Kieran O'Sullivan - Chairman, CEO and President Ashish Agrawal - CFO and VP.

John Franzreb - Sidoti & Company.

Welcome to the CTS Corporation Second Quarter 2017 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Kieran O'Sullivan. Please go ahead, sir..

Thank you, Jessica. Good morning. Thank you for joining us today, and welcome to CTS' Second Quarter 2017 Conference Call. Second quarter sales were $105.7 million, up 7.1% from the same period in 2016. Sales were up 5.5%, excluding our recent acquisition. Our total booked business increased to $1.542 billion.

In the quarter, we acquired Noliac, headquartered in Denmark. This acquisition adds tape cast technology to CTS, in line with our stated strategic plans. Gross margins were 33.9% compared to 34.9% in the second quarter of last year, due to the additional charges from the rework issue we discussed on the first quarter earnings call.

Adjusted earnings per share were $0.28 compared to $0.26 in the second quarter of 2016. In the second quarter, the board approved our ERP capital investment, and our team has started the project. The transition of manufacturing operations is tracking to our previously announced plans.

As usual, our CFO, Ashish Agrawal, is with me on today's call and will take us through with the safe harbor statement.

Ashish?.

I would like to remind our listeners that this conference call contains forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements.

Additional information regarding these risks and uncertainties is contained in the press release issued today, and more information can be found in the company's SEC filings.

To the extent that today's discussion refers to any non-GAAP measures relative to Regulation G, the required explanations and reconciliations are available in the Investors section of the CTS website. I'll now turn the discussion back over to Kieran..

Thank you, Ashish. Second quarter sales were $105.7 million, up $7 million compared to the same quarter last year. Sales increased $5.5 million, excluding Noliac sales in the quarter, representing a 5.5% organic growth rate.

In the quarter, we announced the acquisition of Noliac, a designer and manufacturer of tape cast and bulk piezoelectric components, sensors and transducers. Noliac serves OEMs in the aerospace and defense, test and measurement, medical and industrial markets.

The acquisition is another step forward in our strategic plan as we continue to build momentum in transforming our end market profile. This acquisition has manufacturing facilities in Denmark and the Czech Republic.

In addition to tape cast technology, the acquisition also provides a stronger sales force in Europe and backup foundry capabilities regionally, which is important for our customers.

Some of the growth rate -- areas we are focused on are optical switching and smart water metering applications in monitoring critical natural resources through the Internet of Things and connectivity. By adding tape cast technology with this acquisition, we more than double our available market in piezo material products to $1.4 billion.

We're delighted to welcome the Noliac team to CTS. Most recently, in the month of July, the business secured its largest contract in its history for approximately $2.7 million, which will be included in our third quarter total booked business. Noliac contributed $1.5 million in sales in the second quarter.

Sales for the second half are expected to be in the range of $4 million to $5 million. We added 6 new customers in the quarter, one new automotive customer in China and 5 with applications in industrial, defense, aerospace and telecom. We continue to see good progress in renewing accelerator module awards and several sensor applications.

We continue to make good progress with our RF filter sales. We added a new application in passenger jets for our low-power OCXO product. Demand for our single-crystal and traditional piezoceramic products remain strong. Most recently, we were awarded new military contracts for our piezoceramic product line.

In May 2017, our RF sensing technology was recognized by the German AMA Association as a winner for the Sensor and Measurement category. Our RF sensor enables more efficient engine and emissions system operation and control by providing multiple sensing functions in a single device.

We are working with multiple OEMs in our efforts to commercialize this product. Our total booked business was $1.542 billion. $194 million is expected to be shipped in the remainder of 2017. Order bookings were slightly below our expectation for the second quarter as some automotive customers delayed award decisions.

We continue to work our M&A pipeline toward our 10% growth objectives around products that sense, connect and move. We remain focused on adding technology and talent and broadening our geographic reach. The latest acquisition addresses all of these areas for us.

Our performance in the medical market continues to be strong, delivering significant growth over last year. In the defense and aerospace end market, we made substantial gains with our piezoceramic product line.

Most end markets remain steady, though we do expect the North American automotive seasonally adjusted annual rate in the range of 16.7 million to 17 million units this year. The Chinese market remains robust despite the changes in tax incentives, with a half-yearly volume of 13.3 million, up in the range of 2% to 3% over 2016 volumes.

European sales remain steady at a 22 million unit run rate. On the operations front, our gross margins were 33.9% for the quarter, a decrease of 100 basis points compared to the second quarter of 2016.

As mentioned in our first quarter call, we were impacted by certain rework costs that were resolved in the first quarter but also impacted our second quarter margins. The total onetime charges were in the range of $1 million in the second quarter. Operational changes begun in 2016 are on track for product transfers.

And as previously announced, the Elkhart transfer is expected to be completed in 2018. The consolidation of our 2 Illinois sites is proceeding, and we will provide an update on the progress on our next call. Our board approved a plan to implement a new ERP system, and the design work has begun to implement SAP.

Our guidance for the full year 2017 remains unchanged. We expect sales to be at the upper end of our guidance range of $405 million to $420 million. Adjusted earnings are expected to be in the range of $1.12 to $1.22. I will now hand the call over to Ashish to take you through the results in more detail.

Ashish?.

Thank you, Kieran. Second quarter sales were $105.7 million, up $7 million compared to the same quarter last year. Foreign currency impacted sales unfavorably by $800,000 in the second quarter. Sales to automotive customers increased by 5.6%, and sales of electronic components increased by 9.9% compared to the second quarter of 2016.

Organic growth for electronic components was 5.3%, excluding sales from the Noliac acquisition. Sales to the HDD end market declined approximately 12% in the quarter, in line with our expectations. Gross margin for the quarter was 33.9% versus 34.9% in the same quarter a year ago.

The margin decline was driven primarily by approximately $1 million in rework charges Kieran discussed a moment ago and an unfavorable impact of foreign currency rate movements. In addition, we recorded lower-than-normal margin on sales from the Noliac acquisition due to the post-acquisition step-up of inventory.

SG&A expenses were $15.8 million or 15% of sales in the second quarter of 2017 compared to 16% of sales in the second quarter last year. The SG&A expenses for the second quarter of 2017 included acquisition costs as well as amortization and other ongoing costs from the Noliac acquisition.

R&D expenses were $6 million in the second quarter of 2017, roughly flat to the same period last year. Our effective income tax rate in the second quarter of 2017 was 28.4%. There were certain discrete items that reduced our tax rate in the second quarter. We expect our ongoing tax rate for 2017 to be in the mid-30% range.

As we have discussed previously, we continue to evaluate opportunities to improve our tax rate in 2018 and beyond. Our second quarter 2017 earnings were $0.30 per diluted share. Adjusted earnings per diluted share were $0.28 in the second quarter, an 8% growth over the second quarter of last year. I'll now cover a few items on the balance sheet.

Cash and cash equivalents were $107.8 million at the end of second quarter of 2017 compared to $113.8 million at the end of 2016. Our long-term debt balance was $92.8 million, up from $89.1 million at December 31, 2016. Debt to capitalization was 21.8% at the end of second quarter of 2017, down from 22.1% at the end of last year.

Our controllable working capital as a percentage of sales was 14.2% in the second quarter of 2017, up from 11.8% a year ago. The primary drivers of this increase are the buildup of safety stock as part of our manufacturing transition plan and the addition of working capital from the Noliac acquisition.

Cash flow from operations for the second quarter was $13.5 million compared to $13.4 million in the second quarter of last year. Capital expenditures were $5.3 million compared to $4.6 million in the second quarter of 2016. As Kieran mentioned earlier in the call, we have started the implementation of SAP to replace our aged ERP systems.

This project, combined with growth-related CapEx and the building transitions announced earlier, are expected to increase our CapEx spend to be in the range of 6% to 8% of sales in 2017 and 2018. CapEx spending should be closer to normal levels in 2019 and beyond. This concludes our prepared comments. We would be glad to take questions at this time..

[Operator Instructions]. And we'll go first to John Franzreb with Sidoti & Company..

Got a couple of questions. First, Kieran, I guess we'll start with the guidance number that you gave. Thought sales were going to be at the high end of the range, but you had no mention of EPS.

Is the sales at the high end of the range due to the Noliac acquisition? Or can you just kind of walk me through why you excluded any kind of color on the EPS, sir?.

Yes. John, I would say, on the sales side, first, obviously, it's helped a little bit by the acquisition, and we're comfortable with the range and what we provided. On the EPS side, obviously, we had those onetime costs that hit us in the first and second quarter. There's going to be some costs from the acquisition as well.

And that's why we're staying within the range on EPS..

Okay. Regarding the costs, if I heard it [indiscernible], there was $1 million in rework in the second quarter.

Is that true, Ashish?.

That is the number of onetime costs, John, for the -- go ahead, sorry..

And without continuing to the third quarter or are we done with those expenses?.

John, if you think back to the first call -- first quarter earnings call, we had resolved the issue. So we're not expecting and don't believe we'd have any issues in the third quarter, with the issues resolved..

Perfect, all right. And just regarding -- I guess I'm stuck here on some of the numbers. Just around the tax rate, I thought I heard you say a mid-30s tax rate for the full year. That -- what that, I think, suggests us [indiscernible] I've been using.

Did I hear that properly? Isn't tax rate going to be around 35% for the year?.

John, we have said mid-30%. If we exclude some of the discrete items that we had in the second quarter and also in Q1, we are in that ballpark. So that's what we are forecasting for the rest of the year.

And as we have talked about in the past, we are continuing to work on some things that will help us improve the tax rate, but that, in fact, won't be visible to us at least -- the earliest would be 2018..

Okay, all right.

The piezo acquisition strategy, can you kind of walk me through how much of your revenues are actually now associated with the piezo market? And what's the underlying strategy to increase your penetration there? What do you find attractive in that market that you continue to target?.

John, if you think back on the strategy, if we go back even 2, 3 years, we said we were in bulk processing. We wanted to add single crystal and tape cast, and this is the piece that we wanted to add in after single crystal. And we've done a lot of work here. It gives us a number of things. It gives us that sort of technology.

It gives us a backup foundry in Europe. It gives us a stronger sales force in Europe as well. When you look at the markets, it also helps us with our end market profile transition for CTS, with aero and defense, test and measurement, medical and industrial. And we believe it's a really nice fit for our market going forward.

Specifically to your question on the percent of sales, it's part of our electronic components, so we don't break it out. But you can see the end market more than double to $1.4 billion. We're getting into several new products and complementing some other ones and adding new customers. We really like the acquisition..

[Operator Instructions]. And we'll take our next question from John Franzreb with Sidoti & Company..

Sorry, I didn't mean to hog it, but I guess I got more.

Regarding the SAP rollout, can you talk a little bit about that, if we should expect the costs associated with that be just part of our ongoing expenses or you'd be calling those out?.

John, the bulk of the costs related with the implementation will be capitalized. And that's -- they're combined with all the other major projects that we've got going on. That's the reason for our elevated CapEx in 2017 and 2018..

Okay. And Kieran, can you talk a little bit about your expectations in the automotive market? I know you called out some of the expectations regarding the U.S. and Europe and Asia.

Can you just talk a bit -- a little bit about your exposure and what you think personally of the outlook in the near term?.

Yes. And John, linking you back to your question earlier on guidance as well in terms of the sales side of it, we're kind of being very cautious on the automotive market as part of our overall guidance. So take that into account, please, in terms of our comments and how we position our message here.

North America, we still see softening where we have been, for a number of quarters, have remained concerned. If you look at some of the OEMs on handy supply, which you'd normally like to see at the 70 range, are now locked on 1 or 2 OEMs at over 100, which is pretty significant. So we're closely watching North America. The other piece is Europe.

We don't have as many concerns. We've been clear we're gaining share and launching products in the second half of this year. And that's part of the CapEx increase as well. And Asia, we're doing pretty well. We're pleased with how it's going and adding new customers. Overall, just the market is a little bit of a watch more in North America.

If you look at 16.7 million to 17 million or 17-odd million, it's down from last year. But we've always said, on a total basis, we're looking at a flat market. That's how we're viewing it in terms of the year, and that feels okay still. And there's a number of plant shutdowns. We've had them in the second quarter. We've had them earlier in the year.

We monitor that very closely. So more -- most concerned with North America, but also, our position is gaining share and adding customers..

Perfect, got it. And longer term, okay, your booked business was [indiscernible] sequentially to $1.542 billion. How should we think about that? And how does that translate into increased business over what kind of cycle? Just give me kind of -- discuss a little bit about how we should look at that number..

I think -- again, auto on its own tends to run out there 4 years or so. Commercial vehicle orders that are in the backlog would run out a little bit longer, more like the 5 to 7. Piezoceramic side of it is -- some of it's -- just on an annual basis, a big chunk of it's on a 2-year period on contracts.

And then electronic components mostly tends to be within the year within purchase orders. So when you link it all back to how we're performing, our target has always been 10% growth, which we have not achieved yet and that goal stays. They are very firm for us to achieve.

And then the other side of it is half of that was meant to be organic and half on the acquisition side. And you see now we're demonstrating momentum on the organic side. So I can't lay it out for you by forecasting each year, but we feel good that the total booked business is much stronger than it was 2, 3 years ago.

And we feel we've got a lot of business to win here in the second half of the year that we're working on. Pipeline's good also in some of the product lines. You focused a little bit earlier on the ceramic product line. We added a number of new customers in that area. We've got several new customers we're developing in that area. We feel good..

[Operator Instructions]. At this time, I show no additional questions. I'd like to turn the call back to Kieran O'Sullivan for any additional or closing remarks..

Okay. We'll be brief. Thank you for your participation on today's call. We've got work to do, and we look forward to updating you at the end of the third quarter. Thank you for joining the call..

This does conclude today's call. Thank you for your participation. You may now disconnect..