CTS Corp (CTS) 2006 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the CTS Corporation fourth quarter and full year 2006 earnings. 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. (Operator Instructions.) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host today, Mr. Mitch Walorski. Please begin, sir.

Thank you, Sean. I'm Mitch Walorski, Director of Planning and Investor Relations, and I will host the CTS Corporation's Fourth 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 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 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 finally released our fourth quarter financial results as well as restated financial results for 2005. As you probably know, the release of this information was delayed because of accounting irregularities which were discovered in one of our EMS locations just before the originally planned earnings release in late January. The magnitude and character of the irregularities was such that management and the Audit Committee of the Board felt it advisable to conduct a comprehensive investigation, including use of independent forensic accountants and outside legal experts. That investigation has now been completed, and restated financial statements have been turned over to our auditors for their final review. Once that review is done, we will file our 10-K and amended 10-Qs for 2006, which we now expect will occur around the middle of May. Within a few weeks after that, we expect to release first quarter results for 2007.

The restated financial statements will show a reduction to the Company's previously released net earnings by $1.5 million for 2005 and by $1.9 million for the first three quarters of 2006. This equates to a diluted per share impact of $0.04 in 2005 and $0.05 in 2006. Unfortunately, the erroneous accounting entries masked the true profitability of our EMS business. Once visible, we were able to identify several operational problems that contributed to the weaker financial results, some of which were quite easy to fix. Others will take longer. In any case, the organization is aggressively tackling the issues they have identified, and we look for steadily improving profitability going forward. Vinod will provide further details on this issue in a moment.

Before that, I want to provide at least some commentary on Q4 and full year results, even though some of this might be stale news at this point. Sales in Q4 of $173.5 million were up 12.2% year over year and up 4.7% sequentially. Sales for the full year were $655.6 million, up 6.2% over 2005, our fourth consecutive year of sales growth. Diluted earnings per share in the quarter were $0.20 versus $0.19 as restated in the fourth quarter of 2005.

Earnings in the quarter were hurt by the continuing impact of the automotive product launch issues which I discussed in the third quarter conference call, also by the significant weakening of the U.S. dollar versus foreign currencies which occurred in the quarter, and of course, by the operational issues in our EMS business that had originally been masked by the accounting irregularities. Additionally, both sales and earnings were negatively impacted by further production cutbacks by the Big Three and by a significant falloff in demand for communications-related electronic components and EMS services that developed late in the quarter.

On a segment basis, the Component and Sensors segment had Q4 sales of $65.7 million, which is up about 5% over the fourth quarter of 2005. This was driven by double-digit growth in automotive product sales, offset by component sales declines in the computing infrastructure and mobile handset applications.

Comparisons were also negatively impacted by the divestiture of our LTCC operation late in Q4 of 2005. Component sales in the communications infrastructure applications grew only about 5% quarter over quarter, which was significantly lower than the strong double-digit growth rates we saw in the previous three quarters. As I noted a moment ago, we saw a sharp cutback in demand for communications infrastructure components during the latter part of the quarter, which incidentally continued into Q1.

Despite the Q4 slowdown, component sales in the communications infrastructure applications on a full-year basis were up about 22% year over year, continuing the strong growth trend that we have seen now for several years. For us, an important indicator of future growth has been design wins for our components, and the fourth quarter produced another record, as we obtained 62 design wins in communication infrastructure applications. Total design wins on the year were 193, up almost 40% over last year, and over twice the 2004 total. These wins typically take 12 to 24 months to translate into revenue streams, though we should begin to see the benefits of some '06 wins later this year.

EMS sales in the quarter at $107.8 million were up 17% over Q4 2005, despite lower sales to HP. Sales growth was driven by both new and existing customers. During the quarter, we added 10 new customers, mostly in defense and aerospace. For the year, EMS sales were up 6%, with the strongest growth coming in the medical, defense, and aerospace markets. Sales to HP, our largest customer, were down about 20% from the fourth quarter 2005, driven by mixed changes in the end user demand for server-based storage, which we don't make for HP, versus network-attached storage products, which we do manufacture for them. HP represented about 30% of EMS sales and made up about 19% of total Company sales in Q4.

Looking back on the full year, there were several factors that had major impacts on the year's results, some market driven, and two, unfortunately, of our own making. First, automotive sales by the Big Three were down significantly year over year, materially impacting both sales and earnings. This knocked $5 million to $6 million off of our automotive sales from expectations we had at the beginning of the year.

Foreign exchange shifts were another negative factor. These shifts impacted earnings by about $0.04 over the full year, with Q4 being particularly hard hit as the dollar weakened dramatically versus the Euro and the British pound during the quarter.

Increasing commodity prices also hurt earnings, as sharp run-ups in copper, gold, silver, and oil prices cut into margins. The automotive product launch problems, which I discussed in last quarter's conference call, adversely impacted earnings in both Q3 and Q4, and of course there are the operational issues in our EMS business that were originally masked by the accounting irregularities at the Moorpark location.

Despite these issues, the year overall was pretty positive. Sales were up just over 6%, around 9% if you exclude the sales decline from the divestiture of our LTCC operation in late 2005, and the year-over-year decline in component sales to handsets, which we consciously exited. More importantly, the growth initiatives we have pursued are clearly working. Automotive product sales were up about 13%, despite the Big Three volume losses. Automotive product sales in Asia were up 40%. Electronic component sales in the infrastructure applications, which is a targeted market segment, grew 22% year over year, and EMS sales to new and existing customers other than HP grew 27%. GAAP diluted earnings per share were up almost 19%. Even when adjusted to exclude the impact of things like the Berne restructuring and related expenses in '06 and the one-time tax-related impact and gain on the LTCC sale in '05, the earnings growth is still around 16%, despite the earning hits from currency, commodities, and launch problems.

We expect 2007 to be another year of sales and earnings growth. Sales are expected to increase 7% to 10% over 2006. Automotive products and communication component sales into infrastructure applications are expected to again register double-digit growth, offsetting declines in some of our older, resistor-based components. EMS sales are expected to show single-digit growth as new customers and expanding business with existing customers are partially offset by expected volume declines in some HP storage products.

Diluted earnings per share are expected to be in the range of $0.76 to $0.80. The projected earnings range reflects improved results in our automotive operations as we implement various changes to resolve the product launch problems encountered last year, as well as margin improvement in our EMS business. The earnings guidance also reflects a negative impact of about $0.03 per share due to the cost of the investigation and additional audit fees that will be incurred as a result of the accounting misstatements previously discussed. Much of this was incurred in Q1.

Note that Q1 2007 earnings will be lower than Q1 last year, even though in sales we'll be up around 8% year over year. Q1 last year included unusually high royalty income as well as a favorable insurance settlement, which together added about $0.05 to earnings, while Q1 this year will have about $0.03 per share negative impact from the one-time costs associated with the accounting investigation. We're still feeling the lingering effects of the launch problems--excuse me---we are also still feeling the lingering effects of the launch problems, although the situation is clearly improving.

Our overall business strategy remains unchanged, as it is clearly working for us. In automotive products, we will continue to focus on expanding our products and technology offerings, broadening our customer base, and increasing our penetration into Asian markets. Under terms of the licensing and collaboration agreement signed with Sonceboz last year, we are jointly developing a new family of smart brushless motor-driven actuators and will be pursuing several significant award opportunities during the year.

Automotive product sales in Asia, which grew about 40% last year, are expected to show strong growth again this year. To support that growth, we are moving our Dongguan manufacturing operation into a new, larger building in nearby Zhongshan during the second quarter. Similarly, our electronic components business units are focused on aggressively expanding their product offerings.

Several new families of products are in development and will be introduced to market this year. Within our EMS business, we continue to pursue customers with complex products and special requirements, where our higher level of service is recognized as a value add and serves as a differentiator. We also will continue to focus on expanding our base in the medical, aerospace, defense, and industrial markets. These strategies have served us well for the past several years, and we are optimistic that they will enable us to continue to drive the Company forward. Our objective is to leverage our sales growth to enable earnings to grow faster than sales over the planning horizon. We expect 2007 to be another step in that direction.

Now I will turn the floor over to Vinod Khilnani, our CFO, who will provide further color on our financial results and expectations.

Thanks, Don, and good morning, everyone. We sure were glad to finally release our fourth quarter and full year 2006 earnings yesterday and wrap up a rather long, but necessary, independent investigation at one of our EMS locations. The investigation essentially confirmed earlier findings of management investigation of irregularities, which left a couple of key balance sheet accounts unreconciled and resulted in overstatement of gross margins and therefore operating earnings. The problematic entries in the account at issue were made by, or possibly made by, the former controller for the Moorpark facility and not discovered by management until shortly before the February 9 release. Needless to say, management has taken a series of actions to tighten controls at all levels, including addition of internal audit resources, to ensure that all reasonable steps are taken to avoid such situations from recurring.

The restatement has an impact of lowering our diluted earnings per share by $0.01 and $0.03 in Q3 and Q4 of 2005, respectively. The impact of the misstatement in 2006 is a negative $0.03 in Q1, a negative $0.02 in Q2, and a positive $0.01 in Q3. However, the three quarters of 2006 still add up to a negative impact of $0.05 on the earnings per share.

In reviewing the fourth quarter and full year 2006 financial results, therefore, we finished the quarter with sales of $173.5 million, up 12% from last year. Diluted earnings were $0.20 per share, compared to $0.19 in the 2005 fourth quarter. On a full-year basis, sales were up 6%, while diluted earnings per share increased 19% year over year, thereby continuing to demonstrate our ability to increase earnings at a much higher rate than sales.

Adjusted diluted earnings per share of $0.71, which excludes $0.08 per share for the Berne restructuring and related expenses and impairment of an idle facility, went up 16% from an adjusted diluted earnings per share in 2005. In making this comparison, please remember that 2005 full year adjusted earnings per share were $0.61, which excludes $0.08 per share due to certain tax-related adjustments from foreign cash repatriation, taxes of reversal, and gains on the sale of our LTCC operations net of certain severance costs.

Fourth quarter 2006 gross margins have 17.2%, or 3.1 percentage point lower year over year. Lower margins were driven by essentially by four major factors which impacted the growth margins roughly equally. First, EMS sales as a percent of total CTS consolidated sales were higher, at 62.1% in 2006, versus 59.7% in 2005. EMS sales inherently have lower gross margins than our Component and Sensor segment.

Second, higher commodity prices and currency impacts due to weaker U.S. dollar impacted gross margins by approximately one-tenth of a percentage point. The biggest adverse currency impact came from a 12% to 13% drop in the U.S. dollar against the British pound between Q4 of 2005 and Q4 of 2006, which alone created an unfavorable impact of approximately $1 million. Prices of commodities, like gold, silver, and palladium used in our products increased anywhere from 35% to 60% year over year, with an impact of approximately $400,000 on our gross margin. Third, continuing expense from launch-related issues, which we discussed in our third quarter earnings call, had an impact of approximately $1.3 million, or again, approximately one-tenth of a percentage point on our gross margins.

And lastly, a less favorable product mix within our Component and Sensor segment and EMS segment compared to Q4 of 2005 lowered the margins. The Components and Sensor segment was adversely affected by increased sales of certain pedal modules and new actuator products with somewhat lower margins, on the one hand, and lower sales of certain sensor products on heavy vehicles, which normally have higher margins, on the other. Negative impact on the EMS segment was caused by operational inefficiencies and new customer start-up expenses. On a full-year basis, gross margins are 19.5% in 2005, versus adjusted gross margins of 18.5% in 2006 if the Berne restructuring and related expenses, et cetera, are excluded.

SG&A and R&D expenses combined were 12% of sales in the fourth quarter of 2006 versus 13.1% in the fourth quarter of 2005. This 1.1 percentage point improvement was primarily due to higher mix of EMS business which has lower SG&A expenses. Overall, we continued to leverage our operating expenses and more than offset the adverse impact of expensing of stock options and lower pension income. On a full-year basis, SG&A and R&D expenses combined were 0.6% lower, to 13.2% of sales in 2006, versus 13.8% in 2005.

During the fourth quarter, our full-year 2006 effective tax rate was reduced to 21.1%, primarily due to a higher percentage of profit in foreign jurisdictions with lower tax rates. This compared to an effective tax rate of approximately 24.1% in 2005, if the unusual items like repatriation of foreign cash and reversal of certain tax reserves are excluded.

From the balance sheet management perspective, we had an excellent quarter and full year. Our controllable working capital, defined as inventories plus receivables minus payables as a percent of sales, steadily improved from its unusually high level of 14.7% in the first quarter to 12.7% at year end 2006. Lower inventories as we worked up our extra (inaudible) inventories which we had built up to facilitate projects like Czech Republic, plant start-up, product launches, et cetera, and higher payables helped bring the controllable working capital below our 13% target. As a result, our operating cash flow in the fourth quarter was $18.7 million versus $14.8 million in the fourth quarter of 2005. Full-year 2006 operating cash flow of $47.2 million compared with $44.5 million in 2005.

Capital expenditure for the full year 2006 at $15.8 million, or 2.4% of sales, was the same as 2005 as a percentage of sales, but somewhat lower than our earlier projected range of $16 million to $19 million.

Our record free cash flow for full year 2006 at $31.4 million included an advance payment at year end 2006 of $3 million from a customer. This essentially has the impact of improving 2006 free cash flow at the expense of 2007. However, even after excluding this $3 million, free cash flow of $28.4 million is higher than our earlier guidance of $24 million to $28 million.

We finished the year with the debt-to-capital ratio of 17.2% versus approximately 20% at year end 2005 and below our target range of 20% to 30%.

All in all, in 2006, in addition to new customers and new product introductions which Don talked about, other positives included streamlining of our manufacturing capacity by consolidating our Berne, Indiana facility and establishing our new automotive manufacturing in the Czech Republic. And from a capital structure point of view, we replaced our three-year, $75 million bank facility, which had essentially all of our assets pledged, with a new, five-year $100 million facility, which is completely unsecured and with better pricing.

On the negative side, however, we experienced a sharp drop in the value of the U.S. dollar. Most of the negative impact was due to a weaker U.S. dollar against pound sterling of 12% to 13% and against Singapore dollar of around 9%. This primarily impacted our EMS business earnings, which were adversely affected by approximately $3 million, or 0.8% of segment sales on a full year basis. Other negative factors included price escalations of certain precious metals, some unusually large and unplanned product launch expenses, and finally, the accounting misstatements which had the effect of masking lower profitability in one of our EMS locations.

Looking ahead into 2007, we see continued improvement and with financial results driven by sales growth and operational improvement. We expect our full-year 2007 gross margins to improve by approximately 100 basis points over 2006 full-year adjusted gross margin of 18.6%. Full-year effective tax rate is expected to be around 24% in 2007. Cost of free cash flow is expected to be in the range of $24 million to $27 million, with CapEx in the range of $20 million to $24 million for the full year 2007.

Keep in mind that 2006 included a gain on the sale of assets of $2.1 million, a favorable settlement of an old insurance claim of $1.5 million, and approximately $1 million in higher-than-normal royalty income, which Don talked about earlier. Despite these three items which will not recur in 2007 and the higher tax rate, which together equate to approximately $0.11 to $0.12 per share, CTS expects diluted earnings per share to increase to $0.76 to $0.80 in 2007.

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

Thank you, ladies and gentlemen. (Operator Instructions.) Our first question comes from John Franzreb from Sidoti.

Good morning, guys. My first question is regarding the SG&A line. Vinod, you said that the mix with EMS is what brought the number down. But as I look at the Q3 versus Q4, the sales were up in both the Component segment and the EMS segment sequentially, but in absolute dollar terms, SG&A was down, let's just call it roughly $1 million. Can you kind of reconcile the difference there?

John, there are obviously some adjustments as we finalize various things around either health expenses or variable compensation kind of things. We had some favorable adjustments at the end of the year which did benefit the fourth quarter.

Can you give me an approximation so, for modeling purposes, I have an accurate thought about what my SG&A line should look like?

For modeling purposes, I think the best I can say is that looking at the full-year percent is probably the best indicator of what our SG&A and R&D expenses are doing.

Okay. And regarding the accounting issues, could you tell me where those, the adjustments were? Were they mostly in cost of goods sold, or were they dispersed throughout the P&L?

They were essentially in the cost of goods sold.

Will you get an 8-K filing so that we can kind of go back and restate the numbers accordingly?

We would be filing a 2005 restated numbers in our 2006 10-K. And in addition, we will be filing first, second, and third quarters of 2006 as restated documents.

Okay. And one other question--two other questions, actually. The EPS guidance you gave. You said there's $0.03 in the investigation that's going to pop, mostly for at least into the first quarter. Is there any other numbers that we should be thinking about as one-time items in that year-ahead outlook?

That is the only one we can think of at this point, John. And that is also an estimate which we will get a better handle on, on our investigative costs, probably by the end of this month.

Okay. And the last question and I'll get back into queue. You cite the general weakness in electronic component demand in your press release. Can you talk a little bit about the component demand sales trends as you exited the year and into the first quarter?

They, the infrastructure market which I referred to started softening very late in the fourth quarter, so it was kind of a December kind of time frame. It was pretty dramatic. That continued into the early part of Q1, but it certainly has--and this has always been like this. This, that market is very, very lumpy quarter to quarter and doesn't follow a consistent pattern. So it really did worry us, but, and we've seen it come back now, so--.

Okay.

All right. Thank you very much, John.

Our next question comes from Kevin Kessel from Bear Stearns.

Thank you very much. My question, actually, is in regards to what you think for the end market right now as you go forward. You mentioned that you won 10 new EMS customers. Maybe you could help us quantify what that might mean for next year in terms of, just in general, as an aggregate, in terms of overall sales impact.

Hang on a second.

Kevin, as Don is looking for the numbers, I would say that the sales per new customer do vary quite a bit from customer to customer. For EMS, they can range anywhere from a low of $5 million, $6 million, or $7 million per year to a high of $20 million to $30 million. And the other thing that changes that is sometimes we will get a new customer because we are excited by the potential in the long term, and they may get us started on a smaller program which may only give us--pick a number--$5 million to $8 million in the first year, but we would have the potential to take that up to a much higher number in the future.

Okay.

Okay, this is rough. It's going to be, from those 10, our estimate right now is in the, oh, $15 million to $20 million range.

Okay. So these are all, for the most part, these are relatively small kind of starter-type programs with all these customers.

Yes. The size varies a lot.

Okay.

Some are bigger, some are smaller. As Vinod said, they grow over time, or the business is transferred over time.

Okay.

Kevin, another thing which will be fair to say is that, as Don indicated earlier, that most of these customers are coming to us in defense, aerospace, medical kind of fields, which has been our focus.

Okay.

Yes, if I looked at, on this, we got 20 new customers last year. Fourteen of the 20 were in medical, defense, and aerospace and industrial.

Okay. And then you mentioned Hewlett-Packard declining your--if I heard you correctly, you said they were 19% of sales in the fourth quarter?

I've got to go--I did, I did remark. I don't have that--.

Kevin, on a full-year basis in 2006, HP was actually 22% of net sales. Just to compare, in 2005 they were 28%. So they have gone from 28% to 22%, and as Don is looking, I think Don, it's 19%, probably, the first Q.

Nineteen in Q4, Q4.

Okay. Where would you expect them to go, then, if they were 22% in '06, in '07? It sounds like it's, it's slowly declining?

Yes, there's several product lines that we've manufactured for them. A few of these lines are slowly being displaced by server-based storage. So some are going down from that kind of mixed change going on, and some of the network, newer network products are growing in unit volumes. The prices for these products, however, come down fairly fast. So even with the unit volumes growing, the prices don't tend to grow a lot. As a result, when we look at the whole year, we do expect sales to HP to decline over the course of '07, and we expect the overall business to grow. So I don't have an exact number or even a range, but it will drop.

Okay. And there's, at this point, there are no new wins coming in there to offset?

From HP, you mean?

Yes.

No. They continually update these, the newer products, so that goes on fairly steadily. But there hasn't been a fundamental new line in the network-attached storage that's come out for a while.

Okay. Were there any other 10% customers?

No.

Okay. And would it be possible to give us the breakdowns and markets? Percentage breakdowns?

Hang on a minute.

I'm reading these as my colleague is handing me the sheet here. Automotive, and we're looking at full year 2006, automotive is 25%, communication is 22%, computer is 26%, and then we have medical and industrial, 7% each, and defense is 5%, which leaves 8% for the rest.

Okay. And you don't have it for Q4, do you?

I don't have it, but I'll have Mitch call you back and provide you that information.

Okay. Thank you.

Our next question comes from Lakshminarayana Ganti from Thomas Weisel.

Hello?

Hi, hello?

Hi. How are you?

I'm doing fine. How are you?

Good.

Okay. A couple of questions, first on the sales breakdown by geography. Have you given that, or can you give it to me?

Yes, we have not talked about sales breakdown by geography. I'm actually looking for it. We did not give it out, but I think we have it. You know, from a macro point of view, 60% of net sales are non-U.S., but we can also break it down by North America, Europe, and Asia.

This is a sell-to question you're asking, not where we manufacture, right?

You're talking about where we sell it to, right, not where we manufacture?

Yes. I'm talking about sales record by geography.

All right. If we look at it from a fourth quarter 2006 point of view, then roughly 50% is in North America, 14% to 15% in Europe, approximately, and the rest--roughly 35% to 36%--is in Asia-Pacific.

Okay. I think you talked a little bit about the product launch issues that you faced in Q3 and also Q4. When do you think you'll be over the hill in terms of these launch issues? And then the second question would be, how will that impact margins for, in the near term?

You know, we saw a pretty significant impact of these launches on our bottom line in Q3 and Q4 of '06. We continue to make very good progress, and we clearly see that number go down as far as the negative impact on the bottom line is concerned, but we pointed out earlier that we will see some lingering effects of that in the first quarter of '07. We hope they are gone completely by the second quarter, but again, we may have some impact on second quarter. But hopefully, by the second quarter, it will be pretty minuscule and not material. So we will see some negative impact in the first quarter from the launches.

Okay. And when will you be coming out with Q1 numbers?

We're hoping that we will be able to release our earnings for the first quarter by the end of May. We're still working out the timing internally and with our external auditors, but as soon as we file a 10-K for 2006, we will very quickly turn around and do the earnings for the first quarter--hopefully by the end of this month.

Okay. Thanks a lot, guys.

Our next question comes from Chris Hussey from Goldman Sachs.

Hi, guys. This is Joshua Pollard for Chris Hussey. How are you today?

Good. Hi, Josh.

My question is, some of our, some of your competitors in the computing segment said that it was a bit softer in the most current quarter. This may be once you, that you guys are not willing, haven't talked about yet. But we're wondering if even through the latter part of the fourth quarter, if you guys were seeing some of that same pressure? On the (inaudible), when you look out over 2007, are you expecting a pickup? Can you through those numbers again and what goes into your outlook in computing?

Our participation in the computing segment is primarily through our EMS business, and it relates to the storage business. So we don't have the kind of general exposure that might tell us or give us a feel for market trends overall. So I don't think that--I don't even have the information. But even if I had the information of our, specifically of what was happening in some of our components, I don't think it would be meaningful in this regard.

And anything as far as an outlook in '07, as far as the computing segment for you guys?

Again, it's pretty much driven by the EMS side of the business, and most of our participation is through HP, our largest customer.

Okay. And my last question, and I'll just jump back in the queue. Could you guys provide any color on growth in aerospace, medical, and defense, if you guys can?

Again, most of our business in that arena is EMS business. We do sell some components in there, but that's pretty small. And it's really driven by, our growth is driven by our ability to attract customers, and then their success in the marketplace. But it's certainly more so by the ability to attract customers to CTS, and at this point, we've been, I think, outgrowing what you see as the general growth rate for those markets, which has been historically, the last several years, tended to 12% and even up to 15% at times. But in that kind of a range.

Got it.

I don't see any reason to believe it's going to be much different.

Thanks, guys.

Thanks, Josh.

(Operator Instructions.) Our next question comes from John Franzreb from Sidoti.

In light of what's happened in the EMS business, should we be rethinking about the profit contribution from that segment? It was pretty low in the quarter, that, could you kind of work out what your profit expectations are in the EMS now, and if you can achieve maybe some of those previous operating margin targets you kind of talked about in the past, even with the change in mix?

That's a very good question, John. We have obviously spent quite a bit of time in the last couple or three months not only looking at what happened and, but also, as Don indicated, the business has looked at various areas where they need to take action, or they have already taken action, to improve their profitability.

And the areas which they have focused on are, they include things like pricing adjustments to improve profitability of low-margin programs, enforcement of customer returns, our rework policies, tighter charge-outs to customers for all non-recurring engineering expenses, things like bearer and factor alignment of direct and indirect workforce with demand, production fluctuations, and better control on freight costs and bill-backs to customers in that area. All of these areas, they have either already taken some action, or some actions are underway to improve the profitability of the EMS segment.

We clearly expect EMS profitability to be higher in '07 than '06. But we probably will not be able to quantify any more than that, but we clearly will improve profitability in the EMS segment in '07 compared to '06.

That sounds like an awful lot of moving pieces. Will that necessitate any kind of restructuring charges in the area?

No, these are all--these things I just talked about are all ongoing operational things which they are tightening up and are already seeing some results of that in improved bottom line.

Okay. And one last question, and I know you touched on this, Vinod. You talked about how the currency's been hurting you. Most of the companies that I cover, the currency has been a benefit. Can you just kind of walk through me fundamentally why the currency's been a headwind for your company?

Sure. I will answer it in two parts. Overall, a weaker dollar is a headwind for us, because as you know, we have a lot of costs based in foreign currency areas. So essentially, we are more cost-based in foreign currencies than revenues-based in foreign currencies. And so when the dollar weakens, your costs are magnified in the U.S. dollar terms. And so overall, net/net, when the dollar weakens, we have an unfavorable impact on CTS.

The second thing I will comment is we are continuing to naturally balance our currencies between revenues and cost to make sure that the impact of any kind of currency fluctuation is minimized on the Company.

The other comment I will make is the impact of weaker dollar is different on our two segments. When the dollar weakens, we actually have a larger negative impact on our EMS segment. But on our Component and Sensor segment, we actually have a positive impact. And so overall, if you look at the total Company, that the negative impact gets, to some extent, offset by the favorable movement in the Component and Sensor business, but EMS business gets the brunt of it because most of EMS business revenues are in U.S. dollars. So they don't much change, but all their products, which is made in either Singapore or in Europe, increases because the dollar weakens. So overall, EMS gets the brunt of it. We offset some of it in our Component and Sensor segment, but we are not able to completely offset the EMS segment impact because of the weaker dollar.

Okay. That was very helpful. Very much so. And one last question. You said there was $1.3 million in costs related to the production rollout, the launch issue in the fourth quarter?

Yes.

So in terms of profitability for the company in the quarter, we should be looking at it as organically it should have been, or if you threw it out, it would have been $0.03 better?

Yes.

That make sense?

Yes.

Okay. All right. Thank you very much, guys. Good luck.

Thanks.

Our next question comes from Kevin Kessel from Bear Stearns.

Yes, just a couple of housekeeping questions. Can you tell us what stock option expense was in the quarter?

The stock option expense in the fourth quarter of '06, as we look for it, I think it was, it was--the quarter number was probably half a penny.

About a quarter of a million.

Yes. Half a penny. About a quarter of a million dollars. Not a huge amount--nevertheless, a negative.

$250,000, and was that split between cost of goods sold and SG&A? or primarily SG&A?

That would be split between cost of goods sold and SG&A.

Primarily SG&A.

I would say it's primarily SG&A.

Okay.

On a full-year basis, you can extrapolate that. That's roughly $1 million, or $0.02.

Okay. And then the other thing is, did you, did I hear correctly, did you say that Q1 revenue is going to be up 8% year on year?

Well, yes, in that range is our expectation, Q1 2007.

Okay. And then, all right, so then that's like $165 million or so? Or--I'm sorry--$162 million or so?

It would be about that.

Now, what about for the impact you said about $0.03 for the accounting investigation, so that's what? $1.2 million or so?

It's more like $1.6 million.

$1.6 million. Okay. And do you see any other customers--?

I hope you don't take me down to the fourth quarter guidance here.

No, no. Do you have any other customers that you think will emerge in 2007 as either potential 10% customers or potential new top 10 customers?

One will be really hard to imagine that they will be in the top ten of the Company, but there may be customers which may end up in top 10, because by the time you get to top 10, the number goes down.

Yes, the top 10, there might be some swings in the top 10. There's only one other customer that's really close to the 10% kind of number.

Motorola?

Yes, and that could happen.

But any other new customers that we could see maybe becoming top five customers of the Company?

I just don't have the data in front of me to--.

Okay. Okay. That's fine. Thank you.

Thanks, Kevin.

I'm not showing any further questions at this time.

I have a final comment. I would like to remind our listeners that a replay of this conference call will be available from 4:15 p.m. today to 11:59 p.m. on Tuesday, May 8, 2007. 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 872039. And thank you for joining us today.

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