MTS Systems Corporation - Managing Technology for Growth · 2015. 8. 6. · In 1998 MTS once again...

1998 Annual Report to Shareholders

Managing Technology for Growth

m

1

1998 1997 Change(expressed in thousands except per share data)

Net revenue $ 339,682 $303,480 11.9%

Net income $ 20,766 $18,2091 14.0%

Net income per share $ 1.08 $ .961,2 12.5%

Return on sales 6.1% 6.0%1

Return on beginning share-holders’ investment per share 15.8% 15.6%1

Return on average net assets 20.9% 22.9%1

Dividends per share $ .24 $ .202 20.0%

Shareholders’ investment per share $ 7.70 $ 6.822 18.1%

Long-term capitalization ratio 24.0% 5.7%

Weighted average shares outstanding (000’s) 19,252 18,9562

New orders $ 332,998 $356,123 (6.5%)

Backlog of orders at year end $ 175,439 $175,841

1 Excludes an after-tax gain of $2,654,000 from the sale of land in May 1997, which is equal to $.14 per share2 Restated retroactively for the two-for-one stock split effective February 2, 1998

Return on BeginningShareholders’Investment per Share

9.0%10.5% 12.8% 15.6%1 15.8%94 95 96 97 98

$201 $234 $261 $303 $34094 95 96 97 98

$8.7 $10.5 $14.1 $18.21 $20.894 95 96 97 98

Financial Highlights

Backlog ofOrders$ Million

$85 $99 $120 $176 $17594 95 96 97 98

Net Incomeper Share

$.46 $.58 $.74 $.961 $1.0894 95 96 97 98

Net Revenue$ Million

Net Income$ Million

In 1998 MTS once again demon-

strated that technology leadership

focused on solving customers’

problems leads to strong financial

performance—even during unset-

tled market conditions.

MTS established three long-term

objectives during 1998 that set the

tone for both this year’s results and

those anticipated for the future.

' We seek profitable growth: 12 to 15

percent top line, 14 to 18 percent

bottom line, and 21 percent return

on average net assets. This would

put us in the half-billion-dollar rev-

enue range by the year 2001.

' Second, we lead technologically

in each business and effectively

leverage these technologies into

new markets and solutions. In

effect, we said we should be excep-

tionally good at recognizing both

market trends and customer needs

where our technological strengths

would differentiate MTS from all

competitors.

' Third, we want to ensure that MTS is

a fun and exciting place to work—

where people are passionately

involved in what they make or

design, where customers are enthu-

siastic about doing business with us,

where innovation and creativity are

valued skills, and where teamwork

across the globe is a way of life.

We believe that by managing our

technology well, we could indeed

achieve exciting and profitable

growth for everyone: our share-

holders, customers, and employees.

During 1998 we met many of those

goals. For the year we achieved 11.9

percent revenue growth and 12.5 per-

cent earnings per share growth despite

the economic slowdown that occurred

first in Asia then in North America.

The largest revenue gains occurred in

our Factory Automation Sector—

achieving an 18 percent growth rate,

while pretax profit margins were up

64 percent. The much larger

Mechanical Testing and Simulation

Sector achieved a 10 percent top line

growth, with a 2 percent improvement

in profit margins.

Return on average net assets—the

company’s internal measurement of

how well we employ all our invest-

ment assets—dipped to 20.9 percent

versus 22.9 percent last year. This

reflects the impact of increased good-

will from acquisitions and extensive

ongoing investments to replace our

internal business systems with those

purchased from SAP America, Inc.

One disappointment in 1998 was the

reduced level of orders in the vehi-

Shown left to right:

William G. AndersonVice PresidentMTS Automation Division

Daniel T. SparksVice President Material Testing Division

Sidney W. Emery, Jr.President and Chief Executive Officer

Mauro TogneriVice PresidentSensors Division

Keith D. ZellExecutive Vice PresidentMechanical Testing and Simulation Sector

Hal J. GalvinVice PresidentCorporate Business Development

William G. BeduhnVice President Advanced Engineering Solutions Division

Marshall L. CarpenterVice President and Chief Financial Officer

Bruce M. HebeisenManagerHuman Resources

Letter to Shareholders

Another Record Year . . .

2

Don Sullivan—Building Value Through Leadership

cles business. Coming off three con-

secutive record revenue years, we

had planned for a lower growth rate

when in fact our new bookings

dropped by more than 20 percent.

As a result, and looking forward to

flat markets worldwide in both

vehicles and civil construction, we

decided to trim investment and

infrastructure. After the close of the

year, we announced a restructuring

program as part of our plan to

reduce annual operating expenses

by $10 million.

Yet 1998 was an exceptional year for

expanding our product base, through

both acquisitions and internal devel-

opment, setting the stage for further

growth. We completed three acquisi-

tions: Nano Instruments, a world

leader in measuring the mechanical

properties of thin films and surface

coatings; Performance Controls, a

strong market player in high power

drives for the automation market; and,

on the last day of the fiscal year, the

noise and vibration software business

of Structural Dynamics Research

Corporation. Together, these additions

will bring nearly $30 million of prof-

itable new business to MTS in 1999.

We introduced our broadest ever set

of new products and components in

1998. They include new low-force

actuators, a state-of-the-art line of

digital controllers for factory automa-

tion, a family of quiet hydraulic

pumps, revolutionary wheel force

transducers, a microforce material

testing system, and an array of bio-

mechanical testing products covering

everything from hip simulators to

knee joint testers to chewing

mechanics machines.

Finally, our AeroMetSM subsidiary is

progressing right on plan. Since

start-up in the first quarter, this

development-stage company has

received orders from major aircraft

manufacturers around the world for

proof of concept demonstrations.

Early results are encouraging.

The past year was an exciting and

successful one for MTS. Indeed, we

delivered another year of record rev-

enues and profits. We have a new

President and CEO in position since

March and the top management tran-

sition is progressing well. We have

great expectations for MTS, its

employees, and its shareholders and

have managed our technology

toward continued profitable growth.

Donald M. Sullivan

Chairman

Sidney W. Emery, Jr.

President and Chief Executive Officer

In March 1998, the Board of Directors announced theappointment of Sidney W. Emery, Jr., to the positions ofcompany president and chief executive officer, succeed-ing Donald M. Sullivan.

Don Sullivan held these positions since 1982 and1987 respectively. He has been chairman since1994, a position from which he plans to retire afterthe January 1999 Board of Directors election.

During his tenure at the helm of MTS, Don has ledthe company through a period of dramatic growth.He has managed the company through both tur-bulent times and periods of rapid expansionmarked by growing profitability.

Under Don’s leadership, we expanded ourbusiness through technological innovation,

leveraging those technology investments into new markets,and complementing the core business through selective

strategic acquisitions. It was Don’s vision that saw oppor-tunities in factory automation which led to the company’s

successful entry into, and fast growth in, this market.His grasp of the big picture also led to our aggressiveexpansion into the global marketplace.

In 1987, when Don became chief executive officer, the company reported revenues of $112 million and

net income of $7.1 million. Revenues and earnings haveabout tripled since that time.

His seemingly boundless energy and personal commit-ment to MTS become immediately apparent to all whowork closely with him. His contributions are deeplyappreciated and his enthusiasm will be sorely missed.

4

Since 1966, MTS Systems Corporation has been the world’s

leading supplier of mechanical testing and simulation equip-

ment. Whether it’s used to test delicate electronics, repro-

duce the force of an earthquake, or automate an assembly

line, MTS equipment helps ensure the quality and safety of

countless products and structures used every day by people

throughout the world.

The World of MTS

Material Testing

Vehicle Dynamics

Aerospace

Software Products

Factory Automation

Advanced Engineering Solutions

Civil Engineering

6

Performance in our MT&S sector was mixed

in 1998. Revenues grew by 10.3 percent,

in line with our plans. However, pretax

earnings growth was less than expected,

at 2 percent. We did very well in our tradi-

tional strongholds of vehicle dynamics

and material testing, growing their com-

bined revenue by 14.4 percent and earn-

ings by over 60 percent. Our acquisition of

Nano Instruments in May provided a small

but important portion of this growth.

However, revenue declines and cost over-

runs in several of our project niches kept

us from maintaining the stellar earnings

produced in 1997.

Our strategy in this sector is focused on

expanding our technology base of hard-

ware, software, and services that help

customers reduce the time and cost of

product development. In line with this

approach, we entered into numerous

alliances with providers of mechanical

design analysis software. As the year

closed we acquired the noise and vibra-

tion software assets of Structural

Dynamics Research Corporation (SDRC).

— Keith ZellExecutive Vice PresidentMechanical Testing and Simulation

Mechanical Testing and Simulation Sector

Vehicle DynamicsOrder growth in vehicle dynamics systems

slowed in 1998, primarily influenced by the Asian

financial turmoil. This was partially offset by an

upswing in Europe and by significant large

orders from both new and existing customers.

Order rates increased in the fourth quarter, and

forecasts are strong for the foreseeable future.

Several industry trends are driving our growth:

' Collapsing product development time is the

primary customer driver. Customers are achiev-

ing this goal by increasing laboratory testing,

as opposed to relying exclusively on test

tracks, and through computer-based analysis

or “virtual engineering.” Computer analysis

affords us the opportunity to offer systems

and analysis capabilities that increase the value

of this virtual engineering. Our growth in

this area has significantly outpaced growth in

traditional durability testing systems.

' Escalation of consumer expectations for econ-

omy, durability, performance, and safety often

place conflicting demands on vehicle design-

ers. Increasingly sophisticated test systems are

required to understand trade-offs and compro-

mises. This situation has created a natural

upgrade market for all of our systems.

' Customer outsourcing of subsystem and com-

ponent manufacturing has created a new class

of customers. Predominantly auto industry

suppliers, they are accepting greater responsi-

bility for subsystem design, development, and

validation. Our total solutions, including test

systems, consulting, and training, make us

natural partners for these customers.

' Increased demand from nontraditional cus-

tomers such as motorcycle manufacturers,

Financial Comparison

1998 1997 1996

Revenue $265,612 $240,706 $212,763

PretaxEarnings $ 24,558 $ 24,1531 $ 15,299

Percent of 9.2% 10.0% 7.2%Revenue

1Excludes $4.3 million pretax gain on sale of land

MTS Acquires Noise and Vibration Software BusinessIn September we announced the acquisitionof the I-DEAS™ noise and vibration test soft-ware and services businesses from StructuralDynamics Research Corporation (SDRC™). Thisacquisition gives us a significant presence in the noise and vibration market, whichincludes a variety of industries that evaluatethe vibration characteristics of mechanicalsystems during product development.

Our initial focus for this business will be in the ground vehicles industry. The acquisitionenhances the position established by our MTS

Engineering Office™ software, which we havemarketed to the ground vehicles industrysince 1997. The I-DEAS noise and vibrationsoftware provides advanced analysis capabili-ties that complement our mechanical simula-tion systems to provide the industry with atotal solution for noise, vibration, and harsh-ness evaluations.

motorsports participants, and the rail industry

are counter-cyclical to automotive industry dri-

ven growth.

Investments in 1998, which we believe will fuel

growth in 1999 and beyond, included:

' New crash simulation techniques to help cus-

tomers develop products more quickly that

meet and exceed consumer expectations for

frontal and side impact. We believe that con-

sumer demands for safer vehicles will drive

automotive investment in this area at a rate

well above that of other markets.

' Development of new and enhanced products

for the durability market to increase efficiency

and reduce development cycle time. These

products included new software, electronic

controls, and the SWIFT™ transducer family.

Motorcycle TestingCruising into New MarketsTo produce competitive products, automakersneed to assess the performance, durability, andhandling of new car designs. Motorcycle manu-facturers need to test their products for the samecharacteristics. Until now the only choice formotorcycle testing was the test track, a time-consuming and limited tool.

But now there is an alternative. When the U.S.motorcycle manufacturer Harley-Davidson®

approached us about their need for a motorcycletest system, we met the challenge. Our experi-ence in vehicle fixturing, test control systems,and road-simulation software made us a naturalchoice for developing such a system. Harley-Davidson knew aboutour capabilities fromprevious work involv-ing test systems formotorcycle compo-nents and subsystems.

The custom systemthat we developed forHarley-Davidson mettheir requirements andis now in use at the company’s development facili-ties in Milwaukee, Wisconsin. We have since lever-aged this experience into a standard test systemfor various types of two-wheeled vehicles. Thissystem delivers to motorcycle and scooter manu-facturers around the world the same advantagesthat our other vehicle test systems deliver to carand truck manufacturers: faster time to market andimproved product quality.

™

8


The SWIFTTransducerTaking It on the RoadAutomotive engineers around the world rely onour road simulators to determine the forces thatimpinge on vehicles when they are driven over awide range of surfaces. But until now engineershave had a difficult time acquiring force datadirectly from rotating wheels. This typicallyrequires an elaborate and time-consuming instru-mentation of a vehicle’s suspension system. Toprovide an alternative to this inefficient and unreli-able process, we developed the SWIFT wheelforce transducer.

The Spinning Wheel Integrated Force Transducer(SWIFT) technology allows multiple force andmoment measurements to be taken directlyfrom a rotating spindle. SWIFT technology savesengineers weeks and evenmonths of preparation eachtime a prototype is evaluated.The SWIFT transducer providesreliable, low-noise data fromeither a test track or laboratoryroad simulator.

The convenience, speed, and accuracy of theSWIFT transducer surpass the capabilities of anycompeting product on the market today. Inrecognition of its innovative design, the SWIFT

transducer received an MHTA LASER award fromthe Minnesota High Technology Association. Byleveraging our knowledge of force transducertechnology and an innovative package design,we were able to bring a fundamentally newproduct to market quickly and with a minimalinvestment. The result is a new tool that helpsour automotive customers produce safer, morecomfortable, and more durable vehicles.

' The acquisition of the I-DEAS™ noise and

vibration test software and services business-

es from Structural Dynamics Research Cor-

poration (SDRC), as well as new releases of

the MTS Engineering Office™ software.

' Continued investment in a complete line of

solutions for the powertrain market, includ-

ing test systems for engines and for power-

train subsystems, such as transmissions, axles,

and driveshafts.

Operational improvements concentrated on

a worldwide operations team that was put in

place at the beginning of 1998. The team has

focused on the following areas:

' Increased pre-engineering or standardization

of custom systems to improve margins and

shorten delivery cycles.

' More efficient use of facilities in Detroit,

Berlin, and Tokyo to increase local content

and to lower costs.

' Improvements in the component design, manu-

facturing, and delivery processes to dramatically

improve on-time delivery performance.

Although we do not have a single competitor

across all of our markets, we see common trends

among competitors. One is mergers, acquisitions,

and partnerships. Like our competitors, we have

pursued alliances to help us offer enterprise-wide

solutions. In the short term, the primary competi-

tive influence that we forecast is increased pric-

ing pressure in a market share battle. Coupling

the results of the above initiatives with a large

installed base, strong customer relationships, and

technically superior products, we believe we are

strongly positioned to win this battle.

Going into 1999, our primary objective is to

maintain the increased order levels experienced

in the fourth quarter of 1998. Based on high lev-

els of inquiries, as well as the availability of new

products and offerings described above, we are

confident that we will meet this objective.

SilentFlo PumpsHydraulic Power Comes CleanHydraulic oil under pressure is the preferred powersource for our dynamic testing systems, as well asfor commercial elevators, manufacturing equip-ment, and countless other applications. Hydraulicpower provides unmatched dynamic control andfeedback capabilities, along with very high forces.However, hydraulic power units are notoriouslynoisy, and they invariably leak oil, which can posesafety hazards and expose users to substantialclean-up costs. For these reasons, hydraulic pumpsare isolated in special sound-dampening rooms thatcan cost tens of thousands of dollars to build.

To overcome the drawbacks of traditional pumps, wedeveloped the SilentFlo™ hydraulic power unit, aclean, quiet power source that eliminates the needfor a separate pump room. The SilentFlo power unit’sunique design eliminates leakage and minimizesnoise through the use of multiple sound-absorbingtechnologies. Without the need for a separate pumproom, customers are free to place the units near theequipment they power. The SilentFlo pump presentsan outstanding opportunity for customers to cut theiroperating costs by reducing facility costs, ventilation,and hydraulic distribution piping.

Introduced during our fiscal fourth quarter, theSilentFlo hydraulic power unit allows us to providecustomers with more versatile and easy-to-maintaintesting and simulation systems and opens newopportunities for us to provide hydraulic power totesting and industrial markets around the world.

AerospaceOur North American and European aerospace

business remained strong, with Europe provid-

ing growth that made up for weakness in Asia.

Business with large airframe manufacturers

slowed, but outsourcing and a resurgence in

the general aviation market buoyed sales and

revenues, keeping our aerospace business on

plan. Our solid reputation with large commer-

cial manufacturers helped us sign significant

orders from new customers in the general avia-

tion and business jet markets.

Consolidation among aerospace companies

generally has delayed capital spending due to

redundant capacity and pressure to reduce cost

structures. Countering this trend, however, is a

drive to outsource for equipment and services.

Our strategy of customer intimacy has helped

us maintain strong sales in this rapidly chang-

ing environment.

Another significant development is the trend

among prime contractors to require their sup-

pliers to validate designs and certify compo-

nents. This trend has made component and

subassembly testing among suppliers the fastest

growing segment of our aerospace business. To

help us address this opportunity, while control-

ling development costs, our next-generation

aerospace control systems will provide a more

open architecture and leverage investments

made at the corporate level in standard control

system platforms, which include technologies

ideally suited for component testing. The use of

more standard systems will enable us to not

only reduce costs, but also provide customers

with broader software options.

Growing demand for commercial air travel,

increased activity in space development, and

expansion of the commuter and general avia-

tion sectors will provide us with ongoing

growth opportunities. We expect increased

orders from our aerospace business in 1999,

with continued growth in profitability.

10

Advanced Engineering SolutionsRevenues and profits were solidly above plan for

our advanced engineering business, though down

significantly from 1997.

This segment of our business supplies

advanced equipment and services primarily

of five types:

' Systems that reproduce seismic events

' Systems that reproduce ocean waves

' Systems that reproduce high-energy

shock pulses

' Systems that meet the simulation needs of the

U.S. government.

' Systems that use advanced technology for

manufacturing.

We shipped and installed unique equipment dur-

ing the year in all of these market niches. In par-

ticular, we made good technical progress in the

development of large high-performance motion

systems for simulating full-scale military vehicle

movement, passenger car motions, and full-scale

tire testing systems for military and civilian appli-

cations. These new systems offer our customers

a much higher grade of simulation capability

than that available from any other supplier.

New orders were slightly under plan globally.

New orders from Asia were only 30 percent of

plan. We were able to refocus our sales and

marketing efforts onto other markets to mini-

mize the overall impact on our business.

During the year we received significant contracts

for systems that could result in the development

of three new business areas for the company:

' A high-speed ground plane system to be

incorporated into new and existing high-per-

formance wind tunnels. These wind tunnels

AeroMetForging Ahead with Titanium DepositionIts strength-to-weight ratio and corrosion resis-tance have made titanium the metal of choice forproducing a range of products, from aircraft bulk-heads to golf clubs. Soaring demand is goodnews for manufacturers but puts pressure onthem to deliver parts faster. Unfortunately, tradi-tional methods of casting and forging titaniumare slow and wasteful.

As an alternative to these methods, and in coop-eration with researchers from leading public andprivate research organizations, we developed and are now commercializing an innovative laserdirect metal deposition process for manufactur-ing titanium parts.

The process uses a laserto fuse titanium powder,layer upon layer, into sol-id structures. The resultis a near-final shape thatrequires only minimalmachining. This comput-er-driven process collaps-es to mere hours theproduction of large, com-plex parts that can require a year or more toproduce by conventional methods.

To bring this technology to market, we estab-lished a wholly owned subsidiary, AeroMetCorporation. AeroMet has evaluation contracts inplace with Boeing, Lockheed Martin, andNorthrup Grumman. Successful evaluation ofparts by these customers is an important step onthe way to realizing the AeroMet premise: A rev-olutionary new process that could obsolete exist-ing titanium product manufacturing methods,thereby creating an explosive new business.


EntertainmentFor the Thrill of ItOur precise motion and control technologieshave enabled us to create equipment that plays a central role in assuring the quality of automo-biles, aircraft, civil structures, and many othercommercial goods and large structures. But ourcore technologies have even wider applications.

Rides and show systems for the theme parkindustry is one example. This fast-growing indus-try continually seeks safe new thrills for park visi-tors, and MTS is uniquely capable of meeting thisneed. The same actuation and electronic controlcapabilities that enable us to simulate earthquakesand test automotive suspension systems enableus to engineer ride vehicles, complex animatedfigures, and other attractions and subsystems forthe world’s theme parks.

This new business initiative has grown rapidly. Wecurrently are supplying systems or components toUniversal Studios, The Walt Disney Company,Warner Bros., and Six Flags theme parks, includinginternational locations. We are projecting ongoinggrowth as our reputation for superior engineeringspreads within the theme park industry.

are used to conduct critical experiments on a

wide range of vehicles, including passenger

cars, race cars, airplanes, and military equip-

ment. We anticipate that these new systems

will lead to significant additional business in

the coming years.

' Systems that utilize linear friction welding,

a new technique for joining materials. For

certain welding applications, this technique,

which uses only force and vibration, offers

excellent benefits over more traditional

welding techniques.

' Direct metal deposition, an innovative fabri-

cation technique that fuses powdered

material with a computer-guided laser beam.

A wholly owned MTS subsidiary, AeroMet

Corporation, was established to commer-

cialize this technology.

MTS Inventor Recognized Bill Langer, principal staff scientist of ourVehicle Dynamics Group, was honored inSeptember at the National Inventors Hall ofFame Induction Weekend in Akron, Ohio.

Bill was recognized for his many contri-butions to tire testing technology, whichhave given the tire industry invaluabletools for designing safer, better per-forming, and longer-lasting tires.

Bill’s contributions play a significantrole in our success in the automo-tive industry. A nearly 30-yeartechnology and project leaderwith MTS, Bill has been personal-ly responsible for some of ourmost complex and excitinginnovations, including the Flat-Trac® tire testing systems andthe Flat-Trac Flat SurfaceRoadway System.

12

Nano InstrumentsSmall Is BeautifulMicroelectronics, medical devices, and even paintsand razor blades have one thing in common. Theypresent new challenges and opportunities for ourmaterial testing business. Companies that developthese products need to characterize their physicalproperties with microscopic precision to ensuretheir performance and durability. The mechanicalbehaviors of thin films, microcircuitry, and a varietyof surfaces must be evaluated in some casesdown to the level of merely tens of atoms.

To meet this testing challenge, and provide a broader range of solutions to these fast-growingconsumer and industrial markets, MTS acquiredNano Instruments, Inc., of Oak Ridge, Tennessee.The world’s leading supplier of nanoindentation sys-tems, Nano® pioneered the use of dynamic meth-ods for testing the mechanical properties ofmicrocircuitry and thin films. The company’s NanoIndenter® systems measure mechanical propertiesdown to the scale of a few nanometers, a resolu-tion equal to about 1/4000 the width of a human hair.

With only 18 employees, Nano Instruments built a customer base comprising prominent researchcenters throughout the United States, Europe,Asia, and Latin America based on the company’ssuperior technology. Now, by combining that tech-nology with our global business infrastructure andproven software platforms, we are well positionedto expand our material testing business. The NanoInstruments acquisition exemplifies our strategyof acquiring best-in-class technologies that com-plement our existing base, to serve new markets.

Material TestingOur material testing business enjoyed a fine

year in fiscal 1998. Despite reduced industrial

investments in much of Asia, orders there for

our material testing products were up 30 per-

cent. Our total revenues in the material testing

market grew by 11 percent, and operating

income improved by more than $3 million.

Market share gains over the past few years have

established us as the number-two player world-

wide in this $600 million market.

A number of internal initiatives helped us

improve profitability in 1998. We are continu-

ing to consolidate the operations and products

managed at our Raleigh, North Carolina, and

Paris, France, facilities. Our expanded config-

ure-to-order process in Minneapolis has given

us the ability to manufacture servohydraulic

testing systems faster, more cost effectively,

and with higher quality than in the past.

Further improvements in profitability are possi-

ble from better execution of large custom pro-

jects. To make this happen, we established the

Engineered Systems Group, which combines

sales support and project execution resources

under common leadership.

We have focused our investment in the material

testing market’s fastest growing segments:

microelectronics, medical devices, and plastics.

These segments place a premium on flexible,

low-force, high-precision testing. This strategy

has already yielded positive results. Orders for

biomaterial and medical-device testing systems

increased more than 60 percent over last year.


To meet the needs of these fast-growing seg-

ments, we have expanded our testing solutions

through internal development and acquisition.

Internally, we introduced an enhanced version

of our Tytron™ microforce testing system for

high-precision, dynamic testing of small test

articles, such as electronic leads, bond pads,

and medical device components. In May, we

acquired Nano Instruments of Oak Ridge,

Tennessee, the leading supplier of systems for

probing the mechanical properties of thin films

and coatings.

We also introduced the TestWorks® 4 software plat-

form, which automates and simplifies static testing

for applications that range from advanced materi-

als research to consumer product development

and quality control testing on the factory floor. In

addition, our advanced robotic technology earned

us a $640,000 order for four fully automated test-

ing systems from a major supplier of plastic resins.

We also introduced a unique test system capable

of running long-duration tests at frequencies of up

to 1000 Hz. This system was developed primarily

to address research needs related to the fatigue

life of alloys used in jet engines.

By improving our internal efficiencies and tar-

geting opportunities in high-tech industries, we

are confident that we can provide continued

growth and profitability in our material testing

business in 1999.

Civil EngineeringOver the past four years our civil engineering

and geomechanical testing and simulation busi-

ness has been driven primarily by the rapid

infrastructure development in the Asian coun-

tries. We have been involved in supplying

several large laboratories with seismic and

structural test equipment, primarily in Korea,

Japan, and Taiwan. Currently, we are complet-

ing structural test equipment to be used for test-

ing highway bridges in the Peoples Republic of

China. In fact, there were plans for additional

laboratory expansions, for which we were

expecting significant orders, when the Asian

crisis hit. Given its dependency on Asia for

growth, this niche of our business was most

impacted. Orders dropped more than 40 per-

cent and revenue declined by 34 percent. Profit

margins were similarly impacted.

Yet we continue to work with customers around

the world in this market to supply equipment for

structural testing of bridges, buildings, and other

civil engineering related structures. For example,

we developed a large system for the University

of California that will be used to test isolation

bearings and viscous dampers for bridges. The

system can apply realistic earthquake velocities

of up to 70 inches per second, with forces of up

to several million pounds, to bridge bearings

and dampers to test their ability to mitigate

earthquake damage.

We expect future requirements such as these to

continue. But for the near term, the worldwide

market potential for our civil engineering and

geomechanical testing and simulation business

has declined substantially.

14

We had a superb year in the factory

automation sector, growing revenue by

18 percent and pretax earnings by 64

percent, in line with our internal plans.

This performance reflects the strong mar-

ket position we are creating in both

North America and Europe.

The acquisition of Performance Controls

in June helped offset a slow market in

North America, while we enjoyed healthy

growth in Europe across all product

lines. In local currency, our European vol-

ume grew by more than 30 percent, with

accompanying earnings growth. We were

able to maintain gross margins in a very

competitive market by improved opera-

tional performance particularly in our

two German factories.

Our strategy in this sector is to provide

motion and control products to the high-

performance sector of machine manufac-

turers. Through focused technology

development and acquisitions, we achieve

excellent gross margins in the most

demanding specialty machine markets.

— Sidney W. Emery, Jr.President and CEO

Financial Comparison

1998 1997 1996

Revenue $ 74,070 $ 62,774 $ 48,266

PretaxEarnings $ 6,915 $ 4,227 $ 4,707

Percent of 9.3% 6.7% 9.7%Revenue

Factory Automation Sector

SensorsOur sensors business posted a good year,

despite the problems in Asia and the resulting

slowdown of several U.S. industrial sectors.

Overall, revenue for this business was less than

expected, but earnings exceeded plan.

Primary growth drivers have been the improved

performance of our sensors, resulting from a

continuing investment in the core technology

of magnetostrictive position sensing, and our

ability to transform technology breakthroughs

quickly into new products. In Europe, products

introduced after 1997 accounted for two-thirds

of revenue. In Asia, nearly 100 percent of the

product now sold is from the Temposonics® III

line of displacement sensors, introduced in

1997. The success of these new products rein-

forces our reputation in the market as the tech-

nology leader in magnetrostrictive sensing.

Our German facility is now manufacturing sen-

sor elements in large quantities for on-board

automotive and other high-volume applica-

tions. These sensors will be used initially to

improve automobile suspensions, but they also

are suitable for off-road machinery, medical

and marine equipment, and other applications

that require rugged and accurate linear mea-

surements. We already have received an order

for 80,000 of the units from Leopold Kostal

GmbH and Co. KG, which will supply them to

two major automotive manufacturers, one in

Europe and one in the United States, for use in

four car models starting in 1999.

The challenges that face us include leveraging

both current and new technologies. New

embodiments of magnetostrictive sensing along

with other technologies now being developed

will help us expand into new applications and

new markets.

Automation—Custom Servo MotorsWe renamed our servomotor business MTS

Automation to reflect its growing scope. The

name encompasses Customer Servo Motors,

Custom Servo Motors Anstreibstechnik GmbH,

and Performance Controls, the Pennsylvania-based

company we acquired in June.

MTS Automation provides motors and controls

for material handling, packaging, robotics,

textiles, and printing. In addition, its motors

power applications such as converting, auto-

mated inspection, web lines, positioning,

winding, automated assembly, metal working,

and machine tool and cut-to-length applica-

tions. MTS Automation also serves the press-

feed, semiconductor, and lumber industries.

Our acquisition of Performance Controls helps

support our success in new markets. The acquisi-

tion provides us with an enhanced talent pool and

expanded technological knowledge in high-power

motor drives.

We also developed a new digital technology

platform that has enabled us to introduce the

first in a new family of digital drives to the

global marketplace, as well as to develop pro-

prietary software that will support all of our

digital products in the future.

To help meet growing customer demand, we

opened an expanded, state-of-the-art manufactur-

ing facility in Stralsund, Germany, for the produc-

tion of servodrives. A low-cost, high-volume

electronic manufacturing facility, the Stralsund

plant will improve product quality and increase

production throughput, allowing us to maintain

our highly cost-effective manufacturing strategy.

Our goal for this business is to increase revenues

through new product development and acquisi-

tions or licensing agreements. Each strategic initia-

tive of 1998 supports this goal.

Performance ControlsAutomating AutomationThe June acquisition of Performance Controls,Inc. (PCI) reflects our strategic growth vision forour automation business. A provider of propri-etary, custom-engineering solutions based inHorsham, Pennsylvania, PCI brings a high level ofexpertise in servo-drive technology, includingsophisticated electronics, mechanical design, dig-ital technology, and thermal analysis.

Performance Controls also has distinguished itselfas a leader in very-high-power electronics. PCI prod-ucts are differentiated from those of other drivemanufacturers by their performance level even atelevated current and voltage levels. PCI productsare used primarily with gradient drives for magneticresonance imaging (MRI) equipment and spindle drives used in high-speed machining centers.

The depth of technical expertise that PCI bringsshould enable us to create better products in lesstime. It also should allow us to penetrate promis-ing new markets beyond the traditional onesalready served by our automation business.

To nurture PCI’s core competency of proprietaryproduct development, we plan to invest in thecurrent Horsham facility, where the PCI principlesand staff remain based.

16

Six Year Financial Summary

(September 30)

1998 1997 1996 1995 1994 1993

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

Operations

Net revenue $339,682 $303,480 $261,029 $234,131 $200,550 $189,499United States revenue 182,505 143,913 128,593 125,659 101,747 92,153International revenue 157,177 159,567 132,436 108,472 98,803 97,346Gross profit 130,364 121,503 106,104 91,638 79,840 78,882Income before income taxes 31,473 28,3801 20,006 14,031 12,629 14,937Net income 20,766 18,2091 14,109 10,461 8,659 10,382Net income per share, diluted basis 1.08 .961 .74 .58 .46 .57Research and development expense 21,930 17,511 17,696 13,733 12,645 13,697Net interest expense 1,948 1,125 1,123 2,424 1,860 1,207Depreciation and amortization 9,715 8,557 7,820 7,217 6,214 5,648

Financial Position

Current assets $193,593 $152,805 $130,382 $131,589 $123,206 $123,445Current liabilities 105,214 79,479 60,834 67,014 66,361 66,961Current ratio 1.8:1 1.9:1 2.1:1 2.0:1 1.9:1 1.8:1Net working capital 88,379 73,326 69,548 64,575 56,845 56,484Property and equipment, net 67,737 50,419 48,090 48,490 47,368 37,254Total assets 298,448 216,132 187,396 189,500 175,708 165,716Interest bearing debt 74,682 12,865 11,836 22,965 23,851 33,299Shareholders’ investment 143,036 124,619 112,814 106,677 100,046 93,011Shareholders’ investment per share 7.70 6.82 6.15 5.80 5.48 5.12

Other Statistics and Ratios

Diluted shares outstanding219,252 18,956 19,106 18,180 18,672 18,288

Number of common shareholders of record 1,7603 1,575 1,523 1,395 1,394 1,400

Number of employees 2,272 1,981 1,725 1,612 1,557 1,447New orders $332,998 $356,123 $282,753 $245,919 $195,260 $178,786Backlog of orders $175,439 $175,841 $120,481 $ 98,757 $ 84,591 $ 88,731Gross profit percent 38.4% 40.0% 40.6% 39.1% 39.8% 41.6%Research and development costsas a percent of net revenue 6.5% 5.8% 6.8% 5.9% 6.3% 7.2%Net income as a percent of net revenue 6.1% 6.0%1 5.4% 4.5% 4.3% 5.5%Effective tax rate 34% 36% 29% 25% 31% 30%Interest bearing debt to shareholders’ investment percent 52% 10% 10% 22% 24% 36%Return on average net assets4

20.9% 22.9%1 17.2% 12.9% 11.6% 16.3%Return on beginningshareholders’ investment per share 15.8% 15.6%1 12.8% 10.5% 9.0% 11.9%Cash dividends paid per share $ .24 $ .20 $ .16 $ .14 $ .14 $ .121 Excludes an after-tax gain of $2,654,000 from the sale of land in May 1997, which is equal to $.14 per share2Presented 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 1, 1998, there were 1,760 common shareholders of record, with another estimated 2,000 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).

Backlog/New Orders1998 1997 1996

(expressed in thousands)

New Orders:North America* $179,779 $186,155 $139,725International 153,219 169,968 143,028

Total $332,998 356,123 $282,753

Backlog $175,439 175,841 $120,481

*Includes U.S. and Canada

1998 new orders of $333.0 million were down 6% from1997 but represented a 18% increase over 1996. 1997orders included a $18.5 million contract for a large crashsimulation system and 1996 orders included a $23.3 millionearthquake simulator. There were no orders over $10 millionin 1998.

In 1998, the Mechanical Test and Simulation sector (MT&S)new orders of $254.6 million decreased 13% from 1997 but represented a 9% increase over 1996. Orders fromthe ground vehicle industry and for civil engineeringapplications were particularly strong in 1997 and 1996but declined in 1998 due to the Asian situation and theJapan recession. Solid growth in our materials businessand specialty entertainment projects partially offset theloss of business in Asia and Japan.

The Factory Automation sector (FA) new orders in 1998of $78.4 million increased 24% over the prior year (70% of the increase from the acquisition of Performance Controls, Inc.[PCI]) and represented a 63% increase over 1996. About 17% of the order growth in 1997 came from the acquisition ofBregenhorn-Bütow & Co., (BB & Co.). The European andJapanese markets for FA products reflected solid growth in localcurrencies but were affected in translation due to the strength-ening dollar. Orders for industrial automation applications (ser-vo motors, amplifiers, and motion controllers) and industrialsensors were affected, in 1998, by a soft domestic market.

North American orders decreased 3% in 1998, but increased33%, in 1997, and1% in 1996. International orders decreased10% in 1998 but increased 19% in 1997, and 32% in 1996. SeeGeographic Analysis of New Orders (below) for the percentagebreakdown by geographic area. See Foreign Currencies Effects(page 19) for the impact on orders due to changing foreign cur-rency rates.

The backlog of undelivered orders at September 30, 1998amounted to $175.4 million, which was about flat with the prior year. The order backlog at the end of 1997 hadincreased 46% from 1996 as a result of the record neworders received in 1997. Approximately 10% of the ordersin backlog have delivery dates beyond fiscal 1999.

Net Revenues

1998 1997 1996


United States $182,505 $143,913 $128,593International 157,177 159,567 132,436

Total $339,682 $303,480 $261,029

Record 1998 net revenues of $339.7 million were up 12% fromthe prior year and represented a 30% increase over 1996 rev-enues. For 1998, MT&S revenues of $265.6 million increased10% from 1997 and represented a 25% increase over 1996revenues. FA revenues in 1998 of $74.1 million increased 18%over the previous year and represented a 53% increase over1996 revenues (the PCI acquisition in 1998 represented 78%of the 1998 growth). For industry sector and geographic infor-mation, see Note 2 of “Notes to Consolidated FinancialStatements.” See Foreign Currencies Effects (page 19) forimpact on revenues due to changing foreign currency rates.

Revenues in the United States increased over the prioryears: 27% in 1998, 12% in 1997, and 2% in 1996. Thedomestic market, which was strong in 1997 for most ofthe Company’s business segments, softened somewhatfor our FA sector and certain niches of our MT&S sectorin 1998.The domestic market was soft in 1996. Inter-national revenues decreased 1% in 1998 and increased 20% in 1997, and 22% in 1996. International revenues grew at afaster rate in 1997 and 1996 reflecting improved economicconditions which began late in 1995. In 1998, the Asianeconomies and Japan were in a deep recession whichcaused the decline in revenues between years. Europecontinued to show recovery from its low point in 1995.

The MT&S sector revenue increases for 1998 and 1997reflected positive worldwide demand from our groundvehicle customers, solid growth in our entertainmentprojects niche, a strong market for aftermarket sales ofaccessories and services, and, in 1998, an improvementin market share for our materials test business. Our civilengineering structural test business which was strong in1997 declined in 1998 due to the Asian situation.

The FA sector revenue increase for 1998 reflected goodgrowth in demand from European original equipmentmanufacturers for our sensor products and the PCI acqui-sition. The demand for our servo motor, amplifier, andmotion control products was soft for most of 1998 butstrengthened in the fourth quarter.

Selective price increases and decreases were implementedin all three years. However, the overall impact of pricingchanges did not have a material effect on reported rev-enue volume.

Geographic Analysis of New Orders1998 1997 1996 1995 1994

North America 54% 52% 49% 57% 52%

Europe/Africa/Middle East 30 28 22 25 21

Asia Pacific/Japan 14 18 26 17 26

Latin America/Rest of the World 2 2 3 1 1

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

18

Gross Profit1998 1997 1996


Gross Profit $130,364 $121,503 $106,104

% of Net Revenue 38.4% 40.0% 40.6%

The gross profit percentage for 1998 decreased to 38.4%from 40.0% in 1997. The decrease was principally causedby a higher revenue content of “specialty” projects that are sold at a lower gross margin than in our coreautomotive and material test business, and a high unfa-vorable overhead manufacturing variance caused byincreased expenses and lost direct labor due to trainingassociated with our new enterprise-wide financial andoperating software system.

The small decrease in the gross profit percentage in 1997compared to 1996 was due to higher continuing productengineering costs in the MT&S sector, associated withenhancing current product offerings, and a material costproblem at our FA plants in Germany.

Research and Development Expense1998 1997 1996


R & D Expense $21,930 $17,511 $17,696

% of Net Revenue 6.5% 5.8% 6.8%

The Company provides funds for product, system andapplication developments (R&D) in both the MT&S andFA sectors. The majority of the R&D expenditures in allthree years were for new systems and system compo-nents such as software, controls and mechanical prod-ucts; new measurement products; servo motors andamplifiers; and accessories. 1998 product introductionsincluded low-force actuators, a family of quiet hydraulicpumps, wheel force transducers, a microforce materialtesting system, and an array of bio-mechanical testingproducts.

The R&D as a percentage of net revenue reflected aboveare representative of the ratio range the Company normallycommits to in its annual planning process. A shift of someMT&S engineering personnel from R&D to continuing prod-uct engineering caused the R&D expense and ratio reduc-tion in 1997 versus 1996. Accelerated development programsin both the MT&S and FA sectors and a shift from customerfunded development caused the higher percentages in 1998and 1996.

The Company also undertakes “first of their kind” systemlevel development efforts as part of its custom projects soldto customers. The cost of these efforts is reported as cost ofrevenue. The combination of internally funded R&D andthese customer funded system innovations typically approxi-mates about 10% of net revenue.

Selling, General, and Administrative Expenses

1998 1997 1996


Selling Expense $51,905 $52,229 $48,260General & Administrative Expense 23,254 20,898 17,260

Total $75,159 $73,127 $65,520

% of Net Revenue 22.1% 24.1% 25.1%

Selling and General & Administrative (SG&A) expensesfor 1998 as a percentage of net revenue was 2.0 percent-age points lower than 1997 and 3.0 percentage points low-er than 1996. Full year spending for 1998 totaled $75.2million, which represented a $2.0 million (3%) increaseover 1997 and a $9.7 million (15%) increase over 1996.

All three years were similar in that cost control and align-ment of existing resources with markets having the great-est potential were heavily emphasized during the annualplanning process. New investments were made based on evaluations as to how to serve our markets better or tosupport long-term business strategies. Specific expensesin the selling category are variable, such as commissions,and increased significantly in 1997 due to record neworders. SG&A expenses of newly acquired companiesrepresented $1.1 million of the expense increase in 1998and $1.9 million of the increase in 1997.

Income1998 1997 1996

(expressed in thousands except per share data)Income Before Income Taxes $31,473 $32,712 $20,006

% of Net Revenue 9.3% 10.8% 7.7%

Net Income $20,766 $20,863 $14,109

% of Net Revenue 6.1% 6.9% 5.4%

Effective Tax Rate 34.0% 36.2% 29.5%

Return On Beginning Shareholder’s Investment Per Share 15.8% 17.9% 12.8%

Basic Earnings Per Share $ 1.13 $ 1.15 $ .76

Diluted Earnings Per Share $ 1.08 $ 1.10 $ .74

Income before Income Taxes (pretax income) in 1998increased $3.1 million or 11% from 1997 (1997 pretaxincome excluding the $4.3 million land sale gain amountedto $28.4 million or 9.4% of net revenue), and representeda $11.5 million or 57% increase over 1996. The improvedpretax income percentage in both 1998 and 1997 com-pared to 1996 reflects revenue growth that was achievedwith lower operating expense ratios. The MT&S pretaxincome of $24.6 million, in 1998, was slightly better than


1997 pretax (excluding the $4.3 million land sale gain). FApretax operating income increased 64% to $6.9 million from1997. FA pretax operating income had decreased 9% in1997 from 1996 which was primarily caused by integra-tion costs associated with the BB & Co. acquisition, high-er development costs for new and expanded uses of ourindustrial sensors products, and a material cost problemat our plants in Germany. (See Note 2 of “Notes toConsolidated Financial Statements”).

Net income increased $2.6 million or 14% from 1997(excluding the gain from the sale of land which amounted to $2.7 million after taxes, or $.14 per diluted share) andrepresented a $6.7 million or 47% increase over 1996.

The effective tax rate is influenced by the level of taxcredits available from the Company’s Foreign SalesCorporation and qualified Research and Developmentexpense; and on the level of foreign sourced incomewhich is taxed at a higher rate than domestic sourcedincome. See Note 4 of ”Notes to Consolidated FinancialStatements“ for the reconciliation between the federalstatutory and effective income tax rates and other relatedtax information.

Foreign Currencies Effects

The Company is exposed to market risk from changes in foreign currency exchange rates which can affect itsresults from operations and financial condition. To mini-mize the risk, the Company manages exposure to changesin foreign currency rates through its regular operating andfinancing activities and, when deemed appropriate, throughthe use of derivative financial instruments, principally for-ward exchange contracts. Foreign exchange contracts areused to hedge the Company’s overall exposure to exchangerate fluctuations, since the gains and losses on these con-tracts offset losses and gains on the assets, liabilities, andtransactions being hedged.

Approximately 50% of the Company’s revenue occursoutside 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 earn-ings. Conversely, weakening of the U.S. dollar has thereverse impact on revenues and earnings. During 1998,1997 and 1996, the U.S. dollar was generally strongeragainst other major currencies. Gains and losses attrib-uted to translating the financial statements for all non-U.S. subsidiaries and the gains and losses on forward exchangecontracts used to hedge these exposures, are included inother expense (income).

The total effect of foreign exchange rate fluctuations ontranslation of orders, revenues, and net income plus trans-action gains and losses reported in other expense(income) is set forth in the following table:

1998 1997 1996

(expressed in thousands)Increase (Decrease)from Translation:

Orders $(10,838) $(13,150) $ (8,980)Revenues (6,704) (8,852) (4,921)Net Income (236) (237) (66)

Transaction Gain in “Other Expense (Income)” $ 2,340 $ 1,266 $ 104

Liquidity and Capital Resources1998 1997 1996

(expressed in thousands except per share data)Total InterestBearing Debt $ 74,682 $ 12,865 $ 11,836% of TotalCapitalization 34.3% 9.4% 9.5%

Shareholders’Investment $143,036 $124,619 $112,814

Per Share $ 7.70 $ 6.82 $ 6.15

At September 30, 1998, the Company’s capital structurewas comprised of $29.4 million of current debt, $45.3 mil-lion of long-term debt and $143.0 million of shareholders’investment. The ratio of total debt to total capitalizationwas 34.3% compared to 9.4% at September 30, 1997.

Total debt increased $61.8 million during 1998 to $74.7million. This resulted from a $23.8 million increase innotes payable to banks, and a $37.7 million increase inlong-term debt.

The increase in notes payable to banks principallyfinanced an increase in the Company’s working capitalneeds in 1998. The long-term debt increased as a result ofthe Company’s $35 million private placement of long-termnotes. Proceeds of the private placement were used tofund acquisitions made by the Company in 1998 and tofund the Company’s investment in an enterprise-wide dataprocessing system.

In May 1998, the Company amended its multi-currencyrevolving credit facility with its principal bank, increasingthe commitment to $35 million, and extending the com-mitment to September 2001. There was $20.8 million outstanding under this facility at September 30, 1998.Additionally, the Company has an additional $35 million of uncommitted lines of credit, of which $8 million wasoutstanding at year end.

Shareholders’ investment increased $18.4 million in 1998to $143.0 million. The increase was primarily due to anincrease in retained earnings of $20.8 million from currentyear net earnings and $3.2 million from the Company’semployee stock option and purchase plans. These increaseswere offset by $4.4 million of dividend payments and $1.2million of treasury stock purchases.

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.

20

Cash Flows During 1998 operating activities used $5.0 million of cash,compared with $9.6 million that was generated in 1997and $36.1 million in 1996. The decrease in cash generatedin 1998 was largely due to increased accounts receivablefrom strong shipments in the fourth quarter. Major uses ofcash included $29.0 million for acquisition of businesses,$24.1 million for additions to property and equipment, and$4.4 million of dividend payments.

Capital expenditures for property and equipment addi-tions totaled $24.1 million in 1998, $12.4 million in 1997,and $7.4 million in 1996. Significant additions in 1998 were associated with an enterprise-wide financial andoperations software system.

Capital spending in 1999 is planned to be about $12 mil-lion. The Company anticipates that 1999 capital expendi-tures will be financed primarily with funds from operations.

DividendsThe Company’s dividend policy is to maintain a payoutratio which allows dividends to increase with the long-term growth of earnings per share, while sustaining divi-dends in down years. The Company’s dividend payoutratio target is about 25 percent of earnings per share. Thecurrent quarterly dividend of 6 cents per share equates to26 percent of the 1996 through 1998 average net earningsper share.

Share Repurchase PlanIn 1998, the Company repurchased 76,000 shares of com-mon stock on the open market for $1.2 million, at an aver-age cost of $15.56 per share. The Company repurchased698,130 shares in 1997 for $7.6 million, at an average cost of $10.91 per share. The Company’s purpose for share repur-chases is to offset the dilutive effect of shares of commonstock issued from the Company’s stock option and stockpurchase plans, and for other corporate stock-based pro-grams. During the past two years, the Company issued1,000,000 shares of its common stock from these stockoption and stock purchase plans.

In November 1996, the Company’s Board of Directorsauthorized the repurchase of 1,000,000 shares of com-mon stock in the open market within the Securities and Exchange Commission guidelines. At September30,1998, 533,780 shares remained available to be repur-chased under this authorization.

The above share amounts have been adjusted for theCompany’s two-for-one stock split in the form of a 100%stock dividend, effective February 2, 1998.

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:

1998 1997

Shares Shares

High Low Traded High Low Traded

1st Quarter 20 173/8 3049 103/4 95/8 15742nd Quarter 19 131/2 5298 115/16 93/4 15383rd Quarter 191/4 151/2 2379 151/4 101/4 43884th Quarter 173/4 119/16 1600 195/8 143/8 2196

(1) Source: The Nasdaq Stock Market

The above prices and share volumes have been adjusted for the Company’s two-for-one stock split in the form of a 100% stock dividend, effective February 2, 1998.

Quarterly Financial Information (Unaudited)Quarter-to-quarter revenue and earnings comparisons do not necessarily reflect changes in the demand for theCompany’s products or its operating efficiency. Revenuesand earnings in any quarter can be significantly affectedby delivery delays or acceleration of one or more high-value systems, not accounted for using the percentage-of-completion accounting method. The use of the percent-age-of-completion revenue recognition method for largelong-term projects helps alleviate those fluctuations. (SeeNote 1 of “Notes to Consolidated Financial Statements”).High-value, state-of-the-art custom orders can also containleading-edge applications of the Company’s technology,which in some cases have resulted in lower gross profitmargins, albeit not necessarily low marginal profit contri-bution. Product development in these state-of-the-art cus-tom orders is as essential to the Company’s long termgrowth as is Company funded research and development.

Quarterly earnings also vary based on the use of estimated, effective income tax rates for providing federal,state, and foreign income taxes. See Note 4 of “Notes toConsolidated Financial Statements” for more informationon the Company’s income taxes.

Euro ConversionOn January 1, 1999, certain member countries of theEuropean Economic and Monetary Union (EMU) will adopta common currency, the Euro. For a three-year transitionperiod, both the Euro and individual participants’ currencieswill remain in use. The Company is upgrading systems,where necessary, to properly handle the Euro. It is expectedthat the Company’s European operations will formallybegin reporting in euro currency starting in October, 2000.However, beginning January 1, 1999, the Company will beable to process euro transactions in dealing with its cus-tomers. The costs of addressing the euro conversion are not expected to have a material impact on the Company’sfinancial condition or operating results.


Year 2000

The following is a Year 2000 Readiness Disclosure pursuant to the Year 2000 Information and ReadinessDisclosure Act.

The Company is evaluating the potential impact of whatis commonly referred to as the Year 2000 issue, concern-ing the inability of certain computer-based products andsystems to operate correctly into and during the year 2000.If not corrected, these products and systems could fail orcreate erroneous results. Following preliminary work donein fiscal 1997, in early fiscal 1998 the Company establisheda full-time Year 2000 central project office led by a seniortechnical manager reporting directly to an executive. Theproject is being executed solely by company personnelwho use third party testing software where appropriate.

The central project office has been working with each of the Company's twelve producing sites to evaluate thefollowing areas:1. Site Infrastructure, Equipment and Vendors

' Business Information Systems' End User Computing Systems' Telecommunications Infrastructure' Service Providers' Material Suppliers' Manufacturing and Metrology Equipment and Facilities

2. Products Manufactured at SiteExcept for a noise and vibration product line acquired at

the end of fiscal 1998 (which will be included in the projectin 1999), all of the Company’s twelve producing sites hadbeen audited by October 31, 1998 and the areas whichwere not yet Year 2000 ready, or where questions remainas to readiness, were identified and schedules set tobecome ready. A summary of the results of these audits is presented below.Site Infrastructure, Equipment and VendorsThe Company’s major Business Information, End UserComputing and Telecom Systems have been identified ateach site, and the vast majority of these systems that havebeen tested are compliant. Each site has developed a planfor completion of testing and remediation of critical sys-tems. No projects have been accelerated due to Year 2000nor are Year 2000 efforts precluding other importantefforts in these areas.

The Company believes its greatest Year 2000 exposurelies with a limited number of critical/sole source serviceproviders and material suppliers. A failure of these ven-dors to be able to operate up to and through the year 2000could have a material adverse effect on the Company’sbusiness, financial condition and operating results. TheCompany has sent surveys to such vendors and hasreceived responses from most of them about their Year2000 readiness. Where the Company does not have suffi-cient comfort that a critical vendor will be ready, site man-agement will obtain more detailed information and

establish a plan for working with the vendor to prevent aninterruption of supply. During fiscal 1999, the Companywill develop contingency plans, where feasible, in thosecases where such interruption remains reasonably possible.

The Company’s manufacturing and metrology equip-ment and facilities contain embedded processors and codewhich have been inventoried and evaluated for Year 2000readiness. A few instances require remediation.

The Company's target date is June 30, 1999 for the com-pletion of testing and remediation at each site. By the samedate, the Company expects to complete verification of readi-ness (or contingency plan) for each of its critical vendors.Products Manufactured at SiteThe Company’s FA Sector products contain few date sensi-tive computer and embedded processors. The Companyhas completed an evaluation of the vast majority of theseproducts and will complete the balance in early fiscal 1999.All of the products evaluated to date have been found tobe year 2000 ready, in some cases with stipulations, andthe Company believes that will be the case with the prod-ucts yet to be evaluated.

The Company’s MT&S products are by their nature com-puter intensive. The Company has assessed the vastmajority of the products in the sector and advised its cus-tomers as to their Year 2000 readiness via its web site andwritten communication. The balance of products will beassessed by March, 1999.

In those cases where MT&S’s products were found to be non-compliant, less than 2%, or in the case of discon-tinued products that were not evaluated, the Company isactively working with its customers to provide upgradesthat are year 2000 ready. The Company considers thisprocess to be business as usual in its MT&S sector due tothe rapid evolution in computer and software technology.The Company does not expect the costs to be incurred orrevenue to be lost in this process, if any, to have a materialimpact on its financial condition or operating results. SummaryThe Company estimates that the costs directly related to itsYear 2000 project were $300,000 in fiscal 1998 and will be$800,000 in fiscal 1999. Such costs are expensed as incurred.

This Readiness Disclosure is a Forward Looking state-ment as defined by the Securities and ExchangeCommission and the Company recognizes that, althoughnot expected, there are risks of project delays, costsincurred, vendor compliance, and loss of business whichare outside the direct control of the Company and/or couldprove to be material.

1 Includes $4.3 million pretax gain on land sale equal to $.14 per share after taxes.2 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, 1998, is presented below.First Second Third Fourth Total

Quarter Quarter Quarter Quarter Year(expressed in thousands except per share data)

1998

Net revenue $73,938 $81,685 $85,826 $98,233 $339,682Gross profit 30,239 31,612 32,278 36,235 130,364Income before income taxes 6,712 7,523 7,751 9,487 31,473

Net income $ 4,312 $ 4,866 $ 5,087 $ 6,501 $ 20,766

Net income per share2

Basic $ .24 $ .27 $ .27 $ .35 $ 1.13Diluted .22 .26 .26 .34 1.08

1997

Net revenue $66,841 $73,880 $74,153 $88,606 $303,480Gross profit 27,091 30,359 29,481 34,572 121,503Income before income taxes 4,683 7,060 10,947

110,022 32,712

1

Net income $ 3,221 $ 4,642 $ 6,7411

$ 6,259 $ 20,8631


Basic $ .18 $ .26 $ .371

$ .34 $ 1.151

Diluted .17 .25 .361

.32 1.101

1996

Net revenue $56,135 $67,082 $60,630 $77,182 $261,029Gross profit 23,867 28,066 24,374 29,797 106,104Income before income taxes 3,570 5,363 4,286 6,787 20,006

Net income $ 2,430 $ 3,632 $ 2,914 $ 5,133 $ 14,109


Basic $ .13 $ .20 $ .15 $ .28 $ .76Diluted .13 .19 .15 .27 .74

22


Assets 1998 1997

(expressed in thousands except per share data)

Current Assets:Cash and cash equivalents $ 10,512 $ 10,285Accounts receivable, net of allowance for doubtful accounts of $2,135 and $2,010 89,278 62,023Unbilled contracts and retainage receivable 35,891 32,653Inventories 53,675 43,591Prepaid expenses 4,237 4,253

Total current assets 193,593 152,805

Property and Equipment:Land 2,437 2,453Buildings and improvements 40,432 37,779Machinery and equipment 88,626 68,071Accumulated depreciation (63,758) (57,884)

Total property and equipment, net 67,737 50,419

Other Assets 37,118 12,908

$298,448 $216,132

Liabilities and Shareholders’ Investment

Current Liabilities:Notes payable to banks $ 28,243 $ 4,356Current maturities of long-term debt 1,180 920Accounts payable 19,406 17,771Accrued compensation and benefits 26,919 25,487Advance billings to customers 17,360 21,065Other accrued liabilities 12,106 9,880

Total current liabilities 105,214 79,479

Deferred income taxes 4,939 4,445Long-term debt 45,259 7,589

Commitments and Contingencies

Shareholders’ Investment:Common stock, 25¢ par; 64,000,000 shares authorized:18,579,481 and 9,135,766 shares issued and outstanding 4,645 2,284Additional paid-in capital 3,322 1,438Retained earnings 133,203 119,167Cumulative translation adjustment 1,866 1,730

Total shareholders’ investment 143,036 124,619

$298,448 $216,132

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

Consolidated Balance Sheets(September 30)

Income 1998 1997 1996


Net Revenue $339,682 $303,480 $261,029Cost of Revenue 209,318 181,977 154,925

Gross Profit 130,364 121,503 106,104

Operating Expenses:

Selling 51,905 52,229 48,260General and administrative 23,254 20,898 17,260Research and development 21,930 17,511 17,696

Income From Operations 33,275 30,865 22,888

Interest expense 2,327 1,531 1,524Interest income (379) (406) (401)Other expense (income), net (146) (2,972) 1,759

Income Before Income Taxes 31,473 32,712 20,006Provision for Income Taxes 10,707 11,849 5,897

Net Income $ 20,766 $ 20,863 $ 14,109

Net Income Per Share

Basic $ 1.13 $ 1.15 $ .76Diluted 1.08 1.10 .74

Shareholders’ Investment

Common Stock Additional CumulativeShares Paid-In Retained TranslationIssued Amount Capital Earnings Adjustment


Balance, September 30, 1995 4,598,311 $1,150 $ 255 $100,443 $ 4,829

Exercise of stock options 264,604 66 3,642 — —Translation adjustment — — — — (793)Common stock purchased and retired (381,055) (95) (3,897) (3,904) —Stock split, 2 for 1 4,691,658 1,172 — (1,172) —Net income — — — 14,109 —Cash dividends, 16¢ per share — — — (2,991) —

Balance, September 30, 1996 9,173,518 2,293 — 106,485 4,036

Exercise of stock options 311,313 78 4,511 — —Translation adjustment — — — (83) (2,306)Common stock purchased and retired (349,065) (87) (3,073) (4,453) —Net income — — — 20,863 —Cash dividends, 20¢ per share — — — (3,645) —

Balance, September 30, 1997 9,135,766 2,284 1,438 119,167 1,730

Exercise of stock options 300,091 75 3,086 — —Translation adjustment — — — — 136Common stock purchased and retired (60,800) (15) (1,202) — —Stock Split, 2 for 1 9,204,424 2,301 — (2,301) —Net income — — — 20,766 —Cash dividends, 24¢ per share — — — (4,429) —

Balance, September 30, 1998 18,579,481 $4,645 $ 3,322 $133,203 $ 1,866

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

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

24

1998 1997 1996


Operating Activities:Net income $ 20,766 $ 20,863 $ 14,109Adjustments to reconcile net income to net cash provided by (used in)operating activities:Depreciation and amortization 9,715 8,557 7,820Deferred income taxes 319 (227) 740Gain from sale of real estate — (4,332) —Changes in operating assets and liabilities, exclusive of aquisitions:Accounts receivable, unbilled contracts and retainage receivable (27,974) (26,056) 13,362Inventories (6,470) (6,954) (1,071)Prepaid expenses 587 363 (2,380)Advance billings to customers (3,736) 8,157 (455)Other liabilities, net 1,802 9,197 3,969

Net Cash Provided by (Used in) Operating Activities (4,991) 9,568 36,094

Investing Activities:Property and equipment additions (24,149) (12,374) (7,437)Proceeds from sale of real estate — 5,700 —Acquisition of businesses, net of cash received (29,012) (5,947) —Other assets (334) (223) (649)

Net Cash Used in Investing Activities (53,495) (12,844) (8,086)

Financing Activities:Net borrowings under notes payable to banks 23,770 3,743 (10,386)Proceeds from issuance of long-term debt 38,637 1,008 2,202Repayments of long-term debt (1,152) (2,745) (2,169)Cash dividends (4,429) (3,645) (2,991)Proceeds from employee stock option and stock purchase plans 3,160 4,589 3,708Payments to purchase and retire common stock (1,217) (7,613) (7,896)

Net Cash Provided by (Used in) Financing Activities 58,769 (4,663) (17,532)

Effect of Exchange Rate Changes on Cash (56) (1,007) 19

Net Increase (Decrease) in Cash and Cash Equivalents 227 (8,946) 10,495

Cash and Cash Equivalents at Beginning of Year 10,285 19,231 8,736

Cash and Cash Equivalents at End of Year $ 10,512 $ 10,285 $ 19,231

Supplemental Disclosures of Cash Flows Information:Cash paid during the year for:Interest $ 1,881 $ 1,531 $ 1,458Income taxes 8,024 13,295 6,677

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

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

26

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 as ofthe end of the fiscal year. Income statement items are trans-lated at average exchange rates during the year. The resultingtranslation adjustment is recorded as a separate componentof shareholders’ investment. Gains and losses from transla-tion of foreign currency denominated transactions and fromforeign exchange hedge contracts are included in “Otherexpense (income) net” in the Consolidated Statements ofIncome and amounted to $2,340,000 in 1998, $1,266,000 in1997 and $104,000 in 1996.

Revenue RecognitionRevenue is recognized upon shipment of equipment whenthe customer’s order can be manufactured, delivered, andinstalled 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 terms ofsuch contracts, revenue recognized using the percentage ofcompletion method may not be invoiced until completion ofcontractual milestones, upon shipment of the equipment, orupon installation and acceptance by the customer. Unbilledamounts for these contracts appear in the ConsolidatedBalance Sheets as Unbilled Contracts and RetainageReceivable. Amounts unbilled or retained at September 30,1998 are expected to be invoiced during fiscal 1999.

Long-term contracts consider the duration of the manu-facturing and collection cycles at the time the contract isbid. Accordingly, Accounts receivable in the accompany-ing Consolidated Balance Sheets approximate fair value.

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 investmentswhich 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:

1998 1997

(expressed in thousands)Customer projects invarious stages ofcompletion $10,750 $ 5,559

Components,assemblies and parts 42,925 38,032

Total $53,675 $43,591

Property and EquipmentProperty and equipment is stated at cost. Additions,replacements and improvements are capitalized at cost,while maintenance and repairs are charged to operations as incurred. Depreciation is provided over the following estimated useful lives of the property:Buildings and improvements: 10 to 40 years.Machinery and equipment: 3 to 12 years.

Most major building and equipment purchases are depreciated on a straight-line basis for financial reportingpurposes and on an accelerated basis for income tax purposes.

Derivative Financial InstrumentsThe Company periodically enters into forward exchangecontracts principally to hedge the eventual dollar cashflow of foreign currency denominated transactions (primarily British Pound, German Deutschemark, FrenchFranc, Swedish Krona, Italian Lira, 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 of Income.

Use of EstimatesThe preparation of financial statements in conformity withgenerally accepted accounting principles requires man-agement to make assumptions and estimates that affectthe reported amounts of assets and liabilities and disclo-sure of contingent assets and liabilities at the date of thefinancial statements and the reported amounts of revenuesand expenses during the reporting period. Ultimate resultscould differ from reported amounts based upon thoseassumptions and 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 profitvariation from difficulties in estimating the ultimate cost of such contracts.

Future Accounting PronouncementsIn June 1997, the Financial Accounting Standards Board(FASB) issued Statement of Financial AccountingStandards (SFAS) No. 130, “Reporting ComprehensiveIncome.” SFAS No. 130 establishes requirements for disclosure of comprehensive income and becomes effec-tive beginning with the Company’s first quarter ending on December 31, 1998. Reclassification of earlier financialstatements for comparative purposes is required.

In June 1997, the FASB issued SFAS No. 131, ”Disclosuresabout Segments of an Enterprise and Related Information.“SFAS No. 131 requires reported segments to be those usedby management to disaggregate a company. The new standard becomes effective for the Company‘s fiscal yearending September 30, 1999, and requires that comparativeinformation from earlier years be restated.

In June 1998, the FASB issued SFAS No. 133,“Accounting for Derivative Instruments and HedgingActivities.” The statement establishes accounting andreporting standards requiring that every derivative instru-ment (including certain derivative instruments embeddedin other contracts) be recorded in the balance sheet aseither an asset or liability measured at its fair value. Thestatement requires that changes in the derivative's fair value be recognized currently in earnings unless specifichedge accounting criteria are met. Special accounting forqualifying hedges allows a derivative’s gains and losses tooffset related results on the hedged item in the incomestatement and requires that a company must formally doc-ument, designate and assess the effectiveness of transac-tions that receive hedge accounting. SFAS No. 133 iseffective for fiscal years beginning after June 15, 1999.

The Company anticipates that the effect of adoptingSFAS Nos. 130, 131 and 133 will not have a materialimpact on the Company’s financial statements.

The Company‘s accounting policy for these contracts isbased on the Company‘s designation of foreign currencycontracts as hedging transactions. The Company does notuse derivative financial instruments for speculative or trad-ing purposes. The criteria the Company uses for designat-ing a contract as a hedge include the contract‘seffectiveness in risk reduction and matching of contracts tounderlying transactions. On September 30, 1998, therewere open hedge contracts totaling $2,800,000 with anunrealized loss of $3,000. On September 30, 1997, therewere no open hedge contracts.Other AssetsOther assets consist principally of patents andexcess costover net assets acquired (goodwill), net of accumulatedamortization. The carrying value of goodwill less accumu-lated amortization was $31,468,000 and $10,861,000 in 1998and 1997, respectively.These assets arebeing amortizedover various periods ranging from 7 to 40 years.

The Company periodically evaluates whether events and circumstances have occurred that may affect the estimat-ed useful life of its goodwill and other long-lived assets. Ifsuch events or circumstances were to indicate that the car-rying amount of these assets would not be recoverable, animpairment loss would be recognized. No such impair-ment has been recognized for the year ended September30, 1998.Net Income Per ShareThe Company adopted Statement of Financial AccountingStandards (SFAS) No. 128, “Earnings per Share” during the first quarter of fiscal 1998. As a result, all prior periodspresented have been restated to conform to the provisionsof SFAS No. 128, which requires the presentation of basicand diluted earnings per share. Basic earnings per share iscomputed by dividing net income by the weighted averagenumber of common shares outstanding during the year.Diluted earnings per share includes the dilutive effect ofpotential common shares. Weighted average commonshares and per share computations have been restatedretroactively for the two-for-one stock split effectiveFebruary 2, 1998.

1998 1997 1996


Weighted averagecommon sharesoutstanding 18,441 18,207 18,669

Dilutive potentialcommon shares 811 749 437

Total dilutivecommon shares 19,252 18,956 19,106

Basic net incomeper share $ 1.13 $ 1.15 $ .76

Diluted net incomeper share 1.08 1.10 .74

1998 1997 1996

(expressed in thousands)Net RevenueMechanical Testing & Simulation $265,612 $240,706 $212,763Factory Automation 74,070 62,774 48,266

Total $339,682 $303,480 $261,029

Income Before Income TaxesMechanical Testing & Simulation $ 24,558 $ 28,485 1 $ 15,299Factory Automation 6,915 4,227 4,707

Total $ 31,473 $ 32,712 1 $ 20,006

Identifiable AssetsMechanical Testing & Simulation $268,829 $189,727 $165,110Factory Automation 51,766 46,194 38,670Eliminations between sectors (22,147) (19,789) (16,384)

Total $298,448 $216,132 $187,396

Other Sector DataMechanical Testing & Simulation:

Capital expenditures $ 20,564 $ 10,614 $ 6,198

Depreciation 6,834 5,979 5,706Amortization 371 379 380

Factory Automation:

Capital expenditures $ 3,959 $ 1,787 $ 1,803Depreciation 1,674 1,532 1,216

Amortization 836 667 5181Includes $4.3 million pretax gain on land sale equal to $.14 per share after taxes.

2. Industry Sector and Geographic Information:

Customers use the Company’s hardware and softwareproducts and services to improve product quality, stimulateinnovation, and increase machine and worker productivity.MTS sells these products and services in two markets—Mechanical Testing and Simulation (MT&S) and FactoryAutomation (FA). MT&S customers use the Company’s

products and services to determine how their products(materials, vehicles, components, or structures) will per-form under actual service conditions. FA customers use the Company’s instrumentation products to monitor andautomate industrial processes and equipment. Financialinformation by sector follows:

28

Notes to Consolidated Financial Statements(Continued)

International_________________________________________________United Elimi- Consoli-States Far East Europe Other nations dated


Operations for the YearEnded September 30, 1998Net revenue $182,505 $ 53,112 $85,181 $18,884 $ — $339,682Transfers between geographic areas1 1,092 12,679 29,625 — (43,396) —

Total $183,597 $ 65,791 $114,806 $18,884 $ (43,396) $339,682

Income before income taxes $ 16,469 $ 7,547 $ 2,783 $ 4,674 $ — $ 31,473

Operations for the YearEnded September 30, 1997Net revenue $143,913 $ 74,710 $66,905 $17,952 $ — $303,480Transfers betweengeographic areas1 825 26,988 27,927 — (55,740) —

Total $144,738 $101,698 $94,832 $17,952 $(55,740) $303,480

Income (loss) before income taxes $ 17,327 $ 13,600 $(1,481) $ 3,266 $ — $ 32,712

Operations for the YearEnded September 30, 1996Net revenue $128,593 $ 54,392 $63,023 $15,021 $ — $261,029Transfers between geographic areas1 2,513 18,411 21,499 3 (42,426) —

Total $131,106 $ 72,803 $84,522 $15,024 $ (42,426) $261,029

Income before income taxes $ 10,690 $ 2,208 $ 3,876 $ 3,232 $ — $ 20,006

Identifiable Assetsat September 301998 $293,829 $10,026 $56,787 $ 306 $ (62,500) $298,4481997 198,055 11,335 50,670 266 (44,194) 216,1321996 174,507 12,060 42,098 175 (41,444) 187,3961Transfers between geographic areas are made at prices which allow appropriate markup to the manufacturing or selling unit.

A geographic summary of the Company’s operations and related year-end asset information for the three years endedSeptember 30, 1998 follows:

No individual country, other than the United States, exceeded 10% of consolidated revenues on a recurrent annual basis.

Aggregate annual maturities of long-term debt for the next five fiscal years are as follows: 1999—$1,180,000;2000—$1,174,000; 2001—$3,928,000; 2002—$6,888,000;2003—$7,428,000 and $25,841,000 thereafter. The carryingvalue of the Company’s long-term debt at September 30,1998, approximates the fair value at current interest ratesoffered to the Company for debt with the same remainingmaturities.

The Company has credit agreements with two domesticbanks totaling $40,000,000. One credit agreement, for$5,000,000, permits the Company to issue domestic andEuro-currency notes. The other credit agreement, for$35,000,000, permits the Company to issue domesticnotes, Euro-currency notes, and banker’s acceptances. As part of the same credit agreement, the bank has agreedto issue term loans up to a maximum of $10,000,000 untilMarch 30, 2002. This agreement provides for repayment ofthese term loans through September 2005. The Companycompensates both banks with loan commitment fees forthe unused portion of the credit lines. The Company also

has three uncommitted lines of credit with banks that total $35,000,000, of which $8,000,000 is outstanding atSeptember 30, 1998. In addition, the Company has standby letter-of-credit lines totaling $30,000,000. At September 30,1998, standby letters of credit outstanding totaled $13,619,000.

Under the terms of its credit agreements, 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, 1998, net worth exceeded the defined minimum amount by $24,808,000 and the Company had$16,346,000 available for repurchases of its common stock.The Company was in compliance with the terms andcovenants of its credit agreements and its lines of credit at September 30, 1998.

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

3. Financing:

Long-term debt as of September 30 follows:1998 1997

(expressed in thousands)6.6% Notes, unsecured, due in July 2008 35,000 —

7.8% Mortgage, due in October 2015, collateralized by building 6,444 6,287

5.3% Note, unsecured, due in March 2003 1,264 —

6.0% Note, unsecured, due in May 2008 1,943 —

Other 1,788 2,222

Total $46,439 $ 8,509

Less Current Maturities (1,180) (920)

Total Long-Term Debt $45,259 $ 7,589

1998 1997 1965


Balance outstanding at September 30 $28,243 $ 4,356 $ 56

Average balance outstanding 23,498 11,903 3,282

Maximum balance outstanding 51,216 23,458 11,223

Year-end interest rate 5.9% 6.0% 7.0%

Weighted-average interest rate 6.1% 6.0% 6.9%

30


4. Income Taxes:

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

1998 1997 1996


Current payable (receivable):Federal $ 5,966 $ 7,389 $ 3,717State 898 835 499Foreign 3,894 3,568 1,830

Deferred (52) 57 (149 )

Total provision $10,706 $11,849 $ 5,897

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

1998 1997 1996

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

Effective rate 34% 36% 29 %

Deferred Tax Asset:1998 1997


Accrued compensation and benefits $2,151 $1,703Inventory reserves 2,309 2,088Allowance for doubtful accounts 244 301Other assets (11) (15)

Total Deferred Tax Asset $4,693 $4,077

Deferred Tax Liability:1998 1997

Property and equipment $4,881 $4,445

Net Deferred Tax Liability $ 188 $ 368

The following table summarizes information concerning outstanding and exercisable options as of September 30, 1998:

These options will expire if not exercised at specific datesranging from January 1999 to August 2002. Prices foroptions exercised during the three-year period endedSeptember 30, 1998 ranged from $5.78 to $15.75.

In January 1992 the Company’s shareholders authorizedan Employee Stock Purchase Plan (the Purchase Plan),whereby 1,000,000 shares of the Company’s common

stock were reserved for sale to employees until April 2002.Participants in the 1998 and 1997 phases, all at dates spec-ified in the Purchase Plan, were issued 105,240 shares in1998, and 83,368 shares in 1997. During 1998, participantssubscribed to purchase 137,861 shares at 85% of marketprice for issuance in 1999.

1998 1997 1996

Shares WAEP* Shares WAEP* Shares WAEP*

Outstanding at beginning of year 1,920 $ 8.35 1,964 $ 7.12 2,156 $ 6.11

Granted 545 $15.79 608 $10.72 642 $ 8.14

Exercised (295) $ 6.51 (616) $ 6.78 (788) $ 5.23

Forfeited (27) $10.40 (36) $ 7.87 (46) $ 6.37

Outstanding at end of year 2,143 $10.30 1,920 $ 8.35 1,964 $ 7.12

Options exercisable at year-end 1,156 $ 8.19 894 $ 7.59 926 $ 6.77

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

$5.78-7.88 340 3.1 $ 5.88 333 $ 5.85

$7.94-8.13 711 2.3 $ 8.06 539 $ 8.04

$9.69-14.63 683 3.5 $ 11.31 256 $ 10.70

$15.38-19.38 409 4.3 $ 16.19 28 $ 15.99

Total 2,143 3.20 $10.30 1,156 $ 8.19

Shares in thousands*In Years

5. Stock Options:The Company has made certain stock-based awards to its officers, non-employee directors, and key employeesunder various stock plans. Awards under these plans can include incentive stock options (qualified), non-quali-fied stock options, stock appreciation rights, restrictedstock, deferred stock, and other stock-based and nonstock-based awards.

At September 30, 1998, the Company had awardedincentive stock options, non-qualified stock options andrestricted stock. These were granted at exercise prices that are 100% of the fair-market value at the day of grant.Beginning one year after grant, the options generally can

be exercised proportionately each year for periods ofthree, four, or six years, as defined in the respective plans.Options currently expire no later than seven years fromthe 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. During1998 and 1997, option holders exchanged 22,335 and77,266 shares, respectively, of the Company’s stock in payment of options exercised. (All share and share pricedata herein have been restated retroactively for the two-for-one stock split, effective February 2, 1998.)

A summary of the status of the Company’s stock option plans as of September 30, 1998, 1997, and 1996, and changesduring the years ending on those dates follows:

32


Pro forma Information: The Company has elected to follow 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 Compen-sation,” requires the use of option valuation models toestimate compensation expense from the granting ofemployee stock options and to present the pro formaeffect of such expense on reported net income and earn-ings 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.The fair value of options granted in 1998 and 1997 report-ed below has been estimated at the date of grant using theBlack-Scholes option valuation model with the followingweighted average assumptions:

1998 1997 1996

Expected life (in years) 2.0 2.1 2.1Risk-free interest rate 4.2% 5.8% 5.8%Volatility .40 .49 .50Dividend yield 1.6% 1.2% 1.9%

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. Because the Company’s options havecharacteristics significantly different from those of tradedoptions, and because change in the subjective inputassumptions can affect materially the fair value estimate,in the opinion of management, the existing models do notnecessarily provide a reliable measure of the fair value ofits options. The weighted average estimated fair value ofemployee stock options granted during 1998 and 1997 was$4.39 and $10.54 per share, 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 pro forma infor-mation follows (in thousands except for earnings pershare data):

1998 1997 1996

Pro forma net income $19,474 $20,020 $13,556Pro forma earnings per share $ 1.01 $ 1.06 $ .71

The effects on pro forma disclosures of applying SFAS No.123 are not likely to be representative of the effects on proforma disclosures of future years. Because SFAS No. 123is applicable only to options granted in fiscal years subse-quent to December 31, 1994, the pro forma effect will notbe fully reflected until 2002.

6. Employee Benefit Plans:

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 1998 and1997, respectively, and 4.3% in 1996. The provisions forprofit sharing were $3,577,000 in 1998, $3,163,000 in 1997and $2,338,000 in 1996, and are distributed among the various operating expenses shown in the accompanyingConsolidated Statements 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 modifiedto provide for contributions based solely on annual com-pensation levels.

The expenses for these plans consist of the following components:1998 1997 1996


Service cost-benefit earned during the period $ 178 $327 $ 360Interest cost on projected benefit obligation 218 269 261Net amortization and deferral 11 29 5

Net Periodic Pension Cost $ 407 $625 $ 626

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

1998 1997


Actuarial Present Value:Accumulated benefit obligation:Vested $ 3,778 $3,332Nonvested 542 575

Total $ 4,320 $3,907

Projected benefit obligation 5,110 4,723Unrecognized net gain 460 464Unrecognized net liability being amortized (478) (528)Adjustment required to recognize minimum liability 25 29

Accrued Pension Liability $ 5,117 $4,688

Major assumptions at year-end are:

Discount rate 3.5 to 6.2% 3.5 to 6.5%Rate of increase in future compensation levels 3.0% 3.0%

7. Acquisitions:

In fiscal 1998 the Company acquired three entities, allaccounted for by the purchase method of accounting, with an aggregate purchase price of approximately $29million, net of cash acquired. The Company acquired allthe outstanding stock of Performance Controls, Inc., amanufacturer of high performance power amplifiers forfactory automation and magnetic resonance machineapplications, in an all cash transaction. The Companyacquired the stock of Nano Instruments Inc., a manufac-turer of instrumented indentation systems for ultra-lowforce nanoindentation testing surfaces and thin films, forcash and debt. In addition to the stock purchase of NanoInstruments Inc., the Company purchased the rights to apatent from the two principal shareholders of NanoInstruments, Inc. The Company also acquired the assetsand technology of SDRC’s noise and vibration test soft-ware business along with a major portion of SDRC’s noiseand vibration consulting engineering services, in an allcash 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 ofthe operations of the acquired companies are included in the Company’s financial statements for the periods inwhich they were owned.

In fiscal 1997 the Company acquired the stock ofBregenhorn-Butow & Co., Freiburg, Germany (name sub-sequently changed to Custom Servo Motors AntriebstechnikGmbH & Co KG), a privately held supplier of low power,electronic servo motors and drives, for cash and debt. Thetransaction was accounted for by the purchase method ofaccounting.

The pro forma results for 1998 and 1997, assuming theseacquisitions had been made at the beginning of the year,would not be materially different from reported results.

34


8. First Quarter Fiscal Year 1999 Restructuring Charge:

The Company has taken a series of actions to better alignits organizational structure with market elements, improveoperational performance, and reduce costs. These actionswill result in a one-time charge in the first quarter of fiscal

year 1999 of approximately $2.1 million ($1.3 million after-tax, or $.07 per share). This charge relates principally to aworkforce reduction and $.3 million for operational con-solidations. Annualized pretax cost savings from reducingthe number of employees and contractors is estimated to be $5 million.

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 corporation) and Subsidiaries as of September 30, 1998 and1997, and the related consolidated statements of income,shareholders‘ investment and cash flows for each of thethree years in the period ended September 30, 1998. Thesefinancial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion onthese financial statements based on our audits.

We conducted our audits in accordance with generallyaccepted auditing standards. Those standards require thatwe plan and perform the audit to obtain reasonable assur-ance about whether the financial statements are free ofmaterial misstatement. An audit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit alsoincludes assessing the accounting principles used and significant estimates made by management, as well 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 relatedinternal controls, which are designed to provide reasonableassurance that assets are safeguarded, transactions areproperly recorded, and the policies and procedures areimplemented by qualified personnel.

The Audit Committee of the Board of Directors, which is comprised solely of outside directors, meets regularly with management and its independent auditors to reviewaudit activities, internal controls, and other accounting,reporting, and financial matters. This Committee also recommends independent auditors for appointment by the full Board, subject to shareholder ratification.

Sidney W. Emery, JrPresident and ChiefExecutive Officer

Marshall L. CarpenterVice President andChief Financial Officer

evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the financialposition of MTS Systems Corporation and Subsidiaries asof September 30, 1998 and 1997, and the results of theiroperations and their cash flows for each of the three yearsin the period ended September 30, 1998 in conformitywith generally accepted accounting principles.

ARTHUR ANDERSEN LLP

Minneapolis, Minnesota,November 20, 1998

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 necessary in setting the scope of their audits.

36

Corporate Information

Board of DirectorsDonald M. SullivanChairman, MTS SystemsCorporation

Sidney W. Emery, Jr.President and CEO MTS 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. GullottiChairman, President, Chief Executive Officer National Computer Systems

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

Thomas E. HolloranProfessor University of St. Thomas

Thomas E. Stelson, Ph.DIndependent EngineeringConsultant

Linda Hall Whitman, Ph.DPresident Ceridian Performance Partners

Executive OfficersSidney W. Emery, Jr.Chief Executive Officer President

William G. AndersonVice President MTS Automation Division

William G. BeduhnVice President, AdvancedEngineering Systems Division

Marshall L. CarpenterVice President Chief Financial Officer

Hal J. GalvinVice President, CorporateBusiness Development

Bruce M. HebeisenManager, Human Resources

Daniel T. SparksVice PresidentMaterial Testing Division

Mauro TogneriVice President Sensors Division

Keith D. ZellExecutive Vice President Mechanical Testing &Simulation Sector

Divisional OfficersFrank G. ArcellaPresident, AeroMet Corporation

Steven M. CohoonVice PresidentVehicle Dynamics Group

James M. EgerdalVice President, ProductServices & Customer Support

Kenneth E. FlorenVice President, AerospaceStructures & Materials Division

Werner OngyertVice President/Europe

J. Howell OwensVice President, Operations

Richard S. WhiteVice President/Asia Pacific

Corporate OfficersBarbara J. CarpenterAssistant Corporate Secretary

Patrick DelaneySecretary Partner, Lindquist & VennumPLLP

Thomas J. MinnemanTreasurer

ReferencesBank ReferenceUS BankMinneapolis, MN

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

General CounselLindquist & Vennum PLLPMinneapolis, MN

Patent CounselWestman, Champlin & KellyMinneapolis, MN

Independent PublicAccountantsArthur Andersen LLPMinneapolis, MN

Notice of Annual MeetingThe annual meeting ofstockholders will be held at4:00 p.m. (Central StandardTime) on Tuesday, January 26, 1999 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, and quarterlyreports are available onrequest without charge fromMarketing Communications MTS Systems Corporation14000 Technology DriveEden Prairie, Minnesota55344-2290.Telephone 612-974-6073

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 612-937-4647Email:[email protected]

Dividend Reinvestment PlanWith the January 1999 divi-dend payment, shareholderswill receive informationabout enrolling in the newMTS Systems CorporationDividend Reinvestment Plan.Under the plan, sharehold-ers can invest MTS Systemsdividends in additionalshares of company stockand make periodic voluntarycash investments for thepurchase of company stock.

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

TrademarksMTS, Flat-Trac, Nano, NanoIndenter, Temposonics andTestWorks are registeredtrademarks, and MTSEngineering Office,SilentFlo, SWIFT and Tytronare trademarks of MTSSystems Corporation.

AeroMet is a servicemark ofMTS Systems Corporation.

I-DEAS and SDRC are trademarks of StructuralDynamics ResearchCorporation

MTS Systems Corporation - Managing Technology for Growth · 2015. 8. 6. · In 1998 MTS once again...

Documents

Transcript of MTS Systems Corporation - Managing Technology for Growth · 2015. 8. 6. · In 1998 MTS once again...