CTS Corp (CTS) 2018 Q1 法說會逐字稿

Good day, everyone. Welcome to the CTS Corporation First Quarter 2018 Earnings Conference Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Kieran O'Sullivan. Please go ahead.

Good morning. Thank you for joining us today, and welcome to CTS First Quarter 2018 Conference Call. The following are some notable items for the quarter.

The first quarter sales were $113.5 million, up 13.4% from the same period in 2017. Gross margins were 33.9% compared to 34.2% in the same period of last year. Adjusted earnings per share were $0.34 compared to $0.26 in the first quarter of 2017.

Total booked business increased to $1.76 billion. Operating cash flow was $20.2 million in the quarter, up from $9.8 million in the same period last year.

The transition of manufacturing operations continues with the consolidation of the Bolingbrook site to our Lisle location expected in the third quarter and the end of production in Elkhart in the second half of 2018.

Ashish Agrawal is with me for today's call, and will take us through the safe harbor statement. Ashish?

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 Investors section of the CTS website.

I will now turn the discussion back over to our CEO, Kieran O'Sullivan.

Thanks, Ashish. First quarter sales were $113.5 million, up 13.4% compared to the same quarter last year. Our organic growth rate was 10.8%. We are pleased with the sales improvement, driven by our teams globally.

Gross margins were 33.9%, which is below our expectation for the business. As you are aware, we are transferring products from our oldest location, which has been in production since 1902. Given the resident institutional knowledge, we've implemented extra controls and incurring in -- incurring additional costs to ensure we protect our customers and train our teams for longer periods at the receiving sites. And this has impacted our margins, and we expect to see improvements as we complete the transfers.

As always, we continue to focus on operational execution and quality, which are foundational for a manufacturing company.

We are gaining traction with sales growth. We shipped our filters to 5 new customers with applications primarily in small cell wireless systems. Revenue for new filters is expected to be in the range of $3 million to $5 million this year. We added a new customer for our EMC product line with an application in heavy transportation where we expect revenue of $500k this year.

In accelerated pedals, we added 2 new customers in China with future annual revenue of approximately $1 million.

In the communications market, we secured design wins for frequency products in several applications, including cellular base stations. We recently began shipments to a U.S. OEM of a new wireless cardiac stimulator using our single crystal material. The single crystal elements are the size of a needle tip and are incorporated in the cardiac implant. This piezo element receives ultrasonic energy from an external source and transforms that energy into electrical current, enabling the pacemaker to function. The reduction of wires represents a significant step forward in simplifying the medical procedure.

This medical pacemaker technology is currently approved for use in Europe. In March of 2018, our customer announced the start of clinical trials in Australia and in the U.S. with the goal of obtaining FDA approval.

Initial revenue this year amounts to $0.25 million. We are working to further advance the application of our single crystal technology, such as reducing the size and improving the performance of hearing aids. We ended the quarter with a total booked business of $1.76 billion, up from $1.74 billion at the end of 2017.

Our order backlog increase was primarily driven by 5 wins for accelerator pedals with 2 wins in North America, 1 win in Europe and 2 new customer wins in Asia.

We have 4 platform wins for sensors in Asia and North America, primarily for passive safety applications.

One customer increased its forecast for actuators. And in electronic components, we renewed a contract for a microactuation application in industrial printing.

At the end of last year, we announced the signing of a long-term agreement to provide piezoceramic product for a device security application with expected low sales in 2018. We now expect sales of approximately $1 million for 2018 and expect sales to increase in subsequent years. We will update you on our progress.

The development of our sensor for soot and ash measurement and exhaust aftertreatment systems for heavy vehicles continues to advance with sample shipments to customers.

We see a heightened interest in the technology in terms of performance and onboard diagnostic enhancements compared to today's delta pressure solutions. The onboard diagnostic capability is enhanced by our RF sensor's accuracy through direct measurement and enables real-time performance measurement and early failure detection.

Performance enhancements include improved fuel consumption, reduced emission system cost and a reduction in warranty expenses as a result of increased system robustness.

The California Air Quality Board recently proposed the doubling of the warranty period for heavy vehicles, which is likely to drive a focus on managing warranty costs over time.

We continue to target for the progress in our end-market profile in line with our strategy for profitable growth with technologies and products that sense, connect and move. We're also working our M&A pipeline to meet our growth objectives with a continued focus on international expansion.

We are closely monitoring the recent activity on tariffs in aluminum, steel and other components. Our current view is an impact of less than $0.5 million, and we expect to take offsetting actions to address these headwinds.

Our end markets are stable. Automotive volumes remain steady and are expected to be in the range of 16.7 million to 17.2 million units for North America, 22 million to 23 million for Europe and 28 million to 28.5 million for China.

Even with this current high confidence, we expect some headwinds in North America volumes in the next 24 months.

Medical and defense markets remain robust, where we grew 36% in medical and 10% in defense.

Our guidance for full year 2018 remains unchanged. We expect full year 2018 sales to be in the range of $435 million to $455 million.

Adjusted earnings are expected to be in the range of $1.32 to $1.44.

I'll hand over to Ashish to take you through the results in more detail. Ashish?

Thank you, Kieran. First quarter sales were $113.5 million, up 13.4% versus the last year.

Foreign currency rates impacted sales favorably by $2.8 million. Organic sales growth was 10.8% year-over-year excluding sales from the Noliac acquisition. Sales to automotive customers increased by 11.9% and sales of electronic components increased by 16.2%.

Our gross margin for the first quarter was 33.9% compared to 34.2% in the first quarter of 2017. As Kieran mentioned, we are taking a cautious approach with our product transfers and incurring additional costs to protect our customers. We expect to see improvements in margin as we complete the transfers.

SG&A expenses were $17.4 million or 15.3% of sales in the first quarter of 2018 compared to 15.2% of sales in the first quarter last year. Included in SG&A expenses is the increasing cost from the Noliac acquisition and an unfavorable impact from noncash pension expenses. R&D expenses were $6.5 million in the first quarter 2018 compared to $6 million in the same period last year.

Our effective income tax rate in the first quarter of 2018 was 24.5%. There were certain discrete items that reduced our tax rate in the first quarter. Our updated expectation for our tax rate for 2018 to be in the range of 24% to 27% excluding discrete items. This is slightly better than our previous estimate. We continue to work on opportunities to improve our tax rate beyond 2018.

Our first quarter 2018 earnings were $0.34 per diluted share. Included in this number is a $0.03 charge for restructuring expenses, $0.01 charge for costs incurred related to various tax projects and a $0.04 gain for foreign -- from foreign currency impact of balance sheet translation. Excluding these items, adjusted earnings per diluted share remained $0.34 in the first quarter of 2018, an increase of 31% compared to the first quarter of last year.

Now I'll discuss the balance sheet and cash flow. Cash and cash equivalents were $121.4 million on March 31, 2018, compared to $113.6 million at the end of 2017. Our long-term debt balance was $74 million, down from $76.3 million at December 31, 2017.

Our controllable working capital as a percentage of sales was 12.3% in the first quarter of 2018, down from 13% a year ago. Consistent with prior communication, included in our controllable working capital is the safety stock related to our manufacturing transfers. We expect to work our inventory levels down towards the end of 2018 as we complete the manufacturing transfers.

Cash flow from operations in the first quarter was $20.2 million, up from $9.8 million in 2017. Capital expenditures were $6.9 million. As we have communicated in the past, we expect 2018 CapEx to be in the range of 7% to 9% of sales. The various projects are on track, and we expect to return to more normal levels of CapEx beyond 2018.

Our debt-to-capitalization ratio was 17.2% compared to 18.2% at the end of 2017. The ERP implementation project is progressing. Our team is working hard to design and test the system. We expect to roll out the SAP system to our sites in phases, starting in the third quarter of 2018.

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

(Operator Instructions) We'll have our first question from John Franzreb with Sidoti & Company.

A couple of questions here. First, I don't know if I missed this number, but the -- could you give me the impact of what you're doing as far as facility rationalization on the gross margin? How much of that was in the quarter? And maybe just talk a little bit about what you're doing that's actually weighing down the gross margin?

John, what was the first part of your question on gross margin? I just want to make sure I heard it.

What was the absolute number, if I heard it?

I'll just give you the commentary. Ashish, you can follow up the absolute number there. But John, we're transferring products. The site's been there since 1902. We've gone through a number of manufacturing transitions. And with the institutional knowledge and experience, we've had to put in some extra costs and controls, and really make sure that we're doing the right thing to protect the customers and train the receiving site. So as I said in the prepared comments, this will be part of the transition and you'll see our margins improve as we go forward. And the absolute number was...

There was an impact of several hundred thousand dollars, John. We expect improvements as we go through the product transitions more in the fourth quarter and a little bit in the third quarter as well.

Okay. So you're going to incur another $700,000 in or on or about Q2 that diminishes by Q3 and essentially gone by Q4, is that what we're thinking here?

John, I said several hundred, I didn't say 700. But I would expect depressed margins may be in the second quarter to some extent, and then better recovery in third and fourth quarter.

Got it, Ashish. And in addition, it looks like the revenue profile in auto sequentially Q4 was roughly 12%, Q3 was roughly 7%. How much of that is increased volume or market penetration? And how much of that is FX benefit?

John, on the whole market side of it, most of the growth, if you look at it, we break it into 3 buckets, I would say. We'd one customer, which we had significant increase in demand. We also have the share gains we've talked about for the last number of quarters and we had the market yield slightly flat to a little bit up. The FX impact...

Yes. John, the FX impact that I talked about in my comments, most of that is related to the auto market. So the total impact was $2.8 million.

Right, right, okay. So that's all automotive. Got it. So that also suggests that you had another really good quarter in electronics business, 16% of growth versus 3Q of roughly 13%. Could you just talk -- highlight what's the biggest driver in that growth?

Yes, a few things, John. First of all, the organic growth rate was about 8.5% when you back out the Noliac sales. And probably 4 things driving the growth there: the medical markets with single crystal, we see good growth there. Also, we continue to make gains in defense. And industrial printing and RF filters continues to build momentum.

And we'll have our next question from Hendi Susanto, Gabelli & Company.

Kieran, first question. You see any potential impact of some political discussions with regard to the China-U. S. trades?

What we highlighted there was the impact on tariffs and everything else. We've cited up in total at about less than $0.5 million, Hendi. And we have some offsetting actions as well. So we feel pretty good there.

Okay. And then, second one...

Hendi, let me just clarify. The -- this is based on what is in place today. If there are further actions from either of those -- either from the U.S. or from China, then we could have a bigger impact that we would need to assess when we get better clarity on what those changes are.

Okay. And then looking at your manufacturing footprint, the best cost manufacturing location, I think, the target is 80% post the current restructuring. I would like to revisit that, whether it's still like 80% by mid-2018? I'm wondering where it will be by the end of 2018? And where it is in 2019?

So Hendi, we always said, we would target 80%. We're on good track, and hopefully, do a little bit better. But we feel good about it.

It should be over 80% when Elkhart transition is completed.

Okay. And then, Kieran, I think, you mentioned that you're expecting some headwind in automotive in North America at some point in the future. May I clarify that?

Yes, we -- I mean, we saw last year, it was over 17 million. We've seen some numbers above and below 17 million this year. We're late in the auto cycle. And obviously, there's some momentum out there from the tax cuts and other things. But the number of cars coming off leases is something we're concerned about as well. So we don't think something is going to fall off at a dramatic rate, but we think there'll be some headwinds, Hendi. And we're taking that into account in our planning in not just this year but in out-years as well.

And then, when you look at that headcount, would you be able to partially offset that with increase in contents and share gains. Is that reasonable?

Yes, we've always said, even in a flat market, we would be gaining share. And so we continue to focus on platforms and expanding and expanding our customers and working on new products. So we're not overly concerned. We just want to be cautious. And also, if there's ever a softness, you want to be ready to handle that with the appropriate actions, so we stay healthy.

Okay. And then, for Noliac acquisitions, do you see revenue to be stable? Or do you see revenue to grow this year?

Sorry, Hendi, what was the start of that sentence?

So from Noliac acquisitions, do you expect sales to be steady versus last year? Or do you expect sales to grow meaningfully in 2018?

No, we expect sales to grow. And we're working hard on leveraging that capability because we now have foundries board in Europe and North America. We got the extra technology. We got new customers. And we're leveraging that into new products as well. So absolutely expect it to grow.

Okay. And then any other growth drivers that we may not be aware of for 2018, Kieran?

No, we would pick some of the big things in terms of the sensor platforms, the accelerators. And certainly, on the electronic components, we've got some good momentum going and adding new customers. And we continue to add new customers. I think your guidance range is probably a good measure of our growth.

(Operator Instructions) We'll go next to Ian Gilson, Zacks Investment Research.

The net gain in cash, was that primarily in China?

Ian, we don't disclose cash by currency. But the cash is -- the bulk of our cash is outside the U.S., as you know. But it's a little bit more -- it's a little less restricted at this point in time. And if you go back to our earnings call from February, we did talk about roughly $50 million at that point in time in terms of the cash that could be brought back to the U.S., if we decided to do that.

Okay. So I wonder the new tax laws, the penalties for bringing cash into U.S. is less than it was under the older laws?

That is correct.

Okay. You talked about the auto market, however, on one of the major growth companies that you've been involved in is Cummins. Could you talk a little bit about that relationship? And how the heavy-duty market is likely to change?

Ian, we've obviously got a good relationship with our customer. We've worked very closely on current and the next-generation products. And we're seeing good progress in the end markets, and we don't see any warning signs at this point in time. We're actually more in discussion about how we can expand our product offering.

Okay. So the continued growth, I presume that, that is primarily in the United States as opposed to what -- the Far East?

Ian, they've got -- I'm not going to get into their -- the breakdown in their end markets, but they're a global company. So we're supporting products in all regions.

Okay. So when you talk about the tax rate, you were saying any discrete items may impact that. Are they going to be relatively random? Or are we going to be biased upward or downward?

Ian, the discrete items, they -- we had some favorable impact in the first quarter. I'm not aware of anything that would be significantly positive or negative, but that's the nature of some of -- sometimes the tax items that -- but at this point in time, I feel reasonably good about the 24% to 27% range that I mentioned on the call earlier.

Okay. And then, finally, are your acquisitions profitable at this point in time? Or are they looking for growth in profit, Noliac?

Ian, yes, the last couple of acquisitions we've done, they are performing to our expectation from the acquisition models that we set at the time when we made those acquisitions. We've talked actively about double-digit growth we're getting in the single crystal space, and the profit expectations from those businesses are being met. And we are making good progress on the Noliac acquisition as well. We are seeing the top line improvements and profit improvements that we're expecting from that business as well.

And we'll return to John Franzreb with Sidoti.

I apologize if I missed this, but the booked business number of $1.762 billion, that's up nearly 15% year-over-year and, last quarter, it was up 14%. So you've had some really quick growth there of late. I guess, there's 2 questions. One, is there one end market that is driving disproportionate amount of that growth? And two, what are your thoughts about how that business -- that booked business grows or plays out for the balance of the year, because the sequential numbers have kind of flatlined a little bit?

So John, we're pretty comfortable in terms of how we're performing on securing business, booking business. We see a good mix across each of the product lines, whether it's auto or electronic components. And there is good momentum there. And we're not seeing anything that's causing us any concern.

John, we've also talked about lumpiness in our orders, just -- that's just the nature of the business. So you will see certain quarters are bigger than others. And given the nature of how we are booking business, a fairly large portion of the total backlog will be -- or total booked business will be representative of long-term supply agreements we have on the automotive side with the automotive customers. And then some of our non-automotive customers, we also have supply agreements. But most of that business is going to be PO-based business.

Okay. And I guess, just on the recent news about Ford, does that change in their mix away from sedans towards SUVs, does that impact you at all?

John, not a major concern for us and not a major impact for us. We -- in the product line, we ship some passive and safety sensing. We don't see any significant impact coming from that at all. Not a concern. And we see -- also of note is that GM added another shift and that's a product platform we're on as well. So always some changing dynamics out there.

Certainly is.

And we'll go next to Hendi Susanto, Gabelli & Company.

Ashish, may I know how much the noncash pension expense in SG&A line was in Q1?

So the total change year-over-year, Hendi, which is I think, the underlying question you have was about $500,000. So last year, we were booking a noncash income, approximately $2 million for the full year. And this year, we will be recording an expense of approximately $0.5 million for the full year.

$0.5 million for the full year versus $2 million for 2017?

That is correct.

Okay. Yes. And then second question with regard to SAP ERP implementation, should we expect it to drive operating margin expansion to a certain degree?

We haven't guided to that, Hendi. But I would not expect any improvements from that at least till 2020.

And we'll go next to Ian Gilson, Zacks Investment.

Just one little question. In the first quarter, you reported other income net of $2 million, which is higher than other income that you reported prior quarter. So is there any extraordinary item in there? What is included in that number?

Almost all of that is related to foreign currency gains when we do our balance sheet translation. And we do carve it out for adjusted earnings purposes.

(Operator Instructions) We'll go next to Hendi Susanto; Gabelli.

Ashish and Kieran, one more question. So with regard to the FX positive impact on sales in Q1. Should we anticipate FX positive impact to continue in Q2 and remainder of the year? If FX is at the current, today's rate?

Hendi, the impact is obviously year-over-year and you will see that we had started seeing some strengthening towards the latter half of 2017. So the impact year-over-year will probably change, but if the rates remain where they are then I would expect us to continually seeing some favorability. But the extent of favorability will continue coming down.

(Operator Instructions) And we have no further questions in the queue. I'll turn the conference back over to Mr. O'Sullivan for any additional or closing remarks.

Thank you, Shannon. I just want to thank everybody for joining the call. Again, we feel good about our strategy and gaining momentum on sales. And we are optimistic we can make operational improvements going forward. So we look forward to updating you at the end of Q2. Thank you very much.

That does conclude today's conference. Thank you for your participation. You may now disconnect.