CTS Corporation — Q2 2019 Form 10-Q
Business context and reporting period. CTS designs and manufactures sensors, actuators, electronic components and engineered products for aerospace and defense, industrial, medical, telecom/IT, and transportation markets. This unaudited quarterly report covers the three and six months ended June 30, 2019; financial amounts below are in millions of dollars unless noted.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $120.7 | $118.0 | $238.3 | $231.6 |
| Gross margin | $41.2; 34.1% | $41.8; 35.4% | $81.8; 34.3% | $80.2; 34.7% |
| Operating earnings | $17.1; 14.2% | $14.5; 12.3% | $31.3; 13.1% | $27.9; 12.1% |
| Net earnings | $11.9 | $7.2 | $23.4 | $18.8 |
| Diluted EPS | $0.36 | $0.21 | $0.70 | $0.56 |
Cash flow and liquidity. First-half operating cash flow was $24.2 million, versus $27.7 million a year earlier. Capital expenditures were $9.4 million, compared with $14.9 million; cash increased $4.6 million to $105.6 million from year-end 2018. Working capital increased $18.7 million. At June 30, current assets were $250.4 million and current liabilities $96.3 million.
Debt and capital. Long-term debt was $50.0 million, unchanged from December 31, 2018; debt was 11.2% of total capitalization. CTS had a $300 million revolving facility, $248.2 million available after outstanding borrowings and letters of credit, and was in compliance with its covenants. The weighted-average borrowing rate was 3.54%. The company paid $2.6 million in dividends and repurchased $5.0 million of shares during the first half.
Material changes and management commentary
- Q2 sales rose 2.3% year over year and first-half sales rose 2.9%. Transportation sales increased 8.7% in Q2 and 7.4% for the first half; sales to other markets declined. Foreign exchange reduced sales by $1.9 million in Q2 and $3.6 million for the first half.
- Gross margin percentage declined in both comparison periods. Management attributed this primarily to ceramic foundry execution challenges and higher material and wage costs, partly offset by manufacturing-transition savings and other cost improvements.
- Operating earnings and net earnings increased despite lower gross margin percentage, supported by lower SG&A and, in Q2, substantially lower other expense. Prior-year Q2 SG&A included a $0.95 million environmental charge and $0.525 million in tax-project professional fees.
- The effective tax rate was 25.1% in Q2 and 22.7% for the first half, down from 37.7% and 30.2%, respectively. CTS attributed the decline primarily to a $1.703 million withholding-tax payment on a one-time Taiwan distribution in 2018.
- Sales concentration remained notable: Cummins represented 18.0% of Q2 sales and 18.3% of first-half sales; Toyota represented 11.8% and 11.1%, respectively. Honda represented 9.9% of Q2 sales and 10.1% of first-half sales.
Outlook, risks, contingencies and unusual items
- Management did not provide specific earnings or revenue guidance. It said operating cash flows and available revolver borrowings should fund working capital, capital expenditures and debt service for at least the next 12 months; additional financing may be pursued for liquidity or acquisitions.
- Restructuring charges were $0.9 million in Q2 and $3.0 million in the first half, mainly for relocation, severance and travel under the 2016 restructuring plan. The filing also reports $0.892 million of restructuring-related impairment charges in the first half.
- Environmental remediation reserves were $10.6 million at June 30. CTS reported environmental matters at several current or former sites, including Superfund sites, and cautioned that ultimate costs could materially exceed accrued amounts. Management said provisions for probable and estimable losses were recorded; it did not expect other pending contingencies to have a material impact based on information then available.
- CTS adopted lease accounting standard ASC 842 in January 2019, recording a $24.8 million lease liability and $22.1 million right-of-use asset at adoption, with no opening retained-earnings adjustment. The company reported $26.8 million of lease liabilities at June 30.
- Risks cited include economic and end-market conditions, customer reliance, pricing and demand, technology change, acquisition integration, international operations and foreign exchange, and litigation, environmental and product-liability matters. The filing reported no significant change in risk factors or material change in market risk; disclosure controls were deemed effective.
Important facts for investors to verify
- Whether transportation-market growth and customer concentration, particularly Cummins, are sustainable.
- Whether ceramic foundry execution issues, material costs and wage increases continue to pressure gross margins.
- The future cash cost and timing of environmental remediation and restructuring obligations.
- Revolver availability, covenant compliance and the effect of variable rates and foreign-exchange exposure.
- How share repurchases, dividends, lease obligations and the company’s capital-spending needs affect cash generation.