CTS Corporation — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. CTS designs and manufactures sensors, actuators, and electronic components for transportation, industrial, medical, aerospace and defense, and telecom and IT markets. Unless otherwise indicated, amounts below are in USD millions, rounded.
Financial performance and liquidity
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Net sales | $84.2 | $120.7 | $187.3 | $238.3 |
| Gross margin | $26.6; 31.6% | $41.2; 34.1% | $59.5; 31.8% | $81.8; 34.3% |
| Operating earnings | $6.2; 7.4% | $17.1; 14.2% | $14.7; 7.9% | $31.3; 13.1% |
| Net earnings | $4.9 | $11.9 | $8.7 | $23.4 |
| Diluted EPS | $0.15 | $0.36 | $0.27 | $0.70 |
| Operating cash flow | Not reported quarterly in this filing | $23.7 | $24.2 |
- Q2 gross margin fell 2.5 percentage points year over year, mainly from lower volume, partly offset by cost reductions. Operating margin declined 6.8 points as sales fell faster than operating expenses.
- At June 30, cash was $146.0 versus $100.2 at year-end 2019; current assets were $264.8 and current liabilities $77.8. Long-term debt was $141.3, up from $99.7. CTS reported net cash, defined as debt less cash, of $4.7, and $157.0 available under its revolving credit facility, subject to covenants.
- First-half cash generation included $23.7 operating cash flow and $7.2 of capital expenditures. Cash increased $45.7, principally reflecting $41.6 of net additional borrowings. Dividends paid were $2.6 and share repurchases were $8.1.
- The credit facility had a 2.17% weighted-average interest rate at June 30. CTS reported compliance with all debt covenants.
Material changes and business drivers
- Q2 sales declined 30.2%; first-half sales declined 21.4%. Transportation sales fell 52.5% in Q2 and 37.4% for the first half. Sales to all other markets combined rose 14.2% in Q2 and 10.7% for the first half.
- QTI, acquired in July 2019, contributed $5.4 of Q2 sales and $11.0 in the first half. Foreign exchange reduced year-over-year sales by $0.8 in Q2 and $1.3 for the first half.
- SG&A declined in dollars but increased as a share of sales: 17.4% in Q2 versus 14.1% and 16.8% for the first half versus 14.5%. R&D was 6.6% of Q2 sales and 6.9% of first-half sales, also above prior-year ratios.
- First-half interest expense increased to $1.8 from $0.9, primarily due to higher debt. First-half other expense was $1.7, attributed principally to pension expense and foreign currency translation losses. Q2 other income was $0.3, mainly from currency translation gains partly offset by pension expense.
Outlook, risks, contingencies, and unusual items
- COVID-19: Management said the pandemic disrupted customer demand, CTS production, suppliers, and operations, including mandated facility closures and labor restrictions. It expected these effects to continue in the second half of 2020 and warned that prolonged disruption could materially affect results, financial position, and cash flows. The duration and magnitude were not quantifiable. The filing provides no specific numerical financial guidance.
- Restructuring: CTS said it was implementing a new plan starting in July 2020 to adapt costs to lower demand and the expected multi-year transportation-market recovery. The plan focuses on manufacturing-footprint optimization and operational efficiency; expected charges and savings were not quantified. Q2 restructuring charges were $0.1, versus $0.9 a year earlier.
- Pension plan: CTS set July 31, 2020 as the effective termination date for its U.S. pension plan. The process is expected to take 12–18 months and requires regulatory approvals. The company expects no required cash contribution because plan assets exceed estimated liabilities; settlement would reclassify pension losses from accumulated other comprehensive loss into earnings.
- Environmental and legal matters: Remediation reserves were $9.3 at June 30. CTS is potentially responsible for contamination at several sites, including two designated Superfund sites, and notes that ultimate costs from environmental, legal, or warranty claims could exceed accruals and materially affect results or cash flows.
- Other items: A $1.0 asset impairment charge was recorded in Q1. The Q2 effective tax rate was 17.6%, partly reflecting favorable tax items and reduced uncertain-tax-position reserves; the first-half rate was 27.1%, affected by valuation allowances on certain U.S. tax credits and the decision not to permanently reinvest Taiwan subsidiary earnings. COVID-related rent concessions were not material.
- Key risks also include customer concentration, competition, pricing and demand, technology changes, international and currency exposure, acquisition integration, and potential litigation or product-liability claims. Cummins represented 13.4% of first-half sales; Toyota represented 11.7%.
Important facts for investors to verify
- Whether transportation demand and production recover as expected, and how prolonged COVID-19 disruption affects sales, margins, and cash conversion.
- The cost, timing, and expected savings of the restructuring plan announced for July 2020, once disclosed in subsequent filings.
- Credit-facility availability and covenant headroom if cash needs or borrowings increase.
- Final regulatory approvals, settlement accounting, and any earnings impact from the U.S. pension-plan termination.
- Changes in remediation estimates, legal or warranty exposure, and the recoverability of goodwill and intangible assets under continued weak market conditions.