CTS Corporation (CTS) on Q2 2021 Results - Earnings Call Transcript
Operator: Good day, and welcome to the CTS Corporation Second Quarter 2021 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Kieran O’Sullivan. Please go ahead, sir.
Kieran O’Sullivan: Thank you, . Good morning. Thank you for joining us today, and welcome to CTS’ Second Quarter 2021 conference call. Sales in the second quarter were $129.6 million, up 54% compared to the same period in 2020. Customer demand remains robust, while supply challenges persist, especially for automotive products. Second quarter gross margin was 36.8%, up 525 basis points from 31.6% in the second quarter of 2020. Though improved, gross margin performance continues to be impacted by semiconductor and commodity price increases as well as increased logistics costs. EBITDA margin of 21.5% was up 480 basis points from 16.7% in the same period last year.
Ashish Agrawal: 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.
Kieran O’Sullivan: Thanks, Ashish. In the second quarter, our sales were $129.6 million, up 54% from the second quarter of 2020. Excluding sales from the acquisition of Sensor Scientific, sales were up 52% organically. The SSI acquisition continues to deliver solid growth. As I referenced in our last earnings call, we expected the transportation sales run rate to be slightly lower than our first quarter 2021 performance due to ongoing supply challenges. Our teams work creatively and diligently to secure parts, approve substitutions and adapt with speed to support our customers. Transportation sales, while up 88% from the same period last year, would have been stronger by a few million dollars if we did not have these supply challenges. We expect the supply challenges and some customer shutdowns to persist in the second half. New business awards were $174 million for the quarter, up from $105 million in the same period last year. We added three new customers in the quarter; two in transportation and one in telecom. In Asia, we added a new transportation customer in China for a large platform that will ship in the 2023 timeframe. Across the accelerator modules, we had wins with two existing customers in China, secured awards with two Japanese OEMs for the North American market and added a new electric vehicle customer in Europe.
Ashish Agrawal: Thank you, Kieran. Second quarter sales were $129.6 million, up 54% compared to the second quarter of 2020 and up 1% sequentially from the first quarter. Sales to transportation customers bounced back 88% compared with the pandemic-driven lows in the second quarter of 2020. However, we were down 6% sequentially as we saw the impact of supply challenges on global production volumes. Sales to other end markets increased 26% year-over-year and were up 10% sequentially. We had another quarter of solid year-over-year double-digit growth in the industrial as well as aerospace and defense end markets. Sales to the transportation end market represented 55% of our total revenue. This reflects progress towards our strategic goal to further diversify our business by growth in the industrial, medical as well as aerospace and defense end markets. Our two temperature sensing acquisitions have performed well and had strong top-line growth in the second quarter. Changes in foreign exchange rates impacted our revenue favorably by approximately $2.7 million. Our gross margin was 36.8% in the second quarter, up 525 basis points compared to the second quarter of 2020 and up 360 basis points sequentially from the first quarter of 2021. These improvements reflect the progress in operational efficiency in our foundry operations over the last 12 months as well as improvements in other parts of our business. We also benefited from a larger portion of our revenue coming from the industrial, medical and aerospace and defense end markets. Raw material price increases, as well as freight costs, continue to impact us unfavorably, and we are working closely with our customer base to offset or share these cost increases. In the last quarter, we generated $0.03 of EPS in savings from our restructuring program announced in the third quarter of 2020, bringing the total savings to $0.12 of EPS so far. As we mentioned back in April, the timing of some of our projects is being impacted due to the ongoing impact of COVID-19 on travel as well as an increase in demand. We are still on track to achieve the targeted annualized savings of $0.22 to $0.26 by the end of 2022. SG&A and R&D expenses were $27 million or 21% for the second quarter. Operating expenses increased primarily as a result of reinstating cost cuts made during the pandemic to offset the impact of revenue declines and higher incentive compensation expenses. In the second quarter, we recorded a noncash charge of $20.1 million related to the termination of the U.S. pension plan. We are expecting the remaining noncash charge of approximately $101 million to be booked in the third quarter when we complete the settlement process. As a reminder, these are noncash charges and the U.S. pension plan is expected to be overfunded at settlement.
Operator: We will now take our first question. Please go ahead, caller, your line is open.
Unidentified Analyst: Maybe I’ll start with one on the guidance. So if I look at the midpoint of the updated revenue guidance, it was up about 4%. The midpoint of the EPS guidance was up 18%. Can you just help us understand how your assumptions have changed from a margin perspective, along with any tailwinds below the line that can just help us bridge that gap between the revenue upside and the EPS upside?
Kieran O’Sullivan: Yes, Justin, I’ll start with the revenue side of it, and Ashish can address the margin. If you look at it, you can see that we’re being a little cautious in the second half of the year. The supply situation has been very challenging. We did -- the team did a great job here in the second quarter where we faced an uphill battle on many parts, and we made a lot of progress. And to give you a sense of that, I’m on escalation calls on a regular basis here with our suppliers. If you take the second half of the year, we’re probably looking at a $10 million to $15 million risk per quarter in the revenue side of it. Now I will tell you, we are doing everything possible to get parts. And if you talked to us earlier in Q2, we would have been in a tougher situation, and we met a lot of progress, but it’s still pretty challenging out there. And what we’re seeing from some of the OEM customers is extending some shutdowns in certain areas as well, along with the summer month shutdowns. So that’s on the top-line. Ashish?
Ashish Agrawal: Justin, on the profit side, you’ll see that the gross margin and the EBITDA performance in the second quarter was considerably stronger than the first quarter. We are gaining more confidence in the operating efficiency in our operations. And we have been working hard on that for the last 12-plus months as we have updated you guys every quarter. So that is built into it. We are actually being cautious, as Kieran mentioned, on the revenue. So the same level of profitability may not continue in the second half, just as the volumes come down. And we still have the pressure from commodity pricing, freight costs, although some of it, as we’ve talked about, we are passing on to our customers. And so it’s a mix of all that, that is giving us a little bit more confidence on the earnings for the second half.
Justin Long : Okay. That’s helpful. And Kieran, following up on what you said about the $10 million to $15 million revenue risk in the second half. Is most of that in the transportation segment? Or is a component of that within the non-transportation end markets. Maybe you could just give us a rough split on that?
Kieran O’Sullivan: Yes, Justin, absolutely. Nearly all of it’s in the transportation segment. The other areas of the business had some small challenges, but we overcame those. It’s really the transportation side.
Justin Long : Okay. And then, Ashish, maybe a quick one for you on the share repurchase authorization. Anything on the timing of executing on this plan that you could share? And maybe you could clarify if this is baked into the updated 2021 guidance as well. So Justin, the one thing that I’d like to point out that Kieran mentioned, our biggest priority in capital deployment is on organic and the right inorganic activities. The share buyback program was authorized by the board in the second quarter. The primary purpose is not to significantly reduce the shares outstanding. It’s more from an opportunistic as well as a maintenance sort of buyback. So we’ll periodically do stuff, but I don’t think it will have a massive impact on our earnings per share in the second half.
Operator: We will now take our next question. Please say your name and company before posing your questions.
John Franzreb: It’s John Franzreb from Sidoti. I guess I want to start with some of the input costs that you expect in the second half. Is there any meaningfully different costs than you expect in the second half from the first half? Or are you dealing with the exact same issues?
Ashish Agrawal: John, the issues are the same. The magnitude has actually increased. We saw inflation. We talked about roughly $1.6 million impact. And that number has gone up slightly and freight costs also continue to impact us unfavorably. And as we discussed earlier in the year, we are actively working with our customers to pass on some of those cost increases, and we are getting traction in many cases, some more than others, obviously. But we are working closely to balance that out to the extent possible.
John Franzreb: Okay, and --
Ashish Agrawal: Our indication, John, is that the cost increases will continue impacting us in the second half.
John Franzreb: Okay. So -- and recovering these costs, are these the price increases or surcharges?
Ashish Agrawal: We’ve gone with price increases in most of the cases, John. We are We are also evaluating where it makes sense to do surcharges. Freight costs would be a good example of that. But in our case, it’s mostly through price increases at the moment.
Kieran O’Sullivan: And John, just to add to that, I mean, the main challenges across the supply base are on semiconductors and also on residences, and then there’s some other areas, too. So those tow really standout has been the biggest challenge.
John Franzreb: Rising steel costs, a big supply issue? There was a doubt that that was only a Texas issue and that’s kind of gone away for the most part, no?
Ashish Agrawal: Yes. I understand the Texas piece, but there’s other components or materials to go into it like some glass substrates and other things. And I would tell you, the inflation there is not just double digit. It’s high.
John Franzreb: Okay. And Kieran, you actually said something in your prepared comments, you -- concerns about inventory buildup. Where are your concerns? What market are you seeing that in?
Kieran O’Sullivan: Yes, John, just to be clear, my comment was we are not seeing signs so far of any inventory buildup, but we remain a bit cautious. We’re watching that, checking that, but we haven’t seen any yet.
John Franzreb: Okay. Okay. My misunderstanding. All right. And you have automotive customer confirmations through 2022, and it sound like class commercial vehicle construction through the first half of 2022, at least as far as visibility. How is that different than in prior years?
Kieran O’Sullivan: Normally, we would -- while we have long-term contracts, the POS would extend for a few months as we go forward on the transportation side. So some of our customers there have come and said, hey, we want to book out through the first half or the end of 2022 in transportation and in some other areas as well, John. So it’s a much longer -- it’s a firm commitment on the parts.
Ashish Agrawal: And John, that does not apply to all customers. And there’s a few customers that have done that more to ensure that we can provide more clarity on the supply chain continuity there.
John Franzreb: And does that encompass the price increases that you’re talking about? Is that kind of factored into those longer term agreements?
Kieran O’Sullivan: It’s a mix, John. Some of the pricing terms are for this year. Next year is kind of probably going to get reevaluated as well.
John Franzreb: Okay. And one last question, I’ll get back into queue. You talked about the higher SG&A as other deferred costs come back. Is there anything else in that $20.7 million number? That’s kind of how I backed it out in the quarter? Or is that a good go-forward kind of a run rate for the balance, not only this year but through 2022? Or will there be changes from other restructuring items?
Ashish Agrawal: John, we normally don’t guide at that level, but the 20.7% should be a reasonably good representation of where our cost base is right now. And as we go forward, we’ll give more updates on that as we generally don’t guide on the SG&A, but we’ll obviously talk about it as we publish our actual results.
John Franzreb: Okay. But, I’ll re-phrase the question, are there any other restructuring actions that have yet to happen that are going to lower the SG&A number going forward?
Ashish Agrawal: The restructuring costs that we are working on -- or the savings, sorry, are more associated at this point with the gross margin side. There will be some impact on overall operating expenses as well, but the larger portion of the remaining will come out from the gross margin numbers.
Operator: We will now take our next question. Please state your name and company before posing your questions.
Unidentified Analyst: Hello, guys. This is for Karl Ackerman from Cowen. Congrats on the quarter and -- So last quarter, you indicated 18% of order backlog was tied to electric vehicles. While you have previously said, you are agnostic between electric vehicles and gas powered. Would you -- my question is, would you receive a price premium or margin uplift from your EV products? And I have another question, please.
Kieran O’Sullivan: So just on the EV side of it, for pure transportation awards, it’s -- the automotive market is tough. It’s always been difficult. And you got to win it and you’ve got to be reducing costs and good quality. So I wouldn’t say a huge difference at all.
Unidentified Analyst: Okay. All right. And you talked about commercial vehicle builds staying strong into the first half of next year. Maybe just discuss what assumptions you have for commercial vehicles and light vehicles unit growth for Q3? Any color would be helpful.
Kieran O’Sullivan: Just -- I’ll probably take the part of your question for next year. Obviously, we read some industry reports out there on the forecast and where the volumes are at. The biggest headwind there is just component supply. But where we’re going from that is just what we’re hearing from our customers and what we can secure in parts in terms of supporting that as well.
Operator: We will now take our next question. Please state your name and company before posing. Please go ahead.
Hendi Susanto: Hendi Susanto, Gabelli Funds. Kieran, I’m wondering whether you are -- whether you can give us some insight on customer behaviors. At some point, given the supply shortage, the customer will start building up their inventory of components. I mean this applies to your customers as well. So what kind of track or path are we expecting going forward? Like, okay, currently, there’s a supply chain shortage and then at some point, customer will build like perhaps like higher inventory of components, which include some of your products as well. So what is your expectation in that area?
Kieran O’Sullivan: Yes, Hendi, it’s -- as we said in the earlier comments, we’re cautious about the inventory buildup, but we haven’t seen any, certainly on the component side of it. On the transportation side of it, actually, inventory levels are way down. They’re down at historical lows at 25 to 30 days on hand days of supply in North America when that should be up in the 65 day range. Basically, at the moment, it’s just get every part you can to build the vehicles. So we’re not seeing any inventory buildup. And looking at the forecast out there, there were some people saying, if we didn’t have supplies, we could be getting back to, I don’t know, $16 million, $17 million SAAR, I don’t think we’re going to fly back to a $17 million SAAR in the next year or two, but staying more robust around $16 million seems somewhat possible. And, again, on the other end markets and through distribution, we are not seeing an inventory buildup. And believe me, we’re keeping a very cautious eye on that. The that is on escalation meetings with our suppliers, they’re checking as well, making sure that people are not over-ordering because you can imagine they’ve got other customers who can take the parts as well. And so it’s really a pretty robust demand environment. It’s just this whole supply chain. And we see it getting better in the fourth quarter and into next year, but it’s just challenging at the moment.
Hendi Susanto: I see. So Kieran, so let’s say, if supplies shortage like for several quarters, I’m wondering whether inventory buildup may happen later. And then, therefore, inventory buildup may not be in the second half of 2021.
Kieran O’Sullivan: Yes. And, we’re not seeing any signs of inventory buildup in the second half of 2021. And it’s probably a little too soon to comment with great detail on 2022, but all the signs we’re seeing are just securing supply for more sustained demand.
Hendi Susanto: I see. Yes. Okay. And then second question is for Ashish. So, Ashish, I think my understanding about gross margin is directionally, for the second half, we will still see some headwinds, but there’s also some improvement. And then I think can we look at your long-term target range as our base case scenario or the restructuring may take gross margin a little bit above the high end of the gross margin target range?
Ashish Agrawal: So Hendi, I think you’re right on in terms of restructuring, we would expect further improvements. Some of the headwinds that we did talk about, volume is probably the biggest one that we are anticipating in the second half. And you can see the magnitude of that based on our guidance that we’ve provided. And the material cost increases that we just mentioned, they’ve gotten slightly worse compared to the first half. So there will be some added pressure there. And the other thing that does have an impact on our cost structure is the foreign exchange rates. Most of our manufacturing is done outside the U.S. and that can also have an impact on the gross margin percentage from time to time.
Operator: We will now take our next question. Please go ahead.
John Franzreb: Just a quick follow-up. Ashish, I think you said you’ve realized $0.12 of savings. And maybe I didn’t hear you properly in the first half of the year from restructuring actions. Is that -- did I hear that properly?
Ashish Agrawal: $0.12 from the launch of the restructuring program, John. So I believe the number was $0.03 in the first quarter, $0.03 in this quarter. And we had said in the second half of last year, and there’s some rounding in there. So it’s $0.12 program to date.
John Franzreb: Okay. So that’s an annualized number, $0.03 in the first quarter, $0.03 in the second, you’re running at an annualized $0.12. Is it -- am I understanding that properly?
Ashish Agrawal: It would be $0.12 in the last 12 months, and we are looking for more savings as we go forward.
John Franzreb: Okay. Okay. Okay. I was just confused on that one. Okay. And just on the revenue that expectations to go down, can we just work through that one more time? Why is that the case?
Kieran O’Sullivan: Supply chain challenges, John, particularly in transportation. That’s where the real issue is and getting semiconductors is the real crunch point at the moment. And then the other side of that is some of the customers are doing extended shutdowns as well or shutting down because there’s other semiconductors that they can’t get like microcontrollers.
Ashish Agrawal: Sorry, John, I was going to say Kieran’s comments earlier on the call. We were able to pretty reasonably manage the second quarter, and we did better than we expected to be able to do because of the supply chain challenges. We are expecting things to be much tougher in Q3.
Kieran O’Sullivan: And John, obviously, we’ll be doing everything we can to support our customers and minimize that as much as possible, but that challenge and risk exists at the moment.
John Franzreb: Well, I guess I’m just curious because we had a fair amount of high-profile shutdowns in the first half of the year. So are you suggesting you expect more shutdowns in the second half of the year than the first half?
Ashish Agrawal: Yes, at least the same or a little -- sorry, a little more is what we’re reading, John. When I look at the whole forecast, we see about $6 million of shortage on vehicles overall globally. And I think $5 million has been announced up to about a week ago, but there’s other noise out there that’s indicating more like $6 million.
Operator: It appears there are no further questions at this time. I would like to turn the conference back to Mr. O’Sullivan for any additional or closing remarks.
Kieran O’Sullivan: Thank you, Tracy, and thank you to everyone for your participation on today’s call. We look forward to updating you on our performance in October and getting through these supply chain challenges as best we can. Thank you.
Operator: This concludes today’s call. Thank you for your participation. You may now disconnect.
