Good day and welcome to the CTS Corporation Second Quarter 2020 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Kieran O'Sullivan. Please go ahead, sir..

Thank you. Good morning. Thank you for joining us today, and welcome to CTS' Second Quarter 2020 Conference Call. I'll begin by sharing a few thoughts on our company and our business performance. As we mentioned on our last earnings call, we expected the second quarter to be our most challenging quarter this year due to the impact of COVID-19.

Operationally, all of our plants are running, though, we continue to experience challenges at our Mexico locations. The return to the appropriate production staffing levels has been impacted by state and local regulations. Our leadership in global teams are prioritizing the safety of our employees and adapting quickly to serve our customers' needs.

Sales were $84 million, down 30% from the second quarter of 2019. As expected, we saw significant challenges in the transportation end market, sales in the rest of our business were stable. Second quarter gross margins were 31.6% compared to 34.1% in the same period in 2019. We delivered an adjusted EBITDA margin of 16.7%, despite a 30% drop in sales.

Second quarter adjusted earnings per share were $0.16. We had a promising new sensor win in transportation for application in hybrid electric vehicles, and continue to make progress with RF product wins in defense. We added 13 new customers in the quarter. We ended the quarter with $146 million in cash, and $141 million in debt.

We expect a prolonged recovery from the COVID-19 impact. As a result, we are implementing a restructuring plan to realign our cost structure to the new demand environment. This plan will be completed over the next 24 months. 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 several 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 turn the discussion back over to our CEO, Kieran O'Sullivan..

Number one, driving profitable growth; number two, building stronger customer relationships; number three, improving operating systems and; four, strengthening talent and culture globally. As part of our emphasis on profitable growth, we are evaluating the product portfolio for longer-term growth and margin expansion.

Our focus on M&A is to strengthen our pipeline as we seek to expand our range of technologies, products, customers and geographic reach. We are sharpening our go-to-market strategy by adapting our sales and application engineering setup to build stronger customer relationships.

Working more closely with our customers on next generation products and applications is more important than ever as we emerge from the COVID-19 pandemic. To advance CTS operating systems, we have added a senior resource to lead this initiative. We aim to build capability and drive continuous improvements.

Our goal is to eliminate waste and enhance profitability, and this will be a multi-year initiative.

Strengthening our talent pipeline and leadership bench while aligning our culture globally will enable us to achieve our vision of being a leading supplier of sensing and motion devices and connectivity components, and they bring in intelligence and seamless work. We remained cautious on the broader economic environment in the second half of 2020.

From a light vehicle view, it is still too early to close the book on the pandemic. Premium brands are expected to rebound faster than volume brands. In the U.S., sales of used cars increased while the SAAR for 2020 is closer to 13 million, down 23% from last year.

On-hand days of supply are at 54 days, down 20% from the five year average, which should help short-term demand. We expect an improving sales trend in the third quarter, providing operations run normally. European sales are forecasted to decline 26% from last year.

The China market continues to recover with volumes predicted to be down 14% in the $21 million to $22 million range for the year. We continue to see growth in medical and defense markets. We suspended guidance for 2020 earlier this year due to continued market uncertainty. Our liquidity remains solid with a positive net cash position.

We aim to emerge from this crisis as a stronger Company. Now, Ashish will walk us through the financial performance in more detail.

Ashish?.

Thank you, Kieran. Our second quarter sales were $84.2 million, down 30% compared to the prior year. Sales to transportation customers decreased by 53%, and sales to other end markets increased by 14%. Our temperature sensing acquisition added $5.4 million and organic sales to non-transportation customers were up 1%.

We continue to get traction in the aerospace and defense, as well as medical end markets and saw a robust double-digit sales growth rates to customers in these markets. Our gross margin was 31.6% for the second quarter, impacted substantially by lower sales. We are making progress on various actions to improve our tax rate.

As a result, we expect to be closer to the lower end of our previously communicated range of 23% to 25% excluding discrete items. As we complete our work on this effort, we expect some further improvements in the tax rate in 2021. Our second quarter 2020 earnings were $0.15 per diluted share, adjusted earnings per diluted share were $0.16.

As we communicated back in April, due to lower volume expectations, we implemented measures to reduce cost through temporary payroll reduction, suspension of 401-k contributions, furloughs, plant shutdown, reduced Board compensation and control over all discretionary spending.

Revenue in the second quarter was significantly lower and conditions remain uncertain. We will regularly evaluate market conditions to determine the extent and duration of these temporary measures. As Kieran mentioned, we have started implementing a restructuring plan due to the prolonged impact of COVID-19.

We expect restructuring costs to be in the range of $10 million to $12 million over the next two years. Anticipated annualized savings are in the range of $0.22 per share to $0.26 per share by the end of 2022.

Savings from the restructuring, once fully implemented will help offset the impact of the temporary cost reduction measures as those costs return. Timing for some aspects of the restructuring project is being finalized, and we will communicate more on the timing of savings and cost in the coming quarters.

In terms of cash, we were net cash positive by approximately $5 million, which is an improvement from zero net cash at the end of first quarter. We have access to an additional $157 million through our revolving credit facility. In March, we borrowed $50 million from our credit facility.

We are continuing to maintain this position to ensure adequate liquidity for the next several quarters at all our sites globally. Including this debt, we remain well within our debt covenants. And at this time, it is our expectation that we will remain compliant.

Our controllable working capital as a percent of sales was 21.2% at the end of the second quarter. The increase was driven primarily due to the sharp reduction in revenue in the second quarter. In dollar terms, controllable working capital increased slightly from Q1 to Q2, and our focus remains on improvements in the coming quarters.

Our teams are maintaining emphasis on reducing inventory levels across our operations, and on receivables collection. We generated $11.8 million in operating cash flow in the second quarter. CapEx was $2.7 million. For the full year, we are expecting capital expenditures to be approximately 4% of sales.

We are committed to investing in programs that help us progress our strategic growth objectives. We are continuing to implement SAP, and went live successfully at another large manufacturing location at the beginning of July.

This go-live was accomplished despite most of the implementation team working remotely due to COVID-19 related travel constraints. This is a significant accomplishment by our team in Matamoros as well as the SAP implementation team.

With the go-live in Matamoros, we have completed the rollout to plants that provide approximately 80% of the Company's revenue. We are on track to complete the SAP implementation around the middle of 2021. This concludes our prepared comments. We would like to open the line for questions at this time..

Thank you. [Operator Instructions] And we'll take our first question from Justin Long..

Thanks, and good morning..

Good morning, Justin..

Hi, Justin..

Thanks, and good morning.

So, maybe to start just given things are changing so rapidly in the world today, could you provide a little bit more color on how your revenue trended throughout the second quarter kind of month to month, and then any update on what you're seeing so far in July?.

Yes, probably the best way to describe it is, obviously April and May were tough months for us. June was a more normal month, and we've seen a similar increasing trend in July, just to give you a sense of how sales are going. But the earlier part of the quarter was particularly tough.

And if you look at the quarter as well, and that 55% in transportation, if you remember, last year we were particularly strong from a comp basis on the commercial vehicle, and that really skewed us a little bit this quarter as well, because that was a tough market for us.

And we are – on the light vehicle side, we are in line with where the market is from everything we see..

Okay, that's helpful. And I think you made the comment that in the third quarter, you expect sequential improvement in revenue.

I know you're not giving formal guidance, but is there any additional color you can share on kind of roughly how much of a pickup we could see in 3Q and maybe talk about the progression you're expecting for the transportation end markets versus the non-transportation end market sequentially..

Yes. So the non-transportation markets performed solidly. We saw we were up 1% organically. We still expect steady performance there. I'm not going to give you percentages, because it's – it's a moving target, as they are a little bit at the moment. On the transportation side, what I'd like to emphasize is an improving trend.

And the reason why we're a little cautious is, we've got some challenges in our Mexico operations, and where we're not fully staffed with local regulations, and while it's improving, we need that to get back to a full run rate.

But the best way to give you a message on the third quarter is, we expect it to improve, we've seen that improving trend already in July. And we – we've got to make sure we try and support and make that happen..

Great. And last question from my end. More on the margin side. Ashish, you mentioned that there were some temporary cost-outs. I know you talked about those earlier in the year.

Can you help us think about back half of this year, how those could come back online, given the sequential pickup in revenue that you're expecting?.

So the cost reduction measures are made up of several components. And, given the level of sales reduction we saw in the second quarter, that would be the quarter where we have the maximum impact and we would expect smaller impact of the cost reduction measures, the temporary measures.

Some of them will continue through the third quarter, and then as I mentioned, we'll continue evaluating as volume levels in the market are changing, we'll adapt our approach to those temporary measures..

Okay. But you still feel like if revenue is getting better sequentially, then directionally adjusted operating margin should get sequentially better as well..

That would be a good assumption, Justin, yes..

Okay, thanks. I appreciate the time..

Thanks, Justin..

And we'll take our next question from John Franzreb..

Good morning, guys. I guess I want to start a little bit about the – especially on the revenues sequentially. You – if I heard you properly, you expect revenues to be up, but you also expect the European revenues to be down 26% and China to be down 14% or you're referencing that as the second quarter, what actually happened..

No, John, that's a reference and those percentages on a full year basis year-over-year from 2019 to 2020..

For the industry..

For the industry..

And that's your expectations for the full year, 2020 versus 2019?.

Yes. On the transportation side, yes. And to give you a sense, we clearly stated that from Q2, which was going to be our most challenging quarter, we expect revenues to improve in Q3, and obviously we want to make sure that operation stay stable and we're improving in Mexico.

But that's an important improvement that we need to have to go through the quarter fully, and again I want to emphasize, our June and July performance was trending in the right direction..

Got it.

So what's the North American portion of the transportation in that assumption, without Europe and China?.

John, we don't break out our numbers for the different end markets by region. But as we've talked about, they'll be generally in line with what our overall business is..

Okay. I know you kind of don't seem like you want to provide too much color on the consolidation efforts and you're going to do, but I’d imagine [Technical Difficulty] at some point this year and if you actually worked in through 2022.

So you should – is it fair to assume we will see some sort of profit improvements from these actions in 2021, or is that not fair to assume?.

So John, if you look at it, you'll see we have minimal impact in the second half of this year, more of the impact as we get to the second half of 2021 and into 2022. The projects are more longer-term projects, but they're very focused..

Got it. Thank you, Kieran. And just two quick questions, I guess, kind of, it's of late, what's your supply chain issues been like and Mexico has been a problem with a lot of other suppliers.

What are your thoughts about when that kind of eases up the restrictions in the – and the local and federal level down there?.

John, on the supply chain overall, we've been doing pretty well, and we're really pleased with how our plans have come back online. And in Mexico, we are monitoring everything as you can imagine on a daily basis.

And the staffing levels are limited by the local regulations, so going from a code red to a code orange, you're allowed to increase your percentage at the plant. And there has been some positive rooms but we wanted to see it stabilize and continue to move..

Okay. And one last question, just because it came up yesterday in a call. One of my companies was getting government reimbursements from government sponsored programs that were part of both their cost of goods sold and SG&A lines.

Did you guys receive any just kind of government reimbursements?.

So John, there are certain portions of government incentives that we are getting a benefit of, but we chose not to move in the direction of getting financing through the programs. But there are certain tax incentives that we are taking benefit of. But they are not significant enough to have a material impact on our financial result..

Okay. Thank you, Ashish. Thank you, guys. I'll get back into queue..

Thanks, John..

[Operator Instructions] We'll take our next question from Karl Ackerman from Cowen..

Hey, good morning, gentlemen. I wanted to follow-up first on the OpEx commentary, you mentioned you take some cost actions or in the process of taking some restructuring actions this quarter. That of course would follow some actions you took in both the December quarter and March quarter.

So I guess just as a catch-up, how much cost have you taken out of the model at this point and how much would you view as temporary that gets reinvested in the business versus how much is permanent?.

So Karl, the actions that we've taken over the last couple of quarters to adjust the structure were more in line with what was happening in the commercial vehicle market at the end of last year. And then the impact that we were dealing with in the second quarter, which was more temporary in nature.

The restructuring that we are implementing will allow us to offset the impact of the temporary measures that we were able to implement in the second quarter, once we start realizing the full benefits. So that should give you some idea of the magnitude of the impact on both sides..

Okay. So it sounds like the – it sounds like the restructuring actions that you're taking today are going to be limited from a margin recovery standpoint in the second half certainly will lower your fixed cost. Much of the benefit seems to be in 2021 and 2022, if I understand it correctly..

Yes. Karl, as Kieran mentioned, we are expecting a bigger impact from the restructuring actions in the second half of 2021 and then going into 2022..

Got it, okay. Another follow up if I may, is how would you characterize your inventory in the channel today? And from a working capital perspective what steps are you taking to improve inventory days on hand that I think could drive improving cash flow later on this year? Thank you..

So as you saw, we mentioned that the working capital sequentially increased very slightly. And our plants have been reducing our purchases and just the impact of the sudden drop in sales. We were not able to fully correct that situation but we expect that we should be able to make good progress as we go forward here in Q3 and into Q4.

And in terms of receivables and payables, those components of the working capital remain in good shape and we are managing those carefully and the quality of the receivables remains good as far as we can see so far..

Thank you..

Thank you. And we will take our last question, and it's from Hendi Susanto from Gabelli Funds..

Good morning, Kieran. Good morning, Ashish..

Hi..

Good morning, Hendi.

How are you?.

Good. Kieran, if I see the sales of automotive to transportation market, the sales decline seem weaker than the overall automotive market, some companies believe that the second quarter was the trough.

Can you share your insight into those?.

So Hendi on the – when we look at the commercial vehicle side of it, we think the second quarter with the trough as well, we think we see improvements there. And when you look at it, and if you look at some of our bigger customers in that space, they had declines of about 55% or so. Much steeper than what you'd see in the light vehicle side of things.

And so we think that will recover steadily, and some of those products go into the mid-range which may do a little bit better in the heavy-duty side of it. We're not sure exactly yet, if that's one or two quarter cycle or more, but that's something we are monitoring closely..

Got it. And then Kieran, you also mentioned that the premium brand in automotive should rebound faster.

Could you remind us what kind of exposure CTS has with regard to premium versus non-premium?.

So in North America, we've got good exposure. In Europe, we're a little lighter on the premium side of it and we're good with the Japanese transplants on the premium side as well. But Europe was a little weaker for us..

And then Ashish, with regard to the new $12 million of restructuring costs between now and year-end 2022, what is the linearity of the $12 million cost?.

Hendi, as Kieran mentioned, we are expecting a small impact in 2020. We expect a bigger impact toward the end of 2021. And then obviously by the end of 2022, we should be able to realize all of those targeted savings..

I mean, the cost associated with that benefit....

Okay. Sorry, I misunderstood your question..

No problem..

The cost should be generally in line as we get improvements, maybe leading by a quarter or two quarters. But the timing of some of those projects is still being finalized, and we will articulate a little bit more on that as we go forward, Hendi..

Got it. Yes. And then Kieran, the QTI acquisition contribution was stronger than my expectation. Where did you see strength in QTI business in the second quarter, and whether or not you expect to see those strength to continue? Some companies have mentioned the benefit of, let's say like outdoor activities, and then outdoor equipment.

I'm wondering whether CTS did benefit from those in the second quarter?.

We've been very pleased with the performance both on a top line and on the margin perspective with the QTI acquisition. Mostly our improvements have been coming in industrial and the medical side. And we're focused on expanding in both of those areas on the hot and cold side, we want to expand.

We also want to go deeper into the medical and leverage some of the channels that we have from existing customers at CTS. And then obviously expand into the regions, which is part of our plan as we go forward as well in Europe and Asia..

Got it. Thank you, Ashish. Thank you, Kieran..

Thanks Hendi..

Thanks Hendi..

And it looks like there are no further questions. I'd now like to turn the call back over to Kieran O'Sullivan for any closing remarks..

Thank you, Celestina, and thank you all for your participation on today's call. And be safe, we're getting back to work here. We have much to do and we look forward to updating you again in October. Thank you very much..

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