May 24, 2007

 

Dear CTS Shareholder:

 

You are cordially invited to attend the 2007 Annual Meeting of Shareholders of CTS Corporation. The meeting will be held on Thursday, June 28, 2007, at 9:00 a.m. CDT at the Hilton Chicago O’Hare Airport Hotel in Chicago, Illinois.

 

The official notice of meeting, proxy statement and proxy form are enclosed. These materials were first mailed to shareholders on May 24, 2007. We hope you will attend the meeting in person. Whether you plan to attend the meeting or not, we encourage you to read this proxy statement and vote your shares. The vote of every shareholder is important.

 

We look forward to seeing you at the meeting.

 

 

Donald K. Schwanz

Chairman of the Board,

President and Chief

Executive Officer

 

 

Notice of Annual Meeting of Shareholders

 

June 28, 2007

 

To CTS Shareholders:

 

The Annual Meeting of Shareholders of CTS Corporation will be held at 9:00 a.m. Central Daylight Time, Thursday, June 28, 2007 at the Hilton Chicago O’Hare Airport Hotel in Chicago, Illinois.

 

Only shareholders of record at the close of business on May 9, 2007 may vote at this meeting or any adjournments that may take place. At the meeting, we will:

 

1. Elect a Board of Directors;

 

2. Approve the CTS Corporation 2007 Management Incentive Plan; and

 

3. Attend to other business properly presented at the meeting.

 

Your Board of Directors recommends that you vote in favor of the proposals described in this proxy statement.

 

By Order of the Board of Directors,

 

Richard G. Cutter

Secretary

 

May 24, 2007

 

 

 

 

PROXY STATEMENT

 

 

ANNUAL MEETING OF SHAREHOLDERS

 

June 28, 2007

 

This proxy statement, which was first mailed to shareholders on May 24, 2007, is furnished in connection with the solicitation by the Board of Directors of CTS Corporation of proxies to be voted at the Annual Meeting of Shareholders to be held on Thursday June 28, 2007. Following is important information in a question-and-answer format regarding the Annual Meeting and this proxy statement.

 

 

 

 

 

ITEM 1: ELECTION OF DIRECTORS

 

CTS’ Articles of Incorporation provide that the number of directors will be between three and fifteen, as fixed from time to time by the Board of Directors. The CTS Board of Directors has established the current number of authorized directors at nine. All directors are elected to one-year terms or until their successors are elected and qualified.

 

Nominees For The Board of Directors.  Each of the nominees named below is currently a director of CTS. The ages shown are as of the scheduled date for the 2007 Annual Meeting of Shareholders. Each of the nominees has agreed to serve as a director if elected by the shareholders. If one or more of the nominees unexpectedly becomes unavailable for election, the votes will be cast, pursuant to authority granted by the proxy, for such person or persons as may be designated by the present Board of Directors, or the authorized number of directors may be reduced accordingly.

 

Age 62

 

Mr. Catlow served as President of Ameritech Cellular Services, a wireless communications service provider, from 1998 until his retirement in 2000. Mr. Catlow previously served as Executive Vice President of Ameritech and as President of Ameritech International, Inc., where he directed Ameritech’s international investments and was responsible for global acquisitions and alliances. In 2006, Mr. Catlow was a member of the Audit Committee of CTS Corporation and the Presiding Director.

 

Age 65

 

Mr. Ciancia is a partner in Corporate Development International, Inc., a corporate search firm specializing in mergers, acquisitions and divestitures. He has served in this capacity since 1998. Previously, he served as President of Uponor ETI, a supplier of PVC pipe products, specialty chemicals and PVC compounds. In 2006, Mr. Ciancia was a member of the Audit Committee and Chairman of the Nominating and Governance Committee of CTS Corporation.

 

Age 65

 

Mr. Cody has served as Vice Chairman of Federated Department Stores, Inc., a nationwide department store retailer, since February 2003. Prior to assuming this position, he served as Executive Vice President, Legal and Human Resources of Federated Department Stores, Inc. since 1992. Mr. Cody also serves as a director of LCA-Vision, Inc. In 2006, Mr. Cody was Chairman of the Compensation Committee and a member of the Nominating and Governance Committee of CTS Corporation.

 

Age 77

 

Mr. Frieling has served as President of Frieling & Associates, a business consulting firm, since 1993. Previously, Mr. Frieling served as Chairman of the Board, CEO and Vice Chairman of the Board of Tokheim Corporation, a manufacturer of electronic and mechanical petroleum marketing systems. Mr. Frieling also serves as a director of Mossberg & Company. In 2006, Mr. Frieling was a member of the Finance Committee, Audit Committee and Nominating and Governance Committee of CTS Corporation.

 

Age 70

 

Mr. Hemminghaus is the retired Chairman and Chief Executive Officer of Ultramar Diamond Shamrock Corporation, a company that refined and marketed petroleum products on a retail and wholesale basis, serving from 1996 until 2000. Mr. Hemminghaus served as Chairman and Chief Executive Officer of Ultramar Diamond Shamrock, Inc. from 1996 until 1999. Mr. Hemminghaus is a past Chairman of the Federal Reserve Bank of Dallas. Mr. Hemminghaus also serves as a Director of Tandy Brand Accessories, Inc. and Xcel Energy, Inc. In 2006, Mr. Hemminghaus was a member of the Compensation Committee and Chairman of the Finance Committee of CTS Corporation.

 

Age 67

 

Mr. Henning is the retired Deputy Chairman of Ernst & Young LLP, an independent accounting firm, serving from 1999 to 2000. Previously, he served as Chief Executive Officer of Ernst & Young International, Inc. from 1993 until 1999. Mr. Henning also serves as a Director of Omnicom Group, Inc. In 2006, Mr. Henning was a member of the Finance Committee and Chairman of the Audit Committee of CTS Corporation.

 

Age 57

 

Mr. Profusek is a partner in Jones Day, a global law firm. Mr. Profusek has been a Jones Day lawyer since 1975, except for May 2000 through August 2002 during which time he served as Executive Vice President of Omnicom Group, Inc., a global communications company. Mr. Profusek also serves as a Director of Valero Energy Corporation. In 2006, Mr. Profusek was a member of the Compensation Committee and the Finance Committee of CTS Corporation.

 

Age 63

 

Donald K. Schwanz is Chairman of the Board, President and Chief Executive Officer of CTS. Mr. Schwanz was named Chief Executive Officer effective October 1, 2001 and was appointed Chairman of the Board of Directors on January 1, 2002. In January 2001, Mr. Schwanz was elected President and Chief Operating Officer of CTS. Prior to joining CTS in January 2001, he was President of the Industrial Control Business at Honeywell, Inc., an aerospace company, since 1999, and previously was President of Honeywell’s Space and Aviation Business.

 

Age 48

 

Ms. Vincent is President and Chief Executive Officer of Public Service Company of Colorado, an Xcel Energy, Inc. subsidiary, a utility company serving electricity and natural gas customers. She has served in this capacity since October 2005. Prior to assuming this position, she had served as President of Customer and Field Operations of Xcel Energy from July 2003, as President of the Retail Services Group of Xcel Energy from March 2001, and as Vice President of Marketing and Sales of Xcel Energy Services, Inc. from August 2000. In 2006, Ms. Vincent was a member of the Compensation Committee and the Nominating and Governance Committee.

 

 

 

ITEM 2: APPROVAL OF THE CTS CORPORATION
2007 MANAGEMENT INCENTIVE PLAN

 

You are asked to consider and approve adoption of the CTS Corporation 2007 Management Incentive Plan. A summary of the plan follows. Please refer to Exhibit A to this proxy statement for the full text of the plan.

 

Shareholder approval of this plan will allow payments made under it to be fully tax deductible as “performance-based” compensation under section 162(m) of the Internal Revenue Code. Section 162(m) of the Internal Revenue Code disallows the corporate tax deduction for certain compensation in excess of $1 million per year paid to an executive officer whose compensation is required to be reported in the proxy statement. However, certain compensation, including compensation based on the attainment of performance goals, is excluded from this deduction limit if the material terms of the plan are approved by the shareholders at least every five years. The prior management incentive plan was approved by the shareholders in 2002. Your approval of this Plan will have the effect of reducing the potential tax to be paid by CTS on certain compensation should it reach limits as set forth in Section 162(m) of the Internal Revenue Code.

 

Purpose.  The plan is intended to focus the efforts of management on achieving the annual goals approved by the Compensation Committee of the Board of Directors to ensure CTS’ profitability and long-term growth.

 

Administration.  The plan will be administered by the Compensation Committee of the Board of Directors which is comprised solely of non-employee, outside directors of CTS.

 

Eligible Participants.  All officers and other key employees of CTS and any of its subsidiaries are eligible to participate in the plan. As of May 9, 2007, approximately 150 employees would be eligible to participate in the plan.

 

Principal Features of the Plan.  Within 90 days after the commencement of each fiscal year, the Compensation Committee will, in writing, select which employees will be plan participants for the year and determine the performance goals applicable to each participant based on one or more measures of CTS’ financial performance as defined in the plan. The Compensation Committee will further determine the payout schedule detailing the amount which may be available for payout to each participant as an award based upon the attainment of the applicable performance goals. The Compensation Committee may delegate its authority to select and establish performance goals for employees who are not executive officers of CTS. Following each fiscal year and subject to audit and certification of CTS’ financial results by independent auditors, the Compensation Committee will certify in writing whether and to what extent the performance goals for the year were satisfied. The Compensation Committee shall determine the amount available for each participant’s award pursuant to the payout schedule established for that year. The Compensation Committee may increase or reduce the amount of a participant’s award, based on any subjective or objective factors that it determines to be appropriate in its sole discretion, provided that with respect to employees covered by

Section 162(m) of the Internal Revenue Code, the Compensation Committee may only reduce (not increase) the amount of an award. Awards under the Plan will be made in lump sum payments in cash or to a deferred plan established for this purpose.

 

The complete text of the CTS Corporation 2007 Management Incentive Plan is included as Exhibit A to this proxy statement.

 

It is not possible at this time to determine the awards that may become payable under the plan for 2007. Notwithstanding any other provision of the plan, in no event will any award under the plan exceed $5,000,000 for any individual with respect to any fiscal year.

 

 

 

 

EQUITY COMPENSATION PLAN INFORMATION

 

The following table provides information about shares of CTS common stock that could be issued under all of CTS’ equity compensation plans as of December 31, 2006. No shares can be issued under the CTS Corporation 2007 Management Incentive Plan.

 

 

In 1990, CTS adopted the Stock Retirement Plan for Non-Employee Directors. Under the plan, CTS annually credited an account for each nonemployee director with 800 common stock units. CTS also annually credited each deferred stock account with an additional number of common stock units representing the amount of dividends which would have been paid on an equivalent number of shares of CTS common stock for each quarter during the preceding calendar year. Upon retirement, the nonemployee director is entitled to receive one share of CTS common stock for each common stock unit in his deferred stock account. CTS has issued only treasury shares for common stock units under the plan. Prior to 2002, the New York Stock Exchange did not require companies to obtain shareholder approval when issuing treasury shares or shares purchased in the open market under compensatory plans. As of December 1, 2004, this plan was amended to preclude crediting any additional units under the plan. At December 31, 2006, the deferred stock accounts contained a total of 56,261 units.

 

SECTION 16(a) BENEFICIAL
OWNERSHIP REPORTING COMPLIANCE

 

Section 16(a) of the Securities Exchange Act of 1934 requires CTS’ directors, executive officers and certain persons who own more than 10% of CTS’ common stock to file with the Securities and Exchange Commission and the New York Stock Exchange initial reports of ownership and reports of changes in ownership of CTS common stock. Executive officers, directors and greater than 10% shareholders are required to furnish CTS with copies of all Section 16(a) reports they file. Based solely on written

representations from reporting persons and on our review of Section 16(a) reports provided by those individuals, CTS believes that all required Section 16(a) filings were completed in a timely manner with respect to 2006.

 

COMMITTEES OF THE BOARD

 

Compensation Committee

 

The Compensation Committee is a standing committee of the Board of Directors. Directors Cody, Hemminghaus, Profusek and Vincent are the current members of the Compensation Committee. Each member of the Committee is an independent director as defined by the New York Stock Exchange Corporate Governance Listing Standards and the CTS Corporation Corporate Governance Guidelines. The Committee held six meetings in 2006. A copy of the Compensation Committee Charter may be obtained free of charge from CTS’ Secretary upon request or from CTS’ website at http://www.ctscorp.com/governance/compensationcharter.htm.

 

The Committee establishes executive compensation policies and reviews and approves senior executive compensation and employment agreements. The Committee reviews and approves corporate goals and objectives relevant to the CEO’s compensation, evaluates the CEO’s performance against those objectives and makes recommendations to the Board of Directors regarding CEO compensation. The Committee administers the CTS Corporation Management Incentive Plan and the CTS Corporation 2004 Omnibus Long-Term Incentive Plan.

 

The Compensation Committee does not delegate authority to perform any of the foregoing functions with respect to the compensation of any executive officer. The Compensation Committee may delegate authority to make cash incentive or equity awards to non-executive officers to the Chief Executive Officer and/or the Senior Vice President Administration subject to specific numeric limits.

 

The Senior Vice President Administration regularly reports to the Compensation Committee regarding trends in executive compensation. The Senior Vice President Administration provides background information, such as peer benchmark data, to assist the Compensation Committee in making decisions about executive compensation. The Compensation Committee may direct the Senior Vice President Administration to research specific issues and make recommendations to the Committee. The Chief Executive Officer recommends to the Compensation Committee the form and level of compensation for each executive officer other than himself. The Compensation Committee recommends the Chief Executive Officer’s form and level of compensation to the full Board of Directors for approval.

 

Every two to three years, management retains Towers Perrin to provide peer benchmark compensation reports for all executive officer positions. In addition, management uses the Equilar compensation database to obtain benchmark data for the Chief Executive Officer and Chief Financial Officer positions. Management also retains consultants for advice regarding specific compensation issues. Management retained Towers Perrin in 2006 for advice regarding long-term incentive plan design and the 2007 performance stock unit plan, as discussed under the caption “Compensation Discussion and Analysis” on page 18. The Compensation Committee also uses an independent consultant to provide advice on specific compensation issues. In 2006, the Compensation Committee retained Compensation Strategies, Inc. for advice regarding the CTS Corporation 2007 Management Incentive Plan. The Compensation Committee also retained Mercer Human Resource Consulting for advice regarding Mr. Schwanz’s employment agreement and equity compensation in 2006, as discussed under the caption “Compensation Discussion and Analysis” on page 18.

 

Compensation Committee Interlocks and Insider Participation

 

Directors Cody, Hemminghaus, Profusek and Vincent served as members of the Compensation Committee during 2006. During 2006, no executive officer of CTS served as a director of any other entity for which any CTS director was an executive officer.

 

Jones Day is a law firm that CTS has retained for specific legal services, on a case-by-case basis, for over ten years. The fees paid by CTS to Jones Day during 2006 were approximately $225,000, which amount is substantially less than .1% of Jones Day’s gross revenues for 2006. Mr. Profusek and Mark A. Cody, the son of Mr. Cody, are each partners of Jones Day. Neither Mr. Profusek nor Mr. Cody’s son personally renders legal services to CTS or supervises any attorney in the rendering of legal services to CTS, and neither Mr. Profusek nor Mr. Cody’s son receives any direct compensation from fees paid by CTS to Jones Day.

 

Directors are assigned to committees of the Board of Directors by the full Board of Directors each year following their election at the annual meeting of shareholders. As of the Annual Meeting date, Mr. Profusek will cease to be a member of the Compensation Committee and will only be a member of the Finance Committee if he is re-elected to the Board.

 

Finance Committee

 

The Finance Committee is a standing committee of the Board of Directors. Directors Frieling, Hemminghaus, Henning and Profusek are the current members of the Finance Committee. The Finance Committee held two meetings in 2006. A copy of the Finance Committee Charter may be obtained free of charge from CTS’ Secretary upon request or from CTS’ website at http://www.ctscorp.com/governance/financecharter.htm.

 

The Finance Committee reviews and makes recommendations to the Board of Directors concerning financing arrangements, tax strategies, dividend policy, financial structure and similar matters. Additionally, the Finance Committee reviews and approves capital project appropriation requests for capital projects that are above certain prescribed limits.

 

Nominating and Governance Committee

 

The Nominating and Governance Committee is a standing committee of the Board of Directors. Directors Cody, Ciancia, Frieling and Vincent are the current members of the Nominating and Governance Committee. Each member of the Nominating and Governance Committee is an independent director as defined by the New York Stock Exchange Corporate Governance Listing Standards and the CTS Corporation Corporate Governance Guidelines. The Nominating and Governance Committee held four meetings in 2006. A copy of the Nominating and Governance Committee Charter may be obtained free of charge from CTS’ Secretary upon request or from CTS’ website at http://www.ctscorp.com/governance/governancecharter.htm.

 

The Nominating and Governance Committee reviews and makes recommendations to the Board concerning the CTS Corporation Corporate Governance Guidelines and matters of corporate governance. The Nominating and Governance Committee recommends candidates for membership on the Board. CTS’ bylaws describe the process for nominating a candidate for election to the Board of Directors at the Annual Meeting of Shareholders. CTS’ bylaws are located on CTS’ website at http://www.ctscorp.com/governance/bylaws.htm. A copy of the bylaws may be obtained free of charge from CTS’ Secretary. CTS does not have a formal policy concerning whether the Nominating and Governance Committee will consider director candidates recommended by shareholders. CTS did not receive any requests for the Nominating and Governance Committee to consider any director candidate at the Annual Meeting. At this time, the Board of Directors does not believe a formal policy is necessary, because CTS’ bylaws provide a process for nomination of directors and no shareholder nominations for director have been received in past years.

 

The Nominating and Governance Committee reviews with the Board, on an annual basis, the requisite skills and director characteristics of new Board members as well as the composition of the Board as a whole. This review includes an assessment of whether each non-management director qualifies as independent and consideration of the diversity, age, skills and experience of the directors in the context of the needs of the Board. Although the Nominating and Governance Committee has not established any specific minimum criteria or qualifications that a candidate must possess, the Committee seeks candidates who possess the experience necessary to make a valuable contribution to the Board. The Nominating and Governance Committee may retain search firms for the purpose of identifying and evaluating director candidates, but does

not currently have any firm on retainer. The Nominating and Governance Committee also considers director candidates identified by management and by non-management directors.

 

The Nominating and Governance Committee charter provides that it is responsible for reviewing and making recommendations to the Board concerning CEO succession planning. In 2005, an ad hoc Leadership Continuity Committee of the Board was formed to assist the Board in overseeing management’s implementation of an overall Management Development and Succession process for executive officers, and to lead the Board in the CEO succession planning process.

 

Audit Committee

 

The Audit Committee is a standing committee of the Board of Directors. Directors Catlow, Ciancia, Frieling and Henning are the current members of the Audit Committee. Each member of the Audit Committee is financially literate and meets the independence standards applicable to audit committee members under the New York Stock Exchange Corporate Governance Listing Standards, as well as the CTS Corporation Corporate Governance Guidelines and the Audit Committee Charter. Mr. Henning qualifies as an audit committee financial expert under the criteria set forth in Item 407(d)(5)(ii) of Regulation S-K. The Audit Committee held nine meetings in 2006. A copy of the Audit Committee Charter may be obtained free of charge from CTS’ Secretary upon request or from the CTS’ website at http://www.ctscorp.com/governance/auditcharter.htm.

 

The Audit Committee is responsible for appointing the independent auditor, approving engagement fees and all non-audit engagements, and reviewing the independence and quality of the independent auditor. The Audit Committee reviews audit plans, audit reports and recommendations of the independent auditor and internal audit department. The Audit Committee reviews systems of internal accounting controls and audit results. The Audit Committee reviews and discusses with management CTS’ financial statements, earnings press releases and earnings guidance. The Audit Committee also reviews CTS’ compliance with legal requirements and the CTS Code of Ethics.

 

FURTHER INFORMATION CONCERNING THE BOARD OF DIRECTORS

 

During 2006, the Board of Directors had eight meetings. In 2006, all of the directors attended 100% of the meetings of the Board of Directors and the standing committees of which they were members. It is the policy of the Board of the Directors that each director endeavor to attend the annual meeting of shareholders, unless exigent circumstances arise. Each of the directors standing for re-election at the 2006 Annual Meeting attended the meeting.

 

The CTS Corporation Corporate Governance Guidelines provide that an independent director is one who:

 

 

 

A copy of the Corporate Governance Guidelines may be obtained free of charge from CTS’ Secretary upon request or from CTS’ website at http://www.ctscorp.com/governance/guidelines.htm.

 

The Board of Directors has determined that each non-management director is an independent director and has no material relationship with CTS, apart from his or her service as a director. The Board of Directors made this determination by reference to the definition of an independent director contained in the New York Stock Exchange Corporate Governance Listing Standards and by reference to the standards set forth in the CTS Corporation Corporate Governance Guidelines. As a result, the Board of Directors concluded that Walter S. Catlow, Lawrence J. Ciancia, Thomas G. Cody, Gerald H. Frieling, Jr., Roger R. Hemminghaus, Michael A. Henning, Robert A. Profusek and Patricia K. Vincent are independent directors.

 

In making this determination with respect to Messrs. Profusek and Cody, the Board of Directors determined that the provision of legal services by Jones Day to CTS did not create a material relationship or impair the independence of Messrs. Profusek and Cody because the legal fees paid to Jones Day did not constitute material indirect compensation as contemplated by the CTS Corporate Governance Guidelines’ independence standards since the legal fees represent a de minimis percentage of Jones Day’s annual gross revenues, neither Mr. Profusek nor Mr. Cody’s son personally renders legal services to CTS or supervises any attorney in the rendering of legal services to CTS, and neither Mr. Profusek nor Mr. Cody’s son receives any direct compensation from fees paid by CTS to Jones Day.

 

CTS does not have a written policy specific to transactions with related persons. CTS has written policies and procedures with respect to conflicts of interest. The Corporate Governance Guidelines provide that the Nominating and Governance Committee will review any situation which might be construed to disqualify a director as independent and make a recommendation to the Board of Directors regarding the director’s service on board committees and nomination for re-election to the Board of Directors. The Nominating and Governance Committee Charter further provides that the Nominating and Governance Committee will review any potential conflicts of interest of directors and recommend appropriate action to the Board of Directors.

 

CTS has adopted a Code of Ethics that applies to all of its employees, including its principal executive officer, principal financial officer and principal accounting officer or controller, and other executive officers, as well as non-employee directors. The Code of Ethics includes an ethical standard concerning conflicts of interest and potential conflicts of interest. With respect to executive officers and other employees, potential conflicts of interest must be reported to management. The Audit Committee is responsible for reviewing

compliance with the Code of Ethics and would review any conflict of interest involving an executive officer. A copy of the CTS Code of Ethics may be obtained free of charge from CTS’ Secretary upon request or from CTS’ website at http://www.ctscorp.com/governance/codeofethics.htm.

 

The CTS Corporate Governance Guidelines encourage all directors to participate in director continuing education programs. The corporation reimburses directors for attendance at such programs. In addition, management monitors and reports to the directors regarding significant corporate governance initiatives. The directors also receive a presentation on new developments in corporate governance no less frequently than annually.

 

The Board of Directors has adopted CTS stock ownership guidelines that apply to non-employee directors and executives in order to align their interests with those of shareholders and promote enduring shareholder value. The guidelines are administered by the Compensation Committee. A copy of the guidelines may be obtained free of charge from CTS’ Secretary upon request or from CTS’ website at http://www.ctscorp.com/governance/stockog.htm.

 

It is the policy of the Board of Directors to hold an executive session of non-management directors at each regular scheduled Board of Directors meeting. The Board of Directors annually appoints one director as the presiding director. The position of presiding director is rotated among all non-management directors on an alphabetical basis. The presiding director chairs the executive sessions of the Board of Directors.

 

Shareholders and other interested parties may address written communications to individual directors, including non-management directors, or to the Board of Directors as a whole, in care of CTS’ Secretary at CTS’ Corporate Office, 905 West Boulevard North, Elkhart, Indiana, 46514. Such communications must include the name and address of the shareholder, as they appear on the record books of CTS, and the name and address of the beneficial owner, if any, on whose behalf the communication is submitted. CTS’ Secretary will compile such communications and forward them to the directors on a periodic basis. However, CTS’ Secretary has authority to disregard any communication which is primarily an advertisement or solicitation or which is threatening, obscene or similarly inappropriate in nature. Communications that have been disregarded for these reasons may be reviewed by any non-management director upon request.

 

STOCK OWNERSHIP INFORMATION

 

Five Percent Owners of Common Stock.  The table below lists information about the persons known by CTS to beneficially own at least 5% of CTS’ common stock as of May 9, 2007. This information is derived solely from the most recent Schedules 13G and Form 13F-HR filed by these persons with the Securities and Exchange Commission.

 

 

 

 

Directors’ and Officers’ Stock Ownership.  The following table shows how much CTS common stock each Named Executive Officer, as identified in footnote (1) to the Summary Compensation Table set forth under “Executive Compensation,” and each director-nominee beneficially owned as of May 9, 2007 including shares covered by stock options exercisable within 60 days of May 9, 2007. Please note that, as reported in this table, beneficial ownership includes those shares a director or officer has the power to vote or transfer, as well as shares owned by immediate family members that reside in the same household with the director or officer. The shares shown as beneficially owned by all current directors and officers do not include 1,458,900 shares held by the Northern Trust Company as Trustee of the CTS Corporation Employee Benefit Plans Master Trust. The CTS Corporation Employee Benefit Plan Investment Committee has voting and investment authority over those shares. Two executive officers are members of that committee.

 

 

 

 

COMPENSATION DISCUSSION AND ANALYSIS

 

The SEC changed the rules regarding disclosure of executive compensation in proxy statements in 2006. In addition to requiring new and different tables, the new rules place greater emphasis on providing discussion and analysis of our compensation practices. Further, the content of our Compensation Committee Report is reduced. Accordingly, the information in this proxy statement is not directly comparable to that in our 2006 proxy statement.

 

Compensation Overview.  The Compensation Committee of the Board of Directors sets compensation for each executive officer, with the exception of the Chief Executive Officer, based on the recommendations of the Chief Executive Officer and supporting data provided by management. The Board of Directors sets compensation for the Chief Executive Officer based on the recommendations of the Compensation Committee.

 

CTS’ general compensation philosophy is to center compensation for each executive officer position at approximately the fiftieth percentile of compensation for similar positions at similarly situated companies based on peer benchmark data.

 

The elements of CTS’ executive compensation program reflect CTS’ objectives to drive improved financial performance, offer competitive compensation and align compensation with shareholder interests. As discussed in more detail in this Compensation Discussion and Analysis, CTS’ executive compensation program includes the following elements: base salary, annual cash incentives, performance-based equity compensation, time-based equity compensation, retirement benefits, other compensation and health and welfare benefits. CTS does not have a fixed formula for allocating compensation across these elements, but each element is considered as a component of total compensation. CTS does not consider the amount of compensation that could be realized from prior compensation awards in setting compensation from year to year.

 

Factors such as the tax and accounting treatment of different forms of compensation may influence the form and structure of executive compensation, but do not necessarily affect the total level of compensation to be provided. CTS has adopted Stock Ownership Guidelines which apply to each executive officer and encourage retention of stock awarded under its equity compensation plans. CTS has change in control severance agreements with each executive officer, but has employment agreements with only two executive officers.

 

Compensation Objectives.  The objectives of CTS’ executive compensation program are to:

 

 

Compensation Philosophy.  CTS’ executive compensation programs provide executives with strong incentives to maximize CTS’ performance and enhance shareholder value. The executive compensation program includes annual compensation, long-term compensation, performance-based compensation and time-based compensation components. CTS’ executive compensation structure consists of base salary, annual cash incentives, performance-based equity compensation, time-based equity compensation, other compensation and retirement benefits. Base salary, other compensation, annual incentive compensation and retirement benefits serve to attract and retain executive talent. Annual incentive compensation and performance-based equity compensation directly promote specific financial and operational performance objectives, which will ultimately benefit shareholders. Performance-based equity compensation and time-based equity compensation directly align the interests of the executives with those of shareholders.

 

The amount of total compensation realized or potentially realizable from prior compensation awards does not directly influence the level of compensation paid or future pay opportunities. Moreover, CTS does not utilize a specific formula for allocating total compensation between current and long-term compensation or between cash and non-cash compensation. As discussed below under the caption “Compensation Process and Methodology”, the amount of compensation allocated to each element reflects allocation percentages in benchmark data for comparable positions. For 2006, base salary among the named executive officers ranges from 37% to 43% of the sum of base salary, cash incentive compensation and equity compensation which we refer to here as annual compensation. Cash incentive compensation ranges from 19% to 28% of annual compensation among named executive officers. Equity compensation ranges from 35% to 37% of annual compensation. As a percent of annual compensation, cash incentive compensation targets and equity compensation increase across the executive officer positions of increasing responsibility. This structure means a higher percentage of at-risk, variable compensation for the most senior executive officers. As a result, the most senior executive officers who have the greatest ability to drive the company’s performance have the most to gain or lose based on that performance. Allocation between types of equity compensation also illustrates this principle. For example, in 2006 the Chief Executive Officer and Chief Financial Officer received a higher percentage of equity compensation in the form of stock options, 35% compared to 25-30% for other named executive officers. This higher allocation reflects the direct impact of those positions on factors that will affect growth in the stock price.

 

Annual compensation as discussed above is not directly comparable to total compensation as shown in the Summary Compensation Table because it uses base salary established in June 2006, rather than salary earned in fiscal year 2006. In addition, annual compensation reflects target cash incentive compensation, rather than actual cash awards. CTS uses a Black-Scholes calculation for purposes of determining the value of equity compensation in analyzing annual compensation. In contrast, equity compensation values in the Summary Compensation Table reflect the stock-based compensation expense calculation used by CTS for financial accounting purposes, excluding forfeiture assumptions. This calculation includes factors such as retirement eligibility, which are not appropriate considerations in setting compensation. Moreover, CTS does not consider increases in pension compensation, which are required to be included in the Summary Compensation Table, as factors in setting compensation.

 

In 2006, the Compensation Committee conducted a comprehensive review of CTS’ executive compensation structure with the participation of management. The Compensation Committee discussed the corporation’s compensation strategy and alternative structures used by other companies. As a result of this analysis, the Compensation Committee determined that while the compensation structure was effective at accomplishing CTS’ compensation objectives, it could be enhanced by adding a performance-based equity compensation element. The Compensation Committee adopted a performance-based equity compensation plan for executive officers and general managers in 2007. By rewarding achievement of certain annual financial performance goals with equity awards which vest over time, the plan is intended to promote strong financial performance, serve as a retention tool and align executives’ interests with those of shareholders.

 

Compensation Process and Methodology.  The Compensation Committee has responsibility for setting and administering CTS’ executive compensation policies. At its June meeting each year, the Compensation Committee reviews the total compensation of executives. This review encompasses industry compensation practices and benchmarks as well as company and individual performance. The Compensation Committee uses market data provided by management to assess CTS competitive position in the area of executive compensation. The Chief Executive Officer provides recommendations on the compensation of each of the other executive officers. Based on this review and these recommendations, the Committee approves adjustments to the annual base salary and grants of equity compensation for each executive officer, other than the Chief Executive Officer. Additionally, at this time, the Compensation Committee reviews the Chief Executive Officer’s total compensation, again considering benchmark data, CTS’ performance and individual performance. The Compensation Committee then makes a recommendation to the full Board of Directors regarding annual compensation and equity grants for the Chief Executive Officer for the following year. The full Board of Directors then reviews and acts on this recommendation.

 

In the first quarter of each year, usually in February, the Compensation Committee reviews and approves annual cash incentive awards for executive officers under the plan established for the prior fiscal year. In addition, the Compensation Committee adopts performance goals and target awards for the current fiscal year, for executive officers other than the Chief Executive Officer. At this time, the Compensation Committee makes recommendations to the full Board concerning the performance goals and target award for the Chief Executive Officer. These recommendations are subject to approval by the full Board of Directors. Management provides benchmark data and the Chief Executive Officer provides recommendations with respect to the other executive officers to aid the Compensation Committee in this process.

 

Benchmarking and Consultants.  For the annual executive compensation review, management provides the Compensation Committee with benchmark data for base salary, perquisites, annual incentives and equity awards. Management uses the web-based Equilar compensation database as a source for benchmark data primarily for the Chief Executive Officer and Chief Financial Officer positions. Equilar draws data from proxy statements and reports filed with the Securities and Exchange Commission. It is difficult for CTS to establish a “pure” peer group because relatively few companies are the same size and have the same business segments as CTS. In 2006, management used a peer group composed of 18 companies, including companies of comparable size and companies in the same or similar businesses. CTS’ peer group for 2006 included Aeroflex, Anadigics Inc., AVX, BEI Technology, Dana Corporation, Dura Auto Systems, Flextronics, Kemet Corporation, LittelFuse, Molex, Pemstar, Plexus, RF Micro Devices, Sanmina-SCI Corporation, Solectron, Stoneridge, Triquint Semiconductor and Vishay Intertechnology. Management reviews and evaluates the Equilar peer group on an annual basis.

 

Every two to three years, CTS obtains benchmark data reports from Towers Perrin for all executive officer positions. CTS’ executive positions other than Chief Executive Officer and Chief Financial Officer, reflect a blend of responsibilities. As a result, a more detailed analysis is necessary to establish comparable positions from which to draw compensation data than can be achieved with Equilar. CTS ages the Towers Perrin data by applying an aging factor supplied by Towers Perrin for those years in which a new report is not obtained. For 2006, the aging factor applied was 4%.

 

Management retains third party consultants for advice on specific compensation issues on an as-needed basis. Management retained Towers Perrin in 2006 for advice regarding long-term incentive plan design and the 2007 performance stock unit plan. The Compensation Committee also uses an independent consultant to provide advice on specific compensation issues. In 2006, the Compensation Committee retained Compensation Strategies, Inc. for advice regarding the 2007 Management Incentive Plan. The Compensation Committee also retained Mercer Human Resource Consulting for advice regarding Mr. Schwanz’s employment agreement and equity compensation in 2006.

 

Elements of Compensation.  CTS provides executives with a mix of cash compensation (base salary and a perquisite allowance), annual cash incentive compensation, performance-based equity compensation, and time-based equity compensation. CTS considers time-based equity compensation, as well as annual cash and equity incentive compensation to be variable incentive pay, as the value of these compensation awards is dependent upon CTS’ financial performance and/or stock value performance. CTS also provides retirement-related benefits under the CTS Corporation Retirement Savings Plan, a qualified defined contribution 401(k) plan; the CTS Corporation Pension Plan, a qualified defined benefit plan; the CTS Corporation 2003 Excess Benefit Retirement Plan, a supplemental executive retirement plan and the CTS Corporation Individual Excess Benefit Retirement Plan, a supplemental executive retirement plan. In addition, CTS also provides executives with a limited set of perquisites and a standard set of health and welfare benefits. Each element of compensation is discussed below.

 

Base Salary:  Annual base salary is intended to provide a competitive level of cash compensation to CTS executives based on their qualifications, responsibilities and performance. CTS establishes a salary range for each executive officer position centered on the fiftieth percentile for similar positions at peer companies based on benchmark data. The sources of benchmark data provided by management to the Compensation Committee are discussed under the caption “Benchmarking and Consultants.” Executive

officers’ actual salaries may vary within the salary range due to their experience and achievements, responsibilities and demonstrated performance.

 

Annual Cash Incentives:  CTS has maintained an annual management incentive plan or MIP for many years. The MIP is designed to make a portion of the cash compensation of executives, officers and other key employees variable and at risk based on the financial performance of CTS and achievement of individual goals. CTS believes that tying annual cash compensation to specific financial and non-financial performance goals motivates executives to achieve results that benefit shareholders.

 

Awards under the MIP are intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code. In order to qualify under Section 162(m) of the Internal Revenue Code, the material terms of the plan must be approved by the shareholders at least every five years. The last management incentive plan was approved by the shareholders in 2002. A new management incentive plan is being submitted for shareholder approval at the 2007 Annual Meeting as described under the caption “Item 2: Approval of the CTS Corporation 2007 Management Incentive Plan” on pages 7 and 8 of this proxy statement.

 

The Compensation Committee annually establishes a target award and performance goals for each executive officer under the MIP. Target awards are established as a percentage of base salary. Annual target awards for each executive officer under the MIP are based upon benchmark data for similar executive positions at peer companies, as discussed above under the caption “Benchmarking and Consultants.” CTS’ philosophy is to structure its executive annual cash incentive compensation to approximate the fiftieth percentile for such compensation among its peers. An executive officer’s actual award is determined under a formula that provides for payment of zero to 200% of the target award based upon actual performance versus established quantitative financial performance goals. In addition, the Compensation Committee may adjust awards downwards based upon the executives’ actual performance versus individual qualitative and quantitative objectives.

 

Quantitative financial performance goals under the MIP are based on CTS’ established business plan for the fiscal year. Management prepares, and the Board of Directors reviews, a business plan for each fiscal year that includes sales, earnings, key balance sheet metrics and cash flow for each business unit. The business plan considers prior year results, strategic initiatives, approved forward investment plans, projected market demands, competition, improvement initiatives and other factors in establishing plan budgets and results. Management endeavors to establish a plan that demands challenging, but achievable, results given expected business conditions. As a general rule, the business plan is established such that targets under the primary metrics can be achieved or exceeded 80% of the time. The business plan performance metrics that are most relevant to CTS’ objectives and strategy are selected as quantitative financial performance goals under the MIP for that year. Quantitative financial performance goals for executive officers with direct operations responsibility are weighted to incorporate business unit performance metrics, as well as corporate performance metrics. Quantitative financial performance goals for executive officers with only corporate responsibilities are based on corporate performance metrics, which reflect performance of the business units in the aggregate.

 

Actual MIP awards may vary from zero to 200% of the target award based on achievement of quantitative financial performance goals over a range that begins below the business plan targets and extends above the business plan targets. To encourage management to focus on financial risk mitigation as well as upside opportunity, the payout “cliff” drops to zero if performance falls below a threshold level of plan achievement. On the upside, payout increases linearly as performance exceeds the business plan. One consequence of this cliff threshold and payout to performance formula is that the executive’s risk of receiving no award is greater than the executive’s opportunity to obtain an award that is substantially above target. Another consequence is that payouts above target represent a fraction of the expected return to the company from “better than plan” performance.

 

While actual awards will vary above and below target from year to year, CTS expects that over a period of several years, payouts under the MIP will average about 100% of target. Over the past five years, payouts

under the MIP based on corporate metrics alone average 95% of target. Over the past five years, payouts under the MIP, including corporate and business unit metrics, averaged 83% of target.

 

In order for awards under the MIP to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code, performance goals must be established within the first 90 days of the fiscal year and cannot be adjusted due to unusual and uncontrollable events or conditions that may materially affect CTS’ financial performance. In addition, to qualify under Section 162(m) of the Internal Revenue Code, awards to named executive officers cannot be adjusted upward to mitigate the effects of such events or conditions. To allow the MIP to be effective in motivating executives to drive results by focusing on factors within their reasonable control, quantitative performance measures are defined to exclude the effects of specific events or conditions, such as changes in accounting principles, which may impact actual results, but generally cannot be predicted or controlled by executives. The method for calculating business unit operating earnings may also be defined to limit exposure to specific risks or to remove disincentives to transactions between business units. In addition, for 2006, to preserve maximum tax deductibility and allow the Compensation Committee the latitude to address unforeseeable and uncontrollable events and conditions, EPS and business unit operating earnings goals for executive officers were set at a level that would allow the Compensation Committee to take into consideration the impact of such events or conditions in adjusting awards downward.

 

The Compensation Committee established quantitative financial performance goals based on CTS’ net sales and CTS’ earnings per share, or EPS under the MIP for 2006 for all executive officers. For executive officers with only corporate responsibilities 5% of the target award was allocated to net sales performance and 95% of the target award was allocated to EPS performance. In addition, quantitative financial performance goals were established under the 2006 MIP for two executive officers based on the operating earnings of the business units over which they exercise direct management responsibility. For those executive officers, 5% of their target awards were allocated to net sales performance, 28.5% of their target awards were allocated to EPS performance and 66.5% of their target awards were allocated to business unit operating earnings performance. For 2006, CTS did not exceed its net sales performance goals as required to support a payout on the portion of awards allocated to that goal. CTS achieved its EPS performance goal at a level sufficient to support a payout on the portion of awards allocated to that goal. The Electronic Components and Electrocomponents business units exceeded their operating earnings goals. The Automotive Products and Electronics Manufacturing Solutions business units did not attain the threshold performance level. Executive officers satisfactorily completed individual performance goals. The Compensation Committee exercised its discretion to adjust the portion of executive officer awards based on net sales downward to 0% of the target award allocated to that goal. The Compensation Committee recognized expenses related to succession planning for the Chief Executive Officer position as a condition that was outside the control of executives and that adversely affected EPS in 2006. The Compensation Committee exercised its discretion to adjust the portion of executive officer awards based on EPS downward to 128% of the target award allocated to that goal. The Compensation Committee exercised its discretion to adjust the portion of executive officer awards based on the operating earnings of business units that did not reach the performance threshold downward to 0% of the target award allocated to that goal.

 

In March 2007, the Compensation Committee approved the terms of the MIP for fiscal year 2007 subject to approval of the CTS Corporation 2007 Management Incentive Plan by the shareholders. The terms of the MIP for 2007 establish quantitative financial performance goals based on CTS’ EPS and/or the operating earnings of specific business units.

 

Performance-Based Equity Compensation:  In 2007, the Compensation Committee established terms applicable to performance-based equity compensation awards for fiscal year 2007 under the CTS Corporation 2004 Omnibus Long-term Incentive Plan. The awards serve to promote multiple objectives which include encouraging strong financial performance, retaining talented executives and aligning compensation with shareholder interests. Depending upon the level of CTS’ achievement of net sales and free cash flow in fiscal year 2007, an executive officer may receive a restricted stock unit award of up to 200% of a target award established for his position. Free cash flow is defined as the sum of cash flow from operating activities and

proceeds from the sale of assets, less capital expenditures. The selection of performance goals based on net sales and free cash flow targets is intended to create a focus on strategies which can drive long-term growth. Seventy percent of the target award is allocated to net sales and 30% of the target award is allocated to free cash flow. Each executive officer other than Mr. Schwanz is eligible for an equity-based incentive award. The opportunity to receive an award will replace the portion of the executive’s annual compensation that was provided in the form of stock options in prior years. The awards are intended to qualify as performance-based compensation under Section 162(m) of the Internal Revenue Code. The performance goals and target awards were established by the Compensation Committee at its meeting in February 2007. Restricted stock units for achievement of the performance goals will be issued in 2008 following certification of 2007 fiscal year results by CTS’ independent auditors. Performance restricted stock units issued under the plan will cliff-vest on December 31, 2010.

 

Time-based Equity Compensation:  CTS believes that stock ownership and equity-based compensation are valuable tools for motivating employees to improve CTS’ long-term performance. CTS also believes that equity grants are an effective way to align executive and shareholder interests, because a significant amount of an executive’s potential income is directly tied to enhanced shareholder value. CTS, historically, used two forms of time-based long-term equity compensation, restricted stock awards and stock options. Prior to 2004 the Compensation Committee granted restricted stock along with an associated cash bonus under the terms of the 1988 Restricted Stock and Cash Bonus Plan. Under that plan, executives received grants of restricted stock vesting in installments over five years together with a cash bonus equal to the fair value of the stock on the vesting date. The Compensation Committee also historically awarded incentive stock options and non-qualified stock options to executives under the terms of various shareholder-approved option plans. Since shareholder approval of the CTS Corporation 2004 Omnibus Long-term Incentive Plan, the Committee has granted restricted stock units in place of the restricted stock and cash bonus grants. In anticipation of changes in the equity compensation expensing rules, CTS’ prior practice of granting options to a broad group of management employees was discontinued under the CTS Corporation 2004 Omnibus Long-term Incentive Plan. Since 2004, only executive officers and general managers, whose contributions are likely to have a direct impact on stock price, have received option grants. The Compensation Committee generally has granted named executive officers stock options in the form of incentive stock options to the extent permitted by Section 422 of the Internal Revenue Code. The value of restricted stock units and stock options granted has been based upon consideration of peer benchmarks for equity grants to executives in similar positions. The value of equity grants made to executive officers by CTS falls below the fiftieth percentile of benchmark companies.

 

The Compensation Committee considers equity grants as part of its review of annual executive compensation. In recent years, the Compensation Committee has generally met in June to conduct this review. This meeting is part of the regular board and committee meeting calendar and the date is generally set at least one year in advance. In 2006, the Compensation Committee granted options to executive officers other than the Chief Executive Officer and recommended an option grant for the Chief Executive Officer that was approved by the full Board of Directors. The number of options granted was determined by the Compensation Committee based on peer data obtained from Equilar and Towers Perrin as discussed above under the caption “Benchmarking and Consultants” and provided to the Compensation Committee by management. The Compensation Committee has not delegated authority to make option grants to any member of management. The terms of the option grants made in 2006 and in prior years provide that the exercise price will be the closing price of CTS stock on the New York Stock Exchange on the date of the Compensation Committee meeting. CTS does not have a program or policy to coordinate option grants to its executives with the release of material non-public information. The terms of the option grants typically provide for vesting in installments over a four-year period.

 

Restricted stock unit awards under the CTS Corporation 2004 Omnibus Long-term Incentive Plan are provided to executives as well as a broader group of management employees. The Compensation Committee generally considers restricted stock unit awards as part of its review of annual executive compensation in June. The Committee grants restricted stock unit awards to executive officers, other than the Chief Executive

Officer, and general managers. The Compensation Committee recommends a restricted stock unit grant for the Chief Executive Officer that is approved by the full Board of Directors. Restricted stock unit awards distribute to the recipient one share of CTS common stock for each unit upon vesting. Most of these awards vest in equal installments over five years. For new hires or to recognize significant individual contributions, the Compensation Committee may grant individual restricted stock unit awards to executive officers at different times during the year and may use alternative vesting schedules or distribution options. In addition, the Compensation Committee delegates authority to the Chief Executive Officer and Senior Vice President Administration to grant a certain number of restricted stock unit awards to employees who are not executive officers.

 

In June 2006, the Compensation Committee awarded restricted stock units vesting over a five-year term to each executive officer, other than Mr. Schwanz, based on the recommendation of management. Management based its recommendations on the number of units to be awarded on peer data obtained from Equilar and Towers Perrin as discussed under the caption “Benchmarking and Consultants” above. At its June meeting, the Compensation Committee deferred consideration of Mr. Schwanz’s restricted stock unit grant for 2006 until later in the year in order to consider the grant in the context of negotiating Mr. Schwanz’s employment agreement. In September 2006, based on information provided by management and following review of Mr. Schwanz’s compensation package by its consultant, Mercer Human Resource Consulting, the Compensation Committee approved an award of 35,000 restricted stock units to Mr. Schwanz to vest one year from the grant date.

 

CTS believes that the general practice of deferred vesting of equity grants over several years further helps to align the interests of executives with shareholders, as the value of the deferred (unvested) portion of the grant depends directly on CTS’ stock price. CTS also believes that deferred vesting helps in the retention of executives, as the terms of option grants provide that employees lose unvested grants if they leave employment with CTS prior to qualified retirement, and the terms of restricted stock unit grants provide that unvested grants are forfeited in the event of termination, including retirement.

 

Retirement Benefits:  CTS’ retirement plans are designed to provide a competitive level of retirement benefits necessary to attract and retain executive talent. Retirement benefits encourage executive retention to the extent that executives are rewarded with increased benefits for extending their terms of service. CTS offers both a 401(k) plan and a defined benefit plan to current executives. Participation in the 401(k) plan is voluntary and is open to substantially all U.S.-based CTS employees. Under the terms of the plan which are applicable to named executive officers and other employees hired on or before March 31, 2006, CTS matches an employee’s contributions $.50 for every dollar, up to 6% of annual salary, subject to limitations under the Internal Revenue Code. Each Named Executive Officer participates in both a qualified defined benefit plan and a supplemental executive retirement plan. The terms of these plans are discussed on pages 31 and 32 under the caption “Pension Benefits”. CTS has closed the qualified defined benefit plan to new entrants and does not anticipate that new executives that join CTS in the future will earn benefits under the plan.

 

The purpose of the supplemental executive retirement plans is to restore retirement benefits the executive would otherwise have earned under the qualified defined benefit plan in the absence of limitations under the Internal Revenue Code and to provide a competitive level of retirement benefits. Benefits earned under a supplemental executive retirement plan are not funded by CTS and are not insured by the Pension Benefit Guaranty Corporation. The supplemental executive retirement plans provide that benefits are payable at the same time and in the same manner as benefits are paid under the qualified defined benefit plan. This provision does not comply with Section 409A of the Internal Revenue Code which applies a 20% excise tax to certain forms of non-qualified deferred compensation. This type of provision is, however, eligible for transition relief through December 31, 2007. In accordance with final regulations under Section 409A of the Internal Revenue Code, the Compensation Committee intends to address the payment provisions of the supplemental executive retirement plans prior to December 31, 2007.

 

Under the terms of the CTS qualified defined benefit plan, annual incentive compensation counts toward determining the sum of average earnings used in the benefit calculation. Under the supplemental executive

retirement plans, one-half of the value of an installment of restricted stock units on the vesting date is considered in the sum of average earnings used in the benefit calculation. Retirement benefits, therefore, are directly affected by earned incentive compensation and the growth in stock value. This relationship further helps align executive interests with shareholder interests.

 

Other Compensation:  CTS provides a limited set of perquisites and other compensation in order to attract and retain executive talent. Other compensation for named executive officers includes a quarterly cash perquisite allowance for non-reimbursed travel expenses, reimbursement for financial planning services, reimbursement for tax preparation services and reimbursement for an executive physical. In addition, Donald R. Schroeder receives a temporary living allowance to compensate him for the increased cost of living associated with his relocation from Indiana to California in order to assume responsibility for a newly acquired subsidiary. Other compensation also includes CTS’ matching contribution to the 401(k) Plan, and imputed income on life insurance benefits.

 

Health and Welfare Benefits:  Named executive officers are eligible to participate in a standard set of health and welfare benefits, including medical and dental insurance, life insurance, disability insurance, and health care and dependent care reimbursement accounts. The same terms of participation that apply to salaried employees generally govern the participation of Named Executive Officers in these benefits.

 

Agreements with Executive Officers.  CTS has change-in-control severance agreements with each of the named executive officers as discussed under the caption “Potential Payments Upon Termination or Change-in-Control” on pages 32 through 34. The purpose of these agreements is to retain executives and encourage them to focus on corporate interests during times of change and uncertainty. CTS has employment agreements with its Chief Executive Officer as discussed under the caption “Employment Agreement with Donald K. Schwanz” on page 26. CTS also has an employment agreement with its Chief Financial Officer as discussed under the caption “Employment Agreement with Vinod M. Khilnani” on page 27. These agreements provides assurances to and promote the retention of the executives in these key positions. CTS does not have written employment agreements with any other executive officers.

 

Policy on Recovery of Awards.  The CTS Corporation 2007 Management Incentive Plan being submitted for shareholder approval includes a provision to address recoupment of incentive awards in the event of financial restatements. The plan provides that if the Board of Directors learns of any intentional misconduct by a plan participant which contributes to CTS having to restate its financial statements, the Board may require that individual to reimburse CTS for the difference between any award he or she received and the amount of the award he or she would have received based on the financial results as restated.

 

Stock Ownership Guidelines.  The Board of Directors has adopted Stock Ownership Guidelines, which are administered by the Compensation Committee. The Stock Ownership Guidelines define expected stock ownership levels for executive officers, general managers and non-employee directors. The intent of the guidelines is to require executives and directors to maintain a significant equity stake in CTS. The Stock Ownership Guidelines provide that executives and directors are expected to retain at least 75% of their share units until threshold ownership levels have been attained and at least 25% of any equity awards received from CTS once they have achieved the threshold levels. To avoid placing an undue tax or cash flow burden on the individual, threshold levels are established based on the premise that they will be attainable through retention of equity awards over five years. Threshold levels for named executive officers range from 100,000 share units to 30,000 share units. Share units include shares of CTS common stock, shares subject to vested options, non-vested restricted stock and non-vested restricted stock units. The Stock Ownership Guidelines are administered by the Compensation Committee. The Compensation Committee may reduce future awards to executives who fail to comply with the guidelines.

 

Deductibility of Certain Executive Compensation.  Section 162(m) of the Internal Revenue Code caps at $1,000,000 the deductible compensation per year for each of the named executive officers in the proxy statement, subject to certain exceptions. In developing and implementing executive compensation policies and programs, the Compensation Committee considers whether particular payments and awards are deductible for federal income tax purposes, along with other relevant factors. Consistent with this policy, the

Compensation Committee has taken what it believes to be appropriate steps to maximize the deductibility of executive compensation. Cash incentives under the MIP and performance stock unit awards under the CTS Corporation 2004 Omnibus Long-term Incentive Plan are designed to qualify as performance-based compensation, one of the exceptions to the $1,000,000 cap. Compensation from the exercise of stock options is generally excluded from the $1,000,000 cap. Compensation from the lapse of restrictions on restricted stock and the vesting of time-based restricted stock units, however, is subject to the cap. While it is the general intention of the Compensation Committee to meet the requirements for deductibility, the Compensation Committee may approve payment of compensation in excess of the $1,000,000 cap.

 

COMPENSATION COMMITTEE REPORT

 

The Compensation Committee of the CTS Corporation Board of Directors has reviewed and discussed the foregoing Compensation Discussion and Analysis with management. Based on this review and discussion, the Compensation Committee recommended to the Board of Directors that the Compensation Discussion and Analysis be included in CTS’ Annual Report on Form 10-K and this proxy statement on Schedule 14A.

 

CTS CORPORATION 2006 COMPENSATION COMMITTEE

 

 

EXECUTIVE COMPENSATION

 

2006 Summary Compensation Table

 

 

 

 

 

 

 

 

 

2006 Grants of Plan-Based Awards

 

 

 

 

Employment Agreement with Donald K. Schwanz.  On December 6, 2006, CTS entered into a new employment agreement with Mr. Schwanz. Mr. Schwanz’ prior agreement expired on October 1, 2006. The new agreement provides for Mr. Schwanz’s continued employment through December 31, 2007 (the “Term”). During the Term, Mr. Schwanz will continue to receive his annual base salary of $779,300, subject to review and increase by the Board of Directors, and shall be eligible for a target annual bonus of 75% of annual base salary. Upon termination of the agreement, Mr. Schwanz will be retained by CTS as a consultant for a term of eighteen months, with consulting fees at an annual rate of $175,000. If CTS terminates Mr. Schwanz’s employment without cause or Mr. Schwanz terminates his employment for good reason (each as defined in the agreement) prior to expiration of the Term, Mr. Schwanz will receive lump sum severance payments equal to the value of the salary, annual bonus, perquisites, restricted stock and cash bonus awards, and the increase in actuarial value of retirement benefits that would have been earned by Mr. Schwanz if his employment had continued through December 31, 2007. In addition, upon the termination of Mr. Schwanz’s employment by CTS without cause or by Mr. Schwanz for good reason during the Term, the vesting of any restricted stock units which would otherwise have vested during the Term will be accelerated. CTS’ obligations to make payments upon a termination without cause or for good reason are subject to Mr. Schwanz’s compliance with certain on-going obligations and the delivery of a release of claims to CTS. The Agreement contains non-compete, confidentiality, non-solicitation, non-disparagement and work-made-for-hire clauses. On December 6, 2006, the Board of Directors also adopted a non-qualified individual excess benefit retirement plan for the benefit of Mr. Schwanz the terms of which are described under the caption “Pension Benefits” on pages 31 and 32.

 

As reported in CTS’ Current Report on Form 8-K filed on December 8, 2006. Mr. Schwanz has expressed his desire to retire as Chairman and CEO. The Board of Directors is engaged in an active succession planning process and would expect to announce a successor in the near term.

 

Employment Agreement with Vinod M. Khilnani.  On October 4, 2005, CTS entered into an employment agreement with Mr. Khilnani. The term of the agreement is four years. The agreement provides that if CTS terminates Mr. Khilnani’s employment without cause (as defined in the agreement) within two years after the time a successor CEO to Mr. Schwanz is appointed, CTS will provide Mr. Khilnani with compensation, equal to his current base salary and his target incentive compensation for the calendar year prior to termination, for a period of two years following his termination date. Termination of his employment under any other circumstances, including death, disability, voluntary termination or termination by CTS for cause (as defined in the agreement), will terminate the employment agreement without the payment of benefits under this employment agreement. Mr. Khilnani agrees to provide at least three months notice if he elects to voluntarily terminate employment and six months notice if he elects to retire. Mr. Khilnani agrees to refrain from solicitation of CTS employees for a period of five years following termination. In the event Mr. Khilnani is eligible to receive greater benefits under another agreement or policy, he may elect to receive such benefits in lieu of benefits under his employment agreement. Benefits received under the employment agreement will be reduced by any benefits received under another agreement or policy.

 

Compensation Arrangements.  CTS does not have employment agreements with any executive officers, other than Mr. Schwanz and Mr. Khilnani. Annual base salary for each named executive officer, other than Mr. Schwanz, is determined by the Compensation Committee of the Board of Directors. Mr. Schwanz’s annual base salary is determined by the Board of Directors based on a recommendation by the Compensation Committee. The annual salaries for named executive officers set in 2006 were as follows: Donald K. Schwanz — $779,300; Vinod M. Khilnani — $364,000; Donald R. Schroeder — $322,200; H. Tyler Buchanan — $256,400; and Richard G. Cutter — $243,100. Other compensation arrangements in which named executive officers participate are discussed below.

 

Bonuses.  Amounts shown in the Bonus column in the Summary Compensation Table reflect cash payments under the CTS Corporation 1988 Restricted Stock and Cash Bonus Plan. Under that plan, recipients receive a cash award equal to the fair market value of each restricted share of CTS stock on the date the restrictions lapse. The plan provided for awards to vest over a five year period. No awards have been made under that plan since 2003 and the Compensation Committee has expressed its intent to make no future awards under this plan. Dividends are paid on restricted shares at the same rate applicable to non-restricted shares of CTS stock. The dividend amounts paid to named executive officers on restricted shares are reflected in the All Other Compensation column of the Summary Compensation Table.

 

Non-Equity Incentive Plan Compensation.  In 2006, each Named Executive Officer, along with other officers and key employees, participated in the 2006 Management Incentive Plan. The Compensation Committee adopted this annual cash incentive plan under the terms of the CTS Corporation Management Incentive Plan approved by the shareholders in 2002. Corporate-wide and strategic business unit quantitative financial performance goals were established for the 2006 fiscal year under the plan. Each participant was also assigned qualitative performance goals for the 2006 fiscal year which contributed to CTS’ financial performance. A target award was established for each participant based on a percentage of his base salary. The Compensation Committee established the performance goals and target awards for each named executive officer, other than Mr. Schwanz. The Board of Directors approved the performance goals and target award for Mr. Schwanz based on a recommendation by the Compensation Committee. The percentage of achievement of performance goals determined the percentage of the target award which each participant earned. Amounts shown in the Summary Compensation Table reflect awards based on achievement of net sales, earnings per share and/or business unit contribution to earnings per share goals. Determination of the achievement of quantitative performance goals was subject to the completion of the annual audit and certification of CTS’ 2006 fiscal year results by its independent auditors. CTS paid the awards to participants in the form of lump sum cash payments.

 

Equity-Based Compensation.  The Compensation Committee has historically awarded equity-based compensation to Named Executive Officers on an annual basis. In 2006, the Compensation Committee awarded the named executive officers, other than Mr. Schwanz, restricted stock units and stock options under the CTS Corporation 2004 Omnibus Long-term Incentive Plan. The Board of Directors approved the grant of stock options and restricted stock units to Mr. Schwanz under the CTS Corporation 2004 Omnibus Long-term Incentive Plan based on the recommendation of the Compensation Committee. Restricted stock unit awards distribute one share of CTS common stock for each unit upon vesting. The award recipient does not receive dividends or other rights related to CTS stock until vesting. Restricted stock units generally vest in 20% installments over a period of five years. Mr. Schwanz’s 2006 restricted stock unit grant is subject to a one-year vesting period. Non-vested restricted stock units are forfeited upon termination of employment, except in the case of death, disability, or change-in-control of the corporation which accelerate the vesting of restricted stock units. Stock options are granted on the date of the Compensation Committee and Board meetings approving the grants. Stock options are generally granted to Named Executive Officers as incentive stock options to the maximum extent permitted by Section 422 of the Internal Revenue Code. The exercise price under the options is the closing market price of CTS stock on the New York Stock Exchange on the date of the grant. Options generally vest in 25% installments over a period of four years. Non-vested options are forfeited upon termination of employment, except upon the occurrence of certain events. In the event of a change-in-control as defined under the severance agreements described on pages 32 through 34, the vesting of options is accelerated. In the event of death or disability, options continue to become exercisable in installments and may be exercised for a period of one-year following the event. In the event of qualified retirement, options continue to become exercisable in installments and may be exercised prior to the expiration date.

 

Proportion of Annual Salary and Bonus to Total Compensation.  Among the Named Executive Officers, salary and non-equity incentive plan compensation as a percent of total compensation ranges from approximately 31% to 50%. Differences in the change in pension value due to different levels of credited service contribute to the breadth of the range. Salary and non-equity incentive plan compensation as a percent of total compensation, excluding change in pension value, ranges from 45% to 60%. The range is further reduced by excluding Mr. Schroeder’s temporary relocation allowance. Excluding this item and change in pension value, salary and non-equity incentive plan compensation as a percent of total compensation ranges from 50% to 60%. CTS considers peer data on the mix of salary, short-term incentive and long-term incentive compensation for comparable positions in setting compensation levels.

 

Outstanding Equity Awards at 2006 Fiscal Year-End

 

 

 

 

 

2006 Option Exercises and Stock Vested

 

 

 

 

2006 Pension Benefits

 

 

 

 

Pension Benefits.  The CTS Corporation Pension Plan is a tax-qualified defined benefit plan. The pension plan requires participants to complete five years of vesting service in order to be eligible for a benefit. Each of the Named Executive Officers has completed the required vesting service. The benefit formula is 1.25% of average monthly pay during the three calendar years of the participant’s last ten calendar years of service in which the participant received the highest pay, multiplied by a participant’s credited service to arrive at a monthly benefit. For calculation purposes, pay includes amounts reported in the salary, bonus, and non-equity incentive plan columns of the Summary Compensation Table. Benefits under the pension plan are not subject to any deduction for social security or other offsets. Normal retirement age under the pension plan is age 65. Participants with five years of credited service may elect an early retirement benefit at age 55. Mr. Schwanz, Mr. Schroeder, Mr. Buchanan and Mr. Cutter are currently eligible to elect early retirement. Early retirement benefits are reduced by .25% for each month that the participant may receive a benefit between the ages of 55 and 65. The normal form of benefit under the pension plan is a single life annuity. Married participants receive a reduced benefit under a joint and 50% survivor annuity absent spousal consent to waive this benefit.

 

Section 415(b)(1) of the Internal Revenue Code, placed a limit of $175,000 for 2006 on the amount of annual pension benefits that may be paid from a tax-qualified plan. Section 401(a)(17) of the Internal Revenue Code limits the amount of annual compensation that may be taken into account in calculating a benefit under a tax-qualified plan to $220,000 for 2006. The pension plan includes a supplemental benefit for named participants, including each of the Named Executive Officers, that allows for payment of benefit amounts, to the extent permitted by the Code in excess of the benefit amounts that would be permitted by those provisions.

 

In connection with entering into a new employment agreement with Mr. Schwanz in 2006, the Board of Directors adopted a non-qualified individual excess benefit retirement plan for the benefit of Mr. Schwanz. Mr. Schwanz’ benefit under the Individual Excess Benefit Retirement Plan replaces the benefit Mr. Schwanz had accrued under the CTS Corporation 2003 Excess Benefit Retirement Plan, referred to as the SERP, in which the other Named Executive Officers participate, as discussed below. Consistent with his benefit under the SERP, the Individual Excess Benefit Retirement Plan provides that upon retirement Mr. Schwanz will receive a supplemental retirement benefit equal to the difference between the benefit that he receives under the pension plan and the benefit he would receive under the pension plan if restrictions imposed on the calculation of benefits under tax-qualified plans were disregarded, early retirement reduction factors were eliminated, 50% of the fair market value of restricted stock units which vest during the three highest pay calendar years were included in the pay calculation and credited service earned after June 30, 2002 was multiplied by two. Under the SERP, benefits are payable at the time and in the manner elected by the participant under the pension plan. This payment provision, however, does not comply with Section 409A of the Internal Revenue Code. Therefore, the Individual Excess Benefit Retirement Plan provides that Mr. Schwanz will receive the actuarial present value of the supplemental retirement benefit calculated as described above. The actuarial present value of the benefit is payable as a single lump sum cash payment from the general assets of CTS in the seventh month following Mr. Schwanz’s separation from service. The actuarial present value is determined using the actuarial assumptions employed under the pension plan for determining lump sum cashouts in the Plan Year during which Mr. Schwanz’s separation from service occurs. Mr. Schwanz will receive interest on the lump sum amount for the period between his separation from service and its payment at an interest rate equal to the lump sum interest rate assumption used to calculate the lump sum amount.

 

Each named executive officer other than Mr. Schwanz participates in the SERP. The SERP is an unfunded supplemental retirement plan that provides that the participant will receive a benefit equal to the difference between his actual benefit under the pension plan and the benefit that would have been payable under the pension plan without regard to the limits on tax-qualified plans as described above. Each participant’s SERP benefit is enhanced by increasing the percentage of compensation included in the benefit formula by 0.1% for each full year of participation in the SERP to a maximum of 1.75% of average monthly pay during the three calendar years of the participant’s last ten calendar years of service in which the participant received the highest pay. The SERP benefit is further enhanced by including 50% of the fair market value of restricted stock units which vest during the three highest pay calendar years in the calculation of pay. Benefits under the SERP are payable at the same time and in the same form as the participant elects under the pension plan. As discussed above, this payment provision does not comply with Section 409A of the Internal Revenue Code, but is eligible for transition relief through December 31, 2007. The Compensation Committee intends to review the SERP and take such actions as may be necessary to bring its payment provisions into compliance with Section 409A prior to December 31, 2007.

 

Present value calculations for Mr. Schwanz are based on commencement of benefits as of December 31, 2006, because normal retirement age is not defined by the Individual Excess Benefit Retirement Plan and his benefit under that plan is not reduced for early commencement of benefits. The present value of Mr. Schwanz’s benefit under the Individual Excess Benefit Retirement Plan is based on a lump sum payment. The present value of Mr. Schwanz’s benefit under the pension plan is based on a single life annuity and reflects reductions for early commencement. Present value calculations for each of the other Named Executive Officers assume a single life annuity commencing at age 65. Actuarial assumptions used in these calculations are set forth in Note I to CTS’ Consolidated Financial Statements as reported in CTS’ Annual Report on Form 10-K for the year ended December 31, 2006, except pre-retirement decrements are not reflected.

 

Potential Payments Upon Termination or Change-in-Control.  Each of the active Named Executive Officers has executed a severance agreement with CTS, which becomes operative only upon a change-in-control of CTS. Change-in-control is defined as:

 

 

 

A Named Executive Officer is entitled to severance compensation if within three years of a change-in-control, he terminates his employment for good reason or his employment is terminated by CTS or its successor for any reason other than cause, disability or death. Good reason is defined as:

 

 

Severance compensation includes:

 

 

In addition, if any payments made to the Named Executive Officer are subject to excise tax under Section 4999 of the Code, he will receive an additional payment to put him in the same after-tax position as if no excise tax had been imposed.

 

Severance compensation must be paid by CTS or its successor. Lump sum payments of severance compensation are to be made within five days of the termination date, provided that interest will accrue at the prime rate then in effect on payments which are not made at that time. Payment of severance compensation under the change-in-control agreement will be reduced to the extent of any corresponding payments under any other agreement. To the extent that the executive receives severance benefits under the Agreement, the executive may not, for a period of one-year following his termination date, participate in the management of any business which engages in substantial and direct competition with CTS or its successor. In September 2005, CTS notified each of the Named Executive Officers that his severance agreement would not automatically renew on January 1, 2006. Therefore, each agreement will expire on December 31, 2007.

 

Assuming that a change-in-control event occurred and the Named Executive Officer was terminated without cause on December 29, 2006, the estimated severance compensation provided to each Named Executive Officer is as follows: