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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended October 1, 2005

OR

o  TRANSITION 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)

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   No x

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   No x

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   No o

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   No o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):    Yes o   No x

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

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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 8 of 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:

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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:

International Sales Offices:

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 8 of 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:

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:

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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 Availability of 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:

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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:

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

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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 Matters to 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’s Common 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. *

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.

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Purchases of Company Equity Securities:

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.

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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)

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

Item 7.   Management’s Discussion and 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 Year
The 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 Results
Orders 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 Policies
The Consolidated Financial Statements are prepared in accordance with U.S. generally accepted accounting principles, which require the Company to make estimates and assumptions in certain circumstances that affect amounts reported. In preparing these financial statements, management has made its best estimates and judgments of certain amounts, giving due consideration to materiality. The Company believes that of its significant accounting policies, the following are particularly important to the portrayal of the Company’s results of operations and financial position and may require the application of a higher level of judgment by the Company’s management, and as a result are subject to an inherent degree of uncertainty. Further information is provided in Note 1 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 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.

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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

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

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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

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.

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Research and Development Expense

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)

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

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

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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:

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

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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:

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:

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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:

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:

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.

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Item 7A.   Quantitative and Qualitative Disclosures 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:

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,

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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 Statements and 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 and Disagreements 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

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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 Executive Officers 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 of Certain 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 Relationships and 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 Fees and 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.

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PART IV

Item 15.   Exhibits and Financial Statement Schedules

        The following documents are filed as part of this report:

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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.

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:

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MTS Systems Corporation and Subsidiaries

Index to Financial Statements

F-1

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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

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