CTS Corp (CTS) 2014 Q2 法說會逐字稿

Good day, everyone, and welcome to the CTS Corporation Q2 2014 earnings release conference call. Today's conference is being recorded. At this time I would like to turn the call over to Mr. Kieran O'Sullivan. Please go ahead, sir.

Thank you. Good morning. Thank you for joining us today and welcome to CTS's second quarter 2014 conference call. The following are the key takeaways from today's call: significantly improved EPS, expanded gross margins while free cash flow improved; our top-line sales were below expectations and I will outline how we are addressing this challenge.

We remain committed to our strategic plan to simplify, to focus and drive profitable growth while we move through this transition year. Joining me today is Ashish Agrawal, our Chief Financial Officer. Ashish will take us through the Safe Harbor statement. Ashish?

Before beginning the business discussion I would like to remind our listeners that this 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 is contained in the press release issued yesterday and more information can also 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 in the Investor Relations section of the CTS website. On this call we will refer to 2013 financials on a continuing operations basis excluding results of the EMS segment which was divested in the fourth quarter of 2013. I will now turn the discussion back over to our CEO, Kieran O'Sullivan.

Thank you, Ashish. Yesterday we reported our second-quarter 2014 financial results. Second-quarter sales were $103 million, down 2% from the same period last year and up 2% versus last quarter. Our sales to automotive markets grew 3% year-over-year. All other sales were down 12% year-over-year as we experienced continued softness in shipments of our electronic components, mainly frequency and HDD products.

While we expect this softness to continue throughout the remainder of this year, we are addressing the challenges in three areas. First, our leadership transition recently announced it had strong industry experience and expertise. Secondly, we continue to strengthen our front-end sales by being more focused regionally and adding channel and OEM front-end talent. And finally, we are selectively refreshing the product portfolio to enhance our product offering. As you may have noticed, we announced a leadership change during the last quarter.

The second-quarter GAAP earnings from continuing operations were $0.19 per diluted share compared to a loss of $0.31 per diluted share for the second quarter of 2013. Adjusted net earnings from continuing operations in the second quarter of 2014 were $0.25 per diluted share compared to $0.22 per diluted share in the second quarter of 2013.

As we transition our business profile you can see our operating margin strengthen and emerge from low-single-digit performance last year to consistent low-double-digit levels this year. We continue to make progress towards improving our cost structure. Gross margin improved to 32.8% in the second quarter, up 210 basis points compared to the same period last year.

SG&A costs were 15.4% in the second quarter, down from 16.3% in 2013. Operating expenses in the second quarter of 2014 were 23.2% compared to 28.4% in the same period last year. Operating expenses for the second quarter of 2014 excluded $2.7 million in restructuring charges compared to $7 million in restructuring charges and $0.8 million in CEO transition costs in the second quarter of 2013.

Debt to capitalization improved slightly to 20% from 20.2% last year. Controllable working capital was 11.1% in the second quarter, an improvement from 17.9% in the same period in 2013. And with free cash flow of $12.9 million we improved from $10 million in the same period last year.

Now moving to new business, new business awards in the second quarter were $89 million. We received a new contract for our piezo product line for application in medical imaging. CTS' ceramic duplexer was selected as a reference design for LTE base stations with production starting in 2015 while we expanded our contract with one distributor to include CTS' frequency products.

On the automotive products we extended our lifetime sales in smart actuators while securing new wins in pedals and sensors with American and Japanese OEMs. Our chassis right height sensor platform was selected by an American OEM. For the quarter we returned $4.6 million to our shareholders from a combination of dividend and share repurchase programs versus $1.6 million in the same period last year.

We will continue to pursue our strategic plan of simplifying and focusing on the core while driving profitable growth. We are on track with our manufacturing footprint consolidation and more recently made some final [adaptions] in our cost structure as we substantially completed the transition service agreements in relation to last year's sale of the EMS business.

We continue to increase our investment in R&D and in sales support for organic growth. As part of our transition we have managed through several talent upgrades. This strengthening of our talent pool will enhance our ability to execute, to add new technologies, to add new products and position us to address organic growth initiatives and suitable inorganic opportunities to reach our targeted growth levels.

We are committed to our strategic plan and have gained greater granularity on our business. Our strategy is delivering results and we expect to continue improvements in profitability as we build a foundation for innovation to support organic growth. Near-term growth will be more modest as we focus on accelerating organic projects. We remain excited by the progress and the clear milestones we have identified in our strategic plan will continue to guide our focus and actions.

As noted in the earnings release last night, we are lowering our sales guidance due to the lower demand for electronic components products. As I already mentioned, we are addressing our issues. Full-year 2014 sales are anticipated to be in the range of $400 million to $415 million and adjusted earnings per share are expected to be at the lower end of our guidance range from $0.96 to $1.02.

I will now turn the call over to Ashish to provide some additional color on our results. Ashish?

Thank you, Kieran. Second-quarter 2014 sales were $103 million, down 2.3% compared to the same quarter last year from continuing operations. Sales grew 2.3% from the first quarter to the second quarter of 2014. Gross margin in the second quarter of 2014 was 32.8% versus 30.7% in the same quarter a year ago.

Gross margin also grew sequentially up 240 basis points from 30.4% in the first quarter of 2014. Margins increased as we continue to improve performance in certain product lines, achieve efficiency gains and implement material and labor productivity projects. We are also realizing margin improvement from our restructuring projects faster than our earlier expectations.

SG&A expenses were $15.8 million, down $1.3 million from the second quarter of 2013. This reduction in cost is the result of savings generated from restructuring actions and a reduction in pension expenses.

Consistent with our strategy and earlier communication last quarter, we continue to enhance our sales and marketing capabilities by adding resources closer to our target customers. This resulted in higher selling and marketing costs in the second quarter as well as in the first half of 2014 compared to the same periods last year. This cost increase was more than offset by the reduction in general and administrative costs.

R&D expenses were $5.3 million in the second quarter of 2014 compared to $5.8 million in the second quarter of 2013. R&D expenses were lower year-over-year due to restructuring and timing of expenses as we streamline and reposition our R&D resources. We remain committed to investing in new products for organic growth.

In the second quarter net interest and other expenses were unfavorable by $100,000 versus the second quarter of 2013. Our net interest cost improved compared to last year primarily due to lower debt. However, this favorability was offset by unfavorable foreign exchange impact in the second quarter of 2014.

The effective tax rate in the second quarter was 34%, which includes the impact of restructuring charges and one-time items. For the full-year 2014 we expect our effective tax rate to be in the low 30s range excluding the impact of restructuring and one-time charges.

In the second quarter of 2014 our GAAP earnings were $0.19 per diluted share compared to a loss from continuing operations of $0.31 per diluted share in the same period last year. Included in the second quarter of 2014 earnings were $0.06 in restructuring and related charges. Excluding these items adjusted earnings per diluted share were $0.25 in the second quarter of 2014.

Included in the second quarter of 2013 were a $0.32 charge related to cash repatriation, a $0.19 charge for restructuring and related expenses, and $0.02 charge for CEO transition expenses. Excluding these items adjusted earnings per diluted share were $0.22 in the second quarter of 2013.

Turning now to the balance sheet, cash and cash equivalents were $127 million at the end of second quarter compared to $124 million at the end of 2013. Our debt balance was $76.2 million as of June compared to $75 million at the end of December 2013.

Controllable working capital comprised of Accounts Receivable plus inventory minus accounts payable was 11.1% of sales in the second quarter compared to 17.9% in the same quarter a year ago. The improvement reflects the impact of the EMS divestiture and ongoing working capital initiatives. Inventory reductions are the biggest driver for the improvement.

Operating cash flow was $10.1 million in the first half of 2014 compared to $10.2 million in the first half of last year. Capital expenditures were $6 million in the first half of 2014 and we expect higher CapEx in the second half of the year due to timing in various projects.

We repurchased 211,000 shares of CTS stock for $3.7 million during the first six months of 2014. Including the dividend we have returned $6.4 million to shareholders through June 2014. We will continue to buy back additional shares during the year as part of our share repurchase program.

This concludes our prepared statements. I would now like to open up the call for questions.

(Operator Instructions). John Franzreb, Sidoti & Company.

Good morning, guys. I would really like to start at the top line. I personally was a little surprised with the year-over-year growth that we saw in the components and sensors side, sensors and mechatronic side of the business, especially given what I thought was a relatively strong automotive market. Can you talk a little bit about what is happening there? Why the relatively soft growth year-over-year?

Yes, John. First of all, as I mentioned in the prepared remarks, that we had a leadership transition. Actually we have had a few changes in the business and we are working on improving our front end even coming into this year and from what we talked about last year.

In the Company overall we are not satisfied with our front end both in terms of regional presence, in terms of how we are interfacing with the OEMs and working with the distributors. We needed better competence in that area.

And on the product side of it specifically two things. HDD we talked about in the last call. We said that we had had some softness there. We saw that softness. It impacted our earnings, as you can see -- our sales, I should say, as you can see.

On the flipside, we have seen the forecast now two or three times for the second half of the year, so we see that coming back. We are pretty confident in that. And so, that was on area of softness that we had on the components side.

The second area was on the OCXOs in particular. Traditional OCXOs are used in base stations. What we are seeing is the demand for those products is declining a little faster than we expected. What is really happening there is to go into smaller solutions and using a combination of software and GPS in the base stations to fulfill the requirements they need.

So what we are doing, as we said, we are transitioning the product portfolio. We are going into lower power solutions for more portable applications. That could be in the military, it could be in marine and sonar. So we are working through that transition. But they are the two big points really that impacted us.

Okay, Kieran, I'm going to stick with what you said then. You said that the HDD looks like it is going to come back in the second half of the year. When you are looking at the adjustment you made to the revenue guidance, are you still neutral on the component side versus what you were three months ago or are you down on the components side and is the driver all the XCXOs?

Let me give you a little bit more color. As we're looking to the quarters ahead we are looking to sequentially get small improvements in that area. We are not looking for dramatic improvements. But I will tell you, even with those two areas, the HDD forecast looks very good because they burned off the inventory.

It was inventory we were dealing with and the transition of the enterprise platforms of those customers. So we are feeling pretty good about that. But on the flipside, I will tell you, we have added four new customers in the quarter in that area.

And even outside of HDD our growth in non-HDD piezo products is very strong. And obviously that is something we are investing in longer-term, not just something you ought to see this year, but we have had strong performance in that area too.

Okay. So does that suggest the weakness that you are seeing in the top line is more on the sensor side of your business?

No, more on the components side we would call it, just like the HDD and what we said with the OCXOs, some of those products.

I am just trying to reconcile -- the biggest reason you are pulling down your revenue expectations for the year is HDD. Is there any other big nut there that we have to think about?

I have given you the main two things. We haven't obviously gotten into the second half results yet. The one thing that's -- because I talked about having more granularity on the business. In the second half -- other than those two points there's one other thing.

Last year we had a onetime order in the second half of the year with one OEM on the automotive side that won't recur. It was for a product they needed and it was in the range of $3 million to $5 million and that won't repeat in the second half of this year.

All right. You mention the R&D expense that you are going to maintain developing new products. If you look at this maybe in a longer cycle here, the Company started picking up the spend in the R&D roughly four years ago.

Are you satisfied with how the money has been spent on the R&D? I would've thought we would have had maybe more of a benefit from some of those past dollars in today's revenue profile, but it seems like it has been spotty in realizing some of those benefits.

John, I will be very frank with you here. I'm not going to comment on the past. What is done is done. We have obviously moved into smart actuators. We continue to grow in that area. So that focus actually continued to improve. We have always talked about margins in that area. We continue to improve it and actually we have extended order wins in that area out to 2020. So I feel pretty good about that.

On the flipside, there is no magic -- when 65% of your business is automotive, you can't turn the ship overnight. What you went back in 2011 and 2012 is your revenue today. So the one good thing we feel very positive about is that in 2013 we had extremely strong new business wins which you won't see until the 2017 timeframe or some at the end of 2016.

If you look at what we report in new business wins, even in the first half now of this year we have reported $225 million. So if you look at our revenue run rate, it is 10% almost above that. So we are doing the work now that is going to help us in the out years. And obviously 65% auto, you can only turn it so quickly. We want to turn some of the other places a little faster.

Okay, great. One last question. Ashish, I think you mentioned that you're starting to realize the benefits of the facility consolidations earlier than anticipated. From my reckoning I think the number was supposed to be a $0.15 to $0.20 EPS benefit in 2015, it was supposed to be fully completed by the end of this year, 2014. I guess my question is how much of the EPS guidance that you now have out there, how much of that benefit is embedded in that guidance?

John, the announcement from June last year talked about a benefit of $8 million to $10 million on an annualized basis and we were anticipating getting roughly half of that in the second half of this year of 2014 and the remaining half in the first half of 2015. And we think the savings that we realize in 2014 will take into account 60% to 70% of that number with the remaining coming through in 2015.

Thank you very much. I'm going to get back into the queue, guys. Thank you.

Lisa Thompson, Zacks Investment Research.

Good morning. I was wondering if you could talk -- could you talk a little bit about this third and fourth quarter? Given what you are seeing now, are they going to be similar with the June quarter or is there any seasonal variation in what is going on?

Then also can you talk about the computer as a part of the entire revenue for the Company? I know you said 65% light vehicles. What happens to computer now? Is that still like 10% of the business or has that kind of dropped off?

I will address the first part of your question, maybe Ashish should take the second part. When it comes to -- we don't really guide by quarter, we guide for the year. So we gave the guidance of $400 million to $415 million for the year. And we feel comfortable with that guidance. No big changes expected.

Obviously we are trying to make every effort we can to accelerate organic improvements, but we are limited in terms of 65% being automotive. In terms of the computer side I presume you are referring to HDD and that is our real sales in that space. And Ashish, if you want to answer anything else.

So Lisa, the computer which is primarily HDD, represents a little less than 10% of our total sales. And in the second half of the year we are expecting some rebound in the HDD volumes, as Kieran already pointed out. It is not going to change the landscape materially -- for the entire sales in the computer industry.

Okay. So it is going to look similar to 2013 this year even though there is weakness?

For the full-year, yes, it will be relatively similar to 2013 sales.

Okay. And if we wanted to look at end user products, [things that go] -- what are the biggest drivers in your revenues? Is there something we can look at other than light vehicles that say oh, wow, this is doing great that means it has got to be good for CTS?

I think you've got a few things, Lisa. First of all it is light vehicles but also commercial with some of the smart actuators. As Ashish mentioned when it comes into communications or computing, that is really around two things, HDD on one side of it and our components products on the other.

Piezo products feed into sonar, marine applications, defense, but also into industrial -- and medical. So the industrial side is another large portion for us, maybe 10%, 15% range. So they would be the end markets I would be looking at.

Right. Okay. But the biggest drivers. If you had to pick two things, what would be the two that I should look at as the biggest drivers?

Lisa, automotive is by far the biggest and then I would point you in the -- sorry, go ahead.

And that is primarily concentrated in (multiple speakers)? Right, and that's -- non-US would be more important than US, right?

I think while sales -- we haven't publicly broken out the geography by market segments, but automotive sales are fairly widespread throughout the various regions.

So Lisa, if you are looking beyond automotive the two bigger markets I'd look at are communications and industrial.

Okay, thank you.

(Operator Instructions). Hendi Susanto, Gabelli & Co.

Good morning. I would like to understand the magnitude of the decline in your guidance. You mentioned that you are expecting HDD sales to come back in the second half. So this represents delayed sales. And I would like to understand the remaining (inaudible). You mentioned that [frequency] product was weaker.

But I think it will be helpful if you can give some insight on what drives the guidance to be lower besides the HDD sales. And it will be helpful if you can probably share some colors on that part.

Yes, HDD obviously was very soft in the second quarter and, again, we mentioned that in Q1. So we see that bouncing back but we can't make up some of the losses that we had in the second quarter as they burned off inventory and transitioned now a little bit later than we expected to some other enterprise platforms. So that is the first piece of it.

The second piece of it is more on the electronics component part of it. OCXOs and I mentioned OCXOs as an example where we are seeing demand decline on base stations and newer solutions are found using GPS. But we are pursuing other expansions in that area and it will take a little bit of time.

It is not as long as automotive obviously, but we are transitioning some of the portfolio. So they are the two big things and there's other pieces moving in the equation, but I would highlight those too. And I do want to reemphasize again that even though we have that softness in the HDD we are very strong in other non-HDD piezo products.

We have added four customers and obviously you will remember from the previous calls, we're out there driving growth, being closer to the customers not just in North America but in Europe and Asia, increasing our spending in sales and marketing and R&D while we manage our G&A to offset that increase. So it is what it is and we've just got to work our way through it at the moment.

Okay. And then, Kieran, do you have updates on your strategic view on streamlining your product portfolio in terms of where CTS will be in 2015 timeframe?

First of all, the strategy hasn't changed. Just to reemphasize that, we are still committed to the simplified focus and drive profitable growth. The EMS divestiture was the big divestiture; we have nothing new to say in terms of changing that. But what I will tell you is we are working very clearly on the execution plans by quarter. We are making some very clear investments on some products in the components area. I'll give you an example.

RF is an important component for us, non -- HDD as well as non-HD. We see ourselves expanding into other verticals using the HDD side of it. And of course on the automotive side of it we are focused on sensors and mechatronics, but we want to get a much better international traction.

Some of those things take one to two years to win the business and then another two years through the development cycle. But hopefully that gives you some color. And we're -- as I said, we will have modest growth now near-term, but we are still targeting 10% growth overall with organic and inorganic initiatives that we have.

And then last question for me. Are you actively looking for potential acquisitions at the moment?

Yes, we are very clear in terms of what is a fit and not a fit. We have nothing to report on this call, but we are much clearer. With every passing month and quarter we are obviously working in that area, but we are not going to rush it.

If we find the right thing we can act quickly provided, again, it is the right fit to the strategy and, of course, at the right valuation and price so we maximize return for shareholders.

Thank you.

(Operator Instructions). John Franzreb, Sidoti & Company.

It seems like everyone is kind of struggling here with the revenue outlook and reconciling that. So my question is -- is there any change in your expectations in the automotive/transportation market versus what it was three months ago?

On a macro level the auto industry is -- if you look at it in terms of the quarter, 21 million to 22 million (inaudible) shift out there. I would say some customers are doing better in the market than others and in one or two areas we may have a little bit of exposure, but we factor that into our guidance.

So no dramatic shifts, but I will tell you, to be very clear, we are specifically targeting certain investments in those areas. We won't just invest in every product line that we have, there are certain ones we want to be very strategic on because we're thinking when we think auto we think what the revenue is going to be in 2017, not in 2014 or 2015. The things we are doing today will impact 2017 and 2018.

Not on the investment side, on the top-line side, is your expectations today the same as what they were three months ago?

They are not materially different, John.

So that would suggest that the adjustment to the guidance on the revenue is clearly the lost revenue opportunity largely on HDD and the XCXOs product lines? Am I understanding this properly?

You are correct in terms of stating that HDD and some of the components like OCXO have been the major ones. They are (multiple speakers).

It just seems like everyone is kind of bouncing around. But it seems like -- I just want to make sure I understand it properly (multiple speakers). Perfect. Okay.

Secondly, cash is starting to build. There is this question about potential M&A. Two things on cash. One, how much is it domestic versus overseas? And two, can you prioritize your uses for cash going forward?

So as we've stated before, the majority of our cash is overseas. You linked it a little bit to maybe what we are looking at going forward. We are looking obviously on the M&A side for potential fits. International ones would be really nice, would help our cash position. And Ashish, you can answer to the second part.

John, can you repeat your second part of your question?

Yes. A, what is the percentage of cash overseas? And two, prioritize the uses of cash.

So substantially all of the cash is overseas, John. In terms of the use, cash that is sitting outside the US we will be primarily looking at using it for M&A and to fund our investments related to the organic growth in terms of product development, R&D investment and some investments in sales and marketing resources in our strategic locations as we are thinking through being closer to our customers.

Will that necessitate a repatriation of the cash again, like you did a year ago?

That is not anticipated at all at this point.

All right. One last question. Could you talk a little bit about the developments in North Carolina, the Supreme Court decision? Do you have any kind of incremental legal costs associated with that that we should be aware of in the P&L?

So, I think, John on that we will be filing our 10-Q later this week. You should read Note G in that. But based on available information relating to any environmental matters that could impact CTS, adequate provisions have been made at this point in time.

Okay, so there is no incremental cost associated with it that we should be cognizant of in the quarter?

From everything we are aware of we have made the right provisions and I would encourage you to read that note in the Q.

Okay, thank you, guys.

That does conclude our question-and-answer session. Gentlemen, I will turn the call back to you for any additional or closing remarks.

Just give it one more minute in case there is another question and otherwise we will wrap it up.

(Operator Instructions). Hendi Susanto, Gabelli & Co.

(Inaudible) ask you some questions about the dividend policy. At what point you may consider like diverting the cash for dividends for investment or for paying down debt on your balance sheet?

Hendi, we are generating enough cash domestically to not only fund the dividend but also the share buyback. I don't anticipate us actively looking to divert funds from dividends to the purposes that you stated. And between the management team and the Board we constantly keep taking a look at what is the most optimum use of cash we are generating both domestically and outside the US in how we deploy those funds.

Okay, thank you.

Gentlemen, there are no further questions at this time.

Okay, just to conclude the call, first of all thanks again for your participation. I just want to reaffirm despite the softness in sales we are dedicated to our strategy to simplify, to focus and drive profitable growth. We are very clearly aware that the biggest challenges we have are sales growth.

We are obviously very focused on these simplification, all the work we are doing in terms of manufacturing, corporate consolidations and making sure we are protecting our customers. And at the same time we are preparing the investments that we are doing to improve organic growth as we move ahead. With that, this will conclude the call. Thank you for your time.

Thank you and that does conclude today's conference. Thank you for your participation.