CTS Corp (CTS) 2005 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. And welcome to the CTS Corporation's Third Quarter 2005 Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Instructions will be given at that time. If you should require assistance during the call, please press "star" then "zero." As a reminder, this conference is being recorded.

I would now like to turn the conference over to Mr. Mitch Walorski, Director of Investor Relations. Please go ahead.

Thank you, Linda. I'm Mitch Walorski, Director of Investor Relations, and I will host the CTS Corporation's third quarter 2005 earnings conference call. Thank you for joining us today. Participating from the Company today are Donald Schwanz, President and CEO, and Vinod Khilnani, Senior Vice President and Chief Financial Officer.

Before beginning the business discussion, I would like to remind our listeners that the conference call contains forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Additional information regarding these risks and uncertainties was set forth in last evening's press release. And more information can be found in the Company's SEC filings.

To the extent that today's discussion refers to any non-GAAP measures relative to Regulation G, the required explanations and reconciliation are available on our website in the "Investor Relations" section.

I will now turn the discussion over to our CEO, Don Schwanz.

Thank you, Mitch. Last night, we released our third quarter financial results. This is the eighth quarter in a row that we have delivered year-over-year sales growth, and it is the fourteenth straight quarter that earnings per share, adjusted to exclude unusual gains or losses, have grown on a year-over-year basis. In that time, sales growth has averaged 16%, while net earnings have improved from a loss to 4.2% of sales.

Sales in the quarter were up 15.6% over Q3 last year, driven by the growth in the EMS segment. EMS sales were actually up 35.4% year-over-year with the SMTEK acquisition that closed last January, the principal driver. While there were other ups and downs in the quarter, we did experience declines in volume from our two largest EMS customers that were not fully offset elsewhere.

At HP, our largest customer, we saw a decline of about $3.4 million in sales. Some of this was due to mix changes and some due to price reductions enabled through the transfer of most HP work to Singapore from North America and Europe. The volume was actually up.

With Motorola, our second-largest customer, sales declined about $4.3 million, driven largely by continued delays in expected orders from Asian service providers for base stations that we assemble for Motorola.

Sales within the Sensors & Components segment declined 4.9% on a year-over-year basis, driven by the continuing reduction in component sales for handset applications. As I have stated on many occasions, we have deemphasized the handset market. So volumes have been declining for several years.

That being said, we have seen volumes drop faster this year than anticipated. This factor alone knocked about 13 points off our year-over-year growth within the segment. Handset sales are now less than 3% of total Sensor & Component sales. So the expected continuing decline will be less of an influence on future growth rates. On the positive side, sales of Components & Sensors into both the automotive market and the communications infrastructure market grew nearly 17% year-over-year.

Earnings also improved significantly in the quarter helped by both volume and cost reductions. Vinod will discuss earnings in more detail, but I do want to note that the operating margins increased in both segments on a year-over-year basis. Before turning the meeting over to him for that purpose, however, I also want to update you on several other factors related to our business.

First, some updates on our growth initiatives. As I noted earlier, we continue to see double-digit growth in automotive product sales. While we continue to win positions with our older product lines, the growth has been driven primarily by success with our newer products, such as the Belt Tension Sensors, Electronic Accelerator Pedal Modules, and Actuators.

New business development activity remains at a very high level with significant evaluation prototyping work underway for two new large OEMs, one of whom is totally new to us as a customer. Implementation readiness testing of our new occupant classification system is continuing with Ford and is now targeted for completion before year end. We have also started working with them on specific sensor configurations for two different key platforms.

As you may have noticed from our recent press release, our expected growth in Europe over the next several years has prompted us to expand our automotive production operations in Central Europe. We are working with a developer on the construction of a facility in the City of Ostrava, on the eastern side of Czech Republic. This facility, which will be leased, should be completed in the second quarter next year, and we will begin operations around midyear 2006.

The Czech Republic operation will allow us to meet expected demand growth in Europe, helps balance euro-denominated receipts and expenses and provides logistic benefits serving the many OEMs that are establishing operations in Eastern and Central Europe.

I also wish to call your attention to the recent award received from Toyota for excellence in product launch. We are especially proud of this award, as Toyota is well known as one of the most demanding customers in the automotive industry. Successfully launching new products is critical to our growth and success in the automotive markets.

So it is especially gratifying that Toyota recognize us for the contribution of our product launch process, having the success of their Avalon vehicle. This type of customer recognition also helps us penetrate new customers, as it clearly demonstrates our commitment to excellence and delighting our customers.

In electronic components, we had a record quarter for design wins and infrastructure applications, including eight new wins in wireless repeaters, two additional wins with Chinese OEMs for their TDS/CDMA base station standard, eight new wins for higher-end modules, and two wins in new video broadcasting applications.

Year-to-date design wins already exceed the total for all of 2004. We expect these wins to continue to drive solid growth rates for infrastructure related component sales, going forward.

In our EMS business, we have been focused on diversifying our customer and market base. Five new customers were added in the quarter, and several existing customers have expanded their business relationship with us. Motorola, for example, has awarded us several new NPI programs for various infrastructure applications, including switching and WiMAX.

NPI programs represent the prototyping or a launch phase of a new program that is expected to ramp to production in the future. These programs broaden our business space with them as well as the variety of infrastructure type applications that drive the revenue stream.

In summary, despite short-term wiggles in demand, we continue to see solid evidence that our business strategies and growth initiatives are working. Finally, I want to update our guidance for the year.

You may recall that during the second-quarter conference call, I presented sales guidance in the range of $630 million to $680 million with diluted EPS expected to be in a range of $0.62 to $0.68 per share, but excluding the $0.07 unusual negative tax impact recorded in the second quarter.

The upper end of this range reflected the potential benefit of a large China Unicom base station order with a major CTS customer. China Unicom, however, has continued to defer the large order and therefore, we are removing this from a consideration in our guidance for the rest of the year.

More broadly, today, we see a little softer outlook across a number of our markets than anticipated last year. In the automotive market, for example, changes in model mix and OEM mix as result of higher gas prices and other factors have adversely impacted our near-term outlook.

As you may know, North American October auto sales are off to a dismal start. Considering all these factors, we are adjusting our sales guidance for the year to $620 million to $640 million. Diluted EPS excluding the $0.07 of unusual tax impacts recorded in the second quarter is expected to be in the range of $0.61 to $0.65.

Now, I will turn the meeting over to Vinod Khilnani, our CFO, to discuss our financial results in more detail.

Thanks, Don, and good morning, everyone. We were pleased to announce another strong quarter with 16% higher sales and net earnings up approximately 60% year-over-year. Third quarter operating earnings were $9.2 million, up 57% from a year earlier level of $5.9 million. Operating margins, at 6.2%, were up 1.7 percentage points year-over-year.

Third-quarter gross margins were high in each of our two segments year-over-year, as we continue to improve our product mix and cost structures. However, higher mix of EMS segment sales, which inherently have lower gross margins, caused overall gross margins of 19.4% to be 1 percentage point lower than last year.

EMS segment sales were 60% of the total sales in the third quarter of this year versus 51% in the same quarter last year, due to inclusion of SMTEK business, which was acquired earlier this year.

Total operating expenses were further lowered to 13.3% of sales in the third quarter 2005 versus 15.9% in the same quarter last year. The 2.6 percentage point reduction year-over-year is partially due to higher mix of EMS business and partially due to our continued tight expense management regime.

As you will note, the higher mix of EMS business affects the gross margins adversely, but affects the operating expenses favorably, since it incurs considerably lower SG&A and R&D expenses as a percent of sales.

Looking at the operating margins, by segment, Components & Sensors segment improved its operating margin to 11.8% in the third quarter versus 7.2% last year. This improvement was driven by higher gross margins and lower SG&A and R&D expenses as a percent of sales.

All major product families within the segment reported improved profitability year-over-year. EMS operating margins of 2.4% were also modestly higher year-over-year, primarily driven by higher gross margins as we added SMTEK's higher margin customers to the mix.

EMS business, however, continues to experience some operating inefficiencies and expenses related to certain new product launch activities. We expect the profit margins to further improve over the next several quarters, as we put these issues behind us. Our effective tax rate stayed at 23% in the third quarter, same as last year.

From the balance sheet perspective, our controllable working capital, defined as receivables plus inventories minus accounts payable, was 14.2% of sales or 1.2 percentage points higher than our target. This was due to quicker processing of our payables and somewhat elevated inventory levels.

Higher inventories were driven by interplant production transfers and new product introduction activities, primarily in our EMS business. We expect controllable working capital as a percent of sales to improve in the fourth quarter.

Operating cash flow in the quarter was $5.2 million versus $5 million in the same quarter last year. Year-to-date operating cash flow was $29.8 million versus $9.7 million last year. We expect our full-year operating cash flow to be around $40 million.

Capital expenditure for the quarter was $6.6 million. Year-to-date 2005 CAPEX was $12.5 million compared to $10.1 million in the same period last year. Our full-year capital expenditure is expected to be in the range of $17 million to $20 million, which as a percent of sales is at the bottom end of our 3 to 5% range.

Our year-to-date 2005 free cash flow, therefore, was $17.2 million compared to roughly breakeven performance in the same period last year. Full-year free cash flow is projected to be around $20 million. During the quarter, the Company repurchased approximately 322,000 shares of its common stock for $3.8 million, or approximately $11.80 per share.

Year-to-date, we have repurchased approximately 644,000 shares for $7.5 million.

In summary, the result of this quarter once again demonstrated that we are continuing to improve our operating margins, despite higher mix of EMS sales, grow our earnings faster than our sales increase, and are going to finish the year with substantially improved operating and free cash flow performance.

Over the last 3 years, adjusted operating margins have climbed from below 1% in 2002, to 4% in 2003, to a little over 5% in 2004, and expect to be around 6% this year. We believe our operating margins will continue to increase over the next couple of years to reach our target of 7.5%.

Let me make a few final comments before we open up the call for your questions. First, as you know, Delphi Corporation filed Chapter 11 in early October. CTS does approximately $20 million to $22 million in annual sales to Delphi, which is roughly 3 to 4% of our total revenue.

We do not expect any significant interruptions in our shipments to them, as we go forward. However, we do expect our receivable balance to run approximately $3 million or so higher over the next 12 to 18 months, since pre-filing receivables will probably take that long to collect. In addition, we may have a reserve for doubtful accounts for Delphi up to $500,000 at year end, depending on how things progress.

Secondly, as we increase our profitability in the US tax jurisdiction, we may see our effective tax inch up a couple of points to around 25% over the next several quarters, impacting our GAAP earnings slightly. However, this will improve our free cash flow, since we will be utilizing our tax loss carry-forward to offset our taxable profit in the United States.

And finally, we continue to review the possibility of repatriating up to an additional $25 million of cash back to the US under the provisions of the American Job Creation Act of 2004, before its year end 2005 deadline. You will remember that we have repatriated approximately $50 million earlier this year under the same program.

And with that, we will open up the call for your questions.

Thank you. Ladies and gentlemen, if you wish to ask a question, please press "star" then "one" on your touchtone phone. You will hear a tone indicating that you've been placed in queue. You may remove yourself from queue at any time by pressing the "pound" key. If you're using a speakerphone, please pick up the handset before pressing the numbers. Once again, if you have a question, please press "star, one" at this time.

And our first question comes from the line of Sid Parakh from Robins Group. Please go ahead.

Hey, good morning, gentlemen.

Morning, Sid.

Hey, Don. I have a question for you on the auto side of the business. Can you just elaborate on the outlook that you've given out for that and also a sense of the timeline and maybe the magnitude of how it might impact CTS? What you could also talk about that would be great is if you could tell us more about how new products or to what extent new products can offset any such impact?

Well, first of all, one of the comments I made looking forward to the next quarter, I alluded to kind of a soft sales environment that we're seeing, right now in North America, in particular. Below that kind of topline environment, our mix changes that are going on between the various OEMs, and we have different levels of penetration with the North American OEMs versus what you might call the transplants, although a lot of them have been around for a long time. So as those mix changes occur, we get hit harder when the Big Three lose sales relative to the transplants, and we've been seeing some of that going on. Some of it may be due to gas prices and other factors. So that's certainly affecting us in the short term. In the longer term, as I've talked about in the past, we have been diversifying our customer base. I talked about Toyota, for example, in my comments. And obviously our position with them is growing, as it is with other transplants. And so in the longer term, the issues that are affecting us in the short term I expect to go away. The new product opportunities that we're seeing and the capture rates that we're experiencing continue to indicate to us that we can expect our automotive product sales to grow in double digits, in the teens. We see nothing different about that over the longer term.

Okay. Also, I guess, one of the things that you did do by revising your guidance was remove a component of your communications or expected sales from communications equipment to Asian companies. What do you think is the likelihood of still getting that business by the end of this year? And do you think it's, say, the early part of next year or is it not there?

Well, first of all, I think it's getting to the point where the supply chain lead-times just won't allow you to capture much anymore this year. So that's why we took it out of the guidance. In terms of when and if it will come, that's a good question. I think that the fundamental needs are still there. The question is, as time goes by, will they change the approach to filling those needs, and I don't have a good answer for that, right now. It's out of the consideration for the quarter. That's about as far as we can see with any accuracy on this one.

Okay. And as far as, say, raw material pricing goes, have you seen any notable increase in raw material prices?

Not that have had any significant effect on us. I mean we do see it and we use a certain amount of gold; and we use a certain amount of silver. We are exposed to price increases in molded plastics, because of oil, and that kind of thing. But it's not of a magnitude that has a material effect on the business.

Okay. And, Vinod, can you give me the SMTEK sales number for the quarter?

I'll give you the SMTEK sales, but I would remind you that as we go forward, we're seeing more and more mixing of the locations and sales. Having said that, SMTEK sales in the third quarter were 24.7 million.

24.7. Now, it is --

(Inaudible).

Say that again?

24.7 million.

Okay. Now, is it fair to assume that this is below what you were originally forecasting when the acquisition was done?

When the acquisition was done, it is true that these sales were slightly lower than what we were projecting. Having said that, their operating earnings or contributions are considerably higher than what we expected. So sales lower, but margins higher.

You get into a difficult thing here in determining would the new sales belong to the SMTEK or do they belong to the legacy EMS business. And so when we look at this, we tend to look at it in terms of almost like main customer sales.

Okay. Okay. And maybe one final question. The trends that you saw with HP, for instance, you saw a 3.4 million decline in revenues. Is that just only a quarterly fluctuation or are you seeing some underlying trend there?

I don't think there is any underlying trend there at all. As I said, the unit volumes are actually up. The product mix changes, that affects it. When we moved the products from North America and Europe into Singapore, there were some fairly significant cost reductions and, therefore, price reductions that went with that. So some of it is due to that. I don't see anything in it of any long-term nature, and I'm not worried about it.

All right. Thank you very much, gentlemen.

Our next question comes from the line of John Franzreb from Sidoti and Company. Please go ahead.

Good morning, gentlemen.

Morning, John.

Morning.

I want to go back to SMTEK. From what I recall, it has a much more diverse customer base than the legacy EMS business. Could you provide some color about what part of that customer base is weak or strong for SMTEK?

I don't know that I could characterize that very well. We saw some weakness, I'll say, relative, but it's more short-term. I don't think it's long-term in the Aerospace & Defense side. As you know, some of this is -- and defense programs, you know, programs come and go. The comment I'm making is probably looking at program cycles as much as anything. I don't know that there is anything underlying that I would see as a trend there.

Okay. All right. Don, you mentioned mix changes in the automotive market. And if I heard your comments correctly, you kind of referenced gas. Does that suggest that you have more exposure to SUVs in the automotive market than regular vehicles or sedans?

No. Actually, it doesn't. We've looked at this, and we're pretty evenly balanced. It's probably more a function of the particular vehicle as opposed to the class of vehicle that affects us.

I think we're pretty well spread between difference sizes of vehicles.

Yes.

Okay. And lastly, regarding the sales, the gross sales to China, (inaudible) chain was a -- I think it was a 6-month lead-time that was necessary. Is that true? And if that's the case, are we looking at pushback sales, as they kind of figure what they want -- what their buying patterns are going to be or do you think these are actual loss?

No. First of all, I want to -- the lead-time for the supply chain is actually only in a month to 2 months range --

Okay.

-- for most of what we do. Some of the assemblies that we get that go into these products come through our customer, and I'm not sure what their lead-times are on all of those assemblies. That could be different. I'm just talking about the material that we go get directly and our time to manufacture it. So it's not that long. But we're close enough to the end of the year that you couldn't alter the year much anymore --

Right.

-- even if the order came in.

So do you think that these are lost revenue opportunities or are they just being pushed back into some kind of the '06 timeframe?

As I mentioned a moment ago, I think the fundamental demand is still there. But as time goes by, you always have to worry about the nature of the solution changing.

Can you explain that to me?

Well, if you go back a year ago, they were buying base stations from a particular OEM to satisfy their needs. So I think they still have need for additional base station capacity, but they could end up solving the problem a different way. They might shift protocols emphasis. They might shift to a different OEM. I have no idea what they are going to do. And I'm not saying they are or even projecting that they will. I'm just saying I think the underlying need is still there. And for whatever reasons, their order has been delayed. And when it will come, I don't know.

Okay. Thank you very much.

Next question comes from the line of Scott Merlis from Thomas Weisel. Please go ahead.

Hi, everybody

Hi, Scott.

Can you review what percent of your automotive sales is to Europe?

It's -- I would say roughly 23% of that is Europe. No. I think that --

We've got the wrong number.

I think 23% of our total sales are automotive, and out of that, I will be giving you a rough guess, and if I'm way off, I'll call you back. I would think that no more than 20% of that number would be Europe,20% to 25%.

Higher, higher.

Okay. Because production was down there -- was down about 3% across there, and you didn't feel it very much, I guess, in automotive?

We're about 12 to 13% in Asia. I don't have the numbers handy in front of me right here. So 60 to 65 in North America and the rest is Europe.

That is (inaudible) 25 or so.

So -- but you didn't see much of the production drag here, did you? Production was down about 3% in the third quarter in Europe. Did Europe pick content growth and penetration just kind of overwhelm that?

Yes. I mean, we make projections as to what we think we're going to see. And we have seen some of the just underlying demand soften through the year from what we had expected. So Europe has been down during the course of the year and North America has been down from a production standpoint.

Okay. So your content growth and penetration is just offsetting that?

Absolutely.

We didn't see any indication to tell us that the (inaudible) having an impact on our shipments.

Got you. So that was a head win, but it will be interesting to see what happens in this tail win too, but good. Also the cash flow numbers that you just -- you implied cash flow numbers for the fourth quarter when you gave year-to-date and then full-year. I guess that looks kind of normal. Would you describe that as normal seasonality or am I missing something unusual there?

No. We have said all along that this year we'll probably see our capital expenditure to be tilted more toward the fourth quarter. And although our full-year capital expenditure is normal to on the low end, we have a disproportionately bigger piece of the capital expenditure timing happening in the fourth quarter.

Got you.

So that would indicate that our free cash flow would be -- we're guessing in the range of 2 million to 5 million for the fourth quarter primarily because we have a higher percent of capital expenditure being incurred in the fourth quarter.

Got you. Great. Well, thanks a lot. So I go back as I have no more questions.

Thank you, John.

Thank you. Once again ladies and gentlemen, if you do have a question, please press "star" "one" at this time. Our next question comes from the line of Kevin Kessel from Bear Stearns. Please go ahead.

Good afternoon, guys.

Hi, Kevin.

Hi, Kevin.

Question back on the guidance, if you look at the guidance where it was a quarter ago, I know that you obviously spoke about the China Unicom taking that out of the numbers, but how would you break out the actual impact here because, on the top end, it ranges about a $40 million reduction. And when I look at it, there is no way China Unicom could maybe even be half of that. It would seem like that would be even too large for it. So how would you breakout the difference there in terms of the delta?

I'm not going to get to specifics but I would tell you in general, that the China Unicom -- if we look at infrastructure in Asia, not just China Unicom, okay? They're a big one. But if you look at infrastructure in Asia in terms of what we have been talking about and expecting, it clearly could be half. Okay, but if I just take a different factor and I say, if I look at our experience in the kinds of swings that we see in volumes for HP and Motorola, we can easily get 20 million in a quarter, kind of swing. And we've seen it before and we could see it again.

And so when we are sitting back there at the end of second quarter, looking at that plus the impacts of things like the automotive demand that I talked about and so on, all that's been taken into account on the top end. The infrastructure demand kinds of things we talked about really didn't play into the bottom into the guidance before. So that's more just kind of other things that we are seeing going on in the market.

Okay. So then infrastructure maybe could make up half of that, would you say the remaining half of that might be more focused on the -- on just automotive being little bit weaker than expected in the fourth quarter?

No. It's more in other EMS; the top end is almost all on the EMS side.

Okay.

And Kevin, that is the reason that despite that drop, we are not deflecting much of a change or drop in the EPS and that is primarily because most of it, if not all of it, is coming primarily from EMS side of the game.

Okay. And would you say the other -- the EMS, is that due to programs being delayed, is it just program weakness? What would you say about the other half?

It's so many different kind of things that will play into it. And obviously, we just talked about the Asian demand situation. There's mix issues that play into it.

Timing can be an issue.

Yes.

Q4 this year versus early next year.

You know, we got some defense customers, and budget timings plays into it. We're just getting used to some of that stuff.

Okay. That being said, it seems like the guidance though is still implying on the bottom end of the range 5% growth over the top and almost 20% sequential growth. Is there a reason, first of all, that it's so wide here going into the last quarter? And then secondly, what are the assumptions behind that sequential growth? Where are you expecting it to come from?

Well, you still see the ability in the EMS arena to see some pretty good size swings.

And what's your larger customer size in there?

Yes, even some of the smaller ones, we can see some pretty good size swings in that area.

Okay.

The lead times are short enough.

So it's more, I mean -- but what about auto? I mean are you expecting (inaudible)?

I'm more worried about auto being softer than I am about -- the auto is not likely to jump up on the other side. So you watch the first couple of weeks of October and say, "What do we got here?"

Right. So mainly it's predicated around just better EMS growth in the fourth quarter or just sequentially of the EMS growth --

Yes.

-- from primarily -- I mean across the board, obviously your two larger customers would dictate most of that?

Yes.

And it seems like communication infrastructure was actually up sequentially despite the delay with China Unicom, it seems like overall that --

There was -- yes, there was some increase.

Okay. Can you remind us quickly who your top five auto customers are?

Yes. I think Delphi will be a large one. Obviously, Visteon is another large automotive customer. In addition, we have Pierburg, Magneti Marelli, KSR International. Those are the top customers today.

Bigger than the Fords and the GMs?

Yes. I mean a lot of Delphi products ends up with GM, and Visteon ends up with Ford. Pierburg products ends up at Volkswagen and Renault. Magneti Marelli products shows up with Fiat and DaimlerChrysler, for example. And as we keep talking about Toyota and ramping up there, I wouldn't be surprised to see those guys in the top five in the next year or so.

Okay. And then if I look at your cash actually in the quarter, the -- because of the CapEx, you actually had negative free cash flow, yet your cash balance rose and you also bought back stocks. I'm just trying to reconcile it all with what is happening in terms of cash flow. Did you draw down your revolver or --

Yes. The revolver drawn was a little bit higher. So, yes, the revolver fluctuates. And I think the debt component was a little bit higher this quarter to offset that.

Okay. Didn't you know how much or where the revolver ended the quarter at?

Yes. I think --

How much was drawn?

I think the overall debt was higher -- trying to find the debt sheet here. I can't easily find that, Kevin.

Okay.

That's -- if I go back to you, my guess is it's 4 million or 5 million higher this quarter from last quarter.

Okay. And then you guys gave CapEx for the year. Do you have an expectation for CapEx for next year assuming you are building on Czech Republic as we speak?

Czech Republic will probably not be a major drain because the building is leased or we will be leasing the building, and a large portion of equipment will be a transfer instead of buying new equipment. I think we will probably continue to see clearly our CapEx in the range we talk about, 3% to 5%. And I suspect it will be again on the lower end of our range than higher end of our range.

Okay.

So 3, 3.5% of sales.

Great. All right. Thanks, guys.

Thank you. Our next question comes from line of Greg McGowan from Value Line. Please go ahead.

Thank you very much. My first question is if you can break out EMS by end market as percent of segment sales for me? Do you have that number handy?

A large part of EMS sales go into computing.

Yes. (Inaudible) last quarter, right?

Yes, I have that change much from that.

So it pretty much looks like it did last quarter, the next, right?

Yes.

The next quarter would be pretty similar. The second largest piece of that is, obviously, communication. That's where the Motorola comes into the play.

Right. Okay. And how much of your sales were HP and Motorola?

You know, we have a very good story there. HP sales as a percent of total of company year-to-date is down to less than 30%, 28, 29%.

Okay.

This number last year was 33% and Motorola last year was 13% of the total company, 13.2% exactly and this year that number is below 10% -- 7.6%.

Okay.

And if you look at the two combined, last year those guys were roughly 47% of the company, this year, year-to-date they are 36.

Right, right.

So we really have only one customer which is higher than 10%. Everything else, including Motorola, is now in single digits customer.

Okay.

And actually, other than these, two everybody else falls below 5%.

Got it.

I think really the other thing that's important here is that especially in the case of Motorola it's important to look upon them as, in many ways, multiple customers because we sell EMS services to them for a variety of different kinds of applications and we sell component to them, components that go in to Telematics application, components that go into base stations, so again it's a variety of in-markets, different divisions within Motorola that we sell to.

All right. Okay. And you have done some good work on controlling cost and also in SG&A. As we go in the next few quarters, do you think that you will be able to keep SG&A contained to within, say, 11.5% of sales from the next few quarters?

Well, of our total operating expenses as a percent of sales this quarter was --

It's 10.8, right.

No, I'm looking at SG&A and R&D combined.

Okay.

That is number is around 13, 13.3. We have continuously brought that number down from 18, 19% range in the last couple of years and we bring it -- we continue to bring it down. We used to say that our target is 13 to 13.5. But as EMS has become a bigger part of the company, we think we can do better than that and we're trying to come up with lower targets. I would think that in the next couple of years, that number will continue to go down more towards the 12, 12.5% range.

Okay. All right. And one last question, did SMTEK exceed $1 million in operating profit in the quarter?

We have not broken our SMTEK profits and all we have said is that what we plan for their performance is better.

Okay. All right. Thank you very much.

If I'm recycled back to Kevin, Kevin, you had a question around debt. Our debt balance has gone up $9 million, which is funding all these activities.

Our next question comes from the line of Greg Weaver from Curian Capital. Please go ahead.

Hi. Don, could you give us a little more color on the Ford situation? You mentioned about the occupant classification system, I guess, the decisions by year end? And then, the other thing was you said about two new seat platform configuration sensors, was it?

Yes. Let me clarify a little bit. What we are doing is, what's called IR testing right now, and that's just validating the product in more of a production configuration, meets all of the requirements. It's much more comprehensive set of tests than you typically go through when you are doing some developmental testing with a customer. So it's pretty comprehensive testing, that will be done, targeted to be done by the end of the year and when you finish that, what that really says is that the platform people are in a position where they can adopt this for use in the platforms. Doesn't mean you've got an order, doesn't mean anything other than you can use it, it will work, etc.

Now, logically, we would expect that if we get in that situation, that's a pretty good place to be and we would hope that it would mean we would move forward toward an order. The other thing I commented on is that we're actually working with them on specific sensor configurations for two different seat platforms. So depending upon the seat platform, you have to modify the mounting, etc., and the sensors and get that kind of work done. And we are working with them on that. So that's also a very positive sign. They are investing their time and effort, and we are investing ours. And those are targeted at future vehicles. Now, all that being said, obviously, we still have to complete the testing successfully. We have to get through all the commercial knotholes and I would assume that they are looking at various kinds of technologies that they might use and what mixture they might want to have them on different vehicles, but it's very positive.

So is the latter thing about the two seat platforms, is that related to the occupant classification system?

Yes, it is.

Right. So what does that mean? Sorry.

It's related to the sensors that are used in there. This is a next generation weight-based classification system. And in the next generation systems, the actual design of the seat changes to accommodate these different kinds of sensors. So you have to -- and different manufacturers make these seats slightly different and they have to be different for different vehicle platforms to accommodate the vehicle. And so the sensors have to be modified slightly to work in the different vehicle and different configuration. So once you have one, you can just put it in every car, for example. It's going to be different from vehicle to vehicle, the part. I'll say seat vehicle combination to seat vehicle combination.

So the sensors -- the occupant clarifications sensors that you're doing IR testing for today aren't the ones that go in the seat?

Yes. They are but there -- that's a baseline configuration. So you're really testing the sensor technology more so than the specifics of the mounting technology. They are -- obviously, they have mounts on them and their mounts are very similar to what would expect to see for various seat platforms. But they are not designed for a particular vehicle.

Okay. So this sounds like it's a ways out yet. I mean, my recollection was that I thought they were going to decide on a vendor by year end or that's not the case?

I think when we first talked about that and we thought that they might to a point where they could and would make a decision by year end. I think it's going to move probably into next year. All the factors that go into that, I am not sure. I mean, testing has gone very well; that has not been an issue. So when a new product like this, a completely new product that has to integrate the vehicle differently so the seats are different, the vehicles are different and stuff like that, the lead times on these are fairly long.

So this is model year '08 kind of stuff?

It's '08, '09 kind of model year, as you look that kind of lead time.

Okay. And Vinod on the Delphi exposure, what's the current accounts receivable exposure there?

The total receivables we have to Delphi is somewhere around 2.5 million, 2.8 million. However, a portion of it, roughly 700,000, is what we call the administrative piece of it, which we think we will get. It's considered three Chapter 11 numbers. So we'll we don't see any exposure there. So the two exposure we have is on net receivables of, I believe, approximately $2 million. So that's the magnitude [upward] three Chapter 11 receivables, which we need to look at and decide that how much of that we want to satisfy in the reserve on the risk point of view.

Okay. That's how we get 500k because it's a subset of the total at this point?

Yes. I mean, that's a guess on my part that if I have $2 million and three Chapter 11 kind of exposure to Delphi, what would be the prudent amount of reserve we would like to see at the end of the year.

Okay. Thank you.

Thank you. And once again, ladies and gentlemen, if you do have a question, please press "star, one".

Our next question comes from the line of Simon Wallace (sic) from Gabriel Company, please go ahead.

Hi, guys. This is Simon Novelli.

Hi, Simon.

Hi. Just had a question with regards to the SMTEK acquisition, it was supposed to bring in some industries that were outside your -- guess who you'd been beforehand. And then I guess a few questions that we heard that end market mix has been relatively constant over the last few quarters. Can you talk about where you're expectations were when you made the acquisition and where they are now with your ability to penetrate those new markets?

Yes. I think when we got them, we had talked about that. We are getting into the industrial, medical, defense kind of areas. And if you look at SMTEK -- if we look at SMTEK mix between those industries, it's fairly close to what we thought we will get. So SMTEK sale is roughly 30% is in industrial and 30, 28, 30% is in medical. And those mix between those categories of industries where we did not have any penetration to talk about before the acquisition, that is turning out to be pretty close to what we thought.

And if we're having this conversation 18 months from now, do you see any change to that organization? Do you think it'll be more or less for the representation (inaudible) as a former SMTEK business?

I think, well, see the -- just I think we'll see the -- and I would expect to see that the markets such as the aerospace and defense markets, the medical markets, the industrial markets will grow, particularly the medical and aerospace and defense side will probably grow or move faster than some of the other ones.

And just from the contract point of view with customers, is there any real difference with customers in those markets versus your more traditional, the computing communications markets for in it?

One of the differences is the certifications that are required. We have to have either medical or aerospace certifications for a lot of that manufacturing work, so there's some different kind of barriers and different kinds of capabilities you've got to have, and the kind of work we do, it's not vastly differently. We're talking about PCBA, where box build test, logistic, that's not very different. And maybe your question was going a different place.

Well, I just was trying to get a sense of how long it takes to win a new customer there or how long customer contracts might be there versus in your traditional business?

Okay. If I understand you correct -- first of all, those products typically are stickier.

Okay. That's what I'm getting at.

They're not easy to move. So if you don't screw up, you're going to pretty much stay with the life of the product.

Okay. And then just one half, you can point. Can you repeat the operating income and issue the segments for the last quarter?

Yes. I think operating income in Component and Sensors segment in the third quarter was 7.1 million and if you compare that with the same quarter last year, that was 4.6 million.

Okay.

And CMS business in the third quarter of '05, operating earnings were 2.1 million and in the same quarter last year, that number was 1.3 million.

Great. Thanks a lot, guys.

Thank you.

Next comes from the line of Kevin Kessel from Bear Stearns. Please go ahead.

Yes. I just wanted to see, could you give us the change in auto sequentially, how much it was down?

I think year-over-year you talked about was up 16%, 17%. Yes, it was down -- sequentially it was down about 11%.

Okay. And was that a little bit weaker than you guys were expecting because I'm trying also to look at -- in the quarter, it seems like revenues were just a couple million lighter than we expected. I think we had a higher auto estimate so I just wanted to get sense of where you guys expected?

It was lighter than we expected.

Okay. And I think you -- when you in the beginning of the call you gave changes for HP and Motorola. I think that was a year-over-year, if I'm not mistaken?

Yes. It was.

Do you have anything there sequentially?

HP and Motorola on a sequential basis, sequentially, HP was down, Motorola was up.

Can you say how much or relatively?

I think sequentially HP was down roughly $3 million --

Yes.

-- slightly.

Yes. And Motorola was up about 2.

Okay. And then Vinod on the stock --

That's in the EMS side -- excuse me, what I'm --.

That was their EMS not their total?

Yes.

But total was up too.

Yes. It was little less than that -- less than total.

Yes. Million and half, still higher --

Okay.

-- which is a 10 increase.

Yes.

Right. And then, Vinod, on the stock buyback, based on my calculation, it seems like you guys still have authorization to buy about 173,000 more shares.

That's exactly right.

And I think that's expires, what, July of next year, is that correct?

I don't know. Yes. I think we did say that it's a two year program.

Two year program. So at this point, it seems like you guys have continued to act on it and is that the intention going forward or do you expect to need to extend the authorization or change it or increase it or anything?

Well, at the speed we have done so far, I mean, I'd -- last thing I would think about is extension.

Right. And I guess in terms of maybe authorizing additional?

Whole debt. We continued to look at those things and will watch it and look at all the variables and the board continues to review that. So it's hard for me to predict that when they will come out with that decision.

Okay. The LTCC business, which is being sold, when do you guys expect that to fully move away from the revenue base?

In fourth quarter.

So it'll be out by Q1?

Yes.

So there is an impact in Q4 then, I guess? It seems like, what, about a $2 million or so, a quarterly impact?

Yes. I think we should be wrapped up with that by the end of November or early December of this year.

Okay. And are there any expectations for the cash flow you might receive from selling that West Lafayette facility?

Nothing material there.

Okay.

West Lafayette facility, it would be couple of million dollars range.

Okay.

I shouldn't say, not material. Couple of million dollars is lot of money. I'm getting dirty looks from my boss, saying $2 million is not a big amount.

All right. And then just two last housekeeping questions. You mentioned five new EMS wins in the quarter. Is there any expectation for what those might add to next year's sales?

A couple of them are NPI kinds of thing and they take a while to ramp-up, so I don't have good solid numbers. I don't think any of these things are going to -- are expected to jump to really high volumes next year.

And then depreciation --

We expect it grow but did not expect a jump.

So maybe a couple of million, low single-digits?

I think it's more than that. I don't have this stuff handy.

Vinod, did you have depreciation and amortization in the quarter?

Yes. The depreciation in the quarter was $5.4 million and amortization was $0.8 million.

Okay. And then, you guys (aren't) required to expense stock options until next year. But do you have some estimation in terms of what kind of impact you think that will have?

Yes. I think the impact -- the preliminary estimates we have -- it may change -- is that the pre-tax impact would be no more than $1 million.

For the year?

For the year.

All right. Okay.

Fairly small number for us.

Right. And that's what we were thinking. Okay. Great. Thank you very much.

Your question from the line of Greg McGowan from Value Line. Please go ahead.

Thanks. One quick one because I know we are at the end. Priorities for cash, can you kind of remind us, acquisitions, debt reductions, share repurchase and dividend, the parities of of those?

Please repeat your question.

Sure. In terms of priorities for cash, can you just give us the priorities there in terms of acquisitions versus debt reduction, share repurchase and dividend?

Well, there isn't much debt reduction to take place. We really don't have much debt to speak of.

Right.

All our debt primarily is showing up on the books is the two converts.

Right..

So debt reduction is not a big deal for us, obviously. Acquisition continues to be a focus and we will continue to look at opportunities from an acquisition point of view.

Okay. Very good. Thank you.

Thank you. At this time, we have no further questions. Please continue.

I would like to remind our listeners that a replay of this conference call will be available from 4:15 PM Eastern Daylight Time today through 11:59 AM on Wednesday November 2nd 2005. The telephone number for the replay is 800-475-6701 or 320-365-3844, if calling outside the US. The access code is 798801 and thank you for joining us today.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.