CTS Corporation Q1 2010 Earnings Call Transcript

May. 1.10 | About: CTS Corporation (CTS)

CTS Corporation (NYSE:CTS)

Q1 2010 Earnings Call Transcript

April 28, 2010 11:00 am ET

Executives

Mitch Walorski – Director, Planning and IR

Vinod Khilnani – Chairman, President and CEO

Donna Belusar – SVP and CFO

Analysts

John Franzreb – Sidoti & Company

Hendi Susanto – Gabelli & Company

Brad Evans – Heartland

Jim McIlree – Neuberger Berman

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the CTS Corporation quarter one 2010 earnings call. At this time, all participants are in a listen-only mode. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Mr. Mitch Walorski, please go ahead.

Mitch Walorski

Thank you, Christina. I am Mitch Walorski, Director of Investor Relations and I will host the CTS Corporation first quarter 2010 earnings conference call. Thank you for joining us today.

Participating from the company today are Vinod Khilnani, Chairman of the Board and CEO and Donna Belusar, Senior Vice President and Chief Financial Officer. Before beginning the business discussion, I would like to remind our listeners that the conference call contains forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements.

Additional information regarding these risks and uncertainties 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 our Chairman and CEO, Vinod Khilnani.

Vinod Khilnani

Thanks, Mitch and good morning, everyone. Last evening, we released our first-quarter financial results for 2010. I am pleased to report that we recorded a stronger-than-expected first quarter with earnings and free cash flow both exceeding expectations.

Our Components and Sensors segment experienced an across the board surge in demand, with sales increasing 74% year over year. EMS sales on the other hand were 26% lower due to weaker demand and timing of certain medical and defense projects. As a result, our sales mix swung in favor of higher-margin Components and Sensors segment, with its sales increasing to 57% of total CTS sales. This mix shift materially benefited from a gross margin percent which improved by 680 basis points year-over-year from a low of 16.8% in the first quarter of last year to one of our highest gross margins up 23.6% in the first quarter of 2010.

We continue to manage our balance sheet in an effective manner with excellent working capital performance. Inventory turns, accounts receivable days and accounts payable days were all better than first-quarter 2009. Overall, our first-quarter results confirmed the benefit of our increasingly diversified business model, global customer base and competitive cost structure.

Sales in the first quarter of 2010 at $129.4 million were up 10% from the first quarter of 2009. On a segment basis, Components and Sensors segment sales were $73.4 million, up 74% from the first quarter of 2009.

Within that segment, sales of automotive sensors more than doubled from the first quarter 2009 levels. Year-over-year light vehicle production volumes in the first quarter of 2010 were up 70% in North America, 28% in Western Europe and 35% in China, reflecting increased vehicle sales and inventory replenishment.

A much larger sales increase in CTS automotive sensors by 103% on the other hand, reflected new product launches and increased market share. Increase in automotive sensor sales was broad-based over our whole product range from pedals and actuators to small engine CPF, exhaust, gas, recirculation sensor products. Our sensor and actuator product sales in Asia Pacific region more than doubled from $7.2 million in the first quarter of 2009 to $16.2 million in the first quarter of 2010.

Ramp-up in new business allowed us to increase our market share and grow our sales much faster than the overall improvement in the automotive sales and production volumes. Continuing with the Component and Sensors segment, sales of electronic components represented 20% of our total sales in the first quarter of 2010. Sales of electronic components were up a healthy 37% over Q1 2009 as we again saw a broad-based recovery in our served markets.

Wireless infrastructure sales were up 16%, piezoceramic sales were up a strong 83% and sales to our medical, ultrasound, commercial inkjet printers and hydrophone applications together more than doubled from previous years. Sales of electronics and electric components through the distribution channel of $6.3 million were up 43% year-over-year and 23% sequentially.

We also continue to record infrastructure design wins at a healthy clip with 51 new wins in the first quarter of 2010. Strength in our Components and Sensors business overall was reflective of our diversification and increased market share, driven by new customers and innovative products.

We have continued to increase our focus on research and development activities to further strengthen our new product offering. As a result, we were granted five new patents in the first quarter 2010. This is in addition to a strong 2009 in which we were granted 21 new patents. Looking at the pipeline for new future patents, we filed 19 new patent applications in the first quarter of 2010 in addition to a record 60 new patent application filings in 2009.

Our EMS segment sales represented only 43% of our total CTS sales, instead of a normal 55 to 58% of our total sales. EMS sales in the first quarter of 2010 at $56 million were down 17.5% versus the first quarter of 2009 if we exclude the discontinuance of the HP business.

Communication sales were up from last year, however, medical and defense were lower year-over-year, primarily due to timing of some programs and delays in certain product launches. We expect to see a bounce back in EMS sales in the second half of 2010 with full-year EMS and Components and Sensors segment split around 50% each.

On the business development front, we won three new programs in the automotive sensor and actuator arena and eight new customers in the EMS business. The most noteworthy recent new business in electronic components was a high-volume program for piezo-electric, micro-actuator for data storage devices. This development and production program is expected to double over 2009 piezoceramic sales of $10 million per year to roughly $20 million per year.

Our order board for the second quarter is staying strong and some of our component and sensors third market are beginning to give indications of a possible V-shaped recovery. Overall, we are increasingly optimistic about continued improvements in the economic environment for the rest of 2010. As a result, we are increasing our guidance for sales growth and earnings per share.

Assuming no significant economic turmoil, we expect our full-year 2010 sales to grow 12 to 20% year-over-year. Full year 2010, diluted earnings per share are now estimated in the range of $0.52 to $0.60 versus the previous range of $0.45 to $0.53.

And now, I will turn the meeting over to Donna Belusar, our CFO, who will provide further details regarding our financial results. Donna?

Donna Belusar

Thank you, Vinod and welcome to all of you on the call. I am pleased to present you the highlights of our 2010 first-quarter financial results.

We are starting the year on a positive note. With our first-quarter 2010 results showing improved sales revenue, strong earnings, excellent working capital performance and positive free cash flow compared to first quarter 2009. Total sales for the first quarter 2010 came in at $129.4 million, an increase of $11.3 million or 9.5% over first-quarter 2009 sales of $118.1 million.

The year-over-year increase in sales was driven by the broad product line sales growth in the Components and Sensors segment, which also had improved sales sequentially from fourth quarter 2009 sales levels. Our Components and Sensors sales segments were $73.4 million, an increase of 73.6% from the same period last year and up 12.2% from the prior quarter.

EMS sales were $56 million, down 26.2% from the first quarter 2009 and down 18.2% from the prior quarter.

With higher sales levels in Components and Sensors segment, our overall segment mix shifted to 56.8% of total sales, being in the higher-margin Components and Sensors segment. This is up from 35.8% in the first quarter of last year and up from 48.9% in the fourth quarter of 2009.

The shift in segment mix and an improved cost structure contributed to an improved total gross profit margin as a percentage of sales. The first-quarter 2010 gross profit margin was the highest since 2001. Gross profit margin for the first quarter was 23.6% of sales, up from 23.1% in the fourth quarter 2009 and improved from 15.8% in the first quarter of 2009.

Roughly, two thirds of the year-over-year gross profit margin improvement can be attributed to the better segment mix from the higher-level Components and Sensors sales. The remaining one third of the gross profit margin improvement is from cost structure and other improvements.

The sequential improvement in gross margin percentage from the fourth quarter is primarily attributed to the better segment mix. As we proceed through 2010, we anticipate EMS sales rebounding from the current levels in part due to new program launches, thereby the segment mix returning to the more balanced sales segment mix. This will naturally bring our overall gross margin to a more normalized level compared to today's nine-year high.

First quarter 2010 had $19.5 million of selling, general and administrative expenses or 15.1% of sales compared to 14.1% of sales in the first quarter 2009 and 14.0% of sales in the prior quarter. The year-over-year increase reflects increased spending to support higher sales as well a reinstatement of certain compensation related items that were temporarily suspended during the first quarter 2009 due to the recessionary economic environment, as well the impact of the higher mix of Components and Sensors.

There was no material impact on our financial performance related to the Toyota recall during the first quarter. Research and development or R&D expenses were $4.6 million, approximately 3.5% of sales compared to an average R&D investment of 2.8% of sales for 2009. The increase reflects our continuing investment in our growth initiatives in Components and Sensor products as well as a reinstatement of certain compensation related items just mentioned above.

Total other expenses which include items such as interest expense, interest income and currency translation gain or loss and other non-operational expenses or gains were $0.7 million compared to $1.1 million in the first quarter 2009 and compared to $0.4 million from fourth quarter 2009. The year-over-year decrease in total other expenses is primarily attributed to a decreased interest expense on a lower overall debt level.

The effective tax rate is approximately 22% which is within range of our previous guidance of 21 to 23%. Net earnings were $4.4 million or $0.13 per diluted share.

As you recall in 2009, we did have a loss in the first quarter with adjusted earnings per share of a negative $0.03 per share excluding non-cash, goodwill impairment and restructuring. We reported positive earnings in the remaining sequential quarters in 2009.

The first quarter 2010 continues with the trend of positive earnings driven by top-line sales growth compared to 2009, while capturing the reinstatement of certain temporary compensation related actions necessitated by the 2009 deteriorating global environment.

I would now like to discuss CTS's balance sheet which reflects our continued strength in our global cash balances, a net cash to debt position, tightly managed controllable working capital and free cash flow. At the end of the first quarter 2010, we had $58.8 million of cash, up $7.6 million from year-end 2009 and up $14.1 million from the first quarter 2009.

Our total long-term debt was $56 million which is up slightly from year-end but is expected due to normal working capital needs. This puts us in a favorable net cash to debt position. Our total debt to capital is 18.2% compared to 26.2% in the same period last year.

In the first quarter, we generated $5.3 million of cash flow from operations with capital expenditures of $1.5 million. Free cash flow which is cash from operations less capital expenditures was $3.8 million for the first quarter 2010. We expect to continue to generate positive free cash flow in 2010 in the range of 25 to $30 million. This is up 20% to 25% from our previous guidance of 20 to $25 million.

Controllable working capital as a percentage of annualized sales which includes accounts receivable plus inventory, plus accounts payable remains in line with our expectations coming in at 14.4%. This is up slightly from year end of 13.8%, driven by the slight growth in inventory and accounts receivable and partially offset by accounts payable requirements to support the anticipated sales growth. CTS's financial position remains strong with a solid balance sheet, continued investment in research and development, capital expenditures to support our growth and positive free cash flow.

With that, I would now like to open the call for questions and I thank you very much. Christina?

Question-and-Answer Session

Operator

(Operator Instructions) And we'll first go to the line of John Franzreb with Sidoti & Co.

John Franzreb – Sidoti & Company

Good morning, everyone.

Donna Belusar

Good morning, John.

John Franzreb – Sidoti & Company

First question is regarding the EMS segment. If I heard you correctly, Vinod, it sounds like you think that's going to be a second half event on that recovery on the deferred programs, not a second-quarter event. Could you talk a little bit about that and why that is the case?

Vinod Khilnani

I think although I did say that the sales would recover nicely in the second half, I would like to say that I expect the second-quarter sales to be better than first quarter. So I think you will see EMS performance to improve quarter-over-quarter in the rest of the three quarters.

John Franzreb – Sidoti & Company

I was certainly surprised that the business was operating at a loss for the quarter. Would it be fair to assume we will be back to at least breakeven by Q2?

Vinod Khilnani

Yeah. I think that's what my expectation. I think first quarter was fairly unusual. On the top line point of view, we had timing of programs affecting us and then the programs which were being pushed out of timing were primarily in defense and medical areas. As you know, those are generally slightly higher margin business.

So the mix was also not favorable in the first quarter and combined with those two, we also had some one-time expenses, which affected us in the first quarter in EMS. So clearly EMS results were below my personal expectations and we should see them improve as we move forward.

John Franzreb – Sidoti & Company

Okay. Regarding the component sensor side of the business, it seems like everything is doing reasonably well. What I'm curious about is your thoughts about the sustainability of the trends in that market. In your view, would you look at the electronic component side as more favorable or would your view be automotive side as more favorable going forward?

Vinod Khilnani

They both are looking very good. And we are increasingly more and more optimistic about these businesses continuing to perform very well. Clearly, they performed better than our expectations in the first quarter. We were pleasantly surprised by the strength in both of those areas and it was pretty much across the board. We saw strength across the board in the electronics families and we also saw strength across the board geographically.

So we saw very positive results and yes, to some extent we continue to be a little worried that would this be sustainable. But today, I'm more optimistic about the fact that it is going to be sustainable and at least the incoming order rate as we came out of the first quarter continued to stay strong. Our book-to-bill ratio is more than one, as we are continuing, indicating that the strength should continue at least in the second quarter. And frankly, I am optimistic that it will carry over in the second half of the year.

John Franzreb – Sidoti & Company

Okay. One last question. Regarding the cost side of the equation here, when I'm looking at the $19.5 and $4.6 million in operating expenses. Should I kind of view that as a run rate going forward for the balance of the year? Particularly I guess the biggest jump that is noticeable is in the R&D side. Or should I take it my expectations on the R&D side if I view the SG&A level as something we should be kind of viewing as a baseline going forward?

Vinod Khilnani

R&D expenses, I think it is by design and by strategy as indicated by very positive outcomes from the patent application and grants we are getting, which on the one side is a very defensive activity because it makes the competition – makes it a lot more difficult for the competition to come and offer product offerings.

On the other hand, it is very critical for us to continue to grow our Component and Sensor business very strongly. As you know, we have said in our investor presentations that we will grow that business double-digit over the next several years and new program wins – I think it's all together. So I'm actually pleased to see R&D expenses driving the company in the direction we want the company to go.

SG&A on the other hand, I expect those numbers to stay flat or maybe slightly down but clearly as a percent of sales, I expect those numbers to improve.

John Franzreb – Sidoti & Company

Okay. Thanks a lot, guys.

Operator

We'll next go to line of Hendi Susanto. Please state your company name.

Hendi Susanto – Gabelli & Company

Good morning all, Gabelli & Company. and congratulations on strong sales of Components and Sensors.

Vinod Khilnani

Thanks, Hendi.

Donna Belusar

Thank you, Hendi.

Hendi Susanto – Gabelli & Company

My first question is how much is your sales to HP this quarter?

Vinod Khilnani

Good question. The sales to HP were minimal, less than $1 million. But the comparable number in the first quarter of 2009 was approximately $8 million.

Hendi Susanto – Gabelli & Company

Okay.

Vinod Khilnani

So it did hurt us from a year-over-year comparison. But going forward it will not.

Hendi Susanto – Gabelli & Company

I see. And then you have – you mentioned like expecting growth opportunity in micro-actuators for data storage. And what kind of data storage do you refer to? I wonder whether they are hard disk drive, network storage or both?

Vinod Khilnani

They are what I am – as they are described to me, they are high density disk drive applications. It is a new generation of disk drive actuation for computer markets and it takes us to brand new customers. We have never sold to these customers in the past. It is what I call the triple head. It's a brand new customer, it's a brand new market and it's a brand new product. So we really like that kind of new business win.

Hendi Susanto – Gabelli & Company

Okay. And how do you see order intake in the other components market going to shape up this year? Similarly, would you also share some insight on the diesel engine market?

Vinod Khilnani

On the automotive side, Hendi, the visibility we have is based on CSM and all these data reports, which are available to us. And those indicate that at least for the next couple of quarters, it's looking fairly strong and those things change, however. What we are feeling more comfortable with to say is that whatever the market data will be, we expect CTS sales to do better than that because of new products and new customers and increased market share. So we should continue to perform better than the general increase in automotive production and automotive sales globally because of our increased penetration.

Hendi Susanto – Gabelli & Company

Okay

Vinod Khilnani

On the diesel engine side, we currently aren't shipping any product in the diesel engine side. The new products we are developing and have one business, the earliest we will start shipping the product will be probably very late in 2011. But essentially you will begin to see those numbers in 2012. And they will be on new engines which are being launched to meet the higher emissions standards.

Hendi Susanto – Gabelli & Company

Okay. And then you have four smart actuator awards, would you please give us updates on the product development and whether prototype productions? Are still on target with respect to the timing?

Vinod Khilnani

Yeah. I think the numbers we shared with you last time when we were in New York indicated that we expect that brand new product and brand new market sales in 2015 time, should go up to $60 million from zero today. And out of that, we estimated that we roughly have one already and booked half of it. So the business we have booked already gives us half of the projected sales in 2013, '14 and '15 timeframe.

Hendi Susanto – Gabelli & Company

Okay. Thank you.

Operator

We'll next go to the line of Brad Evans with Heartland.

Brad Evans – Heartland

Good morning, everybody.

Vinod Khilnani

Good morning, Brad.

Donna Belusar

Good morning, Brad.

Brad Evans – Heartland

Congratulations on a nice quarter.

Vinod Khilnani

Well, thank you.

Donna Belusar

Thank you.

Brad Evans – Heartland

The – can you just give us your thoughts as to where you think you can return EMS operating margins over the intermediate term to the medium term?

Vinod Khilnani

On the medium term, we expect EMS margins to go up to 2.5% range, somewhere between 2.5, 3% range. In the longer term, our target for EMS stays the same, which is around 4, 4.5% and the rationale behind a 4, 4.5% target for EMS was this 12 to 13% operating margin in Component and Sensors is because EMS business turns the assets roughly three times more than Component and Sensors. And so those two numbers from operating margins give us approximately the same corporate target return on invested capital.

So those targets stay the same, Brad, and I know you are and we are not pleased with EMS performance in the first quarter. We think a lot of that is items which are short-term in nature. And the other thing that I would highlight is that although EMS business lost money in the first quarter, it still had a positive contribution towards corporate overhead and some regional and location overhead because we have some facilities as you know where EMS shares the location shares services. And so that – it helps us.

So short, medium term, we expect to go back up to 2, 2.5, maybe 3% range but more in mid 2% range in operating margins. Longer term, we're sticking with our 4% target.

Brad Evans – Heartland

Okay. And just to follow-up on EMS. Can you just speak to component supplies, your suppliers? Are you seeing any bottlenecks in terms of your vendor suppliers being able to supply you with the volumes you need at this point?

Vinod Khilnani

Before I answer the question, let me just comment that within EMS, we clearly saw improvement year-over-year in markets which were hit the most in 2009 and they were industrial and communications. So industrial and communication from those very depressed levels bounced back. However, the markets which did not do too bad which is medical and defense, we are down on those.

The areas which have bounced back industrial and communications, we had some – some difficulty in maybe one or two areas there the ramp-up was with a very short lead time and I did hear nothing material, but I did hear that one or two of our facilities did have some difficulty of getting the parts in a shorter than normal lead time period. That should go away in April, May timeframe.

Brad Evans – Heartland

Okay. Just last one – last housekeeping, if I may. Could you just give us your capital spending plans for the full year and what was capital spending for the first quarter?

Vinod Khilnani

Donna?

Donna Belusar

Well, capital spending they're still targeting around 2.5% of our total sales. So we're looking at a range of anywhere from $14 to $17 million for the full year. In the first quarter, we had a little over $1.5 million of capital expenditures.

Brad Evans – Heartland

Okay. Thank you very much.

Donna Belusar

You’re welcome.

Vinod Khilnani

Thanks, Brad.

Operator

Next to the line of Jim McIlree with Neuberger Berman.

Jim McIlree – Neuberger Berman

Hi. Good morning, everyone.

Vinod Khilnani

Good morning, Jim.

Donna Belusar

Good morning.

Jim McIlree – Neuberger Berman

A most of my questions have been asked. But I wanted to maybe just take a moment to address. Vinod, you had your balance sheet in really excellent condition, generating some free cash flow. Maybe if you could update the thinking on how this is going to be deployed?

Vinod Khilnani

Good question. Two different directions, from the point of view of stock buyback as one possibility or dividend increase as another possibility. The board on an ongoing basis looks at it, looks at the cash flow. They also look at which part of the world we are generating the cash flow. So if they see more cash flow is generated outside the U.S., then they consider that in their thinking versus the cash flow generated inside the U.S. They also look at growth opportunities, new product launches and M&A activity.

So we're obviously balancing all of those things. If I may comment on M&A, 2009 clearly distracted us a little bit and we did not spend that much time and effort on the M&A front in the company as we did successfully in 2008 when we acquired two small companies, which were accretive and bolt on.

We are again switching back to focusing on M&A and our M&A discussion pipeline is filling up nicely. So we are clearly turning that process back up now that we have 2009 and all the recessionary issues behind us. So we will obviously watch that and see if that is an opportunity for a potential deployment of cash before we look at other opportunities.

Jim McIlree – Neuberger Berman

Very good. And we know they did a tremendous job keeping the cash flow going to the growth opportunities, even during '09. So we'll look forward to seeing the moves that you make.

Vinod Khilnani

Thanks, Jim. Appreciate your support.

Operator

Next to the line of John Franzreb with Sidoti & Company.

John Franzreb – Sidoti & Company

Again, you might have touched on it with the last question from Jim, but just an observation. Is where your cash domiciled – is that an issue? Is that why your long-term debt went up sequentially? And especially given the fact that you're free cash flow positive in the quarter, why was that necessary? Could you just talk a little bit that? Were we buying back stock in the quarter also?

Vinod Khilnani

No. No. We didn't buy back any stock in the quarter and I think you are right. It is the location of the cash. That's why cash goes up sometimes. And the debt goes up simultaneously because that increase in cash was domiciled outside the U.S.

John Franzreb – Sidoti & Company

Okay. Thanks a lot, Vinod.

Operator

There are no other questions.

Mitch Walorski

I would like to remind our listeners that a replay of this conference call will be available from 1:30 PM Eastern daylight time today through 11:59 PM on Tuesday, May 4, 2010. 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 153620. Thank you for joining us today.

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