CTS Corporation — Q3 2012 Form 10-Q
Business context and reporting period. CTS manufactures electronic components and sensors and provides electronic manufacturing services (EMS). This unaudited filing covers the quarter and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods. Amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $137.4 | $146.1 | $438.6 | $444.5 |
| Gross margin | 19.4% | 18.8% | 17.0% | 18.9% |
| Operating earnings | $6.8 | $7.8 | $14.4 | $18.0 |
| Net earnings | $5.9 | $5.9 | $11.5 | $15.1 |
| Diluted EPS | $0.17 | $0.17 | $0.33 | $0.43 |
- Quarter: Sales fell 6.0%; net earnings were essentially unchanged. Gross margin improved 0.6 percentage points, helped by a higher Components and Sensors sales mix and lower commodity prices. Operating margin was 5.0%, versus 5.3%.
- Nine months: Sales declined 1.3%; net earnings declined 23.9%. Operating margin was 3.3%, versus 4.1%. Lower gross margin reflected casualty-related costs and lost margin, a shift from pension income to expense, and other factors; insurance recoveries, lower commodity prices, and favorable mix partly offset these pressures.
- Segments: Q3 Components and Sensors sales rose 9.4% to $75.6 million, while EMS sales fell 19.7% to $61.8 million. For nine months, Components and Sensors sales rose 9.4% to $228.8 million and EMS sales fell 10.9% to $209.8 million. EMS weakness was attributed to the weak economy and, for the nine-month period, the Thailand flood.
- Cash flow: Nine-month operating cash flow was $25.0 million, versus $13.4 million. Investing used $24.6 million, including $14.7 million net cash for the Valpey-Fisher acquisition and $9.8 million of capital expenditures. Financing provided $11.8 million. Cash increased to $88.6 million from $76.4 million at year-end 2011.
- Liquidity and debt: Long-term debt was $94.5 million, up from $74.4 million at year-end, primarily to fund the acquisition and working capital. The amended revolving facility is $200 million, with $102.9 million available at quarter-end after letters of credit. The weighted-average borrowing rate was 1.8%; CTS reported compliance with covenants. Current assets were $269.2 million and current liabilities $96.1 million.
- Shareholder returns: Quarterly dividend declared was $0.035 per share, compared with $0.03 a year earlier. CTS repurchased approximately 92,852 shares in the quarter under a new authorization.
Material changes and unusual items
- CTS acquired Valpey-Fisher in January 2012 for approximately $18.3 million, or $14.7 million net of cash acquired. The acquisition added $10.7 million of sales and $0.3 million of pretax earnings since acquisition; CTS said it expected the acquisition to be accretive for full-year 2012. Purchase-price allocations were expected to be finalized by year-end.
- Thailand flood insurance recoveries contributed $4.2 million of business-interruption recovery in Q3 and $14.4 million in the first nine months, plus $1.8 million of property-damage recovery for the nine-month period. CTS said it was still processing a claim for increased expenses and lost sales. Scotland fire insurance recoveries included a $0.9 million business-interruption recovery in the first nine months, described as final settlement.
- Restructuring actions begun in June 2012 are expected to eliminate about 250 positions and were expected to be substantially complete in Q4. Through September, restructuring and impairment charges were $3.4 million and restructuring-related charges were $1.3 million. Actions include consolidating UK EMS operations and the Tucson Components and Sensors facility into other locations.
- CTS recorded a $1.4 million long-lived asset impairment charge during the first nine months. Interest-rate swaps covering $75 million of debt for January 2013–January 2017 generated a $1.5 million unrealized loss in other comprehensive income through September.
Outlook, risks, and contingencies
- Guidance: Management lowered full-year 2012 sales guidance to essentially flat versus 2011, from prior guidance of 4%–7% growth. Adjusted EPS guidance was reduced to $0.70–$0.75 from $0.75–$0.80. Management cited continued weak global conditions and the Japan/China territorial dispute.
- Operating risks: The filing identifies economic and end-market conditions, customer concentration, technology change, pricing and demand, natural disasters, intellectual-property protection, and international, currency, trade, and geopolitical risks. Management also noted potential future valuation allowances if certain foreign tax losses cannot be used within carry-forward periods.
- Legal and environmental matters: CTS reported approximately 37 open lawsuits relating to Toyota vehicle unintended-acceleration claims and said the claims are subject to Toyota’s indemnification agreement, with stated exceptions and limits. CTS is also a potentially responsible party at several non-CTS hazardous-waste sites. Management stated that adequate provisions had been made or that ultimate costs were not expected to materially affect the company; no clear quantified exposure is provided in the filing text.
- Controls: Management concluded disclosure controls were effective as of September 30, 2012, but had not completed an evaluation of Valpey-Fisher’s internal controls over financial reporting.
Important facts for investors to verify
- Whether EMS demand stabilizes and Components and Sensors growth can offset continuing weakness in EMS.
- Whether CTS achieves the revised full-year sales and adjusted EPS outlook, and how adjusted EPS reconciles to GAAP results.
- The timing and amount of remaining Thailand flood insurance recoveries and any related unreimbursed costs or lost sales.
- Whether restructuring actions deliver expected savings, and whether further charges or facility-transfer disruptions arise.
- Debt covenant headroom, borrowing availability, and cash requirements given higher debt, acquisition spending, and share repurchases.
- Final Valpey-Fisher purchase accounting, integration results, and the basis for management’s expected accretion.
- Developments in Toyota-related litigation and environmental matters, including any exposure outside the stated indemnification or existing reserves.