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CTS Corporation (NYSE:CTS)

Q1 2013 Earnings Call

April 24, 2013 11:00 am ET

Executives

Mitchell J. Walorski – Director of Investor Relations

Kieran M. O'Sullivan – President, Chief Executive Officer and Director

Thomas A. Kroll – Vice President and Chief Financial Officer

Analysts

John E. Franzreb – Sidoti & Company

Hendi Susanto – Gabelli & Company, Inc.

Paul S. Szczygiel – Columbia Management Investment Advisers LLC

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the CTS Corporation Q1 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session with instructions being given at that time. (Operator Instructions) And as a reminder, this conference is being recorded.

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

Mitchell J. Walorski

Thank you, John. I'm Mitch Walorski, Director of Investor Relations, and I will host the CTS Corporation first quarter 2013 earnings conference call. Thank you for joining us today. Participating from the company today are Kieran O’Sullivan, President and Chief Executive Officer; and Tom Kroll, Vice President and Chief Financial Officer.

Before beginning the business discussions, I would to remind our listeners that the conference call contains forward-looking statements. These statements are subject to 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 were 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 Kieran.

Kieran M. O'Sullivan

Thanks Mitch. Good morning everyone and welcome. Last evening we released our first quarter financial results. Sales were $149.5 million, 2% higher than the first quarter of 2012. While our total sales increased very modestly, we were very pleased with our mass growth in the component and sensor segment, a 28% year-over-year increase. This was offset by a 27% of timed in EMS sales reflecting soft economic conditions especially in defense markets.

Also our decision to close 2 EMS locations last year impacted our EMS revenues. New products in the automotive sensors and electronic components combined with our acquisition of D&R Technology, helps drive sales higher year-over-year. The integration of D&R is progressing on schedule and we are very pleased with the opportunities this new team brings to CTS in highly engineered automotive sensors for safety and chassis management applications.

We are also pleased with our improvement in gross margin driven by our components and sensor sales. The increased production rate of our smart actuator product was realized in the first quarter. Piezoceramic components for disk drive applications, our other significant new products continues to contribute to solid year-over-year growth, as a large percentage of disk drives in the market are being switched to dual-stage actuation.

Our components and sensor segment sales in the first quarter were $98.1 million up 28.3% year-over-year. Within the segment, automotive sensor sales of $65.2 million in the first quarter were up 36.4% year-over-year despite continued weakness in Europe and to a lesser extent, the impact of the Japan and China island dispute.

Please note that the first quarter 2013 global automotive production of light vehicles declined 1.4% year-over-year, including in North America which was down 0.7%, Europe which was down 8.7%, and Asia was up 2.9%.

Continuing with our components and sensor segment, electronic components sales up $32.9 million in the first quarter of 2013 were up 14.8% year-over-year, driven primarily by increasing new piezoceramic product sales for disk drives.

As I mentioned, EMS sales declined due to weak order rates primarily in defense and aerospace, as well as industrial markets which were lower by $14.3 million and $7.1 million respectively, reflecting the general EMS industry decline and lower government spending, especially in U.S. markets. It also included the impact of lower sales from our decision to exit smaller unprofitable EMS accounts in the U.K and China. However, sales in communication markets were up year-over-year by $3.7 million.

On the new business front, in the first quarter CTS secured new business valued at $54 million. In automotive products, we won eight new pedal module programs for Asian automotive manufacturers.

We also won two sensor programs for the Ctrack and light high position sensors for a U.S. automotive manufacturer. The total value of these awards amounts to $36.5 million.

In electronic components we won five new programs with approximately $10 million of future revenues, primarily in the piezoceramic products for new industrial applications and defense applications.

CTS also acquired a new customer for a new product and open road throttling applications with our RF filter product. In the EMS, we won a second contract from a major medical orthopedic firm to provide printed circuit board assemblies used in new orthopedic surgical applications valued at approximately $6 million over the next three years.

In the first quarter of 2013, we completed the restructuring plan started in the fourth quarter, which primarily related to closing our EMS China operation. This action combined with the UK operation closure a year ago will streamline and simplify our global footprint going forward.

We continue to look for opportunities to sell or sublease the freed up real estate and are committed to lowering our operating expenses and the asset base going forward.

Sales from new programs and the D&R acquisition in the components and sensor segment will benefit the earnings in the coming quarters. As a result, management is maintaining its full year 2013 guidance, though at the low end of the sales increase of 12% to 15% over 2012.

However, this is still a watch item for me. We are still on track for this year’s profitability despite softness in the EMS business and the mixed global economic condition. Therefore, we expect full year 2013 adjusted earnings per share will remain unchanged between $0.73 and $0.78 including $0.05 per share of CEO transition cost, but it excludes $0.02 per share of restructuring and related charges.

Finally, but very importantly for me and for the year ahead, I have the following priorities to charter future direction of our company. Building the leadership strength for our global organization, a complete strategic analysis of our business, which has already begun, simplify our business model while emphasizing quality, products, margins and management of our operating expenses including a lean corporate culture.

Optimize our cost reduction programs and capital utilization to maximize our efficiencies and competitiveness. More details will be available on this in the next 60 days to 90 days. And finally, continue to build on our values by the lining of focus and culture with an emphasis on performance to maximize shareholder return.

I will now turn the call over to Tom Kroll. Tom?

Thomas A. Kroll

Thank you Kieran and welcome everyone. As Kieran mentioned, our first quarter 2013 sales were $149.5 million, an increase of $2.5 million from the prior year and an increase of $11.2 million from the prior quarter. Our gross margins were 20.9% versus 15% last year, or a 5.9 percentage point improvement. There were three drivers making up this 5.9 percentage point increase to our gross margin.

First, the Components and Sensors segment sales mix grew to 56% of total sales in the first quarter of 2013 versus 52% in the first quarter of 2012. This segment sales mix shipped had a positive impact on gross margins of approximately 2.5 percentage points. Secondly, within the EMS business segment gross margins improved due to the 2012 restructuring action and other ongoing cost containment action. Finally, the first quarter 2012 included incremental Thailand flood related expenses which obviously lowered the margins.

Our selling, general and administrative expenses were $21.4 million versus $19.4 million last year. The increase from last year was primarily due to the incremental SG&A from the R&D acquisition including $1 million of higher amortization expense related to the purchase price. Please note that the D&R purchase price amortization is expected to decrease by approximately $400,000 to about $0.6 million in each of the remaining quarter’s this year.

The first quarter 2013 R&D expenses were $6.3 million, up slightly from the $6.1 million last year. As a percentage of components and sensor segment sales, the R&D was 6.4% in the first quarter 2013 compared to 8% in the same period last year reflecting the increase in the segment sales. The restructuring and related charges were $822,000 in the first quarter 2013, thus completing the restructuring plan initiated in the fourth quarter 2012 and it does include the final cost for the closure of our EMS operations in China. Of this $822,000 amount, $559,000 is reflected on the restructuring line on the P&L and the remaining $264,000 is included in cost of goods sold.

Our first quarter 2013 interest, currency and other expenses were $0.2 million unfavorable compared to last year by about $0.6 million due to increased interest expense on a higher debt level and less favorable currency gains.

The first quarter overall effective tax rate was a negative 29.4%. This rate reflects 2012 tax benefits of approximately $1.6 million or $0.05 per share for two retroactive U.S. tax benefits signed into law in early January 2013 and a China high-technology incentive tax credit, both of these 2012 benefits were discussed during the January conference call as they were originally expected in the fourth quarter 2012. These tax benefit items did occur as anticipated, however at a very slightly lower amount of $0.05 compared to the $0.06 discussed in January. On a full year basis, we continue to expect our effective tax rate to be approximately 25%.

First quarter 2013 net earnings were $3.6 million or $0.10 per diluted share compared to net earnings of $2.3 million or $0.07 per diluted share in the same period last year. Included in the first quarter 2013 earnings was a $0.02 per share restructuring charge, and a $0.02 per share CEO transition cost. Excluding these items first quarter 2013 adjusted earnings per share were $0.14.

Now let's look at the balance sheet. Cash and cash equivalents were $109.4 million versus $109.6 million at year-end. Debt was $164 million versus $153 million at year-end 2012. This increase was due to normal working capital requirements. We finished the quarter with a debt-to-capitalization ratio of 37.8% compared to 36.4% at year end.

From a working capital perspective, our accounts receivable days were 57 days versus 51 days a year ago. While we continue to closely monitor our collection terms, our DSO levels are expected to be slightly higher in 2013 compared to 2012. Our accounts payable days were 63 days versus 67 days last year. Both our DSO and DPO now include the D&R acquisition.

Our inventory decreased $10 million from the first quarter last year even with the inventory included from the D&R acquisition. Inventory turns improved to 5.5 from 5.3 last year. Our management team will continue to focus with even greater emphasis on improving these metrics.

Our controllable working capital that we define as these three accounts; receivables, payables and inventory was 18% of annualized sales and improved slightly from last years 18.3%.

Our first quarter 2013 cash flow from operations was a usage of $3.5 million versus a usage of $4.1 million in the same period last year. First quarter 2013 capital expenditures were $4.7 million versus $4.4 million in 2012. Our capital expenditures as a percent of sales were 3.1% approximately at our target level.

Our first quarter free cash flow, which was defined as cash flow from operations less capital expenditures was usage of $8.2 million, approximately at last year’s level. We continue to expect our full year capital expenditures to be approximately 3% of sales.

We also continued our stock buyback activity during the first quarter of 2013 repurchasing approximately 105,000 shares for $1 million at an average price $9.95. Approximately 363,000 shares remain in our 1 million share buyback authorization program.

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

Question-and-Answer Session

Operator

(Operator Instructions) And we do have a question from the line of John Franzreb from Sidoti & Company. Your line is open.

John E. Franzreb – Sidoti & Company

Kieran, Tom, how you’re doing?

Kieran M. O'Sullivan

Yes. Thank you.

Thomas A. Kroll

Good morning.

John E. Franzreb – Sidoti & Company

Actually I want to start off with actually EMS side of the business. The sequential drop in revenues, you kind of highlighted exiting the businesses in the aerospace and defense. Should we kind of reset what we think the revenue profile of this business is at this lower level or you expect to catch perfect in order for you to hit that that revenue target you have for the full year?

Thomas A. Kroll

Yeah, I would say there is few points to consider here. First of all, we expect continued headwinds on the top line and the first half of the year with improvement in the second half. Just a few other points to go with that would be we’ve lowered the breakeven point of the business, but our actions that were taken some $5 million. We’ve got cost controls, management of the usual things in place and what we’re working to do is to get it back to the traditional earnings levels by fourth quarter of this year. So it’s pretty challenging at the moment, but we’re working our way through it.

John E. Franzreb – Sidoti & Company

Okay. And the gross margin profile for the company, is it fair to assume that the new product introductions are having the biggest impact they’re caring or is it something else that’s driving it?

Kieran M. O'Sullivan

I think Tom can comment as well here, but overall I think you’ve seen the components and sensors where we have the better margin mix. And obviously new products are helping that. I think we are very clear in the last call as well that as we ramp with some of the new products we have margin improvements to do and they are being worked as we speak and improving but more work to do.

Thomas A. Kroll

And I really don’t have anything to add to that.

John E. Franzreb – Sidoti & Company

Okay. And is it fair to assume you have highlighted the $54 million in new product wins, would the gross margin profile of those new wins be above the corporate average?

Kieran M. O'Sullivan

We see in line with components and sensors.

John E. Franzreb – Sidoti & Company

Okay. And one last question, the R&D number was up rather substantially. Tom you highlighted the SG&A reflecting the D&R acquisition but you did not call up the same for the R&D, what’s going on with the R&D line?

Thomas A. Kroll

Well the R&D it was up about $150,000 and that relative to last year and that does reflect some D&R spending also.

John E. Franzreb – Sidoti & Company

Okay, is there anything else that we should cognizant off, is your trend in the same levels or was that similar to last year or is it going to drift down again?

Thomas A. Kroll

John, I think you can expect that level for pretty much the rest of the year. So it a little bit higher than last year, but again it does include the D&R portion. And also in Q4, you may remember we highlighted several NRE reimbursements that we did not see in Q1, 2013. But from a trending standpoint the 6.3 run rate is pretty good.

John E. Franzreb – Sidoti & Company

Okay. I will get back to you guys. Thank you.

Operator

We will now go to the line of Hendi Susanto from Gabelli. Please go ahead.

Hendi Susanto – Gabelli & Company, Inc.

Good morning.

Kieran O’Sullivan

Good morning Hendi.

Thomas A. Kroll

Good morning.

Hendi Susanto – Gabelli & Company, Inc.

Yes, first question, what are your implied revenue growth rates for EMS and components and sensors for 2013 now?

Kieran O’Sullivan

EMS, let me start first of all with components and sensors, and we’ve been tracking around…

Thomas A. Kroll

28% - 30%.

Kieran O’Sullivan

28% - 30%.

Hendi Susanto – Gabelli & Company, Inc.

Okay.

Thomas A. Kroll

And Hendi just a comment on the EMS side, as we had mentioned in the January conference call, at that time we didn’t expect EMS to grow relative to 2013 and based on Kieran’s comments, we now realize we will be below 2012.

Hendi Susanto – Gabelli & Company, Inc.

Okay. And then when you said below, anymore clarifications, whether it’s like single digit or double digit?

Thomas A. Kroll

It’s probably going to be in that high single digit range.

Hendi Susanto – Gabelli & Company, Inc.

Okay. And then…

Kieran O’Sullivan

That’s something Hendi as you know we really did not guide on.

Hendi Susanto – Gabelli & Company, Inc.

Okay, yeah, sure. Kieran, would you remind us what the composition of EMS surface is in terms of end markets and I would like to hear your insight also on EMS sales in medical and communication in the first quarter?

Kieran O’Sullivan

So the exact foresight in terms of percentages, Hendi, I don’t have in front of me. But the bigger parts are industrial and the communication side of it has been pretty strong and medical, smaller but growing and defense obviously is the one we were hurting quite a bit at the moment but if you look at it, I would say industrial about 36%, defense 25%, but hurting in that area, communication is 28% and medical 11%.

Hendi Susanto – Gabelli & Company, Inc.

Okay. And then you mentioned that CTS will explore potential sales or sell lease of our real estate, could you share how much real estate as such that potentially can be leased or sold?

Kieran M. O'Sullivan

Okay, you are referring back to the – when you talk about selling the company’s assets, buildings that we may have exited due to the closure of facilities correct?

Hendi Susanto – Gabelli & Company, Inc.

Yes.

Kieran M. O'Sullivan

Yes, so I mean, we’re – it’s still in work in progress. To be very honest with you, I put it on at the target for myself and for the team here we’ve got your 4 or 5 assets out there that I’d like to move on. Given the current climate out there I would be real optimistic if we could secure some progress on two this year.

Hendi Susanto – Gabelli & Company, Inc.

Two, okay. And then you had smart actuator sales of $7.3 million in Q1 and you have a target of $20 million for the year. So what does sales of smart actuator may look like in Q2, Q3 and Q4. Basically I would like to look at whether you’re still keeping that $20 million target or we potentially may see up sight as well?

Kieran M. O'Sullivan

Yeah, you’re probably factoring in a little up sight there but also remember we got some softness in EMS. So a few things happening number one, the run rate would imply 28, we really don’t see 28, we see something in the range of 22 to 24 and just look at comments at the earning report, they had some softness. We already believe we factored that in pretty well, so about the 20, run 22 plus little bit is where we would see it.

Hendi Susanto – Gabelli & Company, Inc.

Okay yes, and D&R sales was higher than my expectation, it was at $12.7 million, considering the D&R had like $15 million annual run rate, do you see some upside as well considering that you have cross sell opportunities?

Kieran M. O'Sullivan

No, it’s on track exactly where we expected it to be.

Hendi Susanto – Gabelli & Company, Inc.

On track, okay. So you’re still expecting $15 million for the year?

Kieran M. O'Sullivan

Absolutely.

Hendi Susanto – Gabelli & Company, Inc.

Yeah. And then Tom, you mentioned that effective tax rate will be 25% for 2013.

Thomas A. Kroll

Yes.

Hendi Susanto – Gabelli & Company, Inc.

How should we model tax rate for the rest of 2013?

Thomas A. Kroll

I think Hendi at that rate it will be level essentially for Q2 through Q4.

Hendi Susanto – Gabelli & Company, Inc.

Like 25% from Q2 to Q4?

Thomas A. Kroll

Yes.

Hendi Susanto – Gabelli & Company, Inc.

Okay, got it.

Thomas A. Kroll

And Hendi, the thing I will just point out, you have to remember that the Q1 tax rate was 25% roughly, but it did include that one-time $1.6 million benefit that I talked about, so you have to factor that into.

Hendi Susanto – Gabelli & Company, Inc.

Okay, got it. Yeah, thank you. Let me go back to the line. Thank you.

Thomas A. Kroll

Thank you.

Operator

(Operator Instructions) And we will go back to the line of Hendi Susanto with Gabelli. Your line is open.

Hendi Susanto – Gabelli & Company, Inc.

Yes. Kieran, I would like to request like further clarification on the press release when it said that like, you would like to work to simplify business and then optimize capital utilization?

Kieran M. O'Sullivan

Yes, so two things there. As I am immersing myself in each of the locations and the businesses, different parts of the business play in different markets and that drives different products and services. So in some areas we’re a mix of products and some areas with service and how we align, so I am trying to simplify that and see what the right identity is for us going forward and so that’s a question. On the second part of your question when it comes to assets utilization, I think I said in my comments that you’d get more details in 60 days to 90 days, but just to be very clear as I look at the global footprint, I believe we can optimize it and you will be getting some details from me on that.

Hendi Susanto – Gabelli & Company, Inc.

Okay, thank you.

Operator

All right. And now we will go to the line of Paul Szczygiel from Columbia Management. Your line is open.

Paul S. Szczygiel – Columbia Management Investment Advisers LLC

Hey guys, what gives you confidence that the second half revenues will be better for EMS than the first half? Is it in the backlog or in the pipeline or?

Kieran M. O'Sullivan

You know it’s a pretty dynamic business overall. I would say Paul, when I look at this business there are two things that really drive the business. One is the strength of management’s relationships and the sales team’s relationship with the customers and secondly internally driving that operational excellence, cadence right across the organizations. Those are two things that make that industry move. And what we’ve been doing is strengthening that inter phase with the customer, we have more work to do there, we have got a good pipeline, but I am looking to make sure we get some good prove points that I need as well.

Paul S. Szczygiel – Columbia Management Investment Advisers LLC

Thank you.

Operator

(Operator Instructions) And nothing more from the phone lines.

Mitchell J. Walorski

All right. I would like to remind our listeners that a replay of the conference call will be available from 1:30 p.m. Eastern Daylight time today through 11:59 p.m. on Wednesday, May 1, 2013. The telephone number for the replay is 800-475-6701 or 320-365-3844, if calling from outside the U.S., the access code is 288166. Thank you for joining us today.

Operator

And ladies and gentlemen, that does conclude your conference for today. Thank you for your participation and using AT&T Executive Teleconference. You may now disconnect.

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