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Edited Transcript of BELFA earnings conference call or presentation 1-Aug-19 3:00pm GMT

Q2 2019 Bel Fuse Inc Earnings Call

Jersey City Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Bel Fuse Inc earnings conference call or presentation Thursday, August 1, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Craig Brosious

Bel Fuse Inc. - VP of Finance, Treasurer & Secretary

* Daniel Bernstein

Bel Fuse Inc. - President, CEO & Director

* Lynn Hutkin

Bel Fuse Inc. - Director of Financial Reporting

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Conference Call Participants

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* Hendi Susanto

G. Research, LLC - Research Analyst

* James Andrew Ricchiuti

Needham & Company, LLC, Research Division - Senior Analyst

* Theodore Rudd O'Neill

Litchfield Hills Research, LLC - CEO & Research Analyst

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Presentation

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Operator [1]

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Good day, and welcome to the Bel Fuse Inc. Second Quarter 2019 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.

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [2]

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Thank you, [Sharlo]. Joining me on the call today is Craig Brosious, our VP of Finance; and Lynn Hutkin, our Director of Financial Reporting.

Before we begin the call, I'd like to ask Lynn to go over the safe harbor statement. Lynn?

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Lynn Hutkin, Bel Fuse Inc. - Director of Financial Reporting [3]

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Thank you, Dan. Good morning, everybody. Before we start, I'd like to read the following safe harbor statement. Expect for historical information contained on this call, the matters discussed on this call, such as statements regarding anticipated sales level, gross margin, cost saving, cost reduction measure, demand for our products and the impact of long-term growth drivers, are forward-looking statements as described under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Actual results could differ materially from Bel's projection.

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 difficulty; the regulatory and 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; 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 statement will, in fact, prove to be correct. We undertake no obligation to update or revise any forward-looking statements.

We also may discuss non-GAAP results during this call, and reconciliations of our GAAP results to non-GAAP results have been included in our release.

I'd now like to turn the call back to Dan for a general business update.

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [4]

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Thank you, Lynn. Before going through the financials, I would like to provide a brief update on how the business did from an operational standpoint this quarter and what we see going forward. Overall, our second quarter was challenging, one, both from the top line sales perspective and the impact of margins. As mentioned in the first quarter, we saw a decline in bookings as some of our customers are currently in an over-inventory position. Customers brought additional products into inventory throughout 2018 in response to material shortages and the tariff increases that took effect in 2018 and 2019. This led to a $13 million year-over-year decline in our sales during the second quarter, which impacted each of our product groups. The lower sales based on the higher material costs led to a low gross margin this quarter. While we have limited visibility of demand of our products and our customer products, or second quarter bookings continue to be soft, indicating flat to lower sales sequentially in the third quarter.

We accelerated our effort to align our costs with our current business level and actively taking steps to reduce fixed costs and improve efficiencies in each of our facilities worldwide.

During the second quarter, we completed the restructuring of power R&D resources and the transition of our Signal Transformer operation from Inwood, New York to other existing Bel facilities. These initiatives are expected to result in annual cost savings of $2.1 million, beginning in the third quarter of 2019. We're currently in the process of streamlining our operations in Asia to enhance productivity at these factories. To date, we have identified and substantially completed measures that will result in incremental annualized cost savings of $1.4 million, which should be expected to benefit the beginning in the fourth quarter 2019.

The global initiative is expected to continue the next several quarters as we complete our strategy that we have put in place.

With a growth of 5G, autonomous and electric vehicles, the cloud data centers and spending in aerospace and military, we still remain very positive of our future growth opportunities. In the short term, there are areas of growth that will offset some of the the expected sales decline. With our connected-- Connectivity Solutions group, we expect strong shipments of our microminiature copper assemblies -- I'm sorry, ammunition applications as well as increased demand for our high-speed optical transceivers for 2 new fighter jet programs that are qualified.

Our Power System Protection group is seeing more near-term upside and power supply demand for using heavy-duty steel-cutting equipment and high-performance computing applications. The power group has also recently project wins with traditional serve applications, which we expect to move into full production on the end of the fourth quarter.

Our power products sold at e-mobility applications. While still small from a dollar perspective, it grew by $700,000, almost 50% from the second quarter of 2018. This area has significant growth potential down the road as some of the startups take hold and move into full production. And with that, I'd like to turn over the call to Craig to run through the financials update.

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [5]

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Thanks, Dan. To provide a quick recap on sales, sales during the second quarter were $127.4 million. By geographic segment, North American sales were $67.1 million, a decline of 6% from last year's second quarter. European sales were $21 million, down 11%, and Asian sales were $39.3 million, down 14% from last year's second quarter.

By product group, Power Solutions and Protection sales were $44 million, down 5% from last year's second quarter. Connectivity Solutions sales were $42.5 million, a decline of 13%, and Magnetic Solutions sales were $40.9 million, down 10% from last year's second quarter.

Gross profit margin declined to be 15.6% in the second quarter of 2019 as compared with 20.6% in the second quarter of 2018 as lower sales in 2019 combined with higher material costs and an unfavorable shift in product mix had significant downward pressure on our gross margin during the second quarter.

Our selling, general and administrative expenses were $18.8 million or 14.7% of sales as compared with $18.3 million or 13% of sales in the second quarter of 2018.

This increase primarily related to foreign exchange fluctuations on a translation of our foreign balance sheet accounts with an exchange gain recognized in the second quarter of 2019 of $450,000 compared to an exchange gain of $1.9 million in the second quarter of last year. This unfavorable variance was partially offset by a reduction in ERP implementation cost of $484,000, lower bad debt expense of $345,000 and reduced sales and marketing expenses of $273,000 compared to the second quarter of 2018.

On a go-forward basis, we would expect SG&A to run between $19 million and $20 million per quarter in the near term, barring any significant fluctuations in foreign currency. During the second quarter, we closed on the sale of a property in Inwood, New York, which resulted in a pretax gain of $4.3 million. As a result of these factors, we generated income from operations of $5 million in the second quarter of 2019 as compared to $10.7 million in the second quarter of 2018.

Interest expense was $1.4 million in the second quarter of 2019, up slightly from the same period last year due to the higher interest rate in effect in the 2019 period.

Our provision for income taxes was $421,000 for the second quarter of 2019 compared to $2.4 million during last year's second quarter. The provision for income taxes during the second quarter of 2019 was lower due to a reduction in overall taxable income and less GILTI tax incurred in the U.S. during the second quarter of 2019 versus the 2018 period.

Earnings per share for the Class A common shares was $0.23 per share in the second quarter 2019 as compared with earnings of $0.52 cents per share in the second quarter of 2018. Earnings per share for the Class B common shares was $0.24 per share in the second quarter of 2019 as compared with earnings of $0.56 per share in the second quarter of 2018.

On a non-GAAP basis, which excludes certain unusual and other nonrecurring items, EPS for Class A shares was $0.03 per share in the second quarter of 2019 as compared with earnings of $0.58 per share in the second quarter of 2018. On a non-GAAP basis, EPS for Class B shares was $0.03 per share in the second quarter of 2019 as compared with earnings of $0.62 per share in the second quarter of 2018.

And now, I'd like to go through some balance sheet and cash flow items. Our cash and cash equivalents balance at June 30, 2019 was $58.4 million, an increase of $4.5 million from December 31, 2018.

During the first half of 2019, we made net payments of $1.5 million towards our outstanding debt balance. We also used cash for capital expenditures of $5.3 million, dividend payments of $1.6 million and interest payments of $2.5 million. Accounts receivable were $84.2 million at June 30, 2019, as compared with $91.9 million at December 31, 2018.

Days sales outstanding were 60 days at June 30, 2019, as compared to 59 days at December 31, 2018. The reduction in our accounts receivable balances was largely due to the lower sales volume in the second quarter 2019 as compared to the fourth quarter of 2018. Inventories were $118.2 million at June 30, 2019, down $1.9 million from December 31, 2018. The decline was primarily in raw materials as purchases of raw materials has slowed while we worked through our inventory on hand.

Accounts payable were $42.8 million at June 30, 2019, down $13.4 million from its level at December 31, 2018, primarily due to lower raw material purchases during the quarter.

Bel's total outstanding debt was reduced by $1.5 million during the first half of 2019, bringing the balance down to $113 million as of June 30, 2019, excluding deferred financing costs.

Book value per share, which is calculated as shareholders equity divided by our combined A and B classes of common stock outstanding, was $14.64 per share at June 30, 2019, as compared to $14.39 per share at December 31, 2018.

One final note on the finance side. Our R&D expenses have historically been part of our cost of sales and therefore are a factor in arriving at our gross margin. This is still the case in the second quarter 2019 financials presented in our earnings release today. This classification is different than the majority of our peers, and investors should keep this in mind when comparing our gross margins to our peers. We are currently evaluating potential reclassification of this expense presentation for future periods.

And with that, I'll the call back over to Dan

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [6]

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Thank you. [Sharlo], can we open up for questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll be taking our first question from Theodore O'Neill of Litchfield Hills Research.

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Theodore Rudd O'Neill, Litchfield Hills Research, LLC - CEO & Research Analyst [2]

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And I'll vote for a re-class of R&D as a separate line item. The question I have for you -- can you hear me okay?

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [3]

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Yes.

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [4]

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Yes.

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Theodore Rudd O'Neill, Litchfield Hills Research, LLC - CEO & Research Analyst [5]

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Okay. So, Craig, the question I have for you is that in the last quarter, in your prepared remarks, you guided SG&A to run at $20 million to $21 million, and it came down in this quarter. Also, so did sales. And so I'm wondering why would it be going -- why would you guide for it to go up in the third quarter, if you're looking for sales to continue to be flat to down?

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [6]

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I think we guided last quarter in the $20 million range. I think what we're guiding now is slightly below that from a $19 million to $20 million.

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Lynn Hutkin, Bel Fuse Inc. - Director of Financial Reporting [7]

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So, Theo, if you're comparing it to third quarter of 2018, just keep in mind the third quarter of 2018 had a $1.5 million FX gain in that number, which we don't expect to recur in this year's third quarter unless something drastic happens in August or September.

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Theodore Rudd O'Neill, Litchfield Hills Research, LLC - CEO & Research Analyst [8]

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Okay, okay. And I do understand what's going on with the inventory, and I don't think some of the distributors helped by making an online tool, so we could calculate in advance how much the tariffs were going to be and sort of scared everyone into buying in front of it but -- so I get that part of it.

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Operator [9]

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(Operator Instructions) We will now take our next question from Jim Ricchiuti of Needham & Company.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [10]

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Couple of questions. Wondering which of the product areas are being mostly impacted by the excess inventory in the OEM channel? Is mainly in Magnetic Solutions? Or is it carrying over into some of the other product areas?

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [11]

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It's hitting us across the board, but the major area is the magnetic, where -- at our integrated connector module that we have, which is affected by some very large OEM customers. So it's not as broad-based as some of our other product lines we have.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [12]

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Got it. And, Dan, you've seen a few of these. How would you characterize the current inventory correction relative to some others that you've seen over the years?

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [13]

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Don't ask. No. As I think -- I think we hate to say it, but we hear this too often, but I think we are all very optimistic about the future. I go back, and hate to say it, with my father, the upsurge, everybody went out and bought a color TV. There was a lot of demand, and all of a sudden, we had a color TV. Then it went down, then mainframe computers, then minicomputers. Then you did networking and high-speed. So we always see these ups and quick downs as people get -- buy the new product. But now we just see so many products that are being introduced from electric cars going from $16 million to $25 million, from data centers what Facebook, Google and Amazon need. I mean, you look at Amazon and a lot of -- all that growth you see is coming a large part from the data centers. How do we penetrate those type of accounts. 5G, well, if you went to the consumer electronic show, everybody is talking 5G. We haven't seen anything, but everybody's introducing tremendous amount of new product. So again, we know it's going to flush out at a certain point, but we're really looking at what I guess the term I think Lincoln came up with the term Electronics Super-Cycle. Now we just see a wealth of products out there that gives everybody a great level of opportunity, it really grow industry.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [14]

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Got it. If we -- looking at that sequential decline that you experienced in gross margins, can you give us a sense how much of that came from the higher material costs and relative to how much came -- let it come from product mix?

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Lynn Hutkin, Bel Fuse Inc. - Director of Financial Reporting [15]

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Sure. So the majority of it related to the higher material costs. We're estimating about 3.8%, so 380 basis points related to material costs. On the -- the sales declined. Just volume decline will have an impact on our margin percentage. But there was also a shift in product mix, and we're estimating that, that had about 250 basis point impact on our margins. And then there were some other favorable factors there and more favorable FX environment. So that was an offset to those 2 unfavorable factors.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [16]

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Okay. Is the -- what you're seeing in higher material cost, is that primarily in the Power Solutions and Protection area?

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [17]

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I think it's across the board, but I think probably majority of it is in the power and protection area.

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [18]

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And Jim, as you know as material lead times come down substantially, the pricing will fall close by.

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [19]

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But we haven't seen pricing return to those like 2017 levels. We're not expecting that for a little while, yes.

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James Andrew Ricchiuti, Needham & Company, LLC, Research Division - Senior Analyst [20]

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Okay. And one final question. I'll jump back in the queue. Just regarding the cost actions that you alluded to in the report, the earnings report today, I'm just wondering you also are suggesting that you're reviewing some other potential initiatives. How should we think about those other potential cost savings, maybe in aggregate, over and beyond what you've already done?

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [21]

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Yes. I mean, we're looking at -- like we mentioned, we're looking at all of our locations and kind of the company structure. I think we can reasonably expect maybe another $3 million to $5 million in fixed costs over a period of time. So these are not going to be short-term-type fixes, but that I think would be a reasonable expectation.

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Operator [22]

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Our next question comes from Hendi Susanto of G. Research.

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Hendi Susanto, G. Research, LLC - Research Analyst [23]

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First question. Can you characterize about the gross margin pressure due to product mix? And when will it be until we shift to a more favorable mix?

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Lynn Hutkin, Bel Fuse Inc. - Director of Financial Reporting [24]

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So in the second quarter, the product group that experienced the highest year-over-year decline was the connectivity business. And that -- most of that is military aerospace driven, and on the military side, the timing is unpredictable. It's based on the timing of the various programs that we're on. So military had a bad quarter in the second quarter, but we do expect that to improve in the third quarter. So we do expect some upside in connectivity related to the military business in the third quarter. And that's a higher-margin business. So that -- we do expect some improvement in the third quarter related to product mix.

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Hendi Susanto, G. Research, LLC - Research Analyst [25]

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And then that is big enough to swing the gross margins one way or the other, I assume?

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [26]

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What we're seeing for the third quarter, based on our existing backlog, kind of basically indicates that we should see an uptick in gross margin percentage for the third quarter

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Hendi Susanto, G. Research, LLC - Research Analyst [27]

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Got it. And then I want to revisit Jim's earlier questions. Can you characterize in which vertical inventory correction is the most significant one? Other companies have talked about excess inventories in hyper scale and data center customers. I'm wondering whether you can share some colors how similar your perspective versus others.

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [28]

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I think we're seeing large inventory correction in our networking equipment end product market. We sell those to large OEMs that are overstocked at the moment. So I think that one is one of the largest ones. We also see similar overinventory situation in the distribution channel, and that -- that's pretty much across the board in all of our product groups.

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [29]

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And it should be noted that we do $120 million during the distribution channel, so it's a big chunk of our sales built through that channel. And if you know, if you've seen writings on Arrow and Avnet, you know what's going on there. And I think everybody's weary of inventory situation.

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Hendi Susanto, G. Research, LLC - Research Analyst [30]

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And then Dan, can you -- how long do you foresee this inventory correction will last?

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [31]

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From what we understand, most people are saying, for the balance of this year. By September, we should get some more visibility because people assume that in September, people order before Chinese New Year. But at this point, I don't know, I think, we don't see any uptick for balance of the year.

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Operator [32]

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(Operator Instructions) The next color is from Hendi Susanto of G. Research, again.

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Hendi Susanto, G. Research, LLC - Research Analyst [33]

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You implied that -- the impact of higher material cost will continue into the second half. What will it look like beyond the second half? Wondering whether -- I'm wondering how you mitigate the higher material costs in 2020. Whether that will come mainly from the cost saving initiatives? Or whether there are other sources to mitigate that?

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [34]

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I think the bulk of the offset would be from our cost reduction initiatives. We are -- we are expecting material costs to gradually trend down as there is more capacity in the market. I think we would primarily offset the increases with our cost reduction efforts.

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Operator [35]

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It appears there are no further questions at this time. I'd like to turn the conference back to you.

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [36]

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Thank you, [Sharlo]. We appreciate everybody joining us today and hope the things we saw improve. Have a nice summer, and thank you.

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Operator [37]

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This concludes today's Bel Fuse Q2 financial update call. Thank you, again, for your participation. All participants may now disconnect.