CTS CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) (in thousands of dollars, 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, 2021. Overview CTS Corporation ("CTS", "we", "our" or "us") is a leading designer and manufacturer of products that Sense, Connect and Move. Our vision is to be a leading provider of sensing and motion devices as well as connectivity components, enabling an intelligent and seamless world. These devices are categorized by their ability to Sense, Connect or Move. Sense products provide vital inputs to electronic systems. Connect products allow systems to function in synchronization with other systems. Move products ensure required movements are effectively and accurately executed. We are committed to achieving our vision by continuing to invest in the development of products and technologies, and talent within these categories. We manufacture sensors, actuators, and connectivity components in North America, Europe, and Asia. CTS provides engineered products to original equipment manufacturers (“OEMs”) and tier one suppliers in the aerospace and defense, industrial, medical, and transportation markets. There is an increasing proliferation of sensing, connectivity, and motion applications within various markets we serve. Our success is dependent on the ability to execute our strategy to support these trends. We are subject to 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. 23 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, 2021, and into 2022. These events have 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 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 for the remainder of 2022 and we remain cautious about the financial impact of these potential disruptions on our business. Results of Operations: First Quarter 2022 versus First Quarter 2021 The following table highlights changes in significant components of the Unaudited Condensed Consolidated Statements of Earnings for the quarters ended March 31, 2022, and March 31, 2021: Three Months Ended Percent of Percent of March 31, March 31, Percent Net Sales – Net Sales – 2022 2021 Change 2022 2021 Net sales $ 147,695 $ 128,427 15.0 % 100.0 % 100.0 % Cost of goods sold 93,355 85,836 8.8 63.2 66.8 Gross margin 54,340 42,591 27.6 36.8 33.2 Selling, general and administrative expenses 21,788 18,325 18.9 14.8 14.3 Research and development expenses 6,194 5,687 8.9 4.2 4.4 Restructuring charges 312 81 285.2 0.2 0.1 Total operating expenses 28,294 24,093 17.4 19.2 18.8 Operating earnings 26,046 18,498 40.8 17.6 14.4 Total other expense, net (300 ) (3,709 ) (91.9 ) (0.2 ) (2.9 ) Earnings before income taxes 25,746 14,789 74.1 17.4 11.5 Income tax expense 5,507 2,799 96.7 3.7 2.2 Net earnings $ 20,239 $ 11,990 68.8 % 13.7 % 9.3 % Earnings per share: Diluted net earnings per share $ 0.63 $ 0.37 Net sales were $147,695 in the first quarter of 2022, an increase of $19,268 or 15.0% from the first quarter of 2021. Net sales to non-transportation markets increased $15,988 or 30.4% while net sales to transportation markets increased $3,280 or 4.3%. The TEWA Temperature Sensors SP.Zo.o. ("TEWA") acquisition, which was completed in February 2022, added $1,439 in net sales for the quarter. Changes in foreign exchange rates decreased net sales by $329 year-over-year primarily due to the U.S. Dollar appreciating compared to the Euro. Gross margin as a percent of net sales was 36.8% in the first quarter of 2022 compared to 33.2% in the first quarter of 2021. 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 attempt to mitigate. Selling, general and administrative ("SG&A") expenses were $21,788 or 14.8% of net sales in the first quarter of 2022 versus $18,325 or 14.3% of net sales in the first quarter of 2021. The increase in SG&A expenses was caused by expenses related to acquisition activity and partly due to increase in incentive compensation expenses. Research and development (“R&D”) expenses were $6,194 or 4.2% of net sales in the first quarter of 2022 compared to $5,687 or 4.4% of net sales in the comparable quarter of 2021. The increase in overall R&D expenses is in line with our commitment to continue investing in research and product development to drive organic growth. 24 Restructuring charges were $312 or 0.2% of net sales in the first quarter of 2022 compared to $81 or 0.1% of net sales in the first quarter of 2021. We continue to implement certain restructuring actions to improve our cost structure to remain competitive. Operating earnings were $26,046 or 17.6% of net sales in the first quarter of 2022 compared to operating earnings of $18,498 or 14.4% of net sales in the first quarter of 2021. The change in operating earnings were driven by the items discussed above. Other income and expense items are summarized in the following table: Three Months Ended March 31, March 31, 2022 2021 Interest expense $ (546 ) $ (555 ) Interest income 180 202 Other income (expense), net 66 (3,356 ) Total other expense, net $ (300 ) $ (3,709 ) The reduction in other expense, net was primarily driven by decreased pension expense due to the U.S. Pension plan termination, effective in 2021 . Three months ended March 31, March 31, 2022 2021 Effective tax rate 21.4 % 18.9 % Our effective income tax rate was 21.4% and 18.9% in the first quarters of 2022 and 2021, respectively. This increase is primarily attributed to the change in the mix of earnings by jurisdiction. 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. 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 $126,118 at March 31, 2022, and $141,465 at December 31, 2021, of which $115,206 and $124,635, respectively, were held outside the United States. Total long-term debt was $50,000 as of March 31, 2022 and $50,000 as of December 31, 2021. Total debt as a percentage of total capitalization, defined as long-term debt as a percentage of total debt and shareholders' equity, was 9.4% at March 31, 2022, compared to 9.7% at December 31, 2021. Cash Flow Overview Cash Flows from Operating Activities Net cash provided by operating activities was $19,286 during the three months ended March 31, 2022. Components of net cash provided by operating activities included net earnings of $20,239, depreciation and amortization expense of $6,749, other net non-cash items of $3,221, and a net cash outflow from changes in assets and liabilities of $10,923. Cash Flows from Investing Activities Net cash used in investing activities for the three months ended March 31, 2022 was $27,884, driven by the payment for the TEWA acquisition of $24,484 and capital expenditures of $3,400 . See Note 3 "Business Acquisitions" in the Notes to the Condensed Consolidated Financial Statements . Cash Flows from Financing Activities Net cash used in financing activities for the three months ended March 31, 2022 was $6,772. The net cash outflow was the result of treasury stock purchases of $3,920, dividends paid of $1,289, taxes paid on behalf of equity award participants of $1,413, and a contingent consideration payment of $150. 25 Capital Resources Revolving Credit Facility Long‑term debt is comprised of the following: As of March 31, December 31, 2022 2021 Total credit facility $ 400,000 $ 400,000 Balance outstanding 50,000 50,000 Standby letters of credit 1,740 1,740 Amount available, subject to covenant restrictions $ 348,260 $ 348,260 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. 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 March 31, 2022. Acquisitions On February 28, 2022, we acquired TEWA, a designer and manufacturer of high-quality temperature sensors. The net cash payment of $24,484 for this acquisition was funded by the Company's cash on hand. On April 12, 2022, we entered into a Share Sale and Purchase Agreement (“SPA”) with Meggitt International, Ltd., a private limited company incorporated in England and Wales (“Seller”), and Meggitt International Holdings, Ltd., a private limited company incorporated in England and Wales (“Guarantor”), to acquire (the “Ferroperm Acquisition”) Meggitt A/S (a/k/a Ferroperm Piezoceramics A/S), a company incorporated in Denmark (“Ferroperm”). Seller and Guarantor are wholly-owned subsidiaries of Meggitt PLC, a public limited company incorporated in England and Wales. Ferroperm is a wholly-owned subsidiary of Seller, and a leading provider of advanced materials focused on high performance piezoelectric ceramics with a majority of its sales in the medical end-market. Pursuant to the SPA, the Company has agreed to purchase all of the issued and outstanding shares of Ferroperm from Seller for DKK 525 million in cash (approximately $76,800 based on the exchange rate between DKK and USD of 6.836 as of April 12, 2022), subject to customary net debt and working capital adjustments. The Ferroperm Acquisition is subject to the receipt of certain governmental approvals and the satisfaction of other closing conditions. The SPA contains customary conditions, representations, warranties, indemnities and covenants by, among, and for the benefit of the parties. At the time of the SPA, we hedged approximately DKK 400 million of the purchase price in order to manage the Company’s foreign currency risk. The hedge does not qualify for hedge accounting. 26 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, 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, 2021. During and as of the three months ended March 31, 2022, 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 March 31, March 31, 2022 2021 Cummins Inc. 15.7 % 15.7 % Toyota Motor Corporation 11.5 % 13.4 % 27 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 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 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: the ultimate impact of the COVID-19 pandemic on CTS’ business, results of operations or financial condition; 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 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; and risks associated with CTS’ international operations, including trade and tariff barriers, exchange rates and political and geopolitical risks (including, without limitation, the potential impact the conflict between Russia and Ukraine may have on our business, results of operations and financial condition). Many of these, and other risks and uncertainties, are discussed in further detail in Item 1A. of CTS’ Annual Report on Form 10-K and other filings made with the SEC. CTS undertakes no obligation to publicly update CTS’ forward-looking statements to reflect new information or events or circumstances that arise after the date hereof, including market or industry changes.