Kieran O'Sullivan - CEO Ashish Agrawal - CFO.

Good day, and welcome to the CTS Corporation First Quarter 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..

Great. Thank you, Jessica. Good morning, and thank you for joining us today, and welcome to CTS' First Quarter 2019 Conference Call. Sales in the first quarter were $117.6 million, up 3.6% versus the same period in 2018. We added four new customers in the quarter.

First quarter adjusted gross margins of 34.5% improved 60 basis points compared to 33.9% in the same period last year. First quarter adjusted earnings per share were $0.39 compared to $0.34 in the first quarter of 2018. We ended the quarter with total book to business of $1.87 billion.

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 under Regulation G, the required explanations and reconciliations are available in the Investors section of the CTS website. I will now just turn discussion back over to our CEO, Kieran O'Sullivan..

Thank you, Ashish. In the first quarter of 2019, our sales growth was 3.6%. We added 4 new customers in the quarter. Total book to business was $1.87 billion, flat to the end of last year. This was driven by the timing of some customer sourcing decisions, which we expect to balance out in the months ahead.

The year began with softness in the Chinese market, industrial markets, and distributors focused on reducing inventories. We continue to see solid performance in medical and defense markets. Our overall 6.1% growth in transportation was primarily driven by gains in our brushless DC motor product line.

Currency rates unfavorably impacted sales by $1.8 million mostly in the transportation end market. We are carefully managing operating expenses, monitoring our capital spending and prioritizing investments as we maintain our focus on results and continue to drive profitable growth.

We continue to expand our range of sensing, connectivity and motion products. Recently, we developed an inductive accelerator module and secured our first OEM award in the first quarter. This product will be an important addition for growth with electric vehicles.

Our piezoceramic sensing technology was successfully qualified for an application in fingerprint security last year, and we expect further progress in the second half of 2019. We believe that sensors are the fundamental building blocks that enabled a safer, cleaner and more efficient world.

We are also innovating with new wireless switch applications for vehicles and e-brake solutions to complement ADAS systems. Consumers and companies demand universal and seamless data connectivity.

Our family of RF filters, ClearPlex and monoblock products gained considerable traction with several new connectivity customers for deployment in massive mimo and small-cell systems. The filters are located in antenna arrays enabling faster data connectivity.

We are excited about the arrival of 5G systems as it will create opportunities for us with applications, technology and devices driving sales growth. We have more to do as we transition our company for success beyond 2020. In the first quarter, we secured several notable wins.

As I mentioned, we continue to gain traction with our expanding RF filter portfolio and see interest in demand for prototypes for applications driven by our universal design in ClearPlex platform and expect revenues will continue to increase in 2019.

In transportation, we secured several new accelerator module awards, including the one I mentioned earlier for our inductive pedal design with a North American OEM, a new EV customer in China and another win for an OEM serving the Eastern European market with a lifetime value of $20 million.

We also had sensor wins in the quarter in the China market for new SUV programs. We were awarded 2 new programs for defense applications with annual revenues of $2 million, and we secured our first order for RF filters for an application in aerospace connectivity.

Last year, we launched our trouble sensing module in the Chinese and Indian 2-wheeler markets. We are now ramping up production and expect sales growth of about $3 million for 2019. Overall, we continue to target a combined sales growth rate of 10%, 5% organic and 5% through strategic acquisitions.

Making further progress on our end market profile is a strategic priority for us. We continue to evaluate our portfolio of products and technologies and strengthen our M&A pipeline. We remain focused on adding the right technologies, expanding our geographic reach and strengthening our product portfolio and customer relationships.

The consolidation of manufacturing from Elkhart, Indiana, to other sites and from Bolingbrook to Lisle, Illinois, have now been completed. We continue to evaluate and work on other consolidation opportunities.

With the largest manufacturing consolidations completed over the past years, we will focus more on the prioritization of R&D projects and engineering effectiveness as we grow our best cost capabilities. Our ERP rollout continues and will position us to gain further efficiencies beyond 2020 in various aspects of our supply chain.

End markets were challenging as we began the year with global trade challenges and slower growth in China. Passenger vehicle volumes have declined by single digits as we near the end of an expansion cycle. Our performance remained steady.

We solved over bookings in industrial and distribution markets in the fourth quarter, and this impacted revenues in the first quarter. Medical and defense markets remain robust where we continue to see solid growth. Profitable growth, margin improvement, ERP implementation and end market profile progress are priorities for us this year.

For full year 2019, we are maintaining our guidance and expect sales to be in the range of $460 million to $500 million and adjusted earnings in the range of $1.50 to $1.70. At this time, Ashish will walk us through the financial performance.

Ashish?.

Thank you, Kieran. First quarter sales were $117.6 million, up 3.6% compared to the prior year. Sales to transportation customers increased by 6.1% and sales to other end markets decreased by 1.1% due to softness in the industrial and distribution markets. Our gross margin was 34.5% in the first quarter versus 33.9% in the first quarter of 2018.

During the first quarter 2019, we realized approximately $1.5 million in savings related to manufacturing transitions, partially offset by material cost increases and Mexico wage increases. We expect full year savings from the manufacturing transfers to be in the range of $3 million to $4 million.

SG&A and R&D expenses were $24.3 million or 20.7% of sales compared to 21% in the first quarter last year. Our effective income tax rate in the first quarter of 2019 was 20% down from 24.5% last year, mainly due to the discrete tax benefit related to equity-based compensation.

We expect our full year tax rate to be in the range of 23% to 25% excluding discrete items. Our first quarter 2019 earnings were $0.34 per diluted share. Adjusted earnings per diluted share were $0.39, up $0.05 compared to the first quarter of last year. Now I'll discuss some items on the balance sheet and cash flow.

Our controllable working capital as a percentage of sales was 15.3% in the first quarter. We started working down our safety stock related to the transfer of production from Elkhart to other locations. We have more work to do to improve working capital efficiency in the coming quarters.

We generated $9.6 million in operating cash flow in the first quarter. CapEx was $5.3 million. Consistent with our prior communication, we expect our 2019 CapEx to be in the range of 6% to 8% of sales with a return to more normal levels in 2020. Cash was $100.7 million on March 31, 2019, compared to $100.9 million at the end of 2018.

Our long-term debt balance was $50 million at the end of March, flat with December 2018. Our debt-to-capitalization ratio was at 11.4% compared to 11.7% at the end of 2018. During the first quarter, we repurchased 31,500 shares of our stock for $849,000. We have $24.7 million remaining under the repurchase plan approved in February.

During the first quarter, we also completed the renewal of our $300 million credit facility and extended the maturity of the facility to February 2024. The SAP implementation project is progressing. We have so far completed the rollout of SAP to 6 manufacturing sites and 2 shared service locations.

We are carefully managing the rollout to minimize the impact on our customers and are expecting to complete the project in the first half of 2020. This concludes our prepared comments. We would like to open the line for questions at this time..

[Operator instructions] We'll go first to John Franzreb from Sidoti & Company..

It's John Franzreb. Good morning, Ashish and Kieran. Just to make sure you heard me there. Couple of questions. First to Kieran, how would you assess the operating environment today compared to three months ago? You've been voicing caution on the transportation market really for quite some time.

Has outlook changed at all?.

John, we were coming into this year saying we expect to see low single digits in the transportation market. You can see that the performance across the industry was probably in quarter 1 negative 5% to 6%.

If you take out our brushless motor, which we called out in the earnings transcript, and you take it the FX adjustment, we were essentially flat when the market was down in transportation for 5.6%. So pretty much in line with where we expect it to be.

And obviously, we saw softness at the end of the year coming at the Q1 in industrial and China, and that impacted sales in Q1 and we're seeing signs of stabilization there. So hopefully that gives you some color..

Yes, because I want to ask about the brushless DC motor sales.

Can you remind us from what they go into and why they were so strong in the first quarter?.

Yes, they go into commercial vehicles and some into trucks as well in the light vehicle market. And we're seeing good share gains there and a good momentum in that market. So we're performing well..

So would you expect those sales to continue to outperform into Q2 and help offset the weakness seen in other products in the transportation lines?.

Yes, when we look at that market, John, we probably see just -- first of all, we expect good performance there. We would -- in the next few quarters, end of the year, we might see some softness towards the very end of the year. If you look at it what we're seeing is, Europe is okay, North America is strong, China has had some softness.

But overall, a good trend for the next few quarters, maybe you could see some softness towards the end of the year..

Okay, fair enough. Regarding the transition and restructurings that you're undertaking, Ashish had mentioned that there's opportunity there to improve your working capital profile.

When do you think that you'll be beyond maybe growing extra inventory or other things like that, that it will be past those hurdles?.

John, as I mentioned in the script, we have already started working through our safety stock. My expectation is in the early part of second half of the year, we should be able to completely deplete our safety stock..

Early part of second. Got it. And one last question. Kieran, you mentioned the target is 10%. You've kind of alluded to the fact you're growing organically in the low single digits, which brings us to the delta there between that and the 10% is M&A.

What does the M&A environment look like right now and you kind of fill us in well on that side of the coin?.

Nothing significant to report, John. All I would say is that we've been working much harder in our pipeline and building strength in that area. But obviously, our strategy hasn't changed for the assets that we're looking for in line with what we've communicated in the past..

[Operator Instructions] We'll go to Hendi Susanto with G. Research..

My first question is similar to John's first question. Can you share more color on your cautious view? This time it's on the industrial side.

What has changed since 3 months ago, and what areas are below and above your prior expectations?.

Yes. We -- first of all, I think we saw the softness in China, and that's probably been the biggest thing we have seen. There's some trade things going on there in the middle of that, but mostly, it's the softness in the market.

And then one or two customers that have basically gutted softer end market because of that and that's really some of the drivers..

I see.

So Kieran, let's say if the U.S.-China trade discussion got resolved, how quickly do you think the market in industrial will improve? Do you think it can improve quickly relatively or do you think it may take some time?.

I think it can improve in a quarter or so. And the other thing, Hendi, I should mention is, to the first part of your question as well, we saw some inventories building up in distribution, and they usually take somewhere between a quarter or two to correct. So that's the other part of the equation just impacting it overall..

And that the inventory build like happened in both industrial and transportation, I assume..

Sorry, can you say that again, Hendi?.

The inventory build that you mentioned, did it happen in both the industrial and transportation? Or did you talk specifically about inventory build in industrials?.

Yes, industrial and in distribution primarily. When I look at the order side of it, there's been -- in transportation, there's been a small increase in days on hand, but it's kind of a mix thing, nothing I'd call out to say we've got a big issue there..

I see. And then, Kieran, you also mentioned the finger sensing application.

So what should be our expectation going forward?.

I would say, Hendi, we're making progress through the development and qualification as we've highlighted. That takes time to get traction. But we should be giving you a more clear update on that in the second half of this year..

And then will you be able to share what type of function of your finger sensing application like how different it is versus what is being offered at the market now?.

Yes, what you're seeing in the market is a combination of facial and fingerprint. They were separate. Now they are combined. So you see the need for that extra security with the fingerprint. And I think you'll see that trend going forward in devices..

Okay. So let's say, I think, we know that the facial and fingerprint now it's already combined.

So what kind of new features that your finger sensing application will bring into the table?.

When you look at it, I think with our technologies that we have, you can get more of a 3D versus a 2D security application getting below the fingerprint into the vessels and into the bones. So you get a much more secure application..

Okay, so it can penetrate deeper into your fingerprint essentially?.

Correct, correct..

I see. Yes. And then, Ashish, a question about restructuring charge.

How much restructuring charge should we expect for the remainder of the year?.

Hendi, the bulk of the work is completed in Elkhart. So going forward, I'm expecting smaller amounts as we go through the final cleanup and other things. There might be some noncash impairment type of things that we might encounter as we go through the final stages, but nothing significant which will require considerable cash outflow at this point..

And then, Kieran, do you have insight into your telecom and IT markets?.

Yes. We've been really focused on the RF filters in that space where we're shipping some products and qualified with others. And in the prepared comments I said that we would continue to see growth in that area.

And then as we look at that space even going forward, we're kind of excited by the 5G opportunities that's there for both our RF filters and RF frequency products as well..

[Operator Instructions] We'll now take a question from John Franzreb with Sidoti & Company..

Yes.

I guess, just regarding the timing of orders that you talked about that your incoming booking was kind of flat at $1.87 billion, how much was deferred by the decision-making process and how much maybe it was just a soft kind of a customer order book for the quarter relative to your expectations?.

Yes, more and more deferred, John, on the timing of decisions and the sourcing. So that's why in the comments we said it's something that we get balanced out here in the next few months. Sometimes these things happen in the quarter. We've seen it in the past. So nothing unusual here..

Okay. And regarding distribution you cited a couple times, Kieran. I assume it's all nontransportation related for you. If that's not the case, clarify that.

And how much is it of your, say, 2018 revenues? And how big of a pie is distribution for you?.

So it's mostly nonautomotive and it's in the single digits of sales overall..

But it so has a meaningful sway factor as far as the revenue profile for you? Is there any....

Yes. For our electronic -- sorry, go ahead, John..

I was going to say is there any seasonality maybe we should be cognizant of when it comes to when distributors order in a normal buying pattern?.

I would say we don't see a lot of seasonality, maybe a touch of it here and there. But also, I would just point out that we see signs of stabilization there. It takes time just to when they build up inventory to burn it off. And I think they've been working through that..

John, there can be some pockets towards year-end. You might see a little bit of a slowdown. And then around Chinese New Year, there will be some slowdown in the Asian markets..

We'll now take a question from Hendi Susanto with G. Research..

Ashish, if I look at the operating expense in Q1, it is higher on a year-over-year increase compared to the same period a year ago.

Should we expect that OpEx level to be higher as we go through the remainder of the 2019 compared to 2018, I mean?.

Hang on one moment, Hendi. I think what you're seeing is a increase in restructuring charges, excluding that the increase in OpEx is pretty nominal. And R&D have gone up slightly about couple of hundred thousand dollars and SG&A is up $150,000-ish. So not a significant cost increase.

I expect us to continue looking at R&D strategically as we invest money in new product introductions and program launches that are already underway. And on the SG&A side, as Kieran alluded, we are not expecting any significant improvements from the ERP implementation for at least beyond 2020.

So our focus right now is to keep managing operating expenses prudently and keep a close eye on how the markets are performing as well..

So in terms of where we should see the benefit of the recent restructuring charge among OpEx and COGS? Can you help us to think about those, Ashish?.

The restructuring charges are related to the Elkhart transition program that we started couple years ago, and that's getting completed as we speak now. And the benefits of that -- the benefits of that, we had talked about savings of $6 million to $8 million on an annualized basis. And last year, we were able to get slightly more than $4 million.

And we are guiding to $3 million to $4 million for this year..

$3 million to $4 million for this year?.

And we had $1.5 million in Q1. Most of the savings, the largest portion of the savings is in the gross margin numbers..

Okay, and then likewise....

And Hendi, just keep in mind that as we mentioned already, we have on the margin side a little bit of pressure with the wage changes in Mexico and so commodity pricing. So there's a little bit of balancing on the savings there..

So let's say the labor expense in Mexico like partially offset benefit in COGS..

That is correct..

I show no additional questions. I'd like to turn the call back to Kieran O’Sullivan for any additional or closing remarks..

Okay. Thank you, Jessica, and thank you, everyone, for joining the call today. We're back to focusing on execution here for the next quarter and for the balance of the year. And we look forward to updating you again in the July period. Thank you..

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