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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 September 30, 2006

OR

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

For the Transition Period from _____________ to ______________

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 a large accelerated filer, an accelerated filer, or a non-accelerated filer (see definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act) Check One:

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: $761,610,020.

As of December 1, 2006, the registrant had outstanding 18,210,587 shares of Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE: Portions of the Proxy Statement for the Registrant’s Annual Meeting of Shareowners to be held January 30, 2007 are incorporated by reference into Part III of this Form 10-K, to the extent described in such Part.

MTS Systems Corporation

Annual Report on Form 10-K

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PART I

MTS Systems Corporation (the “Company” or “MTS”) is a leading global supplier of mechanical 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 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, 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 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, systems, and consulting services are used to test vehicular safety, noise, vibration, durability, performance, and material characteristics. This represents the largest market 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, sub-systems, and materials.

Infrastructure: This market consists of test laboratories owned and/or operated by industrial, academic, or governmental entities as well as medical device manufacturers. Equipment, systems, 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 material testing products for nano, bio, and electromechanical applications that require a high degree of precision and quality control during research and production. The nanomechanical test products address the needs of highly precise applications within the semiconductor, consumer electronics, and thin films and coatings industries. 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 sensors, sensing systems, and accessories 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, 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, durability, 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 dependable, precise position feedback. MTS has the capability of manufacturing cost-effective 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.

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 control technologies for test and process automation, hydraulic and electric servodrives for precise actuation, application software to tailor a test system to a specific customer need and analyze test results, and sensors for measuring machine and process parameters. 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 2006

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 2006 include the following:

Test:

MTS introduced Release 4.0 of its 793 Controller Software, which supports MAST™ test systems and gives vehicle durability test labs a common control platform for all component, sub-system, and full vehicle testing needs.

MTS introduced AeroPro^™ 5.0, which allows aerospace testing labs with multiple controller platforms to reduce the number of software platforms in use and increase productivity. AeroPro^™ 5.0 enables Aero90^™ users to realize the same benefits of ease-of-use and combined data acquisition and control as AeroST^™ users.

The MTS Bionix® Spine Wear Simulator is the first wear simulator on the market designed specifically for spinal applications. It enables orthopedic device manufacturers to perform highly accurate long-term wear, fatigue and durability simulations on both lumbar and cervical spine disc implants.

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MTS introduced the newest model in the hexapod kinematics family -- the Model 353.20 Multi-Axial Simulation Table (MAST™). The Model 353.20 MAST™ provides the durability and squeak/rattle testing results necessary for automobile manufacturers to meet the demands of today’s consumers.

MTS introduced an affordable, single-ended actuator line to meet customer requirements for low dynamic test solutions. Series 201 actuators provide customers with a robust solution that integrates seamlessly with existing MTS products.

MTS introduced a new model of the SWIFT® Wheel Force Transducer family that will accommodate the requirements of worldwide heavy truck applications, including the larger spindle sizes of European and Asian heavy trucks. The SWIFT® 50 GLP is significantly smaller and lighter than previous designs.

The MTS Tire Rolling Resistance Measurement System platform was redesigned to be more compact while accommodating larger and wider drums. A spindle for commercial truck tires offers over 30% greater radial load capacity than previously available.

The Uni-Axial Seismic Simulator is capable of reproducing seismic events to enable researchers and engineers to design structures to withstand such events. The new Uni-Axial Simulator allows customers to begin seismic testing at an affordable price.

The new dynamic platform balance for the MTS Flat-Trac® 5-Belt Rolling Road system offers higher measurement bandwidth than traditional platform balances used in motorsports and passenger car development.

Industrial:

The Temposonics® G-Series redundant sensor opens new markets for the magnetostrictive technology applications that require system redundancy for safety and reliability. The G-Series sensor is based on MTS’ standard modular structure and provides both sensor element and electronics redundancy. The target markets include power generation and medical applications.

The Temposonics® R-Series EtherCat sensor is an addition to the high-performance product line. It leverages the emerging industrial Ethernet communications trend. The combination of high-speed communication and computing power moves MTS’ technology to a higher level of sensor performance. The target market is high-performance motion control in industrial machines.

The Temposonics® MS sensor is the latest addition to the mobile hydraulics product line. This sensor incorporates miniaturized electronics in order to meet the requirements of the small-diameter cylinders typically used in steer-by-wire applications. Markets include construction machines, agricultural equipment, and other off-highway applications.

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MTS, Flat-Trac, SWIFT, and Temposonics are registered trademarks, and Aero90, AeroPro, AeroST, and MAST 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 45-50% of the Company’s revenue is associated with the ground vehicles market, and approximately 65-70% of the Company’s revenue is from customers outside the United States. 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.

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 three 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, 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.

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 Company offers a mail-order catalog of standard material testing components, accessories, and products. 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 systems 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 locations for the Company is as follows:

Domestic Sales Locations:

International Sales Locations:

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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.

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: MTS makes various export sales that require 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 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 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 backlog, defined as firm orders from customers that remain unfilled, totaled approximately $192 million, $220 million, and $186 million at September 30, 2006, October 1, 2005, and October 2, 2004, respectively. Based on anticipated production schedules and other factors, the Company estimates that approximately $177 million of the backlog at September 30, 2006 will be converted to revenue during fiscal year 2007. 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. While the Company’s backlog is subject to order cancellations, the Company has not historically experienced a significant volume of order cancellations.

Competition

Test Segment: Equipment, systems, 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., Zwick, Inc., Moog Inc., Saginomiya Seisakusho Inc., and Horiba, Ltd. 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.

In lieu of purchasing equipment, systems, or services from MTS or its competitors, customers may in some cases 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 the majority 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.

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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 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 $18.4 million, $14.9 million, and $12.7 million for the fiscal years ended September 30, 2006, October 1, 2005, and October 2, 2004, 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 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 1,510 employees at September 30, 2006, including approximately 446 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, 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 website address is www.mts.com. MTS makes available on its website 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 (“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 website.

Environmental Matters

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

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

Possible significant volatility in backlog and/or quarterly operating results may result from the timing of individual large, fixed-price orders in connection with sales of Test segment systems.

Order volumes and other operating considerations may be directly or indirectly impacted by economic conditions generally and/or in various geographic areas in which the Company operates. The Company derives significant revenue from the global ground vehicles and aerospace industries, and therefore is subject to economic cycles affecting these customers.

Export controls based on U.S. initiatives and foreign policy, as well as import controls imposed by foreign governments, may cause delays in certain shipments or the rejection of orders by the Company. Such delays could create material fluctuations in quarterly operating results and could have a material adverse effect on results of operations. Local political conditions and/or currency restrictions may also affect foreign revenue.

Delays in realization of orders in backlog may occur due to technical difficulties, export licensing approval, or the customer’s preparation of the installation site, any of which can affect the quarterly or annual period when backlog is recognized as revenue and could materially affect the results of any such period.

The Company experiences competition on a worldwide basis. Customers may choose to purchase equipment from the Company or from its competitors. For certain of the Company’s products, customers may contract with testing laboratories or construct their own testing equipment from commercially available components. Factors that may influence a customer’s decision include price, service, and required level of technology.

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

With regard to the Company’s new product developments, there may be uncertainties concerning the expected results. In addition, the Company may not be aware of the introduction of new products or product enhancements by its competitors.

The Company’s short-term investments and borrowings carry floating interest rate risk. The Company has minimal earnings and cash flow exposure due to market risks on its long-term debt obligations as a result of the primarily fixed-rate nature of its debt.

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The Company relies on various raw material, component, and sub-assembly suppliers in its production processes and as such, business interruptions affecting these suppliers may cause delays in the Company’s ability to convert its backlog of unfilled orders to revenue.

None.

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. At the current time, approximately 50% of this facility is used for manufacturing and assembly, while the remainder is used as general office space.

In addition to the Minneapolis, Minnesota facility, the Test segment has four other domestic locations. The Company leases 16,000 square feet in a facility located in Madison Heights, Michigan. The lease agreement for this facility terminates in 2009. The Company leases 15,400 square feet in two facilities located in Oak Ridge, Tennessee. In 2006, the Company entered into a seven-year agreement to lease 97,000 square feet of light industrial space in Chanhassen, Minnesota. The lease for this facility expires in 2013.

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.

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

International Facilities:

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

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

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

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

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

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

The Company considers its current facilities adequate to support its operations during fiscal year 2007.

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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.

No matters were submitted to a vote of stockholders during the fourth quarter of the fiscal year ended September 30, 2006.

PART II

Shares of the Company’s common stock are traded on the NASDAQ Global Select Market^SM 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 1, 2006, there were 1,186 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 dilution from new shares created by employee equity compensation such as stock options, restricted stock awards, and the employee stock purchase plan and as a means of returning excess cash to shareholders. The Company executes all of its purchases of Company shares in accordance with Rule 10b-18 of the Securities Exchange Act of 1934.

During fiscal year 2006, Company share purchases were executed under a 3.0 million share purchase authorization approved by the Company’s Board of Directors and announced on August 25, 2005. 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 2006, the Company increased the quarterly dividend 10%, to $0.11 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 September 30, 2006 and October 1, 2005, the Company was in compliance with all such requirements.

Information regarding the Company’s equity compensation plans required pursuant to Item 201(d) of Regulation S-K is included in Item 12 of this form 10-K, which is incorporated herein by reference.

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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 September 30, 2006, October 1, 2005, and October 2, 2004 and the balance sheet data at September 30, 2006 and October 1, 2005 are derived from the audited Consolidated Financial Statements included elsewhere in this report. The statement of income data for the fiscal years ended September 27, 2003 and September 28, 2002 and the balance sheet data at September 27, 2003 and September 28, 2002 are derived from financial statements of the Company that are not included in this report.

Five-Year Financial Summary

(September 30, 2006, October 1, 2005, October 2, 2004, September 27, 2003, and September 28, 2002)

(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.

MTS Systems Corporation is a leading global supplier of mechanical 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 1,510 employees and revenue of $397 million for the fiscal year ended September 30, 2006.

Fiscal Year

The Company’s fiscal year ends on the Saturday closest to September 30. The fiscal years ended September 30, 2006 and October 1, 2005 consisted of 52 weeks. The fiscal year ended October 2, 2004 consisted of 53 weeks.

Summary of Results

Orders for fiscal year 2006 decreased 6.8%, to $376.9 million, compared to orders of $404.4 million for fiscal year 2005. In fiscal year 2004, orders totaled $387.3 million. The decrease in orders in fiscal year 2006 from fiscal year 2005 is primarily due to a decrease in large custom orders in the Test segment in Europe and Asia, an $8.4 million reduction in volume associated with the noise and vibration business that the Company exited at the end of fiscal year 2005, and an estimated $6.9 million unfavorable impact from currency translation, partially offset by increased volume in the Test segment in North America and continued growth in the Industrial segment. 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 favorable impact from currency translation.

Backlog of undelivered orders at September 30, 2006 decreased 12.7%, to $191.8 million, compared to backlog of $219.7 million at October 1, 2005. Backlog at the end of fiscal year 2004 totaled $186.2 million. The current year decrease in backlog from fiscal year 2005 is primarily attributable to decreased custom order volume in the Test segment.

Revenue of $396.8 million for fiscal year 2006 increased 6.0%, compared to revenue of $374.4 million for fiscal year 2005. Revenue for fiscal year 2004 totaled $338.2 million. The increase in revenue in fiscal year 2006 from fiscal year 2005 was primarily due to higher beginning backlog, increased short-cycle and service business in the Test segment, and continued growth in the Sensors business, partially offset by a $7.7 million reduction in revenue associated with the Company’s exit of the noise and vibration software business and an estimated $9.6 million unfavorable impact of currency translation. The increase in revenue in fiscal year 2005 from fiscal year 2004 was primarily due to higher beginning backlog, increased custom 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.

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Gross profit for fiscal year 2006 increased 5.6%, to $172.7 million, compared to gross profit of $163.6 million for fiscal year 2005. Gross profit for fiscal year 2004 totaled $138.4 million. The increase in gross profit in fiscal year 2006 from fiscal year 2005 was primarily driven by higher volume in both segments and $3.6 million in fiscal year 2005 exit costs associated with the noise and vibration business, partially offset by $1.1 million of stock compensation expense and an estimated $2.3 million unfavorable impact of currency translation. The increase in gross profit in fiscal year 2005 from fiscal year 2004 was primarily driven by higher volume in both segments, favorable product mix and productivity gains in the Test segment, and an estimated $2.1 million favorable impact of currency translation, partially offset by $3.6 million of fiscal year 2005 noise and vibration business exit costs.

Income before income taxes and discontinued operations for fiscal year 2006 increased 13.5%, to $58.8 million, compared to $51.8 million for fiscal year 2005. Income before income taxes and discontinued operations for fiscal year 2004 totaled $43.0 million. The increase in fiscal year 2006 from fiscal year 2005 was primarily driven by higher gross profit in both segments, a $0.9 million gain on sale of assets of the noise and vibration business, and $0.9 million of fiscal 2005 costs associated with the exit of the noise and vibration business, partially offset by planned increases in operating expenses, $4.2 million of stock compensation expense, and an estimated $0.9 million unfavorable impact of currency translation. The increase in income before income taxes and discontinued operations in fiscal year 2005 from fiscal year 2004 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, partially offset by $4.5 million of fiscal year 2005 costs associated with the exit of the Company’s noise and vibration business.

Net income was $39.3 million, or $2.04 per diluted share, for fiscal year 2006, an increase of 5.9% compared to $37.1 million, or $1.81 per diluted share, for fiscal year 2005 and increased from $29.0 million, or $1.35 per diluted share, for fiscal year 2004. The increase in net income in fiscal year 2006 from fiscal year 2005 was primarily driven by higher income before income taxes and discontinued operations, a $2.1 million favorable net impact of foreign currency transaction gains, and $1.7 million favorable net interest, partially offset by increased income tax expense and an estimated $0.9 million unfavorable impact of currency translation. The increase in net income in fiscal year 2005 from fiscal year 2004 was due to increased income before income taxes and discontinued 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.

During fiscal year 2006, the Company purchased approximately 1.8 million shares of its common stock. The reduction in shares outstanding positively impacted the Company’s earnings per share by $0.12 for fiscal year 2006.

Detailed Financial Results

Orders for fiscal year 2006 totaled $376.9 million, a decrease of $27.5 million, or 6.8%, compared to orders of $404.4 million for fiscal year 2005. In fiscal year 2004, orders totaled $387.3 million. The decrease in orders in fiscal year 2006 from fiscal year 2005 was primarily due to a decrease in large custom orders in the Test segment in Europe and Asia, as the Company continues to experience a protracted sales cycle on large custom orders. The decrease in orders in fiscal year 2006 was also due to an $8.4 million reduction in volume associated with the noise and vibration business that the Company exited at the end of fiscal year 2005 and an estimated $6.9 million unfavorable impact from currency translation. These decreases were partially offset by increased volume in the Test segment in North America and continued growth in the Industrial segment, particularly in Europe and Asia. The increase in orders in fiscal year 2005 from fiscal year 2004 was 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.

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Orders for the Test segment totaled $310.7 million for fiscal year 2006, a decrease of $32.2 million, or 9.4%, compared to orders of $342.9 million for fiscal year 2005. Test segment orders for fiscal year 2004 totaled $333.4 million. The Test segment booked 82.4% of total Company orders for fiscal year 2006, compared to 84.8% of total Company orders for fiscal year 2005 and 86.1% for fiscal year 2004. The decrease in orders in fiscal year 2006 from fiscal year 2005 was primarily due to a decrease in large custom orders in Europe and Asia, an $8.4 million reduction in volume associated with the noise and vibration business, and an estimated $5.1 million unfavorable impact of currency translation, partially offset by increased order volume in North America. The increase in orders in fiscal year 2005 from fiscal year 2004 was primarily due to increased volume in Europe and Asia and an estimated $6.4 million favorable impact of currency translation.

Orders for the Industrial segment totaled $66.2 million for fiscal year 2006, an increase of $4.7 million, or 7.6%, compared to orders of $61.5 million for fiscal year 2005. Orders for the Industrial segment in fiscal year 2004 totaled $53.9 million. The Industrial segment booked 17.6% of total Company orders for fiscal year 2006, compared to 15.2% of total Company orders for fiscal year 2005 and 13.9% for fiscal year 2004. The increase in orders in fiscal year 2006 from fiscal year 2005 was primarily due to increased volume in the Sensors business in Europe and Asia, partially offset by an estimated $1.8 million unfavorable impact of currency translation. The increase in orders in fiscal year 2005 from fiscal year 2004 reflects growth in the Sensors business across all geographies and an estimated $1.5 million favorable impact of currency translation.

Orders from customers located in North America totaled $153.9 million during fiscal year 2006, up $23.5 million, or 18.0%, compared to orders of $130.4 million for fiscal year 2005. Orders received in North America during fiscal year 2004 totaled $130.1 million. International orders received during fiscal year 2006 of $223.0 million decreased by $51.0 million, or 18.6%, compared to orders received during fiscal year 2005 of $274.0 million. International orders in fiscal year 2004 totaled $257.2 million.

Backlog of undelivered orders at September 30, 2006 totaled $191.8 million, a decrease of approximately $27.9 million, or 12.7%, compared to backlog of $219.7 million at October 1, 2005. Backlog at the end of fiscal year 2004 totaled $186.2 million. The decrease in backlog in fiscal year 2006 from fiscal year 2005 was primarily due to decreased order volume in the Test segment. The increase in backlog in fiscal year 2005 from fiscal year 2004 was 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 $177 million of the backlog at September 30, 2006 will be converted to revenue during fiscal year 2007.

Revenue for fiscal year 2006 totaled $396.8 million, an increase of $22.4 million, or 6.0%, compared to revenue of $374.4 million for fiscal year 2005. Revenue for fiscal year 2004 totaled $338.2 million. The increase in revenue in fiscal year 2006 from fiscal year 2005 was primarily due to higher beginning backlog, increased short-cycle and service business in the Test segment, and continued growth in the Sensors business, partially offset by a $7.7 million reduction in revenue associated with the noise and vibration business, which the Company exited at the end of fiscal year 2005, and an estimated $9.6 million unfavorable impact of currency translation. The increase in revenue in fiscal year 2005 from fiscal year 2004 was primarily due to higher beginning backlog, increased custom 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.

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Revenue for the Test segment totaled $332.6 million for fiscal year 2006, compared to revenue of $313.5 million for fiscal year 2005 and revenue of $285.9 million for fiscal year 2004. The increase in revenue for fiscal year 2006 was primarily due to increased short-cycle and service business, partially offset by a $7.7 million reduction in revenue associated with the noise and vibration business and an estimated $7.8 million unfavorable impact of currency translation. 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.

Revenue for the Industrial segment totaled $64.2 million for fiscal year 2006, compared to $60.9 million for fiscal year 2005 and $52.3 million for fiscal year 2004. The increase in revenue in fiscal year 2006 from fiscal year 2005 was primarily due to higher order volume in Europe and Asia, partially offset by an estimated $1.8 million unfavorable impact of currency translation. 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.

Revenue of $135.9 million in North America for fiscal year 2006 increased $16.1 million, or 13.4%, compared to revenue of $119.8 million for fiscal year 2005. Revenue in North America for fiscal year 2004 totaled $128.8 million. Revenue in Europe of $142.6 million for fiscal year 2006 increased $8.4 million, or 6.3%, compared to $134.2 million for fiscal year 2005. Revenue in Europe for fiscal year 2004 totaled $110.8 million. Revenue of $117.9 million in Asia for fiscal year 2006 decreased $2.0 million, or 1.7%, compared to $119.9 million for fiscal year 2005. Revenue in Asia for fiscal year 2004 totaled $95.3 million. Other international revenue totaled $0.4 million, $0.5 million, and $3.3 million, respectively, for fiscal years 2006, 2005, and 2004.

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 as a percentage of revenue decreased to 43.5% for fiscal year 2006 from 43.7% for fiscal year 2005. Gross profit as a percentage of revenue was 40.9% for fiscal year 2004. The decrease in gross profit as a percentage of revenue for fiscal year 2006 from fiscal year 2005 was primarily due to product mix, increased manufacturing and engineering costs in the Test business, and a 0.3 percentage point unfavorable impact of $1.1 million of stock compensation expense in the Test segment, partially offset by a 1.0 percentage point favorable impact of $3.6 million in fiscal year 2005 costs associated with the exit of the noise and vibration business, reduced warranty charges, and an estimated 0.6 percentage points favorable impact of currency translation. The increase in gross profit as a percentage of revenue for fiscal year 2005 from fiscal year 2004 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 noise and vibration business, as well as an estimated 0.3 percentage points unfavorable impact of currency translation.

Gross profit as a percentage of revenue for the Test segment was 41.6% for fiscal year 2006, a decrease compared to 42.8% for fiscal year 2005 and an increase compared to 39.4% for fiscal year 2004. The decrease in gross profit rate in fiscal year 2006 was primarily due to unfavorable product mix, increased manufacturing and engineering costs, and a 0.3 percentage point unfavorable impact of $1.1 million of stock compensation expense, partially offset by a 1.1 percentage point favorable impact of $3.6 million in fiscal year 2005 costs associated with the exit of the noise and vibration business, reduced warranty charges, and an estimated 0.5 percentage points favorable impact of currency translation. The increase in gross profit rate for the Test segment in fiscal year 2005 from fiscal year 2004 was primarily due to improved project execution and other productivity gains, partially offset by a 1.1 percentage point unfavorable impact from the noise and vibration business exit costs of $3.6 million, as well as an estimated 0.3 percentage points unfavorable impact of currency translation.

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Gross profit as a percentage of revenue for the Industrial segment was 53.6% for fiscal year 2006, an increase from 48.5% and 49.4% for fiscal years 2005 and 2004, respectively. The gross profit rate increase in fiscal year 2006 was primarily due to increased volume and fiscal year 2005 charges associated with excess and obsolete inventory in the Sensors business that resulted from product line changes made in fiscal year 2005. The decrease in fiscal year 2005 gross profit rate from fiscal year 2004 was primarily due to the fiscal year 2005 excess and obsolete inventory charges in the Sensors business. There was no significant impact on gross profit rate due to currency translation in fiscal years 2006, 2005, or 2004.

Selling, general and administrative (“SG&A”) expense as a percentage of revenue decreased 0.6 percentage points in fiscal year 2006 compared to fiscal year 2005. Selling expense decreased $0.1 million for fiscal year 2006, primarily due to a $4.1 million reduction in selling costs associated with the exited noise and vibration business and an estimated $1.1 million favorable impact of currency translation, partially offset by $2.6 million increased spending on sales and marketing initiatives in the Test segment, $1.4 million increased sales incentives and commissions due to higher revenue in the Industrial segment, and $1.1 million stock-based compensation expense. Selling expense increased in fiscal year 2005 compared to fiscal year 2004 primarily due to $5.0 million of increased sales incentives and commissions, $0.7 million in expense related to noise and vibration business exit costs, and an estimated $1.1 million unfavorable impact of currency translation.

General and administrative expense increased $3.8 million for fiscal year 2006, primarily due to $1.9 million stock-based compensation expense, $1.6 million increased consulting and other professional fees, $1.1 million increased legal expenses, and $0.2 million increased bad debt expense, partially offset by $0.9 reduced expense associated with the exited noise and vibration business and a $0.3 million favorable impact of currency translation. General and administrative expense increased $4.3 million in fiscal year 2005 compared to fiscal year 2004, primarily due to $2.2 million 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.

SG&A expense for the Test segment increased to $79.7 million in fiscal year 2006 from $77.6 million and $67.5 million in fiscal years 2005 and 2004, respectively. The increase in fiscal year 2006 was primarily due to $2.7 million stock-based compensation expense, $2.6 million increased consulting, legal, and other professional fees, and $2.6 million increased sales and marketing initiatives, partially offset by $5.0 million reduced expense associated with the exited noise and vibration business and an estimated $0.9 million favorable impact of currency translation. The SG&A expense increase in fiscal year 2005 compared to fiscal year 2004 was primarily due to increased sales incentives and commissions due to higher orders and revenue, and $0.9 million of noise and vibration 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.

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SG&A expense for the Industrial segment increased to $19.6 million in fiscal year 2006 from $18.1 million and $16.1 million for fiscal years 2005 and 2004, respectively. The increase in SG&A expense in fiscal year 2006 was primarily due to $1.6 million increased staffing and related expenses and $0.3 million stock-based compensation expense, partially offset by an estimated $0.4 million unfavorable impact of currency translation. The increase in SG&A expense in fiscal year 2005 from fiscal year 2004 was primarily due to increased selling expense in the Sensors business, consistent with increased revenue, and an estimated $0.4 million unfavorable impact of currency translation.

Research and development (“R&D”) expense includes expenses for both equipment and software development in the Test and Industrial segments. During fiscal year 2006, approximately 80.0% of the Company’s total R&D spending was in the Test Segment, compared to 79.5% and 76.5% in fiscal years 2005 and 2004, respectively.

R&D expense as a percentage of revenue increased in fiscal year 2006, primarily due to a planned increase in expenditures for new product development in both the Test and Industrial segments, partially offset by a $0.4 million decrease in expense associated with the noise and vibration business. The increase in R&D expense as a percentage of revenue in fiscal year 2005 from fiscal year 2004 was also due to planned investments in new product development in both segments.

Gain on Sale of Assets

Gain on sale of assets of $0.9 million for fiscal year 2006 resulted from the sale of assets of the Company’s noise and vibration business.

Interest expense of $1.7 million for fiscal year 2006 decreased compared to interest expense of $2.1 million and $2.8 million for fiscal years 2005 and 2004, respectively, primarily due to a reduction in long-term debt obligations. Interest income of $3.6 million for fiscal year 2006 increased compared to interest income of $2.3 million and $1.8 million for fiscal years 2005 and 2004, respectively, as increases in global interest rates more than offset declines in the Company’s average balance of cash, cash equivalents, and short-term investments.

Other Income (Expense), net

Other income for fiscal year 2006 was $1.0 million, compared to other expense of $1.4 million and other income of $1.9 million for fiscal years 2005 and 2004, respectively. Other income (expense) for fiscal year 2006 included a gain of $0.8 million related to currency transactions, compared to a loss of $1.3 million for fiscal year 2005, as gains from hedging and the revaluation of monetary assets and liabilities more than offset foreign currency transaction losses related to foreign currency-denominated project and payment settlements. Other income (expense) for fiscal year 2004 primarily consisted of net gains on the settlement of foreign currency transactions.

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Income before income taxes and discontinued operations totaled $58.8 million for fiscal year 2006, compared to $51.8 million for fiscal year 2005. The fiscal year 2006 increase was primarily driven by increased gross profit in both segments, $5.4 million reduced operating expenses associated with the noise and vibration business, a $0.9 million fiscal year 2006 gain on sale of assets of the noise and vibration business, an estimated $2.1 million favorable net impact of foreign currency transaction gains, and $1.7 million favorable net interest. These increases were partially offset by $10.8 million planned increases in operating expenses, $4.2 million of stock compensation expense, and an estimated $1.4 million unfavorable impact of currency translation. Income before income taxes and discontinued operations for fiscal year 2005 increased to $51.8 million, compared to income before income taxes and discontinued operations of $43.0 million for fiscal year 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 noise and vibration business exit costs of $4.5 million.

Income from operations for the Test segment was $44.7 million for fiscal year 2006, essentially flat compared to $44.6 million for fiscal year 2005. Income from operations for fiscal year 2004 was $35.4 million Income from operations for fiscal year 2006 decreased from fiscal year 2005 due to $8.5 million planned increases in operating expenses, $3.8 million stock compensation expense, and an estimated $0.4 million unfavorable impact of currency translation. These decreases were offset by increased gross profit, $5.4 million reduced operating expenses associated with the noise and vibration business, and a $0.9 million gain on sale of assets of the noise and vibration business. 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 noise and vibration business exit costs of $4.5 million.

Income from operations for the Industrial segment increased to $11.1 million for fiscal year 2006, compared to income from operations of $8.4 million for fiscal year 2005. Income from operations for the Industrial segment totaled $6.7 million for fiscal year 2004. The increase in income from operations for fiscal year 2006 compared to fiscal year 2005 is primarily due to increased gross profit resulting from higher volume, partially offset by $0.4 million of stock compensation expense, increased SG&A expense, and an estimated $0.5 million unfavorable impact of currency translation. The increase in income from operations for fiscal year 2005 compared to fiscal year 2004 was primarily due to increased volume, partially offset by increased SG&A expenses.

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, tax-exempt investments, research and development credits, and qualified domestic production activities. The effective tax rate is unfavorably impacted by certain stock option and other non-deductible business expenses. During fiscal year 2006, the Company recognized $1.8 million of favorable tax benefits primarily as a result of the closing of tax audits and the release of contingencies associated with tax matters accrued for in prior years. 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. The fiscal year 2005 tax benefit reflected the Company’s foreign tax credit position, which allows the Company to credit taxes paid offshore against taxes assessed in the United States. These fiscal year 2006 and 2005 tax benefits lowered the effective tax rate compared to fiscal year 2004.

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Fiscal year 2006 income before discontinued operations of $38.9 million, or $2.02 per diluted share, increased from income before discontinued operations of $36.6 million, or $1.79 per diluted share, and income before discontinued operations of $27.2 million, or $1.27 per diluted share, for fiscal years 2005 and 2004, 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 are excluded from the results of operations of the Test segment and are reported as discontinued operations for all fiscal years presented.

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 are excluded from the results of operations of the Industrial segment and are reported as discontinued operations for all fiscal years presented.

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 September 30, 2006 and October 1, 2005 were as follows:

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Accounts receivable of $0.6 million at September 30, 2006 primarily consisted of an amount due from a customer for contract work performed in fiscal year 2005 by the Company’s AeroMet subsidiary. This customer receivable balance was fully reserved as of October 1, 2005, as management deemed the receivable uncollectible. Contract close-out negotiations that occurred throughout fiscal year 2006 resulted in the recovery of this receivable balance. The Company recorded the recovery of this receivable balance in the fourth quarter of fiscal year 2006, which resulted in recognition of $0.6 million of income from discontinued operations, or $0.4 million net of tax.

Cash Flow

Total cash and cash equivalents increased $14.8 million during fiscal year 2006, primarily due to strong earnings, net proceeds from the conversion of short-term investments to cash and cash equivalents, and proceeds from the exercise of stock options, partially offset by increased working capital requirements, repayment of long-term debt, dividend payments, and purchases of the Company’s common stock. 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.

Cash flow provided by operating activities provided cash of $38.2 million during fiscal year 2006, compared to cash provided of $56.4 million and $45.9 million in fiscal years 2005 and 2004, respectively. Fiscal year 2006 cash flow from operating activities was primarily due to strong earnings and a net decrease in deferred tax assets of $2.3 million, partially offset by $11.2 million increased working capital requirements. 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. The decrease in cash provided by operating activities during fiscal year 2006 compared to fiscal year 2005 was primarily due to a $17.2 million increase in working capital requirements and a $7.4 million decrease in tax benefit from the exercise of stock options in fiscal year 2005, partially offset by strong fiscal year 2006 earnings. Effective in fiscal year 2006, the Company is required to report the tax benefit from the exercise of stock options as a financing rather than an operating cash flow activity. 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 a $10.6 million decrease in working capital requirements in fiscal year 2005 versus fiscal year 2004.

Cash flow provided by (used in) investing activities provided cash of $47.5 million during fiscal year 2006, compared to a use of cash of $7.5 million during fiscal year 2005 and cash provided of $16.7 million during fiscal year 2004. During fiscal year 2006, the Company received net proceeds of $53.1 million from the maturity of short-term investments and $1.9 million related to the fiscal year 2005 sale of discontinued businesses and invested $7.5 million in property and equipment additions. During fiscal year 2005, the Company invested $14.3 million in net purchases of short-term investments and $7.1 million in property and equipment additions and received $14.2 million net proceeds 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, $2.0 million from the sale of property and equipment, and invested $5.3 million in property and equipment additions.

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Cash flow used in financing activities required a use of cash of $73.6 million during fiscal year 2006, compared to $30.9 million and $47.7 million used in fiscal years 2005 and 2004, respectively. During fiscal year 2006, the Company’s cash usage primarily resulted from purchases of the Company’s common stock of $64.5 million, net repayment of interest-bearing debt of $8.0 million, and payment of cash dividends of $7.6 million, partially offset by a $1.2 million tax benefit from the exercise of stock options and $5.2 million received from stock option exercises and stock purchases under the Company’s employee stock purchase plan. As previously mentioned, effective in fiscal year 2006, the Company is required to report the tax benefit from the exercise of stock options as a financing rather than an operating cash flow activity. 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 stock option exercises and purchases of stock 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 stock option exercises and purchases of stock under the Company’s employee stock purchase plan.

During fiscal year 2006, the Company purchased 1.8 million shares of its common stock for $64.5 million. During fiscal year 2005, the Company purchased 1.0 million shares of its common stock for $33.7 million. During fiscal year 2004, the Company purchased 2.0 million shares of its common stock for $44.3 million.

Liquidity and Capital Resources

At September 30, 2006, the Company’s capital structure was comprised of $0.2 million in short-term debt, $15.7 million in long-term debt, and $169.3 million in Shareholders’ Investment. Total interest-bearing debt was $15.9 million, down from $24.0 million at October 1, 2005 due to scheduled repayments. Shareholders’ Investment decreased by $19.1 million during fiscal year 2006, primarily due to $64.5 million in purchases of the Company’s common stock, $7.6 million in dividend payments, and $1.0 million in unrealized losses on derivative instruments, partially offset by profitable operating results, $5.2 million received from stock option exercises and stock purchases under the Company’s employee stock purchase plan, $4.7 million in stock-based compensation, $2.9 million of foreign currency translation gains, and $1.7 million tax benefit from the exercise of employee stock options.

The Company had cash, cash equivalents and short-term investments of $122 million at September 30, 2006. Of this amount, approximately $46 million was located in North America, $63 million in Europe, and $13 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, short-term investments, 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 acquisitions.

At September 30, 2006, the Company’s contractual obligations were as follows:

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Short-term debt outstanding at September 30, 2006 and October 1, 2005 consisted of borrowings by the Company’s Japanese subsidiaries. At September 30, 2006, the Company was in compliance with the financial terms and conditions of its long-term debt agreements. Under the terms of its long-term debt agreements, the Company has agreed to certain financial covenants. At September 30, 2006, the Company was in compliance with the financial terms and conditions of its debt and credit facility agreements.

At September 30, 2006, the Company had letters of credit and guarantees outstanding totaling $52.1 million and $18.3 million, respectively, primarily to bond advance payments and performance related to customer contracts in the Test segment. The Company’s operating leases are primarily for office space and automobiles.

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 its subsidiaries. The Company has operational procedures to mitigate these non-functional currency exposures. The Company also utilizes forward and optional foreign currency exchange contracts to exchange currencies at set exchange rates on future dates to offset gains or losses on specifically identified exposures.

Historically, approximately 65-70% of the Company’s revenue derives from shipments to customers outside the U.S., and about 65% of this revenue (approximately 45% of the Company’s t