CTS Corporation — Q3 2011 Form 10-Q
Business and period: CTS manufactures electronic components and sensors, principally for automotive, communications, and defense and aerospace markets, and provides electronics manufacturing services (EMS). This unaudited filing covers the three and nine months ended October 2, 2011; comparisons are to the periods ended October 3, 2010.
Financial performance
Amounts below are in millions of dollars except per-share data. Margins are calculated as a percentage of net sales.
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $146.1 | $139.4 | $444.5 | $407.6 |
| Gross profit / margin | $27.5 / 18.8% | $30.0 / 21.5% | $84.0 / 18.9% | $90.8 / 22.3% |
| Operating earnings / margin | $7.8 / 5.3% | $7.8 / 5.6% | $18.0 / 4.1% | $21.9 / 5.4% |
| Net earnings | $5.9 | $6.9 | $15.1 | $17.2 |
| Diluted EPS | $0.17 | $0.20 | $0.43 | $0.50 |
- Segment mix: Q3 EMS sales grew 13.9% to $77.0 million, while Components and Sensors sales declined 3.7% to $69.1 million. For the first nine months, EMS sales rose 23.8% to $235.3 million, while Components and Sensors sales fell 3.8% to $209.2 million.
- Cash flow: Nine-month operating cash flow was $13.4 million, versus $8.1 million in 2010. Investing cash outflow was $13.0 million, including $10.2 million of capital expenditures and $2.9 million for the Fordahl acquisition; the company also received $3.1 million of fire-related property insurance proceeds. Financing provided $16.0 million. Cash increased $15.9 million to $89.2 million.
- Debt and liquidity: Long-term debt was $89.7 million, up from $70.0 million at year-end 2010; cash was $89.2 million. Debt equaled 23.6% of total capitalization, versus 20.3% at year-end. The $150 million revolving facility had $57.5 million available, net of letters of credit; CTS reported covenant compliance. Working capital increased $24.2 million from year-end.
- Dividend: $0.03 per share was declared in Q3, unchanged from the comparable quarter.
Material changes and management commentary
- Q3 sales increased 4.8%, but net earnings declined 15.2%. Gross margin fell 2.7 percentage points, attributed to a higher EMS share of sales, higher commodity and precious-metal prices, unfavorable product mix, and new-product launch costs. Management also noted a $0.7 million discrete pension settlement cost in SG&A.
- Q3 reported operating earnings were essentially unchanged year over year despite lower gross profit; 2011 included $1.1 million of business-interruption insurance recovery and $2.7 million of property-damage recovery related to the Scotland fire. For the nine-month period, reported operating earnings included $4.6 million of fire recoveries and a $0.7 million restructuring charge.
- Nine-month sales grew 9.1%, but net earnings declined 12.3%. Management cited lower Components and Sensors sales and margins, higher input costs and launch costs, and the non-recurrence of a 2010 gain on sale of an idle facility. EMS improved from a prior-year operating loss, supported by higher volume and fire-related insurance recovery.
- Management described its Q4 outlook as positive, based on a modest recovery, but gave no numerical forecast. It cautioned that macroeconomic volatility and natural disasters could adversely affect operations.
Unusual items, risks, and contingencies
- Thailand flooding: A subsequent event after quarter-end. Flooding suspended production at the Bangkok-area EMS facility from the second week of October; closure was expected to last approximately 10–12 weeks. Production was being transferred to other CTS facilities. Management said insurance coverage was adequate and expected no material consolidated financial-statement impact at filing, while continuing to assess the situation.
- Scotland fire: The Q2 fire damaged approximately $1.6 million of inventory and $0.2 million of equipment. CTS received approximately $6.8 million from insurers during Q3, including business-interruption and property-damage proceeds; a fire-related receivable of approximately $0.8 million remained at October 2.
- Acquisition: CTS acquired certain assets and liabilities of Swiss company Fordahl SA in January for approximately $2.9 million net of cash acquired. A contingent earnout of up to $0.9 million may be payable based on 2011–2013 results. The purchase-price allocation was still being finalized; pro forma effects were reported as immaterial.
- Litigation: CTS was a co-defendant in approximately 30 open Toyota-related lawsuits and had been dismissed from 29 others. Toyota agreed to defend and indemnify CTS for specified U.S. and Canadian third-party claims concerning alleged unintended acceleration, subject to stated exceptions and limitations. Government-related matters are not covered by that agreement.
- CTS also disclosed environmental remediation matters and other ordinary-course claims; management said provisions were adequate or that ultimate costs were not expected to materially affect the company. The filing identified risks including economic and end-market conditions, customer reliance, pricing pressure, technology change, international operations, and natural disasters.
Key facts for investors to verify
- Whether the Q4 outlook was achieved and how the Thailand facility interruption affected sales, costs, and insurance recoveries.
- Whether gross-margin pressure from segment mix, commodity prices, and product launches persisted, and whether EMS growth translated into improved segment profitability.
- Subsequent changes in debt, cash, working-capital needs, and borrowing availability under the revolving credit agreement.
- Final Fordahl purchase accounting and any earnout obligation, and the status and financial exposure of Toyota-related litigation and environmental claims.
- The extent to which reported earnings and operating cash flow depended on fire insurance recoveries and other unusual items.