Good day, and welcome to the Bel Fuse Inc. Third Quarter 2018 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Dan Bernstein, President and Chief Executive Officer. Please go ahead, sir.

Thank you, Jessica. Joining me on the call today is Craig Brosious, our Vice President of Finance; and Lynn Hutkin, our Director of Financial Reporting. Before we begin, I'd like to ask Lynn to go over the safe harbor statement. Lynn?

Thank you, Dan. Good morning, everybody. Before we start, I'd like to read the following safe harbor statement. Except for historical information contained on this, the matters discussed on this call such as statements regarding bookings, trends, areas of growth, the impacts of a growth in orders and the impact of sales growth and price stabilization on margin are forward-looking statements as described under the Private Securities Litigation Reform Act of 1995 that involves risks and uncertainties. Actual results could differ materially from those projections. Among the factors that could cause actual results to differ materially from such statements are: the market concerns facing our customers; the continuing viability of sectors that rely on our products; the effects of business and economic conditions; difficulties associated with integrating recently acquired companies; capacity and supply constraints or difficulties; product development, commercialization or technological difficulties; the regulatory trade environment; risks associated with foreign currencies; uncertainties associated with legal proceedings; the market's acceptance of the company's new products and competitive responses to those new products; our ongoing evaluation of the consequences of the U.S. Tax Cuts and Jobs Act; the impact of changes to U.S. trade and tariff policies; and the risk factors detailed from time to time in the company's SEC reports. In light of the risks and uncertainties, there can be no assurance that any forward-looking statements will in fact prove to be correct. We undertake no obligation to update or revise any forward-looking statements. 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 release. I would now like to turn the call back to Dan for a general business update.

Thank you, Lynn. Before going through the financials, I want to provide a brief update on how the businesses did from an operation standpoint this quarter and what we see going forward. Overall, we are extremely pleased with the progress we made. Sales during the third quarter were $146.5 million, up almost 16% from the third quarter of 2017 with double-digit growth in each of our three main product lines. The volume in new orders coming in continue to grow with third quarter bookings reaching its highest level in four years. In addition, our backlog remained strong at $185.1 million as of September 30, 2018, an increase of 28% from a year ago. These top line growth indicators are seen across each of our major product lines providing diversified future growth potential. Our Magnetic Solutions group had sales growth of 20.4% over the last year's third quarter led by high demand of our integrated connector modules that are used in next-generation switching applications. Sales at Signal Transformer group, where products were also strong during this quarter as new programs with medical industrial applications moved into full production. The backlog of orders for our Magnetic Products grew by $22.4 million or 65% by year-end. Our Connectivity Solutions group had another solid quarter with sales growth of 13.3% from last year's third quarter. With this group, we saw increased demand from our Stewart passive connectors from 8 of our top 10 Power Solutions customers in response to improved economic conditions in the construction industry. Sales of passive connector products were also strong in data communication applications during the quarter. Our Cinch products also contributed to the sales growth with increased optical and copper products using encrypted communications and threat detection radar applications. Overall, the backlog of orders for our Connectivity products grew…

Thank you, Dan. To provide a quick recap on sales, sales during the third quarter were $146.5 million. By geographic segment, North American sales were $70.7 million, Asian sales were $53.5 million and European sales were $22.3 million. By product group, Connectivity Solutions sales were $48.5 million, Magnetic Solutions sales were $53 million and Power Solutions and Protection sales were $45 million. Gross profit margin declined to 19.9% in the third quarter of 2018 as compared to 21.9% in the third quarter of 2017. This was largely due to the increase in raw material costs as we continued to see challenges related to component cost and availability, particularly with resistors, capacitors, MOSFETs and printed circuit boards. Labor costs during the third quarter were also impacted as minimum wage increases at all of our factories and PRC had gone into effect by July 1, 2018. We estimate that approximately 35% of our cost of sales is fixed in nature, including overhead costs and R&D expenses. Despite the increase in sales during the third quarter of 2018, we were able to keep these fixed costs in line with the 2017 levels. Our selling, general and administrative expenses were $18.7 million or 12.8% of sales as compared with $20.9 million or 16.5% of sales in the third quarter of 2017. This decline primarily related to foreign exchange fluctuations on the translation of our foreign balance sheet accounts with an exchange gain recognized in the third quarter of 2018 of $1.5 million compared to an exchange loss of $573,000 in the third quarter last year. Other offsetting factors that affected the variance in the third quarter periods were lower legal and professional fees of $500,000 and a reduction in depreciation and amortization of $400,000. These lower costs were partially offset by $569,000 of higher…

Jessica, can we open up the call for questions, please?

[Operator Instructions] We'll go first to Sean Hannan with Needham & Company.

A few questions for you folks here this morning. So first, on a very, very big topic of tariffs, I realize that this might not necessarily always impact you directly, and it might be more of a variable for the end customers of yours, but wanted to see if we can get a perspective on: a, to what degree are you seeing impacts from a tariff standpoint directly for anything that you need to bring in and manufacture here? And then, b, to what degree are you getting feedback from your customers all the way on through for how the tariffs are impacting them and what you can conclude from that at least at this point in time?

Okay. Again. So from the tariffs standpoint, what we're using at this point, we see very little -- again, a lot of -- a large part of our manufacturing is done overseas and done in Mexico. We have one unit, Signal Transformer, and they have been affected by bringing in steel and other materials. And they're in the process of looking at other sourcing areas. In addition to that, we are -- they do bring in a lot of their products into North America, and then looking at possibly moving more production to the Dominican Republic. So overall, as we said, only 10% of the products that we deal with are being affected by tariffs, and most of all, those cost has all been passed on to the customer. Overall, from people feeding back to us, we see very little feedback on tariffs, which we're shocked by. We thought it would be a lot more -- get back again, a lot of our products go to, what they call, our contract manufacturers in the Far East, and they sell them to North America and throughout the world. We got them, and the end customer would be a lot stronger trying to get paybacks on tariffs. So I think everybody realized that the margins that we're on can't afford tariffs. In addition to that, we are very, I think, fortunate at this point in time, a majority of the customers are out there and more concerned with lead time than with pricing. And again, if someone leaves us and goes to a competitor, he might have the 20 lead time today with us, and if he goes to a competitor, he might be facing 45, 50 weeks. So at this point, I think the majority of our customers are a lot more concerned with supply than they are with pricing.

And then it sounds like in terms of the demand environment for you folks, you've got some -- you've been streaming along some decent quarters in terms of some upward momentum. As we consider where backlog stands, whether specific to a certain product or segment or even just in general, when we look forward here from the $146 million, $147 million you did in revenues in September, how are you feeling as might be the cadence of being able to grow on that either sequentially or next year? I don't really know where the -- your customer demands might be and that they -- if we think about other constraints within the supply chain, it may have held up bills, and is there a demand build up that allows for a sequentially flat December or even growth? I want to see if I can get some clarity on that as well as, Dan, of course, the cadence into '19. A little bit more viewpoint would be helpful.

I'll let Lynn give you the top line growth potential we see and how we see the next two or three quarters look. However, before that, from a growth standpoint, we are going to be constrained in the power area, where we have to utilize capacitors, resistors and semiconductors. Even though we've seen extremely long lead times, however, our suppliers have met our previous history. But if we went ahead and asked for a 10% or 15% growth, I don't think we can get that type of allocation. However, our suppliers have done a good job of maintaining our past history, and that's mainly in the power area. In the magnetic area and the connector area, we don't see material constraints as great as we see in the power area. From what we see on the next two or three quarters, Lynn?

Sure. So Sean, as we look to the fourth quarter, as you know, we seasonally have a bit of a softer fourth quarter versus third quarter sequentially. So we do expect a small downward trend from Q3 to Q4. But that said, we are looking at certainly a double-digit growth compared to last year's fourth quarter. And then looking at 2019, first quarter looks positive. We do have the impact of Chinese New Year in that quarter. It tends to be softer than Q4. But we do see that as still being strong. The only kind of uncertainty we have when it comes to 2019 is the tariff question. So currently, we have a group of products subject to a 10% tariff that will increase to 25% in 2019. And at this point, we don't know what impact that will have. If there will be a larger number of orders in Q4 and not as many in Q1, but based on what we see today, it looks like a strong next couple of quarters.

[Operator Instructions] We'll go next to Hendi Susanto with Gabelli & Company.

Dan, there are many companies who provide reports of slowdown in many markets and cautious concern on macro, including those types of trend in Q3. How should we reconcile those reports with your strong Q3 results? And I'm wondering whether some customers may decide to purchase more ahead of the new tariffs being effective in 2019?

I don't -- from our understanding and from what we see out in the marketplace, I don't think we've seen any slowdown from our suppliers or from our customers. So again, that and the visibility I have today, we don't see any negative feelings out there of the market going forward. On your second question, regarding the tariffs.

Yes. We think it's possible people are ordering in advance and then...

It -- again it -- we don't know, it could be. But again, the problem you have with that is if you look at a lot of the components we're getting, lead times is 24 weeks, 30 weeks. So they can't beat the tariff barrier in. You know what I'm saying. The tariffs will be implemented by the time we get the materials in. So I -- we haven't heard of it. And so, anything's possible. I mean again, we know ourselves, for example, we have the inventory, we will bring inventory in beforehand instead of leaving it in the Far East. But there is -- there's only a certain amount of inventory out there.

I think that's very helpful. And then with regard to shortages that you mentioned in raw material availability. When do you see that shortage to end?

That's the $50,000 question. The problem that you have -- we have is a lot of the shortages we see are driven by the auto industry and electric cars. Also somewhat with the cell phone. So if you look at a cell phone three years ago, it might have a 1,000 resistors in it. Today, it maybe has -- I'm sorry, 100 resistors. Today, it might have 1,000 resistors or capacitors. And if anything, the cars, because cars become more electric, they have substantially a lot more electronic components up to 10,000 to 20,000 components in a car from resistors, capacitors to fuses. And the problem that we see is: a, most of our suppliers do not want to increase production, because they're afraid if they do increase production, they would be faced with price pressure. Also they tend to support, I think, especially in Japan and in Germany, I think a lot of the component suppliers are more focused on the automobile industry, and we're seeing how they're going to address that. But if you go, for example, you have Tesla today, you got Volvo in 2020 going 100% electric, you got England in 2035 going 100% electric. So with this a strong demand by electric cars going forward, I don't know how we're going to keep up. So at this point, I would hope -- we would hope people would increase production. But at this time, we haven't seen it.

And then any insight into the BCMZ Precision Engineering acquisitions in terms of what growth profile it has and what kind of revenue run rate there we can expect?

Okay. It only has revenue about $3 million. And again, for us it's more protecting our supply line. They were integral part of our Connector group in Europe. And we felt that we couldn't let someone from the outside take this over. And that's why we put in our supply agreement that we have first right of first -- first right if they decide to sell the company. Initially, we are looking at our own companies to bring product in it, and we think we can increase sales very quickly from $3 million to $4 million and make it a substantially more profitable. So it's a nice little company. Is it going to be a $25 million, $30 million company? Absolutely not. But can it be a nice $5 million, $6 million company to support us internally and make the profits? Definitely, yes. And it's a nice addition to round out our supply, how we handle our supply management.

We'll now take questions from Sean Hannan with Needham & Company.

So just wanted to ask a little bit about the margin profile from here. So if we had a decline quarter-on-quarter despite the revenue growth, and clearly, the most pronounced quarter-on-quarter revenue growth came through magnetics, how should we think about margin progression into this fourth quarter and forward? I'm assuming there's an element to that that's remix dependent. You certainly called out some earlier challenges and working through within your own component supply tightness. So just trying to understand that better. How that's impacting your mix as we move from here?

Yes, Sean. I think what we -- basically our -- a lot of our growth, as we mentioned, is coming out of the Magnetic segment. That's the segment where we have the highest level of direct labor, particularly the Chinese direct labor, which was impacted by wage increases that were implemented by the government during this year and actually on -- particularly during this quarter. That coupled with the material cost increases that we mentioned, that is putting us under margin pressure. I think going forward, as we look at what we've got on the books in backlog, and we think that margin should continue to hover around the 20% to 20.5% in the short term, anyway. So I think that's what we're looking at going forward.

So that downtick in the third quarter while thematically, what created the issue doesn't go away, we should bounce up a little bit from there. Is that fair?

Yes. We should see a little bit of an uptick there.

And it appears there are no further questions at this time. I'd like to turn the conference back to Mr. Bernstein for any additional or closing remarks.

Thank you. And I appreciate you joining our call today, and we look forward to speaking to you in February. Goodbye.