CTS Corp (CTS) 2009 Q2 法說會逐字稿

Welcome to the second quarter 2009 conference call. At this time 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 will now turn the conference over to our host, Mr. Mitch Walorski, Director of Planning and Investor Relations.

I am Mitch Walorski, Director of Planning and Investor Relations, and I will host the CTS Corporation' second quarter 2009 earnings conference call. Thank you for joining us today.

Participating from the Company today are Vinod Khilnani, Chairman of the Board 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 was set forth in last evening's press release, and more information can be found in the Company's SEC filings.

To the extent that today's discussion refers to any non-GAAP measures relative to regulation G, the required explanations and reconciliation are available on our website in the investor relations section.

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

Thanks, Mitch, and good morning, everyone. Last evening we released our second-quarter financial results for 2009. Overall, the financial performance was better than our expectations. The global economic conditions in general seem to have stabilized in the second quarter. While some markets are beginning to strengthen modestly from their first-quarter levels, others are still weak.

In the second quarter CTS successfully continued with simple two-pronged approach to strongly push to win new business and aggressively manage its cost structure and balance sheet. As a result, we recorded a number of key business wins in the second quarter and were able to report improved earnings and strong free cash flow with a modest sequential improvement in sales.

Second quarter 2009 adjusted diluted earnings per share of $0.06 improved from a loss of $0.03 in the first quarter. Free cash flow in the quarter was a strong $18.3 million. Adjusted earnings per share exclude an essentially non-cash tax expense for repatriating some of our international cash. Donna will discuss the financials and the special item in more detail a little later.

Sales in the second quarter 2009 of $120.4 million, although approximately 35% lower from second quarter 2008, were up 2% sequentially from the first quarter and in line with our expectation of a stabilized top line in the second quarter.

Within our Components and Sensors segments, let me discuss automotive sensors and electronic components separately. Automotive sensors represented 26% of our total CTS sales in the second quarter. The automotive industry, as we all know, is going through a severe and unprecedented contraction, in their volumes worldwide. Second-quarter North American light vehicle production was down 51% year-over-year. Sequentially, sales were actually up approximately 18%. However, OEMs still cut production 9% in the second quarter compared to the first quarter. As a result, we have seen a significant reduction of vehicle inventories in the US from over 100 days in the February-March time frame to around 67 days at the end of June.

Clearly, this bodes will for OEMs to keep their factories running at reasonable production levels in the third quarter, assuming the demand continues to sustain.

CTS automotive sensors sales in the second quarter were up 31% sequentially from the first quarter, although they were still down 41% year-over-year. The strong sequential improvement was driven by our increasing presence in Asia, where our sensors and actuarial sales were up 53% and Western Europe where stronger automotive sales helped CTS increase in shipments to Renault, Opel and Toyota. In addition, we had higher year-over-year sales to customers like Honda, Toyota and Nissan as we increased our market share by winning new business and additional platforms.

On the business development front, our sensors and actuators continued to have a strong year, winning significantly more new business awards in each of the last two quarters this year versus last year. We have won 23 new platforms in the second half of this year versus 12 in the same period last year. All of our new business wins were with non-Detroit OEMs and primarily on small, fuel-efficient cars with some on hybrid and electric vehicles. Our Detroit three sales in the quarter were just 4.2% of our total CTS sales compared to approximately 10% in the same period last year as we continued to grow our sales to Japanese global OEMs and other Asian and European customers.

Our continued success in diversifying our customer base and broader application of our sensors and actuator technology to medium- and heavy-duty off- and on-highway applications underlines our confidence in the diversified growth and profitability of our sensor and actuator products as the market conditions normalize.

Continuing with the Components and Sensors segment, sales of electronic components, which represented 15% of the total CTS sales, were flat sequentially compared to the first quarter and still staying approximately 40% below 2008 levels. We saw a small improvement in wireless infrastructure sales, up 3% sequentially from the first quarter as sales which go through the distribution channel improved. However, direct wireless infrastructure sales still did not see any indication of a bounce back. Our piezoceramic sales have yet to show any clear signs of recovery.

New product development activities for electronic components are staying strong despite the economy. Engineering prototype and testing activity are continuing satisfactorily with two of the largest and growing target Asian telecom companies, ZTE and Huawei. Overall, we recorded 59 infrastructure design wins in the second quarter versus 49 in the second quarter last year and 51 in the first quarter of 2009.

The design wins, a leading indicator of future revenues in this part of our business, were in 3G wireless, WiMAX, industrial and defense and aerospace applications. Our EMS segment sales of $70.8 million in the second quarter 2009 were 31% lower than the same period last year, primarily due to continued weakness in the industrial and communications markets, and Hewlett-Packard sales declined year-over-year due to previously discussed end-of-life products.

Our sales to HP in the second quarter were just $6 million and are essentially wrapped up. Defense and medical EMS sales are up double-digit compared to a year-ago levels. We won four new customers in the second quarter, two in defense and aerospace and one each in industrial and telecommunications.

Overall, our mantra to emerge a stronger company from this global recession stays the same. First, vigorously pursue diversification through new business and increased market share; and, second, aggressively manage our cost structure by streamlining our operations to create flatter and more responsible organization structures and a more efficient shared services model. As you can see, we are making good progress on both of these fronts.

Looking forward, some of our businesses, like automotive sensors and actuators, saw strengthening in their order boards in June, which seems to be continuing in July. However, other parts of our business, although stable, have yet to see improvement in their incoming orders. Overall, we believe a most likely scenario is that the business will sustain or continue to recover modestly in the next few quarters. New business quotation activity remains robust, and we are continuing to win new business and increase our market share.

Although first-half results were slightly better than expectations, we believe it is not prudent to provide specific guidance on sales and earnings at this time, given poor visibility and uncertain economic conditions over the next couple of quarters. We do, however, expect to be profitable on an adjusted basis and generate positive free cash flow in 2009 full year. We also believe that, barring any major deterioration in the global economic conditions, earnings in the second half should be better than the first half of 2009, helped by a modest improvement in the top line and a much better cost structure.

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

Thank you, Vinod, and welcome, everyone. The second quarter 2009 financial results reflect modest improvement in top-line sales from the first quarter 2009, though total sales are down year-over-year. We saw substantive improvement in our overall second-quarter operating earnings compared to first quarter, fueled by both the slight growth in sales and, more importantly, the benefits of the Company's reduced cost structure.

As I shared with you in the first quarter, we began proactive cost actions in the second half of 2008 and continued through the first quarter 2009. These tactical responses to the low demand levels are providing the opportunity for improved margins as volumes return to normalized levels. In addition, our second-quarter 2009 cash flow was also strong.

Before I go through our consolidated earnings and balance sheet, I would like to address a discrete item that occurred in the quarter which resulted in a tax charge of $9.1 million, which was primarily non-cash, for the repatriation of international funds.

As you are aware, we ended the first quarter 2009 with two sources of debt, one being an unsecured US credit agreement which we can draw on, and the other being the remaining principal of a convertible note, which had a put option as of May 1. During the second quarter we settled the remaining balance of the convertible with our global liquidity, which in part was through repatriating some of our cash in from foreign jurisdictions. This cash repatriation is a discrete event, as it is our intent to continue to permanently invest in our foreign jurisdictions. We determined that it was an optimal solution to fund the settlement of the convertible notes primarily through cash, given certain tax strategies as well as the favorable market pricing we have on our existing US credit agreement.

As mentioned, there was a tax expense associated with this repatriation, and the tax expense was essentially non-cash, given the existing net operating loss carry-forward we have in the US.

Now I'd like to expand upon the financial results for the second quarter 2009. The second quarter 2009 sales were $120.4 million, up 2% from the first quarter 2009 sales of $118.1 million, though down 35% from the same period last year. The year-over-year sales decline was anticipated in both the Components and Sensors segment and the EMS segment. The improvement from first-quarter to second-quarter 2009 sales was driven by the growth in our Components and Sensors segment, primarily in the automotive product sales. This growth shifted the overall segment mix to be more heavily weighted towards the Components and Sensors segment, which inherently has better margins and helped drive overall improvement in gross profit margins.

Sales in the Components and Sensors segment represented 41% of the total sales, which is up from 36% in the first quarter 2009. The remaining balance of our sales is in the EMS segment, which represented 59% of total sales, down from 64% in the prior quarter.

The sales improvement and the diversification of our sales mix combined with an overall leaner cost structure contributed to a gross margin of 18.2% of sales in the second quarter of 2009 compared to 16.8% in the first quarter of 2009. We also continued with expense management, which was a contributing factor to lower operational selling, general and administration expense, or SG&A, which were reduced year-over-year by approximately $6.3 million to $15.2 million in the second quarter 2009. SG&A as a percentage of sales was 12.7% in the second quarter, down from 14.1% in the prior quarter. The decline includes both permanent cost reductions and temporary reductions such as lowering discretionary spending, salary reductions and other initiatives to align costs with production volumes as well as a $1.1 million pre-tax gain on the sale of an idle facility in the second quarter.

We maintained our investment commitment to research and development with $3.5 million of expense in R&D for the quarter, which is approximately the same spending level as the first quarter 2009.

Total other expenses, which include items such as interest expense, interest income and currency translation gain or loss and other non-operational expenses or gains, was $500,000 for the second quarter 2009. This is a significant improvement both year-over-year and from first quarter, primarily due to the lower worldwide outstanding debt. And I will talk in more detail about our debt when I discuss the balance sheet.

If we exclude the discrete tax provision associated with the repatriation of cash from our foreign jurisdictions to the US and the goodwill impairment in the first quarter, our adjusted full-year tax rate would be approximately 21%, which is slightly lower than our anticipated normal range of 22% to 25%.

To summarize our second-quarter 2009 results, we reported adjusted operating earnings of $3.2 million and adjusted net earnings, which excludes the discrete tax item of $2.1 million or $0.06 per diluted share.

Now I would like to discuss CTS's balance sheet and cash flow. I'm going to start with debt and cash and then conclude briefly with controllable working capital management. At the end of the second quarter 2009 we had $51 million of total debt. This amounted to $35.1 million lower than the prior quarter, primarily due to the settlement of our convertible debt. As previously mentioned, this debt was redeemed with available global liquidity as well as positive cash generated from operations in the second quarter. At the end of the second quarter, no convertible debt remained.

Our remaining debt of $51 million therefore represents funds drawn on our $100 million US unsecured line of credit. This agreement is in effect until June 2011 and is favorably priced in comparison to current financial market conditions. Our total debt to capital has now decreased to 17.7%, down from 26.2% in the first quarter 2009.

Cash flow from operations for the second quarter was $19.7 million, increasing $1.9 million over the same period last year and up $23.7 million from the first quarter. As planned, capital expenditures were $1.4 million, which is unchanged from the first quarter, and down significantly from the same period last year. We believe we will have positive cash flow for the year, and our capital expenditures will continue at a reduced level from the prior year.

Now let me wrap up with a brief look at our controllable working capital management, which includes accounts receivable plus inventory less accounts payable. Controllable working capital as a percent of annualized sales improved 2.7 percentage points to 17.1%, down from 19.8% in the prior quarter. This improvement, even with the higher sales in the second quarter, was primarily due to our inventory reduction initiatives that are driving our inventory levels down and improving our inventory turns, as well as faster collection of our outstanding receivables.

Overall, our efforts are helping to drive our processes back to normal levels.

This concludes an overview of our financial performance for the second quarter 2009. With that, I would now like to open the call for your questions.

(Operator instructions) John Franzreb.

My first question is, Vinod, I think you said that your direct wireless infrastructure sales did not show any sign of recovery. Could you just elaborate on that statement and what you are seeing in that market?

John, I said that overall our wireless infrastructure sales were up. However, within the channel the improvement came primarily from our infrastructure wireless sales which go through the distribution channel. The portion of the wireless infrastructure which goes directly to OEMs was not up. As you know, that tends to be lumpy; and, depending on the launching of the major projects, it can move from one quarter to another. So we were encouraged by the distribution channel sales.

One can make an argument that distribution channels may reflect the leading indicator in that market.

And you did a nice elaboration on what's going on in the automotive market. Would you say that your increased sequential improvement in volumes -- is that more of a function of increased content per vehicle or an increase in the number of platforms that you guys are now penetrating?

That's an interesting question. The answer would be that it's pretty clear that our number of platforms are increasing. And that we report and have done press releases. I'm trying to reflect that if, in addition to increased platform, I can give you some examples of increased content. I would say that primarily our increased sales are a result of increased platform with our existing customers, combined with penetrating new customers.

So it's really just to increase the number of platforms in total, more so than the increase in dollar content per vehicle?

Right.

Considering, if you look at the cost reduction actions that you have taken and if we kind of looked maybe a year or so out into the future, can you quantify what you think a reasonable target operating margin would be for the Company on a normal revenue run rate, based on those cost saving actions?

I'll give you a directional answer. In the past, we have talked about that our target operating margin would be more between 7% and 8% of sales. And I would think that that target should still be a pretty good target. We have lowered our breakeven point, and one can make an argument that that would allow us to reach that target earlier than we otherwise thought or, in other words, we should be able to reach the target at a somewhat lower level of sales than previously thought appropriate. So I would say that the target probably stays in the same 7.5%, 8% range when we bring our capacity utilization to a higher number, around 70%, 80%, compared to our existing capacity utilization, which is probably around 40%, 50%.

Are your expectations for a normal -- that there will be another normal seasonal shutdown in the automotive market in August, or do you think that there will be a catch-up, more of a catch-up effect going into place? What are your expectations on the auto side as we enter into the third quarter as far as production levels?

You know, my personal view is that we will probably not see a normal third-quarter dip in the automotive sales, and that's just my personal view combined with some anecdotal comments I have gotten from some automotive purchasing people who have said that in the second quarter the sales showed a pretty decent increase, but automotive companies actually saw -- cut their production. So that was my comment, that inventories have really come down from 100 and 102 days levels to closer to 60-65 days. That indicated to me that if the sales continued to stay at the levels which every indication is that they will, actually -- I believe there was a preliminary report today that the cash-for-clunker program which the government launched -- I believe last week, that the early reports were pretty positive. So you combine those indicators and the fact that inventory levels are down, my expectation is that we should not see the normal seasonal dip in the third quarter.

Hendi Susanto.

Can you talk more about the business environment in the automotive markets in Europe, specifically on the sales increase, whether part of it is contributed by inventory build, or whether it's mostly by new programs?

The European environment and Asian environment continues to stay pretty decent. We did see strengthening in Europe and Asia, both. And Europe, I believe, is due to their version of the government incentive, which they launched earlier than the US incentive. And early reports clearly were that those programs were very successful and created, in the second quarter, a fairly good upturn in their automotive sales. There is some concern, however, that as people have pushed up the sales on the back of this government incentive program in several countries in Europe -- Germany, France and I believe UK also -- that there may be a little bit of softening in the third quarter as those sales programs subside. However, overall I think Europe is still continuing at a pretty decent clip. Asia is actually stronger than Europe, and I think the Asian strength is continuing, we believe, in the third and fourth quarter.

And then next, in Sensors and Components, are you still seeing excess inventory in the supply chains, and when do you think you will see inventory rebuilds?

In automotive sensors, as I commented earlier, we believe there was a lot of normalization of inventories in the second quarter. In the electronic components side of the business, that's pretty fragmented. We have some pockets where our product goes into communication or some medical or oil and natural gas exploration. We, frankly, hope that in the third quarter or by the end of third quarter, the remaining excess inventories should be gone and we should begin to see some improvement in the order rate.

In the distribution, as I commented, indications are that we are pretty much done with the inventory bleed. And as I commented earlier, we actually are seeing some improvement now in those channels.

This question is for Donna. How much cash did you repatriate in total, and how much of your cash is in US now?

During the quarter we repatriated approximately $31 million in second quarter. We finished the quarter with around $27 million of cash and cash equivalents on the books.

And then how much of that is in the US?

The bulk of the cash is primarily in our foreign jurisdictions, where we have been making a lot of our investments going forward in terms of our facilities there. So the bulk of it is in our foreign countries.

And this is for bookkeeping. How much is the gain on the sale of your idle facility, by the way?

The gain on the idle facility was approximately $1 million.

(Operator instructions) John Franzreb.

Could you just talk little bit about the EMS business? I know you've announced a number of awards, but could you just talk a little bit maybe about the competitive landscape and what the demand trends are looking like now?

John, competitive landscape is pretty much same, no dramatic change in the competitive landscape. When it comes to business conditions, it's pretty fragmented again. We continued to see very soft sales into the industrial market. Some of our industrial customers have a sales decline of closer to 80% year-over-year, so pretty dramatic drop in their sales year-over-year. However, we did see some improvement in Q2 sequentially from Q1, in those very depressed markets like industrials.

When it comes to medical and defense, which are staying reasonably strong, and we saw a fairly healthy increase year-over-year -- however, from those very strong levels we did see some softening in the second quarter compared to first quarter.

So the businesses, which are very weak year-over-year, saw some improvement in the second quarter. Businesses which have stayed very strong year-over-year did see some weakening in the second quarter, although we think it's all timing-driven. There is nothing fundamental which concerns us that those sales were down sequentially. I think they were just at a very, very strong level, and the timing of the programs or the changeover made the second quarter somewhat softer compared to the first quarter. And what is your exposure to the commercial aerospace market, Vinod?

John, we have not broken out, historically, our defense and aerospace numbers. I don't have them on my fingertips, but I'll have Mitch cycle back to you and try to maybe break out our commercial aerospace out of our defense and aerospace. I would say, though, that that number should be fairly small.

Okay, because there's certainly enough concern out there about that whole market rolling over.

No, no, very small in the commercial aerospace. I would say bulk of it is in defense, military and satellites and that kind of business. And in defense, also, there has been some concern in the markets around defense spending going down. But the bulk of CTS business on the defense is not on the large ticket aircraft carriers or expensive jet side of the business. Our exposure is more homeland security, encryption, armored personnel carriers, night vision kind of things.

So we continue to feel pretty good about our exposure to defense and aerospace business.

And, Donna, you said the asset sale, the facility sale, was $1 million?

Yes.

Okay, was that included in your non-GAAP reconciliation?

Yes, it was.

Where would I find that line item?

It's in our SG&A expense line item.

Okay, so SG&A should be about $1 million higher?

Yes.

And that's about $0.02 a share, if I'm doing the quick math right?

That's correct.

(Operator instructions). I'm showing no questions in the queue.

Okay, I'd like to continue. I would like to remind our listeners that a replay of this conference call will be available from 1:30 PM Eastern daylight time today to 11:59 PM on Tuesday, August 4, 2009. The telephone number for the replay is 800-475-6701 or 320-365-3844 if calling from outside the US. The access code is 106596. And thank you for joining us today.

Ladies and gentlemen, that does conclude our conference for today. Thank you for your participation, and for using AT&T executive teleconference. You may now disconnect.