2  cts corporation

EXHIBIT (13)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

Overview

CTS is a global manufacturer of components and sensors used primarily in the automotive, communications, and computer markets. The Company also provides electronic manufacturing solutions, including design and supply chain management functions, primarily serving the communications, computer, industrial, medical, and defense and aerospace markets under contract arrangements with the original equipment manufacturers (OEMs). Sales and marketing are accomplished through CTS sales engineers, independent manufacturers’ representatives, and distributors.

Total sales in 2006 of $655.6 million were reported through two segments, Electronics Manufacturing Services (EMS) and Components and Sensors, which represented 58.8% and 41.2% of CTS’ total sales in 2006, respectively. In 2005, EMS contributed 59.0% of total sales while Components and Sensors contributed 41.0% of total sales.

In 2006, the Company experienced a year-over-year sales increase and improved net earnings from 2005. During this period, the Company continued to focus on three key priorities: (1) improving profitability concurrently with growing sales; (2) strengthening the balance sheet; and (3) developing new sources of revenue to drive future growth. During 2006, CTS continued to see growth in certain of its existing served markets, as well as new business awards from existing and new customers.

As discussed in more detail throughout the MD&A:

•   CTS’ revenues increased 6.2% during 2006 compared to 2005, following 16.2% sales growth in 2005 compared to 2004. The sales increase in 2005 was partially driven by acquisition of the SMTEK business. Sales in the Components and Sensors segment increased by 6.7% driven by growth in automotive product sales, while the EMS segment increased by 5.8% due to higher sales into the communication, medical, and defense and aerospace markets, partially offset by decreased sales into the computer market.

•   Gross margins in 2006 increased $0.6 million from 2005 due to higher sales volume, partially offset by operational inefficiencies in both segments. Gross margins as a percent of sales were 18.4% in 2006 compared to 19.5% in 2005. Within the Components and Sensors segment, margins were unfavorably impacted primarily by automotive launch-related costs for certain new products, commodity price increases and restructuring-related costs. Within the EMS segment, margins were unfavorably impacted by expenses incurred for a new customer start-up, excessive freight costs, labor inefficiencies and pricing pressures.

•   Selling, general and administrative and research and development expenses decreased as a percent of sales to 13.2% in 2006 from 13.8% in 2005. During 2006, expenses increased due to CTS’ adoption of the provisions of FAS No. 123(R), “Share- Based Payment”, which required CTS to recognize the expense related to the fair value of equity-based compensation awards. Nevertheless, by continuing to leverage selling, general and administrative and research and development expenses, the Company was more than able to offset the increase.

•   Operating earnings decreased to $32.8 million in 2006 from $37.9 million in 2005. The 2006 operating earnings included $4.3 million of restructuring and restructuring-related charges associated with the consolidation of the Berne, Indiana operation and the further impairment of an idle facility lease.

•   Net earnings increased to $24.2 million in 2006 from $20.8 million in 2005. In 2006, net earnings included a net impact of $3.4 million, or $0.08 per share, for restructuring and restructuring-related charges. In 2005, income tax expense included a net unfavorable impact of $4.3 million, or $0.10 per share, consisting of $6.0 million of expense relating to the repatriation of foreign cash to the United States under the provisions of the American Jobs Creation Act of 2004 and a $1.7 million benefit relating to the reversal of income tax reserves due to the successful resolution of tax issues in certain foreign jurisdictions.

•   Excluding the restructuring and restructuring-related charges in 2006, and excluding the impact of the tax repatriation and reversal of reserves, and the gain on sale of excess equipment related to the divestiture of the Low Temperature Co-fired Ceramics (LTCC) business in 2005, the adjusted earnings per share, diluted was $0.71 in 2006 and $0.61 in 2005.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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The following table provides a reconciliation of Earnings Per Share, diluted to Adjusted Earnings Per Share, diluted

		Year Ending December 31,
				2005
		2006		(as restated)
Earnings per share — diluted		$	0.63	$	0.53
Tax affected charges (credits) to reported earnings per share:
	•  Restructuring and restructuring-related charges		0.08
	•  Gain on sale of excess equipment less LTCC severance				(0.02	)
	•  Impact of tax repatriation & reversal of tax reserves				0.10
Total tax affected adjustments to reported earnings per share			0.08		0.08
Adjusted earnings per share — diluted		$	0.71	$	0.61

Adjusted earnings per share, diluted is a non-GAAP financial measure. The most directly comparable GAAP financial measure is earnings per share, diluted. CTS calculates adjusted earnings per share, diluted to exclude the per share impact of restructuring-related charges and certain other unusual charges or gains. We exclude these items because they are discrete events that significantly impact comparable GAAP financial measures and could distort an evaluation of our normal operating performance. CTS used adjusted earnings per share, diluted to evaluate overall performance, establish plans and perform strategic analyses. Using adjusted earnings per share, diluted avoids distortion in the evaluation of operating results by eliminating the impact of events that are not related to normal operating performance. Because adjusted earnings per share, diluted is based on the exclusion of specific items, it may not be comparable to measures used by other companies which have similar titles. CTS’ management compensates for this limitation when performing peer comparisons by evaluating both GAAP and non-GAAP financial measures reported by peer companies. CTS believes that adjusted earnings per share, diluted is useful to its management, investors and stakeholders in that it:

–  provides a truer measure of CTS’ operating performance,

–  reflects the results used by management in making decisions about the business, and

–  helps review and project CTS’ performance over time.

We recommend that investors consider both actual and adjusted earnings per share, diluted in evaluating the performance of CTS with peer companies.

Critical Accounting Policies

CTS management’s discussion and analysis is based on its consolidated financial statements that have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses and the related disclosure of contingent assets and liabilities. CTS evaluates its estimates on an ongoing basis, based on historical experience and other assumptions believed to be relevant under the circumstances. Actual results may differ, perhaps materially, from the estimates under different assumptions or conditions.

CTS’ served markets are characterized by rapid technological change and frequent new product introductions and enhancements. These characteristics, along with global economic conditions, are risks that require management judgment when determining appropriate accounting decisions. Management believes that judgment and estimates related to the following critical accounting policies could materially affect its consolidated financial statements:

Estimating inventory valuation, the allowance for doubtful accounts and other accrued liabilities

CTS management makes estimates of the carrying value of its inventory based upon historical usage, new product introductions and projected customer purchase levels. The ever-changing technology environment of the served markets affects these estimates. Similarly, management makes estimates of the collectability of its accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. Finally, CTS is involved in litigation in the normal course of business and is regulated under a number of environmental and safety laws. Accruals for known exposures are established based on management’s best estimate after considering the advice of legal counsel.

Valuation of long-lived and intangible assets, goodwill and depreciation/amortization periods

CTS assesses the carrying value of long-lived and intangible assets and the remaining useful lives whenever events or changes in circumstances indicate the carrying value may not be recoverable or the estimated useful life may no longer be appropriate. Factors considered important which could trigger this review include significant decreases in operating results, significant changes in its use of the assets, competitive factors and the strategy of its business, and significant negative industry or economic trends. The Company cannot predict the occurrence of future impairment-triggering events nor the impact such events might have on the reported asset values. Such events may include strategic decisions made in response to the economic conditions relative to product

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CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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lines, operations and the impact of the economic environment on our customer base.

When the Company determines that the carrying value of long-lived and intangible assets may not be recoverable based on an assessment of future undiscounted cash flows from the use of those assets, an impairment charge to record the assets at fair value may be recorded. Impairment is measured based on fair values utilizing estimated discounted cash flows, published third-party sources, third-party offers and information furnished by third-party brokers/dealers.

Goodwill is measured as the excess of cost of acquisition over the sum of the amounts assigned to tangible and identifiable intangible assets acquired less liabilities assumed. CTS performs goodwill impairment tests at least on an annual basis. CTS had goodwill of $24.7 million at December 31, 2006 and December 31, 2005.

Income Taxes

Deferred tax assets and liabilities are determined based on the difference between the financial statement and income tax bases of assets and liabilities and carryforwards using currently enacted tax rates. CTS must also estimate its current tax exposure for situations where taxing authorities would assert tax positions different than those taken by the Company. Such reserves are routinely reviewed and adjusted when required to reflect changes in estimates based on factors such as changes in tax laws, results of tax authority reviews and statutory limitations. CTS estimates its income tax valuation allowance by assessing which deferred tax assets are more likely than not to be recovered in the future. The valuation allowance is based on CTS’ estimates of taxable income in each jurisdiction in which it operates and the period over which the deferred tax assets will be recoverable.

No valuation allowance was recorded in 2006 against the U.S. federal net deferred tax assets including the U.S. federal net operating loss carryforward asset of $56 million expiring in 2021-2024. The Company assessed the future realization of these deferred tax assets utilizing taxable income projections for years 2005 through 2013. Those projections applied taxable income estimates consistent with historical earnings patterns of its traditional automotive and electronic component product lines and a return to levels of profitability in its communication component product lines consistent with management and independent consensus views of the moderate recovery expected in the markets served by CTS. Management believes that, based upon the historical operating performance of its business units and the successful cost reduction efforts, the Company will more likely than not realize the benefits of its U.S. net deferred tax assets.

The annual effective income tax rate is based on CTS’ current legal organization and forecasted earnings in the various taxing jurisdictions in which the Company operates. Changes in CTS’ legal organization, the amount or the location of global earnings could impact its future effective income tax rate. In 2006, CTS’ effective tax rate decreased from 24.1% to 21.1% as a result of increased profits being reported in lower taxed jurisdictions and decreased profits being reported in the U.S.

Retirement Plans

Actuarial assumptions are used in determining pension income and expense and the pension benefit obligation. CTS, after considering the recommendations of its actuaries, assumes a discount rate, expected rate of return on plan assets and a rate of compensation increase in determining its annual pension income and expense and the projected benefit obligation. Experience gains/losses arising from any variance between the expected rate of return of plan assets and the actual results are amortized over periods ranging from five to 13 years. During the fourth quarter of each year, CTS reviews its actuarial assumptions in light of current economic factors to determine if the assumptions need to be adjusted. Changes in the actuarial assumptions could have a material affect on CTS’ results of operations in future years.

For 2006, CTS had a weighted-average discount rate of 5.92% for pension income and expense. The discount rate on its domestic plans was 6.0% at January 1, 2007. The range of discount rates utilized by its foreign plans was decreased from 3.5%-5.2% in 2006 to 2.5%-5.2% in 2007. Additionally, CTS moved to a more conservative mortality table, in 2006, that is more reflective of the longer lives the assets will be required to support and continues to use that new table.

The expected return on domestic plan assets at January 1, 2007 remained at 8.50% and the range of expected returns on foreign plan assets stayed the same, at 2.50%-7.00%. CTS expects these changes in actuarial assumptions will reduce 2007 consolidated pension income by approximately $1 million.

Equity-Based Compensation

Effective January 1, 2006, CTS adopted the provisions of FAS No. 123(R) that required CTS to recognize the expense related to the fair value of equity-based compensation awards in the Consolidated Statement of Earnings. CTS elected to follow the modified prospective transition method allowed by FAS No. 123(R), and therefore, only applied the provisions of FAS No. 123(R) to awards modified or granted after January 1, 2006. In addition, for awards that were unvested as of January 1, 2006, CTS is recognizing compensation expense in the Consolidated Statement of Earnings over the remaining vesting period. Prior to January 1, 2006, CTS accounted for equity-based compensation using the intrinsic value method prescribed in APB No. 25, “Accounting for Stock Issued to Employees.”

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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FAS No. 123(R) requires companies to estimate the fair value of equity-based awards on the date of grant using an option-pricing model. CTS uses the Black-Scholes option-pricing model. A number of assumptions are used by the Black-Scholes option-pricing model to compute the grant date fair value, including expected price volatility, option term, risk-free interest rate, and dividend yield. These assumptions are established at each grant date based upon current information at that time. Expected volatilities are based on historical volatilities of the Company’s common stock. The expected option term is derived from historical data on exercise behavior. Different expected option terms result from different groups of employees exhibiting different behavior. The dividend yield is based on historical dividend payments. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. The fair value of awards that are ultimately expected to vest is recognized as expense over the requisite service periods in the Consolidated Statement of Earnings. CTS’ stock options primarily have a graded-vesting schedule. CTS recognizes expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards.

Results of Operations

Segment Discussion

Refer to “Note N — Segments,” for a description of the Company’s segments.

The following table summarizes net sales and operating earnings by segment:

				Components
($ in thousands)	EMS			& Sensors			Total
2006
Net sales to external customers	$	385,744		$	269,870		$	655,614
Segment operating earnings	$	6,179		$	30,963		$	37,142
% of segment sales		1.6	%		11.5	%		5.7	%
2005 (as restated)
Net sales to external customers	$	364,458		$	253,026		$	617,484
Segment operating earnings	$	7,705		$	30,227	(1)	$	37,932
% of segment sales		2.1	%		11.9	%		6.1	%
2004
Net sales to external customers	$	270,334		$	260,982		$	531,316
Segment operating earnings	$	7,817		$	23,311	(2)	$	31,128
% of segment sales		2.9	%		8.9	%		5.9	%

(1)	Includes $3.1 million of gain on sale of excess equipment and disposition of LTCC assets.
(2)	Includes a $3.9 million of gain on asset sales, of which, $2.7 million relates to the sale of excess land in Canada.

Components and Sensors Segment Discussion

Sales in the Components and Sensors segment in 2006 increased $16.8 million, or 6.7%, from 2005. The increase was primarily due to higher sales of automotive products of $19.0 million, higher sales of communication infrastructure products of $7.4 million, and increases in other electronic component sales, offset by lower sales into mobile handset applications of $8.4 million as CTS continued to de-emphasize sales of these products, and the reduction of sales associated with the divestiture of the Low Temperature Co-fired Ceramic (LTCC) business in 2005.

Segment operating earnings increased by $0.7 million, or 2.4%, from the prior year. Major drivers in the year-over-year increase were the margin contribution from the higher sales volume, operational savings related to the divestiture of the LTCC business in 2005, a year-over-year reduction in severance expenses, a favorable insurance claim settlement taken in the first quarter of 2006, higher royalties, and a gain on the sale/leaseback of an Albuquerque building. Operating earnings were unfavorably impacted by automotive launch-related costs for certain new products, increased expenses related to recognizing the fair value of equity-based compensation, lower pension income and commodity price increases.

In 2006, CTS recorded pension income of $4.0 million, including $0.3 million of pension curtailment losses included in the restructuring charges that are associated with the Berne, Indiana consolidation, compared to $7.0 million of pension income recorded in 2005. The pension income results primarily from U.S. pension plans that have assets in excess of projected benefit obligations. The primary factors contributing to the decrease in pension income were lower expected returns on the plan assets, the recognition of prior years’ investment losses, and other actuarial losses.

The Components and Sensors segment sales in 2005 decreased $8.0 million, or 3.0%, from 2004. The decrease was primarily due to lower sales into mobile handset applications of $20.8 million as CTS continued to de-emphasize sales of these products. This decrease was partially offset by increased demand for automotive sensor products of $11.8 million and communication infrastructure products of $3.7 million.

Despite a sales decrease in 2005, segment operating earnings improved by $6.9 million, or 29.7%, from 2004. The primary driver in the year-over-year earnings improvement was the impact of favorable product mix of approximately $4.9 million as sales volume shifted from the less profitable handset applications into the more profitable communication infrastructure products and automotive markets. Gross margin improvement also reflects savings related to personnel reductions and lower depreciation expenses due to a lower level of capital expenditures in recent years versus high levels of

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capital expenditures in the preceding years. The segment operating earnings also included a $3.1 million gain on the sale of excess equipment and the disposition of LTCC assets. Selling, general and administrative expenses decreased by $2.2 million in 2005 compared to 2004, mainly as a result of savings related to personnel reductions and professional services. Research and development expenses decreased $2.0 million in 2005 compared to 2004, as a result of a decrease in product launch costs and lower professional services related to consultation on new product development. These favorable factors were partially offset by the unfavorable volume impact of $2.7 million and a reduction to pension income of $2.4 million.

Electronic Manufacturing Services Segment Discussion

EMS segment sales in 2006 increased $21.3 million, or 5.8%, from the prior year. The increase was driven by higher sales into the communication, defense and aerospace, and medical markets, offset by lower sales into the computer market.

The segment operating earnings of $6.2 million decreased $1.5 million, or 19.8%, from the prior year. Earnings were unfavorably impacted primarily by lower margins related to expenses incurred for a new customer start-up, excessive freight costs, labor inefficiencies and pricing pressures. During 2006, earnings were also impacted by the adverse effects of foreign exchange rate changes and higher salaries and fringes, partially offset by higher sales volume.

CTS’ earnings are subject to fluctuations of foreign currency exchange rates. For 2006, the impact of foreign exchange rates negatively impacted the operating earnings in the EMS segment by approximately $2.1 million, primarily due to the weakening of the U.S. dollar against the Singapore dollar and against the British pound.

EMS segment sales in 2005 increased $94.1 million, or 34.8%, from 2004. The revenue increase included sales from the acquired SMTEK business of $100.4 million and a $14.5 million increase in new customer sales, partially offset by a $20.5 million decrease in sales for communications infrastructure applications.

The 2005 segment operating earnings of $7.7 million decreased slightly by $0.1 million, or 1.4%, from $7.8 million the prior year. Higher gross margins were partially offset by an incremental increase in expenses related to the SMTEK business acquisition and integration.

Sales in Geographic Regions

CTS’ sales in 2006 decreased in the Americas to 49% from 53%. CTS has continued its expansion into the Asia-Pacific markets, increasing total net sales in this region by $34.7 million to $247.6 million, up 16.0% from 2005. The Asia-Pacific region accounted for 38% of CTS sales in 2006. Sales in Europe were unchanged at 13% in both 2006 and 2005. The following table presents the percentage of net sales into each geographic region within each segment and consolidated:

	Components & Sensors						EMS						Consolidated Total
Geographic Region	2006		2005		2004		2006		2005		2004		2006		2005		2004
Americas		51%		61%		56%		48%		47%		34%		49%		53%		45%
Europe		23%		20%		17%		6%		7%		20%		13%		13%		19%
Asia-Pacific		26%		19%		27%		46%		46%		46%		38%		34%		36%
Total		100%		100%		100%		100%		100%		100%		100%		100%		100%

Discussion — Most Recent Three Years

The following table highlights significant information from CTS’ consolidated results of operations during the past three years:

		Year Ended December 31,
					2005
(In thousands of dollars)		2006			(as restated)			2004
Net sales		$	655,614		$	617,484		$	531,316
Cost of goods sold			534,784			497,270			421,560
Gross margin			120,830			120,214			109,756
	% of net sales		18.4	%		19.5	%		20.7	%
Selling, general and administrative expenses			70,913			68,255			63,485
	% of net sales		10.8	%		11.1	%		11.9	%
Research and development expenses			15,873			17,092			19,063
	% of net sales		2.4	%		2.8	%		3.6	%
Gain on asset sales			(2,142)			(3,065)			(3,920)
Restructuring and impairment charges			3,368			—			—
Operating earnings			32,818			37,932			31,128
	% of net sales		5.0	%		6.1	%		5.9	%
Interest expense			3,654			5,902			5,535
Other income			(1,502)			(966)			(324)
Earnings before income taxes			30,666			32,996			25,917
Income tax expense			6,469			12,240	(2)		5,961
Net earnings		$	24,197	(1)	$	20,756		$	19,956
	% of net sales		3.7	%		3.4	%		3.8	%
Diluted earnings per share		$	0.63	(1)	$	0.53	(2)	$	0.53

(1)

Net earnings and diluted earnings per share include a net impact of $3.4 million, or $0.08 per diluted share, related to restructuring and restructuring-related charges associated with the consolidation of the Berne, Indiana operations and the further impairment of an idle facility lease.

(2)

Income tax expense and diluted earnings per share include a net impact of $4.3 million, or $0.10 per diluted share, respectively, consisting of $6.0 million of expense relating to the repatriation of foreign cash to the United States under the provisions of the American Jobs Creation Act of 2004 and a $1.7 million benefit relating to the reversal of income tax reserves due to the successful resolution of tax issues in certain foreign jurisdictions.

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CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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Net sales increased $38.1 million in 2006, or 6.2%, from prior year, primarily due to the EMS sales increase of $21.3 million and the increased sale of automotive products of $19.0 million. The EMS sales increase related to growth in the communication, defense and aerospace, and medical markets, partially offset by the decrease in the computer market. In addition to the growth of automotive product sales in the Components and Sensors segment, sales into the communication infrastructure applications increased by $7.4 million, sales of electronic components increased by approximately $4.1 million, partially offset by lower sales into the mobile handset applications of $8.4 million as CTS continued to de-emphasize these products.

Net sales increased $86.2 million in 2005, or 16.2%, from 2004, primarily due to the EMS increase of $94.1 million. The EMS sales increase related to the acquired SMTEK business of $100.4 million and other new EMS customer sales, partially offset by the decrease in sales for communications infrastructure applications and data storage. In addition, Components and Sensors sales decreased $8.0 million, due to lower sales into mobile handset applications as CTS continued to de-emphasize these products, partially offset by increased demand for the automotive sensor products and communication infrastructure products.

The Company’s 15 largest customers represented 61% of net sales in 2006, unchanged from 61% in 2005 and lower than the 69% in 2004. CTS continues its efforts to broaden its business base with expansion into the defense and aerospace and medical markets in the EMS segment, and the diversification of automotive and wireless infrastructure product offerings in the Component and Sensors segment. Sales to Hewlett-Packard Company represented 22% of net sales in 2006, 28% of net sales in 2005 and 33% of net sales in 2004. Sales to Motorola, Inc. were less than 10% of net sales in both 2006 and 2005 and 13% of net sales in 2004.

CTS’ products are usually priced with consideration to expected or required profit margins, customer expectations and market competition. Pricing for most of CTS’ Components and Sensors and EMS products generally decrease over time and also fluctuate in accordance with total industry utilization of manufacturing capacity. In both CTS segments, nominal annual price reductions are in the single-digit range, which is typical of the industry. CTS continues to work on cost reductions to offset the negative price impact on profit margin.

Gross margins in 2006 increased $0.6 million from 2005 due to higher sales volume, partially offset by operational inefficiencies in both segments. Gross margins as a percent of sales were 18.4% in 2006 compared to 19.5% in 2005. Within the Components and Sensors segment, margins were unfavorably impacted primarily by automotive launch-related costs for certain new products, commodity price increases and restructuring-related costs. Within the EMS segment, margins were unfavorably impacted by expenses incurred for a new customer start-up, excessive freight costs, labor inefficiencies and pricing pressures.

In 2005, gross margin increased by $10.5 million, or 9.5%, from the prior year, primarily due to higher sales of $86.2 million. Gross margin as a percent of sales improved within both segments. However, CTS’ total gross margin percentage decreased to 19.5% of sales in 2005 from 20.7% in 2004. This decrease was driven by a higher proportion of EMS segment sales, contributing 59.0% of total sales in 2005 compared to 50.9% in 2004. The EMS segment sales have an inherently lower gross margin percentage than the Components and Sensors segment sales.

Selling, general and administrative expenses as a percentage of sales decreased to 10.8% in 2006 from 11.1% in the prior year. The selling, general and administrative expense increased $2.7 million, primarily driven by an increase in expenses due to CTS’ adoption of the provisions of FAS No. 123(R), which required CTS to recognize the expense related to the fair value of equity-based compensation awards, increases in salaries and fringes, and lower pension income, partially offset by a favorable insurance claim settlement recorded in 2006.

As a result of adopting FAS No. 123(R), CTS has included additional compensation expense relating to stock option awards to employees in its operating earnings, earnings before income taxes, net income, and earnings per share. The impact of this incremental expense, for the year ended December 31, 2006 is shown in the following table:

			Year Ended
			December 31,
($ in thousands, except per share amounts)			2006
Impact of adopting FAS No. 123(R) on:
	Operating earnings		$	988
	Earnings before income taxes			988
	Net earnings			592
	Net earnings per share:
		Basic	$	0.02
		Diluted	$	0.01

Selling, general and administrative expenses as a percentage of sales decreased to 11.1% in 2005 from 11.9% in 2004, as the Company was able to effectively control spending in this area and leverage the higher sales. The total CTS selling, general and administrative expense increased only $4.8 million, despite the $7.4 million incremental increase related to the SMTEK business acquisition and integration. CTS was able to offset a portion of the SMTEK increase with savings related to personnel reductions and lower spending on

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professional services, as discussed in the Components and Sensor segment discussion.

Research and development expenses were $15.9 million in 2006 versus $17.1 million in 2005 and $19.1 million in 2004. The reductions in research and development spending reflect organizational consolidations from restructuring-related activities, personnel savings for actions taken in 2005 and a decrease in product launch costs. Ongoing research and development activities continue in the Components and Sensors segment, particularly for automotive products in support of growth initiatives. CTS’ research and development investment is primarily focused on expanded applications and new product development, as well as current product and process enhancements. Research and development expenditures in the EMS segment are typically very low.

Operating earnings in 2006 decreased to $32.8 million, or 5.0% of sales, from $37.9 million, or 6.1% of sales, in 2005. Operating earnings were adversely impacted by $3.9 million of expenses from restructuring and restructuring-related charges associated with the consolidation of CTS’ Berne, Indiana manufacturing operations and $0.4 million of restructuring charge for CTS’ revised estimate of fair value of the remaining net liability of the operating lease for an idle facility. These expenses were partially offset by a $0.7 million pre-tax gain for the sale/leaseback of the Albuquerque building.

Operating earnings in 2005 increased to $37.9 million, or 6.1% of sales, from $31.1 million, or 5.9% of sales, in 2004. Favorable changes contributing to the margin improvement were the gross margin increase and favorable operating expense reductions, as discussed above, partially offset by the incremental impact on spending related to the SMTEK business acquisition. Operating earnings in 2005 included a gain on asset sales of $3.1 million.

Interest expense decreased $2.2 million, to $3.7 million in 2006 from $5.9 million in 2005, due to CTS carrying a lower average outstanding debt balance.

CTS changed its effective tax rate from 37.1% in 2005 to 21.1% in 2006. CTS’ 2005 tax rate before the benefit of release of reserves and expense of the Homeland Investment Act dividend was 24.1%. The lower tax rate reflects the increased profits reported in lower-tax foreign jurisdictions with decreased profits being reported in the U.S.

Net earnings increased $3.4 million, to $24.2 million in 2006 from $20.8 million in 2005. Net earnings in 2006 included a net impact of $3.4 million, or $0.08 per diluted share, of restructuring and restructuring-related charges, while net earnings in 2005 included a net tax impact of $4.3 million consisting of $6.0 million of expense relating to the repatriation of foreign cash to the United States under the provisions of the American Jobs Creation Act of 2004 and a $1.7 million benefit relating to the reversal of income tax reserves due to the successful resolution of tax issues in certain foreign jurisdictions.

Net earnings per share of $0.63 in 2006 were $0.10 higher than the earnings per share in 2005. Excluding the impact of the 2006 restructuring and restructuring-related charges, and the 2005 income tax expense related to the cash repatriation, reversal of tax reserves and net impact of gain on sale of excess equipment and severance related to the sale of the LTCC business, as noted above, adjusted earnings per share, diluted for 2006 were $0.71, a $0.10 per share increase from adjusted earnings per share in 2005 (see reconciliation of adjusted earnings per share above).

Restructuring and Restructuring-Related Charges

In January 2006, CTS announced its intention to consolidate its Berne, Indiana manufacturing operations into three of its other existing facilities. Automotive product operations at Berne were transferred to CTS’ automotive facilities in Matamoros, Mexico and Elkhart, Indiana. Electronic components operations in Berne were moved to CTS’ Singapore facility. The Berne facility is currently being marketed for sale. As of December 31, 2006, the Berne consolidation process was substantially completed, with all expected charges recorded.

The following table displays the planned costs associated with the Berne consolidation, as well as a summary of the actual costs incurred through December 31, 2006:

			Actual
			incurred
			through
	Planned		December 31,
($ in millions)	Costs		2006
Workforce reduction	$	3.1	$	2.6
Postemployment obligation curtailment, net — Note I		0.2		0.2
Other		0.1		0.1
Restructuring charge		3.4		2.9
Equipment relocation		0.3		0.5
Other employee related costs		0.3		0.5
Restructuring-related costs		0.6		1.0
Total restructuring and restructuring-related costs	$	4.0	$	3.9

Additionally, during 2006, CTS recorded a pre-tax restructuring charge of $0.4 million, or $0.3 million after-tax and $0.01 per diluted share, when it revised its estimate of the fair value of the remaining net liability of the operating lease for an idle facility.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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cts corporation 9

Of the restructuring and restructuring-related costs, $3.9 million relates to the Components and Sensors segment and $0.4 million relates to the EMS segment. Restructuring charges are reported on a separate line on the Consolidated Statement of Earnings and the restructuring-related costs are included in cost of goods sold.

The following table displays the restructuring reserve activity for the Berne consolidation for the year ending December 31, 2006:

($ in millions)
Restructuring liability at January 1, 2006	$	—
2006 charge		3.9
Costs paid		(3.7	)
Restructuring liability at December 31, 2006*	$	0.2

* CTS expects to pay all of the remaining $0.2 million during 2007.

Liquidity and Capital Resources

Overview

At December 31, 2006, cash and cash equivalents balance increased to $38.6 million from $12.0 million in 2005. Total debt decreased to $66.2 million from $81.8 million in 2005. Total debt as a percentage of total capitalization was 17.2% at the end of 2006, compared with 19.9% in 2005.

Cash and cash equivalents increase of $26.6 million was impacted by the following:

Cash Used:

•  Net debt repayment of $15.6 million.

•  Capital spending of $15.8 million.

•  Purchase of treasury stock of $2.3 million.

•  Dividends paid of $4.3 million.

Cash Provided:

•  Cash provided by operations of $47.2 million.

•  Proceeds from the sale of assets of $14.5 million.

Working capital increased by $43.5 million in 2006 due to the cash and cash equivalents increase detailed above, the accounts receivable increase of $15.2 million, the short-term notes payable decrease of $7.9 million, and an increase in current deferred taxes of $6.0 million, partially offset by an accounts payable increase of $9.5 million, and an increase in the accruals for customer advance payments of $3.0 million. The increase in the accounts receivable balance was due to the fourth quarter of 2006 sales increase of 12.2% compared to fourth quarter of 2005.

Free Cash Flow

The following table summarizes free cash flow for the Company:

	Year Ended December 31,
				2005
(In millions of dollars)	2006			(as restated)			2004
Net cash provided by operations	$	47.2		$	44.5		$	14.0
Capital expenditures		(15.8	)		(15.0	)		(12.7	)
Free cash flow	$	31.4		$	29.5		$	1.3

Free cash flow is a non-GAAP financial measure that CTS defines as net cash provided by operations less capital expenditures. The most directly comparable GAAP measure is net cash provided by operations. CTS’ management uses free cash flow to evaluate financial performance and in strategic planning, specifically, for investing and financing decisions. CTS’ management believes free cash flow is a useful measure because it reflects the performance of its overall operations more accurately than net cash provided by operations and because it provides investors with the same results that management used as the basis for making decisions about the business. Free cash flow is not an indicator of residual cash available for discretionary spending, because it does not take into account mandatory debt service or other non-discretionary spending requirements that are not deducted in the calculation of free cash flow. CTS’ management takes these limitations into account when using free cash flow to make investing and financing decisions.

In 2006, net cash provided by operations was $47.2 million after funding the working capital required for business growth. Net cash provided by operations in 2006 was $2.7 million higher than net cash provided by operations in 2005 primarily due to higher net earnings in 2006 and a restructuring charge, partially offset by higher controllable working capital from an increase in accounts receivable related to higher sales.

In 2005, net cash provided by operations was $44.5 million after funding the working capital required for business growth. Net cash provided by operations in 2005 was $30.6 million higher than net cash provided by operations in 2004 due to higher earnings in 2005, favorable impact of deferred taxes and positive working capital change. Changes in assets and liabilities are net of the effect of the purchase on SMTEK because these balances are included in the purchase price of the business.

Operating Activities

Cash flows provided by operations were $47.2 million in 2006. Components of cash flows from operations include net earnings of $24.2 million, depreciation and amortization of $24.9 million, and $3.4 million of restructuring charges. In addition, there were $15.2 million of unfavorable changes in accounts receivable partially

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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10  cts corporation

offset by a $8.4 million increase in accounts payable and accrued liabilities.

Cash flows provided by operations were $44.5 million in 2005. Components of cash flows from operations include net earnings of $20.8 million, depreciation and amortization of $27.1 million and a favorable impact of $8.3 million in deferred taxes. There were $8.8 million of favorable changes in accounts receivable partially offset by a $3.6 million increase in inventory and a $4.5 million decrease in accounts payable and accrued liabilities. Also, the pension asset increase of $8.7 million was an unfavorable impact. Changes in assets and liabilities were net of the effect of the purchase on SMTEK because these balances were included in the purchase price of the business.

Cash flows provided by operations were $14.0 million in 2004. Components of cash flows from operations include earnings of $20.0 million and depreciation and amortization of $26.1 million, partially offset by gains of $3.9 million on sales of assets. There were $22.6 million of unfavorable changes in accounts receivable and inventory to support a 14.8% annual increase in sales. This effect was partially offset by a $3.9 million increase in accounts payable. Also, the pension asset increase of $10.9 million was an unfavorable impact.

Investing Activities

Cash flows used in investing activities totaled $1.3 million in 2006, including capital expenditures of $15.8 million partially offset by $14.5 million of net proceeds from the sale of assets.

Cash flows used by investing activities totaled $44.5 million in 2005, including the payment for the purchase of SMTEK of $35.6 million and capital expenditures of $15.0 million partially offset by proceeds from sales of assets of $6.1 million, which includes the disposition of the LTCC assets, as previously discussed.

Cash flows provided by investing activities totaled $7.1 million in 2004, including $16.4 million of net proceeds from the sale of the Longtan, Taiwan facility and $2.1 million from the sale of excess land in Canada. These proceeds were partially offset by $12.7 million of capital expenditures for normal, recurring asset replacements and new automotive products, including occupant classification system, pedal assemblies, and belt tension sensor programs.

Financing Activities

Cash flows used by financing activities in 2006 were $22.1 million, consisting of $15.6 million related mainly to the reductions in the subordinated debenture balance and short-term notes payable, $2.3 million purchase of treasury stock and $4.3 million in dividend payments.

Cash flows used by financing activities in 2005 were $45.9 million, consisting primarily of $13.0 million from the repayment of debt related to the SMTEK purchase, $11.3 million purchase of CTS common stock and $4.3 million in dividend payments, as well as the repayment of $17.1 million related mainly to the reductions in the subordinated debenture balance.

In 2004, CTS’ net cash provided by financing activities totaled $12.7 million. This amount consisted primarily of $57.6 million net proceeds from the issuance of $60 million Debentures due 2024, repayment of $42.0 million of the 7.5% industrial revenue bonds, issuance of $3.3 million short-term notes payable, repurchase of $2.0 million of CTS common stock, and payments of $4.5 million in dividends.

Effective December 31, 2006, CTS adopted all of the provisions of FAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R).” FAS No. 158 requires employers to: a) recognize the funded status of a benefit plan — measured as the difference between plan assets at fair value and the benefit obligation — in its statement of financial position, b) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to FAS No. 87, “Employers’ Accounting for Pensions,” or FAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” c) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position, and d) disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. As required by the standard, CTS has applied these FAS No. 158 requirements prospectively.

The following table highlights the incremental effect of applying FAS No. 158 to the Company’s defined benefit pension plans and other post-retirement benefit plan on individual line items in of the

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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Company’s Consolidated Balance Sheet for the year ended December 31, 2006:

	Before		FAS No. 158			After
	Application of		Adjustments			Application of
($ in thousands)	FAS No. 158		Increase/(Decrease)			FAS No. 158
Defined Benefit Pension Plans
Prepaid pension asset	$	158,723	$	(58,057	)	$	100,666
Accrued salaries, wages and vacation		—		167			167
Other long-term obligations		9,153		1,929			11,082
Deferred income tax asset		1,122		23,970			25,092
Accumulated other comprehensive loss		2,267		36,183			38,450
Other Post-retirement Benefit Plan
Other accrued liabilities		370		—			370
Other long-term obligations		4,910		58			4,968
Deferred income tax asset		—		23			23
Accumulated other comprehensive loss		—		35			35

FAS No. 158 had no impact on the Consolidated Statement of Earnings for the year ending December 31, 2006. Furthermore, since CTS had previously measured its assets and liabilities as of December 31, there was no impact of adopting the measurement date provisions of FAS No. 158.

Capital Resources

In 2006, the long-term debt balance decreased by $7.7 million. As of December 31, 2005, the Company had $5.5 million of its 6.5% convertible, subordinated debentures due 2007 (6.5% Debentures) outstanding. However, in accordance with the provisions of the 6.5% Debentures, the remaining debenture holder exercised its put option and accelerated the maturity of this debt, which was repaid by CTS during June 2006. The following table shows the long-term borrowings and related average interest rates as of December 31, 2006 and December 31, 2005:

	December 31, 2006					December 31, 2005
			Average					Average
			Interest					Interest
	Balance		Rate			Balance		Rate
($ in millions)	($)		(%)			($)		(%)
$100 million revolving credit agreement	$	—		6.2	%	$	—		—	%
Former revolving credit agreement		—		—			2.1		6.1
Convertible subordinated debentures due 2007		—		—			5.5		6.5
Convertible senior subordinated debentures due 2024		60.0		2.1			60.0		2.1
Term loan, due 2011		0.8		7.3			0.9		5.8
		60.8					68.5
Less current maturities		0.2		7.3			0.2		—
Total long-term debt	$	60.6		2.2	%	$	68.3		2.6	%

On June 27, 2006, CTS entered into a new $100 million, unsecured revolving credit agreement. Under the terms of the new revolving credit agreement, CTS can expand the credit facility to $150 million. There were no amounts outstanding under the new revolving credit agreement at December 31, 2006. Interest rates on the new revolving credit agreement fluctuate based upon LIBOR and the Company’s quarterly total leverage ratio. CTS pays a commitment fee on the undrawn portion of the new revolving credit agreement. The commitment fee varies based on the quarterly leverage ratio and was 0.15 percent per annum at December 31, 2006. The new revolving credit agreement requires, among other things, that CTS comply with a maximum total leverage ratio and a minimum fixed charge coverage ratio. Failure of CTS to comply with these covenants could reduce the borrowing availability under the new revolving credit agreement. CTS was in compliance with all debt covenants at December 31, 2006. Additionally, the new revolving agreement contains restrictions limiting CTS’ ability to: dispose of assets; incur certain additional debt; repay other debt or amend subordinated debt instruments; create liens on assets; make investments, loans or advances; make acquisitions or engage in mergers or consolidations; engage in certain transactions with CTS’ subsidiaries and affiliates; and the amounts allowed for stock repurchases and dividend payments. The new revolving credit agreement expires in June 2011. The former $75 million revolving credit agreement was terminated in connection with the execution of the new revolving credit agreement.

As described in “Note B — Restatement of the Consolidated Financial Statements,” CTS commenced an investigation of accounting misstatements at its Moorpark and Santa Clara, California manufacturing location in February 2007. As a result, CTS was unable to file its 2006 Annual Report on Form 10-K and will be unable to file its quarterly report on Form 10-Q for the first quarter

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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12  cts corporation

of 2007 within the time required by SEC regulations. Accordingly, on March 13, 2007, CTS and its lenders entered into an agreement under which the lenders agreed to waive until June 30, 2007 the requirements under the new revolving credit agreement that CTS deliver quarterly financial statements, annual financial statements, auditor certifications and compliance certificates with respect to the quarter ending April 1, 2007 and the year ended December 31, 2006.

CTS believes cash flows from operating activities and available borrowings under its new revolving credit agreement will be adequate to fund its working capital and capital expenditure requirements for at least the next twelve months. CTS may choose to pursue additional equity and/or debt financing to fund acquisitions and/or to reduce its overall interest expense or improve its capital structure.

In November 2005, CTS’ Board of Directors authorized a program to repurchase up to one million shares of common stock. The authorization expires June 30, 2007. Reacquired shares will be used to support equity-based compensation programs and for other corporate purposes. During 2006, CTS repurchased 170,600 shares at a total cost of $2.3 million. At December 31, 2006, CTS was authorized to repurchase approximately 690,000 additional shares.

In May 2004, CTS issued the $60 million Debentures due 2024. The debt is an unsecured senior subordinated obligation of CTS. The debentures bear interest at a rate of 2.125% per year and will be convertible, under certain circumstances, into CTS common stock, at the option of the holder, at a price of $15.00 per share, which is equivalent to an initial conversion rate of approximately 66.6667 shares per $1,000 principal amount of the debentures. The conversion price represents a 36.24% premium over the closing price of CTS common stock on May 5, 2004. The offering was closed on May 11, 2004. With the proceeds, CTS repaid outstanding debt, including its industrial revenue bonds outstanding balance of $40 million due in 2013 at a weighted average interest rate of 7.5%, and reduced the amount outstanding under its revolving credit agreement. The other $2 million of industrial revenue bonds were repaid in the first quarter of 2004 with the cash generated from operations. As of December 31, 2006, no conversion condition for the $60 million debentures was met.

In December 1999, CTS’ shelf registration statement on Form S-3 was declared effective by the Securities and Exchange Commission. CTS could initially offer up to $500.0 million in any combination of debt securities, common stock, preferred stock or warrants under the registration statement. During 2006, CTS did not issue any securities under this registration statement. As of December 31, 2006, CTS could offer up to $435.1 million of additional debt and/or equity securities under this registration statement. On May 9, 2007, CTS filed a post-effective amendment on Form S-1 to deregister all of the securities remaining unsold under the registration statement.

Capital Requirements

The following table sets forth the impact that contractual obligations, as of December 31, 2006, are expected to have on the Company’s liquidity and cash flow in future periods:

	Payments Due by Period
($ in millions)	Total		2007		2008-2009		2010-2011		2012-beyond
Long-term debt(1)	$	83.1	$	1.5	$	2.9	$	2.8	$	75.9	(2)
Operating leases		22.5		5.6		8.9		5.3		2.7
Purchase obligations		—		—		—		—		—
Retirement obligations		17.3		1.3		4.6		2.8		8.6
Total	$	122.9	$	8.4	$	16.4	$	10.9	$	87.2

(1)	Including principal and coupon payments of the $60 million Debentures issued in 2004.
(2)	Debentures issued in May 2004. Investor may convert the debentures, under certain circumstances, at any time to CTS common stock. The conversion price is $15.00 per share.

Purchase obligations are defined as agreements that are enforceable and legally binding on CTS and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. CTS purchases direct materials, generally related to customer orders, for production occurring at its manufacturing facilities around the world. These goods are secured using purchase orders, either blanket or discrete. Purchase orders commit CTS to take delivery of the quantities ordered generally over a specified delivery schedule. CTS’ standard purchase order terms and conditions state that, should CTS cancel an order, CTS will reimburse its supplier only for the costs incurred at the time of cancellation. CTS’ purchase order cancellations generally occur due to order cancellation by a customer. If a customer cancels its order, CTS’ standard terms of sale provide for reimbursement of costs, including those related to CTS’ purchase orders. Therefore, these commitments are not included in purchase obligations.

Retirement obligations include defined benefit and other post-retirement benefits. Please refer to “Note I — Retirement Plans” and “Critical Accounting Policies — Retirement Plans” for additional information related to the retirement plans, including the important assumptions.

CTS utilizes a market-related approach in deriving fair value of plan assets. CTS does not expect any significant change in the approach in 2007. For plan asset allocation detail, please refer to “Note I — Retirement Plans.” CTS does not expect any significant change on asset allocation in 2007 based on its current knowledge. However, CTS may change the asset allocation based on the performance of different asset categories after conducting investment portfolio

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

(continued)

cts corporation 13

reviews, annual liability measurements and asset/liability studies on a regular basis.

Based on CTS’ experience, the actual return on plan assets can deviate from the expected return on plan assets. This deviation is taken into account in the market value related approach in deriving fair value of plan assets. The deviation between the expected return and the actual return was primarily due to market conditions. CTS performs a sensitivity analysis to assess the potential impact on the results of operations by the change in the expected long-term rates of return. A 25 basis-point change in the long-term rate of return would have changed the pension income in 2006 by approximately $700,000.

CTS plans to invest in capital projects that maintain current capacity and result in future revenue opportunities. The 2007 capital spending is expected to be between $20 million and $24 million.

CTS has historically been able to fund its capital and operating needs through its cash flows from operations and available credit under its bank credit agreements. CTS believes that cash flows from operations and available borrowings under its current revolving credit agreement will be adequate to fund its working capital, capital expenditures, and debt service requirements for at least the next twelve months. However, CTS may choose to pursue additional equity and/or debt financing to fund acquisition and/or to improve capital structure.

Effect of Recent Accounting Pronouncements.

In September 2006, the FASB issued FAS No. 157, “Fair Value Measurements.” FAS No. 157, defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. FAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, and accordingly, does not require any new fair value measurements. FAS No. 157 is effective for CTS in 2008. The Company is currently reviewing the provisions of FAS No. 157, but does not expect it to have a material impact on its financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108), which provides interpretive guidance on how the effects of carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006 and did not have an impact on CTS’ consolidated financial statements.

In June 2006, the FASB issued Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes.” FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. At present, CTS has substantially completed its process of documenting its tax positions and measuring the expected benefits of each, as required under FIN 48. CTS does not expect adoption of FIN 48 to have a material impact on its financial statements.

In June 2006, the EITF reached a consensus on EITF Issue No. 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)” (EITF 06-3). EITF 06-3 provides that the presentation of taxes assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer on either a gross basis (included in revenue and costs) or on a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. The provisions of EITF 06-3 will be effective for CTS as of January 1, 2007. CTS does not expect EITF 06-3 to have a material impact on its consolidated financial statements.

Market Risk

CTS is exposed to market risk, including changes in foreign currency exchange rates and interest rates. As discussed in “Note A — Summary of Significant Accounting Policies” to the consolidated financial statements, the financial statements of all CTS’ non-U.S. subsidiaries, except the United Kingdom subsidiary, are remeasured into U.S. dollars using the U.S. dollar as the functional currency. The Company does not have any significant net trade asset or liability exposure in a currency other than that of the reporting unit’s functional currency. The market risk associated with foreign currency exchange rates comes primarily from revenue and expense transactions in currencies other than the reporting unit’s functional currency. CTS monitors the effects of foreign currency fluctuations impacting its foreign subsidiaries and attempts, where possible, to mitigate the impact by matching the expenses in the same currencies in which revenues are generated.

As part of CTS’ risk management program, CTS performs sensitivity analyses to assess potential gains and losses in earnings and changes in fair value relating to hypothetical movements in interest rates. A 33 basis-point increase in interest rates (approximately 10% of CTS’ weighted-average interest rate) on variable-rate debt instruments would have increased CTS’ 2006 and 2005 interest expense by $0.1 million and $0.2 million, respectively, and would have an immaterial effect on the fair value of the debt instruments as of the end of such fiscal years.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

(continued)

14  cts corporation

This document contains statements that are, or may be deemed to be, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements include, but are not limited to, any financial or other guidance, statements that reflect our current expectations concerning future results and events, and any other statements that are not based solely on historical fact. Forward-looking statements are based on management’s expectations, certain assumptions and currently available information. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. These forward-looking statements are made subject to certain risks, uncertainties and other factors, which could cause our actual results, performance or achievements to differ materially from those presented in the forward-looking statements. For more detailed information on the risks and uncertainties associated with CTS’ business, see our reports filed with the SEC. Examples of factors that may affect future operating results and financial condition include, but are not limited to: rapid technological change; general market conditions in the automotive, communications, and computer industries, as well as conditions in the industrial, defense & aerospace, and medical markets; reliance on key customers; the ability to protect our intellectual property; pricing pressures and demand for our products; and risks associated with our international operations, including trade and tariff barriers, exchange rates and political and geopolitical risks; and the impact of the accounting misstatements at its Moorpark and Santa Clara, California locations. CTS undertakes no obligation to publicly update its forward-looking statements to reflect new information or events or circumstances that arise after the date hereof, including market or industry changes.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS (2004-2006)

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cts corporation 15

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and
Shareholders of CTS Corporation

We have audited the accompanying consolidated balance sheets of CTS Corporation and subsidiaries (“the Company”) as of December 31, 2006 and 2005, and the related consolidated statements of earnings, shareholders’ equity, and cash flows for the two years then ended. We have also audited the accompanying Schedule II — Valuation and Qualifying Accounts and Reserves as of December 31, 2006 and 2005. The financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note B to the consolidated financial statements, the December 31, 2005 consolidated financial statements have been restated.

As discussed in Note I to the consolidated financial statements, the Company has adopted SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R)” as of January 1, 2006.

As discussed in Note J to the consolidated financial statements, the Company has adopted SFAS No. 123(R) “Share-Based Payment” as of January 1, 2006.

In our opinion, the consolidated financial statements and schedule referred to above present fairly, in all material respects, the financial position of CTS Corporation and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for the two years then ended in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of CTS Corporation’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated May 14, 2007 expressed an unqualified opinion on management’s assessment of, and an adverse opinion on the effective operation of, internal control over financial reporting.

/s/ Grant Thornton LLP

GRANT THORNTON LLP

Chicago, Illinois
May 14, 2007

16  cts corporation

2004 Reissued Report

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and
Shareholders of CTS Corporation:

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of CTS Corporation and its subsidiaries at December 31, 2004, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

PricewaterhouseCoopers LLP

Indianapolis, Indiana

March 3, 2005

cts corporation 17

CONSOLIDATED STATEMENTS OF EARNINGS

(In thousands of dollars except per share amounts)

			Year Ended December 31,
						2005
			2006			(as restated)			2004
Net sales			$	655,614		$	617,484		$	531,316
Costs and expenses:
	Cost of goods sold			534,784			497,270			421,560
	Selling, general and administrative expenses			70,913			68,255			63,485
	Research and development expenses			15,873			17,092			19,063
	Gain on asset sales			(2,142	)		(3,065	)		(3,920	)
	Restructuring charges — Note Q			3,368			—			—
		Operating earnings		32,818			37,932			31,128
Other (expense) income:
	Interest expense			(3,654	)		(5,902	)		(5,535	)
	Interest income			934			1,300			922
	Other			568			(334	)		(598	)
		Total other expense		(2,152	)		(4,936	)		(5,211	)
		Earnings before income taxes		30,666			32,996			25,917
Income tax expense — Note K				6,469			12,240			5,961
		Net earnings	$	24,197		$	20,756		$	19,956
Net Earnings per share — Note E
	Basic		$	0.68		$	0.57		$	0.56
	Diluted		$	0.63		$	0.53		$	0.53

The accompanying notes are an integral part of the consolidated financial statements.

18  cts corporation

CONSOLIDATED BALANCE SHEETS

(In thousands of dollars)

				December 31,
							2005
				2006			(as restated)
ASSETS
Current Assets
	Cash and cash equivalents			$	38,630		$	12,029
	Accounts receivable, less allowances (2006 — $2,139; 2005 — $2,373)				106,012			90,790
	Inventories, net
		Finished goods			12,336			11,931
		Work-in-process			15,059			15,661
		Raw materials			33,148			33,037
		Total inventories			60,543			60,629
	Current deferred tax asset — Note K				13,644			7,671
	Other current assets				8,791			8,597
		Total current assets			227,620			179,716
Property, plant and equipment
	Buildings and land				99,498			113,873
	Machinery and equipment				256,518			248,325
		Total property, plant and equipment			356,016			362,198
	Accumulated depreciation				(259,548	)		(252,545	)
		Net property, plant and equipment			96,468			109,653
Other assets
	Prepaid pension asset — Note I				100,666			152,483
	Goodwill — Notes C and F				24,657			24,657
	Other intangible assets, net — Notes C and F				39,154			42,347
	Deferred income taxes — Note K				37,401			22,887
	Other assets				1,867			2,086
			Total other assets		203,745			244,460
Total Assets				$	527,833		$	533,829
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
	Notes payable — Note G			$	5,425		$	13,299
	Current portion of long-term debt — Note H				186			164
	Accounts payable				78,205			68,720
	Accrued salaries, wages and vacation				11,243			10,661
	Income taxes payable				7,766			5,834
	Other accrued liabilities				22,856			22,645
			Total current liabilities		125,681			121,323
Long-term debt — Note H					60,635			68,293
Other long-term obligations — Note I					22,494			16,120
Contingencies — Note O					—			—
Shareholders’ Equity
	Preferred stock — authorized 25,000,000 shares without par value; none issued — Note L				—			—
	Common stock — authorized 75,000,000 shares without par value; 53,718,801 shares issued at December 31, 2006 and 53,576,243 shares issued at December 31, 2005 — Note L				276,553			275,211
	Additional contributed capital				27,899			24,743
	Retained earnings				315,370			295,478
	Accumulated other comprehensive loss				(31,283	)		(244	)
					588,539			595,188
		Cost of common stock held in treasury (2006 — 17,895,708 shares; 2005  — 17,717,657 shares) — Note M			(269,516	)		(267,095	)
		Total shareholders’ equity			319,023			328,093
Total Liabilities and Shareholders’ Equity				$	527,833		$	533,829

The accompanying notes are an integral part of the consolidated financial statements.

cts corporation 19

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

					Year Ended December 31,
								2005
					2006			(as restated)			2004
Cash flows from operating activities:
	Net earnings				$	24,197		$	20,756		$	19,956
	Adjustments to reconcile net earnings to net cash provided by operating activities:
		Depreciation and amortization				24,896			27,059			26,082
		Prepaid pension asset				(6,173	)		(8,741	)		(10,864	)
		Equity-based compensation — Note J				4,071			2,704			1,668
		Deferred income taxes — Note K				1,885			8,263			153
		Gain on asset sales				(2,142	)		(3,065	)		(3,920	)
		Restructuring charge — Note Q				3,368			—			—
		Changes in assets and liabilities, net of effects from purchase of SMTEK
			Accounts receivable			(15,222	)		8,824			(11,822	)
			Inventories			87			(3,644	)		(10,809	)
			Accounts payable and accrued liabilities			8,404			(4,488	)		3,855
			Income taxes payable			1,933			(3,320	)		150
		Other				1,881			171			(482	)
			Total adjustments			22,988			23,763			(5,989	)
				Net cash provided by operations		47,185			44,519			13,967
Cash flows from investing activities:
	Proceeds from sale of assets					14,482			6,093			19,813
	Capital expenditures					(15,787	)		(15,009	)		(12,711	)
	Payment for purchase of SMTEK, net of cash acquired — Note C					—			(35,561	)		—
				Net cash provided by (used in) investing activities		(1,305	)		(44,477	)		7,102
Cash flows from financing activities:
	Borrowings of long-term debt					73,850			161,160			172,185
	Payments of long-term debt					(81,608	)		(188,285	)		(153,915	)
	Increase (decrease) in short-term notes payable					(7,874	)		9,988			3,311
	Debt issue costs					—			—			(2,406	)
	Repayment of debt assumed in connection with purchase of SMTEK					—			(13,013	)		—
	Purchase of treasury stock					(2,309	)		(11,283	)		(2,005	)
	Dividends paid					(4,307	)		(4,343	)		(4,537	)
	Exercise of stock options and other					112			(113	)		87
				Net cash provided by (used in) financing activities		(22,136	)		(45,889	)		12,720
Effect of exchange rate changes on cash						2,857			(3,129	)		1,870
Net increase (decrease) in cash and cash equivalents						26,601			(48,976	)		35,659
Cash and cash equivalents at beginning of year						12,029			61,005			25,346
Cash and cash equivalents at end of year					$	38,630		$	12,029		$	61,005
Supplemental cash flow information
	Cash paid during the year for:
		Interest			$	3,133		$	5,360		$	4,857
		Income taxes — net				1,568			5,114			6,901

Supplemental schedule of non-cash investing and financing activities:

Refer to Note D, “Supplemental Schedule of Non-cash Investing and Financing Activities”

The accompanying notes are an integral part of the consolidated financial statements.

20  cts corporation

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands of dollars)

											Accumulated
					Additional						Other
		Common			Contributed			Retained			Comprehensive			Comprehensive			Treasury
		Stock			Capital			Earnings			Earnings (Loss)			Earnings			Stock			Total
Balances at January 1, 2004		$	262,748		$	21,520		$	263,430		$	151					$	(253,658	)	$	294,191
Net earnings									19,956					$	19,956						19,956
Cumulative translation adjustment												2,074			2,074						2,074
Minimum pension liability adjustment (net of tax of $580)												(877	)		(877	)					(877	)
	Comprehensive earnings														21,153
Cash dividends of $0.12 per share									(4,322	)											(4,322	)
Returned 7,600 shares on restricted stock and cash bonus plan — net			(40	)		119												(79	)
Issued 19,246 shares on exercise of stock option — net			171			13												(24	)		160
Issued 603 shares under Direct Stock Purchase Plan			6																		6
Issued 9,018 shares to former DCA shareholders			104																		104
Acquired 183,000 shares for treasury stock																		(2,005	)		(2,005	)
Stock compensation			308			1,109															1,417
Balances at December 31, 2004			263,297			22,761			279,064			1,348						(255,766	)		310,704
Net earnings (as restated)									20,756						20,756						20,756
Cumulative translation adjustment												(786	)		(786	)					(786	)
Minimum pension liability adjustment (net of tax of $455)												(806	)		(806	)					(806	)
	Comprehensive earnings (as restated)														19,164
Cash dividends of $0.12 per share									(4,342	)											(4,342	)
Issued 812,315 shares in connection with acquisition of SMTEK			10,932																		10,932
Returned 2,150 shares on restricted stock and cash bonus plan — net			11			21												(32	)
Issued 35,651 shares on exercise of stock option — net			250			41												(14	)		277
Issued 41,084 shares on vesting of restricted stock units			473			(656	)														(183	)
Issued 643 shares under Direct Stock Purchase Plan			7																		7
Issued 18,552 shares to former DCA shareholders			113																		113
Acquired 956,400 shares for treasury stock																		(11,283	)		(11,283	)
Stock compensation			128			2,576															2,704
Balances at December 31, 2005 (as restated)			275,211			24,743			295,478			(244	)					(267,095	)		328,093
Net earnings									24,197						24,197						24,197
Cumulative translation adjustment												4,810			4,810						4,810
Minimum pension liability adjustment (net of tax of $50)												369			369						369
	Comprehensive earnings													$	29,376
Adjustment to initially apply FAS No. 158, net of tax												(36,218	)								(36,218	)
Cash dividends of $0.12 per share									(4,305	)											(4,305	)
Issued 70,943 shares on exercise of stock option — net of tax			575															(112	)		463
Issued 64,372 shares on vesting of restricted stock units			767			(1,133	)														(366	)
Acquired 170,600 shares for treasury stock																		(2,309	)		(2,309	)
Tax benefits on exercise of options						193															193
Stock compensation						4,096															4,096
Balances at December 31, 2006		$	276,553		$	27,899		$	315,370		$	(31,283	)				$	(269,516	)	$	319,023

The accompanying notes are an integral part of the consolidated financial statements.

cts corporation 21

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE A — Summary of Significant Accounting Policies

Principles of Consolidation: The consolidated financial statements include the accounts of CTS and its wholly owned subsidiaries. Refer to Note C, “Acquisition,” for a discussion of the acquisition made by CTS in 2005. All significant intercompany accounts and transactions have been eliminated.

Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.

Translation of Foreign Currencies: The financial statements of CTS’ non-U.S. subsidiaries, except the United Kingdom subsidiary, are remeasured into U.S. dollars using the U.S. dollar as the functional currency with all remeasurement adjustments included in the determination of net earnings. CTS’ Consolidated Statements of Earnings includes $0.3 million, ($0.5) million, and ($0.7) million of foreign currency translation gain/(loss) for the years ended December 31, 2006, 2005, and 2004, respectively.

The assets and liabilities of CTS’ United Kingdom subsidiary are translated into U.S. dollars at the current exchange rate at period end, with resulting translation adjustments made directly to the “accumulated other comprehensive earnings (loss)” component of shareholders’ equity. Statement of earnings accounts are translated at the average rates during the period.

Comprehensive Earnings: CTS reports comprehensive earnings in accordance with the Financial Accounting Standards Board’s (FASB) Financial Accounting Standard (FAS) No. 130, “Reporting Comprehensive Income (Loss).” The components of comprehensive earnings for CTS include foreign currency translation adjustments, unrecognized pension losses and prior service costs, and net earnings and are reported within the Consolidated Statements of Shareholders’ Equity in the columns titled “Comprehensive Earnings” and “Accumulated Other Comprehensive Earnings (Loss).”

The table below shows the components of accumulated other comprehensive earnings (loss) at December 31:

($ in thousands)		2006			2005
Accumulated translation		$	7,202		$	2,392
Minimum pension liability			—			(2,636	)
Unrecognized amounts relating to benefit plans:
	Net loss		(36,367	)		—
	Prior service costs		(2,118	)		—
Accumulated other comprehensive loss		$	(31,283	)	$	(244	)

Revenue Recognition: Substantially all of CTS’ revenue is from product sales. CTS recognizes revenue from product sales when title transfers, the risks and rewards of ownership have been transferred to the customer, the sales price is fixed and determinable, and collection of the related receivable is probable, which is generally at the time of shipment. The Company has agreements with its distributors that provide limited rights of return within a limited time and protection against price reductions initiated by the Company. The effect of these programs is estimated based on historical experience and current economic conditions and provisions are recorded at the time of shipment. CTS customers typically have a right to return products that they consider to be defective. Revenue is recorded net of estimated returns of products, based on management’s analysis of historical returns, current economic trends, and changes in customer demands. Provisions for returns and other adjustments are provided for in the same period the related sales are recorded based on experience and other relevant factors.

Concentration of Credit Risk: The majority of cash and cash equivalents approximately 89%, is maintained in U.S. dollar demand deposits, AAA money market mutual funds, and in U.S. government securities, with the remainder maintained with several major financial institutions. Deposits with these banks exceed the amount of insurance provided on such deposits; however, the deposits typically may be redeemed upon demand and, therefore, bear minimal risk.

Trade receivables subject CTS to the potential for credit risk with major customers. CTS sells its products to customers principally in the automotive, communications, computer, medical, and industrial markets, primarily in North America, Europe, and Asia. CTS performs ongoing credit evaluations of its customers to minimize credit risk. CTS does not require collateral. The allowance for doubtful accounts is based on management’s estimates of the collectability of its accounts receivable after analyzing historical bad debts, customer concentrations, customer credit worthiness, and current economic trends. Sales to Hewlett-Packard Company (Hewlett-Packard) were 22% of net sales for the year ended December 31, 2006, 28% of net sales for the year ended December 31, 2005 and, 33% of net sales for the year ended December 31, 2004. Sales to Motorola, Inc. (Motorola) were less than 10% of net sales for each of the years ended December 31, 2006 and 2005, and 13% of net sales for the year ended December 31, 2004. Amounts due from Hewlett-Packard and Motorola aggregated $30 million and $33 million at December 31, 2006 and 2005, respectively. Significant sales to a single customer expose CTS to a concentration of credit risk. Management, however, believes the likelihood of incurring material losses due to concentration of credit risk is remote.

Research and Development: Research and development costs include expenditures for planned search and investigation aimed at discovery of new knowledge to be used to develop new products or processes or to significantly enhance existing products or production processes. It also includes the implementation of the new knowledge through design, testing of product alternatives, or construction of

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

22  cts corporation

prototypes. CTS expenses all research and development costs as incurred.

Earnings Per Share: Basic and diluted earnings per common share are reported in conformity with the FAS No. 128, “Earnings per Share.” Basic earnings per share excludes any dilution and is computed by dividing net earnings available to common shareholders by the weighted-average number of common shares outstanding for the period.

Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock resulted in the issuance of common stock that shared in the earnings of CTS. Diluted earnings per share is computed by dividing net earnings adjusted for the after-tax effect of interest on dilutive convertible debt by the weighted-average number of common shares outstanding during the period plus the incremental shares that would have been outstanding upon the assumed exercise of dilutive securities. If the common stock equivalents have an anti-dilutive effect, they are excluded from the computation of diluted earnings per share. Refer also to Note E, “Earnings Per Share.”

Equity-Based Compensation: Effective January 1, 2006, CTS adopted the provisions of FASB’s FAS No. 123(R), “Share-Based Payment,” which requires CTS to recognize expense related to the fair value of equity-based compensation awards in the Consolidated Statement of Earnings. CTS elected to follow the modified prospective transition method allowed by FAS No. 123(R), and therefore, only applied the provisions of FAS No. 123(R) to awards modified or granted after January 1, 2006. In addition, for awards that were unvested as of January 1, 2006, CTS recognizes compensation expense in the Consolidated Statement of Earnings over the remaining vesting period. Prior to January 1, 2006, CTS accounted for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) No. 25, “Accounting for Stock Issued to Employees.” See Note J, “Equity-Based Compensation,” for a further description of the impact of the adoption of FAS No. 123(R) and the Company’s stock compensation plans.

FAS No. 123(R) requires companies to estimate the fair value of stock-based awards on the date of grant using an option-pricing model. CTS uses the Black-Scholes option-pricing model. A number of assumptions are used by the Black-Scholes option-pricing model to compute the grant date fair value, including expected price volatility, option term, risk-free interest rate, and dividend yield. These assumptions are established at each grant date based upon current information at that time. Expected volatilities are based on historical volatilities of the Company’s stock. The expected option term is derived from historical data on exercise behavior. Different expected option terms result from different groups of employees exhibiting different behavior. The dividend yield is based on historical dividend payments. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve at the time of grant. The fair value of awards that are ultimately expected to vest is recognized as expense over the requisite service periods in the Consolidated Statement of Earnings. CTS’ stock options primarily have a graded-vesting schedule. CTS recognizes expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards.

Cash Equivalents: CTS considers all highly liquid investments with a maturity of three months or less from the purchase date to be cash equivalents.

Inventories: Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method.

Income Taxes: CTS provides deferred income taxes pursuant to the requirements of FASB’s FAS No. 109, “Accounting for Income Taxes.” Under FAS No. 109, deferred tax assets and liabilities are determined based on the difference between the financial statement and income tax bases of assets and liabilities and carryforwards using currently enacted tax rates. CTS estimates its income tax valuation allowance by assessing which deferred tax assets are more likely than not to be recovered in the future. Refer also to Note K, “Income Taxes.”

Property, Plant and Equipment: Property, plant and equipment are stated at cost. Depreciation is computed over the estimated useful lives of the assets using the straight-line method. Useful lives for buildings and improvements range from 10 to 45 years. Machinery and equipment useful lives range from three to eight years. Amounts expended for maintenance and repairs are charged to expense as incurred. Upon disposition, any related gains or losses are included in operating earnings.

CTS assesses the carrying value of long-lived assets and the remaining useful lives whenever events or changes in circumstances indicate an impairment may have occurred. If the future cash flows (undiscounted and without interest) expected to result from the use of the related assets are less than the carrying value of such assets, an impairment charge may be required to reduce the carrying value of the long-lived assets to fair value.

Retirement Plans: CTS has various defined benefit and defined contribution retirement plans covering a majority of its employees. CTS’ policy is to annually fund the defined benefit pension plans at or above the minimum required by law. Refer also to Note I, “Retirement Plans.”

Effective December 31, 2006, CTS adopted the provisions of FASB’s FAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements 87, 88, 106, and 132(R).” FAS No. 158 requires employers to: a) recognize the funded status of a benefit plan — measured as the difference between plan assets at fair value and the benefit obligation — in its statement of financial position, b) recognize as a

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

cts corporation 23

component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to FAS No. 87, “Employers’ Accounting for Pensions,” or FAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” c) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position, and d) disclosure in the notes to financial statement additional information about certain effects on net periodic benefit costs for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. As required by the standard, CTS has applied these FAS No. 158 requirements prospectively.

Intangible Assets: CTS does not amortize goodwill, but tests it annually for impairment using a fair value approach at the “reporting unit” level. A reporting unit is the operating segment, or a business one level below that operating segment (the “component” level) if discrete financial information is prepared and regularly reviewed by segment management. However, components are aggregated as a single reporting unit if they have similar economic characteristics. CTS would recognize an impairment charge for any amount by which the carrying amount of a reporting unit’s goodwill exceeds its fair value. CTS uses discounted cash flows to establish fair values.

CTS amortizes the cost of other intangibles over a straight-line basis using their estimated useful lives. CTS assesses useful lives based on the period over which the asset is expected to contribute to CTS’ cash flows. CTS reviews the carrying value of its intangible assets whenever events or changes in circumstances indicate an impairment may have occurred. If impaired, the asset is written down to fair value based on either discounted cash flows or appraised values. Refer also to Note F, “Intangible Assets.”

Financial Instruments: CTS’ financial instruments consist primarily of cash, cash equivalents, trade receivables and payables, and obligations under short-term notes payable and long-term debt. The carrying value for cash and cash equivalents, and trade receivables and payables and short-term notes payable approximates fair value based on the short-term maturities of these instruments. CTS has estimated the fair value of its long-term debt to be $68.9 million, or $8.1 million more than the carrying value of $60.8 million. The estimated fair value of long-term debt was based on quoted dealer prices for the same or similar issues.

Amortization of Debt Issue Costs: CTS has debt issue costs that relate to the Company’s long-term debt and are being amortized over the life of the debt or, for convertible debt, the period until the debt is first convertible into common stock. Amortization expense totaled $0.6 million in 2006, $0.8 million in 2005, and $0.7 million in 2004 and is included in interest expense in the accompanying Consolidated Statements of Earnings.

Reclassifications: Certain reclassifications have been made for the periods presented in the consolidated financial statements to conform to the classifications adopted in 2006.

New Accounting Pronouncements: In September 2006, the FASB issued FAS No. 157, “Fair Value Measurements.” FAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP), and expands disclosures about fair value measurements. FAS No. 157 applies under other accounting pronouncements that require or permit fair value measurements, and accordingly, does not require any new fair value measurements. FAS No. 157 is effective for CTS in 2008. The Company is currently reviewing the provisions of FAS No. 157, but does not expect it to have a material impact on its financial statements.

In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (SAB 108) which provides interpretive guidance on how the effects of carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 is effective for fiscal years ending after November 15, 2006 and did not have a material impact on our consolidated financial statements.

In June 2006, the FASB issued Interpretation (FIN) No. 48, “Accounting for Uncertainty in Income Taxes.” FIN No. 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FAS No. 109, “Accounting for Income Taxes.” FIN No. 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. At present, CTS has substantially completed its process of documenting its tax positions and measuring the expected benefits of each, as required under FIN 48. CTS does not expect adoption of FIN 48 to have a material impact on its financial statements.

In June 2006, the Emerging Issues Task Force (EITF) reached a consensus on EITF Issue No. 06-03, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation)” (EITF 06-03). EITF 06-03 provides that the presentation of taxes assessed by a governmental authority that is directly imposed on a revenue-producing transaction between a seller and a customer on either a gross basis (included in revenue and costs) or on a net basis (excluded from revenues) is an accounting policy decision that should be disclosed. The previsions of EITF 06-3 will be effective for us as of January 1, 2007. We do not expect EITF-06-3 to have a material impact on our consolidated financial statements.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

24  cts corporation

NOTE B — Restatement of the Consolidated Financial Statements

In February 2007, management commenced an investigation of accounting entries at CTS’ Moorpark and Santa Clara, California manufacturing locations. The investigation was conducted under the oversight of the Audit Committee and with the assistance of outside legal counsel and forensic accountants.

The investigation determined the Moorpark Controller made numerous incorrect accounting entries beginning in 2005 and continuing through 2006. These entries transferred significant costs from income statement accounts, primarily cost of goods sold, to balance sheet accounts, primarily accounts payable.

The net tax adjusted effect of the misstatements in these accounts on CTS’ 2005 earnings was $1.5 million and on CTS’ 2006 earnings for the nine-month period ended October 1, 2006 was $1.9 million. Management determined that the effect of these misstatements on CTS’ 2006 consolidated financial statements was material. Amendments to CTS’ Quarterly Reports on Form 10-Q/A restating CTS’ consolidated financial statements for each of the first three quarters of 2006 are being filed contemporaneously with this Annual Report on Form 10-K.

The following table sets forth the impact of the misstatements and related tax effects on CTS’ condensed consolidated financial statements for the year ended December 31, 2005.

Income Statement

	Year-Ended December 31, 2005
(in thousands, except per share amounts)	As Reported		Adjustments			As Restated
Cost of Goods Sold	$	495,069	$	2,201		$	497,270
Selling, general and administrative expenses		68,049		206			68,255
Operating Earnings		40,339		(2,407	)		37,932
Earnings before income taxes		35,403		(2,407	)		32,996
Income tax expense		13,169		(929	)		12,240
Net earnings	$	22,234	$	(1,478	)	$	20,756
Net earnings per share
Basic	$	0.61	$	(0.04	)	$	0.57
Diluted		0.57		(0.04	)		0.53

Balance Sheet

		December 31, 2005
		As Reported		Adjustments			As Restated
Account receivable		$	91,265	$	(475	)	$	90,790
	Finished goods		11,771		160			11,931
	Work-in-process		16,039		(367	)		15,672
	Raw materials		32,754		272			33,026
	Total Inventories		60,564		65			60,629
Other current assets			9,145		(548	)		8,597
Total current assets			180,674		(958	)		179,716
Machinery and equipment			248,348		(23	)		248,325
Deferred income taxes			22,011		876			22,887
Other assets			2,088		(2	)		2,086
	Total other assets		243,586		874			244,460
Total Assets		$	533,936	$	(107	)	$	533,829
Accounts payable			67,196		1,524			68,720
Accrued salaries, wages and vacation			10,496		165			10,661
Income taxes payable			6,127		(293	)		5,834
Other accrued liabilities			22,651		(6	)		22,645
	Total current liabilities		119,933		1,390			121,323
Other long-term obligations			16,139		(19	)		16,120
Retained earnings			296,956		(1,478	)		295,478
	Total shareholders’ equity		329,571		(1,478	)		328,093
Total Liabilities and Shareholders’ Equity		$	533,936	$	(107	)	$	533,829

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

cts corporation 25

NOTE C — Acquisition

Effective January 31, 2005, CTS acquired 100% of the outstanding capital stock of SMTEK International Inc. (SMTEK). The results of SMTEK’s operations have been included in the consolidated financial statements since that date. SMTEK is an EMS provider serving original equipment manufacturers in the medical, industrial, instrumentation, telecommunications, security, financial services, automation, aerospace, and defense industries. SMTEK had four facilities located in Moorpark and Santa Clara, California; Marlborough, Massachusetts; and Bangkok, Thailand. Subsequent to the acquisition, CTS consolidated the Marlborough, Massachusetts facility into its Londonderry, New Hampshire facility.

In conjunction with the purchase, CTS acquired net assets valued at $48.1 million. The purchase price was comprised of $34.7 million of cash consideration, CTS common stock valued at $10.9 million, and $2.5 million of estimated transaction cost. In addition, CTS immediately repaid $13.0 million of the SMTEK debt which was assumed. CTS issued 812,315 shares of common stock in connection with the acquisition. The value assigned to the common stock was determined based on the average market price of CTS’ common stock over the two-day period before and after the terms of the acquisition were agreed to and announced.

The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition.

($ in thousands)		At January 31, 2005
Current assets		$	34,867
Property, plant and equipment			6,108
Amortizable intangible assets			11,158
Goodwill			24,144
Other long-term assets			4,627
	Total assets acquired		80,904
Current liabilities			16,702
Long-term liabilities			3,098
Debt assumed and repaid by CTS			13,013
	Total liabilities acquired		32,813
Net assets acquired		$	48,091

Of the $11.2 million of amortizable intangible assets, $10.7 million was assigned to customer relationships (13 year useful life), $0.4 million to customer order backlog (90 days useful life), and $0.1 million to employment agreements (2 year useful life). The $24.1 million of goodwill was assigned to the EMS business segment. None of these amounts are deductible for tax purposes.

The following table presents CTS’ unaudited pro forma consolidated results of operations for the twelve months ended December 31, 2005 and 2004 as if the acquisition had been completed at the beginning of each period. The pro forma information is presented for comparative purposes only and does not purport to be indicative of what would have occurred had the acquisition actually been made at such date, nor is it necessarily indicative of future operating results.

		Pro forma Twelve Months Ended
($ in thousands, except		December 31, 2005
per share amounts)		(as restated)		December 31, 2004
Revenues		$	627,531	$	645,948
Net income		$	20,930	$	21,923
Earnings per share:
	Basic	$	0.58	$	0.60
	Diluted	$	0.53	$	0.57

NOTE D — Supplemental Schedule of Noncash Investing and Financing Activities

In 2005, the Company purchased 100% of the capital stock of SMTEK. In conjunction with the acquisition, CTS issued common stock and assumed liabilities as follows (refer also to Note C, “Acquisition”):

($ in millions)
Cash paid	$	37.2
Fair value of stock issued		10.9
Liabilities assumed		32.8
Fair value of assets acquired	$	80.9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

26  cts corporation

NOTE E — Earnings Per Share

FAS No. 128, “Earnings per Share,” requires companies to provide a reconciliation of the numerator and denominator of the basic and diluted earnings per share (EPS) computations. The calculation below provides net earnings, average common shares outstanding and the resultant earnings per share for both basic and diluted EPS for the years ended December 31, 2006, 2005, and 2004.

				Shares
		Net Earnings		(In thousands)			Per Share
(In thousands of dollars, except per share amounts)		(Numerator)		(Denominator)			Amount
2006
Basic EPS		$	24,197		35,826		$	0.68
Effect of dilutive securities:
	Equity-based compensation plans				402
	Convertible debt		984		4,000
Diluted EPS		$	25,181		40,228		$	0.63
2005 (as restated)
Basic EPS		$	20,756		36,307		$	0.57
Effect of dilutive securities:
	Equity-based compensation plans				653
	Convertible debt		978		4,000
Diluted EPS		$	21,734		40,960		$	0.53
2004
Basic EPS		$	19,956		35,910		$	0.56
Effect of dilutive securities:
	Equity-based compensation plans				382
	Convertible debt		632		2,575
	Other				26	(1)
Diluted EPS		$	20,588		38,893		$	0.53

(1)  Represents shares of CTS common stock to be issued to the former DCA shareholders, a company which was acquired by CTS in 1997.

The following table shows the securities which could potentially dilute EPS in the future, but have been excluded from the 2006, 2005, and 2004 diluted earnings per share calculations because they are either anti-dilutive or the exercise price exceeds the average market price.

	Year Ended December 31,
(Number of shares in thousands)	2006		2005		2004
Stock options where the exercise price exceeds the average market price of common shares during the period		695		659		737
Securities related to subordinated convertible debt		—		1,060		1,247

Note F — Intangible Assets

CTS has the following intangible assets as of December 31:

			2006					2005
			Gross					Gross
			Carrying		Accumulated			Carrying		Accumulated
($ in thousands)			Amount		Amortization			Amount		Amortization
Amortized intangible assets:
	Customer lists/ relationships		$	47,075	$	(10,501	)	$	47,075	$	(8,451	)
	Patents			10,319		(7,744	)		10,319		(6,673	)
	Employment agreements			142		(137	)		142		(65	)
	Customer order backlog			—		—			346		(346	)
		Total		57,536		(18,382	)		57,882		(15,535	)
Goodwill				24,657		—			24,657		—
		Total intangible assets	$	82,193	$	(18,382	)	$	82,539	$	(15,535	)

Of the net intangible assets at December 31, 2006, $33.3 million relates to the EMS segment and $30.5 million relates to the Components and Sensors segment. Of the $24.7 million of goodwill, $24.2 million relates to the EMS segment and $0.5 million relates to the Components and Sensors segment. CTS recorded amortization expense of $3.2 million, $3.4 million, and $2.3 million for the years ended December 31, 2006, 2005, and 2004, respectively. CTS estimates annual amortization expense of $3.1 million in 2007, $3.1 million in 2008, $2.5 million in 2009, $2.0 million in 2010, $2.0 million in 2011 and $26.4 million thereafter.

NOTE G — Notes Payable

CTS had line of credit arrangements of $27.2 million and $23.0 million at December 31, 2006 and 2005, respectively. These arrangements are generally subject to annual renewal and renegotiation, and may be withdrawn at the banks’ option. The majority of the line of credit arrangements at December 31, 2006 are unsecured. However, one line of credit for $0.6 million is secured by land and building in Thailand. The weighted-average interest rate, computed by relating interest expense to average daily short-term borrowings, was 5.4% in 2006 and 4.2% in 2005.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

cts corporation 27

NOTE H — Debt

Long-term debt was comprised of the following at December 31:

($ in thousands)		2006		2005
Revolving credit agreement, weighted-average interest rate of 6.2% (2006), due in 2011		$	—	$	—
Former revolving credit agreement, average interest rate of 6.1% (2005)			—		2,080
Convertible, senior subordinated debentures at a weighted-average rate of 2.1%, due in 2024			60,000		60,000
Convertible, subordinated debentures at a weighted-averaged rate of 6.5%, due in 2007			—		5,500
Term loan, interest 7.3% (2006) and 5.8% (2005) due in 2011			821		875
Other debt, weighted-average rate			—		2
			60,821		68,457
Less current maturities			186		164
	Total long-term debt	$	60,635	$	68,293

The debt matures as follows: 2007 — $0.2 million; 2008 — $0.2 million, 2009 — $0.2 million; 2010 — $0.2 million; 2011 — none; thereafter — $60.0 million.

On June 27, 2006, CTS entered into a new $100 million, unsecured revolving credit agreement. Under the terms of the new revolving credit agreement, CTS can expand the credit facility to $150 million. There were no amounts outstanding under the new revolving credit agreement at December 31, 2006. Interest rates on the new revolving credit agreement fluctuate based upon LIBOR and the Company’s quarterly total leverage ratio. CTS pays a commitment fee on the undrawn portion of the new revolving credit agreement. The commitment fee varies based on the quarterly leverage ratio and was 0.15 percent per annum at December 31, 2006. The new revolving credit agreement requires, among other things, that CTS comply with a maximum total leverage ratio and a minimum fixed charge coverage ratio. Failure of CTS to comply with these covenants could reduce the borrowing availability under the new revolving credit agreement. CTS was in compliance with all debt covenants at December 31, 2006. The revolving credit agreement requires CTS to deliver quarterly financial statements, annual financial statements, auditors certifications and compliance certificates within a specified number of days after the end of a quarter and year-end. Due to the accounting investigation described in Note B, the company and its lenders entered into an agreement under which the lenders agreed to waive these dates until June 30, 2007. Additionally, the new revolving agreement contains restrictions limiting CTS’ ability to: dispose of assets; incur certain additional debt; repay other debt or amend subordinated debt instruments; create liens on assets; make investments, loans or advances; make acquisitions or engage in mergers or consolidations; engage in certain transactions with CTS’ subsidiaries and affiliates; and the amounts allowed for stock repurchases and dividend payments. The new revolving credit agreement expires in June 2011. The former $75 million revolving credit agreement was terminated in connection with the execution of the new revolving credit agreement.

CTS has $60 million convertible senior subordinated debentures (2.125% Debentures). These unsecured debentures bear interest at an annual rate of 2.125%, payable semiannually on May 1 and November 1 of each year through the maturity date of May 1, 2024. The 2.125% Debentures are convertible, under certain circumstances, into CTS common stock at a conversion price of $15.00 per share (which is equivalent to an initial conversion rate of approximately 66.6667 shares per $1,000 principal amount of the notes). Upon conversion of the 2.125% Debentures, in lieu of delivering common stock, the Company may, at its discretion, deliver cash or a combination of cash and common stock.

The conversion price of the 2.125% Debentures will be adjusted if CTS completes certain transactions, including: distribution of shares as a dividend to substantially all shareholders; subdivision, combination or reclassification of its common stock; distribution of stock purchase warrants to substantially all shareholders; distribution of cash, stock or property to shareholders in excess of $0.03 per share; or purchase of its common stock pursuant to a tender offer or exchange offer under certain circumstances.

Holders may convert the 2.125% Debentures at any time during a conversion period if the closing price of CTS common stock is more than 120% of the conversion price ($18.00 per share) for at least 20 of the 30 consecutive trading days immediately preceding the first trading day of the conversion period. The conversion periods begin on February 15, May 15, August 15, and November 15 of each year. Holders may also convert the notes if certain corporate transactions occur. As of December 31, 2006, none of the conditions for conversion of the 2.125% million Debentures were satisfied.

CTS may, at its option, redeem all or a portion of the 2.125% Debentures for cash at any time on or after May 1, 2009, at a redemption price equal to the principal amount of the notes plus any accrued and unpaid interest at the redemption date. Holders may require CTS to purchase for cash all or part of their notes on May 1, 2009, 2014, and 2019, or upon the occurrence of certain events, at 100% of the principal amount of the notes plus accrued and unpaid interest up to, but not including, the date of purchase.

CTS has a registration rights agreement relating to the 2.125% Debentures which became effective in 2004. CTS had an obligation to keep the registration statement continuously effective for a period of two years, which expired in May 2006. The registration rights

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

28  cts corporation

agreement provided that in the event of a default in this obligation, CTS was subject to an additional interest penalty of 0.25% per annum of the principal for the first 90 days of default and 0.5% per annum of principal thereafter. Accordingly, as of December 31, 2006, there was no interest penalty that CTS could incur as a result of the failure to maintain an effective registration statement.

As of December 31, 2005, the Company also had $5.5 million outstanding under its 6.5% convertible, subordinated debentures (6.5% Debentures). However, in accordance with the provisions of the 6.5% Debentures, the remaining debenture holder exercised its put option and accelerated the maturity of this debt, which was repaid by CTS during June 2006.

In connection with the acquisition of SMTEK, CTS assumed a term loan, which has a balance of $0.8 million (denominated in Thailand Baht) at December 31, 2006. The term loan is secured by machinery and equipment of the Thailand manufacturing facility and requires monthly payments through May 2011.

NOTE I — Retirement Plans

Defined Benefit and Other Postretirement Benefit Plans

CTS has a number of noncontributory defined benefit pension plans (Pension Plans) covering approximately 18% of its employees. Plans covering salaried employees provide pension benefits that are based on the employees’ compensation prior to retirement. Plans covering hourly employees generally provide benefits of stated amounts for each year of service.

CTS provides postretirement life insurance benefits for certain retired employees. Domestic employees who were hired prior to 1982 and certain domestic union employees are eligible for life insurance benefits upon retirement. CTS funds life insurance benefits through term life insurance policies and intends to continue funding all of the premiums on a pay-as-you-go basis.

Effective December 31, 2006, CTS adopted all of the provisions of FAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R).” FAS No. 158 requires employers to: a) recognize the funded status of a benefit plan — measured as the difference between plan assets at fair value and the benefit obligation — in its statement of financial position, b) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to FAS No. 87, “Employers’ Accounting for Pensions,” or FAS No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions,” c) measure defined benefit plan assets and obligations as of the date of the employer’s fiscal year-end statement of financial position, and d) disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. As required by the standard, CTS has applied these FAS No. 158 requirements prospectively.

The following table highlights the incremental effect of applying FAS No. 158 to the Company’s defined benefit pension plans and other post-retirement benefit plan on individual line items in of the Company’s Consolidated Balance Sheet for the year ended December 31, 2006:

			FAS No. 158
	Before		Adjustments			After
	Application of		Increase/			Application of
($ in thousands)	FAS No. 158		(Decrease)			FAS No. 158
Defined Benefit Pension Plans
Prepaid pension asset	$	158,723	$	(58,057	)	$	100,666
Accrued salaries, wages and vacation		—		167			167
Other long-term obligations		9,153		1,929			11,082
Deferred income taxes		1,122		23,970			25,092
Accumulated other comprehensive loss, net of tax effect		2,267		36,183			38,450
Other Post-retirement Benefit Plan
Other accrued liabilities		370		—			370
Other long-term obligations		4,910		58			4,968
Deferred income taxes		—		23			23
Accumulated other comprehensive loss, net of tax effect		—		35			35

FAS No. 158 had no impact on the Consolidated Statement of Earnings for the year ending December 31, 2006. Furthermore, since CTS had previously measured its assets and liabilities as of December 31, there was no impact of adopting the measurement date provisions of FAS No. 158.

The measurement date for the Pension Plans and other postretirement plan assets and benefit obligations was December 31, 2006 and 2005. The following table provides a reconciliation of benefit

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

cts corporation 29

obligation, plan assets, and the funded status of the Pension Plans and other postretirement benefit plan at that measurement date.

									Other Postretirement
			Pension Plans						Benefit Plan
($ in thousands)			2006			2005			2006			2005
Accumulated benefit obligation			$	199,929		$	197,411		$	5,338		$	5,145
Change in projected benefit obligation:
	Projected benefit obligation at January 1		$	208,579		$	196,492		$	5,145		$	5,433
	Service cost			5,113			5,236			19			29
	Interest cost			12,087			11,338			299			318
	Plan amendment and other			1,785			(850	)		—			—
	Actuarial (gain) loss			87			6,616			118			(485	)
	Benefits paid			(10,341	)		(9,754	)		(161	)		(150	)
	Curtailment			(383	)		(499	)		(82	)		—
Projected benefit obligation at December 31			$	216,927		$	208,579		$	5,338		$	5,145
Change in plan assets:
	Assets at fair value at January 1		$	277,035		$	276,991		$	—		$	—
	Actual return on assets			37,726			8,688			—			—
	Company contributions			1,109			1,713			161			149
	Benefits paid			(10,341	)		(9,754	)		(161	)		(149	)
	Other			815			(603	)		—			—
Assets at fair value at December 31			$	306,344		$	277,035		$	—		$	—
Reconciliation of prepaid (accrued) cost:
	Funded status (plan assets less projected benefit obligations)		$	89,417		$	68,456		$	(5,338	)	$	(5,145	)
	Amounts not recognized:
		Actuarial (gains) losses		—			75,468			—			(62	)
		Prior service cost		—			3,857			—			3
Prepaid (accrued) cost, net			$	89,417		$	147,781		$	(5,338	)	$	(5,204	)

The components of the prepaid (accrued) cost, net are classified in the following lines in the Consolidated Balance Sheets:

							Other Postretirement
	Pension Plans						Benefit Plan
($ in thousands)	2006			2005			2006			2005
Prepaid pension asset	$	100,666		$	152,483		$	—		$	—
Other accrued liabilities		(167	)		(1,156	)		(370	)		(150	)
Other long-term obligations		(11,082	)		(7,648	)		(4,968	)		(5,054	)
Accumulated other comprehensive loss		—			4,102			—			—
	$	89,417		$	147,781		$	(5,338	)	$	(5,204	)

CTS has also recorded the following amounts to Accumulated Other Comprehensive loss at December 31, 2006:

			Other
			Postretirement
($ in thousands)	Pension Plans		Benefit Plan
Unrecognized loss	$	36,333	$	34
Unrecognized prior service cost		2,117		1
Total	$	38,450	$	35

Of these amounts, CTS expects to recognize approximately $3.4 million and $0.9 million of losses and prior service costs, respectively, in 2007 related to its Pension Plans. CTS does not expect to recognize any significant amounts of the Other Postretirement Benefit Plan unrecognized amounts in 2007.

The projected benefit obligation, accumulated benefit obligation and fair value of plan assets for those Pension Plans with accumulated benefit obligation in excess of fair value of plan assets at December 31, 2006 and 2005 is shown below:

($ in thousands)	2006		2005
Projected benefit obligation	$	21,012	$	17,830
Accumulated benefit obligation		18,916		16,502
Fair value of plan assets		9,763		7,698

Net pension (income)/postretirement expense in 2006, 2005, and 2004 includes the following components:

											Other Postretirement
		Pension Plans									Benefit Plan
($ in thousands)		2006			2005			2004			2006			2005			2004
Service cost		$	5,113		$	5,236		$	5,292		$	19		$	29		$	31
Interest cost			12,086			11,338			11,265			299			318			310
Expected return on plan assets(1)			(24,739	)		(25,661	)		(27,051	)		—			—			—
Amortization of unrecognized:
	Transition obligation		—			(304	)		(492	)		—			—			—
	Prior service cost		482			799			901			1			—			1
	Loss		2,716			1,125			658			—			—			—
Curtailment loss			325			475			—			(81	)		—			—
Net (income) expense		$	(4,017	)	$	(6,992	)	$	(9,427	)	$	238		$	347		$	342
Weighted-average actuarial assumptions(2)
Benefit obligation assumptions:
	Discount rate		5.72	%		5.93	%		5.94	%		5.75	%		6.00	%		6.00	%
	Rate of compensation increase		4.78	%		4.70	%		4.83	%		—			—			—
Pension income/postretirement Expense assumptions:
	Discount rate		5.92	%		5.94	%		6.17	%		6.00	%		6.00	%		6.25	%
	Expected return on plan assets(1)		8.43	%		8.45	%		8.70	%		—			—			—
	Rate of compensation increase		4.70	%		4.83	%		4.83	%		—			—			—

(1)	Expected return on plan assets is net of expected investment expenses and certain administrative expenses.
(2)	During the fourth quarter of each year, CTS reviews its actuarial assumptions in light of current economic factors to determine if the assumptions need to be adjusted.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

30  cts corporation

CTS utilizes a building block approach in determining the long-term rate of return for plan assets. Historical markets are reviewed and long-term relationships between equities and fixed-income are preserved consistent with the generally accepted capital market principle that assets with higher volatility generate a greater return over the long term. Current market factors such as inflation and interest rates are evaluated before long-term capital market assumptions are determined. The long-term portfolio return is established via a building block approach with proper consideration of diversification and rebalancing. Peer data and historical returns are reviewed to ensure for reasonableness and appropriateness.

CTS’ pension plan asset allocation at December 31, 2006 and 2005, and target allocation for 2007 by asset category are as follows:

					Percentage of Plan
		Target			Assets at
		Allocations			December 31,
Asset Category		2007			2006			2005
Equity securities(1)			65	%		67	%		66	%
Debt securities			33	%		30	%		32	%
Real estate			—	%		—	%		—	%
Other			2	%		3	%		2	%
	Total		100	%		100	%		100	%

(1)  Equity securities include CTS common stock in the amounts of approximately $23 million (8% of total plan assets) at December 31, 2006 and approximately $16 million (6% of total plan assets) at December 31, 2005.

CTS employs a total return investment approach whereby a mix of equities and fixed income investments are used to maximize the long-term return of plan assets for a prudent level of risk. Risk tolerance is established through careful consideration of plan liabilities and funded status. The investment portfolio primarily contains a diversified mix of equity and fixed-income investments. The equity investments are diversified across U.S. and non-U.S. stocks, as well as growth, value, and small, and large capitalizations. Other assets such as private equity are used modestly to enhance long-term returns while improving portfolio diversification. Investment risk is measured and monitored on an ongoing basis through quarterly investment portfolio reviews, annual liability measurements, and asset/liability studies at regular intervals.

The expected contributions to be made by CTS to the Pension Plans and the other postretirement benefit plan during 2007 are $1.0 million and $0.4 million, respectively.

Estimated Future Benefit Payments

The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:

			Other
			Postretirement
($ in thousands)	Pension Plans		Benefit Plan
2007	$	10,673	$	370
2008		13,740		377
2009		11,590		381
2010		12,401		384
2011		13,929		387
Years 2012-2016		77,856		1,903

Defined Contribution Plans

CTS sponsors a 401(k) plan that covers substantially all of its U.S. employees. Contributions and costs are generally determined as a percentage of the covered employee’s annual salary. Amounts expensed for the 401(k) plan and the other plans totaled $2.9 million in 2006, $3.3 million in 2005, and $3.0 million in 2004.

NOTE J — Equity-Based Compensation

Effective January 1, 2006, CTS adopted the provisions of FAS No. 123(R). FAS No. 123(R) requires that CTS recognize expense related to the fair value of equity-based compensation awards in the Consolidated Statement of Earnings.

Prior to January 1, 2006, CTS accounted for equity-based compensation using the intrinsic value method prescribed in APB Opinion No. 25, and its related Interpretations. Accordingly, equity-based compensation expense was not recognized in the Consolidated Statement of Earnings for stock options granted with an exercise price equal to the market value of the common stock on the grant date. However, prior years’ financial statements did include pro forma disclosures for equity-based awards as if the fair-value approach had been followed. The following table presents the pro forma net earnings and net earnings per share for the years ending

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

cts corporation 31

December 31, 2005 and 2004, as if CTS had applied the provisions of FAS No. 123(R) during those periods:

	Year Ended December 31
	2005
($ in thousands, except per share amounts)	(as restated)			2004
Net earnings, as reported	$	20,756		$	19,956
Deduct: Equity-based employee compensation cost, net of tax, if fair value based Method were used		(888	)		(1,254	)
Pro forma net earnings	$	19,868		$	18,702
Net earnings per share — basic	$	0.57		$	0.56
Pro forma net earnings per share — basic		0.55			0.52
Net earnings per share — diluted		0.53			0.53
Pro forma net earnings per share — diluted	$	0.51		$	0.50

In December 2005, CTS’ Board of Directors approved the accelerated vesting of approximately 70,000 unvested and “out-of-the-money” stock options with exercise prices ranging from $14.02 — $16.24 that were previously granted under an employee stock option plan. These options became immediately exercisable on December 31, 2005. The pro forma net income disclosed in this note includes approximately $310,000 of expense, or $0.01 per diluted share, related to this accelerated vesting. Accordingly, the 2005 pro forma amounts are not necessarily indicative of future annual expense to be recognized by CTS under FAS No. 123(R).

CTS has elected to follow the modified prospective transition method allowed by FAS No. 123(R), and therefore, has applied the provisions of FAS No. 123(R) to awards modified or granted after January 1, 2006. In addition, for awards which were unvested as of January 1, 2006, CTS is recognizing compensation expense in the Consolidated Statement of Earnings over the remaining vesting period. The compensation expense for these awards will be based on the grant-date fair value as calculated for the prior years’ pro forma disclosures. As allowed under the modified prospective transition method, the financial results for prior periods have not been restated for the adoption of FAS No. 123(R). The cumulative effect of the change in accounting principle from APB Opinion No. 25 was not material.

As a result of adopting FAS No. 123(R), CTS has included additional compensation expense relating to stock option awards to employees in its operating earnings, earnings before income taxes, net income, and earnings per share. The impact of this incremental expense, for the year ended December 31, 2006 is shown in the following table:

			Year Ended
($ in thousands, except per share amounts)			December 31, 2006
Impact of adopting FAS No. 123(R) on:
	Operating earnings		$	988
	Earnings before income taxes			988
	Net earnings			592
	Net earnings per share:
		Basic	$	0.02
		Diluted	$	0.01

At December 31, 2006, CTS had five equity-based compensation plans: the 1988 Restricted Stock and Cash Bonus Plan (1988 Plan), the 1996 Stock Option Plan (1996 Plan), the 2001 Stock Option Plan (2001 Plan), the Nonemployee Directors’ Stock Retirement Plan (Directors’ Plan), and the 2004 Omnibus Long-Term Incentive Plan (2004 Plan). All of these plans, except the Directors’ Plan were approved by shareholders. As of December 2004, additional grants can only be made under the 2004 Plan. CTS believes that equity-based awards align the interest of employees with those of its shareholders.

The 2004 Plan, and previously the 1996 Plan and 2001 Plan, provide for grants of incentive stock options or nonqualified stock options to officers, key employees, and nonemployee members of CTS’ Board of Directors. In addition, the 2004 Plan allows for grants of stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and other stock awards.

The following table summarizes the compensation expense included in the Consolidated Statement of Earnings for the years, ending December 31, 2006, 2005, and 2004 relating to equity-based compensation plans:

	Year Ended December 31
($ in thousands)	2006		2005		2004
Stock options(1)	$	1,033	$	101	$	223
Restricted stock units		2,826		2,289		766
Restricted stock		212		478		680
Total	$	4,071	$	2,868	$	1,669

(1)  Stock option expense includes $45, $101 and $223 ending December 31, 2006, 2005, and 2004, respectively, related to non-employee director stock options.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

32  cts corporation

The following table summarizes the plan status as of December 31, 2006:

	2004 Plan		2001 Plan		1996 Plan
Awards originally available		6,500,000		2,000,000		1,200,000
Stock options outstanding		332,000		887,963		306,900
Restricted stock units outstanding		658,138		—		—
Awards exercisable		113,788		806,413		294,200
Awards available for grant		5,372,011		—		—

Stock Options

Stock options are exercisable in cumulative annual installments over a maximum 10-year period, commencing at least one year from the date of grant. Stock options are generally granted with an exercise price equal to the market price of the Company’s stock on the date of grant. The stock options generally vest over four years and have a 10-year contractual life. The awards generally contain provisions to either accelerate vesting or allow vesting to continue on schedule upon retirement if certain service and age requirements are met. The awards also provide for accelerated vesting if there is a change in control event.

The Company estimates the fair value of the stock option on the grant date using the Black-Scholes option-pricing model and assumptions for expected price volatility, option term, risk-free interest rate, and dividend yield. Expected price volatilities are based on historical volatilities of the Company’s stock. The expected option term is derived from historical data on exercise behavior. The range of option terms shown below results from certain groups of employees exhibiting different behavior. The dividend yield is based on historical dividend payments. The risk-free rate for periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant.

	Year Ended December 31
($ in thousands)	2006		2005		2004
Expected volatility		53.3%-58.2%		52.4%		61.8%- 69.9%
Weighted-average expected volatility		54.1%		52.4%		65.3%
Expected dividends		0.9%		1.1%		1.1%
Expected term		4.0-10.0  years		10.0  years		4.5 years
Weighted-average risk-free rate		5.1%		4.1%		2.9%

The increase in the expected life assumption from 2004 to 2005 reflects a greater proportion of stock options being awarded to officers who have historically held stock options for their full term.

A summary of the status of stock options as of December 31, 2006, and changes during the year then ended, is presented below (in thousands of dollars except per share amounts):

						Weighted-
				Weighted-		Average
				Average		Remaining		Aggregate
				Exercise		Contractual		Intrinsic
Options	Shares			Price		Term		Value
Outstanding at January 1, 2006		1,567,499		$	15.93
Granted		93,000			13.68
Exercised		(68,186	)		8.43
Expired or Forfeited		(65,450	)		22.44
Outstanding at December 31, 2006		1,526,863		$	15.88		5.9 years	$	5,848
Exercisable at December 31, 2006		1,185,963		$	17.13		5.2 years	$	4,428

The weighted-average grant-date fair value of options granted during the years 2006, 2005, and 2004 was $6.53, $6.50, and $5.90, respectively. The total intrinsic value of options exercised during the years ended December 31, 2006, 2005, and 2004 was $0.4 million, $0.1 million, and $0.1 million, respectively. The exercise price of options granted during the years ended December 31, 2006, 2005, and 2004 equaled the trading price of the Company’s stock on the grant date.

A summary of the nonvested stock options as of December 31, 2006, and changes during the year then ended, is presented below:

	2006
				Weighted-
				Average
($ in thousands,				Grant-Date
except per share amounts)	Options			Fair Value
Nonvested at January 1, 2006		488,943		$	5.35
Granted		93,000			6.53
Vested		(231,493	)		4.74
Forfeited		(9,550	)		4.56
Nonvested at December 31, 2006		340,900	(1)	$	6.11

(1)  Based on historical experience, CTS currently expects approximately 329,000 of these options to vest.

The total fair value of options vested during the years ended December 31, 2006, 2005, and 2004 was approximately $1.1 million, $2.9 million, and $2.6 million, respectively. As of December 31, 2006, there was $0.6 million of unrecognized compensation cost related to nonvested stock options. That cost is expected to be

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

cts corporation 33

recognized over a weighted-average period of 1.4 years. CTS recognizes expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards.

The following table summarizes information about stock options outstanding at December 31, 2006:

	Options Outstanding						Options Exercisable
			Weighted-
			Average
	Number		Remaining		Weighted-		Number		Weighted-
Range of	Outstanding		Contractual		Average		Exercisable		Average
Exercise	at		Life		Exercise		at		Exercise
Prices	12/31/06		(Years)		Price		12/31/06		Price
$7.70 - 11		.11 866,013		6.6	$	9.39		630,113	$	8.97
13.68 - 16		.24 237,800		6.9		14.10		132,800		14.34
23.00 - 33		.63 318,800		4.0		24.58		318,800		24.58
35.97 - 50		.00 102,750		3.7		47.00		102,750		47.00
56.94 - 79		.25   1,500		2.8		64.38		1,500		64.38

Restricted Stock Units

Stock settled restricted stock units (RSUs) entitle the holder to receive one share of common stock for each unit when the unit vests. RSUs are issued to officers and key employees and non-employee directors as compensation. Generally, the RSUs vest over a five-year period.

RSUs granted to non-employee directors vest one month after granted. Upon vesting, the non-employee directors elect to either receive the stock associated with the RSU immediately, or defer receipt of the stock until their retirement from the Board of Directors. The fair value of the RSUs is equivalent to the trading value of the Company’s stock on the grant date.

A summary of RSU activity as of December 31, 2006, and changes during the year then ended, is presented below (in thousands of dollars except per share amounts):

								Weighted-
				Weighted-		Weighted-		Average
				Average		Average		Remaining		Aggregate
				Exercise		Grant Date		Contractual		Intrinsic
RSUs	Units			Price		Fair Value		Term		Value
Outstanding at January 1, 2006		525,898		$	—	$	11.49
Granted		258,500			—		13.80
Converted		(101,010	)		—		11.24
Forfeited		(25,250	)		—		11.44
Outstanding at December 31, 2006		658,138		$	—	$	12.21		4.3 years	$	2,143
Convertible at December 31, 2006		28,438		$	—	$	12.85		21.4 years	$	81

The weighted-average grant-date fair value of RSUs granted during the years ended December 31, 2006, 2005, and 2004 was $13.80, $11.82, and $11.08, respectively. The total intrinsic value of RSUs converted during the years ended December 31, 2006 and 2005 was $0.5 million, and less than $0.1 million, respectively. No RSUs were converted in 2004.

A summary of the nonvested RSUs as of December 31, 2006, and changes during the year then ended, is presented below:

				Weighted-
				Average
				Grant Date
	RSUs			Fair Value
Nonvested at January 1, 2006		507,460		$	11.43
Granted		258,500			13.80
Vested		(111,010	)		11.31
Forfeited		(25,250	)		11.44
Nonvested at December 31, 2006		629,700		$	12.42

The total fair value of RSUs vested during the years ended December 31, 2006 and 2005 was approximately $1.3 million and $1.0 million, respectively. As of December 31, 2006, there was $4.1 million of unrecognized compensation cost related to nonvested RSUs. That cost is expected to be recognized over a weighted-average period of 1.7 years. CTS recognizes expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

34  cts corporation

Restricted Stock and Cash Bonus Plan

CTS’ 1988 Plan originally reserved 2,400,000 shares of CTS’ common stock for sale at market price, or award, to key employees. Under the 1988 Plan, 32,666 shares of Restricted Stock were outstanding as of December 31, 2006. Shares sold or awarded are subject to restrictions against transfer and repurchase rights of CTS. In general, restrictions lapse at the rate of 20% per year beginning one year from the grant date. In addition, the 1988 Plan provides for a cash bonus to the participant equal to the fair market value of shares on the dates restrictions lapse, in the case of an award. The total bonus paid to any participant during the restricted period is limited to twice the fair market value of the shares on the date of award. As of December 31, 2006, there was $0.2 million of total unrecognized compensation cost related to nonvested Restricted Stock. That cost is expected to be recognized over a weighted-average period of 1.1 years. CTS recognizes expense on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in substance, multiple awards.

Stock Retirement Plan

The Directors’ Plan provided for a portion of the total compensation payable to nonemployee directors to be deferred and paid in CTS stock. The Directors’ Plan was frozen effective December 1, 2004. All future grants will be from the 2004 Plan.

NOTE K — Income Taxes

Earnings before income taxes consist of the following:

			2005
($ in thousands)	2006		(as restated)		2004
Domestic	$	11,584	$	11,335	$	2,921
Non-U.S.		19,082		21,661		22,996
Total	$	30,666	$	32,996	$	25,917

Significant components of income tax provision (benefit) are as follows:

						2005
($ in thousands)				2006		(as restated)			2004
Current:
	Federal			$	318	$	(1,419	)	$	—
	State				365		578			563
	Non-U.S.				3,903		4,818			5,245
		Total Current			4,586		3,977			5,808
Deferred:
	Federal				886		5,535			(3,100	)
	State				939		800			1,654
	Non-U.S.				58		1,928			1,599
			Total Deferred		1,883		8,263			153
Total Provision (Benefit) for Income Taxes				$	6,469	$	12,240		$	5,961

Significant components of the CTS’ deferred tax liabilities and assets at December 31, 2006 and 2005 are:

				2005
($ in thousands)	2006			(as restated)
Pensions	$	38,345		$	56,367
Depreciation		4,075			124
Other		2,572			7,883
Gross deferred tax liabilities	$	44,992		$	64,374
Postretirement benefits		1,792			1,821
Inventory reserves		1,112			1,419
Loss carryforwards		74,590			81,681
Credit carryforwards		12,173			7,826
Nondeductible accruals		10,215			7,507
Research expenditures		8,775			5,974
Other		2,433			2,613
Gross deferred tax assets		111,090			108,841
Net deferred tax assets		66,098			44,467
Deferred tax asset valuation allowance		(17,207	)		(17,133	)
Total	$	48,891		$	27,334

At each reporting period, the Company assesses the ultimate realizability of its net deferred tax assets, including deferred tax assets associated with accumulated net operating losses in the

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

cts corporation 35

various jurisdictions in which it operates. In assessing the ultimate realizability of its net deferred tax assets, the Company considers its past performance, available tax strategies, and expected future taxable income during the tax loss and credit carryforward periods.

Generally, the Company assesses that it is more likely than not its net tax assets will be realized during the available carryforward periods. The Company has determined, however, that a valuation allowance of $17.2 million should be provided for certain deferred tax assets. The $0.1 million increase in the valuation allowance from December 31, 2005 to December 31, 2006 is due to an increase in the valuation allowance related to foreign tax credits of $3.3 million, a decrease in the valuation allowance related to state net operating and credit carryforwards of $1.7 million, and a net decrease in operating loss carryforwards in certain foreign jurisdictions of $1.5 million. As of December 31, 2006, the $17.2 million valuation allowance includes $6.9 million for state net operating loss and credit carryforwards, $5.5 million in foreign tax credit carryforwards, and $4.8 million related to net operating losses.

The overall effective income tax rate (expressed as a percentage of income before income taxes) varied from the U.S. Statutory income tax rate as follows:

				2005
	2006			(as restated)			2004
Taxes at the U.S. statutory rate		35.0	%		35.0	%		35.0%
State income taxes, net of federal income tax benefit		2.8	%		1.5	%		5.6%
Non-US income taxed at rates different than the U.S. statutory rate		(15.6	)%		(8.6	)%		(13.6)%
Tax exempt earnings		(0.4	)%		(0.4	)%		(0.5)%
Benefit of scheduled tax credits and adjustment of valuation allowance		(1.2	)%		(4.4	)%		(4.0)%
Other		0.5	%		1.0	%		0.5%
Tax rate before the benefit of reversal of reserves and HIA dividend		21.1	%		24.1	%		23.0%
Tax Benefit, reversal of reserves		0.0	%		(5.1	)%		0.0%
Tax expense, HIA dividend income		0.0	%		18.1	%		0.0%
Effective income tax rate		21.1	%		37.1	%		23.0%

During 2006, CTS changed its effective tax rate from 37.1% to 21.1%. CTS’ 2005 tax rate before the benefit of release of reserves and expense of the HIA dividend was 24.1%. The lower tax rate reflects the increased percentage of profits reported in lower-tax foreign jurisdictions.

In certain taxing jurisdictions, CTS business operations continue to qualify for income tax holidays. As a result, certain earnings of CTS are subject to tax at reduced rates for a specific period of time. These tax holidays, unless extended, are scheduled to expire in 2009-2011.

At December 31, 2006, no provision had been made for U.S federal and state income taxes on approximately $141 million of foreign earnings, which are expected to be permanently reinvested outside of the United States indefinitely. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to U.S. income taxes (subject to possible adjustments for foreign tax credits), state income taxes, and withholding taxes payable to the various foreign countries determination of the amount of unrecognized deferred U.S. tax liability is not practical because of the complexities associated with the related calculation.

No valuation allowance was recorded in 2006 against the U.S. federal net deferred tax assets, including the U.S. federal net operating loss carryforward asset of $56 million expiring in 2021-2024. The Company assessed the future realization of these deferred tax assets utilizing taxable income projections for years 2005 through 2013. Those projections applied taxable income estimates consistent with historical earnings patterns of its traditional automotive and electronic component product lines and a return to levels of profitability in its communication component product line consistent with management and independent consensus views of the moderate recovery expected in the markets served by CTS. Management believes that, based upon the historical operating performance of its business units and the successful cost reduction efforts, the Company more likely than not will realize the benefits of its U.S. net deferred tax assets.

NOTE L — Capital Stock

CTS adopted a Rights Plan on August 28, 1998. The Rights Plan was implemented by declaring a dividend, distributable to shareholders of record on September 10, 1998, of one common share purchase right (Right) for each outstanding share of common stock held at the close of business on that date. Each Right under the Rights Plan will initially entitle registered holders of common stock to purchase one one-hundredth of a share of CTS’ Series A Junior Participating Preferred Stock for a purchase price of $125, subject to adjustment. The Rights will be exercisable only if a person or group (1) acquires or obtains the right to acquire 15% or more of the common stock or (2) announces a tender offer that would result in any person or group acquiring beneficial ownership of 15% or more of the outstanding common stock. The Rights are redeemable for $0.01 per Right (subject to adjustment) at the option of the Board of Directors. Until a Right is exercised, the holder of the Right, as such, has no rights as a shareholder of CTS. The Rights will expire on August 27, 2008, unless redeemed or exchanged by CTS prior to that date.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

36  cts corporation

NOTE M — Treasury Stock

Common stock held in treasury at December 31, 2006 totaled 17,895,708 shares with a cost of $269.5 million, compared to 17,717,657 shares with a cost of $267.1 million at December 31, 2005.

In November 2005, CTS’ Board of Directors authorized a program to repurchase up to one million shares of CTS common stock. The authorization expires June 30, 2007. Reacquired shares will be used to support equity-based compensation programs and for other corporate purposes. During 2006, CTS repurchased 170,600 shares of common stock at a total cost of $2.3 million. At December 31, 2006, CTS was authorized to repurchase approximately 690,000 additional shares.

NOTE N — Segments

FAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires companies to provide certain information about their operating segments. CTS has two reportable segments: 1) Electronics Manufacturing Services (EMS) and 2) Components and Sensors.

EMS includes the higher level assembly of electronic and mechanical components into a finished subassembly or assembly performed under a contract manufacturing agreement with an OEM or other contract manufacturer. Additionally for some customers CTS provides full turnkey manufacturing and completion including design, bill-of-material, management, logistics, and repair.

Components and sensors are products which perform specific electronic functions for a given product family and are intended for use in customer assemblies. Components and sensors consist principally of automotive sensors and actuators used in commercial or consumer vehicles; electronic components used in communications infrastructure and computer markets; terminators, including ClearONE^tm terminators, used in computer and other high speed applications, switches, resistor networks and potentiometers used to serve multiple markets, and fabricated piezo-electric materials and substrates used primarily in medical and industrial markets.

The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Management evaluates performance based upon operating earnings before restructuring and restructuring-related charges, interest, and income taxes.

Summarized financial information concerning CTS’ reportable segments for the years end December 31, 2006, 2005, and 2004 is shown in the following table:

			Components &
($ in thousands)	EMS		Sensors			Total
2006
Net sales to external customers	$	385,744	$	269,870		$	655,614
Segment operating earnings		6,179		30,963			37,142
Total assets		169,623		358,210			527,833
Depreciation and amortization		6,843		18,053			24,896
Capital expenditures		6,057		9,730			15,787
2005 (as restated)
Net sales to external customers	$	364,458	$	253,026		$	617,484
Segment operating earnings		7,705		30,227	(1)		37,932
Total assets		159,822		374,007			533,829
Depreciation and amortization		6,649		20,410			27,059
Capital expenditures		5,844		9,165			15,009
2004
Net sales to external customers	$	270,334	$	260,982		$	531,316
Segment operating earnings		7,817		23,311	(1)		31,128
Total assets		99,757		422,420			522,177
Depreciation and amortization		3,520		22,562			26,082
Capital expenditures		2,887		9,824			12,711

(1)  Includes $3.1 million and $3.9 million of gain on asset sales in 2005 and 2004, respectively.

Reconciling information between reportable segments’ operating earnings and CTS’ consolidated pre-tax income is shown in the following table:

	Year Ended December 31,
				2005
($ in thousands)	2006			(as restated)			2004
Total segment operating earnings	$	37,142		$	37,932		$	31,128
Interest expense		(3,654	)		(5,902	)		(5,535	)
Interest income		934			1,300			922
Other income (expense)		568			(334	)		(598	)
Restructuring and restructuring-related charges — Components and Sensors		(3,849	)		—			—
Restructuring charge — EMS		(475	)		—			—
Earnings before income taxes	$	30,666		$	32,996		$	25,917

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

cts corporation 37

Financial information relating to CTS’ operations by geographic area was as follows:

	Year Ended December 31,
($ in thousands)	2006		2005		2004
Net Sales
United States	$	263,097	$	278,397	$	197,557
Singapore		173,118		143,815		66,989
United Kingdom		82,178		87,411		122,129
China		77,713		66,528		105,196
Canada		40,277		27,303		28,468
Other non-U.S.		19,231		14,030		10,977
Consolidated net sales	$	655,614	$	617,484	$	531,316

Sales are attributed to countries based upon the origin of the sale.

	Year Ended December 31,
			2005
($ in thousands)	2006		(as restated)		2004
Long-Lived Assets
United States	$	24,296	$	38,487	$	42,016
China		35,560		37,254		40,659
United Kingdom		15,637		16,493		14,990
Singapore		9,845		7,550		7,319
Canada		5,373		5,545		5,292
Taiwan		2,065		1,880		2,008
Other non-U.S.		3,692		2,444		211
Consolidated long-lived assets	$	96,468	$	109,653	$	112,495

The EMS segment revenues from Hewlett-Packard represented $143.2 million, or 37%, $173.3 million, or 48%, and $177.3 million, or 66%, of the segment’s revenue for the years ended December 31, 2006, 2005, and 2004, respectively. EMS segment revenues from Motorola were $51.4 million, or 13%, $40.3 million, or 11%, and $60.9 million, or 23%, of the segment’s revenue for the years ended December 31, 2006, 2005, and 2004, respectively.

NOTE O — Contingencies

Certain processes in the manufacture of CTS’ current and past products create hazardous waste by-products as currently defined by federal and state laws and regulations. CTS has been notified by the U.S. Environmental Protection Agency, state environmental agencies and, in some cases, generator groups, that it is or may be a Potentially Responsible Party (PRP) regarding hazardous waste remediation at several non-CTS sites. In addition to these non-CTS sites, CTS has an ongoing practice of providing reserves for probable remediation activities at certain of its manufacturing locations and for claims and proceedings against CTS with respect to other environmental matters. In the opinion of management, based upon presently available information relating to all such matters, either adequate provision for probable costs has been made, or the ultimate costs resulting will not materially affect the consolidated financial position, results of operations or cash flows of CTS.

Certain claims are pending against CTS with respect to matters arising out of the ordinary conduct of its business. For all claims, in the opinion of management, based upon presently available information, either adequate provision for anticipated costs has been made or the ultimate anticipated costs resulting will not materially affect CTS’ consolidated financial position, results of operations, or cash flows of CTS.

NOTE P — Leases

CTS incurred approximately $5.7 million of rent expense in 2006, $8.1 million in 2005, and $7.1 million in 2004. The future minimum lease payments under the Company’s operating leases are $5.6 million in 2007, $4.6 million in 2008, $4.3 million in 2009, $3.0 million in 2010, $2.3 million in 2011, and $2.7 million thereafter.

During 2006, CTS entered into a sales/ leaseback agreement related to its Albuquerque facility. The building, which had a net book value of $8.8 million, was sold for net proceeds of $12.5 million. A portion of the building was leased back under a five-year operating lease. At the close of the transaction, CTS recognized approximately $0.7 million of the gain on the sale in 2006. The remaining gain of $3.0 million was deferred and is being amortized over the term of the operating lease.

NOTE Q — Restructuring Charges

In January 2006, CTS announced its intention to consolidate its Berne, Indiana manufacturing operations into three of its other existing facilities. Automotive product operations at Berne were transferred to CTS’ automotive facilities in Matamoros, Mexico and Elkhart, Indiana. Electronic components operations in Berne were moved to CTS’ Singapore facility. The Berne facility is currently being marketed for sale. As of December 31, 2006, the Berne consolidation process was substantially completed, with all expected charges recorded.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(continued)

38  cts corporation

The following table displays the planned costs associated with the Berne consolidation, as well as a summary of the actual costs incurred through December 31, 2006:

			Actual incurred
			through
($ in millions)	Planned Costs		December 31, 2006
Workforce reduction	$	3.1	$	2.6
Postemployment obligation curtailment, net — Note H		0.2		0.2
Other		0.1		0.1
Restructuring charge		3.4		2.9
Equipment relocation		0.3		0.5
Other employee related costs		0.3		0.5
Restructuring-related costs		0.6		1.0
Total restructuring and restructuring-related costs	$	4.0	$	3.9

Additionally, during 2006, CTS recorded a pre-tax restructuring charge of $0.4 million, or $0.3 million after-tax and $0.01 per diluted share, when it revised its estimate of the fair value of the remaining net liability of the operating lease for the idle Marlborough facility.

Of the restructuring and restructuring-related costs, $3.9 million relates to the Components and Sensors segment and $0.4 million relates to the EMS segment. Restructuring charges are reported on a separate line on the Consolidated Statement of Earnings and the restructuring-related costs are included in cost of goods sold.

The following table displays the restructuring reserve activity for the Berne consolidation for the year ending December 31, 2006:

($ in millions)
Restructuring liability at January 1, 2006	$	—
2006 charge		3.9
Costs paid		(3.7	)
Restructuring liability at December 31, 2006	$	0.2

cts corporation 39

CTS CORPORATION

SCHEDULE II — VALUATION AND QUALIFYING ACCOUNTS

			Additions
	Balance at
	Beginning of		Charged to		Charged to						Balance at
	Period		Expense		Other Accounts			Deductions			End of Period
	(In thousands of dollars)
Year ended December 31, 2006:
Allowance for doubtful accounts	$	2,373	$	883	$	—		$	(1,117	) (1)	$	2,139
Inventory reserve provision	$	6,187	$	3,184	$	—		$	(3,943	)	$	5,428
Year ended December 31, 2005:
Allowance for doubtful accounts	$	1,450	$	577	$	426	(2)	$	(80	)	$	2,373
Inventory reserve provision	$	5,648	$	2,883	$	857	(2)	$	(3,201	)	$	6,187
Year ended December 31, 2004:
Allowance for doubtful accounts	$	1,585	$	—	$	—		$	(135	)	$	1,450
Inventory reserve provision	$	8,513	$	1,612	$	—		$	(4,477	)	$	5,648

(1)	Majority of deductions relates to the write-off of receivables due from Delphi Automotive Systems, which declared Chapter 11 bankruptcy.
(2)	Amounts relate to the acquisition of SMTEK International, Inc. Refer also to Note C, “Acquisition,” appearing in the notes to the consolidated financial statements as noted in the Index appearing under Item 15(1)(1) and (2).

40  cts corporation

Shareholder Information

(In thousands of dollars except per share data)

Quarterly Results of Operations

(Unaudited)

	Net		Gross		Operating		Net
	Sales		Margins		Earnings		Earnings
2006
4th quarter(1)	$	173,520	$	29,916	$	9,141	$	7,651
3rd quarter(2) (as restated)		165,676		29,105		8,524		6,247
2nd quarter (as restated)		165,925		31,768		7,556		5,259
1st quarter (as restated)		150,493		30,041		7,597		5,040
	$	655,614	$	120,830	$	32,818	$	24,197
2005
4th quarter(3) (as restated)	$	154,598	$	31,454	$	13,469	$	7,495
3rd quarter (as restated)		149,210		28,253		8,471		5,932
2nd quarter(4)		158,346		32,292		10,321		3,942
1st quarter		155,330		28,215		5,671		3,387
	$	617,484	$	120,214	$	37,932	$	20,756

Per Share Data

(Unaudited)

					Dividends		Net Earnings
	High(5)		Low(5)		Declared		Basic		Diluted
2006
4th quarter(1)	$	16.23	$	13.55	$	0.03	$	0.21	$	0.20
3rd quarter(2)(as restated)		15.00		13.35		0.03		0.17		0.16
2nd quarter (as restated)		14.89		12.26		0.03		0.15		0.14
1st quarter (as restated)		13.38		11.06		0.03		0.14		0.13
					$	0.12	$	0.68	$	0.63
2005
4th quarter(3)(as restated)	$	12.53	$	10.91	$	0.03	$	0.21	$	0.19
3rd quarter (as restated)		13.40		11.15		0.03		0.16		0.15
2nd quarter(4)		13.16		10.13		0.03		0.11		0.10
1st quarter		14.10		11.29		0.03		0.09		0.09
					$	0.12	$	0.57	$	0.53

(1)	The fourth quarter of 2006 reflects a reduction in the effective tax rate from 24.1% to 21.1%. The reduction was primarily due to an increased percentage of profits reported in lower-tax foreign jurisdictions.
(2)	The third quarter of 2006 includes a pre-tax gain of $0.7 million, or $0.6 million after-tax and $0.07 per diluted share, relating to the sale/leaseback of the Albuquerque building.
(3)	The fourth quarter of 2005 includes $1.5 million, or $0.03 per diluted share, of tax expense relating to the repatriation of foreign cash to the United States under the provisions of the American Jobs Creation Act of 2004 and $0.7 million of tax expense, or $0.02 per diluted share, relating to an increase in the tax rate before the benefit of reversal of reserves and HIA dividends from 23% to 25%.
(4)	The second quarter of 2005 includes $4.5 million, or $0.11 per diluted share, of tax expense relating to the repatriation of foreign cash to the United States under the provisions of the American Jobs Creation Act of 2004 and $1.7 million of tax benefit, or $0.04 per diluted share, relating to the reversal of income tax reserves due to the successful resolution of tax issues in certain foreign jurisdictions.
(5)	The market prices of CTS common stock presented reflect the highest and lowest sales prices on the New York Stock Exchange for each quarter of the last two years.

cts corporation 41

Five-Year Summary

(In thousands of dollars except per share and other data)

					% of			2005 (as			% of						% of						% of						% of
		2006			Sales			restated)			Sales			2004			Sales			2003			Sales			2002			Sales
Summary of Operations
Net sales		$	655,614			100.0		$	617,484			100.0		$	531,316			100.0		$	462,987			100.0		$	457,804			100.0
Cost of goods sold			534,784			81.6			497,270			80.5			421,560			79.3			366,275			79.1			366,775			80.1
Selling, general and administrative expenses			67,720			10.3			64,812			10.5			61,174			11.5			54,390			11.8			59,467			13.0
Research and development expenses			15,873			2.4			17,092			2.8			19,063			3.6			21,476			4.6			24,118			5.3
Amortization of intangible assets			3,193			0.5			3,443			0.6			2,311			0.4			2,467			0.5			3,870			0.8
Gain on asset sales			(2,142	)		(0.3	)		(3,065	)		(0.5	)		(3,920	)		(0.7	)		—			—			—			—
Restructuring and impairment charges			3,368			0.5			—			—			—			—			4,563			1.0			18,343			4.0
Operating earnings (loss)			32,818			5.0			37,932			6.1			31,128			5.9			13,816			3.0			(14,769	)		(3.2	)
Other expense — net			(2,152	)		(0.3	)		(4,936	)		(0.8	)		(5,211	)		(1.0	)		(7,568	)		(1.6	)		(9,031	)		(2.0	)
Earnings (loss) before income taxes			30,666			4.7			32,996			5.3			25,917			4.9			6,248			1.4			(23,800	)		(5.2	)
Income tax expense (benefit)			6,469			1.0			12,240			2.0			5,961			1.1			(6,327	)		(1.3	)		(5,950	)		(1.3	)
Net earnings (loss)			24,197			3.7			20,756			3.3			19,956			3.8			12,575			2.7			(17,850	)		(3.9	)
Retained earnings — beginning of year			295,478						279,064						263,430						255,085						276,988
Dividends declared			(4,305	)					(4,342	)					(4,322	)					(4,230	)					(4,053	)
Retained earnings — end of year		$	315,370					$	295,478					$	279,064					$	263,430					$	255,085
Net earnings (loss) per share:
	Basic:	$	0.68					$	0.57					$	0.56					$	0.36					$	(0.54	)
	Diluted:	$	0.63					$	0.53					$	0.53					$	0.36					$	(0.54	)
Average basic shares outstanding (000’s)			35,826						36,307						35,910						34,723						33,148
Average diluted shares outstanding (000’s)			40,228						40,960						38,893						34,989						33,148
Cash dividends per share		$	0.12					$	0.12					$	0.12					$	0.12					$	0.12
Capital expenditures			15,787						15,099						12,711						9,044						12,833
Depreciation and amortization			24,896						27,059						26,082						33,605						43,373
Financial Position at Year End
Current assets		$	227,620					$	179,716					$	204,146					$	164,766					$	152,334
Current liabilities			125,681						121,323						102,961						95,689						134,556
Current ratio			1.8 to 1						1.5 to 1						2.0 to 1						1.7 to 1						1.1 to 1
Working capital		$	101,939					$	58,393					$	101,185					$	69,077					$	17,778
Inventories			60,543						60,629						42,734						31,925						36,262
Property, plant and equipment — net			96,468						109,653						112,495						122,481						148,632
Total assets			527,833						533,829						522,177						482,250						490,032
Short-term notes payable			5,425						13,299						3,311						—						—
Long-term debt			60,821						68,457						94,150						75,880						67,000
Long-term obligations, including long-term debt			83,315						84,577						105,669						87,013						78,501
Shareholders’ equity			319,023						328,093						310,704						294,191						265,020
Common shares outstanding (000’s)			35,823						35,859						35,909						36,067						34,101
Equity (book value) per share		$	8.91					$	9.16					$	8.65					$	8.16					$	7.77
Other Data
Stock price range		$	16.23-11.06					$	14.10-10.13					$	15.85-9.90					$	14.94-4.90					$	19.56-3.65
Number of employees			4,977						4,902						4,487						5,041						5,313
Number of shareholders at year-end			1,647						1,683						1,628						1,527						1,585