CTS Corporation — Q3 2015 Form 10-Q
Business context and reporting period
CTS manufactures electronic components and sensors, primarily for automotive, communications, defense and aerospace, medical, industrial, and computer markets. This unaudited report covers the quarter and nine months ended September 27, 2015; comparatives are the periods ended September 28, 2014.
Key financial metrics
Amounts are in millions of dollars, except per-share data and percentages.
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net sales | $90.6 | $100.0 | $289.0 | $303.6 |
| Gross margin | 34.7% | 32.5% | 33.5% | 31.9% |
| Operating earnings (loss) | $(3.9) | $11.2 | $17.2 | $32.0 |
| Operating margin | (4.2)% | 11.2% | 5.9% | 10.5% |
| Net earnings (loss) | $(4.8) | $8.1 | $20.6 | $19.6 |
| Diluted EPS | $(0.15) | $0.24 | $0.61 | $0.57 |
| Cash provided by operating activities | Not stated separately | Not stated separately | $24.1 | $15.3 |
| Capital expenditures | Not stated separately | Not stated separately | $6.6 | $9.0 |
At September 27, cash and cash equivalents were $150.8 million, versus $134.5 million at year-end 2014. Long-term debt was $90.5 million, up from $75.0 million; total debt was 23.4% of capitalization, versus 20.6%. The new $200 million revolving facility had $107.2 million available, and CTS reported compliance with its debt covenants. Working capital rose $5.7 million from year-end. Dividends declared were $0.04 per share for Q3 and $0.12 for the first nine months.
Material changes versus prior periods
- Q3 sales fell 9.3%; nine-month sales fell 4.8%. Management attributed declines to lower automotive and other electronic-component volumes and unfavorable currency translation. Currency movements reduced sales by about $1.7 million in Q3 and $6.2 million year to date.
- Gross margin improved, which management attributed to efficiency, material and labor productivity, restructuring savings, and favorable currency effects on manufacturing costs.
- Q3 operating results included a $14.5 million non-recurring environmental charge, turning operating earnings into a loss. Excluding the charge, operating earnings would still reflect lower sales and other reported costs; the filing does not present an adjusted operating result.
- Nine-month operating earnings declined 46.3%, while net earnings increased 5.4%, primarily reflecting a $7.7 million income-tax benefit. The reported nine-month effective tax rate was negative 59.2%; tax-return amendments for 2006–2013 reduced the rate by 122.1 percentage points, while uncertain tax benefits increased it by 42.9 points.
- Other expense increased, including $4.6 million of foreign-currency transaction losses for the first nine months. Q3 other expense was $3.1 million, compared with $0.7 million of other income in the prior-year quarter.
Outlook, management commentary, risks, and unusual items
- Management stated that operating cash flow and available credit were expected to be adequate for working capital, capital expenditures, and debt service for at least the next 12 months. No specific revenue or earnings guidance was provided.
- The $14.5 million environmental charge relates to anticipated remediation and monitoring at the Asheville, North Carolina site, including interim work accepted by the EPA and expected future site-wide remediation. The reserve may change as investigation and cleanup progress; CTS cannot assure ultimate costs will not exceed the reserve.
- CTS revised its restructuring plans. Actions include consolidating Canadian operations and other facility and workforce changes; the plans were expected to be substantially complete in 2015. Disclosed actions would eliminate approximately 120 positions under the April 2014 plan and approximately 350 under the June 2013 plan, including later additions.
- CTS entered a new five-year, $200 million revolving credit agreement in August 2015, replacing the prior facility. Borrowings carry variable rates, with interest-rate swaps used to fix rates on $75 million of debt through January 2017. Facility covenants and restrictions include limits on certain debt, investments, acquisitions, repurchases, and dividends.
- CTS was co-defendant with Toyota in approximately 31 U.S. and Canadian lawsuits related to the 2010 vehicle pedal recall. Toyota agreed to indemnify CTS for covered third-party claims, subject to stated exceptions and insurance-related limits; government investigations, hearings, and recalls are not covered by that agreement.
- Other risks identified include customer concentration, automotive and other end-market demand, pricing and technology changes, foreign exchange and international operations, and environmental and litigation contingencies. Three customers each represented about 10% or more of Q3 sales.
Important facts for investors to verify
- Progress and updated cost estimates for the Asheville environmental remediation, including whether the $19.1 million remediation and monitoring reserve is sufficient.
- Whether restructuring actions finish on schedule and deliver the anticipated savings without further material charges.
- Underlying sales trends and margins by end market, separating volume changes from foreign-exchange effects.
- The sustainability of cash generation and liquidity after share repurchases, dividends, and increased borrowings; verify future covenant headroom.
- The amount and recurrence of tax benefits, foreign-currency losses, and other unusual items affecting reported earnings.
- Developments in Toyota-related litigation and the scope and limits of the indemnification agreement.