Jon Franzreb - Sidoti & Company:

Good morning. My name is Bailey and I will be your conference operator today. At this time, I would like to welcome everyone to the CTS Corporation Second Quarter 2022 Conference Call. All lines have been placed on mute to prevent background noise. A supplemental slide presentation to accompany the prepared remarks can be found on the company's website. After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] At this time, I would like to turn over the call to Mr. Kieran O'Sullivan, CEO of CTS Corporation. Mr. O'Sullivan, you may begin your conference.

Thanks, Bailey. Good morning and welcome everyone to our second quarter 2022 earnings call. We delivered another strong quarter. In addition, we finalized the acquisition of Ferroperm Piezoceramics at the end of June, further advancing our diversification strategy. I'm excited to have this talented team join CTS, which will allow us to expand our market opportunities and support a broader range of customers. Sales in the second quarter were $145 million, up approximately 12% compared to the second quarter of 2021. Second quarter adjusted gross margin was 36.1%, down 70 basis points from 36.8% in the second quarter of last year. Adjusted EBITDA margin of 22.4% was up 90 basis points from 21.5% in the same period last year. Second quarter adjusted earnings per diluted share of $0.62 were up almost 20% from $0.52 in the second quarter of 2021. As I already mentioned, during the quarter, we completed the Ferroperm acquisition, the acquisition is expected to be accretive in 2023. Ashish 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 defer 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 reconciliation are available in the Investors section of the CTS website. I will now turn the discussion back over to our CEO, Kieran O'Sullivan.

Thank you, Ashish. We had a solid quarter with sales increasing 12% to $145 million versus the second quarter of 2021. Organic sales were up approximately 9% for the quarter. These results underscore our investments in business development as front end sales enabled us to expand our customer base. The TEWA acquisition added $4 million in sales in the quarter and the business is performing well. Demand was solid across medical and industrial markets, while defense was softer. Demand for transportation products was impacted by COVID-19 lockdowns in Asia and some OEM production cuts. Our global team continues to execute well and remains committed to both operational excellence initiatives and achieving our long-term goals. Adjusted gross margin for the second quarter was 36.1%, down 70 basis points from 36.8% for the same period last year. We are operating in a very dynamic environment as we continue to be impacted by rising commodity prices, supply chain headwinds and other macro challenges, which are likely to further pressure margins. However, we continue to partner with our customers to offset or share cost increases, and we expect freight costs to improve in the quarters ahead as Trans-Pacific container volumes to the U.S. return to more normalized pre-pandemic levels. Operationally, we are seeing savings materialize from our restructuring activities. As we move forward, we will continue to evaluate and refine our footprint to optimize our ability to serve our customers, while also enabling us to deliver improved operating leverage. We are also continuing to gain traction with our CTS operating system with over 90 continuous improvement projects driving incremental performance. Adjusted EBITDA margin was 22.4%, up 90 basis points from 21.5% in the second quarter of 2021. Second quarter adjusted earnings per share of $0.62 were up almost 20% from $0.52 in the same…

Thank you, Kieran. Second quarter sales were $145 million, up 11.9% compared to the second quarter of 2021 and down 2% sequentially from the first quarter of 2022. Foreign currency exchange rates impacted revenue unfavorably by approximately $2.2 million. Sales to non-transportation end markets increased 21.1% year-over-year, supported by another quarter of double digit growth in the industrial and medical end markets. Excluding sales from TEWA acquisition, sales to non-transportation end markets were up 14.1% year-over-year. Sales to transportation customers increased 4.4% compared to the second quarter of 2021. We have continued to see momentum in our smart actuator products, which primarily go into commercial vehicle applications. Sales to the transportation end market decreased 5.6% sequentially due to lower market volumes caused by supply constraints and COVID-related shutdowns. Our adjusted gross margin was 36.1% in the quarter, down 70 basis points compared to the second quarter of 2021 and down 110 basis points compared to the first quarter of 2022. Inflationary factors and supply chain headwinds pressured margins during the quarter, which we were able to partially offset through pricing and operational improvements across our organization. Foreign currency exchange rates also impacted gross margin unfavorably by approximately 0.5 percentage point. We have realized $0.19 of savings to date from our previously announced restructuring program. As previously communicated, we are on target to achieve the lower end of the $0.22 to $0.26 of savings. However, some of these projects will extend into 2023 as we balance growth with the completion of the projects. We reported earnings of $0.39 per diluted share for the second quarter. Adjusted earnings for the second quarter were $0.62 per diluted share compared to $0.52 per diluted share for the same period last year and $0.67 per diluted share in the prior quarter. Moving on to cash…

To start, I wanted to ask about the updated guidance. Is there any way you could ballpark how much of the increase was driven by the acquisition versus upside in the business from an organic basis?

So Justin, in terms of sales, we have talked about the acquisition delivering in the low to mid $20 million range. So, that'll give you a rough idea of how much to expect in second half of the year, $10 million, $11 million is how we are thinking about it. And the EPS, we are not counting on much accretion at this point. Most of it we are expecting in 2023.

Got it. So that EPS raise at the midpoint I think was around $0.15. Is there a little bit more color you can provide on the key drivers to that upside?

So the biggest one is our continued improved confidence in the revenue expectation from our core business. And we have also been continuing to work on offsetting the cost pressures with pricing and operational improvements like we talked about. So those are what are contributing to our improved confidence around the EPS numbers.

Got it. And last one on the guidance. Looking at the implied EPS guidance for the second half of the year, is there anything you can share on your expectation for the quarterly cadence of EPS? Do you feel like it will be relatively even in 3Q and 4Q or is there anything or any reason to expect one quarter to be stronger than the other?

I think the best way to answer that is, as we see at the moment, we are off to a reasonable start in Q3. We don't have the same level of visibility yet into Q4 is probably the best way to answer that, Justin.

Okay. Got it. And last question for me. Obviously, there are a lot more headlines around the economy and economic concerns. If I kind of reflect back on when the pandemic initially hit in 2020, I felt like you moved pretty quickly to adjust the cost structure lower. If some of the recession headlines become a reality, can you talk about how quickly you can adjust the cost structure moving into next year? And maybe just from a high level, I'm curious what kind of economic environment you're planning for as we look into 2023?

So Justin, two points in that. And in our prepared remarks, we said, we expect some softness in the second half of the year. Obviously, the degree of that is not clear yet. And if you look back to the COVID period when we had to respond to a pretty down market where we saw huge drops even in transportation, we remain positive. We adapted our cost structure pretty much within a quarter and had things moving. And we tried to do that very thoughtfully, so that we're improving the long-term prospects of the business as well.

The next question today comes from the line of Jon Franzreb from Sidoti.

I want to start with, you had previously voiced some concerns about supply chain issues, really calling it a whack-a-mole kind of a situation? Can you give us update of the supply chain issues facing the company? Are they behind you at this point? Any kind of color would be appreciated.

Yes, Jon, I would say for the most part in the non-transportation markets, we're doing pretty well. That doesn't mean we don't have issues but we're still managing through that pretty well. On the transportation side, it has improved and is improving. And we still have one or two watches on the semiconductor side. But several have improved. So we expect a little better second half. I think more of our concern in transportation as we look forward beyond supply chain is just where the consumer is with inflation and will that bring any softness to demand as well.

And regarding Ferroperm, can you talk a little bit about that the piezo technology that they bought? Is it materially different than what you were doing? Or is it a scenario where you just access to new markets and new customers was the bigger driver of the acquisition?

The technology Jon is very similar to what we're doing at the moment. But it allows us to scale with new products and new customers. As an example, we said therapeutics, so we're in the pacemakers. We're into skin care, other applications in that area. But we really like it. And it also gives us capability in industrial applications and aerospace and defense for high temp applications.

Jon, they have a good technology team. They have good powder formulations, which will add to our portfolio of ceramic compounds that we can offer that are suitable for different applications. So that's really what we gain out of the acquisition in addition to depth in the European markets.

And Jon, we expect it to help us penetrate the defense markets in Europe even more.

Right. So when you talk about the potential of non-transportation related businesses potentially being above the 50% threshold -- and I'm looking at temperature sensing portfolio versus piezo portfolio, which would be the most significant driver of reaching that kind of a threshold of greater than 50%?

Jon, both product areas are pretty important to us and we're moving on in several end markets with each of those. And I'd tell you, if we look today, we're probably closer to a 48-52 split, so that's before Ferroperm. So we see ourselves crossing that bridge in the future.

Got it. And just one last here. I think, Kieran, I heard you say that the inventory levels at the customer level is close to equilibrium now. Is that the case? There's no inventory stocking going on, and people are worried about supply chain issues that you need to worry about?

Jon when I was talking about inventory, it was more for the distribution side of the business, which is now approximately 10% of our sales, and just saying it's getting back to more normal levels.

And if you look at it on a broader sense, the balance of the -- your customer base, are they inventory equilibrium?

Transportation side, we're not seeing any inventory issues and in the other markets we're doing pretty well. No big issues to flag at this point in time.

Your next question today comes from the line of Joshua Buchalter from Cowen.

I wanted to follow-up on some of Justin's questions from earlier. The guidance sort of implies a flat second half versus the first half despite tailwind from Ferroperm and TEWA. I understand you pointed us to some weakness. But could you walk us through some of the assumptions that are baked into the guidance? In particular I'm asking because bookings were again above 170 million this quarter. So it doesn't seem like you're seeing a material slowdown in demand yet, but I was wondering where you're taking potentially more conservative approach? Thank you.

Yes. Josh, there are several parts to your question. First of all, the bookings, Kieran pointed out in his call that a lot of the strength in the booking compared to the first quarter came from the transportation market where we don't recognize sales from those bookings for a period of time, typically two to three years. The demand environment, we are expecting stable compared to Q2, Q1 for the transportation with potential to increase. But again, there's that question mark of does the consumer demand start softening because of higher interest rates? And in the rest of the end markets, we are concerned about potential softening as we go towards the end of the year. So that's sort of the backdrop that we are looking at in terms of end market dynamics.

And then on the inventory line on books picked up sequentially. But you also closed Ferroperm on June 30th, I believe. Is there a way to back out how much of the inventory increase was due to just closing the deal and the inventory step up versus what happened organically with prior CTS? Thank you.

Yes, so our working capital would be about 1.5 points lower without the Ferroperm acquisition.

Got it. Thank you. Last one for me. I saw in the deck you called out a target of greater than 25% of transport from EVs in 2025. And then longer term the -- I guess it was like 25% of your SAM being from EV. Is there any benchmarks we can view as to how that business is tracking today for some of the applications like current sensors and eBrakes or is that more of a second half of a decade before it becomes material? Thanks and congrats again.

Great. Thanks. Just on that question, well, some of the wins in EV and some of the growth in EV today is from legacy product. And we mentioned in the prepared remarks that on the EV side our first wins on new product, so with current sensing where we have had two wins. So you are going to see that grow incrementally. And obviously past 2025, we'd expect that to accelerate.

On the eBrake product, Josh, we would expect revenue only in the second half of the decade beyond 2025.

[Operator Instructions]. The next question today comes from Hendi Susanto from Gabelli Fund. Please go ahead. Your line is now open.

Yes. My first question is on Ferroperm. I think you indicated that accretion will be in 2023. May I inquire like how much operating expense dollars come from Ferroperm, let's say, in the second half for '22? And given your comment that accretions will be in 2023, does that imply that the operating profitability is somewhat comparable to your corporate CTS level?

So Hendi, in the initial period of the acquisition, we will be incurring some incremental expenses. So, without going into the details of operating expense levels, the overall profitability of the business will be accretive to CTS. So the gross margins will help us from a mix standpoint. And as we work through the initial integration period, then that's when we start expecting accretion as we get towards the end of this year, early next year.

And Hendi, the quality of the earnings is something we like about the business.

Okay. And then I think on the more optimism or more optimistic side, may I know what the top end of the sales guidance imply, Kieran?

So on the high end, we would be looking at either no softening in the other end markets to maybe very marginal softening, and transportation remaining strong to slightly growing. And you could take the inverse of that on the lower end, where the markets on the other -- non-transportation side are softening as we expect and transportation is stable. So that's kind of how we are thinking about the guidance range.

And then, with regard to the goal of like more than 25% of revenue in light vehicle sensors come from EV, should we expect the EV customer base by 2025 represents your existing customer base? Or should we expect it may look different than your legacy customer base, Kieran?

It will have some legacy, but also some new customers. And actually we have been adding some new customers in that space already, Hendi. So it'll definitely change.

Thank you. There are no additional questions waiting at this time. Mr. O'Sullivan, I turn the call back over to you.

Thanks, Bailey. And thank you again for joining us today. I also want to thank our global teams for their dedicated efforts in driving strong execution and operational efficiency. I'm confident that our diversification strategy, bolstered by our recent M&A activities and the breadth of our geographic footprint, will position us for profitable growth while navigating the macro uncertainty we all face. I'd like to reiterate that CTS is well positioned for future growth. We have a strong team aligned around common goals that continues to advance the business for long-term value creation for our shareholders. Thank you. This concludes our call.

Thank you for your participation. You may now disconnect your lines.