CTS Corporation — Q1 2016 Form 10-Q
Business context and period: CTS manufactures electronic components and sensors for automotive, communications, defense and aerospace, medical, industrial, and computer markets. This unaudited report covers the three months ended March 31, 2016; the comparable period ended March 29, 2015. Amounts below are in millions of dollars unless otherwise stated.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change / context |
|---|---|---|---|
| Net sales | $96.705 | $98.311 | Down 1.6% |
| Gross margin | $33.468; 34.6% | $32.136; 32.7% | Gross profit up 4.1% |
| Operating earnings | $12.433; 12.9% | $10.488; 10.7% | Up 18.5% |
| Earnings before taxes | $11.965 | $9.004 | Up 32.9% |
| Net earnings | $7.863 | $6.287 | Up 25.1%; net margin approximately 8.1% versus 6.4% |
| Diluted EPS | $0.24 | $0.19 | — |
| Operating cash flow | $0.353 | $0.483 | Low relative to net earnings |
| Capital expenditures | $2.877 | $1.192 | — |
Liquidity, debt, and balance sheet
- Cash was $130.964 million at March 31, down from $156.928 million at December 31, 2015; $129.997 million was held outside the United States.
- Long-term debt rose to $141.300 million from $90.700 million, primarily reflecting borrowing for the acquisition. Debt was 32.9% of total capitalization, versus 24.4% at year-end.
- The $200 million revolving facility had $56.385 million available; weighted-average interest rate was 1.8%. CTS reported compliance with debt covenants.
- Working capital decreased $16.213 million during the quarter. The filing attributes the cash decline principally to acquisition spending and capital expenditures.
- Cash used in investing was $75.704 million, including $72.830 million paid for the acquisition, net of cash acquired. Financing provided $49.993 million, including $50.600 million in net borrowings; dividends paid were $1.303 million.
Material changes and notable items
- Automotive sales increased $0.600 million on higher volume, partly offset by unfavorable foreign exchange. Other sales declined $2.206 million due to lower demand in certain end markets. Foreign exchange reduced sales by $0.699 million.
- Management attributed improved gross margin to efficiency and productivity gains, restructuring savings, and favorable currency effects on manufacturing costs. SG&A declined 5.3%, while R&D increased 18.5% as CTS invested in new products.
- CTS acquired CTG Advanced Materials, LLC on March 11 for approximately $73 million in cash. Preliminary purchase accounting included $63.110 million of goodwill and intangible assets and remains subject to valuation adjustments. The acquired business contributed $0.758 million of sales and a $0.064 million net loss after acquisition. CTS recorded $0.804 million of transaction costs in SG&A.
- No restructuring or impairment charges were recorded in Q1 2016, compared with $0.738 million of restructuring and impairment charges and $0.075 million of restructuring-related costs in Q1 2015.
- The effective tax rate increased to 34.3% from 30.2%, primarily due to withholding tax expense on China earnings not expected to be retained there; management expects this practice to continue.
Outlook, risks, and contingencies
- CTS gave no specific financial guidance in the filing. Management said operating cash flows and available revolver borrowings should be adequate for working capital, capital expenditures, and debt service for at least the next 12 months; it may pursue additional financing for liquidity or acquisitions.
- Key disclosed risks include acquisition integration, customer reliance, market and pricing conditions, foreign-exchange exposure, international operations, technology and intellectual-property risks, and environmental, litigation, and product-liability contingencies.
- Honda, Toyota, and Cummins represented 11.7%, 10.7%, and 10.4% of Q1 sales, respectively.
- Accrued remediation reserves were $20.819 million. CTS stated that reserves were adequate based on available information but cautioned that ultimate environmental investigation and cleanup costs could materially exceed current reserves.
- CTS reported no significant change in risk factors since year-end and no material change in market risk. Disclosure controls were assessed as effective at March 31, 2016.
Important facts for investors to verify
- CTG-AM’s final purchase-price allocation, integration progress, and contribution to revenue and earnings.
- Whether cash generation improves, given $0.353 million of operating cash flow against $7.863 million of net earnings, and whether the acquisition-related debt remains manageable.
- Sales trends by end market, foreign-exchange effects, and exposure to the three customers each exceeding 10% of quarterly sales.
- Future tax expense related to China withholding taxes and any cash-tax implications of foreign earnings or repatriation.
- Environmental remediation developments and whether the $20.819 million reserve remains sufficient.