CTS Corp (CTS) 2003 Q1 法說會逐字稿

Ladies and gentlemen thank you for standing by. Welcome to the CTS Corporation first quarter results conference call. At this time all participants are in a listen-only mode. Latter we will conduct a question and answer session, instructions will be given at that time. If you should require assistance during this call please press zero then star. As a reminder this conference is being recorded. I would now like to turn the conference over to your host President and Chief Executive Officer, Don Schwanz.

Thank you Cindy and I want to thank all of you for joining us today. Participating from management are Vinod Khilnani, Senior Vice President and Chief Financial Officer; Don 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 the statements we make during the call.

Good morning. I would 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 expressed in the forward-looking statements. Additional information regarding these risk and uncertainties were set forth in last evenings press release. More information can be found in the company's SEC filings. I will now turn the discussion back to Don.

Thank you George. Our first quarter results released last evening came in pretty much as we had expected. As projected in our January conference call Q1 sales were down from Q4, much of this decline was due to seasonal factors affecting demand for communication components for handsets and EMS assemblies. However we also saw a softening automotive market and a slightly lower demand for communications related products and electronic manufacturing services than we had expected, reflecting the continuing softness and uncertainty in the general economy.

About $2m of the decline in sales from Q4 to Q1 was due the sale and end of life of our high volume handset TCXO and BCO business announced last year. Profits for the quarter were $0.02 per share, essentially equal to the fourth quarter of 2002. However we were able to earn these profits at 9% less revenue than we did in Q4 reflecting the continued improvement in our cost structure and sales mix. Cash flow for the quarter was again positive enabling us to further reduce debt by about $10m from year-end.

Overall we are quite satisfied with the financial results given the continuing very challenging economic environment. Vinod will discuss these results in more detail in a moment. Prior to that I want to update you in some the business development initiatives we have underway. Though at times obscured by the overall impact of soft markets, we have made great strides in developing new products and capturing new customers to help drive top line growth in the future. In automotive products we continue to add to our platform wins for our belt tension sensor.

During the quarter we captured two additional platforms bringing the total to 14, and work is continuing with other potential customers to add more platforms to this list. The total estimated revenue potential for these platforms over the next three years is over $45m. Production of belt tension sensors for 2004 model year cars will begin this quarter. Electronic throttle controls and integrated Pedal Assemblies represent another growth area for our automotive sensor operations. We expect the market for electronic throttle controls and integrated Pedal to grow about 15% a year over the next five years. CTS has a very strong technology base and market position in electronic throttle control sensors and we have been quite successful in leveraging in the integrated Pedal Assemblies. Currently we have positions on three platforms for two OEM's and we are working closely with several other OEM's to add platforms.

Those two are small in comparison to the total, sales revenues from automotive sensors delivered in to Asia approached $2m in the first quarter, this is up about 30% over the first quarter last year. CTS products being delivered in to Asia includes throttle position sensors, exhaust gas re-circulation sensors, fuel centers and integrated Pedals. We actually started manufacturing our small engine throttle position sensor in Taiwan late last year and now in the early planning stages to begin manufacturing automotive products in China. During the first quarter we opened a sales office in Shanghai to provide additional support to our growth initiative.

Based on customer response and the expanding opportunities in the region we expect Asia to become a significant area of growth for our automotive sensors. These are just a few examples of the new product, customer and geographic initiatives that we believe will allow us to double our sales of automotive sensors over the next five years. We are also having very positive results for the frequency components and modules targeted for communications infrastructure applications. The infrastructure market has been served for many years by a highly fragmented supply base including many -- including many small companies with high cost operations located in the US or Europe. The down turn in communications infrastructure spending in the last two years has pushed some suppliers in to bankruptcy and left others in perilous financial condition often leading to damaging reductions in R&D, quality and customer service. Customers not surprisingly have become increasingly concerned about the supply base risk and have been turning to CTS as an alternate source.

As a result, we are growing shares in this market. During the first quarter for example we won over 70% of the new designing opportunities we pursued at Infrastructure OEMs against traditional competitors. These included wins at eight new customers. Another indicator of share growth is the fact that our sales on a year-over-year basis have increased even though capital spending by service providers has actually fallen. New timing and synchronization module designs are also helping to drive our growth in the communications infrastructure market. The market for frequency modules in fact did not exist until recently.

Traditionally, infrastructure OEM's designed their own timing and synchronization circuitry from discreet components or sub assemblies. Today we can offer them modules that are smaller, provide better performance and are more cost effective than the discreet design options. In the last year, CTS has introduced seven new module products. During the last quarter, we won 10 new module-designing opportunities and are actively engaged with customers in numerous additional new opportunities. While volumes for these modules are still low we expect them to drive a significant incremental sales by next year. Our ClearONE line of terminator products also continue to do very well. We added 10 new design wins during the quarter bringing the total over 80. ClearONE production volume in the quarter increased to about 50% over Q4 as more of our customers new products were introduced into the market and we expect to see continued growth in volume through the rest of the year.

This is a product where demand growth would accelerate with the pick up in IT spending. We also had a number of key design wins in the first quarter for our Ceramics Filters and Duplexers. In the handset arena, we were ordered positions on eight new platforms including one of the new supposedly throwaway phones. We also have begun to pick up a significant number of design wins for infrastructure applications. To summarize our view of the first quarter, bottom line results were essentially as we expected reflecting continued progress in cost reduction. Sales were softer than expected though we had anticipated that sequential decline. New business captures and development was positive and it is encouraging as we look to the quarters ahead. Now I will turn the meeting over to Vinod Khilnani, our CFO to provide a brief discussion of our financial results.

Thanks Don and good morning everyone. I am sure you have reviewed our first quarter earnings news release, which went out after the market closed yesterday. CTS sales in the first quarter at $105.8m or $6.8m or 6% lower than the prior year quarter. Approximately 4m or 60% of the drop in revenues was attributed to our previously announced decision to exit certain end of life zero or negative gross margin products related to our communication components business.

Geographically, sales from America and Europe were down 7% and 18% respectively versus the first quarter of 2002. However, Asia was up 10% from the year ago quarter. Sequentially, sales in the first quarter of 2003 were lower than fourth quarter of last year due to seasonality, which helped the fourth quarter due to the impact of holiday sales in North America. And on top of that hurts the first quarter due to Chinese New Year related shut downs in many parts of Asia. Gross margin in the first quarter was 19.9% versus 20.1% in the year ago quarter. Please note that the gross margin in the first quarter of 2002 included a favorable customer reinvestment of 3.1m and a one-time restructuring related charge of $0.8m. Excluding these two special items, the gross margin in the first quarter of 2002 was 18.1%. This 1.8 percentage point gross margin improvement in the first quarter of 2003 from a year ago quarter was achieved primarily through lower depreciation and restructuring related savings, in spite lower volumes.

Operating expense, which includes SG&A and R&D expenses, came down further in the first quarter to 18.5m or 17.5% of sales. Compared to a year ago quarter, operating expense were 18% lower in absolute terms. As a percent of sales, operating expense came down 2.4 percentage points from the year ago levels of 19.9%. Sequentially, operating expense came down by $1.9m and stayed at 17.5% of sales, despite lower sales levels. Operating earnings were 2.6m or 2.5% of sales compared to an essentially breakeven performance in the year ago quarter. Please note that the year ago quarter would have an operating loss, if adjusted for the customer credit and one-time charge, the two special items we have discussed earlier. Interest expense of $2m was $0.7m lower than the year ago quarter and $0.5m lower sequentially, primarily due to continued decline in our debt levels. Other income was 0.2m better, a positive 0.1m in the first quarter versus a negative 0.1m in the year ago quarter. This was primarily due to foreign currency gains in the first quarter.

Our effective tax rate remained at 25%. Net earnings were 0.6m versus a loss of 1.9m in the year ago quarter. Earnings per share were $0.02 with the consensus of $0.01 and a loss of $0.06 in the year-ago quarter a substantial improvement if you consider the fact that revenues were lower and the year ago quarter had the two one time items which we talked about earlier. On the balance sheet front we continued to maintain a very tight grip on our working capital, which excluding cash and revolving bank debt came down to 35.4m or a 8.4% of the sales versus 14.8% of the sales in the year-ago quarter.

Cash balance and revolving bank debt at the end of the first quarter of 2003 was 7.7m and 18.2m respectively. On a side note I would mention that bank debt is the only component of our total debt with financial covenants was as high as 187m in the mid 2001 time frame, which is now down to 18m range. Receivable day sales outstanding improved further to 51 days compared to 61 days at the end of first quarter of last year and 52 days in the previous quarter. Inventory turns of 6.9, improved from 5.0 from a year-ago quarter.

Capital expenditures were a low of 2.2m, sales of assets generated 3.9m in cash, operating cash flow net of all investing activities generated 9.9m cash inflow compared to an outflow of 3.8m a year ago. Total debt came down further by 10.2m this quarter to 85.2m, please note that compared to first quarter of 2002 total debt including notes payable is down 35m or 29%. Total debt to capital ratio has also improved to 24.4% in the first quarter versus 30.7% a year ago and 26.5% at the end of the previous quarter. Only 20, I think as I pointed out earlier only 18m of our total debt is funded from our revolving bank credit facility, which will expire at the end of this year, we expect to put in place a new credit facility well before at the end of the year and have already started that process to accomplish that. And with that, I will hand it back to you Don.

Thank you Vinod. Unfortunately the markets we serve still show little indication in near-term acceleration. Infrastructure markets driven by capital spending on information technology or communications have softened further from the fourth quarter. This impacts us in both component sales and EMS sales. Mobile handset demand is forecast to show modest unit growth, but this tends to offset by price erosion, still even modest growth is an improvement over the last year.

North American automotive production in Q2 is currently projected to be down about 9% on a year-over-year basis, as manufacturers constrain production to work off currently high inventories. Compared to Q1 projected automotive production in North America is flat to up slightly. Similarly European sales continued to soften. The bright spot right now is China where auto sales continue to strengthen albeit on a small base. Even though the underlying markets offered little encouragement as regard to growth, we still expect our second quarter sales to be up modestly over Q1 mostly due to seasonal patterns and demands.

We also begin production of our new belt tension sensor for 2004 model year cars later in the quarter which will have some additive affect. Note that the national highway transportation safety authority just recently relaxed the percentage of 2004 model year cars required to be equipped with occupancy classification systems. Originally the requirement called for 35% but this has been reduced to 20%. As a result, one of our customers has delayed platform introduction of belt tension sensor from summer to late fall. Though this has only a minor impact on Q2 sales, it does impact sales for the year by about $3m. Our outlook for the year remains positive though somewhat dampened by the lingering weakness in the economy. I still expect that we will see modest year-over-year sales growth with most of the increase coming in the second half. Current consensus earning estimates of $0.25 are in a range that we believe that is achievable, though there remains a lot of uncertainty and variables that could swing results significantly.

Before opening the call to questions, I would like to comment on the SARS issue and it's potential impact on the company. As you know CTS has extensive global operations, including operations in regions that have shown a high incidence of SARS. This is also true of many of our customers, suppliers and competitors. We have like most companies taken prudent steps to try to prevent the spread of SARS, including educating our employees, restricting travel, taking extra precautions in monitoring the health of our workforce etc. We also have plans in place in the event that someone in the workforce does get sick or represents high risk, these actions mitigate the risk but they do not eliminate it. Fortunately we have some measure of backup capability and excess surge capacity that would allow us to deal with short-term disruptions to the business. Now I will open the call to questions.

Thank you. Ladies and gentlemen if you wish to ask the question please press the one on your touchtone phone. You will hear a tone indicating that you have been placed in queue. If you have pressed 'one' prior to this announcement we ask that you please do so again at this time. You may remove yourself from queue at any time by pressing the 'pound' key. If you are using a speakerphone, please pick up your handset before pressing the numbers. Once again if you have a question please press the 'one' at this time. For our first question we go to the line of Allison Fish from Denzer. Please go ahead.

Hi, I think, I just misheard you, just to clarify, the decline in revenue that was due to exiting businesses was that 2m or 4m?

I think, you heard that 2m was the impact if you look at the sales decline sequentially.

Oh, and it was 4 year-over-year?

That's exactly right.

Okay great, thanks.

Thanks Allison.

And for our next question we go to Lee Zeltser of Needham & Co. Please go ahead.

Hi, guys a couple of questions if you could, first if you could give us a sense of a vertical market mix in the quarter?

Lee, this is George Newhart. As you know EMS was approximately 43% of the total with the computing and sensors being -- still they remain in 57%. In the -- within the computing and sensors, of course automotive stayed about the 25% to 27% of the total. Total communications was about 18% of the total and then computing and other would be the remaining 12%. So, it wasn't too much different than what we've experienced over the last couple of quarters.

Okay George or Don, if you could comment on the pricing environment that we are seeing in the different segments, sequentially?

I'll ask Donald Schroeder to comment on that Lee.

Yeah, in the computer area the components that we manufacture with that particular marketplace held firm over the quarter as compared to what we have experienced last year. So basically flat quarter-on-quarter, same thing with our products in the communications and computer arena in the EMS environment where we've seen very stable price environment.

In the handset area, communication handsets and the frequency control products in that area we've seen some continued price rose in the 5% to say 10% region quarter-over-quarter versus our ceramic filter product line which has held very stable over the quarter. In our automotive business again very stable pricing environment quarter-over-quarter.

Okay, so I see no real movement in pricing trends.

Nothing substantial in the quarter.

Okay. If you could talk about, you mentioned some design wins in different product areas, could you give us a total design win number versus Q4?

I don't have that number handy.

Okay. That's fine.

Lee we can cycle back to you. What are you trying to imply the dollar magnitude of it?

No. Just to get a sense of the design win trends versus Q4 to see if they are going up or flatter or down?

Okay.

Just to get a sense on --

We will cycle back to you. Without checking it I would say that definitely not going down to be there stable or up.

Sure. Okay but we can get that after the call. And then lastly, if you can talk about D&A for the quarter, what that was?

D&A for the quarter, depreciation for the quarter was 8.1m with amortization at 0.7m. So the total D&A was 8.8m for the quarter. And just to compare it, if you compare that with the first quarter of 2002 a year ago depreciation was 10.2m and amortization was 1m. So a total of 11.2m.

Okay. Thanks very much guys.

Well thanks.

And for our next question we go to the line of Reik Read of Robert Baird & Company, please go ahead.

Hi good morning.

Good morning Reik.

Don, could you spend a minute more on the wireless side and is you all kind of given your guidance for the second quarter, you were talking about some degree of weakness and I guess, what we've seen out of some of the bigger players like Motorola and Nokia are actually some reasonably good unit increases, I think on the infrastructure side some of the EMS players had suggested that the things are picking up for them. Are you guys just being cautious at this point given, given an uncertain environment or what might be the disconnect there?

I guess, I have not seen the same reports that you are looking at. If you look at the infrastructure side from a communication standpoint the spending levels by service providers are down and we saw a softening in demand for products that were not new, I put it that way. And that's for both components and EMS assemblies.

Reik, I would add that when we think about communication components we also bake in our thinking the fact that the end of live products, which we announced last year, would have an impact on us.

So if you look at, I guess when we look at it, we are looking at it from, I think a fairly broad prospective, we are seeing multiple regions and so our sense was it was softer. And from some of the things I have read and some of the reports from infrastructure providers, I read into those reports are based on soft or sequentially as well.

Okay. And then you talked about within the organized crystal products that, the tough environment has cost some of those players to go away and you mention you are doing 70% of the new wins. Can you give us historically what has your win rate been there, and really how much competition has gone away in the last couple of quarters?

The comparison probably wouldn't very valuable, because the way this market [Inaudible] in the past you had a few customers each of that their suppliers had a few customers that typically provided most of their volume. And within a certain class of products and you stayed focused for the most part on those customer in fairly high win rate.

What's significant here is what we've done is going outside what might have been considered our traditional customers ad (ph). And so we are biding much more broadly to new customers and getting the high win rate. But we wouldn't have been able to do that in a couple of years ago.

So you are going after customers where, and there is not that much competition any more --

We were able to beat him.

Okay. And then last question from me, from an SG&A perspective better than, than I was expecting. Can you guys give an overview in terms of why this sequential improvement and how much of that is sustainable?

Reik, the improvement is primarily coming from salaries and fringes kind of category, 60% range clearly higher than 50%, 60%, 65% is coming from that category. Bulk of it is sustainable, I would point out that a portion it is variable and in that variable category we many have things like commissions which all variable to sales and then there is a component of fringes which is related to profit shedding related expenses which do vary with the profits of the quarter. So there is an element of variability, but as the percent of sales the numbers you are seeing, operating expenses as the percent of sales, most of it should be sustainable.

Okay. Great.

On a percent basis.

Thank you very much guys.

And for our next question we go to the line of Kevin Kessel, Bear Stearns. Please go ahead.

Good morning.

Good morning.

Don earlier you were speaking about the new design win in modules and I think you mentioned that you guys expect a much more significant part of your revenue to be driven by the module business next year. Can you characterize what type of an impact you guys believe that will have on your gross margin?

The margins are significantly higher for module business. If you take the precision engineered components that we have typically sold into the communications infrastructure market, the double ozonized oscillators etc., margins in that arena varied from 20% to 50% depending upon the particular product and the amount of competition and how long it had been around and how complex it was etc. Modules add another 10 or more points on average to the margin.

How would you characterize the percentage of business now that is currently module?

Well from a revenue standpoint it is still nil because these are being designed in products that have not yet been introduced to the market.

All right.

So it is going to be next year before we expect to see anything of significance. It will ramp up and it is a little hard to make good projections here yet because designers are still converting over from one way of designing to another way of designing and we are kind of winning them over to this concept.

Right, I got it, and Vinod in terms of the debt paid down, you guys made some more progress this quarter reducing the debt. What is your target that's a capital issue? Do you guys have one and what you feel is the relevant leverage?

We have talked about Kevin debt to capital range for CTS of 20% to 30% range and we would like to be closer to 20% when we sense more uncertainty than normal over the horizon and allow it to go up to 30% if we have an acquisition opportunity or if we have a project we will allow it to go up to 30% or maybe opportunistically a little bit beyond that but stay generally within that range.

Okay, from the sounds of it then at this point you guys are in pretty good shape, I guess you could still reduce it a little bit more based on the current environment you say, but, were you are at right now is a comfortable area?

Exactly we are pretty much in the middle of that range and opportunistically we may lower it just a little bit more, but not much.

And then in terms of the belt tension sensor ramp, you guys said that's primarily a second half of the year event but it sounds like there is going to be ramping towards the end of the quarter. I guess you guys are certainly factoring in may be as much as $10m or $11m a quarter incremental from these new programs. Well what would you expect to be able to get this quarter if it's ramping late? Could you get as much as just half of that or is that optimistic?

You too high.

So, much more in the $1m, $2m, $3m range?

Yeah, remember what I said about $45m over the next several years.

So, its not 45 a year, it's actually 45 over [Inaudible] .

Right, exactly. Yeah and so, you have got think about it this way, what we are seeing is the OEM's have to go from what is now 20% for 2004 model year cars to 65% the following year and 100% the year after that.

Okay.

And so, they will ramp new models on over time and to catch the right mix and so on. So, we are seeing a set of cars come on right now that are intended to help them meet the 2004 requirement.

Requirement, which has been lowered right.

Yes, it's lower to 35%, okay. By the middle of next year - actually during next year, we will see more come on line as they are trying to ramp up towards the 65% goal. And then it goes on after that. So, we have a half-year, roughly, this year supporting a 20% level. Next year, we will have about a half-year supporting a 20% level and a half-year supporting a 65% level. And it's - that's a -it's a little smoother than that makes it sound but in any event - I don't know that I want to give the specific numbers.

Kevin the impact this year would be very, very small.

Right.

The numbers become more interesting in double-digit in millions in revenue from next year.

All right.

Yes, It is incremental to the year that [Inaudible] doesn't mean much to the quarter.

All right.

There is no question.

I got that. And, in terms of in your comments on SARS and also from the growth in Asia and also the shift over to China potentially for the manufacturing. Do you foresee currently the shift slowing down a little bit, just given the SARS, or should it progress as planned?

Well we will have to obviously watch what happens in that regard from a timing perspective, and I see you are talking about my comment on manufacturing automotive parts in China.

Right exactly.

At this point in time what we are looking at [Inaudible] is one, where and the pros and cons of where ever we go, what we go in with, how we would make that transition. So, it's in planning stages. We will continue with that and kind of watch the situation and modulate it if we have to.

One last thing is, Vinod, I didn't get the CAPEX, but the core CAPEX in the quarter excluding the gains from selling (ph) equipment, I think last quarter is 1.5m?

Yeah. CAPEX this quarter was 2.2m.

2.2m. Okay. Great. Thank you guys.

Thanks.

And our next question will be from the line of David Dagleo, Boston & Company. Please go ahead.

Hi gentlemen.

Hi David.

I think, what I heard you say is on these ceramics filter side you are seeing stable pricing. So, I guess the advent of Agilent FBAR won't have you really isn't causing any disruption of pricing environment at all? Is that a fair statement? Am I looking into the right market is first question?

Yeah. I think, the way to think about this is to recognize that the FBAR is focused at certain applications where the size becomes the driving force. It is considerably more expensive than a Ceramic Duplexer. So, it's not a matter of competing on price between those two products.

Got it. Thank you.

Okay. Thanks.

Ladies and gentlemen, if there are any other questions, please press the one at this time. Mr. Schwanz, there are no further questions in the queue, please continue.

Okay. Again I thank you all for joining us today and Cindia will turn it back to you so, you can tell people about the replay etc.

Thank you. Ladies and gentlemen, this conference will be available for replay after 3:15 p.m. today through April 30, 2003 at midnight. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 679810. International callers, please use 320-365-3844. Once again, your dial-in numbers are 800-475-6701and 320-365-3844 with the access code for this conference 679810. That does conclude our conference for today. Thank you for your participation and for using AT&T executive teleconference. You may now disconnect.