Good day, and welcome to the CTS Corporation First Quarter 2021 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, Olivia. Good morning. Thank you for joining us today and welcome to CTS's First Quarter 2021 Conference Call. Sales in the first quarter were $128 million, up 25% compared to the same period in 2020.

While customer demand has been robust, we have been challenged by supply chain disruptions, including the impact of semiconductor and resin shortages, customer shutdowns and increasing logistic costs due to the ongoing COVID-19 pandemic. We are also seeing increases in raw material pricing, which have been significant in some cases.

We expect some of the supply chain challenges to persist through the second quarter with the potential to improve from that point forward. First quarter gross margin was 33.2%, up 130 basis points from 31.9% in the same period last year.

Our gross margin performance was negatively impacted by the supply chain challenges already mentioned and pricing pressure, which is increasing across several commodities this year. EBITDA margin of 20% was up 500 basis points from 15% in the first quarter of 2020.

All our plants are operational and functioning at approximately 100% capacity despite the pandemic challenges impacting our European and Mexican operations. First quarter adjusted earnings per share of $0.46 were up 142% from $0.19 in the first quarter of 2020. New business awards of $156 million were up from $105 million in the same period last year.

Operating cash flow was $20 million, up from $12 million in the first quarter of 2020. 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 will now turn the discussion back over to our CEO, Kieran O'Sullivan..

3 in industrial and 2 in communications. In transportation, we were awarded large wins for accelerator modules with 5 Asian OEMs and 3 North American OEMs. In sensors, we secured wins with a North American OEM for 3 ride height sensing applications and wins with 2 Tier 1 suppliers for passive safety products.

In addition, we were awarded a brake sensor, a brake position sensor for a Chinese OEM electric vehicle platform. Across accelerator modules and sensors, we had 5 EV awards. In total, EV wins as a percentage of total awards were 18% in the first quarter. Moving to auto electronic components.

We secured a large win in industrial printing with an existing customer and an extension with other customers. We also supplied initial volumes for an industrial HoloLens application with potential for approximately $1 million in sales in the next year.

In defense, we received 2 awards for undersea applications and shipped the first prototypes for next-generation textured ceramic and we expect to deliver further samples throughout the year as we enhance product performance. Additionally, we are developing next-generation ceramic formulations for new solar programs.

We continue to make progress on sample qualification with new European customers. Finally, we're awarded a grant by the Office of Naval Research for a multiyear development program. In communications, we had design wins for our filters and an order for an antenna application, which will ship in the fourth quarter.

We continue to gain traction with our precision frequency product in niche areas as customers test their modems for 5G applications. Moving to medical, where we experienced softness in sales in 2020, we now see signs of recovery.

We were recently awarded a significant new order for single crystal technology for a medical ultrasound application and shipped samples to a new customer for an intravascular medical ultrasound. Temperature sensing remains robust in industrial and medical applications.

We received a new award for an aviation application with first revenues expected later this year. Building and strengthening our M&A pipeline continues to be a priority.

With domestic travel expanding and international travel not far behind, we expect the improving conditions will help us to continue to build relationships with companies in line with our strategy. Our stated goal is to achieve 5% inorganic growth on an annual basis.

We seek to expand our range of technologies, products, customers and geographic reach, and at the same time, continue to diversify our end market profile and ultimately enhance the future quality of earnings.

Given our strong balance sheet, we seek to make more meaningful progress on our inorganic growth goals while remaining disciplined in our approach. On the operations front, we recently went live on SAP at our Zhongshan facility, which brings our coverage to over 90% of revenue.

Ashish will provide more commentary later as we can now see the end of the journey and the rollout of this new capability. We are very focused on maximizing the return on this capital investment through enhanced training of our teams, smarter reporting, data analytics and operational efficiencies.

The restructuring plan we announced last year continues to progress with small delays from the ongoing impact of COVID-19. We are on track to deliver an annualized EPS improvement of more than $0.22 by the second half of 2022. Transitioning to end markets. For the U.S.

light vehicle transportation market, the outlook for demand has improved from our last call. We expect approximately a 15 million to 16 million unit range this year, up from 13 million units last year. On hand days of supply of 50 days is below the 5-year average of 68 days.

European production is forecasted in the 18 million to 19 million unit level, though there may be further softening due to the ongoing lockdowns in that region where our sales exposure is lower. The Chinese market remains solid, with volumes expected in the 24 million to 26 million unit range for this year.

The commercial vehicle market remains strong. Larger Class A backlog remains robust, while the mid-range and below continues to demonstrate double-digit growth. However, supply chain shortages remain challenging and may impact our transportation sales in the second quarter.

The medical end market is expected to continue to improve in the second half of this year. We see good growth in industrial and defense markets as we navigate some lower risk supply chain issues. In terms of guidance for full year 2021, we previously communicate we would update the range as we progress through the year.

Our previous guidance was for sales in the range of $430 million to $490 million and adjusted earnings in the range of $1.20 to $1.60. We are now updating our guidance for sales to be in the range of $445 million to $500 million, and adjusted earnings are expected to be in the range of $1.35 to $1.70.

Further updates will be provided as we gain more clarity on the supply chain disruptions we are facing. Finally, our Focus 2025 initiative is progressing. As I look across the 4 initiatives we previously communicated, progress on talent and growth are central to success across the entire program.

Over the past years, we've continued to improve our ability to execute, which we need to maintain. Phase 2 of our journey is about layering on a more robust sales growth profile. At this time, Ashish will take us through the financial performance in more detail.

Ashish?.

Thank you, Kieran. First quarter sales were $128 million, up 25% compared to the first quarter of 2020 and up 4% sequentially from the fourth quarter. Sales to transportation customers increased by 23% year-over-year, but were down 1% sequentially. Sales to other end markets increased 27% year-over-year and were up 13% sequentially.

We saw solid double-digit growth in all end markets, including the medical end market, which has been soft in the last 2 quarters of 2020. Our most recent acquisition, Sensor Scientific, had a strong start and added $1.8 million in sales in the first quarter.

Our gross margin was 33.2% for the first quarter, up 130 basis points compared to the first quarter of 2020. Gross margin is down from 34.7% level we achieved in the fourth quarter due to a challenging supply chain environment, including reduced material availability and cost increases.

Raw material price increases impacted us by approximately $1.6 million, with a portion offset by price increases. We expect a similar trend for the second quarter and are working with our customers to the impact. We have also reinstated most of the temporary cost reduction measures that were put in place in 2020.

In the first quarter of 2021, we generated $0.03 of EPS in savings from our restructuring program announced in July 2020, bringing the total savings to $0.08 of EPS so far. However, some of our projects are facing challenges due to the ongoing impact of COVID-19 on travel as well as an increase in demand.

We are still on track to achieve the targeted annualized savings of $0.22 to $0.26 by the end of 2022. SG&A and R&D expenses were $24 million or 19% of sales versus $24.2 million or 23% of sales for the same period last year. First quarter tax rate was 19%.

This improved tax rate is a result of the various projects we have been working on in the last couple of years. We anticipate our 2021 tax rate to be in the range of 20% to 23%, excluding discrete items. This may be impacted by new tax policies initiatives of the Biden administration. First quarter 2021 earnings were $0.37 per diluted share.

Adjusted earnings per diluted share were $0.46 compared to $0.19 in the same period last year and $0.43 last quarter. Now I'll discuss the balance sheet and cash flow. Our controllable working capital as a percentage of sales was 14.8% at the end of the first quarter. This is a slight improvement from the end of 2020.

We have made progress over the last few quarters. And while we remain focused on working capital efficiency, we anticipate carrying some excess inventory where possible to manage supply chain concerns over the next few quarters.

Our operating cash flow was $20.1 million for the first quarter, which is an improvement from $12 million in the first quarter of 2020. We achieved $18.5 million in free cash flow. CapEx was low in the first quarter, primarily due to the timing of various CapEx projects. In 2021, we expect CapEx to be in the range of 4% to 4.5% of sales.

Our cash balance on March 31, 2021 was $103.4 million, up from $92 million on December 31, 2020. Our long-term debt balance was $50 million, down from $55 million on December 31, 2020. Our debt to capitalization ratio was 10.3% at the end of the first quarter compared to 11.4% at the end of 2020.

The combination of a strong balance sheet with a net cash position and access to over $240 million through our credit facility gives us the liquidity to make progress on the right M&A transactions. In early April, we went live on SAP at another large manufacturing location.

Our teams completed these rollouts successfully despite many of our resources having to work remotely, which is a significant accomplishment. As Kieran already mentioned, more than 90% of our revenue now comes from sites that are running on SAP. The remaining sites are from our recent acquisitions in the last several years.

We are expecting to complete these rollouts in early 2021. However, COVID related restrictions could cause some delays. This concludes our prepared comments. We would like to open the line for questions at this time..

[Operator Instructions]. We will take our first question from Justin Long with Stephens..

So I wanted to start with the question on the guidance. The first quarter was pretty strong. When I look at the EPS that was reported and what the guidance for the full year implies, it suggests that sequentially, earnings will be down over the remainder of the year.

Can you talk a little bit more about the incremental headwinds that you're expecting that are driving that? Because -- I mean I get that there's some macro uncertainties out there, but at the same time it feels like we're recovering, the vaccine is being distributed, and so I was a little surprised to see the guidance suggesting some sequential pressure..

Yes, Justin, it's a fair question and we understand it. I think, first of all, from the COVID perspective, the vaccine is out there. It's very good. In North America, making a lot of progress. But remember, we've got business in China and Europe, the Mexico operations.

So from an operational side, we've got concerns with Mexico and Europe, and we're just navigating our way through that. And that will continue to improve and that's why we will continue to adjust as we gain confidence through the year. The second wildcard out there is the supply chain.

And I would tell you, I'm probably spending more of my time these days being an expeditor of materials than anything else in helping out situations. There were a few times in the first quarter where we could have been several million down in sales than where we ended up and that's because of the great work of the team.

So we're actually -- you can tell from the guidance. We're just being a little cautious because we know as we go into the second quarter and sit here today, we've got some big bumps still to overcome on supply chain issues. I'm not going to get into the details of those.

We're working them with our supply chain and with our customers, but some of those are magnitude of millions of dollars. We've been fortunate that our teams have been really well -- managed really well through that. And you'll also see we took the upper end of the guidance up as well because, to your point, if things go well, we will do better.

But we've got to get through these supply chain headwinds..

Okay. And as a follow-up to that, is there a way to quantify what the supply chain headwinds cost in the first quarter? And it sounds like the view is that those will continue into the second and then maybe get better.

So do you think that the supply chain costs are similar in 2Q versus 1Q? Do they get worse? Just some directional guidance would be helpful..

So Justin, we talked about $1.6 million impact from raw material costs in terms of the inflation pressures we saw. That's relatively easy to identify. There's a little bit more on the freight side. The harder things to quantify is the impact of customers reducing their capacity because they cannot find other components from other suppliers.

The impact of that becomes a little bit harder to quantify on the business. So to that extent, we expect second quarter to have a similar trend. And as Kieran mentioned earlier, we are looking for improvements in the second half of the year and we'll just need to watch things very carefully as we go along..

Okay. And lastly, I'd love to just get an update on the acquisition pipeline.

If you've seen any changes there year-to-date? And just an update on valuations that you're seeing in the market today?.

It's a big part of our strategy with a 10% growth goal and 5% through an organic acquisitions. It remains in focus. We've got a pipeline we're working. I would tell you, we've been out there traveling domestically, internationally.

We know it's an important part of our growth progress and we feel good about the pipeline and -- but we need to continue to work it..

Next we will move to Karl Ackerman with Cowen..

Two questions if I may. So your sales for distribution are modest, but some peers across the supply chain have spoken about OEMs and resellers have been restocking inventory where possible in order to avert any future supply shortages in the second half.

I'm curious if you are seeing that customer activity at all across your automotive and industrial product lines now as you think about some of the conservatives you have perhaps going into the second half....

So Karl, I'm going to make an attempt, you were a little bit faint. I think the first part of your question was on our distribution sales, which is pretty small, and the concern over inventory buildup there. And we haven't seen any signals on inventory buildup, but we're a little bit cautious there because we don't know what's happening.

We -- yes, some of our products will go through to contract manufacturers and we don't know what they're doing after distribution. So it seems to be okay, but we're a little cautious there. On the automotive side, I would tell you, demand is strong.

The biggest problem in automotive is having parts and making sure you're in good standing to supply and meet the forecast. The rest of the markets, industrial and medical, I would say we feel good about the second quarter. If you look into the second half of the year, that's something we're still monitoring.

It's probably the best way I describe it, but we haven't seen inventory buildups yet..

Got it. As my follow-up, how are you thinking about the margin trajectory for the balance of the year, understanding that there are various tightness across substrates and passive components from a manufacturing standpoint. There are -- other peers have spoken about rising freight costs and elevated freight costs.

And so I'm curious to the extent you may not be able to pass along all of that cost to some of your OEMs, I'm curious if you've been able to engage in perhaps longer duration of volume contracts with them as perhaps an offset.

So any commentary in terms of how you are working with your largest OEMs and able to pass along some of these rising input costs would be helpful..

Karl, if I don't fully address your question, please ask it again because your voice was a little bit faint, but I'll give it a shot. The question you had was how are we working with our customers in terms of sharing the impact of increased cost of raw materials. We have been able to price pass some of it to our customers already.

There are several customers we are still in discussions with. We are evaluating all options ranging from permanent price increase to temporary price increase to changes in contracts, how we work with them going forward. All of those options are being evaluated and our teams are working very closely with our customers.

We want to make sure that we respect the long-term nature of those relationships. And my expectation is that we will not get 100% recovery, but we should be able to work out good solutions going forward.

Kieran?.

Yes. Just to add to that, Karl, obviously, there's two sides to this equation. One is we're going to have some margin pressure here as we go through the year. And Ashish already gave a run rate coming out of the first quarter.

The other side with the customers, getting longer contracts or more volumes, that's -- we can do that on the electronic component side, harder to do it on the transportation side where contracts are pretty fixed..

And the volumes are more dependent on platform lifetime that's remaining, so -- Karl, did we answer your question fully?.

Yes..

[Operator Instructions]. We will move to our next caller. That is Hendi Susanto with Gabelli Funds..

Kieran and Ashish, are we at a point now where you can talk about some benefit from SAP potentially in the coming 2022?.

operational efficiencies in our plants; better data analytics, which will help us with decision-making, both from the perspective of how we look at information available to us and how quickly that information is available to us. We are looking at those aspects as well that will help drive further improvements.

My expectation is the restructuring-related savings we'll achieve by 2022. But longer term, we should see further improvements as we get better at using information coming out of the new system..

I see. And then second question in ceramic foundry operation.

What is the current status of yield and operational efficiency?.

Hendi, we talked about a year -- as you're correct, last year. We've made a lot of progress, improved, it's running well. And obviously, we never stop looking for improvements, but nothing to be concerned about there..

I see. So you are done making the improvement that you intended from last year.

Is that right?.

Yes. The improvements we talked about last year, Hendi, certainly then turn the corner on that, but we're always looking for further improvements, just to put it in perspective..

I see. And all the other participants on the call, I accidentally said that the SAP implementation will be completed in early 2021. I meant to say early 2022. So I just wanted to correct that comment..

Okay. That's helpful. And then Kieran, last question for me.

Any color on like new product development for 2021 besides the one that you mentioned when you presented a long list of awards?.

Yes. Hendi, when you look at it on the transportation side, we're looking for new sensors and applications on the EV side of it. We were already working on temperature and thermal, the one that's probably the most advanced, but is -- where we're working on concepts with customers is e-brake where you're getting electronic brake, on that side of it.

And then if you move over on the electronic component side, we're getting into new markets on temperature and continue to expand our capability in medical. And on the hot and cold side on the temperature, for industrial, new sonar programs that we're working on.

Texture ceramics is something we've started to ship samples to customers and received very good feedback. So we expect that to help us in the towed arrays and forward arrays as we go forward as well as other products too and will enable us to come down as some of the price curves in that area. EU defense is something that's moving very nicely for us.

It takes a little bit of time because these new materials take time to get qualified. But I would tell you, we're working on new products with a few customers over there. So they are just some things and we continue to expand on the frequency side. The RF filters, we're getting some good traction on those.

And yes, we're also working on some newer formulations in ceramics because of the nature of lead in those areas that we think won't be something that you'll see in the next year, but it's something important for our future as well. So yes, they're just some of the points I'd highlight, Hendi..

Thank you. With no further questions in queue, Mr. O'Sullivan, I will turn the conference back to you for any additional remarks..

Great. Thank you, Olivia, and thank you all for your participation on today's call. We look forward to updating you again on our progress in July. Thank you again. This ends the call..

Thank you, and thank you all for your attention. This does conclude today's conference. You may now disconnect..