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CTS: Continued margin improvement with a richer product mix drives fourth quarter earnings above expectations

By Ian Gilson, PhD,CFA


Full year 2016 financials were reported on Feb. 07, 2017 with a conference call later in the morning.

Revenue was slightly below our estimate but gross margins increased again and operating expenses were below our estimates (we exclude restructuring and impairment charges from operating results and including them in other income). Operating income and pretax income were above our forecasts.

The strong US dollar versus the renminbi had a negative impact on currency holdings and revenue from China but other areas did benefit from lower costs as local currencies declined against the dollar.

The hard drive business for CTS (NYSE:CTS) continues to decline in absolute terms as solid state drives make inroads into the market. No new investments are likely in this area.

Despite the current production cutbacks in auto production, and changes in forecasts for the 2017 calendar year, new contracts  should offset a poor auto market and we expect minimal impact on CTS's auto related business. Over 75% of the companies new order flow was in auto related areas.

New orders increased substantially from year ago levels, up 25% to $132 million. CTS will move from announcing new orders to a bookings number. This is a more conventional number for capital goods companies. The current book includes new business to be delivered in the next twelve months plus firm orders on longer term business contracts. At the end of 2016 bookings were $1500 million.

Cisco has announced that a clock signal components used in many of its, and its competitors, routers is defective. CTS is a supplier to Cisco but there are no known problems with any of its products sold to Cisco (which is not a major customer).

We believe that the new level of gross margins is not only sustainable but will improve as the product mix moves towards the components and medical area. CTS intends to adopt some measures to reduce its tax rate, which has been volatile over the last two years, from a normalized level in the mid-30%s down to the lower-30s level over the next two to three years.

The company reiterated its guidance for 2017 for sales in the range of $405 to $420 million and Adjusted diluted earnings per share in the range of $1.12 to $1.22. Our forecasts are within the ranges given. Continued growth into 2018 is, in our opinion, highly likely and we have increased our target price from $15 a share to $28 a share.


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