe’s tax rates are generally equivalent; and Asia has the lowest tax rates of the Company’s three geographic regions. See Note 12, “Income Taxes”.

The provision for income taxes for the three months ended March 31, 2024 and 2023 was $4.5 million and $4.2 million, respectively. The Company’s earnings before income taxes for the three months ended March 31, 2024, were $1.6 million higher when compared with the same period in 2023, primarily attributable to an increase in income from the North America and Europe regions, partially offset by a decrease in the Asia region. The Company’s effective tax rate was 22.0% and 22.2% for the three months ended March 31, 2024 and 2023, respectively. Our tax rate for the first quarter of 2024 remained relatively consistent compared to the same quarter of 2023, affected by rates in foreign jurisdictions and the relative amounts of income earned in those jurisdictions. See Note 12, “Income Taxes”.

Liquidity and Capital Resources

Our principal sources of liquidity include $71.3 million of cash and cash equivalents at March 31, 2024, $49.9 million of held to maturity investments in U.S. Treasury securities, cash provided by operating activities and borrowings available under our credit facility. We expect to use this liquidity for operating expenses, investments in working capital, capital expenditures, interest, taxes, dividends, purchases of common stock under our Repurchase Program, and debt obligations and other long-term liabilities. Our liquidity may also be utilized to fund potential acquisitions in future periods. We believe that our current liquidity position and future cash flows from operations will enable us to fund our operations, both in the next twelve months and in the longer term.

Cash Flow Summary

During the three months ended March 31, 2024, our cash and cash equivalents decreased by $18.1 million. This decrease was primarily due to the following:

• net cash provided by operating activities of $6.2 million; and
• proceeds from held to maturity securities of $30.4 million; offset by:
• purchases of held to maturity and marketable securities of $42.7 million;
• purchases of common stock under our Repurchase Program of $6.3 million;
• purchases of property, plant and equipment of $2.9 million; and
• dividend payments of $0.8 million.

During the three months ended March 31, 2024, our accounts receivable decreased by $0.7 million due to lower sales volume in the first quarter. Days sales outstanding (DSO) was 59 days at March 31, 2024 as compared to 55 days at December 31, 2023. Inventory decreased by $5.7 million at March 31, 2024 compared to December 31, 2023, as component availability has started to ease and we have worked to consume our inventory on hand. Inventory turns were 3.0 at March 31, 2024 as compared to 3.1 at December 31, 2023.

Cash and cash equivalents, held to maturity U.S. Treasury securities and accounts receivable comprised approximately 36.9% of our total assets at each of March 31, 2024 and at December 31, 2023. Our current ratio (i.e., the ratio of current assets to current liabilities) was4.2 to 1 at March 31, 2024 and 3.4 to 1 at December 31, 2023. At March 31, 2024 and December 31, 2023, $42.0 million and $40.9 million, respectively (or 59% and 46%, respectively), of our cash and cash equivalents was held by our foreign subsidiaries. We repatriated $3.0 million from outside of the U.S. during the three months ended March 31, 2024. We continue to analyze our global working capital and cash requirements and the potential tax liabilities attributable to further repatriation, and we have yet to make any further determination regarding repatriation of funds from outside the U.S. to fund our U.S. operations in the future. In the event these funds were needed for our U.S. operations, we would be required to accrue and pay U.S. state taxes and any applicable foreign withholding taxes to repatriate these funds.

Future Cash Requirements

We expect foreseeable liquidity and capital resource requirements to be met through existing cash and cash equivalents and anticipated cash flows from operations, as well as borrowings available under our revolving credit facility, if needed. Our material cash requirements arising in the normal course of business are outlined in Item 7A, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023. There were no material changes to our future cash requirements during the three months ended March 31, 2024.

Credit Facility

In September 2021, we entered into the CSA, as further described in Note 11, "Debt". During January 2023, we amended our CSA and related interest rate swap agreements to transition the reference rate from LIBOR to a Secured Overnight Financing Rate ("SOFR") effective January 31, 2023. The CSA contains customary representations and warranties, covenants and events of default. In addition, the CSA contains financial covenants that measure (i) the ratio of our total funded indebtedness, on a consolidated basis, less the aggregate amount of all unencumbered cash and cash equivalents, to the amount of our consolidated EBITDA (“Leverage Ratio”) and (ii) the ratio of the amount of our consolidated EBITDA to our consolidated fixed charges (“Fixed Charge Coverage Ratio”). If an event of default occurs, the lenders under the CSA would be entitled to take various actions, including the acceleration of amounts due thereunder and all actions permitted to be taken by a secured creditor. At March 31, 2024, we were in compliance with our debt covenants, including the most restrictive covenant, the Fixed Charge Coverage Ratio. The unused credit available under the credit facility at March 31, 2024 was $115.0 million, all of which we had the ability to borrow without violating our Leverage Ratio covenant based on our existing consolidated EBITDA.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements include certain amounts that are based on management's best estimates and judgments. We base our estimates on historical experience and on various other assumptions, including in some cases future projections, that are believed to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Different assumptions and judgments could change the estimates used in the preparation of the condensed consolidated financial statements, which, in turn, could change the results from those reported. Management evaluates its estimates, assumptions and judgments on an ongoing basis.

Based on the above, we have determined that our most critical accounting estimates are those related to business combinations, inventory valuation, goodwill and other indefinite-lived intangible assets, and those related to our pension benefit obligations. For a detailed discussion of our critical accounting estimates, refer to “Critical Accounting Estimates” in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2023. There have been no material changes in our critical accounting policies, judgments and estimates, including assumptions or estimation techniques utilized, as compared to those disclosed in our 2023 Annual Report on Form 10-K.

Recent Accounting Pronouncements

The discussion of new financial accounting standards applicable to our Company is incorporated herein by reference to Note 1, “Basis of Presentation and Accounting Policies”.

The Company is exposed to market risk primarily from changes in foreign currency exchange rates and changes in interest rates associated with its long-term debt. Under the Company’s risk management strategy, the Company periodically uses foreign currency forward contracts to manage its short-term exposures to fluctuations in operational cash flows resulting from changes in foreign currency exchange rates. To partially mitigate risks associated with the variable interest rates on revolver borrowings under the Company's credit agreement (see Note 11, “Debt”, to the condensed consolidated financial statements herein, and Note 11, “Debt”, to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023), the Company maintains two pay-fixed, receive-variable interest rate swap agreements with two multinational financial institutions (see Note 10, “Derivative Instruments and Hedging Activities”, to the condensed consolidated financial statements herein, and Note 13, “Derivative Instruments and Hedging Activities”, to the consolidated financial statements in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2023). The Company’s primary objective for holding derivative financial instruments is to manage foreign currency exchange rate risk and interest rate risk, when deemed appropriate. The Company enters into these contracts in the normal course of business to mitigate risks and not for speculative purposes. There have not been any material changes with regard to market risk during the three months ended March 31, 2024. Refer to Item 7A, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023 for further discussion of market risks.

Disclosure controls and procedures: As of the end of the period covered by this report, the Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15. Based on that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Changes in internal controls over financial reporting: There has not been any change in the Company’s internal control over financial reporting that occurred during the Company’s last fiscal quarter to which this report relates that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

The risk factors described in Part I, Item 1A, "Risk Factors," of our Annual Report on Form 10-K for the fiscal year ended December 31, 2023 should be carefully considered before making an investment decision. These are the risk factors that we consider to be the most significant risk factors, but they are not the only risk factors that should be considered in making an investment decision. There have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2023. This Quarterly Report on Form 10-Q also contains Forward-Looking Statements that involve risks and uncertainties. See the "Cautionary Notice Regarding Forward-Looking Information," above. Our business, consolidated financial condition and consolidated results of operations could be materially adversely affected by any of the risk factors described, under "Cautionary Notice Regarding Forward-Looking Information" or with respect to specific Forward-Looking Statements presented herein. The trading price of our securities could decline due to any of these risks, and investors in our securities may lose all or part of their investment. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also materially adversely affect our business in the future. Except as required by the federal securities law, we undertake no obligation to update or revise any risk factor, whether as a result of new information, future events or otherwise.