Table of Contents

# SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

# (Mark One)

# xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

# For the fiscal year ended
October 1, 2005

# OR

# oTRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

# For the Transition Period from _____________ to ______________

# Commission File No.
0-2382

MTS SYSTEMS CORPORATION
(Exact Name of
Registrant as Specified in its Charter)

|Minnesota                                |  | 41-0908057          | 
|---------------------------------------- |  | ------------------- | 
|                                         |  |                     | 
|(State or other jurisdiction of          |  | (I.R.S. Employer    | 
|incorporation or organization)           |  | Identification No.) | 
|14000 Technology Drive                   | 
|Eden Prairie, MN                         |  | 55344               | 
|                                         |  |                     | 
|(Address of Principal Executive Offices) |  | (Zip Code)          | 

# Registrants telephone number, including area code: (952)
937-4000

# Securities registered
pursuant to Section 12(b) of the Act: None

# Securities registered pursuant
to Section 12(g) of the Act: Common Stock, $.25 par value per share

Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act.
   Yes o
  Nox

Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
   Yes o
  Nox

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.
   Yes x
  Noo

Indicate by check mark if disclosure
of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of registrants knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  x

Indicate by check mark whether the
registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act):
   Yes x
  Noo

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

State the aggregate market value of
the voting and non-voting common equity held by non-affiliates computed by reference to
the price at which the common equity last sold, or the average bid and asked price of such
common equity, as of the last business day of the registrants most recently
completed second fiscal quarter: $564,933,286.

As of December 7, 2005, the
registrant had outstanding 19,403,474 shares of Common Stock.

DOCUMENTS INCORPORATED BY
REFERENCE: Portions of the Proxy Statement for the Registrants Annual Meeting of
Shareholders to be held January 31, 2006 are incorporated by reference into Part III of
this Form 10-K, to the extent described in such Part.

---

MTS Systems Corporation
Form 10-K

Table of Contents

|         | PART I                                                                                                       |   
|-------- | ------------------------------------------------------------------------------------------------------------ | --
|Item 1.  | Business                                                                                                     | 1 
|         | Customers and Products by Business Segment                                                                   | 1 
|         | Common Technologies                                                                                          | 2 
|         | Product Development Highlights for Fiscal Year 2005                                                          | 2 
|         | Characteristics of Sales                                                                                     | 3 
|         | Backlog                                                                                                      | 5 
|         | Competition                                                                                                  | 5 
|         | Manufacturing and Engineering                                                                                | 5 
|         | Patents and Trademarks                                                                                       | 5 
|         | Research and Development                                                                                     | 6 
|         | Executive Officers                                                                                           | 6 
|         | Employees                                                                                                    | 7 
|         | Sources and Availability of Raw Materials and Components                                                     | 7 
|         | Available Information                                                                                        | 8 
|         | Environmental Matters                                                                                        | 8 
|Item 1A. | Risk Factors                                                                                                 | 8 
|Item 1B. | Unresolved Staff Comments                                                                                    | 9 
|Item 2.  | Properties                                                                                                   | 9 
|Item 3.  | Legal Proceedings                                                                                            | 10
|Item 4.  | Submission of Matters to Vote of Security Holders                                                            | 10
|        
|         | PART II                                                                                                      |   
|        
|Item 5.  | Market for Registrants Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities | 10
|Item 6.  | Selected Financial Data                                                                                      | 12
|Item 7.  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        | 13
|Item 7A. | Quantitative and Qualitative Disclosures About Market Risk                                                   | 27
|Item 8.  | Financial Statements and Supplementary Data                                                                  | 28
|Item 9.  | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure                         | 28
|Item 9A. | Controls and Procedures                                                                                      | 28
|Item 9B. | Other Information                                                                                            | 29
|        
|         | PART III                                                                                                     |   
|        
|Item 10. | Directors and Executive Officers of Registrant                                                               | 29
|Item 11. | Executive Compensation                                                                                       | 29
|Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters               | 29
|Item 13. | Certain Relationships and Related Transactions                                                               | 29
|Item 14. | Principal Accountant Fees and Services                                                                       | 29
|        
|         | PART IV                                                                                                      |   
|        
|Item 15. | Exhibits and Financial Statement Schedules                                                                   | 30

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Table of Contents

# PART I

# Item 1.    Business

MTS Systems Corporation is a leading
global supplier of test systems and high-performance industrial position sensors. The
Companys testing 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. The
Companys mission is to help its customers design, develop, and produce their
products faster, with higher quality and at a lower cost. The Company was incorporated on
September 12, 1967.

# Customers and Products by Business Segment

The Companys operations are
organized into two business segments  the Test segment and the Industrial segment.
The operational alignment of these segments allows the Company to maintain a strategic
focus on markets having different product and market applications for the Companys
technologies.

Test Segment: Customers of
this segment use the Companys products, systems, software, and services for
research, product development, and quality control to determine the mechanical properties
and performance of materials, products, and structures. In addition to standard products,
the Company offers highly customized systems for simulation and testing. These systems
frequently contain first of kind advances that are new to a specific
application. Products include rolling road simulators, multi-axial test systems, and
earthquake simulation systems. Many of the segments products and services support
its customers mechanical design automation processes. The Test segment serves
customers in the following markets:

Ground Vehicles: This market
consists of automobile, truck, motorcycle, construction, agricultural equipment, and
off-road vehicle manufacturers and their suppliers. Equipment, software, and consulting
services are used to test vehicular safety, noise, vibration, durability, performance, and
material characteristics. This represents the largest market segment within the Test
segment.

Aerospace: This market
consists of manufacturers of commercial, military, and private aviation aircraft and their
suppliers, including engine manufacturers. These customers use the Companys
products, systems, and software for full-scale structural tests on aircraft and aerospace
vehicles and components, subsystems, and materials.

Infrastructure: This market
consists of construction and mineral/petroleum production companies and test laboratories
owned and/or operated by industrial, academic, or governmental entities. Equipment,
software, and consulting services are used to test effects of seismic activity, effects of
forces on structures, characteristics of materials, and biomechanical properties.
Customers also use the Companys nanomechanical, biomechanical, and servo-hydraulic
material testing products and systems in research and product development applications,
where a high degree of precision and quality control is required during research and
production. The nanomechanical test products address the needs of the highly precise
semiconductor industry. Biomechanical applications include implants, prostheses, and other
medical and dental devices and materials. Material producers include metal, ceramic,
composite, paper, and plastic manufacturers.

Services offered to customers in the
above markets include on-site installation, training of customer personnel, and
after-market support and maintenance.

The Test segment typically represents
approximately 85% of the Companys total revenue and provides the principal markets
for the Companys technologies.

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Industrial Segment: Customers
of the Industrial segment use the Companys measurement and control instrumentation
products to measure process variables and to automate production processes. Typical
customers include manufacturers of mobile equipment, steel-making equipment, plastic
molding machines, pulp and paper processing equipment, transfer lines and various types of
semiconductor equipment, and surgical room equipment. Products in the Industrial segment
include:

Displacement Position and Liquid
Level Sensors based on Magnetostrictive Technology:Displacement sensors accurately
measure position and are often used where accurate positioning and continuous control are
critical, such as in discrete (piece part) manufacturing machinery, mobile equipment,
process control elements and continuous measurement devices. Displacement sensors are also
used in high-volume applications requiring low-cost position feedback. MTS has the
capability of manufacturing low-cost sensor products in various lengths and
configurations, while maintaining an extremely high degree of accuracy. Liquid level
sensors accurately measure the level of liquids in tanks and other vessels. These products
are marketed to the ultimate end users, such as chemical-producing companies, and to
original equipment manufacturers that design level measurement or leak detection into
their control systems or accessories for remote indication.

Titanium Part Formation: The
Company, through its wholly owned subsidiary AeroMet Corporation, developed an innovative,
laser-directed metal deposition process for manufacturing parts from titanium and other
metals. This computer-driven process uses a laser to fuse titanium powder or powder of
other metals, layer-by-layer, into solid structures. The process significantly reduces the
time and amount of material required to produce complex parts used in the aircraft and
aerospace industries. The Company exited this business as of October 1, 2005.

The Industrial segment typically
represents approximately 15% of the Companys total revenue.

For additional information regarding
the Companys revenue from external customers and measures of profit and loss and
total assets, see the Consolidated Financial Statements and accompanying Notes to
Consolidated Financial Statements appearing under Item 8of this Form 10-K.

# Common Technologies

MTS specializes in the control and
measurement of forces and motion. Technologies include sensors for measuring machine and
process parameters, control technologies for test and process automation, hydraulic and
electric servodrives for precise actuation, and application software to tailor a test or
automation system to a specific customers needs and to analyze test results. In
combination, these technologies and products provide integrated solutions to customers in
a variety of markets. The Companys manufacturing capability includes the production
of low- to medium-volume standard and custom products and systems.

# Product Development Highlights for Fiscal Year 2005

MTS invests in product, system, and
application development. A combination of internal and customer funding enables MTS to
advance the application of its existing technologies and develop new capabilities.
Selected highlights of product developments that were in progress or completed during
fiscal year 2005 include the following:

| |  | Uni-axial
Seismic TablesMTS® seismic simulators are used throughout the world to research and
develop earthquake-resistant buildings and bridges. MTS has extended its line of
seismic simulators with a new, more affordable option that will help bring
seismic testing capability to developing nations. The new Uni-axial Seismic
Simulators are complete-package systems that can be easily installed into existing
civil structure laboratories.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | MTS Insight Electromechanical
Material Test SystemThe new MTS Insight Electromechanical Load Frame
family further enhances the Companys line of material testing solutions.
MTS Insight Electromechanical Load Frame features a new load frame, load cells, and Testworks®
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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| |  | Software to
provide an affordable, high-performance solution. The product family is designed to
provide a wide range of force capacities and performance characteristics to meet
individual customer requirements.
| |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | SWIFT® 50 GLP
The new Spinning Wheel Integrated Force Transducer (SWIFT®) 50 Global Low Profile (GLP) was launched to meet and improve
upon the demands of data acquisition and road simulation testing of heavy trucks. SWIFT® enhances the speed and accuracy of
durability testing to ensure safe, long-term operation of vehicles.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Ride
and Comfort Roadway SystemBuilt on industry-leading Flat-Trac®
technology, MTS delivered its first Ride and Comfort Roadway system. The system
provides automakers with a repeatable laboratory environment to research and
improve the vibration and sound characteristics of a vehicle. The MTS solution
permits vehicle manufacturers to produce better vehicles by simulating a wide
variety of surface conditions that are too costly and time-consuming to conduct
via road tests.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Multi-Axial
Simulation TableMTS introduced a new high-frequency Multi-Axial
Simulation Table (MAST) system. This model features a compact design, higher
frequency of operation and advanced acoustical features to enhance squeak,
rattle, noise, vibration, and harshness testing. MTS high-frequency MAST
system accelerates vehicle development processes, expands testing options, and
increases productivity in a laboratory testing environment.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | AeroPro
4.1AeroPro Version 4.1 introduced new functionality called
Calculations in the Loop, which allows experienced test engineers to
modify a control loop to achieve unparalleled control of their tests.
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | RPC® Pro 4.2Release of RPC® Pro Version 4.2 addresses test lab
productivity by incorporating new features that standardize the test reporting
process and improve the softwares overall usability. Some of the key
features of this release include easy-to-use, standardized test reporting,
expanded durability testing functionality, and enhanced data management
functionality.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | Temposonics® C-Series SensorsThe Temposonics® C-Series sensors were introduced as
the smallest and lowest-cost sensors based on magnetostrictive technology. Their
modular design and high electronic migration offer the maximum value for the
light industrial market.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

MTS, RPC, SWIFT, Flat-Trac, Testworks, and Temposonics are
registered trademarks, and AeroPro and MTS Insight are trademarks of MTS Systems Corporation.

# Characteristics of Sales

The Companys systems and
products are sold worldwide to a large variety of industrial companies, government
agencies, and academic and other research institutions. MTS is generally not dependent on
any single customer for a significant portion of its business. Approximately 45% of the
Companys revenue is associated with the ground vehicles market, and approximately
70% of the Companys revenue is from customers outside the United States.

Test segment products and services
range in price from less than $20,000 to over $20 million. The majority of Test segment
revenue is generated by contracts valued at less than $5 million. The timing and volume
of contracts valued at $5 million or greater may produce volatility in orders, backlog,
and quarterly operating results. The majority of customer orders are based on fixed-price
quotations and typically have an average sales cycle of six to nine months due to the
technical nature of the products and systems. The production cycle for a typical test
system ranges from one to twelve months,

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depending on the complexity of the
system and the availability of components. The production cycle for larger, more complex
test systems may be up to three years.

Industrial segment sensor products
are sold in quantity at unit prices ranging from $100 to $2,000. Production cycles
generally vary from several days to several months, depending on the degree of product
customization and manufacturing capacity.

During fiscal year 2005, the
Companys products were shipped to North America, Europe, Asia, and Latin America.
The Companys foreign operations and revenue derived from customers located in
foreign countries may be affected by local political conditions, export licensing issues
and restrictions, and foreign currency exchange rate fluctuations.

Sales Channels: The Company
sells its products, systems, and services through a direct sales force, independent sales
representatives, and, to a much lesser extent, via the Internet and catalog. The sales
channels for the Test and Industrial segments are separate. The direct sales force is
generally staffed by engineers or highly skilled technicians who are trained to sell MTS
equipment, software, and services. The direct sales force is compensated through salary
and sales incentives programs, while independent sales representatives are paid on a
commission basis.

A list of domestic and international
sales offices for the Company is as follows:

Domestic Sales Offices:

|                          |                           
|------------------------- | --------------------------
|Akron, Ohio               | Los Angeles, California   
|Austin, Texas             | Milwaukee, Wisconsin      
|Baltimore, Maryland       | Minneapolis, Minnesota    
|Boston, Massachusetts     | Newark, New Jersey        
|Charlotte, North Carolina | Philadelphia, Pennsylvania
|Chicago, Illinois         | Pittsburgh, Pennsylvania  
|Cincinnati, Ohio          | Raleigh, North Carolina   
|Dallas, Texas             | Rockford, Illinois        
|Dayton, Ohio              | San Francisco, California 
|Denver, Colorado          | Seattle, Washington       
|Detroit, Michigan         | Washington, D.C.          

International Sales Offices:

|                                  |                        
|--------------------------------- | -----------------------
|Beijing, Hong Kong, and Shanghai, | Paris, France          
|Peoples Republic of China        | Seoul, South Korea     
|Berlin and Luedenscheid, Germany  | Tokyo and Nagoya, Japan
|Gloucester, United Kingdom        | Turin, Italy           
|Gothenburg, Sweden               

The Company also has independent
sales and service representative organizations in nearly all industrialized countries of
the world and in many of the developing countries of Latin America, Asia, Africa, and the
Middle East. The Company offers a mail-order catalog of standard material testing
components, accessories, and products.

For additional information regarding
the Companys operations by geographic area, see Note 4 to the Consolidated Financial
Statements, Business Segment Information, appearing under Item 8of
this Form 10-K.

Export Licensing: During the
fiscal year ended October 1, 2005 and in prior fiscal years, MTS made various export
sales that required the Company to obtain approval from the United States government.
Although the Company typically does not undertake manufacturing on custom systems or
projects until it is assured that the appropriate governmental units will grant export
approval, initial design and development work may be performed on certain systems
concurrent with the license approval process. Changes in political relations between the
United States and foreign countries and/or specific potential

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customers for which export licenses
may be required, as well as various other factors, can adversely affect the Companys
ability to complete a shipment should a license application be denied or a previously
issued license be unexpectedly withdrawn. Political activities in various regions of the
world may result in dramatic changes in export control regulations and restrictions
within a relatively short period of time. In addition, the United States government
maintains multilateral controls in its agreements with allies and unilateral controls
based on U.S. initiatives and foreign policy that may, in certain situations, cause
delays or cancellations of the Companys orders or shipments.

# Backlog

The Companys revenue backlog,
defined as firm orders from customers that remain unfilled, totaled approximately $220
million, $186 million, and $141 million at October 1, 2005, October 2, 2004, and September
27, 2003, respectively. Based on anticipated production schedules and other factors, the
Company estimates that approximately $179 million of the backlog at October 1, 2005 will
be converted to revenue during fiscal year 2006. Delays may occur as a result of technical
difficulties, export licensing, changes in scope, manufacturing capacity, supplier issues,
or the availability of customer installation sites. Such delays may affect the period in
which the backlog is recognized as revenue. The Companys backlog is subject to order
cancellations. Historically, the Company has not experienced a significant volume of order
cancellations.

# Competition

Test Segment: Equipment, software, and services produced by the Test
segment are produced by several other companies throughout the world. The product availability and the intensity of competition
vary by product line and by geographic area. The Companys major competitors include, among others, Illinois Tool Works Inc.
(purchased Instron Corporation in 2005), Moog Inc. (purchased FCS Control Systems in 2005), Saginomiya Seisakusho Inc., and
Horiba, Ltd. (purchased the Development Test Systems Group (DTS), including Schenck Pegasus, in 2005). Customers consider such
factors as engineering capabilities, quality, technical features of the equipment, overall responsiveness to customer needs,
service, and price as they evaluate supplier options.

Alternatively, in lieu of purchasing
equipment, software, or services from MTS or its competitors, customers may elect to
contract with testing laboratories, including those operated by certain universities
and/or governmental units, or they may choose to construct their own testing equipment
from commercially available components.

Industrial Segment: The
Company competes directly with small-to-medium sized specialty suppliers and also with
divisions of large companies specializing in measurement and control instrumentation
products. Competitors include Balluff Inc., Ametek Inc., and Novotechnik.

# Manufacturing and Engineering

The Company conducts a significant
portion of its manufacturing and engineering activities for the Test segment from its
corporate headquarters in Minneapolis, Minnesota. The Test segment also has a
manufacturing plant in Oak Ridge, Tennessee. In addition, engineering, project management,
final systems assembly, and service may be performed in Berlin, Germany; Tokyo, Japan;
Paris, France; Turin, Italy; Gloucester, United Kingdom; and Gothenberg, Sweden.
Manufacturing and engineering in the Industrial Segment are located in Raleigh, North
Carolina; Luedenscheid, Germany; and Tokyo, Japan.

# Patents and Trademarks

The Company relies on a combination
of patents, trademarks, copyrights, trade secrets, and confidentiality agreements to
establish and protect its proprietary technology. The Company has filed and obtained
numerous patents in the United States and abroad and regularly files patent applications
worldwide in its continuing effort to establish and protect its proprietary technology.
In addition, the Company has entered into exclusive and non-exclusive licenses relating
to certain third-party technologies. The Company has also obtained certain trademarks for
its products, and the Company maintains certain details about its processes, products and
strategies as trade secrets. The Companys

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efforts to protect its intellectual
property and avoid disputes over proprietary rights have included ongoing review of
third-party patents and patent applications.

There can be no assurance that
pending patent applications will result in issued patents, that patents or trademarks
issued to the Company will not be challenged or circumvented by competitors, or that such
patents or trademarks will be found to be valid or sufficiently broad to protect the
Companys proprietary technology or to provide it with a competitive advantage.

# Research and Development

MTS generally does not perform basic
research, but the Company does invest in significant product, system, and software
application development. Costs associated with these development programs are expensed as
incurred and aggregated $14.9 million, $12.7 million, and $13.8 million for the fiscal
years ended October 1, 2005, October 2, 2004, and September 27, 2003, respectively. From
time to time, the Company also contracts with its customers to advance the state of
technology and increase product functionality.

# Executive Officers

The Executive Officers of the Registrant on the date of this report were:

|Name                 |  | Office |                                                 | OfficerSince |  | Age 
|-------------------- |  | ------ | ----------------------------------------------- | ------------ |  | ----
|                     |  |        |                                                 |              |  |     
|Sidney W. Emery, Jr. |  |        | Chairman, President and Chief Executive Officer |              |  | 1998
|Laura B. Hamilton    |  |        | Senior Vice President, Test                     |              |  | 2000
|Joachim Hellwig      |  |        | Vice President, Sensors                         |              |  | 2003
|Susan E. Knight      |  |        | Vice President and Chief Financial Officer      |              |  | 2001
|Douglas E. Marinaro  |  |        | Vice President, Software and Consulting         |              |  | 2002
|Kathleen M. Staby    |  |        | Vice President, Human Resources                 |              |  | 2000

Executive Officers serve at the
discretion of and are elected annually by the Companys Board of Directors. Business
experience of the Executive Officers (consisting of positions with the Company, unless
otherwise indicated) for the last five years, at a minimum, is as follows:

|                
|----------------
|                
|S. W. Emery, Jr.
|                
|L. B. Hamilton  

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|              
|--------------
|              
|J. Hellwig    
|              
|S. E. Knight  
|              
|D. E. Marinaro
|              
|K. M. Staby   

# Employees

MTS had 1,549 employees at October 1,
2005, including approximately 437 employees located outside the United States. None of the
Companys employees in the United States are currently covered by collective
bargaining agreements. In the past, the Company has not experienced any work stoppages at
any of its U.S. locations.

# Sources and Availabilityof Raw Materials and Components

A major portion of products and
systems delivered to customers may consist of equipment and component parts purchased from
third-party vendors. The Company promotes a partnership relationship with its vendors,
with an emphasis on continuous improvement in a number of critical areas including, but
not limited to, quality, performance, and technological advances. The Company is
dependent, in certain situations, on a limited number of vendors to provide computer
hardware, electronics, and software devices and raw materials. However, MTS has not
experienced significant issues in procuring any essential materials, parts, or components
needed in its engineering or production processes for any extended period of time.

Since the Company generally sells its
products based on fixed-price contracts, fluctuations in the cost of materials or
components between the date of order and the delivery date may impact the expected
profitability of any project. The Company believes that such fluctuations in the cost of
raw materials and components have not had a significant effect on reported operating
results.

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# Available Information

The MTS web site address is
www.mts.com. MTS makes available on its web site annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those
reports as soon as reasonably practical after it electronically files such material with,
or furnishes it to, the Securities and Exchange Commission (the SEC). The MTS
Code of Business Conduct, as well as any waivers from and amendments to the Code, are also
posted on the Companys web site.

# Environmental Matters

Management believes the Companys operations are in compliance with
federal, state, and local provisions relating to the protection of the environment.

# Item 1A.    Risk Factors

The following important risk factors, among others, could affect the
Companys actual results in the future and could materially harm the Companys business, financial condition, operating
results, or cash provided by operations:

| | 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company operates internationally and thus is subject to foreign currency exchange rate
changes, which can affect its results from operations and financial condition.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | 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.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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# Item 1B.    Unresolved Staff Comments

None.

# Item 2.    Properties

Properties Located in the United States:

The Company owns its corporate headquarters and major Test segment
manufacturing, assembly, and research facility, which occupies 420,000 square feet and is located on 56 acres of land in the City
of Eden Prairie, a suburb of Minneapolis, Minnesota. Since the original plant was placed in service in 1967, six additions of
various sizes, with the most recent addition being completed in 1997, have occurred. At the current time, approximately 50% of
this facility is used for manufacturing and assembly, while the remainder is used as general office space.

The Industrial segment has a Company-owned, 65,000-square foot, office and
light manufacturing facility in Cary, North Carolina, a suburb of Raleigh, North Carolina. This facility was originally
constructed in 1988 and was expanded in 1992.

In addition to the Minneapolis, Minnesota facility, the Test segment has four
other domestic locations. The Company leases 29,000 square feet in two facilities located in Madison Heights, Michigan and
Milford, Ohio. The lease agreements for these facilities terminate in 2009 and 2006, respectively. The Company also leases 15,400
square feet in two facilities located in Oak Ridge, Tennessee. The Company sold a 57,200-square foot facility in Ann Arbor,
Michigan as part of the sale of its engine test business in the fourth quarter of fiscal year 2005.

The Company also has a five-year lease agreement that terminates in 2006 for
a 90,000-square foot office, light manufacturing, and warehousing facility in Montgomeryville, Pennsylvania, a suburb of
Philadelphia, Pennsylvania. This facility was used by the Companys Automation division, which was sold in fiscal year 2003.
The Company is currently subleasing a portion of this facility to a third party.

MTS also leases space in various other cities in the United States that
serves primarily as sales and service offices. Neither the amount of leased space nor the rental obligations are significant
individually or in the aggregate. The agreements pertaining to each of its leased facilities in the United States contain
conventional operating lease terms.

International Facilities:

MTS has manufacturing, assembly, warehousing, and/or office facilities in
several countries to support its international operations:

| | Berlin,
Germany  an 80,000-square foot Company-owned Test segment facility, of which a
portion is leased to non-MTS entities. This facility is situated on land leased from the
city government. The lease expires in 2052.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Paris,
France  a 22,000-square foot leased Test segment facility used for warehousing,
service, and administrative functions. The lease expires in 2009.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------

| | Luedenscheid,
Germany  a 35,000-square foot leased Industrial segment facility located on six
acres of land and used for light manufacturing and administrative functions. The lease
expires in 2009.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Tokyo,
Japan  an 8,400-square foot leased Industrial segment facility used for light
manufacturing and administrative functions. The lease expires in 2015.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
Company also leases small office and general-purpose space for its sales and service
subsidiaries in Gloucester, United Kingdom; Gothenburg, Sweden; Turin, Italy; Seoul, South
Korea; Tokyo and Nagoya, Japan; and Beijing, Hong Kong, and Shanghai in the Peoples
Republic of China. No manufacturing is conducted at these locations.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Company considers its current
facilities adequate to support its operations during fiscal year 2006.

9

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# Item 3.    Legal Proceedings

From time to time, the Company is party
to various claims, legal actions, and complaints arising in the ordinary course of
business. Management believes the final resolution of these matters will not have a
material adverse effect on the consolidated financial position or results of operations of
the Company.

# Item 4.    Submission of Mattersto a Vote of Security Holders

No matters were submitted to a vote
of stockholders during the fourth quarter of the fiscal year ended October 1, 2005.

# PART II

# Item 5.    Market for RegistrantsCommon Equity, Related Stockholder Matters and Issuer Purchases of
Equity Securities

Shares of the Companys common stock are traded on The Nasdaq Stock
Markets National Market under the symbol MTSC.

The following table sets forth the
low, high, and closing share prices for the fiscal quarters indicated, as well as the
volume of shares traded in the quarter. *

|Quarter Ended                           |  | Low |   | High  |  | Close |       | Volume
|--------------------------------------- |  | --- | - | ----- |  | ----- | ----- | ------
|                                        |  |     |   |       |  |       |       |       
|December 27, 2003                       |  |     | $ | 14.40 |  | $     | 19.79 |       
|March 27, 2004                          |  |     | $ | 18.91 |  | $     | 28.77 |       
|June 26, 2004                           |  |     | $ | 21.00 |  | $     | 29.21 |       
|October 2, 2004                         |  |     | $ | 18.95 |  | $     | 23.85 |       
|January 1, 2005                         |  |     | $ | 20.29 |  | $     | 35.15 |       
|April 2, 2005                           |  |     | $ | 27.82 |  | $     | 37.72 |       
|July 2, 2005                            |  |     | $ | 26.13 |  | $     | 35.50 |       
|October 1, 2005                         |  |     | $ | 32.93 |  | $     | 42.90 |       
|* Source: The Nasdaq Stock Market, Inc. |  |    

At December 7, 2005, there were 1,450
holders of record of the Companys common stock. This number does not reflect
shareholders who hold their shares in the name of broker-dealers or other nominees.

10

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Purchases of Company Equity Securities:

|Fiscal 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
|----------------- |  | -------------------------------- |  | ---------------------------- |  | -------------------------------------------------------------------------------- | ----- | ------------------------------------------------------------------------------
|                 
|First Quarter     |  |                                  |  |                              |  |                                                                                  |       |                                                                               
|October 3, 2004 - |  |                                 
|January 1, 2005   |  |                                  |  | 183,600                      |  | $                                                                                | 29.39 |                                                                               
|                 
|Second Quarter    |  |                                 
|January 2, 2005 - |  |                                 
|April 2, 2005     |  |                                  |  | 269,200                      |  | $                                                                                | 31.36 |                                                                               
|                 
|Third Quarter     |  |                                 
|April 3, 2005 -   |  |                                 
|July 2, 2005      |  |                                  |  | 292,000                      |  | $                                                                                | 30.52 |                                                                               
|                 
|Fourth Quarter    |  |                                 
|Fiscal Month      |  |                                 
|July 3, 2005 -    |  |                                 
|August 6, 2005    |  |                                  |  | 105,600                      |  | $                                                                                | 35.37 |                                                                               
|                 
|August 7, 2005 -  |  |                                 
|Sept. 3, 2005     |  |                                  |  | 88,000                       |  | $                                                                                | 40.71 |                                                                               
|                 
|Sept. 4, 2005 -   |  |                                 
|Oct. 1, 2005      |  |                                  |  | 83,600                       |  | $                                                                                | 40.00 |                                                                               
|                 
|                 
|Fourth Quarter    |  |                                  |  | 277,200                      |  | $                                                                                | 38.46 |                                                                               
|                 
|                 
|Fiscal Year 2005  |  |                                  |  | 1,022,000                    |  | $                                                                                | 32.69 |                                                                               
|                 

The Company purchases Company common
stock to offset share dilution from new shares created by employee equity compensation
such as stock options, restricted stock awards, and the employee stock plan, and as a
means of returning excess cash to shareholders.

During fiscal year 2005, Company
share purchases were completed under a 2.5 million share purchase plan that the Company
announced and its Board of Directors approved on January 27, 2004. On August 25, 2005, the
Company announced its Board of Directors authorized an additional 3.0 million share
purchase program. Authority over pricing and timing under the program has been delegated
to management. The program has no expiration date.

The Companys dividend policy is
to maintain a long-term payout ratio of 25% of net earnings. In the fourth quarter of
fiscal year 2005, the Company increased the quarterly dividend 25% to $0.10 per share.

The Companys long-term debt
agreements have requirements on the minimum level of net worth that restrict the
Companys ability to purchase stock or pay dividends. At October 1, 2005 and October
2, 2004, the Company was in compliance with all such requirements. In fiscal year 2005,
the Company reached agreements with the holders of its debt, reducing the minimum net
worth requirement in order to provide the Company additional capacity for dividends, share
purchases, and other investments.

11

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# Item 6.    Selected Financial Data

The table below provides selected
historical financial data for the Company, which should be read in conjunction with the
Consolidated Financial Statements, the Notes to the Consolidated Financial Statements, and
Managements Discussion and Analysis of Financial Condition and Results of
Operations, which are included elsewhere in this report. The statement of income
data for each of the three fiscal years ended October 1, 2005, October 2, 2004, and
September 27, 2003 and the balance sheet data at October 1, 2005 and October 2, 2004 are
derived from the audited Consolidated Financial Statements included elsewhere in this
report. The statement of income data for the fiscal years ended September 28, 2002 and
September 30, 2001 and the balance sheet data at September 28, 2002 and September 30, 2001
are derived from financial statements of the Company that are not included in this report.

Five-Year Financial Summary(October 1, 2005, October 2, 2004, September 27, 2003, September 28, 2002, and September 30, 2001)
(expressed in thousands, except per share data and numbers of shareholders and employees)

|                                              |  | 2005 |   | 20041   |   | 2003 |         | 2002 |   | 2001   
|--------------------------------------------- |  | ---- | - | ------- | - | ---- | ------- | ---- | - | -------
|                                              | 
|Operations                                    |  |      |   |         |   |      |         |      |   |        
|Revenue                                       |  |      | $ | 374,377 |   | $    | 338,204 |      | $ | 316,213
|Gross profit                                  |  |      |   | 163,582 |   |      | 138,361 |      |   | 117,350
|Gross profit as a % of revenue                |  |      |   | 43.7    | % |      | 40.9    | %    |   | 37.1   
|Research and development expense              |  |      | $ | 14,936  |   | $    | 12,663  |      | $ | 13,827 
|Research and development as a % of revenue    |  |      |   | 4.0     | % |      | 3.7     | %    |   | 4.4    
|Effective income tax rate                     |  |      |   | 29.4    | % |      | 36.7    | %    |   | 33.8   
|Income before discontinued operations and     |  |     
|cumulative effect of accounting changes       |  |      | $ | 36,569  |   | $    | 27,208  |      | $ | 19,574 
|Net income                                    |  |      |   | 37,058  |   |      | 28,983  |      |   | 20,313 
|Net income as a % of revenue                  |  |      |   | 9.9     | % |      | 8.6     | %    |   | 6.4    
|Diluted earnings per share of common stock    |  |     
|before discontinued operations and cumulative |  |     
|effect of accounting changes                  |  |      | $ | 1.79    |   | $    | 1.27    |      | $ | 0.92   
|Diluted earnings per share of common stock    |  |      |   | 1.81    |   |      | 1.35    |      |   | 0.95   
|Weighted average dilutive shares              |  |     
|outstanding during the year2                  |  |      |   | 20,509  |   |      | 21,464  |      |   | 21,474 
|Net interest (income) expense                 |  |      | $ | (220    | ) | $    | 983     |      | $ | 1,453  
|Depreciation and amortization                 |  |      |   | 8,638   |   |      | 8,371   |      |   | 8,432  
|                                             
|Financial Position                            |  |     
|Cash, cash equivalents and                    |  |     
|short-term investments                        |  |      | $ | 159,793 |   | $    | 129,303 |      | $ | 132,743
|Property and equipment, net                   |  |      |   | 42,953  |   |      | 44,406  |      |   | 47,562 
|Total assets                                  |  |      |   | 353,485 |   |      | 341,635 |      |   | 330,378
|Interest-bearing debt3                        |  |      |   | 23,963  |   |      | 30,718  |      |   | 37,709 
|Total shareholders investment                |  |      |   | 188,432 |   |      | 171,796 |      |   | 176,106
|Interest-bearing debt as a % of               |  |     
|shareholders investment                      |  |      |   | 12.7    | % |      | 17.9    | %    |   | 21.4   
|Return on equity4                             |  |      |   | 21.6    | % |      | 16.5    | %    |   | 12.5   

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|                                 |  | 2005 |   | 20041   |  | 2003 |         | 2002 |   | 2001   
|-------------------------------- |  | ---- | - | ------- |  | ---- | ------- | ---- | - | -------
|                                 | 
|Other Statistics                 |  |      |   |         |  |      |         |      |   |        
|Number of common shareholders of |  |     
|record at year-end5              |  |      |   | 1,471   |  |      | 1,644   |      |   | 1,907  
|Number of employees at year-end  |  |      |   | 1,549   |  |      | 1,501   |      |   | 1,531  
|Orders                           |  |      | $ | 404,377 |  | $    | 387,307 |      | $ | 295,195
|Backlog of orders at year-end    |  |      |   | 219,680 |  |      | 186,228 |      |   | 141,386
|Cash dividends paid per share    |  |      |   | 0.34    |  |      | 0.26    |      |   | 0.24   

1The fiscal year ended
October 2, 2004 was a 53-week fiscal year, whereas all other fiscal years presented were 52-week periods.2Assumes the conversion of potential common shares using the treasury stock method.3Consists of notes payable and the current and non-current portion of long-term debt.4Calculated by dividing Net Income by beginning Shareholders Investment.5Does not include shareholders whose stock is held in the name of broker dealers or other nominees.

# Item 7.   Managements Discussionand Analysis of Financial Condition and Results of Operations

MTS Systems Corporation is a leading
global supplier of test systems and high-performance industrial position sensors. The
Companys testing 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.

Fiscal YearThe Companys fiscal year ends
on the Saturday closest to September 30. The fiscal years ended October 1, 2005 and
September 27, 2003 consisted of 52 weeks. The fiscal year ended October 2, 2004 consisted
of 53 weeks.

Overall ResultsOrders for fiscal year 2005 increased
4.4% to $404.4 million, compared to orders of $387.3 million for fiscal year 2004. In
fiscal year 2003, orders totaled $295.2 million. The increase in orders in fiscal year
2005 from fiscal year 2004 is primarily due to increased volume in the Test segment in
Europe and Asia, increased volume in the Industrial segment across all geographies, and an
estimated $7.9 million of favorable currency translation. The increase in orders in fiscal
year 2004 from fiscal year 2003 is primarily due to increased volume in both the Test and
Industrial segments in Europe and Asia and an estimated $17.4 million of favorable
currency translation.

Backlog of undelivered orders at
October 1, 2005 increased 18.0% to $219.7 million, compared to backlog of $186.2 million
at October 2, 2004. Backlog at the end of fiscal year 2003 totaled $141.4 million. The
current year increase in backlog from fiscal year 2004 is primarily attributable to
increased order volume in the Test segment.

Revenue of $374.4 million for fiscal
year 2005 increased 10.7%, compared to revenue of $338.2 million for fiscal year 2004.
Revenue for fiscal year 2003 totaled $316.2 million. The increase in revenue in fiscal
year 2005 from fiscal year 2004 was primarily due to higher beginning backlog, increased
project and short-cycle business in the Test segment, continued growth in the Sensors
business, and an estimated $7.4 million favorable impact from currency translation. The
increase in fiscal year 2004 revenue from fiscal year 2003 was primarily due to higher
orders, an increase in aftermarket product volume in the Test segment, and an estimated
$17.1 million favorable impact of currency translation, partially offset by lower
beginning backlog.

Income before income taxes and
discontinued operations for fiscal year 2005 increased 20.5% to $51.8 million, compared
to income before income taxes and discontinued operations of $43.0 million for fiscal
year 2004. Income before income taxes and discontinued operations for fiscal year 2003
totaled $29.6 million. The increase in fiscal year 2005 from fiscal year 2004 is
primarily driven by increased volume in

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both segments, improved margins in
the Test segment, and an estimated $0.6 million favorable impact of currency translation,
partially offset by $4.5 million of costs associated with the exit of the Companys
noise and vibration software business, which were recorded in the fourth quarter of
fiscal year 2005. These business exit charges, as well as the related operating results
of the noise and vibration software business, are reported in continuing operations for
fiscal year 2005, as the Company will continue to support customers of this business
through fiscal year 2006. The increase in income before income taxes and discontinued
operations for fiscal year 2004 from fiscal year 2003 was primarily due to increased
volume, high-margin product mix, and an estimated $2.3 million favorable impact of
currency translation.

Net income was $37.1 million, or
$1.81 per diluted share, for fiscal year 2005, an increase of 27.9% compared to $29.0
million, or $1.35 per diluted share, for fiscal year 2004 and increased from $20.3
million, or $0.95 per diluted share, for fiscal year 2003. During fiscal year 2005, the
Company sold its engine test business, which resulted in a gain of $3.8 million, net of
tax. Also during fiscal year 2005, the Company closed its laser deposition technology
business, previously conducted through its wholly owned subsidiary AeroMet Corporation,
which resulted in a loss of $0.7 million, net of tax. Both of these business exits are
reported as discontinued operations effective with fiscal year 2005. The increase in net
income for fiscal year 2005 from fiscal year 2004 was due to increased income from
operations, a $2.6 million reduction in tax expense resulting from resolution of
previously reserved tax matters, a $3.1 million net gain on the disposal of discontinued
businesses, net of tax, and an estimated $0.4 million favorable impact of currency
translation. These effects were partially offset by a $2.6 million loss from discontinued
operations, net of tax, in fiscal year 2005 and $1.8 million income from discontinued
operations, net of tax, in fiscal year 2004. The increase in net income for fiscal year
2004 compared to fiscal year 2003 was primarily due to increased income from operations, a
$1.2 million loss on sale of discontinued businesses, net of tax, in fiscal year 2003, and
an estimated $1.4 million favorable impact of currency translation, partially offset by a
higher effective income tax rate in fiscal year 2004.

Critical Accounting
PoliciesThe 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 to the Consolidated Financial
Statements.

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 level of inventory valuation reserves. 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.

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|Orders and Backlog |  |                          |   |         |  |  
|------------------ |  | ------------------------ | - | ------- |  | -
|2005               |  | 2004                     |   | 2003   
|                  
|                   |  | (expressed in thousands)
|Orders             |  |                          | $ | 404,377 |  | $
|                  
|Backlog of         |  |                         
|Undelivered Orders |  |                          | $ | 219,680 |  | $
|                  

Orders for fiscal year 2005 totaled $404.4
million, an increase of $17.1 million, or 4.4%, compared to orders of $387.3 million for
fiscal year 2004. In fiscal year 2003, orders totaled $295.2 million. The increase in
fiscal year 2005 orders from fiscal year 2004 is primarily due to increased volume in the
Test segment in Europe and Asia, increased volume in the Industrial segment across all
geographies, and an estimated $7.9 million favorable impact of currency translation. The
increase in fiscal year 2004 orders from fiscal year 2003 was primarily the result of
increased volume in both the Test and Industrial segments across all geographies and an
estimated $17.4 million impact of favorable currency translation.

Orders for the Test segment totaled
$342.9 million for fiscal year 2005, an increase of $9.5 million, or 2.8%, compared to
orders of $333.4 million for fiscal year 2004. Test segment orders for fiscal year 2003
totaled $250.2 million. The Test segment booked 84.8% of total Company orders for fiscal
year 2005, compared to 86.1% for fiscal year 2004 and 84.8% for fiscal year 2003. The
increase in fiscal year 2005 orders from fiscal year 2004 is primarily due to increased
volume in Europe and Asia and an estimated $6.4 million favorable impact of currency
translation. The increase in fiscal year 2004 orders from fiscal year 2003 was primarily
due to increased volume across all geographies and an estimated $14.1 million favorable
impact of currency translation.

Orders for the Industrial segment
totaled $61.5 million for fiscal year 2005, an increase of $7.6 million, or 14.1%,
compared to orders of $53.9 million for fiscal year 2004. Orders for the Industrial
segment in fiscal year 2003 totaled $45.0 million. The Industrial segment booked 15.2% of
total Company orders for fiscal year 2005, compared to 13.9% for fiscal year 2004 and
15.2% for fiscal year 2003. The increase in fiscal year 2005 orders from fiscal year 2004
reflects increased Sensors business volume across all geographies and an estimated $1.5
million favorable impact of currency translation. The increase in fiscal year 2004 orders
from fiscal year 2003 primarily resulted from volume increases in the Sensors business
across all geographies and an estimated $3.3 million favorable impact of currency
translation.

Orders from customers located in
North America totaled $130.4 million during fiscal year 2005, virtually flat compared to
orders of $130.1 million for fiscal year 2004. Orders received in North America during
fiscal year 2003 totaled $120.6 million. International orders received during fiscal year
2005 of $274.0 million increased by $16.8 million, or 6.5%, compared to orders received
during fiscal year 2004 of $257.2 million. International orders in fiscal year 2003
totaled $174.6 million.

Backlog of undelivered orders at
October 1, 2005 totaled $219.7 million, an increase of approximately $33.5 million, or
18.0%, compared to backlog of $186.2 million at October 1, 2004. Backlog at the end of
fiscal year 2003 totaled $141.4 million. The increase in fiscal year 2005 backlog from
fiscal year 2004 is primarily attributable to increased order volume in the Test segment.
The Company believes backlog is not an absolute indicator of its future revenue because a
substantial portion of the orders constituting this backlog could be cancelled at the
customers discretion. However, the Company seldom experiences cancellations of
orders larger than $1.0 million. Based on anticipated production schedules and other
factors, the Company believes that approximately $179 million of the backlog at October 1,
2005 will be converted to revenue during fiscal year 2006.

|Revenue |  |                          |   |         |  |  
|------- |  | ------------------------ | - | ------- |  | -
|2005    |  | 2004                     |   | 2003   
|       
|        |  | (expressed in thousands)
|Revenue |  |                          | $ | 374,377 |  | $
|       

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Revenue for fiscal year 2005 totaled $374.4 million, an increase of $36.2
million, or 10.7%, compared to revenue of $338.2 million for fiscal year 2004. Revenue for fiscal year 2003 totaled $316.2
million. The increase in fiscal year 2005 revenue from fiscal year 2004 was primarily due to higher beginning backlog, increased
project and short-cycle business in the Test segment, continued growth in the Sensors business, and an estimated $7.4 million
favorable impact of currency translation. The increase in fiscal year 2004 revenue from fiscal year 2003 was primarily due to
higher orders, an increase in after-market product volume in the Test segment, and an estimated $17.1 million favorable impact of
currency translation, partially offset by lower beginning backlog.

Revenue for the Test segment totaled $313.5 million for fiscal year 2005,
compared to revenue of $285.9 million for fiscal year 2004 and revenue of $271.4 million for fiscal year 2003. The increase in
revenue for fiscal year 2005 was primarily due to higher beginning backlog, increased project and short-cycle business, and an
estimated $5.8 million favorable impact from currency translation. The increase in fiscal year 2004 revenue from fiscal year 2003
was primarily due to higher orders, increased after-market product volume, and an estimated $13.7 million favorable impact from
currency translation, partially offset by lower beginning backlog.

Revenue for the Industrial segment totaled $60.9 million for fiscal year
2005, compared to $52.3 million for fiscal year 2004 and $44.8 million for fiscal year 2003. The increase in fiscal year 2005
revenue from fiscal year 2004 was primarily due to higher beginning backlog, increased order volume in the Sensors business across
all geographies, and an estimated $1.6 million favorable impact of currency translation. The increase in fiscal year 2004 revenue
from fiscal year 2003 was primarily driven by increased volume in the Sensors business across all geographies and an estimated
$3.4 million favorable impact from currency translation.

Revenue of $119.8 million in North America for fiscal year 2005 decreased
$9.0 million, or 7.0%, compared to revenue of $128.8 million in North America for fiscal year 2004. Revenue in North America for
fiscal year 2003 totaled $136.6 million. Revenue in Europe of $134.2 million for fiscal year 2005 increased $23.4 million, or
21.1%, compared to $110.8 million for fiscal year 2004. Revenue in Europe for fiscal year 2003 totaled $116.8 million. Revenue of
$119.9 million in Asia for fiscal year 2005 increased $24.6 million, or 25.8%, compared to $95.3 million for fiscal year 2004.
Revenue in Asia for fiscal year 2003 totaled $59.9 million. Other international revenue totaled $0.5 million, $3.3 million, and
$2.9 million, respectively, for fiscal years 2005, 2004, and 2003.

Although selective product price changes were implemented during each of the
three fiscal years, the overall impact of pricing changes did not have a material effect on reported revenue.

# Gross Profit

|                        
|------------------------
|                        
|(expressed in thousands)
|Gross Profit            
|                        
|% of Revenue            
|                        

Gross profit as a percentage of revenue increased to 43.7% for fiscal year
2005 from 40.9% and 37.1% for fiscal years 2004 and 2003, respectively. The increase in gross profit rate for fiscal year 2005 was
primarily driven by improved project execution, favorable product mix, and other productivity gains in the Test segment, partially
offset by a 1.0 percentage point unfavorable impact of $3.6 million of costs associated with the exit of the Companys noise
and vibration software business, as well as an unfavorable impact of currency translation of an estimated 0.3 percentage points.
The increase in gross profit as a percentage of revenue for fiscal year 2004 from fiscal year 2003 was primarily driven by
favorable product mix in both the Test and Industrial segments, partially offset by an unfavorable impact of foreign currency
translation of an estimated 0.5 percentage points.

Gross profit as a percentage of revenue for the Test segment was 42.8% for
fiscal year 2005, an increase from 39.4% and 35.2% for fiscal years 2004 and 2003, respectively. The increase in gross profit rate
in fiscal year 2005 was primarily due to improved project execution and other productivity gains, partially offset by a 1.1
percentage point unfavorable impact from the previously mentioned

16

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business exit costs of $3.6 million, as well as an unfavorable impact of
currency translation of an estimated 0.3 percentage points. The increase in gross profit rate for the Test segment in fiscal year
2004 from fiscal year 2003 was primarily due to product mix, partially offset by an unfavorable impact of currency translation of
an estimated 0.6 percentage points.

Gross profit as a percentage of revenue for the Industrial segment was 48.5%
for fiscal year 2005, a decrease from 49.4% and 49.0% for fiscal years 2004 and 2003, respectively. The gross profit rate decrease
in fiscal year 2005 was primarily due to charges associated with excess and obsolete inventory in the Sensors business, resulting
from product line changes made in fiscal year 2005. The increase in fiscal year 2004 gross profit rate from fiscal year 2003 was
primarily due to favorable product mix. There was no significant impact on gross profit rate due to currency translation in fiscal
years 2005 or 2004.

# Selling, General, and Administrative Expense

|                        
|------------------------
|                        
|(expressed in thousands)
|Selling                 
|General & Administrative
|                        
|Total                   
|                        
|% of Revenue            
|                        

Selling, general and administrative (SG&A) expense as a
percentage of revenue increased 0.9 percentage points in fiscal year 2005 compared to fiscal year 2004. Selling expense increased
during fiscal year 2005 primarily due to $5.0 million of increased sales incentives and commissions, $0.7 million in expense
related to the previously mentioned costs associated with the exit of the Companys noise and vibration software business,
and an estimated $1.1 million unfavorable impact of currency translation. Selling expense increased in fiscal year 2004 compared
to fiscal year 2003 primarily due to $5.0 million increased investment in marketing initiatives and an estimated $2.4 million
unfavorable impact of currency translation.

General and administrative expense increased by $4.3 million during fiscal
year 2005, primarily due to $2.2 million associated with increased legal fees and expenses associated with Sarbanes-Oxley
compliance, $0.9 million increased contract labor, $0.7 million favorable bad debt and workers compensation reserve adjustments
made in fiscal year 2004, and an estimated $0.4 million unfavorable impact of currency translation. General and administrative
expense increased by $1.5 million in fiscal year 2004 compared to fiscal year 2003, primarily due to increased consulting, legal
and other professional fees, as well as an estimated $0.4 million unfavorable impact of currency translation.

SG&A expense for the Test segment increased to $77.6 million in fiscal
year 2005 from $67.5 million and $58.3 million in fiscal years 2004 and 2003, respectively. The increase in fiscal year 2005 was
primarily due to increased sales incentives and commissions, $0.9 million of business exit costs, $0.5 million increased legal
expenses, and $1.5 million of expenses associated with Sarbanes-Oxley compliance. In addition, fiscal year 2005 SG&A expense
included an estimated $1.1 million unfavorable impact of currency translation. The SG&A expense increase in fiscal year 2004
compared to fiscal year 2003 was primarily due to increased investment in marketing initiatives, consulting expense, sales force
expansion, and other professional fees, as well as an estimated $1.9 million unfavorable impact of currency translation.

SG&A expense in the Industrial segment in fiscal year 2005 increased to
$18.1 million from $16.1 million for fiscal year 2004 and $15.0 million for fiscal year 2003. The increase in SG&A in fiscal
year 2005 from fiscal year 2004 was primarily due to an increase in selling expense in the Sensors business, consistent with
increased revenue, and an estimated $0.4 million unfavorable impact of currency translation. Fiscal year 2004 selling expense as a
percentage of revenue was 19.3%, relatively flat compared to selling expense as a percentage of revenue of 19.1% for fiscal year
2003. Fiscal year 2003 SG&A expense included an estimated $0.9 million unfavorable impact of currency translation.

17

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# Research and Development Expense

|                        
|------------------------
|                        
|(expressed in thousands)
|Research & Development  
|                        
|% of Revenue            
|                        

Research and development (R&D) expense includes expenses for
both equipment and software development in the Test and Industrial segments. During fiscal year 2005, approximately 79.5% of
R&D spending was in the Test Segment, compared to 76.5% and 77.5%, respectively, in fiscal years 2004 and 2003.

R&D expense as a percentage of revenue increased in fiscal year 2005,
primarily due to planned investments in new product development. The decrease in R&D expense as a percentage of revenue in
fiscal year 2004 from fiscal year 2003 was primarily due to efforts to prioritize investments and better focus R&D spending on
developments with the greatest market potential and the highest return on investment.

# Interest Income (Expense)

|                        
|------------------------
|                        
|(expressed in thousands)
|Interest Expense        
|Interest Income         
|                        

Interest expense of $2.1 million for fiscal year 2005 decreased compared to
interest expense of $2.8 million and $3.6 million for fiscal years 2004 and 2003, respectively, primarily due to a reduction in
long-term debt obligations. Interest income of $2.3 million for fiscal year 2005 increased compared to interest income of $1.8
million and $2.2 million for fiscal years 2004 and 2003, respectively. The increase in fiscal year 2005 interest income reflects
higher interest rates, partially offset by a lower average balance in cash, cash equivalents and short-term investments in fiscal
year 2005 compared to fiscal year 2004. The decrease in fiscal year 2004 interest income from fiscal year 2003 reflects a shift to
short-term, tax-exempt investments with lower interest rates, partially offset by a higher average balance in cash, cash
equivalents and short-term investments in fiscal year 2004 compared to fiscal year 2003.

Other (Expense) Income, net
Other expense for fiscal year 2005 was $1.4 million, compared to other income of $1.9 million and $0.8 million for fiscal
years 2004 and 2003, respectively. Other expense for fiscal year 2005 primarily consisted of losses on the settlement of foreign
currency transactions. Other income for fiscal year 2004 primarily consisted of gains on the settlement of foreign currency
transactions. Other income for fiscal year 2003 consisted of proceeds of $1.3 million from penalties associated with a canceled
customer contract, partially offset by losses on foreign currency transactions.

# Operating Results

|                                          | 2005 |  | 2004 |        | 2003
|----------------------------------------- | ---- |  | ---- | ------ | ----
|                                         
|(expressed in thousands)                 
|Income Before Income Taxes and            |      |  |      |        |     
|Discontinued Operations                   |      |  | $    | 51,814 |     
|% of Revenue                              |      |  |      | 13.8   | %   
|                                         
|Effective Income Tax Rate                 |      |  |      | 29.4   | %   
|                                         
|Income Before Discontinued Operations     |      |  | $    | 36,569 |     
|                                         
|Income Before Discontinued Operations per |      | 
|Diluted Share                             |      |  | $    | 1.79   |     
|                                         

Income before income taxes and discontinued operations totaled $51.8 million
for fiscal year 2005, compared to income before income taxes and discontinued operations of $43.0 million for fiscal year

18

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2004. The fiscal year 2005 increase was primarily driven by increased volume
in both segments, improved margins in the Test segment, and an estimated $0.6 million favorable impact of currency translation.
These favorable impacts were partially offset by increased SG&A expense of $12.1 million and the previously mentioned business
exit costs of $4.5 million. These business exit costs, as well as the related operating results of the noise and vibration
software business, are reported in continuing operations for fiscal year 2005 because the Company will continue to support
customers of this business through fiscal year 2006. Income before income taxes and discontinued operations for fiscal year 2004
increased to $43.0 million compared to $29.6 million for fiscal year 2003. This increase was primarily driven by increased volume,
favorable product mix, and an estimated $2.3 million favorable impact of currency translation.

Income from operations for the Test segment was $44.6 million for fiscal year
2005, an increase of $9.2 million compared to $35.4 million and $26.3 million for fiscal years 2004 and 2003, respectively. The
increase in income from operations for fiscal year 2005 compared to fiscal year 2004 was primarily due to increased volume and
improved margins, partially offset by increased SG&A expense and the business exit costs of $4.5 million. The increase in
income from operations for fiscal year 2004 compared to fiscal year 2003 was primarily due to stronger revenue and a high-margin
product mix, partially offset by increased SG&A expense. Income from operations for the Industrial segment increased to $8.4
million for fiscal year 2005 compared to $6.7 million for fiscal year 2004, primarily due to increased volume, partially offset by
increased SG&A expenses. Income from operations for the Industrial segment totaled $3.9 million for fiscal year 2003.

The effective tax rate for each of the years presented is impacted by the
Companys geographic mix of income, with foreign income generally taxed at higher rates than domestic income. In addition,
the effective tax rate is favorably impacted by the Companys foreign exports and qualified R&D expenses. During fiscal
year 2005, the Company recognized a favorable tax benefit of $2.6 million from the release of contingencies associated with tax
matters accrued for in prior years. This tax benefit reflects the Companys foreign tax credit position, which allows the
Company to credit taxes paid offshore against taxes assessed in the United States. This tax benefit lowered the effective tax rate
compared to fiscal year 2004. During fiscal year 2004, a greater percentage of the Companys income was earned in higher tax
jurisdictions compared to fiscal years 2003, resulting in a higher effective tax rate in fiscal year 2004 compared to fiscal year
2003.

Fiscal year 2005 income before discontinued operations increased to $36.6
million, or $1.79 per diluted share, from $27.2 million, or $1.27 per diluted share, and $19.6 million, or $0.92 per diluted
share, for fiscal years 2004 and 2003, respectively.

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.

During the second and third quarters of fiscal year 2003, the Company sold
its Automation division, which was based in New Ulm, Minnesota and also maintained operations in Montgomeryville, Pennsylvania and
Freiburg and Straslund, Germany. On March 31, 2003, the Company sold

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substantially all of the net assets and intellectual property associated with
the Automation divisions gradient amplifier product line. On April 11, 2003, the Company sold the remaining net assets of
the North American Automation division, based in New Ulm, Minnesota and on April 30, 2003 sold, to the same buyer, its stock in
the Automation divisions German operations, which completed the sale of the Companys entire Automation division and
its exit from the motor and amplifier business. In March 2003 the Company discontinued the custom military business of its
Automation division. As a result of these sales, the Company recorded a loss of $1.2 million, net of tax of $0.8 million. The
Automation division was historically included in the Companys Industrial segment for financial reporting, and its results of
operations are reported as discontinued operations.

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
for the respective fiscal years:

|                                                      
|------------------------------------------------------
|                                                      
|(expressed in thousands)                              
|Revenue                                               
|(Loss) income on discontinued operations before       
|taxes and gain (loss) on sale                         
|(Benefit) provision for income taxes                  
|                                                      
|(Loss) income from discontinued operations, net of tax
|                                                      

The assets and liabilities of discontinued operations at October 1, 2005 and
October 2, 2004 were as follows:

|                                                             | 2005 |  | 2004
|------------------------------------------------------------ | ---- |  | ----
|                                                            
|(expressed in thousands)                                    
|Accounts receivable, net of allowances for doubtful accounts |      |  | $   
|Unbilled accounts receivable                                 |      |  |     
|Inventories                                                  |      |  |     
|Prepaid expenses                                             |      |  |     
|Current deferred tax assets                                  |      |  |     
|Other current assets                                         |      |  |     
|                                                             |     
|Current assets of discontinued operations                    |      |  |     
|                                                             |      | 
|Land                                                         |      |  |     
|Buildings and improvements                                   |      |  |     
|Machinery and equipment                                      |      |  |     
|Accumulated depreciation                                     |      |  |     
|Long-term deferred tax assets                                |      |  |     
|                                                             |     
|Long-lived assets of discontinued operations                 |      |  |     
|                                                             |      | 
|                                                             |     
|Total assets of discontinued operations                      |      |  | $   
|                                                             |     
|                                                             |      | 
|Accounts payable                                             |      |  | $   
|Accrued payroll-related costs                                |      |  |     
|Advance payments from customers                              |      |  |     
|Accrued warranty costs                                       |      |  |     
|Accrued income taxes                                         |      |  |     
|Other accrued liabilities                                    |      |  |     
|                                                             |     
|Total liabilities of discontinued operations                 |      |  | $   
|                                                             |     

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Cash Flow
Total cash and cash equivalents increased $16.2 million during fiscal year 2005, primarily due to strong earnings, decreased
working capital requirements, proceeds from the exercise of stock options, and proceeds from the sale of the discontinued engine
test business, partially offset by net purchases of short-term investments, repayment of long-term debt, dividend payments, and
purchases of the Companys common stock. Total cash and cash equivalents increased $17.2 million during fiscal year 2004,
primarily due to improved earnings, net proceeds from the conversion of short-term investments to cash and cash equivalents, a
decrease in net deferred tax assets, and proceeds from the exercise of stock options, partially offset by net purchases of
short-term investments, repayment of long-term debt, dividend payments, and purchases of the Companys common stock. Total
cash and cash equivalents increased $3.1 million during fiscal year 2003, primarily due to strong earnings, decreased working
capital requirements, proceeds from the exercise of stock options, and proceeds from the sale of discontinued businesses,
partially offset by net purchases of short-term investments, repayment of long-term debt, dividend payments, and purchases of the
Companys common stock.

Cash flow from operating activities provided cash of $58.8 million
during fiscal year 2005, compared to cash provided of $43.7 million and $49.4 million in fiscal years 2004 and 2003, respectively.
Operating cash flow in fiscal year 2005 primarily resulted from strong earnings during the year, a $6.0 million decrease in
working capital requirements, and $6.2 million tax benefit from the exercise of stock options. Fiscal year 2004 cash flow from
operating activities was primarily due to strong earnings and a net decrease in deferred tax assets of $5.1 million, partially
offset by a $4.6 million increase in working capital requirements. Fiscal year 2003 cash flow from operating activities was
primarily due to strong earnings, a $19.1 million decrease in working capital requirements, and a $3.3 million net decrease in
deferred tax assets. The increase in cash provided by operating activities during fiscal year 2005 compared to fiscal year 2004
was primarily due to improved earnings of $8.1 million and decreased working capital requirements of $10.6 million. The decrease
in cash provided by operating activities during fiscal year 2004 compared to fiscal year 2003 was primarily due to $42.4 million
of improvements in accounts receivable and inventory in fiscal year 2003, which more than offset increased advance payments from
customers of $12.0 million, accrued payments to vendors of $6.8 million and improved earnings of $8.7 million in fiscal year 2004.

Cash flow used in investing activities required a use of cash of $7.1
million during fiscal year 2005, compared to cash provided by investing activities of $17.3 million during fiscal year 2004 and
cash used in investing activities of $25.5 million in fiscal year 2003. During fiscal year 2005, the Company invested $14.3
million in short-term investments and $7.1 million in property and equipment additions, partially offset by $14.2 million received
from the sale of discontinued businesses. During fiscal year 2004, the Company received net proceeds of $20.6 million from the
maturity of short-term investments and $2.0 million from the sale of property and equipment and invested $5.3 million in property
and equipment additions. During fiscal year 2003, the Company invested $32.1 million in short-term investments and $6.0 million in
property and equipment additions, partially offset by $12.6 million received from the sale of discontinued businesses.

Cash flow used in financing activities required a use of cash of $30.9
million during fiscal year 2005, compared to $47.7 million and $29.9 million used in fiscal years 2004 and 2003, respectively. The
cash usage in fiscal year 2005 primarily resulted from purchases of the Companys common stock of $33.7 million, net
repayment of interest-bearing debt of $6.7 million, and payment of cash dividends of $4.8 million, partially offset by $14.4
million received from employees exercise of stock options and purchases under the Companys employee stock purchase
plan. During fiscal year 2004, the Companys cash usage primarily resulted from purchases of the Companys common stock
of $44.3 million, net repayment of interest-bearing debt of $6.7 million, and payment of cash dividends of $6.6 million, partially
offset by $9.9 million received from employees exercise of stock options and purchases under the Companys employee
stock purchase plan. During fiscal year 2003, the Companys cash usage primarily resulted from purchases of the
Companys common stock of $16.5 million, net repayment of interest-bearing debt of $15.4 million, and payment of cash
dividends of $5.1 million, partially offset by $7.0 million received from employees exercise of stock options and purchases
under the Companys employee stock purchase plan.

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During fiscal year 2005, the Company reclassified its investments in highly
rated, liquid municipal securities and corporate preferred stock from cash equivalents to short-term investments. Prior period
balances associated with these investments were reclassified for comparability. This reclassification was due to the securities
having a final maturity date in excess of three months beyond the date of acquisition.

Liquidity and Capital Resources
At October 1, 2005, the Companys capital structure was comprised of $1.6 million in short-term debt, $22.4 million in
long-term debt, and $188.4 million in Shareholders Investment. Total interest-bearing debt was $24.0 million, down from
$30.7 million at October 2, 2004 due to scheduled repayments. Shareholders Investment increased by $16.6 million during
fiscal year 2005, primarily due to profitable operating results, $14.4 million of employee purchases of the Companys stock
under its employee stock purchase plans, a $6.2 million tax benefit from the exercise of employee stock options, and $1.4 million
in unrealized gains on derivative instruments, partially offset by $33.7 million in purchases of the Companys common stock,
$6.8 million in dividend payments, $1.6 million of foreign currency translation losses, and a $0.9 million minimum pension
liability adjustment.

The Company had cash, cash equivalents and short-term investments of $160
million at October 1, 2005. Of this amount, approximately $86 million was located in North America, $55 million in Europe, and $19
million in Asia. The North American balance was primarily invested in U.S. state and local municipal securities not subject to
federal taxation, as well as in taxable and tax-free money market funds. In Europe, the balances were primarily invested in
Euro-denominated money market funds and bank deposits. In Asia, the balances were primarily invested in bank deposits.

The Company believes its cash and cash equivalents and anticipated funds from
operations are adequate to fund ongoing operations, capital expenditures, and Company share purchases, as well as to fund
opportunities to grow its business organically and through business acquisitions.

At October 1, 2005, the Companys contractual obligations were as
follows:

|                                               | 
|---------------------------------------------- | 
|Payments Due by Period(expressed in thousands)
|                                              
|Contractual Obligations                        | 
|                                               | 
|Notes Payable                                  | 
|Long-Term Debt Obligations                     | 
|Capital Lease Obligations                      | 
|Operating Lease Obligations                    | 
|Interest Payable                               | 
|Pension and Other Long-Term                    | 
|Obligations                                    | 
|                                              
|Total                                          | 
|                                              

The Company did not renew its $25 million revolving bank credit facility in
fiscal year 2005 given liquidity available from domestic cash equivalents and short-term investments held for sale. There were no
amounts outstanding on the revolving credit facility during fiscal year 2005 or fiscal year 2004. The Companys foreign
subsidiaries have uncommitted bank facilities available on either a free-standing basis or supported by Company guarantees.
Short-term debt outstanding at October 1, 2005 and October 2, 2004 consisted of borrowings by the Companys Japanese
subsidiaries. At October 1, 2005, the Company was in compliance with the financial terms and conditions of its long-term debt
agreements.

At October 1, 2005, the Company had letters of credit and guarantees
outstanding totaling $46.0 million and $8.6 million, respectively, primarily to bond advance payments and performance guarantees
related to customer contracts in the Test segment. The Companys operating leases are primarily for office space and vehicles
related to sales and service offices.

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Changes in Foreign Currency Exchange Rates
The Company exports products outside the United States and often invoices customers in foreign currencies. The Companys
international subsidiaries have functional currencies other than the Companys reporting currency and may also transact
business in currencies other than their functional currencies. The operating results and financial position of the Companys
international subsidiaries are reported on a consolidated basis in U.S. dollars. Thus, the Company has expected cash flows,
assets, and liabilities denominated in currencies other than the U.S. dollar or the functional currencies of its international
subsidiaries. This exposes the Company to market risk related to the market value of foreign currencies versus the functional
currencies of the subsidiaries. The Company has operational procedures to minimize these non-functional currency exposures. The
Company also enters into forward contracts with banks to exchange currencies at set exchange rates on future dates to offset gains
or losses on specifically identified exposures.

Historically, approximately 50-60% of the Companys revenue derives from
shipments to customers outside the U.S., and about 65% of this revenue (approximately 35% of the Companys total revenue) is
denominated in currencies other than the U.S. dollar. As a result, a strengthening of the U.S. dollar relative to foreign
currencies decreases the foreign currency-denominated revenue and earnings when they are translated to U.S. dollars. Conversely, a
weakening of the U.S. dollar has a favorable effect on revenue and earnings.

Gains and losses on foreign currency transactions are included in Other
(Expense) Income, net in the accompanying Consolidated Statements of Income. Mark-to-market gains and losses on derivatives
designated as cash flow hedges in the Companys currency hedging program, as well as on the translation of non-current assets
and liabilities, are recorded within Accumulated Other Comprehensive Income in the Consolidated Balance Sheet. The Company
recognizes gains and losses on fair value and cash flow hedges at the time a gain or loss is recognized on the hedged exposure in
the Consolidated Statement of Income or at the time the cash flow hedge is determined to be ineffective. The gains and losses
associated mark-to-market gains and losses are reclassified from Accumulated Other Comprehensive Income to Other (Expense) Income,
net on the Consolidated Statement of Income.

Restructuring and Other Charges
In the fourth quarter of fiscal year 2005, the Company decided to exit its noise and vibration software business. 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. Of the total
business exits costs of $4.5 million recorded, $3.6 million, $0.7 million and $0.2 million are included in Cost of Sales, Selling
Expense, and General and Administrative Expense, respectively, on the Consolidated Statement of Income for fiscal year 2005. These
expenses are reported within the results of operations of the Companys Test segment. Substantially all of the severance
costs will be paid in fiscal year 2006.

In fiscal year 2004 the Company had no significant restructuring activities.
In fiscal year 2003, the Company had no significant restructuring activities related to business consolidation other than the sale
of its Automation division (see Note 2 to the Consolidated Financial Statements). For the fiscal years ending October 1, 2005,
October 2, 2004, and September 27, 2003 the reserve for restructuring was as follows:

|Year                     |  | BeginningBalance |   | Provision |  | Write-off |       | EndingBalance
|------------------------ |  | ---------------- | - | --------- |  | --------- | ----- | -------------
|(expressed in thousands)
|2003                     |  |                  | $ | 21        |  | $         |      |              
|2004                     |  |                  |   |          |  |           |      |              
|2005                     |  |                  |   |          |  |           | 1,319 |              

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Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standard (SFAS) No. 151, Inventory Costs, an Amendment of ARB No. 43, Chapter 4, which clarifies the types
of costs that should be expensed in Cost of Sales rather than capitalized in inventory. This statement also clarifies the
circumstances under which fixed overhead costs associated with operating facilities involved in inventory processing should be
capitalized. The provisions of SFAS 151 are effective for fiscal years beginning after June 15, 2005. No material impact on the
Companys financial statements is expected from the adoption of this standard.

In December 2004, the FASB issued SFAS No. 123 (Revised 2004),
Share-Based Payment (SFAS 123R). SFAS 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 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 is effective as of the beginning of the first annual reporting period that begins
after June 15, 2005. The Company will adopt SFAS 123R in the first quarter of fiscal year 2006. While the Company cannot precisely
determine the impact on net earnings as a result of the adoption of SFAS 123R, estimated compensation expense related to prior
periods is included in Note 1 to these Consolidated Financial Statements. The ultimate amount of compensation expense recorded
will be dependent on the number of option shares granted during the year, their timing and vesting period, and the method used to
calculate the fair value of the awards, among other factors.

In December 2004, the FASB issued Staff Position (FSP) No. 109-1,
Application of FASB Statement No. 109 (SFAS 109), Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of 2004. FSP 109-1 clarifies that the manufacturers
deduction provided for under the American Jobs Creation Act of 2004 (AJCA) should be accounted for as a special
deduction in accordance with SFAS 109 and not as a tax rate reduction. The FASB also issued Staff Position No. 109-2,
Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of
2004. The Company is currently evaluating the potential impact of the various provisions of the AJCA on the Companys
financial statements.

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 154 requires retrospective application of changes in accounting
principles to prior period 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 154 are effective for fiscal years beginning after December 15, 2005.

Quarterly Financial Information
Revenue and operating results reported on a quarterly basis do not necessarily reflect trends in demand for the
Companys products or its operating efficiency. Revenue and operating results in any quarter may be significantly affected by
customer shipments, installation timing, or the timing of the completion of one or more contracts where revenue is recognized upon
shipment or customer acceptance rather than on the percentage-of-completion accounting method. The Companys use of the
percentage-of-completion revenue recognition method for large, long-term projects generally has the effect of smoothing
significant fluctuations from quarter to quarter. See Note 1 to the Consolidated Financial Statements for additional information
on the Companys revenue recognition policy. Quarterly earnings also vary as a result of the use of estimates including, but
not limited to, the rates used in recording federal, state, and foreign income tax expense. See Notes 1 and 6 to the Consolidated
Financial Statements for additional information on the Companys use of estimates and income tax related matters,
respectively.

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Selected quarterly financial information for the fiscal years ended October
1, 2005 and October 2, 2004 was as follows:

|                                               
|-----------------------------------------------
|                                               
|(expressed in thousands, except per share data)
|2005                                           
|Revenue                                        
|Gross profit                                   
|Income before income taxes and                 
|discontinued operations                        
|Income before discontinued operations          
|Discontinued operations, net of tax            
|                                               
|Net income                                     
|                                               
|Earnings per share:                            
|Basic                                          
|Income before discontinued operations          
|Discontinued operations, net of tax            
|                                               
|Earnings per share                             
|                                               
|                                               
|Diluted                                        
|Income before discontinued operations          
|Discontinued operations, net of tax            
|                                               
|Earnings per share                             
|                                               
|                                               
|2004                                           
|Revenue                                        
|Gross profit                                   
|Income before income taxes and                 
|discontinued operations                        
|Income before discontinued operations          
|Discontinued operations, net of tax            
|                                               
|Net income                                     
|                                               
|Earnings per share:                            
|Basic                                          
|Income before discontinued operations          
|Discontinued operations, net of tax            
|                                               
|Earnings per share                             
|                                               
|                                               
|Diluted                                        
|Income before discontinued operations          
|Discontinued operations, net of tax            
|                                               
|Earnings per share                             
|                                               

# Forward-Looking Statements

Statements included or incorporated by reference in this Managements
Discussion and Analysis of Financial Condition and Results of Operations, elsewhere in this Form 10-K, in the Companys 2005
Annual Report to Shareholders, in the proxy statement for the annual meeting to be held in January 2006, and in the Companys
press releases and oral statements made with the approval of an authorized executive officer, which are not historical or current
facts are forward-looking statements, as

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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.
| | ---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (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.

26

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Table of Contents

# Item 7A.   Quantitative and QualitativeDisclosures About Market Risk

The Company is exposed to market risks from changes in foreign currency
exchange rates and interest rates. Additional information relative to these risks is included in Managements Discussion and
Analysis of Financial Condition and Results of Operations on page 23 and in Note 1 to the Consolidated Financial Statements
included in Item 8 of this Form 10-K.

Foreign Currency Exchange Risk
The Company is directly exposed to the financial impact of market changes in currency exchange rates on orders, revenue, and
net income, as well as on the translation of foreign currency-denominated assets and liabilities into U.S. dollars. This is in
addition to the indirect impact of changes in currency exchange rates on interest rates and overall business activity.

Gains and losses from the settlement of foreign currency-denominated
transactions are recorded within Other (Expense) Income, net in the Consolidated Statements of Income included in Item 8 of this
Form 10-K. Currency gains and losses on specifically identified currency hedge transactions, as well as changes in the translated
values of long-term assets and liabilities denominated in foreign currency, are recorded within Accumulated Other Comprehensive
Income on the Consolidated Balance Sheet. When a gain or loss is recognized on the hedged exposure or the hedge is determined to
be ineffective, associated mark-to-market gains and losses are reclassified from Accumulated Other Comprehensive Income to Other
(Expense) Income, net on the Consolidated Statement of Income.

The following table restates financial results utilizing currency exchange
rates from the prior year to hypothetically estimate the impact of currency on the following financial items:

|                                      
|--------------------------------------
|                                      
|(expressed in thousands)              
|Increase from currency translation on:
|Orders                                
|Revenue                               
|Net Income                            
|Transaction (loss) gain included in   
|"Other (expense) income, net"         
|                                      

A weakening of the U.S. dollar relative to foreign currencies increases the
value of foreign currency-denominated revenue and earnings translated into U.S. dollars. Conversely, a strengthening of the U.S.
dollar decreases the value of foreign currency-denominated revenue and earnings. During fiscal year 2005, the U.S. dollar
generally strengthened against other major currencies, increasing by approximately 3% against the Euro and by approximately 3%
against the Japanese Yen. However, the net effect of currency translation on orders, revenue, and net income during the year was
favorable due to the delayed effect of currency changes relative to the calculation of the weighted average income statement rates
used to translate the Consolidated Statements of Income. Gains and losses attributed to translating the financial statements for
all non-U.S. subsidiaries are included in the currency translation adjustments recorded within Accumulated Other Comprehensive
Income on the Consolidated Balance Sheet.

A hypothetical 10% appreciation in foreign currencies against the U.S.
dollar, assuming all other variables were held constant, would have resulted in an increase in fiscal year 2005 revenue and asset
balances of approximately $16.4 million. A hypothetical 10% depreciation in foreign currencies against the U.S. dollar, assuming
all other variables were held constant, would have resulted in a decrease in fiscal year 2005 revenue and asset balances of
approximately $16.4 million.

The Company regularly assesses its exposure to changes in market currency
rates and employs certain practices to mitigate possible adverse effects of this risk. The Company utilizes forward currency
forward exchange contracts to hedge the functional currency value of foreign currency-denominated transactions,

27

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Table of Contents

assets, and liabilities. See Note 1 to the Consolidated Financial Statements
included in Item 8 of this Form 10-K.

Interest Rates
The Company is also directly exposed to changes in market interest rates on cash equivalents, short-term investments, and
debt. The Company is also indirectly exposed to the impact of market interest rates on currency rates and overall business
activity.

On floating-rate investments, increases and decreases in market interest
rates will increase or decrease future interest income, respectively. On floating-rate debt, increases or decreases in market
interest rates will increase or decrease future interest expense, respectively. On fixed-rate investments, increases or decreases
in market interest rates do not impact future interest income but may decrease or increase the fair market value of the
investment, respectively. For fixed-rate debt or other interest-bearing obligations, increases or decreases in market interest
rates do not impact future interest expense but may decrease or increase the fair market value of the debt, respectively.

At October 1, 2005, the Company had cash, cash equivalents and short-term
investments of $160 million. Most of this amount was invested in interest-bearing accounts or investments. For virtually all of
these investments, interest rates re-set every 1-49 days. A hypothetical increase or decrease of 1% in market interest rates could
increase or decrease interest income by $1.6 million per annum. The Company had an insignificant amount of short-term debt
outstanding at the end of fiscal year 2005 and therefore would not be materially impacted by the effect of increases or decreases
in market interest rates on interest expense.

A discount rate of 4.3% and an expected rate of increase in future
compensation levels of 3.2% were used in the calculation of the accrued pension liability related to one of the Companys
international subsidiarys non-contributory, unfunded defined benefit pension plan.

# Item 8.   Financial Statementsand Supplementary Data

The Companys audited financial statements and notes thereto described
in Item 15(1) of this report on Form 10-K and appearing on pages F-1 through F-26 of this report are incorporated by reference
herein. See also Quarterly Financial Data in Managements Discussion and Analysis under Item 7 of this Form 10-K,
which is incorporated herein by reference.

# Item 9.   Changes in andDisagreements With Accountants on
Accounting and Financial Disclosure

None.

# Item 9A.   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 October 1, 2005. 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 October 1, 2005 that have materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting.

The Companys management is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. The
Companys internal control over financial reporting is designed to provide reasonable assurance

28

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regarding the reliability of financial reporting and the preparation of
financial statements. Under the supervision and with the participation of management, including its Chief Executive Officer and
Chief Financial Officer, the Company conducted an evaluation of the effectiveness of internal controls over financial reporting as
of October 1, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations
of the Treadway Commission in Internal Control  Integrated Framework. Based on managements assessment using
this framework, management concluded that the Companys internal control over financial reporting is effective as of October
1, 2005.

Managements assessment of the effectiveness of the Companys
internal control over financial reporting as of October 1, 2005, has been audited by KPMG LLP, an independent registered public
accounting firm. Their report appears on page F-3.

# Item 9B.   Other Information

None.

# PART III

# Item 10.   Directors and ExecutiveOfficers of Registrant

The required information with respect to the directors of the Registrant,
information regarding compliance with Section 16(a) of the Securities Exchange Act of 1934, and the Registrants Code of
Business Conduct are incorporated herein by reference to the information set forth under the headings Election of
Directors and General Section 16(a) Beneficial Ownership Reporting Compliance in the Registrants Proxy
Statement for the Annual Meeting of Shareholders scheduled to be held on January 31, 2006. Information regarding the
Companys executive officers is contained under Item 1 of this annual report.

# Item 11.   Executive Compensation

The information required by this Item is incorporated herein by reference to
the information set forth under heading Executive Compensation (except as expressly set forth therein) in the
Registrants Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on January 31, 2006.

# Item 12.   Security Ownership ofCertain Beneficial Owners and Management and Related Stockholder Matters

The information required by this Item is incorporated herein by reference to
the information set forth under headings Security Ownership of Principal Shareholders and Management and
Executive Equity Compensation Plan Information in the Registrants Proxy Statement for the Annual Meeting of
Shareholders scheduled to be held on January 31, 2006.

# Item 13.   Certain Relationshipsand Related Transactions

The information required by this Item is incorporated herein by reference to
the information set forth under heading Executive Compensation  Certain Transactions in the Registrants
Proxy Statement for the Annual Meeting of Shareholders scheduled to be held on January 31, 2006.

# Item 14.   Principal Accountant Feesand Services

The information required by this Item is incorporated by reference to the
information set forth under the heading Independent Registered Public Accountants in the Registrants Proxy
Statement for the Annual Meeting of Shareholders scheduled to be held on January 31, 2006.

29

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Table of Contents

# PART IV

# Item 15.   Exhibits and FinancialStatement Schedules

The following documents are
filed as part of this report:

| | (1) |  | Consolidated Financial Statements:
| | --- |  | ----------------------------------

| | Report of Independent Registered Public Accounting Firm
| | -------------------------------------------------------

| | Report of Independent Registered Public Accounting Firm
| | -------------------------------------------------------

| | Consolidated Balance Sheets  October 1, 2005 and October 2,
2004
| | -----------------------------------------------------------------

| | Consolidated Statements of Income for the Years Ended
October 1, 2005, October 2, 2004, and September 27, 2003
| | --------------------------------------------------------------------------------------------------------------

| | Consolidated Statements of Shareholders Investment for
the Years Ended October 1, 2005, October 2, 2004, and September 27, 2003
| | --------------------------------------------------------------------------------------------------------------------------------

| | Consolidated Statements of Cash Flows for the Years
Ended October 1, 2005, October 2, 2004, and September 27, 2003
| | ------------------------------------------------------------------------------------------------------------------

| | Notes to Consolidated Financial Statements
| | ------------------------------------------

| | Financial Statement Schedule
| | ----------------------------

| | (2) |  | Financial Statement Schedules:
| | --- |  | ------------------------------

| | See accompanying Index to Financial Statements on page F-1.
| | -----------------------------------------------------------

| | (3) |  | Exhibits:
| | --- |  | ---------

|ExhibitNumber | Description                                                                                                                                                                                                                                                             
|------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             
|3.a           | Restated and Amended Articles of Incorporation, incorporated herein by reference from Exhibit 3.a of the Registrants Form 10-K for the fiscal year ended September 30, 1996.                                                                                           
|             
|3.b           | Restated Bylaws, incorporated herein by reference to Exhibit 3.1 of the Registrants Form 8-K filed on December 2, 2005.                                                                                                                                                
|             
|10.a          | Executive Variable Compensation Plan, incorporated herein by reference to Exhibit 99.1 of the Registrants Form 8-K filed on November 30, 2004.                                                                                                                         
|             
|10.b          | 1994 Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.e of the Registrants Form 10-K filed for the fiscal year ended September 30, 1996.                                                                                                  
|             
|10.c          | 1997 Stock Option Plan, as amended, incorporated herein by reference to Exhibit 10.p of the Registrants Form 10-K filed for the fiscal year ended September 30, 1996 and Exhibit 10.p of the Registrants Form 10-K filed for the fiscal year ended September 30, 1999.
|             
|10.d          | 2002 Employee Stock Purchase Plan, as amended (Filed herewith).                                                                                                                                                                                                         
|             
|10.e          | Severance Agreement, dated March 16, 1998, between the Registrant and Sidney W. Emery, Jr., incorporated herein by reference to Exhibit 10.r of the Registrants Form 10-K filed for the fiscal year ended September 30, 1998.                                          

30

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|ExhibitNumber | Description                                                                                                                                                                                                                                                                 
|------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|             
|10.f          | Severance Agreement dated January 3, 2000, between the Registrant and Kathleen M. Staby, incorporated herein by reference to Exhibit 10.x of the Registrants Form 10-K filed for the fiscal year ended September 30, 2000.                                                 
|             
|10.g          | Form of Change in Control Agreement between the Registrant and Sidney W. Emery, Jr., Kathleen M. Staby, and Susan E. Knight (Filed herewith).                                                                                                                               
|             
|10.h          | Description of the terms of employment of Susan E. Knight, pursuant to an offer letter, incorporated by reference to Exhibit 10.r of the Registrants Form 10-Q/A for the fiscal quarter ended December 31, 2001.                                                           
|             
|10.i          | Description of the terms of employment of Sidney W. Emery, Jr., pursuant to an offer letter dated March 3, 1998, incorporated by reference to Exhibit 10.s of the Registrants Form 10-K for the fiscal year ended September 28, 2002.                                      
|             
|10.j          | Change in Control Agreement, dated January 28, 2003, between the Registrant and Douglas E. Marinaro, incorporated herein by reference to Exhibit 10.s of the Registrants Form 10-K filed for the fiscal year ended September 27, 2003.                                     
|             
|10.k          | Description of the terms of employment of Douglas E. Marinaro, pursuant to an offer letter dated November 6, 2002, incorporated herein by reference to Exhibit 10.t of the Registrants Form 10-K filed for the fiscal year ended September 27, 2003.                       
|             
|10.l          | Letter dated February 6, 1987 from MTS Sensor Technologie GmbH and Co. KG (formerly, Hellwig GmbH) regarding its pension commitment to Joachim Hellwig, incorporated by reference to Exhibit 10.p of the Registrants Form 10-K filed for fiscal year ended October 2, 2004.
|             
|10.m          | Employment Contract dated January 1, 1991 between MTS Sensor Technologie GmbH and Co. KG and Joachim Hellwig, incorporated by reference to Exhibit 10.q of the Registrants Form 10-K filed for fiscal year ended October 2, 2004.                                          
|             
|10.n          | Change in Control Agreement, dated April 22, 2002, between the Registrant and Laura B. Hamilton, incorporated herein by reference to Exhibit 10.m of the Registrants Form 10-Q/A for the fiscal quarter ended June 30, 2002.                                               
|             
|21.           | Subsidiaries of the Registrant (Filed herewith).                                                                                                                                                                                                                            
|             
|23.           | Consent of Independent Registered Public Accounting Firm (Filed herewith).                                                                                                                                                                                                  
|             
|31.1          | Certification of the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith).                                                                                                                                                    
|             
|31.2          | Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Filed herewith).                                                                                                                                                    
|             
|32.1          | Certification of the Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed herewith).                                                                                                                                                    
|             
|32.2          | Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed herewith).                                                                                                                                                    

31

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# SIGNATURES

Pursuant to the requirement of Section 13 or 15(d) 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
| | By:                                                                 |                         | /s/   Sidney W. Emery, Jr. | 
| |                                                                    
| | Sidney W. Emery, Jr.Chairman, Chief Executive Officer and President |                        

Date:   December 14, 2005

Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated:

|Signatures                 |  | Title                     |  | Date              | 
|-------------------------- |  | ------------------------- |  | ----------------- | 
|/s/   Sidney W. Emery, Jr. |  | Chairman, Chief Executive |  | December 14, 2005 | 
|                           |  | Officer and President     | 
|Sidney W. Emery Jr.        |  |                           | 
|                          
|/s/   Susan E. Knight      |  | Chief Financial Officer   |  | December 14, 2005 | 
|                           |  | and Vice President        | 
|Susan E. Knight            | 
|                          
|/s/   Dugald K. Campbell   |  | Director                  |  | December 14, 2005 | 
|                          
|Dugald K. Campbell         | 
|                          
|/s/   Jean Lou Chameau     |  | Director                  |  | December 14, 2005 | 
|                          
|Jean Lou Chameau           | 
|                          
|/s/   Merlin E. Dewing     |  | Director                  |  | December 14, 2005 | 
|                          
|Merlin E. Dewing           | 
|                          
|/s/   Brendan C. Hegarty   |  | Director                  |  | December 14, 2005 | 
|                          
|Brendan C. Hegarty         | 
|                          
|/s/   Barb J. Samardzich   |  | Director                  |  | December 14, 2005 | 
|                          
|Barb J. Samardzich         | 
|                          
|/s/   Linda Hall Whitman   |  | Director                  |  | December 14, 2005 | 
|                          
|Linda Hall Whitman         | 

32

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# MTS Systems Corporation and Subsidiaries

# Index to Financial Statements

|                                                           | Page
|---------------------------------------------------------- | ----
|CONSOLIDATED FINANCIAL STATEMENTS                         
|Report of Independent Registered Public Accounting Firm    |     
|Report of Independent Registered Public Accounting Firm    |     
|Consolidated Balance Sheets  October 1, 2005              |     
|and October 2, 2004                                        |     
|Consolidated Statements of Income for the Years Ended      |     
|October 1, 2005, October 2, 2004, and                      |     
|September 27, 2003                                         |     
|Consolidated Statements of Shareholders Investment and    |     
|Comprehensive Income (Loss) for the Years Ended October 1, |     
|2005, October 2, 2004, and September 27, 2003              |     
|Consolidated Statements of Cash Flows for the              |     
|Years Ended October 1, 2005, October 2, 2004,              |     
|and September 27, 2003                                     |     
|Notes to Consolidated Financial Statements                 |     
|Financial Statement Schedule                              

|Schedule |  | Description                                                                      
|-------- |  | ---------------------------------------------------------------------------------
|II       |  | Summary of Consolidated AllowancesFor Doubtful Accounts and RestructuringReserves

F-1

---

Table of Contents

# Report of Independent Registered Public Accounting Firm

# The Board of Directors and Shareholders
MTS Systems Corporation:

We have audited the accompanying consolidated balance sheets of MTS Systems
Corporation and subsidiaries as of October 1, 2005 and October 2, 2004 and the related consolidated statements of income,
shareholders investment and comprehensive income (loss), and cash flows for each of the fiscal years in the three-year
period ended October 1, 2005. In connection with our audits of the consolidated financial statements, we also have audited the
financial statement schedule as listed in the accompanying index. These consolidated financial statements and financial statement
schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of MTS Systems Corporation and subsidiaries as of October 1, 2005
and October 2, 2004 and the results of their operations and their cash flows for each of the fiscal years in the three-year period
ended October 1, 2005, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related
financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.

We also audited, in accordance with the Standards of the Public Company
Accounting Oversight Board (United States), the effectiveness of the Companys internal control over financial reporting as
of October 1, 2005, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO), and our report dated December 14, 2005 expressed an unqualified
opinion on managements assessment of, and effective operations of, internal control over financial reporting.

/S/ KPMG LLP

Minneapolis, Minnesota
December 14, 2005

F-2

---

Table of Contents

# Report of Independent Registered Public Accounting Firm

# The Board of Directors and Shareholders
MTS Systems Corporation:

We have audited managements assessment, included in the accompanying
Managements Report on Internal Control Over Financial Reporting appearing on page 28 under Item 9A of this Form 10-K, that
MTS Systems Corporation and subsidiaries (the Company) maintained effective internal control over financial reporting
as of October 1, 2005, based on criteria established in Internal ControlIntegrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for maintaining
effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial
reporting. Our responsibility is to express an opinion on managements assessment and an opinion on the effectiveness of the
Companys internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit
included obtaining an understanding of internal control over financial reporting, evaluating managements assessment, testing
and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A companys internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A companys internal control
over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with
authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the
financial statements.

Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.

In our opinion, managements assessment that the Company maintained
effective internal control over financial reporting as of October 1, 2005 is fairly stated, in all material respects, based on
criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of
the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control
over financial reporting as of October 1, 2005, based on criteria established in Internal ControlIntegrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets of the Company and subsidiaries as of October 1, 2005
and October 2, 2004, and the related consolidated statements of income, shareholders investment and comprehensive income
(loss), and cash flows for each of the fiscal years in the three-year period ended October 1, 2005, and our report dated December
14, 2005 expressed an unqualified opinion on those consolidated financial statements.

/S/ KPMG LLP

Minneapolis, Minnesota
December 14, 2005

F-3

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Table of Contents

Consolidated Balance Sheets
(October 1 and October 2, respectively)

|Assets                                                                                                                       |  | 2005                     |   | 2004   
|---------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | - | -------
|                                                                                                                             | 
|                                                                                                                             |  | (expressed in thousands)
|Current Assets:                                                                                                              |  |                          |   |        
|Cash and cash equivalents                                                                                                    |  |                          | $ | 83,143 
|Short-term investments                                                                                                       |  |                          |   | 76,650 
|Accounts receivable, net of allowance for doubtful accounts of                                                               |  |                         
|$1,210 and $1,197, respectively                                                                                              |  |                          |   | 64,363 
|Unbilled accounts receivable                                                                                                 |  |                          |   | 25,093 
|Inventories                                                                                                                  |  |                          |   | 38,029 
|Prepaid expenses                                                                                                             |  |                          |   | 2,600  
|Current deferred tax assets                                                                                                  |  |                          |   | 6,415  
|Other current assets                                                                                                         |  |                          |   | 2,351  
|Assets of discontinued operations                                                                                            |  |                          |   | 1,710  
|                                                                                                                             | 
|Total current assets                                                                                                         |  |                          |   | 300,354
|                                                                                                                             | 
|Property and Equipment:                                                                                                      |  |                         
|Land                                                                                                                         |  |                          |   | 1,668  
|Buildings and improvements                                                                                                   |  |                          |   | 40,906 
|Machinery and equipment                                                                                                      |  |                          |   | 72,837 
|Accumulated depreciation                                                                                                     |  |                          |   | (72,458
|                                                                                                                             | 
|Total property and equipment, net                                                                                            |  |                          |   | 42,953 
|                                                                                                                             | 
|Goodwill                                                                                                                     |  |                          |   | 4,423  
|Other assets                                                                                                                 |  |                          |   | 2,291  
|Non-current deferred tax assets                                                                                              |  |                          |   | 1,711  
|                                                                                                                             | 
|Total assets                                                                                                                 |  |                          | $ | 351,732
|                                                                                                                             | 
|Liabilities and Shareholders Investment                                                                                     |  |                         
|                                                                                                                             | 
|Current Liabilities:                                                                                                         |  |                         
|Notes payable                                                                                                                |  |                          | $ | 1,582  
|Current maturities of long-term debt                                                                                         |  |                          |   | 6,708  
|Accounts payable                                                                                                             |  |                          |   | 16,142 
|Accrued payroll-related costs                                                                                                |  |                          |   | 31,059 
|Advance payments from customers                                                                                              |  |                          |   | 49,901 
|Accrued warranty costs                                                                                                       |  |                          |   | 5,333  
|Accrued income taxes                                                                                                         |  |                          |   | 3,643  
|Current deferred income taxes                                                                                                |  |                          |   | 3,767  
|Other accrued liabilities                                                                                                    |  |                          |   | 15,026 
|Liabilities of discontinued operations                                                                                       |  |                          |   | 890    
|                                                                                                                             | 
|Total current liabilities                                                                                                    |  |                          |   | 134,051
|                                                                                                                             | 
|Deferred income taxes                                                                                                        |  |                          |   | 2,310  
|Long-term debt, less current maturities                                                                                      |  |                          |   | 15,673 
|Other long-term liabilities                                                                                                  |  |                          |   | 11,266 
|                                                                                                                             | 
|Total liabilities                                                                                                            |  |                          |   | 163,300
|                                                                                                                             | 
|Shareholders Investment:                                                                                                    |  |                         
|Common stock, 25¢ par value; 64,000 shares authorized:                                                                       |  |                         
|19,664 and 19,652 shares issued and outstanding                                                                              |  |                          |   | 4,916  
|Retained earnings                                                                                                            |  |                          |   | 173,487
|Accumulated other comprehensive income                                                                                       |  |                          |   | 10,029 
|                                                                                                                             | 
|Total shareholders investment                                                                                               |  |                          |   | 188,432
|                                                                                                                             | 
|Total liabilities and shareholders investment                                                                               |  |                          | $ | 351,732
|                                                                                                                             | 
|The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.

F-4

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Table of Contents

Consolidated Statements of Income
(For the Years Ended October 1, October 2, and September 27, respectively)

|                                                                                                                             |  | 2005                                            |   | 2004    |   | 2003
|---------------------------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------- | - | ------- | - | ----
|                                                                                                                             | 
|                                                                                                                             |  | (expressed in thousands, except per share data) |  
|Revenue:                                                                                                                     |  |                                                 |   |         |   |     
|Product                                                                                                                      |  |                                                 | $ | 328,514 |   | $   
|Service                                                                                                                      |  |                                                 |   | 45,863  |   |     
|                                                                                                                             | 
|Total Revenue                                                                                                                |  |                                                 |   | 374,377 |   |     
|                                                                                                                             | 
|Cost of Sales:                                                                                                               |  |                                                
|Product                                                                                                                      |  |                                                 |   | 187,261 |   |     
|Service                                                                                                                      |  |                                                 |   | 23,534  |   |     
|                                                                                                                             | 
|Total Cost of Sales                                                                                                          |  |                                                 |   | 210,795 |   |     
|                                                                                                                             | 
|Gross Profit                                                                                                                 |  |                                                 |   | 163,582 |   |     
|                                                                                                                             | 
|Operating Expenses:                                                                                                          |  |                                                
|Selling                                                                                                                      |  |                                                 |   | 65,254  |   |     
|General and administrative                                                                                                   |  |                                                 |   | 30,417  |   |     
|Research and development                                                                                                     |  |                                                 |   | 14,936  |   |     
|                                                                                                                             | 
|Income From Operations                                                                                                       |  |                                                 |   | 52,975  |   |     
|                                                                                                                             | 
|Interest expense                                                                                                             |  |                                                 |   | (2,128  | ) |     
|Interest income                                                                                                              |  |                                                 |   | 2,348   |   |     
|Other (expense) income, net                                                                                                  |  |                                                 |   | (1,381  | ) |     
|                                                                                                                             | 
|Income Before Income Taxes and Discontinued Operations                                                                       |  |                                                 |   | 51,814  |   |     
|Provision for Income Taxes                                                                                                   |  |                                                 |   | 15,245  |   |     
|                                                                                                                             | 
|Income Before Discontinued Operations                                                                                        |  |                                                 |   | 36,569  |   |     
|                                                                                                                             | 
|Discontinued Operations:                                                                                                     |  |                                                
|(Loss) income from discontinued operations, net of tax                                                                       |  |                                                 |   | (2,589  | ) |     
|Net gain (loss) on disposal of discontinued businesses, net of tax                                                           |  |                                                 |   | 3,078   |   |     
|                                                                                                                             | 
|Income from Discontinued Operations, net of tax                                                                              |  |                                                 |   | 489     |   |     
|                                                                                                                             | 
|Net Income                                                                                                                   |  |                                                 | $ | 37,058  |   | $   
|                                                                                                                             | 
|Earnings Per Share                                                                                                           |  |                                                
|Basic:                                                                                                                       |  |                                                
|Income Before Discontinued Operations                                                                                        |  |                                                 | $ | 1.86    |   | $   
|Discontinued Operations:                                                                                                     |  |                                                
|(Loss) income from discontinued operations, net of tax                                                                       |  |                                                 |   | (0.13   | ) |     
|Net gain (loss) on disposal of discontinued businesses, net of tax                                                           |  |                                                 |   | 0.15    |   |     
|                                                                                                                             | 
|Income from Discontinued Operations, net of tax                                                                              |  |                                                 |   | 0.02    |   |     
|                                                                                                                             | 
|Earnings Per Share                                                                                                           |  |                                                 | $ | 1.88    |   | $   
|                                                                                                                             | 
|Diluted:                                                                                                                     |  |                                                
|Income Before Discontinued Operations                                                                                        |  |                                                 |   | 1.79    |   |     
|Discontinued Operations:                                                                                                     |  |                                                
|(Loss) income from discontinued operations, net of tax                                                                       |  |                                                 |   | (0.13   | ) |     
|Net gain (loss) on disposal of discontinued businesses, net of tax                                                           |  |                                                 |   | 0.15    |   |     
|                                                                                                                             | 
|Income from Discontinued Operations, net of tax                                                                              |  |                                                 |   | 0.02    |   |     
|                                                                                                                             | 
|Earnings Per Share                                                                                                           |  |                                                 | $ | 1.81    |   | $   
|                                                                                                                             | 
|The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.

F-5

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Table of Contents

Consolidated Statements of
Shareholders Investment and Comprehensive Income (Loss)(For the Years Ended October 1,
October 2, and September 27, respectively, expressed in thousands, except per share data)

|                                                                                                                            
|----------------------------------------------------------------------------------------------------------------------------
|SharesIssued                                                                                                                
|                                                                                                                            
|Balance, September 28, 2002                                                                                                 
|                                                                                                                            
|Net income                                                                                                                  
|Foreign currency translation                                                                                                
|Derivative instruments                                                                                                      
|                                                                                                                            
|Total comprehensive income                                                                                                  
|Exercise of stock options                                                                                                   
|Restricted stock compensation                                                                                               
|Tax benefit from equity compensation                                                                                        
|Issuance for employee stock purchase plan                                                                                   
|Common stock purchased and retired                                                                                          
|Dividends, $0.24 per share                                                                                                  
|                                                                                                                            
|Balance, September 27, 2003                                                                                                 
|                                                                                                                            
|Net income                                                                                                                  
|Foreign currency translation                                                                                                
|Derivative instruments                                                                                                      
|                                                                                                                            
|Total comprehensive income                                                                                                  
|Exercise of stock options                                                                                                   
|Restricted stock compensation                                                                                               
|Tax benefit from equity compensation                                                                                        
|Issuance for employee stock purchase plan                                                                                   
|Common stock purchased and retired                                                                                          
|Dividends, $0.26 per share                                                                                                  
|                                                                                                                            
|Balance, October 2, 2004                                                                                                    
|                                                                                                                            
|Net income                                                                                                                  
|Foreign currency translation                                                                                                
|Minimum pension liability adjustment                                                                                        
|Derivative instruments                                                                                                      
|                                                                                                                            
|Total comprehensive income                                                                                                  
|Exercise of stock options                                                                                                   
|Restricted stock compensation                                                                                               
|Tax benefit from equity compensation                                                                                        
|Issuance for employee stock purchase plan                                                                                   
|Common stock purchased and retired                                                                                          
|Stock option compensation                                                                                                   
|Dividends, $0.34 per share                                                                                                  
|                                                                                                                            
|Balance, October 1, 2005                                                                                                    
|                                                                                                                            
|The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.

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Consolidated Statements of Cash
Flows(For the Years Ended October 1, October 2, and September 27, respectively)

|                                                                                                                            
|----------------------------------------------------------------------------------------------------------------------------
|                                                                                                                            
|(expressed in thousands)                                                                                                    
|Cash Flows from Operating Activities:                                                                                       
|Net income                                                                                                                  
|Adjustments to reconcile net income to net cash                                                                             
|provided by operating activities:                                                                                           
|Loss (income) from discontinued operations                                                                                  
|Net (gain) loss on disposal of discontinued businesses                                                                      
|Gain on sale of property and equipment                                                                                      
|Depreciation and amortization                                                                                               
|Deferred income taxes                                                                                                       
|Bad debt provision (benefit)                                                                                                
|Equity compensation income tax benefits                                                                                     
|Restricted stock compensation                                                                                               
|Changes in operating assets and liabilities, net of effects of                                                              
|businesses divested:                                                                                                        
|Accounts and unbilled contracts receivable                                                                                  
|Inventories                                                                                                                 
|Prepaid expenses                                                                                                            
|Other assets                                                                                                                
|Accounts payable                                                                                                            
|Accrued payroll-related costs                                                                                               
|Advance payments from customers                                                                                             
|Accrued warranty costs                                                                                                      
|Other current liabilities                                                                                                   
|                                                                                                                            
|Net Cash Provided by Operating Activities                                                                                   
|                                                                                                                            
|Cash Flows from Investing Activities:                                                                                       
|Additions to property and equipment                                                                                         
|Proceeds from sale of property and equipment                                                                                
|Proceeds from maturity of short-term investments                                                                            
|Purchases of short-term investments                                                                                         
|Net proceeds from sale of businesses                                                                                        
|                                                                                                                            
|Net Cash (Used in) Provided by Investing Activities                                                                         
|                                                                                                                            
|Cash Flows from Financing Activities:                                                                                       
|Net receipts (repayments) under short-term borrowings                                                                       
|Proceeds received under notes payable                                                                                       
|Payments of notes payable                                                                                                   
|Repayments of long-term debt                                                                                                
|Cash dividends                                                                                                              
|Proceeds from exercise of stock options and employee stock                                                                  
|purchase plan                                                                                                               
|Payments to purchase and retire common stock                                                                                
|                                                                                                                            
|Net Cash Used in Financing Activities                                                                                       
|                                                                                                                            
|Net Cash (Used in) Provided by Discontinued Operations                                                                      
|                                                                                                                            
|Effect of Exchange Rate Changes on Cash and Cash Equivalents                                                                
|                                                                                                                            
|Cash and Cash Equivalents:                                                                                                  
|Increase during the year                                                                                                    
|Balance, beginning of year                                                                                                  
|                                                                                                                            
|Balance, end of year                                                                                                        
|                                                                                                                            
|Supplemental Disclosures of Cash Flows:                                                                                     
|Cash paid during the year for:                                                                                              
|Interest                                                                                                                    
|Income taxes                                                                                                                
|                                                                                                                            
|The accompanying Notes to Consolidated Financial Statements are an integral part of these consolidated financial statements.

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Table of Contents

# Notes to Consolidated
Financial Statements

# 1.   Summary of
Significant Accounting Policies:

Fiscal YearThe Companys fiscal year ends on
the Saturday closest to September 30. The Companys fiscal years ended October 1,
2005 and September 27, 2003 consisted of 52 weeks. The Companys fiscal year ended
October 2, 2004 consisted of 53 weeks.

ConsolidationThe Consolidated Financial Statements
include the accounts of MTS Systems Corporation and its wholly owned subsidiaries (the
Company). Significant intercompany balances and transactions have been
eliminated.

Revenue RecognitionOrders 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 or ratably over a defined contractual period for service
maintenance contracts.

Research and DevelopmentResearch and development costs
associated with new products are charged to operations as incurred.

Foreign Currency
TranslationThe financial position and results of
operations of the Companys foreign subsidiaries are measured using local currency as
the functional currency. Assets and liabilities are translated using period-end exchange
rates, and statements of income are translated using average exchange rates for the fiscal
year, with the resulting translation adjustments recorded as a separate component of
Shareholders Investment. The Company recorded (losses)/gains on foreign currency
translation in Comprehensive Income of ($1.6) million, $3.5 million and $7.3 million for
fiscal years 2005, 2004 and 2003, respectively.

Cash EquivalentsCash equivalents represent cash,
demand deposits, and investments with original maturities of three months or less and are
recorded at cost, which approximates fair value. Cash is invested in money

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market funds
and bank deposits. Cash equivalents outside the United States are invested in local
currency money market funds and bank deposits.

Short-Term InvestmentsShort-term investments have original
maturities beyond three months. All short-term investments are classified as
available-for-sale as the Company intends to liquidate them to fund current operations,
acquisitions, or the return of capital to shareholders. At October 1, 2005
and October 2, 2004, all available-for-sale investments consisted of highly rated auction
rate municipal obligations and corporate preferred equity securities. All investments in
available-for-sale securities are carried at fair value, and unrealized gains and losses
are reported as a component of Accumulated Other Comprehensive Income. At
October 1, 2005 and October 2, 2004, unrealized gains or losses from the investment
in available-for-sale securities were immaterial.

Accounts Receivable and
Long-Term ContractsThe Company grants credit to its customers but generally does not require collateral or other security
from domestic customers. When deemed appropriate, receivables from customers located outside the United States are supported by
letters of credit from financial institutions. 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 be invoiced upon
completion of contractual milestones, shipment to the customer, or installation and customer acceptance. Unbilled amounts relating
to these contracts are reflected as Unbilled Accounts Receivable in the accompanying Consolidated Balance Sheets. Amounts unbilled
at October 1, 2005 are expected to be invoiced during fiscal year 2006.

# 

InventoriesInventories consist of material,
labor, and overhead costs and are stated at the lower of cost or market value, determined
under the first-in, first-out accounting method. Inventories at October 1, 2005 and
October 2, 2004 were as follows:

|                     |  | 2005                     |   | 2004  
|-------------------- |  | ------------------------ | - | ------
|                     | 
|                     |  | (expressed in thousands) |  
|Customer projects in |  |                          |   |       
|various stages of    |  |                         
|completion           |  |                          | $ | 13,845
|Components,          |  |                         
|assemblies and parts |  |                          |   | 24,184
|                     | 
|Total                |  |                          | $ | 38,029
|                     | 

Property and EquipmentProperty and equipment is stated at cost.
Additions, replacements, and improvements are capitalized at cost, while maintenance and
repairs are charged to operations as incurred. Depreciation is recorded over the following
estimated useful lives of the property:

| | Buildings and improvements:   10 to 40 years. Machinery and equipment:   3 to 15 years.
| | ---------------------------------------------------------------------------------------

Building and equipment additions are
generally depreciated on a straight-line basis for financial reporting purposes and on an
accelerated basis for income tax purposes.

The Company reviews the carrying
value of long-lived assets when events or changes in circumstances such as market value,
asset utilization, physical change, legal factors, or other matters indicate that the
carrying value of the assets may not be recoverable. When this review indicates the
carrying value of the asset or asset group representing the lowest level of identifiable
cash flows exceeds the sum of the expected future cash flows (undiscounted and without
interest charges), the Company recognizes an asset impairment charge against operations.
The amount of the impairment loss recorded is the amount by which the carrying value of
the impaired asset or asset group exceeds its fair value.

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GoodwillGoodwill represents the excess of
acquisition costs over the fair value of the net assets of businesses acquired. Statement
of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets, requires that goodwill and certain other intangible assets having
indefinite lives not be amortized to income, but instead be periodically tested for
impairment. The Company determined there was no impairment of its goodwill at October 1,
2005 or October 2, 2004. At both October 1, 2005 and October 2, 2004, $2.9 million and
$1.5 million of goodwill was associated with the Test and Industrial segments,
respectively. There was no change in these Goodwill balances over the three-year period
ending October 1, 2005 other than changes associated with the effect of currency
translation.

Other AssetsOther assets primarily consist of
patents and other intellectual property. Other intangible assets are amortized on a
straight-line basis over the expected period to be benefited by future cash inflows, up to
25 years. The Company periodically evaluates the recoverability of the carrying amount of
other intangible assets when events or changes in circumstances indicate the carrying
amount of an asset may not be fully recoverable. An impairment is assessed when the
undiscounted expected future cash flows derived from an asset are less than its carrying
amount. Impairment losses are measured as the amount by which the carrying value of an
asset exceeds its fair value and are recognized in operating earnings. The Company also
periodically evaluates the estimated useful lives of all intangible assets and
periodically revises such estimates based on current events.

Annual amortization of other
intangible assets was $0.5 million, $0.5 million, and $0.7 million in fiscal years 2005,
2004, and 2003, respectively. The anticipated amortization expense related to other
intangible assets for the next five fiscal years is as follows:

|                                  |  | Fiscal Year             
|--------------------------------- |  | ------------------------
|                                  |  |                         
|                                  |  | 2006                    
|                                  |  |                         
|                                  |  | (expressed in thousands)
|Amortization of intangible assets |  |                         

Warranty ObligationsSales 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 incidence 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 years ended October 1, 2005 and October 2, 2004 were as
follows:

|                       |  | 2005                     |   | 2004  
|---------------------- |  | ------------------------ | - | ------
|                       | 
|                       |  | (expressed in thousands)
|Beginning balance      |  |                          | $ | 5,811 
|Warranty provisions    |  |                          |   | 6,971 
|Warranty claims        |  |                          |   | (7,286
|Translation adjustment |  |                          |   | (163  
|                       | 
|Ending balance         |  |                          | $ | 5,333 
|                       | 

F-10

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Derivative Financial
InstrumentsThe Company operates in several
currencies and is exposed to changes in the reporting currency value of transactions,
current assets, and current liabilities denominated in foreign currencies. Gains or losses
related to these currency exposures are recognized in Other Expense (Income), net on the
Consolidated Statement of Income.

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

Currency contracts used to maintain
the reporting currency value of expected financial transactions are designated as cash
flow hedges. Subsequent changes in the market value of the derivative contracts are
recorded in Accumulated Other Comprehensive Income (Loss) 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 change in
reporting currency value of the forecasted transaction. When a contract is no longer
effective as a hedge, the Company discontinues cash flow hedge reporting prospectively,
and reclassifies accumulated unrecognized earnings or loss from Accumulated Other
Comprehensive Income (Loss) into Other Expense (Income), net on the Consolidated Statement
of Income in the current period. Gains or losses on currency contracts used to maintain
the reporting currency value of current assets and current liabilities denominated in
foreign currencies are recognized as incurred in Other (Expense) Income, net on the
Consolidated Statement of Income in the current period.

At October 1, 2005 and October 2,
2004, the Company had outstanding foreign currency forward exchange contracts with gross
U.S. dollar notional equivalent amounts of $99.9 million and $39.1 million, respectively.
At October 1, 2005 and October 2, 2004, the market value of the foreign currency contracts
was $2.1 million and ($0.2) million, respectively. The mark-to-market adjustment on these
contracts is recorded within Other Current Assets on the Consolidated Balance Sheet. The
amount recognized in earnings as a result of the ineffectiveness of cash flow hedges was
immaterial for the periods ended October 1, 2005 and October 2, 2004. At October 1, 2005
and October 2, 2004, the amount projected to be reclassified from Accumulated Other
Comprehensive Income into earnings in the next 12 months was approximately $1.4 million
and ($0.2) million, respectively. The maximum original maturity of any derivative was 2.0
years and 1.75 years at October 1, 2005 and October 2, 2004, respectively.

Income TaxesDeferred tax assets and liabilities
are recognized for the expected future tax consequences attributed to differences between
the financial statement carrying amounts of existing assets and liabilities and their
respective tax basis. Deferred tax assets and liabilities are measured using the enacted
tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to reverse.

# 

Earnings Per ShareBasic net earnings per share is
computed by dividing net income 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. The number of options that has been excluded from
the diluted weighted average shares outstanding calculation was not material for the
period ended October 1, 2005. Options to acquire 0.2 million and 1.4 million weighted
common shares have been excluded from the diluted weighted average shares outstanding
calculation for fiscal years 2004 and 2003, respectively, because the exercise price was
more than the weighted average market value of these shares. The potentially dilutive
effect of common shares issued in connection with outstanding stock options is determined
based on income before discontinued operations and cumulative effect of accounting
changes. A reconciliation of these amounts is as follows:

F-11

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|                                                |                                                 | 
|----------------------------------------------- | ----------------------------------------------- | 
|                                                |                                                
|                                                | (expressed in thousands, except per share data)
|Income before discontinued operations           |                                                 | 
|Income from discontinued operations, net of tax |                                                 | 
|                                                |                                                
|Net income                                      |                                                 | 
|                                                |                                                
|Weighted average common shares outstanding      |                                                 | 
|Dilutive potential common shares                |                                                 | 
|                                                |                                                
|Total dilutive common shares                    |                                                 | 
|                                                |                                                
|Earnings per share:                             |                                                 | 
|Basic:                                          |                                                 | 
|Income before discontinued operations           |                                                 | 
|Income from discontinued operations, net of tax |                                                 | 
|                                                |                                                
|Earnings per share                              |                                                 | 
|                                                |                                                
|Diluted:                                        |                                                 | 
|Income before discontinued operations           |                                                 | 
|Income from discontinued operations, net of tax |                                                 | 
|                                                |                                                
|Earnings per share                              |                                                 | 
|                                                |                                                

Stock-Based CompensationThe Company grants stock options to
officers and key employees at the market price of the Companys stock on the date of
the grant. The Company also maintains an employee stock purchase plan that allows
employees to purchase shares of Company stock at a 15% discount to the lower of the
beginning or ending market price of the shares over defined six month intervals of
participation.

The Company elects to follow
Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock
Issued to Employees, in accounting for its employee stock-based compensation. Under
APB 25, no compensation expense for stock-based compensation is recognized for shares
granted at or above market value. Had the Company determined compensation cost based on
the fair value at the grant date for stock options and the fair value of the discount
related to the employee stock purchase plan under Statement of Financial Accounting
Standards No. 123, Accounting for Stock Based Compensation, the Companys
net income and earnings per share would have been reported as shown below:

|                                           |                                                 | 
|------------------------------------------ | ----------------------------------------------- | 
|                                           |                                                
|Net Income                                 | (expressed in thousands, except per share data)
|As Reported                                |                                                 | 
|Deduct: fair value of employee stock-based |                                                 | 
|compensation expense, net of tax           |                                                 | 
|                                           |                                                
|Pro Forma                                  |                                                 | 
|                                           |                                                
|Basic Earnings Per Share                   |                                                 | 
|As Reported                                |                                                 | 
|Pro Forma                                  |                                                 | 
|                                           |                                                
|Diluted Earnings Per Share                 |                                                 | 
|As Reported                                |                                                 | 
|Pro Forma                                  |                                                 | 
|                                           |                                                

The estimated fair value of employee
stock options granted at market price during fiscal years 2005, 2004, and 2003 averaged
$9.55, $7.94, and $5.60, respectively. The fair value of options granted under stock-based
compensation 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

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and thus allocates proportionately more of the resulting
cost to early vesting periods. In general, the fair value of a grant will increase or
decrease based on certain assumptions summarized as follows:

|                         |  | 
|------------------------ |  | 
|                         | 
|Expected life (in years) |  | 
|Risk-free interest rate  |  | 
|Expected volatility      |  | 
|Dividend yield           |  | 
|                         | 

In the fourth quarter of fiscal year
2005, the Company changed its estimate of stock price volatility used in the Black-Scholes
valuation model from a calculation using a historical daily observation to one using a
historical weekly observation. The Company believes this calculation provides a more
accurate estimate of long-term stock price volatility as the historical average market
trading volume in the Companys stock is low relative to the number of total shares
outstanding, increasing the price impact of trades. This change resulted in a reduction in
estimated stock-based compensation expense of $0.8 million, which will be realized over
the next three years.

Related to the sale of the
Companys engine test business in the fourth quarter of fiscal year 2005, the Company
elected to accelerate the vesting schedule of options held by employees of this business
to the date of the divestiture. As these options were priced below the market value of the
Companys stock on the date of the accelerated vesting, the value of the options was
re-measured to the difference between the market price and the option price of the stock
on the date of re-measurement. Accordingly, related expense of $0.4 million, net of tax,
was recorded in Income (Loss) from Discontinued Operations in the fourth quarter of fiscal
year 2005.

# 

Comprehensive Income
(Loss)Comprehensive Income (Loss), a
component of Shareholders Investment, consists of net income, minimum pension
liability adjustment, unrealized gains or losses on investments classified as
available-for-sale, derivative instrument gains or losses, and foreign currency
translation adjustments. There were no substantive unrealized gains or losses from
available-for-sale securities at October 1, 2005, October 2, 2004, or September 27, 2003.

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The accumulated balances for each
component of Accumulated Other Comprehensive Income (Loss) were as follows:

|                                         |                          |  |  
|---------------------------------------- | ------------------------ |  | -
|                                         |                         
|                                         | (expressed in thousands)
|Balances at September 28, 2002           |                          |  | $
|Foreign exchange translation adjustments |                          |  |  
|Change in unrealized gain                |                          | 
|(loss), net of tax of ($430)             |                          |  |  
|Realized (gain) loss, net of tax of $236 |                          |  |  
|                                         |                         
|Balances at September 27, 2003           |                          |  | $
|                                         |                         
|Foreign exchange translation adjustments |                          |  |  
|Change in unrealized gain                |                          | 
|(loss), net of tax of ($279)             |                          |  |  
|Realized (gain) loss, net of tax of $421 |                          |  |  
|                                         |                         
|Balances at October 2, 2004              |                          |  | $
|                                         |                         
|Foreign exchange translation adjustments |                          |  |  
|Minimum pension liability adjustment,    |                          | 
|net of tax of ($550)                     |                          |  |  
|Change in unrealized gain                |                          | 
|(loss), net of tax of $623               |                          |  |  
|Realized (gain) loss, net of tax of $248 |                          |  |  
|                                         |                         
|Balances at October 1, 2005              |                          |  | $
|                                         |                         

Use of EstimatesThe preparation of financial
statements in accordance with U.S. generally accepted accounting principles requires
management to make estimates and assumptions that affect the reported amounts of assets
and liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and reported amounts of revenue and expense during the reporting
period. Ultimate results could differ from those estimates. Additionally, the Company
frequently undertakes significant technological innovation on certain of its long-term
contracts, involving performance risk that may result in delayed delivery of product
and/or revenue and gross profit variation due to changes in the estimate of the ultimate
costs of these contracts.

# 

Recent Accounting
PronouncementsIn November 2004, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standard (SFAS) No. 151, Inventory Costs, an Amendment of ARB No. 43,
Chapter 4, which clarifies the types of costs that should be expensed in Cost of
Sales rather than capitalized in inventory. This statement also clarifies the
circumstances under which fixed overhead costs associated with operating facilities
involved in inventory processing should be capitalized. The provisions of SFAS 151 are
effective for fiscal years beginning after June 15, 2005. No material impact on the
Companys financial statements is expected from the adoption of this standard.

In December 2004, the FASB issued
SFAS No. 123 (Revised 2004), Share-Based Payment (SFAS 123R). SFAS
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 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

F-14

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exchange for the award. SFAS 123R is effective as of the
beginning of the first annual reporting period that begins after June 15, 2005. The
Company will adopt SFAS 123R in the first quarter of fiscal year 2006. While the Company
cannot precisely determine the impact on net earnings as a result of the adoption of SFAS
123R, estimated compensation expense related to prior periods is included in Note 1 to
these Consolidated Financial Statements. The ultimate amount of compensation expense
recorded will be dependent on the number of option shares granted during the year, their
timing and vesting period, and the method used to calculate the fair value of the awards,
among other factors.

In December 2004, the FASB issued
Staff Position (FSP) No. 109-1, Application of FASB Statement No. 109
(SFAS 109), Accounting for Income Taxes, to the Tax Deduction on Qualified
Production Activities Provided by the American Jobs Creation Act of 2004. FSP 109-1
clarifies that the manufacturers deduction provided for under the American Jobs
Creation Act of 2004 (AJCA) should be accounted for as a special deduction in
accordance with SFAS 109 and not as a tax rate reduction. The FASB also issued Staff
Position No. 109-2, Accounting and Disclosure Guidance for the Foreign Earnings
Repatriation Provision within the American Jobs Creation Act of 2004. The Company is
currently evaluating the potential impact of the various provisions of the AJCA on the
Companys financial statements.

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 154 requires retrospective
application of changes in accounting principles to prior period 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 154 are effective for fiscal years beginning after December
15, 2005.

# 

ReclassificationsCertain amounts included in the prior
year Consolidated Financial Statements have been reclassified to conform to the current
year presentation. These reclassifications had no effect on previously reported
Shareholders Investment or Net Income. During fiscal year 2005, the Company
reclassified its investments in highly liquid municipal securities and corporate preferred
stock from Cash Equivalents to Short-Term Investments. Prior period balances were
reclassified for comparability. This reclassification was based on the securities having a
final maturity date in excess of three months from their date of acquisition.

# 2.   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.

During the second and third quarters
of fiscal year 2003, the Company sold its Automation division, which was based in New Ulm,
Minnesota and also maintained operations in Montgomeryville, Pennsylvania and Freiburg and
Straslund, Germany. On March 31, 2003, the Company sold substantially all of the net
assets and intellectual property associated with the Automation divisions

F-15

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gradient
amplifier product line. On April 11, 2003, the Company sold the remaining net assets of
the North American Automation division, based in New Ulm, Minnesota and on April 30, 2003
sold, to the same buyer, its stock in the Automation divisions German operations,
which completed the sale of the Companys entire Automation division and its exit
from the motor and amplifier business. In March 2003 the Company discontinued the custom
military business of its Automation division. As a result of these sales, the Company
recorded a loss of $1.2 million, net of tax of $0.8 million. The Automation division was
historically included in the Companys Industrial segment for financial reporting,
and its results of operations are reported as discontinued operations.

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
for the respective fiscal years:

|                                                       |                          | 
|------------------------------------------------------ | ------------------------ | 
|                                                       |                         
|                                                       | (expressed in thousands)
|Revenue                                                |                          | 
|(Loss) income on discontinued operations before        |                          | 
|taxes and gain (loss) on sale                          |                          | 
|(Benefit) provision for income taxes                   |                          | 
|                                                       |                         
|(Loss) income from discontinued operations, net of tax |                          | 
|                                                       |                         

The assets and liabilities of the
discontinued operations at October 1, 2005 and October 2, 2004 were as follows:

|                                                             |                         
|------------------------------------------------------------ | ------------------------
|                                                             |                         
|                                                             | (expressed in thousands)
|Accounts receivable, net of allowances for doubtful accounts |                         
|Unbilled accounts receivable                                 |                         
|Inventories                                                  |                         
|Prepaid expenses                                             |                         
|Current deferred tax assets                                  |                         
|Other current assets                                         |                         
|                                                             |                         
|Current assets of discontinued operations                    |                         
|                                                             |                         
|Land                                                         |                         
|Buildings and improvements                                   |                         
|Machinery and equipment                                      |                         
|Accumulated depreciation                                     |                         
|Non-current deferred tax assets                              |                         
|                                                             |                         
|Long-lived assets of discontinued operations                 |                         
|                                                             |                         
|                                                             |                         
|Total assets of discontinued operations                      |                         
|                                                             |                         
|                                                             |                         
|Accounts payable                                             |                         
|Accrued payroll-related costs                                |                         
|Advance payments from customers                              |                         
|Accrued warranty costs                                       |                         
|Accrued income taxes                                         |                         
|Other accrued liabilities                                    |                         
|                                                             |                         
|Total liabilities of discontinued operations                 |                         
|                                                             |                         

F-16

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Table of Contents

# 3.   Business Segment
Information:

The Companys Chief Executive
Officer and its management regularly review the available financial information for the
Companys discrete business units. Based on similarities in 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 hardware and software solutions to the
ground vehicles, aerospace, and infrastructure markets. The Industrial segment
manufactures high-performance position sensors for a variety of industrial and vehicular
applications.

In evaluating each segments
performance, management focuses on income from operations. This financial 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 fiscal years ended October 1, 2005, October 2, 2004, and September 27,
2003, was as follows:

|                              |                          | 
|----------------------------- | ------------------------ | 
|                              |                         
|                              | (expressed in thousands)
|Revenue                       |                          | 
|Test                          |                          | 
|Industrial                    |                          | 
|                              |                         
|Total Revenue                 |                          | 
|                              |                         
|Income from Operations        |                          | 
|Test                          |                          | 
|Industrial                    |                          | 
|                              |                         
|Total Income from Operations  |                          | 
|                              |                         
|Identifiable Assets           |                          | 
|Test                          |                          | 
|Industrial                    |                          | 
|Discontinued Operations       |                          | 
|                              |                         
|Total Assets                  |                          | 
|                              |                         
|Other Segment Data            |                          | 
|Test:                         |                          | 
|Capital expenditures          |                          | 
|Depreciation and amortization |                          | 
|                              |                         
|Industrial:                   |                          | 
|Capital expenditures          |                          | 
|Depreciation and amortization |                          | 
|                              |                         

F-17

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Table of Contents

Geographic information was as
follows:

|                                  |                          | 
|--------------------------------- | ------------------------ | 
|                                  |                         
|                                  | (expressed in thousands)
|Revenue                           |                          | 
|United States                     |                          | 
|Europe                            |                          | 
|Japan                             |                          | 
|Asia, excluding Japan             |                          | 
|Other                             |                          | 
|                                  |                         
|Total Revenue                     |                          | 
|                                  |                         
|Property and Equipment, Net       |                          | 
|United States                     |                          | 
|Europe                            |                          | 
|Asia                              |                          | 
|Other                             |                          | 
|                                  |                         
|Total Property and Equipment, Net |                          | 
|                                  |                         

Revenue by geographic area is
presented based on customer location. No country other than the United States and Japan
had revenue in excess of 15% of the Companys total revenue. No single customer
accounted for 10% or more of the Companys consolidated revenue for any of the
periods presented.

# 4.   Financing:

Information on short-term borrowings
for the years ended October 1, 2005 and October 2, 2004 was as follows:

|                                               |                          | 
|---------------------------------------------- | ------------------------ | 
|                                               |                         
|                                               | (expressed in thousands)
|Balance outstanding at year-end                |                          | 
|Interest rate at year-end                      |                          | 
|Weighted-average interest rate during the year |                          | 
|                                               |                         

Short-term debt consists of
borrowings by the Companys Japanese subsidiaries.

The Company did not renew its $25
million revolving bank credit facility in fiscal year 2005 given liquidity available from
domestic cash equivalents and short-term investments. There were no amounts outstanding on
the revolving credit facility during fiscal year 2005 or fiscal year 2004. The Company was
in compliance with all terms and conditions of the revolving bank credit agreement during
fiscal year 2005 and at October 2, 2004.

At October 1, 2005, the Company had
letters of credit and guarantees outstanding totaling $54.6 million, primarily to bond
advance payments and performance guarantees related to customer contracts in the Test
segment.

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Long-term debt at October 1, 2005 and
October 2, 2004 was as follows:

|                                                                                       |                          | 
|-------------------------------------------------------------------------------------- | ------------------------ | 
|                                                                                       |                         
|                                                                                       | (expressed in thousands)
|6.6% notes, unsecured, due in annual installments of $4,375 beginning in July 2001     |                          | 
|7.5% note, unsecured, due in semi-annual installments of $1,153 beginning in July 2003 |                          | 
|Other                                                                                  |                          | 
|                                                                                       |                         
|Total Long-Term Debt                                                                   |                          | 
|Less Current Maturities of Long-Term Debt                                              |                          | 
|                                                                                       |                         
|Total Long-Term Debt, Less Current Maturities                                          |                          | 
|                                                                                       |                         

Aggregate annual maturities of
long-term debt for the next five fiscal years are as follows:

|     |                         
|---- | ------------------------
|     |                         
|     | (expressed in thousands)
|2006 |                         
|2007 |                         
|2008 |                         
|2009 |                         
|2010 |                         
|     |                         
|     |                         
|     |                         

The 6.6% and 7.5% notes contain
pre-payment penalties that make early repayment economically disadvantageous to the
Company based on current market interest rates. The Company estimates the fair market
value of its long-term debt portfolio exceeds its carrying value by approximately $0.8
million at October 1, 2005, due to lower current market interest rates relative to
interest rates at the time of issuance of the debt.

The Company is subject to financial
covenants, among other restrictions, under the 6.6% and 7.5% notes. At October 1, 2005 and
October 2, 2004, the Company was in compliance with these financial covenants. Under these
covenants the Company is required, among other matters, to maintain certain financial
ratios and to meet certain indebtedness and restricted payment tests. In the first quarter
of fiscal year 2005, the Company reached agreements with the holders of the notes to
reduce the minimum net worth covenant requirements in order to provide the Company with
additional capacity for dividend payments, Company share purchases, or investments.

# 5.   Income Taxes:

The components of income before
income taxes for the fiscal years ended October 1, 2005, October 2, 2004, and September
27, 2003 were as follows:

|                                                        |                          | 
|------------------------------------------------------- | ------------------------ | 
|                                                        |                         
|                                                        | (expressed in thousands)
|Income before income taxes and discontinued operations: |                          | 
|Domestic                                                |                          | 
|Foreign                                                 |                          | 
|                                                        |                         
|Total                                                   |                          | 
|                                                        |                         

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Table of Contents

The provision for income taxes from
continuing operations for the fiscal years ended October 1, 2005, October 2, 2004, and
September 27, 2003 was as follows:

|                             |                          | 
|---------------------------- | ------------------------ | 
|                             |                         
|                             | (expressed in thousands)
|Current provision (benefit): |                          | 
|Federal                      |                          | 
|State                        |                          | 
|Foreign                      |                          | 
|Deferred                     |                          | 
|                             |                         
|Total provision              |                          | 
|                             |                         

A reconciliation from the federal
statutory income tax rate to the Companys effective income tax rate for continuing
operations for the fiscal years ended October 1, 2005, October 2, 2004, and September 27,
2003, is as follows:

|                                                  |  | 
|------------------------------------------------- |  | 
|                                                  | 
|                                                  | 
|Statutory income tax rate                         |  | 
|Tax benefit of export sales                       |  | 
|Foreign provision in excess of U.S. tax rate      |  | 
|State income taxes, net of federal benefit        |  | 
|Research and development tax credits              |  | 
|Foreign tax credits                               |  | 
|Tax exempt income                                 |  | 
|Meals and entertainment and other permanent items |  | 
|                                                  | 
|Effective income tax rate                         |  | 
|                                                  | 

A summary of the deferred tax assets
and liabilities for the fiscal years ended October 1, 2005, October 2, 2004, and
September 27, 2003, is as follows:

|                                                 |                          | 
|------------------------------------------------ | ------------------------ | 
|                                                 |                         
|                                                 | (expressed in thousands)
|Deferred Tax Asset:                              |                          | 
|Accrued compensation and benefits                |                          | 
|Inventory reserves                               |                          | 
|Intangible assets                                |                          | 
|Allowance for doubtful accounts                  |                          | 
|Other assets                                     |                          | 
|Net operating loss carryovers                    |                          | 
|Unrealized derivative instrument losses          |                          | 
|Capital loss carryovers                          |                          | 
|Research and development and foreign tax credits |                          | 
|Less valuation allowance                         |                          | 
|                                                 |                         
|Total Deferred Tax Asset                         |                          | 
|                                                 |                         
|Deferred Tax Liability:                          |                          | 
|Property and equipment                           |                          | 
|Unrealized derivation instrument gains           |                          | 
|Foreign deferred revenue and other               |                          | 
|                                                 |                         
|Total Deferred Tax Liability                     |                          | 
|                                                 |                         
|Net Deferred Tax Asset (Liability)               |                          | 
|                                                 |                         

F-20

---

At October 1, 2005 the Company had research and development credit carryovers
for state purposes of approximately $0.4 million. These credits will expire between the years 2015 and 2018 if not utilized. The
Company also had foreign tax credit carryovers of approximately $0.8 million that, if not used, will expire between the years 2010
and 2014. The Companys French, Swedish and German subsidiaries have net operating loss carryovers of $3.0 million, $0.4
million and $1.2 million, respectively. These losses will not expire under local law.

At October 2, 2004 and September 27,
2003, research and development credit carryovers for federal and state purposes were $1.5
million and $4.8 million, and foreign tax credit carryovers were $1.5 million and $1.2
million, respectively.

As a result of current business
operations, the Company determined during fiscal year 2005 that it would realize the full
benefit of its foreign tax credits. Accordingly, the Company released tax contingencies of
$2.9 million previously recorded. The decrease in the Companys effective tax rate in
fiscal year 2005 from fiscal year 2004 was primarily due to the release of these tax
contingencies.

The Company has assessed its taxable
earnings history and prospective future taxable income. Based on this assessment, the
Company has determined it is more likely than not that its net deferred tax assets will be
realized in future periods. The Company has determined it will utilize its $1.6 million
U.S. capital loss carryover in fiscal year 2005. Accordingly, the Company reversed a $0.6
million valuation allowance related to the U.S. capital loss carryover in fiscal year
2005. Of this adjustment, $0.5 million is recorded within results of discontinued
operations and $0.1 million is recorded within results of continuing operations.

The Company also determined it was
more likely than not that it will be unable to realize the benefit of its German net
operating loss carryovers of approximately $1.2 million. Accordingly, the Company has a
full valuation allowance against the German net operating loss in the amount of $0.5
million, of which $0.1 million is a result of the fiscal year 2005 German net operating
loss.

At September 27, 2003 the Company
determined it was more likely than not that it would be unable to realize the benefit of
its Italian net operating loss carryforward of approximately $0.4 million. Accordingly,
the Company recorded a full valuation allowance against the net operating loss and did not
recognize any benefit associated with that asset. During the year ended October 2, 2004,
the Company determined the net operating loss will be fully utilized and therefore
reversed the valuation allowance. The net change in the valuation allowance was $0.1
million.

According to APB 23, Accounting
for Income Taxes  Special Areas, U.S. income taxes are not provided on
undistributed earnings of international subsidiaries that are permanently reinvested. At
October 1, 2005, undistributed earnings permanently reinvested in international
subsidiaries were approximately $74 million. The Company has not provided for U.S. income
taxes on these earnings. The Company is in the process of analyzing the tax impacts of the
undistributed earnings of its foreign affiliates, including the potential impact of
repatriating the undistributed earnings under the American Jobs Creation Act of 2004. A
decision regarding the repatriation of undistributed earnings is expected to be made by
the end of fiscal year 2006.

In the fiscal years ended October 1,
2005, October 2, 2004, and September 27, 2003, the Company recognized tax benefits of $6.2
million, $2.6 million, and $1.1 million, respectively, related to the Companys
equity compensation plans. These benefits were directly allocated to Equity within
Shareholders Investment on the Consolidated Balance Sheet. Additionally, the
deferred tax asset or liability related to the Companys unrealized gain or loss
associated with derivative instruments is directly allocated to Accumulated Other
Comprehensive Income within Shareholders Investment. Under SFAS 87, Pension
Accounting, the deferred tax asset associated with the Companys German defined
benefit pension plan is also directly allocated to Accumulated Other Comprehensive Income
within Shareholders Investment.

F-21

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# 6.   Stock Plans:

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 fiscal year ended October 1, 2005,
the Company awarded incentive stock options, non-qualified stock options, and restricted
stock grants under these 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 over three years, beginning one year after grant date, and
expire five years from the grant date. A status of the Companys stock plans is
summarized below (in thousands, except per share amounts):

|                                         |  | 2005   |  | 2004   |   | 2003  
|---------------------------------------- |  | ------ |  | ------ | - | ------
|                                        
|                                         |  | Shares |  | WAEP*  |   | Shares
|                                        
|Options outstanding at beginning of year |  |        |  | 2,229  |   | $     
|Granted                                  |  |        |  | 560    |   | $     
|Exercised                                |  |        |  | (1,005 | ) | $     
|Forfeited or expired                     |  |        |  | (98    | ) | $     
|Options outstanding at end of year       |  |        |  | 1,686  |   | $     
|Options subject to exercise at year-end  |  |        |  | 650    |   | $     
|                                        
|*Weighted Average Exercise Price         |  |       

The following summarizes information
concerning stock options outstanding at October 1, 2005 (in thousands, except per share
amounts):

|Range ofExercise Prices |  | Number Outstanding |  | Weighted Average Remaining Contractual Life |  | Weighted Average Exercise Price |      | Number Subject to Exercise |   | Weighted Average Exercise Price
|----------------------- |  | ------------------ |  | ------------------------------------------- |  | ------------------------------- | ---- | -------------------------- | - | -------------------------------
|                       
|$6.37-$13.12            |  |                    |  | 342                                         |  |                                 | 1.31 |                            | $ | 11.30                          
|                       
|$13.12-$21.48           |  |                    |  | 356                                         |  |                                 | 2.69 |                            | $ | 14.81                          
|                       
|$21.48-$33.98           |  |                    |  | 457                                         |  |                                 | 3.66 |                            | $ | 22.52                          
|                       
|$33.98-$35.15           |  |                    |  | 520                                         |  |                                 | 4.76 |                            | $ | 35.15                          
|                       
|$35.15-$40.59           |  |                    |  | 11                                          |  |                                 | 4.88 |                            | $ | 40.58                          
|                       
|Total                   |  |                    |  | 1,686                                       |  |                                 | 3.33 |                            | $ | 22.63                          
|                       

At October 1, 2005, a total of
602,729 shares were available for future grant under the two stock plans.

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 one year subsequent to the
purchase. Two purchase periods closed in fiscal year 2005 with the combined
issuance of 29,379 shares at an average price of $22.85. In fiscal years 2004
and 2003, purchases were 47,095 and 97,202 shares, respectively, with average
share prices of $13.71 and $8.51, respectively. At October 1, 2005, 576,325
shares remained reserved for issuance under the ESPP plan.

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 vest over three years. No
restricted stock grants were awarded in fiscal year 2004.

See Note 1 to the Consolidated
Financial Statements for further information regarding stock-based compensation.

F-22

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Table of Contents

# 7.   Employee Benefit
Plans:

The Company offers a retirement plan
that has two components  a 401(k) component with a Company match and a fiscal year
Company contribution.

The 401(k) component of the
retirement plan allows eligible employees to contribute a portion of their pre-tax income
to the plan each pay period. The Company matches 50% of employees pre-tax
contributions (excluding catch-up contributions that employees age 50 or older
may make to the plan), up to 6% of compensation, subject to limitations imposed by federal
law. The Companys matching contribution was $2.0 million, $1.9 million, and $1.8
million in fiscal years 2005, 2004, and 2003, respectively. Employees may also contribute
a percentage of their salary to the plan on an after-tax basis.

The Company also provides an annual
fiscal year contribution to the retirement plan for eligible employees. Employees who have
been paid for 1,000 hours or more of service during a plan year are eligible for a fiscal
year contribution. After three years as a participant, employees have a vested interest
equal to one-third of the total Company fiscal year contributions. The vested interest
increases each subsequent year by one-third of the total balance, until total vesting is
reached after five years of participation. The plan provides for a minimum fiscal year
contribution of 3% of participant compensation below the Social Security taxable wage base
and 6% of participant compensation in excess of the Social Security taxable wage base, up
to the maximum contribution allowed by federal law. The Companys Board of Directors
approves any changes to the contribution levels under the plan. The Companys fiscal
year contributions under the plan totaled $3.0 million, $2.8 million, and $2.7 million in
fiscal years 2005, 2004, and 2003, respectively.

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 Company uses a
September 30 measurement date for this defined benefit retirement plan.

The cost for the plan included the
following components:

|                                              | 
|--------------------------------------------- | 
|                                             
|(expressed in thousands)                     
|Service cost-benefit earned during the period | 
|Interest cost on projected benefit obligation | 
|Net amortization and deferral                 | 
|                                             
|Net Periodic Retirement Cost                  | 
|                                             

F-23

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Table of Contents

The following summarizes the change
in benefit obligation and the change in plan assets:

|                                                | 
|----------------------------------------------- | 
|                                               
|(expressed in thousands)                       
|Change in benefit obligation:                   | 
|Projected benefit obligation, beginning of year | 
|Service cost                                    | 
|Interest cost                                   | 
|Translation change                              | 
|Actuarial loss (gain)                           | 
|Benefits paid                                   | 
|                                               
|Projected benefit obligation, end of year       | 
|                                               
|Change in plan assets:                          | 
|Fair value of plan assets, beginning of year    | 
|Actual return on plan assets                    | 
|Employer contributions                          | 
|Benefits paid                                   | 
|                                               
|Fair value of plan assets, end of year          | 
|                                               

The funded status of the Companys
defined benefit retirement plan at October 2, 2004 and September 27, 2003 was as follows:

|                                                         | 
|-------------------------------------------------------- | 
|                                                        
|(expressed in thousands)                                
|Funded status                                            | 
|Unrecognized net gain                                    | 
|Unrecognized net liability being amortized               | 
|Required adjustment to recognize minimum liability       | 
|                                                        
|Accrued Pension Liability                                | 
|                                                        
|Major assumptions used in the above calculation include: | 
|Discount rate                                            | 
|Expected rate of increase in future compensation levels  | 
|                                                        

Information regarding the
Companys defined benefit retirement plan at October 1, 2005 and October 2, 2004 was
as follows:

|                               | 
|------------------------------ | 
|                              
|(expressed in thousands)      
|Projected benefit obligation   | 
|Accumulated benefit obligation | 
|Fair value of plan assets      | 
|                              

Statement of Financial Accounting
Standard No. 87, Employers Accounting for Pensions, requires
recognition of an additional minimum pension liability if the fair value of pension plan
assets is less than the accumulated benefit obligation at the end of the plan year. In
fiscal year 2005, the Company recorded a non-cash adjustment to Accumulated Other
Comprehensive Income of $0.9 million, or $1.4 million on a pre-tax basis.

F-24

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Table of Contents

The Company expects to contribute
approximately $0.2 million to its defined benefit retirement plan in fiscal year 2006. The
future pension benefit payments, which reflect expected future service, are as follows:

|Year                     |                   | PensionBenefits
|------------------------ | ----------------- | ---------------
|                        
|(expressed in thousands)
|                         | 2006              |                
|                         | 2007              |                
|                         | 2008              |                
|                         | 2009              |                
|                         | 2010              |                
|                         | 2011 through 2015 |                
|                         |                  
|                         |                   |                
|                         |                  

# 8.   Restructuring and
Other Charges:

In the fourth quarter of fiscal year
2005, the Company decided to exit its noise and vibration software business. 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. Of the total business
exits costs of $4.5 million recorded, $3.6 million, $0.7 million and $0.2 million are
included in Cost of Sales, Selling Expense, and General and Administrative Expense,
respectively, on the Consolidated Statement of Income for fiscal year 2005. These expenses
are reported within the results of operations of the Companys Test segment.
Substantially all of the severance costs will be paid in fiscal year 2006.

In fiscal year 2004 the Company had
no significant restructuring activities. In fiscal year 2003, the Company had no
significant restructuring activities related to business consolidation other than the sale
of its Automation division (see Note 2 to the Consolidated Financial Statements). For the
fiscal years ending October 1, 2005, October 2, 2004, and September 27, 2003 the reserve
for restructuring was as follows:

|Year |  | Beginning
Balance |   | Provision                |  | Write-off |       | Ending
Balance
|---- |  | ----------------- | - | ------------------------ |  | --------- | ----- | --------------
|     |  |                   |   |                          |  |           |       |               
|     |  |                   |   | (expressed in thousands) |  |          
|2003 |  |                   | $ | 21                       |  | $         |      |               
|2004 |  |                   |   |                         |  |           |      |               
|2005 |  |                   |   |                         |  |           | 1,319 |               

# 9.   Commitments and
Contingencies:

Litigation: The Company is a party to
various claims, legal actions, and complaints arising in the ordinary course of business.
In the opinion of management, final resolution of these matters will not have a material
adverse effect on the consolidated financial position or results of operations of the
Company.

F-25

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Table of Contents

Leases: Total lease expense
associated with continuing operations was $4.7 million, $4.9 million, and $5.6 million for
fiscal years 2005, 2004, and 2003, respectively. The Company has non-cancelable operating
lease commitments for equipment, land, and facilities that expire on various dates through
2052. Minimum annual rental commitments for the next five fiscal years and thereafter are
as follows:

|Year       |  |                          |   | Payments
|---------- |  | ------------------------ | - | --------
|           | 
|           |  | (expressed in thousands)
|2006       |  |                          | $ | 3,587   
|2007       |  |                          |   | 3,547   
|2008       |  |                          |   | 2,239   
|2009       |  |                          |   | 810     
|2010       |  |                          |   | 378     
|Thereafter |  |                          |   | 2,799   
|           |  |                         
|           |  |                          | $ | 13,360  
|           |  |                         

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Table of Contents

MTS SYSTEMS
CORPORATION AND SUBSIDIARIES

SCHEDULE II 
SUMMARY OF CONSOLIDATED ALLOWANCES

FOR DOUBTFUL
ACCOUNTS AND RESTRUCTURING RESERVES

FOR THE YEARS ENDED
OCTOBER 1, 2005, OCTOBER 2, 2004,

AND SEPTEMBER 27,
2003

(expressed in thousands)

|                                
|--------------------------------
|                                
|Allowance for Doubtful Accounts:
|                                
|2005                            
|                                
|2004                            
|                                
|2003                            
|                                
|                                
|Restructuring Reserves:         
|                                
|2005                            
|                                
|2004                            
|                                
|2003                            

S-1

---