CTS Corp (CTS) 2002 Q4 法說會逐字稿

Thank you for standing by. Welcome to the CTS Corporation fourth quarter and 2002 results conference call. At this time, all participants are in a listen only mode. Later, you will be able to ask questions. As a reminder, today's call is being recorded.

I will now turn the call to the President and Chief Executive Officer, Mr. Donald Schwanz.

Thank you. I will host the CTS Corporation fourth quarter earnings conference call today and I thank you all for joining us. Participating from management are Vinod M. Khilnani, Senior Vice President and Chief Financial Officer; Don Schroeder, Executive Vice President and Chief Technology Officer; and George T. Newhart, Vice President Investor Relations.

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

Good morning. I would like to remind participants that this conference call may involve forward-looking statements. These statements are subject to 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 was set forward in last evening's press release. More information can be found in the company’s SEC filings.

During the fourth quarter of 2002, the company renamed the reportable business segments and refined the product lines included in each segment to reflect changes in this organizational structure and the manner that results are evaluated and resources allocated. The few reclassifications were immaterial and all segment dated discussed in the press release or this conference call reflects those reportable business segments which are components and sensors and electronics manufacturing services.

Also, I'd like to announce that we will be presenting at the Wall Street Analyst Forum on Wednesday February 12th at 11 a.m. More information is on our web-site.

I will now turn the discuss back to Donald Schwanz.

Thank you. We ended 2002 on a positive note with sales up sequentially over Q3 and earnings slightly positive. This marks the second successive profitable quarter on our road to recover. Free cash flow was also a positive $4.4m driven by improved operating results and reduced working capital. Inventory turns improved to record levels. Total debt to capital was also reduced to 26.5%, down nearly 18 points since year 200 levels.

Profitability for the quarter reflected the positive impact of our continuing cost reduction initiatives. This was partially offset by sales mix during the quarter. As you know, the gross margin is higher than it is for the EMS segment though total sales were up approximately $5.6m over the third quarter. This increase was driven by our EMS segment where sales were up about $10m quarter over quarter.

Sales in the higher margin components and sensor segments were down about $4m. Automotive sensor and communication component sales were both slightly softer than we had expected. While the markets we serve remained generally flat, there were a number of very positive developments in the quarter which we expect to help drive future revenue growth.

First, we captured another award for automotive belt tension sensor, bringing the total of platforms to 11 representing $45m in sales over the next three years. Belt tension sensors are used by automotive OEM's to help the federal mandate on sensing occupant weight in order to control air bag deployment. This mandate comes into effect for the 2004 model year with increasing percentages of new vehicles required to meet the mandate each year until reaching 100% in 2006. Interest in this product remains very high and we will add additional platforms over the course of the year.

Secondly, we captured 14 new design wins bringing the total to 72. This is the best ever in a quarter and demonstrates the widening application for this product. Production rates are expected to increase steadily over the next year as customers increasingly release their new product designs to production. Several new variations of this product are in development.

Third, we saw increasing demand for our communications infrastructure components, particularly in OCXO's. In Q4, we won positions with new customers for OCXO’s including applications of GPS, router timing modules and base stations.

We also introduced a new frequency translation module which is part of our strategy to expand our product line in this market by moving aggressively to higher valued modules. Our sales of communications infrastructure products declined dramatically in 2001 and early 2002 as communications cut their demand.

In contrast, sales have now grown over the last three quarters as we have introduced new products, captured 25 new design wins, and added 2 new strategic customer accounts. At least part of the increase reflects customers shifting their supply base to stronger suppliers like CTS. They have higher cost, U.S.-based manufacturing operations. You may recall that we shifted our manufacturing these components into Asia over the last two years significantly lowering our cost and enabling us to be much more competitive.

Finally, we again increased sales from our China operation reflecting new customer orders from both local and multi-national OEMs. Volumes from our China EMS operation are now running about 65% ahead of last year.

So in summary, Q4 generally met our expectations with substantial progress achieved in profit improvement, new business development, and balance sheet management.

Now, I will turn the meeting over to Vinod M. Khilnani, our CFO to provide a brief discussion of our financial results.

Thanks Don and good morning everyone. As you know, CTS released its fourth quarter and full year earnings after the markets closed yesterday. We are pleased to report that after achieving break even in the fourth quarter, CTS has recorded positive net earnings of 2 cents per share diluted in the fourth quarter of 2002. Sales in the fourth quarter at $116.5m were up $5.6m, or 5% sequentially.

From the third quarter of 2002, driven primarily from the EMS segment, geographically sales were 9% in North America and 11% in Europe quarter over quarter sequentially. This was due to stronger computer and automotive product shipment. Asia was 6% lower due to softness in communication components.

Gross margins for the fourth quarter were 20%. It was at 17.2% in the fourth quarter last year and 21.6% in the third quarter of 2002. Please note that both third quarter of 2002 and fourth quarter of 2001 have some one time charges which would exclude it fro comparison purposes.

Gross margin improvement of 2.8 percentage points from last year was primarily due to the restructuring driven improvements in the communications components business. Gross margins sequentially were, however, 1.6 percentage points lower in the fourth quarter partially due to a one-time customer credit of approximately $1m which favorably effected third quarter margins by nine tenth of a percent and partially in the fourth quarter which effected the margins by approximately one percentage point.

SG&A expenses in the fourth quarter were $14.8m, a further reduction of $1.8m or 11% sequentially from the third quarter of 2002. Research and development expenses $5.6m were essentially flat sequentially from the third quarter 2002 levels.

Overall, operating expenses have not only come down dramatically in absolute terms, but also be reduced as a percent of sales from 21.4% in the fourth quarter of 2001 to 19.9 % in the third quarter of 2002 to 17.5% in the fourth quarter of 2002. Interest and other expenses were $2.3m and tax rates remained at 25% developing in net earnings of $0.5m in the quarter versus break even in the third quarter of 2002.

And loss of $5.7m in the fourth quarter of 2001 exclusive of restructuring and related one time charges in the third quarter of 2002 and fourth quarter of 2001.

Diluted earnings per share for the quarter were a positive 2 cents compared to consensus estimated of 1 cent per share. On a full year basis, 2002 sales at $457.8m were 20.7% lower than last year. However, excluding restructuring and one time charges the net loss was $3.1m in 2002 down from $7.3m in 2001 despite the significant loss.

Overall, we are pleased with our progress over the fourth quarter of 2002 and delighted at reaching a cost structure and break even revenue point which allows us to generate net earning even at our current depressed sales volumes. Please note our last positive EPS quarter was the first quarter of 2001 when sales were $60m higher than the fourth quarter 2002 levels.

Despite our progress, however, we are not satisfied and will continue to look for ways to further improve our cost structure as we go forward. From the balance sheet, management perspective too, we have made significant improvements throughout 2002 and especially in the fourth quarter.

Working capital as a percent of sales came down to 7.9% at year end 2002 versus 12.1% at the end of 2001. Controllable working capital which includes receivables, inventory, and payables steadily improved throughout 2001 from 16.7% in the first quarter to 14.7% in the second quarter, 13.6% in the third and finished the year at 11.9%.

Year over year, controllable working capital came down by 4.2 points or 26%. Receivables for 52 days at year end 2002 versus 59 days in 2001, a 7 day or 12 % improvement. Inventory turns also improved to 7.4 at year end 2001, a record I believe, versus 4.4 at year end 2001.

Capital expenditures of approximately $1.5m were well within our target. Our focus on working capital management, combined with lower levels of CAPEX allowed us to generate a positive operating and free cash flow of $5.3m and $5.4m respectively. This is the third consecutive quarter with positive free cash flow. Please note that free cash flow is defined as cash provided by operating activities, less net cash used in investing activities.

For year 2002, free cash flow it was the negative $12.4m. It was negative $1.1m in 2001. At year end, bank debt of $28.4m and total debt of $95.4m reflected deductions of $8.1m in Q4 and $57.2m for the full year of 2002. Debt has further dropped from 38.6% at year end 2001 to 26.5% at year end 2002, a very steady decline through 2002. These are significant reductions and we are pleased to see our debt level now down to more reasonable levels.

On a side note, let me share with you a few changes we are making. After discussions with our consultants, CTS is lowering its long term expected return on pension assets from 9.75% to 9.0%. In addition, we are also changing the current discount rate for pension liabilities from 7.25% to 6.75%. Both of these changes, combined with the pension after balances at the end of 2002, would lower our consolidated total from approximately $15m in 2002 to around $9m in 2003.

Despite tightening these two, CTS continues to be in a situation and expects to make no cash contributions to its pension plan in the foreseeable future. Looking-forward, we expect our depreciation expense to decline further from of approximately $9m a quarter to $8m a quarter in 2003. That combined with a potential drop in our tax rate for 2003 from certain one-time favorable adjustments is expected to more than offset the reduction in our pension income.

With that, I’ll hand it back over to Don.

While we look forward to a time when an improving economy for margin growth, our plans are based on seeing more of what we are seeing today which is generally flat and stable in markets. In this environment, our management priority and focus will continue to be cost reduction and margin improvement, developing new sources of revenue to drive future growth, and strengthening the balance sheet further through cash flow generation.

In 2001 and 2002, we announced initiatives to expand into Asia to improve operating and reduce our cost structure. We also took steps to streamline our structure, reducing SG&A and burden. Some of the 2002 actions are still in process and will continue in 2003. Our plans for 2003 have targeted additional cost reductions to be achieved through product and process cost reduction, as well as further improvements of operational efficiency.

Our focus of developing new products is largely built around the introduction of new products offering superior growth and profit potential as well as to improve execution of sales and marketing disciplines. Our growth strategy includes, first, aggressively pursuing growth in automotive sensors, where we have a strong market position, excellent margins, and an abundance of new products and geographic opportunities to profitably grow the business. We have a number of new products under development and see opportunities to more than double sales over the next five years.

Second, growing our business in communications infrastructure components through a combination of new product introductions and share growth. We believe we can capitalize on the recently completed consolidation into Asia to provide highly competitive pricing and customer service advantages at good margins, allowing us to gain shares versus weaker players.

We have targeted our new product development efforts in higher end precision modules and oscillators, where our expertise and precision courts frequency products provides us with differential advantages.

Third, we intend to capitalize on our ceramic filter to expand in the new markets, while continuing to improve our position in this technology in the cell phone market particularly as it relates to CDMA protocols and GPS filters.

Fourth, we will continue to apply our market niche strategy to build our EMS business. Leveraging our strength and complex back plain design and global manufacturing along with our skill of serving higher mix lower volume electronic manufacturing needs.

From a balance sheet perspective, we expect positive cash flow during the year. Capital expenditures should be near the lower end of the normal range of 4% to 7% of sales. While we are comfortable with current debt levels, we will continue to seek ways to strengthen the balance sheet and find other ways to deploy our capital.

Outlook for 2003. We are expecting modest single sales growth though most of this will come in the last half of the year. First quarter sales will likely be slightly lower than fourth quarter sales reflecting seasonal factors in an otherwise flat market. Continuing growth component sales as well as initial production of belt tension sensor products for the 2004 model year will help drive sales growth in the second half. In general, margins are expected to continue improve through the year, driven by our ongoing focus on cost reduction and improvements in generation products.

Now, I will open the call for question.

If you do have a question at this point. Please press the one on your touch tone phone. You'll here a tone indicating you've been placed in queue. You may remove yourself by pressing the pound key. If you are using a speaker phone, please pick up your hand set before pressing any numbers. If you have a questions, please press one.

We have Kevin Kessel with Bear Stearns.

In terms of your hand set business. What is the outlook in terms for the March quarter? And in 2003? In terms of the way you guys see that growing given the commentary on the apparent inventory overhang that might be existing at the end of the December quarter?

First of all, we would agree that there is an inventory overhang out there that is hard to get our arms around exactly how big it is and how great an effect it will have. But that's not unusual. We typically see component sales for cell phones fall off in the first quarter. On a full year basis, there's a lot of different projections out there. There is some expectation for unit growth. Probably more important to us, though, is the trend toward growth in CDMA protocols. We supply the ceramic duplexers into that protocol and that is growing faster than overall cell phone sales. That is still pretty positive.

Kevin Kessel; Okay. In terms of your overall communications at year end, what percentage of the communications revenues were hand sets versus infrastructure? Can you give us an update on that?

Let's see, for the quarter, it's about 15%. It was for handsets. 16% for infrastructure.

How does that compare to last quarter?

It hasn't changed a lot. Hand sets are up, but they're only moving a couple of points. They bounce around depending on what season it is.

What was it last quarter?

18% for handsets, 14% for infrastructure.

Okay. Can you just remind us who your top customers are in the hand set segment besides Motorola and Nokia and you want some business with Erickson?

We have business with Samsung and we have business with Samuel. Those are the bigger ones.

Besides Motorola?

Yes. Motorola is the biggest.

Perfect. I appreciate it very much. Thank you.

We will move onto the line of Lee Zeltser with Needham.

Can we start with a pricing environment relative to the September quarter?

Relative to the September quarter in our communications is in hand sets where we've seen significant price erosion over the past year. This is relatively flat maybe down 2%. That is a little different than we've seen throughout the year. Through the year 18%-28% depending on which product family we're talking about. So we've seen a slow up of the price degradation in the fourth quarter of the year.

On the automotive side?

Nothing more than with what we typically see quarter for on quarter which is relatively flat.

How about in the EMS business?

Nothing that's not typical of that particular marketplace. It's been relatively flat also.

Would you anticipate pricing to normalize in 2003? Do you see potential for some abnormal pressure particularly in the handset area?

I don't think it's going to get back to what you call a normal situation if there's still excess capacity out there that will have an impact. As Don said, there are indications that it is firming up from what we've seen in the 2001 and earlier in the year. Hopefully, that's a trend.

EMS business had rebounded pretty well. What drove that exactly?

Two factors are at play here. One, there seemed to be a little bit of a fourth quarter uptick in IT spending. And a little bit of a surge in infrastructure spending.

In terms of the business with HP formerly Compaq, have you continued to see disruptions in the merger integration? Do you think it's behind you?

It's behind us.

Not a lot of lost business? Any programs there?

No, I don't see that as a factor at all.

Lastly, with regard to the credit facility outstanding, is there a plan to refinance that at any point in 2003? Or do you believe you'll pay it off?

Lee, the current credit facility will be left until the end of the year. We have plans to put a new credit facility in place in 2003, despite the fact that our projections indicate that we may or may not need it. We'll still put it in place.

Okay. Thank you very much.

We have a question from the line of Reik W. Read with Robert W. Baird.

Can you talk about the automotive segment? Don, you gave great information with the seat belt tension side of things but what about the throttle sensing business? You had some contracts that seem like they're ramping up in Asia. Can you give us an overview of how that business is doing?

I don't have all of that data right at my fingertips here. In the past, we talked about putting a production in place in Asia for a small engine TPS that we're using on motor scooters. That is ramping up over there. It's still relatively low volume as they introduce it on new models of the motor scooters. We got a little bit of revenue during the latter part of 2002. We would expect to see more this year. I just don't have it all at my fingertips right now.

That's no problem. I can always follow up. I want to get a sense of what's going on. It's still in a ramp phase? Is that fair?

It is. Certainly, we've seen this go on throughout the year. Sales, automobiles in Europe have softened pretty steadily through the year. Right now down roughly 7% from where they were in the beginning of the year. So that's one counter-trend. Obviously, automotive sales in the U.S. ended the year at about 16.8m units which was still an excellent year, certainly driven a lot by the incentives that were in place and it will be to speculate on how that's going to play out over the coarse this next year.

What extent do you see yourselves being able to be on more platforms as we go through '03?

We will do what, not only for bell tension but speaking with all the products. One of the initiatives we have in place is to widen our customer set in the U.S., Europe and in Asia.

If I could turn over to the cost side of things. Do you have an expectation of what the operating margin can be in '03 and in '04?

I think in '03, we expect cost reduction initiatives to help us improve the margin as we go forward. We will also see improvements year over year because in '02 we have finished the year with a better run rate in Q4 than full year. But in addition to that, we expect maybe some more improvement as we go forward.

Can you give us a sense for what the total cost reduction, the incremental cost reduction in '03 might be?

I think if you look at it from the run rate point of view, at this point the restructuring which we have announced and put in place that is probably a small incremental cost reduction activity of roughly a couple of million dollars from the bottom line is expected beyond the run rate point of view.

So beyond that it would be leverage as far as you're concerned?

It will be a combination of leverage. Yes, the run rate. The full year over year will show us a bigger improvement.

Can you give us an idea right now at least on a run rate business what the incremental operating margin might be on incremental revenue?

That's a tough question to answer because it depends on the mix. As you know, our contribution margins from component business is very different from the contribution margin of the EMS business. The range is so wide anywhere from a low of 10% to a high of potentially 60% on some products. It becomes very difficult to project that for the mix.

If we kept the mix steady state, can you give us an idea of what that would be?

If you keep the mix as a steady state, then it would be fair to assume that barring any unusual pricing or cost pressures, the contribution rates can be around 20% -25%.

Thank you very much guys.

Just a quick reminder. Ladies and gentlemen, if you do have a question please press the one. We have a follow-up question with Kevin Kessel.

I just wanted to see if at year end who the customers were that were above 10%?

For the full year?

Full year and quarter.

As we look for that information, I suspect that the top ten will not materially charge. Included in that category would obviously be, as usual, Hewlett Packard, Motorola, Delphi Visteon, and Morelli from automotive sensors. I believe Kyocera, Alkatel. I would not expect any material change for the top ten customers.

I guess while you are looking for that, what are automotive in Q4?

Yeah, approximately 25%.

That was pretty much unchanged.

Yeah.

For the interest expense, what drove interest expense up and what do you think it's going to settle at, going forward as you continue to reduce that?

That's a good question, interest expense. We would expect it to continue to go down. There was a slight increase in the fourth quarter and the reason for that was we reduced our credit facility from $115m to $85m. That would save us money as we go forward. As you know, we pay a certain amount of fees on a portion of the line which we do not utilize.

However, because we reduced the line from $115m to $85m, we had to write-off the fees which we paid to put the facility in place. It ends up spreading it over the future quarters. Because we lowered the facility, we took an usual $250,000 to $300,000 write-off which went into that line.

That was this quarter?

That was in fourth quarter.

Maybe that was at the end of the quarter?

I think that impact went into the fourth quarter.

I didn't catch. I think you said CAPEX was $1.5m?

Yes. Cash flow from operations in the fourth quarter was $5.3m.

Okay. And depreciation and amortization in this quarter?

It was approximately $10m.

That's expected to decrease?

Yeah, depreciation was $9m and $1m for amortization.

Were you able to see who the top 10% of customers were?

Yes. Hewlett Packard was number one, Motorola was the second one who had more than 10%. I believe Hewlett Packard was the big one at close to 32%-33% and Motorola was around 11%-12%.

That was for the full year or for the quarter?

Full year.

Great thank you very much.

We do have a follow up from Lee Zeltser.

Just a quick follow up on pricing. You mentioned components for communication hand sets, pricing and moderated, what do you think drove that?

I think the designs for the products that we manufactured here over the past 6 months have been relatively stable and there hasn't been a significant amount of design expense that we've encountered. So, I think there's a design stabilization phenomenon that we've seen. There hasn't been a significant amount of size reduction which a lot of times drives costs down. As Don pointed out earlier, since this is the first quarter we're not sure if it's a trend or not.

So, you think if you do see above average pressure going forward it could be because of the fact that you do have further design as the competitors do as well?

Correct.

Okay, thank you very much.

An we'll have a question from the line of David McGill.

Your guidance for increasing margins. Is that before or after the pension hit?

I think we don't want to specifically imply that quarter over quarter we expect our margins to go up. I think Don was implying a general direction that overall in ’03 we expect our margins to be slightly higher than '02. A mix and various factors and launches of the products that would obviously effect that.

So, do you expect the first quarter margins to be higher or lower than the fourth quarter?

It's hard to say since we don't know the lines and mix. It's difficult for us to project quarterly.

Okay. Then your book was what in the quarter?

Book to bill was 98% in the fourth quarter.

Then, I don't know if you report this number, but shipments are deliverable in the next 90 days, how does that look versus the prior quarter?

We don't talk about that because, again, it varies depending on how the customers pull the products from our hubs.

Great. Thank you.

Once again, ladies and gentlemen, if you do have a question, please press the one on your touch tone phone.

Mr. Schwanz, no further questions in queue.

Okay. Do you want to talk about the replay?

Certainly ladies and gentlemen this conference is available for replay starting January 28th until February 5th at midnight. You can access the executive play back service at any time by dialing 800-475-6701. The access code is 670175. Mr. Schwanz, any closing comments?

No, thank you and thanks to everyone for joining us. Have a good day.

Thank you, ladies and gentlemen that does conclude your conference for today. Thank you for your participation and you may now disconnect.