CTS

Business Context and Reporting Period

Company: CTS Corporation (CTS)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2005
Business Overview: CTS is a global manufacturer of electronic components, sensors, and electronics manufacturing services (EMS). The company operates two reportable segments: EMS and Components & Sensors. Major markets include automotive, computer, communications, medical, and industrial sectors.
Key Event: On January 31, 2005, CTS acquired 100% of SMTEK International, Inc., an EMS provider, to expand its global footprint and reduce customer concentration. SMTEK results are included in the consolidated financial statements from the acquisition date.

Key Financial Metrics

Note: Specific revenue, profit, and cash flow totals for the fiscal year are incorporated by reference to the 2005 Annual Report and are not explicitly stated in the provided text. The following metrics are available from the filing text:

• Debt Balance (Dec 31, 2005): $68.5 million total.
  • $60.0 million in 2.125% convertible senior subordinated notes.
  • $5.5 million in 6.5% convertible subordinated debentures.
  • $2.1 million in borrowings under the revolving credit facility.
  • $0.9 million in borrowings under foreign credit facilities.
• Order Backlog (Jan 29, 2006): $82.7 million (up from $70.5 million in Jan 2005).
  • EMS Segment: $21.4 million.
  • Components & Sensors Segment: $61.3 million.
• Research & Development (2005): $17.1 million (down from $19.1 million in 2004 and $21.5 million in 2003).
• Stock Repurchases (Q4 2005): 312,700 shares purchased at an average price of $12.02 per share.
• Dividends: Quarterly rate of $0.03 per share ($0.12 annual).
• Employees: 4,902 as of December 31, 2005 (71% employed outside the U.S.).

Material Changes and Segment Performance

• Customer Concentration: The top 15 customers represented 61% of net sales in 2005, a decrease from 69% in 2004 and 71% in 2003.
  • Hewlett-Packard accounted for 28% of net sales in 2005 (down from 33% in 2004).
  • Motorola accounted for less than 10% of net sales in 2005 (down from 13% in 2004).
• Segment Mix: The EMS segment grew to 59% of consolidated net sales in 2005, up from 51% in 2004 and 45% in 2003. The Components & Sensors segment decreased to 41% of net sales.
• Geographic Sales: Non-U.S. net sales decreased to 55% of total in 2005, compared to 63% in 2004. This shift is primarily attributed to the SMTEK acquisition.
• Restructuring: In January 2006, CTS announced plans to consolidate its Berne, Indiana operations, estimating a pre-tax charge of $4.5 million to $5.0 million.

Outlook, Risks, and Management Commentary

• Outlook: Management expects to continue depending on major customers. The company is focused on broadening its customer base and expanding into new EMS markets via the SMTEK acquisition. Future success depends on developing new products to keep pace with rapid technological changes.
• Key Risks:
  • Customer Dependence: Significant reliance on a small number of customers (HP, Motorola) creates vulnerability to order cancellations or delays.
  • Competition: Intense competition in both EMS and Components segments, with competitors often having greater financial resources.
  • Cyclical Markets: Exposure to downturns in automotive, computer, and communications industries.
  • Currency Fluctuations: Exposure to foreign exchange rates, particularly the UK pound, Euro, and Chinese RMB, which can adversely affect operating results.
  • Debt Covenants: The credit facility and debt agreements contain restrictive covenants. Breach could lead to acceleration of indebtedness.
• Accounting Change: CTS dismissed PricewaterhouseCoopers LLP on June 3, 2005, and appointed Grant Thornton LLP as its new independent auditor. No disagreements were reported regarding accounting principles.

Investor Verification Checklist

• Verify the specific consolidated net sales, net income, and operating cash flow figures for 2005, 2004, and 2003 in the "Five-Year Summary" or "Consolidated Statements of Earnings" referenced in the filing.
• Confirm the impact of the SMTEK acquisition on the 2005 financial results, noting that SMTEK represented approximately 16.3% of 2005 net sales but was excluded from the internal control assessment.
• Review the "Consolidated Statements of Cash Flows" to assess liquidity and the company's ability to service its $68.5 million debt load.
• Monitor the execution of the Berne, Indiana facility consolidation and the associated $4.5–$5.0 million restructuring charge in 2006.
• Assess the stability of the top two customers (Hewlett-Packard and Motorola) given their combined historical significance to revenue.