United States
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON,
D.C. 20549



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FORM 10-Q



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|  |                                                                                                                                                     
|- | ----------------------------------------------------------------------------------------------------------------------------------------------------
|x | Quarterly Report Pursuant to Section 13 or 15(d) of
  the Securities Exchange Act of 1934 for the Quarterly period ended April 1,
  2006            
|  |                                                                                                                                                     
|  | or                                                                                                                                                  
|  |                                                                                                                                                     
|o | Transition Report Pursuant to Section 13 or 15(d) of
  the Securities Exchange Act of 1934 for the transition period from __________
  to __________



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Commission File Number 0-2382

MTS SYSTEMS CORPORATION(Exact name of Registrant as specified in its charter)

|                                                                   |  |                                       
|------------------------------------------------------------------ |  | --------------------------------------
|MINNESOTA                                                          |  | 41-0908057                            
|(State or other jurisdiction
  of
  incorporation or organization) |  | (I.R.S. Employer
  Identification No.)

| |                                                            |  |  | 
| | ---------------------------------------------------------- |  |  | 
| | 14000 Technology Drive, Eden Prairie, MN 55344             | 
| | (Address of principal executive
  offices)    (Zip
  Code) | 
|
| | Registrants telephone number: (952) 937-4000              | 



---

Indicate by
check mark whether the Registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.

|          |         
|--------- | --------
|x     Yes | o     No

Indicate by
check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and
large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

|                                 |                           |                              
|-------------------------------- | ------------------------- | -----------------------------
|Large
  accelerated filer      x | Accelerated
  filer     o | Non-accelerated
  filer     o

Indicate by
check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Exchange Act):

|          |         
|--------- | --------
|o     Yes | x     No

The number of
shares outstanding of the Registrants common stock as of May 5, 2006 was 18,248,910 shares.





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MTS SYSTEMS CORPORATION
REPORT ON FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED APRIL 1, 2006

INDEX

|                               |         |  |                                                                                                        |         
|------------------------------ | ------- |  | ------------------------------------------------------------------------------------------------------ | --------
|                               |         |  |                                                                                                        | Page No.
|                               |         |  |                                                                                                        |         
|                               |         |  |                                                                                                        |         
|PART I  FINANCIAL INFORMATION |        
|                               |         |  |                                                                                                        |         
|                               | Item 1. |  | Financial Statements (unaudited)                                                                       |         
|                               |         |  |                                                                                                        |         
|                               |         |  | Consolidated Balance Sheets as of April 1, 2006 and October 1, 2005                                    | 2       
|                               |         |  |                                                                                                        |         
|                               |         |  | Consolidated Statements of Income for the Three and Six Months Ended
  April 1, 2006 and April 2, 2005 | 3       
|                               |         |  |                                                                                                        |         
|                               |         |  | Consolidated Statements of Cash Flows for the Six Months Ended April
  1, 2006 and April 2, 2005       | 4       
|                               |         |  |                                                                                                        |         
|                               |         |  | Condensed Notes to Consolidated Financial Statements                                                   | 5 - 15  
|                               |         |  |                                                                                                        |         
|                               | Item 2. |  | Managements Discussion and Analysis of Financial Condition and
  Results of Operations                | 15 - 23 
|                               |         |  |                                                                                                        |         
|                               | Item 3. |  | Quantitative and Qualitative Disclosures About Market Risk                                             | 23      
|                               |         |  |                                                                                                        |         
|                               | Item 4. |  | Controls and Procedures                                                                                | 24      
|                               |         |  |                                                                                                        |         
|PART II  OTHER INFORMATION    |        
|                               |        
|                               | Item 1. |  | Legal Proceedings                                                                                      | 24      
|                               |         |  |                                                                                                        |         
|                               | Item 1A |  | Risk Factors                                                                                           | 24      
|                               |         |  |                                                                                                        |         
|                               | Item 2. |  | Unregistered Sales of Equity Securities and Use of Proceeds                                            | 24      
|                               |         |  |                                                                                                        |         
|                               | Item 3. |  | Defaults Upon Senior Securities                                                                        | 24      
|                               |         |  |                                                                                                        |         
|                               | Item 4. |  | Submission of Matters to a Vote of Security Holders                                                    | 25      
|                               |         |  |                                                                                                        |         
|                               | Item 5. |  | Other Information                                                                                      | 25      
|                               |         |  |                                                                                                        |         
|                               | Item 6. |  | Exhibits                                                                                               | 25      
|                               |         |  |                                                                                                        |         
|SIGNATURES                     |         |  |                                                                                                        | 26      

1

---



PART 1  FINANCIAL
INFORMATION
Item 1. Financial Statements

MTS SYSTEMS CORPORATION
Consolidated Balance Sheets
(unaudited - in thousands, except per share data)

|                                                                                                    |  |          |         |            |   |         |  
|--------------------------------------------------------------------------------------------------- |  | -------- | ------- | ---------- | - | ------- | -
|                                                                                                    |  | April 1, |         | October 1, |  
|                                                                                                    |  | 2006     |         | 2005       |  
|                                                                                                    |  |          |         |            |  
|ASSETS                                                                                              |  |          |         |            |   |         |  
|                                                                                                    |  |          |         |            |   |         |  
|Current Assets:                                                                                     |  |          |         |            |   |         |  
|Cash and cash equivalents                                                                           |  | $        | 84,159  |            | $ | 83,143  |  
|Short-term investments                                                                              |  |          | 23,025  |            |   | 76,650  |  
|Accounts receivable, net of allowances for
  doubtful accounts                                      |  |          | 73,682  |            |   | 64,363  |  
|Unbilled accounts receivable                                                                        |  |          | 30,271  |            |   | 25,093  |  
|Inventories                                                                                         |  |          | 40,505  |            |   | 38,029  |  
|Prepaid expenses                                                                                    |  |          | 4,790   |            |   | 2,600   |  
|Current deferred tax assets                                                                         |  |          | 6,418   |            |   | 6,415   |  
|Other current assets                                                                                |  |          | 2,217   |            |   | 2,351   |  
|Assets of discontinued operations                                                                   |  |          | 1,433   |            |   | 1,710   |  
|                                                                                                    |  |          |         |            |   |         |  
|Total current assets                                                                                |  |          | 266,500 |            |   | 300,354 |  
|                                                                                                    |  |          |         |            |   |         |  
|                                                                                                    |  |          |         |            |   |         |  
|Property and Equipment:                                                                             |  |          |         |            |   |         |  
|Land                                                                                                |  |          | 1,668   |            |   | 1,668   |  
|Buildings and improvements                                                                          |  |          | 41,048  |            |   | 40,906  |  
|Machinery and equipment                                                                             |  |          | 76,659  |            |   | 72,837  |  
|Accumulated depreciation                                                                            |  |          | (76,153 | )          |   | (72,458 | )
|                                                                                                    |  |          |         |            |   |         |  
|Total property and equipment, net                                                                   |  |          | 43,222  |            |   | 42,953  |  
|                                                                                                    |  |          |         |            |   |         |  
|                                                                                                    |  |          |         |            |   |         |  
|Goodwill                                                                                            |  |          | 4,428   |            |   | 4,423   |  
|Other assets                                                                                        |  |          | 2,119   |            |   | 2,291   |  
|Non-current deferred tax assets                                                                     |  |          | 1,710   |            |   | 1,711   |  
|                                                                                                    |  |          |         |            |   |         |  
|Total Assets                                                                                        |  | $        | 317,979 |            | $ | 351,732 |  
|                                                                                                    |  |          |         |            |   |         |  
|                                                                                                    |  |          |         |            |   |         |  
|LIABILITIES
  AND SHAREHOLDERS INVESTMENT                                                          |  |          |         |            |   |         |  
|                                                                                                    |  |          |         |            |   |         |  
|Current Liabilities:                                                                                |  |          |         |            |   |         |  
|Notes payable                                                                                       |  | $        | 1,579   |            | $ | 1,582   |  
|Current maturities of long-term debt                                                                |  |          | 6,683   |            |   | 6,708   |  
|Accounts payable                                                                                    |  |          | 17,567  |            |   | 16,142  |  
|Accrued payroll-related costs                                                                       |  |          | 23,719  |            |   | 31,059  |  
|Advance payments from customers                                                                     |  |          | 58,487  |            |   | 49,901  |  
|Accrued warranty costs                                                                              |  |          | 4,511   |            |   | 5,333   |  
|Accrued income taxes                                                                                |  |          | 6,546   |            |   | 3,643   |  
|Current deferred income taxes                                                                       |  |          | 3,792   |            |   | 3,767   |  
|Other accrued liabilities                                                                           |  |          | 17,152  |            |   | 15,026  |  
|Liabilities of discontinued operations                                                              |  |          | 150     |            |   | 890     |  
|                                                                                                    |  |          |         |            |   |         |  
|Total current liabilities                                                                           |  |          | 140,186 |            |   | 134,051 |  
|                                                                                                    |  |          |         |            |   |         |  
|                                                                                                    |  |          |         |            |   |         |  
|Deferred income taxes                                                                               |  |          | 2,314   |            |   | 2,310   |  
|Long-term debt, less current maturities                                                             |  |          | 14,519  |            |   | 15,673  |  
|Other long-term liabilities                                                                         |  |          | 11,834  |            |   | 11,266  |  
|                                                                                                    |  |          |         |            |   |         |  
|Total Liabilities                                                                                   |  |          | 168,853 |            |   | 163,300 |  
|                                                                                                    |  |          |         |            |   |         |  
|                                                                                                    |  |          |         |            |   |         |  
|Shareholders Investment:                                                                           |  |          |         |            |   |         |  
|Common stock, $.25 par; 64,000 shares
  authorized: 18,200 and 19,664 shares issued and outstanding |  |          | 4,550   |            |   | 4,916   |  
|Retained earnings                                                                                   |  |          | 135,755 |            |   | 173,487 |  
|Accumulated other comprehensive income                                                              |  |          | 8,821   |            |   | 10,029  |  
|                                                                                                    |  |          |         |            |   |         |  
|Total shareholders investment                                                                      |  |          | 149,126 |            |   | 188,432 |  
|                                                                                                    |  |          |         |            |   |         |  
|Total Liabilities and Shareholders
  Investment                                                    |  | $        | 317,979 |            | $ | 351,732 |  
|                                                                                                    |  |          |         |            |   |         |  

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

2

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MTS SYSTEMS CORPORATION
Consolidated Statements of Income
(unaudited - in thousands, except per share data)

|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|---------------------------------------------------------------- |  | -------------------- | ------- | ------------------ | - | -------- | - | -------- | ------- | - | - | ------- | -
|                                                                 |  | Three
  Months Ended |         | Six Months
  Ended |  
|                                                                 |  |                      |         |                    |  
|                                                                 |  | April 1,             |         | April 2,           |   | April 1, |   | April 2, |        
|                                                                 |  | 2006                 |         | 2005               |   | 2006     |   | 2005     |        
|                                                                 |  |                      |         |                    |   |          |   |          |        
|Revenue:                                                         |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Product                                                          |  | $                    | 89,035  |                    | $ | 83,597   |   | $        | 168,524 |   | $ | 166,829 |  
|Service                                                          |  |                      | 13,833  |                    |   | 12,518   |   |          | 26,187  |   |   | 22,367  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Total revenue                                                    |  |                      | 102,868 |                    |   | 96,115   |   |          | 194,711 |   |   | 189,196 |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Cost
  of sales:                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Product                                                          |  |                      | 50,882  |                    |   | 47,857   |   |          | 95,897  |   |   | 95,973  |  
|Service                                                          |  |                      | 6,205   |                    |   | 5,912    |   |          | 12,464  |   |   | 11,141  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Total cost of sales                                              |  |                      | 57,087  |                    |   | 53,769   |   |          | 108,361 |   |   | 107,114 |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Gross profit                                                     |  |                      | 45,781  |                    |   | 42,346   |   |          | 86,350  |   |   | 82,082  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Operating
  expenses:                                            |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Selling                                                          |  |                      | 15,933  |                    |   | 16,016   |   |          | 31,937  |   |   | 31,199  |  
|General and administrative                                       |  |                      | 8,896   |                    |   | 7,824    |   |          | 17,000  |   |   | 14,745  |  
|Research and development                                         |  |                      | 4,694   |                    |   | 3,910    |   |          | 8,841   |   |   | 7,625   |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Total operating expenses                                         |  |                      | 29,523  |                    |   | 27,750   |   |          | 57,778  |   |   | 53,569  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Gain
  on sale of assets                                         |  |                      | 860     |                    |   |         |   |          | 860     |   |   |        |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Income
  from operations                                         |  |                      | 17,118  |                    |   | 14,596   |   |          | 29,432  |   |   | 28,513  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Interest
  expense                                               |  |                      | (415    | )                  |   | (520     | ) |          | (869    | ) |   | (1,115  | )
|Interest
  income                                                |  |                      | 782     |                    |   | 485      |   |          | 1,464   |   |   | 890     |  
|Other
  income, net                                              |  |                      | 302     |                    |   | 269      |   |          | 327     |   |   | 424     |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Income
  before income taxes                                     |  |                      | 17,787  |                    |   | 14,830   |   |          | 30,354  |   |   | 28,712  |  
|Provision
  for income taxes                                     |  |                      | 6,488   |                    |   | 5,151    |   |          | 11,099  |   |   | 10,301  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Income
  before discontinued operations                          |  |                      | 11,299  |                    |   | 9,679    |   |          | 19,255  |   |   | 18,411  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Discontinued
  operations:                                       |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Loss from discontinued operations, net of
  tax                  |  |                      |        |                    |   | (1,206   | ) |          |        |   |   | (1,746  | )
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Net
  income                                                     |  | $                    | 11,299  |                    | $ | 8,473    |   | $        | 19,255  |   | $ | 16,665  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Earnings
  per share:                                            |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Basic-                                                           |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Income before discontinued operations                            |  | $                    | 0.59    |                    | $ | 0.49     |   | $        | 1.00    |   | $ | 0.93    |  
|Discontinued operations:                                         |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Loss from discontinued operations, net of
  tax                  |  |                      |        |                    |   | (0.06    | ) |          |        |   |   | (0.09   | )
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Earnings per share                                               |  | $                    | 0.59    |                    | $ | 0.43     |   | $        | 1.00    |   | $ | 0.84    |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Weighted average number of common shares
  outstanding - basic   |  |                      | 19,072  |                    |   | 19,857   |   |          | 19,263  |   |   | 19,783  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Diluted-                                                         |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Income before discontinued operations                            |  | $                    | 0.58    |                    | $ | 0.47     |   | $        | 0.97    |   | $ | 0.89    |  
|Discontinued operations:                                         |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Loss from discontinued operations, net of
  tax                  |  |                      |        |                    |   | (0.06    | ) |          |        |   |   | (0.08   | )
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Earnings per share                                               |  | $                    | 0.58    |                    | $ | 0.41     |   | $        | 0.97    |   | $ | 0.81    |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  
|Weighted average number of common shares
  outstanding - diluted |  |                      | 19,580  |                    |   | 20,654   |   |          | 19,792  |   |   | 20,625  |  
|                                                                 |  |                      |         |                    |   |          |   |          |         |   |   |         |  

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

3

---



MTS SYSTEMS CORPORATION
Consolidated Statements of Cash Flows
(unaudited - in thousands)

|                                                                                    |  |                    |         |          |   |          |  
|----------------------------------------------------------------------------------- |  | ------------------ | ------- | -------- | - | -------- | -
|                                                                                    |  | Six Months
  Ended |        
|                                                                                    |  |                    |        
|                                                                                    |  | April 1,           |         | April 2, |  
|                                                                                    |  | 2006               |         | 2005     |  
|                                                                                    |  |                    |         |          |  
|Cash
  flows from operating activities:                                             |  |                    |         |          |   |          |  
|Net income                                                                          |  | $                  | 19,255  |          | $ | 16,665   |  
|Adjustments to reconcile net income to net
  cash provided by operating activities: |  |                    |         |          |   |          |  
|Loss from discontinued operations                                                   |  |                    |        |          |   | 1,746    |  
|Depreciation and amortization                                                       |  |                    | 3,869   |          |   | 4,199    |  
|Gain on sale of assets                                                              |  |                    | (860    | )        |   |         |  
|Deferred income taxes                                                               |  |                    |        |          |   | (8       | )
|Bad debt provision                                                                  |  |                    | 113     |          |   | 11       |  
|Stock-based compensation                                                            |  |                    | 2,142   |          |   | 56       |  
|Equity compensation income tax benefits                                             |  |                    | (971    | )        |   |         |  
|                                                                                    |  |                    |         |          |   |          |  
|Changes
  in operating assets and liabilities:                                      |  |                    |         |          |   |          |  
|Accounts and unbilled contracts
receivable                                          |  |                    | (14,759 | )        |   | 8,850    |  
|Inventories                                                                         |  |                    | (2,261  | )        |   | (859     | )
|Prepaid expenses                                                                    |  |                    | (3,522  | )        |   | (851     | )
|Other assets                                                                        |  |                    | 406     |          |   | (491     | )
|Accounts payable                                                                    |  |                    | 1,447   |          |   | 1,106    |  
|Accrued payroll-related costs                                                       |  |                    | (5,864  | )        |   | (5,990   | )
|Advance payments from customers                                                     |  |                    | 9,171   |          |   | 2,046    |  
|Accrued warranty costs                                                              |  |                    | (825    | )        |   | 383      |  
|Other current liabilities                                                           |  |                    | 5,374   |          |   | 5,576    |  
|Operating activities of discontinued
  operations (revised)                         |  |                    | (463    | )        |   | (2,548   | )
|                                                                                    |  |                    |         |          |   |          |  
|Net cash provided by operating activities
  (revised)                               |  |                    | 12,252  |          |   | 29,891   |  
|                                                                                    |  |                    |         |          |   |          |  
|                                                                                    |  |                    |         |          |   |          |  
|Cash
  flows from investing activities:                                             |  |                    |         |          |   |          |  
|Additions to property and equipment                                                 |  |                    | (3,939  | )        |   | (3,754   | )
|Proceeds from maturity of short-term
  investments                                  |  |                    | 90,632  |          |   | 88,980   |  
|Purchases of short-term investments                                                 |  |                    | (37,007 | )        |   | (107,951 | )
|Proceeds/adjustments from sale of assets                                            |  |                    | (90     | )        |   |         |  
|Investing activities of discontinued
  operations (revised)                         |  |                    |        |          |   | (218     | )
|                                                                                    |  |                    |         |          |   |          |  
|Net cash provided by (used in) investing
  activities (revised)                     |  |                    | 49,596  |          |   | (22,943  | )
|                                                                                    |  |                    |         |          |   |          |  
|                                                                                    |  |                    |         |          |   |          |  
|Cash
  flows from financing activities:                                             |  |                    |         |          |   |          |  
|Net proceeds under short-term borrowings                                            |  |                    | 53      |          |   | 66       |  
|Payments of long-term debt                                                          |  |                    | (1,178  | )        |   | (1,237   | )
|Equity compensation income tax benefits                                             |  |                    | 971     |          |   |         |  
|Cash dividends                                                                      |  |                    | (3,856  | )        |   | (1,593   | )
|Proceeds from exercise of stock options and
  employee stock purchase plan          |  |                    | 2,600   |          |   | 6,950    |  
|Payments to purchase and retire common
  stock                                      |  |                    | (59,508 | )        |   | (13,893  | )
|                                                                                    |  |                    |         |          |   |          |  
|Net cash used in financing activities                                               |  |                    | (60,918 | )        |   | (9,707   | )
|                                                                                    |  |                    |         |          |   |          |  
|                                                                                    |  |                    |         |          |   |          |  
|Effect
  of exchange rate on changes in cash                                        |  |                    | 86      |          |   | 2,668    |  
|                                                                                    |  |                    |         |          |   |          |  
|Net increase (decrease) in cash and cash
  equivalents                              |  |                    | 1,016   |          |   | (91      | )
|                                                                                    |  |                    |         |          |   |          |  
|Cash and cash equivalents, at beginning of
  period                                 |  |                    | 83,143  |          |   | 66,948   |  
|                                                                                    |  |                    |         |          |   |          |  
|Cash and cash equivalents, at end of
period                                         |  | $                  | 84,159  |          | $ | 66,857   |  
|                                                                                    |  |                    |         |          |   |          |  
|                                                                                    |  |                    |         |          |   |          |  
|Supplemental
  disclosure of cash flow information:                                 |  |                    |         |          |   |          |  
|Cash paid during the period for -                                                   |  |                    |         |          |   |          |  
|Interest expense                                                                    |  | $                  | 785     |          | $ | 1,096    |  
|Income taxes                                                                        |  | $                  | 7,207   |          | $ | 3,592    |  
|                                                                                    |  |                    |         |          |   |          |  

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

4

---



MTS SYSTEMS CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(unaudited)

1. Basis of Presentation

The consolidated financial statements include
the accounts of MTS SYSTEMS CORPORATION and its wholly owned subsidiaries (the
Company). All significant intercompany balances and transactions have been
eliminated.

The interim consolidated financial statements
included herein have been prepared by the Company, without audit, pursuant to
the rules and regulations of the Securities and Exchange Commission (SEC).
The information furnished in these financial statements includes normal
recurring adjustments and reflects all adjustments which are, in the opinion of
management, necessary for a fair presentation of such financial statements.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with U.S. generally accepted accounting
principles have been condensed or omitted pursuant to such rules and
regulations. The accompanying financial statements of the Company should be
read in conjunction with the audited consolidated financial statements and
notes thereto included in the Companys 2005 Form 10-K filed with the SEC.
Interim results of operations for the three- and six-month periods ended April
1, 2006 are not necessarily indicative of the results to be expected for the
full year.

Certain prior year amounts included in the
accompanying financial statements have been reclassified to conform to the current
years presentation. Such reclassifications had no material effect on the
Companys previously reported financial position, net income, or total cash
flows.

Cash Flow Statement
Revisions

In accordance with Statement of Financial
Accounting Standard (SFAS) No. 95, Statement of Cash Flows, the net cash
flows from operating and investing activities reported in the consolidated cash
flow statement for the six-month period ended April 2, 2005 have been revised
to separately disclose the net cash flows attributable to the operating and
investing activities of discontinued operations. There were no cash flows
attributable to financing activities of discontinued operations. The Companys
consolidated cash flow statements for fiscal year 2005 and prior fiscal years
and interim periods reported the combined cash flows attributable to operating
and investing activities of discontinued operations as a single amount.

The revisions to the Companys consolidated
cash flow statements resulting from the separate disclosure of the net cash
flows attributable to operating and investing activities of discontinued
operations for the prior three fiscal years are summarized as follows:

|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|----------------------------------------------------------------- |  | --------------------------- | ------- | ---------- | - | --------------- | - | - | ------- | -
|                                                                  |  | Fiscal
  Years Ended        |        
|                                                                  |  |                             |        
|                                                                  |  | October 1,                  |         | October 2, |   | September
  27, |  
|                                                                  |  | 2005                        |         | 2004       |   | 2003            |  
|                                                                  |  |                             |         |            |   |                 |  
|                                                                  |  | (in
  thousands of dollars) |        
|Operating activities:                                             |  |                             |         |            |   |                 |   |   |         |  
|Net cash provided by operating activities (as
reported)           |  | $                           | 58,844  |            | $ | 43,747          |   | $ | 49,367  |  
|Operating activities of discontinued
operations                   |  |                             | (2,436  | )          |   | 2,180           |   |   | 6,239   |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|Net cash provided by operating activities
(revised)               |  |                             | 56,408  |            |   | 45,927          |   |   | 55,606  |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|Investing activities:                                             |  |                             |         |            |   |                 |   |   |         |  
|Net cash (used in) provided by investing activities
(as reported) |  |                             | (7,148  | )          |   | 17,296          |   |   | (25,518 | )
|Investing activities of discontinued
operations                   |  |                             | (368    | )          |   | (646            | ) |   | (620    | )
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|Net cash (used in) provided by investing activities
(revised)     |  |                             | (7,516  | )          |   | 16,650          |   |   | (26,138 | )
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|Financing activities:                                             |  |                             |         |            |   |                 |   |   |         |  
|Net cash used in financing activities (as
reported)               |  |                             | (30,873 | )          |   | (47,708         | ) |   | (29,948 | )
|Financing activities of discontinued
operations                   |  |                             |        |            |   |                |   |   |        |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|Net cash used in financing activities
(revised)                   |  |                             | (30,873 | )          |   | (47,708         | ) |   | (29,948 | )
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|Effect of exchange rate
  changes on cash and cash equivalents    |  |                             | (1,824  | )          |   | 2,292           |   |   | 3,536   |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  
|Net increase in cash and
  cash equivalents                       |  | $                           | 16,195  |            | $ | 17,161          |   | $ | 3,056   |  
|                                                                  |  |                             |         |            |   |                 |   |   |         |  

5

---



Critical Accounting
Policies

The Company believes that of its significant
accounting policies, the following are particularly important to the portrayal
of the Companys results of operations and financial position and may require
the application of a higher level of judgment by the Companys management and,
as a result, are subject to an inherent degree of uncertainty.

Revenue Recognition. Orders that are
manufactured and delivered in less than six months with routine installations
and no special acceptance protocol are considered to involve separable elements
for revenue recognition purposes. Sufficient evidence of fair value of these
elements exists to allow revenue recognition for these systems upon shipment,
less the greater of the fair value associated with installation and training
(if applicable) or the amount of revenue that is deemed contingent upon these
elements, which is deferred until customer acceptance. In cases where special
acceptance protocols exist, installation and training are not considered to be
separable from the other elements of the arrangement. Accordingly, revenue for
these systems is recognized upon the completion of installation and fulfillment
of obligations specific to the terms of the arrangement.

Revenue on contracts requiring longer delivery
periods, generally longer than six months (long-term contracts), is recognized
using the percentage-of-completion method based on the cost incurred to date
relative to estimated total cost of the contract. In most cases, orders with
complex installations and/or unusual acceptance protocols involve long-term
contracts for custom systems that follow the percentage-of-completion method of
revenue recognition through customer acceptance. However, when elements that
would not separately fall within the scope of accounting literature prescribing
percentage-of-completion accounting are included in an arrangement, the fair
value of these elements is separated from the arrangement and accounted for as
such services are provided.

The Company enters into long-term contracts
for customized equipment sold to its customers. Under the terms of such
contracts, revenue recognized using the percentage-of-completion method may
not, in certain circumstances, be invoiced until completion of contractual
milestones, upon shipment of the equipment, or upon installation and acceptance
by the customer. Unbilled amounts for these contracts appear in the
Consolidated Balance Sheets as Unbilled Accounts Receivable.

Revenue for services is recognized as the
service is performed and ratably over a defined contractual period for service
maintenance contracts.

Inventories. Inventories consist of material,
labor and overhead costs and are stated at the lower of cost or market,
determined under the first-in, first-out accounting method. Inventories at
April 1, 2006 and October 1, 2005 were as follows:

|                                                    |  |                           |  |                   |  |   | 
|--------------------------------------------------- |  | ------------------------- |  | ----------------- |  | - | 
|                                                    |  | April 1,
  2006           |  | October 1,
  2005 | 
|                                                    |  |                           |  |                   | 
|                                                    |  | (in thousands of dollars) | 
|Customer
  projects in various stages of completion |  | $                         |  | 14,878            |  | $ | 
|Components, assemblies
  and parts                  |  |                           |  | 25,627            |  |   | 
|                                                    |  |                           |  |                   |  |   | 
|Total                                               |  | $                         |  | 40,505            |  | $ | 
|                                                    |  |                           |  |                   |  |   | 

Warranty
Obligations. Sales of the Companys products and systems are subject to limited
warranty guarantees that are included in customer contracts. For sales that include
installation services, warranty guarantees typically extend for a period of
twelve months from the date of either shipment or acceptance. Product
guarantees typically extend for a period of twenty-four months from the date of
purchase. Under the terms of these warranties, the Company is obligated to
repair or replace any components or assemblies it deems defective due to
workmanship or materials. The Company reserves the right to reject warranty
claims where it determines that failure is due to normal wear, customer
modifications, improper maintenance, or misuse. The Company records warranty
provisions monthly based on an estimated warranty expense percentage applied to
current period revenue. The percentage applied reflects historical warranty
claims experience over the preceding twelve-month period. Both the experience
percentage and the warranty liability are evaluated on an ongoing basis for
adequacy.Warranty provisions and claims for the periods ended April 1, 2006 and
April 2, 2005 were as follows:

6

---



|                       |  |                           |        |                    |   |          |   |          |        |   |   |        |  
|---------------------- |  | ------------------------- | ------ | ------------------ | - | -------- | - | -------- | ------ | - | - | ------ | -
|                       |  | Three
  Months Ended      |        | Six Months
  Ended |  
|                       |  |                           |        |                    |  
|                       |  | April 1,                  |        | April 2,           |   | April 1, |   | April 2, |       
|                       |  | 2006                      |        | 2005               |   | 2006     |   | 2005     |       
|                       |  |                           |        |                    |   |          |   |          |       
|                       |  | (in thousands of dollars) |       
|Beginning
  balance    |  | $                         | 5,045  |                    | $ | 6,652    |   | $        | 5,333  |   | $ | 5,811  |  
|Warranty
  provisions  |  |                           | 868    |                    |   | 1,326    |   |          | 2,071  |   |   | 4,085  |  
|Warranty
  claims      |  |                           | (1,444 | )                  |   | (1,606   | ) |          | (2,909 | ) |   | (3,687 | )
|Currency
  translation |  |                           | 42     |                    |   | (135     | ) |          | 16     |   |   | 28     |  
|                       |  |                           |        |                    |   |          |   |          |        |   |   |        |  
|Ending
  balance       |  | $                         | 4,511  |                    | $ | 6,237    |   | $        | 4,511  |   | $ | 6,237  |  
|                       |  |                           |        |                    |   |          |   |          |        |   |   |        |  

2. Stock-Based Compensation

In December 2004, the
Financial Accounting Standards Board ( FASB) issued Statement of Financial
Accounting Standard (SFAS) No. 123R, Share-Based
Payment. SFAS No. 123R is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation,
and supersedes Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees,
and amends SFAS No. 95, Statement of Cash
Flows,and its related implementation guidance. SFAS 123R focuses
primarily on accounting for transactions in which an entity obtains employee
services through share-based payment transactions. SFAS 123R requires a public
entity to measure the cost of employee services received in exchange for the
award of equity instruments based on the fair value of the award at the date of
grant. The cost is to be recognized over the period during which an employee is
required to provide services in exchange for the award. SFAS 123R also requires
the benefits of tax deduction in excess of recognized compensation expense to
be reported as a financing cash flow, rather than as an operating cash flow as
prescribed under the prior accounting rules. This requirement reduces net
operating cash flows and increases net financing cash flows in periods after
adoption. Total cash flow remains unchanged from what would have been reported
under prior accounting rules. Upon adoption of SFAS 123R, the Company applied
an estimated forfeiture rate to unvested awards. Previously, the Company
recorded forfeitures as incurred. Effective October 2, 2005, the Company
adopted the provisions of SFAS 123R and elected to implement SFAS 123R using
the modified prospective method. The adoption of SFAS 123R had no impact on the
financial statements of previously reported interim or annual periods.

Prior to the adoption of
SFAS 123R, the Company followed the intrinsic value method in accordance with
APB 25 to account for its employee stock options and employee share purchase
plan. Accordingly, no compensation expense was recognized for share purchase
rights granted in connection with the issuance of stock options under the
Companys employee stock option plan or employee stock purchase plan; however,
compensation expense was recognized in connection with the issuance of
restricted shares granted. The adoption of SFAS 123R primarily resulted in a
change in the Companys method of recognizing stock-based compensation and
estimating forfeitures for all unvested awards. The effect of recording
stock-based compensation expense for the periods ended April 1, 2006 was as
follows:

7

---



|                                                                               |  |                                         |   |                    |   |  | 
|------------------------------------------------------------------------------ |  | --------------------------------------- | - | ------------------ | - |  | 
|                                                                               |  | Three
  months ended                    |   | Six months
  ended |  
|                                                                               |  | April 1,
  2006                         |   | April 1,
  2006    |  
|                                                                               |  |                                         |   |                    |  
|                                                                               |  | (in
  thousands, except per share data) |  
|                                                                               |  |                                         |   |                    |   |  | 
|Stock-based compensation
  expense by type of award:                           |  |                                         |   |                    |   |  | 
|Employee stock options                                                         |  |                                         | $ | 993                |   |  | 
|Employee stock purchase plan                                                   |  |                                         |   | 29                 |   |  | 
|Restricted stock units (1)                                                     |  |                                         |   | 169                |   |  | 
|Amounts capitalized as
  inventory                                             |  |                                         |   | (236               | ) |  | 
|Amounts recognized in income for amounts previously capitalized as
  inventory |  |                                         |   | 271                |   |  | 
|                                                                               |  |                                         |   |                    |   |  | 
|                                                                               |  |                                         |   |                    |   |  | 
|Total stock-based compensation included in income from
operations              |  |                                         |   | 1,226              |   |  | 
|Income tax benefit on stock-based compensation                                 |  |                                         |   | (332               | ) |  | 
|                                                                               |  |                                         |   |                    |   |  | 
|Net compensation expense
  included in net income                              |  |                                         | $ | 894                |   |  | 
|                                                                               |  |                                         |   |                    |   |  | 
|                                                                               |  |                                         |   |                    |   |  | 
|Tax effect on:                                                                 |  |                                         |   |                    |   |  | 
|Cash flows from operating
  activities                                         |  |                                         |   | (811               | ) |  | 
|Cash flows from financing
  activities                                         |  |                                         | $ | 811                |   |  | 
|                                                                               |  |                                         |   |                    |   |  | 
|Earnings per share:                                                            |  |                                         |   |                    |   |  | 
|Basic                                                                          |  |                                         | $ | 0.05               |   |  | 
|Diluted                                                                        |  |                                         | $ | 0.05               |   |  | 

(1)
Stock-based compensation expense of $169 and $213 for the three- and six-month
periods ended April 1, 2006, respectively, related to restricted stock units
would have been recorded under the provisions of APB 25.

The Company compensates
officers, directors, and key employees with stock-based compensation under two
stock plans approved by the Companys shareholders in 1994 and 1997, and
administered under the supervision of the Companys Board of Directors. During
the three- and six-month periods ended April 1, 2006 and April 2, 2005, the
Company awarded incentive stock option grants, non-qualified stock option
grants, and restricted stock grants under these plans. At April 1, 2006, a
total of 3,231,680 shares were available for future grant under the stock
incentive plans. Stock option awards are granted at exercise prices equal to
the closing market price of the Companys stock on the date of grant.
Generally, options vest proportionally on the first three anniversary dates of
the grant and expire five years from the grant date. Compensation expense is
recognized evenly over the vesting period of each vesting increment. The
parameters of the Companys share purchase activities are not established solely
with reference to the dilutive impact of issuance under the incentive plans.
However, the Company expects that over time, share purchases will offset the
dilutive impact of share issuances made under the plans.

Stock option activity for
the six-month period ended April 1, 2006 was as follows (in thousands, except
per share amounts and years):

|                                               |  |        |       |       |   |            |  |                    |  |           |   |        | 
|---------------------------------------------- |  | ------ | ----- | ----- | - | ---------- |  | ------------------ |  | --------- | - | ------ | 
|                                               |  |        |       |       |   |            |  | Weighted
  Average |  |           |   |       
|                                               |  |        |       |       |   |            |  | Remaining          |  | Aggregate |  
|                                               |  |        |       |       |   |            |  | Contractual
  Term |  | Intrinsic |  
|                                               |  | Shares |       | WAEP* |   | (in years) |  | Value**            | 
|                                               |  |        |       |       |   |            |  |                    | 
|                                               |  |        |       |       |   |            |  |                    |  |           |   |        | 
|Options outstanding at
  October 1, 2005       |  |        | 1,686 |       | $ | 22.63      |  |                    |  |           |   |        | 
|Granted                                        |  |        | 5     |       |   | 39.94      |  |                    |  |           |   |        | 
|Exercised                                      |  |        | (151  | )     |   | 15.31      |  |                    |  |           |   |        | 
|Forfeited or expired                           |  |        | (147  | )     |   | 22.96      |  |                    |  |           |   |        | 
|                                               |  |        |       |       |   |            |  |                    |  |           |   |        | 
|Options oustanding at April
  1, 2006          |  |        | 1,393 |       |   | 23.49      |  | 3.01               |  |           | $ | 25,548 | 
|                                               |  |        |       |       |   |            |  |                    |  |           |   |        | 
|Options subject to exercise
  at April 1, 2006 |  |        | 483   |       | $ | 15.22      |  | 1.92               |  |           | $ | 12,853 | 
|                                               |  |        |       |       |   |            |  |                    |  |           |   |        | 

*Weighted Average Exercise
Price**Aggregate intrinsic value includes only those options with
intrinsic value (options where the exercise price is below the market value)

8

---



Other
information pertaining to options for the periods ended April 1, 2006 and April
2, 2005 was as follows:

|                                                                  |  |                                       |       |                  |  
|----------------------------------------------------------------- |  | ------------------------------------- | ----- | ---------------- | -
|                                                                  |  | Three Months Ended                    |       | Six Months Ended |  
|                                                                  |  | April 1,
  2006                       |       | April 2,
  2005  |  
|                                                                  |  |                                       |       |                  |  
|                                                                  |  | (in thousands, except per share data) |      
|                                                                  |  |                                       |       |                  |  
|Weighted average grant date
  fair value of stock options granted |  | $                                     |      |                  | $
|Total fair value of stock
  options vested                        |  | $                                     | 173   |                  | $
|Total intrinsic value of
  stock options exercised                |  | $                                     | 2,750 |                  | $

There were
5,000 stock  options  granted in the  six-month  period  ended April 1, 2006 and
5,000 stock  options  granted in the  six-month  period ended April 2, 2005.  No
stock options were granted  during the  three-month  period ended April 1, 2006.
For the six-month period ended April 1, 2006, cash received from the exercise of
stock options and contributions  under the employee stock purchase plan was $2.6
million,  and the income tax benefit realized from exercise of stock options and
the vesting of restricted  shares was $1.0 million.  At April 1, 2006, there was
$3.8 million of total stock option  compensation  expense  related to non-vested
awards not yet  recognized,  which is expected to be recognized  over a weighted
average period of 1.0 years.

Results of
operations for fiscal year 2005 and prior interim and annual periods have not
been restated to reflect recognition of stock-based compensation expense. If
compensation expense for employee stock-based compensation had been determined
based on the fair value at the grant dates consistent with the methods provided
in SFAS No. 123, the Companys net income and earnings per share for the three-
and six-month periods ended April 2, 2005 would have been as follows:

|                                                                           |  |                                       |       |                  |   |        |  
|-------------------------------------------------------------------------- |  | ------------------------------------- | ----- | ---------------- | - | ------ | -
|                                                                           |  | Three Months Ended                    |       | Six Months Ended |  
|                                                                           |  | April 2, 2005                         |       | April 2, 2005    |  
|                                                                           |  |                                       |       |                  |  
|                                                                           |  | (in thousands, except per share data) |      
|Net income:                                                                |  |                                       |       |                  |   |        |  
|As reported                                                                |  | $                                     | 8,473 |                  | $ | 16,665 |  
|Deduct fair value of employee stock-based compensation expense, net of tax |  |                                       | (782  | )                |   | (1,626 | )
|                                                                           |  |                                       |       |                  |   |        |  
|Pro forma                                                                  |  | $                                     | 7,691 |                  | $ | 15,039 |  
|                                                                           |  |                                       |       |                  |   |        |  
|Basic
  Earnings Per Share:                                                |  |                                       |       |                  |   |        |  
|As reported                                                                |  | $                                     | 0.43  |                  | $ | 0.84   |  
|Pro forma                                                                  |  | $                                     | 0.39  |                  | $ | 0.76   |  
|                                                                           |  |                                       |       |                  |   |        |  
|Diluted
  Earnings Per Share:                                              |  |                                       |       |                  |   |        |  
|As reported                                                                |  | $                                     | 0.41  |                  | $ | 0.81   |  
|Pro forma                                                                  |  | $                                     | 0.37  |                  | $ | 0.73   |  
|                                                                           |  |                                       |       |                  |   |        |  

The fair value
of options granted under stock-based compensation programs has been estimated
at the date of each grant using a Black-Scholes multiple option valuation
model. The multiple option form of the model separately values each vesting
increment of the stock grant. This application of the Black-Scholes model
values each vesting period separately and thus allocates proportionately more
of the resulting expense to early vesting periods. In general, the fair value
of a grant will increase or decrease based on certain weighted average
assumptions summarized as follows:

|                         |  |                  |      |  
|------------------------ |  | ---------------- | ---- | -
|                         |  | Six Months Ended |     
|                         |  | April 1, 2006    |     
|                         |  |                  |     
|Expected life (in years) |  |                  | 2.7  |  
|Risk-free interest rate  |  |                  | 4.5  | %
|Expected volatility      |  |                  | 36.7 | %
|Dividend yield           |  |                  | 1.0  | %

9

---



There were
5,000 stock options granted in the six-month period ended April 1, 2006 and
5,000 stock options granted for the six-month period ended April 2, 2005. For
the six-month period ended April 1, 2006 the Company used a projected expected
life for each award granted based on historical experience of employees
exercise behavior. The risk-free interest rate is based on the yield of
constant maturity U.S. Treasury bonds with a remaining term equal to the
expected life of the awards. The Company estimated the stock price volatility
using historical weekly price observations.

U.S. employees
are eligible to participate in the Companys Employee Stock Purchase Plan
(ESPP), which was approved by the Companys shareholders in fiscal year 2002.
Purchases are funded by payroll deductions over calendar six-month periods. The
ultimate purchase price is 85% of the lower of the market price at either the
beginning or end of the six-month period. The shares are required to be held by
the employee for at least 18 months subsequent to the purchase. The amount of
expense related to the plan was recognized in the three- and six-month periods
ended April 1, 2006. At April 1, 2006, the number of shares reserved for
issuance under the ESPP plan was 566,455.

In the
six-month period ended April 1, 2006, the Company awarded non-employee members
of its Board of Directors restricted stock totaling 13,200 shares, with an
aggregate estimated fair value of $0.5 million. In fiscal year 2005, the
Company awarded non-employee members of its Board of Directors restricted stock
grants totaling 15,000 shares, with an aggregate fair value of $0.4 million. In
fiscal year 2003, the Company awarded two officers restricted stock grants
totaling 12,000 shares, with an aggregate grant date fair value of $0.1
million. These grants generally vest over three years. In the six-month periods
ended April 1, 2006, and April 2, 2005, 10,004 and 3,333 shares of restricted
stock vested, respectively. Other information pertaining to restricted stock
awards for the six-month period ended April 1, 2006 was as follows:

|                                      |  |        |        |                                            |   |       | 
|------------------------------------- |  | ------ | ------ | ------------------------------------------ | - | ----- | 
|                                      |  | Shares |        | Weighted Average
  Grant Date
  Fair Value |  
|                                      |  |        |        |                                            |  
|                                      |  |        |        |                                            |  
|Unnvested shares at October
  1, 2005 |  |        | 19,000 |                                            | $ | 25.97 | 
|Granted                               |  |        | 13,200 |                                            |   | 36.65 | 
|Vested                                |  |        | (8,337 | )                                          |   | 22.17 | 
|Forfeited                             |  |        | (1,667 | )                                          |   | 29.95 | 
|                                      |  |        |        |                                            |   |       | 
|Unnvested shares at April
  1, 2006   |  |        | 22,196 |                                            |   | 33.45 | 
|                                      |  |        |        |                                            |   |       | 

3. Discontinued Operations

On August 5,
2005, the Company sold substantially all of the net assets of its engine test
business, which was based in Ann Arbor, Michigan and also maintained operations
in Byfleet, United Kingdom to A&D Co., Ltd., of Tokyo, Japan. This sale
represented the Companys exit from the engine test business. As a result of
this sale, the Company recorded a gain of $3.8 million, net of tax of $1.1
million, in the fourth quarter of fiscal year 2005. The engine test business
was historically included in the Companys Test segment for financial
reporting. The gain on the sale of the engine test business and its results of
operations have been excluded from the results of operations of the Test
segment and are reported as discontinued operations for fiscal year 2005 and
prior fiscal years.

Effective
October 1, 2005, the Company closed its AeroMet subsidiary, a laser deposition
technology business located in Eden Prairie, Minnesota. As a result of this
business closure, the Company recorded a loss of $0.7 million, net of tax of
$0.4 million, in the fourth quarter of fiscal year 2005. The AeroMet subsidiary
was historically included in the Companys Industrial segment for financial reporting.
The loss on disposition of the AeroMet business and its results of operations
have been excluded from results of operations of the Industrial segment and are
reported as discontinued operations for fiscal year 2005 and prior fiscal
years.

The Company
does not allocate interest income or interest expense to discontinued
operations. Following are the operating results of the discontinued operations
included in the Companys results of operations for the three- and six-month
periods ended April 2, 2005:

10

---



|                                                |  |                             |        |                  |   |        |  
|----------------------------------------------- |  | --------------------------- | ------ | ---------------- | - | ------ | -
|                                                |  | Three Months Ended          |        | Six Months Ended |  
|                                                |  |                             |        |                  |  
|                                                |  | April 2,
  2005             |        | April 2,
  2005  |  
|                                                |  |                             |        |                  |  
|                                                |  | (in
  thousands of dollars) |       
|                                                |  |                             |        |                  |   |        |  
|Revenue                                         |  | $                           | 4,777  |                  | $ | 10,187 |  
|Loss on discontinued
  operations before tax    |  |                             | (1,916 | )                |   | (2,794 | )
|Benefit for income taxes                        |  |                             | 710    |                  |   | 1,048  |  
|                                                |  |                             |        |                  |   |        |  
|Loss from discontinued
  operations, net of tax |  | $                           | (1,206 | )                | $ | (1,746 | )
|                                                |  |                             |        |                  |   |        |  

The assets and
liabilities of discontinued operations at April 1, 2006 and October 1, 2005
were as follows:

|                                                               |  |                             |       |                 |   |       |  
|-------------------------------------------------------------- |  | --------------------------- | ----- | --------------- | - | ----- | -
|                                                               |  | April 1, 2006               |       | October 1, 2005 |  
|                                                               |  |                             |       |                 |  
|                                                               |  | (in
  thousands of dollars) |      
|Accounts receivable, net of
  allowances for doubtful accounts |  | $                           | 420   |                 | $ | 12    |  
|Unbilled accounts
  receivable                                 |  |                             |      |                 |   | 258   |  
|Inventories                                                    |  |                             |      |                 |   | 358   |  
|Current deferred tax assets                                    |  |                             | 465   |                 |   | 465   |  
|Other current assets                                           |  |                             | 548   |                 |   | 548   |  
|                                                               |  |                             |       |                 |   |       |  
|Current assets of discontinued operations                      |  |                             | 1,433 |                 |   | 1,641 |  
|Machinery and equipment                                        |  |                             |      |                 |   | 106   |  
|Accumulated depreciation                                       |  |                             |      |                 |   | (37   | )
|                                                               |  |                             |       |                 |   |       |  
|Long-lived assets of discontinued
operations                   |  |                             |      |                 |   | 69    |  
|                                                               |  |                             |       |                 |   |       |  
|Total assets of
  discontinued operations                      |  | $                           | 1,433 |                 | $ | 1,710 |  
|                                                               |  |                             |       |                 |   |       |  
|Accounts payable                                               |  | $                           | 150   |                 | $ | 238   |  
|Accrued payroll-related
  costs                                |  |                             |      |                 |   | 223   |  
|Other accrued liabilities                                      |  |                             |      |                 |   | 429   |  
|                                                               |  |                             |       |                 |   |       |  
|Total liabilities of
  discontinued operations                 |  | $                           | 150   |                 | $ | 890   |  
|                                                               |  |                             |       |                 |   |       |  

4. Recently Issued Accounting Standards

In May 2005,
the FASB issued SFAS No. 154, Accounting
Changes and Error Corrections, which supersedes APB Opinion No. 20, Accounting Changes, and FASB Statement No.
3, Reporting Accounting Changes in Interim
Financial Statements. SFAS No. 154 requires retrospective
application of changes in accounting principles to prior periods financial
statements as of the earliest date practicable. This statement also redefines
restatement as the revising of previously issued financial statements to
reflect the correction of an error. The provisions of SFAS No. 154 are
effective for fiscal years beginning after December 15, 2005.

In November
2005, the FASB issued FASB Staff Position (FSP) FAS 115-1 and FSP FAS 124-1, The Meaning of Other-Than-Temporary Impairment and
Its Application to Certain Investments, which amends FASB Statement
No. 115, Accounting for Certain Investments
in Debt and Equity Securities, FASB Statement No. 124, Accounting for Certain Investments Held by
Not-for-Profit Organizations, and APB Opinion No. 18, The Equity Method of Accounting for Investments in
Common Stock. FSP FAS 115-1 and FSP FAS 124-1 provide guidance for
determining whether impairments of certain debt and equity investments are deemed
other-than-temporary. The provisions of FSP FAS 115-1 and FSP FAS 124-1 are
effective for reporting periods beginning after December 15, 2005. No material
impact on the Companys financial statements is expected from the adoption of
this standard.

In February
2006, the FASB issued SFAS No. 155, Accounting
for Certain Hybrid Financial Instruments, which amends FASB
Statement No. 133, Accounting for Derivative
Instruments and Hedging Activities and FASB No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities. This Statement resolves
implementation issues in FASB No. 133 related to beneficial interests in
securitized financial assets. The provisions of SFAS No. 154 are effective for
financial instruments acquired or issued during fiscal years beginning after
September 15, 2006. No material impact on the Companys financial statements is
expected from adoption of this standard.

11

---



5. Earnings Per Common Share

Basic net
earnings per share are computed by dividing net earnings by the weighted
average number of common shares outstanding during the applicable periods.
Diluted net earnings per share includes the potentially dilutive effect of
common shares issued in connection with outstanding stock options using the
treasury stock method. Options to acquire 0.5 million weighted common shares
have been excluded from the diluted weighted shares outstanding calculation for
the periods ended April 1, 2006 because under the treasury stock method the
exercise of these options would lead to a net reduction in common shares
outstanding. Substantially all options to acquire common shares have been
included in the diluted weighted shares outstanding calculation for the periods
ended April 2, 2005. A reconciliation of these amounts is as follows:

|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|----------------------------------------------- |  | ------------------------------------- | ------ | ---------------- | - | --------------- | - | --------------- | ------ |  | - | ------ | -
|                                                |  | Three Months Ended                    |        | Six Months Ended |  
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|                                                |  | April 1,
  2006                       |        | April 2,
  2005  |   | April 1,
  2006 |   | April 2,
  2005 |       
|                                                |  |                                       |        |                  |   |                 |   |                 |       
|                                                |  | (in thousands, except per share data) |       
|                                                |  |                                       |       
|Income before discontinued
  operations         |  | $                                     | 11,299 |                  | $ | 9,679           |   | $               | 19,255 |  | $ | 18,411 |  
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Discontinued operations:                        |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Loss from discontinued operations, net of
tax   |  |                                       |       |                  |   | (1,206          | ) |                 |       |  |   | (1,746 | )
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Net income                                      |  | $                                     | 11,299 |                  | $ | 8,473           |   | $               | 19,255 |  | $ | 16,665 |  
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Weighted average common
  shares outstanding    |  |                                       | 19,072 |                  |   | 19,857          |   |                 | 19,263 |  |   | 19,783 |  
|Diluted potential common
  shares               |  |                                       | 508    |                  |   | 797             |   |                 | 529    |  |   | 842    |  
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Total diluted weighted
  shares outstanding     |  |                                       | 19,580 |                  |   | 20,654          |   |                 | 19,792 |  |   | 20,625 |  
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Earnings per share:                             |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Basic-                                          |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Income before discontinued operations           |  | $                                     | 0.59   |                  | $ | 0.49            |   | $               | 1.00   |  | $ | 0.93   |  
|Discontinued operations:                        |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Loss
  from discontinued operations, net of tax |  |                                       |       |                  |   | (0.06           | ) |                 |       |  |   | (0.09  | )
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Earnings per share                              |  | $                                     | 0.59   |                  | $ | 0.43            |   | $               | 1.00   |  | $ | 0.84   |  
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Diluted -                                       |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Income before discontinued operations           |  | $                                     | 0.58   |                  | $ | 0.47            |   | $               | 0.97   |  | $ | 0.89   |  
|Discontinued operations:                        |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Loss
  from discontinued operations, net of tax |  |                                       |       |                  |   | (0.06           | ) |                 |       |  |   | (0.08  | )
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  
|Earnings per share                              |  | $                                     | 0.58   |                  | $ | 0.41            |   | $               | 0.97   |  | $ | 0.81   |  
|                                                |  |                                       |        |                  |   |                 |   |                 |        |  |   |        |  

6. Short-Term Investments

At April 1,
2006 and October 1, 2005, all the Companys short-term investments consisted of
U.S. municipal debt obligations with original maturity dates greater than three
months. The Company currently classifies these as available-for-sale short-term
investments as the Company intends to liquidate them to fund current
operations, acquisitions, or the return of capital to shareholders. All
investments in available-for-sale securities are carried at fair value, and
unrealized gains and losses on these securities are reported as a component of
Accumulated Other Comprehensive Income. At April 1, 2006 and October 1, 2005,
unrealized gains or losses from investments in available-for-sale securities
were not material.

7. Business Segment Information

The Companys
Chief Executive Officer and its management regularly review financial
information for the Companys discrete business units. Based on similarities in
the economic characteristics, nature of products and services, production
processes, type or class of customer served, method of distribution and
regulatory environments, the operating units have been aggregated for financial
statement purposes into two reportable segments, Test and Industrial. The
Test segment provides testing equipment, integrated software, and consulting services
to the ground vehicles, aerospace, and infrastructure markets. The Industrial
segment provides component solutions, such as position sensors, that automate
machines and machine tools.

12

---



The accounting
policies of the reportable segments are the same as those described in Note 1
to the Consolidated Financial Statements found in the Companys 2005 Form 10-K.
In evaluating each segments performance, management focuses on income from
operations. This measure excludes interest income and expense, income taxes and
other non-operating items. Corporate expenses, including costs associated with
various support functions such as human resources, information technology,
finance and accounting, and general and administrative costs, are allocated to
the reportable segments primarily on the basis of revenue.

Financial
information by reportable segment for the periods ended April 1, 2006 and April
2, 2005 was as follows:

|                                     |  |                             |         |                  |   |                 |  |                 |         |  |   |         | 
|------------------------------------ |  | --------------------------- | ------- | ---------------- | - | --------------- |  | --------------- | ------- |  | - | ------- | 
|                                     |  | Three Months Ended          |         | Six Months Ended |  
|                                     |  |                             |         |                  |  
|                                     |  | April 1,
  2006             |         | April 2,
  2005  |   | April 1,
  2006 |  | April 2,
  2005 |        
|                                     |  |                             |         |                  |   |                 |  |                 |        
|                                     |  | (in
  thousands of dollars) |        
|Revenue by
  Segment:                |  |                             |         |                  |   |                 |  |                 |         |  |   |         | 
|Test                                 |  | $                           | 86,975  |                  | $ | 80,749          |  | $               | 163,814 |  | $ | 159,856 | 
|Industrial                           |  |                             | 15,893  |                  |   | 15,366          |  |                 | 30,897  |  |   | 29,340  | 
|                                     |  |                             |         |                  |   |                 |  |                 |         |  |   |         | 
|Total revenue                        |  | $                           | 102,868 |                  | $ | 96,115          |  | $               | 194,711 |  | $ | 189,196 | 
|                                     |  |                             |         |                  |   |                 |  |                 |         |  |   |         | 
|                                     |  |                             |        
|Income
  from Operations by Segment: |  |                             |         |                  |   |                 |  |                 |         |  |   |         | 
|Test                                 |  | $                           | 14,602  |                  | $ | 12,750          |  | $               | 24,536  |  | $ | 24,872  | 
|Industrial                           |  |                             | 2,516   |                  |   | 1,846           |  |                 | 4,896   |  |   | 3,641   | 
|                                     |  |                             |         |                  |   |                 |  |                 |         |  |   |         | 
|Total income from operations         |  | $                           | 17,118  |                  | $ | 14,596          |  | $               | 29,432  |  | $ | 28,513  | 
|                                     |  |                             |         |                  |   |                 |  |                 |         |  |   |         | 

8. Derivative Instruments and Hedging
Activities

The Company
periodically enters into forward and optional currency exchange contracts with
banks to exchange currencies at a set future date and rate to maintain the
functional currency value of specifically identified foreign currency
exposures. Because the market value of these currency exchange contracts is
derived from current exchange rates, they are classified as derivative financial
instruments. The Company does not use currency exchange contracts for
speculative or trading purposes.

Currency
exchange contracts utilized to maintain the reporting currency value of
expected financial transactions are matched to the identified exposures and
designated as foreign currency cash flow hedges. Subsequent changes in the
market value of the contracts are recorded in Accumulated Other Comprehensive
Income within Shareholders Investment on the Consolidated Balance Sheet until
they are recognized in earnings at the time income or loss is recognized on the
underlying forecasted transaction. The Company periodically assesses whether
the contracts are effective in offsetting the reporting currency value of the
forecasted transactions. When a contract is no longer effective as a hedge, the
Company discontinues hedge accounting prospectively and reclassifies the
unrealized gain or loss from Accumulated Other Comprehensive Income to Other
Income, net on the Consolidated Statement of Income in the current period.
Subsequent changes in the market value of the contract are recognized in
current period earnings.

The Company
also uses currency exchange contracts to hedge the reporting currency value of
monetary assets and liabilities denominated in foreign currencies. The related
gains and losses are included in Other Income, net on the Consolidated
Statement of Income.

At April 1,
2006 and April 2, 2005, the Company had outstanding currency exchange contracts
with gross notional U.S. dollar equivalent amounts of $93.5 million and $105.1
million, respectively. Netting offsetting contracts, net notional contracts
outstanding in U.S. dollar equivalent amounts were $16.8 million and $40.3
million, respectively. At April 1, 2006 and April 2, 2005, the market value of
the foreign currency forward exchange contracts was $1.0 million and ($52)
thousand, respectively. The amount recognized in earnings as a result of the
ineffectiveness of cash flow hedges was not material for the periods ended
April 1, 2006 and April 2, 2005. At April 1, 2006 and April 2, 2005, the amount
projected to be reclassified from Accumulated Other Comprehensive Income into
earnings in the next 12 months was $0.5 million and not material, respectively.
The maximum original maturity of any derivative was 2 years at both April 1,
2006 and April 2, 2005.

13

---



9. Comprehensive Income

Comprehensive
income consists of net income, unrealized gains or losses on investments
classified as available-for-sale, derivative instrument gains or losses, and
foreign currency translation adjustments and is presented as a component of
Shareholders Investment on the Consolidated Balance Sheet. There were no
significant unrealized gains or losses from available-for-sale securities at
April 1, 2006 and April 2, 2005.

Comprehensive income for the periods ended
April 1, 2006 and April 2, 2005 was as follows:

|                                                                        |  |                           |        |                  |   |                 |   |                 |        |   |   |        |  
|----------------------------------------------------------------------- |  | ------------------------- | ------ | ---------------- | - | --------------- | - | --------------- | ------ | - | - | ------ | -
|                                                                        |  | Three Months Ended        |        | Six Months Ended |  
|                                                                        |  |                           |        |                  |  
|                                                                        |  | April 1,
  2006           |        | April 2,
  2005  |   | April 1,
  2006 |   | April 2,
  2005 |       
|                                                                        |  |                           |        |                  |   |                 |   |                 |       
|                                                                        |  | (in thousands of dollars) |       
|                                                                        |  |                           |        |                  |   |                 |   |                 |        |   |   |        |  
|Net income                                                              |  | $                         | 11,299 |                  | $ | 8,473           |   | $               | 19,255 |   | $ | 16,665 |  
|Change in
  cumulative translation adjustment                           |  |                           | 1,671  |                  |   | (3,149          | ) |                 | 149    |   |   | 3,196  |  
|(Decrease)
  increase in unrealized gain/loss on derivative instruments |  |                           | (950   | )                |   | 868             |   |                 | (1,357 | ) |   | (103   | )
|                                                                        |  |                           |        |                  |   |                 |   |                 |        |   |   |        |  
|Comprehensive
  income                                                  |  | $                         | 12,020 |                  | $ | 6,192           |   | $               | 18,047 |   | $ | 19,758 |  
|                                                                        |  |                           |        |                  |   |                 |   |                 |        |   |   |        |  

10. Retirement Benefit Plan

One of the
Companys international subsidiaries has a non-contributory, unfunded defined
benefit retirement plan for eligible employees. This plan provides benefits
based on the employees years of service and compensation during the years
immediately preceding retirement, early retirement, termination, disability, or
death, as defined in the plan.

The cost for the plan for the periods ended
April 1, 2006 and April 2, 2005 included the following components:

|                                                |  |                             |     |                  |   |                 |  |                 |     |  |   |     | 
|----------------------------------------------- |  | --------------------------- | --- | ---------------- | - | --------------- |  | --------------- | --- |  | - | --- | 
|                                                |  | Three Months Ended          |     | Six Months Ended |  
|                                                |  |                             |     |                  |  
|                                                |  | April 1,
  2006             |     | April 2,
  2005  |   | April 1,
  2006 |  | April 2,
  2005 |    
|                                                |  |                             |     |                  |   |                 |  |                 |    
|                                                |  | (in thousands
  of dollars) |    
|                                                |  |                             |     |                  |   |                 |  |                 |     |  |   |     | 
|Service cost-benefit earned
  during the period |  | $                           | 115 |                  | $ | 86              |  | $               | 229 |  | $ | 172 | 
|Interest cost on projected
  benefit obligation |  |                             | 113 |                  |   | 121             |  |                 | 225 |  |   | 242 | 
|Net amortization and
  deferral                 |  |                             | 34  |                  |   | 3               |  |                 | 67  |  |   | 6   | 
|                                                |  |                             |     |                  |   |                 |  |                 |     |  |   |     | 
|Net periodic retirement
  cost                  |  | $                           | 262 |                  | $ | 210             |  | $               | 521 |  | $ | 420 | 
|                                                |  |                             |     |                  |   |                 |  |                 |     |  |   |     | 

11. Restructuring and Other Charges:

In the fourth quarter of fiscal
year 2005, the Company decided to exit the noise and
vibration software business of the Test segment. The Company assessed the
recoverability of the assets associated with this business using an
undiscounted cash flow methodology. Based on this assessment, the Company
reduced the assets to their fair market value and recorded costs of $0.3
million to write down property, plant and equipment and $0.2 million to write
down inventory. In addition, the Company recorded $1.3 million for employee
severance costs and $2.7 million related to software development expense that
will not recur in future years. Substantially all of the severance costs will
be paid in fiscal year 2006.

For the six-month period ended
April 1, 2006 and the fiscal year ended October 1, 2005, the Companys
provisions and write-offs associated with this restructuring activity were as
follows:

14

---



|                            |  |                             |        |                                  |   |       |   |   |        |  
|--------------------------- |  | --------------------------- | ------ | -------------------------------- | - | ----- | - | - | ------ | -
|                            |  | Severance
  Charges         |        | Contract
  Termination
  Charges |   | Total |  
|                            |  |                             |        |                                  |   |       |  
|                            |  | (in
  thousands of dollars) |       
|Balances at October 2, 2004 |  | $                           |       |                                  | $ |      |   | $ |       |  
|Provision                   |  |                             | 1,267  |                                  |   | 52    |   |   | 1,319  |  
|Write-off/payments          |  |                             |       |                                  |   |      |   |   |       |  
|                            |  |                             |        |                                  |   |       |   |   |        |  
|Balances at October 1, 2005 |  |                             | 1,267  |                                  |   | 52    |   |   | 1,319  |  
|                            |  |                             |        |                                  |   |       |   |   |        |  
|Provision                   |  |                             | 30     |                                  |   |      |   |   | 30     |  
|Write-off/payments          |  |                             | (1,138 | )                                |   | (52   | ) |   | (1,190 | )
|                            |  |                             |        |                                  |   |       |   |   |        |  
|Balances at April 1, 2006   |  | $                           | 159    |                                  | $ |      |   | $ | 159    |  
|                            |  |                             |        |                                  |   |       |   |   |        |  

Item 2.
Managements Discussion and Analysis of Financial Condition and Results of
Operations

MTS Systems
Corporation is a leading global supplier of test systems and industrial
position sensors. The Companys testing hardware and software solutions help
customers accelerate and improve their design, development, and manufacturing
processes and are used for determining the mechanical behavior of materials,
products, and structures. MTS high-performance position sensors provide
controls for a variety of industrial and vehicular applications. MTS had 1,549
employees and revenue of $374 million for the fiscal year ended October 1,
2005.

Overall Results

Three Months Ended April 1, 2006 (Second Quarter of Fiscal
2006) Compared to Three Months Ended April 2, 2005 (Second Quarter of Fiscal
2005)

Orders for the
Second Quarter of Fiscal 2006 decreased 33.8% to $81.5 million, compared to
$123.1 million for the Second Quarter of Fiscal 2005, primarily due to a
decrease in large custom orders in the Test segment. Orders for the Second
Quarter of Fiscal 2005 included two multi-year Test orders in the ground
vehicles and aerospace markets, which totaled $43 million. Backlog of
undelivered orders at April 1, 2006 was approximately $195 million, a decrease
of 9.7% from backlog of approximately $216 million at December 31, 2005, due to
lower order volume. Backlog at the end of the Second Quarter of Fiscal 2005 was
approximately $220 million.

Revenue of $102.9
million for the Second Quarter of Fiscal 2006 increased 7.1%, compared to
revenue of $96.1 million for the Second Quarter of Fiscal 2005, primarily due
to increased short-cycle and service business in the Test segment and continued
growth in the Industrial segment, partially offset by an estimated $5.2 million
unfavorable impact of currency translation. Gross profit for the Second Quarter
of Fiscal 2006 was $45.8 million, an increase of 8.3% compared to gross profit
of $42.3 million for the Second Quarter of Fiscal 2005, primarily due to
increased volume in both segments and reduced Test segment warranty expense,
partially offset by $0.4 million stock-based compensation expense, and an
estimated $1.3 million unfavorable impact of currency translation. Income from
operations for the Second Quarter of Fiscal 2006 was $17.1 million, an increase
of 17.1% compared to income from operations of $14.6 million for the Second
Quarter of Fiscal 2005, primarily due to higher gross profit and a $0.9 million
gain on the sale of assets of the Companys noise and vibration business,
partially offset by planned increases in operating expenses to support growth
initiatives, stock-based compensation expense of $1.2 million, and an estimated
$0.6 million unfavorable impact of currency translation. Net income for the
Second Quarter of Fiscal 2006 was $11.3 million, or $0.58 per diluted share, an
increase of 32.9% compared to $8.5 million, or $0.41 per diluted share, for the
Second Quarter of Fiscal 2005, primarily due to higher income from operations
and a $1.2 million loss from discontinued operations in the Second Quarter of
Fiscal 2005.

Six Months Ended April 1, 2006 (First Half of Fiscal 2006)
Compared to Six Months Ended April 2, 2005 (First Half of Fiscal 2005)

Orders for the First Half of Fiscal 2006 decreased
16.5% to $178.3 million, compared to orders of $213.5 million for the First
Half of Fiscal 2005, primarily due to a decrease in large custom orders in the
Test segment in Asia, partially offset by increased volume in the Industrial
segment across all geographies. Orders for the First Half of Fiscal 2005 included two multi-year
Test orders in the ground vehicles and aerospace markets, which totaled $43
million. Backlog of undelivered orders at April 1, 2006 decreased 11.4%
to approximately $195 million, compared to backlog of approximately $220
million at October 1, 2005, on lower order volume.

15

---



Revenue of $194.7 million for the First Half of Fiscal
2006 increased 2.9% compared to $189.2 million for the First Half of Fiscal
2005, driven by higher beginning backlog and increased short-cycle and service
business in the Test segment and continued growth in the Industrial segment,
partially offset by an estimated $10.3 million unfavorable impact of currency
translation. Gross
profit for the First Half of Fiscal 2006 was $86.4 million, an increase of 5.2%
compared to gross profit of $82.1 million for the First Half of Fiscal 2005,
primarily due to increased volume in both segments and reduced Test segment
warranty expense, partially offset by $0.5 million stock-based compensation
expense and an estimated $2.8 million unfavorable impact of currency
translation. Income from operations for the First Half of Fiscal 2006
was $29.4 million, an increase of 3.2% compared to $28.5 million for the First
Half of Fiscal 2005, primarily due to higher gross profit and a $0.9 million
gain on the sale of assets of the Companys noise and vibration business,
partially offset by planned increases in operating expenses, stock-based
compensation expense of $2.1 million, and an estimated $1.2 million unfavorable
impact of currency translation. Net income for the First Half of Fiscal 2006
was $19.3 million, or $0.97 per diluted share, an increase of 15.6% compared to
$16.7 million, or $0.81 per diluted share, for the First Half of Fiscal 2005, primarily due to increased income
from operations and a $1.7 million loss from discontinued operations in the
First Half of Fiscal 2005.

Critical Accounting Policies

The consolidated
financial statements are prepared in accordance with U.S. generally accepted
accounting principles, which require the Company to make estimates and
assumptions in certain circumstances that affect amounts reported. In preparing
these financial statements, management has made its best estimates and
judgments of certain amounts, giving due consideration to materiality. The
Company believes that of its significant accounting policies, the following are
particularly important to the portrayal of the Companys results of operations
and financial position and may require the application of a higher level of
judgment by the Companys management, and as a result are subject to an
inherent degree of uncertainty. Further information is provided in Note 1 in
the Condensed Notes to Consolidated Financial Statements in this Form 10-Q.

Revenue
Recognition. Due to the diversity of its products, the Company is required to
comply with a variety of technical accounting requirements in order to achieve
consistent and accurate revenue recognition. This requires a certain amount of
judgment in the evaluation of completed contract versus percentage-of-completion
accounting, the determination of estimated costs to complete contracts, and
evaluation of customer acceptance terms.

Inventories. The Company maintains a material amount
of inventory to support its engineering and manufacturing operations, and a certain
amount of judgment is required in determining the appropriate inventory
valuation.
While the Company expects its sales to grow, a reduction in its sales could
reduce the demand for the Companys products, and additional inventory
valuation adjustments may be required.

Warranty
Obligations. The Company is subject to warranty guarantees on sales of its
products. A certain amount of judgment is required in determining appropriate
reserve levels for anticipated warranty claims. While these reserve levels are
based on historical warranty experience, they may not reflect the actual claims
that will occur over the upcoming warranty period, and additional warranty
reserves may be required.

Share-Based
Compensation. For purposes of determining estimated fair value of share-based
payment awards on the date of grant in accordance with SFAS 123R, Share-Based
Payment, the Company utilizes a Black-Scholes option pricing model.
The Black-Scholes model requires the input of certain assumptions that require
management judgment. Because the Companys employee stock options, restricted
stock units, and restricted stock awards have characteristics significantly
different from those of traded options, and because changes in the input
assumptions can materially affect fair value estimates, existing models may not
provide a reliable single measure of the fair value of employee stock options,
restricted stock units, or restricted stock awards. Management will continue to
assess the assumptions and methodologies used to calculate estimated fair value
of share-based compensation. Circumstances may change and additional data may
become available over time, which could result in changes to these assumptions
and methodologies and thereby materially impact the fair value determination.
If factors change and the Company employs different assumptions in the
application of SFAS 123R in future periods, the compensation expense recorded
under SFAS 123R may differ significantly from the expense recorded in the
current period. See Note 2 in the Condensed Notes to Consolidated Financial
Statements in this Form 10-Q for more information regarding share-based
compensation.

New Accounting Principles

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections,
which supersedes APB Opinion No. 20, Accounting
Changes, and FASB Statement No. 3, Reporting
Accounting Changes in Interim Financial Statements. SFAS No. 154
requires retrospective application of changes in accounting principles to prior
periods

16

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financial statements as of the earliest date
practicable. This statement also redefines restatement as the revising of
previously issued financial statements to reflect the correction of an error.
The provisions of SFAS No. 154 are effective for fiscal years beginning after
December 15, 2005.

In November 2005, the FASB issued FASB Staff Position
(FSP) FAS 115-1 and FSP FAS 124-1, The
Meaning of Other-Than-Temporary Impairment and Its Application to Certain
Investments, which amends FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity
Securities, FASB Statement No. 124, Accounting
for Certain Investments Held by Not-for-Profit Organizations, and
APB Opinion No. 18, The Equity Method of
Accounting for Investments in Common Stock. FSP FAS 115-1 and FSP
FAS 124-1 provide guidance for determining whether impairments of certain debt
and equity investments are deemed other-than-temporary. The provisions of FSP
FAS 115-1 and FSP FAS 124-1 are effective for reporting periods beginning after
December 15, 2005. No material impact on the Companys financial statements is
expected from the adoption of this standard.

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments,
which amends FASB Statement No. 133, Accounting
for Derivative Instruments and Hedging Activities and FASB No. 140, Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities. This Statement resolves
implementation issues in FASB No. 133 related to beneficial interests in
securitized financial assets. The provisions of SFAS No. 154 are effective for
financial instruments acquired or issued during fiscal years beginning after
September 15, 2006. No material impact on the Companys financial statements is
expected from adoption of this standard.

Orders and Backlog

Second
Quarter of Fiscal 2006 Compared to Second Quarter of Fiscal 2005

Orders for the
Second Quarter of Fiscal 2006 aggregated $81.5 million, a decrease of 33.8%
compared to orders of $123.1 million for the Second Quarter of Fiscal 2005.
This decrease was primarily due to a decrease in large custom orders in the
Test segment. Second Quarter of Fiscal 2005 orders included two multi-year
orders in the ground vehicles and aerospace markets, which totaled $43 million.

Orders for the
Test segment in the Second Quarter of Fiscal 2006 decreased 39.3% to $65.1
million, compared to orders of $107.2 million for the Second Quarter of Fiscal
2005. This decrease was primarily due to a decrease in large custom orders.
Second Quarter of Fiscal 2005 orders included two multi-year orders totaling
$43 million. The Test segment accounted for 79.9% of total Company orders for
the Second Quarter of Fiscal 2006, compared to 87.1% for the Second Quarter of
Fiscal 2005.

Orders for the Industrial
segment in the Second Quarter of Fiscal 2006 increased 3.1% to $16.4 million,
compared to orders of $15.9 million for the Second Quarter of Fiscal 2005,
reflecting increased demand in the Sensors business in Europe and Asia. The
Industrial segment accounted for 20.1% of total Company orders for the Second
Quarter of Fiscal 2006, compared to 12.9% for the Second Quarter of Fiscal
2005.

Backlog of
undelivered orders at April 1, 2006 was approximately $195 million, a decrease
of 9.7% from backlog of $216 million at October 1, 2005, primarily due to lower
order volume. Backlog at April 2, 2005 was approximately $220 million. While
the Companys backlog is subject to order cancellations, the Company seldom
experiences cancellations of orders larger than $1.0 million.

First
Half of Fiscal 2006 Compared to First Half of Fiscal 2005

Orders for the
First Half of Fiscal 2006 aggregated $178.3 million, a decrease of 16.5%
compared to orders of $213.5 million for the First Half of Fiscal 2005. The
decrease was primarily due to a decrease in large custom orders in the Test
segment, partially offset by increased orders in the Industrial segment across
all geographies.
Orders in the First Half of Fiscal 2005 included two multi-year Test orders in
the ground vehicles and aerospace markets, which totaled $43 million.

Orders for the
Test segment for the First Half of Fiscal 2006 decreased 20.1% to $146.7
million, compared to orders of $183.6 million for the First Half of Fiscal
2005. The decrease is due to a decrease in large custom orders. First Half of Fiscal 2005 orders
included two multi-year orders totaling $43 million. The Test segment accounted
for 82.3% of total Company orders during the First Half of Fiscal 2006,
compared to 86.0% for the First Half of Fiscal 2005.

Orders for the
Industrial segment for the First Half of Fiscal 2006 increased 5.7% to $31.6
million, compared to orders of $29.9 million for the First Half of Fiscal 2005.
The increase primarily reflects continued strength in the Sensors business

17

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across all
geographies. The Industrial segment accounted for 17.7% of total Company orders
for the First Half of Fiscal 2006, compared to 14.0% for the First Half of
Fiscal 2005.

Backlog of
undelivered orders at April 1, 2006 was approximately $195 million, a decrease
of 11.4% from backlog of approximately $220 million at October 1, 2005,
primarily due to lower order volume.

Results
of Operations

Second Quarter of Fiscal 2006 Compared to Second Quarter of
Fiscal 2005

Revenue for the Second Quarter of Fiscal 2006 was $102.9 million, an
increase of $6.8 million, or 7.1%, compared to revenue of $96.1 million for the
Second Quarter of Fiscal 2005. Revenue from international customers for the
Second Quarter of Fiscal 2006 represented 65.0% of total revenue, compared to
70.5% for the Second Quarter of Fiscal 2005. Test segment revenue for the
Second Quarter of Fiscal 2006 was $87.0 million, an increase of $6.3 million,
or 7.8%, compared to revenue of $80.7 million for the Second Quarter of Fiscal
2005. This increase was primarily due to an increase in short-cycle and service
business, partially offset by an estimated $4.2 million unfavorable impact of
currency translation and a $1.9 million reduction in revenue associated with
the Companys exit of the noise and vibration software business. Industrial
segment revenue for the Second Quarter of Fiscal 2006 was $15.9 million, an
increase of $0.5 million, or 3.2%, compared to revenue of $15.4 million for the
Second Quarter of Fiscal 2005, driven by increased volume in the Sensors
business across all geographies, partially offset by an estimated $1.0
million unfavorable impact of currency translation.

Gross
profit for the Second Quarter of Fiscal 2006 increased $3.5
million, or 8.3%, to $45.8 million, compared to gross profit of $42.3 million
for the Second Quarter of Fiscal 2005. Gross profit as a percent of revenue was
44.5% for the Second Quarter of Fiscal 2006, an increase of 0.5 percentage
points from 44.0% for the First Quarter of Fiscal 2005. Test segment gross profit
for the Second Quarter of Fiscal 2006 was $37.4 million, an increase of $2.1
million, or 5.9%, compared to gross profit of $35.3 million for the Second
Quarter of Fiscal 2005. Gross profit as a percent of revenue for the Test
segment decreased 0.7 percentage points to 43.0% for the Second Quarter of
Fiscal 2006, compared to 43.7% for the Second Quarter of Fiscal 2005. This
decrease was primarily due to unfavorable product mix and a 0.5 percentage
point impact of stock-based compensation expense, partially offset by a 0.6
percentage point impact of reduced warranty expense and an estimated 1.1
percentage point favorable impact of currency translation. Industrial segment
gross profit for the Second Quarter of Fiscal 2006 was $8.4 million, an
increase of $1.4 million, or 20%, compared to gross profit of $7.0 million for
the Second Quarter of Fiscal 2005. Gross profit as a percent of revenue for the
Industrial segment increased 7.3 percentage points to 52.8% for the Second
Quarter of Fiscal 2006, compared to 45.5% for the Second Quarter of Fiscal
2005, primarily due to favorable product mix in the Sensors business and 2.6
percentage point impact of charges associated with excess and obsolete
inventory in the Second Quarter of Fiscal 2005. There was no significant impact
on gross profit as a percent of revenue from currency translation in the
Industrial segment for the Second Quarter of Fiscal 2006.

Selling
expense for the Second Quarter of Fiscal 2006 was $15.9
million, a slight decrease compared to $16.0 million for the Second Quarter of
Fiscal 2005, primarily due to $1.1 million decrease in expense associated with
the exited noise and vibration software business, an estimated $0.5 million
favorable impact of currency translation and $0.1 decrease in Test segment commissions
and employee incentives, substantially offset by $1.1 million increased expense
associated with marketing initiatives in the Test segment, $0.3 million
increased staffing and commission expense in the Industrial segment, and $0.2
million stock-based compensation expense. Selling expense as a percent of revenue for the Second
Quarter of Fiscal 2006 was 15.5%, compared to 16.6% for the Second Quarter of
Fiscal 2005.

General
and administrative expensetotaled $8.9 million for the
Second Quarter of Fiscal 2006, an increase of 14.1% compared to $7.8 million
for the Second Quarter of Fiscal 2005. This increase was primarily due to a
$0.7 million increase in consulting expenses associated with growth initiatives
and $0.6 million stock-based compensation expense, partially offset by an
estimated $0.2 million favorable impact of currency translation. General and
administrative expense as a percent of revenue increased to 8.6% for the Second
Quarter of Fiscal 2006, compared to 8.1% for the Second Quarter of Fiscal 2005.

Research
and development expense totaled $4.7 million for the Second
Quarter of Fiscal 2006, an increase of 20.5% compared to $3.9 million for the
Second Quarter of Fiscal 2005. This increase was primarily due to a planned
increase in expenditures for new product development in both segments. Research
and development expense as a percent of revenue increased to 4.6% for the
Second Quarter of Fiscal 2006, compared to 4.1% for the Second Quarter of
Fiscal 2005. There was no significant impact on research and development
expense from currency translation or stock-based compensation for the Second
Quarter of Fiscal 2006.

18

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Gain on
sale of assets of
$0.9 million for the Second Quarter of Fiscal 2006 resulted from the sale of
assets of the Companys noise and vibration business.

Income
from operations increased 17.1% to $17.1 million for the
Second Quarter of Fiscal 2006, compared to $14.6 million for the Second Quarter
of Fiscal 2005. Income from operations in the Test segment increased $1.8 million,
or 14.1%, to $14.6 million for the Second Quarter of Fiscal 2006, compared to
$12.8 million for the Second Quarter of Fiscal 2005, primarily due to $2.1
million increased gross profit and a $0.9
million gain on the sale of assets of the Companys noise and vibration
business, partially offset by increased expenses associated with
operating initiatives, stock-based compensation expense of $1.1 million, and an
estimated $0.3 million unfavorable impact of currency translation. Income from operations in
the Industrial segment increased by $0.7 million, or 38.9%, to $2.5 million for
the Second Quarter of Fiscal 2006, compared to $1.8 million for the Second
Quarter of Fiscal 2005, primarily due to $1.4 million increased gross profit,
partially offset by an estimated $0.3 million unfavorable impact of currency
translation.

Interest
expensewas $0.4 million for the Second Quarter of Fiscal
2006, a decrease of $0.1 million compared to $0.5 million for the Second
Quarter of Fiscal 2005, due to a reduction in the Companys long-term debt
obligations.

Interest
income was $0.8 million for the Second Quarter of Fiscal
2006, an increase of $0.3 million compared to interest income of $0.5 million
for the Second Quarter of Fiscal 2005, primarily due to higher average interest
rates.

Other
income, net was $0.3 million for the Second Quarter of Fiscal
2006, flat compared to the Second Quarter of Fiscal 2005.

Provision
for income taxes totaled $6.5 million for the Second Quarter
of Fiscal 2006, an increase of 25.0% compared to $5.2 million for the Second
Quarter of Fiscal 2005, primarily due to increased income before taxes. The
effective tax rate for the Second Quarter of Fiscal 2006 was 36.5%, an increase
of 1.8 percentage points compared to a tax rate of 34.7% for the Second Quarter
of Fiscal 2005, primarily due to the scheduled phase-out of certain tax
benefits such as the R&D credit and extraterritorial income exclusion.

Net
income was $11.3 million for the Second Quarter of Fiscal
2006, compared to $8.5 million for the Second Quarter of Fiscal 2005. The
increase was primarily due to increased income from operations and a $1.2 million loss from
discontinued operations in the Second Quarter of Fiscal 2005. The
estimated unfavorable impact on net income from currency translation for the
Second Quarter of Fiscal 2006 was $0.4 million.

First Half of Fiscal 2006 Compared to First Half of Fiscal
2005

Revenue for the First Half of Fiscal 2006 was $194.7 million, an increase
of $5.5 million, or 2.9%, compared to revenue of $189.2 million for the First
Half of Fiscal 2005. Revenue from international customers for the First Half of
Fiscal 2006 represented 66.5% of total revenue, compared to 69.1% for the First
Half of Fiscal 2005. Test segment revenue for the First Half of Fiscal 2006 was
$163.8 million, an increase of $3.9 million, or 2.4%, compared to revenue of
$159.9 million for the First Half of Fiscal 2005. This increase was primarily
due to higher beginning backlog and increased short-cycle and service
business, partially offset by
an estimated $8.4 million unfavorable impact of currency translation and a $3.7
million reduction in revenue associated with the Companys exit of the noise
and vibration software business. Industrial segment revenue for the First Half
of Fiscal 2006 was $30.9 million, an increase of $1.6 million, or 5.5%,
compared to revenue of $29.3 million for the First Half of Fiscal 2005, driven
by increased volume in the Sensors business across all geographies, partially
offset by an estimated $1.9 million unfavorable impact of currency
translation.

Gross
profit for the First Half of Fiscal 2006 increased $4.3
million, or 5.2%, to $86.4 million, compared to gross profit of $82.1 million
for the First Half of Fiscal 2005. Gross profit as a percent of revenue was
44.4% for the First Half of Fiscal 2006, an increase of 1.0 percentage points
from 43.4% for the First Half of Fiscal 2005. Test segment gross profit for the
First Half of Fiscal 2006 was $70.0 million, an increase of $1.5 million, or
2.2%, compared to gross profit of $68.5 million for the First Half of Fiscal
2005. Gross profit as a percent of revenue for the Test segment decreased 0.1
percentage points, to 42.7%, for the First Half of Fiscal 2006, compared to
42.8% for the First Half of Fiscal 2005. This decrease was primarily due to
unfavorable product mix and a 0.3 percentage point impact of stock-based
compensation expense, partially offset by a 1.2 percentage point impact of of
reduced warranty expense and an estimated 1.0 percentage point favorable impact
of currency translation. Industrial segment gross profit for the First Half of
Fiscal 2006 was $16.4 million, an increase of $2.8 million, or 20.6%, compared
to gross profit of $13.6 million for the First Half of Fiscal 2005. Gross
profit as a percent of revenue for the Industrial segment increased 6.7
percentage points, to 53.1%, for the First Half of Fiscal 2006, compared to
46.4% for the First Half of Fiscal 2005, primarily due to favorable product mix
in the Sensors business and a 1.4 percentage point impact of charges associated
with excess and obsolete inventory in the

19

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First Half of Fiscal 2005. There was no significant
impact on gross profit as a percent of revenue from currency translation in the
Industrial segment for the First Half of Fiscal 2006.

Selling
expense for the First Half of Fiscal 2006 increased to $31.9
million, or 2.2%, from $31.2 million for the First Half of Fiscal 2005,
primarily due to $2.0 million increased expense associated with marketing
initiatives in the Test segment, $1.0 million increased staffing and commission
expense in the Industrial segment, and $0.5 million stock-based compensation
expense and $0.1 increase in employee incentives, partially offset by a $1.8
million decrease in expense associated with the exited noise and vibration
software business and an estimated $1.1 million favorable impact of currency
translation. Selling
expense as a percent of revenue for the First Half of Fiscal 2006 was 16.4%,
compared to 16.5% for the First Half of Fiscal 2005.

General
and administrative expensetotaled $17.0 million for the
First Half of Fiscal 2006, an increase of 15.6% compared to $14.7 million for
the First Half of Fiscal 2005. This increase was primarily due to a $1.3
million increase in consulting expenses associated with growth initiatives,
$1.1 million stock-based compensation expense, and $0.2 million increased audit
fees, partially offset by an estimated $0.3 million favorable impact of
currency translation. General and administrative expense as a percent of revenue
increased to 8.7% for the First Half of Fiscal 2006, compared to 7.8% for the
First Half of Fiscal 2005.

Research
and development expense totaled $8.8 million for the First
Half of Fiscal 2006, an increase of 15.8% compared to $7.6 million for the
First Half of Fiscal 2005. This increase was primarily due to a planned
increase in expenditures for new product development in both segments. Research
and development expense as a percent of revenue increased to 4.5% for the First
Half of Fiscal 2006, compared to 4.0% for the First Half of Fiscal 2005. There
was no significant impact on research and development expense from currency
translation or stock-based compensation for the First Half of Fiscal 2006.

Gain on
sale of assets of
$0.9 million for the First Half of Fiscal 2006 resulted from the sale of assets
of the Companys noise and vibration business.

Income
from operations increased 3.2%, to $29.4 million, for the
First Half of Fiscal 2006, compared to $28.5 million for the First Half of
Fiscal 2005. Income from operations in the Test segment decreased $0.4 million,
or 1.6%, to $24.5 million for the First Half of Fiscal 2006, compared to $24.9
million for the First Half of Fiscal 2005, primarily due to increased expenses
associated with operating initiatives, stock-based compensation expense of $2.1
million, and an estimated $0.7 million unfavorable impact of currency
translation, partially offset by $4.3 million increased gross profit and a $0.9 million gain on the sale
of assets of the Companys noise and vibration business. Income from
operations in the Industrial segment increased by $1.3 million, or 36.1%, to
$4.9 million for the First Half of Fiscal 2006, compared to $3.6 million for
the Second Quarter of Fiscal 2005, primarily due to $2.8 million increased
gross profit, partially offset by an estimated $0.5 million unfavorable impact
of currency translation.

Interest
expensewas $0.9 million for the First Half of Fiscal 2006, a
decrease of $0.2 million compared to $1.1 million for the First Half of Fiscal
2005, due to a reduction in the Companys long-term debt obligations.

Interest
income was $1.5 million for the First Half of Fiscal 2006, an
increase of $0.6 million compared to interest income of $0.9 million for the
First Half of Fiscal 2005, primarily due to higher average interest rates.

Other
income, net was $0.3 million for the First Half of Fiscal
2006, relatively flat compared to $0.4 million for the First Half of Fiscal
2005.

Provision
for income taxes totaled $11.1 million for the First Half of
Fiscal 2006, an increase of 7.8% compared to $10.3 million for the First Half
of Fiscal 2005, primarily due to increased income before taxes. The effective
tax rate for the First Half of Fiscal 2006 was 36.6%, an increase of 0.7
percentage points compared to a tax rate of 35.9% for the First Half of Fiscal
2005.

Net
income was $19.3 million for the First Half of Fiscal 2006,
compared to $16.7 million for the First Half of Fiscal 2005. The increase was
primarily due to increased income from operations and a $1.7 million loss from discontinued operations in the First
Half of Fiscal 2005. The estimated unfavorable impact on net income from
currency translation for the First Half of Fiscal 2006 was $0.8 million.

20

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Capital
Resources and Liquidity

Total cash and cash equivalents increased $1.0 million
in the First Half of Fiscal 2006, primarily due to strong earnings, advance
payments received from customers, net proceeds generated from the conversion of
short-term investments to cash and cash equivalents, and proceeds from the
exercise of stock options, partially offset by employee incentive and related
benefits payments, increased accounts and unbilled receivables, purchases of
the Companys common stock, and dividend payments. Total cash and cash
equivalents remained flat in the First Half of Fiscal 2005, as strong earnings,
decreased accounts and unbilled receivables, increased accrued income taxes,
and proceeds from the exercise of stock options were offset by net purchases of
short-term investments, employee incentive and related benefits payments,
purchases of the Companys common stock, and dividend payments. The Company
believes that its anticipated operating cash flows and funds available from
cash, and cash equivalents and short-term investments totaling $107.2 million
at April 1, 2006 are adequate to fund ongoing operations, capital expenditures,
and share purchases, as well as to fund internal growth opportunities and
strategic acquisitions.

Cash
flows from operating activities provided cash of $12.3 million
for the First Half of Fiscal 2006, compared to cash provided of $29.9 million
for the First Half of Fiscal 2005. Operating cash flow for the First Half of
Fiscal 2006 primarily resulted from strong earnings and $9.2 million increase
in advance payments received from customers, partially offset by net employee
incentive and related benefits payments of $5.9 million and an increase in
accounts and unbilled receivables of $14.8 million. Operating cash flow for the
First Half of Fiscal 2005 was primarily due to strong earnings, $8.9 million
decrease in accounts and unbilled receivables, $2.0 increase in advance
payments received from customers and a $4.7 million increase in accrued income
taxes, partially offset by net employee incentive and related benefits payments
of $6.0 million.

Cash
flows from investing activities provided cash totaling $49.6
million for the First Half of Fiscal 2006, compared to a use of cash of $22.9
million for the First Half of Fiscal 2005. During the First Half of Fiscal
2006, the Company received net proceeds of $53.6 million from the conversion of
short-term investments to cash and cash equivalents and invested $3.9 million
in property and equipment additions. During the First Half of Fiscal 2005, the
Company made net purchases of short-term investments of $19.0 million and
invested $3.8 million in property and equipment additions.

Cash
flows from financing activities required the use of cash
totaling $60.9 million for the First Half of Fiscal 2006, compared to a use of
cash totaling $9.7 million
for the First Half of Fiscal 2005. The cash usage for the First Half of Fiscal
2006 was due to the use of $59.5 million to purchase shares of the Companys
common stock, payment of cash dividends of $3.9 million, and repayment of
interest-bearing debt of $1.2 million, partially offset by $2.6 million
received in connection with stock option exercises and $1.0 million equity
compensation income tax benefits. The cash usage from financing activities for
the First Half of Fiscal 2005 was due to the use of $13.9 million to purchase
shares of the Companys common stock, payment of cash dividends of $1.6
million, and repayment of interest-bearing debt of $1.2 million, partially
offset by $7.0 million received in connection with stock option exercises.

Under the terms of
its long-term debt agreements, the Company has agreed to certain financial
covenants. At April 1, 2006, the Company was in compliance with the financial
terms and conditions of its debt and credit facility agreements.

During the Second
Quarter of Fiscal 2006, the Company purchased 998,500 shares of its common
stock for $37.3 million. During the Second Quarter of Fiscal 2005, the Company
purchased 269,200 shares of its common stock for $8.5 million.

Restructuring
and Other Charges

In the fourth quarter of fiscal year 2005, the Company
decided to exit its noise and vibration software business in the Test segment.
The Company assessed the recoverability of the assets associated with this
business using an undiscounted cash flow methodology. Based on this assessment,
the Company reduced the assets to their fair market value and recorded costs of
$0.3 million to write down property, plant and equipment and $0.2 million to
write down inventory. In addition, the Company recorded $1.3 million for
employee severance costs and $2.7 million related to software development
expense that will not repeat in future years. Substantially all of the
severance costs will be paid in fiscal year 2006.

For the six-month period ended April 1, 2006 and
fiscal year ended October 1, 2005, the reserve for restructuring was as
follows:

21

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|                            |  |                             |        |                                  |   |       |   |   |        |  
|--------------------------- |  | --------------------------- | ------ | -------------------------------- | - | ----- | - | - | ------ | -
|                            |  | Severance
  Charges         |        | Contract
  Termination
  Charges |   | Total |  
|                            |  |                             |        |                                  |   |       |  
|                            |  | (in
  thousands of dollars) |       
|Balances at October 2, 2004 |  | $                           |       |                                  | $ |      |   | $ |       |  
|Provision                   |  |                             | 1,267  |                                  |   | 52    |   |   | 1,319  |  
|Write-off/payments          |  |                             |       |                                  |   |      |   |   |       |  
|                            |  |                             |        |                                  |   |       |   |   |        |  
|Balances at October 1, 2005 |  |                             | 1,267  |                                  |   | 52    |   |   | 1,319  |  
|                            |  |                             |        |                                  |   |       |   |   |        |  
|Provision                   |  |                             | 30     |                                  |   |      |   |   | 30     |  
|Write-off/payments          |  |                             | (1,138 | )                                |   | (52   | ) |   | (1,190 | )
|                            |  |                             |        |                                  |   |       |   |   |        |  
|Balances at October 1, 2005 |  | $                           | 159    |                                  | $ |      |   | $ | 159    |  
|                            |  |                             |        |                                  |   |       |   |   |        |  

Revenue from the
noise and vibration software business for the First Half of Fiscal 2006
decreased $3.7 million, to $1.1 million, compared to revenue of $4.8 million
for the First Half of Fiscal 2005. Operating expenses for the First Half of
Fiscal 2006 decreased $2.1 million, to $1.0 million, compared to $3.1 million
for the First Half of Fiscal 2005. The Company anticipates a continued
reduction in revenue and operating expenses for this business in the Second Half
of Fiscal 2006, as it depletes its $0.4 million backlog at April 1, 2006 and
finalizes the completion of customer support activities. Revenue and operating
expenses for this business in the second half of fiscal year 2006 are expected
to be negligible, compared to revenue and operating expenses of $4.3 million
and $3.8 million, respectively, for the second half of fiscal year 2005. The
Company does not anticipate any future revenue or operating expenses associated
with the noise and vibration software business after fiscal year 2006.

Other
Matters

The Company is
exposed to market risk from changes in foreign currency exchange rates. The
Company manages exposure to changes in foreign currency exchange rates through
its regular operating and financing activities and through the use of foreign
currency exchange contracts. These contracts are used to hedge the Companys
overall exposure to exchange rate fluctuations, as the gains and losses on
these contracts are intended to offset gains and losses on the Companys
assets, liabilities, and cash flows.

The Companys
dividend policy is to maintain a payout ratio that allows dividends to increase
with the long-term growth of earnings per share, while sustaining dividends
through economic cycles. The Companys dividend payout ratio target is
approximately 25% of earnings per share over the long term.

Forward-Looking Statements

Statements
included or incorporated by reference in this Managements Discussion and
Analysis of Financial Condition and Results of Operations and elsewhere in this
Form 10-Q which are not historical or current facts are forward-looking
statements, as defined in the Private Securities Litigation Reform Act of 1995,
and are subject to certain risks and uncertainties that could cause actual
results to differ materially from historical results and those presently
anticipated or projected. The following important factors, among others, could
affect the Companys actual results in the future and could cause the Companys
actual financial performance to differ materially from that expressed in any
forward-looking statements:

| |      |                                                                                                                                                                                                                                                                                                                                                                            
| | ---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (i)  | Possible significant volatility in backlog and/or
  quarterly operating results may result from the timing of individual large,
  fixed-price orders in connection with sales of Test segment systems.                                                                                                                                                                     
| |      |                                                                                                                                                                                                                                                                                                                                                                            
| | (ii) | Order volumes and other operating considerations may
  be directly or indirectly impacted by economic conditions generally and/or in
  various geographic areas in which the Company operates. The Company derives
  significant revenue from the global ground vehicles and aerospace industries,
  and therefore is subject to economic cycles affecting these customers.

22

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| |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | (iii)  | Export controls based on U.S. initiatives and
  foreign policy, as well as import controls imposed by foreign governments,
  may cause delays in certain shipments or the rejection of orders by the
  Company. Such delays could create material fluctuations in quarterly
  operating results and could have a material adverse effect on results of
  operations. Local political conditions and/or currency restrictions may also
  affect foreign revenue.
| |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | (iv)   | Delays in realization of orders in backlog may occur
  due to technical difficulties, export licensing approval, or the customers
  preparation of the installation site, any of which can affect the quarterly
  or annual period when backlog is recognized as revenue and could materially
  affect the results of any such period.                                                                                                                        
| |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | (v)    | The Company experiences competition on a worldwide
  basis. Customers may choose to purchase equipment from the Company or from
  its competitors. For certain of the Companys products, customers may
  contract with testing laboratories or construct their own testing equipment
  from commercially available components. Factors that may influence a customers
  decision include price, service, and required level of technology.                   
| |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | (vi)   | The Company operates internationally and thus is
  subject to foreign currency exchange rate changes, which can affect its
  results from operations and financial condition.                                                                                                                                                                                                                                                                                  
| |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | (vii)  | With regard to the Companys new product
  developments, there may be uncertainties concerning the expected results. In
  addition, the Company may not be aware of the introduction of new products or
  product enhancements by its competitors.                                                                                                                                                                                                             
| |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | (viii) | The Companys short-term investments and borrowings
  carry floating interest rate risk. The Company has minimal earnings and cash
  flow exposure due to market risks on its long-term debt obligations as a
  result of the primarily fixed-rate nature of its debt.                                                                                                                                                                                         
| |        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | (ix)   | The Company relies on various raw material,
  component, and sub-assembly suppliers in its production processes and as
  such, business interruptions affecting these suppliers may cause delays in
  the Companys ability to convert its backlog of unfilled orders to revenue.                                                                                                                                                                              

The foregoing list is not exhaustive, and the Company
disclaims any obligation to revise any forward-looking statements to reflect
new information, future events, or circumstances after the date of such
statements or to reflect the occurrence of anticipated or unanticipated events.

Item 3.
Quantitative and Qualitative Disclosures about Market Risk

The Companys investment portfolio at April 1, 2006
included $84.2 million of cash and cash equivalents and short-term investments
of $23.0 million. The cash equivalent portion of the portfolio is invested
in money market funds and bank deposits with high credit ratings and for which
interest rates are re-set to market rates every 1-90 days. The short-term
investment portfolio is invested in long-term municipal debt with high credit
ratings reported at market values for which interest rates are re-set every
7-35 days. The short maturities and frequent interest rate re-sets on
these investments significantly mitigate the potential impact of market
interest rates on the value of the investment portfolio.

The Company operates internationally and is subject to
foreign currency exchange rate fluctuations. A hypothetical 10% appreciation in
foreign currencies against the U.S. dollar, assuming all other variables were
held constant, would have resulted in an estimated increase of $17.7 million in
revenue for the six months ended April 1, 2006. A hypothetical 10% depreciation
in foreign currencies against the U.S. dollar, assuming all other variables were
held constant, would have resulted in an estimated decrease of $17.7 million in
revenue for the six months ended April 1, 2006. The Company enters into foreign
currency exchange contracts to reduce its exposure to foreign currency exchange
rate changes on forecasted foreign currency denominated transactions and
monetary balance sheet positions. Additional information is included in Note 8
to the Condensed Notes to Consolidated Financial Statements in this Form 10-Q.

At April 1, 2006, the Companys long-term debt
consisted of notes payable with fixed interest rates ranging from 6.6% to 7.5%.
As such, interest rate fluctuations would not have an impact on interest
expense or cash flows.

23

---



Item 4.
Controls and Procedures

The Companys management, including the Chief
Executive Officer and Chief Financial Officer, have conducted an evaluation of
the effectiveness of the design and operation of the Companys disclosure
controls and procedures pursuant to Rule 13a-15 under the Securities Exchange
Act of 1934 (the 1934 Act) as of April 1, 2006. Based on that evaluation, the
Companys Chief Executive Officer and Chief Financial Officer concluded that
the Companys disclosure controls and procedures are effective in ensuring that
information required to be disclosed by the Company in the reports it files or
submits under the 1934 Act is recorded, processed, summarized and reported
within the time periods specified in the SECs rules and forms.

There have been no changes in internal control over
financial reporting during the fiscal quarter ended April 1, 2006 that have
materially affected, or are reasonably likely to materially affect, the Companys
internal control over financial reporting.

PART II  OTHER INFORMATION

Item 1. Legal Proceedings

None

Item 1A. Risk Factors

No
material changes.

Item 2. Unregistered
Sales of Equity Securities and Use of Proceeds

Purchases
of Company Equity Securities:

| |                                     |  |  |                                      |  |                                    |       |  |                                                                                                |         |  |                                                                                              |           | 
| | ----------------------------------- |  |  | ------------------------------------ |  | ---------------------------------- | ----- |  | ---------------------------------------------------------------------------------------------- | ------- |  | -------------------------------------------------------------------------------------------- | --------- | 
| | Period                              |  |  | Total Number
  of Shares
  Purchased |  | Average
  Price
  Paid per
  Share |       |  | Total Number
  of Shares
  Purchased as
  Part of
  Publicly
  Announced
  Plans or
  Programs |         |  | Maximum
  Number of
  Shares
  that May Yet
  be Purchased
  Under the
  Plans or
  Programs |          
| |                                     |  |  |                                      |  |                                    |       |  |                                                                                                |         | 
| | January 1, 2006-
  February 4, 2006 |  |  | 48,500                               |  | $                                  | 34.78 |  |                                                                                                | 48,500  |  |                                                                                              | 2,573,038 | 
| |                                     |  |  |                                      |  |                                    |       |  |                                                                                                |         |  |                                                                                              |           | 
| | February 5, 2006-
  March 4, 2006   |  |  |                                     |  | $                                  |      |  |                                                                                                |        |  |                                                                                              | 2,573,038 | 
| |                                     |  |  |                                      |  |                                    |       |  |                                                                                                |         |  |                                                                                              |           | 
| | March 5, 2006-
  April 1, 2006      |  |  | 950,000                              |  | $                                  | 37.30 |  |                                                                                                | 950,000 |  |                                                                                              | 1,623,068 | 
| |                                     |  |  |                                      |  |                                    |       |  |                                                                                                |         |  |                                                                                              |           | 
| | Total                               |  |  | 998,500                              |  | $                                  | 37.18 |  |                                                                                                | 998,500 |  |                                                                                              |           | 
| |                                     |  |  |                                      |  |                                    |       |  |                                                                                                |         |  |                                                                                              |           | 

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The Company purchases Company common stock primarily
  to offset the dilution created by employee stock compensation programs such
  as stock options plans, restricted stock grants, and the Employee Stock
  Purchase Plan. A secondary purpose is as an alternative in returning cash
  directly to shareholders. The Company executes all its purchases of Company
  stock in accordance with Rule 10b-18 of the Securities Exchange Act of 1934.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| | On August 25, 2005, the Company announced that its
  Board of Directors approved a 3.0 million share purchase program that covers
  the shares reported above. Pricing under the program has been delegated to
  management. There is no expiration date for the program                                                                                                                                                                             

Item
3. Defaults Upon Senior Securities

None

24

---



Item 4. Submission
of Matters to a Vote of Security Holders

| |     |                                                                                                                                            
| | --- | -------------------------------------------------------------------------------------------------------------------------------------------
| | (a) | The Companys Annual Meeting of Shareowners was held
  on January 31, 2006.                                                                
| |     |                                                                                                                                            
| | (b) | The following persons were nominated and elected to
  continue as directors of the Company until the next Annual Meeting of
  Shareholders:

| |                      |  |            |  |  |                
| | -------------------- |  | ---------- |  |  | ---------------
| |                      |  | Voted For  |  |  | Voted
  Against
| |                      |  |            |  |  |                
| |                      |  |            |  |  |                
| | Jean-Lou Chameau     |  | 16,654,506 |  |  | 1,030,400      
| | Merlin E. Dewing     |  | 16,215,510 |  |  | 1,469,396      
| | Sidney W. Emery, Jr. |  | 16,455,264 |  |  | 1,229,643      
| | Brendan C. Hegarty   |  | 16,367,076 |  |  | 1,317,831      
| | Lois M. Martin       |  | 17,137,138 |  |  | 547,768        
| | Barb J. Samardzich   |  | 16,373,579 |  |  | 1,311,327      
| | Linda Hall Whitman   |  | 16,651,067 |  |  | 1,033,839      

| |     |                                                                                                                                         
| | --- | ----------------------------------------------------------------------------------------------------------------------------------------
| |     | There were 533,138 abstentions and no broker non-votes.                                                                                 
| |     |                                                                                                                                         
| | (c) | The Companys Stock Incentive Plan was approved with
  9,683,242 votes in favor, 4,791,541 votes against, and 200,783 votes
  abstained.

Item 5. Other Information

None

Item 6. Exhibits

| |                  |      |  |                                                                                                                                                                                     |  | 
| | ---------------- | ---- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | 
| | Exhibit
  Number |      |  | Description                                                                                                                                                                         | 
| |                  |      |  |                                                                                                                                                                                     | 
| |                  |      |  |                                                                                                                                                                                     | 
| |                  | 3.a  |  | Restated and Amended Articles of Incorporation,
  adopted January 30, 1996, incorporated by reference from Exhibit 3.a of Form
  10-K for the fiscal year ended September 30, 1996.
| |                  |      |  |                                                                                                                                                                                    
| |                  | 3.b  |  | Restated Bylaws, incorporated by reference from
  Exhibit 3.1 of the Registrants Form 8-K filed on December 2, 2005.                                                              
| |                  |      |  |                                                                                                                                                                                    
| |                  | 31.1 |  | Certification of Chief Executive Officer Pursuant to
  Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) (filed
  herewith).                                          
| |                  |      |  |                                                                                                                                                                                    
| |                  | 31.2 |  | Certification of Chief Financial Officer Pursuant to
  Section 302 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) (filed
  herewith).                                          
| |                  |      |  |                                                                                                                                                                                    
| |                  | 32.1 |  | Certification of Chief Executive Officer Pursuant to
  Section 906 of the Sarbanes-Oxley Act of
  2002 (18 U.S.C. 1350) (filed herewith).                                          
| |                  |      |  |                                                                                                                                                                                    
| |                  | 32.2 |  | Certification of Chief Financial Officer Pursuant to
  Section 906 of the Sarbanes-Oxley Act of 2002 (18 U.S.C. 1350) (filed
  herewith).                                          

25

---



SIGNATURES

Pursuant to the requirements of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.

|                   |  |                                                 | 
|------------------ |  | ----------------------------------------------- | 
|                   |  | MTS SYSTEMS CORPORATION                         | 
|Dated: May 9, 2006 |  | /s/ Sidney W. Emery, Jr.                        | 
|                   |  |                                                 | 
|                   |  | Sidney W. Emery, Jr.                            | 
|                   |  | Chairman, President and Chief Executive Officer | 
|                   |  |                                                 | 
|Dated: May 9, 2006 |  | /s/ Susan E. Knight                             | 
|                   |  |                                                 | 
|                   |  | Susan E. Knight                                 | 
|                   |  | Vice President and Chief Financial Officer      | 

26

---



EXHIBIT INDEX TO FORM 10-Q

|     |                                                                                                                         
|---- | ------------------------------------------------------------------------------------------------------------------------
|31.1 | Certification
  of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
  of 2002 (18 U.S.C. 1350).
|     |                                                                                                                         
|31.2 | Certification
  of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act
  of 2002 (18 U.S.C. 1350).
|     |                                                                                                                         
|32.1 | Certification
  of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
  of 2002 (18 U.S.C. 1350).
|     |                                                                                                                         
|32.2 | Certification
  of Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act
  of 2002 (18 U.S.C. 1350).

---