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

John Franzreb - Sidoti & Company Ian Gilson - Zacks Investment Research Hendi Susanto - Gabelli.

Good day and welcome to the CTS Corporation Third 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..

Thank you, Jim, and good morning. Thank you for joining us today, and welcome to CTS third quarter 2017 conference call. Third quarter sales were $106.2 million, up 6.6% from the same period in 2016. We improved our total booked business from 1.542 billion at the end of the second quarter to 1.698 billion at the end of the third quarter.

Gross margins were 35.3% compared to 36.8% in third quarter of last year. Sequentially gross margins improved from 33.9% in the second quarter. Adjusted earnings per share were $0.31 compared to $0.28 in the third quarter of last year and 11% improvement.

Cash flow from operations improved to 23.7 million, up from 17.8 million in the same period in 2016. We continue to track to our timeline. On our manufacturing transitions for 2017, we have revised the transfer time line for one product line and added three months in order to ensure supply chain continuity.

The move of our corporate building is tracking to plan. The manufacturing consolidation of our acquired single crystal operation into the new corporate location will be completed in the first half of 2018. As usual our CFO, Ashish Agrawal is with me for today's call and will take us through 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 our CEO.

Kieran?.

Thank you, Ashish. Third order sales were $106.2 million, up $6.5 million compared to the same quarter last year. Sales from our Noliac acquisition are tracking to our integration plan and contributed 2.6 million in the third quarter. Our total book business was 1.698 billion at the end of the third quarter.

We expect to ship 103 million of the total booked business in the remainder of 2017. Order bookings were our strongest in the last several years, while this is providing positive momentum. We have more to do to achieve our target growth rate of 10%. We added four new customers in the quarter in communications, defense and automotive markets.

We received an award from a new Asian customer for a new haptic application in mobile phones, with initial shipments starting in the fourth quarter and revenues expected to be in the range of 2 to 3 million next year. We added a new customer for RF Filters with some small revenue in 2017 and the potential of 400,000 next year.

We gained a new single crystal customer for a defense application with annual revenue in the range of 500,000 to 1 million. We also secured a new customer in China for a tubular application. For home appliances we received a new order with an existing customer valued at 1 million.

On the transportation front, we received long-term contracts with existing customers, with requirements through 2025. We had wins with three existing customers for position sensors and added four accelerator module awards with current customers. We also released a new 64 PPR optical encoder during the quarter.

We have begun the development phase for next generation actuator and pedal platforms. On the innovation front, we are advancing new product concepts in the area of sensing and new materials formulations for a variety of applications.

We continue to work our M&A pipeline to meet overall growth targets in line with our investment in products that sense, connect and move. We remain focused on adding technology and talent while broadening our geographic reach and customer base. End markets remain steady.

Automotive volumes globally remain in line with our comments from last quarter, with some potential increases due to the unfortunate hurricane damage in the US. On-hand days of supply of inventory improved from 71 days to 65 days at the end of September for North America.

We're also monitoring our supply base and have a supplier located in Puerto Rico that was impacted by the storms. We are in the process of qualifying alternative sources until supply returns to normal. Other trends that we are carefully monitoring into the recent announcements on the transition to electric vehicles by various countries.

China announced the start date of 2019 for EVs with a 10% quota that is expected to increase over time. We have taken this into account in our strategic planning for our portfolio mix beyond 2020. We still see continued momentum for our medical line of products and a continued softness in telecom infrastructure.

Operational changes begun in 2016 are on track for the product transfers. As previously announced, the Elkhart transfer is expected to be completed in 2018. And as I mentioned in my opening comments we have extended one product line transfer by three months to ensure supply chain continuity.

As you saw in our earnings release, we have narrowed our guidance for full year 2017. We expect full-year sales in the range of $415 million to $420 million. Adjusted earnings are expected to be in the range of $1.13 to $1.18. I will now hand over to Ashish to take you through the results in more detail.

Ashish?.

Thank you, Kieran. Third quarter sales were $106.2 million, up $6.5 million compared to the same quarter last year. Foreign currency impacted sales favorably by $200,000 in the third quarter. Sales to automotive customers increased by 5.8% and sales of electronic components increased by 7.9% compared to the same quarter of 2016.

Organic growth was 4% excluding sales from the Noliac acquisition. As we have discussed in prior calls, in the first half, our profitability was impacted by certain production rework issues. We are getting to a better profitability levels. Gross margin for the third quarter was 35.3% compared to 33.9% in the second quarter of 2017.

Gross margin was down from 36.8% in the third quarter of last year, due primarily to favorable mix last year and unfavorable exchange rate impact year-over-year. SG&A expenses were $15.9 million or 15% of sales in the third quarter of 2017 compared to 16.1% of sales in third quarter last year.

The SG&A expenses for the third quarter of 2017 include amortization and other ongoing costs from the Noliac acquisition. The loss on sale of assets of $0.7 million was related to the sale of vacant land adjacent to our Hopkinton, Massachusetts facility. In third quarter 2017, other income was $1.3 million.

This was driven mostly by foreign currency balance sheet translation gains as the US dollar depreciated against the Chinese renminbi and the euro. Our effective income tax rate in the third quarter of 2017 was 31.1%. Third quarter 2017 earnings were $0.29 per diluted share.

Adjusted earnings per diluted share were $0.31 representing 11% growth versus third quarter of last year. I'll now cover a few items on the balance sheet. Cash and cash equivalents were $116.2 million at the end of third quarter compared to $113.8 million at the end of 2016.

Our long-term debt balance was $82.3 million, down from $89.1 million at December 31, 2016. Our controllable working capital as a percentage of sales was 12.9% in the third quarter of 2017, up from 12.1% a year ago. The Noliac acquisition and safety stock bills were the main drivers for the increase in working capital.

We expect our inventory levels to remain elevated through the first half of 2018 as we maintain safety stock as part of our manufacturing transition. Cash flow from operations for the third quarter was $23.7 million compared to $17.8 million in the third quarter of last year.

Capital expenditures were $2.9 million compared to $7 million in the third quarter of 2016. We expect our cash flow to be considerably lower in the fourth quarter, primarily due to the timing of capital expenditures in connection with ongoing projects. We are also seeing the timing of some expenditures shift into 2018.

As a result of strong operating cash flows in the third quarter, our debt to capitalization ratio was at 19.2%, down from 22.1% at the end of last year. This concludes our prepared comments. We would be glad to take your questions at this time..

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

I want to start with the guidance, Kieran, it seems like you shaved [ph] a couple pennies of the top end of the EPS outlook. What's changed that made you cut some of the earnings outlook a little bit..

John, really what it reflects is, we talked in the last calls about our rework that we have in the first half of the year that impacted our gross margins and we improved them sequentially this quarter, but we've just taken that into account..

So the rework impact is going to continue into the fourth quarter.

I'm sorry, I might have missed, but what's the magnitude of the impact in the third quarter?.

No, we talked about it John in the first and second and said it would improve, we're coming out of that situation in the third which you see in the sequential improvement in gross margins. But we've worked that issue behind us and we're on the right trend, but it impacted the overall year.

So we're just being - we trimmed it a little bit to reflect that..

And could you just give me an update on some of the CapEx spending, is some shifting from 2017 into 2018.

What do you think the total CapEx is going to be, Ashish, in '17 and '18?.

So John, we have talked about in the range of 6% to 8% between the two years. Our current expectation is still in the same range when you combine the two years together. 2017 is a little bit slower than we anticipated. And as you know we'll always carefully manage whatever money we have to spend on CapEx.

But the overall view has not changed significantly between the two years..

And Kieran, you cited that you're monitoring the opportunity for EV in China. Could you just remind me what your exposure is there and what you're monitoring it? I don't recall you talking about that before..

Yeah John, I kind of highlighted China, but I said other countries as well. So when you look at what's been announced there for EV, plug-in hybrid and fuel-cell are same, quote for OEMs to start manufacturing at a 10% rate in 2019. Really what we're looking at is, EV overall just globally.

And as we look at the portfolio out in 2020 and beyond, how much exposure do we have in the power train versus chassis and how you're getting the right product wins to make sure we continue to get to our 10% growth rate.

So nothing to be concerned about, we would have a few single points of sales in exposure today, but over a longer period of time we expect to smooth that out and move forward with the new trends..

Moving on, we'll take our next question from Ian Gilson from Zacks Investment Research..

As we look at the auto sector, how much of the current level of business is what you might call old line and how much is new products that are likely to be in place over the next four to five years?.

Ian, when we look at it, we have, on the Chassis side of it, commercial vehicle side of it, interior of the vehicle, we don't feel we've got any exposure that we're coming up with the current generation, next generation products. We've got product roadmaps to go back several years.

On the powertrain side, it might come into a little bit with [indiscernible]. We have some products, just like we've had in the past that we're not particularly investing, and they will design and some of them have a long tail, but we're more focused on adding new products that will help us going forward.

So some small exposure there, but nothing that's above a few points of sales, a few percentage points of sales. And nothing that we're concerned about next year or the year after, it's going to be something that will phase out over time..

Okay.

As we look at the hard drive business, how much capital is that taking up? Do you still continue to do R&D or are you just letting that decay on a natural curve?.

Ian, could you repeat your question? We missed the first part of it..

Okay.

In the hard drive business, are we laying that or are you still investing capital in that business?.

We've already, because we've been working this for more than a year, redeployed capital. We have some volumes that still ship there. We support our customers, but I would say no substantial big investments, just some maintenance stuff for the lower run rates..

Can you go back, and I missed some of the sector growth.

Could you go back and repeat those numbers for me?.

Sector growth percentages, I don't think I covered that. I don't think I covered the end markets, but to give you a sense, that was in the press release. Automotive was up 5.8%, the components side was up 7.9%. We see the markets remaining pretty robust, where I think everybody knows we've been constant in this for the last few quarters.

Globally, we're okay in automotive, but we're very cautious on North America, 7.6 million to 7.8 million last year in units. This year probably tracking closer to 17 and we've said a high 16 to 17 number would be good and we're gaining share in certain areas..

So in what timeframe are we looking to return to the 10% growth rate and I presume that's bottom line or is that top line?.

The 10% growth rate John is the target we've had for some time. We started to shrink and get smaller for the first 14, 15, 16 and then we started on the growth trend and we've had a very strong buildup in our booked business. It's a very positive signal, but we're not at the 10% yet. So that's still our goal, between organic and acquisitions.

And we won't stop seeking that goal..

So are we looking at next year or are we looking at 2019, 2020 timeframe?.

The way, we'd like to be already there, but we're not. The way we look at it is, it's a combination of the organic and the acquisition, you can see the organics come along quite robustly in the last year.

The acquisitions, it's got to be the right fit, right fit for our strategy and technology requirements globally and we'll just make the right decision for the future of the company..

Moving on, we'll take our next question from Hendi Susanto from Gabelli..

Ashish, how should we view the stronger gross margin of 35.3% in the quarter? Should we see it as a stable gross margin in the near term or should we see potential upside from that level?.

Hendi, we are happy that we are getting the improvement in our gross margin compared to the first half of this year. I would say that we haven't changed our guidance in the gross margin range. We have always talked about 34% to 37% as our range for gross margin. We still see that. The 35% is very much in that range.

We look at currency as one of the major drivers that can swing our gross margin in the short term. And then we expect no additional impact from the quality issues that we had in the first half of the year, the production rework issues that we had in the first half of the year that impacted our margins in first and second quarter..

And then, Ashish, you guys are implementing ERP, new ERP, how much operating efficiency that translates to gross margin and operating margin we can expect down the line?.

Hendi, we have not quantified publicly the impact that we expect in terms of improvements. My expectation is that we will complete the implementation in 2018 and then we will start thinking about the operational changes implementing them after that.

So I would look to 2020 in terms of operating efficiencies from the implementation, but we've not quantified it..

So it may take one year from the end of 2018 to 2020? Is that the?.

That would be the - yeah, we need to work on our plans in terms of exactly what changes we are making, what improvements we are seeing and then there'll be some execution time on that as well. So 2020 is a good target for a first full year of benefits from the implementation..

Okay.

And then Ashish, any update on your tax restructuring project?.

We are working on it. As we have talked about, we are starting to make progress in that direction, Hendi. My expectation is, we should be talking more about it in 2018 and start to see improvements towards the end of 2018 and into 2019..

And then, Ashish, can you give some insight of how much of your revenue guidance is organic versus acquisitions?.

That's consistent from the past, Hendi.

We have talked about, are you referring to 2017 or?.

2017, like if you want to split..

The 2017 415 to 420 is where we expect to end the year. That includes the inorganic piece as well as the organic piece for this year..

Can you elaborate whether you can quantify the range for the inorganic contribution?.

We haven't guided specifically to the sales from acquisition for the fourth quarter, Hendi, but it is included in that number..

Okay.

And then Kieran, may I enquire how CTS is in terms of looking for strategic acquisitions?.

We're always working on our pipeline. We have clear things in line with our strategy, Hendi that we're working on.

That's been pretty evident in the piezoceramic area over the last few years and there are other things we wanted to do in the sensing areas and I just tell you that we're working it hard and we've got something to bring, we'll look forward to updating you..

Moving on, we'll have a follow-up from John Franzreb from Sidoti & Company..

Yeah. Just I was wondering, it's been a year since your Investor Day.

Kieran, how would you, looking back in the page, how would you say that you have progressed toward the new goals, are you ahead of expectations, in line or do you think some things could be better than you were hoping at this point of the game?.

John, we set challenging targets for ourselves and the team. We've got a lot going on with managing to grow the portfolio, the transitions, the moves across locations. So there's a healthy level of stress within the company to move forward, I wouldn't give us an A, I'd give us probably a B. And we have some things we can improve.

So, we're ambitious to do some things, but some of them, you can't force, you got to make sure you protect your customers and move it in the right way and that's where we're being careful. So I would give us a B..

Okay.

Just curious what are your thoughts?.

Moving on, we'll take our next question from Ian Gilson from Zacks Investment Research..

You mentioned currency on, again, it's the Chinese, how about the impact of currency on cost of goods.

I believe you have an impact against the Mexican peso there?.

Ian, yes, we did. And that was one of the things we talked about as part of our gross margin for the quarter compared to last year. Generally, we have exposure in Mexican peso on the cost side and we have exposure on the euro and other European currencies. But in net revenue exposure on the euro side.

So as those currencies are moving, that does have an impact on our gross margin as well as operating earnings..

Could you quantify the overall impact?.

We haven't quantified the impact specifically. It is part of the reduction in gross margin that you see from last year. There was more than a percentage point of decrease in gross margins from last year to this year. And currency is the major piece of that..

[Operator Instructions] And at this time, it appears there are no further questions. I'd like to turn the conference over back to Mr. O'Sullivan for any additional or closing remarks..

Thank you, Jim and thank you everyone for your participation in today's call. We've got our goals set ahead of us to keep improving and we look forward to updating you during the next call with the fourth quarter and full year 2017 results. Thanks for joining the call..

Again, that will conclude today's conference. We thank you for your participation. You may now disconnect..