CTS Corp (CTS) 2008 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Q1 2008 earnings 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. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. I would now like to the conference over to our host, Mr. Mitch Walorski. Please, go ahead.

Thank you, Kathy. I'm Mitch Walorski, Director of Investor Relations, and I will host the CTS Corporation first quarter 2008 earnings conference call. Thank you for joining us today. Participating from the Company today are Vinod Khilnani, President and CEO, and Donna Belusar, 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 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.

Thanks, Mitch, and good morning, everyone. Last evening we released our first quarter financial results for 2008. I'm pleased to report that, despite the challenging economic environment, both sales and earnings per share were better than our expectations for the quarter.

Sales at $172.8 million were up 5.8% over the first quarter last year, driven by strong revenue growth in our components and sensors segment.

Diluted earnings per share were $0.18, up 64% from $0.11 in the first quarter of last year.

The first quarter last year reflected a $0.02 per share negative impact from unusual audit and professional fees. First quarter 2008 earnings, on the other hand, were helped by a favorable segment mix, as our components and sensor sales increased to 45% of our total sales in the first quarter of 2008 versus 42.6% in the same quarter last year.

In addition, both the EMS business and component and sensors business improved their operating margins in the first quarter of 2008 versus first quarter last year.

On a segment basis, component and sensor sales were $77.8 million, up 12% from the first quarter of 2007. Within that segment, automotive sensor and actuator products were up 2.6%, despite a 9% drop in North American light vehicle production, from approximately 4 million units in the first quarter of 2007 to approximately 3.6 million in the first quarter of 2008. Year-over-year, light vehicle production in Europe was also down approximately 4% in the first quarter.

Electronic component sales were up a strong 31% year-over-year. Communication infrastructure and piezo material product shipments were up 46% and 43% respectively in the first quarter of 2008 versus last year.

Our distribution channel sales were also up 9% in the first quarter compared to last year.

In total, organic growth in electronic component sales was approximately 18.5%, with the remaining 12.5% growth in sales coming from the Tusonix acquisition.

Strength in our component and sensor business overall was reflective of our diversification and increased market share, driven by new customers and new products. Our automotive sensors and actuator products continue to diversify away from the big three U.S. OEMs, as we grow our business with customers like Toyota, Nissan and Honda. Continuing growth of our sales in the Asia-Pacific region and new product introductions, especially for communication infrastructure applications, are examples of customer, geographical and product line diversification.

EMS sales in the first quarter were $95 million, up 1.3% from last year. Sales in our focus areas of medical, industrial and defense and aerospace in total were up 6.5% year-over-year.

EMS sales to Hewlett-Packard were approximately $28.6 million in the quarter, down 6.5% from the same quarter last year, as expected and in line with our earlier comments.

Gross and operating margins were both better than last year, helped by improved segment mix, as our component and sensor segment grew faster, success in negotiating some price increases and improved operations overall.

Some other highlights for the quarter are, in automotive, we received six new sensor and actuator business awards. The most noteworthy of them was a $75 million-over-six-year supply agreement with a major North American diesel engine manufacturer to develop a smart actuator for a light-duty diesel engine to be launched in the fourth quarter of 2009. This new customer, new product and new application is helping CTS establish its foothold in the commercial market, which is an important growth opportunity for our sensor and actuator technology to grow into.

In the electronic components arena, we had 45 new design wins for auto components, up 15% from 39 design wins in the same quarter last year. Most of the new design wins were in the military and aerospace, 3G Wireless and WiMAX areas.

On the mergers and acquisition front, we completed two small strategic acquisitions in the first quarter. In January, we completed the acquisition of Tusonix, a $15 million revenue company that manufactures ceramic filters, capacitor assemblies and related components. The acquisition expanded our technology and customer base and will be accretive in 2008.

In March, we completed the acquisition of Orion Manufacturing, a San Jose-based EMS company with annual revenues of approximately $26 million, focused on defense and aerospace, industrial and medical markets. We are currently in the process of consolidating our Santa Clara and Orion, San Jose, operations both currently in a leased facility, into a single leased facility in the same area.

From a macro economic perspective, we did see some weakness primarily in the automotive and communication industries. However, we were able to offset the impact of the weak economic environment in the U.S. with new products, new customers and a strong presence in the Asian markets.

Fully 35% of our total sales in the first quarter were in the Asia Pacific region. We nevertheless remain cautious, given the uncertainties caused by the turmoil in the credit and housing markets here at home.

Given our first quarter performance and diversified business model, we are comfortable with reiterating our full year sales growth guidance in the range of 5% to 8% and full year diluted earnings per share guidance of $0.78 to $0.83.

And now, I will turn the meeting over to Donna Belusar, our Chief Financial Officer, who will provide further details regarding our financial results.

Thank you, Vinod, and a welcome to all of you.

Our first quarter financial results are a good, solid start to 2008, with growth in revenue and earnings per share. As you will see, the performance reflects the strength of our global footprint. By leveraging our manufacturing capabilities and the opportunities of a global economy, we delivered in the first quarter $172.8 million in sales, a growth of 5.8% from sales in first quarter 2007.

We maintained our focus on cost and expense management, while continuing to invest for growth in key markets via acquisitions and increasing to a slightly higher level of research and development expense.

With this operating leverage, net earnings came in at $6.7 million, up $2.6 million from first quarter 2007. Bottom line, our CTS business delivered earnings of $0.18 per diluted share, up 64%, compared to $0.11 per diluted share in first quarter 2007.

Now, let me provide you some further insight into the first quarter details, staring with revenue.

As mentioned, total first quarter 2008 sales were $172.8 million, nearly 6% revenue growth year-over-year from the first quarter of 2007. With this revenue growth our operating earnings margin as a percentage of sales improved nearly two percentage points year-over-year to 4.9%, up from 3% in the first quarter of 2007.

Peeling back operating margin in the first quarter, gross profit margin percentage improved 100 basis points to 19.6%, driven by favorable segment sales mix and favorable product mix.

In addition, selling, general and administrative expenses and research and development expenses as a percentage of sales declined 100 basis points to 14.6% of sales in the first quarter of 2008, down from a high of 15.6% in the first quarter of 2007.

Our operational performance is the result of actions taken to manage spending in the current environment, while continuing to invest in areas that will drive growth over time, especially in expanded applications and new product development, as well as current product and process enhancement.

Total interest and other expenses were flat year-over-year, in spite of higher interest expense in the first quarter 2008 associated with increased debt, primarily due to and in support of the first two quarter strategic acquisitions. I'll discuss debt a bit more shortly.

Our first quarter 2008 effective tax rate was 22% versus 21% in the same quarter last year.

I started our discussion highlighting how our performance reflects the strength of our global footprint. Comparing to the first quarter 2007, the U.S. dollar has weakened against nearly all major foreign currency, approximately 9 to 10% relative to our basket of currencies. This created additional expenses and costs to our business operations.

However, on the other hand, as we grew assets with a foreign currency appreciated against the U.S. dollar, the favorable impact helped minimize any potential negative overall currency impact to the bottom line.

Net earnings were $6.7 million, or $0.18 per diluted share, in the first quarter of 2008, compared with $4 million, or $0.11 per diluted share in the first quarter of 2007. Higher net earnings were the result of improved gross profit margins and overall lower operating expenses in the first quarter of 2008, as other income remained essentially flat.

Now let's turn to CTS's balance sheet performance.

Overall changes in our first quarter 2008 balance sheet reflect the management of our recent strategic acquisitions. Our controllable working capital is $113 million, or 16% as a percent of annualized sales. This is up sequentially from year-end 2007, driven by an increase in the inventory of $10 million and higher accounts receivable of $7.5 million, both of which resulted primarily from acquisitions during the quarter.

Our expectation is to manage the full year controllable working capital to our target objective of 13% of annualized sales.

Net cash used by operating activities for the first quarter 2008 was $5.5 million. Three-quarters of the net cash used in the quarter is timing related to payables, driven by our policy to selectively leverage early payment terms and discounts from some of our key suppliers. The remaining is driven by the integration of the acquisitions into our CTS business during the quarter.

As a result, our long term debt, net of cash and cash equivalents, increased from $19.1 million as of December 31st 2007, to $57.4 million as of March 30th 2008. Roughly half of the debt increase is acquisition-based and the remaining one half is associated with the timing of our working capital.

We expect our full year free cash flow to be on track with early estimates in the range of $28 million to $32 million, with CapEx to be in the range of $22 million to $25 million.

CTS repurchased 689,800 shares of stock during the quarter at an average purchase price of $9.87 per share.

So, we finished the first quarter 2008 with a strong operating and financial position. We have a strong portfolio of products and customers. We have a global footprint base of capabilities. Our operating model is in place and executing well. And we are integrating the acquisitions and are being successful in bringing these technologies and business to our customer base. And we have a solid balance sheet.

So, with that, I'd like to open it up, the call, for your questions. So, operator, would you please open the lines for questions. Thank you.

Thank you. (OPERATOR INSTRUCTIONS) One moment for the first question. Our first question is from the line of Kevin Kessel. Your line is open. Please go ahead.

Sure. Can you hear me?

Yes.

Yes.

Great. So, I guess my first question is Vinod, -- so, for the full year guidance that you mentioned today that you reiterated, 5 to 8% growth and $0.78 to $0.83, when I look at it and I look at the two tuck-in acquisitions you did so far, based on my math- - I don't know if I'm right or not- - but I calculate that you might have got as much as $3 million possibly in contribution in the first quarter. And then overall, based on the run rates they were at, it would be close to $35 million for the year, which actually works out to about 5% year-on-year growth versus '07. So, in other words, if the acquisitions never happened, I'm actually curious whether or not the environment is such that you would actually have to be reducing your expectations. And on top of that, you mentioned they're both accretive yet it's the same EPS range.

Kevin, first commenting on the top line, you will remember that in January when we gave the guidance for 2008, we did say that -- at that time we had one acquisition completed and second acquisition we mentioned was going to be completed. At that time, we said that our growth target on the one hand would reflect what I will call somewhat unusual end of life EMS HP-related product. And so we said that that unusual negative will be offset by non-organic acquisition kind of activity.

And so, in our mind those two things kind of offset each other very roughly and so we believe that the top line growth, which we were guiding the Street, was truly reflective of all the focus areas we are driving. Those are sensors and actuators and communication infrastructure kind of components. And in EMS, defense and aerospace, industrial and medical kind of market.

As far as the bottom line is concerned, you are exactly right. Both of these acquisitions we have done in the first quarter are accretive, approximately one penny each. And so that does give us an upside to our guidance. But as I said, we're still fairly cautious about the rest of the year and we want to watch it. And if the things don't deteriorate, we probably will be on the very top end of our guidance. But we did not feel comfortable to change the guidance at this time, given the fact it's only the first quarter and there were still a few things up in the air from the macroeconomic point of view.

No, that makes sense to me. I had forgotten that you'd made that statement regarding the fact that- - in other words, that they were already contemplated in the 5 to 8%.

But, I'm glad you asked the question, because it allows me to clarify the comment that the top line growth guidance is we believe truly reflective of the increase in our organic business.

Then the other question I guess I have is, you say they roughly offset each other. So, you said, HP now is, I think you said, $28.6 million in the actual quarter. Can you just remind us what it was in the subsequent- - in the previous quarter in December? And then, how that end of life is seen playing out? Is it going to take a year? Is it going to take two years before essentially it becomes almost negligible from a revenue perspective?

Okay. If you allow me to go back to 2005 kind of an environment -- in 2005, for example our total HP sales were in the range of $180 million per year, with the first quarter '05 being around $47 million, $48 million.

Fast forward to '06, that $180 million came down to $140 million, as we went through partial end of life product kind of a discussion, which we have done in the past.

'07 full year was something like $115 million, $116 million kind of a number and that number in 2008 we are projecting is closer to $70 million. And going forward in '09, we're still not clear that how rapidly the product range will be phased out, but our current estimate is that in 2009 that number will probably go from $70 million to probably $40 million in range. But that's uncertain.

I understand. What was it last quarter on a quarterly basis? If it was $28.6 million this quarter -- ?

Sequentially, you mean?

Yes. Sequentially. What was the dollar amount in December?

December quarter was slightly higher. It was $31.7 million.

Okay. So, even though it's end of life, it actually, on a seasonal basis, it doesn't - - even though there's some seasonality in that business, it doesn't appear that it really affected it much.

Yes, actually, it was - - the sales were somewhat higher than our projections to HP. And that's why we have said in the past it's very difficult for us to project the quarterly sales, because they do fluctuate based on the demand and based on the mix of the product, mix of the HP product, from a storage point of view.

From a margin perspective, do you feel like, as this program goes end of life, it's being replaced with, again, the focused business you mentioned at a higher or margin accretive-- or will it be a margin accretive in other words, the revenue that you're backfilling it with in EMS?

Yes. Overall, if you look at HP business or, instead of saying HP business, let me rather say EMS, computer EMS business, versus the three focused areas we have talked about - - defense and medical and industrial - - we clearly have higher gross margins in those markets than computers.

So, over the long term, it's definitely benefiting us. But when you break it down by quarters, depending on how the HP business phases out at what speed and at what speed we replace that, you obviously may have some short term quarter-by-quarter capacity utilization issues, which can swing the margins.

But we are clearly seeing, as we grow our focused areas in EMS faster than those areas are growing. So, we have been growing in the last couple of years, those focus areas double digits, which is higher than the market growth. They are bringing in higher margins than our EMS margins in the computer segment.

I got it. And then, just last question I guess is just more housekeeping for Donna. One is, the tax rate. It came down a little bit below I think what we were expecting of 23.5%. I don't know if the 22% level is sustainable.

And secondly, if there's an expectation at all for cash flow and free cash flow for 2008, because I think in the past you used to give it, Vinod, on an annual basis.

And then any 10% customers besides HP that you could share with us?

You asked three questions. Let me start from the reverse, I guess. There are no other customers other than HP which are more than 10%. And as we continue to diversify our customer base, other than maybe one other customer, there aren't any other customers which are even 5% of our sales. So, that process continues very satisfactorily.

The cash flow -- I think Donna gave the guidance and reiterated the free cash flow. So, that's the same as what we gave last time. We feel reasonably comfortable with that guidance, so that's why Donna reiterated the free cash flow guidance, despite the fact that, due to timing, the first quarter free cash flow was lower than first quarter '07. But that, as she says, primarily timing oriented and she's sticking with the guidance for the full year.

Tax rate it fluctuates between the mix, between the profits we captured in the U.S. versus international. I think the guidance we gave at the end of January was similar to 23, 24% number, which you remember. This quarter did come out little bit lower than that and we still think that the full year number may still be in 23, 24% range. But it can fluctuate, plus, minus, 1%.

Thank you very much.

(OPERATOR INSTRUCTIONS) Mr. Kessel, do you have a question again?

Yes, just a follow up, if there aren't others in queue. So, then, going back to your EMS business, operating margin of 2%. And I think that again the stated goal for a while has been 5%. So, what actually has to happen here? You've got HP obviously going end of life on the computing side. You're adding others in these other spaces, but I don't know- - I certainly don't have really a good feel for who those customers are or what those products are that are going to move the needle. So, is it going to be just growing the revenue base? Or is there a cost component here that costs still aren't aligned the way you would like them to be? And how long do you think it's- - of a project it would be to get those margins to approach kind of where they should be, given the focus you guys have and the mix?

Well, the target remains 5% operating margin, as you know. We expect our gross margins, which we don't break out separately, but we expect our gross margins to improve as our [mixed] goals in favor of defense and medical and other data confirms that. And then, yes, we will get some leveraging off the overhead expenses, SG&A kind of expenses, as the sales grow. But I think bulk of the improvement in operating margin is expected to come from improved gross margins.

The other thing we have also highlighted in our recent presentations is that, since the growth of component and sensor business clearly is going to be higher than EMS business, the other aspect of our margin dynamics is that EMS business, which in the last several years has been 60% of the total company, in the next five years is going to go down to 40% of the company, with component and sensors becoming 60% of the company, instead of 40%. And that swing in mix, which you began to see a little bit in the first quarter of 2008, is going to help us reach our operating targets overall as we go forward.

Okay. And you said that's over the next couple of years.

The EMS comment was over the next couple of years, yes.

I'm talking about the mix comment, like to get to 60-40 components.

We had actually a presentation recently which is on our website, which says that, by 2012, we will actually flip our mix and EMS will be 40% and component and sensor will be 60% of the company. And that is simply because of the fact that the growth rates in component and sensors are double-digits higher than our EMS business. Combine that with a slight bias we have in favor of acquisitions being done in the component and sensors segment, would allow us to get there by 2012.

Great. And when you mentioned the large diesel actuator win, did you say that's going to begin production in Q4 '09?

Yes.

Okay. So, It's a little over $10 million a year, I think, if it's linear. Is that the way we should be looking at that?

Yes.

As a linear ramp and then just essentially slice and dice it by quarters?

Exactly.

Okay. So, you could maybe see a contribution north of $3 million or $4 million in the fourth quarter of '09?

Contribution? No, because if it's starting in the fourth quarter of '09 and the full year sales are $10 million, we'll probably see a - - yes, when you say a contribution, you mean the sales contribution?

Yes, I'm sorry, the sales, yes. Because I'm thinking actually revenue is above ten and then I'm looking at it on a quarterly basis, so it's kind of closer to twelve.

Yes. Yes, I think that's a pretty fair estimate, that we should see somewhere between $2 million and $3.5 million in sales in Q4, depending on when in Q4 they launch the product.

Okay.

It's a pretty significant opportunity for us, not because of this particular opportunity, but it really gives us credibility to take our sensor and actuator products from our traditional light vehicle applications to really a very, very different set of customers who are in diesel engine and commercial engines and heavy duty and medium duty diesel engine markets.

Okay. And is there anything new on the OCS front, or no?

Nothing new on that one.

Okay. And then, just from a SG&A dollars perspective, I think it was a little bit above where I thought it would be for March. And I know that maybe there are some impacts there for currency, as Donna mentioned. But, where from a dollars perspective do you kind of see that trending here over the next, I guess, couple of quarters?

Hard to comment on the dollars, but we do believe that, as a percent of sales, we should see improvement as we go forward.

Okay.

We should be able to leverage that, in other words.

Okay. And then, in terms of your other large customer in the past, on the communications side, it sounds like they're below 10% of sales. I know they have been for a while. But, I just wanted to know if there was any update at all around what was going on there, especially around China, because I know that's where you were focused, their products, going into the China telecom market. And I know that the Olympics coming up, I think they're- - your customer's end customer is doing a pretty substantial build-out of their infrastructure ahead of the Beijing Olympics. So, is there anything there that's affecting it? Or has that business remained stable? Is it going down? Is it coming up?

That business is stable and going up in the sense that we believe that our market share with that customer is little bit higher today than it was a year or two years ago. So, we're doing well. We are winning designs with them. And we do business on both sides, on the EMS side and on the component side. And my comment that we are- - we probably have a higher market share with them is on the component and sensor side. So, no, we're doing well with the customer. To whatever extent the customer is winning new business, we are participating in that.

Do you see the Olympics having any effect whatsoever on the business?

I haven't seen that in the first quarter.

And then, the- - was that correct about the contribution for acquisitions in the quarter that I quoted earlier, about $3 million?

Yes.

Okay. And then just, I guess, the last question for me is, in terms of the stock buyback, if you could just remind us what's left under the authorization.

We had a 2 million authorization which we did wrap up in the first quarter. And so, we are back doing our same analysis, which any good company should do, on ongoing basis to see what should be our next step.

Okay. So, you would, in other words, need to come back with another authorization to buy further stock.

Yes.

Got it. Okay. I appreciate- - appreciate your time.

Thanks, Kevin.

Thank you.

(OPERATOR INSTRUCTIONS) There are no further questions. Please proceed.

I would like to remind our listeners that a replay of this conference call will be available from 1:30 p.m. Eastern Daylight Time today, through 11:59 p.m. on Wednesday, May 7th. 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 917648.

And with that, thank you for joining us today.

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