CTS Corporation — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013; comparisons are to the quarter and six months ended July 1, 2012. CTS makes electronic components and sensors and provides electronics manufacturing services (EMS), primarily for automotive, communications, defense and aerospace, industrial, and related markets. Amounts below are in U.S. dollars.
Financial performance
| Metric | Q2 2013 | Q2 2012 | First six months 2013 | First six months 2012 |
|---|---|---|---|---|
| Net sales | $151.6 million | $154.3 million | $301.1 million | $301.3 million |
| Gross margin | 23.4% | 16.8% | 22.1% | 15.9% |
| Operating earnings | $1.7 million | $5.7 million | $4.7 million | $7.6 million |
| Net earnings (loss) | $(11.3) million | $3.3 million | $(7.8) million | $5.6 million |
| Diluted earnings (loss) per share | $(0.34) | $0.10 | $(0.23) | $0.16 |
| Operating cash flow | — | $10.2 million | $12.0 million |
Q2 gross profit was $35.5 million; operating margin was 1.1% and net margin was (7.5%). For the first half, gross profit was $66.7 million, operating margin 1.6%, and net margin (2.6%). The filing reports $8.4 million of capital expenditures in the first half of 2013. Cash and cash equivalents were $86.0 million at June 30, down from $109.6 million at year-end 2012.
Balance sheet and liquidity
- Long-term debt was $129.5 million, down from $153.5 million at December 31, 2012. The revolving facility matures in 2017 and carried a 2.0% weighted-average rate.
- CTS had $67.9 million available under its $200 million revolving facility, net of $2.6 million in standby letters of credit. It reported compliance with debt covenants at quarter-end.
- Current assets were $294.1 million and current liabilities $117.5 million; working capital was approximately $176.6 million. Management said expected operating cash flows and available credit should fund working capital, capital spending, and debt service for at least the next 12 months.
- First-half financing cash outflow was $25.8 million, including a $24.0 million net debt reduction, $2.3 million of dividends, and $1.5 million of treasury-stock purchases.
Material changes and operating drivers
- Q2 sales declined 1.8% year over year. Components and Sensors sales rose 37.2% to $105.4 million; EMS sales fell 40.4% to $46.2 million. For the first half, Components and Sensors sales increased 32.8%, while EMS sales declined 34.0%.
- Components and Sensors benefited from the D&R Technology acquisition, smart-actuator sales, and higher piezoceramic product sales. D&R contributed $13.2 million of Q2 sales and $25.9 million in the first half.
- EMS weakness reflected uncertain global economic conditions and the company’s prior decision to exit certain customers. Management cited lower sales across industrial, communications, defense and aerospace, medical, and computer markets.
- Gross-margin improvement reflected a larger share of sales from Components and Sensors and the absence of prior-year Thailand-flood and Scotland-fire costs. Q2 2012 included $7.4 million of business-interruption insurance recovery; there were no such recoveries in Q2 2013. First-half 2012 also included $1.8 million of property-damage insurance recovery.
- SG&A increased to $20.7 million in Q2 and $42.2 million in the first half, partly due to D&R and CEO transition costs. R&D rose to $5.8 million in Q2 and $12.0 million in the first half, primarily for product development and growth initiatives.
Outlook, unusual items, and risks
- Management lowered full-year 2013 sales-growth guidance to 6%–8% over 2012, from prior guidance of 12%–15%. It maintained adjusted EPS guidance of $0.78–$0.83. The filing reconciles this with GAAP diluted EPS guidance of $0.15–$0.20; adjusted EPS excludes restructuring and related costs, CEO transition costs, and specified tax effects.
- Q2 restructuring and related costs were approximately $8.1 million. The June 2013 plan targets about 350 position eliminations, facility consolidation and closure actions, and completion in 2014; planned total costs are $18.6 million, of which $8.1 million had been incurred through June 30. The company also reported earlier restructuring plans and related costs.
- Net loss included $10.8 million of tax expense related to repatriating approximately $30 million of Singapore cash, plus about $1.0 million from writing off UK deferred tax assets. Management attributed the repatriation to the Singapore restructuring. The resulting effective tax rate was unusually high: 1,546.8% for Q2 and 319.3% for the first half.
- Other identified Q2 EPS effects included restructuring and related charges of $0.17 per share, UK deferred-tax-asset write-off of $0.03 per share, and CEO transition costs of $0.02 per share; the repatriation tax was $0.32 per share.
- CTS remained a co-defendant with Toyota in approximately 38 open lawsuits concerning alleged unintended acceleration and related economic claims; 34 additional suits had been dismissed. Toyota’s indemnification agreement covers certain third-party civil claims, subject to stated exceptions. CTS said other environmental and ordinary-course claims were not expected to have a material effect, based on currently available information.
- Management highlighted risks including macroeconomic and end-market conditions, customer reliance, acquisition integration, pricing and demand, technology change, international operations, currency and geopolitical exposure, and natural disasters. Disclosure controls were deemed effective, but management had not completed an internal-control evaluation of acquired D&R.
Investor verification points
- Track whether sales growth and adjusted EPS remain within revised guidance, and compare adjusted results with GAAP performance and the stated exclusions.
- Assess whether EMS demand and segment profitability stabilize, and whether Components and Sensors growth persists beyond acquisition contributions.
- Verify the timing, cash costs, savings, and execution of the $18.6 million June 2013 restructuring plan and other facility consolidations.
- Monitor cash conversion, working-capital demands, debt reduction, borrowing availability, and covenant headroom.
- Review the tax consequences of the Singapore repatriation and whether additional foreign earnings may be repatriated.
- Follow Toyota-related litigation, indemnification scope and exceptions, and environmental contingencies; monitor completion of D&R internal-control evaluation.