CTS Corp (CTS) 2016 Q2 法說會逐字稿

Good day, and welcome to the CTS Corporation's second-quarter 2016 earnings conference call. Today's conference is being recorded.

And now at this time, I will turn the conference over to Kieran O'Sullivan. Please go ahead.

Thank you. Good morning and thank you for joining us today, and welcome to CTS's second-quarter 2016 conference call. Our new business wins were robust for the quarter. We continue to improve our margins. The integration and performance of our recent Single Crystal acquisition is on track and performing to our expectations.

We made a significant reduction in our debt in the quarter while maintaining our focus on the execution of our strategic goals. Sales growth is our biggest focus, both organic and through M&A, to realize our growth around products that sense, connect, and move.

As we've discussed in prior calls, we continue to experience headwinds in recent quarters due to declines in the HDD market and certain other components. This continuing challenge is built into our guidance.

In June, we announced further footprint simplification with the relocation of manufacturing from our Elkhart facility. This was a difficult decision as it impacts 230 employees who have contributed to the success of our Company. The transition is not expected to impact jobs until early 2017.

We will maintain a strong presence in Elkhart for R&D in the facility, and continue to invest in our R&D teams. This restructuring will have some savings impact starting in late 2017, with the first full-year benefit realized in 2019.

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

Thank you, Kieran. 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 discussions refer to any non-GAAP measures relative to Regulation G, the required explanations and reconciliations are available in the Investors section of the CTS website.

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

Thank you, Ashish. Here are some highlights for the quarter. New business wins for the quarter were $135 million, up from $118 million in the first quarter of 2016. Sales were $98.7 million for the second quarter, slightly down from the first quarter when we exclude sales from the Single Crystal acquisition.

Gross margins were 34.9%, an improvement of 30 basis points from the first quarter. Diluted EPS was $0.44, which includes a $0.21 net gain related to the sale of our Canadian building. This was the last step in our transition from this manufacturing location.

Adjusted EPS for the second quarter was $0.26, the same as the first quarter. We moved $23.5 million of cash to the US and used it to pay down our debt. We reduced our debt by $30.5 million during the second quarter, and improved our debt to capitalization ratio to 26.8% in Q2, down from 32.9% in Q1.

As mentioned earlier, new business awards were $135 million for the quarter. Automotive products accounted for $105 million. We had several pedal wins in North America, Europe, and Asia with existing customers. We also won several programs for sensor products, including right height sensors and belt tension sensors in North America and Europe.

On the components side, we secured $30 million in new business across our piezoceramic and electronic component products, which included adding a new telecom customer for RF products. In total, we added five new non-automotive customers for the quarter. Our year-to-date new business awards now stand at $253 million.

The integration of the recently acquired Single Crystal technology is on track. The transition is going well with our customers. You can expect a small improvement in the sales run rate going forward as we ramp up sales of the new product.

Our teams are working well together, focused on the integration, operational improvements for this new technology, and most importantly, securing next-generation business awards. We continue to expect modest EPS accretion in the second half of 2016 and stronger accretion in future years as the product lines grow.

The execution of our strategy to realize growth around products that sense, connect, and move, is important for the successful repositioning of CTS. To this end, we are focused on a few key areas. Our first priority is always our customers and our customers' needs. We are continuing to expand regionally and have added new OEM customers in Europe. Our new website provides our customers better insight into our products and capabilities.

New product development is essential to support organic growth. On the innovation front, we have several projects running in the area of new sensors and actuators. Over the last two years, we have expanded our capabilities in piezo from one technology by adding Single Crystal through M&A and internally developing tape cast processes.

We developed RF filter products that are now through qualification with a new telecom customer. We launched a new pedal platform and plan to begin shipping in the second half of 2017. And we acquired new RF sensing technology for vehicle after treatment. We expect to bring you more news regarding innovation success in the quarters ahead.

On the operations front, we continue to focus on footprint simplification and utilization, and we're also working on improving our R&D effectiveness. Process and system improvements are also important as part of our advancement. The first few years were focused on improving working capital, down from 18% to 12%. We have implemented a new financial consolidation tool and a CRM tool, and our next steps will be to replace our ERP system beginning later in 2017.

Our people are at the center of advancing and realizing our strategy. We are carefully modernizing our culture and talent development programs across CTS. And over time, we will look to enhance our organizational effectiveness. These highlights should provide you some insight into the next stages of the development of our Company.

Looking to our end markets, we continue to see softness in the HDD market. Shipments were down sequentially for the last two quarters. Telecom and industrial markets remain soft as well. Automotive remains steady, and we continue to monitor on-hand days of supply in North America and Asian markets, which have increased. According to IHS, overall global automotive production is expected to grow from 88.7 million units in 2015 to 91.6 million units in 2016.

We continue to strengthen our M&A pipeline. Our goal is to carefully advance our end market profile in the years ahead while adding the right regional and technology fits to complement our business growth. Our guidance for the full-year 2016 remains unchanged. We expect sales in the range of $390 million to $410 million, and adjusted earnings-per-share in the range of $0.95 to $1.06. This includes the Single Crystal acquisition and excludes foreign exchange impact related to balance sheet translation.

On September the 8th, we will host an Investor Day in New York, where you will also have the opportunity to see some of our innovative new technology. I hope to see you there in person.

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

Thank you, Kieran. Second-quarter sales were $98.7 million, down slightly compared to the same quarter last year. Foreign currency impacted sales unfavorably by $400,000 in the second quarter. The Single Crystal acquisition contributed $3.1 million in sales in the second quarter.

Gross margin for the second quarter was 34.9%, slightly better than the 34.6% in the first quarter. Year-over-year, gross margin expanded by 160 basis points. We remain focused on execution and continue to make progress on efficiency gains and cost productivity. In addition, foreign exchange rates had a favorable impact on manufacturing costs in the second quarter as compared to the second quarter of 2015.

SG&A expenses were $15.8 million in the second quarter of 2016 compared to $15.2 million in the second quarter last year. Included in the second quarter is an increase in SG&A and amortization expenses as a result of the Single Crystal acquisition. Sales and marketing expenses were slightly higher. This increase was partially offset with savings in other general and administrative expenses.

R&D expenses were $6 million in the second quarter 2016 compared to $5.5 million in the same period last year. This increase is in line with our goal to continue investing in new products to drive organic growth, as Kieran highlighted.

In second-quarter 2016, we sold our building in Canada and recorded a pretax gain of $1.1 million net of costs related to the sale. Interest expense increased in second-quarter 2016 versus the same quarter last year, primarily due to higher borrowings related to the Single Crystal acquisition.

Interest income in second-quarter 2016 was lower than last year due to lower cash balances in China. As the US dollar appreciated considerably in the second quarter, we recorded an expense of $1.3 million related to balance sheet translation losses. In the recent quarters, balance sheet translation gains and losses have impacted our financial statements. To provide more clarity on operating results, we have excluded this impact in our Q1 and Q2 2016 adjusted results, and will continue to do so going forward.

Our effective income tax rate in the second quarter of 2016 was 34.7%, which reflects the change in the mix of earnings by jurisdiction as well as the impact of discrete items. Our second-quarter 2016 GAAP earnings were $0.44 per share. Included in this number is a $0.21 gain on the sale of our building in Canada, net of costs related to the sale.

We also had a $0.03 unfavorable impact related to foreign currency balance sheet translation losses. Excluding these items, adjusted earnings per diluted share were $0.26 in the second quarter of 2016.

I'll now cover a few items on the balance sheet. Cash and cash equivalents were $119.9 million at the end of second quarter of 2016 compared to $156.9 million at the end of 2015. Our debt balance was $110.8 million, up from $90.7 million at December 31, 2015. At the end of the first quarter of 2016, after the Single Crystal acquisition, our debt balance was $141.3 million.

In the second quarter, we reduced our debt by $30.5 million. As Kieran already mentioned, this was achieved partially by moving $23.5 million from Canada to the United States. As a result of the reduction in debt, our debt to capitalization ratio was 26.8%, down from 32.9% at the end of the first quarter and up slightly from 24.4% at the end of last year.

Our controllable working capital as a percentage of sales was 11.8% in the second quarter of 2016 compared to 11.9% a year ago. The second-quarter 2016 controllable working capital includes balances from the Single Crystal acquisition. Cash flow from operations for the second quarter was $13.4 million versus $15 million in the second quarter of last year. Capital expenditures were $4.6 million compared to $2.7 million in the second quarter of 2015.

In the second quarter, we expanded the size of our credit facility from $200 million to $300 million. This extra line of credit gives us more flexibility for future organic growth investments and to fund M&A activity.

In the second quarter, we announced the relocation of production from Elkhart to other existing locations and restructuring at some of our other facilities. The total cost of this project over the next two years will be in the range of $16 million to $18 million, and savings are expected to be in the range of $6 million to %8 million per year.

The production transition is expected to begin in early 2017. As Kieran already highlighted, we expect to see some earnings improvement starting in late 2017. The first full-year impact of savings is expected in 2019.

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

(Operator Instructions)

Jake, before you take the first question, I just want to highlight that we sold the Canada building and recorded a pretax gain of $11.1 million.

(Operator Instructions) Larry Solow, CJS Securities.

It's actually Robert Majek filling in for Larry this morning. I was hoping you could just give us a little more color on the reason for the 5% decline in automotive? And then with auto being flat to slightly down year-to-date, do you still feel like you can achieve the low-to-mid single-digit organic growth for the year?

Yes, the -- you're talking on the year-over-year? Because quarter-over-quarter, we weren't down that much.

There's just some mix changes, we said before, in terms of the products that were going -- some products going end-of-life, some products transitioning for the future. And to give you a better color on the overall -- first of all, to answer the second part of your question -- the growth rate going forward, we feel will be in the low-single digits on an organic basis. Obviously, that means there's something happening in the second-half to drive that.

Overall, on the sales side, just to give you more color, we were down just a [few-hundred-thousand] from the quarter. HDD has been a headwind for us. We've had declines of more than 20%.

I would tell you on the other products, we've had some softness -- a little bit of softness in commercial vehicle, which is classified under automotive as well. And then, as we've talked about in the last few quarters, some older products that we are not investing in on the component side, like resistor networks.

In the non-HDD piezo, we're strong -- up almost double-digit. We are up in our frequency products. And you can tell from the capital investment, we are putting some capital in place for products that will launch next year as well.

That's very helpful. And looking out further, with the outlook for auto being a bit more shaky, including recent warnings by Ford, can CTS still grow sales in a slowing or potentially contracting auto market?

Well, first of all, I saw the Ford news yesterday and we are still comfortable with our guidance.

And secondly, we've been gaining share in some other markets. So, in Europe, we've been adding new customers. So in a downturn in the overall automotive market, we would obviously take some headwinds, but we'd be taking some growth as well with share that we are taking.

Okay. And last but not least for me, we are looking forward to your Analyst Day in September. Without stealing your thunder, can you give us a preview or teaser of the topics you will discuss?

We'll be talking about the new technologies, where our growth is going to come from, and really giving people access to the management team in full, in terms of here's the products, and showing you the technology, so you get a deeper insight into where our focus is around sense, connect, and move.

Okay, I appreciate it. I'll jump back in the queue.

You're welcome.

John Franzreb, Sidoti & Company.

Just to stick on that automotive theme here. Last quarter -- the first quarter you were up -- you commented that new products were filling in for end-of-life products. Now it seems, this quarter, that's not the case.

Last quarter, you talked about -- you expected auto -- your auto sales to be up year-over-year. Is that still the case with the mix in the first half? And could you just talk a little bit about what changed in Q1 versus -- I'm sorry -- Q2 versus Q1 that you were down year-over-year?

Overall, John, first of all, we expect our auto business to be up year-over-year. So you'll see some changes from -- you're correct -- from Q1 to Q2. And a little bit of -- seeing a little bit of softness in some commercial vehicle. Obviously, we had some other changes going on in the Company as we announced some changes across the organization. And -- but we're pretty confident the run rate is looking good for the second-half -- quarter by quarter.

Okay. Can you talk a little bit about the SG&A line? It was up pretty sizably, at least relative to my expectations, in the second quarter. It tracked similarly a year ago, and then -- and tapered off in the second-half. Can you talk a little bit about what we should be thinking about SG&A expenses going forward?

John, I'll handle that. The SG&A expenses that you saw in the second quarter should be fairly representative of what we expect them to be in the second-half. We have added the Single Crystal acquisition. We have pretty much finalized the valuation analysis, and the numbers reflect the ongoing depreciation and amortization expenses related to that business as well. So, that should be fairly representative.

Okay. And we've been peppering you on this topic for, I guess, a couple of quarters now. The gross margin profile -- I thought it was actually spectacular. But you've kind of thrown cold water on the sustainability. One of the things you suggested was that the acquisition would pull it down, and then you would get a bump after some of the inventory write-off was gone.

So, where do we stand in that process? Do you think that the gross margin profile has been reset at a more improved level? Can you give us a take on that?

So, John, you are right about the Single Crystal, that it was having a little negative effect. And obviously, as we go forward, it will be more positive. We started to see signs of that already. And, as we said before, the margins are strong.

I think we've been cautious a little bit on the gross margins because we've -- a lot of simplification going on across the Company; moving products and making sure we are putting in safeguards for our customers. And obviously, I've got to take my hat off to the teams. They've been executing really well, and we've performed at the top end of the range. So -- and we'd like to keep performing at that level.

One thing I would just add to that, John, we do have some tailwinds from FX rates. And that also has upped our gross margin numbers.

How much was the impact of FX in gross margins?

John, the way we have talked about it is, on the sales line, we do talk about the exposure and we had a $400,000 unfavorable impact on sales. At the operating earnings level, it's next to negligible. So, overall, we do have a favorability that flows through gross margins. We do have production in Mexico as well as in China, and those currencies have depreciated considerably against the US dollar.

I'm sorry -- so was FX favorable or unfavorable to gross margins in the quarter?

FX was a favorable impact on the gross margin line. On sales, it was unfavorable.

Okay. And one last question. The restructuring, it's kind of sizable. I'm actually curious about the long tail that you are putting out there for realizations of the gains. 2019 is -- if I heard you correctly -- was the first time we'll see any meaningful impact. Why is that the case?

So, Ashish can comment in a second, but we've got some -- I think in some of the other restructurings we've done, we've completed most of the transfers within one year. In this situation, we have products that are being transferred, and also products that are there that were coming in for launch and were having to have more moving parts.

And also, these are right in the center for some of our bigger customers. And we want to make sure we are putting the right loading in as we move forward. So trying to stage it.

And you can comment on the savings, Ashish.

Sure. John, we do expect savings to start in the second-half of 2017. 2019 is when we expect to see the full impact for the full-year. So, part of the transition go through 2018, the middle of 2018. That's why you won't see the full impact until 2019.

So, Ashish, how much do you expect to realize in the second-half of 2017?

Some of those details we are still working through, John. The line moves are still being planned in coordination with our customers. So we'll have more clarity on that as we work through it in the second-half of this year.

Okay. I'll get back into queue. Thank you.

Thanks, John.

(Operator Instructions) Hendi Susanto, Gabelli & Company.

So Kieran, how should we think of the second-half outlook in terms of your revenue guidance? What is the case for the high-end revenue guidance? And what is the case for the lower end of the revenue guidance?

I would tell you, Hendi, that getting to that high-end of the guidance on the revenue side is -- I don't see it; I see us more at the middle to -- middle of the guidance to a little lower, and markets would have to be very strong. HDD would have to come back really well, and I don't see that happening in that market at the moment.

I know that Western Digital reported yesterday, and other customers, and I haven't had the chance to read the reports. So, we are in the low-single digit growth rate for the year in total.

Okay. And then, Kieran, you mentioned that HDD would -- was weak. Should we expect weaknesses in HDD to be the case for the rest of the year? Or do you expect some, like, slight improvement?

We expect -- our guidance includes that HDD is weak. And I would tell you, Hendi, as we look out at the growth of the Company over the next several years, two or three years, we've really looked at that and said, hey, we're going to dampen our expectations and still grow.

Okay. And then the press release mentioned that sales of electronic components were up 2.4%. HDD was weak. I'm wondering which end markets saw positive growth in Q2?

Yes, mostly -- some of them were on our OCXO products, frequency products. So they go into some communications, some industrial applications. And then also our non-HDD piezo products, which go into military applications, going to medical applications -- we're doing pretty well. We've seen very nice growth rates there, but being offset by the HDD headwind.

I see. And then, Kieran, you -- in the past, you stated that 2016 will be a transition year, and then growth would start in 2017 in light of macro and in current market environment. How much expectation should we have for growth in 2017 based on your business awards and backlog?

We are targeting mid-single-digit growth on an organic basis, and we want to complement that with acquisition. We've -- obviously it's got to be the right acquisitions. We've always said we are targeting an overall growth rate of 10%. We haven't backed off on that, but we're not going to do -- rush into any acquisitions. We've got to have the right ones to make that happen.

Okay. And then -- yes.

And then on the market side, the numbers that Kieran just talked about, that assumes a relatively stable market position.

Okay. And then, Kieran, if I compare the business awards that you got in the first-half of the year, 2016 versus 2015? 2015 is significantly higher than 2016. How should we review those?

Yes. Hendi, we track that very closely. When we look at it, we are roughly tracking about 5 or 6 points -- percentage points behind where our goal would be. It's all a matter of timing. Some OEMs decide to award things, and we've had one or two contracts that slipped, that we thought were going to be awarded this quarter but slipped into the next quarter.

Got it. Yes. And then, Ashish, you mentioned about the tax rate. There is some slight difference in earnings jurisdiction. For modeling purpose, what tax rate should we use?

Hendi, for the rest of 2016, I'm expecting our tax rate to be in a similar range where we are right now. It has increased from the last year. And we will be looking at things from an overall perspective in terms of how we sustainably bring it down. But we are not there yet.

And then may I know how long it may take?

(laughter) My goal is to have some work done on that in the second-half. So, hopefully, we should be able to provide you more clarity towards the end of the year.

You saved me a question, Hendi. (laughter)

Thank you.

Thank you, Hendi.

Ian Gilson, Zacks Investment Group.

If we look at the operating margins before restructuring, impairment and other nonrecurring items, and the second-quarter actually was down; now also, if you take out the $3.1 million from the Single Crystal revenue, your revenue was down close to 4.5%. What can we look for going forward on the traditional side of the business? And what would the growth be in the Single Crystal part of the business?

You want to take the operating income and I'll take the last question?

So, operating earnings, Ian -- actually once you exclude some of the items, the unusuals, the gain on the sale of assets and things like that, we are better than last year. But sorry, excuse me. We are just about on par but on lower volumes, so the percentages are better, improved from last year.

And on the sales side, we are looking at the sales being down, as we have talked about historically. On the automotive business, we saw some product lines go end-of-life, and the ramp-up is happening in 2016. And we have had challenges with HDD as well as some of the telecom market-related product lines in our product portfolio.

Kieran, did you want to add something to that?

Yes. And then just, on a go forward basis for your question, we see, for the balance of the year, low-single digits, organic growth in the base business. And we see on the Single Crystal -- as we've said, I think, when we announced the acquisition -- a double-digit growth around 10%.

Okay. So, $3.1 million -- was that -- I can't remember the effective date of the acquisition. Was that for the full quarter?

March 11 was the effective date of the acquisition. The $3.1 million in the second quarter is for the full quarter.

Okay. Is that a seasonal business? Or do we basically have modest growth sequentially looking forward?

Kieran talked about a product line ramp-up in that business that will contribute partially to it. We don't expect significant seasonality in this business, Ian.

Okay. And last question I have is on the interest expense line. Well, you've taken a significant piece out of the debt line, and return on cash is very, very small. Could you go through why the interest expense has increased so much?

Last year -- compared to last year, our debt balances are higher, and that's the primary driver of the interest -- increase in interest expense. The (multiple speakers) [total] last year was $90 million.

The first quarter, the interest expense was $820,000, and the second quarter, it was $1,009,000. But your net debt went down significantly. What are looking at going forward? Closer to (technical difficulty) $820 million or closer to $1 million?

Yes. So, Ian, if you look at the timing of when the debt went up in the first quarter, the acquisition was closed on the 11th of March. So that you don't see a huge impact of the interest expense increase in Q1, and we see most of that in Q2.

And we paid down the debt relatively close to the end of the quarter in the second quarter. So I expect the interest expense to come down slightly from the second quarter level.

Okay, that's great. Thank you very much.

Hendi Susanto, Gabelli & Company.

You mentioned that you are going to have a new ERP. How much increase in CapEx should we expect out of the new ERP implementation?

So, Hendi, in the past, we have talked about a relative range, and it's a pretty broad range at this point in time. One of the other things we are working on right now is scoping that out. And I expect it to be well north of $5 million, but I'm not expecting it to go significantly north of $10 million.

So I know I'm giving a pretty broad range, but that's where I expect it to be. And once we get the numbers finalized, we can talk about it a little bit more in detail.

And we talked about this for a number of quarters in the past, as well, saying that this is on the radar and coming. And obviously the timing is linked to the simplification of the footprint, so that we are doing it in the locations that are relevant.

So, we can expect that CapEx in 2017 will be higher by that amount?

2017 and 2018.

Okay, 2017 and 2018. Got it. Thank you.

Ian Gilson, Zacks Investment Research.

Could you give us the cash flow for the three groups -- Operations, Investments, and Financing -- on a six-month basis?

Could you repeat your question, Ian? I just want to make sure I got it right.

Yes. Cash flows -- where you have cash flows from Operations, that flows from Investment activities. That's primarily (technical difficulty), and cash flow from Financing. What were the gross numbers for those?

It will be included in the Q that we will file later on today.

Oh, okay. That's fine. I pulled up the 8-K and there was nothing on there, So, but if it's coming in, I will get it from that. Okay, thank you very much.

All right.

And with that, I'll turn the call back over to Mr. O'Sullivan for any closing remarks.

So, thank you for your participation on today's call. We are busy and back to work here. Hope you have a good day. Thank you very much.

Now that, ladies and gentlemen, does conclude your conference for today. We do thank you for your participation. You may now disconnect.