Hello, everyone, and welcome to the CTS Q3 2022 Earnings Call. My name is Seb, and I will be the operator for your call today. [Operator Instructions] I would now hand the floor over to Kieran O'Sullivan, CEO to begin. Please go ahead.

Thanks, Seb. Good morning, and welcome, everyone to our third quarter 2022 earnings call. We delivered another strong quarter and reported solid financial results that were propelled forward by our strategic focus on diversification. Sales in the third quarter were a $152 million, up approximately 24% compared to the third quarter of 2021. Third quarter adjusted gross margin was 36.6%, down 70 basis points from 37.3% in the third quarter of last year. Adjusted EBITDA margin of 22.3% was up 60 basis points from 21.7% in the same period in 2021. Third quarter adjusted earnings per diluted share of $0.62 were up 34% from $0.46 in the third quarter of 2021. Non-transportation sales accounted for approximately 48% of our overall revenue as we continue to advance our diversification strategy. Electrification progress was solid as we added six EV platform wins in the quarter and expanded our total available market with new electrification products. Last quarter, we completed the Ferroperm acquisition. The business is performing well with the work in progress to consolidate the two facilities in Denmark. We are already seeing potential customer wins in North America using Ferroperm proprietary material formulations. We expect the acquisition 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 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.

Thank you, Ashish. We achieved strong results this quarter with sales increasing 24% to $152 million versus the third quarter of 2021. Organic sales growth was 17%. Our recent acquisitions TEWA and Ferroperm added nearly $9 million in sales during the quarter, and the businesses are performing well. Demand was solid across medical and defense markets with mixed demand across the industrial market, where we saw softness in consumer facing products linked to computing and entertainment, which make up a smaller part of our portfolio. We also saw a slowdown in pool and spa for temperature sensing products. The demand for transportation products was robust despite semiconductor supply issues that continued to be a challenge primarily with one supplier. Our global team continues to execute well and remains committed to go to operational excellence initiatives and achieving our long-term goals. Adjusted gross margin for the third quarter was 36.6%, down 70 basis points from 37.3% for the same period last year. We continue to operate in a very dynamic environment as we are impacted by commodity prices, supply chain headwinds, and other macro challenges, which are pressuring margins. In addition, we are now seeing increasing energy costs for our facilities, which is especially evident in our European locations. We continue to partner with our customers to offset our share cost increases. We are moving forward to consolidate our two Denmark locations, and we expect the process to be substantially completed by the end of June, 2023. We are also gaining momentum with our CTS operating system, which continues with continuous improvement projects supporting margin performance. Adjusted EBITDA margin was 22.3%, up 60 basis points from 21.7% in the third quarter of 2021. Third quarter adjusted earnings per diluted share of $0.62 were up almost 34% from $0.46 in the same…

Thank you, Kieran. Third quarter sales were $152 million, up 24% compared to the third quarter of 2021, and up 5% sequentially from the second quarter of 2022. Foreign currency exchange rates impacted revenue unfavorably by approximately $4.1 million in the quarter as the euro and Chinese renminbi depreciated versus the U.S. dollar. Most of this impact was related to sales in the transportation market. Sales to non-transportation end-markets increased 22.5% year-over-year, supported by another quarter of double-digit growth in the industrial and medical end-markets. Our two acquisitions added $8.6 million in sales during the quarter. Sales to transportation customers increased 25.7% compared to the third quarter of 2021 and increased 4.9% sequentially driven by the robustness in demand, which Kieran mentioned. Our adjusted gross margin was 36.6% in the third quarter, down 70 basis points compared to the third quarter of 2021 and up 50 basis points compared to the second quarter of 2022. Ongoing commodity inflation and supply chain headwinds pressured margins during the quarter. We are also seeing increases in energy and labor costs. We have been able to partially mitigate these impacts through pricing and operational improvements across our organization. Due to the significant movement in exchange rates, we saw an unfavorable impact of slightly more than a $1 million on gross margin. We have realized $0.19 of savings to date from our 2020 restructuring program. As previously communicated, we still expect to achieve the lower end of the $0.22 to $0.26 of savings by 2023 as we balanced growth with the completion of some of the restructuring projects. We reported earnings of $0.37 per diluted share in the third quarter. Adjusted earnings for the third quarter were $0.62 per diluted share compared to $0.46 per diluted share at the same time last year, and $0.62…

Thank you. [Operator Instructions] Our first question comes from Joshua Buchalter from Cowen. Please go ahead.

Hey, guys. Thanks for taking my question and congrats on the solid results. The guidance implies a sequential decline in the fourth quarter and totally recognized the prudent conservatism in much of your commentary. But anything you can share on expectations by end-market, in particular auto reaccelerated in the third quarter. So I'm wondering is that – do you feel that's related directly to end-demand or is it more – GM called out completing some vehicles that have been partially completed on lots last quarter. Is it sort of that dynamic or do you feel like you're shipping to end-demand more comfortably? Thank you.

Hey, Joshua. Good morning, and thanks for your question. A few things, obviously, we had a strong third quarter, but in my prepared comments, I mentioned that we're having challenges with a semiconductor supplier impacting our commercial vehicle volumes. And that's something that's going to impact this temporarily both in the fourth quarter and the first quarter of next year and then should be corrected. So that's mid single-digit in value we would think. And then we're just watching the softness in the industrial market. We've seen some strength and some softness and trying to balance that out. So other end-markets are seen to be doing well.

Thank you for that. And then, I know you mentioned a bunch of inflationary cost pressures, but your margins were still hung in pretty nicely. Any changes to, I guess, your ability to pass-on costs – rising input costs to customers or any – really tone changes at your customers that we should be aware of in light of what's objectively some weakening macro data points and softer industrial demand? Thanks, and congrats on the results again.

Josh, the pricing environment we have talked about in the past, it's always a tough discussion. The first round is tough. The second round is tougher by far. That's what we are seeing. We continue having those discussions. We are able to get some pricing, obviously not enough to offset all of our cost increases, but we are finding a reasonable balance of sharing that burden between us and our customers and maintaining long-term relationships. No significant change to that environment, but as you pointed out, as the macroeconomic situation gets more challenging, it is possible that we might start facing some of those pressures and we are keeping a very close eye on that. Our goal will be to also obtain material cost savings to help balance that equation. So I would look at those as mutually going together in terms of price pressures and material cost improvements.

And Joshua, just one point to add, we’ve got a long way to go on the material deflation from where we were two years ago, so it's still quite a bit of pressure we're carrying.

Thank you. Then if I could squeeze one more in. Ashish, towards the end of the prepared remarks, you mentioned, you're sort of taking a close look at inventory, levels have been roughly stable in the last several quarters, but is roughly in the 50, 60 days range, sort of where you feel comfortable and where you'll be managing the business in the next several quarters in this environment? Thank you.

Yes. I mean, the inventory levels have gone up and we are managing that. Our biggest concern is that if there is a slower demand environment, we don't want to be sitting on a lot of excess inventory and we are continuing to manage that throughout our supply chain, also keeping track of inventory levels at our customers and at our suppliers. So not a huge area of concern, we just don't want to be sitting on a lot of excess inventory, if we go into a slower environment.

Got it. Thanks, Ashish. Thanks, Kieran.

Thank you.

Our next question comes from John Franzreb from Sidoti. Please go ahead.

Good morning, guys, and thanks for taking the questions. Kieran, I want to start with something you said in the beginning of your prepared remarks about energy costs in Europe. Could you talk a little bit about how that's maybe kind of being embedded into your guidance right now for the fourth quarter versus how you're thinking about it a quarter-ago and maybe how we should be thinking about it into the first quarter also?

John, I would say, the materiality of it currently is on the lower end. Really it's more of an issue going into next year's where we see the bigger challenge on that with our operations in Czech Republic, Denmark and some other areas as well, but more of an issue going into next year than this year. Some impact, but not the more significant issues next year.

Okay. And you talk a little bit about the goal to hit 25% of sales in the EV market. I'm curious, as you're starting to see this transition materialize become a greater part of your revenue profile, are you seeing increased dollar content on EV vehicles versus ICE, or are you seeing better margin profile or neither?

I would say, John, as we – with EV, we see an opportunity to increase the content. I mentioned in the prepared remarks that we had been funded for a pre-development of an eBrake product, so that's obviously not a production win yet, but doing the engineering work on this, and that's a market of maybe some $600 million, $700 million. So being a player in that market is going to add content significantly for us going forward, but we've got to turn that pre-development into a win to get that content there. And we like the new EV products that we're bringing to the market, they've got – we've got to be competitive of course, but we don't see it, changing our profile dramatically.

Got it. And I might have missed this, but what was the transportation sales as a percent of the total volume in the third quarter?

Ashish?

It would be approximately 52%.

Okay. So it's kind of flat compared to the previous quarter. All right, and one last thing, you talked about the opportunity cost of chips being about 3 million to 4 million units. I'm guessing you're thinking that that's the North American number. Are you putting that as the global number and what's your best guess, Kieran, of when that kind of eases out?

Yes. John, the chip number is probably more of a global number, and I think it ranges somewhere from [3 million to about 4.2 million or 4.3 million] this year. That'll be the final kind of trend rate it's going. And so we see that improving as we go into the next year, but probably still a challenge through the first quarter because I did highlight again, on the commercial vehicle front, we have a supply issue there that impacts us in the fourth and first quarter of the next two quarters.

Okay. And then [indiscernible] I just squeeze one more in. Regarding, Ashish, the 2020 restructuring program that you've gotten $0.19 from year-to-date. The timing of – [realize] the balance of that savings to 22 to 26 albeit at the low end. Is that going to be first half to 2023, second half to 2023 mid? What are your thoughts there?

John, we are really looking at the demand environment in terms of how quickly we can move. So if things are a little bit softer in the first part of 2023, then I would expect us to move more quickly. If the demand environment continues to remain robust, then it might slip a little bit later on, but I would expect by Q3 timeframe, we should be done with those transitions that we were targeting as part of the 2020 plan.

Okay. Thanks, guys. I appreciate you taking my questions.

Thanks, John.

Thank you, John.

Our next question is from Justin Long of Stephens. Please go ahead.

Yes. Good morning, everyone. This is Brady on for Justin. I know there's a lot of cross-currents and some uncertainties in the macro environment right now, but if you were to kind of look across your end-markets and think about the outlook for 2023, what do you kind of see as the up arrows and the down arrows at this point in time?

Yes. We feel good about medical. We feel good about certain parts of industrial and aero and defense is trending in a good direction, but it's probably at a slower pace. And then on the transportation side, it's pretty mixed where we – I said in my prepared remarks that we see it flattening a little bit. There have been supply chain issues that I mentioned already, but it's really – we see that more of an issue with the consumer than supply chain longer term in 2023 with the higher interest rates. And we think that's going to be a bit more challenging. Flat to up single digits would be very good.

Okay. Awesome. And then maybe if I could just get one follow-up in here. Could you talk a little bit about the level of activity in the acquisition pipeline versus a quarter ago? Have you seen any easing of valuation multiples given the uncertain macro environment?

Well, we're actively working the pipeline. We've got a strong balance sheet, that's a key part of our growth trajectory as well as organic growth. We haven't seen a softening in multiples, but we would expect a softening in multiples going forward.

Okay. That's helpful. Thanks guys.

Thank you.

Thank you.

Our next question comes from Hendi Susanto from Gabelli Funds. Hendi, please go ahead.

Good morning, Kieran and Ashish.

Good morning, Hendi.

Hi, Hendi.

First question. So Kieran, how much visibility and ability to adjust when it comes to managing softness in industrials and potentially significant improvement in the supply chain constraint in automotive after Q1 next year? I think what I would like to know is, in industrials, I think there are some inventories in the channels and then there are also like end customer demands and then the two may not move in – at the same levels, let's say. So I'm wondering like, how much visibility and then how you can adjust one way or another?

Yes, Hendi. As I mentioned, we've seen some increasing inventories in certain parts of industrial and distribution as well. And on the transportation side, inventory levels continue to be low. We haven't seen big problems in medical or arrow and defense at this point in time. And then in terms of adjusting, I would say two things. Number one, when we were hit by COVID back in 2020 and our automotive volumes went down by about 50%, we were able to flex pretty quickly and still maintain a profitable trajectory for the company. And I think, you know, that we're pretty disciplined management team. We would have scenarios already prepared for how we would respond to a dip of 10% or greater in the market. So just expect us to be disciplined on that as we go forward.

Okay. I see. And then how much visibility, Kieran in terms of, let's say, like how many weeks you have visibility toward customer demand and fulfillment?

It varies across the different customers and the different applications, but it varies from several weeks up to three months. But you always got to be careful in this type of environment where the demand corrections happen and demand gets pushed out. We haven't seen much of that, but it's something that we're concerned about and watching.

I see. And then second question for Ashish. Ashish, would you be able to share the breakdown of revenue contribution from TEWA and then Ferroperm?

Hendi, let me take a look at that and I'll come back to you. Obviously, the contribution from Ferroperm is larger. I'm expecting it's in the $5 million to $6 million range and the balance coming from TEWA, but I can get back to you on the more precise numbers.

I see. Yes. And then last question for me. If I look at CapEx, I'm wondering whether CapEx will be backend-loaded in Q4 considering that you have spent like $9.3 million in the first nine months, and I believe that CapEx will be higher than that, let's say like a normalized run rate?

Yes. So from a cash flow standpoint, there are a couple of things. The Q4 CapEx will – is expected to be slightly higher Hendi, and I'm wording it that way because we generally say we will spend and then we don't end up spending quite that much because generally the business leaders are very prudent about their CapEx spending. The other thing to watch for, which I mentioned in the prepared remarks also is, the cash that we got back from the pension plan, we will be paying $7 million out of that for excise taxes. So that'll also unfavorably impact the fourth quarter cash flow.

That's very helpful. Thank you so much, Ashish. Thank you, Kieran.

Thanks, Hendi.

[Operator Instructions] We have no further questions on the call, so I will hand the floor back to Kieran.

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

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