CTS Corporation

Good day and welcome to the CTS Corporation first quarter 2020 earnings call. Today's conference is being recorded. At this time, I turn the conference over to Kieran O'Sullivan. Go ahead, sir.

Thank you, David. Good morning and thank you for joining us today and welcome to CTS's first quarter 2020 conference call. I'll start by sharing a few thoughts on our company and on our business performance. It's been a challenging first quarter for our employees, communities, and our company globally. Three CPS employees have been impacted directly by COVID-19 and are returning to good health. Our hearts go out to the families affected by the virus. We were inspired by the healthcare and other essential service workers on the front lines and their relentless efforts to combat the virus. The uncertainty of COVID-19's impact weighs heavy. We've been dealing with COVID-19 in two China locations since early February and have been able to pass the key learnings quickly and effectively to all our European and American locations. Sales in the first quarter were $103 million, down 12.4% versus the same period in 2019. We added six new customers in the quarter. First quarter adjusted gross margin was 31.9%. compared to 34.5% in the same period last year. The adjusted EBITDA margin of 15% was down from 19.2% in the same period last year. First quarter adjusted earnings per share of 19 cents were down from 39 cents in the first quarter of 2019. Our balance sheet is strong. We had $151 million in debt and $151 million in cash at the end of the quarter, a zero net debt position. We have made changes to adapt our business and continue to monitor conditions carefully. While the challenges of COVID-19 are unprecedented, we are working to position CPS to emerge from this recession a stronger company. Ashish Agarwal is with me for today's call and will take us through the state progress 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, Karen O'Sullivan. Thank you, Ashish.

As we work through this challenging environment, our first focus is the safety of our employees. We have taken steps to ensure compliance with local regulations and have taken additional steps for employee safety in our locations that continue to operate. Excuse me. We are working closely with our customers to meet their requirements to the best of our abilities. To reduce operating expenses, we have implemented temporary pay reductions, temporarily eliminating for a monthly match, planned shutdowns, planned furloughs, and a reduction in board cash compensation. We will continue to evaluate further steps to optimize our cost structure and will update you on our progress. We are prioritizing capital spend for growth projects, and have applied the brakes in all other areas on managing needed pay receivables. During this process, my CPS co-workers across the world have displayed tremendous devotion to the company and its customers. They have stepped up to adapt to new ways of conducting business, displayed cooperation and understanding for the cost reduction efforts, and have demonstrated resiliency in these tough conditions. As a team, we have taken the learnings from our early experiences in the January-February timeframe from our China locations and implemented safety measures at our other locations across the world. We are maintaining our focus on the growth of our business as a key strategic priority and continue to expand our range of sensing, connectivity, and motion products. New business awards were $105 million for the quarter, which was a solid performance, given most regions lost three to four weeks in the quarter due to OEMs' advance. We secured large awards in accelerator modules, one with a Japanese OEM and two with Chinese OEMs for the local market, and a win for an application in commercial vehicles. In North America, we were awarded a contract for a right-height chassis sensor application. In ceramics, we had wins in intravascular, medical ultrasound, flow metering, and defense undersea applications. In total, wins outside the transportation end market were approximately $26 million. We see opportunities in this challenging market to gain new sales despite the strong headwinds in automotive. Demand for medical respirators is driving volume for our temperature sensors, and CPAP machines require our analog and digital encoders. Military communications with the RF filter products and speciality frequency applications are an area of focus where we're gaining traction. With our first-inning commercial vehicle, accelerator modules, We are exploring architectures to scale more cost-effectively, as applications tend to be unique in design. We are advancing innovations for hybrid vehicles and electric vehicles, where we are investigating content growth for pedals, current sensing, e-brick, and thermal applications. As previously reported, we continue to progress on pre-development engagements on our sensing to reduce harmful emissions and protect our environment. With ceramic material formulations, we are innovating with new textured laser formulations with a first award for military applications. We continue to maintain a disciplined approach to innovations and product development and have decent security biometrics for consumer electronic applications. Making further progress in our end market profile is a strategic priority for us. We continue to evaluate our portfolio of products and technologies for the work to strengthen our M&A pipeline. We build liquidity and balance sheet capability. We aim to emerge from this recession stronger and to advance our end market profile in an environment where valuations may be favorable for acquiring companies. We remain focused on adding the right technologies, expanding our geographic reach, and strengthening our product portfolio and customer relationships. One of the key learnings for us with the temperature sensing acquisition is our ability to improve front-end sales effectiveness for our other electronic component product lines. We are adopting these best practices with a goal to improve our ability to win new business. Last year, we reported the difficulties we encountered in our ceramic foundry operation. We saw good progress and continue to improve this year. We are also focused on increasing operation efficiency in our temperature sensor manufacturing operations in Mexico. The ERP rollout continues and will position us to gain further efficiency beyond 2020 in various aspects of our supply chain and support structure. To this end, we are evaluating a shared services plan across the regions to be more efficient. Fixed cost and operation expense reductions are always in view as we aim to live our core value of simplification. End markets were challenging in the first quarter of 2020. We expect the most challenging period this year to be the second quarter as the full impact of COVID-19 is realized. Transportation market demand is expected to be down in the 20% to 40% range in the second quarter, depending on the region. For the full year, we expect a decrease of a range of 10% to 20% globally, with some forecasts in a higher range. We are closely monitoring demand in other end markets, given the evolving dynamics. We expect a slow, steady recovery in the second half of the year, with the recovery lingering into 2021. Medical and defense markets remain robust. We are also seeing some incremental opportunities in medical ultrasound, temperature and position sensors for ventilators and respirators. Sales to aerospace and defense and market increased to 9% total revenues in the first quarter, up from 6% last year. Profitable growth marketing improvement, ERP implementation, and progress on our end market profile remain priorities for us this year. This year, we are initiating our drive for 2025 goals for CTS, focused on four key areas. Profitable growth and portfolio management, working more closely with our customers and allowing them technology and product roadmaps, building the capability of CTS operating systems to be more consistent globally to enhance our continuous improvement capabilities and results orientation. And finally, enhancing our organizational capability through leadership and cultural programs aligned with our business performance, our values, communities, and environmental priorities. We will update you annually on our progress. Due to the continuing uncertainties from COVID-19, We have drawn guidance for 2020. As we have said, we expect the second quarter to be more challenging, with some recovery over the following quarters. Again, I want to emphasize our strong liquidity and cash position, as well as our drive to emerge from this recession a stronger company. This time, Ashish will walk us through the financial performance.

Ashish? Thank you, Tim. First quarter sales were $103.1 million, down 12.4%. compared to the prior year. Sales to transportation customers decreased by 22%, and sales to other end markets increased by 7.1% due to the addition of $5.6 million in sales from our temperature sensing acquisition. Organic sales were down 17.1%. Our gross margin was 31.9% for the first quarter. Lower volumes impacted gross margins. As Kiran mentioned, we are starting to see improvements in our ceramic foundry operation and expect further operational improvements during the next quarter. Our first quarter 2020 earnings were 12 cents per diluted share. Adjusted earnings per diluted share were 19 cents, down 20 cents compared to the first quarter of last year. As volumes are declining due to the impact of COVID-19, We have taken steps to reduce costs where possible through temporary payroll reduction, suspension of 401k contributions, furloughs, planned shutdowns, and control over all discretionary spending. We expect the second quarter to be significantly impacted due to the shutdown and stay-at-home orders in most countries, with potential for a slow recovery in the third and fourth quarter of the year. On cash, CTS remains well-funded. At the end of March, we had $151 million in cash on our balance sheet. Our debt balance was $151 million. Overall, we had zero net debt. We have access to an additional $147 million through our evolving credit facility. We have taken measures to ensure we have adequate liquidity for the next several quarters at all our sites around the world in order to manage through this difficult situation. In March, we borrowed $50 million from our credit facility. Including this additional debt, we remain well within our debt covenants, and at this time, it is our expectation that this will remain compliant. Our controllable working capital as a percent of sales was 17% in the first quarter. The increase was driven primarily due to the sharp slowdown in volume in the second half of March. We are focusing on actions to reduce working capital over the next quarters. Our focus is primarily on reducing inventory levels across our operations. We have also enhanced our efforts on credits and receivable collections as we operate in an environment where many companies are cash-constrained. We generated $11.9 million in operating cash flow in the first quarter. Our CapEx was $4.6 million. We are prioritizing CapEx spend on the most critical and strategically important programs. Our goal is to reduce capital spend by 25 to 30% to under $15 million for 2020. We are continuing to implement SAP and went live successfully at another large manufacturing location at the beginning of March. Due to current limitations on operations and travel, we are adapting our plans and have delayed the target date for the next go live to the third quarter. As a result of this push out, our target date for completion has moved into the middle of 2021. We are taking steps to manage costs related to the implementation. This concludes our prepared comments. We would like to open the line for questions at this time.

Thank you. The question and answer session will be conducted electronically. Please press star 1 on your telephone keypad at this time to be placed in queue. If you're using a speaker phone, please make sure your mute function is turned off to apply your signal to reach our equipment. Once again, please press star 1 to ask a question or pause for a moment to assemble the queue. And we'll take our first question from Brian Colley with Stevens.

Hey, good morning, guys. Thanks for taking my question. Hi, Brian. Hi. So you gave some good commentary around expected trends in the transportation end market for the second quarter and the full year. I was curious if you could offer some similar commentary on what you see, you know, for your other end markets for 2Q in the full year. And also, you know, if you could talk a little bit about demand trends and how the business is performing so far in April.

So, Brian, on the automotive side, just to recap, we were down about 22%. We saw the market down somewhere in the region of 24% in the first quarter. Second quarter, we said 20% to 40% down. It will differ across the regions for the year. We said 10% to 20% range. We've seen some forecasts around 23% for the year, and that's different in each of the regions, but we're prepared for those situations. On the non-automotive markets, We're feeling pretty good, but we're also being cautious because we don't know what the effects are if you look out beyond two months, three months. So that side of things is running reasonably well, and as I said, we've got opportunities to gain some new sales. Some of those may be short-term, but we're also looking for opportunities on longer-term contracts. We're pretty pleased with our new business awards. You saw that they were strong in the sense of solid performance in a quarter where we We just had three weeks of shutdowns, and all those contracts were not being awarded. And our non-transportation performance was very solid there. So, again, we feel good about the non-transportation side, but we're also cautious because it's an evolving market at this time.

Got it. That's helpful. And then second question, you know, I know the timing of a recovery is something that's impossible. to predict at this point, but whenever we do see things inflect positively, whether it's later this year or next year, can you talk about the areas of the business where you would expect to see a sharper snapback and more of a V-shaped recovery versus the areas where the recovery could be more prolonged?

Yeah, so on the transportation side, it's going to be tough in the second quarter. We think there will be a slow improvement. If you look at the forecasts that are coming out there every week, they're evolving. I think when you look at big ticket items like vehicles and with the unemployment levels and changes It's going to take some time. Now, fortunately out there, you can buy vehicles online these days, so it helps a little bit in the process versus the dealership, but it will be a slow, steady recovery, not a quick flip back. On some of the other areas, we're seeing good progress in the ceramic product line and in the electronic components. We've got some new products in 5G where we're making some progress. I mentioned that on RF in certain applications, not just in telecom, but in military applications for frequency and for 5G, we see good demand there and a steady performance in medical as well. So, obviously, we'll continue to evaluate it, but those areas feel a little better.

Got it. And then last question just on the cost structure. I'm curious if you have to maybe quantify the cost that you've taken out in response to COVID so far. And then just as you think about additional, you know, expense reductions, it sounds like you guys are kind of planning for a macro scenario where we have, you know, kind of a slow steady recovery in the back half. But if we do see a more prolonged recovery, do you guys have the ability to take another step function down in the cost structure?

So, Brian, as we talked about, we took some cost actions in the fourth quarter last year, then we have started seeing some slowdown in our commercial vehicle and market. And we have taken additional steps, which we talked about on the earnings call today. We are staying away from trying to quantify the full impact from those cost actions because we are considering them as centrally based on market conditions. And at the same time, we are looking at additional options in terms of how we could take further steps down if the market conditions evolve unfavorably from a volume standpoint. So all of those things are in our playbook from that standpoint, and we will take the additional steps at the right time.

And, Brian, just to add a little bit to what Ashish said, you know, obviously our employees are helping out here in this situation, and we want to make sure as things improve that we are fair with our employees as well. And on the flip side to your point, as you look at beyond a few quarters here, how is demand? Is it a new world versus capacity that you have today? Is that something that you've got to be constantly analyzing and planning for? And I think that's what Ashish was also pointing towards as well.

That makes sense. I'll leave it there. I appreciate the time today.

Thank you.

And next, we'll go to Carl Ackerman with Cowan.

Hey, good afternoon, gentlemen, or good morning, gentlemen. Two questions by May. First is on manufacturing. Is there any way to impact margins for the work stoppage orders at the various manufacturing facilities. And are your manufacturing facilities in Mexico fully funded? Now, are you able to alleviate some of those bottlenecks in other geographical manufacturing locations?

Carl, do you mind repeating the question? The line is not perfectly clear.

Sure. Yes. I was hoping you could quantify what the impact to your margins were from these factory shutdowns within order, particularly within your, you know, non-U.S.-based facilities. And are those factories at this point fully functional? And if not, are you able to alleviate some of those bottlenecks in your U.S.-based locations?

So, Carl, if we got your question right, you're asking about the margin impact and how much we can protect margins as we navigate through the situation. You saw that our gross margin declined somewhat in the first quarter as volumes dropped. We are looking at ways where we can reduce manufacturing costs. And we are also making sure that we stay compliant with any local requirements, which may prevent us from being able to fully reduce costs just based on country by country that have different regulations that we have to comply with. And as we move forward, the same situation will continue to evolve in terms of, as Ken mentioned, what does the volume scenario look like, and then based on that, we'll be looking to manage our cost structure as best as we can.

And Carl, to give you some color on the locations, if you look to Asia, We obviously were down during the shutdown in China. Those facilities have been back up and running since about mid-March at full level. Our Taiwan facility has been running all the way through. When we come to Europe, we've had some shutdowns. And we're back in operation there. And if you come to North America, we're running some medical products continuously. And Mexico operations have been impacted. And we're waiting for some clarity on that. What is clear is with the volumes in automotive, we will have furloughs in our facilities as we go through the second quarter.

No, that's helpful. I appreciate that. Let's just see. follow-up to margins. I understand factory utilization is challenged given some of these supply chain disruptions year-to-date, which is probably concerning factory. But, you know, from here, it was helpful to talk about some of the end market dynamics going forward. You know, should a margin recovery be dictated by sales momentum in transportation, or are there other one-time supply chain costs you've incurred here today that may have made up the next three quarters that should provide you a more until.

Thank you. Carl, the primary driver is going to be recovery involvement. And as Kiran mentioned, and I covered as well, we are seeing some underlying improvement in some problem areas that we had last year. But that's going to be tempered with what we're seeing on the volume front.

Carl, the other thing I would add there that we're doing is we're looking at the heat maps locally in terms of, first of all, we've got inventions that we need to also burn down, but we're also very focused on those heat maps in terms of critical components. Is there a component out there that can shut us down? that we need to be planning for. And at the same time, we're also looking at the front end of the business to say, do we have competitors that are in trouble? Is there an opportunity for us to get stronger gain share? Because there's both ends of the supply chain and the front end we need to be flexing to make sure we operate to the maximum viability.

Very helpful. Thank you.

And as a reminder, it is star one if you'd like to ask a question. Next we'll go to John Good morning, guys.

I'll start with an easy one. How many of your facilities are fully operational today?

It's a dynamic situation. But just to give you a bit of color, John, from what I said, we've got three facilities running in Asia. We've got three running in Europe, somewhat at different levels. We've got Two running in North America, one not. And then in Mexico, we've got three, four in Mexico, of which three are fully shut down. One is, sorry, two are fully shut down and two are partial.

Okay. And can you just walk me through the dynamics, how the restart in your China facilities kind of look like and what you learned in that lesson that you can apply to when the restart happens here in North America? Sure.

John, that was something that was really beneficial to us. Our teams in China did an excellent job coming back in very difficult circumstances, and we really took the learnings from them. They were the first ones getting back. It wasn't a digital back on. It was a slow ramp. It took several weeks for us to ramp up. We had some employees who were trapped in areas that were not free to travel, obviously. So we had to flex. We did things from, first of all, different monitoring and safety considerations, detaining in our facilities to make sure we protect our employees, our cross-training that we've done and cross-training that we added on to flex and introduce people to the production lines in a controlled manner was very important. And we've taken those lessons and also applied them here to our locations in Europe and in the Americas as well.

The other thing that I would add, as you mentioned earlier, Kiran, the heat map to ensure that we can adequately secure supply. Other suppliers that are critical, we are working to make sure that, to the extent possible, we can keep our supply lines open so that we can produce product when we are able to get back up and running.

And, John, the other aspect that was pretty important there was with our customers. And, obviously... We have some fixed goods, but knowing their demands and making sure we were aligned with their startup plans was extremely important so that they knew our ability to flex and support them and have the confidence of coming back to CTS.

So do you produce right now for the transportation market here in North America even though they're not taking products, or are they taking products?

So we have... Some product that goes into critical transportation, like ambulances or fire engines. So some of those products are still moving at lower volumes. So hopefully that helps you get an understanding.

OK. And regarding the medical market, my understanding that elective procedures being preferred, that a lot of the medical suppliers are getting it pretty badly. It doesn't seem to be the case with you. Is that because the temperature sensor is doing well, or have you not just seen it yet?

So we're being very careful, and that's why our comments on growth outside of transportation, what we see is reasonable, but we're also very concerned, once you look at beyond 48 weeks, what could be changing in demand that we haven't seen yet, and obviously, When you think about our temperature sensors, they go into food and other areas, support restaurants, what's happening there. On the flip side, on medical respirators and medical ultrasound, we've seen solid demand and seen some increasing demand as well. But we are very cautious there in terms of understanding what the longer-term demand is.

Okay. And can you remind me what your debt covenants are, please?

So John, the primary debt government that we monitor carefully is the gross debt to EBITDA and the upper limit is 3.5 times and at this point we are well under 2 and as I mentioned we had borrowed $50 million additional beyond what we would normally be borrowing, and that is why the covenant is a little bit higher than what it normally would be. So we expect to stay within our covenants, and at least at this point in time, we're not seeing a risk of having any problems on the covenant side.

Okay, so that $137 million left on your revolver, Did that include the 50 million?

Sorry, say that again. So after having borrowed the 50 million, we have another 147 available under the existing facility. Okay.

All right. Great. All right. Thank you. Actually, I'll stop here and let other people ask questions. Thank you, guys. I appreciate it. Thank you.

Next, we'll go to India's Tonto with the Belly Fund.

Good morning, Kiran. Good morning, Ashish. Good morning, Henry. Hi, Henry. Kiran, can you talk more about China? Like I think we read on news that some customers in China have returned back to a higher level of production. So what are you seeing in China in terms of current market demand and then visibility in general?

and what we're seeing is and on the transportation side and where our facility is moved back up we're running as normal and we're and looking out in terms of what does the end of the second quarter look like and what will the third quarter be like I was on with our plant there last night and and we saw some new incentives coming into the marketplace in China where they're incentivizing cleaner fuels like hybrid and electric. Some of those subsidies won't come until 2021, so we expect some impact during the next year. On some other areas, we've seen some softness in two-year markets. We expect some of that to rebound, but more slowly. On the component side, other than that, we've seen pretty steady performance And so, again, it's a little bit of a mix, as you can tell, but we're being careful and cautious because it's an evolving situation still.

Got it. Thank you, Kiran. And then, Aziz, is it reasonable to assume that share buyback will be temporarily suspended?

So, Hendi, we are discussing with our board on what the appropriate steps are to take, and as decisions get made, we will talk about that.

Got it. And then one more question. So, when we look at Nodiac acquisitions, how do you distribute the sales when you report, like, individual segments? Like, how much of that is in industrial? How much of that in, let's say, like medical and transportation, et cetera.

So, Hindi, for the different end markets, which acquisition were you referring to? I thought I heard you say NOLIAC, but... NOLIAC, NOLIAC. Are you referring to the most recent one we made or NOLIAC? Yes, NOLIAC. Sorry, QTI.

No, no, QTI, QTI. I meant QTI.

I see. Okay, okay. So QTI, the primary end market they go into is industrial, and a relatively smaller portion does go into defense end market as well as medical, relatively smaller portions. The primary end market is industrial.

Got it. Thank you, Ashish. Thank you, Kiran.

Thank you, Andy.

I'll turn the call back over to Mr. O'Sullivan for any additional or closing remarks.

Well, thank you for your participation in today's call. I wish everybody to be safe, and we look forward to updating you again in our July update. Thank you very much.