CTS - NYSE

Thank you, Kieran. First quarter sales were $146 million, down 1%, compared to the first quarter of 2022 and up 3% sequentially from the fourth quarter of 2022. Foreign currency exchange rate changes impacted revenue unfavorably by approximately $2 million. Sales to non-transportation end markets increased 5% year-over-year. The medical and defense end markets grew high single digits. As we expected, we experienced softness in the industrial end market. Sales to transportation customers decreased 6%, compared to the first quarter of 2022, primarily due to the short-term semiconductor shortage we experienced over the last 5 months to 6 months. We were able to resolve the semiconductor supply shortage during the first quarter. Our recent acquisitions, Ferroperm, TEWA, and maglab, performed as we expected during the quarter, expanding our capabilities in several key end markets. Our adjusted gross margin was 35.4% in the first quarter, down 180 basis points, compared to the first quarter of 2022. Foreign currency exchange rate changes impacted gross margin unfavorably by approximately $1.8 million. We regularly hedge a portion of our currency exposure to reduce volatility, and these partial hedges are in place through the end of 2023. Inflation continues to pressure margins, and we continue to partner with our customers to partially share the burden of these cost increases. In the first quarter, we reported earnings of $0.58 per diluted share. Adjusted earnings were $0.61 per diluted share, compared to $0.67 per diluted share in the same period last year and $0.56 per diluted share in the prior quarter. Included in the first quarter adjusted EPS are a couple of onetime favorable impacts. The first is a $0.02 favorability on tax related to equity-based compensation. We also had approximately $1 million of favorability in operating expenses. These items are not expected to repeat in the coming quarters. Our tax rate was at 19.2% in the first quarter, due to the onetime equity compensation benefit, and we expect the full-year tax rate to be in the range of 21% to 23%, excluding discrete items. Looking at the second quarter, we expect sales to the transportation end market to be robust as we resolve the supply challenge. We expect continued softness in distribution and in the industrial end market. Overall, our expectation is for revenues in the second quarter to be similar to the first quarter. This mix shift in end market sales will unfavorably impact our gross margins in the second quarter. Although the unfavorable mix will be a headwind for the next few quarters, in the mid-to-long-term, we see strong momentum with our strategic path to diversify our business and deliver healthier margins. Next, discussing our balance sheet and cash flow generation for the first quarter. We generated $11.2 million in operating cash flow for the first quarter of 2023. Cash flow in the first quarter was impacted unfavorably by the timing of sales, as well as the payout of incentive compensation. We remain focused on working capital efficiency and ended the quarter with 18.5% in controllable working capital. As we mentioned in the February call, we will be consolidating our Juarez facility with activity picking up in the second half of 2023. During this period, we will build up some buffer stock to facilitate the transition and our goal is to work through that safety stock quickly in 2024. During the first quarter, we repurchased 198,000 shares of CTS stock for approximately $8.9 million. In total, we returned $10 million to shareholders through dividends and buybacks during the quarter. Sustaining a strong balance sheet continues to be a priority. We had a cash balance of $144 million at the end of March 2023, down from $157 million in December 2022 as we returned cash to shareholders and completed the acquisition of maglab. Our long-term debt balance was $80 million on our total $400 million facility, down from $84 million at the end of 2022. We remain focused on organic growth and strategic acquisitions, supported by our strong cash position and a healthy balance sheet. This concludes our prepared comments. We would like to open the line for questions at this time.

[Operator Instructions] The first question comes from the line of Justin Long of Stephens.

Yes. Justin, in terms of absolute dollars, the transportation end market sales are larger than the rest of our business. And that's what we expect second quarter to be as well.

That is right, Justin. Yes.

Yes. On the surface, Justin, the comments that we made are that there will be some unfavorable mix impact just because of the end market sales, how they are shifting in the short-term. We will be working hard to drive operational efficiency, so looking to offset as much of that mix unfavorability as we can. On the operating expense side, there was some favorability in the first quarter that are not expecting to repeat. And based on that, we may see a little bit of pressure on the operating expense side as well. So, EPS could be unfavorably impacted compared to Q1.

Thank you. The next question comes from John Franzreb of Sidoti. Please proceed.

Yes, John, we talked about distribution, could we see pressure in Q1 and Q2. And now our view is that we could potentially see some pressure in the third quarter, as well as inventory levels normalize. But again, a lot remains to be unfolding in the next few months.

Okay. And Ashish, if I remember correctly, you said there's onetime benefits in the first quarter. I think you said tax and what – could you just go over that again? What those two expenses were – or benefits were – and where would you find them or identify them in the P&L?

So there was a $0.02 benefit on tax expense related to equity-based compensation. So that you would see on the tax line. And then on the operating expenses between gross margin and operating earnings, we had about $1 million of favorability that I'm not expecting to repeat as we move forward.

Thank you. The next question comes from Hendi Susanto of Gabelli Funds. Please proceed.

Okay. And then Ashish, I would like to ask about the impact of the factory consolidation in the form of gross margin pressure. I would like to clarify whether this one is the factory consolidation in Mexico. I think in the past, CTS may have mentioned that it will be completed in like 18 months. I would like to clarify that. And I'm wondering whether you can share like the rough magnitude of the impact on the gross margin?

Yes. So, Hendi, we haven't specifically called out the amount of impact. Most of the activity from the plant consolidation in Mexico will be happening between now and the end of the year, and then we will be completing the project in 2024. My expectation is that the cost burden will be heaviest in the second half of 2023, and we'll call it out at that point in time.

The next question comes from Joshua Buchalter of TD Cowen. Please proceed.

Hey guys. Congrats on the resilient results in a tough backdrop. I wanted to ask about the transportation market again. So, I guess if we isolate the fact that the semi shortage is sort of behind us, is there any sort of catch-up baked into your outlook for the fiscal year or is it just we're now shipping towards – or closer to [indiscernible] demand? I'm trying to understand like where inventory levels are downstream within your transportation vertical? Thank you.

Josh, the semiconductor problem, as Kieran talked about was resolved in the first quarter. We were able to pick up pace on those shipments towards the third month of the quarter, and we expect that to be good momentum moving forward. In terms of timing of revenues, I think we talked about in some of our prior earnings calls that the customers have been managing in terms of how they balance between supplying to OEMs versus supplying to aftermarket. So, there may be some pickup in the next few months from that. But I would expect us to see more normal levels and be more driven by what's happening in the end market demand, which at this point in time, in the commercial vehicle space, as Kieran mentioned, we are seeing a pretty robust demand at the moment.

Got it. And then I wanted to ask about gross margins. If I put the puts and takes together, it sounds like current levels are sort of the right way to think about things unless there's a change in FX or your cost basis. I guess on the flip side, how do you feel about your like-for-like pricing? It sounds like your customers are willing to share some of the increased input costs, but I'd be curious on how we should be thinking about the gross margin trajectory from here through the rest of the year? Thank you.

So, Josh, going back to the pricing first. Those discussions continue to get more challenging. There's no doubt about that. The first time it's a hard discussion and then the second and third time, it continues getting harder. We are working through those. Our teams are doing a good job of having those discussions with our customers and finding the appropriate path forward. We are continuing to monitor carefully if we see the trend reversing on that at some point, which we haven't seen yet. And as we mentioned in our comments, we are actually still seeing some inflationary pressures in different parts of our business. So, that's something we'll have to continue monitoring as we move forward. On the gross margin, we did talk about a little bit of an unfavorable mix impact just as we see stronger transportation sales and some softness on the industrial side of the business. My expectation is, could that continue for the next – definitely in the second quarter, I'm expecting some unfavorable impact. And then we need to monitor how the second half of the year evolves as we work through those different demand environments.

Yes. Josh, just to clarify Kieran's comments, they are higher than the rest of our business. The industrial, it's a little bit of a mixed bag. There are some parts of it where we have higher margins, some parts of it where we have to be more competitive based on distribution channels may not be quite as rich as some of our custom engineered solutions.

Got it, thank you.

Thank you. And our final question is a follow-up from John Franzreb of Sidoti. Please proceed.