Good day, everyone, and welcome to today's CTS Corporation Fourth Quarter and Full Year 2019 Earnings Call. Just as a reminder, today's call is being recorded. At this time, I would like to turn the conference over to your host for today, Kieran O'Sullivan. Please go ahead..

Thank you, Sarah. Good morning. Thank you for joining us today, and welcome to CTS' Fourth Quarter and Full Year 2019 Conference Call. Sales in the fourth quarter were $115 million, down 4.2% compared to the same period in 2018. We added 5 new customers in the quarter. Full year sales were $469 million compared to $470 million last year.

Gross margin was 33.6% in the fourth quarter, down from 35.5% in the same period last year and up sequentially by 160 basis points from the prior quarter. Full year gross margin was 33.6% compared to 35.1% in 2018. Fourth quarter adjusted earnings per share of $0.37 were down from $0.41 in the fourth quarter of 2018.

Full year adjusted earnings per share of $1.45 were down from $1.53 last year. We ended the year with total booked business of $1.88 billion, up slightly from last year. Operating cash flow for 2019 was $64.4 million, up 11% from $58.2 million in 2018. Free cash flow improved from $29.7 million to $42.7 million.

With the recent coronavirus, our priorities are the safety of our employees and managing the supply chain to focus on continuity of supply is a trusted partner for our customers. Ashish Agrawal, our CFO, 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'll now turn the discussion back over to our CEO, Kieran O'Sullivan..

Thank you, Ashish. In the fourth quarter, our sales declined 4.2% to $115 million. Excluding sales from the QTI acquisition, sales declined 8.8%. For the full year 2019, sales were essentially flat at $469 million. Excluding sales from the QTI acquisition, sales declined 2.3% for the year.

We added 5 new customers in the fourth quarter, 4 in industrial and 1 in medical. We continue to see softness in some of our end markets in 2020. The defense end market continues with strong double-digit growth. Gross margin in the fourth quarter was 33.6%, down from 35.5% in the fourth quarter of 2018.

Sequentially, from the third quarter, we improved our performance by 160 basis points. We saw improvements in our foundry operation, and as previously communicated, we expect further improvements in the first 6 months of 2020. We faced margin pressure from Mexico wage inflation and increased cost for gold and other precious metals.

We are sharing some of the burden with our customers. The CTS team remains focused on actions to deliver cost improvements as an ongoing part of our operational process. Fourth quarter adjusted earnings per share were $0.37 compared to $0.41 in the fourth quarter of 2018.

In last quarter's earnings call, we communicated that we would implement projects to align our operating costs and improve fourth quarter earnings. These actions have been successfully implemented. Full year adjusted earnings per share were $1.45 compared to $1.53 in 2018. Despite a challenging year, we maintained an EBITDA margin above 19%.

We ended the year with $1.88 billion in total booked business. Bookings in medical products were solid, where we were awarded a 3-year contract for our medical ultrasound application with a European OEM and a 1-year contract with an Asian OEM.

This is a testament to our leading technology, talented teams and global footprint as we partner with our customers on next-generation products. We expect additional contracts to be finalized in 2020. Transportation markets are declining from peak volumes.

We continue to be guided by the key secular trends with increased safety, protecting the environment, transition to electrification and connected solutions. We secured a large win with a Japanese OEM for an accelerator module and an award from the Chinese OEM.

Subsequently, for accelerated modules, we were awarded the first contract with a Japanese OEM for commercial vehicle platform. We continue to advance the inductor pedal technology with an award from a Chinese OEM. In North America, we secured a ride height sensor award.

In Europe, we delivered first working prototypes for our wireless safety application. Electronic component applications continue to evolve around miniaturization and greater efficiency. In defense, we were awarded a contract for single crystal technology and a solar contract with a Tier 1 defense supplier.

In telecom, we received an order for RF filter product. At the recent CES show, our piezoelectric product was featured in a new gaming handset, which received a show innovation award. Our teams continue to advance innovations in haptics and new material formulations. We have a number of products in AR and VR trials.

The integration of the QTI business is tracking to our plans, and we expect it to be accretive this year. Our priority is maintaining a focus on our customers as we complete our integration. We're also focused on operational improvements in 2020 and further expansion into Europe and Asia in 2021.

I am energized by the QTI leadership team and their approach in driving targeted growth for high-performance applications. We made progress in diversifying our end market profile last year with the QTI acquisition. We have achieved significant increases in the proportion of medical and aerospace and defense revenues.

This is a strategic priority for us, and we have more to do. We have a healthy M&A pipeline and see the potential to drive continued portfolio diversification. We remain focused on adding the right technologies, strengthening our product portfolio, customer relationships and geographic expansion as we move into 2020.

As I said earlier, some of our end markets continue to be challenging. For transportation, global light vehicle volumes are expected to contract further in 2020. Commercial vehicle markets continue to be soft as the market has seen sharp declines for peak volume in North America.

Electronic component markets remain challenged due to inventories and some impact from trade and tariff uncertainty. Distribution inventory levels have dropped closer to more normal ranges, and we are expecting a stronger second half. Defense end markets continue to perform well.

Return to work at our 2 China sites has been delayed by at least 1 week due to the recent coronavirus. Our first priorities are the safety of our employees and the supply of product to our customers. Like most manufacturers, we are assessing the impact on our supply chain, and we're likely to see an impact on our revenues in the first quarter of 2020.

For 2020, we continue to focus on profitable growth, margin improvement and our end market profile. For full year 2020, we expect sales to be in the range of $450 million to $480 million and adjusted earnings are expected to be in the range of $1.35 to $1.60.

At this time, I will hand over to Ashish to take us through the financial performance in more detail.

Ashish?.

Thank you, Kieran. Fourth quarter sales of $115 million, down 4.2% versus last year. Sales to transportation customers declined by 11%, and sales to other end markets increased by 7.9%. Excluding sales from QTI, sales to other end markets decreased 5%, primarily due to softness in the industrial end market.

Foreign currency rates impacted sales unfavorably by $581,000. Our gross margin was 33.6% for the fourth quarter compared to 35.5% in the fourth quarter of 2018. We improved sequentially from the third quarter by 160 basis points. The Albuquerque foundry operations improved during the quarter, and we have more work to do.

In the quarter, we realized approximately $400,000 in savings related to manufacturing transition. As Kieran mentioned, in the fourth quarter, we successfully implemented cost improvement actions that we communicated in the last earnings call. Our fourth quarter 2019 earnings were $0.31 per diluted share.

Adjusted earnings per diluted share were $0.37 compared to $0.41 in the fourth quarter of last year. For the full year 2019, sales were $469 million, almost flat to prior year. Sales to transportation customers declined by 0.4%, and sales to other end markets declined by 0.2%.

Excluding $9.3 million in sales from QTI, sales to other end markets decreased 5.6%. Foreign currency rates impacted sales unfavorably by $5.1 million. Our gross margin was 33.6% for the year, down from 35.1% last year.

The major drivers are lower volume, foundry inefficiency, labor and commodity cost increases and an unfavorable impact from currency movements. These were partially offset by cost improvement projects as well as savings from our manufacturing transition project.

Our focus is to drive improvements as we move forward and get back in our target range of 34% to 37% gross margin. SG&A and R&D expenses were $96.4 million or 20.5% of sales for the year versus $98.9 million or 21% of sales last year. 2019 expenses include incremental operating costs and intangible amortization related to the QTI acquisition.

We also took a charge of $2.3 million for environmental cleanup. We were able to reduce spend through cost controls during the year and cost reduction actions taken in the fourth quarter of 2019. Operating expenses were also lower as there was no payout on the short-term incentive plan because we did not achieve minimum performance targets.

2019 earnings were $1.09 per diluted share. Adjusted earnings per diluted share were $1.45 compared to $1.53 last year. Now I'll discuss the balance sheet and cash flow. Our controllable working capital as a percent of sales was 15.7% in the fourth quarter, down from 16.8% in the third quarter.

We can do better on working capital and will continue driving further improvement. Our cash flow performance in the quarter was strong with $23.7 million in operating cash flow. For the full year, operating cash flow was $54.4 million compared to $58.2 million in 2018. CapEx was $21.7 million for the full year, down from $28.5 million in 2018.

We continue to manage CapEx carefully and came in at the low end of the range that we communicated last quarter. Our cash balance was $100.2 million on December 31, 2019 compared to $100.9 million at the end of 2018. Our long-term debt balance of $99.7 million, up from $50 million at December 31, 2018, due to the QTI acquisition.

Our debt-to-capitalization ratio was at 19.7% at the end of 2019 compared to 11.7% at the end of 2018. Our work on rolling out SAP to our remaining sites is continuing. Our goal is to complete implementation to all our locations, including our recent acquisition in early 2021.

During the fourth quarter, we repurchased 134,000 shares of our stock for $3.7 million. For the year, we repurchased 421,000 shares for $11.7 million at an average price of $27.92. We have $13.8 million remaining under our current repurchase plan.

As Kieran mentioned, we expect 2020 sales to be in the range of $450 million to $480 million and adjusted EPS to be in the range of $1.35 and $1.60. The first half is anticipated to be soft, and we expect improvements in the second half based on better market conditions.

We are carefully monitoring and evaluating the impact of the coronavirus outbreak on our operations, customers and suppliers. As already discussed, due to government mandate, the return to work at both of our sites in China is delayed by at least 1 week.

We will continue to follow regulatory and public health mandates in order to mitigate the impact of this public health crisis. The situation is continuing to evolve, and we are not yet able to determine the impact on our business. We will discuss any material impact in our next update.

During 2020, we see pressure on precious metal pricing, labor costs and uncertainty on volumes. To offset the impact, our teams are focused on driving cost improvement projects and improving efficiency at our foundry operations. Our target is to improve gross margin by over 100 basis points during the year.

SG&A and R&D expenses are expected to increase by slightly more than 1% of sales in 2020, mainly due to the full year of operating expenses and amortization from the QTI acquisition and higher expenses related to short-term incentive compensation. We anticipate our tax rate to be in the range of 23% to 25%, excluding discrete items.

2020 CapEx is expected to be in the range of 4% to 5% closer to our normal levels. This concludes our prepared comments. We would like to open the line for questions at this time..

[Operator Instructions]. We'll go first to Karl Ackerman of Cowen..

First, in terms of your full year outlook for 2020, I would imagine your level of conservatism has more to do with near-term challenges in U.S. commercial vehicle markets. First, what opportunities can you go after that should enable you to outgrow U.S.

commercial vehicle for the year? I think last call, you indicated you have the ability to expand your customer base later in 2020. And then secondarily, does your outlook contemplate QTI sales synergies in Europe and Asia, that would imply growth can scale above the $5 million rate? And I have a follow-up..

All right. Karl, there's quite a few questions that, but let me make an attempt. And we expect 2019 is going to be challenging, just like -- sorry, 2020 is going to be challenging just like the second half of '19 was. Our all light vehicle products are performing better than the market. So we expect that to perform well going forward.

Our commercial vehicle is a real headwind. We had severe declines in the fourth quarter. We had that for most of the second half of the year. And if you look at the customers out there in that market, you're seeing, especially in the heavy duty, declines of 8% to 10% in Europe, 20% plus in North America.

So we're anticipating some recovery towards the back end of the year. We see some upside in terms of the inventory corrections in the distribution side of things, it's coming back to more normal levels. We see good growth in the QTI business, and we're focused on some synergies that are built into our plan in the operations there.

And the expansion of sales in the QTI business will be more evident in Europe and Asia in 2021..

I appreciate that.

For my follow-up, you mentioned inventory, how would you characterize lead times and inventory levels at your automotive OEMs? I guess what is the normal level of weeks on hand? And do you have a view on when sell in and sell-through may more appropriately be matched? Is that something that gets rectified by the end of this quarter? Or is that something that perhaps builds into the June quarter?.

We track the days on hand, they've been up at the higher levels in the last few quarters. So we don't expect a huge contraction in the light vehicle market in 2020, but there'll be some, so we expect that to correct. The fleet sales last year and the incentives were pretty high.

So that's something we're watching carefully for an impact in the sell-through with the OEMs going forward. I think the bigger concern for us in the short term is with China and with the coronavirus and what's happening over there. You're hearing in the news, some South Korean manufacturers were shutting down.

And some -- and I think [indiscernible] in China was looking for ways to open up, but that's really what we'd be most concerned in terms of sell-through..

We'll go next to Brian Colley of Stephens..

So I was wondering if you guys could just talk a little bit more detail about what your guidance assumptions are for your various end markets and geographies? And how we should think about the cadence of earnings and revenue throughout 2020?.

If you look at the guidance on sales, and I'll just start with the sales, you can see that at the lower end of the range, we're probably showing mid-single digit declines, and at the high end at low single-digits growth.

A lot of that is paced by what we're seeing in the commercial vehicle market and the slower recovery in the first half of the year..

And then, Brian, on the -- sorry, go ahead, Brian..

So just in terms of the cadence, I mean, I'm just curious if you guys could give any color on the magnitude of a pickup you're expecting in the back half? Are you expecting kind of mid, high single-digit revenue declines in the first half and slight growth in the back half? Or any color around just the split between first half and second half..

Brian, if you look at 2019, we saw a considerable decline in the second half, especially when you exclude the sales from QTI acquisition. It's pretty realistic to assume that the first half could look similar to those trends, and then we'd be looking for a pickup in the second half..

Okay. That's helpful. And then secondly, I was just wondering if you could give an update on the pipeline of opportunities for new design wins across your different end markets? And any particular areas that you're seeing a lot of traction with customers right now..

Yes. The traditional auto products are running well. We had strong bookings and wins. When we look at 5G, this is something we're working on. We've had a number of design-in wins. Most of that, you wouldn't see in revenue until 2021 because we're in the -- really the right technology areas where we're targeting.

We've got some work as you saw in the script going on with trials in haptics and in VR and AR, and then we were featured -- our product was featured in a phone -- a gaming phone at CES, they got an award. So we see some opportunities there as that piezo application becomes more relevant in different interface devices as we go forward.

On top of that, we're willing to wireless sensors. We're looking at more electronic solutions in the transportation market for electronic braking. And in Europe, we're looking to expand our accelerator product portfolio as well. So we've got quite a pipeline of things we're working on, but we're also very targeted in terms of where to go..

Got it. And then typically, you guys give -- look at how much of your booked business backlog you expect to ship in '20 or in the coming year.

Is there a number you guys could give us here today?.

Let me get that for you, Brian. We will be publishing it as part of our investor presentation, and it should be in the range of $380 million to $390 million..

Got it. That's helpful. And then lastly, just wanted to ask about the industrial business. I mean we saw U.S. manufacturing PMI for January rebound back in a positive territory.

I'm curious have you guys started to see that in your industrial business at all?.

We're seeing signs of some green shoots, but we're kind of a little bit cautious still. So some of our customers were seeing 1 or 2 trends that look directionally positive, but it's early, so we're kind of a little bit cautious on that, some green shoots appearing though..

[Operator Instructions]. Up next from Sidoti & Company, we'll go to John Franzreb..

I want to start with structuring actions.

Can you just kind of review how much cost-saving actions you completed in 2019? What their impact on the P&L is on an annualized run rate? And if you intend on taking any more or are you done with those actions, excluding the SAP rollout?.

So John, the -- let me address the SAP point first. The cost actions that we talked about in the Q3 earnings call were not related to the SAP project. As we have talked about, we want to get the rollout completed first before we start looking for efficiency improvements from that.

We talked about $0.03 to $0.04 improvement in the fourth quarter earnings from the cost action. And as Kieran talked about it, we did successfully implement those cost actions and achieved those savings. The range that we gave was $0.08 to $0.12 for the full year, and that's what we are still expecting.

Most of the actions were completed in Q4 and some will triple into early part of this year..

The other thing, John, that we've been working on just from the last 2 quarters or so is, where we've had opportunities to get second sourcing in place to give us some leverage going forward, where we saw some commodity pricing pressures, we obviously continue to work that side of it as well..

All right. So just remind me what the actions were because I -- from what I remember from last quarter, some of them are going to be temporary and some of them are going to be permanent.

So which ones are temporary or permanent in these actions?.

So there are certain costs that we book in any given quarter, especially things like short-term incentive compensation and all, that don't reoccur. They are more dependent on any particular year than an ongoing savings..

So of those -- of that $0.03 to $0.04 you realized in the fourth quarter, how much was it of the incentive program?.

So as I mentioned in the comments, we did not achieve any -- we're not going to have any payout from the short-term incentive plan because we did not achieve the minimum target. We haven't spelled out the exact amount, but it was included as part of that $0.03 to $0.04 improvement in the fourth quarter, John..

Okay. Your target to improve the gross margin by 100 basis points this year.

How much of that is revenue dependent? And how much of that is mix?.

It's going to be dependent on volumes to some extent. The other things that we are looking to improve is the foundry operation that we have talked about. And then also, we have -- in our regular operations, we drive cost improvement projects and all which give us offset to any pricing that we have to give up.

So the improvement of a percent -- sorry, over 100 basis points, as we talked about, is the combination of all those. And as we move forward, John, we just have to drive the overall improvement. We don't break it down into specifically which action is driving how much improvement. But the overall improvement we're expecting is over 100 basis points..

Okay. And then just shifting over to China, the extra week is already kind of baked into your thoughts.

Maybe a little bit about -- is this just going to be deferred revenue we should think about as you move into Q1 from -- into Q2? How do you think about the delay in reopening and how it impacts you beyond the current quarter?.

John, in terms of the coronavirus, we're monitoring this very closely with all our plants because there's some connection points across the globe as well. It's very hard for us to quantify this at this stage. So we're just monitoring. Obviously, every week is going to be more impactful, but we can't give a good guidance on that at this point in time..

[Operator Instructions]. We'll go next to Hendi Susanto of Gabelli Fund. .

With regard to coronavirus impact, can you help us think about the potential impact split between Q1 and Q2? Does Q2 impact reflect the pushout orders? Or is there more to that?.

Hendi, we could not hear the first part of your question.

Could you ask that again, please?.

Yes. Let me repeat it.

So with regard to coronavirus impact, can you help us think about the potential impact split between Q1 and Q2? Does Q2 impact reflect pushout orders from Q1? Or is there more to that?.

Yes. Our guidance just as Ashish said in his prepared remarks is we're reflecting a softer first half and a stronger second half. We're still evaluating the coronavirus. Obviously, if it extends longer than the week that we're seeing at the moment, the potential for pushout into Q2 goes up definitely..

And then how about CTS internal production in China? Is there any direct impact on that?.

So Hendi, the return to work is already delayed by a week, and our leadership teams in those locations is coordinating with the local government to make sure we come back online as soon as it is appropriate and safe and allowed under the local mandates.

Things are pretty fluid, and we are just keeping track on a day-to-day basis in terms of as things are developing..

Got it.

And then Kieran, where do you see strength in defense and aerospace markets in 2020?.

Yes. We continue to see good growth there. As we came through 2019, and we expect it to continue with the customers we have, with the products we have, and we're continuing to book good business in that area as well. So we feel very confident about the growth..

And then, Kieran, what -- are there some major new products that investors should anticipate coming in 2020?.

New products in 2020? We've talked about different applications with piezoceramic that we're hoping will ramp up a little bit here as we go through the improvements in the foundry. We have several new products being launched in the QTI business as well, with several new customers. We're actively expanding in Europe with new innovations over there.

So Hendi, we'll give you more color as we get into the next quarter and the second half of the year as well. We're obviously always launching new products as we move through each quarter..

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

a focus on profitable growth; stronger customer relationships; operating systems to support continuous improvement; and talent development. Thank you for joining us on the call today. And we look forward to updating you again in the next quarter. Thank you..

And again, that does conclude today's conference. We thank you all for joining..