CTS Corp (CTS) 2006 Q2 法說會逐字稿

Welcome to the CTS Q2 Quarterly Results Conference Call. [Operator Instructions]

At this time I would now like to turn the conference over to our host Mr. Mitch Walorski, who is the Director of Investor Relations. Sir, you may now begin your call.

Thank you Craig. I am Mitch Walorski, Director of Investor Relations and I will host the CTS Corporation Second Quarter 2006 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 on 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 Web site in the Investor Relations section.

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

Thank you Mitch. Last night we reported our second quarter financial results for fiscal 2006. Sales of $165.9 million were up nearly 5% over the second quarter last year and essentially met our expectations for the quarter.

Fully diluted earnings per share of $0.16 were slightly stronger than expected. This amount included a $0.03 per share negative impact from the previously announced closing of our Berne, Indiana operation and the associated transfer of those operations to other facilities. Excluding these unusual expenses, fully diluted earnings per share of $0.19 compared favorably to the second quarter adjusted EPS of $0.17 per diluted share last year.

For purposes of this comparison, I have added back two unusual tax adjustments last year that had a net negative impact on earnings of $0.07 per share.

Both our business segments, electronic manufacturing services and components and sensors, showed growth. Sales of electronic manufacturing services were up about 3% for the quarter on a year-over-year basis and up nearly 14% sequentially.

This growth was achieved even though EMS sales to Hewlett-Packard, our largest customer, were essentially flat to the first quarter and were down 16% year-over-year reflecting mix changes and cost reductions passed through to HP though unit volumes were up slightly. This decline at HP was offset by 19% year-over-year growth in sales to other customers.

Sales of components and sensors increased 7.9% year-over-year, paced by roughly 12% year-over-year growth in automotive product sales. This was a little softer than we expected, driven by weaker auto sales by the big three in North America and by slow sales of certain European models where we have high content. On the other hand, automotive product sales in China more than doubled, though the base at about $2 million in the quarter is still fairly small.

During the quarter we received additional awards from two customers for accelerator pedal modules, increasing the number of captured platforms to 47. Of particular note, we received our first production award from Honda. This is a key win as they are a major global automotive OEM.

We also have seen growing interest in our actuator products and expect this area to become an increasingly important growth driver.

While automotive product sales were slightly weaker than expected, sales of electronic components into non-automotive markets were stronger than expected -- one of the blessings of diversification.

Infrastructure markets were particularly strong with sales up over 30% year-over-year. As we have reported on many occasions, growing our infrastructure-related components business has been a key growth strategy for several years. We have focused our sales efforts on infrastructure applications, aggressively added new products, and dramatically shortened design cycles and production lead times to better support customers.

This initiative has proven to be very successful with sales growth averaging over 20% a year for the last few years.

Annual component sales into infrastructure applications are currently running at about $40 million per year and margins are good. During the quarter we recorded another 54 design wins for infrastructure applications. This is a record and is a very positive indicator of continued strong revenue growth for infrastructure components.

Almost half the design wins are for 3G base station applications. Another nine wins are for WiMAX applications.

While still in its infancy, WiMAX demand is projected to grow dramatically in the years ahead. As a result, sales of WiMAX infrastructure equipment are expected to grow by a factor of 10 by 2009.

CTS is very well positioned to participate in this growth as we have design wins with a broad range of equipment providers.

From an operational perspective, the consolidation and restructuring of our Berne operations are progressing essentially as planned and nearing completion. Most manufacturing operations have now been transferred and are up and running in their new location. Remaining transfers will be completed within the next few weeks.

We are also making good progress bringing our new Czech Republic operation online. You may recall that we initiated this expansion for our automotive products business to enable us to meet expected business growth in Europe and to better serve the increasing number of automotive OEMs manufacturing in Central and Eastern Europe.

Three production lines have now been set up in the factory. One is fully operational producing production components. The other two are in the qualification phase. Additional capability will be added as the year progresses.

While we certainly view this as a normal part of doing business, you should note that the startup of the Czech operation is having a slight negative effect on margins. This is expected to continue over the next couple of quarters.

Finally, I want to comment briefly on the outlook for the rest of the year. As I noted earlier, second quarter sales overall were inline with our expectations. While we see indicators that the general economy is slowing going into the second half of the year, we still expect sales for the full year to fall in the previously projected range. We are therefore maintaining our estimate for full-year sales growth of 6 to 8% over 2005.

Similarly, we are maintaining our estimate for adjusted diluted earnings per share to be in the range of $0.75 to $0.80. This range, incidentally, excludes the full Berne restructuring and related cost estimated to be about $0.08 per share.

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 report the second quarter earnings yesterday, which reflected strong earnings per share and free cash flow. Before I review the financial performance in more detail, I would like to briefly update you on the financial status of the consolidation of our Berne, Indiana facility, which was announced earlier this year in January.

Full-year pre-tax restructuring-related costs for the Berne restructuring were estimated to be between $4 million and $4.5 million, or approximately $0.08 per share, with a payback period of roughly one year. We incurred approximately $1.4 million of the restructuring and related costs or $0.03 per share in the second quarter. $920,000 of these costs were captured separately as restructuring charges and the rest were related costs which were included in the cost of goods sold for the quarter.

Year-to-date we have recorded a pre-tax charge of $3.6 million or $0.07 per share for the consolidation of the Berne facility.

As Don noted, consolidation activity is on track and we expect to essentially complete the process by the end of the third quarter.

We finished the second quarter with sales of $165.9 million, up 5%. However, if discontinued products like handsets, and LTCC components are excluded, sales were actually up 8.2% year-over-year.

Operating margins were 5.5%, which included Berne restructuring and related costs and stock option expensing costs of $1.4 million and $0.5 million respectively.

Excluding them, adjusted operating earnings were approximately 6.6% versus comparable operating margins of 6.5% in the same quarter last year.

GAAP diluted earnings per share for the quarter were $0.16 versus $0.10 last year. However, if Berne restructuring and related costs in the second quarter of 2006 and net repatriation and reserves-related tax expense in the second quarter last year are added back, adjusted diluted earnings per share in the second quarter would be $0.19 per share in 2006, versus $0.17 in the same period last year.

Adjusted gross margins, as a percent of sales, were 20.8%, up from 20.4% in the second quarter last year. Gross margin improvement was driven by favorable segment mix with higher margin component and sensor segment sales representing 43.2% of total sales in the second quarter of this year versus 42% in the same quarter last year.

In addition, EMS margins were higher year-over-year primarily driven by improved manufacturing efficiencies and higher mix of sales in the medical and defense related markets, which generate somewhat higher margins in the EMS segment.

Partially offsetting margin improvements were $300,000 of manufacturing overhead-related startup expenses for our new Czech Republic facility.

SG&A and R&D expenses combined were $24 million or 14.5% of sales in the second quarter of 2006, versus 13.9% of sales in the same quarter last year.

The higher expense level in the second quarter of this year was partially due to option expensing impact of approximately $500,000, lower pension income of approximately $300,000, and SG&A-related startup expenses for our new Czech Republic facility of approximately $200,000, which are over and above manufacturing-related startup expenses which we mentioned earlier.

Total other expenses in the second quarter at $0.8 million were $0.7 million lower than the same period last year. $0.5 million of this reduction was due to lower interest expense driven primarily by reduced debt levels and the rest was mainly due to favorable currency translation.

The effective tax rate in the second quarter was 23.8%, versus 23% in the same quarter last year.

Full-year 2006 effective rate is expected to be around 24.4%.

Adjusted net earnings of $7.4 million in the second quarter were up 10% year-over-year if unusual items like restructuring in 2006, and repatriation and reserve-related net-tax items in the second quarter of 2005 are excluded.

Looking at the balance sheet management, our controllable working capital as a percent of sales improved sequentially to 14.4% in the second quarter from 15.4% in the first quarter, as we improved both our receivable days and inventory turns. We expect our controllable working capital as a percent of sales to improve further by year-end.

Free cash flow for the quarter was a strong $11.4 million, versus slightly above breakeven in the first quarter and $10.8 million in the second quarter last year.

Capital expenditure was $3.4 million this year versus $2.9 million last year. We are staying with our earlier projections of full-year 2006 free cash flow between $23 and $26 million after capital expenditure in the range of $18 million to $20 million.

We finished the quarter with a debt to capital ratio of 18.2%, down sequentially from 19.7% and down from the second quarter 2005 level of 21.6%.

We have also taken some additional steps to improve our capital structure this quarter. The first one is around our revolving credit facility. Last month we put in place a new unsecured $100 million five-year credit facility, replacing the previous three-year $75 million facility which was secured by essentially all of our assets in the U.S. and a pledge of 65% of our stock in some of our international subsidiaries. The new facility has lower pricing and more accommodating financial covenants.

Also during the second quarter we paid down $5.5 million of our convertible subordinated debentures. This was the last remaining piece of our $25 million convert, which carried a 6.5% coupon.

All in all, it was a strong quarter with sales, net earnings, and free cash flow up year-over-year despite some product launch and startup expenses, stock options expensing, and unusually high inflation in certain basic materials utilized in our products.

And now I will open the call for your questions.

[Operator Instructions] Kevin Kessel.

Good morning guys. Can you talk a little bit about margins and what your expectations are going forward here in terms of at the gross line? Would you still expect to see further improvement off of Q2 levels in the second half of the year based on some of the restructuring you've been doing?

And then in terms of SG&A, where are you targeting that? It was up obviously on a sequential basis in terms of dollars quite a bit but where are you targeting dollars going forward and that as a percentage of sales?

From the gross margin perspective Kevin, you are correct, we should see some gross margin improvement due to the fact that Berne restructuring should essentially be wrapped up by the end of third quarter. And so to that extent we expect gross margins to improve.

The piece of gross margins which is very difficult to accurately forecast is the mix between the products and we continue to see changes in that. Some of it can be within our segments, which we expect to improve. As on the EMS side we do more defense and military kind of products and medical kind of products, which carry higher margins. However, the exact impact on gross margins from the fluctuation in the segment mix is more difficult to project. But the basic changes should be positive to the gross margins.

On the SG&A line, our longer-term projections are continue to find more leverage in that number. However, this year, especially when you do year-over-year comparisons, we do need to keep in mind that options expensing and lower pension income overall has a slightly negative impact when you make those comparisons.

Okay. And then in terms of September for you guys, traditionally it's been a seasonally down kind of revenue quarter. Would there be any reason to believe that that would be different this time around?

Third quarter because of shutdowns and all that have traditionally been softer. We don't see any reason to indicate that it will be any different from it.

That only affects the automotive piece of the business and so we would expect that to hold true.

But then-- but even in your EMS business Don would you expect EMS--?

We don't see that to have those seasonal characteristics.

And then can you talk about the revenue generating capacity of your new Czech Republic plant.

At this point in time we're still ramping up revenue. The revenue that we would expect to get out of there this-- the last half of the year is going to be in the mid-single digits kind of range. So that's like a half a year and we'll ramp up a little bit more probably beyond that as we go into next year.

And then customers. Can you give us the customer percentages that were over 10% and how they compared to last quarter?

The only customer who is about 10% is HP. However, as the trend has been in the last several years we continue to lower that percent and in the second quarter, if you look at standalone customers, I believe around 22, 24% continues to come down. And the other customer which comes very close to that and may begin to get into the 10% category is Motorola, where actually their percent continues to improve but technically they are still below 10% so we don't break them out.

So in the quarter I think HP last quarter was 25% if I'm not mistaken. Did you just say it was 24%?

22%.

It was 22%. Okay, great. And 25% was correct the last quarter?

Yes. It's actually 24.5% so yes, 25% gets rounded.

Okay, thank you.

Scott Merlis.

Good morning everybody. In terms of modeling EMS for the second half, does this mix shift continue and does it help margins? Does HP come back? And any thoughts on that? And is the growth more in-- and any more specifics on the 19% growth would be of interest too.

I'll take the first part of the question and Don can comment on the 19% growth. It's hard to project HP on a short-term basis quarter-to-quarter. However, longer term I would think that since our focus has been in these other areas we have talked about, I would think that HP percent will continue to come down. As we have stated that diversification efforts will make that number smaller and smaller as a percent.

That should-- considering everything else being equal, should have a slightly positive impact on our gross margins because, as we have stated, defense and medical EMS business tends to carry slightly higher gross margins.

So yes, that percent should continue to come down over time, and yes, it should have some positive impact on gross margin.

And use of excess cash as it builds up towards the end of the year?

Use of excess cash is a question which the board continues to look at and they will continue to look at initiatives around acquisitions. Or historically you know we have looked at buybacks and the board will continue to look at it on an ongoing basis.

All right. Okay, thank you.

[Operator Instructions] Excuse me, Mr. Walorski, at this time there do not appear to be any further questions. Please continue with any comments you may have.

I would like to remind our listeners that a replay of this conference call will be available from 4:15 pm today to 11:59 pm on Thursday, August 3rd. The telephone number for the replay is 800-475-6701 or 320-365-3844 if calling from outside the U.S. The access code is 836003. And thank you for joining us today.