CTS Corp (CTS) 2011 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the CTS Corporation's first quarter 2011 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, today's conference is being recorded. I would now like to turn the conference over to our host, Director of Investor Relations, Mitch Walorski. Please go ahead.

Thank you, Trisha. I'm Mitch Walorski, Director of Investor Relations, and I will host the CTS Corporation's first quarter 2011 earnings conference call. Thank you for joining us today. Participating for 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 sent 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 reconciliations are available on our website in the Investor Relation 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 first quarter financial results for 2011. I'm pleased to report that we recorded a strong first quarter despite some push-outs of automotive sensor shipments by a few of our Japanese customers and a sharp increase in precious metal pricing which we are normally able to offset through productivity improvements in our manufacturing processes and price increases to our customers, but only after a few month's lag.

Sales in the first quarter of 2011 at $151.5 million were up 4.5% sequentially and up 17% year-over-year. The sequential sales growth was primarily driven by increased components and sensor segment sales and the year-over-year increase was primarily driven by strong EMS business sales.

On a segment basis, component and sensor segment sales were $72 million, up 10% sequentially, but down 2% year-over-year from the first quarter of 2010. Please note that first quarter 2010 component and sensor sales had bounced back sharply partly due to industry-wide inventory replenishment activities after a steep recession in the year before. Year-over-year component and sensor segment sales compared between the first quarter of 2011 and first quarter of 2010 therefore becomes difficult. Within component and sensor segment, sales of automotive sensors had $45.3 million, were up 14% sequentially. Year-over-year these sales decreased 5.6% primarily due to inventory replenishment driven sales in the first quarter of 2010 as mentioned and in addition due to some one-time higher margin service part sales to a Japanese OEM in the first quarter of 2010.

Continuing with the component and sensor segment, sales of electronic components increased by 4.9% year-over-year, helped by stronger sales in the distribution channel, EMI filters, and the electro-mechanical product family.

CTS continues to push forward with strategic focus on research and development, new product development and launch activities in this component and sensor segment. Noteworthy items in the first quarter underlined our commitment in this regard included things like increased success towards growing our intellectual property with two new [patent] grants and almost double the usual rate of new patent filings in the quarter at 31.

We won the final segment of our second global platform pedal module award from a major Japanese OEM with total program revenues now estimated at $70 million for this one global platform. We continued to diversify our component and sensor business with a new transmission sensor award for an [all electric] vehicle, new pedal program wins with a couple of Chinese OEMs for the rapidly growing local market. And launch of our first low-volume smart actuator for global non-automotive OEMs for commercial industrial engine application.

Smart actuators are a major new family of highly engineered products which are expected to begin contributing significant sales and earnings to our component and sensor segment and diversify our sensing technology into on and off hybrid diesel engine applications beginning in late 2012 and early 2013. We have been investing at a clip of approximately $1 million per quarter in R&D expenditure for the last several years to develop this new family of smart actuators. As a result, R&D expenses were 7% of our component and sensor sales in the first quarter of 2011 versus approximately 6.2% in 2010.

So summarizing new business and design wins in the component and sensor segment, we won seven new and two replacement sensor and actuator programs in the first quarter of 2011. In electronic components we recorded 58 communication infrastructure design wins in the first quarter, up 14% from the first quarter of last year with increased design wins in the engineer frequency EMI filters and electro-mechanical products.

Moving on to our EMS segment, sales in the first quarter of 2011 of $79.5 million were up 42% from the first quarter of 2010. All key EMS markets -- defense and aerospace, industrial, medical, and communications -- were up double digit compared to the first quarter of 2010. New customers and timing of program launch activities helped EMS record higher sales in the first quarter of 2011.

Now let me briefly comment on a few of our significant growth initiatives. In addition to our smart actuators for commercial application which I discussed earlier, we have completed the acquisition of Fordahl SA, a small privately-held Swiss company. Fordahl designs and manufactures precision frequency crystal oscillators for wireless infrastructure and military applications. We are finding excellent synergistic opportunities with this acquisition and are now in the process of integrating and streamlining its sales and engineering functions with our electronic components business.

We expect to incur approximately $0.5 million in integration related expenses in the second quarter of 2011 with annualized savings of $1 million going forward or a quick payback period of approximately six months. Another major new growth initiative currently underway is of our new Piezoceramic component for the next generation of high density, hard disk drive application. A 10,000 square foot plus 1K level cleanroom has been commissioned in Tianjin, China. In this space, the capacity to support $15 million in annual sales of this new Piezoceramic component is being put in place. We are training new employees and are in the process of staffing for the three shift operation by August/September timeframe.

This initiative will incur net expenditure in hiring, training and depreciation in the second quarter, becoming breakeven to the bottom line in the third quarter, and will be a net positive contributor with $2 million to $3 million in sales and approximately $1 million in margins in the fourth quarter of 2011.

This translates to incremental annualized Piezoceramic sales of approximately $10 million and $3 million to $4 million in additional gross margin contributions in 2012 for the electronic components business from a new product and new customer standpoint.

And finally, we signed a lease agreement for approximately 19,000 square feet of manufacturing space in the outskirts of New Delhi, India. We expect to outfit the facility in the second quarter and begin manufacturing automotive sensors there by the end of this year.

These are all very exciting developments and position CTS well for double digit annual growth in our top and bottom line for the next several years. Looking forward we generally expect the global economies to grow modestly and steadily in 2011. We are maintaining our guidance of full year 2011 sales increases in the range of 9% to 13% for 2010 and full year 2011 diluted earnings per share to be in the range of $0.70 to $0.75.

Although second quarter earnings will be affected negatively by approximately $0.03 to $0.04 per share due to the combination of factors including the hard disk drive ramp in China, the Fordahl integration and the massive Japanese earthquake-related impact on our automotive sensors and actuators, we expect to claw back a large percent of this short fall in the fourth quarter of 2011 and still deliver sales and earnings per our earlier guidance.

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

Thank you very much, Vinod. And welcome to all who are on today's call. And I will take you through our first quarter 2011 financial results. As Vinod said, our first quarter 2011 sales were $151.5 million, an increase of $22.1 million or 17.1% from first quarter 2010 sales. The sales growth was driven by the EMS segment with $79.5 million of sales, up 42% from prior year. Sales in components and sensors were at $72 million compared to $73.4 million in the first quarter of 2010. With sales growth more pronounced in the EMS segment, we did see that the overall segment mix is slightly more weighted to EMS which is representing 52.5% of total sales.

Before I go through the rest of the financials though I would like to briefly discuss currency which fluctuates in many of the countries we do business in. These fluctuations may vary from positive to negative within our statement of income and from quarter-to-quarter. So in the first quarter 2011 the general weakening of the US Dollar to certain currencies, particularly in Europe and Asia, caused a negative transaction impact of approximately $1 million in gross margins which equates to approximately an unfavorable 0.7 impact on our gross profit margins which I will discuss shortly. Conversely, though, other income reported below operating was positively impacted by the similar amount related to our balance sheet translations. As a result, as you will see, our overall combined basket of currencies resulted in a slight net positive in balance position for the company on a whole for the quarter.

So looking at first quarter 2011 gross margin which was 19.2%, including the unfavorable 0.7 currency impact just discussed, compares to a full year 2010 of 21.7% and versus a historical high of 23.6% in the first quarter of 2010. Last year in the first quarter we had unusually high service volumes related to Toyota and post recessionary replenishment of inventory, both which contributed to higher gross margins and more pronounced shift in our segment mix to be approximately 56.8% components and sensors.

Looking forward to the balance of the year 2011, we can expect gross margins to improve be similar to last year in the range of 21% to 22% as the programs that are currently being ramped up in manufacturing are introduced, we realize some claw back of the higher commodity and precious metal prices to selective customer price increases, and we have overall more balanced segment mix in our sales levels.

Selling, general and administrative expenses were $18.4 million or 12.1% of sales for the first quarter of 2011 compared to $19.5 million or 15.1% of sales in the first quarter of last year. Research and development expenses which Vinod talked about and support to the components and sensors segments were $5 million or 7% of components and sensor segment sales in the first quarter of 2011 compared to $4.6 million or 6.2% in the first quarter of 2010. As you know our research and development efforts support the components and sensors segment and reflect our ongoing commitment to technology advancement in new products and initiatives.

Total operating earnings were $5.8 million or 3.8% of sales including the 0.7 unfavorable currency impact, a temporary lower gross margin performance. This compares to $6.3 million or 4.9% of sales in the first quarter of 2010. Total first quarter 2011 interest and other income was $0.8 million which includes interest income, interest expense and currency translation gain. The improvement over first quarter 2010 is primarily the favorable currency gains related to the balance sheet and it offset the slightly higher interest expense. As I mentioned please note that the currency gain essentially offset the unfavorable currency transaction impact we had in gross margin, therefore on a total earnings basis the overall currency impact is balanced.

The effective full year tax rate for first quarter 2011 was 22.4% and it is within the expected range of 22% to 24%.

First quarter 2011 net earnings were $5.1 million or $0.15 per diluted share. This compares to $4.4 million or $0.13 per diluted share in the first quarter of 2010.

Now, we will turn the focus on our balance sheet starting with a discussion on cash flow. First quarter net cash use in operating activities was $2.5 million. Capital expenditures are back to normal levels at approximately $3.2 million or 2.1% of total sales compared to the $1.5 million or 1.2% that we had in the same period last year. Full year 2011 cash flow expenditures are expected to be in the range of 2.5% to 2.8% of sales.

First quarter free cash flow which is defined as net cash flow from operations less capital expenditures was a usage of $5.7 million. Historically first quarter free cash flow is a usage driven by higher levels of accounts receivable, the replenishment of inventory and payables to support the continued sales growth, and the timing of first quarter incurred liability changes. We expect 2011 full year free cash flow to be consistent with our previous guidance in the range of $30 million to $35 million.

And please note within the balance sheet we also note the decline of certain net assets of Fordahl for $2.9 million.

Controllable working capital which includes accounts receivable plus inventory less accounts payable was 17.3% of annualized sales. We expect the 2011 full year rate to return to the more pre-recessionary level in the range of 14% to 15% of annualized sales.

Cash and cash equivalents were $74.2 million, up $0.9 million from year-end. Our long-term debt was $80.3 million compared to $70 million as of year-end 2010. Our debt-to-capitalization ratio was 22.2% in the first quarter of 2011 compared to 20.3% in the fourth quarter.

This concludes the overall financial review of our first quarter 2011 results. We are pleased that the sales and earnings performance are in line with our expectations. We continue to manage our balance sheet and organizational metrics to deliver growth to our shareholders. With that, I will open the call for questions. Trisha?

(Operator Instructions). And we will go to the line of John Franzreb with Sidoti. Please go ahead.

Good morning Vinod and Donna.

Good morning, John.

Good morning.

Donna, that was very helpful on the currency, I appreciate that. Along the similar metric, a year ago you had the one-time parts shipments that made this comp a little bit tougher. I wonder if you could maybe segment out that number, how it impacted last quarter and if we are going to have any impact on a similar kind of one-time parts shipments that exist in the Q2 of last year.

2Q of last year or Q1? First quarter of last year, right?

No, I'm asking if there was any kind of one-time parts shipment benefit in 2Q of last year.

No, no, there were none. I think we were able to essentially get most of it taken care of in the first quarter. There may be some in the second quarter, but it wasn't material.

And during the first quarter of last year, how much in revenue did that contribute or operating income related to that?

I think the sales for those unusual things we did to support the customer were approximately $3 million.

$3 million?

And because they were special requests of service parts we had higher than normal margins on that business. So we are guessing that the bottom line impact from that one-time was approximately $1 million.

Great. And you mentioned commodity prices a couple of times. I wonder if that is more of an impact in the component and sensors segments or the EMS segment?

It's primarily component and sensors and it is coming from precious metals, gold, silver, [platinum], things like that. There is some impact from the rare earth material which we use in our electronic components. And there is probably some in EMS but I would say the bulk of it is in components and sensors.

Okay, and then what part -- sequentially when I look at the EMS revenues, let's call it flat for argument sake, Q1 '11 versus 4Q'10 -- what part of the mix hurt you that they are now back at break even after having an operating gain in the fourth quarter?

I think it is not the mix which is probably driving it but in the first quarter we have some unusual ramp activity going on in our EMS operations in Mexico. There were some new customers which we introduced in a couple of our locations which we normally -- we will start shipping, we either start shipping in late March or we will start shipping in April/May timeframe. But we had to put certain structure in place in the first quarter. There was a one-time thing which did affect that business combined with the ramps in Mexico.

My last question is, can you give us a sense of what do program wins look like, or looked like I guess, in the first quarter of this year versus a year ago in terms of dollars or number of awards, any way you want to size it all up?

Well in the electronic component we talked about design wins and I think I mentioned that those were up year-over-year in the first quarter by roughly 14%.

Okay, is that a volume number or is that a --?

No, we have never looked at volume number. Volume moves all over on those things and as we have said in the past that in electronic components not all design wins convert to sales. We think we have a [head] rate of somewhere around 70% to 80% of the design wins will convert to sales. And the number moves from a revenue point of view. So it is a rough proxy to give you an indication of the new business won, but we don't talk about revenues.

In sensors and actuators we need to look at the revenues for those although we have not disclosed that, John. It again is a directional indicator that we have substantial new programs coming in. One thing we do is we have historically either not mentioned or highlighted the difference between the replacement new business and new-new business. We generally as a company only like to talk about new business if it is truly incremental new programs. So it gives you an indication.

We do sometimes talk about later on when the product gets launched, so you will remember that last year we talked about, or year before we used to talk about a lot of turbocharger programs and turbocharger sensors. Now, the reason we talked about turbocharger sensors was, one, because it was a brand new family of sensors and we liked it because we are trying to diversity our sensor families from position of pedal module sensors to more and more things like turbocharger sensors, transmission sensors and now smart actuators.

But if you look back two years later from those announcements, turbocharger sensors sales, actual sales, for example -- I believe they went from roughly $1 million range in 2009 full year to $7 million in 2010 and this year we expect that number to probably $10 million to $11 million.

So we do talk about once the programs are launched and the sales are ramping up of all those programs. And sometimes if it is a clearly exceptional large program like the global platform of the pedal module that we talked about, it is one of the most prestigious Japanese OEM and we have, we are not at liberty to mention which platform it is but it is a very popular global vehicle, very well known brand. And we will be on that vehicle everywhere in the world and that one program over its life is going to give us $70 million in sales.

Now that is clearly a very unusual piece, so that is the situation we will normally highlight like we did in this conference.

Okay, thanks a lot, Vinod. I will hop back into the queue.

We will open the line of Hendi Susanto with Gabelli. Please go ahead.

Good morning everyone.

Good morning, Hendi.

Hi Vinod. My first question is could you talk about the increase in inventory and how do you plan to manage your inventory going into the second quarter and then the third quarter of 2011?

Our increase in inventory year-over-year really is driven by the increase in our projected sales growth that we are going to be seeing in the second and third quarter. Now in the past we had talked last year where there were inventory impacts because of supply constraints and there were issues in terms of allocations. That hasn't been so much a discussions driver in first quarter, but our year-over-year inventory growth really is in our EMS space and providing for the purchases that we need in order to -- are forward-looking for our sales.

Are you saying that there is no or minimal impact of orders pushed out?

No, Hendi, I don't think the order push out per se creates an inventory issue. I think our inventories are running higher than normal and as Donna said it is either due to some unusual timing of product launches where you have to build some inventories before you launch the program. The second as we mentioned, we are gearing up our Mexico operations and are transferring some EMS business to improve our margins from our North American, one of our North American factories to China and Mexico.

So when you transfer a program to make sure that you are not disrupting the customer you have to build some inventory banks ahead of them. That is probably the second reason. And third reason to a smaller extent is as we saw shortage of parts develop in electronic component we had a tendency to probably carry a little bit extra inventory so that we don't disrupt our production line. So our inventories are running because of these three reasons higher than normal and we have a program to gradually bring it back to normal levels by year-end.

Vinod, could you talk a little bit about what your backlog looks like especially in EMS and how do you expect your EMS business going to the second, third and fourth quarters of 2011?

Hendi, we have not talked in terms of backlogs in EMS because we believe backlogs by quarter is probably not a very good indicator. But if you really look at our sales [chain], all year last year we kept saying that because of the program delays in EMS you remember in 2010 was fairly weak. And that is why you saw such a huge jump in the first quarter in our EMS business because of the timing and some new business we won in the fourth quarter.

We expect our EMS business to continue to strengthen gradually even from our high Q1 levels. So, you know, net-net we are still expecting a double digit top line and bottom line growth in 2011 compared to 2010 despite all of the things around Japan earthquake and precious metal disruptions and all of that.

And we expect essentially both of our segments to shoot for a double digit growth from 2010 to 2011.

Okay, and last do you have any updates on your Piezoceramic talks with potentially your second hard disk drive manufacturer?

Hendi, say it again please.

Do you have any updates on your Piezoceramic talks with potentially your second hard disk drive customers?

Yes, they are going very well. We are engaged in discussing with them and we believe that we would have the second disk drive customer also. Right now actually our challenge is to ramp up our capacity in China. And right now even from the single disk drive customer we have the difficulty we have is that they are asking us to ramp it up even faster than I talked about in my comments.

So, we are talking about this business going from zero in the first half of 2011 to be at a run rate of $10 million of incremental sales by the fourth quarter. So we are thinking about $3 million range of sales. And that is the maximum ramp we can do right now. We actually are being told by the customer that we need to be ready and ramp it up even beyond that and that is why in my comments I mentioned phase one. Because in phase one we would have this new business grow up to $10 million range in sales and $3 million range in incremental margins and that will turn out to be only phase one because we believe it may go beyond that.

That's helpful. Thank you.

(Operator Instructions). There are no questions queuing up. Please 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 Wednesday May 4, 2011. The telephone number for the replay is 800-475-6701 or 320-365-3844 if calling from outside the US. The access code is 200769. Thank you for joining us today.

Ladies and gentlemen that concludes your conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.