Cts Corp 10-Q for FY2020 Q2
Cts Corp (CTS)
10-Q
2020-07-31
For: 2020-06-30
View Original
Added on
April 07, 2026
About this 10-Q
Cts Corp filed this 10-Q on July 31, 2020, covering the quarter ended June 30, 2020 (FY2020 Q2).
Headline figures
Quarter ended June 30, 2020, as reported in this filing, compared with the same period a year earlier where the filing states it.
- Revenue
- $84.2M
- down 30.2% from $120.68M a year earlier
- Net income
- $4.86M
- down 59.3% from net income of $11.94M a year earlier
- Diluted EPS
- $0.15
- down 58.3% from $0.36 a year earlier
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM | |
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
For The Quarterly Period Ended June 30, 2020
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: | ||
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Trading Symbol(s) | Name of Each Exchange on Which Registered |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
☒ | Accelerated filer ☐ | Non-accelerated filer o | Smaller reporting company | Emerging growth company | ||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13 (a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No x
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of July 28, 2020: 32,267,524 .
CTS CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
Page | |||
2
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
CTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS - UNAUDITED
(In thousands, except per share amounts)
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
Net sales | $ | $ | $ | $ | |||||||||||
Cost of goods sold | |||||||||||||||
Gross Margin | |||||||||||||||
Selling, general and administrative expenses | |||||||||||||||
Research and development expenses | |||||||||||||||
Restructuring charges | |||||||||||||||
Gain on sale of assets | ( | ) | ( | ) | |||||||||||
Operating earnings | |||||||||||||||
Other (expense) income: | |||||||||||||||
Interest expense | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Interest income | |||||||||||||||
Other income (expense), net | ( | ) | ( | ) | ( | ) | |||||||||
Total other (expense), net | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Earnings before income taxes | |||||||||||||||
Income tax expense | |||||||||||||||
Net earnings | $ | $ | $ | $ | |||||||||||
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 | $ | $ | $ | $ | |||||||||||
See notes to unaudited condensed consolidated financial statements.
3
CTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE EARNINGS ‑ UNAUDITED
(In thousands of dollars)
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
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 | $ | $ | $ | $ | |||||||||||
See notes to unaudited condensed consolidated financial statements.
4
CTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands of dollars)
(Unaudited) | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
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 | |||||||
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 | $ | $ | |||||
5
CTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS ‑ UNAUDITED
(In thousands of dollars)
Six Months Ended | |||||||
June 30, | June 30, | ||||||
2020 | 2019 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net earnings | $ | $ | |||||
Adjustments to reconcile net earnings to net cash provided by operating activities: | |||||||
Depreciation and amortization | |||||||
Pension and other post-retirement plan expense | |||||||
Stock-based compensation | |||||||
Asset impairment charges | |||||||
Deferred income taxes | ( | ) | |||||
Gain on sales of fixed assets | ( | ) | |||||
(Gain) loss on foreign currency hedges, net of cash | ( | ) | |||||
Changes in assets and liabilities, net of acquisition: | |||||||
Accounts receivable | ( | ) | |||||
Inventories | ( | ) | |||||
Operating lease assets | ( | ) | |||||
Other assets | ( | ) | |||||
Accounts payable | ( | ) | ( | ) | |||
Accrued payroll and benefits | ( | ) | ( | ) | |||
Accrued liabilities | ( | ) | ( | ) | |||
Income taxes payable | ( | ) | ( | ) | |||
Operating lease liabilities | ( | ) | |||||
Accrued expenses and other liabilities | ( | ) | |||||
Pension and other post-retirement plans | ( | ) | ( | ) | |||
Net cash provided by operating activities | |||||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Capital expenditures | ( | ) | ( | ) | |||
Proceeds from sale of assets | |||||||
Net cash used in investing activities | ( | ) | ( | ) | |||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Payments of long-term debt | ( | ) | ( | ) | |||
Proceeds from borrowings of long-term debt | |||||||
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 changes on cash and cash equivalents | |||||||
Net increase in cash and cash equivalents | |||||||
Cash and cash equivalents at beginning of period | |||||||
Cash and cash equivalents at end of period | $ | $ | |||||
Supplemental cash flow information: | |||||||
Cash paid for interest | $ | $ | |||||
Cash paid for income taxes, net | $ | $ | |||||
Non-cash financing and investing activities: | |||||||
Capital expenditures incurred but not paid | $ | $ | |||||
See notes to unaudited condensed consolidated financial statements.
6
CTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - UNAUDITED
(in thousands of dollars)
The following summarizes the changes in total equity for the three and six months ended June 30, 2020:
Common Stock | Additional Contributed Capital | Retained Earnings | Accumulated Other Comprehensive Earnings/(Loss) | Treasury Stock | Total | |||||||||||||
Balances at December 31, 2019 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
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 $0.04 per share | — | — | ( | ) | — | — | ( | ) | ||||||||||
Acquired 220,731 shares of treasury stock | — | — | — | — | ( | ) | ( | ) | ||||||||||
Issued shares on vesting of restricted stock units | ( | ) | — | — | — | ( | ) | |||||||||||
Stock compensation | — | — | — | — | ||||||||||||||
Balances at March 31, 2020 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
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 $0.04 per share | — | — | ( | ) | — | — | ( | ) | ||||||||||
Acquired 122,000 shares of treasury stock | — | — | — | — | ( | ) | ( | ) | ||||||||||
Issued shares on vesting of restricted stock units | ( | ) | — | — | — | |||||||||||||
Stock compensation | — | — | — | — | ||||||||||||||
Balances at June 30, 2020 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
See notes to unaudited condensed consolidated financial statements.
7
CTS CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY - UNAUDITED
(in thousands of dollars)
The following summarizes the changes in total equity for the three and six months ended June 30, 2019:
Common Stock | Additional Contributed Capital | Retained Earnings | Accumulated Other Comprehensive Earnings/(Loss) | Treasury Stock | Total | |||||||||||||
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 $0.04 per share | — | — | ( | ) | — | — | ( | ) | ||||||||||
Acquired 31,500 shares of treasury stock | — | — | — | — | ( | ) | ( | ) | ||||||||||
Issued shares on vesting of restricted stock units | ( | ) | — | — | — | ( | ) | |||||||||||
Stock compensation | — | — | — | — | ||||||||||||||
Balances at March 31, 2019 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
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 $0.04 per share | — | — | ( | ) | — | — | ( | ) | ||||||||||
Acquired 148,466 shares of treasury stock | — | — | — | — | ( | ) | ( | ) | ||||||||||
Issued shares on vesting of restricted stock units | ( | ) | — | — | — | |||||||||||||
Stock compensation | — | — | — | — | ||||||||||||||
Balances at June 30, 2019 | $ | $ | $ | $ | ( | ) | $ | ( | ) | $ | ||||||||
See notes to unaudited condensed consolidated financial statements.
8
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
(in thousands except for share and per share data)
June 30, 2020
NOTE 1—Basis of Presentation
The accompanying condensed consolidated financial statements have been prepared by CTS Corporation (“CTS” "we", "our", "us" or the "Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been omitted pursuant to such rules and regulations. The unaudited condensed consolidated financial statements should be read in conjunction with the financial statements, notes thereto, and other information included in the Company’s Annual Report on Form 10‑K for the year ended December 31, 2019.
NOTE 2 – Revenue Recognition
The core principle of Topic 606 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance provides a five-step process to achieve that core principle:
• | Identify the contract(s) with a customer |
• | Identify the performance obligations |
• | Determine the transaction price |
• | Allocate the transaction price |
• | Recognize revenue when the performance obligations are met |
We recognize revenue when the performance obligations specified in our contracts have been satisfied, after considering the impact of variable consideration and other factors that may affect the transaction price. Our contracts normally contain a single performance obligation that is fulfilled on the date of delivery based on shipping terms stipulated in the contract. We usually expect payment within 30 to 90 days from the shipping date, depending on our terms with the customer. None of our contracts as of June 30, 2020 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.
9
Disaggregated Revenue
The following table presents revenues disaggregated by the major markets we serve:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, 2020 | June 30, 2019 | June 30, 2020 | June 30, 2019 | ||||||||||||
Transportation | $ | $ | $ | $ | |||||||||||
Industrial | |||||||||||||||
Medical | |||||||||||||||
Aerospace & Defense | |||||||||||||||
Telecom & IT | |||||||||||||||
Total | $ | $ | $ | $ | |||||||||||
NOTE 3 – Accounts Receivable
The components of accounts receivable, net are as follows:
As of | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
Accounts receivable, gross | $ | $ | |||||
Less: Allowance for credit losses | ( | ) | ( | ) | |||
Accounts receivable, net | $ | $ | |||||
NOTE 4 – Inventories
Inventories, net consist of the following:
As of | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
Finished goods | $ | $ | |||||
Work-in-process | |||||||
Raw materials | |||||||
Less: Inventory reserves | ( | ) | ( | ) | |||
Inventories, net | $ | $ | |||||
NOTE 5 – Property, Plant and Equipment
As of | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
Land and land improvements | $ | $ | |||||
Buildings and improvements | |||||||
Machinery and equipment | |||||||
Less: Accumulated depreciation | ( | ) | ( | ) | |||
Property, plant and equipment, net | $ | $ | |||||
Depreciation expense for the six months ended June 30, 2020 | $ | ||||||
Depreciation expense for the six months ended June 30, 2019 | $ | ||||||
10
NOTE 6 – Retirement Plans
Pension Plans
Net pension expense for our domestic and foreign plans included in other income (expense) in the Condensed Consolidated Statement of Earnings is as follows:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
Net pension expense | $ | $ | $ | $ | |||||||||||
The components of net pension expense for our domestic and foreign plans include the following:
Domestic Pension Plans | Foreign Pension Plans | ||||||||||||||
Three Months Ended | Three Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
Service cost | $ | $ | $ | $ | |||||||||||
Interest cost | |||||||||||||||
Expected return on plan assets(1) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Amortization of loss | |||||||||||||||
Total expense, net | $ | $ | $ | $ | |||||||||||
(1) Expected return on plan assets is net of expected investment expenses and certain administrative expenses.
Domestic Pension Plans | Foreign Pension Plans | ||||||||||||||
Six Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
Service cost | $ | $ | $ | $ | |||||||||||
Interest cost | |||||||||||||||
Expected return on plan assets(1) | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Amortization of loss | |||||||||||||||
Total expense, net | $ | $ | $ | $ | |||||||||||
(1) Expected return on plan assets is net of expected investment expenses and certain administrative expenses.
In February 2020, the CTS Board of Directors authorized management to explore termination of our U.S. based pension plan ("Plan") at management's discretion, subject to certain conditions. On June 1, 2020, we entered into the Fifth Amendment to the Plan whereby we set an effective termination date of July 31, 2020. The Plan termination process is expected to take twelve to eighteen months and requires certain approvals from both the Internal Revenue Service and Pension Benefit Guaranty Corporation. Once we receive such approvals, an insurance company will be selected to purchase annuities and fulfill the obligations of the Plan including administering payments to participants. Upon settlement of the pension liabilities, we will reclassify the related pension losses currently recorded in accumulated other comprehensive loss into earnings. We do not expect any cash contributions from the Company to the Plan as a result of this termination because plan assets exceed estimated liabilities.
11
Other Post-retirement Benefit Plan
Net post-retirement expense for our other post-retirement plan includes the following components:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
Service cost | $ | $ | $ | $ | |||||||||||
Interest cost | |||||||||||||||
Amortization of gain | ( | ) | ( | ) | ( | ) | ( | ) | |||||||
Total expense, net | $ | $ | $ | $ | |||||||||||
12
NOTE 7 – Other Intangible Assets
Other intangible assets, net consist of the following components:
As of | |||||||||||
June 30, 2020 | |||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Amount | |||||||||
Customer lists/relationships | $ | $ | ( | ) | $ | ||||||
Technology and other intangibles | ( | ) | |||||||||
In process research and development | — | ||||||||||
Other intangible assets, net | $ | $ | ( | ) | $ | ||||||
Amortization expense for the three months ended June 30, 2020 | $ | ||||||||||
Amortization expense for the six months ended June 30, 2020 | $ | ||||||||||
As of | |||||||||||
December 31, 2019 | |||||||||||
Gross Carrying Amount | Accumulated Amortization | Net Amount | |||||||||
Customer lists/relationships | $ | $ | ( | ) | $ | ||||||
Technology and other intangibles | ( | ) | |||||||||
In process research and development | — | ||||||||||
Other intangible assets, net | $ | $ | ( | ) | $ | ||||||
Amortization expense for the three months ended June 30, 2019 | $ | ||||||||||
Amortization expense for the six months ended June 30, 2019 | $ | ||||||||||
Remaining amortization expense for other intangible assets as of June 30, 2020 is as follows:
Amortization expense | |||
2020 | $ | ||
2021 | |||
2022 | |||
2023 | |||
2024 | |||
Thereafter | |||
Total amortization expense | $ | ||
13
NOTE 8 – Costs Associated with Exit and Restructuring Activities
Restructuring charges are reported as a separate line within operating earnings in the Condensed Consolidated Statement of Earnings.
Total restructuring charges are as follows:
Three Months Ended | |||||||
June 30, 2020 | June 30, 2019 | ||||||
Restructuring charges | $ | $ | |||||
Six Months Ended | |||||||
June 30, 2020 | June 30, 2019 | ||||||
Restructuring charges | $ | $ | |||||
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 $0 and $911 during the three months ended June 30, 2020 and June 30, 2019, respectively. Restructuring charges under this plan were $(32 ) and $2,995 during the six months ended June 30, 2020 and June 30, 2019, respectively. The total restructuring liability related to the June 2016 Plan was $48 at June 30, 2020 and $233 at December 31, 2019. Additional costs related to production line movements, equipment charges, and other costs will be expensed as incurred.
The following table displays the planned restructuring charges associated with the June 2016 Plan as well as a summary of the actual costs incurred through June 30, 2020:
Actual costs | |||||||
Planned | incurred through | ||||||
June 2016 Plan | Costs | June 30, 2020 | |||||
Workforce reduction | $ | $ | |||||
Building and equipment relocation | |||||||
Other charges(1) | |||||||
Total restructuring charges | $ | $ | |||||
(1) Other charges includes the effects of currency translation, non-cash asset write-downs and other charges.
2014 Plan
Other Restructuring Activities
14
The following table displays the restructuring liability activity included in Accrued expenses and other liabilities for all plans for the six months ended June 30, 2020:
Restructuring liability at January 1, 2020 | $ | ||
Restructuring charges | |||
Cost paid | ( | ) | |
Other activity(1) | ( | ) | |
Restructuring liability at June 30, 2020 | $ | ||
(1) Other activity includes the effects of currency translation, non-cash asset write-downs and other charges that do not flow through restructuring expense.
NOTE 9 – Accrued Liabilities
The components of Accrued expenses and other liabilities are as follows:
As of | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
Accrued product related costs | $ | $ | |||||
Accrued income taxes | |||||||
Accrued property and other taxes | |||||||
Accrued professional fees | |||||||
Accrued customer related liabilities | |||||||
Dividends payable | |||||||
Remediation reserves | |||||||
Derivative liabilities | |||||||
Other accrued liabilities | |||||||
Total accrued expenses and other liabilities | $ | $ | |||||
15
NOTE 10 – Commitments and Contingencies
Certain processes in the manufacture of our current and past products create by-products classified as hazardous waste. We have been notified by the U.S. Environmental Protection Agency, state environmental agencies, and in some cases, groups of potentially responsible parties, that we may be potentially liable for environmental contamination at several sites currently and formerly owned or operated by us. Two of those sites, Asheville, North Carolina and Mountain View, California, are designated National Priorities List sites under the U.S. Environmental Protection Agency’s Superfund program. We accrue a liability for probable remediation activities, claims and proceedings against us with respect to environmental matters if the amount can be reasonably estimated, and provide disclosures including the nature of a loss whenever it is probable or reasonably possible that a potentially material loss may have occurred but cannot be estimated. We record contingent loss accruals on an undiscounted basis.
A roll-forward of remediation reserves included in Accrued expenses and other liabilities on the Condensed Consolidated Balance Sheets is comprised of the following:
As of | |||||||
June 30, 2020 | December 31, 2019 | ||||||
Balance at beginning of period | $ | $ | |||||
Remediation expense | |||||||
Net 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 cannot provide assurance that the ultimate disposition of environmental, legal, and product warranty claims will not materially exceed the amount of our accrued losses and adversely impact our consolidated financial position, results of operations, or cash flows. Our accrued liabilities and disclosures will be adjusted accordingly if additional information becomes available in the future.
NOTE 11 - Debt
Long-term debt was comprised of the following:
As of | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
Total credit facility | $ | $ | |||||
Balance outstanding | |||||||
Standby letters of credit | |||||||
Amount available, subject to covenant restrictions | $ | $ | |||||
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 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.
16
The revolving credit facility includes a swing line sublimit of $15,000 and a letter of credit sublimit of $10,000 . Borrowings under the Revolving Credit Facility bear interest at the base rate defined in the Credit Agreement. We also pay a quarterly commitment fee on the unused portion of the Revolving Credit Facility. The commitment fee ranges from 0.20 % to 0.30 % based on our total leverage ratio.
The Credit Agreement requires, among other things, that we comply with a maximum total leverage ratio and a minimum fixed charge coverage ratio. Failure to comply with these covenants could reduce the borrowing availability under the credit facility. We were in compliance with all debt covenants at June 30, 2020. The Credit Agreement requires that we deliver quarterly financial statements, annual financial statements, auditor certifications, and compliance certificates within a specified number of days after the end of a quarter and year. Additionally, it contains restrictions limiting our ability to: dispose of assets; incur certain additional debt; repay other debt or amend subordinated debt instruments; create liens on assets; make investments, loans or advances; make acquisitions or engage in mergers or consolidations; engage in certain transactions with our subsidiaries and affiliates; and make stock repurchases and dividend payments. Interest rates on the credit facility fluctuate based upon the LIBOR and the Company’s quarterly total leverage ratio.
We have debt issuance costs related to our long-term debt that are being amortized using the straight-line method over the life of the debt. Amortization expense for the three and six months ended June 30, 2020 and 2019 was approximately $42 and $41 and $84 and $77 , respectively. These costs are included in interest expense in our Condensed Consolidated Statement of Earnings.
We use interest rate swaps to convert the revolving credit facility's variable rate of interest into a fixed rate on a portion of the debt as described more fully in Note 12 "Derivative Financial Instruments". These swaps are treated as cash flow hedges and consequently, the changes in fair value were recorded in other comprehensive earnings.
Note 12 - Derivative Financial Instruments
Our earnings and cash flows are subject to fluctuations due to changes in foreign currency exchange rates and interest rates. We selectively use derivative financial instruments including foreign currency forward contracts and interest rate swaps to manage our exposure to these risks.
The use of derivative financial instruments exposes the Company to credit risk, which relates to the risk of nonperformance by a counterparty to the derivative contracts. We manage our credit risk by entering 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) income until the hedged transaction affects earnings upon settlement, at which time they are reclassified to cost of goods sold or net sales. If it is probable that an anticipated hedged transaction will not occur by the end of the originally specified time period, we reclassify the gains or losses related to that hedge from accumulated other comprehensive (loss) income to other 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. In accordance with FASB Staff Q&A - Topic 815: Cash Flow Hedge Accounting Affected by the COVID-19 Pandemic (“FASB Staff Q&A Hedge”) issued in April 2020, companies may elect to assess the ineffectiveness of our cashflow hedges utilizing the two-month grace period for assessing whether forecasted transactions will occur. We have made this election in assessing the effectiveness of our cash flow hedges during the three months ended June 30, 2020.
Foreign Currency Hedges
We use forward contracts to mitigate currency risk related to a portion of our forecasted foreign currency revenues and costs. The currency forward contracts are designed as cash flow hedges and are recorded in the Condensed Consolidated Balance Sheets at fair value.
We continue to monitor the Company’s overall currency exposure and may elect to add cash flow hedges in the future. At June 30, 2020, we had a net unrealized loss of $1,247 in accumulated other comprehensive (loss) income, of which $1,037 is expected to be reclassified to earnings within the next 12 months. At June 30, 2019 we had a net unrealized gain of $784 in accumulated other comprehensive (loss) income. The notional amount of foreign currency forward contracts outstanding was $24,434 at June 30, 2020.
17
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 June 30, 2020, 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) income. The estimated net amount of the existing losses that are reported in accumulated other comprehensive (loss) income that are expected to be reclassified into earnings within the next twelve months is approximately $505 .
The location and fair values of derivative instruments designated as hedging instruments in the Condensed Consolidated Balance Sheets as of June 30, 2020, are shown in the following table:
As of | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
Interest rate swaps reported in Other current assets | $ | $ | |||||
Interest rate swaps reported in Accrued liabilities | $ | ( | ) | $ | |||
Interest rate swaps reported in Other long-term obligations | $ | ( | ) | $ | ( | ) | |
Foreign currency hedges reported in Other current assets | $ | $ | |||||
Foreign currency hedges reported in Accrued liabilities | $ | ( | ) | $ | |||
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 $57 and foreign currency derivative liabilities of $1,621 at June 30, 2020.
The effect of derivative instruments on the Condensed Consolidated Statements of Earnings is as follows:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
Foreign Exchange Contracts: | |||||||||||||||
Amounts reclassified from AOCI to earnings: | |||||||||||||||
Net sales | $ | $ | $ | $ | |||||||||||
Cost of goods sold | ( | ) | ( | ) | |||||||||||
Selling, general and administrative expense | ( | ) | |||||||||||||
Total (loss) gain reclassified from AOCI to earnings | ( | ) | ( | ) | |||||||||||
Gain recognized in other expense for hedge ineffectiveness | |||||||||||||||
Total derivative (loss) gain on foreign exchange contracts recognized in earnings | $ | ( | ) | $ | $ | ( | ) | $ | |||||||
Interest Rate Swaps: | |||||||||||||||
(Expense) benefit recorded in Interest expense | $ | ( | ) | $ | $ | ( | ) | $ | |||||||
Total (losses) gains on derivatives | $ | ( | ) | $ | $ | ( | ) | $ | |||||||
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NOTE 13 – Accumulated Other Comprehensive (Loss) Income
Shareholders’ equity includes certain items classified as accumulated other comprehensive (loss) income (“AOCI”) in the Condensed Consolidated Balance Sheets, including:
• | Unrealized gains (losses) on hedges relate to interest rate swaps to convert a portion of our revolving credit facility's outstanding balance from a variable rate of interest into a fixed rate and foreign currency forward contracts used to hedge our exposure to changes in exchange rates affecting certain revenues and costs denominated in foreign currencies. These hedges are designated as cash flow hedges, and we have deferred income statement recognition of gains and losses until the hedged transactions occur, at which time amounts are reclassified into earnings. Further information related to our derivative financial instruments is included in Note 12 - Derivative Financial Instruments and Note 16 – Fair Value Measurements. |
• | Unrealized gains (losses) on pension obligations are deferred from income statement recognition until the gains or losses are realized. Amounts reclassified to income from AOCI are included in net periodic pension income (expense). Further information related to our pension obligations is included in Note 6 – Retirement Plans. |
• | Cumulative translation adjustments relate to our non-U.S. subsidiary companies that have designated a functional currency other than the U.S. dollar. We are required to translate the subsidiary functional currency financial statements to dollars using a combination of historical, period-end, and average foreign exchange rates. This combination of rates creates the foreign currency translation adjustment component of other comprehensive income. |
Changes in exchange rates between the functional currency and the currency in which a transaction is denominated are foreign exchange transaction gains or losses. Transaction gains (losses) for the three and six months ended June 30, 2020 were $892 and $(379 ), respectively and transaction losses for the three and six months ended June 30, 2019 were $829 and $355 , respectively,
which have been included in other income (expense) in the Condensed Consolidated Statement of Earnings.
The components of accumulated other comprehensive (loss) income for the three months ended June 30, 2020, are as follows:
Loss | |||||||||||||||
As of | Gain (Loss) | Reclassified | As of | ||||||||||||
March 31, | Recognized | from AOCI | June 30, | ||||||||||||
2020 | in OCI | to Income | 2020 | ||||||||||||
Changes in fair market value of hedges: | |||||||||||||||
Gross | $ | ( | ) | $ | $ | $ | ( | ) | |||||||
Income tax benefit (expense) | ( | ) | ( | ) | |||||||||||
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) income | $ | ( | ) | $ | $ | $ | ( | ) | |||||||
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The components of accumulated other comprehensive (loss) income for the three months ended June 30, 2019, are as follows:
(Gain) Loss | |||||||||||||||
As of | Gain (Loss) | Reclassified | As of | ||||||||||||
March 31, | Recognized | from AOCI | June 30, | ||||||||||||
2019 | in OCI | to Income | 2019 | ||||||||||||
Changes in fair market value of hedges: | |||||||||||||||
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) income | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | |||||
The components of accumulated other comprehensive (loss) income for the six months ended June 30, 2020, are as follows:
Loss | |||||||||||||||
As of | Loss | Reclassified | As of | ||||||||||||
December 31, | Recognized | from AOCI | June 30, | ||||||||||||
2019 | in OCI | to Income | 2020 | ||||||||||||
Changes in fair market value of hedges: | |||||||||||||||
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) income | $ | ( | ) | $ | ( | ) | $ | $ | ( | ) | |||||
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The components of accumulated other comprehensive (loss) income for the six months ended June 30, 2019, are as follows:
Loss | |||||||||||||||
As of | Gain | Reclassified | As of | ||||||||||||
December 31, | Recognized | from AOCI | June 30, | ||||||||||||
2018 | in OCI | to Income | 2019 | ||||||||||||
Changes in fair market value of hedges: | |||||||||||||||
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) income | $ | ( | ) | $ | $ | $ | ( | ) | |||||||
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NOTE 14 – Shareholders’ Equity
Share count and par value data related to shareholders’ equity are as follows:
As of | |||||
June 30, | December 31, | ||||
2020 | 2019 | ||||
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 new stock repurchase program with a maximum dollar limit of $25,000 in stock repurchases, which replaced the previous program. During the six months ended June 30, 2020 and 2019, 342,731 and 179,966 shares of common stock were repurchased for $8,080 and $5,002 , respectively. Approximately $5,740 is available for future purchases.
A roll-forward of common shares outstanding is as follows:
Six Months Ended | |||||
June 30, | June 30, | ||||
2020 | 2019 | ||||
Balance at the beginning of the year | |||||
Repurchases | ( | ) | ( | ) | |
Restricted share issuances | |||||
Balance at the end of the period | |||||
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NOTE 15 - Stock-Based Compensation
At June 30, 2020, we had five active stock-based compensation plans: the Non-Employee Directors’ Stock Retirement Plan (“Directors’ Plan”), the 2004 Omnibus Long-Term Incentive Plan (“2004 Plan”), the 2009 Omnibus Equity and Performance Incentive Plan (“2009 Plan”), the 2014 Performance & 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 Condensed Consolidated Statements of Earnings related to stock-based compensation plans:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
Service-based RSUs | $ | $ | $ | $ | |||||||||||
Performance-based RSUs | ( | ) | |||||||||||||
Cash-settled RSUs | |||||||||||||||
Total | $ | $ | $ | $ | |||||||||||
Income tax benefit | |||||||||||||||
Net expense | $ | $ | $ | $ | |||||||||||
The following table summarizes the unrecognized compensation expense related to non-vested RSUs by type and the weighted-average period in which the expense is to be recognized:
Unrecognized | |||||
Compensation | Weighted- | ||||
Expense at | Average | ||||
June 30, 2020 | 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 June 30, 2020:
2018 Plan | 2014 Plan | 2009 Plan | 2004 Plan | Directors' Plan | ||||||||||
Awards originally available | N/A | |||||||||||||
Performance-based options outstanding | — | — | — | — | ||||||||||
Maximum potential RSU and cash settled awards outstanding | ||||||||||||||
Maximum potential awards outstanding | ||||||||||||||
RSUs and cash settled awards vested and released | — | — | — | — | ||||||||||
Awards available for grant | — | — | — | — | ||||||||||
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Performance-Based Stock Options
During 2015, the Compensation Committee of the Board of Directors granted a total of 350,000 performance-based stock option awards for certain employees under the 2014 Plan. We did not recognized any expense on these awards because the attainment of the performance target was not deemed to be likely to occur. These performance options expired unexercised in May 2020.
Service-Based Restricted Stock Units
The following table summarizes the service-based RSU activity for the six months ended June 30, 2020:
Units | Weighted Average Grant Date Fair Value | |||||
Outstanding at December 31, 2019 | $ | |||||
Granted | ||||||
Vested and released | ( | ) | ||||
Forfeited | ( | ) | ||||
Outstanding at June 30, 2020 | $ | |||||
Releasable at June 30, 2020 | $ | |||||
The following table summarizes the performance and market-based RSU activity for the six months ended June 30, 2020:
Units | Weighted Average Grant Date Fair Value | |||||
Outstanding at December 31, 2019 | $ | |||||
Granted | ||||||
Attained by performance | ||||||
Released | ( | ) | ||||
Forfeited | ( | ) | ||||
Outstanding at June 30, 2020 | $ | |||||
Releasable at June 30, 2020 | $ | |||||
The following table summarizes each grant of performance awards outstanding at June 30, 2020.
Description | Grant Date | Vesting Year | Vesting Dependency | Target Units Outstanding | Maximum Number of Units to be Granted | ||
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 | ||||
2020 - 2022 Performance RSUs | February 6, 2020 | 2022 | 25% RTSR, 40% sales growth, 35% operating cash flow | ||||
Focus 2025 Performance RSUs | April 23, 2020 | 2024 | Cumulative revenues of $750 million over a trailing four-quarter period | ||||
Total | |||||||
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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 June 30, 2020 and December 31, 2019 we had 33,697 and 17,271 cash-settled RSUs outstanding, respectively. At June 30, 2020 and December 31, 2019, liabilities of $154 and $353 , respectively, were included in Accrued expenses and other liabilities on our Condensed Consolidated Balance Sheets.
NOTE 16 — Fair Value Measurements
We use interest rate swaps to convert a portion of our Revolving Credit Facility’s outstanding balance from a variable rate of interest into a fixed rate and foreign currency forward contracts to hedge the effect of foreign currency changes on certain revenues and costs denominated in foreign currencies. These derivative financial instruments are measured at fair value on a recurring basis. Due to changes in interest rates and foreign exchange rates, these fair values fluctuated significantly during the second quarter and may continue to fluctuate based on market conditions and other factors.
The table below summarizes our financial liabilities that were measured at fair value on a recurring basis at June 30, 2020:
Quoted | |||||||||||||||
Prices | |||||||||||||||
Liability | in Active | Significant | |||||||||||||
Carrying | Markets for | Other | Significant | ||||||||||||
Value at | Identical | Observable | Unobservable | ||||||||||||
June 30, | Instruments | Inputs | Inputs | ||||||||||||
2020 | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Interest rate swaps | $ | ( | ) | $ | — | $ | ( | ) | $ | — | |||||
Foreign currency hedges | $ | ( | ) | $ | — | $ | ( | ) | $ | — | |||||
The table below summarizes the financial assets that were measured at fair value on a recurring basis as of December 31, 2019:
Quoted | |||||||||||||||
Prices | |||||||||||||||
Asset | in Active | Significant | |||||||||||||
Carrying | Markets for | Other | Significant | ||||||||||||
Value at | Identical | Observable | Unobservable | ||||||||||||
December 31, | Instruments | Inputs | Inputs | ||||||||||||
2019 | (Level 1) | (Level 2) | (Level 3) | ||||||||||||
Interest rate swaps | $ | $ | — | $ | $ | — | |||||||||
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 that 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. The fair value of long-term debt approximates carrying value and was determined by valuing a similar hypothetical coupon bond and attributing that value to our long-term debt under the Revolving Credit Facility.
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NOTE 17 — Income Taxes
The effective tax rates for the three and six-month periods ended June 30, 2020 and 2019 are as follows:
Three Months Ended | Six Months Ended | ||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||
2020 | 2019 | 2020 | 2019 | ||||||||
Effective tax rate | % | % | % | % | |||||||
Our effective income tax rate was 17.6 % and 25.1 % in the second quarters of 2020 and 2019, respectively. This decrease is primarily attributed to the change in the mix of earnings by jurisdiction, a reduction in reserves related to uncertain tax positions, and other favorable permanent items, partially offset by a provision recorded due to the company's decision to no longer permanently reinvest the earnings from our Taiwan subsidiary. The second quarter 2020 tax rate was lower than the U.S. statutory federal tax rate for the same reasons as noted above. The second quarter 2019 tax rate was higher than the U.S. statutory federal tax rate primarily due to state taxes and foreign earnings that are taxed at higher rates.
Our effective income tax rate was 27.1 % and 22.7 % in the first half of 2020 and 2019, respectively. This increase is primarily attributed to establishment of valuation allowances on certain U.S. tax credits and the company's decision to no longer reinvest the earnings of its Taiwan subsidiary, offset by a reduction in reserves related to uncertain tax positions. The tax rate in the first half of 2020 was higher than the U.S. statutory federal tax rate for the same reasons noted above. The tax rate in the first half of 2019 was higher than the U.S. statutory federal tax rate primarily due to higher foreign tax rates applicable on foreign earnings offset by tax benefits recorded upon vesting of restricted stock units.
26
NOTE 18 — 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.
In accordance with FASB Staff Q&A - Topic 842 and Topic 840: Accounting for Lease Concessions Related to the Effects of the COVID-19 Pandemic ("FASB Staff Q&A") issued in April 2020, we have elected to account for any lease concessions resulting directly from COVID-19 as if the enforceable rights and obligations for the concessions existed in the respective contracts at lease inception and as such we will not account for any concession as a lease modification. Guidance from the FASB Staff Q&A provided methods to account for rent deferrals which include the option to treat the lease as if no changes to the lease contract were made or to treat deferred payments as variable lease payments. The FASB Staff Q&A allows entities to select the most practical approach and does not require the same approach be applied consistently to all leases. As a result, we have accounted for lease deferrals as if no changes to the lease contract were made and will continue to recognize lease expense, on a straight-line basis, during the deferral periods. During the three and six months ended June 30, 2020, these rent concessions related to COVID-19 were not material.
Components of lease expense for the three and six months ended June 30, 2020 were as follows:
Three Months Ended | Six Months Ended | ||||||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||||||
2020 | 2019 | 2020 | 2019 | ||||||||||||
Operating lease cost | $ | $ | $ | $ | |||||||||||
Short-term lease cost | |||||||||||||||
Total lease cost | $ | $ | $ | $ | |||||||||||
Six Months Ended | |||||||
June 30, | June 30, | ||||||
2020 | 2019 | ||||||
Cash paid for amounts included in the measurement of lease liabilities | $ | $ | |||||
Leased assets obtained in exchange for new operating lease liabilities | $ | $ | |||||
Supplemental balance sheet information related to leases was as follows:
As of | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
Balance Sheet Classification: | |||||||
Operating lease obligations | $ | $ | |||||
Long-term operating lease obligations | |||||||
Total lease liabilities | $ | $ | |||||
Weighted-average remaining lease terms (years) | |||||||
Weighted-average discount rate | % | % | |||||
27
Remaining maturity of our existing lease liabilities as of June 30, 2020 is as follows:
Operating Leases(1) | |||
2020 | $ | ||
2021 | |||
2022 | |||
2023 | |||
2024 | |||
Thereafter | |||
Total | $ | ||
Less: interest | ( | ) | |
Present value of lease liabilities | $ | ||
(1) Operating lease payments include $3,822 of payments related to options to extend lease terms that are reasonably expected to be exercised.
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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 included 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 provided 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 was allocated to the fair values of assets and liabilities acquired as of July 31, 2019.
The following table summarizes the consideration paid and the fair values of the assets acquired and the liabilities assumed as of the date of acquisition:
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 was 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 the 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 | $ | |||
Technology and other intangibles | ||||
Total | $ | |||
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NOTE 20 — Recent Accounting Pronouncements
Accounting Pronouncements Recently Adopted
ASU No. 2018-13 "Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement"
In August 2018, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update ("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. We adopted this ASU on January 1, 2020 and it did not have a material impact on our financial statements.
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) 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 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 adopted this ASU on January 1, 2020 and it did not 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 that reflects losses that are probable rather than the incurred loss model for recognizing credit losses. The standard became effective for interim and annual periods beginning after December 15, 2019. 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 it did not have a material impact on our financial statements.
Recently Issued Accounting Pronouncements
ASU No. 2020-04 "Reference Rate Reform"
In March 2020, the FASB issued ASU 2020-04, “ Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting”, which provides temporary optional guidance for a limited period of time to ease the potential burden in accounting for (or recognizing the effects of) reference rate reform on financial reporting as it relates to our LIBOR indexed instruments. ASU 2020-04 provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. ASU 2020-04 is effective for all entities as of March 12, 2020 through December 31, 2022, and an entity may elect to apply ASU 2020-04 for contract modifications by Topic or Industry Subtopic as of any date from the beginning of an interim period that includes or is subsequent to March 12, 2020, or prospectively from a date within an interim period that includes or is subsequent to March 12, 2020, up to the date that the financial statements are available to be issued. We are currently evaluating the potential impact of adopting this guidance on our consolidated financial statements.
ASU No. 2019-12 "Simplifying the Accounting for Income Taxes"
In December 2019, the 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 are currently evaluating the impact of this ASU on our financial statements.
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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 annual financial statement disclosures but will not impact our interim financial statements and does not have an impact on our consolidated financial position, results of operations, or cash flows.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)
(in thousands, except percentages and per share amounts)
The following discussion should be read in conjunction with our unaudited Condensed Consolidated Financial Statements and notes included under Item 1, as well as our Consolidated Financial Statements and notes and related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the year ended December 31, 2019.
Overview
CTS Corporation 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.
Impact of COVID-19
The COVID-19 pandemic has resulted in a significant disruption to the global economy that has and will continue to adversely affect our business. We have experienced reductions in customer demand in several of our end markets. We expect that social distancing measures, high employee absenteeism, and reductions in production due to mandated labor capacity restrictions at some of our plants in Europe and North America, as well as the reduced operational capacity of our customers and suppliers, will continue to impact our business in the second half of 2020. The pandemic could lead to an extended disruption of economic activity and the impact on our consolidated results of operations, financial position and cash flows could be material.
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Results of Operations: Second Quarter 2020 versus Second Quarter 2019
The following table highlights changes in significant components of the Unaudited Condensed Consolidated Statements of Earnings for the quarters ended June 30, 2020, and June 30, 2019:
Three Months Ended | Percent of | Percent of | ||||||||||||||
June 30, | June 30, | Percent | Net Sales – | Net Sales – | ||||||||||||
2020 | 2019 | Change | 2020 | 2019 | ||||||||||||
Net sales | $ | 84,197 | $ | 120,684 | (30.2 | )% | 100.0 | % | 100.0 | % | ||||||
Cost of goods sold | 57,630 | 79,480 | (27.5 | ) | 68.4 | 65.9 | ||||||||||
Gross margin | 26,567 | 41,204 | (35.5 | ) | 31.6 | 34.1 | ||||||||||
Selling, general and administrative expenses | 14,668 | 17,036 | (13.9 | ) | 17.4 | 14.1 | ||||||||||
Research and development expenses | 5,522 | 6,257 | (11.7 | ) | 6.6 | 5.2 | ||||||||||
Restructuring charges | 135 | 911 | (85.2 | ) | 0.2 | 0.8 | ||||||||||
Gain on sale of assets | — | (83 | ) | (100.0 | ) | — | (0.1 | ) | ||||||||
Total operating expenses | 20,325 | 24,121 | (15.7 | ) | 24.1 | 20.0 | ||||||||||
Operating earnings | 6,242 | 17,083 | (63.5 | ) | 7.4 | 14.2 | ||||||||||
Total other (expense), net | (349 | ) | (1,134 | ) | (69.2 | ) | (0.4 | ) | (0.9 | ) | ||||||
Earnings before income taxes | 5,893 | 15,949 | (63.1 | ) | 7.0 | 13.2 | ||||||||||
Income tax expense | 1,036 | 4,006 | (74.1 | ) | 1.2 | 3.3 | ||||||||||
Net earnings | $ | 4,857 | $ | 11,943 | (59.3 | )% | 5.8 | % | 9.9 | % | ||||||
Earnings per share: | ||||||||||||||||
Diluted net earnings per share | $ | 0.15 | $ | 0.36 | ||||||||||||
Sales were $84,197 in the second quarter of 2020, a decrease of $36,487 or 30.2% from the second quarter of 2019. Sales were negatively impacted as a result of the COVID-19 pandemic and government activities to control its spread. In the second quarter, we were impacted by: (1) successively mandated closures of or labor restrictions at our plants in China, Europe and North America, (2) supply chain disruptions resulting from the closure of a number of our suppliers in China and in North America, and (3) weak demand from certain customers as a result of their mandated or elective plant closures. These economic impacts are ongoing and continue to have an effect on our operations, which we are currently unable to quantify.
Sales to transportation markets decreased $42,214 or 52.5%. Sales to other markets increased $5,727 or 14.2%. The QTI acquisition, which was completed in July 2019, added $5,420 in sales for the quarter. Changes in foreign exchange rates decreased sales by $754 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 31.6% in the second quarter of 2020 compared to 34.1% in the second quarter of 2019. The decrease in gross margin was driven primarily by lower sales volumes, which was partially offset by various cost reduction measures.
Selling, general and administrative ("SG&A") expenses were $14,668 or 17.4% of sales in the second quarter of 2020 versus $17,036 or 14.1% of sales in the second quarter of 2019. The 2020 SG&A costs include savings from cost reduction measures we implemented during the second quarter, partially offset by amortization of intangibles and other operating costs associated with the QTI acquisition.
Research and development expenses were $5,522 or 6.6% of sales in the second quarter of 2020 compared to $6,257 or 5.2% of sales in the comparable quarter of 2019.
Restructuring charges were $135 or 0.2% of sales in the second quarter of 2020 and were mainly for severance charges. Restructuring charges were $911 or 0.8% of sales in the second quarter of 2019.
Operating earnings were $6,242 or 7.4% of sales in the second quarter of 2020 compared to operating earnings of $17,083 or 14.2% of sales in the second quarter of 2019.
Due to the impact of COVID-19, we implemented cost savings measures, some of which are temporary in nature. We will continue to evaluate market conditions to determine the extent and duration of the temporary measures. Given the continued demand
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volatility and expected multi-year recovery in the transportation end-market, the Company is implementing a restructuring plan starting in July 2020 to adapt our cost structure to lower market demand. The restructuring plan is focused on optimizing our manufacturing footprint and improving operational efficiency by better utilizing our systems capabilities. More information will be provided on the details of this restructuring plan in the Company’s subsequent filings.
Other income and expense items are summarized in the following table:
Three Months Ended | |||||||
June 30, | June 30, | ||||||
2020 | 2019 | ||||||
Interest expense | $ | (909 | ) | $ | (467 | ) | |
Interest income | 304 | 440 | |||||
Other income (expense), net | 256 | (1,107 | ) | ||||
Total other (expense), net | $ | (349 | ) | $ | (1,134 | ) | |
Interest expense increased mainly as a result of an increase in debt related to the QTI acquisition and additional borrowings to ensure adequate liquidity for the next several quarters given the current global pandemic. Other income in the second quarter of 2020 was principally driven by foreign currency translation gains, mainly due to the depreciation of the U.S. Dollar compared to the Chinese Renminbi and Euro during the quarter, which were partially offset by pension expense.
Three Months Ended | |||||
June 30, | June 30, | ||||
2020 | 2019 | ||||
Effective tax rate | 17.6 | % | 25.1 | % | |
Our effective income tax rate was 17.6% and 25.1% in the second quarters of 2020 and 2019, respectively. This decrease is primarily attributed to the change in the mix of earnings by jurisdiction, a reduction in reserves related to uncertain tax positions, and other favorable permanent items, partially offset by a provision recorded due to the company's decision to no longer permanently reinvest the earnings from our Taiwan subsidiary.
Results of Operations: Six Months ended June 30, 2020 versus Six Months Ended June 30, 2019
The following table highlights changes in significant components of the Unaudited Condensed Consolidated Statements of Earnings for the six months ended June 30, 2020, and June 30, 2019:
Six months ended | Percent of | Percent of | ||||||||||||||
June 30, | June 30, | Percent | Net Sales – | Net Sales – | ||||||||||||
2020 | 2019 | Change | 2020 | 2019 | ||||||||||||
Net sales | $ | 187,272 | $ | 238,308 | (21.4 | )% | 100.0 | % | 100.0 | % | ||||||
Cost of goods sold | 127,806 | 156,490 | (18.3 | ) | 68.2 | 65.7 | ||||||||||
Gross margin | 59,466 | 81,818 | (27.3 | ) | 31.8 | 34.3 | ||||||||||
Selling, general and administrative expenses | 31,427 | 34,597 | (9.2 | ) | 16.8 | 14.5 | ||||||||||
Research and development expenses | 12,930 | 13,048 | (0.9 | ) | 6.9 | 5.5 | ||||||||||
Restructuring charges | 375 | 2,995 | (87.5 | ) | 0.2 | % | 1.3 | |||||||||
Gain sale of assets | — | (122 | ) | (100.0 | ) | — | (0.1 | ) | ||||||||
Total operating expenses | 44,732 | 50,518 | (11.5 | ) | 23.9 | 21.2 | ||||||||||
Operating earnings | 14,734 | 31,300 | (52.9 | ) | 7.9 | 13.1 | ||||||||||
Total other (expense), net | (2,851 | ) | (1,071 | ) | 166.2 | (1.5 | ) | (0.4 | ) | |||||||
Earnings before income taxes | 11,883 | 30,229 | (60.7 | ) | 6.3 | 12.7 | ||||||||||
Income tax expense | 3,218 | 6,867 | (53.1 | ) | 1.7 | 2.9 | ||||||||||
Net earnings | $ | 8,665 | $ | 23,362 | (62.9 | )% | 4.6 | % | 9.8 | % | ||||||
Earnings per share: | ||||||||||||||||
Diluted net earnings per share | $ | 0.27 | $ | 0.71 | ||||||||||||
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Sales were $187,272 in the six months ended June 30, 2020, a decrease of $51,036 or 21.4% from the six months ended June 30, 2019. Sales were negatively impacted as a result of the COVID-19 pandemic and government activities to control its spread. In the first half of the year, we were impacted by: (1) successively mandated closures of or labor restrictions at our plants in China, Europe and North America, (2) supply chain disruptions resulting from the closure of a number of our suppliers in China and in North America, and (3) weak demand from certain customers as a result of their mandated or elective plant closures. These economic impacts are ongoing and continue to have an effect on our operations, which we are currently unable to quantify.
Sales to transportation markets decreased $59,521 or 37.4%. Sales to other markets increased $8,485 or 10.7%. The QTI acquisition, which was completed in July 2019, added $10,995 in sales for the first six months of 2020. Changes in foreign exchange rates decreased sales by $1,317 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 31.8% for the six months ended June 30, 2020 compared to 34.3% for the six months ended June 30, 2019. The decrease in gross margin was driven primarily by lower sales volumes, which was partially offset by various cost reduction measures.
Selling, general and administrative ("SG&A") expenses were $31,427 or 16.8% of sales for the six months ended June 30, 2020 versus $34,597 or 14.5% of sales for the six months ended June 30, 2019. The 2020 SG&A costs include savings from cost reduction measures we implemented during the second quarter, partially offset by amortization of intangibles and other operating costs associated with the QTI acquisition.
Research and development expenses were $12,930 or 6.9% of sales for the six months ended June 30, 2020 compared to $13,048 or 5.5% of sales for the six months ended June 30, 2019.
Restructuring charges were $375 or 0.2% of sales for the six months ended June 30, 2020 and were mainly for severance charges. Restructuring charges were $2,995 or 1.3% of sales for the six months ended June 30, 2019.
Operating earnings were $14,734 or 7.9% of sales for the six months ended June 30, 2020 compared to operating earnings of $31,300 or 13.1% of sales for the six months ended June 30, 2019.
Due to the impact of COVID-19, we implemented cost savings measures, some of which are temporary in nature. We will continue to evaluate market conditions to determine the extent and duration of the temporary measures. Given the continued demand volatility and expected multi-year recovery in the transportation end-market, the Company is implementing a restructuring plan starting in July 2020 to adapt our cost structure to lower market demand. The restructuring plan is focused on optimizing our manufacturing footprint and improving operational efficiency by better utilizing our systems capabilities. More information will be provided on the details of this restructuring plan in the Company’s subsequent filings.
Other income and expense items are summarized in the following table:
Six Months Ended | |||||||
June 30, | June 30, | ||||||
2020 | 2019 | ||||||
Interest expense | $ | (1,760 | ) | $ | (933 | ) | |
Interest income | 635 | 872 | |||||
Other (expense) income, net | (1,726 | ) | (1,010 | ) | |||
Total other (expense), net | $ | (2,851 | ) | $ | (1,071 | ) | |
Interest expense increased mainly as a result of an increase in debt related to the QTI acquisition and additional borrowings at the end of the first quarter to ensure adequate liquidity for the next several quarters. The increase in Other (expense) income, net for the six months ended June 30, 2020 was principally driven by pension expense as well as foreign currency translation losses, mainly due to the appreciation of the U.S. Dollar compared to the Chinese Renminbi and Euro during the first half of the year.
Six Months Ended | |||||
June 30, | June 30, | ||||
2020 | 2019 | ||||
Effective tax rate | 27.1 | % | 22.7 | % | |
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Our effective income tax rate was 27.1% and 22.7% in the six months ended June 30, 2020 and 2019, respectively. This increase is primarily attributed to establishment of valuation allowances on certain U.S. tax credits and the company's decision to no longer reinvest the earnings of its Taiwan subsidiary, offset by a reduction in reserves related to uncertain tax positions.
Liquidity and Capital Resources
Cash and cash equivalents were $145,981 at June 30, 2020, and $100,241 at December 31, 2019, of which $93,958 and $98,309, respectively, were held outside the United States. The increase in cash and cash equivalents of $45,740 was primarily driven by net proceeds from an increase in borrowings of long-term debt of $41,600 and cash generated from operating activities of $23,724, which were partially offset by treasury stock purchases of $8,080, capital expenditures of $7,245, dividends paid of $2,598, and taxes paid on behalf of equity award participants of $1,903. Total long-term debt was $141,300 as of June 30, 2020 and $99,700 as of December 31, 2019. Total debt as a percentage of total capitalization, defined as long-term debt as a percentage of total debt and shareholders' equity, was 26.1% at June 30, 2020, compared to 19.7% at December 31, 2019.
We increased our cash position during the first quarter to improve liquidity given the current economic environment. Our net debt, defined as long-term debt less cash and cash equivalents, was $(4,681) at June 30, 2020. We currently have $157,000 available for additional borrowings under our credit facility.
Working capital increased by $46,494 during the six months ended June 30, 2020, primarily due to the increase in cash and cash equivalents from borrowings under our credit facility and a decrease in accounts payable, which were partially offset by a decrease in accounts receivable.
Cash Flows from Operating Activities
Net cash provided by operating activities was $23,724 during the first six months of 2020. Components of net cash provided by operating activities included net earnings of $8,665, depreciation and amortization expense of $13,143, other net non-cash items of $2,810, and a net cash outflow from changes in assets and liabilities of $894.
Cash Flows from Investing Activities
Net cash used in investing activities for the first six months of 2020 was $7,245, driven entirely by capital expenditures.
Cash Flows from Financing Activities
Net cash provided by financing activities for the first six months of 2020 was $29,019. The net cash inflow was the result of net proceeds from an increase in borrowings of long-term debt of $41,600, which was partially offset by treasury stock purchases of $8,080, dividends paid of $2,598, and taxes paid on behalf of equity award participants in the amount of $1,903.
Capital Resources
Long‑term debt is comprised of the following:
As of | |||||||
June 30, | December 31, | ||||||
2020 | 2019 | ||||||
Total credit facility | $ | 300,000 | $ | 300,000 | |||
Balance outstanding | 141,300 | 99,700 | |||||
Standby letters of credit | 1,740 | 1,800 | |||||
Amount available, subject to covenant restrictions | $ | 157,000 | $ | 198,500 | |||
Weighted-average interest rate | 2.17 | % | 3.25 | % | |||
Commitment fee percentage per annum | 0.25 | % | 0.23 | % | |||
Our Credit Agreement provides for a revolving credit facility of $300,000, which may be increased by $150,000 at the request of the Company, subject to the administrative agent's approval.
We have entered into interest rate swap agreements to fix interest rates on $50,000 of long-term debt through February 2024. The difference to be paid or received under the terms of the swap agreements is recognized as an adjustment to interest expense when settled.
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We have historically funded our capital and operating needs primarily through cash flows from operating activities, supported by available credit under our revolving credit facility. We believe that cash flows from operating activities and available borrowings under our 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 condensed consolidated financial statements under accounting principles generally accepted in the United States of America. These principles require the use of estimates, judgments, and assumptions. We believe that the estimates, judgments, and assumptions we used are reasonable, based upon the information available.
Our estimates and assumptions affect the reported amounts in our financial statements. The following accounting policies comprise those that we believe are the most critical in understanding and evaluating our reported financial results.
Revenue Recognition
Product revenue is recognized when the transfer of promised goods to a customer occurs in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods. We follow the five step model to determine when this transfer has occurred: 1) identify the contract(s) with the customer; 2) identify the performance obligations in the contract; 3) determine the transaction price; 4) allocate the transaction price to the performance obligations in the contract; 5) recognize revenue when (or as) the entity satisfies a performance obligation.
Product Warranties
Provisions for estimated warranty expenses primarily related to our automotive products are made at the time products are sold. These estimates are established using a quoted industry rate. We adjust our warranty reserve for any known or anticipated warranty claims as new information becomes available. We evaluate our warranty obligations at least quarterly and adjust our accruals if it is probable that future costs will be different than our current reserve. Over the last three years, product warranty reserves have ranged from 2.0% to 3.2% of total sales. We believe our reserve level is appropriate considering all facts and circumstances surrounding any outstanding quality claims and our historical experience selling our products to our customers.
Accounts Receivable
We have standardized credit granting and review policies and procedures for all customer accounts, including:
• | Credit reviews of all new customer accounts, |
• | Ongoing credit evaluations of current customers, |
• | Credit limits and payment terms based on available credit information, |
• | Adjustments to credit limits based upon payment history and the customer's current credit worthiness, |
• | An active collection effort by regional credit functions, reporting directly to the corporate financial officers, and; |
• | Limited credit insurance on the majority of our international receivables. |
We reserve for estimated credit losses based on historical experience, specific customer collection issues, current conditions and reasonable and supportable forecasts that affect the collectability of the remaining cash flows over the contractual terms of our receivables and other financial assets. Over the last three years, accounts receivable reserves have been approximately 0.1% to 1.0% of total accounts receivable. We believe our reserve level is appropriate considering the quality of the portfolio. While credit losses have historically been within expectations of the reserves established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience or our current forecasts.
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 16.8% of gross inventory. We believe our reserve level is appropriate considering the quantities and quality of the inventories.
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Retirement Plans
Actuarial assumptions are used in determining pension income and expense and our pension benefit obligation. We utilize actuaries from consulting companies in each applicable country to develop our discount rates that match high-quality bonds currently available and expected to be available during the period to maturity of the pension benefit in order to provide the necessary future cash flows to pay the accumulated benefits when due. After considering the recommendations of our actuaries, we have assumed a discount rate, expected rate of return on plan assets and a rate of compensation increase in determining our annual pension income and expense and the projected benefit obligation. During the fourth quarter of each year, we review our actuarial assumptions in light of current economic factors to determine if the assumptions need to be adjusted. Changes in the actuarial assumptions could have a material effect on our results of operations.
In February 2020, the CTS Board of Directors authorized management to explore termination of our U.S. based pension plan ("Plan") at management's discretion, subject to certain conditions. On June 1, 2020, we entered into the Fifth Amendment to the Plan whereby we set an effective termination date of July 31, 2020. The Plan termination process is expected to take twelve to eighteen months and requires certain approvals from both the Internal Revenue Service and Pension Benefit Guaranty Corporation. Once we receive such approvals, an insurance company will be selected to purchase annuities and fulfill the obligations of the Plan including administering payments to participants. Upon settlement of the pension liabilities, we will reclassify the related pension losses currently recorded in accumulated other comprehensive loss into earnings. We do not expect any cash contributions from the Company to the Plan as a result of this termination because plan assets exceed estimated liabilities.
Impairment of Goodwill
Goodwill of a reporting unit is tested for impairment annually, or more frequently if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying amount. Examples of such events or circumstances include, but are not limited to, the following:
• | Significant decline in market capitalization relative to net book value, |
• | Significant adverse change in regulatory factors or in the business climate, |
• | Unanticipated competition, |
• | More-likely-than-not expectation that a reporting unit or a significant portion of a reporting unit will be sold or otherwise disposed of, |
• | Testing for recoverability of a significant asset group within a reporting unit, and |
• | Allocation of a portion of goodwill to a business to be disposed. |
If we believe that one or more of the above indicators of impairment have occurred, we perform an impairment test. We have the option to perform a qualitative assessment (commonly referred to as "step zero" test) to determine whether further quantitative analysis for impairment of goodwill and indefinite-lived intangible assets is necessary. The qualitative assessment includes a review of macroeconomic conditions, industry and market considerations, internal cost factors, and our own overall financial and share price performance, among other factors. If, after assessing the totality of events or circumstances we determine that it is not more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, we do not need to perform a quantitative analysis.
If a quantitative assessment is required, we estimate the fair value of each reporting unit using a combination of discounted cash flow analysis and market-based valuation methodologies. Determining fair value using a quantitative approach requires significant judgment, including judgments about projected revenues, 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. At this time, we have not deemed the impact that the current economic environment has or is expected to have on our business to be a triggering event for impairment purposes.
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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 under performance relative to expected historical or projected future operating results, |
• | Significant changes in the manner of use of the acquired assets or the strategy for the overall business, |
• | Significant negative industry or economic trends. |
If we believe that one or more indicators of impairment have occurred, we perform a recoverability test by comparing the carrying amount of an asset or asset group to the sum of the undiscounted cash flows expected to result from the use and the eventual disposition of the asset or asset group. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value. We recorded a charge of $1,016 during the first quarter due to the impairment of a specific asset group. No indicators of impairment were identified during the quarter ended June 30, 2020.
Environmental and Legal Contingencies
U.S. GAAP requires a liability to be recorded for contingencies when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated. Significant judgment is required to determine the existence and amounts of our environmental, legal and other contingent liabilities. We regularly consult with attorneys and consultants to determine the relevant facts and circumstances before we record a liability. Changes in laws, regulatory orders, cost estimates, participation of other parties, timing of payments, input of attorneys and consultants, or other circumstances may have a material impact on the recorded liability.
Income Taxes
Our income tax expense, deferred tax assets and liabilities, and liabilities for unrecognized tax benefits reflect management’s best estimate of current and future taxes to be paid. We are subject to income taxes in the United States and numerous foreign jurisdictions. Significant judgments and estimates are required in the determination of consolidated income tax expense.
Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. In evaluating our ability to recover our deferred tax assets in the jurisdiction from which they arise, we consider all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies, and results of recent operations. The assumptions about future taxable income require the use of significant judgment and are consistent with the plans and estimates we are using to manage our underlying businesses.
The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in a multitude of jurisdictions across our global operations. Accounting Standards Codification (ASC) No. 740 states that a tax benefit from an uncertain tax position may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolution of any related appeals or litigation processes, on the basis of its technical merits. We record unrecognized tax benefits as liabilities in accordance with ASC 740 and adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the unrecognized tax benefit liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is available.
Our practice is to recognize interest and penalties related to income tax matters as part of income tax expense.
Following the enactment of the 2017 Tax Cut and Jobs Act and the associated one-time transition tax, in general, repatriation of foreign earnings to the U.S. can be completed with no incremental U.S. Tax. However, there are limited other taxes that continue to apply such as foreign withholding and certain state taxes. The company records a deferred tax liability for the estimated foreign earnings and state tax cost associated with the undistributed foreign earnings that are not permanently reinvested.
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In the second quarter of 2020, the company made the decision to no longer permanently reinvest the earnings of its Taiwan subsidiary. As a result, a provision for the expected taxes on repatriation of those earnings has been recorded.
Significant Customers
Our net sales to customers representing at least 10% of total net sales is as follows:
Three Months Ended | Six Months Ended | ||||||||||
June 30, | June 30, | June 30, | June 30, | ||||||||
2020 | 2019 | 2020 | 2019 | ||||||||
Cummins Inc. | 9.7 | % | 18.0 | % | 13.4 | % | 18.3 | % | |||
Toyota Motor Corporation | 11.6 | % | 11.8 | % | 11.7 | % | 11.1 | % | |||
Honda Motor Co. | 9.9 | % | 9.9 | % | 8.1 | % | 10.1 | % | |||
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 automotive, communications, and computer industries, as well as conditions in the industrial, defense and aerospace, and medical markets; reliance on key customers; unanticipated natural disasters or other events; the ability to protect our intellectual property; pricing pressures and demand for our products; unanticipated developments that could occur with respect to contingencies such as litigation and environmental matters as well as any product liability claims; 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 CTS' Annual Report on Form 10‑K for the fiscal year ended December 31, 2019. 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.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
For a discussion of current market conditions resulting from the COVID-19 pandemic, refer to Part I, Item 2, "Management's Discussion and Analysis of Financial Condition and Results of Operations” and to Part II, Item 1A, "Risk Factors”.
There have been no other material changes in our market risk since December 31, 2019.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q were effective in providing reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within CTS Corporation have been detected.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting for the quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time we are involved in litigation with respect to matters arising from the ordinary conduct of our business, and currently certain claims are pending against us. In the opinion of management, we believe we have established adequate accruals pursuant to U.S. generally accepted accounting principles for our expected future liability with respect to pending lawsuits, claims and proceedings, where the nature and extent of any such liability can be reasonably estimated based on presently available information. However, there can be no assurance that the final resolution of any existing or future lawsuits, claims or proceedings will not have a material adverse effect on our business, results of operations, financial condition, or cash flows.
See Note 10 "Contingencies" in the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.
Item 1A. Risk Factors
The COVID-19 pandemic is adversely affecting, and is expected to continue to adversely affect, our operations, supply chains and distribution systems, and results of operations. We have experienced, and expect to continue to experience, disruptions in production and supply due to mandated facility closures, labor capacity restrictions, and unpredictable fluctuations in demand for our products. The pandemic could lead to a continued disruption of economic activity and the impact on our consolidated results of operations, financial position and cash flows could be material.
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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On February 7, 2019 the Board of Directors authorized a stock repurchase program with a maximum dollar limit of $25 million. This program authorizes us to make repurchases of our common stock from time to time on the open market, but does not obligate us to make repurchases, and it has no expiration date.
Total Number | Maximum Dollar | ||||||||||||
of Shares | Value of Shares | ||||||||||||
Purchased as | That May Yet By | ||||||||||||
Total Number of | Part of Publicly | Purchased Under | |||||||||||
Shares | Average Price | Announced | Publicly Announced | ||||||||||
Purchased | Paid per Share | Programs | Plans or Programs | ||||||||||
April 1, 2020 through April 30, 2020 | 114,000 | $ | 22.66 | 114,000 | $ | 5,933 | |||||||
May 1, 2020 through May 31, 2020 | 8,000 | $ | 24.11 | 8,000 | $ | 5,740 | |||||||
June 1, 2020 through June 30, 2020 | — | $ | — | — | $ | 5,740 | |||||||
Total | 122,000 | $ | 22.76 | 122,000 | |||||||||
Item 6. Exhibits
10.1 | |
10.2 | |
(31)(a) | |
(31)(b) | |
(32)(a) | |
(32)(b) | |
101.1 | The following information from CTS Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020 formatted in Inline XBRL: (i) Condensed Consolidated Statements of Earnings for the three and six months ended June 30, 2020 and 2019; (ii) Condensed Consolidated Statements of Comprehensive Earnings for the three and six months ended June 30, 2020 and 2019; (iii) Condensed Consolidated Balance Sheets at June 30, 2020 and December 31, 2019; (iv) Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2020 and 2019; (v) Condensed Consolidated Statements of Shareholders’ Equity for the three and six months ended June 30, 2020 and 2019; (vi) Notes to Condensed Consolidated Financial Statements, tagged as blocks of text and including detailed tags. |
104 | The cover page from this Current Report on Form 10-Q formatted as inline XBRL |
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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 | CTS Corporation | |
/s/ William M. Cahill | /s/ Ashish Agrawal | |
William M. Cahill Chief Accounting Officer | Ashish Agrawal Vice President and Chief Financial Officer | |
(Principal Accounting Officer) | (Principal Financial Officer) | |
Dated: July 31, 2020 | Dated: July 31, 2020 | |
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