CTS Corporation — Q2 2018 Form 10-Q
Business context and reporting period. CTS designs and manufactures sensors, actuators, electronic components, and engineered products for transportation, industrial, medical, aerospace and defense, and telecom and IT markets. This unaudited report covers the quarter and six months ended June 30, 2018; dollar amounts below are in millions unless noted.
Financial performance and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $118.0 | $105.7 | $231.6 | $205.8 |
| Gross margin | $41.8; 35.4% | $35.8; 33.9% | $80.2; 34.7% | $70.0; 34.0% |
| Operating earnings | $14.5; 12.3% of sales | $13.2; 12.5% | $27.9; 12.1% | $25.4; 12.3% |
| Net earnings | $7.2 | $10.0 | $18.8 | $18.5 |
| Diluted EPS | $0.21 | $0.30 | $0.56 | $0.55 |
| Operating cash flow | Not separately stated | Not separately stated | $27.7 | $23.3 |
At June 30, cash and cash equivalents were $102.9, current assets $232.1, and current liabilities $105.1. Long-term debt was $57.0, down from $76.3 at year-end 2017. CTS had $241.1 available under its $300.0 revolving credit facility and reported compliance with debt covenants. Cash was primarily held outside the U.S. ($94.5).
First-half capital expenditures were $14.9, mainly for the ERP project and production-line moves. Financing cash outflow was $23.4, including $19.3 of net debt repayments, $2.6 of dividends, and $1.4 of taxes paid for equity-award participants. Cash declined $10.7 to $102.9.
Material changes versus comparable periods
- Q2 sales rose 11.7%; first-half sales rose 12.5%. Growth included higher transportation and other-market sales, Noliac acquisition contributions, and favorable foreign exchange effects.
- Transportation was the largest market: Q2 sales were $73.9 versus $68.7; first-half sales were $148.2 versus $135.1. First-half sales also increased in industrial, medical, and aerospace and defense, while telecom and IT declined.
- Gross margin improved year over year, attributed by management to product-line transfer savings, favorable currency effects, and prior-year production rework costs. Q2 operating margin was slightly lower, as higher operating expenses offset gross-margin improvement.
- Q2 net earnings fell 27.7%, despite higher sales and operating earnings, chiefly reflecting a $2.9 net other expense versus $0.7 of other income in Q2 2017. First-half net earnings increased 1.7%.
- SG&A rose 24.1% in Q2 and 19.1% in the first half, increasing as a share of sales. Management cited a $0.95 environmental charge, tax-project costs, Noliac-related costs and amortization, higher stock compensation, and pension expense versus prior-year pension income.
Outlook, commentary, risks, and unusual items
- The filing gives no specific numerical revenue or earnings guidance. Management said operating cash flow and available revolver borrowings should fund working capital, capital expenditures, and debt service for at least the next 12 months; additional financing could be pursued for liquidity or acquisitions.
- Q2 included $2.194 of foreign-currency transaction losses, with other expense principally attributed to currency movements against the U.S. dollar. First-half foreign-exchange changes increased reported sales by $4.558, according to management.
- The effective tax rate was 37.7% in Q2 and 30.2% for the first half, versus 28.4% and 29.4%, respectively, in 2017. A $1.703 tax expense related to a one-time cash distribution from Taiwan contributed to the increase. CTS continued evaluating certain Tax Act accounting and its foreign-earnings reinvestment assertion.
- First-half restructuring charges were $2.367 under the 2016 plan, which includes phasing out production at the Elkhart facility by the end of 2018 and consolidating facilities. Total planned cost is approximately $13.4; $9.554 had been incurred through June 30, 2018.
- CTS reported $14.570 of remediation reserves at June 30. It is involved in environmental matters, including Superfund-listed sites, and cautioned that ultimate environmental liability could exceed current reserves. Management believes recorded provisions are adequate based on available information.
- Customer concentration is material: Cummins represented 14.0% of Q2 sales and 14.1% of first-half sales; Toyota represented 10.8% and 11.0%, respectively. Management identified risks including customer reliance, pricing and demand, acquisition integration, competition, international operations, foreign exchange, and environmental and litigation contingencies. No significant changes to risk factors or market risk were reported.
Important facts for investors to verify
- Whether sales growth and gross-margin gains persist without relying on favorable currency effects or prior-year comparison benefits.
- Whether higher SG&A, restructuring costs, and the environmental remediation charge continue to pressure operating margins.
- The drivers and potential recurrence of foreign-currency losses, and exposure to exchange-rate movements.
- Cash availability and location, debt repayment plans, revolver covenant headroom, and the impact of variable interest rates.
- The adequacy and possible changes in remediation reserves, as well as the status and cost of the 2016 restructuring plan.
- Customer concentration and the effect of demand changes among major customers and end markets.
- Resolution of remaining Tax Act estimates and the effect of foreign tax, withholding tax, and repatriation decisions.