CTS Corporation — Q3 2019 Form 10-Q
Business context and period. CTS designs and manufactures sensors, actuators and electronic components for aerospace and defense, industrial, medical, telecom and IT, and transportation markets. This unaudited filing covers the quarter and nine months ended September 30, 2019; comparisons are with the same 2018 periods. Financial statement amounts below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net sales | $115.651 | $118.859 | $353.959 | $350.410 |
| Gross margin | $37.057 (32.0%) | $42.082 (35.4%) | $118.875 (33.6%) | $122.328 (34.9%) |
| Operating earnings | $10.124 (8.8%) | $16.118 (13.6%) | $41.424 (11.7%) | $44.021 (12.6%) |
| Net earnings | $2.722 | $10.211 | $26.084 | $28.968 |
| Diluted EPS | $0.08 | $0.30 | $0.79 | $0.86 |
| Operating cash flow | Not presented by quarter | $40.735 | $42.560 |
- Q3 sales declined 2.7%, while nine-month sales rose 1.0%. Q3 transportation sales fell $3.625 million (4.8%); nine-month transportation sales rose $7.348 million (3.3%).
- For the nine months, cost of goods sold increased 3.1% despite sales growth of 1.0%; gross margin declined 1.3 percentage points. Q3 gross margin declined 3.4 percentage points.
- Q3 total other expense was $2.924 million versus $1.763 million; nine-month total other expense was $3.995 million versus $2.791 million. Q3 effective tax rate rose to 62.2% from 28.9%; the nine-month rate was 30.3% versus 29.7%.
Balance sheet, liquidity and capital
- At September 30, cash and cash equivalents were $101.199 million, current assets $245.029 million, and current liabilities $100.551 million. Working capital increased $9.112 million during the first nine months.
- Long-term debt was $112.700 million, up from $50.000 million at year-end 2018. CTS had $185.500 million available under its $300 million revolving facility, net of borrowings and standby letters of credit; the weighted-average interest rate was 3.41%. The company reported compliance with all debt covenants.
- Cash from operations of $40.735 million was more than offset by investing outflows of $88.750 million, including $73.588 million paid for QTI and $15.299 million of capital expenditures. Financing provided $48.068 million, including $62.700 million net proceeds from increased borrowings. Cash increased $0.266 million to $101.199 million.
- CTS paid $3.934 million in dividends and repurchased $8.045 million of stock during the nine months. The quarterly declared dividend was $0.04 per share.
- CTS adopted lease accounting standard Topic 842 in January 2019, recording an opening lease liability of $24.792 million and right-of-use asset of $22.066 million. At quarter-end, operating lease liabilities totaled $27.556 million.
Material changes and unusual items
- CTS acquired Quality Thermistor, Inc. (QTI) on July 31, 2019, for a purchase price of $75.755 million, including estimated contingent consideration. QTI contributed $3.670 million of sales and a $1.086 million net loss through September 30. The purchase-price allocation is preliminary; it includes $37.085 million of goodwill and $31.700 million of acquired intangible assets.
- Management attributed lower gross margin to a one-time inventory fair-value step-up from the QTI acquisition, ceramic foundry execution challenges, a transportation-product replacement charge, and higher material and wage costs. Elkhart transition savings and other cost improvements partly offset these items.
- Q3 restructuring charges were $2.342 million, versus $0.997 million; nine-month charges were $5.337 million, versus $3.364 million. Charges included facility and equipment relocation, severance and impairment, and an $0.800 million lease-termination charge related to QTI.
- Q3 net earnings were also affected by higher foreign-currency translation losses and pension expense, and by increased reserves for uncertain tax positions associated with China operations and foreign earnings taxed at higher rates.
- Foreign exchange reduced sales by $0.922 million in Q3 and $4.554 million for the first nine months, according to management.
Outlook, risks and contingencies
- No specific earnings or revenue guidance is provided. Management said operating cash flows and available revolving-facility borrowings are expected to fund working capital, capital expenditures and debt service for at least the next 12 months; it may seek additional financing for liquidity or acquisitions.
- Management cited risks including economic and end-market conditions, acquisition integration, customer reliance, pricing and demand, technological change, foreign exchange, trade and geopolitical risks, product liability, litigation and environmental matters. It reported no significant changes to the risk factors disclosed in the 2018 Form 10-K.
- Environmental remediation reserves were $9.945 million at September 30, down from $11.274 million at year-end. CTS stated that recorded provisions were adequate based on available information but that ultimate environmental liabilities could materially exceed accrued amounts.
- Cummins represented 14.9% of Q3 sales and 17.2% of nine-month sales; Toyota represented 11.3% and 11.2%, respectively. Management said disclosure controls were effective. QTI’s separate systems and processes represent a material control change; CTS planned to exclude QTI operations from its 2019 Section 404 internal-control assessment.
Key facts for investors to verify
- Whether the QTI acquisition’s preliminary purchase-price allocation, contingent consideration and integration costs change materially.
- Whether the identified gross-margin pressures—particularly foundry execution, product replacement costs, and acquisition-related inventory step-up—persist or improve.
- How foreign-exchange losses and the uncertain-tax-position reserves, especially those relating to China, affect subsequent results and cash taxes.
- Whether operating cash generation remains adequate given acquisition spending, higher debt, capital needs and share repurchases.
- Whether environmental remediation exposure, customer concentration, or QTI-related control integration creates material changes not reflected in current accruals or disclosures.