CTS Corp (CTS) 2007 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Fourth Quarter and Full-Year 2007 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question and answer period. Instructions will be given at that time. (OPERATOR INSTRUCTIONS) As a reminder, today's conference call is being recorded. I would now like to the conference over to your host, Director of Planning and Investor Relations, Mitch Walorski. Please, go ahead.

Thank you, Anna. I'm Mitch Walorski, Director of Planning and Investor Relations, and I will host the CTS Corporation Fourth Quarter 2007 Earnings Conference Call. Thank you for joining us today. Participating from the Company today are Vinod Khilnani, President and CEO; Donna Belusar, Senior Vice President and Chief Financial Officer; and Matt Long, Treasurer.

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, uncertainties, that could cause actual results to differ materially from those expressed in the forward-looking statements. Additional information regarding these risks and uncertainties were set forth in last evening's press release 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, Vinod Khilnani.

Thank you, Mitch, and good morning, everyone. Last evening we released our fourth quarter and full-year 2007 financial results. I'm pleased to report that we recorded a stronger than expected fourth quarter with earnings per share and free cash flow both exceeding our earlier projection. Adjusted earnings per share which excluded a previously announced restructuring charge of $0.25 versus a consensus estimate of $0.20. Full-year adjusted EPS was $0.71 versus our previous guidance of $0.65 to $0.68. Sales in the fourth quarter of $178.3 million was up 3% year over year. Sales for the full-year at $685.9 million was 5% higher than 2006.

On a segment basis, component and sensor sales were $71.1 million, up 8.2% from the fourth quarter of 2006. Automatic sensor and actuator products were 6.2% despite lower fourth quarter 2007 light vehicle sales and production in the U.S. year over year. CTS sensor and actuator sales were deflective off of a growing business with non-big three automotive OEMs and continuation of double-digit growth of our automotive sales in the Asia-Pacific region.

Sales of electronic components were up a strong 11.8%, driven by a 27% increase in sales for communication infrastructure applications. EMS sales in the fourth quarter were essentially flat compared to the same quarter in 2006. Gross and operating margins were both better than expected, helped by favorable segment mix as the component and sensor segment grew faster, combined with some price increases in our automotive business and improved operating efficiencies. Free cash flow was also better than our previous estimates.

Let me now comment on some positive developments in the fourth quarter that will be important as we look ahead. Beginning with the automotive business, we capture 15 new platforms in the fourth quarter with annual sales potential of approximately $8 million. Almost all of these wins came from Japanese and other Asian automotive OEMs. On a full-year basis, CTS Automotive was awarded 28 new business awards in 2007. Approximately 20% of these new awards came from the North American big three OEMs. These new award reflect our progress to successfully broaden and diversify our customer base.

Approximately 50% of our total sensor and actuator sales were the North American big three automotive OEMs in 2007. This percentage is projected to go down to roughly 39% in 2008, reflecting our increasing penetration of OEMs like Honeywell, Toyota, Honda, and Chery.

In the electronic components also we had an excellent quarter with 77 new design wins in the fourth quarter, up 6% sequentially and up 24% year over year. New design wins were in the arenas of WiFi, WiMax applications, 3D wireless, and auto modules for base station.

In the telecommunications market, to highlight a few key activities, electronic components business established the first supply relationships with leading OEMs in Europe, China, and India. Nokia-Simms networks signed a global supply agreement with CTS and began receiving production shipments of radio frequency modules during the year. ZTE, a leading telecomm company based in China, signed a supply agreement and began qualifications of CTS oscillators for shipment in 2008. In addition, CTS won new business from a fast-growing Indian optical network equipment company.

In our EMS business, four new customers were captured in the fourth quarter. On a full-year basis, EMS won 17 new customers. Excluding HP, EMS sales were up 19% in full-year 2007 versus 2006. Our Singapore EMS operations received DS 9100 aerospace quality certification. Only third EMS provider in Singapore to gain such certification. We also received TL 9000, a telecommunications certification at our EMS locations in Thailand and Singapore. These certifications are important for us so the new business has these operations.

In the acquisitions and alliance arena, we have stream-lined the process to surface and evaluation potential targets and execute transactions more efficiently. As a result, we have completed two small tack-on acquisitions -- Alpha Ceramics in December 2007 and Tusonix this month. Both the transactions were in our components and sensors segment. We are now working on two other potential transactions, a small accretive acquisition in the U.S. and a small joint venture in India to manufacture sensor and actuator products for that rapidly growing automotive market.

I would also like to mention a major new strategic growth initiative which we have been pursuing aggressively to penetrate commercial markets with our sensor and actuator products. In is a new $1 billion market and we are targeting to capture 10% of it in the next five, six years. There's an exciting developing opportunity for us which can accelerate our sensor and actuator sales significantly beginning in late next year and beyond. We will be sharing with you more information on this initiative and our progress in the coming months.

On the organization front, I'm delighted to have Donna Belusar join our leadership team as Senior Vice President and Chief Financial Officer. Donna joins CTS after 25 years of leadership experience at IBM and will lead the finance and IT activities at CTS. In addition, we had added a senior resource from EMC Corporation on my staff to drive corporate-wide Six Sigma LEAN manufacturing and other business process improvement initiatives.

Looking ahead to 2008, we expect full-year sales growth to be in the range of 5% to 8% with some EMS end of life sales decline offset by incremental sales from the acquisition activity. Overall, higher growth is expected in our components and sensor segment, making it closer to 45% of the total company in 2008 versus approximately 40% today. Full-year diluted EPS is expected to be in the range of $0.78 to $0.83 which also includes approximately $0.03 to $0.05 per share of engineering and R&D resources on expenses related to those things for the launch of our new commercial market growth initiative which I mentioned earlier.

And now I will turn the meeting over to Matt Long, our Treasurer, to discuss our financial results in more detail.

Thanks, Vinod. We finished the quarter with sales of $178.3 million, up 3% from last year. Adjusted diluted earnings which exclude restructuring charge improved 25% to $0.25 per share, compared to $0.20 per share in the fourth quarter of 2006. Full-year diluted earnings per share increased 5% year over year to $0.66 in 2007 from $0.63 in 2006 on a sales increase of 5%. The adjusted diluted earnings per share of $0.71 which excludes the restructuring expense were equal to the adjusted diluted earnings per share in 2006; however, please note that 2007 earnings per share were adversely effected by the $0.05 charge related to the accounting investigation.

Fourth quarter gross margins were the best we have seen since the beginning of 2006 at 20% which was 0.7% better than third quarter and 2.8% higher than a year ago quarter. The year over year improvement in gross margin is primarily due to the improvement in operational efficiencies and improved product mix within the EMS segment.

SG&A and R&D expenses of $23.7 million or 13.3% of sales in the fourth quarter improved sequentially from 13.7% in the third quarter but was 1.3 points higher than the fourth quarter last year. The year over year increase is primarily due to certain credits in 2006 and the CEO transition costs in 2007. On a full-year basis, SG&A and R&D expenses were 14.3% versus 13.2% for 2006. Excluding the investigation costs from the 2007 expenses, the normalized SG&A and R&D expenses as a percent of sales were 13.8% in 2007 versus 13.2% in 2006.

Interest and other expenses in the fourth quarter were approximately $500,000 better due to higher interest income from higher tax balances. The full-year effective tax rate increased to 21.75% in 2007 from 21% in 2006, primarily due to earnings mix in the various tax jurisdictions where we operate. From the balance sheet perspective we are pleased to report excellent performance in the management of working capital. Our control for working capital is a percent of annualized sales at 12.7%, beat our target of 13% while matching our 2006 performance.

Year over year, we improved our DSO by three days to 50. Inventory turns at eight in 2007 were lower than 2006 of 11 due to higher than normal product transfer activities and new EMS business that required larger inventory levels at the beginning of the program. We expect inventory turns to improve in 2008 as we work those balances down.

Full-year 2007 operating cash flow of $48.6 million further improved from $47.2 million in 2006. Capital expenditure for the full-year 2007 at $16.1 or 2.3% of sales was in line with 2006 at $15.8 million or 2.4% of sales. The 2007 free cash flow of $32.5 million beat last year's record of $31.4 and was higher than our guidance for the year of $27 to $29 million. Positive free cash flow is defined as cash flow from operating activities less capital expenditures.

CTS purchased approximately 1 million shares of its stock during the quarter, leaving just over 600,000 shares remaining in the current 2 million share buyback authorization. The debt to capital ratio stayed below 20% at 18.4% compared to the 17.2% last year.

Looking to 2008, we expect the full-year effective tax rate to move up further by 1% to 2% as our profitability in the U.S. further increases. We expect our CapEx to be in the range of $22 to $25 million for the full-year 2008 and positive free cash flow therefore is expected to be in the range of $28 to $32 million.

With that, we'll open the call for your questions.

(OPERATOR INSTRUCTIONS) Our first question comes from Kevin Kessel from Bear Stearns. Please, go ahead.

Hi. This is HoaiNgo for Kevin. A couple questions. First some bookkeeping question. What was D&A expense for this -- depreciation on the organization for this quarter?

The depreciation was $5.1 million. And amortization was $800,000.

Okay. So what was the stock expense this quarter?

It was $53,000.

Okay. My next question is regarding your largest customer, HP. What was the percentage of sales for them this quarter?

The percentage of sales for HP this quarter -- I'm looking at the full-year numbers first. So let me give you full-year because the quarters may fluctuation. The full-year number for HP was 17.1% for 2007 and the same number for last year was closer to -- I believe 22%.

Okay. So going forward to 2008, what's the percentage range you expect from HP?

We have stated that due to end of life products we will continue to see that percent come down. And as we have stated before, the focus area in EMS which are medical, industrial, and defense, and aerospace will continue to go down as a percent of total EMS business. So for example, full-year 2007, those three focused areas were close to 26% of the EMS business while they were close to 20% last year. So we continue to broaden and grow that piece which is our focus area because we have chosen those areas to target.

Okay. So maybe we can switch gear a little bit. Regarding your EMS business, we noticed for this quarter your operating margin is basically flat on a sequential basis. It's about 3.6% which we noticed this is still below your 5% target. So going forward what's your feel? Can you give us a little bit of color on your margin improvement for your EMS business?

Sure. On a full-year basis, the EMS margins have improved nicely from I believe approximately 2.5% or so. Actually on a full-year basis, EMS has gone from 1.6% which was fairly low to 2.5%. If you look at it on a quarterly basis, they have gone from 2.6% last year in the fourth quarter to 3.6% in the fourth quarter this year. We have said in the past that our goal is for EMS business to go up to 5% of operating margin because 5% operating margin in that business makes it equal to our component and sensor business when you look at total invested capital. Because their capital intensity is lower and they turn their assets more, 5% operating margin in that business is closer to 14% operating margin in component and sensor business when we look at return on invested capital. So as we move these margins up from 2.5% range to 3.5% to 4% range, our goal will stay at 5% and we have said in the past that we do need to take these margins up to 5% and the way we intend to take these margins up is, a, we need to improve the mix in the EMS business which you are seeing us do by making defense medical and industrial as a bigger percent of the EMS business and continuing to improve our capacity utilization in the EMS business.

I see. I guess you mentioned in 2007 the three focus segment -- defense, medical, and industrial -- account for like 26% of your total sales. So what is your target percentage for these three focus area for 2008?

We don't really have a target per say by year. But I think you would hopefully see us continue to increase that percent and make it a bigger percent of the EMS business.

Okay. If I may, my question regarding your acquisition, we noticed that you made two small acquisitions over the last few months, especially this Tusonix acquisition which will add $15 million in sales to year 2008. So can you give us some margin profile of this business? It's compared to your legacy component business; the operating margin or gross margin of this business is higher or lower than your average right now?

The margin profile of this business -- the synergies and everything else we expect to achieve is fairly similar to the margin profile of our overall component and sensor business. Maybe a touch better. The important to note, as I said earlier, is as we grow this segment of our business faster, our overall segment mix improves. So if we go from component and sensor segment business from 40% of the total Company to 45% of the total Company through organic growth and through these kinds of acquisitions, targeted small niche acquisition, you will see an improvement in overall gross margin and operating margin profile of the Company because component and sensor is better than EMS from an operating margin and gross margin perspective.

I see. So I guess -- maybe I'm just jumping around a little bit. What's the motivation for you guys to make this acquisition? Does it broaden your product offering? Are you enhancing your technology capabilities?

Both, actually. We have said historically that we would be very focused in our approach to acquisitions. We will do acquisitions if we believe they are either broadening of our product offering or our technology base. They need to be synergistic which means accretive in year one and they also can be done if we are trying to penetrate a strategic customer or we are trying to penetrate a particular region in the world where we think it's critical for the corporation to have a footprint.

Thank you very much.

Your next question comes from Sean Hannan from Needham and Company.

Yes. Thank you. How are you?

Good. How are you?

Good. So I have a question -- if there's a way, if you could perhaps expand a little bit on your outlook at least as we look into March, what your thoughts are as you look into both your components space as well as EMS, where the different push and pulls are. There was some commentary you had provided last quarter, really specific to some OEM plant shut downs. There were some other challenges I think that you had seen in telecomm. If you could provide a little bit of commentary around that as we look forward? Thank you.

On the sensor and actuator side which we call our automotive side of the business, we obviously have some concerns because we continue to see fairly soft markets in North America and the data which has been published indicates that 2008 would have lower production and sales for light vehicle market in North America in 2008 compared to 2007. So that is definitely somewhat a negative for us. In the case of CTS, however, what is offsetting that to a large extent is the fact that the majority of the business we have won in recent months and quarters is focused on non-big three North American OEMs. So we are very rapidly diversifying our customer base with penetration at customers like Toyota and Honda and Chery. So that is helping us. Our growth in Asian markets is also helping us since our dependence on the North American market continues to go down. The other thing which is happening and I mentioned that, if you heard us talk about our customer base in that business, you have always heard us talk about the big three or Toyota or Renault and those kind of people. You will hopefully begin to hear us talk about names like Honeywell. And what that indicates to you is we are now beginning to broaden our sales base from traditional passenger vehicles to more diesel applications or turbocharger sensors which actually go much broadly beyond the passenger vehicles.

So I guess to summarize what I'm suggesting is that, yes, we are concerned and the market is soft and there are indications that big three specialty will be cutting production and will probably see first and second quarter production levels lower in 2008 compared to 2007; however, our initiatives will to a large extent protect us from those kinds of negative trends. They will impact us but we believe at this point that with all the new initiatives underway, we will be able to offset those kind of headwinds.

In the electronic components arena, you heard me talk about some new customers, some new supply agreements, some new products, so we are fairly optimistic about our prospects in 2008. We obviously hear some negative news coming from a macro economic point of view. But frankly, we haven't seen any impact on us in our order board if I reflect on where we stand in the first quarter of 2008. So we are watching it very carefully but we are not seeing any negative impact on that side of the business yet. As far as EMS is concerned, I frankly don't have anything unusual to report. The markets are pretty stable. Maybe because they're so diversified we're not seeing any indications in either direction as to how 2008 will turn.

Okay. So for EMS, market's stable. On the components side, North America macro-wise, there are concerns but really your diversification also your presence in Asia and it's a specific CTS story that allows you to be confident in the growth there.

That's a pretty good summary.

Okay. Then separately, if I look at your estimates as we look for -- I think it's roughly 5% to 8% growth in 2008 on the top line. When we pull out the recent deals that you've announced, I think that is probably about 2%, 2.5% of that growth. Is that the right way to think about it? In terms of organic versus what's been acquired?

That's not the way I would like to look at it. The way I look at it is that a basic growth in our base business is going to be in 5% to 8% and I would like to see acquisitions try to offset some unusual end of life activity primarily in the EMS arena, primarily with HP. So if you look at that end of life activity offset by acquisitions, then I think in our core businesses you will see us grow organically 5% to 8%.

Okay. So then when we're talking about a $15 million run rate from Tusonix that is added on top, that's not a part of your 5% to 8%?

No. I'm saying that kind of an incremental acquisition related growth should be offsetting some end of life kind of a product activity. And I'm looking at both of those two things as somewhat unusual.

Further, you had mentioned two other potential acquisitions or deals that are in pipe, one being a JV and another being an actual deal. Are those part of the 5% to 8% growth assumptions?

At this point I will assume it is. But it's kind of unclear. Some of the economic conditions are unclear. The size of those may be unclear. Timing may be a little bit unclear. So it's possible that if those things turn out to go in the right direction, we may be on the high end of the 5% to 8%. If the economy stays reasonably stable we may exceed that. On the other hand, it's possible that we may be on the lower end of it. So my thinking is that 5% to 8% should be what we deliver and we will look at these kinds of transactions to make sure they're offsetting some of the end of life products or some unusual economic activity which may be somewhat negative.

Okay. That's helpful. Thanks very much, Vinod.

Thanks.

Our next question is from John Franzrebfrom Sidoti & Company. Please, go ahead.

Hi, Vinod.

I was wondering where you were.

I just want to piggy back on the last question. If I understood you properly it's 5% to 8% organic. You're adding $15 million on but in your prepared comments you discussed EMS sales declines. Is that $15 million offset, is that essentially the HP business that's going away. Or is there other EMS sales declines that you were referencing earlier that we should be aware of?

No. It's really primarily HP which you know we've been talking about it for a couple of years. I'm frankly looking at this $15 million and potentially a little bit more activity in that area to essentially offset HP's end of life product.

Okay. You mentioned that order trends are still positive. Could you talk a little bit about what the order trends are in the automotive business? Have they pulled back at all? A little bit about what your thoughts are in the auto, motorcycle? Especially early in the year?

The order board looks reasonably good on the electronic components side. We are seeing some softness. We did see some softness on the distribution side in fourth quarter and that may continue a little bit, continuing in the first quarter. But overall, electronic component -- it's fairly steady to positive. Automotive we are watching very closely. We haven't seen anything in January. So we are cautiously optimistic; however, I continue to hear that big three are looking at cutting their productions. Maybe a little bit deeper in Q2 timeframe than earlier. I saw one report which said that big three will cut production in Q2, year over year they will be down 6%. Now it is negative, but again, as I said earlier, the impact on CTS will be muted because of our diversification and increasingly higher penetration in the non-big three OEMs.

You mentioned also in your prepared remarks about the $0.03 to $0.05 in R&D and launch expenses that will maybe impact the EPS profile going forward. We're not to take that as any kind of a non-recurring item? Those costs would be imbedded in the R&D and selling lines? Is that correct?

That is exactly right. We will not talk about them normally. I just wanted to give you a flavor that qualitatively $0.78 to $0.83 is actually better than the way it looks because we are going to start some brand new growth initiatives and going to invest some targeted money in R&D and engineering resources which will benefit the Company tremendously a couple of years down the road. We will absorb them and they're already included in our estimate of $0.78 to $0.83.

What's the timing of those expenses?

Probably would be spread throughout 2008.

Okay. So we won't see an incremental bump up sequentially at any given quarter?

No. No. You hopefully will not see any bump ups.

Okay. In the -- a little bit into the nitty gritty here. In the fourth quarter your other income line was up rather than behind on a sequential basis. I was wondering if you could walk through what happened there.

You're looking at income?

The other income line. There's $1.4 million.

Sequentially? You're looking at net earnings?

No. I'm looking at the P&L on the other income line.

Okay. Let me pull that out.

This is Matt Long. It was primarily the interest income that we talked about in the prepared statement. As our cash has increased we've gained incremental interest on that and then we had some favorable translation gains in foreign exchange.

So elaborating on Matt's comment, you see a separate line interest expense but Matt is saying that interest income is included in other lines.

Correct.

Right. It's like $1.4 million versus $800,000. Pretty much a run rate you've been going at.

Yes. And then we have some small translation gains.

One last question. You said stock is pretty weak as of late. Just talk a little bit about your appetite for repurchasing your own stock versus acquisitions?

John, we have never commented on forward action on buyback. We hope people will draw their conclusion based on our reactions looking back. And as Matt pointed out, we were fairly aggressive in the fourth quarter. Obviously we thought that stock was clearly below where it needs to be and it was a tremendous value to us. So we were fairly aggressive at buying back stock. And the other thing I will repeat which Matt said that we have $600,000 left in that program.

Shares.

Shares. I'm sorry. 600,000 shares left in that program. So from time to time the board reviews that along with a whole bunch of other initiatives and they will continue to do that.

Thanks a lot, guys.

Thank you.

(OPERATOR INSTRUCTIONS) And we have a question from Heidi (Sistano) with Gabelli. Please, go ahead.

Hi. I have a question about the detail on the balance sheet. [inaudible] like growth by $13 million. Can you shed some light on that?

Say it again? Which group? $13 million?

Inventories rose by $13 million.

Yes. Some of it was activity related but as Matt pointed out, our inventory turns were not as healthy as they were in the prior year primarily because of some product transfers between our locations and some new program launches. And as he indicated, we had to build some extra inventory in the anticipation of new program launches. So we expect inventory turns to go back to closer to more normal levels I think in the next couple of quarters. Nothing specific. Nothing unusual in our minds.

And then on the SG&A line there's an increase of like $3 million and I wonder what we should expect for 2008?

Are you looking at full-year 2006 versus full-year 2007?

No. Just fourth quarter of 2007.

Hold on. We're looking at the numbers. You're looking at selling, general, and administration number?

Yes.

Okay. We're still trying to look at your number and we're looking at that number to be same as Q3.

Year ago?

Yes. Actually, a year ago.

It's a year ago. So sequentially we are fine. I think year ago level we are higher. And there are some year-end or timing related things. We'll look into that cycle back to you if there's something unusual.

Okay. Those are all my questions. Thanks.

Thank you.

And there are no further questions in queue at this time.

Okay. I would like to remind our listeners that a replay of this conference call will be available from 1 P.M. Eastern Standard time today through 11:59 P.M. on Thursday February 7. 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 906728. And thank you for joining us today.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation. You may now disconnect.