CTS Corporation (CTS) Q2 2012 Earnings Report, Transcript and Summary

Ladies and gentlemen, good morning, thank you for standing by and welcome to the CTS Corporations Quarter 2 Earnings Call. [Operator instructions] I would now like to turn the conference over to our host, Director of Investor Relations, Mr. Mitch Walorski. Please go ahead.

Thank you, Tom. I’m Mitch Walorski, Director of Investor Relations, and I will host the CTS Corporation Second Quarter 2012 Earnings conference call. Thank you for joining us today. Participating from the company today are Vinod M. 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 to 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 Chairman and CEO, Vinod M. Khilnani.

Thanks, Mitch, and good morning, everyone. Last evening, we released our second quarter financial results for 2012. I’m pleased to report that total sales, adjusted net earnings, and free cash flow were all higher year-over-year from second quarter of last year and up sequentially from the first quarter. New business activity was healthy, and new product introductions remain on schedule. We also took some restructuring actions proactively in the second quarter to capture some productivity savings and further lower our overhead expenses. Our global headcount at the end of the second quarter was reduced by approximately 4%, while our sales from the quarter went up 5%. As a result, our productivity in terms of sales per employee improved by 9% year-over-year. The actions in this restructuring will also reduce our global manufacturing and office floor space through consolidation by approximately 10%. The excess floor space is now being either sublet or sold. Tom Kroll will comment further on our restructuring actions and savings going forward. Sales in the second quarter of 2012 at $154.3 million were up 5% year-over-year driven by a strong 12.9% increase in our Component and Sensor segment sales. This was partially offset by a 1.8% decline in the EMF segment sales, mainly due to weakness in the defense and aerospace and communications market. Within our Component and Sensor segment, total automotive sensor and actuator sales at $47.3 million were up a strong 17.3% from the same quarter last year, while global light vehicle production in units was up only 10% in that period. European light vehicle production was actually down approximately 10%, and a strong U.S. dollar versus Euro also had an adverse impact on revenue and earnings. Despite these factors, new product introductions, increased market share, and a strong bounce back in sales to Honda…

Thank you, Vinod, and welcome, everyone. Before we review the financial results in detail, I would like to comment on a couple of unusual second quarter items. First, our restructuring actions and second, our EMS Thailand facility flood-related insurance recoveries and expenses. So first, we proactively initiated a $5 million restructuring action to, number one, further reduce CTS’ overhead cost structure by consolidating a couple of manufacturing sites, and two, move some production to low-cost facilities, and finally, capture some synergies from our recent acquisitions by consolidating engineering functions. This restructuring will reduce head count by 260 employees and provide annualized savings of approximately $6 million. During the second quarter, we recognized $3.8 million, or $0.08 per share, of this $5 million restructuring charge. The remaining $1.2 million will be recorded in the second half of the year. Of this $5 million total restructuring amount, $3.2 million will be cash and $1.8 million will be noncash. Secondly, we received $7.4 million of insurance recoveries and incurred approximately $5 million of flood-related expenses and lost margins. The net of these 2 items benefitted the quarter by about $2.4 million, somewhat greater than expected, and as discussed in our first quarter earnings conference call earlier this year. All Thailand flood-related disruptions and transfers are now substantially complete. Now I’ll discuss the results. Our consolidated second quarter 2012 sales were $154 million, a 5% increase from both prior year and prior quarter. Our diluted earnings per share were $0.10 compared to $0.12 in prior year. Our adjusted earnings per share, which excludes restructuring and related charges, were $0.18 compared to $0.14 in the prior year, a 29% improvement. This improvement was due to a better business segment sales mix and higher sales volume. The quarter included a couple of offsetting non-operational items, specifically…

[Operator instructions] Our first question today comes from the line of John Franzreb with Sidoti & Company.

Actually, I want to start with the restructuring. Could you talk a little bit about how much is allocated to the EMS segment and how much to Components and Sensors? A little bit of color there would be helpful.

John, for the quarter, approximately 2/3 of that was EMS, but with the total restructuring about 60% will be EMS-related. For the full-year, as I mentioned, the annualized savings will be approximately $6 million. Full-year won’t be quite $3 million, but $2 million to $2.5 million of savings is what we would expect.

Now was the restructuring deemed necessary due to the customers lost from the downtime in Thailand, or is it more of a macro call, or is it a -- why did you deem it necessary at this time?

Good question, John. Let me give you some color and give you some examples of what is included in this restructuring. From the EMS point of view, you know in Scotland we have a fairly large automotive operation and with it we also have a small EMS operation. That operation standalone, nothing to do with Thailand floods, we did not think was -- the critical mass and was, in the long run, a profitable operation. And so, we essentially exited from EMS operations in Scotland. So that’s probably the big chunk of the EMS. Since we did that we selectively looked at all of our operations and over the last year or so all the productivity improvements really helps, the little bit of work which we have been doing. We took the opportunity to tweak our indirect head count down a little bit. But the main thing was the Scotland operation. Along with this restructuring, as a result of the Valpey-Fisher acquisition, we had recognized synergistic opportunities between the 2 engineering organizations. We had our own frequency engineering capabilities near Chicago, and Valpey had their own in Hopkinton, near Boston, so we’re consolidating those 2 and achieving those synergies from that acquisition, and so we are reducing our engineering capabilities in Chicago and consolidating that with Valpey-Fisher. We also found opportunities to move from manufacturing from our Tucson facility and take it either to our Albuquerque facility or Nogales, Mexico facility in electronic components. So, we are consolidating our Tucson manufacturing and thereby eliminating all manufacturing in Tucson. Another example of some productivity improvement is that when we bought -- when we did the little acquisition in Switzerland, Fordahl, they were doing some manufacturing, which was overlapping with either our Singapore facilities, or Boston, Valpey-Fisher facilities. So we are exiting that manufacturing, nothing big, just small. But, we found a lot of synergistic opportunities, either created by the Valpey acquisition, or our other productivity improvement actions we have done. As a result, as I pointed out, we have roughly 200,000 square feet of freed up space. Which we are either pursuing subletting, or selling or doing some combination of sale/leaseback kind of transaction, so that we can bring our footprint and make it more efficient.

Okay. Vinod, so, then with the combination, and again, I just want to stick to the EMS side of this conversation. The combination of exiting from lower profitable customers, some of these consolidation actions on the EMS side, let's talk about some of the historical target margins you've had on the EMS. Is it now more achievable? Is the number now higher, or do macro conditions make that still a bit of a stretch?

I think, I will not make the target higher, John. You do these actions to make them more achievable, higher probability, quicker, or all of the above.

Okay. You know, I'll just ask one more question, and then I'll let somebody else go. Regarding the insurance recoveries; how much are you allowing for in Q3?

John, we expect to recover $3 to $4 million, in Q3. [indiscernible] expenses.

Say that again.

John, Q3 will also have expenses of $1 to $2 million. So, net-net should be positive by $1 million to million.

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

A couple of things. Number one, did you, or do you give us what the actual revenues were from the piezo product were?

John, in investor presentations we have a slide on piezo. In that slide, we have said in the past, that in 2012 our piezoceramic sells would be more around $30 million. While 2011 was $20 million. You know, that number has been going up and down. If you would have asked me that question a couple of weeks back, we heard that the disk drive industry was pairing down their orders. Today, I think they are putting some of those back, in the fourth quarter. I suspect, based on the forecast we have today, we'll come very close to that $30 million number, which we had projected earlier.

Okay. But you don't give it for the quarter year. That's what I'm trying to get at.

We historically haven't, but we can give you an approximate range. Tom, you have the piezoceramic sales, approximately in the quarter.

Yes. The piezoceramic sales, Gary, were about $6.5 million.

Okay. That's fine. Thanks. And then, a couple of housekeeping, then some other big picture. You said your effective tax rate for the year is going to be about 25%?

That's correct.

So, there will be some catch up in Q3 and Q4, because you didn't, you had very minimal taxes in Q1, or am I reading that wrong?

No, you're right. But we also had very minimal income in Q1.

Right. Okay. That's fine. Then, in terms of in the verbiage in the press release, we're now talking about lower economic growth, including negative economic growth in Europe. In my recollection this is the first time this has kind of come up, but if we look at your guidance where it was and where it is now; you've got a delta of about $35 million of revenues. I guess, just for our purposes, can you maybe break that down into how much is currency, how much of that is negative economic growth in Europe. Is most of the negative economic growth coming out of Europe, then further between your various divisions?

I think it's a combination, as you said of FX, Europe and softness in some specific areas like defense and aerospace. My guess, Gary, would be, and we can do some more work and give you some more clarity on that. Our estimate is that FX is probably $4 to $5 million, of that amount. We believe Europe is probably another $10 to $15 million. The remaining is softness in industries like defense and aerospace. Where we have seen some of our large customers just push out the orders. They may yet materialize, but it's just that everybody is hedging their bets. We have seen some defense and aerospace weakness; we have seen weakness in our distribution and buy/sell side of the business. So it's a general, one notch more weaker, and more globally, I would say, combined by a much sharper drop in Europe.

Is Europe, most of what you're doing in Europe is not auto related, or is it?

Not what related?

Not auto. It is auto.

It is primarily auto, but it is also electronic components and some EMS. Did that address your question, Gary?

Well, I guess it is, just looking at, as I said this just started cropping up, and so this is some good directionally, where things could go. But, this is not any cancellation of any programs or anything.

No.

It's just across the board slows.

No, not at all. The other thing, Gary, that happened was the bulk of our sales drop, is primarily driven by EMS. That's not to say that we only saw weakness in EMS. We saw weakness in other of our component sensors too. However, we had some positive news on component sensor, which was not expected. In fact, we pulled up the launch of the [indiscernible] actuators. So, some of the component sensor sales declines, or negative surprises are offset by some of the market share which we gained, which was not expected, frankly. So the net-net, our guidance down is primarily coming from the EMS, which helps from a bottom line impact, point-of-view.

Okay. So there's been nothing, all the other product launches are on track, like the hard disk drive pedal module, and then the diesel engine products?

Yes. We had no program cancellations, we had no business lost.

I just -- what is the total sales going to Europe now? About 17% or 12%?

Tom is checking. I think it's more like 17%, but let us double check that.

Yes. Gary, just give me one moment and I'll give you that. [indiscernible]. 15%, 14% to 15%. So, Gary it's approximately 15%, 16%.

Our next question today, comes from the line of Hendi Susanto, with Gabelli & Company.

First question is, I would like to understand better, like how we should think of the profitability related to the guidance. You are lowering the annual revenue growth, but keeping the same earnings guidance. I'm wondering what drove higher profitability, despite the lower revenue target. I would think that part of it is driven by more favorable product mix, and any color is appreciated.

Hendi, as we said, the bulk of the reason we are lowering the sales projection is because of EMS. That is by definition, a lower margin business. So we have a smaller amount we have to overcome, because of the lower sales. We are expecting that the savings generated from these proactive restructuring actions we have taken in the second quarter, and will take some more in the third quarter, as Tom indicated. Some more would be in the third quarter, which I included in the numbers. They should help us offset the bulk of the sales decline, is our expectation. Because, bulk of the sales decline is coming from EMS, it slightly improves our segment mix, which makes it easier to do that.

Okay. Then, if I look at your EMS segment, the operating margin is stronger than my expectations. It's running at like 5.4%, which is relatively high compared to the previous several quarters. I'm wondering whether you can provide any insight into that.

Yes. Hendi, as Tom said, the segment is benefiting from the insurance proceeds. Which are disproportionately large in this quarter, compared to the accrual expenses. So, just like we had the first quarter where EMS had the flip side, they had expenses but no insurance recoveries, they were hurt by that, it was fourth quarter last year.

And the first quarter.

And first quarter. This quarter has the opposite effect. So, I think this year, when the year is complete, we probably need to highlight for you what were the true insurance, flood related expenses and the reimbursements. So that you can get a better gauge of what the true margins are.

Okay. Then, may I know how much sales of [indiscernible] was in Q2, and what's their projection for the remainder of the year?

I think the Q2 number was fairly small. Probably $1 million range. Q2 number, I think should be more -- Q3 numbers should be -- between Q2 and Q3 -- I'm sorry. Between Q3 and Q4, probably we'll do another $3 million.

Then, when will you see the full production ramp of the grill shutter?

The full production ramp should be by the fourth quarter. We had said earlier, Hendi, that the grill shutter, on a full year basis, is probably in the $8 million per year, kind of a business.

Okay. Then, I would like to think of what OpEx looks like, excluding the, like flood reimbursement and cost. May I know where the $5 million related costs is buried in the income statement?

Yes, Henry, or Hendi. That's a very good question. That $5 million is all in cost of goods sold, on the statement of income.

Okay. I see. So, the OpEx run-rate is something we can think of for the remainder of the year?

I'm sorry. Ask your question again.

The OpEx run-rate, should we expect OpEx to run about at the same level, for the remainder of the year?

Yes. Pretty much. If you look at the selling and general and administrative expenses, they're about $19.3 million. That, coupled with about $5 million, of R&D. That's a pretty decent run-rate.

[Operator Instructions] And we will go to the line of John Franzreb, with Sidoti & Company.

I just want to kind of review your expectations on the top-line, guys. What, in your guidance, what are you assuming is the EMS revenue outlook for the balance of the year?

John, I think historically, we have not broken out our guidance, from looking at my notes.

So, John, if we look at EMS for a full year standpoint, it's going to be slightly down, probably, to last year. In a very rough range.

Okay. That makes sense with what I'm looking at now. And, if I strip out new program revenues, like the Somalian actuator and the grill shutter. What is the, call it organic growth, in components and sensors, how does that kind of play out?

Let me give you some directional help on that. I think that within our component and sensors, my sense is that the sensors piece, will still have very strong double-digit growth, year-over-year. Because of new programs, or, if you remember last year, we were affected by the tsunami, and so the year-over-year increased its shipment to our Japanese customers, is pretty robust.

Easy comp there. Right?

Easy comp there, and combined with new products. As I gave you examples, there were a couple of platforms which we shared with the competitors, in the U.S. This year, we're full force on that one. So between components and sensors, sensors and actuators would be very strong. An electronic component piece is a little bit worrisome, and we're watching some indicators. Because it looks like that within that piece, we have a stronger piece, which is piezoceramics, which is helped by the disk drives. But we have a couple of fairly weak pieces, one is the distribution and buy/sell business seems a little weak. The other piece is some ceramic filters, or some of the electronic components we're selling to tier 2 people who then sell to the tier 1 defense and aerospace customers, like Raytheon type people. That segment seems weak, and a lot of question mark on it, on whether it's going to bounce back in the fourth quarter or not. So, we're worried about defense, we're worried about some telecoms infrastructure projects, for customers on a global basis, and we're worried about some distribution and buy/sell businesses. So, we're kind of trying to balance a weak electronic components side, with a fairly strong sensors and actuators side; and that's creating some uncertainty.

That's perfect, Vinod. That's exactly what I was looking for. I guess, on the CapEx side, is there any major spending that's going on here? Or, can you just address the CapEx budget for the balance of the year?

Nothing major. However, we do have a possibility of somewhat of an uptick, in the third and fourth quarter. Purely because we are winning new business.

Ladies and gentlemen, there are no further questions at this time.

I would like to remind our listeners, that a replay of this conference call will be available from 1:30 p.m. Eastern daylight time today, to 11:59 p.m., on Tuesday July 31, 2012. The number for the replay is 800-475-6701, or 320-365-3844, if calling from outside the U.S. The access code is 254229. Thank you for joining us today.

Ladies and gentlemen that does conclude our conference. Thank you for your participation and for using the AT&T Executive Teleconference. You may now disconnect.