CTS Corporation — Q2 2012 Form 10-Q
Business context and reporting period. CTS manufactures electronic components and sensors and provides electronic manufacturing services (EMS). This unaudited report covers the quarter and six months ended July 1, 2012; comparisons are with the periods ended July 3, 2011. The two segments are Components and Sensors and EMS.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Net sales | $154.3m | $146.9m | $301.3m | $298.4m |
| Gross margin | 16.8% | 19.0% | 15.9% | 19.1% |
| Operating earnings | $5.7m | $4.5m | $7.6m | $10.3m |
| Net earnings | $3.3m | $4.1m | $5.6m | $9.2m |
| Diluted EPS | $0.10 | $0.12 | $0.16 | $0.26 |
- Q2 sales increased 5.0%; Components and Sensors sales rose 12.9%, while EMS sales declined 1.8%. For the first six months, sales increased 0.9%, as Components and Sensors growth was largely offset by lower EMS sales.
- Q2 operating margin was 3.7% versus 3.1%; net margin was 2.1% versus 2.8%. For the six-month period, operating margin was 2.5% versus 3.4%, and net margin was 1.9% versus 3.1%.
- Q2 diluted EPS included $0.08 of restructuring and related charges; Q2 2011 EPS included $0.02 of restructuring charges and additional legal costs.
- Cash flow: Six-month operating cash flow was $12.0m, compared with $8.8m. Investing cash outflow was $21.8m, including $14.7m for the Valpey-Fisher acquisition and $9.7m of capital expenditures, partly offset by insurance proceeds and asset-sale proceeds. Financing cash inflow was $16.2m. Cash increased $6.6m to $83.0m.
- Liquidity and debt: At July 1, cash was $83.0m and revolving-credit debt was $97.0m, up from $74.4m at year-end 2011. The $200m facility had $100.4m available, net of letters of credit. CTS reported compliance with debt covenants.
- Cash dividends declared were $0.035 per share in Q2, versus $0.03 a year earlier. CTS repurchased 572,487 shares for $5.6m in the first half.
Material changes and unusual items
- CTS acquired Valpey-Fisher in January for approximately $18.3m, or $14.7m net of acquired cash. Since acquisition, it contributed $6.9m of sales and a $0.1m pretax loss in the first half.
- Thailand flood and Scotland fire costs and lost-margin effects weighed on results, while insurance recoveries materially affected reported earnings. Q2 included $7.4m of business-interruption recovery; first-half statements included $11.1m of business-interruption recovery and $1.8m of property-damage recovery. Management said claims related to the Thailand flood were still being processed, and recovery timing can lag the underlying costs.
- Q2 gross margin fell 2.2 percentage points year over year. Management attributed about 3 percentage points of decline to roughly $5m of expenses and losses primarily related to the Thailand flood, partly offset by lower commodity prices and favorable segment mix.
- June restructuring actions target approximately 260 positions and consolidation of UK EMS and Tucson Components and Sensors operations into other facilities. CTS recorded $3.1m of restructuring and impairment charges and $0.7m of related charges through July 1; total planned restructuring and related costs were approximately $5.0m. Actions were expected to be substantially complete by mid-fourth quarter 2012.
- Other Q2 pressures included higher pension expense, increased R&D spending, and foreign-exchange losses. Q2 effective tax rate rose to 26.9% from 17.9%; the six-month rate was 18.0% versus 20.5%, including a $0.7m discrete tax benefit in Q1.
Outlook, risks and contingencies
- Management lowered full-year 2012 sales-growth guidance to 4%–7% over 2011, citing weaker global economic conditions and lower defense and aerospace spending, particularly affecting EMS.
- Management maintained adjusted EPS guidance of $0.75–$0.80, excluding $0.10 per share of restructuring and related charges; corresponding GAAP diluted EPS guidance was $0.65–$0.70. Adjusted EPS is a non-GAAP measure.
- Management expected operating cash flow and available credit to meet working-capital, capital-expenditure and debt-service needs for at least the next 12 months, while noting it could seek additional financing.
- Risks cited include economic and end-market conditions, customer reliance, pricing and demand, technology change, natural disasters, international and foreign-exchange exposure, and intellectual-property protection. CTS reported no significant change to its risk factors since year-end 2011.
- CTS remained a co-defendant in approximately 33 open Toyota-related lawsuits; Toyota’s indemnification agreement generally covers specified U.S. and Canadian third-party civil claims, subject to stated exceptions and insurance-related limits. Environmental remediation matters and other ordinary-course claims were also disclosed; management did not expect them to materially affect the company based on information then available.
- Disclosure controls were deemed effective, but the evaluation excluded Valpey-Fisher’s internal controls over financial reporting because that review was not yet complete.
Investor verification priorities
- Track the timing and amount of remaining Thailand flood insurance recoveries, related costs, and any effect on margins and cash flow.
- Assess whether CTS achieves the lowered sales outlook and maintained adjusted EPS target, including the reconciliation to GAAP EPS and the effect of restructuring costs.
- Monitor execution, total costs, savings, and completion of the 260-position restructuring and facility consolidations.
- Review EMS demand and recovery, particularly in defense and aerospace, communications, and computer markets, and the sustainability of Components and Sensors growth.
- Monitor debt, borrowing availability, covenant headroom, and the interest-rate swaps covering $50m of debt from 2013 through 2017.
- Confirm final Valpey-Fisher purchase-price allocations and completion of the acquired business’s internal-control evaluation.