Kieran O’Sullivan - CEO Ashish Agrawal - CFO.

John Franzreb - Sidoti & Company Hendi Susanto - Gabelli & Company Craig Bib - CJS Securities Ian Gilson - Zacks Investment Research.

Good day and welcome to the CTS Corporation Third Quarter 2016 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Mr. Kieran O’Sullivan. Please go ahead sir..

Thank you, Denise. Good morning and thank you for joining us today and welcome to CTS' third quarter 2016 conference call. As discussed in previous calls, sales growth is our biggest challenge. Sales of increased for the past four consecutive quarters, despite a decline in HDD revenue from last year.

We've more work to do and our focus on profitable growth continues. Adjusted EBITDA exceeded 20% in the third quarter, showing the results of our strategy to drive profitable growth. Adjusted earnings per share in the third quarter improved 8% sequentially and 22% versus the same quarter last year.

We reduce leverage by paying down our debt, decreasing our debt to capitalization ratio to 23.9%. New business wins were $103 million as our teams continue to focus on growth, while balancing the recently announced manufacturing transition. As usual, Ashish Agrawal, our CFO is joining me on today's call.

Ashish will take us through the Safe Harbor statement.

Ashish?.

I would like to remind our listeners that this 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'll now turn the discussion back over to our CEO, Kieran O’Sullivan..

Thank you, Ashish. Here are some highlights for the quarter. Sales for the quarter were $99.7 million, up 1% from the prior quarter and 10% from the third quarter of 2015. Sales year-over-year for the quarter increased 6.4% organically, despite a 21% reduction in HDD sales and improved 3.6% from the Single Crystal acquisition.

Adjusted EPS for the quarter was $0.28, which excludes one-time unfavorable tax items, restructuring, and the charge to exercise a lease termination option, which will improve our operational performance. New business wins for the quarter were $103 million. We added several new customers in the quarter for sensing and medical micro actuation products.

Gross margin was 36.8%, an improvement of 210 basis points from Q3 2015. Our teams continue to execute in sales, while balancing the first steps of the manufacturing transition from Indiana. During the quarter, we exercised a lease early termination option for our Lisle facility, which will now end in approximately 15 months.

We will then consolidate the recently acquired Bolingbrook site and the Lisle site into a single building in Lisle starting in late 2017. This change is exciting as it enables us to be co-located with our manufacturing being closer to the business while keeping the commute for our employees practically the same.

The transition as I said is more than one year out and will be a phased approach to balance workloads while enabling the organization to be more efficient. New business awards for the quarter were $103 million, automotive products accounted for $76 million. We have seven accelerated headwinds [ph] with existing customers globally.

We also won several programs for right height and seat belt buckles switch sensor products and added one new customer in China. Additionally, we received sample approval for the launch of one of our new OEM customers in Europe with an expected launch in the fourth quarter of 2017.

For our component products, we secured $27 million new business awards across our ceramic and electronic components portfolio.

In the ceramic space, we're working with two customers for new business in medical ultrasound with potential sales of over 0.5 million next year, with four customers for new business in cataract scalpel and ultrasonic therapy applications with potential sales of more than 1 million per year and with six customers in the industrial and telecom space for new business worth approximately $1 million in annual sales.

Year-to-date new business awards add up to $356 million. The integration of our Bolingbrook Single Crystal operation remains on track. Now that we're deeper in the business, we're focused on two primary areas.

Firstly engaging fully with our customers on their needs and next-generation business; secondly, improving the predictability of yields and execution to our timeline on operational and technical improvements, while expanding our technical capability.

The transition of manufacturing from Elkhart to our Mexico, Asia, and European locations is proceeding to plan. Our teams have been very engaged with our customers and agreed transition plans. We have several moving parts and our manufacturing and engineering teams providing strong support taking on the additional workload for this transition period.

One of our sensor lines is already located in Juarez and is now going through validation. We have a lot to accomplish in the next 18 months, while the focus on protecting our customers remains a priority.

Looking to organic growth, as mentioned earlier, we expect to ship the first accelerator pedal for a new European customer in the fourth quarter of 2017. In addition, we will ship to another North American OEM in the second half of 2017. Our ceramic product teams are working to add industrial, telecom, and medical customers in the next 18 months.

The qualification period and process require significant development time. We continue to gain momentum with initial sales for our RF Monoblock filters for cell--base station applications. Revenue is expected to be close to $1 million this year and grow in 2017.

In the third quarter, we released a Universal-Footprint Metro Cell Duplexer family of products that offer a compact, high-performance alternative to air cavity duplexers used in metro base stations. The CTS family of cells duplexers enable modular designs without compromising customer performance requirements.

The same design can be used for different bands thereby reducing engineering effort. We continue to revitalize our innovation pipeline and of several projects in the hopper. The largest efforts are dedicated adding more sensing applications with several applications for Piezo ceramic materials.

We are working diligently with several customers and test phases for our RF sensor for after-treatment applications. We continue to develop and refine our M&A pipeline.

As previously discussed, our goal is to carefully advance our end market profile for the years ahead, while adding the right regional and technology fits to complement our business growth.

For our end markets, the automotive seasonally adjusted rate per IHS for North America is now closer to $70.8 million for 2016 with on-hand days of supply at 64 days. Europe and China remain at $21.5 million and $28.5 million run rates. Telecom and industrial markets remain soft as we build momentum in our medical product lines.

We continue to experience softness in our HDD product line, approximately a 31% decline year-to-date from 2015 to 2016. This decline has already been adjusted in our future planning. We are narrowing our guidance range for the full year 2016.

We expect sales in the range of $390 million to $400 million and adjusted earnings per share in the range of $1 to $1.06. This concludes the Single Crystal acquisition and excludes foreign exchange impact related to balance sheet translation. I will now hand the call over to Ashish to take you through the results in more detail.

Ashish?.

Thank you, Kieran. Third quarter sales were $99.7 million, up 1% from the second quarter and 10% compared to the same quarter last year. Foreign currency impacted sales unfavorably by $600,000 in the third quarter. The Single Crystal acquisition contributed $3.2 million in sales.

Gross margin for the third quarter was 36.8%, up 190 basis points from the second quarter and 210% basis points versus last year. We remain focused on execution and are making progress on efficiency gains and cost productivity. In addition, we benefited from the impact of favorable mix from the Single Crystal sales as well as some other products.

Foreign exchange rates had a favorable impact on manufacturing costs year-over-year. SG&A expenses were $16 million in the third quarter of 2016 versus $12.7 million in third quarter of last year. The increase is primarily attributable to amortization and other costs from the Single Crystal acquisition and the timing of certain expenses.

In addition, as Kieran highlighted earlier, we paid an early termination fee related to our leased facility in Lisle, Illinois. We plan to move to another leased facility in the same area in late 2017, which will allow to consolidate the Bolingbrook and Lisle sites into one facility and reduce ongoing expenses.

R&D expenses were $6.3 million in third quarter of 2016 compared to $5.7 million in the same period last year. This increase is in line with expectations and our goal to continue investing in new products to drive organic growth. The initial activities of our 2016 restructuring actions are progressing as anticipated.

The total costs are expected to be in the range of $16 million to $18 million. In the third quarter, we took a charge of $2 million related to this restructuring. The remaining costs will be incurred through 2018. Interest expense was higher in Q3 this year versus last year, driven by higher borrowings related to the Single Crystal acquisition.

Interest income was significantly lower due to lower cash balances in China. On taxes, in the third quarter of 2016, we had certain one-time items that drove our tax rate higher.

We took a charge of $2.3 million triggered by the restructuring actions and a $1.3 million charge for certain forms [ph] and oils that we expect we will not be able to utilize. Between now and 2017, we will implement certain structural changes that will allow us to reduce our overall tax rate. Our third quarter 2016 GAAP earnings were $0.11 per share.

Included in this number is $0.11 for one-time unfavorable tax items, $0.04 for restructuring, and $0.02 of the lease termination fee mentioned earlier. Excluding these items, adjusted earnings per diluted share were $0.28 in the third quarter of 2016. Now moving to the balance sheet.

Cash and cash equivalents were $114.4 million at the end of third quarter of 2016 compared to $156.9 million at the end of 2015.

Our debt balance was $96 million, up from $90.7 million at December 31st, 2015, but down significantly from $141.3 million at the end of the first quarter when we -- excuse me, at the end of the first quarter as we actively refused debt since the Single Crystal acquisition.

As a result of the deleveraging, our debt to capitalization ratio was 23.9% at the end of the third quarter, down from 32.9% at the end of the first quarter when we completed the Single Crystal acquisition and also down from 24.4% at the end of last year.

Our controllable working capital as a percentage of sales was 12.1% in third quarter of 2016 compared to 12.9% a year ago. Controllable working capital is expected to increase in 2017 as we build safety stock to protect our customers during the transition of manufacturing from Elkhart to other CTS sites.

Year-to-date 2016 cash flow from operations was $31.6 million versus $24.1 million during the same period last year. Capital expenditures were $14.5 million through September compared to $6.6 million year-to-date 2015. The higher CapEx is related to certain program launches as well as the manufacturing transition currently in process.

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

Thank you. [Operator Instructions] And we'll take our first question from John Franzreb of Sidoti & Company..

Am I through?.

Please go ahead..

You're through John..

Okay. Nice quarter guys. First, I'd like to touch on the revenues, little better than I was expecting. Normal seasonality would suggest 3Q would be a little bit weaker.

Could you talk a little bit about the topline, what maybe drove some better than expected seasonality my part?.

John I would say first of all, we're very pleased with the trend now upwards in the sales, but I would be -- what I missed in telling you we're coming off probably soft this quarter over last year,. So we still see that's being a very positive trend.

Third quarter 2015 was our lowest quarter, but then, again, I want to emphasize, even though it was the lowest quarter, we're moving in the right direction.

When you look across the portfolio, it was across probably most of the product lines in automotive, on the electronic component side of things, it was really driven by inkjet printing, RF filters, and military, there were really the drivers of the growth as well.

And obviously we're facing as we have for the last number of quarters a decline in HDD, but we've pretty much factored that into our forecast going forward as well..

Okay. I was just kind of looking at it on a sequential basis though, I thought I was kind of a good quarter, but--.

Yes. We think so too. We think we're trending in the right direction..

Fine. And the gross margin profile, I know you've been remiss to say that you're sustainable at certain levels, but it's becoming readily apparent that you're doing a good job.

Could you talk a little bit about your expectations on the gross margin and the sustainability at a level, say north of 35%?.

I'll let Ashish in a second talk about the changes in the quarter and we talked back in our and New York Stock Exchange about the range of 34% to 37% and moving up. Obviously, we've moved up substantially. Its linking again to just the profile of the company and where we're trying to go in terms of the end markets.

But obviously, we have some things that helped us in the quarter Ashish which you can comment on..

Yes, so John, as we think about the gross margin, we've had favorability from some unusual mix in the quarter, but also foreign currencies. So, those are the two things I would look at as we look forward in terms of things that could impact our gross margin..

I think one of things you called out earlier was the Single Crystal sales, was it a favorable impact on mix?.

Yes..

How much of that was the case? And is that a lumpy business? Or how should we think about the business going forward?.

So, the Single Crystal business, at least so far, hasn't been lumpy for us. The improvement in gross margin there is related to purchase accounting. So, when we bought the business, we had to gross up inventory as is required and once you bleed that off, then you see a slight uptick in the margins as a result of that..

Right.

But that shouldn’t be going away anytime soon if the business is sustainable?.

Right..

Yes. Correct John..

Okay. All right. And one last question. On the incoming orders Kieran can you kind of give us a sense of perspective of the $103 million? It seems like it's got a little bit lumpier, also three quarters of it was order. I know you've been trying to divest away from that.

So, maybe some upper-level thoughts about how should think about incoming order rates going forward?.

Yes. I think first of all for the quarter, it was steady performance I would say. We would look at it in terms of -- when you seasonality or being a bit lumpy, I would agree with you. We would have seen timing in one or two orders that we expected that will still come. So, we're not overly concerned at all.

And I think as you go forward with the profile, obviously, order wins, when you book a win that's over multiple years, its big.

The other ones don't seem as big in comparison, but the momentum is building there and we will do seven year contracts which you'll come over time obviously under ceramic and component products, you'll see that momentum build as we go forward..

Okay.

And just to follow-on on that thought maybe how we should we think about revenue growth in 2017 based on your recurring order take through the first nine months of 2016?.

John we'll guide in January for the 2017, but we've always been very clear we're not happy with our performance on growth, we've targeted 10% both organic and through acquisition and we're not going to take our sights off that goal.

But, again, I would say you're flying a plane little bit, the nose is pointing up just a little bit and we're getting some momentum..

Okay. Thanks for taking my questions Kieran..

You're welcome John..

And we'll take our next question from Hendi Susanto of Gabelli & Company. Please go ahead..

Good morning Kieran and Ashish..

Hi Hendi..

Ashish and Kieran I would like to ask questions about what assumptions in Q4 we should think about? If I do my math for Q4, it will imply that there will be 7% to 13% topline growth and earnings of around $0.20 to $0.25.

So, my first question is should we expect similar Q3 contribution from the Single Crystal business in Q4? And what kind of revenue trajectory we should expect from that business?.

I'll start and I'll had it over to Ashish on the operating side of it. So, the Single Crystal is moving in a good direction. We would think it would be at the same level or better in the fourth quarter. Obviously, we're working towards been better.

And Hendi what was the other part of your question please?.

Like what kind of revenue trajectory you expect from growth in -- flat to growth in Q4? Should we expect like sequential growth -- or like to flat to sequential growth as the incoming trajectory of that business going to 2017?.

Yes. What I would look at Hendi is that if you look over 2015, we were on the lower end of the 90s per quarter in terms revenue, now we're tracking towards the higher end of the 90s and obviously trying to improve that. That's how I would think about the revenue profile..

I see..

And on the earnings, Ashish, do you want to make any comments?.

Yes, Hendi, just going back to the sales for a moment that will tie back to our guidance as well maybe if narrowed the range to 392 to 400. And on the earnings side, I'm expecting in the range of $1 to $1.06, we've narrowed the range a little bit taking the low end of it as we look ahead into the fourth quarter.

Typically, we have some timing of higher expenses in the fourth quarter and then the one-time mix favorability I would expect that the go away in the fourth quarter..

Okay.

And then can you on quantify how much the impact of one-time mix preferable the in Q3, whether it's let's say 1% to 2% range?.

It's not very large, Hendi. It shouldn't impact us materially. You're in the right range so..

I see.

And then Kieran one questions about the HDD business, are we at the bottom yet or sales may get weaker?.

We're planning for sales to continue to weaken in that area. So, we've already taken it into account. You can see I mentioned 21% decline quarter-over-quarter and then year-over-year 31%. It's not -- it's -- we've got well-factored into our growth plans going forward. So, we feel that we've got control of this..

And Kieran I'm interested in hearing your common before you said that electronics was partly driven by the inkjet printing business and I think in the inkjet printing business. And I think in the inkjet printing business, things are still cautious and they didn't see significant growth this year.

Does that represent some time of like market share, business awards, perhaps you can share some color there?.

Yes. There's aspects of this industrial printing market, but we've continue to do well with existing customers. And we've added some new customers as well..

Got. Thank you, Ashish. Thank you Kieran..

You're welcome Hendi..

We'll take our next question from Craig Bib of CJS Securities. Please go ahead sir..

Hi. This is Craig Bib for Larry Solow. Encouraging quarter with the organic revenue growth. Early you said you're targeting 10% growth, you're not sure when you're going to get there.

Do you have like a reasonable range for the next two or three years for organic growth?.

We've always said Craig that we'd like to be getting in the next 12 months or so into mid-single-digit growth rates on the organic basis and complementing it with acquisitions that the profile for what we're looking for..

Okay.

And have you guys given thoughts of breaking out the backlog by year book-to-bill?.

It's something we discussed and we've been modeling internally, because we talk about new business wins and we've talked about presenting a backlog going forward. That's something that's very active insight, but with nothing to update you on today, but something we're looking at..

Just if I miss this, I apologize, but gross margin currently near the high end of the range, is that sustainable or can you improve on it further?.

So, this is Ashish. We will obviously be looking to continue to improve it. But at the same time, the things that I watch for in terms of the direction that can likely impact our gross margins, other than operations, foreign currency is the big element of -- as most of our manufacturing is starting to get done outside of the United States.

That can have impact one way or the other depending on the movement of currency rates..

Okay. Thank you very much..

Thank you, Craig..

[Operator Instructions] And we'll take our next question from Ian Gilson from Zacks Investment Research. Please go ahead sir..

Good morning gentlemen..

Hi Ian..

As we look at the gross margin, which I believe on a quality basis is the highest in the last five years.

Any particular strong drivers are in that improvement? What was the effect of the foreign exchange on the gross margin?.

So, I'll let Ashish talk about foreign exchange, but we're constantly focus on driving the sales and improve managing cost and in all product lines, looking to improve the gross margin.

We -- our teams is part of the mindset and DNA we have the company and that will continue and that as we change the margin or the profile of the company, that can help us with Single Crystal but we've got stronger margins as well..

So, on the foreign currency side, in the -- the biggest benefit we're getting is from the Mexican peso and the exchange rates you can see it's been trending closer to MXN18 to MXN19 to the dollar this year, which is a significant devaluation from last year's rate. So, that's benefited us in 2016..

Okay. Living in San Diego, I probably see more of the peso in Mexico than most people and looks as if we might have been peaked [ph] in number of pesos per dollar.

As you're looking forward on your projections, are you holding currency constant or are you allowing for some deterioration?.

We actively look at the currency rates as well Ian, as it does impact the business. As we look ahead, we do a couple of things. We do scenarios inside the business in terms of different exchange rates and how that's likely to impact us.

And then we also hedge our exposures one year out, so you'll see that in our Q that will be published later on today as well..

Okay.

Your forecast for the year that the high-end is $400 million and that implies that basically flat however 12% of the fourth quarter to fourth quarter gain in revenue, is that momentum? Can that carry into 2017?.

So, if you look at overall year, first of all, you can see we're growing in that. For the full year, probably in the 2% to 5% range is where our growth rate is at and organic is probably 1% to 2%. We will build on that momentum..

Okay.

So, you wouldn’t be looking at t double-digits growth going into the first half of 2017 on topline?.

We'll guide on 2017 in January, but we feel good about -- I think you've heard a few points in time that we said; A, we're building off of a lower base; and that's helped us a little bit this quarter, but we're on the upward trajectory..

Okay.

Tax rate reverts back down in the fourth quarter?.

So, Ian on the tax rate, I would keep expecting us to be where we're in that rough range not only in the fourth quarter, but also going into 2017. As I mentioned earlier on the call, we will be working on structural changes to bring it down, but that will take some time. I'm looking into the later part of 2017 before seeing any meaningful change..

Okay.

So for the first half of year -- this year, we had a tax rate just close to 35%, so looking in the early quarters coming around that again about 35%?.

Yes, mid-30s is the right way to think about us for the next few -- several quarters..

Okay, great. Thank you very much..

It appears there are no further questions at this time. Mr. Kieran O’Sullivan, I'd like to turn the conference back over to you for any additional or closing remarks..

Great. Thank you. And thanks everybody for joining us today. Our strategy is very simple. Build around products that sense, connect, and move, that's where we deploy our capital and our talent. We expect to work for us here and there. Go Cubs. Thank you everyone..

That concludes today's presentation. Thank you for your participation. You may now disconnect..