CTS Corporation (CTS) Q1 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the CTS Corporation Q1 Earnings Call. [Operator Instructions] I would now like to now turn the conference over to our host, Mr. Mitch Walorski, Director of Investor Relations.

Thank you, Kyra. I’m Mitch Walorski, Director of Investor Relations, and I will host the CTS Corporation first quarter 2012 earnings conference call. Thank you for joining us today. Participating from the company today are Vinod Khilnani, Chairman of the Board and CEO; 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 on the company’s SEC filings. To the extent that today’s discussion refers to any non-GAAP measures relative to Regulation G, the required explanations and reconciliations are available on our website in the Investor Relations section. I will now turn the discussion over to our Chairman and CEO, Vinod Khilnani.

Thanks, Mitch, and good morning, everyone. Last evening, we released our first quarter results for 2012. It was a challenging quarter with a combination of new product launch and manufacturing consolidation activities, onetime expenses, and timing of reimbursements. The quarter included major initiatives around recommissioning of our Thailand EMS facility, consolidation of our Asian engineered frequency manufacturing from China into Singapore, launching of our second pedal module for a global vehicle platform and ramping up of our piezo product for disk drives. Let me give you some more details on a couple of these major items. Our Thailand EMS facility, which was extensively damaged in floods last year, has been completely refurbished. Some of the equipment has been installed and process is underway to switch the supply chain and begin moving production back to Thailand from our California facility. By the end of the second quarter or early July, all customers and production, which was in Thailand before the floods should be transferred back. This will eliminate all of our excess flood related headcounts of approximately 220 temporary workforce in California by July. In our Components and Sensors business, we were manufacturing our engineered frequency product at 2 locations in Asia, China and Singapore. We have now simplified the structure and consolidated all Asia frequency products manufacturing in Singapore. This process created some disruptions and inefficiencies which affected our shipments and margins in the first quarter. However, going forward, this should improve our cost structure. Now, moving on to first quarter operations and growth initiatives, sales in the first quarter of 2012 at $147 million, was 3% lower year-over-year, but 2% higher sequentially. Lost EMS sales due to Thailand and overall, a weak start of 2012 in January and February impacted our seasonally weak first quarter. Order rates and shipments…

Okay. Thank you, Vinod, and welcome, everyone. Before I review the financial results in greater detail, I will comment on the continued effects of the October 2011 Thailand flood which continues to disrupt our EMS operations impacting sales, expenses and inventories. During the first quarter, our growth margin was negatively impacted by flood-related expense and the margin on loss sales by approximately $6 million to $7 million. We expect to recover $4 million of this in the second quarter. As expected, a substantial portion of our first quarter, insurance recoveries of $5.4 million were for the fourth quarter 2011 expense and property damage. The second quarter flood-related expense and margin on loss sales are expected to be approximately $3 million to $4 million as production continues to be transferred back to our Thailand facility. The timing of insurance reimbursements related to the second quarter expenses will lag by 2 to 3 months. Our consolidated first, now I will, excuse me, now I will discuss our financial results. Our consolidated first quarter, 2012 sales were $147 million, a 3% decrease from prior year and a 2% increase from the prior quarter. Our first quarter gross margin of 15% includes approximately $6 million to $7 million of flood related expenses in the loss margin on sales impacting our gross margin percent by approximately 4.4% percentage points. If we adjust for these items, our gross margin would have been in the range of prior year’s gross margin of 19.2%. The favorable segment sales mix shift in favor of Components and Sensors had a positive impact on gross margins. But was essential offset by higher commodity and certain product launch and transfer costs. Our selling and general administrative expenses were $19.4 million or 13.2% of sales versus $18.4 million or 12.1% of sales last…

[Operator Instructions] The first question coming John Franzreb with Sidoti.

I’ve got a couple of questions here, Vinod. And I guess first regarding the reimbursement schedule that you just laid out. You said $4 million will flow into the second quarter and did I hear you correctly now the $4 million will flow into the third quarter?

No, we believe something less than $4 million will flow to the third quarter and the reason for that John is because the expense levels will be lower in second quarter than first quarter because first quarter got the full blast of this and during the second quarter we’ll gradually be moving production back to Thailand. So we’re still estimating it, but our guess is that the second quarter would be probably somewhat less than 4 million, but maybe close to 4 million.

Okay. Now regarding this whole process, you said that you estimated loss sales of $10 million to $11 million in EMS. Did I hear that right?

In the first quarter, yes.

In the first quarter. But you’ve maintained your revenue guidance for the full year and I just want to kind of reconcile that. Do you have commitments from your customers, that they're going to come back because I assume they’ve been getting product elsewhere. But you showed a willingness to maintain the revenue outlook, do you have commitments from the customers or do you except to actually make it up someplace else?

It’s a combination. Some customers we believe will be coming back to us and increasing their volumes and we may have a little bit of recovery there. But some of the sales I would say more than half of these sales are lost. For good, because although, we may have those customers, but you’re right. We’re making those customers somewhere else. The reason at this point, we are maintaining the sales guidance is because we expect to make it up in other areas. And it’s possible that some of our programs like the grill-shutter actuator which we were estimating will -- we will start shipping in August timeframe maybe and I think we are looking and working hard to potentially launch that a little bit earlier. So let’s say couple of months earlier. We’re still pulling up our supply chain. Our customer definitely wants us to start shipping that product earlier because the customer is anxious to move that production from a euro cost zone to a dollar cost zone because of the currency. We are right now, trying to see how we can accommodate that request to pull up the launch and so, we’re hoping that, that will get pulled up a little bit and I also expect further strengthening in sensor products because we believe that some of our key customers will still be in the process of increasing their inventory levels. And so, we expect our sensor volumes to rise further from where we stand today.

Okay, that’s helpful. On an unrelated topic, the disruption in Germany in production of Nylon 12[ph], it’s a feeder line I guess into the pedal process, you being pedal module and that manufacturer, have you gotten any feedback on potential implications to your business or not?

We have looked at if that product has a direct impact on any of our components and we essentially don’t have any material impact. We have some very small components where we believe that raw material may be going, but we don’t believe that that’s going to cause any disruption. On the other hand we are in touch with our large automotive customers and trying to find out if they will have impact on their production volumes because of shortage of this, called P12 or something.

P812 [ph], okay.

Component. At this point our customer, our automotive OEM customers are telling us that they do not expect impact disruptions on their production volumes. Having said that they are watching it very quickly because they are developing some alternate material and substitute product and so we have not seen any impact on their orders and our system at this point, however, we continue to watch it very closely.

Okay. And just one last clarification you mentioned on the hard disk drive product line starting to rollout, you gave a revenue number of $50 million to $60 million in sales, I didn’t catch the timeframe that you expect out there?

Over the next 4 years.

Four years. And when does that begins full production?

Now.

So right now, it’s at that run rate?

It will be pretty close to that run rate, we expect the run rate to go a little bit higher, but I would say that 2012 will not be a partial year, or something. We’ll pretty much see -- our estimate is, John, that 2011 sales can be anywhere from $10 million to $14 million, we’re trying to figure that out. If it’s closer to $14 million, you are at the run rate of the 4 year. But that depends not on us, but how our customer is ramping up product of this new generation of disk drive. So they still have a mix thing, they continue to make the old kind disk drives the way I understand it and this new dual actuation disk drive. So the number can be anywhere from $10 million to $14 million. Just to give you a reference point, our sales of this product last year was probably around $2 million to $3 million.

Perfect. Okay. I will let somebody ask questions. Thank you, Vinod.

The next question comes from the line of Gary Prestopino with Barrington Research.

Just for our purposes here, will Q4 be a quarter where we’re not going to have any insurance related payments or coming in just from basically what has happened in Thailand, x-ing out any other natural disasters or whatever?

Exactly. I think Q4 will be a -- we’re expecting it to be a clean quarter because Q3 will be a quarter where we don’t expect really anything material from an expense point of view, but we will see some recovery. So we will see some favorable balance in Q3 which will kind of a catch up of Q1 essentially. And Q4 we are expecting a fairly strong quarter because A, we’re not expecting any disruptions and B, some of the product launches which are taking place middle of the year or in the third quarter, they would be fully operational in the fourth quarter. So unlike in the prior year’s this year because of the timing of all these things, Gary, we are expecting a disproportionately strong quarter in the fall.

Could you just maybe go into what some -- about the product launches in Q3 and Q4. Is that just to...

No, I can’t mention it. The 2 noteworthy products will be, one is the grill shutter actuator, which we will launch in August and which we just commented that we are trying to pull it up to June timeframe. That product in the fourth quarter should generate close to $4 million to $5 million incremental sales. And we really didn’t have anything. I mean we didn’t have anything in Q1 and Q2 and we’ll have some in Q3. So that is probably one program which would benefit us in the fourth quarter. The second one is this hard disk drive which we think although we will benefit from it in Q1, Q2 and Q3, but we believe that in Q4 it will have a slight ramp up impact on the sales. And if I have to very roughly estimate that I would say compared to Q1, Q2 and maybe Q3, Q4 may have $1 million to $2 million in incremental sales on that. So those 2 items are in Components and Sensors, and some of the pedal module programs which got launched in the first quarter, may have some ramp up impact in the third quarter. So those are 3 things. The pedal module, active grill shutter and high density disk drive PSO material and out of these 3, the biggest one will be the grill, because the grill shutter actuator essentially don’t have any sales in Q1 and Q2 and may have some sales in Q3.

And you’re still, this year you’re still spending I think an incremental $0.06 to $0.08 in R&D right, that should go away next year?

That should go away next year. What’s going to happen, Gary, is that the absolute dollars will probably come down slightly, but not go away. But those dollars which don’t have any sales associated with that will have sales associated with it next year. So as a percent of sales R&D definitely should see a decline next year compared to this year.

And then 2 quick ones for Tom. Do you have the DNA in the start comp. I didn’t see a cash flow statement on the press release.

We did put that additional information, Gary, in the press release, but the depreciation and amortization was $4.8 million for the quarter.

...in the supplemental information.

Yes, the equity based comp was a $1.2 million.

Yes, I’m sorry. I see it that, it’s right at the top of page here. So I apologize for that.

And that equity based comp is the same as last year.

The next question comes from the line of Ken Nagy with Zacks Investment Research.

I was just curious on the, if you could provide an update on the effort to bring smart actuators to commercial applications.

Ken, the smart actuators program is on schedule. Actually I was told that the customer, the OEM who makes the diesel engines is in our plant as we speak. From a process point of view, we are still on schedule to launch that product for the first time in December. I understand that almost all technical spec type issues and testing is complete and we are now in the process of looking at ramping up the productions or the supply chain issues and those kind of things are being addressed. We expect to start shipping that product in December, they will be very little this year, maybe half a million, may be a million, but that number is projected to ramp to more like a $15 million to $20 million and that kind of a number next year. A major project clearly a few more things to do, but on schedule.

The next question comes from the line of Hendi Susanto with Gabelli & Company.

A couple of questions, first which sectors represented the loss sales in Thailand?

EMS.

Purely EMS?

Yes.

And then could you specify more like what EMS components?

There were several customers there Hendi. We had some important customers overall who were affected by Thailand were medical customers, there was one large industrial customer. Those are probably the 2 most important customers. Both of those customers we supported beautifully by moving their production to California and those were the 2 customers and a couple of other customers where -- key customers where we actually went out of our way and supported them to make sure that their productions and their shipments were not disrupted. So, they were fine, but in this process, we decided to not support couple of very small customers. I believe one in industrial and one in communications I believe, these were small customers which we decided to walk away from because they were not strategic customers and the margins were lower and we did not want to incur huge expenses to support those.

Okay. How do you characterize the reason of the unexpected delay in the insurance reimbursement. I’m wondering whether it’s driven by purely paper work or regular business practice or whether there are other reasons.

Hendi, it’s a very good question. It’s primarily paperwork driven. And the fact that from an accounting standpoint these recoveries cannot be recognized until you are some certain that the insurer will recognize the expenses. There is a lot of documentation, a lot of hard work going on behind the scenes to get the process moving.

Or if you’re not what drove the lower demand from telecom equipment providers and how long do you expect that to persist?

Hendi, that’s a tough question to answer because a lot of telecom sales are large projects related in the past. We have said these sales can be lumpy and as a percent of our total sales they are kind of small amounts and they are spread over some large OEMs. So it’s very difficult for me to give you a better feel other than saying that we clearly haven’t lost any business. We continue to have more design wins. So these kind of things can be either be driven by timing of some projects so that they didn’t get any large projects in Asia or some other places, they start buying less components from us, it’s kind of very difficult to put a finger on that. Sometimes it can be an impact of the mix between the kind of products they are building. Some of their products whether it is CDMA or LTE time has different mix of components, in some models and products we may have a higher content than others. So their mix, product mix combined by timing of their large projects or the timing of their purchases of components from CTS can have an impact.

Okay. The grills the others actuators, the press release indicate it will go into passenger cars and light trucks. I am wondering whether you can share more color on the target market and what kind of passenger cars and which one of -- which one your first customer is going to use it for?

All we know, Hendi, at this point is that we are Tier 2 on that. We sell the actuator to a German company, German automotive component supplier and they make the whole system and our understanding is that their system is going on a passenger vehicle made by one of the 3 Detroit automotive makers. So I am not sure I know whether it is GM Ford or Chrysler, but it’s one of those vehicles but our sales are to a German company.

Okay. You have expressed excitement about Valpey-Fisher’s strength on engineering resources. What is your plan with regard to Valpey-Fisher future product pipeline?

Valpey-Fisher, glad you asked this question. I will tell you that when we did that acquisition we said it will be slightly accretive and we still looking at their performance for 1 1/2 months or 2 months. We still feel that they are performing exactly the way they had projected for 2012. We are excited by their new product pipeline and as we had said earlier we also like the management team and we actually have the German who was leading Valpey-Fisher is now leading not only Valpey-Fisher, but CTS’s engineered frequency product family and we are right now looking at finding additional synergies between CTS engineered frequency engineering organization and Valpey-Fisher engineering organization.

That’s helpful. Thomas, could you remind us how much revenue is denominated in euros?

Hendi, we have approximately €35 million to €45 million and then that’s offset with some euro expenses too, so net-net probably in the €30 million to €40 million range.

Our next question is from the line of Alek Gasiel from Barrington Research.

Just a couple of questions, and you may have already mentioned this, I apologize. It seems that automotive product sales for the quarter were a bit weaker, I was wondering if you could provide a little more color on that?

As I said in my comments, Alex, the sales were higher than overall market growth, but they were affected somewhat negatively in the translation part of it. As Tom motioned, €30 million to €40 million on an annual basis is euro denominated sales. And if you are making year-over-year comparisons you will note that last year in the first quarter euro was probably sitting at $1.40, $1.45 range and this year in the first quarter the euro is sitting at $1.30 range, that’s like a 10% deterioration. So €30 million to €40 million sales, €40 million sales, 10%, we have a $4 million worth of year-over-year comparison deterioration simply because of exchange rate. So that did have some negative impact on the top-line.

Okay. And then on the call you mentioned book-to-bill for Electronic Components was 1.07, so it definitely looks like then for the balance of the year should be relatively strong and is that fair to say?

Well, 2 comments that book-to-bill which I mentioned we track for the distribution portion of our Electronic Components. So in our Electronic Components we have some sales which goes through distribution channel. I would say that is probably 5% of the total company, 6% of the total company. The reason we watch that is because that gives us some forward-looking indication of what the market is doing. And in that piece of our business we did see our book-to-bill improve above one in March indicating that our distribution shipments in April and May at least should be stronger.

And one last question, I guess looking at the capital structure with the recent Valpey-Fisher acquisition, do you guys have room and are you looking at other little tuck-in acquisitions?

We definitely have room and we are always looking at small tuck-in acquisitions which will -- which can accretive and where we can see clear synergies day one either through the engineering organization or marketing organization. Obviously if we do those acquisitions in U.S. we clearly have room if we look at those acquisitions. Outside U.S., we have even more room because as you know we have close to $70 million in cash outside U.S. which can be utilized for acquisitions. So, yeah, we clearly feel very comfortable from our leverage ratios.

And with the focus primarily be in Electronic Components?

The focus primarily is Electronic Components or Sensors.

Our next question is from the line of John [indiscernible] from Citi.

A follow-up on the guidance Vinod to the second quarter, I think you said $0.15 to $0.21, I think you used the term adjusted -- is it adjusted number, or is that a GAAP number.

Well, at this point it’s a GAAP number, although we are continuing to look at, if we find obvious improvements in our cost structure, which have a relatively low payback then we will continue to look at those opportunities and I always like to keep my options open.

Okay. So I just wanted to make sure what I am talking about. Now, so just a follow-up to an earlier question, Q3 will have the benefit of insurance reimbursement, but also the benefit of having everything online, is that a correct assessment.

Q3 definitely would have some benefit from insurance proceeds. Q3 was also -- would not have any disruptions from the floods, because we think that maybe if not June, July we should be able to clean that up. Q3 will also not have any impact, negative impact from this engineered frequency consolidation because we think that process which affected us in the first quarter will still affect us little bit negatively in April May timeframe, but we should be caught up and done by May timeframe. Where I would probably hedge my bets little bit in Q3 will be that we may have some additional launch related activities going on in active grill shutter actuators, and we would be ramping up the production activity to prepare for the major Q4 start of the smart actuator. So there may be something there that’s why I said that the combination of those things I will probably say between Q3 and Q4, Q4 should be much stronger than Q3.

Okay. That -- you took my question, my next question which way it was going to balance out. But still we’re looking for a substantial step up in Q3 versus Q2, correct?

Yes. But the balance in Q4 should be bigger than that.

Okay, okay. That’s fine. And just want to make sure I heard you correctly on another item you said. Did you say the Sensor business in total you look for 14% and 15% growth year-over-year?

Yes. And that is primarily driven by the mentioning of this global platform we talked about combined with active grill shutter and combine with. We believe that some of our key automotive OEMs should be pulling a little bit more product from us than their underlying demand because we think they should be building little bit more inventory.

Given your debt position and may be your appetite for M&A, will you still be actively be repurchasing stock?

We are constantly looking at our stock repurchase activity by looking at where we think the evaluations are. So that’s kind of an ongoing thing. I am looking towards Tom to let you know how much of dry power do we have in our existing buyback.

And we do have about 300,000 shares remaining.

Regarding the patent infringement case with TK, is that part of the legal expense that you were discussing in the SG&A or is it something else and can you just give us a little bit color on that process.

I’m glad you asked that question because it is clearly adding to my expense base in this year. I think we have spent almost $400,000 in the first quarter, which was frankly was not in my thought process of guidance as I started the year. So it is a pretty material number for me and I may have to spend a little bit more money, but we also look at how, how good the opportunity we have because we think we have a clear cut case against this other company, and the upside is pretty substantial. And on the one hand we’re probably not baking into our thinking additional legal expenses, but on the other hand we’re also not baking into our guidance any recoveries we may have on that. And as you saw in our press release, we’re estimating the recovery potential to be $3 million to $5 million or actually $3 to $6 million range, and we already had one round of favorable ruling from the judge, which made the judgment in favor of CTS that our assertion stands. We have some more work to do, and we believe that there is a second round, which we should know something by the end of June timeframe, and we believe that if we win that round, then, if commonsense prevails that both sides should be able to go in a room and agree that we should compensate CTS for it. Pretty substantial amount and the early rulings from the judge are in our favor.

And one last question if I may on your decision to hang it up at the end of 2013 and move to Florida, could you talk a little bit about the succession plans?

That is just a wild rumor that I’m going to Florida. Seriously, on my succession planning, the Board decided that we should be transparent and the Board decided that we should have a long careful thoughtful process and therefore, unlike many other companies, where the announcements come out 3, 6 months before the CEOs go. The Board decided that’s more prudent to have a much longer runway so that we have a very systematic and controlled process and there is plenty of overlap and transition. And so, we believe that between now and end of 2013 there is a long period, a lot of new products would be launched, I think the company is in excellent shape, the mix of the business is very good, a lot of products which we’ve been working on for the last 4 or 5 years would be launched. And so, it’s a good time for transition. Having said that, the Board also has my commitment that for whatever reason if that period needs to be adjusted in either direction that the Board has the authority and they can do that. So in other words, it’s a very thoughtful, slow, methodical succession process which every good company should pursue.

Our next question comes from the line of Gary Prestopino from Barrington Research.

Just a general question. In the 3 regions of the world where you’re really operating and could you just very briefly summarize your feelings for the outlook, meaning Europe, the Pac RIM and North America.

Gary, North America, the growth rates we are baking into or thinking are GDP growth of around 2% to 2.5% and overall feelings are positive because we believe the things will continue to improve in U.S. or North American market. Europe, we baked in our thinking a flat kind of a year, economic growth wise in Europe and we stay somewhat concerned that Europe actually may do slightly worse than that and may finish 2012 with a negative growth in the European common markets. In Asia, from a growth point of view, it is obviously our strongest growing market. We’re expecting the growth in our key markets like China, India and some other markets to be around seven-ish kind of a GDP growth kind of numbers that are clearly softer than last year, and we clearly continue to watch it, a little bit concerned with all the news coming out of China that whether the growth would be 7% or slightly better or slightly worse. So overall, the growth is clearly highest in Asia, but year-over-year they are down, Europe year-over-year is down and U.S. seems to be improving and we think at the end of the day North American markets will be better than last year.

And then what categories of your sales make up most of Europe, is it mostly the EMS side or the other side of your business or it’s just spread around?

It’s spread around but we have good business in automotive sensors. In Europe as Tom pointed out we have approximately 40 million in euro denominated sales which are all European, primarily made in our Czech Republic and Scotland manufacturing facilities. We have probably little bit in EMS but very little not material to us. So I would say number one would be automotive and number two would be Electronic Components.

The next question comes from the line of Hendi Susanto with Gabelli & Co.

Yes, one follow-up question on the piezoceramic for hard disk drive components. What is the latest status of working with the second major hard disk drive, is there still some hope that you may be able to win some of awards there at this point?

Hendi, the answer is yes. We’re still working and we have -- we hope to win some business with the second disk traffic.

And then let’s say if you win some business, will that -- can they still be for 2012 or will it be for the 2013?

That is yet to be determined, if we sense that the term that ping on, I would say in the next couple of months. We may still be in a position to foresee some shipments in the fourth quarter. If they made the decision much later than that then I think that would probably fall in 2013.

[Operator Instructions] We have no further questions please continue.

I would like to 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 2, 2012. 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 244201. 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. You may now disconnect.