CTS Corp (CTS) 2011 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the CTS Corporation third-quarter 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, Paul. I am Mitch Walorski, Director of Investor Relations, and I will host the CTS Corporation's third-quarter 2011 earnings conference call.

Thank you for joining us today. Participating from the Company today are Vinod Khilnani, Chairman of the Board and CEO, and Tom Kroll, 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 require 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 third-quarter financial results for 2011. Overall, sales and earnings both were in line with our expectations, despite a somewhat lackluster macroeconomic environment.

Some of our key Japanese OEMs continued to see curtailed production in the third quarter due to the tsunami and earthquake-related disruptions in their factories and supply chain. However, we began to see pickup in their production schedules in late September and expect them to continue their ramp-up in the fourth quarter. Honda just announced a couple of days ago that their seven North American assembly plants are now operating at normal levels for the first time since Japan's earthquake in March.

New business wins and product launch activities continued at a robust pace in the quarter. Sales in the third quarter of 2011 at $146.1 million were up 4.8% year-over-year, primarily driven by a 13.9% increase in EMS segment sales. This was partially offset by a decline in the Components and Sensors segment sales caused by the reduced sensor sales to key Japanese OEMs due to the earthquake-related disruptions in their vehicle production, timing of some sensor programs, and reduced electronic components orders from our distributors, who drove their inventories down in the quarter.

Within our Components and Sensors segment, total automotive sensors and actuator sales at $41.6 million were down 3.1% from the same quarter last year but were up 4.6% sequentially from the second quarter. We estimated the third-quarter negative impact on sales from Japan's earthquake disruption at approximately $4 million. Adjusting for that, our sensor sales would have been up 6% year-over-year, helped by new business and increased market share.

North American light vehicle inventories finished September at 49 days versus a more normal level of approximately 60 days. Tight inventory levels, combined with higher production schedules of our key Japanese automotive OEMs, should allow us to increase our fourth-quarter sensor and actuator sales by 15% to 20% sequentially and year-over-year.

Continuing with the Components and Sensors segment, sales of electronic components represented approximately 19% of total CTS sales in the third quarter of 2011. Sales of electronic components were down 4.7% year-over-year primarily due to weak buy -- resale part of our distribution business. In the third quarter, we saw our distributors slow down their orders on CTS to lower their inventories despite the fact that they continued to see a year-over-year increase of 15% in their CTS component sales in the third quarter of 2011.

Our EMS segment sales in the third quarter 2011 of $77 million were up 14% year-over-year, as new programs and customers kicked in and volumes improved in defense and aerospace, industrial, and communications markets.

On the business development front we had a fairly strong third quarter. Within our Components and Sensors segment, we won four new automotive sensor programs in addition to winning seven replacement programs.

In Electronic Components, we recorded 59 new wireless infrastructure design wins, a key indicator of future sales growth. Our year-to-date design wins are running higher than last year's pace. In our EMS segment, we announced two new customers in the medical industry, one of our key target markets.

Overall, we captured $46 million in new business in the third quarter of 2011 versus $39 million last year. On a year-to-date basis, we have now captured $101 million in new business this year versus $60 million in the same period last year.

Qualitatively, more than 70% of the new business captured year-to-date is in Components and Sensors segment, indicating the trend that the Components and Sensors segment will continue to represent a bigger percent of CTS's total sales going forward.

One of the key drivers behind our success to launch new products and win new customers has been our increased focus on engineering and research and development activities. Our R&D expense increased to $5.2 million or 7.5% of our Components and Sensors segment sales in the third quarter of 2011 as compared to 7.1% in the same period last year.

In addition to driving organic sales growth through new products and new applications, our increased focus on R&D continues to provide us with the additional benefit of increasing our intellectual property portfolio. In the third quarter, we were granted six new patents versus five in the third quarter last year. Year to date, we have been granted 17 new patents.

However, a significant forward-looking measure is applications filed for new patents. Year to date, we have filed 24 new patents in the US. Assuming a 90% hit rate, these filings will turn into new patent grants. We expect to see an approximately 25% increase in our new patent grants in the coming years.

Looking forward, we still expect the global economies to either be stable or grow modestly in the fourth quarter. We are still assessing the impact of Thailand floods, which have put one of our EMS manufacturing facilities in the outskirts of Bangkok under water and out of commission for probably a couple of months.

In addition, a new piezoceramic component for disk drive application, which we were ramping up in the fourth quarter at our China facility, has to be slowed down a little bit because our customer's facility in Thailand is impacted by the floods, and their production has been temporarily suspended.

This will push out some of our Electronic Components new product sales from the fourth quarter of 2011 to the first half of 2012. Despite that, we still expect fourth-quarter sales and earnings to be higher sequentially and year-over-year, as we expect our insurance to mitigate most of the earnings impact from these natural disasters.

Based on the year-to-date 2011 results and assuming a modest recovery in the fourth quarter, management maintains its full-year sales guidance of 9% to 13% increase over 2010. However, the impact of the Thailand floods combined with slower than expected recovery from the Japan earthquake in 2011 will cause CTS to be near the bottom of its guidance range, with year-over-year sales growth of around 9% to 10%. Adjusted earnings per share are expected to be in the range of $0.68 to $0.71, despite a series of unusual events mentioned earlier.

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

Thank you, Vinod, and good morning, everyone. Before I review the financial performance I will give you a brief update on an item that occurred in the second quarter of 2011. During our last conference call we discussed a Scotland EMS facility fire that temporarily disrupted manufacturing activities at that site.

Some of our fire-related insurance claims were processed in the third quarter; and accordingly, we recorded insurance recoveries for business interruption and also one for property damage. These two items are reported separately on the statement of earnings.

The business interruption amount essentially offsets the fixed operating expenses we continue to incur after the fire and the margin impact on lost sales. We also recorded a property damage insurance recovery of $2.7 million or approximately $0.05 per share. We do expect additional recoveries to be recorded in the fourth-quarter 2011 covering both our normal business interruption and some property damage.

As Vinod mentioned, our third-quarter 2011 sales were $146.1 million, an increase of $6.7 million or 4.8% from the third-quarter 2010 sales. The third-quarter 2011 gross margin was 18.8%. However, if we adjust for the business interruption recovery to include it in cost of goods sold, our third-quarter margins were 19.4% compared to 21.5% in the third-quarter 2011.

Approximately half of this 2% margin decrease resulted from higher EMS segment sales, which were 53% of total CTS sales in the third-quarter 2011, compared to 49% of total CTS sales in the same period last year, driven by lower automotive sales from the Japan earthquake-related production disruptions and stronger EMS shipments. The rest of the margin decrease is due to higher commodity and precious metal costs relative to last year and some production startup costs, such as our hard disk drive product.

We expect our gross margins to improve in the fourth quarter as our Components and Sensors segment sales improve from Japanese OEM production increasing and new program ramps. Therefore, we believe that the sales in our two business segments will be more balanced in the fourth quarter.

Selling, general, and administrative expenses were $18.3 million or 12.6% of sales in the third-quarter 2011 compared to $17.1 million or 12.3% of sales in the third quarter of last year. The expenses increased year-over-year primarily due to a $0.6 million retirement-related pension charge.

Our research and development expense in the third quarter was $5.2 million or 7.5% of Components and Sensors segment sales, slightly higher than the same period last year. Our R&D expense, which is up 6% year to date compared to last year, is a key investment to drive organic growth as it directly contributes to launching new highly engineered products, securing new customers, and strengthening our patent portfolio.

These expenditures support major growth initiatives such as the new piezoceramic product for hard disk drive applications, with sales having recently started, and the smart actuator for commercial diesel engine applications, with shipments beginning late 2012. As a result, our total operating earnings were $7.8 million or 5.3% of sales compared to $7.8 million or 5.6% of sales in the third-quarter 2010.

Please note that the $2.7 million fire-related property damage insurance recovery discussed previously is included in the $3.6 million of EMS third-quarter segment operating earnings. However, even without this recovery our EMS operating earnings have continued to improve each quarter this year, reflecting our continued focus on getting this business to our target operating earnings percent of sales of 2% to 2.5% in the short term and 4% to 5% in the longer term.

The total third-quarter 2011 interest and other expense, which includes net interest expense and currency translation, was $0.3 million of expense. This compares to a gain of $1.6 million in the third-quarter 2010 which included approximately $1.7 million of favorable currency gain, primarily to the US dollar weakening against the euro. As we continue to focus on our natural hedging strategy, the currency translation impact in the quarter was minimal.

The effective tax rate for the third-quarter 2011 was 21.8% compared to 26.1% in the third-quarter 2010. The decrease in the effective tax rate was primarily due to changes in the mix of earnings by jurisdiction. The full-year 2011 effective tax rate is still expected to be in the range of 22% to 24%.

Our third-quarter 2011 net earnings were $5.9 million or $0.17 per diluted share. This compares to net earnings of $6.9 million or $0.20 per diluted share in the third-quarter 2010. But again, that included approximately $0.04 per share for the currency gain.

Now let's take a look at the balance sheet. Compared to the third quarter of last year, cash and cash equivalents were $89.2 million, up $16.1 million. Long-term debt was $89.7 million, an increase of $12.6 million. Our debt to capital capitalization ratio is 23.6% in third-quarter 2011 versus 22.5% last year.

From a working capital perspective, our accounts receivable days improved from the same period last year, while accounts payable days and inventory turns were slightly unfavorable. Our controllable working capital that we define as these three accounts -- receivables, inventory, and payables -- was 17.6% of annualized sales, fairly similar to the same period last year.

This percentage is a little higher than our target range of 14% to 15%. However, we believe the higher controllable working capital levels are somewhat temporary as we navigate through a mixed micro-macro global economic environment, various product launches, and disruptions caused by natural disasters affecting our automotive product sales and our EMS business segment.

Our third-quarter cash flow from operating activities was $4.5 million versus $1.7 million in the same period last year. Capital expenditures were $3.7 million compared to $4.3 million in the same period last year.

Our full-year 2011 capital expenditures are expected to be in our normal range of 2.5% to 2.8% of sales or approximately in the range of $15 million to $17 million. Our 2010 full-year capital spending was $13.3 million or 2.4% of sales.

Our third-quarter free cash flow, which is defined as net cash flow from operations less capital expenditures, was $0.8 million. Our year to date free cash flow is $3.2 million.

We anticipate generating strong free cash flows in the fourth quarter, with our full-year free cash flow being around $15 million to $18 million range. Our full-year free cash flow projections have been tempered by product launch schedules and the Japan and Thailand natural disasters discussed earlier.

During the third-quarter 2011, we continued our maintenance stock buyback that was triggered in June of 2011 related to the lower stock price. We purchased approximately 111,000 shares at an average price of $9.10 per share under our existing program authorization for a total cash outlay of about $1 million in the third quarter or $1.3 million year-to-date. We have approximately 831,000 shares left in our 1 million share buyback authorization as of the end of the third quarter.

In summary, our sales and earnings performance were in line with our internal expectation. We will continue our diligent focus on cash and controllable working capital going forward, and closely monitor the impact of the Thailand flood on our businesses.

This concludes the financial overview. I will now open the call for questions.

(Operator Instructions) John Franzreb, Sidoti & Company.

Good morning, Vinod. Vinod, first I'd like to touch base with the guidance. You kept the revenue guidance intact but lowered your bottom-line expectations, in part due to what is going on in Thailand.

It seems that something has got to be missing out of that puzzle, because that is an EMS business, it is a low margin contributor. What else is going on that would have you pull back your EPS expectations?

Good question, John. I think in addition to the floods in Thailand which are affecting our EMS business -- and you are exactly right, although the sales will be lower because of that, it will have minimal impact on our bottom-line because of the margin and our insurance coverage.

The other factor which is affecting the floods are because you know we have been ramping up the high density disk drive new product in our China facility, which is going to one of the largest disk drive manufacturers. And that manufacturer has several facilities in Thailand and has indicated to us that they will be pushing out their demand from fourth quarter to next year.

We believe that we will claw those sales back by mid next year; time frame is probably second quarter mostly. That is having an impact of probably a couple of cents on the fourth quarter and moving those revenues and margins, in addition to the EMS, to next year.

Okay. So the pushback gets recovered by Q2 of '12. We are not going to see that recovery in Q1 of '12, okay? It is largely the HDD product line?

Yes, HDD product line. The indications from them are that it would probably be later in the first quarter we will begin to see them pulling that product, although they are projecting extremely strong demand on us.

Actually right now the challenge we have is to ramp up our production capabilities faster. So we are right now in negotiations with them that although their needs may not be until mid next year because of their constraints, we are negotiating that maybe they should continue to buy product from us and increase their inventory so that our plants are loaded more appropriately. Those discussions are going on right now.

Okay. Fair enough. Now in the third quarter, you had some insurance gains. I wasn't cognizant they were going to roll through in the quarter. Are there any one-time items that we should be aware of in Q4 that are similarly going to roll through in (multiple speakers)?

Yes, yes. We will see some additional insurance-related gains happen in the fourth quarter, all related to our Scotland facility. So what happened essentially, if you just focus on unusual items, net-net we had probably $0.05 of hit in the second quarter from the Japan earthquake. So to just on the natural disasters for a moment -- and this year seems to have more than their fair share -- we probably had a net impact of $0.05 to $0.06 on our Corporation in second quarter.

In the third quarter, the insurance gain in Scotland essentially offset the Japan earthquake-related hit on us in the third quarter. And we probably ended up with a net hit of $0.01 in the third quarter.

You can break it down by thinking that the Japan earthquake and a couple of other things and Scotland impact was essentially mitigated by the insurance gain. And maybe we are left with a penny short. So year to date, first three quarters we're probably $0.06 negative -- $0.05 in the second quarter, first, $0.01 in the third quarter.

We believe that the final settlement with the insurance people which is still being negotiated, so we obviously are not sure about that number, but we believe that the final settlement with the insurance people in the fourth quarter will give us probably a $0.05 to $0.06 potential upside, which will partially offset the high density disk drive delays and partially compensate us whatever we lost earlier in the year.

Okay, let me see if I understand. $0.05 to $0.06 in Q4 upside, above and beyond what you already forecasting, or included in what we are forecasting?

No, it is included in our guidance.

Okay. All right, and that will offset the $0.02 to $0.03 in the hard disk drive?

Yes.

And lost revenue due to flooding; is that what you -- do I understand it all properly?

Yes, and fourth quarter essentially would also began to see a ramp-up in automotive. So because of the insurance settlement and because of the automotive ramping up, those two things will obviously more than offset the high density disk drive impact. And therefore we are projecting a fairly strong fourth-quarter in our guidance.

Okay. One last question and I will get back into queue. You mentioned a disconnect in your distributor buying patterns. It sounded like the sales going out the door for distributors was significantly better -- I think you said 16% but I am not quite sure -- significantly better than what the sell into is at the distributors.

A, did I hear that correctly? And B, is there any signs that that trend is going to reverse and they are going to have to restock to catch up with what I assume is a depleted inventory at some point?

So, John, you heard me correctly. That is positive news, because when we saw our shipments to our distributors down we obviously were a little concerned. So that the second set of numbers we see is how our distributors are doing. How well are they selling our product?

And when we looked at what we call point-of-sale data, which is what our distributors are ultimately selling, we saw a 14% to 15% increase in what our distribution was selling -- or what our distribution sold in the third quarter compared to last year third quarter. So that is a very positive sign.

And the distribution clearly have brought their inventories down, which means that ultimately our product is selling well and sooner or later they will have to replenish their inventory. But even if they don't replenish their inventory for a while, they will have to flow through the increased demand by placing more orders on CTS because they have already lowered their inventories.

Thanks a lot, Vinod. I'll get back into queue.

Zacks Investment Research, Ken Nagy.

Hi, thanks for taking my call. Just -- I know over the last year, there has been an effort to get Smart actuators into commercial applications like construction, mining, and agriculture. I was just wondering if you could talk a bit about how that is going.

So, Ken, that is my favorite subject, obviously, because I think it is a game-changer and it's a transformational project. And I don't remember CTS ever launching on an organic basis a major new product for a major new set of customers and industry.

That project is on track. We are having reviews with the diesel engine manufacturer. We recently had a fairly major review with them. The product is on track to be launched at the end of 2012.

We still are looking at projections that that family of product is going to generate sales of approximately $20 million in 2013, rising to $35 million in 2014, and $50 million in 2015.

We are getting designed-in in pretty much most of the product offering of the diesel engine manufacturers. So we are on light-duty diesel, we are in medium-duty diesel, and they are actively talking to us about their heavy-duty diesel applications, which will take this number even higher.

The other reason we like this business is that we are single-sourced, designed-in, and the life of these programs to the best of our knowledge is seven, eight, nine years. So we are locked in on that program for that.

This is also the program on which we have been investing approximately $4 million in incremental R&D expenses over the last several years. So we have been investing in it, taking a hit in our current-year performance to invest for the future.

Right. And that commercial market could probably be between $750 million and $1 billion?

That's correct.

Okay, that's great. Thank you.

Gary Prestopino, Barrington Research.

Hi, good morning. Can you give me what your D&A was for the quarter?

I'm sorry. Can you repeat that?

D&A for the quarter.

And actually your stock comp expense.

I'm sorry; the depreciation and amortization remained similar to prior quarters at about $4.5 million.

All right. What about your stock comp? Can you give me that?

It was right around $1 million.

I am just a little confused -- and I confuse easily. But just to be clear, in your guidance you are including insurance recovery business interruption and the insurance recovery property damage, right?

That's correct.

That's correct.

Okay, let me ask you just a question. I mean I understand the business interruption insurance because that is money -- your business was interrupted; it is recouped; it is kind of taking the place of what you didn't really have.

But why in your guidance are you including the recovery on the property damage? That seems to me to be almost like very much a nonrecurring item.

Very good question, Gary. The insurance policy we have essentially allows us to recover the fair market value of the equipment which were destroyed. If your equipment are obviously brand-new, that would not create any gain because the fair market value would be very similar to your book value. But on the other hand if your equipment are older and your book value is considerably lower than your fair market value, it creates a gain.

And that is why we are flagging it as an unusual, nonoperating kind of an item. Because business interruption is really an offset and actually should have been added back at the gross margin level. So that you had an expense, you got reimbursed; it's neither nor upside nor a downside.

But because we have a fairly unique -- I assume it's a fairly unique insurance policy, which allows us to recover a fair market value compared to the book value, we have to recognize that gain from the GAAP point of view.

Okay, so you have to recognize the gain.

Yes, we don't have a choice.

Okay, but again if I back that out and tax-effect it, or back that out and just tax-effect your business interruption, I get about $0.14 per share. I don't know if you have gone through that exercise, but that would seem to me to be a more realistic number for the quarter.

That is what I was tried to get at here is that -- I understand you have to do that from GAAP. But from an actual run-rate basis on what the Company did in the quarter?

So, Gary, if you just look at that factor, that adjustment which you just made would be accurate. But what we were also trying to explain is that we have a few other equally similar kind of non-run-rate-related items. So if you take this out, you have to take the other one out, and those are Japan earthquake-related sales which are getting pushed out into Q4 and Q1 and to next year.

So we were just summarizing that if you took both the unusual items out, then the quarter was probably a net of $0.01 affected.

Okay. All right. That's fair. Then I just was looking at this and trying to understand how you presented it.

But besides the fact that some of these piezo products are getting pushed out into Q2 of '12, nothing has really changed in terms of what you are seeing out there, as far as some of these new product ramps and business wins, etc.; is that a correct assumption?

Exactly right. I think we have unfortunately seen things in this quarter and this year which have essentially pushed out the opportunity, but haven't fundamentally reduced anything. Same thing, whether it is the floods or the Scotland fire issue, frankly at the end of the day we are not seeing any net-net impact on our bottom line because we will be able to recover most of it, other than the minor deductions you do -- the amount in insurance which is deductible. Tom, you want to add something to that?

Yes, well, Gary, let me just go back to your $0.05 comment on including it in earnings. The other thing, keep in mind that our depreciation expense going forward is going to be substantially higher because the net book value on the assets that were destroyed was pretty small. So going forward, we will see higher depreciation expense.

Right, and that's fine. Then just lastly in terms of this related pension charge, where is that? Is that in the SG&A or cost of goods?

That is in SG&A.

Okay. And on a GAAP basis, you didn't have to segregate that either?

No, it was not material enough.

Okay, thank you.

Gabelli Corporation, Hendi Susanto.

Good morning. Yes, in light of supply chain disruption in the hard disk drive industry, what are your estimates of CTS's piezoceramic product sales in 2011 and 2012 now?

2011 versus 2012? While I look for the right answer, I would say that you will see piezoceramic sales obviously increase substantially next year because of the hard disk drive was ramping next year. This year, only Q4 was affected because of the ramp.

In 2011, the piezoceramic sales in the first half are more like a $9 million for the six-month period, roughly. And we are ramping them up to probably a $10 million kind of first half, so let's say $19 million. So I think 2011 would be more like $19 million in piezoceramic.

Next year, my guess is that that number will increase double-digit. My rough estimate would be about 15%, 16% kind of a year-over-year growth in piezo because of the high-density disk drives.

Okay, because I think I saw on your site that the piezoceramic sales estimate for 2011 was $19 million. So there is no change on that number?

The only change in that number may be that -- because earlier part of the year would be a little slow because the customers' locations have been affected. The open question would be -- are they able to ramp up in the second half of the year enough to offset that? Or would they finish the year with a little bit lower than that?

That is still not clear. But we will still have a substantial increase next year. Whether we will hit that number or whether the customer will not be able to catch up by the end of 2012 is yet to be determined.

Okay, do you have updates on your effort to gain the second-leading hard disk drive manufacturer for your piezoceramic?

We have discussions continue, but we have nothing definitively determined at this time, Hendi.

Okay. Then I would assume that any equipment damaged in your Thailand facility will be covered by the insurance. Having said that, will it require you to purchase new equipment and then therefore we may see some increase in CapEx next year?

I think based on our Scotland experience, Hendi, we have been able to recover the monies within a quarter, three, four months. So no, we do not expect our CapEx to increase in 2012 because of the fire or the floods.

Okay. Then let me switch to financial questions. Could you elaborate on the gap between your current free cash flow target and the previous target of $30 million?

Yes, there's a couple of things, Hendi, but primarily related to the Thailand flood. We are seeing that sales that we had anticipated to ship early in the quarter are either being pushed out late in the quarter, so we cannot turn those sales into cash. Or as Vinod mentioned, some of the sales related to Thailand EMS business and also the EC business on HDD are being pushed out into the first half of 2012.

So it's mainly hard disk drive related sales?

Hard disk drives and the EMS piece related to the Thailand flood.

Okay, yes. Then I am wondering about the timing of the negative hit from Japan earthquake. I am wondering why this would continue into Q4 instead of being completed in Q3.

It will be completed in Q3. Q4 impact actually I am saying is positive as we began to claw back those sales.

So yes, that impact is behind us. The negative impact is behind us, and I think we are beginning to see much stronger shipments to our customers.

Thank you.

(Operator Instructions) Brad Evans, Heartland.

Yes, good morning. Vinod, knowing what you know right now based upon your forward look, including the slippage of some business into 2012, is it possible that you could grow upwards of 15% in 2012?

So, Brad, we normally at this point don't indicate going forward. But because this year is so unusual and so many things have been pushed out, the preliminary planning process which is going on indicates to me that our Components and Sensors business will grow next year compared to this year in midteens as we have said. And EMS business will grow in mid single digits.

And therefore the total Company will grow double-digit next year top line compared to this year. And that is based on preliminary -- the views which we are doing with our business units.

And just knowing that the -- would that mix shift, Components and Sensors becoming a larger portion of your business, can you get back to a 6% operating margin next year? Or do you think that would be aggressive?

I don't know the answer to that, frankly; we are just going through that process. It clearly will improve our gross margins as that mix improves.

But I don't -- you need to give us a little more time to get to the operating margins. But I would say that we would have a fairly strong growth in our Components and Sensors business next year, given all these things and the new product launches. That, combined with the favorable mix impact, should take -- should give us a decent increase in our margins and operating margins.

So said another way, recognizing that over the last year or two you have been aggressively spending R&D, that we should hope to see more pronounced operating leverage in 2012?

We should, '12 and '13. And remember the Smart actuators really give us a huge boost in 2013, although they will start in the fourth quarter of 2012.

Yes, but if you add back your stock-based compensation you might have a shot at doing $60 million of EBITDA next year. Why not be more aggressive in buying back your stock? You are trading at an extremely low level of valuation and approaching below book value; why not become a little more aggressive on the share repurchase here?

You know, we did do some share repurchase in this quarter, and that is something we will continue to look at very carefully. The Board has continuous discussions on buyback versus a dividend increase versus cash needed for acquisitions.

I would support the dividend increase as well as a share buyback. It looks like you've got a fair amount of organic growth, and I don't know why you would want to complicate it with an expensive acquisition. Because I have a hard time believing you would be able to find anything cheaper than yourself at this point.

But let me just ask one more question. I'm a little confused by the trajectory of the SG&A line. So there is a one-time -- in that $18.3 million expense line item this quarter, there is a one-time item in there. Can you quantify that?

Well, we had talked about a little over $600,000 for a pension settlement charge.

Thank you. And did you reverse bonus accruals in the quarter?

No, we haven't done anything unusual there.

We don't accrue them on a quarterly basis. Those will be calculated normally on an annual basis.

Yes, I guess -- I realize this might be a sensitive subject, but it just speaks to the earlier question from the analyst about the guidance.

One could say that in the $0.68 to $0.71 there are a number of nonrecurring items in there. So I don't know whether -- I don't know how the bonus calculations are being calculated and whether it is on that guidance, but it sure seems like -- it has been a volatile year, I understand, with natural disasters and what have you.

But I think that does raise some questions as to whether bonus accruals, which have been previously booked whether indeed you have made your guidance or not this year, but it looks like next year is going to be a strong year, but this year has been -- has not been good for shareholders. And it has been a volatile year, to say the least. So just a comment, not a question. Thank you.

Brad, I would comment that we didn't answer that question appropriately. We do reverse bonuses according to the accounting policies as our businesses go up and down from an earnings point of view. So we do do that.

I would also say that we do adjust for unusual items like this. If I can summarize all the unusual items, then the net-net of all unusual items will be a small couple of cents impact.

Because after we add back all the insurance claims which we will clear in the fourth quarter, that positive would offset most of the earthquake and fire-related issues. So yes, we do adjust that and we do take the bonuses up or down on a quarterly basis to follow the normal accounting practices. So I do want you to not think that we don't do that.

I will follow up with you off-line. Thank you.

John Franzreb, Sidoti & Company.

Just a follow-up on one of the points I think Brad might've brought out, at least I want to make sure I hear it correctly. Did you say the R&D spend will come down in 2012?

No, I was reminding him that the R&D spend would actually come down in a significant fashion as a percent of sales in 2013. Because that spend, which has no sales associated with it, which therefore affects the percent of sales, will get moderated as we begin to add the Smart actuator sales in sync with the Smart actuator R&D we have been incurring.

Okay, so in absolute dollars spent it is going to be unchanged?

Yes.

Okay. The second question is, across all of your businesses, are you seeing any change in demand coming out of China?

Nothing pronounced. We do have -- some of our sales softened, but more in the Taiwan region where we make product which goes to a wide range of industries. So it's probably our most forward-looking indicator we look at. So that demand did soften starting from June, July time frame.

But the sales to China is not a huge percent of our business, and the business we have is relatively new business which we have developed, so we don't have a lot of year-over-year comparisons for that. But I would say overall we are not seeing anything pronounced soften in China.

Okay, and just to stick with the geographic theme here, Europe is roughly somewhere between 10% and 15% of sales, last I recall. Is there any change in the demand profile over there?

Europe overall growth-wise is pretty unexciting. Most of this year we didn't see a strong growth in Europe. So Europe is, I think, continuing with fairly modest growth numbers.

Okay. So no meaningful shift one way or the other?

No meaningful shift in geography. I suspect going forward you will see CTS reporting a slightly higher percent of its total global sales in Asia as we begin to capture some new customers in automotive -- and some EMS which we are shipping here, but it is ultimately ending up in India and China.

Thanks a lot, Vinod.

Gary Prestopino, Barrington Research.

Yes, you may have touched on this, but could you -- just on the theme of what is going on worldwide economically. In terms of the potential new business pipeline, what are you seeing out there in terms of -- has it been curtailed a little bit here by the volatility (technical difficulty)? Or is it still the same or is it increasing in both of the businesses?

Gary, from new business point of view, we are very upbeat because we are seeing our new business wins increasing this year compared to prior year. So we feel very good about new business wins.

Where we are a little bit cautious is our existing customers and existing business. We have seen tendency in the last several months where people don't cancel an order but they tend to push it out.

So we have seen some push-outs in our business, or people being very cautious, like our distribution, where they are tightening their inventories, which is temporarily lowering their order rates on CTS. And they are watching their ultimate sales a little bit more closely and keeping their inventories tight. So we have seen some tendency by large OEMs in the electronic components area, infrastructure, wireless infrastructure side, where customers have pushed out orders, being cautious. And a combination of that and lowering their inventories, which is softening their demand on us.

Okay, thank you.

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