Kieran O’Sullivan - Chief Executive Officer Ashish Agrawal - Chief Financial Officer.

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

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

Thank you, Jessica. Good morning and thank you for joining us today and welcome to CTS’ fourth quarter and full year 2016 conference call. Here are some notable items for the year. Full year sales were at 396.7 million, up 3.8% from 2015. Our fourth quarter sales increased 8.9% over last year.

Full year 2016, gross margins were at 35.4%, up from 33.2% in 2015. Full year 2016, adjusted EBITDA of 19.5% is up from 15.9% in the prior year. Adjusted earnings per share for the full year were at $1.08, 16% increase over 2015. New business wins for the year were 488 million, fourth quarter wins were 132 million.

As usual Ashish Agrawal, our CFO is joining me on today's call and Ashish would 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. Sales for the fourth quarter were 101.6 million, up 1.9% from the previous quarter and 8.6% from the fourth quarter of 2015. Organic sales growth for the fourth quarter was 3.3%. Full year sales for 2016 were at 397 million, up from 382 million in 2015.

Gross margins were 35.4% for the full year of 2016, up 220 basis points from last year. Fourth quarter margins, improved 300 basis points from the fourth quarter of 2015. Adjusted earnings per share for the quarter was $0.29, driven mainly by our margin performance and continued focus on cost management.

This represents 45% improvement over the fourth quarter of 2015. Full year adjusted earnings per share were $1.08, up from $0.93 in 2015. New business awards for the quarter were 132 million; 101 million of the wins were from our automotive customers.

As you saw in early December, we announced the global accelerator pedal win of 28 million with an OEM headquartered in North America. Shipments are planned begin in the latter part of 2018. This product would be manufactured in Europe, Asia and North America. We also added two new customers in the fourth quarter.

We secured 31 million in new business awards in our component product lines. We continue to gain traction with our recently introduced universal RF Filter product family, increasing our end market application to two new frequency brands last quarter. Revenue from this platform is expected to be in the range of 2 million annually.

We also made good progress in different end markets last year with new and existing customers our product lines. On ceramic components, we received an order for a medical scalpel application with a new customer, which we expect will deliver annual revenue of about 1 million.

Additionally, we qualified for a new inkjet application with revenues in the range of 250,000 in 2017. We also expect to be qualified shortly for a next generation VCXO application with revenue of 250,000 in the latter part of 2017. We also added several new customers in our component product lines in the fourth quarter.

One, we saw HDD sales decline 30% in 2016 and we expect this to climb to continue in 2017, we continue to focus in adding new customers and accelerating our growth outside the hard disk drive market. We are focused on securing contracts for our single crystal products, already gaining solid traction.

We have a high degree of confidence about achieving double digit growth for the year. We expect to add more new medical customers in 2017. We have made some progress operating our front-end sales capability. We still see the opportunity to win more business and be more effective globally with our ceramic and electronic component products.

We will now start reporting total book-to-business instead of new business awards to provide more visibility to ongoing growth. Ashish will provide more details shortly. As of January 1, 2017, our book-to-business totaled $1.5 billion.

Our transition plans for Elkhart and the Chicago area site consolidations are tracking to our previously announced plans. We expect to have increases in product inventories, to protect our customers and to ensure a successful transition. As previously announced, our transfer will be completed in 2018.

Improvements in our single crystal operation are progressing in line with our acquisition plan. We have improved yields and other efficiency improvement initiatives are progressing as expected.

We’ve remained focused on securing a first win RF sensor technology for after treatment applications and have several product testing arrangements with potential customers. We are discussing the product’s capabilities with the California Air Quality Board and the test programs with the ADA Consortium in Germany.

ADA members include, VW, Audi, Porsche, Dino and BMW. On the M&A front, we’re actively developing a pipeline to advance our end market profile in line with our strategic plans. As previously communicated, adding the right regional and technology fits to complement our business growth continues to be a priority. Our end markets remain stable.

The seasonally adjusted 2017 North American automotive production rate forecast per IHS is at 17.6 million. Europe is expected to be at 21.8 million and China at 27 million. More recently North American OEMs announced extended shutdowns and changes in mix of small cars and SUVs.

We expect a revenue impact of less than $1 million from this change for the full year of 2017. China has extended its tax break for light vehicle engines of 1.6 liters and smaller through the end of 2017, continuing to support volumes in that market.

We see positive trends in our medical markets and expect some progress in telecom, industrial, and defense markets in the year ahead. We expect full-year 2017 sales in the range of $405 million to $420 million, representing sales growth of 2% to 6%. Adjusted earnings are expected to be in the range of $1.12 to $1.22.

We have included further declines in HDD sales in our 2017 guidance. I will now hand the call over to Ashish to take you through the results in more detail.

Ashish?.

Thank you, Kieran. Fourth quarter sales were $101.6 million, up 8.9% compared to the prior year and up 1.9% from the third quarter. This is our fifth straight quarter of sequential sales growth. Foreign currency impacted sales unfavorably by $1 million in the fourth quarter due to the U.S. dollar strengthening against the renminbi and euro.

Organic sales growth was 3.3% year-over-year. Gross margin in the fourth quarter was 35.3% versus 32.3% in the prior year. The increase in gross margin resulted from various cost saving initiatives, favorable mix, and the addition of sales from the single crystal product line. Foreign exchange rates also had a favorable impact on manufacturing costs.

Our fourth quarter 2016 GAAP earnings were $0.25 per share and adjusted earnings per diluted share were $0.29. In the fourth quarter of 2015, we reported a GAAP loss of $0.42 per share and adjusted earnings per diluted share of $0.20. Now I will discuss the full year results. Full year 2016 sales were $396.7 million, up 3.8% from 2015.

Foreign currency impacted sales unfavorably by $2.7 million for the year, largely because the U.S. dollar appreciated against the renminbi. The single crystal acquisition is performing in line with our expectations and contributed $12.3 million of sales in 2016. Gross margin was 35.4% versus 33.2% in 2015.

The increase in gross margin resulted from various cost saving initiatives, favorable mix, and the addition of sales from the single crystal product line. Foreign exchange also had a favorable impact on manufacturing costs year-over-year, as the U.S. dollar strengthened versus various currencies.

SG&A expenses were $61.6 million in 2016, compared to $59.6 million in 2015. This increase is primarily due to the additional SG&A and amortization expenses from our single crystal acquisition. R&D expenses were $24 million compared to $22.5 million in 2015.

We invested more in R&A to develop new products and drive growth consistent with the strategy we have been communicating. Restructuring costs in 2016 were related to the program we announced in June of last year.

Interest expense, net of interest income was higher in 2016 compared to 2015 due to higher average debt balances relating to the single crystal acquisition, higher interest rates, and lower cash balances in China.

Other expense was $3.5 million in 2016, almost entirely due to the impact of changes in foreign currency rates on our assets and liabilities. The biggest driver is the weakening of the Chinese renminbi against the U.S. dollar.

Our effective income tax rate was 39.9% in 2016, which includes several unfavorable one-time tax items related to deferred tax assets and valuation allowances mostly as a result of restructuring actions announced in June, 2016. In 2017, we expect our tax rate to be in the mid-30’s range.

As we discussed earlier, we are evaluating potential changes to our structure to improve our tax rate in 2018 and beyond. Our 2016 GAAP earnings were $1.03 per diluted share. After excluding various one-time items and restructuring expenses, adjusted earnings per diluted share were $1.08.

In 2015, GAAP earnings were $0.21 per diluted share and adjusted earnings per diluted share were $0.93. Now I'll cover a few items on the balance sheet and cash flow. Cash and cash equivalents were $113.8 million at December 31, 2016, compared to $156.9 million at the end of 2015. The decrease in cash is primarily due to the single crystal acquisition.

Our debt balance was $89.1 million at the end of 2016, down slightly from $90.7 million in December, 2015 and down significantly from the first quarter when we completed the single crystal acquisition. Debt to capitalization was 21.9% at the end of the fourth quarter of 2016, down from 24.4% at the end of 2015.

Cash flow from operations for 2016 was $47.2 million, up 22% from $38.6 million in 2015. Capital expenditures were $20.5 million as we made investments in various growth related programs, compared to $9.7 million in 2015. As Kieran mentioned previously, we will begin reporting total book-to-business in 2017 instead of new business rents.

Total book-to-business represents open purchase orders, contractual commitments, and the total expected lifetime revenue from business awarded to CTS in multi-year platform awards. This information will provide more clarity on the growth trajectory of the company and more insight on the book-to-business for the current year.

Total book-to-business at January 1, 2017, was $1.5 billion of which $319 million is expected to ship in 2017. Please keep in mind that our business is a mix of PO based flow business, shorter term contracts, and multi-year awards such as with customers in the automotive end market. This concludes our prepared comments.

We would like to open the line for questions at this time..

[Operator Instructions] We'll take our first question from John Franzreb of Sidoti & Company..

Can you hear me?.

John, you're a little muted.

Can you come through again?.

Can you hear me now?.

Okay. Yeah..

Let's start with, where you finished, with the book business at $1.5 billion, 319, if I heard you correctly, is to ship this year.

Can you kind of put that in context that 21% of that number and kind of how much normally have booked of the business in the year, this year versus the last year, the two years, so we know how to think about this number going forward?.

Hey, John, probably if you think about it in terms of our transportation market, that’s where you’ve got most of it already booked and you know what end market there is around 66%, 67%. But then there is a portion of our component business that comes in - a lot of it comes in PO based flow business as Ashish highlighted.

But we have a part of that on some of the ceramic components that would be a year or two-year contracts in some cases. There is a mix of things in there..

Okay.

So, would you think this is a relatively high number, the 319 million versus last year or relatively low?.

Ashish, do you want to comment on -.

Yeah, John, the sales guidance is 405 to 420. That takes into account the 319 million on booked business. So that should give you a evaluative perspective on our expectations in terms of whether it is high or low that’s a difficult thing to comment on..

Yeah, I guess, I probably looking for a historical perspective of these..

Again, we haven’t disclosed prior period data, John. So what I would ask you to think about it is in relation to the guidance for sales for 2017..

Okay and thinking about the - Kieran you mentioned that two thirds of the business that tied to automotive market, it sounds to me like you are a little bit more positive on the other sector today than you were over the past three to six months, what changed or am I just miss reading that?.

John, I would say we feel pretty much the same and when you look at the guidance and the comments here, we still feel North America is at the peak and you will see that from January sales rate over the fourth quarter ended for the OEMs, they did pretty well.

There was about 3% decline in January sales but it looks like it is what in that range of the IHS forecast so, it looks like 17 so far is off to a reasonable start. We are just a little bit cautious because we know we are at the top of the market. We feel a bit more balanced about Europe and China, the Asian markets, that’s our perspective on it.

And of course the other thing that we have been doing is working hard to win new business and grow the share..

Got it, and in the HDD market, you kind of suggested that you are projecting that if it continue to drop in 2017, when do you reach the bottom in that business?.

It is hard to predict John, but let me give you a little bit of color, what we see happening is we obviously as we went for a strategy planning, discussed this in the last two years, we see solid state devices really entering this market make sense, Enterprise and Desktop drives have been declining and continue to decline.

To give a bit of color if you think back in the last two to three years, our revenue in that area would have been mid to a little higher in single digits. As we go forward in the forecast of the guidance, it is certainly is much lower in the 1% to 2% and we think it will continue to decline..

And one last question, your new administration put an emphasis on where products have been produced, could you share with us how much is your COGS, domestic versus over overseas?.

I'll let Ashish make a comment in the second but honestly we don’t report, we report our end sales and regional sales and numbers, that’s not the number we report today.

If something changes there, you are looking at it, we are all watching what is going on with the different things out there, that have been disgust on tax and everything else, but if something materially changes we will get back to you on this. But today - we don’t usually guide on those numbers.

Ashish?.

John, the only thing we have really talked about is what percent of our manufacturing is in best, cost locations and that can give you a little bit of perspective. With the moves that we have completed, we are closer to 70% of our total production in best cost locations..

Okay, all right thanks guys. I'll let somebody to get in. Thank you..

Thanks John..

We'll go next to Hendi Susanto..

Good morning, Hendi..

Good morning Kieran and Good morning Ashish.

First question, in terms of 2017, how should we relate to build out the new distribution throughout 2017 on the quarterly basis or first half versus second half?.

So Hendi, the growth expectations will be gradually throughout the year. I would say second half should be heavier than the first half in total revenue..

Hendi, to give you a piece of information on that, I think in the last year earnings call, we said we would be launching one of the recently one OEMs in the fourth quarter. Let's get back to Ashish's comment in terms of little heavier in the latter half of the year..

I see, and then I switch with regards to CapEx that you have made in 2016 any of that income above CapEx will follow through to 2017? Could you share some guidance on 2017 CapEx?.

Hendi, could you repeat the first part of your question?.

What should be our expectation for 2017 CapEx, whether or not some impacts in 2016 will continue in 2017?.

2017, our expectation is to be slightly higher than our - you know if you look at our investor presentation we talk about it, 4% of sales growth expectation. 2017 will be heavier than that to some extent.

We still have ramp up on the growth programs that we saw in 2016 and we will also be incurring some additional CapEx related to the building move here in Lisle. And also we'll be starting to spend some money on ERP in the second half of the year..

Got it, thanks.

One last question for me, any update on turbosmart actuator, Kieran?.

What was the question on the smart actuator?.

Any update on turbosmart actuator business?.

We are continuing to work well with one of the OEMs and our business is running well there. We are continuing to work on adding customers. We are active in several quotes..

Okay, thank you Kieran, thank you Ashish..

You are welcome Hendi..

Thank you..

[Operator Instruction] We'll take our next question. Hello your line is open..

Hi, this is Ian Gilson from Zacks..

Hi, Ian..

Hi, on the tax rate, currently are they more stable quarterly numbers throughout the year or are they going to be again significant fluctuations?.

In the tax rate expectation as I mentioned in the call is in the mid-30s. We are looking at making changes to our structure and depending on the timing on when those structures become effective, we may see some lumpiness in one quarter versus next but I am not able to give you more specifics on the timing of that at this point in time..

Okay.

You said that the HDD business basically declining, when does it become so small that it is not worth keeping it anymore?.

It is hard to predict, Ian. We just see it continue to decline and that’s how we are looking in terms of our guidance and our strategy planning. Some of these businesses tend to have small tale that run for little while and that’s just to –when you see it in the 1% to 2% range you can tell it is getting very small.

But we’ve got some things were active on there and we want to support the customer, but we've scaled our operation and our capital and how we are running that production to be very efficient.

Just a comedy and I know you had a question that you had sent in as well in terms of and the OEM out there are having an issue with the quality on the component, just wanted to be aware of that, we are not the supplier, that you said the supplier had been contacted but we haven’t been contacted.

We don’t believe, it is our component so just in case if there is any confusion around that out there, not our issue..

Okay, that’s good. My other check yesterday was newer anyway [ph] is much bigger than your business in that area.

Are we spending any money in R&D or capital expenditure to all assets on the HDD business or you cutting back on that as well?.

R&D spend over all Ian, is going up year-over-year. We have set it as part of our strategy around products that sends connected move that we will continue to invest and grow. Our R&D percentage will be in the range of 5% to 7%, you can see at the moment we are tracking just above 6%.

On the HDD side of it, minimal investments on that particular certain things that we would do to enable certain things, but it is not worth that biggest percentage of our R&D..

Okay, pension fund expense, assets and liability that’s the only asset side, we jumped up from 33.8 million for 2015 to 61.7 million in 2016.

Why has this change? Is the pension fund fully invested or is that still going to build up the liabilities?.

Ian, the pension fund that you will see us reporting, the biggest chunk of that is related to our U.S. pension plan. It is closed to new participants for at least a decade and it is - also at this point in time there are known members earning benefits under the plan.

The plan is over funded both on a cash basis, as well as on a funding basis and we - the change that you see on the balance sheet is related to how the pension accounting needs to work and I can take you through more details once we have published our 10-K in the next coming weeks, we can get into more details on the specific drivers behind that..

Okay. It’s just that if there is cash to be freed up there, it’s obviously positive..

From everything I have seen, pension funds, getting cash out of pension funds is almost impossible. So, I'm not counting on that cash coming back to the business..

Fine. That’s it from me. Thank you very much..

Thank you, Ian..

We’ll take our next question. Hello, your line is open..

Hi. Good morning, just a couple of follow-ups. Good morning, Ashish.

On the tax structure question, I’m not going to get into more specifics about what you are looking to do, but maybe if you can just sort of share with us what the potential benefits could be? Are we talking sort of mid-30 tax rate today? Could that fall a couple of hundred bps or even into the 30 - low 30’s range?.

Larry, there is a lot changing in the tax as we speak. We need to get clarity on that. And the changes that we are contemplating, some of them are U.S. changes. Some of them are non-U.S. changes. So, it's very difficult for me to give you more specifics at this point in time.

I think it’ll become a little bit more clear when we get later on in our evaluation process and we have more information than we’ll share it with everybody at that point..

Got it and just in terms of border tax or potential impact there and follow-up to John's question, you probably can't answer that specifically obviously a good amount of your - clearly you are a net importer, but this would be likely if anything to come part of a corporate tax overhaul, if I’m not mistaken, I think your statutory rate is probably above 30, right.

So, would you assume that - if that fell to 15, 20, part of the whole border tax equation, would you still potentially be a net benefit of that or hard to say at this point?.

I would rather wait to get more clarity on exactly what changes are likely to get done. And then we can evaluate if we have a significant impact, good or bad, then we’ll obviously talk about it..

Fair enough. And obviously I think [indiscernible] no one truly knows what’s going to happen. In terms of your revenue outlook, sort of a decent size range there, I think 2% growth to 6% growth, 2% maybe sort of lackluster, especially in light of your growing backlog over the last three years.

So, what sort of could happen that would actually put you at the lower end versus the higher end, anything specifically on a macro level or is it just sort of you’re giving yourself some room there?.

Larry, the way to think about it is we guided in the 2% to 6% range as you highlighted. But if you adjust it for the HDD decline, we’re really growing in a range of 3.5% to 7.5%. So we think that's robust and we've had a growth target of 10% and we said 5% organic, 5% through acquisitions. That's still our target.

And the macro things that we would be worried about would be any big changes in auto obviously would be important to us..

Right, right and obviously that’s 3.5% to 7.5% excluding the HDD mostly organic.

I guess you have a quarter's worth of the single crystal acquisition done at the anniversary?.

Yeah, we have about two months’ worth of sales that will be benefiting from in 2017..

Got it and then in terms of the single crystal acquisition, I assume more accretion, rising accretion this year versus last year?.

Yes, we've guided that we're going to be growing that business. We expect it to grow 10% and if you heard from the comments we feel confident by that. We've got good traction there..

Okay.

In terms of - just lastly on gross margin, you guys have done a fabulous job shifting stuff into low across regions and among other initiatives, margins now I think sort of in the lower to middle half of sort of your longer term range or targets, how do you look at ‘17? Do you think it's sort of maybe flattish type year and then we get more benefit from Elkhart to move out of Elkhart in ‘18 and beyond? Is that a fair way to look at it or any thoughts there would be great?.

From the previous comments we've said the savings from the transition in manufacturing are probably going to be in the range of about $6 to $8 million.

You will see that fully for a full year after ‘18 into ‘19 really and quite honestly the way we approach the business, run the business, is we're always looking to improve and we've obviously made some progress, but we're always looking to prove and that’s why we said the ranges in the 34% to 37%..

Got it, okay. Great, thanks..

We’ll go next to John Franzreb with Sidoti & Company..

Yeah, my question is also surrounding the gross margin profile.

The $6 to $8 million you fully expect to realize in 2018, how much of that do you expect to realize in 2017?.

John, the full year of benefit is expected to be in 2019. We will see some very small portions in ‘17 as some of the line moves get completed. But the bigger changes will start benefiting us in the late part of 2018 and then full benefit in 2019..

Okay. And just I guess sticking with the restructuring actions you expect to take this year, you mentioned that ERP roll out in the second half of the year.

Do we have any sense of how big of restructuring actions you'll be taking in 2017?.

The announced restructuring is related to the same plan that we announced back in June of 2016, John. The ERP project will start in the second half of ‘17 where we'll go into designing and testing and things like that. The rollout will be in ‘18 and we haven't announced any restructuring plans related to the ERP implementation..

Okay. All right, ‘18. Got it and one last item, you have a tax impact non-recurring stock compensation change item that you called out in the quarter.

Can you just walk me through what that was?.

So, as we - there was an accounting change that we adopted in the second half of the year and there is a one-time tax change as a result of that accounting change. That created a benefit of about $0.02 of EPS that we’ve carved out, John..

Okay.

And just back to the gross margin again, when we think about 2017, do we think that the mix is going to have a bigger impact, the volume is going to have a bigger impact or the currency, which I believe was a benefit in 2016 will have a bigger impact?.

John when you look at it, we’ve obviously got some benefit from the currency in the last few quarters and that's continuing. It obviously gave us some headwinds on the top line. But overall as we get more volume that helps us, the mix we have a good handle on it.

There are some small changes there with the single crystal, but nothing dramatic to point out..

Okay.

So, embedded in your guidance for 2017, is a steady state kind of a gross margin profile?.

John, we will see some changes to the gross margin obviously, but we’re not specifically calling out ‘17 gross margin guidance. The EPS guidance obviously incorporates any expected changes on the gross margin for ‘17. To your point though, we will continue to see the benefits from the various items that you talked about.

Currency is looking relatively favorable at this point and we will see some benefit from the single crystal product mix as well..

Okay. Alright guys, thanks. That’s all I had, thank you..

Thank you..

[Operator Instructions] And there are no additional questions. At this time I’d like to turn the call over to Kieran O’Sullivan for any additional or closing remarks..

Thank you, Jessica and thanks everybody for your participation on today’s call. We’re back to work and we’ll talk to you at the end of the first quarter. Thank you..

This concludes today’s call. Thank you for your participation. You may now disconnect..