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Edited Transcript of BELFA earnings conference call or presentation 1-Nov-18 3:00pm GMT

Q3 2018 Bel Fuse Inc Earnings Call

Jersey City Nov 12, 2018 (Thomson StreetEvents) -- Edited Transcript of Bel Fuse Inc earnings conference call or presentation Thursday, November 1, 2018 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

* Sean Kilian Flanagan Hannan

Needham & Company, LLC, Research Division - Senior Analyst of Smart Grid, Electronic Mfg Svcs, IT Components & Electronic Components

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Presentation

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Operator [1]

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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.

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

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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?

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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. Except for historical information contained on this call, 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 margins 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.

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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 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 3 main product lines. The volume in new orders coming in continue to grow with third quarter bookings reaching its highest level in 4 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 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 in 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 an increased demand from our Stewart passive connectors from 8 of our top 10 premise wiring 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 by $10.3 million or 21% since year-end.

Sales within our Power Solutions and Protection group were up 13.8% from third quarter of 2017. Excluding the effects of MTS divestiture and sales for this group were up $6.8 million or 17.9% from last year's third quarter driven by continued demand of power supplies and a variety of data applications. Sales of our DC to DC and Circuit Protection Products also saw growth in this quarter. These increases were offset in part by lower sales of our custom modular product group. The backlog of orders of our Power Solutions and Protection group is up $5.9 million or 9% from year-end.

From a profitability standpoint, foreign exchange gains and a favorable adjustments to our transition tax helped to mitigate the higher labor and material costs that impacted our gross margins this quarter. We continue to hold pricing firm and see some opportunities for price increases. Regarding the tariffs that were implemented throughout the past 2 quarters, we estimate that approximately 10% of our consolidated annual sales are currently impacted. The majority of these costs have been passed along to our customers in the form of invoice surcharges. Overall, we remain optimistic as we enter the fourth quarter, and we see positive indicators from our recent booking backlogs as we look into 2019.

And with that, I'd like to turn over the call to Craig to run through the financial update.

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

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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 the 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 fringe benefit expense.

On a go-forward basis, we would expect SG&A to run between $20 million and $21 million per quarter in the near term, barring any significant fluctuations in foreign currency. As a result of these factors, we generated income from operations of $10.5 million in the third quarter of 2018 as compared to $6.8 million in the third quarter of 2017. Interest expense was $1.4 million in the third quarter of 2018, down $75,000 from the same period last year as our lower debt balance mitigated the effect of higher interest rates in 2018. Our benefit from income taxes was $2.2 million for the third quarter of 2018 compared to a provision for income taxes of $60,000 during last year's third quarter. The benefit of this year's third quarter was largely due to a favorable measurement period adjustment of $2.6 million related to the transition tax originally reported in the fourth quarter of 2017.

The 2018 quarter was also affected by a decrease in tax expense in the North American segment due to the reduction in the U.S. tax rate from 35% to 21% in 2018 as well as a decrease in the taxes related to uncertain tax positions. Earnings per share for the Class A common shares was $0.89 per share in the third quarter of 2018 as compared with earnings of $0.40 per share in the third quarter of 2017. Earnings per share for the Class B common shares was $0.94 per share in the third quarter of 2018 as compared with earnings of $0.42 per share in the third quarter of 2017.

On a non-GAAP basis, which excludes certain unusual and other nonrecurring items, EPS for Class A shares was $0.70 per share in the third quarter of 2018 as compared with earnings of $0.42 per share in the third quarter of 2017. On a non-GAAP basis, EPS for Class B shares was $0.75 per share in the third quarter of 2018 as compared with earnings of $0.44 per share in the third quarter of 2017.

And now I'd like to go through some balance sheet and cash flow items. Our cash and cash equivalents balance at September 30, 2018, was $54.3 million, a decrease of $15.1 million from December 31, 2017. During the first 9 months of 2018, we made payments of $8.3 million towards our outstanding debt balance. We also used cash for capital expenditures of $8.8 million, dividend payments of $2.5 million and interest payments of $3.5 million. Accounts receivable were $97.6 million on September 30, 2018, as compared with $78.8 million at December 31, 2017. Days sales outstanding were 61 days on September 30, 2018, compared to 60 days at December 31, 2017. Our increase in accounts receivable balance was largely due to the higher sales volume in the third quarter of 2018 as compared to the fourth quarter of 2017. Inventories were $114.4 million at September 30, 2018, up $6.7 million from December 31, 2017.

In January of this year, we adopted the new revenue recognition standard, which accelerated the timing in which revenue was recognized and the corresponding release of finished goods from our inventory balance related to product held at customer-control hubs. Excluding the effects of this adoption, our inventory balance would have increased by $17.8 million from December 31, 2017, primarily raw materials and work in progress in response to the increase in demand for our products.

Accounts payable were $62.4 million at September 30, 2018, up $14.5 million from its level at December 31, 2017, due to the increase in raw material purchases. Bel's total outstanding debt was reduced by $744,000 during the third quarter, bringing the balance down to $116.7 million as of September 30, 2018, excluding deferred financing cost. Book value per share, which is calculated as stockholders' equity divided by our combined A and B classes of common stock outstanding, was $14.15 per share at September 30, 2018, as compared to $13.13 per share at December 31, 2017.

And now I'd like to turn the call back to Dan and open it for questions. Dan?

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

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

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll go first to Sean Hannan with Needham & Company.

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Sean Kilian Flanagan Hannan, Needham & Company, LLC, Research Division - Senior Analyst of Smart Grid, Electronic Mfg Svcs, IT Components & Electronic Components [2]

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A few questions for you folks here this morning. So first, on the 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?

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

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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 of those costs 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 there 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 thought them and the end customer would be a lot stronger at 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.

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Sean Kilian Flanagan Hannan, Needham & Company, LLC, Research Division - Senior Analyst of Smart Grid, Electronic Mfg Svcs, IT Components & Electronic Components [4]

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Okay. That's very helpful, Dan. Okay. 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're -- if we think about other constraints within the supply chain, it may have held up builds and is there a demand buildup 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.

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [5]

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I'll let Lynn give you the top line growth potential we see and how we see the next 2 or 3 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 2 or 3 quarters, Lynn?

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Lynn Hutkin, Bel Fuse Inc. - Director of Financial Reporting [6]

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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.

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Operator [7]

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(Operator Instructions) We'll go next to Hendi Susanto with Gabelli & Company.

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Hendi Susanto, G. Research, LLC - Research Analyst [8]

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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?

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [9]

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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?

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [10]

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

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

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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.

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Hendi Susanto, G. Research, LLC - Research Analyst [12]

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Okay, 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?

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

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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 3 years ago, it might have 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've 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.

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Hendi Susanto, G. Research, LLC - Research Analyst [14]

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I see. 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 that we can expect?

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [15]

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Okay. It only has revenue about $3 million. And again, for us it's more protecting our supply line. They were an 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 or 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 a profit? Definitely, yes. And it's a nice addition to round out our supply, how we handle our supply management.

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Operator [16]

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

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Sean Kilian Flanagan Hannan, Needham & Company, LLC, Research Division - Senior Analyst of Smart Grid, Electronic Mfg Svcs, IT Components & Electronic Components [17]

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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 very mix dependent. You certainly had 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?

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [18]

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Yes, Sean. I think what we -- basically our -- a lot of our growth, as you 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.

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Sean Kilian Flanagan Hannan, Needham & Company, LLC, Research Division - Senior Analyst of Smart Grid, Electronic Mfg Svcs, IT Components & Electronic Components [19]

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Okay. 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?

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Craig Brosious, Bel Fuse Inc. - VP of Finance, Treasurer & Secretary [20]

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

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Operator [21]

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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.

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Daniel Bernstein, Bel Fuse Inc. - President, CEO & Director [22]

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

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Operator [23]

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This concludes today's call. Thank you for your participation. You may now disconnect.