Oct 29, 2013
Executives
Thomas A. Kroll – Vice President and Chief Financial Officer Kieran M.
O’Sullivan – Chief Executive Officer
Analysts
John Franzreb – Sidoti & Company Hendi Susanto – Gabelli & Company, Inc. Jim Francis McAree – Neuberger Berman LLC
Operator
Ladies and gentlemen, thank you for standing by and welcome to the CTS Third Quarter Earnings Call. At this time, all lines are in a listen-only mode.
Later, there will an opportunity for your questions and instructions will be given at that time. (Operator Instructions) And as a reminder, this conference is being recorded.
I’ll now turn the conference over to your host, Tom Kroll. Please go ahead, sir.
Thomas A. Kroll
Thank you, Cathy and thank you for joking us this morning. My name is Tom Kroll; I am the CFO of CTS.
And joining me today is Kieran O’Sullivan, our Chief Executive 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 reconciliations are available on our website in the Investor Relations section. I will now turn the discussion over to our CEO, Kieran O'Sullivan.
Kieran M. O’Sullivan
Thanks, Tom, good morning and thank you for joining us today. Last evening we've reported third quarter sales of $159.6 million, an increase of 5.3% from the prior quarter; and then increase of 16.2% from the same period last year.
Third quarter net earnings increased 18% to $0.20 per share from $0.17 per share in the same period last year on a GAAP basis. Non-GAAP net earnings were $0.24 per share compared to $0.20 per share in the same period last year and $0.20 per share in the second quarter of 2013.
As I share our results for the quarter, I want to reiterate the priorities that I shared with you in the last two quarters and they remain unchanged. It’s a strong focus on building leadership strength globally, to complete strategic analysis of our business with an emphasis of simplification of the business model, focused on margins, operating expenses and the lean corporate while driving utilization levels in our operations and beginning to align the culture and performance management to maximize shareholder return by driving profitable growth.
Before I get into the details of third quarter, you can expect three themes to become more and more visible in the next quarters and the years ahead. We are strategically repositioning our business and we will initially become a smaller company to merge and grow profitably.
These three themes are simplification; you have already seen the initial reduction of our footprint, which is on track to our planned timelines. More recently, we divested our EMS business which enables the management team to more quickly focus on our core business.
Second theme is focused on improving gross margins, managing operating expenses prudently including a lean corporate and emerging as a stronger and more focused company. And the third theme is driving profitable growth.
Taking actions to strengthen the capabilities at the core business and carefully growing, aligning the culture and performance to enable the right organic and inorganic investments to drive profitable growth while maximizing shareholder return. Let’s briefly discuss our EMS performance.
EMS segment sales of $55.9 million decreased $5.9 million in the third quarter from the same period last year, but increased $9.8 million from the second quarter of 2013. Third quarter Component and Sensor segment sales of $103.6 million grew $28.1 million or 37% from the prior year of which $11.8 million came from the D&R acquisition.
Compared to second quarter 2013, the Components and Sensors sales decreased $1.7 million or 1.7%. The decrease was primarily driven by softness in demand in our HDD PAs or products.
We expect this softness to continue into the early part of 2014 and then return to more normal levels as inventories are depleted and new platforms are launched. The integration of D&R is on track as well as the transition of manufacturing from our Scotland and Carol Stream operations.
We expect these transitions to be completed by second quarter of 2014. Overall gross margins reduced slightly with the increased sales in EMS.
SG&A cost reduced from 14.1% in the third quarter of 2012 to 13% for the third quarter of 2013. R&D cost increased from 3.2% in the third quarter of 2012 to 3.6% in the third quarter of 2013.
We have reduced our debt leverage to 32.3% in the third quarter from 36.4% at the end of last year. Cash flow from operations improved as it controlled our working capital.
Tom will provide more details on these metrics as well as our inventory turns improvement while we built finished goods to enable the restructuring of our manufacturing operations. On the new business front, we secured new orders of $105 million in the quarter, $68 million of the $105 million was for automotive pedals and sensors.
We received our first award for haptic pedal with an Asian OEM which we’ll launch in 2016. We entered into a general procurement agreement around our ClearPlex filter technology with a major OEM.
The application is recognized as a technology breakthrough for small base stations. Additionally, our piezo products were selected for hydrophone applications in sonar arrays for the navy.
Full year 2013 sales are expected to be in the range of $555 million to $560 million reflecting the October 2 DMS divestiture. We are maintaining 2013 adjusted earnings per share guidance in the range of $0.78 to $0.83 per share.
I am encouraged by the initial progress we are making this year. The management team and I remain vigilant, we are keenly aware that we have much more to accomplish to deliver future profitable growth and carefully grow our business next year.
I will now turn the call over to Tom to provide additional details on our Q3 results. Tom?
Thomas A. Kroll
Thank you, Kieran. As Kieran just mentioned, our third quarter 2013 sales were $159.6 million, an increase of $8 million from the prior quarter and an increase of $22.2 million from the prior year.
Our gross margins were 23.5% versus 19.4% last year or a 4.1 percentage point improvement, primarily due to the component and sensor segment mix growing to 65% of total sales in the third quarter of 2013 versus 55% in the third quarter of 2012. Our margins of 23.5% were similar to the gross margins of 23.4% in the second quarter 2013, despite higher EMS sales in Q3 versus Q2.
Our selling, general, administrative expenses were $20.8 million versus $19.4 million last year. The increase from last year was primarily due to the D&R acquisition related amortization expense and CEO transition cost.
The third quarter 2013 R&D expenses were $5.7 million, increasing from the $4.4 million last year and reflects our continued commitment to invest in our future. As a percentage of component and sensor segment sales, the R&D was 5.5% in the third quarter 2013, compared to 5.8% in the same period last year.
The restructuring and related charges were $1.1 million in the third quarter 2013. Of this amount $1 million is reflected on the restructuring line on the P&L and the remaining $0.1 million is included in cost of good sold.
These costs are part of our second quarter restructuring plan of $16 million to $20 million. This restructuring plan, when completed in mid-2014, is expected to generate $8 million to $ 10 million of annualized savings going forward.
Our third quarter net interest currency and other income were $0.3 million or $0.3 million lower than last year. On a full year basis, we continue to expect our adjusted effective tax rate which excludes the second quarter tax expense of $11.8 million from repatriating $30 million of cash from Singapore and the UK tax write-off related to our restructuring to be approximately 25%.
The third quarter net income was $6.8 million or $0.20 per share compared to net earnings of $5.9 million or $0.17 per diluted share in the same period last year. Excluding our restructuring cost and certain other cost, our third quarter adjusted earnings were $0.24 versus adjusted $0.20 in both the prior quarter and the prior year.
Now let’s look at the balance sheet, cash and cash equivalents were $96.7 million versus $109.6 million at the end of 2012. Debt was $128.6 million versus $153.5 million at the end of 2012.
These cash and debt changes were primarily due to using the $30 million cash repatriation to pay down debt. We finished the quarter with a debt to capitalization ratio of 32.3% compared to 36.4% at year end 2012.
Our cash as you know is overseas and our debt is U.S. based.
On October 2, 2013 we sold our EMS business for $75 million. This $75 million was received in the U.S.
enabling us to pay down our debt. From a working capital perspective, our accounts receivable were 53 days versus 52 days a year-ago, our accounts payable were 64 days, or the same as last year, and our inventory turns improved to 5.8 turns versus 5.6 turns in the third quarter.
Our controllable working capital that we define as these three accounts, receivables payables, and inventory was 17.2% of annualized sales improving from both prior quarter up 17.9% of sales and the year-over-year percent of 17.6%. Our management team continues to focus on improving these metrics.
With the EMS divestiture, our overall controllable working capital as a percentage of sales is expected to improve by several percentage points. Our third quarter 2013 cash flow from operations was $15.3 million versus $13 million in the same period last year and improved from the second quarter 2013 up $13.7 million.
Third quarter 2013 capital expenditures were $2.5 million versus $2.9 million in the third quarter 2012 and $3.7 million in the second quarter 2013. Our third quarter 2013 cash flows which is defined as cash flow from operations less capital expenditures was $12.8 million compared to $10.1 million last year, and improved from the second quarter of 2013.
We continue to expect our full year capital expenditures to be approximately 3% of sales. During the fourth quarter, we repurchased approximately 49,800 shares of CTS stock for $731,000 at an average price of $14.69.
This is up slightly from our second quarter repurchases of 44,900 approximately 268,000 shares remain from our 2012 1 million share buyback authorization. For the first nine months of 2013, we repurchased approximately 200,000 shares for $2.2 million.
As previously announced, on June 11, the Board of Directors authorized the repurchase of up to one million additional shares of the company stock. This concludes the financial overview.
I will now open the call for questions. Thank you again.
Operator
(Operator Instructions) Our first question is from John Franzreb with Sidoti & Company. Go ahead, please.
John Franzreb – Sidoti & Company
Good morning, guys.
Kieran M. O'Sullivan
Good morning John.
John Franzreb – Sidoti & Company
Kieran, if I heard you correctly, you said that the piezo product pipeline was soft in the quarter. But components and sensors on an organic legacy basis still had a very strong quarter.
Could you talk about the pieces that offset the weakness in the HDD product line?
Kieran M. O’Sullivan
Yes, maybe first just on the HDD side of it. We had some softness there related to the enterprise and desktop platforms and that will continue a little bit.
But we expect that to fully come back as inventory levels are burned off and they transition into the newer platform, so not too concerned about that. Other things we had going on as we had some increases on the pedal business we had some increases especially with an Asian OEM that helped to spike several million.
So they are probably some of the key points John.
John Franzreb – Sidoti & Company
And how much was the automotive side first on a year-over-year basis versus a year ago?
Kieran M. O’Sullivan
Marginally, from a quarter-over-quarter marginally up, and year-over-year, Tom, you have the number there?
Thomas A. Kroll
Yes. Year-over-year for automotive, John, that’s about $72 million, but keep in mind that has almost $38 million or $37 million of D&R sales in it.
John Franzreb – Sidoti & Company
All right, right, right. Do you have that number on a – okay, that’s fine.
And Kieran, you mentioned that one of the keys which we should be focusing on, I guess notably to me was the gross margin. As a focus, what actions will you be taking to improve that gross margin profile in addition to what you’ve already announced?
Kieran M. O’Sullivan
I think there were two or three components. That first think that you’re already aware of I think is historically we’ve talked about components and sensors as the high margin business and with the divestiture of EMS.
You're going to see that profile changed to a much higher levels. Just as a means of management, it’s where you invest in the new products going forward and quite honestly over-spoken focusing on products in the portfolio in terms of driving margin improvement action.
That’s a constant thing that we focus on. And not right down to the materials, to the operation, different parts that you control.
John Franzreb – Sidoti & Company
Do you have an internal rate of return that you target the new product introductions that you want to more share with us?
Kieran M. O’Sullivan
John, as a general rule, we want to exceed the 12% type of range.
John Franzreb – Sidoti & Company
Okay, perfect. And Tom you mentioned in your remarks that the cash from the EMS divestiture we used to pay down debt, you can’t post quarter.
So can you kind of – have you paid down the debt that can give us an update on what you expected that may be to finish the year-end and how much cash you expect to have?
Thomas A. Kroll
Sure, John as we – the cash did come two days after we closed the quarter. And if you look at our cash that we had at the end of Q3, it was about $98 million like I said.
The debt was about $128 million. We would expect to still generate some cash in Q4 during the normal course, but that debt would most likely come down from $130 million or so by that $75 million.
John Franzreb – Sidoti & Company
Okay. Shipping the whole proceeds to paying down the debt?
Kieran M. O’Sullivan
Yes, initially John, because we sweep then those right against our revolver.
John Franzreb – Sidoti & Company
That’s fine. Okay.
I’ll get back in the queue. Thank you, guys.
Operator
Thank you. And then we’ll go next to Hendi Susanto with Gabelli & Company.
Go ahead please.
Hendi Susanto – Gabelli & Company, Inc.
Good morning, Kieran and Tom.
Kieran M. O’Sullivan
Good morning, Hendi.
Hendi Susanto – Gabelli & Company, Inc.
Yes. So my first question is, with regard to the annual saving of restructuring of the $8 million to $10 million target, how much of that will be reinvested and how much of that will be freed?
Kieran M. O’Sullivan
Well, we’ve guided already that for next year that savings coming in the second half from the restructuring is $8 million to $10 million and then I think what you can expect to see from an investment perspective is our R&D even historically has been around the Components and Sensors, very little on the EMS side. So you can expect it to continue in the 5% to 6% range on the R&D and nothing unusual to call it.
Hendi Susanto – Gabelli & Company, Inc.
Okay, yes. And then, Tom, I think I may have missed this during the call.
May I know how much of automotive sensor and actuator sales in the third quarter?
Thomas A. Kroll
How much were the Components and Sensors sales?
Hendi Susanto – Gabelli & Company, Inc.
The automotive sensors and actuators.
Thomas A. Kroll
Through the quarter…
Kieran M. O’Sullivan
Tom, high 60s.
Hendi Susanto – Gabelli & Company, Inc.
High 60s?
Thomas A. Kroll
As a percentage, I’m sorry, Hendi. Yes.
Hendi Susanto – Gabelli & Company, Inc.
Okay, high 60s. So the electronic components is in the upper 30s?
Kieran M. O’Sullivan
Yes, somewhere in that range.
Hendi Susanto – Gabelli & Company, Inc.
Okay. So you don’t disclose the official number anymore?
Kieran M. O’Sullivan
We can get it for you, not a problem, but it’s kind of a 65/35 mix, something like that.
Hendi Susanto – Gabelli & Company, Inc.
I see. Okay.
And then, Kieran, do you have any update on smart actuator, like what kind of annual run rate it is going at the moment?
Kieran M. O’Sullivan
Yes. I think we mentioned on earlier calls that we’re running in the mid 20 range in sales and we also were very cared that we’re focused on driving the gross margins.
That’s something that’s in constant focus.
Hendi Susanto – Gabelli & Company, Inc.
Okay. Thank you.
Let me get back to the queue.
Operator
Thank you. Then we’ll go next to Jim McAree with Neuberger Berman.
Go ahead please.
Jim Francis McAree – Neuberger Berman LLC
Hey, good morning gentleman. Just two questions.
Kieran, I just want to make sure I understood on the strategic repositioning that you’ve done. You’ve divested EMS.
Are there any further updates that we should be thinking about in that regard? It sounded like the progress may still be continuing?
Kieran M. O’Sullivan
No. I would say very clearly with the divestiture of EMS we’re back focused on the core and obviously as part of looking to the future we’re optimizing always the products in the portfolio, but we’re back to the core essentially.
Jim Francis McAree – Neuberger Berman LLC
Okay, very good. And then, maybe is there the renewed focus on CNS and particularly in R&D?
Is there anything that you can describe to us in terms of the target of the R&D spend, where there projects that didn’t get funded in the past because the corporate constrains or are there new things that you’re exploring with fresh dollars?
Kieran M. O’Sullivan
I would tell you that some examples that we called at this morning were the first half pedals the ClearPlex technology, some of what – the things we’re building off in piezo. So there is a number of things that are continuing, but also I would tell you that you don’t expect the R&D profile to change, but do expect this to continue to adapt and be very focused in terms of where we will invest even building some of the skill sets from things we have done is bringing in some mechatronic capability and skill sets in that area, but nothing to spell out today.
Jim Francis McAree – Neuberger Berman LLC
Right, thank you for the update.
Thomas A. Kroll
You are welcome.
Operator
Thank you. (Operator Instructions) We have a follow-up from John Franzreb with Sidoti & Company.
Go ahead, please.
John E. Franzreb – Sidoti & Co. LLC
Kieran, I haven’t heard much about an appetite for acquisition, it seems like you have lot of the growth that you are looking for is going to be internally driven, am I perceiving that properly?
Kieran M. O’Sullivan
We are going to look at both organic and inorganic investments and so you can expect to hear more of that going forward. We talked in the press release about bolt-on acquisitions and adjacent technologies and yes, it’s possible we consider geographic regions that we could leverage our capabilities with as well.
John E. Franzreb – Sidoti & Co. LLC
Could you put a framework about the size of the acquisitions looking at a – well, could you put a framework around that?
Kieran M. O’Sullivan
I don’t want at the moment, but let me give you some color on it. When you look at the component side of it, there is a few different areas we are looking in there, they could be smaller sized acquisitions to fill out some parts of the portfolio.
On the sensor side of it and on the automotive side of it, we are looking at in enhancing our product profile and mix there that could be something a little different, but it’s got to be the right acquisition at the right point in time, we are not just going to do anything.
John E. Franzreb – Sidoti & Co. LLC
Okay, thank you.
Kieran M. O’Sullivan
You’re welcome.
Operator
Thank you, and gentlemen we have no one else in queue.
Kieran M. O'Sullivan
We will give just another minute in case there is another question.
Operator
(Operator Instructions)
Thomas A. Kroll
Hey Cathy, I think at this point you can give the replay information. Thank you.
Operator
Okay, thank you. Ladies and gentlemen, this conference will be available for replay after 1:30 PM today through midnight Tuesday November 5.
You may access the AT&T Executive playback service at anytime by dialing 1800-475-6701 and entering the access code, 306043. International callers, dial 320-365-3844 using the same access code, 306043.
And Mr. Kroll, did you have any closing remarks?
Thomas A. Kroll
No, thank you very much, Kathy.
Operator
Okay, thank you. Then ladies and gentlemen, that does conclude our conference for today.
Thank you for your participation and for using AT&T Executive teleconference. You may now disconnect.