UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For The Quarterly Period Ended March 31, 2021
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)
IN
35-0225010
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification Number)
4925 Indiana Avenue
Lisle IL
60532
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (630) 577-8800
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Trading Symbol(s)
Name of Each Exchange on Which Registered
Common stock, without par value
CTS
New York Stock Exchange
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of April 26, 2021: 32,348,360.
CTS CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
Item 1.
Financial Statements
3
Condensed Consolidated Statements of Earnings (Unaudited) For the Three Months Ended March 31, 2021 and March 31, 2020
Condensed Consolidated Statements of Comprehensive Earnings (Unaudited) For the Three Months Ended March 31, 2021 and March 31, 2020
4
Condensed Consolidated Balance Sheets As of March 31, 2021 (Unaudited) and December 31, 2020
5
Condensed Consolidated Statements of Cash Flows (Unaudited) For the Three Months Ended March 31, 2021 and March 31, 2020
6
Condensed Consolidated Statements of Shareholder's Equity (Unaudited) For the Three Months Ended March 31, 2021 and March 31, 2020
7
Notes to Condensed Consolidated Financial Statements ‑ (Unaudited)
9
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
25
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
32
Item 4.
Controls and Procedures
33
PART II. OTHER INFORMATION
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Item 6.
Exhibits
34
SIGNATURES
35
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS - UNAUDITED
(In thousands, except per share amounts)
Three Months Ended
March 31,
2021
2020
Net sales
$
128,427
103,075
Cost of goods sold
85,836
70,176
Gross margin
42,591
32,899
Selling, general and administrative expenses
18,325
16,759
Research and development expenses
5,687
7,408
Restructuring charges
81
240
Operating earnings
18,498
8,492
Other (expense) income:
Interest expense
(555
)
(851
Interest income
202
331
Other expense, net
(3,356
(1,982
Total other expense, net
(3,709
(2,502
Earnings before income taxes
14,789
5,990
Income tax expense
2,799
2,182
Net earnings
11,990
3,808
Earnings per share:
Basic
0.37
0.12
Diluted
Basic weighted – average common shares outstanding:
32,319
32,466
Effect of dilutive securities
301
327
Diluted weighted – average common shares outstanding:
32,620
32,793
Cash dividends declared per share
0.04
See notes to unaudited condensed consolidated financial statements.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS ‑ UNAUDITED
(In thousands of dollars)
Other comprehensive earnings (loss):
Changes in fair market value of derivatives, net of tax
124
(4,414
Changes in unrealized pension cost, net of tax
1,422
1,285
Cumulative translation adjustment, net of tax
12
(139
Other comprehensive earnings (loss)
1,558
(3,268
Comprehensive earnings
13,548
540
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
December 31,
ASSETS
Current Assets
Cash and cash equivalents
103,392
91,773
Accounts receivable, net
81,571
80,981
Inventories, net
47,558
45,870
Other current assets
14,115
14,607
Total current assets
246,636
233,231
Property, plant and equipment, net
94,848
97,437
Operating lease assets, net
23,620
23,281
Other Assets
Prepaid pension asset
56,502
56,642
Goodwill
109,468
109,497
Other intangible assets, net
76,931
79,121
Deferred income taxes
24,192
24,250
Other
2,468
2,590
Total other assets
269,561
272,100
Total Assets
634,665
626,049
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Accounts payable
53,315
50,489
Operating lease obligations
3,271
3,294
Accrued payroll and benefits
12,688
12,978
Accrued expenses and other liabilities
37,436
38,171
Total current liabilities
106,710
104,932
Long-term debt
50,000
54,600
Long-term operating lease obligations
23,510
23,163
Long-term pension obligations
7,290
7,466
6,892
7,010
Other long-term obligations
4,547
5,196
Total Liabilities
198,949
202,367
Commitments and Contingencies (Note 11)
Shareholders’ Equity
Common stock
313,008
311,190
Additional contributed capital
39,616
41,654
Retained earnings
549,977
539,281
Accumulated other comprehensive loss
(94,363
(95,921
Total shareholders’ equity before treasury stock
808,238
796,204
Treasury stock
(372,522
Total shareholders’ equity
435,716
423,682
Total Liabilities and Shareholders’ Equity
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ‑ UNAUDITED
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net earnings to net cash provided by operating
activities:
Depreciation and amortization
6,800
6,532
Pension and other post-retirement plan expense
1,980
673
Stock-based compensation
1,219
228
Asset impairment charges
—
1,016
63
333
(Gain) on foreign currency hedges, net of cash
(42
(23
Changes in assets and liabilities, net of acquisition:
Accounts receivable
(1,121
6,176
Inventories
(2,052
(4,005
Operating lease assets
(340
(473
Other assets
168
799
2,864
1,252
(210
(237
Operating lease liabilities
325
542
(1,398
(4,627
Pension and other post-retirement plans
(136
(67
Net cash provided by operating activities
20,110
11,927
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures
(1,638
(4,570
Net cash used in investing activities
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments of long-term debt
(241,600
(764,550
Proceeds from borrowings of long-term debt
237,000
816,050
Purchase of treasury stock
(5,304
Dividends paid
(1,291
(1,299
Taxes paid on behalf of equity award participants
(1,402
(1,903
Net cash (used in) provided by financing activities
(7,293
42,994
Effect of exchange rate changes on cash and cash equivalents
440
363
Net increase in cash and cash equivalents
11,619
50,714
Cash and cash equivalents at beginning of period
100,241
Cash and cash equivalents at end of period
150,955
Supplemental cash flow information:
Cash paid for interest
378
678
Cash paid for income taxes, net
3,510
1,183
Non-cash financing and investing activities:
Capital expenditures incurred but not paid
1,019
1,843
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - UNAUDITED
(in thousands of dollars)
The following summarizes the changes in total equity for the three months ended March 31, 2021:
Common
Stock
Additional
Contributed
Capital
Retained
Earnings
Accumulated
Comprehensive
Loss
Treasury
Total
Balances at December 31, 2020
Cash dividends of $0.04 per share
(1,294
Issued shares on vesting of restricted stock units
1,818
(3,218
(1,400
Stock compensation
1,180
Balances at March 31, 2021
The following summarizes the changes in total equity for the three months ended March 31, 2020:
Balances at December 31, 2019
307,932
43,689
509,766
(91,726
(364,442
405,219
(1,298
Acquired 220,731 shares of treasury stock
2,166
(4,069
212
Balances at March 31, 2020
310,098
39,832
512,276
(94,994
(369,746
397,466
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
(in thousands except for share and per share data)
March 31, 2021
NOTE 1 — Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared by CTS Corporation (“CTS”, "we", "our", "us" 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, 2020.
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. Certain reclassifications have been made to prior year amounts to conform to the current year presentation. The reclassifications had no impact on previously reported net earnings.
NOTE 2 – Revenue Recognition
The core principle of Topic 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides a five-step process to achieve that core principle:
•
Identify the contract(s) with a customer
Identify the performance obligations
Determine the transaction price
Allocate the transaction price
Recognize revenue when the performance obligations are met
We recognize revenue when the performance obligations specified in our contracts have been satisfied, after considering the impact of variable consideration and other factors that may affect the transaction price. Our contracts normally contain a single performance obligation that is fulfilled on the date of delivery based on shipping terms stipulated in the contract. We usually expect payment within 30 to 90 days from the shipping date, depending on our terms with the customer. None of our contracts as of March 31, 2021 contained a significant financing component. Differences between the amount of revenue recognized and the amount invoiced, collected from, or paid to our customers are recognized as contract assets or liabilities. Contract assets will be reviewed for impairment when events or circumstances indicate that they may not be recoverable.
To the extent the transaction price includes variable consideration, we estimate the amount of variable consideration that should be included in the transaction price utilizing the most likely amount method based on an analysis of historical experience and current facts and circumstances, which requires significant judgment. Variable consideration is included in the transaction price if, in our judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.
Disaggregated Revenue
The following table presents revenues disaggregated by the major markets we serve:
Three months ended
March 31, 2020
Transportation
75,854
61,534
Industrial
26,625
20,843
Medical
11,276
9,370
Aerospace & Defense
11,670
9,005
Telecom & IT
3,002
2,323
NOTE 3 – Business Acquisitions
On December 30, 2020, we acquired 100% of the outstanding shares of Sensor Scientific, Inc. (“SSI”). SSI is a manufacturer of high-quality thermistors and temperature sensor assemblies serving original equipment manufacturers (“OEMs”) for applications that require precision and reliability in the medical, industrial and defense markets. SSI has complementary capabilities with our existing temperature sensing platform and the acquisition expands our presence in the medical end market. It also provides high quality ceramic processing capabilities and valuable customer partnerships that expands our temperature sensing product portfolio and builds on our strategy to focus on innovative products that sense, connect and move.
The purchase price, which includes assumed changes in working capital, of $10,309 has been allocated to the fair values of assets and liabilities acquired as of December 30, 2020. The allocation of the purchase price continues to be preliminary pending the completion of the valuation of intangible assets and finalization of management's estimates, which are expected to occur in the second quarter. The information included below represents our current estimate of the purchase price allocation.
The following table summarizes the consideration paid and the fair values of the assets acquired, and the liabilities assumed as of the date of acquisition of SSI:
Consideration
Paid
Cash paid, net of cash acquired of $470
8,309
Contingent consideration
2,000
Purchase price
10,309
Fair Values at
December 30, 2020
Current assets
2,550
Property, plant and equipment
67
3,412
Intangible assets
5,340
Fair value of assets acquired
11,381
Less fair value of liabilities acquired
(1,072
Goodwill represents value the Company expects to be created by combining the operations of the acquired business with the Company's operations, including the expansion of customer relationships, access to new customers, and potential cost savings and synergies. Goodwill related to the acquisition is expected to be deductible for tax purposes.
All contingent consideration is payable in cash and is based on success factors related to the integration process as well as upon the achievement of a revenue performance target through the year ending December 31, 2022, with the possibility of prorated interim payments. The Company recorded $2,000 as the acquisition date fair value of the contingent consideration based on an estimate of the
10
probability of achieving the performance targets. This represents the maximum amount of contingent consideration payable by the Company. This amount is also reflected as an addition to the purchase price and will be evaluated quarterly.
As of March 31, 2021, $150 of the contingent consideration became due based on revenue targets achieved and will be paid out in the second quarter. As of March 31, 2021, and December 31, 2020, $950 and $800 were recorded in accrued expenses and other liabilities and $1,050 and $1,200 in other long-term obligations, in each case, respectively.
The following table summarizes the carrying amounts and weighted average lives of the acquired intangible assets:
Carrying
Value
Weighted
Average
Amortization
Period
Customer lists/relationships
5,200
11.0
Technology and other intangibles
140
3.0
The amounts and assumptions included above remain estimates that may be adjusted by the Company once purchase accounting is complete.
NOTE 4 – Accounts Receivable, net
The components of accounts receivable, net are as follows:
As of
Accounts receivable, gross
82,334
81,745
Less: Allowance for credit losses
(763
(764
NOTE 5 – Inventories, net
Inventories, net consists of the following:
Finished goods
10,222
10,647
Work-in-process
18,841
16,927
Raw materials
26,267
24,893
Less: Inventory reserves
(7,772
(6,597
11
NOTE 6 – Property, Plant and Equipment, net
Property, plant and equipment, net is comprised of the following:
Land and land improvements
1,095
Buildings and improvements
69,346
69,360
Machinery and equipment
235,310
233,743
Less: Accumulated depreciation
(210,903
(206,761
Depreciation expense for the three months ended
4,431
4,237
NOTE 7 – Retirement Plans
Pension Plans
Net pension expense for our domestic and foreign plans included in other expense, net in the Condensed Consolidated Statement of Earnings is as follows:
Net pension expense
1,957
664
The components of net pension expense for our domestic and foreign plans include the following:
Domestic Pension Plans
Foreign Pension Plans
Service cost
Interest cost
1,253
1,443
Expected return on plan assets(1)
(1,113
(2,454
(3
(4
Amortization of loss
1,767
1,622
43
Total expense, net
1,907
611
50
53
(1)
Expected return on plan assets is net of expected investment expenses and certain administrative expenses.
In February 2020, the CTS Board of Directors authorized management to explore termination of the U.S.-based pension plan ("Plan"), subject to certain conditions. On June 1, 2020, we entered the Fifth Amendment to the Plan whereby we set an effective termination date for the Plan of July 31, 2020. In February 2021, we received a determination letter from the Internal Revenue Service that allows us to proceed with the termination process for the Plan. In connection with the termination, the Plan has offered a window extending from March 29, 2021 through May 7, 2021 to certain eligible participants to elect lump sum payments. The distribution date is June 1, 2021. The completion of the Plan termination process, including the final purchase of annuities, is expected to occur in the second half of 2021.
Upon settlement of the pension liability, we will reclassify the related pension losses, currently recorded in accumulated other comprehensive loss, to the Condensed Consolidated Statements of Earnings. As of March 31, 2021, we had gross unrecognized losses related to the Plan of $123,238 in accumulated other comprehensive loss that are expected to be recognized in the income statement in 2021. Since the amount of the settlement depends on a number of factors determined as of the liquidation date, including lump sum payout estimates, the annuity pricing interest rate environment and asset performance, we are currently unable to determine the ultimate cost of the settlement. However, we estimate non-cash settlement charges of approximately $10,000 to $20,000 will be
recognized in the second quarter of 2021 with the remaining amount of the gross accumulated other comprehensive loss balance to be recognized upon final settlement. We do not expect any cash contributions from the Company to the Plan as a result of this termination because Plan assets significantly exceed estimated liabilities.
Other Post-retirement Benefit Plan
Net post-retirement expense for our other post-retirement plan includes the following components:
23
30
Amortization of gain
(21
NOTE 8 – Goodwill and Other Intangible Assets
Other Intangible Assets
Other intangible assets, net consist of the following components:
Gross
Amount
Net Amount
97,393
(45,447
51,946
47,441
(22,456
24,985
In process research and development
2,200
(2,200
147,034
(70,103
Amortization expense for the three months ended
2,369
December 31, 2020
97,355
(44,002
53,353
47,301
(21,533
25,768
146,856
(67,735
2,295
Remaining amortization expense for other intangible assets as of March 31, 2021 is as follows:
expense
7,170
2022
9,173
2023
7,167
2024
7,005
2025
6,783
Thereafter
39,633
Total amortization expense
13
Changes in the net carrying amount of goodwill were as follows:
Goodwill as of December 31, 2020
Decrease from purchase accounting adjustments
(29
Goodwill as of March 31, 2021
NOTE 9 – Costs Associated with Exit and Restructuring Activities
Restructuring charges are reported as a separate line within operating earnings in the Condensed Consolidated Statement of Earnings.
Total restructuring charges are as follows:
September 2020 Plan
In September 2020, we initiated a restructuring plan focused on optimizing our manufacturing footprint and improving operational efficiency by better utilizing our systems capabilities (the "September 2020 Plan"). This plan includes transitioning certain administrative functions to a shared service center, realignment of manufacturing locations, and certain other efficiency improvement actions. The restructuring cost of the September 2020 Plan is estimated to be in the range of $4,600 and $6,000, including workforce reduction charges, building and equipment relocation charges and other contract and asset-related costs. In addition to these charges, we expect an additional $4,000 to $5,100 of other costs to be incurred related to initiatives that would not qualify as restructuring charges. These costs would include certain employee overlap and training costs as well as additional capital expenditures. Restructuring charges under the September 2020 Plan were $(17) during the three months ended March 31, 2021, consisting of $36 of workforce reduction costs and $(53) of other contract termination and facility closure costs. The total restructuring liability related to the September 2020 Plan was $130 at March 31, 2021 and $512 at December 31, 2020.
June 2016 Plan
In June 2016, we announced plans to restructure operations by phasing out production at our Elkhart, IN facility and transitioning it into a research and development center supporting our global operations (the "June 2016 Plan"). Additional organizational changes were also implemented in various other locations. In 2017, we revised the June 2016 Plan to include an additional $1,100 in planned costs related to the relocation of our corporate headquarters in Lisle, IL and our plant in Bolingbrook, IL, both of which have now been consolidated into a single facility. These restructuring actions were completed as of March 31, 2021. Restructuring charges under the June 2016 Plan were $(3) and $(32) during the three months ended March 31, 2021 and March 31, 2020, respectively. The total restructuring liability related to the June 2016 Plan was $0 at March 31, 2021 and $3 at December 31, 2020.
April 2014 Plan
In April 2014, we announced plans to restructure our operations and consolidate our Canadian operations into other existing facilities as part of our overall plan to simplify our business model and rationalize our global footprint (the “April 2014 Plan”). These restructuring actions were substantially completed during 2015. There were no restructuring charges incurred under the April 2014 Plan during the three months ended March 31, 2021 and March 31, 2020, respectively. The total restructuring liability related to the April 2014 Plan was $847 at March 31, 2021 and $839 at December 31, 2020. The remaining liability is expected to be settled in the second quarter of 2021.
14
Other Restructuring Activities
From time to time we undertake other restructuring activities that are not part of a formal plan. During the three months ended March 31, 2021 and March 31, 2020, we incurred restructuring charges of $101 and $272, respectively, primarily related to workforce reduction costs. The total restructuring liability associated with these actions was $83 at March 31, 2021 and $9 at December 31, 2020.
The following table displays the restructuring liability activity included in accrued expenses and other liabilities for all plans for the three months ended March 31, 2021:
Restructuring liability at January 1, 2021
1,363
Cost paid
(232
Other activity(1)
(152
Restructuring liability at March 31, 2021
1,060
Other activity includes the effects of currency translation, non-cash asset write-downs and other charges that do not flow through restructuring expense.
NOTE 10 – Accrued Expense and Other Liabilities
The components of accrued expenses and other liabilities are as follows:
Accrued product related costs
4,013
4,470
Accrued income taxes
6,461
7,320
Accrued property and other taxes
1,590
2,478
Accrued professional fees
1,199
1,663
Accrued customer related liabilities
4,536
3,815
Dividends payable
1,294
1,291
Remediation reserves
10,431
10,642
Derivative liabilities
671
Other accrued liabilities
7,239
5,821
Total accrued expenses and other liabilities
NOTE 11 – Commitments and Contingencies
Certain processes in the manufacture of our current and past products create by-products classified as hazardous waste. We have been notified by the U.S. Environmental Protection Agency, state environmental agencies, and in some cases, groups of potentially responsible parties, that we may be potentially liable for environmental contamination at several sites currently and formerly owned or operated by us. Two of those sites, Asheville, North Carolina and Mountain View, California, are designated National Priorities List sites under the U.S. Environmental Protection Agency’s Superfund program. We accrue a liability for probable remediation activities, claims and proceedings against us with respect to environmental matters if the amount can be reasonably estimated, and provide disclosures including the nature of a loss whenever it is probable or reasonably possible that a potentially material loss may have occurred but cannot be estimated. We record contingent loss accruals on an undiscounted basis.
15
A roll-forward of remediation reserves included in accrued expenses and other liabilities on the Condensed Consolidated Balance Sheets is comprised of the following:
Balance at beginning of period
11,444
Remediation expense
199
2,769
Net remediation payments
(398
(3,639
(12
68
Balance at end of the period
Other activity includes currency translation adjustments not recorded through remediation expense.
Unrelated to the environmental claims described above, certain other legal claims are pending against us with respect to matters arising out of the ordinary conduct of our business.
We provide product warranties when we sell our products and accrue for estimated liabilities at the time of sale. Warranty estimates are forecasts based on the best available information and historical claims experience. We accrue for specific warranty claims if we believe that the facts of a specific claim make it probable that a liability in excess of our historical experience has been or will be incurred, and provide disclosures for specific claims whenever it is reasonably possible that a material loss may be incurred which cannot be estimated.
We cannot provide assurance that the ultimate disposition of environmental, legal, and product warranty claims will not materially exceed the amount of our accrued losses and adversely impact our consolidated financial position, results of operations, or cash flows. Our accrued liabilities and disclosures will be adjusted accordingly if additional information becomes available in the future.
NOTE 12 — Leases
We lease certain land, buildings and equipment under non-cancellable operating leases used in our operations. Operating lease assets represent our right to use an underlying asset for the lease term. Operating lease liabilities represent the present value of lease payments over the lease term, discounted using an estimate of our secured incremental borrowing rate because none of our leases contain a rate implicit in the lease arrangement.
Components of lease expense for the three months ended March 31, 2021 were as follows:
Operating lease cost
1,232
Short-term lease cost
278
167
Total lease cost
1,510
1,366
Supplemental cash flow information related to leases was as follows:
Cash paid for amounts included in the measurement of lease
liabilities
1,221
1,130
Leased assets obtained in exchange for new operating lease
1,157
1,179
16
Supplemental balance sheet information related to leases was as follows:
Balance Sheet Classification:
Total lease liabilities
26,781
26,457
Weighted-average remaining lease terms (years)
7.75
7.88
Weighted-average discount rate
6.41
%
6.40
Remaining maturity of our existing lease liabilities as of March 31, 2021 is as follows:
Operating
Leases(1)
3,653
4,713
4,423
4,285
3,731
14,297
35,102
Less: interest
(8,321
Present value of lease liabilities
Operating lease payments include $3,822 of payments related to options to extend lease terms that are reasonably expected to be exercised.
NOTE 13 - Debt
Long-term debt was comprised of the following:
Total credit facility
300,000
Balance outstanding
Standby letters of credit
1,740
Amount available, subject to covenant restrictions
248,260
243,660
Weighted-average interest rate
1.30
1.92
Commitment fee percentage per annum
0.20
0.23
On February 12, 2019, we entered an amended and restated five-year Credit Agreement with a group of banks (the "Credit Agreement") to extend the term of the facility. The Credit Agreement provides for a revolving credit facility of $300,000, which may be increased by $150,000 at the request of the Company, subject to the administrative agent's approval.
The revolving credit facility includes a swing line sublimit of $15,000 and a letter of credit sublimit of $10,000. Borrowings under the revolving credit facility bear interest at the base rate defined in the Credit Agreement. We also pay a quarterly commitment fee on the unused portion of the revolving credit facility. The commitment fee ranges from 0.20% to 0.30% based on our total leverage ratio.
The Credit Agreement requires, among other things, that we comply with a maximum total leverage ratio and a minimum fixed charge coverage ratio. Failure to comply with these covenants could reduce the borrowing availability under the revolving credit facility. We were compliant with all debt covenants at March 31, 2021. The Credit Agreement requires that we deliver quarterly financial statements, annual financial statements, auditor certifications, and compliance certificates within a specified number of days after the end of a quarter and year. Additionally, it 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
17
repurchases and dividend payments. Interest rates on the credit facility fluctuate based upon the LIBOR and the Company’s quarterly total leverage ratio.
We have debt issuance costs related to our long-term debt that are being amortized using the straight-line method over the life of the debt. Amortization expense for three months ended March 31, 2021 and March 31, 2020 was approximately $42 and $42, respectively. These costs are included in interest expense in our Condensed Consolidated Statement of Earnings.
We use interest rate swaps to convert the revolving credit facility's variable rate of interest into a fixed rate on a portion of the debt as described more fully in Note 14 "Derivative Financial Instruments". These swaps are treated as cash flow hedges and consequently, the changes in fair value were recorded in other comprehensive earnings.
Note 14 - Derivative Financial Instruments
Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates and interest rates. We selectively use derivative financial instruments including foreign currency forward contracts and interest rate swaps to manage our exposure to these risks.
The use of derivative financial instruments exposes the Company to credit risk, which relates to the risk of nonperformance by a counterparty to the derivative contracts. We manage our credit risk by entering derivative contracts with only highly rated financial institutions and by using netting agreements.
The effective portion of derivative gains and losses are recorded in accumulated other comprehensive (loss) income until the hedged transaction affects earnings upon settlement, at which time they are reclassified to cost of goods sold or net sales. If it is probable that an anticipated hedged transaction will not occur by the end of the originally specified time period, we reclassify the gains or losses related to that hedge from accumulated other comprehensive (loss) income to other expense, net.
We assess hedge effectiveness qualitatively by verifying that the critical terms of the hedging instrument and the forecasted transaction continue to match, and that there have been no adverse developments that have increased the risk that the counterparty will default. No recognition of ineffectiveness was recorded in our Condensed Consolidated Statements of Earnings for the three months ended March 31, 2021.
Foreign Currency Hedges
We use forward contracts to mitigate currency risk related to a portion of our forecasted foreign currency revenues and costs. The currency forward contracts are designed as cash flow hedges and are recorded in the Condensed Consolidated Balance Sheets at fair value.
We continue to monitor the Company’s overall currency exposure and may elect to add cash flow hedges in the future. At March 31, 2021, we had a net unrealized gain of $670 in accumulated other comprehensive (loss) income, of which $668 is expected to be reclassified to earnings within the next 12 months. At March 31, 2020, we had a net unrealized loss of $2,076 in accumulated other comprehensive (loss) income. The notional amount of foreign currency forward contracts outstanding was $16,445 at March 31, 2021.
Interest Rate Swaps
We use interest rate swaps to convert a portion of our revolving credit facility’s outstanding balance from a variable rate of interest to a fixed rate. As of March 31, 2021, we have agreements to fix interest rates on $50,000 of long-term debt through February 2024. The difference to be paid or received under the terms of the swap agreements will be recognized as an adjustment to interest expense when settled.
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These swaps are treated as cash flow hedges and consequently, the changes in fair value are recorded in other comprehensive (loss) income. The estimated net amount of the existing losses that are reported in accumulated other comprehensive (loss) income that are expected to be reclassified into earnings within the next twelve months is approximately $518.
The location and fair values of derivative instruments designated as hedging instruments in the Condensed Consolidated Balance Sheets as of March 31, 2021, are shown in the following table:
Interest rate swaps reported in accrued liabilities
(673
(671
Interest rate swaps reported in other long-term obligations
(1,546
Foreign currency hedges reported in other current assets
856
1,125
The Company has elected to net its foreign currency derivative assets and liabilities in the balance sheet in accordance with ASC 210-20 (Balance Sheet, Offsetting). On a gross basis, there were foreign currency derivative assets of $856 and foreign currency derivative liabilities of $0 at March 31, 2021.
The effect of derivative instruments on the Condensed Consolidated Statements of Earnings is as follows:
Foreign Exchange Contracts:
Amounts reclassified from AOCI to earnings:
221
248
Selling, general and administrative expense
(5
Total gain reclassified from AOCI to earnings
243
Gain (loss) recognized in other expense for hedge ineffectiveness
Total derivative gain on foreign exchange contracts recognized in earnings
Interest Rate Swaps:
(Expense) benefit recorded in Interest expense
(176
38
Total gains on derivatives
45
281
NOTE 15 – Accumulated Other Comprehensive (Loss) Income
Shareholders’ equity includes certain items classified as accumulated other comprehensive (loss) income (“AOCI”) in the Condensed Consolidated Balance Sheets, including:
Unrealized gains (losses) on hedges relate to interest rate swaps to convert a portion of our revolving credit facility's outstanding balance from a variable rate of interest into a fixed rate and foreign currency forward contracts used to hedge our exposure to changes in exchange rates affecting certain revenues and costs denominated in foreign currencies. These hedges are designated as cash flow hedges, and we have deferred income statement recognition of gains and losses until the hedged transactions occur, at which time amounts are reclassified into earnings. Further information related to our derivative financial instruments is included in Note 14 - Derivative Financial Instruments and Note 18 – Fair Value Measurements.
Unrealized gains (losses) on pension obligations are deferred from income statement recognition until the gains or losses are realized. Amounts reclassified to income from AOCI are included in net periodic pension income (expense). Further information related to our pension obligations is included in Note 7 – Retirement Plans.
Cumulative translation adjustments relate to our non-U.S. subsidiary companies that have designated a functional currency other than the U.S. dollar. We are required to translate the subsidiary functional currency financial statements to dollars using a combination of historical, period-end, and average foreign exchange rates. This combination of rates creates the foreign currency translation adjustment component of other comprehensive income.
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Changes in exchange rates between the functional currency and the currency in which a transaction is denominated are foreign exchange transaction gains or losses. Transaction losses for the three months ended March 31, 2021 and March 31, 2020 were $1,330 and $1,271, respectively, which have been included in other (expense) income in the Condensed Consolidated Statements of Earnings.
The components of accumulated other comprehensive (loss) income for the three months ended March 31, 2021 are as follows:
(Gain) Loss
Gain (Loss)
Reclassified
Recognized
from AOCI
in OCI
to Earnings
Changes in fair market value of derivatives:
(1,038
206
(45
(877
Income tax benefit (expense)
(47
203
Net
(798
159
(35
(674
Changes in unrealized pension cost:
(128,004
1,847
(126,157
34,917
(425
34,492
(93,087
(91,665
Cumulative translation adjustment:
(2,036
(2,024
Total accumulated other comprehensive (loss) income
171
1,387
The components of accumulated other comprehensive (loss) income for the three months ended March 31, 2020, are as follows:
(Loss) Gain
2019
659
(5,422
(281
(5,044
Income tax (expense) benefit
(150
1,225
64
1,139
509
(4,197
(217
(3,905
(124,140
1,660
(122,480
34,018
(375
33,643
(90,122
(88,837
(2,211
(41
(2,252
98
(98
(2,113
(4,336
1,068
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NOTE 16 – Shareholders’ Equity
Share count and par value data related to shareholders’ equity are as follows:
Preferred Stock
Par value per share
No par value
Shares authorized
25,000,000
Shares outstanding
Common Stock
75,000,000
Shares issued
57,147,983
57,076,410
32,348,360
32,276,787
Shares held
24,799,623
On February 7, 2019, the Board of Directors authorized a stock repurchase program with a maximum dollar limit of $25,000 in stock repurchases. During the three months ended March 31, 2021, no shares of common stock were repurchased. During the three months ended March 31, 2020, 220,731 shares of common stock were repurchased for $5,304. Approximately $5,740 is available for future purchases.
A roll-forward of common shares outstanding is as follows:
Balance at the beginning of the year
32,472,406
Repurchases
(220,731
Restricted share issuances
71,573
94,232
Balance at the end of the period
32,345,907
Certain potentially dilutive restricted stock units are excluded from diluted earnings per share because they are anti-dilutive. The number of outstanding awards that were anti-dilutive for the three months ended March 31, 2021 and March 31, 2020 were 35,167 and 38,839, respectively.
NOTE 17 - Stock-Based Compensation
At March 31, 2021, we had five active stock-based compensation plans: the Non-Employee Directors’ Stock Retirement Plan (“Directors’ Plan”), the 2004 Omnibus Long-Term Incentive Plan (“2004 Plan”), the 2009 Omnibus Equity and Performance Incentive Plan (“2009 Plan”), the 2014 Performance and Incentive Compensation Plan (“2014 Plan”), and the 2018 Equity and Incentive Compensation Plan ("2018 Plan"). Future grants can only be made under the 2018 Plan.
These plans allow for grants of stock options, stock appreciation rights, restricted stock, restricted stock units ("RSUs"), performance shares, performance units, and other stock awards subject to the terms of the specific plans under which the awards are granted.
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The following table summarizes the compensation expense included in selling, general and administrative expenses in the Condensed Consolidated Statements of Earnings related to stock-based compensation plans:
Service-based RSUs
686
580
Performance-based RSUs
494
(368
Cash-settled RSUs
39
Income tax benefit
51
Net expense
938
177
The following table summarizes the unrecognized compensation expense related to non-vested RSUs by type and the weighted-average period in which the expense is to be recognized:
Unrecognized
Compensation
Weighted-
Expense at
3,394
1.54
3,881
2.24
7,275
1.91
We recognize 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.
The following table summarizes the status of these plans as of March 31, 2021:
2018 Plan
2014 Plan
2009 Plan
2004 Plan
Directors'
Plan
Awards originally available
2,500,000
1,500,000
3,400,000
6,500,000
N/A
Maximum potential RSU and cash settled
awards outstanding
656,205
52,500
75,200
35,952
5,522
Maximum potential awards outstanding
RSUs and cash settled awards vested and released
96,136
Awards available for grant
1,747,659
Service-Based Restricted Stock Units
The following table summarizes the service-based RSU activity for the three months ended March 31, 2021:
Units
Grant Date
Fair Value
Outstanding at December 31, 2020
367,428
21.28
Granted
65,450
32.77
Vested and released
(61,342
28.48
Forfeited
(3,789
27.20
Outstanding at March 31, 2021
367,747
22.07
Releasable at March 31, 2021
194,974
15.22
22
Performance and Market-Based Restricted Stock Units
The following table summarizes the performance and market-based RSU activity for the three months ended March 31, 2021:
225,559
28.97
69,872
33.98
Attained by performance
18,107
28.33
Released
(53,137
(24,622
27.02
235,779
30.75
The following table summarizes each grant of performance awards outstanding at March 31, 2021:
Description
Vesting
Year
Vesting Dependency
Target Units
Outstanding
Maximum
Number
of Units
to be Granted
2019 - 2021 Performance RSUs
February 7, 2019
35% RTSR, 35% sales growth,
30% operating cash flow
50,456
100,912
2019 Supplemental Performance RSUs
Succession Planning Targets
6,945
13,890
2020 - 2022 QTI Performance RSUs
September 24, 2019
50% EBITDA growth,
50% Sales growth
1,750
3,500
2020 - 2022 Performance RSUs
February 6, 2020
25% RTSR, 40% sales growth,
35% operating cash flow
63,006
126,012
2021 - 2023 Performance RSUs
February 11, 2021
139,744
Focus 2025 Performance RSUs
April 23, 2020
Cumulative revenues of $750
million over a trailing
four-quarter period
43,750
427,808
Cash-Settled Restricted Stock Units
Cash-Settled RSUs entitle the holder to receive the cash equivalent of one share of common stock for each unit when the unit vests. These RSUs are issued to key employees residing in foreign locations as direct compensation. Generally, these RSUs vest over a three-year period. Cash-Settled RSUs are classified as liabilities and are remeasured at each reporting date until settled. At March 31, 2021 and December 31, 2020 we had 29,824 and 30,009 cash-settled RSUs outstanding, respectively. At March 31, 2021 and December 31, 2020, liabilities of $177 and $396, respectively, were included in accrued expenses and other liabilities on our Condensed Consolidated Balance Sheets.
NOTE 18 — Fair Value Measurements
The table below summarizes our financial liabilities that were measured at fair value on a recurring basis at March 31, 2021:
Quoted
Prices
Liability
in Active
Significant
Markets for
Value at
Identical
Observable
Unobservable
Instruments
Inputs
(Level 1)
(Level 2)
(Level 3)
Interest rate swaps
(1,745
Foreign currency hedges
1,850
The table below summarizes the financial assets that were measured at fair value on a recurring basis as of December 31, 2020:
Asset
(2,217
We use interest rate swaps to convert a portion of our revolving credit facility’s outstanding balance from a variable rate of interest into a fixed rate and foreign currency forward contracts to hedge the effect of foreign currency changes on certain revenues and costs denominated in foreign currencies. These derivative financial instruments are measured at fair value on a recurring basis. The fair value of our interest rate swaps and foreign currency hedges were measured using standard valuation models using market-based observable inputs over the contractual terms, including forward yield curves, among others. There is a readily determinable market for these derivative instruments, but that market is not active and therefore they are classified within Level 2 of the fair value hierarchy.
The fair value of the contingent consideration requires significant judgment. The Company's fair value estimates used in the contingent consideration valuation are considered Level 3 fair value measurements. The fair value estimates were based on assumptions management believes to be reasonable, but that are inherently uncertain, including estimates of future revenues and timing of events and activities that are expected to take place. Refer to Note 3 for further discussion on contingent consideration.
Our long-term debt consists of debt outstanding under the revolving credit facility which is recorded at its carrying value. There is a readily determinable market for our long-term 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 approximates carrying value and was determined by valuing a similar hypothetical coupon bond and attributing that value to our long-term debt under the revolving credit facility.
NOTE 19 — Income Taxes
The effective tax rates for the three months ended March 31, 2021 and March 31, 2020 are as follows:
Effective tax rate
18.9
36.4
Our effective income tax rate was 18.9% and 36.4% in the first quarters of 2021 and 2020, respectively. This decrease is primarily attributed to the change in the mix of earnings by jurisdiction and the establishment of valuation allowance on certain tax credits in the first quarter of 2020. The first quarter 2021 tax rate was lower than the U.S. statutory federal tax rate primarily due to foreign earnings that are taxed at lower rates and tax benefits recorded upon vesting of restricted stock units. The first quarter 2020 tax rate was higher than the U.S. statutory federal tax rate primarily due to the establishment of valuation allowances on certain tax credits and a one-time tax expense resulting from a company restructuring.
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NOTE 20 — Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
ASU No. 2019-12 "Simplifying the Accounting for Income Taxes"
In December 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2019-12, Simplifying the Accounting for Income Taxes, as part of its simplification initiative to reduce the cost and complexity in accounting for income taxes. ASU 2019-12 removes certain exceptions related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period, and the recognition of deferred tax liabilities for outside basis differences. ASU 2019-12 also amends other aspects of the guidance to help simplify and promote consistent application of U.S. GAAP. The guidance is effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. We adopted this ASU on January 1, 2021 and it did not have a material impact on our financial statements.
Recently Issued Accounting Pronouncements
ASU No. 2020-04 "Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting"
In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting”, which provides temporary optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting as it relates to our LIBOR indexed instruments. ASU 2020-04 provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. ASU 2020-04 is effective for all entities as of March 12, 2020 through December 31, 2022, and an entity may elect to apply ASU 2020-04 for contract modifications by Topic or Industry Subtopic as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. We are currently evaluating the impact of the transition from LIBOR to an alternative reference interest rate in our financial instruments including the potential election of certain practical expedients. Our LIBOR based revolving credit facility includes a provision for the determination of a successor LIBOR rate, and we are still evaluating the impact to potential future hedging activities.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)
(in thousands, except percentages and per share amounts)
The following discussion should be read in conjunction with our unaudited Condensed Consolidated Financial Statements and notes included under Item 1, as well as our Consolidated Financial Statements and notes and related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2020.
Overview
CTS Corporation ("CTS", "we", "our" or "us") is a leading designer and manufacturer of products that Sense, Connect and Move. Our vision is to be a leading provider of sensing and motion devices as well as connectivity components, enabling an intelligent and seamless world. These devices are categorized by their ability to Sense, Connect or Move. Sense products provide vital inputs to electronic systems. Connect products allow systems to function in synchronization with other systems. Move products ensure required movements are effectively and accurately executed. We are committed to achieving our vision by continuing to invest in the development of products and technologies, and talent within these categories.
We manufacture sensors, actuators, and connectivity components in North America, Europe, and Asia. CTS provides engineered products to OEMs and tier one suppliers in the aerospace and defense, industrial, information technology, medical, telecommunications, and transportation markets.
There is an increasing proliferation of sensing and motion applications within various markets we serve. In addition, the increasing connectivity of various devices to the internet results in greater demand for communication bandwidth and data storage, increasing the need for our connectivity products. Our success is dependent on the ability to execute our strategy to support these trends. We are subject to challenges including periodic market softness, competition from other suppliers, changes in technology, and the ability to add new customers, launch new products or penetrate new markets.
Impact of COVID-19
The COVID-19 pandemic has resulted in a significant disruption to the global economy that has and is likely to have continued adverse impact on our business. The extent of the impact of the COVID-19 pandemic on our business, financial results and liquidity will depend largely on future developments, including the duration of the spread of the COVID-19 outbreak within the U.S. and globally, the impact on capital and financial markets and the related impact on our suppliers and customers, especially in the transportation end-market. These future developments are outside of our control, are highly uncertain and cannot be predicted. These and other potential impacts of the COVID-19 pandemic, along with the recent increases in consumer demand are resulting in critical raw material and semiconductor chip shortages as well as associated cost increases, that may adversely impact our results for the remainder of 2021, and that impact could be material. We continue to actively monitor the ongoing potential impacts of COVID-19 and the supply chain issues and will seek to mitigate and minimize their impact on our business. We remain cautious about the financial impact of COVID-19 on our business for the remainder of 2021.
Results of Operations: First Quarter 2021 versus First Quarter 2020
The following table highlights changes in significant components of the Unaudited Condensed Consolidated Statements of Earnings for the quarters ended March 31, 2021, and March 31, 2020:
Percent of
Percent
Net Sales –
Change
24.6
100.0
22.3
66.8
68.1
29.5
33.2
31.9
9.3
14.3
16.3
(23.2
4.4
7.2
(66.3
0.1
0.2
Total operating expenses
24,093
24,407
(1.3
18.8
23.7
117.8
14.4
8.2
48.2
(2.9
(2.4
146.9
11.5
5.8
28.3
2.2
2.1
214.9
3.7
Diluted net earnings per share
Net sales were $128,427 in the first quarter of 2021, an increase of $25,352 or 24.6% from the first quarter of 2020. Net sales momentum continued in the first quarter of 2021 as a result of overall improvement in the economy; however, we also experienced significant material inflationary pressures and interruptions in the supply chain particularly due to the global semiconductor chip shortage impacting the operations of our business. The impact of the pandemic and supply chain impacts are ongoing and are expected to continue to have an effect on our operations. We are currently unable to quantify these future impacts.
Net sales to transportation markets increased $14,320 or 23.3%. Net sales to other markets increased $11,032 or 26.6%. The Sensor Scientific, Inc. (“SSI”) acquisition, which was completed in December 2020, added $1,847 in net sales for the quarter. Changes in foreign exchange rates increased net sales by $2,496 year-over-year due to the U.S. Dollar depreciating compared to the Chinese Renminbi and Euro.
Gross margin as a percent of net sales was 33.2% in the first quarter of 2021 compared to 31.9% in the first quarter of 2020. The increase in gross margin was driven primarily by sales volume with raw material price increases adversely impacting the results.
Selling, general and administrative ("SG&A") expenses were $18,325 or 14.3% of net sales in the first quarter of 2021 versus $16,759 or 16.3% of net sales in the first quarter of 2020. Increased net sales drove the overall decrease in SG&A expenses as a percentage of net sales.
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Research and development (“R&D”) expenses were $5,687 or 4.4% of net sales in the first quarter of 2021 compared to $7,408 or 7.2% of net sales in the comparable quarter of 2020. The reduction in overall R&D expenses is primarily due to changes in timing and mix of certain projects.
Restructuring charges were $81 or 0.1% of net sales in the first quarter of 2021 compared to $240 or 0.2% of net sales in the first quarter of 2020.
Operating earnings were $18,498 or 14.4% of net sales in the first quarter of 2021 compared to operating earnings of $8,492 or 8.2% of net sales in the first quarter of 2020. The change in operating earnings were driven by the items discussed above.
Other expense and income items are summarized in the following table:
Other expense in the first quarter of 2021 was principally driven by increased pension expense as well as unfavorable foreign exchange impact primarily from the U.S. Dollar depreciating compared to the Chinese Renminbi and Euro.
Our effective income tax rate was 18.9% and 36.4% in the first quarters of 2021 and 2020, respectively. This decrease is primarily attributed to the change in the mix of earnings by jurisdiction and the establishment of valuation allowance on certain tax credits in the first quarter of 2020.
Liquidity and Capital Resources
Cash and cash equivalents were $103,392 at March 31, 2021, and $91,773 at December 31, 2020, of which $101,883 and $90,051, respectively, were held outside the United States. The increase in cash and cash equivalents of $11,619 was primarily driven by cash generated from operating activities of $20,110, which was partially offset by net payments on long-term debt of $4,600, capital expenditures of $1,638, dividends paid of $1,291, and taxes paid on behalf of equity award participants of $1,402. Total long-term debt was $50,000 as of March 31, 2021 and $54,600 as of December 31, 2020. Total debt as a percentage of total capitalization, defined as long-term debt as a percentage of total debt and shareholders' equity, was 10.3% at March 31, 2021, compared to 11.4% at December 31, 2020.
Working capital increased by $11,627 during the three months ended March 31, 2021, primarily due to the increase in cash and cash equivalents from strong operating cash flows.
Cash Flows from Operating Activities
Net cash provided by operating activities was $20,110 during the three months ended March 31, 2021. Components of net cash provided by operating activities included net earnings of $11,990, depreciation and amortization expense of $6,800, other net non-cash items of $3,220, and a net cash outflow from changes in assets and liabilities of $1,900.
Cash Flows from Investing Activities
Net cash used in investing activities for the three months ended March 31, 2021 was $1,638, driven entirely by capital expenditures.
Cash Flows from Financing Activities
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Net cash used in financing activities for the three months ended March 31, 2021 was $7,293. The net cash outflow was the result of a decrease in borrowings of long-term debt of $4,600, dividends paid of $1,291 and taxes paid on behalf of equity award participants in the amount of $1,402.
Capital Resources
Long‑term debt is comprised of the following:
Our Credit Agreement provides for a revolving credit facility of $300,000, which may be increased by $150,000 at the request of the Company, subject to the administrative agent's approval.
We have entered into interest rate swap agreements to fix interest rates on $50,000 of long-term debt through February 2024. The difference to be paid or received under the terms of the swap agreements is recognized as an adjustment to interest expense when settled.
We have historically funded our capital and operating needs primarily through cash flows from operating activities, supported by available credit under our revolving credit facility. We believe that cash flows from operating activities and available borrowings under our revolving credit facility will be adequate to fund our working capital needs, capital expenditures, debt service and dividend requirements for at least the next twelve months. However, we may choose to pursue additional equity and debt financing to provide additional liquidity or to fund acquisitions.
Critical Accounting Policies and Estimates
Management prepared the condensed consolidated financial statements under accounting principles generally accepted in the United States of America. These principles require the use of estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions we used are reasonable, based upon the information available.
Our estimates and assumptions affect the reported amounts in our financial statements. The following accounting policies comprise those that we believe are the most critical in understanding and evaluating our reported financial results.
Revenue Recognition
Product revenue is recognized when the transfer of promised goods to a customer occurs in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods. We follow the five step model to determine when this transfer has occurred: 1) identify the contract(s) with the customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract; 5) recognize revenue when (or as) the entity satisfies a performance obligation.
Product Warranties
Provisions for estimated warranty expenses primarily related to our automotive products are made at the time products are sold. These estimates are established using a quoted industry rate. We adjust our warranty reserve for any known or anticipated warranty claims as new information becomes available. We evaluate our warranty obligations at least quarterly and adjust our accruals if it is probable that future costs will be different than our current reserve. Over the last three years, product warranty reserves have ranged from 0.5%
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to 2.7% of total sales. We believe our reserve level is appropriate considering all facts and circumstances surrounding any outstanding quality claims and our historical experience selling our products to our customers.
Accounts Receivable
We have standardized credit granting and review policies and procedures for all customer accounts, including:
Credit reviews of all new customer accounts,
Ongoing credit evaluations of current customers,
Credit limits and payment terms based on available credit information,
Adjustments to credit limits based upon payment history and the customer's current credit worthiness,
An active collection effort by regional credit functions, reporting directly to the corporate financial officers, and
Limited credit insurance on the majority of our international receivables.
We reserve for estimated credit losses based on historical experience, specific customer collection issues, current conditions and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual terms of our receivables and other financial assets. Over the last three years, accounts receivable reserves have been approximately 0.1% to 1.1% of total accounts receivable. We believe our reserve level is appropriate considering the quality of the portfolio. While credit losses have historically been within expectations of the reserves established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience or our current forecasts.
We value our inventories at the lower of the actual cost to purchase or manufacture using the first-in, first-out ("FIFO") method, or net realizable value. We review inventory quantities on hand and record a provision for excess and obsolete inventory based on historical usage, forecasts of product demand and related production requirements.
Over the last three years, our reserves for excess and obsolete inventories have ranged from 10.2% to 14.0% of gross inventory. We believe our reserve level is appropriate considering the quantities and quality of the inventories.
Retirement Plans
Actuarial assumptions are used in determining pension income and expense and our defined benefit obligations. We utilize actuaries from consulting companies in each applicable country to develop our discount rates, matching high-quality bonds currently available and expected to be available during the period to maturity of the pension benefit in order to provide the necessary future cash flows to pay the accumulated benefits when due. After considering the recommendations of our actuaries, we have assumed a discount rate, expected rate of return on plan assets, and a rate of compensation increase in determining our annual pension income and expense and the projected benefit obligation. During the fourth quarter of each year, we review our actuarial assumptions in light of current economic factors to determine if the assumptions need to be adjusted. Changes in the actuarial assumptions could have a material effect on our results of operations.
In February 2020, the CTS Board of Directors authorized management to explore termination of our Plan at management's discretion, subject to certain conditions. On June 1, 2020, we amended the Plan whereby we set an effective termination date of July 31, 2020. In February 2021, we received a determination letter from the Internal Revenue Service that allows us to proceed with the termination process. In connection with the termination, the Plan has offered a window extending from March 29, 2021 through May 7, 2021 to certain eligible participants to elect to receive a lump sum payment. The distribution date is June 1, 2021.
The completion of the Plan termination process, including the final purchases of annuities, is expected to occur in the second half of 2021. As of March 31, 2021, we had gross unrecognized losses related to the Plan of $123,238 in accumulated other comprehensive loss that are expected to be recognized in the income statement in 2021. Since the amount of the settlement depends on a number of
29
factors determined as of the liquidation date, including lump sum payout estimates, the annuity pricing interest rate environment and asset experience, we are currently unable to determine the ultimate cost of the settlement. However, we expect non-cash settlement charges of approximately $10,000 to $20,000 will be recognized in the second quarter of 2021 with the remaining amount of the gross accumulated other comprehensive loss balance to be recognized upon final settlement. We do not expect any cash contributions from the Company to the Plan as a result of this termination because Plan assets significantly exceed estimated liabilities.
Impairment of Goodwill
Goodwill of a reporting unit is tested for impairment annually, or more frequently if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying amount. Examples of such events or circumstances include, but are not limited to, the following:
Significant decline in market capitalization relative to net book value,
Significant adverse change in regulatory factors or in the business climate,
Unanticipated competition,
More-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of,
Testing for recoverability of a significant asset group within a reporting unit, and
Allocation of a portion of goodwill to a business to be disposed.
If we believe that one or more of the above indicators of impairment have occurred, we perform an impairment test. We have the option to perform a qualitative assessment (commonly referred to as "step zero" test) to determine whether further quantitative analysis for impairment of goodwill and indefinite-lived intangible assets is necessary. The qualitative assessment includes a review of macroeconomic conditions, industry and market considerations, internal cost factors, and our own overall financial and share price performance, among other factors. If, after assessing the totality of events or circumstances we determine that it is not more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, we do not need to perform a quantitative analysis.
If a quantitative assessment is required, we estimate the fair value of each reporting unit using a combination of discounted cash flow analysis and market-based valuation methodologies. Determining fair value using a quantitative approach requires significant judgment, including judgments about projected revenues, cash flows over a multi-year period, discount rates and estimated valuation multiples. The discount rate applied to our forecasts of future cash flows is based on our estimated weighted average cost of capital. In assessing the reasonableness of our determined fair values, we evaluate our results against our market capitalization. Changes in these estimates and assumptions could materially affect the determination of fair value and impact the goodwill impairment assessment.
Our latest assessment was performed using a quantitative approach as of October 1, 2020, and we determined that it was likely that the fair values of our reporting units were more than their carrying amounts, and therefore no impairment charges were recorded. We will monitor future results and will perform a test if indicators trigger an impairment review.
Impairment of Other Intangible and Long-Lived Assets
We evaluate the impairment of identifiable intangibles and other long-lived assets whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors considered that may trigger an impairment review consist of, but are not limited to, the following:
Significant under performance relative to expected historical or projected future operating results,
Significant changes in the manner of use of the acquired assets or the strategy for the overall business, and
Significant negative industry or economic trends.
If we believe that one or more indicators of impairment have occurred, we perform a recoverability test by comparing the carrying amount of an asset or asset group to the sum of the undiscounted cash flows expected to result from the use and the eventual disposition of the asset or asset group. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value. We recorded a charge of $1,016 during the first quarter of 2020 due to the impairment of a specific asset group. No indicators of impairment were identified during the quarter ended March 31, 2021.
Environmental and Legal Contingencies
U.S. GAAP requires a liability to be recorded for contingencies when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Significant judgment is required to determine the existence and amounts of our environmental, legal and other contingent liabilities. We regularly consult with attorneys and consultants to determine the relevant facts and circumstances before we record a liability. Changes in laws, regulatory orders, cost estimates, participation of other parties, timing of payments, input of attorneys and consultants, or other circumstances may have a material impact on the recorded liability.
Income Taxes
Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management’s best estimate of current and future taxes to be paid. We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgments and estimates are required in the determination of consolidated income tax expense.
Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets in the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. The assumptions about future taxable income require the use of significant judgment and are consistent with the plans and estimates we are using to manage our underlying businesses.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. Accounting Standards Codification (“ASC”) No. 740 states that a tax benefit from an uncertain tax position may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolution of any related appeals or litigation processes, on the basis of its technical merits. We record unrecognized tax benefits as liabilities in accordance with ASC 740 and adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is available.
Our practice is to recognize interest and penalties related to income tax matters as part of income tax expense.
Following the enactment of the 2017 Tax Cut and Jobs Act and the associated one-time transition tax, in general, repatriation of foreign earnings to the U.S. can be completed with no incremental U.S. tax. However, there are limited other taxes that continue to apply such as foreign withholding and certain state taxes. The Company records a deferred liability for the estimated foreign earnings and state tax cost associated with the undistributed foreign earnings that are not permanently reinvested.
Significant Customers
Our net sales to customers representing at least 10% of total net sales is as follows:
Cummins Inc.
15.7
16.5
Toyota Motor Corporation
13.4
11.9
31
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: the ultimate impact of the COVID-19 pandemic on our business, results of operations or financial condition, changes in the economy generally and in respect to the business in which CTS operates; unanticipated issues in integrating acquisitions; the results of actions to reposition our business; rapid technological change; general market conditions in the transportation, telecommunications, and information technology industries, as well as conditions in the industrial, aerospace and defense, and medical markets; reliance on key customers; unanticipated public health crises, natural disasters or other events; environmental compliance and remediation expenses; 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 1A. of our Annual Report on Form 10-K. 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.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
For a discussion of current market conditions resulting from the COVID-19 pandemic, refer to Part I, Item 2, "Management's Discussion and Analysis of Financial Condition” hereof.
There have been no other material changes in our market risk from the disclosure contained in our Annual Report on Form 10-K for the year ended December 31, 2020.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q were effective in providing reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within CTS have been detected.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting for the quarter ended March 31, 2021 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
From time to time we are involved in litigation with respect to matters arising from the ordinary conduct of our business, and currently certain claims are pending against us. In the opinion of management, we believe we have established adequate accruals pursuant to U.S. generally accepted accounting principles for our expected future liability with respect to pending lawsuits, claims and proceedings, where the nature and extent of any such liability can be reasonably estimated based on presently available information. However, there can be no assurance that the final resolution of any existing or future lawsuits, claims or proceedings will not have a material adverse effect on our business, results of operations, financial condition, or cash flows.
See Note 11 "Commitments and Contingencies" in the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors
There have been no significant changes to our risk factors from those contained in our Annual Report on Form 10-K for the year ended December 31, 2020.
Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds
On February 7, 2019, the Board of Directors authorized a stock repurchase program with a maximum dollar limit of $25 million. This program authorizes us to make repurchases of our common stock from time to time on the open market, but does not obligate us to make repurchases, and it has no expiration date. There were no repurchases of the Company's equity securities during the three months ended March 31, 2021. As of March 31, 2021, approximately $5.7 million remained available under the repurchase program.
Item 6. Exhibits
(31)(a)
Certification pursuant to Section 302 of the Sarbanes‑Oxley Act of 2002.
(31)(b)
(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)
101.1
The following information from CTS Corporation’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2021 formatted in Inline XBRL: (i) Condensed Consolidated Statements of Earnings for the three months ended March 31, 2021 and 2020; (ii) Condensed Consolidated Statements of Comprehensive Earnings for the three months ended March 31, 2021 and 2020; (iii) Condensed Consolidated Balance Sheets at March 31, 2021 and December 31, 2020; (iv) Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2020 and 2020; (v) Condensed Consolidated Statements of Shareholders’ Equity for the three months ended March 31, 2021 and 2020; (vi) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text and including detailed tags.
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The cover page from this Current Report on Form 10-Q formatted as inline XBRL
Pursuant to the requirements of Section 13 or 15(d) 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
/s/ Thomas M. White
/s/ Ashish Agrawal
Thomas M. White
Ashish Agrawal
Corporate Controller
(Principal Accounting Officer)
Vice President and Chief Financial Officer
(Principal Financial Officer)
Dated: April 29, 2021