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Item 7. Management’s Discussion and Analysis

2022-02-25 compared with 2021-02-25 · 133 added, 144 removed, 96 unchanged (74% of the section changed)

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This section of this Form 10-K generally discusses 2021 and 2020 items and year-to-year comparisons between 2021 and 2020.

Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Discussions of 2019 items and year-to-year comparisons between 2020 and 2019 that are not included in this Annual Report on Form 10-K can be found in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Part II, Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2020.

CTS Corporation ("CTS", "we", "our" or "us") is a leading designer and manufacturer of products that Sense, Connect and Move.

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We manufacture sensors, actuators, and connectivity components in North America, Europe, and Asia.

CTS provides engineered products to OEMs and tier one suppliers in the aerospace and defense, industrial, information technology, medical, telecommunications, and transportation markets.

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.

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We are subject to challenges including periodic market softness, competition from other suppliers, changes in technology, and the ability to add new customers, launch new products or penetrate new markets.

Impact of COVID-19

The COVID-19 pandemic has resulted in a significant disruption to the global economy that has and is likely to have continued adverse impact on our business.

We have experienced reductions in customer demand in several of our end markets.

We expect that social distancing measures, higher employee absenteeism, and reductions in production due to mandated labor capacity restrictions at some of our plants in Asia, Europe, and North America, as well as the reduced operational capacity of our customers and suppliers, could continue to impact our business into 2021.

As a result of these economic headwinds, we implemented cost savings measures throughout 2020, some of which were temporary in nature.

We continue to evaluate market conditions and the impact on our operations to determine the extent and duration of any future cost measures.

The pandemic could lead to additional extended disruptions of economic activity and the impact on our consolidated results of operations, financial position and cash flows could be material.

We remain cautious about the financial impact into 2021.

COVID-19 Impact and Supply Chain Uncertainties

The COVID-19 pandemic and subsequent supply chain uncertainties have had a significant negative impact on the global economy in 2020 and 2021.

This has disrupted the financial markets, negatively impacted the global supply chain and increased the cost of materials and operations, particularly within the global automotive industry.

Key semiconductor chip and other critical part shortages continue to force OEMs to shut down production, often on short notice.

With customers changing orders on short notice, we run the risk of carrying excess inventory in these situations.

These developments are outside of our control, remain highly uncertain, and cannot be predicted.

In addition, the supply chain shortages continue to put pressure on our manufacturing costs and equally our gross margins.

We continue to actively monitor the ongoing impacts of the COVID-19 pandemic and supply chain issues and will seek to mitigate and minimize their impact on our business, when possible.

We anticipate these challenges to continue to impact our results in 2022 and we remain cautious about the financial impact of these potential disruptions on our business.

Results of Operations:

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(Amounts in thousands, except percentages and per share amounts):

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The following table highlights changes in significant components of the Consolidated Statements of Earnings for the years ended December 31, 2020 , and December 31, 2019 :

The following table highlights changes in significant components of the Consolidated Statements of (Loss) Earnings for the years ended December 31, 2021, and December 31, 2020:

Years Ended December 31,

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Restructuring charges

Gain on sale of assets

Total operating expenses

Operating earnings

Total other income (expense), net

Earnings before taxes

Income tax expense

Diluted earnings per share:

Diluted net earnings per share

Net sales were $424,066 for the year ended December 31, 2020, a decrease of $44,933, or 9.6% from 2019.

Net sales for 2020 were adversely impacted by lower volumes as a result of the COVID-19 pandemic and government activities to control its spread.

Specifically, mandated or selective plant closures due to the pandemic and related government activities drove weak demand in some end markets.

In addition, the activities had a significant impact on our supply chain.

We remain cautious about possible future disruptions on our supply chain, operations, and future demand.

Net sales to transportation markets decreased $57,559 or 19.3%.

Total other (expense) income, net

(Loss) earnings before taxes

Income tax (benefit) expense

Net (loss) earnings

Diluted (loss) earnings per share:

Diluted net (loss) earnings per share

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Net sales were $512,925 for the year ended December 31, 2021, an increase of $88,859, or 21.0% from 2020.

Net sales growth was driven by the overall improvement in the economy including our focus on end-customer diversification.

Net sales to transportation markets increased $42,634 or 17.7%.

Net sales to other markets increased $46,224, or 25.3%.

The QTI acquisition, which was completed in July 2019, added sales of $24,508 in 2020 compared to $9,252 in 2019.

The Sensor Scientific, Inc.

acquisition, which was completed in December 2020, added sales of $7,112 in 2021.

Changes in foreign exchange rates increased net sales by $6,938 year-over-year primarily due to the U.S.

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Gross margin as a percent of sales was 36.0% in 2021 versus 32.8% in 2020.

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 $67,787, or 16.0% of sales for the year ended December 31, 2020, versus $70,408 or 15.0% of sales in the comparable period of 2019.

The 2020 SG&A costs include savings from cost reduction measures we implemented during the year, partially offset by a full year of amortization of intangibles and other operating costs associated with the QTI acquisition.

Research and development expenses were $24,317 or 5.7% of sales in 2020 compared to $25,967 or 5.5% of sales in 2019.

Restructuring charges were $1,830 for year ended December 31, 2020 and were primarily as a result of certain initiatives initiated in the third quarter of 2020.

The restructuring actions are focused on optimizing our manufacturing footprint and improving operational efficiency by better utilizing our systems capabilities.

Restructuring charges were $7,448 in 2019.

Operating earnings were $45,129, or 10.6% of sales in 2020, compared to $53,815, or 11.5% of sales in 2019 as a result of the items discussed above.

The increase in gross margin was driven primarily by sales volume and mix .

We continue to experience significant inflation in material and freight costs as well as interruptions in the supply chain particularly due to the global semiconductor chip and resin shortages impacting the operations of our business.

The impact of the supply chain shortages and OEM shutdowns are expected to continue to have an adverse effect on our operations that we are continuing to mitigate.

Selling, general and administrative ("SG&A") expenses were $82,597, or 16.1% of sales for the year ended December 31, 2021, versus $67,787 or 16.0% of sales in 2020.

Total SG&A expenses tracked higher with higher costs associated with increased net sales including primarily the restoration of cost saving measures, including incentive compensation in 2021.

Research and development (“R&D”) expenses were $23,856, or 4.7% of sales in 2021 compared to $24,317, or 5.7% of sales in 2020.

The decrease in overall R&D expenses was primarily due to changes in timing and mix of certain projects.

Restructuring charges were $1,687, or 0.3% of net sales in 2021, compared to $1,830, or 0.4% of net sales in 2020.

We continue to implement certain restructuring actions to improve our cost structure to remain competitive.

Other income and expense items are summarized in the following table:

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Interest income

Other income (expense)

Total other income (expense), net

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Interest expense increased mainly due to a higher average debt balance during 2020 related to the QTI acquisition and additional borrowings at the end of the first quarter to ensure adequate liquidity for the next several quarters in light of COVID-19 concerns .

Interest income declined as a result of lower interest rates on foreign cash balances.

The Other income, net for the twelve months ended December 31, 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, which were partially offset by pension expense.

Other (expense) income

Total other (expense) income, net

Other expense, net in 2021 was primarily driven by increased pension expense including $126,269 in settlement charges from our U.S.

pension plan termination process in the second and third quarters of 2021 as well as foreign currency translation losses, mainly due to the appreciation of the U.S.

Dollar compared to the Czech Koruna and Mexican Peso.

Years Ended December 31,

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The effective income tax rate in 2021 was 31.2% compared to 23.7% in the prior year.

This decrease is primarily attributed to the change in the mix of earnings by jurisdiction, decreases in uncertain tax position and offset by the company's decision to no longer reinvest the earnings of its Taiwan subsidiary.

The tax rate in 2020 was higher than the U.S.

statutory federal tax rate primarily due to foreign earnings that are taxed at higher rates and unfavorable impacts to reserves.

The tax rate in 2019 was higher than the U.S.

statutory federal tax rate primarily due to foreign earnings that are taxed at higher rates, the impact of taxes on unremitted earnings and unfavorable increases to reserves.

Net earnings were $34,686 or $1.06 per diluted share for the year ended December 31, 2020 compared to earnings of $36,146 or $1.09 per diluted share in the comparable period of 2019.

This increase is primarily attributable to the impact of the U.S.

pension plan settlement charges taken in 2021.

Liquidity and Capital Resources

Cash and cash equivalents were $141,465 at December 31, 2021 and $91,773 at December 31, 2020, of which $124,635 and $90,051 respectively, were held outside the United States.

The decrease in cash and cash equivalents of $8,468 was primarily driven by net payments of long-term debt of $45,100, capital expenditures of $14,858, payments for the SSI acquisition of $8,309, treasury stock purchases of $8,080, and dividends paid of $5,179, which were partially offset by cash generated from operating activities of $76,783.

The increase in cash and cash equivalents of $49,692 was primarily driven by cash generated from operating activities of $86,141 partially offset by $(20,712) and $(15,896) in financing and investing activities, respectively.

Total debt as of December 31, 2021 and December 31, 2020, was $50,000 and $54,600, respectively.

Total debt as a percentage of total capitalization, defined as long-term debt as a percentage of total debt and shareholders’ equity, was 9.7% at December 31, 2021, compared to 11.4% at December 31, 2020.

Working capital decreased by $12,231 from December 31, 2019, to December 31, 2020, driven mainly by the decrease in cash and cash equivalents related to the items noted above.

Cash Flows from Operating Activities

Net cash provided by operating activities was $86,141 during the year ended December 31, 2021.

Components of net cash provided by operating activities included net loss of $(41,866), depreciation and amortization expense of $26,930, non-cash pension and other post-retirement plan expenses of $132,650, and other net non-cash items totaling $(24,912), and a net cash outflow from changes in assets and liabilities of $(6,661).

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Net cash provided by operating activities was $76,783 during the year ended December 31, 2020.

Components of net cash provided by operating activities included net earnings of $34,686, depreciation and amortization expense of $26,670, stock-based compensation of $3,417, other net non-cash items totaling $930, and a net cash inflow from changes in assets and liabilities of $10,064.

Cash Flows from Investing Activities

Net cash used in investing activities for the year ended December 31, 2021 was $15,896, driven primarily by capital expenditures.

Net cash used in investing activities for the year ended December 31, 2020 was $23,167, driven by capital expenditures of $14,858 and the payment for the Sensor Scientific, Inc.

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The net cash outflow was the result of net payments of long-term debt of $4,600, treasury stock purchases of $8,786, dividend payments of $5,173, taxes paid on behalf of equity award participants of $1,503, and a contingent consideration payment of $650.

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Net cash used in financing activities for the year ended December 31, 2020, was $61,333.

The net cash outflow was the result of net payments of long-term debt of $45,100, treasury stock purchases of $8,080, dividend payments of $5,179, taxes paid on behalf of equity award participants of $1,917, and a contingent consideration payment of $1,057.

Capital Resources

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As of December 31,

Total credit facility

Total credit facility availability

Balance outstanding

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Weighted-average interest rate

Commitment fee percentage per annum

On February 12, 2019, we entered into an amended and restated five-year Credit Agreement with a group of banks (the "Credit Agreement") to extend the term of the facility.

The Credit Agreement provides for a revolving credit facility of $300,000, which may be increased by $150,000 at the request of the Company, subject to the administrative agent's approval.

This new unsecured credit facility replaces the prior $300,000 unsecured credit facility, which would have expired August 10, 2020.

Borrowings of $50,000 under the prior credit agreement were refinanced into the Credit Agreement.

The prior agreement was terminated as of February 12, 2019.

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 swingline 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.

The Revolving Credit Facility includes a swing line sublimit of $ 20,000 and a letter of credit sublimit of $ 20,000 .

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.

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.

The commitment fee ranges from 0.175 % to 0.25 % based on our net leverage ratio.

Our liquidity, access to capital, and borrowing costs could be adversely impacted by declines in our credit rating, our financial performance, and global credit market conditions, as well as a broad range of other factors, including those related to the COVID-19 pandemic discussed in this Form 10-K.

See “Item 1A.

Risk Factors” for additional discussion of these and other risks that our business faces.

As of December 31, 2021, our material cash requirements for our known contractual and other obligations were as follows:

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Long-term debt, including interest – Outstanding principal on our Revolving Credit Facility was $50,000 at December 31, 2021, with no amounts payable within 12 months.

Additionally, we had future interest payments based on our hedged borrowings under our Revolving Credit Facility of $3,720 through maturity in December 2026, with approximately $1,162 payable within 12 months.

Interest payments under the Revolving Credit Facility are determined based upon the average outstanding balance of our borrowings and the prevailing interest rate during that time and are inclusive of our hedge impact.

See Note 13, “Debt,” in our Annual Report on 10K for further details of our debt.

Operating lease payments – We enter into various noncancelable lease agreements for land, buildings and equipment under non-cancellable operating leases used in our operations .

Operating lease obligations were $31,894, with $4,826 payable within 12 months.

See Note 12, “Leases,” in our Annual Report on 10K for further detail of our obligations and the timing of expected future payments.

Retirement obligations – Expected future payments relating to our defined benefit postretirement plans were $6,609, with $825 payable in 12 months.

See Note 7, “Retirement Plan,” in our Annual Report on 10K for further detail of our obligations and the timing of expected future payments.

We have historically funded our capital and operating needs primarily through cash flows from operating activities, supported by available credit under our Revolving Credit Facility.

We believe that cash flows from operating activities and available borrowings under our Revolving Credit Facility will be adequate to fund our working capital needs, capital expenditures, and debt service requirements for at least the next twelve months.

However, we may choose to pursue additional equity and debt financing to provide additional liquidity or to fund acquisitions.

Critical Accounting Policies and Estimates

Management prepared the consolidated financial statements under accounting principles generally accepted in the United States of America.

These principles require the use of estimates, judgments, and assumptions.

We believe that the estimates, judgments, and assumptions we used are reasonable, based upon the information available.

Our estimates and assumptions affect the reported amounts in our financial statements.

The following accounting policies comprise those that we believe are the most critical in understanding and evaluating our reported financial results.

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 either using a quoted industry rate or based on customer specific circumstances.

We adjust our warranty reserve for any known or anticipated warranty claims as new information becomes available.

We evaluate our warranty obligations at least quarterly and adjust our accruals if it is probable that future costs will be different than our current reserve.

Over the last three years, product warranty reserves have ranged from 0.5% to 2.4% of total sales.

We believe our reserve level is appropriate considering all facts and circumstances surrounding any outstanding quality claims and our historical experience selling our products to our customers.

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Accounts Receivable

We have standardized credit granting and review policies and procedures for all customer accounts, including:

• Credit reviews of all new significant customer accounts,

• Ongoing credit evaluations of current customers,

• Credit limits and payment terms based on available credit information,

• Adjustments to credit limits based upon payment history and the customer's current creditworthiness,

• An active collection effort by regional credit functions, reporting directly to the corporate financial officers, and

• Limited credit insurance on the majority of our international receivables.

We reserve for estimated credit losses based 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 ranged from 0.1% to 1.1% of total accounts receivable.

We believe our reserve level is appropriate considering the quality of the portfolio.

While credit losses have historically been within expectations of the reserves established, we cannot guarantee that our credit loss experience will continue to be consistent with historical experience or our current forecasts.

We value our inventories at the lower of the actual cost to purchase or manufacture using the first-in, first-out ("FIFO") method, or net realizable value.

We review inventory quantities on hand and record a provision for excess and obsolete inventory based on 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 13.9% of gross inventory.

We believe our reserve level is appropriate considering the quantities and quality of the inventories.

Retirement Plans

Actuarial assumptions are used in determining pension income and expense and our defined benefit obligations.

We utilize actuaries from consulting companies in each applicable country to develop our discount rates, matching high-quality bonds currently available and expected to be available during the period to maturity of the pension benefit in order to provide the necessary future cash flows to pay the accumulated benefits when due.

After considering the recommendations of our actuaries, we have assumed a discount rate, expected rate of return on plan assets, and a rate of compensation increase in determining our annual pension income and expense and the projected benefit obligation.

During the fourth quarter of each year, we review our actuarial assumptions in light of current economic factors to determine if the assumptions need to be adjusted.

Changes in the actuarial assumptions could have a material effect on our results of operations.

In February 2020, the CTS Board of Directors authorized management to explore termination of our U.S.

Pension Plan (“Plan”) at management's discretion, subject to certain conditions.

On June 1, 2020, we amended the Plan whereby we set an effective termination date of July 31, 2020.

In February 2021, we received the determination letter from the Internal Revenue Service that allows us to proceed with the termination process.

The completion of the Plan termination process, including offering lump sum settlements and the final purchases of annuities, is expected to occur in 2021.

Since the amount of the settlement depends on a number of factors determined as of the liquidation date, including lump sum payout estimates, the annuity pricing interest rate environment and asset experience, we are currently unable to determine the ultimate cost of the settlement.

However, w e expect non-cash settlement charges of approximately $10,000 to $20,000 to be recognized in the second or third quarter of 2021 with the remaining amount of the gross accumulated other comprehensive loss balance to be recognized by the end of 2021.

We do not expect any cash contributions from the Company to the Plan as a result of this termination because plan assets significantly exceed estimated liabilities.

Impairment of Goodwill

Goodwill of a reporting unit is tested for impairment annually, or more frequently if an event occurs or circumstances change that would more-likely-than-not reduce the fair value of a reporting unit below its carrying amount.

We have no off-balance sheet arrangements that have a material current effect or are reasonably likely to have a material future effect on our financial condition or changes in our financial condition.

Critical Accounting Estimates and Policies

The Securities and Exchange Commission ("SEC") has defined a company’s critical accounting policies as the ones that are most important to the portrayal of a company’s financial condition and results of operations, and which require a company to make its most difficult and subjective judgments, often as a result of the need to make estimates of matters that are inherently uncertain.

Based on this definition, we have identified the critical accounting policies and judgments addressed below.

We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances.

Actual results may differ from these estimates.

Critical Accounting Estimates

Goodwill, Intangibles and Other Long-Lived Assets

Purchase Accounting

We use the acquisition method of accounting to allocate costs of acquired businesses to the assets acquired and liabilities assumed based on their estimated fair values at the dates of acquisition.

The excess costs of acquired businesses over the fair values of the assets acquired and liabilities assumed are recognized as goodwill.

The valuations of the acquired assets and liabilities will impact the determination of future operating results.

Determining the fair value of assets acquired and liabilities assumed requires management’s judgment and often involves the use of significant estimates and assumptions, including assumptions with respect to future cash inflows and outflows, revenue growth rates, discount rates, customer attrition rates, asset lives, contributory asset charges, and market multiples, among other items.

We determine the fair values of intangible assets acquired generally in consultation with third-party valuation advisors.

Intangible assets other than goodwill are recognized if the benefit of the intangible asset is obtained through contractual or other legal rights, or if the intangible asset can be sold, transferred, licensed or exchanged, regardless of the Company’s intent to do so.

Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible assets acquired in a business combination and is reviewed annually for impairment or more frequently if impairment indicators arise.

Finite-lived intangible assets are reviewed for impairment if facts and circumstances warrant.

Impairment Assessment – Goodwill

Goodwill of a reporting unit is tested for impairment on the first day of its fiscal fourth quarter, 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:

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• 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,

CTS CORPORATION 22

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.

If we believe that one or more indicators of impairment have occurred, we perform an impairment test.

We have the option to perform a qualitative assessment (commonly referred to as a "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.

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Changes in these estimates and assumptions could materially affect the determination of fair value and impact the goodwill impairment assessment.

We typically perform a quantitative assessment at least every three years, or as conditions require.

Our previous quantitative test was in 2017, therefore, we performed the current year assessment using a quantitative approach .

For 2021, w e elected to perform the quantitative assessment.

Based upon our latest assessment, we determined that our goodwill was not impaired as of October 1, 2021.

We will monitor future results and will perform a test if indicators trigger an impairment review.

Impairment of Other Intangible and Long-Lived Assets

Impairment Assessment – Other Intangible Assets and Other 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.

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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.

In addition, we recorded a charge of $2,200 during the third quarter of 2020 due to the impairment of a specific asset group as a result of the restructuring actions being taken.

No other indicators of impairment were identified during the year ended December 31, 2020.

Environmental and Legal Contingencies

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.

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.

Significant judgments and estimates are required in the determination of consolidated income tax provision.

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.

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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.

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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.

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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.

However, there are limited other taxes that continue to apply such as foreign withholding and certain state taxes.

The company records a deferred liability for the estimated foreign earnings and state tax cost associated with the undistributed foreign earnings that are not permanently reinvested.

Contractual Obligations

Our contractual obligations as of December 31, 2020, were:

Payments due by period

Long-term debt, including interest

Operating lease payments

Retirement obligations

Management believes that existing capital resources and funds generated from operations are sufficient to finance anticipated capital requirements.

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Critical Accounting Policies

Revenue Recognition

We recognize revenue in accordance with the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) 606 Revenue from Contracts with Customers net of estimated reserves.

Our revenue reserves contain uncertainties because they require management to make assumptions and to apply judgment to estimate the value of future credits to customers for price adjustments.

We base these estimates on the most likely value method considering all reasonably available information, including our historical experience and current expectations, and are reflected in the transaction price when sales are recorded.

Product Warranties

Provisions for estimated warranty expenses are made at the time products are sold.

The expense and corresponding accrual primarily relate to our products sold to our transportation markets.

These estimates are established using a quoted industry rate and are based on customer specific circumstances.

We adjust our warranty reserve for any known or anticipated warranty claims as new information becomes available.

We evaluate our warranty obligations at least quarterly and adjust our accruals if it is probable that future costs will be different than our current reserve.

Over the last three years, product warranty reserves have ranged from 0.5% to 2.7% of net 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.

We value our inventories at the lower of the actual cost to purchase or manufacture using the first-in, first-out ("FIFO") method, or net realizable value.

We review inventory quantities on hand and record a provision for excess and obsolete inventory based on historical consumption trends as well as forecasts of product demand including related production requirements.

Once reserves are established, write-downs of inventory are considered permanent adjustments to the cost basis of inventory.

Our reserves contain uncertainties because the calculation requires management to make assumptions and to apply judgment regarding historical experience, market conditions, and product life cycles.

Changes in actual demand or market conditions could adversely impact our reserve calculations.

Over the last three years, our reserves for excess and obsolete inventories have ranged from 10.2% to 16.0% of gross inventory.

We believe our reserve level is appropriate considering the quantities and quality of the inventories.

Retirement Plans

Actuarial assumptions are used in determining pension income and expense and our defined benefit obligations.

In February 2020, the CTS Board of Directors authorized management to explore termination of the U.S.-based pension plan ("Plan"), subject to certain conditions.

On June 1, 2020, we entered into the Fifth Amendment to the Plan whereby we set an effective termination date for the Plan of July 31, 2020.

In February 2021, we received a determination letter from the Internal Revenue Service that allowed us to proceed with the termination process for the Plan.

As a result, we offered a lump sum payment to eligible participants with vested qualified Plan benefits in lieu of receiving monthly annuity payments in the second quarter of 2021 and purchased a group annuity contract that transferred our remaining obligations for the remaining participants in the third quarter.

For a further discussion of the process and related financial impact please see Note 7 to Item 8 of this Annual Report on Form 10-K.

Environmental Contingencies

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.

We record environmental contingent loss accruals on an undiscounted basis.

Significant judgment is required to determine the existence and amounts of our environmental liabilities.

We regularly consult with attorneys and consultants to determine the relevant facts and circumstances before we record a liability.

Changes in the estimates on which the accruals are based, unanticipated government enforcement action, or changes in health, safety, environmental, and chemical control regulations and testing requirements could, and have, resulted in higher or lower costs.

CTS CORPORATION 24

Recent Accounting Pronouncements

The information set forth under Note 1 to Item 8 of this Annual Report on Form 10-K is incorporated herein by reference.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis