CTS Q1 2009 Earnings Call Transcript

| About: CTS Corporation (CTS)
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CTS Corp. (NYSE:CTS) Q1 2009 Earnings Call April 29, 2009 11:00 AM ET


Mitchell J. Walorski - Director Planning and Investor Relations

Vinod M. Khilnani - President and Chief Executive Officer

Donna L. Belusar - Senior Vice President and Chief Financial Officer


John Franzreb - Sidoti & Company


Ladies and gentlemen, thank you for standing by. Welcome to the CTS Corporation Q1 2009 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-session, and instructions will be given at that time. (Operator Instructions).

As a reminder, this conference is being recorded. I would now like to turn conference over to our host, Director of Planning and Investor Relations, Mitch Walorski. Please go ahead.

Mitchell J. Walorski

Thank you, Linda. I'm Mitch Walorski, Director of Planning and Investor Relations. And I will host the CTS Corporation first quarter 2009 earnings conference call. Thank you for joining us today.

Participating from the company today are Vinod Khilnani, President 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 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 CEO, Vinod Khilnani.

Vinod M. Khilnani

Thanks Mitch, and good morning, everyone. Last evening we released our first quarter financial results for 2009. Overall, the financial performance was either inline or better than our internal projections.

On the one hand, the short-term economic conditions, and its impact on our financials were dismal. On the other hand, aggressive expense management and repositioning of our global cost structure has further lowered our breakeven revenue point, and therefore, minimize the impact of sharply lower sales on our bottom-line.

We believe the restructuring actions that we have taken will allow us to benefit considerably when the volumes return to the normalized levels.

First quarter 2009 adjusted diluted loss per share was $0.03, which excludes the non-cash goodwill impairment, and our previously announced restructuring costs.

Donna will discuss the financials, and these special items in more detail, a little later. Sales in the first quarter 2009 of 118.1 million. Although, 32% lower year-over-year due to a steep decline in the global demand, were inline with our expectations.

Automotive censors represented 20% of our total sales in the first quarter. The automotive industry is experiencing severe contractions in their volumes worldwide, with light vehicle sales in North America down 38%.

However, production levels fell even more, and were down 51% year-over-year, indicating inventory dry downs. The negative impact on our sales therefore, was magnified beyond the underlying automotive demand, as OEMs extended their year-end production shutdowns well into the first quarter of 2009, to lower their inventory.

On the business development front, our sensors and actuators had a very strong start in 2009. Compared to six new business awards in the first quarter last year, we won 15 new awards in the first quarter of 2009, and penetrated our second large commercial customer, as we continued to deploy our sensor and actuator technology into diesel engine commercial applications.

We also announced our first Accelerator Pedal Module win from a German OEM last week, further broadening our reach for this key product family.

All of our new business wins were well with non-Detroit automotive companies. Our Detroit 3 sales in the quarter were less than 5% of your total CTS sales, compared to a little over 9% in the same period last year.

Our first quarter 2009 sales to Toyota and Honda combined were approximately 5.7 million, up 5% from first quarter 2008, indicating new program wins and increased penetration of these key target customers.

Our continued success and diversifying our customer base and broader application of our sensor and actuator technology, underlines our confidence in the growth and profitability of our sensors and actuator products, when the market conditions normalize.

Continuing with the components and sensors segment, sales of electronic components in the first quarter of 2008, which represented 16% of total CTS sales, were 37% lower year-over-year.

Wireless infrastructure sales and piezoceramics sales for medical, hydrophone and commercial applications, were all lower as a result of recession-driven weak demand and inventory reductions.

We expect that excess inventory in the supply chain will probably clear by June timeframe. And as a result, our incoming order rate may improve by late second quarter.

New product development activities for electronic components are staying strong. We have also increased engineering collaboration and product development activities with two of the largest Asian telecom equipment companies, Huawei and ZTE, and expect them to be key growing customers of CTS going forward.

We also recorded 51 infrastructure design wins in markets and applications like 3G wireless, satellites, industrial and military.

Design wins are a leading indicator of future revenues in this segment of our business.

Our EMS segment sales of 75.8 million in first quarter 2009, were 20% lower than the same period last year, primarily due to Hewlett-Packard sales that declined year-over-year due to previously discussed end-of-life process, which started in early 2007.

Our sales to HP in the first quarter were only $8.3 million. Excluding HP, EMS sales in the quarter were actually up 1.8%, as increased defense and aerospace, and medical sales more than offset the weak EMS sales in the industrial and communications market.

Overall, as a result of the global rescission, which is affecting many of our markets, we are driving two key initiatives.

First, we are aggressively reducing over cost structure, by further streamlining our manufacturing footprint, to create flatter and more responsive organization structures, and a more efficient shared services model.

Second, we have successfully increased our efforts to launch new products and penetrate new customers.

New business awards in the first quarter have been very encouraging. We continue to increase our market share and diversify our customer and product portfolio, to avoid sales concentrations with any one customer or any one industry.

In the first quarter, no single customer exceeded 10% of sales. And all, but three customers were under 5% of our total sales.

Looking at the success of our diversification initiatives from an industrial perspective, we had 41 million or 35% of our total sales in defense and medical markets in the first quarter of 2009, versus only 26 million or 15% of our total sales in the first quarter last year.

Looking forward, our March and April order board seems to indicate that some of our businesses maybe near a bottom. However, we have yet to see a clear uptick in our incoming order rate.

We therefore, are continuing to keep a very tight grip on our expenses and cash outflows.

Several countries, including China, UK, France and Germany, have introduced programs to scrap all the vehicles to stimulate new automobile sales. These programs seems to be having a positive impact on the short-term demand.

We expect second quarter sensors and actuator revenues to probably reflect a modest uptick, driven by the success of these programs.

In addition, we also expect sales to benefit somewhat as excess inventories are used up some time in the late second quarter or early third quarter.

Overall, we believe a modest recovery in late 2009, remains our most likely scenario.

Quotation activity remains surprisingly robust. And we are continuing to win new business, and increase our market share.

Although, first quarter results were slightly better than expectations, we believe it is not prudent to provide specific guidance on sales and earnings at this time, given the extremely poor visibility and uncertain economic conditions over the next couple of quarters.

We do however, expect to be profitable, and generate positive free cash flow in 2009 full year, excluding restructuring and other non-recurring items.

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

Donna L. Belusar

Thank you very much, Vinod, and welcome, everyone. The first quarter 2009 financial results reflect downward pressure in top-line sales from the global recessionary environment.

These financial results also reflect the positive cost actions we have taken to significantly reduce the company's cost structure and cash flow needs.

Before I go through our consolidated earnings and balance sheet, I would like to address two unique items that occurred in the first quarter. First, restructuring charges. And then, the one-time non-cash goodwill impairment charge.

First, let's discuss the restructuring charges taken to reduce our operating costs. CTS' management continues to proactively address the company's cost structure and operations.

In early March, we announced restructuring actions to reorganize certain functions to further mitigate the impact of slowing demand linked to the recession.

In the first quarter of 2009, we incurred 2.2 million of restructuring charges or approximately $0.05 per diluted share. This action, along with the restructuring actions that began in the second half of 2008, are more than short-term tactical responses to the low demand levels. But, are also more permanent in nature, which means as the volumes return to normalized levels, we would anticipate improved margins.

Since the second half of 2008, and including the first quarter 2009 actions, we have reduced our worldwide employees by approximately 20% from our peak resources in 2008.

These resourced actions were achieved by either combining or eliminating certain support function and production roles, at nearly everyone of our manufacturing sites, primarily through the Lean Six Sigma initiative.

We expanded shared services in our Asian facilities, and we continue to generally keep our direct and indirect hourly resources inline with the changing volumes.

As discussed on prior earnings calls, we consolidated manufacturing facilities in our EMS and electronic components operations, and downsized some of our support locations.

Overall, these actions have contributed to reducing the company's cost structure by approximately 15 million. The next item I'd like to talk about is a discreet non-cash charge of 33.2 million for the impairment of goodwill assets.

Traditionally, the discounted cash flow approach was used to determine the fair value of goodwill. A December 2008 SEC speech, emphasized that fair value needs to be reconciled to market capitalization.

This is a same uncertainty and volatility in both the financial and equity markets has contributed to a lower stock prices for most companies. These lower stock prices are resulting in market capitalizations that are below net book value.

At the end of first quarter 2009, CTS performed an internal goodwill valuation, based on that company's market capitalization. And as a result, a non-recurring non-cash goodwill impairment charge of 33.2 million or $0.98 per diluted share was recorded.

While the goodwill impairment charge, does reduce reported earnings under the U.S. Generally Accepted Accounting Principles, the charge does not affect CTS' liquidity, cash flows from operations, or debt to covenants, and will not have an impact on future operations or cash flow.

Now, let me expand upon the financial result for the first quarter.

Our first quarter 2009 sales were a 118.1 million, compared to 172.8 million in the same period last year. As anticipated, the year-over-year decline in the components and sensors segment, reflects overall market declines in light vehicle production, and softness in the sales of electronic components.

EMS segment sales declined year-over-year primarily, due to the planned end-of-life sales to Hewlett-Packard. However, it is really important to note that sales excluding Hewlett-Packard actually increased slightly.

Given the steep decline in sales and components and sensors segment, particularly automotive, the overall segment mix was more heavily weighted towards the EMS segment.

Sales in our EMS segment represented 64% of total sales, with sales in components and sensors representing the remaining 36%.

We continue to successfully diversify our sales mix within each segment, increasing sales into Asia for components and sensors, and increasing sales into targeted EMS markets of defense, aerospace and medical.

This diversification in our sales mix, combined with the cost actions we proactively implemented, contribute to a gross margin of 16.8% in sales in the first quarter 2009, compared to 19.6 in the first quarter of 2008, despite a sharp drop in sales and reduced capacity utilization.

I have discussed the restructuring actions we have taken that both reduced our operating costs in the near term, as well as permanent reduce in the company's cost structure.

In addition, we have taken early anticipatory actions that have allowed us to effectively reduce current period expenses. These actions include, in worldwide pay freeze, suspension of the company's 401(k) match, temporary reductions in salaries, furloughs and tight control of discretionary spending.

In total, these actions have allowed us to lower our selling, general and administrative expenses or SG&A year-over-year by 21%, or approximately 4.4 million to 16.6 million in the first quarter 2009.

In payroll to these expense actions, CTS continues to invest in future technology and products.

Research and Development or R&D expenses were 3.4 million or 7.9% of component and sensor sales in the first quarter of 2009, compared to 5.5% of component sensor sales in the same period last year.

Total other expenses, which includes items such as interest expense, interest income, currency translation and other non-operational expenses or gains, were 1.1 million for the first quarter 2009, unfavorable to the same period last year, primarily due to currency fluctuations.

If we exclude the goodwill impairment charge in the first quarter of 2009, our adjusted full year tax rate would be approximately 23.4%, which is within our normal range of 22 to 25%.

To summarize the first quarter 2009 results, we've reported a net loss of 35.6 million or $1.06 per diluted share. The adjusted net loss, which excludes the restructuring and goodwill impairment charges, was 1.1 million or $0.03 per diluted share.

As shared by Vinod, our overall results were either inline or better than our internal expectations. I would now like to discuss CTS' balance sheet, which can be characterized as balanced and mapping to our liquidity needs.

Working capital management continues to be an important focus for the company, as we work to ensure, accounts receivable, accounts payable and inventory levels are managed effectively.

Controllable working capital, which includes accounts receivable plus inventory, plus accounts payable, as a percentage of annualized sales, was 19.8% for the first quarter of 2009. This is higher than our internal objective from merely due to the fact that sales did fall off faster than the inventory reductions across all the businesses.

Lower inventory reduction efforts are though underway to drive our processes back to normalized level. Quarter-end global cash and cash equivalents held to the December 2008 year-end model of 44.6 million.

Net operating cash flow used in the first quarter was 4 million, which is directionally consistent as operationally first quarter cash flow traditionally can be negative.

We reduced first quarter 2009 capital expenditures by 59% to 1.4 million, consistent with our previous discussions to carefully reduce our overall 2009 capital expenditures.

The 2009 customer demand continues to be difficult to predict, but we still expect positive free cash flow for the year.

Let me conclude the balance sheet review with a discussion of our debt structures, specifically our long-term debt. As of the end of first quarter 2009, we had 85.9 million of long-term debt. As you know, there are two components of our debt.

The first component is a U.S. unsecured revolving credit agreement, which at the end of the first quarter 2009, had 46.5 million in available credit.

The second component is 32.4 million convertible senior debenture, which has a put option as of May 1.

We are well positioned to handle any put options that are tenured. In April, subsequent to the first quarter call, we brought back approximately 15 million cash from our international jurisdictions to the U.S. After the potential pay-off of the convert, we will still have approximately 30 million available in our U.S. revolver, as well as an additional 19.8 million available under our international credit facility.

This concludes an overview of our financial performance for the first quarter 2009. With that, I will now open up call for your questions. Thank you.

Question-and-Answer Session


Thank you. (Operator Instructions). And we have a question from the line of John Franzreb with Sidoti & Company. Please go ahead.

John Franzreb - Sidoti & Company

Good morning, everybody.

Vinod Khilnani

Good morning, John.

Donna Belusar

Good morning, John.

John Franzreb - Sidoti & Company

First question is, the update on Hewlett-Packard. If I heard you correctly, you said that there was $8.3 million in the quarter. When can you expect that business to finally settle off?

Vinod Khilnani

I think John, as you know, that business has continued to come down. And I believe, we have said in the past that we expect that business to pretty much get pretty close to wrapped up by the middle of 2009.

John Franzreb - Sidoti & Company

So, almost by the end of the second quarter, we should be done?

Vinod Khilnani

Yeah. We will continue to do some business with Hewlett-Packard as we have said in the past, which is higher margin service kind of a business. But, that will be very small.

John Franzreb - Sidoti & Company

Okay. And you touched and expanded a little of business in China. You mentioned, ZTE. Just kind of update us on tell communication equipment sales to China, what's going on there? Can you just talk a little bit about that Vinod?

Vinod Khilnani

Sure. As you know we have expanded our operations and sales in China. And frankly, Asia in general. And I can say that, not only from sensors and actuator point of view, but also from electronic components point of view.

You asked a question specifically from electronic components point of view, and we have tried to expand our relationship with companies, which we believe, are growing faster than other companies, and are continuing to expand their market shares.

So, we are positioning CTS to grow their business with those players, who we believe, are going to be winners and expand their market share more.

And when we did that, ZTE and Huawei showed up at the top of our list. And for the last couple of years, we have been trying very hard to penetrate those. And recently, we have had a lot of successes, and we continue to penetrate and do more business with those companies.

And in the first quarter, especially, our interactions and the prototype were and activity with these two companies accelerated, rather noticeably, with their engineering and technical people visiting our locations in the U.S. and further discussing the opportunity we may have with them.

So that was positive from that point of view. And if I may continue to comment on Asia and China, in particular, I made a comment that customers like Hondas and Toyotas were benefiting as we grow our business, and win new market share with those customers.

And I think we have also a lot of new activity going on with some of these customers, and Chinese automotive OEMs. And we hope to frankly, announce more business wins in the very near future, primarily driven by the growth of Asian market.

Indirectly, we have some European and U.S. telecom customers, which are also benefiting because of the wireless infrastructure growth opportunities, which are picking up in countries like China and in India.

So, we have direct participation and indirect participation from the growth in that part of the world.

John Franzreb - Sidoti & Company

All right, that's good news. Net-net, what are the close that were done (ph) during your commentaries that March and April were near the bottom. Could you identify what product launch you would expect to be early cycle recoveries? Or what product lines would you look at and say in this, the inventory drawdown has played out. I expect these products to be early indicators of a turnaround?

Vinod Khilnani

Okay. When I said we are seeing some sings of stability, the sings of stability we are seeing are in sensors and actuators. We are seeing signs of stability, early signs of stability, which are primarily coming from Asian OEMs and Asia specifically.

In electronic components, we are seeing some signs of stability in the infrastructure, wireless infrastructure, in the product families, which are around RF modules and RF filters.

And my view is that those early signs are again driven by demand in countries like China and India, which are continuing to move forward with the wireless infrastructure kind of a thing.

The other areas where we are watching very closely, and that's why we are a little bit guarded, because we have not seen an order uptick, are areas like distribution, where we believe that the inventory, excess inventories are coming down. But that has not translated into placing of higher orders or increased orders with CTS yet.

So, we're watching that, and waiting for those signs to emerge.

John Franzreb - Sidoti & Company

Is that concern about distribution, is that what led you to pull your guidance?

Vinod Khilnani

The guidance is our decision to suspend giving guidance for probably couple of quarters, is probably a broader decision, not tied to distribution per say. We were just watching. There are so many of variables, John that we did not want to come up with the guidance, which was either too aggressive or too conservative.

And we felt it was just prudent to just wait out for couple of quarters, before we gave any specific guidance. We did want to give people comfort that our expectation is to do make earnings, positive earnings in 2009, and have positive free cash flow in 2009.

And we really have -- we're not seeing anything to make us pessimistic, because as Donna pointed out and I pointed out that the first quarter results were essentially inline with what we had projected internally.

John Franzreb - Sidoti & Company

Okay. I'll let somebody else ask some questions. Thank you, Vinod.


Thank you. There are no other questions in queue at this time. Please continue.

Vinod Khilnani

John, you're back.

John Franzreb - Sidoti & Company

Can you hear me, Vinod?

Vinod Khilnani


Donna Belusar


John Franzreb - Sidoti & Company

Okay. The other topic I wanted to touch a little bit more on was the EMS business. The ex-HP up nearly 2%. I gather from the press release that's coming from the aerospace and the medical side of business. Could you elaborate on volume trends in EMS? Are you seeing more outsourcing, or companies keeping production closer to the rest? What's your sense there?

Vinod Khilnani

Okay. John I'm not seeing any clear trends one way or the other, where people are either pulling business in or outsourcing more. I actually have seen examples of, small examples of, people going either direction, okay. To give you some more color in the EMS business; if you exclude it, the computer and the HP side of the gain, you can essentially look at CTS as doing business in four broad areas, communication, industrial, defense and medical.

Communication and industrial are the weak spot. Year-over-year in the first quarter, communication was probably down close to 27%, and industrial down 35%.

On the other hand, on the positive side, our sales into the defense have doubled in the first quarter of '09 from the first quarter of '08. And our medical business is up 24%. So, as I have pointed out earlier, medical and defense is very positive, communication and industrial business clearly is affected by the global recession and down year-over-year.

John Franzreb - Sidoti & Company

Now are you able to impressively double operating profit, year-over-year or operating margin year-over-year. How much of that was cost driven versus how much of that is mix driven?

Vinod Khilnani

I would say at this point bulk of it was cost driven. Because on the one hand within EMS, as you know, the mix is favorable and moving towards higher margin businesses like defense and medical.

John Franzreb - Sidoti & Company


Vinod Khilnani

On the other hand what offsets that is we are seeing temporarily EMS business as a higher percent of the total company. So the segment mix in favor of EMS, and away from sensors and electronic components is having a negative impact on the gross margins.

I see that as a temporary, as our new business wins which are as I pointed out extremely encouraging in electronic component sensors, actuators arena. We'll take that mix back in the direction of electronic components and censors and actuators, as we go forward. And that will give us a positive impact on our gross margin because of mix.

John Franzreb - Sidoti & Company

Just to clarify Vinod, I was actually referencing the operating margin in the EMS business?

Vinod Khilnani

Oh. That is, yeah, that improved, I would say, it's very hard for me to say how much of it is mix driven. And how much of -- clearly, mix is the component as we increase our defense and medical business.

But, it's probably a combination of mix and the cost actions, expense reduction actions. Although, I would say that we have taken more expense reduction actions in electronic component and the sensor world than in the EMS world, simply because that side of the business has declined more, given the recessionary pressures.

John Franzreb - Sidoti & Company

So, it would be fair to assume that the margin improvement is more likely to be sustainable, because there is less of the temporary actions put into the EMS side of the business?

Vinod Khilnani

I would say, you are correct.

John Franzreb - Sidoti & Company


Vinod Khilnani

It is probably sustainable, if you look at that business year-over-year. You may see some fluctuations, if you compare it quarter-by-quarter. So, if you look that as on an annual basis, I think it is very sustainable.

John Franzreb - Sidoti & Company

Okay. And one last question, does the EMS business, do the markets within EMS or EMS in general, have any kind of seasonality that we should be cognizant of?

Vinod Khilnani

I am not aware of any seasonality. We have said in the past that the quarterly sales may fluctuate, because it's a lumpy business. And there maybe some orders, which may move from one quarter to another. But, other than that, there is no seasonality, per say, in the EMS.

John Franzreb - Sidoti & Company

Okay. Thank you very much.


There are no other questions. Go ahead and continue.

Mitchell Walorski

I'd 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 Wednesday May 6, 2009. 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 995978. And with that, thank you for joining us today.


That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect.

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