CTS Corporation

Good day, everyone, and thank you for standing by. Welcome to the CTS Corporation fourth quarter and full year 2020 earnings call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Kieran O'Sullivan. Please go ahead.

Thank you, Hannah. Good morning, and thank you for joining us today, and welcome to CTS's fourth quarter and full year 2020 conference call. Sales in the fourth quarter were $123 million, up 7% compared to the same period in 2019. Full year sales were $424 million compared to $469 million last year impacted by the pandemic in 2020. Today, all of our plants are operational with varying levels of capacity from 85% to 100%. Fourth quarter gross margin was up 110 basis points to 34.7% from the same period last year, Even the margin of 21.4% was up from 20.3% in the fourth quarter of 2019. Fourth quarter adjusted earnings per share of 43 cents were up 16% from 37 cents in the fourth quarter of 2019. Full year adjusted earnings per share of $1.12 were down from $1.45 last year. New business wins for the year were $442 million. down from the prior year as several OEMs pushed outsourcing decisions in 2020. Operating cash flow for 2020 was $77 million, up 19% from $64 million in 2019. In the fourth quarter, we acquired Sensor Scientific, a temperature sensing company primarily serving medical customers. Ashish Agarwal, our CFO, was with me for today's call as usual, 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 investor section of the CTS website. I will now turn the discussion back over to our CEO, Kiran.

Thanks, Ashish. In the fourth quarter, our sales increased to $123 million, up 8% sequentially, and up 7% from last year. For full year 2020, sales were down 10%, from 2019, driven lower by the impact of the pandemic. The quarter's performance was solid. However, we are operating cautiously as we enter 2021 and monitor for any new pandemic disruptions, semiconductor shortages for our OEM customers and the consistency of the recent robust recovery. We continue to prioritize safety in our operations, our team's ability to effectively manage through the crisis, Their resilience as well as the commitment and strength of the senior leadership team greatly helped us navigate these unprecedented market conditions this past year. The restructuring plan we announced last year is progressing with small delays due to the impact of COVID-19. We are still planning to deliver an annualized EPS improvement in excess of 22 cents by the second half of 2022. More importantly, we're focused on returning to growth. building on our performance in the fourth quarter, and leveraging the recent acquisition of Sensor Scientific. Sensor Scientific is a manufacturer of high-quality thermistors and temperature sensor assemblies, serving OEMs for applications that require precision and reliability in medical, industrial, and defense markets. Sensor Scientific's products are used in a variety of medical applications, including neonatal equipment, lab freezers, fluid warmers, and analytical instruments. SSI has locations in Fairfield, New Jersey, and in the Philippines. The acquisition expands our temperature sensing portfolio, has complementary capabilities with our existing platform, and expands CTS's presence in medical. The annualized revenue is in the range of $6 million. The purchase price was slightly less than two times revenue. I'm pleased to welcome the SSI team to CTS, and excited by the addition of many talented individuals and the growth opportunities ahead. We remain focused on our strategic growth investments as part of our planning for 2025. Growing our business and expanding our range of products that sense, connect, and move is a priority. New business awards were $104 million for the quarter. We added six new customers in the quarter, four in transportation, one in medical, and one in telecom. In transportation, we rewarded passive safety sensor wins with three OEMs. One of the wins was with a North American customer for electric trucks and new customer for CTS. This builds momentum on the large passive safety win we recorded last quarter with a Chinese electric vehicle application. We had accelerator module wins with several OEMs across China, Europe, and North America. A few of these wins were on plug-in hybrid electric platforms. We also added a new customer for passive safety sensors in Asia and a new Chinese JV customer for accelerator modules. We continue to focus on electric vehicle applications and products that are technology agnostic and are not impacted by the transition from internal combustion engines to EVs. New electric vehicle applications in current, temperature sensing, and advanced e-brake our innovation projects in our pipeline, as well as next-generation chassis ride height sensing. Total EV wins for the year were in the range of 20% of new business awarded. In Europe, we continue to leverage our footprint and capabilities in Denmark and the Czech Republic with Tier 1 defense customers and are currently in sample qualification. In addition, we were awarded funding from a European agency for the development of next-generation ceramic materials. We saw softness in the medical market in the fourth quarter. However, we are making progress in applications and renewed business with three ultrasound customers in the quarter, with one for a multi-year period. We also secured a win for a sleep apnea control application and a win for a medical temperature application. In other electronic components, we had wins with application in EMC, as well as a micro-actuator application. In Asia, we secured a win for a two-wheeler throttle sensor application. With temperature sensing, we secured orders in pool and spa applications, which continue to be strong. We also had temperature wins in industrial for HVAC and a win for a satellite application. We are gaining momentum with our precision frequency product, enabled by our reference design position. We secured wins for 5G applications linked to large telecom OEMs and shipped a quarter million of samples in the quarter. More recently in January, our product was designed in for a 5G application selected by India's largest telecom provider. The low-power crystal product is also in sample testing with a new North American customer. Building and strengthening our M&A pipeline is a priority. While this is more challenging due to the COVID restrictions, We are actively building relationships with companies in line with our strategy. We seek to expand our range of technologies, products, customers, and geographic reach while we continue to diversify our end market profile and enhance the future quality of earnings. Given our strong balance sheet, we seek to gain momentum with the right strategic fit and evaluation. The FOCUS 2025 initiative which we have previously highlighted has an important emphasis on building stronger customer relationships. As part of this initiative, we continue to focus on our go-to-market capabilities and skills. We are working to improve the quality of the sales funnel, optimize our target new accounts, and align our functional areas to be more responsive and solution-oriented in line with our core values. As we progress into the first quarter of 2021, we've seen a positive start and expect a good first quarter given current customer demand. As I mentioned earlier, we remain cautious for the full year in case of unexpected pandemic supply chain disruptions and the current semiconductor shortage. We are monitoring the consistency of demand in this recovery given there may have been some pull forward in demand in 2020. We are all aware of the backdrop of higher unemployment and the potential for depressed economic and consumer confidence. though we are not experiencing it at this time. We are facing some headwinds on commodity pricing, higher freight charges, increased absenteeism due to the impact of COVID-19, and working diligently to offset these with our continuous improvement projects. We expect to stay within our targeted gross margin range. For the U.S. light vehicle transportation market, volume is expected to improve in the 14 to 16 million unit range. On-hand days of supply are now 59 days, approximately 9% below the five-year average of 65 days. We currently see reasonable control of inventory levels. European sales are forecasted in the 18 to 19 million unit level, though there is some uncertainty given the recent lockdowns throughout the region with some OEMs announcing volume reductions. Our exposure to the European market is lower. The Chinese market is expected to remain solid with volumes of the 24 to 26 million unit range this year. The commercial vehicle market is on an improving trend that started last year. Larger backlogs and heavy duty are driven by increasing fleet orders. In the mid-range and lower, demand has been driven by the increase in e-commerce deliveries. The medical end market is expected to remain soft in the first half of 2021 due to lower elective surgeries. we see good growth in industrial and defense markets. In terms of guidance for full year 2021, we expect sales to be in the range of $430 million to $490 million, and adjusted earnings are expected to be in the range of $1.20 to $1.60. We are closely monitoring the impact of COVID-19, supply chain disruptions, and the broader level of economic activity. We expect to narrow the range as the year progresses. In this more remote working environment, we continue to place an emphasis on connecting with our customers, monitoring products in development, effectively navigating supply chain improvements, innovations, and importantly, our performance and results-driven culture. Our employees globally continue to provide tremendous support and demonstrate resilience to serve our customers while operating safely. I want to thank them for their incredible support this past year. We are confident in our strategy and are using this pandemic period to enhance our foundation, strengthen our core business, and to advance our technology capabilities. Our 2025 initiative is focused on four key areas. 10% annualized profitable growth with active portfolio management. Working more closely with our customers, building relationships, and aligning our technology and product roadmaps. Number three, building the foundation of CTS's operating system. to execute globally on a consistent basis while we enhance our continuous improvement capabilities. And finally, advancing organizational capability through leadership and culture aligned to our customers' needs, our business performance, our core values, supporting our communities and environmental priorities. At this time, Ashish will take us through the financial performance. Ashish?

Thank you, Karen. Fourth quarter sales were $123 million, up 7% compared to last year. and up 8% sequentially. Sales to transportation customers increased by 12% versus the fourth quarter of 2019. Sequentially, we were up 17% in sales to transportation customers. Sales to other end markets were essentially flat year over year. We saw solid growth in sales to both the industrial and defense end markets, and softness continued in the medical end market. Our gross margin was 34.7% for the fourth quarter, up 230 basis points compared to last quarter, and up 110 basis points compared to last year. Adjusted EBITDA in the fourth quarter was 21.4%, up 240 basis points sequentially, and up 110 basis points from last year. Fourth quarter 2020 earnings were 46 cents per diluted share. Adjusted earnings per diluted share were 43 cents, compared to $0.37 last year and $0.34 last quarter. For full year 2020, sales were $424 million, down 10% from 2019. Sales to transportation customers declined 19%, and sales to other end markets increased by 7%. Industrial and aerospace and defense end markets sales experienced double-digit growth. Medical and market was soft, with sales down 7%. Our gross margin was 32.8% for the year, down from 33.6% last year. The major driver was lower volume attributable to COVID-19, which was partially offset by temporary and other cost reductions implemented throughout the year. Our focus is to drive improvements, and moved towards the higher end of our target range of 34% to 37% gross margin. In the second half of 2020, we generated $0.05 of EPS in savings from our restructuring program announced in July 2020. Foreign currency rates impacted gross margin favorably in 2020 by approximately $3 million. Based on recent exchange rates, Currency could impact our 2021 gross margin unfavorably by approximately 100 basis points. SG&A and R&D expenses were $92.1 million, or 21.7% of sales for the year. Consistent with prior communication, we expect 2021 operating expenses to be higher as a result of the reinstatement of temporary cost measures. Our 2020 tax rate was 23.7%, we anticipate our 2021 tax rate to be in the range of 23% to 25%, excluding discrete items. This is subject to change due to the impact of any changes that may be introduced by the new U.S. administration. 2020 earnings were $1.06 per diluted share. Adjusted earnings per diluted share were $1.12, compared to $1.45 last year. Now I'll discuss the balance sheet and cash flow. Our controllable working capital as a percentage of sales was 15.5% in the fourth quarter, improved slightly from the third quarter. We have made progress over the last couple of quarters, but still have more work to do. We are balancing improvements in working capital with having some safety stock to minimize risk of supply chain disruptions. CapEx was $14.9 million for the full year, down from $21.7 million in 2019. We continue to manage CapEx carefully given the current environment. In 2021, we are expecting CapEx to be in the range of 4% to 4.5% of sales, the primary focus being on growth-related projects. We finished 2020 with a healthy balance sheet and a strong liquidity position. Our operating cash flow in the quarter was $26 million. For the full year, operating cash flow was $77 million compared to $64 million in 2019. We ended the year with $92 million in cash compared to $100 million in December 2019. In the fourth quarter, we reduced our long-term debt balance to $55 million from $106 million at the end of the third quarter. Our debt to capitalization ratio was at 11.4% at the end of 2020, compared to 19.7% at the end of 2019. 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 flexibility to appropriately deploy capital towards our strategic objectives. We are progressing on our SAP implementation, As we communicated earlier, more than 80% of our revenue comes from sites that are running on SAP. We expect to complete the implementation in the second half of 2021. However, COVID-related restrictions could cause some delays. This concludes our prepared comments. I'd like to open the line for questions at this time.

Thank you. If you would like to ask a question, please signal by pressing star followed by the one on your telephone keypad. If you are using a speaker phone, please make sure your mute function is turned off. Allow your signal to reach our equipment. A voice prompt on the phone line will indicate when your line is open. Once again, that is star one at this time. And we'll go first to Justin Mong for Stevens.

Thanks, and good morning, and congrats on the solid quarter.

Thank you, Justin.

And so maybe to start with a question on the 2021 guidance, I was wondering if you could help us think through the cadence on a quarterly basis of revenue and earnings, if there's any color you can provide there. There are just a lot of swing factors with the macro environment, you know, the restructuring that you've talked about. So just curious if you could give us a little bit more color as we think through updating our models.

Yeah, Justin, maybe not on a quarterly basis, but just in total because we guide it for the year. The way I would look at it is if you look at the lower end of the range, we're still concerned about some pandemic disruptions. We've seen a second wave in the European region. Fortunately, we haven't seen it here yet, but we're concerned that there could be some things there. So far, we haven't seen anything. The second thing is if you get towards the middle of the range, you can see good, healthy, just above single-digit or mid-single-digit growth. Obviously, we're aiming to do a bit better than that with organic growth and acquisitions at the higher end. The other things on our mind are you're hearing in the automotive market with a shortage on semiconductors. We've been monitoring that pretty closely. I would say at this point in time, we see that the number of units has gone up from about 650,000 vehicles impacted to maybe 850,000. Our impact in the first quarter so far is minimal. It's less than maybe half a million in revenue. So we've got those things going on in the background. And as you can imagine, we're also dealing with some supply chain disruptions. This pandemic has hurt the supply base and we've got to make sure we can carefully navigate through that as well.

Okay. And thinking about the first quarter, you mentioned you're off to a strong start. Any kind of directional commentary you could help us out with as we think about first quarter versus the fourth quarter? Do you think sequentially revenue and earnings can be flat to up or any thoughts around that?

Yeah, I would say flat, and it could be plus or minus a little bit, just depending on how things evolve here in February and March.

Okay, very helpful. And last one for me, I wanted to ask about the acquisition pipeline. I know you just closed the deal at the end of the year, but any commentary on the level of activity you're seeing out there, the likelihood that we see another deal here in the near term, and is that something that's baked into this forecast?

Justin, what I would say is obviously this is our, this one recent thing with Sensor Scientific, which we really like for its technical skills and capabilities and market, especially in the medical. It's our second temperature acquisition, so you can tell we've got some strategic plans in this area as we scale the product and the platform globally. Our pipeline, we're active in our pipeline. It's a bit more challenging because of COVID-19. We're not likely to do a deal without being on the ground and seeing everything, but certainly active. We've got a strong balance sheet, and we want to deploy it for the right fit and the right valuation as well.

Makes sense. I'll leave it at that. Thanks for the time.

Thanks, Justin.

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

Yes, good morning, gentlemen. Hi. So for my first question, could you discuss your order bookings on a year-over-year basis? I ask because if you shipped March quarter based on just orders on hand, that would imply sales down kind of mid-teens. I appreciate the full year outlook, but could you just comment again on I guess your order momentum heading into the March quarter?

Yeah, I'll start in the speech if you want to add to it, please. First of all, we reported, I'm taking it that you're looking at the new business winds of 104, and that was a little softer than we normally would have. And let me tell you that we had several OEMs push decisions on the transportation side primarily. We probably had something in the region of 50 million of decisions not made. Let me kind of add a bit of color in that by saying we're off to a good start in January. And we didn't report, if you look at the new business wins, we didn't report it year over year because a year ago we were recording our book business and backlog what we had there. So we just wanted to make sure we're sticking consistently with what we've done in the past. We'd like to get back into... reporting our backlog later this year as we get through the pandemic and things stabilize. But we feel pretty good. That was a little soft in the fourth quarter, but it's not unusual. We've seen it, I think, twice in 2020 where some large OEMs in the transportation sector market just were slow with making decisions, and they're deciding on platforms and what they're going to do. We're not at all panicked about it. We feel like we're on a good trend, and as I said, we're already off to a good start in January, and we've got some really good things working in the pipeline that are promising for our future as well.

Carl, the other thing to keep in mind is the new business awards that you're reporting here are not the short-term purchase orders what you would normally look at as a book-to-bill type of ratio. These are containing long-term contracts that go out two to three years in terms of generating revenue and then giving us revenue for the next four to five years beyond that. So most of these wins that we are reporting are more longer-term in nature. So a fluctuation in any given quarter doesn't really get us too worried. We do want to make sure it stays healthy for the long run.

I appreciate that. For my follow-up question, ASPs are clearly benefiting from some supply chain tightness for discrete and passive devices. And several of your component peers have raised prices quite a bit. which I think should provide a strong umbrella to use against normalized price decline. So in that context, you've also spoken about higher input costs in your prepared remarks. So I guess in that context, how are these dynamics driving your discussions on both pricing and volume commitments with your customers? Thank you.

Carl, I would say, first of all, on the ASP side of it, with our customers, we're not seeing anything significant in terms of that we would have seen in normal years. On the supply side of it, this past year, in 2020, we've actually raised prices with a number of different end markets. We're also seeing, as you pointed out, some semiconductor price increases, and if they happen, we will have discussions with our customers to share the load.

And Carl, to your point, we've seen some commodity price increases as well that we are working with our customers to work through that equation.

Thank you.

We'll go next to John Fransford with Sidoti.

Just on that last comment, Ashish, on commodity pricing, how much are you taking into account for the full year, so if you can be able to pass it completely through? And you also, I think, mentioned something about currency could work against you. I think you said to the tune of 100 basis points. Is that something you think is a near-term impact or later in the year?

John, the 100 basis points on currency that we talked about, it's for the full year based on what we have seen recently in the exchange rates. The biggest impact is from the appreciation of Mexican peso. And to a smaller extent, but also important, is the Taiwanese dollar. Both of those currencies have appreciated quite a bit compared to 2020 averages, and that's what we are talking about. And the commodity pricing is important, but the impact is not quite as large as the currency impact can be.

And, John, I'd like to just reinforce that message that we expect to stay within our gross margin range that we've published out there, too.

Okay. Regarding the guide, the high end is better than you're able to do in 2018 and 2019, but it's also pretty much the run rate of the fourth quarter. When I think about the high end of the revenue guidance, am I thinking that the current transportation outlook is stable and the balances of the business are stable? or are we thinking that maybe there'll be a step down in the transportation market and maybe we'll see a pickup in, well, either aero and industrial since you indicated that medical's first half will be soft?

John, the way we are looking at it is we have been improving our exposure to industrial, defense, medical, those in markets. And, you know, that will... continue to provide, our expectation is that they'll continue to provide good momentum into 2021. And the range, the higher end of the range will be influenced probably more by how the transportation and market performs. And probably on the low side as well, it will be more influenced by the performance in the transportation and markets.

Got it. And regarding your targeted gross margin, can you just talk about the ability to achieve it when you've completed all your cost-saving actions by next year?

Let me make sure I understand your question. Are you asking where the gross margin is expected to be after the completion of the restructuring action?

Yes, sir.

So the range that we talk about, John, is the 34 to 37%. And in my comments, I mentioned that we want to get towards the higher end of that range. And once we get through all the restructuring actions, the timing is getting slightly impacted because of COVID-related small delays and stuff. But our goal is to be towards that higher end of that range.

Okay. Thank you, Shish.

You know, like we talked about, currency, commodities, some of those things can either help us or hurt us depending on how things are going.

Certainly, and I'm sure Kieran's pressing hard on it.

Squeezing.

And as a quick reminder, if you'd like to ask a question, that is star 1 at this time. We'll go next to Hendy Susanto with GoodBelly Plus.

Good morning, Kiran and Ashish, and congratulations on strong Q4 performance. Thank you, Hendy. Kiran, may I ask what products are you excited in 2021? And then could you also talk about your EV exposure in terms of how much exposure you have to pure EVs? And then how much exposure do you have to products that are agnostic when we look at your transportation market segment?

Yeah, Hendi, in terms of the year ahead, the ceramics business has been on a good trend. I think if you remember last year, we had some challenges with the foundry, which the team has been making really good progress on. We've got a lot more. You hear me talking about the front end of the business. We put a lot of emphasis on improving the front end of the business or go to market. So it's not just the products. It's our ability to work with the customers and get new accounts. And we've been making changes in the organization and leadership in those areas too across all of CTS, not just one area. So we see some good things happening there. Good seeds being sown in air and defense. When we look at the automotive side of it, obviously, we're watching the market side of the equation in terms of the rebound and staying robust. We've had a lot of good momentum on passive safety, and that's extending into different regions of the world. We've been good about that short term. A little bit longer term, from an accelerator module, with the increase in autonomous capabilities of cars, we see the braking system becoming more electronic. And that's something we're working on already, but it's unlikely to even have a revenue benefit before 2024, 2025. So those things are going. On the temperature front, we've really been pleased with how we're performing and the acquisition from two years ago had a good growth year last year, continuing to expand into new products and new customers. So they're just some of the things that we see out there as we move forward. And then to your question, On the EV side of it, I keep referencing, I think we said back in 17, 18, we said our exposure to products going away due to EV was probably in the high single digits and would be fully compensated or balanced by about 21, 22. So we're seeing that as a very, very low single digit percentage at this point in time. So not a concern.

Got it. And then Kiran, when we read news about like shortage in automotive semiconductor, how should we relate that to CTS? Earlier you mentioned that CTS exposure to European is less. Like any guideposts on how we should think about the supply chain exposure? short dates in an automotive semiconductor, if it's improved or if it gets worse?

So, Hendi, two things. The first thing is we don't have any supplies ourselves for our products. That's the first thing I'd like to point out. So it's our OEM. So if they're getting the electronics or the semiconductors for their electronic control units and infotainment systems and other things, that's the watch. So we've seen things from General Motors, We've seen things from Ford. We don't have any big exposure with Ford. We've said so far in the first quarter we would see that at this point in time less than half a million impact. So we haven't seen heavy impact. We've seen the number of units impacted from the industry reports go from about 600,000 units to about 850,000 and that's something we're tracking live and you may see the next report before we do but haven't heard anything. We know there's a lot of pressure out there from the OEMs and back to the suppliers in Taiwan and other areas to ramp up production and I'm sure they're really focused on that at this point in time.

And then embedded in your 2021 guidance, you indicated that you expect softness in medical market to continue in the first half of 2021. What is your assumption in that guidance for medical market in the second half? Do you expect a gradual rebound or do you expect a solid rebound?

We would say what we've seen in softness so far is a little bit higher than mid-single digits. we'd expect that to start flattening out in the second half of the year.

Got it, yeah. And then a question for Ashish. Ashish, would you be able to share QTI sales contributions so that we know what kind of growth QTI is having?

Hendi, we haven't disclosed that, but when you look at the run rate that acquisition is delivering, it is strong improvements. And what really we are happy about is that is despite a good portion of their customer base, the restaurants and the food service industry being down last year. So that business has done a good job of getting new customers online to continue providing the growth momentum. And as Karen pointed out, that's what we are looking forward to in 2021 as well.

Okay, yeah. And Ashish, with regard to your tax project, do you have any updates?

So, Hindi, we completed a big portion of it in 2020, and there are some other pieces that we are working on. The challenge on the tax side is the uncertainty with what we might see in terms of changes in the U.S. at this point in time. So we are watching that very, very carefully. And, you know, we'll talk about it once things become a little bit more clear in terms of what impact it could have on us. Okay. Thank you, Ashish. Thank you, Kirwan. Thank you, Andy. Thanks, Andy.

And that concludes today's question and answer session. I'd like to turn today's call back over to Mr. O'Sullivan for any additional or closing remarks.

Great. Thank you, Hannah, and thank you all for your participation on today's call. We look forward to updating you again in April. Be safe. Thank you very much.

And that concludes today's conference. Thank you for your participation. You may now disconnect.