CTS Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 28, 2015; comparisons are with the periods ended June 29, 2014. Amounts below are U.S. dollars. CTS manufactures electronic components and sensors, primarily for automotive, communications, defense and aerospace, medical, industrial, and computer markets.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $100.1 million | $103.0 million | $198.4 million | $203.7 million |
| Gross margin | 33.3% | 32.8% | 33.0% | 31.6% |
| Operating earnings | $10.5 million | $9.9 million | $21.0 million | $20.8 million |
| Net earnings | $19.1 million | $6.4 million | $25.4 million | $11.4 million |
| Diluted EPS | $0.57 | $0.19 | $0.75 | $0.33 |
Q2 operating margin was 10.5%, versus 9.7%; six-month operating margin was 10.6%, versus 10.2%. The large net-earnings increase chiefly reflects a tax benefit, not a comparable increase in operating earnings.
- Cash flow: First-half operating cash flow was $15.5 million, compared with $10.1 million a year earlier. Capital expenditures were $3.9 million, and cash increased $12.3 million to $146.8 million.
- Liquidity and debt: At June 28, cash was $146.8 million and revolving-credit debt was $88.7 million, up from $75.0 million at year-end 2014. The $200 million facility had $109.0 million available; CTS reported compliance with its debt covenants. Working capital increased $17.8 million from year-end.
- Capital returns: CTS repurchased 626,882 shares for $11.4 million in the first half and paid $2.7 million in dividends. Dividends declared were $0.04 per share for Q2.
Changes versus prior period
- Sales declined 2.8% in Q2 and 2.6% in the first half. Automotive sales fell; management attributed approximately $2.1 million of the Q2 automotive decline and $4.5 million of the first-half decline to U.S. dollar appreciation against the euro and Chinese renminbi. First-half sales outside automotive increased $1.2 million, driven by electronic components.
- Margins improved despite lower sales, which management attributed to productivity, mix, restructuring savings, and favorable currency effects on operating costs. Q2 SG&A declined 3.7%; first-half SG&A increased 5.0%, primarily due to higher employee-related costs.
- First-half other expense improved to $1.2 million from $2.1 million, including a smaller currency-related impact. Interest expense was slightly higher, while interest income rose with higher cash balances.
- First-half operating cash flow increased year over year, although movements in receivables, inventory, accrued liabilities, and deferred taxes affected cash conversion.
Outlook, commentary, and notable items
- Outlook: No specific revenue or earnings guidance is provided. Management said operating cash flows and available credit were expected to fund working capital, capital expenditures, and debt service for at least the next 12 months; additional financing could be pursued for liquidity or acquisitions.
- Taxes: The Q2 effective tax rate was negative 75.7% and the first-half rate negative 27.7%, versus positive 34.0% and 38.7%, respectively, in 2014. CTS recorded a tax benefit tied mainly to its intent to amend 2006–2013 returns, changing the treatment of foreign taxes from deductions to credits. This was partly offset by a reserve for an uncertain tax position; approximately $0.82 million of potential interest was accrued. The benefit is unusual and should not be treated as a recurring operating trend.
- Restructuring: CTS added $4.25 million of planned costs to its April 2014 restructuring plan, including costs associated with an extended plant-shutdown timeline and equipment relocation, training, travel, and shipping. The plan includes eliminating approximately 120 positions. A separate 2013 plan was also amended; the filing describes approximately 350 planned position eliminations plus roughly 130 additional positions. The plans were expected to be substantially complete in 2015. First-half restructuring and impairment charges were $2.9 million, excluding restructuring-related costs included in cost of goods sold.
- Contingencies: CTS disclosed environmental remediation matters, including anticipated groundwater work at the Asheville site expected to commence in 2016; the scope of some further investigation or remediation remained undetermined. CTS was a co-defendant with Toyota in approximately 31 U.S. and Canadian lawsuits related to accelerator-pedal allegations. Toyota’s indemnity generally covers specified third-party civil claims, subject to stated exceptions and insurance limitations. Management said provisions for probable and estimable matters were adequate, but actual costs could differ.
- Other risks: Management cited customer reliance, automotive and other end-market conditions, pricing and demand, foreign exchange and international risks, technology changes, and litigation and environmental matters. One customer represented 10.3% of Q2 sales. CTS reported no significant risk-factor changes since year-end, no material change in market-risk disclosures, and effective disclosure controls.
Important facts for investors to verify
- How much of reported earnings growth reflects the nonrecurring tax-return amendment benefit, and what tax rate may apply in future periods.
- Whether revenue and automotive demand stabilize as currency effects, customer demand, and market conditions evolve.
- Whether productivity and restructuring savings sustain margin improvement, and whether revised restructuring costs and completion timing remain on plan.
- Future cash conversion, working-capital requirements, capital spending, and the use of credit capacity; the revolving facility matures in January 2017.
- Developments in Asheville remediation and Toyota-related litigation, including the reach and limitations of indemnification and insurance.