CTS Corporation — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019; the filing also reports unaudited fourth-quarter results. CTS designs and manufactures sensors, electronic components and actuators for transportation, industrial, medical, aerospace and defense, and telecom/IT markets. Amounts below are in U.S. dollars; financial figures are in millions unless stated otherwise.
Financial performance
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Net sales | $469.0 | $470.5 | (0.3%) |
| Gross margin | $157.6; 33.6% | $165.0; 35.1% | Down $7.4; 1.5 percentage points |
| Operating earnings | $53.8; 11.5% of sales | $61.0; 13.0% of sales | (11.8%) |
| Net earnings | $36.1 | $46.5 | (22.3%) |
| Diluted EPS | $1.09 | $1.39 | Down $0.30 |
| Operating cash flow | $64.4 | $58.2 | Up $6.3 |
| Capital expenditures | $21.7 | $28.5 | Down $6.8 |
Cash and cash equivalents were $100.2 at year-end, compared with $100.9 a year earlier. Current assets were $237.5 and current liabilities $96.9, producing working capital of $140.5 and a current ratio of 2.4. Long-term debt rose to $99.7 from $50.0; $198.5 remained available under the $300.0 revolving facility. Debt was 19.7% of total capitalization, versus 11.7% in 2018. The weighted-average borrowing rate was 3.25%; CTS was in compliance with debt covenants at year-end.
Cash from operations was $64.4. Investing activities used $95.5, including $73.9 for the QTI acquisition and $21.7 in capital spending. Financing activities provided $30.1, primarily from additional borrowings, partly offset by $11.7 of share repurchases and $5.2 of dividends.
Fourth-quarter results
Q4 2019 sales were $115.0, versus $120.1 in Q4 2018. Gross margin was $38.7 versus $42.6; operating earnings were $12.4 versus $17.0; net earnings were $10.1 versus $17.6. Diluted EPS was $0.31 versus $0.52.
Material changes and notable items
- Sales were essentially flat year over year. QTI, acquired July 31, added $9.3 of 2019 sales; currency movements reduced sales by $5.1. Transportation sales declined 0.4%, while sales to other markets declined 0.2% overall.
- Gross margin declined because of lower volume, ceramics foundry inefficiency, higher labor and commodity costs, unfavorable currency movements, and a one-time purchase-accounting step-up in QTI acquired inventory. Cost-improvement initiatives and manufacturing-transition savings partially offset these pressures.
- Restructuring charges increased to $7.4 from $5.1, mainly for facility and equipment relocation, severance, asset impairment and a lease termination fee. CTS also recorded $2.6 of remediation expense; environmental remediation reserves were $11.4 at year-end.
- The effective tax rate increased to 28.1% from 19.9%. The 2018 rate benefited from a one-time tax-accounting benefit related to the Tax Cuts and Jobs Act.
- CTS acquired QTI for a final purchase price of $73.9, including contingent consideration, and recorded $35.0 of goodwill and $32.8 of identifiable intangible assets. QTI contributed $9.3 of sales and a $0.5 net loss after acquisition. The auditor identified valuation of QTI customer relationships as a critical audit matter due to significant estimates and assumptions.
- CTS adopted operating-lease accounting in 2019, recording a $24.8 lease liability and $22.1 right-of-use asset at adoption. Year-end operating lease liabilities totaled $27.7.
Outlook, commentary and risks
- The filing provides no quantified full-year 2020 guidance. Management stated that operating cash flow and available revolver borrowings should fund working capital, capital expenditures and debt service for at least the next 12 months.
- CTS warned that the coronavirus outbreak and related restrictions delayed reopening of two China facilities and affected suppliers and customers. Management expected adverse effects on sales and results in Q1 2020, potentially longer if the disruption continued.
- Customer concentration is significant: the 15 largest customers generated 61.9% of sales. Cummins accounted for 16.1%, Honda 11.6%, and Toyota 9.6%; purchase agreements for these platforms do not provide volume commitments.
- Other key exposures include cyclical end markets, pricing and competition, customer order cancellations or delays, technology changes, foreign exchange, supply availability and costs, international operations, pension assumptions, and environmental and product-liability claims. One product warranty claim remained under investigation, with potential impact not yet quantifiable.
- Management and the auditor reported effective internal control over financial reporting; QTI was excluded from the control assessment. The auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- Whether QTI delivers the expected growth, customer retention and synergies, and whether acquisition-related estimates and contingent consideration prove appropriate.
- Whether margin pressure, restructuring costs and weaker Q4 performance persist, and how the China-related disruption affected subsequent periods.
- Exposure to major transportation customers and the effect of any changes in their orders, pricing or production schedules.
- Environmental remediation and the unresolved warranty claim, including whether recorded reserves are adequate.
- Debt levels, covenant headroom and liquidity after the acquisition, capital spending, dividends and share repurchases.