CTS Corporation
Form 10-K 2004

EXHIBIT (13)

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (2002-2004)

Overview

CTS is a global manufacturer and supplier of components and sensors to the automotive, communications, and computer markets. The Company also manufactures and designs specialized electronic products for industrial, communications, and computing infrastructure OEMs. Sales and marketing is accomplished through CTS sales engineers, independent manufacturers’ representatives, and distributors. Total sales in 2004 of $531.3 million were reported through two business segments, Electronics Manufacturing Services (EMS) and Components and Sensors, which represented 50.9% and 49.1% of CTS’ total sales in 2004, respectively.

In 2004, the Company experienced a strong year-over-year sales increase and improved net earnings significantly from 2003. 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 2004, CTS continued to see growth in certain of its existing served markets, as well as new business awards from existing and new customers. Additionally, CTS continued to report progress in growth initiatives, especially new automotive platform positions and precision frequency products for the communications infrastructure market.

As discussed in more detail throughout the MD&A:

• CTS’ revenues increased 14.8% during 2004 compared to 2003, following 1% sales growth in 2003 compared to 2002. Most of the increase came in the EMS segment, which was up 28.7% compared to 2003, while the Components and Sensors segment experienced 3.2% growth.

• Gross margins in 2004 increased $13.0 million from 2003, primarily due to sales growth.

• The Company continued to leverage selling, general and administrative and research and development expenses and reduced them to 15.5% of sales in 2004 from 16.9% in 2003 and 19.1% in 2002.

• The operating earnings of $31.1 million in 2004 included $3.9 million of gain on asset sales. In 2003, operating earnings of $13.8 million included a $4.6 million asset impairment charge.

• Net earnings of $20.0 million in 2004 substantially exceeded net earnings of $12.6 million in 2003.

• Diluted earnings per share of $0.53 in 2004 increased $0.17 from diluted earnings per share of $0.36 in 2003.

• Cash and cash equivalent balances were $61.0 million at the end of 2004, compared to $25.3 million in 2003.

• Total debt balances were $97.5 million at the end of 2004, versus $75.9 million in 2003, and $95.4 million in 2002. Interest expense decreased over the last two years, benefiting from the lower interest rate and lower average debt balances. Interest expense was $5.5 million in 2004, $7.7 million in 2003, and $10.2 million in 2002.

Acquisition

On November 16, 2004, CTS entered into a merger agreement with SMTEK International, Inc. The agreement was approved by SMTEK shareholders on January 31, 2005. SMTEK is a publicly traded company in the electronics manufacturing services (EMS) industry with sales of $102.4 million and operating earnings of $4.0 million in the reported 12–month period ended September 30, 2004. With operations on both the east and west coasts of the United States, and in southeast Asia, SMTEK serves over 25 major customers in the medical, industrial and security, aerospace and defense, and communications markets. The estimated aggregate purchase price is approximately $60 million, consisting of $35 million cash consideration, $13 million of SMTEK debt assumed by CTS, approximately 812,000 shares of CTS common stock valued at $10 million, and $2 million of estimated transaction costs.

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Benefits of the acquisition include:

• Accelerated expansion into new markets:  SMTEK primarily serves medical, industrial and security, aerospace and defense, and communications markets. CTS’ largest EMS markets are in computing and communications.

• Reduced customer concentration:  SMTEK brings a variety of new large accounts that will significantly broaden CTS’ EMS customer base.

• Enhanced operational capabilities:  SMTEK is a leader in printed circuit board design, assembly and testing for complex electronic products and has key process and agreement certifications in medical and aerospace.

• Increased global footprint:  SMTEK has strong operational capabilities on the east coast and west coast, and in Thailand. CTS has EMS operations on the east coast, in Europe, China and Singapore.

Outlook

Including the impact of SMTEK, CTS expects 2005 full year sales to grow by 30-35%, and diluted earnings per share to be in the range of $0.65 - $0.72. The earnings per share guidance includes a negative impact of approximately $0.05 per share from adopting the new accounting rule on contingently convertible debentures. The Company expects the SMTEK acquisition to be accretive by $0.04-$0.06 per share in 2005.

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 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 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.

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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.

CTS believes it will more likely than not realize the benefits of its $54.4 million U.S. net operating loss carryforwards, which expire in 2021 through 2024. The Company assessed the future realization of these deferred tax assets utilizing taxable income projections for years 2005 through 2013. The projections were based on 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 communications components product lines consistent with management and independent consensus views of the moderate recovery expected in the markets served by CTS. In the event that actual results differ from these estimates in future periods, CTS may need to establish an additional valuation allowance or reduce the valuation allowance, which could materially impact the results of operations and financial position.

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 2004, CTS’s effective tax rate decreased from 25% to 23% primarily as a result of increased profits being reported in lower taxed jurisdictions.

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 5 to 16 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 2004, CTS had a weighted-average discount rate of 6.17% for pension income and expense. CTS reduced the discount rate assumption for 2005 to reflect the interest rate decline on high-quality corporate bonds. The Company reduced the discount rate on its domestic plans from 6.25% at January 1, 2004 to 6.0% at January 1, 2005. The range of discount rates utilized by its foreign plans was also increased from 3.5% - 5.4% in 2004 to 3.5% - 5.6% in 2005.

The Company also revised its long-term expected return on plan asset assumption as a result of its evaluation of long-term returns. The expected return on domestic plan assets at January 1, 2005 was lowered to 8.50% from 8.75% and the range of expected returns on foreign plan assets stayed the same, at 3.50% - 7.00%.

CTS expects these changes in actuarial assumptions, combined with the pension asset balance at the end of 2004, will reduce 2005 consolidated pension income by approximately $3 - $4 million.

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Results of Operations

Business Segment Discussion

CTS has two reportable business segments: 1) Components and Sensors and 2) Electronics Manufacturing Services (EMS).

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 cellular handsets, communications infrastructure, and computer markets; low temperature cofired ceramics (LTCC) used in various communications, military, aerospace, and automotive applications; terminators, including ClearONE™ terminators, used in computer and other high speed applications, switches, resistor networks; and potentiometers used to serve multiple markets.

EMS includes the higher level assembly of electronic and mechanical components into a finished subassembly or assembly, such as printed circuit board assembly, performed under a contract manufacturing agreement with an OEM or other contract manufacturer. EMS also includes the design of interconnect systems and complex backplanes as may be required by the customer.

For additional information on business segments, refer to "Note M - Business Segments."

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

	Components
($ in thousands)	& Sensors			EMS			Total
2004
Net sales to external customers	$	260,982		$	270,334		$	531,316
Segment operating earnings		23,311	(1)		7,817			31,128
% of segment sales		8.9	%		2.9	%		5.9	%
2003
Net sales to external customers	$	252,911		$	210,076		$	462,987
Segment operating earnings		7,394			10,985			18,379
% of segment sales		2.9	%		5.2	%		4.0	%
2002
Net sales to external customers	$	270,919		$	186,885		$	457,804
Segment operating earnings (loss)		(5,927	)		10,790			4,863
% of segment sales		(2.2	)%		5.8	%		1.1	%

⁽¹⁾ Includes $3.9 million of gain on asset sales.

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The 2004 Components and Sensors business segment sales increased $8.1 million, or 3.2%, from 2003. The increase was primarily due to increased demand for the automotive sensor products, communication infrastructure products and favorable foreign exchange, due to the weakening of the U.S. dollar against the British Pound and the Euro. Despite a small sales increase, segment operating earnings more than tripled from the prior year, primarily due to favorable impact from the contribution of incremental sales and product mix of approximately $3.8 million. Lower depreciation expenses of $7.9 million, due to a lower level of capital expenditures in recent years versus high levels of capital expenditures in the preceding years, and an intersegment cost allocation to EMS Singapore operation of $1.7 million also helped to improve segment operating earnings in 2004. The segment operating earnings also included $3.9 million of gain on asset sales, including $2.7 million gain from sale of excess land in Canada, and a favorable impact of foreign exchange rate movements. Research and development expenses decreased $2.7 million in 2004 compared to 2003, as a result of streamlining research and development activities. These favorable factors were partially offset by product launch costs of $2.8 million and higher operating expenses of $4.9 million related to incentive compensation and professional services.

Components and Sensors 2003 business segment sales decreased $18.0 million, or 6.7%, from the prior year. The decrease was primarily due to a reduction of end-of-life product sales of $16.2 million and continuing softness in the communications market. End-of-life product sales represent the final shipments of products that have been replaced by newer technologies or no longer meet the Company’s profit objectives and the decision is made by the company to cease manufacturing. Sales into the automotive market increased slightly in 2003, benefited by the introduction of new product and sales into Asia. Despite the overall sales decrease, segment operating earnings improved $13.3 million primarily from $10.1 million of lower depreciation and amortization expense and reduced operating expenses of $11.9 million mainly in wages and related benefits. These improvements were partially reduced by the impact of lower volume of approximately $4.6 million and $4.1 million of favorable items occurring in 2002, primarily related to a $3.1 million customer reimbursement.

EMS 2004 business segment sales increased $60.2 million, or 28.7%, from the prior year. The revenue increase was primarily due to $24.9 million increase in data storage systems, $20.8 million increase in communications infrastructure systems and $9.3 million increase in networking equipment from both existing customers and new customers. The operating earnings of $7.8 million decreased $3.2 million from the prior year. The decrease in earnings was primarily driven by price reductions in connection with the product transfer to Singapore and an unfavorable impact of foreign exchange rate movements. These price reductions were partially offset by cost reductions. CTS anticipates additional cost reductions after a full year of EMS Singapore operations. Also, EMS incurred an intersegment cost allocation of $1.7 million from the Components and Sensors segment. Additionally, in 2004, some start-up costs were incurred to support the new operation in Singapore. These unfavorable factors were partially offset by the favorable impact of $6.9 million from higher sales and product mix.

CTS earnings are subject to fluctuations of foreign currency exchange rates. For 2004, the impact of foreign exchange rates was positive on Components and Sensors segment operating earnings, while negative on EMS segment operating earnings, primarily due to the weakening of the U.S. Dollar against the Euro and British Pound. To a large extent, the unfavorable impact was offset by the favorable impact.

EMS business segment sales increased $23.2 million, or 12.4%, in 2003 from the prior year. Sales into the communications market increased, due primarily to stronger shipments of infrastructure products into China and Europe. Additionally, shipments of computer products increased in 2003, following a decline in the prior year. Segment operating earnings of $11.0 million increased $0.2 million from the prior year primarily from favorable volume impacts, partially offset by product mix, of $1.2 million, and $1.0 million of higher general and administrative and selling and marketing expenses.

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Sales in Geographic Regions

CTS has continued its expansion into the Asia-Pacific markets. Geographically, sales into the Asia-Pacific region are now 36% of CTS’ total net sales versus 29% in 2003. Sales in Europe and the Americas decreased to 19% from 23% of total net sales and 45% from 48% of total net sales, respectively. 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	2004			2003			2002			2004			2003			2002			2004			2003			2002
Americas		56	%		55	%		56	%		34	%		41	%		45	%		45	%		48	%		52	%
Europe		17	%		15	%		17	%		20	%		32	%		35	%		19	%		23	%		24	%
Asia-Pacific		27	%		30	%		27	%		46	%		27	%		20	%		36	%		29	%		24	%
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,
(In thousands of dollars)	2004			2003			2002
Net sales	$	531,316		$	462,987		$	457,804
Cost of goods sold		421,560			366,275			366,775	1
Gross margin		109,756			96,712			91,029
% of net sales		20.7	%		20.9	%		19.9	%
Selling, general and administrative expenses		63,485			56,857			63,337
% of net sales		11.9	%		12.3	%		13.8	%
Research and development expenses		19,063			21,476			24,118
% of net sales		3.6	%		4.6	%		5.3	%
Gain on asset sales		(3,920	)		—			—
Restructuring and impairment charges		—			4,563			18,343
Operating earnings (loss)		31,128			13,816			(14,769	)
% of net sales		5.9	%		3.0	%		(3.2	)%
Interest expense		5,535			7,688			10,240
Other income		324			120			1,209
Earnings (loss) before income taxes		25,917			6,248			(23,800	)
Income tax expense (benefit)		5,961			(6,327	) 2		(5,950	)
Net earnings (loss)	$	19,956		$	12,575		$	(17,850	)
% of net sales		3.8	%		2.7	%		(3.9	)%

⁽¹⁾ Cost of goods sold includes restructuring-related charges consisting primarily of inventory write downs, equipment relocations and other employee-related costs of $1.3 million in 2002.

⁽²⁾ Includes a $7.9 million benefit resulting from the reversal of reserves that were no longer required following the expiration of statutory deadlines.

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Net sales increased $68.3 million in 2004, or 14.8%, from prior year, primarily due to the EMS increase of $60.2 million related to increased demand for communications infrastructure systems, networking equipment, and data storage systems. In addition, Components and Sensors sales increased $8.1 million, primarily related to increased demand for automotive products, and communications infrastructure components.

The 2003 net sales increased $5.2 million, or 1%, from 2002. This increase was primarily due to higher EMS product sales of $23.2 million, partially offset by an $18.0 million decrease in Components and Sensors product sales. The improved sales volume in the EMS business segment was driven by growth in shipments of communication products primarily in infrastructure end markets in China. The decreased sales volume in the Components and Sensors business segment principally reflects the decision to end-of-life certain products in the third quarter of 2002.

The Company’s 15 largest customers represented 69% of net sales in 2004. This is a slight decrease from 71% and 73% in 2003 and 2002, respectively. This percentage is decreasing as the Company continues efforts to broaden its business base, particularly in automotive and wireless infrastructure product offerings. Sales to Hewlett-Packard Company represented 33% of net sales in 2004, 2003, and 2002. Sales to Motorola, Inc. were 13% of net sales in 2004 and 2003, and 12% in 2002.

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 reduction to offset the negative price impact on profit margin.

Gross margin increased $13.0 million, or 13.5%, in 2004 from 2003, primarily due to higher sales of $68.3 million and lower depreciation expense, as mentioned in the Business Segment Discussion. However, gross margin as a percentage of sales declined because of the higher percent of EMS segment sales, which inherently have a lower gross margin percentage than Components and Sensors segment sales.

Gross margin in 2003 increased $5.7 million, or 1.0 percentage point, over 2002, to 20.9%, on improved sales of $5.2 million. Items contributing to the gross margin percentage increase included $6.2 million of lower depreciation expense, $6.0 million from favorable product mix and volume–related improvements, partially offset by $3.7 million in lower pension income. The 2002 gross margin also included a favorable adjustment of $3.1 million for a customer reimbursement and $1.3 million of restructuring related charges.

Selling, general and administrative expenses as a percentage of sales decreased 0.4 percentage points to 11.9% in 2004 from prior year, as the Company was able to leverage existing resources with higher sales. The total dollar amount increased $6.6 million, primarily due to the increased expenses for incentive compensation, professional services, and normal cost of living adjustments.

Selling, general and administrative expenses decreased to $56.9 million, or 12.3% of net sales in 2003, versus $63.3 million, or 13.8% of net sales in 2002, reflecting Company initiatives to control costs and scale operations to existing market conditions. Cost reductions were achieved primarily in salaries and wages and lower depreciation and amortization expenses.

Research and development expenses were $19.1 million in 2004 versus $21.5 million in 2003 and $24.1 million in 2002. The reductions in research and development spending reflect savings due to organizational consolidation, changing business mix, and the streamlining of research and development activities. Significant ongoing research and development activities continue in the Components and Sensors business 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 business segment are typically very low.

Operating earnings in 2004 increased to $31.1 million, or 5.9% of sales, from $13.8 million, or 3.0% of sales, in 2003. Favorable changes contributing to the margin improvement were gross margin increase and gain on asset sales offset by increase of operating expenses, as discussed above. Operating earnings in 2004 included gain on asset sales of $3.9 million. As discussed in the Restructuring and Asset Impairment Charges section below, operating earnings in 2003 included an asset impairment charge of $4.6 million.

Operating earnings in 2003 of $13.8 million improved $28.6 million over 2002. Favorable changes to operating earnings resulted from gross margin improvement and a reduction in operating expenses. In addition, 2003 included a $4.6 million asset impairment charge, while 2002 included $19.6 million of restructuring, asset impairment and restructuring-related one-time charges, and $4.1 million of favorable items which include a $3.1 million customer reimbursement.

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Interest expense in 2004 was $5.5 million, or 28.0% lower than 2003. This was primarily due to payment in whole of CTS industrial revenue bonds, which carried a coupon rate of 7.5%. Cash from operation and proceeds from the convertible senior subordinated debentures issued in May 2004, as discussed in the Liquidity section, which bear an annual interest rate of 2.125%, financed the payment of the industrial revenue bonds. Interest expense decreased $2.6 million in 2003 compared to 2002 primarily due to lower average outstanding debt balance.

In 2004, CTS changed its estimate of its 2004 effective tax rate from 25% to 23%. The lower effective tax rate reflects the transfer of certain business operations to jurisdictions with lower statutory tax rates and the notification that manufacturing incentives in one foreign jurisdiction qualified CTS for a lower statutory rate, expiring in 2012, subject to certain conditions.

During 2003, the Company recorded a tax benefit of $7.9 million resulting from the reversal of reserves that were no longer required following the expiration of statutory deadlines.

Net earnings in 2004 increased $7.4 million, or 58.7%, to $20.0 million in 2004 from $12.6 million in 2003. Net earnings in 2004 included the impact of $3.9 million pre-tax gain on asset sales. Net earnings in 2003 included the impact of a pre-tax $4.6 million asset impairment charge and a $7.9 million tax benefit.

Restructuring and Asset Impairment Charges

During the third quarter of 2003, CTS recorded a $4.6 million pre-tax impairment charge to reduce the carrying value of certain assets, held by the Components and Sensors business segment, to their estimated fair value. Approximately $3.3 million of the impairment charge reflected a write down for electronic equipment following final production of previously announced end-of-life products and a re-assessment of the current market value for equipment held for sale. An additional $1.3 million of the impairment charge related to excess capacity on a production line following an assessment of future capacity needs. All restructuring-related reserve balances had been fully utilized at December 31, 2003.

In the third quarter of 2002, CTS recorded $18.3 million of pre-tax restructuring and impairment charges. The charges included $5.0 million restructuring charges, $12.5 million of asset impairments and $0.8 million of pension curtailment losses. The charges were incurred in order to effect operational improvements and related organizational realignments primarily in the Components and Sensors business segment, involving the relocation of certain manufacturing operations. CTS completed substantially all of these restructuring actions by the end of 2002. Also during 2002, CTS recorded in cost of sales $1.3 million of restructuring-related charges, consisting primarily of equipment relocation costs.

Liquidity and Capital Resources

Overview

At December 31, 2004, cash and cash equivalents balance increased to $61.0 million, driven by improved net earnings and asset sales. The cash and cash equivalents balance was $25.3 million and $9.2 million in 2003 and 2002 respectively. Total debt net of cash and cash equivalents decreased to $36.5 million from $50.6 million and $86.2 million in 2003 and 2002 respectively. Total debt as a percentage of total capitalization was 24% at the end of 2004, compared with 21% and 27% in 2003 and 2002 respectively.

In 2004:

• CTS completed the sale of the Longtan, Taiwan facility, and received net cash proceeds of $16.4 million. CTS also completed the sale of excess land in Canada and received $2.1 million, with the remaining $0.6 million in a note receivable due May 2006.

• In May, CTS issued $60.0 million in aggregate principal amount of convertible senior subordinated debentures ($60 million Debentures) due 2024. The net proceeds of $57.6 million were used to pay off the outstanding principal of industrial revenue bonds and reduce amounts outstanding under its credit agreement.

• On October 12, 2004, CTS’ $55 million revolving credit agreement was expanded to $75 million and the term was extended from July 2006 to July 2007.

At the end of 2004, working capital increased $32.1 million, compared with 2003 year end. The working capital increase was primarily driven by a $35.7 million increase in cash and cash equivalents, an increase in accounts receivable of $11.8 million due to higher sales in December 2004, and an increase in inventory of $10.8 million to support higher sales and new product launches. The increase was partially offset by a decrease in short-term deferred income taxes of $19.9 million, in part due to changes in timing differences related to inventory reserves and non-deductible accruals, an increase of accounts payable of $3.4 million associated with higher sales, and increase of notes payable of $3.3 million.

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Free Cash Flow

The following table summarizes free cash flow for the Company:

	Year ended December 31,
(In millions of dollars)	2004		2003			2002
Net cash provided by operations	$	14.0	$	25.7		$	24.1
Net cash provided by (used in) investing activities		7.1		(5.1	)	(	10.0	)
Free cash flow		21.1	$	20.6		$	14.1

Free cash flow is a non-GAAP financial measure which CTS defines as net cash provided by operations plus net cash provided by (used in) investing activities. The most directly comparable GAAP financial measure is net cash provided by operations. Management believes that free cash flow provides useful information to investors regarding the Company’s ability to generate cash from business operations that is available for internal growth, service of debt principal, dividends, share repurchases and acquisitions and other investments. Management uses free cash flow as one measure to monitor and evaluate the performance of the Company.

In 2004, net cash provided by operations was $14.0 million, after funding the working capital required for business growth. Net cash provided by operations in 2004 was $11.7 million lower than net cash provided by operations in 2003 due to higher earnings in 2004 that are more than offset by non-cash adjustments and negative working capital change. Increased working capital was required to support a higher level of sales in 2004. Net cash provided by investing activities was $7.1 million after $19.8 million proceeds from the sale of assets offset capital expenditures of $12.7 million.

In 2003, net cash provided by operations was $25.7 million after funding the working capital required for business growth. The capital expenditures of $9.0 million were partially offset by the proceeds of $4.1 million from the sale of assets, primarily temperature compensated crystal oscillator (TCXO) production assets. In 2002, net cash provided by operations was $24.1 million, and the cash used in investing activities was $10.0 million.

Operating Activities

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 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.

Net cash provided by operating activities in 2003 was $25.7 million, as CTS’ net income of $12.6 million, adjusted for non-cash items, primarily depreciation and amortization, and restructuring and impairment charges provided $50.8 million. Working capital and other changes utilized cash totalling $25.1 million.

Net cash provided by operating activities in 2002 was $24.1 million, as CTS’ net loss of $17.9 million, adjusted for depreciation and amortization, restructuring and impairment charges and deferred income taxes, provided $33.0 million. Favorable working capital was offset by other changes for a use of $8.9 million.

Investing Activities

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, 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.

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The 2003 use of $5.1 million for investing activities consisted primarily of $9.0 million of capital expenditures, partially offset by $4.1 million of proceeds from the sale of assets, primarily assets held for sale. Included in capital expenditures is approximately $6.1 million primarily for new products and technologies. Spending for new products included belt tension sensor and pedal sensor programs for the automotive market.

The 2002 cash used in investing activities was $10.0 million. This consisted primarily of $12.8 million of capital expenditures for normal, recurring asset replacements and new products, including automotive belt tension sensor and ClearONE™ components and investments in cost reduction programs. During 2002, the Company sold assets held for sale of $1.6 million and other fixed assets for $1.3 million.

Financing Activities

Cash flows provided by financing activities in 2004 were $12.7 million, consisting primarily of $57.6 million proceeds from the $60 million Debentures due 2024, $42.0 million repayment of the 7.5% industrial revenue bonds, $3.3 million from short-term notes payable, $2.0 million purchase of treasury stock, and $4.5 million in dividend payments.

In 2003, CTS’ net cash used by financing activities totaled $5.9 million, consisting primarily of net repayment of debt of $19.5 million and dividend payments of $4.1 million. These uses were partially offset by the net proceeds from the issuance of stock of $15.6 million and $2.5 million from proceeds of stock option exercises.

In 2002, CTS’ net cash used by financing activities totaled $19.7 million, consisting primarily of an increase in borrowings of $26.1 million, representing the issuance of $25 million in aggregate principal amount of five-year, 6.5% convertible subordinated debentures, and the issuance of common stock for $42.7 million. This was offset by the repayment of long-term obligations of $83.2 million, dividend payments of $3.9 million, and debt issue costs of $1.7 million.

Our cash balances are held in locations throughout the world, including substantial amounts held outside the United States. Undistributed earnings of certain non-U.S. subsidiaries amounted to approximately $174 million at December 31, 2004. Pending consideration of The American Jobs Creation Act of 2004, prior year earnings are intended to be invested indefinitely, and, accordingly, no provision has been made for non-U.S. withholding taxes. In the event all undistributed earnings were remitted, approximately $6 million of withholding tax would be imposed. On October 22, 2004, the President signed the American Jobs Creation Act of 2004 (the “Act”). The Act creates a temporary incentive for U.S. corporations to repatriate accumulated income earned abroad by providing an 85 percent dividends received deduction for certain dividends from controlled foreign corporations. The deduction is subject to a number of limitations, and currently, uncertainty remains as to how to interpret numerous provisions in the Act. As such, the Company is not yet in a position to decide on whether, and to what extent, it might repatriate foreign earnings that have not yet been remitted to the U.S. Based on the Company’s analysis to date, however, it is reasonably possible that it may repatriate some amount between $45 million and $75 million, with a tax liability estimated between $4 million and $6 million. CTS expects to determine the amounts and sources of foreign earnings to be repatriated, if any, no later than the fourth quarter of 2005.

Capital Resources

In 2004, CTS refinanced its debt by paying in whole the Industrial Revenue Bonds with the proceeds from the issuance of $60 million in aggregate principal amount of convertible debentures bearing a lower interest rate, in an effort to reduce interest expense. The following table shows the long-term borrowings and related average interest rates as of December 31, 2004 and December 31, 2003:

	December 31, 2004					December 31, 2003
	Balance ($)		Average interest rate (%)			Balance ($)		Average interest rate (%)
	($ in millions)
$75 million revolving credit agreement	$	9.2		4.2	%	$	8.9		3.1	%
Industrial revenue bonds		—		—			42.0		7.5
Convertible debentures due 2007		25.0		6.5			25.0		6.5
Convertible debentures due 2024		60.0		2.1			—		—
Total long-term debt	$	94.2		3.5	%	$	75.9		6.7	%

10

On October 12, 2004, CTS amended its revolving credit agreement to expand the borrowing capacity from $55 million to $75 million. The amendment also extended the term of the revolving credit agreement by one year, to July 2007, and revised certain financial covenants. The outstanding balance under the revolving credit agreement at December 31, 2004 was $9.2 million. Any outstanding balance would be senior to CTS’ convertible debentures. The revolving credit agreement is collateralized by substantially all U.S. assets and a pledge of 65% of the capital stock of certain non-U.S. subsidiaries. Interest rates on the agreement fluctuate based upon LIBOR. The interest rate as of December 31, 2004 was 4.2% per annum. CTS pays a commitment fee on the undrawn portion of the revolving credit agreement. The commitment fee varies based on performance under certain financial covenants and was 0.375 percent per annum as of December 31, 2004. The revolving credit agreement requires, among other things, that CTS comply with a minimum fixed charge coverage, a maximum leverage ratio and a minimum tangible net worth covenants. As of December 31, 2004, CTS was in compliance with these covenants. Failure of CTS to comply with these covenants could reduce the borrowing availability under the revolving credit agreement. Additionally, the revolving credit agreement limits the amounts allowed for dividends, capital expenditures and acquisitions.

On July 9, 2004, CTS’ Board of Directors authorized the repurchase of up to one million shares of CTS common stock during the next two years. Under this program, CTS purchased 183,000 shares at a total cost of $2.0 million in 2004. The repurchased shares are held as treasury stock and are available for equity-based compensation programs and for other corporate purposes.

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 was repaid in the first quarter of 2004 with the cash generated from operations. As of December 31, 2004, no conversion condition for the $60 million Debentures was met.

In April 2002, the Company issued $25 million in aggregate principal amount of five-year, 6.5% convertible subordinated debentures due 2007. These debentures are unsecured and convert into CTS common stock at a conversion price of $20.05 per share. At any time after the three-year anniversary of the issue date, the purchasers may accelerate the maturity of the debentures. CTS also has the right after such three-year anniversary and under certain circumstances, to force conversion of the debentures into common stock. CTS used the net proceeds from the offering to repay the outstanding term loans in full under its then-existing credit agreement, and the balance was applied to the former revolving credit agreement.

In November 2001, CTS’ Form S-3 registration statement registering two million shares of CTS common stock to be issued under CTS’ Direct Stock Purchase Plan was declared effective by the Securities and Exchange Commission. As of December 31, 2004, CTS could issue up to approximately 48,100 additional shares of common stock under this registration statement.

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 2004, CTS did not issue any securities under this registration statement. As of December 31, 2004, CTS could offer up to $435.1 million of additional debt and/or equity securities under this registration statement.

11

Capital Requirements

The following table sets forth the impact that contractual obligations, as of December 31, 2004, are expected to have on the Company's liquidity and cash flow in future periods:

	Payments Due by Period
($ in millions)	Total		2005		2006-2007			2008-2009		2010-beyond
Long-term debt(1)	$	120.0	$	2.9	$	39.2	(2)	$	2.6	$	75.3	(3)
Operating leases		23.7		6.3		7.9			4.8		4.7
Purchase obligations		—		—		—			—		—
Retirement obligations		16.0		1.9		2.9			3.4		7.8
	$	159.7	$	11.1	$	50.0		$	10.8	$	87.8

⁽¹⁾ Including principal and coupon payments of the $25 million debentures issued in 2002, principal and coupon payments of $60 million Debentures issued in 2004, and principal payment of the revolving credit agreement.

⁽²⁾ Including $25 million in debentures issued in 2002 and $9.2 million outstanding under the revolving credit agreement. For the $25 million debentures, the investors may accelerate the maturity of the debentures at any time after the three-year anniversary of the issue date. These debentures convert into CTS common stock at a conversion price of $20.05 per share.

⁽³⁾ 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 common 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 H —Retirement Plans” and “Critical Accounting Policies - Retirement Plans” for additional information related to the retirement plans, including the important assumptions.

The estimate of the required contributions of CTS’ pension plans for 2005 is $1.6 million. There are no estimates included for these plans beyond 2005. Estimates for years after 2005 may be impacted by changes in actual plan results. In addition to the pension obligation, CTS provides other post-retirement benefits. Please refer to the Capital Requirements table for the estimated cash requirement for other post-retirement benefits.

CTS utilizes a market- related approach in deriving fair value of plan assets. CTS does not expect any significant change in the approach in 2005. For plan asset allocation detail, please refer to Note H. CTS does not expect any significant change on asset allocation in 2005 based on its current knowledge. However, CTS may change the asset allocation based on the performance of different asset categories after conducting investment portfolio 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 2004 by $750,000.

12

CTS plans to invest in capital projects that maintain current capacity and result in future revenue opportunities. The 2005 capital spending is expected to be approximately $23 million.

In 2005, CTS used approximately $48 million of both existing cash balance and credit agreement borrowings to finance the cash portion of the SMTEK acquisition. Approximately $13 million was used to payoff SMTEK’s existing debt and $35 million was delivered to SMTEK shareholders.

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 through December 31, 2005 and until July 2007, when the credit agreement expires. 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 late December 2004, the FASB issued FAS No. 123R, “Share-Based Payment.” FAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). FAS No. 123R eliminates the alternative to use APB Opinion No. 25's intrinsic value method of accounting that was provided in Statement 123 as originally issued. FAS No. 123R will be effective for CTS during the third quarter of 2005. CTS currently follows the provisions of APB Opinion No. 25 to account for stock options. Accordingly, the provisions of FAS No. 123R will reduce earnings upon adoption. CTS is currently reviewing the provisions of FAS No. 123R to determine its impact on CTS’ financial statements.

In November 2004, the FASB finalized FAS No. 151, “Inventory Costs, an amendment to ARB No. 43, Chapter 4.” FAS No. 151 amends the guidance in ARB No. 43 to clarify the accounting for abnormal amounts of idle agreement expense, freight, handling costs and wasted material. FAS No. 151 is effective for CTS on January 1, 2006. CTS is currently reviewing the provisions of the new standard, but does not expect the standard will have a material impact on its 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 45 basis-point increase in interest rates (approximately 10% of CTS’ weighted-average interest rate) on variable-rate debt instruments would have increased CTS’ 2004 and 2003 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.

# # # # # # #

Statements about the Company’s earnings outlook and its plans, estimates and beliefs concerning the future, including statements about the anticipated benefits of the SMTEK acquisition, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on management’s expectations, certain assumptions and currently available information. Actual results may differ materially from those reflected in the forward-looking statements due to a variety of geopolitical, economic, health, industry and other factors which could affect the Company’s operating results, liquidity and financial condition. We undertake no obligations to publicly update or revise any forward-looking statement. Examples of factors which may affect future results include, but are not limited to: rapid technological change, general market conditions in the automotive, communications and computer industries; reliance on key customers; the ability to protect our intellectual property; pricing pressures and demand for our products; risks associated with our international operations, including trade and tariff barriers, exchange rates and political and geopolitical risks; and the ability to successfully integrate SMTEK into the Company’s operations.

13

Consolidated Statements of Earnings (Loss)
(In thousands of dollars except per share amounts)

			Year Ended December 31,
			2004			2003			2002
Net sales			$	531,316		$	462,987		$	457,804
Costs and expenses:
	Cost of goods sold			421,560			366,275			366,775
	Selling, general and administrative expenses			63,485			56,857			63,337
	Research and development expenses			19,063			21,476			24,118
	Gain on asset sales — Note B			(3,920	)		—			—
	Restructuring and impairment charges — Note C			—			4,563			18,343
		Operating earnings (loss)		31,128			13,816			(14,769	)
Other (expense) income:
	Interest expense			(5,535	)		(7,688	)		(10,240	)
	Interest income			922			357			396
	Other			(598	)		(237	)		813
		Total other expense		(5,211	)		(7,568	)		(9,031	)
		Earnings (loss) before income taxes		25,917			6,248			(23,800	)
Income tax expense (benefit) — Note J				5,961			(6,327	)		(5,950	)
		Net earnings (loss)	$	19,956		$	12,575		$	(17,850	)
Earnings (loss) per share — Note D
	Basic		$	0.56		$	0.36		$	(0.54	)
	Diluted		$	0.53		$	0.36		$	(0.54	)

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

CTS CORPORATION

14

Consolidated Balance Sheets
(In thousands of dollars)

				December 31,
				2004			2003
ASSETS
Current Assets
	Cash and cash equivalents			$	61,005		$	25,346
	Accounts receivable, less allowances (2004 — $1,450; 2003 — $1,585)				84,112			72,290
	Inventories
		Finished goods			10,815			8,047
		Work-in-process			8,058			7,779
		Raw materials			23,861			16,099
			Total inventories		42,734			31,925
	Other current assets				7,728			6,697
	Deferred income taxes — Note J				8,567			28,508
			Total current assets		204,146			164,766
Property, Plant and Equipment
	Buildings and land				113,478			112,407
	Machinery and equipment				271,497			271,912
			Total property, plant and equipment		384,975			384,319
	Accumulated depreciation				(272,480	)		(261,838	)
			Net property, plant and equipment		112,495			122,481
Other Assets
	Prepaid pension asset — Note H				143,918			132,960
	Intangible assets, net — Note E				35,145			37,456
	Deferred income taxes — Note J				23,221			5,867
	Other assets — Note B				3,252			18,720
			Total other assets		205,536			195,003
Total Assets				$	522,177		$	482,250
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
	Notes payable — Note F			$	3,311		$	—
	Accounts payable				55,614			52,252
	Accrued salaries, wages and vacation				13,198			11,333
	Income taxes payable				9,109			9,781
	Other accrued liabilities				21,729			22,323
			Total current liabilities		102,961			95,689
Long-term debt — Note G					94,150			75,880
Other long-term obligations — Note H					11,519			11,133
Deferred income taxes — Note J					2,843			5,357
Contingencies — Note N					—			—
Shareholders’ Equity
	Preferred stock — authorized 25,000,000 shares without par value; none issued — Note K				—			—
	Common stock — authorized 75,000,000 shares without par value; 52,666,798 shares   issued at December 31, 2004 and 52,632,088 shares issued at December 31, 2003 — Note K				263,297			262,748
	Additional contributed capital				22,761			21,520
	Retained earnings				279,064			263,430
	Accumulated other comprehensive earnings				1,348			151
					566,470			547,849
			Cost of common stock held in treasury (2004 — 16,757,907 shares; 2003 —16,565,558 shares) — Note L		(255,766	)		(253,658	)
			Total shareholders’ equity		310,704			294,191
Total Liabilities and Shareholders’ Equity				$	522,177		$	482,250

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

CTS CORPORATION

15

Consolidated Statements of Cash Flows
(In thousands of dollars)

					Year Ended December 31,
					2004			2003			2002
Cash flows from operating activities:
	Net earnings (loss)				$	19,956		$	12,575		$	(17,850	)
	Adjustments to reconcile net earnings (loss) to net cash provided by operating activities:
		Depreciation and amortization				26,082			33,605			43,373
		Restructuring and impairment charges				—			4,563			18,343
		Gain on asset sales				(3,920	)		—			—
		Deferred income taxes				153			313			(10,802	)
		Prepaid pension asset				(10,864	)		(12,053	)		(14,803	)
		Income tax benefit related to exercised stock options				—			(301	)		—
		Changes in assets and liabilities:
			Accounts receivable			(11,822	)		(8,488	)		17,761
			Inventories			(10,809	)		4,336			13,887
			Accounts payable and accrued liabilities			3,855			2,452			(24,767	)
			Income taxes payable			150			(13,736	)		(404	)
		Other				1,186			2,402			(601	)
			Total adjustments			(5,989	)		13,093			41,987
				Net cash provided by operations		13,967			25,668			24,137
Cash flows from investing activities:
	Proceeds from sale of assets					19,813			4,126			2,954
	Capital expenditures					(12,711	)		(9,044	)		(12,833	)
	Other					—			(136	)		(145	)
				Net cash provided by (used in) investing activities		7,102			(5,054	)		(10,024	)
Cash flows from financing activities:
	Proceeds from issuance of long-term debt					172,185			104,159			26,050
	Payments of long-term debt					(153,915	)		(123,629	)		(83,213	)
	Increase in short-term notes payable					3,311			—			—
	Debt issue costs					(2,406	)		(570	)		(1,688	)
	Issuance of common stock					—			15,620			42,711
	Purchase of treasury stock					(2,005	)		—			—
	Dividends paid					(4,537	)		(4,087	)		(3,947	)
	Exercise of stock options and other					87			2,563			170
				Net cash provided by (used in) financing activities		12,720			(5,944	)		(19,917	)
Effect of exchange rate changes on cash						1,870			1,451			1,774
Net increase (decrease) in cash and cash equivalents						35,659			16,121			(4,030	)
Cash and cash equivalents at beginning of year						25,346			9,225			13,255
Cash and cash equivalents at end of year					$	61,005		$	25,346		$	9,225
Supplemental cash flow information
	Cash paid during the year for:
		Interest			$	4,857		$	6,443		$	8,348
		Income taxes — net				6,901			7,573			5,882
Noncash investing and financing activities
	Common stock issued in connection with DCA acquisition				$	104		$	1,417		$	110

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

CTS CORPORATION

16

Consolidated Statements of Shareholders’ Equity
(In thousands of dollars)

											Accumulated
											Other
					Additional						Comprehensive			Comprehensive
		Common			Contributed			Retained			Earnings			Earnings			Treasury
		Stock			Capital			Earnings			(Loss)			(Loss)			Stock			Total
Balances at December 31, 2001		$	213,947		$	24,153		$	276,988		$	(1,702	)				$	(270,513	)	$	242,873
Net loss									(17,850	)				$	(17,850	)					(17,850	)
Cumulative translation adjustment (net of tax of $712)												1,661			1,661						1,661
Reversal of deferred gain on forward contract (net of tax of $222)												(333	)		(333	)					(333	)
Minimum pension liability adjustment (net of tax of $215)												(461	)		(461	)					(461	)
	Comprehensive loss														(16,983	)
Cash dividends of $0.12 per share									(4,053	)											(4,053	)
Issued 11,230 shares on restricted stock and cash bonus plan — net			(713	)		151												562
Stock compensation						362															362
Issued 2,000,000 shares under shelf registration			13,450			(1,029	)											15,804			28,225
Issued 1,177,996 shares under Direct Stock Purchase Plan			14,599			(123	)											10			14,486
Issued 9,540 shares to former DCA shareholders			110																		110
Balances at December 31, 2002			241,393			23,514			255,085			(835	)					(254,137	)		265,020
Net earnings									12,575						12,575						12,575
Cumulative translation adjustment (net of tax of $633)												1,476			1,476						1,476
Minimum pension liability adjustment (net of tax of $214)												(490	)		(490	)					(490	)
	Comprehensive earnings														13,561
Cash dividends of $0.12 per share									(4,230	)											(4,230	)
Issued 52,140 shares on restricted stock and cash bonus plan — net			(93	)		(375	)											468
Issued 244,114 shares on exercise of stock option — net			4,164			(1,939	)											11			2,236
Issued 546,358 shares under Direct Stock Purchase Plan			4,930																		4,930
Issued 1,000,000 shares under shelf registration			10,690																		10,690
Stock compensation			247			320															567
Issued 123,384 shares to former DCA shareholders			1,417																		1,417
Balances at December 31, 2003			262,748			21,520			263,430			151						(253,658	)		294,191
Net earnings									19,956						19,956						19,956
Cumulative translation adjustment (net of tax of $889)												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

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

CTS CORPORATION

17

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. 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 (Loss) includes $0.7 million and $0.3 million of foreign currency translation expense for the years ended December 31, 2004 and 2003, respectively. The impact in 2002 was insignificant.

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 FAS No. 130, “Reporting Comprehensive Income (Loss).” The components of comprehensive earnings for CTS include foreign currency translation adjustments, unrealized gains on forward contracts, minimum pension liability adjustments, and net earnings and are reported within the Consolidated Statements of Shareholders’ Equity in the columns titled “Comprehensive Earnings (Loss)” and “Accumulated Other Comprehensive Earnings (Loss).”

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

($ in thousands)	2004			2003
Accumulated translation	$	3,177		$	1,103
Minimum pension liability		(1,829	)		(952	)
Accumulated other comprehensive earnings	$	1,348		$	151

Revenue Recognition:   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 is invested in U.S. and Canadian government securities, with the remainder maintained with seven 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, and computer 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. Sales to Hewlett-Packard Company (Hewlett-Packard) were 33% of net sales for the years ended December 31, 2004, 2003, and 2002. Sales to Motorola, Inc. (Motorola) were 13% of net sales for the years ended December 31, 2004 and 2003, and 12% of net sales for the year ended December 31, 2002. Amounts due from Hewlett-Packard and Motorola aggregated $41 million and $33 million at December 31, 2004 and 2003, 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.

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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 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 Financial Accounting Standards Board's (FASB) Financial Accounting Standard (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 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 D, “Earnings Per Share.”

Stock-Based Employee Compensation:   CTS accounts for stock-based employee compensation using the intrinsic value method prescribed in Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” and its related Interpretations. Refer also to Note I, “Stock Plans,” for more details about CTS’ stock-based compensation plans. Had employee compensation cost for CTS’ fixed, stock-based compensation plans been determined based on the fair value method, as defined by FAS No. 123, “Accounting for Stock-Based Compensation,” CTS’ net earnings (loss) and net earnings (loss) per share would have been adjusted to the pro forma amounts indicated below:

	Year ended December 31,
($ in thousands, except per share amounts)	2004			2003			2002
Net earnings (loss), as reported	$	19,956		$	12,575		$	(17,850	)
Deduct:  Stock-based employee compensation cost, net of tax, if fair value based method were used		(1,254	)		(1,911	)		(3,063	)
Proforma net earnings (loss)	$	18,702		$	10,664		$	(20,913	)
Net earnings (loss) per share — basic, as reported	$	0.56		$	0.36		$	(0.54	)
Proforma net earnings (loss) per share — basic		0.52			0.31			(0.63	)
Net earnings (loss) per share — diluted, as reported		0.53			0.36			(0.54	)
Proforma net earnings (loss) per share — diluted	$	0.50		$	0.30		$	(0.63	)

The weighted-average fair value of each option grant (which is amortized over the option vesting period for purposes of determining the pro forma impact) is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

	2004			2003			2002
	Grants			Grants			Grants
Dividend yield		1.09	%		1.23	%		1.48	%
Expected volatility		64.81	%		67.87	%		62.02	%
Risk-free interest rate		2.89	%		1.81	%		2.87	%
Expected life	4.5 years			4.4 years			4.4 years

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.

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Income Taxes:   CTS provides deferred income taxes pursuant to the requirements of 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 J, “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 H, “Retirement Plans.”

Intangible Assets:   CTS assesses useful lives of its intangible assets based on the period over which the asset is expected to contribute to CTS’ cash flows. Intangible assets with a finite life, such as the Company’s intangibles relating to customer lists and patents are amortized over that life on a straight-line basis. Goodwill is reviewed for impairment at least annually. The Company reviews the carrying value of its intangible assets whenever events or changes in circumstances indicate an impairment may have occurred. Refer to Note E, “Intangible Assets.”

Financial Instruments:   CTS’ financial instruments consist primarily of cash, cash equivalents, trade receivables and payables, and obligations under long-term debt. The carrying value for cash and cash equivalents, and trade receivables and payables approximates fair value based on the short-term maturities of these instruments. The carrying value for all long-term debt outstanding at December 31, 2004 and 2003 approximates fair value where fair value is based on market prices for the same or similar debt and maturities.

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 $0.7 million in 2004, $1.2 million in 2003, and $1.6 million in 2002 and is included in interest expense in the accompanying consolidated statement of earnings.

Reclassifications:   Certain reclassifications have been made for the periods presented in the consolidated financial statements to conform to the classifications adopted in 2004.

New Accounting Pronouncements:  In late December 2004, the FASB issued FAS No. 123R, “Share-Based Payment.” FAS No. 123R requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award - the requisite service period (usually the vesting period). FAS No. 123R eliminates the alternative to use APB Opinion No. 25's intrinsic value method of accounting that was provided in Statement 123 as originally issued. FAS No. 123R will be effective for CTS during the third quarter of 2005. CTS currently follows the provisions of APB Opinion No. 25 to account for stock options. Accordingly, the provisions of FAS No. 123R will reduce earnings upon adoption. CTS is currently reviewing the provisions of FAS No. 123R to determine its impact on CTS’ financial statements.

In November 2004, the FASB finalized FAS No. 151, “Inventory Costs, an amendment to ARB No. 43, Chapter 4.” FAS No. 151 amends the guidance in ARB No. 43 to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material. FAS No. 151 is effective for CTS on January 1, 2006. CTS is currently reviewing the provisions of the new standard, but does not expect the standard will have a material impact on its financial statements.

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NOTE B—Asset Sales

The December 31, 2003 other assets balance sheet item included $17.6 million of assets held for sale. During 2004, CTS sold approximately $16.5 million of assets held for sale, including its Longtan, Taiwan building. The proceeds on the assets sales approximated the carrying value. In addition, due to changes in circumstances, which were previously considered unlikely, $1.1 million of the assets held for sale at December 31, 2003 were reclassified to fixed assets during 2004.

During 2004, CTS also sold excess land located near its Canadian facility for approximately $2.7 million. Cash proceeds related to the sale approximated $2.1 million, with the remaining proceeds of $0.6 million evidenced by a secured note receivable due in May 2006. A gain of $2.7 million was recognized on the sale.

NOTE C—Restructuring and Impairment Charges

During the third quarter of 2003, CTS recorded a $4.6 million pre-tax asset impairment charge to reduce the carrying value of certain assets, held by the Components and Sensors business segment, to their estimated fair value. Approximately $3.3 million of the impairment charge reflected a write down for electronic equipment following final production of previously announced end-of-life products and a re-assessment of the current market value for equipment held for sale. An additional $1.3 million of the impairment charge related to equipment write down on a production line following an assessment of future capacity needs. All restructuring-related reserve balances had been fully utilized at December 31, 2003.

In the third quarter of 2002, CTS recorded $18.3 million of pre-tax restructuring and impairment charges. The charge included $5.0 of million restructuring charges, $12.5 million of asset impairments and $0.8 million of pension curtailment losses. The charges were incurred in order to effect operational improvements and related organizational realignments primarily in the Components and Sensors business segment, involving the relocation of certain manufacturing operations. CTS completed substantially all of these restructuring actions by the end of 2002. Also during 2002, CTS recorded in cost of sales $1.3 million of restructuring-related charges consisting primarily of equipment relocation costs.

NOTE D—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, 2004 and 2003.

		Net		Shares
		Earnings		(In thousands)			Per Share
(In thousands of dollars, except per share amounts)		(Numerator)		(Denominator)			Amount
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
2003
Basic EPS		$	12,575		34,723		$	0.36
Effect of dilutive securities:
	Equity-based compensation plans				146
	Other				120	(1)
Diluted EPS		$	12,575		34,989		$	0.36

⁽¹⁾ Represents shares of CTS common stock to be issued to the former DCA shareholders.

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The following table shows the potentially dilutive securities which have been excluded from the 2004, 2003, and 2002 diluted earnings (loss) 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)	2004		2003		2002
Securities issuable in connection with stock purchase plans		—		—		232
Stock options where the exercise price exceeds the average market price of common shares during the period		737		1,139		1,185
Stock options where the exercise price is below the average market price of common shares during the period		—		—		50
Securities related to the subordinated convertible debt		1,247		1,247		935

In November 2004, the Emerging Issues Task Force (EITF) modified the consensus reached on Issue No. 04-8, “The Effect of Contingently Convertible Debt on Diluted Earnings per Share,” making the new standard effective for CTS in 2004. Contingently convertible debt instruments (commonly referred to as Co-Cos) are financial instruments that add a contingent feature to a convertible debt instrument. Co-Cos are generally convertible into common shares of the issuer after the common stock price has exceeded a predetermined threshold for a specified time period. CTS’ $60 million convertible debentures (refer to Note G, “Debt”) are considered to be a contingently convertible debt instrument.

Prior to the issuance of EITF No. 04-8, generally accepted accounting principles allowed companies to exclude the potential dilutive effect of the conversion feature from diluted earnings per share until the market price contingency was met. EITF Issue No. 04-8 requires companies to include the impact of Co-Cos in their diluted earnings per share computation regardless of whether the market price trigger has been met. Diluted earnings per share in 2004 have been computed following the requirements of EITF No. 04-8. Diluted earnings per share for 2003 were not impacted by this new standard as the $60 million convertible debentures were not outstanding in 2003. EITF No. 04-8 reduced 2004 diluted earnings per share by $0.02.

Note E—Intangible Assets

CTS has the following intangible assets, all relating to the Components and Sensors business segment, as of December 31:

			2004					2003
			Gross					Gross
			Carrying		Accumulated			Carrying		Accumulated
($ in thousands)			Amount		Amortization			Amount		Amortization
Amortized intangible assets:
	Customer lists		$	36,405	$	(6,490	)	$	36,405	$	(5,246	)
	Patents			10,319		(5,602	)		10,319		(4,535	)
	Technology			—		—			12,014		(12,014	)
	Other			—		—			300		(300	)
		Total		46,724		(12,092	)		59,038		(22,095	)
Goodwill				513		—			513		—
		Total intangibles	$	47,237	$	(12,092	)	$	59,551	$	(22,095	)

CTS recorded amortization expense of $2.3 million, $2.5 million, and $3.9 million for the years ended December 31, 2004, 2003, and 2002, respectively. CTS estimates annual amortization expense of $2.3 million in 2005 through 2008, and $1.7 million in 2009, excluding the impact of the SMTEK acquisition in January 2005 as discussed in Note P, “Subsequent Event.”.

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NOTE F—Notes Payable

CTS had unsecured line of credit arrangements of $13.3 million and $17.3 million at December 31, 2004 and 2003, respectively. These arrangements are generally subject to annual renewal and renegotiation, and may be withdrawn at the banks' option. Average daily short-term borrowing, including borrowings denominated in non-U.S. currencies, were $10.0 million during 2004. The weighted-average interest rate, computed by relating interest expense to average daily short-term borrowings, was 3.4% in 2004.

NOTE G—Debt

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

($ in thousands)		2004		2003
Revolving credit agreement, average interest rate of 4.2% (2004) and 3.1% (2003), due in 2007		$	9,150	$	8,880
Convertible, senior subordinated debentures at a weighted-average rate of 2.1%, due in 2024			60,000		—
Convertible, subordinated debentures at a weighted-averaged rate of 6.5%, due in 2007			25,000		25,000
Industrial revenue bonds at a weighted-averaged rate of 7.5%			—		42,000
			94,150		75,880
Less current maturities			—		—
	Total long-term debt	$	94,150	$	75,880

The debt matures as follows:  2007 - $34.2 million; after 2010 - $60 million.

In October 2004, CTS amended its revolving credit agreement to expand the borrowing capacity from $50 million to $75 million. The amendment also extended the term of the revolving credit agreement by one year, to July 2007, and modified provisions related to permitted acquisitions and certain financial covenants. The outstanding balance was $9.2 million at December 31, 2004.

Any outstanding balances under the revolving credit agreement are senior to CTS’ convertible debentures. The revolving credit agreement is collaterized by substantially all U.S. assets and a pledge of 65% of the capital stock of certain non-U.S. subsidiaries. Interest rates on the revolving credit agreement fluctuate based upon LIBOR. CTS pays a commitment fee on the undrawn portion of the revolving credit agreement. The commitment fee varies based on performance under certain financial covenants and was 0.38 percent per annum at December 31, 2004. The revolving credit agreement requires, among other things, that CTS comply with a minimum fixed charge coverage, a maximum leverage ratio, and a minimum tangible net worth. Failure of CTS to comply with these covenants could reduce the borrowing availability under the revolving credit agreement. Additionally, the revolving credit agreement limits the amounts allowed for dividends, capital expenditures, and acquisitions.

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In May 2004, CTS issued $60 million convertible senior subordinated debentures ($60 million 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 $60 million 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 $60 million Debentures, in lieu of delivering common stock, the Company may, at its discretion, deliver cash or a combination of cash and common stock.

Holders may convert the $60 million 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 common 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, 2004, none of the conditions for conversion of the $60 million Debentures were satisfied.

CTS may, at its option, redeem all or a portion of the $60 million 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 used a portion of the proceeds from the issuance of the $60 million Debentures to repay $40 million of its 7.5% industrial revenue bonds that were due in 2013. Another $2 million of industrial revenue bonds were repaid with cash flows from operations in the first quarter of 2004.

In connection with the issuance of the $60 million Debentures, CTS incurred $2.4 million of issuance costs, which primarily consisted of investment banker, legal, and other professional fees. These costs are being amortized to interest expense over the five year period from May 1, 2004 through May 1, 2009.

In April 2002, the Company issued $25 million of five-year, 6.5% convertible, subordinated debentures ($25 million Debentures). These debentures are unsecured and convert into CTS common stock at a conversion price of $20.05 per share. At any time after the three-year anniversary of the issue date, the purchasers may accelerate the maturity of the debentures. CTS also has the right after such three-year anniversary and under certain circumstances, to force conversion of the debentures into common stock. Interest on the debentures is payable semi-annually.

NOTE H—Retirement Plans

Defined Benefit and Other Postretirement Benefit Plans

CTS has a number of noncontributory defined benefit pension plans (Pension Plans) covering approximately 29% 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.

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The measurement date for the majority of the Pension Plans and other postretirement plan assets and benefit obligations was December 31, 2004 and 2003. The following table provides a reconciliation of benefit obligation, plan assets, and the funded status of the Pension Plans and other postretirement benefit plan at that measurement date.

		Pension						Other
		Plans						Postretirement Benefit Plan
($ in thousands)		2004			2003			2004			2003
Accumulated benefit obligation		$	185,302		$	171,470		$	5,433		$	5,100
Change in projected benefit obligation:
	Projected benefit obligation at January 1	$	186,950		$	167,447		$	5,100		$	4,838
	Service cost		5,292			4,916			31			39
	Interest cost		11,265			10,910			309			317
	Plan amendment and other		954			1,237			—			—
	Actuarial loss		1,231			12,165			140			198
	Benefits paid		(9,200	)		(9,725	)		(147	)		(292	)
Projected benefit obligation at December 31		$	196,492		$	186,950		$	5,433		$	5,100
Change in plan assets:
	Assets at fair value at January 1	$	259,764		$	222,435		$	—		$	—
	Actual return on assets		24,364			46,025			—			—
	Company contributions		1,550			571			147			292
	Benefits paid		(9,200	)		(9,725	)		(147	)		(292	)
	Other		513			458			—			—
Assets at fair value at December 31		$	276,991		$	259,764		$	—		$	—
Reconciliation of prepaid (accrued) cost:
	Funded status (plan assets less projected benefit obligations)	$	80,499		$	72,814		$	(5,433	)	$	(5,100	)
	Amounts not recognized:
	Actuarial losses		53,689			50,228			423			284
	Prior service cost		5,157			5,931			5			5
	Transition asset		(304	)		(796	)		—			—
Prepaid (accrued) cost, net		$	139,041		$	128,177		$	(5,005	)	$	(4,811	)

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

	Pension						Other
	Plans						Postretirement Benefit Plan
($ in thousands)	2004			2003			2004			2003
Prepaid pension asset	$	143,918		$	132,960		$	—		$	—
Other accrued liabilities		(1,645	)		(462	)		(150	)		(300	)
Other long-term obligations		(6,073	)		(5,701	)		(4,855	)		(4,511	)
Accumulated other comprehensive loss		2,841			1,380			—			—
	$	139,041		$	128,177		$	(5,005	)	$	(4,811	)

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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, 2004 and 2003 is shown below:

($ in thousands)		2004		2003
Projected benefit obligation	$	15,639	$	13,768
Accumulated benefit obligation		14,123		11,004
Fair value of plan assets		6,405		4,841

Net pension (income)/postretirement expense in 2004, 2003, and 2002 includes the following components:

		Pension Plans									Other Postretirement Benefit Plan
($ in thousands)		2004			2003			2002			2004			2003			2002
Service cost		$	5,292		$	4,916		$	6,059		$	31		$	39		$	33
Interest cost			11,265			10,910			11,467			310			317			318
Expected return on plan assets (1)			(27,051	)		(26,924	)		(29,786	)		—			—			—
Amortization of unrecognized:
	Transition obligation		(492	)		(564	)		(554	)		—			—			—
	Prior service cost		901			883			832			1			1			1
Recognized (gain) loss			658			(936	)		(2,821	)		—			—			—
Curtailment loss (2)			—			—			768			—			—			—
Net (income) expense		$	(9,427	)	$	(11,715	)	$	(14,035	)	$	342		$	357		$	352
Weighted-average actuarial assumptions (3)
Benefit obligation assumptions:
	Discount rate		5.94	%		6.17	%		6.67	%		6.00	%		6.25	%		6.75
	Rate of compensation increase		4.83	%		4.84	%		4.84	%		—			—			—
Pension income/postretirement
expense assumptions:
	Discount rate		6.17	%		6.67	%		7.14	%		6.25	%		6.75	%		7.25	%
	Expected return on plan assets (1)		8.70	%		8.94	%		9.67	%		—			—			—
	Rate of compensation increase		4.83	%		4.84	%		5.84	%		—			—			—

⁽¹⁾ Expected return on plan assets is net of expected investment expenses and certain administrative expenses.

⁽²⁾ The 2002 pension curtailment loss resulted from plant closings and reductions in employment levels that occurred as part of the restructuring actions.

⁽³⁾ 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.

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.

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CTS´ pension plan asset allocation at December 31, 2004 and 2003, and target allocation for 2005 by asset category are as follows:

		Target			Percentage of Plan
		Allocation			Assets at December 31,
Asset Category		2005			2004			2003
Equity securities			65	%		58	%(1)		65	%(1)
Debt securities			33	%		28	%		34	%
Real estate			—	%		—	%		—	%
Other			2	%		14	%(2)		1	%
	Total		100	%		100	%		100	%

⁽¹⁾ Equity securities include CTS common stock in the amounts of approximately $19 million (7% of total plan assets)
at December 31, 2004, and approximately $17 million (7% of total plan assets) at December 31, 2003.

⁽²⁾ Included in the December 31, 2004 "Other" asset category is approximately $25 million of cash. This short-term increase in cash arose as CTS liquidated assets held by a few fund managers and transferred the cash to new fund managers at year end. This change in fund managers was made to further diversify the pension asset portfolio, and improve overall return on assets by reducing administrative expenses. After December 31, 2004, the cash was re-invested by the new fund managers and the percentage of assets by category was as follows: Equity securities - 65%, Debt securities - 33%, and Other - 2%.

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 2005 are $1.6 million and $0.2 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 Plans
2005	$	9,869	$	349
2006		10,237		358
2007		10,657		367
2008		12,024		375
2009		11,894		382
Years 2010 - 2014		72,659		1,954

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 $3.0 million in 2004, $3.0 million in 2003 and $3.4 million in 2002.

27

NOTE I—Stock Plans

At December 31, 2004, CTS had five stock-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). As of December 2004, additional grants can only be made under the 2004 Plan.

CTS applies the provisions of APB Opinion No. 25 in determining compensation costs for stock-based employee compensation. Stock-based compensation expense for nonemployee directors is determined in accordance with FAS No. 123, “Accounting for Stock-based Compensation,” and was approximately $0.1 million in 2004 and $0.2 million in 2003.

The 2004 Plan, and previously the 1996 Plan and 2001 Plan, provides 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 also allows for grants of stock appreciation rights, restricted stock, restricted stock units, performance shares, performance units, and other stock awards.

Options are exercisable in cumulative annual installments over a maximum ten-year period, commencing at least one year from the date of grant. The following table summarizes the status of these plans as of December 31, 2004:

	2004 Plan		2001 Plan		1996 Plan
Awards originally available		6,500,000		2,000,000		1,200,000
Options outstanding		105,100		1,086,775		445,025
Restricted stock units outstanding		258,375		—		—
Awards exercisable		—		515,625		307,875
Awards available for grant		6,111,587		—		—

A summary of the status of stock options as of December 31, 2004, 2003, and 2002, and changes during the years ended on those dates, is presented below:

		2004					2003					2002
					Weighted-					Weighted-					Weighted-
					Average					Average					Average
					Exercise					Exercise					Exercise
		Shares			Price		Shares			Price		Shares			Price
Outstanding at beginning of year			1,621,925		$	17.33		1,560,789		$	18.74		1,287,939		$	23.69
	Granted		129,900			11.74		482,600			9.52		448,500			8.10
	Exercised		(21,000	)		8.12		(244,114	)		10.40		—			—
	Expired or canceled		(93,925	)		20.89		(177,350	)		18.17		(175,650	)		27.55
Outstanding at end of year			1,636,900		$	16.80		1,621,925		$	17.33		1,560,789		$	18.74
Options exercisable at end of year			823,500					525,200					626,664
Weighted-average fair value of options:
	Granted at market price				$	5.49				$	4.84				$	7.22
	Granted above market price					—					3.16					—
Weighted-average exercise price of options:
	Granted at market price				$	11.74				$	9.78				$	8.10
	Granted above market price					—					7.75					—

28

The following table summarizes information about stock options outstanding at December 31, 2004:

		Options Outstanding						Options Exercisable
				Weighted-
				Average		Weighted-				Weighted-
Range of		Number		Remaining		Average		Number		Average
Exercise		Outstanding		Contractual		Exercise		Exercisable		Exercise
Prices		at 12/31/04		Life (Years)		Price		at 12/31/04		Price
$	7.70 - 11.04		894,850		8.22	$	9.01		301,300	$	8.44
	14.02 - 18.90		200,800		5.51		15.14		67,500		16.83
	22.60 - 33.63		415,500		5.98		24.99		341,450		25.39
	35.97 - 50.00		122,250		5.67		47.48		109,750		47.78
	55.06 - 79.25		3,500		5.14		59.05		3,500		59.05

Restricted Stock Units

Restricted stock units (RSUs) entitle the holder to receive one share of common stock for each unit when the units vest. RSUs are issued to officers and key employees as compensation. Generally, the RSUs vest over a five-year period. During 2004, CTS recorded $0.8 million of compensation expense relating to RSUs. The following table summarizes the RSUs outstanding at December 31, 2004:

	RSUs
Number outstanding		258,375
Average grant price	$	11.08

Restricted Stock

CTS’ 1988 Plan originally reserved 2,400,000 shares of CTS’ common stock for sale, at a market price or award, to key employees. Under the 1988 Plan, approximately 83,000 shares were outstanding as of December 31, 2004. 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 the 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 or sale. CTS recorded expense of $0.7 million in 2004, $0.3 million in 2003, and income of $0.9 million in 2002, under the formula provisions of the 1988 Plan which are based on the fair market value of a share of common stock.

Stock Retirement Plan

The Directors’ Plan provides for a portion of the total compensation payable to nonemployee directors to be deferred and paid in CTS stock. The amount of compensation expense under the Directors’ Plan was $0.1 million in 2004, 2003, and 2002. The Directors’ Plan was frozen effective December 1, 2004. All future grants to nonemployee directors will be from the 2004 Plan.

29

NOTE J—Income Taxes

Earnings (loss) before income taxes consist of the following:

($ in thousands)		2004		2003		2002
Domestic		$	2,921	$	767	$	(8,670	)
Non-U.S.			22,996		5,481		(15,130	)
	Total	$	25,917	$	6,248	$	(23,800	)

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

($ in thousands)		2004			2003			2002
Current:
	Federal	$	—		$	(7,889	)	$	—
	State		563			165			368
	Non-U.S.		5,245			1,084			4,484
	Total current		5,808			(6,640	)		4,852
Deferred:
	Federal		(3,100	)		(3,480	)		(7,834	)
	State		1,654			(96	)		(1,275	)
	Non-U.S.		1,599			3,889			(1,693	)
	Total deferred		153			313			(10,802	)
	Total expense (benefit) for income taxes	$	5,961		$	(6,327	)	$	(5,950	)

30

Significant components of CTS’ deferred tax liabilities and assets at December 31, 2004 and 2003 are:

($ in thousands)	2004			2003
Pension	$	51,138		$	48,529
Other		2,274			377
Gross deferred tax liabilities		53,412			48,906
Fixed assets		3,764			—
Postretirement benefits		1,752			1,703
Inventory items		1,671			2,440
Loss carryforwards		59,223			49,598
Research expenditures		7,090			8,207
Credit carryforwards		4,146			3,235
Nondeductible accruals		6,824			8,689
Other		3,308			5,516
Gross deferred tax assets		87,778			79,388
Net deferred tax assets		34,366			30,482
Deferred tax asset valuation allowance		(6,219	)		(2,074	)
Total	$	28,147		$	28,408

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 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 has assessed that it is more likely than not that its net tax assets will be realized during the available carryforward periods. The Company has determined, however, that a valuation allowance of $6.2 million should be provided for the net deferred tax assets in a foreign jurisdiction. The $4.1 million increase in the valuation allowance from December 31, 2003 to 2004 is due to an increase in the related net tax assets resulting, in part, from an increase in the statutory tax rate in the foreign jurisdiction, offset by the utilization of previously reserved net operating loss carryforwards. As of December 31, 2004 the $6.2 million valuation allowance includes $1.4 million related to net operating loss carryforward assets and $4.8 million related to other deductible temporary differences in a foreign jurisdiction.

The Company’s U.S. deferred tax assets of $54.4 million relate to U.S. net operating loss carryforwards that expire in 2021 through 2024. The Company has foreign deferred tax assets of $4.8 million related to foreign net operating loss carryforwards, of which $3.3 million begins expiring in 2006 while the remaining $1.5 million carries forward indefinitely.

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:

	2004			2003			2002
Taxes at the U.S. statutory rate		35.0	%		35.0	%		(35.0	)%
State income taxes, net of federal income tax benefit		5.6	%		0.7	%		(2.5	)%
Non-U.S. income taxed at rates different than the U.S. statutory rate		(11.3	)%		(2.0	)%		25.1	%
Tax exempt earnings		(0.5	)%		(3.4	)%		(4.1	)%
Utilization of foreign NOL		(2.3	)%		—			—
Benefit of scheduled tax credits		(4.0	)%		(6.1	)%		(7.4	)%
Other		0.5	%		0.8	%		(1.1	)%
Tax rate before the benefit of reversal of reserves		23.0	%		25.0	%		(25.0	)%
Tax benefit, reversal of reserves		—			(126.3	)%		—
Effective income tax rate		23.0	%		(101.3	)%		(25.0	)%

31

CTS’ tax rate before the benefit of reserve reversals decreased from 25% to 23% in 2004, primarily as a result of increased profits being reported in lower-taxed jurisdictions. During 2003, the Company recorded a tax benefit of $7.9 million resulting from the reversal of reserves that were no longer required following the expiration of statutory deadlines.

In certain taxing jurisdictions, CTS business operations qualify for income tax holidays. As a result, certain earnings of CTS are subject to tax at reduced rates for specified periods of time. These tax holidays, unless extended, are scheduled to expire in 2009 - 2012.

At December 31, 2004, no provision had been made for U.S. federal and state income taxes on approximately $174 million of foreign earnings, which are expected to be 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 a possible adjustment for foreign tax credits), state income taxes, and withholding taxes payable to the various foreign countries. In the event all undistributed earnings were remitted, approximately $6 million of foreign withholding taxes would be imposed.

In October 2004, the American Jobs Creation Act of 2004 (Jobs Act) was signed into law. The Jobs Act provides certain domestic companies a temporary opportunity to repatriate previously undistributed earnings of controlled foreign subsidiaries at a reduced federal tax rate of 5.25%. The reduced rate is achieved by providing an 85% dividends received deduction on earnings repatriated during a one-year period. To qualify, the repatriated earnings must be reinvested in the United States pursuant to a domestic reinvestment plan established by the company’s chief executive officer and subsequently approved by the company’s board of directors. Certain other criteria in the Jobs Act must be satisfied as well. For CTS, the one-year period during which the qualifying distributions can be made is 2005. The Company is in the process of evaluating whether it will repatriate foreign earnings under the provisions of the Jobs Act and has not made a decision on whether it will make any distributions. If the Company determines that a distribution will be made, the range of reasonably possible amounts eligible for the temporary deduction is $45 million to $75 million. CTS is assessing the impact of proposed statutory technical corrections with respect to certain provisions in the Jobs Act prior to determining the amounts, if any, it will repatriate. CTS expects to determine the amounts and sources of foreign earnings to be repatriated, if any, no later than the fourth quarter of 2005. While the Company is not yet in a position to determine the impact of a qualifying repatriation on its income tax expense for 2005, the related potential range of income tax effects on the reasonably possible repatriation amounts is estimated at $4 million to $6 million, of which foreign withholding taxes are estimated to be approximately $1 million.

NOTE K—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.

NOTE L—Treasury Stock

Common stock held in treasury at December 31, 2004 totaled 16,757,907 shares with a cost of $255.8 million, compared to 16,565,558 shares with a cost of $253.7 million at December 31, 2003.

In July 2004, CTS’ Board of Directors authorized a program to repurchase up to one million shares of its common stock in the open market during the next two years. This July 2004 authorization effectively canceled the board’s previous stock repurchase authorization. Reacquired shares will be used to support equity-based compensation programs and for other corporate purposes. During 2004, CTS repurchased 183,000 shares at a total cost of $2.0 million. At December 31, 2004, CTS was authorized to repurchase approximately 817,000 additional shares.

32

NOTE M—Business 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 business segments: 1) Components and Sensors and 2) Electronics Manufacturing Services (EMS).

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 cellular handsets, communications infrastructure and computer markets; low temperature cofired ceramics (LTCC) electronic substrates used in various communications applications; terminators, including ClearONE™ terminators, used in computer and other high speed applications, switches, resistor networks and potentiometers used to serve multiple markets.

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. EMS also includes design and manufacture of interconnect systems and complex backplanes as may be required by the customer.

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 interest and income taxes.

Summarized financial information concerning CTS’ reportable segments is shown in the following table:

	Components
($ in thousands)	& Sensors			EMS		Total
2004
Net sales to external customers	$	260,982		$	270,334	$	531,316
Segment operating earnings		23,311	(1)		7,817		31,128
Total assets		422,420			99,757		522,177
Depreciation and amortization		22,562			3,520		26,082
Capital expenditures	$	9,824		$	2,887	$	12,711
2003
Net sales to external customers	$	252,911		$	210,076	$	462,987
Segment operating earnings		7,394			10,985		18,379
Total assets		398,791			83,459		482,250
Depreciation and amortization		30,412			3,193		33,605
Capital expenditures	$	8,091		$	953	$	9,044
2002
Net sales to external customers	$	270,919		$	186,885	$	457,804
Segment operating earnings (loss)		(5,927	)		10,790		4,863
Total assets		419,628			70,404		490,032
Depreciation and amortization		40,553			2,820		43,373
Capital expenditures	$	12,298		$	535	$	12,833

⁽¹⁾ Includes $3.9 million of gain on asset sales (refer also to Note B, “Asset Sales”).

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

($ in thousands)	2004			2003			2002
Total segment operating earnings	$	31,128		$	18,379		$	4,863
Interest expense		(5,535	)		(7,688	)		(10,240	)
Interest income		922			357			396
Other income (expense)		(598	)		(237	)		813
Restructuring, asset impairment and related charges — Components & Sensors		—			(4,563	)		(19,498	)
Restructuring, asset impairment and related charges — EMS		—			—			(134	)
Earnings (loss) before income taxes	$	25,917		$	6,248		$	(23,800	)

33

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

($ in thousands)	2004		2003		2002
Net Sales
United States	$	197,557	$	186,675	$	199,982
United Kingdom		122,129		127,522		125,252
China		105,196		96,492		80,615
Singapore		66,989		15,244		21,330
Canada		28,468		27,535		20,201
Other non-U.S.		10,977		9,519		10,424
Consolidated net sales	$	531,316	$	462,987	$	457,804

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

($ in thousands)	2004		2003		2002
Long-Lived Assets
United States	$	42,016	$	48,680	$	58,017
China		40,659		43,220		55,723
United Kingdom		14,990		17,667		17,967
Singapore		7,319		8,077		14,856
Taiwan		2,008		19,098		21,265
Other non-U.S		5,503		3,322		3,939
Consolidated long-lived assets	$	112,495	$	140,064	$	171,767

The EMS business segment revenues from Hewlett-Packard represented $177.3 million, or 66%, and $151.8 million, or 72%, and $150.4 million, or 80%, of the segment’s revenue for the years ended December 31, 2004, 2003, and 2002, respectively. EMS business segment revenues from Motorola were $60.9 million, or 23%, and $40.2 million, or 19%, of the segment’s revenue for the year ended December 31, 2004 and 2003, respectively. The Components and Sensors business segment revenues from Motorola represent $38.6 million, or 14% of the segment’s revenue for the year ended December 31, 2002. The Components and Sensors business segment revenue from Motorola for the year ended December 31, 2004 and 2003 was less than 10% of the segment’s revenue.

34

NOTE N—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 O—Leases

CTS incurred approximately $7.1 million of rent expense in 2004, $6.8 million in 2003, and $7.4 million in 2002. The future minimum lease payments under the Company’s operating leases are $6.3 million in 2005, $5.3 million in 2006, $2.6 million in 2007, $2.6 million in 2008, $2.2 million in 2009, and $4.7 million thereafter.

NOTE P—Subsequent Event

On November 16, 2004, CTS entered into a merger agreement with SMTEK International, Inc. (SMTEK). The agreement was approved by SMTEK shareholders on January 31, 2005. Under the terms of the merger agreement, CTS acquired 100% of the outstanding common shares and SMTEK shareholders received $14.26, comprised of $10.73 in cash and $3.53 worth of CTS common stock. In addition, CTS assumed approximately $13 million of SMTEK debt. In connection with the merger, CTS issued 812,365 additional shares of common stock.

SMTEK is an EMS provider serving original equipment manufacturers in the medical, industrial, instrumentation, telecommunications, security, financial services, automation, aerospace and defense industries. SMTEK's four facilities are located in Moorpark and Santa Clara, California; Marlborough, Massachusetts; and Bangkok, Thailand. As a result of the acquisition, CTS expects to expand into new EMS markets, reduce customer concentrations, and increase its global footprint.

The estimated aggregate purchase price is approximately $60 million, consisting of $35 million cash consideration, $13 million of SMTEK debt assumed by CTS, CTS common stock valued at $10 million, and $2 million of estimated transactions costs. CTS is in the process of obtaining third-party valuations of certain intangible assets, thus the allocation of the purchase price to major assets and liability captions is currently being completed.

35

Shareholder Information
(In thousands of dollars except per share data)

Quarterly Results of Operations
(Unaudited)

					Operating
	Net		Gross		Earnings			Net
	Sales		Margins		(Loss)			Earnings
2004
4th quarter	$	142,496	$	29,918	$	9,737		$	6,618
3rd quarter		129,049		26,312		5,854			3,921
2nd quarter (1)		137,624		28,917		10,628			6,897
1st quarter		122,147		24,609		4,909			2,520
	$	531,316	$	109,756	$	31,128		$	19,956
2003
4th quarter	$	132,025	$	27,454	$	7,369		$	3,947
3rd quarter (2)		108,496		23,655		(654	)		6,074
2nd quarter		116,697		24,520		4,507			1,983
1st quarter		105,769		21,083		2,594			571
	$	462,987	$	96,712	$	13,816		$	12,575

Per Share Data
(Unaudited)

					Dividends		Net Earnings
	High (4)		Low (4)		Declared		Basic		Diluted
2004
4th quarter	$	13.92	$	11.95	$	0.03	$	0.18	$	0.17
3rd quarter		12.99		10.10		0.03		0.11		0.10	(3)
2nd quarter (1)		14.80		9.90		0.03		0.19		0.18	(3)
1st quarter		15.85		11.60		0.03		0.07		0.07
					$	0.12	$	0.56	$	0.53
2003
4th quarter	$	14.94	$	10.75	$	0.03	$	0.11	$	0.11
3rd quarter (2)		14.71		10.01		0.03		0.17		0.17
2nd quarter		11.10		5.50		0.03		0.06		0.06
1st quarter		8.85		4.90		0.03		0.02		0.02
					$	0.12	$	0.36	$	0.36

⁽¹⁾ The second quarter of 2004 includes a gain on the sale of excess land located near CTS' Canadian facility of approximately $2.7 million pre-tax, $2.1 million after-tax, or $0.05 per diluted share.

⁽²⁾ The third quarter 2003 results include an asset impairment charge of $4.6 million pre-tax, $3.4 million after-tax, or $0.10 per diluted share. The third quarter 2003 also includes $7.9 million, or $0.22 per diluted share, favorable income tax adjustment resulting from the reversal of reserves that were no longer required following the expiration of statutory deadlines.

⁽³⁾ Diluted earnings per share for the second and third quarters of 2004 have been restated to reflect the impact of adopting Emerging Issues Task Force (EITF) No. 04-08, "The Effect of Contingently Convertible Debt on Diluted Earnings Per Share." EITF No. 04-08 was issued and became effective in the fourth quarter of 2004. Earlier quarters have been restated to show diluted earnings per share computed on a consistent basis. Refer also to Note D, "Earnings Per Share."

⁽⁴⁾ 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

36

Five-Year Summary
(In thousands of dollars except per share and other data)

						% of						% of						% of						% of						% of
			2004			Sales			2003			Sales			2002			Sales			2001			Sales			2000			Sales
Summary of Operations
Net sales			$	531,316			100.0		$	462,987			100.0		$	457,804			100.0		$	577,654			100.0		$	866,523			100.0
	Cost of goods sold			421,560			79.3			366,275			79.1			366,775			80.1			466,363			80.7			605,598			69.9
	Selling, general and administrative expenses			61,174			11.5			54,390			11.8			59,467			13.0			80,214			13.9			94,501			10.9
	Research and development expenses			19,063			3.6			21,476			4.6			24,118			5.3			32,762			5.7			32,583			3.8
	Amortization of intangible assets			2,311			0.4			2,467			0.5			3,870			0.8			6,765			1.2			5,211			0.6
	Gain on asset sales			(3,920	)		(0.7	)		—			—			—			—			—			—			—			—
	Restructuring and impairment charges			—			—			4,563			1.0			18,343			4.0			40,039			6.9			—			—
		Operating earnings (loss)		31,128			5.9			13,816			3.0			(14,769	)		(3.2	)		(48,489	)		(8.4	)		128,630			14.8
Other expense—net				(5,211	)		(1.0	)		(7,568	)		(1.6	)		(9,031	)		(2.0	)		(12,002	)		(2.1	)		(11,503	)		(1.3	)
		Earnings (loss) before income taxes		25,917			4.9			6,248			1.4			(23,800	)		(5.2	)		(60,491	)		(10.5	)		117,127			13.5
Income tax expense (benefit)				5,961			1.1			(6,327	)		(1.3	)		(5,950	)		(1.3	)		(15,116	)		(2.6	)		32,796			3.8
		Earnings (loss) from continuing operations		19,956			3.8			12,575			2.7			(17,850	)		(3.9	)		(45,375	)		(7.9	)		84,331			9.7
Discontinued operations:
	Net loss from discontinued operations			—			—			—			—			—			—			—			—			(529	)		—
		Net earnings (loss)		19,956			3.8			12,575			2.7			(17,850	)		(3.9	)		(45,375	)		(7.9	)		83,802			9.7
Retained earnings—beginning of year				263,430						255,085						276,988						325,850						245,414
Dividends declared				(4,322	)					(4,230	)					(4,053	)					(3,487	)					(3,366	)
Retained earnings—end of year			$	279,064					$	263,430					$	255,085					$	276,988					$	325,850
Earnings (loss) per share:
	Basic:
		Continuing operations	$	0.56					$	0.36					$	(0.54	)				$	(1.61	)				$	3.05
		Discontinued operations		—						—						—						—						(0.02	)
		Net earnings (loss) per share	$	0.56					$	0.36					$	(0.54	)				$	(1.61	)				$	3.03
	Diluted:
		Continuing operations	$	0.53					$	0.36					$	(0.54	)				$	(1.61	)				$	2.94
		Discontinued operations		—						—						—						—						(0.02	)
		Net earnings (loss) per share	$	0.53					$	0.36					$	(0.54	)				$	(1.61	)				$	2.92
Average basic shares outstanding (000’s)				35,910						34,723						33,148						28,231						27,623
Average diluted shares outstanding (000’s)				38,893						34,989						33,148						28,231						28,675
Cash dividends per share			$	0.12					$	0.12					$	0.12					$	0.12					$	0.12
Capital expenditures				12,711						9,044						12,833						77,654						119,216
Depreciation and amortization				26,082						33,605						43,373						51,674						44,325
Financial Position at Year End
Current assets			$	204,146					$	164,766					$	152,334					$	200,674					$	305,696
Current liabilities				102,961						95,689						134,556						153,857						202,891
Current ratio				2.0 to 1						1.7 to 1						1.1 to 1						1.3 to 1						1.5 to 1
Working capital			$	101,185					$	69,077					$	17,778					$	46,817					$	102,805
Inventories				42,734						31,925						36,262						50,149						104,316
Property, plant and equipment—net				112,495						122,481						148,632						191,958						224,861
Total assets				522,177						482,250						490,032						567,931						672,929
Short-term notes payable				3,311						—						—						—						7,397
Long-term debt				94,150						75,880						67,000						125,013						178,000
Long-term obligations, including long-term debt				105,669						87,013						78,501						132,287						189,069
Shareholders’ equity				310,704						294,191						265,020						242,873						246,357
Common shares outstanding (000’s)				35,909						36,067						34,101						30,902						27,781
Equity (book value) per share			$	8.65					$	8.16					$	7.77					$	7.86					$	8.87
Other Data
Stock price range			$	15.85-$9.90					$	14.94-$4.90					$	19.56-$3.65					$	47.88-$13.49					$	82.75-$31.50
Number of employees				4,487						5,041						5,313						5,837						9,008
Number of shareholders at year end				1,628						1,527						1,585						1,549						1,492

CTS CORPORATION

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