CTS 10-K
Cts Corp (CTS)
10-K
2020-02-20
For: 2019-12-31
View Original
Added on
April 07, 2026
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For The Fiscal Year Ended December 31, 2019
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
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of incorporation or organization) | (IRS Employer Identification Number) | |||||
(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 | ||||
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ¨ Yes x No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. ¨ Yes x No
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. x 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). x 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.
☒ | Accelerated filer | ☐ | Non-accelerated filer | ☐ | Smaller reporting company | Emerging growth market | |||
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 x No
The aggregate market value of the voting and non-voting stock held by non-affiliates of CTS Corporation, based upon the closing sales price of CTS common stock on June 30, 2019, was approximately $890,000,000 . There were 32,433,391 shares of common stock, without par value, outstanding on February 18, 2020.
DOCUMENTS INCORPORATED BY REFERENCE
(1) | Portions of the Proxy Statement to be filed for the annual meeting of shareholders to be held on or about May 14, 2020 are incorporated by reference in Part III. |
TABLE OF CONTENTS
ITEM | PAGE | ||||
CTS CORPORATION 1
Safe Harbor
Forward-Looking Statements
This document contains statements that are, or may be deemed to be, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, any financial or other guidance, statements that reflect our current expectations concerning future results and events, and any other statements that are not based solely on historical fact. Forward-looking statements are based on management's expectations, certain assumptions and currently available information. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof and are based on various assumptions as to future events, the occurrence of which necessarily are subject to uncertainties. These forward-looking statements are made subject to certain risks, uncertainties and other factors, which could cause our actual results, performance or achievements to differ materially from those presented in the forward-looking statements. Examples of factors that may affect future operating results and financial condition include, but are not limited to: changes in the economy generally and in respect to the 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 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 this 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.
PART I
Item 1. Business
CTS Corporation ("CTS", "we", "our", "us" or the "Company") is a global manufacturer of sensors, electronic components, and actuators. CTS was established in 1896 as a provider of high-quality telephone products and was incorporated as an Indiana corporation in February 1929. Our principal executive offices are located in Lisle, Illinois.
We design, manufacture, and sell a broad line of sensors, electronic components, and actuators primarily to original equipment manufacturers ("OEMs") and tier one suppliers for the aerospace and defense, industrial, information technology, medical, telecommunications, and transportation markets. 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 within these categories.
We operate manufacturing facilities in North America, Asia, and Europe. Sales and marketing are accomplished through our sales engineers, independent manufacturers' representatives, and distributors.
See the Consolidated Financial Statements and Notes included in Part II, Item 8 of this Annual Report on Form 10-K for financial information regarding the Company.
PRODUCTS BY MAJOR MARKETS
Our products perform specific electronic functions for a given product family and are intended for use in customer assemblies. Our major products consist principally of sensors and actuators used in passenger or commercial vehicles, electronic components used in telecommunications infrastructure, information technology and other high-speed applications, switches, temperature sensors, and potentiometers supplied to multiple markets, and fabricated piezoelectric materials and substrates used primarily in medical, industrial, aerospace and defense, and information technology markets.
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The following table identifies major products by industry. Products are sold to several industry OEMs, tier one suppliers, and distributors.
Product Description | Transportation | Industrial | Medical | Aerospace and Defense | Telecom and IT |
SENSE | l | l | l | l | |
(Controls, Pedals, Piezo Sensing Products, Sensors, Switches, Transducers) | |||||
CONNECT | l | l | l | l | |
(EMI/RFI Filters, Capacitors, Frequency Control, Resistors, RF filters) | |||||
MOVE | l | l | l | ||
(Piezo Microactuators, Rotary Actuators) | |||||
The following table provides a breakdown of net sales by industry as a percent of consolidated net sales:
2019 | 2018 | 2017 | |
Industry | |||
Transportation | 64% | 64% | 65% |
Industrial | 17% | 18% | 18% |
Medical | 9% | 9% | 8% |
Aerospace and Defense | 7% | 5% | 4% |
Telecommunications and IT | 3% | 4% | 5% |
% of consolidated net sales | 100% | 100% | 100% |
MARKETING AND DISTRIBUTION
Sales and marketing to OEMs is accomplished through our sales engineers, independent manufacturers' representatives, and distributors. We maintain sales offices in China, Czech Republic, Denmark, Germany, India, Japan, Singapore, Taiwan, and the United States. Approximately 89% of 2019 net sales were attributable to our sales engineers.
Our sales engineers generally service our largest customers with application-specific products. The sales engineers work closely with major customers in designing and developing products to meet specific customer requirements.
We utilize the services of independent manufacturers' representatives for customers not serviced directly by our sales engineers. Independent manufacturers' representatives receive commissions from us. During 2019, approximately 6% of net sales were attributable to independent manufacturers' representatives. We also use independent distributors. Independent distributors purchase products from us for resale to customers. In 2019, independent distributors accounted for approximately 5% of net sales.
RAW MATERIALS
We utilize a wide variety of raw materials and purchased parts in our manufacturing processes. The following are the most significant raw materials and purchased components:
Conductive inks and contactors, passive electronic components, integrated circuits and semiconductors, certain rare earth elements ("REEs"), ceramic powders, plastic components, molding compounds, printed circuit boards and assemblies, quartz blanks and crystals, wire harness assemblies, copper, brass, silver, gold, platinum, lead, aluminum, and steel-based raw materials and components.
These raw materials and parts are purchased from a number of suppliers, and we generally do not believe we are dependent upon one or a limited number of suppliers. Although we purchase all of our semiconductors, REEs, conductive inks, and silver pastes from a limited number of suppliers, alternative sources are available.
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Lead times between the placement of orders for certain raw materials and purchased parts and actual delivery to us may vary. Occasionally, we may need to order raw materials in greater quantities and at higher prices to compensate for the variability of lead times for delivery. The price and availability of raw materials and manufactured components is subject to change due to, among other things, new laws and regulations, global economic and political events including strikes, and public health and safety concerns.
The ongoing coronavirus outbreak in China has resulted in travel restrictions and extended shutdown of certain businesses in the region, delaying the re-opening of two of our manufacturing facilities following the Lunar New Year holiday. We rely upon these facilities to support our business in China and to export components for use in our production in other facilities. In addition, we source raw materials and certain components from Chinese suppliers for use in our operations. The closures and limitations on movement in the region are adversely affecting our business and will adversely affect our sales and results of operations in the first quarter of 2020, and possibly longer if coronavirus consequences continue.
PATENTS, TRADEMARKS, AND LICENSES
We maintain a program of obtaining and protecting U.S. and non-U.S. patents relating to products that we have designed and manufactured, as well as processes and equipment used in our manufacturing technology. We were issued 18 new U.S. patents and 15 non-U.S. patents in 2019 and currently hold 148 U.S. patents and 150 non-U.S. patents. We have 12 registered U.S. trademarks, 24 registered foreign trademarks and 4 international trademark registrations. We have licensed the right to use several of our patents. In 2019, license and royalty income was less than 1% of net sales.
MAJOR CUSTOMERS
Sales to our 15 largest customers as a percentage of total net sales were as follows:
Years Ended December 31, | |||
2019 | 2018 | 2017 | |
Total of 15 largest customers / net sales | 61.9% | 63.7% | 64.4% |
Our net sales to significant customers as a percentage of total net sales were as follows:
Years Ended December 31, | |||
2019 | 2018 | 2017 | |
Cummins Inc. | 16.1% | 15.2% | 13.4% |
Honda Motor Co. | 11.6% | 10.5% | 11.2% |
Toyota Motor Corporation | 9.6% | 10.5% | 10.2% |
We sell parts to these three transportation customers for certain vehicle platforms under purchase agreements that have no volume commitments and are subject to purchase orders issued from time to time.
No other customer accounted for 10% or more of total net sales during these periods. We continue to focus on broadening our customer base to diversify our end market exposure.
Changes in the level of our customers' orders have, in the past, had a significant impact on our operating results. If a major customer reduces the amount of business it does with us, or substantially changes the terms of that business, there could be an adverse impact on our operating results.
ORDER BACKLOG
Order backlog is comprised of firm open purchase orders we have received from our customers and generally represents 1 to 2 months of sales for certain products. Our business is a mix of purchase order based business, shorter-term contracts, and multi-year awards, such as with customers who serve the automotive end market. As such, order backlog does not provide a meaningful indication of future sales.
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COMPETITION
We compete with many domestic and foreign manufacturers principally on the basis of product features, technology, price, quality, reliability, delivery, and service. Most of our product lines encounter significant global competition. The number of competitors varies from product line to product line. No one competitor competes with us in every product line, but many competitors are larger and more diversified than we are.
Some customers have reduced or plan to reduce their number of suppliers, while increasing their volume of purchases. Customers demand lower cost and higher quality, reliability, and delivery standards from us as well as from our competitors. These trends create opportunities for us, but also increase the risk of loss of business to competitors. We are subject to competitive risks that are typical within the electronics industry, including in some cases short product life cycles and technical obsolescence.
We believe we compete most successfully in custom engineered products manufactured to meet specific applications of major OEMs.
NON-U.S. REVENUES AND ASSETS
Our net sales to customers originating from our non-U.S. operations as a percentage of total net sales were as follows:
Years Ended December 31, | |||
2019 | 2018 | 2017 | |
Net sales from non-U.S. operations | 40% | 33% | 32% |
Our percentages of total assets at non-U.S. locations were as follows:
Years Ended December 31, | |||
2019 | 2018 | 2017 | |
Total assets at non-U.S. operations | 49% | 46% | 49% |
A substantial portion of these assets, other than cash and cash equivalents, cannot readily be liquidated. We believe the business risks to our non-U.S. operations, though substantial, are normal risks for global businesses. These risks include currency controls and changes in currency exchange rates, longer collection cycles, political and transportation risks, economic downturns and inflation, government regulations, and expropriation. Our non-U.S. manufacturing facilities are located in China, Czech Republic, Denmark, India, Mexico, and Taiwan.
EMPLOYEES
We employed 3,570 people at December 31, 2019, with 84% of these employees located outside the U.S. We employed 3,230 people at December 31, 2018.
ADDITIONAL INFORMATION
We are incorporated in the State of Indiana. Our principal corporate office is located at 4925 Indiana Avenue Lisle, IL 60532.
Our internet address is www.ctscorp.com. We make available free of charge through our website our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission ("SEC"). Other than the documents that we file with the SEC that are incorporated by reference herein, the information contained on or accessible through our website is not part of this or any other report we file or furnish to the SEC.
The SEC maintains an internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov.
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EXECUTIVE OFFICERS OF THE COMPANY
Executive Officers. The following serve as executive officers of CTS as of February 20, 2020. The executive officers are expected to serve until the next annual shareholders meeting, scheduled to be held on or about May 14, 2020, at which time the election of officers will be considered again by the Board of Directors.
Name | Age | Positions and Offices | ||
Kieran O'Sullivan | 57 | President, Chief Executive Officer and Chairman of the Board | ||
Ashish Agrawal | 49 | Vice President and Chief Financial Officer | ||
Luis Francisco Machado | 57 | Vice President, General Counsel and Secretary | ||
Kieran O'Sullivan - 57 - President, Chief Executive Officer and Chairman of the Board. Mr. O'Sullivan joined CTS on January 7, 2013. Before joining CTS, Mr. O'Sullivan served as Executive Vice President of Continental AG's Global Infotainment and Connectivity Business and led the NAFTA Interior Division, having joined Continental AG, a global automotive supplier, in 2006. Mr. O'Sullivan is a member of the board of directors, is chairman of the compensation committee, and is a member of the audit committee of LCI Industries, a supplier of components for manufacturers of recreational vehicles, manufactured homes, marine applications, and for the related aftermarkets of those industries.
Ashish Agrawal - 49 - Vice President and Chief Financial Officer. On November 11, 2013, Mr. Agrawal was elected Vice President and Chief Financial Officer for CTS. Mr. Agrawal joined CTS in June 2011 as Vice President, Treasury and Corporate Development, and was elected as Treasurer on September 1, 2011. Before joining CTS, Mr. Agrawal was with Dometic Corporation, a manufacturer of refrigerators, awnings and air conditioners, as Senior Vice President and Chief Financial Officer since 2007. Prior to that, Mr. Agrawal was with General Electric Co. in various positions since December 1994.
Luis Francisco Machado - 57 - Vice President, General Counsel and Secretary. Mr. Machado joined CTS in August 2015. Before joining CTS, Mr. Machado was at L Brands, Inc., a retailer of intimate apparel, home fragrance and beauty products under the Victoria's Secret, Pink, and Bath and Body Works Brands, as Senior Vice President, Legal and Assistant Secretary since August 2010, and Associate General Counsel, Corporate and Assistant Secretary of Wm. Wrigley Jr. Company since February 2006.
Information with respect to Directors and Corporate Governance may be found in our definitive proxy statement to be delivered to shareholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
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Item 1A. Risk Factors
The following are certain risk factors that could affect our business, financial condition and operating results. These risk factors should be considered in connection with evaluating forward-looking statements contained in this Annual Report on Form 10-K or in any other reports filed or furnished by us, because these factors could cause our actual results and financial condition to differ materially from those projected in any such forward-looking statements. Before you invest in us, you should know that making such an investment involves risks, including the risks described below. The risks that are highlighted below are not the only ones that we face. If any of the following risks occur, our business, financial condition or operating results could be negatively affected.
Because we currently derive a significant portion of our revenues from a small number of customers, any decrease in orders from these customers could have an adverse effect on our business, financial condition and operating results.
We depend on a small number of customers for a large portion of our business, and changes in the level of our customers' orders have, in the past, had a significant impact on our results of operations. If a major customer significantly delays, reduces, or cancels the level of business it does with us, there could be an adverse effect on our business, financial condition and operating results. Significant pricing and margin pressures exerted by a major customer could also materially adversely affect our operating results. In addition, we generate significant accounts receivable from sales to our major customers. If one or more of our major customers were to become insolvent or otherwise unable to pay or were to delay payment for our products, our business, financial condition and operating results could be materially adversely affected.
Negative or unexpected tax consequences could adversely affect our results of operations.
We operate globally and changes in tax laws could adversely affect our results. The international tax environment continues to change as a result of both coordinated actions by governments and unilateral measures enacted by individual countries, such as the comprehensive tax reform enacted in the U.S. in 2017, which could significantly impact our effective tax rate, tax liabilities, and ability to utilize deferred tax assets.
Adverse changes in the underlying profitability and financial outlook of our operations in several jurisdictions could lead to changes in our valuation allowances against deferred tax assets and other tax accruals that could materially and adversely affect our results of operations. In addition, acquisitions or divestitures may cause our effective tax rate to change.
We base our tax accounting positions upon the anticipated nature and conduct of our business and upon our understanding of the tax laws of the various countries in which we have assets or conduct activities. However, our tax accounting positions are subject to review and possible challenge by taxing authorities and to possible changes in law, which may have a retroactive effect.
We may be unable to compete effectively against competitors.
The industries in which we operate are highly competitive and characterized by price erosion and rapid technological change. We compete against many domestic and foreign companies, some of which have substantially greater manufacturing, financial, research and development, and marketing resources than we do. If any customer becomes dissatisfied with our prices, quality, or timeliness of delivery, among other things, it could award business to our competitors. Moreover, some of our customers could choose to manufacture and develop particular products themselves rather than purchase them from us. Increased competition could result in price reductions, reduced profit margins and loss of market share, each of which could materially adversely affect our business, financial condition and operating results. These developments also may materially adversely affect our ability to compete successfully going forward. We cannot assure you that our products will continue to compete successfully with our competitors' products, including OEMs.
We may be unable to keep pace with rapid technological changes that could make some of our products or processes obsolete before we realize a return on our investment.
The technologies relating to some of our products have undergone, and are continuing to undergo, rapid and significant changes. End markets for our products are characterized by technological change, frequent new product introductions and enhancements, changes in customer requirements, and emerging industry standards. The introduction of products embodying new technologies and the emergence of new industry standards could render our existing products obsolete and unmarketable before we can recover any or all of our research, development and commercialization expenses, or our capital investments. Furthermore, the life cycles of our products and the products we manufacture for others vary, may change, and are difficult to estimate.
We may experience difficulties that could delay or prevent the successful development, introduction and marketing of new products or product enhancements and our new products or product enhancements may not adequately meet the requirements of the
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marketplace or achieve market acceptance. If we are unable, for technological or other reasons, to develop and market new products or product enhancements in a timely and cost-effective manner, our business, financial condition and operating results could be materially adversely affected.
Our customers may cancel their orders, change production quantities or locations or delay production.
We generally do not obtain firm, long-term purchase commitments from our customers, and regularly experience reduced or extended lead times in customer orders. Customers cancel orders, change production quantities and delay production for a number of reasons. Uncertain economic and geopolitical conditions may result in some of our customers delaying the delivery of some of the products we manufacture for them and placing purchase orders for lower volumes of products than previously anticipated. Cancellations, reductions or delays by a significant customer or by a number of customers may harm our results of operations by reducing the volumes of products we manufacture and sell, as well as by causing a delay in the recovery of our expenditures for inventory in preparation for customer orders, or by reducing our asset utilization, resulting in lower profitability.
In addition, customers may require that manufacturing of their products be transitioned from one of our facilities to another to achieve cost reductions and other objectives. Such transfers may result in inefficiencies and costs due to resulting excess capacity and overhead at one facility and capacity constraints and the inability to fulfill all orders at another. In addition, we make key decisions based on our estimates of customer requirements, including determining the levels of orders that we will seek and accept, production schedules, component procurement commitments, personnel needs and other resource requirements. The short-term nature of our customers' commitments and the changes in demand for their products may reduce our ability to estimate future customer requirements accurately. This may make it difficult to schedule production and maximize utilization of our manufacturing capacity. Anticipated orders may not materialize and delivery schedules may be deferred as a result of changes in demand for our products or our customers' products. We often increase staffing and capacity, and incur other expenses to meet the anticipated demand of our customers, which causes reductions in our gross margins if customer orders are delayed or canceled. On occasion, customers require rapid increases in production, which may stress our resources and reduce margins. We may not have sufficient capacity at any given time to meet our customers' demands. In addition, because many of our costs and operating expenses are relatively fixed over the short-term, a reduction in customer demand could harm our gross margin and operating income until such time as adjustments can be made to activity and operating levels or to structural costs.
We sell products to customers in cyclical industries that are subject to significant downturns that could materially adversely affect our business, financial condition and operating results.
We sell products to customers in cyclical industries that have experienced economic and industry downturns. The markets for our products have softened in the past and may again soften in the future. We may face reduced end-customer demand, underutilization of our manufacturing capacity, changes in our revenue mix and other factors that could adversely affect our results of operations in the near-term. We cannot predict whether we will achieve profitability in future periods.
We derive a substantial portion of our revenues from customers in the transportation, information technology and telecommunications industries and are susceptible to trends and factors affecting those industries.
Sales to the transportation, information technology and telecommunications industries represent a substantial portion of our revenues. Factors negatively affecting these industries and the demand for their products also negatively affect our business, financial condition and operating results. Any adverse occurrence, including among others, industry slowdown, recession, political instability, costly or constraining regulations, increased tariffs, reduced government budgets and spending, armed hostilities, terrorism, excessive inflation, prolonged disruptions in one or more of our customers' production schedules or labor disturbances, that results in a decline in the volume of sales in these industries, or in an overall downturn in the business and operations of our customers in these industries, could materially adversely affect our business, financial condition and operating results. These industries are generally unionized and some of our customers have experienced labor disruptions in the past. Furthermore, these industries are highly cyclical in nature and sensitive to changes in general economic conditions, consumer preferences and interest rates. The failure of manufacturers that we serve may result in the failure to receive payment in full for products sold in the past and an abrupt cancellation in demand for certain products. Weakness in demand, the insolvency of manufacturers that we serve or their suppliers, and constriction of credit markets may negatively and materially affect our facility utilization, cost structure, financial condition, and operating results.
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Products we manufacture may contain design or manufacturing defects that could result in reduced demand for our products or services and liability claims against us.
Despite our quality control and quality assurance efforts, defects may occur in the products we manufacture due to design or manufacturing errors or component failure. Product defects could result in delayed shipments and reduced demand for our products. We may be subject to increased costs due to warranty claims on defective products. Product defects could result in product liability claims against us where defects cause, or are alleged to cause, property damage, bodily injury or death. As we grow our business in the transportation and medical device markets, the risk of exposure to product liability litigation increases. We may be required to participate in a recall involving products which are, or are alleged to be, defective. We carry insurance for certain legal matters involving product liability; however, we do not have coverage for all costs related to product defects and the costs of such claims, including costs of defense and settlement, may exceed our available coverage. Accordingly, our results of operations, cash flow and financial position could be adversely affected.
We are exposed to fluctuations in foreign currency exchange rates that may adversely affect our business, financial condition and operating results.
We transact business in various foreign countries. We present our consolidated financial statements in U.S. dollars, but a portion of our revenues and expenditures are transacted in other currencies. As a result, we are exposed to fluctuations in foreign currencies. Additionally, we have currency exposure arising from funds held in local currencies in foreign countries. Volatility in the exchange rates between the foreign currencies and the U.S. dollar could harm our business, financial condition and operating results. Furthermore, to the extent we sell our products in foreign markets, currency fluctuations may result in our products becoming too expensive for foreign customers.
Our operating results vary significantly from period to period.
We experience fluctuations in our operating results. Some of the principal factors that contribute to these fluctuations are: changes in demand for our products; our effectiveness in managing manufacturing processes, costs and timing of our component purchases so that components are available when needed for production, while mitigating the risks of purchasing inventory in excess of immediate production needs; the degree to which we are able to utilize our available manufacturing capacity; changes in the cost and availability of components, which often occur in the electronics manufacturing industry and which affect our margins and our ability to meet delivery schedules; general economic and served industry conditions; and local conditions and events that may affect our production volumes, such as labor conditions or political instability.
We face risks relating to our international operations.
Because we have significant international operations, our operating results and financial condition could be materially adversely affected by economic, political, health, regulatory and other factors existing in foreign countries in which we operate. Our international operations are subject to inherent risks, which may materially adversely affect us, including: political and economic instability in countries in which our products are manufactured; expropriation or the imposition of government controls; changes in government regulations; export license requirements; trade restrictions; earnings repatriation and expatriation restrictions; exposure to different legal standards, including related to intellectual property; health conditions and standards; currency controls; fluctuations in exchange rates; increases in the duties and taxes we pay; inflation or deflation; greater difficulty in collecting accounts receivable and longer payment cycles; changes in labor conditions and difficulties in staffing and managing our international operations; limitations on insurance coverage against geopolitical risks, natural disasters, and business operations; and communication among and management of international operations. In addition, these same factors may also place us at a competitive disadvantage compared to some of our foreign competitors.
We may face risks associated with violations of the Foreign Corrupt Practices Act ("FCPA") and similar anti-bribery laws. The FCPA and similar anti-bribery laws in other jurisdictions generally prohibit companies and their intermediaries from making improper payments to government officials for the purpose of obtaining or retaining business. Our Code of Ethics mandates compliance with these anti-bribery laws. We operate in many parts of the world where strict compliance with anti-bribery laws may conflict with local customs and practices. We cannot assure you that our internal controls and procedures always will protect us from the detrimental actions by our employees or agents. If we are found to be liable for FCPA violations (either due to our own acts or inadvertence or due to the acts or inadvertence of others), we could suffer from criminal or civil penalties or other sanctions, which could have a material adverse effect on our business.
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Public health or safety concerns and governmental restrictions, including the recent coronavirus outbreak, that impact the availability of raw materials, labor, or the movement of goods in some of the countries in which we operate could have a material adverse effect on our business, financial condition and operating results.
We may restructure our operations or fail to execute capital projects as planned, which may materially adversely affect our business, financial condition and operating results.
We have announced and initiated restructuring plans or capital projects at various times in the recent past designed to revise and consolidate certain aspects of our operations for the purpose of improving our cost structure or manufacturing efficiency. We may incur restructuring and impairment charges in the future if circumstances warrant. Additionally, if we are unsuccessful in implementing restructuring plans or in executing capital projects, we may experience disruptions in our operations and higher ongoing costs, which may materially adversely affect our business, financial condition and operating results.
Losses in the financial markets could negatively impact pension asset returns and cash flow due to possible required contributions in the future.
We make a number of assumptions relating to our pension plans in order to measure the financial position of the plans and the net periodic benefit cost. The most significant assumptions relate to the discount rate and the expected long-term return on plan assets. If these assumptions prove to be significantly different from actual rates, then we may need to record additional expense relating to the pension plans, which could require cash contributions to fund future pension obligation payments and could have a material adverse effect on our financial condition and results of operations.
We may pursue acquisition opportunities that complement or expand our business as well as divestitures that could impact our business operations. We may not be able to complete these transactions, and these transactions, if executed, may pose significant risks that could materially adversely affect our business, financial condition and operating results.
On an ongoing basis we explore opportunities to buy other businesses or technologies that could complement, enhance or expand our current business or product lines or that might otherwise offer us growth opportunities. We may have difficulty finding suitable opportunities or, if we do identify these opportunities, we may not be able to complete the transactions for any number of reasons including a failure to secure financing. In addition, we may not be able to successfully or profitably integrate, operate, maintain and manage our newly acquired operations or employees. Any transactions that we are able to identify and complete may involve a number of risks, including: the diversion of management's attention from our existing business to integrate the operations and personnel of the acquired or combined business; possible adverse effects on our operating results during the integration process; difficulties managing and integrating operations in geographically dispersed locations; increases in our expenses and working capital requirements, which could reduce our return on invested capital; exposure to unanticipated liabilities of acquired companies; and our possible inability to achieve the intended objectives of the transaction. Even if we are initially successful in integrating a new operation, we may not be able to maintain uniform standards, controls, procedures and policies, and this may lead to operational inefficiencies. In addition, future acquisitions may result in dilutive issuances of equity securities or the incurrence of additional debt. These and other factors could harm our ability to achieve anticipated levels of profitability from acquired operations or realize other anticipated benefits of an acquisition, and could adversely affect our business and operating results.
We have in the past, and may in the future, consider divesting certain business operations. Divestitures may involve a number of risks, including the diversion of management's attention, significant costs and expenses, the loss of customer relationships and cash flow, and the disruption of operations in the affected business. Failure to timely complete or consummate a divestiture may negatively affect valuation of the affected business or result in restructuring charges.
If we are unable to protect our intellectual property or we infringe, or are alleged to infringe, on others' intellectual property rights, our business, financial condition and operating results could be materially adversely affected.
The success of our business depends, in part, upon our ability to protect trade secrets, trademarks, copyrights and patents, obtain or license patents and operate without infringing on the intellectual property rights of others. We rely on a combination of trade secrets, copyrights, patents, nondisclosure agreements and technical measures to protect our proprietary rights in our products and technology. The steps we have taken to prevent misappropriation of our technology may be inadequate. In addition, the laws of some foreign countries in which we operate do not protect our proprietary rights to the same extent as do the laws of the United States. Although we continue to evaluate and implement protective measures, there can be no assurance that these efforts will be successful. Our inability to protect our intellectual property rights could diminish or eliminate the competitive advantages that we derive from our technology, cause us to lose sales or otherwise harm our business.
CTS CORPORATION 10
We believe that patents will continue to play an important role in our business. However, there can be no assurance that we will be successful in securing patents for claims in any pending patent application or that any issued patent will provide us with any competitive advantage. We also cannot provide assurance that the patents will not be challenged by third parties or that the patents of others will not materially adversely affect our ability to do business.
We may become involved in litigation in the future to protect our intellectual property or because others may allege that we infringed on their intellectual property. These claims and any resulting lawsuit could subject us to liability for damages and invalidate our intellectual property rights. If an infringement claim is successfully asserted by a holder of intellectual property rights, we may be required to cease marketing or selling certain products, pay penalties and spend significant time and money to develop a non-infringing product or process or to obtain licenses for the technology, process or information from the holder. We may not be successful in the development of a non-infringing alternative, or licenses may not be available on commercially acceptable terms, if at all, in which case we may lose sales and profits. In addition, any litigation could be lengthy and costly and could materially adversely affect us even if we are successful in the litigation.
We may experience shortages and increased costs of raw material and required electronic components.
Unanticipated raw material or electronic component shortages may prevent us from making scheduled shipments to customers. Our inability to make scheduled shipments could cause us to experience a shortfall in revenue, increase our costs and adversely affect our relationship with affected customers and our reputation as a reliable supplier. We may be required to pay higher prices for raw materials or electronic components in short supply and order these raw materials or electronic components in greater quantities to compensate for variable delivery times. We may also be required to pay higher prices for raw materials or electronic components due to inflationary trends regardless of supply. We are also dependent on our suppliers' ability to supply and deliver raw materials on a timely basis at negotiated prices. Any delay or inability to deliver raw materials by our suppliers may require that we attempt to mitigate such failure or fail to make deliveries to our customers on a timely basis. As a result, raw material or electronic component shortages, price increases, or failure to perform by our suppliers could adversely affect our operating results for a particular period due to the resulting revenue shortfall and/or increased costs.
Loss of our key management and other personnel, or an inability to attract key management and other personnel, could materially affect our business.
We depend on our senior executive officers and other key personnel to run our business. We do not have long-term employment contracts with our key personnel. The loss of any of these officers or other key personnel could adversely affect our operations. Competition for qualified employees among companies that rely heavily on engineering and technology is at times intense, and the loss of qualified employees or an inability to attract, retain and motivate additional highly skilled employees required for the operation and expansion of our business could hinder our ability to conduct research activities and develop marketable products successfully.
We are subject to a variety of environmental, health, and safety laws and regulations that expose us to potential financial liability.
Our operations are regulated by a number of federal, state, local and foreign environmental, health, and safety (“EHS”) laws and regulations that govern, among other things, air and water emissions, worker protection, and the handling, storage and disposal of hazardous materials. Compliance with EHS laws and regulations is a major consideration for us because we use hazardous materials in our manufacturing processes. If we violate EHS laws and regulations, we could be liable for substantial fines, penalties, and costs of mandated remedial actions. Our environmental permits could also be revoked or modified, which could require us to cease or limit production at one or more of our facilities, thereby materially adversely affecting our business, financial condition and operating results. EHS laws and regulations have generally become more stringent over time and could continue to do so, imposing greater compliance costs and increasing risks and penalties associated with any violation, which also could materially affect our business, financial condition and operating results.
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 are potentially liable for environmental contamination at several sites currently and formerly owned or operated by us, including sites designated as National Priorities List sites under the U.S. Environmental Protection Agency’s Superfund program. Superfund liability is joint and several and we may be held responsible for more than our share of contamination at a site. Although we estimate our potential environmental liability and reserve for such matters, we cannot assure you that our reserves will be sufficient to cover the actual costs that we incur as a result of these matters.
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Future events, such as the notification of potential liability at new sites, the discovery of additional contamination or changes to an approved remedy at existing sites, changes to existing EHS environmental laws and regulations or their interpretation, and more rigorous regulatory action by government authorities, may require additional expenditures by us, which could have a negative impact on our operations.
In addition, we could be affected by future laws or regulations imposed in response to climate change concerns. Such laws or regulations could have a material adverse effect on our business, financial condition, and results of operations. Climate change initiatives may result in significant operational changes and expenditures, reduce demand for our products and adversely affect our business. We recognize that climate change is a global environmental concern. Continuing political and social attention to the issue of climate change has resulted in both existing and pending international agreements and national, regional or local legislation and regulatory measures to limit greenhouse gas emissions. These agreements and measures may require equipment modifications, operational changes, taxes, or purchase of emission credits to reduce emission of greenhouse gases from our operations, which may result in substantial capital expenditures and compliance, operating, maintenance and remediation costs. Regulatory initiatives to reduce greenhouse gas usage may also adversely impact some of the industries we serve and our supply chain, adversely impacting our sales and the value of our business.
Our indebtedness may adversely affect our financial health.
Our debt consists of borrowings under our revolving credit facility. Our indebtedness could, among other things: increase our vulnerability to general economic and industry conditions, including recessions; require us to use cash flow from operations to service our indebtedness, thereby reducing our ability to fund working capital, capital expenditures, research and development efforts and other expenses; limit our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate; place us at a competitive disadvantage compared to competitors that have less indebtedness; or limit our ability to borrow additional funds that may be needed to operate and expand our business. Moreover, an increase in interest rates could increase our interest expense.
Our credit facility contains provisions that could materially restrict our business.
Our revolving credit facility 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; repurchase stock; or make dividend payments above a certain amount.
The restrictions contained in our credit facility could limit our ability to plan for or react to changes in market conditions or meet capital needs or could otherwise restrict our activities or business plans. These restrictions could adversely affect our ability to finance our operations, make strategic acquisitions, fund investments or other capital needs or engage in other business activities that could be in our interest.
Further, our ability to comply with our loan covenants may be affected by events beyond our control that could result in an event of default under our credit facility, or documents governing any other existing or future indebtedness. A default, if not cured or waived, may permit acceleration of our indebtedness. In addition, our lenders could terminate their commitments to make further extensions of credit under our credit facility. If our indebtedness is accelerated, we cannot be certain that we will have sufficient funds to pay the accelerated indebtedness or that we will have the ability to refinance accelerated indebtedness on terms favorable to us, or at all.
Regulations related to conflict minerals could adversely impact our business.
The Dodd-Frank Wall Street Reform and Consumer Protection Act contains provisions to improve transparency and accountability concerning the supply of certain minerals, known as conflict minerals, originating from the Democratic Republic of Congo ("DRC") and adjoining countries. As a result, the SEC adopted annual disclosure and reporting requirements for those companies who may use conflict minerals mined from the DRC and adjoining countries in their products. There have been and will continue to be costs associated with complying with these disclosure requirements, including diligence costs to determine the sources of minerals used in our products and other potential changes to products, processes or sources of supply to the extent necessary as a consequence of such verification activities. These rules could adversely affect the sourcing, supply and pricing of materials used in our products. As there may be only a limited number of suppliers offering conflict-free minerals, we cannot be sure that we will be able to obtain necessary conflict-free minerals from such suppliers in sufficient quantities or at competitive prices. Also, we may face reputational challenges if we determine that certain of our products contain conflict minerals or if we are unable to sufficiently verify the origins for all minerals used in our products through the procedures we may implement.
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Ineffective internal control over our financial reporting may harm our business.
We are subject to the ongoing internal control provisions of Section 404 of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley"). Our controls necessary for continued compliance with Sarbanes-Oxley may not operate effectively or at all times and may result in a material weakness. The identification of material weaknesses in internal control over financial reporting could indicate a lack of proper controls to generate accurate financial statements. Further, the effectiveness of our internal controls may be impacted if we are unable to retain sufficient skilled finance and accounting personnel, especially in light of the increased demand for such personnel among publicly traded companies.
Natural disasters may adversely impact our capability to supply product to our customers.
Natural disasters, such as storms, flooding and associated power outages, occurring at any of our locations or supplier locations may lead to disruption of our manufacturing operations and supply chain, adversely impacting our capability to supply product to our customers. In the event of a natural disaster, it may not be possible for us to find an alternate manufacturing location for certain product lines, further impacting our capability to recover from such a disruption.
We could face risks to our systems, networks and production including increased IT security threats and more sophisticated and targeted computer crime.
Increased global information technology security threats and more sophisticated and targeted computer crime pose a risk to the security of our systems and networks and the confidentiality, availability and integrity of our data and communications. While we attempt to mitigate these risks by employing a number of measures - including employee training, comprehensive monitoring of our networks and systems, and maintenance of backup and protective systems - our systems, networks and products remain potentially vulnerable to advanced persistent threats. Depending on their nature and scope, such threats could potentially lead to the compromising of confidential information and communications, improper use of our systems and networks, manipulation and destruction of data, defective products, production downtimes and operational disruptions, which in turn could adversely affect our reputation, competitiveness and results of operations. Additionally, any updates to or implementation of systems, including the selection and implementation of an ERP system, may cause delays or disruptions in our processes or production which could adversely affect our results.
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Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
As of February 20, 2020, we had manufacturing facilities, administrative, research and development and sales offices in the following locations:
Manufacturing Facilities | Square Footage | Owned/Leased | ||
Albuquerque, New Mexico | 114,525 | Leased | ||
Boise, Idaho | 15,000 | Leased | ||
Haryana, India | 19,400 | Leased | ||
Hopkinton, Massachusetts | 32,000 | Owned | ||
Hradec Kralove, Czech Republic | 30,680 | Leased | ||
Juarez, Mexico | 114,600 | Leased | ||
Kaohsiung, Taiwan | 75,900 | Owned | (1) | |
Kvistgaard, Denmark | 30,680 | Leased | ||
Lisle, Illinois | 31,000 | Leased | ||
Matamoros, Mexico | 51,000 | Owned | ||
Nogales, Mexico | 64,000 | Leased | ||
Nupaky, Czech Republic | 55,919 | Leased | ||
Ostrava, Czech Republic | 67,600 | Leased | ||
Tecate, Mexico | 22,537 | Leased | ||
Tianjin, China | 225,000 | Owned | (2) | |
Zhongshan, China | 112,600 | Leased | ||
Total manufacturing | 1,062,441 | |||
(1) Ground lease through 2026; restrictions on use and transfer apply.
(2) Land Use Rights Agreement through 2050 includes transfer, lease and mortgage rights.
Non-Manufacturing Facilities | Square Footage | Owned/Leased | Description | |
Brownsville, Texas | N/A | Owned | Land | |
Brownsville, Texas | 10,000 | Leased | Warehouse | |
El Paso, Texas | 22,400 | Leased | Office and warehouse | |
Matamoros, Mexico | 20,000 | Leased | Warehouse | |
Elkhart, Indiana | 319,000 | Owned | Idle facility | |
Elkhart, Indiana | 93,000 | Owned | Administrative offices and research | |
Farmington Hills, Michigan | 1,800 | Leased | Sales office | |
Lisle, Illinois | 74,925 | Leased | Administrative offices and research | |
Malden, Massachusetts | 3,600 | Leased | Administrative offices and research | |
Nagoya, Japan | 800 | Leased | Sales office | |
Singapore | 5,600 | Leased | Sales office | |
Yokohama, Japan | 1,400 | Leased | Sales office | |
Total non-manufacturing | 552,525 | |||
We regularly assess the adequacy of our manufacturing facilities for manufacturing capacity, available labor, and proximity to our markets and major customers. Management believes our manufacturing facilities are suitable and adequate, and have sufficient capacity to meet our current needs. The extent of utilization varies from plant to plant and with general economic conditions. We
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also review the operating costs of our facilities and may from time-to-time relocate a portion of our manufacturing activities in order to reduce operating costs and improve asset utilization and cash flow.
Item 3. 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 10 "Contingencies" in the Notes to the Consolidated Financial Statements in this Annual Report on Form 10-K.
Item 4. Mine Safety Disclosures
Not applicable.
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PART II
Item 5. Market for Registrant's Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Our common stock is listed on the New York Stock Exchange under the symbol "CTS." On February 18, 2020, there were approximately 919 shareholders of record.
A summary of our repurchases of common stock during the fourth quarter of 2019 is as follows:
(a) Total Number of Shares Purchased | (b) Average Price Paid per Share | (c) Total Number of Shares Purchased as Part of Publicly Announced Programs | (d) Maximum Value of Shares That May Yet Be Purchased Under the Plans or Programs | |||||||
October 1, 2019 - October 31, 2019 | 6,250 | $ | 27.93 | 6,250 | $ | 17,347 | ||||
November 1, 2019 - November 30, 2019 | 74,100 | $ | 27.09 | 74,100 | $ | 15,340 | ||||
December 1, 2019 – December 31, 2019 | 53,694 | $ | 28.31 | 53,694 | $ | 13,820 | ||||
Total | 134,044 | 134,044 | ||||||||
In February 2019, our Board of Directors authorized a new stock repurchase program with a maximum dollar limit of $25,000 in stock repurchases, which replaced the previous authorized plan that was approved by our Board of Directors in April 2015. The authorization has no expiration date. During the year ended December 31, 2019 we purchased 420,770 shares for approximately $11,746, of which $566 was repurchased under the previous plan and $11,180 was repurchased under the most recent board-authorized share repurchase program.
Shareholder Performance Graph
The following graph shows a five-year comparison of the cumulative total shareholder return on CTS common stock with the cumulative total returns of a general market index and a peer group index (S&P 500 and Dow Jones Electrical Components & Equipment Industry Group). The graph tracks the performance of a $100 investment in the Company's common stock and in each of the indexes (with the reinvestment of all dividends) on December 31, 2014.
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Item 6. Selected Financial Data
Five-Year Summary
(Amounts in thousands, except percentages and per share amounts)
2019 | % of Sales | 2018 | % of Sales | 2017 | % of Sales | 2016 | % of Sales | 2015 | % of Sales | ||||||||||||||||
Summary of Operations | |||||||||||||||||||||||||
Net sales | $ | 468,999 | 100.0 | $ | 470,483 | 100.0 | $ | 422,993 | 100.0 | $ | 396,679 | 100.0 | $ | 382,310 | 100.0 | ||||||||||
Cost of goods sold | 311,424 | 66.4 | 305,510 | 64.9 | 282,562 | 66.8 | 256,251 | 64.6 | 255,201 | 66.8 | |||||||||||||||
Gross Margin | 157,575 | 33.6 | 164,973 | 35.1 | 140,431 | 33.2 | 140,428 | 35.4 | 127,109 | 33.2 | |||||||||||||||
Selling, general and administrative expenses | 70,408 | 15.0 | 73,569 | 15.6 | 71,943 | 17.0 | 61,624 | 15.5 | 59,586 | 15.6 | |||||||||||||||
Research and development expenses | 25,967 | 5.5 | 25,304 | 5.4 | 25,146 | 5.9 | 24,040 | 6.1 | 22,461 | 5.9 | |||||||||||||||
Non-recurring environmental expense | — | — | — | — | — | — | — | — | 14,541 | 3.8 | |||||||||||||||
Restructuring charges | 7,448 | 1.6 | 5,062 | 1.1 | 4,139 | 1.0 | 3,048 | 0.8 | 14,564 | 3.8 | |||||||||||||||
(Gain) loss on sale of assets | (63 | ) | — | — | — | 708 | 0.2 | (11,450 | ) | (2.9 | ) | (2,156 | ) | (0.6 | ) | ||||||||||
Operating earnings | 53,815 | 11.5 | 61,038 | 13.0 | 38,495 | 9.1 | 63,166 | 15.9 | 18,113 | 4.7 | |||||||||||||||
Other (expense) income | (3,549 | ) | (0.8 | ) | (2,935 | ) | (0.6 | ) | 1,758 | 0.4 | (5,921 | ) | (1.5 | ) | (5,852 | ) | (1.5 | ) | |||||||
Earnings before taxes | 50,266 | 10.7 | 58,103 | 12.4 | 40,253 | 9.5 | 57,245 | 14.4 | 12,261 | 3.2 | |||||||||||||||
Income tax expense | 14,120 | 3.0 | 11,571 | 2.5 | 25,805 | 6.1 | 22,865 | 5.8 | 5,307 | 1.4 | |||||||||||||||
Net earnings | $ | 36,146 | 7.7 | $ | 46,532 | 9.9 | $ | 14,448 | 3.4 | $ | 34,380 | 8.7 | $ | 6,954 | 1.8 | ||||||||||
Retained earnings - beginning of year | 478,847 | 420,160 | 410,979 | 381,840 | 380,145 | ||||||||||||||||||||
Dividends declared | (5,227 | ) | (5,278 | ) | (5,267 | ) | (5,241 | ) | (5,259 | ) | |||||||||||||||
Implementation of new accounting standard | — | 17,433 | — | — | — | ||||||||||||||||||||
Retained earnings - end of year | $ | 509,766 | $ | 478,847 | $ | 420,160 | $ | 410,979 | $ | 381,840 | |||||||||||||||
Net earnings per share: | |||||||||||||||||||||||||
Basic | $ | 1.11 | $ | 1.41 | $ | 0.44 | $ | 1.05 | $ | 0.21 | |||||||||||||||
Diluted | $ | 1.09 | $ | 1.39 | $ | 0.43 | $ | 1.03 | $ | 0.21 | |||||||||||||||
Average basic shares outstanding (000s) | 32,700 | 33,024 | 32,892 | 32,728 | 32,959 | ||||||||||||||||||||
Average diluted shares outstanding (000s) | 33,105 | 33,569 | 33,420 | 33,251 | 33,484 | ||||||||||||||||||||
Cash dividends per share (annualized) | $ | 0.16 | $ | 0.16 | $ | 0.16 | $ | 0.16 | $ | 0.16 | |||||||||||||||
Capital expenditures | $ | 21,733 | $ | 28,488 | $ | 18,094 | $ | 20,500 | $ | 9,723 | |||||||||||||||
Depreciation and amortization | $ | 24,619 | $ | 22,514 | $ | 20,674 | $ | 18,992 | $ | 16,254 | |||||||||||||||
Financial Position at Year End | |||||||||||||||||||||||||
Current assets | $ | 237,478 | $ | 239,359 | $ | 233,609 | $ | 215,707 | $ | 245,954 | |||||||||||||||
Current liabilities | 96,948 | 103,993 | 102,412 | 98,129 | 94,620 | ||||||||||||||||||||
Current ratio | 2.4 to 1 | 2.3 to 1 | 2.3 to 1 | 2.2 to 1 | 2.5 to 1 | ||||||||||||||||||||
Working capital | 140,530 | 135,366 | 131,197 | 117,587 | 151,334 | ||||||||||||||||||||
Inventories | 42,237 | 43,486 | 36,596 | 28,652 | 24,600 | ||||||||||||||||||||
Net property, plant and equipment | 105,038 | 99,401 | 88,247 | 82,111 | 69,872 | ||||||||||||||||||||
Total assets | 643,354 | 548,341 | 539,696 | 517,697 | 483,373 | ||||||||||||||||||||
Long-term debt | 99,700 | 50,000 | 76,300 | 89,100 | 90,700 | ||||||||||||||||||||
Long-term obligations, including long-term debt | 141,187 | 66,419 | 93,479 | 101,686 | 107,099 | ||||||||||||||||||||
Shareholders' equity | 405,219 | 377,929 | 343,805 | 317,882 | 281,654 | ||||||||||||||||||||
Common shares outstanding (000s) | 32,472 | 32,751 | 32,938 | 32,762 | 32,548 | ||||||||||||||||||||
Equity (book value) per share | $ | 12.48 | $ | 11.54 | $ | 10.44 | $ | 9.70 | $ | 8.65 | |||||||||||||||
Stock price range | 25.10-33.95 | 24.07-39.20 | 19.30-28.35 | 12.87-24.80 | 15.30-20.25 | ||||||||||||||||||||
Certain acquisitions, divestitures, closures of operations or product lines, and certain accounting reclassifications affect the comparability of information contained in the "Five-Year Summary."
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
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 within these categories.
We manufacture sensors, actuators, and electronic 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.
Results of Operations: Year Ended December 31, 2019, versus Year Ended December 31, 2018
(Amounts in thousands, except percentages and per share amounts):
The following table highlights changes in significant components of the Consolidated Statements of Earnings for the years ended December 31, 2019, and December 31, 2018:
Years Ended December 31, | Percent of Net Sales | |||||||||||
2019 | 2018 | Percent Change | 2019 | 2018 | ||||||||
Net sales | $ | 468,999 | $ | 470,483 | (0.3 | ) | 100.0 | 100.0 | ||||
Cost of goods sold | 311,424 | 305,510 | 1.9 | 66.4 | 64.9 | |||||||
Gross margin | 157,575 | 164,973 | (4.5 | ) | 33.6 | 35.1 | ||||||
Selling, general and administrative expenses | 70,408 | 73,569 | (4.3 | ) | 15.0 | 15.6 | ||||||
Research and development expenses | 25,967 | 25,304 | 2.6 | 5.5 | 5.4 | |||||||
Restructuring charges | 7,448 | 5,062 | 47.1 | 1.6 | 1.1 | |||||||
(Gain) on sale of assets | (63 | ) | — | — | — | — | ||||||
Total operating expenses | 103,760 | 103,935 | (0.2 | ) | 22.1 | 22.1 | ||||||
Operating earnings | 53,815 | 61,038 | (11.8 | ) | 11.5 | 13.0 | ||||||
Other (expense) income, net | (3,549 | ) | (2,935 | ) | 20.9 | (0.8 | ) | (0.6 | ) | |||
Earnings before income tax | 50,266 | 58,103 | (13.5 | ) | 10.7 | 12.4 | ||||||
Income tax expense | 14,120 | 11,571 | 22.0 | 3.0 | 2.5 | |||||||
Net earnings | $ | 36,146 | $ | 46,532 | (22.3 | ) | 7.7 | 9.9 | ||||
Diluted earnings per share: | ||||||||||||
Diluted net earnings per share | $ | 1.09 | $ | 1.39 | ||||||||
Sales were $468,999 for the year ended December 31, 2019, a decrease of $1,484, or 0.3% from 2018. Sales to transportation markets decreased $1,119 or 0.4%. Sales to other markets decreased $364 or 0.2%. The QTI acquisition, which was completed in July 2019, added $9,252 in sales for the year (see Note 19). Changes in foreign exchange rates decreased sales by $5,135 year-over-year due to the U.S. Dollar appreciating compared to the Chinese Renminbi and Euro.
Gross margin as a percent of sales was 33.6% in 2019 versus 35.1% in 2018. The decrease in gross margin was driven primarily by lower volume, foundry inefficiency in our ceramics manufacturing operations, labor and commodity cost increases, a one-time purchase accounting step-up in the value of finished goods inventory acquired with our QTI acquisition, and an unfavorable impact from currency movements. These were partially offset by cost improvement projects as well as savings from our manufacturing transition project.
Selling, general and administrative ("SG&A") expenses were $70,408, or 15.0% of sales for the year ended December 31, 2019, versus $73,569 or 15.6% of sales in the comparable period of 2018. The 2019 SG&A costs include amortization of intangibles and other operating costs associated with the QTI acquisition as well as higher environmental expenses, which were offset by
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lower short-term incentive compensation, the impact of cost reduction actions taken in the fourth quarter, and other cost controls during the year.
Research and development expenses were $25,967 or 5.5% of sales in 2019 compared to $25,304 or 5.4% of sales in 2018.
Restructuring charges were $7,448 for year ended December 31, 2019. The charges were mainly for building and equipment relocation, severance, and asset impairment charges related to the restructuring of certain operations, as well as a lease termination fee related to a property lease we acquired in the QTI acquisition. Restructuring charges were $5,062 in 2018.
Operating earnings were $53,815, or 11.5% of sales in 2019, compared to $61,038, or 13.0% of sales in 2018 as a result of the items discussed above.
Other income and expense items are summarized in the following table:
Years Ended December 31, | ||||||
2019 | 2018 | |||||
Interest expense | $ | (2,648 | ) | $ | (2,085 | ) |
Interest income | 1,737 | 1,826 | ||||
Other (expense) income | (2,638 | ) | (2,676 | ) | ||
Total other (expense) income, net | $ | (3,549 | ) | $ | (2,935 | ) |
Interest expense increased mainly as a result of an increase in debt related to the QTI acquisition. Other expense in 2019 was principally driven by foreign currency translation losses, mainly due to the appreciation of the U.S. Dollar compared to the Chinese Renminbi and Euro, as well as an increase in pension expense.
Years Ended December 31, | ||||
2019 | 2018 | |||
Effective tax rate | 28.1 | % | 19.9 | % |
The effective income tax rate in 2019 was 28.1% compared to 19.9% in the prior year. The tax rate in 2019 was higher than the U.S. statutory federal tax rate primarily due to foreign earnings that are taxed at higher rates, the impact of taxes on unremitted earnings and unfavorable increases to reserves. The tax rate in 2018 was favorably impacted by a one-time rate change benefit related to the Tax Cuts and Jobs Act of 2017 resulting from the election of tax accounting method changes to accelerate deductions on the 2017 tax return, partially offset by a one-time withholding tax on repatriation of earnings from one of our foreign subsidiaries that was completed during the year to enable the use of tax credits due to expire in 2018.
Net earnings were $36,146 or $1.09 per diluted share for the year ended December 31, 2019, compared to earnings of $46,532 or $1.39 per diluted share in the comparable period of 2018.
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Results of Operations: Years Ended December 31, 2018, versus Year Ended December 31, 2017
(Amounts in thousands, except percentages and per share amounts):
The following table highlights changes in significant components of the Consolidated Statements of Earnings for the years ended December 31, 2018, and December 31, 2017:
Years Ended December 31, | Percent of Net Sales | ||||||||||
2018 | 2017 | Percent Change | 2018 | 2017 | |||||||
Net sales | $ | 470,483 | $ | 422,993 | 11.2 | 100.0 | 100.0 | ||||
Cost of goods sold | 305,510 | 282,562 | 8.1 | 64.9 | 66.8 | ||||||
Gross margin | 164,973 | 140,431 | 17.5 | 35.1 | 33.2 | ||||||
Selling, general and administrative expenses | 73,569 | 71,943 | 2.3 | 15.6 | 17.0 | ||||||
Research and development expenses | 25,304 | 25,146 | 0.6 | 5.4 | 5.9 | ||||||
Restructuring charges | 5,062 | 4,139 | 22.3 | 1.1 | 1.0 | ||||||
Loss on sale of assets | — | 708 | (100.0 | ) | — | 0.2 | |||||
Total operating expenses | 103,935 | 101,936 | 2.0 | 22.1 | 24.1 | ||||||
Operating earnings | 61,038 | 38,495 | 58.6 | 13.0 | 9.1 | ||||||
Other income (expense), net | (2,935 | ) | 1,758 | (267.0 | ) | (0.6 | ) | 0.4 | |||
Earnings before income tax | 58,103 | 40,253 | 44.3 | 12.4 | 9.5 | ||||||
Income tax expense | 11,571 | 25,805 | (55.2 | ) | 2.5 | 6.1 | |||||
Net earnings | $ | 46,532 | $ | 14,448 | 222.1 | 9.9 | 3.4 | ||||
Diluted earnings per share: | |||||||||||
Diluted net earnings per share | $ | 1.39 | $ | 0.43 | |||||||
Sales were $470,483 for the year ended December 31, 2018, an increase of $47,490, or 11.2% from 2017. Sales to transportation markets increased $24,873 or 9.0%. Sales to other end markets increased $22,617 or 15.3%. The Noliac acquisition added $9,463 in sales in 2018 and $7,084 in sales in 2017. Changes in foreign exchange rates increased sales by $3,238 year-over-year due to the U.S. Dollar depreciating compared to the Chinese Renminbi and Euro.
Gross margin as a percent of sales was 35.1% in 2018 versus 33.2% in 2017. The pension settlement charge recorded in the fourth quarter of 2017 impacted gross margin unfavorably by $4,796, or 1.1% of sales. The increase in gross margin was primarily driven by savings related to product line transfers and a favorable impact of foreign exchange rate movements which were partially offset by material cost increases.
Selling, general and administrative expenses were $73,569, or 15.6% of sales for the year ended December 31, 2018, versus $71,943 or 17.0% of sales in the comparable period of 2017. The pension settlement charge recorded in the fourth quarter of 2017 impacted selling, general and administrative expenses unfavorably by $6,557 or 1.6% of sales. The increase includes higher stock-based compensation and ERP implementation costs as well as incremental costs resulting from the Noliac acquisition in 2017, including amortization of intangibles.
Research and development expenses were $25,304 or 5.4% of sales in 2018 compared to $25,146 or 5.9% of sales in 2017. The pension settlement charge recorded in the fourth quarter of 2017 impacted research and development expenses unfavorably by $2,062, or 0.5% of sales. Research and development expenses are focused on expanded applications of existing products, new product development, and enhancements for current products and processes.
Restructuring charges were $5,062 for year ended December 31, 2018. The charges were mainly for building and equipment relocation, severance, and travel costs related to the restructuring of certain operations as part of the 2016 Restructuring Plan. Restructuring charges were $4,139 in 2017.
The loss on sale of assets in 2017 was driven by a loss on the sale of vacant land at our Hopkinton, Massachusetts facility in September 2017.
Operating earnings were $61,038, or 13.0% of sales in 2018, compared to $38,495, or 9.1% of sales in 2017 as a result of the items discussed above.
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Other income and expense items are summarized in the following table:
Years Ended December 31, | ||||||
2018 | 2017 | |||||
Interest expense | $ | (2,085 | ) | $ | (3,343 | ) |
Interest income | 1,826 | 1,284 | ||||
Other (expense) income | (2,676 | ) | 3,817 | |||
Total other (expense) income, net | $ | (2,935 | ) | $ | 1,758 | |
Interest expense decreased in the year ended December 31, 2018, versus the same period in 2017 primarily due to lower debt balances, a reduction in interest related to interest rate swaps, and a one-time charge related to a liability that was settled in 2017. Interest income increased due to higher interest rates. Other expense in the year ended December 31, 2018, was driven by foreign currency translation losses mainly due to the appreciation of the U.S. Dollar compared to the Chinese Renminbi and the Euro. Other income in the year ended December 31, 2017 was driven mainly by foreign currency translation gains due to the depreciation of the U.S. Dollar compared to the Chinese Renminbi and the Euro.
Years Ended December 31, | ||||
2018 | 2017 | |||
Effective tax rate | 19.9 | % | 64.1 | % |
The effective income tax rate in 2018 was 19.9% compared to 64.1% in the prior year. The tax rate in 2018 was favorably impacted by a discrete one-time rate change benefit related to the Tax Act resulting from the election of tax accounting method changes, partially offset by a one-time withholding tax on repatriation of earnings from one of our foreign subsidiaries that was completed during the year to enable the use of tax credits due to expire in 2018. The tax rate in 2017 was unfavorably impacted by the application of the Tax Act, driven by the remeasurement of the net deferred tax assets from 35% to 21% and the one-time mandatory transition tax on the historical earnings of foreign affiliates, which resulted in a net non-cash charge of $18,001.
Net earnings were $46,532 or $1.39 per diluted share for the year ended December 31, 2018, compared to earnings of $14,448 or $0.43 per diluted share in the comparable period of 2017.
Liquidity and Capital Resources
Cash and cash equivalents were $100,241 at December 31, 2019, and $100,933 at December 31, 2018, of which $98,309 and $96,762, respectively, were held outside the United States. The decrease in cash and cash equivalents of $692 was primarily driven by cash generated from operating activities of $64,405 and net proceeds from an increase in borrowings of long-term debt of $49,700, which were offset by the payment for the QTI acquisition of $73,906, capital expenditures of $21,733, treasury stock purchases of $11,746, dividends paid of $5,238, and taxes paid on behalf of equity award participants of $2,657. Total debt as of December 31, 2019, and December 31, 2018, was $99,700 and $50,000, respectively. Total debt as a percentage of total capitalization, defined as long-term debt as a percentage of total debt and shareholders’ equity, was 19.7% at December 31, 2019, compared to 11.7% at December 31, 2018.
Working capital increased by $5,164 from December 31, 2018, to December 31, 2019, driven mainly by the decrease in accrued payroll and benefits due to lower short-term incentive compensation and the decrease in accounts payable, which were partially offset by an increase in operating lease obligations.
Cash Flows from Operating Activities
Net cash provided by operating activities was $64,405 during the year ended December 31, 2019. Components of net cash provided by operating activities included net earnings of $36,146, depreciation and amortization expense of $24,619, stock-based compensation of $5,015, other net non-cash items totaling $5,160, and a net cash outflow from changes in assets and liabilities of $6,535.
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Cash Flows from Investing Activities
Net cash used in investing activities for the year ended December 31, 2019, was $95,502, driven by the payment for the QTI acquisition of $73,906 and capital expenditures of $21,733.
Cash Flows from Financing Activities
Net cash provided by financing activities for the year ended December 31, 2019, was $30,059. The net cash inflow was the result of net proceeds from an increase in borrowings of long-term debt of $49,700, which was partially offset by treasury stock purchases of $11,746, dividend payments of $5,238, and taxes paid on behalf of equity award participants of $2,657.
Capital Resources
Long-term debt was comprised of the following:
As of December 31, | ||||||
2019 | 2018 | |||||
Total credit facility | $ | 300,000 | $ | 300,000 | ||
Balance Outstanding | $ | 99,700 | $ | 50,000 | ||
Standby letters of credit | $ | 1,800 | $ | 1,940 | ||
Amount available | $ | 198,500 | $ | 248,060 | ||
Weighted-average interest rate | 3.25 | % | 3.10 | % | ||
Commitment fee percentage per annum | 0.23 | % | 0.20 | % | ||
On February 12, 2019, we entered into 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. This new unsecured credit facility replaces the prior $300,000 unsecured credit facility, which would have expired August 10, 2020. Borrowings of $50,000 under the prior credit agreement were refinanced into the Credit Agreement. The prior agreement was terminated as of February 12, 2019.
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 the our total leverage ratio.
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, and debt service 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 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.
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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% to 2.4% 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 significant 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 creditworthiness, |
• | 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 upon historical experience and specific customer collection issues. Over the last three years, accounts receivable reserves have ranged from 0.1% to 0.7% 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.
Inventories
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 forecasts of product demand and production requirements.
Over the last three years, our reserves for excess and obsolete inventories have ranged from 10.2% to 18.4% 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.
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:
CTS CORPORATION 23
• | 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, operating expenses, working capital investment, capital expenditures, and cash flows over a multi-year period. 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 qualitative approach as of October 1, 2019, 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 decline in market capitalization relative to net book value, |
• | Significant underperformance 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, |
• | 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. No indicators of impairment were identified during the year ended December 31, 2019.
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.
CTS CORPORATION 24
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.
Generally, outside of Canada and the United Kingdom, it has been our historical practice to permanently reinvest the earnings of our non-U.S. subsidiaries in those operations. As previously noted, the Tax Act made significant changes to the taxation of undistributed foreign earnings, requiring that all previously untaxed earnings and profits of our controlled foreign corporation be subjected to a one-time mandatory deemed repatriation tax. The transition tax substantially eliminated the basis difference that existed prior to the Tax Act. However, there are limited other taxes that could continue to apply such as foreign withholding and certain state taxes. We completed the evaluation of our indefinite reinvestment assertion as a result of the Tax Act during the fourth quarter of 2018 and decided not to reinvest the current year earnings of our primary operations, except for in the Czech Republic, Denmark, India, Mexico and Taiwan. We intend to continue to indefinitely reinvest the earnings in these non-U.S. subsidiaries.
Contractual Obligations
Our contractual obligations as of December 31, 2019, were:
Payments due by period | |||||||||||||||
Total | 2020 | 2021-2022 | 2023-2024 | 2025-beyond | |||||||||||
Long-term debt, including interest | $ | 111,586 | $ | 2,807 | $ | 5,876 | $ | 102,903 | $ | — | |||||
Operating lease payments | 37,610 | 4,467 | 8,764 | 7,813 | 16,566 | ||||||||||
Retirement obligations | 6,447 | 757 | 1,429 | 1,328 | 2,933 | ||||||||||
Total | $ | 155,643 | $ | 8,031 | $ | 16,069 | $ | 112,044 | $ | 19,499 | |||||
We have no off-balance sheet arrangements that have a material current effect or are reasonably likely to have a material future effect on our financial condition or changes in our financial condition.
Management believes that existing capital resources and funds generated from operations are sufficient to finance anticipated capital requirements.
CTS CORPORATION 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
(in thousands)
Our cash flows and earnings are subject to fluctuations resulting from changes in foreign currency exchange rates and interest rates. We manage our exposure to these market risks through internally established policies and procedures and, when deemed appropriate, through the use of derivative financial instruments. Our policies do not allow speculation in derivative instruments for profit or execution of derivative instrument contracts for which there are no underlying exposures. We do not use financial instruments for trading purposes and we are not a party to any leveraged derivatives. We monitor our underlying market risk exposures on an ongoing basis and believe that we can modify or adapt our hedging strategies as needed.
Interest Rate Risk
We are exposed to risk of changes in interest rates on our revolving credit facility. There was $99,700 and $50,000 outstanding under our revolving credit facility at December 31, 2019, and 2018, respectively. As of December 31, 2019, we had interest rate swaps that fix interest costs on $50,000 of our long-term debt through February 2024.
Foreign Currency Risk
We are exposed to foreign currency exchange rate risks. Our significant foreign subsidiaries are located in China, Czech Republic, Mexico, and Taiwan. As of December 31, 2019, we had foreign currency forward contracts outstanding with a notional value of $8,011 to hedge our exposure against the Mexican Peso.
Commodity Price Risk
Many of our products require the use of raw materials that are produced in only a limited number of regions around the world or are available from only a limited number of suppliers. Our results of operations may be materially and adversely affected if we have difficulty obtaining these raw materials, the quality of available raw materials deteriorates, or there are significant price increases for these raw materials. For periods in which the prices of these raw materials are rising, we may be unable to pass on the increased cost to our customers, which would result in decreased margins for the products in which they are used. For periods in which the prices are declining, we may be required to write down our inventory carrying cost of these raw materials, since we record our inventory at the lower of cost or net realizable value.
Public Health Risk
The coronavirus outbreak is adversely affecting our business. We and some of our suppliers and customers have facilities that were required by Chinese authorities to remain closed for a period of time following the Lunar New Year holiday, and when permitted to reopen, employees have been limited in their ability to return to work due to governmental restrictions. The consequences of the outbreak, and the actions taken to limit its spread, will adversely affect our sales and results of operations in the first quarter of 2020, and possibly longer if coronavirus consequences continue.
CTS CORPORATION 26
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
CTS Corporation
Opinion on the financial statements
We have audited the accompanying consolidated balance sheets of CTS Corporation (an Indiana corporation) and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of earnings, comprehensive earnings, changes in shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and financial statement schedules included under Item 15(a) (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with accounting principles generally accepted in the United States of America.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 20, 2020 expressed an unqualified opinion.
Change in accounting principle
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for operating leases as of January 1, 2019 due to the adoption of ASU 2016-02, Leases (Topic 842).
Basis for opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical audit matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Acquisition of Quality Thermistor, Inc.
As described further in Note 19 to the financial statements, the Company acquired Quality Thermistor, Inc. (QTI) on July 31, 2019 for a total purchase price of $75 million. Accordingly, the purchase price was allocated to the assets acquired and liabilities assumed based on their respective fair values, including identified intangible assets of approximately $33 million, which is primarily comprised of customer relationships of $31 million. The Company estimated the fair value of the customer relationships using the multi-period excess earnings method, which is an income approach that required management to make significant estimates and assumptions related to future revenues and cash flows and the selection of the discount rate. We identified the measurement of the acquisition-date fair value of the acquired customer relationships as a critical audit matter.
CTS CORPORATION 27
The principal consideration for our determination that the acquisition-date fair value of the customer relationships is a critical audit matter was the evaluation required a high degree of estimation uncertainty in determining the following internally developed assumptions for which there was limited observable market information: 1) forecasted revenue growth rates for existing customers, 2) estimated customer attrition rate, and 3) the discount rate.
Our audit procedures related to the critical audit matter included the following, among others:
• | Tested certain internal controls over the Company’s acquisition-date valuation process, including controls over the development of the key assumptions such as the forecasted revenues, customer attrition rate, and the discount rate. |
• | Evaluated the Company’s forecasted revenue growth rates for existing customers by comparing the forecasted growth assumptions to peer and historical results. |
• | Tested the Company’s selected customer attrition rate by comparing it to QTI’s historical customer attrition data. |
• | Assessed the Company’s discount rate by comparing it against a discount rate range that was independently developed using a publicly available market data for comparable peers and performing a sensitivity analysis based on that data. |
Specialists were utilized in evaluating significant assumptions, including the customer attrition rate and discount rate.
/s/ GRANT THORNTON LLP
We have served as the Company’s auditor since 2005.
Chicago, Illinois
February 20, 2020
CTS CORPORATION 28
CTS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Earnings
(in thousands)
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Net sales | $ | $ | $ | ||||||
Cost of goods sold | |||||||||
Gross margin | |||||||||
Selling, general and administrative expenses | |||||||||
Research and development expenses | |||||||||
Restructuring charges | |||||||||
(Gain) loss on sale of assets | ( | ) | |||||||
Operating earnings | |||||||||
Other (expense) income: | |||||||||
Interest expense | ( | ) | ( | ) | ( | ) | |||
Interest income | |||||||||
Other (expense) income | ( | ) | ( | ) | |||||
Total other (expense) income, net | ( | ) | ( | ) | |||||
Earnings before taxes | |||||||||
Income tax expense | |||||||||
Net earnings | $ | $ | $ | ||||||
Net earnings per share: | |||||||||
Basic | |||||||||
Diluted | |||||||||
Basic weighted-average common shares outstanding | |||||||||
Effect of dilutive securities | |||||||||
Diluted weighted-average common shares outstanding | |||||||||
Cash dividends declared per share | $ | $ | $ | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
CTS CORPORATION 29
CTS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Comprehensive Earnings
(in thousands)
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Net earnings | $ | $ | $ | ||||||
Other comprehensive earnings (loss): | |||||||||
Changes in fair market value of derivatives, net of tax | ( | ) | |||||||
Changes in unrealized pension cost, net of tax | ( | ) | |||||||
Cumulative translation adjustment, net of tax | ( | ) | |||||||
Other comprehensive earnings (loss) | $ | $ | ( | ) | $ | ||||
Comprehensive earnings | $ | $ | $ | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
CTS CORPORATION 30
CTS CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands)
December 31, | ||||||
2019 | 2018 | |||||
ASSETS | ||||||
Current Assets | ||||||
Cash and cash equivalents | $ | $ | ||||
Accounts receivable, net | ||||||
Inventories, net | ||||||
Other current assets | ||||||
Total current assets | ||||||
Property, plant and equipment, net | ||||||
Operating lease assets, net | ||||||
Other assets | ||||||
Prepaid pension asset | ||||||
Goodwill | ||||||
Other intangible assets, net | ||||||
Deferred income taxes | ||||||
Other assets | ||||||
Total other assets | ||||||
Total Assets | $ | $ | ||||
LIABILITIES AND SHAREHOLDERS' EQUITY | ||||||
Current Liabilities | ||||||
Accounts payable | $ | $ | ||||
Operating lease obligations | ||||||
Accrued payroll and benefits | ||||||
Accrued expenses and other liabilities | ||||||
Total current liabilities | ||||||
Long-term debt | ||||||
Long-term operating lease obligations | ||||||
Long-term pension obligations | ||||||
Deferred income taxes | ||||||
Other long-term obligations | ||||||
Total Liabilities | ||||||
Commitments and Contingencies (Note 10) | ||||||
Shareholders' Equity | ||||||
Common stock | ||||||
Additional contributed capital | ||||||
Retained earnings | ||||||
Accumulated other comprehensive loss | ( | ) | ( | ) | ||
Total shareholders' equity before treasury stock | ||||||
Treasury stock | ( | ) | ( | ) | ||
Total shareholders' equity | ||||||
Total Liabilities and Shareholders' Equity | $ | $ | ||||
The accompanying notes are an integral part of the consolidated financial statements.
CTS CORPORATION 31
CTS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Cash flows from operating activities: | |||||||||
Net earnings | $ | $ | $ | ||||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||||
Depreciation and amortization | |||||||||
Stock-based compensation | |||||||||
Restructuring and impairment charges | |||||||||
Pension and other post-retirement plan expense | |||||||||
Deferred income taxes | ( | ) | |||||||
(Gain) loss on sale of assets | ( | ) | |||||||
Loss (gain) on foreign currency hedges, net of cash received | ( | ) | |||||||
Changes in assets and liabilities, net of acquisitions and divestitures: | |||||||||
Accounts receivable | ( | ) | ( | ) | |||||
Inventories | ( | ) | ( | ) | |||||
Other assets | ( | ) | ( | ) | ( | ) | |||
Operating lease assets | ( | ) | |||||||
Accounts payable | ( | ) | |||||||
Accrued payroll and benefits | ( | ) | ( | ) | |||||
Accrued expenses and other liabilities | ( | ) | ( | ) | |||||
Income taxes payable | ( | ) | |||||||
Operating lease liabilities | |||||||||
Other liabilities | ( | ) | |||||||
Pension and other post-retirement plans | ( | ) | ( | ) | ( | ) | |||
Total adjustments | |||||||||
Net cash provided by operating activities | |||||||||
Cash flows from investing activities: | |||||||||
Capital expenditures | ( | ) | ( | ) | ( | ) | |||
Proceeds from sale of assets | |||||||||
Payments for acquisitions, net of cash acquired | ( | ) | ( | ) | |||||
Net cash used in investing activities | ( | ) | ( | ) | ( | ) | |||
Cash flows from financing activities: | |||||||||
Payments of long-term debt | ( | ) | ( | ) | ( | ) | |||
Proceeds from borrowings of long-term debt | |||||||||
Payments of short-term notes payable | ( | ) | |||||||
Purchase of treasury stock | ( | ) | ( | ) | |||||
Dividends paid | ( | ) | ( | ) | ( | ) | |||
Taxes paid on behalf of equity award participants | ( | ) | ( | ) | ( | ) | |||
Net cash provided by (used) in financing activities | ( | ) | ( | ) | |||||
Effect of exchange rate on cash and cash equivalents | ( | ) | |||||||
Net decrease in cash and cash equivalents | ( | ) | ( | ) | ( | ) | |||
Cash and cash equivalents at beginning of year | |||||||||
Cash and cash equivalents at end of year | $ | $ | $ | ||||||
Supplemental cash flow information: | |||||||||
Cash paid for interest | $ | $ | $ | ||||||
Cash paid for income taxes, net | $ | $ | $ | ||||||
Non-cash investing and financing activities: | |||||||||
Capital expenditures incurred not paid | $ | $ | $ | ||||||
The accompanying notes are an integral part of the consolidated financial statements.
CTS CORPORATION 32
CTS CORPORATION AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
(in thousands)
Common Stock | Additional Contributed Capital | Retained Earnings | Accumulated Other Comprehensive Earnings/(Loss) | Treasury Stock | Total | |||||||||||||
Balances at January 1, 2017 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
Net earnings | — | — | — | — | ||||||||||||||
Changes in fair market value of derivatives, net of tax | — | — | — | — | ||||||||||||||
Changes in unrealized pension cost, net of tax | — | — | — | — | ||||||||||||||
Cumulative translation adjustment, net of tax | — | — | — | — | ||||||||||||||
Cash dividends of $0.16 per share | — | — | ( | ) | — | — | ( | ) | ||||||||||
Issued shares on vesting of restricted stock units | ( | ) | — | — | — | ( | ) | |||||||||||
Stock compensation | — | — | — | — | ||||||||||||||
Balances at December 31, 2017 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
Net earnings | — | — | — | — | ||||||||||||||
Changes in fair market value of derivatives, net of tax | — | — | — | — | ||||||||||||||
Changes in unrealized pension cost, net of tax | — | — | — | ( | ) | — | ( | ) | ||||||||||
Cumulative translation adjustment, net of tax | — | — | — | ( | ) | — | ( | ) | ||||||||||
Cash dividends of $0.16 per share | — | — | ( | ) | — | — | ( | ) | ||||||||||
Acquired 342,100 shares of treasury stock | — | — | — | — | ( | ) | ( | ) | ||||||||||
Issued shares on vesting of restricted stock units | ( | ) | — | — | — | ( | ) | |||||||||||
Implementation of ASU No. 2018-02 | — | — | ( | ) | — | |||||||||||||
Stock compensation | — | — | — | — | ||||||||||||||
Balances at December 31, 2018 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
Net earnings | — | — | — | — | ||||||||||||||
Changes in fair market value of derivatives, net of tax | — | — | — | ( | ) | — | ( | ) | ||||||||||
Changes in unrealized pension cost, net of tax | — | — | — | — | ||||||||||||||
Cumulative translation adjustment, net of tax | — | — | — | — | ||||||||||||||
Cash dividends of $0.16 per share | — | — | ( | ) | — | — | ( | ) | ||||||||||
Acquired 420,770 shares for treasury stock | — | — | — | — | ( | ) | ( | ) | ||||||||||
Issued shares on vesting of restricted stock units | ( | ) | — | — | — | ( | ) | |||||||||||
Stock compensation | — | — | — | — | ||||||||||||||
Balances at December 31, 2019 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
The accompanying notes are an integral part of the consolidated financial statements.
CTS CORPORATION 33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(in thousands, except for share and per share data)
NOTE 1 — Summary of Significant Accounting Policies
Description of Business: CTS Corporation ("CTS", "we", "our", "us" or the "Company") is a global manufacturer of sensors, electronic components, and actuators operating as a single reportable business segment. We operate manufacturing facilities located throughout North America, Asia and Europe and service major markets globally.
Principles of Consolidation: The consolidated financial statements include the accounts of CTS and its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.
Use of Estimates: The preparation of financial statements in conformity with the accounting principles generally accepted in the United States of America ("U.S. GAAP") 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 reporting period. Actual results could differ materially from those estimates.
Cash and Cash Equivalents: All highly liquid investments with maturities of three months or less at the date of purchase are considered to be cash equivalents.
Accounts Receivable and Allowance for Doubtful Accounts: Accounts receivable consists primarily of amounts due from normal business activities. We maintain an allowance for doubtful accounts for estimated uncollectible accounts receivable. Our reserves for estimated credit losses are based upon historical experience and specific customer collection issues. Accounts are written off against the allowance account when they are determined to no longer be collectible.
Concentration of Credit Risk: Financial instruments that potentially subject us to concentrations of credit risk consist of cash and cash equivalents and trade receivables. Our cash and cash equivalents, at times, may exceed federally insured limits. Cash and cash equivalents are deposited primarily in banking institutions with global operations. We have not experienced any losses in such accounts. We believe we are not exposed to any significant credit risk related to cash and cash equivalents.
Trade receivables subject us to the potential for credit risk with major customers. We sell our products to customers principally in the aerospace and defense, industrial, information technology, medical, telecommunications, and transportation markets, primarily in North America, Europe, and Asia. We perform ongoing credit evaluations of our customers to minimize credit risk. We do not require collateral. The allowance for doubtful accounts is based on management's estimates of the collectability of its accounts receivable after analyzing historical bad debts, customer concentrations, customer creditworthiness, and current economic trends. Uncollectible trade receivables are charged against the allowance for doubtful accounts when all reasonable efforts to collect the amounts due have been exhausted.
Our net sales to significant customers as a percentage of total net sales were as follows:
Years Ended December 31, | |||
2019 | 2018 | 2017 | |
Cummins Inc. | |||
Honda Motor Co. | |||
Toyota Motor Corporation | |||
We sell parts to these three transportation customers for certain vehicle platforms under purchase agreements that have no volume commitments and are subject to purchase orders issued on a periodic basis.
No other customer accounted for 10% or more of total net sales during these periods.
Inventories: We value our inventories at the lower of the actual cost to purchase or manufacture or the net realizable value using the first-in, first-out ("FIFO") method. We review inventory quantities on hand and record a provision for excess and obsolete inventory based on forecasts of product demand and production requirements.
Retirement Plans: We have various defined benefit and defined contribution retirement plans. Our policy is to annually fund the defined benefit pension plans at or above the minimum required by law. We: 1) recognize the funded status of a benefit plan (measured as the difference between plan assets at fair value and the projected benefit obligation) in our Consolidated Balance Sheets; 2) recognize the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit/cost as a component of other comprehensive earnings; and 3) measure defined benefit plan assets and obligations as of the date of our fiscal year-end. See Note 6, "Retirement Plans" for further information.
CTS CORPORATION 34
Property, Plant and Equipment: Property, plant and equipment is stated at cost, less accumulated depreciation. Depreciation is computed primarily over the estimated useful lives of the various classes of assets using the straight-line method. Useful lives for buildings and improvements range from 10 to 45 years, machinery and equipment from 3 to 15 years, and software from 2 to 15 years. Depreciation on leasehold improvements is computed over the lesser of the lease term or estimated useful lives of the assets. Amounts expended for maintenance and repairs are charged to expense as incurred. Upon disposition, any related gains or losses are included in operating earnings.
Income Taxes: We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, we determine deferred tax assets and liabilities on the basis of the differences between the financial statement and tax bases of assets and liabilities by using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
We recognize deferred tax assets to the extent that we believe that these assets are more-likely-than-not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.
We record uncertain tax positions in accordance with Accounting Standards Codification ("ASC") Topic 740 on the basis of a two-step process in which (1) we determine whether it is more-likely-than-not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.
We recognize interest and penalties related to unrecognized tax benefits on the income tax expense line in the accompanying Consolidated Statements of Earnings. Accrued interest and penalties are included in the related tax liability line in the Consolidated Balance Sheets.
See Note 18, "Income Taxes" for further information.
Goodwill and Indefinite-lived Intangible Assets: Goodwill represents the excess of the purchase price over the fair values of the net assets acquired in a business combination. In accordance with ASC 350, Intangibles—Goodwill and Other, goodwill is not amortized, but instead is tested for impairment annually or more frequently if circumstances indicate a possible impairment may exist. Absent any interim indicators of impairment, the Company tests for goodwill impairment as of the first day of its fourth fiscal quarter of each year.
In addition to goodwill, we also have acquired in-process research and development ("IPR&D") intangible assets that are treated as indefinite-lived intangible assets and therefore not subject to amortization until the completion or abandonment of the associated research and development efforts. If these efforts are abandoned in the future, the carrying value of the IPR&D asset will be expensed. If the research and development efforts are successfully completed, the IPR&D will be reclassified as a finite-lived asset and amortized over its useful life.
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.
We completed our annual impairment test during 2019 by performing a qualitative assessment and determined that our goodwill was not impaired as of the measurement date. We have not recorded any impairment of goodwill or other indefinite-lived intangible assets in the years ended December 31, 2019, 2018 and 2017.
Other Intangible Assets and Long-lived Assets: We account for long-lived assets (excluding indefinite-lived intangible assets) in accordance with the provisions of ASC 360, Property, Plant, and Equipment. This statement requires that long-lived assets, which includes fixed assets and finite-lived intangible assets, be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If an impairment test is warranted, recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the sum of the undiscounted cash flows expected to result from the use and the eventual disposition of the asset. If such assets are considered to be impaired, the
CTS CORPORATION 35
impairment to be recognized is measured by the amount in which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Intangible assets (excluding indefinite-lived intangible assets) consist primarily of technology, customer lists and relationships, patents, and trade names. These assets are recorded at cost and usually amortized on a straight-line basis over their estimated lives. We assess useful lives based on the period over which the asset is expected to contribute to cash flows.
We create prototypes and tools related to R&D projects. A prototype is defined as a constructed product not intended for production resulting in a commercial sale. We also incur engineering costs related to R&D activities. Such costs are incurred to support such activities to improve the reliability, performance and cost-effectiveness of our existing products and to design and develop innovative products that meet customer requirements for new applications. Furthermore, we may engage in activities that develop tooling machinery and equipment for our customers.
We occasionally enter into agreements with our customers whereby we receive a contractual guarantee to be reimbursed the costs we incur to construct molds, dies, and other tools that are used to make many of the products we sell. The costs we incur are included in other current assets on the Consolidated Balance Sheets until reimbursement is received from the customer. Reimbursements received from customers are netted against such costs and included in our Consolidated Statements of Earnings if the amount received is in excess of the costs that we incur. The following is a summary of amounts to be received from customers as of December 31, 2019, and 2018:
As of December 31, | ||||||
2019 | 2018 | |||||
Cost of molds, dies and other tools included in other current assets | $ | 7,690 | $ | 5,388 | ||
Financial Instruments: We use forward contracts to mitigate currency risk related to forecasted foreign currency revenue and costs. These forward contracts are designed as cash flow hedges. At least quarterly, we assess the effectiveness of these hedging relationships based on the total change in their fair value using regression analysis. In addition, we use interest rate swaps to convert a portion of our revolving credit facility's variable rate of interest into a fixed rate. As a result of the use of these derivative instruments, the Company is exposed to the risk that counterparties to derivative contracts will fail to meet their contractual obligations. To mitigate the counterparty credit risk, the Company has a policy of only entering into contracts with carefully selected major financial institutions based upon their credit ratings and other factors and by using netting agreements. Our established policies and procedures for mitigating credit risk on principal transactions include reviewing and establishing limits for credit exposure and continually assessing the creditworthiness of counterparties.
We estimate the fair value of our financial instruments as follows:
Instrument | Method for determining fair value | |
Cash, cash equivalents, accounts receivable and accounts payable | Cost, approximates fair value due to the short-term nature of these instruments. | |
Revolving credit facility | 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 credit facility. | |
Interest rate swaps and forward contracts | The fair value of our interest rate swaps and forward contracts are measured using a market approach which uses current industry information. | |
Debt Issuance Costs: 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.
CTS CORPORATION 36
Stock-Based Compensation: We recognize expense related to the fair value of stock-based compensation awards, consisting of restricted stock units ("RSUs"), cash-settled restricted stock units, performance share units ("PSU's"), and stock options, in the Consolidated Statements of Earnings.
We estimate the fair value of stock option awards on the date of grant using the Black-Scholes option pricing model. A number of assumptions are used by the Black-Scholes option pricing model to compute the grant date fair value of an award, including expected price volatility, option term, risk-free interest rate, and dividend yield. These assumptions are established at each grant date based upon current information at that time. Expected volatilities are based on historical volatilities of CTS' common stock. The expected option term is derived from historical data of exercise behavior. Actual option terms can differ from the expected option terms as a result of different groups of employees exhibiting different exercise behavior. The dividend yield is based on historical dividend payments. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve at the time of grant. The fair value of awards that are ultimately expected to vest is recognized as expense over the requisite service periods of the awards in the Consolidated Statements of Earnings.
The grant date fair values of our service-based and performance-based RSUs are the closing price of our common stock on the date of grant. The grant date fair value of our market-based RSUs is determined by using a simulation, or Monte Carlo, approach. Under this approach, stock returns from a comparative group of companies are simulated over the performance period, considering both stock price volatility and the correlation of returns. The simulated results are then used to estimate the future payout based on the performance and payout relationship established by the conditions of the award. The future payout is discounted to the measurement date using the risk-free interest rate.
Both our stock option and RSU awards primarily have a graded vesting schedule. 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. Compensation expense for PSUs is measured by determining the fair value of the award using the closing share price on the grant date and is recognized ratably from the grant date to the vesting date for the number of awards expected to vest. The amount of compensation expense recognized for PSUs is dependent upon a quarterly assessment of the likelihood of achieving the performance conditions and is subject to adjustment based on management's assessment of the Company's performance relative to the target number of shares performance criteria.
See Note 16, "Stock-Based Compensation" for further information.
Earnings Per Share: Basic earnings per share excludes any dilution and is computed by dividing net earnings available to common shareholders by the weighted-average number of common shares outstanding for the period.
Diluted earnings per share is calculated by dividing net earnings by the weighted average shares outstanding assuming dilution. Dilutive common shares outstanding is computed using the Treasury Stock Method and reflects the additional shares that would be outstanding if dilutive stock options were exercised and restricted stock units were settled for common shares during the period. In addition, dilutive shares include any shares issuable related to performance share units for which the performance conditions would have been met as of the end of the period and therefore would be considered contingently issuable. If the common stock equivalents have an anti-dilutive effect, they are excluded from the computation of diluted earnings per share.
Our antidilutive securities consist of the following:
Years Ended December 31, | ||||||
(units) | 2019 | 2018 | 2017 | |||
Antidilutive securities | ||||||
Foreign Currencies: The financial statements of our non-U.S. subsidiaries, except the United Kingdom ("U.K.") subsidiary, are remeasured into U.S. dollars using the U.S. dollar as the functional currency with all remeasurement adjustments included in the determination of net earnings.
Foreign currency (losses) gains recorded in the Consolidated Statement of Earnings includes the following:
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Foreign currency (losses) gains | $ | ( | ) | $ | ( | ) | $ | ||
The assets and liabilities of our U.K. subsidiary are translated into U.S. dollars at the current exchange rate at period end, with the resulting translation adjustments made directly to the "accumulated other comprehensive loss" component of shareholders' equity. Our Consolidated Statement of Earnings accounts are translated at the average rates during the period.
CTS CORPORATION 37
Shipping and Handling: All fees billed to the customer for shipping and handling are classified as a component of net sales. All costs associated with shipping and handling are classified as a component of cost of goods sold or operating expenses, depending on the nature of the underlying purchase.
Sales Taxes: When applicable, we classify sales taxes on a net basis in our consolidated financial statements.
Changes in Accounting Principles: Beginning in January 2019, CTS adopted the provisions of Accounting Standards Update ("ASU") 2016-02, "Leases (Topic 842)" under the optional transition method, which requires, if necessary, a cumulative effect adjustment to the opening balance of retained earnings. The lease liability is based on the present value of minimum lease payments discounted using our secured incremental borrowing rate at the date of adoption. Existing deferred rent liabilities, resulting from our historical practice of using the straight line method for recognizing lease expense, were reclassified upon adoption to reduce the measurement of the lease assets. We elected the package of practical expedients permitted under the transition guidance, which among other things, allows us to carry forward the historical accounting relating to lease identification and classification for existing leases at adoption. Our leases are classified as operating leases and expense is recorded in a manner similar to historical accounting guidance. We have also elected the practical expedient to not separate lease and non-lease components for the majority of our leases and to keep leases with an initial term of 12 months or less off of the balance sheet. Upon adoption we recorded a lease liability of $24,792 and a right of use asset of $22,066 . No adjustment to the opening balance of retained earnings was required.
Recently Issued Accounting Pronouncements
ASU No. 2019-12 "Simplifying the Accounting for Income Taxes"
In December 2019, the Financial Accounting Standards Board (“FASB”) issued 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 GAAP. The guidance is effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. We will adopt this ASU in the first quarter of 2020 and it is not expected to have a material impact on our consolidated financial statements.
ASU No. 2018-14 "Compensation - Retirement Benefits - Defined Benefit Plans - General"
In August 2018, the FASB issued ASU No. 2018-14, "Compensation - Retirement Benefits - Defined Benefit Plans - General." This ASU modifies the disclosure requirements for defined benefit and other postretirement plans. This ASU eliminates certain disclosures associated with accumulated other comprehensive income, plan assets, related parties, and the effects of interest rate basis point changes on assumed health care costs; while other disclosures have been added to address significant gains and losses related to changes in benefit obligations. This ASU also clarifies disclosure requirements for projected benefit and accumulated benefit obligations. The amendments in this ASU are effective for fiscal years ending after December 15, 2020 and for interim periods therein with early adoption permitted. Adoption on a retrospective basis for all periods presented is required. This ASU will impact our financial statement disclosures but will not have an impact on our consolidated financial position, results of operations, or cash flows.
ASU No. 2018-13 "Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement"
In August 2018, the FASB issued ASU No. 2018-13 "Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement". This ASU modified the disclosures related to recurring and nonrecurring fair value measurements. Disclosures related to the transfer of assets between Level 1 and Level 2 hierarchies have been eliminated and various additional disclosures related to Level 3 fair value measurements have been added, modified or removed. This ASU is effective for annual periods beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted upon issuance of the standard for disclosures modified or removed with a delay of adoption of the additional disclosures until their effective date. We will adopt this ASU in the first quarter of 2020 it is not expected to have a material impact on our financial statement disclosures.
ASU No. 2016-16 "Income Taxes (Topic 740) Intra-Entity Transfers of Assets Other Than Inventory"
In October 2016, the FASB issued ASU No. 2016-16, "Intra-Entity Transfers of Assets Other Than Inventory". This ASU is meant to improve the accounting for the income tax effect of intra-entity transfers of assets other than inventory. Currently, U.S. GAAP prohibits the recognition of current and deferred income taxes for intra-entity asset transfers until the asset is sold to a third party. This ASU will now require companies to recognize the income tax effect of an intra-entity asset transfer (other than inventory)
CTS CORPORATION 38
when the transaction occurs. This ASU is effective for public companies, for fiscal years beginning after December 15, 2019 and interim periods within those annual reporting periods. Early adoption is permitted and is to be applied on a modified retrospective basis through a cumulative-effect adjustment to retained earnings as of the beginning of the period of adoption. We will adopt this ASU during the first quarter of 2020 and it is not expected to have a material impact on our financial statements.
ASU 2016-13 "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments"
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which amends the current accounting guidance and requires the measurement of all expected losses based on historical experience, current conditions and reasonable and supportable forecasts. For trade receivables, loans, and other financial instruments, we will be required to use a forward-looking expected loss model rather than the incurred loss model for recognizing credit losses which reflects losses that are probable. The standard will become effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted. Application of the amendments is through a cumulative-effect adjustment to retained earnings as of the effective date. We adopted this ASU on January 1, 2020 and we have determined that it will not have a material impact on our financial statements.
NOTE 2 – Revenue Recognition
The core principle of ASC 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 December 31, 2019 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.
Contract Assets and Liabilities
Contract assets and liabilities included in our Consolidated Balance Sheets are as follows:
As of December 31, | |||||||
2019 | 2018 | ||||||
Contract Assets | |||||||
Prepaid rebates included in Other current assets | $ | $ | |||||
Prepaid rebates included in Other assets | |||||||
Total Contract Assets | $ | $ | |||||
Contract Liabilities | |||||||
Customer discounts and price concessions included in Accrued expenses and other liabilities | $ | ( | ) | $ | ( | ) | |
Customer rights of return included in Accrued expenses and other liabilities | ( | ) | ( | ) | |||
Total Contract Liabilities | $ | ( | ) | $ | ( | ) | |
CTS CORPORATION 39
During the twelve months ended December 31, 2019, we recognized revenues of $256 that was included in contract liabilities at the beginning of the period.
Disaggregated Revenue
The following table presents revenues disaggregated by the major markets we serve:
Twelve Months Ended December 31, | |||||||
2019 | 2018 | ||||||
Transportation | $ | $ | |||||
Industrial | |||||||
Medical | |||||||
Aerospace & Defense | |||||||
Telecom & IT | |||||||
Total | $ | $ | |||||
NOTE 3 — Accounts Receivable
The components of accounts receivable are as follows:
As of December 31, | ||||||
2019 | 2018 | |||||
Accounts receivable, gross | $ | $ | ||||
Less: Allowance for doubtful accounts | ( | ) | ( | ) | ||
Accounts receivable, net | $ | $ | ||||
NOTE 4 — Inventories
Inventories consist of the following:
As of December 31, | ||||||
2019 | 2018 | |||||
Finished goods | $ | $ | ||||
Work-in-process | ||||||
Raw materials | ||||||
Less: Inventory reserves | ( | ) | ( | ) | ||
Inventories, net | $ | $ | ||||
CTS CORPORATION 40
NOTE 5 — Property, Plant and Equipment
Property, plant and equipment is comprised of the following:
As of December 31, | ||||||
2019 | 2018 | |||||
Land and land improvements | $ | $ | ||||
Buildings and improvements | ||||||
Machinery and equipment | ||||||
Less: Accumulated depreciation | ( | ) | ( | ) | ||
Property, plant and equipment, net | $ | $ | ||||
Depreciation expense recorded in the Consolidated Statements of Earnings includes the following:
For the Years Ended | |||||||||
2019 | 2018 | 2017 | |||||||
Depreciation expense | $ | $ | $ | ||||||
NOTE 6 — Retirement Plans
We have a number of noncontributory defined benefit pension plans ("pension plans") covering approximately 3 % of our active employees. Pension plans covering salaried employees provide pension benefits that are based on the employees´ years of service and compensation prior to retirement. Pension plans covering hourly employees generally provide benefits of stated amounts for each year of service.
We also provide post-retirement life insurance benefits for certain retired employees. Domestic employees who were hired prior to 1982 and certain former union employees are eligible for life insurance benefits upon retirement. We fund life insurance benefits through term life insurance policies and intend to continue funding all of the premiums on a pay-as-you-go basis.
We recognize the funded status of a benefit plan in our consolidated balance sheets. The funded status is measured as the difference between plan assets at fair value and the projected benefit obligation. We also recognize, as a component of other comprehensive earnings, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit/cost.
The measurement dates for the pension plans for our U.S. and non-U.S. locations were December 31, 2019, and 2018.
During 2017, we offered certain former vested employees in our U.S. pension plan a one-time option to receive a lump sum distribution of their benefits from pension plan assets. The pension plan made approximately $23,912 in lump sum payments to settle its obligation to these participants. These settlement payments decreased the projected benefit obligation and plan assets by $23,912 , and resulted in a non-cash settlement charge of $13,476 related to unrecognized net actuarial losses that were previously included in accumulated other comprehensive loss. The measurement date of this settlement was December 31, 2017.
In February 2020, the CTS Board of Directors authorized and empowered management to explore termination of our U.S. based pension plans at management's discretion, subject to certain conditions. Management has not yet made a final decision on whether to pursue a plan termination and the potential timing thereof.
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The following table provides a reconciliation of benefit obligation, plan assets, and the funded status of the pension plans for U.S. and non-U.S. locations at the measurement dates.
U.S. Pension Plans | Non-U.S. Pension Plans | ||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||
Accumulated benefit obligation | $ | $ | $ | $ | |||||||||
Change in projected benefit obligation: | |||||||||||||
Projected benefit obligation at January 1 | $ | $ | $ | $ | |||||||||
Service cost | |||||||||||||
Interest cost | |||||||||||||
Benefits paid | ( | ) | ( | ) | ( | ) | ( | ) | |||||
Actuarial loss (gain) | ( | ) | |||||||||||
Foreign exchange impact | ( | ) | |||||||||||
Projected benefit obligation at December 31 | $ | $ | $ | $ | |||||||||
Change in plan assets: | |||||||||||||
Assets at fair value at January 1 | $ | $ | $ | $ | |||||||||
Actual return on assets | ( | ) | |||||||||||
Company contributions | |||||||||||||
Benefits paid | ( | ) | ( | ) | ( | ) | ( | ) | |||||
Foreign exchange impact | ( | ) | |||||||||||
Assets at fair value at December 31 | $ | $ | $ | $ | |||||||||
Funded status (plan assets less projected benefit obligations) | $ | $ | $ | ( | ) | $ | ( | ) | |||||
The measurement dates for the post-retirement life insurance plan were December 31, 2019, and 2018. The following table provides a reconciliation of benefit obligation, plan assets, and the funded status of the post-retirement life insurance plan at those measurement dates.
Post-Retirement Life Insurance Plan | ||||||
2019 | 2018 | |||||
Accumulated benefit obligation | $ | $ | ||||
Change in projected benefit obligation: | ||||||
Projected benefit obligation at January 1 | $ | $ | ||||
Service cost | ||||||
Interest cost | ||||||
Benefits paid | ( | ) | ( | ) | ||
Actuarial loss (gain) | ( | ) | ||||
Projected benefit obligation at December 31 | $ | $ | ||||
Change in plan assets: | ||||||
Assets at fair value at January 1 | $ | $ | ||||
Actual return on assets | ||||||
Company contributions | ||||||
Benefits paid | ( | ) | ( | ) | ||
Other | ||||||
Assets at fair value at December 31 | $ | $ | ||||
Funded status (plan assets less projected benefit obligations) | $ | ( | ) | $ | ( | ) |
The components of the prepaid (accrued) cost of the domestic and foreign pension plans are classified in the following lines in the Consolidated Balance Sheets at December 31:
U.S.Pension Plans | Non-U.S. Pension Plans | ||||||||||||
2019 | 2018 | 2019 | 2018 | ||||||||||
Prepaid pension asset | $ | $ | $ | $ | |||||||||
Accrued expenses and other liabilities | ( | ) | ( | ) | |||||||||
Long-term pension obligations | ( | ) | ( | ) | ( | ) | ( | ) | |||||
Net prepaid (accrued) cost | $ | $ | $ | ( | ) | $ | ( | ) | |||||
CTS CORPORATION 42
The components of the accrued cost of the post-retirement life insurance plan are classified in the following lines in the Consolidated Balance Sheets at December 31:
Post-Retirement Life Insurance Plan | ||||||
2019 | 2018 | |||||
Accrued expenses and other liabilities | $ | ( | ) | $ | ( | ) |
Long-term pension obligations | ( | ) | ( | ) | ||
Total accrued cost | $ | ( | ) | $ | ( | ) |
We have also recorded the following amounts to accumulated other comprehensive loss for the U.S. and non-U.S. pension plans, net of tax:
U.S.Pension Plans | Non-U.S. Pension Plans | ||||||
Unrecognized Loss | Unrecognized Loss | ||||||
Balance at January 1, 2018 | $ | $ | |||||
Amortization of retirement benefits, net of tax | ( | ) | ( | ) | |||
Settlements | |||||||
Net actuarial gain | |||||||
Foreign exchange impact | ( | ) | |||||
Tax impact due to implementation of ASU 2018-02 | |||||||
Balance at January 1, 2019 | $ | $ | |||||
Amortization of retirement benefits, net of tax | ( | ) | ( | ) | |||
Net actuarial (loss) gain | ( | ) | |||||
Foreign exchange impact | |||||||
Balance at December 31, 2019 | $ | $ | |||||
We have recorded the following amounts to accumulated other comprehensive loss for the post-retirement life insurance plan, net of tax:
Unrecognized Gain | |||
Balance at January 1, 2018 | $ | ( | ) |
Amortization of retirement benefits, net of tax | |||
Net actuarial loss | ( | ) | |
Tax impact due to implementation of ASU No. 2018-02 | ( | ) | |
Balance at January 1, 2019 | $ | ( | ) |
Amortization of retirement benefits, net of tax | |||
Net actuarial gain | |||
Balance at December 31, 2019 | $ | ( | ) |
The accumulated actuarial gains and losses included in other comprehensive earnings are amortized in the following manner:
The component of unamortized net gains or losses related to our qualified pension plans is amortized based on the expected future life expectancy of the plan participants (estimated to be approximately 17 years at December 31, 2019), because substantially all of the participants in those plans are inactive. The component of unamortized net gains or losses related to our post-retirement life insurance plan is amortized based on the estimated remaining future service period of the plan participants (estimated to be approximately 4 years at December 31, 2019). The Company uses a market-related approach to value plan assets, reflecting changes in the fair value of plan assets over a five-year period. The variance resulting from the difference between the expected and actual return on plan assets is included in the amortization calculation upon reflection in the market-related value of plan assets.
In 2020, we expect to recognize approximately $6,429 of pre-tax losses included in accumulated other comprehensive loss related to our pension plans and post-retirement life insurance plan, respectively.
The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for those Pension Plans with accumulated benefit obligation in excess of fair value of plan assets is shown below:
CTS CORPORATION 43
As of December 31, | ||||||
2019 | 2018 | |||||
Projected benefit obligation | $ | $ | ||||
Accumulated benefit obligation | $ | $ | ||||
Fair value of plan assets | $ | $ | ||||
Net pension expense (income) includes the following components:
Years Ended December 31, | Years Ended December 31, | ||||||||||||||||||
U.S. Pension Plans | Non-U.S. Pension Plans | ||||||||||||||||||
2019 | 2018 | 2017 | 2019 | 2018 | 2017 | ||||||||||||||
Service cost | $ | $ | $ | $ | $ | $ | |||||||||||||
Interest cost | |||||||||||||||||||
Expected return on plan assets(1) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Amortization of unrecognized loss | |||||||||||||||||||
Settlement loss | |||||||||||||||||||
Net expense (income) | $ | $ | $ | $ | $ | $ | |||||||||||||
Weighted-average actuarial assumptions(2) | |||||||||||||||||||
Benefit obligation assumptions: | |||||||||||||||||||
Discount rate | % | % | % | % | % | % | |||||||||||||
Rate of compensation increase | N/A | N/A | N/A | % | % | % | |||||||||||||
Pension income/expense assumptions: | |||||||||||||||||||
Discount rate | % | % | % | % | % | % | |||||||||||||
Expected return on plan assets(1) | % | % | % | % | % | % | |||||||||||||
Rate of compensation increase | N/A | N/A | N/A | % | % | % | |||||||||||||
(1) | Expected return on plan assets is net of expected investment expenses and certain administrative expenses. |
(2) | 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. |
Net post-retirement expense includes the following components:
Post-Retirement Life Insurance Plan | |||||||||
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Service cost | $ | $ | $ | ||||||
Interest cost | |||||||||
Amortization of unrecognized gain | ( | ) | ( | ) | ( | ) | |||
Net expense | $ | $ | $ | ||||||
Weighted-average actuarial assumptions (1) | |||||||||
Benefit obligation assumptions: | |||||||||
Discount rate | % | % | % | ||||||
Rate of compensation increase | N/A | N/A | N/A | ||||||
Pension income/post-retirement expense assumptions: | |||||||||
Discount rate | % | % | % | ||||||
Rate of compensation increase | N/A | N/A | N/A | ||||||
(1) | 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. |
CTS CORPORATION 44
Our pension plan asset allocation at December 31, 2019, and 2018, and target allocation for 2020 by asset category are as follows:
Target Allocations | Percentage of Plan Assets at December 31, | |||
Asset Category | 2020 | 2019 | 2018 | |
Equity securities | ||||
Debt securities | ||||
Other | ||||
Total | ||||
We employ a liability-driven investment strategy whereby a mix of equity and fixed-income investments are used to pursue a de-risking strategy which over time seeks to reduce interest rate mismatch risk and other risks while achieving a return that matches or exceeds the growth in projected pension plan liabilities. Risk tolerance is established through careful consideration of plan liabilities and funded status. The investment portfolio primarily contains a diversified mix of equity and fixed-income investments. Other assets such as private equity are used modestly to enhance long-term returns while improving portfolio diversification. Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements, and asset/liability studies at regular intervals.
The following table summarizes the fair values of our pension plan assets:
As of December 31, | ||||||
2019 | 2018 | |||||
Equity securities - U.S. holdings(1) | $ | $ | ||||
Equity funds - U.S. holdings(1) (7) | ||||||
Bond funds - government(4) (7) | ||||||
Bond funds - other(5) (7) | ||||||
Real estate(6) (7) | ||||||
Cash and cash equivalents(2) | ||||||
Partnerships(3) | ||||||
Total fair value of plan assets | $ | $ | ||||
The fair values at December 31, 2019, are classified within the following categories in the fair value hierarchy:
Quoted Prices in Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Not Leveled | Total | |||||||||||
Equity securities - U.S. holdings(1) | $ | $ | — | $ | — | $ | — | $ | |||||||
Bond funds - government(4) (7) | — | — | — | ||||||||||||
Bond funds - other(5) (7) | — | — | — | ||||||||||||
Real estate(6) (7) | — | — | — | ||||||||||||
Cash and cash equivalents(2) | — | — | — | ||||||||||||
Partnerships(3) | — | — | — | ||||||||||||
Total | $ | $ | $ | $ | 244,871 | $ | |||||||||
CTS CORPORATION 45
The fair values at December 31, 2018, are classified within the following categories in the fair value hierarchy:
Quoted Prices in Active Markets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Not Leveled | Total | |||||||||||
Equity securities - U.S. holdings(1) | $ | $ | — | $ | — | $ | — | $ | |||||||
Equity funds - U.S.holdings(1) (7) | — | — | — | ||||||||||||
Bond funds - government(4) (7) | — | — | — | ||||||||||||
Bond funds - other(5) (7) | — | — | — | ||||||||||||
Real estate(6) (7) | — | — | — | ||||||||||||
Cash and cash equivalents(2) | — | — | — | ||||||||||||
Partnerships(3) | — | — | — | ||||||||||||
Total | $ | $ | $ | $ | 224,245 | $ | |||||||||
(1) | Comprised of common stocks of companies in various industries. The Pension Plan fund manager may shift investments from value to growth strategies or vice-versa, from small cap to large cap stocks or vice-versa, in order to meet the Pension Plan's investment objectives, which are to provide for a reasonable amount of long-term growth of capital without undue exposure to volatility, and protect the assets from erosion of purchasing power. |
(2) | Comprised of investment grade short-term investment and money-market funds. |
(3) | Comprised of partnerships that invest in various U.S. and international industries. |
(4) | Comprised of long-term government bonds with a minimum maturity of 10 years and zero-coupon Treasury securities ("Treasury Strips") with maturities greater than 20 years. |
(5) | Comprised predominately of investment grade U.S. corporate bonds with maturities greater than 10 years and U.S. high-yield corporate bonds; emerging market debt (local currency sovereign bonds, U.S. dollar-denominated sovereign bonds and U.S. dollar-denominated corporate bonds); and U.S. bank loans. |
(6) | Comprised of investments in securities of U.S. and non-U.S. real estate investment trusts (REITs), real estate operating companies and other companies that are principally engaged in the real estate industry and of investments in global private direct commercial real estate. Investments can be redeemed immediately following the valuation date with a notice of at least fifteen business days before valuation. |
(7) | Comprised of investments that are measured at fair value using the NAV per share practical expedient. In accordance with the provisions of ASC 820-10, these investments have not been classified in the fair value hierarchy. The fair value amount not leveled is presented to allow reconciliation of the fair value hierarchy to total fund pension plan assets. |
The pension plan assets recorded at fair value are measured and classified in a hierarchy for disclosure purposes consisting of three levels based on the observability of inputs available in the marketplace used to measure fair value as discussed below:
• | Level 1: Fair value measurements that are based on quoted prices (unadjusted) in active markets that the pension plan trustees have the ability to access for identical assets or liabilities. Market price data generally is obtained from exchange or dealer markets. |
• | Level 2: Fair value measurements based on inputs other than quoted prices included in Level 1 that are observable for the asset, either directly or indirectly. Level 2 inputs include quoted prices for similar assets in active or inactive markets, and inputs other than quoted prices that are observable for the asset, such as interest rates and yield curves that are observable at commonly quoted intervals. |
• | Level 3: Fair value measurements based on valuation techniques that use significant inputs that are unobservable. |
The table below reconciles the Level 3 partnership assets within the fair value hierarchy:
Amount | |||
Fair value of Level 3 partnership assets at January 1, 2018 | $ | ||
Capital contributions | |||
Realized and unrealized gain | |||
Capital distributions | ( | ) | |
Fair value of Level 3 partnership assets at December 31, 2018 | $ | ||
Capital contributions | |||
Realized and unrealized gain | ( | ) | |
Capital distributions | ( | ) | |
Fair value of Level 3 partnership assets at December 31, 2019 | $ | ||
The partnership fund manager uses a market approach in estimating the fair value of the plan's Level 3 asset. The market approach estimates fair value by first determining the entity's earnings before interest, taxes, depreciation and amortization and then multiplying that value by an estimated multiple. When establishing an appropriate multiple, the fund manager considers recent comparable private company transactions and multiples paid. The entity's net debt is then subtracted from the calculated amount to arrive at an estimated fair value for the entity.
CTS CORPORATION 46
We expect to make $493 of contributions to the U.S. plans and $261 of contributions to the non-U.S. plans during 2020.
The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
U.S. Pension Plans | Non-U.S. Pension Plans | Post-Retirement Life Insurance Plan | |||||||
2020 | $ | $ | $ | ||||||
2021 | |||||||||
2022 | |||||||||
2023 | |||||||||
2024 | |||||||||
2025-2029 | |||||||||
Total | $ | $ | $ | ||||||
Defined Contribution Plans
We sponsor a 401(k) plan that covers substantially all of our U.S. employees. Contributions and costs are generally determined as a percentage of the covered employee's annual salary.
Expenses related to defined contribution plans include the following:
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
401(k) and other defined contribution plan expense | $ | $ | $ | ||||||
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NOTE 7 — Goodwill and Other Intangible Assets
Other Intangible Assets
The following is a summary of the Company’s other intangible assets as of December 31:
As of December 31, 2019 | ||||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Amount | Weighted Average Remaining Amortization Period (in years) | |||||||||
Other intangible assets: | ||||||||||||
Customer lists / relationships | $ | $ | ( | ) | $ | |||||||
Technology and other intangibles | ( | ) | ||||||||||
In process research and development | — | |||||||||||
Other intangible assets, net | $ | $ | ( | ) | $ | |||||||
Amortization expense for the year ended December 31, 2019 | $ | |||||||||||
As of December 31, 2018 | |||||||||
Gross Carrying Amount | Accumulated Amortization | Net Amount | |||||||
Other intangible assets: | |||||||||
Customer lists / relationships | $ | $ | ( | ) | $ | ||||
Technology and other intangibles | ( | ) | |||||||
In process research and development | |||||||||
Other intangible assets, net | $ | $ | ( | ) | $ | ||||
Amortization expense for the year ended December 31, 2018 | $ | ||||||||
Amortization expense for the year ended December 31, 2017 | $ | ||||||||
The estimated amortization expense for the next five years and thereafter is as follows:
Amortization expense | |||
2020 | $ | ||
2021 | |||
2022 | |||
2023 | |||
2024 | |||
Thereafter | |||
Total future amortization expense | $ | ||
Goodwill
Changes in the net carrying value amount of goodwill were as follows:
Total | |||
Goodwill as of December 31, 2017 | $ | ||
Increase from acquisitions | |||
Goodwill as of December 31, 2018 | $ | ||
Increase from acquisition | |||
Goodwill as of December 31, 2019 | $ | ||
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NOTE 8 — Costs Associated with Exit and Restructuring Activities
Restructuring charges are reported as a separate line within operating earnings in the Consolidated Statements of Earnings. Total restructuring charges were:
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Restructuring charges | $ | $ | $ | ||||||
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 ("June 2016 Plan"). Additional organizational changes were also implemented in various other locations. In 2017, we revised this 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. Restructuring charges under this plan, which is substantially complete, were $4,284 , $4,559 , and $4,139 during the years ended December 31, 2019, 2018, and 2017, respectively. The total restructuring liability related to the June 2016 Plan was $233 and $668 at December 31, 2019 and 2018, respectively. Any additional costs related to line movements, equipment charges, and other costs will be expensed as incurred.
The following table displays the restructuring charges associated with the June 2016 Plan as well as a summary of the actual costs incurred through December 31, 2019:
June 2016 Plan | Planned Costs | Actual costs incurred through December 31, 2019 | |||||
Workforce reduction | $ | $ | |||||
Building and equipment relocation | |||||||
Asset impairment charge | |||||||
Other charges (1) | |||||||
Restructuring charges | $ | $ | |||||
(1) Other charges include the effects of currency translation, travel, legal and other charges.
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 ("April 2014 Plan"). These restructuring actions were substantially completed during 2015. Restructuring charges under this plan were $(248 ), $503 , and $0 during the years ended December 31, 2019, 2018, and 2017, respectively. The total restructuring liability related to the April 2014 Plan was $703 and $918 at December 31, 2019 and 2018, respectively.
Other Restructuring Activities
From time to time we incur other restructuring activities that are not part of a formal plan. Beginning in Q3 2019, we incurred restructuring charges of $3,412 for exit and disposal activities at three sites and workforce reduction costs across the company. The remaining restructuring liability associated with these actions was $1,057 at December 31, 2019.
The following table displays the restructuring liability activity for all plans the year ended December 31, 2019:
Restructuring liability at January 1, 2019 | $ | ||
Restructuring charges | |||
Cost paid | ( | ) | |
Other activities (1) | ( | ) | |
Restructuring liability at December 31, 2019 | $ | ||
(1) Other charges include the effects of currency translation, non-cash asset write-downs, travel, legal and other charges.
The total liability of $1,993 is included in Accrued expenses and other liabilities at December 31, 2019.
CTS CORPORATION 49
NOTE 9 — Accrued Expenses and Other Liabilities
The components of accrued expenses and other liabilities are as follows:
As of December 31, | ||||||
2019 | 2018 | |||||
Accrued product-related costs | $ | $ | ||||
Accrued income taxes | ||||||
Accrued property and other taxes | ||||||
Accrued professional fees | ||||||
Contract liabilities | ||||||
Dividends payable | ||||||
Remediation reserves | ||||||
Other accrued liabilities | ||||||
Total accrued expenses and other liabilities | $ | $ | ||||
NOTE 10 — 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.
A roll-forward of remediation reserves included in accrued expenses and other liabilities in the Consolidated Balance Sheets is comprised of the following:
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Balance at beginning of period | $ | $ | $ | ||||||
Remediation expense | |||||||||
Remediation payments | ( | ) | ( | ) | ( | ) | |||
Other activity (1) | ( | ) | |||||||
Balance at end of the period | $ | $ | $ | ||||||
(1) 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 incurred, and provide disclosures for specific claims whenever it is reasonably possible that a material loss may be incurred which cannot be estimated. We have an outstanding warranty claim for which we have not yet determined the root cause of a product performance issue. Testing is ongoing. We are not able to quantify the potential impact on our operations, if any, because we have not yet determined the root cause.
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NOTE 11 — 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.
The operating lease assets and liabilities are adjusted to include the impact of any lease incentives and non-lease components. We have elected not to separate lease and non-lease components, which include taxes and common area maintenance in some of our leases. Variable lease payments that depend on an index or a rate are included in lease payments using the prevailing index or rate in effect at lease commencement.
Options to extend or terminate a lease are included in the lease term when it is reasonably likely that we will exercise that option. We have elected not to record leases with an initial term of 12 months or less on the balance sheet and instead recognize those lease payments on a straight-line basis over the lease term.
We determine if an arrangement is a lease or contains a lease at its inception, which normally does not require significant estimates or judgments. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants and we currently have no material sublease agreements.
Total lease expense for the twelve months ended December 31, 2019 is as follows:
Year Ended December 31, | |||
2019 | |||
Operating lease cost | $ | ||
Short-term lease cost | |||
Total lease cost | $ | ||
Rent expense prior to adoption of ASC 842 was $5,726 and $4,762 for the years ended December 31, 2018 and 2017, respectively.
Future minimum lease payments relating to our existing lease liabilities as of December 31, 2019 is as follows:
Operating Leases(1) | |||
2020 | $ | ||
2021 | |||
2022 | |||
2023 | |||
2024 | |||
Thereafter | |||
Total | $ | ||
Less: interest | ( | ) | |
Present value of lease payments | $ | ||
(1) Operating lease payments include $3,244 of payments related to options to extend lease terms that are reasonably expected to be exercised.
CTS CORPORATION 51
Balance Sheet Classification: | |||
Operating lease obligations | $ | ||
Long-term operating lease obligations | |||
Total lease liabilities | $ | ||
Weighted-average remaining lease terms (years) | |||
Weighted-average discount rate | % | ||
Supplemental cash flow information related to leases: | |||
Cash paid for amounts included in the measurement of lease liabilities | $ | ||
Leased assets obtained in exchange for new operating lease liabilities | $ | ||
NOTE 12 — Debt
Long-term debt was comprised of the following:
As of December 31 | ||||||
2019 | 2018 | |||||
Total credit facility | $ | $ | ||||
Balance outstanding | $ | $ | ||||
Standby letters of credit | $ | $ | ||||
Amount available | $ | $ | ||||
Weighted-average interest rate | % | % | ||||
Commitment fee percentage per annum | % | % | ||||
On February 12, 2019, we entered into 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. This new unsecured credit facility replaces the prior $300,000 unsecured credit facility, which would have expired August 10, 2020. Borrowings of $50,000 under the prior credit agreement were refinanced into the Credit Agreement. The prior agreement was terminated as of February 12, 2019.
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 Revolving Credit Facility 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 in compliance with all debt covenants at December 31, 2019. The Revolving Credit Facility 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, the Revolving Credit Facility contains restrictions limiting our ability to: dispose of assets; incur certain additional debt; repay other debt or amend subordinated debt instruments; create liens on assets; make investments, loans or advances; make acquisitions or engage in mergers or consolidations; engage in certain transactions with our subsidiaries and affiliates; and make stock repurchases and dividend payments. Interest rates on the Revolving 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 the twelve months ended December 31, 2019 was approximately $163 and $185 in 2018 and 2017. These costs are included in interest expense in our Consolidated Statement of Earnings.
CTS CORPORATION 52
NOTE 13 — Derivatives
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 into 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 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 to other income (expense).
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 Consolidated Statement of Earnings for the twelve months ended December 31, 2019.
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 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 December 31, 2019, we had a net unrealized gain of $655 in accumulated other comprehensive loss, of which $595 is expected to be reclassified to income within the next 12 months. The notional amount of foreign currency forward contracts outstanding was $8,011 at December 31, 2019.
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 December 31, 2019, 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.
These swaps are treated as cash flow hedges and consequently, the changes in fair value are recorded in other comprehensive loss. The estimated net amount of the existing gains or losses that are reported in accumulated other comprehensive loss that are expected to be reclassified into earnings within the next twelve months is approximately $82 .
The location and fair values of derivative instruments designated as hedging instruments in the Consolidated Balance Sheets as of December 31, 2019, are shown in the following table:
As of December 31, | |||||||
2019 | 2018 | ||||||
Interest rate swaps reported in Other current assets | $ | $ | |||||
Interest rate swaps reported in Other assets | $ | $ | |||||
Interest rate swaps reported in Other long-term obligations | $ | ( | ) | $ | |||
Foreign currency hedges reported in Other current assets | $ | $ | |||||
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 $648 and foreign currency derivative liabilities of $68 at December 31, 2019.
CTS CORPORATION 53
The effect of derivative instruments on the Consolidated Statements of Earnings is as follows:
Years Ended December 31, | |||||||||||
2019 | 2018 | 2017 | |||||||||
Foreign Exchange Contracts: | |||||||||||
Amounts reclassified from AOCI to earnings: | |||||||||||
Net sales | $ | $ | $ | ( | ) | ||||||
Cost of goods sold | ( | ) | |||||||||
Selling, general and administrative | |||||||||||
Total amounts reclassified from AOCI to earnings | |||||||||||
Loss recognized in other expense for hedge ineffectiveness | ( | ) | |||||||||
Loss recognized in other expense for derivatives not designated as cash flow hedges | ( | ) | |||||||||
Total derivative gain on foreign exchange contracts recognized in earnings | $ | $ | $ | ||||||||
Interest Rate Swaps: | |||||||||||
Benefit recorded in interest expense | $ | $ | $ | ||||||||
Total gain | $ | $ | $ | ||||||||
NOTE 14 — Accumulated Other Comprehensive Loss
Shareholders’ equity includes certain items classified as accumulated other comprehensive loss (“AOCI”) in the Consolidated Balance Sheets, including:
• | Unrealized gains (losses) on derivatives 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 13 - Derivative Financial Instruments and Note 17 – 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 earnings from AOCI are included in net periodic pension income (expense). Further information related to our pension obligations is included in Note 6 – Retirement Plans. |
• | Cumulative translation adjustment 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 earnings. |
In 2018, CTS adopted the provision of ASU No. 2018-02 "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This ASU allows for the reclassification from AOCI to retained earnings for the stranded tax effects resulting from the Tax Cuts and Jobs Act that was enacted in December 2017. The total impact due to adoption of this standard was an increase in retained earnings of $17,433.
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The components of AOCI for 2019 are as follows:
As of December 31, 2018 | Gain (Loss) Recognized in OCI | (Gain) Loss reclassified from AOCI to earnings | As of December 31, 2019 | |||||||||
Changes in fair market value of derivatives: | ||||||||||||
Gross | $ | $ | $ | ( | ) | $ | ||||||
Income tax (expense) benefit | ( | ) | ( | ) | ( | ) | ||||||
Net | ( | ) | ||||||||||
Changes in unrealized pension cost: | ||||||||||||
Gross | ( | ) | — | ( | ) | |||||||
Income tax benefit (expense) | — | ( | ) | |||||||||
Net | ( | ) | — | ( | ) | |||||||
Cumulative translation adjustment: | ||||||||||||
Gross | ( | ) | — | ( | ) | |||||||
Income tax benefit | — | |||||||||||
Net | ( | ) | — | ( | ) | |||||||
Total accumulated other comprehensive (loss) earnings | $ | ( | ) | $ | $ | $ | ( | ) | ||||
The components of AOCI for 2018 are as follows:
As of December 31, 2017 | Gain (Loss) Recognized in OCI | (Gain) Loss reclassified from AOCI to earnings | Impact of ASU No. 2018-02 | As of December 31, 2018 | |||||||||||
Changes in fair market value of derivatives: | |||||||||||||||
Gross | $ | $ | $ | ( | ) | $ | — | $ | |||||||
Income tax (expense) benefit | ( | ) | ( | ) | ( | ) | |||||||||
Net | ( | ) | |||||||||||||
Changes in unrealized pension cost: | |||||||||||||||
Gross | ( | ) | — | ( | ) | — | ( | ) | |||||||
Income tax benefit (expense) | — | ( | ) | ||||||||||||
Net | ( | ) | — | ( | ) | ( | ) | ( | ) | ||||||
Cumulative translation adjustment: | |||||||||||||||
Gross | ( | ) | ( | ) | — | — | ( | ) | |||||||
Income tax benefit (expense) | ( | ) | — | — | |||||||||||
Net | ( | ) | ( | ) | — | — | ( | ) | |||||||
Total accumulated other comprehensive (loss) earnings | $ | ( | ) | $ | $ | ( | ) | $ | ( | ) | $ | ( | ) | ||
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NOTE 15 — Shareholders' Equity
Share count and par value data related to shareholders' equity are as follows:
As of December 31, | ||
2019 | 2018 | |
Preferred Stock | ||
Par value per share | No par value | No par value |
Shares authorized | ||
Shares outstanding | ||
Common Stock | ||
Par value per share | No par value | No par value |
Shares authorized | ||
Shares issued | ||
Shares outstanding | ||
Treasury stock | ||
Shares held | ||
On February 7, 2019, the Board of Directors authorized a stock repurchase program with a maximum dollar limit of $25,000 in stock repurchases, which replaced the previous authorized plan that was approved by our Board of Directors in April 2015. During the year ended December 31, 2019 we purchased 420,770 shares for approximately $11,746 , of which $566 was repurchased under the previous plan and $11,180 was repurchased under the most recent board-authorized share repurchase program. During the year ended December 31, 2018 we purchased 342,100 shares for $9,440 under the previous authorized plan. Approximately $13,820 was available for future purchases.
A roll forward of common shares outstanding is as follows:
As of December 31, | ||||
2019 | 2018 | |||
Balance at beginning of the year | ||||
Repurchases | ( | ) | ( | ) |
Restricted stock unit issuances | ||||
Balance at end of period | ||||
NOTE 16 — Stock-Based Compensation
At December 31, 2019, we had five 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 & Incentive 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.
The following table summarizes the compensation expense included in selling, general and administrative expenses in the Consolidated Statements of Earnings related to stock-based compensation plans:
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Service-Based RSUs | $ | $ | $ | ||||||
Performance-Based RSUs | |||||||||
Cash-settled awards | |||||||||
Total | $ | $ | $ | ||||||
Income tax benefit | |||||||||
Net | $ | $ | $ | ||||||
The fair value of all equity awards that vested during the periods ended December 31, 2019, 2018, and 2017 were $6,589 , $5,805 , and $5,471 , respectively. We recorded a tax deduction related to equity awards that vested during the year ended December 31, 2019, in the amount of $1,489 .
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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 expense at December 31, 2019 | Weighted- average period | |||
Service-Based RSUs | $ | |||
Performance-Based RSUs | ||||
Total | $ | |||
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 December 31, 2019:
2018 Plan | 2014 Plan | 2009 Plan | 2004 Plan | Directors' Plan | ||||||
Awards originally available to be granted | N/A | |||||||||
Performance stock options outstanding | ||||||||||
Maximum potential RSU and cash settled awards outstanding | ||||||||||
Maximum potential awards outstanding | ||||||||||
RSUs and cash settled awards vested and released | ||||||||||
Awards available to be granted | ||||||||||
Stock Options
Stock options are exercisable in cumulative annual installments over a maximum 10-year period, commencing at least one year from the date of grant. Stock options are generally granted with an exercise price equal to the market price of our stock on the date of grant. The stock options generally vest over four years and have a 10-year contractual life. The awards generally contain provisions to either accelerate vesting or allow vesting to continue on schedule upon retirement if certain service and age requirements are met. The awards also provide for accelerated vesting if there is a change in control event.
We estimate the fair value of the stock option on the grant date using the Black-Scholes option-pricing model and assumptions for expected price volatility, option term, risk-free interest rate, and dividend yield. Expected price volatilities are based on historical volatilities of our common stock. The expected option term was derived from historical data of exercise behavior. The dividend yield was based on historical dividend payments. The risk-free rate for periods within the contractual life of the option was based on the U.S. Treasury yield curve in effect at the time of grant.
The only outstanding stock options at December 31, 2019, or 2018 were the performance-based stock options described below.
Performance-Based Stock Options
During 2015 and 2016, the Compensation committee of the Board of Directors (the "Committee") granted a total of 350,000 performance-based stock options, of which 225,000 remain outstanding after considering forfeitures. The Performance-Based Option Awards have an exercise price of $18.37 , a term of five years and generally will become exercisable (provided the optionee remains employed by the Company or an affiliate) upon our attainment of at least $600,000 in revenues during any of our trailing four quarterly periods (as determined by the Committee) during the term. We have not recognized any expense on these Performance-Based Option Awards for the years ended December 31, 2019 and 2018, since the revenue target is not deemed likely to be attained based on our current forecast.
Service-Based Restricted Stock Units
Service-based RSUs entitle the holder to receive one share of common stock for each unit when the unit vests. RSUs are issued to officers, key employees and non-employee directors as compensation. Generally, the RSUs vest over a three -year period. RSUs granted to non-employee directors vest one year after being granted. Upon vesting, the non-employee directors elect to either receive the stock associated with the RSU immediately, or defer receipt of the stock to a future date. The fair value of the RSUs is equivalent to the trading value of our common stock on the grant date.
CTS CORPORATION 57
A summary of RSU activity for the year ended December 31, 2019 is presented below:
Units | Weighted Average Grant Date Fair Value | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||
Outstanding at January 1, 2019 | $ | |||||||
Granted | ||||||||
Released | ( | |||||||
Forfeited | ( | |||||||
Outstanding at December 31, 2019 | $ | $ | ||||||
Releasable at December 31, 2019 | $ | $ | ||||||
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Weighted-average grant date fair value | $ | $ | $ | ||||||
Intrinsic value of RSUs released | $ | $ | $ | ||||||
A summary of non-vested RSU activity for the year ended December 31, 2019 is presented below:
RSUs | Weighted Average Grant Date Fair Value | |||
Nonvested at January 1, 2019 | $ | |||
Granted | ||||
Vested | ( | |||
Forfeited | ( | |||
Nonvested at December 31, 2019 | $ | |||
Performance-Based Restricted Stock Units
We grant performance-based restricted stock unit awards ("PSUs") to certain executives and key employees. Units are usually awarded in the range from zero percent to 200 % of a targeted number of shares. The award rate for the 2017-2019, 2018-2020, and 2019-2021 PSUs is dependent upon our achievement of sales growth targets, cash flow targets, and relative total shareholder return ("RTSR") using a matrix based on the percentile ranking of our stock price performance compared to a peer group over a three -year period. These awards are weighted 35% for achievement of the sales growth metric, 30% for achievement of the cash flow metric, and 35% for achievement of the RTSR metric. Other PSUs are granted from time to time based on other performance criteria.
A summary of PSU activity for the year ended December 31, 2019 is presented below:
Units | Weighted Average Grant Date Fair Value | Weighted Average Remaining Contractual Term | Aggregate Intrinsic Value | |||||
Outstanding at January 1, 2019 | $ | |||||||
Granted | ||||||||
Released | ( | |||||||
Forfeited | ( | |||||||
Added by performance factor | ||||||||
Outstanding at December 31, 2019 | $ | $ | ||||||
Releasable at December 31, 2019 | $ | $ | ||||||
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The following table summarizes each grant of performance awards outstanding at December 31, 2019:
Description | Grant Date | Vesting Year | Vesting Dependency | Target Units Outstanding | Maximum Number of Units to be Granted | ||
2017-2019 Performance RSUs | February 9, 2017 | 2019 | 35% RTSR, 35% sales growth, 30% operating cash flow | ||||
2017-2019 Performance RSUs | February 9, 2017 | 2018-2020 | Operating Earnings | ||||
2018-2020 Performance RSUs | February 8, 2018 | 2020 | 35% RTSR, 35% sales growth, 30% operating cash flow | ||||
2018-2020 Performance RSUs | February 16, 2018 | 2020 | 35% RTSR, 35% sales growth, 30% operating cash flow | ||||
2019-2021 Performance RSUs | February 7, 2019 | 2021 | 35% RTSR, 35% sales growth, 30% operating cash flow | ||||
2019 Supplemental Performance RSUs | February 7, 2019 | 2021 | Succession Planning Targets | ||||
2020-2022 QTI Performance RSUs | September 24, 2019 | 2022 | 50% EBITDA growth, 50% Sales growth | ||||
Total | |||||||
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 December 31, 2019, and 2018, we had 17,271 and 17,248 cash-settled RSUs outstanding, respectively. At December 31, 2019, and 2018, liabilities of $353 and $300 , respectively were included in Accrued expenses and other liabilities on our Consolidated Balance Sheets.
NOTE 17 — Fair Value Measurements
We use interest rates swaps to convert a portion of our Revolving Credit Facility's outstanding balance from a variable rate of interest to 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 table below summarizes the financial asset that were measured at fair value on a recurring basis as of December 31, 2019 and the (gain) loss recorded during the year ended December 31, 2019:
Asset Carrying Value at December 31, 2019 | Quoted Prices in Active Markets for Identical (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | (Gain) loss for Year Ended December 31, 2019 | |||||||||||
Interest rate swap | $ | $ | — | $ | $ | — | $ | ( | ) | ||||||
Foreign currency hedges | $ | $ | — | $ | $ | — | $ | ( | ) | ||||||
The table below summarizes the financial assets that were measured at fair value on a recurring basis as of December 31, 2018 and the (gain) loss recorded during the year ended December 31, 2018:
Asset Carrying Value at December 31, 2018 | Quoted Prices in Active Markets for Identical (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | (Gain) loss for Year Ended December 31, 2018 | |||||||||||
Interest rate swap | $ | $ | — | $ | $ | — | $ | ( | ) | ||||||
Foreign currency hedges | $ | $ | — | $ | $ | — | $ | ( | ) | ||||||
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 the market is not active and therefore they are classified within level 2 of the fair value hierarchy.
Our long-term debt consists of 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.
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NOTE 18 — Income Taxes
Earnings before income taxes consist of the following:
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
U.S. | $ | $ | $ | ||||||
Non-U.S. | |||||||||
Total | $ | $ | $ | ||||||
Significant components of income tax provision/(benefit) are as follows:
Years Ended December 31, | |||||||||
2019 | 2018 | 2017 | |||||||
Current: | |||||||||
U.S. | $ | ( | ) | $ | ( | ) | $ | ||
Non-U.S. | |||||||||
Total Current | |||||||||
Deferred: | |||||||||
U.S. | ( | ) | |||||||
Non-U.S. | ( | ) | ( | ) | |||||
Total Deferred | ( | ) | |||||||
Total provision for income taxes | $ | $ | $ | ||||||
Significant components of our deferred tax assets and liabilities are as follows:
As of December 31, | ||||||
2019 | 2018 | |||||
Post-retirement benefits | $ | $ | ||||
Inventory reserves | ||||||
Loss carry-forwards | ||||||
Credit carry-forwards | ||||||
Accrued expenses | ||||||
Research expenditures | ||||||
Operating lease liabilities | ||||||
Stock compensation | ||||||
Foreign exchange loss | ||||||
Other | ||||||
Gross deferred tax assets | ||||||
Depreciation and amortization | ||||||
Pensions | ||||||
Operating lease assets | ||||||
Subsidiaries' unremitted earnings | ||||||
Gross deferred tax liabilities | ||||||
Net deferred tax assets | ||||||
Deferred tax asset valuation allowance | ( | ) | ( | ) | ||
Total net deferred tax assets | $ | $ | ||||
CTS CORPORATION 60
The long-term deferred tax assets and long-term deferred tax liabilities are as follows below:
As of December 31, | ||||||
2019 | 2018 | |||||
Non-current deferred tax assets | $ | $ | ||||
Non-current deferred tax liabilities | $ | ( | ) | $ | ( | ) |
Total net deferred tax assets | $ | $ | ||||
At each reporting date, we weigh all available positive and negative evidence to assess whether it is more-likely-than-not that the Company's deferred tax assets, including deferred tax assets associated with accumulated loss carryforwards and tax credits in the various jurisdictions in which it operates, will be realized. As of December 31, 2019, and 2018, we recorded deferred tax assets related to certain U.S. state and non-U.S. income tax loss carryforwards of $4,724 and $4,647 , respectively, and U.S. and non-U.S. tax credits of $15,964 and $16,909 , respectively. The deferred tax assets expire in various years primarily between 2021 and 2039.
Generally, we assess if it is more-likely-than-not that our net deferred tax assets will be realized during the available carry-forward periods. As a result, we have determined that valuation allowances of $8,011 and $8,274 should be provided for certain deferred tax assets at December 31, 2019, and 2018, respectively. As of December 31, 2019, the valuation allowances relate to certain U.S. state and non-U.S. loss carry-forwards and certain U.S. state tax credits that management does not anticipate will be utilized.
No valuation allowance was recorded in 2019 against the U.S. federal foreign tax credit carryforwards of $5,785 , which expire in varying amounts between 2023 and 2029 as well as the research and development tax credits of $7,495 , which expire in varying amounts between 2021 and 2039. We assessed the anticipated realization of those tax credits utilizing future taxable income projections. Based on those projections, management believes it is more-likely-than-not that we will realize the benefits of these credit carryforwards.
The following table reconciles taxes at the U.S. federal statutory rate to the effective income tax rate:
Years Ended December 31, | ||||||
2019 | 2018 | 2017 | ||||
Taxes at the U.S. statutory rate | % | % | % | |||
State income taxes, net of federal income tax benefit | % | % | % | |||
Non-U.S. earnings taxed at rates different than the U.S. statutory rate | % | % | ( | )% | ||
Foreign source earnings, net of associated foreign tax credits | % | % | % | |||
Benefit of tax credits | ( | )% | ( | )% | ( | )% |
Non-deductible expenses | % | % | % | |||
Stock compensation - excess tax benefits | ( | )% | ( | )% | ( | )% |
Adjustment to valuation allowances | ( | )% | ( | )% | ( | )% |
Other changes in tax laws and rates | % | ( | )% | % | ||
Change in unrecognized tax benefits | % | ( | )% | % | ||
Impacts of unremitted foreign earnings | % | % | % | |||
Impacts related to the 2017 Tax Cuts and Jobs Act | % | ( | )% | % | ||
Other | ( | )% | % | ( | )% | |
Effective income tax rate | % | % | % | |||
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. We recognized a provisional amount of $18,001 as an additional income tax expense in the fourth quarter of 2017. This amount included $11,734 related to the mandatory deemed one-time transition tax and $6,267 related to the remeasurement of certain deferred tax assets and liabilities.
On December 22, 2017, Staff Accounting Bulletin No. 118 ("SAB 118") was issued to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Tax Act. The remeasurement period for SAB 118 ended on December 22, 2018, and upon completion of our analysis we determined the final impact of the Tax Act resulted in an additional tax benefit of $348 during the fourth quarter of 2018. This amount included a $589 tax benefit related to the one-time transition tax and $241 tax expense related to the remeasurement of certain deferred tax assets and liabilities.
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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 US can be completed with no incremental US Tax. However, there are limited other taxes that continue to apply such as foreign withholding and certain state taxes. The company records a deferred tax liability for the estimated foreign earnings and state tax cost associated with the undistributed foreign earnings that are not permanently reinvested.
The Tax Act also includes provisions for Global Intangible Low-Taxed Income (“GILTI”) wherein taxes on foreign income are imposed in excess of a deemed return on tangible assets of foreign corporations. We elected to recognize the tax on GILTI as an expense in the period the tax is incurred.
We recognize the financial statement benefit of a tax position when it is more-likely-than-not, based on its technical merits, that the position will be sustained upon examination. A tax position that meets the more-likely-than-not threshold is then measured to determine the amount of benefit to be recognized in the financial statements. As of December 31, 2019, we have approximately $5,016 of unrecognized tax benefits, which if recognized, would impact the effective tax rate. We do not anticipate any significant changes in our unrecognized tax benefits within the next 12 months.
A reconciliation of the beginning and ending unrecognized tax benefits is provided below:
As of December 31, | ||||||
2019 | 2018 | |||||
Balance at January 1 | $ | $ | ||||
Increase related to current year tax positions | ||||||
(Decrease) increase related to prior year tax positions | ( | ) | ||||
Decrease related to lapse in statute of limitation | ( | ) | ( | ) | ||
Decrease related to settlements with taxing authorities | ( | ) | ||||
Balance at December 31 | $ | $ | ||||
Our continuing practice is to recognize interest and/or penalties related to unrecognized tax benefits as income tax expense. As of December 31, 2019, and 2018, $707 and $2,515 , respectively, of interest and penalties were accrued.
We are subject to taxation in the U.S., various states, and in non-U.S. jurisdictions. Our U.S. income tax returns are primarily subject to examination from 2016 through 2018; however, U.S. tax authorities also have the ability to review prior tax years to the extent loss carryforwards and tax credit carryforwards are utilized. The open years for the non-U.S. tax returns range from 2008 through 2018 based on local statutes.
NOTE 19 - Business Acquisitions
On July 31, 2019, we acquired 100% of the outstanding shares of Quality Thermistor, Inc. (QTI) for $75 million plus a contingent earn out of up to $5 million based on sales performance objectives. The purchase price includes adjustments for debt assumed and changes in working capital. QTI, doing business as QTI Sensing Solutions, is a leading designer and manufacturer of high-quality temperature sensors serving original equipment manufacturers with mission-critical applications in the industrial, aerospace, defense and medical markets. This acquisition provides us with a new core temperature sensing technology that expands our sensing product portfolio, while increasing our presence in the industrial and medical markets.
The final purchase price of $73,906 has been allocated to the fair values of assets and liabilities acquired as of July 31, 2019.
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The following table summarizes the consideration paid and the fair values of the assets acquired and the liabilities assumed at the date of acquisition:
Consideration Paid | |||
Cash paid, net of cash acquired of $567 | $ | ||
Contingent consideration | |||
Purchase price | $ | ||
Fair Values at July 31, 2019 | |||
Current assets | $ | ||
Property, plant and equipment | |||
Other assets | |||
Goodwill | |||
Intangible assets | |||
Fair value of assets acquired | |||
Less fair value of liabilities acquired | ( | ) | |
Purchase price | $ | ||
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 within our existing business, access to new customers, and potential cost savings and synergies. Goodwill related to the acquisition is expected to be deductible for tax purposes.
The contingent earn out is payable in cash upon the achievement of a revenue performance target for the year ending December 31, 2019. The Company recorded contingent consideration for the earn out of $1,056 based on the achievement performance target for the full year 2019 results. This amount is reflected as an addition to purchase price.
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 | $ | |||
Trademarks, tradenames, and other intangibles | ||||
Total | $ | |||
Results of operations for QTI are included in our consolidated financial statements beginning on July 31, 2019. The amount of net sales and net loss from QTI since the acquisition date that have been included in the Consolidated Statements of Earnings are as follows:
For the period July 31, 2019 through December 31, 2019 | |||
Net sales | $ | ||
Net loss | $ | ( | ) |
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NOTE 20 — Geographic Data
Financial information relating to our operations by geographic area were as follows:
Net Sales | Years Ended December 31, | ||||||||
2019 | 2018 | 2017 | |||||||
United States | $ | $ | $ | ||||||
Singapore | |||||||||
Taiwan | |||||||||
China | |||||||||
Czech Republic | |||||||||
Other non-U.S. | |||||||||
Consolidated net sales | $ | $ | $ | ||||||
Sales are attributed to countries based upon the origin of the sale.
Long-Lived Assets | Years Ended December 31, | |||||
2019 | 2018 | |||||
United States | $ | $ | ||||
China | ||||||
Taiwan | ||||||
Czech Republic | ||||||
Other non-U.S | ||||||
Consolidated long-lived assets | $ | $ | ||||
NOTE 21 — Quarterly Financial Data
Quarterly Results of Operations
(Unaudited)
First | Second | Third | Fourth | |||||||||
2019 | ||||||||||||
Net sales | $ | $ | $ | $ | ||||||||
Gross margin | $ | $ | $ | $ | ||||||||
Operating earnings | $ | $ | $ | $ | ||||||||
Net earnings | $ | $ | $ | $ | ||||||||
Basic earnings per share | $ | $ | $ | $ | ||||||||
Diluted earnings per share | $ | $ | $ | $ | ||||||||
2018 | ||||||||||||
Net sales | $ | $ | $ | $ | ||||||||
Gross margin | $ | $ | $ | $ | ||||||||
Operating earnings | $ | $ | $ | $ | ||||||||
Net earnings | $ | $ | $ | $ | ||||||||
Basic earnings per share | $ | $ | $ | $ | ||||||||
Diluted earnings per share | $ | $ | $ | $ | ||||||||
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(in thousands) | Balance at Beginning of Period | Charged to Expense | Charged to Other Accounts | (Write-offs) / Recoveries | Balance at End of Period | ||||||||||
Year ended December 31, 2019 Allowance for doubtful accounts | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||
Year ended December 31, 2018 Allowance for doubtful accounts | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||
Year ended December 31, 2017 Allowance for doubtful accounts | $ | $ | $ | $ | ( | ) | $ | ||||||||
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Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Not applicable.
Item 9A. Controls and Procedures
(a) Evaluation of Disclosure and Controls
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 Annual Report on Form 10-K. 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 Annual Report on Form 10-K 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 Corporation have been detected.
(b) Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934 as amended (the Exchange Act)). Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2019. In making this assessment, our management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control—Integrated Framework (2013 framework). We have excluded from the scope of our assessment of internal control over financial reporting the operations and related assets of Quality Thermistor, Inc., which we acquired in 2019. At December 31, 2019 and for the period from acquisition through December 31, 2019, total assets and revenues subject to QTI's internal control over financial reporting represented 12% and 2% of our consolidated total assets and total revenues as of and for the year ended December 31, 2019. Based on our assessment under the framework in Internal Control—Integrated Framework (2013 framework), our management concluded that our internal control over financial reporting was effective as of December 31, 2019. The effectiveness of our internal control over financial reporting as of December 31, 2019 has been audited by Grant Thornton LLP, an independent registered public accounting firm, as stated in their report that is included herein.
(c) Changes in Internal Control over Financial Reporting
The Company is implementing an enterprise resource planning (“ERP”) system on a worldwide basis, which is expected to improve the efficiency of certain operational, financial, and related transactional processes. The implementation began in 2018 and is expected to continue in phases over the next year. The implementation of a worldwide ERP system has and will continue to affect the processes that constitute our internal control over financial reporting and will require annual testing for effectiveness.
The Company completed implementation in certain subsidiaries/locations during the fourth quarter of 2019. As with any new information technology application we implement, this application, along with the internal controls over financial reporting included in the related processes, was appropriately considered within the testing for effectiveness with respect to the implementation in these instances. We concluded, as part of our evaluation described in the above paragraphs, that the implementation of the ERP system in these circumstances has not materially affected our internal control over financial reporting.
There were no additional changes in our internal control over financial reporting for the quarter ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders
CTS Corporation
Opinion on internal control over financial reporting
We have audited the internal control over financial reporting of CTS Corporation (an Indiana corporation) and subsidiaries (the “Company”) as of December 31, 2019, based on criteria established in the 2013 Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on criteria established in the 2013 Internal Control-Integrated Framework issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the consolidated financial statements of the Company as of and for the year ended December 31, 2019, and our report dated February 20, 2020 expressed an unqualified opinion on those financial statements.
Basis for opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting (“Management’s Report”). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Our audit of, and opinion on, the Company’s internal control over financial reporting does not include the internal control over financial reporting of QTI, a wholly-owned subsidiary, whose financial statements reflect total assets and revenues constituting 12% and 2%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2019. As indicated in Management’s Report, QTI was acquired during 2019. Management’s assertion on the effectiveness of the Company’s internal control over financial reporting excluded internal control over financial reporting of QTI.
Definition and limitations of internal control over financial reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ GRANT THORNTON LLP
Chicago, Illinois
February 20, 2020
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Item 9B. Other Information
Not applicable.
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PART III
Item 10. Directors, Executive Officers and Corporate Governance
Please see Part I, Item 1 of this Annual Report on Form 10-K for information about our executive officers, which is incorporated by reference herein. Information with respect to Directors and Corporate Governance may be found in our definitive proxy statement to be delivered to shareholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
Item 11. Executive Compensation
Information with respect to this item may be found in our definitive proxy statement to be delivered to shareholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
EQUITY COMPENSATION PLAN INFORMATION
The following table provides information about shares of CTS common stock that could be issued under all of our equity compensation plans as of December 31, 2019:
Plan Category | (a) Number of Securities to be Issued Upon Exercise of Outstanding Options, RSUs, Warrants and Rights (2) | (b) Weighted-Average Grant Date Fair Value of Outstanding Options, RSUs, Warrants and Rights | (c) Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (Excluding Securities Reflected in Column(a)) | ||||
Equity compensation plans approved by security holders | 1,004,746 | $ | 16.44 | 2,229,198 | |||
Equity compensation plans not approved by security holders(1) | 5,522 | — | — | ||||
Total | 1,010,268 | 2,229,198 | |||||
(1) In 1990, we adopted the Stock Retirement Plan for Non-Employee Directors. Prior to December 1, 2004, we annually credited an account for each non-employee director with 800 CTS common stock units. We also annually credited each deferred stock account with an additional number of CTS common stock units representing the amount of dividends which would have been paid on an equivalent number of shares of CTS common stock for each quarter during the preceding calendar year. As of December 1, 2004, this plan was amended to preclude crediting any additional CTS common stock units under the plan. Upon retirement, a participating non-employee director is entitled to receive one share of CTS common stock for each CTS common stock unit in his deferred stock account. On December 31, 2019, the deferred stock accounts contained a total of 5,522 CTS common stock units.
(2) Based on achievement of the maximum targets for performance-based equity grants.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters
Information with respect to this item may be found in our definitive proxy statement to be delivered to shareholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions, and Director Independence
Information with respect to this item may be found in our definitive proxy statement to be delivered to shareholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
Item 14. Principal Accountant Fees and Services
Information with respect to this item may be found in our definitive proxy statement to be delivered to shareholders in connection with our 2020 Annual Meeting of Shareholders. Such information is incorporated herein by reference.
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PART IV
Item 15. Exhibits and Financial Statements Schedules
The following Consolidated Financial Statements of CTS Corporation and Subsidiaries are included herein:
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Earnings: Years ended December 31, 2019, December 31, 2018, and December 31, 2017
Consolidated Statements of Comprehensive Earnings: Years ended December 31, 2019, December 31, 2018, and December 31, 2017
Consolidated Balance Sheets: December 31, 2019, and December 31, 2018
Consolidated Statements of Cash Flows: Years ended December 31, 2019, December 31, 2018, and December 31, 2017
Consolidated Statements of Shareholders' Equity: Years Ended December 31, 2019, December 31, 2018, and December 31, 2017
Notes to Consolidated Financial Statements
Schedule II: Valuation and Qualifying Accounts and Reserves
Other schedules have been omitted because they are not applicable or the required information is shown in the Consolidated Financial Statements or Notes thereto.
(a) (3) Exhibits
All references to documents filed pursuant to the Securities Exchange Act of 1934, including Forms 10-K, 10-Q and 8-K, were filed by CTS, File No. 1-4639.
(3)(i) | |||
(3)(ii) | |||
(10)(a) | |||
(10)(b) | |||
(10)(c) | |||
(10)(d) | |||
(10)(e) | |||
(10)(f) | |||
(10)(g) | |||
(10)(h) | |||
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(10)(i) | |||
(10)(j) | |||
(10)(k) | |||
(10)(l) | |||
(10)(m) | |||
(10)(n) | |||
(21) | |||
(23) | |||
(31)(a) | |||
(31)(b) | |||
(32)(a) | |||
(32)(b) | |||
101 | The following financial statements from the Company's Annual Report on Form 10-K for the year ended December 31, 2019, formatted in Inline XBRL: (i) Consolidated Statements of Earnings, (ii) Consolidated Statements of Comprehensive Earnings, (iii) Consolidated Balance Sheets, (iv) Consolidated Statements of Cash Flows, (v) Consolidated Statements of Stockholders' Equity and (vi) Notes to Consolidated Financial Statements, tagged as blocks of text and including detailed tags. | ||
104 | The cover page from the Company's Annual Report on Form 10-K for the year ended December 31, 2019, formatted in Inline XBRL | ||
______________________________
* | Management contract or compensatory plan or arrangement. |
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SIGNATURES
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 | |||
Date: February 20, 2020 | By: | /s/ Ashish Agrawal | |
Ashish Agrawal Vice President and Chief Financial Officer (Principal Financial Officer) | |||
Date: February 20, 2020 | By: | /s/ William Cahill | |
William Cahill Chief Accounting Officer (Principal Accounting Officer) | |||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
Date: February 20, 2020 | By: | /s/ Kieran O'Sullivan | |
Kieran O'Sullivan Chairman, President, and Chief Executive Officer (Principal Executive Officer) | |||
Date: February 20, 2020 | By: | /s/ Robert A. Profusek | |
Robert A. Profusek Lead Director | |||
Date: February 20, 2020 | By: | /s/ Patricia K. Collawn | |
Patricia K. Collawn Director | |||
Date: February 20, 2020 | By: | /s/ Gordon Hunter | |
Gordon Hunter Director | |||
Date: February 20, 2020 | By: | /s/ William S. Johnson | |
William S. Johnson Director | |||
Date: February 20, 2020 | By: | /s/ Diana M. Murphy | |
Diana M. Murphy Director | |||
Date: February 20, 2020 | By: | /s/ Alfonso G. Zulueta | |
Alfonso G. Zulueta Director | |||
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