CTS Corp (CTS) 2015 Q4 法說會逐字稿

Good day and welcome to the CTS Corporation fourth-quarter 2015 earnings conference call. Today's conference is being recorded. At this time I would like to turn the conference over to CTS's CEO, Kieran O'Sullivan. Please go ahead, Sir.

Thank you, Jessica. Good morning, thank you for joining us today, and welcome to CTS's fourth-quarter and full-year 2015 conference call.

We are disappointed with our full-year sales performance. Despite this we are confident in our strategy and the changes we are driving to position us for future profitable growth and products that sense, connect and move. We made solid progress in several areas.

We received $560 million in new business awards, an increase of [16%] year over year, and added several new customers. We successfully completed a transition from Canada, reducing our manufacturing footprint to 11 locations. We improved our cash flow from operations to $39 million from $32 million in 2014. We acquired filter sensing technologies which provides experience, know-how and IP with an exciting new technology that we expect to be instrumental in driving new product growth in future years.

Although lower sales and foreign exchange translation losses created headwinds in 2015, we were still able to improve our gross margin and control our operating expenses to deliver adjusted earnings that were only marginally lower than in 2014. Driving growth remains our top priority in 2016 and we continue to make targeted investments to support this initiative.

As usual, Ashish Agrawal, our CFO, is joining me on today's call. Ashish will take us through the Safe Harbor statement.

I would like to remind our listeners that this conference call contains forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Additional information regarding these risks and uncertainties is contained in the press release issued today, and more information can be found in the Company's SEC filings. To the extent that today's discussion refers to any non-GAAP measures relative to Regulation G, the required explanations and reconciliations are available in the investor section of the CTS website.

I will now turn the discussion back over to our CEO. Kieran?

Thank you, Ashish. Today we reported our fourth-quarter and full-year 2015 financial results. Fourth-quarter sales were $93.3 million, down $7.1 million or 7.1% compared to the same quarter last year. Sales were lower in certain end markets including automotive, engineer frequency and HDD. In addition, foreign currency impacted sales unfavorably by $1.6 million.

Sales grew $2.6 million or 2.9% sequentially from the third quarter to the fourth quarter. Full-year 2015 sales were $382.3 million down 12. -- $21.7 million or 5.4% versus 2014. The drivers are much the same for the full year with lower volumes in automotive, engineered frequency and HTD. Foreign currency impacted sales unfavorably by $7.8 million. Gross margin improved by 100 basis points year over year to 33.2%.

Adjusted earnings per share were $0.93 in 2015 compared to $0.97 in 2014. Lower volumes and unfavorable foreign exchange impact due to balance sheet translation were the primary drivers for the decline in earnings.

We held adjusted earnings to a small year-over-year decline by improving our gross margin and controlling operating expenses.

New business awards were $105 million for the fourth quarter and $560 million for the year. New business awards increased 16% from $484 million in 2014. We also added several new customers in 2015. We continued to win accelerator pedal awards and gained a second new customer in Europe. Our focus on actuator product performance help us secure additional wins with our existing customers beyond 2020.

We continue to add customers for our chassis [right eye] product, where we now have three major customers and are on multiple vehicle platforms, including the Grand Cherokee, Chevy Cruise, Astro, Malibu, Cadillac, Enclave and Buick Verano.

We also expect to be on the next generation platforms. We met our first shipments of hydrophones and expect to begin shipments in the first half of 2016 of our next generation micro dual stage actuator for the HDD market.

Additionally we met our qualification shipment for piezo material for ultrasonic welding application in the fourth quarter and expect annual revenues of $1 million once shipments begin. On our older switch products we expanded our offering and increased our sales.

Finally we secured a new win in India for our transmission position sensor with shipments beginning late in 2017 and revenues up $1 million to $2 million per year. We have several developments in the hopper as we continue to focus on innovation from next-generation actuators, sensing applications and next generation accelerator pedal solutions to continue to support organic growth. We continue to focus on simplification and our team successfully completed the Canadian facility transfer.

As a management team we continue to look for further simplification and margin improvements throughout our organization with our clear goal to get to an 80% best cost footprint.

Cash flow from operations improved from $32 million in $2014 to $39 million in 2015. And our share repurchases amounted to $18.1 million in 2015.

In the fourth quarter we completed the acquisition of Filter Sensing Technologies. This addition checks two boxes on our strategic plan, products that sense and connect. FST adds a cutting-edge sensing technology to our transportation portfolio and allows us to participate in a market that is expected to be $150 million to $300 million in size by 2025 as new filtering solutions gain traction.

In 2016, we plan to take the prototypes through our development process to have a customer-ready sample to drive new business awards in 2017. Additionally, this acquisition -- with this acquisition we gained a talented team to advance our product development and boost our innovation capabilities. We are excited by what we can do for our future growth.

As you are aware we have the majority of our cash overseas. Given the uncertainty we have seen with the currency rates in China, we are taking steps to address the situation. Ashish will cover this in more detail.

As we enter 2016, our journey to reposition CTS is gaining traction despite the topline sales challenge. We are repositioning the product portfolio to drive profitable growth with products that sense, connect and move. Hopefully you had the opportunity to see our new website. We look forward to adding more color to our growth as we journey ahead.

We continue to focus on developing our M&A pipeline. Our guidance for the full year 2016 sales is in the range of $390 million to $400 million, and adjusted earnings per diluted share in the range of $0.95 to $1.05. This excludes foreign exchange impact related to balance sheet translation.

I will now hand the call over to Ashish to walk us through the financial results in more detail. Ashish?

Thank you, Kieran. I will start with the results for the quarter.

Fourth-quarter sales were $93.3 million, down $7.1 million compared to the same quarter last year. As noted earlier and consistent with prior quarter, sales were soft in certain markets due to lower volume of older automotive products and weak demand for communication and HDD products.

In addition, foreign currency impacted sales unfavorably by $1.6 million as the US dollar [depreciated] against the euro and RMB. On a positive note, sales grew $2.6 million, or 2.9% sequentially from the third quarter to the fourth quarter. Gross margin for the quarter was 32.3% versus 32.9% in the same quarter a year ago. Margins declined primarily due to lower volumes.

Operating expenses in the fourth quarter of 2015 were significantly higher than last year due to restructuring charges primarily related to a non-cash charge for unamortized losses in connection with the wind-up of our UK pension plan. SG&A expenses were $13.8 million in fourth-quarter 2015 compared to $15.8 million in the fourth quarter last year. This decrease was primarily due to continued efficiency gains from restructuring projects, cost containment efforts and timing of certain expenses.

R&D expenses of $6.1 million in fourth-quarter 2015 compared to $5.8 million in the same period last year. R&D expenses also grew compared to third quarter of 2015 in line with our plan to continue investing in new products to drive organic growth.

Interest expense in fourth-quarter 2015 was slightly higher than last year, due to higher debt balances and a slightly higher interest rate. Interest income in fourth-quarter 2015 was slightly lower than last year, due to lower interest rates in China.

In fourth-quarter 2015, other expense was $1.7 million. This is almost entirely due to the impact of changes in foreign currency rates on our assets and liabilities. The main factor was the devaluation of the Chinese renminbi compared to the US dollar.

Now I will cover some details on taxes. In fourth quarter of 2015, we took a charge for withholding taxes related to earnings that can be [remedied] from China in the form of a dividend. In addition, we gave preliminary investment assertions in the UK in Canada where we ceased manufacturing operations recently and booked a tax charge on historical earnings for these locations.

The net impact of these items was an increase of $8.8 million in our tax expense for the fourth quarter. We also recorded additional discrete tax items in the fourth quarter that increased tax expense by $2.5 million. As you have seen, the Chinese currency has depreciated considerably in recent months.

We will continue to dividend money from China to the extent permitted under local law. We intend to use this cash for potential acquisitions outside the US. In the case of UK in Canada, where we have given up the [permanentary] investment assertion, it is our intention to bring cash from these countries back to the US. This cash will be available to us for acquisitions, to pay down debt or for share buybacks.

Our fourth-quarter 2015 GAAP loss was $0.42 per share. Included in this number is a $0.28 charge for restructuring. This charge is for the write-off of unamortized losses related to the wind-up of our UK pension plan, and costs related to the closure of our manufacturing facility in Canada.

Also included was $0.34 tax expense for the discrete tax items cash dividends that I just discussed. Excluding these items, adjusted earnings per diluted share were $0.20 in the fourth quarter of 2015. GAAP earnings were $0.21 per diluted share in the fourth quarter of last year. Included in these earnings were $0.03 in restructuring and related charges. Excluding this item, adjusted earnings per diluted share were $0.24 in the fourth quarter of 2014.

Next, I will review results for the year. Full-year 2015 sales were $382.3 million, down 5.4% versus 2014. Sales were soft in certain end markets due to lower volumes of older automotive products and weak demand for communications and HDD products. Foreign currency impacted sales unfavorably by $7.8 million for the year as the US dollar [appreciated] against the euro and RMB.

Gross margin was 33.2% versus 32.2% last year. Margins increased year over year as we continue to achieve efficiency gains and implement material and labor productivity projects. We also realized a substantial portion of anticipated savings from our project to shift production from Canada to a lower cost location. Currency impact on manufacturing costs was favorable as the US dollar appreciated against various local currencies in countries in which we have manufacturing operations.

Operating expenses in 2015 were significantly higher than last year. There were two large factors.

First, in the third quarter we recorded a $14.5 million charge for anticipated environmental remediation. Second, we recorded restructuring charges related to the transition from Canada and a charge for unamortized losses in connection with the wind-up of our UK pension plan. The charge related to UK pension plan wind-up was largely non-cash. SG&A expenses were $57.4 million in 2015 compared to $59.1 million in 2014. This decrease was primarily due to continued gains from restructuring projects, cost containment efforts and timing of certain expenses.

R&D expenses were $22.5 million in 2015 which is roughly flat with 2014 as we reprioritized our spend on specific projects. We plan to invest more R&D dollars in 2016 to develop new products and drive future organic growth. We will also spend additional money on development of the sensing technology we acquired through the FST acquisition.

Interest expense was slightly higher than last year, due primarily to higher debt balances. Interest income was also slightly higher year over year due to higher cash balances.

Other expense was $6.3 million in 2015. This is almost entirely due to the impact of changes in foreign currency rates on our assets and liabilities. The main factors were the devaluation of the Chinese renminbi and euro compared to the US dollar.

The effective income tax rate was 43.3% in 2015. This includes several discrete tax items, including a $15.7 million reduction in tax expense as a result of our change in treatment of foreign taxes paid from a deduction to a credit, a $5.2 million increase in tax expense related to uncertain tax positions on certain foreign taxes, an $8.8 million increase in tax expense related to dividend from China and change in our permanently reinvested assertion related to the UK and Canada, and an increase in tax expense of $3.5 million related to valuation allowance for certain tax items.

In 2014, the effective tax rate was 32.6%. Our 2015 GAAP earnings were $0.21 per diluted share. Included in this number is a $0.40 charge for restructuring and a net charge of $0.32 for various tax items that I just discussed.

Excluding these items, adjusted earnings per diluted share were $0.93 in 2015.

In 2014, GAAP earnings were $0.78 per diluted share. Included in these earnings were $0.19 in restructuring and related charges. Excluding this item, adjusted earnings per diluted share were $0.97 in 2014.

Now I will cover a few items on the balance sheet. Cash and cash equivalents were $156.9 million at the end of fourth quarter of 2015 compared to $134.5 million at the end of last year. Our debt balance was $90.7 million, up from $75 million at December 31, 2014. This increase is primarily on account of higher share buybacks.

Debt to capitalization was 24.4% at the end of fourth quarter of 2015, up from 20.6% at the end of last year. Our controllable working capital as a percentage of sales was 10.4% in fourth quarter of 2015, which represents a substantial improvement from 12.9% a quarter ago.

Cash flow from operations for 2015 was $38.6 million, up 19% compared to $32.4 million last year. Capital expenditures were $9.7 million compared to $12.9 million in 2014. We repurchased 984,000 shares of CTS stock or $18.1 million in 2015. Including the $5.3 million in dividends paid, we returned $23.4 million to shareholders during the year.

This concludes our prepared comments. We would like to open the line for questions at this time.

(Operator Instructions). Larry Solow, CJS Securities.

Hi, good morning. Just quickly on the revenue outlook, so essentially sales are I think growing 2% to 5% in your guidance range, but it's basically about flat with what your guidance was for 2015, so clearly starting from a lower base. I know you had expected mid-single-digit growth in 2016 which you're getting off the slower base, but as you look out to 2017, do you still see there is acceleration coming towards -- up to the higher single digits? And then part two of that is most of your impact is obviously from legacy products in the automotive side and then some issues in the wireless infrastructure and disk drive market. Do you see all those things combined continuing to sort of impact you going forward?

Let me try to dissect the different pieces of that. The first piece is obviously I said we're disappointed in the revenue performance. And we are working through transition in the business and repositioning of the Company. And if you look even on the external side of it, we've been going down in automotive over the last two or three years, whereas the whole markets have been up. So you see there's a trend that we are building the backlog to turn that around.

We haven't changed any of our goals for growth. You might say we're a little bit more tempered in 2016, given the economic outlook out there, but I will tell you as an indication one of the things in our plan for 2016 is we are upping our capital spend because we always said we're going to get mid-single-digits growth. Our target is to get the 10% growth with a combination of organic and acquisition, and that's still the path we are on very firmly on, we are not changing strategy. And to the last part of your question I would tell you that we obviously see softness and we are being very careful to make sure we understand it.

Communications has not been good for us. HDD has not been good for us in the last two years. We are not planning for increased sales in any of those areas, if anything, slightly lower in this (technical difficulty) give out today. And we will just step through doing all the things we said we would do with the backlog and introducing growth that will come in 2016 and further increases in growth in 2017 with the backlog we have. Hope that answers your question.

Absolutely. Just one quick follow-up on -- we discussed internal growth -- how about external growth? I know you guys have been targeting acquisition, and I realize it's sometimes things just don't come together or it's not easy to complete acquisitions.

With that said, your thoughts, you haven't been able to really do any significant or material acquisition for a couple years. Is it price is too high, you have challenges finding exactly what you're looking for, a combination of the two, any help there would be great. Thanks.

When you look back over the last three years, Larry, first year was really assessing the Company and getting our strengths in place and redirecting the strategy going forward. And obviously we went through a lot of operational changes in 2014 and at the end of 2015 as well.

So we started to refocus. We are working the pipeline, I would tell you we've got very clear targets and we continue to work in that area. It's going to be incense, connect and move and we've got a very clear priority of technologies, we want to get some regional expansion to strengthen our R&D, and we've got the right mix of things to complement the strategy.

Prices have been high and I will tell you I don't know if that's going to change because we have had economic expansion for the last five or six years, and it's easy to look back at the last 12 months' performance and is it going to be as good in the next 12 months? You get to be careful. We always said we would do the right acquisitions at the right price and valuation.

So we are not panicked, we're just going to do the right things.

Got it, great. Thanks very much.

John Franzreb, Sidoti & Co.

Good morning, guys. I'd like to start with the automotive side of the business. You've been exiting certain programs, that's my understanding, in 2015. How much did that impact 2015's revenue, and how much do you expect it to impact 2016's revenue outlook?

John, we had some older products and we had some products that we are going end-of-life and that's what we spoke to in the past. We had a range of just a few million, I wouldn't say anything substantial, $3 million or $4 million range, but the biggest issue was the backlog from prior years wasn't there, so that's why we were challenged with that as well. And we are providing market conditions stay the same going forward. We're pretty confident but our backlog -- that will be increasing.

Just so I understand, so $3 million to $4 million of 2015's revenue was a result of lower end-of-life product lines.

Yes. Actually, let me just add a bit of color to that in total.

If you look at -- we said we were down $21 million, rough-and-tough, year over year. The total automotive impact of that was somewhere just over $10 million, $12 million, and the balance of that is between HDD and frequency and communications end markets. That's roughly how we break it out here.

I'm just trying to parcel out like how much of that headwind that was older products that obviously will occur again in 2016. That's what I'm looking for there. So as long as we're on the right page you're saying $3 million to $4 million.

That's roughly the pressure we face from the older product lines in 2015 that we shouldn't see in 2016.

Perfect. And on the communications side of the business, what's the biggest headwind you are experiencing on that side of the business?

Just end markets are soft, and the demand for the products, whether it's OCXO's, VCXOs, where we've launched some new products. But we are just seeing the end markets are soft.

Okay. And are your customers telling you when they want you to ramp up at all, or is it still kind of a murky outlook there?

On the whole component side, we've got several customers working with us on RF side, on new products where we are gaining traction, we are adding new customers, and we are seeing some increases, but just the overall end market is still pretty mixed. That's probably the best way to answer it.

Okay. And your expectations for 2016, do you expect gross margin improvement as a result of A, you're exiting older products, B, you consolidated facilities, and C, I expect -- my understanding is by the end of 2016 we will have some of these new business awards we've been talking about over the years from into play. So would we expect better gross margins in 2016?

We are always looking to improve gross margins, but I would tell you we have constantly said, hey, we see ourselves in the near term to a few years out just in the low 30s. And that's still our presumption. You have got to have -- even when you launch new products in automotive, there's pricing pressures and different product lines.

So, we are comfortable with the low 30s, and we are slightly above that at the moment you might say, and maybe we'll do better. But -- as we are always focused on it. But if you're modeling off, keep us in that range.

I mean you've consolidated facilities I think so we have come, Kieran, is that the new programs the gross margin profile is lower than your current gross margin profile is. You would think with the consolidation you would have a better gross margin profile going forward.

I would say there's no big change, we have some products that are higher than that, some products that are lower than that. It's just a different mix of products. We are pretty comfortable with the low 30s on the gross margin. And of course we are always looking to improve it, and if we outperform it would be great.

Okay. And one last question. When you talk about considering Filter Sensing Technologies, the acquisition, sounded like you alluded to the R&D spend will be going up to support growth opportunities in this new IP, intellectual property. How much incremental R&D spend are we talking about in the year ahead? $2 million, $4 million? What are we thinking?

Rough and tough, John, in the range of $1 million overall. That would be where I would put it. And that will obviously continue for a period of time, not just one year.

And does that have to accelerate in order to capture that market opportunity you talked about, or is that incremental $1 million steady-state kind of number?

It's -- I tell you we are having a lot of interest, a lot of engagement on that area. If I bring in the two parties together, you've got the innovation side of it coming from FST, you've got the commercialization capability and R&D capability in customers that we have that are new customers that are talking to us. So as we win programs, we said we would expect the first new business awards in 2017.

As we add business there, you would expect two things. Number one, we would actually increase our R&D spend in that area, and of course because of the IP and certain things we may get funding from customers as well. So that's yes, we'd play it out. But it will increase as we win.

Thank you for taking the questions, I will get back into queue.

Ian Gilson, Zaks Investment Research.

Good morning, gentlemen. I've got a few small questions. Are we done with the termination of the UK pension plan as far as extra costs are concerned?

Yes. For all practical purposes, the UK pension plan transition is completed. We handed it over to the insurance company in December of 2015.

Okay. In your currency adjustment, does that include any devaluation of the current reserves held in China, or outside the US?

Yes. In 2015, we recorded the translation impact on both the euro as well as the RMB. And the largest part was as a result of the balances, the net asset exposure we have in China.

Okay. So having repatriated or paid yourself a dividend from China, would we expect the currency impact to be slightly less going forward?

That is our expectation. I mentioned in my commentary that we are going to dividend money from China to the extent permitted under local law. There are limitations on what we can dividend. So to that extent, yes, we will be exposed to a smaller number but there will be some -- still some exposure to currency rate movements.

Okay. So we would expect, say, a continuation of a higher tax dollar number as we look into 2016?

Yes. As a result of the moving money out of China we will see a slightly higher tax rate going forward. On an adjusted basis we are around 30% in 2015, and I would expect that rate to go slightly higher in 2016, in the neighborhood of 31% to 32%.

So looking at the numbers, the tax is accrued on the income statement for almost $13 million, correct?

It was actually $8.8 million, and that relates to the cash that we are moving out of China as well as the repatriation of money from Canada and the UK.

The China portion is not the entire $8.8 million, and so basically the Chinese earnings will be subject to a 10% withholding tax.

Okay. So -- so a portion of the $13 million tax must have been based on some profits outside the US? Or where does the after-tax come from?

I'm trying to get to the $13 million number that you are considering.

I'm looking at the income statement for the three months ended December. And I have an income tax line of $12.974 million.

Right. So $8.8 million of that is the taxes related to China and UK and Canada. And there was an additional charge that we took for some provision on NOLs that we will not be able to utilize going forward.

So there was a charge of $2.5 million related to that, which I mentioned earlier in my script. And the rest of it is the normal tax that you would have on earnings.

Okay. As we look in the progression of business during the year, and the discussions about the automobile industry coming out of Ford, General Motors and they are looking for a -- poorer business climate, is your growth likely to be biased towards the second half of the year?

We modeled the year rough and tough if we look at automotive markets, I would say North America in the region of 3% rough and tough, and Asia China, China more like 4%, Europe somewhere in that range as well. That's how we are seeing it. I think if you look at North American markets you'll see that the days on hand have increased up to about 60 days of inventory.

And we know that we've talked about it before, that the automotive industry has obviously been on the run for some time, and we think it's still not going to fall off a cliff this year. But it certainly is getting to the point where some transition will happen in the years ahead.

I believe that Ford, although they did report an excellent fourth quarter, was talking about 2% growth for this year.

That may be Ford, but you look at the consensus of all the different customers end market analysis out there, it's more in the 3% plus range.

Maybe they're just being conservative. All right, thank you very much. (multiple speakers)

(Operator Instructions). Hendi Susanto, Gabelli & Co.

Good morning. If I may revisit the (multiple speakers) question, what growth profile do you assume in your 2016 guidance as we go from one quarter to another in terms of overall sales?

Could you repeat your question?

What growth profile do you assume in your 2016 guidance as we go from one quarter to another in terms of overall sales?

I'm with you. We would see just second half being a little bit stronger than the first half, overall. And usually we have some softness in the third quarter due to the shutdowns with OEMs and different things. And as you heard earlier on, we are putting in some new capital extra capital this year as we prepare for launching products and things we've been working in the pipeline.

Okay. Kieran, CTS has been working hard to reposition its growth starting in 2017. How should we think of your business awards comp positions and growth opportunity among the three areas sense, connect and move? Are they equal in terms of growth opportunity or were there one or some are bigger growth drivers that we can expect in 2017?

I would say the biggest growth area is the sense, and that covers a few of the different product lines, not just automotive. And the other side of it is as the motion, or move, which really refers to actuation. And they are probably the strongest two areas, and the connect is taking a little bit longer.

Got it. And then you mentioned that investment in R&D will go up in 2016. What should we expect on sales and marketing? Should we expect higher investment in that space as well, and then the higher dollar amount?

Maybe some very minor increases, but typically I think we've run around just around 4% sales and marketing.

Overall, the SG&A expenses are going to be somewhat in line with 2015 numbers. But maybe some small increases but nothing significant for your modeling purposes. And R&D expenses as we talked about will be higher in 2016.

Typically we've looked at 6%-ish of sales as our guideline for R&D, we have been running slightly lower, but we are talking about increasing spend for 2016.

And how much cash do you intend to bring to US, and how should we think of the timing and allocation towards share buyback? How do you (multiple speakers) that decision?

So the UK and Canada are the countries that we have given up preliminary investment assertion. I am expecting somewhere in the range of $30 million to $35 million of cash back to the US. And the cash will be available to us as I mentioned in my script for acquisitions, buybacks, repayment of debt and we will continue to look at the best opportunities for us to utilize that cash.

And when you bring that $30 million to $35 million, how much tax do you expect likely be able to utilize going out against that full amount or should we expect some tax payment?

So the particular amount will be pretty much mostly non-cash tax charge for the US. We've already accrued those expenses but they are mostly non-cash as far as it relates to the US taxes. We will be in a zero NOL position going forward, and as we change the assertion of foreign taxes paid from deductions to a credit in the second quarter, we will still not anticipate cash tax liability in the US since 2016. Does that answer your question?

Thank you, Ashish; thank you, Kieran.

(Operator Instructions). It does appear there are no further questions at this time. Mr. O'Sullivan, I would like to turn the conference back to you for any additional or closing remarks.

Thank you, Jessica. Obviously I just want to repeat again we were disappointed in our topline performance, but we are very much still on strategy in terms of repositioning and growing to the targets we talked about in other earnings calls, and we look forward to giving you an update on the next quarterly report. Thank you for your time today.

This concludes today's conference, thank you for your participation.