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CTS CORP - Quarter Report: 2012 July (Form 10-Q)

Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended July 1, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                                  to                                 

Commission File Number: 1-4639

 

 

CTS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

                Indiana                 

 

                35-0225010                 

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification Number)

                905 West Boulevard North,                

Elkhart, IN

 

            46514             

(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: 574-523-3800

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨  (Do not check if smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of July 20, 2012: 33,939,275.

 

 

 


Table of Contents

CTS CORPORATION AND SUBSIDIARIES

TABLE OF CONTENTS

 

          Page  
PART I.    FINANCIAL INFORMATION   

                   Item 1.

  

Financial Statements

  
  

Unaudited Condensed Consolidated Statements of Earnings

- For the Three and Six Months Ended July 1, 2012 and July 3, 2011

     3   
  

Unaudited Condensed Consolidated Statements of Comprehensive Earnings

- For the Three and Six Months Ended July 1, 2012 and July 3, 2011

     4   
  

Unaudited Condensed Consolidated Balance Sheets

- As of July 1, 2012 and December 31, 2011

     5   
  

Unaudited Condensed Consolidated Statements of Cash Flows

- For the Six Months Ended July 1, 2012 and July 3, 2011

     6   
  

Notes to Unaudited Condensed Consolidated Financial Statements

     7   

                   Item 2.

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     20   

                   Item 3.

  

Quantitative and Qualitative Disclosures about Market Risk

     30   

                   Item 4.

  

Controls and Procedures

     30   
PART II.   OTHER INFORMATION   

                   Item 1.

  

Legal Proceedings

     30   

                   Item 1A.

  

Risk Factors

     31   

                   Item 2

  

Unregistered Sales of Equity Securities and Use of Proceeds

     31   

                   Item 3

  

Defaults Upon Senior Securities

     31   

                   Item 4

  

Mine Safety Disclosures

     31   

                   Item 5

  

Other Information

     31   

                   Item 6.

  

Exhibits

     31   
SIGNATURES      33   

 

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Table of Contents

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

CTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS—UNAUDITED

(In thousands, except per share amounts)

 

     Three Months Ended     Six Months Ended  
     July 1,
2012
    July 3,
2011
    July 1,
2012
    July 3,
2011
 

Net sales

   $ 154,294      $ 146,919      $ 301,263      $ 298,437   

Costs and expenses:

        

Cost of goods sold

     128,356        119,051        253,276        241,409   

Insurance recovery for business interruption — casualties

     (7,423     —          (11,050     —     

Selling, general and administrative expenses

     19,378        18,057        38,782        36,429   

Research and development expenses

     5,131        4,590        11,240        9,619   

Insurance recovery for property damage — casualties

     —          —          (1,769     —     

Restructuring and impairment charge — Note M

     3,139        694        3,139        694   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating earnings

     5,713        4,527        7,645        10,286   

Other (expense)/income:

        

Interest expense

     (626     (511     (1,285     (1,003

Interest income

     467        276        916        472   

Other

     (1,041     743        (466     1,873   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other (expense)/income

     (1,200     508        (835     1,342   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes

     4,513        5,035        6,810        11,628   

Income tax expense

     1,212        903        1,226        2,380   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings

   $ 3,301      $ 4,132      $ 5,584      $ 9,248   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net earnings per share — Note J

        

Basic

   $ 0.10      $ 0.12      $ 0.16      $ 0.27   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.10      $ 0.12      $ 0.16      $ 0.26   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash dividends declared per share

   $ 0.035      $ 0.03      $ 0.07      $ 0.06   
  

 

 

   

 

 

   

 

 

   

 

 

 

Average common shares outstanding:

        

Basic

     34,022        34,375        34,064        34,334   

Diluted

     34,574        35,025        34,647        35,050   

See notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

CTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS—UNAUDITED

(In thousands of dollars)

 

     Three Months Ended      Six Months Ended  
     July 1,
2012
    July 3,
2011
     July 1,
2012
    July 3,
2011
 

Net earnings

   $ 3,301      $ 4,132       $ 5,584      $ 9,248   

Other comprehensive earnings/(loss):

         

Cumulative translation adjustment

     (917     7         245        995   

Amortization of retirement benefit adjustments (net of tax)

     1,311        750         2,269        1,486   

Unrealized loss on cash flow hedges (net of tax)

     (507     —           (507     —     
  

 

 

   

 

 

    

 

 

   

 

 

 

Comprehensive earnings

   $ 3,188      $ 4,889       $ 7,591      $ 11,729   
  

 

 

   

 

 

    

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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CTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars except share amounts)

 

     (Unaudited)
July 1,
2012
    December 31,
2011
 

ASSETS

    

Current Assets

    

Cash and cash equivalents

   $ 83,039      $ 76,412   

Accounts receivable, less allowances (2012 — $1,116; 2011 — $1,100)

     90,604        88,345   

Inventories — Note D

     78,664        92,540   

Other current assets

     24,083        26,089   
  

 

 

   

 

 

 

Total current assets

     276,390        283,386   

Property, plant and equipment, less accumulated depreciation (2012 - $241,634; 2011 — $241,585)

     91,171        84,860   

Other Assets

    

Prepaid pension asset

     7,767        4,359   

Goodwill — Note L

     5,855        500   

Other intangible assets, net — Note L

     31,911        29,886   

Deferred income taxes

     75,045        76,200   

Other

     1,950        1,624   
  

 

 

   

 

 

 

Total other assets

     122,528        112,569   
  

 

 

   

 

 

 

Total Assets

   $ 490,089      $ 480,815   
  

 

 

   

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

    

Current Liabilities

    

Accounts payable

   $ 66,477      $ 80,468   

Accrued liabilities

     42,901        43,769   
  

 

 

   

 

 

 

Total current liabilities

     109,378        124,237   

Long-term debt — Note E

     97,000        74,400   

Other long-term obligations

     18,241        18,881   

Shareholders’ Equity

    

Preferred stock — authorized 25,000,000 shares without par value; none issued

     —          —     

Common stock — authorized 75,000,000 shares without par value; 55,208,565 shares issued at July 1, 2012 and 54,790,110 shares issued at December 31, 2011

     291,024        287,661   

Additional contributed capital

     38,402        39,161   

Retained earnings

     355,410        352,205   

Accumulated other comprehensive loss

     (113,139     (115,146
  

 

 

   

 

 

 
     571,697        563,881   

Cost of common stock held in treasury (2012 — 21,296,593 and 2011 — 20,724,106 shares)

     (306,227     (300,584
  

 

 

   

 

 

 

Total shareholders’ equity

     265,470        263,297   
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 490,089      $ 480,815   
  

 

 

   

 

 

 

See notes to unaudited condensed consolidated financial statements.

 

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CTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—UNAUDITED

(In thousands of dollars)

 

     Six Months Ended  
     July 1,
2012
    July 3,
2011
 

Cash flows from operating activities:

    

Net earnings

   $ 5,584      $ 9,248   

Adjustments to reconcile net earnings to net cash provided by/(used in) operating activities:

    

Depreciation and amortization

     9,646        8,766   

Prepaid pension asset

     (3,408     (4,302

Equity-based compensation — Note B

     2,171        2,361   

Restructuring and impairment charges — Note M

     3,139        694   

Amortization of retirement benefit adjustments — Note F

     3,467        2,542   

Insurance recovery for business interruption and property damage — casualties

     (12,819     —     

Insurance proceeds for business interruption and property damage other than property, plant and equipment — casualties

     13,280        —     

Other

     (1,198     (1,481

Changes in assets and liabilities, net of acquisition

    

Accounts receivable

     (383     10,188   

Inventories

     15,252        (10,633

Other current assets

     1,218        (1,369

Accounts payable and accrued liabilities

     (23,964     (7,174
  

 

 

   

 

 

 

Total adjustments

     6,401        (408
  

 

 

   

 

 

 

Net cash provided by operating activities

     11,985        8,840   

Cash flows from investing activities:

    

Capital expenditures

     (6,877     (6,526

Capital expenditures to replace property, plant and equipment damaged in casualties

     (2,859     —     

Insurance proceeds for property, plant and equipment damaged in casualties

     2,250        —     

Proceeds from sale of assets held for sale

     350        —     

Payment for acquisition, net of cash acquired

     (14,689     (2,930
  

 

 

   

 

 

 

Net cash used in investing activities

     (21,825     (9,456

Cash flows from financing activities:

    

Payments of long-term debt — Note E

     (2,718,850     (1,989,500

Proceeds from borrowings of long-term debt — Note E

     2,741,450        1,994,000   

Payments of short-term notes payable

     (1,666     (2,203

Proceeds from borrowings of short-term notes payable

     1,666        2,449   

Purchase of treasury stock

     (5,643     (326

Dividends paid

     (2,385     (2,056

Exercise of stock options

     1,401        472   

Other

     199        204   
  

 

 

   

 

 

 

Net cash provided by financing activities

     16,172        3,040   

Effect of exchange rate on cash and cash equivalents

     295        (683
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     6,627        1,741   

Cash and cash equivalents at beginning of year

     76,412        73,315   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 83,039      $ 75,056   
  

 

 

   

 

 

 

Supplemental cash flow information — outstanding

    

Cash paid during the period for:

    

Interest

   $ 974      $ 885   

Income taxes — net

   $ 2,788      $ 2,060   

See notes to unaudited condensed consolidated financial statements.

 

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — UNAUDITED

July 1, 2012

NOTE A — Basis of Presentation

 

The accompanying condensed consolidated financial statements have been prepared by CTS Corporation (“CTS” or “the Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. The unaudited condensed consolidated financial statements should be read in conjunction with the financial statements, notes thereto, and other information included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

The accompanying unaudited condensed consolidated financial statements reflect, in the opinion of management, all adjustments (consisting of normal recurring items) necessary for a fair statement, in all material respects, of the financial position and results of operations for the periods presented. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ materially from those estimates. The results of operations for the interim periods are not necessarily indicative of the results for the entire year.

NOTE B — Equity-Based Compensation

At July 1, 2012, CTS had five equity-based compensation plans: the 1996 Stock Option Plan (“1996 Plan”), the 2001 Stock Option Plan (“2001 Plan”), the Nonemployee Directors’ Stock Retirement Plan (“Directors’ Plan”), the 2004 Omnibus Long-Term Incentive Plan (“2004 Plan”), and the 2009 Omnibus Equity and Performance Incentive Plan (“2009 Plan”). All of these plans, except the Directors’ Plan, were approved by shareholders. As of December 31, 2009, additional grants can only be made under the 2004 and 2009 Plans. CTS believes that equity-based awards align the interest of employees with those of its shareholders.

The 2009 Plan, and previously the 1996 Plan, 2001 Plan and 2004 Plan, provides for grants of incentive stock options or nonqualified stock options to officers, key employees, and nonemployee members of CTS’ board of directors. In addition, the 2009 Plan and the 2004 Plan allow for grants of stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and other stock awards.

The following table summarizes the compensation expense included in the Unaudited Condensed Consolidated Statements of Earnings for the three and six months ended July 1, 2012 and July 3, 2011, respectively, relating to these plans:

 

     Three Months Ended      Six Months Ended  

($ in thousands)

   July 1,
2012
     July 3,
2011
     July 1,
2012
     July 3,
2011
 

Restricted stock units

     957         1,181         2,171         2,361   

The following table summarizes the status of these plans as of July 1, 2012:

 

     2009 Plan      2004 Plan      2001 Plan      1996 Plan  

Awards originally available

     3,400,000         6,500,000         2,000,000         1,200,000   

Stock options outstanding

        257,200         246,450         48,500   

Restricted stock units outstanding

     545,551         107,823         

Options exercisable

        257,200         246,450         48,500   

Awards available for grant

     2,160,455         270,800         

 

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Stock Options

Stock options are exercisable in cumulative annual installments over a maximum 10-year period, commencing at least one year from the date of grant. Stock options are generally granted with an exercise price equal to the market price of the Company’s stock on the date of grant. The stock options generally vest over four years and have a 10-year contractual life. The awards generally contain provisions to either accelerate vesting or allow vesting to continue on schedule upon retirement if certain service and age requirements are met. The awards also provide for accelerated vesting if there is a change in control event.

The Company estimated the fair value of the stock option on the grant date using the Black-Scholes option-pricing model and assumptions for expected price volatility, option term, risk-free interest rate, and dividend yield. Expected price volatilities were based on historical volatilities of the Company’s stock. The expected option term is derived from historical data on exercise behavior. The dividend yield was based on historical dividend payments. The risk-free rate for periods within the contractual life of the option was based on the U.S. Treasury yield curve in effect at the time of grant.

A summary of the status of stock options as of July 1, 2012 and July 3, 2011, and changes during the six-month periods then ended, is presented below:

 

     July 1, 2012      July 3, 2011  
      Options     Weighted-
Average

Exercise Price
     Options     Weighted-
Average

Exercise Price
 

Outstanding at beginning of year

     728,050      $ 10.24         1,093,063      $ 12.61   

Exercised

     (154,750   $ 8.71         (59,263   $ 7.91   

Expired

     (11,000   $ 16.22         (195,750   $ 21.99   

Forfeited

     (10,150   $ 9.41         —        $ —     
  

 

 

      

 

 

   

Outstanding at end of period

     552,150      $ 10.57         838,050      $ 10.75   
  

 

 

   

 

 

    

 

 

   

 

 

 

Exercisable at end of period

     552,150      $ 10.57         838,050      $ 10.75   
  

 

 

   

 

 

    

 

 

   

 

 

 

The total intrinsic value of share options exercised during the six-month periods ended July 1, 2012 and July 3, 2011, were $255,000 and $209,000, respectively.

The weighted average remaining contractual life of options outstanding and options exercisable at July 1, 2012 and July 3, 2011 were 1.7 years and 2.2 years, respectively. The aggregate intrinsic values of options outstanding and options exercisable at July 1, 2012 and July 3, 2011 were approximately $182,000 and $378,000, respectively.

There were no unvested stock options at July 1, 2012.

The following table summarizes information about stock options outstanding at July 1, 2012:

 

     Options Outstanding and Exercisable  

Range of

Exercise

Prices

   Number Outstanding
And Exercisable

at 7/1/12
     Weighted Average
Remaining
Contractual

Life (Years)
     Weighted Average
Exercise Price
 

$ 7.70 – 11.11

     450,350         1.48         9.81   

$ 13.68 – 16.24

     101,800         3.34         13.93   

Service-Based Restricted Stock Units

Service-based restricted stock units (“RSUs”) entitle the holder to receive one share of common stock for each unit when the unit vests. RSUs are issued to officers and key employees as compensation. Generally, the RSUs vest over a three to five-year period. A summary of the status of RSUs as of July 1, 2012 and July 3, 2011, and changes during the six-month periods then ended is presented below:

 

     July 1, 2012      July 3, 2011  
      RSUs     Weighted-average
Grant-Date
Fair Value
     RSUs     Weighted-average
Grant-Date
Fair Value
 

Outstanding at beginning of year

     701,449      $ 9.35         807,601      $ 8.39   

Granted

     231,750      $ 10.41         219,100      $ 11.89   

Converted

     (252,964   $ 8.51         (297,104   $ 8.52   

Forfeited

     (26,861   $ 9.06         (39,943   $ 8.89   
  

 

 

      

 

 

   

Outstanding at end of period

     653,374      $ 10.07         689,654      $ 9.42   
  

 

 

   

 

 

    

 

 

   

 

 

 

Weighted-average remaining contractual life

     8.3 years           6.7 years     
  

 

 

      

 

 

   

 

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CTS recorded compensation expense of approximately $496,000 and $1,249,000 related to service-based restricted stock units during the three and six month periods ended July 1, 2012, respectively. CTS recorded compensation expense of approximately $691,000 and $1,400,000 related to service-based restricted stock units during the three and six month periods ended July 3, 2011, respectively.

As of July 1, 2012, there was $2.6 million of unrecognized compensation cost related to nonvested RSUs. That cost is expected to be recognized over a weighted-average period of 1.2 years. CTS recognizes expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards.

Performance-Based Restricted Stock Units

On February 2, 2010, CTS granted performance-based restricted stock unit awards for certain executives. Vesting may occur in the range from zero percent to 200% of the target amount of 78,000 units in 2012 subject to certification of the 2011 fiscal year results by CTS’ independent auditors. Vesting is dependent upon CTS’ achievement of sales growth targets and, as a result, 49,320 units were awarded and vested.

On February 3, 2011, CTS granted performance-based restricted stock unit awards for certain executives. Vesting may occur in the range from zero percent to 200% of the target amount of 53,200 units in 2013 subject to certification of the 2012 fiscal year results by CTS’ independent auditors. Vesting is dependent upon CTS’ achievement of sales growth targets.

On February 8, 2012, CTS granted performance-based restricted stock unit awards for certain executives. Vesting may occur in the range from zero percent to 200% of the target amount of 45,850 units in 2014 subject to certification of the 2013 fiscal year results by CTS’ independent auditors. Vesting is dependent upon CTS’ achievement of sales growth targets.

On February 8, 2012, CTS granted performance-based restricted stock unit awards for certain executives. Vesting may occur in the range from zero percent to 200% of the target amount of 39,300 units in 2014 subject to certification of the 2013 fiscal year results by CTS’ independent auditors. Vesting is dependent upon CTS’ achievement of free cash flow targets.

CTS recorded compensation expense of approximately $229,000 and $459,000 related to performance-based restricted stock units during the three and six month periods ended July 1, 2012, respectively. CTS recorded compensation expense of approximately $177,000 and $343,000 related to performance-based restricted stock units during the three and six month periods ended July 3, 2011, respectively. As of July 1, 2012 there was approximately $1,036,000 of unrecognized compensation cost related to performance-based RSUs. That cost is expected to be recognized over a weighted-average period of 1.1 year.

Market-Based Restricted Stock Units

On July 2, 2007, CTS granted a market-based restricted stock unit award for an executive officer. An aggregate of 25,000 units may be earned in performance years ending in the following three consecutive years on the anniversary of the award date. Vesting may occur in the range from zero percent to 150% of the target award on the end date of each performance period and is tied exclusively to CTS total stockholder return relative to 32 enumerated peer group companies’ total stockholder return rates. The vesting rate will be determined using a matrix based on a percentile ranking of CTS total stockholder return with peer group total shareholder return over a three-year period. During the year ended December 31, 2010, 12,500 units was earned and awarded to the executive officer. There were no units awarded in 2011.

On February 2, 2010, CTS granted market-based restricted stock unit awards for certain executives and key employees. Vesting may occur in the range from zero percent to 200% of the target amount of 117,000 units in 2012. Vesting is dependent upon CTS total stockholder return relative to 28 enumerated peer group companies’ stockholder return rates and, as a result, 67,130 units were awarded and vested.

On February 3, 2011, CTS granted market-based restricted stock unit awards for certain executives and key employees. Vesting may occur in the range from zero percent to 200% of the target amount of 79,800 units in 2013. Vesting is dependent upon CTS total stockholder return relative to 28 enumerated peer group companies’ stockholder return rates.

 

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On February 8, 2012, CTS granted market-based restricted stock unit awards for certain executives and key employees. Vesting may occur in the range from zero percent to 200% of the target amount of 45,850 units in 2014. Vesting is dependent upon CTS total stockholder return relative to 28 enumerated peer group companies’ stockholder return rates.

CTS recorded compensation expense of approximately $232,000 and $463,000 related to market-based restricted stock units during the three and six month periods ended July 1, 2012, respectively. CTS recorded compensation expense of approximately $313,000 and $606,000 related to market-based restricted stock units during the three and six month periods ended July 3, 2011, respectively. As of July 1, 2012, there was approximately $782,000 of unrecognized compensation cost related to market-based RSUs. That cost is expected to be recognized over a weighted-average period of 0.9 year.

Stock Retirement Plan

The Directors’ Plan provides for a portion of the total compensation payable to nonemployee directors to be deferred and paid in CTS stock. The Directors’ Plan was frozen effective December 1, 2004. All future grants will be from the 2009 Plan.

NOTE C — Acquisition

In January 2012, CTS acquired 100% of the common stock of Valpey-Fisher Corporation (“Valpey-Fisher”), a publicly held company located in Hopkinton, Massachusetts for approximately $18.3 million. Valpey-Fisher is a recognized technology leader in the design and manufacture of precision frequency crystal oscillators. This acquisition expands CTS’ technology, and brings strong engineering capabilities and management leadership to support the Company’s strategic initiatives in CTS’ Component and Sensors’ segment.

The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition:

 

     Estimated Fair
Values
 

($ in thousands)

   At January 23,
2012
 

Current assets

   $ 9,077   

Property, plant and equipment

     6,231   

Goodwill

     5,355   

Amortizable intangible assets

     3,570   

Other assets

     231   
  

 

 

 

Fair value of assets acquired, including $3,578 cash acquired

     24,464   

Less fair value of liabilities acquired

     (6,197
  

 

 

 

Net assets acquired

     18,267   

Cash acquired

     3,578   
  

 

 

 

Net cash paid

   $ 14,689   
  

 

 

 

Included in current assets is the fair value of accounts receivable of $2,479. Goodwill recorded in connection with the above acquisition is primarily attributable to the synergies expected to arise after the Company’s acquisition of the business and the assembled workforce of the acquired business. None of the goodwill is expected to be deductible for tax purposes.

The following table summarizes the net sales and earnings before income taxes of Valpey-Fisher that is included in CTS’ Condensed Consolidated Statements of Earnings since the acquisition date, January 23, 2012, that is included in the consolidated statement of earnings for the three months and six months ended July 1, 2012:

 

     Three Months
Ended
    Six Months
Ended
 

($ in thousands)

   July 1, 2012     July 1, 2012  

Net Sales

   $ 3,955      $ 6,946   

Loss before income taxes

   $ (272   $ (111

The following table summarizes the combined net sales and earnings before income taxes of CTS and Valpey-Fisher on a pro forma basis as if the acquisition date had occurred at the beginning of the reporting period:

 

     Three Months Ended      Six Months Ended  

($ in thousands)

   July 1,
2012
     July 3,
2011
     July 1,
2012
     July 3,
2011
 
     (Proforma)      (Proforma)      (Proforma)      (Proforma)  

Net Sales

   $ 154,294       $ 150,804       $ 302,379       $ 305,841   

Earnings before income taxes

   $ 4,528       $ 5,136       $ 6,812       $ 11,617   

 

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The Valpey-Fisher acquisition will be accounted for using the acquisition method of accounting whereby the total purchase price will be allocated to tangible and intangible assets and liabilities based on the fair market values on the date of acquisition. CTS will determine the purchase price allocations on the acquisition based on estimates of the fair values of the assets acquired and liabilities assumed. These allocations are expected to be finalized by the end of 2012.

In January 2011, CTS acquired certain assets and assumed certain liabilities of Fordahl SA, a privately held company located in Brugg, Switzerland. This business was acquired for approximately $2.9 million, net of cash acquired. The assets acquired include inventory, accounts receivable, leasehold improvements, machinery and equipment, and certain intangible assets.

The Fordahl SA product line includes high-performance temperature compensated crystal oscillators and voltage controlled crystal oscillators. This product line expanded CTS’ frequency product portfolio from clock and crystals to highly-engineered precision ovenized oscillators. This acquisition added new customers and opened up new market opportunities for CTS.

The Fordahl acquisition was accounted for using the acquisition method of accounting whereby the total purchase price was allocated to tangible and intangible assets based on the fair market values on the date of acquisition. CTS determined the purchase price allocations on the acquisition based on estimates of the fair values of the assets acquired and liabilities assumed. CTS finalized the purchase price allocation at December 31, 2011. The land and building, machinery and equipment and intangible assets are classified as Level 3 under the fair value hierarchy. The pro forma effect of this acquisition is not material to CTS’ results of operations or financial position.

NOTE D — Inventories

Inventories consist of the following:

 

($ in thousands)

   July 1,
2012
     December 31,
2011
 

Finished goods

   $ 13,592       $ 14,697   

Work-in-process

     17,827         20,602   

Raw materials

     47,245         57,241   
  

 

 

    

 

 

 

Total inventories

   $ 78,664       $ 92,540   
  

 

 

    

 

 

 

NOTE E — Debt

On January 10, 2012, CTS amended its November 18, 2010 unsecured revolving credit agreement. This amendment provided for an increase in the revolving credit facility to $200 million and increased the accordion feature, whereby CTS can expand the facility to $300 million, subject to participating banks’ approval. Additionally, among other covenants, the amendment reduced the applicable margin by 25 basis points, increased the total consideration the company may pay for non-U.S. based acquisitions, and extended the term of the credit agreement through January 10, 2017.

Long-term debt was comprised of the following:

 

($ in thousands)

   July 1,
2012
     December 31,
2011
 

Revolving credit agreement, weighted-average interest rate of 1.8% (2012), and 1.9% (2011) due in 2017 and 2015, respectively

   $ 97,000       $ 74,400   

There was $97.0 million outstanding under the $200 million revolving credit agreement at July 1, 2012, and $74.4 million outstanding under the $150 million revolving credit agreement at December 31, 2011. The Company had $100.4 million available under the $200 million credit agreement at July 1, 2012, net of standby letters of credit of $2.6 million, and $72.8 million available under the $150 million credit agreement at December 31, 2011, net of standby letters of credit of $2.8 million. Interest rates on the revolving credit agreement fluctuate based upon London Interbank Offered Rate and the Company’s quarterly total leverage ratio. CTS pays a commitment fee on the undrawn portion of the revolving credit agreement. The commitment fee varies based on the quarterly leverage ratio and was 0.35 percent per annum at July 1, 2012. The revolving credit agreement requires, among other things, that CTS comply with a maximum total leverage ratio and a minimum fixed charge coverage ratio. Failure of CTS to comply with these covenants could reduce the borrowing availability under the revolving credit agreement. CTS was in compliance with all debt covenants at July 1, 2012. The

 

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revolving credit agreement requires CTS to deliver quarterly financial statements, annual financial statements, auditors certifications and compliance certificates within a specified number of days after the end of a quarter and year. Additionally, the revolving agreement contains restrictions limiting CTS’ ability to: dispose of assets; incur certain additional debt; repay other debt or amend subordinated debt instruments; create liens on assets; make investments, loans or advances; make acquisitions or engage in mergers or consolidations; engage in certain transactions with CTS’ subsidiaries and affiliates; and make stock repurchases and dividend payments.

CTS uses interest rate swaps to convert the line of credit’s variable rate of interest into a fixed rate. During the second quarter of 2012, CTS entered into four separate interest rate swap agreements to fix interest rates on $50 million of long-term debt for the periods January 2013 to January 2017. The difference to be paid or received under the terms of the swap agreement will be accrued as interest rates change and recognized as an adjustment to interest expense for the related line of credit. Changes in the variable interest rates to be paid or received will have a corresponding effect on future cash flows.

These swaps are treated as cash flow hedges and consequently, the changes in fair value were recorded in Other Comprehensive Income. During the second quarter of 2012, an unrealized loss of approximately $832,000 was recorded in Other Comprehensive Income with approximately $79,000 recorded as accrued liabilities section and the remaining $753,000 recorded as a non-current liability in Other Long-term Obligations on the Condensed Consolidated Balance Sheets.

As a result of the use of these derivative instruments, the Company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the Company has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors. CTS’ established policies and procedures for mitigating credit risk on principal transactions include reviewing and establishing limits for credit exposure and continually assessing the creditworthiness of counterparties.

NOTE F — Retirement Plans

 

Net pension expense/(income) for the three months ended July 1, 2012 and July 3, 2011 for our domestic and foreign plans include the following components:

 

     Domestic
Pension  Plans
    Foreign
Pension  Plans
 

($ in thousands)

   July 1,
2012
    July 3,
2011
    July 1,
2012
    July 3,
2011
 

Service cost

   $ 683      $ 687      $ 31      $ 35   

Interest cost

     2,987        3,078        143        152   

Expected return on plan assets (1) 

     (5,376     (5,916     (111     (146

Amortization of prior service cost

     151        153        —          —     

Amortization of loss

     1,517        1,050        74        70   

Additional cost due to retirement

     282        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Expense/(income), net

   $ 244      $ (948   $ 137      $ 111   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net pension expense/(income) for the six months ended July 1, 2012 and July 3, 2011 for our domestic and foreign plans include the following components:

 

     Domestic
Pension  Plans
    Foreign
Pension  Plans
 

($ in thousands)

   July 1,
2012
    July 3,
2011
    July 1,
2012
    July 3,
2011
 

Service cost

   $ 1,367      $ 1,374      $ 62      $ 70   

Interest cost

     5,978        6,156        285        301   

Expected return on plan assets (1) 

     (10,753     (11,832     (220     (289

Amortization of prior service cost

     302        306        —          —     

Amortization of loss

     3,037        2,100        148        139   

Additional cost due to retirement

     282        —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Expense/(income), net

   $ 213      $ (1,896   $ 275      $ 221   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Expected return on plan assets is net of expected investment expenses and certain administrative expenses.

Net post retirement expense for the three and six months ended July 1, 2012 and July 3, 2011 for our post-retirement plan includes the following components:

 

     Three Months
Ended
    Six Months
Ended
 

($ in thousands)

   July 1,
2012
    July 3,
2011
    July 1,
2012
    July 3,
2011
 

OTHER POSTRETIREMENT BENEFIT PLAN

        

Service cost

   $ 2      $ 4      $ 4      $ 8   

Interest cost

     64        72        128        144   

Amortization of gain

     (10     (1     (20     (3
  

 

 

   

 

 

   

 

 

   

 

 

 

Postretirement expense

   $ 56      $ 75      $ 112      $ 149   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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NOTE G —  Segments

CTS reportable segments are grouped by entities that exhibit similar economic characteristics and the segment’s reporting results are regularly reviewed by CTS’ chief operating decision maker to make decisions about resources to be allocated to these segments and to evaluate the segment’s performance. CTS has two reportable segments: 1) Components and Sensors and 2) EMS.

Components and sensors are products which perform specific electronic functions for a given product family and are intended for use in customer assemblies. Components and sensors consist principally of: automotive sensors and actuators used in commercial or consumer vehicles; electronic components used in communications infrastructure and computer markets; terminators, including ClearONE™ terminators, used in computer and other high speed applications, switches, resistor networks and potentiometers used to serve multiple markets; and fabricated piezo-electric materials and substrates used primarily in medical, computer and industrial markets.

EMS includes the higher level assembly of electronic and mechanical components into a finished subassembly or assembly performed under a contract manufacturing agreement with an Original Equipment Manufacturer (“OEM”) or other contract manufacturer. Additionally for some customers, CTS provides full turnkey manufacturing and completion including design, bill-of-material management, logistics, and repair.

The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies in the Company’s annual report on Form 10-K. Management evaluates performance based upon segment operating earnings/(loss) before interest expense, interest income, other non-operating income/(expense), and income tax expense.

Summarized financial information concerning CTS’ reportable segments is shown in the following table:

 

($ in thousands)

   Components
and Sensors
    EMS     Total  

Second Quarter of 2012

    

Net sales to external customers

   $ 76,823      $ 77,471      $ 154,294   
  

 

 

   

 

 

   

 

 

 

Segment operating earnings before corporate and shared services charges

   $ 8,398      $ 6,086      $ 14,484   
  

 

 

   

 

 

   

 

 

 

Corporate and shared services charges

     (3,034     (1,906     (4,940
  

 

 

   

 

 

   

 

 

 

Segment operating earnings

   $ 5,364      $ 4,180      $ 9,544   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 361,483      $ 128,606      $ 490,089   

Second Quarter of 2011

      

Net sales to external customers

   $ 68,037      $ 78,882      $ 146,919   
  

 

 

   

 

 

   

 

 

 

Segment operating earnings before corporate and shared services charges

   $ 8,846      $ 2,259      $ 11,105   
  

 

 

   

 

 

   

 

 

 

Corporate and shared services charges

     (3,995     (1,889     (5,884
  

 

 

   

 

 

   

 

 

 

Segment operating earnings

   $ 4,851      $ 370      $ 5,221   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 355,841      $ 139,582      $ 495,423   

First Six Months of 2012

      

Net sales to external customers

   $ 153,241      $ 148,022      $ 301,263   
  

 

 

   

 

 

   

 

 

 

Segment operating earnings before corporate and shared services charges

   $ 15,742      $ 6,541      $ 22,283   
  

 

 

   

 

 

   

 

 

 

Corporate and shared services charges

     (7,358     (3,449     (10,807
  

 

 

   

 

 

   

 

 

 

Segment operating earnings(1)

   $ 8,384      $ 3,092      $ 11,476   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 361,483      $ 128,606      $ 490,089   

First Six Months of 2011

      

Net sales to external customers

   $ 140,068      $ 158,369      $ 298,437   
  

 

 

   

 

 

   

 

 

 

Segment operating earnings before corporate and shared services charges

   $ 18,651      $ 4,089      $ 22,740   
  

 

 

   

 

 

   

 

 

 

Corporate and shared services charges

     (8,044     (3,716     (11,760
  

 

 

   

 

 

   

 

 

 

Segment operating earnings

   $ 10,607      $ 373      $ 10,980   
  

 

 

   

 

 

   

 

 

 

Total assets

   $ 355,841      $ 139,582      $ 495,423   

 

(1) EMS segment’s operating earnings of $3,092 includes $1,769 of insurance recovery for property damage related to the flood at CTS Thailand’s manufacturing facility.

 

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Reconciling information between reportable segments’ operating earnings and CTS’ consolidated earnings before income taxes is shown in the following table for the three and six-month periods then ended:

 

     Three Months Ended     Six Months Ended  

($ in thousands)

   July 1,
2012
    July 3,
2011
    July 1,
2012
    July 3,
2011
 

Total segment operating earnings

   $ 9,544      $ 5,221      $ 11,476      $ 10,980   

Restructuring charges

     (3,831     (694     (3,831     (694

Interest expense

     (626     (511     (1,285     (1,003

Interest income

     467        276        916        472   

Other (expense)/income

     (1,041     743        (466     1,873   
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings before income taxes

   $ 4,513      $ 5,035      $ 6,810      $ 11,628   
  

 

 

   

 

 

   

 

 

   

 

 

 

NOTE H — Contingencies

Certain processes in the manufacture of CTS’ current and past products create hazardous waste by-products as currently defined by federal and state laws and regulations. CTS has been notified by the U.S. Environmental Protection Agency, state environmental agencies and, in some cases, generator groups, that it is or may be a potentially responsible party regarding hazardous waste remediation at several non-CTS sites. In addition to these non-CTS sites, CTS has an ongoing practice of providing reserves for probable remediation activities at certain of its manufacturing locations and for claims and proceedings against CTS with respect to other environmental matters. In the opinion of management, based upon presently available information relating to all such matters, either adequate provision for probable costs has been made, or the ultimate costs resulting will not materially affect the consolidated financial position, results of operations, or cash flows of CTS.

CTS manufactures accelerator pedals for a number of automobile manufacturers, including subsidiaries of Toyota Motor Corporation (“Toyota”). In January 2010, Toyota initiated a recall of a substantial number of vehicles in North America containing pedals manufactured by CTS. The pedal recall and associated events have led to the Company being named as a co-defendant with Toyota in certain litigation. In February 2010, CTS entered into an agreement with Toyota whereby Toyota agreed that it will indemnify, defend, and hold the Company harmless from, and the parties will cooperate in the defense of, third-party civil claims and actions that are filed or asserted in the United States or Canada and that arise from or relate to alleged incidents of unintended acceleration of Toyota and Lexus vehicles. The limited exceptions to indemnification restrict CTS’ share of any liability to amounts collectable from its insurers.

Certain other claims are pending against CTS with respect to matters arising out of the ordinary conduct of the Company’s business. For all other claims, in the opinion of management, based upon presently available information, either adequate provision for anticipated costs has been accrued or the ultimate anticipated costs will not materially affect CTS’ consolidated financial position, results of operations, or cash flows.

Scotland EMS Manufacturing Facility Fire

During the second quarter of 2011, a fire occurred at the Company’s Scotland EMS manufacturing facility. The fire damaged approximately $1.6 million of inventory and $0.2 million of machinery and equipment at net book value. Property insurance coverage with a $0.1 million deductible had substantially covered the costs of repairing and/or replacing the damaged inventory and machinery and equipment. Business interruption insurance had substantially covered the lost sales impact and related fixed costs in 2011.

During the second quarter of 2012, CTS recorded a recovery of approximately $0.2 million for business interruption in CTS’ Condensed Consolidated Statements of Earnings for the three months ended July 1, 2012. This recovery reflects the final settlement with CTS’ insurance carrier.

 

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In the first half of 2012, CTS recovered approximately $1.0 million from the Company’s insurance carriers and recorded a recovery of approximately $0.9 million for business interruption, after deducting approximately $0.1 million for certain expenses, in CTS’ Condensed Consolidated Statements of Earnings for the six months ended July 1, 2012.

Thailand EMS Manufacturing Facility Flood

During the fourth quarter of 2011, CTS’ Thailand EMS manufacturing facility was flooded. Based on preliminary estimates, the flood damaged approximately $0.5 million of inventory and $0.5 million of fixed assets at net book value. The Company also incurred approximately $2.5 million of fixed costs at this facility. Local and global property insurance coverage covered the costs of repairing and/or replacing the damaged inventory and machinery and equipment. CTS also has business interruption insurance under these policies that covers the lost sales impact and fixed costs.

During the second quarter of 2012, CTS received cash of approximately $7.5 million from the Company’s insurance carriers. Out of the $7.5 million cash, approximately $7.2 million was for business interruption and the remaining $0.3 million was for the reimbursement of costs related to inventory.

In the first half of 2012, CTS received cash of approximately $14.7 million from the Company’s insurance carriers. Out of the $14.7 million cash, approximately $11.6 million was for business interruption and the remaining $3.1 million was for the reimbursement of costs related to property damage. Part of the cash received was to relieve the insurance receivable balance of $2.4 million recorded at December 31, 2011.

CTS recorded a recovery of approximately $10.2 million for business interruption and $1.8 million for property damage in CTS’ Condensed Consolidated Statements of Earnings for the six months ended July 1, 2012. CTS continues to incur costs related to the flood and process the appropriate claim with the Company’s insurance carrier related to increased expenses and lost sales impact.

NOTE I — Fair Value Measurement

Goodwill represents the excess of the cost of businesses acquired over the fair value of the assets acquired and liabilities assumed. CTS does not amortize goodwill, but tests it for impairment annually using a fair value approach at the reporting unit level. A reporting unit is the operating segment, or a business one level below that operating segment or the component level if discrete financial information is prepared and regularly reviewed by senior management. However, components are aggregated as a single reporting unit if they have similar economic characteristics.

The table below summarizes the non-financial assets that were measured and recorded at fair value on a non-recurring basis as of July 1, 2012 and the loss recorded during the six months ended July 1, 2012 on those assets:

 

($ in thousands)

                                  

Description

   Carrying Value
at July 1, 2012
     Quoted Prices
in Active
Markets for
Identical

(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Loss for Six
Months
Ended
July 1,
2012
 

Goodwill

   $ 5,855       $ —         $ —         $ 5,855       $ —     

Intangible assets, other than goodwill

   $ 31,911       $ —         $ —         $ 31,911       $ —     

Long-lived assets

   $ 91,171       $ —         $ —         $ 91,171       $ 1,278   

The fair value of these assets were measured and recorded using an income approach. Projected future cash flows related to these assets were used under this approach to determine their fair values.

The following table reconciles the beginning and ending balance of CTS’ goodwill for the period ended July 1, 2012:

 

($ in thousands)                     
     C&S      EMS      Total  

Balance at January 1, 2012

   $ —         $ 500          $ 500   

2012 first half activity — Note C, “Acquisitions”

     5,355         —              5,355   
  

 

 

    

 

 

       

 

 

 

Balance at July 1, 2012

   $ 5,355       $ 500          $ 5,855   
  

 

 

    

 

 

       

 

 

 

See Note L, “Goodwill and Other Intangible Assets,” for further discussion.

 

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The following table reconciles the beginning and ending balances of CTS’ intangible assets, other than goodwill for the period ended July 1, 2012:

 

($ in thousands)    Total  

Balance at January 1, 2012

   $ 29,886   

2012 addition — Note C, “Acquisitions”

     3,570   

2012 first half amortization expense

     (1,545
  

 

 

 

Balance at July 1, 2012

   $ 31,911   
  

 

 

 

See Note L, “Goodwill and Other Intangible Assets,” for further discussion.

The following table reconciles the beginning and ending balances of CTS’ long-lived assets for the period ended July 1, 2012:

 

($ in thousands)    Total  

Balance at January 1, 2012

   $ 84,860   

Capital expenditures

     6,877   

Capital expenditures to replace property, plant & equipment damaged in Thailand flood

     2,859   

Fixed assets acquired in Valpey-Fisher acquisition — Note C

     6,231   

Depreciation expense

     (8,101

Transfer to asset held for sale

     (350

Impairment charge

     (1,239

Foreign exchange impact and other

     34   
  

 

 

 

Balance at July 1, 2012

   $ 91,171   
  

 

 

 

The table below summarizes the financial liability that was measured at fair value on a recurring basis as of July 1, 2012:

 

($ in thousands)

   Carrying Value
at July 1, 2012
     Quoted Prices
in Active
Markets for
Identical

(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
     Loss for
Quarter Ended
July 1, 2012
 

Interest rate swap — cash flow hedge

   $ 832       $ —         $ 832       $ —         $ —     

The fair value of CTS’ interest rate swaps were measured using a market approach which uses current industry information. There is a readily determinable market and these swaps are classified within level 2 of the fair value hierarchy. $79,000 of the fair value of these swaps are classified as Accrued liabilities and the remaining $753,000 are classified as Other liabilities on CTS’ Consolidated Balance Sheets.

CTS’ long-term debt consists of a revolving debt agreement. There is a readily determinable market for CTS’ revolving credit debt and it is classified within Level 2 of the fair value hierarchy as the market is not deemed to be active. The fair value of long-term debt was measured using a market approach which uses current industry information and approximates carrying value.

NOTE J — Earnings Per Share

The table below provides a reconciliation of the numerator and denominator of the basic and diluted earnings per share (“EPS”) computations. Basic earnings per share is calculated using the weighted average number of common shares outstanding as the denominator and net earnings as the numerator. Diluted earnings per share is calculated by adding all potentially dilutive shares to the weighted average number of common shares outstanding for the numerator. All anti-dilutive shares are excluded from the computation of diluted earnings per share. The calculations below provide net earnings, weighted average common shares outstanding, and earnings per share for both basic and diluted EPS for the three and six month periods ended July 1, 2012 and July 3, 2011.

 

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($ in thousands, except per share amounts)

   Net
Earnings

(Numerator)
     Shares
(in thousands)
(Denominator)
     Per
Share
Amount
 

Second Quarter 2012

        

Basic EPS

   $ 3,301         34,022         0.10   
        

 

 

 

Effect of dilutive securities:

        

Equity-based compensation plans

     —           552      
  

 

 

    

 

 

    

Diluted EPS

   $ 3,301         34,574         0.10   
  

 

 

    

 

 

    

 

 

 

Second Quarter 2011

        

Basic EPS

   $ 4,132         34,375       $ 0.12   
        

 

 

 

Effect of dilutive securities:

        

Equity-based compensation plans

     —           650      
  

 

 

    

 

 

    

Diluted EPS

   $ 4,132         35,025       $ 0.12   
  

 

 

    

 

 

    

 

 

 

First Six Months of 2012

        

Basic EPS

   $ 5,584         34,064         0.16   
        

 

 

 

Effect of dilutive securities:

        

Equity-based compensation plans

     —           583      
     

 

 

    

Diluted EPS

   $ 5,584         34,647         0.16   
  

 

 

    

 

 

    

 

 

 

First Six Months of 2011

        

Basic EPS

   $ 9,248         34,334       $ 0.27   
        

 

 

 

Effect of dilutive securities:

        

Equity-based compensation plans

     —           716      
  

 

 

    

 

 

    

Diluted EPS

   $ 9,248         35,050       $ 0.26   
  

 

 

    

 

 

    

 

 

 

The following table shows the potentially dilutive securities which have been excluded from the three and six-month periods 2012 and 2011 dilutive earnings per share calculation because they are either anti-dilutive, or the exercise price exceeds the average market price.

 

     Three Months
Ended
     Six Months
Ended
 

(Number of Shares in Thousands)

   July 1,
2012
     July 3,
2011
     July 1,
2012
     July 3,
2011
 

Stock options where the assumed proceeds exceed the

average market price

     282         402         282         402   

NOTE K — Treasury Stock

Common stock held in treasury totaled 21,296,593 shares with a cost of $306.2 million at July 1, 2012 and 20,724,106 shares with a cost of $300.6 million at December 31, 2011. Approximately 7.5 million shares are available for future issuances.

In May 2008, CTS’ Board of Directors authorized a program to repurchase up to one million shares of its common stock in the open market at a maximum price of $13 per share. The authorization has no expiration. Reacquired shares will be used to support equity-based compensation programs and for other corporate purposes. During the first half of 2012, 572,487 shares were repurchased at a cost of approximately $5.6 million or $9.86 per share.

NOTE L — Goodwill and Other Intangible Assets

CTS has the following other intangible assets and goodwill as of:

 

     July 1, 2012     December 31, 2011  
($ in thousands)    Gross
Carrying
Amount
     Accumulated
Amortization
    Gross
Carrying
Amount
     Accumulated
Amortization
 

Amortized intangible assets:

          

Customer lists/relationships

   $ 53,923       $ (23,730   $ 51,424       $ (22,390

Patents

     10,319         (10,319     10,319         (10,319

Other intangibles

     2,291         (573     1,220         (368
  

 

 

    

 

 

   

 

 

    

 

 

 

Total

     66,533         (34,622     62,963         (33,077

Goodwill

     5,855         —          500         —     
  

 

 

    

 

 

   

 

 

    

 

 

 

Total other intangible assets and goodwill

   $ 72,388       $ (34,622   $ 63,463       $ (33,077
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Of the net intangible assets excluding goodwill at July 1, 2012, $26.5 million relates to the Components and Sensors segment and $5.4 million relates to the EMS segment. Of the goodwill at July 1, 2012, $5.4 million relates to Components and Sensors segment and $0.5 million relates to the EMS segment. The goodwill at December 31, 2011 relates to the EMS segment. CTS recorded amortization expense of $0.7 million and $1.5 million during the three and six-month periods ended July 1, 2012, respectively. CTS recorded amortization expense of $0.7 million and $1.3 million during the three and six-month periods ended July 3, 2011, respectively. The weighted average remaining amortization period for the amortizable intangible assets is 13.2 years. The weighted average remaining amortization period for customer lists/relationships is 13.7 years and for the other intangibles is 4.2 years. CTS estimates remaining amortization expense of $1.6 million in 2012, $3.1 million in 2013, $3.0 million in 2014, $2.9 million in 2015, $2.8 million in 2016 and $18.5 million thereafter.

NOTE M — Restructuring Charges

During June of 2012, CTS initiated certain restructuring actions to reorganize certain operations to further improve its cost structure. These actions will result in the elimination of approximately 260 positions. These actions are expected to be substantially complete by the middle of the fourth quarter of 2012. The following table displays the planned restructuring and restructuring-related charges associated with the realignment, as well as a summary of the actual costs incurred through July 1, 2012:

 

($ in millions)             June 2012 Plan

   Planned
Costs
     Actual  incurred
through

July 1, 2012
 

Workforce reduction

   $ 2.1       $ 1.8   

Asset impairment charge

     1.2         1.2   

Other charge

     0.1         0.1   
  

 

 

    

 

 

 

Restructuring and impairment charges

   $ 3.4       $ 3.1   
  

 

 

    

 

 

 

Inventory write-down

   $ 0.6       $ 0.6   

Equipment relocation

     0.5         0.1   

Other charges

     0.5         —     
  

 

 

    

 

 

 

Restructuring-related charges

   $ 1.6       $ 0.7   
  

 

 

    

 

 

 

Total restructuring and restructuring-related charges

     5.0         3.8   
  

 

 

    

 

 

 

Of the restructuring and restructuring-related charges incurred, $1.2 million relates to the Components and Sensors segment and $2.6 million relates to the EMS segment. Restructuring and impairment charges are reported on a separate line on the Unaudited Consolidated Statements of Earnings. Restructuring-related charges are reported as a component of Cost of Goods Sold on the Unaudited Consolidated Statements of Earnings.

The following table displays the restructuring reserve activity related to the realignment for the period ended July 1, 2012:

 

($ in millions)             June 2012 Plan

      

Restructuring liability at April 1, 2012

   $ —     

Restructuring and restructuring-related charges, excluding asset impairments and write-offs

     2.0   

Cost paid

     (0.7
  

 

 

 

Restructuring liability at July 1, 2012

   $ 1.3   
  

 

 

 

Included in the restructuring activities discussed above, CTS will consolidate its operations from the United Kingdom (“UK”) EMS manufacturing facility and the Tucson, AZ Components and Sensors facility into other facilities. The EMS operations at the UK EMS facility are currently being transferred to CTS’ EMS facilities located in Londonderry, New Hampshire and Matamoros, Mexico. The Components and Sensors operations at the Tucson, AZ facility are currently being transferred to CTS’ Components and Sensors facility located in Albuquerque, New Mexico.

During April of 2011, CTS initiated certain restructuring actions to reorganize certain operations to further improve its cost structure. These actions resulted in the elimination of approximately 30 positions. The following table displays the planned restructuring and restructuring-related charges associated with the realignment, as well as a summary of the actual costs incurred through July 1, 2012:

 

($ in millions)             April 2011 Plan

   Planned
Costs
     Actual  incurred
through

July 1, 2012
 

Workforce reduction

   $ 0.8       $ 0.7   
  

 

 

    

 

 

 

Total restructuring and impairment charge

   $ 0.8       $ 0.7   
  

 

 

    

 

 

 

 

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Of the restructuring charges incurred, $0.5 million relates to the Components and Sensors segment and $0.2 million relates to the EMS segment. Restructuring charges are reported on a separate line on the Unaudited Consolidated Statements of Earnings. These restructuring actions ended in second quarter 2011.

The following table displays the restructuring reserve activity related to the realignment for the period ended July 1, 2012:

 

($ in millions)             April 2011 Plan

      

Restructuring liability at January 1, 2011

   $ —     

Restructuring and restructuring-related charges, excluding asset impairments and write-offs

     0.7   

Cost paid

     (0.7
  

 

 

 

Restructuring liability at July 1, 2012

   $ —     
  

 

 

 

 

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Table of Contents

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)

Forward-Looking Statements

This document contains statements that are, or may be deemed to be, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, any financial or other guidance, statements that reflect our current expectations concerning future results and events, and any other statements that are not based solely on historical fact. Forward-looking statements are based on management’s expectations, certain assumptions and currently available information. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof and are based on various assumptions as to future events, the occurrence of which necessarily are subject to uncertainties. These forward-looking statements are made subject to certain risks, uncertainties and other factors, which could cause our actual results, performance or achievements to differ materially from those presented in the forward-looking statements. Examples of factors that may affect future operating results and financial condition include, but are not limited to: changes in the economy generally and in respect to the businesses in which CTS operates; rapid technological change; general market conditions in the automotive, communications, and computer industries, as well as conditions in the industrial, defense and aerospace, and medical markets; reliance on key customers; unanticipated natural disasters or other events such as the Japan earthquake and the Thailand flood; the ability to protect our intellectual property; pricing pressures and demand for our products; and risks associated with our international operations, including trade and tariff barriers, exchange rates and political and geopolitical risks. Many of these, and other, risks and uncertainties are discussed in further detail in Item 1.A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. We undertake no obligation to publicly update our forward-looking statements to reflect new information or events or circumstances that arise after the date hereof, including market or industry changes.

Overview

CTS Corporation (“we”, “our”, “us”) is a global manufacturer of components and sensors used primarily in the automotive, communications, and defense and aerospace markets. We also provide electronic manufacturing solutions, including design and supply chain management functions, primarily serving the defense and aerospace, communications, industrial and medical markets under contract arrangements with original equipment manufacturers.

As discussed in more detail throughout the MD&A:

 

   

Net sales in the second quarter of 2012 of $154.3 million were reported through two segments, Components and Sensors and Electronic Manufacturing Services (“EMS”). Net sales increased by $7.4 million, or 5.0%, in the second quarter of 2012 from the second quarter of 2011. Net sales in the Components and Sensors segment increased by 12.9% versus the second quarter of 2011, while net sales in the EMS segment decreased by 1.8%.

 

   

Gross margin as a percent of net sales was 16.8% in the second quarter of 2012 compared to 19.0% in the second quarter of 2011. Approximately 3 percentage points of the decrease in gross margin resulted from approximately $5 million of expenses and losses related primarily to the flood at our Thailand facility. This was partially offset by lower commodity prices and favorable segment mix as the Components and Sensors segment percent of total sales increased to 49.8% of consolidated sales from 46.3% in the same period of 2011.

 

   

Insurance recovery for business interruption primarily due to the flood at our Thailand facility totaled $7.4 million in the second quarter of 2012. This recovery offsets related expenses and losses that negatively impacted our gross margin.

 

   

Selling, general and administrative (“SG&A”) expenses were $19.4 million, or 12.6% of net sales, in the second quarter of 2012 versus $18.1 million, or 12.3% of net sales, in the second quarter of 2011.

 

   

Research and development (“R&D”) expenses were $5.1 million, or 3.3% of net sales, in the second quarter of 2012 compared to $4.6 million, or 3.1% of net sales, in the second quarter of 2011.

 

   

During the quarter we initiated certain restructuring actions to reorganize certain operations to further improve our cost structure. The cost of these actions was approximately $3.8 million.

 

   

Pension expense was $0.4 million in the second quarter of 2012 compared to pension income of $0.8 million in the second quarter of 2011. This non-cash increase in pension expense was driven by changes in certain actuarial assumptions related to our defined benefit plans.

 

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Interest and other expense was $1.2 million in the second quarter of 2012 compared to income of $0.5 million in the same quarter of 2011. The unfavorable impact of $1.7 million was primarily due to foreign exchange losses as the United States Dollar strengthened compared to the European currencies in which we do business and the Chinese Renminbi.

 

   

Income tax expense was $1.2 million and the effective tax rate was 26.9% in the second quarter of 2012 versus expense of $0.9 million and effective tax rate of 17.9% in the same quarter of 2011. The increase in tax rate was primarily due to changes in the mix of earnings by jurisdiction and the expiration of certain tax benefits.

 

   

Net earnings were $3.3 million, or $0.10 per diluted share, in the second quarter of 2012. This compares with $4.1 million, or $0.12 per diluted share, in the second quarter of 2011. The second quarter 2012 diluted earnings per share included a restructuring and related charge of $0.08 per diluted share. The second quarter 2011 diluted earnings per share included a restructuring charge and additional legal costs of $0.02 per diluted share.

 

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Table of Contents

Critical Accounting Policies

MD&A discusses our unaudited condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.

Management believes that judgment and estimates related to the following critical accounting policies could materially affect our consolidated financial statements:

 

   

Inventory valuation, the allowance for doubtful accounts, and other accrued liabilities

 

   

Long-lived and intangible assets valuation, and depreciation/amortization periods

 

   

Income taxes

 

   

Retirement plans

 

   

Equity-based compensation

In the second quarter of 2012, there were no changes in the above critical accounting policies.

Results of Operations

Comparison of Second Quarter 2012 and Second Quarter 2011

Segment Discussion

Refer to Note G, “Segments,” for a description of our segments.

The following table highlights the segment results for the quarters ended July 1, 2012 and July 3, 2011:

 

($ in thousands)    Components
and Sensors
    EMS     Total  

Second Quarter of 2012

    

Net sales to external customers

   $ 76,823      $ 77,471      $ 154,294   
  

 

 

   

 

 

   

 

 

 

Segment operating earnings before corporate and shared services charges

   $ 8,398      $ 6,086      $ 14,484   
  

 

 

   

 

 

   

 

 

 

Corporate and shared services charges

     (3,034     (1,906     (4,940
  

 

 

   

 

 

   

 

 

 

Segment operating earnings

   $ 5,364      $ 4,180      $ 9,544   
  

 

 

   

 

 

   

 

 

 

% of Net sales

     7.0     5.4     6.2

Second Quarter of 2011

      

Net sales to external customers

   $ 68,037      $ 78,882      $ 146,919   
  

 

 

   

 

 

   

 

 

 

Segment operating earnings before corporate and shared services charges

   $ 8,846      $ 2,259      $ 11,105   
  

 

 

   

 

 

   

 

 

 

Corporate and shared services charges

     (3,995     (1,889     (5,884
  

 

 

   

 

 

   

 

 

 

Segment operating earnings

   $ 4,851      $ 370      $ 5,221   
  

 

 

   

 

 

   

 

 

 

% of Net sales

     7.1 %     0.5     3.6

Net sales in the Components and Sensors segment increased $8.8 million, or 12.9%, from the second quarter of 2011. The increase in net sales was primarily attributable to higher net sales of $7.0 million in the automotive market as our Japanese customers recovered from last year’s earthquake, and higher net sales in electronic components of $1.8 million driven by sales from the acquisition of Valpey-Fisher Corporation (“Valpey-Fisher”) which were partially offset by lower net sales of certain electronic components.

 

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Table of Contents

The Components and Sensors segment recorded operating earnings of $5.4 million in the second quarter of 2012 versus $4.9 million in the second quarter of 2011. The favorable earnings change resulted primarily from higher net sales volume and lower commodity prices partially offset by unfavorable product mix and a shift from pension income to pension expense of approximately $1.2 million.

Net sales in the EMS segment decreased $1.4 million, or 1.8%, in the second quarter of 2012 from the second quarter of 2011. The decrease in net sales was primarily due to the impact of the October 2011 flood at our Thailand EMS manufacturing facility. The lower net sales by market were $4.2 million in the defense and aerospace market, $4.0 million in the communications market and $3.1 million in the computer market partially offset by higher net sales of $6.9 million in the industrial market and $3.0 million in the medical market.

EMS segment operating earnings were $4.2 million in the second quarter of 2012 versus $0.4 million in the second quarter of 2011. The favorable earnings change was primarily due to the timing of insurance recoveries related to the flood at our Thailand facility. In the quarter we had approximately $5 million of expenses and losses primarily related to the flood at our Thailand facility while we recorded $7.4 million of insurance recoveries related to business interruption.

Total Company Discussion

The following table highlights changes in significant components of the Unaudited Condensed Consolidated Statements of Earnings for the quarters ended July 1, 2012 and July 3, 2011:

 

     Quarter ended        

($ in thousands, except net earnings per share)

   July 1,
2012
    July 3,
2011
    Increase
(Decrease)
 

Net sales

   $ 154,294      $ 146,919      $ 7,375   

Restructuring-related costs

   $ 692      $ —        $ 692   

% of net sales

     0.4     —       0.4

Gross margin

   $ 25,938      $ 27,868      $ (1,930

% of net sales

     16.8     19.0     (2.2 )% 

Insurance recovery for business interruption .

   $ (7,423 )   $ —        $ (7,423

Operating expenses:

      

Selling, general and administrative expenses

   $ 19,378      $ 18,057      $ 1,321   

% of net sales

     12.6     12.3     0.3

Research and development expenses

   $ 5,131      $ 4,590      $ 541   

% of net sales

     3.3     3.1     0.2

Restructuring and impairment charge

   $ 3,139      $ 694      $ 2,445   

% of net sales

     2.0     0.5     1.5

Operating earnings

   $ 5,713      $ 4,527      $ 1,186   

% of net sales

     3.7     3.1     0.6

Interest and other (expense)/ income

   $ (1,200 )   $ 508      $ (1,708

% of net sales

     (0.8 )%      0.3     (1.1 )% 

Income tax expense

   $ 1,212      $ 903      $ 309   

Net earnings

   $ 3,301      $ 4,132      $ (831

% of net sales

     2.1     2.8     (0.7 )% 

Net earnings per diluted share

   $ 0.10      $ 0.12      $ (0.02 )

Net sales of $154.3 million in the second quarter of 2012 increased $7.4 million, or 5.0%, from the second quarter of 2011 attributable to higher Components and Sensors segment net sales of $8.8 million, offset by lower EMS segment net sales of $1.4 million.

 

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Gross margin as a percent of net sales was 16.8% in the second quarter of 2012 compared to 19.0% in the second quarter of 2011. Approximately 3 percentage points of the decrease in gross margin resulted from approximately $5 million of expenses and losses related primarily to the flood at our Thailand facility. This was partially offset by lower commodity prices and favorable segment mix as the Components and Sensors segment percent of total sales increased to 49.8% of consolidated sales from 46.3% in the same period of 2011.

Insurance recovery for business interruption primarily due to the flood at our Thailand facility totaled $7.4 million in the second quarter of 2012. This recovery offsets related expenses and losses that have negatively impacted our gross margin. We continue to work with our insurance carrier to process our claim for expenses and losses in the next two to three quarters. The timing of insurance recoveries generally lag the actual incurrence of expenses or margin losses by several months.

SG&A expenses were $19.4 million, or 12.6% of net sales, in the second quarter of 2012 versus $18.1 million, or 12.3% of net sales, in the second quarter of 2011. SG&A expenses as a percentage of net sales increased primarily due to the Valpey-Fisher acquisition and a shift from pension income to pension expense.

R&D expenses were $5.1 million, or 3.3% of net sales, in the second quarter of 2012 compared to $4.6 million, or 3.1% of net sales, in the second quarter of 2011. The increase was primarily driven by spending to develop and launch new products and growth initiatives. R&D expenses are incurred by the Components and Sensors segment and are primarily focused on expanded applications of existing products and new product development, as well as current product and process enhancements.

Operating earnings were $5.7 million in the second quarter of 2012, including a restructuring and related charge of $3.8 million, compared to $4.5 million in the second quarter of 2011 which included a restructuring charge of $0.7 million.

Interest and other expense was $1.2 million in the second quarter of 2012 versus income of $0.5 million in the same quarter of 2011. The unfavorable impact of $1.7 million was primarily due to foreign exchange losses as the United States Dollar strengthened compared to the European currencies in which we do business and the Chinese Renminbi.

The effective tax rate in the second quarter of 2012 was 26.9% compared to 17.9% in the second quarter of 2011. The increase in tax rate was primarily due to changes in the mix of earnings by jurisdiction and the expiration of certain tax benefits.

Net earnings were $3.3 million, or $0.10 per diluted share, in the second quarter of 2012 compared with net earnings of $4.1 million, or $0.12 per diluted share, in the second quarter of 2011.

Comparison of First Six Months 2012 and First Six Months 2011

Segment Discussion

The following table highlights the segment results for the six-month periods ended July 1, 2012 and July 3, 2011:

 

($ in thousands)

   Components
and Sensors
    EMS     Total  

First Six Months of 2012

      

Net sales to external customers

   $ 153,241      $ 148,022      $ 301,263   
  

 

 

   

 

 

   

 

 

 

Segment operating earnings before corporate and shared services charges

   $ 15,742      $ 6,541      $ 22,283   
  

 

 

   

 

 

   

 

 

 

Corporate and shared services charges

     (7,358     (3,449     (10,807
  

 

 

   

 

 

   

 

 

 

Segment operating earnings(1)

   $ 8,384      $ 3,092      $ 11,476   
  

 

 

   

 

 

   

 

 

 

% of Net sales

     5.5     2.1     3.8

First Six Months of 2011

      

Net sales to external customers

   $ 140,068      $ 158,369      $ 298,437   
  

 

 

   

 

 

   

 

 

 

Segment operating earnings before corporate and shared services charges

   $ 18,651      $ 4,089      $ 22,740   
  

 

 

   

 

 

   

 

 

 

Corporate and shared services charges

     (8,044     (3,716     (11,760
  

 

 

   

 

 

   

 

 

 

Segment operating earnings

   $ 10,607      $ 373      $ 10,980   
  

 

 

   

 

 

   

 

 

 

% of Net sales

     7.6     0.2     3.7
(1) EMS segment’s operating earnings of $3,092 includes $1,769 of insurance recovery for property damage related to the flood at CTS Thailand’s manufacturing facility.

 

 

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Net sales in the Components and Sensors segment increased $13.2 million, or 9.4% from the first six months of 2011, primarily attributable to higher net sales of $8.8 million in the automotive market primarily as our Japanese customers recovered from last year’s earthquake, and higher net sales in electronic components of $4.4 million driven by incremental sales from the acquisition of Valpey-Fisher which were partially offset by lower sales of certain electronic components.

The Components and Sensors segment operating earnings were $8.4 million in the first six months of 2012 versus $10.6 million in the first six months of 2011. The unfavorable earnings change resulted primarily from a shift from pension income to pension expense of approximately $2.2 million, unfavorable product mix and higher research and development costs partially offset by higher sales volume.

Net sales in the EMS segment decreased $10.3 million, or 6.5%, in the first six months of 2012 from the first six months of 2011. The decrease in net sales was primarily due to the impact of a October 2011 flood at our Thailand EMS manufacturing facility. The lower net sales by market were $15.2 million in the communications market, $8.5 million in the computer market and $4.3 million in the defense and aerospace market, partially offset by higher net sales of $14.9 million in the industrial market and $2.8 million in the medical market.

EMS segment operating earnings were $3.1 million in the first six months of 2012 versus operating losses of $0.4 million in the first six months of 2011. The favorable earnings change was primarily due to the timing of insurance recoveries related to the flood at our Thailand facility. During the first six months of 2012 we had approximately $11.3 million of expenses and losses related to the flood at our Thailand facility and the fire at our Scotland facility while we recorded $12.8 million of insurance recoveries.

Total Company Discussion

The following table highlights changes in significant components of the Unaudited Condensed Consolidated Statements of Earnings for the six-month periods ended July 1, 2012 and July 3, 2011:

 

     Six months ended        

($ in thousands, except net earnings per share)

   July 1,
2012
    July 3,
2011
    Increase
(Decrease)
 

Net sales

   $ 301,263      $ 298,437      $ 2,826   

Restructuring-related costs

   $ 692      $ —        $ 692   

% of net sales

     0.2     —       0.2

Gross margin

   $ 47,987      $ 57,028      $ (9,041

% of net sales

     15.9     19.1     (3.2 )% 

Insurance recovery for business interruption

   $ (11,050 )   $ —          (11,050

Operating expenses:

      

Selling, general and administrative expenses

   $ 38,782      $ 36,429      $ 2,353   

% of net sales

     12.9     12.2     0.7

Research and development expenses

   $ 11,240      $ 9,619      $ 1,621   

% of net sales

     3.7     3.2     0.5 

Insurance recovery for property damage

   $ (1,769 )   $ —        $ (1,769

Restructuring and impairment charge

   $ 3,139      $ 694      $ 2,445   

% of net sales

     1.0     0.2     0.8

Operating earnings

   $ 7,645      $ 10,286      $ (2,641

% of net sales

     2.5     3.4     (0.9  )% 

Interest and other (expense)/income

   $ (835 )   $ 1,342      $ (2,177

% of net sales

     (0.3 )%      0.4     (0.7 )% 

Income tax expense

   $ 1,226      $ 2,380      $ (1,154

Net earnings

   $ 5,584      $ 9,248      $ (3,664

% of net sales

     1.9     3.1     (1.2 )% 

Net earnings per diluted share

   $ 0.16      $ 0.26      $ (0.10 )

 

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Net sales of $301.3 million in the first six months of 2012 increased $2.8 million, or 0.9%, from the first six months of 2011 attributable to higher Components and Sensors segment net sales of $13.2 million, mostly offset by lower EMS segment net sales of $10.3 million.

Gross margin as a percent of net sales was 15.9% in the first six months of 2012 compared to 19.1% in the first six months of 2011. The decrease in gross margin primarily resulted from approximately $11.3 million of expenses and losses related to the flood at our Thailand facility and the fire at our Scotland facility and a shift from pension income to pension expense partially offset by lower commodity prices and favorable segment mix as the Components and Sensors segment percent of total sales increased to 50.9% of consolidated sales from 46.9% in the same period of 2011.

SG&A expenses were $38.8 million, or 12.9% of net sales, in the first six months of 2012 versus $36.4 million, or 12.2% of net sales, in the first six months of 2011. SG&A expenses as a percentage of net sales increased primarily due to the Valpey-Fisher acquisition and a shift from pension income to pension expense.

R&D expenses were $11.2 million, or 3.7% of net sales, in the first six months of 2012 versus $9.6 million, or 3.2% of net sales, in the first six months of 2011. The increase was primarily driven by spending to develop and launch new products and growth initiatives. R&D expenses are incurred by the Components and Sensors segment and are primarily focused on expanded applications of existing products and new product development, as well as current product and process enhancements.

Operating earnings were $7.6 million in the first six months of 2012, including a restructuring and related charge of $3.8 million, compared to $10.3 million in the first six months of 2011 which included a restructuring charge of $0.7 million.

Interest and other expense in the first six months of 2012 was $0.8 million versus income of $1.3 million in the same period of 2011 due to foreign exchange losses primarily due to foreign exchange losses as the United States Dollar strengthened compared to the European currencies in which we do business and the Chinese Renminbi.

The effective tax rate for the first six months of 2012 was 18.0% compared to 20.5% in the first six months of 2011. The overall tax rate decreased as the increase in rate due to changes in the mix of earnings by jurisdiction was offset by the $0.7 million discrete tax benefit recorded during first quarter of 2012.

Net earnings were $5.6 million, or $0.16 per diluted share, in the first six months of 2012 compared with $9.2 million, or $0.26 per share, in the first six months of 2011.

Scotland EMS Manufacturing Facility Fire

During the second quarter of 2011, a fire occurred at our Scotland EMS manufacturing facility. The fire damaged approximately $1.6 million of inventory and $0.2 million of machinery and equipment at net book value. Property insurance coverage with a $0.1 million deductible has substantially covered the costs of repairing and/or replacing the damaged inventory and machinery and equipment. Business interruption insurance had substantially covered the lost sales impact and related fixed costs in 2011.

During the second quarter of 2012 we recorded a recovery of approximately $0.2 million for business interruption in our Condensed Consolidated Statements of Earnings for the three months ended July 1, 2012. This recovery reflects the final settlement with our insurance carrier.

In the first six months of 2012, we recovered approximately $1.0 million from our insurance carrier and recorded a recovery of approximately $0.9 million for business interruption, after deducting approximately $0.1 million for certain expenses, in our Condensed Consolidated Statements of Earnings for the six months ended July 1, 2012.

 

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Thailand EMS Manufacturing Facility Flood

During the fourth quarter of 2011, our Thailand EMS manufacturing facility was flooded. Based on preliminary estimates, the flood damaged approximately $0.5 million of inventory and $0.5 million of fixed assets at net book value. We also incurred approximately $2.5 million of fixed costs at this facility. Local and global property insurance coverage covered the costs of repairing and/or replacing the damaged inventory and machinery and equipment. We also have business interruption insurance under these policies that cover the lost sales impact and fixed costs.

During the second quarter of 2012, we received cash of approximately $7.5 million from our insurance carrier. Out of the $7.5 million cash, approximately $7.2 million was for business interruption and the remaining $0.3 million was for the reimbursement of costs related to inventory.

In the first six months of 2012, we received cash of approximately $14.7 million from our insurance carrier. Out of the $14.7 million cash, approximately $11.6 million was for business interruption and the remaining $3.1 million was for the reimbursement of costs related to property damage. Part of the cash received was to relieve the insurance receivable balance of $2.4 million recorded at December 31, 2011.

We recorded a recovery of approximately $10.2 million for business interruption and $1.8 million for property damage in our Condensed Consolidated Statements of Earnings for the six months ended July 1, 2012. We continue to incur costs related to the flood and process the appropriate claims with our insurance carrier related to increased expenses and the lost sales impact.

Acquisition

In January 2012, we acquired 100% of the common stock of Valpey-Fisher, a publicly held company located in Hopkinton, Massachusetts, for approximately $14.7 million, net of cash acquired. Valpey-Fisher is a recognized technology leader in the design and manufacture of precision frequency crystal oscillators. This acquisition will expand our technology, and bring strong engineering capabilities and management leadership to support strategic initiatives in our Components and Sensors’ segment.

2012 Outlook

As a result of weaker global economic conditions and lower defense and aerospace spending, primarily affecting EMS sales, management is lowering full-year sales guidance to a range of 4% to 7% increase over 2011. However, as a result of expected savings in the balance of the year due to second quarter restructuring actions management is maintaining full-year 2012 adjusted earnings per share guidance of $0.75 to $0.80.

The following table provides a reconciliation of full-year 2012 diluted earnings per share to full-year 2012 adjusted earnings per share:

 

     Full-year 2012  

Diluted earnings per share

   $ 0.65 - $0.70   

Restructuring and restructuring-related charges

     0.10   
  

Adjusted earnings per share

   $ 0.75 - $0.80   
  

Adjusted earnings per share is a term not recognized by Generally Accepted Accounting Principles in the United States (“U.S. GAAP”). The most directly comparable U.S. GAAP financial measure is diluted earnings per share. We calculate adjusted earnings per share to exclude restructuring and restructuring-related charge.

We use the adjusted earnings per share measure to evaluate overall performance, establish plans and perform strategic analyses. We believe using adjusted earnings per share avoids distortion in the evaluation of operating results by eliminating the impact of events that are not related to operating performance. These measures are based on the exclusion of specific items, and, as such, they may not be comparable to measures used by other companies that have similar titles. Our management compensates for this limitation when performing peer company comparisons by evaluating both GAAP and non-GAAP financial measures reported by peer companies. We believe that adjusted earnings per share is useful to our management, investors and stakeholders in that it:

 

   

provides a better measure of our operating performance;

 

   

reflects the results used by management in making decisions about the business; and

 

   

helps to review and project our performance over time.

 

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We recommend that investors and stakeholders consider both diluted earnings per share and adjusted earnings per share, which are both GAAP and non-GAAP measures in evaluating our performance with peer companies.

Liquidity and Capital Resources

Overview

Cash and cash equivalents were $83.0 million at July 1, 2012 and $76.4 million at December 31, 2011. Total debt on July 1, 2012 was $97.0 million compared to $74.4 million at December 31, 2011, as we increased debt for the Valpey-Fisher acquisition and to meet usual working capital requirements. Total debt as a percentage of total capitalization was 26.8% at the end of the second quarter of 2012, compared with 22.0% at December 31, 2011. Total debt as a percentage of total capitalization is defined as the sum of notes payable and long-term debt as a percentage of total debt and shareholders’ equity.

Working capital increased by $7.9 million in the second quarter of 2012 versus year-end 2011, primarily due to a decrease in accounts payable of $14.0 million and an increase in cash and cash equivalents of $6.6 million partially offset by a decrease in inventory of $13.9 million.

Cash Flow

Operating Activities

Net cash provided by operating activities was $12.0 million during the first six months of 2012. Components of net cash provided by operating activities included net earnings of $5.6 million, depreciation and amortization expense of $9.6 million, restructuring and asset impairment charges of $3.1 million and add-backs of other non-cash items such as equity-based compensation, amortization of retirement benefit and net insurance recovery totaling $6.1 million which were partially offset by net changes in assets and liabilities of $7.9 million and an increase in prepaid pension asset of $3.4 million. The changes in assets and liabilities were primarily due to decreased accounts payable and accrued liabilities of $24.0 million partially offset by decreased inventories of $15.3 million.

Net cash provided by operating activities was $8.8 million during the first six months of 2011. Components of net cash provided by operating activities included net earnings of $9.2 million, non-cash adjustments of depreciation and amortization expense of $8.8 million, amortization of retirement benefits of $2.5 million and equity-based compensation expense of $2.4 million which were partially offset by net changes in assets and liabilities of $10.5 million and prepaid pension assets of $4.3 million. The net changes in assets and liabilities were primarily due to increased inventories of $10.6 million, decreased accounts payable and accrued liabilities of $7.2 million, and increased other current assets of $1.4 million, which were partially offset by decreased accounts receivable of $10.2 million.

Investing Activities

Net cash used in investing activities for the first six months of 2012 was $21.8 million for the Valpey-Fisher acquisition of $14.7 million, net of cash acquired, capital expenditures of $6.9 million, and capital expenditures to replace property damaged by casualty of $2.9 million partially offset by insurance proceeds for property damage due to casualty of $2.3 million.

Net cash used in investing activities for the first six months of 2011 was $9.5 million, of which $6.5 million was for capital expenditures and $2.9 million was for the acquisition of certain assets of Fordahl SA.

Financing Activities

Net cash provided by financing activities for the six months of 2012 was $16.2 million, consisting primarily of a net increase in long-term debt of $22.6 million, offset by $5.6 million in Treasury stock purchases and $2.4 million in dividend payments. The additional debt was primarily used to meet usual working capital requirements and to fund the Valpey-Fisher acquisition.

Net cash provided by financing activities for the first six months of 2011 was $3.0 million, consisting primarily of a net increase in long-term debt of $4.5 million, offset by $2.1 million in dividend payments. The additional debt was primarily used to meet usual working capital requirements as net sales increased.

 

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Capital Resources

Refer to Note E, “Debt,” to our unaudited consolidated financial statements for further discussion.

Our principal sources of liquidity have been cash flow from operations and from our credit agreements. We historically have accessed various funding sources, including short-term and long-term unsecured bank lines of credit as well as the debt markets in the United States. We expect to have sufficient sources of liquidity to meet our future funding needs due to the multiple funding sources that have been, and continue to be, available to us.

On January 10, 2012, we amended our November 18, 2010 unsecured revolving credit agreement. This amendment provided for an increase in our revolving credit facility to $200 million and increased the accordion feature, whereby we can expand the facility to $300 million, subject to participating banks’ approval. Additionally, among other covenants, the amendment reduced the applicable margin by 25 basis points, increased the total consideration we may pay for non-U.S. based acquisitions, and extended the term of the credit agreement through January 10, 2017.

Long-term debt was comprised of the following:

 

($ in thousands)

   July 1,
2012
     December 31,
2011
 

Revolving credit agreement, weighted-average interest rate of 1.8% (2012), and 1.9% (2011) due in 2017 and 2015, respectively

   $ 97,000       $ 74,400   

There was $97.0 million outstanding under the $200 million revolving credit agreement at July 1, 2012, and $74.4 million outstanding under the $150 million revolving credit agreement at December 31, 2011. We had $100.4 million available under the $200 million credit agreement at July 1, 2012, net of standby letters of credit of $2.6 million, and $72.8 million available under the $150 million credit agreement at December 31, 2011, net of standby letters of credit of $2.8 million. Interest rates on the revolving credit agreement fluctuate based upon London Interbank Offered Rate and our quarterly total leverage ratio. We pay a commitment fee on the undrawn portion of the revolving credit agreement. The commitment fee varies based on the quarterly leverage ratio and was 0.35 percent per annum at July 1, 2012. The revolving credit agreement requires, among other things, that we comply with a maximum total leverage ratio and a minimum fixed charge coverage ratio. Our failure to comply with these covenants could reduce the borrowing availability under the revolving credit agreement. We were in compliance with all debt covenants at July 1, 2012. The revolving credit agreement requires us to deliver quarterly financial statements, annual financial statements, auditors certifications and compliance certificates within a specified number of days after the end of a quarter and year. Additionally, the revolving agreement contains restrictions limiting our ability to: dispose of assets; incur certain additional debt; repay other debt or amend subordinated debt instruments; create liens on assets; make investments, loans or advances; make acquisitions or engage in mergers or consolidations; engage in certain transactions with our subsidiaries and affiliates; and make stock repurchases and dividend payments.

We use interest rate swaps to convert the line of credit’s variable rate of interest into a fixed rate. During the second quarter of 2012, we entered into four separate interest rate swap agreements to fix interest rates on $50 million of long-term debt for the periods January 2013 to January 2017. The difference to be paid or received under the terms of the swap agreement will be accrued as interest rates change and recognized as an adjustment to interest expense for the related line of credit. Changes in the variable interest rates to be paid or received will have a corresponding effect on future cash flows.

These swaps are treated as cash flow hedges and consequently, the changes in fair value were recorded in Other Comprehensive Income. During the second quarter of 2012, an unrealized loss of approximately $832,000 was recorded in Other Comprehensive Income with approximately $79,000 recorded as accrued liabilities section and the remaining $753,000 recorded as a non-current liability in Other Long-term Obligations on the Condensed Consolidated Balance Sheets.

As a result of the use of these derivative instruments, we are exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, we have a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors. Our established policies and procedures for mitigating credit risk on principal transactions include reviewing and establishing limits for credit exposure and continually assessing the creditworthiness of counterparties.

In May 2008, our Board of Directors authorized a program to repurchase up to one million shares of CTS common stock in the open market at a maximum price of $13 per share. The authorization has no expiration. Reacquired shares will be used to support equity-based compensation programs and for other corporate purposes. During the first six months of 2012, 572,487 shares were repurchased at a cost of approximately $5.6 million or $9.86 per share. There were 1,666 shares remaining as of July 1, 2012 which were settled in July 2012.

 

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We have historically funded our capital and operating needs primarily through cash flows from operating activities, supported by available credit under our bank credit agreements. We believe that expected positive cash flows from operating activities and available borrowings under our current credit agreements will be adequate to fund our working capital, capital expenditures and debt service requirements for at least the next twelve months. However, we may choose to pursue additional equity and/or debt financing to provide additional liquidity and/or fund acquisitions.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no other material changes in our market risk since December 31, 2011.

 

Item 4. Controls and Procedures

Pursuant to Rule 13a-15(e) of the Securities and Exchange Act of 1934, management, under the direction of our Chief Executive Officer and Chief Financial Officer, evaluated our disclosure controls and procedures. Based on such evaluation our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of July 1, 2012, provided that the evaluation did not include an evaluation of the effectiveness of the internal control over financial reporting for the acquired business, as described further below.

Since the date of acquisition of Valpey-Fisher Corporation, our management has not completed an evaluation of the business’s internal controls over financial reporting for the acquired entity, whose results are included in the financial statements and notes filed in this Form 10-Q.

Changes in Internal Control Over Financial Reporting

Other than the changes resulting from the acquisition described above, there were no changes in our internal control over financial reporting for the quarter ended July 1, 2012 that have materially affected or are reasonably likely to materially affect our internal control over financial reporting.

PART II — OTHER INFORMATION

 

Item 1. Legal Proceedings

We manufacture accelerator pedals for a number of automobile manufacturers, including subsidiaries of Toyota. In January 2010, Toyota initiated a recall of a substantial number of vehicles in North America containing pedals manufactured by CTS. The pedal recall and associated events have led to us being named as a co-defendant with Toyota in certain litigation.

In February 2010, we entered into an agreement with Toyota whereby Toyota agreed that it will indemnify, defend, and hold us harmless from, and the parties will cooperate in the defense of, certain third-party civil claims and actions that are filed or asserted in the United States or Canada and that arise from or relate to alleged incidents of unintended acceleration of Toyota and Lexus vehicles. If it is determined that CTS acted negligently in selecting materials or processes where we had sole control over the selection process, in failing to meet Toyota’s specifications, or in making unapproved changes in component design or materials, and such negligence caused or contributed to a claim, we will be responsible for any judgment that may be rendered against us individually, or any portion of a judgment that may be allocated to us, but limited only to the extent of insurance collected from our insurers. Toyota would remain responsible to defend CTS in these actions and would remain responsible for any balance of the remaining liability over amounts recovered by insurance. The agreement also does not cover costs or liabilities in connection with government investigations, government hearings, or government recalls.

Presently, we have been served process and named as co-defendant with Toyota in approximately thirty-three open lawsuits; we have been dismissed as a defendant from an additional thirty lawsuits. The claims generally fall into two categories, those that allege sudden unintended acceleration of Toyota vehicles led to injury or death, and those that allege economic harm to owners of Toyota vehicles related to vehicle defects. Some suits combine elements of both. Claims include demands for compensatory and special damages. To date, the only actions filed where we are aware we have been named as a co-defendant are civil actions filed in the Unites States or Canada. All currently open lawsuits are subject to the indemnification agreement described above. Some of these lawsuits arise out of incidents involving models for which we do not manufacture the pedal, such as all Lexus models, the Toyota Prius, and the Toyota Tacoma, or for which we manufacture only a portion of the pedals, such as the Toyota Camry. Many lawsuits have been consolidated in federal multidistrict litigation in the United States District Court, Southern District of California, though some remain in various other courts.

 

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Certain processes in the manufacture of our current and past products create hazardous waste by-products as currently defined by federal and state laws and regulations. We have been notified by the U.S. Environmental Protection Agency, state environmental agencies, and in some cases, generator groups, that we are or may be a potentially responsible party regarding hazardous waste remediation at several non-CTS sites. In addition to these non-CTS sites, we have an ongoing practice of providing reserves for probable remediation activities at certain of our manufacturing locations and for claims and proceedings against us with respect to other environmental matters. In the opinion of management, based upon all present available information relating to all such matters, either adequate provisions for probable costs has been made, or the ultimate costs resulting will not materially affect our consolidated financial position, results of operations, or cash flows.

Certain other claims are pending against us with respect to matters arising out of the ordinary conduct of our business. For all other claims, in the opinion of management, based upon presently available information, either adequate provision for anticipated costs have been accrued or the ultimate anticipated costs will not materially affect our consolidated financial position, results of operations, or cash flows.

 

Item 1A. Risk Factors

There have been no significant changes to our risk factors since December 31, 2011.

 

Item 2. Unregistered sales of Equity Securities and Use of Proceeds

The following table summarizes the repurchases of CTS common stock made by the Company during the three-month period ending July 1, 2012:

 

     (a)
Total Number  of
Shares Purchased
     (b)
Average Price
Paid per Share
     (c)
Total Number of  Shares
Purchased as Part of
Plans or Programs
(1)
     (d)
Maximum Number
of Shares
That May Yet Be
Purchased Under the
Plans or Programs
 
              302,077   

April 2, 2012 – April 29, 2012

     43,055       $ 10.35         43,055         259,022   

April 30, 2012 – May 27, 2012

     109,552       $ 9.88         109,552         149,470   

May 28, 2012 – July 1, 2012

     147,804       $ 9.34         147,804         1,666   
  

 

 

       

 

 

    

Total

     300,411            300,411      
  

 

 

       

 

 

    

 

Item 3. Default Upon Senior Securities

Not applicable

 

Item 4. Mine Safety Disclosures

Not applicable

 

Item 5. Other Information

Not applicable

 

Item 6. Exhibits

 

  (31)(a)   Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  (31)(b)   Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  (32)(a)   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
  (32)(b)   Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS*   XBRL Instance Document
101.SCH*   XBRL Taxonomy Extension Schema Document

 

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101.CAL*    XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*    XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*    XBRL Taxonomy Extension Label Linkbase Document
101.PRE*    XBRL Taxonomy Extension Presentation Linkbase Document

 

 

* XBRL (Extensible Business Reporting Language) information is furnished and not filed herewith, is not part of a registration statement or Prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, and otherwise is not subject to liability under these sections.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

CTS Corporation     CTS Corporation
/s/ John R. Dudek     /s/ Thomas K Kroll

John R. Dudek

Vice President, General Counsel and Secretary

   

Thomas K. Kroll

Vice President and Chief Financial Officer

Dated: July 24, 2012     Dated: July 24, 2012

 

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