CTS Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016; comparisons are with the periods ended June 28, 2015. CTS designs and manufactures sensors, actuators, and electronic components for multiple markets, including automotive, medical, industrial, aerospace, and defense.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $98.7 million | $100.1 million | $195.4 million | $198.4 million |
| Gross margin | $34.5 million; 34.9% | $33.4 million; 33.3% | $67.9 million; 34.8% | $65.5 million; 33.0% |
| Operating earnings | $24.1 million | $10.5 million | $36.5 million | $21.0 million |
| Net earnings | $14.5 million | $19.1 million | $22.4 million | $25.4 million |
| Diluted EPS | $0.44 | $0.57 | $0.67 | $0.75 |
- Sales declined 1.4% in Q2 and 1.5% year to date. Automotive sales fell on lower volumes and unfavorable currency effects; other sales were affected by weaker electronic-component demand, partly offset by CTG-AM acquisition sales.
- Gross margin improved, which management attributed to efficiency and productivity gains, restructuring savings, acquisition sales, and favorable currency effects on manufacturing costs. R&D expense rose 8.7% in Q2 and 13.5% year to date as CTS invested in product development.
- Operating earnings benefited substantially from an $11.6 million gain on sale of assets, primarily the sale of a Canadian building. Excluding the unusual gain, reported operating earnings are not a straightforward measure of underlying operating improvement.
- Net earnings fell despite higher operating earnings: Q2 included $7.7 million of tax expense versus an $8.2 million tax benefit in Q2 2015; first-half tax expense was $11.8 million versus a $5.5 million benefit. The prior-year benefit included amended-return foreign tax credits, partly offset by an uncertain-tax-position reserve.
Cash flow, balance sheet, and capital
- First-half operating cash flow was $13.8 million, versus $15.5 million a year earlier. Investing activities used $68.3 million, including $73.1 million for the acquisition, partly offset by $12.2 million of asset-sale proceeds; capital expenditures were $7.5 million.
- Cash declined to $119.9 million from $156.9 million at year-end 2015. Management reported that $118.6 million of June cash was held outside the United States.
- Long-term debt increased to $110.8 million from $90.7 million. The revolving facility was expanded from $200 million to $300 million in May; $187.0 million was available at June 30. The weighted-average interest rate was 1.9%. CTS was in compliance with debt covenants.
- Current assets were $220.5 million and current liabilities $97.1 million at June 30. Shareholders’ equity was $302.6 million. Total debt was 26.8% of total capitalization, versus 24.4% at year-end.
- Cash dividends declared were $0.04 per share for the quarter. No shares were repurchased in the first half; $17.6 million remained available under the repurchase authorization.
Material developments, outlook, and risks
- CTS acquired CTG Advanced Materials (CTG-AM), a designer and manufacturer of single-crystal piezoelectric materials, on March 11 for $73.1 million net of cash acquired. Since acquisition, CTG-AM contributed $3.9 million in sales and a $0.1 million net loss. Purchase accounting added $27.9 million of goodwill and $35.4 million of intangible assets; integration and expected synergies remain relevant execution considerations.
- A June 2016 restructuring plan will phase out production at the Elkhart facility by mid-2018 and convert it to a research and development center, with additional organizational changes elsewhere. Preliminary estimated costs are $16 million–$18 million and may change significantly; $0.2 million was accrued by June 30.
- Management stated that operating cash flow and available facility borrowings should be adequate for working capital, capital expenditures, and debt service for at least the next 12 months. The filing provides no specific revenue or earnings guidance.
- Management cited foreign-exchange movements, demand and pricing in end markets, reliance on key customers, acquisition integration, technology changes, litigation, environmental matters, and international risks among factors that could affect results. Honda and Toyota each represented over 10% of first-half sales; Cummins represented 10.0%.
- Environmental remediation reserves were $19.6 million within accrued liabilities. CTS stated that adequate provisions had been recorded based on available information but cautioned that ultimate environmental costs could materially exceed the reserve. Management considered other pending ordinary-course claims adequately provided for or not expected to materially affect the company.
- Management reported effective disclosure controls at June 30 and no significant changes to risk factors since year-end 2015.
Important facts for investors to verify
- How much of operating earnings and cash generation is attributable to the Canadian building sale, and what are recurring earnings absent that gain?
- Whether the CTG-AM integration delivers expected growth and synergies, and how acquisition-related amortization and debt costs affect margins and earnings.
- Final restructuring costs and execution milestones for the Elkhart transition, including potential additional charges through 2018.
- Cash needs and access to funds held outside the United States, debt covenant headroom, and the impact of variable rates and foreign-exchange movements.
- Changes in customer concentration, automotive and electronic-component demand, and the adequacy of environmental remediation reserves.