CTS CORP 10-Q

Item 2. Management’s Discussion and Analysis of Fin ancial 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, 2023. Overview CTS Corporation (“CTS”, “we”, “our” or “us”) is a leading designer and manufacturer of products that Sense, Connect and Move. Our vision is to be a leading provider of sensing and motion devices as well as connectivity components, enabling an intelligent and seamless world. These devices are categorized by their ability to Sense, Connect or Move. Sense products provide vital inputs to electronic systems. Connect products allow systems to function in synchronization with other systems. Move products ensure required movements are effectively and accurately executed. We are committed to achieving our vision by continuing to invest in the development of products, technologies and talent within these categories. We manufacture sensors, actuators, and connectivity components in North America, Europe, and Asia. CTS provides engineered products to OEMs and tier one suppliers in the aerospace and defense, industrial, medical, 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 a number of challenges including, without limitation, periodic market softness, competition from other suppliers, changes in technology, and the ability to add new customers, launch new products or penetrate new markets. Many of these, and other risks and uncertainties relating to the Company and our business, are discussed in further detail in Item 1A. of our Annual Report on Form 10-K and other filings made with the SEC. On July 29, 2024, we acquired substantially all of the assets of SyQwest, LLC (“SyQwest”), a leading designer and manufacturer of a broad set of sonar and acoustic sensing solutions primarily for naval applications, for $125 million, net of cash and debt and up to $15 million in future contingent consideration. The SyQwest acquisition will strengthen our strategy and scale in the defense end market. Results of Operations: Second Quarter 2024 versus Second Quarter 2023 The following table highlights changes in significant components of the Unaudited Condensed Consolidated Statements of Earnings for the quarters ended June 30, 2024 and June 30, 2023: Three Months Ended June 30, 2024 June 30, 2023 Percent Change Percentage of Net Sales – 2024 Percentage of Net Sales – 2023 Net sales $ 130,162 $ 145,182 (10.3 )% 100.0 % 100.0 % Cost of goods sold 83,790 94,440 (11.3 ) 64.4 65.0 Gross margin 46,372 50,742 (8.6 ) 35.6 35.0 Selling, general and administrative expenses 21,332 23,694 (10.0 ) 16.4 16.3 Research and development expenses 6,086 6,721 (9.4 ) 4.7 4.6 Restructuring charges 1,190 1,895 (37.2 ) 0.9 1.3 Total operating expenses 28,608 32,310 (11.5 ) 22.0 22.3 Operating earnings 17,764 18,432 (3.6 ) 13.6 12.7 Total other income (expense), net 5 (2,352 ) (100.2 ) — (1.6 ) Earnings before income taxes 17,769 16,080 10.5 13.7 11.1 Income tax expense 3,062 3,183 (3.8 ) 2.4 2.2 Net earnings $ 14,707 $ 12,897 14.0 % 11.3 % 8.9 % Earnings per share: Diluted net earnings per share $ 0.48 $ 0.41 27 Net sales were $130,162 in the second quarter of 2024, a decrease of $15,020 or 10.3% from the second quarter of 2023. Net sales to the transportation market decreased $17,800 or 21.7% while net sales to non-transportation markets increased $2,780 or 4.4%. The overall decline in net sales was primarily driven by decreased volumes from our commercial vehicle related products and lower sales to transportation customers in China. Changes in foreign exchange rates decreased net sales by $552 year-over-year primarily due to the U.S. Dollar appreciating compared to the Chinese Renminbi and Euro. Gross margin was $46,372 in the second quarter of 2024, a decrease of $4,370 or 8.6% from the second quarter of 2023. The year over year decrease was driven by lower sales volumes. Our gross margin percentage increased from 35.0% for the second quarter of 2023 to 35.6% for the second quarter of 2024 primarily due to improved product mix and the impact of certain cost saving actions previously taken as discussed in Note 9 “Costs Associated with Exit and Restructuring Activities” in the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q. Additionally, changes in foreign exchange rates had a net benefit on our gross margin of approximately $414 primarily from our Mexican Peso hedges. See Note 13 “Derivative Financial Instruments” in the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for further information. Selling, general and administrative (“SG&A”) expenses were $21,332 or 16.4% of net sales in the second quarter of 2024 versus $23,694 or 16.3% of net sales in the second quarter of 2023. Research and development (“R&D”) expenses were $6,086 or 4.7% of net sales in the second quarter of 2024 compared to $6,721 or 4.6% of net sales in the comparable quarter of 2023. Restructuring charges were $1,190 or 1.3% of net sales in the second quarter of 2024 compared to $1,895 or 1.3% of net sales in the second quarter of 2023. The restructuring charges in the quarter ended June 30, 2024 were primarily related to actions undertaken to better align our cost structure with lower end-market demand. See Note 9 “Costs Associated with Exit and Restructuring Activities” in the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for further information. Other income and expense items are summarized in the following table: Three Months Ended June 30, June 30, 2024 2023 Interest expense $ (833 ) $ (818 ) Interest income 1,441 1,072 Other expense, net (603 ) (2,606 ) Total other income (expense), net $ 5 $ (2,352 ) Other expense, net for the quarter ended June 30, 2024 is primarily driven by foreign currency losses, particularly related to the Chinese Renminbi and Mexican Peso, primarily offset by higher interest income from our cash and cash equivalent balances. Three Months Ended June 30, June 30, 2024 2023 Effective tax rate 17.2 % 19.8 % Our effective income tax rate was 17.2% and 19.8% in the second quarters of 2024 and 2023, respectively. The decrease in the effective income tax rate is primarily attributable to a mix of earnings taxed at lower rates. 28 Results of Operations: Six Months ended June 30, 2024 versus Six Months Ended June 30, 2023 The following table highlights changes in significant components of the Unaudited Condensed Consolidated Statements of Earnings for the six months ended June 30, 2024, and June 30, 2023: Six Months Ended June 30, 2024 June 30, 2023 Percent Change Percentage of Net Sales – 2024 Percentage of Net Sales – 2023 Net sales $ 255,912 $ 291,176 (12.1 )% 100.0 % 100.0 % Cost of goods sold 164,450 188,782 (12.9 ) 64.3 64.8 Gross margin 91,462 102,394 (10.7 ) 35.7 35.2 Selling, general and administrative expenses 43,591 45,673 (4.6 ) 17.0 15.7 Research and development expenses 12,687 13,307 (4.7 ) 5.0 4.6 Restructuring charges 2,884 2,807 2.7 1.1 1.0 Total operating expenses 59,162 61,787 (4.2 ) 23.1 21.2 Operating earnings 32,300 40,607 (20.5 ) 12.6 13.9 Total other expense, net (874 ) (1,818 ) (51.9 ) (0.3 ) (0.6 ) Earnings before income taxes 31,426 38,789 (19.0 ) 12.3 13.3 Income tax expense 5,600 7,548 (25.8 ) 2.2 2.6 Net earnings $ 25,826 $ 31,241 (17.3 )% 10.1 % 10.7 % Earnings per share: Diluted net earnings per share $ 0.84 $ 0.98 Net sales were $255,912 in the six months ended June 30, 2024, a decrease of $35,264 or 12.1% from the six months ended June 30, 2023. Net sales to the transportation market decreased $25,572 or 16.4% while net sales to non-transportation markets decreased $9,692 or 7.2%. The decline in overall net sales was primarily driven by lower volumes of commercial vehicle related products, lower sales to transportation customers in China and decreased volumes from our OEM customers in the industrial end market. Changes in foreign exchange rates decreased net sales for the six months ended June 30, 2024 by $1,182 due to the U.S. Dollar appreciating compared to the Chinese Renminbi and Euro. Gross margin was $91,462 for the six months ended June 30, 2024, a decrease of $10,932 or 10.7% from the six months ended June 30, 2023. The year over year decrease in gross margin was primarily driven by lower sales volumes. Our gross margin percentage increased from 35.2% in the first six months of 2023 to 35.7% for first six months of 2024 primarily due to improved product mix and the impact of certain cost saving actions previously taken as discussed in Note 9 “Costs Associated with Exit and Restructuring Activities” in the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q. Additionally, changes in foreign exchange rates had a net benefit on our gross margin of approximately $400 primarily from our Mexican Peso hedges. See Note 13 “Derivative Financial Instruments” in the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for further information. SG&A expenses were $43,591 or 17.0% of net sales for the six months ended June 30, 2024 versus $45,673 or 15.7% of net sales for the six months ended June 30, 2023. R&D expenses were $12,687 or 5.0% of net sales for the six months ended June 30, 2024 compared to $13,307 or 4.6% of net sales for the six months ended June 30, 2023. Restructuring charges were $2,884 or 1.1% of net sales for the six months ended June 30, 2024 compared to $2,807 or 1.0% of net sales for the six months ended June 30, 2023. The restructuring charges were primarily related to actions undertaken to better align our cost structure with lower end-market demand. See Note 9 “Costs Associated with Exit and Restructuring Activities” in the Notes to the Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q for further information. 29 Other income and expense items are summarized in the following table: Six Months Ended June 30, June 30, 2024 2023 Interest expense $ (1,635 ) $ (1,512 ) Interest income 2,827 2,135 Other expense, net (2,066 ) (2,441 ) Total other expense, net $ (874 ) $ (1,818 ) The reduction in total other expense, net was primarily driven by higher interest income from our short-term investments classified as cash equivalents and lower expense related to foreign exchange losses. Six Months Ended June 30, June 30, 2024 2023 Effective tax rate 17.8 % 19.5 % Our effective income tax rate was 17.8% and 19.5% for the six months ended June 30, 2024 and 2023, respectively. The decrease in the effective income tax rate is primarily attributable to a mix of earnings taxed at lower rates. Liquidity and Capital Resources 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 (as defined below). We believe that cash flows from operating activities and available borrowings under our Revolving Credit Facility will be adequate to fund our working capital needs, capital expenditures, investments, and debt service requirements for at least the next twelve months and for the foreseeable future thereafter. However, we may choose to pursue additional equity and debt financing to provide additional liquidity or to fund acquisitions. Cash and cash equivalents were $161,246 at June 30, 2024, and $163,876 at December 31, 2023, of which $117,210 and $99,940, respectively, were held outside the United States. Total long-term debt was $65,000 as of June 30, 2024 and $67,500 as of December 31, 2023. Cash Flow Overview Cash Flows from Operating Activities Net cash provided by operating activities was $37,940 during the six months ended June 30, 2024. Components of net cash provided by operating activities included net earnings of $25,826, depreciation and amortization expense of $14,651, other net non-cash items of $629, and a net cash outflow from changes in assets and liabilities of $3,166. Net cash provided by operating activities was $34,607 during the six months ended June 30, 2023. Components of net cash provided by operating activities included net earnings of $31,241, depreciation and amortization expense of $14,175, other net non-cash items of $4,295, and a net cash outflow from changes in assets and liabilities of $15,104 primarily driven by 2022’s annual bonus payout and an increase in accounts receivable. Cash Flows from Investing Activities Net cash used in investing activities for the six months ended June 30, 2024 was $8,672, driven by payments on capital expenditures. Net cash used in investing activities for the six months ended June 30, 2023 was $(11,846), driven by payments for the Maglab acquisition, finalization of the TEWA Temperature Sensors SP. Zo.o. (“TEWA”) net working capital adjustment of $3,359 and capital expenditures of $8,487. See Note 3 "Business Acquisitions" in the Notes to the Condensed Consolidated Financial Statements. Cash Flows from Financing Activities 30 Net cash used in financing activities for the six months ended June 30, 2024 was $(32,059). The net cash outflow was the result of treasury stock purchases of $22,892, net cash used in the paydown of long-term debt of $2,500, taxes paid on behalf of equity award participants of $3,131, payments of contingent consideration of $1,076 and dividends paid of $2,460. Net cash used in financing activities for the six months ended June 30, 2023 was $(29,967). The net cash outflow was the result of treasury stock purchases of $17,562, net cash used in the paydown of long-term debt of $6,630, taxes paid on behalf of equity award participants of $3,240, and dividends paid of $2,535. Capital Resources Revolving Credit Facility Long‑term debt is comprised of the following: As of June 30, December 31, 2024 2023 Total credit facility $ 400,000 $ 400,000 Balance outstanding 65,000 67,500 Standby letters of credit 1,640 1,640 Amount available, subject to covenant restrictions $ 333,360 $ 330,860 On December 15, 2021, we entered into a second amended and restated five-year credit agreement with a group of banks (the “Revolving Credit Facility”) to (i) increase the total credit facility availability to $400,000, which may be increased by $200,000 at the request of the Company, subject to the administrative agent's approval, (ii) extend the maturity of the Revolving Credit Facility from February 12, 2024 to December 15, 2026, (iii) replace LIBOR with SOFR as the primary reference rate used to calculate interest on the loans under the Revolving Credit Facility, (iv) increase available sublimits for letters of credit, and swing line loans as well as providing for additional alternative currency borrowing capabilities, and (v) modify the financial and non-financial covenants to provide the Company additional flexibility. This new unsecured credit facility replaced the prior $300,000 unsecured credit facility, which would have expired February 12, 2024. Borrowings in U.S. Dollars under the Revolving Credit Facility bear interest, at a per annum rate equal to the applicable Term SOFR rate (but not less than 0.0%), plus the Term SOFR adjustment, and plus an applicable margin, which ranges from 1.00% to 1.75%, based on our net leverage ratio. Similarly, borrowings of alternative currencies under the Revolving Credit Facility bear interest equal to a defined risk-free reference rate, plus the applicable risk-free rate adjustment and plus an applicable margin, which ranges from 1.00% to 1.75%, based on our net leverage ratio. 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. The contractual rate of these arrangements ranges from 1.49% to 2.49%. The Revolving Credit Facility includes a swing-line sublimit of $20,000 and a letter of credit sublimit of $20,000. We also pay a quarterly commitment fee on the unused portion of the Revolving Credit Facility. The commitment fee ranges from 0.175% to 0.25% based on our net leverage ratio. We were in compliance with all debt covenants at June 30, 2024. Acquisition On July 29, 2024, we acquired substantially all of the assets of SyQwest, LLC for $125 million and additional earn out payments based on future performance. The acquisition was funded by a combination of cash on hand and borrowings under our Revolving Credit Facility. Critical Accounting Policies and Estimates The Company’s Condensed Consolidated Financial Statements are prepared in accordance with U.S. GAAP. In connection with the preparation of the Condensed Consolidated Financial Statements, the Company uses estimates and makes judgments and assumptions about future events that affect the reported amounts of assets, liabilities, revenue, expenses, and the related disclosures. The assumptions, 31 estimates, and judgments are based on historical experience, current trends, and other factors the Company believes are relevant at the time it prepares the Condensed Consolidated Financial Statements. The critical accounting policies and estimates are consistent with those discussed in Note 1, Summary of Significant Accounting Policies, to the Consolidated Financial Statements and the MD&A section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2023. During and as of the three and six months ended June 30, 2024, there were no significant changes in the application of critical accounting policies or estimates. 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, 2024 June 30, 2023 June 30, 2024 June 30, 2023 Cummins Inc. 13.1 % 18.6 % 13.4 % 16.4 % Toyota Motor Corporation 11.9 % 12.6 % 12.6 % 11.7 % No other customer accounted for 10% or more of total net sales during these periods. We continue to focus on broadening our customer base to diversify our non-transportation end market exposure. Forward ‑ Looking Statements Readers are cautioned that the statements contained in this document regarding expectations of our performance or other matters that may affect our business, results of operations, or financial condition are, or may be deemed to be, “forward-looking statements” as defined by the “safe harbor” provisions in the Private Securities Litigation Reform Act of 1995. Such statements are made in reliance on the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical fact, included or incorporated in this document, including statements regarding our strategy, financial position, guidance, funding for continued operations, cash reserves, liquidity, projected costs, plans, projects, awards and contracts, and objectives of management, among others, are forward-looking statements. Words such as “expect,” “anticipate,” “should,” “believe,” “hope,” “target,” “continued,” “project,” “plan,” “goals,” “opportunity,” “appeal,” “estimate,” “potential,” “predict,” “demonstrates,” “may,” “will,” “might,” “could,” “intend,” “shall,” “possible,” “would,” “approximately,” “likely,” “outlook,” “schedule,” “on track,” “poised,” “pipeline,” and variations of these terms or the negative of these terms and similar expressions are intended to identify these forward-looking statements , but the absence of these words does not mean that a statement is not forward-looking. These forward-looking statements are not guarantees of future performance, conditions or results. 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 CTS’ 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: supply chain disruptions; changes in the economy generally, including inflationary and/or recessionary conditions, and in respect to the business in which CTS operates; unanticipated issues in integrating acquisitions including, without limitation the integration of SyQwest, LLC.; the results of actions to reposition CTS’ business; rapid technological change; general market conditions in the transportation, as well as conditions in the industrial, aerospace and defense, and medical markets; reliance on key customers; unanticipated public health crises, natural disasters or other events; environmental compliance and remediation expenses; the ability to protect CTS’ intellectual property; pricing pressures and demand for CTS’ products; risks associated with CTS’ international operations, including trade and tariff barriers, exchange rates and political and geopolitical risks (including, without limitation, the potential impact U.S./China relations and the conflict between Russia and Ukraine may have on our business, results of operations and financial condition); the amount and timing of any share repurchases; and the effect of any cybersecurity incidents on our business. Many of these, and other risks and uncertainties, are discussed in further detail in Item 1A. of CTS’ most recent Annual Report on Form 10-K and other filings made with the SEC. CTS undertakes no obligation to publicly update CTS’ 32 forward-looking statements to reflect new information or events or circumstances that arise after the date hereof, including market or industry changes.  Item 3. Quantitative and Qualita tive Disclosures About Market Risk See Item 7A, Quantitative and Qualitative Disclosures about Market Risk, of our Annual Report on Form 10-K for the year ended December 31, 2023. During the six months ended June 30, 2024, there have been no material changes in our exposure to market risk. 33 Item 4. Control s 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 (the “Exchange Act”)) 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 Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. Our management, including our Chief Executive Officer and Chief Financial Officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within CTS have been detected. Changes in Internal Control Over Financial Reporting There were no changes in our internal control over financial reporting for the quarter ended June 30, 2024 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. PART II - OTHE R INFORMATION