CTS Corp (CTS) 2002 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the CTS Corporation third quarter conference call. All lines are in a listen-only mode now. We will conduct a question and answer session later. Instructions will be given at that time.

If you should require assistance during this call, press zero then star. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Donald Schwanz. Go ahead, sir.

Thank you, Morgan. I'm Donald Schwanz, I will host the CTS Corporation third quarter Earnings Conference Call. I thank you for joining us today.

Joining us are Vinod Khilnani, Senior Vice President and Chief Financial Officer, Donald Schroeder, executive Vice President and chief technology officer and George Newhart, Vice President Investor Relations.

Before beginning the business discussion, George would like to remind our listeners about statements we make during the call.

Good morning. I'd like to remind participants that this conference call may contain forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expresses in the forward-looking statements.

Additional information regarding these risks and uncertainties was set forth in last evening's press release. More information can be found in the company's SEC filings, all of which are current. I will now turn the discussion back to Donald Schwanz.

Thank you, George. CTS's third quarter results reflected continued progress in returning this company to acceptable financial performance. Sales were down slightly from the second quarter, but earnings, excluding restructuring and one-time charges were essentially at break even.

Cost reduction actions taken during the quarter will bring our break even sales level down even further in coming quarters. Cash flow from operations, net of capital expenditures, was positive enabling us to further reduce debt and getting us new wins in tension centers and design wins with the Clear One product line, give us confidence about our ability to grow the business in the future.

I will comment more fully on all the factors, but the bottom line for the company is positive.

As I noted, third quarter sales of $119.9 million were down sequentially from the second quarter by about $7 million or nearly 6%. This decrease was driven by the normal summer factory shutdowns in automotive production and a slow down in our contract manufacturing service sales, principally for infrastructure applications.

On the positive side, operating profit margins, excluding restructuring and one-time charges improved for the third quarter in a row, growing from minus .9% to plus .8%. This was realized despite slightly lower sales. EPS was negative 14 cents on a GAAP basis.

Excluding the restructuring and one-time charges I mentioned, the EPS for the quarter was essentially zero. Vinod Khilnani will talk about the numbers in a moment.

The improvement operating result raise driven by the cost reduction and restructuring plans implemented last year and continued this year. The facility consolidation, for example, announced in May of 2001 was completed in August of this year, allowing us in the third quarter to eliminate the remaining infrastructure that was unique to the facilities being closed.

During the third quarter, we announced several additional actions directed at further driving down our break even sales level. In our communication components business, we consolidated several organizations to capture the benefit of shared service functions and to eliminate redundant manufacturing overhead and SG&A structure.

Additionally, final processing of electric components will be transferred from our Albuquerque, New Mexico facility to our facility in Tangin over the next nine months, providing savings over labor rates and shared manufacturing overhead. We stopped developing new designs for certain older, temperature-consolidated crystal oscillator and voltage-controlled oscillator declines due to a decline in volumes. It's expected to phase out of production in the next few years. Current sales run rates are 16 million per year.

Reductions in indirect functions were made at the corporate level and at a few other business units, but the reductions were relatively small portion of the total.

In aggregate, approximately 300 indirect and salaried positions are being eliminated byte 210 reductions were accomplished by the end of Q3 and the remaining reductions will occur in the next several quarters. For the most part, the above actions represent a continuation of our efforts to simplify processes, eliminate unnecessary organizational complexity and duplication and focus on clearly value-producing activities.

Annual pretax savings from the third quarter actions are expected to be about $18 million per year. As I mentioned a moment ago, our new sales initiatives continue to show positive results. During Q3, we received additional warrants for our bell tension sensor for application on several new automotive platforms for the '04 and '05 model years.

Incremental sales from the bell sensor business in 2003 are expected to be about $5 million and should more than double in the following year. Also in the automotive sector, we won a [INAUDIBLE] for our non contacting exhaust gas circulation center.

Production starts in the third quarter next year and will be worth $2.35 million on an annual basis. The contract servicing business, we won a new contract to do the high-level assembly for a new bay station for a major infrastructure provider. This will be done in Tangin, China at our facility there.

We continue to secure new design wins for our clear one product line, adding nine more in Q3. Several major electronic equipment OEMs are now routinely designing clear one into their new products. Production of clear one devices will increase about 45% in the fourth quarter.

During the quarter, we will also begin sampling several new versions -- we began sampling several new versions of the device which we believe will broaden the potential market even further. Our CFO now has a brief discussion of our financial results.

Thank you, Don and good morning, everyone. I'm sure by now you have seen our third quarter earnings, which would at least after the financial markets closed yesterday.

Before I comment on the financials, let me briefly go over the restructuring actions that we announced in the press release on September 30th. CTS book to restructuring charge of $18.3 million in the third quarter, to eliminate approximately 300 mostly indirect positions and write-offs with certain acquired assets.

Approximately $13.3 million or 73% of the restructuring represents a non-cash charge. The remaining $5 million of cash charge is primarily for severance expense. Together, these actions will provide annual savings of approximately $17 million pretax in 2003. All but $3 million of which will be cash savings, primarily due to lower salaries and expenses.

Most of the cash savings will be reflected in the operating expenses and selling GMA and R&D functions. These structuring actions were substantially complete by the end of the third quarter with 70% of the positions eliminated.

Expect for transfer of final processing of these electric components manufacturing to our China facility in late 2003, all restructuring actions will be completed by year-end 2002.

These restructuring actions contributed approximately $2 million pretax to third quarter results and will provide incremental savings of $1.5 million pretax in the fourth quarter of 2002. Looking at the financial performance of the company, third quarter sales at $110.9 million were 6.8 million or 5.7% lower than sales in the second quarter of 2002.

Approximately half of the reduction was due to two of our largest automotive components customers, which were lower due to the expected third quarter plant shut down. The rest was due to lower sales of assembly products, caused by softness in the communications infrastructure market. Component sales to the handset market were actually up by 2%.

Gross margins excluding restructuring and one-time charges were 21.6% versus 18.3% in the second quarter of 2002. This is our third sequential improvement in our quarterly gross margins, up 3.3% over the second quarter of 2002 due to improvements in our communication component operations with our cost reduction efforts have been focused.

Four major factors each contributing about $900,000 to $1 million drove the margin improvements. These were labor rate and material usage efficiencies and manufacturing. Lowered depreciation expenses. Lowered overall other manufacturing overhead expenses and a customer credit for prior period activity.

We also continue to keep very tight control over our operating expenses, third quarter operating expenses came down to $22 million from $22.6 million in the second quarter of 2002 and were substantially lower than the $29.5 million level of the third quarter of the last year. We expect our operating expenses to come down further in the fourth quarter.

Excluding restructuring and one-time charges, operating earnings and the third quarter were $2 million with a loss of $1.1 million last quarter. Total other expenses, which primarily represent interest costs were $1.9 million in the third quarter versus $2.1 million in the second quarter of this year and $3 million in the third quarter of last year, primarily due to lower debt levels.

We are pleased to report that excluding restructuring and one-time charges CTS reported break even net earnings the third quarter. Most recent consensus earnings estimates were a 7 cent loss for the quarter. CTS has now lowered the break even point by $160 million from around $620 million in Q2 of last year to around $460 million. From the balance sheet management perspective, we had an outstanding quarter.

Working capital as a percent of sales was lowered further to 14.1% at the end of the third quarter compared to 14.9% at the end of second quarter of 2002 and 15.9% at the end of third quarter last year. Receivables were reduced by 11.5% from previous quarter.

And day sales outstanding improved to 52 days versus 57 days at the end of second quarter of 2002. Net inventories were also lowered by approximately 5% and currency improved.

Cash expenditures, I'm sorry, capital expenditures for the quarter stayed low at $3.3 million, same level as second quarter of 2002 and considerably lower than third quarter 2001 levels of $15.7 million. Our full year capital expenditure is projected around $20 million, better than our previous estimate.

Operating cash flow for the quarter was a positive $14.5 million, free cash flow, which is defined as operating cash flow minus net capital expenditures for the third quarter was a positive $11.6 million, versus $0.4 million in the second quarter of 2002 and $1.9 million in the third quarter of 2001. Total debt, therefore, came down by $16.5 million or 14% to $103.5 million.

Please note that those levels at the end of the third quarter last year were at $207 million or twice the current levels. Bad debt component of the total debt has been brought down to approximately $37 million, at the end of third quarter; versus $53 million in the second quarter and 77% lower than the $160 million level at the end of third quarter of last year.

Overall from a balance sheet perspective, working capital continues to improve with quarterly receivable days and inventory turns at a better level than any time in 2001 and 2002. Cap Ex has been at our target levels of 4% to 6% of sales in the last four quarters now. As a result, free cash flow for the quarter and year to date is positive.

Year to date free cash flow is a positive $8 million, versus a negative $29.9 million in 2001. Which, in turn, has brought our debt to capital ratio down to 28.2% versus 30.3% at the end of second quarter and 46.2% at the end of third quarter last year.

Our capital structure and balance sheet are therefore very strong. Now I turn the meeting back to Don.

Thank you, Vinod. Looking ahead, we are not expecting our markets to change much during the fourth quarter. Automotive sensor sales should be higher with summer production shutdowns now behind us. We're concerned about softening demand in Europe.

In contrast, component sales to the mobile communications sector typically decline through the fourth quarter as seasonal demand for the holidays abate. Communications infrastructure markets have also continued to soften, though this is a relatively small part of our total business.

On balance, we expect to see some quarter-over-quarter improvement in sales. Even without significant improvement in demand, however, we believe our cost reduction initiatives position us to be profitable in the fourth quarter. Now I will open the call to questions.

Ladies and gentlemen, if you wish to ask a question, press the 1 on your touch-tone phone. You will hear a tone indicating your line has been placed in queue. You may remove yourself by pressing the pound key. Our first question comes from the line of Lee Belstram from Needham. Go ahead.

Hi, guys, a few question if you could. You mentioned product lines being phased out. What were those in terms of sales contributions in the second quarter? And I'm trying to get a sense what kind of contribution they took away in the third quarter on the top line?

I think, Don, you talked about $16 million annualized rate.

It is a run rate and actually in the third quarter it's running about $16 million. For the full year, not during the quarter.

Okay. So about $4 million a quarter?

Yeah. During the third quarter, that's where -- it was a little higher earlier in the year.

But you did have some sales of those products in the third quarter?

Yes, and we expect to have sales going forward for a while yet.

Okay. You mentioned in the release that approximately $1 million of the improvement in operating margins came from credits related to earlier period activities, can you give us more information on that? And do you expect that to continue going forward?

We don't expect that to continue going forward. We do have overall a very conservative policy when we believe we may have a potential either dispute or reconciliation with a customer we normally assume -- we normally do not assume that credit in our numbers until we have a final resolution.

And this was an example where we resolved our reconciliation issues this quarter and therefore we were authorized by our auditors to take that credit.

Okay. Thank you very much.

And our next question comes from the line of Kevin Kessel with Bear Stearns. Go ahead.

Good morning.

Good morning.

Again, going back to the customer credit, I guess if the customer credit didn't occur in this quarter, gross margins would have been around 27%; that right?

I think it is 9/10 of a point less.

Right. I'm trying to look at your gross and operating margins going forward into the December quarter. I remember -- if I remember correctly, there was a customer credit as well in Q2, is that -- this is the second credit in a row?

It was Q1, I believe.

Was it Q1?

Yes. It was a Q1 credit and I believe it was approximately $3 million pretax.

Right. Okay. And you -- and going into Q4 you said you're not expecting another customer credit?

You know, we don't -- we don't have anything to expect that kind of thing going forward. Those things happen, you know, once in a while when we have those issues.

So, I mean on an absolute basis, would you expect gross margins would co-increase just from the remaining cost savings from the restructuring you announced this quarter?

Well, yes, I think we said that compared to the second quarter benefit of $2 million, we expect a benefit in the third quarter of 3.5 but we also said that that incremental 1.5 will primarily show up in the operating expense line.

Right.

On the gross margin line, yes, we will not have this one-time $1 million credit recur in the next quarter so gross margins would, to that extent, be negatively effected.

Right. Some terms of -- in terms of SG&A on an absolute dollar basis, do you expect that to go down? I know you said you only got 2/3 of your head count reduction taking place?

Yes, we expect our SG&A expenses to go down.

Okay. And the remaining impact, I guess of the restructuring, I guess would that be more in the cost of goods sold line as opposed to SG&A?

Yes, for next year, yeah.

For next year.

Uh-huh.

In terms of the restructuring, do you -- at this point do you anticipate taking any additional restructuring charges past what you've announced? Or is this at this point just the plan is in place for all of fiscal '03?

At this point, the plan is in place for the restructuring which we will complete in the fourth quarter. By the end of the year, 90% of the savings will begin to occur starting from the first quarter of next year.

Okay. You mentioned that lower depreciation costs this quarter.

Yes.

What was the de-appreciation in Q3 versus Q2?

If I combined the amortization expenses and in Q3 '02 it was $10.5 million.

Uh-huh.

Q2 was $11.7 million.

Okay. And would you expect D&A to go down again in Q4 given that I guess all the restructuring is not complete yet from what you announced already?

It shouldn't be much impact on the depreciation. The bulk of the impact on depreciation got reflected in the Q3. But the run rate shouldn't change next quarter because of restructuring activities.

Most of the impairment has been done.

Yes.

In terms of interest expense, I noticed it declined 24% sequentially.

Uh-huh.

Is that primarily due to the revolver balance coming down from $53 million to $37 million in the quarter?

That is correct.

And the other this quarter swung to a positive. What was that?

There are normally minor amounts in other categories which can include some small gains and losses. It may include some small gain or losses from the sales of assets and that's a very, very small number.

Okay, and lastly, in terms of your -- your major storage assembly customer, you mentioned, I guess that you saw weakness in Q3 from that customer.

My question is with the -- with the merger that they undertook and the change in their fiscal year, does it seem that the merger integration rises behind that customer and it's more business as usual at this point, just weakened market demand or or are major struggles going on there?

I didn't associate the two together, but in any event, the -- I think the merger integration issues are moving along smoothly, certainly from our perspective. They seem to be I don't know that I would say that they're done with that process. But it seems to be moving along well.

Okay. In terms of I guess your March quarter, given that now this customer has a -- has a quarter ending in January as opposed to I think it used to be December, would you expect that to potentially impact your March quarter in terms, you know, seeing higher revenue than typical or the seasonality might not be as bad for a March given the one month difference there?

I don't know how it's likely to affect that particular quarter. We see less variation month-to-month since the merger than before the merger.

Okay.

Through a quarter. The patterns -- pattern is smoother.

Okay. Again, it appears as if the relationships there are strong and you guys still expect that there's potential maybe to increase your relationship with that customer?

The relationship is certainly as strong as it was before, if not stronger.

Thank you very much.

Thanks, Kevin.

Ladies and gentlemen, if there are additional questions, please press one on your touch-tone phone at this time. We do have a follow-up on the line, Lee Balstram with Needham. Go ahead.

Hi, guys. Can you talk about pricing trends sequentially in the quarter?

Certainly.

Yeah. In the handsets, communication components arena, we see a degradation in the 3 to 6% region depending on the commodity we're talking about.

On a sequential basis.

Yes.

In our automotive area, they were basically flat. These are annual contracts, we're not seeing any issues there, as well as in the inner connect business.

So, the majority of the pricing pressure we see throughout the product lines in the corporation is focused more on the communications components area and handsets, specifically.

Okay. And I guess just getting a sense of your fourth quarter guidance, the improvement on sales in a sequential basis comes specifically from a component side of the business and more specifically from a sensor side; that accurate?

Yes, in the sense of automotive sensors.

Right.

We have the automotive production shutdown period over with, you know, both in Europe and the U.S., they tend to shut down for a couple of weeks during the third quarter. That's now behind us.

Right.

That's probably the biggest change.

Okay. So that would be a fair assessment.

Yeah. As I mentioned, the -- the -- on the mobile communications side, the peak for the holiday season actually occurs right around the end of the third quarter, a little bit at the beginning of the fourth quarter and then tends to ramp down through the quarter.

Okay. And one question with regard to the customer credit; is that attributable to any specific product line or product segment components versus assemblies?

It is more associated with components than assemblies.

Okay. You won't have a more specific breakdown?

It's in the component side and it's more toward the communications side of the business.

Okay. But principally components.

Yes.

Okay. Okay, thank you very much.

Your next question comes from Adam Kimble with Robert W Bates, please go ahead.

Hi, good morning.

Good morning.

A couple of quick questions for you. First to expand on the wireless handset market. Where do you guys feel inventory is at this point? And have you been thinking about a 2003 overall unit volume?

Good question, Adam. We don't have a good way to determine how much inventory is out in the channel. We read the same kinds of publications that you do, I'm sure.

There would normally be inventory for -- an inventory buildup for the holiday season at this time of year, so, the question of is there too much or too little is really a difficult thing for me to answer. We know at last year there ended up being excess inventory in the system.

I think from what we saw, the OEMs were a little more careful going into this holiday season. We didn't see quite as steep a ramp-up. In the latter part of Q3, first part of Q4. So, hopefully that means everyone is being more careful.

Okay.

In terms of total demand for next year, our expectation would be that the demand will be again around the 400 million handset range. Maybe a little bit of growth but there is not an obvious driver for total volume.

Within that, obviously, there will be changes in protocol. We see the CDMA segment, for example, growing within the total. And that's important to us because we sell the ceramic duplexers strongly into that segment.

Okay. The second question I have is related to your pension plan and do you have any expectation for pension income to be recognized in the fourth quarter of '02 and do you expect any, you know, assumption changes for '03?

Yeah, we -- we expect the pension income in Q4 to be essentially at the same level as Q3. Going forward, this is -- this is something which we evaluate normally in the fourth quarter with the help of our actuaries. And we will be doing the same process this year around the December time frame and review all the key assumptions with their guidance and there is a likelihood that, you know, assumptions will change going forward.

Okay. And what was the income in this quarter?

The third quarter pension income was approximately $4 million.

Okay.

Somewhere between 3.5 to 4.

Okay. Final question that I have is it seemed to us that the latest round of reductions came rather rapidly and I'm just wondering, was there any internal disruptions that you guys saw this quarter that might have impacted the third quarter or fourth quarter results or in your view, did it go, you know, as anticipated and relatively smooth?

We think the process went relatively smoothly. We're not aware of any disruptions which were caused -- material disruptions, that were caused to the third quarter. Therefore we do not anticipate any disruptions for the fourth quarter.

Okay, thank you very much.

Our next question comes from the line of Charles Elwain of Elwain Capital. Please go ahead.

Hi guys, congratulations.

Hi, Charles.

Hi. Good results. One question is your liquidity position, can you just comment on what the cash balance was at the end of the quarter, secondly, if you have any sort of a revolving credit line?

And thirdly, what is the sort of term of the bank debt and as well, are there any sort of -- is the rate on the bank debt changed at all, either over time or dependent on credit rating?

Okay, the cash position at the end of the third quarter was $11.6 million. The bank debt as I mentioned was down to $36 million. The available line on our credit, the total line available to us beyond the $36 million is roughly, you know, another $50 million, which is untapped. We do not expect any interest penalty on us because of our covenance or credit going forward.

However, current bank credit agreement goes on until the end of 2003 and as most people do, we will probably begin the process in the first quarter of 2003 to start looking at putting in place a new bank agreement which, given our dramatic reduction in debt levels should not be a difficult task.

Great. And then also, as it relates to the $17 million in pretax savings you're expecting, how much of that have you been able to recognize in the September quarter?

And did I hear you correctly that you're going to recognize the balance of that through the December quarter so that the March cost structure will be at $17 million lower than the September cost structure, essentially?

We recognized approximately $2 million pretax in the third quarter.

Okay.

And we will be recognizing approximately $3.5 million in the fourth quarter. So, if you're looking at an absolute year-over-year terms, then in 2002 we would have recognized 5.5 out of the $17 million full year 2003 number.

Okay.

If you're looking at a run rate point of view then in fourth quarter we'd be at a run rate of $14 million, $3.5 million in the quarter. And the rest of it would begin from January 1, 2003. So, in the first quarter of next year, we would be at a run rate of $17 million full year.

Okay, and then the March numbers will fully reflect the restructuring that you've taken place and we shouldn't anticipate at this stage further cost reduction beyond the March quarter?

There is a little bit of it that comes through over the first three quarters of next year because of the transfer of the PG electric final processing to the Tangin facility. That will occur over time. To some degree, product by-product. Most of that accrues near the end, but you will get benefit from quarter-to-quarter.

So, in the bulk of the 17, then, say 15 or so, will be realized fully by the end of -- in the March quarter.

If you look at the restructuring, the total savings from the restructuring on an annual basis ends up being about $18 billion. We will get 17 of it next year. Okay?

Okay.

By the end of the year, at an $18 million rate.

Great. That sounds good. Thank you very much.

We have a follow-up question from the line of Kevin Kessel with Bear Stearns. Go ahead.

Just a quick follow-up here. In terms of percentage of sales, automotive, I believe last quarter was 27%. You had said, I'm curious what it was this quarter?

It's -- it's in the same range of 25, 26%.

Okay. What what about wireless? You said that was up 2% sequentially?

Uh-huh.

In terms of dollars, okay. And then infrastructure? Telecom infrastructure?

Total communication sector was around 30, $32 million -- 30, 32%. 14, 15% of that, a little less than half of it was infrastructure side of it.

Okay. And maybe I missed this, but did you -- did you give us receivable and inventory at the end of the quarter?

Yes, we mentioned that the days -- the days receivable days at the end of the quarter were 52 days.

Okay.

Versus 57, last quarter.

Okay.

And 60 in the third quarter of 2001. And inventory turns were 6.1 at the end of the third quarter versus 5.9 in the second quarter and 4.0 at the end of third quarter of 2001.

Okay. Absolute inventory balance did it end around $41 million?

Yes, that's correct.

And receivables were 64?

Approximately 65.

65. In terms of interest expense, would you expect it to continue to decline here as you guys are generating cash from operations and paying down the bank debt?

Yeah, I think -- I think it would. It should inch down some more.

Below potentially 2 points yes.

Yep.

And I thought you just said your bank line was $85 million, but I thought at June end it was $115.

Yeah, we -- we -- we gave up some of the unutilized portion and we are one reason that we expect the cost to go down was because of that. We're still keeping $50 million in untapped, but we did not want to keep paying for a fairly large under utilized portion of it.

Your pick fees went down?

Yes.

Now the revolver is $85 million with $50 million untapped.

That's correct.

And last question here is I -- I think maybe a month or two ago a competitor of yours made an announcement, I think it was Agilante, related to products, that might be direct competitors of some of yours. Do you expect that to have an impact going into your '03?

You're referring to the F-bar announcement on -- no, we don't. Our -- our ceramic duplexer product that goes into CDMA right now predominantly and will go into the WCDMA protocols as well into the future, is growing in demand. It is very well received in the marketplace. It has significant competitive advantages in a class of applications that we serve with it. And so we don't see that changing in the near future.

Okay. And I guess the last housekeeping question is on the tax rate. It came down slightly this quarter. Do you expect it to remain at 25% or inch down here as you continue the restructuring and move more stuff?

I -- I think we normally revisit that again in the fourth quarter. At this point, we have no indication that the tax rate will change from the effective rate of 25%.

Okay, that's it. Thank you.

Thank you.

There are no additional questions at this time. Please continue.

All right, I don't have any more. If you want to give your instructions?

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