CTS Corporation — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended July 3, 2011; unaudited. CTS manufactures components and sensors, primarily for automotive, communications, and defense and aerospace markets, and provides electronics manufacturing services (EMS).
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Net sales | $146.9 million | $138.9 million | $298.4 million | $268.3 million |
| Gross margin | $27.9 million; 19.0% | $30.3 million; 21.9% | $57.0 million; 19.1% | $60.8 million; 22.7% |
| Operating earnings | $4.5 million | $7.7 million | $10.3 million | $14.1 million |
| Net earnings | $4.1 million | $5.9 million | $9.2 million | $10.3 million |
| Diluted EPS | $0.12 | $0.17 | $0.26 | $0.30 |
- Q2 sales rose 5.8%, but net earnings fell 29.9%; first-half sales rose 11.3%, while net earnings declined 10.4%.
- Q2 operating margin was 3.1%, versus 5.6% a year earlier. First-half operating margin was 3.4%, versus 5.3%.
- Cash provided by operations was $8.8 million in the first half, compared with $6.3 million in 2010. Capital expenditures were $6.5 million; investing activities used $9.5 million, including $2.9 million for the Fordahl acquisition.
- Cash was $75.1 million at July 3, 2011. Total debt was $74.7 million, including $74.5 million on the revolving facility; debt was 20.7% of total capitalization. The $150 million facility had $72.7 million of availability, net of letters of credit. CTS reported compliance with its debt covenants.
- Current assets were $275.4 million and current liabilities $118.1 million at July 3, 2011. Inventory increased to $88.6 million from $76.9 million at year-end 2010.
Material changes and management commentary
- EMS drove growth: Q2 sales increased 18.4% to $78.9 million, and first-half sales increased 29.2% to $158.4 million. EMS operating earnings improved to $0.4 million in both periods, from a Q2 loss of $0.2 million and a first-half loss of $2.9 million in 2010.
- Components and Sensors sales fell 5.8% to $68.0 million in Q2 and 3.9% to $140.1 million for the first half. Segment operating earnings declined to $4.9 million in Q2 from $7.9 million, and to $10.6 million for the first half from $17.0 million.
- Management attributed weaker Components and Sensors results chiefly to Japan earthquake-related automotive production disruption, higher commodity and precious-metal prices, increased R&D, and product-launch costs. Management expected some earthquake-related sales to recover in the second half of 2011.
- Lower segment mix from Components and Sensors, which generally carried higher margins, contributed to gross-margin pressure. Higher EMS sales and disciplined SG&A spending supported revenue growth and lower SG&A as a share of sales.
- Interest and other income improved to $0.5 million in Q2 from a $0.5 million expense, and to $1.3 million for the first half from a $1.2 million expense, primarily due to foreign-exchange gains. The filing does not quantify the gains separately.
Outlook, risks, and unusual items
- Management maintained full-year 2011 guidance for sales growth of 9%–13% over 2010 and EPS of $0.70–$0.75.
- A Q2 restructuring to eliminate approximately 30 positions produced a $0.7 million charge; the plan anticipated about $0.8 million of total costs. A $0.3 million restructuring liability remained at July 3.
- A fire at the Scotland EMS facility damaged approximately $1.4 million of inventory and $0.3 million of machinery and equipment. CTS recorded a $2.8 million fire-related receivable, expecting property and business-interruption insurance to cover eligible losses, subject to a $100,000 property deductible.
- CTS acquired certain assets and assumed liabilities of Switzerland-based Fordahl SA for $2.9 million net of cash. A contingent earn-out of up to $0.9 million may be payable based on 2011–2013 targets; its acquisition-date fair value was approximately $0.4 million. Management said the acquisition’s pro forma effect was not material.
- CTS remained named as a co-defendant in approximately 37 open lawsuits concerning Toyota vehicle unintended-acceleration claims; it had been dismissed from 21 others. Toyota agreed to defend and indemnify CTS for covered U.S. and Canadian third-party civil claims, subject to stated exceptions and insurance-related limits. Government investigations, hearings, and recalls are not covered by that agreement. Management stated that environmental and other claims were not expected to materially affect the company, based on information available.
- Management cited risks including market conditions, customer concentration, pricing and demand, technology change, international and foreign-exchange exposure, and unanticipated events. It said expected operating cash flow and available borrowing were adequate for anticipated needs over at least the next 12 months, while noting possible additional financing.
Important facts for investors to verify
- Whether EMS growth and the anticipated second-half recovery in earthquake-affected automotive sales materialized, and how segment mix affected margins.
- Whether commodity costs and product-launch expenses continued to pressure gross margin and earnings.
- Cash conversion and working-capital trends, particularly inventory growth, alongside debt, facility availability, and covenant headroom.
- Recovery and timing of insurance proceeds related to the Scotland fire, and any difference from the recorded $2.8 million receivable.
- Developments in Toyota-related litigation, the scope of indemnification, and the potential contingent Fordahl earn-out.
- Progress against maintained full-year sales and EPS guidance; the filing provides guidance but no quarterly forecast.