Good day, and welcome to the CTS Corporation Second Quarter Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Kieran O'Sullivan. Please go ahead.

Thank you, Dorothy. Good morning, thank you for joining us today, and welcome to CTS' Second Quarter 2019 Conference Call. Second quarter sales were $120.7 million, up from $118 million in the same period last year. Gross margins were 34.1% compared to 35.4% in the second quarter of 2018. Adjusted earnings per share were $0.40 compared to $0.39 in the second quarter of last year. Total booked business increased 4% to $1.875 billion, up from $1.8 billion in the same period of last year. Ashish Agrawal, our CFO, is with me for today's call 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 Investors section of the CTS website. I will now turn the discussion back over to our CEO, Kieran O'Sullivan.

Thanks, Ashish. In the second quarter of 2019, our sales grew by 2.3%. We saw softness in industrial market with some customers being impacted by Chinese tariffs. We continue to see a burn-off of inventory with distributors, which is impacting our sales. Currency rates impacted sales unfavorably by $1.9 million. Gross margin performance was impacted by weaker operational performance at our ceramics foundry. The foundry challenges also impacted sales as we saw delayed shipments. The team has focused on the necessary actions to correct this issue, and we expect improvement in the third quarter. Operating expenses are being managed, but not at the expense of strategic priorities to drive profitable growth. We ended the quarter with 20.2% adjusted EBITDA, which is up 60 basis points compared to the second quarter of 2018. Total booked business increased to $1.875 billion driven by improved contract wins in the second quarter. We added 3 new customers in the quarter, one in industrial and two in defense applications. We saw strong bookings for our throttle sensing module in the Asia market as the China National IV emission regulation takes effect in July. OEMs are transitioning to electronic fuel injection systems to meet these new emission requirements for two wheeler models. China National VI emission regulations for vehicles will be implemented in 2021. This is important for us as it has the potential to increase demand for a variable geometry turbocharger actuator product, which we have in development with two OEMs. We received new orders for a low power OCXO Crystal product for application in undersea seismic exploration from two customers and another potential customer is testing our product. We were awarded a four year contract for piezoelectric rings for a gyroscopic guiding system with a defense OEM. This contract will provide future revenues approximately…

Thank you, Kieran. Second quarter sales were $120.7 million, up 2.3% compared to last year. Sales to transportation customers increased by 8.7% and sales to other end markets decreased by 8.6% due to softness in the industrial, IT and medical defense -- sorry, industrial, IT and medical end markets. Currency rates impacted sales unfavorably by $1.9 million. Our gross margin was 34.1% for the second quarter versus 35.4% in the second quarter of 2018. Execution challenges in our ceramic foundry operation and material cost and wage increases were the main drivers for the decline. These were partially offset by approximately $1.8 million in savings related to manufacturing transitions. We expect full year savings from the manufacturing transfers to be in the range of $3 million to $4 million. Exchange rates impacted gross margins unfavorably by approximately 0.5%. SG&A and R&D expenses were $23.3 million or 19.3% of sales compared to 22.1% in the second quarter last year. 2018 expenses included onetime cost of approximately $1.5 million. The remaining reduction in expenses is related to lower spending and timing of certain expenses. We remain focused on managing expenses as we work through challenging market conditions. Our effective income tax rate in the second quarter of 2019 was 25.1%, down from 37.7% last year. Last year's tax rate included a $1.7 million tax expense related to a onetime cash distribution from Taiwan. As we have communicated previously, we expect full year 2019 tax rate to be in the range of 23% to 25%, excluding discrete items. Our second quarter 2019 earnings were $0.36 per diluted share. Adjusted earnings per diluted share were $0.40, up from $0.39 in the second quarter of last year. Now I'll discuss the balance sheet and cash flow. Our controllable working capital as a percentage of sales was…

[Operator instructions] And we'll take our first question from Karl Ackerman with Cowen.

The narrowing of your outlook to the midpoint is somewhat impressive given the many crosscurrents from monetary policy and global trade, particularly production headwinds within automotive, some of the large automotive giant providers have called out that the market should decline low to mid-single digits this year. But based on your outlook this year, it seems that you should actually outperform end demand and maybe many peers in your space. So I'm curious if you may discuss existing or new programs within actuators or sensors, brushless DC motors or maybe accelerator pedals that are enabling you to outpace global production this year? And I'm also particularly interested in the geographical areas of strength too given the well-publicized challenges across China and Europe?

Karl, you have got a few questions in there and good morning to you. And, first of all, as we have been saying for a few quarters now, we feel that if the market is down a few points, we'll perform better than the market and that's what we're seeing. We are seeing strength in really a lot of the work that we have done from '14, '15 and '16 and that's bearing fruit at this point in time. You asked about actuators, we added a second customer, that customer is still in development. And we are also in development on next-generation products with existing customers. And the good news and the exciting news as well this quarter is that small acquisition we did back in 2015 with the RF sensing has gained momentum with funding now from two customers, which we are excited about as well. We know that won't be revenue until plus 2020 and beyond that, but those things are moving well. So we feel it's the work we have been doing the last number of years that's getting us momentum, especially in the transportation market. When we look across the regions, we have seen North America, as I said, down to 2% to 3%, but we have been gaining with OEMs in that market. Europe has been challenging for everybody. We have added some customers there, that we have talked about in the past and continue to pursue new opportunities and gain share. And in the China market where people are getting a lot of pressure, we are strong with the Japanese transplants and that really has worked pretty well for us. So hopefully that gives you some color around the market performance.

Given the variability in the second half of the year, broadly speaking, how are you thinking about the trade-offs between OpEx management and opportunistic M&A?

Well, on the OpEx side of it, we're always very prudent about managing our cost, but not at the expense of making those right strategic choices. And on the M&A side of it, we have been very focused in terms of our strategy, products and end markets that will fit our portfolio and we continue to work that very hard.

Last one for me, and I'll cede the floor. Regarding distribution, we understand that you have very little indirect sales within the distribution channel, particularly given your exposure toward automotive. But any thoughts from CTS about how long you think inventory destocking in the channel may last for and its impact on your industrial outlook?

Yes, Karl, you're right about the percentage there of our overall business. And I would tell you, we would think it's going to take another two quarters or maybe a little bit more to burn off all that inventory, there's going to be some differences across the regions, but it's still going to take a little bit of time to adjust that inventory.

We'll take our next question from John Franzreb with Sidoti & Company.

Making sure you can hear me. Kieran, I guess, regarding the revenue guidance, tapping down the top line a bit, has there been a fundamental change in your end markets that's made you want to reassess what the revenue will look like?

And maybe a few points on that John, obviously, from an automotive perspective and we're just cautious a little bit in terms of where things are going. We had strong progress in the commercial vehicle side of it and mid- to heavy-duty. We have seen some -- maybe some softness in that going forward. So that's something that staying very much on our mind, and the other thing that you might have caught in my opening comments is Chinese tariffs on the industrial side, we have seen one or two customers were their growth is not what we expected. It's good regionally in North America and Europe, but when they are going to China, they are being hit by the tariffs. So there are some of the things that have caused us to adjust the top end a little bit.

Got it, got it. And you mentioned a problem at the ceramic foundry. Could you just walk me through the implications of that either on a revenue line or actually on the revenue in the quarter and on the gross margin in the quarter? And then has that problem been resolved or does it continue to linger?

Yes, so we are not happy about it. It's poor execution in our part. So you can tell it's got our full attention. And from a sales perspective, it's probably somewhere in the region of 1% of impact on sales in the quarter. And what we have had is material formulations and if we get some variation in the material, it impacts our yields, if it impacts our yields, it impacts our finishing, and therefore, it creates inefficiency in the production environment. So again, just I told what it is, it's poor execution by us. We know we can fix it. But not pleased to be in this situation and, again, it's got our full attention. Ashish, you want to add any color?

Yes. John, on the margin side it obviously has a negative impact on us similar to sales, probably in the 1% range. And we would look to recovery in the second half. As Kieran mentioned, there is strong focus on it. We are working through several challenges. We expect to see some improvements in Q3 and more in the fourth quarter.

And I guess, back to the transportation topic, just to kind of board up, you mentioned you have been and you were outperforming the sector as a whole, but I didn't catch the number how much your automotive sales were up in the quarter? Did you provide that and I just missed it?

Yes, I think we said, John, auto sales were up over 8%.

8%?

8.7% to transportation customers.

Yes sir, got it. And one last question. The reduction in the CapEx spending. Is that a change in plans or deferral from something from this year to next year?

So John, some of it is just us managing carefully where the CapEx is being spent, making choices given the tougher end-market conditions. And some of it is deferring, so that -- ERP, we were hoping to accomplish more in 2019 as we have deferred that some of the launches into 2020, then some of that CapEx also gets deferred into next year. In the second half, we'll be working through more clarity on time line of various projects we are working on and as we get closer, we'll provide more clarity on what the expectations are for 2020.

[Operator Instructions] We'll take our next question from Hendi Susanto from G. Research.

If I look at your annual guidance, it represents second half year-over-year between 3% decline and 5% positive growth. How should we think about the divergence of those wide range?

Hendi, the -- as we talked about in Kieran's comments, there is still uncertainty about the various end markets and the evolution of those both on the industrial side. We saw some softness in medical in the second quarter. So we are watching that carefully as well, distribution. The largest end market for us is automotive and we still remain concerned about how that is evolving in the second half as well.

So Ashish, if I may revisit that question. In a positive scenario of 5% year-over-year growth in the second half, where will that growth come from?

If you see our sales, we are getting traction on many different fronts with new programs as well as new product launches that Kieran talked about in terms of where we are getting business win traction. So that will be a key part. Kieran, did you want to...

Yes, I think, Hendi, maybe some of the things we pointed out new products like the throttle sensing module for the market in Europe is gaining good traction, our RF products continue to gain good traction. And medical side of it, and as Ashish said, was a little soft in the second quarter. There were some adjustments of inventory there, but we are seeing orders pick up and we expect that to be good. And defense has been good so far this year and will continue -- that to continue going forward.

Got it. And then, Kieran, I know that now that you have like new ERP and then you would put like more new ERP system by the first half of 2020. In the long run, what can you do with your new ERP? Can you produce like more cost savings or like increase your working capital efficiency?

We definitely will increase our working capital efficiency. I can tell you that's a focus for us. And not happy with where we are at, at the moment. And Hendi, obviously, we are very much and our message has been on the implementation because companies have problems here. And the implement, we're making sure we are doing it carefully and robustly and -- but we are making that investment because when we are through this, it's going to gives us more data around the company. We have done a lot of simplification over the last number of years, but we still see opportunity ahead and, as I talked about, the 2025 goals, we have set some internal things that we haven't talked about, but we'll talk about those as we make progress and it will relate to ERP as well.

And it appears there are no further questions in the queue at this time. Mr. O'Sullivan, I would like to turn things back to you for any additional or closing remarks.

I just wanted to thank everybody for joining us this morning. And we look forward to updating you again in October on our performance. Thank you.

Thank you.

This does conclude today's call. Thank you for your participation. You may now disconnect.