Good day, and welcome to the CTS Corporation Second Quarter 2016 Earnings Conference Call. Today's conference is being recorded. And now at this time, I'll 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' Second Quarter 2016 Conference Call. Our new business wins were robust for the quarter. We continue to improve our margins. The integration of 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 markets 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 discussion 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'll 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 U.S. 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 component side, we secured $30 million in new business across our piezoceramics and electronic component products, which included adding a new telecom customer for RF products. .

In total, we added 5 new nonautomotive 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 working well with our customers. You can expect a small improvement in the sales run rate going forward as we ramp up sales of a 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 success for 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're 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 2 years, we have expanded our capabilities in piezo from 1 technology by adding single crystal through M&A and internally developing tape cast processes. .

We developed our 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 aftertreatment. 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're carefully modernizing our culture and talent developing 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 2 quarters. Telecom and industrial markets remain soft as well. Automotive remain 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 of 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 8, 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 of 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 U.S. 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 2 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 we 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] And we will take the first question from Larry Solow with CJS Securities. .

This is actually Robert Magic [ph] filling in for Larry this morning. I was hoping you could just give us a little more color on the reason for 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, you're talking on the year-over-year, because quarter-over-quarter, we weren't down that much. And there's just some mixed changes we said before in terms of the products that we're going at -- some products going end of life, some products transitioning for the future.

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.

And overall on the sales side, just to give you give more color, we were down just a few 100K 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're not investing in on the components side like resistor networks.

In the non-HDD piezo, we're strong, up almost double-digit, and we're up in our frequency products, and you can tell from the capital investment, we're 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 on a slowing or potentially contracting auto market?.

Well, first of all, I saw the Ford news yesterday, and we're 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 and the overall automotive market, we would obviously take some headwinds but we'd be taking some growth as well with share that we're taking. .

Okay. And last but not least for me, we're looking forward to your Analyst Day in September.

Without stealing your thunder, can you give us a preview or teaser of the topics you'll 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. .

And next, we'll hear from John Franzreb with Sidoti & Company. .

Just to stick on that automotive theme here. Last quarter -- 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 sales to be up year-over-year.

Is that still the case with the mix in the first half? And can 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. And so you'll see some changes from -- you're correct, from Q1 to Q2, and little bit of -- seeing a little bit of softness in some commercial vehicle.

And 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 that 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 sizeably, at least relative to my expectations, in the second quarter. It tracked similarly a year ago, and then and you tape it off in the second half.

Could 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've 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 turned cold [ph] the water on sustainability.

One of the things you suggested was that the acquisition would pull it down, and then you get a bumped after some of the inventory writeoff is 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 your take on that?.

So, John, you're right about the single crystal that it was having a little negative effect. And obviously, as we go forward, it will be more positive, and you 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're putting in safeguards for our customers, and obviously I got to take that -- my hat off to the team. 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 a -- gross margin numbers. .

How much was the impact of FX in gross margins?.

John, the way we've 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 U.S. dollar. .

I'm sorry, Ashish.

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 restructurings is kind of sizable. I'm actually curious about the long tail that you're 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, you can comment in a second. But we've got some -- I think, in some of the other restructions we've done, we've completed most of the transfers within 1 year. In this situation, we have the products that are being transferred and also products that are there that were coming in for launch, and we're -- and having to have more moving parts.

And also, these are right in the center for some of our bigger customers. We want to make sure we're putting the right loading 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 parts of the transition go through 2018, the middle of 2018. So that's why you won't see the full impact till 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. .

[Operator Instructions] Moving on to Hendi Susanto with 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 low 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 as 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 the chance to read the reports. So we're 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, 2, 3 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, go into medical applications, we're doing pretty well. We're seeing 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're targeting an overall growth rate of 10%. We haven't backed off on that. But we're not going to do -- rush in acquisitions.

We've got to have the right ones to make that happen. .

Okay. And then... .

Hendi, on the market side, 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're roughly tracking about 5 or 6 points -- percentage points behind where our goal would be. It's all a matter of timing. And some OEMs decide to award things and we've 1 or 2 contracts that slipped that we thought were going to be awarded this quarter but slipped into the next quarter. .

Got it. And then, Ashish, you mentioned about the tax rate there's some slight different 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 the 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?.

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. .

Got it. .

You saved me a question, Hendi. .

And the next question will come from Ian Gilson with Zacks Investment Group. .

If we look at the operating margins before restructuring, impairments and other nonrecurring items in the second quarter, actually it was down. 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 earnings and I'll take [indiscernible]. .

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 volume, so the percentages are better improved from last year.

And on the sales side, we are looking at the sales being down as we've 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've 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 the go forward basis to 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, and I think when we announce 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. We've taken a significant piece out of the deadline and the 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 our higher, and that's the primary driver of the increase in interest expense because last year it was $90 million. .

The first quarter, the interest expense was $820,000, in the second quarter, it was $1.9 million. But your net debt went down significantly.

What are we looking at there going forward, closer to $820,000 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 levels. .

And now we'll take a follow-up question from Hendi Susanto with Gabelli & Company. .

Kieran and Ashish, you mentioned that you're 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 Hendi, we talked about this for a number of quarters in the past, as well as saying that this was on the radar and coming. And obviously, the timing is linked to the simplification of the footprints so that we're doing it in the locations that are relevant. .

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

'17 and '18. .

And Ian Gilson with Zacks Investment Research has another question. .

Yes, could you give us the cash flow for the 3 groups' operations investments in financing on a 6-month basis?.

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

Yes. Cash flows, we have cash flow from operations, cash flow from investments activities, that's primarily [indiscernible] and cash flow from financings.

What were the gross numbers for those?.

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

Okay, that's fine. I pull it up the 8-K and there was nothing on there. So -- but if it's coming in I'll get it from that. .

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're busy and back to work here, and hope you have a good day. Thank you very much. .

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