CTS CORP - Quarter Report: 2021 March (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For The Quarterly Period Ended March 31, 2021

OR

For the Transition Period from                            to                           

Commission File Number: 1-4639

CTS CORPORATION

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (630) 577-8800

Securities registered pursuant to Section 12(b) of the Act:

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.

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

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PART I - FINANCIAL INFORMATION

Item 1.   Financial Statements

CTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS - UNAUDITED

(In thousands, except per share amounts)

See notes to unaudited condensed consolidated financial statements.

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CTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS ‑ UNAUDITED

(In thousands of dollars)

See notes to unaudited condensed consolidated financial statements.

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CTS CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands of dollars)

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)

See notes to unaudited condensed consolidated financial statements.

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CTS CORPORATION AND SUBSIDIARIES

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:

See notes to unaudited condensed consolidated financial statements.

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CTS CORPORATION AND SUBSIDIARIES

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, 2020:

See notes to unaudited condensed consolidated financial statements.

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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:

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.

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Disaggregated Revenue

The following table presents revenues disaggregated by the major markets we serve:

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:

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

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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:

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:

NOTE 5 – Inventories, net

Inventories, net consists of the following:

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NOTE 6 – Property, Plant and Equipment, net

Property, plant and equipment, net is comprised of the following:

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:

The components of net pension expense for our domestic and foreign plans include the following:

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

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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:

NOTE 8 – Goodwill and Other Intangible Assets

Other Intangible Assets

Other intangible assets, net consist of the following components:

Remaining amortization expense for other intangible assets as of March 31, 2021 is as follows:

Goodwill

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Changes in the net carrying amount of goodwill were as follows:

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.

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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:

NOTE 10 – Accrued Expense and Other Liabilities

The components of accrued expenses and other liabilities are as follows:

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.

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A roll-forward of remediation reserves included in accrued expenses and other liabilities on the Condensed Consolidated Balance Sheets is comprised of the following:

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:

Supplemental cash flow information related to leases was as follows:

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Supplemental balance sheet information related to leases was as follows:

Remaining maturity of our existing lease liabilities as of March 31, 2021 is as follows:

NOTE 13 - Debt

Long-term debt was comprised of the following:

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

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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:

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:

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:

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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: