our customers speak out

Our Customers Speak Out

mAnnual Report to Shareholders 2000

Forward-Looking Statements

Throughout this report there exist forward-looking statements, made pursuant to the safe-harbor provisions of the Private SecuritiesLitigation Reform Act of 1995, which reflect management’s current expectations or beliefs. We caution our shareholders and otherreaders of this report that actual future results could differ materially from those in the forward-looking statements, depending onmany factors, some beyond our control, including factors related to company competitive performance, industry conditions, and inter-national economic trends.

We are a technology-based, market-driven company

providing hardware, software, and engineering services

to researchers, designers and manufacturers.

Our mission is to help our customers design, develop,

and produce their products faster, with higher quality,

and at a lower cost.

Our Mission

Financial Highlights

$163

$147

$187

$191

$131

00

99

98

97

96

$.17

$.59

$1.01

$.921

$.72

00

99

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96

$3.6

$12.4

$21.5

$19.21

$15.2

00

99

98

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$ Million$392

$391

$362

$323

$278

00

99

98

97

96

2.2%

8.0%

15.4%

15.6%

13.0%

00

99

98

97

96

1Excludes an after-tax gain of $2,654,000from the sale of land in May 1997, which isequal to $.13 per share

2000 1999 Change(expressed in thousands except per share data)

Net revenue $391,853 $390,542 .3%

Net income $ 3,624 $ 12,445 (70.9%)

Net income per share, diluted $ .17 $ .59 (71.2%)

Return on sales 0.9% 3.2%

Return on beginning shareholders’ investment per share 2.2% 8.0%

Return on average net assets 4.9% 10.7%

Dividends per share $ .24 $ .24

Shareholders’ investment per share $ 7.61 $ 7.80 (2.4)%

Long-term capitalization ratio 26.9% 27.0%

Weighted average shares outstanding, diluted (000’s) 20,935 21,184

New orders $415,879 $350,190 18.8%

Backlog of orders at year end $162,955 $146,833 10.9%

1

Net Revenue

Net Income

$ Million

Backlog of Orders$ Million

Net Income per Share, Diluted

Return on Beginning Shareholders’ Investment per Share

To Our Shareholders

2

While fiscal 2000 was a difficult year from the

perspective of financial results, we are extremely

proud of our contribution to our customers’ suc-

cess. In the pages to follow they speak out about

our people, our products, and our services. Our

core competencies—understanding motions and

forces and how to control them—are at work

around the world providing lasting value to the

design, development, and automation needs of

customers large and small.

Internally, we faced many challenges, espe-

cially in our Minneapolis-based operations,

where we accelerated the journey begun last

year from our superb engineering heritage

toward superb, disciplined business teams

deploying that engineering strength.

Our customers supported this journey, as

orders grew by 19 percent, and we entered

fiscal 2001 with a backlog $16 million larger

than a year earlier.

The highlight for the year was the revenue

growth in our Factory Automation Sector. Orders

were up 39 percent, and revenues grew by 16

percent. We experienced growing acceptance of

new low-cost displacement sensors produced

by our fully automated facility in Luedenscheid,

Germany. The opening of a new sensor manu-

facturing site in Japan resulted in a jump in

Asian business. The product acquisition and

development strategy began to pay back, as

newly released linear motors, PowerBlok™

amplifiers, and the FLX family of digital drives

represented 8 percent of sector revenue and 35

percent of the sector’s growth during the year.

Despite solid orders growth of 13 percent, it was

in the Mechanical Testing and Simulation Sector

where we experienced the most turbulence; the

6.0 point deterioration of operating margins on

lower revenues severely hurt our profitability. A

good portion of these problems came from techni-

cal difficulties in several large, complex custom

projects, compounded by simultaneous contract

losses in the entertainment market. The re-engi-

neering activity begun in late fiscal 1999 was

stepped up, but could not overcome a deteriora-

tion in predictability on project timing and per-

formance. I believe this situation is behind us.

Considering the mature nature of the world-

wide material testing market, we closed our

manufacturing operations in France, in line with

the strategy to emphasize profitability versus

growth, especially in our electromechanical

material testing product lines.

Additionally, we saw a major downturn in

new orders for powertrain testing equipment,

coincident with the acquisition of DSP

Technology and the integration of a former

MTS business unit into the acquired company.

The resulting combined unit was aggressively

restructured, and in the fourth quarter we for-

malized a plan, and as a result booked a provi-

sion to exit the unprofitable laboratory instru-

ment portion of this business. I believe our

powertrain unit is now right-sized to deliver

solid profits in fiscal 2001 and beyond.

Most importantly, we shifted the strategic

direction of the Mechanical Testing and

Simulation sector to that of providing solutions

across the spectrum of customer needs—physi-

cally, virtually, and analytically. To that end we

strengthened existing alliances and added new

ones. We redirected development funds to

3

enhance these alliances, and our customers

answered with a resounding Yes!

Orders for our new analytical software model-

ing products, enhanced noise and vibration

analysis software, and our latest RPC® test con-

trol software—all industry leading products and

all leveraged off our strengths in mechanical

testing—were up significantly. Customer

demand for our latest generation of Flat-Trac®

tire testers and the new six-degree-of-freedom

road simulators was very strong. We expanded

our service offerings from repairs and upgrades

to providing customers substantially more value

in laboratory performance. Our SWIFT® line

of vehicle mounted force measuring devices

captured the leading market position only

18 months after introduction. Aided by new

data acquisition software, we further strength-

ened our market leading position in aircraft

structural testing. Across the board, customers

are turning more and more to MTS for broader

design evaluation solutions—hardware, soft-

ware, and consulting expertise—and thus

validating our simulation solutions strategy.

We—our people—created long-term value

for our customers. We know how to turn this

into lasting value for our shareholders and are

committed to doing just that.

Sidney W. Emery, Jr.

Chairman and Chief Executive Officer

“We knew that we could rely on MTSto provide the full range of solutionsthat we need to meet our aggressivevehicle development goals.”

— Akito NishiyamaSenior Staff ManagerOffice of Management Innovation ProjectsMazda Motor Corporation

In 1996 Mazda Motor Coorporation in Japan began a multi-phase part-nership with MTS. Mazda’s goal is to acquire the best tools available toensure that the company’s cars get to market as soon as possible andwith the qualities that customers demand. Mazda chose MTS for thispartnership because only MTS could provide testing and simulationsystems that meet Mazda’s high technical standards and the company’sneed for a broad range of integrated capabilities.In phase one, in 1997, Mazda ordered RPC software, a road simulator,

a multi-axial simulation (MAST™) table, and a tri-axial elastomer test sys-tem. Also, key staff members visited MTS for intensive technical training.Phase two concluded in November 1999, with Mazda ordering a Model329 six-degree-of-freedom road simulator, SWIFT® wheel force transduc-ers, another MAST system, and an advanced component test system toexpand the company’s ability to test components and accessories.In phase three of the partnership, announced in September 2000,

Mazda expanded MTS’ role to include software and hardware toolsfor durability, safety, compliance, and tire testing, along with a num-ber of other specialized testing applications. With delivery plannedfor the 2001–2002 period, these tools, coupled with computationalmodeling software from MTS, will allow Mazda engineers to duplicatephysical testing capabilities in a virtual testing laboratory for evenfaster and more efficient design, development, and prototyping.

4

Mazda Motor Corporation

Vehicle Dynamics

Our vehicle testing business grew stronglyagain in 2000, with orders up more than25 percent. Growth was fueled by demandthroughout the ground vehicle market forequipment to reduce development cycletimes, an increase in the number of vehi-cle platform variants, and the demand forever-increasing test accuracy.

Particularly notable successes this year: • A resurgence in tire/wheel testing, trans-

lating into multiple orders for new multi-million dollar systems. Vehicle manufac-turers are driving tire manufacturers toprovide data for advanced modeling andanalysis—data which our Flat Trac® IIItest systems uniquely provide.

• Strong growth of our shock absorberand elastomer test systems, driven byour customers’ need for data to validateanalytical software models. These mod-els are developed using specializedkinematics software and are mademore accurate by our EDM™ software,described below.

• Continued popularity of our durabilitytest systems, including the Model 329six-degree-of-freedom systems firstintroduced in 1999. These new sys-tems, as well as previously developedmodels and accessories, were strongcontributors to our order growth.In addition, our strategy of providing

testing and modeling solutions foundacceptance with two key customers. Wesigned a new contract with the MazdaMotor Corporation for physical testingsystems, modeling software, virtual test-ing tools, and consulting services. Wewere also selected by Nissan as a partnerin a new initiative for long-range strategictesting innovation.

Financial Comparison (expressed in thousands)

2000 1999 1998Orders $ 314,872 $ 277,370 $ 273,750Net revenue $ 302,353 $ 313,685 $ 287,761Income from

operations $ 3,250 $ 16,908 $ 25,011Percent of

net revenue 1.1% 5.4% 8.7%

Mechanical Testing and Simulation Sector

MTS Engineerreceives SAE award

SAE International, the premierengineering society of the automo-tive industry, in January 2000 rec-ognized Dr. Robin Tuluie of MTSwith an Oral Presentation Awardfor his talk at the 1999 SAE SmallEngine Technology Conference.Dr. Tuluie presented a newmethodology for evaluating motor-cycle suspension set-up with aride comfort model used widely in the automotive industry and developed originally by NASA. Dr. Tuluie’s paper, co-authored withMTS motorcycle market manager,Gary Stewart, documented theresults of tests run on MTS equip-ment and demonstrated that thenew methodology can be manytimes more repeatable, and moreaccurate, producing more reliabledata, than traditional road tests.This high repeatability means thatmotorcycle manufacturers nowcan tune their suspension systemsfor ride comfort in the laboratorymore reliably than they can usingroad tests.

Sales of our SWIFT wheel force transduc-er exceeded our forecast, and the newlyintroduced lightweight Ultra model provedvery successful. These products are usedto provide data for analytical models aswell as to perform laboratory tests.

Revenue from TestLine™standard testsystems grew significantly as we reapedthe benefits of a reengineering initiativethat reduced our average delivery leadtimes by nearly one-third. Positive impacton sales is expected to continue into 2001.

The vehicle testing business experi-enced reduced gross margins, resultingfrom two primary factors: poor executionof several large custom system projectsand a strengthening of the dollar againstEuropean currencies. In response, we initiated efforts to improve project execu-tion through more thorough upfront riskassessment, improved project monitor-ing, and improvements in project man-agement systems.

In the short term, the primary chal-lenges to our vehicles testing businessare reducing costs and improving projectexecution to improve profitability. We aretherefore making significant investmentsin cost reduction, value engineering, andprocess methodology. The solid accept-ance of new products released over thepast 12–18 months indicated continuedprospects for growth. We expect com-petitive pressure among vehicle manufac-turers to fuel investments in new vehicletesting and simulation products. We alsobelieve our strong position relative to thecompetition will enable our vehicle test-ing business to grow faster than theoverall market.

Responding to constant pressure todecrease vehicle development time, ourcustomers are demanding better andfaster analytical software models.Improving the models involves performingphysical tests to verify analytically predict-ed results against “real world” events.

Our software modeling group is devel-oping products to help the automotiveindustry meet these demands. In 2000we released the first version of a suite ofsoftware products known as EmpiricalDynamics™ Model (EDM), which allowscustomers to build high-fidelity modelsearlier in the design process. This in turnmeans better, more accurate predictionsthat enable decisions sooner in thedesign cycle while reducing risks later.

The EDM method—which incorporatesour traditional performance component andsubsystem mechanical test systems suchas shock absorber and elastomer sys-tems—produces dynamic, nonlinear resultsthat would be impractical using traditionalsoftware modeling methods.

Additionally, we are in the final develop-ment stage of a series of Virtual TestLab™ (VTL) software models, which accu-rately model the dynamic performance of MTS mechanical test products in a waythat allows customers to determinedynamic performance before physical pro-totypes are available. Integrating the VTLmodels into the development processallows customers to effectively build an information trail that can quickly be val-idated with our mechanical test systems,again reducing time and costs of our customers’ development processes.

The combined strengths and experi-ence of MTS and our alliance partnersMechanical Dynamics, Inc., and nCodeInternational Ltd. offer our customers anintegration of test and analysis unparal-leled in the marketplace.

5

Software Modeling


Jaguar Cars Ltd.

“MTS software allows us to design andtest the sounds that our customersexpect to hear from a Jaguar.”

— Garry DunnePrincipal Technical Specialist, Vehicle RefinementJaguar Cars Ltd.

This year we established our noise andvibration activity as a separate divisionwithin the company.

Operating in close cooperation with thevehicles testing staff, this group success-fully completed its second year of opera-tion, with a solid base of new and contin-uing customers. As a result of a series ofproduct enhancements, we now have anincreased capability to team with otherMTS divisions to provide complete solu-tions to our customers.

In fiscal 2000 we completed the transi-tion from the previous owner, re-establish-ing worldwide sales coverage for noiseand vibration software products and estab-lishing an expert staff of consultants inNorth America. Shortly after the close ofthe year we consolidated all softwaredevelopment for these products into ourCincinnati location, discontinuing develop-ment activity in Belgium.

During the year we focused our effortson solving complex customer problemsinvolving correlation of physical testingand engineering analysis. These problemslend themselves to being best under-stood and solved with our specific soft-ware tools and skill sets. Simultaneously,we made a conscious decision to moveaway from less sophisticated applicationswhere cost is the principal differentiator.

Mid-year we released our first MTS-builtpackage: Jury Evaluation software. Thissoftware, when coupled with the newWindows NT based version of our industry-leading Sound Quality software, provides acomplete solution for helping manufactur-ers eliminate objectionable sounds—andretain desirable ones—in automobiles andother products. Both the Jury Evaluationand Sound Quality software products havereceived strong market acceptance.

Jaguar Cars Ltd., Coventry, England, makes high-performing cars thatoccupy a unique niche in the passenger car market. The cars areknown for their distinguishing qualities, including style, comfort, andperformance. But equally important are the buyers’ perceptions of the cars’ performance.Those perceptions include subjective responses to the sounds that the

cars make. To engineer the most desirable sound qualities, Jaguar CarsLtd. staff worked with MTS noise and vibration specialists to capture aprofile of the distinctive Jaguar sound. Using MTS Jury Evaluation™ andSound Quality™ software, they set out to document the essence of theirproduct’s personality, or as they call it, the “Jaguar DNA.” Testing each prototype for its sound qualities is a time-consuming

and expensive process. But with reliable sound profile data now inhand, Jaguar Cars. Ltd. engineers can quickly and economically evalu-ate and modify cars during development to ensure that they possessthe unmistakable Jaguar sound. By applying advanced analytical toolsfrom MTS, vehicle developers at Jaguar Cars Ltd. can reliably usesound as a way to enhance their brand and product differentiationand deliver to customers the qualities that they value.

6


Noise and Vibration

Federal-Mogul supplies complete cylinder systems to manufacturers ofheavy duty, marine, industrial, and agricultural diesel engines. The com-pany’s services include validating production parts for its customers. To perform this validation quickly and efficiently, Federal-Mogul relieson MTS powertrain testing systems. The high reliability and flexibility ofour testing equipment means that parts can be put directly into produc-tion without further testing by the OEM customer. Federal-Mogul’s Heavy Duty Products Test Lab uses MTS data acqui-

sition and control equipment in all of its engine test cells, which areused to develop advanced engine components. The ease of use ofMTS equipment allows cell operators to develop test schedules them-selves, a task that previously required the time of test engineers. This efficiency saves the company time and reduces operating costs. The flexibility of the MTS system allows data formatting and naming

conventions to be used that are familiar to Federal-Mogul’s cus-tomers. This simplifies communication when customers visit the testlab to review their projects. The MTS testing systems also can becoupled to the other test cell devices that together make up a com-plete advanced powertrain test cell.

“MTS equipment gives us the flexibilityto quickly and easily write customtests for our many customers.”

— Mark LashSupervisorHeavy Duty Products Test Lab Federal-Mogul Corporation

7

Federal-Mogul Corporation

Late in 2000 we gave our DSP TechnologyDivision a new name: MTS PowertrainTechnology Division. We did this in recog-nition of our customers’ increasing needfor advanced testing capability to meet the challenges of powertrain componentdevelopment—technological, environmen-tal, and commercial.

This division encountered an unexpect-ed drop in orders late in 1999, a situationthat continued throughout most of fiscal2000. Despite aggressive restructuringactions, the operating results were disap-pointing. We took a charge late in theyear to exit the laboratory instrument portion of this business, a set of productlines that was both unprofitable and inneed of significant investment to recover.

We completed the consolidation of ourorganizational structure and facilities into asingle new plant in Ann Arbor, Michigan,and, despite problems, released severalnew products. Most significant was theBaseLine™ CAS engine combustion ana-lyzer, the first truly portable engine com-bustion analyzer. This product can ride in acar (powered off of the 12-volt car electri-cal system) and provide real-time enginecombustion data to test and developmentengineers. Optimizing an engine for fueleconomy, power performance, low emissions, and quiet operation is a verycomplex task. The BaseLine CAS analyzerallows engineers to take this measure-ment task into the car and onto the testtrack in an environment that the vehicleuser would actually experience.

Our powertrain business has alsofocused on new products for the dieselengine market. The U.S. EnvironmentalProtection Agency is developing newdiesel standards and is using MTS dataacquisition and control products to accom-plish this task. Many of the major suppli-ers of industrial diesel engines now useMTS testing systems for the productionverification of quality and performance,positioning us for solid growth.

Powertrain Technology

Lockheed Martin Aeronautics Company

When Lockheed Martin Aeronautics Company in Marietta, Georgia,received a contract from the U.S. Naval Air Systems Command fortesting the P-3 Orion and S-3 Viking aircraft, MTS was called upon toprovide the latest Aero-90™ test-control and data-acquisition systems. The Navy P-3 contract calls for Lockheed-Martin to perform structural

life assessment fatigue tests of the aircraft to determine what needs tobe done to extend the service life of this durable and dependable sub-marine hunter and marine patrol plane. The S-3 program is also a lifeextension program and is based on running full-scale fatigue tests ofthis versatile carrier-based aircraft.The P-3 Aero-90 system has 1280 channels of data acquisition,

128 channels of control and three Model 261 structural pressurizationcontrollers. The S-3 Aero-90 system provides 152 channels of controland two Model 261 pressurization controllers.Installation began in November and testing is scheduled to start the

first quarter of 2001.

In 2000, our aerospace business realizeda significant increase in orders—up 26 percent over 1999—in line withexpectations and allowing a strong oper-ating performance.

The aerospace market is experiencing aresurgence in development programs that,along with our customers’ product devel-opment processes, drive our business. Keynew programs include the development ofcommercial transports, regional jets, andlife-extension validation of aging aircraftplatforms. These projects provided signifi-cant business opportunities this past yearand promise to provide more opportunityover the next several years.

In 2000, we introduced our newAeroPro™ software suite for use with our new Scalable Data Acquisition systemhardware product (SDAC). The SDAC sys-tem is based upon a new product fromAgilent designed to provide a high per-formance, cost effective solution for high-channel-count data acquisition systems.We have already delivered over 3000channels of the new SDAC product, withsignificant future potential. The heart ofthis new offering is the AeroPro software,the first release of a next generationnative Microsoft Windows compatibletest manager suite for our structural test-ing control and data acquisition products.

8


Aerospace

“We chose MTS to provide us the equipment for these critical tests.”

— Marc WoodP-3/S-3 Ground Test Manager Lockheed Martin Aeronautics Company

ETREMA Products Inc., Ames, Iowa, makes a variety of smart mate-rials, also called intelligent or active materials, collectively namedTERFENOL-D. These materials elongate when excited by a magneticfield, an unusual property with many specialized applications. Solid-state actuators made of TERFENOL-D are ideal for uses inmachine tools, internal combustion engines, hydraulic pumps andvalves, and as sonar and aerospace components.Testing systems used to evaluate the unique characteristics of each

variety of TERFENOL-D must produce highly accurate and reliabledata, even in the extreme environment of a strong magnetic field. Inpartnership with ETREMA, MTS set out to produce systems with therequired capabilities. Through the use of special wiring, direct strainmeasurement, hydrostatic bearings, and other advanced technologies,we met the technical challenge.

MTS delivered the resulting material testing systems to ETREMA, theU.S. Navy, and Concurrent Technologies Corporation (CTC). Throughround-robin testing of TERFENOL-D samples, these organizations con-firmed the high accuracy and reliability of the MTS solution.

9

ETREMA Products, Inc.

Material Testing

“The consistency of the data that weget from our MTS test system helpsensure that we can develop andevaluate materials that will meet thedemanding needs of our customers.”

— Jonathan SnodgrassVice President Special Projects & Research ETREMA Products, Inc.

Our materials testing business producedmixed results in 2000. Our traditional ser-vohydraulic business experienced modestsingle-digit growth, our Nano product lineorders continued to reflect strong marketacceptance, while our electromechanicalbusiness experienced significant down-turn, primarily in Europe. The lower vol-ume in the electromechanical businesswas primarily due to a decision to drop aline of older products and discontinue ourmanufacturing operations in Paris.

During 2000 we implemented process-es and organizational changes to lowercost and risk in our servohydraulic busi-ness. We implemented a five-step reviewprocess to reduce re-engineering workand minimize the performance gaps ofour more custom opportunities. Weexpect these changes, along with arealignment of engineering staff and astrengthened product management team,to significantly enhance the operatingresults of the servohydraulic business.

In 2000 we introduced the TestStar™IIm digital controller. This state-of-the artcontroller, along with a new and updatedversion of our TestStar IIs controller, completes and updates our controllerplatform for our servohydraulic systems.The TestStar IIm controller in particularhas features that place MTS clearly in theforefront of advanced materials testing.

Additionally, we substantially reducedthe staff dedicated to the electromechan-ical testing products—particularly inEurope—in line with our strategy of seeking profitability in favor of growth.

The University of California at San Diego houses one of the world’smost advanced earthquake-modeling facilities. The Seismic ResponseModification Devices (SRMD) Test Facility of the California Departmentof Transportation (CALTRANS) was created to evaluate full-scale bridgeisolators that are used to support bridges and protect them from thedestructive forces of earthquakes. The isolator designs include largeelastomeric pads and friction pendulum surfaces that dampen earth-quake forces and prevent them from being transferred to the bridgesthat rest on the pads.

At the heart of the 81-foot-long facility is the SRMD test systemjointly designed and built by UCSD and MTS. The system can applyforces of 12 million pounds vertically, 2 million pounds longitudinal-ly, and 1 million pounds laterally. Full-scale earthquake velocities ofup to 70 inches per second can be applied to the loading plate onwhich the test specimens are mounted. The ability to apply such large forces and control them precisely

is essential to reproducing seismic forces accurately. The state ofCalifornia estimates that this device will save taxpayers more than $1 billion in bridge strengthening costs.


10

University of California at San Diego

“MTS contributed significantly withinnovative advances in high-speed,high-force actuation and accuratecontrol to make the SRMD test sys-tem a working reality. The system isunique in the world and is plannedto have a 20 year life role in testingand re-testing working bridge isolation systems.”

— Frieder Seible, Ph.D.Professor and Chair, Department of Structural EngineeringUniversity of California, San Diego

Our Advanced Engineering Solutions busi-ness had unusually high revenues in2000, partly as a result of its consolidationwith our entertainment business in late1999. However, operational difficulties incertain projects resulted in significantlyreduced profits. With those problematicprojects behind us, we are expecting toreturn in 2001 to higher profit rates.

In 2000 we continued the developmentof our Flat-Trac Rolling Road Systems,shipping several of these unique five-beltpassenger car systems. Our Rolling Roadtechnologies have generated interestworldwide from auto manufacturers andracing organizations, resulting in signifi-cant new orders.

A number of successful new projectsthis year have provided us with nichemarket opportunities. We are takingsteps to enhance our position in theareas of wind tunnel Rolling Road, frictionstir welding, and motion simulation sys-tems, while de-emphasizing the pursuitof complex entertainment projects.

In the past year we produced twoadvanced friction stir welding systems.Compared to conventional welding, rivet-ing, and bolting, friction stir welding sig-nificantly reduces the weight, cost, andenvironmental impact of joining sheetand plate stock for vehicle applications.Technology research and new productapplications for friction stir welding arerapidly expanding, creating a rich marketfor systems that leverage the combina-tion of mechanical, software, and controlsystem expertise in which we excel.

In addition, the U.S. Army’s AberdeenTest Center awarded us a $36 millioncost-plus incentive fee contract to designand build a roadway simulator for per-formance and durability testing of militaryand commercial vehicles. This multi-phaseprogram is expected to span four years.

The high volume of advanced engineer-ing projects in 2000 highlighted short-comings in our Advanced Engineeringworkload management. In response, weare implementing a stronger matrix man-agement system to help us predict andcontrol workload leveling problems.

Advanced Engineering

“Our application is feeding a con-stant flow of ‘action’ commands,demanding extremes in speeds,loads, and micron-positioning accu-racy. In my experience, I’ve neverseen the accuracy that we get withthe MTS MaxPlus FLX systems.”

— Larry StocklinePresidentPromess, Inc.

Promess, Inc. is the company that introduced EMAP—the Electro-Mechanical Assembly Press. This innovative manufacturing systemapproaches the goal of all manufacturing: to drive the tolerance of com-ponent parts to zero, regardless of where a part resides. EMAP hasproven its reliable accuracy in challenging applications, such as produc-ing metal springs with an absolute constant retention force from springto spring, and inserting multiple rubber bushings simultaneously intoautomobile suspension control arms. In this demanding application, thecontrol arm and the rubber bushings move as they are being inserted, achallenging situation that typically produces high scrap rates. After having tested and evaluated every major competitive system,

Promess teamed with MTS and developed a motion-control system thatsimultaneously measures displacement and force and, with closed-loopfeedback, can compensate for part tolerance variables to ensure goodparts. With the MTS Digital MaxPlus™ FLX drive and MaxPlus brushlessservo motors at the heart of the EMAP press system, it can function athigh speed, under high loads, with high accuracy. The result is a system that assembles products that consistently achieve

functional specifications. The MTS-based system helped reduce the costof producing metal springs to exact tolerance by 50 percent. In the sus-pension control arm example, EMAP reduced scrap rates by 80 percent.Within user-defined limits, it is theoretically possible to “clone” goodassemblies and reject bad ones with nearly 100-percent reliability.

11

Promess, Inc.

Factory AutomationSector

Financial Comparison (expressed in thousands)

2000 1999 1998Orders $ 101,007 $ 72,820 $ 78,532Net revenue $ 89,500 $ 76,857 $ 74,402Income from

operations $ 8,583 $ 6,429 $ 8,556Percent of

net revenue 9.6% 8.4% 11.5%

This was a year of strong growth for ourautomation business, which is entering2001 with considerable momentum and abacklog almost twice that of the begin-ning of the year. Increased demands forour traditional core of rotating servomotors and drives, combined with busi-ness generated by our new products,fueled record orders. Bookings were up68 percent over last year, and revenueincreased by 24 percent.

Many of the development efforts initiat-ed in 1999 began to pay off. The introduc-tion of linear motors, the MP-FLX family ofdigital drives, and the PowerBlok amplifierline all played a significant role in securingmajor new OEM accounts. These newproduct lines should be significant revenuegenerators for many years to come.

Our automation management teamdevoted considerable efforts this year tointegrating activities across facilities.These activities focused on improvingcommunication and material flow,strengthening our manufacturing teams,and standardizing work functions acrosslocations. As these improvementsprogress, we anticipate that they willreduce manufacturing costs in 2001.

Significant new business opportunitieshave resulted from the expansion andstandardization of our gradient amplifierline. Used in the medical magnetic imag-ing market, which continuously seeks toimprove imaging performance, theseadvanced technology devices are expect-ed to create large market opportunities in2001 and beyond. We will be increasingour efforts in the coming year to positionMTS as a leading supplier of amplifiers tothis niche market.

Automation

Our sensors business revenue grew 9 per-cent this year, more than twice the growthrate of the industries in our traditional sen-sors market. Bookings increased 11.9 per-cent. The strength of the dollar, however,has shifted our most rapid business growthaway from the United States to Europe andAsia, where some machine sectors experi-enced very strong growth rates.

Accordingly, we have increased the tech-nical competence and coverage of oursales force worldwide, increased manu-facturing capacity in Europe, and estab-lished manufacturing in Japan. By shorten-ing development time and adding manu-facturing flexibility, we have improved ourability to produce custom sensors that canbest serve new growth markets such asthe printing and converting sectors, off-road vehicle manufacturers, and geophysi-cal measurement system manufacturers.

While our growth in North America wassolid, it has not matched the growth in“smart sensor” applications seen in Japanand Europe. This is due in part to slowacceptance of these new technologies byU.S. OEMs. However, we plan to continueto leverage application knowledge acrossgeographies to increase our customers’machine performance worldwide.

This year we introduced several newstandard sensors in both our low-costand high-performance lines, including thefirst two models of a new liquid levelsensor line targeted at the pharmaceuti-cal, biotechnology, fine chemical, and liq-uefied petroleum gas markets. Thesenew products, along with increased vol-ume and internal cost reductions, havespurred profit growth.

As part of our long range objective ofmaintaining a leading position in propri-etary sensing technologies, we demon-strated the feasibility of a new measure-ment technology that has the potential to complement our core magnetostrictiveproduct line.

Mercedes-Benz is well known for its innovative approach to cardesign, combining aesthetic appeal and functional performance ineach vehicle. In keeping with this tradition, Mercedes-Benz recentlyintroduced a significant advancement in ride comfort and handling:the Active Body Control (ABC) suspension system. This revolutionarysuspension system relies on MTS Temposonics® Commercial Sensorsfor reliable, ultraprecise position measurements.The MTS sensors, embedded in hydraulic actuators in the suspen-

sion system struts, measure the position of the actuators and the dis-tance between the wheels and the car body. The sensors feed thisdata to advanced microprocessors that then send appropriate com-mands to the actuators to keep the car body level while providingthe most comfortable ride.Thanks to this innovative suspension system, car designers no longer

face a tradeoff between designing a car that handles like a sports carand one that has ride comfort like a limousine. The ABC suspensionsystem gives designers—and drivers—the best of both worlds.

“Our customers value ride quality and excellent handling, and the MTS sensors allow us to delivervehicles with this unique combina-tion of attributes.”

— Peter Patrone Advanced Product Planning ManagerMercedes-Benz

12

Mercedes-Benz

Sensors

Factory Automation Sector

13

Phantom Works is Boeing Corporation’s lead development organizationfor the refinement, qualification, and technical transfer of advancedmanufacturing technologies for use in Boeing’s products and process-es. The Phantom Works organization has been working with MTS’sAeroMet subsidiary to bring AeroMet’s laser forming process for titani-um parts and its benefits to Boeing’s aircraft products. After extensivesample material performance tests, full-scale aircraft component teststhrough flight simulation testing, and near-term tests of complete wingstructure assemblies for the F/A-18 E/F, Boeing Phantom Works quali-fied AeroMet’s laser-formed components for production use.Laser forming can fabricate three-dimensional titanium alloy aircraft

structures with 10 percent of the starting material, 50 percent lessmachining, and in 80 percent less cycle time than are required by cur-rent forging methods. Because laser forming requires no dies or forms,it minimizes up-front non-recurring investments in fixed tooling. Thesefactors contribute to significant savings over conventional manufactur-ing processes. Also, the computer-driven laser forming process permitsinstant design changes and greater part geometry flexibility.

The Boeing Company

AeroMet Corporation

Our AeroMet subsidiary continued todemonstrate the superior qualities of itsadditive manufacturing process for aero-space-grade titanium structures. Full scaleaircraft structural titanium alloy parts fabri-cated by AeroMet’s LasformSM process suc-cessfully passed ground-based qualificationtests simulating load and vibrational modefor 2- and 4-lifetimes aircraft deployment.The individual tests, conducted by Boeing,Lockheed Martin, and Northrop Grumman,were heralded in trade journals and nationalmedia. AeroMet is now conducting sepa-rate business case analyses with all threecompanies for production quantities.

Unfortunately, we did not win the firstcompetitive production opportunity for the Lasform process. Heavy discountingby the incumbents using the traditionalcasting/forging methods undercut our pric-ing. We expect the next major productionopportunity to occur in late 2001.

Looking ahead, AeroMet will continueto introduce and qualify Lasform titaniumalloy aircraft parts. In addition, AeroMethas also begun parallel developmentwork on applying the Lasform process tonickel-base alloy structures for aircraftengines and other specialized structures.

“Laser forming of titanium has thepotential to produce aerospace-quality products with the mechani-cal properties that satisfy fracturecritical requirements, while at thesame time dramatically reducing thecost and lead time associated withequivalent forgings.”

— Jerry EnnisVice PresidentBoeing Phantom Works

14

2000 1999 1998 1997 1996 1995

(expressed in thousands, except per share data and numbers of shareholders and employees)

Operations5

Net revenue $391,853 $390,542 $362,163 $323,424 $278,170 $247,793United States revenue 194,056 200,556 200,490 156,877 140,249 136,862International revenue 197,797 189,986 161,673 166,547 137,921 110,931Gross profit 134,000 151,171 142,227 132,073 116,047 99,923Income before income taxes 6,095 18,770 33,448 29,9861 21,813 15,244Net income 3,624 12,445 21,539 19,2371 15,170 11,105Net income per share, diluted basis .17 .59 1.01 .921 .72 .55Research and development expense 24,619 26,966 24,348 19,798 19,776 15,471Net interest expense 4,892 4,597 1,948 1,125 1,123 2,424Depreciation and amortization 15,294 14,424 10,880 9,608 8,673 7,912

Financial Position

Current assets $225,273 $223,651 $204,311 $162,814 $137,584 $138,159Current liabilities 108,648 104,713 110,223 83,413 63,465 69,312Current ratio 2.1:1 2.1:1 1.9:1 2.0:1 2.2:1 2.0:1Net working capital 116,625 118,938 94,088 79,401 74,119 68,847Property and equipment, net 72,081 73,633 69,942 51,790 49,476 49,465Total assets 330,234 333,347 313,022 229,075 197,679 198,320Interest bearing debt 75,712 71,637 74,682 12,865 11,836 22,965Shareholders’ investment 157,854 162,859 152,689 133,524 120,578 113,311Shareholders’ investment per share 7.61 7.80 7.39 6.56 5.90 5.54

Other Statistics and Ratios

Diluted shares outstanding2 20,935 21,184 21,330 20,945 21,184 20,258Number of common shareholders of record 2,229 2,055 1,760 1,575 1,523 1,395Number of employees 2,350 2,436 2,424 2,125 1,866 1,729New orders $415,879 $350,190 $352,282 $380,870 $302,824 $261,487Backlog of orders $162,955 $146,833 $187,185 $190,784 $130,621 $105,967Gross profit percent 34.2% 38.7% 39.3% 40.8% 41.7% 40.3%Research and development costsas a percent of net revenue 6.3% 6.9% 6.7% 6.1% 7.1% 6.2%Net income as a percent of net revenue .9% 3.2% 5.9% 5.9%1 5.5% 4.5%Effective tax rate 41% 34% 36% 36% 31% 27% Interest bearing debt to shareholders’ investment percent 48.0% 44.0% 48.9% 9.6% 9.8% 20.3%Return on average net assets4 4.9% 10.7% 20.9% 22.7% 17.6% 13.2%Return on beginningshareholders’ investment per share 2.2% 8.0% 15.4% 15.6%1 13.0% 10.6%Cash dividends paid per share $ .24 $ .24 $ .24 $ .20 $ .16 $ .14

1 Excludes an after-tax gain of $2,654,000 from the sale of land in May 1997, which is equal to $.13 per share.2 Presented on a weighted average basis of common shares assuming conversion of potential common shares during each year after retroactive adjustments for issued shares, for stock splits and for reduction of shares from treasury stock purchases (in thousands of shares).3 On December 4, 2000, there were 2,229 common shareholders of record, with another estimated 3,000 beneficial shareholders whose stock is held by nominees or broker dealers.4 (Income before income taxes plus net interest expense) divided by (average quarterly assets minus non-interest bearing liabilities).5 All amounts have been restated to reflect the 1999 acquisition of DSP Technology, Inc., accounted for under the pooling-of-interest method.

Six Year Financial Summary(September 30)

3

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All amounts have been restated to reflect the 1999 acquisi-tion of DSP Technology, Inc., accounted for under pool-ing-of-interest method.

Backlog/New Orders2000 1999 1998

(expressed in thousands)New Orders:North America* $233,679 $196,367 $195,206International 182,200 153,823 157,076

Total $415,879 $350,190 $352,282

Backlog $162,955 $146,833 $187,185

*Includes U.S. and Canada

Orders in 2000 of $415.9 million increased $65.7 millionor 18.8% from 1999. This is compared to orders for 1999of $350.2 million which represents a decrease of $2.1 mil-lion or .6% from the previous year. Orders in 2000 includedan $18.6 million contract with one customer within theMT&S sector. There were no orders over $10 million in1999 or 1998.

In 2000, new orders for the Mechanical Test and Simula-tion sector (MT&S) were $314.9 million representing anincrease of $37.5 million or 13.5%. This is compared toorders for 1999 of $277.4 million which represents anincrease of $3.6 million or 1.3% from the previous year.Orders from the ground vehicle industry and for aero-space applications were particularly strong in 2000. Ordersfrom the Asian/ Pacific region, especially Japan, were verystrong compared to 1999 for Vehicle Testing Systems andAerospace applications. Orders in 2000 from Europe wereconsistent with levels in 1999.

New orders in the Factory Automation sector (FA) in 2000of $101.0 million increased $28.2 million or 38.7% from 1999.This is compared to orders for 1999 of $72.8 million whichrepresents a decrease of $5.7 million or 7.3% from the pre-vious year. The European and Japanese markets for FAproducts continued solid growth in 2000. Orders for indus-trial automation applications (servo motors, amplifiers andmotion controllers) and industrial sensors were strong,reversing the 1999 and 1998 soft North American market.

North American orders for 2000 of $233.7 increased $37.3million or 19.0% from 1999. This is compared to orders for1999 of $196.4 which represents an increase of $1.2 millionor .6% from the previous year. International orders for 2000of $182.2 million increased $28.4 million or 18.5% from 1999.This is compared to orders for 1999 of $153.8 million whichrepresents a decrease of $3.3 million or 2.1% from the pre-vious year. The increase in international orders was due tothe strong MT&S activity in Asia. See Geographic Analysisof New Orders (below) for the percentage breakdown bygeographic area.

The backlog of undelivered orders at September 30, 2000amounted to $163.0 million, representing an increase of$16.1 million or a 11.0% from 1999. The order backlog for1999 of $146.8 million decreased $40.4 million or 21.6%from the previous year.

Net Revenue2000 1999 1998

(expressed in thousands)

United States $194,056 $200,556 $200,490International 197,797 189,986 161,673

Total $391,853 $390,542 $362,163

Record 2000 net revenue of $391.9 million increased $1.3million or .3% from 1999.This is compared to net revenuefor 1999 of $390.5 which represents an increase of $28.4million or 7.8% from the previous year. For 2000, MT&Srevenue of $302.4 million decreased $11.3 million or 3.6%from 1999. This is compared to net revenue for 1999 of$313.7 which represents an increase of $25.9 million or9.0% from the previous year. FA net revenue for 2000 of$89.5 million increased $12.6 million or 16.5% from theprevious year. This is compared to net revenue for 1999of $76.9 million which represents an increase of $2.5 mil-lion or 3.3% from the previous year. For industry sectorand geographic information, see Note 2 of “Notes toConsolidated Financial Statements.”

Net revenue in the United States for 2000 of $194.1 milliondecreased $6.5 million or 3.2% from 1999. This is com-pared to net revenue for 1999 of $200.6 which remainedrelatively flat with the previous year’s net revenue. Inter-national net revenue for 2000 of $197.8 increased $7.8 mil-lion or 4.1% from 1999. This is compared to net revenuefor 1999 of $190.0 million which represents an increase of$28.3 million or 17.5% from the previous year. Internationalrevenue grew at a faster rate from 1998 to 1999 and 2000reflective of improved economic conditions, a broaderproduct offering, and stronger vehicle dynamics and aero-space activity.

The MT&S sector revenue decrease from 1999 to 2000 isattributable to a reduction in demand for our electromechan-ical test products and powertrain systems sold by therecently acquired DSPT business to the vehicle markets. TheMT&S sector revenue increase of $25.9 million from 1999 to1998 reflected positive worldwide demand from our groundvehicle customers and solid growth in entertainment projects.

The FA sector revenue increase of $12.6 million over theprevious year was a result of strong European demand forsensors and an expansion of our product line offerings foramplifiers, servo-electric motors and motion control prod-ucts. Strong order demand and associated revenues werethe result of sales to microchip, pick-in-place and injectionmolding machine manufacturers.

Selective price changes were implemented in all threeyears. However, the overall impact of pricing changes didnot have a material effect on reported revenue volume.

Geographic Analysis of New Orders2000 1999 1998

North America 56% 56% 55%

Europe/Africa/Middle East 26 30 29

Asia Pacific/Japan 18 13 14

Latin America/Rest of the World 0 1 2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

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Gross Profit2000 1999 1998


Gross Profit $134,000 $151,171 $142,227

% of Net Revenue 34.2% 38.7% 39.3%

The gross profit percentage for 2000 decreased to 34.2%from 38.7% in 1999 and 39.3% in 1998. This decline in grossprofit percentage was caused by higher than expectedcosts to complete certain custom entertainment and largecomplex custom projects. The decrease in gross profitmargins in 1999 to 1998 was attributable to differing mar-gins on the mix of products sold.

Selling, General, and Administrative Expenses

2000 1999 1998


Selling Expense $ 61,654 $ 61,490 $ 56,479General & Administrative Expense 34,684 32,276 27,833

Total $ 96,338 $ 93,766 $ 84,312

% of Net Revenue 24.6% 24.0% 23.3%

Selling and general & administrative (SG&A) expenses for2000 as a percentage of net revenue was .6% higher than1999 and 1.3% higher than 1998. Full year spending for2000 totaled $96.3 million, which represented an increaseof $2.6 million or 2.7% over 1999 and an increase of $9.5million or 11.2% over 1998.

All three years were similar in that cost control and align-ment of existing resources with markets having the greatestpotential were heavily emphasized. Increases in administra-tive expense and selling expenses in 2000 from 1999 wererealized in the FA segment, and reduced in the MT&S seg-ment. The administrative expenses for 2000 also include aprovision of $1.8 million associated with the closure of thelaboratory instrument business.

Research and Development Expense2000 1999 1998


R & D Expense $24,619 $26,966 $24,348

% of Net Revenue 6.3% 6.9% 6.7%

The Company provides funds for product, system and appli-cation developments (R&D) in both the MT&S and FA sec-tors. The majority of the R&D expenditures in all three yearswere for new systems and system components such as soft-ware, controls and mechanical products; new measurementproducts; servo motors and amplifiers; and accessories.

The R&D as a percentage of net revenue reflected aboveare representative of the range the Company normallycommits to in its annual planning process. The decline inexpenditures in 2000 from 1999 is due to specific decisionsto curtail certain R&D programs that did not have adequatereturn on investment. These programs were generallyreduced in the MT&S segment.

Income2000 1999 1998

(expressed in thousands except per share data)

Income Before Income Taxes $ 6,095 $18,770 $33,448

% of Net Revenue 1.6% 4.8% 9.2%

Net Income $ 3,624 $12,445 $21,539

% of Net Revenue .9% 3.2% 5.9%

Effective Tax Rate 41% 33.7% 35.6%

Return On Beginning Shareholder’s Investment Per Share 2.2% 8.0% 15.4%

Basic Earnings Per Share $ .17 $ .60 $ 1.05

Diluted Earnings Per Share $ .17 $ .59 $ 1.01

Income before income taxes (pretax income) in 2000 of $6.1million decreased $12.7 million or 67.5% from 1999. This iscompared to a pretax for 1999 of $18.8 million which rep-resents a decrease of $14.7 million or 43.9% from the pre-vious year. 2000 pretax income included a $1.2 millionprovision for closure of the laboratory business classifiedas restructuring, and an additional $1.8 million for thesame action included in administrative expenses.

1999 pretax income included $5.7 million for restructuring(see note 8 of “Notes to Consolidated Financial Statements”)and $1.4 million for acquisition expenses (see Note 7 of”Notes to Consolidated Financial Statements”). Also,leading to a decline in the 2000 pretax income was higherinterest expense due to higher interest rates in 2000. Interestincome of $1.5 million was $1.0 million higher than 1999and was a direct result of a $.7 million receipt of interestfrom a prior period tax overpayment.


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The MT&S 2000 income from operations, before one-timerestructuring charge of $1.2 million and $1.8 million relatedgeneral and administrative expense was $6.3 million. Thisis a decrease of $17.6 million or 73.5% from 1999. Thedecrease in income from operations reflects the leveragedeffect of a 5.5% decline in gross margin percent resultingfrom cost overruns and a 3.6% decrease in sector revenue,both discussed previously. FA 2000 income from opera-tions of $8.6 million increased $2.2 million or 34.4% from1999 reflecting strong revenue growth.

Net income in 2000 decreased $8.8 million or 70.9% from1999 to $3.6 million or $.17 per diluted share (includes$.09 for restructuring and related general and administra-tive expenses). Net income in 1999 decreased $9.1 millionor 42.2% from 1998.

The effective tax rate is influenced by the level of taxcredits available from the Company’s Foreign Sales Corp-oration and qualified R&D expense; and on the level of foreign sourced income which is taxed at a higher ratethan domestic sourced income. 2000 had a higher level offoreign sourced income than 1999 or 1998 contributing tothe higher tax rate.

Foreign Currencies EffectsThe Company is exposed to market risk from changes inforeign currency exchange rates which can affect its resultsfrom operations and financial condition. To minimize thatrisk, the Company manages exposure to changes in foreigncurrency rates through its regular operating and financingactivities and, when deemed appropriate, through the useof derivative financial instruments, principally forwardexchange contracts. Foreign exchange contracts are usedto hedge the Company’s overall exposure to exchange ratefluctuations, since the gains and losses on these contractsoffset gains and losses on the assets, liabilities, and trans-actions being hedged.

Approximately 50% of the Company’s revenue occurs out-side of the United States and about 65% (approximately30% of the Company’s net revenue) of these revenues aredenominated in currencies other than the U.S. dollar. As aresult, a strengthening of the U.S. dollar decreases trans-lated foreign currency denominated revenues and earnings.Conversely, weakening of the U.S. dollar has the reverseimpact on revenues and earnings. During 2000, 1999 and1998, the U.S. dollar was generally stronger against othermajor currencies. Gains and losses attributed to translat-ing the financial statements for all non-U.S. subsidiariesare included in the currency translation adjustments. Thegains and losses on forward exchange contracts used tohedge these exposures, are included in other expense(income).

Liquidity and Capital Resources2000 1999 1998


Total InterestBearing Debt $ 75,712 $ 71,637 $ 74,682% of TotalCapitalization 32.4% 30.5% 32.8%

Shareholders’Investment $157,854 $162,859 $152,689

Per Share $ 7.61 $ 7.80 $ 7.39

At September 30, 2000, the Company’s capital structure wascomprised of $17.6 million of current debt, $58.1 million oflong-term debt and $157.8 million of shareholders’ invest-ment. The ratio of total debt to total capitalization was 32.4%compared to 30.5% at September 30, 1999.

Total debt increased $4.1 million during 2000 to $75.7million. This resulted from an increase of $6.2 million innotes payable and the current portion of long term debtoffset by a $2.1 million payment of long term debt.

Shareholders’ investment decreased $5.0 million in 2000 to$157.9 million. The decrease was a result of a $5.0 milliondividend payment, a $2.2 million treasury stock purchase,and a $2.5 million reduction in accumulated other compre-hensive income. These decreases were offset by a $3.6million increase in retained earnings from the current yearsnet earnings and $1.0 million from the Company’s employeestock option and purchase plan.

The Company believes that the combination of presentcapital resources, internally generated funds, and unusedfinancing sources will be adequate to finance on-goingoperations, allow for reinvestment in the business andstrategic acquisitions.

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Cash Flows

During 2000, $3.0 million of cash was generated fromoperating activities, compared with $26.7 million generatedin 1999 and $3.1 million used in 1998. The decrease in 2000was primarily due to an increase in inventory of $6.8 mil-lion, an increase in accounts receivable of $9.6 million, andlikewise a decrease in customer advanced billings of $5.9million from the prior year.

In addition to cash generated from operating activities, theCompany obtained an additional $1.9 million in short-termdebt and $3.3 million in net long-term debt. These cash flowswere primarily used to support $13.2 million for capitalexpenditures and other assets, $2.2 million for stock repur-chases, and $5.0 million for dividend payments. Cash andcash equivalents decreased $9.9 million during 2000.

Capital expenditures for property, plant, and equipmenttotaled $12.4 million in 2000, compared to $16 million in1999 and $25.5 million in 1998.

Capital spending in 2001 is planned to be about $8.3million. Planned expenditures include investments infacilities and manufacturing equipment. It is anticipatedthat 2001 capital expenditures will be financed primarilywith funds from operations.

Dividends

The Company’s dividend policy is to maintain a payoutratio, which allows dividends to increase with the long-termgrowth of earnings per share, while sustaining dividendsin down years. The Company’s dividend payout ratio tar-get is about 25 percent of earnings per share over the longterm. The current quarterly dividend of 6 cents per shareequates to 40.7% of the 1998 through 2000 average netearnings per share.

Share Repurchase Plan

In 2000, the Company repurchased 299,000 shares ofcommon stock on the open market for $2.2 million, atan average cost of $7.28 per share. In 1999, the Companyrepurchased 8,292 shares of common stock on the openmarket for $.1 million, at an average cost of $11.36 pershare. The Company’s purpose for share repurchases is tooffset the dilutive effect of shares of common stock issuedfrom the Company’s stock option and stock purchase plans,and for other corporate stock-based programs. During thepast two years, the Company issued 398,000 shares ofits common stock from these stock option and stockpurchase plans.

In November 1996, the Company’s Board of Directorsauthorized the repurchase of 1,000,000 shares of commonstock in the open market within the Securities and ExchangeCommission guidelines. At September 30, 2000, the num-ber of shares which remained under this authorizationwere 232,488.

Quarterly Stock Activity(1)

The Company’s common shares trade on The Nasdaq StockMarket’s National Market under the symbol MTSC. The fol-lowing table sets forth the high, low and volume of sharestraded (expressed in thousands) for the periods indicated:

2000 1999

Shares Shares

High Low Traded High Low Traded

1st Quarter 105/8 71/2 3,526 157/16 107/8 2,6312nd Quarter 919/32 53/8 4,318 143/8 95/8 2,4863rd Quarter 77/8 63/16 4,648 131/4 913/16 2,3794th Quarter 71/2 6 3,385 145/8 10 3,259

(1) Source: The Nasdaq Stock Market

Quarterly Financial Information (Unaudited)

Quarter-to-quarter revenue and earnings comparisons donot necessarily reflect changes in the demand for theCompany’s products or its operating efficiency. Revenuesand earnings in any quarter can be significantly affected bydelivery delays or acceleration of one or more high-valuesystems, not accounted for using the percentage-of-com-pletion accounting method. The use of the percentage-of-completion revenue recognition method for large long-termprojects helps alleviate those fluctuations. (See Note 1 of“Notes to Consolidated Financial Statements”). High-value,state-of-the-art custom orders can also contain leading-edgeapplications of the Company’s technology, which in somecases have resulted in lower gross profit margins, albeit notnecessarily low marginal profit contribution. Product devel-opment in these state-of-the-art custom orders is as essen-tial to the Company’s long term growth as is Companyfunded research and development.

Quarterly earnings also vary based on the use of estimated,effective income tax rates for providing federal, state, andforeign income taxes. See Note 4 of “Notes to ConsolidatedFinancial Statements” for more information on the Com-pany’s income taxes.

Euro Conversion

On January 1, 1999, certain member countries of theEuropean Economic and Monetary Union (EMU) adoptedthe “Euro” as a form of common currency. For a three-yeartransition period, both the Euro and individual participants’currencies will remain in use. The Company is upgradingsystems, where necessary, to properly handle the Euro. TheCompany’s European operations will begin reporting inEuro currency in October, 2001. Effective January 1, 1999,the Company began processing Euro transactions with itscustomers. The cost of addressing the Euro conversion didnot have a material impact on the Company’s financialcondition or operating results.


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1 Net income per share has been restated retroactively for the two-for-one stock split effective February 2, 1998.

Selected quarterly financial information, for the three fiscal years ended September 30, 2000, is presented below.

First Second Third Fourth TotalQuarter Quarter Quarter Quarter Year


2000Net revenue $87,214 $95,291 $94,988 $114,360 $391,853Gross profit 22,786 34,470 34,797 41,947 134,000Income (loss) before income taxes (9,221) 2,213 5,831 7,272 6,095

Net income (loss) $ (6,040) $ 1,371 $ 3,697 $ 4,596 $ 3,624

Net income (loss) per shareBasic $ (.29) $ .07 $ .18 $ .18 $ .17Diluted (.29) .07 .18 .18 .17

1999Net revenue $96,142 $93,262 $95,363 $105,775 $390,542Gross profit 38,064 36,775 37,818 38,514 151,171Income before income taxes 5,722 4,666 8,269 113 18,770

Net income $ 3,726 $ 3,146 $ 5,293 $ 280 $ 12,445

Net income per shareBasic $ .18 $ .15 $ .25 $ .01 $ .60Diluted .18 .15 .25 .01 .59

1998

Net revenue $80,338 $87,160 $91,899 $102,766 $362,163Gross profit 33,753 34,560 35,691 38,223 142,227Income before income taxes 7,937 8,009 8,521 8,981 33,448

Net income $ 5,192 $ 4,921 $ 5,667 $ 5,759 $ 21,539

Net income per share1

Basic $ .25 $ .24 $ .28 $ .28 $ 1.05Diluted .24 .23 .27 .27 1.01


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Liabilities and Shareholders’ Investment 2000 1999

Current Liabilities:Notes payable to banks $ 11,945 $ 10,071Current maturities of long-term debt 5,663 1,308Accounts payable 22,755 21,062Accrued compensation and benefits 29,285 28,662Dividends Payable 1,251 —Advance billings to customers 18,673 25,943Accrued warranty 6,487 5,089Other accrued liabilities 12,589 12,578

Total current liabilities 108,648 104,713

Deferred income taxes 5,628 5,517Long-term debt, less current maturities 58,104 60,258

Commitments and Contingencies (Note 9)

Shareholders’ Investment:Common stock, 25¢ par; 64,000,000 shares authorized:20,748,288 and 20,883,639 shares issued and outstanding 5,187 5,221Additional paid-in capital 7,072 8,122Retained earnings 146,228 147,555Accumulated other comprehensive income (loss) (633) 1,961

Total shareholders’ investment 157,854 162,859

Total Liabilities and Shareholders’ Investment $330,234 $333,347

The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated balance sheets.

Consolidated Balance Sheets(September 30)

Assets 2000 1999

(expressed in thousands except share and per share data)

Current Assets:Cash and cash equivalents $ 8,211 $ 18,083Accounts receivable, net of allowance for doubtful accounts of $2,255 and $2,232 117,866 102,011Unbilled contracts and retainage receivable 26,765 38,628Inventories 62,520 56,948Prepaid expenses 9,911 7,981

Total current assets 225,273 223,651

Property and Equipment:Land 3,247 3,247Buildings and improvements 44,733 42,332Machinery and equipment 107,325 101,140Accumulated depreciation (83,224) (73,086)

Total property and equipment, net 72,081 73,633

Other Assets 32,880 36,063

Total Assets $330,234 $ 333,347

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Shareholders’ InvestmentCommon Stock Additional Accumulated Other Total

Shares Paid-In Retained Comprehensive Shareholders’Issued Amount Capital Earnings Income (Loss) Investment

(expressed in thousands except share and per share data)

Balance, September 30, 1997 11,213,471 $2,803 $4,012 $124,973 $1,736 $133,524

Comprehensive income:Net income 21,539Foreign currency translation 189

Total Comprehensive income 21,728Stock split 2 for 1 9,204,424 2,301 (2,301)Exercise of stock options 300,091 75 3,405 3,480Common stock purchased and retired (60,800) (15) (1,599) (1,614)Cash dividends, 24¢ per share (4,429) (4,429)

Balance, September 30, 1998 20,657,186 $5,164 $5,818 $139,782 $1,925 $152,689

Comprehensive income:Net income 12,445Foreign currency translation 36Unrealized loss on investment, net of tax (60)

Total Comprehensive income 12,421Exercise of stock options 234,745 59 2,396 2,455Common stock purchased and retired (8,292) (2) (92) (94)Cash dividends, 24¢ per share (4,612) (4,612)

Balance, September 30, 1999 20,883,639 $5,221 $ 8,122 $147,555 $ 1,961 $162,859

Comprehensive income:Net income 3,624Foreign currency translation (2,594)Unrealized loss on investment, net of tax 54

Total Comprehensive income 1,084Exercise of stock options 163,649 41 1,048 1,089Common stock purchased and retired (299,000) (75) (2,098) (2,173)Cash dividends, 24¢ per share (5,005) (5,005)

Balance, September 30, 2000 20,748,288 $5,187 $ 7,072 $146,228 $ (633) $157,854

The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.

Consolidated Statements of Income and Shareholders’ Investment(For the Years Ended September 30)

Income 2000 1999 1998


Net Revenue $391,853 $390,542 $362,163Cost of Revenue 257,853 239,371 219,936

Gross Profit 134,000 151,171 142,227

Operating Expenses:Selling 61,654 61,490 56,479General and administrative 34,684 32,276 27,833Research and development 24,619 26,966 24,348Restructuring 1,210 5,711 —Acquisition — 1,391 —

Income From Operations 11,833 23,337 33,567

Interest expense 6,371 5,067 2,327Interest income (1,479) (470) (379)Other expense (income), net 846 (30) (1,829)

Income Before Income Taxes 6,095 18,770 33,448Provision for Income Taxes 2,471 6,325 11,909

Net Income $ 3,624 $ 12,445 $ 21,539

Net Income Per ShareBasic $ .17 $ .60 $ 1.05Diluted .17 .59 1.01

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2000 1999 1998


Operating Activities:Net income $ 3,624 $ 12,445 $ 21,539Adjustments to reconcile net income to net cash provided by (used in)operating activities:

Depreciation and amortization 15,294 14,424 10,880Deferred income taxes 455 889 127

Changes in operating assets and liabilities, exclusive of acquisitions:Accounts receivable, unbilled contracts and retainage receivable (9,559) (11,285) (27,765)Inventories (6,759) 373 (7,644)Prepaid expenses (2,395) (3,493) 647Advance billings to customers (5,919) 8,711 (2,874)Other liabilities, net 8,286 4,676 2,015

Net Cash Provided by (Used in) Operating Activities 3,027 26,740 (3,075)

Investing Activities:Property and equipment additions (12,399) (15,990) (25,545)Acquisition of businesses, net of cash received — (1,036) (29,012)Other assets (841) (132) (1,026)

Net Cash Used in Investing Activities (13,240) (17,158) (55,583)

Financing Activities:Net borrowings under notes payable to banks 1,853 (18,168) 23,770Proceeds from issuance of long-term debt 4,271 16,837 38,637Repayments of long-term debt (998) (924) (1,152)Cash dividends (5,005) (4,612) (4,429)Proceeds from employee stock option and stock purchase plans 1,089 2,455 3,480Payments to purchase and retire common stock (2,173) (94) (1,614)

Net Cash Used in Financing Activities (963) (4,506) (58,692)

Effect of Exchange Rate Changes on Cash 1,304 418 (3)

Net Increase (Decrease) in Cash and Cash Equivalents (9,872) 5,494 31

Cash and Cash Equivalents at Beginning of Year 18,083 12,589 12,558

Cash and Cash Equivalents at End of Year $ 8,211 $ 18,083 $ 12,589

Supplemental Disclosures of Cash Flows Information:Cash paid during the year for:Interest $ 6,298 $ 4,291 $ 1,881Income taxes 5,105 6,731 8,756

The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.

Consolidated Statements of Cash Flows(For the Years Ended September 30)

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Notes to Consolidated Financial Statements

1. Summary of Significant Accounting Policies:

Consolidation and TranslationThe consolidated financial statements include the accountsof MTS Systems Corporation (the Company) and its whollyand majority owned subsidiaries. All significant intercom-pany balances and transactions have been eliminated.

All balance sheet accounts of foreign subsidiaries aretranslated to U.S. dollars at the current exchange rates asof the end of the fiscal year. Income statement items aretranslated at average exchange rates during the year. Theresulting translation adjustment is recorded as a separatecomponent of shareholders’ investment. Gains and lossesfrom translation of foreign currency denominated trans-actions and from foreign exchange hedge contracts areincluded in “Other expense (income) net” in the Consoli-dated Statements of Income and amounted to a loss of$538,000 in 2000, loss of $375,000 in 1999, a gain of$2,340,000 in 1998.

Revenue RecognitionRevenue is recognized upon shipment of equipment whenthe customer’s order can be manufactured and deliveredgenerally in less than twelve months. Revenue on contractsrequiring longer delivery periods (long-term contracts) andother customized orders that permit progress billings isrecognized using the percentage-of-completion methodbased on the cost incurred to date relative to estimatedtotal cost of the contract (cost-to-cost method). The cumu-lative effects of revisions of estimated total contract costsand impact on revenues are recorded in the period in whichthe facts become known. When a loss is anticipated on acontract, the amount is provided currently.

Long-term ContractsThe Company enters into long-term contracts for cus-tomized equipment sold to its customers. Under termsof such contracts, revenue recognized using the percent-age of completion method may not be invoiced untilcompletion of contractual milestones, upon shipment ofthe equipment, or upon installation and acceptance bythe customer. Unbilled amounts for these contracts appearin the Consolidated Balance Sheets as Unbilled Contractsand Retainage Receivable. Amounts unbilled or retainedat September 30, 2000 are expected to be invoiced dur-ing fiscal 2001.

Warranty ObligationsThe Company warrants its products against defects inmaterials and workmanship under normal use and service,generally for one year. The Company maintains reservesfor warranty costs based upon its past experience withwarranty claims.

Research and DevelopmentResearch and product development costs associated withnew products are charged to operations as incurred.

Cash EquivalentsCash equivalents represent short-term liquid investments,which have original maturities of three months or less andapproximate fair value.

Accounts ReceivableThe Company grants credit to customers, but generallydoes not require collateral or other security from domesticcustomers. International receivables, where deemed nec-essary, are supported by letters of credit from bankinginstitutions.

InventoriesInventories consist of material, labor and overhead andare stated at the lower of cost or market, determined bythe first-in, first-out method. Inventory components as ofSeptember 30, were as follows:

2000 1999


Customer projects invarious stages ofcompletion $ 2,704 $ 3,625

Components,assemblies and parts 59,816 53,323

Total $62,520 $56,948

Property and EquipmentProperty and equipment is stated at cost. Additions,replacements and improvements are capitalized at cost,while maintenance and repairs are charged to operationsas incurred. Depreciation is provided over the followingestimated useful lives of the property:Buildings and improvements: 10 to 40 years.Machinery and equipment: 3 to 15 years.

Most major building and equipment purchases are depre-ciated on a straight-line basis for financial reporting pur-poses and on an accelerated basis for income tax purposes.

Derivative Financial InstrumentsThe Company periodically enters into forward exchangecontracts principally to hedge the eventual dollar cash flowof foreign currency denominated transactions (primarily theEURO, British Pound, Swedish Krona, and Japanese Yen).Gains and losses on forward exchange contracts enteredinto to hedge foreign currency denominated undeliveredorders and net exposed assets are included in “Otherexpense (income) net” in the Consolidated Statements ofIncome. The Company‘s accounting policy for these con-tracts is based on the Company‘s designation of foreigncurrency contracts as hedging transactions. The Companydoes not use derivative financial instruments for specula-tive or trading purposes. The criteria the Company usesfor designating a contract as a hedge include the contract‘seffectiveness in risk reduction and matching of contracts tounderlying transactions. On September 30, 2000, therewere open hedge contracts totaling $40,500,000 with anunrealized gain of $389,000. On September 30, 1999, therewere open hedge contracts totaling $7,300,000 with anunrealized loss of $202,000.

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Use of EstimatesThe preparation of financial statements in conformity withaccounting principles generally accepted in the UnitedStates requires management to make estimates andassumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabil-ities at the date of the financial statements and the reportedamounts of revenues and expenses during the reportingperiod. Ultimate results could differ from those estimates.

The Company undertakes significant technological inno-vation on some of its long-term contracts. These contractsinvolve performance risk which may result in delayeddelivery of product and/or in revenue and gross profit vari-ation from difficulties in estimating the ultimate cost ofsuch contracts.

New Accounting StandardsThe Company will adopt Statement of Financial AccountingStandards (SFAS) No. 133, “Accounting for DerivativeInstruments and Hedging Activities,” as amended by SFASNo.138, “Accounting for Certain Derivative Instrumentsand Certain Hedging Activities—an amendment of FASBStatement No. 133,” which becomes effective for fiscalyears beginning after June 15, 2000. Effective October 1,2000, the Company will adopt SFAS No. 133 which requiresthe Company to recognize all derivatives on the balancesheet at fair value. Derivatives that are not hedges must beadjusted to fair value through income. If the derivative is ahedge, depending on the nature of the hedge, changes inthe fair value of the hedged assets, liabilities or firm com-mitments are recognized through earnings or in other com-prehensive income until the hedged item is recognized inearnings. The ineffective portion of a derivative’s changein fair value will be immediately recognized in earnings.The Company has determined that the effect of adoptingSFAS 133 and SFAS 138 is immaterial to the earningsand the financial position of the Company.

In December 1999, the SEC issued Staff AccountingBulletin (SAB) No. 101 “Revenue Recognition in FinancialStatements.” SAB No. 101 provides further guidance onthe recognition, presentation and disclosure of revenue infinancial statements filed with the SEC. SAB No. 101 isrequired for fiscal years beginning after December 15, 1999.SAB No. 101 impacts the timing of revenue recognition forthe Company as it requires customer acceptance as acondition for revenue recognition. The Company is in theprocess of fully evaluating the effect that the adoption ofSAB No. 101 will have on the Company’s consolidatedfinancial position and results of operations. The Companyexpects certain revenues will shift across quarters whenSAB No. 101 is implemented. The Company plans to adoptSAB No. 101 in the fourth quarter of fiscal year 2001.

Other AssetsOther assets consist principally of patents and excess costover net assets acquired (goodwill), net of accumulatedamortization. The carrying value of goodwill less accumu-lated amortization was $24.2 million and $31.6 million in2000 and 1999, respectively. These assets are being amor-tized over various periods ranging from 7 to 40 years.Amortization expense was $3.2 million in 2000, $3.3 millionin 1999 and $1.5 million in 1998.

The Company periodically evaluates whether events andcircumstances have occurred that may affect the estimateduseful life of its goodwill and other long-lived assets. If suchevents or circumstances were to indicate that the carryingamount of these assets would not be recoverable, an impair-ment loss would be recognized. No such impairment hasbeen recognized for the year ended September 30, 2000.

Net Income Per ShareBasic earnings per share is computed by dividing netincome by the weighted average number of commonshares outstanding during the year. Diluted earnings pershare is computed under the treasury stock method andis calculated to compute the dilutive effect of potentialcommon shares related to outstanding stock options.Weighted average common shares and per share com-putations have been restated retroactively for the two-for-one stock split effective February 2, 1998.

2000 1999 1998(expressed in thousands except per share data)

Net income availableto common shareholders 3,624 12,445 21,539

Weighted averagecommon sharesoutstanding 20,842 20,763 20,519

Dilutive potentialcommon shares 93 421 811

Total dilutivecommon shares 20,935 21,184 21,330

Basic net incomeper share $ .17 $ .60 $ 1.05

Diluted net incomeper share .17 .59 1.01

Comprehensive IncomeThe Company follows the provisions of Statement ofFinancial Accounting Standards (SFAS) No. 130, “ReportingComprehensive Income.” This statement establishes rulesfor the reporting of comprehensive income and its compo-nents. Comprehensive income consists of net income andforeign currency translation adjustments and is presented inthe Consolidated Statement of Shareholders’ Investment.

ReclassificationsCertain amounts included in the consolidated financialstatements have been reclassified in prior years to con-form with the 2000 financial statement presentation. Theseamounts had no effect on previously reported shareholder’sinvestment or net income.

Notes to Consolidated Financial Statements(Continued)

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2. Business Segment Information:

The Company follows the provisions of Statement ofFinancial Accounting Standards (SFAS) No.131,“Disclosuresabout Segments on an Enterprise and Related Information.”The management approach designates the internal organi-zation that is used by management for making operatingdecisions and assessing performance as the source of theCompany’s reportable segments. SFAS No. 131 also requiresdisclosures about products and services, geographic areasand major customers. The adoption of SFAS No. 131 didnot affect results of operations or financial condition butdid affect the disclosure of segment information.

The Company is organized into five operating businessunits: Vehicle Testing Systems, Material Testing Systems,Advanced Systems, Automation and Sensors. The VehicleTesting business manufactures and markets systems forvehicle and component manufacturers to aid in the acceler-ation of design development work and to decrease the costof product manufacturing. The Material Testing businessmanufactures and markets systems to aid customers inproduct development and quality control toward an effortof design improvement. The Advanced Systems businessoffers highly customized systems primarily for simulationand manufacturing. The Automation business manufac-tures and markets products for high performance industri-al machine applications in a wide range of industries. TheSensor business manufactures and markets displacementand liquid level sensors used in various applications to

monitor and automate industrial processes. The economiccharacteristics, nature of products and services, productionprocesses, type or class of customer, method of distributionand regulatory environments are similar for the VehicleTesting Systems, Material Testing Systems and AdvancedSystems operating units. As a result of these similarities,these units have been aggregated into one reportable seg-ment called Mechanical Testing and Simulation (MT&S)for financial statement purposes. Also, the economic char-acteristics, nature of products and services, productionprocesses, type or class of customer, method of distributionand regulatory environments are similar for the Automationand Sensor business divisions. As a result, these divisionshave been aggregated into one reportable segment calledFactory Automation (FA).

The accounting policies of the business segments are thesame as those described in Note 1. In evaluating the seg-ment performance, management focuses on income fromoperations. This measurement excludes special charges(e.g. restructuring charges, acquisition expenses, etc.),interest expense, interest income, income tax expenseand other non-operating income or expense. Corporateexpenses are allocated to segments primarily on the basisof revenue. This allocation includes expenses for varioussupport functions such as human resource, informationtechnology and finance. Financial information by reportablesegment follows:

2000 1999 1998(expressed in thousands)

Net Revenue by SegmentMechanical Testing & Simulation $302,353 $313,685 $287,761Factory Automation 89,500 76,857 74,402

Total $391,853 $390,542 $362,163

Income from Operations by SegmentMechanical Testing & SimulationBefore restructuring and acquisition $ 4,460 $ 23,809 $ 25,011Restructuring (1,210) (5,510) —Acquisition — (1,391) —

Total $ 3,250 $ 16,908 $ 25,011

Factory AutomationBefore restructuring and acquisition 8,583 6,630 8,556Restructuring — (201) —

Total $ 8,583 $ 6,429 $ 8,556

Total Income from Operations $ 11,833 $ 23,337 $ 33,567

Identifiable Assets by SegmentMechanical Testing & Simulation $267,666 $272,491 $255,816Factory Automation 62,568 60,856 57,206

Total Assets $330,234 $333,347 $313,022

Other Segment DataMechanical Testing & Simulation:Capital expenditures $ 10,057 $ 13,822 $ 21,251Depreciation and Amortization 11,782 11,028 8,333

Factory Automation:Capital expenditures $ 2,342 $ 2,168 $ 4,668Depreciation and Amortization 3,512 3,396 2,547

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2000 1999 1998

(expressed in thousands)Total Net RevenueUnited States $194,056 $200,556 $200,490Germany 49,771 47,172 37,643Other Europe 60,494 69,185 51,495Far East 69,444 56,897 53,652Other 18,088 16,732 18,883

Total $391,853 $390,542 $362,163

Total Long-Lived AssetsUnited States $235,710 $232,177 $227,816Germany 40,979 42,913 39,882Other Europe 34,325 38,799 30,626Far East 18,474 18,882 14,242Other 746 576 456

Total $330,234 $333,347 $313,022

A geographic summary of the Company’s operations and related year-end asset information for the three years endedSeptember 30 follows:

Revenues by geographic location are based on revenues generated from each country’s operations. No individual country,other than the United States and Germany, exceeded 10% of consolidated revenues on a recurrent annual basis. TheCompany did not have sales to any individual customer greater than 10% of total revenues in 2000, 1999 and 1998.


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Aggregate annual maturities of long-term debt for the next five fiscal years are as follows: 2001—$5,663,000;2002—$5,517,000; 2003—$7,082,000; 2004—$7,665,000;2005—$7,690,000 and $30,150,000 thereafter. The carryingvalue of the Company’s long-term debt at September 30,2000 is approximately $1.6 million higher than the fair mar-ket value at current interest rates offered to the Companyfor debt with the same remaining maturities.

The Company has a $35 million credit agreement with adomestic bank that allows the Company to issue domesticand Euro-currency notes. As part of the same credit agree-ment, the bank has agreed to issue term loans up to amaximum of $10 million until March 30, 2002. This agree-ment provides for repayment of these term loans throughSeptember 2005. The Company compensates the bankwith loan commitment fees for the unused portion of thecredit line. The Company also has a $15 million uncom-mitted line of credit with another bank. In addition, the

Company has standby letter-of-credit lines totaling $30million. At September 30, 2000, standby letters of creditoutstanding totaled $10,566,000.

Under the terms of its credit agreement, the Companyhas agreed, among other matters, that (a) its defined cashflow or fixed charge coverage will exceed a defined mini-mum level; (b) its interest bearing debt will not exceed adefined percentage of total capital; (c) repurchases of itscommon stock will not exceed a maximum amount. AtSeptember 30, 2000, net worth exceeded the defined minimum amount by $29,915,000 and the Company had$17,875,000 available for repurchases of its common stock.Effective September 30, 2000, the Company was in com-pliance with or had obtained waivers or amendments withrespect to all such covenants.

Information on short-term borrowings for the years endedSeptember 30 were as follows:

3. Financing:

Long-term debt as of September 30 was as follows:2000 1999


Variable Rate Note, due May 2015, collateralized by building $ 5,519 $ 1,8376.6% Notes, unsecured, due in July 2008 35,000 35,0005.4% Mortgage, due in October 2015, collateralized by building 4,829 5,7425.3% Note, unsecured, due in March 2003 905 1,5036.0% Note, unsecured, due in May 2008 1,943 1,9437.5% Note, unsecured, due in July 2009 15,000 15,000Other 571 541

Total $63,767 $61,566

Less Current Maturities (5,663) (1,308)

Total Long-Term Debt $58,104 $60,258

2000 1999 1998


Balance outstanding at September 30 $11,945 $10,071 $ 28,243Average balance outstanding 22,617 24,903 23,498Maximum balance outstanding 37,500 34,700 51,216Year-end interest rate 8.1% 6.0% 5.9%Weighted-average interest rate 7.0% 5.7% 6.1%

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4. Income Taxes:

The provision for income taxes for the years ended September 30 consisted of the following:

2000 1999 1998


Current provision (benefit):Federal $(3,469) $ 2,239 $ 6,911State (413) 432 1,129Foreign 5,974 2,773 4,104

Deferred 379 881 (235)

Total provision $ 2,471 $ 6,325 $11,909

A reconciliation from the Federal statutory income tax rate to the Company’s effective rate for the years ended September 30 were as follows:

2000 1999 1998

Statutory rate 35% 35% 35%Tax benefit of Foreign Sales Corporation (9) (3) (2)Foreign provision in excess of U.S. tax rate 32 4 3State income taxes, net of Federal benefit (4) 2 2Research and development tax credits (9) (5) (2)Other, net (4) 1 —

Effective rate 41% 34% 36%

Deferred Tax Asset:2000 1999


Accrued compensation and benefits $ 1,073 $ 1,017Inventory reserves 3,649 2,398Allowance for doubtful accounts 242 194Other assets (1,229) (1,276)

Total Deferred Tax Asset $ 3,735 $ 2,333

Deferred Tax Liability:

Property and equipment $ 5,628 $ 5,517

Net Deferred Tax Liability $ 1,893 $ 3,184


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The following table summarizes information concerning outstanding and exercisable options as of September 30, 2000:

The following number of options will expire if not exer-cised at specific dates for fiscal years as follows: 2001:702,884, 2002: 742,891, 2003: 441,130, 2004: 321,525, 2005:1,054,185, 2006: 362,817.

Prices for options exercised during the three-year periodended September 30, 2000 ranged from $5.78 to $15.75.Total options available for future grant as of September30, 2000 were 2,006,728.

In January 1992 the Company’s shareholders authorizedan Employee Stock Purchase Plan (the Purchase Plan),whereby 1,000,000 shares of the Company’s commonstock were reserved for sale to employees until April 2002.Participants in the 2000 and 1999 phases, all at dates spec-ified in the Purchase Plan, were issued 157,818 shares in2000 and 121,810 shares in 1999. During 2000, participantssubscribed to purchase 179,184 shares at 85% of marketprice for issuance in 2001.

2000 1999 1998

Shares WAEP* Shares WAEP* Shares WAEP*

Outstanding at beginning of year 2,816 $11.21 2,143 $10.30 1,920 $ 8.35

Granted 1,115 $ 7.17 880 $12.95 545 $15.79

Exercised (19) $ 6.44 (138) $ 7.25 (295) $ 6.51

Forfeited (287) $11.30 (69) $13.38 (27) $10.40

Outstanding at end of year 3,625 $ 9.98 2,816 $11.21 2,143 $10.30

Options exercisable at year-end 1,891 $10.23 1,566 $ 9.46 1,156 $ 8.19

Shares in thousands*Weighted-Average Exercise Price

Options Outstanding Options ExercisableWeighted Average Weighted Weighted

Range of Number Remaining Average Number AverageExercise Prices Outstanding Contractual Life* Exercise Price Exercisable Exercise Price

$5.78-7.31 1,300 4.0 $ 6.87 284 $ 5.92

$7.50-10.56 1,056 .8 $ 9.09 1,033 $ 9.08

$11.12-14.63 916 3.9 $13.03 313 $ 12.93

$15.38-19.37 353 2.3 $16.21 261 $ 16.21

Total 3,625 2.9 $ 9.98 1,893 $10.23

Shares in thousands*In Years

5. Stock Options:

The Company has made certain stock-based awards to itsofficers, non-employee directors, and key employees undervarious stock plans. Awards under these plans can includeincentive stock options (qualified), non-qualified stockoptions, stock appreciation rights, restricted stock, deferredstock, and other stock-based and non stock-based awards.

At September 30, 2000, the Company had awarded incen-tive stock options, non-qualified stock options and restrictedstock. These were granted at exercise prices that are 100%of the fair-market value at the day of grant. Beginning oneyear after grant, the options generally can be exercised

proportionately each year for periods of three, four, orsix years, as defined in the respective plans. Options cur-rently expire no later than seven years from the grant date,as defined.

Option holders may exercise options by deliveringCompany stock already owned, cash, or a combination ofstock and cash. The shares tendered in the exchange arecancelled and, therefore, reduce shares issued. During2000 and 1999, option holders exchanged 7,145 and25,029 shares, respectively, of the Company’s stock inpayment of options exercised.

A summary of the status of the Company’s stock option plans as of September 30, 2000, 1999, and 1998, and changesduring the years ended were as follows:

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Pro forma Information: The Company has elected tofollow Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees,” in account-ing for its employee stock options. Under this pronounce-ment, no compensation expense is recognized in theCompany’s financial statements because the exerciseprice of the Company’s employee stock options equals themarket price of the underlying stock on the date of grant.However, Statement of Financial Accounting Standards(SFAS) No. 123, “Accounting for Stock-Based Compensa-tion,” requires the use of option valuation models to esti-mate compensation expense from the granting of employeestock options and to present the pro forma effect of suchexpense on reported net income and earnings per share.

SFAS No. 123 requires this information be determined asif the Company had accounted for employee stock optionsgranted in fiscal years beginning subsequent to December31, 1994 under the fair value method of that statement. Thefair value of options granted, as reported below, has beenestimated at the date of grant using the Black-Scholesoption valuation model with the following weighted aver-age assumptions:

2000 1999 1998

Expected life (in years) 1.8 2.7 2.0Risk-free interest rate 6.0% 5.8% 4.2%Volatility .49 .49 .40Dividend yield 3.4% 2.3% 1.6%

The Black-Scholes option valuation model was developedfor use in estimating the fair value of traded options thathave no vesting restrictions and are fully transferable. Inaddition, option valuation models required the input ofhighly subjective assumptions, including the expectedstock price volatility. The weighted average estimated fairvalue of employee stock options granted during 2000,1999, and 1998 was $2.14, $4.47, and $4.39, respectively.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over theoptions’ vesting period. The Company’s net income, asreported, and pro forma net income per share are as follows(in thousands, except per share amounts):

Stock Option Footnote Disclosure

Years Ended September 30th2000 1999 1998

Net IncomeAs Reported - Basic $3,624 $12,445 $21,539Pro forma $2,216 $10,553 $20,247

Basic Earnings Per ShareAs Reported $ .17 $ .60 $ 1.05Pro forma $ .11 $ .51 $ .99

Diluted Earnings Per Share As Reported $ .17 $ .59 $ 1.01Pro forma $ .11 $ .50 $ .95

6. Employee Benefit Plans:

The Company offers a 401(k) Pay Conversion Plan for all ofits U.S. employees. Employees can supplement their retire-ment income by participating in this voluntary pretax sav-ings plan by designating a percentage of their gross income,subject to limitations imposed by federal law. The Companywill match $.50 per each dollar of the first 3% that employ-ees contribute capped at $500 per fiscal year. Employeesare automatically vested. The matching contributionsunder the 401(K) plan were $843,000 in 2000, $730,000 in1999, and $557,000 in 1998.

The Company’s profit sharing plan functions as a retire-ment program for most U.S. and certain internationalemployees. Employees who have completed 1,000 hoursof service during the plan year are eligible to participate.The formula for calculating the Company’s contribution isapproved annually by the Board of Directors and is basedprimarily on operating results for the year, before manage-ment variable compensation. The plan provides for a mini-mum contribution of 4% of participant compensation, asdefined, up to the social security taxable wage base, and8% of participant compensation in excess of the taxablewage base up to the maximum profit sharing contributionallowed by federal law, so long as the entire contributioncalculation does not exceed pretax income. The contribu-tions were 4.4% of participant compensation in 2000, 4.3%in 1999 and 4.4% in 1998. The provisions for profit sharingwere $4,396,000 in 2000, $3,883,000 in 1999 and $3,577,000in 1998, and are distributed among the various operatingexpenses shown in the accompanying ConsolidatedStatements of Income.

Prior to 1998, two of the Company’s international sub-sidiaries had noncontributory, unfunded retirement plansfor eligible employees. These plans provide benefits basedon the employee’s years of service and compensation dur-ing the years immediately preceding retirement, earlyretirement, termination, disability, or death, as defined inthe respective plans. In 1998, one of the plans was modi-fied to provide for contributions based solely on annualcompensation levels.


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The expenses for these plans consist of the following components:2000 1999 1998


Service cost-benefit earned during the period $ 188 $209 $ 178Interest cost on projected benefit obligation 235 249 218Net amortization and deferral 50 17 11

Net Periodic Pension Cost $ 473 $475 $ 407

The change in benefit obligation and plan assets consisted of the following for the years ended September 30, 2000 and 1999.2000 1999

(expressed in thousands)Change in benefit obligation:Projected benefit obligation, beginning of year $ 5,877 $ 5,110

Service cost 177 173Interest cost 211 212Translation difference (156) 80Actuarial (gain) loss 49 332Benefits paid (38) (30)

Projected benefit obligation, end of year 6,120 $ 5,877

Change in plan assets:Fair value of plan assets, beginning of year $ — $ —

Actual return on plan assets — —Employer contributions 38 30Benefits paid (38) (30)

Fair value of plan assets, end of year $ — $ —

The funded status of the Company‘s benefit plans and the amounts recognizedin the consolidated financial statements are:

2000 1999


Funded status (6,120) (5,877)Unrecognized net gain (31) (88 )Unrecognized net liability being amortized 528 536Adjustment required to recognize minimum liability (34) (33)

Accrued Pension Liability $ (5,657) $(5,462)

Major assumptions at year-end are:Discount rate 3.5 to 6.0% 3.5 to 6.0%Rate of increase in future compensation levels 3% 3.0%

7. Acquisitions:

On May 28, 1999, the Company completed a merger withDSP Technology, Inc. (DSP), an enterprise that is active inautomotive engine development market segments. Underthe terms of the agreement, the Company initially issued2,076,913 shares of common stock and subsequently issuedan additional 792 shares of common stock in exchange forall of the outstanding shares and vested stock options ofDSPs’ common stock. In connection with the acquisition,the Company incurred approximately $1.4 million of acqui-sition related costs which were charged to operations inthe third quarter of fiscal year 1999. The acquisition quali-fied as a tax-free exchange and was accounted for as apooling-of-interests. Accordingly, all periods included inthese historical consolidated financial statements havebeen restated to give effect to the merger.

1999 1998

(expressed in thousands )

Net Revenue:MTS $362,708 $339,682DSP 27,834 22,481

Combined Net Revenue $390,542 $362,163

Income before income taxes (note A):MTS $ 18,445 $ 31,473DSP 325 1,975

Combined income before income taxes $ 18,770 $ 33,448

Note A: 1999 amounts include $0.3 million and $1.1 million in acquisition relatedcost for the Company and DSP, respectively.

No significant adjustments were made to the prioryears financial statements of either the Company or DSP.

On September 29, 1999 the Company acquired the exclu-sive license for the PowerBlok product line technology,related inventory and fixed assets, and trade names fromSemipower, Inc. The transaction was accounted for by thepurchase method of accounting.

In fiscal 1998 the Company acquired three entities, allaccounted for by the purchase method of accounting, withan aggregate purchase price of approximately $29 million,net of cash acquired. The Company acquired all the out-standing stock of Performance Controls, Inc., a manufac-turer of high performance power amplifiers for factoryautomation and magnetic resonance machine applications,in an all cash transaction. The Company acquired the stockof Nano Instruments Inc., a manufacturer of instrumentedindentation systems for ultra-low force nanoindentationtesting surfaces and thin films, for cash and debt. In addi-tion to the stock purchase of Nano Instruments Inc., the

Company purchased the rights to a patent from the twoprincipal shareholders of Nano Instruments, Inc. TheCompany also acquired the assets and technology ofSDRC’s noise and vibration test software business alongwith a major portion of SDRC’s noise and vibration con-sulting engineering services, in an all cash transaction.

The total purchase price exceeded the fair value of thenet assets acquired by approximately $23.2 million. Thisamount was recorded as goodwill and other intangibleswith useful lives between 7 and 20 years. The results of theoperations of the acquired companies are included in theCompany’s financial statements for the periods in whichthey were owned.

The pro forma results, exclusive of the DSP merger, for1999 and 1998, assuming these acquisitions had beenmade at the beginning of the year, would not be materiallydifferent from reported results.

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8. Restructuring and Other Charges:

The Company has taken a series of actions to better alignits organizational structure with market elements, improveoperational performance and reduce costs. In 1999, theCompany recorded a restructuring charge of $5.7 million.The Company paid $3.1 million in 2000 and $2.6 million in1999 related to such charges. These charges were theresult of the closure of our manufacturing operations inFrance and the transfer of product to the electromechani-cal test division in Raleigh, North Carolina.

In the fourth quarter of 2000, the Company announced arestructuring charge related to the discontinuation of a lineof data acquisition products acquired as part of the DSPTtransaction in 1999. A pre-tax provision of $3.0 million($0.8 per share), of which $1.8 million was charged to gen-eral and administrative expense, was established for thewind-down of this business. While we expect no materialimpact to the Company going forward, this action reflectsour continuing efforts to focus our investments on thosebusinesses critical to our long-term strategic success.

9. Commitments and Contingencies:

Litigation: The Company is a party to various claims, legalactions and complaints arising in the ordinary course ofbusiness. It is the opinion of management that the finalresolution of these matters will not have a material adverseeffect on the financial position or results of operation ofthe Company.

Leases: The Company has noncancelable operating leasecommitments for equipment and facilities that expire onvarious dates through 2006. Minimum annual rental com-mitments at September 30,2000 for the fiscal years 2001through 2005 and thereafter are $4.9, $5.0, $4.4, $3.2, $2.4and $2.9 million, respectively. Total lease expense was$3.9 million in 2000, $4.2 million in 1999, and $3.1 millionin 1998.


33

Reports on Consolidated Financial Statements

Report of Independent Public AccountantsTo MTS Systems Corporation:

We have audited the accompanying consolidated balancesheets of MTS Systems Corporation (a Minnesota corpora-tion) and Subsidiaries as of September 30, 2000 and 1999,and the related consolidated statements of income, share-holders‘ investment and cash flows for each of the threeyears in the period ended September 30, 2000. These finan-cial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinionon these financial statements based on our audits.

We conducted our audits in accordance with auditingstandards generally accepted in the United States. Thosestandards require that we plan and perform the audit toobtain reasonable assurance about whether the financialstatements are free of material misstatement. An auditincludes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements.An audit also includes assessing the accounting principlesused and significant estimates made by management, as

Report of Management

The management of MTS Systems Corporation is respon-sible for the integrity and objectivity of the financial infor-mation presented in this report. The financial statementshave been prepared in accordance with generally acceptedaccounting principles and include certain amounts basedon management’s best estimates and judgment.

Management is also responsible for establishing andmaintaining the Company’s accounting systems and relat-ed internal controls, which are designed to provide reason-able assurance that assets are safeguarded, transactionsare properly recorded, and the policies and procedures areimplemented by qualified personnel.

The Audit Committee of the Board of Directors, which iscomprised solely of outside directors, meets regularly withmanagement and its independent auditors to review auditactivities, internal controls, and other accounting, reporting,and financial matters. This Committee also recommendsindependent auditors for appointment by the full Board,subject to shareholder ratification.

Sidney W. Emery, JrChairman and Chief Executive Officer

David E. HoffmanVice President andChief Financial Officer

well as evaluating the overall financial statement presenta-tion. We believe that our audits provide a reasonable basisfor our opinion.

In our opinion, the consolidated financial statementsreferred to above present fairly, in all material respects,the financial position of MTS Systems Corporation andSubsidiaries as of September 30, 2000 and 1999, and theresults of their operations and their cash flows for each ofthe three years in the period ended September 30, 2000 inconformity with accounting principles generally acceptedin the United States.

ARTHUR ANDERSEN LLP

Minneapolis, Minnesota,November 28, 2000

The financial statements included in this annual reporthave been audited by Arthur Andersen LLP, independentpublic accountants. We have been advised that their auditswere conducted in accordance with generally acceptedauditing standards and included such reviews of internalcontrols and tests of transactions as they considered nec-essary in setting the scope of their audits.

34

Corporate Information

Board of DirectorsSidney W. Emery, Jr.Chairman and Chief Executive OfficerMTS Systems Corporation

Charles A. BrickmanPresident Pinnacle Capital Corporation

Jean-Lou ChameauDean, College of Engineering Georgia Institute of Technology

Bobby I. GriffinConsultant; formerly Executive Vice President Medtronic, Inc.

Russell A. GullottiPrivate Investor, formerlyChairman, President, Chief Executive Officer National Computer Systems

Brendan C. HegartyConsultant; formerly Executive Vice President andChief Operating Officer,Seagate

Linda Hall Whitman, Ph.DConsultant; formerly President Ceridian Performance Partners

Executive ManagementSidney W. Emery, Jr.Chairman and Chief Executive Officer

William G. AndersonVice President Automation Division

Steven M. CohoonVice PresidentVehicle Dynamics Division

Kelly H. Donaldson, Jr.Vice PresidentStrategic Planning and Product Management

James M. EgerdalVice PresidentService & Support Division

Laura B. HamiltonVice PresidentMaterial Testing and Aerospace Division

David E. HoffmanVice PresidentChief Financial Officer

Donald G. KrantzVice President, AdvancedEngineering Solutions Division

Werner OngyertVice PresidentEurope

Kathleen M. StabyVice PresidentHuman Resources

Mauro TogneriVice President Sensors Division

M. Perry WalravenVice PresidentElectromechanical MaterialTesting Division

Ryoji YamaguchiVice President Asia/Pacific

Keith D. ZellExecutive Vice PresidentModeling, Analysis andPowertrain

Divisional OfficersFrank G. ArcellaPresident, AeroMet Corporation

Corporate OfficersBarbara J. CarpenterAssistant Corporate SecretaryJohn R. HoustonSecretaryPartner, Robins, Kaplan, Miller &Ciresi LLP

Thomas J. MinnemanTreasurer

ReferencesBank ReferenceUS BankMinneapolis, MN

Transfer AgentWells Fargo Bank Minnesota, N.A.South St. Paul, MNShareholder Assistance: 800-468-9716

General CounselRobins, Kaplan, Miller & Ciresi LLPMinneapolis, MN

Patent CounselWestman, Champlin & KellyMinneapolis, MN

Independent PublicAccountantsArthur Andersen LLPMinneapolis, MN

Notice of Annual MeetingThe annual meeting ofstockholders will be held at5:00 p.m. (Central StandardTime) on Tuesday, January 30, 2001 at theCompany’s Headquarters in Eden Prairie, Minnesota.Stockholders who cannotattend the meeting are urgedto exercise their right to voteby proxy. A proxy card, aproxy statement, and areturn envelope are enclosedfor this purpose.

10-K Report and OtherFinancial InformationCopies of the Annual Reporton Form 10-K, filed with theSecurities and ExchangeCommission are availableon request without charge.MTS Systems Corporation14000 Technology DriveEden Prairie, Minnesota55344-2290.Telephone: 952-937-4213

Common StockMTS Systems Corporation’scommon stock publiclytrades on The Nasdaq StockMarket’s National Marketunder the symbol “MTSC”.

For News Releases andOther InformationOur latest news releasesare available on the World Wide Web athttp://www.mts.com.

Investor RelationsSecurities analysts, portfoliomanagers, and representa-tives of financial institutionsseeking information aboutthe Company should directtheir inquiries to:Thomas J. Minneman Treasurer and Manager ofInvestor RelationsMTS Systems Corporation 14000 Technology DriveEden Prairie, Minnesota55344-2290.Telephone: 952-937-4647Email:[email protected]

Dividend Reinvestment PlanUnder the plan, sharehold-ers can invest MTS Systemsdividends in additionalshares of MTS stock andmake periodic voluntarycash investments for thepurchase of MTS stock.

Both alternatives bear anominal transaction chargewhich is netted against thefunds used to purchaseshares of MTS stock.Shareholders may obtain abrochure giving furtherdetails by calling NorwestShareholder Services at 800-468-9716.

TrademarksMTS, RPC, SWIFT, Flat-Trac, and Temposonics areregistered trademarks;PowerBlok, MAST, EDM,TestLine, EmpiricalDynamics, Virtual Test Lab,Jury Evaluation, SoundQuality, BaseLine, Aero-90,AeroPro, TestStar, andMaxPlus are trademarks,and Lasform is a service-mark of MTS SystemsCorporation.

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100-049-672 PRINTED IN U.S.A. 1200©2000 MTS SYSTEMS CORPORATION

Corporate HeadquartersMTS Systems Corporation14000 Technology DriveEden Prairie, Minnesota 55344-2290Telephone: [email protected]

North American SubsidiariesAeroMet Corporation

International SubsidiariesMTS International Ltd. (Barbados, West Indies)

MTS (Japan) Ltd.MTS Systems (China) Inc.MTS Systems GmbH (Berlin)MTS Systems (Hong Kong) Inc.MTS Systems Limited (UK)MTS Systems Norden AB (Sweden)MTS Systems SRL (Italy)MTS Sensors Technologie GmbH and Co. KG (Germany)

MTS Sensors Technology K.K. (Japan)MTS Testing Systems (Canada) Ltd.MTS Korea, Inc.MTS Holdings, SARL (France)MTS Systems (France)MTS Systems (Singapore) Pte Ltd.MTS Systems do BrazilMTS Services Ltd. (Japan)MTS Automotive Sensors GmbHMTS Sensor Technology Verwaltungs GmbH and Co. KG

MTS Systems Holdings for Europe GmbHCustom Servo Motors Antriebstechnik Verwaltungs GmbH

Custom Servo Motors AntriebstechnikGmbH & Co. KG

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