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Executives

Mitchell J. Walorski – Director of IR

Vinod M. Khilnani – Executive Chairman of the Board

Kieran O’Sullivan – President – CEO

Thomas A. Kroll – VP, CFO

Analysts

John Franzreb - Sidoti & Company

Anthony Kure – KeyBanc

Hendi Susanto - Gabelli & Company

Brad Evans – Heartland Advisors

CTS Corporation (CTS) Q4 2012 Earnings Call January 29, 2013 11:00 AM ET

Operator

Ladies and gentlemen, good morning, thank you for standing by and welcome to the CTS Corporation 2012 fourth quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions).

As a reminder, this conference is being recorded.

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

Mitch Walorski 

Thank you, Tom. I'm Mitch Walorski, Director of Investor Relations, and I will host the CTS Corporation fourth quarter and full year 2012 earnings conference call. Thank you for joining us today. Participating from the company today are Vinod Khilnani, Executive Chairman of the Board, and Kieran O’Sullivan, President and Chief Financial Officer, 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 required explanations and reconciliation are available on our website in the Investor Relations section.

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

Vinod Khilnani 

Thanks, Mitch, and good morning, everyone. Last evening, we released our fourth quarter and full-year 2012 financial results. Against the backdrop of weak global economic growth, and Europe in recession, we reported year-over-year Components and Sensors segment sales growth of 7% in the fourth quarter and 9% in 2012 full year.

Our EMS segment continued to lack with sales down 12% in 2012, driven by weak defense in aerospace industry sales of our decision to exit our unprofitable Scotland EMS operations, and some lost sales due to Thailand floods. Lower EMS sales, when in line with our third quarter guidance, offer 10 to 12% decline in 2012.

Total full-year sales as a result were somewhat lower than our expectation of flat sales, and were down 2% in 2012 with improved segment mix in favor of growing Components and Sensor segment. As a result, our gross margin has steadily improved in the fourth quarter of 2012. We were adversely impacted by certain tax benefits, which were expected in 2012, but were delayed into 2013, resulting in lower-than-expected EPS in the fourth quarter.

Working capital and free cash flow were again very strong in the fourth quarter, with full-year free cash flow at $28 million, coming in higher than our guidance range of 22 to 26 million.

On the business growth front, we successfully launched several significant new products, and announced the acquisition of D&R Technologies in December; a synergistic $50 million in revenue sensors company, to fill certain product and geographic voids in our Sensors and Actuators business.

We also completed several significant restructuring initiatives to lower our overhead cost structure, and simplify our global operations by reducing our global square footage by approximately 17%, or 330,000 square feet.

Our Components and Sensors segment sales was 75.7 million in the fourth quarter, up 7% from the fourth quarter of 2011. Within this segment, sales of Automotive Sensors and Actuators were 44.3 million, down 1.4 million from last year, but they were up 9.3 million or 5.3% on a full-year basis despite lower sales in Europe.

The weakness in the fourth quarter was primarily due to softer sales to the Japanese automotive customers and China, due to island-dispute related disruptions. The China situation continues to improve gradually; however, the disruption resulted in approximately $3 million in lower sales in the quarter. Beyond this issue, the underlying sensor sales in fourth quarter were up approximately 3 to 4%, driven by a strong U.S. market and new products, and despite headwinds of a strong U.S. dollar versus Europe, and overall negative economic growth in Europe. European light vehicle production was down approximately 6% year-over-year in 2012.

Overall, our Automotive Sensors and Actuators business continues to do extremely well, with six new program wins in the fourth quarter, three new, and three replacement programs. Our major Smart Actuator program is in volume production as we speak. We expect our Sensors and Actuator sales to grow year-over-year by a strong 40 to 45% in 2013, driven by the D&R acquisition, and organic new products like smart actuator’s growth. Approximately 60% of this growth is acquisition related, and 40% is organic.

Continuing with our component and sensor segment, sales of Electronic Components in the fourth quarter of 2012, were up 6.4 million or 26% to 31.3 million. On a full-year basis, sales of Electronic Components were up 15.3 million, or 14.5%. The strong fourth quarter and full-year sales growth was driven by a strong Piezoceramics sales for the new disk drive application and Valpey acquisition.

This was partially offset by weak wireless infrastructure and distribution channel sales. The 26% fourth quarter year-over-year growth was split 70% due to Valpey acquisition and 30% due to organic growth.

Overall, our electronic component products are also growing in line with our double-digit growth target for this group. In 2012, it grew by 15% and in 2013, it is expected to grow again by 15 to 17%, driven primarily by organic new product growth.

Moving on to our EMS segment, sales in the fourth quarter were 62.6 million or 45% of total company sales, versus 73.3 million or 51% of total company sales in the fourth quarter of 2011. Closure of unprofitable locations and flood-related disruptions caused fourth quarter 2012 sales to be lower by 14.6% year-over-year, and 11.7% lower on a full-year basis.

Much faster growth in our Component and Sensor segment sales, as we discussed earlier on the one hand, and exiting certain low margin EMS business on the other hand, will continue to make our EMS segment a smaller part of total company with more focus on profitability in the EMS segment than growth. We expect EMS segment sales to be approximately 40% for a total sales in 2013.

Many of you will remember that EMS lost 60% of our total sales a few years back, then we launched initiatives to flip the segment mix. We targeted the component and sensor segment to be 60% and the EMS to be 40% of the total sales to a double-digit targeted growth for component and sensor segment, driven by R&D, new products, and some bolt on acquisition.

Staying with the EMS segment, gross and operating margins in the fourth quarter and full-year improved, as we continued to take cost actions and completed our recovery of insurance reimbursements for flood related expenses, lost sales, and business disruption.

Looking ahead, we expect that new products, our recent sensor acquisition, and continued modest recovery in global economic conditions will allow us to grow our 2013 sales in the range of 12 to 15% year-over-year.

Earnings per-share are expected in the range of 73 to $0.78 per share, which includes approximately $0.05 per share for CEO transition cost. Excluding these one-time transition costs, the underlying, on-going, normalized earnings per share is expected to be in the range of $0.78 to $0.83 per share in 2013.

Before I hand the call over to Tom Kroll, our Chief Financial Officer, to go over the financial results in greater detail, let me take a few minutes and introduce Kieran O’Sullivan, new President and CEO of CTS Corporation.

We are delighted to have him onboard. Kieran joined the company on January 7 and has hit the ground running. His extensive global experience leading large business enterprises successfully, familiarity with our technology and strong ties in the automotive and electronic components industries will be a tremendous value to CTS.

Let me invite Kieran to say a few words. Kieran?

Kieran O’Sullivan

Thank you, Vinod, and good morning. I’m excited to join CTS, especially at a time when it is poised to grow from the recent acquisition, and the significant new product introductions like the Smart Actuators and the Piezo products for the hard disk drives.

This is only my fourth week on the job, so I’d like to keep my comments brief. I’m preparing to visit our Asia locations with Vinod. I’ve been to several of our U.S. sites, while also conducting reviews to get quickly up to speed with CTS products and technologies.

I’m looking forward to my first customer meetings next week, and meeting many of you in the very near future. I’ll be happy to answer any questions later on, but for now, let me turn it over to Tom.

Tom Kroll

Thank you, Kieran, and welcome everyone. Before I review the financial results in greater detail, I want to comment on four fourth quarter events.

First, as Vinod mentioned, in late December, we acquired D&R Technology for 63.5 million in cash, utilizing our existing 200 million revolving credit facility.

Our year-end revolver balance was 153.5 million, leaving us with approximately 45 million available under this facility. D&R is expected to add sales of approximately 50 million in 2013, with EBITDA of about 8 million.

The acquisition is expected to be slightly accretive in 2013, even after recognizing non-cash amortization of intangibles created by the acquisition.

Secondly, we entered in to a sale-leaseback transaction at our Singapore facility, netting cash proceeds of 17.7 million. A 10.3 million pre-tax gain was recognized in the fourth quarter, and an addition 4.5 million of gain will be deferred and recognized over the next six years, partially offsetting our lease expense at that facility.

Thirdly, as discussed in our third quarter conference call, we initiated a restructuring action in the fourth quarter, primarily related to the closure of our small unprofitable EMS operation in Tianjin, China, and the partial impairment of an operating lease.

Finally, we completed our Thailand flood-related insurance claim, receiving 5.7 million in reimbursements for our flood-related cost and loss margin on sales.

Now, I will discuss our fourth quarter results. Our consolidated fourth quarter 2012 sales were 138 million, an increase of 1 million from the prior quarter, and a 5.7 million – and 5.7 million lower than the prior year.

Our gross margins were 19.4% versus 17.9% last year. The Component and Sensor segment sales were 55% of total sales in the fourth quarter of 2012, versus 49% in the fourth quarter of 2011. This segment sales mix shift had a positive impact on gross margins of approximately 1.5 percentage points.

Our selling, general and administrative expenses were 22.2 million versus 16.8 million last year. The increase from 2011 was primarily due to acquisition-related expenses, the G&A from the Valpey-Fisher acquisition, which we acquired in January, 2012, higher pension expense, and certain legal expenses. Fourth quarter 2012 R&D expenses of 5.3 million were similar to the fourth quarter of 2011.

Our fourth quarter, net interest and other income were favorable by about a half a million to last year, primarily currency related as the Chinese renminbi strengthened relative to the U.S. dollar.

Fourth quarter 2012 net earnings were 8.8 million or 26% per diluted share, $0.26 per diluted share, compared to net earnings of 5.9 million, or $0.17 per diluted share in the same period last year.

Included in the fourth quarter 2012 earnings was a $0.23 per-share gain from the Singapore facility sale-leaseback transaction, a $0.09 per-share restructuring charge, and a $0.06 per-share of acquisition related and other charges. Excluding these items, our fourth quarter 2012 adjusted earnings per share were $0.18, compared to $0.22 in the prior period.

The year-over-year decrease is primarily due to a higher effective tax rate in the fourth quarter 2012, including a delayed U.S. research tax credit, not signed in to law in 2012 as anticipated, but signed in early 2013 and the delay and the formal approval of a Chinese high technology incentive tax credit. These tax items combined, represent approximately $0.06 per share of lower earnings in the fourth quarter, which we expect to record as a tax benefit in the first quarter 2013.

Looking at the full-year, sales were 576.9 million, a decrease of 2% from prior year revenue of 588.5 million. On a full-year basis, we believe it is prudent to look at gross margins on an adjusted basis, which adjust for insurance reimbursements, and restructuring related cost.

The flood related business interruption reimbursements were 20.9 million, shown as a separate line on the P&L, essentially offset the associated losses and expenses, which are included on the cost of – cost of goods sold line, as well as lost margin on sales not made due to the flood.

Accordingly, our adjusted gross margin of 21.6% compared to 19.4% last year. Approximately half of this percentage increase is related to a favorable sales segment mix, as we had a higher percentage of component and sensor sales in 2012, relative to 2011; 53% versus 48%.

Relative to 2011, the 2012 gross margin includes a negative 3 million impact related to foreign currency and additional non-cash pension expense. This 3 million was more than offset by operational improvements and some margin recovery on lost sales.

Looking ahead to 2013, and given the continued favorable segment sales mix change discussed by Vinod, we expect our gross margin percent to continue to improve another 100 to 150 basis points in 2013.

Our full-year selling, general, and administrative expenses of 80.4 million or 13.9% of sales, versus 71.9 million or 12.2% of sales in 2011. The 2012 amount includes the normal Valpey-Fisher G&A, SG&A of 3.1 million, higher non-cash pension expense of 2.2 million, and higher legal, CEO search, and acquisition-related cost of approximately 3.4 million.

Our R&D expense of 20.9 million compared to 20 million in 2011. In both years, the amount is approximately 7% of Component and Sensor segment sales. Net interest and other income of 0.3 million or 0.8 million less than last year, primarily due to the Chinese renminbi appreciating less in 2012 than in 2011.

We continue to assess our foreign currency exposure, and strive for naturally hedged positions.

Our full-year 2012, overall effective tax rate was 24.5%, which was higher than the tax rate in 2011 of 20.4%, due to the tax items previously discussed. Our 2012 diluted earnings per share were $0.59, including a 23% per share gain on the Singapore facility sale-leaseback transaction, a $0.19 per share charge for restructuring, a $0.05 per share charge for legal and other cost, and a $0.04 per charge for acquisition-related cost. Excluding these items, full-year adjusted earnings per share were $0.64 compared to $0.67 last year.

Again, the difference was primarily due to the delay in receiving certain tax benefits of approximately $0.06 per share, as previously noted.

Now, let’s look at the balance sheet. Cash, and cash equivalence were 109.6 million, versus 76.4 million last year. Approximately half of this cash increase resulted from the Singapore sale-leaseback transaction. The debt was 153.5 million versus 74.4 million last year. Most of the increase resulted from funding the two acquisitions.

From a working capital perspective, our accounts receivable days were 51 days, similar to last year, and our accounts payable days were 65 days, compared to 70 days last year. Our inventory increased – or excuse me, our inventory decreased 16.7 million during the year, helping inventory turns improve to 6.0 from 5.0 last year.

And please note that in order for these metrics to be meaningful, they do exclude the impact of the D&R acquisition, which we acquired in late December.

Our controllable working capital that we define as these three accounts; receivables, payables and inventory, improved to 16.8 million of annualized sales, compared to 17.4% last year. So 16.8% of annualized sales in 2012 versus 17.4% last year. And again, that excludes D&R.

Our 2012 cash flow from operations was 47 – 41.7 million, an increase of 88% from last year’s cash flow from operations of 22.2 million. 2012 capital expenditures were 13.5 million versus 15.6% million in 2011. Our capital expenditures, as a percent of sales, are still below our target of 3%.

Our full-year free cash flow, which is defined as cash flow from operations, less net capital expenditures was a strong 27.6 million versus 8.7 million in 2011.

In addition to our increased dividend this year, we also continued to – continued our stock buyback activity during the quarter, repurchasing 440,000 shares for 3.8 million. During 2012, we repurchased 1.1 million shares, or about 3% of shares outstanding at a cost of 10.4 million.

This concludes the financial overview. I will now open the call for questions. Thank you for joining us today.

Question-and-Answer Session

Operator

(Operator instructions). Our first question today comes from the line John Franzreb with Sidoti & Company. Please go ahead.

John Franzreb – Sidoti & Company

Good morning Vinod and Tom, and welcome aboard, Kieran.

Vinod M. Khilnani

Good Morning, John.

Kieran O'Sullivan

Thank you.

John Franzreb – Sidoti & Company

I guess I wanted to review the restructuring moves that you've made in the past few quarters and I guess continue to make into the first quarter. Can you guys give me an update on the timing of when all the restructuring moves will be fully complete and the potential savings should be realized in the first annualized year?

Thomas A. Kroll

Sure, John. The restructuring that we announced in the second quarter, that is substantially complete. And that included primarily closing our EMF operation in Scotland as well as some other EC action to close a facility or two.

The restructuring action that we announced in the fourth quarter is substantially complete. And we expect the EMF operation in Zhongshan, China to be closed by late January, early February.

The savings associated with the Q2 restructuring, we had talked about a $5 to $6 million number per year. But again, that's a little bit volume sensitive. So we would tone that down a bit to say $4 to $5 million. And the restructuring that we did in the fourth quarter, the one for $3 million, will have a little longer payback of about three to four years.

John Franzreb – Sidoti & Company

You talked a little bit about an adjusted gross margin of 21.6% and that the potential for 2013 to be 100 to 150 basis points better than that. I just want to talk a little bit about this. How much of that margin improvement is mix the D&R versus the product mix of new products? How much of that is cost savings? And is this a GAAP type number that we should expect to see in coming quarters? Could we just talk a little bit about the gross margin profile as you see it progressing and why do you see it progressing this way?

Vinod M. Khilnani

John, let me give it a shot. And then I will have Tom to put some more color on that.

I think the primary benefit, the primary driver behind the margin improvement in segment as you can see from our comments that bulk if not all of our growth in the top line in 2013 is coming from component sensor segment. And so as we take that segment to what we are projecting to be 60% of the company and stuff, I believe 51% this year. The segment mix is the primary driver for that.

Now to the extent that D&R acquisition is in that segment isn't helping the segment sales to go up clearly that contributing too.

As Tom pointed out, the restructuring is benefitting that. And we have not very – clearly we can break out that how much of that is overlapping with the segment mix. If you tell us to really give you a clear view of that, I will probably speculate that one-fourth of the savings, one-fourth of the gross margin improvement, one-third quarter of the improvement has come from the restructuring. But I would suspect bulk of the savings are coming because our segment mix continued to be favorable towards component sensor segment.

Thomas A. Kroll

John, I would agree with that assessment that about two-thirds is probably sales segment mix related. And the rest from other operational efficiencies resulting from some of the restructuring.

And then to answer your other question, yes, you will be able to see that in 2013 as a GAAP number of the face of the P&L.

John Franzreb – Sidoti & Company

Okay, so all the insurance recoveries and noise associated with that is out of the picture at this point?

Thomas A. Kroll

Yes, John, it's all wrapped up.

John Franzreb – Sidoti & Company

Okay, one last question. Are you assuming growth in EMS in 2013 in your forecast?

Thomas A. Kroll

No, John, we're not. Looking at a slight decrease of maybe $10 million net.

John Franzreb – Sidoti & Company

And is that from exited businesses or is that …

Thomas A. Kroll

Yeah, the two businesses that we exited reduced sales by $25, $30 million. But we expect to claw back a portion of that. So maybe net of $10 to $15 million.

John Franzreb – Sidoti & Company

Thank you very much. I'll let somebody else go.

Operator

Our next question today comes from the line of Anthony Kure representing KeyBanc. Please go ahead.

Anthony Kure – KeyBanc

Good morning Gentlemen, how are you?

Vinod M. Khilnani

Good morning, Tony.

Anthony Kure – KeyBanc

I just wanted to clarify. I guess I didn’t, and I apologize if I missed this earlier on the call. I just jumped on. But sort of to the prior question about around the restructuring and the timing. Could you just quantify or maybe give your best guess or estimate as to what the actual hard dollar savings in calendar 2013 is factored into your EPS guidance?

Thomas A. Kroll

Sure, Tony. As I mentioned earlier, the second quarter restructuring charge that we took was a little over $5 million. And we expect – at the time, we had expected about a one year payback. Given some of the volumes, we've tempered that a little bit. So maybe $2.5 to $3 million is our based into our 2013 plan.

And then with the Q4 restructuring that we just announced, roughly $3 million. There's probably $1 million of that or so based into the 2013 plan.

Anthony Kure – KeyBanc

And when you say $1 million of that, you mean $1 million of savings, correct?

Thomas A. Kroll

$1 million of savings, yes. Pre-tax.

Anthony Kure – KeyBanc

And then as far as the impact from the China/Japan issues in the fourth quarter, is there any factor factored into your top line guidance into 2013?

Vinod M. Khilnani

Yeah, I think we are expecting that to continue to improve. Nevertheless, continue to affect negatively in 2013. Our current assumption is that that will continue to affect us negatively probably the first half of the year. But it's very hard to predict. These things have a tendency to improve and then some event spikes it. But if you look at the reported data from the key Japanese companies in China, the numbers we saw were that in the third quarter, their sales year-over-year were down as much as 50% because of this issue. And then we saw the report that in the fourth quarter, it improved.

But even in the fourth quarter, companies like Toyota, Honda, the Nissans were down year-over-year. But more like approximately 25%. So it's improving. Instead of down 50% year-over-year, they were only down 25% year-over-year. We're projecting that they will continue. The situation will continue to improve. Nevertheless, we are projecting that they will still be down year-over-year in the first and second quarter of 2013. And maybe by mid-year, the situation will become normalized.

Anthony Kure – KeyBanc

Is it fair to say from a degree of impact that it will be as big in the first and second quarter as the fourth? Or based on the fact that it's improving, it will be less of a headwind in the first and second quarter?

Vinod M. Khilnani

It will be less of a headwind in the first and second quarter. So we think it will further improve from the fourth quarter.

Anthony Kure – KeyBanc

Okay, great, thank you. And then I just wanted to get one more in as far as what you're hearing or seeing in the distribution channel as it relates to inventory levels. Can you maybe talk about your comfort level with inventory levels in the channel?

Vinod M. Khilnani

Yeah, the year started with distribution sales down year-over-year. And the first half of the year even in the third quarter, our distribution sales as we have commented in the earlier earnings releases was down double-digit year-over-year.

We did see an improvement in the fourth quarter. Our fourth quarter distribution sales year-over-year are flat to maybe slightly down versus earlier in the year, we saw double digit declines.

We are seeing the inventory in the channel to be pretty reasonable. It's not excessive inventory, which tells us that any improvement in the distribution will flow through to us in higher sales into the channels.

So we clearly saw an improvement in the fourth quarter. And frankly, we are expecting that improvement to continue. And we expect first and second quarter to be better than what we saw in 2012.

Anthony Kure – KeyBanc

Great, thank you so much.

Operator

The next question today comes from the line of Hendi Susanto representing Gabelli. Please go ahead.

Hendi Susanto - Gabelli & Company

Good morning, Vinod, Kieran and Tom.

Vinod M. Khilnani

Good morning.

Hendi Susanto - Gabelli & Company

My first question, my I inquire what the operating margin and gross margin of D&R Technology looked like? And if you don’t share numbers, probably like qualitatively?

Vinod M. Khilnani

Yeah, I think, Andy, we have only shared the sales and EBITDA so that people can get a feel for what kind of EBITDA multiple we gave for this company, which is pretty reasonable and pretty fair compared to the market transaction.

Clearly, we expect D&R Technologies to help the overall gross margins of the company because it’s a component sensor kind of a company versus an EMS company. The margins will be tempered in the first couple of years because we will have a fairly large slug of amortization of the intangible cost, but I understand, and I’ll have Tom add to that, is I think those things that amortize on a double-digit declining kind of a balance method and so our margins and the amount we have mentioned as a decreation will continue to improve beyond 2013 as that amount get amortized fully.

Hendi Susanto - Gabelli & Company

Okay. And Tom, what is the estimate for the amortization of intangibles for 2013?

Thomas A. Kroll

Hendi, on that transaction, approximately $3 million.

Hendi Susanto - Gabelli & Company

$3 million, okay. And Tom, may I inquire what the operating margin in Q4 for Component and Sensors look like if we exclude like gain from the Singapore transitions that was upset by acquisition-related costs and legal expenses?

Thomas A. Kroll

Sure, Hendi. In the fourth quarter, if we exclude the – if we exclude the Singapore gain, then that margin of up earnings before corporate charges and before – obviously restructuring is not in there, would be about 10.6%.

Hendi Susanto - Gabelli & Company

10.6%. Tom, how should we think of operating margin for Component and Sensors going into 2013?

Thomas A. Kroll

Well, I think as Vinod mentioned, we’ll have some headwinds on the – one of our automotive products for diesel engines, the smart actuator. In the last conference call, we talked about a safe mode start up, so we’ll see some pressure there on gross margins and operating earnings. But other than that, Hendi, we should see a pretty much consistency relative to the last couple of years.

Vinod M. Khilnani

Hendi, I think we’re sticking with a double-digit operating margin on Component Sensors going forward. And as Tom said earlier, the [inaudible] our gross margins should be higher to by 100, 250 basis points. We frankly expect that to flow through to operating margins too.

Hendi Susanto - Gabelli & Company

Okay. And if I look at your latest corporate presentation, I saw that the – like the target pedal sales for 2012 and 2013 have been lowered to 109 and 112 from 115 and 120 million. Could you share the reason considering that while Europe may be weak, other companies are expecting strong growth of [inaudible] in North America and Asia?

Vinod M. Khilnani

Yeah, I think, good question, Hendi. The underlying sales continue to grow and we continue to get a bigger and bigger share of the key customers. But the two headwinds, which were reflected in that was – one is, we just recently talked about that we had expected continued impact at least in the first half of the year from the China issue around the Japanese OEM. So that, a little bit of a headwind in 2013. And then as you rightly pointed out, we are still expecting Europe to not grow and actually slightly lower in volumes in 2013 as we go forward. So if you look at 2012, I will tell you that Europe, which is approximately 30% of our automotive business was down as much as 7%. It’s a combination of economic weakness, especially a trend there, and a strong dollar compared to euro. It took away 7% of our European sales and we recorded a full year sales growth of 5% year over year in Automotive Sensors despite the fact that 30% of our European sales were down 7%.

Looking at 2013, we don’t expect sales to be down an additional 7%, but I think overall we are looking at Europe to be flat at best, but probably a couple of percent down given what we are hearing from the customers and the general economic trends.

Hendi Susanto - Gabelli & Company

Okay. And then similarly, if I look at the communication infrastructure market estimate, the CAGR was lowered from 11% to 10%. Other than concerns about microeconomic, are there other reasons?

Vinod M. Khilnani

No, no other reasons. We have not lost any sales as we continue to win new business. If we lowered it from 11 to 10, I’ll be honest with you, there wasn’t a conscious adjustment. It was probably rounding or a few other things, but probably effected by the general economic conditions, nothing product or customer specific.

Hendi Susanto - Gabelli & Company

Okay. And if you’re not looking at your growth LIBOR in 2013, the pierzoceramic for hard disk drives, in terms of the end products, like could you share what the product looks like? Like, I would like to know whether it’s part of, let’s say the ultrabook or troubled market as well?

Vinod M. Khilnani

My understanding is – before I say that, we continue to expect growth and that is one of the key reasons why we’re still predicting electronics components to grow double digits into 2013. My understanding is that Western Digital is a key customer in that space for us and they are systematically switching all their products to the dual-stage activation next-generation kind of product. And the growth is coming, not only based on what Western Digital is going to sell more and more disk drives, but the growth is coming because more and more families of their disk drives are being converted into the dual-stage actuation versions and dual-stage actuation products have the piezoceramic element as a key component. And so we see the growth, not only driven by market, but by the conversion.

Hendi Susanto - Gabelli & Company

Okay. And then for the dual-stage activations, is it multi source or single source to CTS?

Vinod M. Khilnani

At this point, my understanding is that we are single source on that product.

Hendi Susanto - Gabelli & Company

Okay. And a question for Tom. Tom, for modeling purpose, what tax rate should we use for our projection?

Thomas A. Kroll

Hendi, it will be similar to 2012 and that EBITDA includes the $0.06 adjustment that I talked about. But it will be pretty similar in 2012.

Hendi Susanto - Gabelli & Company

Okay. And then for – like are we still expecting like more legal expenses to continue in 2013?

Thomas A. Kroll

Nothing unusual, Hendi.

Hendi Susanto - Gabelli & Company

Okay. Thank you.

Operator

Next question today comes from the line of Brad Evans with Heartland. Please go head.

Brad Evans – Heartland Advisors

Heartland Advisors. Vinod, thanks for taking the question, and I guess this might be the last time we’ll be able to speak, and welcome aboard, Kieran. I guess I just wanted to ask a question with regard to you going back, you know, growing shareholder value for CTS has been very allusive and odd, and if you exclude even the bubble period, you know, since 2002, you know, the stock is down an annual rate of about 2%, so 30% total price appreciation negative since 2002. In the same timeframe, you know, the Russell 2000 Index is up a total return of about 103%. Despite all of your better efforts to restructure the company, and I know you’ve had a lot of bad luck with respect to Thailand and the Japanese tsunami and I guess now Europe. So a lot of these things that larger companies are able to side step and manage through have had a disproportionally negative impact on CTS and has resulted in it being very allusive for you to grow shareholder value and the stock has been, frankly, a dead-man’s heartbeat for some time. And I understand the transition you’ve come through with HP on the EMS side and the transition in Components and Sensors, but at the end of the day, you know, growing shows a return is why you’re a public company and I just wanted to understand from your perspective, from the Board’s perspective, why is it not in shareholder’s best interest to perhaps hire an investment banker to pursue strategic alternatives to see if there’s a pathway for some value for shareholders who have been very patient to be realized?

Thank you for answering my question.

Vinod M. Khilnani.

Well, Brad, I think you raised some good points. We have had unusual situations in the last several years, and I agree with you, that we clearly understand that EMS has been a drag on us. If EMS would have been, to be honest, a smaller percent of the company we probably would have looked at some of the alternatives. But given the size of the EMS and the fact that a lot of facilities are intermingled, we have essentially closed the two locations, which were intermingled, so Scotland and China were intermingled and as you know, we announced the closure of that. We also felt that a low-risk strategy would be to not only make EMS more standalone so that the Board has more alternatives available to them, but at the same time, the core of the company, which is Component and Sensors, needs to grow. And as you know, four years back we started the process to develop new products in Component and Sensors and as a result, you know, we feel that despite a lot of issues, we are beginning to see double-digit growth in components and sensors and we’re talking about a 40 to 45% growth in sensors in 2013 as a guidance.

But even if you exclude the D&R acquisition from it, the organic growth in Components and on the Sensor side of the business, we are projecting the double digits. So yes, it has taken us longer. Some of the products, it has taken us two to three years to develop. The smart actuator product is very different from what CTS has ever done. The average selling price of that product is more than $100, when our traditional sensor products will sell for $10 to $15. We have worked hard to win that business. That one customer alone is going to generate 40 to $50 million in sales and once they’re designed in on a diesel engine platform you’re pretty much, you know, locked in for 8 to 9 years as a single source kind of element.

So yes, it has taken us long time, but the flip side of that is that the annuity that we are creating from that is also locked in for a long time, a major design and development effort and as a result, I’m confident that the guidance that we are giving and the new – new programs which are ramping up as we speak and you’ll start seeing those higher volumes starting for the first quarter of 2013, are clearly a game changer for the CTS Corporation. And you know, you’ll remember a slide we had in which we said several years back that we’re going to flip the segment mix; 60% was EMS and 40% was Component. Well, in 2013, we will flip it. We have 60% of our sales coming from Component and Sensors.

So I guess what I’m saying is that the path was long and difficult and painful, but I believe CTS has arrived at a point where not only 60% of our sales, but almost 80% of our profits are now coming – projected to come from our component sensors, which gives the management and the Board lots of alternatives to realistically look at how to drive shareholder value by picking the segments more carefully or driving different kinds of things which are maybe more short-term in nature around buybacks or dividends kind of a thing.

The other thing I will point out is…

Brad Evans – Heartland Advisors

Vinod, if I could interrupt you real quickly. I appreciate that commentary. You know, I would just, you know, we realize and appreciate the hard work of the team, you know, the employees and in transition the company, it’s been a long road as we’ve been watching the progress. So I just – it just comes back to shareholder value creation and you know, shareholders have been eminently patient, many of them and so I would just, you know, I would just urge the board to have a sense of urgency. Kieran, you know, you inherit the history here of a company that has not been able to grow shareholder value, so you know, I just urge the Board to have a sense of urgency and taking steps to unlock shareholder value and pursuing any alternatives that would – to facilitate that in a period of time that doesn’t take too much more time. Thank you.

Kieran O’Sullivan

Brad, I’d just like to make a comment for you here. And obviously, I’m in a steep learning curve at the moment, but the strategic positioning of the business is really important for me as well as driving profitable growth. I think when you look at the Component and Sensor business, and just keep in mind, even in the automotive markets, the trends are around the increasing sales and safety and emissions reductions. We have been in the emissions area with the fuel economy driving that part of it with our sensors and actuators. But also, as we move forward now, we get into the safety area with the D&R acquisition and that gives us another segment to play in and grow the business going forward. And if you look at the hard disk drives, I believe what we’re doing there with Piezo can have applications as we drive toward the cloud, integrate our volume, but also in other markets that we participate in today and within the future as well.

So I’ll certainly get back to you in the next earnings call and you’ll get some progress reports from me.

Brad Evans – Heartland Advisors

I think a lot of investors who have been watching the story develop would have expected – would have all believed that 2013 was essentially an inflection point for you, especially on the Components and Sensor side. I would have to be honest with you that the guidance that – notwithstanding the macro, which obviously is turbulent, so I know you can’t control that, but the guidance that was given for 2013, hopefully it’s conservative, but it is disappointing in my eyes relative to the investment that we’re making and hopefully, you know, the payoff that was hopefully coming for shareholders in 2013 and beyond. So I just put that comment on the table as well. Thanks a lot.

Kieran O’Sullivan

Thanks, Brad.

Operator

(Operator Instructions). We have a follow-up for the line of John Franzreb with Sidoti and Company. Please go ahead.

John Franzreb - Sidoti & Company

Just a little bit about D&R, can you talk a little bit about the company’s historical growth rates, the competitive landscape, how you envision growing up business going forward?

Vinod M. Khilnani

John, as Kieran pointed out, the product is focused towards the safety product, which is a growing component in a vehicle. So we see that as a growth avenue. The other thing we liked about that is D&R has a strong presence with the automotive OEMs in Detroit, and as you know, our – we have a strong presence – a stronger presence with a Japanese OEM and somewhat limited presence with the European and Detroit OEMs. So this gives us an opportunity to cross sell products, CTS product, to the Detroit OEMs and then take the D&R product more to the Japanese OEMs where we have a better presence.

So a combination of customer mix there, which is very interesting to us and the fact that D&R had certain opportunities they couldn’t fully take advantage of because they did not have an Asia footprint, and CTS’s Asia footprint should help us cross sell their product into our markets over there. So those were some of the synergistic key things which draw us towards this acquisition.

John Franzreb - Sidoti & Company

Okay. And what was the historical growth rate of the business?

Vinod M. Khilnani

Historical growth rate were, I believe, Mitch, correct me if I’m wrong, was single digit, mid-to-high single-digit kind of a number. We can cycle back to you with some more exact information.

John Franzreb - Sidoti & Company

Okay, and who the key competitors?

Vinod M. Khilnani

To some extent in the past, CTS may have been a competitor of their product. Other than that, I’m not – there may be some European, Bourns. Kieran is more familiar with that actually. Bourns, a European company is a competitor. Nothing major, but those are the two competitors I’m aware of.

John Franzreb - Sidoti & Company

And one last question, Tom. Which did you say the taxes were going to be in the first quarter?

Thomas A. Kroll

John, in the first quarter, like I said, the full year, John, is going to be in the 25% range. That first quarter, just give me a minute. There will be that – a discrete item and that’s going to be a couple million dollars. So can we cycle back to him? Yeah, I can cycle back to you, John, but it’s – the full year is going to be about 25% and that will include that. So obviously, first quarter will come down and I can give you the exact amount later.

John Franzreb - Sidoti & Company

Okay. That would be great. Thank you, guys.

Operator

Gentlemen, nobody else is queueing up at this time.

Mitchell J. Walorski

Okay. I would like to remind our listeners that a replay of this conference call will be available from 1:30 p.m. Eastern Standard Time today through 11:59 p.m. on Tuesday, February 5th. The telephone number for the replay is 800-475-6701 or 320-365-3844 if calling from outside the U.S.

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