CTS Corp (CTS) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Q2 2008 earnings release 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.) And as a reminder this conference is being recorded.

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

Thank you, Mary. I'm Mitch Walorski, Director of Investor Relations and I will host the CTS Corporation's second 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 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 yesterday'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 relation section.

I will now turn the discussion over to our CEO, Vinod Khilnani.

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

Our increasingly diversified business model helped CTS better manage its business in the turbulent economic environment. Sales at $186.1 million went up 9.7% over the second quarter of last year primarily driven by strong organic growth of the components and sensors segment and a small acquisition in each of our two segments.

Diluted earnings per share of $0.27 in the second quarter were up a strong 80% from $0.15 in the second quarter of last year.

Second quarter 2008 earnings were helped by a higher volumes, strong operational execution, and a favorable segment mix, as the components and sensors sales increased to 45.2% of total sales versus 41.7% in the same quarter last year. In addition, second quarter earnings benefitted by approximately $0.02 per share from some sales and productions pull-ups from the third quarter due to Olympics related restrictions in China.

On a segment basis, components and sensors sales were $84.1 million, up 19% from the second quarter last year. Within that segment, our sales of automotive sensors and actuator products were up 15% despite a very tough automotive environment reflected by a year-over-year drop in the light vehicle production in North America and Western Europe of 15% and 3% respectively.

Our sales to Asia-based OEMs, primarily Toyota and Honda, increased from $3.7 million in the second quarter last year to $8.4 million in the second quarter of 2008. As we increased our Toyota business to eight platforms in the second quarter of this year from four last year, and supplied products for three Honda platforms in the second quarter of this year compared to none last year. Our overall automotive actuator and sensor sales to Asia Pacific was up 58% to $11.5 million in Q2 of this year.

Production of passenger vehicles in China, one of the markets we participate in, grew by approximately 18% year-over-year in the second quarter. Our second quarter 2008 North American sales with the Detroit Big Three at $18.5 million represent less than 10% of our total CTS sales now as we continue to penetrate other global OEMs at a faster pace.

Continuing with the components and sensors segment, our electronic component sales in the second quarter were up 26% year-over-year. 9 percentage points of this growth was organic, with the remaining 17% coming from the Tusonix acquisition which we completed in the first quarter. Organic growth was driven by an 80% increase in our piezo-ceramic product sales. Piezo products are a small but profitable and growing part of our electronic components. In the second quarter, our piezo sales were approximately $4.9 million with applications in the medical, defense, hydro [pone] and inkjet printer arena.

Organic growth in our infrastructure components business was also 9% year-over-year. Shipments to customers like Nokia-Siemens were audit modules and 3-G based stations; Rockwell for military applications; Cisco were up double digits from last year. The strength in our total component sensor business therefore was reflective of our progress in diversifying the customer base and increasing of our market share to new product introductions.

Our increased presence in Asia and Eastern Europe also contributed to include performance in the second quarter. Our EMS sales in the second quarter were $102 million, up 3.2% from the second quarter of last year. As expected, lower HP sales were more than offset by growth in sales driven by our recent acquisition which, was completed earlier this year in the first quarter.

Overall our diversified international sales, which approximate half of CTS's total sales, are helping the Company reduce volatility due to weak economic activity in any one part of our served global market.

The total CTS growth and operating margins were both higher sequentially and year-over-year. Improved segment mix due to factory growth of our components and sensors segment, success in negotiating some price increases, currency exchange, improved manufacturing performance, and tighter expense management were some of the key drivers behind our improved operating earnings in the second quarter.

Some other highlights of the quarter are as follows. In automotive, we received six new sensor and actuator business awards. Five of them were from Asian OEMs and one from a European OEM. In the electronic component arena, we captured 49 new infrastructure frequencies and filter design wins, up 17% from 42 in the same quarter last year.

Design wins, as you know, are the strongest leading indicator for the future program revenues in the electronic components business. Most of the design wins in the second quarter were in the 3G wireless, Wi-MAX, and repeater arenas with customers like Alcatel-Lucent, Motorola, Nokia, Siemens, FTM Networks, Siebel and et cetera.

Looking forward to the second half of 2008, we seem to have somewhat less visibility given the economic uncertainties and since continued weakness in demand for automotive products and electronic components in North America and Europe. However, we expect to offset most of these advents with our new products, new customer initiatives and increased market share. We believe that our second quarter results have benefitted by approximately $0.02 per share at the expense of the third quarter, from sales and production pull-ups relating to the China Olympics restrictions.

In addition, third quarter results will reflect seasonal plans and extended shut-downs in the automotive industry. We're also seeing some electronic components program push outs based on weaker demand from the soft economy. As discussed in the earlier conference call, we expect to incur in the second half of 2008 close to $1.5 million in pre-tax expenses, or approximately $0.03 per share, in engineering and development activities to support growth of sensors and actuators for the commercial market.

This is primarily related to the new $75 million dollar six year supply agreement for diesel engine manufacture that we announced a few months back. Taking these factors into consideration, which tempered our second half results in general, but Q3 in particular, combined with the very favorable first half performance, the Company is reiterating its full year 2008 sales guidance of 5% to 8% growth over 2007 and slightly raising its full year earnings per share guidance to a range of $0.79 to $0.84.

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

Thank you, Vinod, and good morning to everyone.

Our second quarter 2008 financial results continue on a positive trend with growth in revenues and earnings per share. With a solid customer base and flexibility of our global footprint in manufacturing and sales, we delivered in the second quarter $186.1 million in sales, a growth of 9.7% from sales in the second quarter 2007. We maintained our focus on cost and expense management and successfully integrated our recent strategic acquisitions to deliver a strong second quarter.

Second quarter 2008 net earnings came in at $10 million, up $4.1 million from second quarter 2007. Bottom line, CTS delivered diluted earnings of $0.27 per share, up 80% compared to $0.15 per diluted share in the second quarter 2007. Please note that the prior year diluted earnings per share did include approximately a $0.03 negative impact for unusual audit and professional fees.

Now let me provide you some further insight into the second quarter 2008 details. Starting with top line sales growth for the second quarter, sales were $186.1 million, a 9.7% revenue growth year-over-year from the second quarter of 2007 and up sequentially 7.7% from the first quarter 2008 sales of $172.8 million. We had a strong quarter in components and sensors segment sales which increased by 18.8% compared to second quarter 2007 while sales in EMS segment increased by 3.2% versus the second quarter in 2007.

Sales growth in both segments contributed to the year-over-year improvement in gross profit margins. In the second quarter of 2008 sales in EMS and components and sensors segments represented 54.8% and 45.2% of our total sales respectively, compared to 58.3% and 41.7% respectively in the second half quarter of 2007. Favorable segment sales mix, along with favorable product mix and improved manufacturing performances, drove gross profit margin as a percent of sales to a high of 21.6% for the second quarter 2008 up from 19.4% in the second quarter 2007.

Selling, general and administrative expenses and research and development expenses as a percentage of sales declined 70 basis points to 14.1% of sales in the second quarter 2008, down from 14.8% in second quarter 2007. Please know that research and development expenses alone increased by 16% year-over-year reflecting planned initiatives to drive future growth. The resulting operating earnings margin, as a percentage of sales improved more than 2 percentage points quarter to quarter to 7.4%, up from 4.9% in the first quarter of 2008 and nearly 3 percentage points improvement year-over-year from 4.7% in the second quarter 2007.

Our operational performance continues to reflect the results of actions taken to manage spending given the uncertainties associated with the global economic condition. We continue to invest in areas including research and development that are expected to drive growth over time, in current product and process enhancement, expanded applications and new product development.

Total interest and other expenses were slightly higher year-over-year primarily due to higher interest expenses in the second quarter 2008 associated with increased debt in support of the recent strategic acquisition. Our year-to-date 2008 effective tax rate was 22% versus 21% in the same period last year.

I highlighted at the beginning of our discussion how our performance reflects the strength of our customer base and our global footprints both in manufacturing and sales. As we have seen in the first quarter of 2008, the U.S. Dollar continues to remain weakened against nearly all major foreign currencies, approximately 8% to 9% relative to our basket of currencies. While this has created additional expenses and costs to our business operations, we also grew our revenues in countries where we do business in local currencies which helps minimize any potential negative overall currency impact.

Net earnings were $10 million or $0.27 per diluted share in the second of 2008 compared with $5.9 million or $0.15 per diluted share in the second quarter of 2007. Higher net earnings were the result of increased revenues, improved gross profit margins and overall lower operating expenses as a percent of sales in the second quarter of 2008.

Now let's discuss details of the balance sheet performance. Overall changes in our second quarter 2008 balance sheet reflect the full integration of our recent strategic acquisitions. Our control of the working capital which includes accounts receivable and inventory less accounts payable is $111 million or 15% of annualized sales. This is down from 15.7% in the first quarter of 2008.

Within the quarter, we did realize a slight increase in inventory of several million dollars of which more than half of the increase was due to the required pull ahead of certain production related to the China Olympics restrictions. We expect our full-year controllable working capital to come down further toward our long term target of 13% as a percent of annualized sales.

A strong positive free cash flow of $11.6 million, which is defined as cash flow from operating activities less capital expenditures, was achieved in second quarter 2008. This was driven by net cash provided by operating activities for the second quarter 2008 of $17.8 million, less our investment in capital expenditures of $6.2 million in the second quarter.

We also reduced our long-term debt sequentially from the first quarter 2008 by $24.4 million to $92.3 million resulting in a current debt to capital ratio of 21.7%. Considering the challenging economic environment we expect our full-year pre-cash flow to be slightly lower in the range of $26 million to $30 million with CapEx to be in the range of $22 million to $25 million.

We finished the second quarter 2008 with a strong operating and financial position, aided by a strong portfolio of products and customers, a global footprint base of capabilities, successful integration of our recent acquisitions and very solid balance sheet.

With that, I'd like to open the call now for your questioning. Thank you. Operator.

Thank you. (Operator instructions.)

Our first question is from the line of Kevin Kessel from J.P. Morgan. Please go ahead.

Yeah. Hi, guys.

Hi, Kevin.

The first question actually, Donna, you mentioned that your long term debt was reduced, I think you said to $24 million.

Yes.

In the quarter. So what exactly were you guys doing? Was that your barn facility?

You mean the revolvers?

Right.

Yeah. Yes, it was.

Okay so that was a reduction of the revolver stuff?

Yes.

Can you just remind us like where the revolver is in terms of utilization right now?

One moment.

Kevin, the revolver, as you know, is $100 million and --

It's $24 million is our current utilization.

Out of $100 million.

Out of $100 million, yes.

I've got it. So we're about 48?

Yes.

So my question is on your convertible --

Yes.

-- now that it's coming -- I think there's a put -- there's a couple of puts but the first one I believe is in the beginning of May of next year.

Yes.

And so how are you guys thinking about it because I know it's just a little bit over 2%, but at $60 million based on current -- just the current cash on the balance sheet you probably have to go quite a bit into the revolver in order to pay it off. Because I don't believe that you guys are looking to have it convert into stock. I don't even know if that's an option at this point. At the same time, I know that the conversion price -- I think it's at 15 but if I'm not mistaken, I think it has to actually go over 18 because of the conditions that are in the convert to actually convert into stock.

That is correct. I think, Kevin, based on what we know today, we would guess that we will not convert it into stock and we will pay it off, and the options we are continuing to explore are to refinance it, or utilize our revolver to pay down, or do a combination but that's something that the treasury is continuing to evaluate.

Okay. So it's something that more likely than not, I guess this doesn't have to be decided until some point next year?

Yeah. I mean we'll obviously not wait until the very last moment to do that. We're beginning to look at it already and hopefully well before the May deadline we would have a solution. (Inaudible.)

I got it. And then also, just looking at your -- also on the balance sheet here, the other assets, particularly the other long-term assets, they've risen, I think, something like $13 - $14 million since the beginning of the year. What exactly is in that line item and how much of that could theoretically become liquid?

I think that's a category which includes good will and intangible --

Yes.

-- and things like that. And I suspect that the biggest piece of the increase is due to the two small acquisitions we did this year.

I got it. Okay. And then when you look at the overall impact that you mentioned about the Olympics, so, if I understand, you said this impacted you by 2% in the quarter positively.

Two pennies.

Two pennies. But didn't you also quantify the top line impact?

No, we didn't.

Okay. So the bottom line is two pennies.

Yeah, and it's a combination of some sales pull up because lots of restrictions from a logistics point of view or so some of the customers, we believe have pulled up some sales. But the bigger impact -- positive impact -- was you pull up some production into the second quarter so you get that absorption, favorable absorption impact and we wanted to do it to make sure that if there are any supply restrictions in the third quarter because of the movement of product, truck restrictions and things like that, that we are there with the right inventory to support our customers.

Okay. No, that makes sense. So you needed to get ahead of it, but at the end of the day, it's something that obviously will reverse itself here in the third quarter, have some of those -- I guess either your plants within China that are not going to be able operate as freely as they would have otherwise?

Yes. It's primarily one plant which is not too far from Beijing and these are restrictions which are pretty much within, I think, 100 or 150 miles radius of Beijing where the games are taking place. And you're exactly right, this is a flip-flop between Q2 and Q3.

Okay. But in terms of overall top line impact, is there anyway to give us a sense for roughly speaking what it might have -- like what you might have actually pulled into revenue for the second quarter?

It wasn't material at all. It was an extremely small number.

It was a -- but yet it had a material bottom line impact? It should have --

Yeah, because of the production and absorption, it had the $0.02 bottom line impact but the top line was very very small.

Okay. I got it. And then, I did not hear anything regarding the percentage of sales for HP in the quarter. If you could maybe give that as well as how it compared to last quarter.

Sure. The HP sales in this quarter were approximately $20 million. And that compared with close to $25 million in the second quarter of 2007. And so HP sales as a percent of EMS business this quarter is, I would say, around 20%, when they were close to 26% in the second quarter last year. And so as a percent of the total company they probably are 12% - 13% range.

And last quarter the dollar amount for HP was what?

Q1 was actually $28 million.

$28 million, okay.

But the second quarter of last year was around $25 million. So if you compare quarter over quarter, year-over-year in the second quarter, it came down from $25 million to $20 million.

All right. But the sequential decline, is that something that -- I mean at this point you thought it would take a couple of -- it would still take more than a year maybe a year and a half to two years before it really kind of ramps down completely. Is it somehow accelerating now?

No, I won't read anything in it because we know that the quarterly -- the sequential quarterly changes in HP -- they jump all over so --

I got it.

-- I won't read anything whether it's accelerating or it's slowing down.

Okay. And then just lastly, just housekeeping, kind of for Donna. The tax rate, should we be thinking about that Donna, it's been 22% the last two quarters.

Yes.

Should we think about it remaining there or is going --

Yes.

-- to remain more 23.5% or ?

No, I would hold it to the 22%.

Okay. And then the depreciation and amortization in the quarter, I don't think I heard that or maybe I missed it.

No, depreciation is running around the same level it has. It's around $6 million, it's specifically $5.9 million is your depreciation. And amortization would be about $900K. And Kevin, I do want to correct myself because I misspoke on -- you had asked me about the revolver credit balance?

Uh-huh.

It was $32.3 million as of the end of the quarter.

32.3?

Yes.

I got it. And then to know the last thing on the R&D is just a clarification. You said that in the second half of the year, PGS will spend $1.5 million on, I guess, incremental R&D to support the diesel program, which would be about $0.03?

Yes.

Got it. Okay. Thanks guys.

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

Good morning everyone.

Hi, John.

Hi, John.

Could you talk a little about the acquisitions at all? You mentioned that some of them are going faster than expectations. Can you provide a little color there what's doing better than you though originally?

Yeah. The acquisitions we did in components and sensors segment, Tusonix, when we did the acquisition we said that we're buying a company with annual sales of roughly $15 million. And my guess is that that company, that division or that acquisition will probably grow during 2008 by 10%.

But more importantly, the second acquisition, the other acquisition we did in EMS, which was primarily driven by their sales into the medical -- not medical -- defense and aerospace -- when we did that acquisition, we said we are doing that acquisition with annual sales of $27 million. And if I have to guess at this point, I would think that that acquisition will probably do closer to $35 million if not even higher than that this year.

And that's what I meant that they are growing faster than our expectations. And EMS acquisition with its heavy penetration into the defense and aerospace markets is especially performing well.

Great. Great. Now could you provide for us the sales growth on an organic basis for the Company-wide and then even further break it down of the component side and the EMS side what the organic top line growth was versus how much the acquisitions contributed?

I think components and sensors is a pretty good story because we break it down between automotive and electronic components. Automotive growth of 15% is all organic. There was no acquisition there.

Right.

That was probably very encouraging for us to -- frankly, our automotive sales, we were just discussing it among our -- I was discussing with my colleagues that our automotive act -- sensors and actuator sales this quarter is an all time record. So that was 15% all organic.

Electronic components, I said organic was more like 9%. And so if you combine that segment, components and sensors, the organic growth is roughly 12%. So pretty good performance.

EMS on the other hand, almost all the growth came due to acquisition. So the organic growth is minimal if any. If you combine the total company we set our year-over-year growth in the second quarter was 10%. I would say that organic is probably 6.5% - 6.8% range and the organic is more like 3.5%, in that range.

Okay. Great. That's helpful. You also mentioned in the press release that there's been some program push outs. Can you provide a little color on what side of the business and what are the push outs related to?

The push outs we have seen in electronic components, primarily in the wireless infrastructure space. And we have seen some indication that some of the OEMs may be pushing out some of the sales from Q3 to Q4 and therefore, some of the Q4 sales may fall into first quarter of next year.

And they have a tendency to change it, John, as you know. So we're watching it very carefully but we have seen indications of some push outs in that space.

Is this across the board or is this a -- is there a regional bias involved in those push outs?

I can't say definitively but anecdotally, I think that push outs tend to be more from North American and European markets. And Asian markets continue to do very well. And that's probably true with not only electronic components but automotive sensors and actuators also.

Okay. You mentioned that the extended shutdowns in the automotive sector is going to have a disproportionate impact on third quarter profitability. Could you just talk a little bit about what your thoughts are in the auto sector for the balance of the year, maybe into next year, in light of those statement?

We're watching it. It's a changing story everyday. But that OEMs have continued to announce that some of them are going to extend their shut down to the third quarter. We do have a seasonality pattern. We normally have Q3 as our weakest quarter.

The shut downs normally affect sensors and actuator side of the business, the automotive side of the business. And as sensors and actuators become a bigger and bigger part of the company, you may see a little bit of more seasonal patterns in our performance between the quarters. So Q3 being a weaker quarter compared to second quarter and the fourth quarter.

If you look at the full year forecast, we are seeing for North American light vehicle production, last year the numbers were closer to 16.1 million units in North America. This year you see forecasts all the way from a low of 14.2 million units to maybe a high of 14.7 - 14.-- There's nobody forecasting even a 15 million number for 2008 in North America. So depending on where those numbers come out, we think they will be probably closer to 14.3 million - 14.4 million. That's the lowest level since 1995.

So we're watching it very carefully. We are hoping that most of it will be offset by our penetration into OEMs like Toyota and Honda which continue to do well. Actually Honda was probably the only major automotive OEM which showed an increase in their unit sales in 2008 compared to 2007.

So that's positive, combined with, as I indicated in my comments that one of the drivers for our higher sales in automotive sensors was the fact that we are now providing products on several Toyota and Honda platforms, when last year we weren't supplying in the second quarter any Honda products. Honda platforms and Toyota platforms were a lot lower. So, we believe that our increased penetration would help us offset the impact of the economic weakness.

But stepping away from that, the overall North American and European light vehicle market is not looking -- in the second half -- I think the jury's out as to where that number would be for 2009.

I guess that makes sense Vinod. In the context of the beat that you had in the quarter and assuming the $0.02, and the sales pull up would have happened in the third quarter as opposed to the second. I'm just curious -- could you just talk a little about your lack of willingness to raise the outlook? Where does the program push out versus the weak economy, versus the auto sector? How did you rank them or if you can quantify how much that you expect them to be an adverse impact on the earning profile in the second half.

John, I could highlight some of the things we have kind of talked about which answer or attempt to answer your question. The first one, as you know, we talked about is that approximately $0.02 worth of pull up in Q2 from Q3. That's pretty straight forward. We can quantify that and --

But that would have also happened in Q3 no matter what, right? You said it's a pull up? So.

Right, it's a pull up so that says the $0.27 are more like $0.25 and whatever we will do Q3 will have been two pennies higher if we would have had this Olympics phenomenon on the timing. But you're right, it has no impact on the full year numbers.

Right.

But it does have an impact that those $0.02 are already recorded in the second quarter.

The second comment we made is we are driving a brand new growth initiative around sensors and actuators for adjacent markets or commercial markets as we call them. And the announcement of the win we had recently for a diesel engine manufacturer is a very good example of that.

And as I pointed out and Donna pointed out that we have roughly $0.03 per share of impact in the second half because of that and that's an investment into our future. That's an investment in R&D. That's an investment in drive growth in 2010 and beyond.

So $0.03 there which is a drain in the second half. $0.02 which will not be there in the second half because that was pulled up in the second quarter, those two things combined with the fact that the overall economic environment, and especially in North America and Europe, is really still unfolding and those three broad category of things, I think, combined, made us increase our guidance but not go beyond that.

Remind me though. I thought the R&D picked up in the first quarter and that the announcement of the diesel program was already kind of baked into the numbers by the time we had the last conference call. Well, maybe I'm wrong.

No. No. Certain amount of that number was baked into our guidance. But I think that the numbers are probably a little bit higher, when I -- when we gave the guidance, I believe in January, we put that number at, probably $1.5 million to $2 million, $0.02 to $0.03. And now, as we are pointing out, we have that magnitude of number in the six months, the second half alone. So that number has been a little bit higher.

And frankly, that's good news because we are finding some very interesting opportunities and discussing with several major new customers in the commercial or diesel engine arena. And that is requiring us to chase those opportunities and actually strengthen our R&D resources to drive those growth initiatives.

Okay. One last question. Will these R&D levels stay elevated in 2009 or do you expect them just to go end of life -- end of the year?

I think they will stay there in 2009.

Okay. Great. Thank you very much.

Thank you. Our next question is from the line of David Feinberg from Goldman Sachs. Please go ahead.

Good morning, everyone.

Good Morning, David.

Good morning.

A couple quick questions. I'm interested to hear about a particular end market that you have. What end markets are you starting to see some growth in into this economy and which ones are you starting to see some weaknesses?

It's an interesting question because all the markets we are seeing growth in for CTS product. Most of them happen to be markets which are actually weak. And the reason we're growing despite the fact that the markets are weak is either because we are introducing new products or because we have added new customers.

And the clearest example I can give you is automotive. We all know how difficult that environment is with its volumes down pretty materially in North America and to a smaller extent in Europe. Asia is growing, but as I pointed out, that Asian growth in light vehicles was more like 18%. Despite all that, we have grown. And the reason we have grown double digits is because of new customers. So that's an example where markets are weak but we're growing.

The other area where we are growing, but the market is okay but not extremely strong, is what we call the infrastructure -- wireless infrastructure area. Our growth there, organic growth, we believe is somewhat higher than the market growth.

One area where we are growing and the markets are also strong and I pointed out that as one of the key drivers in out electronic component sales, is the PZT, the piezo-ceramic product. And that is probably one example where the markets are growing along with our sales increasing because those markets are either oil and natural gas exploration kind of applications or they are medical applications. So those are examples where the markets are growing and we are growing with them.

Another area where I believe the market is also fairly healthy, and that's where we're benefitting also, is the defense. That market has not been affected like automobiles or wireless infrastructure kind of markets. So there are two examples where markets are weak but we're doing well, and two examples where we are doing well along with the market strengthening.

Just to clarify. The market is very healthy that helps benefit CTS's defense and what was the other one?

One was the piezo product which goes into medical and oil and gas exploration. And the second example was defense.

Okay. And my last question has to do with you were speaking about how the third quarter might be impacted by how the economy is shaping. Are there any particular concerns that you have within the macro economy, whether it's inflation or fuel expenses, labor costs. Are there any particular areas that you're particularly cautious on?

No particular area which we would like to highlight necessarily. In the past we have talked about the negative impact on CTS because of materials, precious materials, commodities kind of a thing. So that actually, we're hoping that as the economy slows down that the pressure should be less compared to what we saw last year or earlier this year. We also have some flexibility to give price increases to the customer on the back of higher material increases.

So I won't point that out as a special concern for Q3, because we think it should actually get better. In the past, currency was another area where we were very worried that as the dollar weakens dramatically, it had a negative impact on CTS, because we had more costs based in the foreign currencies outside the U.S. than revenue based. And when dollar used to weaken, we used to see a negative impact on CTS.

Now, as Donna pointed out, because of our expansion in Czech Republic, we're tapping into the local markets in Asia, all of these are creating sales which are denominated in foreign currencies like the Euro and Czech and Chinese currency in those countries. As we balance our revenues and expenses, even currency, has gone away from the radar as a major concern for us. So we have managed currency and balanced it more so that's not an issue.

I guess if I have to point out what we are worried about, it's just that overall GDP growth in North America and the overall vitality of the economy in Europe which will obviously have an impact on us. If that weakens further, we will see pockets of negative impact on us either because of communication equipment or our automotive applications.

All right. Thank you so much and congratulations on the great quarter.

Thanks, David.

Thank you. Our next question comes from the line of Gerry Heffernan from Lord Abbett and Company. Please go ahead.

Good morning and thank you for a successful quarter here.

Thanks, Gerry.

Hey, Gerry.

On the previous question, I think you discussed the R&D spend for the diesel business and I guess that is for not just that diesel contract that you're working on but also other businesses that you maybe able to get into off of that. Can you just review that business win however, and give us an idea of when you would actually begin to see revenue ramp from that business.

Okay. Good question. Gerry, that business which we announced a couple, three months back was -- the product is a smart actuator which we are developing by working very closely with the engineering organization of this diesel engine manufacturer. And that is $75 million spread over a five - six year period. Kind of a business goes on their light duty diesel engines.

The revenues from that program currently are projected to begin sometime around mid-2010. When I commented that it is opening up potential opportunities with others, we -- when we won that business and started putting a lot of effort in developing different versions of that product. Since then, we have now started discussions with a major turbo charger manufacturer in the United States. And we have been working very closely with them to sell them the product and we have also opened discussions or have inquiries from at least two other very large, major OEMs who make diesel engine related products.

And so we're finding very interesting opportunities for us. These opportunities tend to have a higher margin than our bids business. The only thing we had to point out is that you have to work with the OEM and develop the product for a period of 12 to 18 months before the revenues start. But on the other hand, once you are designed into those products, those revenues then become locked in for a very long period of time, six to eight years. And so it's a very good opportunity, a high margin opportunity, but the revenues lag from the expense or design and development phase by 12 to 18 months.

Okay. And that would be for most all of the products that may be developed in this area regardless of whether it's the turbo charger manufacturer or one of these other two diesel engine related OEMs?

Yes. That is a pretty standard time frame we talk about.

Okay. Thank you very much for that insight. Just two other things, if I could. The HP business, a previous question you were asked about the amount of revenues there. I think it's been pretty widely discussed that you know we're expecting this business to pretty much roll off and go away. Is the roll off of this business happening on a trajectory that is consistent with what you had been expecting one quarter, two quarters ago?

Yes. Absolutely.

Okay. And this is just kind of a detailed question here. There was some discussion on to free cash flow and what do we expect that be full year cash flow and CapEx to be. And unfortunately my wrist and pen weren't reacting as fast as it was being said. So could you just review that information, please?

Normally we give that information very quickly so that you can't capture it.

That's all right. The free cash flow I provided a range of $26 million to $30 million and CapEx between $22 million and $25 million for full year.

And that $22 million -- that $26 million to $33 million cash flow is -- that's an after the $22 million to $25 million CapEx number, right?

Yes. Yes, it is. Yes.

That is correct.

Okay. Thank you very much.

All right. Thank you.

Thank you. Our next question comes from the line of [Hendi Vasanto] from Gabelli, please go ahead.

Actually my question has been answered. Thank you.

Thanks, Hendi.

Thank you. We have a follow up from the line of Kevin Kessel from J. P. Morgan. Please go ahead.

Yeah. I just wanted to just clarify one statement that I think was made in the beginning by Vinod. You were talking, Vinod, about the platforms for Toyota and Honda and I think you said eight platforms right now for Toyota this year in this quarter versus four a year ago, and Honda was three versus zero. And then I think you made mention of some sort of an aggregate sales rate for the two combined. Is --?

Yes.

Maybe you could just review that because I heard the big three at $18.5 million.

Sure. And I didn't necessarily say that that number applies to only -- definitely -- completely for those two but I said, it's primarily because of those two. And that number, I'm just going back on my notes. I said our sales to Asia based OEMs increased from $3.7 million in the second quarter of last year to $8.4 million in the second quarter of this year. And I said Asia based OEMs are primarily Toyota and Honda.

Okay. So, and then the big three you mentioned, you said, they're now less than 10% of sales.

Total CTS, yes.

Of total CTS sales at $18.5 million. What were they a year ago?

That's a good question. Let me quickly check my notes to see if I can pull that information out easily.

And when you're talking "big three" you're talking sales to guys like GM Ford or how are you defining it? Are you defining it as, you're not talking about the [Vistion] and the Delphi?

Good question. When we talk about that, we would generally include in that category, Delphi and (inaudible), so it's a pretty safe definition. So if we sell it to Delphi and it's ending up to GM, it will be included in this number.

So Delphi, [Vistion] and then who else would be kind of considered the third one then?

For CTS those are --

Or you're just saying those won't sell into those two -- sell into the big three.

Those are primarily the two big ones where we sell which we are -- we know the product ends with GM and Ford and Chrysler.

Uh-huh.

In reality there are companies like American Axel which as you know, 70% - 80% of their sales, I believe, still go to GM and we have very little to sales over there so. We tried to go through an analysis and capture everything which ends up with the big three, Detroit, in North America.

I got it. But do you have direct relationships as well with GM, Ford or Chrysler?

Yes. Yes, we do.

Okay. So that's all then incorporated in this 18.5 [million]?

It is. It is incorporated in all that. But the one question you asked was is sales to these big three. I do have some information here that compare -- if I compare Q2 '07 with Q2 '08, the sales to them actually came down 22%.

Okay. So it was 22% higher a year ago?

Yes.

I got it. Now, on a sequential basis, is it easy. Do you have that comparison? I'm just curious to see if there are any.

I don't have that comparison. We can provide you with that information after this call. I suspect you will see a steady trend of them coming down in the percent simply because our sales to the non-big three is growing clearly faster. If you remember, we started saying actually a couple of years back that the new business which we are winning, a very large percent of the new business we are winning is from people like Honda and Toyota and so we had projected at least directionally that a couple of years down the road they will play a much bigger role for the corporation and the Detroit big three as a percent at least would be smaller.

Okay. And then just two last things here. One is inventory. It's up, I think, year-over-year it's up about 17%, which is double -- almost double the sales growth number. And your inventory turns have fallen close to a full turnover the last five quarters so what's the expectation there. I mean are customers -- is this build up then primarily a raw material build up or is this a finished goods build up or you're having to [hub] more inventory or vendor manage more inventory or what exactly is driving the inventory growth?

Well one of the things which is distorting that number is the acquisitions, the two acquisitions we have made. So what we probably should do is after this call provide you the inventory which is apples to apples with last year by taking away the acquisition inventory.

Right. But I guess that last year you wouldn't have had those acquisitions in your revenue numbers so.

Right. But the way -- the terms get calculated I think it does get distorted.

All right. I understand.

But I think, I think -- Donna and Mitch will try to get back to you --

I can do that. Yes.

Okay. So that's part of it. Is there any other part of it besides the acquisitions, do you think? I mean.

No. I think that as we said earlier that there was probably some inventory, extra inventory build up in Q2 because of this China Olympics issue because that did benefit us from the absorption side in the P&L and so the flip side is that we probably are carrying more inventory than normal in China.

Okay. I got that.

We should be able to bleed those by the end of the year.

Okay. Makes sense. All righty. Well, appreciate that.

Thank you. (Operator Instructions.) And there are no further questions. I'll turn it back to you, Mr. Walorski.

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Thank you for joining us today.

Thank you. That does conclude our conference for today. Thank you for using AT&T executive teleconference. You may now disconnect.