CTS Corp (CTS) 2003 Q2 法說會逐字稿

Welcome to the CTS Corporation’s Second Quarter Earnings Conference Call. [Caller instructions]. As a reminder, this conference call is being recorded. I’ll now turn the call over to your host, Vice-President of Investor Relations, Mr. George Newhart. Please go ahead sir.

Thank you [Barbara]. I’m George Newhart, Vice President of Investor Relations and I will host the CTS Corporation’s Second Quarter Earnings Conference Call. Thank you for joining us today. Participating from the Company today are Don Schwanz, President and CEO; Vinod Khilnani, Senior Vice President and Chief Financial Officer and Don Schroeder; Executive Vice President and Chief Technology Officer.

Before beginning the business discussion I would like to remind our listeners that this conference call contains forward-looking statements. These statements are subject to a number or 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 were set forth in last evening’s press release. More information can be found through the Company’s SEC filings. Also to the extent that today’s discussion refers to any non-GAAP measures relative to Regulation G, the required explanations and reconciliation’s are available on our website in the Investor Relations section.

I’ll now turn the call over to our CEO Don Schwanz.

Thank you George. Our second quarter results, which were releases last night, represented the third consecutive quarter of profitability on our road to restoring acceptable financial performance. Sales for the quarter were up about 10% over the first quarter and were essentially flat versus the second quarter last year. However, adjusting for the product lines that were divested or that were announced to go end-of-life last year, sales compared to the second quarter last year were actually up about 3%.

Profits in the quarter were $.06 per share, which is $.04 better than the first quarter and $.14 better than Q2 last year. This sequential improvement in profitability was driven by sales growth and the associated volume leverage, coupled with the impact of our cost reduction initiatives.

We also benefited in the quarter from certain licensing related revenues. Vinod will say more about our financial results in a moment. Though sales grew in the quarter the markets we served remained sluggish and were, in fact, slightly softer than we expected them to be. Seasonal factors and new product sales were the major drivers for quarter-to-quarter sales growth as opposed to any general demand improvement.

During the quarter the markets we serve also showed little clear direction. Component demand for computing and communications applications were softer than expected early in the quarter but appeared to be recovering somewhat near the end.

Automotive sensor demand was affected by both North American and European automotive sales and production running on a pace about 2 to 4% down from last year, while China car sales were up nearly 90% through May, and demand for EMS services in North America and Europe showed no real direction, though Asia was relatively strong in the quarter.

On the plus side, we continue to make good progress with our growth initiatives. During the quarter we won several additional platforms for our automotive built tension sensor and positions our new programs for our integrated accelerator panel. As both product families are relatively new, they contributed only about $2.4 million in revenue in the second quarter. By next year, however, we expect these two products to be significant contributors to automotive sensor sales and growth.

We’re also seeing growing demand for our automotive products in Asia. Sales of automotive sensors in Asia in the first six months of 2003 were approximately 4.6 million, up about 43% on a year-over-year basis. And we see numerous opportunities to drive future growth in the region. Two of the world leaders in motorcycle engine control systems, for example, are designing our small-engine throttle position sensors and to new motorcycle electronic fuel injection systems. To meet the growing demands of this product we installed a production line in our Kaohsiung, Taiwan facility last year. This was our first automotive sensor production operation in the Asian region. Now with the demand rapidly growing for other automotive sensors in China, we are expanding our Dongguan, China manufacturing facility to enable automotive sensor production in that location as well. Production in this expanded facility is expected to begin in the first quarter of 2004.

Overall, the automotive sensor new business capture rate in the first half of 2003 has met our expectation and supports our objective to more than double the automotive business between 2002 and 2007. In past conference calls and investor conferences, I have noted that we believe we can grow our frequency product sales in the communications infrastructure market by capturing share from a weakened competitive field. In contrast to many competitive suppliers or infrastructure frequency products, CTS has taken numerous actions in the past two years to strengthen its position in these markets. We’ve launched a host of new frequency products to serve customer requirements and wireless infrastructure applications. In many cases, cross-designing to replace competitors at the request of the end customer.

Moving up the value chain, we also began offering timing, frequency translator and clock generation modules that often include our precision frequency products, such as oven-controlled oscillators and voltage compensated crystal oscillators. Module based design solutions are relatively new to the infrastructure market, but we are finding strong market acceptance and have captured 22 design positions already this year.

Our strategy to restlessly pursue the infrastructure frequency products market is working. IN the last year we have added 10 significant customers to our active customer base and we have won the majority of all the competitive opportunities we have elected to pursue.

Though this market remains very soft. We believe our strategy positions us very well to see strong sales growth as the market recovers.

Our EMS business also continues to do well. Unlike many EMS players, our EMS business remained profitable over the last couple of years, despite the fall-off in unit deliveries to in-market. During this time we have focused on improving our service to existing customers even further as well as developing new customers.

EMS revenues in the quarter grew about 16% from Q1, reflecting, in particular, the growth of our business in China. Besides volume growth with existing customer programs in the region, in the last six months we have won two new wireless network programs; one for 3G Applications, the other for TDS CDMA, which is a wireless standard specific to China.

Overall, we feel our growth initiatives are on track and expect them to increasingly contribute to improving results in the quarters ahead.

One final comment before I turn this over to Vinod. As I’m sure you know, SARS represented a major issue to many companies during the last quarter, and in some cases, has had a major impact on sales and earnings. One of our major customers, in fact, has sited SARS as having a significant impact on both sales and earnings.

Though we operate facilities in a number of SARS risk areas, we did not have any significant disruptions to our operations due to the virus threat. We did, like most companies, restrict travel to affected areas, which has had the affect of delaying certain cost reduction initiatives. While we are attempting to catch up on these efforts, we do expect this delay to have some bottom-line impact on the year’s results. Assuming the disease stays contained, our guess is the impact on earnings for the year from both lost sales and a cost perspective will be in the range of $.01 to $.03 a share.

Now I would like to turn the conference call over to Vinod Khilnani, our Chief Financial Officer, to discuss the financial results in more detail.

Thanks Don and good morning everyone. We’re pleased to report very positive second quarter results, which were released after the markets closed yesterday. Second quarter sales of $116.7 million went up $10.9 million or 10.3% sequentially from the first quarter of this year.

Reflecting strength across both of our business segments, components and sensor sales increased 3.7 million or 6.1% due to strong sales of both automotive and communication components. EMS business posted an increase of 7.2 million or 16% primarily due to higher shipments to wireless infrastructure customers in China.

Compared to second quarter of 2002 sales this year were up 3% year-over-year if we exclude impact of previously announced end-of-life products which were 4.4 million in Q2 2003 versus last year. New product sales increases of 2.3 million combined with 7.7 million or 17% higher EMS sales due to increase in shipment for our China facilities was able to more than offset the impact of weakened component and sensor markets.

Geographically sales from Americas and Europe were down 5% and 2% respectively versus the second quarter of 2002. But Asia was up 8% from the year-ago quarter.

Gross margins in the second quarter were 21% versus 17.9% in the year-ago quarter. The 3.1 percentage point gross margin improvement in the second quarter of 2003 was achieved despite a higher mix of EMS assembly business, which inherently carries lower margins.

Improvements in communication components manufacturing operations lowered depreciation expenses and larger than normal royalty income in the second quarter made it possible to offset the unfavorable segment mix and still improve the margins by 3.1 percentage points.

Gross margins were also up sequentially at 1.1 percentage point due to improved components and sensor segment margins, driven primarily by improved cost structure, lower depreciation and higher royalty income.

Operating expenses which include SG&A and R&D expenses, were $20.0 million or 17.1% of sales in the second quarter of 2003 compared to 22.6 million or 19.2% last year, a reduction of 2.6 million, primarily due to lower headcount-related expenses.

Sequentially operating expenses improved also, from 17.5% of sales in the first quarter to 17.1% in the second quarter. However, in absolute terms, expenses were up 1.5 million sequentially due to timing and certain volume related variable expenses.

Operating earnings of 4.5 million or 3.9% of sales compares favorably to a loss of 1.5 million in the year-ago quarter and operating earnings up 2.6 million or 2.5% of sales in the first quarter of 2003. Key drivers were higher gross margins and lower operating expenses.

Interest expense of 1.9 million was $1.0 million lower than the year-ago quarter primarily due to lower debt levels. Sequentially, interest expense and total debt levels remain unchanged from the prior quarter.

Please note that other expense in the second quarter of 2002 had included a one-time gain on the sale of certain excess equipment of approximately half a million dollars.

Our effective tax rate remained at 25%. Net earnings for the second quarter were therefore up significantly to $2.0 million with the loss of 2.7 million in the year-ago quarter, and net earnings of 0.6 million in the first quarter of 2003.

Earnings per share were $.06, which is a loss $.08 and the year-ago sequentially earnings per share improved from $.02 in the first quarter to $.06 in the second quarter, an improvement of $.04, half of which came from improved operating results. The other half came due to certain new royalty licensing income, which unusually benefited the second quarter instead of second half of the year.

On the balance sheet front, we continue to manage our current and fixed assets very carefully. Working capital, excluding cash and current portion of debt, was 44.6 million or 9.6% of annualized second quarter sales versus 14.8% in the year-ago quarter. This was the third consecutive quarter in which our adjusted working capital as a percent of sales was lower than our internal target of 10%.

Receivables were 52 days versus 57 days a year ago. Inventory turns was 8.5 versus 6.3 turns a year-ago. Sequentially compared to the first quarter, receivables were up a day due to timing of shipments and inventory turns improved from 7.1 in the first quarter to a record 8.5 in the second quarter.

Capital expenditures stayed very low at 2.3 million in the second quarter, essentially at the same level as the first quarter and slightly lower than the 3.3 million level of second quarter 2002. As a result, we are lowering our expected full year 2003 cap ex estimates to approximately 15 million from our earlier estimates of 20 million.

Free cash flow is defined as operating cash flow net of all investing activities was an outflow or 3.6 million in the second quarter, primarily due to increased receivables. Sales in the month of June were approximately $5.0 million higher than March sales, thereby adversely affecting receivables, which were not due for collection at the end of the second quarter of 2003.

Total debt remained essentially unchanged at 85.3 million from the first quarter level. Please note that compared to second quarter of 2002, total debt including those payables is down 34.7 million or 29%. Total debt to capital ratio improved to 24.1% in the second quarter versus 30.3% a year ago and 24.4% at the end of the previous quarter.

As a final comment, as you know, we’ve put in place a new three-year bank revolving credit agreement earlier this month to replace the older facility which was due to expire at the end of 2003. The new facility contains covenants that are more available and reflect better pricing which is in line with the improved credit standing of CTS.

We will have to write off approximately $400,000 in bank fees, which relate to the old agreement, in the third quarter. However, going forward the new bank deal will save us approximately $1.0 million a year in interest and fees.

Overall we are very pleased with our financial results in the second quarter. With that I’ll turn it back to you, Don.

Thank you Vinod. With the Iraq war over, SARS seemingly behind us, a large simulative tax cut in place, the stock market up and economists predicting much higher growth in the second half, it’s hard not to feel a little bullish about business.

But the fact is, that through June we cannot discern any upward trend in our order patters and many other indicators of market recovery are flashing mixed signals, all of which convinces me that there remains a high degree of uncertainty and risk in any projection for the rest of the year.

With that note of caution, we do look for an improving economy in the second half of this year and expect sales to be up modestly over the first half driven by increasing sales from new products, seasonal factors and some underlying demand growth. Full year earnings are anticipated to be around the current consensus estimate of $.21 per share, though it is possible that a one-time related tax gain could positively impact results.

Now we’ll open the call to questions.

[Caller instructions]. First question in the queue is from the line of [Reik Read] from Robert Baird & Company. Please go ahead.

Good morning. Don, could you talk a little more about the automotive industry and you mentioned the build rate’s have slowed down a little bit, but my understanding it that the big three have been hurt relatively more than the Japanese counterparts. How does that impact your business?

We have a higher percentage of our business with the big three, so it hurts us a little bit more. We are broadening our participation out, through, across the market and increasing our volumes with other OEMs. I cannot give you a statistic as to what we saw coming from the big three in terms of changes in their demand rate. I don’t have that.

And how do you view the inventory situation with the automotive group at this point? What are the levels out there that you see?

If I remember correctly from the statistics right now, it was around 62 days, mid-60’s, which is maybe a little high, then coming down, as you know, it was pretty high for the last several months. There is the potential out there for a strike, obviously, because of the negotiations that are going on right now. So it’s conceivable that some of that inventory is there because of that concern, but there’s a little bit extra out there right now.

And then, Vinod, you had mentioned that June was higher than March by a pretty significant amount, is that something where all of a sudden you saw orders kick in, and can you talk about what areas that might be?

As Don commented, the quarter ended with a slightly stronger, a few stronger signs. I was just looking at receivables and trying to understand why receivables were higher from a cash flow point of view – as you know our days were still in pretty good shape, but the timing between the quarter, especially in our EMS business just created the mix in such a way that I had a slight outflow of cash because of the timing of sales which I expect to get back in July.

As you know, the third month of the quarter is normally stronger because we do four, four, five week, but we had slightly higher sales in June versus March so that affected our cash flow for the quarter.

And then last question, if you can just talk a little bit, Don, about some of your end markets and, at least from maybe a longer-term perspective what you’re starting to see, we’ve actually heard in the last couple of days with earnings, some positive comments with respect to networking and telecomm, computer doesn’t appear so bad, storage doesn’t appear so bad. Are those things that you’re seeing at this point? And can you just talk a little bit about that?

I read the same things, or much the same kind of things and some of the things I read are different and conflict with some of the things I can see. I see orders bounce up and down a little bit. One month up, or even two months up, right now I don’t call a pattern.

From an infrastructure standpoint, a communications infrastructure standpoint, we see the first half of the year as having been down from the last half of last year in terms of in demand. There are a number of companies out there that have commented on that in their earnings reports, and I’ve seen comments that some of the players in that arena don’t see the demand improving significantly before 2005. It depends a lot, as you know, on how quickly the capital spending recovers and the U.S. is still very, very soft. In Europe they’re making a little bit more money. Maybe things will recover there quickly. There’s still a fair amount of money being spent in China and we do benefit from that.

The computing – IT-driven computing marketplace, I think, is, from what I’ve read and what we see, is pretty steady. I don’t see any strong indications there, one way or the other. In the automotive market, you know, as I indicated, down a little bit. Still with pretty good results in a long-term context. Europe has been softening. Maybe with an improvement in the economy over there, we’re at the bottom there.

The more important drivers, as we go ahead, is going to be Asia. With any significant year-over-year growth rate, which everyone expects to happen, and the base getting bigger, it’s going to have an increased effect on total demand, so I think that’s pretty positive. And we can see that happening.

Great. That’s helpful. Thanks.

Next question is from the line of Lee [Zeltser] from Needham. Please go ahead.

Hi guys, congratulations on a strong quarter. A couple of questions. Can you give us a sense of your overall sales mix by end market?

It hasn’t changed dramatically. In communications, we’re looking at a – this is from a component standpoint – it’s about 17% of the total. Looking at it overall, it’s about 25% so that picks up the EMS sales as well.

The computing market, in market, is about 40, 41%, most of it being from our EMS business, that’s about 35%, the rest being from a component standpoint. Automotive is about 27% of the business and the remainder is kind of miscellaneous stuff.

If you can talk about sales trends in the component parts of the business, as far as communications, can you talk about inventory levels and pricing in that end market?

I just talked about the infrastructure pieces; I don’t know that I can –

-- well more so on handsets.

All right. On handsets, if you look at how we participate in the market, our participation is weighted toward CDMA protocols. CDMA protocols, as I recall, our expectation is that the demand, unit demand grow, or unit production will grow about 18% this year. Overall handset demand, depending on who you listen to, is probably more in the 10% range. So, the other segments, some of the pieces are going down, some are going up, it kind of varies.

From a pricing standpoint, Don you want to comment a little bit on the pricing?

Looking across at the entire corporation, would say that the last 12 months, rolling 12 months, has been relatively typical of what we see over past history, short of the down turn, significant price drops we’ve seen [indiscernible] the numbers you’re referring to there would be in the single-digit area. That being said, we have seen some price pressure on specific product families, but, in general, I’d say it’s been relatively typical in the single-digit area.

Typical in the sense of being more normal, as opposed to typical in the last year.

So it’s moderated in the last couple of quarters.

Yes, it’s definitely moderated. It still has an impact, and you get into things like communication components and unless you see some pretty high unit growth rates, it substantially offsets the growth.

Do you think inventory levels, going forward, in the handset market, are normalized or is there some still excess inventories out there?

I don’t see indications that there’s a lot of excess out there. Remember we participate more in the CDMA side. You may recall here, a month or two ago, there was some concern about some excess inventories over in China, in particular, driven by SARS and people not out shopping. That was not so much in the CDMA area, so I believe what we heard would probably be true, that makes sense. And there’s some indication of it in terms of order rates. It’s hard to see exactly how much that’s affecting demand and really sort that out, but we believe there’s some effect there.

Okay. You commented on your operating margins. They ran pretty significantly in the [reclone] division on a sequential basis. Was that driven strictly by operating leverage or were some other factors driving that?

I think it was, as I commented Lee, was split. Operating performance really improved in their sector in this quarter. And when I say operating margins, they came from a reduced scrap expenses, increased manufacturing efficiencies, higher yields in our plants, so they were all real operating improvements.

We did benefit from royalty income in this quarter, although I would point out that [indiscernible] the incomes in 2003 are probably going to be similar to 2002 and 2001 levels, of roughly 2.3 million per year. But a piece of that is fairly lumpy and it falls in different quarters, depending on how the transactions take place.

From that point of view, if you compare the second quarter with either the first quarter of this year or the second quarter of last year, we had roughly a million dollars more in royalty income, which fell in the second quarter this year versus those periods.

And I’m assuming there’s no expense associated with that royalty income?

No, there’s not.

And then you mentioned the shipments on the EMS side to Chinese wireless infrastructure – you mentioned those two contracts -- are those ongoing or was that kind of a one-time win? In other words, you’d expect the same level of activity on the EMS side going forward?

They are ongoing, primarily.

Demand tends to be somewhat lumpy. Our business over there, in general, is growing, but what we see is patterns where will get a spurt in demand and then we respond to it, so we can end up with significant month-to-month variation and that, Lee, is one of the things we’re very good at. We have a lot of flexibility in the way we operate, so we can handle those kind of variability in demand and maintain profitability and service the customer very well. I think that’s one of the reasons why we’ve been successful.

Okay, just one last question to clarify if I’m reading your guidance correctly. Is it safe to say on the top line, as you said for the second half it will probably be up a little bit sequentially, that will probably be the trend in the third quarter as well, to be up a little bit sequentially on the top line versus the June quarter?

We’ve got seasonal impacts because of the automotive shut-down that end up kind of running counter to that, so that’s not clear. We don’t normally make that kind of specific a call.

The comment, Lee, was more second half versus first half.

So I guess it would be safe to imply it would be more fourth quarter weighted because you’d see growth in the second half?

Seasonality indicates that the fourth quarter is generally stronger than third.

Thanks very much.

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

I’d like to remind our listeners that a replay of this conference call will be available from 4:45 Eastern Daylight Time this afternoon through 1 a.m. Eastern Daylight Time August 1st. The telephone number for the replay is 800-475-6701, or 320-365-3844 if calling from outside the United States.

Once again, thank you for joining us today.

Ladies and gentlemen, that does conclude the conference for today. Thank you for your participation.