April 24, 2009

 

Dear CTS Shareholder:

 

You are cordially invited to attend the 2009 Annual Meeting of Shareholders of CTS Corporation. The meeting will be held on Wednesday, May 27, 2009, at 9:00 a.m. Central Daylight Time, at the Hilton Chicago/Indian Lakes Resort & Conference Center, 250 West Shick Road, Bloomingdale, IL 60108.

 

The official meeting notice, proxy statement, and proxy form are enclosed. These materials were first mailed to shareholders on April 24, 2009. 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.

 

Vinod M. Khilnani

President and Chief

Executive Officer

 

Notice of the Annual Meeting of Shareholders

 

To Be Held On

May 27, 2009

 

To CTS Shareholders:

 

The 2009 Annual Meeting of Shareholders of CTS Corporation will be held on Wednesday, May 27, 2009 at 9:00 a.m. Central Daylight Time, at the Hilton Chicago/Indian Lakes Resort & Conference Center, 250 West Shick Road, Bloomingdale, IL 60108. To obtain directions to the meeting location, please call (574) 523-3800.

 

Only shareholders of record at the close of business on April 9, 2009 may vote at this meeting or any adjournments that may take place. At the meeting, shareholders will vote on:

 

1. Election of directors for the ensuing year;

 

2. Approval of the CTS Corporation 2009 Omnibus Equity and Performance Incentive Plan;

 

3. Ratification of the appointment of Grant Thornton LLP as CTS’ independent auditor for 2009; and

 

4. Any other business properly presented at the meeting.

 

Your Board of Directors recommends that you vote in favor of the director-nominees, approve the CTS Corporation 2009 Omnibus Equity and Performance Incentive Plan, and ratify the appointment of Grant Thornton LLP.

 

By Order of the Board of Directors,

 

Richard G. Cutter

Secretary

 

April 24, 2009

 

 

 

 

PROXY STATEMENT

 

 

ANNUAL MEETING OF SHAREHOLDERS

 

To be held on
May 27, 2009

 

This proxy statement was first mailed to shareholders on April 24, 2009, and is furnished in connection with the solicitation by CTS Corporation’s Board of Directors of proxies to be voted at the Annual Meeting of Shareholders. The following is important information in a question-and-answer format regarding the meeting and this proxy statement.

 

 

 

 

2.	APPROVAL OF THE CTS CORPORATION 2009 OMNIBUS EQUITY AND PERFORMANCE INCENTIVE PLAN.
3.	RATIFICATION OF THE APPOINTMENT OF GRANT THORNTON LLP AS CTS’ INDEPENDENT AUDITOR FOR 2009.

 

PROPOSAL 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 eight. There are eight director-nominees for election. Detailed information on each is provided below. All directors are elected annually and serve one-year terms or until their successors are elected and qualified.

 

Nominees for the Board of Directors.  Each director-nominee named below is currently a director of CTS Corporation. The ages shown are as of April 24, 2009, the date on which this proxy statement was first mailed to shareholders. Each director-nominee has agreed to serve as a director if elected. If one or more of the nominees become unavailable for election, the members of the Board of Directors will, in their sole discretion and pursuant to authority granted by the CTS Corporation bylaws, nominate and vote for a replacement director or reduce the authorized number of directors.

Age 64

 

Mr. Catlow is Dean of the College of Business at Concordia University. 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 international investments and was responsible for global acquisitions and alliances.

 

Age 66

 

Mr. Ciancia has been a partner in Corporate Development International, Inc., a corporate search firm specializing in mergers, acquisitions and divestitures, since 1998. Previously, Mr. Ciancia served as President of Uponor ETI, a supplier of PVC pipe products, specialty chemicals and PVC compounds.

 

Age 67

 

Mr. Cody has served as Vice Chairman of Macy’s, Inc. (formerly known as Federated Department Stores, Inc.), a nationwide department store retailer, since February 2003. From 1992 to 2003, Mr. Cody was Executive Vice President, Legal and Human Resources of Federated Department Stores, Inc.

 

Age 50

 

Ms. Collawn is President and Chief Operating Officer of PNM Resources, a utilities corporation serving electricity and natural gas customers, since August 2008. Prior to this position, she served as Utilities President from June 2007. Prior to June 2007, Ms. Collawn was President and Chief Executive Officer of Public Service Company of Colorado, an Xcel Energy, Inc. subsidiary, from November 2005. Ms. Collawn served as President of Customer and Field Operations of Xcel Energy from July 2003.

 

Age 72

 

Mr. Hemminghaus is the Chairman of the CTS Corporation Board of Directors. He is the retired Chairman and Chief Executive Officer of Ultramar Diamond Shamrock Corporation, a corporation that refined and marketed petroleum products on a retail and wholesale basis, serving from 1996 until 2000. 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.

 

Age 69

 

Mr. Henning is the retired Deputy Chairman of Ernst & Young LLP, an independent accounting firm, serving from 1999 to 2000. Mr. Henning served as Chief Executive Officer of Ernst & Young International, Inc. from 1993 until 1999. Mr. Henning also serves as a Director and as a member of the audit committee at each of Omnicom Group, Inc., Landstar Systems, Inc., and Highlands Acquisition Corporation.

 

Age 56

 

Mr. Khilnani joined CTS Corporation in May 2001 as Senior Vice President and Chief Financial Officer. In July 2007, he was elected President and appointed Chief Executive Officer. Mr. Khilnani received his Masters degree in economics from Delhi University in 1973 and his MBA in Finance from the University of New York in 1977. He holds CPA and CMA certifications. Mr. Khilnani has over 30 years of leadership experience in finance, strategy, mergers and acquisitions, and operating roles based in the USA and Europe, including

18 years at Cummins, Inc. Mr. Khilnani also serves as a Director, member of the Nominating and Governance Committee, and member of the Compensation Committee for Brush Engineered Materials, Inc.

 

Age 59

 

Mr. Profusek is the Head of Mergers & Acquisitions for Jones Day, a global law firm which he joined in 1975. Mr. Profusek also serves as a Director of Valero Energy Corporation and is a member of Valero’s Compensation and Nominating and Governance Committees.

 

 

 

 

PROPOSAL 2: APPROVAL OF THE CTS CORPORATION 2009 OMNIBUS EQUITY AND PERFORMANCE INCENTIVE PLAN.

 

On February 4, 2009, the Board of Directors unanimously approved and adopted, subject to shareholder approval, the CTS Corporation 2009 Omnibus Equity and Performance Incentive Plan (the “2009 Plan”). The purpose of the 2009 Plan is to provide certain employees, consultants, and non-employee directors of the corporation (“Participants”) with the opportunity to receive stock-based and performance incentives in order to attract, motivate, and retain qualified individuals and to align their interests with the interests of shareholders. You are being asked to approve the 2009 Plan.

 

CTS currently may grant equity awards under the terms of the CTS Corporation 2004 Omnibus Long-Term Incentive Plan (the “2004 Plan”), including stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, or other stock awards. If the 2009 Plan is approved by the shareholders, no grants will be made under the 2004 Plan in the future, except for grants awarded pursuant to the term of the 2008-2009 Performance Restricted Stock Unit Plan and the 2009-2010 Performance Restricted Stock Unit Plan (an on-target award of 226,000 restricted stock units with a maximum total of 452,000 restricted stock units possible). Approval of the 2009 Plan will in no way affect the validity of prior grants made under the 2004 Plan.

 

You are also being asked to approve certain material terms of the 2009 Plan in order to preserve CTS’ ability to receive a federal income tax deduction for performance-based payments under the 2009 Plan. As discussed in the section entitled “Deductibility of Certain Executive Compensation,” Section 162(m) of the Code disallows the corporate tax deduction for certain compensation in excess of $1 million per year paid to certain executive officers. However, certain compensation, including compensation based on the attainment of performance goals, is excluded from this deduction limit if the compensation is granted under a plan whose material terms for performance-based awards for purposes of Section 162(m) are approved by shareholders. Under Section 162(m) of the Internal Revenue Code and applicable regulations, CTS must seek shareholder approval at five-year intervals to preserve CTS’ ability to receive this federal income tax deduction. Shareholder approval of the 2009 Plan will have the effect of reducing the potential tax to be paid by CTS on certain compensation should it reach the limits set forth in Section 162(m) of the Code. If shareholders fail to approve the 2009 Plan, CTS generally will still be able to make awards of, among other things, stock options, stock appreciation rights, restricted stock and deferred stock under the 2004 Plan, but CTS may be limited in its ability to grant certain performance-based awards under the 2004 Plan for purposes of Section 162(m). The Board of Directors recommends that you vote to approve the 2009 Plan, including the material terms for performance-based awards for purposes of Section 162(m).

 

A summary of the 2009 Plan follows, which summary is qualified in its entirety by reference to the 2009 Plan itself, a copy of which is attached to this proxy statement as Exhibit A. A new plan benefits table is not provided because no grants have been made under the 2009 Plan and all grants will be discretionary.

 

 

 

 

 

 

Federal Income Tax Consequences

 

The following is a brief summary of some of the federal income tax consequences of certain transactions under the 2009 Plan based on federal income tax laws in effect on January 1, 2009. This summary is not intended to be complete and does not describe state or local tax consequences. It is not intended as tax guidance to Participants in the 2009 Plan.

 

Tax Consequences to Participants

 

Nonqualified Stock Options.  In general, (1) no income will be recognized by an optionee at the time a nonqualified stock option is granted; (2) at the time of exercise of a nonqualified stock option, ordinary income will be recognized by the optionee in an amount equal to the difference between the exercise price paid for the shares and the fair market value of the shares, if unrestricted, on the date of exercise; and (3) at the time of sale of shares acquired pursuant to the exercise of a nonqualified stock option, appreciation (or depreciation) in value of the shares after the date of exercise will be treated as either short-term or long-term capital gain (or loss) depending on how long the shares have been held.

 

Incentive Stock Options.  No income generally will be recognized by an optionee upon the grant or exercise of an incentive stock option, or ISO. The exercise of an ISO, however, may result in alternative minimum tax liability. If shares are issued to the optionee pursuant to the exercise of an ISO, and if no disqualifying disposition of such shares is made by such optionee within two years after the date of grant or within one year after the transfer of such shares to the optionee, then upon sale of such shares, any amount realized in excess of the exercise price will be taxed to the optionee as a long-term capital gain and any loss sustained will be a long-term capital loss.

 

If shares acquired upon the exercise of an ISO are disposed of prior to the expiration of either holding period described above, the optionee generally will recognize ordinary income in the year of disposition in an amount equal to the excess (if any) of the fair market value of such shares at the time of exercise (or, if less, the amount realized on the disposition of such shares if a sale or exchange) over the exercise price paid for such shares. Any further gain (or loss) realized by the Participant generally will be taxed as short-term or long-term capital gain (or loss) depending on the holding period.

 

SARs.  No income will be recognized by a Participant in connection with the grant of a SAR. When the SAR is exercised, the Participant normally will be required to include as taxable ordinary income in the year of exercise an amount equal to the amount of cash received and the fair market value of any unrestricted shares received on the exercise.

 

Restricted Stock.  The recipient of restricted stock generally will be subject to tax at ordinary income rates on the fair market value of the restricted stock (reduced by any amount paid by the Participant for such

restricted stock) at such time as the shares are no longer subject to forfeiture or restrictions on transfer for purposes of Section 83 of the Internal Revenue Code (“Restrictions”). However, a recipient who so elects under Section 83(b) of the Internal Revenue Code within 30 days of the date of transfer of the shares will have taxable ordinary income on the date of transfer of the shares equal to the excess of the fair market value of such shares (determined without regard to the Restrictions) over the purchase price, if any, of such restricted stock. If a Section 83(b) election has not been made, any dividends received with respect to restricted stock that is subject to the Restrictions generally will be treated as compensation that is taxable as ordinary income to the Participant.

 

Restricted Stock Units.  No income generally will be recognized upon the award of restricted stock units. The recipient of an award of restricted stock units generally will be subject to tax at ordinary income rates on the fair market value of unrestricted shares on the date that such shares are transferred to the Participant under the award (reduced by any amount paid by the Participant for such restricted stock units), and the capital gains/loss holding period for such shares will also commence on such date.

 

Performance Shares and Performance Units.  No income generally will be recognized upon the grant of performance shares or performance units. Upon payment in respect of the earn-out of performance shares or performance units, the recipient generally will be required to include as taxable ordinary income in the year of receipt an amount equal to the amount of cash received and the fair market value of any unrestricted shares received.

 

Other Stock Awards.  No income generally will be recognized upon the grant of other stock awards. Upon payment of other awards, the recipient generally will be required to include as taxable ordinary income in the year of receipt an amount equal to the amount of cash received and the fair market value of any unrestricted shares received.

 

Tax Consequences to CTS

 

To the extent that a Participant recognizes ordinary income in the circumstances described above, CTS will be entitled to a corresponding deduction provided that, among other things, the income meets the test of reasonableness, is an ordinary and necessary business expense, is not an “excess parachute payment” within the meaning of Section 280G of the Internal Revenue Code and is not disallowed by the $1 million limitation on certain executive compensation under Section 162(m) of the Internal Revenue Code.

 

 

 

PROPOSAL 3: RATIFICATION OF APPOINTMENT OF GRANT THORNTON LLP AS
INDEPENDENT AUDITOR

 

Grant Thornton LLP has served as CTS’ independent registered public auditor since June 2005 and has been appointed by the Audit Committee to continue as CTS’ independent auditor for 2009. In the event that ratification is not approved by a majority of the shares of CTS common stock represented at the Annual Meeting in person or by proxy and entitled to vote on the matter, the Audit Committee and the Board of Directors will review the Audit Committee’s future selection of independent auditors.

 

Representatives of Grant Thornton LLP will be present at the Annual Meeting. The representatives will be available to respond to appropriate questions. The representatives will also be afforded an opportunity at such time to make such statements as they desire.

 

 

 

 

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, 2008:

 

 

 

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 holders of at least 10% of CTS’ common stock 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 in 2008, with the exception of one report on one transaction for Vinod M. Khilnani, which was filed one day late due to an administrative oversight.

 

COMMITTEES OF THE BOARD OF DIRECTORS

 

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.

 

Compensation Committee

 

The Compensation Committee is a standing committee of the Board of Directors. Directors Cody, Catlow, Collawn, and Henning are the current members of the Compensation Committee. Each member of the Compensation 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 four meetings in 2008. 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 Compensation Committee establishes executive compensation policies and reviews and approves senior executive and director compensation and employment agreements. The Compensation Committee reviews and approves corporate goals and objectives relevant to the Chief Executive Officer’s compensation, evaluates the Chief Executive Officer’s performance against those objectives, and makes recommendations to the Board of Directors regarding the Chief Executive Officer’s compensation. The Compensation Committee also administers the CTS Corporation Management Incentive Plan and the CTS Corporation 2004 Omnibus Long-Term Incentive Plan. If the CTS Corporation 2009 Omnibus Equity and Performance Incentive Plan is approved, the Compensation Committee will also administer the 2009 Plan. Annually, the Compensation Committee conducts an evaluation of its performance for the fiscal year.

 

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 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.

 

The Senior Vice President Administration regularly reports to the Compensation Committee regarding market trends in executive compensation. He also 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.

 

Compensation Committee Interlocks and Insider Participation

 

Directors Cody, Catlow, Collawn, and Henning were appointed to the Compensation Committee following their election to the Board of Directors at the 2008 Annual Meeting of Shareholders of CTS Corporation. During 2008, no executive officer of CTS served as a director of any other entity for which any CTS director was an executive officer.

 

Nominating and Governance Committee

 

The Nominating and Governance Committee is a standing committee of the Board of Directors. Directors Ciancia, Cody, Collawn, and Frieling 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 2008. 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 of Directors concerning committee assignments and director-nominees for election at the Annual Meeting. The Nominating and Governance Committee also develops the CTS Corporation Corporate Governance Guidelines for the approval of the Board of Directors and makes recommendations on matters of corporate governance. CTS’ bylaws describe the process for nominating a candidate for election to the Board of Directors at the Annual Meeting of Shareholders. CTS does not have a formal policy concerning whether the Nominating and Governance Committee will consider director-nominees submitted by shareholders. CTS did not receive any shareholder director-nominees for election at the 2009 Annual Meeting of Shareholders. At this time, the Board of Directors does not believe a formal policy regarding shareholder director-nominees is necessary since 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 of Directors, on an annual basis, the requisite skills and director characteristics of any new members as well as the composition of the Board of

Directors as a whole. This review includes an assessment of whether each non-management director qualifies as independent and an assessment of the diversity, age, skills, and experience of the directors in the context of the needs of the Board of Directors. Although the Nominating and Governance Committee has not established any specific minimum criteria or qualifications that a candidate must possess, the Nominating and Governance Committee seeks candidates who possess the experience necessary to make a valuable contribution to the Board of Directors. The Nominating and Governance Committee may retain search firms for the purpose of identifying and evaluating director candidates. The Nominating and Governance Committee also considers director-nominees identified by management and by non-management directors.

 

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. The Board of Directors has determined that Mr. Henning qualifies as an audit committee financial expert under the criteria set forth in Item 407(d)(5)(ii) of Regulation S-K. In addition to being a member of the CTS Audit Committee, Mr. Henning serves on the audit committees of three other public companies. The Board of Directors met and discussed whether or not Mr. Henning’s additional service would negatively impact his service to the CTS Audit Committee. It is the opinion of the Board of Directors that Mr. Henning’s breadth and depth of financial experience and knowledge greatly enhances the abilities and competencies of the CTS Audit Committee and that, as a retiree, Mr. Henning has ample time and capacity to serve four public company audit committees without impairment of his ability to serve the CTS Audit Committee.

 

The Audit Committee held nine meetings in 2008. A copy of the Audit Committee Charter may be obtained free of charge from CTS’ Secretary upon request or from 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 the internal audit department. The Audit Committee reviews systems of internal accounting controls and audit results. The Audit Committee also reviews and discusses with management CTS’ financial statements, earnings press releases, and earnings guidance. In addition, the Audit Committee also reviews CTS’ compliance with public-company regulatory requirements and the CTS Code of Ethics.

 

Finance and Strategic Initiatives Committee

 

The Finance and Strategic Initiatives Committee is a standing committee of the Board of Directors. Directors Catlow, Frieling, Khilnani, and Profusek are the current members of the Finance and Strategic Initiatives Committee. The Finance and Strategic Initiatives Committee held two meetings in 2008. A copy of the Finance and Strategic Initiatives 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 and Strategic Initiatives Committee reviews and makes recommendations to the Board of Directors concerning corporate financing arrangements, tax strategies, dividend policy, financial structure, acquisition and divestiture strategies, and similar matters. Additionally, the Finance and Strategic Initiatives Committee reviews and approves capital project appropriation requests for capital projects that are above certain prescribed limits.

 

FURTHER INFORMATION CONCERNING THE BOARD OF DIRECTORS

 

During 2008, the Board of Directors held seven meetings. It is the policy of the Board of Directors that each director endeavor to attend each Annual Meeting of Shareholders, unless exigent circumstances arise. Each director standing for re-election at the 2008 Annual Meeting of Shareholders attended that meeting.

 

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

 

 

For purposes of determining whether a director has a material relationship with the corporation apart from his service as a director, the Board of Directors has determined that the corporation’s purchase of regulated electric and gas service from a utility company does not constitute a material relationship.

 

Additionally, for purposes of determining whether a director has a material relationship with CTS Corporation apart from his or her service as a director, any transaction that is not required to be disclosed pursuant to Item 404(a) of Regulation S-K shall be deemed categorically immaterial. A copy of the CTS Corporation 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 Corporation, 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, Patricia K. Collawn, Gerald H. Frieling, Jr., Roger R. Hemminghaus, Michael A. Henning, and Robert A. Profusek are each independent directors.

 

CTS does not have a written policy specific to transactions with related persons. However, CTS does have written policies and procedures with respect to conflicts of interest. The CTS Corporation Corporate Governance Guidelines provide that the Nominating and Governance Committee shall review any situation which might be construed to disqualify a director as independent and to 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 shall review any potential director conflicts of interest and recommend appropriate action to the Board of Directors.

 

CTS has adopted a Code of Ethics that applies to all CTS employees, including the principal executive officer, the principal financial officer, the principal accounting officer and/or controller, and all other executive officers and non-employee directors. The CTS Code of Ethics includes ethical standards 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 reviews any potential 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/code_of_ethics.htm.

 

The CTS Corporate Governance Guidelines encourage all directors to participate in director continuing education programs. CTS 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.

 

It is the policy of the Board of Directors to hold an executive session excluding management directors at each regular scheduled Board of Directors’ meeting. In 2008, an executive session was held at each regular board meeting. The Chairman of the Board of Directors presides over the executive sessions.

 

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.

 

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, by writing to Richard G. Cutter, Vice President, Secretary and General Counsel, at CTS’ corporate office located at 905 West Boulevard North, Elkhart, Indiana, 46514. All communications from shareholders must include the name and address of the shareholder as it appears on the record books of CTS Corporation 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 Corporation to beneficially own at least 5% of its common stock as of December 31, 2008, unless a different date is indicated below. There were 33,711,225 shares of CTS common stock issued and outstanding as of December 31, 2008. The information below is derived solely from the most recent Schedules 13D or 13G, and amendments thereto, filed with the Securities and Exchange Commission.

 

 

 

Directors’ and Officers’ Stock Ownership.  The following table shows how much CTS common stock each named executive officer, director, and all executive officers and directors as a group, beneficially owned as of April 9, 2009, including shares covered by stock options exercisable within 60 days of April 9, 2009. 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.

 

 

 

 

COMPENSATION DISCUSSION AND ANALYSIS

 

Executive Summary

 

This compensation discussion and analysis provides details about CTS’ compensation practices for the named executive officers whose names appear in the tables below. The information provided in this section should be read in conjunction with the tables and narratives that accompany the information presented.

 

Throughout 2008, Mr. Vinod M. Khilnani served as President and Chief Executive Officer of CTS. Effective July 2, 2007, CTS Treasurer Mr. Matthew W. Long was appointed Interim Chief Financial Officer. Mr. Long remained in that position until January 21, 2008, when Ms. Donna L. Belusar was appointed Chief Financial Officer. Mr. Long’s appointment as Interim Chief Financial Officer ended that same date, and he continues in his duties as Treasurer for CTS. The following executives are CTS’ named executive officers for 2008, as that term is defined by the Securities and Exchange Commission:

 

 

CTS believes that its policies and practices as presented in this compensation discussion and analysis reflect the corporation’s compensation philosophy and enable it to attract, motivate, and retain high quality executive management. The Compensation Committee met four times in 2008 to discuss compensation matters.

 

CTS uses a mix of cash and equity to compensate its executives. The elements of compensation for each named executive officer include base salary, annual cash incentives, performance-based equity awards, time-based equity awards, retirement benefits, perquisites, and health and welfare benefits. Although not determinative, the Compensation Committee considers the median of peer group data provided by Towers Perrin and data that it compiles from reputable public compensation databases as guidelines when setting CTS executives’ total compensation. The Compensation Committee also considers a number of other factors when establishing executive compensation and recommending total compensation for the Chief Executive Officer. It is possible for CTS executives to earn above-market compensation in any year, but they may earn below market compensation as well, depending on individual and corporate performance for that year.

 

A substantial part of CTS executives’ total compensation is based on performance and is at-risk each year. As an executive officer takes on more responsibility with CTS, the Compensation Committee generally increases the percentage of his or her total compensation that is at-risk. As a result, our named executive officers have a substantial percentage of their total compensation opportunities based on at-risk, variable elements of compensation. CTS believes that this practice is appropriate because the corporation’s named executive officers have the greatest ability to drive performance and, therefore, should have the most to gain or lose in terms of compensation opportunities based on performance.

 

Compensation Philosophy

 

CTS centers total 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, although this measure is a guideline rather than a fixed rule. CTS’ practice to structure its executive compensation at approximately the fiftieth percentile is based upon a philosophy that by using a median award, CTS is able to balance motivating the executive with what it perceives as market-competitive factors in being able to recruit and retain top executive talent. CTS does not generally utilize a specific formula for

allocating total compensation between current and long-term compensation or between cash and non-cash compensation. Beginning in 2008, however, the Compensation Committee adopted a practice whereby approximately one half of the value of an executive’s total long-term incentive award will be comprised of performance-based equity awards. The amount of compensation allocated to each element of compensation reflects allocation percentages in benchmark data for comparable positions. Factors such as level of experience, responsibilities, demonstrated performance, time with the corporation, achievement of individual and corporate goals, and retention considerations also affect the compensation level and structure. 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. 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. Additionally, CTS seeks to motivate executives with performance-based incentives to maximize CTS’ performance and enhance shareholder value.

 

Guided by this philosophy, CTS has specifically designed and administered its executive compensation program to achieve three main objectives:

 

 

CTS offers executive compensation packages that contain a variety of elements. Total compensation packages are designed to achieve each of CTS’ compensation objectives as follows:

 

 

Role of Management in Executive Compensation Decisions

 

In 2008, Mr. Khilnani relied on the competitive information provided by external compensation consultants as compiled by Mr. James L. Cummins, CTS’ Senior Vice President Administration. After reviewing the data compiled by Mr. Cummins, Mr. Khilnani recommends a total compensation package to the Compensation Committee for each named executive officer other than himself. As a benchmark, Mr. Khilnani’s general aim

is to align each executive officer’s total compensation at approximately the fiftieth percentile of similarly situated executives. Mr. Khilnani’s practice promotes CTS’ philosophy in that by using the fiftieth percentile, or median compensation, as a benchmark in setting total compensation, the corporation will be able to attract, motivate, and retain qualified executives who will lead the corporation to achieve its goals.

 

How Executive Compensation is Determined

 

The Compensation Committee discusses the data used by Mr. Khilnani, considers his recommendations, and ultimately decides on total compensation for each named executive officer. At the February meeting of the Board of Directors, the Compensation Committee set targets for compensation opportunities that are intended to qualify as performance-based awards under Section 162(m) of the Internal Revenue Code. For all executives other than the Chief Executive Officer, total compensation packages for the year are finalized when approved by the Compensation Committee. The Compensation Committee recommends a total compensation package for the Chief Executive Officer to the Board of Directors. This package only becomes final upon final approval by the Board of Directors.

 

The Compensation Committee has the responsibility to ensure that a market analysis of executive compensation is performed at regular intervals, generally every two to three years. As discussed above, the Compensation Committee considers the recommendations of the Chief Executive Officer in setting total compensation awards for each executive other than himself. The Compensation Committee also considers benchmark data compiled by or obtained from compensation consultant professionals when it sets total compensation for CTS executive officers, including the Chief Executive Officer.

 

In the fall of 2008, management recommended, and the Compensation Committee approved, a proposal to modify the executive compensation review process. Under the former process, the various elements of executive compensation were reviewed at separate times of the year. The revised process will enable all elements of executive compensation to be reviewed each year during the Compensation Committee’s February meeting. This new process of reviewing compensation in total streamlines and consolidates review and recommendation activities, promotes a better understanding of each executive’s complete compensation package, and improves administrative efficiency. These process changes were approved by the Compensation Committee to be implemented in a phased fashion for future compensation cycles beginning with the compensation for 2009.

 

Overall Mix and Structure of Compensation

 

Annually, the Compensation Committee considers the total compensation opportunities for each named executive officer and determines how total compensation should be allocated across the different types of compensation offered by CTS. The Compensation Committee does not generally follow a definitive policy when determining the mix of and structure for total compensation. Instead, it considers current market practices, individual performance and goal attainment and retention considerations. Generally, the Compensation Committee considers market practices to obtain a baseline of total compensation for each executive. Using this as a starting point, the Compensation Committee engages in discussion to consider the Chief Executive Officer’s recommendations with the objective of ensuring that a substantial portion of each named executive officer’s total compensation is at-risk and measured by the corporation’s performance in the short term, balanced against rewarding the officer in the long term for his or her continued contributions to the corporation. In this way, CTS believes that it is able to align the interests of the named executive officers with those of the shareholders year-over-year, as well as over the long term.

 

Cash incentives and equity compensation opportunities increase across the executive officer positions consistent with increasing responsibility. This structure generally means that the most senior executives will have a higher percentage of their total compensation at-risk and variable than the less senior executives. As a result, the most senior executive officers who have the greatest ability to drive CTS’ performance have the most to gain or lose based on corporate and individual performance.

In addition to cash and equity components, CTS offers its executives retirement, health and welfare benefits, and perquisites. The corporation believes that health and welfare benefits are standard practice in most peer group companies and is an expected component of overall compensation benefits provided to executive officers.

 

How CTS Benchmarks Executive Compensation using Market Data

 

For the annual executive compensation review, Mr. Cummins assembles benchmark data from well-regarded sources for all elements of compensation, including base salary, perquisites, annual incentives, incentive targets, and equity awards. This benchmark information is used by Mr. Khilnani to recommend a compensation package for each executive officer in accordance with CTS’ compensation philosophy. The benchmark data is also provided to the Compensation Committee and used as one consideration in setting executive compensation.

 

Towers Perrin.  Every two to three years, CTS obtains benchmark data reports from Towers Perrin for all executive officer positions in order to determine current prevailing pay rates for such positions. For years in which CTS does not purchase executive compensation data from Towers Perrin, Towers Perrin will provide guidance on the industry and market total compensation increase year-over-year. Towers Perrin provides CTS with detailed, comprehensive, and sophisticated compensation analysis which enables CTS to make well-informed decisions on executive compensation. Towers Perrin produces the benchmark data reports through analysis of information derived from multiple large surveys on the pay practices of other companies. CTS’ executive officer positions are compared to positions with similar job responsibilities in general industry and the electronics and scientific equipment industry. Towers Perrin determines competitive pay based on regression analysis, a statistical technique that considers the relationship between total revenues and compensation. Towers Perrin uses information provided by CTS on job descriptions and CTS’ financial data to select which companies and positions are appropriate comparisons for CTS’ officer positions.

 

Based on its review of corporate pay practices, Towers Perrin has explained to CTS that total compensation levels that are within 15% of the median of the market data are generally considered to be within the range of competitive practice. The Compensation Committee considered this guidance by Towers Perrin when establishing 2008 compensation levels, although the Compensation Committee may deviate from this guideline in light of a particular executive’s level of experience, skills, and tenure with the corporation. In cases where compensation for an executive falls substantially below the 15% of median data threshold, consistent with CTS’ compensation philosophy, the Compensation Committee will ordinarily recommend a larger increase to bring the compensation in line with the acceptable median over time. For example, in 2008, the Chief Executive Officer was substantially below the market data. After considering this and all other relevant compensation factors, the Compensation Committee recommended a larger than average increase for the Chief Executive Officer position in 2008.

 

The data provided by Towers Perrin does not indicate the corporations from which it is derived but provides the Compensation Committee with median data about executive officers’ total compensation from companies that are of similar size and revenue to CTS. CTS does not limit its peer group to its industry because compensation data is not available for all of its competitors and also because CTS believes that it is important to consider compensation practices at other companies of comparable size and scope in order to attract and retain executive talent.

 

Although CTS does not have access to the identities of the benchmarked companies, management and the Compensation Committee have confidence in the Towers Perrin market data reports because the data is pulled from large, detailed, and comprehensive survey data, because the market data for the Chief Executive Officer and Chief Financial Officer are compared against the Equilar benchmark data (discussed below), and because Towers Perrin is a well-known compensation consultant used by CTS on numerous occasions and their benchmark data has historically proven appropriate in attracting and retaining qualified and talented executives of the caliber CTS desires.

Benchmark compensation reports were obtained from Towers Perrin for use in setting 2007 executive compensation. When setting 2008 compensation, CTS aged the 2007 Towers Perrin data by applying a 4% aging factor supplied by Towers Perrin. Management and the Compensation Committee considered this inflationary guideline while setting total 2008 compensation for each executive.

 

In conjunction with the new executive compensation review schedule, Towers Perrin benchmark compensation reports were completed and reviewed in September 2008 for use in setting 2009 executive compensation levels.

 

Equilar.  Mr. Cummins consults 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. Therefore, the companies chosen for benchmark purposes were selected because they fit at least one criterion of similar revenue, similar size, similar industry or similar products and services to CTS. The companies selected for benchmarking in 2008 were ArvinMeritor, Inc., AVX Corporation, Benchmark Electronics, Inc., BorgWarner, Inc., Celestica, Inc., Flextronics International, Ltd., Frequency Electronics, Inc., Gentex Corporation, Jabil Circuit, Inc., KEMET Corporation, Key Tronic Corporation, Kimball International, Inc., LaBarge, Inc., Lear Corporation, LittelFuse, Inc., Methode Electronics, Inc., Molex Incorporated, Plexus Corp., RF Micro Devices, Inc., Sanmina-Sci Corporation, Sparton Corporation, Spectrum Control, Inc., Stoneridge, Inc., Sypris Solutions, Inc., Technitrol, Inc., Triquint Semiconductors, Inc., Vishay Intertechnology, Inc., and Williams Controls, Inc. Mr. Cummins reviews and reevaluates the Equilar peer group annually to ensure that all of the peers continue to meet at least one of the selection criteria. Peers who no longer meet such criteria, or for which information is no longer available through Equilar, may be eliminated or replaced.

 

Management and the Compensation Committee evaluate the Equilar data against the Towers Perrin benchmark data discussed previously. When compared, the data sources should reveal similar benchmark compensation ranges for the Chief Executive Officer and the Chief Financial Officer. A wide disparity may reveal that the Equilar peer group is inadequately representative or that the Towers Perrin data is distorted, and should be reexamined. The comparison of this data helps to assure Management and the Compensation Committee that the benchmark data used is appropriate. For 2008, the Equilar data was found by management and the Compensation Committee to be within an acceptable range.

 

Elements of Total Compensation

 

Base Salary.  Base salary is included as an element of total compensation to ensure that each named executive officer receives a minimum return for his or her service to the corporation each year. In 2008, in keeping with CTS’ compensation philosophy and objectives, the Compensation Committee determined reasonable base salaries for its named executive officers by aligning target compensation for each named executive officer at approximately the fiftieth percentile of peer executives set forth in current market compensation data provided by compensation professionals. The Compensation Committee considers the executive’s duties, responsibilities, past performance and time with the corporation in setting base salary.

 

The annual base salaries for named executive officers set in 2008 were as follows: Mr. Khilnani — $550,000; Ms. Belusar — $288,750; Mr. Long — $185,848; Mr. Buchanan — $272,023; Mr. Schroeder — $341,857; and Mr. Cutter — $260,416. 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 2008, rather than salary earned in fiscal year 2008. Other compensation arrangements in which named executive officers participate are discussed below.

 

In light of the current business recession, the CTS executive officer base salaries were temporarily reduced five percent. This temporary salary reduction began the first pay period of February 2009, and is anticipated to expire on or about June 30, 2009, concurrent with the reinstatement of full salaries for those other corporate employees whose salaries were also temporarily reduced in early 2009. Each executive

officer also took one week of unpaid furlough during the first quarter of 2009. CTS believes that as it looks to reduce costs throughout the corporation, executive pay should also be included in such cost-reduction measures.

 

Non-Equity Incentive Plan Compensation.  CTS believes that it is important to motivate its executives to achieve annual corporate financial goals. Therefore, CTS puts a substantial part of each executive’s total compensation at-risk by tying it directly to overall corporate performance. CTS uses an annual management incentive compensation plan, or MIP, established pursuant to the terms of the CTS Corporation 2007 Management Incentive Plan, in order to focus CTS’ executives on the most critical of its shorter-term financial metrics each year. The MIP provides for annual cash payments to named executive officers based on CTS’ financial performance and achievement of individual goals. An executive’s ultimate award is determined under a formula that provides for payment of zero to 200% of a target award based on CTS’ actual performance versus the established quantitative financial performance goals. In addition, the Compensation Committee may adjust awards downwards based upon the executive’s actual performance versus individual qualitative and quantitative goals.

 

Awards under the annual 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, and goals must be set within the first 90 days of each fiscal year. The terms of the CTS Corporation 2007 Management Incentive Plan were approved by shareholders at the June 2007 Annual Meeting of Shareholders.

 

How Management Incentive Plan Target Awards and Performance Goals are Set.  Each February, the Compensation Committee establishes a target award and qualitative and quantitative performance goals for each executive. Target awards are set as a percentage of base salary. In setting targets, the Compensation Committee takes into consideration the median percentile targets in the Towers Perrin benchmark reports as well as internal parity. As an example, if review of the Towers Perrin benchmark data discloses that, on average, it is customary for a position to be offered an annual cash incentive representing 10% of salary, CTS will usually use a range centered on that 10% mark when it decides what is appropriate for performance-based annual cash awards. CTS’ practice to structure its executive annual cash incentive compensation at approximately the fiftieth percentile is based upon a philosophy that by using a median award, CTS is able to balance motivating the executive with what it perceives as market-competitive factors in being able to recruit and retain top executive talent.

 

Quantitative financial performance goals 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. Provided that a metric is a performance measure authorized under the terms of the CTS Corporation 2007 Management Incentive Plan, the Compensation Committee may use any of the metrics set out in the business plan to establish executive compensation awards each year.

 

In 2008, the Compensation Committee set quantitative financial performance goals using CTS’ operating earnings (per applicable business unit) and CTS’ earnings per share. Operating earnings was selected as a metric because operating earnings is an objective, quantitative value easily measured for performance purposes. CTS chose earnings per share from CTS’ annual business plan as a metric because it believes that earnings per share is a direct measurement of overall corporate performance which takes into consideration market conditions and provides a quantitative measurement from which CTS is able to assess the performance of its named executive officers for each particular year.

 

The Compensation Committee set the performance level for each of these metrics for each executive and established a minimum performance level that must be reached before an award is paid for performance based on a particular metric. When establishing performance levels for particular metrics, the Compensation

Committee will consider past and projected performance levels for both the corporation and the executive, external market conditions, presumptions for the coming year, and desired overall share performance targets for that year.

 

Individual qualitative and quantitative performance goals for each executive are specific items within each executive’s area of job responsibility which are related to the business plan and overall corporate objectives. These are set at the same time as the quantitative financial performance goals.

 

Likelihood of Executive Achieving Management Incentive Plan Goals.  Management endeavors to establish a plan that demands challenging, but achievable results given expected business conditions. 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 four years, payouts under the MIP based on corporate metrics alone averaged 97% of target. Over the past four years, payouts under the MIP, including corporate and business unit metrics, averaged 75% of target.

 

For years 2005 through 2008, the target and actual awards to all participating executives are shown below:

 

Historical Incentive Plan Result (2005-2008)

 

 

Determination of Actual Awards.  Actual MIP award payments are based on a formula and may vary from zero to 200% of the target award based on achievement of the 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 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 corporation from “better than plan” performance.

 

How 2008 Awards were Calculated.  For CTS executives with overall corporate responsibility, Mr. Khilnani, Ms. Belusar, Mr. Long, and Mr. Cutter, performance measurements are weighted 100% for CTS’ earnings per share objective. Those executives with business unit responsibility, Mr. Buchanan and Mr. Schroeder, are weighted with 40% weighted upon earnings per share objectives and 60% weighted upon business unit operating earnings objectives. The target award for Mr. Khilnani was 75% of base salary. For Mr. Schroeder and Mr. Buchanan, the target award was 50% of base salary. For Ms. Belusar and Mr. Cutter,

the target incentive was 45% of base salary. For Mr. Long it was 30% of base salary. These target awards were derived in part from competitive data provided by Towers Perrin and in part by the Compensation Committee’s judgment on internal equity of the positions, their relative value to the corporation, and the desire to maintain a consistent annual target award incentive for the Chief Executive Officer and other key executive officers of the corporation and the business units.

 

As mentioned previously, the named executive officers were eligible to earn from 0% to 200% of their target award. The award opportunities available to each named executive officer ranged from no payment if the goals were met below the 75% performance level to a 200% payout if the goals were met at or above the 130% performance level.

 

The table below lists each named executive officer’s 2008 base salary, which was used to calculate the annual target award, the officer’s 2008 annual incentive plan quantitative financial performance goals, the 2008 performance level results, and the total annual MIP incentive earned for 2008.

 

 

 

 

Use of Discretion for Downward Adjustments.  The incentive plan is based upon an expected set of events, regulations, external conditions, and assumptions regarding the management team’s ability to achieve those results. While it is understood that not all factors impacting the business results are within management’s control, the business plan is expected to reflect reasonable assumptions regarding such factors, and management is expected to adjust to such factors, as best possible, while still working to achieve or exceed targeted results. Despite management efforts, such factors may still negatively impact results. However, it is also recognized that some factors, outside management’s control, may have undue impact on results, defeating the intent of the incentive in terms of motivating or rewarding participants. In order to comply with Section 162(m) of the Internal Revenue Code, however, the incentive plan precludes the Compensation Committee from exercising discretion to increase awards payable to those employees designated by the Compensation Committee as covered employees as part of the year-end calculations. As a result, targets are established at a consistent level lower than that reflected in the business plan. Establishing covered employees’ calculated incentive factors under the incentive plan at a level that enables the Compensation Committee to use its discretion to adjust awards downward achieves the same result that can be obtained by adjusting performance measures for non-covered employees (employees not subject to Section 162(m)). If no unusual condition occurs, the Compensation Committee will adjust the final result downward so that covered employees achieve the same target level achievement as non-covered employees. For 2008, the Compensation Committee downwardly adjusted the EPS result from $0.77 to $0.70, so that a consistent target achievement was met. Additionally, the Compensation Committee downwardly adjusted Mr. Schroeder’s operating earnings result from $13.359 million to $12.359 million and Mr. Buchanan’s operating earnings result from $17.427 million to $14.427 million.

Performance-Based Equity Compensation

 

Performance-based equity grants encourage strong financial performance while aligning executive compensation with shareholder interests. Under the terms of the performance-based plans, executives may earn restricted stock unit awards based upon achievement of financial objectives that CTS believes are beneficial to the corporation and shareholders and/or CTS’ overall performance relative to peers over a longer term. Strong financial performance is encouraged since increasing levels of performance will result in increasing awards to the executive. Evaluating performance by comparison to peers helps to assure a true measure of performance under current market conditions.

 

2008-2009 Performance Restricted Stock Unit Plan.  In February 2008, under the terms of the CTS Corporation 2004 Omnibus Long-Term Incentive Plan, the Compensation Committee established a two-year performance-based equity compensation plan called the 2008-2009 Performance Restricted Stock Unit Plan. Depending upon the level of CTS’ achievement of sales growth and CTS’ total stockholder return relative to an enumerated peer group over a two-year period (fiscal years 2008 and 2009), an executive officer may receive a restricted stock unit award of up to 200% of a target award established for his or her position. Relative total stockholder return was selected as it is a meaningful measure to our shareholders as it compares CTS’ stock price appreciation against the stock price appreciation of our peers. It is a particularly useful measure in volatile economic times. Sales growth was selected to reinforce senior management’s focus on increasing sales.

 

The Towers Perrin benchmark market data discussed previously is used by the Compensation Committee in setting the target awards. Sixty percent of the target award is weighted to relative total stockholder return and 40% of the target award is weighted to sales growth. The peer group used to measure relative total stockholder return originally consisted of 29 peer companies. The plan contains a peer group adjustment protocol. This protocol requires the removal from the peer group of a company that on the last day of a performance period is delisted from its exchange, if the peer or its successor is not relisted on the same or another specified exchange within 30 days. In such event, the relative total stockholder return is calculated as if the delisted company was never a peer. However, a bankrupt company will be retained in the peer group for calculation purposes as bankruptcy is clearly indicative of poor performance. After application of the peer group adjustment protocol removed EPCOS AG, the peer group consists of the same companies used for the Equilar comparison discussed above.

 

All named executive officers are participants in the 2008-2009 Performance Restricted Stock Unit Plan. 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 2008. All participants must remain in the employ of the corporation throughout the performance period, which ends December 31, 2009. Performance will be measured at the end of the performance period, and awards for achievement of the performance goals will be granted in 2010 in the form of restricted stock units and will vest immediately, subject to certification of 2009 fiscal year results by CTS’ independent auditor. Awards will be settled on the basis of one share of CTS stock for each restricted stock unit on the settlement date, which will be no later than March 15, 2010.

 

2009-2010 Performance Restricted Stock Unit Plan.  In February 2009, under the terms of the CTS Corporation 2004 Omnibus Long-Term Incentive Plan, the Compensation Committee established another two-year performance-based equity compensation plan, called 2009-2010 Performance Restricted Stock Unit Plan. Depending upon CTS’ total stockholder return relative to an enumerated peer group over a two-year performance period (fiscal years 2009 and 2010), an executive officer may receive a restricted stock unit award of up to 200% of a target award established for his or her position. Relative total stockholder return was selected as it is a meaningful measure to our shareholders as it compares CTS’ stock price appreciation against the stock price appreciation of our peers. It is a particularly useful measure in volatile economic times. The Compensation Committee did not select sales growth as a metric for the 2009-2010 Performance Restricted Stock Unit Plan due to volatile economic conditions and the lack of visibility beyond the first two quarters of 2009 at the time when the plan was adopted.

The peer group used to measure relative total stockholder return consists of 28 peer companies, the same companies used for the Equilar comparison discussed above. The peer group adjustment protocol for this plan places companies delisted due to performance reasons and bankrupt companies at the bottom of the peer group performers. Any peer company that does not exist at the end of a performance period for any reason other than bad performance shall, for purposes of calculating relative total stockholder return, be removed from the peer group and treated as if it was never a part of the peer group.

 

All named executive officers, with the exception of Mr. Schroeder, are participants in the 2009-2010 Performance Restricted Stock Unit Plan. 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 2009. Performance will be measured at the end of the performance period, and awards for achievement of the performance goals will be granted in 2011 in the form of restricted stock units and will vest immediately, subject to certification of 2010 fiscal year results by CTS’ independent auditor. Awards will be settled on the basis of one share of CTS stock for each restricted stock unit on the settlement date, which will be no later than March 15, 2011.

 

Chief Executive Officer Performance Share Agreement.  In addition to his participation in the long-term incentive plans described above, Mr. Khilnani is a party to an ongoing Performance Share Agreement with CTS, with grants made under the terms of the 2004 Omnibus Long-Term Incentive Plan. Under this agreement, CTS established a performance-based restricted stock unit award for Mr. Khilnani. An aggregate of 25,000 units may be earned over the course of three separate performance periods, commencing on July 2, 2007, July 2, 2008, and July 2, 2009, respectively, and ending on July 1, 2010, July 1, 2011, and July 1, 2012, respectively. Vesting will occur, if at all, at a rate of up to 150% of the target award on the end date of each performance period and is tied exclusively to CTS’ total stockholder return relative to an enumerated peer group of companies. The vesting rate will be determined using a matrix based on CTS’ percentile ranking compared to the peer group. The peer group used to measure relative total stockholder return originally consisted of 32 peer companies; however, the plan contains a peer group adjustment protocol. This protocol requires the removal from the peer group of a company that on the last day of a performance period is delisted from its exchange, if the peer or its successor is not relisted on the same or another specified exchange within 30 days. In such event, the relative total stockholder return is calculated as if the delisted company was never a peer. However, a bankrupt company will be retained in the peer group for calculation purposes as bankruptcy is clearly indicative of poor performance. After application of the peer group adjustment protocol set forth in the plan, removing EPCOS AG, Aeroflex Incorporated, Sirenza Microdevices, Inc., and Solectron Corporation, the peer group consists of the same companies used for the Equilar comparison discussed above.

 

Future Performance-Based Equity Grants.  A new omnibus equity plan is being submitted for shareholder approval at the 2009 Annual Meeting as described in this proxy statement above in “Proposal 2: Approval of the CTS Corporation 2009 Omnibus Equity and Performance Incentive Plan.” If this plan, which we refer to as the 2009 Plan, is approved, all performance-based equity compensation grants after the date of approval will be made under the 2009 Plan, with the exception of grants for the ongoing 2008-2009 Performance Restricted Stock Plan and the 2009-2010 Performance Restricted Stock Plan, which due to their award structure, require the grant to be made after the performance period. Grants pursuant to these performance restricted stock unit plans (with an on-target award of 226,000 restricted stock units up to a maximum total of 452,000 restricted stock units) will continue to be made out of the CTS Corporation 2004 Omnibus Long-Term Incentive Plan, which we refer to as the 2004 Plan, after completion of the performance periods as the relevant performance periods began during the term of the 2004 Plan. In addition, all grants under the 2004 Plan in existence prior to the approval of the 2009 Plan will continue to be settled under the 2004 Plan.

 

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 enhancing shareholder value. Time-based equity grants play a critical role in retaining and motivating executive talent by assuring them that if they remain an employee in good standing they are assured an equity award. The retention of qualified executives over the longer term assists CTS in retaining valuable institutional knowledge. Additionally, this helps to assure that executives are able to meet their obligations under the stock ownership guidelines. 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, although equity grants will now move toward being considered each February beginning in 2009.

 

2008 Grants.  For 2008 time-based equity compensation grants, CTS issued restricted stock units under the 2004 Plan. The 2009 Plan is being submitted for shareholder approval at the 2009 Annual Meeting as described by this proxy statement above in “Proposal 2: Approval of the CTS Corporation 2009 Omnibus Equity and Performance Incentive Plan.” If the 2009 Plan is approved, all time-based equity compensation grants after the date of approval will be made under the 2009 Plan, although grants in existence prior to that date will continue to be settled under of the plan under which they were granted. CTS does not have a program or policy to coordinate option or restricted stock unit grants to its executives with the release of material non-public information.

 

Restricted stock unit awards under the 2004 Plan are provided, and will be provided under the 2009 Plan, if approved by shareholders, 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 are settled one share of CTS common stock for each unit upon vesting. 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.

 

The terms of previous restricted stock unit grants provided for vesting in installments over a five year period; however, in 2008, CTS changed the vesting schedule for new restricted stock unit grants to a three year installment vesting period. The Compensation Committee accelerated vesting to increase the perceived value of the annual awards while effectively managing expenses associated with the plan. In addition, market trends suggest a three year vesting schedule is becoming more prevalent. In June 2008, the Compensation Committee awarded restricted stock units vesting over a three year term to each executive officer, 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 above. CTS did not grant any stock options in 2008.

 

CTS believes that the general practice of deferred vesting of equity awards 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 restricted stock unit grants provide that any unvested portion of a grant is forfeited in the event of any termination, including retirement.

 

Retirement Benefits and Plans

 

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 term of service. CTS offers a 401(k) plan to all current executives and a defined benefit plan to most current executives.

 

Defined Contribution Plan.  Participation in CTS’ 401(k) plan is voluntary and is open to substantially all U.S.-based CTS employees. The company’s matching contribution levels are governed by the rules in effect when employees began employment with CTS. Under the terms of the plan that are applicable to

Mr. Khilnani, Mr. Long, Mr. Buchanan, Mr. Schroeder, and Mr. Cutter, CTS matches an employee’s contributions $.50 for every dollar, up to 6% of eligible pay, for a maximum matching contribution of 3%, subject to limitations under the Internal Revenue Code.

 

Under the terms of the plan that are applicable to Ms. Belusar, CTS matches an employee’s contributions dollar for dollar up to the first 3% of eligible pay, and thereafter at $.50 for every dollar up to the next 2% of eligible pay, for a maximum matching contribution of 4%, subject to limitations under the Internal Revenue Code.

 

In light of the current business recession, effective the first pay date after February 20, 2009, CTS suspended all company matching contributions to the 401(k) plan, except those for bargaining unit employees. Therefore, company matches to executive officers’ 401(k) contributions are not currently being made. It is anticipated that the company match of employee contributions will be restored when conditions improve.

 

Defined Benefit Plan.  Mr. Khilnani, Mr. Long, Mr. Buchanan, Mr. Schroeder, and Mr. Cutter are eligible to participate in the CTS Corporation Pension Plan which we refer to as the Pension Plan. The Pension Plan is a tax-qualified defined benefit plan. On April 1, 2006, CTS closed the Pension Plan to new entrants. Employees and executives that join CTS after that date, such as Ms. Belusar, are ineligible to join the Pension Plan, and thus cannot earn benefits under the Pension Plan.

 

The Pension Plan requires participants to complete a period of vesting service in order to become eligible for a benefit. Each of the eligible named executive officers has completed the required vesting service period. The Pension Plan benefit is based on a formula representing a factor of average monthly earnings over a period of time multiplied by credited service, which determines the monthly benefit. Certain participants may elect an early retirement benefit at age 55, at a reduced benefit. Mr. Khilnani, Mr. Buchanan, Mr. Schroeder, and Mr. Cutter are eligible to take early retirement.

 

Under the terms of the Pension Plan, annual incentive compensation counts toward determining the sum of average earnings used in the benefit calculation. Thus, these benefits are directly affected by earned incentive compensation.

 

Supplemental Executive Retirement Plans.  Each named executive officer who participates in a qualified defined benefit plan also participates in a supplemental executive retirement plan, called an Individual Excess Benefit Retirement 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 unfunded and are not insured by the Pension Benefit Guaranty Corporation. The terms of these plans are discussed under the caption “2008 Pension Benefits” below.

 

Other Compensation

 

CTS provides a limited set of perquisites and other compensation in order to attract, motivate, and retain executive talent. In 2008, compensation for named executive officers included a quarterly cash perquisite allowance for nonreimbursed travel expenses, reimbursement for financial planning services, reimbursement for tax preparation services, and reimbursement for an executive physical. In addition, Mr. Schroeder received a temporary living allowance to compensate him for the increased cost of living associated with his relocation from Indiana to California. Ms. Belusar also received relocation assistance and a tax gross-up on non-deductible reimbursed relocation expenses. Other compensation includes imputed income on life insurance benefits.

 

To create parity among the executives, as well as to better manage the potential costs associated with these perquisites, several program changes were introduced effective January 1, 2009. The changes implemented annual caps on the reimbursement of tax preparation services and executive physicals, and changed the mode of payment for financial planning services from reimbursement to a predetermined quarterly cash perquisite allowance. In addition, Mr. Schroeder’s temporary living allowance was ended in

February 2009 with Mr. Schroeder’s relocation to Illinois to assume the leadership role for the corporation’s Electronic Components business.

 

Health and Welfare Benefits

 

Named executive officers are eligible to participate in a standard set of health and welfare benefits, including medical insurance, dental insurance, vision insurance, life insurance, accidental death & dismemberment insurance, disability insurance, dependent life insurance, employee assistance plan, 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 Named Executive Officers

 

Chief Executive Officer Employment Agreement.  In conjunction with his assumption of the duties of President and Chief Executive Officer, Mr. Khilnani entered into an employment agreement with CTS effective July 2, 2007. The term of this employment agreement is two years. For a complete understanding of the employment agreement, please see the section of this proxy statement titled “Employment Agreement with Vinod M. Khilnani” below. This agreement provides assurances to and promotes the retention of our top executive, a key position. No other named executive officer has an employment agreement with CTS.

 

Change-In-Control Severance Agreements.  On December 5, 2007, CTS entered into change-in-control severance agreements with Mr. Khilnani, Mr. Long, Mr. Buchanan, Mr. Schroeder, and Mr. Cutter. The purpose of these agreements is to retain executives and encourage them to focus on corporate interests during times of change and uncertainty. For a complete understanding of the severance agreements, please see the section of this proxy statement titled “Potential Payments Upon Termination or Change-in-Control” below. On January 22, 2008, CTS entered into a change-in-control severance agreement with Ms. Belusar, similar to the terms of the Tier 1 severance agreements for other named executive officers. Ms. Belusar, however, will not receive certain retirement plan make-whole provisions as she is not a participant in the Pension Plan and does not have an Individual SERP, as discussed above. For a complete understanding of Ms. Belusar’s severance agreement, please see the section of this proxy statement titled “Potential Payments Upon Termination or Change-in-Control” below.

 

Buchanan Retirement Agreement.  On September 25, 2008, Mr. Buchanan informed CTS that he would be retiring from the corporation effective December 31, 2008. In connection with his separation from CTS, Mr. Buchanan entered into an agreement with CTS which entitles him to a lump sum retirement payment equal to $412,500, in exchange for certain promises. For a complete understanding of Mr. Buchanan’s retirement agreement, please see the section of this proxy statement titled “Buchanan Retirement Agreement” below.

 

Policy on Recovery of Awards

 

The CTS Corporation 2007 Management Incentive Plan, under which the annual MIP is administered, and the 2009 Plan being submitted for shareholder approval each include a provision to address recoupment of incentive awards in the event of financial restatements. The recoupment provisions provide 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 guidelines are available online at:

http://www.ctscorp.com/governance/stockog.htm. 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 restricted stock 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 15,000 share units to 100,000 share units. The Chief Executive Officer guideline applicable to Mr. Khilnani is 100,000 share units. The guideline applicable to Ms. Belusar and Mr. Schroeder is 40,000 share units. The guideline applicable to Mr. Buchanan and Mr. Cutter is 30,000 share units. The guideline applicable to Mr. Long is 15,000 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.

 

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 for year ended December 31, 2008 and this proxy statement.

 

CTS CORPORATION 2008 COMPENSATION COMMITTEE

 

 

EXECUTIVE COMPENSATION

 

2008 Summary Compensation Table

 

 

 

2008 Grants of Plan-Based Awards