CTS Corporation — Q3 2018 Form 10-Q
Business context and reporting period. CTS designs and manufactures sensors, actuators, and electronic components for aerospace and defense, industrial, medical, telecom/IT, and transportation markets. This unaudited filing covers the three and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Financial amounts below are in millions of dollars unless noted.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $118.9 | $106.2 | $350.4 | $312.1 |
| Gross margin | $42.1; 35.4% | $37.5; 35.3% | $122.3; 34.9% | $107.6; 34.5% |
| Operating earnings | $16.1; 13.6% | $13.1; 12.3% | $44.0; 12.6% | $38.5; 12.4% |
| Net earnings | $10.2 | $9.6 | $29.0 | $28.1 |
| Diluted EPS | $0.30 | $0.29 | $0.86 | $0.84 |
| Net margin | 8.6% | 9.0% | 8.3% | 9.0% |
Revenue and operating trends. Sales increased 11.9% in Q3 and 12.3% year to date. Transportation sales rose 9.6% in Q3 and 9.7% year to date; other markets collectively increased 15.9% and 17.2%, respectively. For the nine-month period, Noliac contributed $7.0 million in 2018 sales, compared with $4.1 million in the comparable 2017 period. Gross margin improved modestly, with savings from product-line transfers and, year to date, favorable foreign exchange partly offset by tariffs and higher material costs. Operating earnings rose faster than sales, but SG&A increased 15.9% in Q3 and 18.0% year to date.
Cash flow, balance sheet, and debt. Nine-month operating cash flow was $42.6 million, versus $47.0 million in 2017. Investing used $20.8 million, primarily for $20.8 million of capital expenditures. Financing used $31.7 million, including $26.3 million of net long-term debt payments and $4.0 million of dividends. Cash declined to $103.8 million from $113.6 million at year-end 2017; $87.6 million was held outside the U.S. At September 30, long-term debt was $50.0 million, down from $76.3 million, and $248.1 million was available under the $300 million revolving facility, net of outstanding borrowings and standby letters of credit. Debt was 11.7% of total capitalization, compared with 18.2% at year-end. The company reported compliance with debt covenants and said cash flows and available borrowing capacity should meet needs for at least the next 12 months.
Material changes and notable items
- Q3 net earnings rose 6.2%, below sales growth, as other expense shifted to $1.8 million from $0.8 million of other income in the prior-year quarter. Year-to-date other expense was $2.8 million versus $1.6 million of other income in 2017.
- Management attributed 2018 other expense principally to foreign-currency translation losses, mainly related to the U.S. dollar strengthening against the Chinese renminbi. Reported transaction losses were $1.7 million in Q3 and $2.7 million for the first nine months.
- SG&A included higher stock-based compensation and non-cash pension expense rather than pension income. Year-to-date SG&A also included a $0.95 million environmental charge for soil remediation at an older Asian facility and $1.07 million for tax projects, Noliac-related costs, and other items.
- Restructuring charges were $1.0 million in Q3 and $3.4 million year to date, related mainly to the 2016 plan to transition the Elkhart facility and consolidate headquarters and a plant. The plan’s expected total cost is approximately $13.4 million; $10.6 million had been incurred through September 30, 2018.
- Environmental remediation reserves were $13.8 million at September 30, down from $17.1 million at year-end. CTS warns ultimate environmental liability could materially exceed the recorded reserve. Other ordinary-course claims were not expected by management to materially affect results or financial position.
Outlook, risks, and other disclosures
The filing provides no specific sales or earnings guidance. Management expects operating cash flow and available revolving-credit borrowings to be adequate for working capital, capital expenditures, and debt service over at least the next 12 months, while noting it may seek additional financing for liquidity or acquisitions. Risks highlighted include customer reliance, pricing and demand, tariffs and trade barriers, foreign exchange, international and geopolitical exposures, acquisition integration, restructuring, environmental matters, litigation, product liability, and technology change. Cummins represented 16.0% of Q3 sales and 14.7% of nine-month sales; Honda represented 10.8% and 10.4%, respectively. CTS reported no significant change in risk factors or market risk since year-end 2017. Disclosure controls were assessed as effective. Adoption of ASC 606 had no significant opening retained-earnings effect; adoption of the new lease standard was expected January 1, 2019, with operating lease assets and liabilities anticipated.
Important facts for investors to verify
- Whether sales growth and modest gross-margin improvement persist, particularly given tariff and material-cost pressures.
- Whether foreign-exchange losses, including translation and transaction effects, continue to weigh on earnings.
- Progress and remaining cost of the restructuring plan, including the Elkhart transition and facility consolidation.
- Adequacy of environmental remediation reserves and developments at identified contamination sites.
- Cash conversion, rising accounts receivable and inventory, capital spending, and the availability and covenant terms of the revolving facility.
- Customer concentration and the effect of demand changes among major transportation customers.
- Potential effects of lease-standard adoption and the company’s continuing Tax Act measurement and foreign-earnings repatriation assessments.